Chapter

Chapter 1 Developments in the World Economy

Author(s):
International Monetary Fund
Published Date:
September 1980
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Introduction

During the period from the beginning of 1979 to the middle of 1980, the world economic situation was marked by three disturbing features. Rates of inflation in most countries remained very high and, indeed, accelerated; growth of real output in the industrial countries began to slow down markedly, threatening to halt the expansion of world trade and to turn into another international recession; and large surpluses and deficits re-emerged in the external balances on current account for major groups of countries, giving rise to widespread concern about the ability of some countries, particularly in the non-oil developing group, to sustain the financing of current account deficits on the scale projected. In varying degrees, the more than doubling of oil prices after the end of 1978 was a major factor in all three of these disturbing elements in the global economic picture.

However, not all aspects of the international economic situation at mid-1980 were disturbing. Rates of inflation in the industrial countries as measured by gross national product (GNP) deflators remained lower than those evidenced by consumer price indices or domestic expenditure deflators, signifying that secondary effects of higher import prices had not yet, at least, permeated the basic structures of domestic costs and incomes. The slowdown in economic activity, while in itself far from welcome, was undoubtedly tending to relieve some of the upward pressures on prices. Furthermore, the distribution of current account balances among the major industrial countries was less troublesome from the standpoint of international adjustment than in the previous sharp swing of the industrial group’s combined current account balance from surplus to deficit in 1974. At mid-1980, accordingly, the recycling of surplus funds from the oil exporting countries to the countries with large current account deficits appeared, by comparison with the earlier experience, to have proceeded with less intensive competition on the part of industrial countries for funds urgently needed by many non-oil developing countries. Also, exchange rate relationships among major currencies presented fewer difficulties in the past year or so than in the period 1974-75, even though changes in exchange rates for a few of the principal currencies were substantial.

Among the features of the world economic scene that have a disturbing character, the first and foremost is the prevailing rate of inflation in the industrial countries. The general level of prices has been rising much faster in most of those countries since 1970-72 than during the previous decade, despite the recession in 1975 and the moderate character of the economic recovery since then. As measured by GNP deflators, the average annual increases of domestic prices in industrial countries since 1972 have all been in the 7-12 per cent range, compared with an average of only about 4 per cent in the preceding decade. Moreover, there has been a widespread acceleration of inflation among industrial countries during the past year. As already noted (and discussed more fully below), the acceleration was considerably more pronounced in terms of final product prices entering into domestic expenditures than in terms of overall GNP prices, which do not reflect direct effects of price increases for imported goods. Import prices paid by the industrial countries rose faster in 1979 and the first half of 1980, mainly because of the oil price rise, than did domestic prices in those countries.

The prevailing high rate of inflation in the industrial world, as distinguished from the recent acceleration of inflation, is attributable to a variety of factors operative over a period of many years. In retrospect, a principal factor was the application of unduly expansionary fiscal and monetary policies, whose effects were compounded by structural rigidities of an economic and social character, as well as by periodic external shocks, in an economic environment that was a very difficult one for policymakers. The present stress on demand management policies aimed at containment of inflation and inflationary expectations attests to a conviction that reduction of the present high inflation is a precondition for renewal of domestic growth and achievement of international equilibrium.

Even before the onset of the present slowdown, the average rate of expansion of economic activity in the industrial countries since 1976 had remained fairly moderate. After the 1975 recession, it did not exceed 4 per cent in any of the past three years. Indeed, it dropped appreciably below that figure in 1979, reflecting the initial weakening of the U.S., U.K., and Canadian economies. (See Chart 1.) Given the recent signs of a cyclical downturn of economic activity in the United States, it is now expected that the average increase in output of the industrial countries in 1980 may be only about 1 per cent, encompassing outright declines for the United States and the United Kingdom, along with generally lower rates of expansion in the other industrial countries.

Chart 1.Major Industrial Countries: Growth of Real GNP/GDP, 1977-Second Quarter 1980

(In per cent)

For 1981 as a whole, a similarly low average rate of expansion would seem to be in prospect. Such factors as the absence of a boom in fixed investment preceding the current slowdown and an apparently satisfactory balance in the inventory positions of business enterprises should limit the degree and duration of the cyclical slowdown now under way, especially if rates of increase in consumer prices taper off as expected during the second half of 1980. However, it is extremely difficult to gauge the balance of expansionary and contractionary forces in the period ahead, and the possibility of international recession cannot be ruled out.

The most obvious aspect of the unbalanced pattern of external balances on current account that has emerged among major groups of countries is the rise in the current account surplus of the oil exporting countries. With the escalation of oil prices during 1979 and the first half of 1980, that surplus has again been building up rapidly, more or less as it did in 1974. As a group, the oil exporting countries are expected to have a current account surplus of some $115 billion in 1980, compared with $68 billion in 1979 and only $5 billion in 1978.1

Meanwhile, the combined current account balance of the industrial countries, having already shifted from a surplus of $33 billion in 1978 to a deficit of $10 billion in 1979, continues to move more deeply into deficit. For 1980, the deficit may well exceed $50 billion. Of the projected negative shift of more than $80 billion from 1978 to 1980, the bulk—more than $60 billion—will probably be concentrated in the accounts of the major industrial countries and, indeed, almost entirely in the three (the Federal Republic of Germany, Italy, and Japan) whose current account positions were strongest in 1978. However, the projected increase of the current account deficit of the smaller industrial countries to more than $20 billion may present more serious problems for some of them than are posed for the major countries by the larger swing in their accounts.

The non-oil developing countries, whose capital-importing economic structure was reflected in a current account deficit of $36 billion in 1978, incurred a $53 billion deficit in 1979 and will probably have one approaching $70 billion in 1980. Moreover, the deficit of this group will tend to rise considerably higher in 1981.

The ability of the non-oil developing countries to finance such deficits, while following appropriate adjustment policies, is one of the major issues confronting the Fund, as well as the countries themselves. In terms of magnitude, the surplus funds accruing to the oil exporting countries can be said to afford a source of sufficient financing, provided that the “recycling” process can be made to work smoothly enough. To do so, it will have to reconcile wide differences between the distribution of deficits among oil importing countries—especially the non-oil developing countries and the smaller industrial countries—and the distribution of initial placements of surplus funds by the oil exporters, mainly in financial institutions and capital markets of a relatively few industrial countries where such placements are feasible.

The debts and debt service obligations of many non-oil developing countries are already large, and the capacity and willingness of some countries to withstand the costs of still larger debts are widely questioned. At the same time, prudential considerations may inhibit continued expansion of lending to developing countries by some of the private financial institutions that comprise major outlets for funds placed abroad by the oil exporting countries. Such lending appears to be taking on a more selective character, and this tendency may become stronger in 1981. Unless satisfactory movements of loanable funds to the oil importing developing countries take place, curtailment of import growth by such countries is all too likely. Such curtailment would be a depressive influence on world trade, as well as a hindrance to domestic investment and growth in many of the developing countries.

For these reasons, the Fund has been giving active consideration to means that it might use to facilitate the movement of funds to countries that may not have sufficient access to funds from private sources. Many countries may require considerable time to carry out necessary structural adjustments, and may need both financial assistance from the Fund and the Fund’s help in devising realistic programs of structural adjustment. A considerable number of developing countries will also need larger concessional assistance of types provided by international institutions and national governments. Close cooperation among these various agencies is required at the present juncture in order to secure adequate coordination between the specialized assistance of development lending institutions or aid granting agencies and the general macroeconomic approach of the Fund’s operations.

As indicated in the foregoing summary, a pervasive factor in the present situation of the world economy is the influence of the oil price increases of 1979 and 1980. Fund staff estimates of the economic impact of these increases on current account balances, on prices, and on real economic activity have been presented, and the methodology has been described, in a recent publication.2 Highlights of those estimates are as follows:

(i) The estimated increase in the average price of oil from 1978 to 1980 (about $18.50 a barrel, from a little under $13 a barrel to $31.25 a barrel) implies a rise of about $170 billion in the export earnings of the group of oil exporting countries, plus another $20-odd billion in such earnings of non-Fund members and of non-oil developing countries that are net exporters of oil; the estimated additions to oil bills total something like $155 billion for the industrial countries as a group and about $35 billion for developing countries that are net importers of oil. These large flows are the principal generator of the estimated 1978-80 changes, noted above, in current account balances of major groups of countries, (ii) The direct impact of the estimated 1978-80 oil price change on prices (broadly, on the general level of domestic demand deflators) in the industrial and non-oil developing countries might be of the order of 4½ per cent, implying an addition to the annual rate of inflation averaging some 2¼ per cent for this two-year period—the timing of actual effects on inflation rates being uncertain. The estimate does not cover any indirect effects on final-product prices or on non-oil energy prices, (iii) The direct deflationary impact on aggregate demand outside the oil exporting countries that may be expected to result from a diversion into oil import payments of expenditures that would otherwise be directed toward other goods and services can be estimated at something like 2 per cent of GNP in the major groups of countries that are net importers of oil. This estimate relates to the short run and does not include any allowance for indirect or “multiplier” effects that might be associated with the expenditure diversion. With respect to both the price impact and the deflationary impact, effects will be larger or smaller depending on the nature of any policy response to the oil price increases on the part of the oil importing countries.

The recurrence of pressure on energy supplies and of substantial oil price increases during the past year and a half has underlined the need for vigorous pursuit of more effective energy policies in oil consuming countries. Efforts to conserve energy—especially oil—and to accelerate investment in both existing and potential energy resources and technologies will need to be intensified. Progress in energy conservation since 1974, although significant, has been impeded in many countries by policies with respect to taxation, regulatory issues, and related matters that, by blunting the impact of higher oil prices on oil consumers, have failed to provide appropriate price incentives for needed shifts in spending and resource allocations.

Diversification of energy production, so as to reduce dependence on oil, is still in a very early stage, partly because of inadequate incentives for substitution and environmental problems associated with some of the alternative sources of energy. Large-scale investments, involving long lead times, are likely to be required. Thus, long-run solutions for current energy problems should be based on careful appraisal of costs and risks, aimed at development of new energy supplies in both developed and developing countries, and at reorientation toward products and productive techniques that are less energy intensive. In the meantime, however, there is considerable evidence that reductions in energy demand obtained through appropriate pricing policies and other conservation measures can play an important role.

The remainder of this chapter provides a more detailed review of world economic developments, beginning with the evolution of domestic production, demand, prices, and policies and then dealing with international trade and payments. In both the domestic and the international sections of the discussion, separate treatment is given to major groups of countries. In this connection, it should be noted that the classification of countries utilized here differs from the one employed in previous Annual Reports,3 so that many of the key figures are not directly comparable with seemingly similar figures in earlier Reports. The last part of the chapter discusses some of the major economic policy problems now faced by member countries and then touches on issues raised by these problems for the Fund itself, focusing primarily on the intertwined role in payments adjustment and financing that the Fund must play in the period ahead.

Domestic Economic Developments and Policies

Industrial Countries

Inflation. The widespread worsening of inflation in the industrial countries during 1979 and the first half of 1980 exerted a generally unsettling influence on economic activity and policy formulation. Upward movements of prices in the industrial countries began to accelerate early in 1979, even before the main impact of that year’s increases in oil prices was felt. Following the decision of the Organization of Petroleum Exporting Countries (OPEC) at the end of June to introduce oil export prices substantially higher than those previously announced, further momentum was added to the upward trend as the higher oil prices were passed through to final-product prices in the oil importing countries during the second half of the year. The trend was also strengthened somewhat by a similar pass-through of price increases for a number of foodstuffs and other primary commodities whose prices were buoyant in the early or middle part of 1979. The rate of inflation of consumer prices in the industrial countries, which had averaged some 7-8 per cent per annum from 1976 through 1978, despite a decline in the real price of oil during that period, rose to an annual rate of about 13 per cent in the first half of 1980 (by comparison with the immediately preceding half year). Only in the first half of 1974 has a higher semiannual increase in consumer prices been recorded in the industrial countries during the past quarter century.

The acceleration in the first half of 1980 was not only unusually pronounced but also widespread. Almost every industrial country had a higher rate of inflation of consumer prices in the early months of 1980 than in 1978. Degrees of acceleration, however, were far from uniform from country to country. In Canada and some of the smaller European countries, the step-up in the pace of price advances was rather moderate. But unusually rapid increases in consumer prices—ranging up to 15 per cent or more at annual rates in the first half of 1980, although tapering off somewhat toward midyear—occurred in a number of countries, including the United States, the United Kingdom, and Italy. The dispersion of consumer price inflation rates among industrial countries, and particularly among the seven largest ones, has thus widened over the past year.

The generally high and uneven rates of inflation among the major industrial countries have been a source of difficulty in the conduct of policies relating to external payments positions and to the maintenance of stability in exchange markets. This situation complicates the task of achieving a general containment of worldwide inflation.

The consumer price indices reflect, of course, not only price changes of domestic origin but also changes in prices of imported goods and services. Although such indices are useful in the measurement of changes in real incomes of workers or households, they do not furnish a satisfactory basis for gauging underlying inflationary pressures within the industrial countries. For that purpose, requiring a focus on indigenous costs and incomes earned in domestic production of goods and services, attention is better directed toward GNP deflators.

Measured in terms of such deflators, which may be viewed as comprehensive indices of total domestic unit costs, the acceleration of inflation since 1978 has been much less pronounced, except in the United Kingdom, where prices of domestically produced oil affect the deflator, as well as the consumer price index. For the industrial countries as a group, the weighted average of increases in GNP deflators in 1979 exceeded the corresponding average for 1978 by only ¼of 1 per cent (7¾ per cent versus 7½ per cent, as shown in Table 1), and was virtually identical with the 1976 and 1977 figures. The slight acceleration from 1978 to 1979 (on a year-to-year basis) stemmed from a combination of continued deterioration of the price performance of the United States and an arrest or partial reversal of the previous trend toward lower rates of inflation in the other industrial countries.

Table 1.Industrial Countries: Changes in Output and Prices, 1963-79(Percentage changes)
AverageChange from Preceding Year
1963-7211973197419751976197719781979
Real GNP
Canada5.57.63.61.25.52.23.42.7
United States3.95.5−1.4−1.35.95,34.42.3
Japan10.510.0−0.61.56.55.46.06.0
France25.55.42.80.34.63.03.63.3
Germany, Fed. Rep. of4.54.90.4−1.85.32.63.54.4
Italy24.86.94.2−3.55.91.92.65.0
United Kingdom22.97.8−1.2−0.73.71.03.50.9
Other countries34.95.53.5−0.33.61.62.22.8
All industrial countries4.76.20.3−0.65.33.84.03.4
Of which,
Seven larger countries44.76.3−0.2−0.75.64.24.33.5
European countries4.55.71.9−1.14.42.33.03.4
GNP deflator
Canada3.69.215.210.89.57.06.310.3
United States3.65.79.49.65.26.07.38.9
Japan4.910.820.08.65.75.54.12.0
France54.87.711.213.19.79.19.79.6
Germany, Fed. Rep. of4.16.06.86.73.23.83.93.9
Italy55.011.718.317.418.018.914.115.1
United Kingdom55.16.714.927.214.313.810.614.4
Other countries35.69.512.413.110.610.19.18.0
All industrial countries4.37.412.111.37.67.67.47.7
Of which,
Seven larger countries44.17.112.011.07.07.17.17.7
European countries5.08.011.613.69.79.78.68.7

Compound annual rates of change.

GDP at market prices.

Include Australia, Austria, Belgium, Denmark, Finland, Iceland, Ireland, Luxembourg, the Netherlands, New Zealand, Norway, Spain, Sweden, and Switzerland.

As listed separately above.

GDP deflator.

Compound annual rates of change.

GDP at market prices.

Include Australia, Austria, Belgium, Denmark, Finland, Iceland, Ireland, Luxembourg, the Netherlands, New Zealand, Norway, Spain, Sweden, and Switzerland.

As listed separately above.

GDP deflator.

The tendencies evident during 1979 extended into 1980. For the first half of 1980, the GNP deflators for Canada, France, and the United States are estimated to have risen at annual rates of roughly 10 per cent, those for Italy and the United Kingdom at rates in the neighborhood of 20 per cent, and those for the Federal Republic of Germany and Japan at rates of less than 5 per cent. The weighted average increase for the seven major industrial countries was 9 per cent, compared with a 7½ per cent rate 12-18 months earlier. Although the individual rates in the first half of 1980 differed widely, most of them were significantly above the corresponding rates in the earlier period.

The limited movement of GNP deflators in the industrial countries during the current surge of inflation can be attributed primarily to the absence of any marked acceleration of wage advances. As of mid-1980, increases in compensation of employees remained moderate, relative to the experience of the period 1972-74, in both nominal and real terms. (See Chart 2.) Indeed, increases in hourly earnings in the manufacturing sectors of the industrial countries over the period since 1978 have not, on average, accelerated nearly as much as those in consumer prices. This experience contrasts with that of the period 1972-74, when rates of increase in wages accelerated markedly and almost concurrently with increases in consumer prices, especially in major industrial countries other than the United States.

Chart 2.Fourteen Industrial Countries: Hourly Re-muneration in Manufacturing and Consumer Prices, First Half 1971-First Half 1980

(Changes in per cent)1

1 Over preceding half year, seasonally adjusted annual rates.

At least since the early 1970s, wage movements in U.S. manufacturing industries, as shown in Chart 2, have demonstrated greater independence of short-term changes in consumer prices than have those in the other industrial countries. During the 1972-74 bulge in consumer prices, increases in U.S. industrial wages lagged considerably behind, so that real wages were eroded; but they subsequently “caught up” by continuing to accelerate for several quarters after the acceleration of consumer price increases had tapered off. A perhaps even more pronounced lag in responsiveness of U.S. wages to the changes in consumer prices since 1978 is again resulting in a cumulative shrinkage of real wages, building up the potential for another surge in wage demands and a period of unduly large wage increases. Averting such a development, however, has been one of the primary objects of public policy over the past year, not only in the United States but also in the other industrial countries. If such policy succeeds in containing the response of hourly earnings until the current bulge in consumer price increases has receded, subsequent moderation of wage demands should become easier.

For the industrial countries other than the United States, the average rate of increase in hourly earnings, in contrast to that in U.S. industry, has remained consistently above the average rate of increase in consumer prices, as generally warranted by the continuance of substantial productivity gains. However, the margin has been much narrower since 1976 than in the early 1970s (lower panel of Chart 2). Particularly in the European countries, de jure or de facto indexation has tended to preserve the increased labor share of real national income that resulted from the large wage gains of the early 1970s and the impact of the deep recession of 1974-75 on profits of enterprises. From the standpoint of investment incentives in the European industrial countries, avoidance of a renewed spurt in wages is essential to avert a further squeeze on profits.

A striking contrast between the United States and the other major industrial countries with respect to interrelationships of prices, wages, productivity, and profits over the past decade is suggested by the data shown in Chart 3. In the lower panel are plotted composite increases in unit labor costs (reflecting changes in both wages and productivity) and in deflators for value added in manufacturing for the six largest industrial countries other than the United States, along with the cumulative difference between these two sets of increases. It may be inferred from this difference that the labor share of value added rose sharply in the first half of the 1970s. Since 1975, it has tended to decline, but only gradually. It would appear that indexation (whether implicit or explicit) has limited the scope for adjustment to what was provided by a relatively small erosion of earlier real wage gains. In the United States, on the other hand, the implied labor share of value added in manufacturing has remained virtually stable since 1976 at about the pre-1974 level.

Chart 3.Fourteen Industrial Countries: Labor Costs in Manufacturing, First Half 1971-First Half 1980

(Changes in per cent)

1 Change from preceding half year, seasonally adjusted annual rate.

2 Cumulative change from average share for 1968-70.

Several features of the recent inflationary surge suggest that it may have reached a crest in the first half of 1980, provided that there are no further exogenous shocks and that the present stance of demand management policies is maintained. The increase in the real price of oil after the end of 1978 was perhaps the most important single factor in the late 1979 and early-1980 price acceleration. In the United States, for example, energy prices (dominated by oil) accounted for more than three fifths of the entire acceleration (amounting to about 4½ percentage points) in the consumer price index from the four-quarter period ended in March 1979 to the corresponding period a year later. Part of the acceleration in this case stemmed from a phased decontrol of domestic crude oil prices beginning in mid-1979. If increases in energy prices should taper off during the remainder of 1980, an important element in recent rates of inflation in the industrial countries would be removed. Temporary influences exerted by certain more specific factors, such as the increase in U.K. value-added taxation and the emergence of very high U.S. mortgage interest rates, also appear to be fading. If feedbacks of the spurt in consumer prices on wages and other incomes can be contained, there will be a good chance of significant abatement of the inflation of consumer prices. The fact that producer prices in the industrial countries rose less rapidly in the second quarter of 1980 than in the first quarter lends credence to this possibility.

Output and employment. Economic expansion in the industrial countries, which proceeded at a relatively modest pace under conditions of continuing high inflation after the 1975 recession, became somewhat more hesitant, on average, in 1979. That year’s increase in the real GNP of the industrial group as a whole slipped to per cent, compared with about 4 per cent in each of the preceding two years (Table 1).

During the first half of 1980, a more pronounced slowing of growth in total output of the industrial countries set in, and the short-term prospect at midyear was clearly one of marked deceleration, reflecting particularly the recession under way in the United States. A decline in national output of the United Kingdom is also in process, reflecting strong actions of the authorities in an effort to halt inflation and reorient economic priorities. In the other major industrial countries, and also in the smaller ones as a group, aggregate demand remained relatively buoyant through the latter part of 1979 and the first quarter of 1980, but is expected to weaken noticeably during the remainder of the year and to show a substantial deceleration for 1980 as a whole. In combination with the U.S. and U.K. downturns, decelerations elsewhere may well result in an overall increase in GNP of about 1 per cent from 1979 to 1980.

This worsening of growth performance and prospects reflects the increasing drag exerted by the negative impact of accelerated inflation on real incomes of large segments of the population, by the tightening of financial policies to choke off the inflation, and by the growing diversion of domestic expenditures into payments for imported oil.4 The roles of these and other factors have differed from country to country, as have the circumstances in which such influences have operated. Consequently, the strength and timing of responses evident in the various national economies have displayed considerable differences.

In particular, the course followed by the U.S. economy over the past year and a half has been dissimilar to the evolution of economic activity in most of the other industrial countries. Such an absence of parallel tendencies in the major industrial economies has helped to prevent the emergence of another boom during the recovery from the 1975 recession; and it may serve to limit the degree of the slowdown now in process.

In the United States, the past year and a half was a period of hesitation and eventual downturn. Growth of real GNP over the four quarters ended with the first quarter of 1980 amounted to 3½ of 1 per cent, reflecting substantial declines in expenditures on residential structures and motor vehicles. Aggregate outlays for all other types of goods and services (accounting for nearly nine tenths of GNP) increased by about 3 per cent over the same four quarters. It was the buoyancy of these latter components of aggregate demand that staved off a U.S. recession for almost a year. The strong performance of U.S. exports and continued buoyancy of fixed business investment contributed to the maintenance of aggregate demand, but the critical factor (without which it is doubtful that business investment would have been so well sustained) appears to have been the willingness of consumers to reduce their rate of saving in order to maintain the bulk of their consumption expenditures despite the inroads of consumer price inflation on their real incomes. The ratio of personal saving to disposable personal income in the United States dropped to 3½ per cent (an extraordinarily low rate in the perspective of recent decades) during the last quarter of 1979 and the first quarter of 1980, compared with about 5 per cent in 1977 and 1978, and with rates in the 6-8 per cent range during other years of the 1970s. A partial reversal of this dip in the personal saving rate appears to have occurred in the second quarter of 1980, when consumer demand weakened.

In contrast to the weakening of growth in real domestic demand and output in the United States during 1979 and early 1980, growth of output in most of the other industrial countries remained moderately buoyant—and growth of real domestic demand more so—through the early months of 1980. The principal exceptions were Canada (closely affected by U.S. developments) and the United Kingdom, where strong counterinfla-tionary policies were implemented in the spring of 1979. Elsewhere in the industrial world, and particularly in the Federal Republic of Germany, Italy, and Japan, the quickening of economic activity observed in 1979 generally persisted through the first quarter of 1980. Only in the months just before midyear did signs of standards of productivity growth in industrial countries during the period ahead will probably be much closer to the recent average rate (slightly less than 2 per cent per annum for the whole group of industrial countries) than to the average of 3½ per cent per annum over the past two decades.

It appears that the productivity slowdown has been rather pervasive not only internationally but also among broad economic sectors of each of the major industrial countries. Averages computed for each of five sectors (industry, agriculture, commerce, government services, and other services) in those countries indicate that rates of increase in productivity in every sector except government services 5 were lower by 1-2 percentage points in the period 1976-78 than in the period 1960-73. The overall difference was not especially concentrated in particular sectors, nor did it reflect significant shifts in the relative importance of sectors with different rates of gain in output per unit of labor. Explanation of the productivity slowdown, therefore, would seem to depend primarily on such generalized factors as lower rates of capital accumulation, shifts in the composition of the labor force, changed work attitudes and habits, higher energy costs, and inflation.

Stance of policies. In an economic environment featuring strong upward momentum of prices, extensive indexation of nominal incomes, unsettled expectations, and the latest increases in the price of oil and other energy products, the authorities of virtually all the industrial countries accorded top priority in 1979 and the first half of 1980 to the containment of inflation. This priority was reaffirmed in the communiqué issued at the conclusion of the April 25, 1980 meeting of the Interim Committee of the Fund’s Board of Governors in Hamburg, which—after expressing “great concern at the dramatic and widespread rise in rates of inflation since its meeting in Belgrade”—went on to state that “the Committee agreed that the top priority being given in many countries to the fight against inflation must not be relaxed” and that “... success in reducing inflation was considered a condition for better investment performance and resumption of satisfactory growth over the longer term.”

The views embodied in the foregoing quotation stemmed from a widespread conviction that inflation must be brought under better control as soon as possible and reduced substantially over the medium term and longer term, despite the short-run costs, in terms of forgone output and employment, that might be incurred through the necessary actions. Most national authorities in the industrial countries have come to believe that the risks involved in this approach are less threatening than the danger, otherwise posed, that economic developments in the 1980s might be marred by periodic interruptions of growth such as those engendered by the inflationary spurts of the 1970s.

In most of the industrial countries, the priority assigned to combating inflation found its principal expression in the monetary sphere, where policies were tightened appreciably during 1979 and the first part of 1980, rather than in fiscal measures. Nominal interest rates rose progressively throughout most of 1979 and escalated sharply further in early 1980. The increases were especially sharp in the United States in the aftermath of actions taken by the monetary authorities on two occasions, first in October 1979 and then in March 1980. By March, short-term interest rates in the United States averaged some 17½ per cent, compared with 10 per cent a year earlier.

During the middle part of 1979, increases in yields on financial assets denominated in deutsche mark and in sterling were rising faster than U.S. rates. Although these increases stemmed from anti-inflationary monetary policies, they had the incidental effect of putting upward pressures on interest rates in other countries. In late 1979 and early 1980, it was the escalation of U.S. rates that constituted the main source of such pressures—again as a by-product of the effort to check domestic inflation. The cumulative result was a rapid further upward spiraling of yields on financial claims throughout the industrial world. By Match 1980, short-term rates in each of the major industrial countries were some 5-8 percentage points above corresponding levels a year earlier. (See Chart 13.) While long-term government bond yields were also generally higher, these showed somewhat lesser increases (2½-5 percentage points).

Although inflation was also accelerating during the period indicated (and generating expectations that doubtless contributed to the upward movements of interest rates), it was considerably outpaced in most countries by the increases in nominal interest rates. The rise in real interest rates thus implied represented a pervasive new restraining influence on borrowing and spending.

The rise in interest rates reflected, in addition to the acceleration of inflation, the generally declining path traced—under restrictive monetary policies—by rates of expansion of the principal monetary aggregates in nearly all the industrial countries since 1978. On a year-over-year basis, the average growth of broadly defined stocks of money in the major industrial countries, after having risen from 11 per cent in 1977 to 12 per cent in 1978, receded to a little less than 11 per cent in 1979. Moreover, the rise during the course of 1979 was still slower, dropping back to less than 10 per cent for the first time since the late 1960s.

The deceleration of growth in narrowly defined money stocks (Chart 13) was even more pronounced, as holdings of these tended to be discouraged by the escalation of interest rates, which favored shifts into higher-yielding financial assets. During the course of 1979, the average rate of expansion of narrow money holdings in the major industrial countries was only 6 per cent, compared with 11 per cent during the preceding year.

Official targets for expansion of monetary aggregates in 1980 imply a continuing shift toward greater restraint. In no case have announced targets been adjusted upward to reflect or accommodate the unexpected price shocks of the past year. Rather, targets established earlier have been reaffirmed or even lowered. In some countries, moreover, actual rates of expansion of key monetary aggregates in the early part of 1980 dropped below targeted ranges or toward the lower ends of those ranges. Given the additional increases in nominal values of economic transactions likely to result from the unexpectedly high rates of inflation in the period under discussion, the degrees of monetary expansion now contemplated are likely to exert even more significant restraint than originally envisaged.

On the other hand, the marked slowing of real economic activity that became apparent in the second quarter of 1980 is bringing new forces to bear on financial markets. Easing of demands for credit and declines of interest rates from recent peaks may well alter the setting for growth of monetary aggregates as the year progresses. Indeed, striking developments of this type have already occurred in the United States, where the sudden drop in demands for bank credit occasioned by the onset of the current U.S. recession led both to a rapid fall in interest rates—by some 8 percentage points for short-term assets—and to an outright decline in the stock of money. This decline occurred without any shift in the basic stance of policy as enunciated in official statements and embodied (essentially through actions of the monetary authorities) in growth of bank reserves.

The extraordinarily sharp movements in U.S. interest rates over the past year stem in part from a shift in the operating techniques of the Federal Reserve System from primary emphasis on interest rate objectives to primary emphasis on bank reserves. As a result of this change, random or unexpected financial disturbances now tend to be absorbed more extensively, in the first instance, by changes in interest rates, and less fully than heretofore by changes in monetary aggregates. Such tendencies make for noticeably more variability of U.S. interest rates than has usually been observed in the past, and may pose some new difficulties, at least transitionally, with respect to international capital flows and foreign exchange markets.

Shifts toward restraint in the design and application of fiscal policy during 1979 and early 1980, as noted above, were generally less marked than those with respect to management of money and credit. On the whole, fiscal positions in the industrial countries in 1979 differed relatively little from those in 1978. Such changes as were introduced, however, were mostly in the direction of less expansionary policies.

A somewhat more general swing toward restrictive policies is evident in the central government budgets of the industrial countries for 1980, but such shifts have remained cautious. Most of the budgets (translated into calendar 1980 terms) have called for reductions in deficits of the central governments, typically by amounts equivalent to something like ¼—½of 1 per cent of GNP. However, given the projected slowdown in growth of real GNP in most of these countries from 1979 to 1980, the relatively modest changes contemplated in the fiscal balances as ordinarily projected may translate into contractionary impulses of some consequence on a cyclically adjusted basis.

Despite the shifts away from fiscal stimulus, most of the 1980 budgets still involve sizable deficits. For ten of the larger industrial countries, including all seven of the largest, fiscal information available on a relatively uniform basis indicates a weighted average deficit on the order of 3½ per cent of GNP in 1980. Although that average is below the peak recorded in 1975 (5½ per cent of GNP), each of the national figures encompassed is about twice as high (in proportion to GNP) as the largest corresponding deficit incurred in any of the three years immediately preceding 1975.

Except notably for the United States, where the central government deficit has declined markedly in relation to GNP since 1976, the deficits of most industrial countries have either remained near the levels of that year (as percentages of GNP) or tended to increase—in some cases rather substantially. This circumstance makes it difficult for the countries concerned, even if abatement of inflation should soon begin, to contemplate fiscal countermeasures against deflationary tendencies. The threat of rekindling price pressures will remain imminent for some time and maintenance of control over monetary aggregates will generally continue to call for restraint of public sector deficits, especially where private saving has declined noticeably. For the near term, these constraints may mean that fiscal policy can prudently go no further in a number of countries than to permit the working of the so-called automatic stabilizer mechanisms and to strengthen “supply” policies, such as those providing fiscal incentives or support for restructuring of energy use and production.

Developing Countries

From 1978 to 1979, average rates of expansion of real output in most of the developing countries were relatively modest in historical perspective (See Table 2) Available evidence suggests that the results to be expected for 1980 may be no better, on average, although important exceptions among individual countries or particular groups of countries will doubtless be apparent again. The moderately weak growth record of 1979 was widely accompanied by accelerated rates of inflation (Table 2), and data for the first part of 1980 imply another year of exceptionally rapid average increases in consumer prices among developing countries.

Table 2.Developing Countries: Changes in Output and Prices, 1967-79(Percentage changes)
AverageChange from Preceding Year
1967-7211973197419751976197719781979
Real GDP
Oil exporting countries29.010.78.0−0.312.16.22.72.9
Oil sector13.2−1.0−11.113.32.1−4.23.0
Non oil sectors9.712.312.411.19.37.32.8
Non-oil developing countries35.96.75.54.45.55.15.04.7
By area
Africa5.03.86.92.94.91.72.72.6
Asia4.96.23.96.56.26.86.93.5
Europe46.85.84.04.47.55.74.03.5
Middle East6.44.88.81.86.86.37.9
Western Hemisphere6.88.47.33.04.74.44.76.3
By analytical group
Net oil exporters55.97.46.25.14.83.65.87.2
Net oil importers5.96.55.34.35.65.34.94.2
Major exporters of manufactures67.79.66.93.56.45.15.46.3
Low-income countries74.03.52.96.13.25.34.3−0.1
Other net oil importers5.54.54.94.26.35.84.63.9
Consumer Prices
Oil exporting countries28.011.317.018.816.615.49.711.0
Non-oil developing countries39.320.327.227.924.027.023.429.1
Africa4.59.715.415.113.216.914.820.3
Asia5.515.127.310.60.17.85.910.3
Europe47.913.118.414.912.416.122.328.7
Middle East3.912.722.123.420.718.721.026.6
Western Hemisphere13.332.235.352.055.151.141.748.7
Non-oil developing countries excluding
six high-inflation countries87.813.323.316.213.519.316.221.1
Africa4.09.514.914.511.014.312.515.6
Europe8.012.518.813.510.912.212.316.3
Middle East2.78.913.414.416.012.110.612.5
Western Hemisphere12.513.825.423.227.634.529.036.6

Compound annual rates of change.

Comprise Algeria, Indonesia, Iran, Iraq, Kuwait, Libyan Arab Jamahiriya, Nigeria, Oman, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela. This group includes only those countries whose oil exports (net of any imports of crude oil) both account for at least two thirds of the country’s total exports and are at least 100 million barrels a year (roughly equivalent to 1 per cent of annual world oil exports). These criteria are at present applied to averages for 1976-78.

Include all Fund members not mentioned in footnote 2 or in Table 1 (except the People’s Republic of China), plus certain essentially autonomous territories for which adequate statistics are available. The regional subgroups conform to the classification in International Financial Statistics.

Comprises Greece, Malta, Portugal, Turkey, Yugoslavia, Cyprus, and Romania.

Comprise Bahrain, Bolivia, Congo, Ecuador, Egypt, Gabon, Malaysia, Mexico, Peru, the Syrian Arab Republic, Trinidad and Tobago, and Tunisia.

Include Argentina, Brazil, Greece, Hong Kong, Israel, Korea, Portugal, Singapore, South Africa, and Yugoslavia

Thirty-nine countries whose per capita GDP, as estimated by the World Bank, did not exceed the equivalent of US$300 in 1977

Excluded here are six relatively large developing countries (Argentina, Chile, Ghana, Israel, Turkey, and Zaïre) for which rates of inflation are estimated to have been at least twice as high as the respective averages for the areas in which they are located for any of the years covered in this table.

Compound annual rates of change.

Comprise Algeria, Indonesia, Iran, Iraq, Kuwait, Libyan Arab Jamahiriya, Nigeria, Oman, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela. This group includes only those countries whose oil exports (net of any imports of crude oil) both account for at least two thirds of the country’s total exports and are at least 100 million barrels a year (roughly equivalent to 1 per cent of annual world oil exports). These criteria are at present applied to averages for 1976-78.

Include all Fund members not mentioned in footnote 2 or in Table 1 (except the People’s Republic of China), plus certain essentially autonomous territories for which adequate statistics are available. The regional subgroups conform to the classification in International Financial Statistics.

Comprises Greece, Malta, Portugal, Turkey, Yugoslavia, Cyprus, and Romania.

Comprise Bahrain, Bolivia, Congo, Ecuador, Egypt, Gabon, Malaysia, Mexico, Peru, the Syrian Arab Republic, Trinidad and Tobago, and Tunisia.

Include Argentina, Brazil, Greece, Hong Kong, Israel, Korea, Portugal, Singapore, South Africa, and Yugoslavia

Thirty-nine countries whose per capita GDP, as estimated by the World Bank, did not exceed the equivalent of US$300 in 1977

Excluded here are six relatively large developing countries (Argentina, Chile, Ghana, Israel, Turkey, and Zaïre) for which rates of inflation are estimated to have been at least twice as high as the respective averages for the areas in which they are located for any of the years covered in this table.

Almost all developing countries have been affected during the past year or so by both the intensification of inflation in the industrial countries and the recent slackening of growth in those countries. But external factors, notably the higher cost of energy, have affected individual developing countries in different ways and to different degrees. Since these countries also face a wide range of problems of domestic origin, great variety is evident in their policies and programs.

In recognition of this diversity, emphasis is placed below on selected groups and subgroups of developing countries, rather than on any averages or aggregates covering the entire group. The discussion begins with the oil exporting countries, whose present position in the world economy is unique, and then deals with the much larger group of non-oil developing countries, stressing key distinctions among several analytical or regional subdivisions within that group.

Oil Exporting Countries

During 1979 and the first part of 1980, after several years of adjustment following the oil price increases in 1973-74, the financial resources of the oil exporting countries were again greatly enlarged as a result of increases in oil prices. Use of these resources to promote the long-run development of their economies is, of course, a major objective of these countries. However, the pace at which many of them can usefully reinvest oil export earnings in domestic development is constrained by both economic and other considerations. Particular constraints against unduly rapid further absorption have developed in countries where high rates of domestic expansion in recent years have been made possible by rapid growth of the expatriate labor force. In some cases, the resulting high proportions of foreign workers in the labor force have made continuation of this process undesirable in the view of the national authorities.

The authorities of several oil exporting countries have been relatively successful over the past few years in implementing policies aimed at eliminating the excess demand conditions that existed in the mid-1970s. They are now concerned with avoiding a renewed buildup of inflationary pressures or re-emergence of supply bottlenecks such as those experienced a few years ago. Moreover, some of the countries that had current account deficits in 1978 have been utilizing part of their recently increased financial resources to build up foreign exchange reserves or to reduce reliance on external debt.

For these reasons, most of the oil exporting countries have been pursuing considerably more restrained demand management policies in 1979 and early 1980 than those implemented following the oil price increases in 1973-74. Some relaxation of financial policies, however, became evident in several countries as the expansion of financial resources available to them proceeded. Among the actions taken were additions to previously strict budgetary appropriations, easing of import restrictions imposed earlier by a few countries, and steps to foster the expansion of credit to the private sector by bolstering the liquidity of commercial banks.

These policy responses had little impact on economic activity in 1979, both because the shift toward somewhat more expansionary policies took place mostly in the latter part of the year and because of lags in implementation or in reactions of the private sectors. For most of the oil exporting countries, accordingly, rates of expansion in their non-oil sectors remained similar to those in 1978. A major exception, however, was Iran, where economic activity was severely impaired. As a result, the average rate of growth in real non-oil gross domestic product (GDP) for the whole group of oil exporting countries (in which Iran has a large weight) declined from more than 7 per cent in 1978 to about 3 per cent in 1979.

Present indications are that the recent shift toward somewhat more expansionary policies will be maintained throughout 1980. Thus a recovery of growth in aggregate non-oil GDP of the oil exporting countries to at least the 1978 rate would seem probable, particularly if economic activity in Iran does not weaken further. Since the absorptive capacity of several countries in the group has been greatly increased during the past half-dozen years, no emergence of significant excess demand conditions is likely to result from this development. In combination with another sizable increase in import prices, however, the firming of domestic demand in the oil exporting countries is expected to bring a moderate rise in the average rate of inflation (as measured by changes in consumer price indices) in 1980. That rate had already risen slightly in 1979, following three years of appreciable decline (Table 2).

Except in 1979, non-oil GDP of the oil exporting countries has risen much faster in real terms in every year since the early 1970s than the average for total GDPs of other developing countries. However, because of the relative stability in the volume of oil production, this has not been true of the overall average rate of economic growth in the oil exporting countries. In 1978 and 1979, that rate has been on the order of 2½-3 per cent, and the 1980 figure seems likely to be even lower, reflecting an expected decline in output of oil and the heavy weight of the oil sector in total GDP of these countries. However, in terms of a measure such as real national income, which takes account of changes in the terms of trade, the economic gains of the oil exporting countries since 1978 have been quite large.

Non-Oil Developing Countries

This section undertakes to summarize domestic economic developments, as reflected in rates of growth and inflation, in developing countries other than those included in the oil exporting group. In view of the great diversity of the 110 countries covered here,6 generalizations regarding their economic problems and policies are difficult. Comments on these issues are based largely on various analytical or geographic subdivisions of the main non-oil group.

For the group as a whole, the average rate of economic growth in the past several years—while holding up better than that of the industrial world—was lower than during the late 1960s and early 1970s. Since 1976, this average rate has hovered around 5 per cent per annum, compared with about 6 per cent in the period 1967-72. The difference, although seemingly moderate, must be viewed with concern in the light of two related considerations—the rapid population growth characteristic of this group of countries (averaging some 2½ per cent per annum) and their urgent need for accelerated improvement of real incomes. The shortfall of recent growth rates below the average of the late 1960s and early 1970s is proportionately larger on a per capita basis than in the aggregate, and therefore correspondingly more disturbing. Available information for the first half of 1980 does not suggest any real improvement, apart from gains in agricultural output that might be expected to result from a return to normal weather conditions in southern Asia, where the conditions were particularly adverse in 1979.

Two common denominators are now tending to limit growth prospects for many non-oil developing countries. Increased costs of oil and other essential imports are eroding the real value of both export earnings and borrowed funds; and the slowdown in the industrial world, where the principal export markets of the developing countries are found, is constraining the scope for expansion of export volume. With prices for most types of export also sensitive to demand conditions and rates of inflation in major trading partners, a generalized slowdown of the kind now in process must be expected to exert an inhibiting influence of some importance on productive activity in many developing countries. Such activity, it must be emphasized, also responds to many influences originating within the developing countries themselves, imparting great diversity to the paths followed by their economies.

The disappointing overall growth rate of the non-oil developing countries over the past several years comprises an uneven distribution of gains among various subgroups of those countries. In 1979, the average for the whole group was bolstered by strong advances in a small number of countries that are net exporters of oil (although they do not meet the criteria used in this Report for inclusion in the main oil exporting group7). Aided by the financial resources accruing from their oil exports, the dozen countries in the oil exporting subgroup achieved in 1979 an average increase of 7 per cent in real GDP, in contrast to an average of only 4 per cent for the great majority of developing countries that are net importers of oil.

Within the oil importing group, moreover, a disproportionate share of the increase in output in 1978-79 was attributable to a subgroup of 11 middle-income countries whose exports of manufactures have become relatively large. Output of this group, stimulated in part by continuing gains in its exports of manufactured goods, showed a percentage increase half again as large as the average for all oil importing developing countries. (See Table 2.)

By far the weakest growth performance among the subgroups of non-oil developing countries listed in Table 2 was that of the low-income countries, which together appear to have achieved no growth at all in 1979. Reflected in this stagnation of the subgroup’s aggregate output, however, was a negative change in India, which accounts for 45 per cent of the total for the subgroup (and for 58 per cent of its population). India’s output was depressed in 1979 by the impact of exceptionally bad weather on agricultural production.

For the 38 low-income countries other than India, most of which are relatively small, real growth remained positive in 1979, averaging a little more than 2 per cent, but left no margin for per capita income gains. This relative weakness of the low-income countries was by no means new, as their growth rates have lagged appreciably behind those in other major groups of non-oil developing countries throughout the period since the mid-1960s.

This record provides, of course, part of the explanation why the countries in question are in the low-income category. A more basic explanation, however, is to be found in the low rates of investment characterizing most countries in this group. Apart from India, the low-income countries as a group have used resources equivalent to only about 14 per cent of their relatively small output for investment purposes. Such a ratio stands in marked contrast to an average of 20-23 per cent for all non-oil developing countries and compares even more unfavorably with an investment ratio of 23-25 per cent for the major exporters of manufactures in the group.

Very low rates of domestic saving have been associated with the low average investment ratio of 14 per cent. Indeed, they represent in many cases one of the crucial limiting factors with respect to investment.

Largely because it is difficult to raise domestic saving ratios where per capita incomes are very low in relation to basic consumption requirements, the low-income countries are extraordinarily dependent on resources from foreign governments and international agencies for any increase in their capacity to raise investment outlays and growth rates. The importance of additional concessionary financing for these purposes is clear. Under existing circumstances, indeed, a number of low-income countries may need additional external assistance even to maintain present rates of investment and growth.

Regionally, the concentration of low-income countries in Africa is reflected in a particularly weak average growth record for that area in recent years. Even with the improvement that accompanied the return to more favorable weather conditions in 1979, particularly in the Sahel region of West Africa, the average growth rate for the African area remained below 3 per cent. Below-average expansion was also registered in the European developing countries, and a further slowdown for them appeared to be under way in the first part of. 1980. Restraint of domestic demand is urgently needed in some of these countries, for both internal and external reasons; and most of them will be strongly affected by the deceleration of economic activity now in process in the European industrial countries. Another area in which aggregate output of non-oil developing countries rose less than the average in 1979 was Asia. This result, however, reflected the temporary depression of India’s output by unfavorable agricultural conditions, as noted earlier. Growth in other Asian developing countries remained fairly strong in 1979, although not so strong as during the three preceding years. In general, mainly because of policies, Asia has had the best record on growth and prices among the regions over the past several years.

The regions of strongest growth in 1979 were the Middle East and the Western Hemisphere. In the Middle East, this result reflected the continuing impact of rapid expansion in the non-oil sectors of most neighboring oil exporting countries during recent years. For the Western Hemisphere group, a sharp cyclical recovery in Argentina and maintenance of growth rates in the other large countries of the area, including Brazil, outweighed weaker performances in some of the smaller Latin American and Caribbean countries.

In the non-oil developing countries, as in the industrial countries, a clear tendency toward higher rates of inflation emerged in 1979. For the entire group, the average rise in consumer prices in 1979 approached 30 per cent, compared with about 24 per cent in 1978. For both years, the average was markedly affected by a few extremely high national rates of inflation in relatively sizable countries. When these are excluded (as in lines 8-11 of Table 2), the averages for 1978 and 1979 are appreciably lower (16 per cent and 21 per cent, respectively), but the degree of acceleration is virtually the same.

Much of this recent acceleration can be attributed to higher import prices stemming from faster inflation in industrial countries and from the rise in oil prices since the end of 1978. However, domestic factors also exerted a significant influence in the same direction. In many of the non-oil developing countries, fiscal conditions have remained expansionary in the face of widespread supply shortages; and for the group as a whole, the weighted average rate of increase in stocks of money in 1979 continued to exceed by a wide margin the corresponding average for earlier years of the 1970s. It is clear that financial policies in many of these countries have been more expansionary than might be considered desirable from the standpoint of combating inflation, thus reinforcing, rather than offsetting, the inflationary pressures of external origin. At the present time, there is little basis for expecting any slackening of price increases in this group of countries for 1980.

As in the past, rates of inflation in 1979 varied widely among individual non-oil developing countries and regional groups. Exclusive of the high-inflation cases mentioned above (and in Table 2), regional averages of consumer price advances from 1978 to 1979 ranged from about 10 per cent in Asia and 12 per cent in the Middle East to more than 35 per cent in the Western Hemisphere. The acceleration of price increases in 1979, however, was pervasive. In none of the regional or analytical subgroups shown in Table 2 was the consumer price increase lower than the one recorded for 1978. The prevalence of such high rates of inflation represents a serious deterrent to the expanded domestic saving needed to maintain investment and growth in the current adverse circumstances.

International Trade and Payments

Overview

World trade developments since 1978 have featured large changes in prices and terms of trade, coupled with moderate expansion in volume through 1979 but with signs of a marked slowing during 1980. The average increase in foreign trade prices (unit values) from 1978 to 1979 was about 18½ per cent in terms of U.S. dollars (15 per cent in terms of SDRs), and even larger increases appear to be in process for 1980. (See Tables 3Table 4)

Table 3.World Trade Summary, 1962-791(Percentage changes in volume and in unit value of foreign trade)
AverageChange from Preceding Year
1962-7221973197419751976197719781979
World trade3
Volume913−5125
Unit value (U.S. dollar terms)23½40½9291018½
(SDR terms)4212½39½87815
Volume of trade
Imports Industrial countries12½2−8½144
Developing countries
Oil exporting countries921½37½421914−11½
Non-oil developing countries612½8−4588
Exports Industrial countries913½−4½1156
Developing countries
Oil exporting countries912½−1−1114½−3½2
Non-oil developing countries73½1410½
Unit value of trade in SDR terms4
Imports Industrial countries211½38½8815
Developing countries
Oil exporting countries21127½511
Non-oil developing countries21445½78115½
Exports Industrial countries21022½10½712
Developing countries
Oil exporting countries327½202½11½−6½42½
Non-oil developing countries2233½−310½11−312½

Figures are rounded to the nearest ½of 1 percentage point.

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.

Figures are rounded to the nearest ½of 1 percentage point.

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.

Table 4.Terms of Trade Developments, 1962-791(Percentage changes)
AverageChange from Preceding Year
1962-7221973197419751976197719781979
Industrial countries−1−11−1−13
Developing countries
Oil exporting countries115137−51−10½28
Non-oil developing countries−1−8−9½3−4−2½
Reference: World trade prices (in U.S. dollar
terms) for major commodity groups3
(a) Manufactures317½2212½914½14½
(b) Oil440½226649
(c) Non-oil primary commodities
(market prices)5528−181220−516

Based on foreign trade unit values.

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 oil export unit values of the oil exporting countries; and (c) the International Financial Statistics index of market quotations for non-oil primary commodities.

Based on foreign trade unit values.

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 oil export unit values of the oil exporting countries; and (c) the International Financial Statistics index of market quotations for non-oil primary commodities.

Mainly because of the large price increases, the total value of world trade rose more sharply in 1979 than in any other year since 1974 (when an even more explosive upsurge of foreign trade prices took place). Because manufactured goods constitute the dominant component of trade flows, the price component of the increase in world trade from 1978 to 1979 stemmed mainly from the accelerated general inflation of prices for exports of such goods; but the year’s large percentage change in oil prices also contributed importantly to the total rise in value. Prices of primary commodities other than oil rose slightly faster than those of manufactured goods in 1979, but not by a wide enough margin to prevent a 2½ per cent deterioration of the terms of trade of the non-oil developing countries.

Although price movements dominated the 1978-79 rise in world trade values, the growth of volume in that year was the strongest since 1976—6½per cent, compared with 5-5½per cent in the two intervening years (Table 3). All of these recent yearly gains, however, were relatively modest by past standards. Over the decade ended in 1972, for example, the volume of world trade expanded at an average annual rate of 9 per cent.

The expansion of trade volume from 1978 to 1979 was rather strong in relation to the concurrent moderate and somewhat faltering growth of aggregate demand in the industrial countries, which are the principal markets for internationally traded goods. A major factor in the relatively high elasticity relationship thus implied was the strength of investment demand and the achievement of comparatively good domestic growth records during the past year by the European industrial countries, whose imports are relatively large in relation to domestic output. Japan’s import demand was also quite strong in 1979. The slowdown in the United States dampened U.S. import growth substantially, but the United States has a much lower weight in the trade of the industrial countries than in their total output.

The outlook for growth of world trade volume in 1980 and 1981 is poor. Developments during the first half of 1980 seem to presage a year-to-year gain no more than half the size of the increase in 1979, and real growth of world trade during the course of the current year may well prove virtually flat, if not declining. These discouraging prospects stem, of course, from the influence of the U.S. recession and the probable slowdown in other major industrial countries on global import demands. The only import demands expected to remain buoyant throughout 1980 are those of the oil exporting countries.

As of mid-1980, two factors seemed likely to limit the severity of the current setback to world trade growth. First, the difference between the cyclical position of the U.S. economy and the positions of most of the other major industrial economies has already cushioned the impact of the initial phase of the U.S. slowdown; and nonsynchronization of the respective positions in subsequent phases of adjustment to cyclical influences may help to prevent a sharp decline in the volume of world trade. Second, the onset of the current slowdown was not preceded by a massive buildup of inventories in the industrial countries, as was the 1974-75 recession, and this circumstance should militate against any sharp swing to inventory liquidation.

The sharp alterations of current account balances of major groups of countries from 1978 to 1980, summarized in the introductory section of this chapter and delineated more fully in Tables 5 and 7, are manifestations, in the main, of the foreign trade price movements and terms of trade shifts just described. Differential rates of growth in domestic economic activity have also played a part, and may have a larger role in the near future. In particular, the main impact of the current cyclical slowdown on non-oil developing countries may not be felt until 1981. However, the principal influence of differential cyclical phasing to date has been its impact upon the distribution of the combined current account balance of the industrial group among individual countries within that group (discussed in the next section of this chapter), rather than upon the balances of the respective major groups.

The main counterpart of the rise in the current account surplus of the oil exporting countries from 1978 to 1979 was a large swing from surplus to deficit in the current account balance of the industrial countries, which are the principal importers of oil, and a further substantial deterioration is in prospect for 1980. Although there was also a sizable adverse swing in the combined balance of the non-oil developing countries in 1979, the bulk of the current account deficit of that group, as in previous years, reflected the basic capital importing structure of their balance of payments relationships with the rest of the world. These countries are deficient in national saving—in relation to their domestic investment outlays—and have long depended on substantial inflows of capital and aid to cover this gap. Partly because many of them have always tended to stretch their borrowing capabilities to supplement meager domestic resources, the incurrence of current account deficits in 1979 and 1980 that exceed the normal structural levels is creating problems of a difficult and painful nature. Since the additional borrowing entailed is not, generally speaking, bringing a significantly larger inflow of real resources, the developmental capabilities of many non-oil developing countries are being seriously constrained. (The situation of these countries is reviewed in a later section of this chapter.)

Although the industrial countries are absorbing the bulk of the current account shift engendered by the rising surplus of the 12 oil exporting countries, their capacity to withstand the deterioration of their external positions is far greater than that of most non-oil developing countries for two obvious reasons. First, their greater wealth and higher real incomes mitigate the hardship entailed in any reduction of growth in real income; and second, the initial placement of the bulk of the surplus funds accrued by the oil exporting countries in financial institutions and markets in the industrial countries means that the latter, as a group, encounter no particular difficulty in financing their collective current account deficit. However, the inflow of capital and reserve funds from the oil exporting countries tends to be concentrated in a few of the main financial centers, or in affiliated banking enterprises, so that flows to individual industrial countries are not necessarily well matched with the shifts in their respective current account positions. These individual shifts are being affected, of course, by differing cyclical conditions and domestic energy positions.

If the international trade and payments mechanism is to function smoothly in dealing with the major structural adjustments now in process, the financial inflows received in various forms from the oil exporting countries—in the first instance chiefly by financial institutions in a few large industrial countries—must be redistributed in such fashion as to bring a satisfactory matching of net capital movements with current account balances. Such redistribution, both within the industrial group and toward non-oil developing countries, was accomplished predominantly by private financial institutions and markets in the period 1974-75, and the bulk of the rechanneling of funds now needed will doubtless be handled in similar fashion. Indeed, a very large shift in the pattern of balances from 1978 through mid-1980 has already been accommodated, for the most part, through private financial intermediation. This has not occurred, however, without strains; and these may intensify as the imbalances on current account continue and the claims of investing institutions on borrowers in heavily indebted countries build up. Under these conditions, a clear need for public and international financial institutions to assume a larger role in the intermediation may well emerge.

Various aspects of the role of private financial institutions in the process of global financial intermediation are brought out in Chart 5 and (on a somewhat different statistical basis) in Table 6. The chart, based on aggregations of national balance of payments records, points up the great expansion from the early 1970s to the middle 1970s in the proportion of total outflows of capital from the industrial countries that took the form of banking claims (including claims of one industrial country on another). After a pause in 1977, the growth in relative importance of banking transactions among capital outflows from the industrial countries accelerated again in 1978 and 1979.

Table 5.Payments Balances on Current Account, 1973-801(In billions of U.S. dollars)
197319741975197619771978197919802
Industrial countries19.3−11.617.9−0.5−4.133.4−9.8−50
Seven larger countries14.1−3.823.09.09.336.12.9−29
Other countries5.2−7.8−5.1−9.6−13.4−2.7−12.7−21
Developing countries
Oil exporting countries6.667.835.040.031.95.068.4115
Non-oil developing countries−11.5−36.9−45.9−32.9−28.6−35.8−52.9−70
By area
Africa−2.1−4.8−9.1−8.2−6.2−7.0−4.9
Asia−2.6−9.9−8.8−3.4−1.5−5.6−13.5
Europe0.3−4.4−4.8−4.2−7.5−5.1−9.3
Middle East−2.3−4.4−6.6−5.3−4.9−5.7−7.9
Western Hemisphere−4.8−13.3−16.5−11.8−8.5−12.4−17.4
Total314.419.37.06.6−0.82.65.7−5

On goods, services, and private transfers. For the industrial countries, alternative current account balances including official transfers are given for the years 1976—79 in Table 8. Projected 1980 balances including official transfers are—$75 billion for the industrial countries as a group,—$51 billion for the seven larger countries, and—$24 billion for the other industrial countries. 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 the industrial countries, alternative current account balances including official transfers are given for the years 1976—79 in Table 8. Projected 1980 balances including official transfers are—$75 billion for the industrial countries as a group,—$51 billion for the seven larger countries, and—$24 billion for the other industrial countries. 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.

Chart 5Industrial Countries: Changes in External Assets and Liabilities, Bank and Nonbank Components, 1967-79

(In billions of U.S. dollars)
Table 6.International Banking: Global Sources and Uses of Funds, 1976-791(In billions of U.S. dollars)
1976197719781979
Sources
Changes in
Gross liabilities96114194264
Interbank deposits363410588
Net liabilities608089176
Of which, to residents of
Industrial countries2305158113
Oil exporting countries1213736
Non-oil developing countries14112016
Other countries, including n.e.o.345411
Uses
Changes in
Gross claims106110215218
Interbank deposits4363410588
Net claims7075110130
Of which, on residents of
Industrial countries231434570
Oil exporting countries910187
Non-oil developing countries24133243
Other countries, including n.e.o.3691510
Memorandum item: Net sources (+)/uses (—) of international banking funds
Industrial countries29334−3
On account of
Residents10−521−46
Nonresidents−181343
Oil exporting countries33−1129
Non-oil developing countries−10−2−12−27
Other countries, including n.e.o.3−2−4−111

The figures in this table, being taken from records of banks as reported to their respective national authorities, are not necessarily fully consistent with the balance of payments statistics summarized in Tables 7 and 8. In principle, however, changes in banking claims on, and liabilities to, nonresidents, as shown above, are components of the capital flows shown in the other two tables. For classification of countries in groups shown here, see Tables 1 and 2.

Including branches of U.S. banks in the main offshore banking centers.

In addition to countries not specified above, or amounts unallocated, this item includes any mismatching of assets and liabilities ensuing from the assumption noted in footnote 4.

Assumed equal to the BIS measure of such interbank deposits from the liability side.

The figures in this table, being taken from records of banks as reported to their respective national authorities, are not necessarily fully consistent with the balance of payments statistics summarized in Tables 7 and 8. In principle, however, changes in banking claims on, and liabilities to, nonresidents, as shown above, are components of the capital flows shown in the other two tables. For classification of countries in groups shown here, see Tables 1 and 2.

Including branches of U.S. banks in the main offshore banking centers.

In addition to countries not specified above, or amounts unallocated, this item includes any mismatching of assets and liabilities ensuing from the assumption noted in footnote 4.

Assumed equal to the BIS measure of such interbank deposits from the liability side.

Largely because of the scale of intercountry movements of both banking funds and other capital within the industrial group itself, the scale of gross inflows recorded by the industrial countries (lower panel of Chart 5) has increased broadly in parallel with the rise in outflows. The liability side of the international banking accounts of the industrial countries was somewhat less expansive than the asset side in the middle 1970s, but more so in 1979 as bank deposits of oil exporting countries were routed partly to residents of the industrial countries whose banks received the deposits.

Table 6, based directly on banking statistics (as compiled from national sources by the Bank for International Settlements) rather than on balance of payments records, undertakes to separate interbank deposits from the gross changes in claims and liabilities of banks in the industrial countries and in certain so-called offshore banking centers. The changes in net claims and net liabilities, thus measured, are more revealing than the gross flow data as regards sources and uses of funds channeled internationally through private banks. The table shows a geographical breakdown of the funds obtained by reporting banks from sources other than banks in the reporting areas, along with a similar distribution of net lending (excluding deposits with other banks inside the reporting areas).

The fact that every group of countries listed in the table has both substantial placements with the reporting banks and substantial loans from them attests to the size, scope, and flexibility of the intermediary facilities provided. Here, it is noteworthy that the only group with a consistent record of either net placements in or net borrowing from the reporting banks over the past four years is the group comprising non-oil developing countries. In combination, these countries were net borrowers in each of the years 1976-79, even though various countries in the same group were also an important source of funds for the reporting banks, mainly through placements of official reserves. The particularly heavy net use of international banking funds by non-oil developing countries in 1979, it may be noted, comprised some reduction in the gross placement of deposits, as well as a major expansion of borrowing from the reporting banks.

Each of the other three groups of countries listed in Table 6 has a recent history of being, on a net basis, sometimes on the depositing side of the international banking accounts and sometimes on the borrowing side. Contrasts in the direction of net international movements of banking funds from year to year illustrate the flexibility of the channels thus provided. In 1976, for instance, the net movement was mainly from residents of the industrial countries (through banks in their own respective countries), and secondarily from oil exporting countries, to non-oil developing countries. In 1978, however, the oil exporting countries as well as the non-oil developing countries drew on funds raised entirely in the industrial countries. In 1979, the industrial countries as a group joined the non-oil developing countries in drawing on funds originating in the oil exporting countries. The 1979 data also show a notable movement of funds to residents of some industrial countries, through banks in their own countries, from residents of other industrial countries. All the corresponding movements are likely to be larger in 1980, reflecting a larger cash surplus to be placed by the oil exporting countries and increased demand for credit by deficit countries. Even if those countries find nonbank outlets for a higher proportion of their investible funds, placements with international banking institutions are likely to show a considerable increase, with attendant potential for strains on the banks’ capacity to reroute such funds in a fashion mutually satisfactory to themselves and their customers.

Industrial Countries

Swings in Current Account Balances

Apart from the large swings in the current account balance of the industrial countries as a group, discussed earlier in this chapter, a number of shifts in the distribution of individual balances within the group have occurred in recent years. The shifts since 1978 have been conditioned mainly by the sharp rise in oil import payments (against the background of differing positions with respect to the role of imported oil in total use of energy), by contrasting cyclical positions, and, in several cases, by effects of major changes in demand policies and in exchange rates.

Since 1975, the dominant swings within the group of industrial countries have been those in the U.S. current account balance, first from a large surplus to a large deficit while the combined balance of the other industrial countries was moving into substantial surplus, and then—since 1978—back toward balance or surplus over a period in which current account balances of other industrial countries were again, in the aggregate, shifting into deficit. The amounts involved in these partly reciprocating swings were quite large, even in terms of the calendar-year statistics shown in Table 8; and they were considerably larger in terms of annual rates for the extreme quarters of each phase. In the second phase of these swings, the combined current account balance of industrial countries other than the United States deteriorated by some $90 billion, from a surplus of about $40 billion in 1978 to a deficit equivalent to roughly $50 billion at an annual rate in the first half of 1980.

Table 7.Global Balance of Payments Summary, 1976-79(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

Changes

in Reserve

Assets
Industrial countries31976−13.012.5−0.5−4.6415.410.2
1977−17.613.5−4.13.3438.738.0
19788.724.833.4−21.6429.241.1
1979−36.126.3−9.813.84−12.2−8.1
Oil exporting countries3197665.3−25.340.0−31.38.85
197761.6−29.731.9−21.610.35
197841.1−36.15.0−11.6−6.65
1979110.4−42.068.4−46.921.55
Non-oil developing countries31976−26.9−6.0−32.941.44.312.8
1977−22.3−6.2−28.640.10.411.9
1978−29.7−6.1−35.853.30.718.2
1979−42.6−10.3−52.963.90.211.0
By analytical group3
Net oil exporters1976−4.3−2.8−7.16.61.30.8
1977−3.2−3.4−6.58.52.0
1978−3.5−3.7−7.28.31.1
1979−1.0−6.0−7.010.13.1
Net oil importers1976−22.7−3.2−25.934.93.012.0
1977−19.1−2.9−22.031.50.59.9
1978−26.2−2.3−28.645.10.717.1
1979−41.6−4.4−45.953.80.18.0
Major exporters of1976−12.6−0.2−12.917.81.96.8
manufactures1977−7.6−0.4−8.011.80.54.3
1978−9.3−0.1−9.420.40.211.2
1979−19.1−1.8−20.923.9−0.82.2
Low-income countries1976−2.9−1.3−4.16.7−0.12.5
1977−2.7−0.5−3.26.4−0.32.9
1978−6.1−0.4−6.58.0−0.11.4
1979−8.4−0.9−9.411.10.21.9
Other net oil importers1976−7.2−1.7−8.910.41.22.7
1977−8.8−2.0−10.813.30.22.7
1978−10.9−1.8−12.716.70.64.6
1979−14.0−1.7−15.618.80.73.9
Total, all countries6197625.4−18.86.65.419.731.7
197721.7−22.4−0.821.839.160.2
197820.1−17.42.620.129.952.7
197931.7−26.05.730.8−12.024.4

This balance is computed residually as the difference between the balance financed by changes 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, SDR allocations, valuation adjustments, 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 changes in reserve assets of the oil exporting countries as reported here are based on reserve asset holdings as reported in International Financial Statistics. Large additional changes in holdings of external financial claims by official agencies of the oil exporting countries are included in the column “Capital Account Balance” of this table. The dividing line between capital movements and reserve asset changes remains uncertain for some oil exporting countries.

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. Some of 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 Tabic 18 of this Report) were assumed to have been placed in industrial countries, then the adjusted net capital outflows from those countries would amount to $12.8 billion, $13.6 billion, $24.4 billion, and—$11.2 billion over the years 1976, 1977, 1978, and 1979, respectively.

This balance is computed residually as the difference between the balance financed by changes 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, SDR allocations, valuation adjustments, 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 changes in reserve assets of the oil exporting countries as reported here are based on reserve asset holdings as reported in International Financial Statistics. Large additional changes in holdings of external financial claims by official agencies of the oil exporting countries are included in the column “Capital Account Balance” of this table. The dividing line between capital movements and reserve asset changes remains uncertain for some oil exporting countries.

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. Some of 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 Tabic 18 of this Report) were assumed to have been placed in industrial countries, then the adjusted net capital outflows from those countries would amount to $12.8 billion, $13.6 billion, $24.4 billion, and—$11.2 billion over the years 1976, 1977, 1978, and 1979, respectively.

Table 8.Industrial Countries: Balance of Payments Summaries, 1976-79(In billions of U.S. dollars)
Balance onCapital Account Balance
TradeServices

and

private

transfers
Current

account

excluding

official

transfers
Total1Long-Term

capital

and

official

transfers
Other2Changes in

Liabilities

to Foreign

Official

Agencies

3
Balance

Financed by

Changes

in Reserve

Assets
Memo:

Current

Account

Including

Official

Transfers
United States1976−9.318.28.9−19.5−19.70.313.12.54.5
1977−30.921.0−9.9−24.9−17.8−7.235.40.6−14.1
1978−33.824.2−9.6−22.9—14.6−8.331.1−1.4−14.3
1979−29.434.04.56.6—19.726.3−13.6−2.5−0.6
United Kingdom1976−6.45.7−0.7−0.1−0.50.4−0.6−1.4−2.1
1977−3.55.01.613.23.59.71.916.7−0.3
1978−2.37.04.7−6.9−8.41.5−2.1−4.3 :1.5
1979−6.35.9−0.42.2−10.112.30.42.2−4.8
Canada19761.7−5.7−4.04.58.0−3.50.5−3.9
19772.9−7.1−4.12.93.7−0.9−1.3−4.1
19783.4−7.8−4.44.32.61.7−0.1−4.6
19793.8−8.3−4.43.73.7−0.7−4.3
France1976−4.6−0.2−4.81.8−2.84.60.2—2.8−5.9
1977−2.71.1−1.62.3−0.73.0−0.60.2−3.0
19780.74.55.2−2.1−4.52.40.33.43.8
1979−1.64.83.20.7−7.17.80.14.01.5
Germany,197615.2−7.97.2−3.5−4.30.70.23.93.6
Fed. Rep. of197718.4−10.57.9−4.7−9.44.81.64.84.0
197823.2−10.313.0−2.8−5.73.03.213.58.6
197914.7−15.1−0.4−1.9−0.2−1.6−0.3−2.6−6.3
Italy1976−4.22.7−1.62.8−1.03.70.71.9−2.8
1977−0.14.34.21.6−0.72.4−0.65.22.5
19782.96.39.2−2.3−1.5−0.8−3.63.36.4
1979−1.09.38.3−5.5−2.5−3.0−1.11.65.1
Japan19769.8−5.84.0−0.2−1.00.83.83.7
197717.1−5.911.2−4.6−3.6−1.06.610.9
197825.3−7.318.0−7.8−13.96.110.217.6
19791.8−9.6−7.9−5.0−13.58.5−12.9−8.7
Other industrial1976−15.25.6−9.69.6−0.810.41.71.8−10.8
countries41977−18.95.5−13.417.47.59.91.15.2−15.0
1978−10.88.1−2.718.9−2.521.50.416.6−4.7
1979−18.05.4−12.713.0−3.016.02.32.7−14.7
Total industrial1976−13.012.5−0.5−4.6−22.1517.415.410.2−13.7
countries1977−17.613.5−4.13.3−17.4520.738.738.0−19.1
19788.724.833.4−21.6−48.6527.129.241.114.2
1979−36.126.3−9.813.8−52.5 566.312.2−8.1−32.8

See Table 7, footnote 1.

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

See Table 7, footnote 2.

Australia, Austria, Belgium-Luxembourg, Denmark, Finland, Iceland, the Netherlands, New Zealand, Norway, Spain, Sweden, and Switzerland.

See Table 7, footnote 6.

See Table 7, footnote 1.

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

See Table 7, footnote 2.

Australia, Austria, Belgium-Luxembourg, Denmark, Finland, Iceland, the Netherlands, New Zealand, Norway, Spain, Sweden, and Switzerland.

See Table 7, footnote 6.

The countries sharing most heavily in this shift were Japan, with a deterioration of well over $30 billion (in terms of annual rates) and the Federal Republic of Germany, with a deterioration of more than $20 billion. (See Chart 6). For the remaining industrial countries (still apart from the United States), the combined adverse movement in the recent period (on the order of $35 billion) was only slightly larger in nominal terms than the one from 1973 to 1974, despite the escalation of world trade values in the interim.

Chart 6Major Industrial Countries: Payments Balances on Current Account, Including Official Transfers, 1975-First Quarter 19801

(In billions of U.S. dollars)

1 Seasonally adjusted, annual rates.

Certain features of recent changes in the current accounts of industrial countries stand in noteworthy contrast to those in 1974. On the earlier occasion, the largest adverse changes among major industrial countries occurred in the accounts of countries (especially Italy and the United Kingdom) whose external positions at that time were already relatively weak, while the current account balance of the Federal Republic of Germany, already in substantial surplus in 1973, rose considerably further in 1974, notwithstanding the increase in that country’s oil import payments. The result was an intensification of pre-existing pressures on external payments positions within the group of industrial countries, resulting in protracted instability in exchange markets. Since 1978, on the other hand, the largest adverse changes in current accounts have occurred in those that were most strongly in surplus in 1978, while the U.S. position—one of the weakest among major industrial countries in that year—has improved substantially despite a greatly increased oil import bill. These results have conformed broadly to the strategy enunciated by the Interim Committee of the Fund’s Board of Governors at its April 1978 meeting and by the governmental leaders’ meeting at the Bonn “summit” in July of that year.

Differences in the pace and timing of economic expansion since the 1975 recession have accounted in large part for the foregoing developments. Cumulative growth of real domestic demand in the United States from 1975 to 1978 exceeded that in the other six large industrial countries by some percentage points, but the difference was more than reversed from 1978 to the first half of 1980. The main elements in the reversal were brisk increases in real domestic demand in Japan and the Federal Republic of Germany at a time of very little increase in the United States.

Particularly for Japan and the United States, lagged effects of sizable changes in exchange rates (discussed below) appear to have contributed significantly to the current account changes since 1978. Largely because of the sharp appreciation of the effective rate for the yen in 1978, Japan’s share of world export markets for manufactured goods declined substantially in both 1978 and 1979. Although effects of the weak export performance on Japan’s current account balance were masked in 1978 by a large improvement in the terms of trade, they were reinforced in 1979 by reversal of that terms-of-trade gain as the exchange rate for the yen dropped rapidly from its 1978 peak. Growth in the volume of U.S. exports, in contrast, was strong throughout 1978 and 1979, outpacing market growth by wide margins in both years and recouping the export market losses of the two years preceding the 1977-78 depreciation of the dollar. The dollar depreciation also played a part in the virtual arrest of growth in the volume of U.S. imports in 1979, as well as in certain elements of the rapid rise in the U.S. surplus on external service transactions (notably those involving tourism).

With respect to recent changes in current account balances of major industrial countries other than Japan and the United States, the influence of exchange rate changes is much less apparent. The country most affected by that factor since 1978 is the United Kingdom, where the substantial effective appreciation of sterling has contributed to a sharp deterioration of international price competitiveness and a marked weakening of the U.K. trade performance in manufactured goods. Rising production of North Sea oil has offset this weakness, although it has also contributed to the appreciation of sterling; and the impact of declining domestic demand on the volume of imports should provide a further offset in 1980. Canada’s terms of trade and current account position are also benefiting, relative to most of the other industrial countries, from virtual self-sufficiency with respect to oil.

The current account balances of France and Italy continued to show fairly sizable surpluses in 1979, although their terms of trade and trade balances began to weaken in the latter part of the year, largely in reflection of rising oil import prices. In both cases, substantial further movements in the same direction appeared to be in process in the first half of 1980. The terms of trade and trade balance of the Federal Republic of Germany are being similarly affected, and that country’s current account, unlike that of either France or Italy, includes a large and growing deficit on services and private transfers, as well as the largest net outflow of official transfers of any industrial country. Inclusive of all transfers, its current account showed a deficit of $5.7 billion in 1979, contrasting markedly with the surpluses of previous years; and a larger deficit is in prospect for 1980.

When account is taken of the adverse movement in the terms of trade for the major industrial countries as a group during 1979, of the size and variability of each country’s current account balance in relation to its own economy, and of the medium-term history and typical structure of its external accounts, the main shifts from 1978 to the first half of 1980 can be characterized as follows. Clearly, the largest favorable shift has been that in the U.S. current account, which was weak in 1978 but is now relatively strong (partly for cyclical reasons), notwithstanding the dimensions of U.S. oil imports. Canada’s position has also improved, although less dramatically, in the comparative sense of being relatively well sustained over a period of markedly adverse change for most of the industrial countries. In a similar relative sense, the external current account positions of the United Kingdom and France, both moderately strong in 1978, can be considered to have been fairly well sustained to date. The positions of the three other major industrial countries have been substantially modified since 1978. The Federal Republic of Germany, Japan, and Italy, which had the largest surpluses in the major industrial group at that time, have shifted to the opposite end of the spectrum. For these three countries, even the estimated balances of transactions with countries other than the oil exporters deteriorated from 1978 to the first half of 1980. The unfavorable cyclical situations (from the standpoint of external balances) and the comparatively low rates of inflation in the Federal Republic of Germany and Japan, however, provide considerable assurance against undue weakening of the external current accounts of those two countries.

The large increase since 1978 in the combined current account deficit of the smaller industrial countries, to which brief reference has been made, has been somewhat less uneven than the pattern of changes among the major industrial countries. With few exceptions, the 14 smaller countries in the group had sizable current account deficits in 1979, and most of these will doubtless be larger in 1980. Norway, whose current account is moving into surplus because of North Sea oil production, and Switzerland, which apparently remains in surplus, are exceptions. In addition, Australia and the Netherlands, because of their energy endowments, are not sharing in the adverse movement. Among the other smaller industrial countries, the magnitude of adverse shifts from 1978 to 1979 generally reflected the extent of each country’s reliance on imported oil. Most of these countries are likely to undergo further marked deterioration in their external payments accounts in 1980, partly for the same reason and partly because the expected slowdown of economic activity in the larger industrial countries will tend to stifle growth in demand for exports of the smaller ones.

Financing of current account deficits was not a serious problem for the smaller industrial countries in 1979, nor did it become particularly difficult for any of them in the first half of 1980. Given the strong reserve positions of many countries in this group, their favored credit status in international financial markets, and the current liquidity of those markets, the smaller industrial countries appear better equipped to deal with the emerging situation than most developing countries. Nevertheless, a number of the smaller industrial countries may face a need for substantial adjustments of their external positions over the medium term.

Exchange Rate Developments

The period since the exchange crisis of October 1978 nas been one of broad—although by no means uninterrupted—stability of effective exchange rates for most of the major currencies.8 Exceptions are the pound sterling, which appreciated by some 19 per cent from November 1978 through mid-July 1980, and the Japanese yen, which depreciated even more rapidly through early April 1980 but recovered appreciably during the next three months.

In retrospect, October 1978 can be viewed as a significant turning point in the trends of exchange rates for most of the major currencies, and in the general tenor of the foreign exchange markets. For the currencies of the United States, Canada, and Italy, it marked the transition from an extended period of depreciation (in terms of effective exchange rates) to a period of relatively little net change in either direction. In mid-July 1980, each of these three currencies was within 2 percentage points of its average value (on an effective-rate basis) in November 1978. This leveling off contrasted with depreciations in the range of 10-18 per cent for the same currencies over a preceding period of roughly similar length, from January 1977 to November 1978.

For the pound sterling, the sequence of trends before and after October 1978 was the reverse. Nearly two years of relative stability preceded that date, while the appreciation noted above followed it. With respect to the Japanese yen, the contrast between the two periods was even sharper, the depreciation of the 17 months ended in April 1980 having been preceded by an effective appreciation of nearly 50 per cent during 1977 and the first 10 months of 1978.

Only the French franc and the deutsche mark, among major currencies, can be said to have continued since October 1978 to display roughly the same tendencies evident in the previous two years. Gradual appreciation of the deutsche mark and a virtually unchanging effective rate for the French franc remained features of the exchange markets. (See Chart 11.)

On the whole, the tone of those markets was appreciably less discordant during 1979 and the first half of 1980 than in the two years prior to the October 1978 watershed, although since that date substantial intervention has at times been necessary to prevent wider fluctuations. Except for the pound sterling, no major currency showed a larger change in external value during the recent period than during the earlier one, and the virtual absence of cumulative change in effective rates for several key currencies signifies an improved climate for foreign exchange transactions. In this respect, the stability of the U.S. dollar—except for a brief period of temporary appreciation while U.S. interest rates were rising to their recent peaks in the early months of 1980—was particularly important.

In considerable part, the improved climate in foreign exchange markets stemmed from the extensive realignment of current account balances of the three largest industrial countries, discussed above. Capital flows, however, also continued to play an important—and sometimes dominant—role in foreign exchange markets, and such flows were geared, during much of the past 18-20 months, to nominal interest differentials that were generally stabilizing. In the main, such differentials tended most of the time to neutralize differences in rates of inflation and in market expectations regarding future exchange rate movements. In many cases, particularly among the smaller industrial countries, this neutralization was a reflection of monetary policies aimed, inter alia, at precisely that result. A broad pattern of correspondence between interest rates and degrees of inflation was thus apparent.

In recent months, the foregoing relationships between differentials in interest rates and those in rates of inflation have again broken down as far as relationships involving the U.S. dollar are concerned. The precipitous drop in U.S. interest rates accompanying the onset of the U.S. recession, while understandable in terms of the Federal Reserve System’s emphasis on monetary aggregates, has left U.S. rates noticeably below those of other major industrial countries at a time when inflation differentials, in themselves, would still seem to call for an opposite relationship. The drop in U.S. interest rates, however, appears to be part of a cyclical evolution that will probably add substantial strength to the U.S. current account, at least for the time being. Market recognition of this linkage may prevent exchange market disturbances of the type that the inverted interest differentials might otherwise tend to induce.

A feature of exchange market developments during the past year and a half was the introduction of the European Monetary System (EMS) in March 1979. The EMS arrangements, described in last year’s Annual Report, appear to have functioned without undue strains on the participating countries to date. Tensions have arisen from time to time among the currencies involved in these arrangements, particularly during the second half of 1979, when the deutsche mark was rising substantially against the U.S. dollar and a number of other currencies. Under such circumstances, it became difficult for some of the weaker currencies in the group to be kept within the agreed band. In the latter part of 1979, however, adjustments were made in exchange rate relationships among the participating currencies, and tensions eased during the next several months.

When developments of the past 18 months with respect to exchange rates of the major industrial countries are viewed in combination with changes in the most closely relevant price relationships, as in Chart 7, it is clear that the principal changes in international price competitiveness (i.e., in “real” effective exchange rates) have been those for Japan, whose international competitive position has markedly improved, and for the United Kingdom, whose competitive position has considerably worsened since 1978. In the longer-term perspective of the past decade, these recent changes in price competitiveness for Japan and the United Kingdom are seen to be essentially reversals of earlier swings in the competitive positions of both countries. By far the most noticeable cumulative movements over the longer period, as shown in the chart, are the marked improvements in the competitive positions of the United States and Canada, along with the opposite shift in the position of the Federal Republic of Germany. France and Italy, like Japan and the United Kingdom (although with much less pronounced swings in the intervening years), have finished the decade with real effective exchange rates not very different from those at the beginning.

Chart 7Major Industrial Countries: Relative Costs and Prices of Manufactures, Adjusted for Exchange Rate Changes, 1971-Second Quarter 19801

(Indices, 1973 = 100)

1 Indices of the type shown here are frequently referred to as indicators of real effective exchange rates.

2 Annual deflators for gross domestic product originating in manufacturing with quarterly interpolations and extrapolations (beyond the latest available annual data) based on wholesale price data for raw materials and manufactures.

3 Hourly compensation divided by potential “output per man-hour.”

Oil Exporting Countries

Since the early 1970s, the current account balance of the oil exporting countries has displayed much wider variations than the corresponding balances of the other groups of developing countries discussed below. The current account surplus of the oil exporting group rose from about $7 billion in 1973 to $68 billion in 1974, declined irregularly to $5 billion in 1978, and then surged up again, to $68 billion in 1979. It is expected to rise further in 1980, to about $115 billion, and to remain large for some time. The difference between the projected 1980 figure and the previous peak in 1974 corresponds roughly to the general increase in world trade prices over the intervening period. In real terms, therefore, the 1980 surplus would be broadly similar in magnitude to the one recorded in 1974.

The degree of adjustment apparent in the balance of payments record of the oil exporting countries from 1974 to 1978 was notable both for its size and for its contradiction of expectations held at the beginning of the period. The most important single factor in this adjustment was a sharp rise in imports, which more than doubled in volume. Net payments for services and remittances by expatriate workers also became very large. The capacity of the oil exporting countries to absorb real resources from the rest of the world thus proved much stronger than had been anticipated. In addition, two other factors contributed to the shrinkage of the current account surplus. The terms of trade of the oil exporting countries declined by some 11 per cent over the period 1974-78 (mainly in the last of those years); and the volume of their oil exports stagnated because of expanding oil production in other areas and weak demand in major importing countries.

Another aspect of the change in the combined current account surplus of the oil exporting countries from 1974 to 1978 was that it became more unevenly distributed. By 1978, 6 of the 12 countries in the group, after accounting for more than one third of the 1974 surplus, had moved into deficit and were borrowing substantial sums in international capital markets. In contrast, the other 6 countries still had surpluses (aggregating about $20 billion) in 1978.

In 1979, the sharp rise in oil export prices—averaging nearly 50 per cent on a year-to-year basis—restored surpluses in the external current accounts of all except 2 of the countries that had been in deficit in 1978. However, more than half of the 1979 increase in the combined surplus of the 12 countries accrued to the ones that had remained consistently in surplus, as their share of the whole group’s oil exports rose with the fall in Iranian oil production. Some of these countries, because of international considerations, are producing oil at rates higher than their authorities consider desirable over the longer run from the standpoint of their own economic interests. Another important factor in the resurgence of the oil exporters’ current account surplus in 1979 was the interruption of growth in the volume of their imports, which had already tapered off considerably during the preceding three years in reflection of policy shifts toward restraint of domestic demand in a number of countries. Mainly because of the sharp drop in Iran’s imports, the aggregate volume of the group’s imports declined by about 11 per cent in 1979.

Oil export prices at the end of 1979 were much higher than the average for that year, since they had increased in a succession of changes beginning on January 1 and recurring intermittently throughout the year. In addition, all the oil exporting countries increased their prices further during the first two months of 1980 (in most cases, retroactively to the beginning of the year), and again in April or May. Large price increases introduced by countries that are not included in the oil exporting group have also contributed to the rise in the average world oil export price since 1978. By mid-1980, after additional adjustments of prices following the June OPEC meeting, the average price of oil exported by the oil exporting countries had reached roughly $32 per barrel. In the absence of further major changes,9 the full-year average would exceed that of 1979 by some 65 per cent and would be about times the corresponding average for 1978.

In terms of aggregate oil export values, part of the increase in oil prices from 1979 to 1980 is expected to be offset by a decline of about 11 per cent in the volume of oil exports from the oil exporting countries. The expectation of such a decline reflects the prospect of a substantial fall in world oil consumption coupled with a further rise in oil production outside the oil exporting group. Other expected offsets to the 1980 increase in oil prices include a marked upturn in the volume of merchandise imports of the oil exporting countries and a significant rise in net payments for services and private transfers, notwithstanding the prospective enlargement of inflows of investment income earned on external financial assets.

The prospect of an upturn in imports stems partly from the general shift toward more expansionary policies by most of the oil exporting countries since the latter part of 1979 and from an easing of import restrictions by some of them. The absence of certain exceptional factors that held down the aggregate imports of the group in 1979 will also be a major factor.

Current account surpluses seem likely to accrue to all the oil exporting countries in 1980. However, the major share of the projected overall increase is again expected to be recorded in the accounts of the six countries that have remained consistently in surplus throughout the 1970s. Although there are no grounds for expecting that imports and other current account payments by these six countries will rise at significantly different rates from those of the other countries in the oil exporting group, such payments are likely to remain smaller in proportion to the value of oil exports in the case of the “surplus” countries, reflecting the fact that they now account for more than two thirds of the total volume of exports supplied by the whole group.

Beyond 1980, the present outlook suggests a stronger persistence of large current account surpluses for the oil exporting countries than in the years immediately following the oil price rise in 1973-74. As noted earlier, financial policies and domestic economic expansion in the oil exporting countries seem likely to remain more moderate than in the previous period. Also, the tighter balance of oil supply and demand now in prospect is expected to militate against decline in the terms of trade.

In 1979, the net cash inflows available for disposition by the oil exporting countries rose substantially less than their current account surplus, primarily because of a shift in oil sector capital transactions and secondarily because of a decline in external borrowing. The latter development reflected the improvement of current account positions, particularly of the countries in the group that had recorded deficits in 1978, while the main element of the shift in oil-sector capital transactions was an increase in accounts receivable for oil exported but not yet paid for. This increase, stemming from the prevalence of much higher oil prices toward the end of 1979 than a year earlier, would have been considerably larger if credit terms on oil exports had not been reduced from 60 days to 30 days by most of the oil exporting countries during 1979. In 1980, a different relationship of the net cash inflow to the current account balance of the oil exporting group seems likely, the cash surplus being expected to show a somewhat larger increase than the current account surplus.

Although available information regarding the disposition of the net cash surplus in 1979 remains incomplete, it suggests that a high proportion of the funds involved was placed in bank deposits and short-term government securities in the industrial countries. This pattern of disposition resembles that observed in 1974, but will probably be followed (as in the years after 1974) by gradual reinvestment of some of the funds initially held in liquid forms and a general trend toward diversification of asset holdings. The likelihood of shifts into longer-term and less liquid forms of assets stems partly from the concentration of the combined current account surplus of the oil exporting group in countries with already strong liquidity positions and partly from the increasing share of private capital in financial outflows from several oil exporting countries. In general, the propensity of private investors to acquire such assets as real estate and corporate equities or bonds is higher than that of official agencies.

The net flow of funds from oil exporting countries directly to other developing countries, mostly in the form of official foreign aid provided on concessional terms, is estimated to have amounted to about $8 billion in 1979, although lack of adequate information on actual disbursements of aid makes these estimates somewhat uncertain. It is expected that such disbursements will increase in 1980. Activities of both bilateral and multilateral aid institutions sponsored by the oil exporting countries are expanding, and announced or anticipated government contributions to them should facilitate this expansion. In addition, concessional financing of oil sales to developing countries, some of which are receiving interest-free long-term loans, is increasing.

In 1979, as in 1978, holdings by the oil exporters of claims on the Fund and the World Bank declined. Investments in World Bank bonds and loans under the supplementary financing facility were more than offset by repayments of oil facility loans.

Non-Oil Developing Countries

A number of adverse external influences are currently operative on the foreign trade and payments positions of the non-oil developing countries. Their oil import bills rose substantially during 1979 and the first half of 1980, and the accelerated inflation of prices for imports of manufactures added even more substantial sums to the total cost of their imports. Although rising prices have also contributed substantially to their aggregate receipts for exports, their overall terms of trade have deteriorated by several percentage points since 1978. Even at unchanged terms of trade, foreign trade price increases as steep as those witnessed since 1978 would have led to a considerable rise in the current account deficit of the non-oil developing countries because of the difference in magnitude between their imports and their exports.

Another adverse factor at the present time is the emerging weakness of growth in import demands of the industrial countries, coupled with protectionist actions by some of them. Export earning prospects for the non-oil developing countries are dimmed by these developments, and high costs of borrowing in international financial markets exacerbate the difficulty of acquiring the goods and services needed to maintain adequate progress in development.

The combined current account deficit of this entire group of countries rose from $36 billion in 1978 to $53 billion in 1979, and the projections shown in Table 5 indicate another large increase, to $70 billion, in 1980. On present prospects, a further substantial rise can be expected for 1981 unless lack of appropriate financing forces the adoption of measures to curb imports severely.

Adverse factors contributing to the projected deterioration of $34 billion in the aggregate current account balance of non-oil developing countries from 1978 to 1980 have differed substantially in relative importance among individual countries in the group. For all of them taken together, roughly two thirds of the 1978-80 deterioration might be attributed to the merchandise trade accounts and a little less than one third to larger net payments for services and private transfers, among which enlarged payments of interest on external debt are a significant element. The projected deterioration of the trade balance of this group of countries reflects only a slight difference between the respective percentage increases in imports and exports in real terms. In the main, it stems from the decline in the terms of trade and the unequal effects of a given percentage change in foreign trade prices on the two sides of the trade account.

The estimated change in the terms of trade index is a composite result of many changes in prices of both exports and imports. Disaggregation of such an index to identify separate contributions of the relevant price changes is not a fully meaningful exercise. Nevertheless, several observations based on available foreign trade price or unit value series may help to explain the recent deterioration in terms of trade of the non-oil developing countries.

The estimated increase in unit values of exports of these countries from 1978 to 1980 is slightly larger, in percentage terms, than the corresponding increase in unit values of exports of the industrial countries. To the extent that an index of the latter can be taken as a proxy for an index of import unit values of the non-oil developing countries in bilateral trade with the industrial countries, it can be inferred that the 1978-80 change in terms of trade vis-à-vis the latter group was very small (and, indeed, slightly positive). The overall deterioration in the terms of trade, therefore, must be ascribed entirely to bilateral trading relationships with the oil exporting countries and the centrally planned economies and other nonmembers of the Fund. Data on bilateral terms of trade between the non-oil developing countries and these other countries do not exist. However, inasmuch as the rise in oil prices far exceeded that in any other important category of trade, the general significance of the oil price increases in the change in the terms of trade during this period is clear.

An important issue relating to oil import bills is their distribution among countries. A relatively few of the oil importing developing countries, because of their size and degree of industrial development, account for a very large proportion of the group’s oil import bill. The predominant share of those few countries, in turn, is mainly a reflection of their economic size, and only secondarily a manifestation of above-average use of oil in relation to national output. For example, the 12 largest importers of oil among the non-oil developing countries account for about three fourths of the value of net oil imports by that whole group and for nearly two thirds of its aggregate GDP, as well as roughly half of its total imports. For a majority of these 12 countries, ratios of net oil imports to total imports are in the 20-30 per cent range. For the other oil importing developing countries, the corresponding ratios are somewhat lower but not of a greatly different order of magnitude. Included here are a great many countries whose own oil bills, while not representing an impressive percentage of the aggregate for the whole oil importing group, are nevertheless large in relation to their own economies.10

Table 7 subdivides the data on current account balances of non-oil developing countries to show separate estimates for both the net oil exporters and the net oil importers within the larger group. In addition, a further subdivision of the oil importers among three subgroups is shown. Each of the subgroups has displayed certain characteristics with respect to its external payments accounts.

The net exporters of oil that are here classified as non-oil developing countries comprise 12 countries whose oil exports are either not such a dominant share of their total exports or not so large in absolute terms as those of countries in the main oil exporting group discussed in another section of this chapter. Like most of the other non-oil developing countries, these 12 differ from the main group of oil exporting countries in that their current account balances have tended to show sizable deficits even in recent years of sharp increase in oil prices. At the same time, the terms of trade and external payments position of the subgroup under discussion have been subject, at least since 1973, to influences rather different from those operating on most non-oil developing countries. Within the latter category, the subgroup of net oil exporters is the only one likely to have a lower current account deficit in 1980 than in either 1978 or 1979. Current account deficits of each of the three oil importing subgroups of developing countries rose substantially from 1978 to 1979, and they appear to be rising further in 1980.

Countries in the oil exporting subgroup have maintained considerably higher rates of import growth than the other subgroups of non-oil developing countries, making use not only of the export earnings resulting from higher oil prices but also of favorable access to international credit markets. Heavier borrowing in such markets made it possible for accumulation of reserves by the oil exporting subgroup to increase in 1979, in contrast to sharply reduced rates of reserve accumulation by the oil importing subgroups.

Another subgroup whose balance of payments positions and recent experience differ substantially from those of the majority of non-oil developing countries comprises 11 middle-income countries that have become relatively important exporters of manufactures. Although few in number, they include some of the economically largest developing countries, so that they account for major shares of most economic or financial aggregates relating to the non-oil developing group. They are also countries whose domestic output and foreign trade have grown considerably faster during the 1970s than the average for oil importing developing countries, although their ability to sustain this performance is now being jeopardized by tendencies toward increased protectionism in some of their important markets. Other threats to the performance of these countries are posed by the slowdown in the industrial countries and by a high degree of vulnerability to any constriction of international capital markets.

The major exporters of manufactures, because of their relative wealth and rapid growth, have achieved preferential status in international credit markets, and thus greater flexibility of external financing than seems to be available to most developing countries. This characteristic, along with the comparative flexibility for adjustment of external trade transactions that stems from relatively high incomes and diversified domestic production structures, has engendered a record of high variability in the combined current account balance of the manufacturing subgroup. Frequently, but not consistently, its members have accounted for a high proportion of the current account deficit of all non-oil developing countries. Their share was well over one half in 1975, for example, but dropped to the 25-30 per cent range in 1977 and 1978. It rebounded to almost 45 per cent in 1979 and may go higher in 1980.

Although the current account deficit of the major exporters of manufactures now represents a large proportion of the combined deficit of all oil importing developing countries, it is not particularly large in comparison with relevant magnitudes in their own economies. Even in 1979, a year of relatively large deficit on current account for the manufacturing subgroup, its deficit represented only 3½ per cent of GDP and 15 per cent of imports, compared with ratios ranging up to 6½ per cent of GDP and 32 per cent of imports for other subgroups of non-oil developing countries shown in Table 9.

Table 9Non-Oil Developing Countries: Current Account Deficits as Percentage of GDP and of Merchandise Imports, 1973-7911
1973197419751976197719781979
As percentage of GDP
Non-oil developing countries2.05.26.03.93.03.24.0
Net oil exporters2.94.47.14.94.44.23.3
Net oil importers1.95.45.73.72.83.14.0
Major exporters of manufactures1.56.26.03.42.01.93.5
Low-income countries3.15.04.52.51.63.03.7
Other net oil importers1.24.06.55.45.55.75.8
As percentage of merchandise imports
Non-oil developing countries12.425.330.220.615.616.819.1
Net oil exporters22.525.642.829.825.124.017.3
Net oil importers10.825.227.919.113.915.519.3
Major exporters of manufactures3.526.427.026.79.39.315.3
Low-income countries35.444.241.524.815.827.332.8
Other net oil importers5.514.323.720.921.222.121.8

For country classifications, see Table 2

For country classifications, see Table 2

The manufacturing exporters, while utilizing by far the largest net capital inflows of any subgroup, have depended least on official financing. Funds have flowed to the manufacturing countries chiefly in the form of long-term private capital, including substantial amounts of direct investment capital. However, these countries have covered past upturns in their current account deficit to a considerable extent through swings in their short-term capital and reserve accounts, and such swings again played an important role in the upsurge of the current account deficit from 1978 to 1979. Most of the major exporters of manufactures were relatively well positioned to accommodate an adverse current account swing in this fashion, as they had accumulated both official reserves and other short-term foreign claims on an unusually large scale in 1978. It was this flexibility of external financing that enabled the manufacturing exporters to maintain a substantially higher rate of import growth than other oil importing developing countries in 1979; and a similar difference is likely to be observable for 1980, although with weaker import trends for all the oil importing subgroups.

An extreme contrast to the two subgroups discussed above is presented by the low-income countries. These countries, defined in Table 9 to encompass 39 non-oil developing countries whose 1977 per capita GDP is estimated to have been equivalent to no more than US$300 (averaging only about one tenth of the average for the manufacturing subgroup), are characterized by low rates of national saving, of domestic investment, and of overall economic growth. Rates of expansion of both exports and imports of these countries have been relatively weak during the entire period since the middle 1960s.

Current account deficits of most low-income countries (with the notable exception of India, which bulks large in the statistics for this subgroup) have long been exceptionally high, by comparison with other non-oil developing countries, in relation to either domestic output or imports. Despite such heavy external deficits, however, the aggregate volume of imports obtained by the low-income countries in 1979 was only about 5 per cent larger than in 1973. Since India’s import growth record was better than the average, the real import gains of other low-income countries over this period were negligible. Lack of satisfactory growth in the real purchasing power of export earnings was the principal reason for this disappointing record. Real export earnings (i.e., current export receipts deflated by an index of import prices) declined appreciably in 1978 and slightly further in 1979; and they do not appear likely to recover in 1980.

This rigidity of import purchasing power is compounded by limitations inherent in the nature of the external financing available to the low-income countries. These countries are extraordinarily dependent on foreign official and international agency sources of financing, which in recent years have covered close to one third of their imports. In 1979, that proportion was more than twice as high as the average for all non-oil developing countries. Conversely, the role of private long-term capital has been relatively small.

Moreover, many of the low-income countries (particularly those in Africa) entered the current period of intensified balance of payments pressures with already weakened international liquidity positions. With allowance for their use of reserve-related credit facilities, their reserve positions were deteriorating in nominal terms—and much more substantially, of course, in real terms—during both 1978 and 1979. Little scope for reduction of reserves is now available to them, and they may have to make considerable use of short-term and/or official compensatory financing to cover the current account deficits now in prospect for 1980 and beyond.

Nearly 50 oil importing developing countries remain outside any of the subgroups discussed above. These can be characterized, generally speaking, as middle-income exporters of (non-oil) primary products. They include a number of sizable developing countries (as well as many small ones), but very few at the upper end of the per capita income scale. Although some manufactures are included in their exports, primary products predominate. Total export earnings of countries in this subgroup have tended to run ahead of the average for other developing countries in years of unusually strong commodity prices, but behind it in other years, broadly paralleling the average over time.

During the period since the early 1970s, the current account deficit of the middle-income primary product exporters has risen more steadily and consistently, in relation to GDP or to imports, than that for any of the other subgroups of non-oil developing countries. This rise, continuing rather strongly through 1979 and into 1980, was accompanied and underpinned by a progressive increase in the net inflow of externally borrowed funds. These have been obtained from both private and official sources, with private capital, especially in short-term forms, tending to become a more prominent element in the past year or so. The middle-income subgroup reduced its accumulation of reserves from 1978 to 1979, and is likely to cease accumulating reserves in 1980.

The foregoing discussion of current account developments has focused on analytical subgroups of non-oil developing countries, rather than on the regional groupings utilized in previous Annual Reports. However, a summary breakdown of current account balances for five regional groupings is included in Table 5. The most recent regional differences—those with respect to increases in current account deficits since 1978—reflect mainly the concentration of low-income countries in Africa and the location in Asia and the Western Hemisphere of a number of the rapidly growing exporters of manufactures that have had strong access to international capital markets in support of continuing import expansion. Several of the European developing countries, which in the past had also relied to a substantial extent on capital inflows from private foreign sources, have more recently made active efforts to restrain increases in borrowing from abroad.

Financing Patterns and External Debt

With reference again to the entire group of non-oil developing countries, the financing of the increase in their combined current account deficit from 1978 to 1979 involved three main elements. Their net external borrowing rose by $7 billion, from about $38 billion to $45 billion; the inflow of funds that do not generate debt (chiefly official transfers and foreign direct investment, but including SDR allocations) was enlarged by about $3 billion, to nearly $19 billion; and additions to reserves were lowered by $7 billion, from $18 billion in 1978 to some $11 billion in 1979. As shown in Table 10, these changes matched the rise of $17 billion in the group’s combined current account deficit from 1978 to 1979.

Table 10.Non-Oil Developing Countries: Current Account Financing, 1973-79(In billions of U.S. dollars)
1973197419751976197719781979
Current account deficit111.536.945.932.928.635.852.9
Financing through transactions that do not affect net debt positions9.813.2211.712.114.416.219.4
Net unrequited transfers received by governments of non-oil
developing countries4.96.927.47.68.38.010.7
SDR allocations, gold monetization, and valuation adjustments0.60.8−1.0−0.21.02.00.8
Direct investment flows, net4.35.55.34.75.16.27.9
Net borrowing and use of reserves31.723.7234.220.814.219.633.5
Reduction of reserve assets (accumulation,—)−9.3−1.22.0−12.7−11.9−18.2−11.0
Net external borrowing411.024.9232.233.526.137.844.5
Long-term from official sources, net55.59.6211.410.212.413.315.9
On concessionary terms63.76.527.16.68.18.710.7
On nonconcessionary terms61.83.14.33.64.34.65.2
Other long-term borrowing from nonresidents, net6.610.214.717.615.825.123.4
From financial institutions54.08.69.210.915.619.317.3
Through bond issues50.50.30.21.12.63.02.0
Other sources72.11.35.35.6−2.42.84.1
Use of reserve-related credit facilities, net80.31.62.44.30.40.70.2
Other short-term borrowing, net5.16.53.9−0.81.1}5.0
Residual errors and omissions9−1.4−1.6−2.8−2.5−1.7−2.4

Net total of balances on goods, services, and private transfers, as defined for Balance of Payments Yearbook (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 government 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.

Loans on “concessionary terms” are defined to include all loans containing a grant element greater than 25 per cent.

Including suppliers’ credits, acquisition of long-term external assets, and errors and residuals arising from 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.

Net total of balances on goods, services, and private transfers, as defined for Balance of Payments Yearbook (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 government 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.

Loans on “concessionary terms” are defined to include all loans containing a grant element greater than 25 per cent.

Including suppliers’ credits, acquisition of long-term external assets, and errors and residuals arising from 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.

For 1980, the current account projection included in Table 5 would suggest another increase of similar size in net borrowing and a further cutback in the accumulation of reserves, without much further expansion of nondebt-generating inflows. In all probability, outright reductions of reserves will be necessary for a number of individual countries whose external borrowing capacity is limited and whose international payments positions come under severe pressure as they attempt to maintain the flow of needed imports at rising costs.

The 1979 and 1980 increases in net foreign borrowing do not appear to be following the pattern of the 1977 and 1978 flows. The net flow of long-term capital from private financial institutions was actually a little smaller in 1979 than in 1978, and the current concern with prudential considerations on the part of commercial banks engaged in international financial operations suggests a further slight decline in 1980. On the other hand, there has been a sharp rise in short-term credits, including those resulting from longer lags in payments on current obligations; and a relatively moderate rise in flows of long-term capital from official sources, including the oil exporting countries, seems to be in prospect. The bulge in net short-term inflows since 1978 is broadly reminiscent of the one that occurred in 1974 and 1975, when the last previous major upsurge in the current account deficit of the non-oil developing countries was in process. The shock-absorbing role implicit in this variability of short-term capital movements, like that associated with changes in official reserves, is helping to keep demands for long-term credit considerably steadier than the aggregate current account deficit and total financing requirements of these countries.

The steadier course of long-term borrowing has been reflected in progressive additions to the outstanding public and publicly guaranteed long-term debt of the non-oil developing countries. Such debt approached $250 billion at the end of 1979, and will doubtless be higher by several tens of billions of dollars at the end of 1980. Even the end-1979 figure was twice the amount outstanding at the end of 1975 and well over three times the corresponding end-1973 total. Much of the increase, of course, reflects the effects of both real growth and the inflation of the 1970s on values of international transactions. However, the ratio of the outstanding debt to exports of goods and services (taken as a rough scale factor in discounting the impact of inflation and growth on the size of the debt) has also risen; it was about 80 per cent in 1979, compared with 76 per cent in 1975 and 70 per cent in 1973. Ratios of the same year-end debt totals to the estimated GDP of the non-oil developing countries are estimated, respectively, at 18½ per cent, 15 per cent, and 14 per cent. (See Chart 8.)

Chart 8Non-Oil Developing Countries: Ratios of Debt to Exports of Goods and Services and to Domestic Output, 1972-791

(In per cent)

Sources: World Bank Debtor Reporting System and Fund staff estimates.

1 The debt ratios plotted in this chart relate only to external public or publicly guaranteed debt with an original or extended maturity of more than one year.

All of the foregoing ratios—and especially the debt/ export ratio—are generally higher for the low-income countries than for the majority of other non-oil developing countries. In 1978 and 1979, for example, the average debt/export ratio for the low-income subgroup was close to 200 per cent. To a much less striking degree, relatively high debt/export and debt/GNP ratios also prevail in the net oil exporting subgroup. In that case, however, they give rise to little concern at the present time. The corresponding ratios are relatively low for the major exporters of manufactures among the non-oil developing countries, chiefly because comparatively high rates of domestic saving in the manufacturing subgroup have permitted larger shares of investment to be financed from internal sources of funds.

Changes in the composition of the external debt of the non-oil developing countries during the 1970s have been no less important than the change in its magnitude. The principal compositional shifts have been those toward a higher proportion of debt to private creditors, with a correspondingly lower proportion to official creditors, and toward a more prominent role of private financial institutions (mainly commercial banks) among the private creditors. By the end of 1979, four fifths of the privately held debt was owed to financial institutions, compared with about half in 1973, and the share of all private creditors in the total was close to half, compared with just over one third in 1973.11 Although concern of the private financial institutions regarding “exposure” in developing countries may slow or halt these trends during 1980, these institutions are expected to continue playing a leading role.

Between three fifths and two thirds of the total public and publicly guaranteed debt of non-oil developing countries is owed by countries in the Western Hemisphere and in the Asian region. Such a concentration is essentially a reflection of the location in those areas of a number of the economically largest developing countries that have leaned heavily on external financing to accelerate their development. Shares of the various major regions have not changed very notably during the past half-dozen years.

Within each region, of course, individual countries have differed greatly in their propensity and ability to rely on external financing. The debt, accordingly, is unevenly distributed, partly as a manifestation of differences in size among the economies of the non-oil developing countries, but also partly for a variety of other reasons. For example, about two dozen countries in two of the analytical subgroups discussed above—the major exporters of manufactures and the net exporters of oil—have issued well over half of all the public and publicly guaranteed long-term debt outstanding at the end of 1979. In contrast, the 39 low-income countries account for only about one fifth of the debt.

Differences among countries and groups of countries with respect to the structure of external debt are also striking. Official creditors account for more than five sixths of the debt of the low-income subgroup, for example, but for well under half of the indebtedness of the manufacturing and oil exporting subgroups. One class of private creditors—financial institutions—holds more than half of the outstanding external debt of the net oil exporters but less than 10 per cent of the debt of the low-income countries, whose shares of all credit extended by private institutions to non-oil developing countries is only about 3 per cent.

For non-oil developing countries as a group, the shift from official to private sources of credit over the past decade has involved an appreciable increase in both interest and amortization payments, over and above the increase associated with the general rise in interest rates. Private credits usually call for higher interest rates and shorter average maturities than those typical of loans—many of them on highly concessional terms—from foreign government agencies and international lending institutions. These factors, while tending in the circumstances of recent years to raise debt service payments in relation to outstanding indebtedness, have caused only moderate average increases in relation to export earnings of the debtor countries as a group.12 In the average debt service ratio for the whole group, however, very heavy weight is given to the major exporters of manufactures, whose own debt service ratios are comparatively very low and have not risen very much in recent years, partly because of the buoyancy of their export earnings. Both interest and amortization payments of the low-income countries have risen quite sharply as percentages of export earnings since 1977, and their overall debt service ratio, so expressed, is now very substantially higher than the corresponding ratios for the other subgroups of oil importing developing countries. (See Chart 9.)

Chart 9Non-Oil Developing Countries: Debt Service Ratios, 1973-791

(As a percentage of exports of goods and services)

Sources: World Bank Debtor Reporting System and Fund staff estimates.

1 The debt service ratios plotted in this chart relate only to external public or publicly guaranteed debt with an original or extended maturity of more than one year.

Under the international conditions likely to prevail over the next year or so, an increasing number of countries may thus be confronted with problems inherent in the shortening of maturities and higher interest charges (even with some subsidence from early-1980 levels) that have pushed the debt service ratios upward. Such difficulties seem likely to emerge on a selective basis, rather than as a general problem, since most countries whose creditworthiness is maintained can expect to “roll over” maturing loans, taking advantage of the propensity of lending institutions to use receipts from such loans to make new loans to broadly similar categories of borrowers. The low-income countries, however, are poorly positioned to absorb any further rise in their debt service burdens, and it is with respect to these countries that the debt service issue is most worrisome.

Policy Considerations

The 1970s witnessed profound changes in commonly accepted views regarding the role that central authorities should play in the economy. Policymakers and economists alike have been obliged to re-examine postulates that they had come to take for granted during the 1950s and 1960s.

One basic postulate concerned the “fine-tuning” view of economic policy, the failure of which became obvious in the course of the 1970s. During the 1950s and 1960s, the relatively stable growth rates prevailing in most of the industrial world—coupled with good price performance—had led to a certain belief that national economies could be managed effectively through short-term adjustments of fiscal and monetary policies; and in many countries this belief, in turn, led to a short-term emphasis on growth and employment objectives. In retrospect, it seems clear that it was not primarily management of the economy, but the existence of exceptionally favorable conditions for growth, that was responsible for the generally good economic record of the 1950s and 1960s. When these conditions changed during the 1970s, it was not possible to prevent the recurrence of major fluctuations in activity levels. Further, the general approach to national economic policy proved overly ambitious as it often had destabilizing effects because discretionary measures were put into effect too late, the measures were based on faulty economic forecasts, or consumers and enterprises had learned to anticipate policy changes. Recognition of the limits of anticyclical policies had become widespread by the time of initial recovery from the 1974-75 recession, and many national authorities were fully conscious of the need for reorienting economic policies toward the medium term. Nevertheless, in the new and difficult setting of high inflation and high unemployment, attempts to bring about a gradual reduction in the rates of growth of nominal demand during the next few years were often tempered or reversed by strictly short-term considerations. Most recently, the top priority that has been accorded anti-inflation policy appears to signal a definitive change in this regard; a basic challenge is to sustain it.

The changes in economic conditions that developed during the 1970s, it should be emphasized, were of major significance. For one thing, it became clear that direction of fiscal and monetary policies toward the achievement and maintenance of unduly low unemployment rates can be very costly in terms of inflation. In the late 1960s and particularly during the 1970s, a number of economic, social, and political factors brought about an increase in unemployment and a decrease in productivity growth throughout the industrial world. The change in the real price of energy played a role in those broad developments, but other factors such as changes in the composition of the labor force and governmental regulations intended to achieve qualitative improvements in output or working conditions were probably even more important. In many cases, national authorities sought to offset the impact of these factors on productivity and unemployment by having recourse to expansionary monetary and fiscal measures. At least in part, such efforts reflected a lag in recognition that the slowing of growth in potential output had become a new limiting factor. Since increases in nominal demand could not change the effective labor supply or the rate of technical progress, their effects were ultimately felt on the price level. These repeated experiences were gradually, but firmly, translated into higher inflationary expectations on the part of the public, making the problem of inflation more intractable.

The importance of an efficient system of economic incentives to the process of economic growth was also highlighted by economic developments of the 1970s. Countries with such a system of incentives were able to achieve relatively high growth rates despite a lack of comparative advantage in natural resources, while others better endowed with resources were stagnating, or even regressing, under the weight of price and trade restrictions and of unrealistic exchange rates. The 1970s also revealed more clearly the types of economic incentive that are conducive to growth, and in this regard pointed up the need to minimize the negative effects of governmental redistributive income programs on productivity and economic growth, notwithstanding the laudable intent of such programs. Increased attention is also being focused on the harmful effects of some fiscal and financial practices—including unduly high rates of income taxation—on the incentives to save and invest by the community at large.

Further, the 1970s showed a continued increase in the degree of interdependence among countries and demonstrated the importance of international cooperation. In the field of exchange rate policies, a clear message from the latter 1960s and early 1970s was that balance of payments disequilibria should not be allowed to persist for too long; once disequilibria are embedded in the economic structure, adjustment becomes a difficult and costly process even with exchange rate flexibility. Developments since 1973, on the other hand, have also shown that an exchange rate that is allowed to be freely determined by market forces can at times become excessively variable or go too far in one direction. These developments have led to renewed attempts by the authorities to exercise some degree of influence over their exchange rates through market intervention or other instruments, notably monetary policy.

In the prevailing mixed system, however, possibilities for inconsistencies or conflicts among nations in the conduct of their economic policies are abundant, and international surveillance over exchange rate policies is of clear-cut importance. A further lesson of the 1970s was that no international monetary system can function well when underlying domestic economic and financial conditions are unstable in a number of the major industrial countries. Surveillance must, therefore, focus to a large extent on the achievement of more stable domestic conditions. (Fund surveillance is discussed further in Chapter 2.)

The issue of interdependence involves more than the question of the exchange rate system. No matter what that system may be, the various national economies are strongly related, both in the short run and in the long run, through income effects of international trade and service transactions. Interdependence is clear not only among industrial countries but also among the various groups of countries—industrial, non-oil developing, and oil exporting. They are all also bound together through the functioning of an integrated world capital market. Thus, any significant economic decision by a major country or group of countries cannot fail to have effects, positive or negative, throughout the rest of the world. A fundamental principle of international cooperation, therefore, is that countries should always be mindful of others in their economic policies and actions.

Several examples of policy requirements arising from the interdependence of countries may be cited. First, there is urgent need for a strong flow of grants and concessional loans from the industrial and oil exporting countries to the non-oil developing countries, particularly those in the low-income category. Second, because of their heavy weight in the world economy, the major industrial countries have an international responsibility extending beyond the provision of official development assistance. This includes maintenance of open markets and avoidance of protectionism; it also includes, more broadly, both coordinated efforts in exchange market intervention and appropriate conduct of national economic policies in accordance with the principles of the international adjustment process established in the Fund (as summarized in the 1977 Annual Report, page 12). Adherence to such principles would (a) ensure provision of all feasible support to the general level of economic activity and (b) counter forces making for disequilibrium in the distribution of current account balances—a disequilibrium that, as experience of the past few years has shown, can have very disturbing effects on foreign exchange markets.

Another example of the importance of international cooperation concerns the energy problem. Clearly, there is need for cooperation among energy importing and exporting countries for the purpose of developing a basis for more stable conditions in the world oil market. Such cooperation calls for the group of oil exporting countries—given their importance on the supply side of the world oil market—to pay due regard to international considerations in the pursuit of their oil policies consistent with their own national interests. Among the other countries, those that produce substantial amounts of oil have an international responsibility similar to that of the oil exporting group. All the oil importing countries, including the ones that also produce oil, have the particular responsibility of strengthening present efforts to use energy more efficiently, to constrain the demand for oil, and to increase the supply of alternative sources of energy in order to contribute to the achievement of orderly oil market conditions. More reliance on the price system and on direct governmental measures to reduce the ratio of energy consumption to GNP and to help in the development of new energy sources is required. Without such efforts, the economic impact of energy problems could intensify during the 1980s and place a severe constraint on economic growth in both industrial and developing countries.

In sum, the various developments that have been touched on tend to show that—with full awareness of the interdependence of countries and the importance of international cooperation—the proper central focus of national economic policy is the establishment and maintenance of an environment conducive to economic growth with price stability. A basic element of such an environment is a price and incomes system that is not distorted by misguided controls. Another element is a level of public expenditure that does not put undue constraint on the conduct of monetary policy or limit work and investment incentives in the private sector. A third element is the avoidance of frequent discretionary changes in policies that tend to decrease the credibility of the authorities.

Chart 10.Industrial Countries: Energy Consumption and Prices, and Gasoline Taxes, 1970-79

(Indices, 1972=100)

1 For “energy” (in all forms) and for “gasoline,” the energy data relate to final consumption; for “petroleum products,” they include amounts used in production of electricity, scaled to final consumption of electricity. The data for 1979 are for the second quarter.

2 Typical consumer prices (including taxes), as of January 1 in each year, for 21 products in 15 industrial countries, deflated by overall consumer price indices, and weighted by 1977 final consumption weights (1979 estimated).

3 Weighted average of ad valorem rates of taxation (value of the gasoline tax divided by the tax-inclusive price).

* Second Quarter 1979.

Because of inadequate policy management and the external shocks of the 1970s, national authorities are now faced with the major problems of high inflation, low productivity growth, unemployment, rising energy costs, and international payments imbalances inherited from that period. To deal with these problems will require firmness and steadfastness—indeed, courage—on the part of the authorities. Policy prescriptions will of course differ among countries, but they must nevertheless be built on certain general principles.

Reducing inflation has to be the first priority, if only because the achievement of targets concerning growth and employment, as well as viability of the external position, is dependent on it. On the basis of harsh experience, it is now generally agreed that restoration of adequate saving and investment incentives, renewal of satisfactory productivity gains, and efficient allocation of resources require a marked lowering of inflation rates and of inflationary expectations. For that purpose, the central authorities should design their monetary and fiscal policies so as to obtain a gradual decrease in the rate of growth of nominal domestic demand—aiming at a rate consistent with the growth of potential output and a feasible adjustment path for inflation. As mentioned above, this need for gradual adjustment has been recognized for a number of years but, at least up to 1979, when the stance of policies in the industrial countries stiffened noticeably, the degree of adjustment was so gradual as to be almost imperceptible. It now seems to be recognized that, while gradualism is the only feasible course from the standpoint of economic, social, and political considerations, adjustment measures should be decisive so as to bring about a reduction of inflationary expectations. Further, such a policy of adjustment should not be interrupted as soon as the level of economic activity tends to weaken. Any attempt to offset that development through fiscal or monetary expansion would only impair the credibility of the anti-inflation policy stance of the authorities and ratchet the economy to an even higher rate of inflation that would ultimately call for a still more costly process of adjustment. While restoration of satisfactory and sustained economic growth is the target, it is a target that in most countries can be reached only through a reduction in inflation brought about by a difficult period of adjustment—with the extent and duration of the difficulty dependent primarily on the speed with which inflationary expectations can be curtailed.

An actively “stimulative” monetary policy should be avoided because, in addition to the impairment of credibility, its practical effect would be to provide liquidity to banks or corporations that are already highly liquid. The record of the 1960s and 1970s seems to show that aggressive monetary expansion during recession periods contributes very little to revival of real demand and output at the time when such revival is most needed, but leaves a legacy of bank liquidity that will tend to frustrate efforts to moderate credit expansion at a later stage. However, the kind of restraint being suggested does not imply passivity of monetary or credit policy from a countercyclical point of view. With the slackening of demands for credit by business enterprises that is typical of a cyclical easing, interest rates are bound to fall (as has been demonstrated again in the past few months), and the availability of credit to nonbusiness borrowers is bound to rise—in an automatically stabilizing way, even without accelerated provision of reserves to the banking system by the central bank. Likewise with respect to fiscal policy, reliance in countering recessionary tendencies should be placed—with due regard for differences in national fiscal systems—on the well-known stabilizing effects that automatically emerge with the decline in tax revenues and the rise in certain categories of expenditure.

The policy of reducing the rate of growth of nominal domestic demand over the medium term should be accompanied by a policy that aims at achieving a consistent reduction in the growth of nominal incomes. Most attempts during the 1970s to establish formal incomes policies encountered failure because they lacked adequate support of either the private sectors or public policies in the fiscal and monetary fields. Also, this is a controversial area—strongly affected by political, social, and institutional considerations—in which few generalizations are applicable to individual countries. In some countries, nevertheless, measures to restrain the growth of incomes can serve as useful adjuncts to fiscal and monetary policies, and they would seem to be especially appropriate at the present time in view of increased cost pressures of external origin. Measures that would exclude oil prices from the mechanism of wage indexation, and thus serve to limit self-defeating wage-price spirals, are of particular importance in this regard. In a less formal way, further steps by national authorities to increase public understanding of the inflationary mechanism, and to counter the influence of short-sighted pressure groups, could be helpful by impressing upon the general public the limitations of real income gains that are implied by the weak behavior of productivity growth in many countries during recent years and by the rapid escalation of energy prices.

The fight against inflation should be accompanied by further measures that aim at establishing an economic environment more conducive to economic growth. A more stable overall price level is a major part of that environment, but only a part. A change in the fiscal system of many countries to remove existing disincentives against saving and investment seems to be called for, and selective tax adjustments could make a positive contribution to the supply side of the economy through the provision of actual incentives for productive investment. A reconsideration of the overall levels of public taxation and expenditure may be needed in a number of cases. More attention should also be given to the mass of controls and restrictions of various kinds that have accumulated over the years in developing as well as industrial countries. While some may be needed on social or other grounds, many are likely to be found detrimental to the interests of the community at large.

One special factor that will have a predominant influence on the environment for economic growth during the 1980s—as discussed above—is the supply and cost of energy. The seriousness of the situation in that area is now widely recognized.

A further factor that will condition the growth environment is the external payments constraint faced by many non-oil developing countries. Structural adjustments are needed in these countries, where (as in the industrial countries) policy decisions made under the pressure of harsh developments have often led to harmful restrictions and controls and an excessive level of public expenditure. Correcting this situation and adjusting to higher energy prices are bound to take time, and means will have to be found to finance large payments imbalances during the adjustment period. Failure to do so not only would seriously impair the long-term economic development of non-oil developing countries but also could have a significant impact on growth in the industrial countries.

* * * *

In the foregoing review of developments in the world economy, a feature of particular interest and importance to the Fund is the prevalence of large and still growing imbalances in current external payments of member countries. It is evident that many members will need unprecedented amounts of external financing during the prospective period of adjustment.

In the provision of such financing, much will clearly depend on the manner in which surplus funds accruing to the oil exporting countries are redistributed, through various international channels, to ultimate borrowers in other countries. In the main, this channeling of funds can be expected to operate through market mechanisms, with private commercial banks and international capital markets continuing to play a predominant role. It is to be hoped that expanded flows through established international development institutions and official agencies of national governments will also make a significant contribution. However, the shifts in external balances now in progress are so large, and have occurred so suddenly, that the possibility of deficiencies in flows through the existing commercial and official channels cannot be disregarded. Such flows are expected to prove generally adequate through 1980, notwithstanding the problems of some individual countries, but their prospective adequacy in relation to the needs probably emerging in 1981-82 is uncertain. Both in size and in duration, the imbalances now in prospect seem likely to exceed those witnessed in the past.

In this situation, the Fund is prepared to play a larger role in the financing of members’ imbalances. This larger role has been endorsed by the Interim Committee, at its meeting in Hamburg during April 1980. It would involve both the lending of greater amounts in relation to quotas than have usually been authorized in the past and a stretching of adjustment and assistance over longer periods. Implementation of such enlarged financing by the Fund is being elaborated. Furthermore, it is to be noted that the Interim Committee at its Hamburg meeting, while recognizing that the Fund is presently in a relatively liquid position, has approved the proposal put forward by the Managing Director to start discussions with potential lenders on the terms and conditions under which the Fund could borrow to increase its resources, if and when the need arose.

There is a strong belief in the Fund that financing and adjustment must go hand in hand. While there may be cases where a country’s external imbalance can be expected to be corrected on the basis of existing policies, and all that is required is temporary financing, in most instances financing will need to be accompanied by a strong effort on the part of the borrowing member to adjust its unbalanced external position. In these circumstances, there must be a prospect of correcting the external imbalance over a reasonable period, although this may, under present and evolving circumstances, take longer than in the past. Maintenance of these principles is essential both for preservation of the Fund’s revolving resources and for promotion of optimal adjustment. At the same time, flexibility with respect to the choice and implementation of particular adjustment policies, addressed to the specific problems of the concerned countries, must be preserved. There is general agreement that appropriate adjustment policies should emphasize the fostering of improved supply and growth capabilities, as well as fiscal and monetary programs designed to keep aggregate demand realistically aligned with the actual evolution of supply.

While the Fund is not directly involved in the specifics of investment planning, it will intensify its collaboration with the World Bank and, as appropriate, with other developmental-financing institutions in order to assist countries to adjust their payments imbalances in ways that contribute to long-term growth. Cooperation is particularly important in the area of energy development, where the Fund is stressing price and tax policies that would create appropriate incentives to complement the efforts of other institutions to promote and finance adequate investment in productive facilities. More generally, the Fund’s emphasis on the broad economic and financial framework of adjustment programs is necessary to ensure that supply policies are coordinated with demand policies for the purpose of dealing with structural inadequacies that are often at the root of current problems.

These and other current account balances in this section aremeasured in terms of goods, services, and private transfers, asshown in Table 5. For the industrial countries, balances inclu-sive of official transfers are provided through 1979 in and for 1980 in Table 5, footnote 1

World Economic Outlook: A Survey by the Staff of the International Monetary Fund (Washington, May 1980), Appendix B, Section 2

In essence, the framework of classification has been shiftedfrom four to three major groups of countries: an enlargedgroup of 21 industrial countries and two main groups of devel-oping countries, comprising the oil exporting countries (an un-changed grouping) and the non-oil developing countries (agrouping enlarged to include 7 countries formerly classifiedas “more developed primary producing countries”). Membersof the former category of “more developed primary producingcountries” have been regrouped partly with the industrial coun-tries as well as partly with the non-oil developing countries.(See Table 1Table 2 for specifics of the present classification.)

Over a long period of time, and under conditions of suffi-cient flexibility of wages, prices, investment schedules, and pub-lic policies, economic activity financed through recycling ofsurplus funds accruing to the oil exporting countries might beexpected to compensate for the “drag” exerted by the diversionnoted here. In the short run, however, and under actual condi-tions considerably more rigid than those just hypothesized, funds “recycled” to the industrial countries cannot fully replacethe productive activities aborted by the diversion of expend-itures.

Where conventional measurement of output in the nationalaccounts prevents meaningful estimation of productivitychanges

As noted earlier, the present classification of “non-oil de-veloping countries” has wider coverage than the one used inprevious Annual Reports, reflecting the addition of seven coun-tries formerly classified as “more developed primary producingcountries.” Because of the relatively large size of some of thesecountries, their addition to the group has had a significant effecton a number of the statistical averages or aggregates presentedin this Report, most of which are not closely comparable withsimilar figures appearing in earlier Annual Reports.

See Table 2, footnote 2.

The indices of effective exchange rates discussed in this section are the indices from the Fund’s multilateral exchange rate model, reported in International Financial Statistics.

I.e., on the assumption of an unchanged average oil price in real terms during the remainder of the year.

More specific comments on these distributional aspects of the oil imports of non-oil developing countries were made in World Economic Outlook: A Survey by the Staff of the Inter-national Monetary Fund (Washington, May 1980), page 32

These figures relate only to public and publicly guaranteed long-term debt; the proportions indicated would be higher for both 1973 and 1979 if comparable data on nonguaranteed private debt could be included.

See footnote 11; ratios of debt service payments to export earnings would be appreciably higher if fully comprehensive data were available.

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