The dramatic economic developments that erupted in the 1970s presented problems that exceeded in magnitude and complexity any the world had faced since World War II. Indeed, many observers likened the world economy of the 1970s to the severely disabled world economy of the 1930s. For the Fund the implications were profound. The international monetary system for which the Fund was to be the guardian collapsed and a new monetary system started to evolve, with very different international monetary arrangements emerging on a piecemeal basis in the face of turbulent economic conditions. Especially worrisome was that as the decade ended most of the problems were still far from being resolved. Many of the same problems threatened to plague the 1980s.

VIEW AS THE DECADE BEGAN

Few of the developments that shook the world economy to its foundations in the 1970s were foreseen when the decade opened. Public officials and economists recognized, of course, that there were economic problems that were beginning to jeopardize the very high growth rates and the relative stability of prices that had prevailed in the large industrial countries since 1945. The main industrial countries were in the midst of a slump that had begun in 1969 and were beginning to experience more acute inflationary pressures. The United States, in particular, which had had a good record of price stability, was beginning to undergo more rapid inflation, and its balance of payments, which had been in deficit for many years while several European countries and Japan achieved large surpluses, remained in deficit, despite the numerous measures taken during the 1960s by Presidents Kennedy, Johnson, and Nixon. The developing countries, whose economic growth was heavily dependent on exportation, were having a hard time increasing their exports to the economically depressed industrial countries.

But, on the whole, these problems were regarded as temporary. More important, they were believed to be solvable by appropriate government policies. Most economists and public officials had faith that better demand management, through an improved mix of fiscal and monetary policies and an increased emphasis on price stability rather than on full employment, could improve the economic performance of the industrial countries. They had confidence also that improved use of domestic policy instruments could contribute substantially to the elimination of the prolonged imbalance in the balances of payments of the industrial countries. Certainly a realignment of the exchange rates of the major currencies, including a devaluation of the U.S. dollar that was increasingly being advocated in 1970, was expected to help greatly in making the balance of payments adjustment process work satisfactorily again. As far as developing countries were concerned, officials and economists believed that a return to fast economic growth and reduced balance of payments disequilibrium in industrial countries would provide them with adequate export outlets and capital inflow, thus enabling them to maintain, if not increase, their economic growth rates.

Even after the suspension of dollar convertibility by the United States in August 1971—the first big breach in the international monetary system that had occurred since World War II—there remained considerable optimism that the world economy would improve and that the international monetary system could be stabilized and reformed. The successful exchange rate realignment of December 1971 gave rise to euphoria that balance of payments adjustment among industrial countries would come about within a few years and that the United States could again stimulate its own economy, thereby helping also to restore world prosperity, without worrying about the effects of this high level of economic activity on its balance of payments. Actual developments in 1972 seemed to justify this optimism. Economic growth spurted upward again in most industrial countries, unemployment dropped, and by the last quarter of the year, the dollar was showing signs of renewed strength in exchange markets. World trade, widely accepted as the prime factor in the tremendous prosperity of the large industrial countries in the two previous decades, was continuing to grow even more rapidly than before. The Committee of Twenty seemed to be off to an encouraging start in planning a reformed international monetary system. And with increased demand in industrial countries, soaring commodity prices, and a plentiful supply of international credits, developing countries, as a group, achieved an unprecedented overall payments surplus and were even able to accumulate exchange reserves. It is small wonder that as late as the end of 1972 few foresaw the economic disruptions that lay just ahead.

ONSET OF DOUBLE-DIGIT INFLATION AND STAGFLATION

The economic trouble that came to characterize the decade first became acute in late 1972 and early 1973 with the onset of severe worldwide inflation. Thereafter, rates of price increases that were high by historical standards (that is, 10 percent or more a year—“doubledigit inflation”) became common to nearly all industrial countries; much higher price rises were to occur frequently in developing countries. The generation in late 1972 and early 1973 of inflation that was much greater than had been experienced in decades was caused by several factors. The United States financed the Viet Nam war from 1966 to 1972 without the requisite taxation. In 1971–72, industrial countries adopted overly expansive fiscal and monetary policies to overcome the slump that had existed since 1969. These causes were exacerbated by the unusual coincidence of cyclical peaks in all industrial countries in contrast to the previous pattern in which, at any given time, countries were in different phases of the business cycle. These factors, together with crop failures in 1972 and 1973 (especially in the U.S.S.R., which then bought large amounts of grains from the United States) and the commencement of speculative rushes into commodities, which were to characterize the rest of the decade, also pushed up prices of primary commodities. Prices of food grains and of cotton, wool, rubber, and most metals soared in 1972 and 1973 to levels not experienced since the Korean war in the early 1950s.

Once strong inflationary forces were in motion, they were virtually impossible to stop. For one thing, inflationary psychology became deeply embedded. When labor groups and business enterprises, anticipating still further inflation, sought wage and price increases to make up for past and prospective inflation, the cost-push spiral made more inflation an actuality. A second reason why inflation kept going was that public services for education, health, social security, and the like had gradually expanded in most countries since World War II. When the financing of these services became difficult in the 1970s, they could not be cut back without severe social disruptions.

Third, in addition to large jumps in the prices of foodstuffs imported by oil exporting countries, superimposed on continuously rising prices for the manufactured goods which they also imported, the value of the U.S. dollar in terms of other currencies had been declining, following two formal devaluations and further depreciation after the introduction of floating rates in March 1973. The decline of the dollar proved to be a decisive development, since it was used for stating prices for oil and was the currency in which most international transactions were conducted and most reserves held. It was therefore easy for the Organization of Petroleum Exporting Countries (OPEC) to justify sharp boosts in the prices for crude oil. Nevertheless, the sudden quadrupling of these prices announced in October–December 1973 was a powerful shock to the world economy and, by raising costs of production in industrial and developing countries, fanned the fires of inflation even more. With inflation in the world economy at least partly responsible for OPEC’s decisions to raise oil prices, and with oil price rises aggravating inflation further, a circular “no-win” situation seemed to exist at the end of the decade.

Yet another reason for the intractability of inflation was the onset of a previously unknown phenomenon: inflation coexisting with rising unemployment. Joblessness in many industrial countries rose above 5 percent of the labor force, a level that had come to be considered the maximum that was politically tolerable. Inflation existed in a stagnant economy, and the term “stagflation” was coined. Moreover, by the 1970s the traditional macroeconomic policies which governments could institute to stabilize their economies no longer seemed to work. In the past, tighter fiscal and monetary policies could check inflation and slow down the economy, and stimulative policies could reduce unemployment and speed up the economy. Now, stimulating the economy only produced more inflation, not more employment; depressing the economy produced more unemployment, not less inflation.

Government officials and economists could no longer have confidence that “appropriate government policies” would solve either inflation or unemployment. Nor could such policies be relied on any longer to redress balance of payments disequilibrium. So profound was this change and so urgently did economists need explanations and cures for inflation that they increasingly rejected the Keynesian economics that had dominated their thinking since the 1930s and turned to monetarist economics, which became the ascendant doctrine. But by the end of the 1970s, as inflation persisted, monetarism, too, was being questioned. Economists began to think of reducing inflation by basic measures that might change the structure of individual economies—measures that would increase productivity and stimulate investment.

SLUGGISH GROWTH AND ENERGY

Other profound economic changes permeated the 1970s. As economic growth slowed, the pattern of economic and social progress that had continued for almost a quarter of a century broke. After World War II, world production and trade had expanded as never before. In industrial countries, the mass use of the private automobile, extensive road building, the proliferation of suburban housing and shopping centers, and the growth of demand for consumer durable goods of many types had all added to aggregate demand and had made for mild and short business cycles, low unemployment, and a spread of public services. This prosperity in the industrial countries had had a considerable spillover to the developing countries, which had also made impressive economic strides, although markedly less than had industrial countries.

Starting with the 1969–71 slump (except for the temporary boom in 1972 and the first half of 1973), much lower growth rates prevailed. The oil crisis of 1973–74, and the excessively deflationary policies that industrial countries took in response, led in 1974–75 to the deepest international recession in four decades. Despite stimulative policies in several industrial countries, especially in the United States, the pace of subsequent recovery for the industrial countries as a group was so slow that it depressed the levels of employment in all industrial countries and the volume of world trade, including the exports of developing countries. By the end of the decade, it could be argued that it was not the low growth rates of the 1970s that were abnormal but rather the extremely high growth rates of the 1950s and 1960s, which would possibly never be attained again.

Part of the explanation for slower growth was the end of low-cost and abundant energy. Cheap and plentiful supplies of raw materials, especially oil, had greatly assisted the earlier extraordinary growth of the advanced industrial countries; this was no longer true in the 1970s. In 1972 the Club of Rome had warned that shortages of natural resources and the dangers of polluting air and water resources set limits to growth. But it was the prospect of expensive and scarce supplies of oil late in 1973 that caused many economists and public officials to realize that natural resources might, indeed, be finite.

The onset of an energy problem had a number of widespread ramifications. In what might be called the first round of oil price increases—that which followed the quadrupling of oil prices in 1973–74—there was need for financing the unprecedentedly large balance of payments deficits of oil importing countries. The financial intermediation that resulted in a massive recycling of petrodollars from oil exporters to oil importers was amazingly successful. However, there were two notable consequences. First, private commercial banks became a primary source of funds for the world, especially for the oil importing developing countries, and international banking became one of the few growth industries of the times. Second, oil importing developing countries were left with a legacy of tremendous external debt that would be difficult to service, let alone to repay, in the years to come. The creditworthiness of developing countries had been lowered, and the risk to the solvency and liquidity of commercial banks increased. Accordingly, when the second round of oil price increases took place from late in 1978 to the middle of 1979 and the prospect of even more sizable balance of payments deficits, especially for oil importing developing countries, was imminent, it seemed doubtful that private commercial banks could continue to assure a substantial recycling of petrodollars or that a number of developing countries could undertake such further indebtedness.

Beyond these immediate financial implications, in 1979, unlike the situation in 1973–78, was the prospect of actual physical shortages of oil. Hence, those countries dependent on imported oil now had to conserve it and develop alternative energy sources. The 1970s thus ended with many facing the stark realization that standards of living and lifestyles, as well as growth rates and methods of production, might well have to be adapted in the 1980s to fit the new energy realities. At the same time intensive searches for new sources of oil and new energy technology went on.

INTERNATIONAL MONETARY DEVELOPMENTS

Another development was the collapse of the long-standing international monetary system. Following the suspension of dollar convertibility in 1971, the Bretton Woods system, which had been so carefully designed in 1944 and which had functioned smoothly for 25 years, ended once and for all in March 1973 when floating exchange rates for the currencies of most industrial countries, including a floating rate for the U.S. dollar, were introduced. And in 1974, after two years of negotiations, the Committee of Twenty gave up its efforts to plan a reformed system, and the Fund adopted an evolutionary approach to monetary reform.

In place of the orderly system of the 1950s and 1960s, international monetary arrangements from 1973 onward were characterized by floating exchange rates for major currencies. Relatively wide fluctuations in these rates were commonplace, and many government authorities, to different degrees, attempted to “manage” their rates. There was little systematic coordination between their actions and little surveillance by the international community. Disequilibria in countries’ balances of payments were substantially enlarged. Liquidity in the international monetary system, much of it now coming from the private sector as bank lending greatly increased, was larger than ever. There were frequent flights from the U.S. dollar, which, by the end of the decade, took place in response to political events as well as to economic phenomena. The official price of gold was eliminated and there were efforts to demonetize gold. Nevertheless, speculative accumulation of gold was frequent, with prices for gold by 1979 soaring to levels more than ten times the prices at the start of the decade.

Under the Second Amendment of the Articles of Agreement, which became effective on April 1, 1978, Fund members became free to use the exchange rate regime of their choice (with the limitation that their exchange rate practices and policies were subject to surveillance by the Fund). It was clear, too, that members would probably continue to exercise this freedom for some years to come. Despite their disillusionment with floating rates, and the realization that floating exchange rates did not, after all, permit them the autonomy in domestic monetary policy that they had originally expected when floating rates were introduced, monetary authorities saw little alternative except to continue living with the “system” that was evolving.

Not only was the system very different from the original Bretton Woods system but the free and nondiscriminatory trade philosophy on which world prosperity was built after World War II and which was the rationale of international economic organizations also seemed in some jeopardy. Thus, although a new round of trade and tariff negotiations—the Tokyo Round—was successfully concluded, the industrial countries in an environment of slow economic growth and high unemployment began to protect their own industries. Protectionism became a basic issue in world trade, especially as many developing countries increasingly tried to solve their own economic growth, unemployment, and external debt problems by rapidly expanding their exports of manufactures to the industrial countries.

DIFFUSION OF ECONOMIC AND POLITICAL POWER

Perhaps the most dramatic change of all in the 1970s was the diffusion of economic power that took place. By the beginning of the decade, as European countries (especially the Federal Republic of Germany) and Japan had gained greatly in economic power, the United States lost the position it had as the dominant economic nation. Then, as the decade moved on, the newly oil-rich exporting countries quickly developed sizable economic leverage. As several other developing countries, such as Brazil, Mexico, and Korea, became “newly industrialized nations,” and as developing countries generally worked much more in unison than before, industrial countries increasingly had to pay heed to the positions of developing countries and the latter became a greater force in economic circles. As the decade ended, they were pressing their claim for a “New International Economic Order” and for greater transfers of real resources from the rich to the poor countries. Not only were nations to be treated more equally but so were peoples within nations, as redistribution of income and of economic opportunity within countries became more of an objective. In effect, whereas the quarter century from 1945 to 1970 had been “The Age of Growth,” the next quarter century at least as of 1979 seemed to be evolving as “The Age of Equality.”

While the diffusion of economic power made for greater equity, it created a vacuum so far as world leadership was concerned. With the relative decline of U.S. economic power, the lack of sufficient unity among European countries (despite their desires and moves toward economic union), and the unreadiness of developing countries to be “world leaders,” no one country, or even a group of countries, could submerge immediate national interests to the benefit of the world economy as a whole and shape, or suggest, policies that would reconcile conflicting interests. At the same time, finding solutions to the problems was vital to the economic health of nations, and as more economic issues became increasingly political, the political life of national leaders was affected; political leaders began to rise and fall mainly as a result of economic issues, especially inflation. Close cooperation among countries became all the more imperative and many countries with similar interests began to work in groups. Not only did groups such as the European Community, the Organization of Petroleum Exporting Countries, and the Group of Twenty-Four¹ become stronger, but the heads of state and government of the seven largest industrial countries—Canada, France, the Federal Republic of Germany, Japan, Italy, the United Kingdom, and the United States—began to hold periodic meetings at the summit level to try to coordinate their economic policies.

In these forums, as well as through the Fund, international cooperation worked considerably better than might have been expected, given the severity of the prevailing problems. Nevertheless, the euphemism “interdependence” to describe the very close intertwining of the economies of all countries that had gradually come about obscured the fact that policymakers in individual countries (including even the large industrial ones, such as the United States) felt that their ability to exercise autonomy in their monetary or economic policies was limited.

Political leaders felt frustrated, too, by the weakening of governmental authority that developed in the 1970s. Numerous interest groups within countries seemed so divided that political leaders found it difficult, if not impossible, to achieve a consensus even on the policies to be formulated and implemented within their own countries. As disillusionment with government increased, more and more economic decision making was turned over to market forces. But with reduced government authority and with markets in which prices, including exchange rates, were often unstable, the picture that emerged was of a world economy out of control. It was these profound problems in the world economy and in exchange markets that J. de Larosière, the new Managing Director, addressed as he spoke to the Board of Governors at their 1978 Annual Meeting.

In sum, the decade of the 1970s was not just a disturbing period in which severe economic problems surfaced. It marked the end of an era; it was a watershed in economic history. What might be called the old world economic order set up after World War II seemed at an end. The profound problems that had emerged would require structural solutions—which would inevitably come—so that the latter part of the twentieth century was clearly going to be very different from anything that had gone before.