WHILE BILATERAL PAYMENTS arrangements assumed large proportions prior to and after World War II, since then their importance in world trade has been gradually reduced. While it still plays a role, bilateralism in payments and trade no longer interferes as extensively as it once did with the mechanism of a free exchange of goods and services and the movement of capital. Because bilateralism still plays some role in the system of international settlements and trade, it is worthwhile to take a critical look at it; even if we cannot altogether avoid the repetition in the future of mistakes committed in the past, at least we can appraise these errors.
How do the adherents of bilateral payments arrangements justify them? Why do countries enter into and maintain bilateral trade and payments arrangements? Looking at the matter historically, we find that during the general economic upheaval and disorder accompanying the great economic crisis in Europe in the 1930’s, and again after World War II, countries tended to favor bilateral and trade payments arrangements, which were supposed to help to carry out trade and settlements at a time when the multilateral system of trade and payments failed to function satisfactorily and when balance of payments difficulties were very acute.
It is possible to be much more specific about the reasons and aims that act as inducement for various countries to take recourse to bilateral trade and payments arrangements, but the list of such reasons and inducements is relatively long, and only the most important ones’ need be discussed here.
Countries entering into bilateral trade and payments arrangements have generally hoped that such arrangements would assist them in expanding, diversifying, and redirecting their trade. Other countries expect to improve their terms of trade and/or to stabilize their export markets and the prices of exports. Certain countries hope that bilateral arrangements will help them to find new markets for exports and additional markets from which they can draw their imports, so as to become less dependent on traditional markets. Countries are also tempted to conclude bilateral arrangements in order to obtain revolving credits through swing and other loan facilities available under payments arrangements. Another hope is that the introduction of bilateral payments arrangements may serve to liquidate funds of a given country which are blocked by another country; by channeling specified payments through a bilateral account, debtor and creditor countries expect to facilitate the transfer of frozen funds. Certain developing countries that are carrying out economic plans are in favor of bilateral arrangements, as they feel that they would thereby be able to make those plans more efficient.
Last, but not least, a number of countries conclude bilateral arrangements with countries having state trading economies in order to demonstrate their willingness to cooperate with these countries in economic and other fields.
In general, bilateral trade and payments arrangements have not fulfilled the optimistic expectations and hopes of those who set them up. One of the most common difficulties has been that the arrangements have been used by strong partners to the detriment of weak ones, particularly through accumulating debit balances on bilateral accounts. Such tactics may, unfortunately, be carried a long way; in extreme instances, an economically powerful country can gradually obtain extensive control over a weak partner. The first step may be to insulate this weak partner from a world market by raising the prices of its raw materials or agricultural products purchased through bilateral channels, thus leading the weaker country to devote its resources to producing certain products on a greater scale at higher costs. Such a step might well seem to be advantageous to the weaker country in the short run, as its terms of trade would be improved and production and employment would be expanded. But as soon as a strong partner becomes a major factor in the entire export strategy of a weak partner, it can increase the prices of its own exports to that partner, and gradually even the nominal terms of trade are likely to become less advantageous to a weak partner. Once the economy of a weak bilateral country becomes tied to that of a strong bilateral country, the position cannot be easily reversed. The situation may be even worse if a strong partner should also use its political as well as its economic power to influence the policies of its weak partner. This is not a theoretical problem; the recent and less recent history of bilateral arrangements provides interesting examples. History also shows that the weak partners were seldom able to overcome the economic influence attained by their strong partners.
Countries affected in this way have tried to apply various countermeasures in order to reduce to an acceptable amount the bilateral balances owed to them. For economic and political reasons, however, the self-defense possibilities of weak partners are limited, and bilateral arrangements have operated in a number of instances for long periods of time.
In addition to producing particular difficulties in individual instances, bilateralism in payments and trade brings about a number of harmful effects of a broader nature. It produces arbitrary changes in the direction, composition, and volume of imports and exports, and of international movements of services and capital; and it can bring about sudden and substantial fluctuations in the foreign trade of a bilateral country which may also affect other countries.
Few goods are produced exclusively from domestic raw materials. The bilateral trading country, in order to avoid the use of its freely convertible currencies, may through bilateral trade and payments be able to limit bilateral exports to goods which do not require for their production raw materials, parts, and services imported from the free international market; or it may be able to obtain from its bilateral purchasers payments in a freely convertible currency based on the free market content of the bilateral exports. Either way, a country trading bilaterally faces many economic difficulties as well as the technical difficulty of calculating fairly exactly what payments should be made in freely convertible currencies by a bilateral purchasing country. The possibility of making an arrangement satisfactory to each bilateral partner depends to a great extent on its political and economic bargaining position.
According to the degree to which they enjoy or approach monopolistic positions, countries can influence the prices of goods exchanged through bilateral arrangements. Sometimes, the position is obscured by the fact that the prices of both imports and exports are raised, but the terms of trade can turn against one of the partner countries. The weaker bilateral country may make efforts to defend itself, for instance, by establishing higher prices for its exports, but whether it can obtain full compensation for the increased prices of its imports from bilateral sources depends on circumstances over which it may not have effective control.
While most countries participating in bilateral payments arrangements are exposed to dangers and losses, developing countries face particular dangers, as their bargaining position is limited, their experience not wide, and their hopes and beliefs high. Frequently, they are invited to conclude and maintain bilateral arrangements with state trading countries which usually prefer to carry out trade and settlements on a bilateral basis, although this preference is undergoing some change. In particular, when these state trading countries extend economic aid to developing countries in the form of loans and grants in kind, they like to do so through bilateral channels. Sometimes, beneficiary countries have practically no choice; either they conclude bilateral payments arrangements in order to benefit from foreign aid offered by these countries, or they have to give up this external aid.
Independently of external pressures, developing countries are attracted to bilateral payments arrangements by the relative ease with which credits and loans can be obtained from state trading countries, with repayment assured through the planned delivery of locally produced agricultural goods and raw materials. In fact, however, developing countries are often unselective as to the goods obtainable on credit from their bilateral partners. While buying on credit under bilateral arrangements, developing countries commit a percentage of future domestic production and preclude the possibility of choosing, in the future, the most advantageous export markets for their products. If they are unable to fulfill their delivery commitments to bilateral partners, then they are obliged to make repayment in free currencies.
BILATERAL PAYMENTS AGREEMENTS BY CONTINENTS
Moreover, one of the indirect and harmful effects of bilateral arrangements is the undercutting of free markets, particularly for countries that are exporting primary products and raw materials through bilateral channels. In order to earn freely convertible currency, the strong bilateral importers have frequently been found reselling, on the free market, goods bought from their bilateral partners at effectively lower prices. Most bilateral trade agreements include provisions prohibiting such re-exports, but the observance of these resale and re-export clauses depends on the goodwill of the partner, which, in practice, has often been lacking.
In addition, bilateral countries can lose freely convertible currencies because their partners do not pay in such currencies adequately, if at all, that part of their exports or incidental costs which involve the expenditure of freely convertible currencies by exporting countries. This problem can be of considerable importance in practice, and deserves a more detailed explanation.
Last, but not least, bilateralism in payments and trade, once agreed upon, is supported not only for reasons of economic policy, but also from much more prosaic considerations: bilateral arrangements are associated with various controls and regulations which give a country’s bureaucratic administration additional power and importance. The implementation of bilateral arrangements necessitates direct and frequent contacts of various trade and exchange control officials of bilateral partners in the form of trade, financial, technical, and other missions. It is not surprising that the exchange and trade control administrations of bilateral partners are reluctant to reduce or liquidate bilateral arrangements which assure a “full administrative employment” and the expansion of their administrative powers.
Bilateral trade and payments arrangements may thus result in creating a situation where they constitute a kind of art for art’s sake, while productivity and profitability are not fully taken into account. Partners often devote a lot of time and attention to how and to what extent they should balance bilateral trade and payments through patchwork measures and devices, and ignore general economic principles underlying international trade and payments.
Making Bilateral Arrangements Work
Countries have attempted to improve the working of bilateral arrangements by agreeing on limited transferability of excessive balances. Sometimes they have recourse, either by mutual agreement or unilaterally, to transit transactions, which may assume two forms: either a bilateral creditor may sell in other countries goods imported from a bilateral partner, or may sell balances on a bilateral account to a third party, often at a discount.
Other attempts to reduce the negative effects of bilateral arrangements have taken the form of introducing an element of multilateralism, by arranging officially multilateral transactions in respect of bilateral balances, either on an ad hoc basis or on a more lasting regular basis. Such multilateral or triangular arrangements, as they are usually called, have not given satisfactory results in practice. A triangular transaction works in the following way: A bilateral partner (C), being a creditor country, and another bilateral partner (D), being a debtor country, agree to cede a balance (or a part of it) on a bilateral account to a third country (T), against some compensation. When a triangular transaction is carried through, the joint bilateral account maintained by C and D is reduced, with the result that they are not compelled to make arrangements for the reduction of the bilateral account exclusively with one another. The partner C is compensated in some way for ceding its bilateral balance and T, which acquired the balance, can use it for repaying its debt to D, or for purchasing commodities from it. The triangular transaction as described above is simple from the technical point of view. Its success in practice depends, however, on the concurrence of several conditions and circumstances, a concurrence which may be rare. To return to our simple illustration, it can happen that a bilateral creditor country (C) is ready to cede its bilateral balance at a loss, i.e., at a discount. While this kind of sacrifice might make a triangular transaction easier to carry out, it might also prevent its repetition in the future. In any event, each triangular transaction is generally unique, and its execution may not constitute a helpful precedent for the future. When the system of bilateral trade and payments results in the emergence of unrealistic exchange rates and prices which are out of line with world market prices, the difficulties of carrying out a triangular transaction are increased immensely.
In strict bilateral arrangements, as well as in arrangements combined with limited multilateral settlements through triangular transactions, efforts have in fact been made to establish convertibility (in addition to transferability) of bilateral balances which either exceeded certain limits or could not be liquidated through triangular transactions during a relatively long period of time.
When we pursue the subject of bilateral arrangements in this way, we see an interesting phenomenon. When the system of bilateral settlements is applied in practice, its users always tend to have recourse to multilateral settlements, applying convertibility or transferability of bilateral balances in one way or another. This recourse to the multilateral system of payments and the related free market is made also in another way, by using the prices of the international market for establishing prices of goods exchanged bilaterally. Although difficulties might be encountered in recording exactly the prices of this market, yet the prices of the free international market are used in bilateral trade. Their use is particularly favored by weak partners against their strong partners to assure fair bilateral trading terms. After World War II, when bilateral arrangements were spreading and the free international market and trade were not expanding, it was remarked that countries trading bilaterally must preserve some international free market and trade, otherwise guidance for fixing prices in bilateral trade would cease to exist. This was a satirical comment, but it reflects the artificiality of price formation under bilateral arrangements. History shows that in one way or another would-be practitioners of bilateral arrangements find that their trade and payments are subject to a kind of creeping multilateralism.
Although I have argued against bilateral arrangements in any form and at any time, I can understand a case for bilateral arrangements when paralysis strikes the multilateral system of settlements; then they could be used temporarily as a palliative. But the danger always exists of extending indefinitely the system of bilateral settlements which was supposed to exist only temporarily; as soon as the system of multilateral trade and payments is restored, it should play its usual useful role.
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International Monetary Problems, 1957-1963 Selected Speeches of Per Jacobsson
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The Changing Structure
The liquidation of bilateral arrangements in Europe and the return to the international exchange of goods and services on a multilateral basis after World War II was not easy. The collection of reliable statistics illustrating the influence of bilateral arrangements in payments in the world as a whole is difficult; and even if obtained, such data would not give a true picture of the developments that took place in the two decades after World War II. As a substitute for such world-wide statistics about developments in this field, some data can be given about the number of bilateral payments agreements maintained by the countries belonging to the International Monetary Fund. In a sense, such data would give a relatively good picture of the importance of bilateral arrangements, as most important trading countries already belonged to the Fund in 1955-60 when such arrangements were decreasing. The liquidation of bilateral payments arrangements by these countries, particularly by the leading trading countries, is a good indication of the reduction of the importance of bilateralism in international trade and payments on a world-wide scale.
At the end of 1960, there were 86 agreements in operation between Fund members, and 171 between members and nonmembers; thus, the total number of agreements in operation maintained by members among themselves and with non-members was 257. While the number of Fund members increased by 15 in the years 1955-60, the number of agreements maintained by them decreased by about one fourth. The decrease was entirely owing to the discontinuance of agreements between members; the number of agreements between members and nonmembers remained practically unchanged.
The reduction in 1955-60 in the number of bilateral payments agreements in which Fund members participated was more extensive than the figures would indicate. Countries belonging to the French franc area and the sterling area made their settlements under bilateral payments arrangements maintained by France and the United Kingdom, respectively. At the end of 1955, France maintained 26 bilateral payments agreements, but five years later had only 5 such agreements. Between 1955 and 1960, the United Kingdom merged its U.S. accounts and transferable accounts and discontinued all bilateral payments agreements. In consequence, the extent of bilateralism in trade and payments in the world was reduced, not only because of the terminations by France and the United Kingdom, but also because of the correspondingly fewer arrangements by the French franc area and sterling area countries.
The subsequent six years saw Fund membership increase from 70 to 103. In the same period, the number of agreements in operation between Fund members decreased by 8 and that between members and nonmembers increased by 58.
The position at the end of 1967, which did not differ much from that at the end of 1966, was as follows: of the 107 Fund members, 56 members did not maintain any bilateral payments agreements. There were 72 bilateral payments agreements in operation between 51 members, and 228 agreements in operation between members and nonmembers. Of these 228 agreements, there were 224 agreements with Sino-Soviet bloc countries, consisting of 188 with those in Europe (including U.S.S.R.), 29 with those in Asia, and 7 with Cuba.
The major change since 1960 is that only a relatively small number of Fund members, whose share in world trade is small, maintain a relatively large number of bilateral payments agreements.
A further decrease in bilateral payments agreements depends to a great extent on the willingness of Fund members to discontinue their payments agreements; temporary difficulties which could arise occasionally in the event of their discontinuance would not be great. On the other hand, the replacement of bilateral arrangements by multilateral ones would pay great dividends.
It is apparent that the rapid elimination of bilateral payments arrangements cannot be achieved without creating some temporary difficulties, the degree of which would vary from country to country. Where considerable difficulties are anticipated, these could be diminished by spreading the liquidation of bilateralism over a period of time.
The Fund and Bilateralism
As bilateralism involves restrictions on current payments and trade discrimination, it is not compatible with the purposes of the Fund, as formulated in Article I of the Agreement.
The Fund has continuously exerted its influence with member countries to continue their efforts to eliminate bilateralism in payments and trade as much as and as soon as possible. It has frequently emphasized its disapproval of bilateral payments agreements on such occasions as annual consultations with its member countries and when stand-by arrangements are made. If this article has indicated why the Fund opposes bilateral trading and payments arrangements—attractive as these have been at certain times, and appealing as they may yet appear to be in some circumstances—it will have served its purpose.