THE BALANCE OF PAYMENTS problems of the developing countries must be seen against the background of the two circumstances that dominate their entire economic being—the endeavor to better the lives of their people and the high rate by which their populations are increasing. As to economic development, a target of 5 per cent a year for the increase in real output has won wide acclaim. This target, which implies a considerably smaller increase in per capita output or standard of living, say, 2-3 per cent, must be assumed to involve a rise in imports that is not, in general, likely to be less than proportionate to the rise in real output.
On the basis of certain assumptions regarding the growth rates for the economies of the developing countries and their future receipts from exports of goods and services, it is possible to deduce, as has been done in connection with the UNCTAD Conference, that they will be facing a rising “foreign exchange gap.” Such a “foreign exchange gap,” to the extent that it cannot be covered by an inflow of foreign aid and capital, is not, of course, to be regarded as a forecast of a deficit in the developing countries’ balance of payments, but rather an indication of the conflict between the assumed development targets and current expectations for the long-term trend in the developing countries’ receipts from exports and foreign financial resources, a conflict which will have to be reconciled in some way. It must be regarded primarily as a problem of development rather than as a balance of payments problem.
The fact remains, however, that unless the exports of the developing countries rise over the long run at a rate sufficient to support an adequate growth rate, pressures on their balance of payments are likely to persist. It is true that efforts to increase a country’s rate of growth beyond what can be sustained by its foreign receipts are likely to result in wasteful policies of stop and go, and, therefore, to have the opposite result to that intended. Nevertheless, it is one of the facts of life that a number of developing countries have not adapted their development plans to their true foreign situation, with the result that their balance of payments is under constant pressure.
The setting of ambitious development targets is not always the main reason for such pressure. Pressure can develop if a government, in the face of an inadequate rise in real income, takes measures that result in increasing consumption; for example, if it subsidizes the prices of basic commodities. As a result consumption may take too much of the national product and may leave too little for savings to support the investment. This has exactly the same consequences as “excessive” investment under a development program in putting pressure on the balance of payments.
A rational policy for economic growth is made difficult in the developing countries by relatively large short-term fluctuations in their foreign exchange receipts from exports and the slow long-term growth of these receipts (especially when compared with the growth of the population).
The export earnings of the primary producing countries, particularly the developing countries, show, in general, wider short-term fluctuations than those of the industrial countries. This is largely because less elastic supply conditions in the short run subject the prices of most primary products to much wider fluctuations than those of manufactured goods. In addition, the volume of exports of individual primary producing countries may exhibit large fluctuations due to weather conditions, which usually affect the exports of the developed countries much less. There are great differences among exporters of primary products in the magnitude of these fluctuations. The industrial countries do not, of course, escape similar fluctuations; indeed, the export records of some primary producing countries, notably the oil producers and those whose exports are relatively diversified, are more stable than those of some of the industrial countries. On the whole, however, export fluctuations have generally been much wider for the primary producing countries than for the industrial countries.
Terms of Trade
An even more serious problem for the great majority of the developing countries is the adverse longer-term trend in their terms of trade (see Charts I and II). A declining trend in the prices of primary products, which was particularly pronounced for the exports of the developing countries, set in after the temporary Korean boom, while at the same time prices of manufactured products moved upward. In the course of the 1950’s the ratio of prices for primary products to those of manufactured products declined by more than 20 per cent; since then there has not been much change in this ratio; primary product prices have improved somewhat during the last five years, but prices of manufactured products, after a long period of stability, have again begun to edge upward. The decline in ratio of primary product prices to prices of manufactured products somewhat overstates the decline in the terms of trade of the developing countries because they are not only exporters but also importers of primary products, and because they have also benefited from a declining trend in freight rates. In fact, their terms of trade have declined considerably less than might be suggested by the comparison of prices for the two types of goods. However, the volume of exports has also risen much more slowly in the developing countries than in the industrial countries. Over the decade 1950-60, for instance, the volume of exports of the developing countries rose by a little over 50 per cent, while those of the high-income countries rose by about 90 per cent. Because of changes in the terms of trade there was an even greater disparity in the growth of the purchasing power, in terms of imports, of the export receipts of the two groups of countries. The import capacity of the developing countries rose only 44 per cent over the decade 1950-60, while that of the high-income countries doubled. On a per capita basis the relative position of the developing countries was even more unfavorable because of the more rapid population increase; their import capacity per capita rose only some 15 per cent, while that of the high-income countries rose five times as fast.
Chart I.IMPORTING POWER OF EXPORTS AND TERMS OF TRADE: FIVE-YEAR MOVING AVERAGES, 1950-63 Chart II.IMPORTING POWER OF EXPORTS AND TERMS OF TRADE: FIVE-YEAR MOVING AVERAGES, 1950-63
The figures quoted for the developing countries include oil exporters which have increased their export receipts much more than the average. When these are excluded the per capita import capacity of the remaining countries rose only at a very low rate.
Developments during the early 1960’s have been somewhat more favorable to the developing countries than during the preceding decade. Between 1960 and 1964 their import capacity appears to have risen at an annual rate of some 6 per cent. However, developments during this relatively short span of years cannot be interpreted as an indication of a basic change in the trade prospects of the developing countries.
Services are much less important than trade in the balance of payments of the developing countries. According to a compilation which the Fund has recently made, receipts for services amounted to less than one fourth of those for merchandise exports, and payments for services to some 40 per cent of the value of merchandise imports over the 1961-64 period. In the aggregate, receipts from foreign travel and government expenditures are the most important credit items, but both tend to be concentrated in certain countries while being relatively unimportant for the majority. On the debit side the two largest items are payments for transportation, mainly import freight, and investment income.
The statistics on the balance of payments of the developing countries are much less complete and reliable than those on merchandise trade. For this reason only the most general observations are made here. During 1961-64, the annual average deficit of the developing countries on services account was about $4.4 billion, of which $3.1 billion was accounted for by investment income. Of net investment income payments about $2.5 billion again referred to direct investment, much of which is related to export production, oil being the most important commodity. Such investment income payments must be seen in the broad context of the operations of the direct investment companies concerned. These operations involve transactions such as exports, imports, investment income, and capital movements, but taken together these usually leave substantial net foreign exchange receipts to the country in which the investment takes place. Income from direct investment in other than export industries is related in part to the production of types of goods which might otherwise have been imported, and there is also some question whether such investment income payments, and the related inflow of capital, usually involves a net drain on the balance of payments of the developing countries. Other net investment income payments in the 1961-64 period were relatively modest and can best be discussed in the context of the debt problem of the developing countries.1
Inflow of Financial Resources: Basic and Over-All Balances
Since World War II the balances of payments of the developing countries have been supported by a substantial inflow of financial resources from the developed countries in the form of official economic aid and foreign investment. In the early 1960’s such inflows in the aggregate amounted to about one fourth of the export receipts of these countries. Measured in terms of domestic investment, the total inflow of financial resources has also been quite significant, amounting, in the aggregate, to about 18 per cent of the gross domestic capital formation of the developing countries during 1960-62. The rise in the flow of such resources was accounted for almost exclusively by official aid; the inflow of private long-term capital has failed to rise since the late 1950’s. During the last few years the rise in total receipts of financial resources appears to have been leveling off.
Charts III and IV provide a general indication of the balance of payments of developing countries during 1958-65. They show aggregate balances of these countries, and various subgroups, on account (1) of goods, services, and private transfers, and (2) such transactions plus governmental transfers and all long-term capital transactions. The second balance, referred to as the “basic” balance, does not include movements of short-term capital and errors and omissions which have in most years represented a net outflow in the aggregate balance of payments of the developing countries, as is apparent from the chart. It is sometimes believed that this net outflow gives evidence of a flight of capital from the developing countries, but it would be a mistake to accept such a statistical residual as a measure of capital flight. While it is widely held that an outflow of local capital from the developing countries has greatly added to their development and balance of payments problem, we have no way of knowing how large the amounts involved are. This remains a matter of speculation.2
Chart IIIPRIMARY PRODUCING COUNTRIES: BALANCES OF PAYMENTS, 1958-65 Chart IVPRIMARY PRODUCING COUNTRIES: BASIC AND OVER-ALL BALANCES, 1958-65
The balance of payments structure of the developing countries that emerges from these charts is one of persistent deficits on current account, covered over the long run by an almost equivalent inflow of long-term financial resources (including government transfer payments), leaving, again over the long run, an approximate balance in the over-all balance of payments. Moderate surpluses arose, in two periods of rising prices for primary products, but such surpluses have had no tendency to persist, as imports are likely to rise in the wake of an increase in exports. This reflects a relatively low marginal value attached in the developing countries to accumulating reserves, compared with domestic capital formation. On the other hand, the low level of reserves and credit facilities available to these countries explains why deficits cannot persist. In these circumstances, the balance of payments problem of the developing countries tends to express itself in the use of restrictive devices and in depreciation of their currencies rather than in realized balance of payments deficits.
Inflation and the Balance of Payments
The balance of payments problem of developing countries has in many instances been aggravated by inflationary price rises due to an excessive monetary expansion, the primary source more often than not being a government deficit. Such deficits are bound to arise whenever a government is endeavoring to push expenditures for development beyond what can be financed from domestic noninflationary sources and foreign aid and capital (although it can also arise because a government’s current expenditures are unduly high). In the short run domestic savings may perhaps sometimes be increased by resort to inflationary financing; but in the long run the effect of inflation on saving is bound to be harmful. In addition, inflation and the disturbances to international payments that it brings about tends to discourage an inflow of foreign capital, while stimulating an outflow of capital. Inflation, therefore, will in the end reduce the resources available to finance development expenditure.
The use of inflationary financing is usually soon reflected in the balance of payments. Insofar as inflation results in expenditures for domestic capital formation in excess of domestic saving and the net inflow of financial resources from abroad, an over-all deficit in the balance of payments is bound to arise, quite aside from any rise in prices. In addition, the rise in domestic prices, costs, and incomes with which inflationary financing is associated, discourages exports and stimulates imports. These developments are also likely to worsen the capital account of the balance of payments as suggested above.
This article, and the article to appear in a subsequent issue, are based on two papers presented by the author in November 1965 for discussion at a training program organized by the central banks of Southeast Asia, New Zealand, and Australia (SEANZA). This first article omits a section describing the relationship of surplus and deficit in the balance of payments to saving, investment, and international capital flows of autonomous character, since this subject has been covered in two earlier articles in Finance and Development.