Chapter

Chapter 1: Developments in the World Economy

Author(s):
International Monetary Fund
Published Date:
September 1984
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Introduction

The performance of the world economy in 1983 and the early part of 1984 was significantly better than in the preceding several years. Economic expansion proceeded vigorously in the United States and Canada, and showed signs of spreading to other countries in the industrial world. Price inflation receded further in the seven largest industrial countries, dropping to its lowest level in 15 years. And the current account deficit of developing countries was further reduced. Nevertheless, difficult problems remained much in evidence. Developing countries, apart from some in Asia, were generally unable to resume the momentum of their domestic economic development. Financing the debt of those that had borrowed most heavily continued to require exceptional measures. And the persistence of high interest rates, which began to rise again in the early part of 1984, presented risks for the process of sustaining and broadening recovery.

Perhaps the most encouraging aspect of economic developments in 1983 was the resumption of growth in the industrial economies. In the United States and Canada, recovery had been initiated at the end of 1982, and by mid-1983 had gathered considerable momentum. The upswing began in the sectors of housing, stockbuilding, and consumer durables, and in the United States had spread to investment demand by the end of the year. Recovery in the other industrial countries has been more subdued and, except in the United Kingdom, began somewhat later. Nevertheless, by early 1984, the improving trend appeared to be fairly well established, albeit not with sufficient strength outside the United States and Canada to make much inroad on the very high levels of unemployment being experienced in many countries.

Economic recovery was accompanied by a further slowing of inflation. The weighted average rate of increase in the gross national product (GNP) deflator of the seven major industrial countries fell below 5 percent in 1983, having been above 9 percent in 1980.

This continued improvement in price performance was associated with a further decline in interest rates in the first half of 1983. By the second half of the year, however, the decline had come to an end, leaving interest rates at a very high level in relation to current inflation. In the opening months of 1984, interest rates firmed quite significantly, especially in the United States, despite the continuing moderate pace of underlying inflation.

The high level of interest rates has been a major factor complicating the task of developing countries in bringing about external adjustment and restoring the momentum of their development. These countries had been severely affected by the world recession. Their export markets had stagnated and their terms of trade had deteriorated. Their situation was aggravated in a number of cases by delays in taking appropriate adjustment measures and by the actions of trading partners in attempting to preserve domestic employment through an intensification of protectionist measures. Given the large share of their external debt that had been contracted at variable interest rates, developing countries faced severe difficulties in financing their external obligations when international interest rates shifted upward. Although the combined current account deficit of the non-oil developing countries was reduced sharply after 1981, the reduction came too late to avert the financing crisis that developed among heavily indebted countries in the latter half of 1982. This crisis quickly led to a very sharp reduction in spontaneous new bank lending to developing countries.

Faced with this situation, developing countries (oil importing and oil exporting alike) had no alternative but to intensify their efforts toward external adjustment. The combined current account deficit of the non-oil developing countries fell in 1983 to its lowest level, in relation to exports of goods and services, in ten years. For many countries, however, this was not sufficient to bring about a restoration of normal financing of their external debt. As a result, in 1983 and the early part of 1984 there was again a large number of debt reschedulings and concerted new financing packages.

The reduction in the current account deficit of the non-oil developing countries was aided in 1983 by a slight improvement in their terms of trade and an increase in the volume of exports to the industrial countries. Nevertheless, these recent positive developments in the external environment should not be allowed to obscure the difficulties developing countries have faced in achieving the needed adjustment. A massive shift in the pattern of absorption has been required and until recently has had to be brought about largely by a compression of imports. The policies required to achieve this shift took their toll on domestic economic growth. While experience has varied significantly among countries, the average growth rate in non-oil developing countries as a group was only ½ percent in 1983, making three years during which output has grown by less than the rate of population increase. As there was also in these three years a substantial movement of resources toward the external sector, to compensate for adverse terms of trade shifts and to improve the external accounts, it is clear that there has been a very serious erosion of living standards in many of these countries.

Improving economic performance in the developing countries is, therefore, one of the most pressing objectives of international economic policy. It can be attained, however, only if the recovery that is under way in industrial countries is sustained and broadened, and if the heavy burden of debt service faced by many boirowing countries can be handled satisfactorily.

Economic recovery in the industrial countries has been facilitated by the greater measure of price stability that has been established in recent years. It will be important to continue to formulate monetary policy in such a way as to safeguard the progress that has been made. At the same time, if the expansion that is now under way is to be sustained in a balanced manner, a number of policy adaptations will be needed. First, it will be important to frame fiscal policies in such a way that the conflict between government and private demands for credit is minimized. Otherwise, upward pressure on interest rates will be maintained, jeopardizing the stability of recovery and undermining the adjustment efforts of developing countries. Also of major importance is a concerted attack on structural rigidities that hamper the effective functioning of many of the industrial economies. If these rigidities, particularly in labor markets, are not tackled, the prospects of an eventual return to more normal levels of unemployment will be diminished. In addition, determined resistance to protectionist pressures is required, both to promote structural change and growth and to enable indebted countries to service their external debts and bring about needed external adjustment. Many of these indebted countries have, with the encouragement of the international community, based their economic strategies on the development of a vigorous foreign trade sector. Any threat to their adequate access to export markets would seriously inhibit the use of these outward-looking growth strategies.

Of course, developing countries themselves must play the major role in adjustment, by continuing the pursuit of policies that restore domestic economic stability and provide a sound financial basis for resumed growth of output and investment. It is noteworthy that countries that have adapted in a timely way to changes in the international economic environment have generally fared better in their economic performance than those that have been slower to adjust. It remains true, however, that an increased flow of official development assistance will have a vital role to play, particularly to enable those countries that do not have access to commercial credit to participate adequately in an economic upturn.

Domestic Activity and Policies

Industrial Countries

Stance of Policies.—Throughout 1983 and the first half of 1984, the authorities of the industrial countries have continued to place primary emphasis on the restoration of the underlying economic conditions necessary for sustained noninflationary growth. In general, this focus on medium-term objectives has meant perseverance with policies of financial discipline designed to achieve a more stable environment for private economic decision making. The practical implementation of such policies, however, has generally been more consistent and effective in the management of money and credit than in the fiscal field.

In most major countries, monetary policy has been designed to restrain the growth of monetary aggregates and thus to achieve lower inflation on a lasting basis. The implementation of this strategy has proceeded flexibly, taking account of a number of factors that have introduced additional uncertainty into the underlying trend of the relationship between money and nominal GNP. Institutional changes have brought about shifts in the demand for money, while the high level of real interest rates has complicated the task of extrapolating historical relationships between velocity and interest rates into the more recent period. In a number of cases there have also been reversible short-term shifts in money demand, associated, for example, with anticipated currency realignments in the European Monetary System (EMS).

Reflecting such factors, the growth of monetary aggregates was allowed to exceed its target range early in 1983 in several important countries, notably the United States, the United Kingdom, and the Federal Republic of Germany. Subsequently, however, monetary growth was more restrained, and by the early part of 1984 the monetary aggregates were within, or in some cases below, their target ranges in each of the three countries. For the seven major industrial countries as a group, the rate of expansion of both broad and narrow money in 1983 was similar to that recorded in the previous year. Ml grew by 8½ percent, the same rate as in 1982, while M2 grew by 9 percent, against 9½ percent in 1982. (See Chart 1 for a record of the growth rate of target aggregates in the three largest industrial countries.)

Chart 1.Three Major Industrial Countries: Growth of Monetary Aggregates, 1979-First Quarter 19841

(Percent change from corresponding period of preceding year)

1 The aggregates are central bank money for the Federal Republic of Germany, M2 plus certificates of deposit for Japan, and M2 for the United States

Monetary conditions in the industrial countries shifted somewhat during the course of the year. During the first half of 1983, monetary expansion was sufficient to accommodate the revival of economic growth while permitting a decline in interest rates to continue. Later in the year, however, strengthening economic activity in the private sector, together with a deceleration in monetary growth, contributed to a notable tightening in monetary conditions. These factors, in combination with government borrowing requirements that remain very large, have brought a distinct renewal of upward pressures on interest rates in some countries, particularly among those where the cyclical recovery has been most vigorous. The average of short-term interest rates in the major industrial countries, which had fallen to 9¼ percent in the first half of 1983 from a peak of some 15 percent during 1981, rose to 9¾ percent in the first half of 1984. Long-term rates followed a broadly similar pattern, though the amplitude of the movements, until recently, was generally less. (See Chart 2.)

Chart 2.Major Industrial Countries: Interest Rates and Inflation, 1979-Second Quarter 19841

1 Inflation is measured by the percentage change in GNP deflators.

2 Includes Canada, France, the Federal Republic of Germany, Italy, Japan, the United Kingdom, and the United States. Composite interest rates and inflation are averages of variables for individual countries weighted by the average U.S. dollar value of their respective GNPs over the preceding three years.

A noteworthy feature of the recent increases in interest rates is the fact that they have not occurred in response to overt signs of renewed inflation. As a result, real interest rates have probably risen further. The calculation of medium-to-long-term real interest rates requires assumptions about inflationary expectations that are inevitably speculative. Nevertheless, it may be noted that, for the average of the major industrial countries, the gap between interest rates (both long-term and short-term) and the current inflation rate was greater in early 1984 than it had been in 1981. The recent rise in interest rates has been strongest and most persistent in the United States, where both short-term and long-term yields in the spring of 1984 reached levels roughly 2 percentage points higher than in the early months of 1983 (see Chart 2), and in Canada, whose financial markets are closely linked with those of the United States.

During recent years, the broad aims of fiscal policy in most industrial countries have been to contain and if possible reduce the share of national output absorbed by government, and to improve the structure of government finances. In practice, however, the implementation of these objectives has encountered a series of difficulties. The effect of the prolonged recession on the fiscal position of governments was to reduce receipts relative to expenditures and thus to perpetuate and increase budget deficits. Furthermore, in a number of countries, intended cuts in expenditure were not fully implemented, and certain categories of payments, notably transfers under “entitlement” programs, grew more rapidly than envisaged. Planned tax cuts, on the other hand, have in general been more fully implemented.

An additional factor tending to weaken government finances has been the combination of prevailing high interest rates with increased government debt resulting from the succession of large deficits incurred during the recession years. This has produced an important new element of intractability in fiscal balances. General government interest payments in the major industrial countries now average nearly 2 percentage points higher, as a proportion of GNP, than they did in 1979. They represent 9 percent of GNP in Italy, 7 percent in Canada, and about 3-5 percent in each of the five other major industrial countries.

Reflecting these factors, the aggregate deficit of the central government in the seven major industrial countries reached over 5½ percent of GNP in 1983, almost 1 percentage point higher than in 1982 and almost 2 percentage points above the highest figure reached during the 1970s. The overall increase in 1983 cannot be attributed to cyclical factors, since the impact of increases in economic slack in some European countries was broadly offset by the favorable fiscal effects of rapid economic growth in North America. After adjustment for cyclical factors, the increase in the aggregate deficit was largely a consequence of U.S. income tax cuts not matched by corresponding expenditure reductions and of some temporary and unintended slippage in the U.K. Government’s program of fiscal consolidation in the first half of 1983. The large countries of continental Europe and Japan recorded modest improvements in their underlying fiscal position; and some smaller countries undertook more far-reaching fiscal measures.

Seen in a somewhat longer perspective, the past four years have been a period of substantial divergence in the thrust of fiscal policy between the United States, on the one hand, and other major industrial countries, on the other (Table 1). From 1979 to 1983, the expansionary impulse imparted by fiscal policy in the United States is estimated to have amounted to almost 2 percent of GNP.1 In all other major countries, there was a contractionary thrust, ranging up to some 3 percent of GNP in the United Kingdom and the Federal Republic of Germany. Partly as a consequence, the actual deficit of the U.S. Federal Government rose by the equivalent of 4½ percent of GNP between 1979 and 1983, while the corresponding increase for the other major industrial countries was under 1 percent of GNP.

Table 1.Major Industrial Countries: Central Government Fiscal Balances and Impulses, 1977-83 1(In percent of GNP)
1977197819791980198119821983
Fiscal balance

( + surplus, - deficit)
Canada 2-3.5-4.6-3.4-3.3-2.1-5.7-6.3
United States-2.7-2.0-1.2-2.4-2.5-4.3-5.8
Japan 3-5.1-5.3-6.2-6.1-5.9-5.5-5.1
France 4-1.0-2.6-1.5-1.1-2.6-2.8-2.9
Germany, Fed. Rep. of-2.2-2.1-1.8-1.7-2.2-1.9-2.0
Italy5-9.0-14.6-11.1-10.9-12.9-15.1-16.8
United Kingdom-3.1-5.0-5.3-4.9-4.1-2.9-4.9
All seven countries-3.2-3.6-3.1-3.5-3.8-4.7-5.6
All seven countries except

the United States
-3.7-4.9-4.6-4.4-4.7-5.0-5.4
Fiscal impulse

(+ expansionary,

- contractionary)
Canada 21.21.0-0.7-0.4-1.11.40.2
United States0.2-0.80.30.20.51.6
Japan 30.20.21.0-0.3-0.6-0.4
France4-0.41.9-0.8-0.71.0-0.3
Germany, Fed. Rep. of-0.40.1-0.4-0.7-1.8-0.1
Italy5-0.85.3-3.0-0.10.60.6-0.1
United Kingdom-2.32.70.5-2.4-2.5-1.22.4
All seven countries-0.10.7-0.4-0.2-0.2-0.10.9
All seven countries except

the United States
-0.31.3-0.5-0.4-0.50.1

For the definition of the fiscal impulse measure, see World Economic Outlook: A Survey by the Staff of the International Monetary Fund (Washington: International Monetary Fund, April 1984), pages 99-112. Data have been converted where necessary from a fiscal to a calendar year basis for ease of comparison. Composites for the country groups are weighted averages of the individual country ratios, with weights in each year proportionate to the U.S. dollar value of the respective GNPs in the preceding year.

Data for Canada are on a national income accounts basis.

Data for Japan cover the consolidated operations of the general account, certain special accounts, social security transactions, and disbursements of the Fiscal Investment and Loan Program (FILP), except those to financial institutions. Japanese data other than FILP transactions are based on national income accounts.

Data for France do not include social security transactions and are on an administrative basis.

Data for Italy refer to the “state sector” and cover the transactions of the state budget as well as those of several autonomous entities operating at the state level. They also include the deficit of the social security institutions and part of that of local authorities.

For the definition of the fiscal impulse measure, see World Economic Outlook: A Survey by the Staff of the International Monetary Fund (Washington: International Monetary Fund, April 1984), pages 99-112. Data have been converted where necessary from a fiscal to a calendar year basis for ease of comparison. Composites for the country groups are weighted averages of the individual country ratios, with weights in each year proportionate to the U.S. dollar value of the respective GNPs in the preceding year.

Data for Canada are on a national income accounts basis.

Data for Japan cover the consolidated operations of the general account, certain special accounts, social security transactions, and disbursements of the Fiscal Investment and Loan Program (FILP), except those to financial institutions. Japanese data other than FILP transactions are based on national income accounts.

Data for France do not include social security transactions and are on an administrative basis.

Data for Italy refer to the “state sector” and cover the transactions of the state budget as well as those of several autonomous entities operating at the state level. They also include the deficit of the social security institutions and part of that of local authorities.

According to budgetary plans already announced or adopted, the contrasting paths of fiscal developments in the United States and in the other major industrial countries seem destined to persist through 1984. Although the U.S. federal deficit is likely to decline slightly in the current calendar year, the expected decline would be less than could be attributed to the effects of recovery alone. Outside the United States, policy actions are expected to be in the direction of a modest further reduction in deficits and, in conjunction with an improving level of economic activity, should result in the other major industrial countries having the first decline in their recorded deficit for several years.

It is clear, however, that governments are continuing to absorb rather large shares of private saving in virtually all industrial countries. Even in Japan, where saving is high, one eighth of gross private saving is now needed to finance the deficit of the general government sector. In the other major countries, the proportion is considerably higher, ranging up to almost one half. All of these ratios—and especially those in the United States and Canada—are relatively high by the respective national historical standards, and must be cut back significantly as the recovery proceeds if adequate financing for the desired expansion of productive private investment is to be found.

Output and Demand.—At mid-1984, the industrial world as a whole was well into its second year of recovery, following three years of severe recession. Industrial production was about 15 percent higher than a year earlier in the United States and more than 10 percent higher in Japan. (See Chart 3.) For the five largest industrial countries as a group, the average rise in industrial production from the first quarter of 1983 to the first quarter of 1984 exceeded 11 percent.

Chart 3.Major Industrial Countries: Real GNP and Industrial Production, 1979-June 1984

(Indices, 1980 = 100)1

1 Seasonally adjusted.

During the course of 1983, and especially in the first half of the year, the upward momentum of GNP was centered mainly in the United States and Canada. (See Table 2.) Continued moderate expansion of Japan’s output, which had been better sustained than that of most other industrial countries throughout the recessionary period, also bolstered the average growth rate for the group as a whole. In addition, moderate advances were recorded during 1983 by the United Kingdom and the Federal Republic of Germany, as well as by Finland and Norway among the smaller industrial countries. Elsewhere in the industrial world, however, increases in GNP were quite limited, and a few countries, including Italy and Australia, registered declines in output on a year-over-year basis.

Table 2.Industrial Countries: Changes in Output and Prices, 1967-83 1(In percent)
Average

1967-76 2
Change from Preceding Year
1977197819791980198119821983
Real GNP
Canada4.82.03.63.21.13.3-4.43.3
United States2.85.55.02.8-0.32.6-1.93.4
Japan7.45.35.15.24.84.03.33.0
France 34.73.13.83.31.10.22.00.7
Germany Fed. Rep. of3.42.83.54.01.9-0.5-1.11.3
Italy34.31.92.74.93.90.2-0.4-1.2
United kingdom 32.32.23.82.8-2.5-1.62.13.1
Other industrial countries 44.31.72.02.92.10.60.21.9
All industrial countries3.73.94.13.51.31.6-0.22.5
Of which,
Seven major countries above3.64.34.53.61.21.8-0.22.5
European countries3.82.43.03.41.5-0.20.51.4
GNP deflator
Canada6.97.46.710.311.410.610.45.4
United States5.65.87.48.79.29.46.04.2
Japan7.95.74.62.62.82.71.70.7
France 37.39.09.510.412.012.312.59.7
Germany, Fed. Rep. of5.13.74.24.04.54.24.83.2
Italy 39.319.113.915.920.718.417.915.2
United Kingdom 39.913.910.914.519.811.77.05.5
Other industrial countries 48.010.18.78.28.79.59.87.0
All industrial countries6.77.67.58.09.18.77.25.1
Of which,
Seven major countries above6.57.27.38.09.18.56.74.8
European countries7.59.88.69.010.910.09.47.4

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 preceding 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 preceding 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 leading role of the United States in the cyclical turnaround that began during 1983 stemmed initially from a revival of consumer demand and a shift toward reversal of the inventory cycle. Real incomes and purchasing power, which were benefiting from the program of personal income tax reductions, were further enhanced by marked declines in both inflation and interest rates from their 1982 levels. These declines raised consumer confidence and added to household net wealth. Precautionary attitudes that had built up during earlier years of high inflation apparently were relaxed. All of the foregoing factors added stimulus to consumer demand, especially for housing, automobiles, and other durable goods. To meet this rising demand, industrial production expanded rapidly, and the previous tendency to reduce inventories was diminished and gradually reversed as business confidence rose.

While expansion in the United States and Canada has been strongest in the consumer-oriented components of demand, there have also been encouraging signs that recovery is spreading to the investment sector, particularly in the United States. In that country, business capital formation has shown considerable strength, which is all the more noteworthy in the light of the high level of real interest rates that has prevailed throughout the recovery period. The reasons for this strength are not fully apparent, but may reflect both fiscal incentives for investment and the unsuitability of parts of the existing capital stock for the structure of demand growth that is now in prospect.

Outside the two North American industrial economies, expansion has been slower in gathering momentum, although by the second half of 1983 and the early part of 1984, recovery appeared to be better established. The growth in net imports into the United States and Canada has been an important factor underpinning output growth in other industrial countries. This was particularly significant for Japan, although domestic demand now appears to be providing a greater stimulus to GNP growth in that country. In the United Kingdom and the Federal Republic of Germany, as well as in several of the smaller industrial countries, declining inflation and interest rates appear to have led to a further drop in the saving ratio and to have encouraged a revival in investment activity.

In France, where economic activity had been somewhat better maintained in 1981-82 than in most other European countries, recovery tended to be relatively weak in 1983. The need to combat inflation and bring down the external current account deficit limited the scope for increases in domestic demand. As a result, gross domestic product (GDP) was only about Vi of 1 percent higher in 1983 than in 1982, and did not display signs of upward momentum until late in 1983 and early in 1984. Italy, too, was influenced by the need to improve its balance of payments and, especially, its price performance. Italian output, though recovering slowly during 1983 from a sharp drop during 1982, was just over 1 percent lower for the past calendar year as a whole than in 1982.

Among the smaller industrial countries, experience varied considerably in 1983 and in early 1984. On average, however, their economic performance has remained somewhat weaker than that of the seven major industrial countries as a group. With many of the smaller countries still suffering from serious inflation and weak balance of payments positions, their combined GNP growth averaged 1.9 percent in 1983. While this represented an improvement over the sluggish rates of the preceding two years, the output expansion recorded in 1983 was well below the estimated increase in these countries’ productive potential.

In early 1984, the average rate of growth among the smaller industrial countries continued to lag behind that of the larger ones, and in most there was a further worsening in unemployment. However, scattered signs of some acceleration in economic activity were appearing, and some of the smaller countries have laid the foundation for stronger gains as their major trading partners reach more satisfactory stages of recovery. Since most of the smaller countries are closely linked to the European industrial area, the regional pattern of cyclical recovery among major industrial countries has so far been rather unfavorable for the majority of the smaller countries, but this disadvantage may be mitigated as recovery spreads.

Employment and Unemployment.—Except in the United States and Canada, the acceleration of growth in 1983 was generally insufficient to take up much of the slack in the labor market. The average rate of unemployment was higher in 1983 than in 1982 in every major industrial country except the United States, as well as in most of the smaller ones. Altogether, 8 of the 21 countries in the industrial group, including for the first time Denmark and Australia, reported average unemployment exceeding 10 percent of the labor force in 1983,2 and the annual average for the entire group reached 8¾ percent. By the end of the year, however, there were increasing signs of improvement. Unemployment continued to fall rapidly in the United States and Canada, while in several other countries the rise in joblessness seemed to have been halted.

In the early part of 1984, the unemployment rate was reduced substantially further in the United States and was reduced or at least stabilized in several other countries. The United States, however, was the only member of the group whose employment gains during the first half of 1984 were strong enough to outpace labor force growth by a sizable margin. Hiring of additional workers in the United States responded more quickly than usual to the cyclical upturn in demand and production, reflecting the degree to which the sheer duration of the recession had resulted in elimination of the hoarding of labor typically observed during past recessions. At less than 8 percent in the first quarter of 1984, the U.S. unemployment rate was down by more than ½ of 1 percentage point from the previous quarter and by 2½ percentage points from the corresponding quarter a year earlier.

In a number of European industrial countries, by contrast, further increases in unemployment were recorded. Even in the countries whose employment situations seemed to be stabilizing, levels of unemployment remained quite high during early 1984. About 12½ percent of the labor force was out of work in the United Kingdom, and still higher unemployment rates (15 percent or more) prevailed in Belgium, Ireland, the Netherlands, and Spain. The persistence of such high rates of unemployment appears to be attributable not only to cyclical weakness in these economies but also to structural rigidities in their labor markets. Wage costs continue to absorb a higher share of value added in European countries than was common in the 1960s and early 1970s. At the same time, employers are made reluctant to hire additional workers by the difficulty of releasing them should demand conditions change.

Prices and Costs.—The concerted focus of policy on restraint of inflationary pressures met with further success in 1983. Rates of increase in prices subsided significantly in every major industrial country and in most of the smaller ones as well. In a number of countries, including the United States, the United Kingdom, the Netherlands, and New Zealand, the rate of increase in the GNP deflator was more than halved from 1981 to 1983. For the industrial countries as a group, the rise in the GNP deflator dropped to 5 percent in 1983, compared with 7 percent in 1982 and 8½-9 percent in each of the preceding two years. (See Table 2.) With some of the factors underlying this moderating trend having largely run their course by mid-1983, recent quarterly movements in the series have shown less tendency to improve, although there was a further decline in this measure of inflation in the United States in the first half of 1984. Consumer prices in these countries have followed a broadly similar course in recent years, although with more amplitude of movement, reflecting mainly the greater volatility of import costs.

While the dispersion of inflation rates has remained quite substantial, it tended to diminish somewhat during 1983 and the first half of 1984. Canada and France, which had had persistently high rates of price increase during 1979-82, finally achieved some success in reducing inflation. The same can be said of a number of the smaller industrial countries, including Ireland, New Zealand, and Norway. By the first half of 1984, the rate of consumer price increase in most industrial countries had been brought below the double-digit level.

Foremost among the factors leading to the current greatly reduced average rate of inflation has been the perseverance of most national authorities with their anti-inflationary strategy despite its high short-run cost in terms of unemployment and forgone output. In particular, monetary restraint has limited the capacity of business enterprises to accede to higher wage demands or to pass additional wage costs through to their customers in the form of higher prices. Increased flexibility in labor contract negotiations has resulted from the combination of a marked reduction in inflationary expectations with high unemployment and slack productive capacity. During 1982 and 1983, these conditions induced a notable moderation in wage settlements. In several countries, significant modifications of previously rigid indexation arrangements made major contributions to the slowing of wage and price increases.

In 1983, the scaling back of wage and salary increases was reinforced, in its effect on unit labor costs, by an acceleration in productivity gains. After a long period of weakness, the growth of output per man-hour in manufacturing increased sharply, and overall GNP per employee in the industrial countries rose about twice as fast as it had during the 1980-82 period. This favorable result occurred despite the fact that an exceptional degree of labor shedding by cost-conscious employers had occurred during the recession, leaving less scope than in previous cyclical recoveries for productivity increases from fuller utilization of already employed labor.

Factors underlying the welcome acceleration of productivity gains in 1983 cannot be identified with certainty, but some of the probable causes can be suggested. Fuller utilization of existing plant capacity must have been among the more important. It also seems likely that rapid scrapping of obsolete plant and equipment during the years of weak demand and intensified cost pressures may have resulted in an upgrading and a reduction in the average age of facilities in use. The maturing of the labor force could have benefited productivity in countries where high proportions of new entrants from the generation born just after World War II had lowered the average experience of workers employed during the previous decade or so. Whatever the respective roles of these and other underlying factors, it is clear that the recent acceleration of productivity growth has made an important contribution to reducing the rate of increase of unit costs and final product prices.

Developing Countries

A major factor underlying the serious economic and financial difficulties confronted by most developing countries in recent years, and the associated slowdown in their rates of growth, has been the recession in the industrial countries.

This recession was unusually prolonged, in part because of the difficulties of combatting inflationary expectations that had become entrenched during the earlier period of accommodative policies. The impact of the weakness in economic activity was reflected in a reduced demand for developing countries’ exports and a further deterioration in their terms of trade. The recession also tended to intensify protectionist trade measures in industrial countries, restricting the growth of markets for exports of manufactures from developing countries. Oil exporting countries, too, were seriously affected, as a combination of weak aggregate demand, conservation efforts, inventory reductions, and substitution among fuels and among sources of supply led to a sharp reduction in the volume of their oil exports and, eventually, to a decline in price also.

The strains resulting from these adverse external developments were exacerbated in a number of developing countries by inappropriate domestic financial policies in the years immediately following the 1979-80 oil price increases. Inflationary demand management policies and resort to excessive external borrowing or trade and payments restrictions, rather than to needed measures of adjustment, led to a loss in international competitiveness and worsened the payments disequilibrium in several of these countries.

The weakness of foreign exchange earnings, against a background of indebtedness that had been rapidly rising since the mid-1970s and that was largely contracted at variable interest rates, made developing countries particularly vulnerable to the large increase in international interest rates that took place after 1980. The prolongation of this situation contributed to capital flight and to a widespread drying up of new private lending after the middle of 1982. In the circumstances, developing countries were obliged to curtail imports, adopt policy measures to restrict domestic demand, and settle for lower growth rates.

Economic Growth.—In most developing countries, economic growth remained weak in 1983, as it had been in 1981 and 1982. This was true, not only in comparison with these countries’ performance in the 1960s and 1970s but also, more importantly, in relation to their population growth and development needs. The weighted average growth rate for all developing countries, which had been declining steadily from its 1977 level of nearly 6 percent, was less than 1 percent in both 1982 and 1983. (See Table 3.)

Table 3.Developing Countries: Changes in Output, 1967-831(In percent)
AverageChange from Preceding Year
1967-76 21977197819791980198119821983
Developing countries
Weighted average 35.75.85.54.83.51.20.20.8
Median5.05.64.93.73.21.8-1.7
Oil exporting countries37.06.32.33.7-2.0-4.0-4.3-1.1
Oil sector32.0-3.53.0-11.7-15.4-16.0-6.9
Other sectors 39.46.04.14.95.53.91.9
Median8.95.57.811.19.45.53.7
Non-oil developing countries
Weighted average 35.65.76.45.15.02.81.51.6
Median5.05.05.64.83.73.32.01.7
By analytical group
Weighted averages 3
Net oil exporters6.83.66.17.67.36.61.1-1.5
Net oil importers5.45.76.44.74.72.21.62.2
Major exporters of manufactures6.95.74.76.44.50.10.3-0.1
Low-income countries3.86.69.03.36.04.34.36.1
Excl. China and India3.63.65.42.33.43.43.82.6
Other net oil importers5.16.05.63.63.23.10.41.1
Medians
Net oil exporters6.04.96.64.56.34.81.22.3
Net oil importers4.85.05.34.83.73.02.11.7
Major exporters of manufactures7.66.46.76.84.94.21.01.8
Low-income countries3.93.94.73.83.52.82.82.4
Other net oil importers5.15.55.94.93.73.01.81.1
By area
Weighted averages 3
Africa (excl. South Africa)4.82.32.52.23.01.81.20.1
Asia5.07.39.84.75.45.14.56.5
Europe5.55.45.43.91.52.32.40.6
Middle East5.64.37.44.36.85.43.44.2
Western Hemisphere6.65.04.26.76.10.2-1.6-2.3
Medians
Africa4.73.53.54.02.52.02.61.6
Asia4.85.86.76.35.55.03.84.4
Europe6.46.66.85.62.72.52.90.8
Middle East6.45.68.23.86.87.35.44.2
Western Hemisphere4.95.36.44.84.32.1-0.7

Data in this table cover all Fund members except those listed in Table 2, together with a few territories for which output statistics are readily available. The main groups of oil exporting countries and non-oil developing countries, as well as each of the regional subgroups of non-oil developing countries, conform to the classification used in the Fund’s International Financial Statistics. The subgroup of oil exporting countries is defined as those countries meeting both of the following criteria (applied at present to 1978-80 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 percent of annual world exports of oil). Among the non-oil developing countries, the net oil exporters are those countries that export more oil than they import, but do not satisfy the criteria noted above. The major exporters of manufactures are those 12 countries that, in 1977, had manufactured exports amounting to both at least $1 billion and 25 percent of each countrys tota exports. The subgroup of low-income countries comprises 43 countries whose per capita GDP, as estimated by the World Bank, did not exceed the equivalent of $350 in 1978. The subgroup of other net oil importers comprises middle-income countries (according to the World Bank’s estimates) the majority of which export mainly primary commodities. For the specific country coverage of each analytical subgroup, see World Economic Outlook: A Survey by the Staff of the International Monetary Fund (Washington: International Monetary Fund, April 1984), pages 167-68.

Compound annual rates of change. Excludes China.

Arithmetic averages of country growth rates weighted by the average U.S. dollar value of GDPs over the preceding three years.

Data in this table cover all Fund members except those listed in Table 2, together with a few territories for which output statistics are readily available. The main groups of oil exporting countries and non-oil developing countries, as well as each of the regional subgroups of non-oil developing countries, conform to the classification used in the Fund’s International Financial Statistics. The subgroup of oil exporting countries is defined as those countries meeting both of the following criteria (applied at present to 1978-80 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 percent of annual world exports of oil). Among the non-oil developing countries, the net oil exporters are those countries that export more oil than they import, but do not satisfy the criteria noted above. The major exporters of manufactures are those 12 countries that, in 1977, had manufactured exports amounting to both at least $1 billion and 25 percent of each countrys tota exports. The subgroup of low-income countries comprises 43 countries whose per capita GDP, as estimated by the World Bank, did not exceed the equivalent of $350 in 1978. The subgroup of other net oil importers comprises middle-income countries (according to the World Bank’s estimates) the majority of which export mainly primary commodities. For the specific country coverage of each analytical subgroup, see World Economic Outlook: A Survey by the Staff of the International Monetary Fund (Washington: International Monetary Fund, April 1984), pages 167-68.

Compound annual rates of change. Excludes China.

Arithmetic averages of country growth rates weighted by the average U.S. dollar value of GDPs over the preceding three years.

Among the non-oil developing countries, the weighted average rate of growth remained at 1½ percent in 1983, approximately the same pace as in 1982. In per capita terms, economic growth has declined from some 3 percent per annum during most of the 1960s and 1970s to virtually zero in 1981 and to a negative figure in 1982 and 1983. Moreover, the requirements of external adjustment have meant that a sizable additional portion of real output has had to be devoted to net exports over the past three years, both to offset the deterioration in the terms of trade and to bring about a reduction in the current account deficit. Thus, the additional resources available for domestic consumption and investment were substantially less than the increase in measured output. The aggregate output of oil exporting countries, heavily influenced as it is by developments in the oil sector, has been decreasing since 1980. It fell again in 1983, albeit by a relatively small amount. Abstracting from developments in oil production, however, economic growth in the non-oil sectors of these economies has remained positive, though declining from an average rate of 5 percent in 1978-81 to 2 percent in 1983.

The slowdown in growth has been pervasive, with the median rate of output increase having declined in each of the past five years. (See Table 3.) The only regions that seem to have emerged relatively unscathed are the non-oil developing countries of the Middle East and Asia. (See Chart 4.) In the latter region, the performance of the two largest countries, China and India, as well as that of a number of smaller ones, has run counter to the trend in much of the rest of the world.

Chart 4.Non-Oil Developing Countries: Real GDP by Region, 1973-83

(Indices, 1973 = 100)

1 Excluding China.

2 Excluding South Africa..

As noted above, an important factor in the severe deceleration of growth in the non-oil developing countries was the pronounced reduction in the volume and prices of their exports as a result of the recession in the industrial countries. The decline in real GNP growth of industrial countries from 4 percent in 1978 to virtual stagnation in 1982 was accompanied by an even more pronounced slowdown in the expansion of world trade. In particular, the rate of growth of non-oil developing countries’ export volumes declined from 10 percent in 1978 to 1¾ percent in 1982, before recovering to 5¼ percent in 1983. The major exporters of manufactures have suffered the most substantial slowdown in output growth since the onset of the recession, reflecting a significant deceleration (and in 1982 an actual decline) in the volume of their exports.

Their reliance on manufactured exports rendered them vulnerable to protectionist trends in industrial countries, while their high level of international indebtedness required a particularly determined adjustment effort at a time when foreign lending declined.

The smaller low-income countries (i.e., excluding China and India) are relatively less exposed to international economic developments, and their growth rate, though low, was initially less affected by the international recession, remaining at about 3½ percent per annum during 1980-82. In 1983, however, output growth in these countries fell to only 2½ percent, reflecting in part adverse climatic conditions in a number of countries, particularly in sub-Saharan Africa.

Not surprisingly, the weakness of economic activity in the industrial world had a substantial adverse effect on the terms of trade of the non-oil developing countries. These countries’ import payments had already risen as a result of the second round of oil price increases in 1979-80. Subsequently, their export earnings were undercut by the severe decline in non-oil primary commodity prices that occurred in 1981 and 1982. This decline reflected the impact of the world recession, the rise in interest rates (which made it costly to hold commodity stocks), and the impact of the strength of the U.S. dollar on prices quoted in that currency. In addition, record harvests of foodgrains and cotton exerted downward pressure on international market prices of these commodities.

The weakness of export markets of many non-oil developing countries, together with the very high nominal rates of interest prevailing in international financial markets, resulted in a steep increase in real interest rates, as measured by the Eurodollar deposit rates adjusted for changes in these countries’ export prices. In 1980 and 1981, the real rate became increasingly positive, and it fell only moderately in 1982 and 1983, as softening of export prices offset the impact of declines in nominal interest rates. The relative burden of debt service was further increased by the continued appreciation of the U.S. dollar. As the dollar rises in terms of other currencies, the value of payments that are fixed in dollar terms (such as interest payments on dollar-denominated liabilities) tends to rise relative to those (such as payments for developing countries’ exports) that move more closely in line with the average of currency values.

In the face of increased debt service burdens and limited export earnings, many countries had to seek adjustment mainly through a reduction of imports. Such import cuts cause dislocations in the domestic economy and affect the ability to produce goods for domestic consumption and investment. They may also limit the country’s exporting capability insofar as the forgone imports are required for production of exportable goods. In either case, the path of real gross domestic product is deflected downward.

Although 1983 was a disappointing year from the point of view of output growth in developing countries, a number of trends appeared that should have a favorable impact in 1984 and beyond. In particular, the recession in the industrial countries began to ease. The decline in oil prices, while contributing to the balance of payments problems of countries whose external positions depend, directly or indirectly, on oil receipts, tended to ease the adjustment burden for many other developing countries. With some recovery in commodity prices, the terms of trade of non-oil developing countries began to improve, and real export earnings started to grow more rapidly. For the oil exporting countries, the prolonged decline in the demand for their principal export showed signs of coming to an end. Interest rates generally remained below the levels reached in 1981, although they were still high in real terms and showed signs of rising in the second half of 1983 and in early 1984.

Whether the developing countries can build on these developments to achieve higher growth rates will depend in part on the extent to which the trend toward a more favorable external environment is maintained. Primarily, however, it will depend on the determination with which developing countries themselves adopt appropriate policy packages in such areas as fiscal reform, credit restraint, interest and exchange rates, incentives for private sector activity, and pricing in public sector undertakings. Recovery in developing countries will also depend on the extent to which these countries are permitted access to expanding markets in the industrial countries, and on the extent to which international capital flows, private and official, are restored and expanded.

Inflation.—In the developing countries, unlike in the industrial countries, inflation has not shown uniform signs of decelerating in recent years. In sharp contrast to the sustained anti-inflationary policies that have been instrumental in controlling cost and price pressures in the industrial countries, accommodative financial policies have been characteristic of many developing countries, and have been a major factor accounting for the high rates of inflation they have experienced over the past several years. This has been particularly true for the non-oil developing countries, whose weighted average rate of increase in consumer prices increased to 32 percent per annum in 1980-82 and to 44 percent in 1983. (See Table 4.) It may be noted here that this weighted average, being dominated by the poor performance of a few large countries, tends to overstate the rise in inflation for the majority of the non-oil developing countries. The median rate of inflation, which is more representative of price increases in a “typical” developing country, declined from 15 percent in 1980 to 11 percent in 1982 and remained at that level in 1983.

A notable feature of the pattern of inflation rates among developing countries is that Asia has been, for many years, more successful than other regions in containing price increases. This superior performance may be attributed in part to the adjustment programs adopted by many Asian countries in the 1970s and early 1980s, which included policies designed to achieve fiscal and monetary discipline, correction of price distortions, and reduction of external restrictions. The adoption of such policies in the other regions has not always taken place on such a timely basis. Furthermore, the other regional groups all include one or more sizable countries with exceptionally high rates of inflation that tend to push up the average without necessarily affecting the median rate for the area. Such high-inflation countries often have extensive indexation arrangements which, once inflation accelerates, greatly complicate the task of inflation control, particularly in circumstances requiring external adjustment. This is especially true for the Western Hemisphere region, which continued to experience the highest inflation, with the weighted average rate accelerating sharply from 78 percent in 1982 to 123 percent in 1983. However, the median inflation rate for this region showed only a modest rise, from 9½ percent in 1982 to 11½ percent in 1983, with serious inflationary problems being confined to Argentina, Bolivia, Brazil, and Mexico. Similarly, in the non-oil Middle East region, continued high inflation in Israel largely accounted for the increase in the weighted average rate for the group as a whole.

Among the major oil exporting countries, a lower rate of consumer price inflation in the past two years is partly attributable to the weakness in economic activity after 1981, which in turn reflected increasing restraint on government spending. Other factors contributing to the abatement of inflation have been the decline in import prices (in U.S. dollar terms) and the maintenance of comfortable supply conditions in most countries. Nevertheless, a few countries in this group continued to experience significant inflationary pressures.

Adjustment Measures.—In order to improve prospects of domestic and external financial stability, many developing countries have now embarked on programs incorporating measures in areas such as government finance, monetary and banking policy, the exchange rate, and trade liberalization. In addition, structural adjustment efforts included policies relating to subsidies and prices, public enterprise management, and the level and distribution of development expenditures. While these adjustment programs are expected eventually to reduce inflationary pressures, their initial consequence has sometimes been a rise in the level of domestic prices following corrective price adjustments.

Table 4.Developing Countries: Changes in Consumer Prices, 1967-831(In percent)
AverageChange from Preceding Year
1967-76 21977197819791980198119821983
Developing countries
Weighted average 321.918.921.627.727.126.735.4
Median11.29.911.614.613.510.310.0
Oil exporting countries
Weighted average 315.211.910.913.213.28.111.4
Median11.210.610.611.211.17.69.0
Non-oil developing countries
Weighted average 315.923.620.924.832.031.332.944.1
Median7.811.29.412.014.913.711.011.0
By analytical group
Weighted averages 3
Net oil exporters8.222.817.717.724.224.443.674.2
Net oil importers17.323.821.425.933.232.331.139.1
Major exporters of manufactures22.643.240.245.454.561.963.386.5
Low-income countries10.77.03.76.711.710.47.48.1
Excl. China and India14.914.211.517.921.826.420.418.0
Other net oil importers15.819.618.723.931.519.315.716.0
Medians
Net oil exporters7.912.310.69.015.114.616.216.3
Net oil importers7.810.69.112.214.913.510.610.0
Major exporters of manufactures11.512.214.419.024.922.621.020.7
Low-income countries8.19.69.111.014.413.611.913.0
Other net oil importers7.511.28.312.114.312.37.77.6
By area
Weighted averages 3
Africa8.624.319.122.523.328.218.319.5
Asia10.35.53.76.712.510.55.95.9
Europe9.015.119.825.937.924.023.523.3
Middle East9.620.020.925.942.234.036.140.3
Western Hemisphere27.553.845.350.158.665.378.4122.7
Medians
Africa7.512.010.111.613.813.513.513.0
Asia8.05.06.06.314.513.47.48.0
Europe7.311.19.914.316.215.718.514.2
Middle East9.514.312.014.115.210.311.210.0
Western Hemisphere8.711.510.215.618.114.69.411.6

For classification of countries in groups shown here, see Table 3, footnote 1.

Compound annual rates of change. Excludes China.

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

For classification of countries in groups shown here, see Table 3, footnote 1.

Compound annual rates of change. Excludes China.

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

A widespread feature of financial policies in developing countries in recent years has been an acceleration in money and credit growth induced by excessive fiscal deficits. Efforts to reduce fiscal deficits have been hampered by falling government revenues owing to declining economic activity, stagnation in trade, and the difficulty of expanding the tax base during a recession. Attempts to reduce government expenditures have encountered social and political constraints as well as the fear of retarding economic development by substantial reductions in capital expenditure. Since 1982, however, many countries have pursued the objective of fiscal restraint in a more determined manner. As a result, the average ratio of the fiscal deficit to GDP of the non-oil developing countries registered a modest decline to 4½ percent in 1983, after having widened from 3½ percent in 1977-81 to 4¾ percent in 1982. This improvement in the fiscal position permitted a deceleration in the rate of expansion of domestic credit. Credit growth in non-oil developing countries, which had reached 67 percent in 1982, fell back to 50 percent in 1983. There was, nevertheless, some increase in the average rate of growth of the money stock, as the monetary impact of the balance of payments became less negative.

Among the oil exporting countries, substantial adjustment measures have been made necessary by declining oil revenues, and in a few cases also by the need to moderate inflationary pressures. Virtually all the members of this group took measures aimed at reducing public sector spending substantially, and in many countries such measures were combined with efforts to increase domestic non-oil revenue. Nevertheless, falling receipts from the petroleum sector brought about a widening in the overall fiscal deficit, from an average of 5¼ percent of GDP in 1982 to 9 percent of GDP in 1983.

External adjustment has involved, for many developing countries, either an outright, planned reduction of investment outlays or an indirect reduction in investment spending brought about by restrictive monetary and fiscal policies and the higher cost or reduced availability of capital. This is particularly true for countries in the Western Hemisphere and in Africa, which have generally suffered reductions in the share of investment in total GDP in recent years. Although this adjustment has had adverse implications for growth, it needs to be viewed in the perspective of the acceleration in investment spending that occurred in many of these countries in the 1970s. During the mid-1970s, the relatively easy availability of private international credit at low or negative real rates of interest encouraged a rapid growth of investment spending in many countries in the Western Hemisphere. In Africa, a similar, though less pronounced, development took place in response to growing inflows of official finance on concessional terms. Although increased investment was generally associated with increased output and exports, easy access to external credit may have encouraged some countries to reach levels of imports that could not be sustained in the longer run and to avoid the reductions in consumption and investment that would otherwise have been called for. Moreover, negative real interest rates may have led to distortions in the allocation of resources.

However, if the low real interest rates of the mid-1970s may have caused an expansion in investment spending that was ultimately unsustainable, the subsequent rise in rates has had the opposite effect. The steep rise in the real cost of borrowing has narrowed the range of economically attractive investment opportunities, and has reduced the real rate of return (after allowance for the increased cost of borrowing) on all investments. The impact has been especially severe on past investments financed through floating rate debt. The economic viability of these investments has been undermined by the higher real rates of return required to match the increase in real interest costs.

Another difference between the experience of the mid-1970s and that of the early 1980s is in the resource uses of external credit. During most of the 1970s, although some borrowing was used to finance increased energy costs, growing capital inflows were in general associated with a rising absorption of real resources from abroad. While credit was still available in 1980-82—albeit at very high rates of interest—it had to be used primarily to meet the increased cost of servicing the large volume of debt accumulated in earlier years and to finance external deficits arising from the deterioration in the global economic environment, rather than to bring about increases in domestic outlays for investment. The early 1980s were also a period in which flows of industrial country aid to developing countries flattened out. This meant that in the low-income countries, which rely heavily on concessional borrowing, investment spending could not be increased or even maintained at existing rates without cutting already low consumption levels.

Beyond the effects of the increasing cost and scarcity of external credit on investment, domestic capital formation in developing countries has been affected in the short term by policies that have to be employed to restore financial stability on a durable basis. Fiscal retrenchment has led to the curtailment of public sector projects, while monetary restraint has had the effect of limiting the flow of bank credit to the private sector. While in some cases resources released by the public sector have been quickly reabsorbed through an increase in private investment activity, in general this kind of switch in resource use takes time to have its effect.

International Trade and Payments

With the progress of economic recovery in the industrial countries, the volume of world trade began to expand quite strongly in 1983, and the prolonged deterioration in the terms of trade of non-oil developing countries came to an end. (See Table 5 and 6.)Imports into industrial countries grew at an annual rate of over 9 percent, in real terms, from the last quarter of 1982 to the first quarter of 1984. Non-oil commodity prices increased by 20 percent in U.S. dollar terms between the trough reached in November 1982 and May 1984. In consequence, the terms of trade of those developing countries that are net importers of oil improved by an estimated 2 percent in 1983 over 1982, after having deteriorated by some 20 percent over the preceding five years. For oil exporting countries, there was a decline in the terms of trade in 1983, which, however, provided only a limited offset to the improvement that had occurred during 1979-81.

Table 5.World Trade Summary, 1967-831(Percentage changes)
Average

1967-76 2
Change from Preceding Year
1977197819791980198119821983
World trade3
Volume7.55.05.57.01.51.0-2.52.0
Unit value
(in U.S. dollar terms)8.59.010.018.520.0-1.0-4.0-4.5
(in SDR terms)47.07.52.514.519.09.02.5-1.0
Volume of trade
Exports
Industrial countries8.05.36.17.53.73.4-2.12.0
Developing countries6.52.44.25.3-2.5-4.1-7.40.6
Oil exporting countries6.00.5-2.92.3-12.5-15.6-18.4-7.2
Non-oil developing countries6.64.110.08.09.07.81.75.3
Imports
Industrial countries7.64.45.18.6-1.5-1.9-0.54.1
Developing countries8.710.27.25.28.17.2-4.5-3.4
Oil exporting countries18.516.33.8-8.512.420.66.5-10.2
Non-oil developing countries6.07.78.610.76.83.1-8.3-0.6
Unit value of trade

(in SDR terms)4
Exports
Industrial countries6.26.65.211.512.46.13.0-0.3
Developing countries11.310.9-4.025.435.114.01.0-2.8
Oil exporting countries20.18.4-6.239.759.320.62.2-8.4
Non-oil developing countries6.313.4-2.215.014.97.90.9
Imports
Industrial countries7.27.92.315.420.67.71.2-2.4
Developing countries6.56.53.112.817.812.33.4
Oil exporting countries6.27.34.99.510.78.22.50.6
Non-oil developing countries7.16.22.414.220.113.73.7-0.2

For classification of countries in groups shown here, see Table 2 and Table 3, footnote 1. Excludes data for China prior to 1978.

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 U.S.S.R. and other nonmember countries of Eastern Europe and, for years prior to 1978, China). Figures are rounded to the nearest 0.5 percent.

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

For classification of countries in groups shown here, see Table 2 and Table 3, footnote 1. Excludes data for China prior to 1978.

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 U.S.S.R. and other nonmember countries of Eastern Europe and, for years prior to 1978, China). Figures are rounded to the nearest 0.5 percent.

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

Table 6.Summary of Terms of Trade and World Prices, 1967-831(Percentage changes)
AverageChange from Preceding Year
1967-76 21977197819791980198119821983
Terms of trade
Industrial countries-1.0-1.22.8-3.4-6.8-1.51.82.1
Developing countries4.54.1-6.911.214.71.5-2.3-2.9
Oil exporting countries13.11.0-10.527.643.911.5-0.4-9.0
Non-oil developing countries-0.76.8-4.50.8-4.3-5.1-3.51.1
Net oil exporters1.26.9-4.319.311.5-7.1-6.8-2.7
Net oil importers-1.06.8-4.5-2.1-7.1-4.8-2.91.8
Major exporters of manufactures-1.15.0-3.3-2.8-6.8-4.4-2.63.9
Low-income countries3-0.616.4-7.9-0.6-10.4-5.3-2.61.8
Other net oil importers-0.76.1-5.10.2-9.1-8.0-5.5-0.2
World trade prices (in U.S.

dollar terms) for major

commodity groups4
Manufactures7.58.014.514.011.0-6.0-1.0-3.0
Oil21.79.30.446.063.510.0-4.2-12.1
Non-oil primary commodities

(market prices)
7.421.2-4.116.38.7-14.6-12.06.7

Based on foreign trade unit values except where indicated. For classification of countries in groups shown here, see Table 2 and Table 3, footnote 1. Excludes data for China prior to 1978.

Compound annual rates of change.

Excluding China and India.

As represented, respectively, by (1) the United Nations export unit value index for the manufactures of the developed countries; (2) the oil export unit values of the oil exporting countries; and (3) the Fund’s 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 Table 2 and Table 3, footnote 1. Excludes data for China prior to 1978.

Compound annual rates of change.

Excluding China and India.

As represented, respectively, by (1) the United Nations export unit value index for the manufactures of the developed countries; (2) the oil export unit values of the oil exporting countries; and (3) the Fund’s International Financial Statistics index of market quotations for non-oil primary commodities.

The principal change in the pattern of world current account balances among major country groupings in 1983 was a further substantial reduction in the deficit of non-oil developing countries, which fell by $26 billion, to $56 billion. (See Table 7.)With the industrial countries remaining in approximate balance and oil exporting countries in moderate deficit, the principal counterpart to the improvement in the non-oil developing countries’ position was a reduction in the negative “statistical discrepancy” for the world as a whole. The large size, and significant changes, in this balancing item should induce caution in the interpretation of recorded balance of payments developments, though it probably does not invalidate inferences drawn from broad trends in such developments.

The 1983 recovery in world trade permitted non-oil developing countries to resume import growth in the latter part of that year, while still achieving a sizable further reduction in their external current account deficit. This deficit fell to the equivalent of 12½ percent of their export receipts, the lowest figure in a decade. The oil exporting countries, whose record surplus of over $110 billion in 1980 had been converted into a moderate deficit by 1982, managed to stabilize their position in 1983. In their case, however, this was due entirely to a substantial compression of imports, as both the price and the volume of their exports continued to decline.

Table 7.Summary of Payments Balances on Current Account, 1977-831(In billions of U.S. dollars)
1977197819791980198119821983
Industrial countries-2.132.7-5.1-38.14.83.22.8
Canada-4.1-4.0-4.2-1.2-5.41.91.3
United States-11.7-12.32.66.610.7-3.8-35.5
Japan11.117.0-8.1-9.96.38.822.1
France1.08.56.9-2.5-2.8-9.5-1.8
Germany, Fed. Rep. of8.513.40.1-8.30.810.29.8
Italy3.17.96.4-9.5-7.5-4.91.0
United Kingdom2.05.53.012.718.113.37.5
Other industrial countries-12.0-3.2-11.8-26.0-15.6-13.0-1.6
Developing countries-1.0-36.60.523.3-55.7-94.2-72.6
Oil exporting countries29.45.762.5111.053.4-12.0-16.2
Non-oil developing countries-30.4-42.3-62.0-87.7-109.1-82.2-56.4
By analytical group 2
Net oil exporters-6.3-7.4-7.3-10.2-24.3-14.4-6.9
Net oil importers-25.0-34.2-52.5-74.2-86.1-73.5-54.5
Major exporters of manufactures-8.9-10.8-22.9-32.5-37.4-34.6-17.1
Low-income countries-3.7-8.2-10.5-14.1-15.7-15.1-13.1
Other net oil importers-12.5-15.2-19.1-27.6-33.0-23.8-24.3
By area
Africa (excl. South Africa)-6.6-9.4-9.9-12.9-14.0-12.5-10.8
Asia-1.5-8.3-16.9-25.4-23.2-14.6-10.7
Europe-9.1-7.2-10.1-12.7-10.4-6.9-5.5
Middle East-5.1-5.7-7.2-7.1-11.5-9.3-12.0
Western Hemisphere-8.5-13.2-21.4-33.1-45.5-38.8-18.5
Total3-3.1-3.9-4.6-14.8-50.9-91.0-69.8

On goods, services, and private transfers. For classification of countries in groups shown here, see Table 2 and Table 3, footnote 1.

China, which is classified as a low-income country but is also a net oil exporter, is included in the total but not in the subgroups.

Reflects errors, omissions, and asymmetries in reported balance of payments statistics on current account, plus balance of listed groups with other countries (mainly the U.S.S.R. and other nonmember countries of Eastern Europe).

On goods, services, and private transfers. For classification of countries in groups shown here, see Table 2 and Table 3, footnote 1.

China, which is classified as a low-income country but is also a net oil exporter, is included in the total but not in the subgroups.

Reflects errors, omissions, and asymmetries in reported balance of payments statistics on current account, plus balance of listed groups with other countries (mainly the U.S.S.R. and other nonmember countries of Eastern Europe).

Despite the improvements in the balance of payments position of most developing countries, many of them continued to face severe external constraints. The reluctance of commercial banks to extend further credit to many of the most heavily indebted countries, which had come to a head in the second half of 1982, remained a central feature of international credit markets in 1983 and the first half of 1984. Consequently, many developing countries had to have recourse to exceptional means of balance of payments financing, including rescheduling of existing debt and concerted new lending by banking consortia. These arrangements were usually developed in the context of programs of balance of payments adjustment supported by the Fund.

Among the industrial countries, the dominant feature of developments over the past year has been the continued strength of the U.S. dollar, and the very substantial widening in the current account deficit of the United States. Between the end of 1982 and mid-1984, the real effective exchange rate of the U.S. dollar rose by a further 5 percent, having risen by 31 percent during the previous two years: With the Japanese yen little changed, the principal counterweight to the dollar’s strength was in the European currencies. The French franc, the Italian lira, and the pound sterling experienced the largest declines against the dollar. The strength of the dollar must be largely attributed to developments affecting the capital account, notably the large interest differential favoring investment in dollar-denominated assets, the effects of tax changes and strong economic growth on the yield of equity and other investments in the United States, and the attractiveness of U.S. financial markets as a “safe haven’’ for foreign funds. The current account position of the United States has continued to deteriorate markedly; a deficit of $42 billion (including official transfers) was recorded in 1983, and data for the first part of 1984 suggest that the deficit could double in the current year.

Industrial Countries

Exchange Rate Developments.—The rise in the value of the U.S. dollar during 1983 continued the extended upswing that had begun in the third quarter of 1980. Having appreciated by 30 percent in nominal effective terms between that time and December 1982, the dollar rose by another 9½ percent from December 1982 to January 1984. It then declined by 4 percent from January to March 1984, but in the subsequent few months tended to firm again. By the first quarter of 1984, the real effective value of the dollar (based on relative normalized unit labor costs in manufacturing, adjusted for exchange rate movements) had risen to a level more than 25 percent above its average level for 1973-82, the first decade of generalized floating among major currencies.

The continued appreciation of the U.S. dollar indicates that the preference for dollar-denominated assets by market participants remained strong in 1983. Factors that may have contributed to the strength of these investor preferences included relatively high expected returns on both financial and real investments in the United States and the perceived safety of the U.S. financial system in a period of continued international uncertainties.

The recovery of the U.S. economy, which gathered pace during 1983, together with the continued large size of the federal budget deficit, eventually arrested the decline in U.S. interest rates that had been taking place since 1981. Both short-term and long-term interest rates began to rise in mid-1983, pushing differentials vis-à-vis most other major currencies in a direction favoring assets denominated in U.S. dollars. The expectation that the conditions underlying these high interest rates would persist provided an incentive for substantial inflows of capital to the United States from abroad, satisfying the heavy net demand for savings and simultaneously contributing to both the appreciation of the dollar and the deterioration of the current account balance.

The strengthening of the U.S. economy in 1983 also fostered expectations of relatively high returns on real investment, particularly in comparison with countries where economic recovery remained weak. The growth of public and private demand for domestic credit, combined with the debt problems of a number of the larger developing countries, led to a sharp decline in foreign lending by U.S. private banks. This also may have strengthened the U.S. currency, since borrowers had reduced access to dollars to convert into other currencies for the purpose of making payments.

The counterpart to the rise in the effective value of the dollar between late 1982 and mid-1984 is to be found largely in the European currencies (Chart 5). From December 1982 to May 1984, the deutsche mark depreciated substantially against the dollar (by 12 percent) and to an even greater extent (by 17 percent) against the Japanese yen. In real effective terms, the deutsche mark declined by about 5½ percent from the fourth quarter of 1982 to the first quarter of 1984, reaching a level 11½ percent below its average for the decade 1973-82. A factor that may have contributed to the decline in the deutsche mark against the other two major currencies was the easing of German monetary conditions during the first half of 1983. This had the effect of reducing real interest rates significantly below those in the United States and Japan. In addition, the trade performance of the Federal Republic of Germany remained rather weak, given its relative cyclical position, especially in comparison with that of Japan.

Chart 5.Major Industrial Countries: Indices of Monthly Average U.S. Dollar and Effective Exchange Rates, January 1980-May 1984

(Indices, 1977 = 100)

Other European currencies generally declined more against the dollar during 1983 than did the deutsche mark. Within the EMS, the persistence of inflation differentials was one of the factors that led to strong speculative pressures that resulted in a realignment of central rates in March 1983. The deutsche mark, Netherlands guilder, Belgian franc, Danish krone, and Luxembourg franc were revalued against the French franc, Italian lira, and Irish pound. During the remainder of 1983, stability within the EMS was generally maintained, though the Belgian franc fell below its lower divergence threshold in September and remained there until late March 1984. Some pressures re-emerged within the EMS in February 1984, when the deutsche mark appreciated sharply against the U.S. dollar, but they subsided during March and April after the dollar showed renewed strength against the deutsche mark.

The pound sterling, which remained outside the common margins agreement of the EMS, also declined during the period from late 1982 to mid-1984, falling by about 6 percent in nominal effective terms and by some 8 percent in real effective terms. This decline, which was similar to the average of EMS member countries, may have reflected the continuing erosion of the British balance of payments surplus.

Compared with most European currencies, the Japanese yen and the Canadian dollar were relatively strong against the U.S. dollar during 1983. The strengthening of Japan’s current account balance since mid-1980 has been substantial, particularly during the past year. The effect of this strengthening on the exchange rate for the yen, though partly moderated by increasing capital outflows, has nevertheless been important. After reaching a four-year low in the fourth quarter of 1982, the yen was almost 10 percent higher against the dollar in the following quarter. Thereafter, fluctuations in the yen/dollar rate corresponded closely to changes in the interest rate differential between Japan and the United States, with little net movement in the nominal rate until March 1984, when the yen rose by 4 percent compared with the previous month.

For most of the smaller industrial countries, changes in nominal exchange rates during 1983 tended to offset the differences between domestic inflation rates and those in main competitor countries. However, there were a few exceptions to this broad trend. Belgium and Denmark—whose currencies had already depreciated in real terms in 1982—experienced further gains in competitiveness during 1983, partly as a result of the general depreciation of the EMS currencies against the U.S. dollar and the Japanese yen and partly owing to incomes policies that have slowed the growth of normalized unit labor costs. Beginning in late 1982 and continuing through mid-1983, Spain allowed the peseta to depreciate in order to reduce balance of payments pressures. In real effective terms, the level of the peseta was 14 percent lower by the second half of 1983 than its average level in 1982, although by March 1984, 4 percentage points of this decline had been reversed. The Swedish krona, which had depreciated substantially in nominal and real terms in 1981 and 1982, was stable in nominal effective terms during 1983 but tended to appreciate somewhat in real terms. By March 1984 the real effective exchange rate of the Swedish krona was 4 percent higher than its average level in 1983, but was still some 22 percent below its average value during the period 1978-80.

Current Account Developments.—The aggregate current account position of the industrial countries, excluding official transfers, remained in approximate balance in 1983, as it had been in 1981 and 1982.3 It should be remembered, however, that the global balance of payments accounts reflected some $80 billion of net unrecorded receipts during 1983. Given the heavy weight of the industrial countries in world trade, it seems likely that a significant part of these net receipts should be attributed to them and that, consequently, they remained in substantial surplus.

The rather small movement in the recorded aggregate current account balance of the industrial countries during this period was the net result of substantial but largely offsetting shifts in the external positions of individual countries. (See Chart 6.) The U.S. current account (including official transfers) shifted from a small surplus in 1981 to a large deficit in 1983, while the current account surplus of Japan increased substantially and the position of the Federal Republic of Germany shifted from a large deficit to a moderate surplus.

Chart 6.Major Industrial Countries: Payments Balances on Current Account, Including Official Transfers, as Percentage of GNP, 1979-First Quarter 1984 1

1 Based on seasonally adjusted data.

As in prior years, movements in the current account balances of the industrial countries in 1983 were closely linked to movements in their merchandise trade balances. In turn, the rather large shifts in trade balances among the industrial countries can be attributed to changes in countries’ competitive and relative cyclical positions, and to developments in oil trade. For the group as a whole, the $74 billion reduction in the oil trade deficit in 1982-83 resulted not only from declines in the price of oil measured in U.S. dollars, which amounted to 7 percent in 1982 and 9 percent in 1983, but also from the continued drop in the volume of oil imports. The reduction in the net volume of oil imports was, however, substantially less in 1983 than in any of the three preceding years (6 percent, compared with more than 13 percent annually in 1980-82), largely because of the impact of economic recovery on the demand for energy. Nevertheless, virtually all industrial countries showed some improvement in their oil trade balances in 1983.

Among the industrial countries, developments in the pattern of non-oil trade balances during the past year and a half were strongly influenced by the sizable disparities in rates of growth of domestic demand in the industrial countries themselves and in their principal export markets. The large changes in real exchange rates that occurred over the past several years were also a major influence on the direction of non-oil trade flows because of their effects on international price competitiveness among countries. (See Chart 7.)

For the United States, the loss of price competitiveness was an important factor contributing to the sharp deterioration in the non-oil trade balance during the past three years. The growth of U.S. non-oil export volumes fell short of market growth in each year from 1981 to 1983. Moreover, in 1983, when economic activity recovered sharply in the United States, the volume of imports grew three times as fast as real domestic demand.

Chart 7.Major Industrial Countries: Relative Prices of Manufactures Adjusted for Exchange Rate Changes, 1980-First Quarter 1984

(Indices, 1977 = 100)1

1 Indices of the type shown here are frequently referred to as indices of real effective exchange rates. The data for first quarter 1984 are based on preliminary staff estimates.

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

While the effects of relative price changes on the volume of trade flows may take several years to be fully felt, the effects of changes in countries’ relative cyclical positions are usually apparent at once. For example, the major swing in the relative cyclical position of the United States during the past two years had a substantial impact on the U.S. trade balance. In 1982, the decline in economic activity in the United States resulted in a sharp fall in the volume of imports, especially oil imports; then, in 1983 and the first quarter of 1984 the rebound in U.S. economic activity, which was earlier and stronger than in most other countries, contributed to the rapid increase in import volumes.

The United States may also have suffered from an adverse geographical pattern in its external trade. In particular, the contraction of import demand in a number of Latin American countries affected the United States to a greater extent than other industrial countries because of the large proportion of U.S. exports going to these countries. Another source of weakness in the external position of the United States was the $10 billion decline in the surplus on net services in 1981-83, largely the result of a cyclical decline in profits and dividends from foreign direct investment.

The current account of Japan, in contrast to that of the United States, strengthened sharply in 1983 as a result of earlier gains in competitiveness, the resumption of growth in foreign markets, and the lower growth of domestic demand. Export volumes increased much faster than the rise in foreign demand, while the rise in the volume of non-oil imports was held to only 1 percent—below the growth rate of domestic demand and well below that of total output. As Japan’s oil trade balance also continued to improve, the surplus of the current account as a whole, including official transfers, rose by $14 billion, to $21 billion.

The current account position of the Federal Republic of Germany, after moving from a deficit of $16 billion in 1980 to a surplus of $3½ billion in 1982, was little changed in 1983. Only at the end of 1983 and early in 1984 were there significant signs of renewed buoyancy in export receipts. The weak export performance in 1983 may have resulted, in part, from shifts in competitiveness within the EMS following the realignment of central rates in March 1983 and, more importantly, from the effects of the accompanying adjustment policies adopted by Germany’s major trading partners. The volume of non-oil imports increased sharply in 1983 (by 6½ percent) owing partly to the resumption of growth in domestic demand after two years of decline. The weakness of exports and the upswing in non-oil imports during most of 1983 were offset by a lower volume of oil imports.

Cyclical developments largely account for the reductions in the surpluses of the United Kingdom and Canada that took place during 1983. In both countries, the pace of domestic demand resulted in a deterioration in the foreign balance in real terms. The decline in oil prices adversely affected the United Kingdom’s receipts from petroleum exports, but this effect was more than offset by an increase in net export volume. Competitiveness factors may also have played a role, especially in Canada, whose currency has appreciated steadily in real effective terms over the past several years.

The noteworthy improvement in the current account position of France and Italy reflects the strong adjustment measures taken following the 1983 EMS realignment, as well as the gains in external competitiveness realized at that time. With domestic demand restrained and with direct measures to hold down increases in production costs, the current account of each country (inclusive of official transfers) improved by $6-8 billion in 1983, leaving Italy with a small surplus and France with a small deficit.

The combined current account balance of the smaller industrial countries improved by $11 billion in 1983, after showing little change in 1982. Slightly less than half of this improvement was accounted for by an increase in the surplus on non-oil trade; the remainder represented a further reduction in the oil trade deficit. During the past two years a number of countries in this group, notably Belgium, Denmark, Ireland, Spain, and Sweden, have adopted policies designed to improve competitiveness and profitability in the industrial sector and to reduce excessively large public sector deficits; these measures contributed to the improvement in non-oil trade performance during the past year. The improvement in Sweden’s trade balance was particularly large, following the devaluation that took place in late 1982. In 1983, the growth of non-oil export volumes for this group of countries exceeded foreign market growth by 1 percentage point, compared with a loss of market share in the previous year. The growth of non-oil import volumes, on the other hand, was lower, owing to the continued stagnation of domestic demand.

Developing Countries

Current Account Developments.—There was a sharp improvement in the current account position of the non-oil developing countries in 1983, reflecting adjustment efforts made necessary by earlier adverse developments in their payments situation, as well as by the drying up of commercial lending after mid-1982. With the oil price increases of 1979-80, the worldwide recession, and the escalation of interest rates, the current account deficit of those countries had worsened dramatically, reaching $109 billion in 1981, against $30 billion in 1977. (See Table 7.) The deficit fell to $82 billion in 1982, reflecting in the main a compression of imports in the face of a continued weakness in export markets and increasing difficulty in obtaining external financing. Although in 1983 there was a further decline in available financing, exports started to respond to the recovery in the industrial world. The additional reduction in the current account deficit, to $56 billion, was achieved without another overall decrease in reserves and with only a marginal further cutback in the volume of imports.

The current account adjustment by the non-oil developing countries over the past two years has been just as marked when expressed in relative terms. As a proportion of exports of goods and services, the combined current account deficit fell from some 24 percent in 1981 to about 12½ percent in 1983. While the degree of adjustment has been uneven across countries, some of the largest non-oil developing countries, which were also among the largest borrowers, have been among those that have adjusted the most. The combined deficit of the 25 largest borrowing countries (including 4 countries classified as major oil exporters) fell from $80 billion to $40 billion between 1981 and 1983, while the deficit of the low-income countries, whose access to commercial finance had all along been very limited, only fell from $15½ billion to $13 billion.

The experience of the major oil exporters differed in several respects from that of other developing countries. After an initial surge in their current account surplus to $111 billion in 1980, there was a massive decline in demand for their oil exports as a result of energy conservation measures in consuming countries, the global recession, inventory reductions, interfuel substitution, and rising oil production in other countries. By 1982, the current account of the major oil exporters had moved into a deficit of $12 billion. The brunt of this shift was borne by those oil exporters whose external position has traditionally been strongest. All oil exporting countries have responded to declining oil receipts by restraining domestic demand.

By 1983, these policies of restraint had brought about a marked slowing in the previously rapid deterioration of their current account position. As a result, the current account deficit of the major oil exporting countries rose only slightly, to $16 billion, despite the 15 percent reduction in the benchmark price of crude oil decided on by the members of the Organization of Petroleum Exporting Countries in March 1983.

Among both the oil exporting and non-oil developing countries, balance of payments adjustment primarily took the form of a compression of imports. For the non-oil developing countries, for example, imports in value terms fell by $61 billion between 1981 and 1983, exceeding the $53 billion improvement in the current account during the same period. The volume of imports of the non-oil developing countries in 1983 was no higher than it had been in 1979. (See Chart 8.)

Chart 8.Developing Countries: Volume of Imports, 1975-83

(Indices, 1975 = 100)

1 Excluding China.

2 Excluding South Africa.

The degree of import compression in recent years has varied considerably among individual countries and regions depending on the extent of adjustment necessary, the promptness with which adjustment measures were undertaken, and the success attending such measures. The Western Hemisphere, with three of the largest borrowers—Mexico, Brazil, and Argentina—was the region that delayed adjustment the longest, through increased commercial borrowing, especially at short term. After August 1982, when access to commercial borrowing was effectively frozen for the three countries just mentioned, as well as for most other Latin American borrowers, the fall in imports was particularly sharp. The region’s real imports dropped by one fifth in both 1982 and 1983, as net capital inflows fell by half in each year, from $42 billion in 1981 to $10 billion in 1983. The volume of imports of African countries, on the other hand, had already begun to decline in 1981 and continued to do so through 1983. The situation facing African countries has been made more difficult by the 15 percent deterioration in their terms of trade from 1980 through 1983, and by recurrent droughts in large regions of the continent, particularly in 1983. The Asian region, by contrast, has been much more successful in adjusting to external shocks. The volume of Asian countries’ imports barely dropped in 1982 and picked up strongly in 1983. This achievement has been the result of prompt adjustment to the declining availability of external financing. India, for example, launched a major adjustment program in 1981 with the support of the Fund under an extended arrangement. China has also had a very strong balance of payments performance in recent years, following a major reorientation and consolidation of its externally financed investment program.

While import cuts have had to bear the brunt of the adjustment effort in most countries, the purchasing power of exports has held up fairly well, considering the length and severity of the global recession. (See Chart 9.)Real exports of non-oil developing countries (i.e., the value of exports deflated by the import price index) fell only slightly in 1982 and increased by over 6 percent in 1983, the result of a 5 percent increase in the volume of exports and a slight improvement in the terms of trade. The increases in export volume in 1983 reflected, in many countries, measures to stimulate exports taken in the framework of structural adjustment programs. These measures included the establishment of more realistic exchange rates and efforts to increase nontraditional exports, especially of manufactures. Such policies played a major role in the relatively strong growth in export volumes of developing countries in Asia and Europe. The principal exceptions to the trend of increasing exports were to be found among the oil exporting countries (whose export volumes are dependent primarily on demand rather than supply factors) and in the African region, where drought conditions affected the supply of agricultural commodities and the terms of trade remained depressed.

Chart 9.Developing Countries: Purchasing Power of Exports, 1975-831

(Indices, 1975 = 100)

1 Export earnings deflated by import prices, a measure which incorporates developments in both exports in real terms and the terms of trade.

2 Excluding China.

3 Excluding South Africa.

A further factor that has contributed to the decline in current account deficits since 1981 has been a marked deceleration in the growth of net interest payments abroad. After nearly tripling in absolute terms between 1979 and 1982, net interest payments by the non-oil developing countries remained unchanged in 1983 and actually fell as a proportion of exports. This reflected both a slowdown in the growth of debt outstanding, associated with the 1982 debt crisis, and a decline in nominal interest rates. These factors are discussed in more detail below.

Although available information is fragmentary, there are indications that the current account position of the non-oil developing countries as a whole has continued to improve in 1984. Monthly data for the industrial countries show a progressive increase in their imports from non-oil developing countries, relative to their exports to them, implying a strengthening of the developing countries’ trade balance with the industrial countries. This improvement, however, appears to be unevenly distributed, with Asia continuing to be the main beneficiary.

In assessing future prospects for the developing countries, particularly the non-oil countries and the major borrowers among the oil exporters, a number of uncertainties must be taken into account. First, the recent increase in interest rates, if it were to persist, could jeopardize the economic revival of heavily indebted countries, both by increasing their debt-servicing costs and by affecting market perceptions of their creditworthiness and hence their ability to borrow. If this were to lead to a need for a further round of generalized adjustment through import reduction, serious damage could be done both to the developing countries’ own development effort and to the growth of world trade and demand for industrial countries’ exports. Of course, to the extent that higher interest rates are a reflection of stronger economic growth in industrial countries, this stronger growth will have offsetting beneficial consequences for developing countries’ export earnings.

Second, the resolution of the present debt situation depends on borrowing countries both developing the capacity to earn increasing amounts of foreign exchange and having access to markets that are expanding rapidly enough to absorb these additional exports. This latter condition serves to underscore the importance for developing countries of a sustained recovery and the preservation of a liberal trading environment in the industrial world.

Financing and Debt.—As noted above, a substantial decline in private creditors’ willingness to increase their net claims on developing countries was the primary force driving these countries’ current and capital accounts in 1983. From an environment in which large new loans were raised from private sources during 1980-81, the situation changed to one in which many countries could obtain new loan commitments only as part of financing packages established in the context of comprehensive, Fund-supported adjustment programs. This change in financial environment affected all countries that were significant borrowers in international financial markets. While much of the data presented in this subsection pertains to non-oil developing countries, by 1982 several among the major oil exporting countries faced similar circumstances.

The root causes of the change in creditors’ attitudes can be traced to concerns that many debtor countries were not taking adequate steps to reduce their current account deficits to sustainable levels. There were three, mutually reinforcing, reasons for this concern: the growing size of the total debt outstanding; shifts in its maturity structure; and the persistence of high rates of interest which, with continuing weakness in export markets, resulted in a sharp rise in debt service ratios.

The rapid increase in the outstanding debt of developing countries reflected the large size of current account deficits, which in turn had been made possible by the ready availability of private lending. During 1979-81 the aggregate debt of non-oil developing countries had grown at an annual average rate of 19 percent. (See Table 8.) Among four oil exporting countries with significant foreign borrowing (Algeria, Indonesia, Nigeria, and Venezuela) indebtedness had also grown rapidly, increasing at an average annual rate of 27 percent from 1976 to 1979. While in the late 1970s the growth in the debt had been accompanied by a rapid expansion of output and exports, this situation did not persist after 1980. As a result, the debt/export ratio, which was 111 percent in 1980, had risen to 144 percent by 1982. The debt/GDP ratio, which had been fairly stable at about 24 percent in the late 1970s, rose to 33 percent by 1982. Creditors’ concerns were also aggravated by the undue concentration of debt in certain countries and regions. (See Chart 10.) Africa and the Western Hemisphere, which already had high ratios of debt to exports and GDP in 1977, pursued borrowing strategies that further increased these ratios. Both regions allowed their debt/export ratios to rise to very high levels by 1982—Africa’s to 205 percent, and the Western Hemisphere’s to 274 percent. These increases were of particular concern for countries in the Western Hemisphere, where most borrowing was from commercial sources and thus especially vulnerable to shifts in confidence.

Table 8.Non-Oil Developing Countries: Current Account Financing, 1977-83 1(In billions of U.S. dollars)
1977197819791980198119821983
Current account deficit304262881098256
Relatively “stable/autonomous” financing flows27314144504644
Non-debt-creating flows14172424272421
Long-term borrowing from official creditors 213141720232223
Other flows, net3122144593713
Errors and omissions-7-7-3-15-16-19-10
Other financing flows, net10182459755623
Reserve-related transactions-9-14-12-24192
Use of reserves 3-12-16-12-7-54-6
Liabilities constituting foreign

authorities’ reserves
12-147810
Use of Fund credit00026610
Arrears4210137-2
Other net external borrowing518333761703620

For classification of countries in this group, see Table 3, footnote 1.

Excluding monetary institutions.

The flow of resources into reserves will not necessarily equal changes in the stock, owing to exchange rate movements.

Arrears on current account items only.

Essentially net borrowing from private creditors, almost all of which is from banks.

For classification of countries in this group, see Table 3, footnote 1.

Excluding monetary institutions.

The flow of resources into reserves will not necessarily equal changes in the stock, owing to exchange rate movements.

Arrears on current account items only.

Essentially net borrowing from private creditors, almost all of which is from banks.

Chart 10.Non-Oil Developing Countries: Ratios of Debt to Exports, 1977-83

(In percent)

1 Excluding South Africa.

The recourse of borrowers and lenders to shorter maturities for new lending compounded the problems associated with the growing size of the debt by increasing the vulnerability of borrowers to changes in market sentiment. During 1977-79, short-term debt of non-oil developing countries had remained at about 15 percent of their total debt and was mainly related to trade flows. However, as part of their response to the 1979-80 oil price increases, some developing countries increasingly substituted short-term borrowing for the less readily available long-term facilities. Consequently, short-term debt rose rapidly, reaching 20 percent of total debt by 1982. The use of short-term borrowing for longer-term purposes created an increasingly severe mismatch between repayment obligations and the returns generated by debt-financed outlays. Again, this trend was particularly noticeable in the Western Hemisphere region, whose short-term debt rose as a proportion of total debt from 13 percent in 1977 to over 23 percent by 1982. In relation to imports, the region’s short-term debt rose from an average of 40 percent in 1977-79 to 92 percent in 1982.

A third major concern of creditors was the rising debt service costs facing borrowers. The non-oil developing countries’ total debt service payments rose at an average annual rate of 31 percent during 1978— 81, with interest payments rising particularly rapidly. The effect of these rising payments on the debt service ratio (i.e., all payments of interest and amortization of long-term debt as a proportion of receipts from exports of goods and services) was particularly severe after export growth began to slow down in 1980. (See Chart 11.)

Chart 11.Non-Oil Developing Countries: Debt Service Ratios, 1977-83

(In percent of exports of goods and services)

1 Excluding South Africa.

Three factors explain the trends in debt service ratios shown in Chart 11. First, interest payments rose because the volume of debt increased, approximately doubling between 1978 and 1982. Second, interest rates, particularly on private loans, increased sharply after 1979. The 25 major borrowers, whose debt is mainly commercial in origin, paid an average 7.3 percent interest rate in 1978 but 12.1 percent in 1982. The third trend, which helps to explain the falling amortization/ export ratio, is that the substitution of short-term for long-term borrowing by some debtors after 1979 pushed down the conventionally defined amortization ratio in subsequent years. This effect, which is most clearly evident in the Western Hemisphere region, obscures the fact (recognized by creditors) that the rolling over of short-term debt may present problems that are every bit as difficult as refinancing the long-term debt that is included in the amortization ratio.

Beyond the trends just described, other developments in the early 1980s were undermining the ability of developing countries to continue to finance large current account deficits. Despite the high level of private borrowing that was taking place, ratios of official reserves to import payments were declining, from over 26 percent in 1978 to under 17 percent in 1982. A further disturbing sign was that private capital flight from the non-oil developing countries picked up after 1979 and remained at high levels during 1980-82. This outflow not only compounded the financing problems of some countries but also exerted a significant destabilizing influence on external creditors’ confidence.

As noted above, the combined effect of these various developments, together with the continuation of recessionary trends in the world economy, provoked a fundamental shift in the willingness of private creditors to extend financing after mid-1982. As a result, official creditors and international financial institutions, together with commercial banks and the borrowing countries themselves, had to engage in coordinated efforts to restore stability in the financing of indebted countries. The main features of these efforts were the adoption of comprehensive programs of balance of payments adjustment, and the negotiation of a series of “financing packages” involving debt restructuring and in a number of cases concerted new lending. These packages significantly influenced the pattern of current account financing observed in 1983 and accounted for approximately half of new bank lending to non-oil developing countries. The arrangements provided an effective framework in which to reinforce the adjustment efforts of debtor countries and to influence creditors in their attitude toward new lending.

A central feature of most financing packages was the rescheduling of a significant portion of an indebted country’s amortization payments. Such rescheduling does not give rise to new inflows of capital. Nevertheless, it played an extremely important role in easing the external financial constraints facing indebted countries in a situation in which new lending was less readily available. The number of countries undertaking a multilateral rescheduling of their debt to official creditors rose from 6 in 1982 to 16 in 1983, a record level. Debt restructuring agreements between developing countries and their bank creditors also reached a peak in 1983, when 17 countries (including 2 non-member countries) completed restructuring agreements. As a result of these arrangements, debt service payments on medium-term and long-term debt of the non-oil developing countries were reduced by $8 billion in 1982 and by $19 billion in 1983, below what they would otherwise have been. In addition, a large amount of short-term bank debt was converted to medium-term and long-term maturities.

Beyond the rescheduling of existing debts, a number of financing packages involved commitments of new funds, both from official and from private creditors. Some $15 billion of new bank credits were arranged in 1983, mainly to countries in the Western Hemisphere. While this figure was much in excess of what would have been forthcoming in the absence of concerted lending efforts, it represented a considerable slowdown in new lending commitments from the pace of earlier years. As may be seen from Table 8, net external borrowing by non-oil developing countries from private creditors, most of which is debt to banks, fell by half from 1981 to 1982, and nearly halved again in 1983.

Financing flows other than private lending were much more stable from 1982 to 1983. Non-debt-creating flows, which include direct investment and official grants, fell slightly, reflecting weakness in the climate for direct investment. On the other hand, official long-term capital inflows were well maintained. Together, these relatively stable sources of finance covered about four fifths of the non-oil developing countries’ aggregate current deficit in 1983, against only about half in 1982.

Fund assistance in support of adjustment efforts led to increasing use of Fund credit in 1982 and 1983. Net use of Fund credit, which had already increased sharply in 1981, rose further to SDR 6.4 billion in 1982 and SDR 10.3 billion in 1983. The increased use of Fund credit supplemented the non-oil developing countries’ use of reserve-related liabilities in 1982, and offset some of the net repayment of these short-term liabilities in 1983.

Despite the increased use of Fund credit, arrears continued to increase in 1983, albeit at a slower pace than in the previous year. The stock of arrears of all developing countries had jumped from less than $7 billion in 1981 to $23 billion at the end of 1982; in 1983 they increased slightly further, to $27 billion. Gross reserves, however, increased by $0.8 billion during 1983 after having fallen by $16.5 billion in 1982. The fact that the aggregate reserves of developing countries could rise slightly at the same time as arrears continued to accumulate reflects mainly the different stage in the adjustment process reached by various countries.

As may be observed from Charts 10 and 11, developments in the financing of the non-oil developing countries’ current account deficit in 1982 and 1983 have caused a notable break in some of the trends of debt and debt service that were observable in preceding years. The growth rate of the aggregate debt of non-oil developing countries, which had declined from 18 percent in 1981 to 13 percent in 1982, fell further to 6 percent in 1983. Within this total, there was a reduction in short-term debt of some $23 billion in 1983 (overwhelmingly concentrated in the Western Hemisphere), associated in part with debt restructuring agreements, and this reduced the share of such debt to 15 percent, close to the average of the late 1970s. The debt service burden also declined in 1983, with the interest payments ratio falling to 13.2 percent, from 14.3 percent in 1982, and the overall debt service ratio falling to 21.6 percent from 24.5 percent.

The decline in the rate of growth of total debt reflects financial market constraints as well as the substantial compression that has taken place in the aggregate current account deficit of non-oil developing countries. As far as the decline in the debt service ratio is concerned, however, this is attributable largely to the impact of debt rescheduling. The effect of debt rescheduling on the aggregate debt service ratio of non-oil developing countries was to reduce it by 1.8 percentage points in 1982, and by 4.1 percentage points in 1983. If the rescheduled debt service had been paid at the original maturity, these countries’ debt service ratios would have increased from about 21 percent in 1981 to over 26 percent in 1982, and would have declined only marginally, to just under 26 percent, in 1983.

Debt service ratios will continue to be held down in 1984 as further debt restructurings are put in place. Moreover, creditors’ and debtors’ expectations of the availability of funds are now better aligned than was the case in 1982-83. Countries in the Western Hemisphere, which accounted for half the debt restructuring agreements in 1983, are prominent among those requiring further restructurings in 1984, with financial packages having already been put in place for Mexico and Brazil. However, the region remains critically dependent on the floating interest rate loans offered by private creditors. The trend toward higher interest rates in the industrial countries in early 1984 will be reflected in the interest payments required to service the region’s debts. As noted above, however, to the extent that higher interest rates have been caused by more rapid economic growth, this growth will also have resulted in higher export earnings for developing countries.

Policy Issues

Although in 1983 there was a welcome improvement in economic growth in industrial countries, and a further reduction in the external deficit of the non-oil developing countries, important issues continue to confront policymakers. The recovery in the industrial world remains uneven, and could be undermined by the renewed upward movement of interest rates. Higher interest rates also weaken the position of heavily indebted developing countries, whose task is to convert the success achieved in improving their balance of payments into a revival of domestic growth and development. Influencing both these issues is the specter of protectionism, which has been condemned more effectively than it has been resisted.

This section of the chapter focuses on these issues as they affect the domestic economic policies and prospects of member countries. Issues related primarily to the working of the international monetary system are dealt with in Chapter 2.

Sustaining Recovery in the Industrial Countries

Now that the cyclical recovery from the global recession of the early 1980s is well under way in several of the major industrial countries and clearly spreading to others, the essential task of economic policy is to guide it along an orderly path leading gradually, but surely, back to satisfactory levels of employment and steady growth of real incomes. For this purpose, it is important that the authorities of the major industrial countries maintain the basic principles of the strategy they adopted several years ago to deal with an unprecedented combination of high inflation and faltering growth. The progress already made toward restoration of a stable financial environment has played a major role in initiating the present upswing; continuation of this progress will play a central role in broadening and sustaining expansion.

The process of restoring financial stability is still quite uneven and incomplete, and confidence in its continuation remains fragile in many countries. Although it is true that inflation has subsided to an impressive degree in nearly all of the industrial countries, it is also true that it remains unduly high in some of them, and that the downward momentum of price increases will become harder to maintain as economic activity continues to strengthen. Renewed rises in interest rates in several countries represent another warning that the speed at which increases in demand can be accommodated without revival of inflationary expectations is by no means unlimited.

The foremost requirement for consolidation of the recovery, accordingly, is the firm application of monetary and fiscal policies continuously geared to maintenance of an anti-inflationary environment. Observance of this priority does not, of course, call for identical policies among the various individual countries, nor for rigid maintenance of a particular degree of restraint in any of them. Since their circumstances and recent experiences differ considerably, each of them will need to make flexible use of available monetary and fiscal instruments in accordance with its own situation.

Although continued monetary discipline will remain of central importance in every industrial country, the degree of restraint applied will have to be greatest in the countries where inflation remains seriously out of line with the average elsewhere in the industrial world. Effective control of inflation would help to restore domestic investment incentives and maintain international competitive positions that would permit domestic producers to share in the cyclical upswing in world markets.

In the countries where the effectiveness of monetary discipline in bringing down inflation and laying the basis for renewed growth has already been most amply demonstrated, prudence in the provision of liquidity in the early phases of recovery will be necessary. The temptation to attempt to hold down interest rates by easing monetary policy may be strong for some central banks, but it is to be hoped that it will be resisted. Failure to apply an adequate degree of restraint during previous cyclical expansions has been one of the prime factors making for rising inflation over much of the past 15 years. In the present climate of expectations, an attempt to restrain interest rates through more accommodative monetary policies could be counterproductive even in the short run through its effects on market expectations.

Against the background of financial innovations and regulatory changes that have characterized the past several years, gauging the actions necessary to maintain an appropriate degree of monetary restraint without choking off the recovery will not be easy for any of the major central banks. Most of them are relying on indicative targets for expansion of key monetary aggregates to guide their policy actions, but some of them have encountered serious technical problems in interpreting shifting relationships between these aggregates and other economic and financial variables in a rapidly changing financial environment. Flexibility in permitting deviations from targeted paths, or in taking account of alternative aggregates—and of such other variables as exchange rates—has proved helpful during the past year or two and will probably be necessary in the future. However, caution regarding the exercise of such flexibility is also necessary. If the setting of publicized monetary targets is to remain a helpful technique for checking inflationary expectations and reducing uncertainty about macroeconomic policies, the frequency of deviations from targeted paths will have to be limited to cases with compelling justification.

In most of the industrial countries, the management of money and credit has been complicated for a number of years by the prevalence of large fiscal deficits. In a few countries, including some of the larger ones, the effective orientation of fiscal policy has been out of step in important respects with the general strategy of re-establishing a stable financial environment. There has thus been less uniformity in fiscal policies than in monetary policies among the industrial countries, as well as inconsistency within some of the individual countries in the implementation of the two principal instruments of demand management.

Over the past four years, the central governments in three of the major industrial countries—Japan, the Federal Republic of Germany, and the United Kingdom—have carried out significant reductions of the structural components of their budget deficits. Although these reductions were largely or wholly offset in the two European countries by opposite changes in cyclically responsive elements of the budget, they provided in all three cases a considerable degree of support for the policy of monetary restraint that was being implemented at the same time. In the United States, Italy, and Canada, on the other hand, central government deficits increased during the same period, not only for reasons associated with the adverse evolution of cyclical positions but also because of structural changes that raised borrowing requirements. Unless measures are adopted to raise revenue or reduce the spending implied by existing fiscal programs, prospective government borrowing in these three countries will tend to absorb proportions of private saving that are very large by historical standards.

Even in the countries where structural improvements in fiscal balances have been achieved during the past few years, actual deficits remain high. In Japan, this circumstance is a reflection of the degree of imbalance that was reached before the current policy of fiscal retrenchment was adopted. In the United Kingdom and the Federal Republic of Germany, as well as in France, the magnitudes of the present deficits are perhaps mainly a manifestation of the influence of cyclical conditions. The large borrowing requirements associated with all these imbalances have kept total demand for credit strong even at a time of relatively weak domestic economic activity, enhancing the sensitivity of financial markets in these countries to the pressures now being generated by rising interest rates in the United States and Canada.

The very brisk pace of recovery in the United States and Canada provides an exceptional opportunity for those two countries to make useful and necessary adjustments in their budgetary structures while avoiding some of the adverse repercussions that might have resulted from such actions during the recession period. Apart from the long-run need to shift the balance between government and private use of private saving, some additional restraint on the growth of nominal spending may now be helpful for keeping total domestic demand within sustainable bounds. Because of the size of the U.S. economy and the magnitude of the capital inflow now being attracted there, reduction of the U.S. Federal Government deficit could be expected to have a significant impact on availability of funds for private investment throughout the world, as well as in the United States itself.

In Italy and France, recovery has been much slower in coming than in the industrial economies of North America. With growth prospects handicapped by inflation and weakness in the external accounts, however, fiscal restraint is necessary for these countries also—particularly for Italy, whose budget deficit is by far the largest, relative to GNP, among the major countries. Without fiscal discipline, monetary policy, even if well conceived, can achieve only limited results.

Japan and the Federal Republic of Germany, with their comparatively low rates of inflation, strong external positions, and records of progress toward fiscal equilibrium, have perhaps less need than the countries discussed above to press for rapid reduction of their fiscal deficits. Nevertheless, strengthening investment and growth over the longer run may depend importantly on further gradual progress in that direction. For the United Kingdom, which also has a generally strong record of fiscal restraint in recent years, such progress remains central to the authorities’ policy strategy, both because it was interrupted in 1983 and because control of inflation is more recent and less complete—and hence remains less secure—in that country than in the other two.

An integral part of the general strategy followed since 1979 by the major industrial countries has been an effort to reduce or eliminate various structural rigidities that were believed to be impeding optimum allocation and full use of available resources. Toward this end, a number of governments have adopted fiscal measures aimed—over and above their impact on overall budgetary balances—at improving incentives to work, to save, and to invest. Adjustments of wage indexation arrangements and social transfer schemes have been fairly widespread, and government regulations of prices (particularly for energy), of interest rates in some countries, and of other aspects of business and financial operations have been removed or liberalized in a number of countries. Most of these actions have been intended to give greater play to market forces in holding down costs and reallocating resources in a more effective way.

Greater flexibility in the negotiation of wage contracts, particularly in Europe, appears to be essential if profit margins of enterprises and investment incentives are to be restored to a degree that will expedite the absorption of presently unemployed members of the labor force. Unduly rigid attitudes and practices in the setting of wage rates have long tended to interfere with shifts of workers from declining industries into those with greater potential for expansion—and in the process have obscured for all concerned the full potentials of the latter industries. For many European enterprises, prospective profit margins at existing cost structures seem too small to warrant the risk and effort involved in innovative capital investments. Greater flexibility and more realistic alignment of nominal wage increases with current gains in productivity and with national objectives regarding price stabilization would enhance the prospects for stronger investment and reduced unemployment.

Adjustment and Growth in Developing Countries

The length and severity of the downturn in economic growth in non-oil developing countries has made the restoration of adequate rates of economic expansion an urgent priority for policymakers. However, durable expansion can take place only on the basis of a strengthened balance of payments position and improved international creditworthiness.

Following the widening in their current account deficit associated with the 1979-80 rise in oil prices and the recession in the industrial world that began in 1980, many developing countries cushioned the impact of these external developments on their domestic economies by borrowing heavily from commercial sources to finance enlarged deficits. Such a strategy could perhaps have been justified if the adverse developments in the external environment could have been identified as being of strictly temporary duration. In the event, however, the recession was prolonged, and the external position of borrowing countries was further undermined by the effects of the continued high level of interest rates—itself a result of industrial countries’ new-found determination to confront the threat of cumulative increases in inflationary expectations.

With the benefit of hindsight, it may be seen that postponement of adjustment in 1979-81 made the eventual adjustment more difficult. Faced with an abrupt change in the availability of external finance, many developing countries had no option but to cut back sharply their current account deficit. With demand in the industrial world sluggish, the terms of trade for primary producers remaining weak, and access to some industrial markets being restricted, the needed improvement in developing countries’ current account positions could be brought about only through import compression.

The extent to which such import compression has to be associated with a decline in the domestic growth rate depends, of course, on the flexibility with which the economies concerned are able to adapt to new circumstances. Such flexibility is likely to be inhibited by rigidities and distortions in the mechanism for resource allocation, such as those fostered by high rates of inflation, controls over domestic prices and wages, inappropriate exchange rates and interest rates, and restrictions on foreign trade and payments. In present circumstances, the progressive removal of such impediments to the fuller and more effective use of real resources in developing countries must be a central feature of programs of economic adjustment.

Reductions in inflation are needed because, although it may be possible in principle to mitigate inflation’s adverse consequences on resource allocation, the methods that have to be employed in practice are rarely fully effective and are often inimical to the realization of productive potential. The more rapid the rise in the overall price level, the greater, in general, are fluctuations in relative prices. At the same time, future inflation becomes more difficult to foresee, and greater uncertainty surrounds the decision to save and invest productively. Capital tends to flow abroad or into unproductive inflation hedges, thus further complicating the task of economic management.

Distortions in relative prices brought about by direct controls are also harmful. In addition to the welfare losses that stem from resource misallocation, there can be budgetary costs when final product prices are held down by subsidies. When they are held down by other means, such as administrative controls, production incentives are weakened and shortages develop, leading to black markets. The situation is particularly serious when the items that are subsidized are in the traded goods sector. In such a situation, various forms of rationing may have to be resorted to in order to balance the supply and demand for foreign exchange. An economy’s capacity to respond to external disturbances is reduced, since its propensity to consume traded goods is artificially inflated relative to its capacity to produce such goods.

Two prices with a particularly pervasive impact on an economy’s capacity both to adjust in the short term and to grow in the long term are the exchange rate and the interest rate. An overvalued exchange rate is, in effect, a blanket subsidy on the consumption of traded goods, and a tax on their production, with all the adverse consequences just noted. Artificially low interest rates, particularly when they are negative in real terms, reduce savings incentives and give rise to capital flight, thus limiting domestic investment. Correction of inappropriate interest and exchange rates has been an important element in the economic strategy of a number of the most seriously indebted Fund members in 1983 and 1984. The actions they have taken can play an important role in restoring dynamism to their foreign trade sectors. Employment and output will be encouraged directly in export and import-competing industries, and multiplier effects should help to raise output throughout the economy.

Foreign trade restrictions may occasionally be unavoidable for countries whose external situation has become particularly difficult. In anything other than the very short run, however, they tend to have adverse consequences, both for the international trading environment and for the countries that adopt them. The allocation of scarce foreign exchange has to take place by an administrative mechanism that is costly in terms of human resources, hard to make responsive to changing economic requirements, and subject to abuse.

While policy adjustments by developing countries themselves can and must play the main role in restoring a satisfactory rate of growth to these countries’ economies, developments in the surrounding economic environment are clearly of fundamental importance also. Growth must be maintained at a satisfactory rate in industrial countries if developing countries are to succeed in their attempts to expand the size of the sectors of their economy producing for export. And, as discussed above, changes in policy stance in several industrial countries could help contain interest rates and thereby allow the developing countries to devote a larger share of their foreign exchange earnings to the acquisition of goods for the development effort. It will also be important for adequate finance to be available during the remaining stages of the adjustment process. There is a heavy burden of debt falling due in the coming years that far exceeds the capacity of debtor countries to repay out of current earnings. So long as borrowing countries are following well-conceived policies of medium-term adjustment, it is both appropriate and prudent for lenders to make available the finance that enables these countries to sustain moderate rates of growth of output and investment, while lengthening the maturity over which existing debt is effectively repaid. For those low-income countries that cannot expect to have significant access to commercial sources of credit, an adequate level of official development assistance is essential if the adjustment efforts they are making are to bear their full fruit in increased growth potential.

Protectionism

Among the most troubling developments of recent years has been the strengthening of protectionist tendencies. While governments in most industrial countries have generally resisted blatant interference with the trading environment, they have displayed an increased willingness to accede to requests for special measures on a case-by-case basis. These measures have only occasionally taken the form of direct quota restrictions on trade; more frequently they have involved indirect techniques. One such technique is that of “voluntary export restraint,” under which an exporting country is induced to limit its exports to certain markets in order to avoid presumably more severe restrictions imposed by the importing country. Other techniques include the use of “nuisance” measures to complicate customs clearance procedures and increased resort to domestic legislation governing “unfair” competition from abroad.

The case for resistance to protectionist pressures is well known and widely accepted. Import restrictions reduce competition in importing countries, thus pushing up prices to consumers and retarding technical innovation. The support they provide to domestic employment is limited and temporary. In the first place, resort to protection invites retaliation that gives rise to employment losses in export sectors of the economy. Even if this does not happen, the curtailment of imports in one sector of the economy will, other things being equal, tend to push up the exchange rate and lead to an offsetting weakening of the trade balance in sectors that are not protected. Since protective measures are invariably selective in their incidence, they tend to distort the pattern of resource allocation away from most efficient channels. Where factors of production are not employed in accordance with comparative advantage, there are adverse effects not only on the level of output that is achievable in the short term but also on investment and hence on potential output over the longer term.

In present circumstances, resistance to protectionism acquires added importance from the need of heavily indebted countries to enhance their foreign exchange earnings in order to meet their large debt service obligations. Thus far, these countries have had to rely heavily on import compression to reduce their current account deficit relative to their export earnings. Such compression cannot be regarded as indefinitely sustainable, at least not without unacceptable consequences for economic development. For developing countries to achieve renewed growth in living standards, along with a sustained improvement in their external position, it will be essential for them to have adequate access to expanding markets in the industrial countries. At the same time, developing countries should themselves resist the temptation to resort to import restrictions as an instrument of adjustment. In the medium term, adjustment can be regarded as sustainable only if it is based on an improved allocation of resources, in accordance with the requirements of international comparative advantage and domestic financial stability.

Now that world output and trade are once more expanding at a more satisfactory pace, conditions should be propitious for a serious attack on the protectionist tendencies that have been allowed to flourish in a recessionary environment. Several international meetings at the ministerial level have emphasized the determination of participants to resist and roll back protectionist measures. These meetings have included, most recently, the Interim Committee meeting in April 1984 and the ministerial meeting of the Organization for Economic Cooperation and Development in May 1984. It is to be hoped that the coming year will see more success in bringing these intentions to fruition than has been apparent hitherto.

Fiscal policy is measured here in terms of the financial position of the Federal Government. If the financial position of state and local governments is included, the expansionary impulse stemming from the government sector would be about 1½ percent during this period.

On the basis of the respective national statistics, which are not fully comparable in terms of labor force definitions and concepts of unemployment.

Including official transfers, the combined current account of the group of industrial countries recorded a deficit of $20-25 billion during each of the past three years.

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