Journal Issue


International Monetary Fund. External Relations Dept.
Published Date:
September 1988
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Ralph C. Bryant, Dale W. Henderson, Gerald Holtham, Peter Hooper, Steven A. Symansky (editors)

Empirical Macroeconomics for Interdependent Economies

The Brookings Institution, Washington, DC, 1988, xvii + 342 pp., $37.95.

Ralph C. Bryant, Richard Portes (editors)

Global Macroeconomics - Policy Conflict and Cooperation

Centre for Economic Policy Research, London, McMillan Press, London, 1987, xix + 347 pp., $55.00.

One of the most significant economic policy developments of the mid-1980s has been the rediscovery of the importance of policy coordination. The philosophy of the first Reagan Administration had been for each country to focus on getting its own economic house in order, and to allow the free functioning of a floating exchange rate system to take care of international interactions.

We now know where such an approach leads. If the major countries have unplanned divergencies in policy mix, exchange rates can move away from a longer-run sustainable relationship, causing costly shifts in trade patterns, uncertainty, reduced investment, and protectionist pressures. In other words, policy “spillovers” from one country to another carry significant potential for disruption. It is the desire to avoid such outcomes that stands behind the revived interest in policy coordination among both academics and policymakers.

It is one thing to endorse the desirability of international cooperation. It is quite another to undertake the detailed analytical work that is required for effective coordination. That is where the contribution of these two books comes in. Both of them are the product of conferences that brought together academics and officials who are at the forefront of thinking in this field. And both are rich in analytical insights and detailed empirical work. The more ambitious of the two is “Empirical Macroeconomics for Interdependent Economies.” This two-volume study is the outcome of a major project sponsored by Brookings, designed to improve empirical understanding of international macroeconomic interactions. Twelve international econometric models are brought together and used to conduct a common set of simulation experiments. The results of these simulations are presented in both tabular and graphical forms. They are fascinating for what they reveal both about the diversity and points of consensus in the models. The authors provide an invaluable reference of multipliers that will be used by applied econometricians, and indeed the profession at large, for years to come.

Volume One includes the papers presented at a conference to review the results of the project, held in March 1986. One set of papers compares and evaluates the various models, providing a useful basis for distinguishing those relationships that appear to be sufficiently robust to be used for policy purposes from those where the empirical evidence suggests caution in reaching conclusions. Another set examines questions of model specification, including the treatment of expectations, the role of the supply side, and the determination of the exchange rates. And the final set addresses issues related to the use of models in policy making.

The other book, edited by Bryant and Portes, discusses similar issues, although without the practical perspective of model comparisons. The opening two papers consider the application of game theory. In reading these papers, one sympathizes with Willem Buiter’s hope, in his summary of the discussion, that “tool makers will in the future be guided more by the needs of the tool users in macroeconomics and other applied fields.”

More useful insights are to be gained from the papers that examine, respectively, the importance of policymakers’ reputations, and the problems that arise under “model uncertainty.” The conclusion that is reached, not suprisingly, is that strong policy coordination has fewer benefits in circumstances where doubts exist concerning the ways in which economies interact.

Two studies examine the behavior of the European Monetary System as a practical experiment in policy coordination, and the final two papers for the conference address the hitherto neglected area of North-South interdependence. The protracted debt crisis has added a new and seemingly intractable aspect to the question of relations between industrialized and developing countries. One can only applaud the additional attention being given to this question, even though modelling the relationships involved would be difficult.

Andrew Crockett

Richard M. Goodwin and Lionello F. Punzo

The Dynamics of a Capitalist Economy

A Multi-sectoral Approach

Westview Press, Boulder, CO, USA, 1987, xiv + 402 pp., $43.95.

This book is an epic treatment of two major issues in economics: growth and cycles in capitalist economies. Professor Goodwin, long familiar to students of business cycles through his early work on economic dynamics, has again succeeded in extending the frontiers of political economy by applying modern theories of chaos and catastrophe to the study of macro-dynamics.

The authors start from the fundamental hypothesis that growth generates cycles and that cycles interrupt growth, rather than from the more familiar approach which treats growth and cycles as unrelated. Along with Schumpeter, the authors perceive capitalist economies to grow in an unsteady manner. A drive for profit forces recurring changes in industrial structure through technological change.

Goodwin and Punzo reject the classical view that resources and land are constraints on growth. The labor force instead is viewed as the binding constraint. The search for profit generates a rate of growth that reduces unemployment until labor becomes scarce, resulting in a rising real wage and a rising share of wages. Anticipations of a decline in profits lead to a scaling back of investment expenditure and hence output. The ensuing recession reduces employment and growth in wages. Lower profits, caused by excess capacity, encourage the adoption of labor-saving innovations and new production processes. New processes provide the sufficient conditions for a cyclical upswing, while the presence of unemployment provides the necessary conditions. A higher growth rate then eliminates unemployment and the cycle begins anew. Profits and growth rates, initially too high and then too low, average out to long-run equilibrium values. The amplitude of the cycle depends on how important the technological innovations are. In the absence of such innovations, the cycle may be limited in its severity.

The difficulty with this approach, both technically and economically, is in the explanation of the turning points. The upper turning point is reached when the labor supply constraint becomes binding, while explanation of the lower turning point relies on the Schumpeterian appearance of new processes which restore profitability in conditions of excess capacity.

The common cause of growth and cycles in the model constructed by the authors is technical progress. Growth occurs because the economy produces a pure surplus—in the form of profits—available for investment. The arrival over time of new production processes ensures that profit and hence growth accrues even in the long run. Hence, a theory of distribution also flows naturally from the presence of a surplus.

Like Schumpeter, the authors liberally criticize the use of the conventional analytical apparatus in economics, as being appropriate for classical mechanics but not for social systems. They believe that industrial capitalism, viewed as a perpetually evolving organism in a non-steady state, cannot be analyzed with the tools of classical analysis. Instead, they view the evolution of the economy as being driven by such changes in parameters as produce bifurcations, or regime changes, in the dynamic system.

The authors have fully succeeded in their attempt to present a dynamic model with the features described above. Such success, which had eluded Schumpeter, has been made possible by Thorn’s recent work on structural stability. The main shortcoming of this approach is the limited scope it offers for empirical modeling. Thus, while this book greatly improves our conceptual understanding of growth and cycles, its practical relevance for improving policy is limited. This book also leaves much to be desired in its discussion of alternative approaches. For example, the bibliography does not contain a single reference to any of the relevant recent work on equilibrium business cycles.

David Folkerts-Landau

Robert M. Stern (editor)

US Trade Policies in a Changing World Economy

The MIT Press, Cambridge, MA, USA, 1987, 437 pp., $25.

This book contains a series of lucid, well argued, and thought-provoking analytical essays by notable economists on a range of trade policy issues confronting the United States. It is very timely. The Uruguay Round of multilateral trade negotiations is under way. Given the tensions that currently beset trade relations between major trading partners, the liberalization and strengthening of the international trading system is not assured. Success in achieving these aims of the Round will become increasingly elusive if the drift toward protectionism in US commercial policy continues. Advocates of protectionism will find little comfort in this volume. Instead, they will find many sound arguments for liberal US trade policies and continued US support for a nondiscriminatory multilateral trading system based on free trade principles.

The antiprotectionist tone of the volume is especially clear in the essay by Rudiger Dornbusch and Jeffrey Frankel on macroeconomics and protection. They argue persuasively that coordinated macroeconomic action by the major trading partners, rather than protectionist measures (such as an import surcharge in the United States), is required to correct the US trade imbalance. Such a position, by implication, would seem to support the role of the Fund in continuing to promote the stable international economic environment necessary to abate trade tensions.

In an essay entitled “Strategic Sectors and International Competition,” Paul Krug-man eloquently shows that at the micro-economic level, the gains from government intervention to support firms are marginal in an imperfectly competitive environment. Indeed, such intervention could lead to costly trade wars. These are important results for they imply that although the arguments for free trade are no longer as clear cut as they once were, free trade is, as Krugman has written elsewhere, yet an appropriate “rule of thumb in a world whose politics are as imperfect as its markets.”

A corollary of this point, as noted by Alan Deardorff and Robert Stern in their essay on current issues in trade policy, is that a warning by governments to retaliate in response to exploitative trade actions may serve to foster freer trade. However, in “How Should the United States Respond to Other Countries’ Trade Policies?” Avi-nash Dixit finds that the United States is not well placed institutionally for the successful exercise of threats. Rather, it should seek effective cooperation with its trading partners. But the question of what sort of cooperation should be pursued remains. Cooperation on a bilateral basis carries dangers, such as the eventual fragmentation of the system into discriminatory trading blocs.

In his essay entitled “Multilateral and Bilateral Negotiating Approaches for the Conduct of US Trade Policies,” John Jackson says that multilateral cooperation must deal with the “free-rider” question where some countries enjoy the benefits of cooperation but do not themselves extend it. The real problem, as Dixit points out, is to devise a set of rules which will instill trust and so establish a viable regime of free trade. Max Corden, in “On Making Rules for the International Trading System,” is clear that the United States as the largest and most visible market economy and trader, has a dominant role to play in framing the rules, and must set an example by showing it believes in the long-term mutual gain of free trade.

The above are but a sample of the topics covered in the volume. It is must reading not only for students of trade theory and policy but also for the negotiators in the Uruguay Round.

Clemens Boonekamp

Robert Z. Lawrence and Charles L. Shultze (editors)

Barriers to European Growth

A Transatlantic View

Brookings Institution, Washington, DC, USA, 1987, xvii + 619pp., $18.95 (paper), $39.95 (cloth).

This volume is a comprehensive examination by several American scholars of the recent European predicament of low growth and high unemployment. It contains a number of studies which attempt to assess the four principal hypotheses that have been advanced to explain Europe’s difficulties, namely, secular shifts in the structural growth patterns; the debilitating effects of the welfare state on incentives and enterprise; excessively high and downwardly rigid real wages; and the interaction of exogenous shocks with macroeconomic policies. The implications of these hypotheses are carefully examined by individual authors for different areas of economic performance. Krugman sets out an analytical framework within which to examine these issues and the editors provide a thoughtful overview. The sheer range of issues explored and the almost uniformly high quality of the analysis makes this volume invaluable for students of the European economy.

The papers generally reject the pessimistic conclusion that the causes of Europe’s recent disappointing economic performance are so deep-rooted and interlocked as to create an unbreakable cycle of stagnation. Rather, the rise in unemployment in Europe is attributed to two main causes: the “hysteresis” effects in the determination of wages stemming from the phenomenon of the natural rate of unemployment following the actual rate rather closely; and structural rigidities in the labor market characterized by decreased mobility among firms, industries, and regions. While the moderation of real wage aspirations is regarded as important, the consensus of the studies is that the room for expanding employment, with constant output, through a change in the ratio of wages to capital costs is limited. Accordingly, wage moderation needs to be accompanied by macroeconomic policies designed to raise the growth of output above that of its long-term potential. In the overview, the editors suggest that the experience of sustained high unemployment may itself have led to protective mechanisms and rigidities that tend to perpetuate high unemployment. Therefore, structural improvements in the labor and product markets are much more likely to occur in an environment of economic growth than in the present climate of low growth. Hence, they advocate a two-pronged strategy of structural reforms coupled with expansionary macroeconomic policies.

The main thesis and the preferred strategy is rather similar to the “Two-Handed Approach” expounded by European scholars in recent years, notably in studies produced under the joint initiative of the Commission of the European Communities and the Center for European Policy Studies. The contribution of the volume is in a forceful restatement of the argument that, however inevitable and necessary the recent restrictive policies may have been to reduce inflation and to moderate real wage aspirations, there is little evidence that they have improved the flexibility of European economies, and some evidence—such as the hysteretic component of unemployment—that slow growth may have reduced adaptability. The argument for combining expansionary policies with structural reforms rests crucially on the likelihood of a positive relationship between the growth of employment and the reduction in rigidities. Here, one suspects that the volume is unlikely to pursuade those who believe that only austerity is capable of altering entrenched patterns of attitude and behavior.

Subhash M. Thakur

Maxwell J. Fry

Money, Interest, and Banking in Economic Development

The John Hopkins University Press, Baltimore, MD, USA, 1988, xx + 522 pp., $14.95 (paper).

This book effectively summarizes Professor Fry’s views on the development of the financial sector and its impact on economic performance. The first part analyzes theoretical models of financial development. The second is a review of the econometric evidence regarding the effects of financial conditions on economic performance. The third part is less homogeneous and examines several specific issues such as the contribution of financial intermediation to economic progress, characteristics of financial systems in developing countries, and the role of government intervention in financial development and regulation. Finally, Professor Fry offers recommendations on interest rate policies and selective credit controls. This part also includes his general strategy for financial development, illustrated by an analysis of the monetary and financial policies pursued by middle income developing countries in Asia and Latin America. In addition, there is an extensive bibliography which, in itself, is well worth the price of the book.

A key conclusion of this book is that the macroeconomic environment is critical to financial development. Moreover, in the absence of a coherent set of economic policies, a second-best liberalization effort may well produce better results than a textbook strategy that may overlook country-specific problems. The generous use of materials from the IMF and the World Bank throws light on the advice these institutions offer to member countries on financial sector issues.

The wide range of issues that this book covers is both its strong point and its Achilles’ heel. While I am grateful to the author for reviewing such a large body of literature, the sheer size of the undertaking cannot but result in a somewhat cursory discussion of certain topics. Subjects that would have benefited from a more careful analysis include reserve requirements, and the role of financial institutions and markets.

Similarly, examples drawn from so many countries, although helpful, lead to oversimplification. For example, to say that “the interbank market in the Yemen Arab Republic is impeded by reserve requirements imposed on borrowed funds” certainly strikes me as puzzling, considering that there are a number of other equally compelling reasons why the interbank market is not particularly developed in that country and that these requirements are applied in much the same way in a number of other countries.

Despite these shortcomings, I would recommend this book to students of financial sector problems in developing countries.

Sergio Pereira Leite

C. Peter Timmer (editor)

The Corn Economy in Indonesia

Cornell University Press, Ithaca, NY, USA, 1987, + 302 pp., $29.95.

Policymakers, academics, and commodity analysts should find this book interesting and useful. Students and their teachers will find that it presents a good model for commodity studies, and commodity analysts who work in developing countries will find it useful because of its detailed information on production, consumption, and marketing issues needed to understand agriculture in a developing country.

The book is a report on the research of a team studying the food economy of Indonesia primarily through the Food Research Institute of Stanford University. But it is not just policymakers in Indonesia who will find it useful. Policymakers everywhere can use the framework and results to judge the efficacy of planned investments and policy interventions designed to develop agricultural commodity systems.

The study’s approach is three-dimensional. First, the commodity system is examined and the technical and market links are traced from input supplier to producer, processor, and consumer. The second dimension is the macro-trade level in which the role of corn is examined in generating domestic value-added and foreign exchange. The third dimension centers on food policy. In the latter, the efficiency of commodity systems is analyzed together with the distribution of their benefits in order to evaluate potential public investments and policy interventions.

The first of the book’s five sections provides an overview of the Indonesian com economy set against the background of the country’s geography and demography. The second part focuses on production—including agronomic and economic relationships. Part three discusses demand for corn in Indonesia including its role as a staple food, its growing importance as a livestock feed, and its potential use as an industrial product. Part four is a discussion of the marketing and international trade of corn. The final section reviews the policy options available and their likely impact on the corn industry.

Having reviewed the spectrum of policy options, the book stops short of recommending the best ones. This and the scarcity of quantitative analysis are the most significant criticisms that can be made of the book. Although some econometric results are provided, very little quantification of the important demand and supply parameters needed for policy analysis is presented.

Donald Mitchell

James K. Boyce

Agrarian Impasse in Bengal

Institutional Constraints to Technological Change

Oxford University Press, New York, NY, USA, 1987, xviii + 308 pp., $60 (cloth), $24.95 (paper).

Writing a book about the agrarian problems of Bengal is an unusual undertaking because Bengal has been divided between two countries for more than 40 years. The eastern part became East Pakistan in 1947, then Bangladesh in 1971; the western part is now West Bengal—the fourth most populous state of India since partition of the subcontinent.

In a meticulous examination of agricultural production data of Bangladesh and West Bengal, Boyce finds that agricultural output since 1949 has lagged significantly behind population growth in both the territories. Output growth increased in both, however, after the introduction of Green Revolution technology in the mid-1960s. The author argues that rural population growth in both areas led to technological changes and a resulting production increase, although the force of this “induced innovation” was not strong enough to prevent per capita output from falling substantially.

Boyce designates fertilizer, high-yield crop varieties, and water control, including irrigation, as the major determinants of agricultural growth for the region. Because large-scale investment is critical in water control and because such investment is usually beyond the capacity of individual cultivators to finance, he identifies it as the binding technical constraint upon agricultural growth.

Another constraint to agricultural growth in both areas is the inequitable agrarian structure. Such inequality leads to widespread sharecropping and wage labor in spite of low average land to labor ratio. One result is lower labor input and output per unit of land as compared with that of owner farmers. Inequality also impedes technological progress in the critical area of water control: the landless have no incentive to contribute work in a collective effort to build water-related facilities.

The author points out that the State can circumvent institutional barriers to water control. This has happened up to a point in both Bangladesh and West Bengal. But intervention is costly where a government’s resources are limited. An alternative is land reform, so that barriers posed by vested interests of the rural elite are removed.

It is hard to disagree with the book’s main theses. The reader would have benefitted had the book dealt with certain other issues, such as the interrelationship between agriculture and the rest of the economy. This is especially important in view of the difference in the economic and political structure of the two areas.

Second, the book’s main emphasis is on the constraints of supply side. An important question is whether it is possible to have rapid growth even at the cost of a greatly exacerbated income inequality. The question is particularly important for Bangladesh where agricultural production is largely oriented towards domestic consumption. Adequate expansion of domestic demand for agricultural products would largely depend on increased income for the rural masses.

Finally, the author seems overly optimistic about the effect that an egalitarian distribution of land ownership would have on removing constraints to water control projects. Here, one would do well to analyze the recent Chinese experience, where the replacement of the commune system by the system of household contract with egalitarian access to land has led to a dramatic decline in rural infrastructure. It is thus important to recognize that an egalitarian land reform, though highly desirable by itself and conducive to increased efficiency in several ways, would not automatically lead to large-scale capital construction in agriculture through labor mobilization.

A.R. Khan

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