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Finance & Development, June 1978
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World economic recovery and international adjustment: The Managing Director expresses his personal views on the balance of payments adjustment process

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
June 1978
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H. Johannes Witteveen

The recent performance of the world economy has been quite disappointing in a number of respects. Following the satisfactory rates of expansion in output and trade recorded during the period of initial recovery from the severe 1974-75 recession, the pace of economic recovery since about the middle of 1976 has been slow and uneven. In most member countries, unemployment has remained at the historically high levels reached during the recession or has even risen further. Growth in the volume of world trade has fallen considerably below historical standards. And in this difficult setting, rates of inflation are still much too high to be considered acceptable in the great majority of member countries.

Industrial countries: output and prices

The present situation and outlook vary considerably among countries and groups of countries. Within the industrial world, the principal distinction bearing on the global picture is that between the United States and other countries as a group. (See chart.)

Semiannual changes in output and prices in industrial countries, first half 1973-first half 1978

(Percentage changes in real GNP and GNP deflators from preceding half year, seasonally adjusted, at annual rates)

1/ Include, in addition to the countries shown separately in the chart, Austria, Belgium, Denmark, the Netherlands, Norway, Sweden, and Switzerland.

—In the United States, growth of output since the recession trough has been relatively strong, though expected to subside somewhat in 1978 and the first half of 1979. This record is mirrored clearly in the absorption of economic slack: the U.S. unemployment rate, which reached 9.1 per cent in May 1975, has declined by three percentage points and, according to staff estimates, resource utilization in the manufacturing sector is only some 5 per cent short of potential. However, the inflation picture has now become more worrisome: the increase in the gross national product (GNP) deflator is expected to rise from 5½ per cent in 1977 to 6¼ per cent in 1978, and then to an annual rate of 7 per cent in the first half of 1979.

—In the other industrial countries, growth in real GNP has been relatively weak in recent years but is expected to rise from an average of 2¾ per cent in 1977 to 3¾ per cent in 1978. Currently, unemployment rates in these countries are either about the same as or higher than in 1975, and, in general, are not expected to show significant improvement in 1978. Also, the “gaps” between actual and potential output in manufacturing continue to be large; for the six major industrial countries other than the United States, they range from 9 per cent (Germany) to 20 per cent (Japan), the average being about 13 per cent compared with a 2 per cent average over the two decades prior to 1974. On the inflation front, the increase in the GNP deflator for the non-U.S. group of industrial countries is expected to decelerate from 8¼ per cent in 1977 to nearly 6 per cent in 1978.

Primary producing countries: current trends

The record of output and prices among these countries is mixed. (See Tables 1 and 2.)

Table 1Primary producing countries: growth of real output, 1967-77(Percentage changes in real Gross Domestic Product)
1967-72

Average1
19731974197519761977
Major oil exporting countries29.010.78.70.312.46.7
More developed primary producing countries36.16.44.42.03.12.8
Non-oil developing countries46.17.35.33.94.84.7

Compound annual rates of change.

Comprise Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Oman, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela.

Comprise Australia, Finland, Greece, Iceland; Ireland, Malta, New Zealand, Portugal, Romania, South Africa, Spain, Turkey, and Yugoslavia.

Include all Fund members not mentioned above, or in the chart, plus certain essentially autonomous dependent territories for which adequate statistics are available. The regional subgroups correspond to Fund Area Department groupings except that Cyprus and Israel are included in the Middle East and the Netherlands Antilles in Latin America and the Caribbean.

Compound annual rates of change.

Comprise Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Oman, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela.

Comprise Australia, Finland, Greece, Iceland; Ireland, Malta, New Zealand, Portugal, Romania, South Africa, Spain, Turkey, and Yugoslavia.

Include all Fund members not mentioned above, or in the chart, plus certain essentially autonomous dependent territories for which adequate statistics are available. The regional subgroups correspond to Fund Area Department groupings except that Cyprus and Israel are included in the Middle East and the Netherlands Antilles in Latin America and the Caribbean.

Table 2Primary producing countries: price increases, 1967-77(Percentage changes in consumer prices)
1967-72

Average1
19731974197519761977
Major oil exporting countries28.011.217.019.016.115.5
More developed primary producing countries26.011.816.716.915.117.8
Non-oil developing countries2,310.122.133.032.431.632.2

Compound annual rates of change.

For coverage, see footnotes to Table 1.

Excluding Argentina, Chile and Uruguay, the figures for non-oil developing countries in the last four columns would be 25 per cent, 16 per cent, 15 per cent, and 21 per cent respectively; with a similar exclusion, the Latin America and Caribbean figures in the same columns would be 25 per cent, 23 per cent, 28 per cent, and 33 per cent, respectively.

Compound annual rates of change.

For coverage, see footnotes to Table 1.

Excluding Argentina, Chile and Uruguay, the figures for non-oil developing countries in the last four columns would be 25 per cent, 16 per cent, 15 per cent, and 21 per cent respectively; with a similar exclusion, the Latin America and Caribbean figures in the same columns would be 25 per cent, 23 per cent, 28 per cent, and 33 per cent, respectively.

—The more developed primary producing countries have experienced slow economic growth and high inflation in recent years. In 1977, the rise in total output averaged less than 3 per cent whereas consumer prices went up by 18 per cent. The projected results for 1978 are not substantially different.

—The non-oil developing countries have achieved a much better sustained average rate of economic growth during recent years than the other groups of oil-importing countries. Nevertheless, the 5 per cent rate projected for 1978 would still fall considerably short of the pre-1974 trend. Such a shortfall involves a sizable cut in per capita gains in real output, a reduction compounded by the adverse shift in the terms of trade of the non-oil less developed countries (LDCs) since the late 1960s. The inflation record of these countries is quite uneven but, in general, is notably less satisfactory than their growth record.

—The major oil exporting countries have on average achieved relatively large increases of real gross domestic product (GDP) during the past several years. Because of the virtual stagnation in oil production, however, the overall rate of output growth is estimated to have declined to less than 7 per cent in 1977 and is projected to fall to about 5 per cent in the current year. With a tightening of financial policies and efforts on the supply side, inflation is gradually subsiding.

Trend of world trade

The volume of world trade is projected to increase by no more than 5 per cent in 1978, the same as in 1977. (Table 3) Even that sub-par rate of growth rests on the assumption that import expansion will be relatively well sustained in the major oil exporting countries and in the non-oil LDCs.

Table 3World trade summary, 1973-77 1(Percentage changes)
Change from preceding year
19731974197519761977
Volume13-5125
Unit value (U.S. dollar terms)23½40½99
(SDR terms)12½39½87

Excluding trade of certain countries not reporting statistics to the Fund—mainly the Union of Soviet Socialist Republics, other nonmember countries of Eastern Europe, and the People’s Republic of China. Based on approximate averages of growth rates for world exports and world imports.

Excluding trade of certain countries not reporting statistics to the Fund—mainly the Union of Soviet Socialist Republics, other nonmember countries of Eastern Europe, and the People’s Republic of China. Based on approximate averages of growth rates for world exports and world imports.

International adjustment process

There was a worsening of the distribution of current account balances among the industrial countries in 1977: the Japanese balance swung into a large surplus, the German and Swiss surpluses remained stubbornly high, and the United States incurred a huge deficit. Better progress toward balance among the industrial countries would have been achieved had the current account improvements of Italy, France, and the United Kingdom been accompanied by adjustments in the opposite direction of the German, Japanese, and Swiss external payments so that less of the direct or indirect counterpart of these improvements would have been centered on the U.S. balance.

In the wake of these and other developments, the exchange markets have become very unsettled, and at times very disorderly, during recent months. Also, substantial changes have occurred in the effective exchange rates for major currencies.

The prevailing current account pattern among the industrial countries features an unsatisfactory mixture of surpluses and deficits. First, the U.S. deficit is of a size that clearly poses problems. Second, the ongoing surpluses of Japan, Germany, and Switzerland seem difficult to reconcile with the longer-run need of weaker countries—both industrial and primary producing—to reestablish adequate current account positions after having accumulated large amounts of foreign indebtedness in recent years. The improvement of external positions by the weaker countries has in many cases been achieved to a large extent through maintenance of very low growth rates and the buildup of economic slack. The dangers to the world economy inherent in lack of progress toward a better distribution of current account balances among the industrial countries cannot be ignored; these dangers include instability of exchange markets and the possible adoption by weaker countries, under severe pressure, of restrictive trade practices or deflationary policies. Because of the importance of this issue, the staff has worked out estimates (presented in Table 4) of “underlying” current account balances in the industrial countries—based, inter alia, on the calculated effects of a desirable scenario regarding future cyclical developments.

Table 4Summary of current account balances1(In billions of U.S. dollars)
Non-oil primary producers
Industrial

countries2
Major oil

exporters3
More

developed3
Less

developed3
Total4
19739.86.51.1-11.36.1
1974-13.067.8-14.5-29.910.4
197516.434.7-14.8-37.3-1.0
1976-2.440.8-14.3-25.6-1.5
1977-7.634.9-13.6-22.1-8.4
1978423-12½-30-15
Note: The figures for 1978 have been rounded to the nearest half billion.

Goods, services, and private transfers.

See chart for coverage.

See Table 1 for coverage.

Reflects errors, omissions, and asymmetries in reported balance of payments statistics, plus balance of listed groups with other countries (mainly the U.S.S.R., other nonmember countries of Eastern Europe, and the People’s Republic of China).

Note: The figures for 1978 have been rounded to the nearest half billion.

Goods, services, and private transfers.

See chart for coverage.

See Table 1 for coverage.

Reflects errors, omissions, and asymmetries in reported balance of payments statistics, plus balance of listed groups with other countries (mainly the U.S.S.R., other nonmember countries of Eastern Europe, and the People’s Republic of China).

For the non-oil developing countries as a group, the projected deficit of $30 billion for 1978 does not appear large in a historical perspective; nor would its financing seem to require any increase in the net inflow of borrowed funds. Nevertheless, within this group of countries are found strikingly disparate records with respect to adjustment of the external position. Numerous countries, mainly in Asia and in Latin America and the Caribbean, have had considerable success with their stabilization and adjustment policies. These countries are now in a position to contribute to the international adjustment process through measures to revive domestic activity, liberalize imports, or reduce tariffs. But there are also many deficit cases, some involving very difficult situations. The deficit countries are concentrated to a disproportionate extent in the African region but are also to be found in the Asian, Latin American and Caribbean, and Middle Eastern regions.

The more developed primary producers group includes a number of countries whose external positions were sharply affected by the disturbances of 1974 and 1975 and have not yet been adjusted, in part because of the problems created by a persistent deterioration of the terms of trade. Shifts toward more growth-oriented policies have often not proved possible. Several more developed primary producers in southern Europe that had postponed the adoption of stabilization programs are now confronted by situations of serious internal and external imbalances.

There has been a decline in the combined current account surplus of the major oil exporting countries from the $68 billion level of 1974 to an estimated $35 billion in 1977. A further decline, to $23 billion, is projected for 1978.

Policy strategy for the period ahead

There emerged a consensus among the Executive Board in a discussion of the world economic outlook last January on the policies and conditions that would be necessary for sustained improvement of the world economy: a more effective functioning of the international adjustment process, and a reappraisal of domestic policies from the standpoint of encouraging noninflationary growth. By then, it was clear that contributions to world economic recovery could, and should, be made by a sizable number of countries, not just by a few of the largest. Conclusions have now been reached on the formulation of a general strategy of coordinated growth, following additional study and discussion during the past few months.

Several key considerations underlie the recommended strategy. First, there is the need for greater emphasis on policies to stimulate economic growth. Without this, we cannot combat the substantial underutilization of resources, including historically high levels of unemployment, now prevalent in many countries; nor can we raise the low rates of investment that are having a detrimental impact on growth or productive capacity. Related hazards include the slow growth of world trade, which is impairing the effectiveness of the adjustment efforts of deficit countries, and the spread of protectionist trade measures, which I regard as one of the most ominous features of the world economic scene. The existence of so many manifestations of unsatisfactory growth presents a very difficult and potentially dangerous situation.

Second, consideration must be given to the continuing importance of combatting high rates of inflation in most member countries. But there would now appear to be quite a number of countries in which, because of the accumulation of economic slack and the blunting of inflationary expectations, the risks of exacerbating inflation would be minimal if cautious and well-designed policies of expansion were pursued.

A third guiding consideration is that roles of individual member countries in the implementation of a general strategy should be geared to their relative positions in the international adjustment process and to their progress in reducing inflation. This point is of particular importance at a time of extraordinarily wide differences in the current positions of member countries.

A medium-term growth scenario

A strategy based on the foregoing major considerations is embodied in the medium-term economic “scenario” shown in Table 5. This table presents staff calculations of the “underlying” current account balances that could evolve over the medium term if present levels of price competitiveness in the various industrial countries were maintained and if policies geared to growth targets consistent with the considerations listed above were successfully pursued.

Table 5Scenario for coordinated growth and payments adjustment
Growth rate of real GNPCurrent balance in 19771Allowance for:Underlying current balanceOfficial transfersUnderlying current balance including official transfers
1978 (Estimate)1979-80 (Recom’d)Temporary disturbances2Fall in OPEC Surplus3Recent relative price changes4Cyclical developments5
(In per cent at annual rates)(In billions of U.S. dollars)
Canada4.5-4.00.12.6-0.3-1.6-1.6
United States4.54-17.40.81.66.81.8-6.4-2.9-9.3
Japan5.711.21.3-4.6-5.72.2-0.22.0
France3.1-1.80.63.41.73.9-1.42.5
Germany3.17.60.41.1-4.4-4.8-0.1-4.1-4.2
Italy2.643.4-0.70.6-1.01.74.0-1.32.7
United Kingdom2.91.95.8-2.2-1.04.5-2.02.5
Other industrial countries2.2-8.50.83.9-0.61.1-3.3-1.2-4.5
Total4.0-7.51.315.0-5.53.3-13.1-9.8

Goods, services, and private transfers.

These noncyclical disturbances include particularly large fuel imports that were used to increase U.S. fuel inventories, an unusually high outflow on the German investment income account reflecting a change in the German tax on corporate income, unusually high tourist earnings for Italy reflecting capital inflows through the current accounts, and technical difficulties affecting the Norwegian production of North Sea oil.

The calculations presented here assume no change in the real price of oil; the estimates for the United Kingdom and Norway include special adjustments of $5 billion and $3 billion, respectively, reflecting the expected balance of payments effects of North Sea oil.

Estimates of the effects of changes in exchange rates and in domestic price levels that have occurred (through March 23, 1978) but are not reflected in 1977 trade flows.

The effect of projected changes in relative cyclical positions to 1980 on countries’ trade flows at the level of 1977 trade flows.

Goods, services, and private transfers.

These noncyclical disturbances include particularly large fuel imports that were used to increase U.S. fuel inventories, an unusually high outflow on the German investment income account reflecting a change in the German tax on corporate income, unusually high tourist earnings for Italy reflecting capital inflows through the current accounts, and technical difficulties affecting the Norwegian production of North Sea oil.

The calculations presented here assume no change in the real price of oil; the estimates for the United Kingdom and Norway include special adjustments of $5 billion and $3 billion, respectively, reflecting the expected balance of payments effects of North Sea oil.

Estimates of the effects of changes in exchange rates and in domestic price levels that have occurred (through March 23, 1978) but are not reflected in 1977 trade flows.

The effect of projected changes in relative cyclical positions to 1980 on countries’ trade flows at the level of 1977 trade flows.

The calculations involve three steps. First, actual balances for 1977 have been adjusted for a number of temporary disturbances (such as those listed in footnote 2 of Table 5) in order to obtain a better picture of the “true” positions of the various countries. Second, calculations have been made of the effects of past changes in exchange rates and in relative price competitiveness that were still “in the pipeline” as of mid-March 1978—that is, effects that were not yet reflected in 1977 trade flows, but might be expected to occur by about 1980. Third, the 1977 current account balances have been adjusted to take account of the prospective change in the combined current account surplus of the major oil exporting countries to 1980 and of cyclical developments to that year along paths determined by the general strategy for growth and external adjustment.

In the measurement of the impact of cyclical developments, the most important factor is the difference between the actual growth rate and the rate of growth of potential output. With respect to this critical factor, the notional scenario for 1979-80 involves different assumptions for the various industrial countries according to their respective rates of inflation, external positions, and degrees of economic slack. The scenario may be described as a “desirable” one in the sense that individual countries are assumed to expand domestic demand so as to reach a rate of growth of real GNP judged to be appropriate from the standpoint of absorbing available slack, with account being taken of the interdependence of the various countries through flows of foreign trade.

The growth rates chosen for this desirable scenario can be characterized as cautious, especially in view of the fact that all of the industrial countries except the United States presently have large amounts of economic slack, which would be reduced only moderately by the rates of expansion suggested. The continuing danger of rekindling inflationary pressures militates, of course, against more ambitious aims for real growth. At the same time, the risks involved in the accumulation of still larger slack have to be considered, since this could have serious consequences for the world economy. Though cautious in approach, the suggested scenario would represent a very significant shift in strategy, following the subnormal performance that has characterized virtually all of the industrial countries since about the middle of 1976.

Need for differential growth rates

Because of the multiple criteria utilized in their selection, the desirable growth rates vary considerably from country to country. The average 1979-80 growth of 4 per cent assumed for the United States, for example, is only marginally above the estimated rate of growth of that country’s potential output. The 4 per cent rate seems appropriate in view of the markedly lesser degree of slack in the United States than in the other industrial countries and in light also of the prospects for domestic prices and the size of the U.S. current account deficit. For Canada, France, Italy, and the United Kingdom, varying reductions in the respective GNP gaps (averaging roughly ½ per cent per annum) are suggested for the period 1979-80; given the domestic price situations in these countries, larger reductions of slack do not seem warranted. However, GNP gap reductions on the order of 1 to 1½ per cent per annum are suggested for Germany and Japan, whose external strength, domestic price stability, and extent of economic slack appear to permit higher rates of growth relative to potential (while leaving, as for other major industrial countries except the United States, a substantial degree of slack in 1980). The scenario depicted in Table 5 makes broadly similar distinctions among the smaller industrial countries.

Current account implications

Significant changes in current account balances are implied by the suggested differentials in rates of economic expansion in relation to potential. These cyclical differentials could account for reductions of some $5-6 billion each in the German and Japanese current account surpluses, while cutting about $2 billion from the U.S. trade deficit and strengthening the positions of France and Italy by slightly smaller amounts. Effects on the Canadian position would be limited, but perhaps somewhat negative, and a deterioration of $1 billion would be implied for the United Kingdom, along with a net improvement of similar aggregate magnitude for the smaller industrial countries as a group.

For several of the larger countries, the projected effects of recent changes in relative prices, not yet reflected in trade flows, are substantial and run in the same direction as projected cyclical influences. By and large, the “underlying” balances represent a distinct improvement over the actual balances, with substantial changes in the right direction being recorded for the United States ($11 billion), Japan ($9 billion), Germany ($7.5 billion), and other countries.

It is thus obvious that an evolution of current account balances along the lines indicated in Table 5 would tend broadly to promote the international adjustment process without placing excessive weight on further changes in exchange rates (which for purposes of the estimates comprising the suggested scenario are assumed to change only in line with relative prices). Since the scenario not only embodies a higher scale of growth rates than that of recent years, but also would contribute to a better distribution of current account balances, underlying conditions conducive to economic and financial stability would be promoted. Therefore, efforts by the major industrial countries to adhere as closely as possible to the suggested rates of growth would seem to be highly desirable. Without determined efforts along such lines, developments over the next two or three years could turn out to be substantially worse than those implied in the suggested scenario. This, for instance, would be the case if growth rates in Germany, Japan, and other surplus countries continued to lag behind the rate for the United States. Staff calculations show that the quantitative effects of different cyclical patterns can be very substantial.

It is not possible, of course, to give anything resembling a general policy prescription for achieving the “desirable” pattern of growth rates set forth in Table 5. The wide differences among countries with respect to current positions and to the emphases placed on monetary, fiscal, and other policies preclude any such prescription, especially this far in advance of 1979 and 1980. Nevertheless, a few remarks on the question of policies may be in order.

For a number of industrial countries, the combination of growth rates in the suggested scenario and allowances for further reductions in inflation would imply a moderately higher growth of demand in current prices for 1979-80 than has been projected for 1978. However, there would be some countries in which little, if any, change in the rate of increase in nominal demand would be required (in relation to the projected 1978 pace) and a few—most notably the United States—where some decline in the rate of increase in nominal demand would be appropriate.

In any event, I believe governments should increase their efforts to obtain a more favorable split of the change in aggregate demand into its price and volume components. Particularly deserving of consideration is the possible utility of tax reductions for the purpose of influencing wage and price behavior especially in countries where this could be worked out in conjunction with an established incomes policy. More generally, because of the predominance of cost-push factors in the current inflation, incomes policy could play a very useful role, and governments should do whatever they can in this difficult field to rationalize the claims of business and labor on the national product. In a number of industrial countries, especially in Europe, reductions in rates of wage increase are also needed to restore profit margins and provide greater incentives for investment.

Although the stimulus provided through tax reduction seems generally less likely to induce new price pressures than additional government spending, increases in one type of expenditure could be very beneficial in the present situation. Measures by the industrial countries to provide an expanded flow of funds to non-oil developing countries on a concessionary basis would help the latter countries to step up their purchases of foreign goods and services, with benefit not only to the developmental programs of those countries but also to output and employment in the industrial countries themselves.

Whatever the particular policy measures that might be used in dealing with the present difficult situation, it is crucially important that the industrial countries pursue appropriate and mutually consistent targets for economic growth. These should not only conform in the aggregate to an adequate scale of expansion, but should also vary among countries according to the strength of the external position, the rate of inflation, the degree of existing economic slack, and the rate of growth of potential output. Of course, in view of the uncertainties and difficulties, countries cannot undertake to meet their growth targets each and every year, but they would be expected to avoid undue delay in taking measures to compensate for significant deviations and to get back on track.

Without such a coordinated approach, it would not be possible to achieve the underlying conditions essential for economic and financial stability. Exchange rate relationships would be sharply affected by cyclical and other short-term factors, and the instability of exchange rates, in turn, would make it all the more difficult to obtain satisfactory rates of economic growth. Such a combination of circumstances would inevitably lead to a different outcome—and one quite undesirable—from that envisaged in the strategy I have recommended.

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