lIE Imports of Developing Countries An Empirical Model of Intertemporal Allocation and Financial Constraints L. Alan Winters WORLD BANK STAFF WORKING PAPERS Number 740 WORLD BANK STAFF WORKING PAPERS Number 740 Imports of Developing Countries An Empirical Model of Intertemporal Allocation and Financial Constraints L. Alan Winters The World Bank Washington, D.C., U.S.A. Copyright (C 1985 The International Bank for Reconstruction and Development/THE WORLD BANK 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. All rights reserved Manufactured in the United States of America First printing July 1985 This is a working document published informally by the World Bank. To present the results of research with the least possible delay, the typescript has not been prepared in accordance with the procedures appropriate to formal printed texts, and the World Bank accepts no responsibility for errors. The publication is supplied at a token charge to defray part of the cost of manufacture and distribution. The World Bank does not accept responsibility for the views expressed herein, which are those of the authors and should not be attributed to the World Bank or to its affiliated organizations. The findings, interpretations, and conclusions are the results of research supported by the Bank; they do not necessarily represent official policy of the Bank. The designations employed, the presentation of material, and any maps used in this document are solely for the convenience of the reader and do not imply the expression of any opinion whatsoever on the part of the World Bank or its affiliates concerning the legal status of any country, territory, city, area, or of its authorities, or concerning the delimitation of its boundaries, or national affiliation. The most recent World Bank publications are described in the annual spring and fall lists; the continuing research program is described in the annual Abstracts of Current Studies. The latest edition of each is available free of charge from the Publications Sales Unit, Department T, The World Bank, 1818 H Street, N.W., Washington, D.C. 20433, U.S.A., or from the European Office of the Bank, 66 avenue d'lena, 75116 Paris, France. L. Alan Winters is an economist with the International Economic Research Division of the World Bank's Development Research Department. Library of Congress Cataloging in Publication Data Winters, L. Alan. Imports of developing countries. (World Bank staff working papers ; no. 740) Bibliography: p. 1. Developing countries--Commerce--Econometric models. I. Title. II. Series. HF4055.W56 1985 382'.5'091724 85-12131 ISBN 0-8213-0565-4 Abstract This paper specifies and estimates for three developing countries two intertemporal models of total imports. Imports are related alternatively to foreign exchange receipts and to GNP, with explicit account taken of expectations about the future values of these variables, future import prices and interest rates. Using non-nested hypothesis tests, the models are compared between themselves and with two other models of imports in the literature. While the results are not entirely satisfactory, they suggest that the intertemporal approach is quite promising. As this attempt is the first to estimate an intertemporal model of international trade, considerable space is devoted to the operational specification of the theoretical models. In preparing this paper I benefitted considerably from comments on an earlier draft by participants at the International Economics Seminar at the Johns Hopkins School for Advanced International Studies, and by Professors Jonathan Eaton, James Riedel and Robert Stern. Kathi Yu also helped in its preparation, both through discussions and first- rate research assistance. Karen Adams, Jean Epps and Vicky Sugui shared the unreasonable burden of typing several drafts, and Whitney Watriss edited the final text. I am most grateful to all these people. Naturally, none of them is to be implicated in the paper's remaining shortcomings. TABLE OF CONTENTS Page No. Is Introduction .................................................. I II. Models in the Literature .. . .. . 5 Imports and Reserves ................... ......................... . 5 Intertemporal Allocation .... ... ..... ........... ................. 8 III. Some Empirical Aspects of the Problem .................... 14 Plans and Mistakes ........ .............. .o............ 14 The Market for Loans ....... . .......... ........ 16 Utility Functions ...... .. ............... . 18 The Role of Internal Factors .......... ... ... 20 Investment ........................................ o........... 21 IV. A Foreign Model of Imports ............................... 22 The Foreign Wealth Model ....... .................... .. . 22 The Rate of Time Preference . ............................. 26 Measuring Wealth ........ .................. .......... .. . 29 Expectation Tests of the.Foreign.Wealth.Mode............ 38 Interest Rates ..**............................................. 41 Dynamics ......... .......................... 50... 41 V. The Domestic Model ....................................... 44 Sachs' Model ................................................. 44 Dornbusch's Model ....o....... .......,.......... .......... ......47 VI. Specific ation Tests of the Foreign Wealth Model .......... 49 The Sample .................................................. 50 The EsDo m ticon M e....... .. ......... s... .,........... ......... 51 The Tests ional.Mo......... . ..o. ........... .. ....... 53 VII. Preferred Equations for the Foreign Wealth Model ............................... 62 Malaysia ...... .o........................................... 63 Colombia ..*....... .o.........,..... ............... .......... 67 Kenya ..... o......... .......... o........................... 69 Conclusions ........o ...#........... ............................ 71 VIII. Other Models ................ ....... ..*...................... 73 The Domestic Models ...#........................................... 73 The Traditional Model .........................so................... 77 TABLE OF CONTENTS (continued) Page No. The Hemphill Model ..... ....... ................... 77 Structural Stability ............... . 80 IX. Comparing the Models .......... ...................... 83 X. Conclusions ....................................... 93 Appendix: Data and Definitions ........ ........ ...... .. 95 General Definitions ...................... . .......... 95 Malaysia ...... . .. ............. .... ... 96 Colombia. .o ................................... 98 Kenya . . . . .* . ................................ 99 LIST OF TABLES AND FIGURES Page No. Table 6.1 Wealth Definition Tests (r = 10 percent) .. ............ 56 Table 6.2 Restriction Tests (r = 10 percent) ............. ........ 57 Table 6.3 The Effects of Different Interest Rates .......... .....58 Table 7.1 Preferred Equations for Malaysia .......... .... 65 Table 7.2 Preferred Equations for Colombia ...................... 68 Table 7.3 Preferred Equations for Kenya ......................... 70 Table 8.1 Structural Stability Tests ............................ 82 Table 9.1 Non-Nested Tests and Fits-- Malaysia ................. 86 Table 9.2 Non-Nested Tests and Fits - Colombia ............... 88 Table 9.3 Non-Nested Tests and Fits --Kenya .. 90 Figure A.1 Malaysian Oil Exports, Actual and Expected .. . 97 I. INTRODUCTION The recession of the early 1980s hit developing countries in two ways. First, the markets for their exports were depressed and were frequently restricted by protectionism. Second, real rates of interest rose to unprecedentedly high levels. The latter perhaps constitutes the unique aspect of the recent experience and should in particular be contrasted with the experience of the mid-seventies, when interest rates were low and borrowing plentiful. Then, despite depressed export revenues, developing countries were able to maintain fairly high rates of domestic growth by extensive foreign borrowing. This borrowing allowed them to maintain their demand for imported goods from the OECD and contributed to the recovery of world economic activity in 1977-78. It also, however, sowed the seeds of the present difficulties, for many developing countries became heavily indebted. Hence, when the real interest rate rose in 1980, they found their capacity to service their loans severely stretched. This situation was reflected in a reduced demand for imports, which lowered the growth of industrial countries' export growth and prolonged their depression. The mutual reinforcement of depressed markets and declining lending turned the early 1980s into one of the most extended depressions of recent history. These same conditions continue to raise questions about the extent and durability of the current recovery. While it is certain that the amount of debt, rising interest rates and falling export revenues have curtailed developing countries' -2- imports, there has been little formal econometric work devoted to quantifying the effects or even to specifying the precise mechanism. This paper explores certain aspects of how the situation can be modelled and presents a very simple and highly specialized estimation model. The starting point is that developing countries' decisions to borrow and to import are made jointly: one decision does not completely dominate the other. Thus our model assumes neither that imports are determined as the sum of exogenously given exports and net borrowing, nor that borrowing is determined by the difference between exogenously given exports and imports. The basic framework comprises a balance of payments identity and a behavioral sector that explains borrowing and importing. The former is: X + M + N + F =O (1.1) where X = The value of exports of goods and non-factor services M = The value of imports of goods and services N = Net factor payments and F = Net borrowing, including changes in foreign exchange reserves. The behavioral component is: M = M (X,N,Z) (1.2a) F = F (X,N,Z) (1.2b) where Z = A vector of exogenous variables. -3-. Given exports and factor payments, the balance of payments constraint ensures that only one of (1.2a) and (1.2b) is independent. Thus, it is necessary to estimate only one. However, the variables relating to "borrowing," such as the interest rate, will still enter the import equation, and vice-versa. The reason is that since X + N, then am - aF. As our interest here is in imports, we focus on (1.2a). (This approach assumes that the errors and omissions in the balance of payments account are not important. If they were, it might be desirable to estimate both [1.2a] and [1.2b], essentially dropping [1.11 from the system.) Because our purpose is mainly exploratory, we concentrate below on the relationship between imports and the borrowing variables. Our aim is to produce a simple equation that links import behavior to the borrowing variables in a theoretically clear manner. Simplicity is important, because ultimately our intention is to estimate the model for many developing countries, with a view to making global projections. The paper starts with a survey of existing models of import behavior and borrowing (Section II). This review is followed in Section III by a discussion of the various lessons that may be drawn from previous efforts. Next we specify our own models in some detail. We explore two basic versions -- one that is based solely on foreign exchange considerations (Section IV), the other taking into account domestic factors as well (Section V) -- and we distinguish between pure equilibrium models and models embodying some degree of disequilibrium. To our knowledge, this effort is the first empirical implementation of models of the kind we are using. Thus we devote considerable space to the concept and to the measurement of the variables. -4- In the subsequent four sections, the models are estimated for three developing countries chosen at random. Section VI is devoted to a general test of the specification of the wealth model based on foreign exchange earnings. It treats the three countries merely as three examples of the same process and considers, first, whether certain necessary implications of the model are empirically valid and, second, which of several approaches to measuring wealth seems best. In general, the implications are satisfied, so that in the next section, VII, the basic model is estimated and simplified for each country separately. The results suggest a fairly high degree of intertemporal substitution for imports. Section VIII is devoted to estimating three other models - the wealth model based on domestic flows, and two simple models from the literature against which to test the new models. The results of this effort are mixed -- the new model shows some capacity to explain imports, but is matched or surpassed by one of the strawmen. In the final section, X, conclusions are drawn about directions for future research. The heart of the paper is Section IV, in which we describe our models, and Sections VI to IX, where we test them. Readers familiar with (or uninterested in) previous attempts to model imports and financial conditions could start with these sections, referring back only where they require the justification for certain procedures. -5- II. MODELS IN THE LITERATURE Two broad approaches to the question of developing countries' imports and financial variables may be identified. The first looks at the allocation of a given amount of foreign exchange between imports and increments to reserves: reserves are assumed to be desirable for some intertemporal reason, although this assumption does not figure prominently in the specification. The second approach is more explicitly intertemporal: it treats the current account of the balance of payments as an investment flow, arguing that it is primarily determined by the desire to reschedule absorption relative to income. This section briefly considers the research on these two approaches. Imports and Reserves The clearest exposition of the relationship between imports and foreign exchange reserves in developing countries is Hemphill (1974). Hemphill supposes that a country has an exogenously given flow of foreign exchange earnings in each year, Ft, and that this flow must be allocated between expenditures on imports, Mt, and additions to reserves ARt. He assumes that long-run imports, M*, must equal long-run receipts, F*, and that there is a long-run desired stock of reserves, R*, that is also related to receipts. The allocation of foreign exchange is then made to minimize the costs (assumed to be quadratic) of the deviations of actual reserves and imports from their desired (or long-run) levels. The basic estimating equation is: M = aO + aRt- + a2Ft +3 AFt (2.1) -6- where AF occurs as part of the assumed function for F*. In fact, since data on Hemphill's definition of reserves are not available, Rt _ 1 has to be replaced by a cumulative term in AR, but this changes nothing fundamental. Hemphill's research is meticulous, and he makes many important detailed methodological observations. While we do not repeat all of them here, certain basic points should be made. First, Hemphill experiments with several different definitions of reserves, shifting items in the balance of payment accounts from the exogenous component, F, to the endogenous one, AR. Thus this approach can be adopted to deal with borrowing and debt. Furthermore, Hemphill shows that, provided the costs of disequilibrium are quadratic in the differences between actual and desired magnitudes, countries can have targets for different components of R without changing the form of the equation (2.1). This claim amounts to an assumption of separability between imports and the structure of their (net) finance (F - R). In other words, the propensity to spend cash on imports does not depend on whether that cash is owned (reserves) or borrowed. Second, Hemphill's model assumes constant parameters for the cost function. That is, the costs of excessive reserves or excessive borrowing are assumed to be constant over the sample period. This assumption may have been a good approximation for his pre-1970 sample, but it certainly requires reconsideration in later years. A third important feature of Hemphill's approach is that only financial variables explain imports. The traditional variables such as income and relative prices are excluded, as are any policy variables. The logic behind this approach is simple and compelling. Ultimately, -7- with inflows of F*, outflows, M*, must be at the same level. Some rescheduling is possible via AR, but the long-run budget constraint must eventually be binding: regardless of income and prices, and regardless of whether imports are limited to F* by market means or by rationing, ultimately M* = F*. Thus Hemphill conceives the developing country economy as a single decision unit, with no restraints on its ability to minimize the costs of disequilibrium. To this concept he adds his assumption of the constant costs of disequilibrium. The result is that imports depend only on financial variables. Later research on imports and reserves has relaxed this aspect of Hemphill's work. Sundararajan (1983) supposes that desired imports are determined by a traditional import function, including relative prices, (PM/p), income, Y, real balances, EM, and policy variables, and that permitted imports balance these against the need to maintain reserves. He does not, however, impose the long-run budget constraint. His basic equation is Mt =a + (P )t a2 Yt + a3 EMt + a4Ft + a5 R _, (2.2) which is broadly Hemphill's plus some extra terms. While Sundararajan does not rationalize it in this way, this approach is similar to allowing the costs of imports deviating from desired imports to vary in Hemphill's model. In the latter, if the costs of constraining imports go up with income and rising domestic prices, an equation similar to Sundararajan's would emerge. Chu, Hwa and Krishnamurty (1983) adopt a similiar approach to Sundarajan's. -8- Intertemporal Allocation As noted already, the intertemporal nature of Hemphill's model is implicit but not prominent. This condition is rectified - but not without cost -- in the second approach to the determination of imports -- namely, the intertemporal allocation models. These models sprang to prominence with Sachs (1981), who argued that the current account deficits of the seventies owed more to changes in the incentives for investment and savings than to the direct effects of paying more for oil. Sachs used a simple two-period model to show how the responses to economic shocks would vary according to perceptions of the future. In particular, he showed that whereas an oil-importing country might meet a temporary rise in the price of oil by borrowing (running a current account deficit), there was little presumption it would do so for price rises thought to be permanent. In the first instance, the country would feel that its wealth, and hence its sustainable level of consumption, was little changed by the temporary shock. Thus it would tend to maintain consumption levels over the temporary setback by borrowing, relying on a lower price in the future to allow repayment of the debt. In the case of a permanent oil price rise, however, wealth and permanent consumption would fall pari passu with net income. With no relaxation in sight, the incentive would be to cut spending back to equal income as soon as possible. Thus, in this case, the current account would be negative only during the adjustment period. The essence of the intertemporal model of imports lies in this simple model. Consumption depends on wealth -- which includes the present value of all future income -- and on the rate of transformation of present into future consumption. The latter involves both the rate -9- of interest and expectations about future prices; the comparison of these with the (unknown) rate of time preference determines whether consumption is to be shifted forward or backward in time relative to income. Sachs (1982) develops this model further. He defines the "perpetuity" value of any variable, Xp, as that perpetuity that has the same present value as the actual stream of the variable, X. Thus, XP tf e-r* (y - t)dy =tf e-r* (y - t)X d (2.3) where r = The rate of interest and X(y) = The value of X in period y. Then, writing the trade balance, TB, as output, Q, less private and government consumption, C and G, Sachs has: TB = Q - C - G and P P P P TB = Q - C - G. (2.4) (Including investment would, in Sachs' words, "enormously complicate the algebra.") The intertemporal budget constraint means that the present value of all future trade deficits must equal current net foreign assets, B. That is, future trade can only be permanently unbalanced to the extent that we now have the assets to finance it. Hence TBP = -r*B. Furthermore, since the present current account, CA, equals (TB + r*B), we have, from equation (2.4), -10- CA = TB - TBP = (Q - Q ) - (C - Cp) - (G - GP). (2.5) Thus the current account is merely the sum of the differences between the actual and perpetual values of output and consumption. Equation (2.5) may be made operational in a number of ways. Sachs does not discuss government spending, G , further, but perpetual (permanent) private consumption, CP, is, as above, a function of wealth. It is the integral of future private income plus current assets. Thus in period 0, CD W(O) = B(O) + f e r Y[Q(y) - G(y)Idy (2.6) 0 = B(O) + [Q p(0) - GP(0)I/r* . (2.7) However, from the intertemporal budget constraint, CP(O) = r*B(O) + Q p(0) - GP(O) = r*W(O) , (2.8) which merely states that perpetual consumption can just be financed from the returns to wealth. Note that wealth includes all financial and human wealth (and, if it were recognized, physical wealth). Current consumption, C, differs from perpetual consumption according to the incentives to switch consumption between periods. Adopting a particularly simple intertemporal utility function, Sachs expresses c - =(d - r*)W, (2.9) where 6 is the rate of time preference. Sach's model contains two goods, both traded. The imported good has a fixed price in terms of world currency (the numeraire), while the other, which is exported, faces a downward sloping demand curve. Its price is thus endogenous and must be substituted out of equation (2.5) by relating export demand to world trade, T, and overall supply to the labor force, L, and productivity, R. Thus, the final equation contains no explicit relative price terms. Hence, in period 0, the current account may be written as CA = (r* - 6)W + a1(G - G ) + a2(T - T9) + a3(R - Re), (2.10) where all variables are measured for period 0. Imports are clearly derivable from this equation, once we have decided how to calculate the perpetual values. We shall return to this point below. In a model similar to Sachs', Dornbusch (1983) considers the case of traded and non-traded goods. Strictly, he considers four different prices: current and future import prices and current and future domestic prices. Imports are stimulated if their current price falls relative to either current domestic prices or any future prices. Dornbusch deals with discrete time rather than continuous time, and derives conditions for the change in planned consumption between two periods. Given stationary output, -12- d log C = a [r* - 6 + a 2dlogPI, (2.11) where a1 depends on the degree of intertemporal substitution and a2 on the degree of contemporaneous substitution between domestic and foreign goods, and where P is the price of imports in terms of home goods. Dornbusch does not explicitly recognize future import prices in money terms because he uses traded goods rather than money as his numeraire. Thus assets represent claims on future traded goods rather than claims on money. This approach is easily adapted to Sach's nominal framework, however, by treating r* as the real rate of interest in terms of imports. Both Sachs and Dornbusch assume that a country can borrow or lend unlimited amounts at an exogenously given rate of interest that is expected to remain constant forevermore. They further assume a constant rate of time preference. This condition potentially leads to some difficulty with the intertemporal budget constraint, for it appears to allow the possibility of indefinite accumulation or decumulation of assets if r* # 6. Two alternatives are available: first, that imperfect capital markets impose rising interest rates as borrowing increases, and, second, that the rate of time preference is an increasing function of instantaneous utility. This latter option serves to bring consumption forward in time as wealth accumulates, thus stabilizing the system. Both these approaches are adopted by Obstfeld (1982), but since neither utility nor the time preference is observable, the latter case does not look like a promising avenue for empirical research. The former, however, is potentially more promising and could -13- be either tacked onto our present model or used to close a model based on optimal growth paths and borrowing. (Both these alternatives are held to a later occasion.) The models surveyed in this subsection are theoretically more appealing than the import/reserve models treated previously. However, making the intertemporal nature of the import decision explicit vastly complicates the model's empirical application. Sachs (1981) produced some simple statistics to support his basic hypothesis, but these did not constitute a proper test, and later research has, to our knowledge, yielded no empirical work at all. The reason is the difficulties involved in operationally capturing expectations and thus, in particular, in measuring wealth. These problems will be quite evident when we move to our own estimation. -14- III. SOME EMPIRICAL ASPECTS OF THE PROBLEM The literature offers a choice between a theoretically ad hoc but easily applicable model and a theoretically complete but almost totally inapplicable model. The intention of this paper is to bridge that gap by producing an estimable yet theoretically sound alternative. We do so primarily by trying to operationalize the intertemporal models of Sachs and Dornbusch. However, in the course of developing our alternative, we found that many restrictive assumptions were necessary to render the system tractable. These are specified clearly below. Some consideration should be given to their acceptability, even independently of how well the equations happen to fit. This section contains various observations about the models surveyed in the previous section, in terms of both their theoretical and empirical (data-based) specifications. It also discusses how the various features should influence the specification of our own models. The issues covered include the way in which shocks (mistaken plans) affect importing, the special assumptions adopted for the capital markets, the specification of the utility function, the significance of domestic factors in the import decision, and the incorporation of investment into the system. Plans and Mistakes The intertemporal models solve simultaneously for the whole time profile of consumption, given the information and expectations -15- available at a particular time (say, year 0). However, ignoring forward purchases, only year O's expenditures are actually made at the time of calculation; the plans for later years remain only plans. Indeed, by year 1, it is likely that new information and expectations will have become available and that the plan will need revising. We could model the revisions explicitly, but it is easier just to view the plan devised in year 1 as an entirely new project that determines actual expenditures in year 1, and so on with new plans for years 2, 3.... Thus our empirical estimates concern the first year's expenditures in each of a series of plans, rather than a series of more than one year's expenditures from only one plan. In this string of first years, if year 1 turns out exactly as anticipated in year 0, expenditures in year 1 will be the same under both plan 0 and plan 1. Furthermore, there will be no regrets in year 1 about what was done in year 0. If, on the other hand, year 1 contains some surprises, year l's expenditures will be revised from those intended for it in plan 0, and there will most likely be regrets about what was actually done in year 0. That is to say, agents will feel that had they known in year 0 what they know now in year 1, they would have behaved differently in year 0. Thus, in retrospect, mistakes are possible, and they make themselves felt through their effect on the wealth carried forward from one year to the next. If, for example, the actual interest rate on variable rate loans in year 1 were higher than had been expected for that year in year 0, developing country policy-makers may well regret that they imported and borrowed so much in year 0. They will revise consumption (import) -16- plans for year 1 downwards relative to those in plan 0, first because current consumption is rendered more costly relative to future consumption by the rise in the interest rate, and second because the debt overhang now has to be serviced at a higher rate than expected, a situation that reduces real wealth. The Market for Loans The models discussed earlier assume that developing countries can borrow or lend unlimited amounts at exogenously given rates of interest. Three dimensions of this assumption deserve comment. First, if the rates of interest for borrowing and lending were still exogenous but were different, the budget-set of feasible consumption points would be kinked. Thus, whereas a unit reduction in present consumption would allow an increase of (1 + rL) units next year, a unit increase this year would cost (1 + rB) units next year, where (rB > rL.) This situation would considerably complicate both the analytics and the empirics, giving rise to discontinuities in importing and borrowing behavior, without adding much insight to the model. Ignoring it may, of course, substantially bias the model, but we do not expect it to do so. A further and sounder reason for ignoring the problem is that in fact most developing countries do little lending. Thus, provided that developing countries would still not lend much, even if the borrowing and lending rates were equal, the borrowing rate is the relevant one for our purposes. The second dimension of the borrowing/lending question is the exogeneity of the interest rate. We might expect that as a country's -17- indebtedness rose, so too would its risk premium and hence its borrowing rate of interest. The evidence for this pattern is, in fact, rather weak (see Riedel, 1983, and MacDonald, 1983). It could be incorporated into our model by introducing an additional (simultaneous) equation for the supply of credit. However, we will ignore this complication for now. The third aspect of the borrowing/lending nexus also concerns the supply curve of credit. Bankers tend to argue that they ration credit quantitatively rather than through price (interest rates). Hence developing countries may face a constant rate of interest up to some level of borrowing, and thereafter a complete stop in borrowing. However, the evidence that these constraints are frequently or widely binding is also relatively weak (see Riedel, 1983). Nevertheless, we can hardly argue that credit limits were never applied in 1983, and so this problem must be addressed seriously. Theoretically we could construct a regime-switching model, with separate equations for the periods of constrained and unconstrained borrowing. A priori, however, we do not expect to have sufficient observations on the former to identify it correctly, and there is, besides, little guidance on how lending constraints are determined. Further, if the constraint is only on current borrowing, and if we treat running down the reserves as net borrowing, then the import function under the constraint becomes particularly simple and uninteresting in its own right: 1/ 1/ The intertemporal allocation becomes more complex if the constraint, or expected constraints, affect future years. -18- M = X +F, where F = The constrained level of borrowing. Hence, at least in this first attempt, we estimate only the "unconstrained" import function, although we are prepared to omit observations where strong evidence of borrowing constraints exists. This approach is of interest, first, to see if constraints are actually necessary in explaining recent import behavior and, second, even if they are, to define what imports would rise to if the constraints were relaxed. After examining our results, it is clear that there is plenty of scope for plenty of future research in this area. Utility Functions Both Sachs and Dornbusch assume utility maximization over an infinite time horizon. The general utility function is of the form Go V I (1 + d)1iU(Ci) , (3.1) i = O where V = Total utility U = "Instantaneous" utility and Ci = Consumption in year i. Note that the function U() does not change over time and that V is additively separable in U(Ci). The latter severely limits the pattern of intertemporal substitution and means that the composition of any year's consumption bundle is independent of any other's, once the overall levels of consumption have been determined. The degree of intertemporal substitution is determined by the curvature of Uo. -19- Basically, the more sensitive utility is to declines in consumption, the greater will be the substitution that will occur between years in order to smooth away the potential costs. To be specific, Sachs assumes V f e 6t log (C ) dt (3.2) 0 t and Dornbusch Go V = i (1 + 6) l C0 ' (3.3) where, in both cases, Ct is a Cobb-Douglas function of the consumption of the various goods consumed in t, for example, C = C a C (1 -a) (34) t Tt Nt where CT = The consumption of traded goods and CN = The consumption of non-traded goods. The separability of V allows consumption to be determined in two steps - first total consumption, Ct, as a function of wealth and annual price indices and, second, disaggregated consumption, CTt, and CNt as functions of Ct and contemporary prices. The separability assumption is probably too strong for reality. For example, it does not permit the option of consuming, say, a world tour this year rather than next, because next year's composition of consumption is independent of this year's. Nevertheless, its practical attractions are such that we shall adopt it. The simple form -20- of Ct is useful in rendering the price index for total consumption a simple function of PTt and PNt, as well as in easing various algebraic manipulations. This paper is not concerned with disaggregated consumption, so the issue is postponed, although there are good reasons for believing that equation (3.4) is far too restrictive (Winters, 1984). The Role of Internal Factors An important difference between Hemphill's and every other study is that Hemphill derives imports solely from "foreign" variables, that is, variables relating directly to foreign transactions. This approach arises from his view that, ultimately, the only determinant of what can be spent on imports is the foreign exchange generated by exports. Thus, for example, whether imports are relatively cheap or are urgently needed for domestic growth, or are strongly desired because wealth has increased, are not, in his scheme, fundamentally important. It is as if the whole economy were a black box: the input of foreign exchange from exports and the output for imports must be balanced in the long run, and what goes on inside the box is really not very significant. We could perhaps envision a utility function separable between domestic output and imports; given a budget constraint for imports, domestic variables do not affect the import stream. However, this view is clearly very extreme, for even within an entirely foreign-determined long-run budget, we might expect domestic factors to influence the timing of imports. Nonetheless, it is sufficiently attractive empirically to make it worth exploring. Its empirical attraction is the -21- smallness of its parameter set and data requirements. In particular, it might be easier to measure foreign wealth, namely, foreign assets plus the present value of future foreign exchange earnings, than total wealth, namely, total assets plus the present value of future income. Investment As Sachs states, investment greatly complicates the analysis of an intertemporal model, for it both represents a demand and feeds back into wealth. The simplest procedure practically is to assume that consumption and investment can be aggregated into a single composite good (absorption) by virtue of having a constant relative price. This procedure in turn assumes that the marginal productivity of investment (in terms of present value) and the rate of time preference bear a constant relationship to each other. Further, if the aggregate is to be the sum of consumption and investment (namely, absorption), the constant relationship must be equality. Thus, a unit of consumption in year 0 is worth (1 + 6) in year 1 because people are impatient; a unit of investment in year 0 is worth (1 + 6) of consumption in year 1 because it actually produces a stream of output that would buy (1 + 6) in year 1. This condition is the Keynes-Ramsey rule for optimal growth paths, and it implies that consumption and investment are in perfect equilibrium. We adopt this subterfuge in constructing our basic models, but relax it crudely when we examine the disequilibrium forms (pages 27- 28). -22- IV. A FOREIGN MODEL OF IMPORTS Having discussed various practical and empirical points in the previous section, we are now in a position to outline our own models. These are exploratory and are therefore fairly general, and particular emphasis is laid on exploring issues of specification. Unfortunately, many of the models we discuss are not nested, and since they are often rather similar and we have so very few observations, we do not conduct many formal non-nested tests. A certain "ad hocery" will therefore be evident. The Foreign Wealth Model We start with the simpler of the two models -- the foreign wealth one. It follows Hemphill's rationale and concentrates entirely on foreign variables. We assume a country in which the optimal time pattern of imports is independent of any domestic variable, which faces given import prices, and which has exogenous export receipts (strictly current account credits). In the long run, all imports must be paid for in foreign exchange derived from current credits. Thus, given initial assets, these credits define the budget constraint. The country is assumed to face a common exogenous rate of interest for borrowing and lending and to be able to borrow or lend unlimited funds at that rate. Borrowing and assets are seen merely as the means of transferring import consumption over time. Assuming that the import sub-utility is quite separable from domestic factors and that the allocation of imports over types of goods permits two-stage budgetting, we can write: -23- co~~~. V = [ E HiMi ' (4.1) i = O where V = Total "import utility" 6 = The rate of time preference relating consumption in period i to that in period 0, Mi = Aggregate imports in period i in quantity terms and y = A parameter determining the degree of intertemporal substitution. The budget constraint that all imports must eventually be paid for is co 00 Pip, Mi = A0 + X pipi xi (4.2) where p = The export prices for year i, i '-M p = The import prices for year i i Xi = Exports for year i and Pi= The discount factor between years i and 0. Thus Pi = (1 + ro)1 (1 + r 1) .... (1 + ri - 1)1 , (4.3) and pO = 1 where rj = The interest rate for year J. In year 0, all variables with (i > 0) are unknown; they are necessarily the subject of expectations, to be discussed shortly. -24- If we define present value prices (for year 0) as Pi pi (44) then equation (3.2) becomes, M X i p OI HPi Xi =W (4.5) i 0 i0 ~0 which, combined with equation (4.1), yields a perfectly ordinary allocation model: given wealth, W, choose Mi to maximize V subject to budget set (4.5). Equation (4.1) is a CES function, with an elasticity of substitution (a = 1 l ). We can apply standard results by analogy with other applications of the CES function (Armington, 1969; Hickman and Lau, 1973). Thence: a ri-aPi - Mi =6i V (i) a= Vt(t -)/P*] , (4.6) where Pi = PM with the superscript omitted and P* = A present value price index for all future consumption of imports, where P* = I I a E (1-a]1-a (4.7) 1 =0 Obviously, for practical purposes the unobservable V must be eliminated by multiplying equation (4.6) by Pi and P*/P*, summing, and then substituting equation (4.7) for P*: -25- co co Pi. _ p1Mi i I O 0 (VP*) ). (4.8) i 0 i i =0 Thus, VP* Pi M = w (4.9) The import plan derived from equation (4.1), given expectations about future variables, then becomes: P Mi = 6 W(. (4.10) This equation implies that if present value prices are equal in each year, imports will vary over time according to 6di. Since 6 < 6 1- i.e., more distant imports are valued less -- they will fall over time. From equations (4.6) and (4.7) it may also be shown that if the time-discounted present value prices (pi/6 d) were equal, the level of imports would be constant. Recalling that we are interested only in the first year's imports (i = 0) from a series of plans formulated in years t = 1, 2...T, equation (4.10) generates the estimating equation aPt 1 -a ptMt =6 g(P*) w, (4.11) t t where the subscript t denotes variables measured in period t and where =1. -26- The Rate of Time Preference There are three problems (at least) in implementing equation (4.11). First is its non-linearity. All applications of the CES function face the problem that P*, the aggregate price index, depends on the unknown parameter a. This problem is easily solved, however, by non-linear estimation methods or linear approximations (Hickman and Lau, 1973). Our problem is, however, much greater: it is that the 6i are unknown. Let the rate of time discount -- assumed to be constant both across plans and between plans - be d. The discount factor relating -i year i's consumption to year 0's, 6i' is (1 + d) , or, in obvious notation, Si. Thus, all our unknowns about time discounting can be collapsed into a single parameter 6, which appears in equation (4.7), the formula for P*. Jumping ahead, we find it convenient to characterize the present value price series as having a constant growth rate over each plan (but not between plans). Thus, for the plan formulated at t, we assume that prices in the years ahead are expected to be: i Pi(t) = n Pt, (4.12) where nt is the rate of growth of present value prices assumed in plan t which, along with Pt, is assumed to be known exogenously. Thus, from equation (4.7), P t Pt p a (1 _dn1 a- (4.13) Pt 16fl ) -27- whence equation (4.11) becomes ptM = (1 I t1 a) W. (4. 14) Equation (4.14) can be estimated in a number of different forms. -For example, it can be transformed into a linear equation as follows: Pt t from which p M log (1 W t a log 6 - (1 - a) log . (4.15) wt l Whether this approach is desirable, however, depends on the nature of the error process underlying the data. The errors of the regression equation should be normally distributed, homoskedastic and mutually uncorrelated. If those of equation (4.14) were, then those of equation (4.15) certainly would not be, and vice-versa. In fact, such transformations appear to make very little difference at estimation time. In a consumption framework, the constancy of the rate of time discount has some plausibility. However, in an investment context, the rate of discount will be related to the (expected) marginal productivity of investment, which may vary over time. As an alternative to the basic model, therefore, we consider a so-called "disequilibrium" model, in which the rate of time discount varies with investment opportunities. 1/ 1/ "Disequilibrium" is perhaps not such a good nomenclature as "non- steady-state," but we prefer it on the grounds of stylistic elegance. -28- When the capital stock is below that required by the Keynes- Ramsey optimal growth path, the marginal return on investment and the growth rate of GDP will be relatively high, and there will be an incentive to reschedule national absorption from the future back to the present. (Consumption may be lower under these circumstances, but total absorption, of which imports form a part, will be higher.) This condition is reflected in our model by a fall in 6 -- future output is given relatively lower weight. We explore this possibility by setting log 6 = dt = p + Igt (4.16) where gt can be the growth rate of GDP, the ratio of investment to GDP or the ratio of investment to wealth. In each case we would expect I1 < 0. There is, however, a great danger of simultaneity bias in substituting equation (4.16) into (4.14) and (4.15). Investment by developing countries is often thought to depend on imports, in that if the foreign exchange does not exist to generate a flow of imported capital goods, then investment will not take place. By way of illustration, in Malaysia in 1980, imports of machinery and transport equipment were around M$9 billion (about 30 percent of imports) and total fixed capital formation was around M$15 billion. These figures counsel great caution in the use and interpretation of the disequilibrium results. The derivation of equation (4.13) assumes that 6°i 1 < < 1. t If this assumption were violated, it would benefit the country to import infinite amounts now and pay off the debt later with depreciated cash. -29- Thus, in these circumstances, the country will be constrained in its borrowing by the lenders and will fall ou,side the purview of our model. This situation suggests that any observation for which 6 a a > 1 should be omitted from our sample. Unfortunately, however, this approach is not necessarily straightforward. Assuming 6 < 1 and, if, as seems reasonable, 0 4 a < 1, a sufficient condition for the inequality is that nt < 1, which in turn amounts to assuming that the real rate of interest (in import terms) is positive, that is, that import prices increase less rapidly than the rate of interest. If, however, nt > 1, the inequality depends on the unknowns 6 and a, and so cannot be tested prior to estimation. However, to estimate 6 and a correctly, we need to know which observations to include! Short of a switching-regime model, there is no simple solution to this dilemma, and it has to be treated ad hoc. Measuring Wealth The second problem area concerns the measurement of wealth. Conceptually it is very simple to do: wealth constitutes owned assets plus the present value of the stream of foreign exchange receipts, less scheduled repayments on accumulated debts. Owned assets should contain a wide range of instruments, but in practice data are available only for international reserves and the net assets of the banking system. For many developing countries, however, these data probably provide a reasonable approximation of foreign- denominated wealth. We shall assume that domestic assets are not convertible into foreign exchange, that is, that borrowing is possible -30- against future export earnings but not against domestic assets, a fairly strong assumption. The present value of export earnings provides no conceptual problems, once expectations have been determined, but there is one practical difficulty. If we assume an infinite planning horizon, as above, the present value becomes infinite if the (expected) rate of growth of earnings exceeds the (expected) rate of interest. If the former is denoted by vx and the latter by r (both assumed to be constant), the present value Wx is: co icXo + vx Wx = (1 + r)i Xi= i I1 + r} (4.17) which is clearly finite only if the bracketed term is less than one. It is not inconceivable that a country should believe itself infinitely rich, but it is inconceivable that other countries would lend it the infinite amounts it would immediately wish to borrow. Thus, whenever vx > rt, the borrower will be supply-constrained in the loans market, which would put it beyond our model, a situation that suggests we should drop those observations from our sample. Two alternatives to dropping the observations exist. First, we could respecify the model in terms of an (arbitrary) finite time horizon. This procedure, while it would complicate certain formulae, would not change anything fundamental. In these circumstances, Wx would merely become very large. Second, we could argue that countries experiencing v X > rt would recognize it as a temporary phenomenon and would re-adjust their expectations to reverse the inequality. (It is moot whether world income is actually bounded above.) In this case we -31- would merely impose some arbitrary lower limit on (rt - vtX), say, 0.01, and use this to calculate present value. A similar approach would be justified if we explicitly recognized uncertainty, for a risk-averse country would presumably discount future export growth, which would also reduce the long-run average v x below rt. An additional factor that must be considered is capital grants, which are straight additions to wealth. We assume that recipients expect to receive the same nominal grants in the future as in the current year. More complex is concessionary borrowing. While current market borrowing makes no addition to net wealth, borrowing on softer terms clearly does so. We assume that such borrowing is rationed by the donors. If a loan of C is made at concessionary interest rate ri, rather than at market rate ri, the increment to wealth, or the grant element of the loan, GE, is: n GE i Pi ( i d) (4.18) where Pi = The discount factor for year i at market rates, Ri = The necessary repayment stream if ri had ruled (C = X piRi) Ri = The repayment stream at rate ri (using discount factors Pi, C = E piRi, and assuming constant repayments starting immediately are required). If the loan is for perpetuity and the rates of interest are constant, the grant element is easily calculated as: -32- eO co GE = op1 (Ri- ii) =i _ p (rC - rC) i ~~~~~~~O = C (r - r) (+r) (4.19) Obviously, calculating the grant elements requires detailed information on the nature of the loan, in particular, on the repayment stream. This information is not easily available to us, but the External Debt Division of the World Bank has the data and has calculated the grant elements, assuming that r = 10 percent. The precise formula is: GE=~ (1- na) + (1 + -aG +r -am r/aGE(1+ r') - (1 + r') =} (4.20) ri r'(aM aG) where a = The number of repayments a year, r' = The market rate per period, such that (1 + rn)a = (1 + r) = 1.1, G = The grace period before repayments commence and M = The maturity of the loan, and where it is assumed that the disbursement is made at the end of year 0 and that the principal is repaid linearly over the time period G to M. Current borrowing affects net wealth only to the extent that interest rates are below market rates. Past borrowing, however, affects wealth more directly, for it reduces current wealth because it must be repaid. Unfortunately, data on required future repayments at each point in time are not easily available, and an approximation is needed. The -33- total of outstanding debt disbursed at any time (i.e., the principal) is known. We assume that payments of interest are up to date; so that outstanding debt represents the amount that, if paid immediately, would just repay all liabilities. In other words, at market rates of interest, this total just represents the net present value of the future repayment stream. However, because concessionary borrowing does not pay market rates, we must reduce this total by the extent of the grant element. Since we do not know the dates at which current outstanding debts were taken out, we use the mean grant element over the sample period for this calculation. - Strictly speaking, the grant elements should grow with the current rate of interest: the higher current rates, the greater the benefit that a fixed concessionary rate involves, and hence the greater the excess of the value of the outstanding debt (the capital value) over the present value of the actual repayment stream. This situation again is a matter of approximation. Assuming that all loans are for perpetuity, we can calculate the implied rate of interest (taking into account grace periods) using equation (4.19), our assumed grant element and the fact that the grant elements are calculated assuming a market rate of 10 percent. The implied rate of interest suggests a repayment stream, which is then converted into a capital value at the ruling (expected) rate of interest. This capital value is then subtracted from wealth. Non-concessionary borrowing is in principle like concessionary borrowing. We assume that it has a grant element of zero (although, in fact, borrowing is classed as non-concessionary if its grant element is below 25 percent). Thus, no adjustment to current wealth is required. -34- We calculate the negotiated interest on the outstanding non- concessionary debt as a weighted average of the market rate over the previous five years. For the fixed rate debt, we then use this result to calculate the capital value of future repayments. Non-concessionary debt also includes variable rate loans, however, that must be treated differently. The capital value of the principal outstanding is the principal itself if, as we assume, variable rate loans must be paid at market rates. This situation is handled simply. We also assume, however, that between the time of negotiation and the present, any excess of actual interest payments over those expected when the loan was taken out is added to the principal outstanding at the present. This condition is not reflected in the World Bank data and thus must be added in. Our only data are one figure a year on the share of outstanding debt that is at variable rates (from the World Bank Debt Tables). From this we calculate the absolute amount at variable rates and assume that this total had been negotiated over the previous five years, with equal shares of variable interest debt in total debt in each year. Thus, given a stock of variable rate debt in year t, Vt, we calculate the amounts negotiated in year (t - i), iVt, where i = l...m, as Lt V Vt (4.21) i t 5 j Lt j where Lt _j is total non-concessionary loans received in year (t - J). This procedure is dreadfully crude (and temporally inconsistent), but it probably meets our need to pick up major interest rate mistakes satisfactorily. -35- For loans negotiated in year (t - i), the interest rate surprise in year (t - i + J) is (rt - i + j - i + jr - )where rs is the market rate for year s and sru the rate in year s as expected in year u. Thus, the additional payment on these loans is v (r re ), which must be cumulated forward from (t - i + J) to the present, t. Finally, we must sum over the five previous years in which the loans were assumed to be raised. In calculating the burden of interest rate surprises, we make two approximations for simplicity's sake: we assume (1) that the burden arising because rt - i + j exceeds the expected rate accumulates to year t at interest rate rt - i+ j, rather than at rates (rt - i + j, rt - i + j + 1)..., etc.; and (2) that debtors expect to pay off their debt at their long-run expected rate (re e ) a constant, rather than at year- t- specific rates. Thus, the change in the principal outstanding in year t attributable to previous interest rate shocks is 5 i-Ie I Vt( [r - t + j - rt - i [1 + rt - - +). (4.22) This treatment of variable rate loans refers only to loans that are explicitly at variable rates and ignores any fixed rate loans that were contracted with the intention of renewal. In the absence of data, we have no alternative. These calculations use data from the World Bank's External Debt Division and thus cover only loans with maturities of one year or more. Thus, we implicitly assume that short-term borrowing has no wealth effects, i.e., it is always at a rate of interest sufficiently -36- close to current market rates that any revaluations may be ignored. This assumption applies not only to new loans, but also to roll-over credits with periodicities of less than one year. These are not entirely happy assumptions, but they seem unavoidable. Observe that this treatment of grants and borrowing in the wealth calculations assumes that the loans are disbursed entirely in year 0. This assumption leads to some overstatement of the grant element if, in fact, disbursement is delayed. Beyond that small discrepancy, however, the pattern of disbursements is not important under our assumptions, since we presume that any amount of borrowing or lending may be undertaken at market rates. Thus, any given pattern of gross disbursements may be translated into the desired time pattern of expenditures just like any other foreign exchange receipt. (Indeed, in theory we could test whether developing countries are constrained in the capital markets by seeing whether, given wealth, imports respond to different disbursement patterns.) There is, however, one set of circumstances in which our assumption of independence between the disbursement and expenditure patterns may be violated, even with perfect capital markets. Assume that a loan's disbursements are tied to expenditures on a particular project. We would expect to find a closer relationship between disbursements and imports than between commitments and imports if the project being financed (1) requires only "additional" imports, in the sense that none of them would be bought in the absence of the loan, (2) imposes a rigid time pattern for these imports, and (3) has no effect on other imports. This situation basically implies that tied loans finance projects that the borrower's government feels are not socially -37- profitable and hence that it would not finance out of its own borrowing. In these cases, wealth must be reduced by the extent of the disbursement, for while the repayments still represent claims on the "general fund," the loan itself does not contribute to the latter. Hence, we would need to adjust our existing measure of wealth as follows: Restricted loan Adjustment to measured wealth Non-concessionary Subtract current disbursements Concessionary Subtract current disbursements less the current grant elements and the present value of future grant elements Grants Subtract the present value of future grants. Note that by removing the present value of anticipated grants and grant elements, we are implicitly assuming that restricted loans are not expected to be renewed. Without a huge amount of detailed research, it is impossible to know how borrowing is distributed between these constrained and unconstrained forms. However, provided the distribution is constant over time, an adjustment to the estimating equation is feasible. Equation (4.14) becomes: Pt t= (1 _ - a) (Wt- aWt) + aD (4.23) where WI = The addition to wealth stemming from receipts of (but not repayments on) all loans and grants of the type subject to restriction, -38- a = The share of restricted-type loans actually subject to restriction and Dt = Disbursements of restricted-type loans. The constant, a, is theoretically estimable, but in practice it proved possible only to restrict it a priori. Specifically, we experimented with (a = 1) for various definitions of WI, e.g., that all concessionary loans are subject to restriction. If the conditions under which disbursements and imports are linked, are considered sufficiently unlikely in perfect capital markets, tests on equation (4.23) could be interpreted as tests of the hypothesis of perfect capital markets. If disbursements matter, capital markets are not perfect. Expectations The third problem area with equation (4.11) is the treatment of expectations. Expectations figure very prominently in the model as outlined, and clearly their measurement is a crucial consideration. However, we have little guidance as to how to proceed. Below we experiment with different approaches, so that a number of alternatives are listed. We require very simple mechanisms for expectations, for they must be both practical and forecastable. These mechanisms usually amount to assuming a constant rate of growth for the variable concerned. We do, however, use certain exogenous information for particular years of the sample period or particular components of wealth where this seems necessary, as, for example, with expectations about oil prices. -39- Rational expectations are currently popular, but they do not entirely answer our needs. First, we do not have a complete model, so the expectational component cannot be substituted out. Second, while it would be convenient to assume that in each year agents had unbiased expectations of unknown variables, so that we could use actual future values as a proxy, this assumption alone does not help because we would rapidly run out of future data. That is, we could not estimate the model for say, 1980, because the prices for 1983 are not yet available. We do, however, experiment with forward-looking data, but only in conjunction with very crude extrapolative formulae. For transaction flows, simple conservative expectations are used. The inflow of current and capital grants is expected to continue at current nominal rates, and similarly for the grant element in concessionary borrowing. The inflow of current credits is broken into a price and a quantity dimension. For the latter we experiment with both static expectations and a constant expected growth rate equal to the average of the last five years. After preliminary tests, we select the former. An exception is where exports are based on known mineral deposits, in which case expectations are roughly based on known reserves. The price dimension is more tricky still. Initially we had intended to let the expected future growth rate of export and import prices equal next year's actual rate (an element of rational expectations), and the expected interest rate to equal this year's actual rate. This approach leads to fluctuations in measured wealth far greater than could be believed a priori, however. For example, on this -40- measure, Malaysia, one of our test countries, would have had an 80 percent decline in wealth in 1981! Two much more conservative approaches are therefore considered. For export prices we again consider static or constant growth rate expectations, and again prefer the former. Meanwhile, the interest rate is fixed exogenously either at a nominal 10 percent -- the rate the World Bank uses in assessing grant elements -- or at a real 2.5 percent in the long run. In the former case, 10 percent is used for all years, including the current one; in the latter case, the nominal rate is assumed to take three equal annual steps in moving from its current level to (2.5 + p ), where p is the expected long-run change in import prices. The resulting interest rate profile is then averaged to get a single expected rate, the latter being that constant interest rate yielding the same net present value for a constant nominal income stream to infinity as the (assumed) variable rate would (see equation [2.3]). The expected import price series is calculated by assuming that, from three years hence, import prices will grow at their average rate over the last five years. Until then, the growth rate for import prices is assumed to take three equal annual steps from the current level to that long-run level. These procedures are very mechanistic and are imposed a priori. As an alternative, we experiment with an empirical approach, postulating that, ceteris paribus, a higher rate of investment indicates a more optimistic view of the future and thus higher perceived wealth. As a crude measure of this alternative, we consider replacing wealth, W, in some of the equations above by -41- (p, + ''gD + Wt), (4.24) where gt is the investment/GDP ratio or the investment/wealth ratio. Empirically, this equation is rather close to the disequilibrium models discussed on pages 27-28, and in the estimation we treat equations using (4.24) as further disequilibrium models. (It is to try to distinguish the two families of disequilibrium models better that we use equation [4.24] rather than the more natural [W' + §'g tWt.) Interest Rates The model as outlined contains a single interest rate at which countries are assumed both to borrow and lend. This rate should be the rate on marginal transactions, and assuming that concessionary loans are rationed by the donors regardless of the borrowing aspirations of recipients, the marginal transactions will normally be with private financial institutions. We experiment with two possible rates: first, the rate on a country's own long-term borrowing from foreign financial institutions, and, second, the 12-month LIBOR (or an approximation of it for earlier years). The former captures the country risk premium and so may be somewhat endogenous, whereas the latter, while exogenous, may lack relevance, given that most countries borrow rather than lend and do so at varying premia above LIBOR. Dynamics The equations as specified above are entirely static. In the real world, there is at least some chance that an adjustment in the directions postulated takes time. Thus, we should consider the -42- possibility of a lagged adjustment. Given our very small sample of observations (see below), doing so is possible only for the simple forms of the models and for very simple dynamics. In general, the approach is to include only a lagged dependent variable (a partial adjustment model), but in certain cases more general forms are feasible. For example, if 6 = 1 in equation (4.14), the following equation is estimable (where M replaces p M for notational convenience): M = a W + 8 MH1 + y W_1 . (4.25) Linear restrictions of this equation make the following models testable: a static form (B = y = 0), a first difference form (8 = 1, y = -a), a partial adjustment form (y = 0), and a "catch-up" or serial correlation model (y = -aO). In the course of early empirical experiments, there is some evidence of heteroskedasticity in the residuals of equations such as (4.14), with the error variance growing over time. We therefore experiment by deflating the whole of the estimation equation by current import prices. This alternative reduces the heteroskedasticity, but it also suggests that we should perhaps consider the dynamics of "real" imports. Thus, for example, if we deflate equation (4.25) by current prices, and let a = 0, we would have: Mt + O+ t- 1 Pt Pt Pt However, a natural alternative would be to consider the adjustment of (m / M) to itself lagged, viz., p -43- mt t 0 t- Mt Wt+ Mt - (4.26) Pt Pt P t- This approach has considerable intuitive appeal - it is, after all, the adjustment of the quantity of imports that is painful and costly -- and it also allows direct comparison with "traditional" equations, which are usually specified in real terms (see below). Most of the following estimation -makes use of the lagged dependent variable to add a dynamic element to our models. -44- V. THE DOMESTIC MODEL The second of our models, the domestic one, is a development of the first. Whereas in the first, following Hemphill, we consider only the import sector, in the second we extend the analysis to the domestic economy, following Sachs and Dornbusch. The extension is straightforward, at least in a formal sense. However, two new sets of problems present themselves: first, how to incorporate the macroeconomic balances and, second, what units to work in. Sachs' Model Sachs' model, which is built around the national accounting identity, distinguishes two goods and uses world money as the numeraire. As noted, the import good has a fixed world price, while the export good faces a downward sloping demand curve. Its price does not appear explicitly, however, as it is substituted out by factors determining the supply and demand for exports. (Sachs has a very simple model of exports, with unit elastic demand and a single factor exponential supply function). The resulting basic equation (based on equation [2.10] is: CA = f(W ) + a (G - G ) + a2 (T - T ) + a3 (R - R ), (5.1) t t 123 which expresses the current account as a function of wealth, plus the deviations from "perpetuity values" of government expenditures, world demand and productivity. For our purposes, we assume that all adjustment on the current account occurs through imports, with exports -45- and factor payments taken as predetermined. Thus, equation (5.1) can be treated as an import function. The estimation of the perpetuity values of G,T and R is problematical, in that they refer to perpetuity values as perceived at time t. Thus expectations are involved. As a first pass, however, we take them as trend lines through their respective samples of observations. Sachs assumes that government expenditure is exogenous and that investment is determined by the wealth function as part of private absorption. (He ignores the feedback from investment to output, as do we). Both assumptions are somewhat suspect: governments may well restrict their expenditures with a view to the current account, while the dichotomy between savers and investors may cause investment to have an exogenous component. Thus the term (G - GP) may be displaced by (I - IP) or dropped entirely from equation (5.1), with corresponding adjustments to the definition of wealth. Sachs also implicitly assumes that all wealth is owned privately rather than publicly. Thus, the permanent value of private consumption CP equals r*W. This view arises from the assumptions that the government finances its exogenous expenditures that contribute nothing to utility from either current or future taxation, and that future taxation is perfectly foreseen by the private sector and is capitalized into its estimate of wealth. It seems equally plausible, however, to assume that the government has some claim on wealth, a view that reinforces the argument for combining public and private consumption into the same process by-dropping (G - GP) and redefining wealth. -46- Similarly, the terms (T - TP) and (R - RP) are under threat. They appear in the equation by virtue of Sachs' simple model of exports and output. As we are not committed to this model, we work directly with deviations in output. The final component of equation (5.1) is the wealth function. It is similar to the functions developed for the previous model but has some additional features. Consumption is related to total private wealth. Given that spot estimates of wealth are notoriously scarce and unreliable, the best definition appears to be reserves plus the grant and borrowing terms described earlier plus the present value of the expected stream of GNP net of government expenditures. This definition includes, inter alia, all human and physical wealth and current income from abroad. We assume constant expected growth rates for real GNP and the appropriate deflator, with the former rate generally set equal to zero. The estimating equation based on Sachs' model is thus Ptt M CAt + Pt Xt IPDt or (PtX - aIPD - p M )ant ) Wt - a1(G - GP) (5.2) - a (T - T ) - a (R - R ) where IPDt = The flow of interest abroad. The functional form of the wealth component has been taken from equations (4.1)-(4.15), but with consumption replacing imports and a broader definition of wealth. -47- Dornbusch's Model An alternative approach to the domestic model is Dornbusch's (1983). He assumes a traded/non-traded dichotomy and uses traded goods as his numeraire. He also assumes only a single component of demand (called consumption), so that his macrobalances are particularly simple. He finds the relative price of traded and non-traded goods a significant factor in the overall demand for consumption. We need to make slight adjustments to Dornbusch's model to permit us to work in a money metric -- essentially, we define the interest rate in real terms relative to (expected) import prices. Thereafter, combining the model with the macroeconomic balance equation generates an import function M = C - GNP + IPD + X. (5.3) That is, imports equal "total consumption" less GDP plus interest payments and exports, all measured in foreign prices. With C covering all expenditures, wealth has to include the present value of total future GNP. It is possible to adapt equation (5.3) to allow for other elements of macro-imbalance along the lines of (5.1); for example, we could remove government expenditures from the accumulated values of GNP in the calculation of wealth and include (G - GP) directly in the equation. Again, the formalities of the wealth explanation of consumption may be taken from above, but with the price term altered to reflect relative import and domestic prices. A more direct approach to Dornbusch'ls model is to exploit its intertemporal separability, using wealth to determine total absorption, -48- but then using current variables alone to explain the allocation of the latter between imports and domestic goods. In fact, Dornbusch has a Cobb-Douglas function for this division, so that imports claim a constant share of absorption. We have chosen to generalize the model slightly, using a CES function. Thus, given the value of absorption, A, from the wealth calculation, P t a (p) (PtAt), (5.4) where Pt = The aggregate price index for year t, (pM)a (pD)l - a (55) Pt t t 5) and where a may be calculated as (pMM/PA) in the base year of the index numbers, year 0. Using an equivalent of equation (4.15) to determine P tAt -- current absorption - and manipulating so as to reach the equivalent of (4.15), we get - = N ptM = a ( 87) (1 _ 6d 1 - Wt (5.6) where nt = The deflator for total absorption. For both the Sachs and Dornbusch formulations, lagged dependent variables are included at estimation time to allow some element of dynamic adjustment. -49- VI. SPECIFICATION TESTS OF THE FOREIGN WEALTH MODEL There are two components to the empirical application of a model. The first is to try to identify the correct model, while the second, having done so, is to get the best possible estimate of it. The former concerns hypothesis testing, the latter does not. In the present paper, we distinguish these operations carefully. In this section, we explore the various specifications of the models discussed above -- comparing, for example, different formulations of expectations and different treatments of potentially restricted loans. From these experiments we derive preferred specifications of the two models -- foreign and domestic -- in their two forms -- equilibrium and disequilibrium. In the second set of tests, described in the next section, we compare these models between themselves and with two simple alternative models: Hemphill's equation (2.1) and a traditional equation relating imports to GDP and relative import and domestic prices. These comparisons yield a generally preferred model of imports. It should be emphasized at this stage that all our tests are of composite hypotheses comprising, first, the truth of the model concerned and, second, our ability to measure the concepts accurately. This observation is, of course, true of all applied economics, but it is particularly relevant here, given the manifest problems of measurement. However, applied economics does require operational models. Hence, while it may be---philosophically feasible to claim that rejections of a particular model arise from its measurement problems, rather than from -50- its theoretical shortcomings, it is not practically very useful, at least until equally plausible alternative measures have been discovered. This section starts by considering the sample data and the estimation methods adopted. It then specifies more precisely the nature of our general tests of specification. These involve estimating alternative models under a series of different assumptions and attempting to draw from the results some broadly consistent conclusions about the types of models that were introduced before. Specifically, we seek strong evidence to reject the null hypothesis that the intertemporal approach to imports is useful. The restrictions of the null hypothesis we test are that all components of wealth affect imports equally and that neither the pattern of disbursements of loans nor the stock of outstanding debt affects imports. Additionally, we seek information about the best interest rate to use. The three countries used in these experiments show a strong degree of uniformity in their conclusions on these issues. The Sample The preliminary experiments are conducted on three developing countries chosen at random in a stratified sample. The wealth model, with its assumption of unrestricted borrowing, is likely to be more applicable to middle-income than to low-income developing countries. Within that sub-set we seek countries from three different continents, with at least one oil-exporting and one oil-importing country. Finally, the countries chosen have to meet certain minimal conditions of data availability. (We diplomatically ignore the question of data -51- quality.) The three countries chosen are, in the order in which they are tested, Malaysia, Colombia and Kenya. Details of the raw data are given in the Appendix 1. Briefly, however, they cover 1965-82 annually, although for several variables earlier data are also required. The principal sources are International Financial Statistics Yearbook, (1983), Balance of Payments Statistics and the World Bank Debt System. In a few cases, interpolations or extrapolations are required, as noted below. It seems desirable to stretch the sample data as far as possible in both directions in time, given the heavy load they have to bear; even so, our 18 observations is embarrassingly small, especially for the asymptotic test we apply below. Ideally, the models should be tested by their predictions of imports for 1983, as the fierce reductions in imports in that year were almost universally attributed to financial stringency. Unfortunately, however, the data are not yet available for such an acid test. All the calculations in this section have been conducted using TROLL on the World Bank's IBM 3083 computer. (Many tests, as well as all the data preparation, have been carried out by Kathi Yu, to whom I am most grateful.) The Estimation All the models in this section are estimated by single equation least squares methods. Given the small samples, more sophisticated approaches are probably not warranted. There is, however, one potentially serious problem that deserves mention and for the illumination of which we are indebted to- Professor Jonathan Eaton. We assume the exogeneity of export earnings in foreign currency terms. If -52- this assumption is correct, the only role that import prices play in our models is the intertemporal one explored in detail above. If, on the other hand, export revenues are endogenous, this condition involves a simultaneity bias in our estimates, for we omit a second role of import prices -- that of influencing the overall levels (present values) of exports and imports. Under these circumstances, the direction of the bias depends on whether the country is on the elastic or the inelastic segment of its offer curve. If expenditures on imports (and hence the required export revenue) fall as import prices rise, then the coefficient on import prices in our equation will overstate the degree of intertemporal substitution (a will exceed a). Alternatively, if import expenditures rise with import prices, the degree of intertemporal substitution will be understated. 1/ It is difficult to know, a priori, the direction of these biases, but their possible existence should be borne in mind in interpreting the results below. We choose not to allow for them formally in the estimation because of the complexity of modelling exports and imports simultaneously (especially intertemporally), and the fact that, with small samples, ordinary or non-linear least squares are often felt to be at least as efficient as simultaneous estimation methods, in a mean squared error sense. 1/ These biases are derived from a simple log-linear version of equation (4.11). The non-linear forms are more complex, but the result probably can be generalized. -53- The Tests Each country is subjected to the same battery of specification tests. We first explore whether all components of wealth have the same impact on imports. Wealth is defined precisely in the earlier discussion as assets plus the net present value of exports, grants and the grant element of concessionary borrowing, plus the (negative) effects of repayments on past loans. In theory, each component has the same impact on imports. Thus a preliminary test that can provide a rejection of the maintained model is to look for evidence that the components have markedly different effects. These wealth definition tests are conducted by starting with a restricted definition of wealth and progressively testing whether the addition of further components satisfies the null hypothesis. Four components of wealth are considered: (1) Net present value of exports (2) Foreign assets (3) Net present value of grants and grant elements and (4) Repayments. They are tested in this order and also with the last two items reversed. The test equation, derived from (4.14), was: Mt =(l-6\ ) (iW 6+ + i)Wt) (6.1) where Mt = The value of imports (previously denoted pmM 6 = The (unknown) rate of time discounting -54- nt = The rate of growth of discounted future import prices Wt = The ith component of wealth (e.g., assets or grants) and it ~~~~~~~~~~i iWt = The ith wealth concept Wt The test comprises seeing whether a = 1. Similar tests are conducted on the share version of equations (4.14) and (4.15) - and a linearization of (4.14), but in fact neither yields additional information. The next tests concern the possibility that certain loans are restricted in their timing, such that imports and disbursements are coincidental. As noted above, this procedure is largely a test of the perfect capital markets hypothesis. The test equation is (4.23), but there appears to be insufficient sample information to estimate a, so that the constraint (a = 1) is imposed. The model is tested, as written, in share and in linear form, but, again, the last two are quite consistent with the first. These tests are referred to below as the restriction tests. Both sets of tests are conducted in real and nominal terms and for five different interest rates: the actual rate for the country, LIBOR, an "expected rate" based on the actual rates (see page 39), the same based on LIBOR, and 10 percent. In addition, various tests are conducted using 10 percent as the rate in defining wealth, but an actual rate in defining future discounted prices. This process might reflect a conservatism in assessing wealth (risk aversion) that is not reflected in intertemporal allocations. The restriction tests are also conducted with a lagged dependent variable to allow for evident dynamic mis- specification. -55- The comparisons among wealth definitions, loan restrictions and interest rates are made in terms of residual sums of squares, error whiteness and plausibility. At least in the wealth definition and restriction tests, we are seeking strong evidence of a rejection of our null hypothesis that total wealth with no restrictions is the correct way to proceed. Thus, formal non-nested procedures do not seem warranted, given the small sample, the large range of tests and the similarity of the alternatives. A typical set of results from the wealth definition tests is given in Table 6.1. While these are based on a constant 10 percent rate of interest -- our preferred measure (see below) -- the results for the other interest rates and functional forms are very similar. There is clearly some tendency for different elements of wealth to affect imports differently, but except for Malaysia and foreign assets in Colombia and Kenya, this tendency is not particularly marked. Owned assets appear to stimulate imports more strongly than other elements of wealth; this result may reflect their role as collateral for additional borrowing ("banks only lend to people who don't need money"), in which case our capital market assumptions are violated. Grants appear precisely as do other components of wealth, while repayments have different effects in different countries. In Malaysia, higher repayments (a negative component of wealth) curtail imports strongly, while in Colombia they are (insignificantly) associated with higher imports. -56- Table 6.1: WEALTH DEFINITION TESTS (r = 10 percent) a/ W.alth measure Additional- walth Malaysia Cblombia Kenya (W) caomonent (W) 8 (s.e.)b/ B (s.e.)b/ 8 (s.e.)b/ (1) NPV of exports (2) Assets 56.28 c/ (3.12) 2.73 c/ (0.76) 11.64c/ (2.27) (1) + (2) (3) Grants 1.43 (3.47) 1.43 (1.86) 0.92 (0.38) (1) + (2) + (3) (4) Repayments 27.32 c/ (3.37) -1.25 (2.93) 1.51 (1.70) (1) + (2) (4) Repayments 27.26 c/ (3.38) -2.84 (3.04) -0.34 (1.98) (1) + (2) + (4) (3) Grants 1.36 (3.55) 1.99 (3.13) 1.96 (0.37) a/ For definitions of wealth, see page 53. b/ s.e. denotes the standard error of S. c/ Denotes that 8 differs significantly from unity at 5 percent. Note: The estimating equation is: Mt (1 - 6"n a) (iwt + a) The restriction tests also generate somewhat mixed results, with occasional improvements in fit from treating some loans directly. Table 6.2 presents a typical set of results. As before, the conclusions are quite robust with respect to changes in interest rates, functional form, and dynamic specification. The only consistent pattern in these tests is for Colombia, where it generally appears preferable to have -57- Table 6.2: RESTRICTION TESTS (r = 10 percent) a/ Loans restricted (D) Standard error of the equation Malaysia Colombia Kenya None 383 203 110 Non-concessionary 486 194 117 Grants and concessionary 399 205 124 Grants, concessionary and 491 200 130 non-concessionary a/ The estimating equation is: M = (1 - 6d ) (Wt - W't) + Dt + YMt- See pages 36-38 for an explanation. non-concessionary loans entering directly. Since the resulting improvement in fit is very slight, however, and since non-concessionary borrowing seems, a priori, the flow least likely to be subject to timing restrictions, this outcome does not constitute a convincing rejection of our postulated model. Thus we would conclude that any loans that are actually restricted do not increase the overall level of imports and are compensated for by changes in unrestricted or commercial borrowing. This interpretation is consistent with our perfect capital markets hypothesis. The next issue to be decided is the interest rate to be used. The two batches of tests above were conducted on all the interest rates and combinations mentioned above, and certain other equations that are introduced below were also estimated with different interest rates to check whether subsequent specification tests might affect the choice of -58- rates. Thus, we have a considerable number of observations (not, of course, all mutually independent) with which to make the choice. Table 6.3 presents some typical results: the standard errors of the regressions from equation (4.14) estimated with a lagged dependent variable. Table 6.3: THE EFFECTS OF DIFFERENr INTEREST RATES Interest rate Standard error of the equation ($ million) Malaysia Colombia Kenya Actual national 664 304 158 "Expected" national 703 308 131 LIBOR 660 304 276 "Expected" LIBOR 674 339 166 10% 383 203 110 10% and national 361 200 115 10% and LIBOR 356 206 120 a/ The estimating equation is: Mt =(1 - 6 a ) w + yM t ~ ~ ,tt t-1 See page 27 for an explanation. It is very clear from this table that the simple 10 percent interest rate dominates the others, at least for the calculation of wealth. The reason is partly that the actual interest rates cause the wealth estimates to fluctuate unrealistically: for example, with no changes in actual flows, cutting the interest rate from 10 percent to 8 -59- percent increases wealth by around 20 percent. Almost certainly, national authorities would discount such fluctuations in estimating their wealth, although, curiously, our dampened interest rate series (the "expected" rates in Table 6.3) do not improve matters for two out of three countries. (The hypothesis that dampening occurs is supported by the fact that the difference between using actual and constant interest rates to calculate wealth is emphasized in the absence of the lagged dependent variable.) The preference for a constant rate of interest casts some doubt on our composite hypothesis that the wealth model is correct and that we can adequately measure wealth and expectations. This is partly because it is difficult to believe that countries actually reckoned their wealth over 1965-80 using a constant nominal interest rate, but also partly using a constant interest rate takes the model a long way toward being observationally equivalent to a model relating imports to foreign exchange receipts. For example, if we measure wealth, W, as exports, X, plus grants, G, and assets, A, less repayments, R, then _ _ _-, W X +C R :3 r r r and M= (1 + 8 = anW (n = W (x + G + A) R. r r If rA approximates interest receipts on reserves, only the dependence of p( ) on n and the treatment of repayments identifies the wealth model from one in which imports are proportionate to current receipts. -60- In a final set of ad hoc specification tests, we consider including in the basic equation the variables reflecting the stock of indebtedness. The latter are important because they offer another fairly direct test of the null hypothesis that net wealth determines imports. Under the null hypothesis, stocks of indebtness matter only for their influence on net wealth (which enters via Wg), but under many reasonable alternatives, they are crucial in determining both a country's willingness and its ability to borrow. Significant stock effects are, therefore, bad news for the wealth model. Three variables are considered: total debt outstanding and disbursed, DOD, DOD relative to wealth, and DOD relative to GDP. For lack of data, only the medium- and long-term official borrowing reported to the Bank can be included in these measures. In no case and for no country are the stock of debt variables significant. The general specification tests have not been described in great detail, but the overall tenor of the results is accurately represented in the discussion above. There is no doubt about the empirical advantages of assuming a constant 10 percent nominal rate of interest, and no question of significant stock of debt effects (other than those embodied in the wealth estimate). On the other hand, the wealth definition tests do suggest that owned assets may affect imports differently from other components of wealth, and the restriction tests do raise some questions about the perfect capital markets hypothesis. Overall, therefore, the basic foreign wealth model emerges for these tests with at least some credibility: while there certainly are some remaining questions about its relevance that require further -61- investigation, it survives the initial tests well enough to warrant continuing the present exercise by pitching it against some of the alternative theories of developing countries' imports. -62- VII. PREFERRED EQUATIONS FOR THE FOREIGN WEALTH MODEL We turn now to the refinement of the general foreign wealth model into a preferred form for each country. This exercise involves a few remaining hypothesis tests and then the estimation of our final equations. In later sections, these equations are compared with the preferred equations from other models. In comparing models, a strong case can be made for comparing the equations before any data-directed simplification has occurred, that is, for comparing the estimate of the a priori specifications. For several reasons, however, we choose to carry out a little further refinement (hypothesis testing). First, in some cases our theory is far from definite about whether a variable should be included. With small samples, carrying extraneous variables has a high cost in terms of efficiency, and in these cases, if the data do not reject the hypothesis that a coefficient is zero, we impose it. Second, the ultimate objective of this exercise is to produce equations for simulation, an objective that requires plausible parameter values. Thus we must be prepared to override certain implausible estimates. To be sure, when doing so involves imposing statistically significant constraints, we should return to the theory to discover why, but until we have done so, it seems reasonable to impose plausibility on an existing model. This is particularly so when several models are being compared: it is useful to know if model A plus any necessary plausibility constraints dominates model B plus its constraints. (Simulation models are used to make many conditional forecasts, and it is in order that these bear sensible relationships to each other that plausibility is required. If we were -63- making a single unconditional forecast, the case for overriding statistical results with prior views would be much weaker.) The criteria used to determine the preferred equations are fit, plausibility and error whiteness. In the discussion that follows, we quote for each country the initial dynamic estimate of equation (4.14) and describe the path of inference followed. In particular, we highlight and justify any circumstances in which our decisions may be thought contentious. While a degree of judgment is occasionally necessary, we do not believe that other researchers would reach fundamentally different conclusions. The preferred equations for - the foreign wealth models are reported as equations (1) to (4) in Tables 7.1, 7.2 and 7.3. The tables use the notation developed above for the variables and report several summary statistics: R2, Durbin's h or the Durbin-Watson statistic, the standard error of the regression, SER, and the residual sum of squares, SSR, in the units of reported equations, and, finally, the SER and SSR in terms of the nominal value of imports. Malaysia Among the most consistent features of the preliminary results for Malaysia are the smallness and complete insignificance of the coefficient of intertemporal prices, n. Mt = (1 - 0.955nt0.011) Wt + 0.625 Mt 1 (7.1) (.006) (0.60) (.073) R = 0.998 Standard error = 382.8 h = 0.86 SSR/106 = 2.1979 -64- The insignificance of discounted prices, n, implies that a, the intertemporal elasticity of substitution, is not signficantly different from one, which in turn means that a Cobb-Douglas intertemporal utility function is consistent with the data. This result suggests greater intertemporal substitution than we expected a priori, but the result is strong and consistent. Imposing (a = 1) reduces the standard error of the equation and allows us to use the linear model including only W and M as the basis for the tests of dynamic specification (see equation [4.25]). No equation dominates that involving only wealth and lagged imports, and so the preferred foreign wealth equation is (7.1.1) in Table 7.1. We next consider the disequilibrium models, but still in nominal terms. While relating either the rate of time discount or the estimate of wealth to the growth rate of GDP yields no significant improvements, relating them to investment proves most useful statistically. Of the two ratios we try, investment relative to wealth is preferable, with a standard error of the equation, SER, of about 20 percent below that from investment relative to GDP. Of the two models, relating the rate of time discount to investment (equation 4.16) dominates relating wealth to investment (equation 4.24) by a similar amount. In the preferred equation (7.1.3 of Table 7.1), a dollar's investment generates $0.93 of imports, and the hypothesis that the relationship is one-for-one cannot be rejected. Looked at alternatively, a rise in the investment/wealth ratio of 10 percent from its mean of 0.0415 to 0.0457 is associated with a rise in the rate of time discount from 6.5 percent to 7.0 percent. It is clear that this model is a substantial improvement in terms of fit over the equilibrium Table 7.1: PREFERRED) FQUATIONS FOR MALAYSIA a/ Nominal R2 SER SER h or (W) SSR/106 SSR/106 FORFIGN WEALTH (7.1.1) Nominal 1 - 0.041 WF + 0.626 H_1 0.998 371.0 (.005) (.071) 0.96 2.2001 (7.1.2) Real H 0.029 WF + 0.707 (Hl) 0.997 501.4 400.5 (.008) (.104) 0.83 4.0226 2.5662 FOREIlN DISEQUILIBRItI (7.1.3) Nominal N - (0.023 + .927 * a) * WF + 0.260 N1 0.999 201.6 (.004) (.149) (.070) -0.93 .6094 (7.1.4) Real H (0.023 + .483 F) II b * .513 (Ln 1.000 362.3 260.5 FRW PM p (.006) (.136) (.093) 0.64 1.9689 1.0176 DONESTIC WEALTH (7.1.5) Nominal log N - -4.327 + log WD + 0.154 log 1_ 0.993 0.079 501.0 (.179) (.022) 1.07 0.100 b/ 4.3000 Real No plaustble equatlon DONEST IC DISEQUILIBRItUM (7.1.7) Nominal N = 0.569 |1 - (.980 - 2.038 -)J * WD + 0.181 N1_ 0.999 251.8 (.004) (.285) WD (.086) 0.00 .9511 Real No plaustble equation TRAD)IT IONAL (7.1.9) Nominal M - 417.7 + 0.315 GDP - 27.79 P + 0-593 N1 0.995 392.4 (774.6) (.043) (22.01) P (.084) -0.05 2.1560 (7.1.10) Real N 2148.2 + 0.312 GDP- 99.31 P + 0.674 ( 0.984 446.5 275.1 P' (827.1) (.070) pCDP (29.08) pC (.128) P -1.05 2.7915 1.0594 HEMPHILL (7.1.11) Noninal N 76.31 + 0.424 RI + 0.454 F + 0.334 M..1 0.997 295.8 (145.1) (.196) (.087) (.090) 0.85 1.2250 (7.1.12) Real - - -23.25 - + 0.145 R' + 0.405 - + 0-536 (-) 0.999 375.9 266.5 P (71.76) P' (.133) M (.079) PM (.106) P I -0.42 1.9788 0.9946 a/ N - Nominal Imports; Pn M Price of L ports; WV - 'Foreign Wealth (i.e. net present value of foreign exchange receipts + assets); I - laveatment; VD - _ DOestic Wealth (i.e. net present value of GNP and assets); GDP - Ntoinal GDP; pCD GDP Deflator; R - Level of Reserves, F - Foreign Exchange Receipts; n - Growth rate of present value prices. b/ Not divided by 106. -66- version of the foreign wealth model. As observed above, however, there are probably more grounds to fear simultaneity bias here than in any of the other models considered in this paper. The final tests concern the explanation of real imports. As discussed above, imports and wealth are both deflated by current import prices, but lagged imports are considered deflated by either current or lagged prices. The latter proves superior. The specification tests are repeated starting from an estimate of the real equivalent of equation (7.1). Exactly the same conclusions emerge. The resulting equation is (7.1.2) in Table 7.1. It implies slightly larger errors in nominal import predictions than does the nominal equation, which minimizes those errors directly. (The nominal errors from equation [7.1.2] are merely those in real imports multiplied by pM which is assumed to be exogenous.) The estimation in real terms reduces the heteroskedas- ticity, but from inspection it appears that the errors are still substantially larger over the period 1975-82 than prior to 1972. The largest errors affect 1973-75, which is hardly suprising: eighteen observations are too few for conducting a formal test of heteroskedasticity, and as yet no allowance has been made for it in the estimation. It is an obvious area for future research. The disequilibrium analysis of real imports also mirrors its nominal counterpart closely. Again, the investment/wealth ratio proves the most effective of the disequilibrium terms, and, again, it is best seen as modifying the rate of time discounting. Its numerical effect is substantially reduced, however, by the real transformation, with only half of any extra investment showing up as imports. -67- Colombia In most respects the results for the Colombian foreign wealth model are- very similar to those for Malaysia. Intertemporal substitution seems relatively strong (a = 1) and lagged imports highly significant. Thus, Mt (1 - 0.935n -0.084 ) W + 0.610 M (7.2) t t ~~~~~~t t-1 (.010) (.124) (.093) R2 = 0.996 Standard error = 203.1 h = -1.29 SSR/106 = 0.6189 When the intertemporal price effect is eliminated, the result is the preferred equation, (7.2.1), of Table 7.2. In this case, however, there is nothing to choose between the dynamic linear equation embodying serial correlation (SER = 195.3) and that embodying just a lagged dependent variable (SER 200.0). For simplicity, we choose the latter. In real terms, these results are repeated, resulting in the preferred real equation (7.2.2). Again mirroring Malaysia, investment relative to wealth proves to be the best disequilibrium variable, but here it is preferable to use it as a factor in the estimate of wealth (equation [4.24]), rather than using it as part of the discount rate (equation [4.161). The resulting equations, nominal and real, appear as (7.2.3) and (7.2.4), respectively. For nominal imports, the two additional disequilibrium variables are not statistically significant at 5 percent (with an F- statistic of 2.19 compared with a critical value of 3.64), but for real imports they are (F = 5.04). Observe, however, that in terms of Table 7.2: PiReFeRRED EQUATIONS FOR COLONBIA Nominal R2 ~~SER SER h or (DWI SSR/106 SSE/106 FOREIGN WEALTH (7.2.1) Nominal n 0.065 VF + 0.597 K_l 0.996 200.0 (.010) (.087) -1.38 0.6398 (7.2.2) Real N 0.065 WF + 0.547 HP) 0.992 358.3 213.7 pH (.019) PH (.153) p -1.55 2.0541 0.7310 FOREIGN VEALTR DISEQUILIBRIIIM (7.2.3) Nontnal N 0.071 (WF - 15103 + 85741 -I + 0.553 K_I 0.992 186.6 (.010) (7139) (42572)VF (.085) -1.86 0.4873 (7.2.4) Real H _ 0.079 [W- - 32725 + 196740 I + 0.415 ,) 1 0.995 292.0 238.0 Pn (.018) PM (11707) (72427) WF (.146) P -2.03 1.1940 0.7932 DOMESTIC WEALTH (7.2.5) Nominal I - 0.016 (PM)-0-484 * VD 0.990 199.7 (.0003) P (.259) [1.601 0.6379 (7.2.6) Real -- 0.167 * (I - .907) * (D) 0.993 330.2 232. pH (.002) pH 11.4781 1.7443 .8612 0% DOMESTIC WEALTH DISEQUILIBRIUIM 0 (7.2.7) Nomtnal N - 0.167 (P ) -0.071 - ( 0.914 - 0.663 I 0-953 nD 0.047I *WD 0.997 191.8 P (.035) (.007) (.424) (.012) (.012) 11.981 0.5152 Real No plausible equation TRADITIONAL (7.2.9) Nominal log H - -2.495 + 1.063 log GDP 0.982 0.105 193.2 (.341) (.036) 11.931 0.175 */ 0.6355 (7.2.10) Real log - -3.658 + 1.174 log GOP _ 0.900 log PK 0.927 0.103 232.7 pM (.860) (.086) pGDP (.27Z) pGOP [2.0561 0.159 a/ 0.7578 HEMPH ILL (7.2.11) Nomtnal H - 161.7 + 0.301 RI + 0.386 F + 0.526 N-1 0.991 203.6 (124.6) (.129) (.077) (.102) -1.22 0.5802 (7.2.12) Real M _ 145-6 + 0.292 RH + 0.378 F + 0.510 (H 0.994 329.1 200.1 pH4 PM pH 94 pm (87.4) (.126) (.117) (.139) -1.019 1.5165 0.5603 a/ Not divided by 106. -69- nominal fit, the real equilibrium equation still dominates its disequilibrium rival and that the latter displays significant negative serial correlation. This last equation, (7.2.4), implies that a rise of 10 percent in the investment/wealth ratio from its mean of 0.171 to 0.188 will raise the estimate of wealth by 7.4 percent in 1980 and long- run real imports by $534 million in 1980 dollars. Kenya Kenya presents a slightly different picture from the other two countries. The elasticity of intertemporal substitution is stronger (nearly signficantly above unity at 5 percent), while no dynamics are evident. Thus, for example, Mt = (1 - 0.846nt 0.200) w + 0.030 M (7.3) t t t (.016) (.115) (.095) R2 = 0.995 Standard error = 110.1 h = -0.82 SSR/106 = 0.1818 While the coefficient on intertemporal prices is not significant (critical value t16[5%] - + 2.112, 2-tail), it is sufficiently well- determined to be retained in the equation, given our theoretical interest in its effect. 1/ Thus the preferred equation is the basic equation (4.14), which is reported as (7.3.1) in Table 7.3. Almost identical results with real imports lead to a preferred equation (7.3.2) for the real wealth model. 1/ Estimating a considerably reduces the standard error of the equation. In this sense, the actual estimate is better than imposing (a = 1), even though the latter cannot quite be rejected at 5 percent. Table 7.3: PREFERRED EQUATtONS FOR KENYA Nominal RZ SER SeR h or (DWI SSR/106 SSR/106 FORe[GN WEALTH (7.3.1) Nominal M - (I - .841 n 189) * WF .995 106.9 (.004) (.108) 12.361 .183 (7.3.2) Real H (I - .841 n 0-.133 * .993 228 108.4 pH (.004) (.067) pM 12.1161 .834 .188 FOREIGN WFALTH DISEQUILIBRIUM (7.3.3) Nominal H (I - .844 n --189 ) * (-1430 + 16176 * + WF) .995 106.6 (.009) (.119) (1016) (11930) WF [2.348] .159 (7.3.4) Real - I - .844 n -.073) * -4250 + 46468.3 *I + WF) .995 207.8 102.5 PI (.020) (.065) (2188) (22344) IF P[ 12.6621 .605 .147 DOMESTiC WFALTH (7.3.5) Nominal tog M = -4.393 + .331 log P + (I - .304) log WD - .304 log N1 .987 .086 123.6 (.551) (.126) P (.161) (.161) -.26 .111 a/ .229 (7.3.6) Real H - .997 n -.002 A* WD + 8.204 GRP + .243 ( X CGR INVID .992 252 146.8 (.005) (.040) p (12.455) (.225) -' p pH p -5.35 .892 .3142 DOMESTIC WEALTH DISEQIILIBRIUH P .416 (7.3.7) Nominal H - .414 (-) * (I - (.922 - .073 * GRGDP)(1+'076) n .076) * WD .995 104.6 P (.185) (.003) (.048) (.019) (2.9471 .153 Real No plaustble equation TRADITIONAL (7.3.9) Nominal M - -101.7 + .467 GDP - .301 H_1 .974 135.9 (62.5) (.052) (.142) -.641 .274 (7.3.10) Real H - 2045 + .526 GDP - 3240 P .992 249.9 140.9 P (212) (.102)PGDP (646) PGDP 12.5411 .937 .298 HEIPHtLL (7.3.11) Nominal H - 75.5 + .196 RI + 1.132 F - .389 . A F .981 120.1 (54.24) (.233) (.043) (.153) [2.351 .202 (7.3.12) Real p- + .191 RM + 1.005 F - .602 AF 103.2 (21.3) (.168) (.031) (.120) 12.90O1 .347 .149 a/ Not divtded by 1o6. -71- The disequilibrium wealth results for Kenya match those for Colombia almost precisely. The investment/wealth ratio as a component of wealth is the best of the disequilibrium terms, although in this case, the additional terms are significant in neither the nominal model (F-statistic = 1.05) nor the real model (F-statistic = 2.65). Nonetheless, we report some preferred disequilibrium models in Table 7.3. Conclusions Despite their obvious differences, these three countries tell a fairly consistent story about the foreign wealth model. For example, all suggest that a Cobb-Douglas intertemporal utility function is an acceptable approximation, all generate identical functional forms for real and nominal imports, and all find the investment/wealth ratio the best of the disequilibrium terms. Even the differences among the countries have a degree of consistency. For example, Kenya -- the poorest country by a long way -- shows no signs of either smoothing imports from year to year or of responding to disequilibrium shocks such as investment booms. Colombia, on the other hand, clearly smooths imports but is ambiguous about disequilibrium, while Malaysia - the richest country -- displays both smoothing and the ability to respond to disequilibrium. A possible explanation of this pattern is that poorer countries have neither the wealth nor income to permit either smoothing or responses to investment booms, although this explanation seems more likely in a constrained borrowing framework than in our assumed world of perfect capital markets. A further consistency among countries is that the long-run -72- share of imports in wealth falls with increasing affluence, from 16 percent for Kenya through 14.3 percent for Colombia to 9.9 percent for Malaysia (in the equilibrium real models). As is clear from equation (4.14), if the intertemporal price effects are ignored, this share is a measure of the rate of time discount, and the result suggests that poorer countries have shorter horizons, an entirely plausible view. We have, therefore, a reasonable amount of corroboration for the wealth model. True, there are some rejections of the implied hypothesis that all forms of wealth affect imports similarly, and doubts arise from the data's preference for a constant rate of interest and the need, in some cases, to relate imports to investment. Nevertheless, the model appears to perform reasonably well overall. It fits well, it generates fairly clean residuals, it is plausible and it is consistent across countries. There are, however, two further sets of tests to conduct: first, to see if this model can outperform others in explaining the same data, and second, tests of structural stability. -73- VIII. OTHER MODELS In this section we introduce estimates of three other models: the domestic wealth model, discussed already, and two strawmen against which to test our wealth models. A necessary condition for the acceptability of a new model is that, broadly speaking, it outperform existing alternatives. The alternatives considered here are, first, a traditional model relating imports to GDP and relative domestic and import prices, and, second, the Hemphill model that relates imports to foreign exchange receipts and the stock of debt. The section concludes with tests of the structural stability of all the preferred equations in Tables 7.1, 7.2 and 7.3. The Domestic Models The domestic models are not subjected to such vigorous testing as the foreign model. Given their small size relative to the net present value of GNP, it seems unnecessary to test whether different components of wealth have the same effects as GNP or whether the timing of loans is important. Thus, we use only one wealth concept and test versions of two models. The Sachs model is represented by equation (5.2), but with the non-wealth terms summarized into a [log(GNP/GNP) + log p GDP, which is the deviation of real GDP from its exponential trend, GNP, converted into current prices. The Dornbusch model is represented by equation (5.6). The interest rate and stock of debt experiments are repeated, and each model is subjected to the various dynamic specification tests. For the comparisons between -74- models, we select four equations covering real and nominal imports and equilibrium and disequilibrium forms. Before discussing the country results, certain generalizations should be made. First, the preference for a constant rate of interest is repeated. Second, these models prove very much harder to estimate than the foreign wealth models, in part because they contain more parameters. Frequently, it is impossible to achieve satisfactory convergence in the non-linear forms, and, universally, the final convergences are very sensitive to small changes in specifications. This problem alone is a serious handicap in applying the models. There are also, however, substantially more problems with plausibility than previously. 1/ We never achieve a converged plausible disequilibrium equation for real imports. Third, the stock of debt variables never prove useful. Fourth, the investment/wealth ratio again usually proves to be the most successful of the disequilibrium measures. Finally, the Dornbusch formulation far outperforms the Sachs formulation. For Malaysia, only nominal imports can be satisfactorily explained by the domestic models. The Sachs version of the equilibrium model has plausible short-run coefficients, but because of a very high coefficient on lagged imports, it is not acceptable in the long run. The Dornbusch model, which with lagged imports contains five coefficients, requires several constraints to be estimable at all; in its logarithmic transformation some progress is possible, however, and it results in the preferred equation (7.1.5). This equation constrains 1/ For these reasons, the term "preferred equation" should be interpreted very loosely. -75- the coefficient on wealth to unity, which implies the short-run proportionality between imports and wealth. Over the long run, however, imports rise by 1.18 percent for every 1 percent rise in wealth, which is clearly inconsistent with the model theoretically. On the other hand, the constraint is demanded most strongly statistically: imposing long-run rather than short-run proportionality increases the SER by over 50 percent. No other equation approaches the preferred equation in terms of fit, and so we use the latter in the model comparisons, despite its theoretical shortcomings. In the disequilibrium experiments, convergence is very erratic, given the large number of coefficients, and it is necessary to replace the constant of equation (5.6) by the base-year imports/GNP ratio. (This is a normal practice in CES allocation functions; see Hickman and Lau, 1973). Nonetheless, a statistically respectable equation emerges (7.1.7), in which higher investment is associated with greater rates of time discount. It is a constrained version of the Dornbusch model. The Sachs model never converges. The Sachs model encounters severe problems with the Colombian data: it either fails to converge or suggests negative rates of time discount. The Dornbusch model fares better but, as before, requires several constraints. The final equation (7.2.5) shows no auto- regression, but strong contemporaneous substitution between imports and domestic goods. Even stronger restrictions are necessary for real imports. Again, it proves impossible to estimate the constant, and no remotely significant effects can be found for contemporaneous or intertemporal prices, or for lagged imports. Thus, ultimately, imports are expressed as a proportion of total wealth (see equation [7.2.6]). -76- The estimation problems are compounded in the domestic disequilibrium models; indeed, little consistency can be found in the results. The preferred equation, (7.2.6), appears highly desirable, with investment increasing the rate of time discount and with significant contemporaneous and intertemporal price effects. It is not robust, however, and neither the difference between equations (7.2.6) and (7.2.4), nor the single disequilibrium coefficient on (I/WD), is statistically significant. Kenya's nominal domestic models behave similarly to those of the other two countries. The Sachs model proves numerically unstable, while the logarithmic transformation of the Dornbusch model provides the best fit and most robust estimates. In this case, contemporaneous price effects are detected (they imply an import price elasticity of between 0 and -1), and the long-run proportionality of imports and wealth is acceptable. In the disequilibrium models, only the Dornbusch model is viable. Surprisingly, the growth rate of GDP proves a better disequilibrium indicator than does the investment/wealth ratio. It is acceptable either as part of the wealth calculation or in its preferred form, where it positively affects the rate of time discount. Again, while the equation looks good, the estimates are rather sensitive to small changes in specification. The Kenyan real domestic wealth model reverses all previous trends. Here the Sachs model fits better than the Dornbusch equations, and the most general equation is accepted. It implies that higher GNP produces higher imports, which is contrary to Sachs' prediction, but -77- this outcome does not seem so implausible as to require rejection of the model. The Traditional Model The traditional model is the first of our strawmen. It is introduced solely as a foil to the wealth models and receives no research effort. The estimating equation is M M = a + a1 GDP + a2( GDP ) a3 M-1 (8.1) p which is estimated in nominal and real terms, with and without a lagged dependent variable, and in linear and log-linear forms -- eight attempts altogether. The economic coefficients are constrained to zero only in the cause of plausibility, while the lagged dependent variable is retained only where it is significant. The choice between logarithmic and linear forms is made using the criteria of error whiteness and fit. The reported preferred equations, numbered 9 and 10 in the tables, require no comment, save that in this model, in keeping with tradition but not with our treatment of the domestic wealth models, we deflate GDP by its own deflator in the real equations rather than by import prices. The Hemphill Model The Hemphill model was discussed briefly in Sectio.p II, but it is useful to review its features here. 1/ We start with the balance of payments identity, 1/ Greater detail is available in Winters and Yu (1984). -78- F = M + AR, where F = Exogenous (net) foreign exchange receipts M = Total import expenditures and AR = The change in the stock of foreign assets. Hemphill models the allocation of given funds, F, between spending, M, and savings, AR, both of which are endogenous. His estimating equation is t =a + a1 Rt + a2Ft + a3 AF (8.2) where RI is the stock of foreign assets at the beginning of year t t-1 t - 1 t and is cumulated as Rt = AR. = X (F. - M.). We j 0 : j0 J expect a1 > 0 -- that is, higher reserves (lower indebtness) means higher imports. Hemphill experiments with several different allocations of balance of payments items between the exogenous F and endogenous AR elements of his model. We cannot replicate his measures, but experiment ourselves with three different definitions, as follows: Definition of F Definition of AR (1) Narrow Current credits including All capital items transfers (2) Official (1) plus net long- and Monetary items plus medium-term official long-term private and borrowing total short-term capital (3) Basic (2) plus net long- and Monetary items and short- medium-term private term capital borrowing -79- As before, the equations are estimated in real and nominal terms, with and without a lagged dependent variable -- a total of 12 estimates in all. Coefficients on net foreign exchange earnings, F, and the stock of debt, R', are retained whenever plausible, while the dynamic terms AF and M1 are kept only when significant. The choice between the three definitions of F and R' is made by reference to fit and error behavior, and in every case the "basic" definition is favored. This concept of exogenous foreign exchange receipts is the broadest and takes us some way toward estimating the balance of payments identity that, the current account balance (X - M) is equal and opposite to the sum-of the capital account balances. The latter comprise net long-term capital (F - X), short-term capital and official finance, and there is sufficient variation in the last two components to give us some confidence that our equations reflect actual behavior rather than mere accounting. (The ratio of the sample standard deviations of short-term capital plus official financing flows to that of imports is 12.4 percent, 23.0 percent and 21.0 percent for Malaysia, Colombia and Kenya, respectively.) Three general observations should be made about the preferred equations, numbered 11 and 12 in the tables. First, in the real equations, every variable, including the constant, is deflated by the import price. This approach seems correct theoretically (debt accumulates in nominal terms) and is vindicated empirically in the case of Malaysia, for which it is tested. Second, the real equations always fit better than the nominal ones. Third, each equation requires one, but only one, of the dynamic terms. -80- The estimated Hemphill equation is a reduced form, and while the structural form cannot be estimated because it involves unobservables, the structural parameters are identifiable. Fortunately, they seem fairly plausible for all three countries. The most contentious implied structural parameter is the marginal increment in the desired stock of reserves and short-term assets with respect to an increase in long-term foreign exchange receipts; these are 0.41, 0.38 and 0.11 for Malaysia, Colombia and Kenya, respectively. All are positive, suggesting that as wealth rises, countries prefer to have higher short-term assets rather than higher short-term debts; they are related to income -- richer countries like higher reserves; and they are not wildly different from previous estimates of the reserve/import relationship. Structural Stability Clearly, a good model must display stable estimates as the sample period varies. Therefore, we conclude this section by conducting some limited stability tests of the preferred equations of Tables 7.1, 7.2 and 7.3. We use all our data in estimating the various models, so that independent forecasting results are not possible. We do, however, conduct two sets of in-sample tests, which are at least indicative. First, we experiment with Brown, Durbin and Evans' CUSUM and CUSUMSQ tests. Unfortunately, our sample is too small to yield meaningful results: in line with the findings of other researchers using small samples, the CUSUM test never rejects the null hypothesis of stability, while the CUSUMSQ always does. We thus place little reliance on these tests. -81- The second batch of tests are merely Chow tests conducted on various in-sample years. lie separately test 3 years to see if they conform to the model explaining the remaining 17. The three years are 1965, which as the end point of the sample is likely to be the most sensitive indicator of functional misspecification; 1974, the most turbulent year of the sample period; and 1982, an end year also subject to large shocks. The results are reported in Table 8.1. Each model receives at least one rejection, and these tend to be concentrated in the later of the years. On the whole, the tests of stability reflect the other properties of the equations -- the better performing equations tend to show less instability. These results are not perfect -- ideally we want no instability -- but, on the other hand, neither are they indicative of serious and widespread problems, at least among the stronger models (see the next section). Table 8.1: STRUCTURAL STABILITY TESTS a/ Malaysia Colombia Kenya Model 1965 1982 1974 1965 1982 1974 1965 1982 1974 Nominal Foreign wealth X Foreign w. disequilibrium X Domestic x Domestic disequilibrium X Traditional x x Hemphill x _ _ Real Foreign wealth x Foreign w. disequilibrium X X Domestic _ x Domestic disequilibrium _ _ Traditional X X X Hemphill x Note: X = rejection of stability at the 5 percent level. = no preferred equation. blank = hypothesis of structural stability not rejected. a! Chow-test of the null hypothesis that imports in the year tested exhibit the same behavior as in the year of the sample. -83- IX. COMPARING THE MODELS Having identified a preferred real and a preferred nominal equation from each model, we now test them against each other, using, for ease of computation, Davidson and MacKinnon's (1981) P-tests. For non-tested hypotheses, if we have two models of process y, HO Yt f (Xti + ot (9.1) and H:yt g(Z Y) + t (9.2) 1 ti it then we can test the truth of Ho by seeing whether H can contribute to the explanation of y in addition to the factors in H . The test statistic is derived from the equation ^ ^ ^ ~~k aft (y - f ag - k -f (9.3) fY f) = c(gt f f) + i~ . 1 a.i + 1'(93 t t t t To 8 i :1 where ft and gt are fitted values under Ho and H1, respectively, the (-a-) are derived from equation (9.1), and the (8k) are nuisance parameters of no intrinsic interest. This equation asks whether the estimated residuals of Ho, (y - f), are related at all to the factors appearing in H1 but not in Ho0 (g - f). The second set of terms in equation (9.3) appears only to correct for any correlations between the latter and the elements already included in Ho. If H0 is true, the elements in H but not in H0 add nothing to the explanation, and so -84- a = 0. Any other value of a suggests that Ho is incorrect and thus rejects it. Davidson and MacKinnon show that a is asymptotically distributed as N(0,1), under the null hypothesis that Ho is true. The test is not symmetric, for a = 1 does not prove that HI is true. For that, it is necessary to repeat the test with Ho and HI reversed. Davidson and MacKinnon show that several alternatives, y = g.(), can be tested simultaneously by replacing the first term on m the right of equation (9-3) by a 1 (gjt -t) A drawback of this test is that it assumes that y is always the dependent variable, whereas in our case we might actually have any or all of M, /M, log (M) or log ( / M) as dependent variables. We p p have evaded this issue by always converting g to the units in which f is measured. For the deflation by p , this approach is unlikely to be flawed, for pM is exogenous, and we are basically just reversing a heteroskedasticity transformation. For the logarithmic transformation, however, it is potentially serious, and we merely plead that it is not obviously actually so. (Since we completed this work, we have noted that MacKinnon, White and Davidson, 1983, have addressed this problem of the P-test. They suggest using equation [9.3] but with f converted into the units in which g is measured. While this PE-test has few desirable properties in theory, the authors claim it is of considerable practical use. It is not clear how it compares with our procedure, although intuitively we might expect ours to lead to fewer rejections, since in our case, HI meets Ho on H 's own ground.) -85- The models are compared in Tables 9.1, 9.2 and 9.3. These tables report both the standard errors of the various equations in terms of their fit to nominal imports and the results of the non-nested tests. Taking Malaysia first, it is plain that the two nominal disequilibrium models are the best-fitting, followed by the real models in general. The equilibrium wealth models fare very badly. This pattern of preference is largely borne out by the non- nested tests. Reading along each row of the matrix shows which alternative models reject a particular null; the columns show which nulls a particular alternative rejects. Thus, for Malaysia, we observe a general tendency for the real models to reject the nominal ones (in the top right quandrant) and not to be rejected by them (bottom left). Against this result, however, the nominal foreign disequilibrium wealth model (7.3.2) rejects all other models and is rejected by none of them. This finding is powerful, and it is reinforced by noting that in Table 8.1, the foreign disequilibrium wealth model is one of the only two models not to display any structural instability. If we were to put this model aside, however, because of its suspected simultaneity problem or because of the difficulties of projecting investment, then among the remaining equations, the real Hemphill one has similarly persuasive results. Observe how, in this case, the Hemphill model rejects the nominal domestic disequilbrium formulation and is not rejected by it, despite the latter's superior fit. The predominant reason for the differences in fit between the disequilibrium wealth models and most of the other models concerns the former's ability to predict the continuing strong growth of imports in Table 9.1: NON-NESTED TESTS AND FITS -- MALAYSIA Alternative hypothesis a/ FN FDN DN DDN TN HN FR FDR DR DDR TR HR SER b/ Null hypothesis a/ F N X X X X X X X 371.0 FD N X X 197.9 D N X X _ X X X __ X X 518.4 DD N X X X X X __ X X 215.6 T N X X X X X X _ X X 392.4 H N X X X X X X X 295.8 0 F R X X X X X 400.5 FD R X X X 260.5 D R DD R T R X X X X 275.1 H R X 266.5 a/ Definitions: F -- foreign wealth; FD -- foreign wealth disequilibrium; D - domestic wealth; DD -- domestic wealth disequilibrium; T - traditional; H -- Hemphill; N -- nominal imports; R -- real imports; and X -- rejection of Ho by H1 using Davidson and MacKinnon's P-test. b/ Standard error of nominal imports. Note: Not applicable. -87- 1982. This growth occurred despite decelerating foreign exchange inflows, but coincided with a strong expansion of domestic investment. It is also interesting to note the relatively poor performance of the equilibrium wealth models. A priori, Malaysia looked a rather good candidate for this approach to imports, for the responses to the discovery and development of oil typically would appear to be "forward- looking." Wealth, and thus expenditures, rose well before the oil resources came on-stream to boost exports or GDP. Capturing this effect is precisely the novelty of this type of model. Two observations might be made: first, we may be modelling oil expectations wrongly; second, the processes may be as postulated, but because the investment in the oil industry is financed by borrowing from abroad, the associated rise in foreign exchange receipts, which drives the Hemphill model, may reflect the imports of oil equipment more faithfully than does our imperfect wealth measure. Note, again, how we return to the interaction between imports and investment. The discrimination among models is weaker for Colombia. Nearly all models can generate an equation with a standard error of around $200 million, and there are fewer rejections in general. Nonetheless, the nominal foreign disequilibrium model again sweeps the board, rejecting all models and being rejected by none. There are two caveats to this result, however. First, the model shows signs of structural instability in Table 8.1. Second, while by Davidson and MacKinnon's P-test it rejects its equilibrium counterpart, it does not do so in the nested F-test that can also be made between these two models. Since the former is only an asymptotic test, while the latter is correct in small samples, we should really Table 9.2: NON-NESTED TESTS AND FITS -- COLOMBIA Alternative hypothesis a/ FN FDN DN DDN TN HN FR FDR DR DDR TR HR SER b/ Null Hypothesis a/ F N X X X 200.0 FD N 186.6 D N X X X 199.7 DD N c/ 191.8 T N X X 193.2 H N X X _ X X X 203.6 F R X X X X X X X X X 213.7 FD R X X X X X 238.0 D R X X X X X 232.0 DD R T R X X 232.7 H R X X _ X 200.1 a/ Definitions: F -- foreign wealth; FD -- foreign wealth disequilibrium; D -- domestic wealth; DD -- domestic wealth disequilibrium; T - traditional; H - Hemphill; N - nominal imports; R - real imports; X -- rejection of Ho by H1 using Davidson and MacKinnon's P-test. b/ Standard error of nominal imports. c/ Using Davidson and MacKinnon's C-test. Note: Not applicable. -89- simplify the disequilibrium model to its equilibrium form. However, in this form, which is analyzed in row 2 and column 2 of the matrix in Table 9.2, the wealth model is rejected by two models and rejects none. Part of the reason for the greater ambiguity with Colombia is presumably that, in the absence of a large and obviously forward-looking component of wealth such as oil, there is less statistical discrimination between the foreign wealth and the foreign exchange receipts series. Further, Colombia is known to have had considerable illicit exports of narcotics at times. These presumably boost imports without appearing anywhere in our explanatory variables. If this trade fluctuated significantly, it could entirely swamp the "legal" component of trade that we can model. Kenya exhibits a wider range of fit than Colombia and more model rejections. There is no general preference between the real and nominal models. The strongest model appears to be Hemphill's real equation, which rejects all alternatives and is rejected by none. Following it are the 'two nominal disequilibrium models. The Kenyan models show greater structural stability than the other countries'. This outcome partly reflects the fact that the in-sample fits (R 2) for Kenya are worse. Thus, a given percentage prediction error is more likely to be within the range experienced over the sample period. The only instabilities detected for Kenya are for 1974, and they arise from the severe underprediction of import expenditures as the oil-price rose: the share of fuels in Kenya's imports rose from 10.9 percent in 1973 to 22.4 percent in 1974. Although not always statistically significant, this problem afflicts all the Kenyan models. Table 9.3: NON-NESTED TESTS AND FITS -- KENYA Alternative hypothesis a/ FN FDN DN DDN TN HN FR FDR DR DDR TR HR SER b/ Null hypothesis a/ F N X X X X 106.9 FD N X X 106.6 D N X X X X X 123.6 DD N X X 104.5 T N X X X X _ X X X X 135.0 R N X X X X _ X X 120.0 F R X X X X X X 108.4 FD R X X 92.9 D R X X X X X X X X 133.0 DD R T R X X X X X X X X 141.9 H R 103.1 a/ Definitions: F -- foreign wealth; FD -- foreign wealth disequilibrium; D -- domestic wealth; DD -- domestic wealth disequilibrium; T -- traditional; H -- Hemphill; N -- nominal imports; R -- real imports; X -- rejection of Ho by H, using Davidson and MacKinnon's P-test. b/ Standard error of nominal imports. Note: Not applicable. -91- It is interesting that Kenya -- the poorest country of our sample and the one least attractive to lenders -- favors the model which assumes capital market imperfections, while Malaysia -- the richest and, with oil, ostensibly the most attractive -- favors the perfect capital (or unrestricted borrowing) assumption. The upshot of these tests is that, of all the models, the nominal foreign disequilibrium wealth model and the real Hemphill model appear to be the best. In both Malaysia and Kenya, they constitute the optimal pair, while in Colombia the results are ambiguous. There are, however, possible simultaneous biases in both these models that caution against too uncritical an acceptance of the rankings. The disequilibrium model faces a possible link between imports and investment, while both models would be confounded by the endogeneity of exports. We rate the latter as the smaller danger, both absolutely and in terms of the damage that ignored correlations would do to the estimates. We tentatively conclude that foreign exchange-based models of imports dominate GDP-based ones. It is clear that the domestic models need more attention before they can be applied, although it should be recalled that we simplified Sach's version even before estimation. The traditional model, while among the leaders for Colombia, does not in general perform well. In economic terms, the models chosen here suggest a strong and direct link between financial variables and developing countries' imports. The Hemphill model suggests that, subject to some damping through changes in short-term debt, any shock to net foreign exchange receipts will produce a corresponding change in import expenditures. -92- This pattern is equally true for changes in export earnings, long-term borrowing or interest payments. The intertemporal models suggest a similar story. They indicate a degree smoothing to the import path, and in the disequilibrium form admit a role for investment booms, but otherwise changes in revenue get translated directly into changes in imports. The absence of strong intertemporal price effects renders changes in wealth the principal determinant of imports, and these changes in turn are driven primarily by current account receipts and the interest rate. Thus, according to this model, imports have been curtailed over the eighties both by weak export markets and high interest rates. It is not appropriate here to make forecasts (even of past years), but the results of this paper suggest most strongly that greater exports to developing countries will not be a significant engine of recovery for the OECD in the near future. Indeed, without significant progress in at least some of the following directions -- lower interest rates, stronger export markets, or freer borrowing and capital transfers -- most developing countries' imports will remain rather stagnant for several years. -93- X. CONCLUSIONS This paper explores four models of import determination for each of three developing countries. The objectives are twofold. Primarily we wish to explore the issue of financial variables in import determination. To this end, we develop an operational model of intertemporal foreign exchange management, devoting considerable space to its specification and measurement. The model proves viable -- in that an estimable form has been derived- -- and potentially quite useful. For all three countries, it gives fairly plausible results, and there is a strong consistency across countries. It does appear, however, to require some modification to reflect disequilibrium factors for at least one of the sample countries. The model is compared with three others models of imports. One applies the intertemporal analysis to total wealth rather than merely to its foreign exchange component, while the other two relate imports to flows of income- or to foreign exchange receipts. In the case of one country -- Malaysia -- the model developed here is dominant (although the dominant form gives rise to some doubts about simultaneity bias.); in another case -- Kenya -- it is dominated; while in the third -- Colombia -- there is considerable ambiguity. The second, intimately related, objective is to discover a single, simple, robust import function for developing countries for use in the World Bank's and OECD's global modelling activities. The choice is essentially between the foreign disequilibrium wealth form and the real Hemphill model. Neither is perfect, and each is subject to worries about simultaneity. Thus, while they might be preferable to other -94- approaches, we do not at present have sufficient information to distinguish between them. Future research should be devoted to this distinction, a task that basically amounts to exploring the perfect capital markets hypothesis of the model developed here. On the other hand, both approaches agree on the importance of financial variables in developing countries7 imports, and both suggest that until the industrial countries can generate better marketing opportunities, as well as higher capital transfers and lower interest rates, developing countries' imports will remain rather stagnant. - 95 - APPENDIX: DATA AND DEFINITIONS The principal data sources used in the study are: o International Financial Statistics o Balance of payments statistics and o The World Bank debt data bank. The series for LIBOR, which is not published, was supplied privately by the Bank for international settlements. Certain World Bank debt data are also not published. This appendix describes the sources and definitions of data where these are not obvious from the text and the published material. It starts with general definitions and then considers special features of each country's data. All data are measured in (converted into) US dollars. General Definitions Imports: merchandise (f.o.b.) plus shipment plus "other" debits, i.e., total debits, less investment income and unrequited transfers. Import prices: unit value of merchandise imports. Assets: reserves plus gold (valued at London gold price) less net foreign liabilities of banks. Exports: total credits less official grants and net unrequited transfers. Export prices: unit value of merchandise exports. - 96 - National interest rates: rate on borrowing from financial institutions. This rate had to be extrapolated on the basis of the US rates of interest for the years prior to 1965. Price of domestic sales of domestic output: GDP deflator. Debt and lending: all medium and long-term lending, as recorded by the World Bank's Debtor Recording System. All stocks refer to the beginning of the period. Malaysia Expected Export Receipts: Two problems were evident here. First, Malaysia became an oil exporter over our sample period. Merely extrapolating the rate of growth of export revenues seemed wholly inadequate. Therefore, we assumed (1) static expectations on oil prices, and (2) that oil quantities could broadly be foreseen up to five years in advance. Three series of expectations were constructed on this basis: one operating over 1965-69, one over 1970-77 (the switch to this series occurred when the leap in actual exports of 1975-79 was deemed anticipated), and one over 1978-82 (when the rise in exports in 1982-85 was deemed anticipated). The series are shown graphically in Figure A.1. For example, we assumed that the expectation in 1969 of oil exports in 1970 was 45, whereas the expectation in 1970 for that year was 110. The increases projected over 1983-85 are based on specialists' advice, and the export peak in 1971 is dismissed as an aberration, being balanced by abnormally high imports of oil. The second problem concerned non-oil exports. These grew so fast throughout most of our sample period that extrapolating their growth rate led to infinite wealth in most years. When these years were Figure A.l: MALAYSIAN OIL EXPORTS, ACTUAL AND EXPECTED 150 Actual 1978-' L40 -~ Expectations formed 1965-69 - ~ Expectations formed 1970-77 / 130 output_ index 120 Expectations formed 1978-> / 198l, =100 110 - -- - - 1970-77 100 90 80 70 60 50 ---1965-69 40 30 20 10 | .-Changes in expectations Time 65 70 75 80 85 - 98 - adjusted as suggested on pages 30-31 of the text, the wealth series proved highly volatile. We therefore chose to apply static expectations to export revenues, measuring the net present value of exports as (X/r). Expected import prices: It was assumed that most import prices were expected to grow in the long run at their average growth rate over the last five years. The price of oil, however, was assumed fixed in nominal terms, as were all export prices. Exports and imports: For technical reasons, imports for Malaysia include debits of unrequited transfers, while exports include only credits. Experiments suggest that this treatment made no practical difference to the results from the treatment specified above. In economic terms, our standard treatment implied that investment income payments and unrequited transfers were prior claims on foreign exchange revenues before imports could be obtained, whereas our "Malaysian" treatment implies that only investment income was. Colombia Coffee exports: Coffee exports are separated from non-coffee exports when calculating expectations. Non-coffee export price expectations are static, whereas the coffee export price expectation is the average price for the previous five years. Volume expectations are static for both. Non-commercial lending: Our calculations required a series of non-concessional disbursements to Colombia back to 1960. However, there was no information for 1960, and we used half the value for 1961. - 99 - Kenya Exports: Balance of payments data for Kenya begin in 1963, the year Kenya gained independence. It is possible to obtain data on imports and exports of merchandise from the colonial reports. These data -are separated into external trade and trade within the East African territory. Data on trade within the territory are likely to be understated, since the boundaries of the three territories were administered by a total of six customs posts. All pre-independence data are customs data and are reported in East African pounds. These were converted to dollars and added to our sample. We needed data on total trade credits back to 1955, and these were estimated by extrapolating an ordinary least squares regression of the exports of other goods and services and net unrequited transfers (less grants) on merchandise exports and a time trend fitted over 1964-82. Exceptional finance: Data for international capital flows and unrequited transfers contain elements of exceptional financing. In the latter class, these data are broken out because they are considered accommodating. They are not so treated for loans, however, since loans still entered the total stocks of debt. This treatment implies that Kenya could have expected to be able to borrow money without much difficulty to cover its imports; thus such funds are included in the import decision. On the other hand, grants, being costless, were probably more scarce and the country could not expect them. They would be given after the import decision was made. For most of the models, exceptional financing was treated like any other capital flow. However, for Hemphill's model we experimented - 100 - by excluding exceptional financing from one version of the current foreign exchange earnings and by adjusting reserves to take these grants into account. There was little difference between the two versions. Gold: Kenya has very small gold holdings. The data series begins in 1973, with zero values recorded until 1977. It was assumed that gold holdings were non-existent prior to 1973. Interest rates: Data were needed back to 1955 for interest rate expectations. The value of 0.065 was used prior to independence. For years missing data on what the financial institutions were charging (1963, 1964, 1967, 1968, 1969 and 1974), the average rate on non- concessional loans was used. Expectations: Export revenue expectations were adjusted to take into account price fluctuations for tea and coffee. Price expectations for these beverage exports were taken as the five-year averages of a composite price of the two goods. The composite price was calculated with 1970 weights. - 101 - REFERENCES Armington, P. S. 1969. "A Theory of Demand for Products Distinguished by Place of Production." IMF Staff Papers 16:159-77. Chu, K., E. C. Hwa, and K. Krishnamurty. 1983. "Export Instability and Adjustments of Imports, Capital Inflows and External Reserves: A Short-run Dynamic Model." In Bigman, D., and T. Taya, eds. Exchange Rate and Trade Instability. Cambridge, Mass: Ballinger, pp. 195- 213. Davidson, R., and J. G. MacKinnon. 1981. "Several Tests for Model Specification in the Presence of Alternative Hypotheses." Econometrica 49:781-93. Dornbusch, R. 1983. "Real Interest Rates, Home Goods and Optimal External Borrowing." Journal Political Economy 91:141-53. Hemphill, W. L. 1974. "The Effects of Foreign Exchange Receipts on Imports of Less Developed Countries." IMF Staff Papers 21:637-76. Hickman, B. G., and L. F. Lau. 1973. "Elasticities of Substitution and Export Demands in *a World Trade Model." European Economic Review 4:347-86. MacDonald, D. C. 1983. "Debt Capacity and Developing Country Borrowing: A Survey of the Literature." IMF Staff Papers 29:603- 46. MacKinnon, J. G., H. White, and R. Davidson. 1983. "Tests for Model Specification in the Presence of Alternative Hypotheses." Journal of Econometrics 21:53-57. Obstfeld, M. 1982. "Aggregate Spending and the Terms of Trade: Is There a Laursen-Metzler Effect?" Quarterly Journal of Economics XCVII:251-70. Riedel, J. 1983. "Determinants of LDC Borrowing in International Financial Markets: Theory and Empirical Evidence." World Bank, Washington, D.C., February. Mimeo. Sachs, J. 1981. "The Current Account and Macroeconomic Adjustment in the 1970s." Brookings Papers in Economic Activity 10:201-68. . 1982. "The Current Account and Macroeconomic Adjustment Process." Discussion Paper 187, Institute for International Economic Studies, Stockholm. - 102 - Sundararajan, V. 1983. "Exchange Rate Versus Credit Policy: Analysis with a Monetary Model of Trade and Inflation in India." International Monetary Fund. Mimeo. (Forthcoming in Journal of Development Economics.) Winters, L. A. 1984. "Separability and the Specification of Foreign Trade Functions." Journal of International Economics 17:239-64. Winters, L. A., and K. Yu. 1984. "Import Functions for Global Projections." Division Working Paper 1984-9, Global Analysis Division, World Bank, Washington, D.C. World Bank Economic Analysis of Projects Economy-Wide Models and Lyn Scuire and TDevelopment Planning Publications HerLnan G. van der Tak Charles R. Blitzer, Peter B. Clark, of Related Reconsiders project appraisal and rec- and Lance Taylor, editors ommends a more systematic and con- Surveys the specification and uses of Interest sistent estimation and application of medium-term and perspective econo- shadow prices and a calculation of mywide planning models. rates of return that take explicit ac- in8 1982.r382 pres ( 7clud in t- count of the project's impact on the Oxgr 1 n82ers8t Prgess, 1975;n seletepn distribution of income, additional readings, bibliography, subecwt The Johns Hopkins University Press, 1975; and author index). Approaches to Purchasing 4th printing, 1981. 164 pages (including LC 4-29171. ISBN 0-19-920074-2, Stock Power Parity and Real Product appendix, glossary, bibliography). No. OX 920074. S9.95 papeback. Comparisons Using Shortcuts LC 75-40228. ISBN 0-8018-1818-4, Stock and Reduced Information Nvo. /H 1818, $6.50. Sultan Ahmed French: Analyse economique des projets. Staff Working Paper No. 418. 1980. 62 Economtica, 1977; 2nd printing, 1981. pages (including 14 tables, bibliography). ISBN 2-7178-0014-X, Stock No. IB 0550, Stock No. WP-0418. $3. $6.50. Financing of Investment in Comparative Study of the Spanish: Analisis economico de proyectos. India, 1975-1985: A Sources Mianagement and Organization Editorial Tecnos, 1977 ISBN 84-309-0719- and Uses of Funds Approach of Irrigation Projects Armando Pinell-Siles and V.J. Anthony F. Bottrall Economic and Social Analysis Ravishankar Staff Working Paper No. 458. 274 pages of Projects and of Price Policy: Staff Working Paper No. 543. 1982. 92 (including 3 appendixs). The Morocco Fourth pages. Stock No. WP-0458. S10. Agricultural Credit Project ISBN 0-8213-0205-5. Stock No. WP 0543. Kevin M. Cleaver $3. NEW Staff Working Paper No. 369. 1980. 59 pages (including annex tables). Cost-Benefit Analysis: Issues Stock No. WP-0369. $3. and Methodology Anandarup Ray General Equilibrium Models Examines the numerous important NEW for Development Poli o, contributions to the theory and prac- Economic Evaluation of Kemal Dervis, Jaime de Melo, tice of cost-benefit analysis, consolidat- I P and Shesman Robmnson ing much of the recent work in ths Investment rojects: Provides a comprehensive study of area and focusing on aspects that con- Possibilities and Problems of multisector, economywide planning tinue to be controversial. Discusses al- Applying Western Methods in models with particular emphasis on is- ternative types of valuation functions, China sues of trade, distribution, growth, differential weighting for income ine- Adrian Wood and structural change. Theoretical dis- quality and for disparities in the con- This paper describes economttc c cussion of the properties of multisec- sumption of basic needs, shadow ex- bnetanlytor, appaied general equilibrium change rates and the valuation of 19U. analysis and its tci- to models is combined with numerical nontraded and traded goods and serv- project appraisal in China. It was writ- apiain opriua onre n LC 8 04i67.lSBN0-818-368-,Stck tenf Worignalya backgrNoun material.5 aperiaense tof particular countries and ices, valuation of savings and budget fenorigiatamo Chase expegroudtsaterepar- problems. The models considered constraints, and concepts of discount for a tag ueful fra w for policy anals rates nd of hadow age raes. Th ing projet apprisal mnualnfretheom input-output and linear 8018-3069-9 Stock shado.wIH 3 , rs.50 CISBna prnvestmentrai B anku. Wth r 0e63n programming to the more recent non- techniques and implications of using mists pInners, Band . Otaer s linear computable generl equilbrium the more recent approaches are ex- mists,findnitrsefu ind droingt busnaerssi (CGE) models. The authors consider plamnd in ractial trms. ttemps to China. Concentrates on methods of es- how these models can be used to ana- provide a more complete account oft.mtnshdwpiefoprjci- lyeqsinsfgothadtuc the issues and polemics in cost-benefit Ptsmatng sdowtus pricses frproject tuyze quanestionsecto of grwt ond ruc-n analysis than is currently available in pusadotuseicusspoettrxchangergm, an the slcionpaof oforeig the literature. A lengthy overview is impact on the level of national income texcangve regilome,nd sthaegimpac ofn and the need to combine various crite- tenivdvlom tsragesn also provided for nonspecialist read- nawt h eut ffra cnmc the distribution of income. The empiri- ers. analyi winh dh eutoomlecno-u cal applications are based both on T'he Johns Hopkins Univerity Press. 1984. sions. mkn nvsmn cross-country analysis and on the ex- 208 pages. perience of particular countries and LC 83-049367. ISBN 0-8028-3068-0, Stock Staff Working Paper No. 632. 1983. 53 demonstrate how such models provide No. JH 3068, $22.50 (hardcover); ISBN 0- pages. a useful framework for policy analysis. 8018-3069-9, Stock No. JH 3069, $9.50 ISBN 0-8213-0326-3. Stock No. WP 0632. Particular attention is focused on the (papeback). S3. problems of planning and policy for- mulation in mixed-market economies No. JH 2001, $27 hardcover: ISBN 0- and to the conflicting demands of re- and on the nature of models required 8018-2006-5, Stock No. rH 2006, $9.95 gional and global estimates. Compari- to capture the important mechanisms paperback. sons are given of prices, real per capita that constrain policy markets. quantities, and final expenditure com- Cambridge University Press. S44 pages. The International Comparison ponents of GDP for thirty-four coun- LC 81-12307. ISBN 0-521-24490-0, Stock Project tries for 1975. By relating the results to No. IB 0556, $42.50 hardcover, ISBN 0- Three volumes that establish a world- certain widely available national in- 521-27030-8, Stock No. lB 0557, S27.95 wide system of international compari- come accounting data and related vari- pa521 l-2 sons of real product and of the pur- ables, the authors develop extrapolat- chasing power of currencies. in8 equations to estimate per capita The Global Framework: An GuP for the thirty-four countries for Updaee S 1950 to 1978. In addition, the 1975 dis- Briata N [ afi tribution of world product by region Brian N)Jolan lgpXliEf and per capita income class is esti- Staff Working Paper No. 533. 1982. 58 ;_... ._ mated. The 1975 results confirm rela- pages. tions between both quantities and ISBN 0-8223-0047-4. Stock No. WP 0533. prices and per capita income found in S;3 the earlier volumes. Global Modeling in the World The Johns Hopkins University Press, 1982. Glob;d Modeling in the World ~~~~~~~~~~398 pages. Bank, 1973-1976 LC 82-15569. ISBN 0-8018-2359-5, Stock Wouter Tims and Jean Waelbroeck No. JH 2359, $35 hardcover: ISBN 0- Describes the first stage of the global 8018-2360-9, Stock No. IH 2360, $25 pa- analytical system which has become an Pha I: A System of ck. essential feature of the Bank's eco- nonic work. Evaluates the projections International Comparisons of for the world economy generated by Gross Product and Purchasing NEW the models, of particular interest be- Power cause of the sharp rise in petroleum Irving B. Kravis, Zoltan Kenessey, Macroeconomic and prices in the mid-1970s. Points out Alan Heston, and Robert Summers Distributional Implications of uaws in the system which are now re- medied with new analytical tools. Establishes the methodology and pre- Sectoral Policy Interventions: Staff Working Pap No. 54. 1983. 200 sents comparisons of gross domestic The Case of Energy and Rice Staff Working Paper product per capita and currency pur- in Thailand pages. chasing power for ten countries in P. Amnranand and W. Grais ISBN 0-8213-0109-8. Stock No. WP 0544. 1970 and six of the same countries in nan on d fram o S5. 1967. Prsents an economywide framework The fohns Hopkcins University Press, 1975. for policy analysis in Thailand. This Humandz Factors in Project Work 306 pages (ipncldn glossaryPrs, index . framework-the 51AM2 model-is Heli PerreFto 306 a (ncluding glossary, index), used here to analyze two sets of poli- and erancis J. Lethem LC 73-19352. ISBN 0-8018-1606-8, Stock c des. Focuses on energy pricing and Sand Wrangs Pape Let 39he 180m No. IH1- 606, $27.30 hardcover, rice pri'cing. Shows the value of this Staff Woi*ng Pa3per No. 3597. 1980.ts 85l- No. I 1606, S27.JO hardcover. analytical framework for policy analy- pages (including 3 annexes, 5 charts. bibli- Phase II: Intemnational sis that focuses on structural adjust- og° phy). Comparisons of Real Product ment in production and trade patterns. Stock No. WP-0397. $3. and Purchasing Power Staff Working Paper No. 627. 1984. 200 Human Resource Development Irving B. Kravis, Alan Heston, and pages. and Economic Growth in Robert Sumzners Stock No. WP 627. $5. Developing Countries: A Updates Phase I and adds six new Methodologies for Measuring Simultaneous Model countries, comparing the figures for AdutrlPieItreto David Wheeler the sixteen countries for the years 1970 AgiltrlPceIevnio and 1973. Effects Staff Working Paper No. 407. 1980. 130 The Johns Hopkins University Press, 1978. Pasquale L. Scandizzo pages (including 8 appendixes, bibliog- 274 pages (including glossary, index). and Colin Bruce rapy). . LC 77-17252. ISBN 0-8018-2019-7, Stock Staff Working Paper No. 394. 1980. 106 Stock No. WP-0407. SS. No. JH 2029, S25 hardcover: ISBN 0- pages (including 4 appendixs, references). Ilterdependence in Planning: 8018-2020-0, Stock No.JH 2020, $8.50 pa- Stock No. WP-0394. $5. Multilevel Programming pack. A Model of an Agricultural Studies of the Ivory Coast Phase III: World Product and Household: Theory and Louis M. Goreux Income: International Evidence Provides a system for analyzing each Comparisons of Real GDP Howard N. Barnum and Lyn component of a country's economy in- Irving B. Kravis, Alan Heston, Squire dependenly and relates the interde- and lobert Summers Innovative model of short-run behav- pendencies between the components., Thi report restates and extends the ior that combined production and con- The Johns Hopkins University Press, 2977. methodology set out in the first two sumption decisions in a theoretically 448 pagos (including bliogrophy, index). volumes. -Particular attention is given consistent fashion for an agricultural LC 77-4793. ISBN 0-8018-2001-4, Stock to the problem of comparing services household. The Johns Hopkins University Press, 1980. proposes a reorientation of develop- LC 79-12739. ISBN 0-8018-11554. Stock 118 pages (including appendix, references). ment policy to achieve more equutable No. IH 1155, S5.95 paperback. LC 78-21397. ISBN 0-8018-22254, Stock distribution. French: L'appreciation du nsque dens No. IH 2225, S6.95 paperback. Oxford University Press. 1974; 4th print- 1'evaluation des proiets. Dunold Editeur. ing, 1982. 324 pages (including annex, SS95. Multisector Models and the bibliography). Analysis of Alternative ISBN 0-19-920070-X, Stock No. OX Social Cost-Benefit Analysis: A Development Strategies: An 920070, S9.95 paperback. Guide for Country and Project Application to Korea French: Redistribution et croissance. Economists to the Derivation Yuji Kubo, Jeffrey D. Lewis, Jaime Presses Universitaires de France. ISBN and Application of Economic de Melo and Sherman Robinson 22403102. S9.95. and Social Accounting Prices An exploration of the use of multisec- Spanish: Redistribucion con crecimiento. Coln Bruce tor models as tools for analyzing the Editorin Tecnos, 2976. ISBN 84-309- Staff Working Paper No. 239. August relation between altemative develop- 0624-X. S9.95. 1976. 148 pages (including 6 annexes). ment strategies, growth and structural A Relationship between the Stock No WP 0239 55 change in a developing country. Dy- Rate of Economic Growth and namic input-output and CGE models the Rate, Allocation, and Techniques for Project are applied to the 1963-73 period 'in teR e,Alcio adAppraisal under Uncertainty Korea and used as simulation laborato- Efficiency of Investment Appras unger ries for analysis. Dennis Anderson Shlomo Reutlinger Staff Working Paper No. 563. 1983. 52 Discusses how the methods and re- Presents a method of evaluating risk in pages. sults of microeconomics affects the investment projects and means for us- ISBN 0-8213-0174-8. Stock No. WP 0563. analysis of growth in the relationship deisionmakungt $3. described in the title. Drawing on So dheJohsiHopkiansg nvrst.rss 90 low's vintage model of growth, this The Johns Hopkins Univesity Press, 1970; The Political Economy of paper derives an aggregate form of the 4th printing, 1979. 108 pages (including Specialized Farm Credit relationship and compares the ap- annex, bibliography). Institutions in Low-Income proach with those of several long- LC 74-94827. ISBN 0-8018-2154-6, Stock Countries ~~~~~~~~standing studies of the subject. No. JH 1154, $5.95 paperback. J.D. Von Pischke, Peter J. Staff Workng Paper No. 591. 1983.44 What is a SAM? A Layman's Heffernan, and Dale 'W. Adams ISBN 0-8213-0186-1. Stock No. WP 0591. Guide to Social Accounting Staff Working Paper No. 446. 1981. 102 S3. Matrices pages. Risk Analysis in Project Benjamin B. King Stoc-k No. WP-04. $5. ~ Appraisal Staff Working Paper No. 463. 2981. 59 Redistribution with Growth Louis Y. Pouliquen pages (including refernces), Hollis Chenery, Montek S. Discusses methodological problems Stock No. WP-0463. S3. Ahluwalia, Clive Bell, John H. and the usefulness of simulation; illus- Duloy, and Richard Jolly trated by three case studies. Describes existing inequality in in- The Johns Hopkins University Press, 1970; comes in developing countries and 5th printing, 1983. 90 pages. The Developing Countries and Export Promotion Policies International Shipping Barend A. de Vries Harald Hansen Staff Working Paper No. 313. 1979. 80 Staff Working Paper No. 502. 1981. 151 pages. pages (including 12 annexes, 38 tables, Stock No. WP 0313. $3. bibliography). Stock No. WP 0502. $5. NEW Exports of Capital Goods and NEW Related Services from the Republic of Korea Economics and the Politics of Larry E. Westphal, Yung W. Rhee, Protection: Some Case Studies Linsu Kim, Alice Amsden Adjustment to External Shocks of Industries Examines Korea's spectacular export in Developing Economies Vincent Cable growth-from $50 million of goods in Bela Balassa Looks at factors which effect an indus- 1962 to $25 billion in 1982. Five kinds Staff Working Paper No. 472. 1981. 31 try's attitude toward protection by of project-related exports are character- pages (including appendix). analyzing four of Great Britain's indus- ized (overseas construction, plant ex- Stock No. WP 0472. $3. tries: footwear, knitwear, cutlery, and ports, direct investments, consulting consumer electronics. Case studies ex- services, Licensing and technical agree- Policies and ~~amine import competition from devel- ments). Discusses the role of these ex- Adjustment Policies and oping countries and adjustment op- ports in Korea's strategy for develop- Problems in Developed Countries tions exercised within each industry. ment. Shows how these strategies Martin Wolf Study includes some explanations for conform to the country's dynamic Staff Working Paper No. 349. 1979. 236 protectionist behavior among indus- comparative advantage by enlarging its pages (including references). tries and a discussion of the politics of mdustral base. Stock No. WP 0349. $10. decisionmaking in regard to trade pol- Staff Working Paper No. 629. 1983. 80 icy. pages. Staff Working Paper No. 569. 1983. 80 ISBN 0-8213-0310-4.Stock No. WP 0629. Britain's Pattern of pages. $3. Specialization in Manufactured ISBN 0-821340199-3.Stock No. WP 0569. On Exports and Economic Goods with Developing $3. Growth Countries and Trade Protection Gershon Feder Vincent Cable and Ivonia Rebelo Effects of Non-Tariff Barriers Staff Working Paper No. 508. 1982. 24 Staff Working Paper No. 425. 1980. 61 to Trade on Prices, pages (including appendix, references). pages (including 3 appendixes). Employment, and Imports: The Stock No. WP 0508. $3. Stock No. WP 0425. $3. Case of the Swedish Textile and Clothing Industry India's Exports Carl Hamilton Martin Wolf NEW Staff Working Paper No. 429. 1980. 63 Despite improved performance, the pages (including appendix, bibliography). growth of India's exports continues to Bureaucracies and the Political Stock No. WP 0429. $3. lag behind need, potential, and the Economy of Protection: achievements of several of its competi- of a Continental Energy, Inte.national Trade, tors. This study examines India's over- Reflections of a Contmental Energy, Intemational Trade, all export performance in the 1960s European and Economic Growth and 1970s, with emphasis on the cen- Patrick Messerlin Alan S. Manne and Sehun Kim tral role of incentives. The major prob- Analyzes three factors that influence Staff Working Paper No. 474. 1981. 30 lems and policies are discussed, as the "bureaus" (bureaucrats) in their pages (including 2 appendixes, references). well as current strategic options. decisions affecting protectionism in Stock No. WP 0474. $3. Oxford University Press. 1982. 224 pages France. (including index). Staff Working Paper No. 568. 1983. 64 LC 82-6309. ISBN 0-19-520211-2. Stock pages. . No. OX 520211, $22.50 hardcover. (A ISBN 0-8213-0198-5. Stock No. WP 0568. European Communty specially priced edition is available in India $3. Protection against from Oxford University Press branches.) Manufactured Imports from Capital-Importing Oil Developing Countries: A Case Industrial Country Policy and Exporters: Adjustment Issues Study in the Political Economy Adjustment to Imports from and Policy Choices of Protection Developing Countries Alan H. Gelb E. Verreydt and J. Waelbroeck J. M. Finger Staff Working Paper No. 475. 1981. 38 Staff Working Paper No. 432. 1980. 25 Staff Working Paper No. 470. 1981. 22 pages (including 9 tables). pages. pages (including references). Stock No. WP 0475. $3. Stock No. WP 0432. $3. Stock No. WP 0470. $3. Italian Commercial Policies in in the EEC markets but have less effect NEW the 1970s in keeping out non-EEC imports. Enzo R. Grill Staff Working Paper No. 567. 1983. 48 Real Wages and Exchange pages. Rates in the Philippines, 1956- Staff Woreng Paper No. 428. 1980. 47 ISBN 0-8213-0197-7. Stock No. WP 0567 78: An Application of the Stock No. WP 0428. $3. Stolper-Samuelson-Rybczynski Output and Employment Model of Trade Changes in a "Trade Sensitive" Deepak Lal NEW Sector: Adjustment in the U.S. Explains the movements of real wages Footwear Industry in the Philippines in terms of a simple Korea's Competitive Edge: John H. Mutti and Malcolm D. regression model. Examines the coun- ompe,ve ge, try's postwar economic performance Managing Entry into World Bale and draws some tentative conclusions Markets Staff Working Paper No. 430. 1980. 21 for economic policy. Yung Whee Rhee, Bruce Ross- pages (including footnotes, references). Staff Working Paper No. 604. 1983. 60 Larson, and Garry Pursell Stock No. WP 0430. $3. pages. How did Korea manage to expand its Patterns of Barriers to Trade in ISBN 0-8213-0213-2.Stock No. WP 0604. exports from less than $100.milhon a Sweden: A Stud in the 3. year in the early 1960s to more than y $20 bilion a year in the early 1980s? Theory of Protection Shadow Prices for Trade To find out about the underpinnings Lars Lundberg Strategy and Investment of Korea's competitive edge, the au- Staff Working Paper No. 494. 1981. 35 Planning in Egypt thors asked more than 100 major Ko- pages (including 3 appendixes). John Page, Jr. rean exporters what had been impor- Stock No. WP 0494. $3. Working PrN tant for them in institutional support, Sfaff Working Paper No. 521. 1982. 212 in technological development, and in The Political Economy of pages. marketing overseas. The findings Protection in Belgium ISBN 0-8213-0009-1. Stock No. WP 0521. show that there is a strong interaction P.K.M. Tharakan $10. between exporting and the effective- S 1. 1ral an ness of a country's economic institu- Staff Working Paper No. 431. 1980. 22 Structural Change in Trade in tions, both public and private. Without pages (including statistical appendix, refer- Manufactured Goods between effective institutions, a country may ences). W 0 3 Industrial and Developing not be able to implement effective pol- S W 3 $ Countries icies for export promotion. Conversely, successful exporting appears to give The Political Market for Bela Balassa economic institutions more vitality and Protection in Industrial Staff Working Paper No. 396. 1980. 46 effectiveness. The findings also show Countries: Empirical Evidence pages. how Korea's selectivity-in the acqui- Kym Anderson and Robert E. Stock No. WP 0396. $3. sition of technology and in the market- Baldwin ing of products overseas-has been an Staff Working Paper No. 492. 1981. 28 NEW Important part of Korea's success in pages (including references). The Structure of International The Johns Hopkins University Press. June Stock No. WP 0492. $3. Competitiveness in the Federal 1984. About 204 pages. On Protectionism in the Republic of Germany: An ISBN 0-8018-3266-7. $19.95. Netherlands Appraisal K.A. Koekkoek, J. Kol, and L.B.M. Frank D. Weiss On the Political Economy of Mennes Probes the comparative trade advan- Protection in Germany Staff Working Paper No. 493. 1981. 70 tage of the Federal Republic of Ger- H. H. Glismann and F. D. Weiss pages (including 3 annexes, references). many in the 1980s with surprising con- Staff orkin Pape No. 47. 790. 30Stock No. WP 0493. $3. clusions: developing countries are Staff Wor(ing Paper No. 427. 1980. 30 Stc competitive with the Federal Republic pages (including bibliography). of Germany in a far wider range of Stock No. WP 0427. $3. NEW products than had been previously Public ssistane to Inustries thought. Suggests probable trends, es- Public Assistance to Industries hpecaly toward developing countries. NEW and Trade Policy in France Concludes that the faster income in Bernard Bobe developing countries grows, the faster The Political Economy of Describes the institutional structure these countries will become competi- Protection in Italy: Some through which trade police is deter- tive in an even wider range of goods. Empirical Evidence mined. Focuses on the evolution of Innovation, though a key factor, can- Emp ril and J La N France's international commerce in the not determine comparative advantage, Enzo Grilli and Mvauro La NMoce 1970s and assesses probable trends for because innovations spread rapidly This analysis is based on a model that the future. through the world economy. specifies the demand side of the mar- ket. Examines 35 industrial subsectors Staff Working Paper No. 570. 1983. 64 Staff Working Paper No. 571. 1983. 84 in terms of EEC tariff protection and pages. pages. Italy's domestic subsidy assistance. ISBN 0-8213-0200-0. Stock No. WP 0570. ISBN 0-8213-0201-9. Stock No. WP 0571. Finds that tariffs protect Italian exports $3. $3. The Structure of Protection in Trade and Employment Why the Emperor's New Developing Countries Policies for Industrial Clothes Are Not Made in Bela Balassa and others Development Colombia: A Case Study in The Johns Hopkins University Press, 1971, Keith Marsden Latin American and East Asian 394 pages (including 5 appendixes, index). In the last decade, the developing Manufactured Exports LC 77-147366. ISBN 0-8018-1257-7, Stock countries have proved that they can David Morawetz No. IH 1257. $25 hardcover. compete internationally in exporting Focuses on the exports of a particular manufactured goods, as well as pn- commodity (clothing) from a particular mary products and services. This pa- Latin American country (Colombia) in per examines three sets of issues: (a) an attempt to understand why Latin Testing for Direction of whether good export performance is America has been so much less suc- Exports: India's Exports of attributable to special characteristics of cessful at exporting manufactured Manufactures in the 1970s the most successful countries or goods to date than East Asia. It is the Ashok Khaanna whether their success can be readily first study to go into great detail in ex- the hyothess thatthe eportsreplicated in other countries; (b)amigthprc,ndeeilyte Tests whether the penetration of the mar- amninr det einantsof exportysuc- of a developing country with an ad- kets of industrial countries has n vanced manufacturing sector will differ reached, or will soon reach, a limit; cess. among destintions: the capital inten- and (c) whether trade in manufactures Oxfrd Universityj Press, 1981. 208 pages sity of exports will be greater to the among the developing countries can (including appendixes, biblig pahy). more labor abundant destinations, and expand further. Concludes with a dis- LC 81-9547. ISBN 0-19-520283-X, Stock the labor intensity of export will be cussion of the contribution of small No. OX 520283, $22 hardcover. greater to the more capital abundant enterprises to the creation of employ- Worker Adjustment to destinations. India's exports of manu- ment and the alleviation of poverty. Liberalized Trade: Costs and factures for 1973 and 1978 are used for 1982. 70 pages (including annex). Assistance Policies Staff Working Paper No. 538. a983. 41 ISBN 0-8213-0017-2. Stock No. BK 0017. Graham Glenday, Glenn P. pages. W p 8 Jenkins, and John C. Evans ISBN 0-8213-0132-2.Stock No. WP 0538. Staff Working Paper No. 426. 1980. 87 $3. Trade in Non-Factor Services: pages (including 2 appendixes, bibliog- Past Trends and Current Issues raphy). Andre Sapir and Ernst Lutz Stock No. WP 0426. $3. Staff Working Paper No. 410. 1980. 140 World Trade and Output of The Tokyo Round: Results and pages (including 4 annexes). Manufactures: Structural Implications for Developing Stock No. WP 0410. $5. Trends and Developing Countries Countries' Exports Ria Kemper Trade in Services: Economic Donald B. Keesing Staff Working Paper No. 372. 1980. 38 Determinants and Staff Working Paper No. 316. 1979. pages (including annex). drelopmend-Elat Issues 74 pages (including statistical annex). Stock No. WP 0372. $3. Andre Sapir and Ernst Lutz Strend iNo W nte03 tionaTrad Staff Working Paper No. 480. 1981. 38 Trends in u ntedational Trade pages (including appendix, references). i Manufactured Goods and Trade Adjustment Policies and Stock No. WP 0480. $3. Structural Change in the Income Distribution in Three Industrial Countries Archetype Developing Trade Polig for Developing Bela Balassa with the assistance of ArconmetyeDvlpn Trade Policy for Developing Kenneth Meyers Economies Countries Examines recent trends in trade in Robinson Donald B. Keesing manufactured goods between the in- Staff Working Paper No. 442. 1980. 91 tWorld Bank Staff Working Paper No. 353, dustrial and the developing countries. Staffs Workluing Papperno.i442. 1980es.9 August 1979, vii + 264 pages (including Analyzes (a) the implications of these pages (including appendixes, references). references). trends for structural change in the in- Stock No. WP 0442. $3. Stock No. WP-0353. $10. dustrial countries and (b) changes over time in the current dollar value and the commodity composition of trade in Trade Policy Issues for the manufactured goods. Recommends Trade among Developing Developing Countries in the teational trade amned at promoting in- Countries: Theory, Policy 1980s change. Issues, and Principal Trends Isaiah Frank Staff Workeng Paper No. 611. 1983. 44 Staff Working Paper No. 479. 1981. 116 World Bank Staff Working Paper No. 478. pages. pages (including 2 appendixes, references). August 1981. 52 pages. ISBN 0-8213-0251-S.Stock No. WP 0611. Stock No. WP 0479. $5. Stock No. WP-0478. $3. $3. 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