Abstract

Anniversaries are always a time for reflection on the past and future, and the fiftieth anniversary of the Bretton Woods Conference, which in July 1944 created the framework for international economic relations in the postwar era, is no exception. The multilateral organizations and agreements that were created at Bretton Woods, New Hampshire, have facilitated progress toward such goals as open trade and exchange rate convertibility. The resulting expansion of trade and financial flows has stimulated economic progress, increased interdependence among national economies, and underscored the need for international economic cooperation to safeguard systemic stability.

Anniversaries are always a time for reflection on the past and future, and the fiftieth anniversary of the Bretton Woods Conference, which in July 1944 created the framework for international economic relations in the postwar era, is no exception. The multilateral organizations and agreements that were created at Bretton Woods, New Hampshire, have facilitated progress toward such goals as open trade and exchange rate convertibility. The resulting expansion of trade and financial flows has stimulated economic progress, increased interdependence among national economies, and underscored the need for international economic cooperation to safeguard systemic stability.

The period since World War II has been one of extraordinary economic achievement. While problems such as the slowdown in growth in many regions of the world in the 1970s and 1980s, with the associated problems of structural impediments, inflation, and budget deficits, should not be ignored, underlying economic growth in the world economy has been very rapid, both by historical standards and in comparison with expectations at the end of the war. This success is evident in a sustained increase in real output per capita above previous trends and in significant improvements in many wider measures of the quality of life such as literacy, infant mortality, and life expectancy. Although this success has affected all regions of the world, the most striking achievements have been in Japan, east Asia, and, in the earlier part of the period, western Europe.

There are several possible reasons for the high rate of economic growth in the postwar period. Recovery from the economic disruption of World War II and the inter-war depression was undoubtedly important, particularly in the early postwar period, but so were more fundamental factors such as high levels of education, saving and investment, technological advances, and economic specialization. These strong fundamentals were reinforced by the increasing integration of the international economy in trade, communications, technology, and capital markets. Trade has expanded about twice as fast as output throughout the postwar period, helping to stimulate growth and investment by allowing economies to specialize in those products that they make most efficiently. Free trade and rapid communications have allowed technological innovations to diffuse across countries, again boosting productivity. More recently, the liberalization of financial markets and the integration of world capital markets promise increasingly to allow world saving to be channeled into its most efficient uses, providing benefits to savers, investors, and consumers around the globe.

This increasing integration of the world economy was a key objective inspiring the architects of the postwar economic order who gathered at Bretton Woods. The economic distress in the 1930s was severely aggravated by a vicious circle of rising protectionism, dwindling trade, and declining investment. By contrast, the postwar period has been characterized by a virtuous circle involving expanding trade, high rates of investment, and relatively rapid and sustained growth, which has been aided by the expectation that international economic relations would continue to liberalize and expand. Such confidence was clearly bolstered by the existence of international institutions and agreements dedicated to achieving that goal.59

Just as the international economic and monetary system conceived at Bretton Woods has had to adapt to changing circumstances, so does the world economy continue to face a number of challenges. Trade barriers remain significant in sectors such as agriculture and textiles, and in many developing countries. In the industrial world, growth has slowed significantly since 1973, in part because of the disappearance of temporary factors at work during the “Golden Age” of the 1950s and 1960s. However, the slowdown also appears to be associated with policy-related problems such as inflation, fiscal deficits, and structural rigidities. In the developing world, real output growth in Africa, the Western Hemisphere, and the Middle East slowed sharply in the 1980s, again reflecting a combination of structural factors, including the abrupt cessation of access to international capital markets caused by the debt crisis of the early 1980s, and inappropriate government policies. By contrast, economic growth in Asia, home to more than half of the world’s population, has been sustained throughout the 1980s. It has been particularly rapid in east Asia, reflecting high levels of education and investment supported by generally sound macroeconomic policies and outward-looking trade policies. More recently, successful adjustment and stabilization efforts in many other developing countries have improved their longer-term outlook—provided that the reform process can be sustained. Finally, the transformation of the former centrally planned countries into market-based economies, and their integration into the international economy, poses further challenges, as well as opportunities, for the global economy.

Postwar Growth in Historical Perspective

The postwar period has been one of significant economic achievement by historical standards. The industrial countries shown in Table 19 represent six of the ten largest economies in the world in both 1900 and 1994.60 In every case, per capita growth of real output was significantly higher after World War II than during the period of the gold standard. It was also higher than growth in the interwar period for every economy except Germany.61

Table 19.

Selected Industrial Countries: Long-Term Trends in Real Output Per Capita

(Average annual percent change)

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Note: Figures in parentheses are standard deviations of growth rates.Sources: Data before 1950 were derived from Angus Maddison, Dynamic Forces in Capitalist Development (Oxford and New York: Oxford University Press, 1991). except for the United States between 1880 and 1928, which are from Nathan S. Balke and Robert J. Gordon, “The Estimation of Prewar Gross National Product: Meth-odology and New Evidence.” Journal of Political Economy Vol. 97 (February 1989), pp. 38–92. For 1950–90, data are from Robert Summers and Alan Heston. “The Penn World Tables (Mark 5); An Expanded Set of International Comparisons, 1950–88,” Quarterly Journal of Economics, Vol. 106 (May 1991), pp. 327–68.

1885-1913.

Some of this acceleration in growth clearly reflects a recovery from the economic disruption caused by the Great Depression and World War II. Except for the United States, however, there also appears to have been a decisive rise in living standards compared with the underlying trends observed in either the interwar period or the period before World War I (Chart 24).62 Data for the five largest nonindustrial countries indicate that this pattern is also true for the developing world (Table 20). Hence, while the distribution of postwar economic gains has not necessarily been even across regions or countries, almost every country experienced significant benefits. The postwar achievement is even more striking because such rapid growth was not expected at the beginning of the period. Indeed, a major concern of policymakers at the end of World War II was to avoid a repetition of the slump that had gripped the world in the 1930s.

Chart 24.
Chart 24.

Selected Industrial Countries: Real GDP Per Capita, 1880–19901

(Index, 1913 = 100; logarithmic scale)

Sources: Data before 1950 are from Angus Maddison, Dynamic Forces in Capitalist Development (Oxford and New York: Oxford University Press, 1991), except for the United States between 1880 and 1928, which are from Nathan S. Balke and Robert J. Gordon. “The Estimation of Prewar Gross National Product.” Journal of Political Economy, Vol. 97 (February 1989), pp. 38–92. For 1950–90, data are from Robert Summers and Alan Heston, Penn Tables (5.5), described in “The Penn World Tables (Mark 5),” Quarterly Journal of Economics, Vol. 106 (May 1991), pp. 327–68.1Gray sections of curves indicate war years, where the data are inter polated.
Table 20.

Selected Developing Countries: Long-Term Trends in Real Output Per Capita

(Average annual percent change)

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Source: Angus Maddison. The World Economy in the 20th Century (Paris: OECD, 1989), Table 3.2.

In addition to higher average growth of output, the postwar period was also generally characterized by lower variability in the rate of growth of output than in earlier periods. This difference is most evident when the postwar years are compared with those between the two world wars, which included the economic problems associated with restoration of the gold exchange standard in the 1920s and the depression in the 1930s. However, output variability was also generally higher under the pre-1914 gold standard (see Table 19). In part, this reduction in the variability of output reflects smaller underlying disturbances (at least in comparison with the interwar period) and structural factors such as the growing importance of services, which are subject to smaller cyclical variability than manufactures, in overall output. Additional factors seem to have been the growing share of government expenditures and revenues in GDP, with the associated “automatic stabilizer effects” of government budgets, and the expansion of international trade. Finally, conscious efforts by governments to stabilize output through discretionary policies may also have played a role.

Another, less benign characteristic of the postwar period has been high levels of inflation compared with earlier historical periods. Price levels were generally stable in the major industrial countries during the classical gold standard, and inflation was not a significant problem during the interwar years. By contrast, prices have risen steadily throughout the period since World War II. This is particularly true of the 1970s and 1980s, when high levels of inflation worldwide hurt underlying economic performance.

The improvement in prosperity since World War II is evident in a number of more general measures of the quality of life, such as life expectancy, child mortality, and education, with many of the largest strides in these more general indicators being taken in the developing world. Worldwide, life expectancy at birth rose from 53 to 65 years between 1960 and 1990, and child mortality by the age of 5 fell from 195 to 96 per 1,000 over the same period. Education also expanded rapidly, with the percentage of children enrolled in secondary education worldwide rising from 31 to 65 percent between 1970 and 1990.63

The sources of this postwar prosperity are complex and, in many respects, not fully understood. Fundamentals such as education, which raises the productivity of workers, investment, which expands the capital stock, and research and development, which contributes to technological innovation, all performed strongly. Recovery from the devastation of World War II and the problems of the 1930s undoubtedly played an important role in strengthening growth in many regions, particularly in the early postwar years.64 World War II may also have played another role through the technological innovations it generated, although the relatively limited acceleration in the underlying growth rate in the United States after the war suggests that this may not have been a particularly important factor. Many also point to a relatively high level of social consensus in the industrial countries, and hence a reduced level of economic conflict between employers and labor, as another factor permitting rapid growth with exceptionally high levels of employment, although this was true only until the late 1960s. In the developing world, the organized system of development assistance provided by the World Bank and individual nations gave access to capital for many countries before the (re-)emergence of international capital markets. Finally, the gradual liberalization of world trade and external payments helped to accelerate Europe and Japan’s catching up with the United States through the rapid growth of foreign trade.

Growth in trade consistently outstripped growth in output in almost every region of the world, resulting in a steady rise in the percentage of output consumed or invested outside the country of origin.65 Between the 1960s and the 1980s, trade as a share of output rose by half for industrial countries and by a third for developing countries (Table 21). Although starting from a much lower base, trade in services has generally expanded at a faster rate than merchandise trade, implying an even faster rate of growth for trade in goods and services than for trade in goods alone. This expansion in world trade as a share of output has been remarkably resilient over the postwar period. It was unaffected by the switch in the early postwar period from colonial rule to independence in many parts of the developing world, the oil price rises of the 1970s, the move from fixed exchange rates between the major currencies to floating rates in the early 1970s, and the debt crisis of the early 1980s.

Table 21.

Openness in the Postwar Period

(In percent)

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Note: Openness is defined as nominal merchandise exports plus imports as a percent of nominal output. Aggregates are calculated on the basis of purchasing power parity (PPP) weights.Sources: Calculations based on data in Summers and Heston, “The Penn World Tables (Mark 5).” For Africa, the aggregate includes Algeria. Angola, Benin, Botswana, Burkina Faso, Burundi, Cameroon, Cape Verde, Central African Republic, Chad, Congo, Cote d’lvoire. Gabon, The Gambia, Ghana, Guinea, Guinea-Bissau, Kenya, Leosotho, Madagascar, Malawi, Mali, Mauritania, Mauritius, Morocco, Mozambique. Namibia, Niger, Nigeria, Rwanda, Senegal, Seychelles, Somalia, South Africa, Swaziland, Togo, Tunisia, Uganda, Zaire. Zambia, and Zimbabwe. For Asia, the aggregate includes Fiji. Hong Kong, India, Indonesia, Korea, Malaysia, Myan-mar, Pakistan, Papua New Guinea, Philippines, Singapore, Sri Lanka, Taiwan Province of China, and Thailand. For the Middle East, the aggregate includes Egypt, Islamic Republic of Iran, Iraq, Israel, Jordan, and Syria. For the Western Hemisphere, the aggregate includes Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, Guyana, Paraguay, Peru, Uruguay, and Venezuela.

1980-87.

Excluding China.

Economies have benefited from this expansion in trade in a number of ways.66 The growing access to foreign markets has allowed countries to specialize production, engaging in activities that they do best. For example, the early postwar period saw a significant movement of employment from agriculture to manufacturing and services, particularly in Japan and some of the European countries. This promoted substantial productivity increases in agriculture and further boosted output through the high levels of productivity of these workers in the manufacturing and service sectors.67 New activities and products also encouraged investment, thereby contributing to faster output growth through rapid capital accumulation. In addition, the open trading system, foreign direct investment, and enhanced communications permitted technology transfers and a steady reduction in the technological gap between the leading economy—the United States—and other economies, by making high-technology investment goods available around the world and thereby encouraging convergence in economic performance across different economies. The reduction in the technology gap and the convergence in performance have been particularly evident among the industrial countries, to the extent that in some sectors the United States has relinquished its leading technological role to other countries. Finally, faster economic growth in turn has also stimulated trade, leading to a virtuous circle of international economic expansion.

The liberalization of trade was given considerable impetus in the immediate postwar years by the actions of the United States, in particular with respect to Europe. Marshall Plan aid, which provided significant resources to rebuild the shattered economies of Europe, was conditional on recipients agreeing to a timetable for liberalizing their trading relations.68 The immediate focus of the conditionality was on regional trade within Europe; it is a striking feature of Marshall Plan aid that the donor country, the United States, permitted recipients to temporarily levy higher tariffs on U.S. goods than on European ones while their economies recovered.69 In addition, the United States provided significant funding for the European Payments Union (EPU), a regional clearing system designed to foster trade within Europe by minimizing the need to use dollars, which were in short supply, in regional transactions. The EPU also generated a more lasting legacy, the Organization of European Economic Cooperation, subsequently renamed the Organization for Economic Cooperation and Development (OECD), which was originally formed to monitor compliance with the Code of Liberalization associated with the EPU.

These actions led the way to the general resumption of current account convertibility by the European nations on December 31, 1958. Since that time there has been a gradual move throughout the industrial countries toward liberalizing external payments. As a result, the industrial countries are now essentially free of exchange controls on both current account and capital account transactions, and international capital markets are rapidly becoming globalized. The developing world has also seen a trend toward both current and capital account convertibility, particularly during the past few years. Although foreign exchange payments are still far from being free in many parts of the world, even for current account transactions, there is a clear trend toward liberalization.

Despite the generally favorable comparison with earlier trends, the postwar experience is by no means uniform across time or regions (chart 25). For the industrial countries, the period as a whole shows a significant convergence in performance over time. Although there was some acceleration in growth in the 1960s compared with the 1950s in most regions, the most noticeable feature is the slowdown in growth since 1973. This slowdown is most evident in Japan and Europe, and least obvious in North America (chart 26).70 Part of the deceleration reflects the gradual disappearance or reduction of some of the forces at work in the recovery from World War II. In particular, the rapid accumulation of capital in the 1950s and 1960s meant that the same investment ratio provided a smaller boost to the capital stock, while the expansion of trade over the same period realized many of the benefits from greater specialization in production, including the movement of labor out of the agricultural sector, and substantially closed the technology gap. Hence, in addition to a tendency for the share of saving and investment in GDP in the industrial countries to decline somewhat from the levels seen in the 1960s, the impact of this investment on growth probably diminished over time (Table 22).71 The increased importance of service industries, which tend to have a lower rate of productivity growth than industrial sectors, may also have contributed to the slowdown.

Chart 25.
Chart 25.

Postwar Real GDP Per Capita

(In 1985 U.S. dollars; logarithmic state)

Sources: Summers and Heston. “Penn World Tables (Mark 5)”; and World Economic Ouilook data base.
Chart 26.
Chart 26.

Industrial Countries: Postwar Real GDP Per Capita

(In 1985 U.S. dollars; logarithmic scale)

Sources: Summers and Heston, “Penn World Tables (Mark 5)”: and World Economic Outlook data base.
Table 22.

Investment as a Percent of Output

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Source: Summers and Heston, “The Penn World Tables (Mark 5),” The countries in each group are the same as in Table 21.

1980-87.

Excluding China.

However, the slowdown also appears to have been associated with policy-related factors, including the economic disruption caused by the oil price hikes and subsequent policy responses. Many governments in the industrial countries reacted to the recessions caused by the 1973 and 1979 oil price hikes with expansionary economic policies. These may have resulted in some short-term economic benefits, but they also exacerbated rising inflationary pressures that had begun to emerge in much of the industrial world toward the end of the 1960s. The delay in the 1970s in realizing that the slowdown represented a shift in trend growth rather than a temporary cyclical episode contributed to delaying necessary adjustments in labor markets. The resulting rise in structural unemployment and the subsequent restoration of inflation to low and predictable levels during the 1980s proved to be very costly.

Underlying budgetary trends also changed in many industrial countries during the 1970s, contributing to the declining trend in national saving and in business investment as shares of GDP. The 1950s and 1960s had seen a general reduction in the ratio of government debt to output from the very high levels existing after World War II. Starting with the 1974–75 recession, however, fiscal positions deteriorated sharply and have remained in deficit ever since in most industrial countries. This persistence of large structural deficits over the past two decades has reflected a number of factors, including difficulties in controlling the built-in momentum of the rapid growth of public expenditures that had begun in the 1960s together with expectations about potential growth that proved to be optimistic. The large deficits resulted in a steady buildup of government debt that necessarily had to be financed by crowding out potential private investments through high real interest rates.

That the slowdown in growth coincided with the switch from fixed to floating exchange rates between the major industrial countries suggests a relationship. The rise in exchange rate volatility that accompanied this switch in exchange regimes cannot be completely discounted as a factor in the reduction in growth after 1973. However, it appears unlikely to have been a major cause. There is little evidence that the rise in exchange rate volatility had a significant impact on trade, which continued to grow at a faster rate than output after 1973 (see Table 21).72 On a more positive note, the period of floating exchange rates has also seen a significant liberalization of both domestic and international capital markets, thereby enhancing the efficiency of resource allocation within and across countries. Rather than attempting to suggest a clear-cut conclusion on this controversial issue, it is relevant to note that both exchange rate volatility and the slowdown in growth seem, at least to some extent, attributable to the policy-related macroeconomic imbalances that have plagued many industrial countries for much of the period since the late 1960s.

Non-Oil Commodity Prices

Non-oil primary commodity prices have been an important concern of policymakers, particularly in developing countries, throughout the postwar period. In the late 1940s, Raul Prebisch and Hans Singer argued that there had been a secular deterioration in the terms of trade of commodity-dependent developing countries since at least the 1860s.1 They also argued that this trend was likely to continue and urged commodity-exporting countries to protect against the resulting decline in their terms of trade by adopting import-substitution policies, a suggestion that had a profound influence on thinking about trade and development issues during much of the postwar era. Price volatility has been another important concern for policymakers, so much so that John Maynard Keynes proposed a separate Bretton Woods institution to stabilize commodity prices.

Although postwar commodity price developments provide some support of a long-term downward trend in commodity prices, after some twenty years of experimentation import-substitution policies have been largely discredited. The experience of primary commodity exporters instead highlights the need for sound macroeconomic management in the face of commodity market booms and busts, outward-oriented domestic reform strategies to raise economic efficiency and promote export diversification, and the implementation of efficient mechanisms for international risk sharing. In Africa, the most commodity-dependent region, long-term trends in the external environment, including commodity prices, appear to have played only a secondary role in the secular decline in growth, although African countries’ limited capacity to manage terms of trade fluctuations has often led them to adopt exchange rate, fiscal, and agricultural policies that have undermined growth over the medium term.2

Real commodity prices have fluctuated widely over time, reflecting the higher volatility of nominal commodity prices compared with the prices of manufactures (see chart). These large fluctuations make it extremely difficult to distinguish long-term trends from short- and medium-run cycles. Recent empirical work suggests that real prices have decreased at an average annual rate of approximately 0.6 percent since 1900.3 There is also evidence that the trend in prices may have changed over time. Commodity prices trended upward for the first two decades of the twentieth century before dropping abruptly after 1920 and then remained highly volatile, but without any clear trend, for the rest of the interwar and World War II period. Prices trended slowly downward during 1950– 73 but did not exhibit the extreme fluctuations of the interwar period. The downward trend in commodity prices steepened markedly following the surge in oil prices in 1973 and the slowdown of trend growth in the industrial countries. After a sharp run-up in prices in the mid-1970s, reflecting the coffee boom among other things, prices began fifteen years of almost uninterrupted decline. In 1992 the price of non-oil commodities relative to that of exported manufactures reached its lowest level in over ninety years. Formal analysis suggests that much of the weakness is secular, not temporary.4

ch06bx10ufig01

Real Non-Oil Commodity Prices, 1900–92

Sources: Enzo R. Grilli and Maw Cheng Yang, “Primary Commodity Prices, Manufactured Goods Prices, and the Terms of Trade of Developing Countries: What the Long Run Shows,” World Bank Economic Review, Vol. 2 (January 1988), pp. 1–47; and Carmen M. Reinhart and Peter Wickham, “Commodity Prices: Cyclical Weakness or Secular Decline?” Staff Papers (IMF), Vol. 41 (June 1994), pp. 175–213.Note: Commodity prices are deflated by the export unit values of manufactured goods.

The volatility of real commodity prices appears to have increased in the early 1970s. The breakdown of the Bretton Woods exchange rate system, the subsequent marked changes in the exchange value of the U.S. dollar (in which most commodities are priced), and the oil shocks of the 1970s and 1980s have contributed to this rise. There are several ways in which commodity-exporting countries can, in principle, protect themselves in the short run from higher price volatility. For example, there are now a number of hedging strategies, using available market-based instruments, that countries can pursue.5 Similarly, building up foreign assets can provide a buffer against unexpected declines in commodity prices, particularly if access to international credit markets is limited during periods when export revenues decline sharply. There have also been renewed calls for international price stabilization agreements, a Common Fund, and the development of multilateral facilities along the lines of the IMF’s compensatory and contingency financing facility (CCFF).

The decline in prices has affected all commodity-producing countries to some degree. For some countries, productivity growth in the commodity export sector has increased export volumes sufficiently so that they have not experienced a decline in total real earnings. This is particularly true for the industrial countries and the developing countries in Asia. For most African countries, however, the commodity price decline of the past decade has caused a sharp decrease in both the volume of exports and the real value of export earnings.

The decline in commodity prices has had its greatest impact on countries with the least diversified production structures. These countries, which include many of the world’s lowest-income countries, tend to have less flexible economic systems, making substitution away from commodity production more difficult or costly. Reliance on primary commodities as the main source of export earnings has diminished only slightly over the past two to three decades for many of these countries, particularly those in Africa. Although a more diversified export structure is not necessarily an economic objective in itself, in the long run export diversification is probably the most important way to reduce vulnerability to volatility and sustained declines in commodity prices.

Analyses of commodity market developments have usually focused on the macroeconomic conditions in industrial countries as the principal factor affecting prices. Given the role of many commodities as inputs for manufacturing industries, their demand is closely related to the level of world industrial production, the major part of which takes place in industrial countries. The apparent acceleration of the trend decline in commodity prices in the past two decades is, at least in part, related to the secular slowdown in the growth of real output in the industrial countries since the early 1970s. The declining intensity of resource use for some commodities, owing to technological change, has also reduced demand for commodities.

A remarkable feature of developments in commodity markets in the 1980s has been the vigorous growth in the volume of commodity imports by industrial countries. Since 1983, the volume of commodity imports has almost doubled, a larger increase than that for imports in general. This increase in volume, accompanied by a decline in prices, points to the importance of supply-side factors in explaining price developments.

Several factors have contributed to the expansion in supply. Technological innovation and productivity enhancement have been important in some cases. Agricultural policies in the industrial countries typically have also stimulated domestic output, reduced imports, and raised exports. In addition, in the early 1980s many developing countries faced considerably more restricted borrowing opportunities in international financial markets as the debt crisis unfolded. This situation required balance of payments adjustment, which may have contributed to the expansion in the output of commodities in some countries. Finally, the collapse during the 1980s of international stabilization schemes for some major commodities, particularly tin and coffee, also contributed to the supply expansion and the downward pressure on prices.

More recently, developments in central and eastern Europe and, particularly, in the countries of the former Soviet Union have also exerted downward pressures on commodity prices. These countries are important participants in international trade in commodities, and their demand for imported commodities fell with the fall in output and aggregate demand that followed the collapse of centrally planned economic systems. The downward pressure on prices was probably most pronounced in metals markets, where the countries of the former Soviet Union are important suppliers, and where there were dramatic increases in exports of some commodities: exports of zinc, for example, rose by nearly 700 percent during 1989–92.

Stronger growth in industrial countries will help to relieve some of the downward pressures in commodity markets, but it appears unlikely that it will be sufficient to reverse the declines of the past decade. The empirical evidence suggests that an annual average growth of 2½ percent in industrial countries over the next two years would generate an increase of between 6½ and 9 percent in real commodity prices over the same period. Other factors—in particular, trends in the supply of commodities, economic developments in the countries of the former Soviet Union, and the successful conclusion of the Uruguay Round—could also tend to boost commodity prices.

The past two decades highlight the importance of precautionary saving and hedging against commodity price swings in the short run, and of policies that facilitate the diversification of the export base and foster increases in productivity in the primary-commodity-producing sector in the medium term. The commodity exporters that have been most successful in adapting to the downward trend and the increased volatility in commodity prices are those that have used macroeconomic stabilization policies to cope with the inevitable booms and busts, rather than trying to protect private producers from price uncertainty through marketing boards or price stabilization funds.

1 See Raul Prebisch, The Economic Development of Latin America, and Its Principal Problems (New York: United Nations, 1950); and Hans Singer, “The Distribution of Gains Between Investing and Borrowing Countries,” American Economic Review, Vol. 40 (1950), pp. 473–85. All subsequent references to commodity prices and commodity exports exclude energy products.2 See Chapter IV of the May 1994 World Economic Outlook; and World Bank, Global Economic Prospects and the Developing Countries (Washington, 1994).3 See J.T. Cuddington and T. Feyzioglu, “Long-Term Trends in Primary Commodity Prices: Resolving Our Differences Using the ARFIMA Model,” Georgetown University Working Paper (Washington, July 1994).4 See Carmen M. Reinhart and Peter Wickham, “Commodity Prices: Cyclical Weakness or Secular Decline?” Staff Papers (IMF), Vol. 41 (June 1994), pp. 175–213.5 See Stijn Claessens and Robert C. Duncan, Managing Commodity Price Risk in Developing Countries (Baltimore, Maryland: Johns Hopkins University Press for the World Bank, 1993).

The growth experiences in the developing country regions in many respects differ from those of the industrial countries.73 The African and the Western Hemisphere regions show a similar pattern of a slight acceleration in growth followed by a large decline that has already been described for the industrial countries. However, the accelerated rate of growth occurred at the end of the 1960s, not at the beginning, and lasted through the 1970s. The deceleration in per capita growth in these regions in the early 1980s was also much more dramatic than in the industrial countries, and it resulted in declines in per capita output in both regions.74 The Middle Eastern region shows a similar pattern, with relatively rapid growth in the 1960s and early to mid-1970s, followed by a downturn in per capita GDP in the late 1970s. Data for the early 1990s indicate that growth in per capita output has resumed in the Western Hemisphere and Middle Eastern regions, while the rate of decline in Africa has slowed.

The deceleration of economic growth in the early 1980s in these regions reflects several interrelated factors, of which the most important are the decline in real commodity prices, the high volatility of commodity prices after 1973, the debt crisis, the rise in world real interest rates in the 1980s, civil strife, and problems of economic management. Depressed and highly volatile real commodity prices had, and continue to have, a negative effect on the fortunes of those countries, particularly in Africa, where primary commodities represent a major source of export earnings (Box 10). Growth was also adversely affected by the need to restore external viability after the debt crisis abruptly closed access to international capital markets for most developing countries in the early 1980s and by high world real interest rates. These external problems were often exacerbated by poor economic management, characterized by excessive government regulations of the economy, relative price distortions, inward-oriented trade policies, and unsustainable levels of government borrowing and inflation. The resulting economic problems caused major stresses to the international monetary system, and they continue to generate significant challenges for the international community in general and the IMF in particular.

Economic Convergence

Two definitions of economic convergence have been used in the literature on economic growth. According to the first, there is convergence if poor economies tend to grow faster than rich ones. The second definition is that there is convergence if the dispersion of real per capita income across groups of economies tends to fall over time. Although these concepts are related—if poor countries grow faster than rich ones, then it is natural to think that they are getting closer together, and if they are getting closer together, then it implies that poor countries are growing faster—they are not identical and could occur separately. In practice, however, virtually all empirical studies find that when convergence occurs it does so in both dimensions simultaneously, and the two definitions will be treated as equivalent below.

The chart shows the relation between the level of per capita income in 1960 and the growth of per capita income during 1960–85 for a set of 114 developing and industrial countries. Convergence among these economies would be indicated by a negative relationship between these two variables: the poorer a country is at the beginning of the period, the more rapidly it would be expected to grow during the period. The chart, however, suggests that, if anything, the relation between these two variables is positive, as shown by the regression line. During the past thirty years, poor economies do not appear to have caught up with wealthy ones. Cross-country inequality also seems to have increased over the same period.

The finding that there has not been convergence across countries became apparent as soon as comprehensive data on comparative growth became available in the mid-1980s.1 At the end of the 1980s, researchers started focusing on the concept of conditional convergence. According to this concept, a country’s long-run level of income and its growth rate are determined by other factors, such as macroeconomic and structural policies, as well as how poor the country is relative to the rest of the world. Factors that have been found to be significant in cross-country analyses of growth include the level of education of the labor force, investment distortions, financial repression, political and civil unrest, government interventions, and the degree of macroeconomic disarray as measured by extreme inflation rates or public deficits. These studies suggest that economies with higher levels of education have grown faster, and that economies with more distorted investment prices, more public intervention, and more political and macroeconomic instability have grown more slowly. In addition, when the initial level of income is included in these models, its coefficient is negative and highly significant, a result that has been found to be robust under many different specifications.2 Hence the data shown in the chart appear to be consistent with conditional convergence.3

An interesting aspect of this type of analysis is that the implied speed of convergence—the average rate at which the gap between a country’s current and its long-run level of income is closed—is generally about 2 percent a year. This speed of conditional convergence is very similar to the estimated speed of unconditional convergence estimated across regions within countries or across groups of closely related countries. For example, the level of per capita income of the states of the United States has converged at a speed of 2 percent a year since 1880. The same is true for per capita income across the 47 Japanese prefectures since 1930; and for GDP per capita across regions within Belgium, Denmark, France, Germany, Italy, the Netherlands, Spain, and the United Kingdom.4 This convergence is unconditional, since the other factors that determine growth are likely to be essentially the same within countries or groups of similar countries, whereas this is unlikely to be true for a cross-section of developing and industrial countries. The similarity of the speed of convergence across such a diverse set of countries and regions is remarkable, although it is not clear why this is the case.

The estimated rate of convergence is, however, quite slow. Consider a gap of 10 percent between a country’s current income and its long-run level of income. A catch up speed of 2 percent a year suggests an immediate increase in annual per capita growth of 0.2 percent. It will take thirty-five years to reduce by one-half the gap between the current level of income and the new long-run level, and seventy years to eliminate three-fourths of the gap. This relatively slow rate of convergence implies that changes in macroeconomic and structural policies that raise the long-run level of income will result in sustained periods of higher growth, as is suggested by the recent performance of many developing countries.

ch06bx11ufig01

Convergence Across Countries1

1 The samples includes 114 developing and industrial countries.
1 It was partly due to this empirical finding that the new theories of endogenous growth, which did not predict convergence, enjoyed great success. Virtually all empirical research on convergence is based on estimates of per capita GDP on a purchasing-power-parity (PPP) basis; see Robert Summers and Alan Heston, “The Penn World Tables (Mark 5): An Expanded Set of International Comparisons,” Quarterly Journal of Economics, Vol. 108 (May 1991), pp. 327–68.2 Robert J. Barro and Xavier Sala-i-Martín, “Convergence,” Journal of Political Economy, Vol. 100 (April 1992), pp. 223–51.3 Much of this work, however, implicitly assumes that the rate of growth of technical progress is equal across countries. Investigators who have made this assumption have found less strong evidence for convergence. There is also an issue of the degree to which variables such as civil unrest are truly exogenous to the growth process.4 See Robert J. Barro and Xavier Sala-i-Martín. Economic Growth (New York: McGraw-Hill, forthcoming), Chapters 11 and 12, for a summary of these results.

By contrast, economic growth in Asia has been sustained throughout the 1980s and, if anything, has accelerated over time. This is particularly true in east Asia, where growth in per capita output accelerated sharply in the late 1960s to 5½ percent a year in the 1970s and 1980s;75 several of these economies have clearly already caught up with some industrial countries (Box 11). As a result, average per capita incomes in this region have now overtaken those in the Western Hemisphere and the Middle East. Growth in the rest of Asia (excluding China, for which annual historical data are very limited) has been more modest, with an underlying annual rate of growth of output per capita of just over 2 percent throughout the period from the late 1960s. Recently, however, this region has also shown signs of entering a period of higher growth.

The sources of the very high rates of growth seen in east Asian countries over the past two decades are numerous.76 High levels of education, labor force participation, diversification of the export base, and saving and investment have all contributed. The successes in these areas were supported by generally sound macroeconomic management and outward-oriented trade policies, which provided a stable economic environment conducive to saving, investment, and education. As in Europe after World War II, expansion of international trade allowed these countries to specialize production in activities that they do best and to import new technology. The result has been high and rising levels of investment and productivity, and a swift expansion in trade, which in turn have generated a virtuous circle involving investment, trade, and economic growth—an experience that a growing number of emerging market economies now seek to emulate.

Future Challenges and Opportunities

Although the postwar period has seen a tremendous increase in trade, there remains considerable potential for further integration. In particular, there is scope for much deeper integration between the “old” market economies and the transition economies of central and eastern Europe, Russia, and Transcaucasus and central Asia. For these emerging market economies, which have experienced a sharp contraction of previously command-driven trade within the former communist bloc, the expansion of trade ties with other countries is vital for the success of the transformation process. For many of these countries, the natural trading ties are with western Europe. The deepening of trade ties with the transition countries will create new export markets for western European producers. At the same time, however, it will also increase the need for economic restructuring, which could meet with considerable resistance because of the high levels of structural unemployment that have characterized western Europe for almost two decades. Increased flexibility in western European labor markets will therefore be crucial to pave the way for a relatively rapid integration with the transition countries of central and eastern Europe.77

International integration has also remained relatively limited in many other regions. This is particularly true in the Western Hemisphere, Africa, and parts of Asia, where tariffs and nonprice barriers to trade have remained high in many countries. As a result, trade among countries within these regions is often relatively low; indeed, many countries have trade relationships that are skewed away from regional trade and toward trade with industrial countries.78 Trade barriers by the industrial countries in areas such as agricultural products and textiles have also limited the expansion of international trade. Nevertheless, prospects for greater trade integration are currently promising. The completion of the Uruguay Round of the GATT negotiations, assuming that it is ratified by national governments, promises to lower barriers to trade worldwide across a wide range of goods and services, as well as providing benefits in areas such as trade dispute settlements and intellectual property rights. Regional trade agreements, most notably the North American Free Trade Agreement (NAFTA) as well as many other arrangements in South America and in Asia, and the trend toward current account convertibility in many developing countries, also indicate an increased commitment to open trading regimes.79 Many regional integration efforts are inspired by the experience of the European Union, the most economically integrated group of countries in the world (Annex I). Finally, the problems of access to international capital markets generated by the international debt crisis of the 1980s appear to be largely resolved.

The expansion of international capital markets, together with domestic financial deregulation, provides an additional opportunity for improving the underlying performance of the international economy. Free markets in capital allow saving to be directed toward its most productive uses, providing both a more efficient way of channeling saving into investment and greater incentives to save and invest. Reaping the full benefits of these opportunities, however, requires recognition of interdependencies among national economies, and cooperation to safeguard systemic stability. Open international capital markets are now almost universal across the industrial countries, and they are being instituted in an increasing number of developing countries. One feature of this expansion in capital flows is the role played by foreign direct investment recently, particularly into Asia and Latin America; foreign direct investment may have accounted for almost half of all external finance for developing countries in 1993. Another feature has been the rapid expansion of securities markets in emerging market economies.80 Open international capital markets can also discipline government policies, although, as the debt crisis of the 1980s illustrates, it can also increase the volatility of investment flows.

This regime has much in common with the pre-1914 period. Then, as now, capital transactions were relatively free, and capital flows were dominated by securities markets. Hence, the current regime can be seen as a return to the liberal international order that existed before 1914 after a long diversion brought about by the disruptions of two world wars. The main benefits from the liberalization of capital markets, in terms of enhanced private saving and more efficient global investment, probably lie in the future. Even in the industrial countries, much of the move to liberal capital markets has been very recent. Capital market transactions were liberalized in Japan only in the early 1980s, and in the EU in general at the end of 1990, as part of the Single Market program.

Free international transactions in goods and capital provide an important basis for successful economic expansion. Another foundation is sound domestic macroeconomic and structural policies. Great strides have been made toward reducing inflation back to low and predictable levels in the industrial countries during the 1980s and early 1990s. Unfortunately, the same cannot be said for many of the developing countries outside of Asia, or for the countries in transition, where inflation continues to be high. Such high levels of inflation impair the underlying performance of markets by creating macroeconomic and microeconomic uncertainty.

Fiscal policy is another area of concern. The rapid increase in government spending during the 1970s and 1980s was accompanied by a steady expansion in the ratio of government debt to output in most industrial countries, and, despite many attempts to control fiscal deficits, government debt-to-income ratios have continued to expand in many of these countries. In developing countries and in most of the transition countries, where financial markets are often less well-developed, the need to fund the fiscal requirements of the government is often a major reason for high inflation. In all cases, lax fiscal policies have been detrimental to underlying performance.81

The 1970s and 1980s also saw an increase in structural rigidities in the industrial countries, as government policies increasingly impinged on underlying market mechanisms.82 The most obvious manifestation of these rigidities has been in labor markets. Both the actual and the “natural” rate of unemployment have continued to rise over time, with this trend being most obvious in Europe. Structural unemployment causes hardship for individuals and unnecessary costs for society, and steps to reduce it by improving the functioning of labor market mechanisms through policy reforms are urgently needed.83 Structural problems caused by government interference in private markets have also created many problems in the developing world. It is notable that in east Asia, the region of the world with the most successful growth record, governments have often relied relatively heavily on market mechanisms, particularly in agriculture.

These two issues—sound government policies and open markets for international goods—are not unrelated. History indicates that when sound government policies have been combined with open international markets, a virtuous circle can be created in which individuals have incentives to save and invest, thereby creating high underlying economic growth, which in turn provides the best support for sustaining appropriate policies and generating adequate saving around the globe. Fortunately, as discussed above, the benefits of such policies are being increasingly recognized. There appears to be real momentum behind the move toward better macroeconomic and structural policies in many areas of the world. At the same time, the liberalization of exchange markets, the successful completion of the Uruguay Round agreements, the soon-to-be-established WTO, the completion of the EU Single Market, and the completion and possible expansion of the NAFTA all point toward the continued deepening of the process of international economic integration. Together, such domestic and external liberalization should ensure that economic progress touches as many people as possible.

The benefits that flow from sound government policies and open markets will be gradual, but they will also be lasting. The economic achievements of the postwar period throughout the world, in particular those in Europe and Japan in the 1950s and 1960s and elsewhere in Asia and parts of the Western Hemisphere more recently, were built year upon year, with the benefits accumulating steadily. Looking back after fifty years, it is clear that this steady progress has added up to a period of extraordinary progress, unsurpassed in historical terms. Further moves in this direction should generate high and sustained levels of economic growth worldwide, with a gradual convergence to the performance of richer countries similar to the experience of Europe and Japan in the “Golden Age.” At the same time, it is incumbent on the world community to provide assistance to the poorer countries of the world to promote economic progress. Although many types of assistance may be required, the most valuable help will be liberal access to foreign markets.

Annex I European Economic Integration

Since the mid-1980s, there has been renewed vigor in the process of economic integration in Europe. Initially, efforts were focused on deepening economic ties within the European Union (EU) through the Single Market program.1 Plans for monetary union and for strengthened coordination of macroeconomic policies (economic and monetary union, EMU) also gathered momentum. Spurred by developments within the EU and facilitated by political changes in the former centrally planned economies, the early 1990s have seen a notable widening of the integration process: the European Economic Area (EEA) has extended most aspects of the EU’s internal market to five of the seven countries of the European Free Trade Association (EFTA); four of these countries have agreed on terms for full EU membership, subject to ratification; and the EU and EFTA have strengthened their ties with the transition economies in central and eastern Europe.

Main Developments

Until the mid-1980s, market integration within the EU was founded principally on the absence of both tariffs and quantitative restrictions on intra-EU trade and on a common external tariff. These proved inadequate to realize the goal of a common market, owing to national prerogatives in regulating domestic markets and the associated border controls. The unveiling of the internal market program in 1985 signaled a concerted effort to eliminate most physical, technical, and fiscal barriers to market integration by end-1992.

With the EFTA countries eager to enjoy the benefits of the internal market, negotiations on the EEA commenced in 1990, aiming to build on the existing free trade in industrial products between the EU and EFTA. The agreement was signed in 1992 and, after a delay related to the decision of the Swiss people not to participate, came into effect on January 1, 1994.2 Meanwhile, four EFTA countries—Austria, Finland, Norway, and Sweden—entered into negotiations for full EU membership, which were concluded successfully in March 1994. The goal is that these countries accede to the EU in January 1995. The European Parliament approved the enlargement agreements in May 1994, and the Austrian people endorsed EU membership in a referendum in June. Referendums are planned for the other three countries in October and November of this year. Enlargement will also be subject to approval by national parliaments of the existing EU countries.

Economic and political reform in the former centrally planned economies of eastern and central Europe has prompted a rapid eastward reorientation. This is being facilitated by improved access to EU and EFTA markets. Most notably, between December 1991 and March 1993, the EU signed association agreements—known as Europe Agreements—with Bulgaria, Czechoslovakia, Hungary, Poland, and Romania.3 These agreements aim to establish a free-trade area, with the notable exception of agriculture, by 2003 and also include provisions dealing with the movement of labor and capital, competition policy, and the adaptation of legislation in key areas to make it more compatible with that prevailing in the EU. The agreements also commit the EU to continue financial assistance in support of reform. Pending ratification, interim accords containing the trade provisions took effect in 1992 for Czechoslovakia, Hungary, and Poland, and in 1993 for Bulgaria and Romania. The EFTA countries have negotiated broadly similar trade arrangements with these countries.

The EU is liberalizing trade more quickly than the associate countries. Indeed, the schedule for EU liberalization was accelerated unilaterally by the European Council at its June 1993 meeting in Copenhagen, a meeting that also committed the EU to eventual membership for the associate countries.4 Under the interim agreements that took effect in 1992, as amended in Copenhagen, access to EU markets is to be completely liberalized for most industrial products by end-1994, with restrictions on steel products eliminated a year later and those on clothing and textiles by end-1997.5 The agreements, however, provide for only relatively moderate liberalization of agriculture. More generally, the effective degree of liberalization will depend on the extent of recourse to safeguard and antidumping clauses.

The Impetus for Integration

Integration within Europe has important political dimensions. During the reconstruction following World War II, strong and mutually advantageous economic ties were seen as critical to promote political harmony. More recently, the political change that has swept through eastern and central Europe and the former Soviet Union has given an important stimulus to the integration process. For western Europe, economic ties with the countries in transition are a means of supporting reform and fostering political stability. Moreover, for countries with a tradition of neutrality, the disappearance of tensions between eastern and western Europe removed an important constraint on their participation in regional arrangements. For the transition countries, stronger links with western Europe offer a means of consolidating reforms. In these considerations, the economic case for regional integration is intertwined with the political one. It is recognized not only that economic benefits provide important support for the political goals, but also that political instability could threaten regional economic performance.

Political considerations aside, the potential economic benefits alone can be a powerful motivating factor. In assessing the benefits of regional integration, the first step has traditionally been to examine the relative magnitudes of trade creation and trade diversion—the former representing the replacement of domestic production with less costly products of regional trading partners, and the latter the substitution of goods produced by regional trading partners for less costly imports from trading partners outside the region. Trade creation is likely to predominate when the countries forming the regional trading arrangements already do most of their trade with each other or when tariffs facing countries outside the union are relatively low.

Often, however, these static trade effects may be much less important than more dynamic, internal economic effects, notably on the supply side.6 An important aspect of this is the economies of scale that can accompany market enlargement. Efficiency may also be promoted by harmonizing regulations and competition policy. Moreover, as highlighted by the recent literature on economic growth, static supply-side benefits can be augmented significantly by dynamic effects related to higher investment, quicker technological progress, and faster human capital accumulation.7

Most assessments of the earlier stages of European integration have concluded that trade creation exceeded trade diversion, facilitated in part by the progress in global liberalization.8 The supply-side effects are also believed to have been important, facilitated by the growth of regional trade relative to output (see chart 27).9 As discussed further below, the focus of current integration efforts on supply-side performance and the relatively low level of tariffs in western Europe suggest that, if these efforts are successful, pure trade effects are likely to be dominated by supply-side effects, both static and dynamic. Moreover, the continued liberalization of world trade in the context of the Uruguay Round agreement should further limit the extent of trade diversion.

Chart 27.
Chart 27.

European Union: Trade Integration

(In percent)

Source: IMF, Direction of Trade Statistics Yearbook.

Implications of Integration

For the EFTA participants, the EEA holds the promise of significant “internal market” benefits in the form of greater market access, reduced costs, more intense competition, increased economies of scale, and induced growth effects. The potential importance of these benefits can be illustrated by the various “ex-ante” estimates of the impact of the EU’s internal market program. The estimates of the European Commission staff—that full market integration would, over time, yield a 4½-6½ percent boost to EU GDP—have been criticized as too optimistic, and some other estimates suggest benefits of less than half this magnitude.10 Even these smaller estimates are significant, however, particularly when it is recalled that formal estimates have tended to consider only static effects. Some studies have emphasized that the dynamic effects, although difficult to quantify, may well be even more important.11

There has been less quantitative work on the overall effects of the EEA. One study, confined to industry, transportation, and finance, estimates the static benefits for the EFTA countries of full market integration with the EU at 3½ percent of income in these sectors.12 Although the EEA agreement falls somewhat short of full market integration, as discussed below, any assessment of EEA membership needs also to take account of the costs entailed in remaining outside the single market, most notably that EFTA producers would be in a weaker competitive position vis-à-vis EU producers—which the study noted above estimates would cost an additional ½ of 1 percent of the income in the sectors examined—and that investors would be likely to view EFTA locations less favorably.

The economic costs of EEA participation would, at an aggregate level, seem to be relatively limited. Trade diversion should be small—the EFTA countries already do most of their trade with the EU and, except for agriculture, which is not covered by the EEA, EFTA protection against third countries is relatively low (indeed, lower on average than in the EU). The EFTA members of the EEA will contribute to a fund for the EU’s poorer regions—these contributions will amount to about ⅓ of 1 percent of their GDP in 1995, but they will decline subsequently and cease after 1998.

The step to full membership will entail greater institutional involvement in the EU, including participation in legislative and regulatory processes and in the Common Agricultural Policy (CAP), adoption of the common commercial policy vis-à-vis third countries, contributions to the EU budget, the adaptation of regional policies to EU rules, and possibly membership in a future monetary union and in common security arrangements. Given the politically sensitive nature of most of these aspects, it is not surprising that EU accession has tended to be a more controversial issue in the applicant countries than was the EEA.

Set against these considerations is the voice in EU policies that full membership would give. This applies not just in those areas where membership would involve new obligations, but also in the areas covered by the EEA.13 Prospective members will also have influence on environmental issues, where at present they have no say but are affected by EU policies—for example, those on acid rain. While the prospective members are not large—adding 9 percent to the EU’s GDP and 8 percent to its population-—they will have 14 votes of a total of 90 in the Council of Ministers. Thus, on issues where the new applicants have common interests, their votes will account for more than half of the 27 votes needed to block measures that pass on the basis of a qualified majority (which include most measures affecting the internal market).14

Regarding the specific economic issues associated with membership, debate has tended to focus on the financial transfers to the EU: as relatively affluent countries, the prospective members will be net contributors to the EU. Although the gross transfers of the new members to the EU budget will be a little over 1 percent of GDP, these will be offset in part by payments from the EU for, among others, agriculture and regional development. Some of the more affluent current members make net transfers to the EU of about ½ of 1 percent of GDP. Estimates of the net financial transfer understate the impact on government budgets in the acceding countries, since only part of the receipts from the EU will provide budgetary relief by replacing spending previously funded by national governments. More generally, however, such estimates are misleading, since they do not take account of the economic benefits that EU membership is expected to produce—even in a narrow fiscal context, the additional tax revenue resulting from higher output could, over time, compensate fully for the costs to national budgets of EU membership.15

Identifying the economic benefits of EU membership for the new members entails difficult judgments about the extent to which the EEA yields the potential benefits of market integration. It is clear that there are important benefits that would be dependent on full membership. Under the EEA, for example, border controls remain; surveys suggest that these controls add up to 3 percent to the costs of goods in trade. Furthermore, EU rules of origin give less favorable treatment to EFTA producers using goods from the associate countries as intermediate inputs than they do to EU producers. It is also expected that enforcement of competition law would be stronger within the EU.16 More generally, as full membership is less reversible than EEA participation, it would give potential investors greater confidence in the future payoff of investments induced by the market integration process.

Outside the realm of the Single Market program, the key issue is agriculture, which has been more heavily protected in the EFTA countries than in the EU.17 The decline in prices to EU levels will bring sizable gains to consumers and should also entail important improvements in the efficiency of resource allocation. These gains will become even clearer as the implementation of the 1992 CAP reforms is completed. Indeed, there are likely to be pressures for additional CAP reforms, both from within the EU and in international forums, pressures that may well be less intense on small producers outside the EU. As discussed below, such pressures are likely to be reinforced by efforts to integrate further the transition economies with the EU. The size of the benefits of reduced producer subsidies will depend partly on the shift of agricultural manpower to other more productive activities, which will be influenced by the future path of direct income supports for farmers.18 Even without the reallocation of agricultural labor, however, the reform process yields important benefits by reducing distortions facing consumers, by cutting incentives for input-intensive production techniques, and by encouraging a shift of capital to other activities.

For the countries in transition, it is the reduction in formal trade barriers—tariffs and quantitative restrictions—that is the leading element of the integration process. Although the Europe Agreements contain some elements related to harmonization of regulatory policies and legislative frameworks, these are set in a medium-term context and are relatively limited in scope compared with the EU’s internal market. Nevertheless, as with liberalization in western Europe, it is the supply-side effects that are likely to be crucial: in particular, the prospect of realizing a rapid expansion of trade should provide a major stimulus to investment in the transition economies. Trade has already grown rapidly—exports of the eastern European associate countries to the EU rose by 76 percent (in U.S. dollar terms) between 1989 and 1993, and the share of their trade with the EU rose from one-fourth to one-half. Some recent studies estimate a very large potential for growth in trade between countries in transition and the EU.19

The fast pace of EU liberalization for most industrial goods is broadly in line with the needs of the transition economies. However, liberalization has been slower in sensitive areas such as steel, clothing, textiles, and agriculture, which are important for the economies in transition.20 For the sensitive industrial products, the issue is not so much tariffs and quantitative restrictions—these are being reduced quickly and will be eliminated over the next few years—but that the potential exercise of antidumping and safeguard clauses will create important uncertainties for investors. There have already been some examples of the exercise of these clauses, notably against steel imports. In the area of agriculture, liberalization will remain relatively modest when the Europe Agreements are fully implemented, reflecting the institutional and budgetary constraints posed by the CAP.

The evolution of relations among themselves and with other trading partners will have a bearing on the extent to which the transition economies realize the potential benefits from closer economic ties with western European countries. First, it will be important that restrictions on imports from other partners be reduced so as to limit trade diversion as tariffs on imports from the EU decline. Moreover, the relatively restrictive treatment of agriculture in the association agreements with the EU should not deter the transition economies from faster liberalization of agricultural trade among themselves and with other countries. Second, access to neighboring markets is likely to be a prominent factor in investor location decisions. An investor will be more likely to choose a location in a transition economy if this location can easily service other countries in eastern Europe. Thus, efforts to reduce trade barriers among the transition economies themselves should be vigorously pursued.21

The economic benefits for the existing EU countries from the widening of the integration process will be less impressive than for EFTA countries or the economies in transition, if for no other reason than when smaller economies integrate with larger ones, the smaller ones are likely to see proportionately greater effects. It is important, however, not to put too much emphasis on economic size. First, the cumulative effect of adding small new members can be significant. Moreover, the physical size of the eastern European countries in transition, with a population, at present, of close to one-third that of the EU, suggests that they may be an important economic force over the longer run. Second, the process of integration can affect the dynamics of decision making in the EU. For example, the drive to integrate the countries in transition may be an important force for structural change in western Europe. In particular, it is widely recognized that the budgetary implications of an eastward extension of the CAP in its present form would be unsustainable. Similarly, competitive pressures in certain sectors as a result of greater market access for the industrial goods of the transition economies underline the need for more flexibility in western European labor markets, so as to facilitate the profitable absorption of lower-skilled and displaced workers, as well as the need for more effectively targeted education, training, and income support mechanisms.22

Finally, producers in other countries will find themselves in a weaker competitive position vis-à-vis producers in the integrating countries. The negative effects, however, are likely to be offset by the benefits of larger European markets. More generally, the European integration process can provide important lessons for the rest of the world—notably, that attacking impediments to trade other than tariffs and quantitative restrictions has the potential to yield significant welfare gains.

For countries that do not trade heavily with Europe, the effects of the continuing regional integration in Europe are likely, on balance, to be relatively small. For the countries geographically closer to the European integration process, the concerns may be more complex. In particular, to the extent that they lag in their access to western European markets, these countries may have greater difficulty in attracting investment than countries on a faster integration track. This applies also to the countries in transition that have not benefited from as liberal terms as the countries covered by the association agreements with the EU. There is also a group of European economies—Cyprus, Malta, and Turkey—not discussed in this annex that has long-established ties with the EU and that aspires to EU membership. Although these countries have liberal access to EU markets for industrial products,23 they have not had the opportunity to participate in the recent deepening of the integration process among the EU and EFTA countries. The considerations outlined above underline the importance of ongoing EU negotiations with these various groups of countries and, more generally, of the global process of liberalization.

* * *

Although the recent widening of the integration process in Europe has important political dimensions, economic considerations have also been important and are likely to be central to its future development. For the EFTA countries, participation in the EU’s internal market promises important static and dynamic efficiency gains, with concomitant benefits to consumers. While the political dimension has made EU accession a somewhat more controversial issue for these countries than membership in the EEA, this further step is expected to yield important net additional benefits by enabling these countries to take full advantage of market integration and by promoting greater efficiency in agriculture. The countries in transition, which are at an earlier stage in the integration process, may expect gains not only from the reductions in formal trade barriers, but also from dynamic supply-side effects following the expansion of trade. The economic benefits of further deepening of their economic ties with the EU, and ultimately of EU membership, are likely to be important factors sustaining the integration process over the coming years. Although the existing EU countries may not gain as substantially as the EFTA countries and the countries in transition, nonetheless significant benefits can be expected over the longer term as the effects of integration cumulate, and as the accompanying pressures for structural change increase. Finally, while producers in other countries may find that their competitive positions weaken relative to European producers, the effects of market expansion in Europe will tend to offset this. For these countries, as well as for the integrating countries themselves, it will be important that European economic integration continue to take place in a wider context of global liberalization.

Notes

This Annex was prepared by S.G.B. Henry and Donogh C. McDonald.

1

For ease of exposition, EU is used throughout to refer to both the European Union and the European Community (EC).

2

A second EFTA country, Liechtenstein, is currently not participating in the EEA. Although its participation was approved in a referendum, changes to the customs union with Switzerland, also subject to a referendum, will be required before participation can begin.

3

The agreement with former Czechoslovakia was subsequently replaced by separate agreements with the Czech and Slovak Republics. The EU is negotiating a Europe Agreement with Slovenia and is expected to follow up on the free-trade agreements currently being negotiated with the Baltic countries with an offer of association. The EU has also negotiated or is currently negotiating liberalizing trade agreements with other economies in eastern Europe and the former Soviet Union, although these agreements do not provide for the same degree of market access as the Europe Agreements.

4

Hungary and Poland have already formally applied for EU membership.

5

For the interim agreements that took effect in 1993, the corresponding dates are generally one year later.

6

In addition, as recognized early in the literature on customs unions, regional integration may boost welfare by reducing distortions facing consumers, even with net trade diversion. See, for example, Richard Lipsey, “The Theory of Customs Unions: A General Survey,” Economic Journal (1960).

7

Richard Baldwin has emphasized these dynamic effects in “The Growth Effects of 1992,” Economic Policy, Vol. 4 (October 1989), pp. 248—81; and “Measurable Dynamic Gains from Trade,” Journal of Political Economy, Vol. 100 (February 1992), pp. 162–74.

8

See, for example, Bela Balassa, “Trade Creation and Diversion in the European Common Market,” in European Economic Integration, edited by Bela Balassa (Amsterdam and New York: North-Holland. 1975); and Alexis Jacquemin and Andre Sapir, “European Integration or World Integration?” Weltwirtschaftliches Archiv, Vol. 124 (No. 1, 1988), pp. 127–39. Much of the trade diversion that occurred can be attributed to the Common Agricultural Policy (CAP).

9

This is supported by David T. Coe and Reza Moghadam, “Capital and Trade as Engines of Growth in France: An Application of Johansen’s Cointegration Methodology,” Staff Papers (IMF), Vol. 40 (September 1993), pp. 542–66; and David T. Coe and Thomas Krueger, “Why Is Unemployment So High at Full Capacity? The Persistence of Unemployment, the Natural Rate, and Potential Output in the Federal Republic of Germany.” IMF Working Paper 90/101 (October 1990). These studies estimated that European integration made an important contribution to economic growth in France and Germany, respectively, in the 1970s and 1980s. In particular, they found that the growth of regional trade relative to output was an important determinant of the productivity of labor and capital.

10

See Commission of the European Communities, “The Economics of 1992: An Assessment of the Potential Economic Effects of Completing the Internal Market of the European Community,” European Economy, No. 35 (March 1988), pp. 1–222, for the estimates of the Commission staff. A review of the literature can be found in L. Alan Winters, “European Trade and Welfare After ‘1992,’ “CEPR Discussion Paper 678 (London: Centre for Economic Policy Research, June 1992).

11

Richard Baldwin, in a less formal quantification, suggested that the internal market program could add from ¼ to 1 percentage point to the annual growth rate in the EU over the longer run. See Baldwin, “Growth Effects of 1992.”

12

See Jan Haaland, “Welfare Effects of ‘1992’: A General Equilibrium Assessment for EC and EFTA Countries,” CEPR Discussion Paper 828 (London: Centre for Economic Policy Research, July 1993). Haaland estimated the corresponding gain for the EU countries at 2 percent, most of which was accounted for by integration within the EU itself. The larger relative gains for the EFTA countries reflect the greater scope for economies of scale and increased competition in their smaller economies.

13

In the EEA, EFTA countries have no formal say in shaping EU policies, although there is provision for informal consultation. The EFTA countries may reject the extension to the EEA of relevant new EU legislation, but such rejection would entail suspension of the EEA in the area of this legislation.

14

Voting arrangements in the EU will be reviewed by an intergovernmental conference in 1996. Countries with larger populations feel that they are underrepresented in EU institutions. Purely on the basis of population, the acceding countries would have only half their prospective voting power, but they, along with other smaller countries, will be able to yield significant influence in any rearrangement of voting weights.

15

Moreover, in the short term, the gross transfer to the EU is reduced by transitional arrangements and the absorption by the EU as a whole of the new members’ contributions to the regional fund set up under the EEA.

16

The EFTA competition authority has only recently been established.

17

In 1992, producer subsidy equivalents, as measured by the OECD, ranged from 49 to 77 percent for the acceding countries, compared with an EU average of 47 percent. On balance, agricultural output in the EFTA countries currently exceeds domestic demand.

18

Ongoing agricultural reforms in Europe entail a shift from production supports to direct income supports.

19

See Zhen Kun Wang and L. Alan Winters, “The Trading Potential of Eastern Europe,” CEPR Discussion Paper 610 (London: Centre for Economic Policy Research, November 1991). These authors have suggested that if the associate countries were fully integrated in the world economy, their exports to the EU in 1985 would have been many times higher than the actual levels—five times higher for Hungary and Poland, and ten times higher for Czechoslovakia—even at the income levels prevailing in 1985. See also L. Alan Winters, “The Europe Agreements: With a Little Help from Our Friends,” in CEPR, The Association Process: Making It Work—Central Europe and the European Community, CEPR Occasional Paper 11 (London, November 1992); and Richard Baldwin, Towards an Integrated Europe (London: CEPR, 1994).

20

In 1992, clothing, textiles, and steel exports ranged from one-fourth of manufactured exports to the EU for Czechoslovakia to almost one-half for Romania. Agricultural goods accounted, on average, for 14 percent of total exports of the transition economies to the EU.

21

The so called Visegrad countries—the Czech Republic, the Slovak Republic, Hungary, and Poland—are liberalizing trade among themselves at the same pace as they are liberalizing imports from the EU under the Europe Agreements, with the process to be completed by 2003. As noted above, this is somewhat slower than the pace of liberalization for EU imports from these countries.

22

See Chapter III of the May 1994 World Economic Outlook for a discussion of policy priorities in European labor markets.

23

Turkey is scheduled to form a long-planned customs union with the EU in 1995, covering all nonagricultural goods.

Annex II Medium-Term Scenarios for Industrial Countries

The medium-term scenarios for industrial countries presented in Chapter III are based on simulations using MULTIMOD, the IMF staff’s international macroeconomic simulation model.1 Two scenarios are presented in Chapter III: the first illustrating the downside risks of higher structural unemployment in most countries and of delayed monetary policy reaction to the absorption of cyclical slack, and the second assuming greater fiscal consolidation and the implementation of tax and structural policies to reduce structural unemployment. Each of these scenarios is composed of two separate simulations, and this annex discusses all four individual simulations, describing the technical background, assumptions, and simulation results of the two scenarios presented in Chapter III. In the tables, the results of the two scenarios are presented as deviations from the World Economic Outlook baseline projections, rather than as alternative projection paths as in the main text.

The “pessimistic” scenario is a combination of hysteresis in labor markets in Europe and Canada and a monetary policy that responds too slowly to the disappearance of slack during the recovery.2 In all countries except the United States and Japan, it is assumed that the natural rate of unemployment gradually rises by 2 percentage points relative to the baseline, which might represent an underassessment of the current level of the natural rate. It is implemented in MULTIMOD as an exogenous increase in the reservation wage, which puts upward pressure on wages and prices.3 The increase in real and nominal wages tends to lower real output, and the increase in the price level lowers the real money stock, raises interest rates, and leads to a small appreciation of the exchange rate. The result is a permanent decline in investment, consumption, and real exports. The spillover effects to the rest of the world are mixed. The increase in prices in all countries except the United States and Japan raises import demand, but this effect tends to be offset by the decline in domestic demand and higher interest rates. The United States and Japan experience small declines in consumption and investment, resulting from the global increase in real interest rates, but their current account balances are essentially unchanged.

In the monetary simulation, it is assumed that, contrary to the baseline, the monetary authorities in all industrial countries fail to adjust monetary conditions as economic activity recovers and slack is absorbed. As a result, inflationary pressures reignite. In MULTIMOD, this change in policy assumption is implemented by a monetary expansion of 2 percent a year relative to the baseline. For the United States, this begins in 1995, whereas for other industrial countries, where there are still substantial margins of slack, it occurs two years later, in 1997.

The properties of MULTIMOD allow for “rational” expectations—economic agents are assumed to foresee, among other things, the inflationary impact of an increase in money growth. As a result, they also anticipate that nominal interest rates will rise in the future to incorporate the inflation premium and react by increasing interest rates now. Thus, given the forward-looking nature of expectations, a more expansionary monetary policy would normally tend to raise nominal short-term interest rates on impact. For purposes of this simulation, however, the monetary expansion in the first year is modeled as a onetime increase in the money stock, relative to the baseline, which does not have future inflationary consequences (beyond a onetime increase in the price level relative to the baseline). As a result, nominal short- and long-term interest rates fall relative to the baseline. In the second year of expansion it is assumed that agents realize that the growth rate of the money stock has increased, and the corresponding expectation of higher inflation is therefore built into nominal interest rates. This raises the long-term nominal interest rate above baseline and returns the short-term rate approximately to its baseline value. However, since wages are assumed to be partly sticky, real interest rates are lower than the baseline, resulting in higher output and inflation. The difference in timing of the monetary shock between the United States and the other industrial countries is critical to the evolution of exchange rates: the dollar initially depreciates and then appreciates relative to the baseline assumption.

Eventually, concern about the sizable increase in the rate of inflation leads the monetary authorities to respond by shifting monetary policy to a disinflationary stance. After two years of monetary expansion relative to the baseline—that is, in 1997 for the United States and in 1999 for other countries—the rate of increase of the money stock is assumed to return to baseline, although the cumulated rise in the level of money balances from the previous two years’ expansion is not reversed. The first year’s decline in money growth is again assumed to be perceived as a onetime decline in the money stock relative to the inflationary trend. That is, the monetary authorities are assumed to lack credibility in the first year of the disinflation program. The decrease in liquidity growth raises short-term rates, reduces output below potential, and begins to slow the rate of inflation. By the second year of the policy correction—in 1998 for the United States and in 2000 for other countries—it is assumed that agents expect (correctly) that the rate of money growth has returned to the baseline and that inflation expectations have also been adjusted down. Because of price stickiness, the contraction drives output below baseline, where it remains for some years.

The combination of these two simulations, corresponding to the pessimistic alternative in Chapter III, is shown in Table 23.

Table 23.

“Pessimistic” Scenario

(Percentage deviation from baseline unless otherwise noted)

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In percentage points.

The “optimistic” scenario in Chapter III, in which the cyclical expansion is used to implement greater fiscal consolidation and structural reform than in the baseline, also comprises two simulations. The first simulation involves policies that reduce the structural unemployment rate. For all industrial countries except Japan, a decline of 2 percent of GDP in labor income taxes is assumed to be phased in gradually over two years and financed by an equivalent increase in the tax on consumer goods, leaving overall revenue roughly unchanged in an ex ante sense.4 This policy was not simulated for Japan, which recently implemented a fiscal restructuring of this type and magnitude, and which has a very low structural unemployment rate.

The reduction in labor taxes narrows the wedge between actual and take-home pay, reduces the reservation wage of workers, and lowers the natural rate of unemployment. By contrast, the increase in the consumption tax does not affect the natural rate because it reduces labor and nonlabor disposable income to the same extent. The net result of this restructuring of the tax system is a decline in the natural rate of unemployment of 1 percentage point on average.5 Although the higher consumption tax raises consumer prices on impact, this is offset by a compensating increase in money supply—the monetary authorities are assumed to accommodate the onetime impact of the consumption tax on the price level, but not any second-round inflationary effects. In addition to the fiscal restructuring, it is assumed that various structural policies are implemented in all countries, except the United States and Japan, that gradually lower the natural rate of unemployment by another 1 percentage point. It should be noted that this simulation was carried out under the constraint of a neutral long-run fiscal policy, defined as an unchanged ratio of public debt to GDP. Thus, in this simulation the government is assumed to react to the initial higher tax revenues due to the positive output effects by lowering tax burdens over the medium term.

The two tax changes leave real disposable income roughly unchanged, and, in view of the monetary accommodation, the price increase resulting from the VAT has only a modest effect on interest rates. However, the resulting decline in the natural rate of unemployment raises output, lowers interest rates, and provides for an increase in both consumption and investment. The additional, exogenous decline in the natural rate of unemployment amplifies these effects in most countries. The effect on prices is mixed: the increase in the VAT and monetary accommodation tend to raise prices, but the decline in the natural rate lowers wages and prices. The differences in output effects across the European countries over the medium term reflect different speeds of adjustment in the labor market as well as different long-run effects on the natural rate from changes in labor taxes.

The second simulation of the “optimistic” scenario assumes fiscal consolidation efforts are put in place to permanently reduce the outstanding stock of public debt relative to the baseline. This is implemented through a permanent ex ante decline in government expenditures in all the industrial countries of 2 percent of GDP, phased in gradually over three years. As a result, the debt-to-GDP ratio is down by 10 percent by 2000, and by 20 percent by 2005. The output costs of this enhanced debt reduction are minimal; output growth increases after the first year, and in all countries the level of output is above the baseline level by 1998. Indeed, the level of output is permanently higher because investment spending is “crowded in” by lower interest rates. An important feature of this simulation is the assumption that debt reduction is credible. That is, households and firms expect (correctly) that public debt levels will fall in the future, and as a result real interest rates are pushed down immediately. An alternative simulation, which is not shown here, assumed that the future fiscal cuts would not be immediately credible, which would result in noticeably higher short-run costs, although the long-run crowding-in benefits would be similar.

The combined effects of the fiscal restructuring, the decline in the natural rate of unemployment owing to structural reform, and fiscal consolidation—which corresponds to the second scenario in Chapter III—are shown in Table 24.

Table 24.

“Optimistic” Scenario

(Percentage deviation from baseline unless otherwise noted)

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In percentage points.

Notes

This annex was prepared by Steven Symansky.

1

See Paul Masson, Steven Symansky, and Guy Meredith, “MULTIMOD Mark II: A Revised and Extended Model,” IMF Occasional Paper 71 (July 1990), for a description of the basic model; and Leonardo Bartolini, Assaf Razin, and Steven Symansky, “Fiscal Restructuring in the G-7” (IMF working paper, forthcoming) for recent enhancements, including an explicit treatment of taxation and the labor market. The fiscal and monetary properties of the enhanced model are similar to those of the earlier version of the model.

2

As used here, hysteresis refers to the tendency for cyclical increases in unemployment to be transformed into increases in structural unemployment.

3

The increase in the natural rate could also have been assumed to occur through an exogenous decline in labor demand. Although the output and inflation effects would be similar, the composition of demand would be different because real wages would fall rather than increase.

4

In MULTIMOD, the consumption tax is not a true value-added tax (VAT) because it is assumed to be applied only to consumption goods and follows the destination taxation principle.

5

The theoretical and empirical relationship between labor taxes and the natural rate of unemployment, which is very important to the simulated results in this scenario, is discussed in detail in Bartolini, Razin, and Symansky, “Fiscal Restructuring in the G-7.”

Statistical Appendix

Assumptions

The statistical tables in this appendix have been compiled on the basis of information available on September 12, 1994. The estimates and projections for 1994 and 1995, as well as those for the 1996–99 medium-term scenario, are based on a number of assumptions and working hypotheses.

  • For the industrial countries, real effective exchange rates are assumed to remain constant at their average level during August 1–23, 1994, except for the bilateral exchange rates among the ERM currencies, which are assumed to remain constant in nominal terms. For 1994 and 1995, these assumptions imply average U.S. dollar/SDR conversion rates of 1.428 and 1.456, respectively.

  • “Established” policies of national authorities will be maintained.

  • The price of oil will average $15.16 a barrel in 1994 and $15.15 a barrel in 1995. In the medium term, the oil price is assumed to remain unchanged in real terms.

  • Interest rates, as represented by the London interbank offered rate (LIBOR) on six-month U.S. dollar deposits, will average 5 percent in 1994 and 6 percent in 1995; the three-month certificate of deposit rate in Japan will average 1.9 percent in 1994 and 2.7 percent in 1995; and the three-month interbank deposit rate in Germany will average 5.2 percent in 1994 and 4.8 percent in 1995.

Data and Conventions

Data and projections for more than 180 countries form the statistical basis for the World Economic Outlook (the World Economic Outlook data base). The data are maintained jointly by the IMF’s Research Department and the area departments, with the latter regularly preparing country projections based on consistent global assumptions, such as those summarized above.

Although national statistical agencies are the ultimate providers of historical data and definitions, international organizations are also involved in statistical issues, with the aim of harmonizing differences among national statistical systems, of setting international standards with respect to definitions, and of providing conceptual frameworks for measurement and presentation of economic statistics. As regards the World Economic Outlook data base, updates and revisions by both national source agencies and international organizations are used.

Over the past several years, two developments of major importance for improving the standards of economic statistics and analysis have been the comprehensive work to revise the United Nations’ standardized System of National Accounts (SNA) and the IMF’s Balance of Payments Manual. Work on both projects was completed in late 1993, and the System of National Accounts 1993 as well as the fifth edition of the Balance of Payments Manual have been issued.1 The IMF was actively involved in both projects, particularly the new Balance of Payments Manual, which is central to the IMF’s interest in countries’ external positions. Key changes introduced with the new Manual were summarized in the May 1994 World Economic Outlook (Box 13).

Composite data for country groups in the World Economic Outlook are either sums or weighted averages of data for individual countries. Arithmetic weighted averages are used for all data except inflation and money growth for nonindustrial country groups, for which geometric averages are used. The following conventions apply.

  • Country group composites for interest rates, exchange rates, and the growth of monetary aggregates are weighted by GDP converted to U.S. dollars at market exchange rates (averaged over the preceding three years) as a share of world or group GDP.

  • Composites for other data relating to the domestic economy, whether growth rates or ratios, are weighted by GDP valued at purchasing power parities (PPPs) as a share of total world or group GDP.2

  • Composite unemployment rates and employment growth are weighted by labor force as a share of group labor force.

  • For data relating to the external economy (balance of payments and debt), composites are sums of individual country data after conversion to U.S. dollars at the average (for debt, end of period) exchange rates in the years indicated. Composites of foreign trade unit values, however, are arithmetic averages of percentage changes for individual countries weighted by the U.S. dollar value of exports or imports as a share of total world or group exports or imports (in the preceding year). Group composites of trade volumes are derived as sums of trade values (on a balance of payments basis) deflated by corresponding unit-value group composites.

For central and eastern European countries in existence before 1991, external transactions in nonconvertible currencies (through 1990) are converted to U.S. dollars at the implicit U.S. dollar/ruble conversion rates obtained from each country’s national currency exchange rate for the U.S. dollar and for the ruble. Trade among the Baltic states, Russia, and other countries of the former Soviet Union is not yet included in the data for these countries’ external transactions because of insufficient information.

Unless otherwise indicated, multiyear averages of growth rates are expressed as compound annual rates of change.

Classification of Countries

Summary of the Country Classification

The country classification in the World Economic Outlook divides the world into three major groups: industrial countries, developing countries, and countries in transition.3 Rather than being based on strict criteria, economic or otherwise, this classification has evolved over time and is intended only to facilitate the analysis and provide a reasonably meaningful organization of data. Each of the three main country groups is further divided into a number of subgroups. Tables A and B provide an overview by these standard groups in the World Economic Outlook, showing the number of countries in each group and the average 1990 shares of groups in aggregate PPP-valued GDP, total exports of goods and services, and total debt outstanding.

The general features and the compositions of groups in the World Economic Outlook classification are as follows.4

The group of industrial countries (23 countries) comprises

  • Australia

  • Austria

  • Belgium

  • Canada

  • Denmark

  • Finland

  • France

  • Germany

  • Greece

  • Iceland

  • Ireland

  • Italy

  • Japan

  • Luxembourg

  • Netherlands

  • New Zealand

  • Norway

  • Portugal

  • Spain

  • Sweden

  • Switzerland

  • United Kingdom

  • United States

The seven largest countries in this group in terms of GDP—the United States, Japan, Germany, France, Italy, the United Kingdom, and Canada—are collectively referred to as the major industrial countries.

The members of the European Union (12 countries) are also distinguished as a subgroup.5 They are

  • Belgium

  • Denmark

  • France

  • Germany

  • Ireland

  • Italy

  • Luxembourg

  • Netherlands

  • Portugal

  • Spain

  • United Kingdom

In 1991 and subsequent years, data for Germany refer to west Germany and the new eastern Lander (that is, the former German Democratic Republic). Before 1991, economic data are not available on a unified basis or in a consistent manner. In general, data on national accounts and domestic economic and financial activity through 1990 cover west Germany only, whereas data for the central government, foreign trade, and balance of payments apply to west Germany through June 1990 and to unified Germany thereafter.

The group of developing countries (130 countries) includes all countries that are not classified as industrial countries or as countries in transition, together with a few dependent territories for which adequate statistics are available.

The regional breakdowns of developing countries in the World Economic Outlook conform to the IMF’s International Financial Statistics (IFS) classification, with one important exception. Because all of the developing countries in Europe except Cyprus, Malta, and Turkey are included in the group of countries in transition, the World Economic Outlook classification places these three countries in a combined Middle East and Europe region. It should also be noted that Egypt and the Libyan Arab Jamahiriya are included in this region, not in Africa. Two additional regional groupings are included in the World Economic Outlook because of their analytical significance. These are sub-Saharan Africa6 and four newly industrializing Asian economies.7

Table A.

Industrial Countries: Classification by Standard World Economic-Outlook Groups, and Their Shares in Aggregate GDP and Exports of Goods and Services, 19901

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The GDP shares are based on the purchasing power parity (PPP) valuation of country GDPs.

The developing countries are also grouped according to analytical criteria: predominant export, financial criteria, and other groups. The export criteria are based on countries’ export composition in 1984–86, whereas the financial criteria reflect net creditor and debtor positions as of 1987, sources of borrowing as of end-1989, and experience with debt servicing during 1986–90.

The first analytical criterion, by predominant export, distinguishes among five groups: fuel (Standard International Trade Classification—SITC 3); manufactures (SITC 5 to 8, less diamonds and gemstones); nonfuel primary products (SITC 0, 1, 2, 4, and diamonds and gemstones); services and private transfers; and diversified export base. A further distinction is made among the exporters of nonfuel primary products on the basis of whether countries’ exports of primary commodities consist primarily of agricultural commodities (SITC 0, 1, 2 except 27, 28, and 4) or minerals (SITC 27 and 28, and diamonds and gemstones).

The financial criteria first distinguish between net creditor and net debtor countries. Countries in the latter, much larger group are then differentiated on the basis of two additional financial criteria: by predominant type of creditor and by experience with debt servicing.

The country groups shown under other groups constitute the small low-income economies, the least developed countries, and 15 heavily indebted countries.

The group of countries in transition (28 countries) comprises central and eastern European countries, Russia, non-European states of the former Soviet Union, and Mongolia. A common characteristic of these countries is the transitional state of their economies from a centrally administered system to one based on market principles. The group of countries in transition comprises

  • Albania

  • Armenia

  • Azerbaijan

  • Belarus

  • Bosnia and Herzegovina

  • Bulgaria

  • Croatia

  • Czech Republic

  • Estonia

  • Georgia

  • Hungary

  • Kazakhstan

  • Kyrgyz Republic

  • Latvia

  • Lithuania

  • Macedonia. Former Yugoslav Rep. of

  • Moldova

  • Mongolia

  • Poland

  • Romania

  • Russia

  • Slovak Republic

  • Slovenia

  • Tajikistan

  • Turkmenistan

  • Ukraine

  • Uzbekistan

  • Yugoslavia, Fed. Rep. of (Serbia/Montenegro)

Table B.

Developing Countries and Countries in Transition: Classification by Standard World Economic Outlook Groups and Their Shares in Aggregate GDP, Exports of Goods and Services, and Total Debt Outstanding, 19901

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The GDP shares are based on the purchasing power parity (PPP) valuation of country GDPs.

Including Mongolia.