IV Policy Options and Country Experiences
- Jahangir Amuzegar
- Published Date:
- April 1983
The economic policy choices available to oil exporting developing countries in deciding how best to implement their national priorities cover a wide range. They include both conventional policies (i.e., foreign exchange, public revenues and expenditures, and money and credit), and industry-specific measures. Each category, in turn, offers special features that correspond to the particular characteristics of the oil exporting countries.
This section starts with a somewhat detailed discussion of exchange rate policy, followed by a brief examination of fiscal and monetary policies at the macroeconomic level. It then touches upon more specific policies for diversification, industrialization, and export promotion.
Exchange Rate Policy
The choice of an exchange rate policy assumes particular importance in oil exporting developing countries for three reasons. First, since a “market-clearing” exchange rate is widely believed to be inappropriate in the oil exporting developing countries, a concerted search for alternatives may be both theoretically and pragmatically desirable. Second, since a sustained annual balance of payments surplus is likely to push the oil exporting country’s exchange rate upward, directly or indirectly, the question immediately arises as to the choice of an exchange regime that provides sufficient incentives for the non-oil sector. Third, a reference to the pros and cons of different exchange regimes may be needed to clarify the capabilities and limitations of a multiple rate system, which is sometimes intuitively thought to be the proper course of action to be followed by oil exporting developing countries.54
Importance of Exchange Rate
The exchange rate is important because of its role in influencing at least four key relative prices in the economy—the internal price of tradable goods relative to nontradable goods, the foreign currency price of the country’s exports relative to the export prices of its competitors, the domestic currency price of imports relative to the price of domestic substitutes, and the price of exports or import substitutes relative to the cost of producing these goods.55 Through its influence on these relative prices (if only temporarily), the exchange rate can affect the allocation of resources in an economy, including the volume of international trade.56
While a unified exchange rate is too aggregative an instrument to change relative prices among different classes of traded goods, the level of the exchange rate itself, in combination with the given cost structure of different industries, affects the range of a country’s export sector—expanding it when the exchange rate depreciates and contracting it when it appreciates. Concern with the structure of exports, especially with increasing the share and maintaining the competitiveness of non-oil exports, makes the exchange rate particularly important for the oil exporting countries’ development prospects. In this sense, the right (equilibrium) exchange rate is a necessary, though not a sufficient, condition for export diversification.
Limits to Effectiveness of Exchange Rate Adjustments
It should be noted at the outset that the level of the exchange rate (and its equilibrium) is not of equal significance to all oil exporting developing countries. The choice of the exchange regime is of crucial concern for those countries that have sizable diversification prospects, because different rates can, under certain conditions, help or hinder long-term export diversification. For those countries with a limited resource base, exchange rate changes largely affect domestic budgetary accounts and thus may be of limited immediate concern for other purposes.
It must also be recognized that setting the nominal exchange rate is only a partial step toward the diversification objective. What matters for trade flows is real rather than nominal exchange rate changes. Thus, in oil exporting developing countries, as elsewhere, the success of exchange rate policy is conditioned by the accompanying monetary, fiscal, and other policies. Oil exporting developing countries will be successful in using exchange rate depreciation to improve the competitive position of their non-oil export industries only if the depreciation is supported by economic management policies that are restrictive enough to maintain a significant share of the original relative price advantage caused by the depreciation. This means that the oil exporting developing countries’ desire to retain, or actually improve, the competitiveness of their non-oil industries should place rather strict constraints on the rate at which they spend their oil revenues.57 Attempts to expand expenditure beyond the economy’s short-run absorptive capacity will simply give rise to relative and general price level effects that will frustrate the relative price and expenditure-reducing effects of the depreciation. Considerations of export diversification therefore suggest an investment strategy in which oil revenues that are in excess of absorptive capacities be placed, at least temporarily, in foreign financial assets.
Another related constraint on the use of exchange rate policy is that the induced allocation effects on industrial structure and resource allocation are likely to be small if economic agents expect the relative price effects to be short lived. Exchange rate changes, if unaccompanied by offsetting measures to limit domestic absorption, set forces in motion that tend to restore the original pattern of relative prices and costs.58 The practical issue in this context, therefore, is how long the exchange rate induced changes in relative costs and prices are allowed to persist. In this respect, there is substantial empirical evidence suggesting that the period is shorter in small, open economies with strong wage indexation rules than in larger, less open societies with greater real wage flexibility.59 Here, those oilexporting developing countries with relatively low ratios of imports to GDP (e.g., Indonesia, Nigeria, and Mexico) probably have an advantage relative to those with much higher ratios (e.g., the United Arab Emirates, Kuwait, and Saudi Arabia). It is also to be expected that the real effect of exchange rate changes will diminish with the frequency of such changes, since expectations would adapt to the use of the policy instrument.
A further influence on the effectiveness of exchange rate changes is the share of economic activity in the economy that is actually responsive to relative price changes. The predominant role of the government in many oil-based economies implies that many decisions may not be made on the basis of relative prices. In a number of oil exporting developing countries, where the market plays a significant role, however, it is probably true that the role of the exchange rate is greatest in sectors producing traded goods other than oil. For countries with a significant potential for agricultural and manufacturing development, and where these sectors are largely in nongovernment hands (e.g., Mexico, Nigeria, Indonesia, and Venezuela), the relative price effects of exchange rate policy are of key importance. Exchange rate devaluation, however, even when successful in correcting price imbalances in the traded goods sector would leave other noncompetitive aspects of exports unaffected. In many oil exporting developing countries, for example, sluggishness of exportable goods is not the result of price disadvantages but of poor quality, absence of export credit, and other non-price shortcomings that cannot be rectified through exchange rate changes.
Exchange Rate Regimes
The exchange rate regimes available to oil exporting developing countries are the same as those for other countries. The floating exchange rate, so far, has not been favored by them.60 Aside from the more general arguments against floating rates for countries that do not have well-developed capital markets and internationally traded currencies, some oil exporting developing countries are subject to volatile capital movements because of relatively high private savings, limited domestic investment opportunities, and absence of exchange controls. Unexpected changes in world oil prices are another source of exchange rate volatility in a narrow market, particularly where expectations play a major role in exchange rate determination. Since the marketability of non-oil exports is apt to be adversely affected by significant exchange rate uncertainty, it could be that a market-determined exchange rate would be socially suboptimal from the viewpoint of the oil exporting developing country itself.
Under a single and fixed exchange rate regime, which is broadly followed by most oil exporting developing countries, the rate is fixed at some level that is believed to offer the best trade-off between the objectives of promoting diversification and controlling prices. Movements in the real exchange rate are primarily determined by the country’s domestic inflation rate relative to that of its trading partners. By keeping the “appropriate” exchange rate stable, the authorities attempt to provide the private sector with a known, relatively stable incentive for exporting and for producing import substitutes.61 Since under a unified exchange rate relative prices among exportables cannot be altered, this option leaves the range of goods actually exported to be determined by profit and other considerations in the private sector. This can be an advantage if the more socially useful export activities are also privately profitable, and if the unified rate is set low enough so that a sufficient number of non-oil exports are profitable. The effectiveness of a unified exchange rate in encouraging or permitting economic diversification and export promotion depends in large part on how committed, and how able, the oil exporting developing country is to conduct monetary and fiscal policies that will safeguard the original real competitive position.
A fixed but adjustable exchange rate represents a compromise between the floating rate and the unified pegged rate. The main advantage would be the flexibility to depreciate whenever domestic inflation and/or adjustment in a partner country’s exchange rate caused a decline in a country’s competitive position. How large the periodic devaluations should be depends on how many export activities are to be made competitive by the exchange rate adjustment, how much ground needs to be made up since the last revision, and how long the authorities want to go before they have to make the next devaluation. It should be recognized, however, that each devaluation will, via its upward impact on the price of tradable goods, set in motion forces that will raise the domestic price level so that the net improvement in the competitive advantage of the export industries will be less than the size of the devaluation. Furthermore, frequent devaluations will establish expectations of further currency depreciations, and these expectations are likely to increase the speed with which the original relative price level is restored (i.e., each succeeding devaluation is likely to produce a smaller price advantage).
It is often argued that a single exchange rate cannot simultaneously meet the needs of the oil sector and the non-oil sector. It would therefore be better to have two exchange rates, with the more depreciated rate applicable to the non-oil sector.62 The issues raised by the use of multiple exchange rates have received considerable attention in the literature,63 but the following points seem most relevant to the oil exporting developing countries.
Since dual or multiple exchange rates have the same effect of changing the relative prices of various traded goods, multiple rates can have an economic impact only on those goods where relevant consumption and production decisions are sensitive to relative prices. Thus, whatever the case for multiple exchange rates among categories of private sector transactions, there would seem to be little reason for oil exporting developing countries to have a separate exchange rate for transactions in oil, because the oil sector is generally controlled by the government, and the state can place any value on oil revenues in terms of local currency.
Since the intended results of multiple exchange rates can almost always also be effected by a system of taxes and subsidies,64 the choice between the two alternatives depends on ancillary costs and benefits. Taxes and subsidies have the advantage that they appear explicitly in the budgets, whereas the costs and benefits of multiple exchange rates are harder to detect. Multiple exchange rates may also be subject to abuse through manipulation of the effective rate. On the other hand, it is sometimes argued that multiple rates may have lower administrative costs, greater public acceptability, or greater immunity to domestic political pressure.
To the extent that a multiple rate system is used to encourage additional output from certain sectors, macro-economic equilibrium requires that the necessary resources be released from other activities. Unless slack exists in the economy, these resources must be attracted away from other uses by lowering the demand for them in other activities. Changes in multiple exchange rates, however, if unaccompanied by any change in the average rate applied, can only affect the attractiveness of producing different types of traded goods. They are not, therefore, a policy instrument that can be used to switch resources from nontraded sectors to traded goods as a whole.
Multiple exchange rates (like export subsidies) are subject to agreed international rules of behavior. In particular, if used for current transactions, multiple rates constitute a “multiple currency practice” under the Fund’s Articles of Agreement and therefore require approval.65
An oil exporting developing country can obtain much the same economic result that could be achieved through de facto multiple rates by maintaining a single rate and applying a system of differential taxes, subsidies, and other incentives in different economic sectors. An advantage of such an approach is that subsidies may be more varied and subject to more frequent adjustment than multiple exchange rates. Also, the budgetary cost, and the degree to which particular activities are being encouraged or discouraged, can be closely monitored. Against these advantages, tax/subsidy systems can be difficult and costly to administer, particularly if the subsidies and taxes become complex. Also, they are vulnerable to political pressures. Other advantages and disadvantages of tax/subsidy systems are discussed in more detail in the subsection on specific instruments for diversification and export promotion.
“Equilibrium” Exchange Rate
A more general question in the area of exchange rate policy is whether the oil exporting developing countries require an alternative definition or interpretation of the so-called equilibrium exchange rate. The past practice has been to analyze the equilibrium rate by reference to either (i) purchasing-power-parity movements from some equilibrium base period or (ii) the exchange rate that would yield equilibrium in the “underlying” (however defined) balance of payments over some medium term or (iii) the exchange rate that would produce equilibrium in asset markets.66
There are a number of difficulties when one attempts to apply these concepts to the oil exporting developing countries. To begin with, since these countries are undergoing particularly rapid changes in economic structure, it is difficult both to identify an equilibrium base period and to assess how subsequent structural changes should be reflected in the exchange rate. Furthermore, an attempt to define some form of equilibrium exchange rate is complicated by the nature of the oil exporting countries’ external transactions. Since the principal source of external receipts is the sale of a depletable capital asset, it is not clear if, or to what extent, such receipts should be credited to an underlying (or “sustainable”) payments position. With the government controlling such a large component of foreign transactions, it can be debated whether a residual surplus (under one of the conventional definitions of the balance of payments) represents an imbalance requiring correction or an equilibrium of “revealed preference” in the pattern of the oil exporting developing countries’ asset holdings. Still further, the oil exporting countries are forced to plan their development strategies with a longer time horizon in mind than the normal medium term of two to three years. If, for example, a key development objective is export diversification and if the present exchange rate frustrated that objective, then the present rate would not be an equilibrium one in the eyes of the developing country itself, even if the rate meets one or the other of the usual definitions.
What this analysis suggests is that a broader definition of equilibrium rates that includes the competitiveness of selected nontraditional exports must be formulated for oil exporting developing countries. The obvious difficulty, of course, is that such an interpretation of equilibrium rates is hard to determine. Just as it is unreasonable that none of a country’s non-oil export industries should be internationally competitive, it is unreasonable that the exchange rate undervaluation be used to make them all competitive with little regard for the country’s comparative advantage. As with many other questions of exchange rate surveillance, this implies that a case-by-case approach to analyzing the exchange rate for oil exporting developing countries may be most appropriate, with particular attention being given to the estimated life of oil reserves, the necessary gestation lags for creating internationally competitive non-oil industries, the structure of relative costs in the non-oil industries, the expected social benefits of diversification, and the expected impact of exchange rate depreciation by the oil exporting developing countries on the trade position of other countries.
The difficulties involved in defining a proper equilibrium rate of exchange for oil exporting developing countries also give rise to the inevitable, and perhaps controversial, conclusion that the conventional requirements of the external adjustment process (i.e., real exchange rate changes) would fail the test of rationality from the viewpoint of both the oil exporting developing countries’ national interests and the interests of the international community in maintaining world growth and prosperity. Attempts by surplus oil exporting developing countries to reach an equilibrium position on current account, directly through official currency appreciation or indirectly through undesirably high levels of domestic economic activity beyond absorptive capacity, are likely to cause unreasonably high wage and price inflation, an unfavorable impact on non-oil exports, and ruinous consequences for the import substitution sector, thereby impeding the overall objective of diversification. From a global standpoint, too, the waste, inefficiency, and other unhealthy results of a too rapid external adjustment should be considered a net total loss.
Attempts by deficit oil exporting developing countries to achieve external balance directly through official currency depreciation or indirectly through rigid deflationary measures would be equally self-defeating. Since the oil exporting developing countries’ oil prices are commonly denominated in U.S. dollars, no change in the exchange rate could serve as a stimulus to larger oil exports. The effects on exports of other non-oil tradable goods would also be minimal, because at early stages of diversification the supply of these goods is rather limited. Furthermore, the exchange rate is too aggregative a lever to affect the relative international competitive position of specific export industries. At the same time, currency depreciation (official or induced) would increase prices of imports and add to domestic costs of new, diversified, and infant export industries. It would further adversely affect the terms of trade between traditional exports and imported capital goods, technology, and services on which both internal growth and further diversification heavily depend. For these reasons, the very concept of external adjustment in the case of the oil exporting developing countries has to be redefined and equilibrium conditions for such an adjustment re-established.
In the non-oil developing economies, the impact of a change in the exchange rate on the budget is thought to be generally neutral, at least in the short run, with the effects on revenues and expenditures largely offsetting each other. The net outcome depends partly on the magnitude of transactions in foreign exchange. A change in the exchange rate can affect the revenue side of the budget through its impact on the value in local currency of tax receipts. For example, a devaluation is likely to increase exports, raise the domestic price level, and induce output expansion. These will likely result in an increase in public revenues. A change in the exchange rate will also have an impact on the expenditure side of the budget by increasing (or reducing) the price in domestic currency of government purchases abroad.
In many oil exporting developing countries, where oil receipts are usually in dollars (and the main source of budgetary revenue), a change in the exchange rate (especially vis-à-vis the U.S. dollar) would have corresponding effects on fiscal receipts denominated in local currencies. Budgetary expenditures will also be affected depending on the import component of these expenditures, the currency of settlement, and other factors. Nevertheless, the impact on expenditures is likely to be smaller than that on receipts.
An oil exporting developing country whose currency is pegged to the U.S. dollar is usually left with two choices when the U.S. dollar is depreciating in the foreign exchange markets. The authorities may allow the local currency to depreciate along with the U.S. dollar. In that case, the oil receipts in terms of domestic currency will remain unchanged. The impact on expenditures made in foreign exchange will depend on the currency of settlement; expenditures made in U.S. dollars will not change, while those made in other currencies will be higher in domestic currency. If the country lets its currency appreciate vis-à-vis the U.S. dollar, then fiscal receipts will decline in domestic currency, and the budget will have to be reduced, or face a deficit. For a low-absorbing oil exporting developing country with negligible non-oil exports, the exchange rate appreciation might result in cheaper imports from the United States or where invoices are denominated in U.S. dollars. These benefits, therefore, may be a justification for keeping the old rate. The argument is that the decline in revenues to the public sector is compensated by increased resources to the private sector in the form of lower-priced imports and by cheaper public purchases of foreign goods and services from U.S. dollar sources. The net result will obviously depend on the size of imports paid in U.S. dollars and in other currencies.
While these considerations may be relevant for the low-absorbing country, with the U.S. dollar playing a predominant role in its foreign settlement, other factors will have to be taken into account for the high-absorbing country with a large export base and diversified currencies of settlement. Furthermore, the valuation impact of a change in the exchange rate should be compared with the impact on the volume of non-oil exports and imports as well as on non-oil production.
Indexation Against Inflation and Exchange Rate Risk67
Another important question that arises, however indirectly, in connection with the oil exporting developing countries’ exchange rate strategy is how they should respond to exchange rate fluctuations and inflation in supplying countries that have the consequence of reducing the purchasing power of both their oil revenues and their foreign financial assets. Concern over this issue has typically been greatest among oil exporting developing countries whenever depreciation of the U.S. dollar and high inflation in industrial countries have led to declines in the real price of oil and in the oil exporting developing countries’ terms of trade. Not unexpectedly, those oil exporting developing countries with a relatively high concentration of foreign financial assets in dollar-denominated securities have been particularly concerned, but since the price of oil is denominated and mostly invoiced in U.S. dollars, currency fluctuations affect virtually all oil exporting developing countries.68
Proposals that have frequently been discussed as a response to or safeguard against such currency and inflation risks include pricing oil in terms of a basket of currencies (e.g., the special drawing rights—SDR) or indexing the U.S. dollar price of oil to the export prices of the oil exporting developing countries’ main trading partners.69 The aims of such basket or indexation formulas are to stabilize the ex post purchasing power of a barrel of oil in the face of currency fluctuations and import price increases. From the point of view of the oil exporting developing countries, such formulas also supply an added incentive for industrial countries to pursue macroeconomic policies that would produce price level and exchange rate stability.70 In addition, the greater automaticity of such formulas is sometimes claimed to be less unstable than the large, infrequent, and deliberate price adjustments that have occurred in the past.
Although a basket formula for pricing, especially one that attempts to adjust for inflation as well as for exchange rate fluctuations, would result in less instability in the purchasing power of a barrel of oil than present arrangements, the benefits, even for oil exporting developing countries, may not be that great. Frequent reviews of the basic crude price allow a fairly continuous adaptation of price to market conditions—conditions which, of course, include inflation and exchange rate factors but also other influences on supply and demand.71 It may also be that no rigid automatic formula would, for long, be observed once market conditions drastically changed the interests (or the power) of the parties concerned. Needless to say, a flexible formula based on a currency basket with built-in provisions for periodic changes might combine the advantages of both relative stability and adaptability to market conditions.
Fiscal policy encompasses a set of instruments or levers that affect the allocation of resources in terms both of efficiency and equity. For a typical developing country, the primary tasks of fiscal policy are mobilization of savings, promotion of developmental investment, and reduction of income inequality. For some oil exporting developing countries, however, owing to the ample availability of investible funds through oil exports, mobilization of savings may not be a major issue, at least not in the short run. The critical tasks are to use oil revenues to achieve optimum growth and diversification without undue inflationary pressures, to spread the benefits of oil income over the largest segment of population without reducing incentives, and to correct existing distortions in the economy without creating new ones. Since oil revenues typically accrue to the government directly, fiscal policy plays a most crucial role in the direction of development in oil exporting developing countries.
Fiscal policy involves both macroeconomic decisions (spending and taxing to affect the overall level of demand) and microeconomic decisions (choosing a pattern of taxation or expenditure that serves such goals as a better income distribution or greater efficiency or is intended to encourage or discourage specific types of economic activity).
In much conventional analysis, the contribution of government operations to excess demand pressures is related to the size of the fiscal deficit. The overall fiscal deficit represents the amount by which government expenditures on real goods and services exceed government current receipts; and the bank-financed deficit represents the extent to which the government’s excess spending is financed by (relatively more inflationary) monetary expansion, rather than by (relatively less inflationary) long-term borrowing.
An appropriate stance of fiscal policy in open economies (and in particular in economies where a substantial proportion of fiscal revenues is effectively paid by the foreign sector) is the relationship between domestic revenues and expenditures. In an oil exporting developing country with a sudden increase in petroleum sector revenues, a “sterilization” of foreign exchange reserves will leave domestic supply and demand in the same balance as before, despite the fact that the government’s budget balance, and its claims on the banking system, will have improved by an amount equivalent to the whole increase in revenues. Since the government’s extra revenues represent a transfer from foreigners, there is no withdrawal from the domestic income stream, so that the revenues have no deflationary impact. Similarly, on the expenditure side, spending to acquire foreign assets does not increase domestic incomes and liquidity and is not inflationary. If the oil exporting countries wish to avoid undesirable inflationary pressures, they should plan their medium-term fiscal policy in terms of their “domestic budget balance.”72
This is a helpful perspective for the analysis of fiscal policy but, nevertheless, an incomplete framework. At the extreme, it would suggest that oil exporting countries should not spend any of their higher oil receipts, or at least should spend them only on direct foreign purchases. But, while it is true that petroleum exporting countries can derive real benefits from their production only by absorbing real goods and services from abroad, there are other ways of achieving this than through public importation. Domestic expenditures place spending power in the hands of domestic residents who in turn may choose to purchase imported goods. If there were perfect substitutability between domestic and imported goods, then it would be irrelevant where government expenditure was initially directed; any increase in spending would result in the same volume increase in import supply, no matter where the initial spending took place.
In fact, of course, substitutability is less than perfect and indeed is quite limited for many oil exporting developing countries. In the very short run, it is particularly hard to switch domestic resources from one use to another. Over longer time periods, factors of production can be moved somewhat more easily, and the economy can benefit from the greater availability of foreign resources by shifting domestic factors toward nontradable activities and allowing a greater proportion of the demand for tradable goods to be met through imports. With the government deriving its income from producing tradable goods (i.e., oil) and devoting its expenditure to predominantly nontradable goods, while the reverse applies in the private sector, it is apparent that a sustainable long-run equilibrium will involve a domestic deficit for the government, even when its overall position is satisfactory. Nevertheless, too rapid an expansion of expenditures in the short run is liable to generate significant inflation through expansion in the domestic budget deficit.
Once the desired fiscal stance is determined in the light of the overall resource balance in the economy, it can be achieved through measures affecting either revenues or expenditures. In practice, however, it is unlikely that domestic revenue measures can be actively employed as an instrument of macroeconomic fiscal policy. In the first place, the importance of nonoil revenue sources is small in most of the major oil exporting countries. Increasing revenues from outside the oil sector (which would be indicated if the authorities wished to mobilize domestic resources to match the higher availability of foreign investment goods) would probably encounter political resistance and would anyway have only a limited impact on the supply-demand balance in the economy. Reducing taxation levels to effectively transfer a greater share of income to the private sector would tend to exacerbate demand pressures and would have the longer-term effect of undermining habits of taxpaying and skills of tax collection—features that might be useful in a period when oil is no longer so dominant in the economy.73
It is therefore predominantly through its expenditure policies that the government has its main effect on economic development. These expenditure policies must take into account not only social objectives (relating to income distribution) and development goals (industrial diversification) but also the constraints imposed by the limited (and differential) availability of local resources. Some of these issues are addressed in more depth in a later section of this study devoted to industry-specific policies.
Monetary policy affects economic activity by providing liquidity and by changing the relative availability and cost of credit. Since most developing countries do not have a highly developed commercial and central banking system, it is generally believed that monetary (and particularly interest rate) policy plays a limited role in these countries. In an open developing economy, where the flow of foreign revenues into and out of the country is a major source of change in the money supply, monetary policy is even less of an effective instrument under the control of monetary authorities. Yet credit and interest rate policies could still play an important role if these policies were formulated within the institutional framework of individual countries.
The scope for an active monetary policy is further limited in some oil exporting countries, not only because of their openness to capital flows but also because of the large size of the public sector in domestic economic activity. The rate of growth of the domestic money supply reflects, to a large extent, the effect of the government’s domestic deficit in injecting liquidity into the economy and the demand of the private sector for imports, causing liquidity to leak abroad. These two phenomena are, of course, related, since greater liquidity creation (through the government’s financial operations) leads sooner or later to stepped-up demand and a higher induced level of private sector imports.
In an open economy with relatively free capital movements, monetary expansion, the exchange rate, interest rates, and the inflation rate are all jointly determined in the long run. There is, of course, some scope for short-term trade-off in the use of these instruments, especially when uncertainty makes capital mobility less than perfect. Nevertheless, the choice of a medium-term target for any one of the variables just mentioned limits the scope for independent targeting of any of the others. As a result, to achieve their objective of curbing the rate of inflation, oil exporting developing countries might have to limit severely the rate of growth of government expenditures.
The use of interest rate policy is limited in most oil exporting developing countries. Many of them have favored low interest rates, whether on religious or social grounds, to encourage capital formation or to hold down domestic costs. They have felt that the relatively high and fluctuating level of international interest rates adds to the uncertainties of investment in physical capital and tends to discourage it. The question that needs to be asked in this context is whether maintaining a low domestic interest rate will be successful in encouraging the appropriate kind of capital formation.
In general, deliberate reduction of interest rates is likely to have only limited success in promoting investment. In an open economy, savers will have an incentive to place their funds abroad, so that borrowers will either be unable to obtain accommodation or the accommodation will have to come directly or indirectly from the public sector. If for the nonbank sector domestic borrowing rates are below external lending rates, there is a considerable incentive for “round-tripping.”74 Even to the extent that lending does flow to the domestic economy, it is hard to discriminate between projects that the authorities wish to encourage (e.g., because there are sizable external economies) and those that offer a lesser contribution to development. A further disadvantage of low interest rates is that, regardless of capital mobility, investment may be unduly constrained by the limited availability of savings, and the allocation of investable funds may be suboptimal.
On the whole, and leaving religious or other national priority considerations aside, it might be preferable to allow interest rates to fulfill their basic function of balancing the desire to save and invest and to compensate for any adverse effects (e.g., on capital formation or diversification) in other ways. This could be done through instruments unrelated to the cost of credit, or it could be done through sector-specific subsidies to interest charges. The latter have a number of drawbacks, since they may create distortions and the development of techniques that evade the authorities’ intent. Nevertheless, it has been used on a number of occasions (e.g., Korea) and, with adequate administrative control, may be effective.
While macroeconomic policies are important for setting the economic environment for development policies, they cannot easily be used to direct expenditure into particular sectors or industries. Since diversification of production and of the export base is a common objective of oil exporting developing countries, attention needs to be given to the use of industry-specific policies.76
Like multiple exchange rates, industry-specific policy instruments such as subsidies, taxes, tariffs, quantitative restrictions on imports, easier access to credit, and direct government investment aim at favoring some activities over others. There are two basic rationales for not relying on the price system to determine the industrial allocation of resources. The first is that there are socially important side benefits or externalities associated with certain industries or activities that are not reflected in market prices. If these side effects can be reliably identified and measured, social welfare can be improved by including the costs or returns of these side effects in the price-cost system. One example of such an externality is when the knowledge and experience acquired in an infant export industry can be transferred and applied to export industries that develop subsequently. The second rationale for sector-specific policies is that the existing price system already contains some important distortions or imperfections that cannot be altered, thus suggesting an offsetting distortion that will counteract it. In this case, welfare again can be improved, even though the new distortion is clearly a second-best alternative that would not be optimal in the absence of the existing distortions. Two popular examples of such fixed distortions in oil exporting developing countries are an overvalued exchange rate and an excessive wage rate that spills over from the “enclave” sector to the rest of the economy. Here, subsidies to the export industries may help to offset the adverse consequences of the existing distortions.
As a prelude to discussing the variety of industry-specific policies, it may be useful to note a number of considerations underlying their use.
(1) In an open economy with relatively free capital movements, all policy instruments (e.g., monetary, fiscal, exchange, and trade policies) are, as a rule, interchangeable and interdependent. In the absence of specific international commitments (e.g., avoidance of multiple exchange rates under the Fund’s Articles of Agreement), clear trade-offs exist among the exchange rate (or rates), interest rates, special credit allocations, taxes, subsidies, and import-export regulations. The individual country preference for some of these policies over others is thus largely a matter of “underlying” sociopolitical considerations. For this reason, the assessment on the part of the international community of the wisdom and appropriateness of each policy should also consider its significant substitutability and cost/benefit sharing. That is, in the absence of clear and overriding evidence, a nonpreferential posture should be taken vis-à-vis all substitutable policies. In the longer run, all policy instruments affect one another, and any realistic target for one limits the scope for independent targeting of any of the others.
(2) Beneficial externalities are often greatest during the first few years of an industry’s existence; it is at this time that training facilities and social overhead capital are being expanded most rapidly; later, industries become more equal in their generation of economic externalities. This implies that larger industrial incentives may be more justified in those oil exporting developing countries with infant non-oil industries than in those where the non-oil export sector is already established.
(3) Where beneficial side effects can be identified, they usually apply to production for the home market as well as to production for export, an observation that implies that incentives should usually be applied to production as a whole rather than to exports alone.77
(4) Industry incentives need to be relatively predictable and stable if they are to have their intended effects. On-again, off-again incentives create too much uncertainty for producers to undertake the necessary investment and production.
(5) Manufacturing for export is among the activities that are believed to create the largest beneficial externalities, because of the experience gained by the original firms for the use of those that follow. On the other hand, government assistance is often most needed in agriculture, because the most socially beneficial investments are generally too large to be financed by individual farmers.
(6) On the whole, inward-looking policies characterized by high protection of domestic industry and overvalued exchange rates have been associated with lower rates of economic growth, lower overall economic efficiency, and less adaptability to external shocks than more outward-looking policies, characterized by lower import protection, provision of export subsidies, and realistic exchange rates.78
(7) Two of the more general problems with industry-specific policies are that the externalities are difficult to measure and that, once the incentives are implemented, the vested interests in both the industry and government have a large stake in continuing them beyond the point where the externalities have disappeared.
The use of export subsidies by members of the General Agreement on Tariffs and Trade (GATT) must, of course, be assessed against the background of rather specific international rules specified by the GATT. Export subsidies permitted by the GATT include subsidized credit, provision of infrastructure, manipulation of input prices, and temporary tax holidays and other tax breaks given symmetrically to non-exporting enterprises as well. Also permitted are rebates of duties on imported inputs and exemption of exports from indirect taxes. In fact, such exemptions from indirect taxes are not considered by the GATT to be subsidies but to be necessary to the tax neutrality of exports. Oil exporting developing countries can minimize the chances of retaliation from other countries if they use those export subsidies that are countenanced by the GATT and used by the industrial countries (e.g., preferential export credits and credit guarantee plans). In addition, current international codes prescribe retaliation against countries granting export subsidies only when there is “material injury” to the competing industries as a result of those subsidies. For this reason, small oil exporting developing countries, and those larger ones with as yet small non-oil export industries, probably have less to fear from export subsidy rules than those developing countries with significant manufactured exports.
Bearing the foregoing considerations in mind, subsidies may be seen as having two main advantages in the implementation of a development strategy. Unlike exchange rates, they are flexible, adaptable, and disaggregated, so that they can essentially be tailor-made for a particular activity. Unlike restrictions on imports, they do not induce higher consumer prices and an associated reduction in the scale of output, thereby preserving potential economies of scale in production. They also differ from both exchange rates and import protection in that they are more easily applied to specific factors of production, (e.g., capital equipment and raw materials).79 This again provides greater flexibility but also introduces the danger that subsidies can distort the efficiency of input use relative to instruments that are neutral in this regard. Subsidies are also sometimes exceedingly hard to remove once they establish their vested and local constituencies (and particularly when they are hidden).
The types of industry subsidy open to oil exporting developing countries include subsidies for start-up costs and initial losses of new industrial enterprises, public sector ownership or participation in industries, various types of tax holiday, duty-free importation of raw materials and intermediate inputs for use by industrial firms, provision of credit at low interest rates, public investment in infrastructure, and public funding of agricultural research and extension services.
The type of subsidy that would be most useful to a particular oil exporting developing country depends in large part on the industry or industries involved. For example, the oil exporting countries with a comparative advantage in producing oil-based processed goods with high capital intensity and high skilled labor requirements will find subsidized financial capital and subsidized education and training useful in translating these endowments into successful export performance. In contrast, it can be useful for an oil exporting developing country with a relatively low capital endowment (including its oil reserves) and a relatively small domestic market coupled with a relatively large endowment of semiskilled labor to give industrial firms, at least temporarily, duty-free access to imported raw materials so that they can be internationally competitive in exporting manufactures.
If the objective of an export subsidy is to promote domestic economic activity (instead of foreign exchange earnings), it would generally be more efficient if the subsidy were set on value-added in exports rather than on export value. Also, attention should be given to the objective of utilizing domestic factors of production that might otherwise remain unemployed. Many oil exporting developing countries do not have the infrastructure or the skilled labor to use their financial capital efficiently in the establishment of capital-intensive industries and must find profitable employment opportunities for their unskilled and semiskilled labor force. They may perceive this as involving subsidies designed to bring down market wage rates to a level where it becomes profitable to expand employment in the traded goods industries.
Subsidies will be more effective if they are aimed at the source of distortion or externality rather than being based on considerations such as the relative share of exports in the output of different industries. If the principal distortion in the economy is the wage rate in the non-oil sector, subsidies should be directed toward reducing the cost of labor as a factor of production rather than being directed to a particular sector or industry. If an externality is related to an industry’s output (say, because of a derived demand for locally produced inputs), the subsidy is more appropriately applied to output.
What the foregoing suggests is that the pursuit of a policy of industrial subsidy requires detailed industrial and sectoral cost-benefit analysis to achieve efficient diversification. Furthermore, it should be remembered that the cost of subsidies must ultimately fall on taxpayers or consumers, with consequent effects on resource utilization and allocation.
Protection Against Imports
Another potential means of diversification is the use of protection from import competition to pursue a strategy of import substitution. For import substitution to be used as an integral part of economic development, some of the “lessons from historical experience” must be kept in mind.80
As with export subsidies, the strongest case for the protection of certain industries can be made during their first few years of operation. For producer goods industries (steel, chemicals), where economies of scale are quite important, they are likely to develop better over the medium term if they are aided by incentives that expand their output toward the optimum level. Low import duties on raw materials and on intermediate inputs are crucial to developing internationally competitive manufacturing export industries simply because many other strong exporters of manufactures have such access.
Where import protection is used, there is a strong case for preferring import tariffs to quantitative import restrictions. If quantitative restrictions on imports are used, their negative effects can be reduced if licenses are issued promptly and reliably when the foreign exchange position is not critical, if licensing rules are stable, and if the licensing of imports is carried out by the authorities responsible for industrial development. Quantitative restrictions are generally less harmful if applied to consumer goods industries rather than to producer goods industries (because of the more significant input-output links of the latter and the resulting losses of production in other industries if needed inputs are not forthcoming).
The most difficult operational problem with tariffs is that input-output relationships greatly complicate the task of creating a rational tariff structure. Because of tariffs on imported inputs, some industries typically wind up with negative effective protection, while others get very high rates of effective protection.
A typical outcome of import protection designed to promote industrial diversification is that the terms of trade shift sharply against agriculture. To the extent that agricultural production is needed to feed the domestic population, to provide inputs for light industry, or to provide export earnings, this shift represents a troublesome development.81
State Sponsorship of Investment
A more direct way of influencing both the extent and the sectoral posture of diversification is through state ownership of or participation in industry. This is a feasible option for oil exporting developing countries, particularly those where the government is determined to play an active role in the economy, and may be the only practicable way of achieving diversification in sectors with high start-up costs, uncertainties, absence of entre-preneurship, or vulnerability to an adverse exchange rate.
While state ownership of industry avoids the difficulty of designing policy instruments to encourage diversification, it still leaves two major problems to be solved. The first is the identification of long-run comparative advantage, which requires not only an assessment of financial costs and returns in the medium term but also a full appraisal of the external costs and benefits of various projects. Such an assessment can be satisfactorily undertaken only on the basis of a cost-benefit analysis of individual industries. The second problem is to design incentives for the managers of state-owned industries to promote efficient use of resources. If profitability on the basis of full-cost inputs is not attainable, some shadow-pricing mechanism will be necessary to enable planners to monitor the progress of individual industries and to determine what changes are indicated in the thrust of their development strategy.
Experiences in Economic Development
In any meaningful examination of development in the oil exporting developing countries, the pertinent question is, how well have they fared in achieving the over-riding national objective of establishing a sustainable base for a viable non-oil economy through their choice of economic policies.82
Needless to say, any such goal-oriented evaluation of country experiences could provide valuable guidelines for a country in choosing its future development strategy and choice of policies. Regrettably, the task is neither easy nor conclusive, because needed data are, at best, only fragmentary; and the difficulties of drawing analytical conclusions from partial data are complicated by the experiences of the oil exporting developing countries which reflect neither the influence of their economic base nor the impact of their political or ideological “superstructure.” Furthermore, the 1974–81 performances cannot be taken as indicative of a long-term trend because of the relatively short period of oil-based development. The aim of this section, therefore, is to only highlight the post-1973 experiences of some of the oil exporting developing countries (and mainly OPEC members) in relation to their national objectives. A more thorough and more specific analysis may have to inquire into (a) whether high investment to GDP ratios followed by some of these countries necessarily lead to higher growth; (b) whether public investment and public management undertaken by them compare favorably with the private sector performance; (c) whether heavy investment in industrialization, universally emphasized by these countries, fared well compared with other sectors, especially agriculture; (d) whether domestic inflation, experienced by all of the countries, has arisen mainly from excess aggregate demand or from sectoral bottlenecks, and how has it been dealt with; and (e) whether countries that have actively used the exchange rate instrument have been more, or less, successful compared with those who have been more passive. However, as a prelude to such detailed examinations of individual country policies and progress, a brief account of the overall performance is presented here.
Post-1973 Developments: An Overview
The increase in revenue associated with the quadrupling of oil prices in 1973–74 affected the oil exporting developing countries’ national savings, investment, public expenditure, imports, and growth. The immediate effect of the oil price increase was an increase in the savings/GDP ratios, and an improvement in the net barter terms of trade in the countries for which comparable data are available. (See Table 9.) Larger national savings led to increased public spending and investment. Easing of exchange constraints, and the favorable terms of trade, facilitated substantial growth of real imports.
|Libyan Arab Jamahiriya||55.8||47.9||49.5||50.7||45.1 2|
|United Arab Emirates||…||75.4||84.0||72.7||64.6 2|
The countries’ immediate response to their newly acquired income was a massive increase in government expenditure. Either directly through the transfer of financial resources or indirectly through their own spending, the governments also encouraged the private sector to increase its level of investment. While public expenditures were concentrated on infrastructure (roads, telecommunication networks, power, and ports) and on capital-intensive industrial projects (petrochemicals, steel, basic metals, and machine tools), private sector investment, in general, was channeled to light industry and services.
As a result of increasing public outlays, a subsequent slowdown in the growth of oil revenue after 1975, and the sluggish growth of non-oil tax revenues, public sector deficits in the late 1970s rose to historically high levels in some of the countries. Private credit more than doubled for most countries, with the result that the credit/GDP ratio increased substantially in most countries. Fiscal and credit expansion inevitably led to a high growth of liquidity, which was translated into additional private spending.
Expansion of private and government consumption was met partly by the growth of GDP. The favorable effect of the terms of trade significantly increased growth at first. Thereafter, the decline in the real price of oil (relative to the price of imports) dampened GDP growth until late in the decade, when there was a new surge in real oil prices. With the exception of agriculture, all sectors—especially construction, manufacturing, and services—grew substantially, although at a much slower rate than imports.83 Services (the non-traded goods sector) grew faster because governments put greater emphasis on investment in infrastructure, and private outlays were more attracted to housing. The manufacturing sector’s growth was maintained because of special incentives offered by the state. The agricultural sector lagged considerably behind the other two sectors because of lower overall priority.
Owing to the long gestation for most public sector investments in large capital-intensive projects (e.g., hydrocarbons, fertilizer, cement, and metals), domestic output expansion did not match higher national income, and additional demand had to be met through imports.84 Because of port congestion and other distribution inadequacies, excess demand accelerated inflation. By the mid-1970s, domestic inflation reached two-digit figures, and forced all countries to review their development strategies and reduce their expenditures. In many countries, in an effort to minimize the impact of inflation on domestic prices (foodstuffs in particular), the governments imposed direct price controls. This policy led to a lower rate of profitability in the agricultural sector, thus further aggravating the situation. The rural-urban terms of trade deteriorated steadily, contributing to the slow growth in the agricultural sector and increasing dependence on imported food.
Theoretically, in the absence of external financial constraints, imports act as a safety valve against domestic inflation. But because of the fast increase in the volume of foreign purchases and delays in expanding infrastructure and related services, imports often failed to service this function, and inflationary pressures re-emerged without exception. The price increases accelerated from low rates in 1968–73 to much higher rates in 1974–80.
Inflationary pressures naturally affected the levels of real exchange rates between 1972 and 1979. This rate (adjusted for inflation in the country compared with the U.S. dollar rate) appreciated by 50 per cent in Nigeria, 70 per cent in Indonesia, 40 per cent in Gabon, and 25 per cent in Ecuador.85 Exchange appreciation not only contributed to rising public sector deficits but also to declining non-oil exports between 1970 and 1980. In countries with a relatively well-developed non-oil sector, this led to a sharp slowdown in the growth of non-oil exports and also weakened the import-substituting industries.
Adverse developments in the external balance forced a number of countries (e.g., Algeria, Indonesia, and Nigeria) to adopt deflationary measures. In this process of contractionary adjustment, however, private investment was crowded out as private savings were increasingly mobilized to finance public investment projects.
The shift toward a contractionary demand management policy and greater restraint in the mid-1970s, mainly through curtailment of government spending, resulted in lower rates of inflation and the easing of supply bottlenecks in a majority of the countries but also contributed to the slowdown in domestic economic activity. However, with the renewed surge in oil export earnings following the 1979–80 oil price increases, most of the oil exporting countries relaxed their financial restrictions, though the shift toward a more expansionary policy was less pronounced than it was after the 1973–74 oil price increases. This cautious policy stance reflected largely a desire to avoid the experience with supply bottlenecks and rapid inflation that occurred during the mid-1970s; it also reflected a reappraisal of development strategies in some countries.86 As supply bottlenecks largely disappeared, the expansionary impact of higher domestic expenditures by governments stimulated domestic economic activity without generating excessive inflationary pressures.
In the wake of the 1979–80 oil price rise and the onset of the recession in the industrial economies, the demand for oil (and particularly OPEC oil) began to decline sharply. Crude oil production by OPEC members dropped by 16.9 per cent in 1981 to about 22.3 million barrels a day from 26.9 million in 1980 and 31.4 million in 1979—a ten-year low. Energy conservation, greater use of alternative sources (e.g., coal, gas, and nuclear power), and the unusual drawdown of oil inventories further helped to depress demand. Non-OPEC producers increased their output by 3.3 per cent to 18.9 million barrels a day in 1981—a six-year high. Falling consumption and sales put increasing pressure on oil prices. The weakness in prices was evidenced by declining spot market quotations (from a high of US$41 a barrel in 1979–80 to less than US$30 a barrel in early 1982), OPEC action in December 1981 and March 1982 to trim the premium on light crude oil, and the discounts offered by some OPEC members below the official price. Substantial cuts in prices by non-OPEC producers also helped to reduce demand for OPEC oil.
Owing to the substantial weakening of the oil market, the moderately expansionary policy adopted during 1979–81 had to be reversed. The fall in oil export earnings forced some countries to make significant cutbacks in government spending in late 1981 and early 1982, while the policies of others became more restrictive. Sliding oil prices and sagging exports soon left 9 of the 13 OPEC members with budget deficits and 10 of them with balance of payments shortfalls. Hit with serious cash flow problems, Nigeria, the Libyan Arab Jamahiriya, Venezuela, and even Kuwait, among others, began to cut public spending. Several OPEC members also resorted to net foreign borrowing.
While the fall in oil export earnings has been the major cause of the post-1980 retrenchments, underlying the inevitability of a forced economic slowdown has also been the chain-like reaction of certain forces going back to the oil price rise of the early 1970s. Sharply increased revenues from oil-rent taxes expanded both government’s role and its involvement in the economy during the 1970s. The bulk of government spending was concentrated on low-return infrastructure, slow-growing industrial projects, or welfare services (particularly education and health). Expanded aggregate demand in the main centers of industrial and defense activities resulted in rapidly rising wages and fringe benefits. The well-publicized lure of the urban centers, combined with the resulting neglect of the countryside, led to a massive rush of people from villages to the cities. Inflation, agricultural stagnation, and unrealistic exchange rates in some countries created pressure for higher volumes of imports at rising prices. A heavy strain on administrative and institutional capacities, plus some resistant physical bottlenecks and rigidities, helped to refuel inflationary tendencies.
An eagerness to meet, partway at least, the tide of rising popular expectations in turn favored maintenance of low food and fuel prices and subsidies. Increased fiscal deficits, domestic inflation, and inappropriate exchange rates depressed non-oil exports. By the mid-1970s, this, in turn, contributed to deficits in current external accounts in most oil exporting countries, and necessitated an increase in foreign borrowing.
Parallel with these developments in the economic arena, the oil economies had to grapple with a host of other problems. To begin with, in almost all countries—even those with a thriving private sector—dependence on the state as a nucleus of authority, and for assistance and support increased; the state became not only the focus of power but the instigator, supporter, and regulator of major economic activities. The government became more dependent on oil revenues, not only for long-term national economic development but also for its current consumption (including transfer payments). And public revenues from oil exports became, to a growing extent, dependent on factors that were outside the control of national authorities. Domestic monetary, fiscal, and exchange policies, particularly for those countries with substantial foreign assets held abroad, were increasingly influenced by policies in the major oil importing countries. Thus, the national commitment to more elaborate and expensive development plans bound the oil economy to the maintenance, if not the expansion, of oil production and export, even in the face of declining world demand. Finally, addiction by a majority of the articulate urban population to heightened consumerism, the insufficiently competitive (and protected) import-substituting industries, inadequacies of traditional non-oil exports, and the long gestation period of major exchange-earning projects tended to diminish the national freedom to decide on the level of crude production and export.
The post-1980 retrenchments thus promise to be drastic and painful for certain countries, especially if the current weakening of the oil market should continue. Countries that have been severely affected by the sharp decline in oil receipts are curtailing their development programs and are deferring large new projects.
Specific Domestic Policies
The variety of experiences of the oil exporting developing countries, and the patterns of development in countries with vastly differing problems and prospects, can be further appreciated by a brief review of the specific policy stances in some of these countries.
Exchange and Trade Policies
Owing to the large inflow of foreign exchange (and large balance of payments surpluses in some oil exporting developing countries), there has been a tendency for the domestic currency to appreciate, and the oil-based rate to be higher than desirable for the non-oil sectors, with a harmful impact on the competitiveness of domestic production and the objective of diversification. Also, because of the easier availability of foreign exchange and the attendant domestic inflationary pressures, there has been a tendency toward larger purchases abroad, thus jeopardizing domestic import-substituting investments and the promotion of non-oil exports.
Following the oil price increase in 1973–74, there was a shift in relative prices and an appreciation of the real exchange rate in most oil exporting developing countries, although the magnitude of the appreciation varied from one country to another. The appreciation was accomplished in some countries by higher nominal exchange rates against the currencies of trading partners and by higher domestic inflation. In other countries, the nominal exchange rate was fixed, and the real appreciation was accomplished through higher internal prices. The major effect of this appreciation was to reduce the attractiveness of the non-oil tradable sector, especially in those activities most subject to competition from abroad.87
In the face of the distortions created by the shift in relative prices, and the appreciation of the real exchange rates, most oil exporting developing countries opted for fiscal and trade remedies. Only Indonesia attempted to correct the situation with the exchange rate, devaluing the rupiah by 34 per cent in November 1978. However, after 1978, while the nominal effective exchange rate remained relatively stable, the real effective exchange rate appreciated by about 15 per cent.
Although the exchange rate has not been used as an active policy instrument in most of the oil exporting developing countries, many have changed their exchange regime by discontinuing the link to the U.S. dollar and pegging their currency to a basket of currencies of their major trading partners or to the SDR.88 Since 1974, Algeria has followed an independent exchange rate policy, and the daily rates have been established on the basis of a fixed relationship between the dinar and a composite of currencies. Nigeria introduced a basket method of calculating its exchange rate in 1978 as a guide for the central bank to select the rate with due regard to other factors. Kuwait, following a liberal exchange and trade system since 1975, linked the Kuwaiti dinar to a weighted average of currencies of its major suppliers. Also, since 1975, Saudi Arabia, Qatar, and the United Arab Emirates have pegged their exchange rates to the SDR, but margins are not always observed. Iraq and the Libyan Arab Jamahiriya continue to peg their currencies to the U.S. dollar, and since 1973 their exchange rates have not changed. Prior to 1976, a distinction was made in Venezuela’s exchange system between the exchange rate applicable to transactions in the petroleum and iron ore sectors and the one relevant to all other transactions. In July 1976, the dual exchange rate system was unified, and the bolíimported inputs. In Iran, following var was pegged to the U.S. dollar. Under the impact of falling oil revenues, a three-tier exchange market was announced early in 1983. Since 1974, a dual exchange market, and recently a multiple exchange system, have been in operation in Iran, although the rial is officially pegged to the SDR. Indonesia follows limited flexibility vis-à-vis the U.S. dollar. Ecuador and Gabon have their currencies pegged to the U.S. dollar and French franc, respectively.
The trade policies followed by the oil exporting developing countries as a major instrument of diversification vary significantly from one country to another. In general, the high-absorbing countries have followed a more restrictive trade policy. However, the objective of the trade policies has been fairly similar: all countries have aimed at supplementing the domestic market with needed imports and protecting domestic import-substituting industries. In addition, Indonesia, Iran, and Venezuela have, at various times, also concentrated on promoting non-oil exports.
Algeria has maintained comprehensive controls on all imports through an authorization regime of ceilings on imports. In Indonesia, the emphasis has been on the promotion of non-oil exports, and several measures have been taken to stimulate such exports, including exemptions from export taxes for certain commodities and rebates of customs duties paid on imported inputs. In Iran, following the 1973–74 oil price increase, import restrictions were considerably eased to reduce inflationary pressures, but subsequent events reversed the trend. Nigeria also introduced measures to protect infant industries, making the import of certain goods either prohibitive or subject to licensing requirements. In Iraq, foreign exchange allocations for imports have been made on the basis of an annual import program. In the Libyan Arab Jamahiriya, there is an annual planning procedure under which the trading enterprises prepare quantitative import plans, and permits are issued on an annual basis to import within the plan allocations. In Venezuela, prior to 1979, while import payments could be made freely, import transactions were heavily regulated through a complex system of tariff and nontariff barriers, and non-oil exports were regulated through the provision of credit financing and fiscal subsidies. In 1979, in order to rationalize the use of commercial policy instruments, a liberalization program was initiated through a reduction in import duties and a suspension of import prohibition.
The low-absorbing countries, with the exception of the Libyan Arab Jamahiriya, have been following a more liberal trade policy. The trade system in these countries has been virtually free of restrictions on current transactions.
For most oil exporting developing countries, the mobilization of saving was not a major issue during the 1970s, owing to the large amount of capital available. The critical problem was how best to use available resources, without inflationary consequences, to expand and diversify the economy and to correct existing distortions through subsidies, transfers, and rate setting in public agencies.
Earnings from the sale of oil were the principal source of government revenue for the oil exporting developing countries long before the 1973–74 oil price increase. Petroleum receipts had accounted for about 30 per cent of total revenues in Algeria and Indonesia and over 85 per cent in the Gulf countries in 1971–73. When the value of OPEC oil exports more than tripled from $36 billion in 1973 to $112 billion in 1974, government revenues grew at a more rapid rate, reflecting increases in income tax rates, royalty rates, and equity participation. Government receipts in both high-absorbing and low-absorbing countries increased between two and five times in 1974 (Table 10). In the high-absorbing countries, the rapid increase resulted in a correspondingly sharp rise in the share of oil revenue in total revenues, from 31 per cent in 1971–73 to over 50 per cent in 1974 in Algeria and Indonesia and from about 60 per cent to 80 per cent in Iran, Iraq, Nigeria, and Venezuela. There was also an increase in 1974 in the share of oil revenue in the low-absorbing countries, which was already about 90 per cent in the early 1970s (Table 11).
|Average||Total Government Revenue||Average||Oil Revenue|
|1971–73||1974||1975–78||1979||1980||1981 1||1971–73||1974||1975–78||1979||1980||1981 1|
|Iran||33.5||171.4||19.1 2||…||…||…||41.8||258.1||3.5 2||…||…||…|
|Libyan Arab Jamahiriya||2.8||154.9||9.9||57.0||…||…||4.2||179.7||8.3||67.0||…||…|
|United Arab Emirates||51.4||383.3||16.3||17.5||62.7||6.6||46.3||412.0||4.2||25.9||64.4||6.7|
|Average||Oil Revenue||Non-Oil Tax Revenue|
|1971–73||1974||1975–78||1979||1980||1981 1||1971–73||1974||1975–78||1979||1980 1||1981 2|
|Iran||58.4||83.1||75.5 3||…||…||…||30.7||12.8||18.5 2||…||…||…|
|Iraq||66.7||83.9||83.5 3||…||…||…||23.2||9.5||11.2 2||…||…||…|
|Libyan Arab Jamahiriya||84.6||87.9||83.6||88.3||…||…||11.8||10.4||12.8||10.0||…||…|
|United Arab Emirates||92.7||94.5||91.5||94.6||95.6||95.7||1.7||0.5||0.8||0.9||0.9||1.0|
During 1975–78, the rate of growth of oil exports decelerated sharply, reflecting both a relative stagnation in oil prices and in most cases a reduction in export. As a result, the rate of growth of oil revenues declined in most countries, as did the share of oil revenues in total revenues. Following the 1979 price increase, however, oil exports rose by an annual rate of about 45 per cent, as did government oil revenues. The fluctuations in the rate of growth of oil revenues during the 1970s exerted a dominant influence on total government revenue (Table 12). Yet despite such volatility, the rise in oil revenues had a steady impact on total public revenues and contributed to increased foreign exchange earnings. By easing or eliminating financial constraints on development, oil revenues also provided the needed flexibility in budgeting for development plans, enabling the oil exporting developing countries to undertake ambitious projects and to accumulate reserves at a relatively fast pace.
|Libyan Arab Jamahiriya||39.7||49.2||51.7||58.6||…|
|United Arab Emirates||…||73.1||62.4||35.8||42.4|
The post-1979 substantial slack in the world oil market adversely affected oil receipts and total government revenues. In 1981, the growth in oil and total government revenue decelerated sharply. In several countries, oil and total government revenues stagnated or declined. This tendency intensified in 1982. As a result, some countries are facing severe financial constraints, and oil revenues are no longer providing the same flexibility in budgeting for development programs as during the 1970s.
In the high-absorbing countries, non-oil tax revenues accounted for an important part of total government revenues before the first major oil price increase, varying from 23 per cent of total revenues in Iraq to 65 per cent in Indonesia in 1971–73. In the low-absorbing countries (with the exception of the Libyan Arab Jamahiriya, where the figure was 12 per cent), the share of non-oil tax revenues was only about 2 per cent of total revenues. (See Table 11.) Following the oil price increase, the ratio declined in all countries. In the post-1975 years, as oil revenues stagnated and the non-oil sectors expanded, the share of non-oil tax revenues naturally increased in some countries, although in general it remained below the pre-1973 level. For seven oil exporting developing countries, the ratio of non-oil tax revenue to non-oil GDP was comparable to many non-oil developing countries: 24 per cent for Algeria, 15 per cent for Iraq and the Libyan Arab Jamahiriya, 13 per cent for Iran, and about 8 per cent for Indonesia, Nigeria, and Venezuela (Table 13), compared with 15 per cent for 60 non-oil developing countries.
|Libyan Arab Jamahiriya||10.1||13.9||14.5||14.6|
|United Arab Emirates||…||…||1.3||1.1|
For a variety of reasons, the oil exporting developing countries did not make use of non-oil tax revenues to further their economic objectives. In five countries, non-oil taxes (mainly levies on imports) were of minor importance, so that this policy could not be too effective in any case. In seven other countries with very large increases in oil revenues, it was felt that there was no need to raise taxes. In most countries, in fact, taxes on income, domestic excises, and import duties (especially on raw materials used in domestic production) were reduced. Algeria also reduced income taxes, especially for lower-income taxpayers, and exempted public enterprises from taxes on production. Nigeria reduced taxes on net income and profits and import duties on capital goods. Indonesia exempted certain commodities from export taxes to stimulate non-oil exports. There was also a reduction in income and inheritance taxes and custom duties in Iraq and discretionary income and import tax reductions in Iran. The purpose of these reductions was mainly to ease the business tax burden in order to stimulate domestic production. As a result, the growth of non-oil tax revenue was rather slow.
More recently, with the slowdown or decline in oil revenues caused by a depressed oil market, some countries (e.g., Algeria and Nigeria) introduced new tax measures and began to develop revenues from non-oil sources to reduce the volatility of revenue caused by the heavy dependence on oil. In 1981, Algeria increased the maximum taxable income and the tax rates on gasoline and motor vehicles and introduced a real estate tax on urban property for the benefit of local governments. In 1979–80, Nigeria introduced a number of revenue measures, many of which stemmed from recommendations of a domestic task force on tax administration.
The substantial increase in government revenues associated with the first major oil price increase permitted a rapid growth of government expenditures in all oil exporting developing countries in 1974–75. The rate of growth varied from about 50 per cent in Algeria to over 90 per cent in Nigeria. In most of the low-absorbing countries, total expenditures more than doubled (Table 14).
|Iran||32.1 2||80.7||20.5 3||…||…||…|
|Libyan Arab Jamahiriya||16.3||123.3||16.2||25.0||45.7||…|
|United Arab Emirates||…||…||31.3||10.0||41.8||34.3|
The ratio of government expenditures to GDP, which was already high before the 1973–74 price increase, rose from about 27 per cent in 1971–73 to about 35 per cent in 1974–75 in the high-absorbing countries, and from about 40 per cent to over 50 per cent in the low-absorbing countries (Table 15). After a series of contractionary fiscal policies during 1976–78, the annual rate of growth of government expenditure decelerated sharply in most countries, to a rate of less than 10 per cent in Iraq, Nigeria, Venezuela, and Qatar, and ending up with even lower rates than during 1971–73. It is important to point out, however, that actual expenditures, especially in the low-absorbing countries, fell short of allocations, either because of manpower and other constraints or because the authorities were forced to follow a policy of fiscal restraint.89
|Libyan Arab Jamahiriya||37.9||54.6||57.1||57.9||…||…|
|United Arab Emirates||…||34.7||42.7||39.8||45.2||39.1|
Following the second major price increase in 1979–80, and with the easing of inflationary pressures and financial constraints, there was a renewed tendency toward larger government spending, though the shift was less pronounced. As a result, in most of the countries, the moderately expansionary policy contributed to a revival in domestic economic activity without large inflationary pressures. More recently, however, the countries (e.g., Ecuador, Gabon, Iran, Iraq, the Libyan Arab Jamahiriya, Nigeria, and Venezuela) most severely affected by the fall in oil export earnings have been forced to make significant cutbacks in government spending, while others have become more restrictive.
The pattern of expenditures has also changed drastically in most oil exporting developing countries. The changes reflect both national characteristics and development strategies. While there are differences in experience between high-absorbing and low-absorbing countries, the changes in the pattern of expenditures show some similarities. There have been sharp increases in defense spending as well as in civilian wages, salaries, social benefits, and subsidies in all countries, and have made up the largest part of current expenditure. In all countries, the rate of growth of capital expenditure has been higher than that of current expenditure, owing mostly to the implementation of huge development plans. There seems to have been an expenditure bias against agriculture, either because of inadequate opportunities or because of insufficient development priority. In all countries, with the exception of the Libyan Arab Jamahiriya, the share of agriculture in total capital expenditure has declined. Most of the countries have allocated a large proportion of their expenditure to industry, reflecting the focus of their development efforts on hydrocarbon projects, for which they have had abundant resources, and on import substitution for some commodities that have enjoyed a large domestic market. All countries have raised the share of social services (education, health, and housing) in accordance with the objective of improving social welfare.
There have also been many differences in the pattern of expenditures, both between high-absorbing and low-absorbing countries and among countries within each subgroup. In general, the high-absorbing countries, which already had an industrial base and infrastructure, have concentrated on industrialization and the improvement of the existing infrastructure. For example, in Algeria, capital spending has displayed an immensely strong industrial bias, accounting for 60 per cent of total public investment during 1974–78 (Table 16). Expenditures on social services and infrastructure were also ahead of agriculture. Nigeria, too, seems to have shown a pronounced “urban bias.” Agriculture represented less than 4 per cent of total capital expenditure in 1975–79; the major relative increase in capital outlays was in economic services and especially in manufacturing, reflecting the development of local industries. Social services also represented a large share of total expenditure. Indonesian development expenditures were for the most part more evenly distributed, though the share of agriculture in total outlays declined from 31 per cent to 18 per cent between 1975 and 1979. The shares of industry, transportation, education, and regional development increased significantly. In Iraq and Iran, there also was a bias in favor of industry and infrastructure compared with agriculture.
|1971–73||1974–78||1980–81 2||1974/75||1975/76–1978/79||1979/80–1980/81||1971/72–1973/74||1974/75–1977/78||1970/71–1973/74||1975–78||1970/71–1973/74||1975/76–1978/79||1980–81 2|
Including transport and communication.
Including defense and other social and economic expenditures.
Including transport and communication.
Including defense and other social and economic expenditures.
The low-absorbing countries have suffered from limitations on physical and social infrastructure and lack of an industrial base before 1973. They have also been plagued by two principal constraints for balanced growth—small farmlands and a limited native labor force—and have moved toward the development of only basic needs. The share of infrastructure, electricity, and water in capital outlays was thus raised to over 40 per cent in most of these countries by the end of 1979 (Table 17). They have also moved toward industrialization and toward a program to increase the domestic labor supply by importing expatriate labor. In the Libyan Arab Jamahiriya, a large share of investment (23 per cent) has gone to agriculture, in line with the priority assigned to increasing food production and achieving self-sufficiency in foodstuffs. The share of industry has remained at about 19 per cent and that of social services at 27 per cent.
|Kuwait||Libyan Arab Jamahiriya||Oman||Qatar||United Arab Emirates|
Including transport and communication.
Including transport and communication.
During the 1979–80 period, following the second large oil price increase, there seems to have been a shift in the pattern of expenditure in most of the oil exporting developing countries. In Algeria and Nigeria, for example, the emphasis shifted somewhat toward agriculture, which had been neglected in previous years; in some of the low-absorbing countries, expenditures in infrastructure have leveled off and have been replaced by increased outlays in industrial projects. Substantial investments in petrochemical and other petroleum-based industries are being made by the public sectors of some countries.
The effects of revenue flow on the domestic money supply have depended mainly on the government’s decision to inject funds into the economy through domestic expenditure. Monetary policy, to a much greater extent than in most developing countries, has thus been a by-product of public expenditure. The money supply, in turn, has not been an instrument under the exclusive control of the central bank. The real importance of monetary and credit policy has been manifested in the magnitude of the increase or decrease of credit to the private sector (and its allocation to various subsectors). Also, interest rates have played a part in resource allocation only in countries that have an organized banking system, and where religious factors have not been a major consideration.
During the early 1970s before the first oil price increase, the rise in money supply in most oil exporting developing countries was restrained. The annual rate of growth in money was about 20 per cent in five countries, and only in Indonesia and the Libyan Arab Jamahiriya was the rate higher than 30 per cent. (Table 18). Following the oil price increase, there was a dramatic rise in domestic liquidity in all of the countries except Algeria (where the rate remained at about 20 per cent) and the Libyan Arab Jamahiriya (where the rate declined from 36 per cent to 30 per cent). The rapid expansion was due mainly to the sharp increase in government expenditures and a marked widening of domestic budget deficits. The other important factor was the expansion of credit to the private sector, although at much lower annual rates, owing to the surge in the level of economic activity and the rise in import requirements.
|Money Supply||Credit to Private Sector|
|Iraq||15.1||40.8||21.2 1||…||–2.4||20.7||12.4 1||…|
|Libyan Arab Jamahiriya||36.2||29.5||23.8||…||42.5||52.5||13.5||…|
|United Arab Emirates||…||98.3||19.7||29.1||…||87.1||38.9||18.7|
The bulk of expanded commercial bank credit in these years was to commerce, construction, and financial and other services. Investment financing in productive sectors has usually been channeled through specialized credit and development institutions. In Algeria, for example, the Algerian Development Bank has played an important investment financing role in the economy, both by acting as an intermediary between the Treasury and public enterprises in financing of the latter’s investment program and by supervising the operational and financial management of these enterprises. In Iran, before 1979, the specialized banks provided medium-term and long-term capital for investment in the industrial, agricultural, and construction sectors, as well as entrepreneurial leadership by initiating new undertakings and purchasing equity shares. In Iraq, there have been several specialized credit institutions that have lent exclusively to the private sector at low interest rates. Also, in Indonesia, Nigeria, and Venezuela, specialized financial entities have been established to channel resources especially to the agricultural, industrial, and construction sectors. In Kuwait, the Libyan Arab Jamahiriya, and Saudi Arabia, in addition to specialized credit institutions that lend at highly concessionary terms, several investment companies have been established to act as intermediaries in placing funds abroad.
Monetary and credit developments closely reflected developments in government spending. In the aftermath of the 1973–74 oil price increase, the expansionary fiscal policy was accompanied by an expansionary monetary and credit policy. During 1976–78, the rate of growth of domestic liquidity declined sharply in most of the countries as the domestic budget deficit and the expansion of credit to the private sector were reduced. Thereafter, following the 1979–80 oil price increase, the moderately expansionary fiscal policy was reflected in an easing of monetary and credit policies in some countries. However, as in government spending, the average growth of domestic liquidity in 1980 remained well below that of the earlier period.
The main determinants of domestic liquidity in the oil exporting countries have remained the domestic budget deficit and credit to the private sector. The principal instruments have been reserve requirements, selective credit controls, credit ceilings, refinancing facilities, and, in some instances, interest rates and open market operations.90 As in other developing countries, the role and limits of each of these instruments have depended on the state of development of the financial and money markets and in some countries on social, cultural, and religious factors. Because most oil exporting developing countries do not have a well-developed financial market, the role of open market operations has been very limited. The instruments most widely used have been credit controls and credit ceilings.
In Algeria, with the national development plan as a framework, the allocation of credit to the various sectors, industries, or even enterprises, has been the responsibility of high monetary authorities; the role of commercial banks has been to implement these allocations without themselves playing an important part in establishing credit policies. In Indonesia, since 1974 the central bank has imposed ceilings on credit and other net assets of all commercial and development banks. In Iran, the two measures frequently used were minimum reserve requirements and credit ceilings. The principal instruments to regulate credit operations of the commercial banks in Nigeria have been credit guidelines on the desired distribution of private sector credit, a liquidity ratio requirement, interest rate changes, special deposits and stabilization of cash reserve requirements, and a ceiling on credit to the private sector. In Venezuela, which has a better developed financial system, monetary policy instruments have been used more actively, including a minimum ratio of deposit obligation, reserves and portfolio requirements, variations on interest rates, cash reserve requirements, and a ceiling on credit to the private sector.
In Kuwait and the Libyan Arab Jamahiriya, while the central bank has considerable regulatory power over commercial banks, the major instrument of control has been moral suasion. In Saudi Arabia, where Islamic law precludes the use of interest as an instrument of monetary policy, control over credit to the private sector has been exercised mainly through adjustments in the statutory reserve requirements and the use of moral suasion.
With the possible exception of Venezuela and, to a lesser extent, Indonesia and Nigeria, interest rates have not played a major role in monetary policy in the oil exporting developing countries. There are three reasons for this: most of these countries do not have well-developed financial markets; they have decided on low interest rates to encourage investment and to keep down production costs; and, for certain countries, religion has been a deterrent. As shown in Table 19, for the most part interest rates have been lower than the rate of inflation, with the exception of Venezuela, which has had positive real interest rates.
|Libyan Arab Jamahiriya||5||5–9||7–7.5||11.5 1|
In Algeria, interest rates have been kept low as a deliberate social policy. The highest lending rate (6 per cent) is on loans to private business and the lowest rate (2 per cent) on long-term agricultural loans. Interest rates paid by commercial bankers on deposits have ranged between 2.5 per cent and 4.5 per cent. The structure of interest rates has also remained essentially unchanged for several years, apart from a recent moderate increase in the interest rate on household savings deposits. In Iran, interest rates were also kept relatively low (about 8 per cent) during 1973–79, compared with the rate of inflation (15 per cent), mainly to regulate the cost of capital. In Iraq, commercial bank interest rates have been largely unchanged in recent years, with a basic lending rate of 6 per cent and deposit rates in the range of 4–5 per cent.
In recent years there has been increased flexibility in Venezuela through the setting of rates on certificates of deposit and commercial bank loans in relation to a reference rate that is reviewed at least once a month. In Indonesia, interest rates have been relatively high compared with other developing countries; but there is a large differential between controlled and free rates. The state bank’s maximum allowable deposit rate is 15 per cent for small deposits and 12 per cent for large deposits, both with a 24-month maturity. The lending rates range between 9 and 21 per cent, and they are controlled by the Central Bank. In contrast, private banks follow the Eurodollar rate, and as a result their deposits have grown more rapidly than those of the state banks. In Nigeria, interest rates were raised on several occasions between 1977 and 1980. After April 1977, the minimum rediscount rate was raised in several stages from 3.5 per cent to 6.0 per cent, and treasury bill and certificate rates have been increased by the same amount. In April 1980, almost all interest rates were raised by 1 percentage point.
A significant consequence of a low interest rate policy and widening differentials between domestic and foreign interest rates has been the outflow of large amounts of private capital, especially from some of the surplus countries. These outflows have created pressure on the commercial banks, whose ability to increase rates has been limited by legal ceilings set by the central bank. More recently, these pressures were increased by the significant widening of interest rate differentials following the high levels prevailing in international financial markets.
Achievements Vis-à-Vis Aspirations
The examination of specific policies followed by a number of the oil exporting developing countries show that both the capital surplus and the capital deficit countries have raised GDP growth rates by substantial margins and have moved in the direction of diversifying their economies. Economic growth and attempts at diversification, in turn, have had a significant influence on domestic inflation, balance of external payments, and internal distribution of income.
Economic Growth and Diversification
The primary economic objective of all oil exporting developing countries has been rapid economic growth and product diversification. The expansionary fiscal policies that followed the oil price rise accelerated this development process and strongly stimulated non-oil economic activities in most of these countries. Measured by the rate of growth of the non-oil sector, progress during the period 1974–80 has been impressive. The average real rate of growth of non-oil GDP reached 12 per cent per annum in 1974–76 (Table 20).91 In general, the rate was higher in the low-absorbing countries, exceeding 15 per cent in Kuwait, the Libyan Arab Jamahiriya, Saudi Arabia, and the United Arab Emirates, but it was equal to or less than 12 per cent in other countries. However, as a result of tighter financial policies during 1977–79, the average annual rate of growth of non-oil GDP declined gradually to about 6 per cent. The relaxation of financial policies following the 1979–80 oil price increase contributed to higher private sector investment and helped to raise the rate of growth of the non-oil sector in some countries. But, with the continued low level of economic activity in Iran, the average rate of growth in non-oil GDP declined to 4.5 per cent in 1980. The weak domestic demand in Venezuela also led to a virtual stagnation of non-oil economic activity during 1979–81. With Iran and Venezuela excluded, the average annual growth rate is estimated at about 8 per cent, compared with a rate of 3.5 per cent for the non-oil developing countries. As in previous years, Saudi Arabia experienced the highest rate of growth (13 per cent).92
|Real GDP||Non-Oil Sector|
|Kuwait||–4.2 1||9.7 2||4.7||–19.7||9.4 1||24.7 2||3.7||5.0|
|Libyan Arab Jamahiriya||…||13.8 3||5.6||–2.4||…||14.2 3||10.3||6.0|
|Oman||…||18.0 3||–2.1||2.5||…||25.0 3||6.3||10.0|
|United Arab Emirates||…||11.3 3||—||–2.2||…||21.1 3||4.4||6.0|
In the absence of data for 1973 and 1974, the rates can average annual rates for 1972–75.
In the absence of data for 1973 and 1974, the rates can average annual rates for 1972–75.
The most rapid expansion has been in construction and government services. Construction has emerged as a leading growth sector in most oil exporting developing countries, especially in the low-absorbing countries. The latter have also experienced a rapid expansion in electricity and water and other services in response to high demand growth supported by low pricing policies. In general, however, these countries have devoted a larger proportion of total investment to the improvement of physical and social infrastructure, and a smaller proportion has gone into investment in productive sectors for diversification.93 In addition, diversification has been constrained by labor shortages and limited agricultural land. Nonetheless, in the low-absorbing countries, as well as in the more diversified high-absorbing countries, manufacturing, especially hydrocarbons, has expanded rapidly, though at a slower pace than other sectors (except agriculture). The share of the agricultural sector in the economy, particularly in the large agriculturally oriented countries (Nigeria, Indonesia, Algeria, and Iran) has declined, owing mainly to low investment priority (Table 21).
|Oil Sector||Agriculture||Manufacturing||Other Industry||Services|
|Libyan Arab Jamahiriya||52||58||3||2||3||4||13||10||29||26|
|United Arab Emirates||79||62||1||1||1||4||4||11||15||22|
Data for 1973 and 1977.
Data for 1973 and 1977.
Changes in total GDP were markedly affected by changes in the level of crude oil output. The average annual rate of growth for the 12 countries surveyed in this section is estimated at almost 7 per cent for the period 1974–76, varying from about 6 per cent in Algeria and Indonesia to 14 per cent in the Libyan Arab Jamahiriya. During 1977–79, the average rate declined to 3 per cent, owing partly to a slowdown in economic activity in Iran and the stagnation of oil production over the period. In 1980, the rate of growth is estimated to have been negative partly because of a large negative growth rate in Iran and in other countries that reduced their volume of oil production. The average share of the oil sector in total nominal GDP of the 12 countries declined from well over one half in 1974 to less than one third in 1978–80.
The highly expansionary policies adopted by the 12 countries following the 1973–74 oil price increase led to the emergence of excess demand conditions and supply bottlenecks. These, combined with increases in import prices, resulted in strong inflationary pressures during 1974–77. The average rate of inflation, as measured by the consumer price index, jumped from 7 per cent per annum during 1971–73 to over 16 per cent in 1974–77 (Table 22). Particularly large increases were recorded in Indonesia, Iran, Nigeria, Qatar, Saudi Arabia, and the United Arab Emirates.
|Average Annual Rate|
|Libyan Arab Jamahiriya||1.5||7.1||13.2||10.0||…|
|United Arab Emirates||…||27.0 2||15.0||16.9||…|
To contain sharply accelerating inflationary pressures, most of the oil exporting countries tightened their demand management policies during 1976–78. These contractionary policies were generally maintained well into 1979. As a result, the average rate of inflation declined to less than 11 per cent during 1978–79. However, the average price increase is estimated to have accelerated again, to 13 per cent in 1980, and then to have declined slightly in 1981. The moderate shift to a more expansionary policy in 1980 appears to have resulted in only limited inflationary pressures. Venezuela recorded the highest inflation rate in 1980, reflecting the policy of relaxing previously suppressed inflationary pressures through a reduction in price controls and subsidies, but in 1981 its inflation rate fell. There was also a large increase in consumer prices in Iran and a marked slowing of inflation in Indonesia, while changes in most of the other countries were relatively small.
Most of the countries used price controls, and provided subsidies to reduce inflation as well as to offset its effect on particular groups. There were direct subsidies on a wide range of goods and services and indirect subsidies through the pricing policies of public enterprises (especially those responsible for electricity, water, and refined petroleum products),94 and low or no user charges for government-supplied services such as health and education.
Balance of Payments
Following the quadrupling of oil prices in 1973–74, the combined current account surplus of the countries surveyed here jumped from about $7 billion in 1973 to $68 billion in 1974 (Table 23). More than 60 per cent of the 1974 surplus was accounted for by the 6 “surplus” countries (Iraq, Kuwait, the Libyan Arab Jamahiriya, Qatar, Saudi Arabia, and the United Arab Emirates). In subsequent years, balance of payments developments have closely followed fiscal policies. The speed with which highly ambitious development strategies were implemented and the strong ability to absorb real resources from abroad, combined with the stagnation in the volume of oil exports and a deterioration in levels of trade, resulted in significant balance of payments adjustments between 1974 and 1978. The combined surplus on current account dropped to about $3 billion in 1978. Further, this surplus became increasingly concentrated over the 1975–78 period among 5 countries of relatively low absorptive capacity—Saudi Arabia, Kuwait, the United Arab Emirates, Qatar, and the Libyan Arab Jamahiriya. By 1978, 6 other countries, which had accounted for over one third of the 1974 surplus, moved into a deficit estimated at $15 billion.
|Balance on merchandise and trade||18.8||82.2||53.4||65.1||60.7||40.1||112.7||166.6||118.8||58.5|
|Net services and private transfers||–12.2||–13.9||–18.0||–24.8||–30.5||–37.9||–44.1||–52.3||–53.8||–57.5|
|Balance on current account||6.6||68.3||35.4||40.3||30.2||2.2||68.6||114.3||65.0||1.0|
With the sharp rise in oil prices in 1979, the combined surplus of the 12 countries rose again, to about $70 billion in 1979 and to $115 billion in 1980, reflecting a major gain in the terms of trade. The 6 countries that had experienced current account deficits in 1977–78 realized a combined surplus of $12 billion in 1979 and 1980. There was, however, a substantial deterioration in Iran’s current account position during 1979–81, associated with the events in that country. The increasing concentration of the surplus in 6 countries did not reflect a lower level or slower average growth in their imports than for the other 6 countries. Rather, it was explained by the fact that these countries accounted for a larger proportion of oil exports, mainly because of the substantial decline in exports from Iran but also because of various export shortfalls in others.
The expansionary policies followed by the 12 countries during 1974–75 resulted in a rapid expansion of imports. During this period, combined imports (in U.S. dollars) increased at an annual rate of about 67 per cent. During 1976–78, the rate decelerated to 16 per cent following the leveling off of oil revenues and the contractionary policies pursued. In 1979, total imports of the oil exporting countries stagnated, owing mainly to a sharp drop of imports into Iran. The gradual shift toward more expansionary policies, combined with a relaxation of import restrictions in a few countries and a partial recovery of Iran’s imports, contributed to higher import growth (30 per cent) in 1980.
After 1974, non-oil exports declined in relative terms. The share of non-oil exports to total exports fell from 11 per cent in 1973 to 5 per cent in 1980. Partly reflecting this decline, the non-oil current account deficit for the 12 major oil exporters increased from $28 billion in 1973 to $166 billion. Only a few countries, most notably Indonesia, managed to maintain non-oil export growth, thanks to continuous promotion policies.
In 1981, the combined surplus declined to about $70 billion, reflecting partly the fall in oil exports (by about 8 per cent) and the further increase in imports (by 18 per cent). In addition, non-oil exports stagnated, mainly because of a decline in exports of primary products from Indonesia and Nigeria. The larger part of the fall in the combined surplus was reflected in the position of the surplus countries, which as a group experienced a decline in their positive current account from $103 billion in 1980 to $76 billion in 1981; Iraq, one of the countries in the group, registered a sizable current account deficit for the first time since 1970. The combined current account position of the other countries registered a deficit of about $5 billion, compared with a surplus of $12 billion in the previous year. Because of the continuing weakening in the oil market and the deterioration in the terms of trade, the 12 oil exporters’ combined surplus is projected to decline further in 1982, and to only partially recover in 1983.95
Income Distribution and Social Welfare
With the increase in oil revenues, expenditures on housing, education, health, and other services expanded rapidly, and important progress was made in distributing these services in most oil exporting developing countries. Further, a wide range of consumer goods and services were subsidized. In several countries, especially the low-absorbing ones, the development of education, housing, and medical services has, in fact, gone as far as basic facilities and staff could be maximally expanded. Another factor limiting the provision of social services in some of the oil exporting developing countries has been the large proportion of the population in the rural areas, which was difficult to reach.
An assessment of post-1973 accomplishments, measured against national aspirations and objectives, is not easy, for two basic reasons: inadequacy of detailed data on various aspects of domestic development and insufficient time (i.e., a short span of only seven to eight years) for the socioeconomic programs and policies to bear fruit. Furthermore, because of marked differences in national features and domestic development capacity, any collective evaluation would at best be a tentative and simplified generalization—subject to additional examination and correction for each country. Nevertheless, for the 12 countries as a whole, certain indications may be worth noting at this juncture.
A reasonable criterion for a preliminary assessment of achievements would seem to be the degree of progress made during 1974–80 toward an eventually viable “non-oil” economy. This long-term objective, in turn, might be considered best served if the medium-term national goals of diversified growth, price stability, and equity were in fact approached, if not actually attained.
Gauged by the changes in the structure of GDP between 1973 and 1979 (see Table 21), for example, the record of effective diversification and smaller dependence on oil is still inconclusive. During the 1973–79 period, the share of oil in total GDP in fact increased appreciably in more than half of the major oil exporting countries (especially in Iraq). Even among the high-absorbing countries, which already had a good base in infrastructure and manufacturing, the diversification efforts barely increased the share of manufacturing and other industries in total GDP. In certain important cases (Algeria and Iraq), this share declined, even though industrial investment increased faster than total capital formation—reflecting the difficulties in raising efficiency, ensuring productive allocation of resources, and finding an appropriate industrial strategy. Nor did the agricultural sector fare much better. The share of agriculture either declined significantly or remained about the same in all 12 countries, particularly in the large agriculturally oriented economies.
In the low-absorbing countries, characterized by limited physical and social infrastructure, the share of services in GDP increased measurably above the shares of agriculture and industry, thus thwarting the objective of product diversification and necessitating a reappraisal of development strategies for the 1980s.
Recent attention to the agricultural sector in Algeria, Nigeria, and Saudi Arabia may indicate these countries’ dissatisfaction with the behavior of their development models. A relative decline in the share of non-oil exports in most of the oil exporting developing countries (Table 24) also does not augur well for a basic strategy of moving away from economic bondage to oil. Nor can the relative rise in the share of the services sector (mostly government) in many of the countries under review be safely interpreted as a sure sign of declining oil dominance. Similarly, some of the domestic policies pursued by these countries seem, on the surface, to threaten the diversification from petroleum. Cuts in income and other taxes put into effect by some of the countries during the 1970s, even if morally justified and politically popular, are not likely to make future conversion to a non-oil economy any easier.
|Non-oil exports||Total exports||Non-oil exports||Total exports||Annual rate of growth||Share of Non-Oil|
Exports in Total
|Non-oil exports||Total exports||1973||1980|
|(In billions of U.S. dollars)||(In per cent)|
|Kuwait||0.29 1||3.32||2.02 2||19.26||32.0||28.6||8.7||10.5|
|Libyan Arab Jamahiriya||—||3.46||—||22.56||—||30.7||—||—|
|United Arab Emirates||0.06 3||1.80||1.28 3||20.74||54.8||41.8||3.3||6.2|
Of which over 50 per cent, re-exports.
Of which over 70 per cent, re-exports.
Consisting almost entirely of re-exports.
Of which over 50 per cent, re-exports.
Of which over 70 per cent, re-exports.
Consisting almost entirely of re-exports.
The objectives of price stability and a fairer distribution of income have been, at best, only partially achieved. Despite extensive monetary, fiscal, and trade measures, all of these countries have experienced varying degrees of high and protracted inflation. Expansionary policies have universally led to excess demand, supply bottlenecks, and cost overruns. The low interest rate policies, where pursued as a spur to increased production and lower costs, have in some cases triggered unplanned and undesirable capital flight. The ups and downs of public expenditures, following the rise and fall of government oil revenues, seem to indicate administrative or institutional difficulties in using the capital markets as efficient stabilizers.
An appraisal of the impact of the “oil boom” on domestic income distribution is difficult. Reliable data on domestic income distribution are scant and inadequate for any objective welfare evaluation. Changing consumption patterns (particularly toward “luxury” imports) and some anecdotal briefs have led many observers to conclude that the “oil benefits” have not been evenly spread internally and that income redistribution has favored the well-to-do segments of the society. What seems largely incontestable is that, while some groups in the oil-based economies have become enormously better off as a result of the newly acquired national wealth, no one seems to be worse off. There are also indications that the large revenues accruing to the public sector and the decline in the share of agriculture in most of these countries have tended to strengthen the position of the urban sector as opposed to the rural areas. Several studies have shown a greater tendency toward income inequality in all mineral exporting countries than in other countries.96
The tentative and preliminary appraisal presented in the foregoing section seems to show that the task of development in the oil exporting developing countries has been difficult, the path to effective diversification rather bumpy, and the noticeable achievements somewhat blemished by emerging new economic and social problems. In sum, despite the obvious beneficial effects of the oil boom, these countries are still far from reaching their development goals. While the availability of foreign exchange has enabled them to painlessly finance imports, and the oil revenues have made it easy for the governments to be generous with public consumption and capital investment, some basic developmental problems still remain. Most of these countries are yet to find a development strategy capable of achieving their national objectives of industrial growth, reduced underemployment, food security, price stability, and redistribution of income. Many are still in search of a long-term equilibrating exchange regime, a viable fiscal posture, an accommodating monetary system, a globally competitive internal investment program, and a clearly profitable external portfolio. The pertinent question now is, what will the future hold for these countries?
World economic developments since the 1979–80 major oil price rise suggest that the outlook in the 1980s for OPEC members may be somewhat different from their 1970s experience in several important respects. First, world demand for oil, and the share of OPEC in the world oil supply, may not continue to be as strong or assured as before, casting doubts on the projected continued rise of oil prices in real terms during the next several years. Second, the capital surplus countries among the oil exporting developing countries may no longer be willing or able to resist a continued decline in the real price of their oil exports and negative real returns on their foreign investments as they did during 1979–80. Third, an increasing portion of oil extraction in the high-absorbing countries will be allotted to domestic needs in the energy-consuming processes of modernization and industrialization, thus possibly reducing the ranks of present OPEC membership. Fourth, internal pressures for a significant redistribution of social amenities (income, status, power) will likely intensify, calling for accommodating changes in the domestic sociopolitical structure. And finally, the patterns of development are likely to shift from basic facilities (e.g., ports, roads, power, telecommunications) and public services (e.g., education, health, housing) to manufacturing industries, requiring increasingly greater technological know-how and increased human skills.
Given the uncertain world oil situation in the years to come, the oil exporting developing countries export policies and development planning require careful new scrutiny and coordination. Oil revenues are likely to provide foreign exchange to finance part of the investment needs, and the likely prospects of hard currency earnings may enable deficit countries to borrow commercially on the strength of their creditworthiness. But many new problems will also have to be dealt with.
The issues facing the oil exporting developing countries continue to differ from country to country. There are, however, some problems common to most of them. First, the appreciation of the real exchange rate and shifts in relative prices have caused an erosion in the competitiveness of the non-oil tradable sector.97 Part of the problem has been the relatively high wages demanded and paid to skilled and semiskilled workers. The sectors most affected have been agriculture and private manufacturing. Commercial and trade policies aimed at protecting import-substituting industries have created a bias against agriculture and non-oil exports. Other causes underlying agricultural stagnation include labor shortages resulting from migration to cities and, in some countries, low producer prices for food products. In addition, subsidies and low pricing policies appear to have been a disincentive to increased domestic output. Diversification and the creation of a viable economy without oil would thus require removing or reducing existing distortions.
Second, notwithstanding recent successes in moderating inflation, inflationary pressures remain high in some oil exporting developing countries. While high consumer price indices provide an indication of inflationary trends, they still are subject to various caveats and might in fact underestimate the true magnitude of price pressures. The consumer price index data in most of these countries are usually based on insufficient coverage, since they are confined to relatively small segments of the population, and on outdated weighting systems. Furthermore, consumer prices are only one aspect of inflation; other prices, especially real estate prices, have continued to rise at high rates. At the same time, official reliance on price controls and growing subsidies to reduce inflation, while having played a significant role in holding down the rate of increase in official price indices, has left unanswered the question of whether the underlying inflationary pressures have also been reduced.
Third, labor shortages and insufficient skilled manpower remain limiting factors in all, but especially in low-absorbing, countries. A generous immigration policy, while providing a temporary reprieve, does not seem to offer a lasting solution. Foreign labor has undoubtedly helped to provide needed skills and has checked a too drastic rise in local wages, but it has created a good deal of social tension.98 Also, despite extensive efforts to improve the infrastructure in most of these countries, resulting in rapid expansion of transportation, communication, and port facilities, many are still faced with new and more diffuse bottlenecks, especially in rural areas, where inland rail and road systems and other basic facilities are lacking.
Finally, the depletable oil reserves and uncertainty in the world oil market threaten to affect the development strategies of a number of oil exporting developing countries, particularly the high-absorbing ones. The low absorbers, especially Saudi Arabia, are perhaps less likely to be affected by a decline in price or a glut in the world oil market. But countries like Nigeria and Indonesia will either have to accept a lower rate of growth or resort to large external borrowing. With the exception of the few capital surplus countries, a negative resource gap appears likely again in the coming years unless oil prices begin to rise in real terms.
Suggested Policy Stance: A Summary
Policies that can be adopted to cope with the foregoing issues include the appropriate exchange regime, nationally sound fiscal management (including growing reliance on non-oil taxation), adoption of supporting monetary measures, and selection of specific industry incentives.
By way of summing up the earlier discussion in the first part of this chapter, the alternative options suggest the following. A floating exchange rate carries the disadvantage of potentially greater volatility, which could produce uncertainties harmful to the diversification process. A unitary fixed exchange rate that offers a known and relatively stable incentive for exporting and for producing import substitutes can be an attractive option if the rate is set at a level that encourages the desired expansion in the traded goods industry and if the authorities are willing and able to keep inflation under control. If the latter cannot be accomplished, a second-best alternative may be to adopt a unitary but adjustable exchange rate, where depreciation can be employed to offset inflation differentials. However, the more frequently such exchange rate changes are made, and the more they come to be expected, the less effective they are likely to be in changing relative prices (other than in the very short run). Real exchange rates are determined more by expenditure decisions than by the choice of exchange regime and nominal exchange rate. Multiple exchange rates, in contrast to a unitary rate, are capable of changing relative prices among different categories of exports or imports. But since decisions in the oil sector are taken by the government and hence are little affected by the exchange rate, there may be little reason to have a separate exchange rate for oil. If multiple rates are used to discriminate among different private sector transactions, they are most defensible when either there are “externalities” that are not reflected in market prices or when there are unalterable imperfections or distortions that need to be offset. The equalization of marginal social and private benefits is properly the task of fiscal policy and can, therefore, be better accomplished by taxes and subsidies than through the exchange system.
Fiscal policy in oil exporting developing countries is dominated by government expenditure decisions. For this reason, it is particularly important to keep public expenditure within the economy’s absorptive capacity if excessive inflation rates and relative price trends inimical to diversification are to be avoided. In planning their expenditure strategy, governments in these countries should assess the impact on the balance between supply and demand for domestic resources. Conventional measures of fiscal stance, such as the overall or bank-financed balance, have limited usefulness when the bulk of government revenues are derived from abroad. A more useful context in short-run fiscal analysis may be the domestic budget balance, though it must be used with care.
Thus, there is a need for strengthening budget management, maximizing the effects of fiscal measures, and carefully choosing investment priorities. A more active fiscal policy in these countries requires improved fiscal analysis and policy formulation. To this end, care must be taken to prevent the “crowding out” of private productive projects by the exigencies of the not equally productive public sector investments. Another important aspect where improvement is urgent is coordination between national budgets and development plans. For the budget to become an effective planning tool, improvement is needed in accounting performance, budget implementation, and financial control.
Despite obvious limitations in the short run, there are various arguments for encouraging the long-term use of non-oil taxation as a useful additional instrument of demand management. The projected decline in oil production and the uncertainty associated with oil revenues in most of the high-absorbing countries clearly require a much improved non-oil tax effort. To a lesser degree, this concern is also valid for the low-absorbing countries with larger oil reserves, since it takes many years to introduce new taxes and develop the habit of paying them. An early start in preparing for such a move is essential. In the short run, domestic taxation could also play a role in steering economic development, reducing waste and misallocation of resources, and improving income distribution.
In common with many developing countries, most of the oil exporting developing countries have followed a policy of low and stable interest rates. Religious factors aside, the rationale for this policy is usually based mainly on three premises: (a) these countries do not have a well-developed financial market, and thus the role of interest rates is limited; (b) personal savings are responsive primarily to incomes and not to interest rates; and (c) high interest rates adversely affect costs of production and retard competitiveness and trade. For these reasons, the tendency has been to rely primarily on direct credit control in sectoral allocation. However, with the development of new financial and banking institutions, the experience of some oil exporting developing countries has shown that interest rates could play a useful role both in mobilizing savings and in better resource allocation, particularly since direct credit control has not always been an efficient tool in credit allocation.
It should be emphasized, however, that interest rates cannot easily be used as an independent policy instrument to promote development. In open economies without capital controls, the scope for divergence from international levels is limited by the mobility of capital; in economies that have control over capital flows, low interest rates may have the disadvantage of discouraging domestic savings.
Many among the oil exporting developing countries may also need to consider the use of industry-specific policies previously discussed. In general, industry-specific policies that sponsor some industries at the expense of others can be defended where there are identifiable externalities or where existing distortions in resource allocation need to be offset. Past experience suggests the following: beneficial externalities are greatest for infant industries; industry incentives need to be stable to be effective; incentives should be applied to all production rather than to export production alone; outward-looking policies yield better overall economic results than inward-looking ones; and the attractiveness of these policies is diminished by the difficulties of measuring externalities and of dislodging vested interests when externalities have long since disappeared.
Industry subsidies must be consistent with rather specific international codes of conduct, which, of course, restrict their scope. They do, however, carry the advantages, relative to some other policy instruments, of being flexible, adaptable, and disaggregated and of preserving potential economies of scale in production. Protection against competition from imports, where it is necessary, should be used only during the early years of an industry’s development. It should be minimized for producer goods industries, where economies of scale are important, and for raw materials that are crucial to manufacturing export industries. It should take the form of tariffs rather than quantitative restrictions where possible, and efforts should be made to limit the extent of tariff dispersion across industries. Finally, there is evidence that protection from imports, when used to promote industrial diversification, has adverse effects on the development of the agricultural sector—and this should be considered as a serious drawback for those countries that have good agricultural potential.
It may be worth reiterating how these policy guidelines are likely to differ, at least in emphasis, between the different subgroups of oil exporting developing countries. At one extreme, the subgroup that can be characterized as having short-lived oil reserves, large populations, a significant existing non-oil sector, relatively good agricultural potential, limited state intervention in the economy, and small holdings of international reserves has a particularly strong case for limiting present consumption of oil revenues and thereby carrying forward much of their oil wealth. By doing so, they also stand the best chance of avoiding an appreciation in their real exchange rate, which would adversely affect not only the future growth of their non-oil export industries but also the present levels of output and employment in these industries. Because oil reserves are relatively small, these countries need to consider a development strategy that gives an important place to agriculture as well as to labor-intensive manufacturing. Put in other words, their limited oil reserves, in combination with their relatively large endowments of labor, argues for treating capital and foreign exchange as scarce resources (at least in a dynamic sense). Oil-based industrialization is probably not a viable option for these countries. The primary role assigned to the private sector in economic development means that particular attention must be paid to setting up the right kind of incentives. Where the domestic market is large, there is some scope for import substitution, but if this is continued beyond the infant industry stage, there is the danger that both economic growth and economic efficiency will suffer. Industry-specific policies can be useful for these countries, but probably more to offset existing distortions than to capture favorable externalities.
At the other end of the spectrum, the subgroup that can be broadly described as having large oil reserves, small populations, little existing non-oil industry, relatively poor agricultural potential, substantial state intervention in the economy (particularly in aggregate investment), and large holdings of international reserves is faced with a longer time dimension. The large stock of international reserves provides a cushion against short-run adverse external developments, and the government plays an active and leading role in the transformation of the economy. Government expenditure of oil revenues needs to be kept consistent with the economy’s absorptive capacity if undue real exchange rate appreciation is to be avoided and new non-oil industries are to develop. Diversification of the economy is a desirable objective over the long run, and note needs to be taken of the substantial lead times necessary to develop internationally competitive industries. In the short run, however, asset diversification is probably more pressing than export diversification. When diversification of production and of exports does take place, the large endowment of capital embodied in oil reserves will permit a strategy of resource-based (i.e., oil-based) industrialization. Given the flexibility and adaptability of human capital, and considering the limited non-oil sector in place, there are strong advantages in using oil revenues initially to build up skilled labor resources. The dominant role of the government in the economy makes relative price incentives somewhat less important than in oil exporting developing countries with larger private sectors, since the state can use direct intervention to expand investment in productive activities.
See International Monetary Fund, Annual Report of the Executive Board for the Financial Year Ended April 30, 1980 (Washington, 1980), p. 51.
Where the country’s exports and imports are perfectly homogeneous and where the country is a price taker for its exports and imports, only the first and fourth of these relative prices will be relevant.
Even where the exchange rate has no effect on relative prices, it can still affect the volume of trade by affecting the real value of money balances and hence expenditure on imports.
This is basically the conclusion reached in an empirical study of the Iranian economy over the 1960–77 period; see Bijan B. Aghevli and C. Sassanpour, “Growth and Inflation in an Oil Producing Economy: Iran, 1960–77,” World Development, Vol. 10 (September 1982), pp. 791–800.
A corollary of the “temporary” nature of the relative price changes induced by exchange rate changes is that the balance of payments effect will likewise be once and for all rather than continuing; see Susan M. Schadler and George A. Mackenzie, Exchange Rate Policies and Diversification in Oil Exporting Countries (unpublished, International Monetary Fund, May 9, 1980).
See Morris Goldstein, Have Flexible Exchange Rates Handicapped Macroeconomic Policy, International Finance Section, Special Papers in International Economics, No. 14 (Princeton University, June 1980).
Among the 24 oil exporting countries, 11 had a unitary peg to a single currency as of December 31, 1982. One had a link to the SDR. Four had their currencies pegged to a composite basket. Five observed limited flexibility vis-à-vis a single currency or a group of currencies. One was adjusted according to a set of indicators. Two followed a system of managed floating.
A variant of this strategy that can offer a greater measure of stability in average import prices is to fix the exchange rate in terms of a basket of currencies, or the SDR, instead of a single currency.
Another objective of dual rates might be to contain inflationary pressures (by applying an appreciated rate to essential imports) while simultaneously trying to promote import substitution (by applying the depreciated rate to all other imports); see Schadler and Mackenzie, p. 28 (cited in footnote 58).
See, for example, Anthony Lanyi, “Separate Exchange Market for Capital and Current Transactions,” International Monetary Fund, Staff Papers, Vol. 22 (November 1975), pp. 714–49.
For a discussion of the near equivalence between multiple rates and a system of taxes and subsidies, see John F. Laker, “Fiscal Proxies for Devaluation: A General Review” (unpublished, International Monetary Fund, October 21, 1980).
The relevant guideline is as follows: “While urging members to apply alternative policies not connected with the exchange system, the Fund will be prepared to grant temporary approval of multiple currency practices introduced or maintained principally for nonbalance of payments reasons, provided that such practices do not materially impede the member’s balance of payments adjustment, do not harm the interests of other members, and do not discriminate among members.”—Executive Board Decision No. 6790-(81/43), March 20, 1981, Selected Decisions of the International Monetary Fund and Selected Documents, Ninth Issue (Washington, June 15, 1981), pp. 226–27.
See J. Artus, “Methods of Assessing the Long-Run Equilibrium Value of an Exchange Rate,” Journal of International Economics, Vol. 8 (May 1978), pp. 277–99. By some definitions, (i) and (ii) are complementary.
Although this subject might best be considered as pricing policy for oil rather than as part of exchange rate policy, the role accorded to exchange rate factors in the discussion perhaps justifies its placement in this section.
Note also the large disparities across different currencies in realized rates of return for money market instruments over the 1973–80 period. (See Table 3.)
Partial indexation was tried by OPEC in 1974 under the so-called Geneva I and Geneva II formulas. See Jahangir Amuzegar, “OPEC and the Dollar Dilemma,” Foreign Affairs, Vol. 56 (July 1978), pp. 740–50.
Pricing oil in SDRs provides protection against exchange rate fluctuations and gives incentives to the United States to maintain a strong U.S. dollar, whereas pricing in terms of U.S. dollar export prices of major trading partners gives inflation protection and incentives to all OECD countries to moderate price increases. See Hossein Askari and Mehdi Salehizadeh, “Reflections on OPEC Oil Pricing Policies,” OPEC Review, Vol. 3 (March 1979), pp. 21–25.
It may be noted that changing the denomination of oil price contracts need not affect the currency of settlement, nor change the problem of how and where to hold financial claims.
See David R. Morgan, “Fiscal Policy in Oil Exporting Countries, 1972–78,” International Monetary Fund, Staff Papers, Vol. 26 (March 1979), pp. 55–86.
See George A. Mackenzie, “The Role of Non-Oil Revenues in the Fiscal Policy of Oil Exporting Countries,” (unpublished, International Monetary Fund, January 23, 1981.
This has happened in several Persian Gulf countries in recent years.
This section draws rather heavily on the conclusions of two recent studies of trade and adjustment policies in developing countries. An attractive feature of both these studies is that they summarize the experience of many developing countries with various types of industry-specific policy. See Donald B. Keesing, “Trade Policy for developing Countries,” World Bank Staff Working Paper No. 353, International Bank for Reconstruction and Development (Washington, August 1979); and B. Balassa, “Structural Adjustment Policies in Developing Countries,” World Development, Vol. 10 (January 1982), pp. 23–38.
In the following discussion, the term “industry subsidies” should be understood to cover agriculture as well as manufacturing.
Keesing, p. 47 (cited in footnote 75) offers the following general guideline for developing a country’s trade policy: “… favor one industry, product or subsector against another, where there appears to be a strong reason for doing so, but keep incentives neutral between import substitution and exports except in special cases where there is a strong reason to deviate from this principle.”
Using a sample of 12 newly industrialized countries for the 1973–79 period, Balassa (cited in footnote 75) has found significant positive rank correlations between the rate of reliance on export promotion, on the one hand, and both the rate of economic growth and the reciprocal of the incremental capital-output ratios (as a proxy for the level of efficiency in the allocation of resources), on the other.
Subsidization of labor is rare. A notable exception was the Selective Employment Tax, introduced in the United Kingdom in 1965, which had the effect of taxing service industries and through a rebate system subsidizing manufacturing. The tax is credited with inducing a substantial switch in employment from the services to the manufacturing sector. See W.B. Reddaway, and others, The Effects of Selective Employment Tax: Final Report (Cambridge University Press, 1973).
For most of these lessons, see the studies by Keesing and Balassa, (cited in footnote 75).
In this respect, it has been noted that growth rates of agricultural production for oil exporting developing countries have typically been quite poor compared with other developing countries. See Nankani (cited in footnote 21).
A performance evaluation can be made in the context of national priorities or in terms of appropriate strategies suggested in this paper. While the conclusions reached under each approach may not necessarily nor substantially differ (as some of the policies adopted by those authorities conform to suggestions in this paper), the examination here follows the first option.
Available data also show that prices in the nontraded goods sector moved much faster than the prices in the traded goods sector (agriculture and manufacturing); the only decrease was in the import price index.
By World Bank estimates, the incremental capital-output ratios rose during the 1970s despite heavy outlays in relatively labor-intensive activities (e.g., construction and government services). See International Bank for Reconstruction and Development, World Development Report, 1981 (Washington, 1981), p. 89.
See World Economic Outlook: A Survey by the Staff of the International Monetary Fund (Washington, April 1982), pp. 45–48.
See Schadler and Mackenzie (cited in footnote 58).
See International Monetary Fund, Annual Report on Exchange Arrangements and Exchange Restrictions, 1982 (Washington, 1982).
As indicated earlier, the ability of governments to spend increasing oil revenues should not be interpreted to mean high-absorptive capacity in a strict production sense.
For a discussion of the role of these instruments in the non-oil developing countries, see Deena R. Khatkhate, “False Issues in the Debate on Interest Rate Policies in Less Developed Countries,” Banca Nazionale del Lavoro, Quarterly Review, Vol. 33 (June 1980), pp. 205–24; and Warren L. Coats, Jr. and Deena R. Khatkhate, eds., Money and Monetary Policy in Less Developed Countries: A Survey of Issues and Evidence (Oxford and New York, 1980).
The average annual rate of growth in real GDP in the non-oil developing countries during the same period is estimated at 5 per cent.
See World Economic Outlook: A Survey by the Staff of the International Monetary Fund (Washington, April 1982).
See R. Hablutzel, “Issues in Economic Diversification for the Oil-Rich Countries,” Finance & Development, Vol. 18 (June 1981), pp. 10–13.
Subsidies to domestic prices of oil products, apart from their heavy drain on budgets, have also discouraged energy conservation in most oil exporting developing countries.
A recent estimate indicates an expected current account deficit of $9 billion in 1982, owing mainly to the 40 per cent decline in OPEC output compared with the 1979 level. See OPEC Bulletin, Vol 12 (August 1982), p. 2, for this and other estimates.
See Gelb (cited in footnote 47).
Non-fuel exports by oil exporting developing countries reportedly fell between 1970 and 1980. See International Bank for Reconstruction and Development, World Development Report, 1981 (Washington, 1981), p. 89.
The Middle East oil exporters have reportedly recruited more than two million foreign workers from other Asian countries. Saudi Arabia’s population is probably more than 30 per cent foreign, Kuwait’s more than 50 per cent, and the United Arab Emirates’ nearly 70 per cent. Until the recent expulsion, there were perhaps two million alien workers in Nigeria from the neighboring nations. Venezuela attracted possibly two to four million migrants from Colombia and other Latin American countries.