Chapter

V Transmission of Economic Influences from Industrial to Developing Countries

Author(s):
International Monetary Fund
Published Date:
January 1986
Share
  • ShareShare
Show Summary Details
Author(s)

The impact of the recession of 1980–83 on the economies of developing countries, the effects of high interest rates in financial markets since 1979, and the reduction in new bank lending to developing countries since 1982 have been major recent topics of discussion. Nevertheless, the precise mechanisms through which these effects have been transmitted are complex and only partially understood. This paper reviews the available evidence on the principal links through which changes in macroeconomic performance in the industrial countries influence major economic variables, in particular the rate of economic growth, in developing countries.

These links are numerous: changes in the pace of economic growth and inflation as well as shifts in interest rates and exchange rates in the industrial world can all influence developing countries’ economic performance through the markets for goods, services, and migrant labor, as well as through financial markets. The impact of various influences is determined simultaneously. For instance, a shift in the stance of fiscal or monetary policies in industrial countries can alter interest rates and exchange rates and shift the pattern of savings and investment; they can also cause changes in aggregate demand that result in price movements and at least short-term variations in output and employment. These developments in industrial countries in turn affect the price and volume of developing countries’ exports, the price of their imports, and the volume and terms of their capital inflows. Moreover, the resulting changes in developing countries’ economies have a feedback effect on the industrial countries by altering the demand for the latters’ exports of goods and capital and by shifting the supply schedule for their imports.

These various effects can be analyzed either by using single equation (reduced-form) estimates and other partial equilibrium studies of individual linkages, or by constructing a more comprehensive structural model that takes account of the general equilibrium nature of the links between industrial and developing countries. The former approach is used in this paper, since it complements more closely the procedures used to prepare the medium-term scenarios for developing countries in the World Economic Outlook. These scenarios rely heavily on survey estimates prepared by staff members in area departments on the basis of overall environmental assumptions about the world economy (for example, average output growth in industrial countries, prices of manufactured goods imported by developing countries, interest rates on commercial credits, scale of private lending to developing countries, and exchange rates among the major currencies). Comparisons between econometric estimates and estimates obtained from the survey can help to indicate whether, in the aggregate, individual survey data might be inconsistent with the assumed global environment. The general equilibrium framework of the scenarios is provided in two ways: first, the survey gives a set of projections (for example, of trade flows, gross domestic product (GDP), and the balance of payments) for each country that is internally consistent for that country; second, any inconsistencies between the aggregated survey estimates and the assumed global economic environment is eliminated through iterative adjustment.1

Nevertheless, the limitations of the single-equation approach taken in isolation should be borne in mind during the subsequent discussion. In particular, estimates will be biased to the extent that there are significant interactions in the world economy that are omitted from the reduced form and to the extent that variables which would be determined endogenously in a structural model are assumed to be given exogenously in the reduced form.2

As a background to the discussion in the rest of the paper, Table 47 provides information on broad trends in the growth rates of output in industrial and developing countries. Several aspects of these trends deserve special mention. First, there does appear to be a rough association between the rates of economic growth in the industrial countries and those of the developing countries. The slowdown in economic growth in the industrial countries between the 1968–72 period and the 1973–80 period was accompanied by a moderate slowdown in developing countries’ economic growth. Similarly, the 1981–82 recession in industrial countries and the subsequent recovery in 1983–85 were associated with broadly comparable outcomes in the developing countries.

Table 47.Growth Rates of Real Output, 1968–85(Average annual percentage changes)
1968–721973–801981–821983–85
GNP of industrial countries4.43.00.53.3
GDP of developing countries6.85.31.92.8
Developing countries by analytical group
Fuel exporters9.75.30.4–0.2
Non-fuel exporters5.95.32.64.4
Exporters of manufactures5.45.24.87.4
Primary product exporters5.75.0–0.72.2
Service and remittance countries5.14.72.92.7
By area
Africa7.33.31.20.6
Asia4.85.75.27.1
Europe6.54.82.32.3
Middle East10.55.1–1.0–0.3
Western Hemisphere6.35.51.2
By financial criteria
Capital importing countries6.35.32.53.5
Market borrowers7.25.51.21.7
Official borrowers3.63.92.52.5
Countries with recent debt-servicing problems6.15.00.60.9
Countries without recent debt-servicing problems6.55.74.66.1
By miscellaneous criteria
Non-oil developing countries5.65.22.73.9
Fifteen heavily indebted countries7.05.30.10.5
Source: International Monetary Fund, World Economic Outlook.Note: See Appendix 1 to this chapter for the definitions of the country groups referred to in this note. GNP is gross national product, GDP is gross domestic product.

The relationship between output growth in the two groups is not a precise one, however, and there are clearly many other influences on developing countries’ economic growth. This can be seen most clearly when the growth performance of the fuel exporters and non-fuel exporters among developing countries are considered separately. (See Appendix I to this chapter for details on these country groups.) The average rate of economic growth of the non-fuel exporters declined only moderately between the periods 1968–72 and 1973–80, even though industrial country growth slowed more substantially, and the decline in the growth of the fuel exporters was even more pronounced. Also, the recovery in industrial countries’ economic growth in 1983–85 was not reflected in renewed output growth in the fuel exporting countries, while the non-fuel exporters did recover.

A second observation emerging from Table 47 concerns the considerable diversity in the growth performances of different groups of developing countries. Among the non-fuel exporters, the exporters of manufactures managed to sustain their rate of economic growth during the 1981–82 recession while output growth was actually negative in the primary product exporters. The former group also appear to have benefited much more from the recovery in industrial countries during 1983–85. On a geographical basis, the output growth of developing countries in Asia was only moderately affected by the recent recession and has since recovered sharply, whereas the average rates of economic growth of developing countries in Africa, the Middle East, and the Western Hemisphere have been substantially lower during both the recent recession and the recovery phase. There are also substantial variations in growth performance within these groups.

A third observation is the striking divergence between the average growth performances since 1981 of those countries which have and those which have not encountered recent debt-servicing problems. These two groups had broadly similar growth records during the period 1968–80, which suggests that much of the recent sharp decline in output growth in countries with debt-servicing problems is related to those problems and the associated sharp reduction in private capital flows. In this regard, the average rate of economic growth of the market borrowers fell much more sharply between 1973–80 and 1981–85 than did the growth of the official borrowers.

Transmission of Economic Influences Through Goods and Services Markets

Macroeconomic developments in industrial countries can significantly influence the external current account and output growth of developing countries through their simultaneous effects on relative prices and volumes in foreign trade. The resulting changes in export earnings will, in turn, affect developing countries’ growth prospects both in the shorter term, through their impact on the level of aggregate demand and the availability of foreign exchange, and in the longer term, through their effects on the level of investment and the relative size of the export sector. Before discussing these various influences, and those characteristics of the trade structure of developing countries that help determine the size and nature of industrial country influences on the developing world, it is important to make a distinction between those countries that rely on oil exports for a substantial proportion of their foreign exchange earnings and those that do not. The classification of developing countries into fuel exporters and non-fuel exporters reflects this distinction and will be used where possible in this section. However, some econometric results and some statistical information are only available on the basis of the alternative analytical categories of oil exporting countries and non-oil developing countries, and these categories will be used where necessary (see Appendix I to this chapter for details on these classifications).

Developing Countries: Foreign Trade

Several features of developing countries’ foreign trade are important to any discussion of the transmission of economic influences through the goods market. First, the industrial countries as a group represent the major market for developing countries’ exports and supply the major portion of developing countries’ imports, despite some recent decline in their share of developing countries’ foreign trade (Chart 15).

Chart 15.Developing Countries: Destination of Exports and Origin of Imports, 1967–84

(In percent)

Second, export developments for the fuel-exporting and non-fuel exporting developing countries, which were broadly similar during 1968–72, have differed sharply since 1973 because of the wide fluctuations in oil prices. The total volume of exports of the fuel exporters has declined substantially since 1973, although, until 1982, this was more than offset by the rapid increase in export prices (Table 48). The volume of their exports to industrial countries has fallen even more rapidly than those to other regions, owing to a sustained decline in energy consumption per unit of output in these countries, and to rising domestic production of energy in some of them. Nevertheless, the large increases in oil prices caused the share of the fuel exporters in total imports by industrial countries to more than double between the late 1960s and the early 1980s, although their market share has since fallen as a result of the drop in oil prices and a continued decline in export volumes (Table 49).

Table 48.Developing Countries: Changes in Export Volumes, Export Values, and Terms of Trade, 1968–85

(Average annual percentage changes) 1

1968–721973–801981–821983–851968–85
Developing countries
Export volume7.92.4–7.03.72.6
Export unit value 24.024.21.911.5
Export value12.327.9–7.01.714.5
Terms of trade0.88.30.9–0.53.8
Purchasing power of exports8.810.9–6.23.26.6
Fuel exporters
Export volume7.50.1–15.8–1.8–1.3
Export unit value 25.936.43.9–2.717.7
Export value14.636.5–12.5–4.516.1
Terms of trade3.121.55.8–1.610.5
Purchasing power of exports10.821.6–10.9–3.49.0
Non-fuel exporters
Export volume8.16.23.67.56.6
Export unit value 22.614.9–4.3–1.46.6
Export value11.422.1–0.85.913.7
Terms of trade–0.4–1.0–4.00.1–1.0
Purchasing power of exports7.75.1–0.57.65.5
Memorandum
World trade
Volume9.55.2–0.54.75.6
Unit value 24.116.1–2.8–2.97.3
Table 49.Industrial Countries’ Imports From Developing Countries: Changes in Values, Volumes, and Market Shares, 1968–84

(Average annual percentage changes, unless otherwise indicated)1

1968–721973–801981–821983–841968–84
Value of industrial countries’ imports14.520.9–5.33.913.4
Of which from:
Developing countries13.626.7–9.00.414.8
Fuel exporting countries15.932.7–14.5–7.116.1
Non-fuel exporting countries12.120.8–3.810.813.9
Volume of industrial countries’ imports10.04.1–0.89.05.8
Of which from:
Developing countries8.50.2–8.65.12.0
Fuel exporting countries9.3–3.1–15.8–2.8–1.2
Non-fuel exporting countries8.15.51.313.36.6
Share of imports from developing countries in industrial country imports 222.129.430.928.227.3
Of which from:
Fuel exporting countries8.216.217.613.313.7
Non-fuel exporting countries13.913.213.314.913.6

In contrast, the marked slowdown in the rate of growth of the volume of industrial country imports after 1973 had only a moderate impact on the growth of total export volumes by the non-fuel exporters; the latter continued to expand the volume of their exports to the industrial countries more rapidly than the total volume of industrial country imports, and also continued to expand their exports to other developing countries. Between the periods 1968–72 and 1973–80, the average annual growth rate of industrial country imports fell from 10 percent to 4 percent, but the growth rate of total imports from the non-fuel exporters slowed only moderately from around 8 percent to about 5.5 percent (Table 49). This trend has continued through the recent recession and recovery.3 However, for most of the period since 1973, the purchasing power of these exports from non-fuel exporters has been adversely affected by declining terms of trade.

A third important feature of the goods markets is the commodity composition of developing countries’ foreign trade, especially of their exports, which has shifted considerably over time. The share of manufactures in developing countries’ exports has increased markedly since the mid-1960s, while import substitution and the growing cost of fuel imports have contributed to a moderate decline in the share of manufactures in their total imports (Table 50). By 1980, manufactured exports accounted for almost 60 percent of the total exports of capital-importing developing countries, which was not much below the 69 percent share of manufactures in total world trade (Appendix Table I). Developing countries in Europe and in Asia now export mainly manufactures; in 1980, around four fifths and two thirds, respectively, of their total exports consisted of manufactures. Nevertheless, most low-income economies other than China and India still rely on non-fuel primary commodities for the major part of their export earnings; this group includes many countries in sub-Saharan Africa. Also, these commodities still represent over half of all exports by developing countries in the Western Hemisphere.

Table 50.Developing Countries: Commodity Composition of Foreign Trade, 1965 and 1982(Percentage shares)
19651982
Fuels,

minerals

and

metals
Other

primary

commodities
ManufacturesFuels,

minerals

and

metals
Other

primary

commodities
Manufactures
Exports
Low-income economies116524203050
Excluding China and India127810155530
Middle-income oil importers195724132760
Middle-income oil exporters6034679129
High-income oil exporters9811964
Imports 1
Low-income economies52966182854
Excluding China and India52471242056
Middle-income oil importers82864261658
Middle-income oil exporters62272101971
High-income oil exporters2277121583
Source: World Bank, World Development Report, 1984, Tables 10 and 11, pp. 192–95.Note: The classification of countries is that followed by the World Bank in the World Development Report. Low-income economies are those which had a per capita GNP of less than $400 in 1983. The groups low-income economies and middle-income oil importers combined are broadly equivalent to the Fund’s category of non-fuel exporters.

The variations in commodity composition over time and across countries have important implications for the effects on developing countries of economic growth in the industrial world. Apart from fuels, the fastest growing component in imports by industrial countries imports since the 1960s has been manufactures (Table 51). Those developing countries that were well placed to take advantage of this growing demand for manufactures have achieved substantially higher rates of export growth. Thus, during 1973–84, the volume of exports to industrial countries from the group of exporters of manufactures grew at an average annual rate of 9.7 percent, while the export volume of the group of primary product exporters grew at a rate of only 3.2 percent (Table 52).

Table 51.Industrial Countries: Commodity Composition of Imports, 1965 and 1982(Percentage shares)
19651982
Fuels1126
Non-fuel primary commodities3919
Manufactures505
Source: World Bank, World Development Report, 1984, Table 11, p. 195.
Table 52.Industrial Countries: Imports and Implied Income Elasticities, 1973–84(Average annual percentage changes, unless otherwise indicated)
Industrial

Countries
United StatesJapanEurope
1973–19801981–19821983–19841973–19801981–19821983–19841973–19801981–19821983–19841973–19801981–19821983–1984
Real GNP3.00.53.62.8–0.35.04.43.44.12.70.11.8
Volume of total imports4.1–0.59.03.22.621.54.2–1.55.74.0–1.64.3
Of which from: 1
Developing countries0.2–8.65.13.8–7.715.84.5–4.43.6–1.2–11.6–1.1
Fuel exporters–3.1–16.0–2.81.7–19.94.4–0.4–10.40.9–6.1–17.1–8.2
Non-fuel exporters5.51.313.36.28.124.46.65.415.93.6–4.55.9
Primary product exporters2.90.59.44.64.518.53.83.87.41.9–1.84.1
Exporters of manufactures9.32.918.88.412.731.710.34.712.79.4–7.06.8
Service and remittance countries8.2–3.610.98.3–5.49.10.210.220.89.3–3.810.4
Apparent income elasticity: 2
Of total imports1.3–1.42.51.1–8.74.31.0–0.41.41.5–16.02.4
Of imports from non-fuel exporters1.82.63.72.2–27.04.91.51.63.91.3–45.03.3

In addition to their role as demanders of imports, industrial countries are also large exporters of primary commodities. Indeed, their share of global world exports of non-fuel primary commodities has grown over time and, in 1980, they accounted for 69 percent of all such exports by industrial and developing countries combined (Appendix Table II). At the level of aggregation of the single-digit SITC groups, the export market shares of industrial countries were larger than those of developing countries for all categories except beverages and tobacco and fuels. (SITC stands for Standard International Trade Classification.) Consequently, those developing countries that export primary products similar to those produced by industrial countries will be strongly affected by developments, such as changes in domestic agricultural pricing policies, that affect the volume of industrial country primary production or exports.

Finally, a fourth key feature of developing countries’ foreign trade is the wide variations in the importance of different industrial country markets for the various regional groups of developing countries. If the exports of developing countries consisted mainly of relatively homogeneous primary commodities, and if there were no significant trade barriers against these, regional variations in the direction of trade would not be of great importance. Divergent movements in the growth rates or real exchange rates of different industrial countries would cause changes in the demand and hence in the world price of various commodities, and each developing country supplier would face the same price changes, irrespective of the destination of their exports. The resulting change in the volume of their exports would depend on the domestic supply responses to these price changes. In practice, however, a large share of the exports of developing countries consists of relatively non-homogeneous manufactures for which prices can vary between markets and between suppliers. In addition, some of the industrial country markets for certain primary product exports of developing countries—such as sugar, grains, and meat—are in effect fragmented by various quantitative import restrictions. In such circumstances, the growth in demand for a developing country’s exports can be significantly affected by the geographic distribution of those exports.

In this regard, developing countries in Africa and in Europe have strong links with industrial countries in Europe; almost one half and two fifths, respectively, of their total exports are sent to that region (Table 53). In contrast, the principal industrial country markets for Asian developing countries are the United States and Japan, while developing countries in the Western Hemisphere rely heavily on the U.S. export market. These differences in the geographic orientation of exports were especially important during 1983–84, when the structure of expansion in the industrial world was unbalanced. The rapid expansion of economic activity in the United States, together with the appreciation of the U.S. dollar, caused a large increase in U.S. demand for imports; over the two years the volume of total U.S. imports rose by 47.5 percent (Table 52). At the same time, the slow pace of recovery in Europe was reflected in only a moderate increase in import demand; total import volumes grew by only 9 percent over the two years combined. The consequences of this uneven expansion for the different regional groups of developing countries can be seen by calculating the weighted average growth rates of real gross national product (GNP) and import volumes in the industrial countries, using the direction of exports of the regional groups of developing countries as weights (Table 54). During the three-year period 1983–85, developing countries in the Western Hemisphere faced an average industrial country import market that grew by some 3–5 percentage points per annum faster than did the average industrial country import market faced by African, European, or Middle Eastern developing countries, whereas the differences during the 1973–80 period had been relatively minor.

Table 53.Developing Countries: Destination of Exports, 1970 and 1984(As a percentage of total exports)
Industrial

Countries
Of Which:Oil

Exporting

Countries
Non-Oil

Exporting

Countries
Other

Countries 1
EuropeUnited StatesJapan
19701984197019841970198419701984197019841970198419701984
All developing countries72.265.038.925.516.920.010.813.41.74.619.425.36.75.1
Africa68.669.148.546.77.217.96.73.40.71.215.515.615.214.1
Asia66.958.119.313.323.422.619.018.63.34.926.332.53.54.5
Europe46.144.939.037.64.36.00.70.71.912.417.414.934.627.8
Middle East77.259.553.229.33.26.015.222.81.43.911.828.99.67.7
Western Hemisphere76.370.731.322.235.440.47.15.20.53.720.720.82.54.8
Oil exporting countries84.365.754.428.610.112.715.822.50.22.115.027.50.54.7
Non-oil exporting countries67.059.333.523.919.323.79.18.82.15.820.424.510.510.4
Source: International Monetary Fund, Direction of Trade, various issues.
Table 54.Industrial Countries: Output Growth and Growth of Markets Weighted by the Direction of Exports of Developing Country Regional Groups, 1973–85(Average annual percentage changes)
1973–801981–821983–85
Real GNP
Africa2.790.192.56
Asia3.030.983.68
Europe2.690.012.33
Middle East3.301.322.97
Western Hemisphere2.740.073.51
Volume of total imports
Africa4.53–1.007.13
Asia4.318.54
Europe4.27–1.656.46
Middle East4.50–1.535.13
Western Hemisphere4.220.1310.89
Volume of non-oil imports
Africa6.120.918.27
Asia6.742.4910.17
Europe5.91–0.037.57
Middle East7.900.946.97
Western Hemisphere5.301.9212.06
Note: The data show the growth in real GNP, total import volumes, and non-oil import volumes in the industrial countries, weighted by the direction of exports for each developing country group. The weights are based on 1984 exports.

Transmission of Disturbances Through Prices

Developments in industrial countries can cause shifts in the demand and supply on world markets of goods that are exported or imported by developing countries, thereby causing simultaneous changes in both prices and volumes. Most empirical studies of these influences on developing countries’ trade flows have concentrated on the impact on demand.4 These studies typically assume infinite price elasticities of supply. While this assumption may be reasonable for the case of the world supply of imports to individual developing countries (or even to groups of developing countries, if they represent a small part of the total world market), it appears less reasonable for the supply of exports from developing countries. When the price elasticity of export supply is not infinite, an upward shift in demand (due perhaps to a rise in economic activity in the industrial countries) will result in a rise in both the price and volume of developing country exports. In such circumstances, estimates of the impact on developing countries’ export earnings of, say, higher industrial country income that were based on single-equation estimates of demand side relationships would tend to underestimate the price response and overestimate the volume response because substitution effects are omitted. This should be borne in mind during the following discussion.

The most appropriate approach would be to estimate the supply and demand relationships simultaneously. However, there have been relatively few studies of developing country exports that use simultaneous equation models comparable to those used for industrial country exports, in large part because of the difficulties involved in specifying separate supply relationships. Exceptions include the work by Bond (1985 and 1986) and various studies on the determinants of commodity price movements, including those by Chu and Morrison (1984 and 1986) and Holtham et al. (1985). Results from these three sets of studies are used later in this section.

Nominal and Real Commodity Prices

Although prices and volumes are obviously determined concurrently, it is useful to discuss them separately when considering the transmission of economic influences from industrial to developing countries. Movements in the prices of goods in world trade since the late 1960s are summarized in Table 55 and in Chart 16. The prices of non-oil primary commodities have shown large short-term fluctuations in response to shifts in both demand and supply factors, but, over the period 1968–85, have tended to increase at a slower average rate than the prices of manufactures exported by industrial countries.5 Among the factors affecting non-oil primary commodity prices have been, on the demand side, the level of economic activity, interest rates, and rates of inflation in industrial countries and, on the supply side, various changes in industrial country policies affecting levels of domestic production, particularly for agricultural commodities.6

Table 55.Movements in Commodity Prices, 1968–85

(Average annual percentage changes) 1

1968–721973–801981–821983–8419851968–85
Non-oil primary commodities3.513.1–12.05.4–12.25.0
Food5.213.1–13.17.0–18.75.1
Beverages3.615.5–10.711.8–11.65.9
Agricultural raw materials4.211.7–10.74.1–12.24.7
Metals0.613.1–13.5–1.7–2.83.8
Oil26.638.22.6–7.0–4.416.6
Manufactures 34.712.3–3.7–3.51.06.1
Memorandum
Non-oil primary commodity prices deflated by price of manufactures–1.10.7–6.19.2–13.1–1.0

Chart 16.Non-Fuel Exporting Developing Countries: Trends in Real Non-Oil Primary Commodity Prices and in the Terms of Trade, 1967–85

(Indices, 1980 = 100)

1 Index of market prices for non-oil primary commodities deflated by the export unit value index of the manufactures of industrial countries.

A number of recent empirical studies have confirmed that, when supply conditions are relatively stable, a decline in the level of economic activity in industrial countries exerts a downward influence on the prices of non-oil primary commodities (referred to henceforth as primary commodities or just commodities) (Table 56). Although estimates of the exact size of the cyclical effect have varied, a broad consensus estimate might indicate that the elasticity of commodity prices with respect to industrial production in the industrial countries is around 2. Substantially higher estimated elasticities are obtained by Fishlow (1985) and by van Wijnbergen (1985), but the former is based on a very short time period and the latter is derived indirectly, by estimating the relationship between real commodity prices and unemployment in the industrial countries, and then making use of the association between GDP growth and unemployment in the industrial countries—a relationship which may have changed substantially during the last decade. The studies by Chu and Morrison also indicate that the elasticity was substantially higher during the 1972–82 period than for the 1958–71 period; this apparent increase in the elasticity over time may partially account for the relatively low elasticity estimated by Dornbusch (1968) for the period 1960–84. There is also evidence that the prices of metals and agricultural raw materials are more sensitive to cyclical fluctuations in industrial production than are the prices of food and beverages. This is to be expected, since the former groups of commodities are more heavily used as industrial inputs.

Table 56.Estimates of the Elasticity of Real Non-Oil Primary Commodity Prices with Respect to Industrial Countries’ Real Economic Activity
InvestigatorTime

Period
Variable

Investigated
Industrial

Countries’

Economic

Activity

Variable
Estimated

Elasticity
Chu and Morrison (1984) (quarterly data)1958–82Non-oil primary commoditiesIndustrial production1.7**
1958–710.7**
1972–822.2*
Chu and Morrison (1985) (quarterly data)1962–82Non-oil primary commoditiesIndustrial production2.0 1
1962–82Food1.3
1962–82Beverages1.6
1962–82Agricultural raw materials3.4**
1962–82Metals2.6**
Dornbusch (1986) (quarterly data)1960–84Non-oil primary commoditiesIndustrial production1.0**
Fishlow (1985) (annual data)1977–84Non-oil primary commoditiesGNP3.4
van Wijnbergen (1985) (annual data)1970–84Primary commodities, excluding fuelGNP24.5
Note: Although the form of the estimating equation varies, all of the above elasticities estimate the effect on real commodity prices of cyclical fluctuations in the rate of output growth. All of the equations either use primary commodity prices deflated by the price of manufactures as the dependent variable, or include an inflation variable among the right-hand terms. ** and * mean the data are significant at the 1 percent and 5 percent levels, respectively.

All of these estimated elasticities, however, refer to the sensitivity of real commodity prices to relatively short-term, cyclical variations in the rate of output growth in industrial countries. The elasticity of response of real commodity prices to a shift in the longer-term, trend rate of economic growth in industrial countries would probably be lower. Not only would the share of stockbuilding—which has a high raw materials component—in the change in total demand be lower in the longer term, but the supply response would also be greater. In this regard, Holtham et al. (1985) have estimated reduced-form equations for the determination of commodity prices in which, by construction, all commodity prices (other than those for beverages) eventually return to their trend levels following a deviation of industrial country GDP from its trend growth path. Their results (estimated semiannually over the period 1967–84) suggest that such a deviation would cause commodity prices to rise, with the peak response occurring around the fourth semester (that is, up to two years after the initial rise in GDP); the price response then fades and virtually disappears after five to six years. Their results also confirm Chu and Morrison’s (1984) conclusion that cyclical fluctuations in the industrial countries have a bigger impact on the prices of metals and agricultural raw materials than on the prices of food. A 1 percentage point deviation in industrial country GDP from its trend is estimated to cause, at the peak, about a 2 percent increase in the former prices, but a smaller increase in the latter prices.7 Beverage prices are estimated to be permanently affected by the deviation of GDP from its trend—with prices about 3 percent higher as a result of a 1 percentage point deviation in industrial country growth—but this may simply reflect the greater difficulties in empirically estimating the lags in the price responses for these commodities, owing to the long lags in supply response for the crops involved.

As can be seen from Chart 16, the three most recent periods of reduced economic activity in industrial countries—in 1971, 1975, and 1981–82—have broadly corresponded with periods of low real commodity prices. However, there are clearly many other influences on commodity prices; their real level fell substantially in both 1978 and in 1985, when the level of economic activity in the industrial world was rising.8 One factor underlying the most recent weakness of commodity prices has been the geographic imbalance in industrial country growth rates. The European industrial countries account for more than one half of total world imports of non-oil primary commodities (Table 57). If world markets for all primary commodities were relatively homogeneous and free from trade barriers, then it would be the shares of the different industrial countries in total world consumption (and production) of these commodities rather than their shares in world trade that would determine the impact on prices of their GDP changes. However, as noted earlier, the markets for a number of primary commodities are fragmented. The relatively slow economic growth of the European countries in recent years has dampened the demand for commodities, and this has been less than fully offset by the more rapid growth of output in the United States and Japan.

Table 57.World Trade in Non-Oil Primary Commodities and Manufactures(In percent; 1979–81 average)
Non-Oil Primary

Commodities
Manufactures
ImportsExportsImportsExports
World100100100100
Industrial countries79687487
United States12191414
Europe51335358
Japan141312
Other21543
Developing countries21322613
Non-oil developing countries16291912
Oil exporting countries5371
Source: Based on the United Nations, International Trade Statistics, Series D. Some processed primary commodities such as copper, tin, aluminum and coffee concentrates are regarded as primary commodities, while all the other processed or semiprocessed goods are regarded as manufactures.

Inflation in industrial countries influences nominal commodity prices both by increasing the price of substitutes in importing countries and by pushing up the costs of production of those primary commodities exported by developing countries. Chu and Morrison (1984) found that a 1 percent increase in the wholesale price index in industrial countries was associated with an increase in commodity prices of slightly greater than 1 percent.9 Of course, such a close relationship is not surprising since components of the two indices are overlapping; moreover, the direction of causation is probably two way, since changes in commodity prices may also influence industrial country wholesale prices.

The level of interest rates on world financial markets could be expected to have several counteracting influences on commodity prices. High real interest rates discourage stock-holding demand for commodities, which would exert a downward influence on prices, but also tend to raise production costs, which would cause prices to rise. The unusually high level of real interest rates during the 1981–82 recession probably contributed to the sharp decline in commodity prices in that period by encouraging stock liquidation, and the persistence since then of relatively high real rates may have dampened the recovery in commodity prices for the same reason. Most econometric studies have not detected a strong, statistically significant impact of real interest rates on the prices of non-oil primary commodities as a group. There is, however, some evidence of a moderate inverse relationship between interest rates and the prices of agricultural raw materials and metals, demand for which is more affected by stockbuilding than that of other commodity groups (Chu and Morrison (1984), Holtham et al. (1985)).

The relationship between commodity prices and exchange rates has been of particular importance in recent years because of the substantial movements in the U.S. dollar against other major currencies. Two aspects of the relationship can have a direct impact on developing countries’ welfare. First, a depreciation of the dollar will lead to a general increase in the dollar prices in world trade, and will consequently tend to lower developing countries’ debt and debt service ratios, since around four fifths of developing country debt is denominated in U.S. dollars. The larger the rise in dollar prices, the greater will be the decline in the debt ratios. Second, some observers have argued that a change in the dollar exchange rate affects the price of primary commodities relative to the price of manufactures.

These effects can be investigated using two alternative approaches. First, the estimated price elasticities of export supply and import demand for various groups of primary commodities and manufactures, together with information on the share of the United States in world trade of the goods concerned, can be used to calculate the impact of a change in the U.S. dollar exchange rate on the prices of primary commodities and manufactures. Second, a direct econometric analysis of the relationship between nominal and real commodity prices and the U.S. dollar exchange rate can be undertaken.

Beginning with the first approach, the effect of a dollar depreciation on the dollar price of goods in world trade depends on the supply and demand elasticities for those goods in different countries and on market shares. If export supply and import demand elasticities are constant across countries then, other things being equal, the impact of a dollar depreciation on the dollar price of a good will increase: (1) the smaller is the U.S. share in world trade of that good; (2) the smaller are export supply elasticities; and (3) the smaller are import demand elasticities.10 The U.S. share in the world trade of primary commodities as a group is fairly small and also not that different from its share of world trade in manufactures (Table 57). Hence, in the absence of other factors—such as differences in price elasticities of export supply and import demand across countries and commodities—one would expect, on a priori grounds, that a given percentage dollar depreciation would raise the dollar prices of both primary commodities and manufactures by a relatively large fraction of the depreciation and that the relative price of primary commodities to manufactures would not be greatly altered. An analysis using U.S. market shares and estimated price elasticities of supply and demand for various broad commodity groups suggests that a 10 percent depreciation of the dollar would raise the dollar prices of both non-oil primary commodities and manufactures by between 6 and 7 percent.11 A similar exercise suggests that a 10 percent dollar depreciation would raise the dollar price of fuels by around 3.5 percent.

Nevertheless, the effect of a dollar depreciation on relative prices could be considerably larger at a more disaggregated level, since the relative importance of the United States in world markets varies substantially across commodities. Indeed, a dollar depreciation could tend to reduce the relative price in world trade of some primary commodities, compared with the price of other traded commodities and manufactures. For instance, U.S. production of agricultural products such as coarse grains, wheat, and fats and oils is a substantial proportion of the world total. Consequently, a dollar depreciation might be expected to have a significant downward effect on the world prices of these commodities relative to the price of other goods in world trade. This can be explained as follows: a depreciation of the U.S. dollar would raise the price of these commodities relative to the price of nontraded goods in the United States. The resulting output increase and consumption decrease in the United States would then tend to force down the world price of these commodities relative to other traded goods because of the large proportion of supply on world markets for these commodities that is accounted for by U.S. exports. The size of the relative price change would depend on the relevant supply and demand elasticities with respect to price.

Additional evidence on these issues is provided by econometric analyses of the determinants of the dollar prices of primary commodities and manufactures. Analyses of quarterly data covering the period from the early 1970s to the early 1980s find that the elasticity of dollar prices of primary commodities with respect to the exchange rate of the U.S. dollar vis-à-vis other major currencies is around –¾; a similar elasticity is obtained for the dollar price of manufactures.12 These results confirm the above finding regarding the lack of a strong impact of changes in the U.S. dollar exchange rate on the relative price of primary commodities vis-à-vis manufactures.

To a considerable extent, of course, the question of whether changes in the U.S. dollar exchange rate affects “real” commodity prices depends on the price index used to deflate commodity prices. An appreciation of the dollar would tend to lower the price of primary commodities relative to the composite price of U.S. domestic output and raise their price relative to the composite price of domestic output in other industrial countries. In this regard, several econometric studies detect a large and significant negative relationship between the real effective exchange rate of the U.S. dollar and the “real” price of primary commodities when the latter is derived by deflating commodity prices in current U.S. dollars by the U.S. GDP deflator. However, this relationship reflects, in large part, the effect of a dollar appreciation in raising the relative price of nontraded goods in the U.S. economy. This does not directly affect developing countries’ terms of trade since, by definition, developing countries do not purchase U.S. nontraded goods. Nevertheless, the effect of a dollar appreciation or depreciation on the terms of trade of individual developing countries will be strongly influenced by the degree to which their foreign trade is oriented toward the U.S. markets.

Macroeconomic developments in industrial countries will also influence the price of oil. Although the share of industrial countries in total world oil consumption has declined (from 71 percent in 1973 to 57 percent in 1984), changes in real output in industrial countries still have a substantial impact on the total world demand for oil. Most empirical estimates suggest that the elasticity of industrial country demand for oil with respect to real output is somewhat below unity, around, say, 0.8. This would indicate that a 1 percentage point decrease in industrial country output would lead to a decrease in total world demand for oil of just under ½ of 1 percentage point. The response of oil prices to such a change in demand would be strongly affected by the supply policies of the oil producers belonging to the Organization of Petroleum Exporting Countries (OPEC) particularly in the short term. If the members of OPEC reduced their oil output levels to match the decline in world demand, then oil prices would remain unchanged, although total oil export earnings would decline because of the reduced export volumes. However, recent experience has shown that the larger the fall in world demand, and consequently the larger the cuts in production needed to maintain an unchanged oil price, the greater the tendency for production quotas to be exceeded and for the actual oil price to decline as various oil exporting countries offer direct and indirect discounts.

Terms of Trade

It is evident that the consequences for developing countries’ terms of trade of the various shifts in relative prices discussed above will depend on the commodity composition of each country’s exports and imports. To illustrate this, rough estimates of the cyclical elasticity of the terms of trade of groups of developing countries with respect to gross national product (GNP) in industrial countries are given in Table 58. Although the simple estimating equations used to obtain these elasticities are obviously subject to numerous econometric problems, the results do indicate that the terms of trade of those countries that export mainly primary products benefit more from faster growth in industrial countries (and suffer more from slower growth) than do the exporters of manufactures. The terms of trade of the service and remittance countries appear to improve the least, perhaps because their exports are less oriented toward the industrial countries and because most of their exports that do go to the industrial world are destined for the more slowly growing European countries. For the group of non-oil developing countries, the terms of trade elasticity is estimated at 1.7; a similar estimate is derived by van Wijnbergen (1985) using a somewhat different approach.

Table 58.Developing Countries: Estimated Marginal Elasticities of Export Volume and the Terms of Trade with Respect to Industrial Countries’ Real GNP, 1967–84
Elasticity of Export

Volumes
Elasticity of the Terms

of Trade
Implied Elasticity of

the Purchasing Power

of Exports1
By predominant export
Fuel exporters3.9**–3.7
Non-fuel exporters21.6**2.3**3.9
Primary product exporters1.6**2.3**3.9
Exporters of manufactures2.4**1.4**3.8
Service and remittance countries0.80.9**1.7
By region
Africa3.0**–0.22.8
Excluding Algeria and Nigeria2.0*1.9*3.9
Asia2.7**1.5**4.2
Europe1.5**0.7**2.2
Middle East4.1**–4.1
Of which: non-oil exporting countries0.9–0.60.3
Western Hemisphere1.5**1.02.5**
By alternative analytical categories
Non-oil importing developing countries 21.81.73.4
Net oil exporters0.81.82.6
Major exporters of manufactures2.7**1.6**4.3
Low-income countries 30.62.4**3.0
Other net oil importers1.1**1.8**2.9
Note: Estimates show the impact of changes in industrial country GNP within a year. Elasticities were estimated from ordinary least square regressions on equations of the forms:Δ log (volume of exports) = a0 + a1 Δ log (industrial country GNP);Δ log (terms of trade) = α0 + α1 Δ log (industrial country GNP).** and * denote significance at the 1 and 5 percent levels, respectively.

However, there are grounds for believing that such estimates may be biased upward, since part of the effect attributed to changes in industrial country output may actually be due to other factors omitted in the analysis. In this context, two features of these estimates should be noted. First, they measure the rela- Table 58 relate changes in the terms of trade to the rate of output growth in industrial countries during the same year. The longer-term impact of faster industrial country growth could be smaller, because demand from stockbuilding would be less important and because supply would have longer to adjust to the increased demand. In this regard, estimates by Cline (1984) on the effect of economic growth in countries of the Organization for Economic Cooperation and Development (OECD) on the terms of trade of selected developing countries suggest that there may be an initial terms of trade improvement as OECD growth accelerates, but that no further improvement occurs once a stable growth rate is reached. According to his estimates, a 1 percentage point increase in the rate of industrial country growth would cause, on average, a rise in developing countries’ terms of trade of 1.5 percent in the first year and another 1.5 percent in the second year, but the terms of trade would then remain unchanged unless there was a further change in the rate of growth in industrial countries. However, the nature of the supply responses that would generate such a relationship are not clear.

A second reason for believing the estimates may be high is that the earlier estimates of the impact of industrial country growth on the relative price of primary commodities vis-à-vis manufactures, together with the commodity composition of developing countries’ exports and imports, suggest somewhat smaller effects on the terms of trade than those estimated in Table 58. For example, for low-income developing countries (excluding China and India) manufactures represented about 30 percent of exports and 56 percent of imports in 1982 while the shares of primary commodities were around 55 percent and 20 percent, respectively (Table 50). If a 1 percentage point increase in industrial country economic growth raises the price of primary commodities relative to manufactures by 2 percent for both exports and imports then (without taking account of the impact of industrial country growth on the relative price of fuels) this would imply an increase in this group’s terms of trade of the order of 7/10 of 1 percent. The effect on the terms of trade of other developing country groups would be even lower, because of the smaller difference between the share of manufactures in their exports and imports; for middle-income oil importers, this approach would suggest a terms of trade effect of only around ¼ of 1 percent.

It might be argued that these latter figures tend to underestimate the terms of trade elasticities because a substantial proportion of manufactured exports from many developing countries consists of processed primary products. Since the value added in processing for these goods is often relatively small compared with the value of the primary inputs, the world prices of such manufactured exports could be more strongly influenced by the prices of the primary inputs than are the prices of manufactures from industrial countries. Some evidence on the importance of this factor is provided by an econometric analysis of the elasticity of developing countries’ import and export unit values with respect to the world prices of various groups of goods (Table 59). The results suggest that the elasticity of export unit values with respect to the world price of manufactures is as important as the corresponding elasticity for import unit values. This in turn would seem to indicate that the effect on non-oil developing countries’ terms of trade of faster industrial country growth is substantially smaller than that suggested by the directly estimated elasticity of 1.7.13 Consequently, that estimate should perhaps be regarded as an upper limit of the likely true elasticity.14

Table 59.Developing Countries: Long-Run Elasticities of Unit Values of Imports and Exports with Respect to Prices of Fuels, Non-Oil Primary Commodities, and Manufactures, First Half 1962 to Second Half 1979
Non-Oil Developing CountriesOil Exporting Countries
Elasticity of import unit values with respect to:
Price of fuels0.18**0.02**
Price of agricultural goods10.25**0.08**
Price of raw materials20.17**0.03*
Price of manufactures30.41**0.89**
Elasticity of export unit values with respect to:
Price of fuels0.08**1.22**
Price of non-oil primary commodities 40.54**
Price of manufactures0.41**
Note: Estimated elasticities were derived from regressions for semiannual data on equations of the form: Δ log (import unit value) = a1 Δ log (price of fuels) + a2 Δ log (price of agricultural goods) + a2 Δ log (price of raw materials) + a4 Δ log (price of manufactures). Only the long-run elasticities are reported. ** and * represent significance at the 1 and 5 percent levels, respectively.

Finally, a further econometric analysis covering the period 1967–84 finds that an appreciation of the real effective exchange rate of the U.S. dollar does not result in a significant deterioration in the terms of trade of either the group of non-oil developing countries or the non-fuel exporting countries.15 A similar investigation suggests that, on the basis of historical experience, the terms of trade of the fuel exporters among developing countries did improve when the U.S. dollar appreciated. However, this relationship probably reflects the attempts by certain oil exporting countries to maintain a dollar export price for oil unchanged for quite long periods. Consequently, this past experience may not be a good guide to the future relationship between the exchange rate of the U.S. dollar and the terms of trade of the fuel exporters.

Transmission of Economic Influences Through Volumes Changes

There is ample evidence that a faster growth of real incomes in industrial countries leads to a more rapid growth in their total imports, including those from developing countries. The magnitude of the response of developing country export volumes will depend, among other factors, on their commodity composition, the relative importance of the industrial country markets, the relative competitiveness of developing countries’ exports, and the price elasticity of industrial countries’ import demand.

The following discussion presents two sets of evidence on the relationship between industrial countries’ real incomes and developing countries’ export volumes, using the distinction between “marginal” and “average” elasticities.16 In the first set, the implied elasticities of changes in export volumes with respect to changes in industrial country GNP are estimated for broad groups of developing countries. These are marginal elasticities in the sense that they reflect the percentage point increase in the rate of growth in developing country export volumes that would result from a 1 percentage point increase in the rate of economic growth in the industrial world. These estimates do not take account of developing countries’ supply responses, nor of variations in the direction of trade. In the second set, for a sample of the non-fuel exporters among developing countries, the elasticity of the level of export volumes with respect to the level of real GNP in industrial countries is estimated.17 These are average (or conventional) elasticities in the sense that they reflect the percentage increase in the level of developing country export volumes that would result from a 1 percentage point increase in the level of real GNP in industrial countries. For each developing country, the latter index is weighted according to the geographical distribution of its exports. The estimated average elasticities also take account of supply responses to the extent that the effects of changes in developing countries’ relative competitiveness on export volumes are included.

The estimated marginal elasticities are shown in Table 58 and comparable estimates provided in other studies are shown in the first part of Table 60. Three broad conclusions can be drawn. First, the elasticity of changes in export volumes of non-oil developing countries (and of the broadly similar group of non-fuel exporters) with respect to changes in industrial country GNP appear to be within the range 1.3 to 2.3. A higher elasticity is used by Cline but this is based on an estimate for all industrial country imports (with the constant term adjusted to reflect the higher trend growth of developing country exports to industrial countries) and is not confirmed by other studies.18 Second, Goldstein and Khan’s results indicate that this elasticity increased between 1963–72 and 1973–80, perhaps because of the increasing share of manufactures in developing country exports.19 However, experiments with sub-periods during the 1970s and early 1980s (not reported in Table 58) provide no evidence that there has been any further increase in these elasticities over time. Third, the commodity composition of developing countries’ exports does seem to affect their responsiveness to changes in industrial country GNP. The exporters of manufactures recorded an elasticity of 2.4, substantially higher than the elasticity of 1.6 recorded for primary product exporters. The elasticity estimated for the service and remittance countries was even lower, perhaps because of the lesser importance of the industrial country markets for these countries’ exports.

Table 60.Alternative Estimates of the Elasticities of Developing Countries’ Export Volumes with Respect to Real GNP in Industrial Countries and with Respect to Developing Countries’ Real Effective Exchange Rates
InvestigatorTime

Period
Variable

Investigated
Estimated

Elasticity with

Respect to Real

GNP or GDP
Estimated

Elasticity with

Respect to Real

Effective

Exchange Rates
Estimates of marginal elasticities
Cline (1983 and 1984)1961–81Non-oil exports of developing countries3.01
Dornbusch (1986)1960–83Total exports, non-oil developing countries1.3*2
Fishlow (1985)1977–84Total exports, non-oil developing countries1.7
Goldstein and Khan (1982)1963–80Total exports, non-oil developing countries1.3*
1963–72–0.5
1972–802.3*
Goldsbrough (1986) and Zaidi1967–84Total exports, non-oil developing countries1.7**
(see Table 61)
van Wijnbergen (1985)1966–83Total exports, non-oil developing countries1.6
Estimates of average elasticities
Bond (1985)1967–81Total exports, non-oil developing countries32.44–0.84
Goldsbrough (1986) and Zaidi1968–84Total exports, non-fuel exporters2.34–0.64
Total exports, primary product exporters2.4**–0.5**
Total exports, exporters of manufactures2.7**–0.8
Total exports, service and remittance countries0.4–0.7
Note: The estimates of the marginal elasticities were derived from economic investigations of the relationship between the rate of growth of developing countries’ export volumes and the rate of growth of industrial country GNP in the same year. The estimates of the average elasticities were derived from econometric investigations of the relationship between the level of export volumes and the level of industrial country GNP (both in terms of logarithms).

The estimated average elasticities are shown in the second part of Table 60. In general, they are slightly higher than the estimates obtained for the marginal elasticities, but this probably reflects the use of weighted GNP indices for the industrial countries which more closely reflect the pattern of developing countries’ export trade. The results generally confirm the broad conclusions, stated above, on the elasticities of developing countries’ export volumes.20 In addition, the relatively high coefficients obtained for the elasticity of export volumes with respect to developing countries’ real effective exchange rates suggest that broad groups of developing countries, and not just individual developing countries, can expand their shares of industrial country markets by improving their competitiveness.

The effects of changes in industrial country GNP on the exports of the fuel exporters have been largely determined by the singular conditions in world oil markets. The efforts by the members of OPEC to maintain the U.S. dollar prices of their oil exports unchanged for fairly long periods caused them to act as residual suppliers of oil to importing countries for much of the period since 1973. Consequently, the volume of oil exports by these countries has been highly sensitive to fluctuations in economic activity in the industrial world—this is reflected in the high estimated elasticity of 3.9 (Table 58). Also, since the OPEC strategy has caused oil prices to be less affected by short-term, cyclical fluctuations in industrial country output, there has tended to be a negative relationship between changes in fuel exporters’ terms of trade and cyclical changes in industrial country GNP. However, the more recent emphasis of the major oil exporting countries on protecting their market shares rather than on maintaining a given price would suggest that changes in industrial country output in the future may have a smaller impact on these countries’ export volumes than in the past, but a larger positive impact on their export prices.

Finally, there are no strong reasons for expecting that a shift in the exchange rate of the U.S. dollar relative to the currencies of other industrial countries would, by itself, have a significant effect on the total volume of exports by all developing countries as a group. To be sure, if a significant number of developing countries chose to appreciate or depreciate their own currencies along with the U.S. dollar, their export volumes would clearly be affected, but such effects would be more appropriately regarded as resulting from these countries’ own exchange rate action. At a more disaggregated level, however, the shift in merchandise trade deficits among industrial countries that would result from a change in the exchange rate of the U.S. dollar against other major currencies could affect the export volumes of individual developing countries. For those countries that export a large proportion of their exports to the United States, a depreciation of the dollar could be expected to reduce U.S. demand for their exports by more than the increase in demand in other industrial countries.

Purchasing Power of Exports by Developing Countries

The combined effects of changes in the pace of growth in industrial countries on developing countries’ terms of trade and export volumes determine the overall effect on the purchasing power (in terms of imports) of their total export earnings. The results for the marginal elasticities suggest that a 1 percentage point increase in the rate of growth of real GNP in industrial countries would be associated with an increase of around 3½ percent in the purchasing power of exports by non-oil developing countries (Table 58). Because of the uncertainty concerning the estimates for the terms of trade effect, this estimate is probably toward the upper end of the range of likely overall effects. Using the lower estimates of their terms of trade elasticity (of around 0.3) derived from the effects of industrial country growth on commodity prices gives an estimated elasticity of the purchasing power of exports of around 2, which may be regarded as toward the lower end of the range of likely overall effects.

Grouping countries by the category of their dominant exports, the results indicate that a cyclical increase in the rate of economic growth in industrial countries would have the largest impact on export volumes from exporters of manufactures and the largest impact on the terms of trade of primary product exporters, but that the overall impact on the purchasing power of exports from the two groups would be similar (Table 58). However, the group of primary product exporters includes some countries that are substantial exporters of manufactures. Results for the alternative analytical category of major exporters of manufactures, which includes these countries, suggests that the purchasing power of their exports would improve by more than that of primary product exporters without significant manufactured exports. The purchasing power of exports from the service and remittance countries would increase at only about half the rate recorded for the two other groups. On a regional basis, developing countries in Asia appear to record the greatest increase in the purchasing power of exports as a result of faster industrial country growth, while developing countries in Europe record the smallest increase.

However, these estimates reflect the effects of a cyclical increase in industrial country growth. The earlier discussion has suggested that the longer-term impact on developing countries’ purchasing power may be lower, largely because the effect on these countries’ terms of trade of an increase in the trend rate of growth in industrial countries could be substantially smaller than the effect of a cyclical increase.

Transmission of Economic Influences Through Receipts from Services and Private Transfers

Discussions of the economic interdependence between developing and industrial countries have largely concentrated on merchandise trade flows. Nevertheless, earnings from services, migrants’ remittances, and other private transfers are also quite important. During the period 1982–84, earnings from services and net receipts of private transfers amounted to almost 30 percent of total foreign exchange earnings by the non-fuel exporters (Table 61). Within this group, the exporters of manufactures are the least dependent on receipts from services and private transfers—in fact, their reliance on merchandise exports has increased since the late 1960s. In contrast, merchandise exports account for a small and declining share of the total foreign exchange earnings of the service and remittance countries. Investment income earnings have increased markedly in importance for both the service and remittance countries and for the group of fuel exporters. This resulted from, respectively, the substantial accumulation of overseas assets by some oil exporting countries and the rapid expansion of the international financial services sector in a few of the service and remittance countries.

Table 61.Developing Countries: Average Shares of Merchandise Exports, Services, Investment Income, and Private Transfers in Foreign Exchange Earnings, 1968–70 and 1982–84(As a percentage of total foreign exchange earnings)
1968–701982–84
Merchandise

exports
Services,

other than

investment

income
Investment

income
Net

private

transfers
Merchandise

exports
Services,

other than

investment

income
Investment

income
Net

private

transfers
Fuel exporters92.714.22.6–9.588.65.99.3–3.8
Non-fuel exporters71.021.23.04.870.519.25.74.6
Primary product exporters81.415.82.876.616.13.73.6
Exporters of manufactures68.621.44.95.174.218.24.72.9
Service and remittance countries48.232.85.513.532.134.222.814.9

Although little information is available on the geographic destination of developing countries’ service exports, a considerable share must be directed toward the industrial countries. In 1984, just under one third of total service earnings (other than from investment income) by the non-fuel exporters consisted of receipts from shipping and other transportation activities and one third were travel receipts, including those from tourism. The geographic distribution of the former category in particular was probably quite close to that of merchandise trade. Consequently, total demand for these services can be expected to be influenced by real incomes in industrial countries.

The change in the volume and price of services (other than investment income) resulting from a change in industrial country real GNP will depend on the income and price elasticities of demand for such services in industrial countries, the price elasticity of supply from the developing countries, and the price elasticity of supply from other sources, including from within the industrial countries. While it is not possible to estimate these effects directly, some information is available on the reduced-form relationship between the growth of the purchasing power of these service exports and the growth of industrial country real GNP. Econometric estimates suggest that a 1 percentage point increase in the real GNP of industrial countries is associated with an increase of 1.4 percent in the purchasing power of exports of services by the non-fuel exporters (Table 62). This is substantially lower than the corresponding elasticity estimated for the purchasing power of this group’s merchandise exports. As might be expected, the purchasing power of service exports from the service and remittance countries appear to be more sensitive to changes in industrial country GNP than are those of developing countries that rely mainly on merchandise trade. On a regional basis, changes in industrial country growth rates appear to have the largest impact on the purchasing power of service exports from developing countries in Europe and in the Western Hemisphere, whereas the effect on countries in Africa, Asia, and the Middle East are relatively low and insignificant.

Table 62.Developing Countries: Estimated Elasticities of the Purchasing Power of Receipts from Services and Private Transfers with Respect to Industrial Countries’ Real GNP, 1968–84
Elasticity of Purchasing Power

of Exports of Services1
Elasticity of Purchasing Power

of Private Transfers2
By predominant export
Fuel exporters1.2
Non-fuel exporters1.432.33
Primary product exporters0.61.0
Exporters of manufactures1.53.2
Service and remittance countries2.4*2.7
By region
Africa0.74
Asia0.91.8
Europe2.4**3.2
Middle East0.1
Western Hemisphere2.5**7.0
By alternative analytical categories
Non-oil importing developing countries1.5*2.6
Net oil exporters2.8**
Major exporters of manufactures1.8*4.3
Low-income countries 50.75.6
Other net oil importers0.63.4
Note: Elasticities were estimated from ordinary least square regressions on equations of the forms:Δlog(exportsofservicesunitvalueofimports)=a1+a1Δlog(industrialcountryGNP)andΔlog(netprivatetransferreceiptsunitvalueofimports)=α0+α1Δlog(industrialcountryGNP)** and * indicate significance at the 5 and 1 percent levels, respectively.

The major component of private transfer receipts by non-fuel exporting developing countries consists of migrants’ remittances. These countries have exported labor to the industrial countries as well as to the major oil exporting countries. The remittances of these workers back to the home country have been strongly influenced by the level of economic activity in the host country. Estimates by Swamy (1981) of the elasticity of remittance inflows with respect to various measures of cyclical economic activity (either GDP, government expenditures, or exports) in host countries ranged from under 1 to over 3.21 Rough estimates of the elasticity of the purchasing power of developing countries’ net private transfers with respect to industrial country GNP are given in Table 62.22 Although none of these estimated elasticities are statistically significant, they do suggest that, as for service receipts, it is transfer receipts by developing countries in Europe and the Western Hemisphere that are the most sensitive to fluctuations in economic growth in the industrial countries. The lower sensitivity of transfer receipts by other regional groups probably reflects their greater dependence on migrants’ remittances from oil exporting countries.

Effects of Protectionism in Industrial Countries

The stance of trade policies in the industrial countries, which can have significant consequences for developing countries’ export expansion, is influenced by overall macroeconomic conditions in the industrial world. Pressures to impose protectionist trade measures generally arise when individual sectors experience a loss of comparative advantage and when rigidities in labor and other markets hamper rapid structural adjustment. In such circumstances, producer interests in import-sensitive sectors of the economy often seek government action to insulate those sectors from import competition in order to protect employment and wage levels and profit margins. Although rising pressures for protection need not translate themselves into more restrictions if governments firmly refuse to accede to these demands, in practice governments have found it difficult to do so during periods of stagnating or declining economic activity and rising unemployment. Moreover, protectionist measures imposed during periods of rising unemployment often prove difficult to dismantle quickly when economic activity recovers. Consequently, there may be a tendency for a ratchet effect in the degree of protectionism, as the next cyclical downturn begins with a higher prevailing level of protectionism than did the previous downturn.

Such factors underlie the increase in protectionism in most industrial countries during recent years.23 This protectionism has largely taken the form of nontariff restrictions. A recent study by the OECD (1985) estimates that the proportion of manufactures subject to nontariff barriers in the major industrial countries rose from 20 percent in 1980 to 30 percent in 1983.24 One aspect of this drift toward protectionism that is of particular concern to developing countries is the increasing recourse to bilateral, sector-specific trade restraints. Such measures are designed to restrict import competition from countries with a comparative cost advantage and are often imposed on products with relatively labor-intensive production techniques—for which developing countries are more likely to have such a comparative advantage. Nontariff barriers against the agricultural exports of developing countries are even more prevalent than those against their manufactured exports. The World Bank estimates that, in 1983, 29 percent of developing countries’ agricultural exports to industrial countries were affected by non-tariff barriers compared with 18 percent for manufactured exports.25 Overall, around one fifth of industrial country imports from developing countries were subject to nontariff barriers compared with around one tenth of imports from within the industrial country group.26

Increased protectionism in industrial countries has a direct impact on developing countries’ export earnings by lowering the effective demand for their exports and thereby exerting downward pressure on prices and volumes. The final impact will depend on factors such as the elasticity of foreign demand for the goods concerned (in both the industrial countries and in other markets) and on domestic supply and demand conditions in the developing countries themselves. Several studies have investigated these factors. Klein and Su (1979) use the integrated econometric country models of Project LINK to estimate the worldwide effects of tariff increases (or corresponding quantitative restrictions when import equations do not depend significantly on relative prices) on the manufactured imports of 13 OECD countries. Their results suggest that a 20 percent increase in trade barriers, introduced in 1978, would have caused a cumulative deterioration in the trade balance of developing countries of about $28 billion in the first two years and a $6 billion decline in real GNP over the same period.27

Using partial equilibrium analysis, Kirmani et al. (1984) estimate the potential impact on the export volumes of ten developing countries of eliminating the tariff and nontariff barriers to trade in seven relatively highly protected agricultural or manufacturing sectors of industrial countries.28 Their results indicate that such a trade liberalization could generate an increase in the total export volumes of the sample countries in the order of 5 percent to 10 percent. (They do not estimate the terms of trade effects.) Some of the largest estimated gains would result from trade liberalization in the textiles and clothing industries, where trade restraints have been directed primarily at exports from developing countries and have tended to become more extensive and more restrictive in recent years. Indeed, a more recent study by the OECD (1985) concludes that the implementation of the third Multi-Fiber Arrangement, which came into effect in 1982, reduced the volume of textile and clothing imports from non-OECD sources by around a further 10 percent in 1982 and 1983.

However, these various estimates only capture the direct impact of protectionism on developing countries’ exports and economic growth. The longer-term dynamic effects, in terms of the lost opportunities for reaping economies of scale and the potential disincentives for investment in the export sectors, are likely to be even greater, albeit difficult to measure. Also, the spread of nontariff barriers, especially in the form of bilateral restrictions, reduces the price sensitivity of trade flows and can thereby increase the costs of balance of payments adjustment for developing countries. For instance, as industrial countries increase their trade barriers, the reduction in the real exchange rate required to achieve a given improvement in a developing country’s trade balance is likely to rise.

In a more general equilibrium framework, changes in the stance of protectionism in the industrial countries may also affect the volume and price of capital inflows into developing countries. An increase in protectionism that hampers developing countries’ export earnings may increase banks’ perceived risks of lending to these countries and lead them to tighten their credit rationing. van Wijnbergen (1985) also argues that an increase in protectionism is likely to raise world interest rates. He argues that higher protectionism is likely to lead to no ex ante improvement in the current account of industrial countries but to an ex ante deterioration in the current account of developing countries; the latter deterioration is largely due to the assumption that the demand for imported capital goods is price inelastic. These movements in the current account would imply that ex ante world investment increases relative to ex ante savings, necessitating higher real interest rates to restore the global balance. However, empirical evidence on the importance of this effect is not yet conclusive.

Developing Countries: Export Growth, Terms of Trade, and Real Income Growth

The changes in developing countries’ terms of trade and export volumes discussed in the previous sections can in turn affect output growth in developing countries through four broad channels. First, the level of aggregate demand may be affected and cause cyclical fluctuations in the degree of capacity utilization; second, changes in the ability to import scarce inputs may also affect capacity utilization; third, the level of investment may be affected by changes in real incomes and savings rates or by changes in the ability to import capital equipment; and fourth, changes in the rate of growth of the export sector may induce changes in the overall rate of growth through various production linkages. The first two of these channels can be thought of as representing the short-term or “cyclical” effects of export growth on output and the last two channels as representing the longer-term, trend effects.

A quantitative assessment of the impact through these various channels is not easy. The effects will vary substantially across developing countries according to their economic structure, including the relative importance of the foreign trade sector, and will also vary over time for individual countries, according to the degree of internal and external macroeconomic balance. In particular, it should be remembered that developing countries’ own policies will have a substantial influence on the degree to which their output growth is affected by changes in export earnings.

The initial impact on a country’s welfare of an increase in the purchasing power of its exports is likely to differ substantially according to whether the increase is due to a terms of trade improvement or an expansion in export volumes. The former represents a clear gain in real income, since an increased volume of imports could be obtained without any change in the domestic resources allocated to producing exports, whereas an increase in export volumes will require the diversion of resources to the export sector from sectors serving domestic expenditures, unless none of the resources were previously utilized. The welfare effect of such a resource shift will depend on the relative benefits accruing from increased foreign exchange earnings and the alternative production foregone.

In the following, a perspective is offered on the nature of these various interconnections and on the factors influencing their quantitative importance.

Effect on Aggregate Demand

Increased export earnings tend to raise aggregate demand. This can occur directly, as the increase in incomes from exports leads to a general rise in demand, and indirectly if higher exports lead to an improvement in the external position, and this encourages the adoption of more expansionary monetary and fiscal policies. The latter effect could occur if domestic financial policies reacted in response to various indicators of the external position—such as the current account or the debt and debt service ratios—which might be altered by higher exports. Conversely, developing countries may try to maintain their growth rates when export earnings fall by stimulating domestic demand and increasing their recourse to foreign borrowing. This was particularly the case in the years following the first large oil price increase, and led eventually to the need for subsequent harsher adjustment measures.

It is difficult to reach any precise a priori conclusions on the size of the overall change in aggregate demand that would result from a change in export growth. The effect would clearly tend to be larger the greater is the share of exports in a country’s total aggregate demand and the smaller are the propensities to import and to save out of additional income. One important determinant of the degree to which domestic financial policies react to changes in exports will be the extent to which access to international capital flows is constrained. If a country’s debt and debt service ratios are high, so that the possibilities for new external borrowing are restricted, the initial change in aggregate demand resulting from a change in exports is more likely to be magnified by a shift in financial policies than if there is no binding constraint on new borrowing. An additional important factor is the sector to which the export gains initially accrue. This factor is of particular significance for those oil exporting countries where the bulk of receipts from oil exports accrue directly to the government, since in this case the impact on domestic aggregate demand of changes in export receipts will depend almost entirely upon how government expenditures respond to the corresponding changes in fiscal revenues.

The degree to which an increase in nominal aggregate demand is, in turn, reflected in an expansion of real output rather than in increased prices will depend in part on the prevailing level of capacity utilization, the tightness of labor markets, and the manner in which price expectations are affected by changes in demand. Domestic prices are likely to adjust more slowly to changes in nominal aggregate demand when there is substantial unutilized capacity, when labor is in excess supply, and when the change in aggregate demand is unanticipated. In such circumstances, much of the increase in aggregate demand may be reflected in higher output. In contrast, when the degree of capacity utilization is high, labor markets are tight, and prices and wages respond rapidly to changes in aggregate demand, then the impact on real output of externally induced changes in nominal aggregate demand will tend to be small.

Quantitative estimates of these aggregate demand effects would require the formulation of a macroeconomic model for developing countries, including a specification of how domestic financial policies would react to shifts in the external current account. Elaboration of such a model is outside the scope of this paper, but some indicative results for a group of six Asian developing countries—India, Indonesia, Korea, Malaysia, Philippines, and Thailand—are provided by Schadler (1986). Her results suggest that a decline of 2 percentage points in industrial country output growth (say, from a 3 percent rate of growth to a 1 percent rate) that is sustained for two years might be associated with a decline of around 2 percentage points in the annual export volume growth of the six countries and with a deterioration in the terms of trade of around 2 percent in each year. These effects on export earnings imply elasticities with respect to industrial country GNP that are toward the lower end of the range discussed earlier. If financial policies in these countries are moderately restrictive, this decline in export receipts is estimated to result in a reduction in the rate of growth of these countries’ real GNP by almost 1 percentage point in the first year and by about 1.3 percentage points in the second year.29 A larger slowdown in real economic growth would occur if tighter financial policies were adopted to achieve an even more rapid adjustment of the current account.

Changes in the Capacity to Import

Many developing countries are heavily dependent on imports of capital and intermediate goods as inputs into production. Consequently, when the stance of exchange rate and other macroeconomic policies is such that it is necessary to restrict imports either through the exchange system or the trade system, an increase in the purchasing power of exports (or in the level of capital inflows) may increase domestic output by providing foreign exchange to purchase scarce imported inputs. Moreover, the lack of foreign exchange to purchase imported capital goods may directly constrain investment, and therefore long-term growth prospects; this aspect will be considered later.

The strength of the link between import availability and output will depend on the severity of the foreign exchange constraint, the relative openness of the economy, the degree of substitutability between imported inputs and domestic alternatives, and the extent to which a country’s policies permit shifts in relative prices to allocate available imports to the uses with the highest opportunity costs. Changes in the capacity to import will tend to have the largest impact on domestic production in the short term, when substitution possibilities are lowest.

Empirical estimates of the elasticity of output with respect to imports are complicated by the fact that a change in output will itself cause a change in demand for imports; consequently, the direction of causation involved in any direct estimates of the relationship between changes in output and changes in imports may be ambiguous. Nevertheless, some indication of the likely range of the elasticity may be obtained from three alternative estimates.

Leven and Roberts (1983) estimate the relationship between the growth of GDP in Latin American countries during the period 1956–80 and the change in import volumes in current and previous years. Their results suggest that a 1 percentage point rise in real imports leads to an increase in real GDP of about 0.5 percent, of which about one half takes place in the same year and one half over the next five years.30 This estimate is likely to represent an upper bound to the actual elasticity, because of the ambiguous direction of causation already mentioned and because the contribution to output growth of other factor inputs has been ignored. Alternative estimates incorporating the contributions to output growth of fixed capital and labor are derived by Bergsten et al. (1985) for selected Latin American countries. Their estimates for the period 1960–83 suggest that the elasticity of output with respect to the average of the current and previous years’ real imports varies from virtually zero for Argentina, which was not subject to significant foreign exchange constraints for much of the period, to around 0.14 for Brazil, 0.23 for Mexico, and 0.27 for Chile.31

Finally, broadly similar estimates were obtained for the Philippines by Chopra and Montiel (1986) using an entirely different approach. They incorporate a system of foreign exchange rationing of imported intermediate goods into a model in which aggregate demand policies can affect the domestic level of output only to the extent that they produce unanticipated changes in the price level, which cause the supplies of labor and domestic production to deviate from their long-term equilibrium level. In such a system, deviations in domestic output depend upon changes in the level of excess demand for imported intermediate inputs or upon unanticipated changes in either domestic money supply, foreign income, or foreign prices. Their results over the period 1959–84 suggest that a 1 percentage point increase in imports will lead to a 0.28 percent cyclical increase in real output if the increase in imports is anticipated and to a 0.18 percent increase in output if the increase in import availability is unanticipated.

These various results suggest that, for countries which are subject to significant foreign exchange rationing of some form, a 1 percentage point increase in imports is associated with an increase in output in the range of 0.14 to 0.28 percentage points.

Changes in Export Earnings and the Rate of Investment

Changes in export earnings can alter developing countries’ long-term growth prospects by affecting the rate of fixed investment. This can occur through several channels: (1) increased foreign exchange receipts from exports (or from capital inflows) may relax foreign exchange constraints on the importation of scarce capital goods; (2) a large share of the increased export earnings may accrue to central governments or to government-controlled agencies, which generally have high propensities to invest; and (3) if the increased export earnings are due to an improvement in the terms of trade, then the resulting gain in real incomes may change the desired pattern of future consumption and hence lead to changes in the rates of saving and investment.

A scarcity of foreign exchange to purchase imported capital goods would usually have the largest impact on investment in the less industrialized developing countries. These countries generally do not have a significant domestic capital goods industry and so have fewer possibilities for substitution between domestic and foreign goods in capital formation. When such countries are faced with severe foreign exchange constraints, higher export earnings may raise the volume and the speed of implementation of investment. Marquez (1985) estimates that the long-run elasticity of investment with respect to the purchasing power of exports (in terms of imports of capital goods) is around 1.25 for the group of non-oil developing countries.32

In many developing countries (and especially the oil-exporting countries), government revenues are highly dependent on export earnings—both directly through various export taxes and other receipts and indirectly through tariffs on the additional imports that are made possible by higher export earnings. Consequently, an increase in export earnings raises government revenues, which in turn is likely to result in increased public investment. If the increase in export earnings is due to higher export volumes rather than higher prices, thereby requiring a shift of resources to the export sector from other sectors, then investment is likely to fall in those other sectors. However, this fall may not fully offset the increase in public investment especially when the effective rate of taxation of export earnings is high and a large proportion of any increase in government revenues is used to expand public investment.

Finally, it is difficult to determine on a priori grounds the size, or even the direction, of the effect that an improvement in the terms of trade has on the rate of investment, since it depends upon whether the terms of trade improvement is perceived as temporary or permanent and whether it is anticipated or not. In general, the more permanent a terms of trade improvement is considered to be, the more likely it is to generate a higher rate of investment, so as to make possible the desired higher consumption path. There is substantial empirical evidence that an improvement in the terms of trade strengthens a developing country’s external current account, which reflects an increase in aggregate saving relative to aggregate investment. Khan and Knight (1983) estimate that, for a group of non-oil developing countries, a 1 percentage point improvement in the terms of trade leads, on average, to an improvement of over ⅖ of 1 percentage point in the current account balance expressed as a ratio to exports. However, there is only limited evidence concerning how this improvement in the current account is reflected in changes in the rates of domestic savings and investment taken separately. Estimates by Fry (1986b) for a group of Asian developing countries over the period 1961–83 suggest that a 10 percent permanent improvement in the terms of trade leads to an increase in investment as a ratio to GDP of about ½ of 1 percentage point, but that a temporary improvement in the terms of trade has a relatively minor overall impact.33

The Production Linkage

The transfer of factor resources from the rest of the economy to the export sector may raise a developing country’s overall rate of growth because the latter sector is often the most productive and the most open to economies of scale. Faster export growth may also have beneficial effects on the non-export sectors by encouraging the introduction of better infrastructure and a more highly trained labor force and by promoting the spread of improved production and management techniques.

Most of the recent empirical evidence on the quantitative importance of these links between export performance and output growth for developing countries has been reviewed by Goldstein and Khan (1982).34 Their broad conclusions can be summarized as follows. First, cross-country studies suggest that a 1 percentage point faster growth in exports may be associated with a faster growth in real GDP of the order of 1/10 of 1 percent. Second, countries that export relatively more manufactured goods seem to be the ones in which the link between export performance and output growth is the strongest. Third, there is some indication that the relationship between export performance and output growth has grown stronger over time, probably because of the growing share of manufactures in developing country exports.

Transmission of Economic Influences Through Financial Markets

The transmission of economic influences from industrial to developing countries through the financial markets has become increasingly important, both because the external indebtedness of developing countries has increased and because a greater share of capital flows to developing countries has taken the form of bank lending at variable interest rates. The principal financial linkages operate through the level of international interest rates and the exchange rates of industrial countries, which affect debt service burdens, and through the availability of private international lending. These in turn affect the levels of domestic saving and investment and the macroeconomic policies of developing countries. Although financing constraints and externally induced changes in debt service burdens have affected almost all developing countries, the relative importance of these forces has varied widely across individual countries. Developing countries that are most heavily dependent on financing from commercial banks were the most affected by the rise in interest rates and the sharp decline in new bank lending. Accordingly, the analysis presented in this section emphasizes the capital importing developing countries, particularly the subgroups of market borrowers and countries with debt-servicing problems.

The analysis begins with a review of the increased international financial integration of developing countries. This provides the background for a discussion of how changes in international interest rates and in the level of financial flows to developing countries affect key macroeconomic variables in these countries, including domestic saving, investment, and economic growth. The section concludes with a discussion of the links between capital inflows, financial policies, and capital flight.

Increased International Financial Integration

The developing countries became much more dependent on private external financing for their economic development during the 1970s than they were before, as both the public sector and private residents began to borrow heavily in world capital markets. From the end of 1973 through the end of 1981 the total external debt of capital importing developing countries increased at an annual rate of 21 percent. Despite the decline in capital inflows since 1982, this debt rose to $878 billion in 1985 compared with $752 billion in 1982. In real terms—deflated by the export unit value index of these countries—the external debt increased at an annual rate of 8 percent between 1973 and 1985, while export volumes rose at a rate of only 4 percent.

The most notable change in the pattern of capital inflows during the last decade was a marked shift from official flows and private foreign direct investment to international bank lending. During the 1960s, the main form of international bank lending was short-term trade credit. During the 1970s, however, institutional developments in the domestic banking systems of the industrial countries lowered the risk on deposit liabilities of the money-center banks, which enabled the major banks to become the largest recipients of international loanable funds. Furthermore, financial innovations—notably the growth of syndicated loans and the increased use of cross-default clauses, together with the greater use of variable interest rate loans—reduced perceived levels of risk in lending to developing country borrowers, resulting in a significant rise in the volume of private bank lending.35

From the perspective of the borrowing country, the demand for bank loans increased rapidly because of sizable payments imbalances in the 1970s, due in part to the two waves of major oil price increases. The attractiveness of such loans stemmed from their flexibility, convenience, and the low real interest rates prevailing for much of the period. The real three-month London interbank offered rate (LIBOR) on U.S. dollar deposits, to which interest rates charged on many bank loans are linked, averaged only around ½ of 1 percent over the period 1974–78.36

Consequently, there was a marked shift from non-debt-creating flows—official transfers and private direct investment—to debt-creating and interest-sensitive borrowing in world capital markets (Chart 17). The contribution of non-debt-creating flows to the financing required for the current account deficits of capital importing developing countries declined from 61 percent in 1970 to 28 percent in 1981, while the share of bank financing rose from 54 percent to 74 percent.

Chart 17.Capital Importing Developing Countries: Sources of External Finance, 1973–85

(In percent of exports of goods and services)

1 Mainly from banks.

2 Official transfers, SDR allocations, valuation adjustments, and gold monetization.

These developments greatly increased the sensitivity of developing countries to events in world financial markets. Most bank lending was at variable interest rates, and the share of capital importing developing countries’ total external debt that was subject to floating interest rates rose from an estimated 25 percent in 1973 to an estimated 52 percent in 1985. These interest payments were due irrespective of the uses to which the original borrowing had been put, whereas profit payments on foreign equity investments were more closely linked to the returns on the underlying investments.37 Also, new flows of bank lending to a developing country were more likely to be affected by sudden and uniform shifts in the perception of the country’s creditworthiness than were other forms of capital inflows.

Interest Rate and Exchange Rate Effects

The cost of developing countries’ borrowing in world capital markets is largely determined by the financial policies of the industrial countries, since there is a close relationship between domestic interest rates in industrial countries and the rate at which banks lend to developing countries. Furthermore, since a high proportion of developing country debt is denominated in U.S. dollars, an appreciation of the dollar increases the value of debt and debt service payments in terms of the currencies of other industrial countries.

Fiscal and monetary policies in the industrial countries influence interest rates on the world capital markets. For example, a combination of an expansionary fiscal policy and tight monetary policy causes a shift from bank deposits to government securities, which has a negative effect on bank liquidity. Since banks have balance sheet objectives, which they act to secure through asset and liability management, they respond by raising their deposit rates so as to attract the necessary deposits to fund their loan portfolio. The resulting higher cost of funds implies a general hardening of lending terms, including higher interest rates and shorter average maturities on new lending. These in turn affect the volume and cost of international finance to developing countries.

Following a period of relatively high inflation and low real interest rates in the industrial world during the 1970s, which facilitated the servicing of developing countries’ external debt, these countries have faced high interest rates in the 1980s. The disinflationary policies adopted by the industrial countries have entailed historically high nominal and real international interest rates and a consequent rise in borrowing costs (Chart 18). The shift in interest rates has been especially large when compared with changes in developing countries’ export prices. For example, the real interest rate for the capital importing developing countries, measured as the LIBOR on U.S. dollar deposits minus the annual percentage change in these countries’ export unit values was 18 percent in 1981–82, in sharp contrast to the negative real rate of 14 percent in 1973–77 (Table 63). Although this measure of the real interest rate declined during 1983–85, it is still very high by historical standards. Fluctuations in these interest rates were even more substantial for the subgroups of countries with debt-servicing problems and for the fifteen heavily indebted developing countries.

Chart 18.Capital Importing Developing Countries: Interest Rates, 1963–85

(In percent per annum)

1 The real interest is measured as the London interbank offered rate on three-month U.S. dollar deposits minus annual percentage change in export unit values in dollars.

Table 63.Capital Importing Developing Countries: Real Interest Rates and External Borrowing, 1973–85(In percent unless otherwise indicated)
1973–771978–801981–821983–85
Capital importing developing countries
Real interest rate1–14.0–5.317.812.6
Net external borrowing from private creditors2 (in billions of U.S. dollars)22.650.861.213.9
Ratio of net external borrowing from private creditors to imports of goods and services29.210.69.42.3
Ratio of external debt to exports of goods and services3107.9121.1135.7158.2
Market borrowers
Real interest rate1–14.6–6.817.612.7
Net external borrowing from private creditors2 (in billions of U.S. dollars)18.943.762.49.0
Ratio of net external borrowing from private creditors to imports of goods and services211.713.513.62.2
Ratio of external debt to exports of goods and services398.3113.8132.1151.7
Fifteen heavily indebted countries
Real interest rate1–20.3–8.917.912.4
Net external borrowing from private creditors2 (in billions of U.S. dollars)13.834.044.10.7
Ratio of net external borrowing from private creditors to imports of goods and services218.122.821.10.4
Ratio of external debt to exports of goods and services3144.2183.6231.3279.6
Countries without debt-servicing problems
Real interest rate1–12.3–4.116.912.3
Net external borrowing from private creditors2 (in billions of U.S. dollars)5.715.116.114.6
Ratio of net external borrowing from private creditors to imports of goods and services24.55.84.54.0
Ratio of external debt to exports of goods and services386.185.983.394.9
Countries with debt-servicing problems
Real interest rate1–15.9–6.818.913.1
Net external borrowing from private creditors2 (in billions of U.S. dollars)16.935.645.1–0.7
Ratio of net external borrowing from private creditors to imports of goods and services214.316.215.1–0.3
Ratio of external debt to exports of goods and services3132.6163.6207.4252.4
Note: For classification of countries in groups shown here, see the Appendix.

The cost of international bank lending to developing countries is based on a formula, with the costs of funds to the borrower comprising the market interest rate—generally represented by the LIBOR or the U.S. prime rate—plus a margin or spread. The interest rate fluctuates over the maturity of the loan, but the spread is usually fixed. These spreads over LIBOR vary according to the perceived risks associated with lending to a particular country—although generally within a relatively narrow range—and also vary substantially with the degree of liquidity in international capital markets.

The LIBOR itself can be regarded as consisting of a “risk-free” interest rate, which could be represented by the U.S. treasury bill rate and an additional margin or banking spread which reflects both the costs of bank intermediation and the risk premiums that banks have to pay in funding their own lending. This banking spread has varied considerably over time and is significantly influenced by financial developments in industrial countries. Since the probability of a developing country running into debt service difficulties is increased with higher interest rates, the banking spread tends to rise to reflect this increased risk. This relationship between the LIBOR-Treasury bill spread and the level of the Treasury bill rate (T-bill rate) is shown in Chart 19. The difference between the LIBOR and the Treasury bill rate is plotted on the vertical axis and the level of the Treasury bill rate on the horizontal axis.38 The positive correlation between the two is apparent from the clustering of the observations in the upper right-hand and lower left-hand quadrants. The correlation coefficient between the two series is 0.67. Dornbusch (1985) has estimated that a 4 percentage point increase in the level of the T-bill rate raises the spread between the LIBOR and T-bill rates by a full percentage point. Therefore, financial policies in industrial countries may influence the borrowing costs of developing countries not only through the level of domestic T-bill rates but also through the level of the banking spread, which tends to rise along with T-bill rates.39

Chart 19.Capital Importing Developing Countries: Relationship Between Treasury Bill Rate and Banking Spread, First Quarter 1975–Third Quarter 1985

(In percent)

1 Three-month bill rate.

Given the large amount of the debt owed to private creditors at variable interest rates, a rise in real international interest rates has a significant effect on the interest payments ratio—interest payments divided by exports of goods and services. Furthermore, the size of this effect varies considerably across the subgroups of developing countries classified by financial criteria because of considerable differences in both the ratio of external debt to exports of goods and services and the share of external debt owed to private creditors. For the capital importing developing countries as a group, it is estimated that, on the basis of 1985 exports and end-1985 external debt, a 1 percentage point rise in interest rates would directly increase the interest payments ratio by about 1 percentage point. However, for the market borrowers and for the fifteen heavily indebted countries, the increase in this ratio would be larger, at approximately 1¼ and 2¼ percentage points, respectively. In contrast, the rise in the interest payments ratio for the official borrowers (excluding China and India) would be only about ½ of 1 percentage point, reflecting the relatively small proportion of debt owed to private creditors. The impact of the interest rate increase on the interest payments ratio also differs sharply between the subgroups of countries with debt-servicing problems and those without these problems, with increases of approximately 2 percentage points and ½ of 1 percentage point, respectively. In addition to the short-term, direct effect of higher interest rates on debt service ratios, there would also be a further, longer-term impact as debt incurred at fixed interest rates matured, and was replaced by new borrowing at the higher rates.

Moreover, when nominal interest rates move with inflation there are important short-run effects on developing countries’ debt service burdens, even though there is no change in the real interest rate. When nominal interest rates rise in line with inflation because of floating rate loans, the higher interest payments include a component to compensate the lender for the erosion of the real value of loans. Therefore, higher inflation rates produce larger real debt repayments in the near future and lower real debt repayments near the end of the loan repayment schedule. In this way, higher nominal interest rates can result in debt-servicing problems, particularly if new lending is limited.

A depreciation of the U.S. dollar tends to reduce both the debt service and external debt ratios of developing countries. At the end of 1985, approximately 80 percent of the external debt of the capital importing countries was denominated in dollars. Since this is larger than the share of U.S. production and consumption in world markets for those goods and services exported by developing countries, a depreciation of the dollar raises the dollar value of developing country exports by more than the dollar value of their external debt. For example, calculations based on the 1985 values for exports of goods and services and external debt indicate that a 10 percent depreciation of the U.S. dollar would reduce the debt ratio of the capital importing developing countries from 162 percent to 155 percent.40

Rationing International Credit

Commercial banks make decisions not only regarding the distribution of their assets and interest rates but also on which customers to make loans to and to what extent. There has been considerable discussion in recent years about the relationship between credit rationing and default risk. Credit rationing exists when banks are unwilling to lend to a borrower even when the latter is willing to pay a higher interest rate. The availability of funds to developing countries is determined to a large extent by the judgments of commercial banks regarding the creditworthiness of countries. The major determinants of creditworthiness include the borrowers’ export performance, soundness of domestic financial policies, rate of economic growth, international reserve holdings, debt service ratio, and the existing exposure of banks. Consequently, when export earnings decline because of recession in the industrial world or when international interest rates rise, the actual and perceived capacity of developing countries to service their debt is diminished. As a result, the impact of such developments on these countries’ growth prospects can be magnified by a sudden reduction in the availability of external financing.

Several explanations have been offered to explain the phenomenon of credit rationing. It has been observed that a bank’s profit rate could actually decline if interest rates charged to borrowers were raised from “adverse selection effects” as those borrowers who are discouraged are likely to be those who intended to invest in relatively safe projects.41 The lower loan profitability might also be caused by the “incentive effects” of higher interest rates; at higher interest rates, borrowers choose riskier projects. In these circumstances, the resulting equilibrium may be one in which there is an excess demand for loanable funds at a particular interest rate, but banks do not have an incentive to raise the interest rate to eliminate the excess demand. In attempting to maximize their profits, banks ration credit to particular borrowers because the gains from higher interest rates are more than offset by the increase in the expected loss.

Credit rationing will also exist when there are doubts regarding the capacity or willingness of a borrowing country to meet its future debt service payments.42 Although a country that defaults on its debt incurs costs in terms of exclusion from new lending and interruption of trade flows, the threat of default may still limit the amount that any country can be lent since at some level of debt the benefits of default—the real income advantage of not having to service the debt—will outweigh the costs of default—the inability to secure new credit to reduce the variability of consumption or to finance profitable investment projects. An empirical analysis along these lines by Eaton and Gersovitz (1981) estimated that around 80 percent of the developing countries covered in their sample had experienced credit rationing.

Recent trends in net borrowing from private creditors by major groups of developing countries illustrate the changing perceptions of the creditworthiness of developing countries and the consequent availability of funds. The size of private foreign capital inflows expressed as a ratio to developing countries’ GDP or to their imports of goods and services has varied considerably over time and across groups (Table 64). Although these overall trends mask some notable contrasts among individual developing countries, several interesting observations can be made from the aggregate data. For the capital importing developing countries, net external borrowing from private creditors rose from an average of 2 percent of GDP in 1973–77 to almost 3 percent in 1981–82 before declining to less than 1 percent in 1983–85.43 Expressed as a ratio of imports of goods and services, net external borrowing from private creditors was 9 percent in 1973–77, 11 percent in 1978–80, but less than 3 percent in 1983–85. The impact of the cutback in private capital flows on the subgroup of countries with debt-servicing problems and the fifteen heavily indebted developing countries has been particularly striking. For countries with debt-servicing problems, net external borrowing from private creditors as a ratio to GDP averaged 4 percent in 1978–80 but declined sharply to minus 1/10 of 1 percent in 1983–85; for the fifteen heavily indebted countries, the decline in the ratio was from 5 percent to 1/10 of 1 percent. In contrast, for countries without debt-servicing problems, this ratio averaged only 1.6 percent in 1978–80 and showed a slight decrease in 1983–85.

Table 64.Capital Importing Developing Countries: Average Saving, Investment, and External Borrowing, 1973–85(In percent of GDP)
1973–771978–801981–821983–85
Capital importing developing countries
Saving125.224.923.624.4
Investment227.827.325.522.5
Current account deficit32.12.94.21.4
Net external borrowing from private creditors42.12.72.70.6
Net long-term external borrowing from official creditors51.01.11.31.2
Market borrowers
Saving126.726.924.724.9
Investment228.027.325.720.7
Current account deficit32.43.05.10.7
Net external borrowing from private creditors43.04.04.40.7
Net long-term external borrowing from official creditors50.70.60.60.8
Fifteen heavily indebted countries
Saving127.025.322.522.4
Investment227.625.623.517.6
Current account deficit32.13.65.40.6
Net external borrowing from private creditors43.24.74.8–0.1
Net long-term external borrowing from official creditors50.60.50.61.0
Countries without debt-servicing problems
Saving123.924.624.025.0
Investment227.728.527.026.5
Current account deficit31.52.12.71.8
Net external borrowing from private creditors41.11.61.41.2
Net long-term external borrowing from official creditors51.01.01.20.9
Countries with debt-servicing problems
Saving126.625.323.323.7
Investment227.826.124.018.4
Current account deficit32.63.75.61.0
Net external borrowing from private creditors43.13.83.9–0.1
Net long-term external borrowing from official creditors50.91.11.31.4
Note: For classification of countries in groups shown here, see Appendix 1.

Although capital flows to developing countries in recent years have been dominated by movements in private sector flows, official development assistance (ODA) and lending by official export credit agencies are also important channels for the transmission of economic influences from industrial to developing countries. In particular, ODA flows are affected by output trends and the stance of fiscal policies in industrial countries. Net ODA flows from Development Assistance Committee (DAC) countries declined from a peak of around 0.52 percent of these countries’ GNP in 1960–61 to a little over 0.30 percent during 1973—74, and have since fluctuated narrowly in the range 0.35–0.40 percent of GNP.44 Fluctuations in the levels of these flows have an especially large impact on lower-income developing countries, including many in sub-Saharan Africa. Moreover, in some geographical areas (including Africa and the Middle East) officially supported export credits account for a volume of lending nearly as large as that of nonguaranteed bank credits.

Saving, Investment, and External Capital Flows

External borrowing can be used by developing countries to raise investment to a level beyond that which could be financed by domestic savings alone. Ultimately, the influence of larger external borrowing on economic growth depends on the ability of the country to direct investment toward projects that generate sufficient real resources and, directly or indirectly, sufficient foreign exchange to service the larger external indebtedness. Provided the rate of return on additional domestic investment exceeds the cost of borrowed funds, the ensuing growth of output makes it feasible ultimately to close the gap between domestic saving and investment to repay the external loans. If, however, macroeconomic policies in the borrowing country are such as to encourage the use of capital inflows to finance consumption or capital flight, then domestic output will not be increased. The following discussion examines available evidence on the extent to which changes in external borrowing have been associated with changes in the rate of capital formation among different groups of developing countries, and the extent to which changes in the rate of capital formation have, in turn, been associated with variations in the rate of output growth.45

For the capital importing developing countries, saving and investment rates have declined in the 1980s relative to the rates observed in the 1970s. The average ratio of gross domestic savings to GDP declined from 25 percent in 1973–77 to 24 percent in 1983–85, while the average ratio of gross investment fell more sharply, from 28 to 23 percent (Table 64). For the fifteen heavily indebted countries, average saving rates declined from 27 percent in 1973–77 to 22 percent in 1983–85, while investment rates declined from 28 percent to only 18 percent in 1983–85. Finally, there are notable differences in the recent saving and investment performance of countries classified according to debt-servicing difficulties. For countries without debt-servicing problems, saving and investment rates have changed little in recent years. However, for countries with debt-servicing problems, it appears that the sharp reduction in capital inflows in recent years has been reflected primarily in a substantial reduction in investment rather than in a higher savings rate.

The relationship between the volume of financial inflows and the rates of saving and investment is examined further using the following analytical approach: each group of developing countries is divided into two equal parts for each time period considered, according to whether the level of capital inflows (expressed as a percent of imports of goods and services) over that time period was more (“above-median borrowers”) or less (“below-median borrowers”) than the median for the group as a whole.46 The median rates of savings and investment (expressed as a ratio of GDP) for these two subgroups are then compared. The partition was conducted both in terms of the current account deficit and “other external borrowing,” which is residually calculated, and, except for minor discrepancies in coverage, reflects almost exclusively net external borrowing from private creditors. The current account balance is equivalent to a comprehensive measure of net financial inflows, including receipts of official grants, inflows of private direct investment, changes in official reserves, and capital outflows from private residents. But since inflows of private direct investment and official grants have not fluctuated as widely as inflows of private lending to developing countries, and to make the reporting of the results easier for the reader, only the tests conducted for “other external borrowing” are reported. (In the remainder of this discussion, therefore, “other external borrowing” is referred to as external borrowing from private creditors.) The results obtained using the current account deficit were not significantly different.

The results suggest a positive relationship between the rate of external borrowing and the rate of investment (Table 65). Countries which had above-median external borrowing from private creditors (as a percentage of imports of goods and services) also tended to have higher ratios of investment to GDP. However, there were exceptions to this tendency for the group of market borrowers during certain periods. One explanation for the investment rates not always rising with increased external borrowing is inappropriate macroeconomic policies, notably with respect to fiscal deficits, exchange rates and interest rates. Another explanation is the phenomenon of capital flight.

Table 65.Capital Importing Developing Countries: Gross Capital Formation in Countries Classified by External Borrowing, 1971–85
1971–751975–801978–821980–851980–821983–85
Capital importing developing countries
Median external borrowing from private creditors1 (in percent of imports)4.664.254.362.473.762.37
Below-median borrowers0.061.511.360.250.20–1.30
Above-median borrowers9.6010.027.577.308.825.93
Median gross capital formation (in percent of GDP)
Below-median borrowers22.3525.0024.4922.8622.97*19.84
Above-median borrowers22.4826.0225.7622.8526.12*20.39
Market borrowers
Median external borrowing from private creditors1 (in percent of imports)8.2411.838.297.308.822.37
Below-median borrowers1.413.105.500.694.47–2.62
Above-median borrowers13.2817.3318.5110.7616.626.88
Median gross capital formation (in percent of GDP)
Below-median borrowers26.3627.8330.3425.7529.9021.41
Above-median borrowers23.6027.1927.4423.0326.3921.37
Countries with debt-servicing problems
Median external borrowing from private creditors1 (in percent of imports)7.087.054.601.163.501.65
Below-median borrowers1.722.861.24–1.64–1.08–4.65
Above-median borrowers10.8013.109.597.058.354.46
Median gross capital formation (in percent of GDP)
Below-median borrowers21.5224.51*22.7419.1219.58**17.96
Above-median borrowers22.4825.75*24.9020.6724.70**15.87
Countries without debt-servicing problems
Median external borrowing from private creditors1 (in percent of imports)3.482.584.293.294.083.20
Below-median borrowers–0.670.461.391.180.800.22
Above-median borrowers6.935.236.897.348.996.45
Median gross capital formation (in percent of GDP)
Below-median borrowers21.6623.5425.8629.76*27.3627.25
Above-median borrowers23.6226.5226.8224.33*28.0122.34
Note: Countries are classified into equal numbers of below-median and above-median borrowers for each separate time period (see text for further explanation). Asterisks indicate that the estimates in each pair so designated differ significantly from each other at the 90(*), 95(**), or 99(***) percent confidence level.

The median level of external borrowing from private creditors by the capital importing developing countries was the equivalent of 4.7 percent of imports of goods and services in 1971–75, but declined to 4.3 percent in 1975–80 and to 2.4 percent in 1983–85 (Table 65). This pattern was reflected in declining ratios of investment to GDP, particularly for the subgroup of countries with below-median external borrowing. The subgroup with above-median external borrowing tended to have investment rates of up to 3 percentage points more than the subgroup with below-median external borrowing.

Countries with debt-servicing problems tended to show considerably greater variations in their investment rates than countries without debt-servicing problems. In particular, for the subgroup with below-median external borrowing among countries with debt-servicing problems, the investment rate declined from 24.5 percent in 1975–80 to 18 percent in 1983–85. But irrespective of whether one looks at countries with or without debt-servicing problems, the rates of investment were generally higher for that half of the country group with above-median external borrowing.

As was mentioned earlier, large outflows of capital, or “capital flight,” have caused economic difficulties for some developing countries. In particular, capital flight has been shown in a number of studies to have caused a build-up of the gross foreign debt, an erosion of the tax base and, to the extent that there was a net real resource transfer from the country, a reduction in domestic investment.47 Regardless of how broadly or narrowly one defines capital flight, assessing its quantitative importance is difficult because of the imprecision with which financial transactions are often reported in countries’ balance of payments. Presumably, a large part of capital flight escapes recording in the balance of payments accounts, and measurement problems may become more severe in countries with capital controls. For example, when capital flight occurs through the underinvoicing of exports and the overinvoicing of imports, the ownership of the residual foreign currency proceeds being kept abroad cannot be captured in domestic accounts. Despite these measurement problems, some rough estimates of capital flight can be made on the basis of the errors and omissions category in the balance of payments accounts. Cuddington (1985) has argued that the errors and omissions category plus certain sub-categories of the line item “other short-term capital, other sector” in the balance of payments accounts may be used to estimate capital flight.

To examine the overall impact of capital flight on rates of domestic investment, the preceding analysis of the relationship between external borrowing and investment rates was repeated but with the level of external borrowing from private creditors reduced by the volume of capital flight as estimated by the errors and omissions entry in the balance of payments accounts. The results based on these adjusted figures confirm and underscore the positive relationship between external borrowing and investment rates (Table 66). Since capital flight has been substantial for certain developing countries, the median levels of net external borrowing decline by around 2 percentage points when adjusted for capital flight. The adjusted data indicate that countries with higher net external borrowing from private creditors also experienced higher investment rates. The data further suggest that the differences in median investment rates between the above-median and below-median groups of borrowers become more significant when capital flight is taken into consideration.

Table 66.Capital Importing Developing Countries: Gross Capital Formation in Countries Classified by External Borrowing and Capital Flight, 1971–85
1971–751975–801978–821980–851980–821983–85
Capital importing developing countries
Median external borrowing from private creditors minus capital flight1, 2 (in percent of imports)4.234.024.061.903.270.87
Below-median borrowers–0.06–0.34–0.39–0.78–0.83–3.59
Above-median borrowers9.208.638.226.007.856.22
Median gross capital formation (in percent of GDP)
Below-median borrowers21.10*21.85***24.4920.1222.05***19.84
Above-median borrowers23.57*26.68***25.7623.1627.01***20.58
Market borrowers
Median external borrowing from private creditors minus capital flight1, 2 (in percent of imports)6.108.208.124.946.920.61
Below-median borrowers0.891.843.57–0.352.80–5.04
Above-median borrowers12.4616.7514.888.5315.846.53
Median gross capital formation (in percent of GDP)
Below-median borrowers24.8827.8328.4325.7529.9020.20*
Above-median borrowers25.4927.2728.3823.7426.3923.38*
Countries with debt-servicing problems
Median external borrowing from private creditors minus capital flight1, 2 (in percent of imports)5.856.293.530.201.61–1.87
Below-median borrowers0.790.28–2.41–3.71–6.12–5.04
Above-median borrowers9.0810.4810.255.747.633.73
Median gross capital formation (in percent of GDP)
Below-median borrowers21.0819.60**19.21*18.4818.36***15.30
Above-median borrowers22.7026.02**24.97*21.1125.28***17.32
Countries without debt-servicing problems
Median external borrowing from private creditors minus capital flight1, 2 (in percent of imports)1.893.714.273.394.252.47
Below-median borrowers–1.41–0.541.150.451.10–1.14
Above-median borrowers9.205.727.728.379.257.07
Median gross capital formation (in percent of GDP)
Below-median borrowers22.5223.54*26.4026.9726.0928.60*
Above-median borrowers23.6227.60*26.8224.3328.0122.12*
Note: Countries are classified into equal numbers of below-median and above-median borrowers for each separate time period (see text for further explanation). Asterisks indicate that the estimates in each pair so designated differ significantly from each other at the 90(*), 95(**), or 99(***) percent confidence level.

In addition to the issue of the relationship between private external borrowing and investment rates in developing countries, there is also the question of how external borrowing affects saving rates. Other things being equal, if a country borrows abroad because of a fall in saving, then the rise in indebtedness implies a fall in future consumption levels, as the debt must be serviced out of an unchanged stream of future output. However, if the external borrowing results in increased investment, then the economy is trading one asset (the debt instrument) for another (the claim to physical capital). To the extent that borrowed resources have been channeled into productive investment, such investments could be expected—given prudent management of the economy and maintenance of the competitiveness of the external sector—to generate a stream of returns to repay the associated loans. Therefore, it is of considerable interest to know how domestic savings rates were affected by the high level of external borrowing by many developing countries during the 1970s and how they responded to the decline in private lending during the early 1980s. Some evidence on these issues can be obtained by examining whether or not there have been any systematic differences in savings rates between those groups of developing countries that have and have not relied significantly on capital inflows from private creditors.

Domestic saving rates were relatively high during the period of increased external borrowing from private creditors (Table 67). When borrowers were classified into above-median and below-median groups along the lines discussed above, there was a general tendency for saving rates to be higher for the above-median borrowers. For the capital importing developing countries, the subgroup of above-median borrowers had saving rates of up to 9 percentage points higher than the below-median borrowers, although this difference narrowed sharply during the period 1983–85.

Table 67.Capital Importing Developing Countries: Gross Domestic Saving in Countries Classified by External Borrowing, 1971–85
1971–751975–801978–821980–851980–821983–85
Capital importing developing countries
Median external borrowing from private creditors1 (in percent of imports)4.664.254.362.473.762.37
Below-median borrowers0.061.511.360.250.20–1.30
Above-median borrowers9.6010.027.577.308.825.93
Median gross domestic saving (in percent of GDP)
Below-median borrowers12.94*12.86*10.62***13.1611.40*14.80
Above-median borrowers20.36*18.35*19.78***16.5518.66*14.93
Market borrowers
Median external borrowing from private creditors1 (in percent of imports)8.2411.838.297.308.822.37
Below-median borrowers1.413.105.500.694.47–2.62
Above-median borrowers13.2817.3318.5110.7616.626.88
Median gross domestic saving (in percent of GDP)
Below-median borrowers25.1327.6429.47*29.94**29.95**26.33
Above-median borrowers26.7025.3722.93*19.95**20.14**21.26
Countries with debt-servicing problems
Median external borrowing from private creditors1 (in percent of imports)7.087.054.601.163.060.79
Below-median borrowers1.722.861.24–1.64–1.08–4.65
Above-median borrowers10.8013.109.597.058.354.46
Median gross domestic saving (in percent of GDP)
Below-median borrowers14.5314.27*12.53**13.1811.27*13.87
Above-median borrowers24.5119.61*21.22**12.8019.72*12.47
Countries without debt-servicing problems
Median external borrowing from private creditors1 (in percent of imports)3.482.584.293.294.083.20
Below-median borrowers–0.670.461.391.180.800.22
Above-median borrowers6.935.236.897.348.996.45
Median gross domestic saving (in percent of GDP)
Below-median borrowers13.9412.3711.4712.1113.6215.38
Above-median borrowers18.3316.2017.8016.7816.7816.24
Note: Countries are classified into equal numbers of below-median borrowers and above-median borrowers for each separate time period (see text for further explanation). Asterisks indicate that the estimates in each pair so designated differ significantly from each other at the 90(*), 95(**), or 99(***) percent confidence level.

Nonetheless, the market borrowers represented a notable exception to this tendency for higher external borrowing to be associated with higher domestic saving rates. For example, during the period 1980–82, the median saving rates for the below-median borrowers in this subgroup was 30 percent, while for the above-median borrowers it was only 20 percent.

The evidence presented above is, of course, suggestive rather than definitive. In the first place, individual country experiences are too heterogeneous to accord neatly with any very simple generalization. More fundamentally, it should be emphasized that even on a conceptual level, the distinction between investment and consumption expenditure is sometimes blurred. Certain components of investment, such as housing and some other types of construction, may be seen as items on which income is spent—that is, as consumer durables rather than productive investments for generating future income. Conversely, some items classified as consumer goods, such as simple tools and maintenance supplies, are similar to capital goods in their effects on increasing output and productivity. In addition to these conceptual issues, statistical problems are such that estimates of domestic savings are subject to wide margins of error in many developing countries. Therefore, analytical results based on national income accounting data, such as those presented here, need to be interpreted with due caution.

A further question concerns the efficiency of investment. High saving and investment rates by themselves do not imply immunity against difficulties in managing the external debt. A number of countries that apparently devoted the proceeds of external borrowing to investment have nevertheless encountered serious debt-servicing problems. The reasons for this are complex, and include both global economic developments—weakness of international trade, protectionist practices in industrial countries, high international interest rates—and policies in developing countries, especially with regards to fiscal deficits, exchange rates and pricing policies, that lowered the efficiency of investment.

It is difficult to measure the efficiency of investment using macroeconomic data. Perhaps the most frequently used such measure is the incremental capital-output ratio—the measure of investment per unit of additional output. However, this ratio shows wide fluctuations both across countries and over time, and these movements cannot be attributed to the efficiency of investment alone. For example, downturns in developing countries’ economic activity, due in part to the 1981–82 recession and the onset of debt-servicing difficulties caused incremental capital-output ratios to rise substantially in many countries during recent years. Nonetheless, it is interesting to note that the subgroup of countries without debt-servicing problems tend to show substantially lower incremental capital-output ratios than the subgroup of countries with debt-servicing problems.

The relationship between investment and output growth can also be examined using a similar analytical approach to that used in the preceding paragraphs. Each group of developing countries is divided into two equal halves for each time period considered, according to whether their investment as a percentage of GDP was more or less than the median for the group as a whole.

When the data were classified into high-investment and low-investment sub-groups along these lines, then for the group of capital-importing developing countries as a whole, the sub-group of countries with higher investment rates achieved higher growth rates for each time period examined (Table 68). The differences in the growth performances are highly significant statistically. Similar results are obtained for the market borrowers and for the groups of countries with and without debt-servicing difficulties.

Table 68.Capital Importing Developing Countries: Growth Performance of Countries Classified by Gross Capital Formation, 1971–85
1971–751975–801978–821980–851980–821983–85
Capital importing developing countries
Median gross capital formation (in percent of GDP)22.3725.6125.6422.8524.9420.24
Below-median investors17.9619.4818.9417.4818.4114.72
Above-median investors29.3630.2731.9429.5330.7526.48
Growth of real GDP
Below-median investors4.01**4.39**1.42***0.58***1.33***2.40**
Above-median investors4.76**5.51**4.18***3.74***3.15***3.34**
Market borrowers
Median gross capital formation (in percent of GDP)25.0127.8328.4324.3328.4121.41
Below-median investors19.5824.2923.3319.4023.6916.23
Above-median investors31.1331.5833.0529.7233.4425.58
Growth of real GDP
Below-median investors6.065.481.42**–0.22***–0.22***1.80**
Above-median investors5.456.144.38**4.27***3.67***3.88**
Countries with debt-servicing problems
Median gross capital formation (in percent of GDP)21.9425.6623.0819.1821.8717.13
Below-median investors17.7918.0217.8815.3517.5613.53
Above-median investors28.5128.7628.1425.7128.5021.41
Growth of real GDP
Below-median investors3.68*3.46*0.55***–0.49***–0.91***1.58
Above-median investors4.06*5.03*3.59***1.85***2.75***2.48
Countries without debt-servicing problems
Median gross capital formation (in percent of GDP)22.7025.5326.7225.7527.7424.41
Below-median investors18.3720.7922.2820.3821.7218.91
Above-median investors29.3630.9432.8031.6332.9631.88
Growth of real GDP
Below-median investors4.12*4.77**3.282.36***2.93**3.07*
Above-median investors6.27*6.60**4.815.04***5.26**4.12*
Note: Countries are classified into equal numbers of below-median and above-median investors for each time period (see text for further explanation.) Asterisks indicate that the estimates in each pair so designated differ significantly from each other at the 90(*), 95 (**), or 99(***) percent confidence level.

External Capital Flows and Financial Policies

The impact of developments in world financial markets on developing countries’ economic performance depends to a considerable extent on these countries’ own policy responses. Yet there may be circumstances in which these policies are themselves constrained, to some extent, by the prevailing external financial position. While a full analysis of these issues is beyond the scope of this paper, three channels through which changes in the external financial environment can affect domestic policies are: (1) changes in interest rates on external debt and shifts in the availability of external financing can directly affect the stance of domestic fiscal policy when a substantial proportion of external borrowing is undertaken by the government; (2) a high level of capital inflows can lead to an appreciation of the real exchange rate and a consequent shift of resources away from the traded goods sectors, which may be difficult to reverse quickly if capital inflows decline sharply; and (3) developments in industrial countries can affect the level of capital flight from developing countries, both by altering interest rate differentials between world and domestic financial markets and by altering domestic residents’ evaluations of the risks of holding domestic or foreign assets.

In many developing countries, government expenditures form a significant share of total capital formation. If foreign borrowing is important in the financing of these expenditures, changes in international interest rates and the level of lending by international commercial banks will affect the conduct of fiscal policy. Furthermore, returns to government investment, a large part of which generally consists of expenditures on social overhead capital, often accrue to the private sector in the first instance. Instead of receiving a direct return from its investment expenditures, the government relies on increases in the tax base to meet its revenue needs for debt-servicing requirements. This difference between the agents benefiting from the investment expenditures (the private sector) and the agents bearing the repayment obligations (the government) can imply that the traditional rule for optimal foreign borrowing, according to which borrowing should be continued until the marginal rate of return to investment equals the marginal cost of funds, is no longer valid. Since the government taxes domestic residents to generate resources for servicing the external debt, debt-servicing capacity in developing countries depends not only on national income but also on the public sector’s ability to tax that income. If the fiscal system is not flexible enough to adjust to rising debt-service ratios, sharp increases in international interest rates will have an adverse effect on the creditworthiness of the country in world capital markets. In order for long-run creditworthiness to be maintained, tax revenues must expand quickly enough to cover the interest on external debt.

A high level of capital inflows into a developing country, which reflects not only a strong demand for external capital but also the absence of substantial credit-rationing constraints on its supply, will lead to an appreciation of the real exchange rate. This will in turn cause a shift of resources out of the sector producing traded goods. If the level of capital inflows should then fall sharply—perhaps because of changes in the external economic environment that cause a shift in international commercial banks’ evaluation of the risks involved in lending to that country—the adjustment costs involved in reversing the shift away from the traded goods sector may be high.

An insight into some of these issues can be gained from the large literature relating to the adjustment problems of countries richly endowed with natural resources, in which the expanding resource sector leads to a decline in the level of economic activity in the export-oriented and import-competing manufacturing sectors.48 The expanding resource sector is presumed to lead to a contraction of the manufacturing sector via the loss of “competitiveness” due to an appreciation of the real exchange rate. Two important effects of the expanding resource sector have been emphasized in this literature, namely the spending effect and the resource movement effect. The extra spending on nontraded goods resulting from the higher incomes raises the relative price of nontraded goods and leads to further adjustments. The resource movement effect is the drawing of labor out of the traded goods sector into the nontraded goods sector because the real wage rate in terms of nontraded goods declines. However, the wage rate measured in terms of traded goods and the real wage rate (that is, in terms of all goods consumed) both rise because of the resource movement effect. This increase in the cost of labor has an adverse effect on external competitiveness. When the natural resources are exhausted, these resource shifts will need to be reversed and the adjustment costs involved can be substantial, especially if wage rates and other prices are not flexible.

A similar analysis applies to economies which experience substantial variations in the level of capital inflows. A high level of inflows causes an increase in domestic expenditures relative to output. The supply of traded goods required by the increased demand will be met by some combination of increased imports and decreased exports, with the resulting increase in the current account deficit being equal to the capital inflow, other things being equal. The increased demand for nontraded goods can only be met from domestic supply, and if supplies of nontraded goods are unchanged, their relative price will rise. This spending effect and the resulting resource movement effect were just discussed. If one makes the small country assumption that the foreign currency price of traded goods is not affected by developments in the domestic economy, then the rise in the relative price of nontraded goods occurs through either a rise in the domestic currency price of nontraded goods or an appreciation of the nominal exchange rate. A sudden reduction in the level of capital inflows—either because borrowers are frozen out of the markets by the credit-rationing phenomenon or because they cease borrowing voluntarily in the face of high interest rates on world financial markets—will require a fall in the real exchange rate to restore equilibrium and may involve substantial short-run adjustment costs, in terms of foregone output and underemployed resources, if resources cannot be shifted quickly back to the traded goods sectors.

The foregoing discussion of the relationship between capital inflows and exchange rates in developing countries is also relevant for the discussion of capital flight. The acquisition of foreign assets by the private sector of developing countries can be influenced by the same factors that influence international private lenders’ judgments of a country’s creditworthiness. Thus, a decline in industrial country demand for developing countries’ exports, or a rise in interest rates charged on external debt, could cause domestic asset holders to anticipate future adjustment problems and thereby lead to increased capital flight. An important observation in this regard is that while both the public and private sectors in many developing countries borrowed heavily in the world capital markets in the period 1973–82, there was a general tendency for the public sector to incur foreign liabilities that were substantially greater than their acquisition of foreign assets, while the private sector acquired foreign assets considerably in excess of their foreign liabilities.49

Two recent studies provide further insights into the combined effects of domestic economic policies and the external economic environment on the level of capital flight from developing countries. An empirical analysis by Cuddington (1985) suggests that inappropriate domestic policies—in particular, overvalued real exchange rates and financial policies leading to high and variable rates of inflation—are the prime causes of capital flight. For a number of countries covered in his study, there were episodes of overly expansionary monetary and fiscal policies, which were accompanied by severe exchange rate overvaluation that contributed to large outflows of capital as expectations of an imminent devaluation became widespread. High inflation, which is typically accompanied by high variability of the inflation rate, was also a major determinant of capital flight because of the greater uncertainty it implied for the return on domestic real and financial assets. Furthermore, financial policies that kept real interest rates in the domestic economy considerably below those prevailing abroad augmented the incentive for capital flight.

Although the domestic causes of capital flight are paramount, changes in the external financial environment can also play a role. Thus, an increase in interest rates on world financial markets will tend to widen the gap between foreign and domestic rates and—by increasing debt-servicing payments—may also increase domestic residents’ evaluation of the likelihood of an exchange rate depreciation. In regard to the latter effect, results reported by Dooley (1985) suggest that capital flight in part reflects differences in the perceptions of risk faced by residents and nonresidents, and that their respective attitudes toward the risks associated with claims on a developing country are important determinants of the country’s net investment income payments. The political risk premium variable, which measures the nonresidents’ perception of risk in his model, seems to be an important determinant of capital flight for most of the countries considered in his analysis.

Summary and Conclusions

This paper has examined the principal channels through which macroeconomic developments in industrial countries—such as the rate of economic growth, inflation, and the level of interest rates and exchange rates—influence the economic growth and balance of payments of developing countries. It has analyzed the transmission of economic influences both through trade in goods and services and through financial flows. At the risk of oversimplification of the preceding analysis, the main conclusions that emerge can be summarized as follows:

(1) Macroeconomic developments in industrial countries, especially the rate of economic growth, have an important influence on output growth in developing countries but they are not the only, or even the most important factor. The underlying structural characteristics of each country’s economy and the efficacy of domestic economic policies are always major determinants of economic performance. Also, the intensity with which economic influences are transmitted from the industrial world to a particular developing country or group of countries will depend to a large extent on the degree of integration of those countries into world goods and financial markets.

(2) Although the relative importance of the industrial countries as a group in the world market for goods has declined moderately in the last decade and a half, they are still the major market for exports and the major supplier of imports for the developing countries. They are also major competitors in the markets for most primary commodities and manufactures of importance to the developing countries.

(3) The price of non-oil primary commodities in world trade relative to the price of manufactures (“real commodity prices”) is strongly influenced by the level of economic activity in the industrial world. A “consensus” estimate might suggest that a 1 percentage point increase in the rate of economic growth in the industrial countries might be associated with a 2 percent increase in real commodity prices in the short term, although the longer-term effect would probably be lower. There is some evidence that an increase in interest rates in the industrial world might exert downward pressure on real commodity prices, but most available evidence suggests that a shift in the exchange rate of the U.S. dollar vis-à-vis the currencies of other industrial countries would not have a significant effect on real commodity prices. At a more disaggregated level, however, the relative prices of particular primary commodities and manufactures would be substantially affected by a change in the U.S. dollar exchange rate.

(4) The commodity composition of developing countries’ exports are a key determinant of the impact that industrial country growth has on their export volumes and prices. On the basis of historical evidence, the export volumes of the fuel exporters among developing countries appear to be the most sensitive to changes in the real GNP of industrial countries (with an estimated elasticity of almost 4). However, much of this sensitivity can be attributed to the attempt of the OPEC oil producers to maintain a fixed dollar price for oil by varying their production levels to match changes in demand; a change in this strategy would cause their export volumes to be less sensitive (and the world oil price more sensitive) to changes in industrial country GNP. For the group of non-fuel exporters, changes in export volumes respond to changes in industrial country real GNP with an elasticity which is probably within the range of 1¾–2¼. Within this group, the export volumes of those countries which are predominantly exporters of manufactures appear to be more sensitive to changes in industrial country output than do the export volumes of countries that mainly export primary products. The terms of trade of the non-fuel exporters tend to improve as the rate of economic growth in industrial countries accelerates, but there is greater uncertainty regarding the size of this effect than there is for the effect on export volumes. Alternative estimates suggest that the short-term elasticity of changes in the terms of trade with respect to changes in industrial country GNP is at least ¼ but could be as high as around 1½; longer-term elasticities are likely to be toward the lower end of this range, as in the longer run supply responses become more important and inventory accumulation becomes a less important element of changes in demand. Within the group of non-fuel exporters, the terms of trade of the primary product exporters are more sensitive to changes in industrial country economic activity than are those of the exporters of manufactures.

(5) The geographic destination of developing countries’ exports is an important factor in the transmission of economic influences, especially when the structure of expansion in the industrial world is unbalanced. The rapid expansion of U.S. demand for imports during 1983–84 had a much larger impact on export earnings of developing countries in the Western Hemisphere and in Asia than on the earnings of European or African countries, which were much more dependent on the European industrial country market.

(6) Protectionism in industrial countries can have a considerable effect on the price and volume of developing countries’ exports by lowering effective demand for these exports. The adverse indirect effects on developing countries, such as the lost opportunities for reaping economies of scale and the disincentives for investment in the export sectors, can also be substantial.

(7) Developing countries’ earnings from services and private transfers (mainly migrants’ remittances) are an important source of foreign exchange earnings (accounting for around 30 percent of total earnings by the non-fuel exporters) and are also greatly influenced by macroeconomic developments in the industrial world. Econometric estimates suggest that a 1 percentage point increase in industrial country real GNP is associated with an increase of around 1¼ percent in the purchasing power of the exports of services (excluding investment income earnings) of the non-fuel exporters and an increase of around 2¼ percent in the purchasing power of these countries’ net receipts of private transfers.

(8) Changes in developing countries’ export earnings brought about by developments in the industrial world in turn affect their output growth. In the short term, higher export earnings may raise aggregate demand and the degree of capacity utilization, both directly and through the effect of changes in the external current account on the stance of domestic financial policies. Also, in countries which are subject to significant foreign exchange rationing, the greater availability of foreign exchange to purchase imported inputs can also raise output considerably. Available estimates—albeit relatively crude—suggest that in such countries a 1 percent increase in imports could raise output by the order of 0.2 percent. In the longer term, higher growth rates of exports can lead to higher rates of output growth both through the impact on the rate of investment of an improved terms of trade and higher import availability and through the technological and economic factors that tend to cause a positive link between export promotion and overall output growth.

(9) The importance of financial markets in the transmission of economic influences from industrial to developing countries has grown considerably as a result of the increased levels of developing countries’ external debt and the greater role of private creditors, especially international commercial banks. The cost of developing countries’ borrowing in world capital markets is largely determined by the financial policies of the industrial countries. Since a large proportion of capital flows to developing countries has taken the form of bank lending at variable interest rates, the effects of industrial country monetary and fiscal policies are quickly passed on to the developing countries through interest rate changes. For the group of capital-importing developing countries, it is estimated that a 1 percentage point increase in interest rates on world financial markets would, on the basis of 1985 values for exports and external debt, increase debt service ratios by around 1 percentage point in the short term. The longer-term impact would be even greater, as debt contracted at fixed interest rates matures and is rolled over at the new rates. Also, since around four-fifths of the capital-importing developing countries’ external debt is denominated in terms of U.S. dollars, a depreciation of the dollar tends to lower the value of their external debt relative to the value of their export earnings.

(10) The increased importance of commercial bank lending to developing countries during the 1970s increased these countries’ vulnerability to a sharp reduction in the level of capital inflows if a change in the external environment or in domestic economic policies altered banks’ perceptions of the risk involved in lending to particular countries or groups of countries. Such credit rationing reduces the sustainable level of the current account deficit and makes necessary some combination of a decline in the level of domestic investment relative to the level of domestic savings. To the extent that the rate of investment falls, the prospects for output growth are also likely to be lower. In this regard, the marked slowdown in commercial bank lending to developing countries during the last several years, especially to countries that have experienced debt-servicing problems, appears to have been associated with a substantial fall in overall investment rates. However, developing countries’ own economic policies, including those which influence the productiveness of investment, are a crucial factor in determining their vulnerability to such influences.

Appendix I Classification of Countries

The basic distinction, adopted by the Fund in December 1979, is between industrial countries and developing countries. Industrial countries comprise:

  • Australia

  • Austria

  • Belgium

  • Canada

  • Denmark

  • Finland

  • France

  • Germany, Fed. Rep. of

  • Iceland

  • Ireland

  • Italy

  • Japan

  • Luxembourg

  • Netherlands

  • New Zealand

  • Norway

  • Spain

  • Sweden

  • Switzerland

  • United Kingdom

  • United States

The developing countries include all other Fund members (as of January 1, 1986) together with certain essentially autonomous dependent territories for which adequate statistics are available.1 The regional break downs of data for developing countries conform to the regional classification used in IFS. It should be noted that, in this classification, Egypt and Libyan Arab Jamahiriya are part of the Middle East, not Africa.

The analytical groupings currently used by the staff to distinguish among developing countries are (1) countries grouped by predominant export; (2) countries grouped by financial criteria; (3) countries grouped by other criteria; and (4) countries grouped by the former classification criteria. At present, the financial criteria first distinguish among capital exporting and capital importing countries. Countries in the latter, much larger, group are then distinguished on the basis of two additional financial criteria: by predominant type of creditor and by the degree of debt-servicing difficulties faced by countries.

The first analytical criterion used to group developing countries is by predominant export category. Four categories are distinguished: fuel (SITC 3); other primary commodities (SITC 0, 1, 2, 4, and diamonds and gemstones); manufactures (SITC 5 to 8, less diamonds and gemstones); and “services and remittances.” On the basis of data for 1980, countries are assigned to that commodity grouping which accounts for 50 percent or more of their exports. Specifically, countries are assigned to the “services and remittances” category if their receipts on these transactions account for at least half of their exports of goods and services. If countries do not meet this criterion, they are assigned to that trade category (of the three listed above) which accounts for at least half of their total merchandise exports.2

Given these definitions, the fuel exporters comprise the following countries:

  • Algeria

  • Bahrain

  • Congo

  • Ecuador

  • Gabon

  • Indonesia

  • Iran, Islamic Rep. of

  • Iraq

  • Kuwait

  • Libyan Arab Jamahiriya

  • Mexico

  • Nigeria

  • Oman

  • Qatar

  • Saudi Arabia

  • Syrian Arab Rep.

  • Trinidad and Tobago

  • Tunisia

  • United Arab Emirates

  • Venezuela

The primary product exporters, that is, countries whose exports of agricultural and mineral primary products other than fuel accounted for over 50 percent of their total exports in 1980, comprise:

  • Afghanistan

  • Argentina

  • Bangladesh

  • Belize

  • Benin

  • Bhutan

  • Bolivia

  • Botswana

  • Brazil

  • Burma

  • Burundi

  • Cameroon

  • Central African Rep.

  • Chad

  • Chile

  • Colombia

  • Comoros

  • Costa Rica

  • Côte d’Ivoire

  • Djibouti

  • Dominican Rep.

  • El Salvador

  • Equatorial Guinea

  • Ethiopia

  • Fiji

  • Gambia, The

  • Ghana

  • Guatemala

  • Guinea

  • Guinea-Bissau

  • Guyana

  • Haiti

  • Honduras

  • Jamaica

  • Kenya

  • Lao People’s Dem. Rep.

  • Liberia

  • Madagascar

  • Malawi

  • Malaysia

  • Mali

  • Mauritania

  • Mauritius

  • Morocco

  • Mozambique

  • Nicaragua

  • Niger

  • Papua New Guinea

  • Paraguay

  • Peru

  • Philippines

  • Rwanda

  • Sāo Tomé and Principe

  • Senegal

  • Sierra Leone

  • Solomon Islands

  • Somalia

  • South Africa

  • Sri Lanka

  • St. Christopher and Nevis

  • Sudan

  • Suriname

  • Swaziland

  • Tanzania

  • Thailand

  • Togo

  • Turkey

  • Uganda

  • Uruguay

  • Viet Nam

  • Zaïre

  • Zambia

  • Zimbabwe

A further distinction is made among the “primary product exporters” on the basis of whether countries’ exports of primary commodities (other than fuel) consisted primarily of agricultural (SITC 0 and 1) or mineral (SITC 2 and 4 and diamonds and gemstones) commodities. The mineral exporters comprise:

  • Bolivia

  • Botswana

  • Chile

  • Guinea

  • Guyana

  • Jamaica

  • Liberia

  • Mauritania

  • Morocco

  • Niger

  • Peru

  • Sierra Leone

  • South Africa

  • Suriname

  • Togo

  • Zaire

  • Zambia

  • Zimbabwe

The agricultural exporters are those non-fuel primary product exporters that are not also mineral exporters.

The exporters of manufactures (that is, those countries or areas whose exports of manufactures accounted in 1980 for over 50 percent of total exports) include:

  • China

  • Hong Kong

  • Hungary

  • India

  • Israel

  • Korea

  • Romania

  • Singapore

  • Yugoslavia

The service and remittance countries, that is, those countries whose receipts from services (such as tourism) and private transfers (such as workers’ remittances) amount to at least 50 percent of their exports of goods and services, comprise:

  • Antigua and Barbuda

  • Bahamas, The

  • Barbados

  • Burkina Faso

  • Cape Verde

  • Cyprus

  • Dominica

  • Egypt

  • Greece

  • Grenada

  • Jordan

  • Kampuchea, Dem.

  • Lebanon

  • Lesotho

  • Maldives

  • Malta

  • Nepal

  • Netherlands Antilles

  • Pakistan

  • Panama

  • Portugal

  • Seychelles

  • St. Lucia

  • St. Vincent

  • Tonga

  • Vanuatu

  • Western Samoa

  • Yemen Arab Rep.

  • Yemen, People’s Dem. Rep. of

The primary product exporters, exporters of manufactures, and service and remittance countries taken together are referred to as the “non-fuel exporters.”

A second set of analytical groupings of developing countries is based on financial criteria. A first distinction is made between those developing countries that have traditionally been capital exporters and those that have traditionally been capital importers. At present, capital exporters are defined as those developing countries that, on average, recorded a current account surplus during the period 1979–81 and were aid donors over the same period. The capital exporting countries comprise:

  • Iran, Islamic Rep. of

  • Iraq

  • Kuwait

  • Libyan Arab Jamahiriya

  • Oman

  • Qatar

  • Saudi Arabia

  • United Arab Emirates

The capital importing countries comprise all other developing countries.

Within the group of capital importing developing countries and areas, two types of financial distinctions are made. The first distinguishes among countries and areas on the basis of their predominant type of creditor. Market borrowers are defined as those countries which obtained at least two thirds of their external borrowings from 1978 to 1982 from commercial creditors. The group includes:

  • Algeria

  • Antigua and Barbuda

  • Argentina

  • Bahamas, The

  • Bolivia

  • Brazil

  • Chile

  • Colombia

  • Congo

  • Côte d’Ivoire

  • Cyprus

  • Ecuador

  • Gabon

  • Greece

  • Hong Kong

  • Hungary

  • Indonesia

  • Korea

  • Malaysia

  • Mexico

  • Nigeria

  • Panama

  • Papua New Guinea

  • Paraguay

  • Peru

  • Philippines

  • Portugal

  • Singapore

  • South Africa

  • Trinidad and Tobago

  • Uruguay

  • Venezuela

  • Yugoslavia

Official borrowers comprise those countries, except China and India, which obtained two thirds or more of their external borrowings from 1978 to 1982 from official creditors. The countries are:

  • Afghanistan

  • Bahrain

  • Bangladesh

  • Bhutan

  • Burkina Faso

  • Burma

  • Burundi

  • Cape Verde

  • Central African Rep.

  • Chad

  • Comoros

  • Djibouti

  • Dominica

  • Dominican Rep.

  • El Salvador

  • Equatorial Guinea

  • Fiji

  • Gambia, The

  • Ghana

  • Grenada

  • Guatemala

  • Guinea

  • Guinea-Bissau

  • Guyana

  • Honduras

  • Jamaica

  • Jordan

  • Lao People’s Dem. Rep.

  • Liberia

  • Madagascar

  • Malawai

  • Maldives

  • Mali

  • Malta

  • Mauritania

  • Nepal

  • Netherlands Antilles

  • Nicaragua

  • Pakistan

  • Rwanda

  • Sāo Tomé and Principe

  • Senegal

  • Seychelles

  • Sierra Leone

  • Somalia

  • St. Lucia

  • St. Vincent

  • Sudan

  • Swaziland

  • Syrian Arab Rep.

  • Tanzania

  • Togo

  • Tonga

  • Uganda

  • Viet Nam

  • Western Samoa

  • Yemen Arab Rep.

  • Yemen, People’s Dem. Rep. of

  • Zaïre

  • Zambia

Diversified borrowers comprise those capital importing developing countries that are not market or official borrowers. These countries’ external borrowings in 1978–82 were more or less evenly divided between official and commercial creditors. China and India are included in this group.

A second financial distinction among capital importing developing countries is based on whether countries have or have not experienced debt-servicing difficulties in the recent past. Countries that have experienced debt-servicing problems are defined as those countries which incurred external payments arrears during 1983 to 1984 or rescheduled their debt during the period from end-1982 to mid-1985 as reported in the relevant issues of the Fund’s Annual Report on Exchange Arrangements and Exchange Restrictions. Countries classified as not having experienced debt-servicing problems are defined as all other capital importing developing countries.

Several other analytical groups are also used in the report. One of these is the group of capital importing fuel exporters. This group, which is also referred to as the “indebted fuel exporters,” comprises those 12 fuel exporters that are not capital exporters. A second is the group of 15 heavily indebted countries. This group comprises:

  • Argentina

  • Bolivia

  • Brazil

  • Chile

  • Colombia

  • Côte d’Ivoire

  • Ecuador

  • Mexico

  • Morocco

  • Nigeria

  • Peru

  • Philippines

  • Uruguay

  • Venezuela

  • Yugoslavia

A third is the group of low-income countries, which comprises 43 countries whose per capita GDP, as estimated by the World Bank, did not exceed the equivalent of $410 in 1980. The countries in this group are:

  • Afghanistan

  • Bangladesh

  • Benin

  • Bhutan

  • Burkina Faso

  • Burma

  • Burundi

  • Cape Verde

  • Central African Rep.

  • Chad

  • China

  • Comoros

  • Equatorial Guinea

  • Ethiopia

  • Gambia, The

  • Ghana

  • Guinea

  • Guinea-Bissau

  • Haiti

  • India

  • Kampuchea, Dem.

  • Kenya

  • Lao People’s Dem. Rep.

  • Madagascar

  • Malawi

  • Maldives

  • Mali

  • Mauritania

  • Mozambique

  • Nepal

  • Niger

  • Pakistan

  • Rwanda

  • Sāo Tomé and Principe

  • Sierra Leone

  • Somalia

  • Sri Lanka

  • Sudan

  • Tanzania

  • Togo

  • Uganda

  • Viet Nam

  • Zaïre

References to the small or smaller low-income countries refer to the above group, less China and India. Reference is also made to sub-Saharan Africa, which comprises all African countries (as defined in IFS) except Algeria, Morocco, Nigeria, South Africa, and Tunisia.

Finally, some of the tables present data on the developing countries grouped in accordance with the former classification categories. In this system, which was the one used from 1980 to 1984, the developing countries were divided into two groups—“oil exporting countries” and “non-oil developing countries.” The countries included under the heading oil exporting countries3 are:

  • Algeria

  • Indonesia

  • Iran, Islamic Rep. of

  • Iraq

  • Kuwait

  • Libyan Arab Jamahiriya

  • Nigeria

  • Oman

  • Qatar

  • Saudi Arabia

  • United Arab Emirates

  • Venezuela

Among the non-oil developing countries, four analytical subgroups of countries were distinguished. These subgroupings were based primarily on the character of the countries’ economic activity and on the predominant composition of their exports. Since the large “non-oil” group in the basic classification included some countries that had significant production or exports of oil, one of the analytic subgroups shown separately comprised countries (outside the main oil exporting group mentioned above) whose oil exports exceeded their oil imports in most years of the 1970s. The countries classified in the subgroup net oil exporters were:

  • Bahrain

  • Bolivia

  • Congo

  • Ecuador

  • Egypt

  • Gabon

  • Malaysia

  • Mexico

  • Peru

  • Syrian Arab Rep.

  • Trinidad and Tobago

  • Tunisia

The net oil importers subgroup comprises all other non-oil developing countries.

Except where otherwise specifically indicated, the Union of Soviet Socialist Republics and other non-member countries of Eastern Europe, Cuba, and North Korea, are excluded from the tables. Also, it has not been possible to include in the tables a number of small countries or territories for which trade and payments data are not available.

Appendix II Statistical Tables
Table AI.Developing Countries: Commodity Composition of Exports, 1965 and 19801(As a percentage of total exports)
FoodBeverages

and

Tobacco
Agricultural

Raw

Materials
MineralsAll Non-Fuel

Commodities
FuelsManufacturesTotal
1965198019651980196519801965198019651980196519801965198019651980
Developing countries17.57.48.52.911.94.28.84.146.718.620.346.133.035.3100.0100.0
Africa18.99.312.15.014.54.516.510.362.129.10.312.937.658.0100.0100.0
Asia21.511.47.71.923.49.29.04.961.727.40.18.037.464.7100.0100.0
Europe14.610.75.91.77.94.93.73.032.420.367.879.7100.0100.0
Middle East6.60.71.40.45.01.72.20.915.23.760.684.124.212.2100.0100.0
Western Hemisphere30.125.118.314.811.65.115.312.775.257.71.84.322.938.0100.0100.0
Memorandum
Indebted developing countries22.513.711.35.216.06.611.47.261.335.71.07.537.759.7100.0100.0
Total world trade12.88.32.41.07.03.25.33.527.416.05.814.866.869.2100.0100.0
Source: Derived from Bond (1986).
Table AII.Developing Countries: Export Market Shares, 1965 and 19801(As a percentage of total world trade in each commodity group)
FoodBeverages

and

Tobacco
Agricultural

Raw

Materials
MineralsAll Non-Fuel

Commodities
FuelsManufacturesTotal
1965198019651980196519801965198019651980196519801965198019651980
Developing countries33.123.785.378.941.134.340.531.441.231.084.982.811.913.524.226.6
Africa5.32.818.212.37.63.411.47.28.24.40.22.12.02.03.62.4
Asia8.17.815.410.916.215.98.37.810.99.60.73.02.75.24.85.6
Europe2.82.46.13.22.82.91.81.62.92.42.52.22.51.9
Middle East4.11.24.65.55.57.13.23.44.33.182.376.82.82.47.913.5
Western Hemisphere12.89.541.047.09.05.015.811.414.911.41.70.91.91.75.43.2
Industrial countries66.976.314.721.158.965.759.568.658.869.015.117.288.186.575.873.4
Total100.0100.0100.0100.0100.0100.0100.0100.0100.0100.0100.0100.0100.0100.0100.0100.0
Memorandum
Indebted developing countries30.423.080.773.439.528.537.628.638.528.52.97.09.711.917.213.9
Source: Derived from Bond (1986).
References

    Anjaria, Shailendra J., NaheedKirmani, and Arne B.Petersen,Trade Policy Issues and Developments, Occasional Paper No. 38 (Washington: International Monetary Fund, 1985).

    Bergsten, C. Fred and William R.Cline, Bank Lending to Developing Countries: The Policy Alternatives, Policy Analyses in International Economics No. 10 (Washington, Institute for International Economics, April1985).

    Bond, Marian E., Export Demand and Supply for Groups of Non-Oil Developing Countries,Staff Papers, International Monetary Fund (Washington), Vol. 32 (March1985), pp. 5677.

    Bond, Marian E., “An Econometric Study of Commodity Exports from Developing Country Regions to the World” (unpublished, International Monetary Fund, May1986).

    Chopra, Ajai and PeterMontiel, “Output and Unanticipated Money with Imported Intermediate Goods and Foreign Exchange Rationing” (unpublished, International Monetary Fund, January29, 1986).

    Chu, Ke-Young and Thomas K.Morrison, The 1981–82 Recession and Non-Oil Primary Commodity Prices,Staff Papers, International Monetary Fund (Washington), Vol. 31 (March1984), pp. 93140.

    Chu, Ke-Young and Thomas K.Morrison, World Non-Oil Primary Commodity Markets: A Medium-Term Framework of Analysis,Staff Papers, International Monetary Fund (Washington), Vol. 33, (March1986), pp. 13984.

    Cline, William R., International Debt and the Stability of the World Economy, Policy Analyses in International Economics (Washington, Institute for International Economics, 1983).

    Cline, William R., International Debt: Systemic Risk and Policy Response (Washington, Institute for International Economics, 1984).

    Corden, W.M., The Exchange Rate, Monetary Policy and North Sea Oil: The Economic Theory of the Squeeze of Tradeables,Oxford Economic Papers (Oxford, England), Vol. 33, Supplement 1 (July1981), pp. 2246.

    Cuddington, John T., Capital Flight: Estimates, Issues, and Explanations,CPD Discussion Paper 1985–51 (unpublished, World Bank, March1985, Rev.May6, 1986).

    Deppler, Michael C. and Duncan M.Ripley, The World Trade Model: Merchandise Trade,Staff Papers, International Monetary Fund (Washington), Vol. 25 (March1978), pp. 147206.

    Dooley, Michael, “Country-Specific Risk Premiums, Capital Flight and Net Investment Income Payments in Selected Developing Countries,” (unpublished, International Monetary Fund, December2, 1985).

    Dooley, Michael, and others, An Analysis of External Debt Positions of Eight Developing Countries Through 1990,Board of Governors of the Federal Reserve System, International Finance Discussion Papers (Washington), No. 227 (August1983), pp. 117.

    Dornbusch, R., The Effects of OECD Macroeconomic Policies on Non-Oil Developing Countries: A Review,World Bank, World Development Report (1985) Background Paper, forthcoming in International Capital Flows and the Developing Countries, edited byF.Colaço and S.van Wijnbergen.

    Eaton, Jonathan J. and MarkGersovitz, Debt with Potential Repudiation: Theoretical and Empirical Analysis,Review of Economic Studies (Edinburgh, Scotland), Vol. 48 (April1981), pp. 289309.

    Fishlow, A., “Capital Requirements for Developing Countries in the Next Decade,” a study commissioned by the United Nations Committee for Development Planning. First draft, November1985.

    Folkerts-Landau, David, The Changing Role of International Bank Lending in Development Finance,Staff Papers, International Monetary Fund (Washington), Vol. 32 (June1985), pp. 31763.

    Fry, Maxwell J., Terms of Trade Dynamics in Asia: An Analysis of National Saving and Domestic Investment Responses to Terms-of-Trade Changes in 14 Asian LDCs,Journal of International Money and Finance (Guildford, England), Vol. 5 (March1986), pp. 5773.

    Goldstein, Morris and Mohsin S.Khan, Effects of Slowdown in Industrial Countries on Growth in Non-Oil Developing Countries (Washington: International Monetary Fund, August1982), Occasional Paper No. 12.

    Hicks, Norman L., A Model of Trade and Growth for the Developing World,European Economic Review (Amsterdam), Vol. 7 (April1976), pp. 23955.

    Holtham, Gerald and TapioSaavalainen, Commodity Prices in Interlink,Organization for Economic Cooperation and Development, Economics and Statistics Dept., Working Papers (Paris), No. 27 (November1985), pp. 157.

    Houthakker, Hendrik S., and Stephen P.Magee, Income and Price Elasticities in World Trade,Review of Economics and Statistics (Cambridge, Massachusetts), Vol. 51 (May1969), pp. 11125.

    International Monetary Fund, World Economic Outlook: A Survey by the Staff of the International Monetary Fund (Washington, 1983, 1984, 1985a).

    International Monetary Fund, Foreign Private Investment in Developing Countries, Occasional Paper No. 33 (Washington, 1985b).

    Khan, Mohsin S., Import and Export Demand in Developing Countries,Staff Papers, International Monetary Fund (Washington), Vol. 21 (November1974), pp. 67893.

    Khan, Mohsin S., and NadeemUl Haque, Foreign Borrowing and Capital Flight: A Formal Analysis,Staff Papers, International Monetary Fund (Washington), Vol. 30 (December1985), pp. 60628.

    Khan, Mohsin S., NadeemUl Haque, and Malcolm D.Knight, Determinants of Current Account Balances of Non-Oil Developing Countries in the 1970s: An Empirical Analysis,Staff Papers, International Monetary Fund (Washington), Vol. 30 (December1983), pp. 81942.

    Kirmani, Naheed, LuigiMolajoni, and ThomasMayer, Effects of Increased Market Access on Exports of Developing Countries,Staff Papers, International Monetary Fund (Washington), Vol. 31 (December1984), pp. 66184.

    Klein, Lawrence R. and VincentSu, Protectionism: An Analysis from Project LINK,Journal of Policy Modeling (New York), Vol. 1 (No. 1, 1979), pp. 535.

    Leven, Ronald and David L.Roberts, Latin America’s Prospects for Recovery,Federal Reserve Bank of New York, Quarterly Review (New York), Vol. 8 (Autumn1983), pp. 613.

    Lucas, R.E., Econometric Policy Evaluation: A Critique,” inThe Phillips Curve and Labor Markets, Carnegie-Rochester Conference Series on Public Policy, Vol. 1, ed. by KarlBrunner and Allan H.Meltzer (Amsterdam: North Holland, 1976), pp. 1946.

    Marquez, Jaime, Foreign Exchange Constraints and Growth Possibilities in the LDCs,Journal of Development Economics (Amsterdam), Vol. 19 (September1985), pp. 3957.

    Organization for Economic Cooperation and Development, Costs and Benefits of Protection (Paris: OECD, 1985).

    Poats, Rutherford M., Twenty-five Years of Development Co-Operation: A Review: Efforts and Policies of the Members of the Development Assistance Committee (Paris: Organization for Economic Cooperation and Development, 1985).

    Rhomberg, Rudolf R., Transmission of Business Fluctuations from Developed to Developing Countries,Staff Papers, International Monetary Fund (Washington), Vol. 15 (March1968), pp. 129.

    Sachs, Jeffrey D., “The Current Account and Macroeconomic Adjustment in the 1970s,” Brookings Papers on Economic Activity: 1 (1981), The Brookings Institution (Washington), pp. 20168.

    Sachs, Jeffrey D., and Warwick J.McKibbin, Macroeconomic Policies in the OECD and LDC External Adjustment,Brookings Discussion Paper in International Economics, The Brookings Institution (Washington, February1985), pp. 176.

    Schadler, Susan M., “Effect of a Slowdown in Industrial Economies on Selected Asian Countries” (unpublished, International Monetary Fund, January30, 1986).

    Spencer, Grant H., The World Trade Model: Revised Estimates,Staff Papers, International Monetary Fund (Washington), Vol. 31 (September1984), pp. 46998.

    Spencer, Grant H., “Revised Estimates for the World Trade Model” (unpublished, International Monetary Fund, April30, 1984).

    Stiglitz, Joseph R. and AndrewWeiss, Credit Rationing in Markets with Imperfect Information,American Economic Review (Nashville, Tennessee), Vol. 71 (June1981), pp. 393410.

    Swamy, Gurushri, Remittances of Migrant Workers: Issues and Prospects,” (World Bank Division Working Paper Draft, Washington, March1981).

    van Wijnbergen, Sweder, Interdependence Revisited: A Developing Countries Perspective on Macroeconomic Management and Trade Policy in the Industrial World,Economic Policy: A European Forum (Cambridge, England), Vol. 1 (November1985), pp. 81137.

    Williamson, Martin, “Developing Countries’ Acquisitions of Foreign Assets, 1970–83: Theory and Empirical Evidence” (unpublished, Washington: International Monetary Fund, December1985).

    World Bank, World Development Report, 1985: International Capital and Economic Development; World Development Indicators (Washington, 1985).

    Zaidi, Iqbal M., Saving, Investment, Fiscal Deficits and the External Indebtedness of Developing Countries,World Development (Oxford, England), Vol. 13 (May1985), pp. 57388.

For a more detailed discussion of the methodology used in preparing the medium-term scenarios, see World Economic Outlook 1984 Supplementary Note 7, pp. 157–62. The most recent medium-term scenario is contained in “The Debt Situation: Prospects and Policy Issues,” Chapter V of World Economic Outlook, April 1986 (Washington: International Monetary Fund, 1986).

Structural models to analyze various aspects of the interdependence between industrial and developing countries have been constructed by, among others, Hicks (1976), Sachs and McKibbin (1985), and van Wijnbergen (1985).

A notable exception was in 1985, when growth in the export volumes of the non-fuel exporters lagged behind the growth in industrial country import volumes (at around 3.5 and 4.7 percent, respectively).

More detailed discussions of the factors underlying the recent movements in non-oil primary commodity prices are contained in World Economic Outlook, April 1986 Supplementary Note 3. Some of the empirical studies referred to in the following paragraphs are also discussed in the World Economic Outlook, May 1983, pp. 154–59.

One example of the impact of agricultural supply policies occurred in 1983. The United States, a major producer and exporter of food commodities, implemented an acreage reduction program for many agricultural crops which succeeded in reducing production. On top of this, a drought in the United States in the summer of 1983 further reduced production. As a result, world food prices rose by over 11 percent in 1983.

These estimated effects are based on commodity price indices from the United Nations Conference on Trade and Development.

Both these downturns in prices appear to have been due in large part to supply factors. For instance, see Chu and Morrison (1985).

Chu and Morrison (1984), op. cit., Table 6, p. 117. All prices are expressed in terms of U.S. dollars.

This is on the basis of an imperfect substitutes model of world trade. A simple theoretical model describing how a change in the exchange rate among industrial countries affects the price of competitively traded commodities can be found in chapter 4 of this volume.

These estimates are based on the assumption that those developing countries that are pegged to the U.S. dollar depreciate their currencies along with the dollar, that those countries that peg their currencies to the French franc continue to do so, and that all other developing countries maintain unchanged their effective exchange rates vis-à-vis all industrial country currencies combined. The values of the price elasticities of supply and demand used to derive these results are those estimated by Bond (1986). The dollar price of manufactures is measured by the average unit value of the industrial countries’ exports of manufactures.

The dollar price of manufactures in these estimates is measured by the average unit value of industrial countries’ exports of manufactures. The lag in response for manufactures appeared to be somewhat longer than for primary commodities, but took place within a year. Such econometric estimates are likely to be biased upwards, however, since both prices and exchange rates are really endogenous variables that are simultaneously determined by other, exogenous factors. For instance, a loosening of monetary policy in the United States would be likely both to raise dollar prices and to lead to a depreciation of the dollar exchange rate.

Repeating the earlier analysis, but replacing data on the commodity composition of foreign trade by the estimates of Table 59, a 2 percent increase in the price of non-oil primary commodities relative to manufactures with the price of fuel assumed unchanged would raise the terms of trade of non-oil developing countries by 0.24 percent [2x(0.54 – 0.25 – 0.17)].

One additional reason for the wide variation in estimates of the impact on developing countries’ terms of trade of industrial country growth given by the two approaches discussed in the text is the high level of aggregation involved. Non-oil developing countries as a group are large net importers of some primary commodities for which the industrial countries are dominant suppliers. Some of these commodities, particularly agricultural goods, have been subject to significant protectionist influences in some industrial countries, which may have caused industrial country growth to affect their prices differently than those of other primary products.

The estimated equations were of the form:

Ln(TOT)=4.36(8.57)+0.008(4.11)CAPUT0.084(0.95)Ln(RLEXUS)0.011(4.41)tR2=0.83,DW=1.81,rho=0.46

where the results reported are for non-oil developing countries. CAPUT is the GNP-weighted rate of utilization of manufacturing capacity for industrial countries, RLEXUS is the real effective exchange rate of the U.S. dollar, and t is a time trend. Figures in parentheses are t-statistics.

The “average” (or conventional) elasticity is measured by: (ln(XVOL))(ln(GNP)) where XVOL is the volume of developing country exports and GNP is industrial country real GNP. The “marginal” elasticity is measured by:

(Δln(XVOL))(Δln(GNP)),i.e.,by(gx)(gind)

where gx is the growth rate of developing country export volumes and gind is the growth rate of industrial country GNP. Cline (1984), p. 41, and also Fishlow (1985) make use of this distinction. The two elasticities will only be identical if the growth rate of developing country exports is zero when the growth rate of industrial country GNP is zero.

The sample of countries used here is broadly similar to the sample of countries used in the survey exercise conducted as part of the preparation for the medium-term scenario of the World Economic Outlook, but does not include the People’s Republic of China.

See Cline (1984), footnote 3, p. 41.

The somewhat lower estimated elasticity obtained by Dornbusch for the period 1960–83 may be due in part to this effect.

The low elasticity of the volume of exports by service and remittance countries with respect to industrial country real GNP is confirmed, but the number of such countries covered in the sample is limited.

This evidence is also discussed by Goldstein and Khan (1982).

Strictly speaking, this analysis should be conducted in terms of gross transfers, but a sufficiently long time series is not available. For most countries other than the oil exporters—which are excluded from the analysis—outflows of private transfers appear to have been small.

Recent developments in trade policies are reviewed in Anjaria et al. (1985).

The proportion of manufactures subject to nontariff measures is measured by the ratio of consumption of product groups subject to such barriers to total consumption of manufactures. The proportions were calculated using 1980 values.

World Bank, World Development Report, 1985, p. 40.

World Bank, World Development Report, 1985, Table 3.3, p. 40. Such a measure tends to understate the impact of trade restrictions since the value of imports of goods that are most subject to restrictions will be correspondingly lower.

These and other estimates are discussed at greater length in Anjaria et al. (1985).

The importing countries are the United States, the European Community, Japan, and Canada. The seven sectors considered are meat, cereals, sugar, textiles, clothing, footwear, and iron and steel. The developing countries considered are Argentina, Brazil, India, Kenya, the Republic of Korea, Mexico, Pakistan, the Philippines, Turkey, and Yugoslavia.

In this context, moderately restrictive financial policies are defined as those necessary to achieve a reduction in the gap between the actual and a target current account deficit by one half within a year. The annual target for the current account deficit for the second year is equivalent to 2 percent of GNP, compared with an actual deficit equivalent to 2½ percent of GNP in 1984, which is the base year for the simulation. However, such simulations suffer from the problem that the behavioral relationships in the model may themselves be affected by changes in policy, since the behavioral relationships depend on expected future movements in relevant variables, including those under the control of the authorities (see Lucas (1976)).

Leven and Roberts’ estimated equation is of the form:

go=5.0(2.46)+0.24(1.26)gm+0.28(3.46)gmavgR2=0.44

where g is growth of GDP, gm is growth of real merchandise imports in the current year, and gmavg is the average growth of imports over the past five years. Figures in parentheses are t-statistics.

These estimates are derived by estimating a production function of the form: log Y = a0 + a1log K + a2log L + a3log M + a4t where Y is real GDP, K and L are fixed capital stock and the active labor force, respectively, M is the average of real imports current and lagged one year, and t is a time trend. Since the current year level of imports still enters, to some extent, into the import variable, the elasticity estimates will still tend to be biased upwards because of the simultaneity problem.

Marquez (1985), Table 2, p. 51.

These estimates were evaluated for a country with a ratio of exports to GNP of 0.5, and on the assumption that all other variables remain unchanged. Countries with a small ratio of exports to GNP would experience smaller increases in the investment ratio.

See Goldstein and Khan (1982), pp. 24–27.

These issues are discussed in detail by Folkerts-Landau (1985).

The real interest rate is calculated as the nominal interest rate less the rate of change of the U.S. GNP deflator.

See International Monetary Fund (1985b), for an analysis of the impact of foreign direct investment in developing countries.

It should be noted that the spread being discussed (LIBOR less the T-bill rate) reflects not only a loss of confidence due to increased perceptions of risks concerning commercial bank lending but also reflects competition by banks for funds as public sectors absorb a greater portion of available savings. Furthermore, the portion related to perceptions of riskiness reflects not only country risks but risks on all lending (such as domestic lending to the energy and agricultural sectors).

In domestic financial markets, another reason for a positive correlation between the banking spread and the T-bill rate is the existence of reserve requirements, which are similar to an indirect tax on banks’ interest earnings; however, there are no reserve requirements in the Eurodollar market, where the LIBOR is set.

This calculation uses the estimated impact of a dollar depreciation on the world dollar prices of fuels, non-oil primary commodities, and manufactures discussed earlier.

For instance, see Stiglitz and Weiss (1981).

These issues are discussed by Eaton and Gersovitz (1981).

These ratios of external capital flows to GDP should be regarded as indicators of broad trends only, since movements in the ratios from year to year can be significantly affected by shifts in the real exchange rate.

OECD, 1985, Table III-I, p. 93 and Chart III-4, p. 97.

However, conclusions are sometimes difficult to draw from the data on the savings performance of the capital importing developing countries. For certain periods, inconsistent results are obtained from two methods of estimating savings; savings calculated as GDP less public and private consumption does not always correspond to savings calculated as domestic investment plus net exports of goods and nonfactor services.

Countries were reclassified for each time period since their capital inflows ratios varied over time, as did the median for the group. Capital inflows are expressed as a percent of imports of goods and services rather than GDP because many of these developing countries had overvalued exchange rates for considerable periods of time and often these rates have shown wide fluctuations. Since capital inflow data are available in foreign currency units and GDP data in domestic currency, changes in the real exchange rates may cause sharp changes in the ratio of these two variables. To limit the impact of extreme observations, the data are based on medians instead of weighted averages.

See, for example, Corden (1981).

For a detailed discussion of these issues, see Williamson (1985).

It should be noted that the term “country” used in this study does not in all cases refer to a territorial entity that is a state as understood by international law and practice. The term also covers some territorial entities that are not states but for which data are maintained and provided internationally on a separate and independent basis.

Two countries which did not meet any of the above criteria were assigned to that trade category which accounted for the largest share of their exports.

The countries included here were those whose oil exports (net of any imports of crude oil) both accounted for at least two thirds of total exports and were at least 100 million barrels a year (roughly equivalent to 1 percent of annual world exports). These criteria were applied to 1978–80 averages.

    Other Resources Citing This Publication