Balance of Payments Aims and Structures in the 1970's

(#711 ip RFD Series)

INTERNATIONAL FINANCE DISCUSSION PAPERS

BALANCE OF PAYMENTS AIMS AND STRUCTURES IN THE 1970'S

by

Helen B, Junz

Discussion Paper No. 38, December 3, 1973

Division of International Finance

Board of Governors of the Federal Reserve System

The analysis and conclusions of this paper represent the views of the author and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or its staff, Discussion papers in many cases are

circulated in preliminary form to stimulate discussion and

comment and are not to be cited or quoted without the permission of the author,

* Balance of Payments Aims and Structures in the 1970's +/

Helen B. Junz

August 15, 1971 marks a crucial turning point in international financial history. With the suspension of the convertibility of the U.S. dollar into gold or other reserve assets and the de facto adoption of a regime of managed floats for many currencies, the way the international — financial system had’ been functioning since the Bretton Woods conference in the mid- "Forties came to an end. Up to that date, the operation of | the Brettoh' Woods system hinged upon the central role of the U.S. dollar. Other nations pegged the exchange value of their currencies to the : dollar and tied this value to gold on the basis of the readiness of the U.S.: Treasury to convert officially-held dollar balances into gold at fixed rates. Because of this, the dollar had comé to be the hub of the system. Within given rules, other currencies were freely able to vary their exchange value vis-a-vis the dollar. The dollar rate, however, was viewed as the fixed point in the multilateral exchange rate structure and, thus, considered not to be variable at the initiative of the U.S.

‘

authorities.

*This paper was prepared for the Committee for Economic Development: and will be published in The Adjustment Process and Convertibility: Key Issues in International Monetary Reform, CED, forthcoming Spring 1974, and is not to be cited or quoted without CED’ permission.

The views expressed in this paper are those of the author and do not necessarily represent those of the Board of Governors or its staff.

1/ I am grateful to my colleagues, and'in particular to Geza Feketekuty, for patient comment.

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There was nothing in the rules laid down at Bretton Woods that stipulated this asymmetrical treatment of the dollar. The explanation why the dollar came to play this central role in the monetary system is found in the post-war economic reality that the United States was the strongest economy for almost two decades after the end of World War II. By the same token, the restoration anc then the expansion of industrial capacity in Western Europe and Japan has meant a diminished relative economic importance for the United States in more recent years. That is, the United States gradually moved from a dominant position in the international economy towards one of “primus inter pares" among the major industrial powers. The international monetary authorities, however, were slow to recognize the implications of this process. As a result, they did not make needed changes in the way the international monetary arrangements were operated.

It is true that, as a practical matter, the role of the dollar had been changing well before August 15, 1971. Thus, the dollar had not been fully convertible into reserve assets for several years prior to that date. “Moreover, as strains on the international payments system grew during the second half of the 1960's, other countries began to make more active use of exchange rate policy than in the past in order to achieve external as well as domestic policy goals. ‘But these changes were ‘génerally made under crisis conditions and were insufficient to bring

about substantial progress toward better payments equilibriun.

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Thus, there was no. question at-the time of the Smithsonian: . Agreement in December 1971; that a ‘multilateral realignment of exchange rates aimed at eliminating the existing external payments disequilibriawas long overdue. It was .also clear, however, that the realignment -though necessary -- was not, a sufficient step towards assuring that the world economy could operate smoothly in future.

What. other steps were needed? Clearly, the rules urder whith the international economic system had operated had not been sufficient to prevent the build-up of. large and disruptive disequilibria.. When the Bretton Woods system was designed, the. memories of the Nineteen Thirties had predominated. Exchange rate policy during the 'Thirties had been _ used actively, but it had been used with two aims in mind that were not necessarily conducive to restoring equilibrium: first, simply to prevent losses of reserves in the belief that. such losses were inherently un-. desirable; and second, to. achieve:domestic policy goals, in particular the restoration of full employment... This use of exchange rate: policy led to competitive devaluations -- a prime example of so-called beggarthy-neighbor policies -- and international isolationism.

The fixed rate. principle of. the Bretton Woods system sought to prevent these mistakes of the 'Thirties. .And in this way .it- served well. In the post-war world, countries pursued demand management goals by using fiscal and monetary policies, reserving exchange rate policy to .

affect their external payments situation, However, with the rapid growth

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of the flow of goods, services and capital across national borders which this system helped to foster, new problems started to come to the fore. The growing interdependence. of the national economies accelerated the speed with which effects of differential domestic policies and differing economic structures were felt elsewhere. And the system was not sufficiently flexible in that it. provided the opportunity for -- but

did not ensure -- prompt adjustment of international flows to these national differences.

The task of formulating ways and means to prevent the build-up of large disruptive disequilibria in the future has been assigned to an ad hoc Committee of the Board of Governors of the International Monetary Fund on Reform of the International Monetary System and Related Issues, the so-called Committee of Twenty. The talks now going on in that Committee aim at achieving a system that will be responsive to the changing needs of the international community, In fact, the Committee is specifically charged to see that. "reform should meet the present and future needs of the world economy .'2/ However, in order to devise a system that will be shaped to take care not only of current, but also of coming problems, it is necessary to be aware of how economic relations among countries may be changing.

If anything is to be learned from experience, it is that simple

extrapolation of the past into the future may lead to grave misconceptions.

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2/ International Monetary Fund, Annual Report, 1972, Washington, D.C., a 1972,

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This is clearly evident. as one looks at . the sharp differences between the post-war decades. Thus, the late "Forties and the early ‘Fifties were characterized by supply constraints. This meant that markets, .and. . particularly markets for manufactured goods, were dominated by those who had the capacity to supply, i.e., producers in Great Britain and in the United States. In the late 1950's and 1960's, as war-damaged capacities were rebuilt and restrictions on the flows of transactions across national borders were relaxed, sellers' markets were gradually transformed into buyers’ markets and market competition increased on sharply. This was particularly true for trade among industrial countries, especially after the growth of this trade was further stimulated by the formation of the European Economic Community (EEC) (See Table 1). Questions regarding the ‘Seventies

As the international community embarks. upon the design of new trading and payments rules for the next decade, the following questions will become particularly relevant: In what respect should one expect. payments trends in the ‘Seventies to differ basically from those that characterized the ‘Fifties and the ‘Sixties? How will: such. differences. * affect the balarce-of-payments aims and policies of different countries? Do the answers to these questions apply equally to the United States and to other countries, or are U.S. payments trends likely to be"subject, to G

a unique set of influences?

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Table 1. Structure of World Trade are OF world trade 1960-1972 (Percentages)

Destination - > Industrial Developing Eastern Total Originy Areas Areas Trading Area World=

Industrial Areas

1960 42.5 — 16.3 2.3 63.8 1965 46.9 13.7 2S 65.9 1970 51.5 12.8 2.6 69.2 1971 51.7 12.9 Uo 26 69.4 1972 52.6 12.1 2.8 69.3 Developing Areas 1960 15.0 4.9 1.0 21.4 1965 13.6 “4.1 1.3 19.5 1970 12.8 3.6 1.0 17.8 1971 12.9 3.7 0.9 17.9 1972 12.9 3.6 0.8 17.9 Eastern Trading Area 1960 2.2 1.0 8.5 11.7 1965 2.5 1.7 7.4 11.7 1970 2.5 1.6 6.4 10.5 1971 2.5 1.5 6.3 10.3 1972 2.4 1.5 6.3 10.3 Total Wor1dt/ 1960 61.9 22.8 11.8 100.0 1965 65.2 ; 20.0 11.4 100.0 1970 63.5 18.5 10.1 100.0 1971 68.9 18.6 9.9 °100.0 1972 69.8 17.9 10.1 100.0

hearer ee eee . .

1/ Including Australia, New Zealand and South Africa, which are not shown separately,

Note: Percentage distributions are based on dollar values of f.0.b. exports.

Source: General Agreement on Tariffs and Trade, International Trade, 1972, Geneva, 1973.

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payments flows during the coming ¢ decade principally 1 relate to (1) the trading relationships between the industrial countries and the rest

of the world; (2) the wor ldwide trading relationships among mitinational firms; and (3) the freedom with which goods, services and capital can

flow across national borders: - rn

—industrial countries

Trade _relationshi 8 between industrial and non-

It has become customary to define the industrial countries as those included in the Organization for Economic Cooperation and Development (ozeD), with the rest of the world constituting the. non-industrial countries, This definition is somewhat misleading, however, since the rest of the world is becoming more and more differentiated in terms of the structure of output of individual countries. Although., it. would be hard to discern an embryo industrial giant similar to Japan. among the non-OECD countries et this time, the capacity of a. growing number. of these countries .to supply manufactured goods is. rising fast. The share . of manufacturing output in total domestic product has grown rapidly. in many of these countries. Perhaps the most notable examples are Mexico, Chile, Peru, Korea, Taiwan, Hong Kong, Tran .and Zaire, to name a few (see Table 2). Clearly, industrialization and export-led growth of . industry is a spreading pattern in a growing number of countries of the non-OECD.

world,

Table 2: Share of Manufacturing Output in Gross Domestic Product at Factor Cost

.., (In, Per Cent)

Mexico Chile Peru. Iran Zaire Hong Kong Korea Taiwan 1950 23 17 i 6258/5 ab/ ae! i968 = 308/ ast! 20S 328/20 38 212/208!

a/ 1960; b/ 1953; c/ 1951; d/ 1967; e/ 1969.

Source;:, United Nationa, Handbook-of International Trade and Development Statistics, New York, 1972.

As shown in Table 3, imports of manufactured goods by industrial countries have risen rapidly, both in total value and as a per cent of apparent internal consumption. It appears that developing countries have a not only been able to expand their capacity to export manufactured goods in line with the rapid rise in’ overall consumption of industrial | countries, but have also increased their share in that consumption slightly. Although this share is still very small, there is little question that it will continue to expand and perhaps, in the absence of trade restrictions, expand very rapidly. In addition, the ability of these countries to meet increasing export demand also indicates an increasing capacity to satisfy internal demand for these products.

As the table shows, the recent increase in the share of non- OECD countries in domestic consumption of industrial countries was largely concentrated in the United States and Japan. For the United

States, for example, the share of total imports of consumer goods

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(other than automobiles) that is supplied by non-industrial countries has risen from 17% in 1965 to 29-1/2% in 1972. Over the same period their share in U.S. imports of non-durable consumer. goods rose from 29-1/2% to 48% and for durable consumer goods from 7-1/4% to 17-3/4%.

The United States and Japan account for the fastest growth of foreign investment activity in a number of the developing countries, particularly in countries in the Pacific area. But there are indications that various European countries, especially Germany, are now stepping up private foreign investment expenditures. Among the factors contributing to this development are increasing labor costs and shortages of skilled labor in these countries; the growth in special trading arrangements between the EEC countries and a number of developing nations; and the changing cost relationships stemming from the recent exchange rate adjustments. Thus, it can be expected that more and more of the manufacture of relatively low-skill, labor intensive goods will spread to various developing countries. Moreover, unless restrictive trade policies are employed that check this, it is likely that the industrial countries as a whole will become increasingly dependent on imports of such goods.

The growth in earnings from exports of light manufactures and the lessened dependence of non-OECD countries on imports of such goods are likely to be accompanied by an increase in demand for capital goods

imports as well as by an expansion in overall import demand as per capita

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incomes rise. In addition, increasing foreign investment in these countries ‘will lead to rising remittances of earnings to the industrial countries. While: the growing industrialization of a number of the non- OECD countries is thus likely to producé a significant shift in individual components of ‘trade. and payments flows between them and OECD countries, , net flows may ‘be affected to a much lesser extent, |

The shift in trade in manufactured goods is likely'to be a fairly gradual and long-run process. A more rapid and, in terms of total values, more important shift will -be produced: by what appears to be a growing import need of the industrial countries for certain primary ‘ products.” The most widely discussed and the most important example of this reed ‘is petroleum. ‘The growth ‘in OECD countries" demand for , energy sources. ‘appears to be outpacing new discoveries within that . area, including the ‘Large natural gas deposits in the North Sea. , In “addition, demand for oil ‘supplies outside the industrial countries! area has’ grown," and is projected to continue to grow rapidly. “While long- ‘range projections necessarily must be very tentative -- and to a ‘certain extent ‘are’ based upon ‘extrapolation of the present | -- even the lover range forécasts' foresee a growing Flow of payments to the oil-producing counties. “The OLL Committee of the OECD estimated in mid- 1973 that the ‘vo lime of import ‘demand for oii in the OECD area is likely t to “about double between 1970 and 1980 (see Table 4). ‘ This ‘would imply, at 1970

prices, ‘an import bill of some $37- $40 billion dollars by 1980 and

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Table 4: Imports of Oil

. Ta | | as per cent of each

Millions of tons area's total demand for oil

— change

1970 — 1989 1970-1980 1970 1980

North America OECD Europe

Japan

TOTAL OECD : OO

Source: Qil, the Present Situation and Future Prospects, Oil Committee,

Organization for Economic Cooperation and Development, Paris, 1973, p. 90.

probably of about two-and-a-half times that amount at current prices. Net receipts of the oil producing countries would be considerably less because of remittances of'oil company and tanker earnings to OECD coufttries: However, they still would be very large compared with current:levels.

It seems that recent events have brought the future a greal deal nearer than the OECD projections of even this recent date could have foreseen. It now appears that in 1974, the oil import bill: for. all OECD.céantries combined -- under the assumption that: normal flows of oil from Arab countries are restored sometime during the first half of the year -could run to about $40 billion. However, the production cutbacks by the Arab countries and the large price increases for crude oil themselves

probably are altering the longer-range outlook materially, | Governments

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have been led to change their policies towards initiation and acceleration of prograns “leading to greater degrees of self- sufficiency in the energy field and both, exploration for energy sources and shifts towards oil alternatives are being stimulated. Consequently, oil import requirements by 1980 may look quite different from those projected now. Nevertheless, whether or not programs aimed at greater self-sufficiency | are successful, oil producing countries outside the OECD area are likely to receive very large earning flows from exports for at least a large part of the decade. Although a number Of ‘the ail producing countries can be expected to respend ali or most of their rising foreign exchange earnings, the ability of some of these countries to increase imports is very low, These latter countries, moreover, are among ‘the main potential producers of large quantities of oil over a long period. They may, at least initially, be “expected ‘to add some part of additional earnings to their reserves. They are also Likely to search intensively for investment outlets for. these funds -- as a number of them are, indeed, already in the process of doing. Consequently, the structure of payments between | the OECD

countries and the rest of the world could be materially altered. The

traditional current account surpluses of the OECD countries may well

diminish significant ly ‘and their net capital flows to the rest of the world may be reduced. ‘To some extent the oil situation, while clearly of special

importance, may only be representative of what is likely to oceur in

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the case of other. primary products. It is true that in contrast to the

oil producing countries, increased imports from the non-oil primary commodity producers should. generally be expe¢ted to be matched by increased exports to these areas, though only with some time lag. Still, for the

industrial world as a whole, such increases in trade. would clearly also

imply a structural shift away from growing current account surpluses with

the rest of the world.

-Trading Relationships, of Multinational Firms

_ The developments discussed in the preceding section are likely to be intensified by trends in the investment and trading patterns of multinational firms. In the 'Sixties, the dynamics of international transactions were dominated by expanding trade among industrial nations. These trends, moreover, were also reflected in and, to some extent, shaped by the investment decisions of multinational firms .: Thus, the largest growth in direct investment flows in the ‘Sixties occurred among industrial nations.. But, as suggested above (p. 8) the 1970's may: be characterized. by a great expansion of trade flows between the industrial countries and the rest of the world. A major role in this shift in trend, furthermore ; will be played by. the activities of. multinational firms.

In the past decade, productive foreign investment has tended to

be located in, or near, the markets it was intended to serve. For example, sales of U.S. subsidiaries to the local market constitute 70

per cent of their total sales. This pattern of inveetment reflected a 7

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reaction to various types of trade barriers and an awareness of differences in local market practices and tastes; and it was also influenced by differences in wage rates and other costs of production. More recently, the latter factors have begun to predominate in some investment flows. Hence, foreign investment patterns are beginning to shift towards production designed to serve export markets. This is particularly true for various investments by U.S. and Japanese. firns,

but European foreign investment for this purpose has also been increasing.

The recent changes in exchange rate relationships, in part, tend to reinforce this process. The change in relative cost relation- _ ships that has resulted from the exchange rate changes has made it more profitable for Japan and European countries to produce in foreign lowcost areas in order to supply both other foreign and their own domestic markets. But, because the change in relative cost relationships also makes it more profitable to produce in the United States, this trend may to some extent be offset as both foreign and U.S. producers increase their investments in the United States in order to supply the local market,

The growth of investment by multinational firms in manufacturing activities in the lesser developed countries is likely to be further stimulated by a growing trend towards initial processing of raw materials in the country of origin. This reflects in part a desire of the material-

rich countries to share in the profits related to utilization of their

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natural resources s and in part @ tendency for industrial countries _to export some high polluting industrial activities. _ These trends, coupled with further growth of investment in the industrial areas stimulated by the enlargement of the Common Market, indicate that trade of multinational firms will continue to be an increasingly important element

in overall trade. _ | -

For the United States at ‘Least, this trend was already apparent during the ‘Sixties, “According to ) estimates made by the U.S, Department of Commerce, about one half of U. s. exports in 1970 involved, in one way or another, subsidiaries of multinational firms, i Perhaps more important, about 20 per cent ‘of U.S. exports in | 1970 appears to have stemmed from transactions of multinational firms with their own affiliates.

The corresponding import share was 15 per cént and mainly involved imports of industrial materiale. “In the nanufecturing area, imports were largely concentrated in the automotive sector, partly reflecting the Canadian automobile agreenent.

| It is "reasonable to. believe that international trade among entities of the same multinational firm will continue to be a very dynamic

factor in the ‘Seventies, and it should be noted that these developments.

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are not confined to the United States. In fact, multinational firms - : “¢ .

‘resident in industrial countries other than the United States are likely

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to expand their worldwide activities ‘more rapidly than U. Ss. based

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companies during the current decade. TT TS

3/ Betty L. Barker, "U.S. Foreign Trade Associated with U.S. Multinational

Companies," Survey of Current Business, U.S. Department of Commerce, Washington, D.C., December, 1972,

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The growing ability‘of a given company to supply: particular markets from different locations may speed the responses of trade flows to changes in market conditions and cost’ structures. Multinationak firms, by their nature, are better placed than purely domestic firms to accumulate market information and, in combination with efficient channels of communication and considerable flexibility of supply possibilities, to act quickly upon such information. Consequently, the growing activities. of multinational firms are likely to accelerate the pace of balance-ofpayments shifts in response to changes in economic activity.

At the same time, balance-of-payments adjustment to structural changes, and notably to exchange rate changes, may on balance well be retarded because of the existence of multinational firms. Quick adjustment requires that domestic producers take full advantage of changes in their competitive position vis-a-vis foreign producers. In other words, the domestic producer should aim to cut as much as possible into the sales of the foreign producer. However, if the foreign producer is part of a multinational complex, it may, at least in the short-run, be more profitable for him not to reduce his subsidiaries' sales to the full extent possible, Such a course, moreover, may not solely be based on economic grounds. There often are also strong political reasons, connected with labor relations and relations with foreign governments, that

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may tend to slow the:adjustment process. . 2

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In all cases, however -- whether they involve slow or fast adjustment -- the responses to changes in cost differentials will first be reflected in profits and second in either earning flows or capital requirements. This leads to a further intermeshing of the various accounts in the external payments structures of individual. countries and intensifies the need for a much better understanding of the relation-

ships among the various accounts and their responses to changes in

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market conditions. For a misunderstanding of these interrelationships can lead to an erroneous view of both the balance-of-payments adjustment process and of countries' balance-of-payments aims. Balance of Payments Aims

Overall equilibrium in payments balances, it is often argued, does not necessarily require a specific notion about what the structure of individual countries' external balances should look like. This may well be true from an accounting point of view: as long. as official settlements balances tend more or less. towards zero, balance-of- payments aims would be met, at least from the limited point of view of equilibrium in international reserve positions. Nevertheless, whether countries do or do not say so explicitly, there are certain payments flows which they consider matters of national priority, or which for economic or political reasons cannot easily be changed. Consequently, external payments goals generally presume a particular longer-run relationship between at least

the current and the capital accounts, if not between items within

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those accounts. Rightly or wrongly, countries will attempt to pursue policies aimed at achieving these goals, Discussions within Working Party 3 (WP-3) of the Economic

Policy Committee of the OECD, a body concerned with international policy consultation on the balance-of-payments adjustment process, have centered upon the question of national balance-of-payments aims and their mutual compatibility. A major element in these discussions has been the assumption that the industrial countries as a whole are justified in aiming at a substantial current surplus vis-4-vis the rest of the world. Such surpluseg are said to be required because of the need to provide real resources to the less developed countries that are financed by both aid and private capital. . |

“In recent years, the current account surplus of the industrial countries vis-d-vis the rest of the’ world has run at about $11 billion annually, equal ‘to about 1/2 of one percent of the combined GNP of the OECD area (see Table 5). But the oil-producing countries have run a small current account , surplus -* of about $1/2 billion -- with the

4/

industrial countries. If the oil producers in the years to come were to run a substantial eurrent account surplus with the industrial

countries amounting to- approximately 1/2 of one percent of the GNP of

4/ For purposes: of Table 3, the oil producing countries are Algeria,

Indonesia, Iran, Iraq, Kuwait, Libya, The Netherlands Antilles, Nigeria, Saudi Arabia, Trinidad and Tobago, und Venezuela. This is the definition used by the International Monetary Fund in compiling its statistics.

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the industrial countries +- that is, of perhaps $20-$30 billion by 1980 depending upon price assumptions and based on the GNP projections to 1980 submitted to the OECD in 1969-70 -- this would fully offset the current surplus the OECD area might be running ~ with the non-oil producers.

These developments suggest that the rationale for the maintenance of relatively large current account surpluses by the industrial countfies needs to be re-examined. The shift in trading relationships between the OECD area and the rest of the world discussed in the preceding section may by itself tend to diminish some of the need for continued growth in the transfer of real resources from the industrial to the less developed countries, This does not mean ‘that poverty levels in the developing countries are such that the need for substantial aid flows no longer remains pressing.

Most of these flows, however, are not without ‘cost and the debt

service ‘ratios for a growing number of the poorer ¢eountries already tends to be excessively high. In addition, the absorptive capacity of these countries for financial capital is limited by their deve lop-

ment potential.

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- 22-7

If the industrial countries were to continue to formulate their balance-of-payments aims in the same GNP percentage terms as they have hitherto -- and as the Japanese government, for example, has continued to do in its official projections to 1977 -- the less developed nations, excluding oil producers, would need to be able to absorb about $40 billion or more in financial flows by 1977. Around $20 billion directly from the industrial countries and perhaps another $20 billion to offset the current account surpluses the oil producing countries would be running with the OECD area. These magnitudes show that under the circumstances assumed, the balance-of-payments aims of the industrial countries would clearly not be realistic. Pursuit of such aims would thus lead to considerable adjustment problems.

Thus, although there is a continuing need for the industrial countries to transfer real resources to the rest of the world, this need is not likely to grow as fast as the stated ba lance-of-payments aims of the industrial countries indicate. Consequently, it will be necessary for OECD countries, individually and as a whole, to rethink their balanceof-payments aims and policies. An integral part of such an exercise would be the problem of how resources from the oil countries might be transmitted to other non-OECD countries. If the oil producers were not to invest directly in non-OECD countries but should find investment in the industrial areas more profitable, this might imply that industrial

countries would need to subsidize such a transfer of resources.

“

(= 23 --

A partial, and’ probably small, offset to. what appears to be a tendency towards a lesser dependence by the .rest. of the world upon direct capital flows from the OECD countries, may result from the growing economic relationships between.the OECD countries and the non-market economies of Eastern Europe, Russia and China. Trade of the OECD area with these countries is still not very large -- it constituted only. 3-1/2 percent of total OECD trade (exports plus imports) in 1972 -- but it has. been growing very fast. Between 1968 and 1972 trade flows between the two areas have about doubled, While some part of this increase resulted from the crop failures in the Soviet Union-in 1972, a large part seems to represent a more basic trend. Since 1967, in fact, trade of Russia and Eastern Europe with OECD countries has been by far the most dynamic. element in. the overall trade of the Eastern trading area. A large part of this trade is financed by export credits, giving rise to increasing capital flows to these countries as the value of trade grows.

Effects on the United States. a

What do the changes in payments trends discussed above imply for the ability of the United States to achieve equilibrium in its overall . payments position in a reasonable period of time?

Although the United States has not generally aimed at a particular structure in its payments balance, it was readily apparent that elimination of the disequilibrium which had been buble up during the "Sixties required

a large shift in the trade balance. In: fact, the U.S. representatives at

the Smithsonian Conference estimated that achievement of a reasonable equilibrium position in the U.S. payments balance required a shift of about $10 billion=’ in the trade balance. They then estimated that in 1972 the U.S. deficit on current account, under conditions of reasonably full employment in the United States and abroad, would amount to $4 billion in the absence of exchange rate or other policy changes; government and private capital flows abroad were figured to run at an underlying annual rate of $6 billion. Reasonable equilibrium in the U.S. payments position, therefore, required a current account surplus of at least $6 billion, implying a swing in the current account balance of $10 billion.

Government analysts arrived at the conclusion that almost all the adjustment would have to come in the trade balance. It is true that a number of observers had postulated that service receipts -- particularly investment income from abroad -- would over time rise sufficiently to allow a sizable current account surplus, even with a zero trade balance. But whatever the arguments pro and con this view, the interest costs of : cumulating official liabilities with rapidly increasing deficits cut substantially into net income from abroad. Hence, this postulate became largely academic.

The realignment of exchange rates from 1971 onward has resulted in an effective devaluation of the U.S. dollar against all other currencies $7 The figure of $13 billion that was widely quoted as the needed shift in

the U.S. current account included a $1 billion offset to a persistent outflow on ‘errors and omissions’ and a $2 billion ‘safety margin." ”

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of over 15 percent. This is a very substantial, change, particularly since the change against some of the main surplus countries, notably. Japan and Germany, has been much greater, i.e., about 27% and. 30% respectively, as of early September 1973. This has, probably created the potential to bring about the desired swing in the U.S.. trade position over the next three years or so. Whether this development will actually result in lasting payments equilibrium depends largely:upon cost.and price trends here and abroad as well as on the extent to which individual countries. may adopt policies. to resist the required shifts in resources. In the debate on what was needed to achieve equilibrium in the

U.S. payments positions, various doubts have been expressed regarding the efficacy of exchange rate changes as an adjustment mechanism. - These doubts, however, rest largely upon a short-run view of the reaction of consumers to relative price changes. In the long run, adjustment that is not achieved by the reaction of pur chases to price changes is likely to be achieved by the reaction of producers to changes in profits. A market situation where there is no discernible reaction to changes either in prices or in profits would imply a degree of compartmentalization that would make markets totally unresponsive to any policy instrument, be it for domestic or for external purposes.

_If the exchange rate changes effected over the past two years are, indeed, sufficient to bring the U.S. payments balance back into equilibrium around the middle of the decade, how are“the structural changes

envisaged for the decade likely to affect this process?

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It is clear | that the increasing dependence of industrial countries upon imports of certain primary products is going to affect the United States more Strongly than it will others, This is so because the United States has in the past been much more self-sufficient for a number of these commodities than have other countries (see Table 4 for oil). ‘It is also probably true, however, that the United States will provide greater Possibilities for the investment needs of the non-OECD - reserve accumulators than will other countries, In addition, the shift in the growth of market demand for goods produced by non-OECD countries may give U.S. producers a competitive advantage. This may occur both as a result of the recent exchange rate changes and because of the commodity and geographic com~ position of this demand, | Conclusion |

A number of the questions raised about structural trends in international transactions show that the 1970's may, indeed, turn out to differ from the 1960's in a number of important respects,

- First, the trading relationships between the OECD and the non- OECD countries may be in the process of fundamental change. It appears clear that the oil-producing countries will run growing current surpluses with the OECD countries and that various other primary producing countries may reduce their current account deficits with the industrial countries. In addition, a number of the more advanced "less-developed! countries may

become more self-sufficient in supplying their own needs for certain kinds

aot ie

of manufactured goods. They may-also attract private investment funds from the industrial’countries in- g¥eater measure than hitherto: . The latter developments could lead to some dimunition of the needs for certain kinds of imports on the part of these’ countries. On the other’ hand, the more rapid pace of industrialization is likely to increase the demand of these countries for capital goods. Consequently,’ while there may be little net change in their overall current balance account: positions vis-a-vis the iridustrial area, a rather ‘significant shift may be registered in the structure of that balance, °The extent to which this will occur will depend largely upon the willingness of the ‘industrial countries to allow further import penetration in their markets for essentially light manufactures,

Second, the current account surpluses or reduced deficits of the primary producers will tend to diminish the need for rising net capital outflows from the industrial countries, ‘In the case of the oil producers, there will be increased capital flows to the industrial countries. This means that the industrial countries will need to review their balance of payments goals which have generally been expressed in terms of substantial and growing current account surpluses.

To the éxtent that countries agree that these goals should be modified, they are likely to err on the: side of attempting to hold on to greater than necessary surpluses. This is partly so because countries have

traditionally erred on this side, but also becduse there may be :littté

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