Journal Issue


International Monetary Fund. External Relations Dept.
Published Date:
June 1987
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Stanley Fischer

Indexing, Inflation, and Economic Policy

MIT Press, Cambridge, MA, USA, 1986, xi + 490 pp., $25.

This collection of Stanley Fischer’s previously published papers has, unlike many volumes of this sort, a clear unifying theme. The individual chapters are held together by four very useful introductory notes. The basic problem addressed by the volume is one the author identifies as the fundamental question in monetary economics: “Why does money matter?” As with all really important questions, this sounds simple, but is not. Answers are elusive.

The first section of the book attempts to clarify and, to some extent, quantify the costs of inflation. The basic puzzle here, and it is a theme repeated throughout the volume, is that wage and financial contracts, tax systems, and other institutions in most industrial countries seem to assume the existence of a stable price level. Given these arrangements, inflation imposes costs on the community as a whole and generates arbitrary redistributions of income. The author argues that the quantitative evidence presented supports the view that the welfare costs of high inflation, even if inflation is expected, are large in the current US economy.

The second and third sections of Fischer’s essays deal with indexation in labor and capital markets. After pointing out that the degree of indexation in the economy is endogenous, in that it reflects past inflationary experience, the author provides a key insight by asking why contracts are generally so simple. It is easy to show that typical wage and financial contracts have unwanted real effects in some circumstances. It is not easy to understand why such contracts are widely utilized. While the author does not solve this riddle, the reader will be rewarded with a clear discussion of how monetary economies that depend on simple contracts behave.

The final section of the volume addresses policy issues. Here the author provides a clear exposition of the controversy surrounding the role of monetary policy in models that assume rational expectations. The issue of consistent behavior of the monetary authority over time is also addressed. Finally, two essays deal with recent Israeli experience with high inflation.

Perhaps the volume’s greatest contribution is the author’s insistence on utilizing theory to understand the institutions that actually exist in industrial countries today. Wage and financial contracts, as well as the behavior of national and international monetary authorities, will continue to evolve in response to economic conditions. Analysis of how this institutional framework provides, and perhaps distorts, signals for economic behavior is the essential task for economists interested in policy issues.


Les vertiges de la finance internationale

Henri Bourguinat

Economica, Paris, 1987, 295 pp., 98 F.

This readable and topical book examines recent developments in the international monetary system and sketches the author’s solutions for the problems he perceives. Bourguinat sees the present system as fragile and he faults, in part, the systemic changes related to the increasing global interdependence of financial markets and the coexistence of the developing country debt crisis and US fiscal deficits.

Bourguinat observes that given reduced transactions costs, “securitization,” and an expanded volume of currency trading, exchange rates will increasingly reflect financial, rather than real, factors. The ability of governments to “manage” their exchange rates is also diminished. The author evokes the fear—raised notably elsewhere by Stephen Marris—of a sudden shift in portfolio preferences away from the dollar and expresses concern that the dollar would be a weak pillar for the international monetary system.

Another worrying development for Bourguinat is the debt overhang, or what he terms the overdraft economy (I’économie de découverts). Bourguinat discusses the developing country debt problems and the increasing indebtedness of the US Government and of the United States generally vis-à-vis the rest of the world. He also highlights the increase in the ratio of corporate debt to equity. A system with a high level of debt is more likely to be vulnerable to shocks and the resulting pressure on debt-financing abilities of individual debtors or debtor countries could lead to a financial crisis.

What changes might strengthen the international monetary system? Bourguinat argues for greater fixity of exchange rates and lower capital mobility. The author is somewhat agnostic, however, concerning how these could be achieved. He discusses John Williamson’s target zone proposal, Ronald McKinnon’s plan to target the world money supply, and the possibility of anchoring exchange rates to gold or a commodity standard, pointing out some difficulties in implementing each. He also considers the European Monetary System a possible model for a global system, and argues (quite rightly, in my opinion) that there are factors that make it unique to that regional block, and that its cohesion is aided by capital controls. He favors a global system that taxes foreign exchange transactions rather than capital controls per se. Since such a tax would affect annualized returns on short-term investments much more than on long-term ones, it would, in his view, serve a useful purpose in discouraging speculative flows. The author is much too sanguine, however, about the possibility of effectively imposing such a tax. It would, I believe, simply induce a shifting of exchange markets “offshore” to countries that did not participate.

Well-reasoned and accurate though it is in its review of recent developments, the book is unduly severe, I feel, in its judgment of the performance of the present system. A “hard landing” of the dollar has been predicted for at least three years now. It may still occur, but what we have seen since early 1985 is an orderly and gradual depreciation of the US dollar. While the strong appreciation of the dollar in 1980-85 was perhaps undesirable, the exchange rate system should not be faulted so much as the policies followed by major industrial countries. The remedies Bourguinat proposes seem, in fact, to deal with symptoms rather than causes. I do, however, agree with Bourguinat’s contention that greater policy coordination will be needed if exchange rate “misalignments” are to be minimized in a world of increased capital mobility.

PaulR. Masson

D.K. Fieldhouse

Black Africa 1945-1980 Economic Decolonization and Arrested Development

Allen and Unwin, London, England, 1986, xix + 260 pp., £25.

Debate about the African economic crisis has moved somewhat beyond the sterile polarities of a few years ago. There is better understanding in the international community of how severely exogenous factors—for example, climate, commodity markets—have affected development efforts, and of what limited resources African countries possess to overcome economic adversity. And there is greater acceptance within Africa of the responsibility governments and leaderships bear for gross policy errors and mismanagement in the past, and for initiating difficult policy reforms and economic reconstruction now.

But most of the discussion has been curiously ahistorical, lacking any convincing connection between the generalized crisis of the 1980s and the particular economic and political circumstances from which individual states emerged. Professor Fieldhouse’s fine book goes a long way to remedying this shortcoming.

The book offers a detailed examination of Africa’s colonial economic inheritance. Its judgment is bleak. Although there was impressive growth in 1945-60, the predominance of low-productivity agriculture, low levels of industrialization and infrastructure, and a small savings and investment capacity “were hallmarks of limited development and a low-level equilibrium poverty trap.” The political reality, beneath the euphoria of nationalism and independence, was also sobering: political leaderships dependent on the state bureaucracy and on fragile ethnic conditions, “encumbered with layers of claimants to power and wealth whom they could not satisfy…and…saddled with promises of rapid economic and social development which were unrealizable.”

Against this background, Fieldhouse weighs the merits of “policy” and “non-policy” (e.g., drought, terms of trade, indebtedness, cultural attitudes) explanations for poor African economic performance. Nonpolicy factors were important but not decisive, and their impact was magnified by “policy” errors which frequently served to accelerate impending economic disaster.

The heart of the book is six case studies reviewing policy performance in Ghana, Nigeria, Kenya, Tanzania, Côte d’lvoire, and Senegal. These cases very effectively exemplify the broad themes of the book. They also dispose enpassant of some of the more obviously banal characterizations of the Black African economic crisis—for example as a continent awash in a sea of socialism, or alternatively caught in the vice of neocolonialism. Neither socialism nor imperialism, these cases suggest, seemed able to get much grip on a stubborn and discouraging African reality.

Fieldhouse’s conclusion is that most African governments took the worst of all possible paths away from colonialism: they retained the least progressive aspects of the colonial legacy (such as the autocratic state), but did away with the low-level stability and security of the colonial economy without really being able to replace it with an enduring alternative.

“Growth resulted from booming exports, unexploited domestic tax potential and huge injections of foreign capital; it did not reflect structural development in Black Africa. When it was no longer possible to extract so large a surplus from the peasants and foreign borrowing became prohibitively expensive at a time when commodity markets were depressed, most African states found themselves virtually bankrupt.” The path back from bankruptcy, Fieldhouse suggests, will be long and difficult, and requires that African governments (and by implication their external financiers) tackle the structural economic weaknesses which both colonial and post-colonial regimes had avoided, or at any rate had failed to overcome.

There this elegant book ends. A pity, since it would have been instructive (if probably rather daunting) to have current efforts at policy reform and structural adjustment, recent and uncertain though they are, judged from its cool historical perspective.


International Transactions in Services

Karl P. Sauvant

The Politics of Transborder Data Flows

Westview Press, Boulder, CO, USA, 1986, xvii +

372 pp., $38.50.

Gerald Faulhaber et al (editors)

Services in Transition

The Impact of Information Technology on the Service Sector

Ballinger Publishing Co., Cambridge, MA, USA, 1986, xix + 218 pp., $29.

Both these volumes on information technology begin by pointing out the importance of the service sector in modern economies and decrying the lack of attention that both economic theory and empirical research have paid to services in general and the special subject of the books in particular. As a result of an intellectual bias in favor of the goods sector, issues relating to services are poorly understood and have been all but ignored in the formulation of economic policies in most countries.

Sauvant begins by presenting a considerable amount of detailed information on the evolution and impact of data service industries. Data services are termed a core service, as they change “the parameters for the operations of most other services and indeed most economic activities.” After a review of conceptual issues and available data on international trade and direct foreign investment in data services, the book describes the interests of different groups of countries in developing an international regulatory framework covering transborder data flows. The last two chapters give a thorough account of the main international negotiations in bilateral and multilateral forums to develop rules covering trade and direct foreign investment in data services. The volume’s more than 370 pages of rather small print contain an enormous amount of valuable reference material on transborder data flows and the more general but very topical issue of trade in services.

The volume edited by Faulhaber, Noam, and Tasley is a collection of papers and comments presented at a conference on the role of information technology held at the Wharton School of the University of Pennsylvania. Both in focus and quality, the eight chapters form a rather heterogeneous collection. They include several theoretical papers on the role of information technology in services and industry in general; three describing development and use of information technology in the US health care, insurance, and financial services industries; and one on issues relating to international trade in services. The essays give a picture of a field of research in its infancy, where problems center on defining and clarifying concepts and categories, and on organizing available information into a form that allows testing of hypotheses. Nevertheless, they contain interesting insights on the role of information in development of the service sector, that are likely, as in the expressed hope of the editors of the volume, to spark further work on what is a long agenda of academic research and public policy debate.

J. Paljarvi

Robert E. Looney

The Political Economy of Latin American Defense Expenditures

Case Studies of Venezuela and Argentina

Lexington Books, Lexington, MA, USA, 1986, xxii + 325 pp., $39.

The developing countries as a group doubled their defense expenditures in the decade after 1973. A large part of this growth was the result of the more than triple jump in such expenditures attributed to OPEC countries. In 1985, military expenditures in the Third World accounted for some 20 percent of global military spending, up from an 8 percent share in 1960. About 26 developing countries now produce military hardware; some are becoming important exporters. In a period when many developing countries are facing economic hard times (with their medium- and long-term external debt, for example, having increased from $68 billion to $686 billion and debt-service payments having leapt from $9.3 billion to $100 billion over 1970-84), attention is now focusing on the growth of military expenditures and their effects on economic development and financial stabilization in the Third World.

The book’s title promises more than it delivers. In fact, it produces only a partial picture based on statistical analysis rather than a political economy approach. The author tests the relationship of military expenditures with a wide range of factors, including, interalia, GNP, external debt, capital inflows, current accounts, and the share of public consumption in GDP. The broad results indicate, among other things, a high correlation between increases in per capita income and per capita military spending, and an association between the latter and increases in public external debt. Economic resource constraints are seen as a major factor explaining the differences in the defense burdens of developing countries. A high level of technology transfer and access to foreign exchange (through increased public external debt or exports) help explain the growth of indigenous arms industries.

Having established the use of regression and discriminant analysis for developing countries as a group, Looney applies these techniques to Venezuela and Argentina in an effort to explain the relationship between socioeconomic conditions and military spending in those countries. Rather surprisingly, he downplays the importance of political instability as a major explanatory variable.

In doing so, Looney appears to ignore the fragmentation of global power into a number of loci, regional conflicts, and social upheavals within emerging societies attempting to develop rapidly while trying to maintain traditional national identities and social values. All these factors have created an uncertain world. In the absence of internationally guaranteed security against external threats, developing countries have found it necessary to be prepared to defend their fragile boundaries against predatory neighbors. In many cases, domestic political confusion has led to the emergence of military and quasi-military dictatorships that rely on armed force to maintain control and that nurture a large military establishment to sustain their power. The rapidly rising costs of increasingly sophisticated military hardware have added to the burden of military expenditures. Any attempt at analyzing the “political economy” of military expenditures must take into account these broader, though much less quantifiable, factors.

Shuja Nawaz

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