Table Of ContentStudies in
Contemporary Economics
Gerhard RObel
Factors Determining External Debt
An In tertem paral Study
Springer-Verlag
Berlin Heidelberg GmbH
Editorial Board
О. 80S G. 80mbach 8. Gahlen К. W. Rothschild
Author
Ог. Gerhard RQbel
Fakultat Юг Volkswirtschaftslehre und Statistik
Universitat Mannheim
0-6800 Mannheim, FRG
ISBN 978-3-540-50504-4 ISBN 978-3-642-83655-8 (eBook)
DOI 10.1007/978-3-642-83655-8
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© Springer-Verlag Berlin Heidelberg 1988
Originally pubIished Ьу Springer-Verlag Berlin Heidelberg 1988
CONTENTS
1. INTRODUCTION 1
2. EXTERNAL DEBT AND THE BALANCE ON CURRENT ACCOUNT 6
2.1. The External Debt Position of a Single Country 6
2.2. A More Expensive Imported Raw Material and
the Current Account Balance 9
2.3. The Current Account Balance as the Difference
Between Aggregate Saving and
Aggregate Net Investment 14
3. THE DETERMINANTS OF EXTERNAL DEBT - THE BASIC
MODEL OF A SMALL OPEN ECONOMY 23
3.1. The Structure of the Model 25
3.2. Determinants of the Present Value of
Real Disposable Wealth 39
3.2.1. Changes in the Raw Material Price 39
3.2.2. A Change in the Level of the World
Interest Rate 42
3.2.3. Influences of Government Activity 43
3.3. Factors Determining External Debt 43
3.3.1. Changes in the Raw Material Price 44
3.3.2. A Change in the Level of the World
Interest Rate 53
3.3.3. Other Factors that Influence the
Current Account Balance 56
3.3.4. Government Activity and External Debt 57
3.3.4.1. Constant Total Government
Activity 58
3.3.4.2. Changes in Total Government
Activity 60
3.3.4.3. The Level of Government
Expenditure and Consumer
Satisfaction 63
3.4. Erroneous Expectations 66
3.5. Summary of the Results of the Basic Model 72
IV
4. NON-TRADED GOODS AND THE BALANCE ON CURRENT ACCOUNT 74
4.1. The Structure of the Model 75
4.2. Determinants of the External Debt 83
4.2.1. Change in the Present Value of
Available Real Wealth 83
4.2.2. Determinants of the Current Account
Balance 83
4.2.3. Determinants of Supply and Demand in the
Market for Non-Traded Goods 87
4.3. Direct and Indirect Effects of a Change in
the Raw Material Price on the Current
Account Balance 91
4.3.1. Temporary Rise in the Raw Material Price 91
4.3.2. Expected Future Rise in the Raw Material
Price 93
4.3.3. Permanent Rise in the Raw Material P~ice 95
4.3.4. The Non-Traded Good as a Pure
Investment Good 97
4.4. Government Activity and the Balance on
Current Account 100
4.4.1. Constant Total Government Activity 101
4.4.2. Increase in Total Government Activity 103
4.5. Labor Mobility in Period 2 104
4.6. Summary of the Results 109
5. EXTERNAL DEBT IN GENERAL EQUILIBRIUM MODELS 111
5.1. A Raw Material Exporting Country and a Raw
Material Importing Country 112
5.1.1. The Structure of the Model 112
5.1.2. Wealth Changes in the Raw Material
Exporting Country 116
5.1.3. Determinants of the Level of the World
Interest Rate 119
5.1.4. The Structure of External Debt 124
5.1.5. Government Activity 129
5.2. Three Country Relationships 130
5.2.1. The Structure of the Model 131
5.2.2. Changes in Wealth 138
v
5.2.3. Factors Determining the Balance on
Current Account in the Raw Material
Importing Countries 142
5.2.4. Factors that Influence World
Goods Markets 149
5.2.4.1. The Market for Good 1
in Period 1 149
5.2.4.2. The Market for Good 2
in Period 1 155
5.2.4.3. The Market for Good 1
in Period 2 158
5.2.5. Direct and Indirect Factors that
Determine External Debt 161
5.2.5.1. Temporary Raw Material
Price Rise 162
5.2.5.2. Expected Future Raw Material
Price Rise 173
5.2.5.3. Permanent Raw Material
Price Rise 177
5.2.6. Government Activity and the Inter-
national Structure of External Debt 178
5.2.6.1. Temporary Increase in Govern-
ment Demand for Good 1
in Country 1 179
5.2.6.2. Temporary Increase in Govern
ment Demand for Good 2
in Country 1 185
5.2.6.3. Permanent Increase in Govern-
ment Demand for Good 1
in Country 1 187
5.3. Summary of the Results 189
6. AN EXTENDED PLANNING HORIZON 192
6.1. The Structure of the Three Period Model 193
6.2. Changes in Raw Material Prices and Real
Interest Rates within an Extended
Planning Horizon 198
6.3. Expected and Unexpected Rises in
Raw Material Prices 205
6.3.1. Expected Raw Material Price Rise 205
6.3.2. Unexpected Raw Material Price Rise 209
6.3.3. Welfare Losses from Unexpected
Raw Material Price Rises 214
VI
6.4. Inflexible Real Wages, Welfare and
Tariffs on Imports 218
6.4.1. Inflexible Real Wages with Unexpected
Raw Material Price Rises 218
6.4.2. Tariff and Subsidy Prices with
Imported Raw Materials 221
6.5. Summary of the Results 226
7. CONCLUSION 228
APPENDICES 237
Appendix to Chapter 3 237
Appendix to Chapter 4 242
Appendix to Chapter 5 250
Appendix to Chapter 6 255
BIBLIOGRAPHY 258
1. INTRODUCTION
The international debt problem has proved to be one of most
intractable of the world's current economic problems. The
extent of the problem had become evident by 1982/83 when
some of the most highly indebted countries began having
di fficul ties in servicing their loans!), and the danger of
both a complete breakdown in the international debtor/
creditor structure and an imminent world wide financial and
economic crisis appeared acute.2) The payments commitments
of the non-oil-developing countries were mainly responsible
for this situation. These growing commitments were the
result of two factors, on the one hand a large increase in
these countries' external debt, especially at the end of
the seventies and the beginning of the eighties, and, on
the other, an even more dramatic increase in the burden of
interest rates. Al though the BIS, Central banks and the
3)
IMF have, until now, succeeded in their efforts to
stabilize the situation, it is certainly not possible to
claim that a final solution to the debt problem has been
found.
It is generally agreed that the wide fluctuations in the
prices of industrial raw materials since the beginning of
the 1970' s were the main cause of this development. Such
large fluctuations had been unknown previous to this.
4)
Developments in the price of crude oil show most clearly
the nature and size of these fluctuations. Apart from the
1) The most spectacular examples were Mexico, Brazil, Argentinia and
Poland.
Cf. a presentation of this development in ARTUS (1983), p. 265 ff.
2)
and BAER (1984), p. 205 ff. Baer focuses particularly on the efforts
of the BIS and the IMF to solve the payments problem.
The external debt of the non-oil-developing countries rose, in
3)
inflation adjusted terms, from US$ 340 bn. to about US$ 640 bn.
between 1978 and 1982, i.e., by about 90%. In the same period their
interest rate burden rose by over 300%, from about US$ 20 bn. to
almost US$ 66 bn. (current dollars) because of the extremely high
world interest rate levels at the beginning of the eighties. For
this see FRATIANNI (1983), p. 37.
4) Cf., e.g., BRUNO (1982b) and SACHS (1981).
2
Korean war period, oil prices fell continously from 1955 to
the beginning of the 1970's at a rate of about 0.5%-1%
p.a., so that in 1970 the average world market price per
barrel was under US$ 1.8. Then, up to September 1973, the
price rose to over US$ 3 and it continued rising during the
Yom Kippur War until by 1974 it was over US$ 11.5) After a
period of stability in the middle seventies when the price
- at least the real price - fell slightly, prices rose in a
second wave from around US$ 13 in December 1978 to over US$
35 in January 1981. Despite the price falls evident in
recent years, there are grounds for believing that, in the
long run, the price of this limited resource will again
rise.l )
The first price jump in crude oil and other industrial raw
materials led to a dramatic worsening of the world economic
situation. In most oil importing countries this was
characterized by falls in output, factor productivity,
capital accumulation, real growth, and employment.?) At the
same time a strong, world wide, inflationary trend began.8 )
There were huge current account imbalances; the oil
exporting countries had large surpluses, partly because of
their still limited absorption capacity, which were the
counterpart of equally large deficits in the rest of the
world. However, the effects of the oil price changes on the
oil importing countries were not uniform because of
differences in the ability to adjust and in political
5) For these price developments see KOOPMANN/MATTHIES/RESZAT
(1984), p. 25 f.
I) Cf. KOOPMANN/MATTHIES/RESZAT (1984), p. 21. The price
fluctuations were not limited to crude oil, similar price fluctuations
also occurred in the prices of other industrial raw materials. See
BRUNO (1982b), p 83 f.
7) See, for example, an analysis of the developments in growth,
productivity and other macroeconomic variables following the oil
price rise in a group of selected OECD countries in BRUNO (1982b).
8) This was partly attributable to the drastic rise in the prices of
US$ denominated import goods, which led, among other things, to
rises in domestic prices, depending on what was happening to
exchange rates. The inflationary tendency was also the result of
the increase in world liquidity at the end of the sixties. Cf. BRUNO
(1980), p. 479.
3
reactions. The current account situations of the countries
in this group were therefore also different. Large
fluctuations in exchange rates, expanding world capital
flows and both a rapid increase and a structural change in
international credit linkages also occurred at this time. 9 )
While most industrialized countries were able to cope with
the effects of the first oil price jump relatively quickly
by taking adjustment measures and were thus able to reduce
their current account deficits, the non-oil-developing
countries tried to finance their increased deficits by
borrowing abroad. They thought this would enable them to
put off taking adjustment measures and allow them to
continue with their, often very ambitious, development
projects.10 ) Their endeavours came at an opportune time for
the international commercial banks. The enormous export
revenues of the OPEC countries were mounting up and the
banks, with world interest rates falling11) , were looking
for ways to reinvest them. 12 )
The second oil price jump affected the non-oil-developing
countries particularly severely because, at the end of the
seventies, they still had current account deficits.
Economic recession in most industrial countries reduced
their export chances, as did the tight, anti-inflationary
policies that these countries introduced at the end of the
seventies. The latter caused a large increase in world
interest rates and thus contributed to the increasing
9) See BAER (1984), p. 207.
10) The current account developments in the seventies will be
discussed in chapter 2. For the differences between developments
in the industrial and non-oil-developing countries see also BAER
(1984), p. 206 ff.
U) Developments in interest rates in the 1970's are discussed in
SACHS (1981), p. 224 f.
12) See BAER (1984), p. 208 ff. Between 1978 and 1981 the commercial
banks contributed about 60% of the balance of payments financing
of the non-oil-developing countries. Thus, general balance of
payments financing largely replaced lending for particular
investment projects which had been usual practice up to this time.
4
interest rate burdens of the non-oil-developing countries
mentioned above.l3)
The present study makes no suggestions as to how the
current international debt problem might be solved, nor
does it look at the suitability of the measures taken by
the IMF. Rather, the situation outlined above provides a
starting point for a discussion of the causes of a
country's external debt, when a raw material needed for
production purposes is not available from domestic sources.
The microeconomic basis of the study makes it possible to
analyze in a detailed way, for example in the case of a
rise in raw material prices, the channels through which the
effects are transmitted and to decide, from a welfare point
of view, whether priority should be given to an immediate
adjustment to the external debt.l t ) In addition, an
intertemporal approach has been chosen, because of the
importance of the investment behaviour of firms and the
savings decisions of households for a country's external
debt. This behaviour is primarily determined by
expectations concerning future economic aggregates.lS)
First, chapter 2 explains some of the economic relation
ships which are essential for the study. It is shown, by
using very simplified examples, how most static analyses of
oil prices have been structured and why, in contrast to
these, a microeconomic based intertemporal study, which
13) For example, the London three month interest rate, LIB OR, rose
between the middle of 1978 and the end of 1979 by 100% in nominal
terms, from 7.5% to 15%. For the developments in interest rates
see, e.g., ARTUS (1983), p. 271 and also FRATIANNI (1983), p. 42.
14) When a current account deficit is being assessed, it certainly
makes a difference whether it is, for example, caused by a lack of
substitutes for the necessary imported raw material, whether the
short run adjustment problem is one of adapting consumption to
lower income or whether the difficulty is caused by foreign
borrowing used to finance investment projects aimed at developing
new technologies or alternative energy sources, that, in the long
run, will make the country less dependent on fluctuations in raw
material prices. Cf. SACHS (1981), p. 211
15) For this see the explanation in Chapter 2 and also SVENSSON
(1982), p. 223.
