lIE Imports of Developing Countries
An Empirical Model of Intertemporal Allocation
and Financial Constraints
L. Alan Winters
WORLD BANK STAFF WORKING PAPERS
Number 740
WORLD BANK STAFF WORKING PAPERS
Number 740
Imports of Developing Countries
An Empirical Model of Intertemporal Allocation
and Financial Constraints
L. Alan Winters
The World Bank
Washington, D.C., U.S.A.
Copyright (C 1985
The International Bank for Reconstruction
and Development/THE WORLD BANK
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Washington, D.C. 20433, U.S.A.
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First printing July 1985
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L. Alan Winters is an economist with the International Economic Research Division
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Library of Congress Cataloging in Publication Data
Winters, L. Alan.
Imports of developing countries.
(World Bank staff working papers ; no. 740)
Bibliography: p.
1. Developing countries--Commerce--Econometric
models. I. Title. II. Series.
HF4055.W56 1985 382'.5'091724 85-12131
ISBN 0-8213-0565-4
Abstract
This paper specifies and estimates for three developing
countries two intertemporal models of total imports. Imports are
related alternatively to foreign exchange receipts and to GNP, with
explicit account taken of expectations about the future values of these
variables, future import prices and interest rates. Using non-nested
hypothesis tests, the models are compared between themselves and with
two other models of imports in the literature. While the results are
not entirely satisfactory, they suggest that the intertemporal approach
is quite promising. As this attempt is the first to estimate an
intertemporal model of international trade, considerable space is
devoted to the operational specification of the theoretical models.
In preparing this paper I benefitted considerably from comments
on an earlier draft by participants at the International Economics
Seminar at the Johns Hopkins School for Advanced International Studies,
and by Professors Jonathan Eaton, James Riedel and Robert Stern. Kathi
Yu also helped in its preparation, both through discussions and first-
rate research assistance. Karen Adams, Jean Epps and Vicky Sugui shared
the unreasonable burden of typing several drafts, and Whitney Watriss
edited the final text. I am most grateful to all these people.
Naturally, none of them is to be implicated in the paper's remaining
shortcomings.
TABLE OF CONTENTS
Page No.
Is Introduction .................................................. I
II. Models in the Literature .. . .. . 5
Imports and Reserves ................... ......................... . 5
Intertemporal Allocation .... ... ..... ........... ................. 8
III. Some Empirical Aspects of the Problem .................... 14
Plans and Mistakes ........ .............. .o............ 14
The Market for Loans ....... . .......... ........ 16
Utility Functions ...... .. ............... . 18
The Role of Internal Factors .......... ... ... 20
Investment ........................................ o........... 21
IV. A Foreign Model of Imports ............................... 22
The Foreign Wealth Model ....... .................... .. . 22
The Rate of Time Preference . ............................. 26
Measuring Wealth ........ .................. .......... .. . 29
Expectation Tests of the.Foreign.Wealth.Mode............ 38
Interest Rates ..**............................................. 41
Dynamics ......... .......................... 50... 41
V. The Domestic Model ....................................... 44
Sachs' Model ................................................. 44
Dornbusch's Model ....o....... .......,.......... .......... ......47
VI. Specific ation Tests of the Foreign Wealth Model .......... 49
The Sample .................................................. 50
The EsDo m ticon M e....... .. ......... s... .,........... ......... 51
The Tests ional.Mo......... . ..o. ........... .. ....... 53
VII. Preferred Equations for the Foreign Wealth Model ............................... 62
Malaysia ...... .o........................................... 63
Colombia ..*....... .o.........,..... ............... .......... 67
Kenya ..... o......... .......... o........................... 69
Conclusions ........o ...#........... ............................ 71
VIII. Other Models ................ ....... ..*...................... 73
The Domestic Models ...#........................................... 73
The Traditional Model .........................so................... 77
TABLE OF CONTENTS (continued)
Page No.
The Hemphill Model ..... ....... ................... 77
Structural Stability ............... . 80
IX. Comparing the Models .......... ...................... 83
X. Conclusions ....................................... 93
Appendix: Data and Definitions ........ ........ ...... .. 95
General Definitions ...................... . .......... 95
Malaysia ...... . .. ............. .... ... 96
Colombia. .o ................................... 98
Kenya . . . . .* . ................................ 99
LIST OF TABLES AND FIGURES
Page No.
Table 6.1 Wealth Definition Tests (r = 10 percent) .. ............ 56
Table 6.2 Restriction Tests (r = 10 percent) ............. ........ 57
Table 6.3 The Effects of Different Interest Rates .......... .....58
Table 7.1 Preferred Equations for Malaysia .......... .... 65
Table 7.2 Preferred Equations for Colombia ...................... 68
Table 7.3 Preferred Equations for Kenya ......................... 70
Table 8.1 Structural Stability Tests ............................ 82
Table 9.1 Non-Nested Tests and Fits-- Malaysia ................. 86
Table 9.2 Non-Nested Tests and Fits - Colombia ............... 88
Table 9.3 Non-Nested Tests and Fits --Kenya .. 90
Figure A.1 Malaysian Oil Exports, Actual and Expected .. . 97
I. INTRODUCTION
The recession of the early 1980s hit developing countries in
two ways. First, the markets for their exports were depressed and were
frequently restricted by protectionism. Second, real rates of interest
rose to unprecedentedly high levels. The latter perhaps constitutes the
unique aspect of the recent experience and should in particular be
contrasted with the experience of the mid-seventies, when interest rates
were low and borrowing plentiful. Then, despite depressed export
revenues, developing countries were able to maintain fairly high rates
of domestic growth by extensive foreign borrowing. This borrowing
allowed them to maintain their demand for imported goods from the OECD
and contributed to the recovery of world economic activity in 1977-78.
It also, however, sowed the seeds of the present difficulties,
for many developing countries became heavily indebted. Hence, when the
real interest rate rose in 1980, they found their capacity to service
their loans severely stretched. This situation was reflected in a
reduced demand for imports, which lowered the growth of industrial
countries' export growth and prolonged their depression. The mutual
reinforcement of depressed markets and declining lending turned the
early 1980s into one of the most extended depressions of recent
history. These same conditions continue to raise questions about the
extent and durability of the current recovery.
While it is certain that the amount of debt, rising interest
rates and falling export revenues have curtailed developing countries'
-2-
imports, there has been little formal econometric work devoted to
quantifying the effects or even to specifying the precise mechanism.
This paper explores certain aspects of how the situation can be modelled
and presents a very simple and highly specialized estimation model. The
starting point is that developing countries' decisions to borrow and to
import are made jointly: one decision does not completely dominate the
other. Thus our model assumes neither that imports are determined as
the sum of exogenously given exports and net borrowing, nor that
borrowing is determined by the difference between exogenously given
exports and imports.
The basic framework comprises a balance of payments identity
and a behavioral sector that explains borrowing and importing. The
former is:
X + M + N + F =O (1.1)
where X = The value of exports of goods and non-factor services
M = The value of imports of goods and services
N = Net factor payments and
F = Net borrowing, including changes in foreign exchange
reserves.
The behavioral component is:
M = M (X,N,Z) (1.2a)
F = F (X,N,Z) (1.2b)
where Z = A vector of exogenous variables.
-3-.
Given exports and factor payments, the balance of payments
constraint ensures that only one of (1.2a) and (1.2b) is independent.
Thus, it is necessary to estimate only one. However, the variables
relating to "borrowing," such as the interest rate, will still enter the
import equation, and vice-versa. The reason is that since X + N, then
am - aF. As our interest here is in imports, we focus on (1.2a).
(This approach assumes that the errors and omissions in the balance of
payments account are not important. If they were, it might be desirable
to estimate both [1.2a] and [1.2b], essentially dropping [1.11 from the
system.)
Because our purpose is mainly exploratory, we concentrate below
on the relationship between imports and the borrowing variables. Our
aim is to produce a simple equation that links import behavior to the
borrowing variables in a theoretically clear manner. Simplicity is
important, because ultimately our intention is to estimate the model for
many developing countries, with a view to making global projections.
The paper starts with a survey of existing models of import
behavior and borrowing (Section II). This review is followed in Section
III by a discussion of the various lessons that may be drawn from
previous efforts. Next we specify our own models in some detail. We
explore two basic versions -- one that is based solely on foreign
exchange considerations (Section IV), the other taking into account
domestic factors as well (Section V) -- and we distinguish between pure
equilibrium models and models embodying some degree of disequilibrium.
To our knowledge, this effort is the first empirical implementation of
models of the kind we are using. Thus we devote considerable space to
the concept and to the measurement of the variables.
-4-
In the subsequent four sections, the models are estimated for
three developing countries chosen at random. Section VI is devoted to a
general test of the specification of the wealth model based on foreign
exchange earnings. It treats the three countries merely as three
examples of the same process and considers, first, whether certain
necessary implications of the model are empirically valid and, second,
which of several approaches to measuring wealth seems best. In general,
the implications are satisfied, so that in the next section, VII, the
basic model is estimated and simplified for each country separately.
The results suggest a fairly high degree of intertemporal substitution
for imports. Section VIII is devoted to estimating three other models
- the wealth model based on domestic flows, and two simple models from
the literature against which to test the new models. The results of
this effort are mixed -- the new model shows some capacity to explain
imports, but is matched or surpassed by one of the strawmen.
In the final section, X, conclusions are drawn about directions
for future research.
The heart of the paper is Section IV, in which we describe our
models, and Sections VI to IX, where we test them. Readers familiar
with (or uninterested in) previous attempts to model imports and
financial conditions could start with these sections, referring back
only where they require the justification for certain procedures.
-5-
II. MODELS IN THE LITERATURE
Two broad approaches to the question of developing countries'
imports and financial variables may be identified. The first looks at
the allocation of a given amount of foreign exchange between imports and
increments to reserves: reserves are assumed to be desirable for some
intertemporal reason, although this assumption does not figure
prominently in the specification. The second approach is more
explicitly intertemporal: it treats the current account of the balance
of payments as an investment flow, arguing that it is primarily
determined by the desire to reschedule absorption relative to income.
This section briefly considers the research on these two approaches.
Imports and Reserves
The clearest exposition of the relationship between imports and
foreign exchange reserves in developing countries is Hemphill (1974).
Hemphill supposes that a country has an exogenously given flow of
foreign exchange earnings in each year, Ft, and that this flow must be
allocated between expenditures on imports, Mt, and additions to reserves
ARt. He assumes that long-run imports, M*, must equal long-run
receipts, F*, and that there is a long-run desired stock of reserves,
R*, that is also related to receipts. The allocation of foreign
exchange is then made to minimize the costs (assumed to be quadratic) of
the deviations of actual reserves and imports from their desired (or
long-run) levels. The basic estimating equation is:
M = aO + aRt- + a2Ft +3 AFt (2.1)
-6-
where AF occurs as part of the assumed function for F*. In fact, since
data on Hemphill's definition of reserves are not available, Rt _ 1 has
to be replaced by a cumulative term in AR, but this changes nothing
fundamental.
Hemphill's research is meticulous, and he makes many important
detailed methodological observations. While we do not repeat all of
them here, certain basic points should be made. First, Hemphill
experiments with several different definitions of reserves, shifting
items in the balance of payment accounts from the exogenous component,
F, to the endogenous one, AR. Thus this approach can be adopted to deal
with borrowing and debt. Furthermore, Hemphill shows that, provided the
costs of disequilibrium are quadratic in the differences between actual
and desired magnitudes, countries can have targets for different
components of R without changing the form of the equation (2.1). This
claim amounts to an assumption of separability between imports and the
structure of their (net) finance (F - R). In other words, the
propensity to spend cash on imports does not depend on whether that cash
is owned (reserves) or borrowed.
Second, Hemphill's model assumes constant parameters for the
cost function. That is, the costs of excessive reserves or excessive
borrowing are assumed to be constant over the sample period. This
assumption may have been a good approximation for his pre-1970 sample,
but it certainly requires reconsideration in later years.
A third important feature of Hemphill's approach is that only
financial variables explain imports. The traditional variables such as
income and relative prices are excluded, as are any policy variables.
The logic behind this approach is simple and compelling. Ultimately,
-7-
with inflows of F*, outflows, M*, must be at the same level. Some
rescheduling is possible via AR, but the long-run budget constraint must
eventually be binding: regardless of income and prices, and regardless
of whether imports are limited to F* by market means or by rationing,
ultimately M* = F*. Thus Hemphill conceives the developing country
economy as a single decision unit, with no restraints on its ability to
minimize the costs of disequilibrium. To this concept he adds his
assumption of the constant costs of disequilibrium. The result is that
imports depend only on financial variables.
Later research on imports and reserves has relaxed this aspect
of Hemphill's work. Sundararajan (1983) supposes that desired imports
are determined by a traditional import function, including relative
prices, (PM/p), income, Y, real balances, EM, and policy variables, and
that permitted imports balance these against the need to maintain
reserves. He does not, however, impose the long-run budget
constraint. His basic equation is
Mt =a + (P )t a2 Yt + a3 EMt + a4Ft + a5 R _, (2.2)
which is broadly Hemphill's plus some extra terms.
While Sundararajan does not rationalize it in this way, this
approach is similar to allowing the costs of imports deviating from
desired imports to vary in Hemphill's model. In the latter, if the
costs of constraining imports go up with income and rising domestic
prices, an equation similar to Sundararajan's would emerge. Chu, Hwa
and Krishnamurty (1983) adopt a similiar approach to Sundarajan's.
-8-
Intertemporal Allocation
As noted already, the intertemporal nature of Hemphill's model
is implicit but not prominent. This condition is rectified - but not
without cost -- in the second approach to the determination of imports
-- namely, the intertemporal allocation models. These models sprang to
prominence with Sachs (1981), who argued that the current account
deficits of the seventies owed more to changes in the incentives for
investment and savings than to the direct effects of paying more for
oil. Sachs used a simple two-period model to show how the responses to
economic shocks would vary according to perceptions of the future. In
particular, he showed that whereas an oil-importing country might meet a
temporary rise in the price of oil by borrowing (running a current
account deficit), there was little presumption it would do so for price
rises thought to be permanent. In the first instance, the country would
feel that its wealth, and hence its sustainable level of consumption,
was little changed by the temporary shock. Thus it would tend to
maintain consumption levels over the temporary setback by borrowing,
relying on a lower price in the future to allow repayment of the debt.
In the case of a permanent oil price rise, however, wealth and permanent
consumption would fall pari passu with net income. With no relaxation
in sight, the incentive would be to cut spending back to equal income as
soon as possible. Thus, in this case, the current account would be
negative only during the adjustment period.
The essence of the intertemporal model of imports lies in this
simple model. Consumption depends on wealth -- which includes the
present value of all future income -- and on the rate of transformation
of present into future consumption. The latter involves both the rate
-9-
of interest and expectations about future prices; the comparison of
these with the (unknown) rate of time preference determines whether
consumption is to be shifted forward or backward in time relative to
income.
Sachs (1982) develops this model further. He defines the
"perpetuity" value of any variable, Xp, as that perpetuity that has the
same present value as the actual stream of the variable, X. Thus,
XP tf e-r* (y - t)dy =tf e-r* (y - t)X d (2.3)
where r = The rate of interest and
X(y) = The value of X in period y.
Then, writing the trade balance, TB, as output, Q, less private and
government consumption, C and G, Sachs has:
TB = Q - C - G
and
P P P P
TB = Q - C - G. (2.4)
(Including investment would, in Sachs' words, "enormously complicate the
algebra.")
The intertemporal budget constraint means that the present
value of all future trade deficits must equal current net foreign
assets, B. That is, future trade can only be permanently unbalanced to
the extent that we now have the assets to finance it. Hence TBP =
-r*B. Furthermore, since the present current account, CA, equals (TB +
r*B), we have, from equation (2.4),
-10-
CA = TB - TBP = (Q - Q ) - (C - Cp) - (G - GP). (2.5)
Thus the current account is merely the sum of the differences between
the actual and perpetual values of output and consumption.
Equation (2.5) may be made operational in a number of ways.
Sachs does not discuss government spending, G , further, but perpetual
(permanent) private consumption, CP, is, as above, a function of
wealth. It is the integral of future private income plus current
assets. Thus in period 0,
CD
W(O) = B(O) + f e r Y[Q(y) - G(y)Idy (2.6)
0
= B(O) + [Q p(0) - GP(0)I/r* . (2.7)
However, from the intertemporal budget constraint,
CP(O) = r*B(O) + Q p(0) - GP(O) = r*W(O) , (2.8)
which merely states that perpetual consumption can just be financed from
the returns to wealth. Note that wealth includes all financial and
human wealth (and, if it were recognized, physical wealth).
Current consumption, C, differs from perpetual consumption
according to the incentives to switch consumption between periods.
Adopting a particularly simple intertemporal utility function, Sachs
expresses
c - =(d - r*)W, (2.9)
where 6 is the rate of time preference.
Sach's model contains two goods, both traded. The imported
good has a fixed price in terms of world currency (the numeraire), while
the other, which is exported, faces a downward sloping demand curve.
Its price is thus endogenous and must be substituted out of equation
(2.5) by relating export demand to world trade, T, and overall supply to
the labor force, L, and productivity, R. Thus, the final equation
contains no explicit relative price terms.
Hence, in period 0, the current account may be written as
CA = (r* - 6)W + a1(G - G ) + a2(T - T9) + a3(R - Re), (2.10)
where all variables are measured for period 0. Imports are clearly
derivable from this equation, once we have decided how to calculate the
perpetual values. We shall return to this point below.
In a model similar to Sachs', Dornbusch (1983) considers the
case of traded and non-traded goods. Strictly, he considers four
different prices: current and future import prices and current and
future domestic prices. Imports are stimulated if their current price
falls relative to either current domestic prices or any future prices.
Dornbusch deals with discrete time rather than continuous time, and
derives conditions for the change in planned consumption between two
periods. Given stationary output,
-12-
d log C = a [r* - 6 + a 2dlogPI, (2.11)
where a1 depends on the degree of intertemporal substitution and a2 on
the degree of contemporaneous substitution between domestic and foreign
goods, and where P is the price of imports in terms of home goods.
Dornbusch does not explicitly recognize future import prices in money
terms because he uses traded goods rather than money as his numeraire.
Thus assets represent claims on future traded goods rather than claims
on money. This approach is easily adapted to Sach's nominal framework,
however, by treating r* as the real rate of interest in terms of
imports.
Both Sachs and Dornbusch assume that a country can borrow or
lend unlimited amounts at an exogenously given rate of interest that is
expected to remain constant forevermore. They further assume a constant
rate of time preference. This condition potentially leads to some
difficulty with the intertemporal budget constraint, for it appears to
allow the possibility of indefinite accumulation or decumulation of
assets if r* # 6. Two alternatives are available: first, that
imperfect capital markets impose rising interest rates as borrowing
increases, and, second, that the rate of time preference is an
increasing function of instantaneous utility. This latter option serves
to bring consumption forward in time as wealth accumulates, thus
stabilizing the system. Both these approaches are adopted by Obstfeld
(1982), but since neither utility nor the time preference is observable,
the latter case does not look like a promising avenue for empirical
research. The former, however, is potentially more promising and could
-13-
be either tacked onto our present model or used to close a model based
on optimal growth paths and borrowing. (Both these alternatives are
held to a later occasion.)
The models surveyed in this subsection are theoretically more
appealing than the import/reserve models treated previously. However,
making the intertemporal nature of the import decision explicit vastly
complicates the model's empirical application. Sachs (1981) produced
some simple statistics to support his basic hypothesis, but these did
not constitute a proper test, and later research has, to our knowledge,
yielded no empirical work at all. The reason is the difficulties
involved in operationally capturing expectations and thus, in
particular, in measuring wealth. These problems will be quite evident
when we move to our own estimation.
-14-
III. SOME EMPIRICAL ASPECTS OF THE PROBLEM
The literature offers a choice between a theoretically ad hoc
but easily applicable model and a theoretically complete but almost
totally inapplicable model. The intention of this paper is to bridge
that gap by producing an estimable yet theoretically sound
alternative. We do so primarily by trying to operationalize the
intertemporal models of Sachs and Dornbusch. However, in the course of
developing our alternative, we found that many restrictive assumptions
were necessary to render the system tractable. These are specified
clearly below. Some consideration should be given to their
acceptability, even independently of how well the equations happen to
fit.
This section contains various observations about the models
surveyed in the previous section, in terms of both their theoretical and
empirical (data-based) specifications. It also discusses how the
various features should influence the specification of our own models.
The issues covered include the way in which shocks (mistaken plans)
affect importing, the special assumptions adopted for the capital
markets, the specification of the utility function, the significance of
domestic factors in the import decision, and the incorporation of
investment into the system.
Plans and Mistakes
The intertemporal models solve simultaneously for the whole
time profile of consumption, given the information and expectations
-15-
available at a particular time (say, year 0). However, ignoring forward
purchases, only year O's expenditures are actually made at the time of
calculation; the plans for later years remain only plans. Indeed, by
year 1, it is likely that new information and expectations will have
become available and that the plan will need revising. We could model
the revisions explicitly, but it is easier just to view the plan devised
in year 1 as an entirely new project that determines actual expenditures
in year 1, and so on with new plans for years 2, 3.... Thus our
empirical estimates concern the first year's expenditures in each of a
series of plans, rather than a series of more than one year's
expenditures from only one plan.
In this string of first years, if year 1 turns out exactly as
anticipated in year 0, expenditures in year 1 will be the same under
both plan 0 and plan 1. Furthermore, there will be no regrets in year 1
about what was done in year 0. If, on the other hand, year 1 contains
some surprises, year l's expenditures will be revised from those
intended for it in plan 0, and there will most likely be regrets about
what was actually done in year 0. That is to say, agents will feel that
had they known in year 0 what they know now in year 1, they would have
behaved differently in year 0. Thus, in retrospect, mistakes are
possible, and they make themselves felt through their effect on the
wealth carried forward from one year to the next.
If, for example, the actual interest rate on variable rate
loans in year 1 were higher than had been expected for that year in year
0, developing country policy-makers may well regret that they imported
and borrowed so much in year 0. They will revise consumption (import)
-16-
plans for year 1 downwards relative to those in plan 0, first because
current consumption is rendered more costly relative to future
consumption by the rise in the interest rate, and second because the
debt overhang now has to be serviced at a higher rate than expected, a
situation that reduces real wealth.
The Market for Loans
The models discussed earlier assume that developing countries
can borrow or lend unlimited amounts at exogenously given rates of
interest. Three dimensions of this assumption deserve comment.
First, if the rates of interest for borrowing and lending were
still exogenous but were different, the budget-set of feasible
consumption points would be kinked. Thus, whereas a unit reduction in
present consumption would allow an increase of (1 + rL) units next year,
a unit increase this year would cost (1 + rB) units next year, where (rB
> rL.) This situation would considerably complicate both the analytics
and the empirics, giving rise to discontinuities in importing and
borrowing behavior, without adding much insight to the model. Ignoring
it may, of course, substantially bias the model, but we do not expect it
to do so. A further and sounder reason for ignoring the problem is that
in fact most developing countries do little lending. Thus, provided
that developing countries would still not lend much, even if the
borrowing and lending rates were equal, the borrowing rate is the
relevant one for our purposes.
The second dimension of the borrowing/lending question is the
exogeneity of the interest rate. We might expect that as a country's
-17-
indebtedness rose, so too would its risk premium and hence its borrowing
rate of interest. The evidence for this pattern is, in fact, rather
weak (see Riedel, 1983, and MacDonald, 1983). It could be incorporated
into our model by introducing an additional (simultaneous) equation for
the supply of credit. However, we will ignore this complication for
now.
The third aspect of the borrowing/lending nexus also concerns
the supply curve of credit. Bankers tend to argue that they ration
credit quantitatively rather than through price (interest rates). Hence
developing countries may face a constant rate of interest up to some
level of borrowing, and thereafter a complete stop in borrowing.
However, the evidence that these constraints are frequently or widely
binding is also relatively weak (see Riedel, 1983). Nevertheless, we
can hardly argue that credit limits were never applied in 1983, and so
this problem must be addressed seriously.
Theoretically we could construct a regime-switching model, with
separate equations for the periods of constrained and unconstrained
borrowing. A priori, however, we do not expect to have sufficient
observations on the former to identify it correctly, and there is,
besides, little guidance on how lending constraints are determined.
Further, if the constraint is only on current borrowing, and if we treat
running down the reserves as net borrowing, then the import function
under the constraint becomes particularly simple and uninteresting in
its own right: 1/
1/ The intertemporal allocation becomes more complex if the constraint,
or expected constraints, affect future years.
-18-
M = X +F,
where F = The constrained level of borrowing.
Hence, at least in this first attempt, we estimate only the
"unconstrained" import function, although we are prepared to omit
observations where strong evidence of borrowing constraints exists.
This approach is of interest, first, to see if constraints are actually
necessary in explaining recent import behavior and, second, even if they
are, to define what imports would rise to if the constraints were
relaxed. After examining our results, it is clear that there is plenty
of scope for plenty of future research in this area.
Utility Functions
Both Sachs and Dornbusch assume utility maximization over an
infinite time horizon. The general utility function is of the form
Go
V I (1 + d)1iU(Ci) , (3.1)
i = O
where V = Total utility
U = "Instantaneous" utility and
Ci = Consumption in year i.
Note that the function U() does not change over time and that V is
additively separable in U(Ci). The latter severely limits the pattern
of intertemporal substitution and means that the composition of any
year's consumption bundle is independent of any other's, once the
overall levels of consumption have been determined. The degree of
intertemporal substitution is determined by the curvature of Uo.
-19-
Basically, the more sensitive utility is to declines in consumption, the
greater will be the substitution that will occur between years in order
to smooth away the potential costs.
To be specific, Sachs assumes
V f e 6t log (C ) dt (3.2)
0 t
and Dornbusch
Go
V = i (1 + 6) l C0 ' (3.3)
where, in both cases, Ct is a Cobb-Douglas function of the consumption
of the various goods consumed in t, for example,
C = C a C (1 -a) (34)
t Tt Nt
where CT = The consumption of traded goods and
CN = The consumption of non-traded goods.
The separability of V allows consumption to be determined in
two steps - first total consumption, Ct, as a function of wealth and
annual price indices and, second, disaggregated consumption, CTt, and
CNt as functions of Ct and contemporary prices.
The separability assumption is probably too strong for
reality. For example, it does not permit the option of consuming, say,
a world tour this year rather than next, because next year's composition
of consumption is independent of this year's. Nevertheless, its
practical attractions are such that we shall adopt it. The simple form
-20-
of Ct is useful in rendering the price index for total consumption a
simple function of PTt and PNt, as well as in easing various algebraic
manipulations. This paper is not concerned with disaggregated
consumption, so the issue is postponed, although there are good reasons
for believing that equation (3.4) is far too restrictive (Winters,
1984).
The Role of Internal Factors
An important difference between Hemphill's and every other
study is that Hemphill derives imports solely from "foreign" variables,
that is, variables relating directly to foreign transactions. This
approach arises from his view that, ultimately, the only determinant of
what can be spent on imports is the foreign exchange generated by
exports. Thus, for example, whether imports are relatively cheap or are
urgently needed for domestic growth, or are strongly desired because
wealth has increased, are not, in his scheme, fundamentally important.
It is as if the whole economy were a black box: the input of foreign
exchange from exports and the output for imports must be balanced in the
long run, and what goes on inside the box is really not very
significant.
We could perhaps envision a utility function separable between
domestic output and imports; given a budget constraint for imports,
domestic variables do not affect the import stream. However, this view
is clearly very extreme, for even within an entirely foreign-determined
long-run budget, we might expect domestic factors to influence the
timing of imports. Nonetheless, it is sufficiently attractive
empirically to make it worth exploring. Its empirical attraction is the
-21-
smallness of its parameter set and data requirements. In particular, it
might be easier to measure foreign wealth, namely, foreign assets plus
the present value of future foreign exchange earnings, than total
wealth, namely, total assets plus the present value of future income.
Investment
As Sachs states, investment greatly complicates the analysis of
an intertemporal model, for it both represents a demand and feeds back
into wealth. The simplest procedure practically is to assume that
consumption and investment can be aggregated into a single composite
good (absorption) by virtue of having a constant relative price. This
procedure in turn assumes that the marginal productivity of investment
(in terms of present value) and the rate of time preference bear a
constant relationship to each other. Further, if the aggregate is to be
the sum of consumption and investment (namely, absorption), the constant
relationship must be equality. Thus, a unit of consumption in year 0 is
worth (1 + 6) in year 1 because people are impatient; a unit of
investment in year 0 is worth (1 + 6) of consumption in year 1 because
it actually produces a stream of output that would buy (1 + 6) in year
1. This condition is the Keynes-Ramsey rule for optimal growth paths,
and it implies that consumption and investment are in perfect
equilibrium. We adopt this subterfuge in constructing our basic models,
but relax it crudely when we examine the disequilibrium forms (pages 27-
28).
-22-
IV. A FOREIGN MODEL OF IMPORTS
Having discussed various practical and empirical points in the
previous section, we are now in a position to outline our own models.
These are exploratory and are therefore fairly general, and particular
emphasis is laid on exploring issues of specification. Unfortunately,
many of the models we discuss are not nested, and since they are often
rather similar and we have so very few observations, we do not conduct
many formal non-nested tests. A certain "ad hocery" will therefore be
evident.
The Foreign Wealth Model
We start with the simpler of the two models -- the foreign
wealth one. It follows Hemphill's rationale and concentrates entirely
on foreign variables. We assume a country in which the optimal time
pattern of imports is independent of any domestic variable, which faces
given import prices, and which has exogenous export receipts (strictly
current account credits). In the long run, all imports must be paid for
in foreign exchange derived from current credits. Thus, given initial
assets, these credits define the budget constraint. The country is
assumed to face a common exogenous rate of interest for borrowing and
lending and to be able to borrow or lend unlimited funds at that rate.
Borrowing and assets are seen merely as the means of transferring import
consumption over time.
Assuming that the import sub-utility is quite separable from
domestic factors and that the allocation of imports over types of goods
permits two-stage budgetting, we can write:
-23-
co~~~.
V = [ E HiMi ' (4.1)
i = O
where V = Total "import utility"
6 = The rate of time preference relating consumption in period i
to that in period 0,
Mi = Aggregate imports in period i in quantity terms and
y = A parameter determining the degree of intertemporal
substitution.
The budget constraint that all imports must eventually be paid for is
co 00
Pip, Mi = A0 + X pipi xi (4.2)
where
p = The export prices for year i,
i
'-M
p = The import prices for year i
i
Xi = Exports for year i and
Pi= The discount factor between years i and 0.
Thus
Pi = (1 + ro)1 (1 + r 1) .... (1 + ri - 1)1 , (4.3)
and
pO = 1
where rj = The interest rate for year J.
In year 0, all variables with (i > 0) are unknown; they are necessarily
the subject of expectations, to be discussed shortly.
-24-
If we define present value prices (for year 0) as
Pi pi (44)
then equation (3.2) becomes,
M X
i p OI HPi Xi =W (4.5)
i 0 i0 ~0
which, combined with equation (4.1), yields a perfectly ordinary
allocation model: given wealth, W, choose Mi to maximize V subject to
budget set (4.5).
Equation (4.1) is a CES function, with an elasticity of
substitution (a = 1 l ). We can apply standard results by analogy with
other applications of the CES function (Armington, 1969; Hickman and
Lau, 1973). Thence:
a ri-aPi -
Mi =6i V (i) a= Vt(t -)/P*] , (4.6)
where Pi = PM with the superscript omitted and
P* = A present value price index for all future consumption
of imports, where
P* = I I a E (1-a]1-a (4.7)
1 =0
Obviously, for practical purposes the unobservable V must be eliminated
by multiplying equation (4.6) by Pi and P*/P*, summing, and then
substituting equation (4.7) for P*:
-25-
co co Pi.
_ p1Mi i I O 0 (VP*) ). (4.8)
i 0 i i =0
Thus,
VP* Pi M = w (4.9)
The import plan derived from equation (4.1), given expectations about
future variables, then becomes:
P Mi = 6 W(. (4.10)
This equation implies that if present value prices are equal in
each year, imports will vary over time according to 6di. Since
6 < 6 1- i.e., more distant imports are valued less -- they will
fall over time. From equations (4.6) and (4.7) it may also be shown
that if the time-discounted present value prices (pi/6 d) were equal, the
level of imports would be constant.
Recalling that we are interested only in the first year's
imports (i = 0) from a series of plans formulated in years t = 1, 2...T,
equation (4.10) generates the estimating equation
aPt 1 -a
ptMt =6 g(P*) w, (4.11)
t t
where the subscript t denotes variables measured in period t and where
=1.
-26-
The Rate of Time Preference
There are three problems (at least) in implementing equation
(4.11). First is its non-linearity. All applications of the CES
function face the problem that P*, the aggregate price index, depends on
the unknown parameter a. This problem is easily solved, however, by
non-linear estimation methods or linear approximations (Hickman and Lau,
1973). Our problem is, however, much greater: it is that the 6i are
unknown.
Let the rate of time discount -- assumed to be constant both
across plans and between plans - be d. The discount factor relating
-i
year i's consumption to year 0's, 6i' is (1 + d) , or, in obvious
notation, Si. Thus, all our unknowns about time discounting can be
collapsed into a single parameter 6, which appears in equation (4.7),
the formula for P*. Jumping ahead, we find it convenient to
characterize the present value price series as having a constant growth
rate over each plan (but not between plans). Thus, for the plan
formulated at t, we assume that prices in the years ahead are expected
to be:
i
Pi(t) = n Pt, (4.12)
where nt is the rate of growth of present value prices assumed in plan t
which, along with Pt, is assumed to be known exogenously. Thus, from
equation (4.7),
P t Pt
p a (1 _dn1 a- (4.13)
Pt 16fl )
-27-
whence equation (4.11) becomes
ptM = (1 I t1 a) W. (4. 14)
Equation (4.14) can be estimated in a number of different
forms. -For example, it can be transformed into a linear equation as
follows:
Pt t
from which
p M
log (1 W t a log 6 - (1 - a) log . (4.15)
wt l
Whether this approach is desirable, however, depends on the nature of
the error process underlying the data. The errors of the regression
equation should be normally distributed, homoskedastic and mutually
uncorrelated. If those of equation (4.14) were, then those of equation
(4.15) certainly would not be, and vice-versa. In fact, such
transformations appear to make very little difference at estimation
time.
In a consumption framework, the constancy of the rate of time
discount has some plausibility. However, in an investment context, the
rate of discount will be related to the (expected) marginal productivity
of investment, which may vary over time. As an alternative to the basic
model, therefore, we consider a so-called "disequilibrium" model, in
which the rate of time discount varies with investment opportunities. 1/
1/ "Disequilibrium" is perhaps not such a good nomenclature as "non-
steady-state," but we prefer it on the grounds of stylistic
elegance.
-28-
When the capital stock is below that required by the Keynes-
Ramsey optimal growth path, the marginal return on investment and the
growth rate of GDP will be relatively high, and there will be an
incentive to reschedule national absorption from the future back to the
present. (Consumption may be lower under these circumstances, but total
absorption, of which imports form a part, will be higher.) This
condition is reflected in our model by a fall in 6 -- future output is
given relatively lower weight. We explore this possibility by setting
log 6 = dt = p + Igt (4.16)
where gt can be the growth rate of GDP, the ratio of investment to GDP
or the ratio of investment to wealth. In each case we would expect
I1 < 0.
There is, however, a great danger of simultaneity bias in
substituting equation (4.16) into (4.14) and (4.15). Investment by
developing countries is often thought to depend on imports, in that if
the foreign exchange does not exist to generate a flow of imported
capital goods, then investment will not take place. By way of
illustration, in Malaysia in 1980, imports of machinery and transport
equipment were around M$9 billion (about 30 percent of imports) and
total fixed capital formation was around M$15 billion. These figures
counsel great caution in the use and interpretation of the
disequilibrium results.
The derivation of equation (4.13) assumes that 6°i 1 < < 1.
t
If this assumption were violated, it would benefit the country to import
infinite amounts now and pay off the debt later with depreciated cash.
-29-
Thus, in these circumstances, the country will be constrained in its
borrowing by the lenders and will fall ou,side the purview of our
model. This situation suggests that any observation for
which 6 a a > 1 should be omitted from our sample. Unfortunately,
however, this approach is not necessarily straightforward.
Assuming 6 < 1 and, if, as seems reasonable, 0 4 a < 1, a sufficient
condition for the inequality is that nt < 1, which in turn amounts to
assuming that the real rate of interest (in import terms) is positive,
that is, that import prices increase less rapidly than the rate of
interest. If, however, nt > 1, the inequality depends on the
unknowns 6 and a, and so cannot be tested prior to estimation. However,
to estimate 6 and a correctly, we need to know which observations to
include! Short of a switching-regime model, there is no simple solution
to this dilemma, and it has to be treated ad hoc.
Measuring Wealth
The second problem area concerns the measurement of wealth.
Conceptually it is very simple to do: wealth constitutes owned assets
plus the present value of the stream of foreign exchange receipts, less
scheduled repayments on accumulated debts.
Owned assets should contain a wide range of instruments, but in
practice data are available only for international reserves and the net
assets of the banking system. For many developing countries, however,
these data probably provide a reasonable approximation of foreign-
denominated wealth. We shall assume that domestic assets are not
convertible into foreign exchange, that is, that borrowing is possible
-30-
against future export earnings but not against domestic assets, a fairly
strong assumption.
The present value of export earnings provides no conceptual
problems, once expectations have been determined, but there is one
practical difficulty. If we assume an infinite planning horizon, as
above, the present value becomes infinite if the (expected) rate of
growth of earnings exceeds the (expected) rate of interest. If the
former is denoted by vx and the latter by r (both assumed to be
constant), the present value Wx is:
co icXo + vx
Wx = (1 + r)i Xi= i I1 + r} (4.17)
which is clearly finite only if the bracketed term is less than one. It
is not inconceivable that a country should believe itself infinitely
rich, but it is inconceivable that other countries would lend it the
infinite amounts it would immediately wish to borrow. Thus,
whenever vx > rt, the borrower will be supply-constrained in the loans
market, which would put it beyond our model, a situation that suggests
we should drop those observations from our sample.
Two alternatives to dropping the observations exist. First, we
could respecify the model in terms of an (arbitrary) finite time
horizon. This procedure, while it would complicate certain formulae,
would not change anything fundamental. In these circumstances, Wx would
merely become very large. Second, we could argue that countries
experiencing v X > rt would recognize it as a temporary phenomenon and
would re-adjust their expectations to reverse the inequality. (It is
moot whether world income is actually bounded above.) In this case we
-31-
would merely impose some arbitrary lower limit on (rt - vtX), say, 0.01,
and use this to calculate present value. A similar approach would be
justified if we explicitly recognized uncertainty, for a risk-averse
country would presumably discount future export growth, which would also
reduce the long-run average v x below rt.
An additional factor that must be considered is capital grants,
which are straight additions to wealth. We assume that recipients
expect to receive the same nominal grants in the future as in the
current year.
More complex is concessionary borrowing. While current market
borrowing makes no addition to net wealth, borrowing on softer terms
clearly does so. We assume that such borrowing is rationed by the
donors. If a loan of C is made at concessionary interest
rate ri, rather than at market rate ri, the increment to wealth, or the
grant element of the loan, GE, is:
n
GE i Pi ( i d) (4.18)
where
Pi = The discount factor for year i at market rates,
Ri = The necessary repayment stream if ri had ruled (C = X piRi)
Ri = The repayment stream at rate ri (using discount factors
Pi, C = E piRi, and assuming constant repayments starting
immediately are required).
If the loan is for perpetuity and the rates of interest are constant,
the grant element is easily calculated as:
-32-
eO co
GE = op1 (Ri- ii) =i _ p (rC - rC)
i ~~~~~~~O
= C (r - r) (+r) (4.19)
Obviously, calculating the grant elements requires detailed
information on the nature of the loan, in particular, on the repayment
stream. This information is not easily available to us, but the
External Debt Division of the World Bank has the data and has calculated
the grant elements, assuming that r = 10 percent. The precise formula
is:
GE=~ (1- na) + (1 + -aG +r -am
r/aGE(1+ r') - (1 + r') =} (4.20)
ri r'(aM aG)
where a = The number of repayments a year,
r' = The market rate per period, such that (1 + rn)a = (1 + r)
= 1.1,
G = The grace period before repayments commence and
M = The maturity of the loan,
and where it is assumed that the disbursement is made at the end of year
0 and that the principal is repaid linearly over the time period G to M.
Current borrowing affects net wealth only to the extent that
interest rates are below market rates. Past borrowing, however, affects
wealth more directly, for it reduces current wealth because it must be
repaid. Unfortunately, data on required future repayments at each point
in time are not easily available, and an approximation is needed. The
-33-
total of outstanding debt disbursed at any time (i.e., the principal) is
known. We assume that payments of interest are up to date; so that
outstanding debt represents the amount that, if paid immediately, would
just repay all liabilities. In other words, at market rates of
interest, this total just represents the net present value of the future
repayment stream. However, because concessionary borrowing does not pay
market rates, we must reduce this total by the extent of the grant
element. Since we do not know the dates at which current outstanding
debts were taken out, we use the mean grant element over the sample
period for this calculation.
- Strictly speaking, the grant elements should grow with the
current rate of interest: the higher current rates, the greater the
benefit that a fixed concessionary rate involves, and hence the greater
the excess of the value of the outstanding debt (the capital value) over
the present value of the actual repayment stream. This situation again
is a matter of approximation. Assuming that all loans are for
perpetuity, we can calculate the implied rate of interest (taking into
account grace periods) using equation (4.19), our assumed grant element
and the fact that the grant elements are calculated assuming a market
rate of 10 percent. The implied rate of interest suggests a repayment
stream, which is then converted into a capital value at the ruling
(expected) rate of interest. This capital value is then subtracted from
wealth.
Non-concessionary borrowing is in principle like concessionary
borrowing. We assume that it has a grant element of zero (although, in
fact, borrowing is classed as non-concessionary if its grant element is
below 25 percent). Thus, no adjustment to current wealth is required.
-34-
We calculate the negotiated interest on the outstanding non-
concessionary debt as a weighted average of the market rate over the
previous five years. For the fixed rate debt, we then use this result
to calculate the capital value of future repayments. Non-concessionary
debt also includes variable rate loans, however, that must be treated
differently. The capital value of the principal outstanding is the
principal itself if, as we assume, variable rate loans must be paid at
market rates. This situation is handled simply. We also assume,
however, that between the time of negotiation and the present, any
excess of actual interest payments over those expected when the loan was
taken out is added to the principal outstanding at the present. This
condition is not reflected in the World Bank data and thus must be added
in.
Our only data are one figure a year on the share of outstanding
debt that is at variable rates (from the World Bank Debt Tables). From
this we calculate the absolute amount at variable rates and assume that
this total had been negotiated over the previous five years, with equal
shares of variable interest debt in total debt in each year. Thus,
given a stock of variable rate debt in year t, Vt, we calculate the
amounts negotiated in year (t - i), iVt, where i = l...m, as
Lt
V Vt (4.21)
i t 5
j Lt j
where Lt _j is total non-concessionary loans received in year (t -
J). This procedure is dreadfully crude (and temporally inconsistent),
but it probably meets our need to pick up major interest rate mistakes
satisfactorily.
-35-
For loans negotiated in year (t - i), the interest rate
surprise in year (t - i + J) is (rt - i + j - i + jr - )where
rs is the market rate for year s and sru the rate in year s as
expected in year u. Thus, the additional payment on these loans is
v (r re ), which must be cumulated forward
from (t - i + J) to the present, t. Finally, we must sum over the five
previous years in which the loans were assumed to be raised.
In calculating the burden of interest rate surprises, we make
two approximations for simplicity's sake: we assume (1) that the burden
arising because rt - i + j exceeds the expected rate accumulates to year
t at interest rate rt - i+ j, rather than at rates (rt - i + j, rt - i
+ j + 1)..., etc.; and (2) that debtors expect to pay off their debt at
their long-run expected rate (re e ) a constant, rather than at year-
t-
specific rates. Thus, the change in the principal outstanding in year t
attributable to previous interest rate shocks is
5 i-Ie
I Vt( [r - t + j - rt - i [1 + rt - - +). (4.22)
This treatment of variable rate loans refers only to loans that
are explicitly at variable rates and ignores any fixed rate loans that
were contracted with the intention of renewal. In the absence of data,
we have no alternative.
These calculations use data from the World Bank's External Debt
Division and thus cover only loans with maturities of one year or
more. Thus, we implicitly assume that short-term borrowing has no
wealth effects, i.e., it is always at a rate of interest sufficiently
-36-
close to current market rates that any revaluations may be ignored.
This assumption applies not only to new loans, but also to roll-over
credits with periodicities of less than one year. These are not
entirely happy assumptions, but they seem unavoidable.
Observe that this treatment of grants and borrowing in the
wealth calculations assumes that the loans are disbursed entirely in
year 0. This assumption leads to some overstatement of the grant
element if, in fact, disbursement is delayed. Beyond that small
discrepancy, however, the pattern of disbursements is not important
under our assumptions, since we presume that any amount of borrowing or
lending may be undertaken at market rates. Thus, any given pattern of
gross disbursements may be translated into the desired time pattern of
expenditures just like any other foreign exchange receipt. (Indeed, in
theory we could test whether developing countries are constrained in the
capital markets by seeing whether, given wealth, imports respond to
different disbursement patterns.)
There is, however, one set of circumstances in which our
assumption of independence between the disbursement and expenditure
patterns may be violated, even with perfect capital markets. Assume
that a loan's disbursements are tied to expenditures on a particular
project. We would expect to find a closer relationship between
disbursements and imports than between commitments and imports if the
project being financed (1) requires only "additional" imports, in the
sense that none of them would be bought in the absence of the loan, (2)
imposes a rigid time pattern for these imports, and (3) has no effect on
other imports. This situation basically implies that tied loans finance
projects that the borrower's government feels are not socially
-37-
profitable and hence that it would not finance out of its own
borrowing. In these cases, wealth must be reduced by the extent of the
disbursement, for while the repayments still represent claims on the
"general fund," the loan itself does not contribute to the latter.
Hence, we would need to adjust our existing measure of wealth as
follows:
Restricted loan Adjustment to measured wealth
Non-concessionary Subtract current disbursements
Concessionary Subtract current disbursements less
the current grant elements and the
present value of future grant
elements
Grants Subtract the present value of future
grants.
Note that by removing the present value of anticipated grants and grant
elements, we are implicitly assuming that restricted loans are not
expected to be renewed.
Without a huge amount of detailed research, it is impossible to
know how borrowing is distributed between these constrained and
unconstrained forms. However, provided the distribution is constant
over time, an adjustment to the estimating equation is feasible.
Equation (4.14) becomes:
Pt t= (1 _ - a) (Wt- aWt) + aD (4.23)
where WI = The addition to wealth stemming from receipts of (but not
repayments on) all loans and grants of the type subject
to restriction,
-38-
a = The share of restricted-type loans actually subject to
restriction and
Dt = Disbursements of restricted-type loans.
The constant, a, is theoretically estimable, but in practice it
proved possible only to restrict it a priori. Specifically, we
experimented with (a = 1) for various definitions of WI, e.g., that all
concessionary loans are subject to restriction.
If the conditions under which disbursements and imports are
linked, are considered sufficiently unlikely in perfect capital markets,
tests on equation (4.23) could be interpreted as tests of the hypothesis
of perfect capital markets. If disbursements matter, capital markets
are not perfect.
Expectations
The third problem area with equation (4.11) is the treatment of
expectations. Expectations figure very prominently in the model as
outlined, and clearly their measurement is a crucial consideration.
However, we have little guidance as to how to proceed. Below we
experiment with different approaches, so that a number of alternatives
are listed.
We require very simple mechanisms for expectations, for they
must be both practical and forecastable. These mechanisms usually
amount to assuming a constant rate of growth for the variable
concerned. We do, however, use certain exogenous information for
particular years of the sample period or particular components of wealth
where this seems necessary, as, for example, with expectations about oil
prices.
-39-
Rational expectations are currently popular, but they do not
entirely answer our needs. First, we do not have a complete model, so
the expectational component cannot be substituted out. Second, while it
would be convenient to assume that in each year agents had unbiased
expectations of unknown variables, so that we could use actual future
values as a proxy, this assumption alone does not help because we would
rapidly run out of future data. That is, we could not estimate the
model for say, 1980, because the prices for 1983 are not yet
available. We do, however, experiment with forward-looking data, but
only in conjunction with very crude extrapolative formulae.
For transaction flows, simple conservative expectations are
used. The inflow of current and capital grants is expected to continue
at current nominal rates, and similarly for the grant element in
concessionary borrowing. The inflow of current credits is broken into a
price and a quantity dimension. For the latter we experiment with both
static expectations and a constant expected growth rate equal to the
average of the last five years. After preliminary tests, we select the
former. An exception is where exports are based on known mineral
deposits, in which case expectations are roughly based on known
reserves.
The price dimension is more tricky still. Initially we had
intended to let the expected future growth rate of export and import
prices equal next year's actual rate (an element of rational
expectations), and the expected interest rate to equal this year's
actual rate. This approach leads to fluctuations in measured wealth far
greater than could be believed a priori, however. For example, on this
-40-
measure, Malaysia, one of our test countries, would have had an 80
percent decline in wealth in 1981!
Two much more conservative approaches are therefore
considered. For export prices we again consider static or constant
growth rate expectations, and again prefer the former. Meanwhile, the
interest rate is fixed exogenously either at a nominal 10 percent -- the
rate the World Bank uses in assessing grant elements -- or at a real 2.5
percent in the long run. In the former case, 10 percent is used for all
years, including the current one; in the latter case, the nominal rate
is assumed to take three equal annual steps in moving from its current
level to (2.5 + p ), where p is the expected long-run change in import
prices. The resulting interest rate profile is then averaged to get a
single expected rate, the latter being that constant interest rate
yielding the same net present value for a constant nominal income stream
to infinity as the (assumed) variable rate would (see equation [2.3]).
The expected import price series is calculated by assuming
that, from three years hence, import prices will grow at their average
rate over the last five years. Until then, the growth rate for import
prices is assumed to take three equal annual steps from the current
level to that long-run level.
These procedures are very mechanistic and are imposed a
priori. As an alternative, we experiment with an empirical approach,
postulating that, ceteris paribus, a higher rate of investment indicates
a more optimistic view of the future and thus higher perceived wealth.
As a crude measure of this alternative, we consider replacing wealth, W,
in some of the equations above by
-41-
(p, + ''gD + Wt), (4.24)
where gt is the investment/GDP ratio or the investment/wealth ratio.
Empirically, this equation is rather close to the disequilibrium models
discussed on pages 27-28, and in the estimation we treat equations using
(4.24) as further disequilibrium models. (It is to try to distinguish
the two families of disequilibrium models better that we use equation
[4.24] rather than the more natural [W' + §'g tWt.)
Interest Rates
The model as outlined contains a single interest rate at which
countries are assumed both to borrow and lend. This rate should be the
rate on marginal transactions, and assuming that concessionary loans are
rationed by the donors regardless of the borrowing aspirations of
recipients, the marginal transactions will normally be with private
financial institutions. We experiment with two possible rates: first,
the rate on a country's own long-term borrowing from foreign financial
institutions, and, second, the 12-month LIBOR (or an approximation of it
for earlier years). The former captures the country risk premium and so
may be somewhat endogenous, whereas the latter, while exogenous, may
lack relevance, given that most countries borrow rather than lend and do
so at varying premia above LIBOR.
Dynamics
The equations as specified above are entirely static. In the
real world, there is at least some chance that an adjustment in the
directions postulated takes time. Thus, we should consider the
-42-
possibility of a lagged adjustment. Given our very small sample of
observations (see below), doing so is possible only for the simple forms
of the models and for very simple dynamics. In general, the approach is
to include only a lagged dependent variable (a partial adjustment
model), but in certain cases more general forms are feasible. For
example, if 6 = 1 in equation (4.14), the following equation is
estimable (where M replaces p M for notational convenience):
M = a W + 8 MH1 + y W_1 . (4.25)
Linear restrictions of this equation make the following models testable:
a static form (B = y = 0), a first difference form (8 = 1, y = -a), a
partial adjustment form (y = 0), and a "catch-up" or serial
correlation model (y = -aO).
In the course of early empirical experiments, there is some
evidence of heteroskedasticity in the residuals of equations such as
(4.14), with the error variance growing over time. We therefore
experiment by deflating the whole of the estimation equation by current
import prices. This alternative reduces the heteroskedasticity, but it
also suggests that we should perhaps consider the dynamics of "real"
imports. Thus, for example, if we deflate equation (4.25) by current
prices, and let a = 0, we would have:
Mt + O+ t- 1
Pt Pt Pt
However, a natural alternative would be to consider the adjustment of
(m / M) to itself lagged, viz.,
p
-43-
mt t 0 t-
Mt Wt+ Mt - (4.26)
Pt Pt P t-
This approach has considerable intuitive appeal - it is, after
all, the adjustment of the quantity of imports that is painful and
costly -- and it also allows direct comparison with "traditional"
equations, which are usually specified in real terms (see below).
Most of the following estimation -makes use of the lagged
dependent variable to add a dynamic element to our models.
-44-
V. THE DOMESTIC MODEL
The second of our models, the domestic one, is a development of
the first. Whereas in the first, following Hemphill, we consider only
the import sector, in the second we extend the analysis to the
domestic economy, following Sachs and Dornbusch. The extension is
straightforward, at least in a formal sense. However, two new sets of
problems present themselves: first, how to incorporate the
macroeconomic balances and, second, what units to work in.
Sachs' Model
Sachs' model, which is built around the national accounting
identity, distinguishes two goods and uses world money as the
numeraire. As noted, the import good has a fixed world price, while the
export good faces a downward sloping demand curve. Its price does not
appear explicitly, however, as it is substituted out by factors
determining the supply and demand for exports. (Sachs has a very simple
model of exports, with unit elastic demand and a single factor
exponential supply function). The resulting basic equation (based on
equation [2.10] is:
CA = f(W ) + a (G - G ) + a2 (T - T ) + a3 (R - R ), (5.1)
t t 123
which expresses the current account as a function of wealth, plus the
deviations from "perpetuity values" of government expenditures, world
demand and productivity. For our purposes, we assume that all
adjustment on the current account occurs through imports, with exports
-45-
and factor payments taken as predetermined. Thus, equation (5.1) can be
treated as an import function.
The estimation of the perpetuity values of G,T and R is
problematical, in that they refer to perpetuity values as perceived at
time t. Thus expectations are involved. As a first pass, however, we
take them as trend lines through their respective samples of
observations.
Sachs assumes that government expenditure is exogenous and that
investment is determined by the wealth function as part of private
absorption. (He ignores the feedback from investment to output, as do
we). Both assumptions are somewhat suspect: governments may well
restrict their expenditures with a view to the current account, while
the dichotomy between savers and investors may cause investment to have
an exogenous component. Thus the term (G - GP) may be displaced by (I -
IP) or dropped entirely from equation (5.1), with corresponding
adjustments to the definition of wealth.
Sachs also implicitly assumes that all wealth is owned
privately rather than publicly. Thus, the permanent value of private
consumption CP equals r*W. This view arises from the assumptions that
the government finances its exogenous expenditures that contribute
nothing to utility from either current or future taxation, and that
future taxation is perfectly foreseen by the private sector and is
capitalized into its estimate of wealth. It seems equally plausible,
however, to assume that the government has some claim on wealth, a view
that reinforces the argument for combining public and private
consumption into the same process by-dropping (G - GP) and redefining
wealth.
-46-
Similarly, the terms (T - TP) and (R - RP) are under threat.
They appear in the equation by virtue of Sachs' simple model of exports
and output. As we are not committed to this model, we work directly
with deviations in output.
The final component of equation (5.1) is the wealth function.
It is similar to the functions developed for the previous model but has
some additional features. Consumption is related to total private
wealth. Given that spot estimates of wealth are notoriously scarce and
unreliable, the best definition appears to be reserves plus the grant
and borrowing terms described earlier plus the present value of the
expected stream of GNP net of government expenditures. This definition
includes, inter alia, all human and physical wealth and current income
from abroad. We assume constant expected growth rates for real GNP and
the appropriate deflator, with the former rate generally set equal to
zero.
The estimating equation based on Sachs' model is thus
Ptt M CAt + Pt Xt IPDt
or
(PtX - aIPD - p M )ant ) Wt - a1(G - GP) (5.2)
- a (T - T ) - a (R - R )
where IPDt = The flow of interest abroad.
The functional form of the wealth component has been taken from
equations (4.1)-(4.15), but with consumption replacing imports and a
broader definition of wealth.
-47-
Dornbusch's Model
An alternative approach to the domestic model is Dornbusch's
(1983). He assumes a traded/non-traded dichotomy and uses traded goods
as his numeraire. He also assumes only a single component of demand
(called consumption), so that his macrobalances are particularly
simple. He finds the relative price of traded and non-traded goods a
significant factor in the overall demand for consumption.
We need to make slight adjustments to Dornbusch's model to
permit us to work in a money metric -- essentially, we define the
interest rate in real terms relative to (expected) import prices.
Thereafter, combining the model with the macroeconomic balance equation
generates an import function
M = C - GNP + IPD + X. (5.3)
That is, imports equal "total consumption" less GDP plus interest
payments and exports, all measured in foreign prices. With C covering
all expenditures, wealth has to include the present value of total
future GNP. It is possible to adapt equation (5.3) to allow for other
elements of macro-imbalance along the lines of (5.1); for example, we
could remove government expenditures from the accumulated values of GNP
in the calculation of wealth and include (G - GP) directly in the
equation.
Again, the formalities of the wealth explanation of consumption
may be taken from above, but with the price term altered to reflect
relative import and domestic prices.
A more direct approach to Dornbusch'ls model is to exploit its
intertemporal separability, using wealth to determine total absorption,
-48-
but then using current variables alone to explain the allocation of the
latter between imports and domestic goods. In fact, Dornbusch has a
Cobb-Douglas function for this division, so that imports claim a
constant share of absorption. We have chosen to generalize the model
slightly, using a CES function. Thus, given the value of absorption, A,
from the wealth calculation,
P t a (p) (PtAt), (5.4)
where Pt = The aggregate price index for year t,
(pM)a (pD)l - a (55)
Pt t t 5)
and where a may be calculated as (pMM/PA) in the base year of the index
numbers, year 0. Using an equivalent of equation (4.15) to
determine P tAt -- current absorption - and manipulating so as to reach
the equivalent of (4.15), we get
- = N
ptM = a ( 87) (1 _ 6d 1 - Wt (5.6)
where nt = The deflator for total absorption.
For both the Sachs and Dornbusch formulations, lagged dependent
variables are included at estimation time to allow some element of
dynamic adjustment.
-49-
VI. SPECIFICATION TESTS OF THE FOREIGN WEALTH MODEL
There are two components to the empirical application of a
model. The first is to try to identify the correct model, while the
second, having done so, is to get the best possible estimate of it. The
former concerns hypothesis testing, the latter does not.
In the present paper, we distinguish these operations
carefully. In this section, we explore the various specifications of
the models discussed above -- comparing, for example, different
formulations of expectations and different treatments of potentially
restricted loans. From these experiments we derive preferred
specifications of the two models -- foreign and domestic -- in their two
forms -- equilibrium and disequilibrium. In the second set of tests,
described in the next section, we compare these models between
themselves and with two simple alternative models: Hemphill's equation
(2.1) and a traditional equation relating imports to GDP and relative
import and domestic prices. These comparisons yield a generally
preferred model of imports.
It should be emphasized at this stage that all our tests are of
composite hypotheses comprising, first, the truth of the model concerned
and, second, our ability to measure the concepts accurately. This
observation is, of course, true of all applied economics, but it is
particularly relevant here, given the manifest problems of measurement.
However, applied economics does require operational models. Hence,
while it may be---philosophically feasible to claim that rejections of a
particular model arise from its measurement problems, rather than from
-50-
its theoretical shortcomings, it is not practically very useful, at
least until equally plausible alternative measures have been discovered.
This section starts by considering the sample data and the
estimation methods adopted. It then specifies more precisely the nature
of our general tests of specification. These involve estimating
alternative models under a series of different assumptions and
attempting to draw from the results some broadly consistent conclusions
about the types of models that were introduced before. Specifically, we
seek strong evidence to reject the null hypothesis that the
intertemporal approach to imports is useful. The restrictions of the
null hypothesis we test are that all components of wealth affect imports
equally and that neither the pattern of disbursements of loans nor the
stock of outstanding debt affects imports. Additionally, we seek
information about the best interest rate to use. The three countries
used in these experiments show a strong degree of uniformity in their
conclusions on these issues.
The Sample
The preliminary experiments are conducted on three developing
countries chosen at random in a stratified sample. The wealth model,
with its assumption of unrestricted borrowing, is likely to be more
applicable to middle-income than to low-income developing countries.
Within that sub-set we seek countries from three different continents,
with at least one oil-exporting and one oil-importing country. Finally,
the countries chosen have to meet certain minimal conditions of data
availability. (We diplomatically ignore the question of data
-51-
quality.) The three countries chosen are, in the order in which they
are tested, Malaysia, Colombia and Kenya.
Details of the raw data are given in the Appendix 1. Briefly,
however, they cover 1965-82 annually, although for several variables
earlier data are also required. The principal sources are International
Financial Statistics Yearbook, (1983), Balance of Payments Statistics
and the World Bank Debt System. In a few cases, interpolations or
extrapolations are required, as noted below. It seems desirable to
stretch the sample data as far as possible in both directions in time,
given the heavy load they have to bear; even so, our 18 observations is
embarrassingly small, especially for the asymptotic test we apply
below. Ideally, the models should be tested by their predictions of
imports for 1983, as the fierce reductions in imports in that year were
almost universally attributed to financial stringency. Unfortunately,
however, the data are not yet available for such an acid test.
All the calculations in this section have been conducted using
TROLL on the World Bank's IBM 3083 computer. (Many tests, as well as
all the data preparation, have been carried out by Kathi Yu, to whom I
am most grateful.)
The Estimation
All the models in this section are estimated by single equation
least squares methods. Given the small samples, more sophisticated
approaches are probably not warranted. There is, however, one
potentially serious problem that deserves mention and for the
illumination of which we are indebted to- Professor Jonathan Eaton. We
assume the exogeneity of export earnings in foreign currency terms. If
-52-
this assumption is correct, the only role that import prices play in our
models is the intertemporal one explored in detail above. If, on the
other hand, export revenues are endogenous, this condition involves a
simultaneity bias in our estimates, for we omit a second role of import
prices -- that of influencing the overall levels (present values) of
exports and imports. Under these circumstances, the direction of the
bias depends on whether the country is on the elastic or the inelastic
segment of its offer curve. If expenditures on imports (and hence the
required export revenue) fall as import prices rise, then the
coefficient on import prices in our equation will overstate the degree
of intertemporal substitution (a will exceed a). Alternatively, if
import expenditures rise with import prices, the degree of intertemporal
substitution will be understated. 1/
It is difficult to know, a priori, the direction of these
biases, but their possible existence should be borne in mind in
interpreting the results below. We choose not to allow for them
formally in the estimation because of the complexity of modelling
exports and imports simultaneously (especially intertemporally), and the
fact that, with small samples, ordinary or non-linear least squares are
often felt to be at least as efficient as simultaneous estimation
methods, in a mean squared error sense.
1/ These biases are derived from a simple log-linear version of
equation (4.11). The non-linear forms are more complex, but
the result probably can be generalized.
-53-
The Tests
Each country is subjected to the same battery of specification
tests. We first explore whether all components of wealth have the same
impact on imports. Wealth is defined precisely in the earlier
discussion as assets plus the net present value of exports, grants and
the grant element of concessionary borrowing, plus the (negative)
effects of repayments on past loans. In theory, each component has the
same impact on imports. Thus a preliminary test that can provide a
rejection of the maintained model is to look for evidence that the
components have markedly different effects.
These wealth definition tests are conducted by starting with a
restricted definition of wealth and progressively testing whether the
addition of further components satisfies the null hypothesis. Four
components of wealth are considered:
(1) Net present value of exports
(2) Foreign assets
(3) Net present value of grants and grant elements and
(4) Repayments.
They are tested in this order and also with the last two items reversed.
The test equation, derived from (4.14), was:
Mt =(l-6\ ) (iW 6+ + i)Wt) (6.1)
where Mt = The value of imports (previously denoted pmM
6 = The (unknown) rate of time discounting
-54-
nt = The rate of growth of discounted future import prices
Wt = The ith component of wealth (e.g., assets or grants) and
it ~~~~~~~~~~i
iWt = The ith wealth concept Wt
The test comprises seeing whether a = 1. Similar tests are conducted
on the share version of equations (4.14) and (4.15) - and a
linearization of (4.14), but in fact neither yields additional
information.
The next tests concern the possibility that certain loans are
restricted in their timing, such that imports and disbursements are
coincidental. As noted above, this procedure is largely a test of the
perfect capital markets hypothesis. The test equation is (4.23), but
there appears to be insufficient sample information to estimate a, so
that the constraint (a = 1) is imposed. The model is tested, as
written, in share and in linear form, but, again, the last two are quite
consistent with the first. These tests are referred to below as the
restriction tests.
Both sets of tests are conducted in real and nominal terms and
for five different interest rates: the actual rate for the country,
LIBOR, an "expected rate" based on the actual rates (see page 39), the
same based on LIBOR, and 10 percent. In addition, various tests are
conducted using 10 percent as the rate in defining wealth, but an actual
rate in defining future discounted prices. This process might reflect a
conservatism in assessing wealth (risk aversion) that is not reflected
in intertemporal allocations. The restriction tests are also conducted
with a lagged dependent variable to allow for evident dynamic mis-
specification.
-55-
The comparisons among wealth definitions, loan restrictions and
interest rates are made in terms of residual sums of squares, error
whiteness and plausibility. At least in the wealth definition and
restriction tests, we are seeking strong evidence of a rejection of our
null hypothesis that total wealth with no restrictions is the correct
way to proceed. Thus, formal non-nested procedures do not seem
warranted, given the small sample, the large range of tests and the
similarity of the alternatives.
A typical set of results from the wealth definition tests is
given in Table 6.1. While these are based on a constant 10 percent rate
of interest -- our preferred measure (see below) -- the results for the
other interest rates and functional forms are very similar. There is
clearly some tendency for different elements of wealth to affect imports
differently, but except for Malaysia and foreign assets in Colombia and
Kenya, this tendency is not particularly marked. Owned assets appear to
stimulate imports more strongly than other elements of wealth; this
result may reflect their role as collateral for additional borrowing
("banks only lend to people who don't need money"), in which case our
capital market assumptions are violated. Grants appear precisely as do
other components of wealth, while repayments have different effects in
different countries. In Malaysia, higher repayments (a negative
component of wealth) curtail imports strongly, while in Colombia they
are (insignificantly) associated with higher imports.
-56-
Table 6.1: WEALTH DEFINITION TESTS (r = 10 percent) a/
W.alth measure Additional- walth Malaysia Cblombia Kenya
(W) caomonent (W) 8 (s.e.)b/ B (s.e.)b/ 8 (s.e.)b/
(1) NPV of exports (2) Assets 56.28 c/ (3.12) 2.73 c/ (0.76) 11.64c/ (2.27)
(1) + (2) (3) Grants 1.43 (3.47) 1.43 (1.86) 0.92 (0.38)
(1) + (2) + (3) (4) Repayments 27.32 c/ (3.37) -1.25 (2.93) 1.51 (1.70)
(1) + (2) (4) Repayments 27.26 c/ (3.38) -2.84 (3.04) -0.34 (1.98)
(1) + (2) + (4) (3) Grants 1.36 (3.55) 1.99 (3.13) 1.96 (0.37)
a/ For definitions of wealth, see page 53.
b/ s.e. denotes the standard error of S.
c/ Denotes that 8 differs significantly from unity at 5 percent.
Note: The estimating equation is:
Mt (1 - 6"n a) (iwt + a)
The restriction tests also generate somewhat mixed results,
with occasional improvements in fit from treating some loans directly.
Table 6.2 presents a typical set of results. As before, the conclusions
are quite robust with respect to changes in interest rates, functional
form, and dynamic specification. The only consistent pattern in these
tests is for Colombia, where it generally appears preferable to have
-57-
Table 6.2: RESTRICTION TESTS (r = 10 percent) a/
Loans restricted (D) Standard error of the equation
Malaysia Colombia Kenya
None 383 203 110
Non-concessionary 486 194 117
Grants and concessionary 399 205 124
Grants, concessionary and 491 200 130
non-concessionary
a/ The estimating equation is:
M = (1 - 6d ) (Wt - W't) + Dt + YMt-
See pages 36-38 for an explanation.
non-concessionary loans entering directly. Since the resulting
improvement in fit is very slight, however, and since non-concessionary
borrowing seems, a priori, the flow least likely to be subject to timing
restrictions, this outcome does not constitute a convincing rejection of
our postulated model. Thus we would conclude that any loans that are
actually restricted do not increase the overall level of imports and are
compensated for by changes in unrestricted or commercial borrowing.
This interpretation is consistent with our perfect capital markets
hypothesis.
The next issue to be decided is the interest rate to be used.
The two batches of tests above were conducted on all the interest rates
and combinations mentioned above, and certain other equations that are
introduced below were also estimated with different interest rates to
check whether subsequent specification tests might affect the choice of
-58-
rates. Thus, we have a considerable number of observations (not, of
course, all mutually independent) with which to make the choice. Table
6.3 presents some typical results: the standard errors of the
regressions from equation (4.14) estimated with a lagged dependent
variable.
Table 6.3: THE EFFECTS OF DIFFERENr INTEREST RATES
Interest rate Standard error of the equation ($ million)
Malaysia Colombia Kenya
Actual national 664 304 158
"Expected" national 703 308 131
LIBOR 660 304 276
"Expected" LIBOR 674 339 166
10% 383 203 110
10% and national 361 200 115
10% and LIBOR 356 206 120
a/ The estimating equation is:
Mt =(1 - 6 a ) w + yM
t ~ ~ ,tt t-1
See page 27 for an explanation.
It is very clear from this table that the simple 10 percent
interest rate dominates the others, at least for the calculation of
wealth. The reason is partly that the actual interest rates cause the
wealth estimates to fluctuate unrealistically: for example, with no
changes in actual flows, cutting the interest rate from 10 percent to 8
-59-
percent increases wealth by around 20 percent. Almost certainly,
national authorities would discount such fluctuations in estimating
their wealth, although, curiously, our dampened interest rate series
(the "expected" rates in Table 6.3) do not improve matters for two out
of three countries. (The hypothesis that dampening occurs is supported
by the fact that the difference between using actual and constant
interest rates to calculate wealth is emphasized in the absence of the
lagged dependent variable.)
The preference for a constant rate of interest casts some doubt
on our composite hypothesis that the wealth model is correct and that we
can adequately measure wealth and expectations. This is partly because
it is difficult to believe that countries actually reckoned their wealth
over 1965-80 using a constant nominal interest rate, but also partly
using a constant interest rate takes the model a long way toward being
observationally equivalent to a model relating imports to foreign
exchange receipts. For example, if we measure wealth, W, as exports, X,
plus grants, G, and assets, A, less repayments, R, then
_ _ _-,
W X +C R :3
r r r
and
M= (1 + 8 = anW (n = W (x + G + A) R.
r r
If rA approximates interest receipts on reserves, only the dependence
of p( ) on n and the treatment of repayments identifies the wealth
model from one in which imports are proportionate to current receipts.
-60-
In a final set of ad hoc specification tests, we consider
including in the basic equation the variables reflecting the stock of
indebtedness. The latter are important because they offer another
fairly direct test of the null hypothesis that net wealth determines
imports. Under the null hypothesis, stocks of indebtness matter only
for their influence on net wealth (which enters via Wg), but under many
reasonable alternatives, they are crucial in determining both a
country's willingness and its ability to borrow. Significant stock
effects are, therefore, bad news for the wealth model. Three variables
are considered: total debt outstanding and disbursed, DOD, DOD relative
to wealth, and DOD relative to GDP. For lack of data, only the medium-
and long-term official borrowing reported to the Bank can be included in
these measures. In no case and for no country are the stock of debt
variables significant.
The general specification tests have not been described in
great detail, but the overall tenor of the results is accurately
represented in the discussion above. There is no doubt about the
empirical advantages of assuming a constant 10 percent nominal rate of
interest, and no question of significant stock of debt effects (other
than those embodied in the wealth estimate). On the other hand, the
wealth definition tests do suggest that owned assets may affect imports
differently from other components of wealth, and the restriction tests
do raise some questions about the perfect capital markets hypothesis.
Overall, therefore, the basic foreign wealth model emerges for
these tests with at least some credibility: while there certainly are
some remaining questions about its relevance that require further
-61-
investigation, it survives the initial tests well enough to warrant
continuing the present exercise by pitching it against some of the
alternative theories of developing countries' imports.
-62-
VII. PREFERRED EQUATIONS FOR THE FOREIGN WEALTH MODEL
We turn now to the refinement of the general foreign wealth
model into a preferred form for each country. This exercise involves a
few remaining hypothesis tests and then the estimation of our final
equations. In later sections, these equations are compared with the
preferred equations from other models.
In comparing models, a strong case can be made for comparing
the equations before any data-directed simplification has occurred, that
is, for comparing the estimate of the a priori specifications. For
several reasons, however, we choose to carry out a little further
refinement (hypothesis testing). First, in some cases our theory is far
from definite about whether a variable should be included. With small
samples, carrying extraneous variables has a high cost in terms of
efficiency, and in these cases, if the data do not reject the hypothesis
that a coefficient is zero, we impose it. Second, the ultimate
objective of this exercise is to produce equations for simulation, an
objective that requires plausible parameter values. Thus we must be
prepared to override certain implausible estimates. To be sure, when
doing so involves imposing statistically significant constraints, we
should return to the theory to discover why, but until we have done so,
it seems reasonable to impose plausibility on an existing model. This
is particularly so when several models are being compared: it is useful
to know if model A plus any necessary plausibility constraints dominates
model B plus its constraints. (Simulation models are used to make many
conditional forecasts, and it is in order that these bear sensible
relationships to each other that plausibility is required. If we were
-63-
making a single unconditional forecast, the case for overriding
statistical results with prior views would be much weaker.)
The criteria used to determine the preferred equations are fit,
plausibility and error whiteness. In the discussion that follows, we
quote for each country the initial dynamic estimate of equation (4.14)
and describe the path of inference followed. In particular, we
highlight and justify any circumstances in which our decisions may be
thought contentious. While a degree of judgment is occasionally
necessary, we do not believe that other researchers would reach
fundamentally different conclusions.
The preferred equations for - the foreign wealth models are
reported as equations (1) to (4) in Tables 7.1, 7.2 and 7.3. The tables
use the notation developed above for the variables and report several
summary statistics: R2, Durbin's h or the Durbin-Watson statistic, the
standard error of the regression, SER, and the residual sum of squares,
SSR, in the units of reported equations, and, finally, the SER and SSR
in terms of the nominal value of imports.
Malaysia
Among the most consistent features of the preliminary results
for Malaysia are the smallness and complete insignificance of the
coefficient of intertemporal prices, n.
Mt = (1 - 0.955nt0.011) Wt + 0.625 Mt 1 (7.1)
(.006) (0.60) (.073)
R = 0.998 Standard error = 382.8
h = 0.86 SSR/106 = 2.1979
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The insignificance of discounted prices, n, implies that a,
the intertemporal elasticity of substitution, is not signficantly
different from one, which in turn means that a Cobb-Douglas
intertemporal utility function is consistent with the data. This result
suggests greater intertemporal substitution than we expected a priori,
but the result is strong and consistent. Imposing (a = 1) reduces
the standard error of the equation and allows us to use the linear model
including only W and M as the basis for the tests of dynamic
specification (see equation [4.25]). No equation dominates that
involving only wealth and lagged imports, and so the preferred foreign
wealth equation is (7.1.1) in Table 7.1.
We next consider the disequilibrium models, but still in
nominal terms. While relating either the rate of time discount or the
estimate of wealth to the growth rate of GDP yields no significant
improvements, relating them to investment proves most useful
statistically. Of the two ratios we try, investment relative to wealth
is preferable, with a standard error of the equation, SER, of about 20
percent below that from investment relative to GDP. Of the two models,
relating the rate of time discount to investment (equation 4.16)
dominates relating wealth to investment (equation 4.24) by a similar
amount. In the preferred equation (7.1.3 of Table 7.1), a dollar's
investment generates $0.93 of imports, and the hypothesis that
the relationship is one-for-one cannot be rejected. Looked at
alternatively, a rise in the investment/wealth ratio of 10 percent from
its mean of 0.0415 to 0.0457 is associated with a rise in the rate of
time discount from 6.5 percent to 7.0 percent. It is clear that this
model is a substantial improvement in terms of fit over the equilibrium
Table 7.1: PREFERRED) FQUATIONS FOR MALAYSIA a/
Nominal
R2 SER SER
h or (W) SSR/106 SSR/106
FORFIGN WEALTH
(7.1.1) Nominal 1 - 0.041 WF + 0.626 H_1 0.998 371.0
(.005) (.071) 0.96 2.2001
(7.1.2) Real H 0.029 WF + 0.707 (Hl) 0.997 501.4 400.5
(.008) (.104) 0.83 4.0226 2.5662
FOREIlN DISEQUILIBRItI
(7.1.3) Nominal N - (0.023 + .927 * a) * WF + 0.260 N1 0.999 201.6
(.004) (.149) (.070) -0.93 .6094
(7.1.4) Real H (0.023 + .483 F) II b * .513 (Ln 1.000 362.3 260.5
FRW PM p
(.006) (.136) (.093) 0.64 1.9689 1.0176
DONESTIC WEALTH
(7.1.5) Nominal log N - -4.327 + log WD + 0.154 log 1_ 0.993 0.079 501.0
(.179) (.022) 1.07 0.100 b/ 4.3000
Real No plaustble equatlon
DONEST IC DISEQUILIBRItUM
(7.1.7) Nominal N = 0.569 |1 - (.980 - 2.038 -)J * WD + 0.181 N1_ 0.999 251.8
(.004) (.285) WD (.086) 0.00 .9511
Real No plaustble equation
TRAD)IT IONAL
(7.1.9) Nominal M - 417.7 + 0.315 GDP - 27.79 P + 0-593 N1 0.995 392.4
(774.6) (.043) (22.01) P (.084) -0.05 2.1560
(7.1.10) Real N 2148.2 + 0.312 GDP- 99.31 P + 0.674 ( 0.984 446.5 275.1
P' (827.1) (.070) pCDP (29.08) pC (.128) P -1.05 2.7915 1.0594
HEMPHILL
(7.1.11) Noninal N 76.31 + 0.424 RI + 0.454 F + 0.334 M..1 0.997 295.8
(145.1) (.196) (.087) (.090) 0.85 1.2250
(7.1.12) Real - - -23.25 - + 0.145 R' + 0.405 - + 0-536 (-) 0.999 375.9 266.5
P (71.76) P' (.133) M (.079) PM (.106) P I -0.42 1.9788 0.9946
a/ N - Nominal Imports; Pn M Price of L ports; WV - 'Foreign Wealth (i.e. net present value of foreign exchange receipts + assets); I - laveatment; VD -
_ DOestic Wealth (i.e. net present value of GNP and assets); GDP - Ntoinal GDP; pCD GDP Deflator; R - Level of Reserves, F - Foreign Exchange Receipts;
n - Growth rate of present value prices.
b/ Not divided by 106.
-66-
version of the foreign wealth model. As observed above, however, there
are probably more grounds to fear simultaneity bias here than in any of
the other models considered in this paper.
The final tests concern the explanation of real imports. As
discussed above, imports and wealth are both deflated by current import
prices, but lagged imports are considered deflated by either current or
lagged prices. The latter proves superior. The specification tests are
repeated starting from an estimate of the real equivalent of equation
(7.1). Exactly the same conclusions emerge. The resulting equation is
(7.1.2) in Table 7.1. It implies slightly larger errors in nominal
import predictions than does the nominal equation, which minimizes those
errors directly. (The nominal errors from equation [7.1.2] are merely
those in real imports multiplied by pM which is assumed to
be exogenous.) The estimation in real terms reduces the heteroskedas-
ticity, but from inspection it appears that the errors are still
substantially larger over the period 1975-82 than prior to 1972. The
largest errors affect 1973-75, which is hardly suprising: eighteen
observations are too few for conducting a formal test of
heteroskedasticity, and as yet no allowance has been made for it in the
estimation. It is an obvious area for future research.
The disequilibrium analysis of real imports also mirrors its
nominal counterpart closely. Again, the investment/wealth ratio proves
the most effective of the disequilibrium terms, and, again, it is best
seen as modifying the rate of time discounting. Its numerical effect is
substantially reduced, however, by the real transformation, with only
half of any extra investment showing up as imports.
-67-
Colombia
In most respects the results for the Colombian foreign wealth
model are- very similar to those for Malaysia. Intertemporal
substitution seems relatively strong (a = 1) and lagged imports highly
significant. Thus,
Mt (1 - 0.935n -0.084 ) W + 0.610 M (7.2)
t t ~~~~~~t t-1
(.010) (.124) (.093)
R2 = 0.996 Standard error = 203.1
h = -1.29 SSR/106 = 0.6189
When the intertemporal price effect is eliminated, the result is the
preferred equation, (7.2.1), of Table 7.2. In this case, however, there
is nothing to choose between the dynamic linear equation embodying
serial correlation (SER = 195.3) and that embodying just a lagged
dependent variable (SER 200.0). For simplicity, we choose the
latter. In real terms, these results are repeated, resulting in the
preferred real equation (7.2.2).
Again mirroring Malaysia, investment relative to wealth proves
to be the best disequilibrium variable, but here it is preferable to use
it as a factor in the estimate of wealth (equation [4.24]), rather than
using it as part of the discount rate (equation [4.161). The resulting
equations, nominal and real, appear as (7.2.3) and (7.2.4),
respectively. For nominal imports, the two additional disequilibrium
variables are not statistically significant at 5 percent (with an F-
statistic of 2.19 compared with a critical value of 3.64), but for
real imports they are (F = 5.04). Observe, however, that in terms of
Table 7.2: PiReFeRRED EQUATIONS FOR COLONBIA
Nominal
R2 ~~SER SER
h or (DWI SSR/106 SSE/106
FOREIGN WEALTH
(7.2.1) Nominal n 0.065 VF + 0.597 K_l 0.996 200.0
(.010) (.087) -1.38 0.6398
(7.2.2) Real N 0.065 WF + 0.547 HP) 0.992 358.3 213.7
pH (.019) PH (.153) p -1.55 2.0541 0.7310
FOREIGN VEALTR DISEQUILIBRIIIM
(7.2.3) Nontnal N 0.071 (WF - 15103 + 85741 -I + 0.553 K_I 0.992 186.6
(.010) (7139) (42572)VF (.085) -1.86 0.4873
(7.2.4) Real H _ 0.079 [W- - 32725 + 196740 I + 0.415 ,) 1 0.995 292.0 238.0
Pn (.018) PM (11707) (72427) WF (.146) P -2.03 1.1940 0.7932
DOMESTIC WEALTH
(7.2.5) Nominal I - 0.016 (PM)-0-484 * VD 0.990 199.7
(.0003) P (.259) [1.601 0.6379
(7.2.6) Real -- 0.167 * (I - .907) * (D) 0.993 330.2 232.
pH (.002) pH 11.4781 1.7443 .8612
0%
DOMESTIC WEALTH DISEQUILIBRIUIM 0
(7.2.7) Nomtnal N - 0.167 (P ) -0.071 - ( 0.914 - 0.663 I 0-953 nD 0.047I *WD 0.997 191.8
P (.035) (.007) (.424) (.012) (.012) 11.981 0.5152
Real No plausible equation
TRADITIONAL
(7.2.9) Nominal log H - -2.495 + 1.063 log GDP 0.982 0.105 193.2
(.341) (.036) 11.931 0.175 */ 0.6355
(7.2.10) Real log - -3.658 + 1.174 log GOP _ 0.900 log PK 0.927 0.103 232.7
pM (.860) (.086) pGDP (.27Z) pGOP [2.0561 0.159 a/ 0.7578
HEMPH ILL
(7.2.11) Nomtnal H - 161.7 + 0.301 RI + 0.386 F + 0.526 N-1 0.991 203.6
(124.6) (.129) (.077) (.102) -1.22 0.5802
(7.2.12) Real M _ 145-6 + 0.292 RH + 0.378 F + 0.510 (H 0.994 329.1 200.1
pH4 PM pH 94 pm
(87.4) (.126) (.117) (.139) -1.019 1.5165 0.5603
a/ Not divided by 106.
-69-
nominal fit, the real equilibrium equation still dominates its
disequilibrium rival and that the latter displays significant negative
serial correlation. This last equation, (7.2.4), implies that a rise of
10 percent in the investment/wealth ratio from its mean of 0.171 to
0.188 will raise the estimate of wealth by 7.4 percent in 1980 and long-
run real imports by $534 million in 1980 dollars.
Kenya
Kenya presents a slightly different picture from the other two
countries. The elasticity of intertemporal substitution is stronger
(nearly signficantly above unity at 5 percent), while no dynamics are
evident. Thus, for example,
Mt = (1 - 0.846nt 0.200) w + 0.030 M (7.3)
t t t
(.016) (.115) (.095)
R2 = 0.995 Standard error = 110.1
h = -0.82 SSR/106 = 0.1818
While the coefficient on intertemporal prices is not significant
(critical value t16[5%] - + 2.112, 2-tail), it is sufficiently well-
determined to be retained in the equation, given our theoretical
interest in its effect. 1/ Thus the preferred equation is the basic
equation (4.14), which is reported as (7.3.1) in Table 7.3. Almost
identical results with real imports lead to a preferred equation (7.3.2)
for the real wealth model.
1/ Estimating a considerably reduces the standard error of the
equation. In this sense, the actual estimate is better than
imposing (a = 1), even though the latter cannot quite be rejected
at 5 percent.
Table 7.3: PREFERRED EQUATtONS FOR KENYA
Nominal
RZ SER SeR
h or (DWI SSR/106 SSR/106
FORe[GN WEALTH
(7.3.1) Nominal M - (I - .841 n 189) * WF .995 106.9
(.004) (.108) 12.361 .183
(7.3.2) Real H (I - .841 n 0-.133 * .993 228 108.4
pH (.004) (.067) pM 12.1161 .834 .188
FOREIGN WFALTH DISEQUILIBRIUM
(7.3.3) Nominal H (I - .844 n --189 ) * (-1430 + 16176 * + WF) .995 106.6
(.009) (.119) (1016) (11930) WF [2.348] .159
(7.3.4) Real - I - .844 n -.073) * -4250 + 46468.3 *I + WF) .995 207.8 102.5
PI (.020) (.065) (2188) (22344) IF P[ 12.6621 .605 .147
DOMESTiC WFALTH
(7.3.5) Nominal tog M = -4.393 + .331 log P + (I - .304) log WD - .304 log N1 .987 .086 123.6
(.551) (.126) P (.161) (.161) -.26 .111 a/ .229
(7.3.6) Real H - .997 n -.002 A* WD + 8.204 GRP + .243 ( X CGR INVID .992 252 146.8
(.005) (.040) p (12.455) (.225) -' p pH p -5.35 .892 .3142
DOMESTIC WEALTH DISEQIILIBRIUH
P .416
(7.3.7) Nominal H - .414 (-) * (I - (.922 - .073 * GRGDP)(1+'076) n .076) * WD .995 104.6
P (.185) (.003) (.048) (.019) (2.9471 .153
Real No plaustble equation
TRADITIONAL
(7.3.9) Nominal M - -101.7 + .467 GDP - .301 H_1 .974 135.9
(62.5) (.052) (.142) -.641 .274
(7.3.10) Real H - 2045 + .526 GDP - 3240 P .992 249.9 140.9
P (212) (.102)PGDP (646) PGDP 12.5411 .937 .298
HEIPHtLL
(7.3.11) Nominal H - 75.5 + .196 RI + 1.132 F - .389 . A F .981 120.1
(54.24) (.233) (.043) (.153) [2.351 .202
(7.3.12) Real p- + .191 RM + 1.005 F - .602 AF 103.2
(21.3) (.168) (.031) (.120) 12.90O1 .347 .149
a/ Not divtded by 1o6.
-71-
The disequilibrium wealth results for Kenya match those for
Colombia almost precisely. The investment/wealth ratio as a component
of wealth is the best of the disequilibrium terms, although in this
case, the additional terms are significant in neither the nominal model
(F-statistic = 1.05) nor the real model (F-statistic = 2.65).
Nonetheless, we report some preferred disequilibrium models in Table
7.3.
Conclusions
Despite their obvious differences, these three countries tell a
fairly consistent story about the foreign wealth model. For example,
all suggest that a Cobb-Douglas intertemporal utility function is an
acceptable approximation, all generate identical functional forms for
real and nominal imports, and all find the investment/wealth ratio the
best of the disequilibrium terms.
Even the differences among the countries have a degree of
consistency. For example, Kenya -- the poorest country by a long way --
shows no signs of either smoothing imports from year to year or of
responding to disequilibrium shocks such as investment booms. Colombia,
on the other hand, clearly smooths imports but is ambiguous about
disequilibrium, while Malaysia - the richest country -- displays both
smoothing and the ability to respond to disequilibrium. A possible
explanation of this pattern is that poorer countries have neither the
wealth nor income to permit either smoothing or responses to investment
booms, although this explanation seems more likely in a constrained
borrowing framework than in our assumed world of perfect capital
markets. A further consistency among countries is that the long-run
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share of imports in wealth falls with increasing affluence, from 16
percent for Kenya through 14.3 percent for Colombia to 9.9 percent for
Malaysia (in the equilibrium real models). As is clear from equation
(4.14), if the intertemporal price effects are ignored, this share is a
measure of the rate of time discount, and the result suggests that
poorer countries have shorter horizons, an entirely plausible view.
We have, therefore, a reasonable amount of corroboration for
the wealth model. True, there are some rejections of the implied
hypothesis that all forms of wealth affect imports similarly, and doubts
arise from the data's preference for a constant rate of interest and the
need, in some cases, to relate imports to investment. Nevertheless, the
model appears to perform reasonably well overall. It fits well, it
generates fairly clean residuals, it is plausible and it is consistent
across countries.
There are, however, two further sets of tests to conduct:
first, to see if this model can outperform others in explaining the same
data, and second, tests of structural stability.
-73-
VIII. OTHER MODELS
In this section we introduce estimates of three other models:
the domestic wealth model, discussed already, and two strawmen against
which to test our wealth models. A necessary condition for the
acceptability of a new model is that, broadly speaking, it outperform
existing alternatives. The alternatives considered here are, first, a
traditional model relating imports to GDP and relative domestic and
import prices, and, second, the Hemphill model that relates imports to
foreign exchange receipts and the stock of debt. The section concludes
with tests of the structural stability of all the preferred equations in
Tables 7.1, 7.2 and 7.3.
The Domestic Models
The domestic models are not subjected to such vigorous testing
as the foreign model. Given their small size relative to the net
present value of GNP, it seems unnecessary to test whether different
components of wealth have the same effects as GNP or whether the timing
of loans is important. Thus, we use only one wealth concept and test
versions of two models. The Sachs model is represented by equation
(5.2), but with the non-wealth terms summarized into
a [log(GNP/GNP) + log p GDP, which is the deviation of real GDP from
its exponential trend, GNP, converted into current prices. The
Dornbusch model is represented by equation (5.6). The interest rate and
stock of debt experiments are repeated, and each model is subjected to
the various dynamic specification tests. For the comparisons between
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models, we select four equations covering real and nominal imports and
equilibrium and disequilibrium forms.
Before discussing the country results, certain generalizations
should be made. First, the preference for a constant rate of interest
is repeated. Second, these models prove very much harder to estimate
than the foreign wealth models, in part because they contain more
parameters. Frequently, it is impossible to achieve satisfactory
convergence in the non-linear forms, and, universally, the final
convergences are very sensitive to small changes in specifications.
This problem alone is a serious handicap in applying the models. There
are also, however, substantially more problems with plausibility than
previously. 1/ We never achieve a converged plausible disequilibrium
equation for real imports. Third, the stock of debt variables never
prove useful. Fourth, the investment/wealth ratio again usually proves
to be the most successful of the disequilibrium measures. Finally, the
Dornbusch formulation far outperforms the Sachs formulation.
For Malaysia, only nominal imports can be satisfactorily
explained by the domestic models. The Sachs version of the equilibrium
model has plausible short-run coefficients, but because of a very high
coefficient on lagged imports, it is not acceptable in the long run.
The Dornbusch model, which with lagged imports contains five
coefficients, requires several constraints to be estimable at all; in
its logarithmic transformation some progress is possible, however, and
it results in the preferred equation (7.1.5). This equation constrains
1/ For these reasons, the term "preferred equation" should be
interpreted very loosely.
-75-
the coefficient on wealth to unity, which implies the short-run
proportionality between imports and wealth. Over the long run, however,
imports rise by 1.18 percent for every 1 percent rise in wealth, which
is clearly inconsistent with the model theoretically. On the other
hand, the constraint is demanded most strongly statistically: imposing
long-run rather than short-run proportionality increases the SER by over
50 percent. No other equation approaches the preferred equation in
terms of fit, and so we use the latter in the model comparisons, despite
its theoretical shortcomings.
In the disequilibrium experiments, convergence is very erratic,
given the large number of coefficients, and it is necessary to replace
the constant of equation (5.6) by the base-year imports/GNP ratio.
(This is a normal practice in CES allocation functions; see Hickman and
Lau, 1973). Nonetheless, a statistically respectable equation emerges
(7.1.7), in which higher investment is associated with greater rates of
time discount. It is a constrained version of the Dornbusch model. The
Sachs model never converges.
The Sachs model encounters severe problems with the Colombian
data: it either fails to converge or suggests negative rates of time
discount. The Dornbusch model fares better but, as before, requires
several constraints. The final equation (7.2.5) shows no auto-
regression, but strong contemporaneous substitution between imports and
domestic goods. Even stronger restrictions are necessary for real
imports. Again, it proves impossible to estimate the constant, and no
remotely significant effects can be found for contemporaneous or
intertemporal prices, or for lagged imports. Thus, ultimately, imports
are expressed as a proportion of total wealth (see equation [7.2.6]).
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The estimation problems are compounded in the domestic
disequilibrium models; indeed, little consistency can be found in the
results. The preferred equation, (7.2.6), appears highly desirable,
with investment increasing the rate of time discount and with
significant contemporaneous and intertemporal price effects. It is not
robust, however, and neither the difference between equations (7.2.6)
and (7.2.4), nor the single disequilibrium coefficient on (I/WD), is
statistically significant.
Kenya's nominal domestic models behave similarly to those of
the other two countries. The Sachs model proves numerically unstable,
while the logarithmic transformation of the Dornbusch model provides the
best fit and most robust estimates. In this case, contemporaneous price
effects are detected (they imply an import price elasticity of between 0
and -1), and the long-run proportionality of imports and wealth is
acceptable.
In the disequilibrium models, only the Dornbusch model is
viable. Surprisingly, the growth rate of GDP proves a better
disequilibrium indicator than does the investment/wealth ratio. It is
acceptable either as part of the wealth calculation or in its preferred
form, where it positively affects the rate of time discount. Again,
while the equation looks good, the estimates are rather sensitive to
small changes in specification.
The Kenyan real domestic wealth model reverses all previous
trends. Here the Sachs model fits better than the Dornbusch equations,
and the most general equation is accepted. It implies that higher GNP
produces higher imports, which is contrary to Sachs' prediction, but
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this outcome does not seem so implausible as to require rejection of the
model.
The Traditional Model
The traditional model is the first of our strawmen. It is
introduced solely as a foil to the wealth models and receives no
research effort. The estimating equation is
M
M = a + a1 GDP + a2( GDP ) a3 M-1 (8.1)
p
which is estimated in nominal and real terms, with and without a lagged
dependent variable, and in linear and log-linear forms -- eight attempts
altogether. The economic coefficients are constrained to zero only in
the cause of plausibility, while the lagged dependent variable is
retained only where it is significant. The choice between logarithmic
and linear forms is made using the criteria of error whiteness and fit.
The reported preferred equations, numbered 9 and 10 in the tables,
require no comment, save that in this model, in keeping with tradition
but not with our treatment of the domestic wealth models, we deflate GDP
by its own deflator in the real equations rather than by import prices.
The Hemphill Model
The Hemphill model was discussed briefly in Sectio.p II, but it
is useful to review its features here. 1/ We start with the balance of
payments identity,
1/ Greater detail is available in Winters and Yu (1984).
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F = M + AR,
where F = Exogenous (net) foreign exchange receipts
M = Total import expenditures and
AR = The change in the stock of foreign assets.
Hemphill models the allocation of given funds, F, between spending, M,
and savings, AR, both of which are endogenous. His estimating
equation is
t =a + a1 Rt + a2Ft + a3 AF (8.2)
where RI is the stock of foreign assets at the beginning of year
t t-1 t - 1
t and is cumulated as Rt = AR. = X (F. - M.). We
j 0 : j0 J
expect a1 > 0 -- that is, higher reserves (lower indebtness) means
higher imports.
Hemphill experiments with several different allocations of
balance of payments items between the exogenous F and endogenous AR
elements of his model. We cannot replicate his measures, but experiment
ourselves with three different definitions, as follows:
Definition of F Definition of AR
(1) Narrow Current credits including All capital items
transfers
(2) Official (1) plus net long- and Monetary items plus
medium-term official long-term private and
borrowing total short-term capital
(3) Basic (2) plus net long- and Monetary items and short-
medium-term private term capital
borrowing
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As before, the equations are estimated in real and nominal
terms, with and without a lagged dependent variable -- a total of 12
estimates in all. Coefficients on net foreign exchange earnings, F, and
the stock of debt, R', are retained whenever plausible, while the
dynamic terms AF and M1 are kept only when significant. The choice
between the three definitions of F and R' is made by reference to fit
and error behavior, and in every case the "basic" definition is
favored. This concept of exogenous foreign exchange receipts is the
broadest and takes us some way toward estimating the balance of payments
identity that, the current account balance (X - M) is equal and opposite
to the sum-of the capital account balances. The latter comprise net
long-term capital (F - X), short-term capital and official finance, and
there is sufficient variation in the last two components to give us some
confidence that our equations reflect actual behavior rather than mere
accounting. (The ratio of the sample standard deviations of short-term
capital plus official financing flows to that of imports is 12.4
percent, 23.0 percent and 21.0 percent for Malaysia, Colombia and Kenya,
respectively.)
Three general observations should be made about the preferred
equations, numbered 11 and 12 in the tables. First, in the real
equations, every variable, including the constant, is deflated by the
import price. This approach seems correct theoretically (debt
accumulates in nominal terms) and is vindicated empirically in the case
of Malaysia, for which it is tested. Second, the real equations always
fit better than the nominal ones. Third, each equation requires one,
but only one, of the dynamic terms.
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The estimated Hemphill equation is a reduced form, and while
the structural form cannot be estimated because it involves
unobservables, the structural parameters are identifiable. Fortunately,
they seem fairly plausible for all three countries. The most
contentious implied structural parameter is the marginal increment in
the desired stock of reserves and short-term assets with respect to an
increase in long-term foreign exchange receipts; these are 0.41, 0.38
and 0.11 for Malaysia, Colombia and Kenya, respectively. All are
positive, suggesting that as wealth rises, countries prefer to have
higher short-term assets rather than higher short-term debts; they are
related to income -- richer countries like higher reserves; and they are
not wildly different from previous estimates of the reserve/import
relationship.
Structural Stability
Clearly, a good model must display stable estimates as the
sample period varies. Therefore, we conclude this section by conducting
some limited stability tests of the preferred equations of Tables 7.1,
7.2 and 7.3. We use all our data in estimating the various models, so
that independent forecasting results are not possible. We do, however,
conduct two sets of in-sample tests, which are at least indicative.
First, we experiment with Brown, Durbin and Evans' CUSUM and CUSUMSQ
tests. Unfortunately, our sample is too small to yield meaningful
results: in line with the findings of other researchers using small
samples, the CUSUM test never rejects the null hypothesis of stability,
while the CUSUMSQ always does. We thus place little reliance on these
tests.
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The second batch of tests are merely Chow tests conducted on
various in-sample years. lie separately test 3 years to see if they
conform to the model explaining the remaining 17. The three years are
1965, which as the end point of the sample is likely to be the most
sensitive indicator of functional misspecification; 1974, the most
turbulent year of the sample period; and 1982, an end year also subject
to large shocks. The results are reported in Table 8.1. Each model
receives at least one rejection, and these tend to be concentrated in
the later of the years. On the whole, the tests of stability reflect
the other properties of the equations -- the better performing equations
tend to show less instability.
These results are not perfect -- ideally we want no instability
-- but, on the other hand, neither are they indicative of serious and
widespread problems, at least among the stronger models (see the next
section).
Table 8.1: STRUCTURAL STABILITY TESTS a/
Malaysia Colombia Kenya
Model 1965 1982 1974 1965 1982 1974 1965 1982 1974
Nominal
Foreign wealth X
Foreign w. disequilibrium X
Domestic x
Domestic disequilibrium X
Traditional x x
Hemphill x _ _
Real
Foreign wealth x
Foreign w. disequilibrium X X
Domestic _ x
Domestic disequilibrium _ _
Traditional X X X
Hemphill x
Note: X = rejection of stability at the 5 percent level.
= no preferred equation.
blank = hypothesis of structural stability not rejected.
a! Chow-test of the null hypothesis that imports in the year tested exhibit the same behavior as
in the year of the sample.
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IX. COMPARING THE MODELS
Having identified a preferred real and a preferred nominal
equation from each model, we now test them against each other, using,
for ease of computation, Davidson and MacKinnon's (1981) P-tests. For
non-tested hypotheses, if we have two models of process y,
HO Yt f (Xti + ot (9.1)
and
H:yt g(Z Y) + t (9.2)
1 ti it
then we can test the truth of Ho by seeing whether H can contribute
to the explanation of y in addition to the factors in H . The test
statistic is derived from the equation
^ ^ ^ ~~k aft
(y - f ag - k -f (9.3)
fY f) = c(gt f f) + i~ . 1 a.i + 1'(93
t t t t To 8 i :1
where ft and gt are fitted values under Ho and H1, respectively,
the (-a-) are derived from equation (9.1), and the (8k) are nuisance
parameters of no intrinsic interest. This equation asks whether the
estimated residuals of Ho, (y - f), are related at all to the factors
appearing in H1 but not in Ho0 (g - f). The second set of terms in
equation (9.3) appears only to correct for any correlations between the
latter and the elements already included in Ho. If H0 is true, the
elements in H but not in H0 add nothing to the explanation, and so
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a = 0. Any other value of a suggests that Ho is incorrect and thus
rejects it. Davidson and MacKinnon show that a is asymptotically
distributed as N(0,1), under the null hypothesis that Ho is true.
The test is not symmetric, for a = 1 does not prove that HI
is true. For that, it is necessary to repeat the test with Ho and HI
reversed. Davidson and MacKinnon show that several alternatives,
y = g.(), can be tested simultaneously by replacing the first term on
m
the right of equation (9-3) by a 1 (gjt -t)
A drawback of this test is that it assumes that y is always the
dependent variable, whereas in our case we might actually have any or
all of M, /M, log (M) or log ( / M) as dependent variables. We
p p
have evaded this issue by always converting g to the units in which
f is measured. For the deflation by p , this approach is unlikely to
be flawed, for pM is exogenous, and we are basically just reversing a
heteroskedasticity transformation. For the logarithmic transformation,
however, it is potentially serious, and we merely plead that it is not
obviously actually so.
(Since we completed this work, we have noted that MacKinnon,
White and Davidson, 1983, have addressed this problem of the P-test.
They suggest using equation [9.3] but with f converted into the units
in which g is measured. While this PE-test has few desirable
properties in theory, the authors claim it is of considerable practical
use. It is not clear how it compares with our procedure, although
intuitively we might expect ours to lead to fewer rejections, since in
our case, HI meets Ho on H 's own ground.)
-85-
The models are compared in Tables 9.1, 9.2 and 9.3. These
tables report both the standard errors of the various equations in terms
of their fit to nominal imports and the results of the non-nested
tests. Taking Malaysia first, it is plain that the two nominal
disequilibrium models are the best-fitting, followed by the real models
in general. The equilibrium wealth models fare very badly.
This pattern of preference is largely borne out by the non-
nested tests. Reading along each row of the matrix shows which
alternative models reject a particular null; the columns show which
nulls a particular alternative rejects. Thus, for Malaysia, we observe
a general tendency for the real models to reject the nominal ones (in
the top right quandrant) and not to be rejected by them (bottom left).
Against this result, however, the nominal foreign disequilibrium wealth
model (7.3.2) rejects all other models and is rejected by none of
them. This finding is powerful, and it is reinforced by noting that in
Table 8.1, the foreign disequilibrium wealth model is one of the only
two models not to display any structural instability.
If we were to put this model aside, however, because of its
suspected simultaneity problem or because of the difficulties of
projecting investment, then among the remaining equations, the real
Hemphill one has similarly persuasive results. Observe how, in this
case, the Hemphill model rejects the nominal domestic disequilbrium
formulation and is not rejected by it, despite the latter's superior
fit.
The predominant reason for the differences in fit between the
disequilibrium wealth models and most of the other models concerns the
former's ability to predict the continuing strong growth of imports in
Table 9.1: NON-NESTED TESTS AND FITS -- MALAYSIA
Alternative
hypothesis a/ FN FDN DN DDN TN HN FR FDR DR DDR TR HR SER b/
Null hypothesis a/
F N X X X X X X X 371.0
FD N X X 197.9
D N X X _ X X X __ X X 518.4
DD N X X X X X __ X X 215.6
T N X X X X X X _ X X 392.4
H N X X X X X X X 295.8 0
F R X X X X X 400.5
FD R X X X 260.5
D R
DD R
T R X X X X 275.1
H R X 266.5
a/ Definitions: F -- foreign wealth; FD -- foreign wealth disequilibrium; D - domestic
wealth; DD -- domestic wealth disequilibrium; T - traditional; H --
Hemphill; N -- nominal imports; R -- real imports; and X -- rejection of Ho
by H1 using Davidson and MacKinnon's P-test.
b/ Standard error of nominal imports.
Note: Not applicable.
-87-
1982. This growth occurred despite decelerating foreign exchange
inflows, but coincided with a strong expansion of domestic investment.
It is also interesting to note the relatively poor performance
of the equilibrium wealth models. A priori, Malaysia looked a rather
good candidate for this approach to imports, for the responses to the
discovery and development of oil typically would appear to be "forward-
looking." Wealth, and thus expenditures, rose well before the oil
resources came on-stream to boost exports or GDP. Capturing this effect
is precisely the novelty of this type of model. Two observations might
be made: first, we may be modelling oil expectations wrongly; second,
the processes may be as postulated, but because the investment in the
oil industry is financed by borrowing from abroad, the associated rise
in foreign exchange receipts, which drives the Hemphill model, may
reflect the imports of oil equipment more faithfully than does our
imperfect wealth measure. Note, again, how we return to the interaction
between imports and investment.
The discrimination among models is weaker for Colombia. Nearly
all models can generate an equation with a standard error of around $200
million, and there are fewer rejections in general. Nonetheless, the
nominal foreign disequilibrium model again sweeps the board, rejecting
all models and being rejected by none.
There are two caveats to this result, however. First, the
model shows signs of structural instability in Table 8.1. Second, while
by Davidson and MacKinnon's P-test it rejects its equilibrium
counterpart, it does not do so in the nested F-test that can also be
made between these two models. Since the former is only an asymptotic
test, while the latter is correct in small samples, we should really
Table 9.2: NON-NESTED TESTS AND FITS -- COLOMBIA
Alternative
hypothesis a/ FN FDN DN DDN TN HN FR FDR DR DDR TR HR SER b/
Null Hypothesis a/
F N X X X 200.0
FD N 186.6
D N X X X 199.7
DD N c/ 191.8
T N X X 193.2
H N X X _ X X X 203.6
F R X X X X X X X X X 213.7
FD R X X X X X 238.0
D R X X X X X 232.0
DD R
T R X X 232.7
H R X X _ X 200.1
a/ Definitions: F -- foreign wealth; FD -- foreign wealth disequilibrium; D -- domestic
wealth; DD -- domestic wealth disequilibrium; T - traditional; H - Hemphill;
N - nominal imports; R - real imports; X -- rejection of Ho by H1 using
Davidson and MacKinnon's P-test.
b/ Standard error of nominal imports.
c/ Using Davidson and MacKinnon's C-test.
Note: Not applicable.
-89-
simplify the disequilibrium model to its equilibrium form. However, in
this form, which is analyzed in row 2 and column 2 of the matrix in
Table 9.2, the wealth model is rejected by two models and rejects none.
Part of the reason for the greater ambiguity with Colombia is
presumably that, in the absence of a large and obviously forward-looking
component of wealth such as oil, there is less statistical
discrimination between the foreign wealth and the foreign exchange
receipts series. Further, Colombia is known to have had considerable
illicit exports of narcotics at times. These presumably boost imports
without appearing anywhere in our explanatory variables. If this trade
fluctuated significantly, it could entirely swamp the "legal" component
of trade that we can model.
Kenya exhibits a wider range of fit than Colombia and more
model rejections. There is no general preference between the real and
nominal models. The strongest model appears to be Hemphill's real
equation, which rejects all alternatives and is rejected by none.
Following it are the 'two nominal disequilibrium models. The Kenyan
models show greater structural stability than the other countries'.
This outcome partly reflects the fact that the in-sample fits (R 2) for
Kenya are worse. Thus, a given percentage prediction error is more
likely to be within the range experienced over the sample period. The
only instabilities detected for Kenya are for 1974, and they arise from
the severe underprediction of import expenditures as the oil-price rose:
the share of fuels in Kenya's imports rose from 10.9 percent in 1973 to
22.4 percent in 1974. Although not always statistically significant,
this problem afflicts all the Kenyan models.
Table 9.3: NON-NESTED TESTS AND FITS -- KENYA
Alternative
hypothesis a/ FN FDN DN DDN TN HN FR FDR DR DDR TR HR SER b/
Null hypothesis a/
F N X X X X 106.9
FD N X X 106.6
D N X X X X X 123.6
DD N X X 104.5
T N X X X X _ X X X X 135.0
R N X X X X _ X X 120.0
F R X X X X X X 108.4
FD R X X 92.9
D R X X X X X X X X 133.0
DD R
T R X X X X X X X X 141.9
H R 103.1
a/ Definitions: F -- foreign wealth; FD -- foreign wealth disequilibrium; D -- domestic
wealth; DD -- domestic wealth disequilibrium; T -- traditional; H -- Hemphill;
N -- nominal imports; R -- real imports; X -- rejection of Ho by H, using
Davidson and MacKinnon's P-test.
b/ Standard error of nominal imports.
Note: Not applicable.
-91-
It is interesting that Kenya -- the poorest country of our
sample and the one least attractive to lenders -- favors the model which
assumes capital market imperfections, while Malaysia -- the richest and,
with oil, ostensibly the most attractive -- favors the perfect capital
(or unrestricted borrowing) assumption.
The upshot of these tests is that, of all the models, the
nominal foreign disequilibrium wealth model and the real Hemphill model
appear to be the best. In both Malaysia and Kenya, they constitute the
optimal pair, while in Colombia the results are ambiguous. There are,
however, possible simultaneous biases in both these models that caution
against too uncritical an acceptance of the rankings. The
disequilibrium model faces a possible link between imports and
investment, while both models would be confounded by the endogeneity of
exports. We rate the latter as the smaller danger, both absolutely and
in terms of the damage that ignored correlations would do to the
estimates.
We tentatively conclude that foreign exchange-based models of
imports dominate GDP-based ones. It is clear that the domestic models
need more attention before they can be applied, although it should be
recalled that we simplified Sach's version even before estimation. The
traditional model, while among the leaders for Colombia, does not in
general perform well.
In economic terms, the models chosen here suggest a strong and
direct link between financial variables and developing countries'
imports. The Hemphill model suggests that, subject to some damping
through changes in short-term debt, any shock to net foreign exchange
receipts will produce a corresponding change in import expenditures.
-92-
This pattern is equally true for changes in export earnings, long-term
borrowing or interest payments. The intertemporal models suggest a
similar story. They indicate a degree smoothing to the import path, and
in the disequilibrium form admit a role for investment booms, but
otherwise changes in revenue get translated directly into changes in
imports. The absence of strong intertemporal price effects renders
changes in wealth the principal determinant of imports, and these
changes in turn are driven primarily by current account receipts and the
interest rate. Thus, according to this model, imports have been
curtailed over the eighties both by weak export markets and high
interest rates.
It is not appropriate here to make forecasts (even of past
years), but the results of this paper suggest most strongly that greater
exports to developing countries will not be a significant engine of
recovery for the OECD in the near future. Indeed, without significant
progress in at least some of the following directions -- lower interest
rates, stronger export markets, or freer borrowing and capital transfers
-- most developing countries' imports will remain rather stagnant for
several years.
-93-
X. CONCLUSIONS
This paper explores four models of import determination for
each of three developing countries. The objectives are twofold.
Primarily we wish to explore the issue of financial variables in import
determination. To this end, we develop an operational model of
intertemporal foreign exchange management, devoting considerable space
to its specification and measurement. The model proves viable -- in
that an estimable form has been derived- -- and potentially quite
useful. For all three countries, it gives fairly plausible results, and
there is a strong consistency across countries. It does appear,
however, to require some modification to reflect disequilibrium factors
for at least one of the sample countries.
The model is compared with three others models of imports. One
applies the intertemporal analysis to total wealth rather than merely to
its foreign exchange component, while the other two relate imports to
flows of income- or to foreign exchange receipts. In the case of one
country -- Malaysia -- the model developed here is dominant (although
the dominant form gives rise to some doubts about simultaneity bias.); in
another case -- Kenya -- it is dominated; while in the third -- Colombia
-- there is considerable ambiguity.
The second, intimately related, objective is to discover a
single, simple, robust import function for developing countries for use
in the World Bank's and OECD's global modelling activities. The choice
is essentially between the foreign disequilibrium wealth form and the
real Hemphill model. Neither is perfect, and each is subject to worries
about simultaneity. Thus, while they might be preferable to other
-94-
approaches, we do not at present have sufficient information to
distinguish between them. Future research should be devoted to this
distinction, a task that basically amounts to exploring the perfect
capital markets hypothesis of the model developed here. On the other
hand, both approaches agree on the importance of financial variables in
developing countries7 imports, and both suggest that until the
industrial countries can generate better marketing opportunities, as
well as higher capital transfers and lower interest rates, developing
countries' imports will remain rather stagnant.
- 95 -
APPENDIX: DATA AND DEFINITIONS
The principal data sources used in the study are:
o International Financial Statistics
o Balance of payments statistics and
o The World Bank debt data bank.
The series for LIBOR, which is not published, was supplied
privately by the Bank for international settlements. Certain World Bank
debt data are also not published.
This appendix describes the sources and definitions of data
where these are not obvious from the text and the published material.
It starts with general definitions and then considers special features
of each country's data.
All data are measured in (converted into) US dollars.
General Definitions
Imports: merchandise (f.o.b.) plus shipment plus "other"
debits, i.e., total debits, less investment income and unrequited
transfers.
Import prices: unit value of merchandise imports.
Assets: reserves plus gold (valued at London gold price) less
net foreign liabilities of banks.
Exports: total credits less official grants and net unrequited
transfers.
Export prices: unit value of merchandise exports.
- 96 -
National interest rates: rate on borrowing from financial
institutions. This rate had to be extrapolated on the basis of the US
rates of interest for the years prior to 1965.
Price of domestic sales of domestic output: GDP deflator.
Debt and lending: all medium and long-term lending, as
recorded by the World Bank's Debtor Recording System. All stocks refer
to the beginning of the period.
Malaysia
Expected Export Receipts: Two problems were evident here.
First, Malaysia became an oil exporter over our sample period. Merely
extrapolating the rate of growth of export revenues seemed wholly
inadequate. Therefore, we assumed (1) static expectations on oil
prices, and (2) that oil quantities could broadly be foreseen up to five
years in advance. Three series of expectations were constructed on this
basis: one operating over 1965-69, one over 1970-77 (the switch to this
series occurred when the leap in actual exports of 1975-79 was deemed
anticipated), and one over 1978-82 (when the rise in exports in 1982-85
was deemed anticipated). The series are shown graphically in Figure
A.1. For example, we assumed that the expectation in 1969 of oil
exports in 1970 was 45, whereas the expectation in 1970 for that year
was 110. The increases projected over 1983-85 are based on specialists'
advice, and the export peak in 1971 is dismissed as an aberration, being
balanced by abnormally high imports of oil.
The second problem concerned non-oil exports. These grew so
fast throughout most of our sample period that extrapolating their
growth rate led to infinite wealth in most years. When these years were
Figure A.l: MALAYSIAN OIL EXPORTS, ACTUAL AND EXPECTED
150 Actual
1978-'
L40 -~ Expectations formed 1965-69
- ~ Expectations formed 1970-77 /
130
output_
index 120 Expectations formed 1978-> /
198l,
=100 110 - -- - - 1970-77
100
90
80
70
60
50 ---1965-69
40
30
20
10 | .-Changes in expectations Time
65 70 75 80 85
- 98 -
adjusted as suggested on pages 30-31 of the text, the wealth series
proved highly volatile. We therefore chose to apply static expectations
to export revenues, measuring the net present value of exports as (X/r).
Expected import prices: It was assumed that most import prices
were expected to grow in the long run at their average growth rate over
the last five years. The price of oil, however, was assumed fixed in
nominal terms, as were all export prices.
Exports and imports: For technical reasons, imports for
Malaysia include debits of unrequited transfers, while exports include
only credits. Experiments suggest that this treatment made no practical
difference to the results from the treatment specified above. In
economic terms, our standard treatment implied that investment income
payments and unrequited transfers were prior claims on foreign exchange
revenues before imports could be obtained, whereas our "Malaysian"
treatment implies that only investment income was.
Colombia
Coffee exports: Coffee exports are separated from non-coffee
exports when calculating expectations. Non-coffee export price
expectations are static, whereas the coffee export price expectation is
the average price for the previous five years. Volume expectations are
static for both.
Non-commercial lending: Our calculations required a series of
non-concessional disbursements to Colombia back to 1960. However, there
was no information for 1960, and we used half the value for 1961.
- 99 -
Kenya
Exports: Balance of payments data for Kenya begin in 1963, the
year Kenya gained independence. It is possible to obtain data on
imports and exports of merchandise from the colonial reports. These
data -are separated into external trade and trade within the East African
territory. Data on trade within the territory are likely to be
understated, since the boundaries of the three territories were
administered by a total of six customs posts. All pre-independence data
are customs data and are reported in East African pounds. These were
converted to dollars and added to our sample. We needed data on total
trade credits back to 1955, and these were estimated by extrapolating an
ordinary least squares regression of the exports of other goods and
services and net unrequited transfers (less grants) on merchandise
exports and a time trend fitted over 1964-82.
Exceptional finance: Data for international capital flows and
unrequited transfers contain elements of exceptional financing. In the
latter class, these data are broken out because they are considered
accommodating. They are not so treated for loans, however, since loans
still entered the total stocks of debt. This treatment implies that
Kenya could have expected to be able to borrow money without much
difficulty to cover its imports; thus such funds are included in the
import decision. On the other hand, grants, being costless, were
probably more scarce and the country could not expect them. They would
be given after the import decision was made.
For most of the models, exceptional financing was treated like
any other capital flow. However, for Hemphill's model we experimented
- 100 -
by excluding exceptional financing from one version of the current
foreign exchange earnings and by adjusting reserves to take these grants
into account. There was little difference between the two versions.
Gold: Kenya has very small gold holdings. The data series
begins in 1973, with zero values recorded until 1977. It was assumed
that gold holdings were non-existent prior to 1973.
Interest rates: Data were needed back to 1955 for interest
rate expectations. The value of 0.065 was used prior to independence.
For years missing data on what the financial institutions were charging
(1963, 1964, 1967, 1968, 1969 and 1974), the average rate on non-
concessional loans was used.
Expectations: Export revenue expectations were adjusted to
take into account price fluctuations for tea and coffee. Price
expectations for these beverage exports were taken as the five-year
averages of a composite price of the two goods. The composite price was
calculated with 1970 weights.
- 101 -
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World Bank Economic Analysis of Projects Economy-Wide Models and
Lyn Scuire and TDevelopment Planning
Publications HerLnan G. van der Tak Charles R. Blitzer, Peter B. Clark,
of Related Reconsiders project appraisal and rec- and Lance Taylor, editors
ommends a more systematic and con- Surveys the specification and uses of
Interest sistent estimation and application of medium-term and perspective econo-
shadow prices and a calculation of mywide planning models.
rates of return that take explicit ac- in8 1982.r382 pres ( 7clud in t-
count of the project's impact on the Oxgr 1 n82ers8t Prgess, 1975;n seletepn
distribution of income, additional readings, bibliography, subecwt
The Johns Hopkins University Press, 1975; and author index).
Approaches to Purchasing 4th printing, 1981. 164 pages (including LC 4-29171. ISBN 0-19-920074-2, Stock
Power Parity and Real Product appendix, glossary, bibliography). No. OX 920074. S9.95 papeback.
Comparisons Using Shortcuts LC 75-40228. ISBN 0-8018-1818-4, Stock
and Reduced Information Nvo. /H 1818, $6.50.
Sultan Ahmed French: Analyse economique des projets.
Staff Working Paper No. 418. 1980. 62 Economtica, 1977; 2nd printing, 1981.
pages (including 14 tables, bibliography). ISBN 2-7178-0014-X, Stock No. IB 0550,
Stock No. WP-0418. $3. $6.50. Financing of Investment in
Comparative Study of the Spanish: Analisis economico de proyectos. India, 1975-1985: A Sources
Mianagement and Organization Editorial Tecnos, 1977 ISBN 84-309-0719- and Uses of Funds Approach
of Irrigation Projects Armando Pinell-Siles and V.J.
Anthony F. Bottrall Economic and Social Analysis Ravishankar
Staff Working Paper No. 458. 274 pages of Projects and of Price Policy: Staff Working Paper No. 543. 1982. 92
(including 3 appendixs). The Morocco Fourth pages.
Stock No. WP-0458. S10. Agricultural Credit Project ISBN 0-8213-0205-5. Stock No. WP 0543.
Kevin M. Cleaver $3.
NEW Staff Working Paper No. 369. 1980. 59
pages (including annex tables).
Cost-Benefit Analysis: Issues Stock No. WP-0369. $3.
and Methodology
Anandarup Ray General Equilibrium Models
Examines the numerous important NEW for Development Poli o,
contributions to the theory and prac- Economic Evaluation of Kemal Dervis, Jaime de Melo,
tice of cost-benefit analysis, consolidat- I P and Shesman Robmnson
ing much of the recent work in ths Investment rojects: Provides a comprehensive study of
area and focusing on aspects that con- Possibilities and Problems of multisector, economywide planning
tinue to be controversial. Discusses al- Applying Western Methods in models with particular emphasis on is-
ternative types of valuation functions, China sues of trade, distribution, growth,
differential weighting for income ine- Adrian Wood and structural change. Theoretical dis-
quality and for disparities in the con- This paper describes economttc c cussion of the properties of multisec-
sumption of basic needs, shadow ex- bnetanlytor, appaied general equilibrium
change rates and the valuation of 19U. analysis and its tci- to models is combined with numerical
nontraded and traded goods and serv- project appraisal in China. It was writ- apiain opriua onre n
LC 8 04i67.lSBN0-818-368-,Stck tenf Worignalya backgrNoun material.5 aperiaense tof particular countries and
ices, valuation of savings and budget fenorigiatamo Chase expegroudtsaterepar- problems. The models considered
constraints, and concepts of discount for a tag ueful fra w for policy anals
rates nd of hadow age raes. Th ing projet apprisal mnualnfretheom input-output and linear
8018-3069-9 Stock shado.wIH 3 , rs.50 CISBna prnvestmentrai B anku. Wth r 0e63n programming to the more recent non-
techniques and implications of using mists pInners, Band . Otaer s linear computable generl equilbrium
the more recent approaches are ex- mists,findnitrsefu ind droingt busnaerssi (CGE) models. The authors consider
plamnd in ractial trms. ttemps to China. Concentrates on methods of es- how these models can be used to ana-
provide a more complete account oft.mtnshdwpiefoprjci- lyeqsinsfgothadtuc
the issues and polemics in cost-benefit Ptsmatng sdowtus pricses frproject tuyze quanestionsecto of grwt ond ruc-n
analysis than is currently available in pusadotuseicusspoettrxchangergm, an the slcionpaof oforeig
the literature. A lengthy overview is impact on the level of national income texcangve regilome,nd sthaegimpac ofn
and the need to combine various crite- tenivdvlom tsragesn
also provided for nonspecialist read- nawt h eut ffra cnmc the distribution of income. The empiri-
ers. analyi winh dh eutoomlecno-u cal applications are based both on
T'he Johns Hopkins Univerity Press. 1984. sions. mkn nvsmn cross-country analysis and on the ex-
208 pages. perience of particular countries and
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that constrain policy markets. quantities, and final expenditure com-
Cambridge University Press. S44 pages. The International Comparison ponents of GDP for thirty-four coun-
LC 81-12307. ISBN 0-521-24490-0, Stock Project tries for 1975. By relating the results to
No. IB 0556, $42.50 hardcover, ISBN 0- Three volumes that establish a world- certain widely available national in-
521-27030-8, Stock No. lB 0557, S27.95 wide system of international compari- come accounting data and related vari-
pa521 l-2 sons of real product and of the pur- ables, the authors develop extrapolat-
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The Global Framework: An GuP for the thirty-four countries for
Updaee S 1950 to 1978. In addition, the 1975 dis-
Briata N [ afi tribution of world product by region
Brian N)Jolan lgpXliEf and per capita income class is esti-
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pages. tions between both quantities and
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Global Modeling in the World The Johns Hopkins University Press, 1982.
Glob;d Modeling in the World ~~~~~~~~~~398 pages.
Bank, 1973-1976 LC 82-15569. ISBN 0-8018-2359-5, Stock
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essential feature of the Bank's eco-
nonic work. Evaluates the projections International Comparisons of
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the models, of particular interest be- Power
cause of the sharp rise in petroleum Irving B. Kravis, Zoltan Kenessey, Macroeconomic and
prices in the mid-1970s. Points out Alan Heston, and Robert Summers Distributional Implications of
uaws in the system which are now re-
medied with new analytical tools. Establishes the methodology and pre- Sectoral Policy Interventions:
Staff Working Pap No. 54. 1983. 200 sents comparisons of gross domestic The Case of Energy and Rice
Staff Working Paper product per capita and currency pur- in Thailand
pages. chasing power for ten countries in P. Amnranand and W. Grais
ISBN 0-8213-0109-8. Stock No. WP 0544. 1970 and six of the same countries in nan on d fram o
S5. 1967. Prsents an economywide framework
The fohns Hopkcins University Press, 1975. for policy analysis in Thailand. This
Humandz Factors in Project Work 306 pages (ipncldn glossaryPrs, index . framework-the 51AM2 model-is
Heli PerreFto 306 a (ncluding glossary, index), used here to analyze two sets of poli-
and erancis J. Lethem LC 73-19352. ISBN 0-8018-1606-8, Stock c des. Focuses on energy pricing and
Sand Wrangs Pape Let 39he 180m No. IH1- 606, $27.30 hardcover, rice pri'cing. Shows the value of this
Staff Woi*ng Pa3per No. 3597. 1980.ts 85l- No. I 1606, S27.JO hardcover. analytical framework for policy analy-
pages (including 3 annexes, 5 charts. bibli- Phase II: Intemnational sis that focuses on structural adjust-
og° phy). Comparisons of Real Product ment in production and trade patterns.
Stock No. WP-0397. $3. and Purchasing Power Staff Working Paper No. 627. 1984. 200
Human Resource Development Irving B. Kravis, Alan Heston, and pages.
and Economic Growth in Robert Sumzners Stock No. WP 627. $5.
Developing Countries: A Updates Phase I and adds six new Methodologies for Measuring
Simultaneous Model countries, comparing the figures for AdutrlPieItreto
David Wheeler the sixteen countries for the years 1970 AgiltrlPceIevnio
and 1973. Effects
Staff Working Paper No. 407. 1980. 130 The Johns Hopkins University Press, 1978. Pasquale L. Scandizzo
pages (including 8 appendixes, bibliog- 274 pages (including glossary, index). and Colin Bruce
rapy). . LC 77-17252. ISBN 0-8018-2019-7, Stock Staff Working Paper No. 394. 1980. 106
Stock No. WP-0407. SS. No. JH 2029, S25 hardcover: ISBN 0- pages (including 4 appendixs, references).
Ilterdependence in Planning: 8018-2020-0, Stock No.JH 2020, $8.50 pa- Stock No. WP-0394. $5.
Multilevel Programming pack. A Model of an Agricultural
Studies of the Ivory Coast Phase III: World Product and Household: Theory and
Louis M. Goreux Income: International Evidence
Provides a system for analyzing each Comparisons of Real GDP Howard N. Barnum and Lyn
component of a country's economy in- Irving B. Kravis, Alan Heston, Squire
dependenly and relates the interde- and lobert Summers Innovative model of short-run behav-
pendencies between the components., Thi report restates and extends the ior that combined production and con-
The Johns Hopkins University Press, 2977. methodology set out in the first two sumption decisions in a theoretically
448 pagos (including bliogrophy, index). volumes. -Particular attention is given consistent fashion for an agricultural
LC 77-4793. ISBN 0-8018-2001-4, Stock to the problem of comparing services household.
The Johns Hopkins University Press, 1980. proposes a reorientation of develop- LC 79-12739. ISBN 0-8018-11554. Stock
118 pages (including appendix, references). ment policy to achieve more equutable No. IH 1155, S5.95 paperback.
LC 78-21397. ISBN 0-8018-22254, Stock distribution. French: L'appreciation du nsque dens
No. IH 2225, S6.95 paperback. Oxford University Press. 1974; 4th print- 1'evaluation des proiets. Dunold Editeur.
ing, 1982. 324 pages (including annex, SS95.
Multisector Models and the bibliography).
Analysis of Alternative ISBN 0-19-920070-X, Stock No. OX Social Cost-Benefit Analysis: A
Development Strategies: An 920070, S9.95 paperback. Guide for Country and Project
Application to Korea French: Redistribution et croissance. Economists to the Derivation
Yuji Kubo, Jeffrey D. Lewis, Jaime Presses Universitaires de France. ISBN and Application of Economic
de Melo and Sherman Robinson 22403102. S9.95. and Social Accounting Prices
An exploration of the use of multisec- Spanish: Redistribucion con crecimiento. Coln Bruce
tor models as tools for analyzing the Editorin Tecnos, 2976. ISBN 84-309- Staff Working Paper No. 239. August
relation between altemative develop- 0624-X. S9.95. 1976. 148 pages (including 6 annexes).
ment strategies, growth and structural A Relationship between the Stock No WP 0239 55
change in a developing country. Dy- Rate of Economic Growth and
namic input-output and CGE models the Rate, Allocation, and Techniques for Project
are applied to the 1963-73 period 'in teR e,Alcio adAppraisal under Uncertainty
Korea and used as simulation laborato- Efficiency of Investment Appras unger
ries for analysis. Dennis Anderson Shlomo Reutlinger
Staff Working Paper No. 563. 1983. 52 Discusses how the methods and re- Presents a method of evaluating risk in
pages. sults of microeconomics affects the investment projects and means for us-
ISBN 0-8213-0174-8. Stock No. WP 0563. analysis of growth in the relationship deisionmakungt
$3. described in the title. Drawing on So dheJohsiHopkiansg nvrst.rss 90
low's vintage model of growth, this The Johns Hopkins Univesity Press, 1970;
The Political Economy of paper derives an aggregate form of the 4th printing, 1979. 108 pages (including
Specialized Farm Credit relationship and compares the ap- annex, bibliography).
Institutions in Low-Income proach with those of several long- LC 74-94827. ISBN 0-8018-2154-6, Stock
Countries ~~~~~~~~standing studies of the subject. No. JH 1154, $5.95 paperback.
J.D. Von Pischke, Peter J. Staff Workng Paper No. 591. 1983.44 What is a SAM? A Layman's
Heffernan, and Dale 'W. Adams ISBN 0-8213-0186-1. Stock No. WP 0591. Guide to Social Accounting
Staff Working Paper No. 446. 1981. 102 S3. Matrices
pages. Risk Analysis in Project Benjamin B. King
Stoc-k No. WP-04. $5. ~ Appraisal Staff Working Paper No. 463. 2981. 59
Redistribution with Growth Louis Y. Pouliquen pages (including refernces),
Hollis Chenery, Montek S. Discusses methodological problems Stock No. WP-0463. S3.
Ahluwalia, Clive Bell, John H. and the usefulness of simulation; illus-
Duloy, and Richard Jolly trated by three case studies.
Describes existing inequality in in- The Johns Hopkins University Press, 1970;
comes in developing countries and 5th printing, 1983. 90 pages.
The Developing Countries and Export Promotion Policies
International Shipping Barend A. de Vries
Harald Hansen Staff Working Paper No. 313. 1979. 80
Staff Working Paper No. 502. 1981. 151 pages.
pages (including 12 annexes, 38 tables, Stock No. WP 0313. $3.
bibliography).
Stock No. WP 0502. $5.
NEW
Exports of Capital Goods and
NEW Related Services from the
Republic of Korea
Economics and the Politics of Larry E. Westphal, Yung W. Rhee,
Protection: Some Case Studies Linsu Kim, Alice Amsden
Adjustment to External Shocks of Industries Examines Korea's spectacular export
in Developing Economies Vincent Cable growth-from $50 million of goods in
Bela Balassa Looks at factors which effect an indus- 1962 to $25 billion in 1982. Five kinds
Staff Working Paper No. 472. 1981. 31 try's attitude toward protection by of project-related exports are character-
pages (including appendix). analyzing four of Great Britain's indus- ized (overseas construction, plant ex-
Stock No. WP 0472. $3. tries: footwear, knitwear, cutlery, and ports, direct investments, consulting
consumer electronics. Case studies ex- services, Licensing and technical agree-
Policies and ~~amine import competition from devel- ments). Discusses the role of these ex-
Adjustment Policies and oping countries and adjustment op- ports in Korea's strategy for develop-
Problems in Developed Countries tions exercised within each industry. ment. Shows how these strategies
Martin Wolf Study includes some explanations for conform to the country's dynamic
Staff Working Paper No. 349. 1979. 236 protectionist behavior among indus- comparative advantage by enlarging its
pages (including references). tries and a discussion of the politics of mdustral base.
Stock No. WP 0349. $10. decisionmaking in regard to trade pol- Staff Working Paper No. 629. 1983. 80
icy. pages.
Staff Working Paper No. 569. 1983. 80 ISBN 0-8213-0310-4.Stock No. WP 0629.
Britain's Pattern of pages. $3.
Specialization in Manufactured ISBN 0-821340199-3.Stock No. WP 0569. On Exports and Economic
Goods with Developing $3. Growth
Countries and Trade Protection Gershon Feder
Vincent Cable and Ivonia Rebelo Effects of Non-Tariff Barriers Staff Working Paper No. 508. 1982. 24
Staff Working Paper No. 425. 1980. 61 to Trade on Prices, pages (including appendix, references).
pages (including 3 appendixes). Employment, and Imports: The Stock No. WP 0508. $3.
Stock No. WP 0425. $3. Case of the Swedish Textile
and Clothing Industry India's Exports
Carl Hamilton Martin Wolf
NEW Staff Working Paper No. 429. 1980. 63 Despite improved performance, the
pages (including appendix, bibliography). growth of India's exports continues to
Bureaucracies and the Political Stock No. WP 0429. $3. lag behind need, potential, and the
Economy of Protection: achievements of several of its competi-
of a Continental Energy, Inte.national Trade, tors. This study examines India's over-
Reflections of a Contmental Energy, Intemational Trade, all export performance in the 1960s
European and Economic Growth and 1970s, with emphasis on the cen-
Patrick Messerlin Alan S. Manne and Sehun Kim tral role of incentives. The major prob-
Analyzes three factors that influence Staff Working Paper No. 474. 1981. 30 lems and policies are discussed, as
the "bureaus" (bureaucrats) in their pages (including 2 appendixes, references). well as current strategic options.
decisions affecting protectionism in Stock No. WP 0474. $3. Oxford University Press. 1982. 224 pages
France. (including index).
Staff Working Paper No. 568. 1983. 64 LC 82-6309. ISBN 0-19-520211-2. Stock
pages. . No. OX 520211, $22.50 hardcover. (A
ISBN 0-8213-0198-5. Stock No. WP 0568. European Communty specially priced edition is available in India
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Manufactured Imports from
Capital-Importing Oil Developing Countries: A Case Industrial Country Policy and
Exporters: Adjustment Issues Study in the Political Economy Adjustment to Imports from
and Policy Choices of Protection Developing Countries
Alan H. Gelb E. Verreydt and J. Waelbroeck J. M. Finger
Staff Working Paper No. 475. 1981. 38 Staff Working Paper No. 432. 1980. 25 Staff Working Paper No. 470. 1981. 22
pages (including 9 tables). pages. pages (including references).
Stock No. WP 0475. $3. Stock No. WP 0432. $3. Stock No. WP 0470. $3.
Italian Commercial Policies in in the EEC markets but have less effect NEW
the 1970s in keeping out non-EEC imports.
Enzo R. Grill Staff Working Paper No. 567. 1983. 48 Real Wages and Exchange
pages. Rates in the Philippines, 1956-
Staff Woreng Paper No. 428. 1980. 47 ISBN 0-8213-0197-7. Stock No. WP 0567 78: An Application of the
Stock No. WP 0428. $3. Stolper-Samuelson-Rybczynski
Output and Employment Model of Trade
Changes in a "Trade Sensitive" Deepak Lal
NEW Sector: Adjustment in the U.S. Explains the movements of real wages
Footwear Industry in the Philippines in terms of a simple
Korea's Competitive Edge: John H. Mutti and Malcolm D. regression model. Examines the coun-
ompe,ve ge, try's postwar economic performance
Managing Entry into World Bale and draws some tentative conclusions
Markets Staff Working Paper No. 430. 1980. 21 for economic policy.
Yung Whee Rhee, Bruce Ross- pages (including footnotes, references). Staff Working Paper No. 604. 1983. 60
Larson, and Garry Pursell Stock No. WP 0430. $3. pages.
How did Korea manage to expand its Patterns of Barriers to Trade in ISBN 0-8213-0213-2.Stock No. WP 0604.
exports from less than $100.milhon a Sweden: A Stud in the 3.
year in the early 1960s to more than y
$20 bilion a year in the early 1980s? Theory of Protection Shadow Prices for Trade
To find out about the underpinnings Lars Lundberg Strategy and Investment
of Korea's competitive edge, the au- Staff Working Paper No. 494. 1981. 35 Planning in Egypt
thors asked more than 100 major Ko- pages (including 3 appendixes). John Page, Jr.
rean exporters what had been impor- Stock No. WP 0494. $3. Working PrN
tant for them in institutional support, Sfaff Working Paper No. 521. 1982. 212
in technological development, and in The Political Economy of pages.
marketing overseas. The findings Protection in Belgium ISBN 0-8213-0009-1. Stock No. WP 0521.
show that there is a strong interaction P.K.M. Tharakan $10.
between exporting and the effective- S 1. 1ral an
ness of a country's economic institu- Staff Working Paper No. 431. 1980. 22 Structural Change in Trade in
tions, both public and private. Without pages (including statistical appendix, refer- Manufactured Goods between
effective institutions, a country may ences). W 0 3 Industrial and Developing
not be able to implement effective pol- S W 3 $ Countries
icies for export promotion. Conversely,
successful exporting appears to give The Political Market for Bela Balassa
economic institutions more vitality and Protection in Industrial Staff Working Paper No. 396. 1980. 46
effectiveness. The findings also show Countries: Empirical Evidence pages.
how Korea's selectivity-in the acqui- Kym Anderson and Robert E. Stock No. WP 0396. $3.
sition of technology and in the market- Baldwin
ing of products overseas-has been an Staff Working Paper No. 492. 1981. 28 NEW
Important part of Korea's success in pages (including references). The Structure of International
The Johns Hopkins University Press. June Stock No. WP 0492. $3. Competitiveness in the Federal
1984. About 204 pages. On Protectionism in the Republic of Germany: An
ISBN 0-8018-3266-7. $19.95. Netherlands Appraisal
K.A. Koekkoek, J. Kol, and L.B.M. Frank D. Weiss
On the Political Economy of Mennes Probes the comparative trade advan-
Protection in Germany Staff Working Paper No. 493. 1981. 70 tage of the Federal Republic of Ger-
H. H. Glismann and F. D. Weiss pages (including 3 annexes, references). many in the 1980s with surprising con-
Staff orkin Pape No. 47. 790. 30Stock No. WP 0493. $3. clusions: developing countries are
Staff Wor(ing Paper No. 427. 1980. 30 Stc competitive with the Federal Republic
pages (including bibliography). of Germany in a far wider range of
Stock No. WP 0427. $3. NEW products than had been previously
Public ssistane to Inustries thought. Suggests probable trends, es-
Public Assistance to Industries hpecaly toward developing countries.
NEW and Trade Policy in France Concludes that the faster income in
Bernard Bobe developing countries grows, the faster
The Political Economy of Describes the institutional structure these countries will become competi-
Protection in Italy: Some through which trade police is deter- tive in an even wider range of goods.
Empirical Evidence mined. Focuses on the evolution of Innovation, though a key factor, can-
Emp ril and J La N France's international commerce in the not determine comparative advantage,
Enzo Grilli and Mvauro La NMoce 1970s and assesses probable trends for because innovations spread rapidly
This analysis is based on a model that the future. through the world economy.
specifies the demand side of the mar-
ket. Examines 35 industrial subsectors Staff Working Paper No. 570. 1983. 64 Staff Working Paper No. 571. 1983. 84
in terms of EEC tariff protection and pages. pages.
Italy's domestic subsidy assistance. ISBN 0-8213-0200-0. Stock No. WP 0570. ISBN 0-8213-0201-9. Stock No. WP 0571.
Finds that tariffs protect Italian exports $3. $3.
The Structure of Protection in Trade and Employment Why the Emperor's New
Developing Countries Policies for Industrial Clothes Are Not Made in
Bela Balassa and others Development Colombia: A Case Study in
The Johns Hopkins University Press, 1971, Keith Marsden Latin American and East Asian
394 pages (including 5 appendixes, index). In the last decade, the developing Manufactured Exports
LC 77-147366. ISBN 0-8018-1257-7, Stock countries have proved that they can David Morawetz
No. IH 1257. $25 hardcover. compete internationally in exporting Focuses on the exports of a particular
manufactured goods, as well as pn- commodity (clothing) from a particular
mary products and services. This pa- Latin American country (Colombia) in
per examines three sets of issues: (a) an attempt to understand why Latin
Testing for Direction of whether good export performance is America has been so much less suc-
Exports: India's Exports of attributable to special characteristics of cessful at exporting manufactured
Manufactures in the 1970s the most successful countries or goods to date than East Asia. It is the
Ashok Khaanna whether their success can be readily first study to go into great detail in ex-
the hyothess thatthe eportsreplicated in other countries; (b)amigthprc,ndeeilyte
Tests whether the penetration of the mar- amninr det einantsof exportysuc-
of a developing country with an ad- kets of industrial countries has n
vanced manufacturing sector will differ reached, or will soon reach, a limit; cess.
among destintions: the capital inten- and (c) whether trade in manufactures Oxfrd Universityj Press, 1981. 208 pages
sity of exports will be greater to the among the developing countries can (including appendixes, biblig pahy).
more labor abundant destinations, and expand further. Concludes with a dis- LC 81-9547. ISBN 0-19-520283-X, Stock
the labor intensity of export will be cussion of the contribution of small No. OX 520283, $22 hardcover.
greater to the more capital abundant enterprises to the creation of employ- Worker Adjustment to
destinations. India's exports of manu- ment and the alleviation of poverty. Liberalized Trade: Costs and
factures for 1973 and 1978 are used for 1982. 70 pages (including annex). Assistance Policies
Staff Working Paper No. 538. a983. 41 ISBN 0-8213-0017-2. Stock No. BK 0017. Graham Glenday, Glenn P.
pages. W p 8 Jenkins, and John C. Evans
ISBN 0-8213-0132-2.Stock No. WP 0538. Staff Working Paper No. 426. 1980. 87
$3. Trade in Non-Factor Services: pages (including 2 appendixes, bibliog-
Past Trends and Current Issues raphy).
Andre Sapir and Ernst Lutz Stock No. WP 0426. $3.
Staff Working Paper No. 410. 1980. 140 World Trade and Output of
The Tokyo Round: Results and pages (including 4 annexes). Manufactures: Structural
Implications for Developing Stock No. WP 0410. $5. Trends and Developing
Countries Countries' Exports
Ria Kemper Trade in Services: Economic Donald B. Keesing
Staff Working Paper No. 372. 1980. 38 Determinants and Staff Working Paper No. 316. 1979.
pages (including annex). drelopmend-Elat Issues 74 pages (including statistical annex).
Stock No. WP 0372. $3. Andre Sapir and Ernst Lutz Strend iNo W nte03 tionaTrad
Staff Working Paper No. 480. 1981. 38 Trends in u ntedational Trade
pages (including appendix, references). i Manufactured Goods and
Trade Adjustment Policies and Stock No. WP 0480. $3. Structural Change in the
Income Distribution in Three Industrial Countries
Archetype Developing Trade Polig for Developing Bela Balassa with the assistance of
ArconmetyeDvlpn Trade Policy for Developing Kenneth Meyers
Economies Countries Examines recent trends in trade in
Robinson Donald B. Keesing manufactured goods between the in-
Staff Working Paper No. 442. 1980. 91 tWorld Bank Staff Working Paper No. 353, dustrial and the developing countries.
Staffs Workluing Papperno.i442. 1980es.9 August 1979, vii + 264 pages (including Analyzes (a) the implications of these
pages (including appendixes, references). references). trends for structural change in the in-
Stock No. WP 0442. $3. Stock No. WP-0353. $10. dustrial countries and (b) changes over
time in the current dollar value and
the commodity composition of trade in
Trade Policy Issues for the manufactured goods. Recommends
Trade among Developing Developing Countries in the teational trade amned at promoting in-
Countries: Theory, Policy 1980s change.
Issues, and Principal Trends Isaiah Frank Staff Workeng Paper No. 611. 1983. 44
Staff Working Paper No. 479. 1981. 116 World Bank Staff Working Paper No. 478. pages.
pages (including 2 appendixes, references). August 1981. 52 pages. ISBN 0-8213-0251-S.Stock No. WP 0611.
Stock No. WP 0479. $5. Stock No. WP-0478. $3. $3.
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