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Climate for Development: the Fund’s Influence

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
September 1972
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Eduard H. Brau

A developing country’s ability to accelerate its social and economic development depends greatly on the economic opportunities open to it in the outside world, opportunities that are determined largely by the developed countries and their individual or common economic policies as they affect developing countries.

The importance to developing countries of this “development climate” is demonstrated by the fact that in 1970 approximately 78 per cent of developing countries’ exports went to developed countries while 77 per cent of their total imports came from these countries.1 Developed countries are, therefore, the major market for developing countries’ exports as well as the major source of their imports. This has pervasive consequences. It means that the export opportunities of developing countries depend fundamentally on demand conditions in developed countries in the sense that the higher the economic activity of these countries, the higher are the exports of the developing countries. Higher export receipts give developing countries an increased capacity to import needed consumer and capital goods. The importation of capital goods, the production of which in developing countries, if possible at all, would often involve prohibitive costs, is one prerequisite for achieving rapid development. In addition, the importation rather than the domestic production of certain capital goods allows developing countries to use their resources more efficiently, which is of course better for their development in the long run.

Aside from the success of developed countries in achieving high rates of capacity utilization, developing countries are greatly affected by the degree to which developed countries succeed in containing inflationary pressures. Inflationary pressures not only intensify the problem of balance of payments management in developed countries and increase the cost of external credit to developing countries, but may also result in increases in the cost of imports of manufactured products to developing countries, which surpass the gains in prices of exports from these countries. Inflationary pressures spreading from developed to developing countries make it more difficult to achieve in the latter the degree of stability that is necessary for sustained rapid growth.

Exports from developing countries consist mainly of primary commodities, prices of which undergo wide fluctuations. However, as a means of improving their standard of living many developing countries wish to reduce their dependence on primary production by industrializing their economies and exporting manufactured products. The success of such efforts depends, to a large extent, on the access of their manufactured products to the markets in developed countries, since the relatively small economic size of many developing countries does not provide a sufficiently large market to support manufacturing production on an efficient scale. The problem of market access, therefore, involves the question of trade and marketing barriers as they may exist in the form of quotas, high nominal tariffs, or high effective rates of protection of the value added of developing countries’ export products, and lack of marketing channels. Thus, the trading prospects of developing countries, and through them their efforts to accelerate economic development, are significantly affected by external economic conditions.

The climate of development is also influenced by the availability of foreign aid. Aid resources are of basic importance because they supplement domestic savings and therefore enable developing countries to achieve more quickly the investment base required for economic growth. The amount of aid and, in turn, the terms on which it is provided, depend on the ability and willingness of the developed countries to extend it. Balance of payments difficulties in developed countries, for example, have been an impediment, prompting many donor countries to tie aid to the purchase of their own goods, resulting in a reduced real value of aid; the country receiving aid may have to accept higher prices and is, in any case, restricted in its choice of supply sources.

One could go on to indicate how economic developments and policies in the developed countries affect developing countries through the dissemination of managerial and technical know-how, by direct foreign investments and other capital movements, and in other ways. All such examples would serve to show that the climate for development has significant direct and indirect dynamic effects on the economic progress of the developing countries.

It is clear, then, that developing countries, in composing their overall development strategy, have to give great attention to external factors. Among the constraints imposed upon an accelerated economic development, those resulting from the climate for development are often more easily removed than those internal contraints which might require basic changes in economic and cultural habits. In turn, higher economic returns resulting from improved external conditions for development enable developing countries to pursue more effectively desirable internal economic policies.

INFLUENCE THROUGH DEVELOPED COUNTRIES

Enforcement of the Articles of Agreement

The improvement of the external conditions of development for all member countries is the raison d’ütre of the International Monetary Fund. The achievement of high levels of employment and the growth of real incomes, particularly for the economically smaller countries and for developing countries, depend crucially on economic cooperation and collaboration between countries; this can be appreciated by looking at economic events between the two world wars when that cooperation was largely absent.

The Fund was established in 1946 to avoid a recurrence of the experience of the 1930s, when each country sought to improve its prosperity at the expense of the other with everyone ending up worse off. Under its Articles of Agreement the Fund was, therefore, charged with facilitating cooperation among countries to ensure the proper functioning of the international monetary system in order “to facilitate the expansion and balanced growth of international trade, and to contribute thereby [italics supplied by the author] to the promotion and maintenance of high levels of employment and real income and to the development of the productive resources of all members as primary objectives of economic policy” (Article I(ii)). The Fund’s immediate concern with international monetary cooperation is therefore seen as an indispensable tool for furthering world trade and thereby high levels of real income and rapid development. To achieve the same end, the World Bank and the General Agreement on Tariffs and Trade (GATT) were established in complementary roles to facilitate long-term capital transfers to developing countries and to further cooperation in trade matters.

Under the Articles of Agreement, member governments have agreed to establish and maintain a liberal and multilateral international exchange and payments system, to promote exchange stability, to maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciations. Governments have, thereby, opened to international scrutiny what was once regarded as the exclusive domain of national sovereignty in economic affairs. They have undertaken such obligations in order to help ensure smooth balance of payments adjustments among countries without resorting to measures that are harmful to national or international prosperity. In many countries it has been balance of payments disequilibria and undesirable ways of coping with them that have provoked harmful effects. These result when a country, in particular a large industrial country, attempts to resolve balance of payments difficulties by imposing exchange and trade restrictions, such as import quotas. Through the adoption of protectionist devices, the country exports its troubles in a way which commonly has a haphazard, injurious effect on industries in other countries. Moreover, trade quotas are usually introduced to protect domestic production of those products which other countries can produce at comparative advantage. In an industrial country this frequently means that import quotas are placed on labor-intensive and technologically less sophisticated products, i.e., those goods that developing countries are most likely to be able to export. If this happens to a significant degree, developing countries are denied an important means of utilizing effectively what may well be their most abundant resource—labor—with serious adverse social consequences.

Through enforcement of the Articles of Agreement by requiring countries to seek temporary approval for exchange practices inconsistent with the Articles while more basically corrective policies are being prepared, through consultations with member countries, and through the use of its financial resources, the Fund endeavors to help countries minimize the use of protectionism and deflationary policies to cope with balance of payments difficulties. If developed countries can make full use of their productive capacity in an environment of smooth balance of payments adjustment, less developed countries benefit from expanding opportunities for profitable trade, and the integration of their economies into the international division of labor—which is one important basis for prosperity in developed countries—is speeded up.

A point that is significant economically and politically may be mentioned in this context. Over the long run, the production of relatively simple and labor-intensive products tends to shift from the industrial countries, where labor costs are high, to the developing countries. This tendency means that workers and capital in affected industries of developed countries need to find employment in alternative industries. This shift of resources, however, is difficult, since economic activity in developed countries is low and demands for protection of affected industries from foreign competition are typically high in such periods. In this sense, high levels of activity in developed countries are a precondition for the growth of developing countries’ export markets in a proportion higher than increases in annual income in developed countries.

During the recent international monetary crisis, when major currencies were floating with respect to the U. S. dollar, less developed countries emphasized their strong interest in the preservation of an ordered system of international trade and payments which is regulated on a multilateral basis by institutions in which these countries have a voice. The effects of the wide variety of restrictions adopted by several developed countries at that time and the disturbances to the trading interests of developing countries made it very clear that rules of international conduct in economic affairs, observed by all countries, help to protect the interest of economically weaker countries. As a result, less developed countries as a group strongly supported the efforts of the Fund to promote an early return to stability in exchange arrangements.

Consultations and Multilateral Coordination

The Fund’s regular consultations with developed countries serve, in a sense, as an early warning system for identifying economic issues affecting less developed countries. These consultations review recent economic developments in a country and outline and evaluate the authorities’ planning for the near future. Emphasis is placed on ways and means of preventing the emergence of balance of payments difficulties and, if they exist, of solving them in the best way. In this respect, the international experience of the Fund is helpful to member countries. The policies of a developed country are reviewed, particularly with a view to examining their compatibility with policies pursued in other major developed countries and with a view to drawing the attention of policymakers to the repercussions of their policies on the developing countries. Such efforts are of potential importance since international coordination of economic policies can forestall the emergence of serious balance of payments difficulties. When the report of the Fund staff on a consultation mission to a developed country is discussed by the Executive Board of the Fund, the Executive Directors from developing countries regularly express their views on the specific economic policies of developed countries that are of concern to them. In this way, a continuing interchange of views regarding pertinent day-to-day issues is maintained among developed and less developed countries.

Developing countries frequently express concern about the barriers that prevent the free access of their export products to markets in developed countries. Through its efforts to secure a smooth balance of payments adjustment process, the Fund attempts to encourage the adoption by developed countries of commercial policies that will speed the progress of the less developed countries, by helping their integration into the international economy. An important step in this direction has been taken by several industrialized countries that recently implemented the generalized system of preferences for the exports of manufactures and semimanufactures from developing countries which was worked out under the auspices of the United Nations Conference on Trade and Development. An especially welcome feature of this arrangement is its generalized application to all developing countries, counteracting recent trends toward the formation of associations between specific developed countries perhaps in regional groupings and specific less developed countries. From an economic viewpoint, the development of such economic blocks seems deplorable. These groups are likely to increase barriers to trade and capital movements with countries not in the group, while at the same time reducing such barriers with countries within the group.

A problem confronting developing countries for many years is the effect of the reliance by developed countries on capital control devices to cope with balance of payments disequilibria on capital exports and aid flows. Although governments in developed countries often explicitly exempt from such controls capital exports to less developed countries, any decrease in competition in world capital markets tends to be detrimental to the interests of less developed countries as a group. In addition, if fundamental balance of payments disequilibria in developed countries go uncorrected for longer periods of time, the inducements for seeking speculative returns from capital placements are high and create a climate which discourages flows of private capital on a longer-term basis to less developed countries. Anxiety about a possible change in the par value of a major currency, moreover, increases the difficulties of developing countries in finding adequate sources of financing for their trade, as was widely observed during the recent currency crisis.

In its reports on consultations with developed countries, the Fund regularly reviews the policies of developed countries with respect to private and official capital transfers to less developed countries. It also reviews those actions relating to specific commodities which have the effect of reducing the export earning capacity of developing countries. The Fund has a particular interest in commodity trade practices that may lead to use of the compensatory financing facility of the Fund or that affect the operation of buffer stock schemes. Therefore, the Fund staff is making efforts in consultation discussions to conduct a closer review of the international aspect of commodity problems and policies.

In the Annual Reports of the Executive Directors, in other publications, and in speeches by the Managing Director, the Fund directs attention to the implications for developing countries of the economic policies of industrial countries. An example from the 1971 Annual Report is much to the point.

The record of the past half-dozen years or so clearly indicates a number of ways in which they [developing nations] would stand to gain from an improvement in the economic policies of industrial countries. Thus, the less developed nations have been affected by the higher cost and restricted availability of credit in international financial markets because of the undue emphasis by industrial countries on monetary policy in programs of financial restraint; by a less-than-satisfactory environment for development planning because of the alternating impact of overexpansion and contraction in those countries; and by a sluggishness in the flow of official capital and aid, perhaps in part because of the preoccupation of the industrial countries with their own problems of inflation, balance of payments difficulties, and budgetary pressures. Further, experience has shown that when periods of slack in the industrial countries follow excessive rates of resource utilization, the less developed countries tend to lose earlier gains in the volume and prices of their exports while they may sometimes feel a more lasting impact of cost escalation on prices of the manufactured products that predominate among their imports.

Against this background, the efforts now under way in other international organizations to assist the developing nations by untying aid and by granting preferential treatment to their exports of manufactured products are gratifying and deserve the widest possible support. At the same time, there remains an urgent need for major improvement in the volume and quality of development assistance as a whole. The flow of official capital and aid to the developing nations failed by a substantial margin, as is well known, to keep pace with the relative growth of income in the industrial countries over the 1960s, and in recent years the aid flow has probably declined somewhat in real terms. It is to be hoped that the industrial countries will endeavor to raise the level of development assistance according to their potential; this would be in accord with the interests of the international community as a whole, as well as responsive to the immense needs of the less developed countries.

Earlier articles in this series were “Financial Stability and Planning,” by Subimal Mookerjee, Finance and Development, March 1972 and “Fund Activities in Developing Countries,” by Ernest Sturc, Finance and Development, June 1972.

A practice has evolved for the Fund to be represented in international meetings of governmental groups concerned with such developing country problems as aid and debt consolidation. Groups in which various developed countries are represented have been formed, usually under the chairmanship of the World Bank, to review periodically the aid requirements of specific developing countries. At these meetings the Fund staff normally presents a review of the economic conditions and policies of the developing country concerned. At multilateral conferences dealing with the consolidation of the external debt of a developing member, the Fund also assists on technical matters such as balance of payments position and prospects. The Fund has been invited by both creditor and debtor to attend these meetings because of its close acquaintance with the problems of the developing countries. The 1965 Annual Report of the Fund has assessed the Fund’s role in this way:

Although the debtor usually can present an exposition of its position, there is a decided advantage to both the debtor and the creditor if there can be an impartial presentation of the facts. The Fund is in a good position to provide such an analysis of the short-term and medium-term balance of payments prospects, while the IBRD is in a comparable position to assess longer-term development trends.

The Fund has especially close relations with the World Bank and also collaborates with other international organizations concerned with developing countries’ problems, such as the Economic and Social Council (ECOSOC), the United Nations Conference on Trade and Development (UNCTAD), the General Agreement on Tariffs and Trade (GATT), regional development banks and agencies, and others. (See “The Fund and the GATT” in this issue.)

FUND RESOURCES AND SPECIAL DRAWING RIGHTS

Perhaps the most visible ways in which the Fund furthers the balance of payments adjustment process is through the provision of Fund resources to countries and through the maintenance of adequate international liquidity by means of increases in Fund quotas and allocations of special drawing rights (SDRs) to member countries.

Fund resources are made available usually in connection with a stand-by arrangement which is granted in support of economic programs that the authorities wish to implement in the next year. The balance of payments financing through Fund resources allows the country to adjust aggregate demand to a level compatible with the productive capacity of the economy and/or to facilitate the time-consuming process of any shifts in productive resources within the economy called for as a result of an exchange rate depreciation. During the time that these adjustments take place, the temporary financing of the remaining balance of payments deficit through Fund resources may enable the country to avoid introducing trade and exchange restrictions and deflationary policies. In the past, the Fund has actively encouraged, with Fund resources, such balance of payments adjustment policies in major developed countries. Recent cases in point are stand-by arrangements with the United Kingdom (in 1964, 1967, and 1969) and with France (in 1969).

In addition to the availability of Fund resources, the Special Drawing Account established by the Fund in 1969 is intended to play an important role in facilitating balance of payments adjustments in an environment of high employment. The pre-SDR international liquidity mechanism relied for the additional supply of internationally accepted reserve assets on the vagaries of gold production and on the supply of reserve currencies, particularly the U. S. dollar. In the discussions leading to the establishment of SDRs, it was feared that the needed achievement of equilibrium in the U. S. balance of payments would lead to an inadequate expansion in global liquidity. This, it was argued, would in turn place a constraint upon the expansion of world trade and production as countries sought to accumulate desired portions of insufficient global reserves. Such a development would, of course, be averted if an adequate growth of world reserves were to be assured by deliberate reserve creation, as in the form of SDRs.

In the event, the major outflows of dollars from the United States in 1970 and 1971 represented a departure from the assumptions made at the time when the decisions on SDR allocations for the first basic allocation period (1970-72) were taken. This departure and related events in the past year or so brought about a fundamental re-examination of the international monetary system, including the SDR scheme, that is still under active discussion. Although the objective of promptly securing a greater degree of control over international reserves was not fulfilled, recent developments have led many to believe that in the reformed international monetary system SDRs should play a larger role. This would, of course, require some changes in the SDR mechanism.

In the first basic allocation period, developing countries received a total of SDR 2,348 million, representing about 43 per cent of the increase in total international reserve holdings of developing countries in that period and more than 11 per cent of the total outstanding at the end of 1971. The cumulative allocations of SDR 2,348 mililon are equivalent to about 4 per cent of total imports of developing countries in 1970. By the end of March 1972, developing countries had made important net use of their SDRs, reducing their holdings by some SDR 766 million, or about one third of the total allocation.

Before concluding, it must be noted that there is widespread agreement that improvements in international monetary rules are needed in order to achieve the goals, cited earlier, that are set out in the Fund’s Articles of Agreement. Discussions are now in progress covering a wide range of issues difficult to summarize in a brief statement. Among the issues being considered are ways in which changes in par values might be made with less political difficulty and more promptly than in the past; wider exchange rate margins; the future roles of reserve currencies, gold, and SDRs; the management of volatile capital flows; and the need to increase the supply of resources for development. Associated with such issues is the problem of reducing trade barriers among industrialized countries and between industrialized and developing countries.

Developing countries have, of course, a big stake in a smoothly functioning international monetary and trade system. In the pending reform of the system, one question of particular interest to them is whether future allocations of SDRs might not be used—consistently with the other objectives that SDRs are to fulfill—to make available finance for development, inasmuch as official development aid has stagnated and possibly declined in real terms as of late. Among the principal proposals that have been advanced is one to allocate SDRs directly for purposes of development aid, possibly through international development lending agencies, and another to modify the formula for SDR allocation or to increase the developing countries’ quotas in the Fund, both with the aim of ensuring a higher share for developing countries in future SDR allocations.

A recurrent theme in this article has been that on important questions of the growth and stability of their economies the interests of developing and developed countries coincide, not obscuring the fact, however, that each group has problems unique to its economic situation. It is important, therefore, that a universal code of conduct should continue to apply to all countries and in a manner that takes cognizance of their special circumstances.

1International Monetary Fund and International Bank for Reconstruction and Development, Direction of Trade, Annual 1966–70 (Washington, D.C.).

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