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Krugmanobstfeldch22
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Krugmanobstfeldch22

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  • 1. Chapter 22 Developing Countries: Growth, Crisis, and Reform Prepared by Iordanis Petsas To AccompanyInternational Economics: Theory and Policy, Sixth Edition Policy by Paul R. Krugman and Maurice Obstfeld
  • 2. Chapter Organization  Introduction  Income, Wealth, and Growth in the World Economy  Structural Features of Developing Countries  Developing Country Borrowing and Debt  Latin America: From Crisis to Uneven Reform  East Asia: Success and Crisis  Lessons of Developing Country Crises  Reforming the World’s Financial “Architecture”  SummaryCopyright © 2003 Pearson Education, Inc. Slide 22-2
  • 3. Introduction  The macroeconomic problems of the world’s developing countries affect the stability of the entire international economy. • There has been greater economic dependency between developing and industrial countries since WWII.  This chapter examines the macroeconomic problems of developing countries and the repercussions of those problems on the developed countries. • Example: Causes and effects of the East Asian financial crisis in 1997Copyright © 2003 Pearson Education, Inc. Slide 22-3
  • 4. Income, Wealth, and Growth In the World Economy  The Gap Between Rich and Poor • The worlds economies can be divided into four main categories according to their annual per-capita income levels: – Low-income economies – Lower middle-income economies – Upper middle-income economies – High-income economiesCopyright © 2003 Pearson Education, Inc. Slide 22-4
  • 5. Income, Wealth, and Growth in the World Economy Table 22-1: Indicators of Economic Welfare in Four Groups of Countries, 1999Copyright © 2003 Pearson Education, Inc. Slide 22-5
  • 6. Income, Wealth, and Growth in the World Economy  Has the World Income Gap Narrowed Over Time? • Industrial countries have shown convergence in their per capita incomes. • Developing countries have not shown a uniform tendency of convergence to the income levels of industrial countries. – Countries in Africa and Latin America have grown at very low rates. – East Asian countries have tended to grow at very high rates.Copyright © 2003 Pearson Education, Inc. Slide 22-6
  • 7. Income, Wealth, and Growth in the World Economy Table 22-2: Output Per Capita in Selected Countries, 1960-1992 (in 1985 U.S. dollars)Copyright © 2003 Pearson Education, Inc. Slide 22-7
  • 8. Structural Features of Developing Countries  Most developing countries have at least some of the following features: • History of extensive direct government control of the economy • History of high inflation reflecting government attempts to extract seigniorage from the economy • Weak credit institutions and undeveloped capital markets • Pegged exchanged rates and exchange or capital controls • Heavy reliance on primary commodity exports • High corruption levelsCopyright © 2003 Pearson Education, Inc. Slide 22-8
  • 9. Structural Features of Developing Countries Figure 22-1: Corruption and Per Capita IncomeCopyright © 2003 Pearson Education, Inc. Slide 22-9
  • 10. Developing Country Borrowing and Debt  The Economics of Capital Inflows to Developing Countries • Many developing counties have received extensive capital inflows from abroad and now carry substantial debts to foreigners. • Developing country borrowing can lead to gains from trade that make both borrowers and lenders better off.Copyright © 2003 Pearson Education, Inc. Slide 22-10
  • 11. Developing Country Borrowing and DebtTable 22-3: Current Account Balances of Major Oil Exporters, Other Developing Countries, and Industrial Countries, 1973-2000 (billions of dollars) Copyright © 2003 Pearson Education, Inc. Slide 22-11
  • 12. Developing Country Borrowing and Debt Table 22-3: ContinuedCopyright © 2003 Pearson Education, Inc. Slide 22-12
  • 13. Developing Country Borrowing and Debt  The Problem of Default • Borrowing by developing countries has sometimes led to default crises. – The borrower fails to repay on schedule according to the loan contract, without the agreement to the lender.Copyright © 2003 Pearson Education, Inc. Slide 22-13
  • 14. Developing Country Borrowing and Debt • History of capital flows to developing countries: – Early 19th century – A number of American states defaulted on European loans they had taken out to finance the building of canals. – Throughout the 19th century – Latin American countries ran into repayment problems (e.g., the Baring Crisis). – 1917 – The new communist government of Russia repudiated the foreign debts incurred by previous rulers. – Great Depression (1930s) – Nearly every developing country defaulted on its external debts.Copyright © 2003 Pearson Education, Inc. Slide 22-14
  • 15. Developing Country Borrowing and Debt  Alternative Forms of Capital Inflow • Five major channels through which developing countries have financed their external deficits: – Bond finance – Bank finance – Official lending – Direct foreign investment – Portfolio investment in ownership of firms – This channel has been reinforced by many developing countries’ efforts at privatization.Copyright © 2003 Pearson Education, Inc. Slide 22-15
  • 16. Developing Country Borrowing and Debt Figure 22-2: Privatization in AfricaCopyright © 2003 Pearson Education, Inc. Slide 22-16
  • 17. Developing Country Borrowing and Debt • The five types of finance can be classified into two categories: – Debt finance – Bond, bank, and official finance – Equity finance – Direct investment and portfolio purchases of stock sharesCopyright © 2003 Pearson Education, Inc. Slide 22-17
  • 18. Latin America: From Crisis to Uneven Reform  Inflation and the 1980s Debt Crisis in Latin America • In the 1970s, as the Bretton Woods system collapsed, countries in Latin America entered an era of inferior macroeconomic performance.Copyright © 2003 Pearson Education, Inc. Slide 22-18
  • 19. Latin America: From Crisis to Uneven Reform • Unsuccessful Assaults on Inflation: The Tablitas of the 1970s – 1978 – Argentina, Chile, and Uruguay all turned to a new exchange- rate-based strategy in the hope of taming inflation. – Tablita – It is a preannounced schedule of declining rates of domestic currency depreciation against the U.S. dollar. – It is a type of exchange rate regime known as a crawling peg. – It declined the rate of currency depreciation against the dollar by reducing the rate of increase in the prices of internationally tradable goods to force overall inflation down.Copyright © 2003 Pearson Education, Inc. Slide 22-19
  • 20. Developing Country Borrowing and DebtFigure 22-3: Current Account Deficits and Real Currency Appreciation in Four Stabilizing Economies, 1976-1997Copyright © 2003 Pearson Education, Inc. Slide 22-20
  • 21. Developing Country Borrowing and Debt Figure 22-3: ContinuedCopyright © 2003 Pearson Education, Inc. Slide 22-21
  • 22. Developing Country Borrowing and Debt Figure 22-3: ContinuedCopyright © 2003 Pearson Education, Inc. Slide 22-22
  • 23. Developing Country Borrowing and Debt Figure 22-3: ContinuedCopyright © 2003 Pearson Education, Inc. Slide 22-23
  • 24. Developing Country Borrowing and Debt • The Debt Crisis of the 1980s – The great recession of the early 1980s sparked a crisis over developing country debt. – The shift to contractionary policy by the U.S. led to: – The fall in industrial countries aggregate demand – An immediate and spectacular rise in the interest burden debtor countries had to pay – A sharp appreciation of the dollar – A collapse in the primary commodity prices – The crisis began in August 1982 when Mexico’s central bank could no longer pay its $80 billion in foreign debt. – By the end of 1986 more than 40 countries had encountered several external financial problems.Copyright © 2003 Pearson Education, Inc. Slide 22-24
  • 25. Developing Country Borrowing and Debt  Reforms, Capital Inflows, and the Return of Crisis • Argentina – 1970s – It tried unsuccessfully to stabilize inflation through a crawling peg. – 1980s – It implemented successive inflation stabilization plans involving currency reforms, price controls, and other measures. – 1990s – It adopted a currency board (peso-dollar peg). – 2001-2002 – It defaulted on its debts and abandoned the peso-dollar peg.Copyright © 2003 Pearson Education, Inc. Slide 22-25
  • 26. Developing Country Borrowing and Debt • Brazil – 1980s – It suffered runaway inflation and multiple failed attempts at stabilization accompanied by currency reforms. – 1990s – It introduced a new currency (the real pegged to the dollar), defended it with high interest rates, and decreased inflation under 10%. • Chile – 1980s – It implemented more reforms and used a crawling peg type of exchange rate regime to bring inflation down gradually. – 1990-1997 – It enjoyed an average growth rate of more than 8% per year and a 20% inflation decrease.Copyright © 2003 Pearson Education, Inc. Slide 22-26
  • 27. Developing Country Borrowing and Debt • Mexico – 1987 – It introduced a broad stabilization and reform program and fixed its peso’s exchange rate against the U.S. dollar. – 1989-1991 – It moved to a crawling peg and crawling band. – 1994 – It joined the North American Free Trade Area and achieved 7% inflation.Copyright © 2003 Pearson Education, Inc. Slide 22-27
  • 28. East Asia: Success and Crisis  The East Asian Economic Miracle • Until 1997 the countries of East Asia were having very high growth rates. • What are the ingredients for the success of the East Asian Miracle? – High saving and investment rates – Strong emphasis on education – Stable macroeconomic environment – Free from high inflation or major economic slumps – High share of trade in GDPCopyright © 2003 Pearson Education, Inc. Slide 22-28
  • 29. East Asia: Success and Crisis Table 22-4: East Asian CA/GDPCopyright © 2003 Pearson Education, Inc. Slide 22-29
  • 30. East Asia: Success and Crisis  Asian Weaknesses • Three weaknesses in the Asian economies’ structures became apparent with the 1997 financial crisis: – Productivity – Rapid growth of production inputs but little increase in the output per unit of input – Banking regulation – Poor state of banking regulation – Legal framework – Lack of a good legal framework for dealing with companies in troubleCopyright © 2003 Pearson Education, Inc. Slide 22-30
  • 31. East Asia: Success and Crisis  The Asian Financial Crisis • It stared on July 2, 1997 with the devaluation of the Thai baht. • The sharp drop in the Thai currency was followed by speculation against the currencies of: Malaysia, Indonesia, and South Korea. – All of the afflicted countries except Malaysia turned to the IMF for assistance. • The downturn in East Asia was “V-shaped”: after the sharp output contraction in 1998, growth returned in 1999 as depreciated currencies spurred higher exports.Copyright © 2003 Pearson Education, Inc. Slide 22-31
  • 32. East Asia: Success and Crisis Table 22-5: Growth and the Current Account, Five Asian Crisis CountriesCopyright © 2003 Pearson Education, Inc. Slide 22-32
  • 33. East Asia: Success and Crisis  Crises in Other Developing Regions • Russia’s Crisis – 1989 – It embarked on transitions from centrally planned economic allocation to the market. – These transitions involved: rapid inflation, steep output declines, and unemployment. – 1997 – It managed to stabilize the ruble and reduce inflation with the help of IMF credits. – 2000 – It enjoyed a rapid growth rate.Copyright © 2003 Pearson Education, Inc. Slide 22-33
  • 34. East Asia: Success and Crisis Table 22-6: Real Output Growth and Inflation: Russia and Poland, 1991-2000 (percent per year)Copyright © 2003 Pearson Education, Inc. Slide 22-34
  • 35. East Asia: Success and Crisis • Brazil’s 1999 Crisis – It had a public debt problem. – It devalued the real by 8% in January 1999 and then allowed it to float. – The real lost 40% of its value against the dollar. – It struggled to prevent the real from going into a free fall and as a result it entered into a recession. – The recession was short lived, inflation did not take off, and financial-sector collapse was avoided.Copyright © 2003 Pearson Education, Inc. Slide 22-35
  • 36. East Asia: Success and Crisis • Argentina’s 2001-2002 crises – Its rigid peg of its peso to the dollar proved painful as the dollar appreciated in the foreign exchange market. – 2001 – It restricted residents’ withdrawals from banks in order to stem the run on the peso, and then it stopped payment on its foreign debts. – 2002 – It established a dual exchange rate system and a single floating-rate system for the peso.Copyright © 2003 Pearson Education, Inc. Slide 22-36
  • 37. Lessons of Developing Country Crises  The lessons from developing country crises are summarized as: • Choosing the right exchange rate regime • The central importance of banking • The proper sequence of reform measures • The importance of contagionCopyright © 2003 Pearson Education, Inc. Slide 22-37
  • 38. Reforming the World’s Financial “Architecture”  The Asian crisis convinced nearly everyone of an urgent need for rethinking international monetary relations because of two reasons: • The fact that the East Asian countries had few apparent problems before their crisis struck • The apparent strength of contagion through the international capital marketsCopyright © 2003 Pearson Education, Inc. Slide 22-38
  • 39. Reforming the World’s Financial “Architecture”  Capital Mobility and the Trilemma of the Exchange Rate Regime • The macroeconomic policy trilemma for open economies: – Independence in monetary policy – Stability in the exchange rate – Free movement of capital • Only two of the three goals can be reached simultaneously. • Exchange rate stability is more important for developing than developed countries.Copyright © 2003 Pearson Education, Inc. Slide 22-39
  • 40. Reforming the World’s Financial “Architecture” Figure 22-4: The Policy Trilemma for Open Economies Exchange rate stability o ls Cu ntr rre co nc yb al p it oa Ca rd Monetary Floating exchange rate Freedom of policy autonomy capital movementCopyright © 2003 Pearson Education, Inc. Slide 22-40
  • 41. Reforming the World’s Financial “Architecture”  Proposals to reform the international architecture can be grouped as preventive measures or as ex-post measures.  “Prophylactic” Measures • Among preventive measures are: – More “transparency” – Stronger banking systems – Enhanced credit lines – Increased equity capital inflows relative to debt inflows • The effectiveness of these measures is controversial.Copyright © 2003 Pearson Education, Inc. Slide 22-41
  • 42. Reforming the World’s Financial “Architecture”  Coping with Crisis • The ex-post measures that have been suggested include: – More extensive lending by the IMF – “Chapter 11” bankruptcy proceeding for the orderly resolution of creditor claims on developing countries that cannot pay in full.Copyright © 2003 Pearson Education, Inc. Slide 22-42
  • 43. Reforming the World’s Financial “Architecture”  A Confused Future • In the years to come, developing countries will experiment with: – Floating exchange rates – Capital controls – Currency boards – Abolition of national currencies and adoption of the dollar or euro for domestic transactionsCopyright © 2003 Pearson Education, Inc. Slide 22-43
  • 44. Summary  There are vast differences in per-capita income between countries at different stages of economic development.  Because many developing economies offer potentially rich opportunities for investment, it is natural that they have current account deficits and borrow from richer countries.  In the 1970s countries in Latin America entered an era of distinctly inferior macroeconomic performance.Copyright © 2003 Pearson Education, Inc. Slide 22-44
  • 45. Summary  Despite their excellent records of high output growth and low inflation, key developing countries in East Asia were hit by currency depreciation in 1997.  Proposals to reform the international architecture can be grouped as preventive measures or as ex-post measures. • The architecture that will ultimately emerge is not at all clear.Copyright © 2003 Pearson Education, Inc. Slide 22-45

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