Macroeconomics for Developing Countries

Raghbendra Jha

• Publisher: Routledge
• Year: 2003
• eBook ISBN: 9781134505432
• Topic: Business
• Subtopic: Business General
• Index: Business

This comprehensively revised and updated edition develops the themes presented in the first edition. Students and teachers who are familiar with the book will notice entirely new chapters as well as significant revision and uptating of existing chapters to take into account global economic changes since the turn of the millennium. With qu

Part 1
The Basic Macroeconomic Framework

1
Macroeconomic problems of developing countries

AN INTRODUCTION

This book is about macroeconomic problems of developing countries. Until quite recently, there was scarcely any independent analysis of such problems within the purview of mainstream macroeconomics. There were several reasons for this and two of them may be mentioned here. First, it was generally perceived that a traditional concern of macroeconomic theory—countercyclical stabilisation—was not very relevant to developing countries. It was felt that the most important concern of policy makers in developing countries was medium- and long-term growth and not short-term stabilisation. Second, there was a perception, almost up to the late 1980s, that the developing countries were not different from developed countries except for levels of per capita income and the like. The developed country represented to the developing country a mirror image of its future.

To be sure, so far as macro problems of developing countries are concerned, there was a significant and distinguished line of theory called structuralism that had always challenged this point of view. It argued that the problem of developing countries were qualitatively different from developed countries and, therefore, required separate treatment. Structuralism provided alternatives to the received doctrine. More recently, structuralism has been enriched by significant contributions from economists such as Sweder van Wijnbergen and Lance Taylor.

The most significant impetus to structuralism, however, was provided not by concerted intellectual debate (although that certainly played a role) but by a historical turn of events in the 1970s. The price of fuel oil quadrupled overnight and the whole trading world was dealt a very significant shock. Developed and developing countries alike faced ever increasing bills for imported fuel oil. Developed countries were more able to deal with this shock for several reasons. First, they produced goods that the Organisation of Petroleum Exporting Countries (OPEC) needed and the prices of these goods could be increased to compensate to the sharp deterioration in the terms of trade. Second, OPEC placed much of its revenues from fuel oil exports in the banks of the developed countries. Third, developed countries had the technological capacity to develop fuel efficient processes and substitutes.

None of these conditions was satisfied in the case of developing countries.¹ The prices of less developed countries’ (LDCs) exports could not be increased substantially; indeed the prices of primary exports from many developing countries have stagnated, LDCs faced adverse balance of payments positions and their technological abilities were and are limited. The LDCs therefore faced a sharp deterioration in their terms of trade as the prices of fuel oil and goods imported from developed countries went up (see Gilbert, 1987). This led to a sharp drop in output potential, which the LDCs tried to counteract by increasing domestic money supply. The ensuing inflation and large balance of payments deficits sent LDC economies into deep crisis. They borrowed from international banks, since borrowing in home markets could only be very limited, and from the International Monetary Fund (IMF).

The IMF imposed severe conditions on loans advanced to LDCs. They were required to devalue currencies, reduce import and other indirect taxes and reduce government expenditure at home. The rationalisation for these policy measures came from the monetary approach to the balance of payments—a theory developed to analyse the balance of payments problems of more developed economies.

The logic behind this approach was as follows. Devaluation was necessary to make the price of foreign exchange realistic. In most LDCs it was felt that the ‘official’ exchange rate of the home currency was overvalued. Devaluation was often made a precondition for granting of assistance.

Devaluation was to be followed by reduction in credit and reduction of indirect taxes and imported goods. The former, by controlling aggregate demand, would reduce inflationary tendencies. Reduction in indirect taxes would lead to more efficient allocation of resources, which would, in turn, improve aggregate supply. This step and devaluation would increase exports. Hence, inflation and the balance of payments deficit could be brought under control.

This is the premise on which IMF conditionalities are based. The record of the performance of countries that had agreed to the IMF conditionalities, however, is somewhat mixed. The immediate impact was to cause hardships to LDC populations as social programmes and employment were sharply curtailed to accommodate lower ceilings on government expenditure. It was hoped that the set of policy measures advocated by the IMF would result in LDC economies becoming more competitive and efficient in the medium run. In some cases this did turn out to be the case but, in other instances, LDC economies experienced sharp stagflation—high unemployment and high inflation—for protracted periods.

The crisis due to the oil shock helped to focus attention on the theoretical underpinnings of the IMF policy prescription. The IMF had been following the point of view that it is not necessary to develop a separate theory to understand the macroeconomic problems of developing countries. It had been focusing almost exclusively on the demand side under the implicit assumption tha...

Table of contents

• COVER PAGE
• TITLE PAGE
• COPYRIGHT PAGE
• PREFACE
• PREFACE TO THE FIRST EDITION
• PART 1 THE BASIC MACROECONOMIC FRAMEWORK
• PART II MACROECONOMIC MODELS OF DEVELOPING COUNTRIES
• PART III POLICY DILEMMAS FACED BY DEVELOPING COUNTRIES
• PART IV ISSUES IN DEVELOPING COUNTRIES’ MACROECONOMICS
• BIBLIOGRAPHY