Chapter

Chapter 1: Developments in the World Economy

Author(s):
International Monetary Fund
Published Date:
September 1979
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Introduction

The performance of the world economy during 1978 and the first half of 1979 was characterized by a mixture of gains and disappointments. On the one hand, the evolution of domestic demand in several of the largest industrial countries proceeded broadly along the lines of a strategy of policy that had been agreed in various international forums, and this development was beneficial to the distribution of external current account balances among individual countries within the industrial group. The sizable changes in exchange rates for major currencies that occurred during 1978 also made for a better pattern of international payments relationships among the principal industrial countries, and a substantial improvement in the pattern of their current account balances did, indeed, emerge in the first half of 1979. Further, the more orderly conditions prevailing in foreign exchange markets during the current year to date attest to the calming impact of the internationally coordinated measures taken, in combination with adjustments of domestic policy, in the latter part of 1978.

On the other hand, with respect to several of the most fundamental economic problems, little visible progress has been made in the period since the 1978 Annual Report. Both inflation and unemployment remain much too high in most member countries, and the efforts of national authorities to deal with these persistent problems have proved less effective than might have been hoped. Indeed, a rather general renewal of upward momentum in rates of inflation was apparent during the first half of 1979, and the oil price increases introduced at midyear will bring further upward pressures on prices. Many structural problems affecting the supply capabilities of member countries have not yet been adequately treated, and it has become progressively clearer that such problems must be addressed through measures other than general demand management policies.

Another disturbing development emerging during the current year is a sharp resurgence of the combined current account deficit of the non-oil developing countries. At a time when they cannot expect buoyant growth of demand in the industrial world to facilitate expansion of their export earnings, and when costs of imports are rising rapidly, many of the non-oil developing countries—and particularly the poorer ones—may face difficulty in attaining desirable growth rates because of insufficient financing for the volume of imports of goods and services that such growth rates would imply.

The continued prevalence of high unemployment in most industrial countries has reflected growth rates since 1976 that (with the conspicuous exception of the United States) have been insufficient to absorb any significant degree of slack in the labor force, even with productivity growing at a markedly slower rate than in the 1960s. In a number of countries, a combination of unsatisfactory growth rates (even with the slower growth of potential output), rising labor costs, and high inflation have impeded the restoration of satisfactory levels of profitability and cash flow of business firms and depressed incentives for additions to the capital stock. Although the pattern of economic growth within the industrial world has shifted during recent years, featuring a progressive deceleration in the United States after 1976 and some acceleration in Europe and Japan during 1978, the average rate of output expansion for all industrial countries remained more or less unchanged at 4 per cent in 1977 and 1978. However, this rate dropped to less than 3 per cent in the first half of 1979. By midyear, signs of a likely recession in the United States had multiplied as real gross national product (GNP) rose only slightly in the first quarter and declined appreciably in the second.

During most of 1978, domestic imbalances continued to generate imbalances in world trade and payments relationships, culminating in a major currency crisis in October. Actions undertaken by authorities of several large industrial countries, and particularly by those of the United States at the beginning of November, were successful in arresting the precipitate movements of exchange rates and of private capital that characterized the later stages of the currency disorder. Restoration of more orderly conditions in exchange markets was followed, after the turn of the year, by reversal of many of the earlier movements of short-term capital, as well as (in part) some of the principal changes in exchange rates that had occurred during the first ten months of 1978.

With respect to the broad global pattern of current account balances, several years of progressive reduction in the disequilibrium between oil importing and oil exporting countries came to an end in the first half of 1979. Largely through increased imports of goods and services by the major oil exporters, the current account surplus of that group had been cut back from $68 billion in 1974 to about $6 billion in 1978. However, the previous trend toward reduction of the oil exporters’ surplus was sharply reversed by the succession of oil price increases during the first six months of 1979 that culminated in the decision taken by members of the Organization of Petroleum Exporting Countries (OPEC) toward the end of June, by which further large price increases were put into effect under a complex system in which official export prices for most crude oils exported by OPEC members range from $18 a barrel to $23.50 a barrel (compared with a weighted average of less than $13 a barrel in 1978). These price changes occurred against a background of rising demand for oil and the impact of the Iranian situation on the supply of oil, which together pushed up spot market prices early in 1979; and they have been accompanied by similar changes in the pricing of oil exported from other countries.

Although the exact implications of the new OPEC prices depend on a number of still uncertain factors regarding the shares of various producing countries and types of oil in total exports, it is estimated that the average price charged by the major oil exporting countries under the arrangements announced at the conclusion of the June 1979 OPEC meeting will be about $20.50 a barrel. With such an average price (60 per cent above the 1978 level), the current account surplus of the major oil exporting countries will be raised to an estimated $43 billion in the calendar year 1979 and to more than $50 billion for a full year beginning in July 1979.

These estimates are predicated on the rough assumption that, in the year ahead, additional outlays for imports of goods and services might absorb between two fifths and one half of the incremental export earnings of the major oil exporting countries as a group. On the volume of oil that they exported in 1978, the price increase (over the 1978 average) would add some $75 billion to the aggregate value of their exports.

A corresponding addition to the aggregate import bill of countries other than the major oil exporters is, of course, in prospect. On a full-year basis, this would mean about $70 billion for developed countries and a net total of some $5 billion for developing countries that are not major exporters of oil. Within the latter group of “non-oil” developing countries, however, net oil importers may face an additional annual import cost of about $12 billion, while a small number of other countries that are net exporters (but not “major” exporters) of oil will gain some $7 billion in net export earnings. For many countries in the subgroup of net oil importers, the financing of such large incremental payments for imports may pose problems, in view of their existing external debt and the heavy borrowing in prospect even before the latest rise in oil prices.

Along with its marked effects on international payments positions, both of individual countries and of major groups, the 1979 oil price increase will have an adverse impact on rates of inflation and on the pace of economic activity in oil importing countries. On the assumption that prices for much, but not all, of the oil produced outside the major oil exporting countries and the Sino-Soviet countries will move upward in broad parallel with the price of OPEC oil,1 it can be calculated that the direct addition to the level of prices in the world economy outside the areas just mentioned will be on the order of 1½ per cent. Additional effects of an indirect character, although highly uncertain and dependent in great part on the policies adopted by the affected countries, could be quite substantial.

While the diversion of purchasing power into imports of OPEC oil will be gradually offset, at least in part, by the feedback of additional exports of goods and services to the major oil exporting countries, the deflationary effects of this diversion in the short run may also be substantial. For the whole group of industrial countries and non-oil primary producing countries, the direct deflationary impact is calculated at ⅔ to ¾ of 1 per cent of GNP before allowance for any “multiplier” effects or for any possible offsets to such effects induced by policy measures on the part of national authorities.

An issue commanding immediate attention concerns the question of how the policies of oil importing countries should respond to the 1979 increases in oil prices. Actually, this response has several aspects. First, and of fundamental importance, is the need to conserve energy and develop additional sources of supply. For both purposes, realistic pricing policies for energy are a prime requisite. Second, with wage earners trying to prevent or recoup losses in real earnings, governments face the difficult task of limiting the indirect effects of the oil price increase on the general level of prices. Third, the policy reaction to the deflationary impact is bound to vary widely among countries, but many with relatively high rates of inflation or weak external positions will doubtless find it advisable to accept—not to offset—it. Fourth, in many oil importing countries the authorities will have to contend with a deterioration in the current account position, with the policy reaction depending on individual circumstances.

This chapter reviews developments in the world economy during 1978 and 1979, separately for the several major groups of countries. Two broad subjects are first considered: domestic activity and policies, and international trade and payments. Then, against this background, a concluding section discusses a number of key issues of policy facing member countries—including the domestic and international implications of a probable U.S. recession—and touches on the role of the Fund itself in helping members to deal with their economic difficulties.

Domestic Activity and Policies

Industrial Countries

Output and prices.—Developments in the world economy during recent years have been governed in large part by the course of real economic activity and prices in the industrial countries, which account for three fourths of the estimated total output of Fund members.

It may be recalled that, following the severe international recession of 1974–75, economic recovery in the industrial countries proceeded at a slow and uneven pace under conditions of continuing high inflation. For most of these countries, the increases of real GNP in 1977 and 1978 (Table 1) did not exceed the estimated growth of potential GNP, and hence did not bring about any significant reduction in the prevailing high level of unemployment.

Table 1.Industrial Countries: Changes in Output and Prices, 1962–78(Percentage changes)
Annual

Average

1962–721
Change from Preceding Year
197319741975197619771978
Real GNP
Canada5.57.53.61.25.42.43.4
United States3.95.5−1.4−1.35.95.34.4
Japan10.310.0−0.51.46.55.45.6
France26.05.42.80.34.63.03.3
Germany, Fed. Rep.4.54.90.4−1.95.12.63.4
Italy4.66.94.2−3.55.92.02.6
United Kingdom22.96.5−1.6−1.53.31.73.3
Other countries34.64.73.7−1.73.81.62.1
All industrial countries4.66.10.2−0.95.44.04.0
Of which,
Seven larger countries44.66.2−0.1−0.85.64.24.2
European countries4.55.51.8−1.54.42.22.9
GNP deflator
Canada3.69.215.310.89.77.06.4
United States3.55.89.69.65.26.07.3
Japan4.910.920.18.65.65.64.8
France24.47.811.613.310.18.99.9
Germany, Fed. Rep.4.06.16.96.73.23.83.9
Italy5.011.918.317.418.018.913.3
United Kingdom25.27.015.127.414.613.510.1
Other countries35.27.99.611.07.66.96.0
All industrial countries4.17.311.911.07.17.17.0
Of which,
Seven larger countries44.07.312.111.07.17.17.1
European countries4.97.711.113.39.18.77.6
Sources: National statistical publications, IMF Data Fund, and Fund staff estimates.

Compound annual rates of change.

GDP (at market prices).

Includes Austria, Belgium, Denmark, the Netherlands, Norway, Sweden, and Switzerland.

As listed separately above.

Sources: National statistical publications, IMF Data Fund, and Fund staff estimates.

Compound annual rates of change.

GDP (at market prices).

Includes Austria, Belgium, Denmark, the Netherlands, Norway, Sweden, and Switzerland.

As listed separately above.

Despite this picture of sluggish overall growth rates in the industrial countries, some welcome changes occurred in the pattern of expansion of real domestic demand in 1978. (See Chart 1.) They represented a partial reversal of the movements in 1976 and 1977, when the combination of a relatively high rate of expansion in the United States and markedly lower rates among the other industrial countries, especially Japan and the Federal Republic of Germany, became an important source of imbalance in international payments (as discussed later). In 1978, the rate of growth of real domestic demand in the United States, after averaging about 6 per cent annually in 1976 and 1977, receded to 4½ per cent. On the other hand, the growth of real domestic demand in Japan—after averaging only about 4 per cent annually in 1976 and 1977—increased to 7 per cent in 1978. For the Federal Republic of Germany, the main point in this context is that domestic demand expansion accelerated from only 2¼ per cent in 1977 to nearly 4 per cent in 1978. Considerable acceleration of growth in domestic demand from 1977 to 1978 was also evident in most of the other industrial countries. For all of the major countries in that group except the United States, as shown in the upper left-hand panel of Chart 1, the acceleration averaged almost 2 percentage points.

Chart 1.Major Industrial Countries: Changes in Domestic Demand and Output, First Half 1976-First Half 1979

(Percentage changes from preceding half year; seasonally adjusted at annual rates)

1 Canada, Japan, France, the Federal Republic of Germany, Italy, and the United Kingdom.

The shift in the pattern of expansion of real domestic demand has continued into 1979. In the United States, the pace of domestic demand expansion dropped to an annual rate of less than 1 per cent in the first half of the year; a decline in the rate of U.S. economic expansion had been generally expected and was desired by the authorities in view of the high level of resource utilization and the worsening of domestic inflation. In many other industrial countries, the recovery of domestic demand has continued apace and was particularly marked in the latter part of 1978. For the first half of 1979, real domestic demand is estimated to have exceeded the levels of a year earlier by about 5 per cent in the Federal Republic of Germany and Italy, and by 9 per cent in Japan.

Particularly in the case of Japan, the increases in domestic demand that have been cited above differ markedly from the corresponding increases in GNP; the differences are due, of course, to the behavior of the foreign balance on goods and services in real terms. The change in this balance in Japan, after being sizably positive for several years, turned negative in 1978 and the first half of 1979 (by amounts cumulating to almost 3 per cent of GNP) as the real effects of exchange rate appreciation and other measures to adjust the external position became progressively larger. It is this withdrawal of stimulus through deterioration of the real foreign balance that reduced the growth of real GNP in 1978 and the first part of 1979 substantially below the corresponding increases in total domestic demand. Such negative shifts in foreign balances—which loom large in the domestic situations of the Federal Republic of Germany and Italy as well—find their main counterpart in the balance of the United States, where rapid expansion of exports during 1978 brought about a growth of total output that was higher than that of domestic demand by about ½ of 1 percentage point. (See Chart 1.)

The shift in growth rates among industrial countries, as already indicated, left the overall rate for these countries unchanged at 4 per cent in 1978; the slowdown in the United States was just offset by the pickup of recovery in the rest of the industrial world. Such a balancing of changes, however, has probably come to an end. The continuing deceleration in the growth rate of the United States, together with a leveling off in the pace of expansion in the other large industrial countries, resulted in overall growth of only about 2¾ per cent, at an annual rate, in the first half of 1979 for the whole group of industrial countries. This tendency toward increasing sluggishness should become somewhat more pronounced during the remainder of 1979 as the adverse effects on real demand that may be expected to emanate from the current surge in oil prices and from inflation more generally begin to be felt.

With respect to inflation, the rate of increase in the weighted average of GNP deflators in the industrial countries dropped from a peak annual rate of 13½ per cent in the second half of 1974 to 7 per cent in the first half of 1976 but remained at that rate in every semiannual period through 1978. This remarkable lack of change was a result of countervailing movements in the United States and in the rest of the industrial world. From 1976 to 1978, the rate of price increase went up from 5 per cent to 7½ per cent in the United States (Table 1) but declined from 8½ per cent to 7 per cent in the other industrial countries taken as a group. Among these countries, the degree of improvement, if any, varied markedly, being most pronounced in those countries (Italy and the United Kingdom) with the highest inflation rates. In a number of countries, declines in oil prices expressed in terms of local currencies, together with the general weakness of prices of imported primary commodities, contributed to the slowing of inflation. Despite the marked convergence of inflation rates that had occurred, price increases in the industrial countries were still quite disparate in 1978; they ranged from less than 3 per cent in Switzerland to more than 13 per cent in Italy.

The stability of the overall rate of price increase in the industrial countries did not continue in the first part of 1979. Following a 5 per cent average increase in 1978, wholesale prices in the major industrial countries as a group rose at an annual rate of 11–13 per cent in each of the first four months of 1979.2 Consumer prices in the major industrial countries rose at average annual rates of 9–12 per cent in the early months of the year, compared with 7 per cent for 1978 as a whole. (See Chart 2.) With respect to the GNP deflator (which covers price changes relating to national production, and not to imported commodities such as oil), prices in the whole group of industrial countries increased from the second half of 1978 to the first half of 1979 at an annual rate of 8 per cent. A worrisome factor is that the acceleration of the inflation rate was wide-spread, affecting countries that had previously succeeded in bringing inflation under control and that had considerable slack in resource utilization.

Chart 2.Major Industrial Countries: Consumer Prices, 1975-June 1979

(Changes in per cent)1

1 Three months ending in the months indicated over the preceding three months; seasonally adjusted at annual rates.

The acceleration of price increases in early 1979 occurred in an environment of reduced productivity gains, unduly high rates of monetary expansion, and inflationary expectations. It would appear, however, that this acceleration was to a large extent attributable directly to the pass-through of price increases for oil, food, and other primary products that are unlikely to continue at recent rates. Although at midyear such increases had yet to be fully registered in general price movements, they need not result in a lasting escalation of the underlying rate of inflation in the industrial countries. Such an outcome was avoided during a similar, but considerably less pronounced, episode in the first half of 1977 (Chart 2). In this context, it is encouraging to note that rates of increase in employee compensation (by far the largest single element, over time, of price formation in the industrial countries) remained rather stable through the early months of 1979. Nevertheless, some acceleration must be expected because of institutionalized mechanisms of wage indexation. Therefore, a primary issue for policy—particularly in the United States, where the pressure on resources is greatest—is to hold the secondary effects to a minimum and to prevent the present surge in inflation from adding to the strength of price expectations, and thus being built into wage and profit behavior. Otherwise, much of the all too modest progress made by industrial countries in curbing inflation over the past five years would be jeopardized.

Utilization of resources.—Mainly because of the moderate pace of expansion in economic activity since the trough of the 1974–75 recession, the industrial world continues to be troubled by a considerable under-utilization of resources. In this respect, however, a sharp distinction must be drawn between the United States and other countries. According to staff estimates of the “gap” between actual and potential output,3 underutilization of capacity in the manufacturing sector as a whole in the second half of 1978 was virtually nonexistent in the United States, but ranged from a moderate level in the Federal Republic of Germany and Canada to considerably wider gaps for most other countries.

The indication of substantial slack in manufacturing capacity in most industrial countries other than the United States is buttressed at the economy-wide level by available unemployment data. Unemployment in the major industrial countries rose sharply during the 1974–75 recession, but subsequent progress toward reducing it has been confined largely to the United States. There, total unemployment has been reduced from a peak of 9 per cent of the labor force in May 1975 to about 5¾ per cent since early 1978—a rate that, although high in relation to unemployment levels during the 1950s and 1960s because of various structural changes in labor markets, is thought to be within the range that corresponds to full employment. More gradual, but significant, progress in reducing unemployment is also evident in the Federal Republic of Germany, where the 3¾ per cent rate for June 1979 compares favorably with the recession peak of 5¼ per cent in 1975. Elsewhere, unemployment rates in 1978, while generally holding steady during the year, were still appreciably higher on average than in the recession year 1975; thus, they reflected the generally unfavorable impact of cyclical influences, as well as various long-run structural factors that have tended, as in the United States and the Federal Republic of Germany, to raise the level of unemployment associated with a given demand for labor.

The high level of unemployment in the industrial world as a whole during recent years has been accompanied by a growth of employment that, in conjunction with the generally sluggish pace of output growth, has involved a substantial reduction in productivity gains. As measured by real GNP per person employed, the overall gain in productivity for the seven major industrial countries amounted to only about 1½ per cent per annum from 1973 to 1978, compared with an average increase of 3¾ per cent for the period 1960–73.

What remains unclear, given the considerable amount of slack that still exists, is the degree to which output per employee is depressed by cyclical factors, as opposed to those of an underlying structural character. A major cyclical element in the initial downturn or slowdown in productivity gains after 1973 is readily apparent in Chart 3, as is an upswing in the recovery of 1976. It is equally clear, however, that economy-wide trends of productivity since 1973 have been generally flatter than those prevailing for many years prior to 1973. Particularly striking in this context is the case of the United States, where the rate of increase in employment during the past several years has been too strong to leave room for a supposition that any appreciable cyclical redundancy of employment still exists. These observations—also broadly applicable to Canada—would support a judgment that structural factors may have contributed to a deceleration of underlying growth in output per head. On the other hand, direct attempts to trace the slowdown of productivity growth in the industrial countries to particular structural factors—e.g., intersectoral shifts in the composition of output, lower rates of capital accumulation, changing age-sex composition of the work force, environmental regulations, and the effects of higher energy prices—have generally failed to account for much of the actual slowdown. It is thus difficult to rule out cyclical factors (and related measures to bolster employment) in explanations of the weak trend of productivity growth in the industrial world, especially for countries other than the United States and Canada.

Chart 3.Major Industrial Countries: Real Gross National Product Per Employee, 1958-781

(Indices, United States in 1973 = 100)

1 Intercountry differences (for 1973) are based on a study by the United Nations and the World Bank. Irving B. Kravis and others, International Comparisons of Real Product and Purchasing Power (Johns Hopkins University Press, 1978).

Stance of policies.—The current inflationary situation, combined with widespread underutilization of resources and generally disappointing growth of output, raises basic questions about the appropriate strategy of economic policy. In the Fund’s 1976 Annual Report, the importance of bringing down inflation and greatly reducing inflationary expectations was stressed. A “gradual” approach was recommended—but one that “would need to be adhered to firmly.” It was observed (a) that budget deficits remained very large in a number of countries and (b) that rates of monetary expansion were still in double digits in most of the industrial countries, and would need to be reduced considerably if a return to reasonable price stability was to be achieved in the next few years. The Report made clear that primary emphasis should be placed on demand management policies for the purpose of reducing inflation and inflationary expectations, but it indicated important supplementary roles for incomes policy and for various measures to improve supply conditions, alleviate cost pressures, and achieve higher levels of saving and investment. Also, it was recognized that labor market and other specific measures might be needed in order to cushion the hardships of unemployment and help to reduce its level.

Now, three years later, it is clear that the suggested strategy of policy has not led to satisfactory results; for the industrial countries, average rates of inflation and unemployment have not been reduced. The reasons for this unsatisfactory outturn are manifold and complex, but perhaps the basic one has been the pursuit of policies that have failed to make a dent in inflationary expectations. It is evident that governments have felt severe economic and political constraints in launching an effective anti-inflation program, since in the short run this would be bound to have adverse employment effects whose timing and magnitude would depend primarily on the ability to reduce inflationary expectations and hence would be difficult to predict. Also noteworthy is that economic forecasting and policymaking have been subject to a substantial degree of error in the unaccustomed situation of “stagflation”—an error often compounded, however understandably, by official optimism toward the future or misleading assessments of past developments.

The upshot has been that “gradualism” as an approach to the reduction of inflation and inflationary expectations has been too “gradual”—in many countries, to the point of no reduction at all. This seems clearly evident from the fact that the overall rate of monetary expansion in the industrial countries has not come down, but has remained about 10 per cent in every year since 1975 (Chart 4). Experience in the monetary sphere has, of course, differed markedly among countries on a year-to-year basis. But in none of the countries covered in the chart does one find a consistent pattern of movement toward lower rates of monetary expansion. Doubts as to whether rates of monetary expansion have been sufficiently low are also stirred by two other considerations: (a) countries with monetary targets have often exceeded them; and (b) official price projections have, by and large, been too optimistic. This latter consideration might well have implied an insufficient awareness of, or resistance to, the strength of inflationary pressures and, therefore, an insufficiently restrictive (or unduly accommodative) stance of monetary policy.

Chart 4.Major Industrial Countries: Rates of Monetary Expansion, 1973–78

(Percentage changes in annual averages)

Use of the fiscal instrument in industrial countries during the period since 1975 has been generally characterized by caution—in the sense of hesitation to introduce significant changes in the presence of high rates of both inflation and unemployment. There have been, to be sure, certain shifts of a general nature toward withdrawal of fiscal stimulus in 1976 and 1977, provision of stimulus in 1978, and back toward restraint in 1979 (Chart 5). There have also been noteworthy differences among countries—e.g., the consistent withdrawal of fiscal stimulus in the United States and the provision of significant stimulus in Japan in both 1978 and 1979. Over all, however, changes in the thrust of fiscal policy in the major industrial countries during recent years have been neither sustained nor particularly marked. Indeed, cumulated over the period since 1975, changes in both the cyclically adjusted fiscal deficits and the unadjusted fiscal deficits of the countries covered in the chart, measured as a proportion of these countries’ combined GNP, show a decline of about 1 per cent. Thus, the combined deficit (unadjusted) of the central governments of the major industrial countries amounted to 4½ per cent of their GNP in 1978, compared with 5½ per cent in the recession year 1975. Further, most of this change reflected withdrawal of stimulus in the United States that, in retrospect, is widely considered to have been too gradual. For the other industrial countries, cumulative fiscal shifts have been roughly neutral over the period taken as a whole, with the combined central government deficit of this group of countries having amounted to 6 per cent of GNP in both 1975 and 1978.

Chart 5.Major Industrial Countries: Fiscal Balances, 1973–791

(In per cent of gross national product)

1 The estimates relate only to central government and social security transactions.

2 A positive change is expansionary, and a negative change is contractionary.

3 Excluding social security transactions.

4 Fund staff projections.

However, while it seems clear that “gradualism” has been “too gradual,” it would also appear that governments have in practice no alternative but to stick with the established strategy and—mindful of the various difficulties experienced—try to make it work more effectively. Some of the principal aspects of such an approach are touched on below.

—Policy in individual countries should be reviewed with an eye toward gradually but consistently reducing the rate of monetary expansion. Particularly in countries with a margin of unused resources, a reduction in the rate of monetary expansion could—through its impact on expectations—have beneficial effects on inflation without marked effects on employment, although this is admittedly difficult. While the implications of such an approach vary from country to country, it should be noted first that particular effort is required of countries where inflation rates are running well above the averages for past periods. It should also be noted that monetary accommodation to the recent surge in inflation would be counterproductive from the standpoint of restraining a wage-price spiral and would end up as yet another slip in the implementation of a gradualist policy. The steps toward greater monetary restraint taken last November in the United States and, more recently, in other industrial countries—which have been manifested in higher interest rates (Chart 6)—should contribute to avoidance of such slippage.

Chart 6.Major Industrial Countries: Short-Term Interest Rates, 1975-June 19791

(In per cent per annum)

1 The rates shown are monthly averages of daily rates on money market instruments of about 90 days’ maturity (the call money rate for Japan).

—With respect to the fiscal instrument, various considerations come into play in the formulation of current policy: the amount of fiscal stimulus, as distinct from the change in such stimulus; the strength of private demand; fears of “crowding out”; concern about the structure of the budget (levels of expenditure and taxation) in a medium-term context; public attitudes; etc. Given such wide-ranging concerns, as well as the quite different unemployment and inflation situations in each country, there is clearly a need for rather differentiated stances of fiscal policy. In the United States, given the high level of resource utilization, the declared intention of exercising fiscal restraint is clearly appropriate. In some countries (e.g., Canada and the United Kingdom, where there have been recent changes in government), fiscal policy is being subjected to a fundamental reassessment. On a matter of general relevance, as already noted, the policy reaction to the deflationary impact of the 1979 increases in oil prices may be expected to vary widely among countries, but many countries with relatively high rates of inflation will undoubtedly decide to accept it, rather than to offset it. Any offsetting adjustments of the fiscal stance should not be allowed to compromise targets with respect to the monetary aggregates. Short-term inconsistencies between such fiscal actions and monetary objectives might best be resolved through increases in nominal interest rates, in the expectation that subsequently these would subside with reduction in the rate of inflation.

—The prevailing situation of “stagflation” raises the question of the possible use of some form of incomes policy. An effective incomes policy, where considered feasible, should make it possible to limit cost pressures and achieve price moderation without incurring greater slack and unemployment. Throughout the 1970s, the Fund has called attention to this point and has advocated increased consideration of the use of incomes policy. The efforts classifiable under the heading of incomes policy have varied markedly from country to country—depending not only on the economic circumstances but also on each country’s own institutions, traditions, and social and political settings—and have had a mixed record of effectiveness. Still, suitable incomes policies can serve as useful adjuncts to fiscal and monetary policies, and would seem to be especially appropriate at the present time in view of increased cost pressures of external origin. Of particular importance in this regard are measures that would exclude oil prices from the mechanism of wage indexation and thus serve to limit self-defeating wage-price spirals.

—Finally, greater emphasis needs to be placed on measures intended to effect structural adjustments and improve productivity. It is becoming increasingly clear that the early 1970s were something of a watershed for the industrial countries and that traditional policy responses were often stymied by structural impediments. Removal of these impediments generally calls for measures to stimulate investment—in some cases, via measures to strengthen the profit position. Protectionism has also been a worrisome feature of the past few years, and supplementary measures to foster the reallocation of resources required for an expanding volume of international trade merit consideration. An important objective for the industrial countries—and other countries as well—is to speed up the process of adjustment to an age of higher-cost energy. In this respect, realistic pricing of domestic energy supplies, conservation programs, and development of alternative energy sources appear to be essential.

Primary Producing Countries

The primary producing countries have been affected, in varying degrees, by the relatively slow pace of economic activity and high rates of inflation in the industrial world during the past several years. The impact of these external influences has been superimposed upon a variety of problems of internal origin, including, in many primary producing countries, inadequacies of domestic policy. In this setting, real output of both the more developed and the less developed groups of non-oil primary producing countries has generally been increasing less rapidly during the past few years than it did for a number of years prior to 1973, and rates of inflation have been much higher, on average, than in the 1960s or early 1970s. The experience of the major oil exporting countries, although varying widely within the group, has been relatively favorable, on the whole, with respect to both inflation and growth of the non-oil sectors of their economies.

Domestic economic developments and policies are reviewed below for three major groups of primary producing countries. The discussion begins with the largest of these groups, the less developed countries among the non-oil primary producers, and continues with briefer comments on the major oil exporting countries and the more developed primary producing countries.

In general, the past three years can be characterized as a period of steady, but modest, economic growth for the less developed non-oil primary producing countries, generally identified more briefly as “non-oil developing countries.” Although the average rate of expansion of real gross domestic product (GDP) in these countries had declined less severely than that of the industrial countries during the 1974–75 recession, its subsequent recovery was limited, and the vigor of the late 1960s and early 1970s has not been regained. (See Table 2.) Weighted averages of increases in real GDP for this group as a whole remained in the neighborhood of 5 per cent in every year from 1976 to 1978, compared with a little more than 6 per cent per annum for the period 1967–72. However, because of the implied curtailment of real income growth on a per capita basis, the difference of nearly 1 percentage point was by no means insignificant for a group of countries with a combined population increase of about 2½ per cent per annum.

Table 2.Primary Producing Countries: Changes in Output and Prices, 1967–78(Percentage changes)
Annual

Average

1967–721
Change from Preceding Year
197319741975197619771978
Real GDP
More developed primary producing countries6.16.44.42.03.32.63.0
Europe26.57.34.92.43.63.53.2
Australia, New Zealand, South Africa5.14.63.41.22.60.42.6
Major oil exporting countries39.010.78.0−0.312.86.22.6
Non-oil developing countries46.17.35.34.15.05.15.2
Africa5.02.25.62.34.74.03.7
Asia4.87.92.76.15.86.66.9
Latin America and the Caribbean6.88.17.72.64.84.34.3
Middle East8.84.8−1.08.42.85.96.5
Consumer prices
More developed primary producing countries56.011.816.716.914.417.816.6
Europe2,56.813.518.618.215.020.920.8
Australia, New Zealand, South Africa4.69.313.614.613.212.28.7
Major oil exporting countries38.011.317.018.816.415.19.9
Non-oil developing countries4,610.122.133.032.929.929.724.6
Africa74.89.318.616.417.424.421.2
Asia5.414.927.811.50.99.06.8
Latin America and the Caribbean815.930.840.954.662.451.643.1
Middle East94.312.721.820.320.219.221.7

Compound annual rates of change.

Comprises Finland, Greece, Iceland, Ireland, Malta, Portugal, Romania, Spain, Turkey, and Yugoslavia.

Comprise Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Oman, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela.

Include all Fund members not mentioned above, or in Table 1, plus certain essentially autonomous dependent territories (Hong Kong and the Netherlands Antilles) for which adequate statistics are available. The regional subgroups correspond to the groupings shown in International Financial Statistics.

Excluding Turkey, the average for the European countries in the last four columns would be 18.0 per cent, 14.6 per cent, 19.8 per cent, and 16.2 per cent, respectively; and the average for the total would be 16.7 per cent, 14.1 per cent, 16.8 per cent, and 13.3 per cent, respectively.

Excluding the high-inflation countries listed in footnotes 7–9, the figures for non-oil developing countries in the last four columns would be 16.5 per cent, 14.2 per cent, 20.6 per cent, and 16.8 per cent, respectively.

Excluding Ghana, Uganda, and Zaïre, the African figures in the last four columns would be 14.6 per cent, 9.4 per cent, 13.9 per cent, and 12.6 per cent, respectively.

Excluding Argentina, Chile, and Uruguay, the Latin America and Caribbean figures in the last four columns would be 22 per cent, 27.2 per cent, 33.5 per cent, and 28.1 per cent, respectively.

Excluding Israel, the Middle East figures in the last four columns would be 10.1 per cent, 14.5 per cent, 12.5 per cent, and 10.9 per cent, respectively.

Compound annual rates of change.

Comprises Finland, Greece, Iceland, Ireland, Malta, Portugal, Romania, Spain, Turkey, and Yugoslavia.

Comprise Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Oman, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela.

Include all Fund members not mentioned above, or in Table 1, plus certain essentially autonomous dependent territories (Hong Kong and the Netherlands Antilles) for which adequate statistics are available. The regional subgroups correspond to the groupings shown in International Financial Statistics.

Excluding Turkey, the average for the European countries in the last four columns would be 18.0 per cent, 14.6 per cent, 19.8 per cent, and 16.2 per cent, respectively; and the average for the total would be 16.7 per cent, 14.1 per cent, 16.8 per cent, and 13.3 per cent, respectively.

Excluding the high-inflation countries listed in footnotes 7–9, the figures for non-oil developing countries in the last four columns would be 16.5 per cent, 14.2 per cent, 20.6 per cent, and 16.8 per cent, respectively.

Excluding Ghana, Uganda, and Zaïre, the African figures in the last four columns would be 14.6 per cent, 9.4 per cent, 13.9 per cent, and 12.6 per cent, respectively.

Excluding Argentina, Chile, and Uruguay, the Latin America and Caribbean figures in the last four columns would be 22 per cent, 27.2 per cent, 33.5 per cent, and 28.1 per cent, respectively.

Excluding Israel, the Middle East figures in the last four columns would be 10.1 per cent, 14.5 per cent, 12.5 per cent, and 10.9 per cent, respectively.

Of particular concern is the continuing relatively slow rate of economic growth in countries where per capita incomes are lowest. For 39 countries in the non-oil group of less developed countries whose GDP per capita did not exceed US$300 in 1977, the average annual rate of growth in total GDP over the past three years is estimated at only about 4 per cent. Total population in the low-income group, however, was growing at about the same average rate as that in the other non-oil developing countries. The margin for improvement of living standards was thus commensurately lower in the low-income group, where it was most needed.

More than half of the non-oil developing countries with the lowest per capita incomes are located in Africa, and their relatively weak growth performance has been instrumental in giving that area the lowest rate of real GDP expansion of any regional group of non-oil developing countries in recent years. In the Asian area, on the other hand, there are a number of countries at the opposite end of the spectrum; their successful development of domestic industry and rapid expansion of exports of manufactures have contributed notably to the region’s economic performance. Growth of output in the non-oil developing countries of Asia was about 6 per cent or higher in every year from 1974 to 1978. An important factor underlying this sustained expansion was the superior record of the Asian countries with respect to inflation. In a number of these countries, early adoption of realistic policies of financial restraint during and immediately following the global boom of the early 1970s helped to damp down inflationary pressures to a degree not achieved by many countries in other regions.

On the whole, however, the record of the non-oil developing countries with respect to inflation has not been good in recent years. As measured by consumer price indices, the average rate of inflation for the group as a whole amounted to 30 per cent or more in every year from 1974 through 1977. That average declined only to about 25 per cent in 1978—a figure still about 2½ times as high as the rate of price increase that prevailed during the period 1967–72.

Wide differences in inflation rates among regional groups of countries have been apparent. In 1978, regional averages ranged from 7 per cent in Asia to more than 40 per cent in Latin America and the Caribbean (Table 2). Among individual countries, much more extreme differences could be cited. Most of the regional groups include some countries that have been afflicted by extraordinary rates of inflation, along with others whose price records compare favorably with those of most industrial countries. If countries with highly exceptional experience (as listed in the footnotes to Table 2) are excluded, the average rate of inflation in Latin America and the Caribbean, for example, would be about 28 per cent for 1978, and that year’s average for all non-oil developing countries (with similar exclusions) would be roughly 17 per cent.

In part, the high rates of inflation prevailing in the non-oil less developed countries during recent years can be traced to rising costs for imported products. In many cases, however, they are also rooted in overexpansionary fiscal programs and in excessive rates of monetary expansion (often as a direct consequence of the means used to finance government deficits). In every major region, weighted averages of the principal monetary aggregates increased faster during the past three years—by several percentage points—than they did during the preceding three-year period.

During the past several years, the major oil exporting countries were generally consolidating the gains made possible by the additional financial resources that became available to them as a result of the oil price increases of 1973–74. After an initial period of highly expansionary policies, generating substantial demand pressures, supply bottlenecks, and large increases in domestic prices, most of these countries shifted toward more cautious domestic policies in efforts to curb inflation. Several of them also took a variety of steps to eliminate constraints on supplies of goods and services. After the turn toward retrenchment, growth rates in the non-oil sectors of the major oil exporters’ economies tended to subside gradually, but to remain generally high by the standards of most developing countries. In 1978, the average increase in non-oil output of these 12 countries was still almost 8 per cent, even though it was significantly affected by the impairment of economic activity in Iran during the latter part of the year.

Year-by-year changes in total output of the major oil exporting countries have differed considerably from those recorded for other developing countries, reflecting the comparatively fast expansion of non-oil sectors and fluctuations of oil output peculiar to the changing demand and supply conditions in world markets for petroleum. Crude oil production now accounts for about two fifths of the group’s total GDP. When the small increase in output of the oil sector in 1977 and the 4½ per cent decline in 1978 are added to the increases in non-oil output, the overall GDP expansion for the major oil exporting group as a whole is seen to have dropped from a cyclically high rate of nearly 13 per cent in 1976 to 6 per cent in 1977 and about 2½ per cent in 1978 (Table 2).

With respect to inflation, the major oil exporters have in general been more successful than most other developing countries in bringing down the high rates that emerged in the middle 1970s. As a result of restrained demand management policies and expanding capacity to absorb imports, especially in those countries whose current accounts have remained in surplus, the average rate of inflation in the major oil exporting countries was almost halved from 1975 to 1978 (Table 2).

The mid-1970s have been a period of prolonged and difficult adjustment for the more developed primary produring countries. They have had to contend with slow growth, severe unemployment, and high inflation rates, as well as with the serious external problems discussed later in this chapter.

Total output for this group rose by only 3 per cent annually from 1975 through 1978, while consumer prices increased during those years at rates averaging 14–18 per cent. (See Table 2.) The subdued pace of economic activity reflected both unfavorable external developments—e.g., the slow recovery of the industrial countries from the 1974–75 recession and a severe deterioration in the terms of trade—and deliberate policy actions. Tight fiscal and monetary policies had to be adopted by an increasing number of the more developed primary producers in order to reduce absorption of domestic production and imports and to fight inflation, which was being fueled by wage developments, price increases for oil and other imports, and, in some cases, by currency devaluations. Large and ill-timed increases in real wages, occurring in a period of deterioration of the terms of trade and generally poor productivity gains, were particularly damaging in several cases; and undue delays in modifying the accommodative monetary policies adopted during the recession trough were also a widespread factor.

By 1978, however, several countries in the more developed group had achieved considerable success in reducing inflation. In Australia, Finland, and Ireland, rates of increase in prices decelerated to 7–8 per cent in 1978, after several years of double-digit rates; and New Zealand, Portugal, and Spain cut their respective inflation rates by several percentage points. Only Iceland and Turkey, among the countries in the more developed primary producing group, experienced sharply higher inflation rates.

For the group as a whole, this relative success in moderating inflation, together with a return to generally less sizable external deficits on current account, made possible a reversion to more growth-oriented policies. Consequently, rates of output expansion increased somewhat in most countries of the group in 1978. Only the Turkish and Portuguese economies, after adoption of long-delayed stabilization programs, grew significantly less in 1978 than in 1977. For the more developed countries as a group, a further acceleration in output expansion is expected for 1979.

International Trade and Payments

Global Perspectives

Efforts to adjust international payments positions over the past few years have been carried out in a global environment of modest expansion of world trade volume and continuing inflation of world trade prices. Although trade volume rebounded strongly in the first year of recovery from the 1974–75 recession, the annual increases in 1977 and 1978 averaged only about 5 per cent (Table 3). The moderate size of these gains is attributable primarily to the persistence since 1976 of a moderate rate of growth (3¾ per cent per annum) in real domestic demand in the industrial countries, which account for more than 70 per cent of world imports.

Table 3.World Trade Summary, 1962–781(Percentage changes in volume and in unit value of foreign trade)
Annual

Average

1962–722
Change from Preceding Year
197319741975197619771978
World trade3
Volume91351½−51255
Unit value (U.S. dollar terms)23½40½9910
(SDR terms)4212½39½878
Volume of trade
Exports Industrial countries9148−4½10½55
More developed primary producing countries832211½69
Major oil exporters912½−1−1114½−4½
Non-oil developing countries8521458
Imports Industrial countries12½−7½14½56
More developed primary producing countries16½−74½−½
Major oil exporters921½37½4219155
Non-oil developing countries14−6½459
Unit value of trade in SDR terms4
Exports Industrial countries2923½117
More developed primary producing countries2232461
Major oil exporters327½20412−6½
Non-oil developing countries2436½−4½12½12½−2½
Imports Industrial countries211½3988
More developed primary producing countries210½41½1083
Major oil exporters2112810
Non-oil developing countries212½48½102
Sources: National economic reports, IMF Data Fund, and Fund staff estimates.

For classification of countries in groupings shown here, see Tables 1 and 2.

Compound annual rates of change.

Sum of the groupings shown separately; based on approximate averages of growth rates for world exports and world imports.

For years prior to 1970, an imputed value of US$1.00 has been assigned to the SDR.

Sources: National economic reports, IMF Data Fund, and Fund staff estimates.

For classification of countries in groupings shown here, see Tables 1 and 2.

Compound annual rates of change.

Sum of the groupings shown separately; based on approximate averages of growth rates for world exports and world imports.

For years prior to 1970, an imputed value of US$1.00 has been assigned to the SDR.

Foreign trade prices, as measured by unit values in terms of U.S. dollars, rose by 9–10 per cent in each of the past two calendar years 4 and were continuing upward at an even faster pace in the first half of 1979. In view of the increases in oil prices during recent months, no slowing of foreign trade prices can be expected for the rest of the year despite the expected slowdown of economic activity in the industrial countries and the concomitant easing of demands for imports.

Although the rate of increase in the unit value of world trade expressed in terms of U.S. dollars appears to be remaining in the neighborhood of 10 per cent per annum for a third consecutive year, the underlying pattern of changes in prices and terms of trade has shifted markedly from year to year. In 1977, the largest increases occurred in primary commodity prices, and especially in those for the tropical beverage products. Accordingly, it was the non-oil developing countries whose terms of trade showed the strongest improvement in that year, extending a recovery already evident in 1976. A slight improvement in the terms of trade of the oil exporting countries was also registered from 1976 to 1977, while those of the industrial countries, as well as of the more developed primary producing countries, deteriorated somewhat.

The 1976–77 upswing in market prices of primary commodities peaked in the first half of 1977 and was followed by a sharp decline over the next several months. However, the trend of these prices (except for the beverage commodities) was again generally upward from late 1977 through the second quarter of 1979 (Chart 7). Given the lags with which market prices are reflected in foreign trade unit values, the foregoing movements were translated into a moderate increase from 1977 to 1978 in the average unit value of the non-oil developing countries’ exports, expressed in terms of U.S. dollars. This increase, however, fell considerably short of matching the concurrent rise in import prices, reflecting (in the main) the high average rate of inflation in the industrial world. The previous year’s terms of trade improvement for the non-oil developing countries was thus reversed.

Chart 7.Indices of Prices of Commodities, Except Oil, Exported by Primary Producing Countries, 1972-June 1979

(1968–70 = 100)

1 Deflated by UN index of manufactured exports of developed countries.

2 Expressed in U.S. dollars.

A considerably larger terms of trade deterioration was experienced in 1978 by the major oil exporters, whose export prices remained virtually unchanged in terms of U.S. dollars throughout that year. (See Chart 8.) On the other hand, the terms of trade of the industrial countries benefited strongly from the stability of oil prices and the general weakness of prices for primary commodities other than oil. (See Table 4.)

Chart 8.Indices of Prices of Oil and Manufactures in International Trade, 1972-July 1979

(1972 = 100; based on export unit values in terms of U.S. dollars)

1 Estimate for July 1979.

Table 4.Terms of Trade Developments, 1962–781(Percentage changes)
Annual

Average

1962–722
Change from Preceding Year
197319741975197619771978
Industrial countries−2−113−1−13
More developed primary producing countries11−10½−7½−½−2½−2
Major oil exporters115137−551−10½
Non-oil developing countries−½10−8−1354−4½
Reference: World trade prices (in U.S. dollars)
for major commodity groups3
(a) Manufactures3172212915
(b) Oil440226569
(c) Non-oil primary commodities (market prices)5528−181220−5
Sources: National economic reports, the United Nations, and Fund staff estimates.

Based on foreign trade unit values; for classification of countries in groupings shown here, see Tables 1 and 2.

Compound annual rates of change.

As represented, respectively, by: (a) the United Nations’ export unit value index for the manufactures of the developed countries; (b) the oil export unit values of the major oil exporting countries; and (c) the International Financial Statistics index of market quotations for non-oil primary commodities.

Sources: National economic reports, the United Nations, and Fund staff estimates.

Based on foreign trade unit values; for classification of countries in groupings shown here, see Tables 1 and 2.

Compound annual rates of change.

As represented, respectively, by: (a) the United Nations’ export unit value index for the manufactures of the developed countries; (b) the oil export unit values of the major oil exporting countries; and (c) the International Financial Statistics index of market quotations for non-oil primary commodities.

Still a different pattern is clearly in the making for 1979. It features a substantial improvement in the terms of trade of the oil exporters and deteriorating terms of trade for all other major groups of countries. Such deterioration will probably be most noticeable in the case of the non-oil developing countries, whose export prices are not expected to keep pace with the prices of imported manufactured goods, much less with the price of oil.

Apart from the long decline in prices of the beverage commodities from a peak in the second quarter of 1977 through early 1979, all major classes of primary commodities have been subject to moderately rising average prices since the latter part of 1977. Until the second quarter of 1978, faster increases were recorded for food prices than for prices of agricultural raw materials and metals. Subsequently, the reverse was true over the next several quarters; but the upward momentum of prices for industrial materials appeared to be abating toward the middle of 1979 (Chart 7).

Changes in international price relationships and in cyclical conditions, along with policies directed toward adjustment of internal and external positions, have exerted strong influence on the global structure of external current account balances in recent years. Over the period since 1974, the pattern of such balances has shifted markedly from year to year, gravitating back toward the pre-1974 pattern in some major respects but continuing also to display certain contrasting features.

The outstanding point of similarity is the persistence of substantial current account deficits in the two groups of predominantly capital-importing countries: the non-oil developing countries and the more developed primary producing countries. This point is readily evident from the aggregate deficits for those countries shown in Tables 5 and 6.

Table 5.Payments Balances on Current Account, 1973–791(In billions of U.S. dollars)
19731974197519761977197819792
Industrial countries19−425743310
More developed primary producing countries1−14−15−14−13−6−10
Major oil exporting countries668354032643
Non-oil developing countries−11−30−38−26−21−31−43
Total315207822

On goods, services, and private transfers. For classification of countries in groups shown here, see Tables 1 and 2.

Fund staff projections.

Reflects errors, omissions, and asymmetries in reported balance of payments statistics, plus balance of listed groups with other countries.

On goods, services, and private transfers. For classification of countries in groups shown here, see Tables 1 and 2.

Fund staff projections.

Reflects errors, omissions, and asymmetries in reported balance of payments statistics, plus balance of listed groups with other countries.

Table 6.Global Balance of Payments Summary, 1975–78(In billions of U.S. dollars)
Balance on
TradeServices

and

private

transfers
Current

account

excluding

official

transfers
Capital

Account

Balance1
Change in

Liabilities

to Foreign

Official

Agencies2
Balance

Financed by

Transactions

in Reserve

Assets
Industrial countries3197522.22.724.9−25.045.35.1
1976−3.010.37.3−12.3415.710.8
1977−7.310.83.5−5.4437.435.5
197816.717.734.4−29.2428.834.0
More developed primary1975−18.94.1−14.79.82.4−2.5
producing countries31976−16.12.4−13.711.52.90.7
1977−15.02.0−13.012.01.1
1978−10.95.2−5.811.3−0.45.0
Major oil exporting countries3197553.4−18.435.0−23.9−0.210.95
197665.3−25.240.1−31.58.65
197761.7−29.532.2−24.18.15
197841.2−35.06.2−19.10.3−12.65
Non-oil developing countries31975−28.6−9.5−38.037.01.70.7
1976−15.4−10.1−25.533.43.411.3
1977−12.2−8.9−21.232.40.411.6
1978−21.6−9.7−31.344.1−0.212.5
In Africa1975−2.4−3.8−6.25.80.4−0.1
1976−1.3−4.7−5.95.70.50.2
1977−1.5−5.0−6.57.10.10.6
1978−3.1−5.3−8.47.50.5−0.5
In Asia1975−9.50.9−8.69.30.71.4
1976−3.31.0−2.37.20.45.3
1977−3.82.2−1.66.2−0.34.3
1978−8.42.6−5.99.1−0.13.1
In the Middle East1975−8.01.3−6.77.50.8
1976−7.72.3−5.45.30.80.6
1977−8.43.9−4.55.21.21.9
1978−10.54.7−5.87.01.2
In Latin America and the1975−8.7−7.8−16.514.50.5−1.4
Caribbean1976−3.1−8.8−11.915.31.85.2
19771.4−10.0−8.613.9−0.64.8
19780.4−11.7−11.320.5−0.58.7
Total, all countries6197528.2−21.07.1−2.19.214.2
197630.7−22.68.21.222.131.5
197727.1−25.61.514.838.855.1
197825.4−21.93.57.028.538.9
Memorandum item: Low-income1975−5.5−1.7−7.26.50.80.1
non-oil developing countries1976−2.8−1.3−4.15.80.11.8
1977−3.0−0.4−3.56.4−0.32.6
1978−6.8−0.1−6.97.70.8
Sources: Data reported to the International Monetary Fund and Fund staff estimates.

This balance is computed residually as the difference between the balance financed by transactions in reserve assets and the sum of the current account balance and the change in liabilities to foreign official agencies; it includes net errors and omissions, as well as reported capital movements, government transfers, and gold monetization. (See also footnote 2.)

The concept of “liabilities to foreign official agencies” used in this table encompasses use of Fund credit and short-term balance of payments financing transactions in which the liabilities of the borrowing country are presumably treated as reserve assets by the creditor country.

For classification of countries in groups shown here, see Tables 1 and 2.

See footnote 6.

The changes in reserve assets of the major oil exporting countries as reported here, unlike corresponding figures listed in previous Annual Reports, are based (with estimated valuation adjustments to take account of changes in exchange rates) on reserve asset holdings as reported in International Financial Statistics. Large additional changes in holdings of external financial claims by official agencies of the major oil exporting countries (some of which were classified in the global balance of payments summaries presented in previous Annual Reports as changes in reserves) are included in the column “Capital Account Balance” of this table. The dividing line between capital movements and reserve asset changes remains uncertain for some oil exporting countries.

Global balance of payments aggregations inevitably contain many asymmetries arising from discrepancies of coverage or classification, timing, and valuation in the recording of individual transactions by the countries involved. A major area of asymmetrical classification during recent years concerns the recording of official claims placed in Eurocurrency markets. Some of these transactions, although treated as changes in reserve assets by the investing countries, are recorded as capital inflows by the recipient countries (mainly, the industrial countries). Had such transactions been recorded symmetrically, the global summations would show both a larger net capital outflow and a larger aggregate change in liabilities to foreign official agencies. If identified Eurocurrency reserve placements (shown in terms of SDRs in Table 19 of this Report) were assumed to have been placed in industrial countries, then the adjusted net capital outflows from those countries would amount to $33.1 billion, $21.3 billion, $22.6 billion, and $35.2 billion over the years 1975, 1976, 1977, and 1978, respectively. (The adjustments made in deriving these estimates for the years 1975–77 have been affected by the change of classification mentioned in footnote 5, above.)

Sources: Data reported to the International Monetary Fund and Fund staff estimates.

This balance is computed residually as the difference between the balance financed by transactions in reserve assets and the sum of the current account balance and the change in liabilities to foreign official agencies; it includes net errors and omissions, as well as reported capital movements, government transfers, and gold monetization. (See also footnote 2.)

The concept of “liabilities to foreign official agencies” used in this table encompasses use of Fund credit and short-term balance of payments financing transactions in which the liabilities of the borrowing country are presumably treated as reserve assets by the creditor country.

For classification of countries in groups shown here, see Tables 1 and 2.

See footnote 6.

The changes in reserve assets of the major oil exporting countries as reported here, unlike corresponding figures listed in previous Annual Reports, are based (with estimated valuation adjustments to take account of changes in exchange rates) on reserve asset holdings as reported in International Financial Statistics. Large additional changes in holdings of external financial claims by official agencies of the major oil exporting countries (some of which were classified in the global balance of payments summaries presented in previous Annual Reports as changes in reserves) are included in the column “Capital Account Balance” of this table. The dividing line between capital movements and reserve asset changes remains uncertain for some oil exporting countries.

Global balance of payments aggregations inevitably contain many asymmetries arising from discrepancies of coverage or classification, timing, and valuation in the recording of individual transactions by the countries involved. A major area of asymmetrical classification during recent years concerns the recording of official claims placed in Eurocurrency markets. Some of these transactions, although treated as changes in reserve assets by the investing countries, are recorded as capital inflows by the recipient countries (mainly, the industrial countries). Had such transactions been recorded symmetrically, the global summations would show both a larger net capital outflow and a larger aggregate change in liabilities to foreign official agencies. If identified Eurocurrency reserve placements (shown in terms of SDRs in Table 19 of this Report) were assumed to have been placed in industrial countries, then the adjusted net capital outflows from those countries would amount to $33.1 billion, $21.3 billion, $22.6 billion, and $35.2 billion over the years 1975, 1976, 1977, and 1978, respectively. (The adjustments made in deriving these estimates for the years 1975–77 have been affected by the change of classification mentioned in footnote 5, above.)

The principal contrast between the recent global pattern of current account balances and that characteristic of the 1960s and early 1970s lies in the distribution of surpluses among groups of predominantly capital-exporting countries. In 1974, oil price increases wiped out the traditional current account surplus of the industrial countries taken as a group; this surplus had represented the preponderant counterpart of the deficits on current account incurred by the two groups of capital-importing countries. By 1978, the industrial countries were again substantial net exporters of goods and services, but their combined current account surplus is projected to fall sharply in 1979 under the likely impact of the latest oil price increases. At the same time, the combined current account surplus of six oil exporting countries with limited short-run absorptive capacity is projected to rise from an estimated $21 billion in 1978 to $43 billion in 1979—thus dominating the overall current account surplus being recorded for the larger group of “major oil exporting countries.”

Changes in the aggregate current account balance of the industrial countries over the past half-dozen years have resulted mainly from cyclical fluctuations in export and import volumes and shifts in the terms of trade, including those stemming from oil price increases. This balance became a sizable surplus in 1978, when the general sluggishness of import demand in the industrial countries was coupled with a shift of the terms of trade in their favor. Amounting to $33 billion, this surplus is expected to decline to about $10 billion in 1979 with the payment of considerably higher prices for oil imports. (The figures cited here are those shown in Table 5 on the basis of goods, services, and private transfers.)

Within the group of industrial countries, differences in the phasing of cyclical developments and in the degree of dependence on imported fuels, as well as changes in exchange rates, have contributed to strongly contrasting swings among the larger members. At this juncture, from the standpoint of the working of the international adjustment process, a particularly welcome set of developments is the marked shrinkage of the U.S. current account deficit and of the German and Japanese current account surpluses. (See Chart 9.) Also noteworthy is the fact that several large industrial countries (notably the United Kingdom and Italy) are now in better position than they were in 1974 to meet the effects of a large increase in the price of oil. Further comments on the external positions of individual industrial countries are offered in the following section.

Chart 9.Major Industrial Countries: Balances on Current Account and Effective Exchange Rates, 1975-First Quarter 1979

1 Including official transfers; seasonally adjusted annual rate.

2 MERM indices as reported in International Financial Statistics.

The changes in the global pattern of current account balances expected for 1979 as a whole do not depict the situation that is likely to prevail in the latter part of the year. At that time, current account balances will more fully reflect the recent oil price increases, and the combined current account surplus of the major oil exporting countries will have reached an annual rate considerably above the estimate shown in Table 5 for the full year. Depending upon cyclical developments in the industrial countries, a considerable part of the offset to this increase in the oil exporters’ surplus may appear among the non-oil primary producing countries, for which sizable increases in current account deficits are likely. For the industrial countries, an expected sharp deterioration in the current account balance in the latter part of 1979 because of increases in the oil import bill may be tempered to some extent by a weakening of general import demand.

Industrial Countries

Exchange rate developments.—An acceleration of exchange rate adjustments in industrial countries took place in 1978 in response to balance of payments dis-equilibria that had been cumulating since 1976. As noted below, relationships among major currencies were significantly altered in real, as well as nominal, terms.

Exchange rates continued to move in a direction generally consistent with the reduction of current account imbalances, as shown in Chart 9. Appreciation of the currency of Japan—the country with the largest surplus last year—and depreciation of the U.S. dollar, as well as that of the Canadian dollar, became more rapid in the course of 1978. Exchange rate influences on relative cost and price movements, and thus on competitive positions in international trade, were correspondingly more pronounced, and began in the first half of 1978 to have perceptible effects on trade volumes. Adjustment of trade balances in value terms (based on the U.S. dollar or SDR to facilitate international comparisons) was slower to emerge, as the terms of trade effects of exchange rate changes temporarily outweighed their corrective influence on real flows. These so-called J-curve effects contributed to the instability of foreign exchange markets in the months preceding November 1978, as day-to-day movements in exchange rates became increasingly volatile in thin and nervous markets.

From September 1977 through the end of October 1978 the U.S. dollar depreciated steeply—by some 19 per cent in effective terms 5—while the yen and the deutsche mark appreciated by 40 per cent and 13 per cent, respectively. Although the Swiss franc also appreciated strongly (by 35 per cent), exchange markets were for the most part dominated by the changing relationships among the currencies of the three largest industrial countries. During the fourth quarter of 1977 and again after mid-1978, rates for both the deutsche mark and the yen appreciated sharply. Changes in effective exchange rates of other major currencies in the period from September 1977 to the end of October 1978 were generally smaller: depreciations of 15 per cent for the Canadian dollar and 8 per cent for the Italian lira, and little change in effective rates of the French and U.K. currencies. The increasing tendency of anticipatory or speculative capital movements to dominate exchange markets in basically unstable conditions came to a head in October 1978. In the course of that month, which witnessed the most severe unrest in exchange markets since early 1973, the U.S. dollar depreciated by 6 per cent, with correspondingly large movements in the exchange rates of other major currencies.

In retrospect, it is clear that the economic disturbances of the 1970s have given rise to difficulties in achieving mutually compatible variations in current account balances and private capital flows in several of the major industrial countries. This lack of quantitative adjustment has resulted in substantial price variability—the price in this instance being the exchange rate. The emergence of unstable conditions in the period up to, and particularly during, October 1978—along with a sharp depreciation of the U.S. dollar against virtually all major currencies—led to the announcement on November 1, 1978 of a package of coordinated policy measures by authorities of the United States, the Federal Republic of Germany, Japan, and Switzerland. These exchange rate and monetary policy measures were designed to correct a situation in which movements in the dollar exchange rate were considered to have exceeded any decline that might be related to fundamental factors.

The period since the introduction of the November 1 measures has witnessed an extensive reversal of previous exchange rate movements, accompanied by a reduction in the volatility of movements. The U.S. dollar has appreciated with respect to most major currencies: the effective exchange rate for the dollar rose substantially during the eight months from November 1, 1978 through June 30, 1979, and in late July was more than 6 per cent above its end-October level, despite an appreciable decline during the weeks after mid-June. The obverse movement in the Japanese yen from November to July was pronounced; following an appreciation of 36 per cent over the first ten months of 1978, the yen depreciated against the dollar by 18 per cent during the next eight months and recovered only slightly during July. Exchange rates of currencies within the European Monetary System (EMS), which was introduced on March 13, 1979,6 showed little net change vis-à-vis the U.S. dollar over the first six months of 1979, but rose appreciably from mid-June to late July; the deutsche mark, for example, appreciated by about 4½ per cent during that brief period, reaching a higher level against the U.S. dollar than at any time since October 1978. The pound sterling appreciated even more strongly than the EMS currencies from October 1978 to late July 1979, while the Canadian dollar showed little net change. The rise in the effective rate for the U.S. dollar in the first seven months of 1979 therefore largely reflected developments vis-à-vis the yen.

The reversal of exchange rate movements of major currencies after October 1978 was accompanied by massive intervention in support of the dollar. This intervention occurred first in the face of the sharp decline of the dollar in October 1978—which it did not prevent—and then continued at a heavy rate for the rest of the year. Since the beginning of 1979, however, U.S. foreign official liabilities have been greatly reduced, and all borrowings under the November agreements had by the end of March been repaid. Correspondingly, large increases in the official reserves of the Federal Republic of Germany and Japan took place in November and December as a result of intervention, but these were also fully unwound in the subsequent quarter.

Although there is little doubt that the introduction of the November 1 measures did much to stabilize market conditions, developments with respect to other short-run influences on exchange rates were also important in the recent period. Domestic activity in both the Federal Republic of Germany and Japan has accelerated in recent quarters, while the tightening of monetary and other policies introduced in the United States (in part, along with the November 1 package) has contributed to a shift in growth rates of domestic demand conducive to an improvement in the distribution of current account balances. The reported declines in the U.S. trade deficit and in the German and Japanese surpluses have had important effects on market sentiment in recent months. It would appear that the outcome of the November 1 measures has provided a clear demonstration of the importance of credible policies and favorable underlying conditions in support of exchange market interventions and other short-term measures.

The EMS was launched in March under the favorable auspices of a strengthened and steady U.S. dollar. So far, the Italian lira and, more recently, the deutsche mark have been among the strong currencies in the EMS group, while the Belgian franc and (recently) the Danish krone have been at the bottom of the EMS band. Austria, although officially not a member of the EMS, has continued its exchange rate policy of keeping the schilling fairly close to the currencies of its main trading partners. This policy had previously given Austria a de facto link with the “snake” arrangements and now associates it similarly with the EMS.

Effects of exchange rate adjustments in 1978 and the first half of 1979 on relative cost/price relationships among major countries have been considerable. With domestic inflation rates showing some tendency toward greater convergence in 1978, the major influence on competitive positions stemmed from the changing pattern of exchange rates (Chart 10). Relative deflators for manufactures adjusted for exchange rate changes (which are indicators of “real exchange rates”) declined sharply over the first three quarters of 1978 in the United States and Canada and rose markedly in Japan. Movements for other currencies were less pronounced but, generally speaking, were also consistent with adjustment needs in direction, although the appropriateness of the magnitudes is more difficult to assess. With the subsequent reversal of exchange rate movements for major currencies in the last quarter of 1978, a movement that for some countries continued into 1979, these adjustments were partly unwound. Effects on the cost/price competitiveness of Japan have been particularly marked, resulting in a reversal of a large part of the real exchange rate appreciation experienced in late 1977 and in 1978.

Chart 10.Major Industrial Countries: Relative Prices of Manufactures, Adjusted and Unadjusted for Exchange Rate Changes, 1970-First Quarter 19791

(Indices, 1973 = 100)

1 Annual deflators for gross domestic product originating in manufacturing with quarterly interpolations and extrapolations (beyond the latest available annual data) based on wholesale price data for raw materials and manufactures.

On balance, however, real exchange rates—including the rate for the yen—were substantially different in the first quarter of 1979 from their levels in the third quarter of 1977, when the rapid exchange rate adjustments commenced. Among currencies that depreciated in real terms over that period were the U.S. dollar (12 per cent), the Canadian dollar (8 per cent), and the Italian lira (8 per cent); appreciating currencies, also in real terms, were the Japanese yen (13 per cent) and the deutsche mark (5 per cent). The currencies of France and the United Kingdom also appreciated somewhat from the third quarter of 1977 to the first quarter of 1979, although neither country can be said to have had a particularly strong balance of payments position.

The imprecision attaching to intercountry comparisons of costs and prices warrants mention. Indices such as those used above to explore shifting conditions of relative competitiveness are subject to a number of conceptual and statistical problems. Correspondence between these indices and actual developments may be clouded, for example, by differences in the composition of manufacturing and export or import-substituting industry, divergent profit developments in exporting industry (partly as a response to price movements abroad), and developments in nonprice competitiveness. Moreover, important structural shifts affecting comparative trading positions are seldom reflected directly or quickly in such indices. Nevertheless, the indices are considered to be indicative of broad movements in relative competitive positions.

Current account balances.—Significant shifts in the distribution of current account balances among industrial countries toward a more satisfactory pattern became increasingly evident in 1978 and early 1979. The initial response of current account balances to the exchange rate adjustments of recent years had, however, been largely one of greater disequilibrium in the short run. Changes in the terms of trade resulting from rapid exchange rate changes overwhelmed the response of trade volumes, which is subject to a time lag, and led to increases in surpluses or deficits. The delay in reduction of current account imbalances was evident in the emergence of large surplus and deficit positions during 1978, in the face of substantial exchange rate adjustments. (See Chart 9.)

Underlying effects of earlier exchange rate adjustments became evident in trade volumes of several major countries early in 1978. From 1977 to the first half of 1978, imports in real terms accelerated in Japan and the Federal Republic of Germany but decelerated in the United States. Similarly, the volume of exports from the United States picked up sharply in the first half of 1978, while the exports of Japan and the Federal Republic of Germany slowed perceptibly. This process of contrasting trade volume developments continued for the United States and Japan in the second half of 1978. Terms of trade movements were sufficiently strong, however, that the current account surpluses of Japan and the Federal Republic of Germany underwent large upward swings from 1977 to 1978 as a whole—from $11 billion to $17½ billion in Japan and from $4 billion to $9 billion in the Federal Republic of Germany (including official transfers).

In several respects, the distribution of current account balances among industrial countries reached its most unsatisfactory stage of recent years in the first quarter of 1978. From a large surplus ($20 billion at an annual rate) in the second half of 1975, the U.S. balance had shifted steadily to a large deficit (at a rate of some $28 billion) in the first quarter of 1978. Conversely, the Japanese current account had moved from approximate balance to a surplus of $20 billion (annual rate) over roughly the same period. During the remainder of 1978, the U.S. deficit on current account including official transfers declined to about $9 billion at an annual rate, so that the deficit for the full-year 1978 was somewhat lower than that of 1977. Similarly, the Japanese surplus declined considerably toward the end of 1978 and continued to contract in the first half of 1979, under the impetus of the appreciation of the yen and the expansion of domestic demand. The surplus of the Federal Republic of Germany, although continuing to rise during 1978, also declined in the first half of 1979.

Most of the other industrial countries experienced markedly stronger current account balances in 1978 than in the preceding year. For the most part, these changes stemmed from favorable shifts in the terms of trade. Sizable improvements in terms of trade were recorded for France, Italy, the United Kingdom, Austria, Norway, and Sweden, and these were generally in accordance with the need for a strengthening of the balance of payments of those countries. For the industrial countries as a group, the combined balance on current account (goods, services, and private transfers) moved from a surplus of $4 billion in 1977 to one of $33 billion in 1978. (See Table 7, which also shows balances including official transfers.) Except for a $7 billion increase in the net surplus on invisibles, the change can be ascribed to an improvement in the terms of trade of the industrial countries vis-à-vis the rest of the world generally, especially the developing countries (both oil and non-oil). Developments in the first half of 1979 largely represented an extension of the within-1978 movement toward a better distribution of current account balances.

Table 7.Industrial Countries: Balance of Payments Summaries, 1975–78(In billions of U.S. dollars)
Balance onCapital Account BalanceMemo:

Current

Account

Including

Official

Transfers
TradeServices

and

private

transfers
Current

account

excluding

official

transfers
Total1Long-Term

capital

and

official

transfers
Other2Change in

Liabilities

to Foreign

Official

Agencies3
Balance

Financed by

Transactions

in Reserve

Assets
United States19759.113.322.3−26.7−23.7−3.05.30.818.3 4
1976−9.318.39.0−19.5−19.70.213.12.64.6
1977−30.920.9−9.9−25.1−17.6−7.535.40.4−14.1
1978−34.225.0−9.2−22.4−16.1−6.330.9−0.8−13.9
United Kingdom1975−6.63.2−3.43.20.32.9−1.3−1.4−4.2
1976−5.85.2−0.6−0.3−0.40.1−0.5−1.4−2.0
1977−2.55.02.511.63.58.12.616.70.6
1978−1.85.53.7−5.9−5.6−0.3−2.1−4.30.5
Canada1975−0.4−4.2−4.64.23.70.5−0.4−4.7
19761.7−5.5−3.84.48.0−3.60.6−3.8
19773.0−6.9−3.82.54.2−1.7−1.3−3.9
19783.4−7.6−4.24.12.71.4−0.2−4.6
France19751.5−0.31.22.3−2.24.50.54.00.1
1976−4.7−0.2−4.91.8−2.74.50.2−2.8−5.9
1977−2.70.9−1.92.6−0.83.4−0.60.1−3.3
19781.63.85.4−2.4−4.82.30.33.34.0
Germany, Fed. Rep.197517.7−10.57.1−8.0−10.42.4−0.2−1.03.6
197616.7−9.47.3−3.9−4.00.10.33.83.5
197719.7−11.28.6−3.8−9.86.0−0.34.44.3
197825.3−12.113.2−3.4−5.42.03.112.98.9
Italy1975−1.11.90.7−3.4−0.3−3.11.0−1.7−0.6
1976−4.22.7−1.61.3−1.02.32.62.3−2.9
19770.13.94.01.7−0.72.4−0.65.22.3
19783.16.19.2−2.4−1.9−0.5−4.02.76.3
Japan19755.0−5.4−0.4−0.2−0.30.1−0.6−0.7
19769.9−6.03.9−0.1−0.90.83.83.7
197717.3−6.211.1−4.6−2.8−1.86.510.9
197825.6−7.917.7−7.7−11.74.010.017.5
Other industrial1975−3.04.91.93.4−2.76.10.15.40.3
countries51976−7.15.2−2.04.0−6.010.02.0−3.0
1977−11.44.4−7.19.70.98.80.93.5−8.6
1978−6.34.9−1.411.0−8.019.00.810.4−3.5
Total industrial197522.22.724.9−25.06−35.510.55.35.112.3 4
countries1976−3.010.37.3−12.3 6−26.614.315.710.8−5.9
1977−7.310.83.5−5.46−23.217.737.435.5−11.8
197816.717.734.4−29.26−50.721.528.834.015.2
Sources: Data reported to the International Monetary Fund and Fund staff estimates.

See Table 6, footnote 1.

Includes recorded net movements of short-term capital, net errors and omissions, and gold monetization.

See Table 6, footnote 2.

Includes the effect of a revision of the terms of the disposition of economic assistance loans made by the United States to India and repayable in rupees, and of rupees already acquired by the U.S. Government in repayment of such loans. The revision has the effect of increasing U.S. Government transfer payments by about $2 billion, with an offset in net official loans.

Austria, Belgium-Luxembourg, Denmark, the Netherlands, Norway, Sweden, and Switzerland.

See Table 6, footnote 6.

Sources: Data reported to the International Monetary Fund and Fund staff estimates.

See Table 6, footnote 1.

Includes recorded net movements of short-term capital, net errors and omissions, and gold monetization.

See Table 6, footnote 2.

Includes the effect of a revision of the terms of the disposition of economic assistance loans made by the United States to India and repayable in rupees, and of rupees already acquired by the U.S. Government in repayment of such loans. The revision has the effect of increasing U.S. Government transfer payments by about $2 billion, with an offset in net official loans.

Austria, Belgium-Luxembourg, Denmark, the Netherlands, Norway, Sweden, and Switzerland.

See Table 6, footnote 6.

On a retrospective view of the long and substantial deterioration of the U.S. current account from late 1975 to early 1978, it is clear that the swing represented primarily a higher rate of increase in imports than in exports in volume terms. Some deterioration of the terms of trade also contributed, but this resulted mainly from reductions in prices for U.S. agricultural exports, rather than from “J-curve” effects of the exchange rate change. Such effects did not come into play until late in the downswing of the current account balance, as the external value of the dollar was virtually stable at a relatively high level throughout 1976 and the first three quarters of 1977. Indeed, the high effective exchange rate prevailing in that period (compared with the average of immediately preceding years) was doubtless one element in the deterioration of the trade balance, as it involved a rising real exchange rate damaging to the U.S. competitive position. Another element, perhaps the main one, was the faster pace of economic expansion in the United States than elsewhere in the industrial world after mid-1976.

The striking growth of the Japanese current account balance, from near balance in 1975 to a surplus of $18 billion in 1978, was in part a terms of trade phenomenon, particularly in 1978, but it also reflected a strong export performance coupled with a downward shift in imported raw material requirements. More buoyant domestic demand combined with sizable exchange rate depreciation, as well as policy measures focusing directly on the current account, has been responsible for a sharp curtailment in the current account surplus since late 1978—to the point that the Japanese balance on current account has swung into deficit during recent months. Although the deficit may not be sustained in the period ahead, the degree of adjustment obtained represents a gratifying response to policy measures undertaken for the purpose.

Viewed from a medium-term perspective, the current accounts of all four major European industrial countries—France, the Federal Republic of Germany, Italy, and the United Kingdom—strengthened appreciably from 1975 to 1978, showing a combined upward movement of about $26 billion. In three of the four cases, however, the improvements began from weak current account positions during the period 1974–76, and the recent surpluses of Italy and the United Kingdom can be regarded as desirable from the standpoint of facilitating the repayment of borrowed funds. In the case of the Federal Republic of Germany, the increase of the surplus in 1978 reinforced an already strong external position. For Canada, changes in the current account deficit during the past several years have not been sizable. In view of the substantial depreciation of the Canadian dollar since 1976, this experience is perhaps illustrative of the long lags with which effects of exchange rate changes on trade and service transactions are sometimes felt. Most of the smaller industrial countries—with the notable exception of Switzerland, with its very large surplus of about $6 billion in 1978—have also been capital importers throughout the middle and latter 1970s. For the group of smaller industrial countries during these years, a generally upward tendency of current account deficits of most members has been evident, although the movement was partly reversed in 1978. Marked growth of Switzerland’s surplus, however, is also an element of the combined balance shown in Table 7 for the smaller industrial countries.

Capital flows.—Exchange market disturbances during 1977 and 1978 both reflected and contributed to large destabilizing flows of capital. These flows were sometimes responsive to cyclical interest rate differentials, but were often contrary to them because of the influence of exchange rate expectations, which on occasion generated forward exchange rate premiums or discounts large enough to override the uncovered spreads in interest rates. In several countries, changes in capital restrictions also played an important role.

Reversal of exchange rate pressures in the first quarter of 1979 was paralleled by large movements of short-term private capital. From a $14 billion outflow in the last quarter of 1978, U.S. bank-reported net capital flows reverted to a $14 billion inflow in the first quarter of 1979. In the Federal Republic of Germany, net short-term flows also showed a reversal in these quarters. Covered arbitrage favoring the Tokyo market persisted until March because of the continued large forward premium on the yen, but the premium narrowed considerably in March as the decline in the trade surplus was sustained.

As in the past, restrictive measures designed to prevent or contain flows of capital have proved of limited usefulness in recent years. For example, fairly comprehensive measures introduced by Japan in late 1977 did not prevent the substantial flows that accompanied the exchange rate reversal in late 1978. Another lesson that may be derived from recent experience concerns the important role of exchange rate expectations—particularly in the presence of exchange restrictions that permit large forward exchange rate premiums or discounts to build up. These premiums or discounts have in some countries offset the anticipated equilibrating effects of interest rate policies on capital flows, and have thus added to exchange market pressures.

In general, as already mentioned, staff analyses of developments in the major industrial countries over the 1970s point to a limited equilibrating role of private flows in offsetting changes in current account balances. Reasons cited for this result include the uncertainties and risks associated with foreign investment, official restrictions on capital movements or the fear of future restrictions, and institutional rigidities, as well as differences in the size and efficiency of the various national capital markets. Lack of the necessary correspondence between prevailing current account balances and external investment propensities of private residents has been all too evident among the industrial countries throughout the 1970s. It was the proximate cause—reinforced by intensification of exchange rate expectations—of the volatile exchange rate movements and huge changes in reserve assets and related liabilities that characterized the international financial scene during much of the past two years.

Neither of the two major industrial countries with the largest surpluses on current account—the Federal Republic of Germany and Japan—was a net supplier of private capital to the rest of the world on a commensurate scale in 1977 and 1978. Substantial amounts of long-term capital were invested abroad by residents of both countries during these years, but these outflows were not large enough in either case to cover both the current account surplus and the net movement of short-term capital, which was very responsive to exchange rate expectations. In the case of the Federal Republic of Germany, indeed, net inflows of short-term funds matched or exceeded long-term outflows in both 1977 and 1978, so that the net external investment corresponding to the current account surpluses (including official transfers) took the form of increases in international reserves held by the monetary authorities. In the case of Japan, increases in reserves were equivalent to well over half of the current account surplus in each of the past two years. During the course of 1978, however, the net outflow of long-term capital from Japan increased sharply, amounting to $11½ billion for the year as a whole. In both countries, the additions to reserves in 1978 stemmed from official intervention to prevent disorderly movements of exchange rates at times of strong upward pressure in currency markets. However, the reserves of the Federal Republic of Germany and Japan were sharply reduced in the first part of 1979, when earlier speculative movements of short-term funds were apparently unwound.

In the United States, where a substantial net capital inflow was needed to finance by far the largest current account deficit among the industrial countries in both 1977 and 1978, the net flow of private capital was in fact substantially outward. That outflow, together with the current account deficit itself, was financed mainly through exceptionally large increases in U.S. Government liabilities to foreign official agencies—i.e., chiefly through the accumulation of U.S. dollar reserves by the monetary authorities of other countries.

In other industrial countries over a longer time perspective, a similar lack of correspondence between private capital flows and current account imbalances was also observed. Until 1978, Canada was an exception, having traditionally experienced a large and relatively consistent net influx of autonomous long-term capital. In 1978, however, capital inflows would have declined sharply if the Government of Canada had not borrowed heavily in foreign capital markets.

For industrial countries as a group, the general result of markedly unequal capital account and current account balances has been a considerable movement, back and forth, of short-term and medium-term capital flows (including claims on the Eurocurrency market) between surplus countries and the rest of the world. But there has been no adequate net outflow of total private capital (long-term and short-term combined) from the surplus countries on a steady or consistent basis.

The broad pattern of capital movements among major groups of countries has long featured net flows from the industrial countries to the non-oil primary producing countries. This flow reflects the provision of resources by areas with excess saving (i.e., saving in excess of concurrent domestic investment) to areas that are deficient in savings. In recent years, this pattern has been modified to a considerable extent by the emergence of the oil surplus countries as large-scale suppliers of national savings to international financial markets. In the main, however, as noted in recent Annual Reports, the capital and reserve funds invested by the oil surplus countries have been placed in financial claims on the industrial countries, which have continued to be the direct suppliers of the bulk of the capital and official transfers flowing to the non-oil primary producing countries. In relation to total world trade, the order of magnitude of this flow remains similar to that of the late 1960s and early 1970s, even though the industrial countries are now supplying less than half of the aggregate net flow from the excess of their own national saving over domestic investment (the remainder representing a “recycling” of national savings originating in the oil surplus countries).7

Non-Oil Developing Countries

Aggregate current account deficit and its financing.— For many years, the balance of payments structure typical of most developing countries has been one featuring net inflows of capital and/or official transfers (in supplementation of domestic savings insufficient to finance desired capital formation) and a sizable excess of imports over exports of goods and services (reflecting the real-resource counterpart of the capital inflow). A current account deficit of some size is thus a normal characteristic of the balance of payments of most developing countries, although exceptions occur, for example, when export earnings situations are particularly favorable or during periods of adjustment when external financial positions are being rebuilt. Sustained maintenance of balance or surplus in the current account would mean that a country (or group of countries) had failed to make use of external resources to supplement its development efforts.

Taken together, the current account balances of the non-oil developing countries have undergone several distinct phases during the 1970s. From a position of unusual and largely cyclical strength (1972–73), they were plunged into an unprecedented degree of deficit in 1974 and 1975 by the global recession, the increase in oil prices, and severe inflation of world trade prices generally. The next two years were dominated by the effects of a partial cyclical recovery in the industrial world and by widespread balance of payments adjustments on the part of developing countries in the aftermath of the preceding strains on their external financial positions. Consequently, the aggregate current account deficit of the non-oil less developed countries as a group was relatively low in historical perspective during 1976 and 1977 (with due allowance for inflation and growth), despite the continued incurrence of sizable imbalances by many individual countries.

Against this background, a rebound was to be expected. The resurgence of current account deficits among non-oil developing countries raised their combined deficit from $21 billion in 1977 to $31 billion in 1978, and is projected to raise it markedly further, to $43 billion, in 1979 (Table 5). In 1978, their combined deficit was moderate in historical perspective, although a number of countries were struggling with severe problems of external financing. By 1979, however, the projected deficit would appear to be high in terms of relationships to such relevant magnitudes as world trade, total output of the non-oil developing countries, or the aggregate value of their imports. Moreover, since the imbalances on current account are quite unevenly distributed among developing countries, the projected rise in the total deficit would mean that strained external positions are likely to become more numerous.

The nature of the actual and projected increases in the combined current account deficit of the non-oil developing countries from 1977 to 1979 gives as much cause for concern as their size. Of the $22 billion rise implied by the estimates shown in Table 5, some $16 billion would be attributable to deterioration of the terms of trade of these countries, whose export prices did not keep pace with prices of their imports in 1978 and are expected to lag again in 1979, while about $6 billion would probably reflect increased net payments of interest and other forms of investment income. The estimated decline in the terms of trade index for the non-oil developing countries over the period 1977–79 would leave that index at about the level to which it receded in 1975. The prominence of interest charges and deterioration of the terms of trade in the rise of the deficit of the non-oil less developed countries since 1977 is a cause for concern, since these factors have been absorbing borrowed funds without increasing the real flow of external resources for development.

Despite the modest rates of expansion projected for aggregate real demand in the industrial countries and for world trade generally, growth in the volume of exports of the non-oil developing countries in 1979 is expected to be maintained at a relatively high rate. Partly because the developing countries that have become significant exporters of manufactures are still gaining shares in markets that are very large in relation to their own exports, total exports of the non-oil developing countries are believed to be rising somewhat faster in real terms in 1979, as they did in 1978, than total real imports of the industrial countries. In addition, unit values of exports of primary commodities are expected to show a moderately more favorable movement than in 1978. This movement, however, is unlikely to match the rise in import unit values stemming from a combination of oil price increases and continued inflation of prices for manufactured goods from the industrial countries. (See Chart 11.)

Chart 11.Non-Oil Developing Countries: Real Export Earnings and Import Volume, 1972–79

(Indices, 1972 = 100)

1 Export earnings deflated by import prices.

2 Fund staff projections.

In 1978, the non-oil developing countries as a group borrowed abroad on a greatly expanded scale, sufficient (in combination with inflows of official transfers and direct investment capital) not only to cover their deficit on current account but also to permit another large addition (about $12½ billion) to their international reserves. (See Table 8.) In 1979, they appear to be receiving larger amounts in forms (official transfers, SDR allocations, and direct investment capital) that do not generate debt. At present, a considerable slowdown in the rate of accumulation of reserves seems probable.

Table 8.Non-Oil Developing Countries: Current Account Financing, 1973–78(In billions of U.S. dollars)
197319741975197619771978
Current account deficit111.330.438.025.521.231.3
Financing through transactions that do not affect net debt positions8.410.9211.210.611.913.0
Net unrequited transfers received by governments of non-oil
developing countries4.26.226.25.86.77.0
Direct investment flows, net4.24.74.94.85.26.0
Net borrowing and use of reserves32.919.5226.814.99.318.3
Reduction of reserve assets (accumulation,—)−7.7−2.9−0.7−11.3−11.7−12.5
Net external borrowing 410.622.4227.526.221.030.8
Long-term from official sources, net54.66.9210.79.411.112.4
On concessionary terms63.13.724.46.85.56.2
On nonconcessionary terms61.53.26.32.65.66.2
Other long-term borrowing from nonresidents, net5.99.111.012.911.817.8
From financial institutions53.75.97.510.912.116.9
Through bond issues50.50.30.21.22.63.6
Other sources71.72.93.30.8−2.9−2.7
Use of reserve-related credit facilities, net80.11.41.73.40.4−0.2
Other short-term borrowing, net0.94.86.94.2−1.5−1.2
Residual errors and omissions9−0.90.2−2.7−3.7−0.82.0
Sources: Fund balance of payments records and staff estimates.

Net total of balances on goods, services, and private transfers, as defined for Balance of Payments Yearbook (with sign reversed).

Excludes the effect of a revision of the terms of the disposition of economic assistance loans made by the United States to India and repayable in rupees, and of rupees already acquired by the U.S. Government in repayment of such loans. The revision has the effect of increasing government transfers by about US$2 billion, with an offset in net official loans.

I.e., financing through changes in net debt positions (net borrowing, less net accumulation—or plus net liquidation—of official reserve assets).

Includes any net use of nonreserve claims on nonresidents, errors and omissions in reported balance of payments statements for individual countries, and minor deficiencies in coverage.

Public and publicly guaranteed borrowing only.

Loans on “concessionary terms” are defined to include all loans containing a grant element greater than 25 per cent.

Including suppliers’ credits and errors and residuals arising from mismatching of data taken from creditor and debtor records.

Comprises use of Fund credit and short-term borrowing by monetary authorities from other monetary authorities.

Errors and omissions in reported balance of payments statements for individual countries, plus gold monetization and minor omissions in coverage.

Sources: Fund balance of payments records and staff estimates.

Net total of balances on goods, services, and private transfers, as defined for Balance of Payments Yearbook (with sign reversed).

Excludes the effect of a revision of the terms of the disposition of economic assistance loans made by the United States to India and repayable in rupees, and of rupees already acquired by the U.S. Government in repayment of such loans. The revision has the effect of increasing government transfers by about US$2 billion, with an offset in net official loans.

I.e., financing through changes in net debt positions (net borrowing, less net accumulation—or plus net liquidation—of official reserve assets).

Includes any net use of nonreserve claims on nonresidents, errors and omissions in reported balance of payments statements for individual countries, and minor deficiencies in coverage.

Public and publicly guaranteed borrowing only.

Loans on “concessionary terms” are defined to include all loans containing a grant element greater than 25 per cent.

Including suppliers’ credits and errors and residuals arising from mismatching of data taken from creditor and debtor records.

Comprises use of Fund credit and short-term borrowing by monetary authorities from other monetary authorities.

Errors and omissions in reported balance of payments statements for individual countries, plus gold monetization and minor omissions in coverage.

For the group as a whole, reserve holdings had reached by the end of 1978, after three consecutive years of major additions, a level that in terms of historical standards must be considered rather high in relation to imports. The significance of this observation, however, is subject to certain important qualifications. In the first place, the distribution of both the reserve gains of recent years and the outstanding holdings of reserve assets among individual countries has been quite uneven. Notwithstanding the magnitude of the overall additions to reserves and the now high average ratio of reserves to imports, many individual developing countries, especially among the low-income countries of Africa and Asia, have not shared in the reserve gains and do not have comfortable reserve positions. A second qualification is that some of the largest increases in reserves during recent years, and especially during 1978, accrued to countries whose net external debt was also expanding more rapidly. This “grossing up” of their external financial assets and liabilities detracts somewhat from the significance to be attached to the high reserve/import ratio, even in the cases of large developing countries with a strong status in international financial markets.

In the general context of reserve positions, attention may be called to the decline in use of reserve-related credit facilities by non-oil developing countries since 1976. New borrowing in this category, which comprises mainly use of Fund credit, has not been as large in the past two years ($0.1 billion per annum) as during the period 1974–76 ($2.2 billion per annum), and the limited amount of new borrowing that has occurred since then has been partly offset by repayments of credits obtained in the earlier period.

For non-oil developing countries other than those in the low-income category, the marked acceleration of net borrowing in 1978 was primarily a manifestation of the expanded role of many of the larger developing countries as fund raisers in the international banking markets. In 1978, the net absorption of long-term loans from private financial institutions by non-oil developing countries is estimated to have risen by nearly $5 billion, or well over one third, from an already historically high level in 1977. If changes in various major elements of the financing pattern (including a reduction in the rate of accumulation of reserves) materialize along the lines suggested above, the projected 1979 increase of $12 billion in the current account deficit of the non-oil developing countries as a group could be accommodated without any further increase in net external borrowing. But the overall rate of borrowing would nevertheless remain high, and the growth of external debt thus generated would continue to increase the burden of debt service charges on balance of payments positions. (See Chart 12.) Total public and publicly guaranteed debt of the developing countries expanded sharply throughout the period 1973–78, and a large proportion of the new debt contracted during this period reflected borrowing in international financial markets (Chart 13) on terms less favorable (with respect to interest rates and maturities) than those associated with traditional development financing. Largely as a consequence of this development, debt service charges have been rising faster than the debt itself.

Chart 12.Non-Oil Developing Countries: Debt and Debt Service, 1970–781

(As a percentage of exports of goods and services)

Sources: World Bank Debtor Reporting System and Fund staff estimates.

1 The debt and debt service ratios plotted in this chart relate only to external public, or publicly guaranteed, debt with an original or extended maturity of more than one year.

Chart 13.Non-Oil Developing Countries: Share of External Debt1 Owed to Various Groups of Creditors, End 1970-End 1978

(As a percentage of total debt outstanding)

Sources: World Bank Debtor Reporting System and Fund staff estimates.

1 Public and publicly guaranteed debt with an original or extended maturity of more than one year.

2 Comprises financial institutions and holders of bonds.

The above developments seem likely to reinforce the tendency that has been observed in recent years for more countries to encounter debt servicing problems. From 1974 to the end of 1978, the number of countries experiencing arrears on current payments or conducting or seeking multilateral debt renegotiations increased from 3 to 18. At the end of 1978, these countries accounted for about 12 per cent of the total outstanding external debt of developing countries. For the 18 countries with debt servicing problems, deterioration in the balance of payments was brought about by a combination of circumstances, of which one of the most common was a serious decline in the rate of export growth. In a number of cases, inadequacy of domestic policies also played a part. The growth of total indebtedness in this group of 18 countries did not differ much from that of other developing countries, but the expansion of their export earnings—and hence of their ability to service debt—did not keep pace with the average for other developing countries.

At the present time, trade and payments prospects of the non-oil developing countries are subject to important new uncertainties. Among these are the probability of a U.S. recession, the recent acceleration of inflation in the industrial countries, with its implications for prices paid by the developing countries for imports of manufactures, and the impact that the oil price increases of recent months may have on current account balances. This impact has been discussed in the introduction to the present chapter.

Experience of subgroups.—Observations formulated in terms of group aggregates or averages necessarily blur distinctions among individual countries in a group as large and diverse as the one under review. Whether in terms of levels or of net changes, the distribution of current account deficits and capital flows (as well as reserve changes) within the group of non-oil less developed countries is quite uneven.

A class of countries for which this tends to be particularly true is the low-income subgroup, whose weight in almost any macroeconomic statistics tends to be small in relation to its size in terms of population or geographic area. External positions of low-income countries were severely strained by the end of 1978, and most of them do not have effective access to the international financial markets—nor to the flows of direct investment capital—that have contributed so much to the financing of increased current account deficits for the other non-oil developing countries as a group. Since the low-income countries, unlike some of the others, were not gaining reserves on any substantial scale in 1978, they have little scope for accommodating a rise in their current account deficit through further reduction of reserve accumulations. Also noteworthy is that their external financing pattern is directed toward official and international sources of assistance that are less flexible than the international capital markets on which many other developing countries have been relying heavily in recent years. About two thirds of the total cumulative net inflow of capital to low-income countries over the period 1973-78 came in the form of concessionary loans and official transfers. As shown in Table 9, loans and grants from official external creditors provided financing for nearly 18 per cent of total imports of goods and services by these countries, and more than four fifths of the net inflow from official sources abroad was on a concessional basis. In contrast, other non-oil developing countries financed only 7 per cent of their imports through official grants or credits, with roughly two thirds of such financing on a concessional basis.

Table 9.Non-Oil Developing Countries: Comparative Structures of Import Financing for Low-Income Countries and Other Countries, 1973–78(In per cent)
Low-Income

Countries
Other

Countries
Imports of goods and services100.0100.0
Financed by
Exports of goods and services182.286.2
Officially provided long-term
capital and aid17.97.3
Official transfers, net9.32.5
Concessionary loans, net5.42.4
Subtotal14.75.0
Other official loans3.32.3
Private long-term capital, net2.310.6
Direct investment3.3
Other2.37.3
Residual financing flows, net21.90.4
Reduction in reserves−4.4−4.6

Including net receipts of private transfers.

Including use of Fund credit, short-term capital flows, and net errors and omissions.

Including net receipts of private transfers.

Including use of Fund credit, short-term capital flows, and net errors and omissions.

Relatively high dependence on official financing during a period of very limited buoyancy in the provision of this type of financing by the donor or creditor countries has produced a virtually flat trend, in real terms, in the net inflow of capital and aid received by low-income countries. In relation to the import purchasing power of the funds, this net inflow is estimated to be no larger in 1978 and 1979 than in 1973.

Even with respect to the current account itself, patterns of change during recent years have differed in the low-income countries from those observed in other developing countries. Since the middle 1970s, the former group has undergone a larger deterioration of its trade balance, partly compensated by more favorable developments in the service accounts. Because of their limited reliance on private capital markets, the low-income countries have not incurred parallel increases in interest costs on external debt; and some countries in this group have benefited to a substantial extent from receipts of migrant workers’ remittances.

An opposite deviation from the general pattern is evident in the balance of payments accounts of those developing countries that have become important exporters of manufactures.8 For this still rather small group, external positions have been relatively strong in recent years on both current account and capital account. However, it is particularly these countries—along with other developing countries where diversification of the export base has proceeded far enough to permit them to compete successfully in world markets for various manufactures—that are now threatened by the swing in the industrial countries during the past few years toward restrictive trade measures for protective purposes. Such actions have already affected access of developing countries to markets for a variety of manufactures, including textiles and clothing, footwear, steel, and electrical consumer goods; and representatives of developing countries have been voicing increasing concern about effects on their export earnings and, more broadly, on their growth and development prospects.

The recently concluded Multilateral Trade Negotiations (MTN) have provided for some potentially significant improvements in trading conditions for developing countries, but it is too early to judge whether the implementation of the various MTN agreements will succeed in arresting and reversing the drift toward protective trade policies. Success with respect to that objective will also depend in considerable part on the adoption by industrial countries, as well as developing countries, of policies to encourage desirable structural adjustments.

Regional developments.—All but one of the manufacturing exporters singled out for special attention above are in the Asian and Latin American areas, while more than half of the low-income countries, as noted earlier, are concentrated in Africa. This uneven distribution of countries with quite different characteristics goes far toward explaining regional differences in the evolution of trade and payments balances. Another differentiating factor, of course, is the prevalence of dissimilar trends in prices for various classes of primary commodities (discussed briefly in the foregoing commentary on global perspectives). While recent differences in such price movements are too numerous to trace in this Report, they have clearly contributed to some of the major divergences observable in regional comparisons. Relative weakness has been apparent during the past year or so in export prices of many African and Latin American countries, as well as some in the Middle East, while Asian primary product prices have been relatively buoyant. Indeed, Asia was the only major region for which market prices of primary commodity exports rose in 1978. The strength of exports of manufactures from several Asian developing countries has also been an important factor in the evolution of their external balances for several years, but may be of diminishing influence in 1979 because of various protectionist shifts in some of the importing countries.

Regional current account balances depend not only on export earnings, of course, but equally on flows of imports. Here, too, the most rapid expansion in 1978, as in each of the preceding two years, was that recorded for the Asian countries. For them, a large increase in import volume raised the region’s aggregate current account deficit to $5 billion in 1978, compared with less than $1 billion in 1977 and about $1½ billion in 1976. The regional current account deficit also rose substantially in Latin America and the Caribbean, where it had been halved from 1975 to 1977 by a combination of favorable commodity prices, especially for coffee, and declining imports in real terms. Both of these factors were reversed in 1978, as import volume rose moderately after three consecutive years of decline. In addition, increased payments for services, including interest payments on external debt, contributed importantly to the rebound of the combined current account deficit of the Latin American and Caribbean countries in 1978.

In the African area, weak growth of export earnings from 1977 to 1978 made an intensification of external payments pressures almost unavoidable. Even with a very small rise in import volume (the smallest for any of the regional groups), the aggregate current account deficit of the African countries increased by about $2 billion in 1978, to some $8½ billion. The non-oil developing countries of the Middle East showed an appreciably smaller increase in their current account deficit, despite a relatively marked deterioration of their trade balance. For these countries, rapid expansion of receipts for services and private transfers, including remittances from expatriate workers in neighboring oil countries, has counterbalanced the enlargement of their trade deficit over the past two years.

Major Oil Exporting Countries

The balance of payments experience of the major oil exporting countries during recent years has differed greatly from the general experience of other developing countries. It may be recalled that the combined current account surplus of the oil exporting group declined sharply and somewhat irregularly from $68 billion in 1974 to about $32 billion in 1977. Over those three years, the volume of imports expanded substantially, although at a decelerating pace, while the volume of exports rose only slightly because of the relatively slow growth of world oil consumption and the rise in oil production of other countries in 1977. Cumulatively, the further increases in oil prices that occurred intermittently after 1974 were about equal to the rise in import prices paid by the oil exporting countries, so that the terms of trade of those countries were virtually the same in 1977 as in 1974.

The deficit of the oil exporting countries on account of services and private transfers showed a strong upward trend throughout those three years, reaching a level of about $30 billion in 1977. The latter figure was almost 2½ times the size of the corresponding deficit in 1973, reflecting mainly a rapid growth in payments to foreign contractors, in remittances by expatriate workers, and in payments of freight and insurance on merchandise imports. Payments of this last type were particularly high from 1975 through 1977 because of the freight surcharges and demurrage payments associated with port congestion. The increase in total payments for “invisibles” was only partly offset by the relatively large rise in investment income on external assets.

According to the provisional estimates given in Table 6, the combined current account surplus of the major oil exporting countries fell by $26 billion in 1978, to about $6 billion. This sharp decline reflected the effects of an appreciable dip in the value of oil exports and of further growth in both imports and net payments for services and private transfers.

The 1977–78 decline in the value of oil exports—which account for more than 93 per cent of all exports of the major oil exporting countries—stemmed almost entirely from a fall in export volume. The demand for oil from these countries was relatively weak in the first half of the year, and the supply was curtailed by interruptions of oil production in Iran during the closing months. The average oil export price in terms of U.S. dollars remained virtually unchanged in 1978 on a year-to-year basis, as the OPEC meetings in December 1977 and June 1978 did not result in any decision to change the price of the marker crude. Meanwhile, the volume and value of total imports continued to rise, although at a decelerating rate.

For 1979, a strong rebound in the current account surplus of the major oil exporting countries is clearly indicated, their combined surplus being tentatively projected at $43 billion (Table 5). In the main, this rebound is a reflection of the improvement in the terms of trade of the oil exporters resulting from the large increases in oil prices that have taken place this year. A virtual cessation of the previously rapid increase of imports in real terms, however, is another notable reason for the upsurge in the surplus. This leveling off of total imports reflects mainly a substantial decline in imports of Iran because of the recent impairment of economic activity in that country. For the other major oil exporters as a group, increased receipts from oil exports are expected to contribute to an acceleration of import growth in 1979, although most of these countries are continuing to pursue relatively restrained demand management policies.

Within the group of major oil exporters, the current account surplus has become increasingly concentrated. By 1978, six of the countries in the group still had a combined surplus of $21 billion, while the other six major oil exporters had a combined current account deficit of $15 billion. Positive shifts are projected for both groups in 1979, but the greater part of the combined improvement is likely to be reflected in the position of the first group because of a shift, associated with the Iranian situation, in the origins of oil exports.

The total net cash surplus available for disposition by the major oil exporting countries is estimated to have declined less in 1978 than the combined current account surplus, mainly because of changes in outstanding oil export credits and a rise in borrowing by official institutions of oil exporting countries with enlarged current account deficits. Incomplete information on the disposition of the net cash surplus in 1978 indicates a marked decline in net placements in bank deposits and government securities, a more moderate decline in other capital flows (such as placements in corporate equities and bonds) to the developed countries, and maintenance of the flow of funds from the major oil exporters to other developing countries at approximately the same level as in 1977. The much smaller increase in assets of a relatively liquid nature during 1978 than during the preceding years appears to have reflected, at least to some extent, drawdowns of liquid holdings by those oil exporting countries that incurred balance of payments deficits in 1978.

In 1979, the total net cash surplus of the major oil exporters is expected to increase less sharply than their combined current account surplus. One reason is the lag of cash payments for oil behind the corresponding exports. Also, net borrowing by the six major oil exporters that were in deficit on current account in 1978 is likely to decline with the strengthening of their external positions because of the recent price increases.

More Developed Primary Producing Countries

During the mid-1970s, most of the more developed primary producing countries encountered severe balance of payments problems. Their combined current account deficit rose to $14 billion in 1974 and remained stubbornly in the $13–15 billion range through 1977 (Table 5). Relatively weak demand for their exports on the part of the industrial countries, a persistent decline in their terms of trade, and comparatively high rates of inflation, in some cases not accompanied by exchange rate adjustments, were among the factors underlying the prolonged maintenance of such large current account deficits. The initially strong external financial positions of the majority of countries in the more developed primary producing group, coupled with their generally ready access to international capital markets, allowed a number of them to postpone adjustment to the external shocks and inflationary forces that emerged in the middle 1970s.

Although several countries in the group did adopt effective stabilization programs early in that period, the response in their external accounts tended to be weakened by the sluggishness of export markets and severe deterioration of the terms of trade, and to be offset within the group total by widening current account deficits of countries that continued to pursue expansionary policies. These latter countries drew down reserves and resorted increasingly to international financial markets to finance the deficits until 1977 or early 1978, when several of them finally adopted stabilization programs.

More restrictive fiscal and monetary policies, various kinds of incomes policy measures, and adjustments of exchange rates were among the elements in these programs. With their implementation, 1978 became something of a turning point in the external adjustment history of the more developed primary producing group. Its aggregate deficit on current account was cut by more than half, in comparison with the deficits of 1977 and the immediately preceding years, to a level that was no longer seriously out of line with the experience of the countries in this group during the 1960s and early 1970s. This major adjustment reflected, in addition to a sharp reduction in the trade deficit, a substantial increase in the surplus on external service transactions, mainly through larger receipts from tourism in the Mediterranean countries. The reduction in the trade deficit reflected a cutback in domestic absorption of goods and services (with real imports declining slightly and real exports expanding sharply) under the influence of more restrained domestic demand management policies and lower exchange rates for some of the countries concerned.

The non-European countries among the more developed primary producers were perhaps hit harder by the external shocks of the mid-1970s than most of the other members of the group. Their terms of trade deteriorated by 30 per cent from 1973 to 1978, and their traditional deficit on service transactions rose progressively throughout the period. Despite early adjustment measures, which kept their internal and external imbalances generally within manageable proportions, the economic policies of the non-European countries continue to be constrained by considerations relating to their external accounts.

Of the more developed primary producers that adopted Fund-supported stabilization programs in late 1977 or early 1978, Spain was the one achieving the clearest success on the external side. Its current account balance, after several years of widening deficits, accompanied by increasing reliance on foreign borrowing, moved from a deficit of $2½ billion in 1977 to a surplus of $1½ billion in 1978, and its gross official reserves—bolstered also by substantial capital inflows into the private sector—rose by $4 billion. Stabilization efforts in Portugal also achieved encouraging, although more limited, results. Large depreciations of the escudo in 1977 and 1978, as well as cuts in real wages in both years, improved the international competitiveness of Portuguese industry and resulted in an improvement of the trade balance in real terms in 1978, after substantial deteriorations in the preceding two years. In Turkey, financial policies for too long took inadequate account of changed external circumstances. In 1977, the Turkish lira was depreciated but mounting inflationary pressures and further large-scale expansion of domestic credit contributed to the intensification of balance of payments difficulties. The further depreciation of the currency in 1978 was accompanied by a more cohesive program of economic policies, but this failed to slow down the rapid rise in costs and prices, partly because there was not sufficient policy flexibility to follow through with the necessary additional measures. The halving of the current account deficit from 1977 to 1978 reflected primarily the need to cut imports severely in view of the shortage of external financing. Recently, however, a new stabilization program coupled with substantial further exchange rate adjustments has been agreed with the Fund.

In 1979, a moderate pickup in domestic economic activity in the more developed primary producing countries seems likely to induce an expansion of their imports in real terms for the first time in five years. Along with yet another deterioration in the group’s terms of trade, this resumption of import growth would imply a considerable increase in its aggregate current account deficit. The increase foreseen would not appear likely, in general, to strain the external borrowing capacities of most of the countries under review. A few members of the group, however, remain in precarious external positions and could ill afford to share in the enlargement of the combined deficit.

Key Issues of Policy

At the end of 1978, worries were being felt in many quarters about the international energy picture over the longer term and about fundamental aspects of economic performance, including high inflation, sluggish economic growth, underutilization of resources, periodic instability of foreign exchange markets, the difficult situation of the non-oil developing countries, and the spread of protectionist trade measures. To these factors has been added the steep run-up in oil prices during 1979. The current environment of great uncertainty clearly foreshadows a period of severe strains in the world economy, emphasizing the need for policies to deal with them.

Of key importance in this regard will be the character of domestic economic policies pursued in the industrial countries. The present array of problems confronting national authorities in the industrial world precludes simple prescriptions offering promise of early success, but rather points to the need for pursuit of a many-sided strategy of policy in a medium-term framework. Similar in this regard is the position of a number of more developed primary producing countries.

As suggested earlier in this chapter, the basic approach must be a “gradual” one, but not “too gradual.” It calls for determined and skillful use of the traditional monetary and fiscal instruments, combined with the application of suitable incomes policies (e.g., to prevent oil price increases and other external cost pressures from entering into the indexation, formal or de facto, of wages and other incomes) and increased emphasis on measures to effect structural adjustments and improve supply capabilities, including adaptation to the lower availability and higher price of energy. Obviously, a strategy of policy along these lines will be difficult to implement; it will require courage and perseverance so as to elicit public support for national economic policies and, above all, to reduce inflationary expectations.

The international setting in which industrial countries will be conducting their domestic economic policies is in the process of changing substantially. At the beginning of 1979, the growth of total output in these countries, after proceeding at a pace of 4 per cent in each of the past two years, was expected to decline moderately because of an economic slowdown in the United States—a slowdown that was sought by the U.S. authorities, and welcomed internationally, in view of the need to curb domestic inflationary pressures. Now, it seems clear that the decline of output growth in the industrial world will prove to be much sharper than had been generally expected.

Two developments are important in this respect. First, the oil price increases since the end of 1978 may be expected to have a generally depressive effect on economic growth, both directly through their deflationary impact and indirectly through their intensification of the inflationary process.9 Second, the course of real GNP in the United States during the first half of 1979—very little increase in the first quarter and a decline in the second—has turned out to be quite weak. At the present juncture, U.S. economic indicators available through June are inconclusive; but, with allowance also for the strength of the current inflationary spiral and for the probable effects of the shortage of oil, it seems likely that a U.S. recession is now under way—a view in line with statements by U.S. officials, who expect the recession to be short-lived and mild.

Such a situation raises a number of important policy issues. In the first place, a U.S. recession (whatever its duration or severity) could not be “offset” in the other industrial countries; in general, their economies are not buoyant and, because of either the fact or the threat of inflation, they would not be in a position to adopt significantly more expansionary policies in the endeavor to compensate for a recessionary development in the United States, although they could reasonably be expected to maintain their growth rates as much as possible. As for the United States itself, a “cooling off” period of very low growth of output or of declining output would serve to dampen inflationary pressures, but it would not permit any lowering of the priority that has been accorded by the U.S. authorities to the reduction of inflation in a medium-term context. Indeed, policies to counter recession would need to be very cautious, with primary reliance placed on built-in (“automatic”) fiscal stabilizers to support the economy. On the external side, a flattening out or decline in U.S. economic activity would have a positive impact on the current account balance through an easing of the demand for imports. However, the impact on the overall U.S. balance of payments and on the effective exchange rate for the dollar would depend also on the extent to which changes in relative monetary conditions affected capital account positions.

A more general point of significance is that exchange rates for the major currencies would be subject to different influences in a setting of weaker demand conditions, coupled with the higher oil prices and continuing inflation. Whether the relative calm that has characterized the exchange markets in recent months would be extended would depend to a large extent on policies. The larger industrial countries, while keeping their policies attuned to fundamental objectives, might well find it necessary to coordinate their actions regarding exchange market intervention and, at least to some extent, their monetary policies.

A softening in the pace of economic activity in the industrial world could have markedly adverse effects on the primary producing countries. Within this very large and heterogeneous group, conditions and policies differ widely but particular attention needs to be paid to the situation of the non-oil developing countries. Most of these countries have been experiencing growth rates in recent years not commensurate with their developmental needs, and an increasing number of them are struggling with balance of payments problems stemming from recently enlarged current account deficits and mounting burdens of external indebtedness—all of which will be exacerbated, in the year or so ahead, by effects of the recent oil price increases and of the continuing slowdown of economic activity in the industrial countries. Among the non-oil less developed countries, conditions and prospects are particularly unsatisfactory in many of the poorest countries that have been singled out for special attention in this chapter. The economic performance of the low-income group of developing countries, which contain more than two fifths of the population of all Fund members, is clearly a major cause for concern in terms of human welfare.

Many of the non-oil developing countries need to adopt better domestic policies in order to deal with the very difficult situation that they now face, as well as to establish an environment attractive to foreign investment and financing. But their problems could be eased by actions on the part of industrial countries. One such problem derives from the fact, already noted, that the bulk of new indebtedness incurred by the non-oil less developed countries in the past five years came from borrowing in international financial markets on terms less favorable than those associated with traditional development financing, so that debt service charges are now rising faster than the debt itself, and faster than export earnings. Particularly in the case of many low-income, low-growth developing countries, the debts contracted since 1974 represent—from the standpoint of such borrowers—a costly and ill-adapted way of transferring savings internationally.

To assist developing countries with their external financing, industrial countries in a strong position on current account should take all feasible steps to improve their position as capital exporters. An important area of such improvement must be to ensure a larger stabilizing flow of private capital—something that inevitably takes time to achieve but that can be influenced by additional governmental measures to encourage capital outflows, both directly and through changes in institutional arrangements and practices in the private sector. In addition, and here immediate action could be taken, there is a strong case for all industrial countries—surplus and deficit alike—to increase their official development assistance. Such assistance amounts to only about ⅓ of 1 per cent of GNP for industrial donor countries combined, with several of the large countries—including those in a surplus position—having even lower percentages. Expanded flows of capital and aid to the developing countries—along with measures to improve market access for their exports—are essential for their economic development, and also for the proper functioning of the international monetary system.

Considerable scope for improvement of economic conditions around the world lies in a better working of the international adjustment process. The wide differences that characterize the current positions of member countries call for adjustment policies on a broad scale, carefully differentiated on an individual country basis. As a general proposition, each country should contribute to world economic growth in relation to the strength of its external position and to its price performance. The implications of such an approach—if carried out effectively—are that countries in a relatively strong external position would act to support growth to the extent that it would not jeopardize their anti-inflation programs, while countries in a relatively weak external position and with high inflation would adopt corrective measures of a fundamental nature to deal with their problems.

In this context, the industrial countries could make a particularly important contribution by coordinating their growth objectives and policies over the medium term. Such a process could serve to bolster economic growth, to safeguard the recent improvement in the distribution of current account balances, and thus to promote the maintenance of orderly exchange markets and of reasonable stability in the exchange rates for major currencies. Important in this connection is the finding that seemingly moderate differences in growth rates among the major industrial countries could lead to substantial differences in their current account balances, with possibly severe impact on the functioning of the international adjustment process. It is clear that the rest of the world has a strong stake in the pursuit of policies by the major industrial countries directed toward coordinated growth and payments adjustment.

It must be stressed that the preceding brief sketch of how the functioning of the international adjustment process could be improved involves issues that are very controversial, as well as complex. Yet, hope for further progress in this area is to be found in the widespread recognition that—given the interdependence among countries in a world of serious economic and financial problems—no country can afford to ignore international influences in the management of its economy.

The very difficult conditions now confronting the authorities of most member countries also portray a large, and probably difficult, task for the International Monetary Fund. The role of the Fund is a very broad one, ranging from the conduct of a worldwide forum on economic and financial problems to the provision of financial, consultative, and technical services to individual countries. In the exercise of all its functions, such as those involving the principles of conditionality or of surveillance over exchange rate policies, the Fund must act fairly and evenhandedly—an assurance given by the Managing Director in his concluding remarks at the 1978 Annual Meeting of the Board of Governors.

It seems evident that, under the conditions that loom ahead, the Fund must be prepared to assist many of its member countries in dealing with their economic and financial problems. But, notwithstanding the high priority that has to be given to adjustment, it would appear that claims on the Fund’s resources in the next few years could be large. The Fund has endeavored to adapt its policies and facilities to the needs of member countries in the changing circumstances of recent years, and it is continuing to assess the adequacy of improvements that have been, or are being, introduced. In addition, in view of the uncertainty that characterizes the international economic situation, it would be highly desirable for member countries to expedite their acceptance of quota increases under the Seventh General Review of Quotas. If all members accepted quota increases to the maximum amounts proposed, total quotas in the Fund (as explained in Chapter 3) would rise as a result of the Seventh General Review from the current level of SDR 39.0 billion to SDR 58.6 billion—thus placing the Fund in a much better financial position to meet potential needs for use of its resources.

1By far the most important exception is oil produced in the United States, for which price increases are not expected to parallel those in the world market.
2These developments in wholesale prices are clearly noteworthy. But it should be recalled that wholesale price indices, particularly those covering all commodities, are generally subject to a number of statistical inadequacies, and that they tend to be much more volatile than indices of final product prices, such as GNP deflators and consumer price indices.
3These were described briefly in the Annual Report, 1978, pages 6–7.
4Corresponding changes in unit values expressed in terms of SDRs are given in Table 3.
5Based on the MERM indices published in International Financial Statistics.
6See Chapter 2 for comment on the founding and objectives of the EMS.
7As a group, the major industrial countries other than Canada have supplied a relatively steady net flow of capital to other areas in recent years. The magnitude of this flow, it should be noted, is seriously understated in conventional balance of payments statistics because official Eurocurrency deposits by other countries in banks located in the industrial countries are reported by the latter as capital inflows, rather than as reserve-related official financing.
8Here defined to comprise nine developing countries (Argentina, Brazil, the Republic of China, Hong Kong, India, Israel, Korea, Mexico, and Singapore), each of whose exports of manufactures amounted to at least $1 billion in 1976.
9For a brief discussion of the effects of the recent oil price increases and of the appropriate policy responses, see the introduction to this chapter, page 2.

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