- Email: [email protected]
International debt and the stability of the world economy
248
Book Reviews
LDCs) arising when the pattern of OPEC’s spending does not match the pattern of its oil receipts. The last three papers in the volume report simulation experiments based on large scale empirical models. Michael Darby’s experiments are based on the Mark III macro model estimated by Darby and others for the major industrial countries over the recent periods of fixed and flexible exchange rates. The simulations he performs for the fixed rate period reveal a high degree of policy independence for most industrial countries, with sterilization effectively shielding each country’s money supply from balance of payments influences. Alan Deardorff and Robert Stern analyze effective protection in a set of simulations based on a disaggregated trade model. In contrast to previous studies of effective protection, this one allows endogenous price changes in every industry, exchange rate responses under flexible exchange rates, and the effects of tariffs levied by each country’s trading partners. The simulation experiments in both of these papers are somewhat difficult to follow since, given the limitations of space, the underlying models are not described in any detail. The final paper, by Malcolm Knight and Donald Mathieson, does present the estimated model, a small macro model of the Canadian economy. This model differs from conventional structural models in two respects: it is specified in continuous time and it traces the spillover effects of monetary disequilibrium through the other structural equations. Like the Darby model, this one is careful to incorporate the numerous channels of transmission linking one country to another and to take into account the policy reactions of the authorities. Bhandari and Putnam have produced a volume which has much to offer the reader. The internal refereeing process chosen by the editors, with each paper being refereed by another author, helped in improving individual papers. In principle, however, I think such collections of papers should be subject to the same type of external refereeing as are submissions to journals, perhaps by a board of referees appointed by the editors or the publisher. References FRANKEL, J., ‘On the Mark: A Theory of Floating Exchange Rates Based on Real Interest Differentials’, Am. Econ. Rev., September 1979, 69: 610-22. KOURI, P., ‘The Exchange Rate and the Balance of Payments in the Short Run and in the Long Run: A Monetary Approach,’ Stand. /. Eton., 1976, 78: 28G304. DORNBUSCH, R. AND S. FISCHER, ‘Exchange Rates and the Current Account’, Am. Econ. Rev., December 1980,70: 96&971.
William R. Cline, International Debt and the Stabi&y of the World Economy, Policy Analyses in International Economics, Vol. 4, Washington: Institute of International Economics (distributed by MIT Press), 1983, pp. 134, US $6.00 (paper), ISBN 0-262-53048-l. reviewed by SEBASTIAN EDWARDS Universio of Calzfornia, Los Angeles Los Angeles, CA 90024, USA
This monograph,
published by the Institute for International
Economics,
presents
Book Reviews
249
a comprehensive analysis of the current international debt crisis, providing a large amount of statistical information. The monograph is divided into eight chapters covering topics ranging from the origins of the crisis (Chapter l), to possible radical solutions (Chapter 7). The major question that Cline addresses throughout the analysis is whether the present situation can be characterized as an illiquidity or as an insolvency problem. His main conclusion is that we are basically facing an illiquidity problem, and that there are reasons for limited optimism about the crisis solution. In the first chapter Cline divides the origins of the present LDC’s debt crisis into external and domestic causes. Among the external causes, Cline mentions: (1) The oil shocks of 1973 and 1979; (2) The recent (1982-83) higher world real interest rates; (3) The 1980-83 world recession, which resulted in a significant drop in the value and volume of LDC’s exports; and (4) the international banking community ‘herd’ instinct, which resulted in an unnecessary reduction of exposure in some regions. The discussion of the domestic causes of the crisis, however, is less satisfactory. Here Cline mentions, among other things, the dramatic increase in government deficits in some countries (i.e., Mexico), and the over-valuation of the domestic currency in some large debtors (Argentina, Chile, Mexico) as major domestic policy errors. What Cline fails to point out, however, is that in a number of cases (i.e., Chile and Argentina) this overvaluation of the domestic currency was a necessary short-run equilibrium result, required to absorb massive inflows of foreign funds. This point is related to the traditional transfer problem, and has been recently emphasized in relation with the so-called ‘Dutch disease’. The domestic policy mistake, then, was not the currency overvaluation per se, but failing to realize that opening the capital account of the balance of payments (as Argentina and Chile did in the late 1970s) would result in a short-run massive inflows (i.e., an overshooting) of capital, which would necessarily generate a short-run real appreciation of the domestic currency. In this chapter Cline argues that in spite of these domestic policy mistakes it should be recognized that by and large foreign funds obtained through additional indebtedness were put to productive uses. As an evidence of this he mentions that in middle income oil importing countries, as a group, gross domestic saving increased from 19% to 21 o/o between 1960 and 1980. These figures, however, can be somewhat misleading for two main reasons. First, in five of the ten larger debtors (Brazil, Spain, Venezuela, Indonesia and Yugoslavia) gross domestic savings were lower (or equal) in 1980 than in 1960. Second, these figures--and those of gross domestic investment-do not say anything about the quality (i.e., social rate of return) of the investment financed with those funds. The magnitude of the crisis is illustrated in Chapter 2. The discussion here is very effective and the reader gets a clear perspective on how serious the situation actually is. Cline also describes the problems faced by some countries in the early 1980s and the rescue operations staged at that time. Here the crucial role played by the IMF, by bringing the private banks into the rescue operation, is emphasized. Chapter 3 is possibly the most important chapter in the monograph, and is the basis for Cline’s optimism on the future solution to the debt problem. In this chapter Cline uses a projection model to analyze the repayment prospect during the next few years. The main question addressed is whether we are facing an illiquidity problem or a solvency problem. On the basis of the results obtained from this model Cline concludes that ‘. . . the debt problem can be managed, and that it is
250
Book Reviews
essentially a problem of illiquidity, not insolvency’ (p. 71). Cline devotes a large portion of the chapter to discuss the sensitivity of these results to the assumptions made. He points out that the projection results are particularly sensitive to the assumptions of the world’s rate of growth, the price of oil and world interest rate behavior. In this chapter the results-though not the details--of a logit model of debt-servicing difficulties are also presented. These results are extremely interesting, and make the reader want to learn more about the procedure used to generate them. Particularly interesting are the dramatic jumps that the ‘difficulty’ indicator takes for some countries in some years (i.e., Brazil 1981, Argentina 1982, 1983; Egypt 1983). Chapter 4 discusses three important issues: involuntary lending, rescheduling, and default incentives. Cline shows that during 1983, for the case of large banks, the expected benefits of the so-called ‘involuntary lending’ exceed their cost. There is however a free-rider problem which basically affects smaller banks. Cline, then, discusses several ways of forcing the cooperation of smaller banks. The analysis then, focuses on rescheduling techniques, and a short-too short perhaps-discussion on the role of private debt is presented. Finally the chapter deals with LDC’s incentives to default. Cline argues that if the expected costs of default--especially the disruption of foreign trade-are properly measured, they largely outweigh the benefits. The arguments presented here are largely impressionistic, and little numerical analysis of the kind that appears in other parts of the monograph is offered. It seems to this reviewer that this area-the incentives to default for LDC’s-requires significant additional attention. Chapters 5 and 6 analyze the adequacy of the present banking insititutions and discuss some policy recommendations for capital flows. In Chapter 5 Cline discusses the extent to which banks can be blamed for the present crisis. Even though he concludes that it is ‘. . . inaccurate to attribute the debt problem chiefly to past bank irresponsibility. . . .’ (p. 97), he recognizes that some efforts toward reforming and organizing the international lending practices should be undertaken. In Chapter 6 Cline tackles the important question of the desirability of increasing the IMF quotas and lending capabilities. After critically analyzing several arguments that have been given during the recent debate on the IMF quota, Cline concludes that. . . ‘[i]t would be important to raise IMF quotas even if there were no debt problem’, (p. 106). In this chapter Cline also discusses briefly the sometimes controversial IMF stabilization programs. In his analysis he presents some of the arguments that have been used to criticize the IMF stabilization efforts. He concludes that the IMF critics have generally missed the point since they incorrectly make the ‘implicit assumption that countries in difficulty have any alternative to reducing their deficits’ (p. 113). In Chapter Seven Cline critically examines several reform plans recently suggested to cope with the debt problem. Obviously, his analysis is strongly influenced by his belief-presented at length in Chapter 3 of this monograph-that the debt crisis is of an illiquidity nature, and that by and large it can be solved if, under a scenario of world economic recovery, countries are left on their own. Instead of implementing drastic general reforms Cline proposes to elaborate contingency plans that could be used in case the debt crisis becomes more serious. An important characteristic of Cline’s contingency plans is that debt problems would still be handled on a cou@y-by-cou’~fy basis. Only if the adjustment programs
Book Reviews
251
fail to solve the problem should the banks capitalize some fraction of the interest not being paid by that particular country. Finally, Chapter Eight contains a summary and the policy conclusions. The main policy recommendations made by Cline can be summarized in the following form: (a) since world economic recovery is essential for the solution of the crisis, industrialized countries should pursue consistent macro policies. In that respect Germany, Japan and the UK should implement more expansionary policies, while the US should reduce the fiscal deficit; (b) the role of official lending through the IMF, World Bank and other agencies, should be strengthened in order to smooth the transition period; (c) since the solution of the crisis depends critically on LDC’s exports performance, industrialized countries should avoid implementing new protectionist policies; and (d) the new banking regulation should not generate a regulation ‘overkill’ that would reduce new lending beyond what is desirable. In summary this is an excellent little book that will appeal to the broad group of readers, including bank officials, academics and politicians. There is no doubt that once reading it, many people will look forward to the accompanying volume International Debt: Systematic Risk and Policy Response, also by Cline. Even though the discussion presented in the present monograph is extremely effective and covers a number of problems, there still are a set of unresolved issues that should be tackled by future discussions on the subject. The main problem is that Cline’s analysis, as well as most of the other recent work on the topic, largely looks at the problem from the perspective of the lending countries, without sufficiently emphasizing the analysis from the borrower’s perspective. In that respect future work should focus more thoroughly on the domestic causes of the debt crisis (i.e., policy mistakes); the LDC’s incentives to collude and default; and the role of private non-guaranteed borrowing.
John S. Odell, U.S. International Monetaty Policy: Markets, Power, and Ideas as Sources of Change, Princeton: Princeton University Press, 1982, pp. xvi+385, US $35.00 (cloth) or US $8.95 (paper), ISBN 0-691-07642-l (cloth) or o-691-02212-7 (paper). reviewed by Department
of Economics,
THOMAS D. WILLETT Ciaremont Gradtite School and Claremont McKenna Claremont CA 91711, USA
College,
Professor Ode11 has given us an example of historical scholarship at its finest. He offers an excellent illustration of the type of valuable contributions which political scientists can make to the re-emerging field of non-Marxist political economy in a book which can be read profitably by a wide range of audiences. For those seeking a readable, well-informed historical survey of US international policies during the critical period of the breakdown of the Bretton Woods system and adoption of widespread floating of exchange rates, it is perhaps the best single account available. Professor Ode11 draws widely on the published accounts of the developments of
Book Reviews
LDCs) arising when the pattern of OPEC’s spending does not match the pattern of its oil receipts. The last three papers in the volume report simulation experiments based on large scale empirical models. Michael Darby’s experiments are based on the Mark III macro model estimated by Darby and others for the major industrial countries over the recent periods of fixed and flexible exchange rates. The simulations he performs for the fixed rate period reveal a high degree of policy independence for most industrial countries, with sterilization effectively shielding each country’s money supply from balance of payments influences. Alan Deardorff and Robert Stern analyze effective protection in a set of simulations based on a disaggregated trade model. In contrast to previous studies of effective protection, this one allows endogenous price changes in every industry, exchange rate responses under flexible exchange rates, and the effects of tariffs levied by each country’s trading partners. The simulation experiments in both of these papers are somewhat difficult to follow since, given the limitations of space, the underlying models are not described in any detail. The final paper, by Malcolm Knight and Donald Mathieson, does present the estimated model, a small macro model of the Canadian economy. This model differs from conventional structural models in two respects: it is specified in continuous time and it traces the spillover effects of monetary disequilibrium through the other structural equations. Like the Darby model, this one is careful to incorporate the numerous channels of transmission linking one country to another and to take into account the policy reactions of the authorities. Bhandari and Putnam have produced a volume which has much to offer the reader. The internal refereeing process chosen by the editors, with each paper being refereed by another author, helped in improving individual papers. In principle, however, I think such collections of papers should be subject to the same type of external refereeing as are submissions to journals, perhaps by a board of referees appointed by the editors or the publisher. References FRANKEL, J., ‘On the Mark: A Theory of Floating Exchange Rates Based on Real Interest Differentials’, Am. Econ. Rev., September 1979, 69: 610-22. KOURI, P., ‘The Exchange Rate and the Balance of Payments in the Short Run and in the Long Run: A Monetary Approach,’ Stand. /. Eton., 1976, 78: 28G304. DORNBUSCH, R. AND S. FISCHER, ‘Exchange Rates and the Current Account’, Am. Econ. Rev., December 1980,70: 96&971.
William R. Cline, International Debt and the Stabi&y of the World Economy, Policy Analyses in International Economics, Vol. 4, Washington: Institute of International Economics (distributed by MIT Press), 1983, pp. 134, US $6.00 (paper), ISBN 0-262-53048-l. reviewed by SEBASTIAN EDWARDS Universio of Calzfornia, Los Angeles Los Angeles, CA 90024, USA
This monograph,
published by the Institute for International
Economics,
presents
Book Reviews
249
a comprehensive analysis of the current international debt crisis, providing a large amount of statistical information. The monograph is divided into eight chapters covering topics ranging from the origins of the crisis (Chapter l), to possible radical solutions (Chapter 7). The major question that Cline addresses throughout the analysis is whether the present situation can be characterized as an illiquidity or as an insolvency problem. His main conclusion is that we are basically facing an illiquidity problem, and that there are reasons for limited optimism about the crisis solution. In the first chapter Cline divides the origins of the present LDC’s debt crisis into external and domestic causes. Among the external causes, Cline mentions: (1) The oil shocks of 1973 and 1979; (2) The recent (1982-83) higher world real interest rates; (3) The 1980-83 world recession, which resulted in a significant drop in the value and volume of LDC’s exports; and (4) the international banking community ‘herd’ instinct, which resulted in an unnecessary reduction of exposure in some regions. The discussion of the domestic causes of the crisis, however, is less satisfactory. Here Cline mentions, among other things, the dramatic increase in government deficits in some countries (i.e., Mexico), and the over-valuation of the domestic currency in some large debtors (Argentina, Chile, Mexico) as major domestic policy errors. What Cline fails to point out, however, is that in a number of cases (i.e., Chile and Argentina) this overvaluation of the domestic currency was a necessary short-run equilibrium result, required to absorb massive inflows of foreign funds. This point is related to the traditional transfer problem, and has been recently emphasized in relation with the so-called ‘Dutch disease’. The domestic policy mistake, then, was not the currency overvaluation per se, but failing to realize that opening the capital account of the balance of payments (as Argentina and Chile did in the late 1970s) would result in a short-run massive inflows (i.e., an overshooting) of capital, which would necessarily generate a short-run real appreciation of the domestic currency. In this chapter Cline argues that in spite of these domestic policy mistakes it should be recognized that by and large foreign funds obtained through additional indebtedness were put to productive uses. As an evidence of this he mentions that in middle income oil importing countries, as a group, gross domestic saving increased from 19% to 21 o/o between 1960 and 1980. These figures, however, can be somewhat misleading for two main reasons. First, in five of the ten larger debtors (Brazil, Spain, Venezuela, Indonesia and Yugoslavia) gross domestic savings were lower (or equal) in 1980 than in 1960. Second, these figures--and those of gross domestic investment-do not say anything about the quality (i.e., social rate of return) of the investment financed with those funds. The magnitude of the crisis is illustrated in Chapter 2. The discussion here is very effective and the reader gets a clear perspective on how serious the situation actually is. Cline also describes the problems faced by some countries in the early 1980s and the rescue operations staged at that time. Here the crucial role played by the IMF, by bringing the private banks into the rescue operation, is emphasized. Chapter 3 is possibly the most important chapter in the monograph, and is the basis for Cline’s optimism on the future solution to the debt problem. In this chapter Cline uses a projection model to analyze the repayment prospect during the next few years. The main question addressed is whether we are facing an illiquidity problem or a solvency problem. On the basis of the results obtained from this model Cline concludes that ‘. . . the debt problem can be managed, and that it is
250
Book Reviews
essentially a problem of illiquidity, not insolvency’ (p. 71). Cline devotes a large portion of the chapter to discuss the sensitivity of these results to the assumptions made. He points out that the projection results are particularly sensitive to the assumptions of the world’s rate of growth, the price of oil and world interest rate behavior. In this chapter the results-though not the details--of a logit model of debt-servicing difficulties are also presented. These results are extremely interesting, and make the reader want to learn more about the procedure used to generate them. Particularly interesting are the dramatic jumps that the ‘difficulty’ indicator takes for some countries in some years (i.e., Brazil 1981, Argentina 1982, 1983; Egypt 1983). Chapter 4 discusses three important issues: involuntary lending, rescheduling, and default incentives. Cline shows that during 1983, for the case of large banks, the expected benefits of the so-called ‘involuntary lending’ exceed their cost. There is however a free-rider problem which basically affects smaller banks. Cline, then, discusses several ways of forcing the cooperation of smaller banks. The analysis then, focuses on rescheduling techniques, and a short-too short perhaps-discussion on the role of private debt is presented. Finally the chapter deals with LDC’s incentives to default. Cline argues that if the expected costs of default--especially the disruption of foreign trade-are properly measured, they largely outweigh the benefits. The arguments presented here are largely impressionistic, and little numerical analysis of the kind that appears in other parts of the monograph is offered. It seems to this reviewer that this area-the incentives to default for LDC’s-requires significant additional attention. Chapters 5 and 6 analyze the adequacy of the present banking insititutions and discuss some policy recommendations for capital flows. In Chapter 5 Cline discusses the extent to which banks can be blamed for the present crisis. Even though he concludes that it is ‘. . . inaccurate to attribute the debt problem chiefly to past bank irresponsibility. . . .’ (p. 97), he recognizes that some efforts toward reforming and organizing the international lending practices should be undertaken. In Chapter 6 Cline tackles the important question of the desirability of increasing the IMF quotas and lending capabilities. After critically analyzing several arguments that have been given during the recent debate on the IMF quota, Cline concludes that. . . ‘[i]t would be important to raise IMF quotas even if there were no debt problem’, (p. 106). In this chapter Cline also discusses briefly the sometimes controversial IMF stabilization programs. In his analysis he presents some of the arguments that have been used to criticize the IMF stabilization efforts. He concludes that the IMF critics have generally missed the point since they incorrectly make the ‘implicit assumption that countries in difficulty have any alternative to reducing their deficits’ (p. 113). In Chapter Seven Cline critically examines several reform plans recently suggested to cope with the debt problem. Obviously, his analysis is strongly influenced by his belief-presented at length in Chapter 3 of this monograph-that the debt crisis is of an illiquidity nature, and that by and large it can be solved if, under a scenario of world economic recovery, countries are left on their own. Instead of implementing drastic general reforms Cline proposes to elaborate contingency plans that could be used in case the debt crisis becomes more serious. An important characteristic of Cline’s contingency plans is that debt problems would still be handled on a cou@y-by-cou’~fy basis. Only if the adjustment programs
Book Reviews
251
fail to solve the problem should the banks capitalize some fraction of the interest not being paid by that particular country. Finally, Chapter Eight contains a summary and the policy conclusions. The main policy recommendations made by Cline can be summarized in the following form: (a) since world economic recovery is essential for the solution of the crisis, industrialized countries should pursue consistent macro policies. In that respect Germany, Japan and the UK should implement more expansionary policies, while the US should reduce the fiscal deficit; (b) the role of official lending through the IMF, World Bank and other agencies, should be strengthened in order to smooth the transition period; (c) since the solution of the crisis depends critically on LDC’s exports performance, industrialized countries should avoid implementing new protectionist policies; and (d) the new banking regulation should not generate a regulation ‘overkill’ that would reduce new lending beyond what is desirable. In summary this is an excellent little book that will appeal to the broad group of readers, including bank officials, academics and politicians. There is no doubt that once reading it, many people will look forward to the accompanying volume International Debt: Systematic Risk and Policy Response, also by Cline. Even though the discussion presented in the present monograph is extremely effective and covers a number of problems, there still are a set of unresolved issues that should be tackled by future discussions on the subject. The main problem is that Cline’s analysis, as well as most of the other recent work on the topic, largely looks at the problem from the perspective of the lending countries, without sufficiently emphasizing the analysis from the borrower’s perspective. In that respect future work should focus more thoroughly on the domestic causes of the debt crisis (i.e., policy mistakes); the LDC’s incentives to collude and default; and the role of private non-guaranteed borrowing.
John S. Odell, U.S. International Monetaty Policy: Markets, Power, and Ideas as Sources of Change, Princeton: Princeton University Press, 1982, pp. xvi+385, US $35.00 (cloth) or US $8.95 (paper), ISBN 0-691-07642-l (cloth) or o-691-02212-7 (paper). reviewed by Department
of Economics,
THOMAS D. WILLETT Ciaremont Gradtite School and Claremont McKenna Claremont CA 91711, USA
College,
Professor Ode11 has given us an example of historical scholarship at its finest. He offers an excellent illustration of the type of valuable contributions which political scientists can make to the re-emerging field of non-Marxist political economy in a book which can be read profitably by a wide range of audiences. For those seeking a readable, well-informed historical survey of US international policies during the critical period of the breakdown of the Bretton Woods system and adoption of widespread floating of exchange rates, it is perhaps the best single account available. Professor Ode11 draws widely on the published accounts of the developments of