Chapter

Chapter 1: Developments in the World Economy

Author(s):
International Monetary Fund
Published Date:
September 1981
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Introduction

The world economic situation during 1980 and the first half of 1981 was difficult and disappointing in important respects. Nevertheless, signs of progress in dealing with some of the severe economic problems of recent years have begun to emerge. Both the encouraging aspects of the situation and the difficulties confronting national authorities, as well as the policies being utilized to meet those difficulties, are outlined in the following paragraphs and discussed more fully in later sections of this chapter, as well as in Chapter 2.

For the past two years, dominant characteristics of the world economic picture have included the continuation of inflation at very high rates in many countries; the marked slowing of growth in the industrial countries, resulting in high unemployment and a slowdown in world trade expansion; and external imbalances on current account that have been both extremely large—reflecting major changes in terms of trade—and unusually volatile for some individual countries. Sharply increased deficits on current account have generated financing problems for many countries. Although international flows of credit through private market channels have been remarkably well sustained, a number of the non-oil developing countries, particularly among those with low per capita incomes and limited access to capital markets, have not obtained enough financing to sustain the growth of imports needed to achieve satisfactory domestic development.

Among the industrial countries, the magnitude and rapid shifting of external imbalances on current account have contributed to exceptionally wide movements of exchange rates for major currencies. The complexity of pressures in exchange markets, as well as their variability, has been compounded by sharp differences among the industrial countries with respect to monetary conditions, interest rates, and rates of inflation, with unusually large capital movements having taken place. Changes in exchange rates of magnitudes not witnessed since the currency realignments of the early 1970s have resulted, and the instability of exchange rates, in turn, has added to the difficulties of domestic economic and financial management in some countries. Upward pressures on prices and wages have been intensified, in countries with sharply depreciating currencies, for example, while producers in some of the countries with markedly appreciating currencies have found their international competitive positions impaired.

The prevalence of wide differences in rates of inflation, and in the particular actions of national authorities to deal with inflation, has underlain many of the exchange market pressures of recent years. Not infrequently, monetary policies deemed appropriate for domestic purposes have contributed to conditions in financial markets that were not conducive to short-term external equilibrium and orderly exchange markets. By the same token, monetary policies designed to give substantial weight to external objectives have sometimes threatened to produce unwanted domestic consequences. The authorities of some countries have felt themselves confronted by a dilemma when making decisions on policy objectives and means of implementation.

A particular source of uncertainty and international concern during 1980 and the first half of 1981 was the prevalence of very high rates of interest, in real as well as nominal terms. These interest rates resulted from the interaction of firmer monetary restraint in a number of the industrial countries with the momentum of the ongoing inflation after a long period of generally inadequate fiscal restraint. Although there are sound theoretical and practical reasons to anticipate a substantial decline in nominal interest rates when inflationary expectations subside, the absence of a reliable basis for gauging the timing of any such change in expectations has tended to maintain uncertainty about the prospects for interest rates.

Meanwhile, the present levels of real interest rates are creating a drain on the international purchasing power of most net debtor countries. This problem is especially serious for the non-oil developing countries at a time when their international purchasing power is already under pressure because of deterioration in their terms of trade, weak markets for their exports, and relatively slow growth in flows of concessional assistance to low-income countries. Any decline in nominal interest rates in major financial centers will be rather quickly reflected in the nominal value of external interest payments by developing countries relying heavily on market finance (because of the prevalence of flexible interest rates—linked to London market rates—on a considerable proportion of their outstanding debt). However, any such decline might be short-lived if inflation and inflationary expectations are not curbed. In view of the imperative need for the industrial countries to control inflation, there seems to be a strong prospect that real interest rates will remain well above the abnormally low or negative levels of the 1970s. The likelihood that external borrowing will remain more costly in real terms than it has been for many years underscores the need for prudent adjustment measures in many of the borrowing countries.

Among the encouraging aspects of the world economic situation at mid-1981 were indications that the inflationary surge of 1979 and 1980 has abated. An opportunity is now presented for its reversal. Monetary expansion in the major industrial countries has been considerably restrained, and might be brought under lasting control if policies of restraint are not relaxed prematurely and are accompanied by appropriate fiscal policies. Although the desired results of firmer monetary control can appear only with an uncertain lag, substantial progress has been made toward establishment of a monetary environment conducive to more stable prices.

One of the obstacles to achievement of a less inflationary monetary environment is clearly the prevalence in many countries of government expenditures at levels beyond those which the public is willing to cover through payment of taxes. The resultant fiscal deficits have made governments strong competitors in credit markets, and have thus contributed to the upward pressure on interest rates. Here, too, however, a considerable shift in direction seems to be in process. Most governments in the larger countries are engaged in strenuous efforts to tighten their fiscal policies, and some of them are working to limit or reduce the role of government in the economy. These efforts do not appear to have been made in vain. With allowance for the more or less automatic effects of the current international recession on both revenues and expenditures, fiscal positions have been appreciably less expansionary in this recession, as noted in the next section, than they were in the 1974-75 recession.

An indication that the more restrained financial policies of the past two years have not been ineffectual is the flattening or deceleration of price increases in a number of countries since the first half of 1980. This development, which has recently been offset in a number of countries by the impact of currency depreciation on import prices, is in part a reflection of the relative stabilization of oil prices after two years of large increases. However, the incipient tapering of inflation rates also reflects a considerable degree of success, in most of the industrial countries, in containing secondary repercussions of the 1978-80 upsurge in energy costs. In this respect, adjustment to the latest round of oil price increases has been much better managed than was the adjustment of the mid-1970s. In particular, the rise in wages has been distinctly more moderate in relation to current increases in consumer prices during the period 1978-81 than it was following the oil price increases of 1973-74.

A related development of hopeful significance is that the former close linkage between economic growth and oil consumption appears to have been severed during the past few years. After a decline of 3 per cent from 1979, total energy consumption in the industrial countries during 1980 was approximately the same as in 1973 despite a 19 per cent growth of real gross national product (GNP) over the period. In addition, more rapid substitution of non-oil sources for oil has emerged in recent years. Consumption of non-oil energy in the industrial countries is estimated to have risen by 7 per cent from 1978 to 1980, compared with an 8 per cent decline in the consumption of oil. These developments both reflect and support the policy that has now been adopted in most industrial countries of allowing a full pass-through of oil price increases so as to encourage conservation of energy and substitution of alternative energy sources for oil.

Another reassuring aspect of developments over the past two years is the smooth fashion in which the recycling of the large cash surpluses accumulated by the oil exporting countries has been carried out, mainly through private market channels. Many borrowing countries, despite the rise in real costs of credit, have gained valuable time for adaptation and adjustment through the continuation on a large scale of international lending by private financial institutions. Private facilities have been supplemented by expanded activities of international agencies, including the Fund; and the Fund, in particular, now has in place and in prospect arrangements that permit further enlargement of its role. Member countries making sufficiently strong efforts to adjust their external payments imbalances may be permitted to draw on Fund credit up to 450 per cent of their newly increased quotas over a three-year period (subject to a cumulative ceiling of 600 per cent of quota), not counting any drawings under the low-conditionality facilities for compensatory and buffer stock financing. The new policies under which these expanded resources available are detailed in Chapter 3.

A vital feature of this expansion of resources available through the Fund is the linkage of substantial financial support with strong programs of economic adjustment in the member countries utilizing it. In line with the Fund’s conviction that balance of payments financing and adjustment of external deficits to levels that can be managed on a sustainable basis must go hand in hand, some three fourths of the Fund’s large new lending commitments currently involve high conditionally—that is, commitments by the members concerned to rigorous adjustment policies. At the end of June 1981, upper credit tranche and extended arrangements were in effect with 39 members, about four times as many as (on average) during the five years preceding 1979, and they involved large sums. During 1980, new loan commitments and other use of Fund resources reached a total of SDR 9.5 billion, some two to three times the level of previous years; and the corresponding total for the first half of 1981 alone was even larger—nearly SDR 10 billion. The programs underlying these figures offer solid grounds for hope that orderly adjustment toward viable external positions for the longer run will be widely carried out.

Domestic Activity and Policies

Industrial Countries

Stance of policies.—Financial policies throughout the industrial world during 1980 and the first half of 1981 were directed toward controlling inflation. This thrust had already become dominant in 1979. Thus, the communiqué issued by the Interim Committee after its meeting in Belgrade on October 1, 1979 had emphasized that “the main task of economic policy was to contain inflationary pressures and to reduce inflationary expectations,” and also had noted the Committee’s “satisfaction that reduction of inflation was being given priority in the economic policies of industrial countries.” Such views were stated by the Interim Committee at each of its two meetings during 1980 and again at its meeting in Libreville in late May 1981, when the Committee “reaffirmed its conviction that the fight against inflation must continue to receive the highest priority.”

As in 1979, the brunt of the anti-inflation thrust of policies in 1980 and the first half of 1981 was borne by monetary policy. This emphasis was most apparent with respect to interest rates, which reached record levels in most industrial countries, first in the spring of 1980 and again a year later (Chart 1). While the rise in interest rates had much to do with financial developments in the United States, it also reflected the rise in inflationary expectations and the tightening of monetary policy in other countries. Long-term government bond yields were significantly higher in 1980 than in 1979 or 1978 in each of the major industrial countries. The changes from 1978 to 1980 ranged from 1¼ percentage points in the United Kingdom (where nominal rates had already become quite high) to 4 percentage points in France, and averaged 3 percentage points. The increases in three-month money market interest rates, which are more reflective of short-term monetary actions, were considerably larger. The increases from 1978 to 1980 ranged from 4¼ percentage points to 6½ percentage points, and averaged 5¼ percentage points. The yield curve has become inverted, much to the detriment of the bond market and of long-term financing arrangements generally.

Chart 1.Major Industrial Countries: Short-Term Interest Rates, 1977-June 19811

(In per cent per annum)

1 The rates shown are monthly averages of daily rates on money market instruments of about 90 days’ maturity except for Japan, for which the discount rate on two-month (private) bills is used.

Increases in interest rates of this magnitude exceeded by a considerable margin the concurrent rise in inflation, so that they reflected changes in real as well as nominal terms. Any estimate of the extent of the rise in real terms is of course dependent upon the statistical gauge of expected inflation chosen to adjust nominal interest rates. Although this is a difficult matter on which there is not definitive agreement, changes over time in the GNP deflator provide one acceptable indication of changes in the “inflation-premium” component of interest rates. The acceleration in the rise of GNP deflators in the major industrial countries from 1978 to 1980 amounted to about 1¾ percentage points, from 7¼ per cent to 8½ per cent. This was about half as a large as the increase in long-term bond yields from 1978 to 1980, and only a third as large as the increase in three-month money market rates. Clearly, therefore, a key financial development of recent years was the rise in real interest rates, which moved decisively into the positive range for the first time since the 1960s.

Interest rates continued to rise in most industrial countries in 1981. The exceptions were Japan and the United Kingdom, where short-term rates in the first half of 1981 were 2 to 3 percentage points lower than the 1980 averages. In part, this easing reflected a slackening of inflationary expectations in both countries. Elsewhere, despite generally stable inflation rates (as measured by GNP deflators), interest rates continued to rise sharply in the first half of 1981. Short-term interest rates in the United States and Canada were 4-5 percentage points above those of 1980 as a whole, while such rates in France, the Federal Republic of Germany, and Italy were 1 to 2½ percentage points above 1980 levels. By May 1981, the levels of nominal interest rates in all five countries were well above their spring 1980 peaks and real interest rates had also continued their rapid advance.

The restrictiveness of monetary policy was also evident in a general slowing of the rates of monetary expansion. This was most apparent with respect to narrow money (generally, M1), which slowed dramatically because of the very high opportunity cost of holding money. In most of the larger industrial countries, the growth of M1 during the course of 1980 was significantly below that of 1978 or 1979. (See Chart 2 and Table 14.) The most marked reductions over the two years from 1978 to 1980 occurred in the Federal Republic of Germany, Japan, the United Kingdom, and Italy, where decelerations ranging from 10 to 15½ percentage points were achieved. In part because of the strength of nominal demand, the reduction achieved in the United States was much more modest.

Chart 2.Major Industrial Countries: Monetary Aggregates, 1978-June 1981

(Percentage changes)1

1 Average of three months ended in the month indicated over corresponding three months a year earlier.

2In general, M1.

3In general, M2 or nearest equivalent.

The inflation-driven strength of nominal demand also helps account for the somewhat mixed record with respect to the expansion of broad money among the larger industrial countries. As shown in Chart 2, four of these countries—the Federal Republic of Germany, Italy, Japan, and France—achieved substantial reductions in the rate of M2 expansion from 1978 to 1980. In Canada, the deceleration started later, but was substantial from 1979 to 1980. In the United States and the United Kingdom, however, the expansion of broad money tended to rise from end-1978 to end-1980.

Recent fiscal developments have provided a lesser degree of restraint than the dramatic changes that have occurred in the monetary sphere. Actual fiscal balances in per cent of GNP changed only fractionally in each of the major industrial countries other than the United States from 1979 to 1980, and on average not at all. Although these results occurred during a cyclical slowdown that tended, in itself, to reduce the growth of revenues and raise various types of government payments, and thus to increase deficits, the fiscal restraint involved in offsetting this tendency was relatively moderate. In the United States, the drift toward progressively lower deficits initiated in 1976 was reversed in 1980, when the federal deficit increased by almost 1½ per cent of GNP, in part because of the workings of the automatic stabilizers in response to the slowing of the economy. However, on present fiscal plans, this increase in the deficit would be reversed in 1981, so that the 1981 deficit would amount to the same proportion of GNP as that of 1979 (1.2 per cent).

Reduction of the public sector deficit—more pronounced than in 1980—pervades the budgetary plans of most industrial countries for the calendar year 1981. With allowance for the state of demand and capacity utilization, central government budgets in the ten countries covered in a staff survey are expected to have net contractionary effects ranging from the equivalent of ½ per cent to 2½ per cent of GNP, and averaging 1 per cent.

The restrictive shift in fiscal policy stems from two factors. One is the sheer magnitude of existing fiscal deficits, which remain large by historical standards in virtually all industrial countries. In most of these countries, budget deficits in 1980 were still larger in relation to GNP than the recession-swollen deficits of 1976. Another factor is the widespread disillusionment with the results, in terms of growth and employment, of the large fiscal imbalances of the second half of the 1970s. This, together with increased concern about the financial implications of public sector deficits, has focused the overall thrust of fiscal policy mainly on reductions of public sector deficits over the medium term.

In his concluding remarks to the Board of Governors at the Annual Meeting in 1979, the Managing Director noted that the statements by Governors during the meeting had shown agreement that “inflation must be tackled with greater determination and accorded higher priority among the objectives of national economic policy,” and that “inflation had to be dealt with not only through the control of demand—by means of a decisive use of fiscal and monetary policies—but also through greater emphasis on supply policies directed toward longer-term problems of a structural nature.” Since then, the relevance and importance of supply policies have been emphasized increasingly by governments, as well as by the Fund in the programs that it supports. Among the measures adopted or proposed by various governments in the industrial countries are reductions of marginal tax rates to increase the net returns available to individuals and business enterprises for saving and investment; substantially more generous allowances than those heretofore available for depreciation of capital assets; and measures designed to encourage reliance on market forces. Further, in the general context of improving the long-run supply characteristics of their economies, most countries have provided special incentives to investment in the energy field that would reduce their dependence on the world oil market.

Inflation.—The widespread worsening of inflation during the past few years is particularly evident from the movements of consumer prices. For the industrial countries as a group, increases in consumer prices accelerated from 7 per cent in 1978 to 12 per cent in 1980. In the face of this development, all of the countries adopted restrictive financial policies during the course of 1979-80, as noted above. These policies, in turn, contributed to the marked slowdown in the pace of economic activity that is now evident. However, the tighter policies do appear to have been reasonably successful in limiting secondary effects of the inflationary spiral on domestic wages and costs. By the first half of 1981, changes in cost and price indices, although high in historical perspective, were in general noticeably lower than the peak rates of 1980.

As measured by consumer prices, the rate of inflation worsened almost continuously from the end of 1978 to the first half of 1980. For the seven major industrial countries as a group, the quarter-to-quarter changes in consumer prices accelerated from an average annual rate of 7 per cent in the fourth quarter of 1978 to one of 15 per cent in the first quarter of 1980 (Chart 3). By the latter quarter, the level of consumer prices in the larger industrial countries was some 5 per cent higher than if inflation had continued at the 1976-78 pace. The direct effects of the concurrent increases in international oil prices account for the bulk of this increment. However, other factors were also important. The acceleration of domestic inflation in the United States was notable in that context, as were various special factors, such as the changes in value-added tax rates in the United Kingdom.

Chart 3.Major Industrial Countries: Consumer Prices, 1977-June 1981

(Percentage changes)1

1 Three months ended in the months indicated over the preceding three months; seasonally adjusted, annual rates.

2Average for the major industrial countries.

3The figures for the second half of 1979 are affected by the approximately 3¾ per cent increase in the United Kingdom’s value-added tax, effective June 18, 1979.

The phase of accelerating inflation (as measured by consumer prices) ended with the first quarter of 1980. A significant deceleration of price advances became evident in all of the major countries after the middle of the year. This deceleration was interrupted during the next two quarters, in the United States principally by a rise in food prices and the elimination of controls on domestic oil prices, and in the continental European countries by effects of the depreciation of their currencies vis-à-vis the U.S. dollar and other major currencies. Nevertheless, inflation in the first half of 1981 remained well below the peak rates of early 1980 in most of the large industrial countries. Further, the expectation toward midyear was that effects of the special factors that had been operative in the fourth and first quarters would wane, permitting a further decline in consumer price inflation from the roughly 10 per cent average rate still prevailing in the first half of 1981.

The flare-up and subsequent easing of consumer price inflation over the period since 1978 have gone hand in hand with corresponding changes in the dispersion of individual inflation rates for major countries. The worsening of inflation from late 1978 to early 1980 engendered a marked increase in the range of such rates, from 9 percentage points in 1978 to 22 points in the first quarter of 1980 (in terms of annual rates). As in the past, this increased dispersion resulted from relatively large changes in rates that were already high. However, the subsidence of inflation evident since the beginning of 1980 has been accompanied by a narrowing of the range, which was reduced to 12 percentage points by the first quarter of 1981. (See Chart 3.)

Consumer prices are typically the focal point of popular concern about inflation. However, the inclusion of imported goods and services in the commodity coverage of consumer price indices makes these misleading indicators of domestic inflationary forces when the terms of trade change substantially, as they have done over the past several years. It is important, therefore, to look at measures of inflation that are more directly reflective of developments within the industrial countries.

One such measure, the rate of increase in hourly compensation of employees in the manufacturing sector, points up the generally moderate tone of wage claims (relative to consumer price movements) in the major industrial countries (Chart 4). For the group as a whole, rates of increase in hourly compensation began to accelerate in the first half of 1979, but the acceleration remained significantly less than that of consumer price increases until the middle of 1980, so that the rise in real wages was moderated. Indeed, average real wages in the industrial countries declined for the first time in at least 20 years in the second half of 1979 and fell further in the first half of 1980. Some recovery of this loss in real income of workers became evident during the middle quarters of 1980, when the rise in wage claims gained momentum despite a substantial slowing in the pace of consumer price inflation; but this recovery did not make up for the preceding losses, and it was short-lived. By the fourth quarter of 1980, nominal wage increases were moderating sharply, and they dropped in the early part of 1981 to rates roughly comparable with those for consumer prices. Thus, while average wages did respond (with a lag) to the acceleration of consumer price inflation, the cumulative response was muted and involved a persistent shortfall in real wage gains. For the entire group of industrial countries, the net change in real wages over the nine quarters ended with the first quarter of 1981 was slightly negative. This result contrasted sharply with increases averaging 3½ per cent per annum in the period 1973-75—also a period of deterioration in the external terms of trade—and 2¼ per cent in 1976-78.

Chart 4.Major Industrial Countries: Hourly Compensation in Manufacturing and Consumer Prices, 1971-First Half 1981

(Percentage changes)1

1 Over preceding half year; seasonally adjusted, annual rates.

2Partially estimated.

The recent general pattern of relatively moderate wage responses to the acceleration of inflation was evident in nearly all of the industrial countries. There was, however, a difference of degree between the experience of the United States and that of the other countries (Chart 4). The bulk of the outright losses of real wages occurred in the United States, where past responses of hourly compensation to increases in consumer prices have typically been long delayed. Nevertheless, it is significant that advances in real wages in the other industrial countries did not accelerate, on average, from the first half of 1979 to the first half of 1980. In the light of the historical record shown in Chart 4, this result attests to the moderation of wage increases in most of those countries, as well as in the United States.

The most comprehensive indicator of “internal” inflationary pressures, the GNP deflator, also suggests that the acceleration of domestic inflation has been reasonably well contained in most industrial countries. For the entire group, the average rate of increase in the deflator rose from 7½ per cent in the period 1976-78 to 7¾ per cent in 1979 and 9 per cent in 1980. (See Table 1.) Such an increase in domestic inflation, to rates higher than those recorded in any previous years except 1974 and 1975, represented a serious setback in the context of the efforts made by the authorities to control inflation. In the perspective of prior experience, however, the extent to which the authorities have so far been able to contain the secondary repercussions of the rise in consumer prices can be viewed with some gratification. The recent record in this respect is considerably more satisfactory than that of the period 1972-74, when the acceleration of the rise in GNP deflators (about 7 percentage points) was not much less than that for consumer prices (9 percentage points). The cumulative acceleration shown by the GNP deflators from 1978 to 1980, in contrast, amounted to only 1¾ percentage points, compared with more than 4¼ percentage points for consumer prices. Clearly, the feedback of consumer price changes onto domestic wages and costs has been much better contained over the past two years than it was in the mid-1970s. Continued vigilance on this front is nevertheless essential to prevent renewed pressures from developing, as they did in a number of European countries in 1975 and 1976.

Table 1.Industrial Countries: Changes in Output and Prices, 1962-801

(In per cent)

AverageChange from Preceding Year
1962-72219731974197519761977197819791980
Real GNP
Canada5.57.53.61.25.52.13.73.0
United States4.05.8-0.6-1.15.45.54.83.2-0.2
Japan10.410.0-0.31.46.55.35.15.64.2
France35.55.43.20.25.23.13.73.51.2
Germany, Fed. Rep. of4.54.90.5-1.85.22.83.64.51.8
Italy34.86.94.2-3.55.91.92.74.94.0
United Kingdom32.97.1-2.0-1.12.81.63.91.7-1.7
Other industrial countries44.95.43.5-0.23.71.62.22.81.8
All industrial countries4.86.30.7-0.65.23.94.03.71.2
Of which,
Seven larger countries above4.86.40.3-0.75.44.34.43.81.2
European countries4.55.82.0-1.14.62.23.13.51.4
GNP deflator
Canada3.69.115.310.89.57.16.310.410.6
United States3.65.78.79.35.25.87.38.59.0
Japan5.010.020.08.64.85.74.62.53.1
France34.87.811.113.49.99.09.510.111.6
Germany, Fed. Rep. of4.06.06.86.73.23.83.93.95.0
Italy35.111.718.317.418.019.113.915.720.3
United Kingdom35.27.015.026.914.613.910.614.818.8
Other industrial countries45.69.412.313.010.510.38.97.69.0
All industrial countries4.17.311.611.27.47.67.57.89.0
Of which,
Seven larger countries above4.07.011.510.96.97.17.27.99.0
European countries5.08.211.613.79.79.88.58.510.7

Composites for the country groups are averages of percentage changes for individual countries weighted by the average U.S. dollar value of their respective GNPs over the previous three years.

Compound annual rates of change.

GDP at market prices.

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

Composites for the country groups are averages of percentage changes for individual countries weighted by the average U.S. dollar value of their respective GNPs over the previous three years.

Compound annual rates of change.

GDP at market prices.

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

The acceleration of domestic inflation since 1978 has been pervasive. In every industrial country except Spain and New Zealand, the rise in the GNP deflator was larger in 1980 than in 1979. As noted above, the sharpest increases occurred in countries where inflation was already high in 1979—notably, in the United Kingdom and Italy, where the 1980 increases amounted to 19 per cent and 20 per cent, respectively. In each case, that figure was some 4 percentage points higher than in 1979. In the United Kingdom, however, the increase was due partly to the previous year’s shift to greater reliance on value-added taxes. Moreover, in contrast to developments in other industrial countries, a marked deceleration of domestic inflation became apparent in the United Kingdom during the course of 1980. Elsewhere in the industrial group, the rise in domestic inflation from 1979 to 1980 generally ranged from ½ per cent to 1½ per cent. Japan and the Federal Republic of Germany remained low-inflation countries (their GNP deflators rising in 1980 by 3 per cent and 5 per cent, respectively), while the deflators for the United States, France, and Canada rose at rates (9 to 11½ per cent) not far from the average. The inflation rate as measured by the GNP deflator changed the least from 1979 to 1980 in Canada, but in that country remained at a level (10½ per cent) that compared unfavorably with the Canadian price performance of 1977 and 1978.

Viewed from a longer perspective, the pattern of relative inflation rates has shifted significantly since the early 1970s. The largest industrial country, the United States, has shifted from having an inflation rate well below the industrial country average in the early years of the past decade to having one recently near or a little above the average. In terms of GNP deflators, for example, U.S. price increases were consistently below the average for the other industrial countries by some 2 percentage points throughout the first half of the 1970s. However, the margin narrowed after the middle of the decade and was reversed for a time during 1978 and 1979. Both the Federal Republic of Germany and Japan shifted in the opposite direction, from average or slightly above average rates of inflation at the beginning of the decade to outstandingly low rates in recent years. (See Chart 5.) Nevertheless, the “center of gravity” of global price developments has been raised to a degree that could hinder the reduction of global inflation if the U.S. inflation rate is not lowered in the years ahead. Moreover, avoidance of excessive variability of exchange rates for major currencies is also likely to depend partly on a narrowing of the dispersion of inflation rates, especially among the largest industrial countries.

Chart 5.Major Industrial Countries: GNP Deflators, 1970-80

(Percentage changes from preceding half year; seasonally adjusted, expressed at annual rates)

Output, demand, and employment.—In 1980, after four years of growth at about 4 per cent per annum, real GNP of the industrial countries rose by only 1¼ per cent. (See Table 1.) This marked slowdown reflected a variety of factors, including the sharp cyclical dip in aggregate demand in the United States, the widespread application of restrictive financial policies to contain the flare-up of inflation after 1978, and the deflationary consequences of the rise in oil import payments during 1979 and 1980. These pervasive influences on real demand and output in the industrial world persisted into 1981. At midyear, the expectation with respect to real GNP in the industrial countries was that the average rate of expansion for the group as a whole from 1980 to 1981 would remain in the 1 to 2 per cent range.

A more precise record of the course of developments over the past two years is provided by the seasonally adjusted quarterly data available for the major industrial countries. These data show that real growth of aggregate GNP in those seven countries was relatively well sustained through the first quarter of 1980, but turned sharply negative in the second. (See Chart 6.) Although it then returned to the positive range over the following three quarters, vigor was not restored. Because of the depth of the decline in the second quarter and the modest average pace of the subsequent recovery, the level of output in the seven major industrial countries toward the end of 1980 was no higher than it had been a year earlier.

Chart 6.Major Industrial Countries: Growth of Real GNP/GDP, 1977-First Quarter 1981

(In per cent)

The decline in real GNP in the second quarter of 1980 was large, averaging 6½ per cent at annual rates, and affected all of the major countries except Japan. The largest declines occurred in the United Kingdom, the United States, and the Federal Republic of Germany, where they amounted (at annual rates) to 12 per cent, 10 per cent, and 8 per cent, respectively. For Canada, France, and Italy, more moderate declines—all in the range of 1½ to 4½ per cent—were registered.

Both before and after the second quarter of 1980, the path of cyclical developments in the United States and Canada differed considerably from that followed by the major European economies. Growth of output in North America, which had been quite weak over the year from early 1979 to early 1980, strengthened appreciably after the sharp dip in the second quarter of 1980. Over the succeeding three quarters, through the first quarter of 1981, it averaged about 4½ to 5 per cent, in terms of annual rates, in both the United States and Canada. In Europe, the changes of pace over the same two-year period were just the reverse. Growth was strong through the first quarter of 1980, but very sluggish thereafter. Each of the major European industrial countries experienced at least one further quarterly decline in real GNP after the second quarter of 1980, and the aggregate output of these four countries in the first quarter of 1981 was no larger than in the three months before mid-1980. Economic activity was particularly depressed in the United Kingdom, where real gross domestic product (the “output” estimate) in early 1981 was 5½ per cent below the level of the corresponding period a year earlier. In Japan, on the other hand, partly because of strong growth of exports, national output continued to increase, at a rate averaging more than 3½ per cent from the second quarter of 1980 to the first quarter of 1981.

Preliminary indicators suggest that some convergence of cyclical paths occurred in the second quarter of 1981. At midyear, a marked slowdown in the United States was apparent, while evidence was accumulating that the recession in Europe might be passing its trough. However, the emerging rates of expansion were expected to remain low for some time.

The impact of recessionary forces on the economies of the industrial countries during 1979 and 1980 was felt first and most strongly on aggregate domestic demand, rather than on total output. Growth of nominal demand in the major industrial countries was reduced from 12½ per cent in 1979 to 10½ per cent in 1980, mainly through widespread application of policies of financial restraint, while inflation (as measured by the domestic demand deflator) accelerated from 8 per cent in 1979 to 10 per cent in 1980. The result was a sharp curtailment of growth of domestic demand in real terms, from 4 per cent in 1979 to virtually no increase in 1980. The corresponding slowdown in real GNP growth was much less pronounced—from 3¾ per cent in 1979 to 1¼ per cent in 1980—chiefly because of the impact of increased exports to the oil exporting-countries on the real foreign balances of industrial countries.

All of the main components of domestic demand in the industrial countries were affected by the slowdown. The growth of consumer expenditures in real terms slowed more or less in step with that of real disposable income. Real investment outlays rose less rapidly in most industrial countries and turned downward in a few of them, including the United States and the United Kingdom. The relationship of changes in consumer spending to those in investment spending, however, differed considerably from that typical of previous recessions, and especially from corresponding developments in 1975. In that year, as shown in the accompanying tabulation, real consumption was markedly more buoyant than total output, rising by 2½ per cent while real GNP was declining by ¾ of 1 per cent. From 1979 to 1980, on the other hand, both consumption and GNP increased in real terms at similar rates.

An even more striking difference was that the volume of gross nonresidential fixed investment in the major industrial countries expanded by about 1½ per cent in 1980, in contrast to a decline of 8 per cent in 1975. Even after allowance for the difference in depth of the two recessions, the degree to which business fixed investment was sustained in the past year is noteworthy. Moreover, the 1980 pattern of relatively buoyant investment and subdued consumption appears to be persisting in 1981.

Major Industrial Countries: Changes in Real Demand and Output1(In per cent)
19751980
GNP-0.71.2
Consumption2.51.2
Gross nonresidential fixed investment-8.11.6

Averages of percentage changes for individual countries, weighted by the average U.S. dollar value of their respective GNPs over the previous three years.

Averages of percentage changes for individual countries, weighted by the average U.S. dollar value of their respective GNPs over the previous three years.

Although the reasons for this departure from earlier cyclical patterns are not entirely clear, a few pertinent factors can be cited. With respect to consumption, the shift from a less than proportional to a fully proportional response in the cyclical downswing appears to have stemmed mainly from differences in the role of fiscal policy. In previous recessions, various fiscal supports were widely provided to cushion declines in real disposable income of households, but recent fiscal policies have been essentially neutral on that score. Increases in government transfer payments have been approximately offset by increases in taxes, in sharp contrast to the experience of 1975, when tax cuts and increases in transfers together accounted for almost all of a 2¾ per cent rise in real disposable income.

Fiscal policy has begun to play a supportive role in the recent relative buoyancy of nonresidential fixed investment. However, the impact of most of the fiscal incentives for investment that are being offered or proposed by governments of a number of industrial countries remains to be felt in 1981 and later years. In general, as noted in the previous section, these plans to stimulate investment are being put forward in the context of “supply” policies aimed at improving productivity.

Another major factor tending to boost capital spending in most industrial countries is the sharply increased relative price of energy now prevailing. Investment demand in the energy field itself has been stimulated by efforts to reduce dependence on imported oil, and stimulus for a broader range of capital spending is coming from efforts to reduce the energy intensity of production.

Because of the weakening of growth in total economic activity, increases in employment slackened and unemployment rates rose during both 1980 and the first part of 1981. For the industrial countries as a group, the rise in employment slowed from 1¾ per cent in 1979 to ½ per cent in 1980—a rate that carried over into the early part of 1981. This softening of the demand for labor was less than commensurate with the corresponding shortfall in output. Consequently, productivity growth in the industrial countries dropped from 2 per cent in 1979 to less than 1 per cent in 1980.

Cumulatively, the increase in real GNP per employee from 1973 to 1980 was equivalent to 1½ per cent per annum, compared with 3¾ per cent over the previous decade. However, the weakness of productivity gains served to hold down the rise in unemployment. Even so, the growth of employment fell well short of what would have been necessary to absorb normal increases in the labor force. Accordingly, unemployment rose to 5¾ per cent of the combined labor force of the industrial countries in 1980, and to 6½ per cent in the first half of 1981, compared with 5 per cent in 1979 and 5½ per cent in 1975. Mainly because of the differing national developments with respect to growth of output, the rise in unemployment has not been uniform. Among the larger industrial countries, the most notable increases were those in the United States, the Federal Republic of Germany, France, and the United Kingdom.

Oil Exporting Countries

The few years preceding the large oil price increases of 1979 and 1980 were a period of generally cautious and restrained demand management policies in the oil exporting countries. These policies, stemming mainly from concern on the part of the authorities about inflation and other undesirable (including noneconomic) effects of unduly rapid development, continued into 1979, a year of generally moderate growth in the non-oil sectors of the 12 countries in the group. Although rapid advances were maintained in a few countries with particularly strong external positions (notably Saudi Arabia and Iraq), the severe impairment of economic activity in Iran (which has a large weight in statistical composites for the group) held the average rate of growth in real non-oil gross domestic product (GDP) for the group as a whole to about 2 per cent in 1979. (See Table 2.)

Table 2.Developing Countries: Changes in Output, 1967-801

(In per cent)

AverageChange from Preceding Year
1967-72219731974197519761977197819791980
Oil exporting countries39.010.78.0-0.312.35.91.92.3-3.0
Oil sector13.2-1.0-11.113.51.8-4.22.8-12.5
Non-oil sectors9.712.312.411.38.96.02.13.9
Non-oil developing countries35.36.55.24.8
Excluding China5.86.35.64.05.44.85.54.94.4
By area
Africa5.03.66.91.94.21.42.23.24.9
Asia7.09.74.74.9
Excluding China4.65.44.06.16.46.48.33.33.5
Europe6.15.64.14.37.15.25.34.42.0
Middle East7.45.13.24.83.75.88.06.35.1
Western Hemisphere7.28.37.22.84.64.44.66.55.8
By analytical group
Net oil exporters46.07.56.15.34.83.25.87.16.7
Net oil importers5.66.64.94.2
Excluding China5.86.05.53.75.55.15.54.54.0
Major exporters of
manufactures58.19.66.63.46.15.15.26.54.7
Low-income countries66.38.83.55.0
Excluding China3.42.93.25.73.44.76.00.23.1
Other net oil importers5.54.16.02.66.45.45.64.13.4

Data in this table cover all Fund members except those listed in Table 1, together with a few territories for which balance of payments statistics are readily available. The figures are averages of percentage changes in real GDP for individual countries weighted by the average U.S. dollar value of GDPs over the previous three years.

Compound annual rates of change.

These groups, and each of the regional subgroups of non-oil developing countries, conform to the classification now used in International Financial Statistics. The main group of “oil exporting countries” comprises only countries meeting both of the following criteria (applied at present to 1977-79 averages): that oil exports (net of any imports of crude oil) account for at least two thirds of the country’s total exports; and that such net exports are at least 100 million barrels a year (roughly equivalent to 1 per cent of annual world exports of oil).

Comprise Bahrain, Bolivia, Congo, Ecuador, Egypt, Gabon, Malaysia, Mexico, Peru, the Syrian Arab Republic, Trinidad and Tobago, and Tunisia. Although these countries export more oil than they import, none of them satisfies both of the criteria mentioned in footnote 3.

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

Comprise 40 countries whose per capita GDP, as estimated by the World Bank, did not exceed the equivalent of US$350 in 1978.

Data in this table cover all Fund members except those listed in Table 1, together with a few territories for which balance of payments statistics are readily available. The figures are averages of percentage changes in real GDP for individual countries weighted by the average U.S. dollar value of GDPs over the previous three years.

Compound annual rates of change.

These groups, and each of the regional subgroups of non-oil developing countries, conform to the classification now used in International Financial Statistics. The main group of “oil exporting countries” comprises only countries meeting both of the following criteria (applied at present to 1977-79 averages): that oil exports (net of any imports of crude oil) account for at least two thirds of the country’s total exports; and that such net exports are at least 100 million barrels a year (roughly equivalent to 1 per cent of annual world exports of oil).

Comprise Bahrain, Bolivia, Congo, Ecuador, Egypt, Gabon, Malaysia, Mexico, Peru, the Syrian Arab Republic, Trinidad and Tobago, and Tunisia. Although these countries export more oil than they import, none of them satisfies both of the criteria mentioned in footnote 3.

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

Comprise 40 countries whose per capita GDP, as estimated by the World Bank, did not exceed the equivalent of US$350 in 1978.

Toward the end of 1979, a general tendency to relax financial policies became apparent in the oil exporting countries. This tendency, which was responsive to a revival of popular expectations engendered by the renewed upsurge in oil export earnings, was manifested chiefly in an increase of government spending. With that impetus, the average rate of growth in real non-oil GDP rose to about 4 per cent in 1980, notwithstanding the persistence of slack economic activity in Iran and the effects, both there and in Iraq, of the conflict between those two countries in the latter part of the year. As in the immediately preceding years, the highest growth rate among the oil exporting countries was that of Saudi Arabia.

The step-up of economic activity in the non-oil sectors in 1980 was accompanied by a noticeable upturn in rates of inflation. Consumer prices in the oil exporting countries are estimated to have risen, on average, by 13½ per cent in 1980, compared with about 11 per cent in 1979. This acceleration reflected particularly large increases for Iran and for Venezuela, in the latter country partly in response to a policy of releasing previously suppressed inflationary pressures through cutbacks of price controls and subsidies.

The shift by the oil exporting countries toward more expansionary policies, although widespread, has remained much more gradual than the corresponding shift following the 1973-74 oil price increases. Avoidance of the inflationary pressures experienced in that earlier period has been given a high priority by the authorities of most countries in the group. Some of them, recognizing the risks of misallocation of resources, have been reappraising the development experience of the past several years and deferring investment decisions while preparing new development plans.

In the countries with particularly strong external positions and generally small populations, progress in developing an adequate physical and social infrastructure has paved the way for a shift in investment priorities toward more directly productive ventures. Nevertheless, in part because concern about the social and economic implications of further additions to the expatriate labor force has led to policies aimed at moderating such additions, it is likely that medium-term economic growth in this group of countries will fall short of the high rates of the mid-1970s.

In the oil exporting countries with relatively large populations and more diversified economies, the increases in financial resources during 1979 and 1980 have generally tended to encourage and permit accelerated domestic economic expansion. However, in these countries also, adoption of strongly expansionary policies has been deterred by the desire to avoid a revival of inflationary pressures and to give priority to social objectives. In addition, the authorities in some of these countries are anxious to protect their external payments positions against recurrence of the sizable current account deficits and heavy external borrowing requirements experienced in 1978.

At present, some acceleration of economic activity appears to be continuing in most of the oil exporting countries. On the assumption that the conflict between Iran and Iraq brings little further destruction in the coming months, an appreciable further rise in the average rate of growth in real non-oil GDP for the oil exporting group is thus in prospect for 1981. However, the 1980 upturn in the average rate of inflation is not projected to continue in 1981. Both the prevalence of relatively cautious demand management policies and the absence of significant supply bottlenecks—thanks to the expansion of infrastructure in recent years—militate against a repetition of the 1974-76 experience with respect to inflation. With a much smaller rise in import prices than in recent years, the average rate of inflation in the oil exporting countries is expected to decline somewhat in 1981.

Because of the sharp rise in oil prices, the proportion of nominal GDP of the oil exporting countries originating in the oil sector rose from a little over one third in 1978 to nearly one half in 1980. However, in the aggregate, the substantial drop in the volume of oil output in 1980 more than offset the increase in non-oil production, resulting in a 3 per cent decline in total real GDP of this group of countries. The contrasting movements of oil and non-oil output are expected to extend into 1981, when total real GDP is expected to change little. Despite the lack of growth in total real GDP since 1978, real national income of the oil exporting countries—a measure that takes account of changes in the terms of trade—has increased substantially.

Non-Oil Developing Countries

A wide variety of domestic developments was evident in 1980 and the first half of 1981 among the non-oil developing countries. In the discussion that follows, an effort is made to depict some of the salient distinctions within this group of some 110 countries by focusing attention on selected analytical and regional subgroups.

For the group as a whole, 1980 was a year of high inflation and reduced growth in output. The average increase in real GDP was a little less than 5 per cent, compared with 5¼ per cent in 1979 and 6½ per cent in 1978. (See Table 2.) All these figures are increased appreciably by the inclusion of data for the People’s Republic of China, which was not covered in previous Annual Reports and for which data are available only from 1977 to date. Apart from that country, the average 1980 growth rate was about 4½ per cent, considerably below the average of close to 6 per cent for nonrecession years of the late 1960s and 1970s.

At least in part, this shortfall was a reflection of the impact of the current recession in the industrial countries, which has markedly affected the predominant markets for exports of the non-oil developing countries. The recession has tended not only to inhibit the expansion of export volume but also to exert a progressively stronger downward influence on primary commodity prices. The index of such prices (expressed in U.S. dollars) rose substantially less rapidly in 1980 than in the previous year; and it declined in most months from October 1980 through June 1981. As noted in a later section of this chapter, the combination of slower growth of export volume and falling terms of trade cut into the purchasing power of export earnings, and a rising share of those earnings was diverted into interest payments on external debt.

For many developing countries, the inflow of real resources obtainable from abroad was thus limited, despite a sharp expansion in the net flow of funds acquired through foreign borrowing. Confronted with a squeeze on the total availablility of resources for consumption and investment, some of the affected countries were unable to avoid constraints on the pace of their developmental spending, and these constraints reinforced the negative impact of the international recession on total demand for their domestic output.

During the latter part of 1980 and the first half of 1981, another factor tending to retard the expansion of output in many developing countries was the emergence of more restrained fiscal and monetary policies. Such policies were adopted to combat inflation, or to curb import demands and external deficits on current account, or both. To some extent, the slowing of growth now in process thus reflects implementation of adjustment measures made necessary by the prevalence of internal and external imbalances. However, the shifts away from accommodative financial policies came generally too late to prevent a worsening of inflation for 1980 as a whole. That year’s monetary expansion in the non-oil developing countries was larger by about one fifth, on average, than the corresponding expansion in 1979.

Growth of domestic credit, to which the progressive increases of recent years in the average size of central government fiscal deficits have contributed, was the primary force behind the 1980 acceleration in rates of monetary expansion and price inflation. These developments reflected the efforts of many non-oil developing countries to maintain adequate growth in the face of soaring import costs and softening of export markets. Such efforts, however, often came into conflict with other objectives. The tightening of financial policies that began in many countries during the latter part of 1980 appears, as already mentioned, to represent a shift toward renewed emphasis on containment of inflation and of external imbalances.

The only major subgroup of non-oil developing countries maintaining strong domestic growth in 1980 was that comprising the net exporters of oil.1 These countries, whose terms of trade gains in both 1979 and 1980 contrasted sharply with the deteriorating terms of trade of other non-oil developing countries, also enjoyed especially good access to international credit markets. With these advantages, they were able to sustain real growth in 1980 at a rate approaching 7 per cent—by far the highest average recorded for any of the subgroups distinguished in Table 2. This pace is not expected to slacken in 1981.

In 1979, the growth performance of the net oil exporting subgroup was almost matched by that of the developing countries that have become major exporters of manufactures. For this latter subgroup, average increases in GDP had generally exceeded those of most other non-oil developing countries by a considerable margin earlier in the 1970s, as well as during the 1960s. In 1980, however, total real output of this group of manufacturing exporters rose considerably less rapidly than that of the net oil exporters—and, indeed, no faster than the average for all non-oil developing countries. The manufacturing exporters were especially vulnerable to the slackening of demand in the industrial countries, as well as to protectionist measures taken by some of these countries.

Slack demand in the industrial world was also a factor in the relatively weak rates of growth in real GDP recorded in 1980 for both the middle-income exporters of primary products 2 and most of the low-income countries (whose exports, in most cases, also consist mainly of primary products). This weakness was especially marked for the numerous small countries in the low-income group. Although the growth rate for that subgroup as a whole was bolstered in 1980 by comparatively sizable gains in the two largest low-income countries (the People’s Republic of China and India), real GDP expansion in the other 38 low-income countries is estimated to have amounted to only 3 per cent in 1980. For them, it was the second consecutive year of growth at that disappointingly low rate, barely sufficient to prevent complete stagnation of per capita income. Even with the higher increases for China and India included, the average per capita increase in real income in the low-income countries—which contain some two thirds of the population of the entire developing world—was not much above 2 per cent in 1980.

With respect to growth of national output in real terms, the middle-income exporters of primary products did not fare much better in 1980 than the 38 low-income countries mentioned above. Their real GDP gains averaged some 3½ per cent—by far the lowest annual increase since 1975. Like most of the low-income countries, these middle-income countries were confronted by a sharply adverse swing in the terms of trade that limited their access to resources for development. For many countries in both of these subgroups, agricultural protectionism in potential market areas also constituted an obstacle to expansion of export earnings. By the first half of 1981, a good many countries were finding it necessary to restrain aggregate demand in order to keep their external balances within manageable bounds.

Regionally, the best growth records among non-oil developing countries in both 1979 and 1980 were those of the Western Hemisphere area (comprising Latin America and the Caribbean), where several of the largest countries are either major exporters of manufactures or net exporters of oil, and of the Middle East, where a number of countries continued to benefit from strong demand among neighboring countries in the main oil exporting group. At the other extreme were the developing countries in the European area, whose average increase in real GDP from 1979 to 1980 was only 2 per cent. This figure reflects implementation of more restrictive financial policies in several key countries of the area, as well as the heavy dependence of their exporting industries on markets in the industrial countries. Similar factors were operative in a number of non-oil developing countries in the Asian region, where real output outside the People’s Republic of China rose by only 3½ cent in 1980. In Africa, apart from South Africa, the average was also about 3½ per cent. In a number of African countries, agricultural output remained low in the aftermath of drought in the Sahelian region, and some countries suffered severe economic disruptions as a result of civil disorders.

The economic record of the non-oil developing countries in 1980 was marred by another sharp rise in the rate of inflation, which had already turned upward in 1979. As measured by a weighted average of consumer price increases, the inflation rate for the whole group reached 32 per cent in 1980, compared with 24 per cent for the previous year and 19 per cent in 1978. (See Table 3.) This disturbing flare-up of inflation reflected both the sharp rise in costs of imported goods and the pursuit of expansionary financial policies by a majority of the non-oil developing countries during 1979 and part of 1980. However, as already noted, a shift away from strongly expansionary policies has become evident in many countries over the past year. If the numerous adjustment programs that have been instituted with a view to improving both internal demand/supply relationships and external balances are appropriately implemented, some easing of the average rate of inflation among non-oil developing countries in 1981 would seem likely.

Table 3.Developing Countries: Changes in Consumer Prices, 1967-801

(In per cent)

AverageChange from Preceding Year
1967-72219731974197519761977197819791980
Oil exporting countries
Weighted average38.011.317.018.816.815.510.210.813.4
Non-oil developing countries
Weighted average322.719.424.532.5
Excluding China9.122.128.727.027.627.123.728.937.7
Median44.310.418.415.410.011.89.912.215.0
By area
Weighted averages3
Africa4.69.815.315.115.019.215.619.219.4
Asia5.12.36.412.2
Excluding China6.719.528.810.60.56.85.29.516.2
Europe6.212.717.514.712.516.221.127.540.3
Middle East4.212.522.021.519.219.521.325.844.4
Western Hemisphere15.432.137.552.066.251.442.449.360.2
Medians
Africa4.39.416.416.010.714.610.511.914.0
Asia44.114.024.310.56.27.66.08.214.4
Europe3.812.916.213.411.612.212.519.016.6
Middle East4.417.120.114.114.114.310.812.118.2
Western Hemisphere4.512.919.517.09.711.410.717.519.5
By analytical group
Weighted averages3
Net oil exporters4.111.120.614.614.922.817.717.724.7
Net oil importers22.719.725.633.5
Excluding China10.024.130.229.430.227.924.931.140.2
Major exporters of manufactures14.121.324.940.155.840.937.344.656.0
Low-income countries6.22.16.611.1
Excluding China6.622.030.112.011.26.711.515.9
Other net oil importers8.631.940.329.019.720.819.324.232.6
Medians
Net oil exporters3.811.218.715.510.512.111.09.916.0
Net oil importers44.310.318.415.39.911.69.512.215.0
Major exporters of manufactures6.418.224.315.213.312.214.419.025.0
Low-income countries44.310.017.918.98.511.69.411.013.6
Other net oil importers3.910.618.413.39.711.59.412.616.5

For classification of countries in groups shown here, see Table 2.

Compound annual rates of change.

Geometric averages of country indices, weighted by the average U.S. dollar value of GDPs over the previous three years.

Excludes the People’s Republic of China.

For classification of countries in groups shown here, see Table 2.

Compound annual rates of change.

Geometric averages of country indices, weighted by the average U.S. dollar value of GDPs over the previous three years.

Excludes the People’s Republic of China.

Within the non-oil developing group, rates of inflation for individual countries are considerably more varied than are their respective growth rates. Because a number of the larger developing countries in some areas (especially in Latin America and Europe, although not in Asia) are among those that have experienced relatively high rates of inflation, the weighted averages of such rates are not necessarily representative of the majority of countries in any of the regional or analytical subgroups shown in Table 3. In order to provide an indication of the skew in the distribution of individual inflation rates, that table gives median rates for each subgroup (and for the whole non-oil developing group), as well as weighted average rates. In general, the median rates for recent years are both substantially lower and less variable from year to year than are the weighted average rates. The difference in levels of the respective measures signifies that the majority of non-oil developing countries have had inflation rates less than half as high as the weighted average, but also underscores the economic importance of a number of the countries with particularly high rates of inflation.

This last consideration is especially relevant to the regional data for the Western Hemisphere. That area includes several large countries with traditionally rapid increases in prices, giving it not only the highest average rate of inflation among the regional subgroups but also the widest dispersion of individual rates. Even the median rate for the Western Hemisphere group was higher than that for any other region in 1980, but the difference was much smaller than that with respect to weighted averages.

To a lesser degree, a broadly similar contrast between the median and average rates also characterized the European developing countries in 1980. In the Asian area, on the other hand, recent rates of inflation in the largest developing countries—the People’s Republic of China and India—had differed much less strikingly from those in the majority of smaller countries. In 1980, the two figures for the Asian group were of the same order of magnitude (Table 3), and both of them—but especially the average rate—were low in comparison with corresponding figures for other regions. This result can probably be attributed, at least in considerable part, to the relatively conservative financial policies traditionally followed by many of the Asian developing countries.

International Trade and Payments

Global Perspectives

International trade and payments developments of the past two years featured unusually pronounced changes in the terms of trade of major groups of countries, large swings in their current account balances, with accompanying shifts in capital movements, and substantial changes in exchange rates, including wide short-term variations in response to changes in monetary conditions and interest rates in the major industrial countries. (See Table 4.) These changes occurred against a background of continuing high—and quite uneven—rates of inflation and, during 1980 and the first half of 1981, very slow growth of world trade.

Table 4.World Trade Summary, 1962-801

(Percentage changes)

AverageChange from Preceding Year
1962-72219731974197519761977197819791980
World trade3
Volume8.512.55.0-4.011.05.05.56.51.5
Unit value (in U.S. dollar terms)3.022.539.08.51.58.510.018.020.0
(in SDR terms)2.011.538.07.57.07.52.514.519.0
Volume of trade
Exports
Industrial countries8.813.76.7-4.010.75.15.96.94.5
Developing countries
Oil exporting countries9.213.2-0.9-11.514.60.2-3.73.0-13.2
Non-oil developing countries6.710.11.50.313.93.911.29.27.9
Imports
Industrial countries9.112.20.4-8.114.24.15.48.1-0.8
Developing countries
Oil exporting countries8.420.338.541.420.414.65.2-11.615.4
Non-oil developing countries6.213.97.5-4.02.46.77.811.95.8
Unit value of trade (in SDR terms)4
Exports
Industrial countries2.39.323.710.15.76.75.511.812.3
Developing countries
Oil exporting countries2.627.6202.24.111.68.4-6.341.257.7
Non-oil developing countries1.320.635.1-2.29.512.9-2.914.016.3
Imports
Industrial countries2.011.740.27.86.38.02.615.420.4
Developing countries
Oil exporting countries2.112.526.810.05.77.85.010.511.2
Non-oil developing countries1.613.245.07.47.16.22.914.520.0

For classification of countries in groups shown here, see Tables 1 and 2. Excludes data for the People’s Republic of China prior to 1977.

Compound annual rates of change.

Averages based on data for the three groups of countries shown separately below and on partly estimated data for other countries (mainly, the Union of Soviet Socialist Republics and other nonmember countries of Eastern Europe). Figures are rounded to the nearest ½ of 1 percentage point.

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

For classification of countries in groups shown here, see Tables 1 and 2. Excludes data for the People’s Republic of China prior to 1977.

Compound annual rates of change.

Averages based on data for the three groups of countries shown separately below and on partly estimated data for other countries (mainly, the Union of Soviet Socialist Republics and other nonmember countries of Eastern Europe). Figures are rounded to the nearest ½ of 1 percentage point.

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

The relative importance of sources of change in the terms of trade in the past two years can be inferred from the following: the terms of trade of the oil exporting countries rose by 28 per cent in 1979 and another 42 per cent in 1980 (Table 5); those of the industrial countries fell by 3 per cent in 1979 and 6½ per cent in 1980; and the terms of trade of the oil importing developing countries were reduced by about 8½ per cent over the two years. (Because the non-oil terms of trade of this last group displayed moderate cyclical strength in 1979, but were cyclically weak during the last two or three quarters of 1980, the group’s overall terms of trade deterioration over both years was concentrated in the second.)

Table 5.Terms of Trade Developments, 1962-801

(Percentage changes)

AverageChange from Preceding Year
1962-72219731974197519761977197819791980
Industrial countries0.2-1.7-11.72.1-0.8-1.22.8-3.1-6.7
Developing countries
Oil exporting countries0.513.4138.3-5.45.60.6-10.827.841.8
Non-oil developing countries-0.36.5-6.9-8.92.26.3-5.6-0.5-3.1
Memorandum item
World trade prices (in U.S.
dollar terms) for major
commodity groups3
(a) Manufactures3.017.721.812.39.014.714.511.0
(b) Oil3.040.6225.85.36.29.30.148.162.5
(c) Non-oil primary commodities
(market prices)2.553.727.8-18.213.320.6-4.616.59.6

Based on foreign trade unit values except where indicated. For classification of countries in groups shown here, see Tables 1 and 2. Excludes data for the People’s Republic of China prior to 1977.

Compound annual rates of change.

As represented, respectively, by (a) the United Nations’ export unit value index for 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 except where indicated. For classification of countries in groups shown here, see Tables 1 and 2. Excludes data for the People’s Republic of China prior to 1977.

Compound annual rates of change.

As represented, respectively, by (a) the United Nations’ export unit value index for 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 in reflection of changes in terms of trade, but under the influence also of the cyclical slowdown in world trade stemming from the recession in the industrial countries, swings in the current account balances of major groups of countries in 1979 and 1980 were by far the largest since the middle 1970s. (See Table 6.) From 1978 to 1980, the increase in the current account surplus of the oil exporting countries amounted to nearly $110 billion, while the current account balance of the industrial countries shifted by $75 billion in the opposite direction—from a surplus of $31 billion (excluding official transfers) in 1978 to a deficit of $44 billion in 1980—and the aggregate current account deficit of the non-oil developing countries more than doubled, to $82 billion. For the industrial and oil exporting groups of countries, partial reversals of these shifts are expected in 1981, reflecting rapid increases in imports of the oil exporters and further declines in the volume of their exports. The combined deficit of the non-oil developing countries, on the other hand, is expected to rise further.

Table 6.Payments Balances on Current Account, 1973-811

(In billions of U.S. dollars)

1973197419751976197719781979198019812
Industrial countries19.7-11.617.6-0.2-4.630.8-7.8-44.1-29
Seven larger countries14.1-3.723.29.18.034.24.7-15.7-1
Other countries5.5-7.9-5.5-9.3-12.6-3.4-12.5-28.4-28
Developing countries
Oil exporting countries6.667.835.040.031.13.368.4112.296
Non-oil developing countries3-11.5-36.8-46.5-32.9-28.6-37.5-57.6-82.1-97
By area
Africa-2.0-4.8-9.2-8.0-6.0-7.3-5.8-7.3-14
Asia3-2.5-9.8-9.0-3.5-0.7-5.8-14.1-23.7-25
Europe0.3-4.3-4.7-4.1-7.6-5.2-8.5-10.3-9
Middle East-2.6-.4.5-7.0-5.4-5.2-6.3-8.3-7.7-8
Western Hemisphere-4.7-13.4-16.6-11.9-9.1-12.920.9-33.1-40
Total414.819.46.16.9-2.1-3.43.0-14.0-30

On goods, services, and private transfers. For the industrial countries, alternative, current account balances including official transfers are given for the years 1977-80 in Table 9. Projected 1981 balances including official transfers are $50 billion for the industrial countries as a group, $18½ billion for the larger countries, and $31½ billion for the other industrial countries. For classification of countries in groups shown here, see Tables 1 and 2.

Fund staff projections.

Excludes data for the People’s Republic of China prior to 1977.

Reflects errors, omissions, and asymmetries in reported balance of payments statistics plus balance of listed groups with other countries (mainly, the Union of Soviet Socialist Republics and other nonmember countries of Eastern Europe and, for years prior to 1977, the People’s Republic of China).

On goods, services, and private transfers. For the industrial countries, alternative, current account balances including official transfers are given for the years 1977-80 in Table 9. Projected 1981 balances including official transfers are $50 billion for the industrial countries as a group, $18½ billion for the larger countries, and $31½ billion for the other industrial countries. For classification of countries in groups shown here, see Tables 1 and 2.

Fund staff projections.

Excludes data for the People’s Republic of China prior to 1977.

Reflects errors, omissions, and asymmetries in reported balance of payments statistics plus balance of listed groups with other countries (mainly, the Union of Soviet Socialist Republics and other nonmember countries of Eastern Europe and, for years prior to 1977, the People’s Republic of China).

The large and sudden shifts in current account balances since 1978 have required equally sharp alteration of global flows of capital and reserves. The non-oil developing countries greatly expanded their external borrowing, despite rising interest rates in world financial centers, and in 1980 virtually ceased the earlier accumulation of reserves, while most of the industrial countries shifted from net lending (and/or reserve accumulation) in international markets to net borrowing. The counterpart of these new or vastly increased capital inflows, of course, was the external investment by the oil exporting countries of the enlarged national savings made possible by the rise in oil prices. Predominantly, this investment (described more fully in a later section of this chapter) took the form of placements of funds in banks and securities markets in the industrial countries; and the funds so placed were then channeled by the financial institutions and markets that received them to borrowers in both the industrial countries and the non-oil developing countries. Table 7 summarizes the components of these “recycling” flows (comprising a substantial proportion of the total) that were channeled through banks reporting to the Bank for International Settlements.

Table 7.International Banking: Global Sources and Uses of Funds, 1975-801

(In billions of U.S. dollars)

197519761977197819791980
Sources
Changes in
Gross liabilities8998114194263215
Interbank deposits3936341058867
Net liabilities50628089175148
Of which, to residents of
Industrial countries24331515811398
Oil exporting countries12121373738
Non-oil developing countries4141317166
Other countries, including n.e.o.3-953796
Uses
Changes in
Gross claims115106110215218212
Interbank deposits43936341058867
Net claims767076110130145
Of which, on residents of
Industrial countries2403143467087
Oil exporting countries79101775
Non-oil developing countries322513314247
Other countries, including n.e.o.3-351016116
Memorandum item: Net sources (+)/uses (—) of
international banking funds
Industrial countries2298433-28
On account of
Residents269-421-45-3
Nonresidents3-18124311
Oil exporting countries633-103033
Non-oil developing countries-28-11-14-26-41
Other countries, including n.e.o.3-6-7-9-2
Source: Bank for International Settlements (BIS).

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 8 and 9. 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 the effects of any mismatching of assets and liabilities ensuing from the assumption noted in footnote 4 or, in 1975, from a discontinuity in the classification of countries in the BIS reports on which this table is based.

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

Source: Bank for International Settlements (BIS).

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 8 and 9. 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 the effects of any mismatching of assets and liabilities ensuing from the assumption noted in footnote 4 or, in 1975, from a discontinuity in the classification of countries in the BIS reports on which this table is based.

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

The upper section of the table (“Sources”) shows how these banks increased their borrowing from both the oil exporting countries and the industrial countries after 1978, while receiving a smaller flow of deposits from non-oil developing countries and from unspecified (mainly Eastern European) countries. The middle section (“Uses”) shows how the same banks increased their lending to non-oil developing countries, as well as to the industrial countries, from 1978 to 1980, while sharply reducing the flow of new loans to the oil exporting countries and the Eastern European countries. The lower part of the table, recapitulating the net movements of funds among broad groups of countries that resulted from the combined borrowing and lending of the reporting banks, shows the marked shift in the pattern of these net flows from 1978 to 1980. In the former year, funds raised entirely in the industrial countries were recycled to all three of the other groups listed in the table, with less than half of the net total going to the non-oil developing countries. In 1980, on the other hand, funds raised predominantly in the oil exporting countries and only secondarily (on a net basis) in the industrial countries were recycled exclusively (again, on a net basis) to non-oil developing countries.

As can be seen from comparison of the net banking flows recorded in the lower part of Table 7 with the more comprehensive net capital movements summarized in Table 8, large sums also moved outside the banking channels covered in Table 7. Some of the largest of these movements were the placements of funds belonging to the oil exporting countries directly in nonbank assets in the industrial countries; the flows of official loans and transfers from both industrial and oil exporting countries to non-oil developing countries (Table 11); and movements of direct investment capital from industrial to developing countries (much of which is also recorded in Table 11).

Table 8.Global Balance of Payments Summary, 1977-80

(In billions of U.S. dollars)

Balance on
CurrentChange inBalance
ServicesaccountLiabilitiesFinanced by
andexcludingCapitalto ForeignChanges
privateofficialAccountOfficialin Reserve
TradetransferstransfersBalance1Agencies2Assets3
Industrial countries41977-18.313.7-4.63.6539.538.6
19787.423.430.8-18.1532.244.9
1979-37.629.8-7.832.45-13.511.1
1980-67.223.1-44.151.3524.531.7
Oil exporting countries4197761.5-30.431.1-20.810.3
197841.1-37.83.3-13.3-10.0
1979111.0-42.668.4-54.414.0
1980163.0-50.8112.2-92.519.7
Non-oil developing countries41977-23.3-5.3-28.641.3-0.612.1
1978-33.0-4.4-37.553.8-0.515.8
1979-48.4-9.3- 57.667.50.210.1
1980-65.2-16.9-82.180.33.01.2
By analytical group4
Net oil exporters1977-3.6-3.2-6.88.8-0.11.9
1978-4.0-3.6-7.68.71.1
1979-2.7-5.3-8.011.1-0.13.0
1980-2.2-8.3-10.513.70.43.6
Net oil importers1977-19.7-2.1-21.832.4-0.510.1
1978-29.0-0.8-29.845.0-0.514.7
1979-45.7-4.0-49.756.50.37.1
1980-63.0-8.6-71.566.62.6-2.4
Major exporters of1977-8.50.5-8.112.7-0.24.4
manufactures1978-9.9-9.920.3-0.79.7
1979-18.8-2.9-21.723.9-0.41.8
1980-24.5-7.2-31.727.80.5-3.4
Low-income countries1977-2.2-0.2-2.46.2-0.33.5
1978-8.31.2-7.18.1-0.20.8
1979-12.61.6-11.013.10.22.3
1980-18.12.4-15.813.70.6-1.5
Other net oil importers1977-9.0-2.4-11.313.52.2
1978-10.8-2.1-13.016.80.44.2
1979-14.3-2.6-16.919.40.53.0
1980-20.4-3.7-24.025.01.52.5
Total, all countries6197719.9-22.0-2.124.238.961.0
197815.5-18.8-3.422.431.750.7
197925.0-22.13.045.5-13.335.2
198030.6-44.6-14.039.127.552.6

This balance is computed 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.

The changes in reserve assets indicated here are calculated as the changes in U.S. dollar equivalents of period-end stocks of total reserves with gold valued at SDR 35 per ounce. It may be noted that official agencies of some countries hold external financial claims that are not classified as reserves. Changes in such claims are included in the column “Capital Account Balance” of this table. The dividing line between capital movements and reserve asset changes remains particularly uncertain for some oil exporting countries.

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

See footnote 6.

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 smaller net capital inflow and a larger aggregate change in liabilities to foreign official agencies. If identified Eurocurrency reserve placements (shown in terms of SDRs in Table 21 of this Report) were assumed to have been placed in industrial countries, then the adjusted net capital inflows to those countries would amount to—$14.8 billion,—$19.8 billion, $29.7 billion, and $41.7 billion over the years 1977, 1978, 1979, and 1980, respectively.

This balance is computed 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.

The changes in reserve assets indicated here are calculated as the changes in U.S. dollar equivalents of period-end stocks of total reserves with gold valued at SDR 35 per ounce. It may be noted that official agencies of some countries hold external financial claims that are not classified as reserves. Changes in such claims are included in the column “Capital Account Balance” of this table. The dividing line between capital movements and reserve asset changes remains particularly uncertain for some oil exporting countries.

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

See footnote 6.

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 smaller net capital inflow and a larger aggregate change in liabilities to foreign official agencies. If identified Eurocurrency reserve placements (shown in terms of SDRs in Table 21 of this Report) were assumed to have been placed in industrial countries, then the adjusted net capital inflows to those countries would amount to—$14.8 billion,—$19.8 billion, $29.7 billion, and $41.7 billion over the years 1977, 1978, 1979, and 1980, respectively.

On the whole, the recycling process worked smoothly and effectively during the past two years. Huge sums were transferred from new or greatly expanded savings in the surplus countries to borrowers elsewhere, largely through decentralized operation of normal forces in financial markets. Those mechanisms were supplemented, however, by arrangements for expanded flows through the Fund and other international institutions, as well as by various intergovernmental loans under special bilateral arrangements.

The large and growing transmission of financial resources through the recycling mechanism during 1979 and 1980 coincided with a widespread shift of policies in the major industrial countries toward more determined efforts to bring inflation under control. In particular, firmer emphasis was placed on slowing the growth of monetary aggregates in order to contain the expansion of nominal demand. The stronger emphasis on quantitative aspects of monetary restraint interacted with changing pressures of underlying demand and shifts in market expectations to produce both an unprecedentedly high level of interest rates in the major industrial countries, greatly increasing the real costs of borrowing for other countries. The fluctuations in those interest rates, as well as the differentials among them, were exceptionally wide. The main focus of attention was on interest rate relationships between the United States and the continental European countries, but also involved, at times, the U.K. or Japanese financial markets. During a period also featuring severe and rapidly changing imbalances in current account positions, as well as periodic social and political uncertainties, the result was an emergence of strong and variable pressures in exchange markets. As noted in a later section, the management of exchange rates and related issues became more difficult and complex for a number of countries than at any time since the early 1970s.

Some of the continental European countries whose currencies depreciated sharply during the latter part of 1980 and the first half of 1981 faced dilemmas in their efforts to reconcile conflicting policy objectives. Although stringent monetary conditions were needed to prevent outflows of interest-sensitive capital and further depreciation of effective exchange rates, levels of domestic employment and investment were such as to make high interest rates unwelcome. On the other hand, acceptance of more rapid exchange rate depreciation would have made it even more difficult for the countries concerned to hold down domestic inflation and wage demands at a time of sharp increase in domestic currency costs of imports—most notably of oil—and deterioration of the terms of trade.

For the non-oil developing countries, with their almost universal capital-importing balance of payments structure, the sharply altered relationship between interest rates and inflation rates in the industrial countries that has emerged over the past two years presents some serious short-range problems, whatever its promise for ultimate benefits in the form of worldwide reductions of inflation. Rates of increase in GNP deflators and export prices of the industrial countries finally began to subside in the latter part of 1980 and the first half of 1981, with a good prospect of further declines in the average rate of inflation in those countries over the next year or two. Given this situation, borrowers in the developing countries cannot realistically expect their own export prices, even after the trough of the current international recession is passed, to rise fast enough to negate much of the real cost of debt service, as they did during most of the past decade. In that period, nominal interest rates were considerably lower than at present and real interest rates (as computed ex post) were negative much of the time, so that interest and amortization payments on external loans typically became less costly in terms of current export earnings at the time of payment than at the time when the obligations were incurred. At current interest and inflation rates, this relationship is reversed, and the prospect that substantially positive real interest rates may persist for some time could prove a significant deterrent to borrowing by oil importing developing countries. Avoidance of the sharply increased real cost of such borrowing has become an important inducement for adjustment of external payments imbalances, not only for developing countries but also for a number of the industrial countries.

More specific aspects of recent developments in the external payments positions of particular groups of countries, and of a few of the large industrial countries individually, are discussed in the following sections. They deal first with the industrial countries, reviewing both the evolution of current account balances and changes in exchange rates, and then, successively, with the oil exporting countries and the non-oil developing countries.

Industrial Countries

Current account developments.—The negative changes in the combined current account balance of the industrial countries in 1979 and 1980 were not only exceptionally large but also unevenly distributed among countries in the group. Over the two-year period, the cumulative net change, in terms of balances including official transfers, amounted to $80 billion. Within that net total, however, were opposite (positive) movements for three of the seven major industrial countries. These totaled $25 billion, of which the United States alone accounted for $18 billion. They left the U.S. and U.K. current accounts in surplus and Canada with its smallest deficit since 1973. (See Chart 7.)

Chart 7.Major Industrial Countries: Payments Balances on Current Account, Including Official Transfers, 1977-First Quarter 19811

(In billions of U.S. dollars)

1 Seasonally adjusted, annual rates.

Negative changes in the current account balances of the other four major industrial countries from 1978 to 1980 totaled $79 billion, of which Japan and the Federal Republic of Germany accounted for more than $50 billion. All four of these large industrial countries recorded sizable deficits for 1980, in contrast to their surpluses in 1978 (Table 9). Collectively, the smaller industrial countries also had a large current account deficit (some $32 billion), reflecting a deterioration of $26 billion from their combined position in 1978. All of these smaller countries except Norway and Australia shared in the deterioration, and Norway was the only one with a significant current account surplus in 1980.

Table 9.Industrial Countries: Balance of Payments Summaries, 1977-80

(In billions of U.S. dollars)

Balance onCapital Account BalanceMemo:
CurrentLong-termChanges inBalanceCurrent
ServicesaccountcapitalLiabilitiesFinanced byAccount
andexcludingandto ForeignChangesIncluding
privateofficialofficialOfficialin ReserveOfficial
TradetransferstransfersTotal1transfersOther2Agencies3Assets4Transfers
United States1977-30.920.9-10.0-24.3-17.9-6.435.41.1-14.1
1978-33.824.3-9.5-21.4-14.7-6.731.10.2-14.2
1979-27.334.16.87.2-18.525.7-13.60.41.6
1980-25.435.410.0-17.4-14.7-2.714.87.43.5
United Kingdom1977-3.95.61.612.53.59.02.716.8-0.3
1978-3.07.84.8-6.9-8.71.8-1.9-4.01.4
1979-7.38.81.51.8-10.812.60.23.5-2.9
19802.37.910.2-13.9-15.01.14.60.96.0
Canada19772.9-7.0-4.12.93.7-0.8-1.2-4.1
19783.9-8.0-4.14.13.11.0-4.3
19794.0-8.3-4.43.73.30.5-0.7-4.2
19807.1-9.1-2.02.11.20.90.1-1.6
France1977-2.71.1-1.6- 2.7-0.73.4-0.6- 0.5-3.0
19780.74.55.2-1.8-4.52.70.33.73.8
1979-2.04.82.84.5-7.111.60.17.41.1
1980-12.05.9-6.115.2-10.926.10.59.6-7.8
Germany,197718.4-10.57.9-4.6-9.65.01.64.93.9
Fed. Rep. of197823.2-9.913.3-2.4-5.83.4•3.214.19.0
197914.4-14.7-0.33.70.13.6-0.3. 3.1-6.1
19807.2-16.2-9.0-1.1-2.91.85.4-4.7-15.4
Italy1977-0.13.23.12.90.42.5-1.05.02.5
19782.94.87.7-3.5-0.4-3.1-0.93.36.2
1979-1.17.26.11.8-2.03.8-1.56.45.1
1980-16.16.8-9.413.95.18.80.34.8-9.8
Japan197717.3-6.211.1-4.5-3.4-1.16.710.9
197824.6-7.816.8-6.6-12.66.010.216.5
19791.8-9.8-8.0-4.9-13.48.5-12.9-8.7
19802.1-11.6-9.514.51.113.45.1-10.7
Other industrial1977-19.26.6-12.616.16.79.41.44.9-14.5
countries51978-11.17.7-3.420.4-1.121.50.417.4-5.3
1979-20.07.5-12.514.7-4.319.01.73.9-14.4
1980-32.44.1-28.437.86.131.7-1.18.3-31.6
Total industrial1977-18.313.7-4.63.66-17.120.839.538.6-18.7
countries19787.423.430.8-18.16-44.726.632.244.913.1
1979-37.629.8-7.832.46-52.885.2-13.511.1-28.4
1980-67.223.1-44.151.36-30.081.124.531.7-67.4
Memorandum
Total industrial
countries
excluding
United States197712.6-7.25.427.90.7-27.3-4.137.5-4.6
197841.2-0.940.33.3-30.033.31.144.727.3
1979-10.3-4.3-14.625.2-34.359.50.110.7-30.0
1980-41.8-12.3-54.168.7-15.383.99.724.3-70.9

See Table 8, footnote 1.

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

See Table 8, footnote 2.

See Table 8, footnote 3.

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

See Table 8, footnote 6.

See Table 8, footnote 1.

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

See Table 8, footnote 2.

See Table 8, footnote 3.

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

See Table 8, footnote 6.

Among the foregoing changes, particular significance must be attached to the shift of the U.S. current account into surplus. This was instrumental, along with the tightening of U.S. monetary conditions during the past two years, in moving the U.S. dollar from a condition of weakness toward the end of 1978 to one of strength by mid-1981. The improvement of the U.S. trade balance from 1978 to 1980, which occurred despite an increase of more than $35 billion in oil imports, reflected two principal factors: comparative cyclical conditions—stemming from earlier onset of the recession in the United States than in most of the other industrial countries—that favored such a development, at least through mid-1980; and a comparative cost-price position, following the depreciation of the U.S. dollar during 1977 and 1978, that appears to have made U.S. manufactures considerably more competitive in international trade than in earlier years of the decade. In addition, a substantial part of the improvement in the U.S. current account balance stemmed from rising net receipts for services, including income on foreign investments.

The 1978-80 strengthening of the U.K. and Canadian current account balances (as well as Norway’s) reflected oil trading positions quite different from those of most industrial countries. In the United Kingdom, growing importance of oil production played a major role in the emergence of a sizable current account surplus, and this was reinforced by the dampening of import demand resulting from the severity of the U.K. recession. These factors more than compensated for the weakness of U.K. export growth, which reflected the impact of both relatively high inflation and an appreciating exchange rate on the competitiveness of British manufactures. Although Canada’s balance of trade in oil and natural gas did not improve over the past two years, national production of oil and gas was sufficient to meet a high proportion of domestic demand, and thus avert any severely negative impact of the increase in oil prices on the balance of payments. The improvement of the Canadian current account balance from 1978 to 1980, centered in the merchandise trade accounts, stemmed mainly from substantial improvement in the terms of trade, reflecting comparatively buoyant prices for most of Canada’s principal exports of primary products.

The two largest declines in current account balances from 1978 to 1980—those for Japan and the Federal Republic of Germany—were dominated by large increases in payments for oil imports. For Japan, indeed, the deterioration of the oil trade balance exceeded that in the overall trade balance, which benefited from a 17 per cent increase in export volume in 1980. This increase, assisted by the effects of a favorable evolution of unit labor costs and of the sharp depreciation of the Japanese yen during 1979 on Japan’s international competitive position, followed two years of unusual declines in Japan’s share of world markets, caused partly by the pre-1979 appreciation of the yen.

Germany’s trade balance, aside from the increasing oil import bill, was adversely affected during 1979 and 1980 by a widening of the degree to which the country’s cyclical position was less slack than the average position of its trading partners. Lagged effects of the appreciation of the deutsche mark through 1979 may also have contributed to the erosion of the trade surplus, but Germany’s international competitive position was improving during 1980, when the relatively low rate of increase in German prices was reinforced during the latter part of the year by depreciation of the deutsche mark—a combination that continued during the first half of 1981.

The negative changes in the current account balance of the Federal Republic of Germany were not confined to the trade account. Growth of net external payments for services and transfers during the past two years was also an important contributing factor.

For France and Italy, too, the predominant elements in the 1978-80 deterioration of current account balances were the respective increases in net deficits on trade in oil. In both countries, however, the volume of non-oil imports considerably outpaced the real growth of exports over this two-year period. Indeed, Italy’s export volume declined by about 8 per cent in 1980, a year of moderate growth in its export markets. Both countries, however, were able to offset part of the deterioration in the trade accounts by increasing their net receipts from services and transfers.

The deterioration of $26 billion in the combined current account balance of the smaller industrial countries from 1978 to 1980 was much larger in relation to their economies than the concurrent deterioration in the combined accounts of the seven large industrial countries. For the smaller countries as a group, the deterioration amounted to 2¼ per cent of GNP, raising their deficit to 3 per cent of GNP in 1980. The corresponding deterioration for the large countries was equivalent to only 1 per cent of their aggregate GNP. This difference reflected a much smaller decline in oil import volumes, and stronger growth of non-oil imports in real terms, for the smaller countries than for the seven larger ones. In addition, the increase in the volume of non-oil exports was weaker for the smaller countries, partly because of their weaker linkages with the rapidly expanding markets in the oil exporting countries.

Within the group of smaller industrial countries, the current account changes from 1978 to 1980 (shown for the group as a whole in Tables 6 and 9) were far from uniform. Deteriorations in the range of 4-7 per cent, when expressed as percentages of GNP, were experienced by six of the countries—Spain, Sweden, Belgium, Finland, Switzerland, and Ireland. At the other end of the spectrum, the current account balances of Norway and Australia improved, and the deteriorations experienced by Denmark and the Netherlands were equivalent to less than 1 per cent of GNP. The current accounts of the last two countries were improving in the latter part of 1980 and the first part of 1981. Several of the smaller industrial countries whose current account deficits rose sharply in 1980 have relied on programs of official foreign borrowing to assure the financing of their current account deficits, and most of them have pursued restrictive monetary policies at least partly for that purpose. Little change in either the level or the distribution of the total current account deficit of the smaller industrial countries is expected for 1981.

Exchange rate developments.—The period since about the middle of 1980 has been one of substantial changes in exchange rates for major currencies and of intermittent pressures in markets for foreign exchange. Exchange rate developments of the past year have thus contrasted with those between the exchange crisis of October 1978 and mid-1980, a period characterized in last year’s Annual Report as “one of broad—although by no means uninterrupted—stability of effective exchange rates for most of the major currencies.”

Even with respect to that earlier period, exceptions were mentioned in the 1980 Report. Attention was called, for example, to the strong appreciation of the pound sterling from November 1979 to mid-1980 and to the rapid depreciation and recovery of the Japanese yen over the same period, as well as to a brief upsurge and relapse of the effective rate for the U.S. dollar in the first six months of 1980. These short-lived movements of the dollar reflected the initial climb of U.S. interest rates to unprecedented levels following the adoption by the Federal Reserve System of new operating procedures (placing greater emphasis on bank reserves) and then the precipitous drop in those rates as the onset of the U.S. recession brought a sudden (and temporary) easing of demands for credit in the United States. (See Chart 1.)

After about the middle of 1980, the general stability of exchange rates that had prevailed since the October 1978 crisis disappeared under the combined pressures of rapid shifts in current account balances, marked differences in rates of inflation and demand conditions, wide and fluctuating interest-rate differentials (often not in line with relevant inflation-rate differentials), and changes in financial policies (including those relating to intervention in exchange markets) in some of the major industrial countries. The period from mid-1980 to mid-1981 was one of marked change in the effective exchange rate of every major currency except the Canadian dollar, and of considerably larger movements of nominal rates between some pairs of those currencies. In general, the movement was sharply downward for the continental European currencies and sharply upward for the U.S. dollar, the Japanese yen, and—until January 1981—the pound sterling. (See Chart 8.) The Canadian dollar also appreciated by several percentage points in effective terms, while effective rates for most currencies of the smaller industrial countries declined (as did the pound sterling soon after the turn of the year). These declines were greatest for participants in the European Monetary System (EMS) and the small central European countries whose economies are closely integrated with those of the EMS group. The Norwegian krone and Swedish krona showed less effective depreciation than the other European currencies, but Australia was the only one of the smaller industrial countries whose effective exchange rate appreciated significantly from mid-1980 to mid-1981.

Chart 8.Major Industrial Countries: Exchange Rates, 1978-June 1981

(Indices, 1977 = 100)

1Based on the Fund’s multilateral exchange rate model.

Apart from the March 1981 devaluation of the Italian lira within the EMS framework, changes in bilateral rates between European currencies were relatively small, being limited in many cases by the nature of the commitments made by EMS members and in other cases by the pursuit of policies adopted by non-members in broad accord with the EMS arrangements. Bilateral rates between continental European currencies and the appreciating currencies of the large industrial countries elsewhere, on the other hand, showed much wider movements than any of the relevant effective rates.

Of the four major currencies (including the Canadian dollar) that appreciated over the year to mid-1981, three were currencies of countries whose current account balances improved in 1980, contrary to the general tendency for industrial countries in that year. The fourth appreciating currency was that of Japan, whose current account balance deteriorated only slightly on an annual basis from 1979 to 1980 and improved strongly during the latter year. This improvement now appears to be extending into 1981, along with that of the U.S. and U.K. current account balances. Conversely, all of the continental European countries whose currencies have depreciated substantially since mid-1980 are countries whose current accounts swung into deficit in 1980 (Chart 7) and appear to be remaining in deficit to a similar degree in 1981. Because of the sheer weight of current account purchases and sales among all the transactions affecting supply and demand in foreign exchange markets, it is very difficult to doubt the strong influence of the contrasting current account changes just described, and perhaps of expectational shifts prompted by them, on the general direction and degree of recent broad swings in exchange rates.

Many other factors, however, have also played substantial roles, either as underlying influences of a broad character or as temporary elements affecting the actions and attitudes of market participants. Actual and expected differentials in rates of inflation, for example, remain pertinent considerations, as do major changes in monetary conditions and policies, taxes, government expenditure programs, and resource development. All these various factors have sometimes reinforced and sometimes tended to offset each other in their impact on exchange rates. Rarely can one of them be considered to have been an exclusive or predominant cause of exchange rate changes over a substantial period.

Perhaps the most prominent factors bearing on exchange rate movements over the past year, apart from the current account changes already noted, were those involved in comparative interest rates and monetary conditions. During most of the period since the latter part of 1978, U.S. interest rates have been substantially higher in relation to those of the other major industrial countries, at least in nominal terms, than they were during earlier years of the 1970s. Although the U.S. inflation rate has also risen somewhat in relation to the average for the other countries, this factor appears to have been overridden by a combination of the wider nominal yield spread and other factors attracting funds to the United States. To the extent that this was true, it clearly reinforced the upswing of the current account in strengthening the U.S. dollar.

However, it was not until the upsurge of U.S. interest rates in early 1980 and their rebound to exceptional levels toward the end of that year, following a steep fall during the middle months, that widespread attention came to be focused on the resultant differentials between U.S. rates and those of the other major industrial countries (as shown in Charts 1 and 9). During the period from November 1980 through February 1981, and again in May, the spread between U.S. short-term interest rates and a weighted composite of rates for other major industrial countries climbed into the 5-6 per cent range. The only precedent for such a strongly positive differential, prior to 1980, was an almost equal widening of the spread for a few months after October 1978. On that occasion, however, the emergence of such a spread was generally accepted as a necessary element in the defense of the U.S. dollar at a time of recent severe weakness in the U.S. current account.

Chart 9.Major Industrial Countries: Interest and Inflation Rate Differentials, 1977-May 1981

1 The rates shown are monthly averages of daily rates on money market instruments of about 90 days’ maturity except for Japan, for which the discount rate on two-month (private) bills is used.

2 Average rate of change in the deflator for private final domestic demand in the current quarter and the next two quarters.

3 Differential between each country’s own interest or inflation rate and a weighted average of the interest or inflation rates of those partner countries whose currencies are included in the SDR basket. The weights are those of the SDR calculation for January 1, 1981.

Subsequent peaks in U.S. interest rates, on the other hand, have coincided with strength in the U.S. current account (relative to current accounts of other industrial countries), and hence with relatively little need for the United States to attract funds from abroad for retention in the U.S. economy. The fact that such funds were nevertheless attracted was a by-product of a domestic monetary policy aimed more firmly than in previous years at reduction of inflation. The most recent upsurge of U.S. interest rates differed from that of early 1980 in that it came at a time when maintenance by European authorities of the stringent monetary conditions needed to prevent loss of interest-sensitive funds was generally less appropriate for their domestic economic situation than a year earlier in view of the recessionary conditions. Nevertheless, a number of the continental European countries—particularly those participating in the EMS arrangements—did permit or induce changes in their own monetary conditions that resulted in an upswing in their interest rates in the spring of 1981. Although this upswing did not arrest the depreciation of European currencies against the major overseas currencies, it can be credited with preventing more rapid depreciation.

For two of the major currencies that appreciated throughout 1980 and the early months of 1981, a partial reversal began in March and continued, at a moderate pace, through midyear. Both of these downturns—involving the pound sterling and the Japanese yen—were associated with declines in the respective domestic interest rates (and negative changes in interest differentials vis-à-vis the other major industrial countries) that had begun a few months earlier.

In the United Kingdom, the growth of the monetary aggregates for which a target is set exceeded the upper end of the target range, partly because a quantitative control on the banking system was abolished. But monetary policy continued to be firm, as attested by the slow growth of the narrowly defined money supply throughout 1980 (Chart 2) and the emergence of a positive real rate of interest. The impact of the severe recession in the United Kingdom, together with the effect of the decline in the rate of inflation on expectations, contributed to a fairly steady downward movement of short-term interest rates in the United Kingdom throughout the second half of 1980 and the first part of 1981. A high nominal yield differential in favor of the U.K. financial market (against a composite of yields in other markets) in the middle of 1980 disappeared by the turn of the year and became negative in the early months of 1981. This reversal of a long-prevailing nominal interest differential favoring investments in the United Kingdom was accompanied by, and doubtless helped to cause, the turn in the U.K. exchange rate that began in February 1981 despite a strong current account balance in the first quarter.

Japan’s short-term interest rates also declined throughout the second half of 1980 and the first part of 1981, with a somewhat similar effect on the exchange rate. Nominal interest differentials in favor of Japan during the middle months of 1980 turned negative in the closing months and markedly so by the second quarter of 1981. Despite this widening of an adverse interest differential, the effective exchange rate for the Japanese yen continued to rise through February 1981, reflecting the improvement of the current account balance and the performance of the Japanese economy. However, it then fell back in the following months because of the increasingly negative interest differential. This decline began while the current account was still improving.

The effective exchange rate for the Canadian dollar has fluctuated only within a narrow range throughout the period since the beginning of 1980. However, the principal movements over that time—a slight dip from March to May of 1980 and another from August to December, together with a moderate increase in the early months of 1981—all followed closely behind changes in yield differentials between Canadian money markets and those of its trading partners.

Despite the large changes in exchange rates between currencies of the continental European countries and major currencies outside that area, and despite wide differences in inflation rates among the European countries, exchange rates within the European Monetary System were relatively stable during most of the past year. Moreover, movements of these rates were broadly paralleled by those in the currencies of Switzerland and Austria, whose economic links with the EMS group are close.

Until February 1981, the most noticeable tensions within the EMS were those between the French franc and the deutsche mark, resulting partly from differences in the respective current account developments of the two countries and partly from interest rate arbitrage at a time of high nominal interest rates in France, low rates in the Federal Republic of Germany, and sufficient market confidence in the stability of the exchange rate between the French franc and the deutsche mark to override the marked difference in inflation rates between the two countries. (See Chart 9.) When German interest rates rose during February and March, this source of tension disappeared. In May, the pressures involving these two currencies were reversed as uncertainties associated with the presidential election in France triggered a marked, but temporary, weakness of the French franc in the exchange markets, countered by intervention on the part of the Bank of France and by a sharp increase in French interest rates. During the latter part of May, these pressures against the French franc abated.

Pressures also arose at various times during the past year or so with respect to currencies of three EMS countries whose underlying external positions were widely regarded by market participants as relatively weak. In Italy, where the extremely high and persistent inflation rate was a major source of weakness in the balance of payments, the authorities took countervailing action in March 1981, devaluing the Italian lira by 6 per cent in terms of EMS central rates, raising the discount rate and reserve requirements for the banking system, and announcing their intention to reduce the government deficit through measures on both the revenue and the expenditure sides of the budget. The Belgian authorities, confronted with protracted weakness of the Belgian franc, pursued a restrictive monetary policy and undertook substantial foreign borrowings to finance the current account deficit and support the exchange rate. Notwithstanding heavy intervention and extremely high real interest rates in Belgium, that country’s EMS divergence indicator remained below its lower threshold for many weeks during the first few months in 1981. In Denmark, where considerable intervention in the exchange markets was undertaken in early 1980, the deterioration of the external position appears to have been checked by adjustment measures and a depressed level of domestic demand.

Oil Exporting Countries

International implications of the re-emergence of a large current account surplus for the oil exporting countries were discussed earlier in this chapter. From the standpoint of these countries themselves, the salient features of this development were another large improvement in the terms of trade; renewed concern about preservation of the real value of the financial claims acquired in exchange for a depletable natural resource; and, in 1980, a resumption of rapid growth in import volume (at a rate not matched by any other major group of countries).

The upward movement of oil prices during 1979 and 1980 raised the current account surplus of the oil exporters from $3 billion in 1978 to $68½ billion in 1979 and to an estimated $112 billion in 1980. Although the volume of oil exported by this group of countries declined by more than 12 per cent from 1978 to 1980, some of the countries continued to produce and export volumes of oil well beyond their financial needs. In 1981, the group’s combined surplus on current account is expected to recede to about $96 billion.

Although the increases in oil prices and in the terms of trade were considerably greater (on a year-over-year basis) in 1980 than in 1979, the increment in the current account surplus was less sizable in 1980 because of divergent changes in the volumes of oil exports and of imports. The former, mainly because of a substantial decline in world oil consumption, fell by about 14 per cent in 1980 after having risen slightly in 1979. Imports by the oil exporting countries, on the other hand, rose in 1980 by about 15 per cent in real terms (and 29 per cent in terms of U.S. dollars), following a 12 per cent decline in real terms in 1979. That decline was primarily a reflection of the unsettled economic conditions in Iran, and the upsurge of the oil exporters’ imports in 1980—associated mainly with the recent shift toward more expansionary policies—would have been somewhat larger in the absence of the recent hostilities between Iran and Iraq.

Part of the large rise in the trade surplus of the oil exporting countries from 1978 to 1980 was offset by increases in net payments for services and private transfers. These increases occurred despite the tendency of some countries to curb the growth in the number of expatriate workers, and despite a near doubling of income received on foreign investments as both holdings of assets abroad and international interest rates rose sharply.

Of the oil exporters’ aggregate current account surplus of $112 billion in 1980, more than $100 billion was accounted for by the six countries (Kuwait, Iraq, Libyan Arab Jamahiriya, Qatar, Saudi Arabia, and the United Arab Emirates) whose current accounts had remained in surplus throughout the 1970s. This concentration was considerably higher than that occurring in 1974, when the same six countries accounted for less than two thirds of the total. Their share of total oil export volume of the whole group was about 70 per cent in 1980, compared with one half in 1974, reflecting both the rise in the volume of Saudi Arabian exports and the substantial decline in Iran’s exports after 1978.

The expectation of a decline in the current account surplus of the oil exporting countries in 1981 reflects mainly the probability of continued relatively strong import demand in these countries and a further substantial drop in the volume of their oil exports, stemming from the continuing fall in world oil consumption. Although the oil market has softened considerably since the beginning of the year, the terms of trade of the oil exporting countries are expected to show a further improvement mainly because of the continuous upward movement of oil prices throughout 1980 and smaller import price advances in U.S. dollar terms from 1980 to 1981.

Information on the disposition of the current account surplus of the oil exporting countries continues to be uncertain because of the lack of complete balance of payments statistics for some members of the group and gaps in the coverage of data from alternative sources. The available estimates indicate that the cash surplus available for disposition in 1980, as in other years since 1975, exceeded the current account surplus because of substantial net external borrowing by some of the oil exporting countries. More than one third of the 1980 cash surplus is estimated to have been placed in highly liquid form, such as bank deposits and short-term government securities of major industrial countries, while slightly more than half was absorbed by acquisitions of longer-term or less liquid assets in the industrial countries.

Almost one tenth of the total cash surplus in 1980 went directly into grants or loans to other developing countries and contributions to regional or international development agencies. This outflow of funds, mainly on a concessional basis, has been the most stable element in the disposition of the surplus throughout the period since 1974. It increased in both 1979 and 1980, and the upward trend is expected to continue during 1981, reflecting growth of contributions or capital commitments to both bilateral and multilateral development agencies (particularly the OPEC Fund for International Development).

The proportion of placements in liquid assets was much lower, and that of longer-term investments much higher, in 1980 than in 1979, when about two thirds of the available cash surplus was placed in bank deposits and money market instruments. This pattern of initially high concentration in liquid assets, followed by a shift toward longer-term investments, was broadly similar to the sequence observed during the period 1974-76. The shift appears likely to continue through 1981 in view of the present concentration of the surplus in countries with already large holdings of liquid external assets, as well as the magnitude of capital outflows from the private sectors of the oil exporting countries.

In 1980, net investments by the oil exporting countries in claims on the Fund and the World Bank represented only 1 per cent of the cash surplus at the disposal of those countries. However, this share is expected to be significantly larger in 1981, reflecting particularly the recent loan agreement between Saudi Arabia and the Fund. (See Chapter 3, page 91).

Non-Oil Developing Countries

The aggregate current account deficit of the non-oil developing countries was pushed upward dramatically in 1979 and 1980. By the latter year, it had reached $82 billion, compared with $38 billion in 1978; and a further increase to $97 billion is projected for 1981.

The external financing problems associated with this rapid growth of the current account deficit have attracted a great deal of attention, and are discussed at some length below. However, the changes in external transactions of the non-oil developing countries that have generated the enlarged flows of financing also carry strong implications with respect to more fundamental factors, such as the availability of real resources for development. Examination of some of these implications may help to provide perspective for discussion of financing problems.

Factors in current account deficits.—Key elements of the rise in current account deficits of non-oil developing countries since 1978 have included a retardation of growth in the volume of exports, deterioration of the terms of trade (reflecting primarily the advances in oil prices during 1979 and 1980), and an upsurge of interest payments on external debt. (See Table 10.) The first two of these factors produced an erosion of growth in the purchasing power of export earnings, and the third factor diverted a significant portion of the rise in potential purchasing power away from procurement of imports. Consequently, expansion of import volume was sharply reduced in 1980, despite the upsurge of external borrowing undertaken to sustain the inflow of needed resources.

Table 10.Non-Oil Developing Countries: Current Account Deficits as Percentage of GDP, 1973-801

(In per cent)

19731974197519761977197819791980
Weighted averages2
Non-oil developing countries2.05.05.83.73.03.24.04.8
Net oil exporters2.94.57.35.34.44.33.83.8
Net oil importers1.85.15.53.42.73.04.04.9
Major exporters of manufactures1.56.26.03.21.92.03.54.3
Low-income countries3.14.94.72.61.83.14.04.7
Other net oil importers0.93.15.34.34.84.85.06.5
Medians
Non-oil developing countries4.16.08.96.76.47.47.610.1
Net oil exporters3.11.97.06.75.96.95.83.4
Net oil importers4.26.29.16.76.67.47.710.6
Major exporters of manufactures0.46.24.94.03.03.04.84.2
Low-income countries7.910.111.89.48.613.911.213.9
Other net oil importers2.63.67.46.45.96.77.210.1
Memorandum item
Weighted averages (including
People’s Republic of China)
Non-oil developing countries2.52.73.54.2
Low-income countries0.71.72.22.8

Excludes data for the People’s Republic of China, except where noted. For classification of countries in groups shown here, see Table 2.

Ratios of current account balances to GDP for individual countries, averaged on the basis of current GDP weights. Such estimates correspond exactly to those obtained through calculation for any particular grouping of countries of the ratio of the sum of the current account balances to the corresponding sum of GDP values.

Excludes data for the People’s Republic of China, except where noted. For classification of countries in groups shown here, see Table 2.

Ratios of current account balances to GDP for individual countries, averaged on the basis of current GDP weights. Such estimates correspond exactly to those obtained through calculation for any particular grouping of countries of the ratio of the sum of the current account balances to the corresponding sum of GDP values.

The slowing of export volume growth since 1979 has stemmed mainly from a generally unfavorable evolution of conditions in major markets for exports of the non-oil developing countries. With demand in the industrial countries weakened by the recession, the strong export volume gains of 1978 moderated appreciably in 1979; further reduction in these gains is estimated to have occurred in 1980 and to be continuing in 1981. An annual rate of increase on the order of 7-8 per cent since the end of 1979 contrasts with a prerecession increase of 11 per cent in 1978 and an average of well over 9 per cent during the late 1960s and early 1970s.

The recession-induced slack in demand in the industrial countries also underlay a marked weakening of primary commodity prices during the latter part of 1980 and the first half of 1981. Particularly since around the turn of the year, this weakening has become the principal factor in the continuing deterioration of the terms of trade of the non-oil developing countries. During 1979 and much of 1980, this deterioration had resulted chiefly from the rise in prices of oil imports, as prices for non-oil exports and imports moved along broadly parallel paths during that period.

For the main group of oil importing countries, the impact of declining terms of trade and reduced export volume growth on the real import purchasing power of export earnings has been severe—indeed, for the low-income countries, almost devastating. Even for the whole group of net oil importers, including the relatively prosperous exporters of manufactures, the rise in purchasing power of exports3 dropped to 1 per cent in 1980, compared with 5 per cent during each of the previous two years and well over 10 per cent in the period of bouyant primary commodity prices (1976-77). And for the low-income countries, the purchasing power of export earnings actually declined by about 6 per cent in 1980, after having already undergone a cumulative decline of almost equal magnitude during the preceding two years. The only group of non-oil developing countries with buoyant export earnings expressed in terms of external purchasing power was the subgroup comprising net exporters of oil.

The foregoing considerations explain to a considerable extent both the marked reduction of real import growth for the entire group of non-oil developing countries in 1980 and the sharp contrasts among the main subgroups of such countries with respect to import trends. Even though many countries borrowed heavily to avoid undue curtailment of imports, the 1980 increase in imports of the group as a whole was only half as large in real terms as that of the previous year—6 per cent versus 12 per cent. In 1979 and 1980, however, these increases reflected the peculiarly favorable position of the net oil exporters in the group. Their imports rose in volume by some 16-18 per cent in each of those years. For the oil importing developing countries, however, total growth of import volume was cut back from 8½ per cent in 1979 (roughly equal to the average over the late 1960s and early 1970s) to 3½ per cent in 1980. An equally low or lower rate of increase in the volume of imports into these countries is expected in the current year.

This flattening of import growth—due in part to limited growth of official development assistance and the high cost of private capital—is tending to constrain the total availability of resources and thus, for many countries, to make it more difficult to maintain a desirable pace of development. Given the deterioration of the terms of trade over the past several years, and the consequent rise in the real cost of obtaining supplementary resources from abroad, maintenance of investment programs geared to developmental objectives would require a significant shift of domestic resources from consumption to investment and probably also larger inflows of official development assistance and other capital. For many developing countries, and especially for those in the low-income group whose living standards are already minimal, such a shift is generally not feasible. In these cases, the constraint on the inflow of external resources can only limit the expansion of productive investment and prevent or delay a badly needed acceleration of growth in productivity and per capita incomes.

Efforts to avoid such results have led many countries to increase their net external borrowing very sharply in recent years. Import expansion has thus been better sustained than the purchasing power of export earnings. However, the resultant increase in outstanding debt, coupled with the marked rise in interest rates in major financial centers, has itself created a further drain on the availability of foreign exchange to pay for imports of goods and services. Interest payments by the non-oil developing countries on medium-term and long-term external debt more than doubled from 1978 to 1980, exceeding $30 billion in the latter year. Such payments thus absorbed about 7½ per cent of receipts from exports of goods and services in 1980, compared with 5½ per cent in 1978. Increases in interest payments on short-term external debt, although not reported separately in available statistics on investment income flows, undoubtedly accounted for a further absorption of export earnings. Moreover, while the rise in interest rates also boosted interest receipts of the non-oil developing countries on their reserves and other external financial claims, these asset holdings were increasing much less rapidly than external debt, especially in short-term forms. The rise in interest rates, accordingly, has produced an essentially one-sided effect on the payments balances of many developing countries over the past two years.

Unlike some of the other adverse influences on external payments positions of non-oil developing countries during this period, the rise in interest rates did not bear as heavily on the low-income countries as on the middle-income groups. The large reliance of the low-income countries on official financing, much of it on a concessional basis, and their relatively slight use of credit from private financial intermediaries on market terms (Chart 10) have prevented an upsurge of interest payment commensurate with that experienced by all of the other subgroups of non-oil developing countries. This upsurge has been especially marked for the middle-income exporters of primary products (the “other” net oil importers), whose use of external credit from private financial institutions remained on a considerably smaller scale than that of the major exporters of manufactures or the net oil exporters through the middle 1970s, but has been rising more rapidly over the past few years.

Chart 10.Oil Importing Developing Countries: Financing of Current Account Deficits and Reserve Accretions, 1977-80 Average

(Proportions of total financing requirement)

In absolute terms, however, it is the major exporters of manufactures that have been most affected by the rise in interest rates. This small subgroup accounts for a large share of the total external indebtedness of the non-oil developing countries, and particularly of debt owed to private foreign financial institutions.

Despite the rise in interest payments, adverse changes in the balance of external service transactions since 1978 have been dwarfed by the deterioration of trade balances. Here, of course, the experience of the oil importing countries diverged sharply from that of the net exporters of oil. For the latter, a $16 billion rise in their combined oil trade surplus from 1978 to 1980 roughly matched the concurrent increase in their non-oil trade deficit, leaving a rise in payments of investment income as the main factor contributing to a moderate net increase in the collective current account deficit of the oil exporting subgroup. For the nearly 100 developing countries that are net importers of oil, on the other hand, the composition of changes in their combined trade balance was just the reverse. The net deficit on trade in oil rose by some $40 billion from 1978 to 1980, while the balance of non-oil trade swung into moderate surplus. This improvement of the non-oil trade balance, along with an increase in net receipts from various services and private transfers, was sufficient to offset the substantial rise in external payments of interest and other forms of investment income. For the oil importing countries as a group, the increase in their current account deficit from 1978 to 1980 was thus about the same—some $40 billion—as the growth of their oil trade deficit. Within this group, the ratio of net oil imports to total imports is estimated to have reached 22 per cent in 1980, compared with about 14 per cent in 1978 and 6½ per cent in 1973, prior to the first round of major increases in oil prices.

Pattern of financing.—To manage the financing of the enlarged current account deficit of 1980, the non-oil developing countries not only raised their net foreign borrowing by some $16 billion over the already expanded 1979 total but also reduced their combined annual accumulation of reserves to a small amount. (See Table 11, which details the capital and reserve accounts of this group.) Indeed, with import prices rising by one fifth in 1980, that year’s small increase in the nominal value of reserve holdings (only $1¼ billion) was tantamount to a sharp reduction of reserves in real terms. Many individual developing countries did reduce their reserves, even in nominal terms, in the effort to sustain imports. Moreover, a number of countries averted still further impairment of their gross international liquidity positions only through official borrowing, including use of Fund credit.

Table 11.Non-Oil Developing Countries: Current Account Financing, 1973-801

(In billions of U.S. dollars)

19731974197519761977197819791980
Current account deficit211.536.846.532.928.637.5-57.682.1
Financing through transactions that do not
affect net debt positions10.412.8312.011.914.615.321.620.6
Net unrequited transfers received by governments
of non-oil developing countries5.66.937.37.48.27.810.410.6
SDR allocations, valuation adjustments, and
gold monetization0.40.5-0.7-0.31.01.23.02.1
Direct investment flows, net4.45.45.34.85.46.28.27.9
Net borrowing and use of reserves41.124.0334.621.014.022.236.161.5
Reduction of reserve assets (accumulation—)-9.9-1.42.5-12.5-12.1-15.8-10.1-1.2
Net external borrowing511.025.4332.133.526.138.046.262.7
Long-term borrowing11.419.8326.728.227.735.144.748.1
From official sources5.79.9311.710.812.514.314.521.0
From private sources10.413.514.919.021.327.033.127.2
From financial institutions9.012.313.216.117.623.032.124.2
From other lenders1.41.21.82.93.64.01.03.0
Residual flows, net6-4.7-3.60.1-1.6-6.1-6.1-2.9-0.1
Use of reserve-related credit facilities71.52.33.7-0.6-0.50.23.0
Other short-term borrowing, net5.17.84.9-0.52.27.6
11.6
Residual errors and omissions8-0.4-1.0-4.7-3.3-0.51.2-6.3

Excludes data for the People’s Republic of China prior to 1977. For country classification, see Table 2.

Net total of balances on goods, services, and private transfers, as defined for the Fund’s Balance of Payments Statistics purposes (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.

That is, 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.

These residual flows comprise two elements: (1) net changes in long-term external assets of non-oil developing countries; and (2) residuals and discrepancies that arise from the mismatching of creditor-source data, taken from debt records, with capital flow data taken from national balance of payments 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, and minor omissions in coverage.

Excludes data for the People’s Republic of China prior to 1977. For country classification, see Table 2.

Net total of balances on goods, services, and private transfers, as defined for the Fund’s Balance of Payments Statistics purposes (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.

That is, 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.

These residual flows comprise two elements: (1) net changes in long-term external assets of non-oil developing countries; and (2) residuals and discrepancies that arise from the mismatching of creditor-source data, taken from debt records, with capital flow data taken from national balance of payments 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, and minor omissions in coverage.

Another sign of widespread pressure on external financial positions during 1980 was the fact that much of the year’s rise in foreign borrowing took forms significantly different from those that had predominated in the borrowing pattern of recent years. In particular, use of short-term credit was stepped up sharply. There was also a considerable increase—of a more sustainable character—in net long-term borrowing from official sources (including international development lending institutions). On the other hand, the net inflow of long-term loans from private financial institutions showed a marked decline, reflecting both caution of the lending institutions regarding the pace of further growth of their claims on some developing countries and resistance among borrowers to the high cost of loans from commercial banks.

Inflows of direct investment capital were also lower in 1980 than in 1979. Neither these inflows nor receipts of official transfers (the other principal form of non-debt financing) have kept pace with the rise in net external borrowing by non-oil developing countries in recent years. Whereas such borrowing was almost 70 per cent larger in 1980 than in 1978, the concurrent increases in direct investment and official transfers were on the order of one fourth and one third, respectively.

Both the cutback in reserve accumulation and the sharply increased role of short-term (or unidentified) credits in the financing of the 1980 current account deficit of the non-oil developing countries were strongly reminiscent of the changes in the financing pattern that accompanied the upsurge of the current account deficit in 1975. Precedent for several other recent changes in the pattern can also be seen in the 1975 experience. On both occasions, increases in use of reserve-related credit facilities were of considerable importance, and long-term capital inflows from official sources also rose, while earlier rapid growth in net borrowing from private financial institutions was either greatly slowed (1975) or reversed (1980). Clearly, the first three of the foregoing points of similarity are symptomatic of strains encountered in dealing with swollen current account deficits. To a considerable extent, the indicated forms of financing on both occasions reflected temporary responses to external shock, rather than viable solutions of persisting external financial problems. Reliance on such temporary sources of funds will in due course have to be replaced either by sustainable longer-term credits or by downward adjustment of the associated current account deficits, probably involving lower growth rates.

The strains implicit in the 1980 financing patterns sketched above are most evident in the accounts of the low-income countries, which, as a group, suffered relatively substantial losses of reserves in 1980. Since reserves of many of these countries were already inadequate or barely adequate, and since such countries do not, typically, have ready access to private sources of credit, the impairment of their international financial positions threatens serious hardship unless larger inflows of aid and official capital can be arranged. Inflows of these types—on which the low-income countries are much more dependent than any of the other subgroups of non-oil developing countries—did rise in 1980, but not enough to assure an adequate inflow of real resources, even with the reduction of reserves that occurred.

The major exporters of manufactures also reduced their reserves and expanded their short-term indebtedness during 1980. Most of the countries in this subgroup, however, had been accumulating reserves for several prior years, in some cases on a substantial scale, and were in relatively strong external financial positions before the latest upsurge in current account deficits. They were thus able to withstand a considerable erosion of those positions without serious damage. For some of these countries, in fact, the rundown of reserves was less a necessity than a means of minimizing undue use of private market credit at a time when its net cost was relatively high. The largest share of the 1980 cutback in borrowing from foreign commercial banks by non-oil developing countries was concentrated in the exporters-of-manufactures subgroup.

With regard to current account financing, as in other respects, recent experience of the net oil exporting subgroup has diverged from that of the oil importing countries. The oil exporters did not noticeably increase their reliance on short-term credit, and they continued to accumulate reserves in sizable amounts during 1980, despite an increase in their current account deficit. Having particularly ready access to private financial markets, they easily covered both that deficit and the additions to reserves through increased borrowing, mainly in the form of long-term capital from private financial institutions.

External debt and debt service.—The heavy net borrowing of recent years has resulted, of course, in broadly commensurate increases in the outstanding external debt of the non-oil developing countries.4 Available estimates of the long-term and medium-term components of such debt (including rough estimates of private debt without a guarantee from the authorities of the borrowing country—a component not covered in previous Annual Reports) indicate a total of $370 billion at the end of 1980, nearly $100 billion above the amount outstanding at the end of 1978 and more than 3½ times the end-1973 total. (See Table 12.) These nominal comparisons, however, do not give a meaningful view of the scale of changes in debt over a period of high inflation and substantial real growth. A more realistic notion of the changes in the scale of the debt can be obtained by comparing it with other basic economic variables that also reflect inflation and growth.

Table 12.Non-Oil Developing Countries: Long-Term External Debt, 1973-801

(In billions of U.S. dollars)

19731974197519761977197819791980
Total outstanding debt of non-oil
developing countries97.3120.6147.1175.6216.7272.7322.8370.1
By type of creditor
Official creditors49.159.369.381.297.8117.8134.8155.8
Governments36.944.250.458.568.981.692.1106.0
International institutions12.215.218.822.728.936.242.849.8
Private creditors48.361.277.994.4118.9154.9188.0214.3
Unguaranteed debt21.426.032.037.543.151.460.768.2
Guaranteed debt27.035.246.057.075.8103.5127.3146.1
To financial institutions13.121.729.839.054.373.996.1112.8
Other private creditors13.813.516.118.021.529.631.233.3
By area
Africa12.915.719.723.831.138.342.947.8
Asia27.031.536.743.552.762.672.085.0
Europe12.214.616.719.624.933.145.552.7
Middle East8.510.113.116.020.324.628.632.1
Western Hemisphere36.748.660.972.787.7114.1133.9152.5
By analytical group
Net oil exporters15.620.731.038.850.461.568.777.4
Net oil importers81.799.9116.1136.8166.2211.2254.2292.6
Major exporters of manufactures38.947.656.366.980.7107.9128.6143.0
Low-income countries21.625.829.134.040.246.252.360.7
Other net oil importers21.226.530.735.945.357.173.388.9
Sources: World Bank Debtor Reporting System; and Fund staff estimates and projections.

Excludes data for the People’s Republic of China prior to 1977. For classification of countries in groups shown here, see Table 2.

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

Excludes data for the People’s Republic of China prior to 1977. For classification of countries in groups shown here, see Table 2.

This purpose is served by Chart 11, which shows ratios of external debt to exports of goods and services and to GDP, both for the non-oil developing countries as a group and for the principal analytical subgroups of such countries distinguished in this Report. In general, the record depicted by the chart is one of increasing magnitude of debt in relation to both exports and GDP from 1974 through 1978, followed by moderate declines in the ratios over the next two years. These declines reflected at least three significant factors: the recent substitution of short-term for long-term borrowing; the virtual cessation of reserve accumulation by the non-oil developing countries, which had given rise to a sizable portion of their borrowing for several preceding years; and the fact that a given year’s inflation, although fully reflected in that year’s exports or GDP, affects only the newly incurred component of the year-end debt.

Chart 11.Non-Oil Developing Countries: Ratios of Debt to Exports of Goods and Services and to Domestic Output, 1974-80

(In per cent)

1Consisting of middle-income countries that, in general, export mainly primary products.

Chart 11 also brings out some important differences among subgroups of countries with respect to the relative magnitude of external debt and recent changes therein. It may be noted, for example, that the debt/export ratios are much higher for the low-income countries than for the others; while those for the major exporters of manufactures are relatively low, even though the latter subgroup accounts for a large share (nearly two fifths) of the aggregate external debt of the non-oil developing countries. The ratios for the exporters of manufactures declined sharply from 1978 to 1980, reflecting the relative buoyancy of their exports, and this was doubly true for the net exporters of oil. Only for the middle-income exporters of primary products (the “other” subgroup) was there an increase in the debt/GDP and debt/export ratios in 1979 and 1980. These countries began to step up their external borrowing later than the two other middle-income subgroups, but in recent years have been rapidly gaining (and using) access to international credit markets. Despite this trend, the role of private financial institutions as suppliers of external credit remains smaller in the debt structure of the primary product exporters than in the debt structure of the other middle-income subgroups.

The rise in total external debt and the shift toward private financial markets as sources for larger shares of the funds borrowed by non-oil developing countries during the 1970s have had a marked impact on the level of debt service payments. Since 1978, the upward tendency has been greatly reinforced by the general escalation of interest rates in major financial markets. The rise in interest payments by non-oil developing countries, already discussed in the review of developments with respect to their current account balances, is placed in a somewhat different perspective in Chart 12, which relates these payments to exports of goods and services in order to make rough allowance for changes over time in the scale of nominal values. As the chart shows, the burden on export earnings created by the increase in long-term interest payments since the middle 1970s is substantial, averaging about 3 percentage points and strongly affecting all of the subgroups shown in the chart except the low-income countries. Among the latter, the rise in the ratio of interest payments to export earnings was only about ½ of 1 per cent from the mid-1970s to 1980, but it now seems to be accelerating somewhat.

Chart 12.Non-Oil Developing Countries: External Debt Service Payments, 1973-80

(In per cent)

1Annual interest payments as percentage of annual exports of goods and services.

2Consisting of middle-income countries that, in general, export mainly primary products.

3Annual amortization payments as percentage of annual exports of goods and services.

The chart also shows the substantial increases of recent years in the ratio of debt amortization payments to export earnings. These increases reflect a shortening of the average maturity of the debt, associated with the larger proportion of commercial market financing, as well as the rise in total indebtedness. For non-oil developing countries as a group, the higher amortization payments can be readily absorbed through “rolling over” of maturing debt, and in any case are not a burden on the current account of the balance of payments. Higher amortization payments, however, can present serious problems for any individual country whose ability to refinance maturing debt may become impaired for whatever reason.

Policy Issues

The world economic situation, as described above, is a troublesome one—fraught with problems and difficulties. Nevertheless, any balanced assessment must also take note of certain positive or encouraging aspects. For one thing, private markets have so far done well in the recycling process. The response of policies to the large increases in oil prices during 1979 and 1980—with the threefold impact of those increases on prices, real economic activity, and the current account of the balance of payments—has been much better than was the response to the oil price increases of 1973-74, and the adjustment this time has proceeded more smoothly. Primarily as a result of the restrictive stance of fiscal and monetary policies, wage increases in the industrial countries have been more restrained, profits have been less severely squeezed, business investment has held up better, and secondary repercussions of oil price increases on the general price level have been limited—with consumer price increases having subsided markedly since the first part of 1980. Also important, as noted in the Introduction to this chapter, some clear progress has been made in the energy field, where developments of the past year or two are more encouraging.

The progress embodied in these positive aspects of the world economic situation—if sustained by continued pursuit of responsible policies—should prove helpful in the tackling of two basic problems over the next few years. One such problem is the prolonged disappointing performance of industrial countries with respect to both economic growth and price stability. Another key problem area is that of balance of payments adjustment and financing.

“Stagflation” in the industrial world.—The factors behind the interrelated problems of high inflation, slow growth, and high unemployment that are now widespread throughout the industrial world were built up during the 1960s and the 1970s. In retrospect, the causes of this “stagflation” are attributable largely to three broad (and partly overlapping) developments.

First, various economic, social, and political factors brought about a reduction in the rate of growth of real per capita income and an increase in the average rate of unemployment. Prominent among these factors were excessive expansion of government services and transfers, financed in large part through higher marginal tax rates on incomes and money creation; the decline in the rate of growth of productivity, stemming from a variety of complex factors; problems of industrial structure resulting from changes in the composition of world demand and in the comparative advantage of various countries; changes in composition of the labor force that accompanied its generally rapid growth; and the major increases in the price of oil and other forms of energy since the early 1970s.

Second, the adverse effects of these supply-side developments were exacerbated by the reaction of private economic agents, who strongly resisted any decrease in the rate of growth of their real incomes. Such resistance was facilitated by the widespread and growing indexation (whether formal or implicit) of labor incomes and social transfers to the cost of living. In the circumstances of a marked decline in productivity growth and in the external terms of trade, this mechanism obviously contributed to inflation.

Third, stagflation in the industrial world has also been a result of the ways in which national authorities have reacted to the forces tending to depress the growth of real per capita income and to raise the unemployment rate. Examples of policy reactions that have had particularly adverse effects on prices and employment in recent years include the following: increases in protectionist trade measures, subsidization of declining firms or industries, improvement and extension of unemployment compensation benefits that (however desirable from a social or political standpoint) have reduced the private opportunity cost of unemployment in some industrial countries, and failure to make prompt adjustment of domestic prices of energy products to world market levels.

Whereas other specific examples along the foregoing lines could be cited, by far the most disappointing results of national economic policy have occurred in the area of demand management. In many cases, national authorities sought to offset or cushion the harshness of economic developments through recourse to expansionary monetary and fiscal measures. At least in part, such efforts reflected a lag in recognition that the slowing of growth of potential output had become a new limiting factor. Since increases in aggregate nominal demand could not change what was happening on the side of supply, including 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.

Even after quantitative targets for the growth of monetary aggregates had been established in anti-inflation programs during the latter part of the 1970s, these targets were frequently missed. Further, government expenditure programs that had been built up during the 1960s and the first half of the 1970s proved difficult to cut back in the interest of inflation control. The examples of ineffective monetary targeting, together with the continuation of sizable fiscal deficits widely expected to involve monetary creation for their financing, have contributed to the persistence of inflationary expectations notwithstanding the weakness in real activity.

In sum, as the foregoing sketch has attempted to indicate, the current problem of stagflation in the industrial world has stemmed from a variety of long-term developments that have caused both (i) structural imbalances and impairment of productive efficiency and (ii) a severe worsening of inflation and a buildup of inflationary expectations. It seems clear that the degree of rigidity and inflexibility in the economies of many industrial countries has increased markedly over the past decade or so, and that failure to control the growth of nominal demand has adversely affected public perception of the efficacy of national economic policies.

Since the origins of stagflation in industrial countries are both complex and deep rooted, the policy approach to deal with this problem has to be multipronged. Although policies will have to differ among countries, in order to take account of their respective economic situations and objectives, the crucial elements of the needed general approach may be readily defined.

Moderation of inflation in the industrial countries is unlikely to occur without a reduction in rates of growth of aggregate nominal demand that is sufficiently marked and prolonged to break inflationary expectations. Such control of nominal demand requires steady and careful restraint on the growth of monetary aggregates, coupled with a consistent fiscal policy doubtless entailing, in most countries, a reduction in the size of present budget deficits. The advantages of a consistent, supportive fiscal policy are that it facilitates achievement of the monetary targets and reduces the likelihood that monetary policy, through its impact on real interest rates, will have seriously disturbing effects on private investment and exchange rates.

Control of nominal demand is essential for the purpose of reducing inflation and providing an economic environment conducive to the revival of private investment and the restoration of sustainable economic growth. But a policy of marked reduction in the growth of nominal demand—depending on the effect it has on expectations—could have an adverse impact on output and employment for a considerable period of time and thus prove politically difficult to maintain. If the fight against inflation and unemployment in the industrial countries is to be successful over time, an integrated policy approach is required, one that includes supporting or supplementary measures directed mostly toward problems of supply. Some of these measures may be designed to improve efficiency in the goods and labor markets through the gradual removal of existing rigidities and inefficiencies. Also important are measures to eliminate disincentives—and provide positive encouragement—to saving and investment. Other fundamental measures should aim at more efficient use of energy resources and development of additional sources of energy. Also, the policy of reducing the rate of growth of aggregate nominal demand over the medium term should be accompanied by a policy seeking to achieve a consistent reduction in the growth of nominal incomes. During the 1970s, most attempts to establish formal incomes policies encountered failure because they lacked adequate support of the private sector or of public policies in the fiscal and monetary fields. In addition, 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, flexible or informal policies to restrain the growth of incomes can serve as useful adjuncts to fiscal and monetary policies. Such policies would seem to be especially appropriate at the present time in view of the need for public understanding of the inflationary mechanism, and of the limitations on real income gains that are implied by the rapid escalation of energy prices and by the weak behavior of productivity growth in many countries during recent years.

The need for an integrated policy approach in tackling stagflation in the industrial world can hardly be emphasized too strongly. Admittedly, it involves a difficult process requiring firmness and patience on the part of the authorities—a process that cannot successfully be cut short through resort to fiscal and monetary expansion. This would only impair the anti-inflation policy stance of the authorities and ratchet the economy to an ever higher rate of inflation that, in due course, would call for a still more costly process of adjustment.

Payments adjustment and financing.—In this broad area, three important problems command attention.

One problem concerns the outlook for adjustment between oil exporting and oil importing countries over the medium term. As described earlier in this chapter, the imbalance in current account positions between oil exporting and oil importing countries is now quite large; and it may be expected to remain sizable for a number of years if, among other things, the authorities in the oil exporting countries hold to their intention of pursuing relatively cautious policies so as to minimize inflationary pressures and foster balanced development of their economies. Also, the current market situation notwithstanding, the uncertainties to be faced in the next few years regarding the supply/demand balances in the oil and energy markets could be considerable.

With respect to policy approach, the rate of domestic absorption in the oil exporting countries should not be expected to accelerate beyond that desired by the authorities of those countries in their own national interests. As already emphasized, the international adjustment process requires the oil importing countries to bring about a more efficient and broader-based use of energy. Further, the transfer of goods and services from oil importing to oil exporting countries should be facilitated by increasing the capital stock in oil importing countries and allowing for a better adjustment of the real wage rate to the decline experienced by those countries in their external terms of trade.

Another problem concerns the weakness of the external positions of some of the smaller industrial countries, which have built up large current account deficits in the past few years. The financing of such deficits is not expected, in general, to pose problems, but the external adjustment difficulties of these countries are now having significant effects on their volume of exports and level of economic activity.

The payments imbalances in these smaller industrial countries are due as much to domestic as to international developments. Most of them experienced a sharp decline in the share of national income going to profits during the 1970s because of three developments: the rapid expansion of social transfers financed by employer contributions, the granting of major increases in nominal wage rates during the first half of the 1970s, and the use of indexation schemes that, during the latter part of the 1970s, tended to prevent real wage rates and social transfers from adjusting to the fall in terms of trade resulting from the increases in energy prices.

The decline in the profits share has been particularly marked in the manufacturing sectors that provide the bulk of export earnings. Because these countries have small and open economies, the burden of adjustment has been borne by profits in the traded goods sectors whenever costs have tended to increase more than in partner countries. With the deterioration in profit margins, marginal firms have been closed and new investment has been discouraged. The traded goods sectors have shrunk in relative terms and the smaller production bases have led to reduced market shares in both domestic and foreign markets. Unless adequate profit margins are restored, particularly in the manufacturing sector, it is difficult to see how external imbalances can be reduced or eliminated.

The third, and most severe, problem in the field of balance of payments adjustment stems from the weakness of the external positions of many non-oil developing countries. Here, the main focus of concern is on two subgroups of non-oil developing countries—the low-income countries and the middle-income countries exporting mainly primary products (the “other net oil importers” in Table 8), which together comprise about 90 developing countries that are net oil importers but not major exporters of manufactures. Many of the countries in these subgroups do not produce the kinds of goods and services most in demand by oil exporting countries and are thus handicapped in trying to offset their rising import bill by additional exports to those countries. More importantly, the countries in these subgroups typically export primary commodities for which world demand has recently been weak because of the sluggish rate of economic growth in the industrial world. As a result, the growth of their export volumes since the early 1970s has been quite moderate. Taking into account the decline in their terms of trade, the “real” export earnings (export earnings deflated by import prices) of the low-income countries actually declined over this period, while those of the middle-income exporters of primary products increased at an average rate of only about 1 per cent a year. In addition, these two subgroups of non-oil developing countries have been severely affected by the decrease in the real value of the flow of official transfers from industrial countries in recent years, as well as by the difficulty of exporting to the industrial countries in the face of protectionist measures against both agricultural and manufactured products.

So far, these two subgroups have, on the whole, succeeded in sustaining economic growth (at an average of 4 to 4½ per cent a year) without excessive increases in their ratios of debt or debt service payments to exports of goods and services, although difficulties have arisen in a number of individual countries. As one looks ahead, however, it is apparent that the burden of external indebtedness may become more serious in some of these countries over the medium term. First, a major reason why the debt situation of these two subgroups was still generally manageable at the end of 1980 was the large negative ex post real interest rates that they had experienced in the previous several years.5 The large increase in real interest rates that occurred in world financial markets in 1980-81 (and which may not be reversed over the next few years), along with the gradual change in the structure of commitments that has been taking place (toward debt contracted at market-related interest rates), will inevitably tend to increase considerably the real debt service burden of many countries in the two subgroups under discussion. Second, the current account deficits of these subgroups were much larger in 1980 than in the period 1974-79, and they are likely to increase further in 1981 and 1982 as a result of recession and slow growth in the industrial world.

As discussed in Chapter 2, structural actions and exchange rate changes, accompanied by supportive demand management policies, have a crucial role to play in the adjustment process of many developing countries. In the final analysis, however, it must be recognized that the prospects for developing countries—despite their own best adjustment efforts—could soon become critical if the real price of oil were to increase further and growth in industrial countries were to continue at a low rate. Under such conditions, it is uncertain whether many of the middle-income primary producers and low-income countries could even maintain rates of economic growth sufficient to prevent outright declines in per capita real income.

*****

The two major policy issues that have just been discussed—stagflation in the industrial countries and problems of balance of payments adjustment and financing—are closely interrelated and global in scope, involving a large number of Fund member countries. Thus, it seems clear that a solution to these problems can be achieved more readily if there is an enhanced degree of international cooperation among individual countries and groups of countries. In the case of the major industrial countries, cooperation should include concerted efforts to address the underlying causes of stagflation and to conduct fiscal and monetary policies so as to ensure a satisfactory degree of stability of real exchange rates among the key currencies, a topic to be discussed in Chapter 2. International cooperation is also crucial from the standpoint of preventing the expansion of world trade from being stifled by increased protectionism, particularly in the industrial world. Further, especially for the low-income developing countries, increased efforts by industrial and oil exporting nations to provide grants and concessionary loans are vitally necessary.

The Fund is playing an active role in helping member countries to deal with policy issues. In its regular consultations with individual members, the Fund provides assistance in the diagnosis of economic problems and in the prescription of requisite policies. It also provides a forum for dialogue and cooperation through its periodic reviews of economic developments and policies in the context of the World Economic Outlook. Both of these activities are pursued in connection with the Fund’s general responsibility for surveillance over member countries’ exchange rate policies.

In the area of adjustment and financing, the role of the Fund is being sharply expanded. Since the outlook for the next few years is for large and persistent payments imbalances, adjustment has become imperative in many countries and may require more time and may have to include measures directed toward structural problems. In order to support its adjustment programs with member countries, the Fund has increased its resources and has enlarged the access of members to them (as described in Chapters 2 and 3). These new approaches of the Fund have found a rapid response on the part of member countries. As pointed out in the Introduction to this chapter, the activity of the institution is at a very high level in regard to both the number of arrangements with members involving high conditionality and the total amount of resources being made available.

The opportunity of addressing and overcoming the problems of stagflation in the industrial world and of balance of payments adjustment and financing is clearly an extremely important one for the Fund and its members. Success in handling these problems over the medium term—during what could be a very difficult period of adjustment—would set the stage for resumption of satisfactory growth with better price performance in the industrial world during the second half of the 1980s, while also fostering exports and economic growth in the non-oil developing countries and enabling many of them to reduce the burden of external indebtedness. On the other hand, failure to come to grips with the basic problems discussed above would be very costly in terms of national and world economic performance throughout the current decade. The stakes are thus high; the premium on pursuit of sound and cooperative policies is unquestionably great.

See Table 2, footnote 4, for identification of these countries.

That is, the “other net oil importers” in Table 2. More precisely, this subgroup comprises middle-income countries that, in general, export mainly primary agricultural and mineral products.

That is, the value of export earnings deflated by an appropriate index of import prices.

Mainly because of valuation changes, especially for debt denominated in currency units other than U.S. dollars, changes in reported debt do not exactly match the net long-term capital flow estimates given in Table 11.

That is, the average nominal interest rates on the external debt of these two subgroups of non-oil developing countries during the period 1974-79 was much smaller than the average annual rate of increase in their export prices. (For a fuller discussion of this matter, see World Economic Outlook: A Survey by the Staff of the International Monetary Fund (Washington, June 1981), page 11.)

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