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The world economy, external debt and prospects for development financing
World Development Vol. 7, pp. 125-133 Pergamon Press Ltd. 1979. Printed in Great Britain.
The World Economy, External Debt and Prospects for Development Financing ARIEL BUIRA SEIRA Banco de Mexico
Summary. - This paper provides an overview of the evolution of the industrial economies in the 196Os, with particular attention to the factors which gave rise to the economic crisis of recent years. The effects of this international economic instability on the developing economies is then considered, especially the weakening of their balance-of-payments position which has increased their dependence on external finance. The author indicates that the developing countries’ growing reliance on credits from private international banks gives cause for concern and he proceeds to make some suggestions for other mechanisms of dwelopment financing.
Over the 25 years which ended in 1973 the world economy experienced an unprecedented which facilitated the growth of expansion developing countries’ exports. Nevertheless, the financial requirements of these countries exceeded their export revenues and their external public debt grew substantially to a level of $43 billion by 1970. Since 1,973 the world economy has been characterized by a lower rate of growth, greater unemployment, and marked instability of prices and exchange rates. As to a large extent these phenomena respond to structural changes, it is unlikely that over the coming years the high rates of growth and relative stability which characterized the previous decade will be reattained. Nevertheless, in recent years, the developing countries managed to sustain higher rates of growth than the industrial countries, but at the cost of large external disequilibria financed through growing external indebtedness. This essay reviews the evolution of the industrial economies in the 196Os, with particular attention to the factors that gave rise to the economic crisis of recent years; the evolution of the developing countries’ economies over this period is considered, particularly the weakening of their balanceof-payments position which increased their dependence on external finance. Finally, some implications of the accelerated growth in the indebtedness of developing countries to commercial banks are analysed, and other mechanisms of development financing that could avoid the problems posed by that growth are suggested.
1. INDUSTRIAL COUNTRIES: EVOLUTION AND OUTLOOK The international economy experienced a period of unprecedented growth with high employment and relative price stability in the 1950s and 1960s. In retrospect this period could be characterized by a rising trend with moderate fluctuations in the level of economic activity, in the rates of inflation and of unemployment. The growth of those years may be attributed to a number of factors among which the following could be singled out: liberalization of trade and payments, technical progress, the expansion in the supply of labour, high rates of saving and investment, relative price stability, and the climate of confidence which prevailed, due in part to the belief that Keynesian theory allowed governments to minimize cyclical problems and to sustain a high level of employment in industrial economies. This period, which viewed from the vantage point of 1978 could be seen as one of bonanza, came to an end with the decade of the 1960s. In the early 1970s several of the factors that stimulated economic growth in the previous decade lost vigour; the growth of the labour force was reduced as large population movements from the countryside to the cities dwindled and as a growing resistance to the migration of foreign workers became apparent in both Europe and America; the liberalization of trade amongst industrial countries and, in particular, European economic integration lost momentum, and as industries in Europe and 125
126
WORLD DEVELOPMENT
Japan approached frontiers of technical gress, the rate of innovation declined.
pro-
At the end of the 1960s inflationary pressures appeared in most industrial countries. In the US, inflation increased due to an excess demand resulting from simultaneous financing of a considerable war effort in Vietnam and ambitious domestic social programme F:resident Johnson’s Great Society). In Europe growing social unrest combined with the studen; and worker revolts of May 1968 led a number of countries to grant salary increases substantially in excess of what could be justified by increased prices or productivity. Of course, the inflationary pressures generated by these factors could only become effective due to an expansionary monetary policy which validated them. It was at about this time that discussion began of the inflationary bias inherent in the industrial economies due to the political commitment of their governments to sustain full employment. These inflationary pressures supported by an expansionary economic policy contributed to a unique phenomenon in recent economic history: a simultaneous expansion of the industrial economies which, amplifying in an unforseen manner the demand pressures present in each one of them, severely worsened inflationary pressures, The expansion of demand in different countries which in different circumstances might not have been excessive, when joined by the expansion in the other countries, provoked a cumulative growth of aggregate demand that was strongly inflationary. The effects of this mistake in economic policy were compounded by a number of factors, some of which were difficult to foresee. Among these were the sharp increase in the prices of cereals due to the bad crops of 1972 and to the sustained increase in demand as a consequence of the growing income in wide areas of the world. Another factor was the sudden rise in the prices of raw materials,
particularly of minerals, as a consequence of the simultaneous expansion of demand in industrial countries and of their low supply elasticities. Moreover, inflationary pressures gave rise to speculative stockpiling which worsened the shortages apparent in international commodity markets. Given the reserve currency role of the US dollar, the growing current account and capital account deficits of the US provoked an unprecedented expansion in international liquidity which passed from $90 billion in 1970 to $260 billion by the end of 1977. Thus, growing liquidity seemed to remove all external payments constraints on the financial policies of other industrial countries creating a climate that favoured the adoption of expansionary monetary and fiscal policies by all. (See Table 1.) The devaluation of the dollar marked the end of the fixed exchange rate system established in Bretton Woods at the end of the Second World War giving rise to a new system of floating exchange rates which seemed to relax the financial discipline previously imposed by fixed exchange rates. Economic expansion in industrial countries accelerated in 1972 and 1973 to a point that made a slowdown in economic activity unavoidable. By the end of 1973, with the purpose of diminishing inflationary pressures, most industrial countries had introduced restrictive fiscal and monetary policies intended to lead to a reduction in economic activity. It was in these circumstances that the sharp increase in oil prices occurred, intensifying both the inflationary pressures and the recessionary trends present in the industrial economies. Initially, most industrial countries look favourably on the decline which took place. However, the cumulative impact of a simultaneous economic contraction was again underestimated. Industrial production in the OECD countries fell 13% below its 1973 levels and their GNP fell by 3.5% between the first semester of 1974 and the corre-
Table 1. International liquidity (Billions of SDR’s)
International reserves Gold SDR’s Reserve position in the Fund Foreign exchange Source: International
1960
1970
1971
1972
1973
1974
1975
1976
1977
61.2 -
93.2 37.0 3.1
123.2 36.0 5.9
146.8 35.6 8.7
152.6 35.6 8.8
180.2 35.6 8.9
194.3 35.5 8.8
222.1 35.4 8.7
260.0 35.5 8.1
3.6 18.5
7.7 45.4
6.4 75.1
6.3 96.2
6.2 101.7
8.8 126.9
12.6 137.4
17.7 160.3
18.1 198.3
Financial Statistics,
and Annual Report
(IMF, 1977).
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PROSPECTS FOR DEVELOPMENT FINANCING
wide range of enterprises thus limiting the incentives and the financial resources available for investment. In 1975, the severe recession in industrial countries and the expansion of imports of OPEC countries allowed the former to substantially reduce their current account deficit; however, the recovery of 1976 widened their external deficit to $27 billion. In 1977, due to the restrictive financial policies adopted as well as to prevailing uncertainty and low levels of business investment, the industrial countries experienced a new decline in the growth of aggregate demand and their rate of growth fell from 5.3% in 1976 to 3.7%. This low rate of growth impeded a reduction in unemployment which at 5% remained at about the level prevailing in 1976 and the second half of 1975. The slowdown in demand in industrial countries, plus their exchange rate instability and growing protectionist trends, substantially limited the expansion of world trade to about 5% in 1977, a rate well below the 9% average of the previous decade and the 12% expansion achieved in 1976. In recent years a number of changes, many of them structural, have taken place in industrial countries, which limit their growth prospects
sponding period of 1975. These results point to the deepest and longest recession suffered by the industrial countries since the 1930s. The rise in the price of oil led to increases in transport costs, the price of manufactures, fertilizers, and more generally in the cost of living. These in turn gave rise to new wage demands as trade unions tried to maintain the real income of their members. The increase in oil prices signified a large transfer of real income from the oil importing industrial countries to OPEC countries, with the consequent contractionary impact on the income of the former. This contractionary effect was not immediately recognized by the governments of industrial countries which generally intensified their restrictive fiscal and monetary policies with the purpose of minimmizing the inflationary impact of the rise in oil prices and thus contributed to the worsening of the recession. The size of the transfer that took place may be illustrated by the worsening of the current account of the OECD countries which went from a surplus in 1973 to a deficit of $33 billion in 1974. (See Table 2.) Moreover, the increase in the price of oil made energy-intensive machinery and technology obsolete, diminished the productivity of capital and therefore reduced the profits of a
Table 2. Balance of payments on current account (In billions of US dollars) 1973 Industrial countries
9.8 -
Canada United States Japan France Germany Italy United Kingdom Belgium-Luxembourg Denmark Netherlands Austria Norway Sweden Switzerland Other developed countries Developing countries Major net exporters of oil Other developing countries Total*
1.6 0.1 -
0.4 6.8 1.2 1.3 1.6 0.7 2.2 0.3 0.3 1.4 0.4 1.1
6.5 -11.3 6.1
I974 - 13.0 - 1.6 0.4 - 4.5 5.5 12.5 - 6.9 - 7.5
1975 16.4 4.7 14.4 - 0.4
-
-
-
1.0 1.2 2.1
-
0.5
-
0.5 7.5 0.8 2.8 0.8 0.6 2.0 0.3 2.3 1.1 2.7 14.8
1.0 - 0.6 0.3 - 14.5
-
67.8 - 29.9 10.4
34.7 - 37.3 - 1.0
-
Sources: National statistical publications and IMF Data Fund. Reflects errors, omissions, and asymmetries in reported balance-f-payments
statistics.
1977
I976 -
2.4
-
-
4.3 1.7 3.9
- 4.0 - 17.4 11.2
-
5.3 7.1 1.8 0.6
-
0.3 2.2 2.5 1.5 4.1 1.9 3.7 14.3
-
-
40.8 - 25.6 - 1.5
-
7.5
1.8 7.6 3.4 1.9 0.1 1.9 0.3 2.8 5.0 2.7 3.7 13.6 34.9
- 22.1 - 8.3
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WORLD DEVELOPMENT
in the short and medium term and suggest that these countries may tend towards a new equilibrium at lower rates of growth and higher rates of inflation and unemployment than in the previous decade. Outstanding among these changes are a marked decline in the rate of growth of productivity, a decline in profit rates, a slower growth of the labour force and a higher natural rate of unemployment, higher rates of inflation and exchange rate instability, a trend towards protectionism and a generalized loss of public confidence in the prospects for economic growth and in the ability of governments to combine low rates of unemployment with relative price stability. The growth of labour productivity in industrial economies has been adversely affected by a number of factors. Among these are the increased cost of energy, lower rates of investment, a greater concern for the environment, the deceleration of the process of international economic integration, a reduced rate of transfer of labour from low productivity activities to higher productivity industries and a lower rate of technical change due to reduced investment and due to the fact that industrial countries have largely modernized the major sectors of their economy. The new structural conditions prevailing in industrial countries make the achievement of satisfactory rates of growth more difficult than in the past. Even if the developed world were to emerge shortly from its current recession, the medium-term prospects for these countries are for a rate of growth well below that attained in the last decade. Consequently, the recovery of the industrial economies should not be counted upon to enable them to reach high rates of growth that would stimulate the vigorous expansion of international trade and of developing country exports, allowing the developing countries to sharply reduce their deficit on current account and their external financial requirements over the coming years.
2. DEVELOPING
COUNTRIES
Since industrial countries are the main market for the exports of developing countries their sustained growth appears to be a necessary condition for the growth of the exports of developing countries. Moreover, since flows of official development assistance have stagand only a few developing countries nated’ have substantial access to international capital markets or receive significant amounts of
private direct investment, the expansion of their exports may be regarded as a necessary condition for their growth on current development patterns. From 1961 to 1970, the income per capita of developing countries as a whole grew at an average annual rate of 3.2%. This growth, made possible by the expansion of industrial economies, allowed a number of developing countries to develop considerable industrial sectors and a few to produce intermediate and capital goods. In some cases, their industrial structure and their income levels approached those of the least advanced industrial countries.* In the period 1971-75 developing countries as a whole sustained annual rates of growth of 3%, which were substantially above those attained by the OECD countries over the same period.3 That is to say, the impact of the recession on the rate of growth of these countries was less than could be expected. However, the international recession and the rise in the inflationary pressures had a severe impact on their balance of payments. The current account deficit of non-oil developing countries rose from $9-11 billion in the first years of the decade to $30 billion in 1974 and $37 billion in 1975. (See Table 3.) In 1976 this deficit was reduced to $26 billion as a result of the recovery of activity in some industrial countries, the rise in the prices of commodities and the adjustment efforts undertaken by some of the larger developing countries. Since the current account deficit of non-oil developing countries was largely financed through external borrowing, their indebtedness grew sharply in recent years due to their effort to sustain positive rates of growth despite an unfavourable international economic situation which affected both the quantum of their exports and their terms of trade.4 (See Table 4.) In fact, their outstanding long-term external public debt, which had risen from $33 billion to $43 billion in the period 1967-70, virtually doubled in the years 1970-74 and by the end of 1977 stood at more than 4 times the level of only 10 years earlier. (See Table 5.) In view of the strong political, social and demographical pressures to which the governments of developing countries find themselves subject, it is understandable that for these governments a sustained reduction in the per capita income of their population for several years was generally more difficult to accept than for the governments of industrial countries.’ It can be said that the growth of external indebtedness was the price deveioping countries paid to sustain positive rates of growth. It must
PROSPECTS FOR DEVELOPMENT FINANCING
129
Table 3. Non-oil developing countries: current account financing, 1913-17 (In billions of US dollars)
Current account deficit* Financing through transactions that do not affect net debt positions Net unrequited transfers received by governments of non-oil developing countries Direct investment flows, net Net borrowing and use of reserve& Reduction of reserve assets (accumulation, -) Net external borrowing§ Long-term loans received by governments from official sources, net Other long-term borrowing from non-residents, net From private banks abroad11 Through suppliers’ credits11 Other sources7 Use of reserve-related credit facilities, net** Other short-term borrowing, net Residual errors and omissions
1973
1974
1975
1976
1977
11.3
22.9
37.3
25.6
22.1
8.2
10.6t
11.6
10.8
11.3
4.2 4.0
6.lt 4.5
6.4 5.2
5.9 4.9
6.5 4.8
3.1 - 8.3 11.4
19.3t - 2.8 22.1t
25.7 -0.9 26.6
14.8 -11.8 26.6
10.8 - 11.8 22.6
5.3 5.2 3.9 0.3 1.0 0.2 0.5 0.2
7.5t 7.5 5.7 0.5 1.3 1.4 4.3 1.5
10.2 9.8 7.7 0.8 1.2 3.3 5.2 - 1.9
12.9 9.5 10.6
13.0 7.9 9.4 1.2 - 3.2 0.5
- ::: 3.0 3.3 - 2.1
1.2
Source: IMF Balance of payments records and staff estimates. * Net total of balances on goods, services, and private transfers, as defined for Balance of Payments Yearbook purposes (with sign reversed). t Excludes the effect of a revision of the terms of the disposition of economic assistance loans made by the United States to India and repayable in rupees, and of rupees already acquired by the US Government in repayment of such loans. The revision has the effect of increasing government transfers by about US$2 billion with an offset in net official loans. $ i.e. financing through changes in net debt positions (net borrowing, less net accumulations - or plus net liquidation - of official reserve assets). 0 Includes any net use of non-reserve claims on non-residents, errors and omissions in reported balance-ofpayments statements for individual countries, and minor deficiencies in coverage. 11Public and publicly guaranteed borrowing only. B Including errors and residuals which arise from the mismatching of data taken from creditor and debtor records. ** Comprises use of Fund credit and short-term borrowing by monetary authorities from others.
Table 4. Non-oil developing countries: merchandise trade, 1967-77 (Percentage changes)
Value in US dollars Exports Imports Volume Exports Imports Unit value in US doIlars Exports Imports Terms of trade Source: IMF.
Average 19671 1972
1973
1974
1975
1976
1977
11.9 11.4
47.1 40.6
44.4 62.3
- 1.9 3.6
22.4 7.0
18.9 14.0
9.0 4.1
7.8 23.7
5.2 8.7
1.2 -6.7
13.5 4.1
6.7 4.9
2.7 4.1 - 1.3
36.4 23.7 10.3
37.3 49.3 -8.0
- 3.1 11.0 - 12.7
7.8 2.7 5.0
11.5 8.7 2.6
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WORLD DEVELOPMENT Table 5. Non-oil developing countries: public and publicly guaranteed long-term ext?mal debt outstanding. year-ends 1973-77 (In billion of US dollars) 1974
1975
1976
1977
66
82
99
122
146
43
51 14 37 31 16 8 4 2
59 17 42 40 24 9 4 3
69 20 49 53 33 10 5 4
81 24 58 65 43 11 6 5
1973 Total outstanding*
Total from official sources International institutions Governments Total from private sources Private banks Suppliers’ credits Bond issues Other Reference
:: 24 11 7 4 2
items:
Value of annual debt service paymentst(in billion of US$) Interest payments Amortizations Ratio of annual debt service payments to annual exports of goods and services (in %) Of which: Ratio of annual interest payments (in %) Ratio of annual amortizations (in %) Ratio of year-end outstanding external public debt to annual exports of goods and services (in %)
8.5 2.6 5.9
9.5 3.3 6.2
11.3 4.4 6.9
13.4 5.2 8.2
18.4 6.6 11.8
10.9
8.5
10.1
10.0
11.5
3.3
3.3
3.9
3.9
4.1
7.6
5.6
6.1
6.1
7.4
85.0
73.1
88.3
90.6
91.2
Sources: World Bank Debtor Reporting System and IMF staff estimates. Year-to-year changes in public debt outstanding do not necessarily correspond with annual net disbursements because of the effects of cancellations, nationalizations, and exchange rate and other adjustments. ? Interest charges and repayment of principal.
also be admitted that in so doing they made an important contribution to the moderationofthe severity of the recession of industrial countries and to the alleviation of their external disequilibria. In a sense, the growth of the external debt of these countries could be taken as a measure of their contribution to the sustenance of world economic activity.
3.
PROSPECTS FOR DEVELOPMENT FINANCING
The stagnation of exports and of official assistance flows led to the concentration of the indebtedness of developing countries in international capital markets, and to a growing reliance on credits from international banks. The share of other creditors, both governments and multilateral financial institutions diminished in relative terms from some two-thirds in the
period 1967-70 to about onequarter of the total by 1977. Since commercial bank loans are characterized by higher rates of interest and shorter maturities than credits provided by official sources of development finance, this trend has given rise to a more than proportional increase in the debt service payments of developing countries. Such an increase has provoked doubts regarding the credit-worthiness of this group of countries and of certain borrowers among them and has led a number of observers to conclude that in the future, external credits to these countries should not be allowed to grow at a rate similar to that of the last few years. However, at present there are strong pressures on the part of industrial countries toward the redistribution of official assistance flows in favour of health, housing, education and other socially oriented projects in the least developed countries. This suggests that middle income
PROSPECTS FOR DEVELOPMENT FINANCING developing countries may be forced toward greater reliance on the market and therefore that a hardening of the terms on which finance is made available to them is to be expected. The prospect that middle income developing countries must increasingly depend on the expansion of private capital flows, mainly bank credits, gives cause for concern. The continued availability of these private flows may be questioned. On the one hand, a continued disposition of private banks to increase their finance to those countries must be assumed in spite of the doubling of their external debt in the period 1970-75 and of a projected further doubling of their debt in the period 1975-80. In addition, one must assume that the new regulatory activities of the monetary authorities of industrial countries will not limit the expansion of external lending operations to these countries. On the assumption, in a sense optimistic, that the expansion of banking credit to developing countries will continue to grow in adequate amounts, the World Bank estimates that their debt service will absorb 60% of all the new flows of finance received by these countries by 1980. Obviously, this average of 60% includes countries with much higher ratios - a fact that may make it extremely difficult for them to obtain new credits and could have serious consequences for their external payment capacity and for the stability of international capital markets. 4. NEED FOR NEW MECHANISMS OF DEVELOPMENT FINANCING The above analysis suggests that while existing financing arrangements were adequate to allow developing countries to moderate the effects of the 1974-75 recession on their rates of growth, they do not constitute a viable response to the problem of development financing which the world economy now faces. The medium-term financing of commercial banks and capital markets gives rise to a liquidity problem in the medium term for countries that depend heavily on it, even if the financing is used for sound investment projects. It appears unlikely that industrial countries may, in the near future, achieve the high rates of growth required to generate a strong and sustained expansion of international trade that would reduce the external borrowing requirements of developing countries. On the other hand,it is also apparent that developing countries must remain important capital importers so as
131
not to seriously limit their growth prospects. The gravity of the problems that the stagnation of the developing countries would pose for the international community makes it necessary to find adequate solutions to the problem of external financing. The current situation in industrial countries of high rates of unemployment, low utilization of existing productive capacity (particularly in the capital goods industries), and abundant liquidity in their financial markets suggests that the solution of the problem of development financing may also contribute to the solution of the problems of the developed countries, underscoring the growing interdependence among them. Therefore, what is required is an improved ‘technology’ of financing that will allow a lengthening of maturities and an increase in capital flows from industrial and oil surplus countries to finance investment in developing countries. This would not only permit developing countries to sustain higher rates of growth, but would also generate demand for capital goods stimulating economic activity in industrial countries. There are several ways in which this might be achieved. A few of them are presented below: (i) An increase in official assistance flows from industrial countries, as well as an increase in long-term export credits granted those countries with government guarantee. The existence of excess capacity and unemployment in industrial countries indicates that the marginal social cost of these measures would be very low while their benefits, including those to the donor country, would be substantial. (ii) An increase in the capital of international development financial institutions such as the IBRD and the regional banks to allow them to play a much greater role in meeting the financial requirements of developing countries. Should substantial increases in the capital resources of these institutions not be achieved, their financial capacity could also be enlarged by means of supplementing their resources with long-term loans from surplus countries, both industrial and oil-exporting, as in the case of the ‘Supplementary Financing Facility’ of the IMF. This was the thrust of Mexico’s proposal to the Joint IMF-IBRD Development Committee in its April 1978 meeting. In essence the Mexican proposal consists of the creation of a fund, tentatively set at $15 billion, that would operate on commercial lines obtaining long-term credits in surplus countries and in international markets.6 This fund would grant 15-year financing for investment projects
132
WORLDDEVELOPMENT
and the acquisition of capital goods in both industrial and developing countries. For developing countries, this financing would permit the achievement of a higher rate of investment and growth as well as the improvement in their debt profile and therefore of their creditworthiness. For industrial countries, it would mean higher levels of economic activity and employment particularly in the capital goods industries, as well as greater levels of exports, thus making it easier for them to resist the protectionist trends apparent in the world economy. This would also contribute to improving the prospects for the medium-term growth and stability of the international capital markets. This approach recognizes that it is not a sound banking principle to finance long-term capital investments with short-term money and instead seeks to provide long-term financing. Thus, rather than the restrictive approach to the problem of development financing taken by several bank regulatory agencies of developed the proposal suggests a positive countries, approach which would benefit all parties concerned. In making this proposal the Mexican government was keenly aware of the inadequacy of the capital resources of the World Bank and of other regional development finance institutions and of the enormous difficulties they face in increasing their capital resources to a level that will allow them to sustain an adequate expansion of their lending programmes. The proposal seeks to circumvent the major difficulty international institutions face, i.e. the reluctance of developed countries to raise their capital contributions through outright grants. This is done by creating an attractive investment outlet for both institutional investors and industrial and surplus country governments. Since contributions to the fund would be loans at market rates of interest they would not have to be funded as grants by parliaments. The Mexican proposal also considers the possibility that some industrial countries may contribute to the enlargement of the financial capacity of multilateral development institutions through the granting of guarantees for up to specified sums on the credits granted by the market to these institutions. The proposed fund could be administered by the World Bank or some other international institution in order to avail itself of existing infrastructure for project appraisal and credit administration. (iii) Stimulate the development of a market for long-term bonds issued by developing countries. In order to be attractive to the market, these bonds could be dominated in
SDRs or a basket of currencies and have floating rates to adjust for inflation.’ Industrial countries, particularly those which face difficulties in increasing their official development assistance and their contributions to the capital of development financial institutions, could stimulate the placement of developing country bonds in their markets through the tax exemption of revenues arising from investments in such bonds. Such exemptions, whether partial or total, would make these bonds attractive since they would have the effect of increasing the return for investors without increasing the cost of financing for the debtors. It may be recalled that municipal bonds in the United States enjoy a fiscal treatment such as the one proposed here, and that the ‘Colonial Stock Act’ of 1900 granted such treatment to the bonds issued in the United Kingdom by the Commonwealth countries. This latter mechanism allowed capital flows to what were then developing countries in amounts equivalent to several percentage points of the UK’s GNP. Placing bonds with institutional investors of industrial countries beyond a certain proportion of their capital would, in some cases, require changes in existing regulations that limit their holdings of securities issued by non-residents. However, the effort to change these regulations should be made in order to open up an important new source of funds.s At present the huge institutional market has hardly been tapped by developing countries. In addition, efforts would also be required to develop a secondary market that would give liquidity to the bonds issued by developing countries. (iv) Increase flows of foreign investment to developing countries. Industrial countries have shown marked interest in increasing their investment, particularly in mining, energy and such commodities as may be in short supply in the mediumand long-term. However, creditor countries ask for a ‘favourable climate’ for foreign investments which includes, as essential elements, the establishment of investment protection agreements, recourse to international arbitration in the event of a dispute and ‘full, just and prompt compensation’ in the event of nationalization or expropriation. To be acceptable to developing countries, direct foreign investment must fully submit to the laws and jurisdiction of the host country and contribute to its overall development within the framework of its economic and social policies. It would seem that in many cases the expansion of direct foreign investment will not. take place until a code of conduct for transnational corporations is developed which is acceptable
PROSPECTS FOR DEVELOPMENT FINANCING to both sides. The serious political and philosophical differences behind the positions of the two groups of countriessuggest that the solution to this problem may take some time.
5. CONCLUSIONS In recent years, the world economy has experienced lower rates of growth, higher rates of unemployment and marked instability of prices and exchange rates. To a considerable extent these phenomena reflect structural changes; therefore its unlikely that the high rates of growth and relative stability of the 1960s may be reached in the coming years. Despite adverse developments in the .world economy managed industrial achieved and of a Most of national interest
in the 197Os, developing countries to sustain higher rates of growth than countries. However, these rates were at the cost of large externalimbalances dramatic increase in their external debt. this debt was contracted with intercommercial banks at higher rates of and at shorter maturities than tra-
133
ditional credits for development financing. As a result, debt service payments have grown very rapidly giving rise to questions regarding the credit-worthiness of a number of countries. By now it has become apparent that developing countries should not continue to depend on commercial bank loans to the same large extent as in the recent past. However, the prospects of low rates of growth in developed countries make it necessary for developing countries to continue as substantial capital importers if their growth is not to be seriously impaired. The current situation of high rates of unemployment, low utilization of existing productive capacity and abundant liquidity in the developed countries suggests that greater capital flows towards developing countries can not only contribute to the growth of these countries but also play an important role in the solution of the problems of the developed economies. Therefore, new mechanisms to increase capital flows to developing countries on terms and maturities suitable for development financing are required.
NOTES
1. As a proportion of GNP of OECD countries, official assistance to developing countries declined from 0.35% in 1975 to 0.33% in 1976 and to 0.31% in 1977. 2. However, a number of important differences in the rates of growth of different groups of developing countries were observed. While countries In SubSaharan Africa and South-east Asia achieved growth rates of 1.5% and 1.6% respectively, countries in Latin America reached growth rates of 2.5% and those of the Middle Fast grew at a rate of 4.4% per annum. 3. The rate of growth of GNP of OECD countries was -0.1% in 1974, 1.4% in 1975 (excluding Greece, PortugaI, Spain and Turkey); therefore their per cupit income at the end of 1975 felI below 1973 levels. For the period 1971-75 OECD countries grew at an average annual rate of 2.3%. 4. Some developing countries utibzed part of their external borrowing to accumulate international reserves to ensure their ability to sustain an adequate level of imports and an adequate rate of growth in the future.
5. Since population pressures are clearly smaIIer in developed countries and their population enjoys living standards which generally cover the basic needs of food, health and shelter. 6. While it was realized that a larger figure might be required in order to alIow this fund to have a sub stantial impact on the level of international economic activity, it was felt that a much larger initial fwre would make the establishment of this fund more difticult .
7. Tbe same could apply to loans to the special fund for long-term development financing proposed for Mexico. 8. In the course of the discussion on access to capital markets at the CIEC (North-South Dialogue) the representatives of a major developed country indicated their wiRingtress to assist efforts to remove or greatly liberalize such regulations as and when required by developing countries.
The World Economy, External Debt and Prospects for Development Financing ARIEL BUIRA SEIRA Banco de Mexico
Summary. - This paper provides an overview of the evolution of the industrial economies in the 196Os, with particular attention to the factors which gave rise to the economic crisis of recent years. The effects of this international economic instability on the developing economies is then considered, especially the weakening of their balance-of-payments position which has increased their dependence on external finance. The author indicates that the developing countries’ growing reliance on credits from private international banks gives cause for concern and he proceeds to make some suggestions for other mechanisms of dwelopment financing.
Over the 25 years which ended in 1973 the world economy experienced an unprecedented which facilitated the growth of expansion developing countries’ exports. Nevertheless, the financial requirements of these countries exceeded their export revenues and their external public debt grew substantially to a level of $43 billion by 1970. Since 1,973 the world economy has been characterized by a lower rate of growth, greater unemployment, and marked instability of prices and exchange rates. As to a large extent these phenomena respond to structural changes, it is unlikely that over the coming years the high rates of growth and relative stability which characterized the previous decade will be reattained. Nevertheless, in recent years, the developing countries managed to sustain higher rates of growth than the industrial countries, but at the cost of large external disequilibria financed through growing external indebtedness. This essay reviews the evolution of the industrial economies in the 196Os, with particular attention to the factors that gave rise to the economic crisis of recent years; the evolution of the developing countries’ economies over this period is considered, particularly the weakening of their balanceof-payments position which increased their dependence on external finance. Finally, some implications of the accelerated growth in the indebtedness of developing countries to commercial banks are analysed, and other mechanisms of development financing that could avoid the problems posed by that growth are suggested.
1. INDUSTRIAL COUNTRIES: EVOLUTION AND OUTLOOK The international economy experienced a period of unprecedented growth with high employment and relative price stability in the 1950s and 1960s. In retrospect this period could be characterized by a rising trend with moderate fluctuations in the level of economic activity, in the rates of inflation and of unemployment. The growth of those years may be attributed to a number of factors among which the following could be singled out: liberalization of trade and payments, technical progress, the expansion in the supply of labour, high rates of saving and investment, relative price stability, and the climate of confidence which prevailed, due in part to the belief that Keynesian theory allowed governments to minimize cyclical problems and to sustain a high level of employment in industrial economies. This period, which viewed from the vantage point of 1978 could be seen as one of bonanza, came to an end with the decade of the 1960s. In the early 1970s several of the factors that stimulated economic growth in the previous decade lost vigour; the growth of the labour force was reduced as large population movements from the countryside to the cities dwindled and as a growing resistance to the migration of foreign workers became apparent in both Europe and America; the liberalization of trade amongst industrial countries and, in particular, European economic integration lost momentum, and as industries in Europe and 125
126
WORLD DEVELOPMENT
Japan approached frontiers of technical gress, the rate of innovation declined.
pro-
At the end of the 1960s inflationary pressures appeared in most industrial countries. In the US, inflation increased due to an excess demand resulting from simultaneous financing of a considerable war effort in Vietnam and ambitious domestic social programme F:resident Johnson’s Great Society). In Europe growing social unrest combined with the studen; and worker revolts of May 1968 led a number of countries to grant salary increases substantially in excess of what could be justified by increased prices or productivity. Of course, the inflationary pressures generated by these factors could only become effective due to an expansionary monetary policy which validated them. It was at about this time that discussion began of the inflationary bias inherent in the industrial economies due to the political commitment of their governments to sustain full employment. These inflationary pressures supported by an expansionary economic policy contributed to a unique phenomenon in recent economic history: a simultaneous expansion of the industrial economies which, amplifying in an unforseen manner the demand pressures present in each one of them, severely worsened inflationary pressures, The expansion of demand in different countries which in different circumstances might not have been excessive, when joined by the expansion in the other countries, provoked a cumulative growth of aggregate demand that was strongly inflationary. The effects of this mistake in economic policy were compounded by a number of factors, some of which were difficult to foresee. Among these were the sharp increase in the prices of cereals due to the bad crops of 1972 and to the sustained increase in demand as a consequence of the growing income in wide areas of the world. Another factor was the sudden rise in the prices of raw materials,
particularly of minerals, as a consequence of the simultaneous expansion of demand in industrial countries and of their low supply elasticities. Moreover, inflationary pressures gave rise to speculative stockpiling which worsened the shortages apparent in international commodity markets. Given the reserve currency role of the US dollar, the growing current account and capital account deficits of the US provoked an unprecedented expansion in international liquidity which passed from $90 billion in 1970 to $260 billion by the end of 1977. Thus, growing liquidity seemed to remove all external payments constraints on the financial policies of other industrial countries creating a climate that favoured the adoption of expansionary monetary and fiscal policies by all. (See Table 1.) The devaluation of the dollar marked the end of the fixed exchange rate system established in Bretton Woods at the end of the Second World War giving rise to a new system of floating exchange rates which seemed to relax the financial discipline previously imposed by fixed exchange rates. Economic expansion in industrial countries accelerated in 1972 and 1973 to a point that made a slowdown in economic activity unavoidable. By the end of 1973, with the purpose of diminishing inflationary pressures, most industrial countries had introduced restrictive fiscal and monetary policies intended to lead to a reduction in economic activity. It was in these circumstances that the sharp increase in oil prices occurred, intensifying both the inflationary pressures and the recessionary trends present in the industrial economies. Initially, most industrial countries look favourably on the decline which took place. However, the cumulative impact of a simultaneous economic contraction was again underestimated. Industrial production in the OECD countries fell 13% below its 1973 levels and their GNP fell by 3.5% between the first semester of 1974 and the corre-
Table 1. International liquidity (Billions of SDR’s)
International reserves Gold SDR’s Reserve position in the Fund Foreign exchange Source: International
1960
1970
1971
1972
1973
1974
1975
1976
1977
61.2 -
93.2 37.0 3.1
123.2 36.0 5.9
146.8 35.6 8.7
152.6 35.6 8.8
180.2 35.6 8.9
194.3 35.5 8.8
222.1 35.4 8.7
260.0 35.5 8.1
3.6 18.5
7.7 45.4
6.4 75.1
6.3 96.2
6.2 101.7
8.8 126.9
12.6 137.4
17.7 160.3
18.1 198.3
Financial Statistics,
and Annual Report
(IMF, 1977).
127
PROSPECTS FOR DEVELOPMENT FINANCING
wide range of enterprises thus limiting the incentives and the financial resources available for investment. In 1975, the severe recession in industrial countries and the expansion of imports of OPEC countries allowed the former to substantially reduce their current account deficit; however, the recovery of 1976 widened their external deficit to $27 billion. In 1977, due to the restrictive financial policies adopted as well as to prevailing uncertainty and low levels of business investment, the industrial countries experienced a new decline in the growth of aggregate demand and their rate of growth fell from 5.3% in 1976 to 3.7%. This low rate of growth impeded a reduction in unemployment which at 5% remained at about the level prevailing in 1976 and the second half of 1975. The slowdown in demand in industrial countries, plus their exchange rate instability and growing protectionist trends, substantially limited the expansion of world trade to about 5% in 1977, a rate well below the 9% average of the previous decade and the 12% expansion achieved in 1976. In recent years a number of changes, many of them structural, have taken place in industrial countries, which limit their growth prospects
sponding period of 1975. These results point to the deepest and longest recession suffered by the industrial countries since the 1930s. The rise in the price of oil led to increases in transport costs, the price of manufactures, fertilizers, and more generally in the cost of living. These in turn gave rise to new wage demands as trade unions tried to maintain the real income of their members. The increase in oil prices signified a large transfer of real income from the oil importing industrial countries to OPEC countries, with the consequent contractionary impact on the income of the former. This contractionary effect was not immediately recognized by the governments of industrial countries which generally intensified their restrictive fiscal and monetary policies with the purpose of minimmizing the inflationary impact of the rise in oil prices and thus contributed to the worsening of the recession. The size of the transfer that took place may be illustrated by the worsening of the current account of the OECD countries which went from a surplus in 1973 to a deficit of $33 billion in 1974. (See Table 2.) Moreover, the increase in the price of oil made energy-intensive machinery and technology obsolete, diminished the productivity of capital and therefore reduced the profits of a
Table 2. Balance of payments on current account (In billions of US dollars) 1973 Industrial countries
9.8 -
Canada United States Japan France Germany Italy United Kingdom Belgium-Luxembourg Denmark Netherlands Austria Norway Sweden Switzerland Other developed countries Developing countries Major net exporters of oil Other developing countries Total*
1.6 0.1 -
0.4 6.8 1.2 1.3 1.6 0.7 2.2 0.3 0.3 1.4 0.4 1.1
6.5 -11.3 6.1
I974 - 13.0 - 1.6 0.4 - 4.5 5.5 12.5 - 6.9 - 7.5
1975 16.4 4.7 14.4 - 0.4
-
-
-
1.0 1.2 2.1
-
0.5
-
0.5 7.5 0.8 2.8 0.8 0.6 2.0 0.3 2.3 1.1 2.7 14.8
1.0 - 0.6 0.3 - 14.5
-
67.8 - 29.9 10.4
34.7 - 37.3 - 1.0
-
Sources: National statistical publications and IMF Data Fund. Reflects errors, omissions, and asymmetries in reported balance-f-payments
statistics.
1977
I976 -
2.4
-
-
4.3 1.7 3.9
- 4.0 - 17.4 11.2
-
5.3 7.1 1.8 0.6
-
0.3 2.2 2.5 1.5 4.1 1.9 3.7 14.3
-
-
40.8 - 25.6 - 1.5
-
7.5
1.8 7.6 3.4 1.9 0.1 1.9 0.3 2.8 5.0 2.7 3.7 13.6 34.9
- 22.1 - 8.3
128
WORLD DEVELOPMENT
in the short and medium term and suggest that these countries may tend towards a new equilibrium at lower rates of growth and higher rates of inflation and unemployment than in the previous decade. Outstanding among these changes are a marked decline in the rate of growth of productivity, a decline in profit rates, a slower growth of the labour force and a higher natural rate of unemployment, higher rates of inflation and exchange rate instability, a trend towards protectionism and a generalized loss of public confidence in the prospects for economic growth and in the ability of governments to combine low rates of unemployment with relative price stability. The growth of labour productivity in industrial economies has been adversely affected by a number of factors. Among these are the increased cost of energy, lower rates of investment, a greater concern for the environment, the deceleration of the process of international economic integration, a reduced rate of transfer of labour from low productivity activities to higher productivity industries and a lower rate of technical change due to reduced investment and due to the fact that industrial countries have largely modernized the major sectors of their economy. The new structural conditions prevailing in industrial countries make the achievement of satisfactory rates of growth more difficult than in the past. Even if the developed world were to emerge shortly from its current recession, the medium-term prospects for these countries are for a rate of growth well below that attained in the last decade. Consequently, the recovery of the industrial economies should not be counted upon to enable them to reach high rates of growth that would stimulate the vigorous expansion of international trade and of developing country exports, allowing the developing countries to sharply reduce their deficit on current account and their external financial requirements over the coming years.
2. DEVELOPING
COUNTRIES
Since industrial countries are the main market for the exports of developing countries their sustained growth appears to be a necessary condition for the growth of the exports of developing countries. Moreover, since flows of official development assistance have stagand only a few developing countries nated’ have substantial access to international capital markets or receive significant amounts of
private direct investment, the expansion of their exports may be regarded as a necessary condition for their growth on current development patterns. From 1961 to 1970, the income per capita of developing countries as a whole grew at an average annual rate of 3.2%. This growth, made possible by the expansion of industrial economies, allowed a number of developing countries to develop considerable industrial sectors and a few to produce intermediate and capital goods. In some cases, their industrial structure and their income levels approached those of the least advanced industrial countries.* In the period 1971-75 developing countries as a whole sustained annual rates of growth of 3%, which were substantially above those attained by the OECD countries over the same period.3 That is to say, the impact of the recession on the rate of growth of these countries was less than could be expected. However, the international recession and the rise in the inflationary pressures had a severe impact on their balance of payments. The current account deficit of non-oil developing countries rose from $9-11 billion in the first years of the decade to $30 billion in 1974 and $37 billion in 1975. (See Table 3.) In 1976 this deficit was reduced to $26 billion as a result of the recovery of activity in some industrial countries, the rise in the prices of commodities and the adjustment efforts undertaken by some of the larger developing countries. Since the current account deficit of non-oil developing countries was largely financed through external borrowing, their indebtedness grew sharply in recent years due to their effort to sustain positive rates of growth despite an unfavourable international economic situation which affected both the quantum of their exports and their terms of trade.4 (See Table 4.) In fact, their outstanding long-term external public debt, which had risen from $33 billion to $43 billion in the period 1967-70, virtually doubled in the years 1970-74 and by the end of 1977 stood at more than 4 times the level of only 10 years earlier. (See Table 5.) In view of the strong political, social and demographical pressures to which the governments of developing countries find themselves subject, it is understandable that for these governments a sustained reduction in the per capita income of their population for several years was generally more difficult to accept than for the governments of industrial countries.’ It can be said that the growth of external indebtedness was the price deveioping countries paid to sustain positive rates of growth. It must
PROSPECTS FOR DEVELOPMENT FINANCING
129
Table 3. Non-oil developing countries: current account financing, 1913-17 (In billions of US dollars)
Current account deficit* Financing through transactions that do not affect net debt positions Net unrequited transfers received by governments of non-oil developing countries Direct investment flows, net Net borrowing and use of reserve& Reduction of reserve assets (accumulation, -) Net external borrowing§ Long-term loans received by governments from official sources, net Other long-term borrowing from non-residents, net From private banks abroad11 Through suppliers’ credits11 Other sources7 Use of reserve-related credit facilities, net** Other short-term borrowing, net Residual errors and omissions
1973
1974
1975
1976
1977
11.3
22.9
37.3
25.6
22.1
8.2
10.6t
11.6
10.8
11.3
4.2 4.0
6.lt 4.5
6.4 5.2
5.9 4.9
6.5 4.8
3.1 - 8.3 11.4
19.3t - 2.8 22.1t
25.7 -0.9 26.6
14.8 -11.8 26.6
10.8 - 11.8 22.6
5.3 5.2 3.9 0.3 1.0 0.2 0.5 0.2
7.5t 7.5 5.7 0.5 1.3 1.4 4.3 1.5
10.2 9.8 7.7 0.8 1.2 3.3 5.2 - 1.9
12.9 9.5 10.6
13.0 7.9 9.4 1.2 - 3.2 0.5
- ::: 3.0 3.3 - 2.1
1.2
Source: IMF Balance of payments records and staff estimates. * Net total of balances on goods, services, and private transfers, as defined for Balance of Payments Yearbook purposes (with sign reversed). t Excludes the effect of a revision of the terms of the disposition of economic assistance loans made by the United States to India and repayable in rupees, and of rupees already acquired by the US Government in repayment of such loans. The revision has the effect of increasing government transfers by about US$2 billion with an offset in net official loans. $ i.e. financing through changes in net debt positions (net borrowing, less net accumulations - or plus net liquidation - of official reserve assets). 0 Includes any net use of non-reserve claims on non-residents, errors and omissions in reported balance-ofpayments statements for individual countries, and minor deficiencies in coverage. 11Public and publicly guaranteed borrowing only. B Including errors and residuals which arise from the mismatching of data taken from creditor and debtor records. ** Comprises use of Fund credit and short-term borrowing by monetary authorities from others.
Table 4. Non-oil developing countries: merchandise trade, 1967-77 (Percentage changes)
Value in US dollars Exports Imports Volume Exports Imports Unit value in US doIlars Exports Imports Terms of trade Source: IMF.
Average 19671 1972
1973
1974
1975
1976
1977
11.9 11.4
47.1 40.6
44.4 62.3
- 1.9 3.6
22.4 7.0
18.9 14.0
9.0 4.1
7.8 23.7
5.2 8.7
1.2 -6.7
13.5 4.1
6.7 4.9
2.7 4.1 - 1.3
36.4 23.7 10.3
37.3 49.3 -8.0
- 3.1 11.0 - 12.7
7.8 2.7 5.0
11.5 8.7 2.6
130
WORLD DEVELOPMENT Table 5. Non-oil developing countries: public and publicly guaranteed long-term ext?mal debt outstanding. year-ends 1973-77 (In billion of US dollars) 1974
1975
1976
1977
66
82
99
122
146
43
51 14 37 31 16 8 4 2
59 17 42 40 24 9 4 3
69 20 49 53 33 10 5 4
81 24 58 65 43 11 6 5
1973 Total outstanding*
Total from official sources International institutions Governments Total from private sources Private banks Suppliers’ credits Bond issues Other Reference
:: 24 11 7 4 2
items:
Value of annual debt service paymentst(in billion of US$) Interest payments Amortizations Ratio of annual debt service payments to annual exports of goods and services (in %) Of which: Ratio of annual interest payments (in %) Ratio of annual amortizations (in %) Ratio of year-end outstanding external public debt to annual exports of goods and services (in %)
8.5 2.6 5.9
9.5 3.3 6.2
11.3 4.4 6.9
13.4 5.2 8.2
18.4 6.6 11.8
10.9
8.5
10.1
10.0
11.5
3.3
3.3
3.9
3.9
4.1
7.6
5.6
6.1
6.1
7.4
85.0
73.1
88.3
90.6
91.2
Sources: World Bank Debtor Reporting System and IMF staff estimates. Year-to-year changes in public debt outstanding do not necessarily correspond with annual net disbursements because of the effects of cancellations, nationalizations, and exchange rate and other adjustments. ? Interest charges and repayment of principal.
also be admitted that in so doing they made an important contribution to the moderationofthe severity of the recession of industrial countries and to the alleviation of their external disequilibria. In a sense, the growth of the external debt of these countries could be taken as a measure of their contribution to the sustenance of world economic activity.
3.
PROSPECTS FOR DEVELOPMENT FINANCING
The stagnation of exports and of official assistance flows led to the concentration of the indebtedness of developing countries in international capital markets, and to a growing reliance on credits from international banks. The share of other creditors, both governments and multilateral financial institutions diminished in relative terms from some two-thirds in the
period 1967-70 to about onequarter of the total by 1977. Since commercial bank loans are characterized by higher rates of interest and shorter maturities than credits provided by official sources of development finance, this trend has given rise to a more than proportional increase in the debt service payments of developing countries. Such an increase has provoked doubts regarding the credit-worthiness of this group of countries and of certain borrowers among them and has led a number of observers to conclude that in the future, external credits to these countries should not be allowed to grow at a rate similar to that of the last few years. However, at present there are strong pressures on the part of industrial countries toward the redistribution of official assistance flows in favour of health, housing, education and other socially oriented projects in the least developed countries. This suggests that middle income
PROSPECTS FOR DEVELOPMENT FINANCING developing countries may be forced toward greater reliance on the market and therefore that a hardening of the terms on which finance is made available to them is to be expected. The prospect that middle income developing countries must increasingly depend on the expansion of private capital flows, mainly bank credits, gives cause for concern. The continued availability of these private flows may be questioned. On the one hand, a continued disposition of private banks to increase their finance to those countries must be assumed in spite of the doubling of their external debt in the period 1970-75 and of a projected further doubling of their debt in the period 1975-80. In addition, one must assume that the new regulatory activities of the monetary authorities of industrial countries will not limit the expansion of external lending operations to these countries. On the assumption, in a sense optimistic, that the expansion of banking credit to developing countries will continue to grow in adequate amounts, the World Bank estimates that their debt service will absorb 60% of all the new flows of finance received by these countries by 1980. Obviously, this average of 60% includes countries with much higher ratios - a fact that may make it extremely difficult for them to obtain new credits and could have serious consequences for their external payment capacity and for the stability of international capital markets. 4. NEED FOR NEW MECHANISMS OF DEVELOPMENT FINANCING The above analysis suggests that while existing financing arrangements were adequate to allow developing countries to moderate the effects of the 1974-75 recession on their rates of growth, they do not constitute a viable response to the problem of development financing which the world economy now faces. The medium-term financing of commercial banks and capital markets gives rise to a liquidity problem in the medium term for countries that depend heavily on it, even if the financing is used for sound investment projects. It appears unlikely that industrial countries may, in the near future, achieve the high rates of growth required to generate a strong and sustained expansion of international trade that would reduce the external borrowing requirements of developing countries. On the other hand,it is also apparent that developing countries must remain important capital importers so as
131
not to seriously limit their growth prospects. The gravity of the problems that the stagnation of the developing countries would pose for the international community makes it necessary to find adequate solutions to the problem of external financing. The current situation in industrial countries of high rates of unemployment, low utilization of existing productive capacity (particularly in the capital goods industries), and abundant liquidity in their financial markets suggests that the solution of the problem of development financing may also contribute to the solution of the problems of the developed countries, underscoring the growing interdependence among them. Therefore, what is required is an improved ‘technology’ of financing that will allow a lengthening of maturities and an increase in capital flows from industrial and oil surplus countries to finance investment in developing countries. This would not only permit developing countries to sustain higher rates of growth, but would also generate demand for capital goods stimulating economic activity in industrial countries. There are several ways in which this might be achieved. A few of them are presented below: (i) An increase in official assistance flows from industrial countries, as well as an increase in long-term export credits granted those countries with government guarantee. The existence of excess capacity and unemployment in industrial countries indicates that the marginal social cost of these measures would be very low while their benefits, including those to the donor country, would be substantial. (ii) An increase in the capital of international development financial institutions such as the IBRD and the regional banks to allow them to play a much greater role in meeting the financial requirements of developing countries. Should substantial increases in the capital resources of these institutions not be achieved, their financial capacity could also be enlarged by means of supplementing their resources with long-term loans from surplus countries, both industrial and oil-exporting, as in the case of the ‘Supplementary Financing Facility’ of the IMF. This was the thrust of Mexico’s proposal to the Joint IMF-IBRD Development Committee in its April 1978 meeting. In essence the Mexican proposal consists of the creation of a fund, tentatively set at $15 billion, that would operate on commercial lines obtaining long-term credits in surplus countries and in international markets.6 This fund would grant 15-year financing for investment projects
132
WORLDDEVELOPMENT
and the acquisition of capital goods in both industrial and developing countries. For developing countries, this financing would permit the achievement of a higher rate of investment and growth as well as the improvement in their debt profile and therefore of their creditworthiness. For industrial countries, it would mean higher levels of economic activity and employment particularly in the capital goods industries, as well as greater levels of exports, thus making it easier for them to resist the protectionist trends apparent in the world economy. This would also contribute to improving the prospects for the medium-term growth and stability of the international capital markets. This approach recognizes that it is not a sound banking principle to finance long-term capital investments with short-term money and instead seeks to provide long-term financing. Thus, rather than the restrictive approach to the problem of development financing taken by several bank regulatory agencies of developed the proposal suggests a positive countries, approach which would benefit all parties concerned. In making this proposal the Mexican government was keenly aware of the inadequacy of the capital resources of the World Bank and of other regional development finance institutions and of the enormous difficulties they face in increasing their capital resources to a level that will allow them to sustain an adequate expansion of their lending programmes. The proposal seeks to circumvent the major difficulty international institutions face, i.e. the reluctance of developed countries to raise their capital contributions through outright grants. This is done by creating an attractive investment outlet for both institutional investors and industrial and surplus country governments. Since contributions to the fund would be loans at market rates of interest they would not have to be funded as grants by parliaments. The Mexican proposal also considers the possibility that some industrial countries may contribute to the enlargement of the financial capacity of multilateral development institutions through the granting of guarantees for up to specified sums on the credits granted by the market to these institutions. The proposed fund could be administered by the World Bank or some other international institution in order to avail itself of existing infrastructure for project appraisal and credit administration. (iii) Stimulate the development of a market for long-term bonds issued by developing countries. In order to be attractive to the market, these bonds could be dominated in
SDRs or a basket of currencies and have floating rates to adjust for inflation.’ Industrial countries, particularly those which face difficulties in increasing their official development assistance and their contributions to the capital of development financial institutions, could stimulate the placement of developing country bonds in their markets through the tax exemption of revenues arising from investments in such bonds. Such exemptions, whether partial or total, would make these bonds attractive since they would have the effect of increasing the return for investors without increasing the cost of financing for the debtors. It may be recalled that municipal bonds in the United States enjoy a fiscal treatment such as the one proposed here, and that the ‘Colonial Stock Act’ of 1900 granted such treatment to the bonds issued in the United Kingdom by the Commonwealth countries. This latter mechanism allowed capital flows to what were then developing countries in amounts equivalent to several percentage points of the UK’s GNP. Placing bonds with institutional investors of industrial countries beyond a certain proportion of their capital would, in some cases, require changes in existing regulations that limit their holdings of securities issued by non-residents. However, the effort to change these regulations should be made in order to open up an important new source of funds.s At present the huge institutional market has hardly been tapped by developing countries. In addition, efforts would also be required to develop a secondary market that would give liquidity to the bonds issued by developing countries. (iv) Increase flows of foreign investment to developing countries. Industrial countries have shown marked interest in increasing their investment, particularly in mining, energy and such commodities as may be in short supply in the mediumand long-term. However, creditor countries ask for a ‘favourable climate’ for foreign investments which includes, as essential elements, the establishment of investment protection agreements, recourse to international arbitration in the event of a dispute and ‘full, just and prompt compensation’ in the event of nationalization or expropriation. To be acceptable to developing countries, direct foreign investment must fully submit to the laws and jurisdiction of the host country and contribute to its overall development within the framework of its economic and social policies. It would seem that in many cases the expansion of direct foreign investment will not. take place until a code of conduct for transnational corporations is developed which is acceptable
PROSPECTS FOR DEVELOPMENT FINANCING to both sides. The serious political and philosophical differences behind the positions of the two groups of countriessuggest that the solution to this problem may take some time.
5. CONCLUSIONS In recent years, the world economy has experienced lower rates of growth, higher rates of unemployment and marked instability of prices and exchange rates. To a considerable extent these phenomena reflect structural changes; therefore its unlikely that the high rates of growth and relative stability of the 1960s may be reached in the coming years. Despite adverse developments in the .world economy managed industrial achieved and of a Most of national interest
in the 197Os, developing countries to sustain higher rates of growth than countries. However, these rates were at the cost of large externalimbalances dramatic increase in their external debt. this debt was contracted with intercommercial banks at higher rates of and at shorter maturities than tra-
133
ditional credits for development financing. As a result, debt service payments have grown very rapidly giving rise to questions regarding the credit-worthiness of a number of countries. By now it has become apparent that developing countries should not continue to depend on commercial bank loans to the same large extent as in the recent past. However, the prospects of low rates of growth in developed countries make it necessary for developing countries to continue as substantial capital importers if their growth is not to be seriously impaired. The current situation of high rates of unemployment, low utilization of existing productive capacity and abundant liquidity in the developed countries suggests that greater capital flows towards developing countries can not only contribute to the growth of these countries but also play an important role in the solution of the problems of the developed economies. Therefore, new mechanisms to increase capital flows to developing countries on terms and maturities suitable for development financing are required.
NOTES
1. As a proportion of GNP of OECD countries, official assistance to developing countries declined from 0.35% in 1975 to 0.33% in 1976 and to 0.31% in 1977. 2. However, a number of important differences in the rates of growth of different groups of developing countries were observed. While countries In SubSaharan Africa and South-east Asia achieved growth rates of 1.5% and 1.6% respectively, countries in Latin America reached growth rates of 2.5% and those of the Middle Fast grew at a rate of 4.4% per annum. 3. The rate of growth of GNP of OECD countries was -0.1% in 1974, 1.4% in 1975 (excluding Greece, PortugaI, Spain and Turkey); therefore their per cupit income at the end of 1975 felI below 1973 levels. For the period 1971-75 OECD countries grew at an average annual rate of 2.3%. 4. Some developing countries utibzed part of their external borrowing to accumulate international reserves to ensure their ability to sustain an adequate level of imports and an adequate rate of growth in the future.
5. Since population pressures are clearly smaIIer in developed countries and their population enjoys living standards which generally cover the basic needs of food, health and shelter. 6. While it was realized that a larger figure might be required in order to alIow this fund to have a sub stantial impact on the level of international economic activity, it was felt that a much larger initial fwre would make the establishment of this fund more difticult .
7. Tbe same could apply to loans to the special fund for long-term development financing proposed for Mexico. 8. In the course of the discussion on access to capital markets at the CIEC (North-South Dialogue) the representatives of a major developed country indicated their wiRingtress to assist efforts to remove or greatly liberalize such regulations as and when required by developing countries.