Abbas Mirakhor and Peter Montiel
After the onset of the international debt crisis of the early 1980s, economic growth in developing countries slowed markedly, especially in countries which are heavily indebted, which have borrowed extensively in private financial markets, and have experienced recent debt-servicing problems. Once the average population growth rate of 2–3 percent a year is taken into account, it is clear that real per capita incomes in these countries have failed to increase, or even contracted, thus far in this decade.
The challenge before the international community is to help countries with debt difficulties restore growth, while at the same time promoting adjustment. The trade balance of developing countries is of key importance to resolving these problems. Unfortunately, improvement in trade balances usually has been brought about by reducing import volumes, rather than by increasing exports. Continued reliance on import compression promises serious repercussions for a country’s short- and medium-term growth, unless reductions in its import intensity of growth—the rate of growth in the import to output ratio—can exert an offsetting influence.
Import compression for adjustment
For capital-importing developing countries, adjustment has implied very abrupt improvements in their trade balances. As a group, their trade balance increased from a negative $67.2 billion in 1981 to a positive $9.9 billion just four years later. During the same period, countries with the most severe debt problems also made impressive relative adjustments: in particular, the 15 heavily indebted countries increased their trade surplus by $47.4 billion.
Trade balance adjustments of these magnitudes became mandatory after mid-1982, as developing countries faced a virtual drying up of private capital inflows and massive obligations on high-interest debts run up prior to 1981. An indication of the burden of interest payments in the adjustment process is the fact that in 1985 capital-importing countries paid $79 billion in interest on their debt (14 percent of export earnings), of which sum the 15 heavily indebted countries paid over half ($43 billion or 29 percent of export earnings).
Factors both external and internal to indebted developing countries have worked to bring about heavy reliance on import compression rather than export growth in the adjustment process. Chief among the external factors has been slow average growth in industrial countries during 1982–85 and protectionist policies limiting access to their markets, which reduced the demand for exports. Internal factors concern chiefly inappropriate incentives for exports, including overvalued currencies, commercial policies designed to promote import substitution, and inefficient public investment.
For a significant number of developing countries, the growth in export volume has not kept up with its 1973–81 pace. Lagging exports coupled with adverse terms of trade movements in recent years have meant that the burden of trade balance adjustment has fallen on imports. In fact, the volume of imports for developing countries in the aggregate actually shrank during 1982–85. For the 15 heavily indebted developing countries, imports contracted by an annual average of over 10 percent in real terms (see table).
The prospect that the supply of external financing will continue to be limited over the medium term implies that the large adjustment in the trade balance achieved by many developing countries over the last four years will need to be sustained. Achieving this objective, of course, will involve some combination of stimulating the growth of exports and continuing to restrain that of imports. In view of the likely magnitude of the adjustment in the trade balance that must be sustained over the medium term and of current prospects for growth in world markets, there is little likelihood that the growth of import volumes in indebted developing countries can be sustained at pre-1982 rates in the foreseeable future. How, then, can desirable levels of real income growth be restored in these countries?
Import intensity of growth
Prospective levels of economic growth in developing countries over the next few years can be analyzed as the difference between two components: the rate of growth of real imports, that is, the degree of import compression, and the rate of growth in the import to output ratio, or the import intensity of growth. Analyzing growth from this perspective is useful because the quantity of real imports is often perceived to be closely linked to the level of real economic activity. This is so not only because developing countries typically import a large proportion of intermediate and capital goods needed for current production and future growth of productive capacity, but also because higher real incomes typically result in increased demand for consumer goods, including those produced abroad. Thus, continued import compression in developing countries is likely to stunt their short- and medium-term growth, unless reductions in the import intensity of growth can exert an offsetting influence.
|Growth rate of GDP1||Growth rate of imports2|
|By financial criteria|
|Capital importing countries||5.7||5.1||3.2||6.9||7.3||–0.5|
|Countries with recent debt-servicing problems||5.5||4.5||0.7||5.9||6.2||–7.2|
|Countries without debt-servicing problems||5.8||5.6||5.7||7.7||8.4||3.8|
|By miscellaneous criteria|
|Fifteen heavily indebted countries||6.1||4.8||0.4||7.2||8.2||–10.1|
|Small low-income countries||3.0||3.5||3.2||1.2||2.4||1.0|
Nominal GDP daflatad by me GDP deflator.
Nominal imports deflated by the import price index.
Nominal GDP daflatad by me GDP deflator.
Nominal imports deflated by the import price index.
One way to assess the scope for such an offsetting influence is to examine the historical relationship between imports and growth. During the high-growth period of 1973–81, the rate of growth of imports for developing countries exceeded that of output (see chart) by about 4 percentage points (see table). Furthermore, as illustrated in the chart, during these years the excess of import growth over output growth was, with the exception of 1975, fairly constant. This would suggest that a stable relationship exists between these variables and that the scope for sustaining growth by reducing its import intensity may be limited.
Nevertheless, this period may have been unusual. To assess whether this is so, it is necessary to investigate the factors that may have affected the import intensity of growth during the period. Economic theory suggests that the growth of import volume associated with a given rate of expansion of real output depends on a number of such factors, which include the following.
Terms of trade. The more favorable a country’s terms of trade, the larger will be its domestic income. This will stimulate additional consumer spending, which will be reflected in larger levels of imported consumer goods. In addition, greater profitability of domestic production may encourage domestic investment, leading, in its turn, to additional imports of capital goods.
Real interest rate. A decrease in the real interest rate will tend to stimulate current consumption, including that of imported goods. At the same time, low interest rates encourage the purchase of imported capital goods and are conducive to the accumulation of inventories of imported intermediate goods.
Real exchange rate. Demand for imported consumer, intermediate, and capital goods depends on the price of such goods relative to their domestically produced counterparts. An appreciation of the real exchange rate is associated with a decrease in the relative price of imported vis-à-vis domestically produced goods, thus increasing the demand for such goods. The strength of this effect will depend, of course, on the degree of substitutability between imports and domestically produced goods.
During 1973–81, these three factors behaved in a way that stimulated import demand, contributing to the “import bulge” of the period. Capital-importing developing countries experienced very favorable changes in their terms of trade during 1973–74, an improvement which continued until 1982, despite a partial reversal at mid-decade. Similarly, international real interest rates were negative during most of 1976–79, achieving significant positive levels towards 1981. The experience among developing countries with regard to real exchange rates was mixed. Many large countries in Latin America and smaller ones in Africa underwent periods of significant real exchange rate appreciation—an experience which Asian countries, by and large, avoided.
Consequences of compression
The severe import compression that has been observed in developing countries since 1982 can be attributed in part to a reduction of the rate of growth of real output and in part to a drop in the import intensity of output. The rate of growth of real imports for capital-importing developing countries slowed from an average value of 8.7 percent per year in 1973–81 to negative 1.6 percent during 1982–85. This drop of 10.3 percentage points in the growth rate can be broken down to a 3.3 percentage decrease in the output growth rate and a 7 percentage point drop in the average import intensity of growth. The drop in import intensity of growth is due in part to a reversal of the factors which had stimulated an unusual increase in import intensity during 1973–81. Terms of trade for capital-importing developing countries had deteriorated during 1982–85, with their terms of trade index averaging 4 percent below its 1973–81 level. International real interest rates have persisted at high levels, rising to an average of 19.6 percentage points above their 1973–81 level. In addition, in response to these factors and to the international debt crisis, many developing countries have sought to improve their competitiveness in world markets through more flexible exchange rate policies, often with Fund and Bank support.
The combination of these factors, together with the slowdown in output growth, would have contributed to an important contraction in import growth. But import compression has proceeded beyond what can be attributed to these factors. Import demand equations incorporating these factors and estimated during the 1973–81 period, both for individual countries and for groups of countries, do not produce the expected results for 1982–85. They greatly overpredict imports, that is, they exhibit large negative residuals.
A possible explanation is that households and firms in developing countries have been unable to satisfy their desired demand for imports, that is, they are no longer operating on their “notional” demand curves for imports. This observation is consistent with evidence that quantitative restrictions on imports and on foreign exchange have become much more severe in developing countries in the period since the onset of the debt crisis, in spite of the well known efficiency costs such restrictions are known to entail. Such losses have been judged to be less costly in terms of output forgone than additional reductions in aggregate demand. Nonetheless, the cost of such measures is likely to increase over time as inventories of imported materials are drawn down and as imported producer and consumer durables wear out. Available evidence suggests that the drawdown on stocks has continued throughout the period. In 1985, for example, the contribution of stock building to growth of demand was substantially negative.
Other important effects
Since many of the imports of developing countries are made up of intermediate and capital goods, the severe import compression of the past several years has been associated with reduced levels of investment and capital formation. In fact, evidence suggests that weakness of investment has been a most disturbing feature of the economic performance of recent years.
Retrenchment of investment, which is the main domestic counterpart to the adjustment in the external current accounts, has occurred both in the public and private sectors of developing countries. Private investment has been affected because import compression tends to reduce anticipated rates of return. In addition, private investment has been “crowded out” by increased pressure of public sector demand on domestic savings to finance external debt-service payments. Public investment has been reduced primarily because of the political sensitivity to reductions in some categories of current expenditures in the public sectors and, again, because of the massive increase in interest payments on government debt.
The prolonged period of import compression in developing countries, coupled with the probable role that quantitative restrictions and foreign exchange rationing have played in producing this outcome, lead to the conclusion that a large unsatisfied demand for imports currently exists in many developing countries. Existence of this demand suggests that future reductions in the import intensity of growth cannot be expected to offset the continued slow expansion of import volume, thereby permitting the resumption of desirable levels of economic growth in developing countries. Although it would be a positive step to replace quantitative restrictions on imports and foreign exchange rationing by continued improvements in external competitiveness, such improvements cannot be expected, in the presence of a substantial unsatisfied demand for imports at current real exchange rates, to have a significant favorable short-run impact on the import intensity of growth under present circumstances.
Furthermore, realistic depreciation of the real exchange rate in developing countries may not be sufficient to raise the market price of foreign exchange to the price that is needed to clear the markets without controls. If this is the case, then the import intensity of growth is likely to increase in the short run if quantitative restrictions and foreign exchange rationing are removed to enhance efficiency in the allocation of foreign exchange.
In short, evidence that import compression over the last several years has forced households and firms in developing countries off their notional demand curves for imports has left these countries and the international community in a policy quandary. The current situation has been sustainable over the short run to an important extent through administrative controls. Because of the unsatisfied demand for imports, relaxing these controls without very substantial improvement in competitiveness could cause the short-run import intensity of growth to overshoot its long-run level, though the latter is more likely to approximate the experience of the more normal pre-1973 period than what occurred during the “import bulge” period of 1973–81.
With this temporary overshooting of the import intensity of growth, either the rate of expansion of import volume will have to increase or the rate of economic growth must continue at low levels. Increased import volume will require some combination of faster growth in industrial countries, increased access to industrial country markets, or a marked reduction in international real interest rates if import expansion in developing countries is to be reconciled with only marginal increases in indebtedness. If continued slow growth in developing countries is to be ruled out, the only remaining alternative is a significant expansion in the net flow of resources to these countries from the international community.
Capital-importing developing countries: growth rate of real output and real imports
Source: International Monetary Fund. World Economic Outlook, April 1987.