INTERNATIONAL FINANCE: THE CYCLE OF ECONOMIC AUSTERITY

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• Collection: General CIA Records
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• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 16
• Document Creation Date: December 22, 2016
• Document Release Date: November 10, 2010
• Sequence Number: 3
• Publication Date: December 1, 1982
• Content Type: REPORT

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25X1
Secret 25X1
Intern
ational Finance:
The Cycle of
Economic Austerity
Secret
GI 82-10288
December 1982
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International Finance:
The Cycle of
Economic Austerity
Economic expansion in the 1970s was due, in part, to
growing economic and financial links between the
OECD and Third World countries.' LDC growth was
fueled by increased exports to the industrial West
while LDC demand, underwritten in part by heavy
flows of financial capital from Western commercial
banks, was a significant element in OECD growth.
High interest rates and a sharp reduction in export
earnings from sales to depressed OECD markets have
put many key LDCs under severe pressure to curb
imports. This, in turn, has implications for both
Western recovery and the economic and financial
health of other LDCs that count heavily on exports to
their financially troubled neighbors.
The Current Environment
The persistent and worsening financial situation of the
LDCs is closely tied to the global recession that is now
well into its third year. The LDCs are faced by two
distinct but related problems:
? LDC exporters have been hit by a collapse of
commodity prices without any rise in OECD
demand.
? High interest rates have greatly increased debt
service obligations
Export Decline. The recession-induced falloff in
OECD purchases of LDC products has been a major
reason for the eroding ability of the LDCs to manage
their debt. LDC exports to the OECD expanded
steadily in 1976-80, rising an average of $50 billion a
year, but beginning in 1981 the situation changed
dramatically. The OECD recession has led to a
collapse of commodity prices and to a reduction in
demand for LDC products. We calculate that LDC
exports to the OECD have declined by an estimated
$80 billion in 1981-82. OPEC bore the brunt of this
two-year revenue decline-nearly $75 billion-but
non-OPEC LDCs also suffered substantially (table 1).
Eight of the 12 Third World countries with the most
serious debt problems suffered major declines in
' Economic data used in this paper were obtained from standard
IMF, UN, OECD, and other open sources unless noted otherwise
export earnings in 1982;' all of the others have
experienced substantial slowdowns in expansion of
exports to the OECD. Chile's exports to the OECD
were off by nearly $700 million in 1981, representing
a 20-percent drop in earnings. Ivory Coast, Jamaica,
Kenya, the Philippines, and Thailand have had their
exports reduced for two or more years in a row.
Interest Rates.The continuing runup in commercial
interest rates in 1980-81 has imposed a severe burden
on LDC borrowers, who can no longer count on the
increase of export revenues that was prevalent for
most of the past decade. The interest premium for
most LDC loans is linked to the London Interbank
Offer Rate (LIBOR) or to the US prime rate. We
estimate that the nearly 5-percentage-point rise in
interest rates that took place over 1980-81 added
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some $10 billion to the debt service costs of the LDCs
during that period. With exports stagnant or falling,
the burden of interest payments rose to over a quarter
of total foreign earnings for such countries as Mexico,
Brazil, Chile, and Argentina:
Interest as a
Percent ofExpori25X 1
of Goods and Service
Argentina
14
12
29
Brazil
19
29
38
Chile
17
17
31
South Korea
7
7
13
Mexico
17
23
27
Peru
12
15
19
Philippines
6
11
18
Ecuador
NEGL
12
27
Nigeria
NEGL
3
4
Venezuela
1
6
11
' Nigeria, Venezuela, Ivory Coast, Jamaica, Kenya, Pakistan, the
Philippines, and Thailand. 25X1
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Table 1
LDC Debt Crises: Contributing Factors
Average annual change
in million US S
(except where noted)
LDC exports to OECD
38,530
95,330
-21,270
-59,380
OPEC
18,980
66,780
-20,340
-53,100
Nigeria
2,230
7,000
-6,540
-6,250
Venezuela
690
2,260
1,040
-2,440
Other
16,060
57,520
-14,840
-44,410
Non-OPEC
19,550
28,550
-930
-6,280
Argentina
800
-880
-130
310
Brazil
1,220
2,200
530
320
Chile
400
630
-700
390
Ivory Coast
370
-40
-490
-160
Jamaica
25
150
-45
-70
Kenya
110
35
-190
-45
Mexico
1,730
6,130
3,640
120
Pakistan
120
110
5
-45
Philippines
500
850
-75
-610
Thailand
500
590
-15
-10
Other
13,780
18,780
3,460
-6,480
LDC imports from OECD
24,500
57,120
24,110
-4,200
OPEC
7,480
22,800
16,960
7,020
Nigeria
590
5,330
1,730
-1,380
Venezuela
880
860
1,030
1,160
Other
6,010
16,610
14,200
6,800
Non-OPEC
17,020
34,320
7,150
-11,220
Argentina
870
1,990
-1,460
-2,960
Brazil
280
1,640
-1,470
-930
Chile
270
900
480
-1,290
Ivory Coast
280
190
- 600
-360
Jamaica
- 30
- 30
230
-15
Kenya
130
460
- 420
-60
Mexico
1,610
7,090
4,100
-5,130
Pakistan
270
250
-170
410
Philippines
480
530
-40
700
Thailand
560
580
190
1,160
Other
12,300
20,720
6,310
-2,750
LIBOR (percentage points)
1.2
2.0
2.8
-2.5
Trade weighted dollar exchange rate (percent)
1.7
-0.8
17.8
13.0
Actual level of new private commercial bank lending
to LDCs (yearend total)
35,840
42,170
64,630
OPEC
10,520
11,810
14,010
Nigeria
930
810
3,030
Venezuela
3,420
7,060
6,440
Other
6,170
3,940
4,540
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Secret
Table I (continued)
25,320
30,360
50,620
Argentina
1,910
2,550
3,800
Brazil
5,430
6,280
7,150
Chile
670
1,000
2,360
Ivory Coast
240
600
160
Jamaica
50
0
180
Kenya
70
10
120
Mexico
6,760
6,080
15,180
Pakistan
80
590
360
Philippines
1,700
1,390
1,500
Thailand
400
900
880
Other
8,010
10,960
18,930
The recent falloff in commercial money market
rates-LIBOR has dropped 6 percentage points since
June 1982-will provide badly needed relief. Nonethe-
less, the present level of interest payments is still high
in terms of the poor outlook for export earnings.
LDC Response
Foreign Borrowing. In our judgment, many LDCs
initially sought to insulate their domestic economies-
and otherwise delay politically sensitive economic
adjustments-from the adverse trade and financial
trends by borrowing heavily from commercial banks.
During 1981, medium- and long-term external debt of
the non-OPEC LDCs grew by $50 billion to $350
billion; 80 percent of the gain was from private
sources. Many LDCs also resorted to sharp increases
in short-term borrowing because of either a desire to
avoid long-term borrowing at higher rates or an
inability-because of declining credit standings-to
obtain longer term credits. As long as banks were
willing to lend, most LDCs were able to maintain
domestic consumption while avoiding serious declines
in their foreign exchange reserves.
This option is no longer available to the LDCs with
the most serious debt problems. Although we believe
new bank lending to LDCs may approach $40 billion
this year, the pace fell sharply in second-half 1982.
Several factors appear to be playing a role:
? The LDCs' poor economic prospects and inability to
rapidly expand sales to the OECD countries con- 25X1
strain private demand for funds and lender confi-
dence in the ability of LDC borrowers to raise
requisite revenues. During 1976-80, for example,
the rise in non-OPEC LDC international debt was
almost completely offset by rising exports. During
this period the LDCs' average ratio of debt service
to exports remained about 15 percent; it is now on
the order of 25 percent.
? The Mexican, Argentine, and Polish payments cri-
ses shocked the banking system and increased bank-
ers' assessments that their risks were rising. Many
banks are now refusing loan requests outright; those
that continue to lend are demanding a substantial
premium for the increased risk. The average spread
for non-OPEC LDCs is up for the third straight
year, and borrowers such as Argentina and Mexico
were hit earlier this year with spreads of 1.5 to 2.2'25X1
percentage points above LIBOR when they could
obtain loans at all.
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Table 2
Estimated Aggregate GNP Growth
1974-79
5.9
5.6
5.3
5.5
5.8
4.8
1980
5.4
5.6
4.8
5.4
5.4
5.4
1981
2.3
3.0
1.6
1.4
5.9
-1.3
1982
1.1
1.1
0.8
-0.1
3.0
-2.1
? Lenders' problems have been compounded by reces-
sion, high interest rates, and mounting domestic
business failures. With perceptions of heightened
risk both at home and abroad growing rapidly,
bankers report they are taking steps to protect the
adequacy of their capital by curtailing lending. =
Increased Austerity. With the borrowing option cut .
sharply, we believe the LDCs have little choice but to
accommodate the OECD recession and their own
financial problems by curbing economic growth, in
large measure by severe reductions in imports. We
expect aggregate LDC output growth this year to be
on the order of 1 to 1.5 percent, the lowest rate since
at least 1950. The growth rate is barely a fifth of the
average growth that occurred in 1974-79. African
countries have been especially hard hit because of
their heavy dependence on exports of primary com-
modities. Latin American output growth has especial-
ly suffered from declining commodity exports and
austerity-imposed cutbacks in Brazil, Mexico, and
Argentina.
In most cases, the downturn in growth is an inevitable
result of the inability of countries to maintain suffi-
cient exports and imports to sustain economic devel-
opment. In other cases, a deliberate program of slow
growth has been the price paid to qualify for IMF
funding. Some 30 LDCs are operating under, or are
about to begin, IMF-mandated adjustment programs
that generally include devaluation, restrictive mone-
tary and fiscal policies, and longer term measures to
boost economic efficiency (table 3). We calculate that
the combined GNP of these countries is on the order
of $1.1 trillion, about 60 percent of total LDC output.
LDC austerity, whether imposed by external financ-
ing constraints or by IMF requirements, may bring
about political instability. In our judgment, politically
powerful groups are likely to react to the fall in their
living standards that will occur. That risk is probably
one of the key reasons many LDCs find it difficult to
comply with IMF conditions and why they tend to
maintain the same sort of expansionary domestic
policies-such as large budget deficits and consumer
subsidies-that helped create their economic prob-
lems.
Import Cutbacks. Both OPEC and non-OPEC LDCs
alike are trimming their imports. The following tabu-
lation for a sample of financially troubled LDCs is
based on data from Embassy reporting and open
sources for the first six months of 1982:
Mexico Down 27 percent
Brazil Down 13 percent
Argentina Down 47 percent
Chile
Philippines
Venezuela
Down 35 percent
Up 5 to 6 percent
Up 2 to 3 percent
Down 9 percent (c)
First-half 1982
compared with
first-half 1981
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Secret
Table 3
Troubled Borrowers: Austerity Adjustment
Country
GDP Growth
(percent)
Change in Imports
(million S)
IMF Program
1974-79
1980
1981
1982
1980
1981
1982?
1980
1981
1982
Argentina
2.2
-1.6
-6.0
-5.0
568
-150
-4,000
No
No
Yes
Bangladesh
6.8
5.9
6.0
0.0
670
479
122
Yes
Yes
Yes
Bolivia
4.4
0.8
-1.0
0.0
-149
12
-379
No
No
No
Brazil
6.9
8.0
-2.0
0.0
5,157
-882
-2,100
No
No
Yes
Chile
3.9
6.0
5.0
-3.0
1,603
543
-2,256
No
No
Yes
Costa Rica
5.1
1.9
-3.6
-6.0
111
617
245
No
Yes
Yes
Dominican
Republic
5.0
5.4
3.4
-1.0
427
28
-431
No
No
No
Ecuador
6.4
4.6
4.0
3.0
264
-3
-85
No
No
No
Guyana
1.5
0.0
-6.0
-10.0
78
10
-95
Yes
Yes
Yes
Honduras
4.4
2.6
0.3
0.0
183
-60
-186
Yes
Yes
Yes
India
1.9
7.5
4.6
-0.5
4,183
819
11
No
Yes
Yes
Ivory Coast
7.2
6.9
1.5
1.5
528
-580
166
No
Yes
Yes
Jamaica
-2.6
-3.0
1.5
1.5
186
327
-139
Yes
Yes
Yes
Kenya
5.0
2.0
2.0
3.5
658
14
-4
Yes
Yes
Yes
Liberia
2.2
-1.0
2.0
1.0
27
- 56
60
Yes
Yes
Yes
Madagascar
1.9
4.2
1.0
3.0
-4
447
152
Yes
Yes
Yes
Comment
Letter of intent signed; ef-
fects of program will not
be felt until 1983.
Standby canceled this
summer; new agreement
possible in early 1983.
Likely to obtain an extend-
ed fund facility in early
1983.
Likely to obtain approval
for a three-year extended
fund facility
Approval from the IMF
for an extended fund facil-
ity is expected soon.
Current facility suspend-
ed; approval expected for
another credit this month.
Has reached agreement in
principle for an extended
fund facility.
IMF credit likely in early
1983.
Unable to comply with
IMF conditions.
Unable to comply with
previous programs; ob-
tained new loan in Novem-
ber 1982.
Currently under an IMF
program signed in Novem-
ber 1981.
Operating under an ex-
tended fund facility ar-
rangement signed Febru-
ary 1981.
Operating under an ex-
tended fund facility ar-
rangement signed April
1981.
Has had some trouble
meeting IMF measures.
Relies heavily on IMF as-
sistance; current standby
expires August 1983.
Unable to comply with
previous agreements; re-
cently obtained a new loan.
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Table 3
Troubled Borrowers: Austerity Adjustment (continued)
Country
GDP Growth
(percent)
Change in Imports
(million $)
IMF Program
Malawi
5.1
0.9
0.5
1.5
40
-39
-28
Yes
Yes
Yes
Mexico
6.1
8.3
8.1
1.0
746
6,000
-9,400
No
No
Yes
Morocco
6.3
4.3
-1.0
2.0
626
1,095
603
Yes
Yes
Yes
Nicaragua
-1.8
10.0
0.0
0.0
556
157
-30
No
No
No
Pakistan
4.9
6.7
5.5
6.1
1,294
89
201
Yes
Yes
Yes
Panama
3.5
4.9
3.6
1.0
261
91
103
Yes
Yes
Yes
Peru
2.3
3.1
3.9
3.5
110
258
92
No
No
Yes
Philippines
6.5
5.4
0.0
-1.0
1,800
593
-51
No
No
Yes
Senegal
1.9
-6.6
-5.2
9.0
11
-16
9
No
Yes
Yes
Sierra Leone
1.2
3.5
2.0
-4.0
108
-188
-3
No
Yes
Yes
Sudan
3.3
-0.5
0.5
1.0
622
96
-4
Yes
Yes
Yes
Thailand
7.4
5.8
7.0
4.9
2,077
1,286
848
No
Yes
Yes
Togo
2.5
0.2
-5.9
4.0
29
46
79
No
Yes
Yes
Uganda
-0.9
-2.0
1.0
5.0
95
102
83
No
Yes
Yes
Uruguay
5.7
4.7
-0.8
-3.0
2,831
17
502
Yes
Yes
Yes
Comment
Obtained another arrange-
ment in August 1982.
Likely to obtain approval
for a three-year standby
loan.
Two previous programs
canceled; current arrange-
ment expires in late 1983.
Continues to oppose IMF
support because of the re-
quired austerity measures.
Previous facility canceled;
current arrangement ex-
pires in late 1983.
Struggling to comply with
IMF constraints.
Recently obtained three-
year facility; targets will
probably not be met.
Reached agreement in
principle; effects of pro-
gram will not be felt until
1983.
Has shown a willingness to
implement steps in support
of IMF programs
IMF canceled facility in
April 1982; negotiations
are under way for a new
loan.
Unable to meet previous
IMF conditions; negotiat-
ing for a new credit.
Current standby approved
in November 1982.
Standby disbursements
suspended; approval for a
new loan likely in early
1983.
1981 arrangement can-
celed; new credit obtained
this summer.
Unable to comply with
IMF conditions on two
previous standby loans
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Table 3
Troubled Borrowers: Austerity Adjustment (continued)
Country
GDP Growth
(percent)
Change in Imports
(million $)
Zaire
-2.5
2.5
-2.0
0.0
456
142
-34 No
Yes
No
Zambia
0.0
-0.9
-1.8
-1.0
248
54
-82 . No
Yes
Yes
159 No
Yes
Yes
IMF suspended disburse-
ments last fall due to
noncompliance.
Current program suspend-
ed; a new loan is possible in
early 1983.
Seeking IMF assistance,
but apprehensive over
IMF conditions.
We believe the import falloff was even greater during
the last six months-Mexico's imports for the past
three months, for example, are 50 percent lower than
the comparable period in 1981. For much of 1983, any
gains in export earnings probably will have to be used
to meet debt service obligations rather than to boost
imports. Even for countries with liberal debt reschedul-
ing arrangements or IMF loan programs, the ability to
import anything beyond fuel and food will be difficult.
For some key countries, we believe the size of the
import austerity demanded threatens the ability of
governments to manage the decline in living standards
it portends. Mexico's IMF accord, for example, will
allow it to avoid a second year of precipitant decline in
imports in 1983; even so, we estimate that imports will
be on the order of $15 billion, down from $24 billion in
1981. If Mexico cannot meet IMF conditions and
support is withdrawn, we estimate that imports could
drop as low as $10 billion. Brazil, for its part, has
announced a projected 20-percent drop in imports next
year as part of its austerity program.
We calculate that the bulk of the LDC import cutback
will fall on the industrial countries. The OECD sold
more than $300 billion worth of goods to LDCs in
1981, up from only $40 billion in 1970. Country
differences are substantial, with sales to LDCs provid-
ing about 40 percent of US and Japanese exports and,
in the aggregate, 15 to 20 percent of exports from
Western Europe (figure 1). Because LDCs have more
discretion over nonfuel and nonfood imports than over
fuel and foods, most adjustment probably will take
place in purchases of manufactures. The 25 key
financially troubled LDCs alone purchased $50-55
billion in manufactures from the OECD last year; this
constituted 18 percent of the overseas market for
manufactures exports from the United States, 10
percent for Japan, and 5 percent for Western Europe
(figure 2). Moreover, these LDCs provided about 10
percent of the growth in manufactures exports during
the past decade (figures 3, 4, 5). 25X1
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Table 4
Selected Countries: Imports and Import Trends
Percent
changes
Percent
change
Percent
change
Percent
change
15.0
-39
10.0-15.0
0 to -33
Brazil
23.0
28
22.1
-4
20.0
-10
14.0-18.0
-10 to -30
Argentina
9.4
57
9.2
-2
5.0-6.0
-35 to
-46
5.0-6.0
0
Eastern Europe (hard
currency)
46.4
10
42.0
-9
35.0
-17
33.6
-4
? Percent change over previous year.
e Estimated.
OECD exporters must also cope with a dropoff in
sales to Eastern Europe. The United States has been
affected most heavily, followed by France and the
United Kingdom. East European imports from the
West fell an average of 22 percent in the first six
months of the year, largely because of the sharp
decline in Western bank lending to East European
countries. Poland and Romania slashed imports by
half, while East Germany, Yugoslavia, Bulgaria,
Hungary, and Czechoslovakia reduced them an aver-
age of 15 percent. For the year, hard currency imports
will be off by some 17 percent and should continue to
fall through 1983. Since June, Hungary has imple-
mented import restrictions and Yugoslavia has put in
place austerity measures to reduce its unaffordable
trade deficit. The improvement in trade balances will
probably not eliminate Western bankers' caution
about lending to the East.
Intra-LDC trade also is affected by debtor austerity.
We believe there is the risk especially in South
America that countries such as Bolivia, Paraguay,
and Uruguay may find it increasingly difficult to
finance their own debt payments and import bills if
their troubled neighbors reduce purchases because of
their troubled neighbors reduce purchases because of
their own financing constraints. These linkages are
less strong for Mexico and East European debtors, but
as countries scramble for funds, even small declines in
exports become troublesome (tables 5 and 6).
Quantifying the Linkages
OECD Demand and LDC Growth. The financial and
economic linkages between the LDCs and the major
Western economies have increased markedly over the
past decade. The key linkage has been in trade ties.
LDC exports to the industrial countries have expand-
ed from $40 billion in the early 1970s to over $400
billion by 1980. Most of this gain was in oil exports;
nearly half of the GNP of OPEC members, for
example, comes from exports to the OECD compared
with about a quarter in 1970. The linkage is less
substantial for other countries; only about 12 percent
of the GNP of non-OPEC LDCs comes from exports
to the OECD. The ratio has remained fairly stable for
more than a decade. This stability probably reflects
such factors as the increasing sophistication of the
domestic aspects of many LDC economies and greater
intra-LDC trade.
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Figure 1
Industrial Countries: Direction of Exports
= OECD
LDC
Other
All Commodities, 1970-82
United States
Manufactures, 1981
United States
Japan
160
I FTC- Financially Troubled Countries; the 25 LDCs with the most
severe debt repayment problems.
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Table 5
Direction of World Trade, 1980
Exports From/
Exports to
World
United
States
Japan
Other
Developed
Market
Economies
Africa
Latin Middle
America East
Asia
Oceania
Centrally
Planned
Economies
World a
1,995
240
125
980
85
130
100
150
3
230
United States
215
20
105
5
40
10
25
NEGL
10
Japan
130
30
30
5
10
15
30
NEGL
15
Other developed market
economies
920
90
20
600
55
30
45
30
2
65
Africa
95
30
2
50
3
5
2
1
0
5
Latin America
110
40
5
30
2
25
2
1
NEGL
15
Middle East
210
20
40
90
4
10
10
25
NEGL
5
Asia
140
30
30
30
4
4
10
30
1
10
Oceania
2
NEGL
NEGL
NEGL
NEGL
NEGL
NEGL
NEGL
NEGL
NEGL
Centrally planned
economies
175
2
5
50
5
5
10
10
NEGL
115
0 Because of rounding and inconsistencies in reporting, rows and
columns may not add to world total.
Table 6
Key Debtors: Trade Linkages
With Neighboring Countries
Key Debtor Neig
hbor
Debtor's Share of
Neighbor's
Export Market
(percent)
Major Commodities
Exported to Key Debtor
Argentina Boliv
ia
26
Wood, tin, gas
Para
guay
23
Food, wood
Chile
5
Copper, wood, pulp, plastics
Peru
2
Manufactures
Brazil Para
guay
18
Food, soybeans, wood
Urug
uay
11
Food, dyestuffs, rubber
Arge
ntina
8
Food, soybeans, leather
Mexico Braz
il
2
Machinery, transport equipment
Chile
2
Pulp, chemicals
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Figure 2
US Trade With Latin America: Direction of
Exports, 1981
Even among non-OPEC LDCs, however, this growth
link depends heavily on the relative size of their
export sectors. Exports to the OECD are one-fifth of
Ivory Coast's GNP but only 4 percent of Pakistan's.
Among the top LDC debtors, these export-GNP
shares range from 5 percent for Argentina and Brazil
to 9 percent for Mexico. Although these shares are
small, they are important because of the sheer size of
the economies of these countries; together, they con-
stitute 40 percent of non-OPEC LDC output
A study prepared by the IMF in 1982 shows that
slower industrial country growth rates are associated
with slower LDC growth rates and vice versa. Accord-
ing to this study:
? A change of 1 percentage point in OECD GNP
alters nonoil-LDC export volume by 2.3 percentage
points. This relationship is stronger now than during
the 1960s and early 1970s. The impact is especially
strong on LDC exporters of manufactures-includ-
ing many who are currently "troubled debtors"-
and weakest for low-income exporters of primary
products.
Figure 3
Financially Troubled Countries: Imports from
OECD, 1981
?Other
L us
Mexico
Venezuela
Brazil
Yugoslavia
Argentina
Philippines
Poland
Chile
Peru
Romania
Pakistan
other
25X1
? A positive albeit weaker link exists between LDC
exports and LDC economic growth. A 1-percentage
point change in nonoil-LDC export volume is associ-
ated with a change in GNP growth that ranges from
a 0.04 percentage point to a 0.25 percentage point, 25X1
with the most plausible rate at about a 0.1 percent-
age point. As with the OECD growth-LDC export
link, the relationship is strongest for major exporters
of manufactures and weakest for low-income LDCs
with exports made up largely of primary commod-
ities.
Although this sort of relationship cannot be used for
short-run projections, it does illustrate the sensitivity
of LDCs to OECD growth. In its recently completed
forecasting round, the OECD Secretariat projects
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Figure 4
Financially Troubled Countries: Shares of
Total OECD Exports, 1981
Table 7
Industrial Countries:
GNP and Exports, 1981
Mexico
Venezuela
Brazil
Yugoslavia
Argentina
Philippines
Poland
Chile
Other
aggregate OECD GNP growth of only 1.8 percent for
1983, the fourth consecutive year of growth under
2 percent. If, however, OECD growth were to average
4 percent, the IMF analysis suggests that an addition-
al $15 billion could be earned by the non-OPEC
LDCs to meet debt service obligations and import
bills. At the same time, their own GNP would
increase an additional 0.5 percentage point
LDC Demand and OECD Growth. Over the past
decade, OECD exports to LDCs as a share of OECD
countries' GNP have doubled, as shown in the follow-
ing tabulation:
United
States
Japan
Western OECD
Europe
GNP
2,940
1,130
3,020
7,520
Exports (total)
235
150
740
1,215
To LDCs
85
65
145
305
To OPEC LDCs
20
25
70
115
To non-OPEC LDCs
65
45
75
190
To financially
troubled LDCs a
40
15
30
90
(table 7)
Because most trade still takes place between industrial
countries, the growth response of the OECD countries
to changes in LDC growth is far less than the reverse
Several recent studies have tried to capture the impact
on the OECD countries of a fall in LDC growth caused
by a cutback in bank lending. None of these studies is
directly comparable because of the differing assump-
tions used. They all point to similar impacts on the
OECD from a decline in exports to LDCs. The actual
impact on individual OECD countries from cutbacks
to specific borrowers is more complex and needs to be
explored further:
1970
1981
1981
Total OECD
2
4
16
United States
1
3
8
Japan
3
6
13
Western Europe
2
5
24
? An OECD Secretariat assessment of changes in net
new bank lending to the nonoil LDCs indicates that
each $10 billion drop in financial flows reduces
OECD real GNP by 0.25 percentage point. Thus, if
financial flows are off by $25 billion, OECD GNP
growth would be down by 0.6 percentage point.
25X1
25X1
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Figure 5
Exports to Financially Troubled LDC Group'
United States
The FtCs accounted for 17 percent
of US export growth from 1980
to 1981.
Japan .
The FTCs accounted for 8 percent
of Japanese export growth from
1980 to 1981.
Western Europe
The FTCs accounted for 4 percent
of West European export growth
from 1980 to 1981.
1975
1981
1975
1981
1975
1981
aFTC= Financially Troubled Countries; the 25 LDCs with the most
severe debt repayment problems.
? An analysis recently drafted by the Council of
Economic Advisers in reference to only six "credit
constrained countries"-Argentina, Brazil, Chile,
Mexico, Peru, and Venezuela-assumes a $25 billion
cutback in net new lending to this group. On that
basis, US exports would fall by $9.2 billion directly,
but the effects of linkage mean a total falloff in world
trade of $59 billion and, ultimately, a $14 billion
overall decline in US exports. As a result, the CEA
model predicts that US GNP would fall 0.9 percent-
age point
The CIA's Linked Policy Impact Model provides
estimates that are roughly in line with these studies.
According to this model, a $10 billion decrease in
financial flows to LDCs would, if apportioned in line
with usual suppliers' market shares, reduce OECD
25X1 ~
GNP by almost $20 billion, or about 0.2 percentage
point. Alternatively, a $25 billion LDC import cutback
as a result of an equivalent financing shortfall would
result in a $49 billion fall in OECD GNP, or about 0.5
percentage point. 25X1
In practice, it may be possible for some LDCs to
moderate the effect of a sharp slowing in bank
financing. Imports can be reduced selectively through
controls and a more realistic exchange rate policy.
This kind of cutback would take exceptionally carefu25X1
management-and tough political decisions-on the
part of the LDCs. Most of the LDCs have been able
to cut back the growth of oil imports over the last
several years, and generally favorable weather has
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moderated the need for food imports. Solely on the
basis of aggregate import data, however, it appears
that the LDCs have squeezed a substantial amount of
fat out of their import bills already and further
reductions will be increasingly difficult. More re-
search must be done on this aspect of the LDCs'
adjustment process in order to gauge the full effect of
financing problems on their economic development
and political stability.
The Effect of the Business Cycle
Any acceleration in the pace and timing of economic
recovery in the industrial countries would provide the
LDCs with needed breathing room. We believe it also
would provide the banking community with a signal
that LDC export prospects will improve and that
LDCs are in a better position to handle their debts.
The direct gains from a more rapid OECD economic
expansion, however, will not occur immediately and
will not be evenly distributed among the LDCs. Some
will benefit sooner than others and some more than
others. In our judgment, most of the initial pickup in
economic activity will be concentrated in the consum-
er sector. Increased demand for LDC raw materials
will take significantly longer to materialize in part
because of the large inventory overhang for many raw
materials. In the case of copper, non-Communist
stocks amount to 1.2 million tons
or roughly 15 to 20 percent of annual
consumption. We estimate that only a third of these
stocks are under the control of raw material produc-
ers.
Altogether, we would expect a delay in LDC export
responses to stronger OECD growth of anywhere
from six months to a year. For some commodities the
delay will be appreciably longer. OECD demand for
key LDC agricultural exports such as sugar is not
sensitive to the industrial country business cycle.
Beyond this, the excess capacity available for most
industrial materials sold by LDCs would dampen
much of the price response. Industry data show that in
the case of copper the LDCs continued to expand
capacity long after demand began to decline. As a
result, producers are operating at only about 70
percent of capacity. A similar situation exists for
many other metals and minerals. Because of these
capacity overhangs, we believe competition amok
This is not to say that business cycle advantages to all
nonoil LDCs will develop slowly. If past cycles are a
guide, the LDCs that provide consumer-oriented man-
ufactured goods will quickly capitalize on Western
recovery. South Korea, Hong Kong, Taiwan, and
Singapore-countries in relatively healthy financial
position-would be the chief gainers. To some extent
this pattern of demand will also benefit Mexico and
Brazil, so long as they have access to supplier credits.
The Protectionist Risk
We believe growing pressures for protectionist policies
in the OECD countries could derail the LDCs' re-
sponse to an upturn in the business cycle. In recent
months several industrial countries have been putting
in place a number of policies designed to discourage
imports. Although some of these barriers are aimed at
aggressive industrial exporters such as Japan, they
indicate a willingness to restrict imports generally:
? France now requires imported video tape recorders
to clear customs at a small inland city and has
instituted a stringent French language requirement
for documentation on all imports. Both measures
will substantially delay import processing.
? Canada is reintroducing quotas on imports of leath-
er shoes and is attempting to use legal clauses in
bilateral agreements with Hong Kong, South Korea,
and Taiwan to reduce clothing imports.
? The EC is moving to restrict steel imports from
LDCs in order to reduce the impact on EC steel
producers of the Community's export restraint
agreement with the United States. In addition, the
EC is cutting textile import quotas and negotiating
agreements with major textile suppliers that go
beyond Multifiber Agreement limits.
We believe industrial country governments will be
hard pressed to ignore pleas for relief from such
industries as mining, manufacturing, and construction
that have suffered disproportionately in the recession.
According to the OECD Secretariat, OECD unem-
ployment, now over 31 million, could approach 34
producers will limit the speed of any price rise.
25X1
25X1
25X1
25X1
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million next year with rates above 10 percent. Even
so, OECD manufacturers are producing far below the
capacity of their factories. Even if the upturn is
vigorous, we believe that industries and unions both
will want to accelerate and protect their gains by
reducing import competition.
Looking Ahead
The next few months will be touch and go on the full
range of issues affecting international finance, trade,
and the OECD business cycle. The immediate risk is
to avoid a sharp and sudden curtailment of bank
lending to any particular country such as Brazil.
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