Chapter

Chapter 1 Developments in the World Economy

Author(s):
International Monetary Fund
Published Date:
September 1978
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General Survey

The period since the previous Annual Report—the third year of recovery from the most severe recession in four decades—has been one in which world economic developments were again unsatisfactory in some important respects. World output and trade continued to increase, but the pace of domestic expansion in the industrial world, which had been satisfactory during the first year or so of the recovery period, became slow and uneven, contrary to earlier expectations. The slowdown was general among industrial countries other than the United States. Historically high levels of unemployment persisted—especially in Europe—and the growth of world trade slowed. Despite some easing of inflation in industrial Europe and Japan, unduly high rates of inflation continued to mar the economic performances of many countries, both in the industrial group and (even more so) among the primary producers. Mainly because of marked inequalities in rates of growth and inflation, especially as between the United States and several other large industrial countries, international payments relationships featured a maldistribution of current account balances among major industrial countries and were marked by periods of disturbing instability of exchange markets.

These circumstances presented a number of serious hazards. The combination of slow growth of world trade and high unemployment appeared to be generating increased resort to protectionist actions and danger that these might escalate. The prevailing conditions thus threatened to create an environment unfavorable to the trading interests of all countries. Such an environment could be frustrating to the aspirations of primary producing countries, both developed and developing; the economies of those countries are highly dependent on markets in the industrial world and on the maintenance of access to such markets. For the industrial countries themselves, whose basic problems could only be worsened by protectionism, the slack in aggregate demand meant low capacity utilization, inadequate profits for business enterprises, and weak investment trends, as well as high unemployment. Yet, in the prevailing inflationary environment, the authorities of the industrial countries were fearful of expansionary policies that might revive price pressures of the type that had left the present legacy of cost-push momentum. It is noteworthy that shifts in fiscal positions of industrial countries after 1975 were predominantly contractionary until late 1977, and that monetary policies were also generally restrained or cautious, notwithstanding the sluggishness of demand.

For a considerable number of countries, a further barrier to the use of expansionary policies was—and is—weakness of the external position. Some of the major sources of difficulty in balance of payments management, to be sure, were mitigated during 1976 and 1977. By mid-1978, the concentration of current account surpluses in a small group of major oil exporting countries, for example, had been greatly reduced through the rise in their purchases of foreign goods and services. In general, current account deficits of the non-oil primary producing countries had declined considerably from the alarming levels reached under the combined influence of the 1973-74 oil price increase and the international recession of 1974-75; and financing for the reduced aggregate deficit of those countries was proving more readily available than had been widely feared two or three years earlier. Some of the most serious external payments problems among the industrial countries had also been eliminated or brought under control. However, other serious imbalances within the group of industrial countries had arisen (most notably, through the wide swing of the U.S. current account balance into deficit and the emergence of a large Japanese surplus), and there remained a good many individual countries throughout the world—especially, e.g., in Africa, southern Europe, and parts of Latin America and the Caribbean—whose external adjustment problems were severe.

In these difficult circumstances, delineated more fully in the following two sections of this chapter, the need for an effectively coordinated strategy of policies to restore satisfactory growth and price stability and to improve the functioning of the international adjustment process was becoming progressively clearer. The interdependence of the various national economies is such that the authorities in each of them must take adequate account of conditions and policies in the others when formulating their programs. The gradual evolution of a consensus among international financial officials regarding an appropriate strategy for doing so, in the interests of their common objectives, is outlined in the concluding section of this chapter.

The capacity of the Fund to participate effectively in the solution of international adjustment problems has been enhanced by actions taken—or completed—during the past year. In this context, an important step was the coming into effect on April 1, 1978 of the Second Amendment of the Articles of Agreement. That Amendment has brought about a modernization of the Articles that should improve the operation of the Fund in current conditions and permit its adaptation to future conditions.

The entry into force of the Second Amendment has significance for the evolution of the international monetary system in at least three respects. First, it establishes a legal structure that accommodates the changes in the system that have already taken place, including the adoption by countries of a wide variety of exchange arrangements. Second, it establishes objectives for members of the Fund that will help to determine directions of change in the coming years. For example, the Articles attach importance to fostering orderly economic growth with reasonable price stability as a means of achieving a stable system of exchange rates, and they also express the objective of making the special drawing right the principal reserve asset in the international monetary system. Third, the Second Amendment provides a framework within which practical procedures and policies can be devised to deal with the problems of the international monetary system as it is today. In particular, the Second Amendment made it possible to bring into force the principles and procedures for Fund surveillance over exchange rate policies endorsed by the Interim Committee and approved by the Executive Board in April 1977.

* * * *

Some of the main features of the revised Articles and their implications for the international monetary system are discussed in Chapter 2. The first half of the chapter analyzes the operation of the exchange rate system in the context of the amended Article IV and the Executive Board’s decision on “Surveillance over Exchange Rate Policies.” The factors that have given rise to the increased exchange rate variability since the breakdown of the par value system are analyzed, as are some of the problems associated with that variability. It is observed that, while there has been an undesirable degree of market volatility, the cumulative changes in exchange rates that have occurred over the past two years have generally been in a direction helpful to the adjustment process. With reference to Fund surveillance of exchange rates, it is pointed out that appraisal of exchange rate policy is necessarily a judgmental matter and that a case-by-case approach will be followed.

The second half of Chapter 2, devoted to international liquidity, includes a description of the magnitude and distribution of recent large increases in reserves, and especially of official holdings of foreign exchange. There is also a discussion of the causes of these changes and the mechanisms through which they have occurred, with an emphasis on the highly elastic nature of the supply of reserves resulting from financial intermediation in international capital markets. The adequacy of existing reserves is appraised; the Fund’s role in providing liquidity is explored; and consideration is given to the objective (stated in the amended Articles) of making the SDR the principal reserve asset in the international monetary system.

The coming into effect of the Second Amendment has required reviews of some major aspects of the Fund’s operations and extensive revisions of the By-Laws, Rules and Regulations, and general decisions. A number of these matters are summarized in Chapter 3, which also reports on various other principal developments during the past year with respect to activities of the Fund. Among such developments were the following: quota increases under the Sixth General Review of Quotas (most of which had come into effect by the end of May 1978), together with discussions in the Executive Board and the Interim Committee relating to the Seventh General Review of Quotas; further consideration of the role of the SDR in the monetary system and of its characteristics, giving attention to the question of a further allocation of SDRs to participants, to the method of determining the value of the SDR, to the interest rate on it, and to its wider use; the establishment of a supplementary financing facility (to become effective upon completion of the necessary borrowing agreements) to meet demands for the Fund’s resources from members experiencing payments imbalances that are large in relation to their economies and their Fund quotas; the adoption of a new schedule of charges on currency holdings; the conduct of a continuing series of gold sales by means of public auctions, together with completion of a distribution of gold to members; and a net contraction of Fund credit equivalent to almost SDR 2 billion, stemming from large-scale repurchases made by several industrial and developing countries and from a marked reduction in the amount of balance of payments assistance provided by the Fund (especially for compensatory financing) compared with that of the preceding few years.

Domestic Activity and Policies

Industrial Countries

Output and prices.—The year 1977 was a period of relatively slow and uneven expansion of production in the industrial countries. Following the severe international recession of 1974-75, economic recovery proceeded satisfactorily in its initial phase and real gross national product (GNP) increased by about 5½ percent from 1975 to 1976 (Table 1). The second half of 1976, however, was marked by an unexpected slowdown, and the pickup that followed this worrisome pause proved to be generally weak and short-lived (Chart 1). By the second half of 1977, the European industrial countries had lost virtually all of their previous upward momentum; only the United States, among the larger industrial countries, was achieving a rate of output expansion sufficient to reduce economic slack.

Table 1.Industrial Countries: Changes in Output and Prices, 1962–77(Percentage changes)
Change from Preceding Half Year2
Change from Preceding Year19761977
Annual

Average

1962-721
19731974197519761977First

Half
Second

Half
First

Half
Second

Half
Real GNP
Canada5.57.53.61.35.52.78.90.83.72.5
United States3.95.5−1.4−1.36.04.96.43.55.65.0
Japan10.39.8−1.32.56.05.37.73.27.03.7
France6.05.42.30.15.23.06.52.73.91.6
Germany, Fed. Rep.4.54.90.4−2.55.72.47.63.02.71.2
Italy4.66.94.2−3.55.71.79.14.13.2−3.6
United Kingdom 32.96.5−1.6−1.52.40.84.72.9−0.71.7
Other countries 44.64.73.7−1.93.61.85.12.91.61.2
All industrial countries4.66.10.1−0.95.43.76.73.24.43.2
Of which,
Seven larger countries 54.66.2−0.3−0.75.64.06.93.24.73.5
European countries4.55.51.7−1.84.62.16.53.12.00.8
GNP deflator
Canada3.69.215.310.79.76.99.78.06.36.9
United States3.55.89.69.65.55.54.94.95.75.7
Japan4.911.620.77.46.56.37.37.17.04.1
France4.47.611.612.99.78.89.89.98.19.2
Germany, Fed. Rep.4.06.16.97.13.23.72.63.92.85.3
Italy5.011.918.317.218.318.322.021.120.112.6
United Kingdom 35.27.015.128.214.914.010.214.213.114.7
Other countries 45.27.99.611.86.97.17.27.06.97.4
All industrial countries4.17.311.910.97.26.96.86.96.96.5
Of which,
Seven larger countries 54.07.312.210.87.26.96.76.96.96.4
European countries4.97.711.113.79.08.78.59.28.38.6
Sources: National statistical publications, IMF Data Fund, and Fund staff estimates.

Compound annual rates of change.

Seasonally adjusted changes, at annual rate.

GDP (at market prices).

Includes Austria, Belgium, Denmark, the Netherlands, Norway, Sweden, and Switzerland.

As listed separately above.

Sources: National statistical publications, IMF Data Fund, and Fund staff estimates.

Compound annual rates of change.

Seasonally adjusted changes, at annual rate.

GDP (at market prices).

Includes Austria, Belgium, Denmark, the Netherlands, Norway, Sweden, and Switzerland.

As listed separately above.

Chart 1.Semiannual Changes in Output and Prices in Industrial Countries, First Half 1973-First Half 1978

(Percentage changes in real GNP and GNP deflators from the preceding half year, seasonally adjusted, at annual rates)

1 Include, in addition to the countries shown separately in the chart, Austria, Belgium, Denmark, the Netherlands, Norway, Sweden, and Switzerland.

For 1977 as a whole, real GNP in the industrial countries as a group was only about 3½ percent higher than in 1976. A disproportionate share of this rise was centered in the United States, where output growth amounted to some 5 percent. Among European countries, some of which were restraining aggregate demand for stabilization purposes, the average increase from 1976 to 1977 was only 2 percent; and rates of expansion in Japan (5 percent) and Canada (2½ percent) were also, in each case, well below the estimated medium-term rate of growth in potential output.

According to preliminary and incomplete information, the rate of growth of real GNP in the industrial world for the first half of 1978 was at a pace similar to that of 1977. The latest semiannual advance differed from the ones immediately preceding it chiefly with respect to its geographic composition. Output rose less rapidly in the United States and more rapidly in most of the European countries than in either half of 1977. (See Chart 1.)

Shifts in the net foreign balance on goods and services had a noticeable impact on growth rates in some of the major industrial countries in 1977, as in some of the major industrail countries in 1977, as in 1976, and became a principal source of imbalance in international payments (as discussed later in this chapter). The United States was the only large industrial country in which the growth of domestic demand exceeded that of real GNP in both 1976 and 1977. During each of those years, domestic demand equivalent to about ½ of 1 percent of real GNP was supplied through a deterioration in the foreign balance on goods and services. In Japan, on the other hand, the growth of real GNP was boosted substantially in 1976 and 1977 by an increase in the foreign balance. Japan’s domestic demand rose in real terms by only about 4 percent in each of those years, and the remainder of the rise in current production—which averaged about 5½ percent per annum—was delivered to foreign markets. In the Federal Republic of Germany, the foreign sector also contributed to the overall growth rate in 1976, but that contribution—about ½ of 1 percent of GNP—virtually disappeared in 1977. In the other major industrial countries (Canada, France, Italy, and the United Kingdom), improvements of foreign balances supported growth of output in 1977, although only Italy and the United Kingdom (as a product of their stabilization programs) had a growth of domestic demand below that of real gross product in both 1976 and 1977.

A basic factor in the slow and uneven pace of economic recovery in the industrial world has been the disappointing behavior of private fixed investment. Among the major industrial countries except the United States, the increase in private nonresidential investment from 1976 to 1977 averaged only about 3 percent; and no significant acceleration was apparent in the first half of 1978. In the main, the substantial margins of excess industrial capacity still prevailing in these countries may be expected to continue to exert a discouraging influence on private investment demand for some time to come.

In most of the industrial countries, levels of private fixed investment during 1977 and the first half of 1978 were very low in a medium-term perspective. To an important extent, this weakness of investment demand was a straightforward cyclical phenomenon that would be reversed during an extended period of improved economic performance. However, although evidence bearing on the issue remains ambiguous and uncertain, part of the problem is commonly believed to be more deep-seated. Clearly, there exists a widespread view among public officials and business executives of the industrial countries that the current weakness of investment demand derives at least in part from an impairment of the profit position (and hence of incentives to invest) caused by a variety of adverse structural changes that have added significantly to business costs. Although it is difficult to establish either meaningful methods of measuring profits or standards of reference regarding the incentives they are presumed to furnish, this view appears to have a good deal of validity.

Among the negative factors or uncertainties widely believed to be clouding the outlook for profits are the following: higher inflation and greater instability of domestic price levels, as well as of exchange rates; the large increases during the 1970s in costs of energy, with attendant technological obsolescence; the cost-raising effects of new laws or regulations intended to protect the quality of the environment; a tendency for conflicting claims on the national product to be resolved through accommodation of wage demands; and an apprehension of increased government intervention in wage-price determinations or of further increases in tax burdens. Net effects of these factors are extremely difficult to measure objectively and reliably, but all of them are perceived as causing reductions in the profitability of investment.

Whether or not the share of profits in total income generated by current production has been squeezed in recent years is itself a complex question, in part because of uncertainties relating to the measurement of capital consumption allowances in the calculation of net income, especially during a period of high and variable rates of inflation. However, data available for the seven major industrial countries on ratios of compensation of employees to total value added in manufacturing clearly suggest a squeeze on profits from the middle or late 1960s to the mid-1970s, only partially relieved in more recent years. These ratios tended to rise over the decade ending in 1975, suggesting a distinct decline in the residual (including gross profits before direct taxes) of income shares other than employee compensation. While the ratios of employee compensation to total value added have fallen back since the recession trough in 1975, indicating some substantial degree of cyclical restoration of profit margins, these ratios generally remain higher than they were in the late 1960s, implying a lower share for profits (as the major component of a residual in which they are not adequately distinguishable).

The slack demand conditions resulting from the international recession of 1974-75 and the generally slow pace of the subsequent recovery have been accompanied by a marked reduction of inflation in the industrial countries. The overall rate of price increase in those countries—as measured by a weighted average of GNP deflators—dropped from a peak annual rate of 13½ percent in the second half of 1974 to 7 percent in 1977 and to an annual rate of 6 percent in the first half of 1978. This decline, although representing a substantial improvement, leaves the price situation still unsatisfactory. Inflation rates of the order of magnitude now prevailing in most of the industrial countries—well above the standards of the 1960s and early 1970s—are still much too high to be considered acceptable.

The degree to which this is true varies from country to country. Despite a marked convergence of inflation rates over the past few years, price increases in the first half of 1978 ranged from an annual rate of about 1 percent in Switzerland and 3 percent in the Federal Republic of Germany to 13 percent in Italy. Moreover, recent changes in rates of increase have lacked uniformity, even as to direction. Decelerations in a number of countries have been mixed with accelerations in a few others, among which the U.S. experience is by far the most notable.

In the United States, where demand expansion remained relatively vigorous during 1977, price changes showed a renewed upward tilt in the first half of 1978. In part, this reflected some special influences, such as the effect of severe winter weather on food prices, increases in payroll taxes for employers and in the minimum wage, and the impact of the turn-of-the-year depreciation of the dollar. However, as indicated in the following discussion of labor market conditions, there is also a possibility that demand in the United States may be pressing more closely against capacity than would be suggested by conventional measures of slack in the economy.

With respect to the industrial countries other than the United States, inflation generally continued to subside in the recent period, with the increase in their combined GNP deflator slowing from an annual rate of 8 percent in the first half of 1977 to about 6 percent in the first half of 1978. A considerable part of the change stemmed from a marked deceleration of price increases in the two countries—Italy and the United Kingdom—where they have been the highest, although several other countries also experienced a reduction in rates of inflation. In some instances, currency appreciations—which significantly lowered the national-currency denominated costs of internationally traded goods—were an important contributing factor. Declines in the prices of many primary products, or decelerations in their rates of advance, worked in the same direction, as did declines in rates of wage increase in some countries (e.g., Sweden). Weak demand conditions in markets for both goods and labor were, of course, a pervasive underlying influence.

Utilization of resources.—Three years after the trough of the 1974-75 recession, the industrial countries continue to be burdened by a substantial underutilization of resources, particularly outside the United States. The degree of such underutilization is very difficult to measure accurately, especially during a period such as that of the past few years, when marked changes in both cyclical influences and structural factors of various types have been occurring simultaneously. However, the Fund staff has made estimates of “gaps” between actual and potential output in the manufacturing sectors of the seven largest economies (Chart 2). According to these estimates, the average degree of underutilization for the seven countries as a group was of the order of 10-11 percent in the second half of 1977 (with preliminary data indicating little change in the first half of 1978).1 Such a gap, while noticeably smaller than that prevailing during 1975, has shown no further improvement since the first half of 1976.

Chart 2.Major Industrial Countries: Output Gaps in Manufacturing, 1966-771

(As a percentage of potential output)

1 Difference between actual and potential output.

For the United States, the estimated gap in the second half of 1977 was less than one third of its size in the first half of 1975, and indicated that resource utilization in the manufacturing sector as a whole was only about 5 percent short of potential. For the six largest industrial countries other than the United States, however, the gaps remained large, ranging from about 9 percent (the Federal Republic of Germany) to about 20 percent (Japan), the average being about 15 percent compared with 3 percent over the two decades prior to 1974. It should also be noted that these gap estimates are premised on marked decelerations in the estimated rates of growth of potential output in most of the six countries. For the group as a whole, potential output in manufacturing is estimated to be increasing currently by some 4 percent a year, compared with 6 percent at the beginning of the decade. Much of this deceleration is due to the slower rate of capital accumulation.

The indication of substantial slack in manufacturing capacity is buttressed, at the economy-wide level, by available unemployment data. Reported unemployment in the major industrial countries increased by 2 percent of their combined labor force from 1973 to 1975, and subsequent progress toward reducing it has been disappointing for the group as a whole. Trends in unemployment rates among individual countries, however, have shown significant differences—explicable, for the most part, by reference to cyclical considerations. In the United States, the unemployment rate was reduced from a peak of 9 percent in May 1975 to about 6 percent in the first half of 1978. In most of the other industrial countries, unemployment rates in 1977 were either about the same as or higher than in the recession year 1975, and showed little or no improvement in the first half of 1978.

In comparisons of recent unemployment rates with those prevailing during the 1960s or earlier, interpretation requires allowance for various structural changes in labor markets. A number of such changes have involved primarily the supply side of the market, operating in the first instance through shifts in labor force participation rates. These rates have risen in most industrial countries because of such factors as increasing participation of women and the associated drift toward multiple income-earner families (doubtless accelerated by the downward pressure on real incomes of households arising from the inflation and recession of the middle 1970s); the improved benefits and reduced opprobrium attaching to unemployment, which have tended to raise both unemployment (by decreasing the opportunity costs of being unemployed) and labor force participation (e.g., by inducing persons who would otherwise withdraw from the labor force to remain in it); and job-creating and job-preserving programs recently introduced by many governments (which have had the secondary effect of attracting into the labor force individuals who would not otherwise actively seek employment). These factors, in combination with medium-term and long-term changes in the age-sex composition of the labor force, have altered the relationship between unemployment and job vacancies in most of the major industrial economies, so that a relatively greater “excess” demand for labor (i.e., a larger number of vacancies) appears to be associated with any given unemployment rate today than 10-15 years ago. This means, of course, that a given demand for labor is now accompanied by higher unemployment than formerly, and that proximity to full (noninflationary) utilization of manpower resources must be judged accordingly.

With respect to the United States, for example, a computation that adjusts the “full employment” standard generally used in the late 1950s and early 1960s for just one set of structural factors—i.e., the subsequent changes in the age-sex composition of the labor force—yields an estimate of 4.9 percent for the unemployment rate that would correspond currently to the 4 percent rate formerly associated with “full employment.” Adjustment for some of the other factors mentioned above would indicate a further substantial narrowing of the margin between the present U.S. unemployment rate and one that would imply considerable tightness in the labor market.

The high unemployment rates of the past few years have not resulted from abnormally slow growth of employment. Although differences among countries have been considerable, the average rate of increase in employment for the industrial countries as a group has been quite high—1½ percent per annum since 1975, compared with about 1 percent throughout the 1960s and the early 1970s. Only a marked acceleration of labor force growth since 1975 has prevented these increases in employment from cutting sharply into the average unemployment rate. Generally speaking, the recent faster growth of the labor force has stemmed from rising labor force participation rates (reflecting various structural shifts and other factors, as noted above), rather than from any acceleration in growth of the working-age population.

The pace of recent increases of employment in the industrial countries is perhaps surprising in relation to the corresponding pace of growth in real output, since it has involved a substantial reduction of productivity gains. As measured by real GNP per person employed, the overall gain in productivity for the seven major industrial countries dropped to slightly less than 1½ percent per annum from 1973 to 1977, compared with an average increase of 3¾ percent for the period 1960-73.

In view of the sluggish pace of output growth, the poor record of productivity gains since 1973 can be explained at least in part as a cyclical phenomenon. Employment declined less than output from 1973 to 1975, as is usual during a cyclical downtown, reflecting the natural propensity of employers to limit the various costs associated with the dismissal and hiring of employees; and, except for a characteristic rebound in productivity during the initial cyclical recovery of 1976, subsequent productivity gains have been weak in relation to pre-1973 trends. It remains unclear, however, to what extent this weakness may still be cyclical (reflecting underutilization of already-employed workers) and to what extent it may reflect more enduring changes.

In this context, there seems to be a difference between the United States and most of the other industrial countries. In the case of the United States, there are grounds for presuming that noncyclical factors contributed importantly to the weakening of the productivity trend, although cyclical factors also played a part. During the period since 1975, above-average employment gains were especially pronounced in the United States, where they outpaced the growth of the labor force by a considerable margin and were unusually large in relation to the change in output. It is implausible to suppose that such strong employment gains could have occurred while any substantial redundancy in the employed labor force still prevailed, and it is thus difficult to attribute the weakness of U.S. productivity gains over the past several years primarily to cyclical factors.

In industrial Europe and Japan, there may be greater scope for acceleration of productivity gains if the expansion of demand and output can be stepped up. In the major European industrial countries, the recovery of employment was negligible during 1977 and the first half of 1978, so that even a small increase in growth of the labor force was not absorbed. For these countries, there can be no presumption that most of the underutilization of employed labor that characterized the recession period has been worked off; hence, stronger productivity gains might occur in response to an accelerated expansion of demand.

Stance of policies.2—One reason for the lack of buoyancy in the industrial world during the past two years is to be found in the predominance of contractionary shifts in fiscal positions. (This is illustrated in Chart 3 by reference to estimates on a cyclically adjusted basis prepared by the Fund staff.) A partial reversal of these shifts, however, appeared to be in process in late 1977 and early 1978.

During 1976, most industrial countries withdrew significant portions of the fiscal stimulus that had been injected during the previous year to counter the recession. In that general swing toward less stimulus, the largest shifts occurred in countries that had particularly high rates of inflation (Italy, France, and the United Kingdom).

Chart 3.Major Industrial Countries: Fiscal Developments, 1973-781

(Deficit or change in deficit as a percentage of GNP)

1 The estimates relate only to central government and social security transactions.

2 A positive change is expansionary and a negative change is contractionary.

3 Excluding social security transactions.

Tendencies toward contractionary changes in fiscal positions continued to predominate during 1977, although the pattern that emerged in that year was somewhat mixed. Another characteristic of fiscal policy in the industrial world during 1977 was that it proved, on balance, less stimulative (or more contractionary) than intended by the authorities at the beginning of the year.

Toward the end of 1977 and in the early part of 1978, some shift in the orientation of fiscal policy appears to have taken place. In most of the major industrial countries, more expansionary stances have now been adopted.3

In the United States, the Administration proposed soon after the turn of the year a $25 billion tax-reduction package (effective for the most part on October 1, 1978) that would serve to offset inflation-induced tax increases, as well as the large increases in social security taxes scheduled to start in 1979. Subsequently, the Administration cut the size of the proposed tax reduction in response to renewed difficulty in controlling inflation. At mid-year, the prospect was that the federal fiscal position on a cyclically adjusted basis would be little changed in 1978 (compared with 1977), and that on current plans there would again be little change in 1979.

In the Federal Republic of Germany, the fiscal program being followed during the first half of 1978 would imply for the full year an expansionary impulse equivalent to ½ of 1 percent of GNP for the central government alone and 1 percent for the government sector as a whole (including the Lander and municipalities). In Japan, the cyclically adjusted deficit of the central government is expected to increase from 1977 to 1978 by 1½ percent of GNP and that of the entire general government sector by more than 2 percent. Larger shifts in fiscal policy, also in the direction of relaxation, are being undertaken by Italy and the United Kingdom. In a number of the industrial countries, the actual size of the budget deficit (Chart 3) has been an independent source of concern to the authorities.

Monetary policies in the major industrial countries, like fiscal policies, were generally restrained or cautious during 1976, and this posture was carried over into 1977. Where targets for the expansion of monetary aggregates were announced, as in the United States, the United Kingdom, the Federal Republic of Germany, France, and Canada, they typically implied an extension of somewhat smaller increases in these aggregates than in the projected nominal value of GNP, so as to maintain or induce (in the absence of substantial unexpected changes in velocity) some downward pressure on rates of increase in prices.

During the course of 1977, however, as the pace of activity outside the United States faltered, the situation changed; monetary conditions became easier and policies more accommodative than had been envisaged at the start of the year. In nearly all of the larger industrial countries, monetary aggregates increased more rapidly in the second half of 1977 than in the first, despite the concurrent slowing of advances in nominal GNP. Reflecting this combination of accelerated monetary expansion and weakness of credit demands, interest rates receded everywhere except in the United States. (See Chart 4.)

Chart 4.Major Industrial Countries: Short-Term Interest Rates, 1975-June 19781

(In percent per annum)

1 The rates shown are monthly averages of daily rates on money market instruments of about 90 days’ maturity (the call money rate for Japan).

The general easing of monetary conditions in 1977 varied considerably among countries, however. In Canada, France, and Italy, monetary policies remained, on the whole, cautious, whereas they were relaxed in the Federal Republic of Germany and Japan in view of the strong external positions and relatively low rates of inflation in those countries. German interest rates, already among the lowest in the industrial world, declined during the last three quarters of 1977; and German monetary expansion, after being kept within narrow limits until about mid-1977, proceeded at a rate in the second half of the year well above the Bundesbank’s target. In Japan, the discount rate was reduced progressively from 6½ percent to 3½ percent, and the window-guidance credit ceilings were substantially eased. Increases in net foreign assets hampered domestic monetary management in the Federal Republic of Germany and were particularly troublesome in the case of the United Kingdom, where, in the face of heavy demand for sterling, an effort was made to maintain exchange rate stability and to safeguard the position of those sectors of the economy that are vulnerable to international competition. Official sales of sterling led to large declines in interest rates, and fears developed toward the end of 1977 that, if such sales continued, the inflows of funds would threaten the Government’s money supply policy. As in the Federal Republic of Germany and the United Kingdom, rates of monetary expansion in the United States exceeded the target ranges, but the U.S. “overrun” occurred in tandem with sharply rising interest rates.

Contrasting monetary trends continued to characterize the situation among major industrial countries in the first half of 1978. In Japan, relaxation of credit conditions continued, facilitated by further reductions in the rediscount rate, deposit rates, and lending rates in March. In the Federal Republic of Germany, although the Bundesbank set a target rate of increase in central bank money for 1978 (over 1977) equivalent to the original target for 1977 (8 percent), another overrun of the new target rate during the first several months of 1978 was accompanied by continuing declines in long-term interest rates and by short-term rates below those of late 1977. In the United States, on the other hand, both short-term and long-term rates showed substantial further increases during the first six months of 1978. Yields on Canadian financial assets moved upward in broadly parallel fashion. French monetary conditions remained rather firm through the first quarter of 1978, but eased appreciably in the second quarter. In the United Kingdom, interest rates turned upward toward the end of the first quarter and rose more strongly in the second as action was taken by the authorities to arrest an excessive rise in the money supply and to counter a waning of confidence in sterling. In Italy, interest rates were stabilized in the first half of 1978 after falling fairly steadily during the latter part of 1977.

In most of the smaller industrial countries, economic policymaking during 1977 was focused increasingly on their external positions, which were adversely affected—along with domestic employment—by low export growth in a world trade environment of unexpectedly weak demand from major trading partners. The majority of these countries were deeply concerned about inflation and unemployment, and some of them faced difficult conflicts between domestic objectives and deteriorating external positions, leading them to make major exchange rate adjustments. In early 1978, the cautious policies pursued by the smaller industrial countries appeared to be restraining inflation and/or bringing about some improvement in external payments, accompanied by continued sluggishness of domestic demand.

Within the constraint imposed by the need to avoid exacerbating the external position, and by the prevalence of public sector deficits that were already large, fiscal policies of the smaller industrial countries in the first half of 1978 were aimed primarily at the problem of alleviating the unemployment situation. Monetary policies remained tied mainly to external considerations, their primary function being either to maintain the exchange rate vis-à-vis currencies of major trading partners or to ensure—in conjunction with official borrowing in some instances—a capital inflow sufficient to finance the current account deficit.

Given the difficult choices between pursuit of external adjustment and domestic employment objectives, the smaller industrial countries except Switzerland have resorted to some form of incomes policy. The emphasis placed on such policy, however, differs considerably among countries. In Denmark, a restrictive incomes policy is crucial to the external adjustment efforts. In Sweden, which resorted to devaluation, the unions—recognizing the importance of the Government’s strategy to improve the country’s competitive position—have agreed to modest contractual wage increases over a 21-month period extending through October 1979. In Austria, Belgium, and the Netherlands, where the close link of the currencies to the deutsche mark appears to have contributed considerably to the containment of domestic price pressures, the role of incomes policy may be characterized as supportive of fiscal and monetary policies.

Primary Producing Countries

Information on the current economic situation in many of the primary producing countries is much less complete than that available for the industrial world. Moreover, it is less susceptible to meaningful aggregation or averaging, because of the large number and diversity of the countries classified as primary producers. Nevertheless, some observations with respect to major features of recent domestic developments in this group of countries may be offered on the basis of the estimates of output and prices summarized in Table 2.

Table 2.Primary Producing Countries: Changes in Output and Prices, 1967-77(Percentage changes)
Annual

Average
Change from Preceding Year
1967-72 119731974197519761977
Real GDP
Major oil exporting countries 29.010.78.00.112.96.3
More developed primary producing countries6.16.44.42.03.12.7
Europe 36.57.34.92.43.73.3
Australia, New Zealand, South Africa5.14.63.41.22.11.4
Non-oil developing countries 46.17.35.34.14.84.9
Africa5.02.25.62.34.22.2
Asia4.87.92.76.15.86.4
Latin America and the Caribbean6.88.17.72.64.54.3
Middle East8.84.8−1.08.42.16.7
Consumer prices
Major oil exporting countries 28.011.317.019.016.215.0
More developed primary producing countries6.011.816.716.915.117.8
Europe 36.813.518.618.216.120.8
Australia, New Zealand, South Africa4.69.313.614.613.312.2
Non-oil developing countries 4,5−10.122.133.032.932.331.5
Africa4.89.318.616.418.825.0
Asia5.414.927.811.51.58.8
Latin America and the Caribbean 515.930.840.954.662.751.6
Middle East4.312.721.820.317.424.2

Compound annual rates of change.

Comprise Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Oman, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela.

Comprise Finland, Greece, Iceland, Ireland, Malta, Portugal, Romania, Spain, Turkey, and Yugoslavia.

Include all Fund members not mentioned above, or in Table 1, plus certain essentially autonomous dependent territories (Hong Kong and the Netherlands Antilles) for which adequate statistics are available. The regional subgroups correspond to the groupings shown in International Financial Statistics.

Excluding Argentina, Chile, and Uruguay, the figures for non-oil developing countries in the last four columns would be 25 percent, 17 percent, 16 percent, and 22 percent, respectively; with a similar exclusion, the Latin America and Caribbean figures in the same columns would be 25 percent, 22 percent, 28 percent, and 34 percent, respectively.

Compound annual rates of change.

Comprise Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Oman, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela.

Comprise Finland, Greece, Iceland, Ireland, Malta, Portugal, Romania, Spain, Turkey, and Yugoslavia.

Include all Fund members not mentioned above, or in Table 1, plus certain essentially autonomous dependent territories (Hong Kong and the Netherlands Antilles) for which adequate statistics are available. The regional subgroups correspond to the groupings shown in International Financial Statistics.

Excluding Argentina, Chile, and Uruguay, the figures for non-oil developing countries in the last four columns would be 25 percent, 17 percent, 16 percent, and 22 percent, respectively; with a similar exclusion, the Latin America and Caribbean figures in the same columns would be 25 percent, 22 percent, 28 percent, and 34 percent, respectively.

Non-oil developing countries.—During the past several years, the average rate of growth in output has been relatively well sustained in the non-oil developing countries as a group. It dipped only to about 4 percent in 1975 and approached 5 percent both in 1976 and in 1977. That pace—which is expected to be roughly maintained in 1978—was 2 percentage points below the peak rate of 1973 and more than 1 percentage point short of the average achieved during the period 1967-72, under reasonably balanced cyclical conditions in the industrial countries (i.e., the main trading partners).

Such a shortfall has meant, of course, a relatively sizable cut in per capita gains in real income. This reduction has been compounded by the adverse cumulative shift in the terms of trade of the non-oil developing countries that has occurred (with short-term swings in both directions) since the late 1960s. In these circumstances, which have tightened the squeeze on national saving, it has been difficult for many of the developing countries to maintain earlier rates of expansion of investment, even with the aid of enlarged inflows of foreign resources. Nevertheless, it would appear that growth and investment have been remarkably well sustained in the face of the extended weakness of demand in major industrial centers. Factors contributing to this result have included the expansion of exports (especially from countries with relatively dynamic manufacturing sectors), increased agricultural output, and financial support provided directly or indirectly through the surpluses of the oil exporting countries.

Growth of real gross domestic product (GDP) has been particularly notable in the Asian countries, where in each of the past three years it actually exceeded the average for the period 1967-72. The achievement of such a relatively favorable result, while assisted by more favorable agricultural conditions on the Indian subcontinent, was attributable in no small measure to pursuit of prudent economic policies by a number of Asian countries in adjustment to the upsurge of export earnings and import prices in 1973 and 1974.

In developing areas outside Asia, however, rates of output expansion in 1977 lagged behind the 1967-72 averages. Shortfalls from their respective averages for 1967-72 were especially marked in Africa and in the Latin American and Caribbean area, where the gaps were of the order of 2-3 percentage points. Growth of output in Latin America and the Caribbean was maintained at about 4½ percent in 1977 despite the lack of buoyancy in world markets and a sharp slowdown (from 9 percent in 1976 to 5 percent in 1977) in Brazil, whose economy is by far the largest in the area; improved growth rates were recorded in most of the other countries. Among the African non-oil countries, economic performance in 1977 continued to be strongly affected by weak demand conditions in the main industrial markets for their primary export commodities, by weather conditions, and in some cases by political strife and border and port closures. The average of these countries’ estimated rates of output growth in 1977, at just over 2 percent (compared with about 4 percent in 1976), was lowest among the major regional groups listed in Table 2. However, a number of African countries are pressing ahead with public sector investments intended to promote larger GDP increases in 1978, and some improvement in agricultural production seems likely to contribute to attainment of that goal.

In the Middle Eastern area, the average growth rate for the non-oil countries in 1977 was nearly 2 percentage points higher than the average for all non-oil developing countries, even though the larger economies in the area were subject to constraints stemming from efforts to deal with inflationary pressures and from burdensome obligations of external debt servicing. In the recent past, certain of the countries confronted with such difficulties have taken steps toward price stabilization and maintenance of realistic exchange rates, and these steps should contribute to a still better growth performance in 1978.

With respect to domestic prices, the record of the non-oil developing countries in recent years has been one of relatively high rates of increase. As measured by consumer price indices, the average rate of inflation in these countries rose to some 33 percent in 1974 and remained above 30 percent in every subsequent year through 1977. In considerable part, the maintenance of such a high average after 1974 reflected the extraordinary rates of inflation prevailing in several South American countries; exclusive of those countries, the average rate dropped from about 25 percent in 1974 to 16-17 percent in 1975 and 1976. However, inflation accelerated again in 1977, when the average rise in consumer prices (with the same exclusion of countries having highly atypical rates of inflation) again exceeded 20 percent.

This faster price increase in 1977, like the subsidence of inflation from 1974 to 1976, was a widespread development. Of the 88 non-oil developing countries for which consumer price indices are available, 51 showed higher rates of increase in 1977 than in 1976, while only 23 showed lower rates and 14 remained approximately unchanged. This record contrasted sharply with the two intervening years of predominantly decelerating inflation.

The causes of the recent acceleration of inflation in the non-oil developing countries were doubtless multiple and complex in detail. Nevertheless, some widely prevalent influences can be identified. Important among these were the immediately preceding buoyancy of export earnings (stemming mainly from an increase in primary commodity prices), rising costs of imports, and rates of monetary expansion out of line with the pace of advances in real economic activity (partly, in some cases, because of the impact of the surge in foreign exchange receipts on domestic bank liquidity).

By early 1978, a reversal or slackening of the main factors behind the 1977 flare-up of inflation appeared to be in process. Prices of primary commodities had declined from their peak reached about the middle of 1977, and the decline was affecting the growth of export earnings of the non-oil developing countries. This development, combined with the tendency of an increasing volume of imports to absorb domestic demand pressures, was exerting a dampening effect on domestic price movements. At the same time, the numerous stabilization programs being implemented by the authorities of developing countries were helping to dissipate inflationary pressures generated by the 1976-77 bulge in primary commodity prices and export earnings. In a number of countries, deceleration of growth in the monetary base because of a deterioration of the external payments balance and a marked slowdown in net acquisitions of foreign assets by the monetary authorities limited the need for other actions to implement a more restrained monetary policy. Nevertheless, inflation continues at high rates in many of the non-oil developing countries, constituting a hazard to economic management.

More developed countries.—Since the 1974-75 recession, recovery of activity in the more developed group of primary producing countries has been markedly slower on average than in either the industrial countries or the non-oil developing countries. Total output in this group (Table 2) rose by only 3 percent annually in 1976 and 1977—half the prerecession rate—and developments in the early months of 1978 suggested an even slower rise.

The inflation record in recent years has also been disappointing. From 1974 to 1976, only a slight deceleration of consumer price increases was achieved, and in 1977 the average rate for the group as a whole went up to 18 percent—a little higher than in 1974 and three times the pre-1973 average (Table 2). With only one exception, 1977 rates of inflation in this group of countries were in double digits, and in four of them the rate ranged upward from 25 percent. For 1978, however, some reduction in the average rate of consumer price increases is presaged by the introduction of new stabilization programs in several of the countries.

The persistence of inflation has been a principal factor behind the poor average growth record of the more developed primary producing countries in recent years. To combat it, restrictive fiscal and monetary policies have been necessary; and these have curbed demand and contributed to the slowing of economic expansion in a number of cases. Another important reason for the restrictive policy measures and the slow growth—and one closely interrelated with the high rate of inflation—has been the prevailing weakness in the external accounts of many countries in this group (discussed in a later section). The external weakness has resulted not only from the effects of domestic inflation upon trade balances but also from four years of deterioration in the terms of trade since 1973 and from the difficult trading environment of this period.

Although nearly all of the more developed primary producers continue to experience higher inflation and lower growth rates than they did 5-10 years ago, those countries which were first to adopt stabilization programs have been in relatively favorable positions in charting their courses for 1978. In contrast, the countries that earlier opted to postpone adjustment—through increased reliance on foreign financing—are now facing still slower growth in 1978, under the burden of deflationary measures adopted in recent months.

Countries in the first group—including Australia, New Zealand, South Africa, and Finland—tightened their fiscal and monetary policies during late 1975 and early 1976 in response to deteriorating current account balances and an upsurge in inflation, and they also supported these policies through the implementation of incomes policies. Because of both shifts in policy stance and unfavorable external conditions, growth of output has been low in these four countries and unemployment has increased sharply. In the first half of 1978, the rate of inflation decelerated considerably, although improvement of growth in output was not yet apparent.

Countries of the second group—mainly in southern Europe—experienced very high rates of inflation in 1977 and face decelerating rates of output growth in 1978 during the process of adjustment. Outside either group are Greece, Ireland, and Yugoslavia, which have inflation rates below the average for more developed primary producers, are enjoying relatively satisfactory growth rates, and have been relatively free of balance of payments constraints (although Yugoslavia’s current account balance deteriorated in 1977).

Major oil exporting countries.—Following the sharp rise in oil prices four years ago, the oil exporting countries have undergone several changes in policy orientation. They first adopted highly expansionary fiscal and monetary policies in an attempt to achieve rapid development of their economies, but then found it necessary during late 1975 and 1976 to shift these policies toward restraint in order to reduce demand pressures and combat inflation. At the same time, several countries undertook a variety of measures—including expansion of port capacity—to improve the supply of goods and services.

Through mid-1978, the demand management policies of the oil exporting countries remained generally cautious. However, the policies of individual countries have become more diverse, reflecting the considerable differences in their economic positions, particularly as to the balance of payments, and in their policy objectives. In some of the more highly absorptive countries, policies are being aimed at restraining demand pressures, not only in order to reduce inflation or maintain domestic financial stability but also to contain mounting current account and overall balance of payments deficits. The current account positions of four of the seven countries in this subgroup had moved into deficit by 1977 and substantially higher deficits are expected for 1978.

As a result of the tightening of financial policies and efforts on the supply side, inflationary pressures started to abate in 1976. Reflecting also smaller increases in import prices, the average rise in consumer prices declined from 19 percent in 1975 to about 15 percent in 1977. In the countries characterized by limited absorptive capacity in relation to their current export earnings (Saudi Arabia, Kuwait, the United Arab Emirates, Qatar, and the Socialist People’s Libyan Arab Jamahiriya), the decline in the average rate of inflation was substantially sharper in 1977—from 22 percent in 1976 to 11 percent. The overall inflation rate of the oil exporting countries declined further in the first half of 1978.

Changes in total output of the major oil exporting countries in recent years have been influenced to a large extent by movements in output of crude oil, which now accounts for about two fifths of total GDP. Because of the recovery of such output from the depressed level of 1975, real GDP rose by about 13 percent in 1976, following a negligible increase in 1975. (See Table 2.) With only a small increase in oil production in 1977, the rate of growth in real GDP is estimated to have declined to about 6 percent. It fell further in the first half of 1978 as oil output declined substantially.

The rate of expansion in the non-oil sectors of the exporting countries has been rapid in recent years. However, the annual rate of growth of their total non-oil GDP in real terms declined from an average of over 12 percent in 1974-76 to about 10 percent in 1977 because of the prevalence of tighter demand management policies as well as other factors. The slowdown was concentrated in the Middle Eastern oil exporting countries.

International Trade and Payments

An Overview

One of the serious consequences of the faltering pace of recovery from the international recession has been a disappointing growth in the volume of world trade in 1977 and the first half of 1978. The 1976-77 increase in total world trade was only 5 percent in real terms, compared with 12 percent in the previous year and an average of some 9 percent over the decade ending in 1972. (See Table 3 and Chart 5.)

Table 3.World Trade Summary, 1962-77 1(Percentage changes in volume and in unit value of foreign trade)
Annual

Average
Change from Preceding Year
1962-72 219731974197519761977
World trade 3Volume913−5125
Unit value (U.S. dollar terms)23½40½99
(SDR terms) 4212½39½87
Volume of tradeImportsIndustrial countries12½−7½14½5
Other developed countries16½−7
Major oil exporters921½37½43½1913
Other developing countries14−6½45
ExportsIndustrial countries9148−4½10½
Other developed countries8321127
Major oil exporters912½−1−11½14
Other developing countries85113½
Unit value of tradeImportsIndustrial countries211½396
in SDR terms 4Other developed countries210½41½6
Major oil exporters211281077
Other developing countries212½48½1087
ExportsIndustrial countries2923½11
Other developed countries223245
Major oil exporters327½2044128
Other developing countries2436½−413½10
Sources: National economic reports, IMF Data Fund, and Fund staff estimates.

For classification of countries in groupings shown here, see Tables 1 and 2.

Compound annual rates of change.

Sum of the groupings shown separately; based on approximate averages of growth rates for world exports and world imports.

For years prior to 1970, an imputed value of US$1.00 has been assigned to the SDR.

Sources: National economic reports, IMF Data Fund, and Fund staff estimates.

For classification of countries in groupings shown here, see Tables 1 and 2.

Compound annual rates of change.

Sum of the groupings shown separately; based on approximate averages of growth rates for world exports and world imports.

For years prior to 1970, an imputed value of US$1.00 has been assigned to the SDR.

Chart 5.World Trade, 1960-771

(Annual percentage changes)

1 Based on averages for world exports and world imports.

2 Compound annual rates of change.

One identifiable factor in the reduced vigor of world trade in 1977 was the geographic pattern of recent domestic growth rates in the industrial countries. Slow growth predominated among countries having high ratios of imports to domestic production, while the trade effects of faster growth in the United States were blunted by that country’s relatively low ratio of imports to production. On an import-weighted basis, the real GNP of the industrial countries as a group increased by less than 3 percent in 1977, compared with 5 percent in 1976.

However, the deceleration of international trade expansion from 1976 to 1977 was quite disproportionate to the concurrent deceleration of growth in output. In the main, this difference can be considered a reflection of normal cyclical relationships between trade and production in the industrial countries. As usual in the early stages of a cyclical recovery, the volume of their imports had risen much faster than production in 1976, and a substantial decline in the marginal ratio of the change in imports to that in output was inevitable as the pace of growth in output moderated. It is possible that some part of the difference between the ratios for 1976 and 1977 may also reflect structural influences, but any such hypothesis remains to be tested in a period of fuller cyclical recovery.

Weakness of import demand in the industrial countries was reinforced by that in the primary producing countries, where the slow pace of import growth established by many countries in dealing with their balance of payments difficulties of 1974-75 was continued in 1977. The only significant element of buoyancy—but one not carrying great weight in the world trade aggregate—was the strong further growth of imports into the major oil exporting countries. Except for that group, whose export volume was almost unchanged in 1977 (for reasons noted in a following section), the major groups of countries distinguished in Table 3 shared fairly evenly in the relatively weak growth of export markets in 1977. Developments in the first half of 1978 have not suggested the emergence of a more buoyant trend in world trade.

In general, foreign trade prices continue to reflect the considerable degree of inflation still prevalent in most countries. For world trade as a whole, the average price rise from 1976 to 1977, expressed in SDRs, was about 7½ percent—substantially the same as in the previous year.4 The comparative stability in the overall rate of increase in world trade prices during the past two years, however, was not a reflection of uniform trends in prices of various classes of goods moving in international trade. Widely disparate rates of change in the export prices of various groups of countries were observable in 1976, but a tendency toward convergence was evident in 1977. In that year, the average increase in (SDR) export prices of the industrial countries was somewhat higher than in 1976 (reflecting, inter alia, the rise in manufacturing unit labor costs associated with recently poor productivity gains), while the export prices of both the major oil exporting countries and the non-oil developing countries rose less rapidly than in the previous year. Even so, the latter group of countries experienced a further recovery in its terms of trade, which had deteriorated severely during the recession. (See Table 4.)

Table 4.Terms of Trade Developments, 1962-77 1(Percentage changes)
Annual

Average
Change from Preceding Year
1962-72 219731974197519761977
Industrial countries−2−113−1
Primary producing countries
More developed countries11−12−6−½−2
Major oil exporters115137−551
Non-oil developing countries−½10−8−1353
Reference: World trade prices (in U.S. dollars) for
major commodity groups 3
(a) Manufactures317221219
(b) Petroleum440226569
(c) Non-oil primary commodities (market prices)5528−181220
Sources: National economic reports, the United Nations, and Fund staff estimates.

Based on foreign trade unit values; for classification of countries in groupings shown here, see Tables 1 and 2.

Compound annual rates of change.

As represented, respectively, by: (a) the United Nations’ export unit value index for the manufactures of the developed countries; (b) the petroleum export unit values of the major oil exporting countries; and (c) the International Financial Statistics index of market quotations for non-oil primary commodities.

Sources: National economic reports, the United Nations, and Fund staff estimates.

Based on foreign trade unit values; for classification of countries in groupings shown here, see Tables 1 and 2.

Compound annual rates of change.

As represented, respectively, by: (a) the United Nations’ export unit value index for the manufactures of the developed countries; (b) the petroleum export unit values of the major oil exporting countries; and (c) the International Financial Statistics index of market quotations for non-oil primary commodities.

The 1976 and 1977 terms of trade gains of the non-oil developing countries reflected a sharp bulge in primary commodity prices, centered predominantly in movements of prices for beverage crops (coffee, cocoa, and tea). This upswing reached a peak in the first half of 1977, however, and commodity prices—especially for the beverage products—have tended downward since then (Chart 6). It seems quite likely, therefore, that renewed deterioration of the terms of trade of the non-oil developing countries will be a feature of 1978 world trade and payments developments. The major oil exporters comprise another group of countries whose terms of trade are destined to deteriorate in 1978, because of the continuation of the present price freeze of the Organization of Petroleum Exporting Countries through the end of the year. The corresponding terms of trade gains will accrue mainly, of course, to the industrial countries.

Chart 6.Indices of Prices of Commodities, Except Oil, Exported by Primary Producing Countries, 1972-June 1978

(Expressed in U.S. dollars; 1968-70 = 100)

During 1976 and early 1977, when the overall index of prices for primary commodities surged upward, market prices of primary products other than beverage crops were not, in general, consistently buoyant. Average food prices, which have a heavy weight in the overall commodity price index plotted in Chart 6, actually declined in both 1976 and 1977, despite a temporary rise in the first half of 1977. Market prices of agricultural raw materials increased by 24 percent in 1976, but by only 3 percent in 1977, when they dropped sharply in the second half. Metals prices showed a steadier average trend during 1976 and 1977 than the other groups mentioned, but their increase was only about 6-7 percent a year (in terms of U.S. dollars). Like prices for other groups of primary commodities, those for metals were soft in the second half of 1977, and little strengthening was apparent in the first six months of 1978. During the latter period, the only major primary commodity group showing sizable price increases was food, where strong demand for wheat and flour resulted in markedly higher prices despite the large 1977-78 crops; measures taken by the U.S. Government to raise producer prices for cereals also may have begun to affect prices of these products.

The world trade volume and price changes outlined above affected different groups of countries in different ways, depending on the composition of their trade. These differential effects were the main influences governing shifts in the global pattern of current account balances in 1977 and will be the main factors in 1978, although changes in international service transactions and private transfers are also important for many individual countries and for certain of the major groups.

In 1977, net changes in current account balances for the major groups of countries shown in Table 5 were relatively small, consisting of a moderate decline in the collective current account surplus of the major oil exporting countries, a slight shrinkage in that of the industrial countries, and some decrease in the deficit of the non-oil developing countries, with little change for the more developed primary producing countries. These shifts in consolidated group balances in 1977, however, were dwarfed by some of the shifts among individual countries in the industrial group.

For 1978, according to the estimates summarized in the same table, changes in current account balances of the four groups of countries will be generally greater than in 1977, and not all in the same direction. A sizable further decline in the surplus of the major oil exporters, from $35 billion in 1977 to about $20 billion in 1978, is in the making, along with a rebound in the current account deficit of the non-oil developing countries. The counterparts are expected to be a rise of $13 billion in the combined surplus of the industrial countries and a long-postponed reduction in the deficit of the other developed countries.

The 1978 pattern that would result from the projected changes is, in broad outline, essentially the same as the one prevailing during 1976 and 1977. However, relative magnitudes of the various balances have been changing and the singular concentration of surpluses in the oil exporting countries that emerged in 1974 (when their combined current account surplus jumped to $68 billion) has been greatly reduced. The most serious imbalances in the pattern of current account surpluses and deficits now appear to be those among individual countries within the industrial world, rather than those among major groups of countries. Attesting to this emergent change in the nature of the international adjustment problem is the likelihood that the three largest current account surpluses among the industrial countries in 1978 will exceed the aggregate surplus of the major oil exporting countries.

From the standpoint of capital flows and international financing, the projected 1978 pattern of current account balances indicates that the industrial countries as a group are placing abroad, through capital investment or official transfers, a larger part of their own national savings than they did in the previous two years, when the bulk of the net financial outflow from the industrial countries as a group represented intermediation of funds flowing indirectly from the oil exporting countries to the non-oil primary producing countries. If the latter countries are to sustain their inflows of external resources to facilitate development, they may have to depend more heavily in the future, as they did before 1973, on financial flows originating in the industrial countries.

International capital movements, particularly among the industrial countries, were seriously affected during late 1977 and early 1978 by the outbreak of disorderly conditions in the foreign exchange markets. At times, speculative short-term capital movements, including many not identified as such in official balance of payments statistics, contributed strongly to those conditions. Although (as indicated later) the exchange markets regained a calmer tone during the second quarter of 1978, these striking developments pointed up the need for policy changes to achieve more stable conditions in the domestic economy—which would lead to a better equilibrium of current account positions and, in turn, to greater exchange market stability. Meanwhile, until this better equilibrium is achieved, national authorities face the need to secure a satisfactory adaptation of capital flows to the current account balances as they evolve.

The following sections review more specifically the recent history of international adjustment problems and progress in each of four major groups of countries, beginning with the industrial group and continuing with three groups of primary producing countries.

Industrial Countries

Current account balances.—After a downward shift of $19 billion in 1976, the aggregate current account surplus of the industrial countries showed little further overall change in 1977. The surplus for that year was about $½ billion, compared with roughly $7 billion in 1976. (These balances, as shown in Tables 5-7, are defined in terms of goods, services, and private transfers; current account balances inclusive of official transfers are also shown in Table 7.)5

Table 5.Payments Balances an Current Account, 1973-78 1(In billions of U.S. dollars)
197319741975197619771978 2
Major oil exporting countries76835413520
Industrial countries19−4267114
More developed primary producing countries1−15−15−14−13−11
Non-oil developing countries-11-30-38-25-22-30
Total 31619891−7

On goods, services, and private transfers. For classification of countries in groups shown here, see Tables 1 and 2.

Fund staff projections.

Reflects errors, omissions, and asymmetries in reported balance of payments statistics, plus balance of listed groups with other countries.

On goods, services, and private transfers. For classification of countries in groups shown here, see Tables 1 and 2.

Fund staff projections.

Reflects errors, omissions, and asymmetries in reported balance of payments statistics, plus balance of listed groups with other countries.

Table 6.Global Balance of Payments Summary, 1974-77(In billions of U.S. dollars)
Balance on
TradeServices

and

private

transfers
Current

account

excluding

official

transfers
Capital

Account

Balance1
Change in

Liabilities

to Foreign

Official

Agencies2
Balance

Financed by

Transactions

in Reserve

Assets
Industrial countries 31974−9.45.5−3.9−10.8418.33.6
197522.23.826.0−26.445.34.8
1976−3.09.86.8−11.5415.510.7
1977−8.08.60.6−3.8437.934.7
Major oil exporters 3197482.1−14.367.8−24.90.143.05
197553.1−18.434.7−17.5−0.217.05
197665.2−24.340.9−22.918.05
197762.3−26.935.4−18.417.05
Other primary producing countries 31974−41.4−3.0−44.441.51.9−1.1
1975−47.6−4.8−52.446.74.0−1.6
1976−31.9−7.0−38.945.45.812.3
1977−28.2−7.1−35.246.70.111.6
More developed areas1974−19.24.7−14.510.00.6−3.9
1975−18.94.1−14.810.02.4−2.4
1976−16.02.3−13.711.62.80.7
1977−15.22.0−13.312.40.8
Less developed areas1974−22.2−7.8−29.931.41.42.8
1975−28.7−8.9−37.736.81.60.8
1976−15.9−9.4−25.233.83.111.6
1977−12.9−9.0−22.034.3−0.811.6
In Africa19740.7−3.2−2.62.80.20.4
1975−2.5−3.5−6.05.40.4−0.2
1976−1.6−3.6−5.24.80.50.1
1977−1.7−4.5−6.26.80.10.6
In Asia1974−9.90.4−9.611.11.02.6
1975−9.40.9−8.59.30.71.6
1976−3.60.5−3.18.50.35.7
1977−3.31.1−2.27.1−0.34.6
In the Middle East1974−6.11.6−4.54.40.1−0.1
1975−8.11.3−6.87.60.8
1976−7.72.4−5.25.50.40.6
1977−9.44.2−5.17.1−0.11.9
In Latin America and the1974−6.8−6.5−13.313.2−0.1
Caribbean1975−8.7−7.7−16.414.50.5−1.4
1976−3.0−8.7−11.715.11.95.2
19771.4−9.9−8.413.4−0.44.5
Total, all countries 6197431.3−11.919.55.820.345.5
197527.7−19.48.42.89.120.2
197630.3−21.48.811.021.241.0
197726.1−25.40.824.637.963.3
Sources: Data reported to the International Monetary Fund and Fund staff estimates.

This balance is computed residually as the difference between the balance financed by transactions in reserve assets and the sum of the current account balance and the change in liabilities to foreign official agencies; it includes net errors and omissions, as well as reported capital movements, government transfers, and gold monetization. (See also footnote 2.)

The concept of “liabilities to foreign official agencies” used in this table encompasses use of Fund credit and short-term balance of payments financing transactions in which the liabilities of the borrowing country are presumably treated as reserve assets by the creditor country.

For classification of countries in groups shown here, see Tables 1 and 2.

See footnote 6.

The dividing line between capital movements and reserve asset changes is uncertain for some oil exporting countries. The data used here are based on estimated changes in official holdings of bank deposits and other money market assets, together with oil facility loans to the Fund and investments in World Bank bonds.

Global balance of payments aggregations inevitably contain many asymmetries arising from discrepancies of coverage or classification, timing, and valuation in the recording of individual transactions by the countries involved. A major area of asymmetrical classification during recent years concerns the recording of official claims placed in Eurocurrency markets. These transactions, although treated as changes in reserve assets by the investing countries, are recorded as capital inflows by the recipient countries (mainly, the industrial countries). Had such transactions been recorded symmetrically, the global summations would show both a larger net capital outflow and a larger aggregate change in liabilities to foreign official agencies. If identified Eurocurrency reserve placements (shown in terms of SDRs in Table 15 of this Report) were assumed to have been placed in industrial countries, then the adjusted net capital outflows from those countries would amount to $26.2 billion, $33.8 billion, $18.7 billion, and $25.2 billion over the years 1974, 1975, 1976, and 1977, respectively.

Sources: Data reported to the International Monetary Fund and Fund staff estimates.

This balance is computed residually as the difference between the balance financed by transactions in reserve assets and the sum of the current account balance and the change in liabilities to foreign official agencies; it includes net errors and omissions, as well as reported capital movements, government transfers, and gold monetization. (See also footnote 2.)

The concept of “liabilities to foreign official agencies” used in this table encompasses use of Fund credit and short-term balance of payments financing transactions in which the liabilities of the borrowing country are presumably treated as reserve assets by the creditor country.

For classification of countries in groups shown here, see Tables 1 and 2.

See footnote 6.

The dividing line between capital movements and reserve asset changes is uncertain for some oil exporting countries. The data used here are based on estimated changes in official holdings of bank deposits and other money market assets, together with oil facility loans to the Fund and investments in World Bank bonds.

Global balance of payments aggregations inevitably contain many asymmetries arising from discrepancies of coverage or classification, timing, and valuation in the recording of individual transactions by the countries involved. A major area of asymmetrical classification during recent years concerns the recording of official claims placed in Eurocurrency markets. These transactions, although treated as changes in reserve assets by the investing countries, are recorded as capital inflows by the recipient countries (mainly, the industrial countries). Had such transactions been recorded symmetrically, the global summations would show both a larger net capital outflow and a larger aggregate change in liabilities to foreign official agencies. If identified Eurocurrency reserve placements (shown in terms of SDRs in Table 15 of this Report) were assumed to have been placed in industrial countries, then the adjusted net capital outflows from those countries would amount to $26.2 billion, $33.8 billion, $18.7 billion, and $25.2 billion over the years 1974, 1975, 1976, and 1977, respectively.

Table 7.Industrial Countries: Balance of Payments Summaries, 1974-77(In billions of U.S. dollars)
Balance onCapital Account Balance
TradeServices

and

private

transfers
Current

account

excluding

official

transfers
Total 1Long-Term

capital

and

official

transfers
Other2Change in

Liabilities

to Foreign

Official

Agencies3
Balance

Financed by

Transactions

in Reserve

Assets
Memo:

Current

Account

Including

Official

Transfers
United States 41974−5.313.58.1−17.0−13.5−3.410.31.41.75
19759.113.422.4−27.1−23.6−3.65.30.518.5
1976−9.418.18.7−19.3−18.7−0.613.12.54.3
1977−31.120.0−11.1−24.2−16.7−7.635.50.2−15.2
United Kingdom1974−11.74.2−7.54.63.61.03.10.3−8.2
1975−6.53.7−2.82.70.22.6−1.3−1.4−3.7
1976−5.75.6−0.1−0.8−0.8−0.5−1.4−1.5
1977−2.44.62.211.93.28.62.616.70.4
Canada19741.9−3.4−1.51.51.10.4−1.5
1975−0.4−4.2−4.64.23.50.7−0.4−4.7
19761.4−5.5−4.14.68.0−3.30.6−4.1
19773.0−6.9−3.92.54.0−1.5−1.3−4.0
France1974−3.9−1.0−4.84.5−1.35.80.3−0.1−5.9
19751.5−0.41.12.4−2.14.60.54.0
1976−4.7−0.3−5.02.2−2.64.9−0.1−2.8−6.0
1977−2.70.9−1.82.0−0.82.80.1−3.2
Germany,197422.2−9.612.6−13.2−5.1−8.20.1−0.59.8
Fed. Rep.197517.7−10.07.7−8.5−10.52.0−0.2−1.04.1
197616.7−9.07.7−4.3−3.9−0.30.33.83.9
197719.3−11.38.0−3.3−9.15.9−0.34.43.8
Italy1974−8.51.7−6.82.22.10.15.30.7−8.0
1975−1.11.90.7−3.4−0.3−3.11.0−1.7−0.6
1976−4.02.3−1.71.4−1.12.52.62.3−2.9
19770.13.43.62.0−0.72.6−0.65.02.1
Japan19741.4−5.9−4.55.7−5.010.71.2−4.7
19755.0−5.4−0.4−0.2−0.70.5−0.6−0.7
19769.9−6.03.9−0.1−1.21.13.83.7
197717.3−6.211.1−4.6−3.4−1.26.210.9
Other industrial1974−5.66.10.50.8−1.52.2−0.80.5−0.3
countries 61975−3.04.91.93.4−2.76.10.15.40.3
1976−7.24.5−2.64.7−5.910.62.0−3.7
1977−11.64.0−7.510.03.36.70.93.3−9.0
Total, industrial1974−9.45.5−3.9−10.87−19.58.718.33.6−17.25
countries197522.23.826.0−26.47−36.29.95.34.813.2
1976−3.09.86.8−11.57−26.214.815.510.7−6.3
1977−8.08.60.6−3.87−20.216.337.934.714.1
Sources: Data reported to the International Monetary Fund and Fund staff estimates.

See Table 6, footnote 1.

Includes recorded net movements of short-term capital, net errors and omissions, and gold monetization.

See Table 6, footnote 2.

The data in columns 2, 3, 4, 5, and 9 shown here for the United States differ substantially from comparable estimates included in previous Annual Reports because they reflect a recently adopted change in the official presentation of U.S. balance of payments estimates which now include an allowance for the net undistributed earnings of direct investment enterprises as a component of investment income flows in the current account, with an offsetting entry for the reinvestment of those earnings in the capital account.

Includes the effect of a revision of the terms of the disposition of economic assistance loans made by the United States to India and repayable in rupees, and of rupees already acquired by the U.S. Government in repayment of such loans. The revision has the effect of increasing U.S. Government transfer payments by about $2 billion, with an offset in net official loans.

Austria, Belgium-Luxembourg, Denmark, the Netherlands, Norway, Sweden, and Switzerland.

See Table 6, footnote 6.

Sources: Data reported to the International Monetary Fund and Fund staff estimates.

See Table 6, footnote 1.

Includes recorded net movements of short-term capital, net errors and omissions, and gold monetization.

See Table 6, footnote 2.

The data in columns 2, 3, 4, 5, and 9 shown here for the United States differ substantially from comparable estimates included in previous Annual Reports because they reflect a recently adopted change in the official presentation of U.S. balance of payments estimates which now include an allowance for the net undistributed earnings of direct investment enterprises as a component of investment income flows in the current account, with an offsetting entry for the reinvestment of those earnings in the capital account.

Includes the effect of a revision of the terms of the disposition of economic assistance loans made by the United States to India and repayable in rupees, and of rupees already acquired by the U.S. Government in repayment of such loans. The revision has the effect of increasing U.S. Government transfer payments by about $2 billion, with an offset in net official loans.

Austria, Belgium-Luxembourg, Denmark, the Netherlands, Norway, Sweden, and Switzerland.

See Table 6, footnote 6.

The large downswing in 1976 was mainly cyclical in origin, reflecting the response of import demand in the industrial countries to the initial rebound of economic activity from the recession trough. Relatively little additional cyclical change was included in the small further decline in 1977, so far as the aggregate balance of the whole group of industrial countries was concerned. Nevertheless, differences in cyclical conditions within the industrial group were among the most important determinants of shifts in the distribution of current account surpluses and deficits among the individual industrial countries themselves, and some of these shifts were quite large.

Several of the major shifts in 1977 were in the direction of rectifying some of the more serious imbalances. In particular, the U.K. and Italian balances swung sharply from deficit into surplus, and France’s deficit was considerably reduced. For these three countries, the combined improvement from 1976 to 1977 was about $11 billion. Other major changes, however, cannot be considered appropriate from the standpoint of external payments adjustment and exchange rate stability. The U.S. current account balance underwent a very large downward swing, from a surplus of nearly $9 billion in 1976 to a deficit of $11 billion,6 while the Japanese surplus, already sizable in 1976, rose by $7 billion, to more than $11 billion. Both of these changes, as they became apparent during the course of 1977, undoubtedly contributed to the disturbances in exchange markets that characterized much of the period from September 1977 to April 1978. The absence of a significant downward adjustment in the current account surplus of the Federal Republic of Germany in 1977 must also be viewed as inadequate from the standpoint of international payments adjustment. In addition, the sizable increase in the deficit of the smaller industrial countries as a group signified the emergence of serious adjustment problems for some of its members.

The 1977 pattern of current account balances that resulted from these swings was one characterized by sharp contrast between countries with surpluses (including Switzerland, as well as Japan and the Federal Republic of Germany) and the United States, with its deficit. The other major industrial countries had positions closer to balance. However, relatively large current account deficits were recorded by a majority of the smaller industrial countries (Austria, Denmark, Norway, and Sweden).

For 1978, the distribution of current account balances among the industrial countries is not expected to change substantially. A large U.S. deficit and a large Japanese surplus are again occurring, and the surpluses of the Federal Republic of Germany and Switzerland seem to be persisting, along with the more nearly balanced positions of the majority of other industrial countries.

An important part of the adverse swing in the U.S. current account balance in 1977 can be explained by the change in the cyclical position of the U.S. economy in relation to the other industrial economies. Changes in relative cyclical positions in 1978 may begin to reverse themselves in the course of 1978, but the favorable effect on the U.S. current account balance for the year as a whole is likely to be small. One of the negative factors operative in 1977—the marked increase in the proportion of U.S. oil consumption supplied by imported petroleum—will be suppressed in 1978 by enlargement of crude petroleum production in Alaska. On the other hand, the rise in sales of manufactures to the United States by some of the non-oil developing countries may well continue. Although the effective depreciation of the U.S. dollar over the months around the turn of the year will eventually work toward reducing the U.S. current account deficit, during 1978 its net effects on trade volume may be expected to be temporarily offset by adverse terms of trade effects associated with the exchange rate depreciation. All in all, there is thus little chance of a major improvement in the U.S. current account balance for 1978 as a whole, but progress in that direction should begin to emerge before the end of the year.

The three major surplus countries—Japan, the Federal Republic of Germany, and Switzerland—together showed a current account surplus of $22½ billion in 1977. Their combined balance, like the negative balance of the United States, is unlikely to shrink in 1978. In Japan, the surplus grew strongly in the early part of the year. Although it is expected to decline in the second half as a result of stronger domestic demand, the trade-volume effects of the recent exchange appreciation, and import liberalization measures taken by the Japanese Government, this decline is unlikely to compensate for the earlier rise. In all three of the major surplus countries, weakness of domestic demand has tended to inhibit import growth in recent years, but does not fully explain the remarkable ability of exporters in these countries to gain market shares. For the Federal Republic of Germany, in particular, cyclical factors do not appear to have contributed to the strength of the current account, as the level of domestic demand has been weaker in that country’s major European trading partners than in the Federal Republic itself.

With respect to France, Italy, and the United Kingdom, the major improvements of current account positions recorded in 1977 resulted mainly or in considerable part from stabilization policies and low rates of economic growth. In all three countries, the improvements are expected to be maintained or increased in 1978, with the French and Italian changes continuing to reflect depressed domestic demand conditions. In the case of the United Kingdom, the expansion of North Sea oil production is the main factor behind the strengthening of the current account. Although deterioration of the U.K. balance on non-oil transactions has been arrested, that balance has not improved significantly even under conditions of slack domestic demand.

Most of the smaller industrial countries are expected to remain in substantial deficit on current account in 1978. However, stabilization policies have been implemented by the countries with the weaker balances, and deficits lower than those of 1977 are expected in Austria, Denmark, Norway, and Sweden.

Capital flows.—Net outflows of capital (including official transfers) from the industrial countries to non-oil primary producing countries changed only moderately from 1976 to 1977, in line with the small change in the balance of current account transactions between these two sets of countries. However, the small net outflow shown in the consolidated capital account balances of the industrial countries in Tables 6 and 7 masks a complex network of financial flows7 in which large aggregate net outflows of capital and official transfers from the industrial countries to the non-oil primary producing countries are financed in considerable part through receipts of capital and reserve placements from the oil exporting countries, as well as through placements of reserves held by the non-oil primary producing countries themselves. For reasons explained in footnote 6 to Table 6, changes in the foreign exchange reserves of the reserve holding countries are by no means fully reflected in changes in liabilities to foreign official agencies as reported by the reserve currency countries—most of the difference being asymmetrically reported as capital inflows by countries in which Eurocurrency banking operations are conducted. With allowance for this peculiarity in the summations of national balance of payments statistics, the total net outflow of capital (and official transfers) from the industrial countries to other areas would be estimated at some $19 billion in 1976 and $25 billion in 1977, instead of the $11.5 billion and $3.8 billion, respectively, shown in the balance of payments summaries. These flows, together with a large capital outflow from the major oil exporting countries (much of which was also channeled to ultimate borrowers through financial institutions and markets in the industrial countries), represented the main sources of funds obtained by the non-oil primary producing countries to finance their current account deficits and additions to reserves.

Shifts in capital account balances among industrial countries from 1976 to 1977 were more striking than the changes in the net outflow from the group as a whole. Moreover, some of these shifts were ill-matched with concomitant swings in the current accounts of the respective countries, and this circumstance was an important factor in generating the exchange market pressures that emerged during the latter part of 1977. In particular, the rise in U.S. capital outflows,8 coinciding as it did with the exceptionally unfavorable 1976-77 swing in the U.S. current account balance, led to both a large increase in U.S. liabilities to foreign official agencies and a marked decline in the exchange value of the dollar. For Japan and the Federal Republic of Germany, total net outflows of capital and official transfers in 1977 were equivalent to less than one half of the respective current account surpluses; and in each case, sizable increases in reserves and sharp appreciation of the exchange rate resulted from these payments relationships. For Germany, however, it may be noted that the long-term component of the net capital outflow in 1977, together with official transfers, could have financed that year’s current account surplus if there had not been inward movements of short-term capital.

In the United Kingdom, the relatively moderate swing into surplus on current account was accompanied by a surge of net capital inflows, which rose to $12 billion in 1977 (inclusive of balance of payments errors and omissions), compared with a negligible net amount in 1976. The result was an unprecedented rise in U.K. reserves, as well as a temporary appreciation of the effective exchange rate for the pound sterling.

Among the other industrial countries, differences between capital account and current account balances in 1977 were generally neither wide nor radically changed from the previous year. Canada, France, Italy, and the smaller industrial countries as a group were all net borrowers in international markets, and a substantial part of the external borrowing by a number of these countries (including Canada, France, Austria, Denmark, Norway, and Sweden) was done by public or semipublic agencies or enterprises, or by the governments themselves.

Some of the principal capital movements among the industrial countries during 1977 were unevenly distributed through the year. During the first three quarters, current account surpluses and deficits of the individual countries were financed, on the whole, without sizable exchange rate movements or disorderly market conditions. In that period, the U.S. current account deficit was much lower than it became toward the end of the year, and several factors tended to dampen the outflow of U.S. banking and portfolio capital and to encourage capital inflows. Improvements in the external balances of a number of countries that had been heavy borrowers in the U.S. market during recent years led to sharp reductions in foreign demands for U.S. bank and portfolio capital; at the same time, relatively strong demands for credit in the U.S. market, together with a progressive shift of interest rate differentials in favor of the United States (Chart 4), had a further dampening effect on the net outflow of funds. Prior to the fourth quarter, these factors were sufficient to permit the U.S. current account deficit inclusive of official transfers to be offset by capital inflows and large purchases of U.S. dollars by the U.K. authorities, with little change in the effective exchange rate for the U.S. dollar. During the first three quarters, the United Kingdom and Italy, both recovering from severe balance of payments difficulties, accounted for the great bulk of all reserve accumulations by industrial countries.

In the last quarter of 1977, however, as the U.S. current account deficit rose and its magnitude and implications came to be more widely recognized, active downward pressure on the value of the U.S. dollar came rapidly into play. This led to large outflows of banking funds from the United States, as well as to sharply reduced inflows of foreign investments, and to massive interventions in the exchange markets by foreign authorities, whose acquisitions of dollar reserves thus assumed a greatly expanded role in the financing of the U.S. deficit on current account. In the October-December period, more than two thirds of the reserve increases accruing to industrial countries were acquired by the Federal Republic of Germany, Japan, and Switzerland. The disorderly market conditions and relatively sharp changes in exchange rates that occurred in these circumstances extended into the early months of 1978.

Exchange rate developments.—Changes in exchange rates among the major currencies during 1977 and the first half of 1978 are traced, against the background of the two preceding years, in the monthly indices of effective exchange rates (based on the “MERM” indices published in International Financial Statistics) for currencies of each of the major industrial countries shown in Chart 7. In general, the largest changes of the past year and a half or two years have all been of a kind—in direction, if not in degree—conducive to reduction of existing current account balances. The currencies of countries with strong current account positions—notably, the Federal Republic of Germany, Japan, and Switzerland—have appreciated greatly, while the currency of the major deficit country—the United States—has undergone considerable effective depreciation, even though the currency of its largest single trading partner—Canada—has depreciated substantially against the U.S. dollar. Effective rates for the currencies of the major industrial countries whose external positions were most nearly balanced in 1977 (France, Italy, and the United Kingdom) were relatively stable during 1977 and the first half of 1978, following the sharp declines in value that they had undergone during 1976.

In retrospect, it can be said that what was disturbing about the major exchange rate changes over the last few months of 1977 and the early months of 1978 was not so much the nature of the realignment that took place, but the speed with which it occurred and the disorderly and uncertain exchange market conditions that characterized the period. Large day-to-day movements in the rates occurred frequently, with changes of sometimes as much as several percentage points, in reflection of rumors, misunderstandings, and other erratic influences. These characteristics of the market, together with a belief shared by various national authorities that market forces were causing excessively rapid movements of the exchange rates of their currencies against the U.S. dollar, underlay the massive official interventions mentioned above.

With respect to the yen and the deutsche mark, appreciation against the U.S. dollar, although particularly rapid during the last quarter of 1977 and the first quarter of 1978, had been proceeding since mid-1976. The depreciation of the dollar after September 1977 occurred despite interest rate differentials highly favorable to the United States (Chart 4) and the adoption by both Japan and the Federal Republic of Germany of measures to discourage capital inflows. Early in January, the U.S. authorities announced that the swap network between the Federal Reserve System and a number of foreign central banks would “henceforth be utilized actively” to counter disorderly market conditions, and, that a new swap line had been established between the U.S. Treasury and the Bundesbank. Subsequently, market conditions led to heavier interventions by the U.S. authorities, and the central banks of Japan and the Federal Republic of Germany continued their intervention policies. In March, it was announced that the swap facility existing between the Bundesbank and the U.S. Federal Reserve System had been doubled to the equivalent of $4 billion, that the U.S. Treasury had arranged for a sale of SDR 600 million to the Bundesbank for deutsche mark, and that the United States was prepared to draw on its reserve position in the Fund, if and when necessary, to acquire more foreign exchange.

Chart 7.Major Industrial Countries: Effective Exchange Rates, 1975-July 19781

(Indices, 1977 = 100)

1 “MERM” indices as reported in International Financial Statistics.

During the April-July period of 1978, effective rates for major currencies other than the Japanese yen became notably steadier. As shown in Chart 7, the yen continued to appreciate rapidly through July. The deutsche mark fell back somewhat over the period. The effective rate for the U.S. dollar, after firming early in the second quarter, declined during June and July. The appreciation of the yen from April to the end of July amounted to some 15 percent, while the depreciation of the U.S. dollar was almost 5 percent and that of the deutsche mark 3 percent. Effective rates for the currencies of other major industrial countries at the end of July differed from their respective April averages by less than 3 percent.

The French franc experienced a sharp but temporary dip in February 1978, under the impact of anticipatory influences and subsequent reactions associated with national elections in March; otherwise, it has been, steady since late 1976. The effective exchange rate for the Italian lira declined gradually during 1977 and the first half of 1978, but the cumulative movement was not large. The stability of the pound sterling through the first ten months of 1977 required massive purchases of foreign exchange by the U.K. monetary authorities, and their discontinuance of efforts to stabilize the rate was followed by a fairly sharp, but short-lived, appreciation of the effective rate around the turn of the year. Since mid-February, that rate has receded to about the level prevailing during the first three quarters of 1977.

The developments outlined above with respect to exchange rates of major industrial countries have had important implications, of course, for a number of other countries. Within the European common margins arrangement, the various currencies that participate with the deutsche mark have generally appreciated with that currency. Effective exchange rates for the Belgian franc and the Dutch guilder, for example, rose by 7-9 percent from mid-1976 to June 1978, with consequent effects on the relative cost positions of the two countries in international trade. Such developments brought periods of tension within the “snake,” forcing Belgium to raise domestic interest rates substantially for a time in order to maintain the agreed margins and leading to exchange rate adjustments by members of the “snake” whose domestic developments made their authorities unable to keep their currencies in line with the deutsche mark. Sweden, Denmark, and Norway devalued twice during 1977, in April and in August, with Sweden leaving the “snake” on the latter occasion; and Norway devalued again in February 1978.

The differing movements of exchange rates for major currencies created problems of exchange rate management for many countries outside the industrial world. In this context, a number of countries faced the problem of reassessing the pattern of their external trading relationships; this problem was particularly difficult for countries where contrasting geographic distributions of exports and imports tended to magnify the impact of exchange rate movements for major currencies on import costs and on prices received by domestic exporters.

It is important that the marked changes in exchange rates for the U.S. dollar, the deutsche mark, and the yen over the past year and a half be viewed in perspective. Although the dollar depreciated by 27 percent against the yen and 13 percent against the deutsche mark from December 1976 to June 1978, it depreciated much less against most currencies and appreciated over the same period against some, such as the Canadian dollar and the Swedish krona, so that the decline in the effective rate for the U.S. dollar during these 18 months was only 9½ percent. In large part, the major exchange rate changes compensated for previous and concurrent differences in rates of increase in domestic prices. Even after the recent rapid changes in exchange rates, the index of relative prices of German manufactures adjusted for exchange rate changes was about the same in the second quarter of 1978 as the average for 1973. Changes in corresponding relative prices for the United States (downward) and for Japan (upward) over the same period have not been large.

Major Oil Exporting Countries

Since the beginning of 1974, the large current account surplus of the major oil exporting countries, resulting from the sharp increase in the price of oil, has been a central feature of the global pattern of international payments. Most of the oil exporting countries, however, have rapidly expanded their imports of goods and services, with the result that their combined current account surplus has ceased, at least in 1978, to dominate the international payments picture. That surplus declined irregularly from $68 billion in 1974 to some $35 billion in 1977. The latter figure would have been considerably higher (by perhaps $7-8 billion) under more normal conditions of activity in the industrial world. However, given the probable course of developments in the industrial countries, the oil exporters’ surplus is expected to show a large drop this year, to about $20 billion—the most notable change in the projected global pattern of current account balances. (See Table 5.)

The main assumptions underlying this expected decline in the oil surplus are (i) a small decline in the volume of oil exports (for the second consecutive year), with the increase in world oil consumption again expected to be approximately matched by production increases in countries other than the major oil exporters; (ii) very little increase in the average export price of oil (because of a continued freeze in the price of the OPEC marker crude, in line with the results of the OPEC meetings of December 1977 and June 1978); (iii) a rise of some 16 percent in the (U.S. dollar) value of merchandise imports; and (iv) a further increase of about $1½ billion in the deficit on services and private transfers.

The current account surplus of the oil exporters is now concentrated among five countries of relatively low absorptive capacity—Saudi Arabia, Kuwait, the United Arab Emirates, Qatar, and the Socialist People’s Libyan Arab Jamahiriya. These countries, producing about half of the entire group’s oil exports, but having only about 3-4 percent of its population, accounted for almost 90 percent of the combined surplus in 1977. With the position of other oil exporters (as a group) shifting into deficit, they are expected to account for more than 100 percent in 1978.

As pointed out in last year’s Annual Report, available information on placements of the financial surpluses accruing to the oil exporters since 1974 indicates a trend toward diversification of investments and shifts into less liquid forms. This trend, which can be regarded as tending to increase the stability of international capital movements, continued in 1977, although at a reduced rate. The expected decline in new external investments of the oil exporters from 1977 to 1978 is likely to be smaller than the projected drop in their current account surplus because of an increase in new borrowings by oil exporting countries with high absorptive capacity.

Less Developed Primary Producing Countries

The past two years have witnessed a striking reduction of the current account deficit of the non-oil developing countries as a group, following an unprecedented bulge in that deficit during 1974 and 1975. From a peak of some $38 billion in 1975, it dropped to $25 billion in 1976 and to about $22 billion in 1977 (Table 6). The decline was partly a reflection of cyclical developments in the industrial countries that became more favorable to expansion of exports of other countries after 1975, but also stemmed to an important extent from widespread efforts by non-oil developing countries to adjust their external payments positions in the wake of the difficulties resulting from the international recession and the 1973-74 change in the price of oil.

The initial reduction of the combined current account deficit of these countries in 1976, while reflecting a temporarily strong cyclical upswing in the volume of demand for their exports, as well as a favorable shift in their terms of trade, also owed a good deal to their achievement of a very moderate rate of growth in import volume (Table 3). The improvement in the terms of trade continued in 1977, although on a reduced scale and with a reversal of the favorable movement before midyear. Growth in the volume of exports slackened because of the hesitancy of market expansion in most of the industrial countries, and also because of domestic absorption of exportable goods in developing countries with high inflation, but remained a little stronger than the rise in imports. For 1978, however, the expansion of imports appears to be catching up with that of exports in terms of volume, and a partial reversal of the favorable shift in the terms of trade that occurred during 1976 and 1977 is pushing the trade deficit of the non-oil developing countries to a higher level. In addition, some increase in net payments for services—including interest payments on enlarged external debts—seems likely to contribute toward a larger current account deficit. The Fund staff projections summarized in Table 5 place this deficit at $30 billion, compared with $22 billion in 1977.

Financing of the projected deficit would not seem to require any increase in the net inflow of borrowed funds. Indeed, it could be accomplished with a slight reduction in such borrowing if present expectations regarding moderation of reserve increases should be borne out.

The rapid downward adjustment of the combined current account deficit of the non-oil developing countries from 1975 to 1977 was not accompanied by any commensurate decline in net inflows of capital and aid. On the contrary, aggregate external borrowing by this group of countries was maintained in 1976 at the previous year’s level and decreased only moderately in 1977 (Table 8). In both years, net inflows of financial resources far exceeded the shrinking current account deficits, permitting sizable additions to official reserve assets.

These additions to reserves followed two years (1974 and 1975) in which the urgency of large current account financing requirements had prevented any significant reserve accumulation, even in nominal terms, and during which inflation had eroded the real value of the reserves held. By the end of 1977, however, the accumulation of official reserves that resulted from two years of borrowing well in excess of the immediate requirements of current account financing had restored the average ratio of reserves to imports, for the non-oil developing countries as a group, to about the level prevailing for the period 1967-72.

Increases in reserves of the developing countries, it may be noted, provided one of the main sources of funds channeled through the international banking system during 1976 and 1977. Liabilities of reporting banks to non-oil developing countries rose rapidly in these years, and placements of official reserves in Eurocurrency deposits accounted for much of this increase. Since borrowers in the non-oil developing countries were also among the principal users of funds lent by the Eurobanking institutions, these countries, in effect, have collectively provided a considerable part of their combined external financing through their own placements of reserves in the form of Eurocurrency claims.

Table 8 summarizes, for the period 1974 through 1977, Fund staff estimates of the financial transactions by which the aggregate current account deficit of the whole group of non-oil developing countries was covered. Major shifts in sources of financial inflows are not expected for 1978, but there may be some slackening of reliance on bank financing, probably counterbalanced by increases in funds—both long-term loans and grants—obtained by governments of non-oil developing countries from official agencies of other governments and from international development lending institutions.

Table 8.Non-Oil Developing Countries: Current Account Financing, 1974-77(In billions of U.S. dollars)
1974197519761977
Current account deficit 129.937.725.222.0
Financing through transactions that do not affect net debt positions10.6 211.310.211.7
Net unrequited transfers received by governments of non-oil
developing countries6.1 26.55.76.9
Direct investment flows, net4.44.84.54.8
Net borrowing and use of reserves 319.3 226.415.010.3
Reduction of reserve assets (accumulation,—)−2.8−0.8−11.6−11.6
Net external borrowing 422.1 227.226.621.9
Long-term from official sources, net 58.3 210.28.710.0
Long-term by governments55.426.25.65.3
By other borrowers52.94.03.14.7
Other long-term borrowing from nonresidents, net7.810.815.013.1
From private banks abroad55.77.710.69.4
Through suppliers’ credits50.50.81.31.2
Other sources61.62.33.12.5
Use of reserve-related credit facilities, net 71.41.63.1−0.8
Other short-term borrowing, net4.36.22.9
-0.5
Residual errors and omissions 80.5−1.8−3.0
Sources: Fund balance of payments records and Fund staff estimates.

Balance on goods, services, and private transfers (with sign reversed).

Excludes the effect of a revision of the terms of the disposition of economic assistance loans made by the United States to India and repayable in rupees, and of rupees already acquired by the U.S. Government in repayment of such loans. The revision has the effect of increasing official transfers by about US$2 billion with an offset in net official loans.

I.e., financing through changes in net debt positions (net borrowing, less net accumulation—or plus net liquidation—of official reserve assets).

Includes any net use of nonreserve claims on nonresidents, errors and omissions in reported balance of payments statements for individual countries, and minor deficiencies in coverage.

Public and publicly guaranteed borrowing only.

Including errors and residuals that arise from the mismatching of data taken from creditor and debtor records.

Comprises use of Fund credit and short-term borrowing by monetary authorities from other monetary authorities.

Errors and omissions in reported balance of payments statements for individual countries, plus minor omissions in coverage.

Sources: Fund balance of payments records and Fund staff estimates.

Balance on goods, services, and private transfers (with sign reversed).

Excludes the effect of a revision of the terms of the disposition of economic assistance loans made by the United States to India and repayable in rupees, and of rupees already acquired by the U.S. Government in repayment of such loans. The revision has the effect of increasing official transfers by about US$2 billion with an offset in net official loans.

I.e., financing through changes in net debt positions (net borrowing, less net accumulation—or plus net liquidation—of official reserve assets).

Includes any net use of nonreserve claims on nonresidents, errors and omissions in reported balance of payments statements for individual countries, and minor deficiencies in coverage.

Public and publicly guaranteed borrowing only.

Including errors and residuals that arise from the mismatching of data taken from creditor and debtor records.

Comprises use of Fund credit and short-term borrowing by monetary authorities from other monetary authorities.

Errors and omissions in reported balance of payments statements for individual countries, plus minor omissions in coverage.

Although outstanding debt of the non-oil developing countries has leveled off in relation to their export earnings, the ratio of debt service payments to such earnings rose in 1977 (Chart 8) and may be expected to show another increase in 1978. The main factor is an upsurge of amortization payments, reflecting the shorter maturities of the bank loans so prominent in the recent financing pattern (Chart 9), together with the expiration of grace periods for amortization of many of the debts incurred in the wave of heavy borrowing after 1973.

Chart 8.Non-Oil Developing Countries: Debt and Debt Service, 1970-781

(As a percentage of exports of goods and services)

Sources: IBRD Debtor Reporting System and Fund staff estimates.

1 The debt and debt service ratios plotted in this chart relate only to medium-term and long-term external public, or publicly guaranteed, debt.

Chart 9.Non-Oil Developing Countries: Share of External Debt1 Owed to Various Groups of Creditors, End 1970-End 1978

(As a percentage of total debt outstanding)

Sources: IBRD Debtor Reporting System and Fund staff estimates.

1 Public and publicly guaranteed medium-term and long-term external debt.

Regional developments.—Developments in many of the non-oil developing countries have deviated significantly from the composite picture sketched in the foregoing overview. The breadth of the prevailing differences may be suggested in the following regional summaries.

The Asian region was one featuring a predominance of strong overall balance of payments positions in 1977. Its aggregate external deficit on current account was reduced further below the 1974-75 level than that of any of the other major developing regions. As shown in Table 6, the Asian current account deficit was only about $3 billion in 1976 and $2 billion in 1977, compared with $8½ billion in 1975 (and a peak of 9½ billion in 1974). The marked reduction after 1975 reflected the adoption and implementation of relatively strong stabilization policies in a number of Asian countries at a comparatively early stage. These policies, with their moderating impact on domestic demand, and particularly on private investment, helped to check the import expansion, and their impact was supplemented by a strong revival of export growth in 1976, particularly for countries supplying substantial amounts of manufactured goods to international markets.

In 1977, a moderate deterioration in the capital account of the regional balance of payments resulted from fairly substantial reductions in long-term capital inflows. However, the change in the net balance on capital account roughly matched that in the current account, so that the overall balance of payments surplus of the Asian countries as a group changed very little from 1976 to 1977. Substantial overall balance of payments surpluses were again achieved by India, Korea, and Malaysia, although the Malaysian surplus was appreciably lower than in the previous year.

For 1978, a moderate upswing in the current account deficit of the Asian region is in prospect, probably involving reduced overall payments surpluses or increased deficits for nearly all the countries in the area. These changes, however, are unlikely to invalidate the characterization of the Asian region as one with relatively strong external payments positions. On the whole, the larger countries have coped well with the domestic monetary problems arising from their surpluses. Also, in formulating their economic policies, these countries have recognized the desirability of reducing their external surpluses. In general, they have opted for import liberalization, tariff reductions, and attempts to stimulate investment, rather than action to appreciate their exchange rates. Such decisions stemmed largely from a widespread view that the balance of payments surpluses were temporary, in some cases reflecting good crops due to favorable weather, cyclically favorable commodity prices, or short-term capital inflows. Reluctance to contemplate appreciation of exchange rates was rooted in concern about the future course of exports, which seemed uncertain in the face of faltering demand and rising protectionist tendencies in the industrial countries.

Most of the Latin American and Caribbean countries have also had considerable success with their stabilization and adjustment policies. In 1977, their combined deficit on current account amounted to $8½ billion, down from $11½ billion in 1976 and $16½ billion in 1975 (Table 6). A substantial portion of the drop in 1977 reflected marked improvement in the terms of trade, arising to a considerable extent from an unprecedented increase in coffee prices during late 1976 and early 1977. Export values in various countries were further boosted by favorable prices for fishmeal, soybeans, and most of the region’s agricultural raw material exports, as well as by a strong rise in import demand in the United States, which is the main trading partner for countries in the area. Although prices of most cereals, sugar, and meat remained depressed, and those for non-ferrous metals other than tin dropped further in world markets, the overall increase in export earnings in 1977 was on the order of 20 percent. In contrast, imports of the Latin American and Caribbean oil importing countries remained sluggish, chiefly because of efforts to restrain domestic demand in order to curb inflation and improve the balance of payments.

The reduction of the aggregate current account deficit of the Latin American and Caribbean oil importing countries in 1977 was accompanied by a moderate decline in the capital inflow. Although official borrowing from governments and international organizations continued to rise, public sector borrowing from private sources declined substantially. Private direct investment remained steady, but market borrowing by the private sector was reduced. Nevertheless, net capital inflows into the area exceeded the current account deficit by a wide margin, permitting a $4½ billion accumulation of reserves. At year-end, reserve holdings of countries in the area totaled $20 billion, equivalent to almost six months of imports at the 1977 rate.

An upswing in the current account deficit of these countries seems inevitable for 1978. With a decline in coffee prices playing a major role, the terms of trade have been moving unfavorably, and export earnings are not expected to keep pace with import expansion. Since virtually no change in the inflow of capital is anticipated, the area’s overall balance of payments surplus will probably be reduced substantially, and the accumulation of reserves may slacken.

Positions of individual Latin American and Caribbean countries are mixed. Countries that have moved into relatively favorable balance of payments positions and made progress in controlling or moderating inflation—generally through application of more restrained credit and fiscal policies—include Argentina, Brazil, and Chile. Mexico also achieved a major adjustment in its external position in 1977, and has in place policies that should be instrumental in permitting a revival of economic activity without renewed deterioration of the overall balance of payments position. Guyana, Jamaica, and Peru, on the other hand, continue to face difficult situations, which they are taking steps to improve. In Central America, the authorities are expected to rely, as in the past, on cautious demand policies to limit the effect of the latest downswing in coffee prices on the overall balance of payments position.

The African region was the only one in which the combined current account deficit of non-oil countries increased from 1976 to 1977—from $5 billion to $6 billion. Among the countries of that area, the current account deterioration reflected in the group’s aggregate balance was a pervasive, but by no means universal, experience.

In many African countries, economic and foreign trade performances were strongly affected by the weak trend of demand in industrial Europe, which is a particularly important market for those countries. Among the commodities for which demand and prices were weak in 1977 were copper (particularly important for Zaïre and Zambia), iron ore (Liberia and Mauritania), phosphates (Morocco, Senegal, and Togo), and sugar (Mauritius and Swaziland). On the other hand, export earnings of some African countries benefited greatly from the high coffee prices prevailing at the beginning of 1977. Weather conditions and political strife, accompanied by border or port closures, had substantial adverse effects in various parts of Africa.

Stabilization measures were adopted by some 20 African countries in 1977, mostly in connection with use of Trust Fund resources. These adjustment measures helped to hold down the aggregate trade deficit for the area. This achievement, however, was swamped by a sharp increase in net payments for external services.

Despite the predominance of enlarged current account deficits, total international reserves of the African non-oil countries rose by about $½ billion (following two years of virtually unchanged holdings) as receipts from capital inflows and official transfers exceeded the imbalance on current account in 1977. The foreign borrowing that produced an overall balance of payments surplus for the African countries in that year raised their external debt substantially, but very unevenly. External debts have reached troublesome levels in a number of cases.

For 1978, sustained or rising economic activity in Africa, supported by rising public sector investments, appears to be resulting in a further expansion of imports. In the absence of strong demand expansion in industrial Europe, the opportunity for gains in the volume of exports is limited; and price trends for African export commodities during 1978 to date, though mixed, have not, on the whole, been favorable. A smaller rise in the value of exports than in that of imports is thus implied for 1978. There is cause for concern, therefore, that an increasing number of countries may experience external debt servicing problems and other financial pressures unless additional remedial measures are taken (particularly to reduce public sector deficits). With some exceptions, the African countries have not made much use to date of exchange rate changes to deal with their balance of payments problems.

The balance of payments positions of all the non-oil exporting countries of the Middle Eastern region are characterized by trade and current account deficits. Faced with a resource constraint, most of these countries have financed large and persistent public sector deficits through domestic credit creation and foreign borrowing, thus incurring heavy burdens of external debt servicing and generating domestic inflationary pressures that, in turn, have contributed to the current account deficits in their balances of payments. However, private remittances by workers in the neighboring oil exporting countries and increased official transfers have provided a major balance of payments support to these countries, so that there is an overall surplus for the group as a whole. In general, the smaller countries in the area account for a disproportionate share of this combined overall surplus.

More Developed Primary Producing Countries

The more developed primary producers include a number of countries whose adjustments of external positions since the disturbances of 1974 and 1975 were late or minimal through 1977. As a group, consequently, they have been slower to achieve any major reduction of their combined current account deficit than the other major groups of non-oil primary producing countries. Their deficit, after reaching a peak of nearly $15 billion in 1975 under the adverse impact of the international recession and the oil price increase, still remained above $13 billion in 1977 (Table 6). Although some of the countries in the group have made significant adjustments, others actually had larger negative balances on current account in 1977 than in 1975.

For the group as a whole, an important factor in this situation has been a strikingly unfavorable evolution of the terms of trade over the period since 1973 (Table 4). Unlike the terms of trade of the non-oil developing countries, those of the more developed group did not recover after 1975, but continued to worsen in each subsequent year. Consequently, although import expansion has been quite moderate in volume terms, improvement of the trade balance has been difficult, even with relatively strong gains in export volume. In effect, the more developed primary producing countries as a group have had to increase their real exports substantially to support even the moderate expansion of real imports that they have obtained.

Moreover, these countries have undergone a substantial impairment of their international financial positions. Their reserves were exceptionally high at the beginning of the period of difficulty (because of favorable terms of trade and strong exports during the preceding boom), and were used rather freely in the financing of the initial large deficits in 1974 and 1975. In addition, most of the countries in the group had good access to international capital markets, and a number of them drew freely on lines of credit there to provide the needed financing for the current account deficits (Table 9). Although their total external borrowing rose further after 1975 (unlike that of the less developed non-oil primary producing countries), they did not achieve any significant net rebuilding of reserves during 1976 and 1977 (as did the less developed countries).

Table 9.More Developed Primary Producing Countries: Current Account Financing, 1974-77(In billions of U.S. dollars)
1974197519761977
Current account deficit114.514.813.713.3
Financing through transactions that do not affect net debt positions2.11.01.31.9
Net unrequited transfers paid (—) or received (+) by governments
of more developed primary producing countries−0.2−0.3−0.20.1
Direct investment flows, net2.31.31.51.8
Net borrowing and use of reserves 212.413.812.411.4
Reduction of reserve assets (accumulation,—)3.92.4−0.7
Net external borrowing 38.511.413.111.4
Long-term loans received by governments from official sources, net0.50.51.00.9
Other long-term borrowing from nonresidents, net6.48.88.48.6
Public and publicly guaranteed borrowing from private banks abroad1.73.42.12.0
Other sources44.75.46.36.6
Use of reserve-related credit facilities, net 50.62.42.80.8
Other short-term borrowing, net0.70.90.8
1.1
Residual errors and omissions 60.4−1.20.1
Sources: Fund balance of payments records and Fund staff estimates.

Balance on goods, services, and private transfers (with sign reversed).

I.e., financing through changes in net debt positions (net borrowing, less net accumulation—or plus net liquidation—of official reserve assets).

Includes any net use of nonreserve claims on nonresidents, errors and omissions in reported balance of payments statements for individual countries, and minor deficiencies in coverage.

Including errors and residuals that arise from the mismatching of data taken from creditor and debtor records.

Comprises use of Fund credit and short-term borrowing by monetary authorities from other monetary authorities.

Errors and omissions in reported balance of payments statements for individual countries, plus minor omissions in coverage.

Sources: Fund balance of payments records and Fund staff estimates.

Balance on goods, services, and private transfers (with sign reversed).

I.e., financing through changes in net debt positions (net borrowing, less net accumulation—or plus net liquidation—of official reserve assets).

Includes any net use of nonreserve claims on nonresidents, errors and omissions in reported balance of payments statements for individual countries, and minor deficiencies in coverage.

Including errors and residuals that arise from the mismatching of data taken from creditor and debtor records.

Comprises use of Fund credit and short-term borrowing by monetary authorities from other monetary authorities.

Errors and omissions in reported balance of payments statements for individual countries, plus minor omissions in coverage.

The moderate pace of import expansion in the more developed primary producing countries since 1975 is partly attributable to restrictive fiscal and monetary policies applied by several members of the group in response to the external shocks and high inflation rates of the mid-1970s. As noted earlier, Australia, New Zealand, South Africa, and Finland all took relatively early and decisive action to control inflation and to reduce external imbalances; and they were successful to a considerable extent in achieving those aims, although at the expense of marked slowdowns in the growth of domestic output. Shifts back toward more growth-oriented policies have been inhibited by the weakness of foreign markets and in some cases also by shrinkages of capital inflows from abroad, which have intensified balance of payments constraints on financial policy.

Among the other more developed primary producers, the current situation is rather different. Some of them, including Greece, Ireland, and Yugoslavia, have been relatively free of balance of payments constraints in recent years. On the other hand, three of the countries in southern Europe—Spain, Portugal, and Turkey—encountered severe balance of payments difficulties during this period, but did not adopt adjustment measures until their problems had become deep-seated. In these countries, the postponement of action was generally due to internal problems and political uncertainties. Meanwhile, the authorities concerned were confronted with high and accelerating rates of inflation, widening current account deficits, and rapidly rising external debts as reliance was placed increasingly on credits from international markets to balance the external accounts.

In Spain, the current account showed substantial improvement from 1976 to 1977, chiefly because of the stagnation of domestic demand, in part reflecting a tightening of monetary policy, and a marked increase in earnings from tourism. Devaluation of the Spanish peseta in July 1977 and the introduction of a major stabilization program in October of that year provided a basis for further adjustment of Spain’s external position. During the early months of 1978, Portugal and Turkey also adopted major stabilization programs, and substantial reductions in their respective current account deficits are to be expected in 1978.

Primarily because of the long-postponed improvements in the southern European countries, a fairly sizable drop in the aggregate current account deficit of the whole group of more developed primary producers is in prospect, as indicated by the 1978 estimates given in Table 5. Although the group includes a number of countries whose current account deficits will probably rise in 1978, nearly all of these upward changes are likely to be moderate. For the entire group, the net decline in the aggregate deficit now visualized (some $2½ billion) would lower it to roughly $11 billion.

Policy Strategy and the Adjustment Process

It was pointed out in the 1977 Annual Report that economic policies in the industrial countries, and in most other countries as well, were placing a primary emphasis on medium-term objectives. The central aim was to combat inflation and, where necessary, strengthen the external position over a period of a few years in the firm belief that such an approach would yield the best results for economic growth and employment in the longer run. At the same time, the approach being followed envisaged that, at least for the industrial countries as a group, rates of economic growth over the medium term would be sufficient to permit a gradual absorption of the prevailing slack in utilization of resources. It was felt that success in the pursuit of these objectives would contribute greatly to the smooth working of the international adjustment process.

By the end of 1977, it had become evident that this strategy, while still appropriate, had not been implemented as originally expected. The overall growth of output in the industrial countries since around the middle of 1976 had not proved sufficient to bring about even a moderate reduction in unemployment and excess industrial capacity in these countries as a group, or to foster a satisfactory expansion in world trade.

Conclusions of the Executive Board

In Executive Board discussions of this situation in the early part of 1978, drawing on discussions of the Fund’s Interim Committee and Board of Governors in their September 1977 meetings, several conclusions or judgments were reached concerning the policies and conditions necessary for sustained improvement of the world economy.

1. A more effective and symmetrical functioning of the international adjustment process was called for. There was clearly a need for adequate stimulation of demand (and imports) by the surplus countries, without intensifying inflationary pressures, in order to support and facilitate the necessary stabilization efforts by countries in relatively weak positions.

2. There was agreement on the need for greater emphasis on policies to stimulate economic growth. This need derived from the substantial underutilization of resources, including high levels of unemployment, prevalent in very many countries; the concurrent low rates of investment, with their detrimental impact on the growth of productive capacity; the slow growth of world trade, which was impairing the effectiveness of the international adjustment process; and the spread of protectionist trade measures, a particularly ominous development on the world economic scene.9 Together, these various manifestations of inadequate economic growth were viewed as presenting a very difficult and potentially dangerous situation. Dealing with it was complicated by a number of structural changes that have taken place or are now in process in many countries.

This conclusion on the need for more emphasis on policies to encourage growth was reached with full regard to the problem of inflation—to the importance of continuing to combat the unacceptably high rates of price increase prevailing in most member countries. Nothing would be gained, and problems could be made much worse, by jeopardizing progress on the inflation front. However, it was recognized that there were now quite a number of countries in which, because of the accumulation of economic slack and the blunting of inflationary expectations, the risks of exacerbating inflation would be minimal if cautious and well-designed policies of expansion were pursued.

3. The strategy of policy for the period ahead must reflect the major changes that had taken place since the time when a valid distinction could be made between (a) three countries in relatively strong positions—the United States, the Federal Republic of Germany, and Japan—that could lead the economic recovery and (b) a number of other countries that had to give overwhelming attention to balance of payments and inflation problems. Many of these latter countries had made substantial strides in dealing with their problems, although at the cost of a protracted slowing of economic growth, while the United States had lost strength on both the inflation and payments fronts.

Thus, the main guiding principle in any general strategy had to be that the roles of individual countries should be based on their relative positions in the international adjustment process and on their progress in reducing inflation. That is to say, countries should be expected to contribute to world economic growth in relation to both strength of the balance of payments and price performance—a proposition of particular importance because of the extraordinarily wide differences in the positions of member countries. In this regard, the unsatisfactory mixture of surpluses and deficits characterizing the current account pattern of the industrial countries was considered to be one of the most troublesome features of the world economic situation.

4. It could be assumed that a strategy so designed would also respond to the desirability of making a basic contribution to greater stability in exchange markets, beyond what can and should be achieved in this area by monetary policy and by exchange market intervention.

A Medium-Term Scenario

A general strategy reflecting the foregoing considerations has been translated by the Fund staff into a medium-term “scenario” of coordinated growth and balance of payments adjustment in the industrial countries. It shows how the economies of those countries might evolve over the period to 1980 if national policies were to follow an appropriate course.

This “desirable” scenario provides for a significantly higher average growth rate than that of recent years. It is based on the assumption that individual countries are able to expand domestic demand so as to achieve a rate of growth in real GNP judged to be appropriate from the standpoint of absorbing available slack without aggravating inflation, account being taken of the interdependence of the various countries through flows of foreign trade. Within this framework, the overall growth of real GNP in the industrial countries is placed at 4¾ percent (on average) for the years 1979 and 1980, compared with the subpar rate of 3¾ percent experienced in 1977 and now expected for 1978. Growth rates for individual countries have been selected on the basis of their respective rates of inflation, external positions, degrees of economic slack, and rates of growth in potential output. Because of the multiple criteria utilized, these selected growth rates for 1979-80 vary considerably from country to country. For the United States, a rate below the growth of 4½-5 percent experienced in the recent period is considered a suitable objective in view of the much lesser degree of slack in that country and the prospects for domestic prices, and it would also have the effect of constraining the size of the U.S. current account deficit. For industrial countries other than the United States, the notional growth rates for 1979-80—though differing markedly among themselves—are in general significantly higher than actual rates for 1977 and projected rates for 1978; realization of these notional rates would bring about only a gradual and moderate reduction in the large amount of available economic slack, but the continuing danger of rekindling inflationary pressures militates against more ambitious aims for real growth.

The staff scenario also embodies a pronounced improvement in the distribution of current account balances, with both the U.S. deficit and the major surpluses being sharply reduced. The chief sources of this improvement are (a) the impact on trade flows of the growth rates projected for 1978 and chosen for 1979-80; (b) the effects, still in the pipeline, of past changes in exchange rates and in relative prices—that is, effects that were not yet reflected in 1977 trade flows but might be expected to occur by about 1980; and (c) an assumed fall in the combined surplus of the major oil exporting countries from 1977 to 1980. Clearly, such an evolution of current account balances in the industrial countries would contribute greatly to the international adjustment process without placing excessive weight on further changes in exchange rates (which for purposes of the estimates in the scenario are assumed to change only in line with relative prices).

This scenario of coordinated growth and balance of payments adjustment was presented by the Fund’s Managing Director to the April 1978 meeting of the Interim Committee in Mexico City. As indicated above, it does not represent a forecast but rather is in the nature of a normative projection showing what the situation of the industrial countries might look like by 1980 if they were to pursue policies geared to appropriate and mutually consistent targets for economic growth. Indeed, staff calculations based on different scenarios with respect to economic growth over the medium term show that the quantitative effects of different cyclical patterns on current account balances can be very substantial, so that—depending on the policies pursued and the growth rates achieved—developments over the next two or three years could turn out to be much worse than those envisaged in the “desirable” scenario.

Of course, in view of the problems and uncertainties involved, countries could not expect to reach particular growth targets or objectives each and every year. It presumably would be more feasible for them to work toward their objectives in a medium-term framework, endeavoring without undue delay to compensate for any significant deviations so as to get back on a path consistent with the medium-term goals.

Regardless of the extent to which coordination of growth targets may play a role in the conduct of economic policy in the industrial countries over the next few years, it is of crucial importance that actual developments accord at least broadly with those envisaged in the “desirable” scenario discussed above—that is, that growth rates move higher, on average, and also undergo a marked convergence. It is to be stressed that achievement of this sort of pattern would be in the interest of the industrial countries themselves, as well as of the world economy. Without a development along such lines, these countries would not be able to establish the underlying conditions essential for national economic and financial stability or to contribute to better balance in the world economy. Exchange rate relationships would then be sharply affected by cyclical and other short-term factors, and the instability of exchange rates, in turn, would make it all the more difficult to attain satisfactory rates of economic growth.

Recent Policy Discussions

At the April meeting of the Interim Committee, a consensus was reached (as noted in the communiqué following the meeting) on “the general outlines of a coordinated strategy, containing mutually supportive and reinforcing elements, designed to promote non-inflationary growth of the world economy, leading to higher employment, a reduction of imbalances in international payments, and the conservation of energy.” The Committee emphasized that the implementation of this strategy, covering the medium term through 1980, should take due account of the wide differences in current positions of individual countries and thus lead to a pattern of differentiated growth rates.

In view of the risk of reviving inflationary pressures, the Committee noted the utility of policies appropriate to counter the predominance of cost-push factors in the current inflation. The Committee suggested that, for countries where such factors were strong, fiscal stimulus provided through tax reductions might often be more appropriate than equivalent stimulus applied through domestic government spending unless such spending was investment oriented.

In giving attention to the special problems of the developing countries, the Interim Committee noted (inter alia) that the vulnerability of the economies of those countries to slow growth of markets in the industrial world or to reduced access to markets there was a source of widespread concern. The Committee stressed the desirability of measures on the part of the developed countries to assure continued expansion on an adequate scale of the flow of real resources to the developing countries—which would help to promote the adjustment process.

The Committee expressed concern about the risk of increasing resort to protectionist action of all kinds in the wake of slow growth, low capacity utilization, and high unemployment. In this regard, the Committee stressed the importance of a successful completion of the Multilateral Trade Negotiations now under way.

The question of an appropriate general strategy of policy has also been a preoccupation of the Organization for Economic Cooperation and Development (OECD). At the June 1978 meeting of the OECD Council at the ministerial level, agreement was reached on a strategy—broadly similar to that outlined above—of “internationally concerted action by member countries to achieve more sustained economic growth, and on the respective responsibilities of individual member countries in contributing to faster growth, greater price stability, better payments equilibrium, and strengthened energy policies.” Also noteworthy is the conclusion expressed in the Annual Report of the Bank for International Settlements (issued in June 1978) that “the potential consequences of near-stagnation are sufficiently dangerous to warrant a concerted international effort to put the world economy back on a more satisfactory path of development.”

The problems in the world economy that have been the subject of so much concern in international financial institutions were confronted at the recent summit meeting held in Bonn, where leaders of the seven major industrial countries—Canada, the Federal Republic of Germany, France, Italy, Japan, the United Kingdom, and the United States—convened on July 16-17. In the communiqué issued at the end of the meeting, the governmental leaders announced agreement on “a comprehensive strategy covering growth, employment and inflation, international monetary policy, energy, trade, and other issues of particular interest to developing countries.” They went on to declare that, “We are dealing with long-term problems, which will only yield to sustained efforts. This strategy is a coherent whole, whose parts are interdependent.”

Particular concern was expressed about worldwide unemployment, and it was emphasized that improvement in growth was needed where that could be achieved without rekindling inflation. Improved growth, it was noted, would also reduce the extremes of balance of payments surpluses and deficits, reduce destabilizing exchange rate movements, and help to reduce protectionist measures.

The situation, it was indicated, called for “a program of different actions by countries that face different conditions” for the purpose of assuring steady noninflationary growth. In countries whose balance of payments position and inflation rate did not impose special restrictions, this program required a faster rise in domestic demand; where rising prices and costs were creating strong pressures, it would mean taking new measures against inflation. For each of the summit countries, the communiquè set forth specific policy initiatives or objectives.

In the area of trade, the leaders of these seven countries charged their negotiators in the Tokyo Round, in cooperation with other participants, to resolve the outstanding issues and to bring about a successful conclusion of the detailed negotiations by December 15, 1978. It was recognized, they said, that the products of developing countries required better access to the markets of their own countries, and they stated that in the years ahead the developing countries could count on them for an increased flow of financial assistance and other resources for development. They looked forward to working even more closely with the developing countries, and called for “joint action on the basis of shared responsibility” in order to derive the mutually reinforcing benefits of economic progress.

With respect to international monetary policy, the erratic fluctuations of exchange markets in recent months were said to have had a damaging effect on confidence, investment, and growth throughout the world. Essentially, exchange rate stability could only be achieved by attacking the fundamental problems which had contributed to the present large balance of payments deficits and surpluses. Implementation of policies in the framework of a concerted program would help to bring about a better pattern of world payments balances, leading to greater stability of exchange markets and, thereby, to improvement in confidence and in the environment for sustained economic growth. The leaders of the summit countries also stated that, although exchange rates needed to respond to changes in underlying economic and financial conditions among nations, their monetary authorities would continue to intervene to the extent necessary to counter disorderly conditions in the exchange markets and would maintain extensive consultations to enhance the effectiveness of these efforts. “We will support,” they said “surveillance by the International Monetary Fund to promote effective functioning of the international monetary system.”

If national authorities succeed in implementing a strategy around which the broad consensus outlined above has formed, prospects will be greatly enhanced for a more satisfactory rate of economic expansion throughout the world economy, within a pattern of differentiated growth rates among countries designed to reduce external payments imbalances and blunt the threat of rising protectionism without impeding further progress toward price stability. It should be emphasized, in accord with the Bonn communiquè, that such an improvement of basic underlying conditions would provide the essential foundation for greater stability of exchange markets, and that this stability would in turn help to achieve the higher growth rates desired and to improve the prospects for developed and developing countries alike.

1Apart from the roughness of these estimates, for reasons indicated above, it may be noted that the estimates reveal nothing, of course, about the utilization of capacity within industrial subgroups of the manufacturing sector—a matter of importance in any analysis of the current or prospective degree of pressure on resources. But the size of gaps shown by the estimates is all the more impressive in that potential output is defined in terms of a “normal” intensity of use of capital and labor sustainable over a long period of time, rather than in terms of the high intensity of such use at the peak of the cycle (as in most published indices of capacity utilization).
2This subsection is confined mainly to comments on fiscal and monetary policies. As discussed in the 1977 Annual Report (page 5), the complexity of current problems has led to an unusual degree of reliance on measures supplementary to these policies. Such measures embrace the wide variety of efforts being made by the industrial countries with respect to incomes policy, labor market policy, and various policies aimed at “structural” problems involving supply conditions, cost pressures, and levels of saving and investment.
3The stance of policies in the major industrial countries as described in the following passages may be affected significantly in some cases, especially for the period beyond 1978, by the policy initiatives or objectives announced by these countries in the communiqué issued after the summit conference in Bonn on July 16-17.
4Measured in terms of U.S. dollars, the global rate of increase in foreign trade prices accelerated sharply during the past two years, from 1½percent in 1976 to 9 percent in 1977, reflecting the swing from effective appreciation of the dollar in the former year to effective depreciation in 1977.
5The levels of all these balances for the industrial countries as a group, and of the U.S. current account balances shown in Table 7, have been revised considerably, compared with corresponding figures in previous Annual Reports, by a change in the definitions underlying the official U.S. balance of payments statistics (used in these compilations) to include reinvested earnings of direct investment enterprises among current account transactions. As a counterpart, net capital outflows from the United States and from the industrial countries as a group are increased by the same amounts (approximately $6 billion a year for the period covered in Tables 6 and 7) to include the reinvestments of the earnings in question.
6See footnote 5.
7Involving changes in reserves and in liabilities to foreign official agencies, as well as flows of funds recorded in the capital accounts of countries’ balance of payments statistics.
8Including the “errors and omissions” component of the balance of payments, in which changes often reflect unidentified capital movements.
9This development has been described and analyzed in The Rise in Protectionism, prepared by the Trade and Payments Division of the Exchange and Trade Relations Department, IMF Pamphlet Series, No. 24 (Washington, 1978).

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