The past decade proved to be a period of considerable stress for non-oil developing countries. Throughout most of the 1970s, a combination of events caused the international economic environment to become less conducive to stable growth for this group of countries and made the problem of economic management in general—and of balance of payments adjustment in particular—much more difficult. The substantial fluctuations in the world market prices of primary commodities, the sharp increases in the price of energy products, the slowdown of economic activity in the industrial countries, and the rise in real interest rates toward the end of the period were all major contributors to a serious deterioration in the current account positions of most non-oil developing countries. At the same time, domestic developments in a number of economies also played a significant role in exacerbating payments disequilibrium. In many non-oil developing countries, inflationary demand-management policies—combined with rigid exchange rate policies and restrictions on trade and payments—resulted in domestic demand pressures and cumulative losses in international competitiveness that also gave rise to current account and overall balance of payments difficulties.
While the broad outlines of these developments have been discussed at length in the literature, the assessment of the contributions of the afore-mentioned factors to the payments problems of developing countries has often relied on casual observation, rather than on a systematic evaluation of trends in a broad-based sample of non-oil developing countries. A number of studies, including Reichmann (1978), Dell (1980), Dell and Lawrence (1980), Killick (1981), and Khan and Knight (1982), have drawn conclusions from the “stylized facts” of developing countries’ experience during the past decade but have not subjected the available data to standard empirical tests. The purpose of this paper is to go beyond these previous studies and to examine empirically the influences of external and domestic factors on the evolution of the current accounts of non-oil developing countries during the 1970s. For this purpose, a simple model is specified that relates the current account to its main determinants and the relationship is estimated for a broad group of 32 non-oil developing countries. The results of this exercise are then used to draw inferences about the relative contributions of various factors to the behavior of the current accounts of the countries in this group during the period 1973–81—a matter over which there is still considerable controversy. 1 It is argued here that this continuing controversy on the role of external and internal factors stems to a large extent from the lack of formal statistical testing of the basic relationships involved.
At the outset, it is necessary to point out certain areas that the paper does not cover, even though they are closely related to the subject at hand. First, there is no explicit consideration of the important question of how the burden of external adjustment should be shared among surplus and deficit countries, or between the non-oil developing countries as a group and the industrial world. These are essentially normative issues about how the international monetary system should ensure some degree of symmetry between various countries in undertaking balance of payments adjustment. As such, they extend beyond the scope of the empirical analysis undertaken here. Second, the issue of the appropriate trade-off between adjustment and financing in the context of transitory versus permanent shocks to the balance of payments is covered only in passing. A number of recent papers (Nowzad (1981), Guitián (1981), and Polak (1982)) have dealt extensively with this particular topic.
The outline of the rest of the paper is as follows. Section I briefly describes recent current account developments in the non-oil developing countries and discusses the behavior of the various factors considered responsible for these developments. Section II assesses the quantitative role of the main factors on the basis of empirical tests undertaken with a pooled cross-section time-series sample of the 32 non-oil developing countries for which the necessary data are available. Section III briefly summarizes the results and indicates their relevance for balance of payments adjustment policies in developing countries.
Aghevli, Bijan B., “Experiences of Asian Countries with Various Exchange Rate Policies,” in Exchange Rate Rules: The Theory, Performance and Prospects of the Crawling Peg, ed. by John Williamson (New York, 1981), pp. 2983–318.
Artus, Jacques R., “Prospects for the External Position of Non-Oil Developing Countries,” Chap. XV in International Lending in a Fragile World Economy, ed. by Donald E. Fair and Raymond Bertrand (The Hague, 1983), pp. 264–80.
Dell, Sidney, “The International Environment for Adjustment in Developing Countries,” World Development, Vol. 8 (November 1980), pp. 833–42.
Frenkel, Jacob A., and Michael L. Mussa, “Monetary and Fiscal Policies in an Open Economy,” American Economic Review, Papers and Proceedings, Vol. 71 (May 1981), pp. 253–58.
Goldstein, Morris, and Mohsin S. Khan (1982 a), Effects of Slowdown in Industrial Countries on Growth in Non-Oil Developing Countries, IMF Occasional Paper No. 12 (Washington, August 1982).
Goldstein, Morris, and Mohsin S. Khan (1982 b), “Income and Price Effects in Foreign Trade” (unpublished, International Monetary Fund, September 20, 1982).
Kelly, Margaret R., “Fiscal Adjustment and Fund-Supported Programs, 1971–80,” Staff Papers, Vol. 29 (December 1982), pp. 561–602.
Khan, Mohsin S., and Malcolm D. Knight, “Some Theoretical and Empirical Issues Relating to Economic Stabilization in Developing Countries,” World Development, Vol. 10, Special Issue (September 1982), pp. 709–30.
Killick, Tony, “Extent, Causes and Consequences of Disequilibria in Developing Countries,” Overseas Development Institute Working Paper, No. 1 (March 1981).
Nowzad, Bahram, The IMF and Its Critics, Essays in International Finance, No. 146, International Finance Section, Princeton University (December 1981).
Polak, Jacques J., “Review of The Balance of Payments Adjustment Process in Developing Countries, by Sidney Dell and Roger Lawrence,” Journal of Money, Credit and Banking, Vol. 14 (November 1982), pp. 557–60.
Reichmann, Thomas M., “The Fund’s Conditional Assistance and the Problems of Adjustment, 1973–75,” Finance & Development, Vol. 15 (December 1978), pp. 38–41.
Mr. Khan, Advisor in the Research Department, is a graduate of Columbia University and the London School of Economics and Political Science.
Mr. Knight, Chief of the External Adjustment Division of the Research Department, is a graduate of the University of Toronto and of the London School of Economics and Political Science, where he also served as a member of the Economics Department from 1972 to 1975.
For example, Dell (1980) argues that most of the deterioration in the current account balances of developing countries during the period 1973–76 can be attributed to external factors, and principally to adverse changes in the terms of trade. This has been disputed by, among others, Killick (1981) and Khan and Knight (1982).
The analysis abstracts, therefore, from the effects of domestic supply shocks, for example, droughts and other weather-related phenomena and rising protectionism in the export markets of developing countries that were also important elements in the experiences of a number of non-oil developing countries.
The terms of trade are defined in the customary manner as the ratio of the price of exports to the price of imports, expressed in U.S. dollars.
T-values are shown in parentheses below the coefficients. R2 is the adjusted coefficient of determination, and D-W is the Durbin-Watson test statistic.
This type of analysis is the mainstay of the so-called fiscal approach to the balance of payments. See Kelly (1982) for a brief summary of this approach.
For purposes of this exercise, the real exchange rate is defined as the home country’s consumer price index relative to an import-weighted average of consumer price indices in partner countries, adjusted for the nominal exchange rate.
For example, a worsening of the terms of trade owing to an increase in import prices would raise the domestic price level. If domestic policies, including exchange rate policy, were not changed, the real effective exchange rate, as defined here, would tend to appreciate.
These 32 countries are Bolivia, Brazil, Burma, Colombia, Cyprus, Dominican Republic, Ecuador, Ethiopia, Fiji, Greece, Guyana, Honduras, Israel, Jamaica, Jordan, Kenya, Korea, Malawi, Malaysia, Malta, Mauritius, Pakistan, Panama, Paraguay, Philippines, Rwanda, South Africa, Sri Lanka, Suriname, Thailand, Turkey, and Yugoslavia. Since the requisite published data are not available for all these countries for 1981, the period of coverage was reduced to 1973–80.
The export variable (X) is used only to scale the current account balance to make it comparable across countries. To avoid problems associated with exchange rate conversions, it was considered preferable not to use domestic income to scale the dependent variable.
Presumably, this would also include the effects of rising protectionism over the sample period.
In all cases, the trend variable was included.
This yielded 256 observations for each of the variables. Basic data are obtained from International Monetary Fund, International Financial Statistics (various issues). For each country, the variables CA and X are in current U.S. dollars; TOT is the ratio of the unit value of exports to the unit value of imports, both expressed in terms of U.S. dollars; RRI is the three-month Eurodollar deposit rate adjusted for changes in the individual country’s U.S. dollar export price index; RER is calculated using 1977 import weights and the relevant consumer price indices; and FP/Y is the ratio of government revenues minus expenditures to nominal GDP.
Ideally, one would wish to scale the foreign real interest rate faced by each non-oil developing country by its outstanding stock of foreign debt, to reflect changes in interest payments more accurately. This was not possible, owing to the absence of data on total stocks of foreign debt for the individual countries in the sample. In effect, the simple specification assumes implicitly that the stock of foreign debt has grown smoothly over the period, so that most of the year-to-year variations in interest payments have occurred because of changes in the interest rate on this debt.
As the variable FP/Y is defined as the ratio of the difference between government revenues and expenditures to GDP, an increase in FPIY implies an improvement in the fiscal position, and vice versa.
In this equation, however, the coefficient for industrial-country growth is significantly different from zero at the 10 percent level.
As was mentioned earlier, rising protectionism in the export markets of these countries could be one possible candidate, among others.
Since the statistical distribution of Beta coefficients is unknown, one cannot perform formal tests of significance in assessing the relative importance of the external and domestic factors.
By the same token, it would require a depreciation of 2.4 percent to offset a fall of 1 percentage point in the growth rate in industrial countries, and a depreciation of 0.6 percent to counter an increase of 1 percentage point in the foreign real interest rate.
In this context, one must be careful to make a distinction between using nominal exchange rate adjustment to restore the equilibrium real exchange rate when it has moved out of line as against trying to change the equilibrium rate.