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A Sectoral Approach to Balance of Payments Analysis

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
March 1969
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Jonathan Levin

BECAUSE foreign trade and payments are generally so important in developing countries, balance of payments considerations are never far in the background in the deliberations that take place in these countries on national economic policy. Indeed, the mechanism of balance of payments adjustment is the stuff of most national economic policy decisions, posing the problems to be solved and setting the limits to possible solutions. In dealing with sectoral economic questions, however, government decisions are often taken with entirely different considerations in mind, and these may have implications for the balance of payments that are quite inconsistent with the national objectives.

It is most important, therefore, that each country’s policymakers and foreign advisors should have a full and accurate understanding of how the balance of payments mechanism works in the country with which they are concerned, not only in the aggregate but also in the individual sectors. The broad lines of the adjustment process, and the outer limits to possible actions, are adequately presented in most circumstances by the general explanations of balance of payments adjustment now available. These approaches deal mainly with aggregates for the economy as a whole. They argue, for example, that increases in total exports, capital inflows, and domestic credit increase national income and the money supply, and lead to the generation of import demand and, in some circumstances, capital outflows. While delineation of the relationships between these national aggregates is essential to an over-all view of balance of payments movements for the economy as a whole, a full understanding of how the adjustment process works in the institutional setting of each country may call for something more than this.

In this area, as in many other areas of modern economics, we may find that the essence of greater wisdom lies in disaggregation—that is to say, if we want to understand changes in the aggregates for the economy as a whole, we should perhaps be examining what happens to those homogeneous economic groups which, for lack of a better word, we may refer to as sectors of the economy. To explore one possible area open to this approach, we shall have a look at one kind of balance of payments adjustment in developing countries—adjustment to a change in export proceeds in a country assumed, for the purpose of simplicity, to be dependent for its exports upon a single crop. Treatment of this example by a general approach using national aggregates would deal constantly in totals, i.e., with the impact of changes in total exports upon total national income or money supply, the resulting variation in demand, and the proportion devoted to imports. It may be more revealing, however, to examine first the behavior of the parts or subtotals. To judge the need for such a sectoral analytical approach we shall examine successively the income, expenditures, and direct imports of each major group receiving export proceeds. We may then assess, on this basis, what contribution an examination of the parts may make to an understanding of the whole.

This analysis may be particularly important in bringing to light policy decisions made at the sectoral level with insufficient attention to their implications for national economic policy. The recognition of these inconsistencies may help to reconcile sectoral and national economic policies, either through modification of government policies in the sectors concerned or through offsetting action elsewhere in the economy.

Export Proceeds Remitted Abroad

In a number of developing countries, a considerable share of export fluctuations is absorbed by foreign-owned export enterprises and may not actually reach the national economy. As the first step in an analysis of export receipts, therefore, we should distinguish that portion of receipts which is received by foreign firms in the export industry and remitted home to their parent companies or their countries of origin. Although such remittances have no immediate impact upon income or demand within the country, they are not necessarily useless to it, for they may be very important in promoting the future flow of investments from abroad. In times past, such remittances generally represented a greater share of exports than they do today, but they remain important in countries that export oil, mined products, and plantation crops.

The amount of such remittances—the earnings of what we call foreign factors of production—represents the margin between total export proceeds and what may be referred to as national export proceeds. Fluctuations in this remitted margin cannot be expected to follow the same course as total exports, since profits, being dependent upon the importance of fixed costs and the flexibility of returns to labor, usually fluctuate more widely than total sales. In present circumstances, however, probably the most important single influence upon the relationship between fluctuations in total exports and the receipts and remittances of foreign factors of production is the structure of export taxation, affecting the share of any change in export proceeds absorbed by government. This influence bears upon the timing of fluctuations in remittances, since the government’s exaction may be current—and coincide with variations in exports—when collected through an export tax; or lagged, when levied through income taxation payable the following year. Taxation also bears upon the magnitude of fluctuations in remittances of export income, as the government’s levy may take many forms, each producing a different variation in the tax when export proceeds or prices change. Thus the tax may be proportional to total exports, a specific sum per unit regardless of variations in unit price, a sliding scale moving upward more than proportionately with unit price, a proportion of net income calculated after any number of deductions, some kind of a partnership arrangement between the government and the exporting company, or possibly some combination of these. All these differences in tax structures—differences in timing and in form—play their part in determining the margin of foreign factors’ remittances separating fluctuations in total export receipts from national export receipts.

National Export Proceeds

For our purposes, the several sectors participating directly in export proceeds may be listed as follows: the growers or producers of the export product; the intermediary processors or traders; official or semiofficial marketing boards or grower federations or associations; and the government.

In many countries, particularly before independence or the introduction of new policies adopted since World War II, a growing dissatisfaction arose over the plight of small producers, ignorant of the market and without the wherewithal or storage capacity to hold their crop past harvest time against the stronger bargaining position of intermediary traders or processors. This sentiment gave birth in many areas to official or semiofficial producer associations and government marketing bodies designed primarily to protect the interests of the growers against unfavorable treatment by traders. As a result, the trading profits of intermediaries within such countries have generally come within the legal or effective control of some official marketing entity and have ceased to be of wider significance. At the same time, however, the protection of growers’ export proceeds against not only traders’ practices but also market movements has attracted increased concern from marketing boards and governments. As a result, whether through marketing bodies or tax policy, governments have come to make important sectoral decisions with profound implications for the balance of payments adjustment process.

Sectoral Export Receipts

Today the incomes of many producers are affected not only by the market—that is, by fluctuations in export proceeds—but to an important extent by the policies of the government and semiofficial entities as well. The same range of government tax measures which affects the export earnings of foreign factors of production remitting profits abroad can affect the timing and magnitude of export fluctuations transmitted to national producers. In addition, however, a greater government desire to protect national producers from declines in export proceeds may bring deliberate decisions to reduce or eliminate export taxes (whatever form these may take), or by any means to reduce deliberately the export industry revenues the government might otherwise expect. Where semiofficial marketing entities exist, moreover, their influence on producer incomes can go even further than a sacrifice of their normal revenues and may involve the payment of substantial subsidies. Such bodies have often been able to accumulate large deficits in order to maintain producer incomes above those warranted by actual national export receipts—sometimes quite inconsistently with national economic objectives.

A number of considerations have influenced official policies to seek to stabilize export producers’ income. The distress of producers under the impact of fluctuations is determined by the importance of export earnings in their total income, their ability to shift out of the affected export industry into some other income-producing activity, and the existence of debt obligations or the availability of credit. Probably most significant to the determination of official policy, however, is the government’s market strategy with regard to long-term supply of the export product, and the social and political importance of the export producers in the country. In one coffee-exporting country, for example, where the producers are predominantly small holders, they have been at least partially insulated from declining export prices by government and marketing agency deficits financed through credit from the central bank. In another coffee country, where the producers are mainly plantation owners, they have borne the full proportional impact of export price fluctuations, but the government’s market strategy has subjected official export receipts to even more severe variations, as bumper crops have been added to official buffer stocks to keep them off the market. Whatever the basis for such decisions, what is significant for the present discussion is the fact that the export receipts of many producers’ groups characteristically follow, over a period of time, a pattern very different from total export proceeds.

The export-derived proceeds of marketing bodies and the government present the obverse of this image. Automatic or deliberate variations in the magnitude or timing of the tax burden borne by foreign factors or national export sectors yield equal and opposite variations in the government’s export receipts. Similarly, a marketing body’s maintenance of prices paid to the producers of exports at levels above the prices it receives on the world market produces a decline in the income of the marketing body itself. Viewing the export-sharing sectors as a whole, it is self-evident that the export income of all of these must be equal to the total of export proceeds. This is true also of changes in export proceeds. Because the export income of the government may virtually disappear and that of the marketing entity can be negative, however, the composition of total export receipts may vary quite widely.

Sectoral Expenditures

The next stage in our analysis of the effects of export fluctuations is concerned with the impact of the actual variations in each sector’s export income upon the volume of its expenditures. Income variations may bring more or less parallel movements in the expenditures of producers, reflecting very little modification through changes in saving or dissaving. Expenditures by the government, on the other hand, may be adjustable upward only with some lag and may not be amenable to downward adjustment except with considerable difficulty. Raising other taxes to compensate for temporary export shortfalls is seldom found feasible. In the confluence of social, political, and economic forces a somewhat more complex pattern may emerge. In one country, for example, the government’s investment expenditures are found to fluctuate, with some lag, along the lines of export changes, while operating expenditures follow an independent (and generally upward) trend. Whatever the pattern, a single feature permits the divergence between receipts and expenditures of both government and marketing entities in most developing countries: that is, recourse to credit from the central bank. In this access to the central bank for politically or socially determined needs lies the fundamental difference between official and private sectors receiving export income and the impact of income fluctuations that each sustains upon imports and the economy as a whole. Primarily because of such central bank credit, the total expenditures of national export income recipients may sometimes exceed quite substantially their total receipts, a development which may or may not be consistent with the government’s over-all economic objectives.

Sectoral Imports

Tracing further the impact of export fluctuations upon the domestic economy, one is led to distinguish between that part of each export sector’s expenditures which is spent directly for imports and that part which is spent for domestic goods and services and gives rise to a whole chain of additions to domestic income which in turn eventually generate greater import demand. The proportion of each export sector’s additional expenditure which is spent for imports—its “marginal propensity to import”—will be determined in part by the extent to which the domestic economy is already developed and making available a range of goods and services. This marginal propensity to import may also vary significantly for different sectors, however, depending upon how they characteristically spend their funds. At one extreme, wealthy export producers in a relatively undeveloped country may find they have little additional demand for domestically produced goods when their export proceeds increase so that they may have a very high marginal propensity to import; elsewhere, producer sectors may be found to consist primarily of small holders with a wide range of unsatisfied demands for locally produced goods and a corresponding small marginal propensity to import.

The marginal propensity to import of the government sector, on the other hand, may combine another set of influences. A marginal propensity to import of .1 may characterize a government’s operating expenditures, for example, while a considerably higher figure, perhaps .4, may hold for its investment expenditures. The total marginal propensity to import for government, therefore, may depend also upon the composition of government expenditures as between operating and investment outlays, and this, we have noted, may itself vary in reaction to fluctuations in export income. For all of these reasons, consequently, the portion of expenditures devoted directly to imports and that adding to domestic demand may vary considerably between sectors sharing the national export proceeds.

Impact on Balance of Payments

The effect of these variegated sector developments—of the shifting distribution of export income between sectors quite disparate in their behavior—is to alter from period to period the amount of domestic income, demand and imports which a given change in export proceeds tends to generate. While the principles of demand and import generation employed in aggregative analyses are basically correct, the relationships between total exports, domestic credit creation, and imports may not remain constant under a different sectoral distribution of export income and expenditures. To measure the impact of export changes upon the economy, therefore, we will have to take the sum of the impact of all sectors sharing in export proceeds (and this will have to be the algebraic sum because some may move down while others move up). At the same time, to discern more clearly the mechanism by which export fluctuations affect the domestic economy and import demand, it will also be necessary to view the resulting changes in imports as the sum of two parts: (1) the direct result, coming from changes in the export sectors’ own imports (which may be taken as the algebraic sum of each sector’s change in expenditures multiplied by its marginal propensity to import); and (2) the indirect result, coming from changes in imports by the rest of the economy as a consequence of the export sector’s domestic expenditures and savings. These domestic expenditures by the export sectors, which may give rise to more general variations in income and demand within the economy, are the result (or algebraic sum) of each export sector’s change in expenditures multiplied by its marginal propensity to consume domestically.

From a monetary view, too, the total impact will be the sum of the parts. Since each export sector’s expenditures are financed by either the proceeds of exports, capital inflows, or net borrowing from domestic banks, the sum of the changes in all the export sectors’ domestic expenditures will cause an initial change in the money supply which will in turn generate changes in imports by the rest of the economy and perhaps capital outflows. The principles are those of the aggregative analysis but the results depend upon the sometimes independent movements of the parts.

Conclusion

While the total impact of export fluctuations upon the economy and the balance of payments can be calculated from the algebraic sum of the impact of each export sector, this impact will show up also in movements in the aggregates alone. Movements of the aggregates alone are sometimes inadequate or misleading, however. As regards description of balance of payments in some past period, identical results in terms of national aggregates may conceal important differences in how the adjustment was carried out, what the distribution of income and expenditures was among sectors, and what implications there may be for future behavior. As for the forecasting of future movements in national aggregates, significant changes in the distribution of income, expenditures, and imports between export sectors will undermine any consistency of relationship between aggregate exports and resulting domestic expenditures and imports, upon which aggregate forecasts must be based. So long as the weight of each export sector varies from period to period, the weighted average of all the sectors—reflected in the aggregates—cannot be expected to remain the same.

A sectoral examination of balance of payments developments in a country, therefore, can contribute a great deal to the policymaker’s understanding of how this adjustment process actually works, and of what reconciliation may be necessary between sectoral and national economic policies. Why then is sectoral analysis so rarely used for balance of payments purposes in developing countries today? The main reasons are probably an inadequate appreciation of its importance and a general shortage of trained economists to carry out the necessary research. The research effort is greatest at the outset, however, and is reduced considerably once the analytical framework has been established. The construction of such a sectoral analysis requires first empirical research on the economic behavior of the relevant sectors and then the integration of each sector’s operations into a framework for operations of the economy as a whole. Substantially the same kind of work is already carried out in the analysis of national income, for example.

Although evidence unearthed in this way might make interesting contributions to economic theory, it is of more than theoretical importance today because quite frequently policy decisions are made about individual sectors without adequate consideration of their balance of payments impact upon the economy as a whole. At the same time, other decisions may be made at those levels of government concerned with the national aggregate without consideration of the impact upon particular sectors and possible political difficulties which may ensue. Governments neglect such sectoral developments at their peril, for the pursuit of inconsistent policies in some sectors must lead to the sacrifice of national targets or the intensification of pressures upon other sectors. A framework integrating national and sectoral developments, therefore, can be of the highest importance in permitting policy issues to be decided with both elements in view.

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