©International Monetary Fund. Not for Redistribution · and experience of the Bank's country...

The Swedish National Bank (Riksbank) in Stockholm(right); the Parliament (Riksdag) is to the left. See FrankA. Southard Jr.'s article, "The Central Bank in the PolicyMaking Process," page 17.

Photo by Ed Huffman—World Bank

Cover: See Eric Himsworth's article,"Financial Administration in De-veloping Countries," p. 31.

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EDITOR

J. D. Scott

DEPUTY EDITOR

Donald Townson

CONSULTING EDITORS

L. Ruben Azocar

Jean van der Mensbrugghe

ADVISORS TO THE EDITOR

Roger V. Anderson

W. A. Beveridge

Barend A. de Vries

Raymond J. Goodman

H. Geoffrey Hilton

Michael L. Hoffman

F. A. G. Keesing

Lars Lind

Samuel Lipkowitz

Charles F. Schwartz

Marcin R. Wyczalkowski

DESIGN

Fund Graphics Section

Finance and Development is pub-lished quarterly in English, French,and Spanish by the InternationalMonetary Fund and the InternationalBank for Reconstruction and Develop-ment, Washington, D.C., 20431, U.S.A.

A selection of its contents is pub-lished annually in Rio de Janeiro,Brazil, in cooperation with the UnitedNations Information Center.

Opinions expressed in articles andother material are those of the writeror writers; they are not statements ofFund or Bank policy.

The contents of Finance and De-velopment may be quoted or repro-duced without further permission. Dueacknowledgment is requested.

Volume 5 Number 2 June 1968

CONTENTS

Measuring Capital Requirements 2

E.K. Hawkins

The Magnitudes of Exchange Devaluation g

Margaret G. de Vries

The World Bank's Proposals for 13Supplementary Finance Measures

Irving S, Friedman

The Central Bank in the Policy Making Process 17

Frank A. Southard, Jr.

Consultants for Agricultural Development 20

M.M.M. van Gent

National Income Accounting in Developing Countries 26

Emanuel Levy

Financial Administration in Developing Countries 31

Eric Himsworth

Economies of Scale and Economic Integration 35

G. Nguyen Tien Hung

Book Notices 41

Views and Comments 43

Recent Activity—International Bank for Reconstruction 46and Development, International Development Associa-

tion, and International Finance Corporation

Recent Activity—International Monetary Fund 48

Finance and Development


Measuring CapitalRequirements

The author discusses the origins of recent estimates of capital require-ments for development and highlights some of the issues involved.

E. K. Hawkins


ISCUSSIONS of the theory and practice of provid-ing aid for development have included in recent

years various calculations of the amount of capitalrequired. Here, as an example, is one made by theWorld Bank:

While the amount of external finance has grownlittle in recent years after a substantial rise in the1950's, the capability of the developing countries tomake productive use of resources has increasedconsiderably. A preliminary Bank inquiry, carriedout country by country and based on the judgmentand experience of the Bank's country specialists andarea economists, suggests that the developing coun-tries could effectively use, on the average over thenext five years, some $3 billion to $4 billion moreof external capital per year than has been providedin the recent past.1

In a world in which it is increasingly difficult tomobilize such funds, estimates of this kind have anunreal quality for many people. Shortage of fundsshould not, however, be used as an argument againstexploring the size of the gap that is emerging betweenthe amount of capital likely to be available for devel-oping countries and the amount that they could useeffectively. The making of such estimates raises prob-lems both of theory and measurement which are ofinterest in themselves and which involve issues centralto any consideration of the development process.

Nature of RequirementsEstimates of this kind are now generally known as

estimates of capital requirements. The word "require-ments" is used in this context as indicating a need fora transfer of goods and services in order to achieve cer-tain targets; these may be target rates of growth for theeconomies as a whole, or they may be target rates ofinvestment, although, where this is so, investment isnormally thought of as being the means by which ratesof growth of income are increased. The basic idea,however, is that such estimates of capital inflow orcapital requirements shall be related to a generallyrecognizable and agreed aim, and that this aim shouldinclude the transformation of the recipient economy insuch a way as to increase permanently its ability tocontribute to economic welfare. They are not normallyregarded as subsidies to current consumption, althoughsuch capital flows may include such subsidies withina suitable framework of foreign aid.

Two ApproachesThere are two possible approaches to making such

estimates and both are based on the idea that increased

i World Bank and International Development Association,Annual Report, 1964-65 (Washington), p. 62. This inquiry wasinitiated by Mr. Irving S. Friedman, Economic Adviser to thePresident, and carried out under his direction.

income and wealth depend fundamentally upon theapplication of more capital, either to increase outputdirectly when used in combination with local resources,or indirectly when the use of such capital will lead toa more effective use of other resources.

The first approach is to make an over-all estimateof the uses that are made of the output of goods andservices, with particular reference to the share that isallocated to consumption and the share that is allo-cated to investment. It is then argued that the futuregrowth of the economy depends on a suitable increasein the share of goods and services allocated to invest-ment. An attempt is made to estimate the effect uponthe future growth of income of any additional invest-ment so as to be able to assess how much capital isneeded to achieve a given rate of growth. This is thencompared with the estimated ability of the economy tomake available such a share of resources. (In otherwords, how much saving can an economy at a particularstage of development carry out?) The difference be-tween these two estimates will then give some indicationof the required size of the capital inflow from abroad.

Such estimates are made without any considerationof the specific form that the investments are likely totake. By contrast, the second approach builds up suchan over-all estimate from below by a detailed study,on a project-by-project or a sector-by-sector basis, ofthe need for capital. An examination is then made ofthe possible sources of such capital locally, and a dis-crepancy will thus emerge between the needs for thedevelopment of all the projects under consideration andthe resources which can be made available. This differ-ence is the required capital outflow from overseas, thecounterpart of which can be the estimate reached bythe first approach mentioned.

These two approaches are different not only in theirnature, but in their provenance. The first approach cor-responds to the various calculations of capital require-ments which have been made in the last 20 years bythe United Nations and by the U.S. Government. Thesecond approach is, generally speaking, the one fol-lowed by the World Bank in producing the estimateswhich have been developed in recent years by its ownthinking on the subject.

There is a further important difference, however, inthe manner in which this subject has been treated byother international organizations and the way in whichit has been viewed by the World Bank Group. Esti-mates made outside the Bank have all been concernedwith the requirements aspect of capital inflows. Theybegin by specifying a target rate of growth which is tobe the aim of the developing country and then proceedto estimate the amount of capital which would beneeded to reach that target. In the estimates made by

3

D1


the World Bank Group no explicit target is used; in-stead, the estimates emerge from a multidimensionalexamination of the economy in question and representthe amount of capital which the Bank feels might beused in an effective way in the future, provided thatcertain levels of economic performance are achievedand suitable policies are followed by the country con-cerned.

Evolution of Estimating

One of the first of the over-all estimates made wasprepared in 1949 by a group of experts under the aegisof the United Nations. This group proceeded to reacha figure of capital requirements by way of an analysisof the capital that would be needed to bring about astructural change in the developing countries, definedin terms of a continuous transfer of labor from theagricultural sector of the economy to the industrialand commercial sectors. The investment per capita re-quired to prepare a worker for employment in theindustrial sector is much higher than that required forthe employment of the same worker in the agriculturalsector, and this is especially true where the agriculturalsector has not been modernized in any way. The figureproduced by this group was $12 billion a year, definedas the net additional foreign resources required to per-mit the developing countries to reach a target growthrate of income of 2.5 per cent a year.

The United Nations has made subsequent estimatesbased on work carried out by the Secretariat and firstpresented in 1962.2 These estimates were of some im-portance because they formed the basis of a submissionto the first UNCTAD meeting in 1963. This approachagain concentrated on the performance of the economyas a whole and was based on relationships between therates of growth of gross domestic product, exports, im-ports, and investment. The basic idea is that develop-ment depends not only on investment but also on otherscarce resources as well, for example the availabilityof skills at particular levels, or the existence of groupsof the population able to act as businessmen andmanagers.

The "Two-Gap" Approach

Attention is also focused, however, on what is thoughtto be a more important limitation on development: apossible shortage of foreign exchange, as a result ofwhich countries may be unable to acquire from abroadthe goods and services necessary for promoting domes-tic development. This approach has become known asthe "two-gap" approach because it operates in two

2 United Nations, Studies in Long-Term Economic Projectionsfor the World Economy (New York, 1964), pp. 67-68.

dimensions; while continuing to argue that develop-ment is a function of investment it also holds that suchinvestment, which requires domestic savings, is not suf-ficient to ensure that development takes place. It mustalso be possible to obtain from abroad the goods andservices that are complementary to those available athome. In most developing countries the structure ofthe economy is so simple that it can produce only alimited range of products when relying solely on do-mestic sources. In these circumstances an act of saving,by itself, even though it releases resources for invest-ment purposes, may not make available the correct kindof resources. In physical terms a country may be unableto produce the cement, steel, or machinery which gointo the various projects required to raise income in thefuture, although it may be able to make the necessarysavings by cutting down on consumption. Unless thesesavings can be used to purchase the necessary goodsand services from overseas no progress can be made.

Estimates made as a result of this approach startfrom certain basic relationships which are generallyaccepted as holding true for all countries. The usagesof modern national accounting are designed to expressthe fact that the amount that can be invested in anycountry is identical with the amount that is saved; thatis to say, only those goods and services which are notconsumed can be deployed to increase future incomethrough investment. At the same time, if these resourcesare to be supplemented from abroad, such a flow ofresources will appear in this accounting framework asan excess of imports over exports. It will, in fact, alwaysappear twice, first as the difference between investmentand the amount that can be saved within the economyand second as an equal excess of imports and servicesover exports of goods and services.

The Four Important MagnitudesCalculations of capital requirements proceed on the

basis of projections of the four important magnitudes:savings, investments, exports, and imports. A targetrate of growth is specified, and then the amount ofadditional capital that will be required in order to reachthat target rate of growth is estimated. This gives afigure for capital requirements which can be comparedwith the likely availability of domestic savings. At thesame time it is possible to make projections of thelikely behavior of exports and imports. The formerwill depend on the supply of goods and services avail-able, or likely to be available, for export from thedomestic economy, the state of the world markets, andthe economic health of the developed countries whichare the markets for such exports. A similar estimatecan be made for import requirements. All these pro-jections (which are of course capable of much sub-division) can be made independently of one another,

4


and it follows that there is very little likelihood thatsuch independent projections will all arrive at an an-swer which satisfies the basic accounting relationshipalready referred to above. Projected investments maywell exceed projected savings; projected imports, onthe other hand, may exceed the projected exports by adifferent amount. However, national income account-ancy demonstrates that the excess of investment oversavings must necessarily be equal to the excess of im-ports over exports and this must hold true at all pointsof time. It follows that there is something inconsistentabout the projections that have been made independ-ently. The two-gap method, therefore, is essentiallya way of ensuring that inconsistencies, which may beimplicit in other ways of making projections, arebrought out into the open.

Estimates of capital requirements made by thismethod, therefore, yield not one, but two figures forconsideration. For example, the UN estimates, men-tioned above, show a savings gap of $12 billion in 1970($20 billion in 1975) and a trade gap of $20 billion($32 billion in 1975). The use of this approach re-quires either that the projections include the necessarychanges in the structure and the behavior of the econ-omy which will make the two estimates consistent witheach other, or that a decision has to be made that thelarger of the two gaps will be the more significant andwill be taken as the required capital inflow from abroad.

The two-gap approach was used in an importantseries of country studies carried out by UNCTAD tomake a very elaborate calculation of the capital needsof the developing countries at various dates in the fu-ture. It was elaborate because the projections werederived from econometric calculations for the variouscountries concerned, so that each estimate could besaid to be based on all the known factors which canbe put into quantitative terms. (An additional problemwas that of combining the individual country resultsinto a consistent world total.) These studies have beenused as the basis of the presentation made to the secondUNCTAD Conference (New Delhi, February-March1968) of a new set of gap estimates. Emphasis wasplaced on the trade gap, projecting a "low" figure of$17 billion in 1975, and a "high" figure of $26 billion.3

A "Three-Phase" ApproachA variant on the approach has also been followed

by two American writers, Mr. Hollis B. Chenery andMr. Alan M. Strout, who, in a study' prepared for theU.S. Agency for International Development (AID),

employed a three-phase approach, where an attemptwas made to specify in quantitative terms the constrainton development arising from the limit of absorptivecapacity.5 This work has had a considerable influenceon discussions of the subject. In their study, variousconstraints—a savings constraint, the foreign exchangeconstraint, and the limitation of absorptive capacity—come into operation for a particular developing econ-omy at various stages of its growth. They focus specialattention on two aspects: first, the savings behavior ofthe economy concerned, or its ability to refrain fromconsumption and allocate additional resources to in-vestment; and second, the question of absorptivecapacity, viewed, in this instance, as a performancefactor. In other words, if absorptive capacity is increas-ing over the years, it can be regarded as a measure ofthe improved economic performance of the countryconcerned, and of its ability to make better use of capi-tal from abroad. In their work they spelled out the op-eration of these three constraints in terms of threedifferent stages of development. An interesting featureof this study is its extensive coverage on a countrybasis, since the model was applied to 50 developingcountries and totals obtained for a spectrum of differentassumptions. For this reason the results cannot be sum-marized easily, and the indicated range of capital re-quirements for 1970 is as wide as $10-17 billion.

This three-phase approach can be useful for exposi-tory purposes, but it can only be an approximation tothe real life problems of many developing countrieswhere the three constraints often coexist and interactwith one another. It has been found, for example, thatthe limitations of absorptive capacity may apply onlyto particular sectors of the economy, while other partsof the economy are able to absorb more capital thancan be obtained from local sources of savings. Thiscoexistence of the various constraints on developmentis in many ways a central characteristic of an under-developed country.

One limitation of all the approaches detailed aboveis precisely that they operate at a highly aggregate level.Any aggregative approach of this kind treats all unitsof investment as if each were adding to a volume ofcapital which is homogeneous. In practice this is onlytrue of the monetary units in which capital and invest-ment are measured. It is convenient to measure invest-ment and capital in monetary terms, but the moneyvalues often only hide the significance of the specific

3 "Low" and "high" refer to different assumptions as tocountry growth rates.

4 Hollis B. Chenery and Alan M. Strout, "Foreign Assistanceand Economic Development," American Economic Review,September 1966.

5 Absorptive capacity covers all the ways in which the abilityto plan and execute development projects, to change the struc-ture of the economy, and to reallocate resources is circum-scribed by the lack of crucial factors, by institutional problems,or by unsuitable organization. Not only the structure of theeconomy but also the utilization of its existing capacity willhave an important bearing on a country's absorptive capacity.Cf. J.H. Adler Absorptive Capacity: The Concept and ItsDeterminants, Brookings Institution, Washington, 1965.

5


nature of the investment item. Cement once incorpo-rated into a highway cannot be used for other purposes;steel once built into a building must yield additionalwealth in that form, otherwise the investment will havebeen wasted. It is the underlying importance of thisaspect of development which emphasizes the projectand sector approach to the measurement of capitalrequirements.

The estimates of capital requirements prepared bythe World Bank Group over the period 1964-67, andwhich have already been quoted, can be best describedas estimates of capital inflows, since, as already ex-plained, there is no formal element of "requirements"behind such figures. In addition, there is an importantdistinction between the origin of these estimates andothers which have been prepared by other internationalorganizations.

World Hank Economic ReportsIn the course of its regular work the World Bank

prepares a number of different kinds of economic re-ports, depending upon the purpose in mind. All ofthem, however, have in common an analysis of theactual situation of the member country as far as thepublic sector, fiscal situation, and external economicrelations are concerned. Generally speaking, the con-text and the focus of these reports would include notonly the possible direct role of the World Bank Grouplending in the country concerned but also the place ofall such external assistance in the over-all developmentprospects. Considerable attention is paid, in addition,to an assessment of the economic performance andofficial policies.

A typical report focuses on possible developmentsfor a period up to five years ahead. These developmentswill often be determined largely by events that havealready taken place and changes in the structure of theeconomies will be largely the result of past investmentdecisions. Because of this it can be argued that the rela-tively short viewpoint taken is one of the reasons whyit is possible to make plausible projections of capitalinflow; the pattern of main developments in the econ-omy is already largely determined for some years ahead,and the implications of these developments can beanalyzed with some confidence. The same is true ofthe likely availability and quality of the factors of pro-duction which are also likely to be relatively stable overthe next four or five years. As a result, it is possible tomake forecasts and projections of the trends expectedin the main sectors of the economy, in public revenues,expenditures, and savings, and in imports, exports,and the balance of payments. These projections, whichform the basic material from which capital inflow esti-mates can be assembled, will often assume certain ad-justments in official policies affecting exports and sav-

ings, as well as resource allocation. They will normallyinclude direct estimates of investments, investment pos-sibilities, and plans (often on a project-by-project orsector-by-sector basis). They take into account notonly "needs" in the narrow sense of the word but alsothe way in which the possibilities are dependent upona constellation of policies bearing on the efficiency withwhich the economy is managed, resources are em-ployed, and savings are mobilized.

The estimates that emerge from such appraisals takeinto account what can actually be invested in an effec-tive way. They rest upon the past ability of a countryto prepare and bring forward economically justifiableprojects; they also take into account the financialresources available to the country for that part of thecosts which will not be covered by a capital inflow fromabroad. The foreign capital inflow can then be regardedas a missing element required to permit a larger invest-ment than would be possible, given all the domesticfactor availabilities, local infrastructure, and the savingspossibilities opened up by the policies and level ofperformance of the government.

Limiting FactorsIn making these appraisals attention is paid to the

limitations which are faced by developing economies.The first is absorptive capacity, which will express it-self in terms of the amount of time required to set upand organize projects so as to be able to make effectiveuse of a capital inflow from abroad. A second kind ofconstraint is that imposed by the inability to generatesufficient domestic savings, and the third is a likelyshortage of foreign exchange; these last two limitationshave already been discussed.

When appraising the significance of these limitationsfor a particular country over a short period ahead, it isusually desirable to include a realistic estimate of theamount of external capital likely to be available. (Thiswill often be limited by factors not connected in anyway with the internal characteristics of the economy.)It is clearly unrealistic to calculate needs or require-ments essentially in the form of a large gap to be filledfrom overseas, without any consideration as to thelikelihood of the financing being obtained. What mayoften happen is that discussions will be held with thecountry concerned in which the implications of a short-age or limitation on external funds is discussed so thatit may be reflected in the country's internal planning.

This brief description of the manner in which theWorld Bank carries out its analysis of the economiesof individual countries is intended to illustrate the de-tailed inquiries which are the raw material from whichthe estimates of capital inflow are derived. Since thisanalysis proceeds along a country-by-country approach,

6


there are further calculations required before globalfigures can be obtained for all the developing countries,or for different regions. Such calculations raise furtherproblems of methodology that will not be discussedhere, especially problems connected with reconcilingthe individual projections for separate countries withone another. (For example, export projections for themajor commodities for individual countries must bereconciled with over-all projections that can be madefor the world market for those commodities.)

The Reports' Importance in Policy PlanningThe estimates that are obtained from such exercises

represent, at best, orders of magnitude of the size ofthe problem of development. They cannot be accuratein the sense that they can be regarded as projections orforecasts of what is likely to come about. Nevertheless,they have a value for purposes of policy planning inthat they indicate the size of the gap that exists between

what is and what is possible, given the funds and rea-sonable economic performance on the part of the de-veloping countries. They are some measure of thedemands made upon the consciences of the richercountries, not as demands for charity, but as the re-quirements to enable the poorer countries to achievepossibilities of growth that are within their grasp.

E.K. Hawkins, an English-man, is an economist in chargeof the Applied Quantitative Re-search Division of the Econom-ics Department of the WorldBank. He is a graduate of theUniversities of London andOxford and carried out eco-nomic research in Nigeria andUganda before joining thefaculty at the University ofSheffield. He joined the staff ofthe Bank in 1963.

quoting orreprintingFinance and Developmentarticles. . .

No permission is required to quote or reproduce material appearing in Financeand Development. A credit line or other acknowledgment is requested.

The Editor would be glad to receive two copies of publications containingreprints or quotations.

7


The Magnitudes ofExchange DevaluationIn debates among economists over the relative merits of fixed and fluc-

tuating rates it has often been assumed that postwar exchange rates haveremained virtually unchanged; the business community, on the other hand,tends to focus on every change that takes place. This article examines justhow extensive and how frequent these changes have been since WorldWar II.

Margaret G. de Vries

N RECENT YEARS a number of economists, espe-cially in the universities, have lamented the relatively

little use that countries have made of exchange rates tosolve their balance of payments difficulties. For exam-ple, many of these economists have been advocatingflexible rates to overcome the infrequency of changeof fixed rates or have been considering how fiscal ormonetary policies can be made more flexible to compen-sate for the rigidity of exchange rates. For the mostpart, these economists have focused their observationson the large industrial countries. They have been notingthat, until the devaluation of the pound sterling inNovember 1967, few changes had been made since1949 in the exchange rates of the major industrialpowers.

On the other hand, the business community and com-mercial traders have had a keen awareness of all ex-

8

change rate changes. With an eye on their competitivepositions, their fears of other countries' devaluationsmay have been exaggerated.

With so much current interest in exchange rates, itis worthwhile to take a brief look at the magnitudesand frequencies of exchange devaluation that have oc-curred in a broad spectrum of countries since WorldWar II. It is evident that use of the exchange ratemechanism has been rather common.

Measuring the Magnitudes

Percentage changes in the exchange rates for 109countries—by major geographic region—for the 19-year period from the end of 1948 to the end of 1967are presented in Table 1; by using long-term datanumerous small devaluations can be compressed intoa single figure. The end of 1948 as a starting date has

I


been preferred to the end of 1946 (when initial parvalues were set for most of the Fund's original mem-bers) because the exchange rates of several countrieswere more settled by that year (or by early 1949) thanthey were immediately after the war, and because datafor 1948 are readily available.

Because the results depend on the particular ex-change rates used, and because in some instances (suchas countries with multiple currency practices) a choiceof rates existed, an endeavor has been made to selectfor these calculations currently used exchange rates asagainst, say, legal parities. For most countries, parvalues, or at least fixed official rates, could be used;but for some countries, free market rates have beenused, and for a few a choice among multiple rates hasbeen made. The percentage changes in exchange rateshave been measured relative to gold, or to the U.S.dollar with gold content expressed in the weight andfineness in effect on July 1, 1944, with 100 per centbeing the maximum possible devaluation.

How Much Devaluation?

Table 1 also shows the distribution of 109 countriesover five major geographic regions according to the netpercentages by which their currencies have been de-valued. The first group shows 13 countries which havenot devalued at all: the United States, 7 Central Amer-ican countries, Ethiopia and Liberia, and Switzerlandand Japan.1 In Lebanon a slight appreciation occurred.The second group comprises 12 countries that havedevalued less than 30 per cent—that is, approximatelythe amount by which sterling was devalued in Septem-ber 1949; in this group are not only several major in-dustrial nations (Belgium, Canada, Germany, Italy,Luxembourg, and the Netherlands) but also 3 LatinAmerican countries (Costa Rica, Nicaragua, and Vene-

zuela) and Portugal, Saudi Arabia, and the SyrianArab Republic. Germany and the Netherlands, afterdevaluing by about 30 per cent in September 1949,both revalued their currencies upward by 5 per centin 1961.

The third group comprises 22 countries which havedevalued a total of 30-39 per cent. This includes mainlycountries which devalued along with sterling in 1949but which did not go along in the devaluations of 1967.It also includes Denmark, which devalued again inNovember 1967, by 7.9 per cent—less than the 14.3per cent of the 1967 sterling change. Apart fromAustralia, Denmark, Norway, and Sweden, the groupincludes developing countries in Asia, the Middle East,and Africa—for example, Burma, Iraq, Kenya, Malay-sia, Nigeria, Pakistan, and Singapore.

What is often not fully realized is that for 62 coun-tries (groups four and five) the magnitude of postwardevaluation has exceeded 40 per cent. Some 38 coun-tries have devalued between 40 and 75 per cent; thisincludes not only the United Kingdom and Ireland,which have devalued just over 40 per cent in total, butalso Austria, Finland, India, Mexico, New Zealand,Peru, the Philippines, and Turkey, which have devaluedby larger amounts.

For another 24 countries devaluation has gonebeyond 75 per cent. Among European countries in thislast group are France, Greece, Iceland, Spain, andYugoslavia. Other countries devaluing by these largeamounts have been 7 Latin American countries (Argen-tina, Bolivia, Brazil, Colombia, Chile, Paraguay, andUruguay), as well as Ghana, Indonesia, Israel, Korea,and Viet-Nam.

1 Japan's official rate was set in April 1949 and has sinceremained unaltered.


In sum, devaluations, even by the major powers, fallin all five categories. Among less developed countriestwo patterns of devaluation are apparent. One patternfollows that of the major currencies. Countries in Cen-tral America have conformed generally to the U.S.dollar and have devalued either not at all or very little.Many others in Asia and Africa have followed the leadof either sterling or the French franc.

The second pattern of devaluation among develop-ing countries is related to the price and balance ofpayments experiences of the individual country. Manyof them in all geographic regions have thus devaluedindependently of the major currencies, by amounts from40 to nearly 100 per cent.

The average (that is, the arithmetic mean) devalua-tion of all 109 countries for these years is 48.2 percent. The arithmetic mean for those 96 countries thatdid engage in some devaluation (eliminating the 13countries of group one) is, of course, higher—54.7per cent. The global picture is seen in better perspec-tive, however, when account is taken of the differingimportance in world trade of various countries. Arith-metic means have, therefore, been calculated (Table 2)which have been weighted by the share in 1966 of thecountry's exports in total world exports.

Australia, Canada, New Zealand, and the UnitedStates, as a group, have devalued by the least amounts.The weighted average for Europe is 23.5 per cent.The Latin American countries have devalued by thegreatest amounts—a weighted average of 62.2 per cent—with the Middle East, Asia, and Africa in between.As would be expected (because the larger trading na-tions devalued less than most smaller ones) the over-all

world weighted average (calculated for 109 countries)is 22.8 per cent, much less than the unweighted average.

TABLE 1: PERCENTAGES OFDEVALUATIONS

EUROPEAND LATIN MID-

MAJOR AMER- OLETOTAL AFRICA ASIA POWERS ICA EAST

No DevaluationLess than 30%30-39%40-75%More than 75%

Total

1312223824

109

20

10186

36

10464

15

27465

24

73157

23

12332

11

The Frequency of Devaluation

The frequency with which devaluation occurs is alsooften underestimated. Admittedly some 12 countrieshave not devalued at all in the postwar period—1 haseven slightly appreciated its currency—and another 27have devalued only once, most of them in the generalrealignment of 1949. However, an impressive total of48 countries has devalued at least once more after1949, and another 21 have devalued quite frequently.Table 3 shows these frequencies.

TABLE 2: EXTENT OF DEVALUATION,1948-67, BY REGIONS

REGION

Australia, Canada,New Zealand, andthe United States

EuropeMiddle EastAsia (excluding Japan)AfricaLatin America

Total

NUMBER OFCOUNTRIES

42012143623

109

AVERAGEWEIGHTED

DEVALUATION

5.223.538.446.147.662.222.8

Among the 24 countries that have devalued onceagain after 1949, for a total of two devaluations, arenot only those which devalued in November 1967along with the United Kingdom (such as Ceylon, Den-mark, Ireland, Jamaica, and New Zealand) but severalwhich found it necessary earlier to devalue once morethe rates they had set in 1949: Austria, Ghana, Greece,India, and the United Arab Republic. France and theFrench franc area have devalued twice since 1949—once in 1954 and again in 1958—making a total ofthree devaluations.

Devaluations for countries with multiple or fluctuat-ing rates have been even more numerous. Some fivecountries—Bolivia, China, Paraguay, Thailand, andYugoslavia—had frequent devaluations until 1962, buthave not changed their rates subsequently. Another 16

10


TABLE 3: FREQUENCY OF DEVALUATION,END 1948-END 1967

NUMBER OFCOUNTRIES

AppreciationNo Devaluation since 1948One DevaluationTwo DevaluationsThree DevaluationsFrequent Devaluations, but no change

since 1962Frequent Devaluations, including

changes since 1962Total

112272424

5

16109

countries have continued to devalue fairly often, evenin ttfe last five years. These include not only severalLatin American countries (Argentina, Brazil, Chile,Colombia, and Uruguay) but also a few countries inEurope and several in the Middle East and Asia.

Comparison With Prices

Interesting as these figures are, measurements of thechanges in exchange rates for various countries aremore revealing when juxtaposed with movements intheir domestic prices. While the Brazilian cruzeiro andthe Chilean peso have, for example, been devalued by99.9 per cent betwen 1948 and the end of 1967, theirdomestic price levels have, in the meantime, gone up100-fold. The question, therefore, arises of how muchthe exchange rate has changed in comparison with risesin internal prices?

Accordingly, ratios have been calculated betweenactual exchange rates at December 1967, and no-tional rates which are those which have just keptpace with subsequent inflation. A notional rate for eachof 65 countries has been obtained by taking the ex-change rate in 1948 and adjusting it to take accountof the rise in the cost of living index in that countryfrom 1948 to mid-1967.2 This rate shows what ex-change rate would have prevailed in mid-1967 had therate been devalued since 1948 merely to the sameextent as the country's consumer prices have increased.

It is thus possible to see what changes in exchangerates have occurred in something like "real terms"—that is, abstracting from differences in internal pricechanges. The actual exchange rate for each country inDecember 1967 was expressed as a percentage of thenotional rate, that is, as a ratio. A ratio of 100 indicatesthat the exchange rate and prices are in the same rela-tionship in 1967 as they were in 1948. Where the ratioexceeds 100, devaluation has been less than the increaseof the country's prices of consumer goods. Where the

2 Those 65 countries have been selected for which price databack to 1948 are available.

ratio is below 100, the exchange rate has been devaluedmore than the country's prices have increased.

The 65 countries have been grouped into five cate-gories, and an average actual-notional exchange ratioobtained for each group. These average ratios are pre-sented in Chart 1. Nineteen countries—the UnitedStates, Canada, the major powers of Western Europe,Japan, and others—have been placed in group one as"industrial countries." Most of these have had what ishere labeled as "moderate inflation"—that is, the levelof consumer prices in mid-1967 was about 1.4 to 2.0times its 1948 level.

The remaining 46 countries—comprising what areusually called the developing countries—have beendistributed over four groups according to the degree ofinflation. Twelve—some in Central America, a few inthe Middle East, and 2 in Asia—have had what can beregarded as "little inflation," using as a benchmarkless inflation than that of the United States (group two).Another 10—the rest of General America and a fewcountries in Asia and Africa—are in group three, thatof "moderate inflation," as defined above.

Another 9 (group four)—some from each region—have had what is here called "strong inflation," that is,their price levels rose more than two, but less thanthree, times from 1948 to 1967. Finally, in group five,are 15 countries characterized as those with "chronicinflation"; their consumer price levels have gone upmore than three times, and many by much more; half ofthese countries are in South America, but a few insouthern Europe, the Middle East, and Asia are alsoincluded.

This arrangement of countries enables one to inter-pret the actual-notional exchange rate ratios with refer-ence to the degree of inflation. Low ratios in countrieswith little inflation, for example, reflect their having hadvery little increase in prices; they may not have adjustedtheir exchanges rates at all since 1948. On the otherhand, low ratios for countries with very large inflationreflect degrees of exchange devaluation which are evengreater than the rises in their internal prices.

Realignment of Postwar Exchange Rates

In Chart 1, low ratios appear on the left side of the100 mark and high ratios on the right. It is revealedthat the major industrial powers have an average ratiowell above 100—indeed 141. In other words, thegeneral level of postwar consumer prices in these coun-tries has risen more than their exchange rates havebeen devalued.

The ratios for the four groups of developing coun-tries, on the other hand, were considerably lower, andtwo of the four groups of developing countries were

11


even below 100. For the developing countries in grouptwo, the explanation for the average ratio of only 95 issimple: their price increases have been virtually negligi-ble. Several of them have also devalued in line withmajor currencies, although only two or three of themhave devalued in the last few years. The average ratioof 121 for group three, developing countries with mod-erate inflation, is also lower than that of the industrialcountries, partly because the rates of inflation in theindustrial countries have been somewhat lower andalso because some of these countries have devalued bylarger amounts than most of the developing countries.

What is more surprising are the relatively low ratiosfor groups four and five, developing countries with rela-tively strong and even chronic inflation. This clearly re-flects extensive exchange depreciation, even in realterms (apart from price rises). And the greater the infla-tion, the larger, on average, is the depreciation, even inreal terms.

Several factors help to explain this extensive devalua-tion by the developing countries even relative to theirgreater inflation. First, the exchange rates of manydeveloping countries may well, in 1948, have beenmore out of line with prices in the rest of the world,compared with prices at home, than the exchange ratesof the major countries. Hence, more "correction" mayhave been necessary to realign their rates. Second,developing countries have used, more than industrialcountries, exchange rate adjustment as a policy tool.Industrial countries have relied more heavily on mone-tary and fiscal policies and on other domestic measures.Third, demand for the exports of the industrial coun-tries has, on the whole, been more dynamic than thatfor the exports of the developing countries. Moreover,the productivity advances in industrial countries in ex-port industries have also been more marked than indeveloping countries; these have helped to keep theirexport prices relatively lower than their general con-sumer prices. Hence, the general level of prices inindustrial countries could often run ahead of exchangerates without damaging their export positions; this hasbeen much less true for developing countries.

Fourth, the mechanism by which exchange rates wereadjusted also seems to have been a factor in the extentof depreciation. Countries which have used multiplerates—and these were mainly developing countries—have devalued much more in relation to their generaldomestic prices than have countries with unitary ex-change rates. As countries have eliminated multiplerates, they have usually devalued down to the pre-vailing free market rate; the free market rate, at leastat the time of devaluation, has usually been below thatdetermined by general prices. Finally, it has been sug-gested in a Fund study that inflation itself, because ofits price distorting effects, may induce a degree of

exchange depreciation in excess of the rise in domesticprices.3

Not Equilibrium Rates

These comparisons between actual and notional ex-change rates based on internal prices cannot, of course,be taken as suggesting equilibrium rates. For one thing,the base period used here, 1948, is widely known to beanything but an equilibrium year to be used as a startingpoint. And the 1967 pattern is undoubtedly a morerealistic structure. More importantly, there has beenincreasing recognition in the last 20 years that equilib-rium exchange rates are a function not only of relativeprices but also of changes in productivity, capital flows,and levels of tariffs and trade barriers considered ap-propriate, as well as the domestic monetary, fiscal, andemployment policies a country wishes to pursue.

However, it is evident that over the long haul, from1948 to the end of 1967, important alterations hadoccurred in the structure of international exchangerates. Many countries—industrial and developing alike—have devalued their exchange rates extensively sincethe postwar international monetary system commencedin 1946. Furthermore, compared with that startingpoint, the relative realignment of rates between coun-tries that has occurred has been striking. Countries withchronic inflation have engaged in severe and frequentdevaluation which has more than offset their subse-quent aggregate domestic price rises. Countries withlesser amounts of inflation have also offset considerableamounts of their domestic price increases via adjust-ments in their exchange rates. And a substantial realign-ment of the exchange rates of the developing countriesvis-a-vis the major industrial countries has occurred,even allowing for the price advances of the developingcountries. Where their prices have risen, they haveusually devalued a good deal more than the price rise.Where they have not devalued—or devalued very little—generally their price rise has been very small.

3 Graeme S. Dorrance, "The Effect of Inflation on EconomicDevelopment," Staff Papers, International Monetary Fund(Washington, D.C.), Vol. X (March 1963), pp. 1-47.

Margaret G. de Vries, anAmerican, is a Consultant to theFund, and was a member of thestaff from 1946 to 1959. She isalso a Consultant in Researchto the Graduate Council of theGeorge Washington Universitywhere she has also been Lec-turer in Economics. Mrs. deVries graduated from the Uni-versity of Michigan and hasa Ph.D. in economics fromthe Massachusetts Institute ofTechnology.

12


TheWorld Bank's

Proposalsfor

SupplementaryFinance

Measures

The Economic Adviser to the President of the World Bank describes thescheme proposed by the staff of the Bank to assist countries whose economicdevelopment may be impeded by unexpected shortfalls in their exportearnings.

Irving S. Friedman

ANY of the balance of payments problems facingthe developing countries are already familiar to

Finance and Development readers.1 On the paymentsside, these countries are faced with large and increasingneeds for foreign exchange to pay for normal imports,the more specialized imports increasingly needed fordevelopment, and a growing burden of debt service. Onthe receipts side, their foreign exchange earnings, whichare much larger than capital inflow, expand slowly andfluctuate widely. This is, to a large extent, the result of

1 See, for example, Poul H0st-Madsen, "Balance of PaymentsProblems of Developing Countries," Part I and II, Financeand Development, June and December 1967.

concentration of their exports in a few primary com-modities for which world demand has been growingvery slowly, at a much lower rate than the demand formanufactures. At the same time, owing to the low elas-ticities of demand and supply with regard to price, theprimary commodity trade has been subject to violentfluctuations in prices and, as a result, earnings. Finally,the less developed countries have generally such a poorforeign reserve position that they have had seriousdifficulties in coping with these problems on their own.

Various international efforts have been made toassist the less developed countries in dealing with theseproblems. The need to overcome the difficulty created

13

M


The second United Nations Conference on Trade and Development (UNCTADII) was held in New Delhi in February and March.

by slow growth of exports is a major consideration inthe efforts to provide assistance needed to acceleratethe process of development and diversification, andalso underlies the pressure to secure better access tomarkets for less developed countries. The operations ofthe International Monetary Fund are addressed toassisting countries to deal with relatively short-termdisequilibria in their balance of payments; in particular,the compensatory financing facility established in1963 has been concerned with the problem of fluctua-tions in export receipts by providing funds to com-pensate for temporary declines in export receipts froma medium-term trend.

National Planning and Export ShortfallsHowever, two aspects of the development efforts of

the less developed countries give rise to a special kindof balance of payments problem for the solution ofwhich there is no international machinery available atpresent. One aspect is the increasing use of the plan-ning or programing technique in organizing their devel-opment efforts. This involves fairly firm commitmentsto development activities extending some way into thefuture on the basis of certain expectations about avail-able resources, especially foreign exchange receipts,over this period. To the extent that export earnings fallshort of such expectations, the development program isput in jeopardy. Second, one of the most usual andimportant aims of planned development is to bringabout, by deliberate policy measures, a change in pasttrends in export performance. An unanticipated disturb-ance in the export market resulting in a shortfall inexport earnings from expectations may have grave con-sequences for the balance of payments of the develop-ing countries. Because the aim has been to change thetrend, this kind of uncertainty cannot be measured by

extrapolations of past trends, but rather from estimatesof future expectations, which take account of theeffects of the country's own policies.

Projections of export earnings are built into develop-ment programs in two ways: the development programcontains commitments to certain policies affecting ex-ports, which enter into the projections; the developmentprogram in turn is based on the export projection andis tested for financial feasibility on the basis of antici-pated export earnings and other sources of developmentfinance. If exports fail to materialize according to ex-pectations, then at least the time schedule of plannedexpenditures is put in jeopardy unless the countryenjoys an unusually high level of reserves or can relyon other sources of external capital on suitable terms.

Few developing countries, however, have sufficientreserves or adequate access to appropriate foreignfunds to meet this kind of problem. As a result, anunexpected export shortfall usually leads to slowingdown—and even halting—planned investment, and tohastily improvised programs of import restriction whichimpede efficiency, particularly in the productive sectors.Investments already made may be wasted; investmentsthat have been started may have to be discontinued;completed plants may be only partially utilized. Con-traction as well as the reshaping of domestic expendi-tures is usually necessary, and sometimes even desir-able, when unexpected declines in export earningsoccur, but too often the ax falls on long-term—butbasic—investments, resulting in a loss of momentumin the development effort. The hastily improvised reduc-tion in development expenditures becomes the counter-part to the unexpected reduction in external fundsavailable for development.

A Case in Point

In a number of countries a disruption of developmenthas precisely been the result of an unexpected exportshortfall. What is more, in a number of these cases,the export shortfall has been due largely to unexpectedmovement in supply and demand conditions abroad,over which the affected country had no control. Colom-bia in the early 1960's is an outstanding example. InColombia there was a significant shortfall in exportsbelow the plan target made in 1961, largely because ofthe fall in coffee exports. Though some decline in coffeeprices had been expected, the extent of the decline wasfar beyond anything that could have been reasonablyanticipated. The most immediate effect of the resultingshortfall in export earnings was the slowing down ofthe rate of growth of industrial output. The rate ofcapital formation in Colombia is heavily dependent onthe flow of imported machinery and equipment whichincreased by some 20 per cent in 1960 and 7 per cent in1961, but declined by 13 per cent in 1962 and 19

14


per cent in 1963. Actual investment expenditures of thenational government in 1963 were less than two thirdsof the target established under the plan which had beenreviewed by the World Bank staff.

The Bank Staff Proposals

In November 1965, the World Bank staff proposeda scheme, generally known as the Scheme for Supple-mentary Finance, to meet the problem of unexpectedshortfalls which are potentially disruptive to the de-velopment efforts of the developing countries. The studyincorporating the Bank staff proposals was made inresponse to a resolution adopted by the first UnitedNations Conference on Trade and Development(UNCTAD) in 1964. This requested the Bank to studythe feasibility of a new scheme which "should aim todeal with problems arising from adverse movements inexport proceeds which prove to be of a nature or dura-tion which cannot adequately be dealt with by short-term balance of payments support." An adverse move-ment was defined as a "shortfall from reasonableexpectations" and the object of the scheme was "toprovide longer-term assistance to developing countrieswhich would help them to avoid disruption of theirdevelopment programs." The resolution, originallysponsored by the United Kingdom and Sweden, andadopted by a vote of 107 to 0 with 10 abstentionsfrom East European countries, also requested theWorld Bank to work out such a scheme, if appropriate.

During the course of 1966/67, the Bank staff studyon Supplementary Financial Measures was furtherexamined by an expert group of governmental repre-sentatives of 14 developed and developing countriesset up by the Trade and Development Board of theUnited Nations. All developing countries in the inter-governmental group, and some developed countries,expressed the view that the important objective towhich the UNCTAD resolution was addressed couldbe met by a scheme with the essential characteristicsof the Bank staff scheme. The view was also expressedthat as a result of the deliberations of this Group, anumber of points with regard to the operation of thescheme had become clearer; there were also a numberof points which were left open for further considera-tion. The report of this Group was sent to the SecondUnited Nations Conference on Trade and Develop-ment, which concluded its deliberation in March inNew Delhi. In order to resolve the issues requiringfurther consideration, the Conference has recom-mended the continuation of the intergovernmentalGroup. The Group is expected to begin its furtherwork soon and report to the Trade and DevelopmentBoard as early as possible.

The Scheme Outlined

The scheme would be administered by an interna-tional agency, which might be one already existing ora new one established for the purpose. A membercountry wishing to benefit from the scheme would enterinto an understanding with this agency about the mainelements in its development program, the related poli-cies, and its export projection. As long as the agencywas satisfied that the member country was implementingthese agreed policies and programs, it would be pre-sumed that any shortfall from the agreed export projec-tion was outside the country's control and likely todisrupt its development program. The scheme wouldthen provide speedy relief.

Within the over-all limitation of funds available tothe agency, the amount of assistance would depend onthe shortfall of actual exports from the internationallyagreed projections, the amount of previously accumu-lated earnings above expectations (so-called over-ages), the amount of financing available from othersources, and, finally, the adjustments that the countryitself could undertake to absorb part of the effects ofan export shortfall without disrupting its developmentprogram. The extent to which the country would becalled upon to use other sources of finance, as well asthe nature of the feasible domestic adjustment, wouldbe discussed in advance with the agency.

Member governments of the agency would provideresources permitting operations during an initial five-year period; the Bank staff study estimated that $300million to $400 million per year would probably beneeded for the first five years. The benefits of thescheme would be available to all developing countriesprepared to met the agency's requirements, and terms ofassistance for each country would be essentially thesame as for basic external development finance. Formany countries the terms would have to be quite con-cessional.

Adoption of the scheme would provide developingcountries with the assurance that, if policies with whichthe administering agency agreed were conscientiouslycarried out, development aims would not have to bescaled down because of a shortfall of export receiptsfrom reasonable expectations. The agency would actquickly to fill the need for supplementary resources ifa shortfall occurred which threatened disruption andcould not otherwise be overcome or offset. On the otherhand, if failure to pursue agreed policies were tojeopardize the country's eligibility for assistance, thegovernment would be informed of this without delay.The scheme thus aims to provide an incentive to coun-tries to adhere to high standards of performance in thepursuit of economic development objectives.

15


Building on Existing Foundations

The policy understanding between the country andthe agency stipulated in the scheme builds on existingpractices in the field of international developmentfinance. Already, for example, understandings emergein the course of day-to-day relationships between theWorld Bank and member countries; understandings onstabilization programs with the International MonetaryFund are a well-established practice. For successfuloperation, the scheme envisages close collaborationbetween the agency and the World Bank and the Fundand other international agencies. As a result, the under-standing would reflect a realistic evaluation of themembers' needs and possibilities reached after full con-sultation rather than imposed on the country by theagency. The ingredients of the understanding wouldvary from country to country. Standardized criteriawould be avoided; and much reliance would be placedon the objectivity of the international agency and itscompetence to agree with the country concerned onpolicy measures adapted to the conditions of the coun-try, yet designed to achieve the objectives of economicdevelopment.

Another basic principle is that the export projectionfrom which shortfalls are to be calculated would notonly be as objective and scientific as statistical tech-niques and available data permitted but also that it beagreed to between the agency and the country. Thisprojection, usually extending over the entire period ofthe development program, would be arrived at in thecontext of an understanding on the program as a whole.Revisions in export projections would be made whenconditions, other than the export shortfall, necessitatedthe reformulation of the development program itself.

Many developing countries are already used tomaking export projections, which are an integral partof the planning process, serve as the basis for assess-ing the feasibility of investment programs which consti-tute the core of countries' planned development efforts.The World Bank is similarly accustomed to makingand judging the reasonableness of projections in thecourse of its regular country work. The quality ofprojections can, of course, be improved by sharpeninganalytical tools and strengthening the basis for technicaljudgments, but the improvement in projection tech-niques by itself will certainly not eliminate the problemof shortfalls since unexpected changes in the worldeconomy will continue to take place.

Close cooperation between the member country andthe international agency (or agencies) is really the keyto the scheme. The performance criteria and exportprojections are to be worked out in such a way thatthe country concerned and the international agency can

agree on what is feasible and desirable, thus worthy ofsupport by the international community. As a conse-quence, both donors and recipients would have a stakein the success of the agreed development programs.

Prices of Primary Commodities

An interesting relationship exists between the schemefor supplementary financial measures and internationalefforts to stabilize prices of primary commodities.Progress in negotiating international agreements on par-ticular commodities will reduce the cost of supple-mentary financial measures to the extent that suchagreements make certain parts of a country's earningsmore predictable and thus reduce the size of exportshortfalls. There will, however, still be a need for sup-plementary financial measures in respect of that part ofexport earnings not covered by agreements, and this islikely to be substantial, at least for the foreseeablefuture.

Because the two approaches deal with related prob-lems, it has sometimes been suggested that the adoptionof supplementary financial measures might reduce theefforts to achieve commodity agreements. This is un-likely to happen. One reason is that countries deriveimportant advantages from earning foreign exchange bymeans of their own exports, subject to commodityagreements, as against obtaining foreign exchange asloans from supplementary finance, even if the loans areprovided on concessional terms. Secondly, supple-mentary financial measures are concerned only with theextent to which actual export earnings are close to theirexpected values, and not with the price behavior ofparticular commodities.

Irving S. Friedman becameThe Economic Adviser to thePresident of the World Bank inOctober 1964, having previ-ously been Director of the Ex-change Restrictions Departmentof the International MonetaryFund since 1950. He joined theFund staff in 1946, serving firstas Chief of the United States-Canada Division and then from1948 to 1950 as assistant forpolicy matters to the DeputyManaging Director. He receivedhis Ph.D. at Columbia Univer-

sity. He was active in international discussions leading tothe formation of the Fund and the Bank, the European Pay-ments Union, the re-establishment of convertability of Euro-pean currencies and the review of the international monetarysystem and international liquidity. In the World Bank he isin charge of economic activities, policies, and mechanismsrelating to development finance and is chairman of the Eco-nomic Committee.

16


The Central Bank in the

Policy Making ProcessThe Deputy Managing Director of the Fund discusses the contribution

that a central bank may make to a country's economic well-being and ad-vancement, and offers some of his own views.

Frank A. Southard, Jr.

THE DEVELOPMENT of central banking in thetwentieth century has been one of the most impor-

tant elements in the evolution of modern monetarysystems—possibly the most important. From amonga number of reasons three in particular are worth dis-tinguishing.

The whole concept of modern monetary mangementhas come to depend upon the existence of an institu-tion at the apex of the banking system; in most coun-tries this institution is a central bank.

It is central bankers who have been largely respon-sible for developing the techniques of monetary manage-ment. Among these techniques are the setting of obliga-tory reserve requirements, alterations in rediscountrates and in the volume of rediscounts, various kindsof open market operations, certain more direct controlsof bank credit activities, and in some countries poolingof international reserves.1

In the development of money markets, which hasbecome an essential element in the strengthening ofmodern economies, the central bank plays a salient role.

The Fund's Interest in Central Banks

The Fund's interest in the development of strong andvigorous central banks is far from being academic;where they exist in its member countries the Fund findsthe whole process of collaboration with these memberssimplified and more effective. This is natural, for theFund itself is a product of the same stream of monetaryevolution which has given rise to the emergence ofmodern central banking.

1 For an account of open market operations, see "CentralBank Open Market Operations," by David Sheppard, Financeand Development, Vol. V, No. 1, March 1968.

It is therefore not surprising that the Fund has veryclose relations with central bankers. The Fund is con-cerned with monetary policy and its administration,with the analysis of the flow of savings and credit, andwith trends in the balance of payments; all of these are,of course, the day-to-day concerns of any central bank.

There is thus a kind of natural alliance between theFund and the central banks of its member countries.But, at the same time, neither the Fund nor the centralbanker can afford to take a purely monetary view ofthe functioning of a modern economy and of the mixof policies which is essential. It is evident today thatthe proper set of goals is the maintenance of a soundcurrency and a vigorous money market alongside astrong fiscal system and an effective incomes policy, asbases of vigorous and sustained economic development.

The importance of an appropriate balance in policycannot be overestimated. We will look in vain for acountry which is accomplishing its aims in the fieldof economic and social development and, at the sametime, is continuously running a heavy fiscal deficit whichthe central bank is financing; which is moving fromone massive wage increase to another, and throwingonto the central bank most of the burden of trying tostem the tide of inflation. The consequences of this stateof affairs have become painfully evident: a destructionof the flow of savings, a frustration of monetary policy,balance of payments difficulties, low foreign exchangereserves, and an unsatisfactory rate of economic growth.Under these adverse conditions, no central bank canplay an effective role.

It is not only the central banks in less developedcountries that are confronted by these difficulties. TheFund has had occasion in its Annual Report for 1967to urge on all countries—including many of the indus-trial countries, such as the United States—the impor-

17


tance of more vigorous fiscal policy alongside effectivemonetary policy. This serves to emphasize the rolewhich the central bank must be allowed to play as afull partner in the formulation of the over-all economicand financial policies of any country.

One development in particular during the last fewyears illustrates the importance which the Fund attachesto vigorous central banking. A Central Banking Servicehas been established which aims at helping Fund mem-

The new Bank of Guatemala building in the city of Guatemala: the muralswere executed by local artists. The building is 15 stories high and contains32,217 square meters of office space.

ber countries—especially the newly independent mem-bers—in two ways. First, Fund staff members, botheconomists and lawyers, assist member countries inreviewing their central banking and other bankinglegislation, organization, and techniques. Since the es-tablishment of this department, 23 countries haveturned to the Fund for such advice. Second, the Fundprovides experienced central bankers to go to othercountries to serve as officials in their central banks.These include governors and general managers, direc-tors of research, advisors, supervisors of operations,inspectors of banks, and accountants. At the end of thisfiscal year the Fund will be supporting some 50 expertsin such varied assignments.

Central banks have some responsibilities which arepurely operational in character and need little attentionfrom the Fund—for example, the issuing of currency,and services as fiscal agent for the government. Centralbanks also collect and publish information; in a greatmany countries the periodic bulletins of central banksare the most valuable sources of reliable and expertlydesigned statistical series and general economic andfinancial data.

Major Responsibilities

In considering the problems faced by central bankers,we can distinguish four major areas of central bankresponsibility over economic and financial policymaking.

1. One overriding responsibility is participation inbalance of payments management. This includes acentral bank's influence over the setting of exchangerates and upon capital movements; and policies relatedto restrictions on international payments and tradewherever such restrictions exist.

2. Another fundamental responsibility of the centralbank, closely connected with balance of paymentsconsiderations, is the determination of the total volumeof the domestic bank credit. In regulating the volumeof credit, central banks have to take into account themonetary impact of treasury policies and of the actionsof nonbanking credit institutions.

3. A central bank, besides being concerned withthe total volume of credit, is also responsible for policiesand rules which tend to determine the distribution ofbank credit among different economic activities, themost important of these being distribution between thepublic and private sectors. In some countries, centralbanks are more directly involved in the allocation ofresources through the rationing of credits, while inother countries the structure of the banking system andthe money market is such that a central bank finds littleopportunity for effective intervention in directing credittoward particular economic sectors. Nevertheless, therecan be no doubt that at some point in the emergenceof a strong central bank and in the evolution of thebanking system of a country, this third responsibilityassumes salient importance.

4. The fourth major responsibility of a central bankis the formulation of policies dealing with the level andstructure of interest rates and their effects on the formsand volume of saving.

A central banker needs to relate all of the policieswhich he must formulate and the decisions which hemust make within the policy mixes agreed with thegovernment to two overriding issues of policy: thedesired level of external reserves and the desired volumeof bank credit. Depending on the economic situation,the first or the second policy consideration takes prece-dence. The idea of stimulating economic growth bycredit expansion is attractive particularly in developingcountries. Credit expansion, however, when it is allowedto result in losses of external reserves can be adoptedas a line of policy only in countries where such reservesare relatively ample. Unfortunately, comfortable reservesare generally the exception rather than the rule in de-veloping countries. Experienced central bankers know

18


that in actual practice it is exceedingly difficult to relateaccurately changes in credit and in external reserves. Tobegin with there is a problem of quantifying at everystep the effects of the policy tools which are at thecentral banker's disposal. An experienced centralbanker knows that it is difficult to establish in quantita-tive terms the exact interdependence between changesin the volume of credit and changes in the volume ofexternal reserves. He also knows that the same volumeof credit (or the same rate of its growth) will influencethe external reserves in different ways depending on itsdistribution. Because of the difficulty of attaining ac-curate results in calculation of the effects, the centralbanker prefers a margin of safety in his decisionmaking. Finally, even where the balance of paymentsand credit policies have been translated into specificaims, these aims are not, as a rule, fully attainable inthe face of keen competition for scarce resources.These pressures tend to be so overwhelming that therisks are high that improvisation on the part of policy-makers, including central bankers, will often lead toconflicting measures adopted in relatively quick succes-sion, and to vain attempts to increase the distributiveshares of all sectors at once.

When these pressures are met in any such improvis-ing way, the central banker abdicates his real responsi-bility. By allowing excessive credit demands to becomeeffective, he passes to the market place the task ofreconciling competing calls on real resources. Price in-creases which could have been avoided may well occur;apart from their internal effects, they may require theabandonment of exchange rate stability—with all thedifficulties entailed—if the international reserve targetis to be achieved. Even if excessive credit expansiondoes not unleash price increases, it will cause thebalance of payments to suffer, in which case the inter-national reserve target will, in all likelihood, not beattained.

Fiscal DifficultiesThe greatest threat to the effectiveness of any central

banker comes from a government in fiscal difficulties.Moreover, since in many less developed countriesmoney markets are relatively weak, and the ability ofthe government to cover its fiscal deficit by genuine andnoninflationary borrowing from the banking system andthe money market in general is limited, the centralbanker all too frequently finds himself under extremepressure to finance the deficit. If, in the end, he has toyield to this pressure, he gravely damages his capacityto play an effective role in the sound economic andfinancial development of the country. A rational distri-bution of bank credit is rarely possible when the gov-ernment pre-empts the loanable funds. Moreover, attimes the government's utilization of bank credit is

carried to the point where the international reservepolicy is compromised, notwithstanding the utmostrestraint in bank lending to all private activities. Itfollows from this that the central banker must, asfar as possible, resist inroads by the government, inorder to defend his most essential responsibilites.

Central Bank Independence

This brings me to the edge of an often debated aspectof central banking. Put briefly, it is the issue of centralbank independence—that is, independence from thegovernment. Without choosing my words, I must saybluntly that I am in favor of a high degree of centralbank independence. This does not mean that I supposethat the central bank can live outside of the institutionalframework of government (in the broader sense), isdivorced from sharing the role of over-all policymaking, and can go its blind way ignoring the needs ofthe country and the broad objectives of government.Not at all; I have already argued for full participationby the central bank in the determination of the propermix of policies in the financial and economic fields.What is meant by independence is that the central bankmust be allowed to be a full-fledged partner at the stagewhen major economic policy decisions are made affect-ing the price level, the balance of payments, and mone-tary and credit conditions; and must be enabled tohelp to carry out such policies with vigor and courage.This means, for example, that the government shouldavoid creating situations of fait accompli, where itscommitments can be honored only through endorse-ments of public deficits by the central bank. It alsomeans that the central banker must, with equal resolu-tion, withstand the demands from the private sector fortoo easy credit. It is encouraging that in many countriesstrong and properly independent central banks haveemerged. It is also illuminating that these tend to beeconomically successful countries.

This article is based on a talk given at a meetingsponsored by the Central Bank of Costa Rica, inSan Jose, on September 8, 1967.

Frank A. Southard, Jr. re-ceived his Ph.D. from the Uni-versity of California, and was amember of the faculties of thatuniversity and Cornell Univer-sity. He has served in variouspositions in the U.S. Govern-ment, principally in the Treas-ury Department and the FederalReserve Board, and was forsome years Executive Directorfor the United States in the In-ternational Monetary Fund be-fore becoming Deputy Manag-ing Director in 1962.

19


M.M.M. van Gent

IN THE BROAD FIELD covered by consultants,agricultural consulting has its own place. But because

there is no common understanding between countriesof basic terminology it is difficult to locate this place."Agricultural engineering" means different things indifferent countries, and it is often not clearly distin-guished, for example, from civil engineering. In mostof continental Europe and in Latin America, all grad-uates in any one of the agricultural sciences are called

agricultural engineers, whereas in the United Kingdomand the United States this term is much more restrictedand has become connected with agricultural machinery.Another important difference is that in several of theEuropean countries an intermediate sector betweenagriculture and civil engineering has developed, whichhas no direct counterpart in the United Kingdom andthe United States. This sector can best be describedas rural engineering and it is a separate field of study

Consultants for AgnswtmDevelopment "̂ ^

Agriculture is receiving increasing attention in economic development,and consulting services play an increasingly important part in its progress.


as well as a separate service, dealing with reclama-tion, drainage, irrigation, land reform, and settlementproblems.

For the purpose of this article "agriculture" is con-sidered as covering a broad field from rural engineering,including irrigation and drainage, through crop growingand livestock industry to agricultural economics. There-fore, although a large part of consulting in agriculturemay be classified as engineering consulting, instead ofusing the term "consulting engineer" I propose to usefor agriculture the more general term "agricultural con-sultant," a term which, incidentally, can represent anindividual or a firm.

The use of the term "agricultural consultant" has oneparticular advantage in identifying the kind of responsi-bility carried: agriculture incorporates both physicaland biological sciences; also the human element is muchmore involved in agriculture than it is in pure engineer-ing which concentrates on the material. This makes thetask of agricultural consultants more complex and lessconcrete.

Due to this close relation of agriculture with people,agricultural development includes an important socialelement and has therefore in the past largely been agovernment occupation. In most countries only specifictechnical problems, like the design of irrigation struc-tures or storage facilities, have been entrusted to con-sultants, who often had little knowledge of agricultureitself. The result of the extensive government role isthat there are only a few agricultural consulting firms:fewer than a dozen firms have more than 30 profes-sionals and more than 10 years of international experi-ence in agricultural consulting, compared with morethan a hundred similar firms in the civil engineeringfield.

Since 1950, however, the role of agricultural con-sultants has broadened with the increasing demand foragricultural development, often complex and requiringcooperation of different disciplines. The evolution offinancing by industrialized countries and internationalorganizations has also required a steady supply of well-prepared agricultural projects and hence—once again—the services of consultants. Consulting firms have, there-fore, adapted themselves to the new requirements bybroadening their field of activity, and several new firms,covering the whole or part of the agricultural field, havebeen created; many individual agricultural consultantshave also established themselves during the last 15years.

Fields Covered by Agricultural ConsultantsAgricultural consultants play many roles; their work

can, however, be grouped under the general headingsof projects, fields of expertise, and managerial services.

Projects cover a very wide range. The most com-prehensive are those for regional development. Inthese, agriculture is only one among many elements,although it is in many developing countries the mostimportant, as it provides the basis for development.There is a welcome tendency to tackle problems moreand more through this regional approach. The prepara-tion of such projects requires the close collaborationof experts in all sectors of the economy. For agricul-ture alone studies are needed on the natural environ-ment (soils, climate) and the measures to make theland productive (reclamation, irrigation); on problemsof land tenure, settlement and adaptability of farmers;on handling, storage and processing facilities; and onmarketing and organizational matters.

Somewhat more restricted in objectives and in areaare a multitude of irrigation, drainage, reclamation,colonization, and plantation projects, while projects forstorage, mechanization, fertilizer application, and plantprotection need not be tied to a particular area. Finally,all programs for development of livestock, fishery, andforestry production fall under the heading of projects.

A soil technician in Lesotho: "Consulting firms may supervise the executionof projects."

A "standard" project includes the following phases:reconnaissance, feasibility study, final design, and exe-cution. The phases can be considered to be divided bystages in terms of decisions whether to proceed or notwith a following phase. Consultants, mainly firms, areinvolved in all the phases of a project; they may do thepreliminary studies, including field work and research;prepare the general layout of the project and its justifi-cation; then make the final design and eventually drawup the contract documents. Finally they may supervisethe execution of the works.

The value of this new breed of agricultural con-sultants is illustrated in one problem that appears espe-cially in irrigation projects round the world. Theseprojects have an engineering element (dam, inlet works,pumping stations) and an agricultural element (fieldleveling, water consumption, cropping pattern, farm

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Looking over the plans in the new wing at the Compania Industrial Del Lukus S.ft. factory in Larache, Morocco: this food process-ing and canning factory was expanded and modified with financing from the International Finance Corporation and the World Bank.

type, organization of water distribution). Very oftenthe irrigation projects are prepared by engineers frompublic works departments or civil engineering consultingfirms, who have only a slight knowledge of agricultureand the related human element. The result of this one-sided project preparation is that only the engineeringaspect is adequately covered, while the agriculturalaspect is either not studied at all or else studied fartoo late. So there are to be found in many countriescompleted projects with technically well designed irri-gation facilities, which in practice are of much less useto the farmers than they might have been. The need forimproved coordination of different specialized fields ofwork in project preparation cannot better be demon-strated than by visiting a frustrated irrigation project ofthis kind.

Fields of expertise cover an even wider range thanprojects; they are usually addressed to specific items ordisciplines and result in the production of specializedinformation or recommendations, rather than in projectsready for execution. Expertise is in particular demandin all the individual fields needed for the study of aproject; on all problems which are subject to agriculturalresearch, in particular on the practical application ofresearch results; and in fields complementary to agri-culture, such as marketing, processing, credit, and

mechanics. Sometimes also the opinion of an expertis requested on a study or project report prepared by athird party. The nature of fields of expertise makes themmore suitable for individual consultants than for firms,although sometimes firms provide individual experts.

Managerial services provided by agricultural con-sultants have tended to become more important in thelast few years. They are often temporary and self-liquidating, being needed only while local successorsare being trained, such training being itself an importantpart of the consultant's job. Examples in this field ofactivity are the organization and provision of extensionservices to rural populations, the management of co-operatives, supply and service organizations, researchinstitutes or plantations. Under the same heading comeinvestigations of the efficiency of such services andorganizations already in existence.

Role of Consulting Firms in ManagingAgricultural Projects

The number of agricultural projects in developingcountries has risen steadily over the last 15 years andit may be expected that it will still rise more in thefuture. It is increasingly difficult to find qualified personsor teams for the management of these projects. Al-though many organizations are providing educational

22


and training programs for persons from developingcountries, many of the projects will still have to bemanaged, directly or through advisers, by foreign ex-perts. One reason why individual foreigners are notavailable in sufficient numbers is that many of theeligible persons have permanent jobs, with security andcareer possibilities which they do not want to lose byaccepting temporary assignments abroad. Various pro-posals have been made and experiments carried out toimprove the supply of expatriates by giving them moresecurity for re-entry in their jobs and seniority rightsand advancement opportunities after return. No doubtsome of these proposals and experiments will besuccessful.

Another promising approach may be that of retaininga consulting firm for the management job. There aresome advantages to this approach over the selectionof individuals and the composition of a team by theclient himself.

1. A firm can give more continuity to the mission,not only by providing the managers for a longer period,but also by continuous supervision from its headquar-ters and replacement of employees at the end of a tourof duty by persons with the same background.

2. A firm is responsible for all replacement ofpersonnel, not only for normal relief, but also in emer-gencies or in case of unsatisfactory performance. Oncea firm is chosen the client has no more trouble withthese replacements, while it is usually easier to call forreplacement of the firm's personnel than to dismissindividuals and find replacements.

3. A firm can often provide a more seasoned teamin which the capacities of the members are better co-ordinated than in a team composed of persons whohave never worked together.

4. The problem of job security and advancement isautomatically solved within the firm where the managersremain normal employees. For this reason and becauseof the firm's supervision and the easier replacementpossibilities, personal rivalries and incompatibilities be-tween the managers and local counterparts are less likelyto grow into major difficulties.

In some developed countries the practice exists ofentrusting the day-to-day management of agriculturalprojects to consulting firms subject to regular consulta-tion with, and inspection by, the client. This system hasworked well over a long period of time and meritsextension to international development projects. Insome developing countries, during the last few years,the management of plantation projects (e.g., tea,sugar cane, and fibers) has been successfully entrustedto consulting firms or to commercial plantation firm's.

Sources of Agricultural Consultants

It can be seen that the distinction between individualconsultants and consulting firms is important, but evenwithin these two groups further distinctions may bemade.

In the group of individual consultants there areprivate consultants who operate on their own accountfull time, and temporary consultants who normally haveanother job and whose firm or organization makesthem available for certain jobs. Private consultants inagriculture, of whom there are relatively few comparedwith civil engineers and architects, have now establishedthemselves, in general after having gathered experienceand knowledge of some specific field in another job.Some of them have retired from their regular employ-ment.

There are many organizations and agencies whichhave temporary consultants at their disposal; somemake them available only for special occasions, whilefor others it is a normal practice. In agriculture it ismainly government agencies and institutes that havetemporary consultants available for work in developingcountries, but there is an increasing number of private(often commercial) organizations which have experts

An irrigation ditch in Thailand: the management of plantation projects hasbeen successfully entrusted to consultants in some countries.

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A technician works in the laboratory of the Villavicencio Works of theALMAVIVA Grain Company near Bogota, Colombia.

available for certain fields, e.g., a commodity or fishery.Recently, several countries providing technical assistancehave begun to employ in their agricultural and educa-tional services a few persons as additional experts of thekind that are more than normally in demand, in orderto have a small reserve pool out of which personnel canbe sent to developing countries.

One international organization is outstanding in pro-viding individual agricultural consultants: the Foodand Agricultural Organization (FAO), which from itsown staff, or by means of contracting, regularly providesexperts to governments or other organizations; operatingon a more restricted scale are the World Bank which,through its Agricultural Development Services (ADS),operating in East Africa, enters into contracts withagricultural experts whereby they are put at the disposalof governments, in principle for managerial services andin practice also for project preparation work; and theOperational, Administrative and Executive Personnel(OPEX) program of the United Nations, which trans-fers senior administrators to the service of developingcountries.

The consulting firms can be classified according totheir fields of activity, and also according to their formof organization. We can distinguish between indepen-dent, private firms, firms which have connections withcontractors or manufacturers, and firms which aredependent in some way or another upon governments.

Very few of the independent, private firms have theirorigin in agriculture; most of them added agriculture totheir interests only after 1950. In Europe, the end ofthe colonial period, since it terminated employment in

the colonies of many kinds of experts and at the sametime increased demand for development, led to thecreation of several new consulting firms in the agricul-tural field. The creation of the European CommonMarket, with its Development Fund, was another factor.These new firms can be found in all three organizationalforms mentioned above.

The independent private consulting firms, and alsomany individual consultants, have their own nationaland international organizations which maintain anethical code in the profession; through self-policingresponsibilities, which must be implemented by eachmember, the profession guarantees its trustworthinessand observance of ethical practices. In general, and forinternational development work in particular, the inde-pendent firms, of which an unbiased judgment may beexpected, can be retained, if technically qualified forthe task, with complete confidence. In dealing with theother two categories, namely, firms with connectionswith contractors or manufacturers and government-controlled firms, safeguards against possible impropercommercial or political practices may have to be estab-lished before contracts are signed.

Consulting firms may not be equipped to handle thebroad field of disciplines, including those in connectionwith agriculture, which has to be covered. Most firmsaccordingly have arrangements with other firms or re-search institutes to provide the type of expert that theydo not have themselves. In this way the consulting firmscan maintain their advantage of sending out teams ofexperts who usually at least know each other and havealready gained experience in collaboration during previ-ous missions. For very large projects, such as those forregional development, often a "principal" consultant — -preferably an agricultural consulting firm if the devel-opment will be basically agricultural — is retained. Thisprincipal arranges for the services of other consultantswith different specialities and assures coordinationamong all of them.

The larger agricultural consulting firms are activethroughout the world, although each firm in practicetends to concentrate on specific areas, of which ithas experience or to which its home country experi-ence applies — and also for language reasons. Theestablishment of branch offices in developing countrieshas been very helpful.

In agriculture, as has been indicated, clients areusually governments and their agencies or internationalorganizations. When a government is faced with largeagricultural tasks, one of the questions which arisesfirst is: who should perform this task, the governmentitself or a consultant? In many countries a general un-

24

Relations Between clients and consultants


derstanding about the division of tasks has establisheditself during the years, especially in engineering. Agri-cultural consulting, however, developed too late in mostcountries for a similar division of work to have beenarrived at, and almost no rules exist; the relationshiphas still to develop.

Already, however, some principles are recognized. Itis generally accepted to be the task of the governmentto define the policy for the agricultural sector, to formu-late the broad lines of projects and programs, and toestablish their priorities. Governments also usually pro-vide for agricultural research, education (training), andextension services. Consultants can assist with all kindsof studies needed to prepare an agricultural policy andin particular in the detailed preparation and supervisionof projects and programs. The division of tasks wouldthus be more or less according to a criterion of durationand degree of detail.

Extension Services

The provision of extension services to farmers, whichis entrusted to consulting firms in some African coun-tries, should preferably remain a government task. Inspecial cases consultants could handle this work tem-porarily, but in principle the extension service is anexample of a task too little defined, and extending overtoo long a period, and with too much agricultural policyinvolved, to be entrusted on a permanent basis to con-sultants. On the other hand, irrigation, reclamation,plantation, and other development projects are verysuitable for consultants. Unfortunately many govern-ment officials spend too much of their time on thedetailed preparation of such projects, leaving the for-mation of an agricultural policy to politicians.

There is generally a third party involved in the prepa-ration of development projects financed by internationalagencies or foreign governments. This is the financingagency. Often it is the financing agency which providestechnical assistance for the preparation of the project.There is a difference, however, between cases wherethe agency only advises the government on how toprepare the project and cases in which it prepares theproject itself. The latter procedure, more frequentlyadopted in agriculture than in other fields, may raisedifficulties later on if the project appears not to besufficiently justified for financing by that agency or ifquestions arise about the data, quality, or recommenda-tions of the project report. The mere use of theagencies' own personnel may have unintentionallyraised false hopes about financing, and hampers freediscussion of the merits of the project. Financing agen-cies should for these reasons avoid becoming too muchinvolved in project preparation and should leave thepreparation work proper to government or consultants.

Competition Between Firms

There has been up to now little agreement about thebasis of selection of consultants. The most appropriatesystem, used by the World Bank and already wellestablished in some countries at least, is that competi-tion betwen firms should be on the basis of qualifica-tions rather than of price. After a firm is chosen for itssuitability for the mission, the contract price is nego-tiated; only if the firm is unreasonable in its demandsis another firm contacted. The judgment on the suit-ability of the consultant is based on his experience insimilar missions and his proposals for the specific mis-sion, including an appreciation of the personnel to beassigned to the task. This system implies a situation ofconfidence between client and consultant.

Yet, although some guidelines to the employment ofagricultural consultants have been laid down, they arerather tenuous and infrequent. Clients in the agricul-tural branch have not enough experience in the use ofconsultants and are not aware of the respective profes-sional responsibilities. Even FAO introduced onlyrecently the above-mentioned system of selection ac-cording to qualifications. A more judicious and skilledunderstanding of the character of the tasks that con-sultants are called upon to undertake is also required.International organizations which finance projectscould help here by providing an example and by teach-ing governments as well as consultants. The WorldBank, for example, which frequently employs, orrequires its borrowers to employ, consultants for tech-nical assistance and project preparation, now encouragesemployment of domestic firms in the developing coun-tries—where such firms are found to be qualified—either alone or in combination with foreign firms.

Room for Improvement

Agricultural consulting is by now definitely recog-nized as an important factor for economic development.Yet there is still much room for improvement indeveloping ways of finding the right person or firm atthe right time, in establishing standards for apprecia-tion and comparison of qualifications, and in introduc-ing a sound relationship between client and consultant.

M.M.M. van Gent, a Dutch-man, is an Agricul tur is tin the Agriculture Division ofthe Projects Department of theWorld Bank. A graduate of theLandbouwhogeschool, Wagenin-gen, he was with a firm of con-sulting engineers in De Bill, theNetherlands, before joining tnestaff of the Bank in 1965.

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National Income Accountingin Developing Countries

Despite their limitations, the national income accounts constitute in bothdeveloping and developed countries what is probably the most effective toolavailable for the assessment of over-all economic performance and develop-ment.

Emanuel Levy

T HE WORKING of even the least developed economyinvolves innumerable transactions between indi-

viduals, enterprises, and organizations, and most coun-tries today compile and publish a varying range ofprimary statistics reflecting these transactions in indi-vidual branches and sectors of the economy. TheseStatistics assist decisionmaking in the branches andsectors to which they relate. They do not, however,meet the needs of economic analysts and policymakerswhose concern is to understand and influence the eco-nomic process as a whole. For this purpose, it isnecessary to organize and consolidate the mass ofprimary statistics and information into a system de-signed to bring out the main national economic aggre-gates and interrelationships pertaining to income,product, and expenditure. This is what is achieved bythe national income accounts.

Ideally, these accounts reflect within an integratedframework the structure, level, and trend of activity inall important branches and sectors of the economy. As

26

a result, and depending on the diversity of the economyand the availability of data, they frequently form anintricate and complex pattern, In brief, however, thefocal point of the system can be taken to be the sum-mary account depicting the total resources availableto the economy and the major end-uses to which theyare put. Resources, in this context, comprise the valueof goods and services produced by the domesticeconomy (gross domestic product) less goods andservices sold abroad (exports) plus goods and serv-ices acquired from abroad (imports). The major end-uses are private consumption, government consump-tion, and capital formation (investment).

Details of the composition of these major aggre-gates are provided in separate tables relating to indi-vidual branches and sectors. Additional tables sum-marize the receipts and expenditures of households,government, and the foreign trade sector, from whichare derived estimates of national saving and foreigncapital inflow. These latter estimates can also be com-bined in a further account showing the absolute and


relative contributions of national saving and foreigncapital to the finance of domestic investment.

The Purpose of National Accounting

To fulfill their purpose, the national income accountsshould provide three categories of information on themajor aggregates:

(a) the absolute size of the aggregates;(b) long-term trend;(c) short-term (annual) changes and fluctuations.

Accurate information on the absolute size of theaggregates is obviously necessary in assessing both thedegree of development and the structural pattern ofthe economy. It is also a prerequisite for the determina-tion and analysis of the interrelationships existing be-tween the aggregates, such as capital formation andnational saving, capital-output ratios, private consump-tion and disposable income, government consumptionand the gross domestic product, etc. Many aspects ofmarket analysis and research likewise depend on thistype of information.

A reasonably reliable picture of the trend over, say,the past 10 or 15 years is essential in order to forman opinion as to how the economy is performing, inwhich direction and at what rate it is moving, andwhether medium and long-term aims are being achieved.This information is also an indispensable basis forsound projections into the future. Without reliable esti-mates of aggregate and per capita rates of growth ofproduct, consumption, capital formation, etc., in thepast, it is impossible to estimate what is likely tohappen in the future.

The question of long-term trend is also bound upwith the development process per se. In all countries,economic growth is accompanied by or gives rise tostructural changes and adjustments in the economy.But whereas in developed economies these changes andadjustments are largely incidental to the growth process

and are not likely to be pronounced except over a con-siderable period of time, in developing countries theyare fundamental to the growth process itself. A devel-oping economy is one in which not only the nationalproduct is increasing but one in which the industrialcomposition of the product and the economic structureitself are undergoing considerable change. Indeed, therate at which these changes are occurring is often initself a measure of the rate at which development isproceeding.

The basic structural change characteristic of a de-veloping economy is usually a relative decline in agri-cultural net product, and a corresponding rise in manu-facturing, construction, and services. But beneath thesurface, other and more profound changes occur. Withthe introduction of new crops and production tech-niques in agriculture, the composition of agricultural netoutput and input may change considerably, togetherwith the absolute and relative level of farm income.This may be still more true of manufacturing, wherenew industries are being established and domestic pro-duction progressively increased. At the same time, theprocess of development will generally be reflected in theemergence of a growing wage and salary earning classwhose share in the national income may be expected toincrease steadily. These and similar changes occurringover time need to be reflected adequately in any prop-erly constructed set of national income accounts.

For purposes of guiding policy, the most importantset of information is that on short-term fluctuations.Up-to-date knowledge of the rate of growth of aggre-gate product, and also of product in the majorbranches, is essential, for example, if the authoritiesare to decide on the type of fiscal or credit policy calledfor. The same applies to information on income anddemand. In the more developed countries, this informa-tion is frequently provided not only annually but quar-terly. In most developing countries, however, quarterly

27


information is ruled out by lack of data and resources,and the emphasis is necessarily on the measurement ofthe changes occurring from year to year.

It cannot be too strongly emphasized that the pro-vision of accurate information on annual change gen-erally makes by far the heaviest demands on thenational accounts and on those engaged in their com-pilation. Given a minimum of basic data and a measureof resourcefulness and initiative, it is not unduly diffi-cult to obtain a fair picture of the orders of magnitudeof the main national aggregates in a particular year.Nor do the accounts have to be very sophisticated inorder to provide a general picture of trend over thepast 10 or 15 years. It is quite another thing, however,for those estimating the national income to be able tostate with confidence whether the national product ina given year rose by 4, 6, or 8 per cent above thepreceding year. Experience indicates that, even in coun-tries with sophisticated techniques of national account-ing, the possible margin of error in this type of estima-tion is very great. Ostensibly minor adjustments to theestimating coefficients or to the price indices employed,for example, may often result in the emergence of asignificantly different rate of real growth. Irregularfactors such as drought may also be operative, theeffects of which need to be measured and taken intoaccount in order to obtain a reliable picture of year-to-year change.

The Pitfalls

With the wealth of basic and current statistics attheir disposal, a problem frequently confronting na-tional income accountants in developed countries is,first, to select the most relevant and reliable of themany data series available. Moreover, since theseeconomies are not generally subject to marked struc-tural change and fluctuation over the short and mediumrun, much of the statistical information may, from theviewpoint of the over-all reliability of the accounts, beof marginal importance only. Paradoxically, therefore,it may be possible to construct tolerably accurate ac-counts, at least for a limited number of years, simply byextrapolating from bench-mark data on the basis ofestimating coefficients and assumptions that changevery little from year to year.

In developing countries, the problems and pitfalls ofnational accounting are magnified severalfold by thepaucity of statistical information and the necessity toreflect in as much detail as possible the structuralchanges and adjustments indicative of the developmentprocess itself. Developing countries are by definitionchanging countries. To the extent that these changesare not reflected in the national accounts, the result isnot only a loss of vital information but the emergencein many instances of a distorted picture of economic

performance. It is, therefore, precisely in developingcountries that the employment of fixed estimating co-efficients and assumptions, such as the percentage ofvalue added in the various branches, is to be avoidedexcept in marginal cases and for limited periods only.Developing countries cannot use the shortcuts that areopen to highly developed countries, which may needthem less. Use of the short cuts must mean in practicethat estimators are begging the question they should beanswering: to what extent are the assumed relationshipsactually undergoing modification as a result of the de-velopment process?

Among the factors contributing to the outdating ofthe standard economic coefficients and static relation-ships frequently employed for estimating are changesin technology and capital intensity, changes in pro-duction and input patterns, changes in the geographicaldistribution of population and capital formation, andso on. An important influence may also be exerted bychanges in relative prices. Value added in a particularbranch of manufacturing, for example, is determinedby, among other things, the relative prices received andpaid per unit of output and input. To the extent thatthese prices move differently, the percentage of valueadded in the branch is also affected. The same appliesto relative changes in wage, interest, and profit rates,which affect the distribution of the national income.The importance of such price changes may be especiallygreat in developing countries, where prices in general,and relative prices in particular, are frequently lessstable than in developed countries.

Estimating Procedures

In most developing countries, the absence of infor-mation about expenditure on private consumption rulesout the possibility of deriving an estimate of productfrom the expenditure side of the accounts. Estimatorsmust, therefore, rely all the more heavily upon the netproduct estimate obtained as the sum total of valueadded in each economic branch, i.e., they must try tomeasure primarily what is produced rather than whatis consumed. It may be worthwhile, therefore, to reviewbriefly the procedures commonly employed for obtain-ing these estimates.

Except in a relatively small number of countries, thefactor payments making up value added in each branchof the economy (i.e., compensation of employees, in-terest, rent, and net profit) are not generally estimatedindependently. Instead, value added is obtained, ex-plicitly or implicitly, as a global figure calculated as apercentage of the estimated value of gross output ineach branch. The principal exception is the govern-ment sector, where information on factor payments isgenerally available from the government accounts. Thepercentages used to derive value added are generally

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updated at infrequent intervals only, and in not a fewcountries remain unchanged for a decade or more.

The drawbacks of the "fixed percentage" methodare fairly obvious: for each subbranch the annual per-centage change in value added is simply identical tothat of gross output and is not obtained as a distinctcalculation. The size and accuracy of the value-addedestimates are likewise directly determined by that ofgross output.

The method thus rules out in advance the possibilityof detecting or reflecting changes in the aggregate sizeand relative factor composition of value added bybranch, caused by technological and relative pricechanges, irregular short-term fluctuations, etc. Agricul-ture is particularly sensitive in this respect. With agiven pattern of inputs, value added in agriculture willgenerally constitute a considerably higher proportionof the value of gross output in years of good harvestthan in years of crop failure. In such circumstances, theuse of fixed estimating coefficients may result in aseriously distorted picture of what is in fact happening.Moreover, given the relatively high weight of agricul-tural production in total net product in developingcountries and the fact that agricultural output in thesecountries is particularly subject to the vagaries ofnature, the effect on the aggregate picture of growthmay be very considerable.

Few Systematic Annual Surveys

It is also unhappily true that the estimates of grossoutput which form the basis for calculating the size andchange in value added in the various branches arethemselves often seriously deficient. Although theremay be an occasional agricultural census, few develop-ing countries carry out systematic annual surveys ofagricultural production, whether on the basis of samplecrop cutting and area estimates or representative farmunits. In some countries, the intercensus estimates arebuilt up from partial data on marketing and a frame-work of assumptions about what the farmers themselvesconsume. In others, they are little more than guesses,informed or otherwise, based on presumed changes incrop areas and average yields. While these methodsmay perhaps provide rough estimates of the absolutelevel of production in particular years, the implicitpicture of annual change can seldom be relied on.

Manufacturing is hardly in better shape than farming,although owing to the smaller weight of manufacturingin total net product, the effect on the over-all growthrate for the economy is less pronounced. With all toofew exceptions, the annual estimates of gross output inmanufacturing are obtained by extrapolating frombench-mark census or survey data relating to remoteyears, updated on the basis of current indices or otherindicators of output in the branch. The census data

themselves are often deficient owing to incompletecoverage of the branch and/or because the informationprovided was itself incorrect. But here too, the mostserious source of error undoubtedly lies in the currentindicators employed. In a surprisingly large number ofinstances, the manufacturing indices employed for cur-rent extrapolation are compiled from returns sent in bya fixed sample of establishments selected in a com-paratively remote base year. This means that the indexreflects the growth of output only in those establish-ments which were already operating at that time. Onthe other hand, there is a lack of information on newestablishments commencing production. It is quite pos-sible, however, especially in developing countries, foroutput in a particular branch of manufacturing to in-crease considerably through the opening of new estab-lishments even if output in older-established enterprisesremains unchanged. Over a period of years, the cumula-tive downward bias resulting from this omission can bevery considerable indeed. To this must be added thefact that the index frequently turns out to be based noton a genuine "sample" of enterprises but on thoseenterprises that chose to cooperate in the inquiry-—mainly, in any country, the larger enterprises.

Crude Construction Estimates

In the absence of systematic information, the esti-mates of construction are in almost all developingcountries extremely crude. Few countries maintaincomprehensive and effective systems of building licens-ing which could provide reliable information on thelevel and trend of activity in the branch. At best,licensing is effective only in the larger towns and isrestricted to the issue of building permits. Little if anyfollow-up is practiced, with the result that informationon actual building starts and completions in a givenperiod is generally unavailable. In order to arrive at anestimate of building construction for the country as awhole, estimators are thus reduced to reliance on aflimsy framework of assumptions about the geographi-cal distribution of construction, the time-lag betweenthe date of issue of permits and actual implementation,etc. The sole component for which direct informationis available is generally public sector construction,which is derived from the government budgetary ac-counts. Here, too, the reliability of the estimate dependsto a large extent on the system of government account-ing employed and the possibility of adjusting from acash payment to an implementation (accrual) basis.Yet the aggregate estimate of the value of building andconstruction thus derived not only serves as the basisfor computing value added in the branch but constitutesa major component of the estimate of gross capitalformation.

As a rule, the estimating procedures outlined for thethree major branches of agriculture, manufacturing,

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and construction may be taken as typical of the otherbranch and sector estimates making up the nationalincome accounts. In most countries, indeed, the esti-mates for the trade and services branches are evencruder. Most frequently, they are obtained not throughdirect measurement at all but as a function of the leveland movement of output in other branches, estimatedin the manner already described.

Measuring Real ChangeFor the most part, the deficiencies outlined so far

have been associated with the compilation of estimatesat current prices. But these provide a measure ofnominal change only. For many purposes, the mostimportant information provided by the national incomeaccounts is the picture of real change derived fromestimates at constant prices. Where detailed commodityand sector indices of prices are available, it may be amatter of comparative indifference whether the esti-mates at constant prices underlying the picture of realtrend are compiled directly from quantitative data onproduction and expenditure, or by deflation of estimatesderived in the first place at current prices. However,where the requisite price indices are not available, asin most developing countries, it becomes especially im-portant to compute the constant price series directly, asfar as possible, from data on physical production orconsumption. In practice, they are all too frequentlyderived by the deflation of current price series by in-appropriate global indices, such as the general whole-sale or cost of living indices. Since the annual rates ofgrowth in developing countries are often quite small,the distorting effect of this procedure on the picture ofreal trend may be very considerable. For example: anerror of 2 per cent only in the estimated price rise ina particular year could mean that a calculated growthrate of 2 per cent should in fact read either zero or 4per cent, depending on the direction of the error in theestimate of prices.

Given the objective difficulties in the way of obtain-ing accurate production statistics in most developingcountries, it is vital that greater efforts be made toarrive at estimates of aggregate product also from theexpenditure side of the accounts. Since the major gapin information on expenditure relates to private con-sumption, this would necessitate among other thingsthe initiation and development of systematic surveys ofhousehold expenditures. In many, if not most, develop-ing countries, the estimate of private consumption isobtained at the present time as a residual balancingitem in the national accounts framework (i.e., as thedifference between domestic product and net imports,on the one hand, and government consumption anddomestic investment, on the other), with the result thatit incorporates the entire net estimating error of the

other items in the accounts. Apart from providingdirect information on consumption and a much-neededcheck on the aggregate product estimates obtained fromthe production side of the accounts, this approachwould also facilitate a bypassing of the conceptual andpractical difficulties involved in estimating value addedat constant prices, which is generally the basis of thepresent estimates of aggregate product at constantprices in developing countries.

Initiative and ResourcefulnessWith such a formidable array of pitfalls and

difficulties, the burden and responsibility thrust on na-tional accounts estimators in developing countries isparticularly great, and it is hardly surprising that thenational accounts in most of these countries still remainvery crude tools indeed. It is true that a major con-tributing factor is undoubtedly the generally meagerresources allocated for statistical purposes and theresulting dearth of reliable and detailed information ondevelopments in the various branches and sectors ofthe economy. Any radical improvement in the situationwill therefore depend on the willingness of governmentsto make the requisite funds available—especially forthe collection and compilation of current basic statistics.(In this context, the carrying-out of expensive andtime-consuming censuses for isolated years is probablynot a high priority for most countries.) But despitethis, often much more can be done, even with existingresources, to produce accounts capable of depicting atleast in general terms the major changes and fluctua-tions characteristic of developing economies. To ac-complish this, however, estimators in these countriesare called upon to display an even greater degree ofinitiative and resourcefulness in seeking out sources andtechniques of estimation than is required of their coun-terparts in the more developed countries. While this isadmittedly not an easy goal, experience in a number ofdeveloping countries gives grounds for hope that it isfar from being unattainable.

Emanuel Levy, an Israeli citi-zen, has been Chief of the Com-parative Data Division of theEconomics Department of theWorld Bank since August 1965.A graduate of Hebrew Univer-sity, he was director of nationalincome accounting in Jerusalemfrom 1955 to 1963. Prior to as-suming his present duties, hewas a Consultant with theWorld Bank's resident missionin the Philippines. He is theauthor of Israel Economic Sur-vey, 1950-54 and Israel's Na-tional Income and Expenditure,1950-62.

30


Financial Administration in

Developing CountriesTaking "financial administration" to mean budget making, payments pro-

cedures, the accounting and reporting of expenditures and receipts and thefinal auditing, but not monetary policy itself, which is the sphere of the cen-tral bank, the author seeks to determine how and why this kind of financialadministration has so often gone wrong in developing countries.

Eric Himsworth

IN ALMOST ALL countries the task of compiling theannual budget is the function of the budget agency

or agencies, although it is not uncommon to have oneagency responsible for compiling the annual recurrentbudget and another for planning the developmentbudget.

Where is the best place for the budget agency in agovernment? Logically it would seem that it should belocated (1)—and this is the vital requirement—withthe supreme decision-making body. It follows from thisthat it should be located (2) where it has easy access toall fields of government action, (3) where it can con-tinuously review the programs of the government as maybe required from time to time, and (4) where it cananswer the inquiries of the legislature about the budget.

Some Common Disadvantages

In many less developed countries, the budget agencymay be weakened because of the following:

1. It is not associated with the supreme decision-making body, which may take decisions without con-sulting it.

2. The Minister of Finance is not first among equalsbut just another minister, so that the budget agency ofthe Ministry of Finance, which, in order to assist inprogram formulation and reviewing, must have accessto information from all departments, is denied that in-formation. In such circumstances, the budget agencybecomes merely a clerical compiler.

3. Programing is sometimes allocated to a ministryhaving a separate development budget. This division ofresponsibility hinders financial coordination. In thosecountries where it exists it sometimes results in dis-agreements between the Ministry of Finance and theMinistry of Economics of a kind which reduce effi-ciency. Moreover, plans tend to be considered and ac-cepted for the economic or social benefits that they are

expected to produce, with little consideration of theresidual annual costs that they bring in their wake, andhave to be accepted more or less as a fait accompli.

4. More often the budget agency is stultified by lackof financial discipline in the administrative service. Ifministers are a law unto themselves and do not have totake cognizance of financial regulations, the country islikely to find itself with large expenditures for whichno provision can be found. Recently a number ofcountries have set up a system of one-party rule, whichoften vests the executive functions of the governmentin the leader of the party. It is a point for considerationwhether, in these circumstances, the responsibility forthe budget agency should not be transferred to the officeof the President, who is usually also the party leader,and away from the Ministry of Finance.

Compiling the Estimates

The exercise of compiling the budget itself usuallystarts with the issuance from the budget agency of the"call circular" which asks the various ministries ordepartments to forward their estimates for the forth-coming year. It is desirable to issue this circular early,but the tendency in most countries is to leave it untilvery late—say, three months before the beginning of anew financial year; then all departments and the budgetagency are under pressure to get the document com-pleted, submitted to the legislature, and approved intime for the opening of the new year. When the deadlineis not met, alternative arrangements for expenditurehave to be made, and often these have not been care-fully provided for in advance; so there is more ad hocaccounting, adding to the strain on an administrativemachine which at the best of times finds it difficult tocope with the normal routine.

Another reason for an early start is that the issuanceof the "'call circular" is regarded by many ministries asthe signal for beginning the discussion of proposals for

31


additional staff and plans for the forthcoming year. Ifthe circular is late there is no time for this vital process.Many budgets in less developed countries do, in fact,suffer severely from the fact that consideration of theestimates begins too late.

Since most recurrent expenditure is routine—it is thesame as that of the previous year—calculations of thisclass of expenditure can begin early at a fairly lowlevel in the budget agency. But requests that call for in-creased staff and for new programs of expenditureshould be permitted only in exceptional circumstancesat the time of compiling the budget. These are matterswhich the budget agency should be discussing with thedepartments throughout the whole year; and, whenagreement between the various departments and thebudget agency has been reached, they can be approvedfor "inclusion in the preliminary estimates"—the inten-tion of the budget agency being to accept the proposalsas agreed if resources are available.

A timetable is usually fixed for the submission ofestimates, which are then examined by the budgetagency and re-examined by a higher, ministerial com-mittee under the chairmanship of the Minister ofFinance. Normally, it is found that, because there is notconstant contact between the budget agency and depart-ments, inflated estimates are submitted in the first in-stance in the expectation that they will be cut—asindeed they usually are. Hence, in the time available,little but indiscriminate slashing of estimates is possibleeven in dealing with items of expenditure that it isknown in advance will have to be supplemented laterin the year.

This situation may be remedied by:

1. refusing to admit proposals for additional posts,extension of services or new services that have not beenthoroughly thrashed out before issuance of the callcircular;

2. ensuring that the call circular is issued early;

3. organizing the budget agency so that one sectiondeals with "formal," or repeated, annual expenditurewhile another section handles "special" or new items ofexpenditure;

4. creating the practice within the government ofconstant communication on programing between thebudget agency and the department concerned. It ismore difficult to counter opposition from ministersthemselves who, for political reasons, oppose economies,refuse to abandon work of lower priority, insist uponthe retention of their own projects, and inflate theirbudget portfolios, the si/e of which is supposed toindicate both to ministerial colleagues and to the publicat large the importance of the work of the ministry andhence of the minister himself.

It will be seen that the remedies suggested for thissituation are not primarily financial, but administrativeand political. Ministers must submit to the same type ofdiscipline as government officials of lower rank; theoverriding authority of financial laws and regulationsmust be wholeheartedly accepted by all if any govern-ment is to perform its job effectively.

Single or Multiple BudgetsIn most developing countries the question arises

whether there shall be a double-headed budget--abudget for development (sometimes called a capitalbudget) and a recurrent (ordinary) budget for annuallyrepeated expenses. In favor of separate budgets, it issaid that current expenditure should be financed fromcurrent receipts; that if a surplus on current accountis inadequate, loan finance is justified for projects whichwill earn their service charges; otherwise, if the surpluson the ordinary budget is inadequate, capital schemesshould be reduced. A special "capital" budget permitsflexibility in the apportionment of capital resources andenables clearer decisions to be made with reference tocurrent expenditure.

On the other hand, there are those who point outthat although the capital and development budgets aresupposed to be synonymous, all development expendi-ture is not of a capital nature, e.g., the annual costs inan agricultural extension scheme. Moreover, it is notnecessarily justifiable that all loans should be spentmerely on the creation of physical assets or that capitalworks should be financed exclusively by borrowing.In a development plan, expenditure on education andhealth pays dividends to a state which sometimes justi-fies these dividends being financed from loan funds.In addition, it may be difficult to coordinate develop-ment and recurrent budgets, especially if, as often hap-pens, they are compiled by two different agencies,which may mean that the long-term financial implica-tions of a development plan (the responsibility of theplanning agency) will be decided without reference torevenue projections and may, therefore, cause embar-rassment to a future recurrent budget. Again, in a dualbudget system there is a temptation to believe that if theregular budget has been financed from current re-sources, expenditure on the capital or developmentalprojects can be financed in large part from the normalexpansion of money or quasi-money. Any attempt bythe authorities to appropriate this finance for a plan-ning budget will almost certainly result in the creationof additional bank credit with its attendant inflation.

Since a writer on this subject will be expected togive his own view, this is in favor of a double budget:a recurrent budget compiled by the Finance Divisionof the Ministry of Finance; and a development budgetby the Economic Division of the same ministry, which

32


should also control the Department of Statistics andthe Organization and Methods Division. In this waythe close and effective coordination of the two budgetsand of the resources available for their financing with-out inflationary pressures, essential for good budgetaryadministration, would be achieved at the highest depart-mental level below the minister; in British parlance "atPermanent Secretary level." The difficulties which oftenarise when the Minister of Finance is called upon todecide between competing claims of two equally im-portant divisions of his own ministry, or to effect coor-dination with a separate Ministry of Planning, arethereby avoided.

Execution of the BudgetOnce the budget has been given approval, usually by

the legislative authority, the next stage in financial ad-ministration is the "execution of the budget" or spend-ing by the departments. In the British practice thenormal way is for the Accountant-General to issue a"General Warrant," which is the signal that departmentsmay proceed to spend the money allocated to them inthe budget without further ado. Some governments, suchas that of the United States, make quarterly allocationsto the various departments; but this is an additional stepand in some countries may cause delay. Other countries,particularly those following the French tradition, requirespending departments to seek an "authority to incurexpenditure" (fiche d'engagement) before any expendi-ture can take place, even though such expenditure hasalready been authorized by the budget; and authoritywill be withheld if adequate funds are not availablewithin the budgeted provision. The "mandate" or payorder can only be issued after the fiche d'engagement,and the procedure on both must be finalized beforecash can be disbursed.

PaymentOnce expenditure has been incurred, there are a

number of ways in which payment can be made. Itmay be made from a departmental or ministerial ac-count which will be kept in funds by the centraltreasury. This involves the department's handling cashand keeping both cash books and the appropriateledgers, and has the advantage of making the depart-ment the unit responsible for government accounts, aresponsibility which tends to develop within the depart-ment a sense of the importance of finance and its placein practical administration. But there are dangers also,for if accounts are brought under the control of min-isters with anything less than the highest sense of theirpublic responsibilities, finance intended for one purposemay be diverted to another, possibly one for which nobudgetary provision has been made.

A centralized system of payments is much moreusual. Cash is disbursed from central or regional treas-

uries or paymasters' offices, which work on theimprest-accounts system, their cash balances beingreplenished from central funds as required. This limitsthe number of points at which cash is available, whichincreases security and at least tends to reduce delay andpaper work.

In nearly all less developed countries, there is delayin the payment of official bills, usually because theprocess of verification takes so long. In theory, all thatshould be required is the signature of a responsibleofficer that the goods and services have been receivedin good order, a certification from the departmental ac-countant that funds are available in the budget (or inthe allocation for the period) after which the bills canbe passed to the cashier for payment. In many develop-ing countries, however, a pay order must pass througha remarkable number of stages and checks before itreaches the cashier. Often, additional documents areattached to the original pay document; the particularsare recorded in department after department, in bookafter book, when all that is required is one entry in thevote ledger of the department and another in the cashbook of the cashier, the latter entry being subsequentlytransferred to the appropriate ledger. The object ofthese innumerable recordings is said to be to obviatefraud, but in fact such complexity probably delays thediscovery of fraud where there is any; for the largenumber of recordings increases the number of points atwhich mistakes in postings can be made, and the recon-ciliation of a large number of ledgers almost invariablymeans that the books do not all agree, with resultantchecking and rechecking and long delays during whichreal fraud may go undetected.

Accounting and Reporting

One of the major weaknesses in nearly all less de-veloped countries lies in the accounting system. Thefirst essential to any method of keeping accounts is thatitems of receipt or expenditure should be posted quickly—cash receipts or disbursements as they are made,ledger accounts preferably daily but at the very leastweekly. A general weakness in any administrative sys-tem will nearly always betray itself in the circumstancethat, notwithstanding the financial regulations, accountsare posted weeks and sometimes months after they areincurred. The minimum degree of supervision is lack-ing, and often disciplinary action cannot be takenagainst defaulting clerks because they hold their posi-tions, as do the supervisors, at the pleasure of theminister in power. Closely allied with the failure to postaccounts is the failure to report expenditures whencompleted at the periphery. It is obvious that, if a pay-ment has been made to a contractor in some remote partof the country, the payment voucher has to be receipted,posted in an account book, and reported to some central

33


authority. Failure to comply with the regulations at anyone of these points means that accounts cannot beclosed, and therefore that vital information, which thebudget agency must have if it is to operate effectively, isnot forthcoming. It is usually to this level that onecan trace a decisive cause of ineffective financial ad-ministration in less developed countries. Vouchers arenot posted to the appropriate cash books and ledgers;reporting to the central accounting authority is delayedand often incomplete when done, so that the collationand the production of periodic accounts become impos-sible. Accounts are less than complete when publishedand sometimes are not published at all. The net resultis that a government can never be sure of its financialposition at any given moment, and this is often a hind-rance to the formation of decisive policies. On the otherhand, k is worth noting that discipline in this mundanebut important field can be attained; in Malaysia, forexample, discipline in financial matters is strictly main-tained and has contributed much to that country'ssuccess since independence.

Auditing

The final stage of financial procedure is the ex postfacto auditing, which may take various forms. It may bedone by special accounts committees of the legislature,which usually examine one or two important heads ofexpenditure, for example, those of education and health.Such committees are often helpful in maintaining a strictwatch on public expenditures, especially that of publiccorporations which may be subject to no more thanordinary commercial accounting, and this type of in-quiry has the added advantage that the committee mayexamine and question the whole policy that lies behindthe expenditure. Experience, however, shows that thisaspect of financial administration gets little support inless developed countries. In the legislatures of at leastsome of these countries, an observer has the impressionthat the educated elite that composes them is moreinterested in law and academic pursuits than in therough and tumble of the commercial and financialworld. In any event the system has the weakness that,being ex post facto, by the time the reports are pub-lished, the period to which they relate belongs to history,and thus fails to attract much interest.

More effective is the annual report of the comptrollerand auditor-general, where such an officer exists. Thisofficial is usually an officer of the legislature, to whichhe reports; and his tenure of office is guaranteed likethat of the senior judges. He is required to certify thatthe money voted by the legislature has been spent inaccordance with the wishes of the legislature as ex-pressed in the budget or supplementary votes; but he isalso permitted to express his personal views on themanner in which expenditure has been effected. He

may, for example, indicate that certain contracts seemto him to have been unduly expensive or that there hasbeen undue delay in the completion of contracts, orthat the executive has not enforced penalty clauseswhere this is possible. His reports also suffer frombeing a post mortem examination of events whichhave lost much, if not all, their interest for the legisla-ture to which his reports are made. Moreover, anauditor-general is only as effective as the legislaturepermits him to be. If the legislature-takes little or nointerest in financial control the auditor-general willspend much of his time baying at the moon.

Perhaps the best known alternative system is theFrench Court of Accounts (Cours des Comptes). Thisis as much a judicial as an administrative body, whosetask is to make an examination of the national accounts,call to task, where necessary, accountable officers ofthe executive, and issue an annual report on its findings.It plays an important part in the system of financialcontrol, but it is not, as in many countries which followthe Anglo-Saxon pattern, an organization of the legis-lature. It probably represents another aspect of thedoctrine of the separation of powers, and being inde-pendent of both legislature and excutive, with freedomfrom political pressures, is thought to be capable ofexercising a greater degree of impartiality than might bethe case if it were more closely allied to the other twodivisions of the sovereign power.

It is my opinion that administration of finance is themain factor which determines the general quality ofgovernment administration, for if the financial progressof a country goes wrong or is unknown throughout theyear, little else in the field of government activity canbe expected to go right. The interest of officials inexercising the disciplined control and constant supervi-sion that a good system of financial administrationrequires is sometimes difficult to excite on behalf ofwhat appears a routine and prosaic exercise. It is im-portant that they should understand that it is the effi-ciency of the machine which processes government en-deavor, as well as the quality of the input, whicheventually determines the measure of the resultantproduct. And it is this product that we call "economicdevelopment."

Eric Himsworth, an English-man, joined the Fiscal AffairsProgram of the Fund's Tech-nical Assistance Program inFebruary 1965. He is a grad-uate of Merton College, Oxford,and was formerly a UN Ad-visor to the Government ofNepal (1956-64), and FinancialSecretary to the Governor ofMalaya (1952-55), and for 20years was a member of theHong Kong Civil Service.

34


Economies of Scale andEconomic Integration

Moves toward the economic integration of neighboring countries are be-ing made in many regions of the world. Various advantages are urged bythose involved in such moves; this article discusses one of these.

G. Nguyen Tien Hung

OVER THE LAST FEW YEARS, the strikingresults of European economic integration have

prompted many developing nations to make efforts oftheir own toward the integration of their separate econ-omies. Africa has made attempts to move toward awide range of such integrated economies, from a pro-posed Economic Community of West Africa to theCentral African Customs and Economic Union; in LatinAmerica a Free Trade Association and a Central Amer-ican Common Market have been established. An am-bitious Mekong River regional project has been under-taken in Asia, and the Southeast Asian Association hasrecently been expanded. Economic integration hastaken place on all the continents. As Frank A. South-ard, Deputy Managing Director of the InternationalMonetary Fund, pointed out in his August 1967 ad-dress to the Central American Union, this is because"What they [developing nations] have come to concludeis that in the longer evolution the accelerated economicprogress within an integrated area will increase its in-come and enable it to trade more effectively and on agrander scale with the rest of the world. It is at thispoint where the regional grouping and the internationaleconomy are harmonized." 1

Moreover, it has often been said that, in addition to"trade creation" (i.e., an increase in the efficiency withwhich resources are allocated, with a consequent in-crease in welfare), the prospect for economic develop-

ment offers an attractive argument to support economicgrouping in the less developed world. The prospect ofdevelopment, in turn, rests on the assumption that in-tegration will present the opportunity to gain the benefitof economies of scale, thereby overcoming the unfavor-able consequences of the size of small nations and, insome instances, of the so-called micro-states. The pros-pect of economies of scale is regarded by the pro-ponents of integration as a dynamic aspect of develop-ment that tends to outweigh other standard require-ments for the success of economic integration whichthe developing nations may not seem to meet fully. Thedeveloping nations involved in integration projects donot generally have a high proportion of intraregionaltrade and a low proportion of trade with the outsideworld, or a low proportion of foreign trade in rela-tion to domestic product and a high degree of comple-mentarity of the members' economies. Yet these nationspress on, for they argue that economic integrationwould dismantle the national economic frontiers toprovide a wider market for expanding existing industriesas well as for establishing new industries. Generallyspeaking, they are sure that this reward is more im-portant than the collective deficiences that mightprevent them from seeking it. In this article, I propose

1 Southard, Frank A., Jr., "The Fund and Economic Inte-gration Movements," address given at a meeting sponsored bythe Executive Secretariat of the Central American Union,Guatemala City, August 31, 1967.

35


A rotary kiln at the Ismail Cement factory in Ismailwal in West Pakistan. This plant, which is providing large amounts ofcement for the vast Indus Basin Development project, has been expanded with the assistance of funds made available by theWorld Bank and the International Finance Corporation.

to discuss only the economic concept of economies ofscale and some of its implications in the framework ofregional economic cooperation; I do not, therefore,attempt to appraise the validity of other issues relatedto the theory of international exchange.

The Concept

It is a well-known element in economic theory that,as an enterprise expands its scale of operation, i.e.,increases the size of its plants, the cost of productionper unit generally decreases. There are forces withinas well as outside the firm that tend to make largerand larger production less and less costly. The greateconomist, Alfred Marshall, maintained that "the chiefadvantages of production on a large scale are economyof skill, economy of machinery, and economy of mate-

rials." There are several factors which have a bearingupon the reduction of cost when output is large.

First, the labor cost would be reduced as a result ofthe increase in labor productivity; "mass production"necessitates specialization and increases the worker'sefficiency, since his job performance over a smallrange of duties is generally better than that of a workerwith a wider range. In economic literature, the so-calledlabor learning curve or progress ratio indicates consid-erable gains in efficiency of the worker by repetition ofhis work when the "production runs" are long. Anattempt to measure the relationship between man-hourrequirement and scale of operation has been made inthe air frame industry, the result indicating that thenumber of labor hours expended in the production ofan air frame of one type decreases as the number of airframes produced increases; generally, the rule is that

36


the marginal labor cost is one sixth when outputdoubles.2

Second, a larger scale of production normally makespossible the employment of more advanced machinesand equipment which, because of their "indivisibilities,"cannot be used efficiently in a smaller operation. Indivi-sibility implies that certain machines, which may not bebuilt in small sizes, often operate at less than fullcapacity in a smaller-scale operation. When this hap-pens, then the expansion of production merely uses upthe excess capacity; this is particularly true in manufac-turing that requires heavy initial investment cost, suchas steel mills, railroads, and hydroelectric plants. Inthe capital intensive industries, one convenient way tomeasure the reduction in capital cost is the "0.6 rule,"which helps to estimate the increase in capital cost whenthe plant grows. According to this rule, the increase incost is equal to the increase in capacity multiplied tothe scale coefficient. Scale coefficient is generally equalto 0.6 for a number of products such as chemicalprocesses, gas holders, etc.: for calcium carbide, sulfuricacid, the coefficient is 0.8; for aviation gasoline, 0.9;for natural gasoline, 0.5.

Third, costs may be reduced by an increase of effi-ciency in management, which tends to be better organ-ized in large enterprises owing to the specification offunctions as well as the more scientific approach tothe task of coordination.3 Management would also beexpected to apply more technical methods of produc-tion, or better techniques of combining and transform-ing resources, so as to bring about a new productionfunction, as was emphasized by the late J. A. Schum-peter; the saving of management is especially importantin developing countries because managerial skill isscarce.

Fourth, large-scale production often permits the firmto buy materials in large quantities, with the possibilityof discount as well as bargaining advantages. Savingalso occurs in handling, marketing, and transportation.

Fifth, the statistical law of large numbers implies thepossibility of cost reduction in larger-scale operationsbecause of the so-called stochastic economies of scale.For example, when a department store expands andexpects twice as many customers as before, it does nothave to double its inventory since it can predict fromthe behavior of the original customers what the newones will mostly want; a firm doubling the number ofmachines in operation may not have to keep twice asmany spare parts over a given period of time, nor

2 For a further discussion of this matter, see, for example,Arrow, Kenneth J., "The Economic Implication of Learning byDoing," Review of Economic Studies, Vol. XXIX (June1962), pp. 155-73.

3 For an interesting treatment of the subject, see Bechman,M.J., "Some Aspects of Returns to Scale in Business Adminis-tration," Quarterly Journal of Economics, Vol. LXXIV(August 1960), pp. 464-71. <

The Baton Rouge alumina producing facility in Louisiana, U.S.A.

employ twice as many maintenance workers, since theexpected number of breakdowns is not likely to doublein that period.4

Finally, the cost of financing production, i.e., intereston capital, may also be reduced not only because ofthe economies in inventory but also because the creditstanding of a large enterprise is usually better than thatof a small one on account of the size of its collateral aswell as its capacity to repay. In the same way, a largeproject that is undertaken by a group of nations mayhave better access to capital; a "Borrower Club" wouldbe in a better position to secure loans from the "LenderClub."

In Industrialized Countries

Economies of scale are, then, diverse and important,and an aim clearly worth the closest attention of thedeveloping world. When the leaders of these countrieslook at the economies of the industrialized countries,they see such economies of scale achieved in every field.Empirical studies of different types of manufacturing inthe industrialized countries generally suggest that vari-ous degrees of economies of scale are to be found inmany industries, especially cement, farm machinery,and the milling, smelting, refining, rolling, and drawingof metals, while automobile and typewriter manufactur-ing are also believed to be among those which benefitmost from the cost reducing factor of large-scale opera-tion.

Hundreds of examples could be given of the actualeffects achieved, but one may suffice (Table 1). Theoperating cost of the Baton Rouge Company, whichproduces alumina in Louisiana, was reduced by 9 percent a ton by increasing output from 300 tons a day to

4 A brief summary of the principle behind the stochasticmodels is presented in Haldi, John and David Whitcomb,"Economies of Scale in Industrial Plants," Quarterly Journal ofEconomics, Vol. XLVII (August 1967), pp. 373-85.

37©International Monetary Fund. Not for Redistribution

500 tons; at 1,000 tons, the cost was reduced by 16per cent.

TABLE 1. OPERATING COST OF ALUMINAPRODUCTION: BATON ROUGE CO.

Production Operating Cost

(Tons per day)300500

1,000

($ per ton)

32.4329.6327.28

Source: F. T. Moore, "Economies of Scale: Some Statistical Evidence,"Quarterly Journal of Economics, Vol. LXXIII, (May 1959), p. 241.

A study of the power industry in the United States byReyutaro Koniiya shows that economies of scale arevery important in steam power generation. Koniiyademonstrated that "the reduction in the fuel require-ment to produce steam power in recent years is dueprimarily, and in the capital requirement, solely, to theexpansion in the scale of production." •"•

Other examples of economies of scale may be foundin the railroad transportation and shipping industries,where it is often possible to avoid waste of freight capa-city and to spread heavy overhead expenses.

Implications for Economic Integration

Nearly two centuries ago, Adam Smith contendedthat the size of the market is the chief ultimate checkon the development of high productivity. A quickglance at the economies of the developing nations,especially in Africa and Asia, indicates that one of themain factors limiting investment, and therefore thedevelopment of industries, is the small size of themarkets. According to Professor Tibor Scitovsky, "theeconomy is too small when, technologically, it is toosmall to provide an adequate outlet for the full capacityoutput of the most efficient plant (i.e., the plant whichprovides the lowest unit cost) in a given industry." Themanufacturing sector of the less developed countrieshas often been characterized as the sector of cottageand small-scale industry. Cottage industry is that whichis carried on wholly or partly with the help of themembers of the family, either as a full-time or part-timeoccupation; small-scale industry is that which isoperated mainly with hired labor usually not exceeding50 workers in any establishment.

Economic integration makes large-scale productionpossible, not only by widening the market for existingplants as well as new industries but also—as long asintegration has an outward orientation—by improvingthe welfare of the region and, thus, in turn, the level of

5 Komiya, R., "Technological Progress and the ProductionFunction in the U.S. Steam Power Industry," Review of Eco-nomics and Statistics, Vol. XLIV (May 1962), p. 156.

demand for manufactured products. This is obviouslyvery important, since in less developed countries peopleare commonly too poor to buy what they need, whichis a major obstacle to the growth of industry. Poorpeople need all their money for food and have little ornone left over for manufactured goods. By its expectedeffect of raising income, economic integration is likelyto produce a higher demand for manufacturing, whichin turn favors the growth of industry. A further ad-vantage of large-scale production lies in the behaviorof consumers' choice. In the markets of the less devel-oped nations, consumers pay more attention to lowprices than to style or quality. In the developing coun-tries with small markets, it is precisely the low-qualityproduct which appears to be suited for mass produc-tion techniques.

However, there is no difficulty in either enumeratingthe various kinds of economies of scale or in demon-strating what has been achieved by their attainment inthe industrialized countries. Those who advocate econ-omic integration as a means of achieving such econ-omies of scale in the less developed countries must gofurther and demonstrate some more concrete possibili-ties. Among the examples of potential economies ofscale in the integration schemes of developing nationswhich are actually under consideration are the cementand steel industries, oil refinery, and hydroelectricenergy.

Cement Industry in AsiaLarge quantities of cement are used in power installa-

tions, housing construction, flood control and irrigationwork, roads, and port and highway building in Asia.Insofar as large plants can be located in places wherea supply of raw materials is available, it seems thatcement may be produced at a much lower cost than itis now in the region. Empirical studies of the industryhave shown that cement is among the products thatcould enjoy large economies of scale in Asia. In aUnited Nations estimate of the hypothetical cost ofcement production in the continent, potential economiesof scale were found (Table 2). From the level of outputof 50,000 tons a year to 900,000 tons, both operatingcost and capital charges decrease by some 39 per cent.Looking at the cement industry in Asia, one finds thatmany cement factories now operating in a number ofdifferent countries are in the range of output of100,000-230,000 tons. At the same time, excludingMainland China and Japan, the region consumes some10 million tons a year. There is obviously much to beachieved here; although, in view of the high transpor-tation cost of cement, a decision on the number ofcement plants within the region as well as their scalesof operation requires further analysis and carefulplanning.

38


TABLE 2. ECONOMIES OF SCALE IN CEMENT PRODUCTION

Capacity of PlantThousand Tons

in Decrease inCost from

CaDacitv of50,000-900,000

Operating cost per tonCapital charges per ton

Total cost/ton

50

15.511.5

27.0

100

15.210.8

26.0

230

U.S. dollars

14.710.0

24.7

450

11.08.8

19.8

900

9.47.0

16.4

Tons

U.S.dollars

6.14.5

10.6

Percent

39.439.1

39.3

Sources: Data from United Nations, Formulating Industrial Development with Special Reference to Asia andthe Far East (Bangkok, 1961), p. 46.

Production of Rolling Flats in Latin America

Steel products are considered as the backbone ofmodern industry. As the developing nations advancealong the road of industrialization the production ofsteel has been given priority in many developmentplans. An example of cost and capacity in the produc-tion of rolling flats in a hypothetical integrated mill inLatin America is illustrated in Table 3. Among thefactors of production, all of which show substantialreduction in cost per ton at an annual output of 1.5million tons compared with 100,000 tons, capitalcharges decrease by 60 per cent, the cost of ferrousmaterial by nearly 38 per cent, labor cost by 79 percent, and total per unit cost by 46 per cent. Between100,000 tons and 400,000 tons, costs are criticallyreduced. The benefits of cost reduction would then call

for joint projects undertaken by a number of countrieswithin the region. Here again, consideration must begiven to the high cost of transportation of steel in adispersed regional market; however, even after allow-ance is made for this factor, the benefit of scales insteel production may still be seen when the import costof flat products, which is about $182 a ton in LatinAmerica, is compared with the unit cost of productionat various levels of output in Table 3.

Hydroelectric Energy in Central Africa

Another example of potential gain in large-scale pro-duction is hydroelectric energy in Central Africa. Con-siderable hydroelectric potential exists throughout theregion. At present, there are several installed hydroelec-tric power plants—the Edea complex with 160 (to be

TABLE 3. COST OF ROLLING FLAT PRODUCTS INHYPOTHETICAL PLANTS OF DIFFERENT SIZES

Cost Item

Total cost

Annual Capacity of Plant inThousands of Tons of Finished Products

Decrease in Costfrom 100,000-1,500,000

Tons100 400 800 1,500

U.S. dollars

Cost of ferrous materialSalaries and wagesOther conversion cost

Total direct costCapital charges

120.7115.5212.30

148.5343.46

92.586.22

10.67

109.4729.70

82.944.518.60

96.0519.80

75.473.307.30

86.0717.37

U.S.dollars

45.2412.225.00

62.4626.09

Percent

37.578.640.7

42.160.0

191.99 139.17 115.85 103.44 88.55 46.1

Source: Data from United Nations, Interregional Symposium on the Application of Modern Technical Practices in the Iron andSteel Industry to Developing Countries, "The Iron and Steel Industry of Latin America, Plans and Perspectives" (New York,1964), p. 107.

39


increased to 180) megawatts output in Cameroon, theDjoue hydroelectic plant with 15 megawatts in Congo(Brazzaville), and the South Katanga plant with 470megawatts in the Democratic Republic of Congo.These, combined with others, may soon be adequateto supply energy to other countries in the region. Thereduction in cost installation when a large-scale projectis undertaken is illustrated in Table 4, which showsthe estimate of price per kilowatt installed at theplanned Inga Project in the Democratic Republic ofCongo; from an output of 100 to 300 megawatts,installment cost per kilowatt is expected to be reducedby one half since the cost of civil engineering does notincrease in proportion to the capacity of the plant.

TABLE 4. ESTIMATE OF COST PER KILO-WATT INSTALLED IN THE INGA

HYDROELECTRIC PROJECT

Cost per kilowattinstalled

Capacity inMegawatts

100 150 200 300

U.S.dollars

500 370 300 250

Decrease inCost From100 to 300Megawatts

U.S. Perdollars cent

250 50

Source: Data from United Nations, Economic Commission for Africa,Report of the ECA Mission on Economic Cooperation in Central Africa,(New York, 1966).

Are Economies of Scale Unlimited?

How far can economies of scale be pushed? They areof course not unlimited. At one extreme, large-scaleproduction may not by itself offer a guarantee of anyeconomies of scale. In economic literature, this iscalled constant returns to scale, where total cost variesproportionately with production: when output isdoubled, the cost will be doubled because twice as manyresources will be required. The condition of constantreturns to scale is not rare in reality and is actuallybelieved to be present in many industries. Paul Douglas,whose name was associated with the famous Cobb-Douglas production function, believed that constant re-turns to scale are a prevalent characteristic of manufac-turing in U.S. industry. There are also instances ofdecreasing returns to scale where higher average costwill result from larger scale of production, but a de-scription of these instances would go far beyond thescope of this article. In economic literature, the plantwhich is just large enough to enjoy fully the benefit oflarge-scale production is called the "optimum plant."In developing nations, it appears also that, given lowwages and disguised unemployment, there may be aquite proper preference for labor intensive industrieswhich may employ "optimum plants" smaller than thosein the capital intensive industries.

Three Observations

This is only a brief study of a large subject, but itcan support three general observations:

First, the benefits of large scale present an attractivecase for economic cooperation among the less devel-oped countries; second, in the highly delicate and tech-nical task of regional planning, the possibility of econo-mies of scale deserves great attention from the plannersin their attempt to formulate joint industrial plans, sothat the priority and types of projects, as well as thelocation of the plants, will assure the maximum benefitsfor the region and the best allocation of resources; andthird, since economies of scale are not unlimited, it isalso important to decide the number of plants andtheir scale of operation in a given industry that willsecure the maximum economies. This last decision alsoinvolves careful analysis of the actual and potentialdemand—the supply of the product in question, thesupply of resources in the region, and the social cost.Also involved in the judging of the appropriateness ofsize are considerations of other related aspects of anintegrated plant, such as technological adaptation,training of management and labor, establishing suppliesof raw materials and other inputs, and developing mar-kets for the output of the plant.

To these three observations, which would probablybe widely accepted by those who have studied the sub-ject, I shall add a more personal opinion. It is that thebenefits of economies of scale considered in conjunc-tion with the smallness of small nations also suggestthere is a greater interest on the part of the aid-givingnations as well as the international institutions in pur-suing a regional approach to development and in thefinancing of selected joint projects for a number ofcountries with a view to developing entire regions of theworld and on a longer-term basis.

The regional approach to development, though notwithout difficulties, is advocated not only in terms ofcost consideration but also because of its side effect inhelping developing nations to strengthen their questfor cooperation in all fields.

G. Nguyen Tien Hung, acitizen of South Viet-Nam, is aneconomist in the African De-partment of the Fund. Beforejoining the Fund in 1966, hetaught at North Carolina Wes-leyan College, Howard Univer-sity, and Trinity College, Wash-ington, D.C. He studied at theUniversity of Saigon and theUniversity of Virginia, where hereceived his Ph.D.

40


Book Notices

Sayers, R.S., A History of Eco-nomic Change in England,7880-1939, New York, N.Y.,The Oxford University Press,1967, 179 pp., $1.35.

In this short book ProfessorSayers surveys the main forces thatdetermined the increase ineconomic well-being in Englandbetween 1880 and 1939, as wellas the different forms that thiswell-being took. He ranges overmajor factors which influenced theBritish economy—the swings inpopulations, international migra-tion, national income, foreigntrade, etc.—as well as providingdetailed analyses of crucially im-portant industries which, with theirchanging pace of technologicalinnovation, not only significantlyaltered the face of England in acomparatively short period of timebut also determined the rate ofeconomic advancement infuture decades.

There is no chapter on economicpolicy as such, though the mainlines are drawn by the descriptionof various legislative programs,particularly those concerned withlabor and unemployment, theevolution of the welfare state, andgenerally increased governmentparticipation in economic affairs;there are, too, some tantalizingasides on certain aspects ofmonetary policy. Professor Sayersis, however, more concerned tooutline the changing economiccontours of the period than toprovide a detailed analysis of

economic interrelationships; for,as he says, this "book will be thefirst rather than the last they[children in their last year at

school, and first year universitystudents] read in this field." Heachieves his aim admirably.

During the period covered inthis book—a period essentiallyof decline in the economic positionof England in relation to the restof the world—the discontinuity ofeconomic progress was marked.Out of the 60 years between 1880and 1939, economic improvement,i.e., per capita increases in realincome, was confined to "as fewas 20 ... years, for ... [therewere] . . . many years of backsliding or stagnation in the levelof real income." From one pointof view it could be inferredthat the domestic economicreadjustments which often occurredwith brutal severity are an indict-ment of the manner in which eco-nomic policy was conducted overmuch of the period. But what isperhaps more important, thediscontinuity in economic progresswas also a matter of the extent towhich England needed to adjust,and, for long periods, did notadjust, to changes in theinternational economy.

Herein, perhaps, lies thegeneral appeal of ProfessorSayers1 slim and elegantly writtenbook. For it is not only afascinating account of Englisheconomic (and socio-economic)change, but a vivid example of the

vagaries of internationaleconomic relationships.

David Williams

Simha, S.L.N., Essays on Fi-nance, Bombay, India, Voraand Co., Publishers PrivateLtd., 1967, x + 340 pp., Rs.20.

This is a collection of twentyessays written for the most partover a period of three years.Seventeen of these are onproblems of monetary policy,development finance, andinternational finance, thusjustifying the title of the book. Theremaining three deal withproblems of planning.

The author began his career asa teacher, and has beenconnected, subsequently, with theReserve Bank of India, theIndustrial Delevopment Bank ofIndia, and the InternationalMonetary Fund. The essayscollected in this volume reflect thiscombination of academic andpractical background. They areanalytical without being pedanticand practical without beingincorrect.

While many of the essays areconcerned with Indian experience,they are in most cases discussedin a context which gives them awider interest for all thoseconcerned with the problems ofthe developing economies. Fromthis point of view the essay on"Monetary and Credit Policy in theFramework of an Economic Plan"will be found of special interest.This paper deals with monetarypolicy in a developing economy ingeneral terms and was in factprepared by the author as a basisfor his discussions in Latin America.

Most of the essays in the fieldof international finance includedin this volume are of generalinterest. The author's suggestionfor the use of gold certificatesin payment of gold subscriptions inconnection with Fund quotaincreases attracted considerableattention at the time. His discussionof the Fund's drawing policy andof its stand-by arrangementsreflect a freshness of approach toquestions that are of continuinginterest. This volume is, therefore,likely to be found interesting anduseful by many readers.

Hannan Ezekiel

41


The Ninth Annual Yearbook ofThe Far Eastern Economic Re-view, published as a supple*merit to Far Eastern EconomicReview, The Far Eastern Eco-nomic Review Co., Hong Kong,352 pp., $5.00.

Violence is the main theme ofthis edition of the Far EasternEconomic Review Yearbook. Thevarious conflicts and disturbanceswhich marred 1967 are reviewedagainst the backdrop of thetwo major upheavals which havedominated the area—theCultural Revolution in Chinaand the war in Viet-Nam.

As in past editions, theYearbook provides a survey of theevents of the last 1 2 months in26 countries of Asia and of theinternational developments whichaffected the region as a whole. Itfurther attempts to place theseevents and developments inperspective and to use them as abase for the review for theprospects of 1968.

Derek Davies, the editor of theYearbook and of the weeklyFar Eastern Economic Reviewmagazine, states that violencebred violence in the region in1967. "China's rejection of thepossibility of a peaceful road torevolution and the fate of theUnited Front tactics in Indonesiaencouraged pro-Peking elementselsewhere in Asia to attempt toachieve their ends by force."

Mr. Davies, however, alsosuggests that the general revulsionfrom this violence inspired acollective reaction to the internaland external threats it appeared topose and drew nations togetherfor collective security. "For thefirst time, the phrase 'regionalcooperation' began to take onreal meaning," he states. "ASEAN,the Association of SoutheastAsian Nations, comprising Fivehitherto divided countries,Malaysia, Singapore, thePhilippines, Indonesia, andThailand, was founded in Bangkok.Japan mounted several initiativesaimed at uniting the region insome sort of free trade area and,more significantly, Mr. Satoembarked on unprecedented toursof Asia that were widelyinterpreted as indicating a newanti-Peking, pro-Washingtonpolicy."

The volume contains the usualsections on banking and finance(which this year evaluate the workdone by the newly created AsianBank, and by the World BankGroup). A Business Survey sectioncovers development in majorselected industries andcommodities, and a sectionlabeled Economy evaluatesperformance and prospects of thenational plan, data on nationalincome, capital formation, and rateof growth of each of the 26countries covered. There is a largesection at the end of the volumedevoted to special tables givingeconomic indicators of thosecountries on which adequatestatistical data is available.

Finance and Developmentdoes not attempt to evaluatebooks or contributions theretoby members of the staff of theInternational Monetary Fundor the World Bank Group,but notes them as likely tobe of interest to its readers.

Baranson, Jack, Manufactur-ing Problems in India: TheCummins Diesel Experience,Syracuse, N.Y., U.S.A., Syra-cuse University Press, 1967, xix+ 146pp., $5.95.

Utilizing the case studyapproach, the author describesthe experiences of Cummins EngineCompany of the United States, inestablishing and operating adiesel assembly plant inPoona, India.

The author points out thenumerous pitfalls to be avoidedby any company planning to beginoperations in a less developedcountry, and he offers a suggestionto the governments of developingnations; if they expect to receivethe benefits from havingtechnically advancedmanufacturing firms located intheir countries, they should bemore realistic and responsible inreconciling measures to managethe economy with the corporateneed to maintain efficiencyand profitability.

In the Introduction, ProfessorHarry G. Johnson notes that thevolume is an importantcontribution to the extremely smallresearch literature on theoperations of international

companies in the less developedcountries.

Jack Baranson is a lecturer inthe Economic Development Instituteof the World Bank. His first book,Technology for UnderdevelopedAreas.- An Annotated Bibliography,was also published in 1967.

Hirsch, Fred, Money Interna-tional, London, U.K., AllenLane, The Penguin Press, 1967,443 pp., 70s.

Fred Hirsch's new book isconcerned with the internationalfinancial system in its broadestcontext—what it means, how itdeveloped, how it works, whereit creaks, and what should bedone to improve it.

Its underlying purpose is toprovide a perspective and atextbook for current policyquestions in this field. These havemoved increasingly into the publiceye and the political arena, andjudgments about many of themdepend on an understanding ofeither the work of financialmarkets or of basic economicconcepts; and very often ofboth together.

Money International is dividedinto five parts. The first sets outthe main issues in terms whichshould be understandable tothose who are neither economistsnor bankers. Part 2 delves intodomestic (primarily British)financial issues. Parts 3 and 4 arebasically institutional, describingand assessing the maindevelopments in the markets,central banks, and internationalfinancial organizations—interspersed are several diversions,including a discussion of somecontrasts in national financialattitudes, and a chapter entitled"Is Gold Money?" Part 5 goes intogreater detail on the issuesdiscussed earlier, and puts forththe author's interpretationsand recommendations.

Among the topical chapters isone on the nature of the balanceof payments, with an explanationof why this has currently achievedsuch importance; another on therelationship between the balanceof payments and economicwelfare; the role of speculationand the bankers of Zurich; and achapter on "New Reserves: Which,Why, and to Whom."

42


Mr. Hirsch is the author of ThePound Sterling: A Polemic, and ofnumerous articles, including amuch-quoted "argument" on goldwith Jacques Rueff.

The author was graduated fromthe London School of Economicsin 1952, when he became afinancial journalist. He wasfinancial editor of The Economistfrom 1963 to 1966.

In 1966 he joined the staff ofthe International Monetary Fundas a Senior Advisor in theResearch and StatisticsDepartment. "Since this book hasbeen finished in midstreambetween my old position on TheEconomist and my new one at theInternational Monetary Fund," henotes in the Preface, "it is plainthat neither organization can haveany responsibility for the text."

Leon, Paolo, Structural Changeand Growth in Capitalism—ASet of Hypotheses, Baltimore,Md., U.S.A., The Johns HopkinsPress, 1967, xiv + 162 pp.,$6.75.

Originally published in Italianunder the title of Ipotesi sullosviluppo dell'economiacapitalistica in 1965 by EditoreBoringhieri Torino, the Englishversion has been translated andrevised by the author. His centraltheme is that the rate of profits inthe capitalist system is not uniform,but instead is permanentlydifferentiated industry by industryand sector by sector, with resultingmonopolistic tendencies.

The author claims that thisdifferentiation is derived from thevarying growth pattern in theconsumption of commodities. Hisconcept of a series of profit ratesdiffers drastically from thetraditional theories about thelong-run functioning of the systemand suggests a system of pricesdominated by demand.

The author concludes that theworkings of capitalism cannot bediscussed within the framework oftraditional methodology. Hesuggests a new method of"dialectical economics" andprovides examples of its possibleapplication.

Paolo Leon, who was a staffeconomist with the World Bankuntil March, has returned to Italyto work in private industry.

views and comments

Excerpts from the statement ofthe Secretary-General of theUnited Nations Conferenceon Trade and Development(UNCTAD), Raul Prebisch, atthe 39th plenary meeting ofthe Conference in New Delhi,February 2, 1968.

"In my opinion, the startingpoint here must be recognitionof the following principles:

"Development is the primaryresponsibility of the countries thatpropose to develop.

"In order to discharge thisresponsibility, the peripheralcountries need the cooperationof the centers.

"The cooperation of the centersshould not be residual—as it hasbeen so far—but should be givena high priority; and it cannot bebased on the immediate tradeinterest of this or that industrialcountry, nor on its particularintention to secure certain politicalconcessions, but on the aim ofsolving a great common problem,namely, the problem ofdevelopment.

"All this, as well as meeting acompelling human need, is ofparamount political importancefor the whole world and opens upvast prospects for the expansionof world trade to the mutualadvantage of industrial centersand peripheral countries.

"This solution of the commonproblem of development requiresboth groups of countries to adopta series of converging measuresaimed at clear and definite targetswhich should be progressivelyquantified at the level of theperipheral countries and at theinternational level.

"These converging measures areindispensable for tackling thethree main obstacles that make itdifficult to accelerate the rate ofdevelopment: the persistenttrend toward externaldisequilibrium—the trade gap—the chronic disparity betweensavings and mounting investmentrequirements—the savings gap—and the external vulnerability ofthe peripheral economies.

"As regards this combination ofconverging measures, it is essentialthat the industrial centers shouldafford greater access to theirmarkets for the exports of theperipheral countries.

"Similarly, the centers mustincrease their flow of financialresources in order to acceleratethe rate of growth of theperipheral countries. Theseresources should be accessible tocountries showing theirdetermination to shoulder thisresponsibility. Their determinationto develop will be very limited inscope unless this flow of resourcesis adequate. And these resourceswill be largely wasted without anenergetic policy of internaldevelopment.

"This policy of internaldevelopment makes it absolutelynecessary for the peripheralcountries to undertake withdetermination a series of internaltransformations of their structuresand attitudes, where this has notalready been done; and it alsorequires them to be prepared toadhere to the reasonablediscipline of a development plan,to spur on their reciprocal trade bymeans of regional or subregionalgroupings aimed at economicintegration, and to promoteinterregional measures for theexpansion of trade.

"All these converging measuresare geared to the need to quickenthe pace of development of theperipheral countries until suchtime as they manage, one afterthe other, to achieve a high growthrate and to maintain it with theirown investment resources."

The following are excepts fromthe printed report of the Secre-tary-General of UNCTAD pre-sented to the Second Sessionin New Delhi, February 1, ',1968.

"The conception of developmentpolicy and its requirements hasmade great strides, but a difficultstage of controversy had to be

43


gone through before a certainbasic consensus emerged on thenature of the process and thesignificance of the action requiredto deal with it.

"Neither the concept of aglobal strategy nor the convictionthat it is necessary to formulateone came about suddenly. Theyexperienced some vicissitudes. Thestubborn resistance to which thevery idea of industrialization gaverise up to the early 1950's maybe remembered, as also thedispute over economic planningand the repeated objection tofinancing public enterprises, evenwhen they were well run. All thesedifficulties have been overcome,as has the reluctance to recognizethe fact that, although inflationintensifies the trend towardsexternal disequilibrium, the latteris a consequence of thedevelopment process itself andcannot be remedied bymonetary mechanisms alone.

"The fund of knowledgeaccumulated so far is now enoughto define the key elements of aninternal development policy,including those transformations onwhich such great stress has beenlaid. This material could nowhelp governments themselves todecide in a general way, at theUnited Nations level, on the mainguidelines of a developmentpolicy and on the criteria on whichinternational financial cooperationshould be based.

"The twofold pledge to mobilizeinternational and domesticresources is an interesting case ofdemarcation between the aimsof a strategy and the exclusiveresponsibilities of each country,because, in pledging to mobilizeits resources, a peripheral countrydoes not waive its right todetermine what kind of internalaction it will take to fulfill it.Similarly, it is the prerogative ofthe industrial centers to decide onthe ways and means which suitthem best for making the financialcontribution to which they havecommitted themselves.

"The inflow of internationalfinance for a development planshould, as a rule, be greater, thehigher the proportion of additionalincome a country proposes to setaside for savings and productiveinvestment.

"This would be the mosteffective and economical way ofusing international finance,because, if these resources wereto be concentrated over arelatively small number of yearsand with a great multiplier effect,a smaller total amount of themwould be required than would benecessary if they were employedin smaller annual quantities withless multiplier effect for arelatively long period. Herein liesthe most serious defect ofinternational cooperation in thisdecade: it has not beenforthcoming on a scale largeenough to generate the manytimes larger amount of domesticsavings and the correspondingacceleration of growth.

"This all goes to show that,whatever efforts are made todemarcate the objective elementsof a plan and to limit to them theconditions that might beestablished for granting to aperipheral country the supple-mentary resources it requires forfinancing it, there is an undefinedzone in which examination of aplan may go beyond the limits ofobjectivity and intrude into theprivate preserve of a country'spolitical decisions. It must berecognized that this examination,together with the influence thatthe suppliers of internationalfinance naturally wield, exposes acountry to the risk of unacceptableinterference in decisions affectingits sovereignty. This is a pointwhich causes the developingcountries the utmost concern, aswas evident in the discussionson supplementary financingand at the Algiers Conference.

"This concern is very legitimateand while, as stated earlier, it istrue that the examination of adevelopment policy is carried outchiefly by the International Bank, itis equally true that the morecomprehensive requirements of adevelopment strategy make itadvisable to raise a specificquestion, namely, whether it mightnot be convenient and feasibleto choose new procedures, inview of the delicate responsibilityinvolved in examining a planand in following its implementationas regards the honoring ofpledges to provide basic andsupplementary financing.

"It has thus been thought thata body of independent experts,equidistant from the partiesinvolved, might meet theserequirements better."

Excerpts from a speech by theSecretary-General of the UnitedNations, U Thant, to the Sec-ond Session of the United Na-tions Conference on Trade andDevelopment, in New Delhi,on February 9, 1968.

"The intimate relationshipbetween the political andeconomic aspects of worldproblems was the subject of aremarkable statement by thePresident-designate of theInternational Bank forReconstruction and Developmentat Montreal nearly two yearsago. As he pointed out at thattime, there is a direct and constantrelationship between the incidenceof violence and the economicsituation of the countries afflicted,and he drew attention to thedanger of assuming that problemsof security could be dealt with bypurely military means. The mostimportant ingredient ofinternational security is economicand social development, and notthe armaments and armed forces,however powerful the latter mayseem to be. Mr. George Woods,who is here with us this morning,has, of course, expressed similarsentiments and viewpoints onseveral occasions.

"What can we say aboutprogress since the first Conferencein 1964 in creating the conditionsfor economic and socialdevelopment? It must be admittedthat to a large extent it has beena period of frustrated hopes. Thecountries that agreed in 1964 tothe establishment of UNCTADare well aware that the buildingof a new institution, howevernecessary and important, cannotbe a substitute for substantivemeasures. Nevertheless, the settingup of UNCTAD has unfortunatelynot yet led to the adoption of themeasures which the situationpatently requires.

. . . "Unfavorable as thecircumstances have been, it wasfound possible by the major

44


trading nations to agree on anunparalleled program of tariffdisarmament in the middle of lastyear. This was quickly followedby agreement at the annualmeeting of the InternationalMonetary Fund at Rio de Janeiroon qn outline scheme forinternational monetary reform.What is it that made it possiblefor success to be achieved in thesetwo major areas at a time when itwas considered impossible toexpand the efforts being made inthe much more basic problem ofworld economic development?

"If we are frank with ourselves,I think we may identify two mainreasons for the difference. Thefirst is that, although both theKennedy Round and the outlinescheme for international monetaryreform will tend to benefit thedeveloping countries to someextent, their main significance is inregard to the economic relationsamong the developed countries.And it is simply a fact of life thatthe developed countries have alarger volume of trade andmonetary exchanges with oneanother than with the developingworld.

"But there is a second andperhaps even more significantreason for the difference. Whilethe new developments in tradeand monetary relationships amongthe developed countries involvean exchange of reciprocalobJigations, the developed worldcontinues to regard its economicrelationships with the lessdeveloped countries as a one-sided affair in which concessionsare granted but not received.Human nature being what it is,countries are much more willing toconsider concessions for whichthere is some quid pro quo thanthose which are, or at leastappear to be, unilateral."

Excerpts from a speech by theGovernor of the Bank of Italy,Dr. Guido Carli, to the Over-seas Bankers Club, London, onFebruary 5, 1968.

"The events of November showthat the international monetarysystem suffers damage when thebusiness community reckons thatthe process of adjustment in impor-tant countries cannot be carriedout without resorting to an alter-ation in the rate of exchange. On

the other hand, clearly themaintenance of existing paritiesrequires that each country beprovided with an adequate volumeof reserves, particularly countries,such as the United Kingdom, whichhold external reserves of thirdcountries. In this connection Ishould like to repeat the proposal,advanced some time ago, wherebyat least part of the variations in thesterling balances would befinanced by the internationalcommunity; it continues to be valid.This is necessary if we wish tokeep the international paymentssystem safe from shocks causedby events taking place in distantcountries.

"The experience your countryis undergoing seems to confirmthat the variation in the parity ofthe pound sterling will play a partin the improvement of the balanceof payments, to the extent towhich it is coupled with areallocation of the real resourcesthat are available to Britain. Ithink one might say that thevariation of parity is no alternativeto an incomes policy; it can be acontributory element, but does notconstitute an exemption from theobligation of freeing a greaterquantity of resources for exports.All the more so in a country thatmust acquire surpluses on balanceof payments at least for someyears, in order to reconstitute asufficient volume of reserves. Tomake this possible, the rest of theworld must collaborate, wideningthe receptivity of the market bypolicies supporting domesticdemand. An authoritativepersonality, the French FinanceMinister, M. Debre, acknowledgedat recent talks in Rome that 'ilconvient, sans tomber dansI'inflation, d'avoir dans chacun denos pays une politique poursoutenir et accoitre I'expansion.'

"In these conditions, with theUnited States set to eliminate theirdeficit, and the United Kingdomengaged in acquiringsurpluses, the way to make theprocess of readjustment lesspainful for the internationalcommunity is to proceed urgentlyto the reform of the internationalmonetary system according to theprinciples stated at the Rio deJaneiro conference and with thewilling participation of all theIMF countries. Here 1 should liketo say that the greater the number

of countries participating in aninstitution, all the more easy it is toensure respect for its decisions.And this is a consideration infavor of the admittance to theFund of the socialist economies ofEastern Europe, provided, ofcourse, they accept thestatutory obligations.

"The evolution of theinternational monetary system isabout to enter a new phase withthe reform of the Fund and, aboveall, the creation of reserves in theform of special drawing rights. Tome it seems evident that themeaning of these recentdevelopments is the accelerationof the process, already under wayfor some time, whereby theimportance of the role played bygold in the system is decreasing. Iunderline this point becausesome continue to insist on the needfor an increase in the priceof gold and a return to the goldstandard. The defenders of thisthesis hold that the assumedinability of the United States torepay their short-term debts ingold is the main fault of thepresent system, but to correct itthey suggest, paradoxically, thatthe United States pay only halftheir debits and refrain fromcontracting new onesin the future!

"The process of creation ofreserves must be in the hands ofthe countries responsible formaking the system work, so thateach may take part in thedecisions in proportion to itsimportance and to the role it playsin international economicrelations. Conversely, a systemmainly centered on gold—and thiswould inevitably happen if itsprice were raised—would handover the helm to forces operatingin a way quite unconnected withrational decisions. There is asaying that gold is the policemanwho ensures internationalmonetary order; but why shouldthis duty be entrusted to a robotinstead of human beings?Furthermore, to the extent to whichnational currencies continue to beused as a reserve instrument, astrengthened multilateralsurveillance or a harmonizedpolicy of reserve managementshould prevent the relevantdecisions from being exclusivelyentrusted to the countrieswhich issue these currencies."

45


Recent MyINTERNATIONAL BANK FORRECONSTRUCTION ANDDEVELOPMENT

INTERNATIONAL FINANCECORPORATION

INTERNATIONALDEVELOPMENT ASSOCIATION

Proposal for (DAReplenishment

By December 1967, IDA hadextended credits totaling $1,713million to help financedevelopment projects in 38 of its98 member countries. Thesecommitments had virtuallyexhausted all usable resourcesavailable to IDA at that date andnegotiations were being activelyconducted for their replenishment.

In March 1968, the ExecutiveDirectors of IDA recommendedand transmitted to membergovernments for approval aproposal for the secondreplenishment of IDA's resourcesby $1,200 million. The firstreplenishment, agreed to in 1964,amounted to $750 million.

On April 1, Mr. Robert S. McNamara (left) succeeded Mr. George D. Woods (right) asPresident of the World Bank, and its two affiliates, the International DevelopmentAssociation, and the International Finance Corporation. Mr. Woods retired after five yearsof service as President of the World Bank Group.

Eighteen member countries,plus Switzerland, propose makingavailable to IDA $400 millionannually for three years. Theproposal is now before membergovernments. The proposal wouldenable IDA to increase itscommitments by an average of 60per cent annually over the levelwhich the first replenishmentwas designed to achieve.

Sweden's SpecialContribution to IDA

In addition to its ordinaryand supplementary contributions,Sweden proposes to make aspecial supplementary contributionto IDA's resources amounting to$21.36 million. The specialcontribution, to be paid in freelyconvertible currencies over thenext three years, is included ina special bill on Swedishdevelopment assistance whichis to be submitted for approvalto the Swedish Parliament inthe near future.

IDA CREDITS DURING THE THIRD QUARTER OF FISCAL 1968

COUNTRY PURPOSECameroonEthiopiaMalawi (two credits)MalawiTanzania

EngineeringRoadsAgricultureRoadsRoads

Credits extended during the third quarter of fiscal 1968Credits extended during the first half of fiscal 1968Total credits extended during the nine months offiscal 1968 ended March 31, 1968

AMOUNT($ MILLIONS)

0.557.709.70

11.503.00

32.4519.40

51.85

If the proposal is approvedby the Swedish Parliament,Sweden will have paid or pledgedto IDA a total of $104.22million—including its initialsubscription, participations in theFirst and Second Replenishmentand numerous supplementarycontributions. With the exceptionof Kuwait, Sweden has been andwould continue to be the largestcontributor to IDA on a per capitabasis.

Loan Interest Rate Increased

Early in 1968 the rate ofinterest charged on Bank loanswas raised from 6 per cent to 6 VAper cent. The rise reflected thegeneral increase in interest ratesin the main capital marketsand the consequent rise in the costof the Bank's borrowings.

World Bank Bond IssuesIn January, the World Bank

entered the Canadian market withan issue of Can$l 5 million 7per cent 25-year Canadian dollarbonds. The issue was offeredby a syndicate of investmentdealers and banks headed byDominion Securities CorporationLimited, A.E. Ames & Co. Limited,and Wood Gundy SecuritiesLimited. The issue was offered at97.50 and accrued interest.This was the Bank's seventhoffering of its bonds in Canada.

In March, the Bank arrangedthe sale, entirely outside the

46


United States, of a $1 25 millionissue of U.S. dollar bonds. Thesale, at par, was made by privateplacement with central banksand other governmental institutionsof 47 countries and with twointernational organizations. Thebonds bear interest at 6 Vaper cent payable semiannually,with the first payment dueSeptember 15, 1968.

In the same month, the Bankoffered in Germany a new issue ofDM 120 million (U.S. equivalent$30 million) of 6% percentten-year Deutsche mark bonds. Itwas offered by a group of some70 leading German banks headedby the Deutsche Bank A.G. asthe principal manager and theDresdner Bank A.G. as theco-manager. The new issue wasoffered at 98 Vi per centand accrued interest.

Morgan Stanley & Co. and theFirst Boston Corporation, asmanagers of a nation-wideunderwriting group in the UnitedStates, announced in March apublic offering of $150 million26-year, 6 Vi per cent World Bankbonds of 1968, due March 15,1994, at 99 V2 per cent toyield 6.54 per cent.

Tarbe/a Project

In March, representatives ofthe Governments of Canada,France, Italy, Pakistan, the UnitedKingdom, and the United Statesmet under the chairmanship of theBank and reached accord onthe terms of an agreementproviding for the setting up of afund to finance the cost ofconstructing the Tarbela Dam inPakistan. The World Bank is alsoexpected to provide financing forthe project and to act asAdministrator of this fund.

The total costs of the TarbelaDam are estimated to beabout $827 million, with a foreignexchange component of $492million. The Government ofPakistan will provide the localcurrency costs. A large part of theforeign exchange costs, about$324 million, will be financed by acarry-over from the Indus BasinDevelopment Fund. Canada,France, Italy, the United Kingdom,and the United States havepromised, subject to any necessarygovernmental and parliamentary

action, to finance expenditures intheir countries on the projects.

Tarbela is a strategic elementin the integrated development ofWest Pakistan. The first major damconstructed under the programto develop West Pakistan's waterresources, the Mangla Dam, wasinaugurated in November 1967.

Ceylon Aid MeetingA meeting of a group of seven

countries—Australia, Canada,France, Germany, Japan, theUnited Kingdom, and the UnitedStates—interested in aid toCeylon met in Paris in March underthe chairmanship of the Bank.The group was encouraged by thecontinued progress made by theGovernment of Ceylon since thelast meeting of the group in April1967 in overcoming basicobstacles to economic growth. Inparticular it welcomed the in-creases in agricultural andindustrial production although it

recognized that continued declinesin the prices of Ceylon's principalexports had hindered growth.

The Group noted that theholding operation started in early1965 had been transformed intoa growth effort. It discussed thelonger-term prospects andendorsed the basic developmentstrategy of the Government incontinuing to promote efficientproduction for domestic use withparticular emphasis on increasedfood production.

Preliminary indications bymembers of the Group of their aidintentions during the rest of 1968,together with aid from earliercommitments, suggest that Ceyloncan expect a higher level of aidedimports during 1968 than in1967. A number of developmentprojects would be ready forfinancing shortly, some of wnichwere expected to be suitable forBank/IDA financing.

WORLD BANK LOANS DURING THE THIRD QUARTEROF FISCAL 1968

COUNTRY PURPOSE

Argentina Electric PowerBrazil IndustryChina (Taiwan) RailwaysEthiopia RoadsGreece Development Finance CompanyKorea Development Finance CompanyMexico IrrigationMexico RoadsNicaragua EducationSudan Electric PowerYugoslavia Railways

Loans made during the third quarter of fiscal 1 968Loans made during the first half of fiscal 1 968

Total amount lent during the 9 months offiscal 1968 ended March 31, 1968

AMOUNT($ MILLIONS)

55.0022.0017.5013.5012.505.00

25.0027.50

4.0024.0050.00

256.00341.10

597.10

IFC INVESTMENT COMMITMENTS ANNOUNCED DURINGTHE THIRD QUARTER OF FISCAL 1968

COUNTRY

KoreaMexicoNicaragua

TYPE OF PROJECT

Development Finance CompanySteelTextiles

AMOUNT $

702,0437,338,8862,071,428

Investments announced during the thirdquarter of fiscal 1968 $10,112,357

Investments announced during the firsthalf of fiscal 1968 19,998,000

Total investments announced during the9 months of fiscal 1968 ended March 31, 1968 $30,110,357

47


Recent ActivityINTERNATIONAL

MONETARY

FUND

During the first quarter of 1968the Fund's resources were utilizedby 14 countries. They drewcurrencies equivalent to $791.5million, over twice the amountof drawings in the same periodlast year. Repayments duringthe quarter totaled $238.4 million.Total drawings in the Fundreached an aggregate of$14,571.8 million on March 31,1968. (This last figure includes theFund's repayment of its 1965borrowing of $35 million

; from Canada.)

Drawings

Canada drew the equivalent of$391 million in February, anamount corresponding to thatcountry's gold subscription of $1 85million to the IMF augmented bythe amount of Canadian dollarswhich the Fund has provided toother members. This was the firstuse of Fund resources by Canadasince June 1962. At the same time,the Fund made a repayment ofits indebtedness to Canada, (seeabove) under the provisions of theGeneral Arrangements to Borrow,of the equivalent of $35 million,in four currencies, also in February,equivalent of its gold subscription,in four currencies also in February.This was the first use of Fundresources by Iran since October1964. In March the United Statesmade its first drawing on theFund since December 1966. Itdrew the equivalent of $200million in four currencies.

A drawing by the United ArabRepublic equivalent to $40 millionwas approved in March. This wasin support of the U.A.R.'s effortsto strengthen its domestic economyand its payments position. TheU.A.R. economy, which hasexperienced serious paymentsdifficulties in recent years, sufferedfrom the Middle East hostilitieslast June. The Suez Canal closureand a virtual standstill in touristtraffic led to a severe drop in

DRAWINGS BY FUND MEMBERSDURING THE FIRST QUARTER OF 1968

Member

BoliviaCanadaChileColombiaIndonesiaIranLiberiaPhilippinesSomaliaSudanTunisiaUnited Arab RepublicUnited StatesUruguay

Total drawings in

Total net drawingsof 1968

Month

February, MarchFebruaryJanuary, MarchMarchFebruaryFebruaryJanuaryJanuaryMarchFebruaryJanuaryMarchMarchFebruary

the first quarter of 1968

at the end of the first quarter

Amount($ million)

12.000391.00

25.257.50016.00031.25

.5027.50

2.502.503.00

63.00200.00

9.50

791.50

4,555.30

exchange earnings. The situationwas weakened further by loss anddamage within the oil productionand refining sectors. To deal withthese developments, the U.A.R.authorities have acted to controlthe expansion of demand andcredit and to reduce spending.Simultaneously with its $40 milliondrawing, the U.A.R. also drew $23million under the Fund'scompensatory financing facility(see below).

Other Deve/opmenfs

In January, Zambia introduceda new currency unit, the kwacha,to replace the Zambian pound. Thenew unit, which was madeequivalent to 10 shillings of theprevious currency, did not reflectany appreciation or depreciationof Zambia's currency. A par valueof 1 Zambian kwacha = US$1.40was established.

Deve/opmenfs in InternationalLiquidity

At its September 1967 AnnualMeeting in Rio de Janeiro, theFund's Board of Governorsrequested Fund Executive Directorsto proceed with work relating tothe establishment of a new facilityfor special drawing rights (SDRs)

to be operated in the Fund. Anoutline scheme for them wasapproved at the Rio meeting, aculmination of discussions whichhad been in progress for severalyears both within the Fund andoutside of it. After the Rio meeting,Executive Directors and Fund stafftook up the task of drafting thenecessary amendmentsto the present Fund Articlesof Agreement.

In March 1968, Ministers andCentral Bank Governors of the tennations which participate in theFund's General Arrangements toBorrow met in Stockholm toconsider the amendments pro-posed. The Fund's ManagingDirector, Mr. Pierre-PaulSchweitzer, took part in thesediscussions. In a communiqueissued at the conclusion of theStockholm meeting, the Ministersexpressed agreement on thespecial drawing rights facility andalso approved other modificationsin the existing rules and policies ofthe Fund. France reserved itsposition pending the final text ofthe amendments.

Earlier in March, the Governorsof the central banks of seven goldpool nations (Belgium, Germany,Italy, the Netherlands, Switzerland,the United Kingdom, and theUnited States) met in Washington,

48


D.C. to examine the operationof the pool. Their meeting followeda period of uncertainty andintense activity in internationalgold markets. It was attended bythe Managing Director of theFund as well as the GeneralManager of the Bank forInternational Settlements. At theconclusion of the Washingtonmeeting, the Governors issued acommunique noting the effortsbeing made by the United Statesand the United Kingdom in thedefense of the value of theircurrencies. They gave their support

to the declared U.S. policy tomaintain the existing gold price of$35 an ounce in transactions withmonetary authorities. They alsodecided that henceforth officiallyheld gold should be used only toeffect transfers between monetaryauthorities. The Governorsannounced their intention to haltsupplies of the metal to goldmarkets in London and elsewhere.The existing stock of monetarygold was considered sufficient bythe Governors in view of theFund's prospective specialdrawing rights facility. They also

agreed that it would no longer benecessary to buy gold frommarkets or to sell gold to monetaryauthorities to replace gold sold toprivate markets. The Governorspointed out that their decisioninvolved no departure from theobligation of Fund members tomaintain the par values of theircurrencies established with theFund. They stressed the importancefor all member countries ofconducting gold transactionsconsistently with their undertakingto collaborate with the Fund inpromoting exchange stability andorderly exchange agreements. TheGovernors' statement concludedwith the hope that the specialdrawing rights facility will enterinto force "with the least possibledelay in order to make it possibleto supplement existing reserveassets as and when needed."

Compensatory FinanceDrawings

Uruguay made a $9.5 milliondrawing in February under theFund's policy of compensatoryfinancial assistance to countriesexperiencing a temporary shortfallin total export earnings largelyattributable to circumstancesbeyond their control. Uruguayanexport earnings are derivedprimarily from animal husbandryand the drawing reflects losses inthis sector from drought and asevere winter during the fiscal yearended October 31,1967.

The $23 million drawing by theUnited Arab Republic in Marchunder this facility was to help meeta shortfall in export earningsduring the year ended November30, 1 967. This resulted fromdamage to the U.A.R.'s raw cottoncrop by pests and from adverseweather conditions.

Monetary and Fiscal Librariesfor Latin America

The Fund is currently workingwith the Inter-American Develop-ment Bank and the Center forLatin American Monetary Studies(CEMLA) to provide financial andeducational institutes in LatinAmerica with collections of publi-cations in Spanish on monetaryand fiscal affairs. Over 200 sets ofthese publications are to bedistributed to assist the study andunderstanding of financialproblems relevant to economicdevelopment in Latin America.

49


Stand-By Arrangements

Stand-by arrangements totaling$216.85 million were approvedduring the first quarter for tencountries in Africa, Asia, Europe,and Latin America. Undrawnbalances available to membersunder such arrangements stood at$1,861.06 million on March 31,1968.

A stand-by arrangement forIndonesia of the equivalent of$51.75 million was the largestarrangement approved duringthe quarter. The Indonesianarrangement will assist a programof measures to stabilize andrehabilitate the country's economy.Major features of Indonesia's1968 program are strong measuresagainst inflation, steps to revivedomestic production (with anemphasis on rice), and restraintson monetary expansion. Chilereceived the Fund's approval fora $46 million stand-by arrange-ment in support of a fiscal andcredit program to promotecontinued economic growth.

Nicaragua ($19 million), thePhilippines ($27.5 million), Turkey($27 million), and Uruguay ($25million) also figured inarrangements approved in the firstquarter. The Nicaraguanarrangement was in support ofefforts designed primarily tobalance the country's externalpayments, which have sufferedfrom two years of poor crops andsagging exports. The arrangementwith the Philippines is to sustaineconomic development andexchange rate stability while stepsare taken to curb credit expansionand to reverse the decline ininternational reserves. Turkeybegins a Second Five-Year Planin 1968, aiming at a 7 per centannual increase in real grossnational product. The arrangementprovides a secondary line ofreserves to help Turkey meettemporary payments difficultiesbecause of the country's heavydependence on agriculturalexports.

The stand-by arrangement withUruguay will support policies toimprove Uruguay's internal andexternal finances. Uruguay took

FUND STAND-BY ARRANGEMENTS

APPROVED DURING THE FIRST QUARTER OF 1968

Member

BurundiChileGuyanaIndonesiaNicaraguaPhilippinesSierra LeoneSomaliaTurkeyUruguay

Month

MarchMarchFebruaryFebruaryMarchMarchJanuaryJanuaryMarchMarch

Amount($ million)

6.0046.00

4.0051.7519.0027.50

3.607.00

27.0025.00

the first step toward therestoration of more stableeconomic conditions when itadjusted the official exchange ratefor the peso in November 1967from Ur$99 to Ur$200 perU.S. dollar.

Measures to stabilize andimprove payments positions werealso prominent in the economicprograms supported by thestand-by arrangements approvedfor Burundi, Guyana, SierraLeone, and Somalia.

50


Agricultural Developmentin Tropical Africa

Vol. 1, The Synthesis

Vol. 2, The Case Studies

by John C. de Wilde et al

'T'HE PROFITABLE employment of people on the land is one of the most im--*- portant aims of the underdeveloped countries today. Agriculture has lagged

behind other sectors of the economy in practically all of them, but still absorbs the

greater part of their populations; it will remain the basis of their economies for along time. This study analyzes selected experiences with a view to providing dataand guidelines for future agricultural development.

Tropical Africa was chosen as the area for study because it offered the mostdiverse selection of programs, societies, soils, and climatic conditions. Case studieswere made of five areas in Kenya, two in Mali, two in Uganda, and one each inTanzania, Upper Volta, the Republic of Chad, and Ivory Coast; and a numberof experiences elsewhere in Africa also were evaluated. Volume I draws certainconclusions regarding the factors conditioning successful agricultural developmentin tropical Africa; Volume II presents the case studies on which this assessment is

based.

These volumes were published for the International Bank for Recon-

struction and Development. Volume I costs US$6.50 and Volume IIcosts US$12.50. The combined price for both volumes is US$15. Theymay be ordered from The Johns Hopkins Press, Baltimore, Maryland,

21218, U.S.A.


STAFF PAPERSStaff Papers is a publication through which the Fund makes available some of

the studies on monetary and financial problems prepared by members of its staff. Thestudies published thus far have dealt with such subjects as international liquidity, bal-ances of payments and exchange rates, inflation in relation to economic development,and national monetary and fiscal policies. Summaries in French and Spanish are ap-pended to each article. There are three issues each year.

The subscription is $6.00 a year or $2.50 for a single copy; university libraries, fac-ulties, and students may obtain it for $3.00 a year or $1.00 a single copy.

Orders may be sent to

The Secretary

INTERNATIONAL MONETARY FUND

19th and H Streets, N.W. Washington, B.C. 20431, U.S.A.

PROGRESS REPORT OFTHE INTERNATIONAL INSTITUTE FOR

EDUCATIONAL PLANINGProgress Report, a booklet describing the work of the Inter-

national Institute for Educational Planning (HEP) since itscreation in 1963, has just been published.

The Institute, located in Paris, is a world center for researchand advanced training in educational planning. Its purpose isto help all member states of UNESCO in their social andeconomic development efforts, by enlarging the fund of knowl-edge about educational planning and the supply of competentexperts in this new and fast-growing technical field.

The booklet is available free of charge in English, French,or Spanish, only from:

The International Institute for Educational Planning7, rue Eugene-DelacroixParis 16e, France


Second Printing Just Out

Development Planning:Lessons of Experience

by Albert Waterston

A two-part comparative study that assesses the results of planning experiencein more than 100 mixed-economy and socialist countries in Africa, Asia, Europe,and the Americas.

Part I describes and analyzes the process in the countries under review, withspecial emphasis on the problems of implementing development plans. Part IIdeals with organizational and administrative structures and functions. Theoreticalinformation is included, but the approach is essentially pragmatic.

Appendices contain a comprehensive listing of national development plans,a list of central planning agencies and their addresses, and a bibliography ondevelopment planning.

The author is Advisor on Planning Organization in the Development ServicesDepartment of the World Bank. He is also the author of Planning in Pakistan,Planning in Yugoslavia, and Planning in Morocco, and coauthor of The EconomicDevelopment of Mexico.

The U.S. edition of Development Planning is priced at $10.75, the Englishedition at 86s. Od. An edition in Italian is now available from Guiffre Editore,Milan, at 8.000 Lit.

Orders may be sent to:

U.S.A. British CommonwealthJohns Hopkins Press Oxford University PressBaltimore, Maryland 21218 Ely House, 57 Dover StreetU.S.A. London W.I, England

Canada Europe, Latin America, and the Near EastThe Copp Clark Publishing Co. International Book Export Group517 Wellington Street West P.O. Box 231Toronto 2B, Ont. Princeton, New Jersey, U.S.A.


The Hope Estate Farming Development in Tobago; the World Bank made a $5 millionloan to the Government of Trinidad and Tobago for the first stage of this agriculturalland settlement scheme. See "Consultants for Agricultural Development," page 20.


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