International monetary issues and the developing countries: a survey

World Development,

Vol. 3, No. 9, September 1975, pp. 609-631

International Monetary Issues and the Developing Countries: A Survey GEOFFREY

MAYNARD

University of Reading and GRAHAM BIRD

University of Surrey Summary.

- This review of the academic and official literature relating to international monetary issues and the developing countries concentrates on three matters: the appropriateness of conventional fiscal, monetary and exchange-rate measures for balance-of-payments adjustment in developing countries; the need of developing countries for international liquidity and the adequacy of supply to them; and the monetary legitimacy and technique of linking international liquidity creation and development aid. It describes the opportunity which the breakdown of the Bretton Woods system in 1971, and the subsequent establishment of the Committee of Twenty, have provided for developing countries to have a voice in international monetary affairs; and it indicates a number of areas for further research and study at the policy level.

In the intense discussion of international monetary problems that occupied much of the decade of the 196Os, the specific interests of the less developed countries (LDCs) were not so much ignored as regarded as irrelevant. LDCs took little part in discussion at intergovernmental level although, through the medium of the United Nations (particularly The United Nations Conference on Trade and Development), they were able to make their opinions known on specific issues and to get some of them discussed. At first, the international Monetary Fund (IMF) provided the centrepiece of international reform negotiations, but as the Fund became increasingly a protagonist of developing country interests, these negotiations were increasingly concentrated in the forum of the Group of Ten. LDCs played little or no part in the establishment of the Special Drawing Rights (SDR) Scheme although, despite early opposition by developed countries, they were eventually included as full members, and shared in the distribution of SDRs. The main academic and official literature relating to international monetary issues and LDCs concentrated on three issues: the appropriateness of conventional fiscal, monetary and exchange rate measures for producing adjust609

ment in the balances of payments of developing countries; the need of LDCs for international liquidity and the adequacy of supply available to them; and the possibility and monetary legitimacy of linking international liquidity creation and development aid. On the first of these there seems to have been general consensus that domestic policy measures appropriate for developed countries are not necessarily appropriate for many LDCs, owing to the internal and external structural problems which they face; and further, that the bias towards trade liberalization and unrestricted capital flows implicit in the Bretton Wood system was more in the interests of the developed countries than the developing ones. On the second, although no clear demonstration has been made that LDCs need proportionately more liquidity than do developed ones, a presumption exists in the literature that this is in fact the case. On the other hand, it is reasonably clear that LDCs have benefited significantly from both normal and special arrangements for providing liquidity at the international level, mainly through the IMF. On the third issue, which has probably created most controversy among academics and_ officials, there seems to be fairly general agreement that there are no specific economic and

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monetary grounds on which a link between liquidity creation and aid can be rejected, and there are some in its favour. It is largely a political question whether a link would result in more or less aid being given. The breakdown of the Bretton Woods system in 1971 and the subsequent establishment of the Committee of Twenty on Reform of the International Monetary System provided developing countries with an opportunity to participate fully, for the first time in the post-war period, in the remaking of the system. In the course of the discussions, the main aim of the representatives of LDCs was to achieve an international monetary system that would contain within it, as an integral element, arrangements for transferring real resources to poorer countries. They put most effort in securing a link between SDRs and development aid; but they were also successful in getting included in the discussions, at the technical working level, other measures for promoting their economic development. The Committee of Twenty did not succeed in its task, partly because of fundamental disagreement among developed country members on a number of issues, and partly because of the steep rise in the price of oil and the associated appearance of large oil-producer financial surpluses which made some of the issues under examination at least temporarily irrelevant. Nonetheless, LDCs scored a major success in getting established a Joint Ministerial Committee of Bank and Fund which will in the future concern itself with the transfer of real resources from rich to poor countries. To this extent they succeeded in linking international monetary reform with the economic development of poor countries. Efforts are necessary to get a parallel reform of the international trading system to complement what can be achieved on the monetary front. The border areas between monetary, trade and development issues are clearly areas for future research and study at the policy level.

I. INTRODUCTION: THE PROBLEM

DEFINING AREA

The international monetary issues which engaged the attention of government policymakers and academic economists in the 1960s and early 1970s fall under three broad interrelated headings, namely : international liquidity; the problem of confidence; and balance-of-payments adjustment. Under the heading of international liquidity can be grouped a number of associated issues:

first, the conceptual definition and measurement of a trading country’s need for international liquidity and of the need of the world as a whole for such liquidity; second, the nature of the liquidity, conditional or unconditional, which ideally should be made available; third, the exercise of international control over the supply of liquidity, both to countries individually and to the system as a whole; and finally, the appropriate basis for determining allocations of internationally created reserve assets among countries and institutions. The conji’dence problem relates to the destabilizing effects on the international monetary system and on national monetary policies of having more than one reserve asset in the system; and, in the main, the discussion has turned on such issues as the relative roles of dollars and gold in the system; the price of gold in terms of dollars; and the mechanics of replacing both dollars and gold as basic international reserve assets. Under the heading of balance-of-payments adjustment can be listed such issues as the reconciliation between external and internal equilibrium (i.e., the simultaneous maintenance of balance-of-payments equilibrium, domestic full employment and relative price stability); the distribution of the burden of adjustment between surplus and deficit countries; and the nature of the exchange rate system. These issues have been examined at length in the context of the Bretton Woods system, which underpinned the growth of world trade and the spread of economic development from the end of the Second World War until August 197 1 when the system broke down. The founding fathers of the system had aimed at devising an international monetary system which would, on the one hand, provide the benefit of stable exchange rates for international trade and avoid the dangers of competitive depreciation, and, on the other hand, escape the deflationary rigidities of the pre-war operation of the gold standard. The system served reasonably well until the late 1960s but its basic defects became increasingly obvious. These were: the inherent contradiction in a reserve currency system which demands that a reserve currency have the characteristics of being a strong and a weak currency at the same time; the tendency for exchange parities-to be adjusted less than was in the interests of the system as a whole (indeed, probably less than the founding fathers would themselves have wished); and an asymmetrical bias in the de facto working of the system which put greater pressure on deficit countries to adjust than on

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INTERNATIONAL MONETARY ISSUES AND THE DEVELOPING COUNTRIES surplus ones. By 197 1 the strains on the system had become too great for it to bear and it was formally dissolved in August 1971 when the United States declared the inconvertibility of the dollar into gold. An attempt at the conference in Smithsonian international December 197 1 to retain in being at least the adjustable peg element in the system, while discussions took place in the Committee of Twenty 1 on the reform of the system in toto, had but short-lived success. Within eighteen months or so of the conference, most of the major currencies of the world were floating against each other, thus short-circuiting at least for a time the long debate between officials and academics on the relative merits and demerits of fixed and floating exchange rate systems. For the most part the interests of developing countries in the resolution of the international monetary issues of the 1960s were not so much ignored as rejected as irrelevant in the discussions that took place. This was as much true of academic discussion as of discussion at the official level: relatively few references to the special interests of LDCs can be found in the academic literature of the period. It was thought self-evident that the economic develop ment and the trading prospects of the LDCs depended on the efficient functioning of the international monetary system; moreover, it was fully recognized that LDCs, like developed countries, could and did suffer from temporary and fundamental disequilibrium in their balances of payments which had to be met by access to international liquidity and exchange rate changes. But the efficient functioning of the international monetary system was thought to be determined by the policies and practices of the major industrial countries, whose own well-being was crucial for the development hopes of the poor countries. Also, it was felt that the provision of conditional liquidity and the handling of balance-of-payments adjustment problems in the case of the LDCs could be safely left to the IMF. Hence much of the literature dealing with LDCs and the international monetary system refers to relations, often uneasy, between the former and the IMF. However, this rather broad generalization should be qualified in respect of the discussions concerning international liquidity. In the early discussions of this topic, the view had been taken by officials, if not by academics, that LDCs had a need for development aid, not liquidity; moreover, it was also argued that LDCs could not be directly involved in the creation of new reserve assets, since these had to be backed by strong currencies if they were

to be both credible and acceptable to central banks. But the possibility of linking the creation of international liquidity with the pro vision of development aid had a very early airing in the literature and was the subject of two UN reports in the early 1960s. It came up for discussion at the intergovernmental level, but the attitude of officials and governments was generally unfavourable. Even so, in the course of the decade increasing regard was paid to the special liquidity needs of the LDCs, and special facilities were eventually set up in the IMF to meet at least some of these needs. Paradoxically, the collapse of the Bretton Woods system and the subsequent establishment of the Committee of Twenty provided LDCs with an opportunity of making their views heard as to the future of the system. LDCs were allotted nine representatives in the Committee of Twenty; and during the course of the Committee’s work two technical working groups, one dealing specifically with arrangements for linking SDR creation with develop ment aid,2 the other dealing with other measures for transferring real resources to LDCs,a were set up, thus ensuring that issues of special concern to the developing world would not be ignored. The lack of success of the Committee of Twenty to produce a new, workable international monetary system, incorporating benefits for the LDCs was undoubtedly a great disappointment; on the other hand, one of the contributory causes of the failure of the Committee, namely the steep rise in the price of oil and the emergence of large oil-producer surpluses, could provide further opportunities for LDCs, as we indicate later. In the next section of this paper we shall survey the literature relating to the main issues of concern to LDCs: first, the balance-ofpayments adjustment problem and relationships with the IMF; second, the need of LDCs for international liquidity and arrangements for meeting this need; and third, the link between liquidity creation and development aid. In the final section, we shall indicate the main areas of interest for future research and policy. 1. Committee of the Board of Governors of the International Monetary Fund on Reform of the International Monetary System and Related Issues, which was established by a resolution adopted on 16 July 1972 by the Board of Governors of the Fund. 2. Technical Group Related Proposals. 3. Technical Resources.

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II. THE MAJOR ISSUES A. Balance-of-payments adjustment: relations between the International Monetary Fund and developing countries The Bretton Woods system and the establishment of the IMF were largely the result of accord between the United States and the United Kingdom. Despite some attempt by the Indian delegation at the Bretton Woods Conference to include some specific and appropriate reference to LDCs and the problem of development [36, 19691, [26, 19711, United States opposition prevented the Articles of Agreement from making any distinctign between developed and less developed countries, although Article 1, Section (ii) stated that a responsibility of the IMF would be ‘to facilitate the expansion and balanced growth of international trade and to contribute thereby to the promotion and maintenance of high levels of employment and real income and to the development of productive resources of all members as primary objectives of economic policy’. It can be argued [26, 19711 that the wording of Article 1, Section (ii) made little difference to the Fund’s attitude towards LDCs, since the uniform legal position of all member countries under the Articles of Agreement has not precluded the Fund from adopting policies Indeed LDCs. favour tend to which Schleiminger [76, 19701 has argued that it would have been harmful to international monetary co-operation, and thus to LDCs, had the Fund differentiated between various groups of countries, a view however which is not shared by Marquez [ 6 1, 19701. In 1946 the Executive Directors of the LMF provided an interpretation of the Articles of Agreement which viewed the IMF’s purpose as that of giving ‘temporary assistance in financing current deficits on balance-of-payments account for monetary stabilization operations’. Economic development was viewed as being purely incidental, and, indeed, the IMF actively sought assurances that such assistance as was given was to be used only for short-term stabilization and not for reconstruction or development. Despite certain policy changes in the early 1950s and other innovations beneficial to LDCs, this interpretation of the Articles of the IMF served as a guide to its operations with LDCs as well as developed countries. The philosophy of the IMF seems to have been that monetary stabilization and restraint was the most appropriate policy for promoting growth. According to the IMF [41, 19561, inflation,

and not lack of capital, was the major impediment to development. The philosophy of the IMF emerges fairly clearly in its dealings with countries wishing to utilize its resources for meeting actual or expected balance-of-payments deficits. The IMF sees it as its duty to provide financial assistance when a country is in temporary balanceof-payments disequilibrium and to agree to a change in exchange parity when fundamental disequilibrium exists. In the former case the IMF expects (indeed, in the case of drawings in the later tranches of members’ total drawing rights, can insist) that a country pursues appropriate (i.e., primarily monetary and fiscal) domestic policies to remove the disequilibrium within a reasonable period of time: in the latter case, it expects the drawing country to demonstrate its fundamental disequilibrium to the satisfaction of other members and to seek their agreement to a change in parity. In either case, it seeks to follow Bretton Woods philosophy in eschewing controls over trade and current payments which interfere with the free movement of goods and capital. It seems reasonably clear that during the early years of its operation the IMF was excessively preoccupied with domestic monetary stability, believing not only that it was a necesprecondition for sustained economic sary development but that its absence was the prime cause of balance-of-payments disequilibrium. Although the terms on which the IMF provided particular countries with ‘stand-by’ assistance are largely confidential, published ‘letters of intent’ give some indication of the kind of policies the IMF supports. They include measures to control some or all of domestic credit expansion, government expenditure and taxation, foreign indebtedness, prices and wages. trade practices and exchange rates. The IMF typically makes little distinction between developed and developing countries, a fact which itself has attracted considerable recrimination on the part of its critics. The essence of the ‘critics’ view’, which is expressed in, for example, Krasner [ 55, 19681, Scott [SO, 19671, The Colloqium on the Interests of Developing Countries in International Monetary Reform 18, 19701, Corea [lo, 19711 and Payer 171, 19741, is that the 1MF has put too much emphasis on internal adjustment as a means of obtaining balance-ofpayments equilibrium and too little on development. More specifically, criticisms include thz following. First, it has been suggested that I?,;IF policies reflect the attitudes of the richer

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nations from which the IMF derives most of its resources. Whilst the IMF has supported the objective of free trade and convertibility and has perhaps therefore shown a preference for structural internal monetary adjustment, changes and some measure of protection are more appropriate for LDCs (Krasner [ 55, 19681, Payer [71, 19741. A second criticism is that although monetary restriction may temper inflation, it does so at the cost of development (Scott [80, 19671, Morley 167, 19711, Payer [71, 19743). Third, it has been suggested that the economic policies advocated by the IMF are frequently politically infeasible (Scott [80, 19671). Fourth, where. payments problems have been externally generated, internal contractionary adjustment which endeavours to reduce imports to a level which is consistent with balance-of-payments equilibrium may be inappropriate (Corea [IO, 19711). Fifth, IMF assistance is granted on condition that action is initiated at the time that drawings are made. Little account is taken of the fact that the deficit may be self-correcting over a number of years (Corea [ 10, 197 I] ). A wide ranging, if somewhat intemperate, study of IMF policies with respect to LDCs can be found in Payer [ 71, 19741. She argues that much of the IMF’s policy is politically motivated and has operated to the advantage of developed countries. According to her, the consequences for LDCs have been: a takeover of domestic production by foreign-owned multinationals; a simultaneously inflationarydeflationary situation stemming from an unwise attempt to balance the budget by raising the price of public utility goods and services (see also Eshag and Thorpe [ 18, 19651); a reduction in the real standard of living of much of the population; and an increase in debt-service payments arising from excessive foreign borrowing to fill a foreign exchange gap which could have been better closed in other ways. In her view, trade liberalization has been the price which LDCs have had to pay for aid, but the costs of . the former have far exceeded the benefits of the latter. Both Kramer [ 55, 19681 and Corea [ 10, 19711 agree that emphasis on trade liberalization and on domestic monetary and fiscal measures to adjust the balance of payments have been more appropriate for developed countries than for LDCs because of the structural problems and imbalances many of the latter face. These structural problems take a number of forms. Perhaps the important one from the balance-of-payments point of view is that the exports of LDCs are predominantly primary

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products for which income and price elasticities of demand are rather low. LDCs’ own income elasticity of demand for imports are, on the other hand, very high. Hence the feasible growth rate of the typical LDC is very dependent on economic demand and growth in industrial countries; and it may be difficult for many LDCs to maintain a reasonable rate of economic growth without pushing the current balance of payments into deficit. Moreover, besides imposing a constraint on the long-run growth rate of developing countries, economic activity in the industrial world may be a potent source of short-run price and income instability in LDCs. A short-run boom in activity in the industrial world may create short-run excess demand for many primary products, as a con; sequence of which prices and money incomes may be forced up in the developing world, irrespective of domestic monetary and fiscal policies being pursued; at other times, excess supply conditions will cause a contraction of prices and incomes, creating fiscal and other difficulties for exporting countries. Although, through appropriate exchange rate policy, some LDCs may be able to insulate to some extent their economies from world price instability, devaluation of the exchange rate may not be the answer to fundamental and structurally-based deficits in the balance of payments. As indicated earlier, price elasticities of demand tend to be rather low. (See Konig [54, 19681, Streeten [86, 19711, Jayarajah [47, 19691, Cooper [9, 19711). So, too, may be the price elasticity of export supply in countries which have only one or two major export commodities, in which the domestic consumption of exports is small in relation to total production, and/or where structural bottlenecks exist on the side of supply. Where domestic consumption is relatively more important, but for structural reasons total supply cannot be quickly increased, devaluation may have a potent inflationary impact on the devaluing economy (Maynard and van Rijkeghem [64, 19681, Corea [IO, 19711, Cooper [9, 19711) with no sustained benefit to the balance of payments except that provided by a fall in real income and output of the economy when a restrictive monetary policy is being pursued at the same time. The income redistribution consequences of devaluation may have political and social repercussions which by engendering price and income responses quickly nullify the putative effects of devaluation (Cooper [9, 197 11 1. Finally, in the absence of discriminatory import controls, reliance on devaluation to reduce imports may reduce developmental

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imports, with long run effects on both future development prospects and future balance of payments. Some LDCs have attempted to meet the problem imposed by unfavourable income and price elasticities for their major imports and exports by resorting to a system of multiple exchange rates. Although the IMF has been largely opposed to such practices (de Vries [ 13, 1965; 15, 1969; 16, 19693, Horsefield [36, 19691) other commentators (Konig [.54, 19681, Streeten [86, 19711, Cooper [9, 19711 and Jayarajah [47, 19691) have seen advantages. The apparent gain to be had from such a system is that it allows a country to discriminate between various imports and exports which have different price elasticities of demand and supply and which have different degrees of importance in development. Import substitution and export promotion can be specifically encouraged with fewer side effects on the economy. Moreover, the system can be an important source of revenue while providing a politically acceptable method of realizing economic objectives. In some cases, where under IMF insistence multiple exchange practices have been abandoned, the alternative measures to achieve the same end have been inferior (Konig [ 54, 19681). Clearly, although bad monetary, fiscal, and exchange rate policies can inhibit and frustrate economic development, good ones are not necessarily sufficient in themselves to ensure growth. In its eaily stages, economic developoften ment implies substantial structural changes in the nature of the economy and it often induces short-run bottlenecks in supply which cannot be overcome without substantial changes in relative prices, which cannot easily be made compatible with a stable price level. Insistence on monetary stability may inhibit or make more difficult the structural shifts in required (Maynard and van resources Rijkeghem [ 64, 19681). Although the IMF was perhaps slow to recognize the specific balance of payments difficulties of LDCs, it is obvious that structural problems of LDCs cannot be blamed on the IMF; hence, many of the criticisms of the IMF in its relations with LDCs are misplaced. The IMF has little choice but to offer assistance to LDCs within its Articles of Agreement; and despite possible long-run inappropriateness of which under and conditions terms the assistance has been provided, it is difficult to believe that LDCs would have been better off without the IMF than with it. Critics are on stronger ground when they argue that the

Bretton Woods monetary system and the associated international trading system based on GATT (The General Agreement on Tariffs and Trade) were not designed actively to promote-indeed they may have actively discouraged-the economic development of poorer countries. The IMF has probably recognized this sooner than governments of industrial countries. Indeed, in the late 1950s there was a significant shift in the IMF’s attitude towards development, as the IMF began to recognize the special nature of the problems facing LDCs (Scott [SO, 19671, Krasner [55, 19681). The change took the form of a number of innovations aimed at alleviating the economic problems facing LDCs. Scott attributes this change in attitude to a number of factors: the deteriorating terms of trade of primaryproduct-exporting countries; a growing awareness of the instability of the export receipts of LDCs; an increasing representation of LDCs in international councils; a gradual thaw in the cold war, which softened the United States’ preoccupation with international stability; and finally, but not least, the introduction of more imaginative IMF leadership under Jacobsson. who in 1960 went on record as recognizing that the IMF did have a positive role to play in promoting development. The innovations which the IMF introduced at this time were various, although they mainly took the form of providing LDCs with more conditional liquidity. For instance, action was taken to increase the size of quotas; the IMF began to make more of its resources available to LDCs and less to industrial countries; and, perhaps most important of all, the IMF irrtroduced a scheme designed to compensate members against shortfalls in export receipts. The Compensatory Financing Facility (CFF), although officially open to all members alike, was of greatest benefit to primary-productexporting countries. Arguably, it represented the first formal institutional response to the demands of LDCs (Corea [ 10, 197 1] ). We comment further on this scheme in the section on liquidity. In 1967 Scott felt sufficiently confident to conclude that ‘the overwhelming evidence is that the fund is currently doing all it possibly can to assist developing nations within its traditional sphere of operations, but that it is resisting with equal vigour any substantial modification of this very limited sphere’. If d shift in attitude had occurred. it was only within the constraints imposed by what the IMF considered to be its sphere of competence, or,

INTERNATIONAL MONETARY ISSUES AND THE DEVELOPING COUNTRIES perhaps more accurately, its terms of reference. Financial assistance provided by the IMF to LDCs remained constrained by quotas, the short-term nature of agreements, and the balance-of-payments orientation of that assistance (Mookerjee [66, 19661). Paradoxically, the growing awareness of the IMF of the peculiar problems of the LDCs appears to have coincided with a decline in its influence with the DCs. Through the 1960s the latter became increasingly preoccupied with the problems of the international monetary system. Their main concern was to remove the dependence of international liquidity creation on the unregulated behaviour of the United States balance of payments. International discussions to this end were carried on largely outside the forum of the IMF, and LDCs were not invited to participate. Early proposals to create a new international fiduciary asset did not envisage that LDCs would directly participtie in the arrangements, it being thought that it would be sufficient for the health of the monetary system if developed countries were enabled to augment their own reserves (Machlup [60, 19681). However, the IMF remained a staunch supporter of the LDCs in this respect, insisting that all member countries should be treated equally. The IMF view won the day; and when the SDR scheme was finally introduced in 1970, LDCs were allocated SDRs on the same basis as were developed countries. The IMF continued its role as supporter of the interests of the LDCs when the eventual breakdown of the Bretton Woods system precipitated international discussions on the reform of the system. In a Report on the Rqform of the International Monetary System, the IMF in 1972 examined the role which the system could play in encouraging development. In concerning itself with ‘measures directly addressed to the needs of developing countries’, the IMF recognized that it had a role to play in making foreign markets more accessible to the exports of LDCs and in increasing the flow of capital to them. The picture presented by the IMF in 1972 contrasts markedly with that painted by Krasner [55, 19681, Payer [ 17, 19741 and others who view the IMF as an representing agency the rich developed countries. B. The liquidity issue International liquidity may theoretically be defined as access to the means of international settlement. From a functional point of view the liquidity available to a country is in principle measured by its ability to finance a

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balance-of-payments deficit without having to resort to adjustment. Operationally, therefore, a country’s liquidity position should include items such as ability to borrow, the foreign exchange holdings of its commercial banks, inventories of foreign trade goods held, the willingness of foreigners to hold its currency in the event of a payments deficit, and the extent to which ‘innocuous’ increases in interest rates would encourage a capital inflow, as well as the more customary forms of reserve assets-gold, convertible foreign exchange, reserve positions in the IMF, and SDRs (Williamson [ 96, 19731). LDCs do, of course, have access to the customary forms of liquidity and, like developed countries, can draw on credit tranches in the IMF; but their ability to finance balance of payments deficits without adjustment is a good deal less than that of the developed countries. In the next section, we discuss whether their need for liquidity is more or less than that of the developed countries. 1. The demand for liquidity Recent years have witnessed a marked expansion in the literature dealing with the demand for international liquidity (or reserves), voluminous enough to warrant a number of survey articles. Notable contributions include those by Clower and Lipsey [7, 19681, Niehans [68, 19701, Grubel [ 28, 19711 and Williamson [96, 19731. Most of the work has been conducted at a fairly high level of aggregation and relatively little deals directly with the question of individual countries’ demand functions, or and inter-country group, difinter-country, ferences in th’e demand function for reserves. Although our main concern is with the liquidity needs of LDCs, it will be useful to begin by referring to the more general literature. The major contributors have been Kenen and Yudin [52, 19651, Machlup [59, 19661, Heller (34, 19661, Ciark [S, 1970; 6, 19701, IMF [44, 1970) and Kelly [Sl, 19701, Archibald and Richmond [ 2, 19711. It is generally agreed that reserves are held for the benefits they yield. In principle, reserves are held as a buffer stock against undesirable and immediate balance-of-payments adjustment which might otherwise be forced on a country. The benefit of holding reserves is then equal to the cost of the forced adjustment which is avoided. If reserves yield a benefit and are without cost, it can be assumed that the demand for reserves will be infinite. But holding reserves involves an opportunity cost, i.e., the foregoing of real resources which could otherwise be purchased.

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In theory, then, the demand for reserves is functionally related to the benefits and costs of holding them. The demand for reserves will be a positive function of both the cost of adjustment and the probability that adjustment will be required; and it will be a negative function of the opportunity cost of holding them. Along this line of approach most empirical estimations of the demand for international reserves have included as independent variables some measure of the variability of the balance of payments, some measure of the cost of adjustment and some measure of the opportunity cost of holding reserves. The results of this research are summarized in Williamson [96, 1973 1. The demand for reserves by LDCs has been the specific concern of Kafka [49, 19681, Agarwal [1, 19711, Flanders [19, 19711 and Frenkel [22, 19741, and has also been alluded to in more general investigations by Clark [6, 19701 and Kelly [ 5 1, 19701. Clark concludes that the demand function for reserves is structurally similar in both developed countries and LDCs. On the basis of such a demand function and, abstracting from the influence of size, it might be anticipated that LDCs would demand a higher level of -reserves than developed countries if their balances of payments are subject to greater variability than those of developed countries, and if the cost of adjustment is higher in LDCs than in developed countries. LDCs will, however, tend to demand a lower level of liquidity than developed countries if the opportunity cost of holding reserves is higher in LDCs than in developed countries. Flanders is not satisfied that LDCs do experience greater payments instability, although she bases her conclusion on rather out-dated evidence. More recent evidence presented by Erb and Schiavo Campo [ 17, 19691, Glezakos [23, 19721 and Lawson [57, 19741 implies that, on average, LDCs indeed experience greater instability in their balance of trade than do developed countries and that, therefore, cereris paribus, could be expected to demand or require more reserves. The cost of adjustment will tend to be high in LDCs since, as both Flanders and Agarwal point out, imports are likely to be strategic to the developmental process and may not be very compressible. A given decline in imports may thus have a greater impact on a LDC than on a developed country. Flanders, on the other hand, suggests that LDCs may find it relatively easy to adjust to balance-of-payments disequilibrium since they tend to make considerable use of direct controls over trade. According to Heller [34, 19661, the opportunity cost of

holding reserves is similar for both LDCs and developed countries because the higher social rate of return in LDCs is perfectly offset by a tendency for LDCs to hold a relatively larger proportion of their reserves in interest-bearing balances; but Flanders and Agarwal maintain that, even so, the opportunity cost of holding reserves is higher for LDCs. Unfortunately no clear picture emerges from this analysis. Although LDCs may experience greater payments instability, and although maintaining the supply of imports may be vital to development in LDCs. the opportunity cost of holding reserves is also likely to be high. Given that the demand for reserves by LDCs is related to broadly the same determining variables as in developed countries, the question arises whether the elasticity of response to changes in determining variables is also broadly the same. Evidence collected on a cross-section basis by Frenkel implies that as a group, the LDCs’ demand for reserves is more (positively) responsive to increases in the level of trade than is the demand for reserves by developed countries, whilst it is less (positively) responsive than that of developed countries to greater instability in the balance of payments. The fact that LDCs may have different response elasticities to changes in explanatory variables has implications for the various measures of the optimality and/or adequacy of LDCs’ reserve holdings which rely on trends in reserve-import ratios (Kafka [49, 19681) and on the variability of reserves (Heller [ 34, 19661). Kafka concluded that since over the period 1951-66 the reserve-import ratio of LDCs as a group behaved not very differently from that of developed countries, LDC need for liquidity was no greater or less than that of developed countries. This conclusion, however, would not hold if. as Frenkel maintains, the import elasticity of demand for reserves is greater for LDCs than it is for developed countries. Similarly, Frenkel’s work casts doubt on Heller’s conclusion that. as a group, LDCs hold sub-optimal reserves, for this was arrived at on the assumption that the relationship between the demand for reserves 2nd the variability of the balance of payments was the same for developed and less developed countries. There seems to be general consensus that LDCs are not an homogeneous group as far as the demand for reserves is concerned. Sonle LDCs appear to have deficient reserves whi!st others have excessive reserves (Heher [34. 19661. Agarwal [ 1, 19711, and Frenkel [12. 19743). A general conclusion reached b-v

INTERNATIONAL MONETARY ISSUES AND THE DEVELOPING COUNTRIES Flanders [ 19, 19711 is that the world is made up of two types of monetary authority. One type possesses relatively high levels of reserves and endeavours to maintain reserves at these high levels, whilst the other type has lower reserve holdings and is less concerned with keeping reserves at a steady level. Unfortunately, from the viewpoint of neatness, it appears that LDCs do not fit exclusively into either category. That simple models do not fully explain the demand for reserves seems fairly clear from an examination of the literature. On the other hand, more sophisticated demand functions including a wide range of independent variables have also failed to provide significant results (Flanders [ 19, 19711). Perhaps this is not so surprising when it is remembered that the demand for reserves may depend on the preferences of individual monetary authorities (Clark [S, 1970; 6, 19701, Kelly [51, 19701 and Flanders [ 19, 19711) and on expectations concerning the likelihood that reserves will be needed (Agarwal [ 1, 197 l]). In practice, a variety of factors other than instability of export flows-for example, uncertainty of capital and aid flows and the need to maintain investor confidence when foreign borrowing is being resorted to4-all come into it, but they are not easily quantified. The literature fails to reveal any generally accepted demand function for reserves. Even so, some authors vigorously maintain that the of liquidity to LDCs has been supply relation to the economic inadequate in problems which LDCs face (Belsare [4, 19661, Corea [ 10, 19711). It is sometimes difficult to disentangle the extent to which these claims really represent a demand for more aid rather than more liquidity (McLeod [65, 19701 and Helleiner [33, 19741). We therefore turn to an examination of the literature which deals with the supply of liquidity to LDCs. 2. The suppl_v of liquidity Of the various sources of liquidity, LDCs, as a group, have relied most heavily on drawings from the IMF, although, as Krasner [55, 19681 observes, the significance of the IMF as a source of short-term financing varies as between LDCs. Since the introduction of the SDR scheme, SDR allocations have also become a significant source of liquidity for them. But LDCs have been excluded from the informal arrangements developed within the Group of Ten. Basically, IMF drawings are of two types, namely, quota drawings within the normal facilities provided by the IMF, and drawings

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under certain special facilities which have been set up. Technical details of ordinary drawings on the IMF are well-known and have been described at length elsewhere (for instance, Horsefield [36, 19691). The size of a Fund member’s permitted ordinary drawings is determined by the size of its quota. Drawings are in part automatic (the gold tranche) and in part conditional (the credit tranches). The severity of conditions attached to credit tranche drawings increases as countries make use of higher tranches. On the first credit tranche, the IMF’s policy is usually fairly liberal and access to this tranche merely requires a demonstration that the member is making reasonable efforts to solve its problems. Requests for higher credit tranches ‘are likely to be favourably received’ when the transactions ‘are intended to support a sound programme aimed at establishing or maintaining the enduring stability of the member’s currency at a realistic rate of exchange’. For the higher credit tranches, however, the criterion is quite exacting ‘and requires a member to make a more convincing demonstration of the adequacy of the policies it is pursuing or intending to pursue’ (Gold [ 26, 19711). Since 1952, ordinary drawings on the IMF have conventionally been made under stand-by arrangements which serve to guarantee the borrowing member an assured line of credit for a certain period of time. The granting of a stand-by arrangement, in the first instance, depends on agreement between the IMF and the borrowing member concerning appropriate domestic policies (see Gold [24, 1969; 25, 1970; 26, 197 1) ). LDCs have made considerable use of stand-by arrangements (Spitzer [ 82, 19691, Gold [25, 19701). Ordinary drawings as a source of liquidity for LDCs have been severely criticized in the literature. The criticisms generally relate either to the size of permitted drawings as determined by quotas, or to the conditional nature of the drawings. Many commentators have argued that the quotas of LDCs are too small relative to the problems they face, while the conditions upon which assistance has been given have often been inappropriate to development. Moreover, access to IMF facilities has been dependent on the LDCs being willing and able to deposit in the

4. See Report of Technical Group on the Transfer of Real Resources, 30 April 1974, in International Monetary Reform, Documents of the Committee of Twenty (IMF, 1974).

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IMF twenty-five per cent of their quota in the form of gold (Belsare [4. 19691, Helleiner [33, 19741 ).5 The adequacy of LDCs’ quotas and the appropriateness of the conditions attached to drawings have been discussed at some length by Scott [80, 19671, Corea [ 10, 19711, Horsefield [36, 1969; 38, 19701 and The Colloquium on the Interests of Developing Countries in International Monetary Reform [8, 19701. The main points that emerge are that the original fixing of quotas at Bretton Woods had been a political exercise which had little regard for the LDCs (Marquez [61, 19701, Horsefield [38, 19701); that a wider-based formula for quota fixing should be adopted, which, by increasing the quotas of LDCs, would take ‘adequate cognisance of the structure and consequent fluctuations in the trade of many developing countries’ (Colloquium [8, 19701); that the failure of the system to provide adequate liquidity for developing countries had forced them to impose payments restrictions and make overuse of short- and medium-term suppliers’ credits (Corea [ 10, 19711); that the ‘performance criteria’ attached to stand-by arrangements, often of a quantitative character, had enabled the IMF to exercise considerable but not necessarily appropriate control over the policies pursued by the drawing country; that the repayment period, generally of three to five years, had been too short to enable developing to restore equilibrium in their countries balances of payments; that instead of the normal repayment period, the rate at which the developing countries should be expected to repurchase their currencies from the IMF should be linked to the current state of their balances of payments, their terms of trade and the amount of aid they had received: and, finally, that, because of their lower incomes, LDCs should pay lower rates of interest than do developed countries on their outstanding debt with the IMF. Scott [80, 19671 argues that the frequent use of waivers by the IMF in its dealings with LDCs, especially in the mid-1950s, is evidence that LDC quotas are too small in relation to their needs, while Marquez [ 61, 19701 and .Krasner [55, 19681 maintain that increasing the quotas of LDCs would impose little cost on developed countries since the absolute levels involved are small. It should be noted that IMF quotas, for LDCs as well as for developed countries, have been increased on a number of occasions since the inception of the IMF and are regularly reviewed. The general inadequacy of both LDC IMF quotas and IMF support to LDCs under normal

arrangements is perhaps demonstrated by the establishment of new and special facilities in the 1960s. These facilities are the Compensatory Financing Facility (CFF) and the Buffer Stock Financing Facility (BSFF). References to the CFF abound in the literature (for instance, Horsefield [ 36, 1969; 37, 19691, Horsefield and Lovasy [39, 19691, Lovasy [58, 19651, Krasner [55, 19681, Thornton [87, 19691, Scott [80, 19671, Corea [ 10, 1971 I, Schiavo Campo and Singer [ 75, 19701, Gold [26, 19711, Fleming, Rhomberg and Boissonreault [ 2 1, 19631, United Nations Conference on Trade and Development (UNCTAD) 190, 19651 and Special IMF Reports [42, 1963; 43, 19641). Essentially, it is a scheme designed to protect the balance of payments of members from shortfalls in export receipts which have been caused by factors largely beyond the control of the member. IMembers may draw foreign currency from the IMF to compensate for a failure of export earnings to cQme up to reasonable expectations. Although in theory, the CFF is available to all members of the IMF alike, it is intended to be of assistance mainly to LDCs. The CFF scheme has attracted three types of criticism: first, as to the manner in which the export shortfall is measured (UNCTAD), however, see the Fund’s defence of its statistical methods (Horsefield); second, as to the appropriateness of a short-term expedient like the CFF for dealing with problems that are essentially long term; and, third as to the adequacy of the CFF as a short-term measure. Corea [ 10, 197 l] lists three reasons why the CFF is inadequate as a short-term measure. First, the size of the facility, which is limited by the size of the relevant IMF quota as well as by the quantitative provisions of the CFF itself, is small in relation to the size of the problem. Second, since the CFF applies only to shortfalls in export proceeds, caused by either a fall in price or a fall in quantity sold, it does not compensate for payments difficulties caused by externally generated increases in import prices, or by bad domestic harvests which force additional outlays on food impbrts. Third, since the CFF requires the repayment of a drawing to be made within three to five years, it implicitly assumes that the export shortfall will be sufficiently reversed within this period to make this possible. 5. At its second meeting on 15-16 January 1975 of the Board of Governors it the Fund decided to abolish the obligation of members to make quota subscriptions in pold. the Interim Committee

INTERNATIONAL MONETARY ISSUES AND THE DEVELOPING COUNTRIES The major criticism of the CFF scheme is that it fails to deal with more fundamental and long-term problems facing LDCs, problems such as worsening terms of trade, heavy concentration on the export of one or two commodities, and the existing structure of production and trade. To meet these problems long-term finance is required. The provision of such finance, however, cannot be reconciled with the IMF’s Articles of Agreement and with the charadter of the IMF as a monetary institution (Schleiminger [ 76, 19701). It was unfortunate, therefore, that the scheme for Supplementary Financial Measures, proposed by the govemments of the UK and Sweden at the first meeting of the United Nations Conference on Trade and Development in 1964 came to nothing. A feature of this scheme was that it have provided compensation for would unexpected shortfalls in export receipts which t adversely affected the implementation of a country’s development plan which had had prior vetting by the International Bank for Reconstruction and Development (IBRD) and was regarded as realistic (UNCTAD, Supplementary Financial Measures; Final Report of the Inter-Governmental Group, November 1967). Indeed, the scheme might well have fostered a link between the operations of the IMF as a provider of short-term stabilization assistance and the IBRD as a provider of longer-term finance, which so many commentators have considered to be highly desirable (Scott [80, 19671, Marquez [61, 19701, Corea [ 10, 19711). Scott, for instance, envisages ‘the IMF and the IBRD acting jointly to approve long-term development projects and plans, with the IBRD providing the bulk of the financing and the IMF pledging a use of its resources as a guarantee of the fulfilment of the plan’. Little has been written on the Buffer Stock Financing Facility (BSFF). The purpose of this is to support international commodity agreements which attempt, ex ante, to maintain prices and export receipts within agreed ranges (see Horsefield [37, 19691). The infrequency of the BSFF’s use since 1969 suggests that the organization of buffer stock schemes under prevailing economic conditions may be somewhat difficult. Despite some obvious shortcomings, the IMF has been a significant source of liquidity for developing countries. Although the drawing rights of the developed countries greatly exceed those of the LDCs, the actual drawings of the former, with one or two exceptions, fall far short of the actual drawings of the latter (Helleiner [33, 19741 ). Assistance has been

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provided at relatively low rates of interest; it has been fairly freely available; and it has not been tied to projects or to the supplier country. 3. Special Drawing Rights LDCs have also obtained extra liquidity in the form of SDRs. A concise and penetrating description of the SDR scheme, whose aim was to provide the international monetary system with a source of liquidity that was independent of both the unregulated outcome of the US balance of payments and of current gold production and the attitude of speculators, can be found in Machlup [60, 19681. Since 1970 the scheme has provided all participants with worthwhile, although by no means large amounts of liquidity. As of September 1974, a total of SDR 9,315 million had been allocated, of which SDR 2,348 million have gone to LDCs. On average each industrial country has received SDR 441 million, while each LDC has received only SDR 27 million. On the other hand, LDCs have made greater proportionate use of the facility. During the first basic period of allocation, LDCs were net users to the value of SDR 835 million, fifty-nine of the eightyfour participating countries having used them (Helleiner 133, 19741). Apart from the UK, the US, France and Italy, industrial countries as a group made net acquisitions of SDRs. Undoubtedly, the SDR scheme has been of direct benefit to LDCs. Apart from the reconstitution provision, the use of SDRs is unconditional: participants in the scheme do not have to obtain prior approval of their domestic economic policies. The interest rate payable on net use (1.5 per cent) was until very recently6 also very low. Moreover, although the aim of the scheme is to provide countries with extra reserve assets to hold rather than to spend, the scheme has in fact produced a net transfer of real resources to LDCs which may well be permanent. More generally, LDCs are likely to gain indirect benefits from the expansion of trade and aid expected to flow from the improved liquidity position of developed countries (Machlup [ 60, 19681). Even so, there has been criticism of the scheme. A familiar argument is that, given the nature of their balance-of-payments problems, LDCs received an unfairly small proportion of the total allocation (Sinha [ 8 1, 19701, Helleiner [33, 19741); as a result not only have LDC reserves been insufficiently augmented,

6. On 1 July 1974 the interest rate was increased to 5 per cent and will be reviewed periodically.

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the transfer of real resources to LDCs within the terms of the scheme has been insignificant. The most potent criticism of the scheme in general, however, has been of its failure to incorporate within it a durable and deliberate link between liquidity creation and development aid. C. A link between liquidity creation and development aid 1. History The possibility of linking credit creatidn and development aid has, in the course of the discussions carried on in the Committee of Twenty on the reform of the international monetary system, became a major point of confrontation between the wealthy countries of the world and the poorer ones. It can be said that the establishment of the link was the major aim of the LDCs in these discussions. To begin with, controversy over the link largely took place among government officials in the context of their many and continued attempts to deal with international monetary problems. In general, officials were against the link, believing that if a new reserve asset were established it should be introduced in a way that would be resource-transfer-neutral (Group of Ten [27, 19651). As a result of these views, a link was not incorporated in the present SDR scheme. Academic interest in the link tended to be lukewarm throughout most of the 1960s but hotted up in the 1970s when the Committee of Twenty was established. With the conspicuous and influential exception of Johnson [48, 19721, Haberler [31, 19711 and Bauer [3, 19733, it may fairly be said that academics were either neutral on the subject or in favour. The possibility of linking international liquidity creation and economic development has a fairly long history. Park [69, 19731 and Haan [ 30, 19711 provide useful summaries of the development of the link concept. The germ of the idea can be found in the so called ‘Keynes Plan’ [53, 19431 which provided the basis for the British position in the negotiations that led up to the Bretton Woods system. In 1958 Maxwell Stamp [83, 19581 proposed that the IMF be enabled to issue Fund Certificates primarily to supplement international liquidity, but also to finance development aid through the IBRD and the International Finance Corporation (IFC). In 1961 he suggested that an aid co-ordinating agency allocate Fund Certificates among LDCs; and in 1962 he elaborated his ideas on how the scheme would work. Basic&y, the IMF would put Fund Certificates

into circulation by lending them to the International Development Authority (IDA), for use in credits to LDCs. IDA would obtain the currency it desired by presenting the Certificates to the central banks in the countries in which orders have been placed for development projects, who would be obligated to receive them. However, countries could opt out of the scheme by being unwilling to accept additional orders. Triffin [S8, 19591 suggested that the foreign exchange component of monetary reserves be transformed into currency deposits with the IMF. The IMF would use such deposits to make advances or provide overdraft facilities to member countries at the latters’ request, or, on its own initiative, to make open market purchases of securities or investments in national capital markets, including dealings in IBRD bonds. This proposal, among others. was considered in a report written by an influential group of economists which analysed the various plans for the reform of the international monetary system (International Study Group, 1964, pp. 85-8). By this time the United Nations was becoming interested in link proposals. In 1965 UNCTAD issued a report [90, 19651 recommending that the IMF issue IMF units to member countries who would deposit currency in the Fund in exchange. (At this time it was thought that if a new reserve asset was to be created, it would have to be ‘backed’ by the currencies of the major industrial countries of the world.) The IMF would then use the currencies to invest directly in IBRD bonds. The IBRD would transfer funds to IDA for ‘soft’ loans to LDCs. This proposal was supported by the Inter-American Committee on the Alliance for Progress [45, 19661. a plan Scitovsky [ 77, 19651 proposed different from that of Triffin. New international currency units should be created to meet the balance-of-payments financing needs of deficit (presumably developed) countries. However, the currency units would not be given directly to the deficit country but to a LDC which could spend them in the deficit country only: the latter would be earning the increase in its reserves which would then become freely for spending elsewhere. Later available Scitovsky [77, 19661 modified his plan so that the newly created international currency units would in the first instance be given to IDA, which would spend them in the balance-ofpayments deficit country. The US Congress was urged to endorse the concept of the link as early as 1961. In a state-

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ment before a sub-committee of the Joint Economic Committee, Day [ll, 19611 advocated a plan similar to that of Triffin. The sub-committee itself gave some support for the idea in 1965 (US Congress Sub-Committee [93, 1965]), and by 1967 it was expressing its unanimous support. Despite the build-up of support for the link, officials generally remained cold. The Group of Ten [27, 19651 actively opposed it, as they had earlier the suggestion for including the poorer countries in a scheme for creating new international monetary reserves even without a link. Eventually, the Group of Ten changed its mind on the latter point, and when the SDR scheme came into operation at the beginning of 1971, LDCs were allocated SDRs along with developed countries; but, as indicated earlier, a link was not incorporated. The collapse of the Bretton Woods system in August 197 1 and the subsequent establishment of the Committee of Twenty, which included representatives from less developed countries, provided the latter with an opportunity for bringing link proposals into the forefront of discussion. A special Technical Working Group was set up to examine the link and make proposals. Since then all proposals for linking liquidity creation with development aid have been conducted in the context of the SDR scheme. We therefore list below the various ways of linking development aid with SDR allocation. 2. Linking SDRs and aid The present SDR scheme does not involve currency ‘backing’ for the new reserve asset. Hence Triffin and UNCTAD-type methods of linking aid with reserve creation are not relevant. Methods of linking SDRs with aid are usually grouped into two categories: ‘organic’ and ‘inorganic’. ‘Organic’ methods are those directly incorporated into the SDR system itself, requiring amendment to the Articles of Agreement establishing the SDR facility. An ‘inorganic’ link would be much simpler (Pate1 [ 70, 19671) since it would take the form of an agreement among developed countries to make voluntary contributions to international aid agencies, in particular IDA, whenever new SDRs were allocated. The contributions would be in national currencies and would represent a uniform proportion of each contributor’s SDR allocation. To make the proposal more acceptable to certain contributors, contributions could be tied to procurement in the contributor’s own country (Scitovsky [79, 1969]), although this practice would clearly reduce the

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real value of the link. Because of the ease of implementation, the ‘inorganic’ approach has been supported, if only as a transitory step, by some international agency officials (Dell [ 12, 19691, Prebisch [73, 19691) but it has obvious disadvantages. Indeed, given the ‘voluntary’ nature of the method, there must be a query whether it constitutes a link at all. One of the advantages of a formal link is that it is a method by which a collective multilateral increase in aid can be achieved in a way that would tend to minimize the adverse balance-ofpayments effects on individual countries (Inter-American Committee on the Alliance for Progress [45, 19661, Maynard [62, 1972; 63, 19731, Kahn [50, 19731). If a number of developed countries failed to participate, this advantage would be greatly attenuated. Moreover, a voluntary link would still leave aid flows at the mercy of the budgetary process (Reuss [74, 19691). Current proposals for an ‘organic’ link can be, classified into four groups: (1) An increase in the amount of SDRs allocated to LDCs, either by raising their IMF quotas or by breaking the link between present IMF quotas and SDR allocations. For instance, whereas under present allocation procedures, LDCs receive about 28 per cent of the total allocations of SDRs, it could be decided that they should receive 50 per cent, shared among them according to the relative size of their IMF quotas or on some other basis. The important thing to note is that the recipients of the ‘extra’ SDRs would be expected to spend them, not hold them. (2) SDRs would be allocated directly to development agencies which, like member countries, would have accounts in the IMF Special Drawing Account, and which would purchase currency from other countries, in order to finance development aid loans on soft terms (e.g., the SDR interest rate plus a small service charge). Some amendment of the Articles establishing the SDR facility would be required, but apart from this the method is simple and easily understood; moreover, once parliamentary approval for the scheme had been obtained, aid through a link would lie outside national budgetary control. (3) Alternative but similar to the procedure under (2) participating countries would first receive their normal SDR allocations, but afterwards, the developed count-r-y members of the scheme only would contribute a fixed proportion of their allocation to the development agencies. All other pr9visions would be the same as in (2). The advantage of this scheme is

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that the LDCs would get their normal (IMF-quotadetermined) allocations and would not contribute directly to the link. (4) Assuming that the international monetary system eventually becomes a fully SDR-based system, in respect of both numeraire and reserve asset functions, a link between the amortization of and interest payable on funded reserve currency balances and development aid could be envisaged (Maynard 19731). Alternatively or [62, 1972; 63, additionally, gold demonetization could also be used as a means of financing aid (Krause [ 56, 19711). In the transition towards such a countries now system, holding reserve currencies in their reserves would be asked to substitute SDRs in their place. The IMF SDR facility would then have a claim on the reserve currency country which would be expected to pay interest to the facility on its debt and perhaps to amortize it over time. The IMF could either lend or transfer a part of these interest and amortization payments in the form of SDRs to the development agencies. An advantage of the scheme is that it could still function even in years in which, in the opinion of the Governors of the IMF, the international monetary system did not require an increase in total reserves. Moreover, by preventing a destruction of SDRs and by providing a readymade deficit to match the required balance-ofpayments surplus of the former reserve currency country, it would remove a possible deflationary to the international threat economic system. In the case of gold demonetization, gold would be replaced by SDRs at the official price and sold at world market-price, the profit being devoted to development aid. In the course of the Committee of Twenty discussions, representatives of the LDCs. i.e.. the Group of 24. expressed a preference for an organic link of the first type, i.e.. a direct allocation of SDRs to LDCs as a group in excess of what they would get on the basis of the sum of their IMF quotas. There was not complete agreement on how these extra SDRs should be distributed among the LDCs. One possibility would be simply to add to each country’s IMFquota-based allocation a proportionate amount: another might be based on population or some other criteria of need. Grounds for opposing ‘link-aid’ channelled through the international development agencies apparently included the following: the disproportionate influence of the developed countries in the IBRD; dislike of IBRD lending policies, particularly the apparent preference for project aid over programme aid ; and, given,

at that time, a 1.5 per cent interest rate charge on net use, the high grant element implicit in direct SDR allocations (even accepting that 30 per cent of allocations have to be reconstituted in the relevant allocation period) which makes such allocations quite as attractive as soft loans from the IDA (Helleiner [ 33. 19741). Against this, it could be argued that since the developed countries would be bearing the real cost of the link, they would be more likely to accept it if there were some guarantee, provided by the IBRD, IDA, etc., that the aid so provided would be used for development and for no other purpose; that since the need for aid on preferential terms is not the same for all LDCs, some criteria for distribution would have to be agreed before each allocation, thus inviting acrimony and delay-hence, the IBRD would be a better vehicle; and third, that LDCs cannot rely on the rate of interest on SDRs remaining at this low level of 1.5 per cent.7 A higher interest rate, which it has been argued (Williamson [ 94, 19721) is theoretically necessary for the proper operation of the SDR seems likely to come about. This scheme, would significantly reduce, if not eliminate, the grant element in direct SDR allocations, so that unless the LDCs can manage to get agreement on a lower rate to be paid by them on their net use of SDR, (Isard and Truman [46. 1974]), aid channelled through the IDA would be cheaper. 3. Arguments f‘or und against u link It is often argued that because international liquidity creation and development aid meet different economic objectives, it is inappropriate and indeed bad monetary practice to link them together. Whether or not a link is inappropriate clearly depends on whether a single instrument, i.e., SDR creation. can satisfy both objectives simultaneously without harm, and perhaps with gain, to each activity considered separately. In part, at any rate, this will depend on the precise nature of the link that is established: but it also depends on the general economic and political desirability of creating money to finance real expenditure. The accusation that a link would be bad monetary practice stems from the view that new money should not be introduced into the system as a byproduct of financing real expenditure and transferring real resources. This view appears to overlook the fact that new money is typically introduced into domestic monetary systems

?. But see note 6, above.

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when governments and firms finance an excess of expenditure over revenue by borrowing from the banking system. Within limits determined by the non-inflationary monetary requirements of the economy, the practice is perfectly legitimate. The accusation also overlooks the fact that in the international gold-exchange system, international money creation has historically been a direct consequence of the balance-of; payments deficits, i.e., excess of expenditure over income, of the reserve currency country or countries, or has involved purchases of gold from gold-producing countries. In other words, countries gaming monetary reserves have had to transfer real resources to the suppliers. It is therefore necessary to examine more closely the economic and political arguments for and against a link, to come to a judgement about the validity and desirability of the practice. (a) Economic arguments The establishment of the SDR system has produced two major benefits for the international monetary system, first, by assuring, in principle at any rate, an orderly and adequate growth of international liquidity, and second, by producing social savings through the substitution of SDRs, with virtually negligible production and administration costs, for gold which requires real resources for its mining, refining, transportation and security keeping (Grubel [29, 19721). It could be argued that the social savings provided by the SDR system will in fact be negligible since gold has provided a diminishing proportion of total international reserves available to the system. In fact, gold made a negative contribution to the increase in international reserves which occured between 1960 and 197 I, the bulk of the increase being provided by the US dollar. The social cost of producing dollars and other reserve currencies is of course also negligible, so that from this point of view there is little or no social saving in moving from a reserve currency system to an SDR system. However, since the rate of interest to be earned on short-term dollar assets was probably lower than the return on other assets which had to be exchanged for them, nonreserve countries acquiring dollars were involved in transferring net real wealth to the reserve currency country; and the latter therefore derived a ‘seigniorage’ from its ability to supply reserves to the system as a whole. Thus, it has been argued that the SDR system in principle provides a third benefit, namely, that international reserves can be created not only at no real resource cost to the international community as a whole, but also without the need

623

for transfers of real resources from one country to another (Johnson [48, 19721). However, although in principle this is or can be a characteristic of the SDR system, it does not follow that it would be economically wrong to manage the system so as to produce a transfer of real resources which would meet internationally desirable ends (Williamson [95, 19733 ). (b) Distribution of seigniorage Assuming that the SDR will, when in full operation, give rise to social saving, how will this saving be distributed among the participants in the scheme? The answer depends on the actual method adopted for allocating SDRs among the member countries. Grubel 129, 19721 provides the analyses and distinguishes between three possible methods of allocation: Demand method; Market method; and Government method. Under the Demand method, the IMF would periodically increase the SDR accounts of each country by amounts designed to keep its cumulative allocations equal to its desired longrun average holdings.’ Although a country may make short-term use of SDRs allocated to it for balance-of-payments financing temporary deficits (or alternatively, would temporarily acquire extra SDRs over and above its allocation when in temporary surplus) countries would on average and in the long-run hold precisely the reserves they were allocated. Thus they would not use them to acquire or lend permanently any real resources through the international financial system. Moreover, since countries pay interest on allocations of SDRs and receive interest at the same rate on holdings of SDRs, the system of interest payments would not lead to any wealth redistribution among countries. Seigniorage would accrue to alI countries in exactly the same proportion in which they contribute to the aggregate demand for reserves and share in the corresponding allocation. Under the Market method, which was in essence suggested by Professor Triffin in his reform plan for the IMF presented in 1960 (Triffin [89, 1960]), the IMF would act rather like a national central bank. It would purchase financial assets in the financial markets of the world and pay for them by increasing its demand liabilities denominated in SDRs, at a rate determined by the required growth in world reserves. The rate of interest would be the same for assets and liabilities, and could be, although it need not necessarily be, determined by market forces. The IMF could distribute its purchases geographically according to its knowledge of the long-run average demand for

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reserves of each country, in which case there would be no difference in substance from the Demand method. But it need not do so: provided individual national central banks did not pursue deliberate sterilizing policies, it could carry out its open market policies in one or two markets only, relying on interest rate arbitrage operations to redistribute the reserves throughout the system. Theoretically, the market method would not affect wealth distribution among member nations; and, like the Demand method, seigniorage would be distributed according to long run average demand for reserves. In contrast to the Demand and Market methods, the Government method would aim quite deliberately at bringing about a transfer of wealth as a by-product of increasing reserves. Whereas the former two methods assume that, in the long run, countries will make zero rret use of the reserves allocated to them, the latter method would give some countries more reserves than would be indicated by their longrun demand for them, and would give other countries less. The former group of countries would be expected to spend the excess on the goods and services of the latter group, who would then be able to acquire reserves to satisfy their long-run demand. Under the Government method, the nature and level of interest payments on SDRs would determine its wealth redistribution effects. The wealth gain accruing to countries initially given an excess of SDRs and the wealth loss borne by countries initially provided with a deficit of SDRs, would depend on the rates of return on real resources and the social discount rates in the two groups of countries respectively, as well as on the interest paid on SDRs (assumed to be the same for allocations and holdings) and the initial excess amount of the SDRs received by the former. If the rate of return on real resources were equal to the rate of interest on SDRs there would be no permanent transfer of wealth from the latter group to the former: but if the rate of interest on SDRs is zero, the valuation of the permanent transfer of real resources from the latter to the former, as perceived by each country, would depend on the relative values of the real return on resources and the social discount rate in the two groups of countries respectively. The wealth gain accruing to countries with an initial excess of SDRs would be equal to this excess if the social discount rate were equal to the rate of return on real resources in these countries, whilst the wealth loss borne by the second group of countries would also equal the initial

shortfall of SDRs if the social discount rate and the rate of return of real resources were equal in these countries. An interesting implication of Grubel’s analysis is that it would be possible for the countries getting the initial excess of SDRs to derive a gain of wealth without a corresponding loss of wealth by the other countries. This would happen if (i) the social discount rate were the same in both countries, (ii) the rate of return on real resources were higher in the first group than in the second group. and (iii) the interest rate on SDRs were below the rate of return on real resources in the countries initially foregoing SDRs; and it emerges as a result of increased efficiency in the allocation of world resources brought about by the initial allocation of SDRs. Under the Government method the distribution of the seigniorage, as distinct from wealth transfer (i.e.. the social saving,arising from the use of SDRs’instead of gold) will depend on the interest rate paid on SDRs and on the elasticity of world demand for reserves with respect to this interest rate. A zero interest rate on SDRs would result in all seigniorage going to the countries initially receiving an excess allocation of SDRs, while the closer this interest rate approximates the rate of return on real resources in the world as a whole the more of the seigniorage goes to the other group of Finally, the actual amount of countries. seigniorage available will be greater, the greater the SDR interest rate elasticity of world demand for reserves.. (c) Resource trunsj‘er and seigniorage dlstribution in (he SDR scheme Early opposition by government officials to ,proposals for linking liquidity creation and development aid was based on the argument that the latter should be resource-transfer neutral. Does the present SDR scheme in fact meet this requirement? Are SDRs in fact allocated to countries according to their longrun average demand for reserves to hold? The answer to both questions is quite clearly ‘no’. In the first place, it is quite obvious that SDRs have not simply been created for members to ‘hold’ rather than ‘to spend’. The scheme allows 70 per cent net use of newly created reserves, since participating countries using SDRs to finance balance-of-payments deficits are only required to ‘reconstitute’ 30 per cent of their initial allocations in any allocation period. Although net users are involved in a net interest payment, the interest rate payable, currently 5 per cent, is clearly well

INTERNATIONAL MONETARY ISSUES AND THE DEVELOPING COUNTRIES below market rates of interest on other assets, so that there is a substantial ‘grant’ element in SDR allocations (Polak [ 72, 197 I] , Williamson j9.5, 19721). This grant element is given by the expression lOO( l-i/r) where i is the interest rate on SDRs and r is the market-related reference interest rate. If this is about 7.5 per cent, the grant element is approximately 33 per cent. Johnson, the outstanding academic critic of a link between reserve creation and aid, admits that the present SDR scheme permits international transfers of real resources. The amount of potential grant obtained by a member of the SDR scheme will depend on its share in the total allocation of SDRs. If SDR allocations in fact matched each country’s long-run demand for reserves-so that no country had an incentive in the long run to add to or run down the reserves given to it-then there would be no transfer of real resources, and seigniorage would be shared proportionately to the reserves allocated to each country. However, while some experts hold that the present system of allocation according to the size of IMF quotas distributes SDRs roughly in line with individual countries’ long-run average demand for them (Grubel [29, 1972]), others deny the appropriateness of such quotas. Hawkins and Rangarajan [32, 19701 argue that IMF quotas are inappropriate for two reasons. First, the original purpose of the IMF quotas was not to allocate ‘owned’ reserves but to determine and finance drawing rights, i.e., conditional liquidity; it was therefore biased towards countries, in particular the US and the UK, which had relatively large reserves and convertible currencies or international responsibilities. Second, the original formula for fixing quotas was based on economic relationships prevailing before 1945. Although adjustments have taken place since 1945, it is doubtful whether these have accurately reflected changes in economic relationships: rather they have occurred as a result of political pressure. Hawkins’ and Rangarajan’s own quantitative study of the appropriateness of IMF quotas for SDR allocations takes into account the relative costs of coping with balance-of-payments problems; and it concludes that the distribution of new reserves according to these quotas unduly favours the rich industrial countries at the expense of poorer countries which tend to be primary producers with -high costs of adjustment. However. if valid, Hawkins’ and Rangarajan’s conclusion points to the need to adjust quotas, not necessarily to the need for a link between reserve creation and aid.

625

(d) Attitude of governments It must be doubted whether the attitude of governments towards link proposals is influenced by the rather theoretical and longrun considerations we have been discussing so far. It is a debatable point whether national governments do in fact operate their economies with some long-run wealth maximization and reserve holding criteria explicitly in mind. In negotiations they seem to show more interest in the short-run implications of an SDR-aid link for foreign exchange reserves; for the shortterm balance of payments; for aid burden sharing; and for inflationary pressures. From this point of view, the most frequent criticism of the proposal is that, far from being a costless way of providing development aid, the link would be an inflationary way of doing so. It cannot be ‘costless’ because the,provision of ‘real resources’, which have alternative uses, is necessarily involved; and it would be inflationary, first, because such aid would not be appropriated through the budgetary process, and therefore financed by increases in taxation or cuts in other government expenditure in donor countries and, second, because the LDCs would have an incentive to press for the overcreation of SDRs (Haberler [ 31, 19711, Bauer [3, 19731). These criticisms have been countered by Grubel [29, 19721, Howe [40, 19721, Maynard [62, 1972; 63, 19731 and Kahn [50, 19731. Insofar as the introduction of the SDR system produces ‘social saving’, extra resources become available for increasing development without donor countries having to reduce their own standards of living. Insofar as the SDR replaces a reserve currency, nonreserve countries are freed from the obligation of transferring real resources to reserve currency countries to obtain reserves, and could increase their aid flows without lowering real consumption at home. Of course, the loss would be borne by the reserve currency country which would no longer have the right to the seigniorage involved in providing the reserve asset. How far this loss would be absolute rather than relative would depend on how far the reserve currency country has had to run its economy below full employment output in order to maintain confidence in its currency. Two other criticisms of the inflationary argument have been made. First, even if the developed world as a whole will suffer a real resource loss as a consequence of the introduction of an aid link, the order of magnitude involved would be rather insignificant in relation to the real income of the developed countries. An extra $1 billion of aid channelled

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through a link would represent barely 0.05 per cent of their combined GDP (Maynard [62, 1972: 63. 19733). Second, the operation of the link should not be viewed in a static context. The GDP of the developed world increases over time. If the quantity of SDRs created each year grows in line with the growth of world production and trade, a link might ensure that at least a part of the increase in the developed world’s GDP was devoted to aid (Maynard [62, 1972: 63, 19731). In practice, developed country governments are concerned with how much of their own allocation of SDRs they would have to forego in favour of LDCs because of the link; how many SDRs they could expect to earn back in trade with LDCs; and what would be the burden-sharing implications and real resource cost to each country of aid channelled through a link. These admittedly short-run considerations are analysed in Maynard [63, 19731, where it is shown that the short-term real resource cost incurred by a donor country per unit of extra reserves gained (i.e., SDRs directly allocated plus SDRs earned in meeting the linkfinanced orders from LDCs) wilI depend on (i) the size of the country’s IMF quota, (ii) the proportion of total SDRs created in the allocation period which are devoted to the link, (iii) the country’s assigned share in the amount of SDRs foregone in favour of the link,8 (iv) the country’s earning share in meeting the LDCs’ link-financed orders for development goods. The resource cost per unit of reserves gained will be greater. the smaller is (i) and the larger are (ii), (iii) and (iv). The share referred to in (iii) would depend on whether a country foregoes SDRs in proportion to the relative size of its IMF quota in the total quotas of the developed donor countries, or in proportion to the share of its GDP in the total GDP of the developed countries. or according to its established relative contribution to recent IDA replenishments. Some countries, for example the UK, Japan and Germany would be likely to acquire more SDRs if a link were attached to the operation of the SDR facility than if it were not; other countries. in particular the US. wouid obtain less SDRs over-all with a link than without it. Considerations of this sort may well have affected the attitude of some developed countries towards a link. (e) Political, procedural and practical urguments against the link Aside from the economic considerations discussed above, arguments of a political or prohave been cedural or practical nature marshalled against the link. These are discussed

and in part at least countered in Grubel [ 29, Howe [40, 19721, Maynard [63, 19721, 19731, Park [69, 19733 and Reuss [74, 19691. The main criticisms are (i) aid channeiled through a link would by-pass legislative control, which would be unconstitutional and undemocratic (.in addition to not being financed properly); (ii) a link would not lead to additional aid since major donors would be likely to reduce correspondingly other forms of multilateral or bilateral aid; (iii) linking aid to SDR creation would lead to undersirable fluctuations in the flow of aid (since there can be no presumption that SDRs would be created at a steady annual rate), thereby severely inhibiting long-range planning of aid by administrating agencies; and (iv) a link would prejudice confidence in the embryonic SDR asset, particularly since it would encourage the developing members of the IMF to press for larger creations of SDRs than could be justified on international monetary grounds. Against these criticisms, it has been argued that the establishment of a link would require parliamentary approval in the first place. so that democratic control would not be bypassed; that although there is no way of ‘additionality’ (additional to guaranteeing what?), a link does provide a multilateral and concerted way of raising untied aid which has balance-of-payments advantages for donors (Maynard [63, 19731, Streeten [85, 19701 and Kahn [ 50, 19731): that the proportion of SDRs created in any allocation period which was devoted to the link could be varied to offset fluctuations in the former (Maynard [63. 19731); that owing to long delays in project approval and actual disbursement of aid funds, the international aid agencies would not be unduly hampered in their long-run planning by fluctuations in SDR creation (Fleming [20. 197 1 ] ); and finally that although an interim period is required to establish the SDR in the system, the procedures governing its use and supply are such that developed countries would have no difficulty in preventing over-creation. Indeed an opposite danger could be that, because of the link. the influence of developed country members of the scheme would !ead to too few SDRs being created rather than too many (Hirsch [ 35, 1973 1).

8. It is assumed that only the developed forego SDRs in fJvour of the link.

countries

INTERNATIONAL

MONETARY

ISSUES AND THE DEVELOPING COUNTRIES

III. AREAS OF INTEREST FOR RESEARCH AND POLICY In the course of the international discussions on the reform of the international monetary system, developing countries aimed at achieving a new system that would explicitly contain, as an integral element, ‘arrangements for transferring real resources to, and promoting economic development in, the poorer countries of the world. Clearly, however, reform of the international monetary system along these lines will not by itself be sufficient to produce an economic environment that will fully meet LDC needs and aspirations; and it is evident that they will need to seek a parallel reform of the international trading system. Achievement of a trading system more appropriate to the needs of LDCs will not be easy. In the meantime, it may be necessary for LDCs to look for ways of fostering trade among themselves. The establishment of regional payments arrangements may be a step in this direction. Previous experience with such arrangements suggests that the problem of financing is not easily overcome, but the proposal advanced by Stewart [84, 19721 may promise greater success. In the deliberations of the Committee of Twenty. LDC representatives put most effort in getting accepted a link between SDR allocation and development aid. Although they were not successful, there was more support among developed countries-with, however, the influential exception of the US-than at any time during the post-war period. It may be a reasonable presumption that at some point in the future, the SDR-aid link will become an element in a reformed system. LDCs managed to get discussed at the Technical WorkingGroup level a variety of other measures to promote real resource transfer, and they achieved a major success in getting established a Joint Ministerial Committee of the Boards of Governors of the Bank and the Fund which will concern itself with the transfer of real resources to developing countries. Thus, although the reform discussions were terminated before a new system could be contrived, LDCs achieved at the diplomatic level, at any rate, a link in principle between monetary reform and economic development which may stand them in good stead in the future. Future policy of LDCs must be directed towards exploiting this breakthrough. Reference to the Report of the Technical Group

on the

Transfer

of Real

Resources,

627

study. The Annex to this report (Documents, pp. 204-7) sets out four main headings of study at the intergovernmental level: Amounts and Quality of Official Development Assistance; Policies and Procedures of Multilateral Development Finance Institutions; Access to Capital Markets; and International Schemes for Commodity Regulation and Price Stabilization. These headings introduce many familiar topics and some well-covered ground; but there are a number of important policy issues which will clearly repay further study and research by academics as well as by government officials. Readers are therefore referred to the Report for suggestions. The inclusion of International Schemes for Commodity Regulation and Price Stabilization is particularly interesting. LDC representatives in the Technical Working Group were helped in establishing the relevance of such schemes to international monetary reform by being able to cite two unpublished papers’by John Maynard Keynes, which linked his proposals for an International Clearing Union with buffer stock finance. A subsequent proposal for a commodity reserve international currency along similar lines, which would also act to stabilize commodity prices, can be found in UNCTAD [9 1, 19651. Proposals along these lines link international monetary issues with international trading issues and establish a further border area for future research and policy decision. At the more technical level, there are perhaps two matters of concern to developing countries which in future discussions they may have to resolve among themselves. The first relates to the nature of the exchange rate system, and the second to the nature of the basic reserve asset in the system. After the coHapse of the Bretton Woods system, the world rather rapidly moved to a system of more flexible exchange rates, and, for a time at least, the exchange rates of many major currencies were allowed to find their own level in exchange markets. The system very quickly became one of managed floating; and although the Committee of Twenty in its early deliberations had agreed in principle that a system of stable but adjustable rates should be at the centre of international monetary arrangements, it seems likely that considerable time will elapse before such a system is once again established. In general, LDC representatives appeared to be keen on returning to the adjust-

30

April 19749 indicated a wide variety of issues bearing on future policy and requiring further

9. International Monetary Reform, Documents of the Committee of Twenty (IMF, 1974).

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able peg system, believing that floating rates would be inimical to their interests; but it is by no means clear that the belief is justifiable either in theory or in practice. LDCs have been cautious about supporting a move towards a more flexible exchange rate system. They fear that more flexible exchange rates will, through the climate of uncertainty they produce, inhibit international trade, with adverse effects on development; and they fear the domestic and international monetary instability, and particularly inflation, that they expect to accompany floating rates (Zulu [97, 19701, Colloquium [8, 19701). A more solid objection may be that greater flexibility of rates is virtually irrelevant to the interests of LDCs unless developed countries are willing to take accompanying measures to liberalize trade, particularly in respect of imports from LDCs (Jayarajah [47, 19691). Indeed, perhaps the most weighty objection is that a permanent move towards a system of unmanaged or partly managed floating rates would be that it would represent a decisive move away from a centrally-managed monetary and trading system which, so LDCs have had in mind, could be designed to provide them with substantial benefits in the way of real resource transfers and freer markets for their goods. If, for instance, greater exchange rate flexibility reduced the system’s need for international reserve assets, there would be less need for further or continuing SDR creation, and LDCs would forego actual and potential benefits as a result (Helleiner [ 33, 1974 ] ). Clearly. however, more research on the implications of greater exchange rate flexibility for world trade, monetary instability and economic development of the poorer countries is certainly necessary. Unfortunately the lessons to be learned from the period 1972-5, during which exchange rates have been more flexible, may not be relevant from the long-run point of view, since, it is to be hoped, the period was not typical. It followed a number of -years of massive balance-f-payments disequilibrium among industrial countries which eventually triggered off the acute monetary instability which plagued the world through 1972-4: moreover, the massive rise in the price of oil and its consequences occurred independently of the exchange rate system. It would therefore be inappropriate to draw the ready conclusion that a system of floating or more flexible exchange rates must inevitably be accompanied by general monetary instability and inflation. It must also be borne in mind that a system of more flexible exchange rates will, in principle at

developed countries to any rate, permit maintain balance-of-payments equilibrium with less recourse to restrictions on trade, both with each other and with LDCs, and on aid and capital flows to the latter. There could be favourable effects on the development prospects of LDCs, outweighing the difficulties created by exchange flexibility for domestic policy. Similar conflicts apply to LDC attitudes towards the reserve assets in the international monetary system. Certainly the existence of a number of reserve assets in the system and the possibility of frequent moves in the exchange rates between them, impose reserve management difficulties for all countries, not least the LDCs (UNCTAD [92, 19691, Helleiner [33, 19741). To manage a reserve asset portfolio in a multiple reserve asset system, when the. exchange rates between them are apt to vary, requires skilled personnel and sophisticated information and communication facilities, which not many LDCs possess. In practice. LDCs may attempt to overcome the trading and reserve management problems presented by more flexible exchange rates by tying their currencies to that of a major industrialized trading partner. It might be thought that they would welcome a system in which an SDR, with relative stability of value in terms of currencies in general, was the basic reserve asset. In the course of the reform discussions, LDCs were reluctant to go all the way with ideas for a comprehensive replacement of reserve currencies with SDRs, since the interest rate on the latter was unattractive compared with what could be obtained on sterling and dollars.10 The fall in the value of the US dollar in terms of other currencies and gold after 1971 has of course imposed a cost on LDCs, which typically hold a large proportion of their reserves in terms of dollars, although, as Helleiner [33. 19743 points out, since much of LDC foreign debt is denominated in dollars, they also gained substantially. Hence the attitude of LDCs towards an SDR asset, which is valued in terms of a basket of major currencies, may have changed in recent years. It would be surprising, however, if it did not remain ambivalent. On the one hand. from the liquidity point of view, LDCs would welcome an SDR which carried an interest rate closer to what could be earned on reserve currency assets; on the other hand, the higher the

10. But sea note 6. above.

INTERNATIONAL MONETARY ISSUES AND THE DEVELOPING COUNTRIES interest rate on SDRs the less are the real resource transfer gains they get from SDR allocation. Poorer LDCs, as potential net users of SDRs, would seem bound to favour a low interest SDR and large allocations; richer ones with greater access to capital markets would favour a high interest SDR. This constitutes an area of conflict but also of possible compromise. Finally, the rise in the price of oil and the transfer of world income to less’developed but although countries, oil-producing major imposing a severe burden on the current balances of payments of other LDCs, may also provide further opportunities for transfers of real resources in their favour. LDC representatives on the Committee of Twenty were quick to point out (Report of the Technical Group on the Transfer of Real Resources, 1974) that, insofar as the oil-producing countries could not absorb in the form of imports of real goods and services the whole or even major part of their oil revenues, an opportunity existed for increasing the flow of real resources to non-oilproducing LDCs, i.e., an increased flow of

exports from the major industrialized countries to cover the higher cost of their oil imports. A mechanism of financing would have to be developed, but basically it would take the form of either the oil-producing countries lending their revenue surpluses directly, or indirectly through aid agencies, to non-oil-producing countries, or the developed industrial countries increasing their aid and capital flows to LDCs on the basis of oil-producing country investment in or loans to them. Obviously, the developed industrial countries would be involved in paying the real cost of the higher price of oil; moreover, there would be problems of risk and relative interest rates on the flows of aid and capital involved. But if the alternative

was a kall in world real income and output owing to the rise in the price of oil, the burden on developed countries would be more apparent than real. There is room here for further study of the institutional arrangements that might be established. It is evident that the present state of the world trading and monetary system is imposing new strains on LDCs. At the same time, the general interdependence between the international monetary and trading systems and the spread of economic development throughout the world is becoming ever clearer. Realization of this fact may make it easier for developing countries to achieve an integrated international monetary and trading system that will help further their development.

629

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