Journal Issue


International Monetary Fund. External Relations Dept.
Published Date:
March 1984
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John Williamson

The Exchange Rate System

Policy Analyses in International Economics No. 5, Institute for International Economics, Washington, DC, 1983, 92 pp., $6.

This study attempts to provide a framework for a worldwide return to a structured exchange rate system. The great failing of floating exchange rates has been the large misalignments they have allowed to emerge. It would therefore be desirable, Williamson argues, for each individual country to identify the equilibrium exchange rate that would be appropriate from the standpoint of long-run competitive considerations. Ideally those exchange rates would then become the central rates in a set of mutually consistent and publicly declared target zones that countries would support by concerted intervention and, more important, by coordinated monetary policy.

Misalignments may emerge either from inefficiencies in the foreign exchange market (“market failure”) or from policy mixes chosen with no concern for their exchange rate consequences (“policy failures”). Misalignments lead to a situation in which a country cannot expect to generate a current account balance to match its underlying capital flow over the cycle. The fundamental equilibrium exchange rate would, by contrast, produce a current account position consistent with the balance between saving and investment that exists in a cyclically neutral situation. That balance, and the underlying capital flow that it defines, depend, of course, on the macro-economic policy regarded as appropriate over the medium term.

For this reason, finding a mutually consistent set of central rates for the world clearly depends on finding agreement on appropriate macroeconomic policies for all concerned. Shared objectives would help provide a basis for such agreement. Williamson sees no reason why interests should be competitive rather than cooperative in regard to levels of real resource transfer. Given a consensus on such transfers, he argues, negotiations on target zones for exchange rates that will realize them should not be particularly difficult. Agreement on target zones would then force the international coordination of macroeconomic policies that is needed for everyone’s long-run good.

Apparently exchange rates are to be judged by the macroeconomic policies that generate them, and those macroeconomic policies, in turn, by the exchange rates to which they give rise. The apparent circularity is broken by linking both exchange rates and domestic policies to agreed levels of real resource transfer. To this critic, such agreement seems objectively hard to come by. Growth may be threatened by an exchange rate so soft as to create an external surplus that exports all investable savings abroad; growth may similarly be threatened by an exchange rate so hard as to render all domestic investment uncompetitive. Specifying the growth-maximizing exchange rate for each country does not obviously produce a consistent set of exchange rates for the world as a whole.

Hans Schmitt

Pedro Aspe Armella, Rudiger Dornbusch, and Maurice Obstfeld (editors)

Financial Policies and the World Capital Market:

The Problem of Latin American Countries

National Bureau of Economic Research and the University of Chicago Press, Chicago, 1983, ix + 293 pp., $36.

A common theme of this collection of papers presented to a National Bureau of Economic Research conference in 1981 is that progress toward financial integration among countries can give rise to new opportunities—and of course to new risks—for lenders and borrowers in the international sphere as well as impose tight constraints on domestic macroeconomic policies.

Though differing in subject and scope, the papers share a concern with the problems of economic management faced by open economies, particularly those in Latin America, and in this context they discuss issues of interest to policymakers. Some of the articles are theoretical and provide analyses of general applicability. Others are empirical and center either on the study of a particular country experience or on the investigation of a particular issue within a specific country.

An interesting setting for the volume is provided by Carlos Diaz Alejandro’s paper, which surveys financial and exchange policy in Latin America in the 1930s as a basis for drawing parallels with the current decade. This historical survey is followed by several theoretical articles. Michael Mussa discusses economic integration and its advantages in the light of typical impediments to optimal integration strategy. Stanley Fischer uses optimal inflation tax analysis as a basis for arguing that seigniorage is relevant to the choice of an exchange rate regime. Nissan Liviatan discusses the effects of indexation on the functioning of an economy and argues that there is a market-determined equilibrium degree of wage indexation that is related to the nature of the shocks to which the economy is exposed. The last theoretical paper, by Michael Bruno, also deals with issues concerning an economy subject to real and monetary shocks and discusses the characteristics of a semi-industrialized country; this is relevant for international linkages as well as for macroeconomic management.

The empirical papers examine the experiences of three Latin American countries: Argentina, Brazil, and Mexico. Guillermo Calvo discusses the phenomenon of exchange rate overvaluation in Argentina from 1976 to 1980. Domingo Cavallo and Humberto Petrel, in turn, are concerned with the behavior of real interest rates in Argentina and how it has affected the financial position of private firms. Olivier Blanchard uses a formal growth model to address the subject of external debt and the current account deficit in Brazil. The paper’s finding—that when current account adjustment is needed, it ought to come at the expense of consumption rather than investment—is not particularly controversial. In contrast, recent events have overtaken the paper’s now more controversial assertion that, from the point of view of solvency, the Brazilian current account deficit, and presumably its foreign debt, were not matters of concern. Those events cannot but raise doubts about the appropriateness of the assumptions of the model.

Mexico is the subject of the three last articles: Guillermo Ortiz discusses the causes and implications of the growing importance of the dollar in the Mexican financial system, placing it in the context of a currency substitution model. In a related paper, Jose Li-zondo explores the behavior of interest rate differentials between assets denominated in U.S. dollars and those denominated in Mexican pesos. Finally, Robert Cumby and Maurice Obstfeld investigate the scope for sterilization by the Bank of Mexico in the presence of capital mobility.

In sum, this collection is a useful one. While no major new ground is broken, the papers do provide insights into the constraints and quandaries that policymakers face in a closely interdependent international economy, in general, and into the experiences of three major Lation American countries, in particular. As such, the book provides interesting reading for practitioners and scholars alike.

Manuel Guitián

Andrew M. Kamarck

Economics and the Real World

University of Pennsylvania Press, Philadelphia, 1983, x + 165 pp., $16.50.

Economic “laws” may not have changed but analytical techniques have, drastically—to an extent that most of the theoretical work being undertaken is all but incomprehensible to the majority of those interested in economic affairs, let alone to the ordinary reader. Economics has come a very long way from the “political economy” of the eighteenth and nineteenth centuries, but the relevance of the present-day “technology” of economics has been questioned by many.

This book gathers the various limitations that afflict the discipline of economics. Two chapters are devoted to the problems of measurement, and one discusses the conceptual difficulties of economics. These are followed by discussions of problems in specific areas of economics, including those in national accounting, the balance of payments, macroeconomic and microeconomic modeling, welfare economics and cost-benefit analysis, and the definitional problems of “capital” and “investment” in LDCs.

Most of Kamarck’s points will be familiar to most responsible economists, and some are rather obvious (such as the statement on p. 60 that the national accounts are not a precise measure of the physical quality of life, welfare, or happiness). The chief beneficiaries of this book will be, to use a term coined by the author, the noneconomist “consumers of economic memoranda.”

After a veritable litany of the shortcomings of economics as currently practiced, the reader will look forward to the author’s conclusions and recommendations. Kamarck’s “operational conclusions” are common-sensical rather than dramatic. In brief: economists (and those who listen to them) must be keenly aware of the limitations of the discipline; they must be more cautious; and they must make greater use of judgment. Specifically, there is need for a greater understanding of the data (their nature, accuracy, scope, and bias) as well as some experience in the actual gathering of data; the current emphasis on the technical sophistication of analytical techniques is to be decried; more work should be done on real-world problems and deductive reasoning should be supplemented by intuition, insight, and judgment; and in the field of policy-making the degree of ignorance about variables and parameters should be better recognized and greater reliance placed on the “Delphi” technique (tapping the experience and judgment of a wide circle of people).

Will Kamarck’s strictures and advice be heeded? As far as the theoreticians and some model-builders are concerned, Kamarck’s advice runs counter to the fashion of the times. He uses the term “science fiction” to characterize the activity of those model-builders more intrigued by technique than applicability. But this tendency is not limited to economics: other fields such as sociology, history, and even literature are proving vulnerable to our modern fascination with quantification, model-building, and technical virtuosity. For many economists, the intellectually stimulating is more gratifying than the “relevant,” but their activities are, by and large, harmless and should be continued, though one may question the resources that are devoted to them. Of course all model-builders cannot be tarred with the same brush: forecasting models are designed with the specific purpose of being relevant and no one (including their creators) will take issue with the contention that they can be improved.

Of more immediate interest for the real world, which is Kamarck’s main concern, is the usefulness of the book to policy-oriented economists and the “consumers of economic memoranda.” How will they react? The niche that economists—in spite of all the deficiencies of their trade—have succeeded in securing for themselves and their consequent responsibility to provide sensible advice are the real problems here. In the real world, government ministers (and company presidents) want answers. They have to make fairly precise decisions on budgets, taxes, money expansion, prices, the level of the exchange rate, etc. Economists could behave in a more cautious, circumspect, intelligent, and wise manner, á la Kamarck. But frequently they are expected to provide precise, simple advice, whatever the shortcomings of the data and the analytical techniques. They, too, live in the real world.

This small, lucidly written book is a pertinent reminder of the pitfalls and shortcomings of our discipline and of the need to address them.

Bahram Nowzad

Michael Beenstock

The World Economy in Transition

Allen & Unwin, Winchester, MA, USA, 1983, xvii + 238 pp., $25 (cloth).

The Transition Theory, the centerpiece of Michael Beenstock’s book, offers an intriguing explanation of the slowdown in growth of the industrial countries since the late 1960s and the accompanying shift in relative world economic power toward the developing countries. In the process, what seemed like purely exogenous events, such as the commodity boom of the early 1970s and the subsequent oil price shocks, become at best contributing phenomena and appear to some extent endogenous to other, more sweeping changes on the global economic scene.

Beenstock postulates that the initial, autonomous change came in the second half of the 1960s. During that period, the growth in manufacturing output of a dozen or so leading developing countries (today’s newly industrialized countries) accelerated from an already strong pace. The increased supplies of manufactured goods from the NICs began to compete successfully with a range of light and a few heavy manufactured goods from the industrial countries. This was possible due to lower wages in the developing countries, held from rising too rapidly by the influx of cheap labor from the countryside into the urban areas.

Sharply increased supplies of manufactured exports by the developing countries pulled up the prices of primary good inputs, thus making an important contribution to the relative rise of commodity prices, including oil. They also put competitive pressure on the manufacturing sectors of the industrial nations. Productivity of capital in the manufacturing sector of the industrial countries fell and resources began moving into the service sector. Industrial countries began to “de-industrialize” and, to the extent that labor could not shift rapidly enough away from manufacturing, unemployment rose.

This view contrasts with the more conventional analysis, which has developing countries linked to and dependent upon shifts in their industrial trading partners—their current account deficits thus driven by the policies of the North. Instead, the Transition Theory suggests that the predominant influence is the industrialization push in the South, which in the process of importing Northern capital for investment causes deficits in the current accounts of developing countries.

After three initial chapters that set out the Theory, the author launches into a set of direct and indirect empirical tests and corroborations of various aspects of his central proposition. The evidence is compelling at times, somewhat stretched at others. Along the way, the relative weaknesses of the empirical underpinnings of the competing Kon-dratieff cycle proposition and several other deterministic long-wave hypotheses are exposed. An imaginative historical section also examines a period (1860–1900) when Britain went through a transition analogous to that being experienced today by the industrial countries, as a result of the rise of the developing countries of that period—the United States, Germany, Russia, and France. The parallels to today’s events are striking, although the length of something that is referred to as “transitory” is disturbing.

Chapters 7 and 8 are perhaps the book’s weakest points. Chapter 7, while presenting an interesting little econometric global model, argues that “OPEC has been responsible to a large degree for the spiral of worldwide inflation and recession since 1973,” which seems to contradict the author’s own basic hypothesis that the recession in the North was largely due to the negative impact of industrial growth in the South. Chapter 8, on the other hand, opts to focus upon developments in the United Kingdom in 1950–80. This choice is puzzling, since the main premise and an attraction of the book is its promised emphasis on explaining the common causes of the slowdown in the North and hence its “global character” rather than the experience of any single economy. The book would have been more effective had these two chapters been omitted.

The concluding chapter covers some policy implications of the Theory. The message is optimistic, based on the author’s assessment that the unemployment created by “de-industrialization” is transitional, a matter of a temporary mismatch of skills and opportunity. It follows that a solution is not to be sought through blocking or offsetting the disruption caused by the industrialization push from the South, for this would distort the efficiency of worldwide resource reallocation. Instead, the industrial countries should focus on their own factor markets, help reduce the rigidities in wages, and help design measures to encourage the unemployed to move to those areas where new jobs are being created. If these steps were implemented, the old rates of growth in output would return, making the relatively stagnant 1970s a period of once-and-for-all adjustment in the rate of growth of the industrial countries.

This would be all very well if the Theory were a one-time explanation of a soon-to-be-extinct phenomenon. But what happens if the industrial push of the first-tier NICs is followed by successive waves of industrialization shocks as new groups of developing countries get on the growth bandwagon? What happens if a string of transitions turns into permanent stagnation?

Peter Miović

Louis T. Wells, Jr.

Third World Multinationals:

The Rise of Foreign Investment from Developing Countries

The MIT Press, Cambridge, MA, USA, 1983, viii + 206 pp., $25.

Why do so many developing country firms produce abroad through some form of foreign investment rather than export goods or enter into licensing arrangements? The author attributes this new phenomenon primarily to protectionist threats to their export markets and to the contractual difficulties of selling their competitive advantages through licensing or other arrangements.

Employing data from overseas subsidiaries and branches established in 125 host developing countries by 963 parent firms from developing countries, Wells finds that the competitive advantages of Third World multinationals stem largely from the relevance of their experience in their own home markets—use of small-scale production technology, locally available inputs, and the manufacture of more appropriate products.

The advantages, however, are likely to be short lived; in most cases local firms in the host markets will be able to copy or develop similar skills. These advantages are also rarely protected by the mechanisms used by developed country multinationals. There is little investment in research and development; scant development of trade names to achieve market differentiation; and infrequent establishment of integrated manufacturing operations across countries to obtain economies of scale. Although the life cycles of many of these subsidiaries will probably be short, total investment flows will not fall off because firms with new competitive advantages will replace those whose advantages have eroded. Overall, Wells infers from these firms’ operations a net benefit to the development process and to international relations—not so much due to economic gain as from an easing of political tensions over the issue of direct foreign investment.

Although some of the hypotheses are tested on limited data and the evidence for some of the conclusions is impressionistic, this is an impressive compilation of data in an area noted for scarce and unreliable figures and includes very instructive examples drawn from interviews in various countries.

Carl Dahlman

William R. Cline

International Debt and the Stability of the World Economy

MIT Press, Cambridge, MA, USA, 1983, 134 pp., $6 (paper).

A comprehensive analysis of the international debt situation and the main areas of public policy response, this book examines the origins of the current debt problem and the potential risk it poses for the stability of the international financial system, and assesses prospects over the next three years. Diagnosing debt problems to be mostly ones of temporary illiquidity rather than insolvency, Cline bases his forward-looking analysis on a simulation model for 19 major borrowers and concludes that debt problems are manageable provided that global recovery is satisfactory—citing the critical threshold OECD growth of 3 percent annually over 1984–86. The recommended policy strategy for industrial countries is to ensure a healthy global recovery and to approach the problem of debt on a case-by-case basis, mainly through country adjustment programs agreed with the Fund, other official financial support as needed, and a maintenance or Increase in commercial bank net lending. Sweeping debt reform proposals and a severe tightening in bank regulations are, Cline argues, counterproductive, as these would choke off needed new bank lending. Contingency plans are preferred to deal with major disruptions. Aiming at a non-economist audience, the study covers all dimensions of the present policy debate and is far more balanced than most writings on the subject. Its one weakness might be that it does not deal more extensively with the consequences of failure to realize the major assumptions.

International Development Research Center

Aquaculture Economics Research in Asia

Report No. 1DRC-193e, Ottawa, 1982, 128 pp.

The ten brief articles in this volume, the proceedings of a 1981 workshop, are a useful source of information on costs and production aspects of fish farming in South and East Asia where fish are becoming an increasingly important source of high quality protein.

Calvin Goldscheider (editor)

Urban Migrants in Developing Nations:

Patterns and Problems of Adjustment

Westview Press, Boulder, CO, 1983, xvii + 287 pp., $22.

This volume confirms current analysis of the economic and social prospects of rural-urban migrants in the developing world. Within a theoretical framework that seeks to explain the economic adjustment process, four case studies of rural-urban migration to Seoul, Surabaya, Bogota, and Teheran present data to illustrate the range of factors that determine the income levels and social mobility of migrants. This comparative review of the findings demonstrates that migrants frequently do better than urban-born residents; whether education is taken into account or not, the data suggest that the self-selection and motivation of migrants go far in integrating them into the labor market in developing country cities. The length of urban residence also explains income differentials within the migrant population, confirming the hypothesis that integration proceeds in phases as migrants take on increasingly remunerative and productive employment the longer they remain in town. The book, however, would have been more useful had it included more complete references to the large volume of country migration studies that already exist.

John Zysman and Laura Tyson (editors)

American Industry in International Competition

Cornell University Press, Ithaca, NY, USA, 1983, 436 pp., $34.95 (cloth).

A collection of essays on conditions in some of the major manufacturing subsectors in the United States that are under pressure from competing imports and the implications of the change in U.S. industrial circumstances for government and corporate policies.

George Macesich


Theory and Policy

Praeger, New York, 1983, xi + 269 pp., $31.95 (cloth).

An extended and reasonably up-to-date review of the debate between monetarists, fence sitters, and Keynesians, on the suitability of monetary and fiscal instruments for the conduct of macroeconomic policy.

Daniel Yergin and Martin Hillenbrand (editors)

Global Insecurity

Penguin Books, New York, 1983, ix + 427 pp., $6.95.

This is a book with a purpose: to alert oil importing countries to the inevitability of recurrent oil scarcity and to the importance of formulating a coherent energy strategy. The opening chapter, by Daniel Yergin, gives a good analysis of the past oil shocks, the main elements of global adjustment, and the issues affecting the continuance of the adjustment process: the manner in which oil prices move, the rate of investment, and protectionism. The meat of the book presents two main oil scenarios—a moderately tight energy balance and a dangerously taut one, with periodic references to a third, more foreboding, possibility of a drastic curtailment of oil supply. The reasoning for these scenarios is well developed in a chapter by Robert Stobaugh. The remaining chapters on the United States, Japan, and Europe add the occasional insight and additional information but little by way of analysis. The chapter on developing countries is valuable but follows closely the World Bank’s analysis that is available in other publications. Though a useful introduction to energy policy, the book fails to provide more penetrating analyses of key issues. There is only a cursory evaluation of the future role of coal and nuclear energy, and while several chapters stress the importance of moderating energy demand, there is little analysis of the effectiveness of policy in this area.

Primary Health Care:

The Chinese Experience

World Health Organization, Geneva, 1983, ix + 105 pp., SwF 14.

The success China has enjoyed In providing basic medical services has attracted much attention. While political commitment and social organization played a major role, the structure of the health care system and the mode of financing used were no less important and can conceivably be adapted by other countries. This slim volume, the outcome of a seminar conducted in China in June 1983, describes three aspects of the health care system in China: its structure, the organization of health manpower, and the financing of medical services. It should be a helpful introduction for health administrators in developing countries.

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