Global changes, domestic policies and the debt crisis.

Transcription

1 Global changes, domestic policies and the debt crisis. Master of Economics Thesis by Sven Tengstam Thesis Advisor: Anders Danielson 1

2 Abstract This thesis reports on an attempt to develop an extended model for quantification of the relative contribution of global conditions (global export changes, interest rate changes and changes in aid) and domestic policies (the export performance and macro policy impact) to the deterioration of individual countries debt / exports ratio. For 18 middle income, heavily indebted countries results for the period are provided. By adding two extra factors compared to an earlier study, largely different results are obtained for at least five countries. Global export changes are still the outstanding most important factor. The assumption that interest rates and growth of exports will be constant is a very vulnerable basis for a country s export and macro economic policies. There is no doubt that taking more factors into account gives more understanding of the causes of, and response to, the debt crisis, even though these estimates are very sensitive to changes in the model and the way to measure. Understanding and quantification of this is important when trying to asses the needed shifts in domestic policy. Contents Abstract Contents A list of variables 1 Introduction 1.1 Background to the situation 1.2 Aim 2 Presentation of Krueger s analysis 2.1 Introduction 2.2 The Simonsen-Krueger model 2.3 Krueger s results 2.4 Krueger s implications 3 An extended model. 3.1 Introduction 3.2 The model 3.3 The results 3.4 Comments 4 Conclusions 5 Notes 6 References

3 A list of variables All rates of growth are per year. a the share of the country s exports which constitute fuel a the fall in aid as percent of D* Definition: a = - (A - A 0 ) / D* A aid defined as unrequited official transfers: credit. In particular in present time, i. e A 0 aid in the nearest past, i. e D* the stock of foreign debt d the rate of growth of D* the change of a variable during one year g the export performance. The impact of the export performance on the rate of unsustainable borrowing. Definition g = w - x G the resource gap (G > 0) or surplus (G < 0), here defined as the noninterest current account external deficit, minus aid, minus direct investment into the country, plus gross capital exports from the country. m two names: Unsustainable macro economic policy and Macro policy impact. The impact of the macro economic policy on the rate of unsustainable borrowing. Definition: m = u - g - w in Krueger s model. m = u - g - w - r - a in the extended model. r the interest rate on average on outstanding external debt. In particular in the present time, i. e r the rise in interest rates Definition: r = r - r 0 r 0 r in the nearest past, i. e u two names the rate of unsustainable borrowing and net. The rate of growth of (D* / X). Estimated by the approximation: u = d - x w the county s share weighted rate of growth of exports. In particular in the present time, i. e Definition: w = aw f + (1 - a)w n w f the rate of growth of world exports of fuel w n the rate of growth of world exports of non-fuel w two names: global changes and global export changes. The changes in the share weighted export growth from the period to the period Definition: w = w 0 - w w 0 w in the nearest past, i. e X Exports of goods and non factor services x the rate of growth of X 3

4 1 Introduction 1.1 Background to the situation Ever since Mexico in August 1982 announced that it would not be able to pay its interest and amortizations the debt crisis has been an important and urgent topic. One main issue has been: What went wrong in the 70s and early 1980s? The oil price increases of contributed to the fast expansion of the Eurodollar market. The earnings of the oil exporting countries increased, and they deposited these earnings in the international banks operating in Europe. These banks in turn lent to borrowers in the developing world. Consequently, many governments that had previously been unable to loan on the international markets suddenly met banks eager to lend. At this point it seemed reasonable to both borrowers, the banks and economists that the developing world was financing large resource gaps by taking new loans. Since a less developed economy is supposed to have more investment opportunities and higher marginal productivity, the flow of capital into the developing world in the 1970s was in line with the dominant economic theory. At this time the interest rates were very low. Furthermore the exports of these countries were growing fast. These export earnings were of course the money by which the debt was to be served. During the 1970s, when debtor countries were expanding their exports far more rapidly than the interest rates, resource gaps were considered a natural element in the balance of payments of the non-oilexporting developing countries. (Simonsen, 1985:104) As long as the growth rate of exports of debtor countries exceeded international interest rates it was no problem to borrow new money to pay interests and amortization payments. This could be done without the debt stock / exports ratio growing. Actually, real interest rates were negative in most countries in the 1970s, so even with real exports being constant the situation would have been acceptable (Krueger, 1987:180). However, in 1979 and 1980 the international economic environment changed dramatically. The second oil price shock 1979 raised the import costs for the oil importing countries. The antiinflation policy adopted by the U. S., the U. K. and other countries involved higher interest rates. The world rescission slowed down the growth of world export markets. Raw materials prices fell. Therefore, what had seemed to be a sustainable path, over a few years turned into a crisis. It became harder to raise new borrowings and in 1982 one country after the other, starting with Mexico, announced that they were not able to service their debt according to schedule. The fact that so many countries were hit simultaneously suggests that international factors were important. On the other hand not all countries were hit. Latin America fell into a deep crisis, but South Asia did not. Consequently internal factors must also have been important. In the debate we can distinguish two main attitudes to the crisis. One view is that the borrowing was sustainable all the way; what occurred in the 1980s were only liquidity problems, not solvency problems. If this is correct, it is just a question of rescheduling the debt service. The other view is that there is a debt over hang, i. e. a part of the debt will not be serviced with less than superhuman suffering of the debtor countries, if even then. In some cases it is obviously so. For example Mozambique s foreign debt is 3.5 times its GNP (World Bank, 1995). And no matter whether a country has a debt overhang or not, one can argue that the heavy indebtedness is not a temporary situation. In many countries the debt situation no doubt causes large human suffering, so we can say that something went wrong. This thesis connects to that view. So, what went wrong? 4

5 One possible factor is domestic policies. One important question, which was not given enough attention in the 1970s, is: how was the capital distributed within each country? The money did not always go to investments. Much money were used to consumption and capital flight. Dornbusch and Fischer (1986:837) assert: A large part of Latin American borrowing was wasteful or unjustified in that it primary financed consumption and government budget deficits rather than investment. A significant part of the increase in external debt has its counterpart capital flight by resident of those countries In other countries part of the debt accumulation financed import binges as, for example, in Chile or Israel. In only a few instances, notably Brazil, was the buildup of external debt the counterpart of an expansion in productive capacity. Both the governments of the debtor countries and the lenders can be blamed for this. Many banks did not make sure that the money was used in a way ensuring that the debtor country would be able to service its debt. The next aspect of domestic policies is how the debtor countries responded to the world recession of To what extent did they undertake policy reforms designed to rectify the situation? Did they use their trade policies to support adequate growth of export earnings to sustain additional debt, and did they use macro economic policies supporting an appropriate resource gap? Other economists focus on the changes in the world economic environment in the early 1980s. Higher interest rates, higher import costs for oil importers, the reduced growth of export markets and the fall of raw materials prices. One might say that these external factors were the crucial ones. One central question is how to measure the different factors contribution to the debt crisis. Edwards and Larrain (1989), for example, approximate the impact of the higher interest rates and the worsened terms of trade. They compute the relevant real interest rate faced by the Latin American countries as the nominal London Inter Bank Offer Rate (LIBOR) deflated by the rate of change of an index of the region s export prices. They find that this real interest rate was negative during most of the 1970s, but 19.9 percent 1981, 27.5 percent 1982 and 17.4 percent in 1983 (Edwards and Larrain, 1989:4). One important question is: what do we exactly mean by the term debt crisis? Krueger (1987) has chosen to look at the debt / export ratio, and tries to estimate how much various factors contributed to the growing of this ratio. This thesis also uses this ratio as a measure of the debt situation. 1.2 Aim This thesis has three aims. Firstly, to, based on Krueger (1987), develop a model, which successfully estimates the relative importance of various factors which contributed to the rise of the debt crisis in the early 1980s. The factors considered are global export changes, the rise in interest rates, the fall in aid, the impact of macro economic policy and the impact of the export performance. Secondly, to present results, based on the model, for the group of heavily indebted middle income countries that Krueger used. Third to compare the new results with those Krueger got, and to discuss the differences. 5

6 2 Presentation of Krueger s analysis 2.1 Introduction Section 2 is a presentation of the analysis that is the starting-point for this thesis. It was first presented in Krueger (1987). Krueger s paper is an attempt to quantify the relative contribution of global and domestic policies to the origins of individual countries debt difficulties. The paper provides some preliminary results. Krueger identifies three sets of factors, first the unsustainability of the debt build up in the 70s. Second the unexpected changes in worldwide conditions, and third the developing counties unwillingness or inability to adjust to the harder economic realities of the 1980s. To evaluate the first set Krueger analyzes what happened in the 70s, to see if the unsustainable situation developed as early as then. This is not the part that is the topic for this thesis, so we leave it there. To simplify the discussion, she assumes that a current account deficit is entirely debt-financed and ignores capital flight. She then attempts a quantitative assessment of the extent to which: (i) the downturn in the early 1980s resulted in an altered world economic environment which enhanced the debt burden, and (ii) individual countries undertook policy reforms designed to rectify the situation , either in form of their trade policies supporting adequate growth of export earnings to sustain additional debt, or in form of macro economic policies supporting a appropriate resource gap. 2.2 The Simonsen-Krueger model To do this assessment a model is used. It is an extension of Simonsen (1985: ). The rate of growth of foreign debt stock is denoted d, the rate of growth of exports of goods and nonfactor services x. The rate of growth of the ratio (debt / exports of goods and non-factor services) is denoted u. This is over a period of time of one year. For example d being (24.5 percent) for Argentina on average means that the foreign debt stock rose 24.5 percent per year on average during the period. So u = (d - x) / (1 + x), which for small x can be approximated as d - x. This approximation is used: (2.1) u = d - x u is called the rate of unsustainable borrowing. Why is the rate of growth of exports at the level it is? Would we expect it to be higher or maybe lower, because of the growth of world exports, taking the growth of exports of different commodity groups into account? Let us now use a simple model with only two commodity groups. It is, as Krueger (1987:174) notes, tempting to further disaggregate world exports However, insofar as countries do have large shares of world market in commodities whose prices and/or volumes of world trade are relative laggards, an appropriate policy response would in any event be to alter incentives to induce other exports. The country s share-weighted growth of world exports, w, is defined as (2.2) w = aw f + (1 - a)w n where w f is the rate of growth of world exports of fuel, and w n is the rate of growth of world exports of non-fuel. The share of the country s exports which constitute fuel is denoted by a, and the share of non-fuel exports is one minus a. We now define g, the export performance, as (2.3) g = w - x 6

7 making g the difference in the rate of growth of the country s export from that rate which had been present if the country had maintained its shares of worldwide trade. g > 0 reflects a failure in export performance relative the rest of the world. We can now divide the rate of growth of exports, x, into two parts: (2.4) x = w - g. Then we want to estimate the extent to which the international environment was a cause for the debt build-up in the early 1980s. The first step is to estimate the magnitude of the impact the shift in that environment had on individual countries. (We from hereon formalize Krueger s reasoning). Therefore we estimate the difference between the share-weighted growth of world trade over the period, and the same growth over the period, we denote this historical growth w 0. The difference, which Krueger calls global changes, is interpreted as the shift, except for interest rates. I call it global export changes and denote it w. I think that name is more descriptive. Therefore (2.5) w = w 0 - w We can now divide the rate of growth of exports, x, into three parts. First the share-weighted export growth the previous period, w 0. Second global export changes, w. Third export performance, g. (2.6) x = w 0 - w - g When we have data for individual countries on (i) growth rates of export earnings, x, (ii) deviations of those growth rates from share-weighted growth rates of world trade, g, (iii) deviations of the share-weighted growth rates of world trade from the share-weighted growth rates of world trade the previous period, which I call w, and (iv) growth rates of debt, d, we can estimate the unsustainable borrowing, u. Then the unsustainable borrowing is apportioned between three factors: g, w and what Krueger (1987:173) calls unsustainable macro economic policy. Following Danielson and Mjema (1997:8), I call it the macro policy impact because I find this name a bit more clear and distinct. I denote it m. This can be express as: (2.7) u = g + w + m and consequently (2.8) m = u - g - w m is consequently formally a residual. The idea is that a country should have a macro economic policy leading to a resource gap matching with expected/planned growth rate of exports. Krueger (1987: 175) writes given the rate of growth of exports [and thereby the deviation of this from the expected/planned rate of growth of exports], it can be argued that the remaining excess of debt growth reflected macro economic policy not compatible with the given trade policy stance. The words in brackets are mine. Krueger uses the share-weighted growth rates of exports , w 0 as expected/planned growth rates of exports (see equation 2.5.). 2.3 Krueger s results Krueger chose 19 middle income, heavily indebted countries to analyze. The reason for choosing these countries were largely the availability of data. These countries had 55 percent of the total 7

8 debt outstanding 1982 (Krueger 1987:173). In principle the same sort of estimates can be done for low-income countries. Krueger obtained data for the rate of growth of exports, debt, and share weighted rate of growth of exports for the 19 countries. Based on this the rate of unsustainable borrowing and the export performance are estimated. We get the global export changes by estimating the difference between the share-weighted growth of world trade over the period, and the same growth over the period. These estimates are presented in table 2.1. Table 2.1 World growth rates of exports (average annual percentage change), and Country Changes Argentina Bolivia Brazil Chile Colombia Costa Rica Côte d'ivoire Ecuador Jamaica Korea Mexico Morocco Nigeria Peru Philippines Turkey Uruguay Venezuela Yugoslavia Source: Krueger 1987:181. Table 2.1 shows the rates of growth of exports for the two different periods that would have been if the countries had maintained their weighted shares of world trade. These rates were on the basis of the countries shares of fuel and non-fuel exports in world markets. Krueger (1987:176) verifies that the choice of period was a bit arbitrary, but it was desirable that it be representative of the post-1973 situation, and not include 1979 (because of the oil price increase of that year). Use of averages would not alter the results. The drop was sharp for all countries. The higher shares of oil in their exports, the more rapid were the decrease in share weighted rate of growth of exports. Venezuela and Nigeria had the largest decreases, from 27.8 percent and 27.7 percent respectively to 0.6 percent. But even for oil importers the drop was large, for Argentina and other oil importers it was 16.6 percent! Table 2.2 presents all these data and estimates and factors. The first column is the share-weighted growth of world exports. The average annual rates of growth of exports and debt from 1979 to 1982 are presented in the second and third column. Then comes global export changes (derived from table 2.1). Then export performance, and macro policy impact. The last two columns are u, i. e. unsustainable borrowing (Krueger also calls u net ), and debt / exports ratio in D* denotes total foreign debt stock. X denotes exports of goods and non-factor services. 8

9 Table 2.2 Debt build-up, (average annual percentage change) w x d w' g m u D*/X 1982 Argentina Bolivia Brazil Chile Colombia Costa Rica Côte d'ivoire Ecuador Jamaica Korea Mexico Morocco Nigeria Peru Philippines Turkey Uruguay Venezuela Yugoslavia Source: Krueger 1987:182 Five countries stand out: Brazil, Korea, Mexico, Turkey and Yugoslavia. They all managed to not let debt grow essential faster than export during the recession. Brazil, Turkey and Yugoslavia had unsustainable policies and high debt in the 70s. These three countries undertook significant policy reform packages before In all three countries export performance together with macro policy impact almost offset the adverse shift in world conditions. Finally table 2.3 summarizes the situations for the different countries. We distinguish four categories of economic performance with respect to debt. First those countries that were able to more than offset the entire shift in world conditions, that is - (g + m) > w, then those countries that offset more than half, those with some offset, and those with negative offset, that is the unsustainable borrowing was larger than the downward shift in the world economy. We also distinguish three categories of initial situations depending on debt developments Those with high debt are those countries that 1979 had a debt / exports ratio greater than 2. Slack in debt means the ratio of 2 or less. To have a sustainable policy is to have no unsustainable borrowing. 9

10 Table 2.3 Initial country situation, and responses to the shift in worldwide conditions through Economic performance Initial Offset Offset Some Negative situation entire shift more than half offset offset Slack in debt Sustainable Korea Philippines Nigeria policies Uruguay Argentina Chile Colombia Unsustainable Venezuela Ecuador Costa Rica policies Côte d'ivoire Jamaica High debt Mexico Brazil Bolivia Turkey Morocco Yugoslavia Peru Source: Krueger (1987:183) Looking at table 2.3 we see that of the twelve countries with some offset, seven had had high levels of debt in Three (Mexico, Ecuador and Venezuela) were oil exporters that had relatively high rates of export growth. On the other hand, of the seven countries with negative offset none had high debt 1979; all had slack in debt. 2.4 Krueger s implications We can say that the countries in the first three columns of table 2.3 made efforts to adjust to the altered international economic environment. Of those countries that did not make efforts to adjust three countries - Costa Rica, Côte d Ivoire and Jamaica - had had unsustainable policies in the 1970s. But none of the countries in the final column had entered the 1980s with unsustainable debt/exports ratios (they all had this ratio less than 2). Probably they could not have had as high rate of growth of debt as they had, if they had not had slack in debt. At the end of 1982 the average interest rate paid on outstanding debt of these countries were almost double what it had been in the mid-1970s. Thus a sustainable debt-service / exports ratio would have required the debt / exports ratio to decrease to about half of the level we have called sustainable here, that is approximately 1. But in most countries the debt / export ratio had risen sharply, with only the five rapid adjusters (Yugoslavia, Turkey, Mexico, Korea and Brazil) experiencing limited increases. In that sense, it is small wonder that there was a debt crisis, as only those with excellent policy response and low initial levels of debt were able to maintain debtservicing on normal terms. Of the countries covered here, only Colombia and Korea entirely avoided rescheduling; Turkey did not reschedule any debt after Argentina, the Ivory Coast, the Philippines, and Venezuela did not complete any rescheduling before 1984; every other county rescheduled at least some debt by (Krueger 1987:184) 10

11 3 An extended model. 3.1 Introduction It is important to develop some sort of metric by which to gauge the necessary magnitude of reform efforts across countries. Krueger (1987:185) points out that additional steps need to be taken. A more satisfactory treatment of changes in interest rates and a better measure of the impact of macro economic policy are two example of this. I agree with Krueger and think that it would be desirable to extend the Simonsen-Krueger model by trying to identify more factors contributing to the unsustainable borrowing. This thesis uses the debt stock / exports ratio as a measure of the debt situation. One could argue that the debt service / exports ratio is more relevant. It was the debt service being to large that caused the acute crisis. The debt stock / exports ratio is however a better measure of the debt situation in a longer perspective. Therefore this thesis uses the debt stock / exports ratio following Krueger (1987). There are many candidates to be an additional factor in an extended model for estimation of factors contribution. We will extend it with two more factors: interest rate changes and changes in aid. Aid is obviously relevant because it direct influence the unsustainable debt build up. The more aid a country gets, the less must it borrow, and the less does the debt stock grow. Table 3.1 shows the average aid the countries received It also shows this average as percent of debt stock. Table 3.1 Aid average aid average aid in million USD as % of debt stock Argentina Bolivia Brazil Chile Colombia Costa Rica Côte d'ivoire Ecuador Jamaica Korea Mexico Morocco Nigeria Peru Philippines Turkey Uruguay Venezuela Source: Unrequited official transfers, credit, and exchange rate from IMF (1986). Debt from World Bank (1996). 11

12 Two countries did not get any aid at all, Argentina and Venezuela. Average aid were 1 percent and the four countries that got more aid than 1.5 percent of the debt stock are Côte d Ivoire, 3.6 percent, Jamaica, 2.7 percent, Morocco, 1.9 percent and Philippines 1.9 percent. This means that if Jamaica had not got any aid its debt stock, and thereby the debt / exports ratio too, had grown 2.7 percent more per year than it actually did. Interest rates also direct influence the debt build up. When interest rates raise the countries must borrow more money if they not are able to adjust to the new situation extremely fast. Table 3.2 shows estimates for average interest rates paid on outstanding debt for two different periods, and , and the difference. Table 3.2 Interest rates, , and the difference. Country difference all in percent Argentina Bolivia Brazil Chile Colombia Costa Rica Côte d'ivoire Ecuador Jamaica Korea Mexico Morocco Nigeria Peru Philippines Turkey Uruguay Venezuela Yugoslavia Source: World Bank (1996) Interest rates did actually grow in all nineteen countries and were a large change in many cases. The maximum change were 7.7 percent (Chile 5.1 to 12.8). The factor macro policy impact, m, is vague and is some kind of residual. By taking interest rates and aid into account m starts reflecting a real quantity to a larger extent. At least two more factors could maybe be relevant, capital flight and inflation 2 (or changes in export unit prices). It is no doubt that capital flight is an important factor. Edwards and Larrain (1989:6) found that in Argentina, Mexico and Venezuela capital flight explains over 60 percent of the increase in their external indebtedness In Venezuela the number actually was percent! These estimates is based on the unexplained portions of the balance of payments. Krueger (1987:186) found that also Bolivia and Uruguay had a substantial capital flight. Over the period she got a capital flight / GNP ratio of 4.6 percent for Bolivia and 5.7 percent for Uruguay. Her estimates were based on the sum of short term capital and errors and 12

13 omissions. These figures must however be seen as very approximate. It is difficult to estimate capital flight. Kahn and Ul Haque (1985) discusse these difficulties and reports on some different ways to measure capital flight that gives very different results. However it would be fair to conclude that gross private capital outflows, with one or two exceptions, were significant for the major debtor countries during the past decade. (Kahn and Ul Haque, 1985:613) Inflation is interesting in this case, because it affects changes in the price level of export products. The question of how world exports could grow at an average annual rate of 20.1 percent during the decade is of course largely answered by the inflation (Krueger 1987:169) percent is the nominal value, but not the real value. Surprisingly I found that inflation (measured as US Consumer Price Index) actually was higher than It was average annually 10.0 percent and 7.2 percent (World Bank, 1995). But if we instead measure the annual change in export prices we get another result. In the early 1980s the economic situation changed dramatically. The world recession made raw materials price fall. Thus, the export earnings of the developing countries stopped growing rapidly and in some cases even started to decline. Higher interest rates and falling export prices in combination meant that debtor countries started to pay very high real interest rates on their foreign debt. Here real interest rate is based on inflation measured by the annual change in export prices. Table 3.3 shows an evaluation of interest rates and export prices for Latin American borrowers. Table 3.3 Interest rates and rate of change in export unit prices in Latin America (%) Year Nominal LIBOR Rate of change in Real LIBOR export unit prices Source: Sachs and Larrain 1993:698 Sachs and Larrain found that real interest rates were negative almost the whole period , with an average of 4.7 percent. But then changed dramatically and had an average of 21.6 percent We can split growth of exports into three parts. First we have the increase of the export volume (more kilograms coffee are sold, for example), then we have the increase of export unit values (coffee prices rise, for example), which can be split into inflation and the increase of real export unit values. The average annual rate of increase of export unit values were

14 percent for the world as a whole, and fell at an average annual rate of 3.3 percent , so it is no doubt that changes in export unit prices is an important factor to the debt build up (Krueger, 1987:169). I do not use capital flight and inflation (and changes in real export unit values) as additional factors. These factors are quite complex and I have to restrict myself and this paper. However, it would be interesting to make a more extensive study which included capital flight and inflation. 3.2 The model We ignore capital flight just as Krueger does. Following Krueger we denote the rate of growth of debt d, the rate of growth of exports of goods and non-factor services x. The rate of growth of (debt / exports of goods and non-factor services) is u. So u = (d - x) / (1 + x) which for small x can be approximated as d - x. Krueger uses this approximation, as do I. (3.1) u = d - x Following Krueger u is called the rate of unsustainable borrowing. The idea is that if u > 0 for a long time or u >> 0 for a shorter time, then the country will end up in an unsustainable debt situation, with the debt/exports ratio being too big. But it is important to notice that it can be good for a country to have a unsustainable borrowing for some years. It is absolutely normal to have a u bigger than zero during a period of heavy investments. The export expansion comes only after a few years. And sometimes a higher debt-output ratio can give a higher output. This has Danielson and Mjema (1997:13) analyzed and concluded: While an increase in the county s external borrowing effects growth both positively (through the increased capacity to import capital and intermediates) and negatively (through increased debt repayment), (13) means that economic growth will vary positively with external borrowing if: We are interested in what the factors causing a country to have a u > 0 as a trend during several years are. Inspired by Simonsen (1985) we can also describe the dynamics of foreign indebtedness by: (3.2) D* = rd* + G - A G stands for the resource gap (G > 0) or surplus (G < 0), here defined as the noninterest current account external deficit, minus aid, minus direct investment into the country, plus gross capital exports from the country. Aid or unilateral transfers, is denoted A. So G is the need for borrowing if we do not take interest payments and aid into account. We denote the average interest rate on outstanding external debt r, and the stock of foreign debt D*. Since d = D* / D* we now see that (3.3) d = r + G / D* - A / D* Now (3.1) and (3.3) give us (3.4) u = G / D* + r - A / D* - x Following Krueger we define the country s share-weighted growth of world exports, w, as (3.5) w = aw f + (1 - a)w n 14

15 where w f is the rate of growth of world exports of fuel, and w n is the rate of growth of world exports of non-fuel. The share of the country s exports which constitute fuel is denoted by a, and the share of non-fuel exports is one minus a. This model can easily be expanded with more commodity groups. But notice the risk with further disaggregation that is mentioned in section 2.2. We now define g, the export performance, as (3.6) g = w - x i. e. g is the difference in the rate of growth of the country s export from that rate which had been if the country had maintained its shares of worldwide trade. g > 0 reflects a failure in export performance relative the rest of the world. We can now divide the rate of growth of exports, x into two parts x = w - g. If we put that into (3.4) we get (3.7) u = G / D* - A / D* + r - w + g Following Krueger (1987:180) we now try to estimate the magnitude of the shift in the international environment as it impacts on the individual countries. We estimate the w that prevail over present time and contrast that with the rate in the nearest past: w 0. Now define (3.8) w = w 0 - w w is the drop in the country s share weighted rate of growth of exports. We also want to estimate the rise in interest rates and the drop in aid. Therefore we contrast the interest rates and the level of aid that prevail over present time with those in the nearest past: r 0 and A 0. Define (3.9) r = r - r 0 r is the raise in the interest rates. And define (3.10) a = - (A - A 0 ) / D* making a the fall in aid as percent of D*. Note that A 0 is the historical level of aid, it is not a ratio, it is not as percent of D*. Putting (3.8), (3.9) and (3.10) into (3.7) gives (3.11) u = G / D* - (A 0 / D* - a ) +(r 0 + r ) - (w 0 - w ) + g When we have estimated the unsustaiable borrowing, u as d - x, we can, in line with Krueger (1987:173), apportion it between g, w, r, a and macro policy impact (effecting the resource gap), that we denote m. So we now have (3.12) u = g + w + r + a + m and therefore (3.13) m = u - g - w - r - a This can be considered to be our main result. Equation (3.13) gives us a method to estimate the macro policy impact. These two latest equations can be compared to the corresponding equations in the Simonsen-Krueger model. 15

16 (2.7) u = g + w + m and (2.8) m = u - g - w These equations are, and were supposed to be, very similar. The difference is that the equations from our extended model also take interest rate changes and aid changes into account. m is the part of u that is not explained by g, w, r or a. Both the name unsustainable macro economic policy and the name macro policy impact is somewhat misleading, because the macro economic policy effect u both through export performance, g, and through the resource gap, expressed via m. This macro policy impact, m, consists of all economic conditions that effects the resource gap one way or the other. The idea is that macro economic policy ought to be designed to imply a G fitting g = w = r = a = 0. It is not obvious that one should design the policy like that. If we for example know that interest payments will rise, it does not seem reasonable to design the policy based on r = 0. And if a country has a extremely high level of aid, say for example that A 0 is as big as the county s output, one can ask if its reasonable to assume it to stay on that level. However, the m we use can be seen as some kind of approximation. It can be shown that (3.14) m = (G / D* + r 0 - A 0 / D*) - w 0 Thus, macro policy impact is the imbalance between the resource gap G, the country s expected interest rate, r 0, and the expected level of aid, A 0, on the one hand, and the country s expected share-weighted growth of world exports, w 0, on the other hand. (G / D* + r 0 - A 0 / D*) is the growth of the debt stock that had been if interest rates and aid had kept their historical levels, and w 0 is the growth of exports that had been if it had kept its historical level. Thus the difference is the rate of unsustainable borrowing that had been if all these factors had kept their historical levels. This matches with equation (3.13), saying that m is the part of u that is not explained by g, w, r or a. 3.3 The results The first step was to find the interest rate at average on the outstanding debt. The outstanding long-term debt as reported by the World Bank is used 3. (Interest payments (INT), long term debt + Short-term debt, of which interest arrears on LDOD) / (Long-term debt stock (LDOD), average for the actual year and previews year 4 ) were used. Krueger uses as previous period when w is estimated, so we try to do that with interest rate and aid. All the figures for 1970 were not found so r 0 is represented as average interest rate The difference can be supposed to be negligible. Table 3.2 in the introduction of this chapter presents the results. Interest rates did actually grow in all nineteen countries and with more than 2 percent in all except one (Jamaica 7.1 to 7.7). This shift was important for many countries. Interest rates close to doubled in eight countries (Brazil, Colombia, Côte d Ivorie, Ecuador, Mexico, Turkey, Venezuela and Yugoslavia) and more than doubled in three countries (Bolivia, Chile and Nigeria). The average growth is 4.0 percent and the maximum is 7.7 percent (Chile 5.1 to 12.8) We can now add r into the model and therefore get another m also. Our intention is to add both interest rates and aid as factors, but we start with looking at the estimates when just interest rates is added 16

17 as a factor. When we add interest rate growth as an explanatory variable to Krueger s table, we get the following table: Table 3.4 Debt build-up, (average annual percentage change), including interest rates. w x d w' g r' m u D*/X 1982 Argentina Bolivia Brazil Chile Colombia Costa Rica Côte d'ivoire Ecuador Jamaica Korea Mexico Morocco Nigeria Peru Philippines Turkey Uruguay Venezuela Yugoslavia Source: See table 2.2 and table 3.2 Looking at table 3.4 we see that the macro policy impact is even better than before, interest rate changes can explain an additional part of the debt build up. Comparing the macro policy impact that Krueger got in table 2.2 and the new one gives that all the positive m in Krueger s result (Chile, Colombia, Mexico, Nigeria and Uruguay) are almost fully changed into negative values when taking interest rates into consideration. Only Argentina has still a macro policy impact significant contributing to debt build up. All the countries that had a negative m (that is, macro policy impact offset some of the shift) got an even more negative m when we took interest rates into account. Table 3.5 shows this: 17

18 Table 3.5 Macro policy impact, m, from different sets of factors (including or not including interest rate) Krueger s result New result Argentina Bolivia Brazil Chile Colombia Costa Rica Côte d'ivoire Ecuador Jamaica Korea Mexico Morocco Nigeria Peru Philippines Turkey Uruguay Venezuela Yugoslavia Source: See table 2.2 and table 3.4 To expand the estimating with aid relevant data are needed. Aid in this model is not what is called Official Development Assistance, because ODA includes the soft part of soft loans and so on. What we are looking for is unilateral transfers from officials. Official unrequited transfers, credit in the Balance of Payments Statistics were used 5. A 0 is the real aid Yugoslavia is left out of the rest of the analysis, because no data were found. 18

19 Table 3.6 Aid , and the difference in relation to debt LDOD average Difference in average aid from to millions USD millions USD 1981:s money value Contribution to debt build up in percent a Argentina Bolivia Brazil Chile Colombia Costa Rica Côte d'ivoire Ecuador Jamaica Korea Mexico Morocco Nigeria Peru Philippines Turkey Uruguay Venezuela Source: Unrequited official transfers, credit from IMF(1975), IMF (1976), IMF (1982) and IMF (1986). Debt from World Bank (1996). Exchange rate from IMF (1976, December), IMF (1982) and IMF (1986).Consumer Price Index from World Bank (1995). These are low numbers. One can say that aid differences not were an important factor. In Colombia and Uruguay, lower aid contributed about 1 percent of each year s debt build up. In Chile, Morocco and Peru, higher aid reduced debt build up about 1 percent. Putting this new a into the analysis we get new estimates, which are shown in this table: Table 3.7 Debt build-up, (average annual percentage change), including interest rates and aid. w x d w' g r' a' m u D*/X 1982 Argentina Bolivia Brazil Chile Colombia Costa Rica Côte d'ivoire Ecuador Jamaica Korea Mexico Morocco Nigeria Peru Philippines Turkey Uruguay Venezuela Source: See table 3.4 and table

20 Just as Krueger we get the result that five countries stand out: Brazil, Korea, Mexico, Turkey and Yugoslavia. They all managed to not let debt grow essential faster than export during the recession. Looking at table 3.7 we can compare the five factors. Three of them are external, connected to the shift in the international economic environment: global export changes, interest rate changes and aid changes; two of them are internal: export performance and macro policy impact. Aid changes is less than 1 percent in all countries. The interest rate changes is 7.7 percent at maximum, and global export changes is 16.6 percent at minimum. Obviously global export changes is the outstanding most important factor contributing to the build up of the debt stock / exports ratio in these countries ! These estimates also highlight the great differences in the countries situations and reactions to the changes in the international economic environment of the early 1980s. We get slightly different estimates of macro policy impact when aid is also taken into account. For example, Colombia s macro policy impact is not responsible for anything of the debt build up; actually it has made it 0.8 percent better. Lower aid is responsible for 0.9 percent. Table 3.8 shows the different estimates of m depending on which factors that is taken into account. Table 3.8 Macro policy impact from different sets of factors (including or not including interest rate and aid) Krueger s result Considering considering interest rates interest rates and aid Argentina Bolivia Brazil Chile Colombia Costa Rica Côte d'ivoire Ecuador Jamaica Korea Mexico Morocco Nigeria Peru Philippines Turkey Uruguay Venezuela Sources: See table 3.5 and table 3.7 Now we want to analyze to which extent different countries did offset the shift in the international economic environment. One could say that export performance and macro policy impact were ways to offset the shift these countries met. The question now is: how much were export performance plus macro policy impact (g + m) in relation to the shift in the international 20

21 economic environment? The shift is in the extended model represented by the sum of the shift in the share weighted growth of world exports, the shift in interest rates and the shift in aid (w + r + a ). In the Simonsen-Krueger model this shift is represented by only the shift in the share weighted growth of world exports. Table 3.9 shows the new result and Krueger s result. Table 3.9 How much the countries offset the shift Krueger -(g+m)/w New -(g+m) /(w +r +a ) Difference Argentina Bolivia Brazil Chile Colombia Costa Rica Côte d'ivoire Ecuador Jamaica Korea Mexico Morocco Nigeria Peru Philippines Turkey Uruguay Venezuela Source: Table 2.2 and table 3.7 For all countries except Jamaica, Mexico and Turkey we get better results concerning how large a part of the shift in the international economic environment they managed to offset when we take interest rates and aid into account. For five countries I and Krueger get very different results. Chile, Colombia and Nigeria had much less negative offsets if one takes interest rests and aid into account. Their offsets changed 30 percentage units or more. Costa Rica and Côte d Ivoire even had some positive offset in my accounts. Table 3.10 summarizes the situations for the different countries in line with Krueger s summation in table 2.3. Just as Krueger we distinguish four categories of economic performance with respect to debt. First those countries that were able to more than offset the entire shift in world conditions, that is - (g + m) > (w + r + a ), then those countries that offset more than half, those with some offset, and those with negative offset, that is the unsustainable borrowing were larger than the downward shift in the world economy. We also distinguish three categories of initial situations depending on debt developments Those with high debt are those countries that 1979 had a debt / exports ratio greater than 2. Slack in debt means the ratio of 2 or less. To have a sustainable policy is to have no unsustainable borrowing. 21

22 Table 3.10 Initial country situation, and responses to the shift in worldwide conditions through Economic performance Initial Offset Offset Some Negative situation entire shift more than half offset offset Slack in debt Sustainable Korea Philippines Nigeria policies Uruguay Argentina Chile Colombia Unsustainable Venezuela Ecuador Jamaica policies Costa Rica Côte d'ivoire High debt Mexico Brazil Bolivia Turkey Morocco Peru Source: Table 2.3 and table 3.9 We get the same result as Krueger does, with two exceptions. Costa Rica and Côte d Ivoire now is in the group with some offset instead of the group with negative offset. 3.4 Comments The most important difference between the new results and Krueger s is that Costa Rica and Côte d Ivoire belong to the group of countries that did make efforts to adjust when we take aid and interest rates into account. That is; if we say that the countries in the first three columns in table 3.10 made efforts to adjust to the altered international economic environment, we gets this result. So the new results indicate that Jamaica is the only country that had had unsustainable policies in the 1970s and made no effort to adjust to the altered international economic environment Chile and Colombia seem, when we do not take the new extra factors into account, to have worsened the situation substantially. But interest rates and aid can explain almost the whole negative offset. Krueger finds that these two countries contributed with 62 percent and 46 percent of the shift respectively. Using the extended model we get 15 percent and 16 percent respectively. Concerning Nigeria, Krueger found that Nigeria contributed 59 percent to the shift, whereas the new result is 27 percent. 22