Article

Sharing the Oil Deficit

Author(s):
International Monetary Fund. Research Dept.
Published Date:
January 1975
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I. Introduction

ANDREW D. CROCKETT and DUNCAN RIPLEY *

It is clear that a number of major oil exporting countries will continue to have large structural surpluses in their current accounts for several years to come and that these surpluses will have as their counterpart capital outflows to the rest of the world. If the adjustment process is to operate smoothly,1 the aggregate surplus of the oil exporting countries must be reflected in a pattern of current account deficits which is both acceptable to the individual countries concerned and capable of being financed by sustainable capital inflows.

Starting from the proposition that the capital and current accounts for each country will sum to zero in equilibrium, this paper approaches the problem of reconciling current account objectives by considering what would constitute an equilibrium pattern of capital flows in the new situation. It discusses some of the economic considerations relevant to an optimal and sustainable pattern of capital flows over the medium term. Although no very rigorous framework for combining these considerations is provided, several distributional schemes for sharing the oil deficit are presented as a focus for further discussion. The substantial differences between the pattern of deficits thus derived, and the actual effect of oil developments on the current account positions of individual countries, serve to highlight the need for a coordinated approach to the establishment of balance of payments objectives.

It is widely accepted that, at present oil prices, the current account surpluses of certain oil exporting countries cannot be eliminated even in the medium term, and that they must be financed through a willingness on the part of the rest of the world to incur deficits. It is also accepted that the medium-term pattern of capital inflows from the oil exporting countries will not match the pattern of increased current account expenditures for oil (the oil “impact effect”). To permit countries to finance their higher oil expenditures—either through capital inflows or an increased surplus in their nonoil trade balances—a radical reordering of payments objectives is called for. But while these general principles meet with widespread agreement, it is much less clear whether the individual current account deficits which the oil importing countries would like to incur will add up to the total deficit to be shared.

The size of the shifts in the countries’ trade balances, coupled with the rapidity with which they have occurred, increases the possibility of inconsistent external policies being pursued by individual countries, unless special efforts are made to prevent these inconsistencies from arising. It is desirable to avoid such inconsistencies, since the uncoordinated reconciliation of national objectives will at best tend to result in a mis-allocation of resources and at worst may lead to competitive external policies even more harmful to the general welfare. The existence of accepted guidelines for the management of floating rates mitigates these dangers considerably. However, for effective implementation, the guidelines require some notion of what constitutes a medium-term equilibrium in the current account.

Since, in the absence of reserve movements, the capital account must balance the current account, some forecasting of future capital flows is necessary to arrive at any view on how current account deficits should be allocated. A matching of the capital inflow with the current account deficit can be brought about by forecasting how capital will flow, and by then taking measures to adjust the current account; or by assessing where capital ought to flow, and then taking measures to adjust both the capital and current account. (A combination of the two approaches is also possible.)

Unfortunately, there is a lack of information on where capital would flow in the absence of official action. Past experience is of limited usefulness in making projections for the future, since the sums involved now are so much larger than in the past and the countries controlling these flows have had little opportunity to demonstrate their investment preferences.2 Security considerations (relating to both the assured capital value of the investment and its yield) may be of particular importance to the creditor countries, but just how these countries will assess investment opportunities in terms of risk is not clear. In addition, it is probable that these investors may prefer at least initially to hold liquid assets, and the returns on these assets are particularly sensitive to the relative stances of national monetary policies.

Because of these difficulties, the approach followed here is to determine a pattern of capital flows based on efficiency criteria and to use this as a guide for distributing current account deficits among countries. For those who feel that the pattern of capital flows should not be guided by official action, this approach may be viewed as a short-term response to a lack of adequate information; for others, it may be viewed as a normative approach, since capital movements are affected by national monetary policies in any case, and by a number of market influences that it may be desirable to counterbalance in order to achieve an optimal allocation of investment.

Although in principle the analysis should be applied to all countries, this paper deals only with the allocation of the oil deficit among the developed countries. This is partly to keep the discussion within manageable bounds, and partly because noneconomic considerations are likely to play a more important role in capital flows to developing countries. Furthermore, the rather sweeping assumptions that are necessary to derive results are likely to be more realistic if applied to a relatively homogeneous group of countries.

It should also be noted that the analysis applies only to the additional balance of payments flows resulting from the oil price increases. It is therefore implicitly assumed that pre-existing objectives in the balance of payments area, whether or not strictly optimal from an efficiency point of view, can be accepted as “given” in the present analysis.

The paper begins by discussing sequentially how the increased capital flows from major oil exporting countries are likely to affect savings and investment, both in the short term and medium term. With certain simplifying assumptions, a scheme is devised for the efficient allocation of a given increment to global investment. A parallel section on how to allocate most efficiently a fall in savings is also presented, although it seems reasonable to assume that most governments would prefer a capital inflow to be reflected mainly in an increase in domestic investment rather than a reduction in domestic savings. These schemes of allocation are essentially static and involve an implicit assumption of given exchange rates. The implications of relaxing this assumption are examined, and the likely influences of institutional and confidence factors are considered. A concluding section summarizes considerations relating to an optimal sharing of the oil deficit and makes simple suggestions for combining the readily quantifiable approaches. Appendix I sets out in a somewhat more rigorous manner the assumptions behind several of these approaches.

II. Effects on Savings and Investment

The inability of many oil exporting countries to spend their higher receipts in the short term or medium term may be thought of as an outward shift in the world savings schedule.3 In order to ascertain the consequences of this increase in savings, however, it is necessary to make certain assumptions about the shape of the savings and investment schedules, as well as about the nature of government policy responses. It is well known that a sudden increase in thrift can generate a circular contraction in incomes if investment is not perfectly responsive to the greater availability of savings. It is assumed here that policy responses are geared to maintaining real output (full employment) in each country.

The degree to which the additional savings by the major oil exporting countries has to be offset by deliberate policy action4 on the part of other countries depends to a considerable extent on whether one takes a Keynesian or a monetarist view of income determination. Under an extreme monetarist view, a current account deficit that was precisely offset by capital inflows would not affect aggregate demand, since it would have no effect on money balances. There might, of course, be a change in the distribution of expenditure, since the shift in the world savings schedule would be expected to reduce interest rates and thus encourage capital accumulation at the expense of current consumption. Under Keynesian assumptions the reduction in real income in the oil importing countries, caused by the deterioration in the terms of trade, would be a more potent factor in reducing current consumption than the greater availability of finance would be in increasing investment. Thus additional measures would have to be taken to preserve full employment equilibrium. In a rather longer-term perspective, however, both Keynesian and monetarist approaches would imply a new savings-investment equilibrium at full employment with a somewhat lower interest rate and a somewhat higher volume of investment.

The extent to which the additional savings generated in the oil exporting countries may find their counterparts in additional real capital formation in the rest of the world, or in a reduction of savings there, is important in determining the optimum pattern of international capital flows. This is because it cannot automatically be assumed that increases in investment should be allocated in the same way as reductions in savings.

There is, however, no very satisfactory way of establishing just how the distribution of expenditure between investment and consumption will be affected by the present situation. Most experience suggests that the availability of savings is not a particularly important short-term constraint on investment in developed countries; and this would suggest that private investment would not increase very much, at least initially, in response to the greater availability of savings from the oil exporting countries. However, to the extent that there is substantial need for structural changes in many economies, particularly the need for investment in energy conservation and in alternative sources of energy production, capital formation may well increase. Furthermore, governments may undertake investment projects in the public sector in preference to encouraging domestic consumption as a means of maintaining full employment.

Rather than make necessarily tentative assumptions about the precise nature of policy responses and about the relative sensitivities of savings and investment to interest rates and real income, the analysis in this paper proceeds in two stages. It is first assumed that the additional savings of oil exporting countries are fully reflected in new investment in the rest of the world, and optimal allocation schemes are derived based on this assumption. Secondly, the assumption of no additional investment is made so that maintenance of full employment requires a large reduction in savings by the oil importing countries, brought about through a reduction in the average propensity to save; how this reduction in savings might be allocated is examined. In principle, the results of the two approaches can be combined to reflect what is perceived to be the most likely or appropriate response of savings and investment.

III. Distribution of a Given Increase in Investment 5

This section focuses on how best to distribute among countries an increase in global investment for a given time period. This is a problem of static allocation, since the only factor that has changed is the level of capital formation. Clearly, the optimum distribution of a given volume of investment from a global perspective equalizes the (expected) marginal efficiency of capital in all employments. However, no reliable figures are available on the marginal efficiency of capital in different countries or on how this would change with additional investment, all other things being equal.6

To arrive at an optimal distribution of this additional investment, therefore, a number of simplifying assumptions are needed. One such assumption would be that the marginal productivity of capital is the same in all developed countries. This assumption could be justified on the grounds that substantial discrepancies in capital productivity tend to be eliminated by differential rates of capital accumulation and by capital movements across national frontiers.

A second and perhaps more important assumption that is needed relates to how the marginal product of capital will change in response to additions to the capital stock, all other things being equal. The most straightforward assumption would be that, at any one time, proportionate additions to the capital stock in different countries would result in equal reductions in the marginal efficiency of investment. In other words, equality in the marginal productivity of capital would be preserved between countries when the capital stock of each country increased by the same proportion. This assumption is more easily justified in an analysis that is essentially static and is restricted to developed countries, since these countries have reasonably similar technologies and face similar constraints on factor availability.

If both of the foregoing assumptions are accepted, it follows that the additional capital from the oil exporting countries should flow to other countries in proportion to the existing capital stock of these countries. The problem then reduces to one of deriving comparable estimates of the capital stock of the countries being considered in the analysis. Direct estimates of capital stock could be used in this context, but in general these are of rather doubtful reliability. However, it might be assumed that a country’s gross national product (GNP) is proportionate to its capital stock.7 It would then follow that the optimum distribution of the additional capital would be one in which countries received inflows in proportion to their shares in GNP; the shares of industrial countries in the GNP of developed countries are shown in Table 1. The implications for the capital receipts of a single oil importing country based on this type of distribution are worked out in Appendix I.

Table 1.Factors Relating to the Optimal Allocation of Investment(In per cent)
CountryGross National

Product as

Percentage

of Total
Gross Investment

as Percentage

of Total
Average

Share
United States43.035.039.0
United Kingdom5.84.75.2
Austria0.81.11.0
Belgium-Luxembourg1.41.31.4
Denmark0.80.80.8
France7.48.68.0
Germany9.711.410.5
Italy4.43.84.1
Netherlands1.71.81.8
Norway0.50.70.6
Sweden1.61.51.6
Switzerland1.11.51.3
Canada3.93.83.8
Japan10.916.913.9
14 Industrial countries93.092.993.0
Other developed countries7.07.17.0
All developed countries100.0100.0100.0
Note: Original data and sources are given in Appendix II, Table 5. All of the figures are based on 1972 data.
Note: Original data and sources are given in Appendix II, Table 5. All of the figures are based on 1972 data.

The assumptions concerning capital productivity made above imply that, all other things being equal, the rates of capital accumulation ought to be the same across countries. Since this clearly has not been the case, it is useful to consider to what extent differences in rates of accumulation call in question the underlying static assumptions about the productivity of investment, as well as reflect different rates of growth of other factors of production (for example, the labor force).

There are several reasons why the marginal efficiency of capital in one country may decline less rapidly than in others when additional investments are made. For example, there may be differences in the availability of complementary factors of production such as skilled labor.8 A situation in which the marginal efficiency of investment declines less rapidly in one country than in another, assuming that these countries have identical capital stocks, is shown in Chart 1 where r represents the marginal efficiency of investing in an additional unit of capital, and I represents the amount of investment. According to the chart, proportionate increases in the capital stocks of countries A and B would result in a greater fall in the marginal efficiency of capital in country A than in country B.

Chart 1.Differences in the Marginal Efficiency of Investment Schedules for Two Countries

(Assuming that the capital stocks are equal)

An alternative possibility is that high investment countries have deliberately accepted a lower marginal productivity of capital and have oriented their domestic policies so as to increase the rate of capital formation and maximize growth. This is shown in Chart 2, where the high investment country faces the same schedule of investment possibilities as the low investment country, but by accepting lower marginal productivity has a higher investment level. (In a riskless situation, it should be noted that this result could come about only if there were imperfections in the world capital market or if policies were followed that encouraged investment in certain countries.)

Chart 2.Countries with Identical Marginal Efficiency of Investment Schedules, but with Different Levels of Investment

(Assuming that the capital stocks are equal)

The reasons why investment levels may differ between countries have an important bearing on the question of the optimum allocation of a given increment to world investment. Insofar as a high investment level is associated with a rate of return that declines more gradually in response to increments to the capital stock, this phenomenon should be reflected in the distribution of additional investment. From Chart 1 it will be seen that a given addition to investment will have to go more to the high investment country than to the low investment country if equality of marginal product is to be preserved. Under certain assumptions,9 efficient allocation of the additional investment should be in proportion to the initial amounts of net capital formation in the two countries. Although the appropriate measure of capital accumulation is a net one, consistent and reliable information on capital depreciation is lacking. Gross investment is therefore used as a proxy for net capital formation, and country shares in gross investment are shown in Table 1.

If, on the other hand, the higher rate of current investment in some countries has already resulted in a lower than average yield on marginal investment, there is no reason for additional investment to be directed disproportionately toward these countries. Insofar as differences in the physical productivity of capital in the various countries exist, it could be considered that these should be taken as “given,” reflecting social or political considerations which are not taken account of in a purely economic calculation. The existing discrepancy in marginal rates of return between countries would be maintained constant under the second example above, if the increment to the rate of capital accumulation was distributed in proportion to the existing capital stock rather than to the level of gross capital formation.

The above analysis suggests that before a fully satisfactory distribution scheme for allocating additional investment can be proposed, it is necessary to understand what lies behind existing variations in the rate of capital accumulation. In the absence of this information, a simple rule of thumb for the optimum distribution of additional investment would be to take the average of a distribution based on proportionate additions to increases in capital stock (proxied by GNP) and a distribution based on proportionate additions to increases in capital stock (proxied by gross investment). This average is shown in Table 1.

IV. Distribution of a Given Reduction in Savings

The opposite extreme to assuming that all of the increased savings of oil exporting countries is translated into additional investment in the rest of the world is to assume that there is no response of investment. Although it is probable that investment will respond in the medium term, at least to a large extent, this analysis of the consequences of no response is presented for completeness and also for its relevance to the short term.

If investment in oil importing countries does not respond to an increase in savings by oil exporting countries, and if there is not to be a fall in employment, the net inflow of capital from the oil exporting countries must be matched by a large reduction in the average propensity to save (and thus the level of savings) in the capital receiving countries. The fall in real incomes in the oil importing countries will itself contribute to a reduction in desired savings, and changes in financial market conditions may also have an effect on the savings propensity of the private sector. In the short run, however, it seems unlikely that the reduction in domestic savings in the oil importing countries will be sufficient to offset the demand reducing effects of the oil situation and that further government intervention will be necessary in the form of a change in the budgetary position of the public sector.10

If the increase in savings by the major oil exporting countries has to be matched by a reduction in savings on the part of the rest of the world, the problem for the adjustment process becomes one of how such a reduction should be shared to minimize the welfare loss to this group of countries. In a perfect market situation, one might expect the fall in real income in oil importing countries, combined with the fall in the interest rate (reflecting the decline in the interest sensitivity of global savings) to act to squeeze out marginal savers. The allocation of the required reduction in savings among these countries would then be to some extent a function of different rates of time preference as between savers in different countries.

However, given the goal of maintaining full employment and assuming that in the short run savings may not be very sensitive to the interest rate, it seems unrealistic to expect that pure market forces will bring about the most efficient allocation of the required reduction in savings in oil importing countries. As was noted above, much of the reduction in savings may have to be achieved by government action. Nevertheless, by means of some not-too-unrealistic assumptions, it is possible to get some useful answers as to how a reduction in savings might best be shared among the oil importing countries.

The approach followed here is a two-step approach. It first considers the fall in savings in countries that will result from the fall in real income generated by the increased real cost of oil; it then allocates the additional reduction in savings, which will result from direct government intervention, according to an optimal sharing scheme.

As a first step it is assumed that full employment output is maintained and that real income levels in oil importing countries have been reduced in direct proportion to their higher oil costs.11 (The full employment assumption means that government action keeps expenditure on domestic output constant, and this is quite consistent with a fall in the income of domestic factors of production.) The relative distribution of the increases in these costs is shown in Table 2. It seems reasonable to assume for purposes of exposition that the first ingredient in the optimal sharing of the required reduction in savings would reflect the initial fall in savings resulting from these reductions in real income.

Table 2.Factors Relating to the Optimal Allocation of Savings(In per cent)
CountryImpact Effect

as Percentage

of Total1
Gross Savings

as Percentage

of Total
Composite

Savings

Share 2
United States23.433.831.7
United Kingdom9.54.85.8
Austria0.71.00.9
Belgium-Luxembourg2.51.51.7
Denmark1.50.60.8
France9.88.48.7
Germany11.011.011.0
Italy7.24.04.6
Netherlands3.21.92.2
Norway0.80.70.7
Sweden2.31.51.7
Switzerland1.21.41.4
Canada–1.53.82.7
Japan19.318.218.4
14 Industrial countries90.992.692.3
Other developed countries9.17.47.7
All developed countries100.0100.0100.0
Note: Original data and sources for the savings shares are given in Appendix II, Table 5. All of the figures are based on 1972 data.

Shares were estimated from country data for 1972, and they reflect the distribution of additional import expenditures generated by the oil price increases.

This share was calculated as 0.2 (impact effect share) +0.8 (savings share).

Note: Original data and sources for the savings shares are given in Appendix II, Table 5. All of the figures are based on 1972 data.

Shares were estimated from country data for 1972, and they reflect the distribution of additional import expenditures generated by the oil price increases.

This share was calculated as 0.2 (impact effect share) +0.8 (savings share).

It should in principle be possible to compute the marginal propensity to save in individual countries and then multiply the resulting figures by the real income loss resulting from the oil price increase. To keep the present analysis extremely simple, however, it is assumed that the marginal propensity to save is 0.2 in all developed countries. This would mean that the first 20 per cent of the required reduction in savings by oil importing countries as a group would be allocated in proportion to the oil “impact effects,” that is, in proportion to the increase in expenditure for oil imports.

The allocation of the remaining 80 per cent is somewhat more complicated, depending on assumptions about the yield on savings. First, let it be assumed that, prior to the oil developments, the marginal return to savings had been more or less equalized across countries. (This assumption is not likely to hold precisely, but one may note that, before these developments, countries were prepared to accept whatever discrepancies existed in the return on savings without desiring any substantial capital flows to correct them.) Next, let it be assumed that the elasticity of savings with respect to changes in interest rates is the same in all countries. It follows from the above assumptions that countries should reduce their savings in proportion to the existing flow of savings.12 (If the existing flow of savings in most countries were proportional to the country’s GNP, the optimal reductions in savings for the oil importing countries would also be in proportion to either their gross savings or their GNPs.) The distribution of gross savings, as shown in Table 2, is very similar to that of gross domestic investment, as shown in Table 1. A weighted average of the impact and gross savings distribution is also given in Table 2, indicating one possible distribution scheme for the additional capital flows.

V. Exchange Rate Effects

If the optimum distribution of capital flows under any of the schemes described above is to be combined with overall equilibrium in the balance of payments, the pattern of current account deficits must match the pattern of capital inflows. Since optimum capital flows are not the same as the oil impact effects on current account positions, some exchange rate movements will have to take place to bring about the necessary adjustment. This section considers whether the changes in relative exchange rates needed to achieve adjustment carry additional implications for payments flows which necessitate a further modification of the analysis.

For purposes of exposition, let pattern 1 be the equilibrium level of exchange rates prior to the oil developments, and let pattern 2 be the exchange rate levels needed to secure the current account deficits implied by optimum capital flows. Provided the exchange rates move immediately from pattern 1 to pattern 2, and no further exchange rate change is anticipated, there is no reason why the new level, in itself, should have any significant effect on relative rates of return on real investment. It is true that the income from a given volume of physical investment will have gone up in an appreciating country and down in a depreciating country; but the supply price of capital will have changed in roughly the same proportion, leaving percentage yields constant.

However, pattern 2 may not itself represent a long-term equilibrium set of exchange rates. The members of the Organization of Petroleum Exporting Countries (OPEC) are presumably planning to step up their imports of goods and services quite rapidly, financing this increase by reducing the proportion of current receipts devoted to acquiring claims on the rest of the world. The proportionate shares of countries in the increase in these imports of goods and services and in the inflow of capital will not necessarily be the same, and to the extent that they differ, further changes in relative exchange rates will be necessary before an ultimate long-term equilibrium is achieved. Let pattern 3 represent the ultimate equilibrium set of exchange rates when there are no more capital flows from the oil exporting countries and when current account balance has been restored.

If pattern 3 is expected to be different from pattern 2 and if this expectation of further exchange rate change is allowed to affect capital flows, it will be seen that pattern 2 will not ensure a balance between current account deficits and capital inflows. This is because pattern 2 abstracts from further exchange rate changes, and expectations play no role; in fact, however, investment in a country whose currency is confidently expected to appreciate will become more attractive, since there will be an exchange rate gain to add to the marginal yield. Similarly, investment in a country whose currency is expected to depreciate would become less attractive. Thus, at the exchange rates of pattern 2 capital movements will not exactly match current account deficits if expected exchange rate changes are introduced.

If payments balance is to be restored over the medium term, relative exchange rates must be allowed to adjust at once part of the way toward pattern 3.13 For example, at the exchange rates of pattern 2, investment in a country whose exchange rate was expected to appreciate would become particularly attractive, so that the capital inflow would tend to exceed the projected current account deficit. This surplus would then tend to result in an upward movement in the exchange rate which would dampen expectations of further appreciation and thus reduce the incentive for capital inflows. The incentive for inflows would also be reduced as additional capital formation in the country concerned resulted in a lower marginal physical productivity of investment. At the same time, appreciation would cause a deterioration in the current account.14 Payments balance would be achieved at a pattern of exchange rates where the capital inflow due to expectations of further appreciation just balanced the deterioration in the current account due to the appreciation that had already occurred. (It must be noted that although the equilibrium set of exchange rates at any particular time will lie between patterns 2 and 3, this equilibrium set will change continuously through time as the OPEC countries move toward full adjustment of their current account.)

Exactly where in the range between patterns 2 and 3 the set of rates that would balance current and capital accounts would initially lie depends, inter alia, on the speed with which OPEC surpluses are expected to decline and on the sensitivity of the yield on marginal investment in developed countries to increments to the capital stock. Perhaps it would not be unreasonable to assume that one fourth to one third of the movement of exchange rates from patterns 2 to 3 would take place at once.

What would be the implication of such an exchange rate adjustment for the sharing of the current account deficit in the short and medium term? To recapitulate, the exchange rates of pattern 2 imply a sharing of the increase in the aggregate current account deficit which just mirrors optimum capital flows as described earlier. Pattern 3, at the other extreme, if established immediately, can be shown to imply a sharing of this increase in relation to the expected shares of countries in the growth of OPEC imports. This is because it is, by hypothesis, the pattern of exchange rates which would produce a current account equilibrium for all countries when OPEC imports have grown to meet their current receipts. If the exchange rates of pattern 3 were adopted before this import growth occurred, the countries which will eventually supply the imports would now have current account deficits reflecting their expected export growth.

A solution in which exchange rates over the short term move one fourth to one third of the distance from pattern 2 to pattern 3 would therefore imply current account deficits shared in the following way: two thirds to three fourths based on optimum capital flows as calculated in Sections II and III above; one fourth to one third based on expected shares in export growth to OPEC countries. Probably the best guide to shares in the growth of OPEC markets is to take existing market shares and assume that competitiveness among supplier countries remains the same. Table 3 shows the relative shares of developed countries in OPEC imports in the first part of 1974, and presents several combinations of these trade shares with shares representing investment and savings considerations.

Table 3.Factors Relating to Exchange Rate Effects, Savings, and Investment(In per cent)
CountryShare in

Exports to

Oil Exporting

Countries 1
Share Based

on Export and

Investment

Considerations 2
Share Based

on Export

and Savings

Considerations 3
United States23.635.129.6
United Kingdom9.66.36.8
Austria0.91.00.9
Belgium-Luxembourg2.51.71.9
Denmark0.70.80.8
France10.58.69.1
Germany13.711.311.7
Italy6.74.85.1
Netherlands3.02.12.4
Norway0.20.50.6
Sweden1.41.61.6
Switzerland1.81.41.5
Canada1.83.32.6
Japan18.515.018.4
14 Industrial countries94.993.593.0
Other developed countries5.16.57.0
All developed countries100.0100.0100.0

Shares were calculated from country import figures for January-August 1974; the original data are given in Appendix II, Table 5.

This share was calculated as 0.75 (average investment share) +0.25 (export share).

This share was calculated as 0.75 (composite savings share) +0.25 (export share).

Shares were calculated from country import figures for January-August 1974; the original data are given in Appendix II, Table 5.

This share was calculated as 0.75 (average investment share) +0.25 (export share).

This share was calculated as 0.75 (composite savings share) +0.25 (export share).

VI. Other Considerations

Thus far emphasis has been on economic efficiency as a criterion for the allocation of capital flows. In practice, however, there are imperfections both in capital and exchange markets. Furthermore, financial investment decisions reflect a number of factors other than the physical productivity of capital; these include liquidity and risk considerations. Consequently, the pattern of financial flows is not likely to conform automatically to any of the patterns suggested by the simple models set forth above. Official policies may be used to secure an “optimal” allocation of the overall deficit, but to the extent that this allocation conflicts with forces existing in the capital and exchange markets, attempts to secure this allocation may result in substantial strains being introduced into these markets. Since the avoidance of such strains is a legitimate objective of adjustment policies, it is useful to consider the extent to which existing financial structures and market mechanisms might give rise to a pattern of capital flows different from that expected on efficiency grounds.

One factor that is likely to be important both for economic and non-economic reasons is the distribution of the impact of the oil price increase on countries’ balance of payments. This impact distribution represents a basic situation which can be modified to a greater or lesser degree through policy actions. It has already been discussed in connection with the optimal distribution of savings and investment. In addition, it will influence the sharing of the deficit that countries are willing to accept.

Another factor that is likely to affect the ability of oil exporting countries to invest their surplus funds is the relative depth of financial markets in capital receiving countries. It is generally thought that the capital markets of London and New York are more broadly based and operate more flexibly than those of other financial centers. This is cited as one reason why a relatively greater proportion of the capital from the oil exporting countries has flowed to the United Kingdom and the United States than to other developed countries. Insofar as this flow is likely to continue and as these funds are absorbed domestically, it could be argued that these two countries are able to bear a somewhat larger share of the overall deficit than would be suggested on the basis of the assumptions stated earlier in this paper.

However, care needs to be exercised in accepting this conclusion too readily. Although it is widely believed that the London and New York financial markets are more sophisticated than other markets, it is not easy to measure their relative abilities to absorb capital inflows. For example, although the United States had the largest volume of security flotations in 1973, its share was no more than commensurate with its share in GNP.15 In contrast, the share of the United Kingdom in total security flotations was far smaller than its share in GNP, and the shares of Japan and Italy in total flotations exceeded that of the United Kingdom, although neither of these countries is generally thought of as an important financial center. Further, it is by no means clear that the capacity of a financial system initially to absorb capital inflows from abroad will be matched by the ability of the domestic economy concerned to utilize these funds productively. To the extent that the initial flows are immediately relent to other countries, the size of these inflows is not important in determining the optimum sharing of the current account deficit.

Another factor that may possibly influence the investment behavior of oil exporting countries is their confidence in the ability of capital receiving countries to ensure the servicing and perhaps ultimate repayment in real resources of their financial claims. This factor, of course, has a political dimension which is beyond the scope of the present paper, but there are also economic considerations which affect confidence. Thus, one might expect investment in countries which have had a strong balance of payments record in recent years backed by large reserve holdings (corrected for compensatory borrowings or other official liabilities to foreign monetary authorities) to be more attractive than investment in countries whose balance of payments and reserve positions have been weak. (To the extent that the reserve holdings of any of these countries is excessive, it could be argued that they should accept a current account deficit even larger than their expected capital inflow so as to redistribute a share of these holdings, but this would reflect a relaxation of one of the basic assumptions in this paper.) Thus, the relatively weak reserve positions of Italy, the United Kingdom, and under some circumstances, the United States, might largely offset any advantages which these countries possess in terms of the superiority of their financial markets.

Finally, countries in a relatively favorable position to develop alternative sources of energy will probably be more attractive outlets for surplus funds, ceteris paribus, for two reasons. In the first place, their capacity to absorb additional financial resources in real investment will be greater; and secondly, their ability to service debt and ultimately effect a large transfer of real resources will be enhanced. Thus, because Canada, Norway, and the United Kingdom have larger shares of recoverable energy resources, relative to other developed countries, this might argue for a relatively greater flow of investment to these countries than would be warranted by their economic size and the relative strength of their export sectors.

VII. Summary and Conclusions

The question asked in this paper is how a large change in the current account position of oil importing countries, reflecting the recent price increases for petroleum products, should be shared to minimize the loss of welfare resulting from this change. The increase in the aggregate deficit of these countries with the oil exporting countries is assumed to be given, with the further assumption that, at least in the medium term, this increase will be financed by capital inflows from the oil exporting countries.

Optimum patterns for the sharing of the oil deficit depend essentially on how real capital formation and savings are expected to be affected and on the efficiency of exchange and capital markets. Because the rates of return on investments are subject to a large degree of uncertainty and because of imperfections in these markets, many other factors also affect the optimal sharing of the deficit.

This paper isolates five distributive keys that are of particular importance for developed countries and that could affect the optimal sharing of the oil deficit among these countries under certain assumptions described in the paper. These keys are:

(1) The impact effect of the oil price increase. This affects real incomes, and therefore savings and investment. It is one of the least uncertain factors in an uncertain situation. It may also have some influence on what countries will accept by way of additional current account deficits.

(2) GNP. This may be taken as a proxy for capital stock and could be used as a guide in sharing the deficit if the marginal productivity of additional investment declines in proportion to the percentage increase in capital stock represented by the investment. (Under other assumptions it may be an optimal guide to the allocation of a reduction in savings.)

(3) Investment. In some circumstances, gross investment may be a better guide than GNP to the marginal productivity of capital and thus to the optimal allocation of additional investment.

(4) Savings. Insofar as the maintenance of full employment requires a reduction in savings levels in the rest of the world, this may be most efficiently achieved, under certain assumptions, if the reduction in savings is allocated in proportion to existing savings flows.

(5) Export shares. Current shares in exports to the oil exporting countries give some indication of the future competitive position of developed countries as the major oil exporters expand their absorptive capacity. Under certain assumptions, this can be shown to have a bearing on the expected pattern of capital flows.

How these factors should be combined is uncertain. The analysis in the paper suggests, however, that each is likely to have some bearing on the expected (optimal) pattern of capital flows. For example, it could be assumed that the reduction in real incomes resulting from higher payments for oil imports is translated into a reduction in desired savings in the developed countries. If the marginal propensity to save is assumed to be 0.2, then this fall in savings would equal 20 per cent of the fall in real income and would imply that 20 per cent of the capital flow resulting from the oil situation would be distributed in proportion to the shares of developed countries in the impact effects of higher oil prices.

As far as the remaining 80 per cent of the capital flow is concerned, it could be assumed that this would ultimately be reflected in higher investment and therefore should be distributed according to the criterion outlined in the section on investment above. (To the extent that actual investment does not rise by as much as this, some account should be taken of the savings distribution criterion, but since this is in practice similar to that for investment, the resulting figures would not be much changed).

The overall distribution resulting from the foregoing assumptions constitutes a first approximation which might be modified, to some extent, to take account of two other factors mentioned in the analysis. First, the distribution of the impact effect, representing as it does a given element in an uncertain situation, might be expected to play a direct role in the eventual outcome as well as through its effect on real income and savings. Secondly, shares in exports to the oil exporting countries will influence expectations of future balance of payments developments, and to the extent that these expectations have immediate implications for exchange rates will affect current account targets in the short and medium term.

To take into account these two modifying factors, one might assign a weight of 50 per cent to the first approximation and weights of 25 per cent each to the two modifying distributions.16 This subjective distribution scheme was calculated for the group of developed countries, and the shares of the industrial countries are given in Table 4.

Table 4.A Composite Approach to Sharing the Oil Deficit Among Developed Countries
CountryImpact

Effect as

Percentage

of Total1
Optimal

Percentage

Share in

Deficit2
Deficit

in Millions of

U.S. Dollars 3
United States23.429.714,850
United Kingdom9.57.83,900
Austria0.70.9450
Belgium-Luxembourg2.52.11,050
Denmark1.51.0500
France9.89.24,600
Germany11.011.55,750
Italy7.25.82,900
Netherlands3.22.61,300
Norway0.80.6300
Sweden2.31.8900
Switzerland1.21.4700
Canada–1.51.4700
Japan19.316.98,450
14 Industrial countries90.992.746,350
Other developed countries9.17.33,650
All developed countries100.0100.050,000

See Table 2, footnote 1, for explanation.

This share was calculated as a weighted average of the impact distribution, export distribution, GNP distribution, and gross investment distribution, with weights of 0.35, 0.25, 0.2 and 0.2 respectively.

These figures (in millions of U.S. dollars) were derived by multiplying $50 billion by the optimal percentage share in deficit.

See Table 2, footnote 1, for explanation.

This share was calculated as a weighted average of the impact distribution, export distribution, GNP distribution, and gross investment distribution, with weights of 0.35, 0.25, 0.2 and 0.2 respectively.

These figures (in millions of U.S. dollars) were derived by multiplying $50 billion by the optimal percentage share in deficit.

The increase in the annual current account deficit of the developed countries vis-à-vis the oil exporting countries has been crudely estimated at $50 billion17 between 1972 and the second half of 1975, and a distribution of this deficit based on the subjective weighting scheme described above is also given in Table 4. The deficit alloted to the industrial countries under this approach totals $46 billion. Although this distribution of the deficit is only one plausible allocation among many, it is presented as a contrast to current account projections and as a focus for further consideration.

APPENDICES
APPENDIX I: Optimal Schemes for Sharing the Oil Deficit Under Alternative Assumptions About Savings and Investment

This Appendix focuses on the sudden shift in the terms of trade between two groups of countries: the oil importing countries and the oil exporting countries. This shift, which reflects the increase in the price of oil, has resulted in a trade deficit for the oil importing countries, and this deficit is assumed to be given. It is further assumed that this aggregate deficit will be matched by an outflow of capital from the oil exporting countries. Although the trade deficit is fixed for the group as a whole, the deficits of individual oil importing countries can be modified from their initial values so as to minimize the welfare loss of this group of countries resulting from the change in the terms of trade and the fall in real income.

To explore how the group deficit might optimally be shared, very simple macro-economic models are developed representing (1) the group of oil importing countries taken as a whole and (2) a small oil importing country. These models are then used to derive optimal patterns for sharing the aggregate trade deficit under certain restrictive assumptions. The two principal alternative assumptions explored here are that the increase in savings in the oil exporting countries will be matched by (1) an increase in investment in the rest of the world or (2) a fall in savings in the rest of the world.

In the first section of this Appendix the models relating to the group of deficit countries and to the individual deficit country will be presented. In the second section these models will be used to derive optimal patterns for sharing the aggregate trade deficit under alternative assumptions about savings and investment.

TWO ECONOMIC MODELS

Two very simple economic models are presented below, representing the group of oil importing countries and a small country within the group. The variables are expressed in real terms, and the models abstract from financial variables such as the money stock or official reserve holdings. Governments can influence the level of output by means of certain types of fiscal policy, and the out-turn is sensitive to exchange rate changes. However, monetary policy lies out of the scope of these models. Although the two models were constructed along similar lines, no further effort was made to assure consistency between them. For purposes of this Appendix it was felt that the additional complications that would have had to be introduced so that one could aggregate across country models to arrive at the group model were not warranted.

Aggregate model for the group of oil importing countries

where

Qd=domestic output, measured in units of real output
Cd=private domestic consumption of domestically produced goods, measured in units of real domestic output
Id=domestic investment of domestically produced goods, measured in units of real domestic output
G=government consumption of domestically produced goods, measured in units of real domestic output
X=exports of domestically produced goods, measured in units of domestic output, where X0 is the volume of exports in the base period, 0
S=net savings measured in units of domestic output
KAP=the capital flow from the oil exporting countries to the oil importing countries, measured in units of domestic output
Y=real income in the oil importing countries
t=the tax rate on real income in per cent
R=the interest rate in per cent
M=the constant volume of oil imports
k=the percentage increase in the price of oil, initially equal to zero.

Behavioral parameters are represented by co, c1, and x1, where c1 is the marginal propensity to consume domestically produced goods in the oil importing countries, and x1 is the marginal propensity of the oil exporting countries to import as a result of an increase in real income. It is assumed that the private marginal propensity to consume in the oil importing countries, c1, exceeds the propensity of oil exporting countries to import from their increase in income, x1; if this were not the case, demand would be more than maintained in the oil importing countries by the increased demand for their exports and the problem would be how best to reduce investment (or, under other circumstances, to encourage savings).

Equation (1) states that domestic output, Qd, goes to private domestic consumption, Cd, private domestic investment, Id, government consumption, G, or is exported, X. Equation (2) relates real income, Y, to domestic production minus imports. Equation (3) is a behavioral equation expressing private domestic consumption as a function of real income and the tax rate. Equation (4) states that government consumption is equal to government tax revenues and is the product of the tax rate and real income; this implies that all savings takes place in the private sector. Domestic investment, Id, and savings, S, are sensitive to the interest rate, R. According to equation (6), imports of the oil exporting countries (exports of the non-oil exporting countries) will increase as their real income increases. The assumption that the current account deficit of the oil importing countries will be financed by a capital inflow is given in equation (7). (Since there are no reserves in the model, a deficit must necessarily be financed by a capital inflow.)

Model for a small oil importing country

For a small oil importing country j, it is assumed that the following model holds:

where

Ej=the change in the exchange rate of country j, initially equal to zero.18
XOj=exports of country j to other oil importing countries expressed in units of domestic output of j, and XOj0 is their initial level
MOj=imports into country j from other oil importing countries expressed in units of domestic output of j at the initial terms of trade.

Equations (8) through (17) can be seen to be very similar to equations (1) through (7) with the exception that the variables are largely subscripted; the subscript j indicates that the variable relates to country j, rather than to the group aggregate, but otherwise the variable is defined as above for the aggregate model. For example, KAPj is the capital flow from the oil exporting countries to country j in real terms, and Mj is the volume of oil imports into country j.

The three variables defined above (Ej, XOj, and MOj) have no counterparts in the aggregate model, because they largely affect or reflect intergroup flows. For example, XOj represents exports of country j to other non-oil exporting countries and is determined by the base level of these exports, XOj0, modified by the change in real income experienced by these countries, M (k),19 and by the relative change in country j’s exchange rate, Ej. Several of the variables that appeared in the aggregate model appear throughout the country model without subscripts. They include k, which represents the increase in the real cost of oil and is assumed to be uniform across importing countries, and M, the volume of oil imports for the group as a whole. Rj appears subscripted in equation (17) but is not subscripted in the savings and investment equations; this notation was used to indicate that, while the interest rate is essentially uniform across countries, very slight and temporary variations can evoke substantial capital flows.

PATTERNS FOR SHARING THE DEFICIT

In equilibrium, desired savings must equal desired investment; and the increase in the savings of the oil exporting countries, generated by the increased price of oil, must be matched either by a reduction in savings elsewhere or by an increase in investment.20 At the same time, the increase in savings in the oil exporting countries will be reflected in capital flows from these countries to the rest of the world.

If previously established payments objectives are to be achieved in the oil importing countries (for example, no reserve changes), measures must be taken so that current account deficits match capital inflows from the oil countries. In the absence of accurate information about how capital will in fact flow, it seems reasonable to postulate how it should flow to result in an efficient pattern of capital formation or even of reduced savings levels. The first section below focuses on the optimal allocation of additional investment and its implications for current and capital account flows. The second section focuses on the optimal allocation of a reduction in savings.

Under both approaches it is assumed that full employment output is maintained in every country and that the volume of oil imports remains unchanged by the price increases. Thus ΔM, ΔMj, and ΔQjd are all equal to zero.

Investment considerations

The models presented above will generally be overdetermined if both investment and savings are functions of the interest rate. It is assumed here that only investment is responsive and that government consumption plays no role in bringing about adjustment. Thus the model presented in equations (1) through (7) is modified by omitting (5b) and by setting t and G to zero; the model given in equations (8) through (17) is modified by omitting equation (13b) and setting tj and Gj to zero.21

Given the real increase in the cost of oil imports for the group (M · Δk) and constant real output, it is possible to solve for the endogenous variables in the group model:

Given that investment in the oil importing countries will increase by (c1–x1) · M · Δk, the question arises as to how this additional investment is to be distributed most efficiently. Under certain assumptions it would be optimal to distribute it in proportion to the pre-existing level of investment (or income),22 and it is assumed that this distribution will be reflected in countries’ investment functions. More precisely, it is assumed that a fall in the interest rate, ΔR, given in equation (23), will result in equal percentage increases in the desired level of net capital formation in each country j. Thus

where

isi = (Ii/I)

From equation (9), and noting that t = 0,

where Mj and MOj are imports at base level values. Substituting equation (25) in equation (10), and making further substitutions in equation (8), AEj can be

solved for in terms of Δk,

where

Equation (26) can be substituted in equation (25) to solve for the change in real disposable income in terms of k and a number of parameters and initial levels, and this solution can be used to arrive at the optimal change in capital inflow (current account deficit) into country j expressed in terms of various coefficients, the optimal change in investment, and the change in the real price of oil imports

If b1/b2 and m1i are very small, then

ΔKAPj ≃ isj · ΔI + mpsj · MjΔk

where mpsj is the marginal propensity to save of country j.

Savings considerations

Here it is assumed that additional investment will not be forthcoming as a result of the fall in the interest rate and that savings outside the oil exporting countries will have to fall. While a fall in the interest rate is expected to discourage marginal savers, government intervention (in the form of expanded government consumption) will also be needed to achieve the desired reduction in savings consistent with full employment output. Following this assumption, equations (5a) and (13a) are omitted from the two models; it is initially assumed that both the tax rate, t, and government consumption, G, are equal to zero, but that subsequently the tax rate becomes a policy instrument.23

Given the assumptions that investment, the volume of oil imports, and real output will not be changed by an oil price increase, the implication of such an increase for other economic variables and the overall tax rate can be derived from the aggregate model described above.

Substituting equations (29) and (30) in equation (1), and assuming that the initial tax rate is zero, the needed change in the average tax rate can be expressed in terms of various coefficients, initial levels of income and oil imports, and the oil price change:

Gross savings of the oil importing countries, S, is defined as,

and the needed change can be expressed as

This expression can be solved for the equilibrium change in the interest rate, as

Given that savings in the oil importing countries, taken together, will need to fall (1 – x1)M · Δk, the question arises as to how this fall in savings should be distributed among the countries. If it is assumed that there is a single interest rate, so that the marginal rate of time preference has been equalized across countries and so that the elasticity of savings with respect to changes in the interest rate is the same for all developed countries, then the savings reduction across countries should be allocated in proportion to the existing level of savings. Thus the savings function of country j, given in equation (13b), can be used in conjunction with the requisite fall in group savings (and the fall in the interest rate implied by this reduction) to arrive at the optimal reduction in savings in country j:

where

ssj = Si/S.

Noting that, by definition,

equation (36) can be used in conjunction with equations (37), (8), and (16) to solve for the desired change in the capital inflow:24

Equations (8) and (9) can both be used to express ΔYj in terms of Δtj, ΔEj, and Δk, and these two expressions can be set equal to solve for Δtj in terms of ΔEj and Δk. Thus

where

Equation (39) can now be used in equation (9) to solve for ΔYj in terms of ΔEj and Δkj

where

The exchange rate that results in the desired fall in savings can be derived from equations (9), (16), and (38) by using equations (39) and (40) for Δtj and ΔYj, and noting that the change in real income (with the opposite sign) is equal to the change in the value of imports. Thus,

where

The equilibrium values for Δtj and ΔYj can be solved for by substituting equation (41) back through equations (40) and (39).

APPENDIX II
Table 5.Sharing the Oil Deficit: Factors Relating to the Optimal Allocation of Investment and Savings Among Developed Countries(Values in millions of U.S. dollars)
CountryGross National

Product

(GNP) 1
GNP as

Percentage

of Total

GNP
Gross

Savings 2
Gross Savings

as Percentage

of Total

Savings
Gross

Investment 1
Gross Investment

as Percentage

of Total

Investment
Exports to Oil

Exporting

Countries 3
Exports as

Percentage

of Total

Exports
United States1,158,00043.0212,361433.8209,826435.04,03623.6
United Kingdom156,3005.830,1644.828,2734.71,6499.6
Austria20,5320.86,153 51.06,4841.11450.9
Belgium-Luxembourg35,9611.49,16051.57,5651.34342.5
Denmark20,6570.83,755 50.64,5660.81170.7
France198,5937.452,8258.451,5368.61,79510.5
Germany261,7129.768,843 511.068,17211.42,34513.7
Italy118,2574.425,3004.022,8403.81,1516.7
Netherlands45,9581.711,887 51.910,9191.85133.0
Norway14,4850.54,362 50.74,1150.7410.2
Sweden41,7561.69,496 51.59,1941.52351.4
Switzerland30,4091.18,903 51.48,722 61.53071.8
Canada104.4303.923,6213.822,7143.82991.8
Japan294,46110.9114,16718.2101,43516.93,17118.5
14 Industrial countries2,501,51193.0580,99792.6556,36192.916,23894.9
Finland13,3440.54,1160.73,6710.6550.3
Greece12,5600.53,4100.53,3870.6840.5
Iceland75518722000.0
Ireland5,5840.21,2030.2194130.1
Malta303 7435940.0
Portugal8,5830.31,0610.21,7320.380.1
Spain45,9281.710,3001.69,4311.63051.8
Turkey16,9710.61,907 50.32,8860.5400.2
Yugoslavia14,435 80.64,3000.74,3590.7610.3
Australia42,6501.612,5132.09,4121.62681.6
New Zealand8,4320.32,8560.51,9650.3280.1
South Africa19,5430.74,5640.75,4430.9110.1
Other developed countries189,0887.046,4607.442,7597.18775.1
Total2,690,599100.0627,457100.0599,120100.017,115100.0

Figures for 1972 were taken from the International Monetary Fund’s International Financial Statistics and were converted to U.S. dollars.

Gross savings figures were taken from the United Nations Yearbook of National Accounts Statistics, and from national sources; they relate to 1972.

Trade figures were taken from the International Monetary Fund’s Direction of Trade and show the value of exports during January-August 1974.

These figures were taken from U.S. Department of Commerce, Survey of Current Business, July 1974; savings consist of private savings and government savings; investment consists of gross private investment and government gross fixed capital formation.

Estimates by Fund staff.

Includes changes in inventories estimated at 1.5 billion Swiss francs.

Figure taken from United Nations sources.

Figure represents gross material product.

Figures for 1972 were taken from the International Monetary Fund’s International Financial Statistics and were converted to U.S. dollars.

Gross savings figures were taken from the United Nations Yearbook of National Accounts Statistics, and from national sources; they relate to 1972.

Trade figures were taken from the International Monetary Fund’s Direction of Trade and show the value of exports during January-August 1974.

These figures were taken from U.S. Department of Commerce, Survey of Current Business, July 1974; savings consist of private savings and government savings; investment consists of gross private investment and government gross fixed capital formation.

Estimates by Fund staff.

Includes changes in inventories estimated at 1.5 billion Swiss francs.

Figure taken from United Nations sources.

Figure represents gross material product.

Mr. Crockett is Chief of the Special Studies Division of the Research Department. He is a graduate of the University of Cambridge (England) and Yale University.

Ms. Ripley is an economist in the Special Studies Division of the Research Department. She received her doctorate in economics from Harvard University.

What is implied by “smoothly” is that official recycling among the oil importing countries is to avoided, as well as a transfer of assets for the financing of oil imbalances.

To the extent that financial intermediation is without cost and is fully efficient, the initial investment preferences of the creditor countries will not necessarily be reflected in the net pattern of capital inflows.

The extent of such a shift is measured by the increased cost of oil, multiplied by the difference between the marginal propensity to save in the major oil exporting countries, whose income is increased, and that in the oil importing countries, whose income is reduced.

“Action” in this context should be taken to include refraining from taking deflationary measures which might otherwise have been necessary.

The approach followed here was suggested by J. Marcus Fleming of the Fund staff.

Incremental capital-output ratios are frequently unreliable, and in any case are not relevant in this context since they reflect increases in output resulting from capital formation in conjunction with changes in other factors of production.

To the extent that the value of a given stock of capital is the discounted value of its product, it could be argued that GNP is a better measure of capital value than a more direct estimate.

A dynamic explanation for a higher investment ratio is some countries is that capital widening may be relatively more important for them.

The necessary assumption is that the slopes of the two lines AA and BB for the marginal efficiency of capital (over the relevant range) are in the same ratio as the initial investment proportions, p(A)° and p(B)°: that is,

This condition is automatically satisfied for any initial values of p(A) and p(B) if the marginal efficiency of investment schedules are linear with the same vertical intercept.

A change in the budgetary position could take the form of an increased deficit, or even an increase in both government receipts and expenditures. The effects of the oil imbalance on the real income of oil importing countries under assumptions of full employment and no increase in investment are worked out in Appendix I.

There may be additional real income effects as a result of exchange rate changes. On the whole, however, the distribution of these additional effects is likely to be related to the impact effects of higher oil costs. Countries where impact effects exceed the expected capital inflows are likely to have additional income losses from exchange rate adjustment; while countries where impact effects fall short of the expected inflows are likely to gain from exchange rate adjustment. Because the inclusion of exchange rate effects makes the exposition extremely complex and will not materially affect the outcome for most countries, it is not considered further here. However, the precise implications for a country’s exchange rate of a given change in its oil balance and a scheme for allocating the reduction in savings are worked out in Appendix I.

Let ΔSiSi/ΔRR=K for each country i, where Si is the level of savings, R is the global interest rate, and K is a constant. Let L be the desired fall in savings. From the relationship it then follows that for country i, ΔSi = (Si/ƩSi)L.

The extent to which exchange rates move toward pattern 3 will depend, inter alia, on the costs of intertemporal arbitrage.

This discussion abstracts from differences in the response times of the capital and current accounts.

See Organization for Economic Cooperation and Development, Financial Statistics, 1973/74, Vol. 1, Supplement 7E.

This weighting implicitly gives weights of 0.35 to the distribution of the impact effect, 0.25 to the distribution of exports, and 0.2 to the distribution of GNP and gross investment, assuming that the appropriate investment key is based on average shares in GNP and gross capital formation.

Developments since this paper was first drafted suggest that this figure is likely to be on the high side as an estimate of the bilateral deficit in the medium term.

For consistency with the group model two necessary restrictions would be Σj=1NΔEiMi=0 and Σj=1NΔtiYi=ΔtY, where N is the number of countries.

This formulation basically assumes that ΔY can be considered exogenous to country j. If this assumption is not made and if all the constraints necessary for consistency are incorporated in the model, solutions for all oil importing countries must be reached simultaneously.

For a fuller discussion, see Section II of the paper.

Thus in the aggregate model there are 6 equations and 6 variables to be solved for; in the country model there are 9 equations and unknowns.

See Section III of the paper for a fuller discussion.

With these assumptions the aggregate model contains 8 equations and unknowns, with equation (33); the country model contains 11 equations and unknowns, including equation (37).

In obtaining this solution, it is important to remember that, by assumption, ΔMi=ΔIid=ΔQid=0.

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