Basu 2016

Structural Revolution in International Business Architecture
Structural Revolution in
International Business
Architecture
Modelling and Analysis: Volume 1
Dipak Basu
Nagasaki University, Japan
Victoria Miroshnik
Tsukuba University Graduate School of Management, Tokyo, Japan
© Dipak Basu and Victoria Miroshnik 2016
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My father Walter, with love
Victoria
My uncle Nisith Ranjan Mitra, with respect
Dipak
Contents
List of Tables viii

List of Figures x
Preface xi
Introduction 1
1 The Meaning of Structural Revolution 3
2 Tariff Policy and Employment Structure
in the UK 21
3 Structural Reforms in China 50
4 Structural Reforms in India 91
5 Structural Reforms in Nigeria 127
6 Structural Reforms in Egypt 162
References 193
Index 207
vii
List of Tables
1.1 Exports and Gross Domestic Product, 1980–2000 5

1.2 Sub-Saharan Africa: evolution of employment in the
formal sector during the early adjustment phase
(as percentage of the active population) 6
1.3 Informal employment as percentage of labour
force (non-agricultural) in early globalization in
selected countries in Latin America 6
1.4 Composition of social sector expenditures
(percentage of GDP) 10
1.5 Trends in the selected social indicators 11
2.1 Distribution of the UK exports 41
2.2 Origins of the UK imports 42
2.3 Structure of employment, UK (percentage share of total) 43
2.4 Effects of different import control regimes
on imports of the UK 46
3.1 China—historical data: 1985–90 63
3.2 Investment, savings and foreign investment 64
3.3 Policy assumptions—simulation 1 and 2 64
3.4 Chinese economy, simulation 1 65
3.6 Historical exchange rate 1987–95 74
3.8 Country share for China 78
3.9 The Chinese economy, simulation 1 80
3.10 The Chinese economy, simulation 2 81
3.11 Export growth rates in East Asian economies (unit: %) 84
3.12 Trade destructions caused by China 85
4.1 Per-capita daily availability of food grain (grams) 98
4.2 Annual growth in food grains production (per cent) 99
viii
List of Tables ix
4.3 Money supply, GNP and price levels: 1985–97 102

4.4 Some important ratios 102
4.5 Financial policies, 1985–97 103
4.6 Fiscal dynamics 116
4.7 Debt ratios and foreign borrowings: history (%) 117
A1 Historical data for all variables in the model 124
A2 Target 125
A3 Simulated planned solutions 126
5.1 Simulation assumptions—Nigeria 138
5.1a Movement of policy instruments, 1985–92 140
5.2 Summary table—Nigeria, historical data 141
5.3 Simulation 1 143
6.1 Selected macroeconomic indicators of Egypt, 2000–10 163
6.2 Historical data, Egypt 1987–1991 175
6.3 Historical data, Egypt 1992–1997 175
6.4 Policy assumptions, simulation 1 176
6.7 Policy simulation 1 of the Egyptian economy 178
List of Figures
3.1 Simulation 1, GDP and domestic demand, China 69

3.2 Simulation 1, current account balances, China 70
3.3 Simulation 1, consumer prices, China 71
3.4 Simulation 2, GDP and domestic demand, China 72
3.5 Simulation 2, current account balances, China 73
3.6 Simulation 2, consumer prices, China 74
4.1 Comparisons, GNP 118
4.2 Comparisons, public budget 118
4.3 Comparisons, net foreign borrowing 119
4.4 Comparisons, government bond sales 119
4.5 Comparisons, government expenditure 120
4.6 Comparisons, tax revenues 120
5.1 Nigeria, growth in aggregate GDP, 1990–2010 132
5.2 Nigeria, Dollar/Naira exchange rate, 1990–2010 133
5.3 Nigeria’s medium and long-term debt by creditor group 149
5.4 Nigeria—history 150
5.5 Nigeria—simulation 1 151
6.1 Egypt, GDP and foreign exchange reserve 171
6.2 Egypt, simulation 1 172
x
Preface
This book is the result of many years of fierce debates and discussions
between us, the authors, and with our friends including Alexis Lazaridis,
Shigeru Uchida, Buddhadev Ghosh and participants of seminars in
the Indian Statistical Institute, Calcutta, India. Garry Mason went
through the entire text to improve the language. Liz Barlow of Palgrave
Macmillan contributed the most by supporting our effort to publish
this book.
In this book, we are going against the tide by raising questions against
the privatization process and the new international economic order,
against which both the youths of the USA and the workers in India are
protesting in vain. In this book we have tried to analyse some promi-
nent countries of the world—the UK, China, India, Egypt and Nigeria—
to examine the above issue from two specific points of view. The first is
to answer the basic question of whether it was necessary to dismantle
the old system and privatize the economy rather than utilizing the tra-
ditional stabilization policy through monetary and fiscal instruments,
when economic crises appeared in the late 1980s and early 1990s. The
second objective is to examine whether there was any alternative way.
In this book, in the analysis of the recent globalization, we have used
the techniques of simulations of ‘economy-wide’ models to analyse
alternative policy frameworks for the countries we have covered. The
purpose is to re-examine the relative merits of alternative economic and
international business policy regimes. This project is unique because
it uses ‘simulation techniques’ to discuss possible alternative policy
regimes. We hope this book will initiate the debate regarding the effi-
ciency of this new international business system and be a call for action
to change the ‘reform agenda’.
xi
Introduction
An economic reform programme was started by the International

Monetary Fund (IMF) and World Bank a long time ago, first in Africa
in the mid 1980s. The aim was to have a structural reform to make the
economy more efficient. It was not declared at that time what ‘eco-
nomic reform’ would mean in practical terms, but instead a number of
critical remarks were made against the planned or managed economic
systems and their inefficiency. The declared aim was to remove obsta-
cles against efficient running of the economy. The major criticisms
against a planned economy were: (1) absence of a price system that allo-
cates resources efficiently; (2) bureaucracy that prohibits individual’s
initiatives and progress; and (3) controlled trade regimes that prevent
the producers from obtaining the world price for their products and
prohibits consumers from having the best products at the lowest price.
It was not clear then how the IMF and World Bank would proceed to
remove these inefficient characteristics from the economy. Since 1991,
after the collapse of the Soviet Union, it became clear that by an effi-
cient economy, the IMF and World Bank meant a free market economy.
That doctrine was enhanced after the completion of the GATT (General
Agreement on Trade and Tariff) in 1995 and with the establishment of
the World Trade Organization (WTO) to create a revolution in world
trade, production and flows of capital from one country to another,
in a world unrestricted by any sense of nationalism. This book is the
analysis and modelling of the historical process of the first phase of
‘globalization’ of economic policy, through the World Bank, IMF and
WTO induced structural adjustment programme.
Capitalism has a long history of more than 200 years, during which it
has progressed mainly through colonialism to extract surplus from out-
side to finance developments. Thus, the first globalization was through
1
2 Structural Revolution in International Business Architecture, Volume 1
colonization. During that phase, companies were subservient to the

colonizer government, which used to dictate terms to the companies.
In the second globalization, major multinational companies are trying
to expand their activities to the entire world. In this phase, the inter-
est of the nation is subservient to the companies. Companies are now
declaring their terms to host governments and to the country of their
origin. The interests of the companies are different from those of the
nation. Indian importers are importing textiles from China, although
India itself is a major textile producing country. Similarly, Newcastle in
the UK is importing coal and Nippon Steel is producing steel in China
not in Japan. Most of the established theories of economics, particularly
of international trade, became obsolete in this new world trade and
production architecture. The main issue is how, in these new circum-
stances, host nations organize their economic resources.
In this book we have tried to analyze some prominent countries of
the world to examine the issue from two specific points of view. The
first is to answer the basic question of whether it was necessary to dis-
mantle the old system and privatize the economy, rather than utilizing
the traditional stabilization policy through monetary and fiscal instru-
ments, when crises appeared in the late 1980s and early 1990s mainly
due to the demise of the Soviet Union and the East European economic
union causing serious disruptions in world trade, and the resultant wars
and destruction. The second objective is to examine whether there was
any alternative way. In the analysis of the recent globalization we have
used the simulations of economy-wide models to analyze alternative
policy frameworks for the economies of the UK, China, India, Nigeria
and Egypt. The purpose is to re-examine the relative merits of alterna-
tive economic and trade policy regimes through economy-wide models.
1
The Meaning of Structural
Revolution
Multinational Companies and National Economies
During the colonial period, and even after the Second World War, state
powers were used to provide security for the interests of multinational
companies. Since the 16th century, there have been imperial conquests
by Western European countries, and as early as the 7th century by Islamic
countries, to promote their business interests and to capture essential
sea and land routes for international business. Since the Second World
War, ‘regime changes’ have been used for the same purposes. The
interests of the multinational companies and their governments were
identical in these imperialistic conquests. The impacts of these inter-
ventions on colonized countries are great social and economic upheav-
als, destructions of domestic industries, forced migration of people and
devastating famines. Within ten years of 1757, when the East India
Company acquired the contract to collect taxes in Bengal, one fifth of
the population were wiped out. Nearly a million people were killed in
1973 in Chile in order to protect the interest of the American mining
companies. At those times, some parts of these colonized countries,
particularly in the coastal areas, benefited from the expansion of trading
activities and participations in the global economy controlled by the
multinational companies of the great colonial powers.
The rapid developments of the East Asian countries, including China,
are mainly due to foreign investments. As a result, now developing
countries are competing for foreign investments and offering more
and more attractive terms to multinational companies. The slave trade,
which used to be dominated by the Islamic, Arabic, Turkish and north
African countries and sanctified by the Khalifas, was taken over by the
Christian countries of Western Europe and blessed by the Popes.
3
The International Monetary Fund (IMF), the World Bank, and the
World Trade Organization (WTO) have now replaced those Popes and
Khalifas, creating and maintaining their shared motives and objectives to
promote the interests of multinational companies in the area of trade. Just
as the 19th-century high priests of the Age of Enlightenment, John Stuart
Mill, David Ricardo and Jeremy Bentham of the East India Company, did
to justify colonialism in the name of free trade, the IMF, the World Bank
and WTO promote services and investments but not people. They do so to
create free flow of products and privatization of public industries, in order
to promote the so-called ‘efficiency of resource use’ and to abolish any
central planning of investment for the country. Promotion of free trade is
the most important agenda. The IMF’s declared policy is to facilitate the
balanced growth of international trade. However, the historical examples
are against it. Free trade between India and the UK had ruined the domes-
tic textile industry in India in the 19th century. Free trade between the USA
and China has since ruined the established industries in USA. India’s trade
deficit with China had reached around US$60 billion in 2014.
The WTO claims that it creates a rules-based system for the conduct of
trade relations; but once again the historical experience in recent years
has been very different. China has a variety of non-tariff restrictions and
an artificially low fixed exchange rate to promote its exports. WTO is
unable to do anything.
The Role of Trade Policy in IMF-Supported Programmes
The overall objectives of IMF-supported programmes are to achieve

balance of payments stability and macroeconomic stability with a high
level of economic activity. The reforms of the trade regimes generally
mean removal of quantitative restrictions on imports and reductions of
subsidies for exports to create a competitive atmosphere in the interna-
tional trade system. The Extended Fund Facility (EFF) and the Poverty
Reduction and Growth Facility (PRGF) are designed as both carrots and
sticks. These provoke the liberalization of restrictions on trade flows and
exchange rate systems and complement structural reforms to reduce the
role of the government in the total economic activity (IMF, 1991).
The Trade Restrictiveness Index (TRI), developed by the IMF, gives a
measure of the restrictive practices of a country’s trade policy. Countries
are rated on their index of liberalized trade practices. According to the
IMF and the World Bank, the rapid expansion of trade was the result of
liberalization. However, fears are raised that trade has not accompanied
real rate of growth for the domestic economies.
The Meaning of Structural Revolution 5
Extent and Focus of Trade Policy Conditions
This section examines the overall trends in structural conditions related

to trade policy in IMF-supported programmes during the early days of
globalization, 1987–99, based on the Monitoring of Fund Arrangements
database (MONA). Data from MONA indicate that the structural condi-
tions on trade policy reforms were relatively stable.
Effects on Employment Patterns
A strange result has emerged in Africa where, since the introduction of

reforms, the percentage of the labour force working in formal sector jobs
has declined, as a result of the reduced scale of the public sector and
the relative inability of the countries in Africa to achieve higher growth
paths (van der Hoeven and van der Geest, 1999). This is foreshadowed
by the fact that African countries in general have implemented the
Table 1.1 Exports and Gross Domestic Product, 1980–2000
1980–2000 1980–90 1990–2000
(average growth rate %)
World
Volume of exports of goods 5.6 4.5 6.8
Real GDP growth 3.3 3.4 3.2
Advanced Economies
Developing Countries
Asia
Sub-Saharan Africa
Middle East and North Africa
Western Hemisphere
Source: Word Economic Outlook (World Bank).

structural reforms as suggested by the IMF, the World Bank and the
WTO. Foreign domestic investment in English-speaking Africa, which
is needed to provide the financial backing for the necessary structural
changes, has not been forthcoming. Foreign investments are lacking
and there is a low rate of domestic investment flows.
Experiences are different in Asia where their high formal sector
employment, employment in the manufacturing sector and, in South
Asia, employment in the informal sector were impressive (ILO, 1996).
In Latin America, the cost of liberalization was high. As Lee (1996)
points out:
The experience of Chile in the early 1980s illustrates that the output con-
tracted by 23 per cent in 1982–93 and unemployment remained above 23
per cent for 5 years. Similarly the Mexican crisis of 1994–95 illustrated the
devastating effect of wrong monetary and exchange rate policies.
Table 1.2 Sub-Saharan Africa: evolution of employment in the formal sector

during the early adjustment phase (as percentage of the active population)
Country 1990 1995
Kenya 18.0 16.9

Uganda 17.2 13.3
Tanzania 9.2 8.1
Zambia 20.7 18.0
Zimbabwe 28.9 25.3
Source: UNILO.
Table 1.3 Informal employment as percentage of labour force (non-agricultural)

in early globalization in selected countries in Latin America
1990 1991 1992 1993 1994 1995 1996 1997
Latin America 51.6 52.4 53.0 53.9 54.9 56.1 57.4 57.7
Argentina 47.5 48.6 49.6 50.8 52.5 53.3 53.6 53.8
Brazil 52.0 53.2 54.3 55.5 56.5 57.6 59.3 60.4
Chile 49.9 49.9 49.7 49.9 51.6 51.2 50.9 51.3
Colombia 55.2 55.7 55.8 55.4 54.8 54.8 54.6 54.7
Mexico 55.5 55.8 56.0 57.0 57.0 59.4 60.2 59.4
Paraguay 61.4 62.0 62.2 62.5 68.9 65.5 67.9 59.4
Uruguay 36.3 36.7 36.6 37.0 37.9 37.7 37.9 37.1
(Montevideo
only)
Venezuela 38.8 38.3 37.4 38.4 44.8 46.9 47.7 48.1
Source: UNILO (1998).

Despite positive growth rates, liberalization measures in Latin

America have resulted in more and more insecure and low paid jobs in
the informal sectors (Fanelli and Frenkel, 1995, 2003). Latin American
workers are fearful of further liberalization measures (ILO, 1995).
Trade-off between growth and equity

There is an old argument that inequality is good for growth because
higher level of inequality creates more savings from the higher income
groups and, as a result, the growth rate will be higher. While that may
be true in the initial level of liberalization, there is increasing evidence
that inequality is not good for growth (Alesina and Perotti, 1994).
Increasing equality means higher levels of demand for manufactured
products and increased levels of education, leading to high levels of
skilled manpower. Increased inequality also means increasing power
of the oligarchs, which leads to demands for lower taxes and subsi-
dies. These in turn can result in both fiscal deficits and inability of the
poorer sections of society to create sufficient demands for a privatized
economy (Persson and Tabellini, 1994) and are all growth destructive.
Inequality can cause social turmoil and eventual destruction of a civil
government, swiftly replaced by a military government. This may pre-
vent governments from taking effective measures for economic growth
(Stern, 1991). Macroeconomic policies can have emphasis on tax poli-
cies and on expenditure policies (Pyatt, 1993), with monetary policies
playing only a lesser role, as tested by Keynes, which can bring social
stability and growth. Active minimum wage policy, redistribution of
the fiscal burden, targeted public expenditure and redistribution of
ownership assets can all contribute a lot towards the goal of equality
through growth. However, in reality this is not the case and, as a result,
we are experiencing increasing social turmoil (UNDP, 1991; Khan 1992;
Stiglitz, 1998).
The IMF and the World Bank’s programmes to liberalize the economy
might have done serious damage to the fortunes of the poorer people of
the countries receiving their funds and advice (Easterly, 2000). The poor
have lost the advantages of subsidies and protected employments. They
are mainly in the informal sector and the small scale low technology-
oriented manufacturing sectors, which are under increasing attack from
Chinese exports over which WTO cannot offer any protection.
World Poverty Trends over the Last Decade
Recent history, after the structural reforms, does not support the
theoretical views given by the IMF, the World Bank and the WTO. The
number of people living on US$1 a day or less fell from about 1.3 billion
in 1990 to 1.2 billion in 1998. We concentrate on the income dimen-
sion of poverty, not the calorie consumption of the people, because in
that situation there is no case for liberalization at all. To hide the real
poverty rate, most countries, India for example, do not care anymore
about the calorie content that makes up people’s consumption. Even the
proportion of the population living in poverty—the poverty rate—fell a
little, from 29 per cent to 24 per cent during the same period (1990–98).
Poverty reduction performance was also extremely uneven. Poverty fell
by the most in East Asia, to about 1.8 billion people. However, much of
the reduction in poverty was in China, whose statistics are most unreli-
able. Poverty outcomes were much less impressive in other developing
regions. Total numbers of people living under US$1 a day increased in
all other regions. In South Asia, there was a decline of four percentage
points in the poverty rates. Poverty rates never went down at all in Latin
America, sub-Saharan Africa and the Middle East and North Africa.
Disaster struck in Eastern Europe and Central Asia, where countries
moved away from socialism to a free enterprise system and real poverty
returned after an absence of at least 50 years.
Has Globalization Increased Inequality between Countries?
It seems that globalization has increased inequalities between countries

as well as people. In 1960 the average per capita GDP in the richest 20
countries in the world was 15 times that of the poorest 20. In 2000, rich
countries were earning 30 times more per capita. Real incomes in the
poorest 20 countries have stagnated since 1960, but have gone down
in a number of countries. After globalization, in most cases, the poorer
countries grew less rapidly than the richer countries.
Labour Market Developments
There is a causal link between the liberalization policy and labour mar-
ket trends in the countries that adopted these adjustment processes. In
Africa, for example, formal sector employment declined mainly because
of the much reduced public sector and the repressed growth of the
private sector, which failed to create alternative employment (van der
Hoeven and van der Geest, 1999). Thus, the proposed aim of the liber-
alization process, to create more jobs in the formal sector, is still unful-
filled. With rich natural resources, and low wage rates, African countries
have no excuse not to develop. However, despite implementing most
aspects of the reform process they could not develop their economies.
Foreign investments are coming mainly from China, which has never
seriously embarked upon any liberalization programme; instead state
planning is still the norm.
In South Asia there are strong indications that employment in the
informal sector has expanded, but not in the formal sector (ILO, 1996).
Also in Latin America, transitional costs of liberalization policies have
been high. As Lee (1996) points out, ‘The experience of Chile in the
early 1980s illustrates the severe effects of overshooting in terms of
stabilization policy. Output contracted by 23 per cent in 1982–93 and
unemployment remained above 23 per cent for 5 years’.
Changes in wage and income inequality increased in Asia in six out
of 12 countries, Bangladesh, Indonesia, Thailand, China, Singapore and
Sri Lanka; in Africa in four out of six countries, Nigeria, Tanzania, Kenya
and Ethiopia: and in Latin America in nine out of 14 countries, Bolivia,
Mexico, Argentina, Brazil, Panama, Venezuela, Guatemala, Honduras
and Peru (World Bank, 1996).
The theory of liberalization suggests that liberalization means
declining inequality, as trade liberalization will favour a country
that has comparative advantage in the production of certain goods.
Developing countries have the advantage of low cost labour (Berry,
1997). However, as the ILO (1996) have pointed out, in most coun-
tries that underwent the liberalization process the result was falling
real wages and increasing poverty of the labour force, particularly
in the privatized public sectors. The manufacturing industry tends
to be dominated by large companies in the formal sector, where
wages are higher but there are weak linkages to the small scale sector.
Liberalization makes it easier to import capital goods and raises the
demand for skilled labour (UNDP, 1997).
Amsden and van der Hoeven (1996) observed that the distribution
between incomes from labour and capital in industry was shifted in
the direction of capital in the 1980s. This has led to changes in con-
sumption patterns and lifestyles, adding to inequity (Pieper, 1997; ILO,
1996). Liberalization has resulted in the decline of trade union member-
ship, which has weakened the bargaining power of workers.
Changes in Human Capital Formation
Liberalizations had negative effects on social expenditure in the public

budget, because governments’ revenues from import tariffs went down
significantly. The natural response of the governments in the developing
countries was to reduce expenditures on health, education and social wel-

fare. The World Bank (1996) pointed out that, ‘especially in Latin America
and Africa, adjustment programmes were accompanied with a decline in
the percentage of social expenditure in total government expenditures’.
Educational and health indicators measuring primary and secondary
school enrolment encountered deterioration in educational standards.
In Africa, primary school enrolment rates declined, affecting large parts
of the population, especially in poorer areas (van der Hoeven and van
der Geest, 1999). In Latin America, even the middle class suffered large
setbacks in providing their children with accessible quality education.
Limited or absent progress in education has serious effects on the
quality of the work force of a country. As a result, that country may
not be able to take advantage of the liberalization process by producing
high quality products for the export markets. Londono (1996) argues
that the growing of exports has reduced the demand for a low-skilled
labour force, because the small scale industries are overwhelmed by
competition from China.
UNCTAD (1997) reported on educational attainment and the skill
intensity of exports in a number of countries. The analysis provides
support for the hypothesis that:
Table 1.4 Composition of social sector expenditures (percentage of GDP)
Asia Latin America(a) Sub Saharan Africa(a)
Before During After Before During After Before During After
Expenditure
Total social 2.7 3.3 3.4 7.1 7.3 7.8 5.9 5.6 5.3
spending
Education 1.8 2.2 2.2 3.0 2.7 2.6 3.4 3.3 3.1
Health 0.5 0.6 0.6 1.7 2.1 2.4 1.3 1.2 1.1
Percentage of total expenditures
Total social 17.9 19.6 19.6 23.7 23.4 19.3 26.1 22.4 19.9
spending
Education/total 11.8 12.9 12.6 19.6 16.9 14.3 16.3 14.2 13.5
expenditures
Health/total 3.6 3.4 3.7 9.2 10.9 11.0 6.0 5.4 5.2
expenditures
Note: a = Only countries with data for the post-adjustment period.

Source: World Bank (1996).
Table 1.5 Trends in the selected social indicators
Indicator Asia Latin America(a) Africa(a)
Before During After Before During After Before During After
% change in gross 1.3 0.5 0.3 1.4 −0.4 1.0 4.7 −0.5 −0.4
enrolment ratio
% change in infant −2.5 −3.1 −3.6 −5.6 −2.5 −2.4 −1.8 −1.7 −1.4
mortality rate
Note: a = only countries with data for the post-adjustment period.

Source: World Bank (1996).
educational attainment is a necessary but not a sufficient condition for

skill-intensive production … All countries with a high share of skill-
intensive exports also have a relatively high educational attainment while
evidence from countries such as Argentina, Chile, Peru and Uruguay sug-
gests that relatively high educational attainment does not automatically
translate into skill-intensive exports … Almost all countries where high
educational attainment has translated into skill-intensive exports are
those that have sustained a rapid pace of capital accumulation, techno-
logical upgrading and productivity growth over many decades. (van der
Hoeven, 2000)
Thus, a slowdown in primary, basic, secondary and vocational educa-

tion gives rise to greater inequality in society. Reduction in government
revenues, due to the lowering of import tariffs, can create shortages of
highly skilled labour and thus the country will be unable to compete in
international markets.
Privatization as Economic Reform
Trade liberalization means the removal of restrictions on import tariffs,

reduction of subsidies on exports, legislation barriers and quotas and
other non-tariff restrictions on imports. Most developed countries have
initiated trade liberalization as the most important part of their eco-
nomic reform programme, starting in the 1980s. Privatization of public
sector industries and other public commercial establishments is one
of the integral parts of the economic reform to turn the semi-socialist
countries into free enterprise economies.
Some European countries have privatized their public utility
sectors—electricity, water and gas—to promote competition between
these industries with the declared aim to increase efficiency or to

‘roll back socialism’. The reform programme, as suggested to the
developing countries, includes privatization as its main component
of the World Bank’s Poverty Reduction Strategy Papers (PRSPs), and
privatization now is required to obtain funding from international
organizations, leading commercial banks and non-banking financial
organizations.
The rationale for privatization is improving the efficiency of the busi-
ness organizations by putting emphasis on strict financial accounts.
The theory is that private sectors are better than public sectors when it
comes to allocating resources in order to increase efficiency, although
there is no evidence. The theory also suggests that it will increase
economic activity of a nation, and remove poverty by creating more
employment. It is argued that the government of a country can gain
financially by reducing its budget deficits and increasing budget sur-
plus. As a result, the government can spend more on the social sectors
to improve the standard of living of the people (Campbell-White and
Bhatia, 1998). However, this is only a theory. The question of how
privatization can increase private investment continuously to create
production efficiency and employment has not been answered. These
theoretical gains depend on various other factors in the economy that
are unrelated to the ownership structure. In many countries, both
developed and developing, the government needs to provide subsidies
to the private sector in order to sell off the public sector enterprises,
thus creating net loss for the government (Bayliss, 2003). As profit is
the only motive for the private sector, there would be a tendency to
avoid environmental regulations to create monopolistic power in order
to eliminate any competition.
The private sector will put pressure on the government to reduce
or eliminate regulation and, as they are financially stronger than the
government, particularly if they are giant multinational companies, the
state will be in a subordinate position when it comes to implementing
any anti-monopoly laws or protecting the people from the abuses of
any monopolistic organization. Private firms will not invest if there are
not enough prospects for profit. They will invest only in a profitable
public enterprise and avoid any loss-making but socially needed public
enterprises. Thus, the government will end up with a number of loss-
making public companies but will lose the opportunity to earn regular
income from the profit-making public companies or natural resource
based public companies.
In Africa, Campbell-White and Bhatia (1998) found that only the

profit-making enterprises were privatized and that the net gains from
privatization in the long run are negative. In Zimbabwe, in 1999, the
UK firm Biwater withdrew from a proposed private water project because
its dependency on customers who were too poor meant it would not
be profitable (Bayliss, 2002). For its power generation project in India,
ENRON requested a reduction in import tariffs on natural gas, sovereign
guarantee on the loans it had taken, subsidies on the company’s loan
repayments and gigantic loans from the public sector banks of India.
ENRON defaulted and now has a power purchase agreement (PPA) in
which the publicly-owned electricity distribution companies agree to
purchase the output of the plant at a fixed price, which is substantially
more than the price that was charged previously by either public or
private electricity generating plants (Bayliss and Hall, 2000).
Efficiency of the private sector was never proven. Historically, due to
the failure of the private sector to provide public services, utility and
municipal services were nationalized. There is no evidence that the
private sector—where corruption and exploitation are endemic—has
better managers or that there are better systems in place to create com-
mitment of the workers. In Puerto Rico, after massive mismanagement
of the French multinational company Vivendi, the water authority
forced the state to subsidize the operation to a degree that the state-
managed entity was cheaper to operate (Bayliss, 2002). Private invest-
ment in infrastructure in a developing country demands subsidies and
huge initial public investments so as to make the project profitable for
the private sector. In Guinea, Côte d’Ivoire and West Bengal state of
India, where the governments had created all the infrastructure and
electricity-generating plants at huge cost to the public, private operators
were given the responsibility of distributing water and electricity and
collecting bills from the customers. As was demonstrated clearly in the
case of ENRON in India, when the organization borrowed more than
US$10 billion from the Industrial Bank of India but never paid it back,
a private firm can profit while the state-owned enterprise continues to
pay for investment. When ENRON went bankrupt its creditors obtained
more than US$400 million from the government of India. ENRON
produced a generating plant with an output of electricity that was so
expensive there were no customers. In the end, the government had to
take over the plant at huge loss of public money.
In most developing countries increased charges imposed by pri-
vatization of the water supply has reduced the people’s access to water.
In order to achieve their guaranteed rates of return, private firms have to

increase charges for usage (Cowen and Cowen, 1998). The Plurinational
State of Bolivia provides one such example (Lobina and Hall, 2000). In
most developing countries with privatized water supplies the poorest
people can no longer afford water (Magdahl et al, 2006), because the
governments and their often corrupt politicians are unable to control
the profit motive of the private sector (Nixson and Walters, 2006).
Privatization has adverse effects on employment too. The private
owners tend to lower costs by substantially reducing the work force.
Privatization in Russia and Eastern Europe caused the unemployment of
millions. Recently in 2014, for example, the privatized Togliatti plant of
Fiat in Russia fired 15,000 workers following the arrival of the new chief
executive from Sweden. This pattern emerges because foreign executives
in a multinational company can only look at the management in a
mechanical way without any human or cultural considerations. This is
particularly true in the Korean owned companies in China.
Privatization in developing countries reduced employment signifi-
cantly. Privatization of basic facilities like medical services, education
and social welfare normally creates a two tier system, one for the rich
and another for the poor (Macarov, 2003; Bayliss, 2002).
Privatization had demonstrably harmed the poor, either through loss of

employment and income, or through exclusion from, or reduced access to,
basic services, as the result of private firms’ principal concern with profits,
prices and costs; at the same time, weak governance and regulatory capac-
ity in many developing countries led to poor control of market abuses by
private utility companies. (Van der Hoeven and Sziráczki, 1998)
Economic growth and structural change do not necessarily mean

wholesale trade liberalization. Reforms should address the questions
of gross inequality and lack of access for the poor to the basic services
needed for even a minimum standard of living. Employment provides
the maximum level of social welfare.
Employment creation should be at the core of any strategy for eco-
nomic reform. Thus, a combined effort towards a comprehensive strat-
egy for agricultural and industrial development and trade is needed;
financial stability should not be the only consideration. That requires
a planned economy, not a privatized economy, which is the agenda of
the WTO.
Due to liberalization, unfortunately, government policy in most coun-
tries tends to go in the opposite direction. Most developing countries
have toned down their directed credit support programmes for the rural
economy and small scale industries. In response to suggestions from
the IMF and the WTO, they have also removed government controls
on interest rates. As a result of this, supply of credit to the priority areas
declined. In India, all banks (public and private) were required to lend
at least 40 per cent of net credit to what they called ‘priority sectors’.
However, there are increasing pressures on governments from the IMF
and the WTO to abandon these programmes.
At the heart of this debate lies a set of ten specific economic policy
prescriptions that a reform package must include called the Washington
Consensus, a collaborative effort by the World Bank, the US Treasury
and the IMF. According to Rodrik (2006), the components of the
Washington Consensus were:
1. Fiscal discipline.
2. Reorientation of public expenditures.
3. Tax reform.
4. Financial liberalization.
5. Unified and competitive exchange rates.
6. Trade liberalization.
7. Openness to FDI.
8. Privatization.
9. Deregulation.
10. Secure property rights.
Deraniyagala and Fine (2001) observed that there is little justification

to support trade liberalization. Mexico provides an example of a failed
economy where trade liberalization, under pressure from the US and the
IMF, created a surge of imports without any corresponding increases in
foreign direct investments and exports (Dornbusch et al, 1994). Mexico,
as well as Latin America as a whole, did worse during the 1980s and
onwards than it did in the pre-1980 period, when import substitution,
protectionism and public investments were predominant (Rodrik, 2008,
2009).
On the other hand, South Korea refused to accept trade liberaliza-
tion, but it had implemented central planning and protections of
industries while the government acted to induce desirable private
investments toward some targeted industries. South Korean trade lib-
eralization thus was highly selective, driven by the desire to capture
the world market using selective export strategy and significant gov-
ernment support. The country has developed many successful large
manufacturing industries, including automobile, electrical appliances

and ship building.
China started its reform with the slogan ‘Socialism with Chinese
Characteristic’, but rejected trade liberalizations. They moved from
central planning to decentralized planning, with the entire policy
mechanism geared to capture the world market by whatever means. The
country relied instead on township and village enterprises owned by
local governments and special economic zones (Rodrik, 2004).
Economic reform held the promise of a shareholding democracy,
competition, falling costs and better public services. During the last
30 years, most people have a very different experience. From energy to
water, rail to public services, the reality of the liberalization programme
has created private monopolies, huge subsidies, increased prices, under-
investment, profiteering and corporate greed. Private cartels have
immobilized public regulating authorities. In Britain the energy costs
for consumers rose by 140 per cent within 10 years between 2004 and
2014 and the cost of water rose by 74 per cent (The Guardian, 2013).
The government sold off public assets at knock-down prices and earned
some £50 billion (at 2000 prices), but that doesn’t take into account
debt write-offs, pension obligations or extra subsidies that the state has
to pay to maintain the essential services privatized so far. Consumers
and politicians are confused by private commercial culture and com-
plexity. Labourers have experienced reduced wages, increasing unem-
ployment and growing uncertainty. Controls of essential services are
transferred to foreign multinational companies, which are sometimes
owned by foreign governments.
Privatization of the British railway system, for example, has seen
fragmentation of the network and services, much reduced investment,
a public subsidy of £1.2 billion per year—nearly double the level of
subsidy when the railways were in the public sector—and very expen-
sive train fares (actionforrail.org) with train fares in parts of the south
east of England doubling after privatization. Britain’s publicly-owned
East Coast Main Line (ECML) has however provided a far better service
and has generated a net income of £800 million for the government.
Privatized services are more expensive and inefficient than their pub-
licly owned counterparts. It is therefore not surprising that the public
have no trust in them. In the case of energy supplies in Britain, the
private monopolies have failed to invest properly according to the long-
term requirement to replenish capital stocks.
In Latin America, the USA and Western Europe, privatized public ser-
vices, utilities and resources are being steadily brought back into public
ownership. In the past decade, 86 cities have reclaimed water back into
social ownership. In Germany alone, more than 100 energy companies
have been returned to public ownership since the period 2007–8 (The
Guardian, 2014).
Gambling Instrument as a Financial Product
Derivatives are financial contracts whose price is derived from that of

underlying items, such as commodity price, exchange rate, share price,
rates of interests in different countries or event, which are important
politically or for business. Derivatives are essentially forecasts of future
movements of these items. Those who are correct in their forecasts will
gain the benefits and those who are wrong will lose a fortune. These
forecasts and the contracts based on these forecasts can be purchased
and sold in the ‘derivative market’, which is now much bigger than the
worldwide share market. While derivatives markets have been in exist-
ence for as long as, and by many accounts even longer than, securities
markets, it is their growth in the past 25 years that has made them one
of the foundations of the financial system of the reformed markets of
the world. This is true not only of developed but also developing econo-
mies. In the effort to force a liberalized capital market on developing
countries, Western countries, particularly the USA and the UK, have
shown no apparent concern for the dangers of unregulated derivatives
markets.
The drive to liberalize financial markets suggested elimination of
controls and taxes on capital flows relating to bank lending, share
issuances and trading, and foreign direct investment (FDI). Trading
in derivatives is closely related to transactions involving these capital
flows. Established economic theory suggests that financial markets are
sufficiently disciplined themselves, and naturally efficient. Thus, gov-
ernment imposed regulation can only reduce the degree of efficiency of
the financial markets. According to theory, derivatives may distribute
the risks but they also create new risks that can destabilize economies by
destroying the financial institutions if the outcome or forecasts underly-
ing the derivative go in the wrong direction.
The risks of derivatives emerge from possible fraud, manipulation,
tax evasion or avoidance and the distortion of information that is
vital for the efficient function of the market. These in turn create new
risks, which are of a higher degree than a financial system without
any derivatives. Thus, the creation and distribution of derivatives
increases the vulnerability of the financial system and economy as a
whole. That increases the costs of capital, due to lower trust and con-
fidence in financial and commodity markets, because derivatives can
seriously distort the market prices of any financial products. Abusive
practices in the derivative markets include destructive competition,
tax evasion or false information about a country’s balance of pay-
ments, debts, financial obligations and direction of the exchange rate.
This increases a country’s risk of default, speculative attacks on the
exchange rate down gradation of their financial status and eventual
financial crisis. The category of ‘misuse’ covers negative long-term
loans that can become short-term ones if attached ‘put’ options are
exercised (Dodd, 2001).
As was demonstrated when some famous US companies portrayed
Greece as being attractive for foreign investment despite being under
a mountain of debt it couldn’t pay back, just before the country’s
financial crisis, total return swaps can make short-term dollar loans
(liabilities) appear as portfolio investments. The requirement to meet
a margin or collateral calls on derivatives may generate sudden, large
foreign exchange flows that would not be indicated by the amount of
foreign debt and securities in a nation’s balance of payments accounts.
As a result, the balance of payments accounts no longer serve as reli-
able or valuable information on the financial health of the country.
Liquidity is especially critical in derivatives markets. The lack of
liquidity has adverse consequences for financial markets. It means
that participants cannot adjust their positions, and it also means that
there are no prices to serve as benchmarks or reference prices for other
related financial transactions. The result can be panic buying or selling
of shares that can initiate serious recession or prolonged depression of
the economy.
Derivatives can spread the disturbance of one country to another
because many derivatives involve cross-border counterparties. Thus,
losses of market value and credit rating in one country will affect
counterparties in other countries. That is what happened in 2008
when the mortgage market in the USA defaulted and, through the
derivative market, the crisis spread throughout the world by making
most of the bonds and stocks issued by American banks toxic assets of
no practical value. When there is a problem in one country’s market,
finance companies and investment banks sell in the markets of other
countries because the banks need additional funds to purchase assets
denominated in strong currencies in order to meet capital requirements
as determined by the central bank of that country. In order to obtain
these assets, banks will sell their shares in the markets of countries with
strong currency. This demand for collateral assets can distribute the
financial crisis from one country to another if the shares of the banks
of the country in crisis become worthless overnight (Eatwell and Taylor,
2001). Thus, investment banks with large derivative funds are facing the
danger of maintaining large enough capital as collateral requirements
on their derivatives transactions. Provided here are some assessments of
major investment banks’ exposure to derivatives and the danger they
are suffering from possible and sudden collapse of their financial status,
which the current level of capital requirements cannot sustain.
JPMorgan Chase
Total Assets: US$2,476,986,000,000 (about US$2.5 trillion)
Total Exposure to Derivatives: US$67,951,190,000,000 (more than
US$67 trillion)
Citibank
Total Assets: US$1,894,736,000,000 (almost US$1.9 trillion)
Total Exposure to Derivatives: US$59,944,502,000,000 (nearly US$60
trillion)
Goldman Sachs
Total Assets: US$915,705,000,000 (less than US$1 trillion)
US$54 trillion)
Bank of America
Total Assets: US$2,152,533,000,000 (a bit more than US$2.1 trillion)
US$54 trillion)
Morgan Stanley
Total Assets: US$831,381,000,000 (less than US$1 trillion)
US$44 trillion)
Deutsche Bank
Total Assets: €1,709 billion with total liability €1,635.48 billion
Another US$75,000,000,000,000 in derivative exposures (US$75 tril-
lion approximately the size of GDP of the world itself)
(Source: http://www.statista.com/topics/1350/deutsche-bank/)
Capital market liberalization, a result of globalization and trade liberal-

ization, refers to the relaxation of government restrictions in the market
for financial products including derivatives, explained earlier, so that
investors irrespective of their national origins can invest in the shares
and bonds of any other countries. Non-tariff and tariff trade barriers are
being eliminated and regulations and taxes are being removed gradu-
ally. The suggested rationales are improvement in productivity and
general efficiency of the economy. The entire capital market has become
a global market. The financial crisis that began in 2008 witnessed a
weak economy of all the major countries of the world. The results are
high unemployment, lower demands, huge public debts and overall
economic depressions. These have created lower export demands,
increased unpredictability in capital flows and decline in commodity
prices, particularly crude petroleum. Neo-liberal economic reforms
have had significant impact on the economies that have adopted them
and third world countries have undergone radical structural changes
since their implementation. Economic reform was intended to attract
private investment. Major focuses of such reforms are privatization, sta-
bilization and deregulation. In the primary stages, these measures have
resulted in some negative effects on the poverty factor. Privatizations
of public sector units have caused unemployment. Deregulation in the
financial market has led to increasing risks and uncertainties in the
economy. The process of deregulation leads to state non-interventions
in the informal sector; and these have caused insecurities. Thus, as eco-
nomic reforms are continuing, a serious in-depth examination of some
important economies of the world is needed.
2
Tariff Policy and Employment
Structure in the UK
Developing countries, those who started their industrialization in the

1950s and 1960s, have already attained some degree of maturity regard-
ing their industrial production. Whereas most of the small countries
in South-East Asia have concentrated on light manufacturing products
(i.e. consumption goods), some large economies in the third world,
notably India, Brazil, Mexico and Argentina, have developed capital
goods industries. However, due to various kinds of distortions, both
domestic and international, the development of their internal market
is not yet such as would sustain a high rate of growth of capital goods
industries. Recently some of these countries have tried to export more
of their manufacturing products in the world market, in order to avoid
the constraints posed by sluggish internal demand, and to raise the
necessary foreign exchanges to pay for the import of essential raw
materials.
Although efforts have been made by various international organi-
zations, such as GATT (General Agreement on Tariffs and Trade) and
UNCTAD (United Nations Conference on Trade and Development),
developments in the area of trade liberalization have not been encour-
aging. Trade restrictions on manufactured exports of developing coun-
tries have, in fact, increased in various forms. Moreover, the European
Common Market, with its high tariff and increasing non-tariff restric-
tions, has deprived many of the developing countries the opportunity
to export manufactured products. The recent arrival to the European
Economic Community (EEC) of semi-industrialized countries such as
Spain, Portugal, Greece, Finland and East European countries is likely to
intensify the difficulties facing developing countries, because a number
of products, which these countries export, are in competition with the
exports from some of the third world countries.
21
The efforts to liberalize the markets of the developed countries are

difficult because of the fear of the possible distortions these could cre-
ate in structure of employment. Due to the recent recessions in the
industrialized countries, a strong protectionist lobby has emerged with
support from industrialists, trade unionists and some economists. In
their view, the solution to the problem of unemployment and industrial
decay would be to have import controls. The burden of such controls
on imports would fall upon exports from developing countries, because
in practice it would be impossible to impose tariff restrictions on other
OECD (Organization for Economic Co-operation and Development)
countries, without having retaliation. Again, the unionists and industri-
alists who are in favour of import controls belong to those sectors of the
economy (e.g. textiles) that feel threatened by the increasing exports
from the third world countries. But to what extent are these fears real?
Are these import controls likely to preserve jobs? (Ricardo et al, 1988;
Kruger et al, 1988; Baldwin and Lewis, 1977; Cline et al, 1978.)
The purpose of this chapter is to examine the adjustment costs and
gains in sectoral employment if the UK had followed a liberalized tar-
iff system towards the newly industrialized developing countries. In
international trade commodities and countries are inter-linked. What is
needed is a multisectoral and multilateral model of international trade.
This study examines one such model for the UK, in order to determine
the impact of liberalization. It analyses the exports and imports of the
UK and shows how these are related to domestic demands and structure
of domestic production. So far most of the research on such trade flows
has ignored the indirect effects of different commercial policies. The
indirect effects are mainly those that come as a reaction to the original
commercial policies and become effective only in the long run. Trade
policies can alter the foreign exchange balance position of home and
foreign countries, thereby altering the demands and supplies of exports
and imports. Again, trade policies can alter the structure of domestic
production by changing the relative demand structure of various goods
and their relative prices. Only a comprehensive model that can effec-
tively inter-relate the domestic economy to the foreign trade sector
is able to capture such influences. This study analyses those indirect
influences as well as direct influences, which work through the terms
of trade and exchange rate.
This model analyses the UK economy in the context of a time-varying
input−output structure. The components of the input−output matrix
are changing over time depending on the demand structure and the
possible supply structures, which are in turn affected by structures of
Tariff Policy and Employment Structure in the UK 23
exports and imports. The exports and imports of various commodi-

ties are multilateral and these are affected by various countries and
blocks. The relative prices are affected by the tariff and the exchange
rate, whereas purchasing power is affected by the balance of payments
situation of that particular block or country in relation to the UK. With
this simple mechanism this study ties together the internal sector and
the external economy. We will examine the tariff reductions as well as
import control, taking into account both the direct and the indirect
effects on the structure of the labour market in the UK.
The Methods of Analysis
In recent quantitative studies of world trade (Cline et al, 1978; Whalley,

1985; Teh and Piermartini, 2005; Anderson, Martin and van der
Mensbrugghe, 2006; Anderson, Valenzuela and van der Mensbrugghe,
2009) emphasis was on the OECD countries, where the developing
countries have received insignificant attention. Cline et al (1978) have
analysed the trade negotiations in the Tokyo round tariff reductions for
the major industrialized countries; parameters of the model were not
estimated but either calibrated from a variety of individual studies or
assumed. A large scale mathematical programming model was formu-
lated in that study to see the impacts of various arrangements regarding
tariff reduction on trade flows of the OECD countries. Baldwin and
Lewis (1977) made a similar study based on the US trade relationships
with other major industrialized countries where the model was esti-
mated in parts, otherwise parameters were assumed. Whalley (1985)
and Shoven and Whalley (1984) have constructed a general equilibrium
model of world trade; the purpose was to see the impact on the US econ-
omy of various tariff reductions schemes. Nguyen, Perroni and Wigle
(1993) have constructed a general equilibrium model to see the impact
of the Uruguay round negotiations where the developing countries
are divided into three groups, the model was composed of calibrated
parameter values. There are a number of studies (using either calibrated
or assumed parameter values) for individual developing countries where
the effects of various trade policies are analysed (Chenery et al, 1986,
for Korea; Greais, de Melo and Urata, 1986, for Turkey; Dahl, Devarajan
and van Wijnbergen, 1986, for Cameron; Mitra, 1986, for India). In
this analysis, a partial equilibrium model for the UK was estimated and
analysed in the context of both the industrialized and the developing
countries. The model is multisectoral to examine the differential impact
of various trade regimes on different sectors.
We describe, in what follows, a multilateral model of the world econ-

omy. The levels of disaggregation to be used are as follows:
Country/blocks considered:
1. UK
2. EEC other than the UK
3. US
4. Japan
5. Other OECD countries (ODEV)
6. OPEC
7. Former planned economies (Eastern Europe, China, Cuba, Vietnam,
Cambodia, Laos, N. Korea)
8. Newly industrialized Latin American countries (Mexico and Brazil)
9. Newly industrialized Asian countries (Hong Kong, Singapore,
Taiwan, S. Korea)
10. India
11. Other less developed countries
Commodities considered:
1. Agriculture, food and drinks: traded, C

2. Coal and coke: traded, C, I
3. Oil and gas: traded, C, I
4. Electricity: non-traded, C, I
5. Metals, chemicals and other industrial raw materials: traded, I
6. Capital goods and construction: traded, I
7. Consumer’s manufacturing items: traded, C
8. Vehicles: traded, C
9. Textiles: traded, C
10. Transport, commerce and services: non-traded
(Note: C = consumption goods, I = investment goods)
The algebraic framework of the model is as follows:

Definition:
Yj = national output of the jth country, million, local currency,

1990 prices
Yi ,UK = output vector of the UK, £million, 1990 prices
PiUK = price of commodity i of the UK , index, 1990 = 100
Pij = price of commodity i of the jth block, index, 1990 = 100
FI j = foreign investment of the jth block in the UK, £million,
1990 prices
Dijc = consumption demand of commodity i in the jth block,

£million, 1990 prices
Dim = factor demand of commodity i in the UK, £million, 1990
prices
Di = total domestic demand of commodity i in the UK, £million,
1990 prices
INVjD = total domestic investment in the jth block, million, local
currency, 1990 prices
Gj = government expenditure in the jth block, million, local
currency
Yj = GNP in the jth block, million, local currency, 1990 prices
Eij = export of the commodity i to the jth block, £million, 1990
prices
TBj = trade balance of the jth block, £million, 1990 prices
IUK = market interest rate in the UK, index, at 1990 prices
YUK = GNP of the UK; Δ YUK = YUK t− YUK t −1, £million, 1990
prices
INV D = domestic investment demand in the UK, £million, 1990
prices
INV F = foreign investment in the UK, £million, 1990 prices
INVIBj = invisible inflow to the jth block, £million, 1990 prices
Li = demand for labour in the sector producing ith commodity,
thousands
EXR = exchange rate, $/£
FI j = foreign investment of the UK in the jth block, £million,
1990 prices
At = input output matrix of the UK in the year t
K(I − At)− = rows corresponding to the capital goods in the
1
inverse matrix
Ki = capital stock in the ith sector, £million, 1990 prices
INVi D = domestic investment in the ith sector in the UK, £million,
1990 prices.
1) National income identity of the jth block

Yt = ∑ Dij + INVjD + TBj + Gj
j
2) Export of commodity i to the jth block, from the UK

Eij = f (Yj , (TB/ EXR) j , (Pi UK/Pij ), FI j )
3) Import of commodity i from the jth block, to the UK
Imij = f [( DiUK − YiUK ), ( T BUK /EXR ), FI j , YUK , (PiUK /Pij )]
4) Domestic demand for commodity i in the UK

Di = Dic + Dim
5) Domestic consumption demand for commodity i in the UK
Dic = f ( YUK , Pi UK )
6) Domestic industrial demand for commodity i in the UK
Dim = (I − A)−1Yi UK
7) Domestic investment demand in the UK
INV D = f (ΔYUK , IUK )
8) Foreign investment in the UK
∑ FI j = INV F = f (ΔYUK )
j
9) Trade balance between the UK and the jth block

TBj = ∑ ∑ Eij −∑ ∑ Imij + ∑ FI j − ∑ FI j +∑ INVIBj −∑ INVIBt
i j i j j j t t
10) Invisible outflow to the jth block

INVIB j = f ( ∑ FI j )
j
11) Invisible inflow from the jth block

INVIBj = ∑ FI j
j
12) Sectoral labour demand

Li /Yi = f (Ki /Yi ,T ).
We adopt the following method to project the input—output matrix At

of the UK. Following Stone (1966) let
At = Rt At −1St ,
t = 1, …, N, N being their last period of forecasting. Rt and St can be

determined by using the familiar equation
−1
∑ nj =1 j [ Rt At −1StYt ] = ∑ im=1i [I − At ] Yt
−1
∑ nj =1i [ Rt At −1StYt ] = ∑ im=1 j [I − At ] Yt .
(Subscript j implies jth column and subscript i implies ith row for LHS
matrix; i = j = number of commodities in the system, Yt is the output
vector with dimension i.)
In the usual Stone method (Stone, 1966) the right-hand side is assumed
to be known. In our model instead we add extra questions:
(I − At )−1 ⎡⎣⎢ Ditc ⎤⎦⎥ = [Yit ]

−1
K (I − At ) Yit −K (I − At −1 ) Yit −1 i = Δ Kit = INVitD ;
∑ i
INVitD = INVt D .
Then At is determined from the solution of the model sequentially.

The explanation of the theoretical structure is as follows. Eqn (1)
describes the usual national identity for the gross domestic output.
The domestic consumption demand ( Dic ) is determined in Eqn (5) by
both the output and the price factor. The equation is in implicit form;
the functional form is to be determined empirically. Eqn (6) describes
the factor demand, which emerges from the input—output matrix.
Domestic investment demand in the UK is determined by the gross
domestic output for the UK and the real interest rate, according to
Eqn (7). Eqn (8) shows the foreign investment inflows, which is deter-
mined by the growth in the UK economy, signified by the changes
in the gross domestic output. Eqn (9) summarizes all foreign trade
accounts in terms of trade balance (TBj) between the UK and jth block,
which are the main determining factors for the outcome of the model,
as they signify the purchasing powers of each block. Implicit in these
equations are the export functions of all UK blocks and commodities.
The determining factors, as shown below in the econometric estima-
tion, are the gross domestic output of the recipient block, bilateral
trade balance (TB/EXR), the relative price structure (PiUK/Pij) and the
UK’s investment in that block, which will demonstrate the closeness
of the economic relationships. Similarly implicit are the import func-
tions for the UK for all blocks and for all commodities, which are, as
shown in the econometric estimations, influenced by a variety of fac-
tors like domestic demand pressures ( DUK i
− Yi ,UK ), trade balance (TBUK/
EXR), relative price structure (Pi, UK/ Pij), gross domestic output of the
UK and the investment inflows from the jth block to the UK signify-
ing the closeness of the bilateral economic relationships. Eqns (10)
and (11) show the determinants of invisible outflows and inflows in
terms of foreign investment inflows and outflows. The empirical stud-
ies described here show the exact relationships and the lag structures
of the explanatory variables. The employment effects of the model can
be captured by Eqn (12) where labour−output ratio and the time trend
indicate any technical progress. Empirical evidence shows that the
technical progress is capital augmenting (Guscina, 2007; Schneider,
2011). The production functions implicit in these types of equations
indicate the importance of the capital−output ratios, which determine
the employment prospects, although there are possibilities of substitu-
tions; that is why labour−output ratio is a function of the capital−out-
put ratio, not a fixed factor as it is in standard input−output analysis.
This idea is that the drive for new technology determines employment
and capital−output ratios, although there is a secular tendency for the
labour−output ratios to fall due to technological changes and changes

in the production system and organizational structures. The effects
of the exogenous or policy variable of the model can be obtained by
solving the model for the endogenous or state variables. The solution
method is the Gauss-Sidel method of solving non-linear systems of
equations.
The Econometric Model
The analytical model presented in the previous section was estimated

by using annual data from 1960 to 1990. The method of estimation is
2SLS least squares with autoregressive error process. For each block of
countries we describe now a subset of the complete model in order to
save space.
Labour requirement functions: UK

Agriculture: (2.1)
LAg KAg
= .585. − 0.23T + .152
YAg YAg
(2.976) (3.555) (1.903)
R 2 = .85 DW = 1.26 ρ = .77
Coal (2.2)
LCoal KCoal
= .213 − .313T + (8.497)
YCoal YCoal
(2.718) (3.666) (2.497)
R 2 = .77 DW = 1.85 ρ = −.24
Oil and Gas (2.3)

LOil KOil
= .023 − .007T − .078
YOil YOil
(2.828) (2.613) (3.218)
R = .82 DW = 2.25 ρ = −.13
2
Electricity (2.4)
LE KE
= − .256 − .018T + .234
YE YE
(3.045) (3.113) (2.876)
R 2 = .79 DW = 1.96 ρ = −.03
Chemicals (2.5)
LCh KCh
= .064 − .014T + 0.386
YCh YCh
(2.765) (2.316) (3.161)
R = .97 DW = 2.79 ρ = −.54
2
Capital goods (2.6)

LCap KCap
= .813 − .013T + 0.222
YCap YCap
(2.252) (3.504) (3.252)
R 2 = .88 DW = 2.24 ρ = .72
Consumption goods (2.7)

LCo KCo
= 1.761 − .053T + 0.509
YCo YCo
(2.855) (3.942) (2.799)
R 2 = .69 DW = 2.67 ρ = −.54
Vehicles (2.8)
LV KV
= .177 − .011T + 0.286
YV YV
(3.297) (3.599) (2.931)
R 2 = .72 DW = 1.81 ρ = .65
Textiles (2.9)
LT KT
= .064 − .010T + 0.432
YT YT
(3.113) (3.238) (2.819)
R = .73 DW = 2.52 ρ = .45
2
Demand (consumption): UK
Agriculture (2.10)
log (DAg ) = .025 log (DAg −1 ) + .216 log ( YUK ) − .014
(3.089) (2.813) (2.997)
R = .82 DW = 2.78 ρ = −.26
2
Coal (2.11)
log (DCoal) =
.171 log (DCoal−1 ) − .478 log (YUK ) − .197 (YUK −1 ) − 0.053T + 11.27
(2.481) (2.895) (3.559) (3.816) (4.667)
R 2 = .86 DW = 3.01 ρ = −.79
Oil and gas (2.12)

log (DOil) =
.007 log (DOil−1 ) + .181 log (YUK ) − .193 (POil ) + 0.39T
(3.235) (3.164) (2.936) (1.874)
R 2 = .78 DW = 2.76 ρ = − .61
log (DCon) =
.085 log (DCon−1 ) + .077 log (YUK ) − .2521 (YUK −1 ) + 0.028T + 8.488
(2.532) (2.817) (2.612) (3.367) (2.141)
R 2 = .87 DW = 3.01 ρ = − .08
Vehicles (2.14)
log (DVeh) =
.025 log (DVeh−1 ) + .211 log (YUK ) − 1.391 (PVeh ) + 142T + 3.285
(2.687) (2.578) (2.859) (2.304) (3.369)
R 2 = .82 DW = 2.48 ρ = − .74
Textiles (2.15)
log (DTex) =
.251 log (YUK ) + .151 log (YUK −1 ) + .021T + 6.034
(3.453) (3.386) (2.834) (2.104)
R 2 = .91 DW = 2.72 ρ = − .06
Housing (2.16)
log (DHouse) =
0.39 log (YUK ) − .115 log (DHouse−1 ) + .12T + 10.313
(2.682) (3.196) (1.589) (1.764)
R = .82 DW = 2.72 ρ = .09
2
Investment functions: UK
Domestic private investment (2.17)
log (INV) =
1.235 log (YUK ) + .019 log (YUK −1 ) − .007 IUK − .016T − 4.796
(3.557) (2.381) (3.576) (3.299) (1.299)
R 2 = .93 DW = 2.05 ρ = − .33
Foreign investment (inflow) (2.18)
F.I. =
−1.421 (F.I .−1 ) + .145(YUK ) − .136YUK −1 + 6394.43 Exr + 1468.71T − 14465.8

(3.221) (2.791) (2.583) (3.584) (1.448) (1.391)
R 2 = 94 DW = 3.27 ρ = − .23
Invisible earning outflow (2.19)

INVIBO =
0.63 INV F − .175 INV−1F + 1592.90 Exr + 2267.67T − 6891.33
(3.342) (3.483) (2.907) (4.285) (3.531)
R 2 = .91 DW = 2.96 ρ = .61
Invisible earning inflow (2.20)

INVIBI =
1.478 F.total + .639 F.total−1 − 1070.49 Exr + 1958.53T
(3.349) (3.547) (2.297) (4.635)
R 2 = 96 DW = 1.67 ρ = .68
Investment to EEC (2.21)

F.EEC = .099 YEEC + 9.719T + 191.072
(3.112) (4.081) (3.679)
R 2 = .71 DW = 2.41 ρ = − .29
Investment to USA (2.22)

F.USA = .388 YUSA − 11.859T + 19.068
(3.504) (3.103) (2.391)
R 2 = .77 DW = 2.05 ρ = − .01
Investment to ODEV (2.23)

F.ODEV = .276 YODEV + 60.323T − 4.776
(3.211) (2.599) (3.021)
R 2 = .87 DW = 2.68 ρ = − .74
Investment to OPEC (2.24)

F.OPEC = .021 YOPEC + 50.816T − 268.246
(3.033) (3.365) (2.895)
R 2 = .72 DW = 2.13 ρ = − .71
Total foreign investment outflow: UK (2.25)

F.total = F.EEC + F.USA + F.ODEV − F.OPEC + F.OTHERS
= ∑ J FI j
Exchange rate: UK (2.26)

Exr =
3508 * Exr (−1) + .00006* TBUK (−1) − .0337 * TBUK + 1.604
(2.642) (3.379) (3.441) (1.997)
R 2 = .73 DW = 2.35 ρ = .096
Export to the newly industrialized Latin American countries (NIL)

Agriculture (2.27)
log (Eag) = .42 log (YNIL) + 9.496
(2.627) (3.742)
R = .77 DW = 2.58 ρ = .25
2
Oil (2.28)
log (EOil) = .276 log (YNIL) − .458 log (YNIL−1) + 4.436
(2.574) (3.381) (2.911)
R 2 = .95 DW = 2.31 ρ = − .37
Coal (2.29)
log (ECoal) =
.366 log (ECoal−1) + 3.446 log (YNIL) + 1.123T − 23.98
(3.278) (2.807) (3.703) (2.152)
R = .89 DW = 2.67 ρ = − .61
2
Capital goods (2.30)

pCapUK
log (ECap ) = .774 log (YNIL ) − .092 log ( ) + 7.603
pCapw
(2.117) (3.078) (2.171)
R 2 = .89 DW = 1.38 ρ = .33
log (ECon) = .512 log (YNIL ) + .0039 log (FINIL ) + 7.491
(2.086) (3.232) (3.091)
R 2 = .81 DW = 2.12 ρ = .81
Vehicles (2.32)
log (EVeh) = −.013 log (EVeh) + .126 log (YNIL) + .147T + 9.311
(3.118) (2.223) (1.549) (3.072)
R 2 = .73 DW = 2.38 ρ = − .46
Textiles (2.33)
pTex UK
log (ETex) = 1.011 log (YNIL ) − .0714 log ( ) + 2.523
pTexw
(3.386) (2.062) (1.677)
R 2 = .77 DW = 1.86 ρ = − .18
Chemicals and metals (2.34)

pChem UK
log (EChem ) = .283 log (YNIL ) − 1.385 log ( ) + 6.152
pChem
(2.612) (1.873) (2.574)
R 2 = .80 DW = 2.06 ρ = − .22
Export to the newly industrialized South-East Asian countries (NIA)

Agriculture (2.35)
log (Eag) =
− .114C log (TBNIA) − .209 log (ETBNIA−1 ) − .596T − .058T 2 + 9.996
(2.531) (2.590) (2.213) (2.221) (2.910)
R = .98 DW = 3.37 ρ = − .19
2
Coal (2.36)
log (ECoal) = .296 log (ECoal−1) + .209T − 1.468
(3.672) (3.581) (4.616)
R 2 = .72 DW = 1.63 ρ = − .29
Oil (2.37)
log (EOil) = 951.754T − 54.996 TBNIS − 1369.52
(2.207) (2.751) (2.738)
R = .76 DW = 2.19 ρ = − .26
2

log (ECap) =
−.0202 log (Cap−1) − .106 log (TBNIA) − .383T + 15.732
(2.366) (3.351) (3.471) (3.765)
R 2 = .78 DW = 1.64 ρ = − .73
log (ECon) = .477 log (YNIA) + .273 log (FINIA) + 7.772
(2.017) (3.466) (4.823)
R 2 = .88 DW = 1.91 ρ = − .11
Vehicles (2.40)
log (EVeh) =
pVehUK
2.709 log (YNIA) − 2.210 log (YNIA−1 ) − .259 log ( ) + 10.496
pVehw
(2.409) (2.281) (2.536) (3.979)
R 2 = .73 DW = 2.74 ρ = − .004
Textiles (2.41)
log (ETex) =
.250 log (YNIA) − 2.295 log (YNIA−1) − .014T − .969 log (ETex−1) + 20.245
(2.261) (3.731) (2.159) (2.321) (3.641)
R 2 = .79 DW= 2.21 ρ = − .45

pChemUK
log (EChem ) = .998 log (YNIA) − .788 log ( ) + 7.288
pChemw
(6.296) (3.458) (3.382)
R 2 = .91 DW = 1.98 ρ = .07
Export to India
Agriculture (2.43)
log (EAg ) = − .1009 log (TBI ) − .534 log ( EAg −1 ) + .055T 2 + 9.104
(2.784) (3.395) (4.811) (2.505)
R 2 = .93 DW = 2.27 ρ = .21
Oil (2.44)
log (EOil) =
−51.053 log (TBI) + 536.05 Y − 28.606 log (TBI−1) − 1225.81
(3.789) (2.945) (2.661) (2.686)
R 2 = .78 DW = 1.89 ρ = .488
Coal (2.45)
log (ECoal) = −.261 log (ECoal) −.016T − .479
(3.577) (2.121) (3.651)
R 2 = .69 DW = 2.23 ρ = .257
log (ECap) =
pCapUK
−.967 log (YIND ) − .325 log (TBI ) − 1.148 E log ( ) + 6.321
pCapw
(1.806) (3.446) (3.411) (2.347)
R 2 = .77 DW = 2.23 ρ = − .86
log (ECon) =
pConUK
.227 log (YNID ) − .106 log (TBI ) − .271 log + 7.772 ( ) + 8.425
pConw
(3.156) (3.307) (2.303) (1.161)
R 2 = .73 DW = 1.26 ρ = − .02
Vehicles (2.48)
log (EVeh) = 2.359 log (YNID) − .157 log (TBI) − .218T + .151
(3.565) (2.051) (4.331) (.049)
R 2 = .94 DW = 2.11 ρ = .008
Textiles (2.49)
log (ETex) =
−.282 log (TBI) + .181 log (TBI−1) − .694T + 0.56T2 + 9.356
(2.035) (3.364) (3.481) (2.578) (2.105)
R 2 = .99 DW = 2.86 ρ = −.45

log (EChem) = −.782 log (TBI) −.301T − .037 log (TBI−1) + 11.974
(2.892) (3.331) (2.548) (3.186)
R 2 = .90 DW = 2.49 ρ = −.67
Export to the other less developed countries

Agriculture (2.51)
log (EAG) = .808 log (YLDC) − .479 (YLDC−1) + 10.492
(3.139) (4.177) (1.019)
R 2 = .94 DW = 2.1 ρ = − .06
Oil (2.52)
log (EOil) =
.0007 log (YLDC) − 2.042 log (YLDC−1) −.667 log ( pOilUK ) + 20.733
(1.591) (3.018) (2.386) pOilw (2.488)
R = .71 DW = 2.01 ρ = −.93
2

log (EChem) =
43.953 YLDC − 12539.4 PChemUK + 4971.62 PChemw + .131T +.07
(2.469) (3.574) (3.863) (3.985)
R 2 = .96 DW = 2.67 ρ = −.11
Imports from Latin American newly industrialized developing

countries (NIL)
Agriculture (2.54)
⎛ ImAg ⎞⎟
log ⎜⎜ ⎟=
⎜⎝ YAg ⎟⎟⎠
.970 log (DAGUK) + 3.166 log ( pAgUK ) + 117T − 7.657
pAgw
(2.485) (3.149) (3.474) (2.327)
R 2 = .77 DW = 2.002 ρ = − .11
Coal Not available

Oil and gas (2.55)
⎛ ImOil ⎞⎟
log ⎜⎜ = 5.919 log (DOilgUK ) + .958T − 59.96
⎜⎝ YOil ⎟⎟⎠
(3.361) (2.924) (1.421)

R 2 = .77 DW = 2.27 ρ = − .21

⎛ ImCap ⎞⎟
log ⎜⎜⎜ ⎟⎟ =
⎝⎜ YCap ⎠⎟
⎛ pCapUK ⎞⎟
.819 log (Dcap UK) + .599 log ⎜⎜⎜ ⎟ − .027T − 7.487
⎜⎝ pCapw ⎟⎟⎠
(2.662) (−2.558) (1.009) (3.593)
R 2 = .98 DW = 2.56 ρ = −.323
Consumer goods (2.57)
⎛ ImCon ⎞⎟
log ⎜⎜ =
⎜⎝ YCon ⎟⎟⎠
⎛ ⎞
.643 log (DConUK) + 1.373 log ⎜⎜ pConUK ⎟⎟⎟ − .007T − 4.735
⎜⎜⎝ pConw ⎟⎠
(1.395) (4.117) (2.671) (1.486)
R = .99 DW = 2.56 ρ = .68
2
Vehicles (2.58)
⎛ ImVeh ⎞⎟ ⎛ pVehUK ⎞⎟
log ⎜⎜ = 2.091 log (DVehUK) + 2.051 log ⎜⎜⎜ ⎟ + .458T − 21.519
⎜⎝ YVeh ⎟⎟⎠ ⎜⎝ pVehw ⎟⎟⎠
(3.715) (3.075) (3.335) (2.906)
R 2 = .93 DW = 3.14 ρ = − .67
Textiles (2.59)
⎛ ImTex ⎞⎟
log ⎜⎜ =
⎜⎝ YTex ⎟⎟⎠
⎛ pTexUK ⎞⎟
.999 log (DTexUK) + .323 log ⎜⎜⎜ ⎟ − .067T − 6.647
⎜⎝ pTexw ⎟⎟⎠
(3.943) (2.066) (2.759) (4.229)
R 2 = .99 DW = 2.50 ρ = − .48
Imports from South-East Asian newly industrialized countries (NIA)

Agriculture (2.60)
⎛ ImAg ⎞⎟
log ⎜⎜⎜ ⎟⎟ =
⎝ YAg ⎟⎠
pAgUK
1.153 log (DAGUK) − .039 log ( ) + .109T − 11.082
pAgw
(2.589) (3.013) (4.391) (2.483)
R 2 = .79 DW = 2.33 ρ = − .22
Coal Not available

Oil Not available
⎛ ImCap ⎞⎟
log ⎜⎜⎜ ⎟=
⎜⎝ YCap ⎟⎟⎠
⎛ pCapUK ⎞⎟
.655 log (DCapUK) + .021 log ⎜⎜⎜ ⎟ + .071T − 6.041
(4.933) (3.051) (2.056) (4.601)

R = .95 DW = 2.273 ρ = − .41
2

⎛ ImCon ⎞⎟
log ⎜⎜ =
⎜⎝ YCon ⎟⎟⎠ ⎛ pConUK ⎞⎟
.329 log (DConUK) + 1.526 log ⎜⎜⎜ ⎟ + .024T − 1.57
⎜⎝ pConw ⎟⎟⎠
(2.191) (4.095) (2.487) (3.047)
R 2 = .96 DW = 2.14 ρ = .20
Vehicles (2.63)
⎛ ImVeh ⎞⎟
log ⎜⎜ =
⎜⎝ YVeh ⎟⎟⎠
⎛ pVehUK ⎟⎞
3.241 log (DVehUK) + 1.402 log ⎜⎜⎜ ⎟ + .589T − 31.303
⎜⎝ pVehw ⎟⎟⎠
(2.756) (2.822) (2.421) (3.786)
R 2 = .64 DW = 2.07 ρ = .26
Textiles (2.64)
⎛ ImTex ⎞⎟
log ⎜⎜ =
⎜⎝ YTex ⎟⎟⎠
⎛ pTexUK ⎞⎟
.996 log (DTexUK) + .322 log ⎜⎜⎜ ⎟ − .067T − 6.601
(3.912) (2.291) (2.438) (4.334)

R 2 = .95 DW = 2.49 ρ = − .47
⎛ ImChem ⎞⎟
log ⎜⎜ =
⎜⎝ YChem ⎟⎟⎠
⎛ pChemUK ⎞⎟
.874 log (DChemUK) + .268 log ⎜⎜ ⎟ + .132T − 7.764
⎜⎜⎝ pChemw ⎟⎟⎠
(3.941) (2.991) (3.327) (3.801)
R 2 = .96 DW = 1.147 ρ = −.36
Imports from India

Agriculture (2.66)
⎛ ImAg ⎞⎟
log ⎜⎜⎜ ⎟⎟ = .254 log (PAgUK/PAw ) + .024T + 3.319
⎝ YAg ⎟⎠
(3.108) (2.384) (3.581)
R 2 = .79 DW = 2.53 ρ = − .45

Coal Not available
Oil Not available
⎛ ImCap ⎞⎟
log ⎜⎜⎜ ⎟=
⎜⎝ YCap ⎟⎟⎠
⎛ pCapUK ⎞⎟
.955 log (DCapUK) + .399 log ⎜⎜⎜ ⎟ − 0.47T − 8.611
(2.715) (2.931) ( 2.888) (4.424)
R 2 = .97 DW = 1.58 ρ = .34

⎛ ImCon ⎞⎟
log ⎜⎜ =
⎜⎝ YCon ⎟⎟⎠
⎛ pConUK ⎞⎟
.856 log (DconUK) + .992 log ⎜⎜⎜ ⎟ − .062T − 6.438
(3.424) (2.469) (3.593) (3.641)

R 2 = .96 DW = 2.09 ρ = .24
Vehicles (2.69)
⎛ ImVeh ⎞⎟
log ⎜⎜ =
⎜⎝ YVeh ⎟⎟⎠
⎛ pVehUK ⎞⎟
1.992 log (DVehUK) + .992 log ⎜⎜⎜ ⎟ − .062T − 6.438
⎜ pVehw ⎟⎟⎠
(2.951) (2.469) ⎝ (1.591) (3.641)
R 2 = .96 DW = 2.09 ρ = − .24
⎛ ImChem ⎞⎟
log ⎜⎜ =
⎛ pChemUK ⎞⎟
1.116 log (DChemUK) + .438 log ⎜⎜ ⎟ + .064T − 9.943
⎜⎜⎝ pChemw ⎟⎟⎠
(3.195) (2.984) (2.666) (5.088)
R 2 = .99 DW = 3.18 ρ = −.42
Textiles (2.71)
⎛ ImTex ⎞⎟ ⎛ pTexUK ⎞⎟
log ⎜⎜ = .892 log (DTexUK) + .248 log ⎜⎜⎜ ⎟ − .048T − 5.574
⎜⎝ YTex ⎟⎟⎠ ⎜⎝ pTexw ⎟⎟⎠
(2.731) (2.988) (3.611)(1.946)

R 2 = .99 DW = 3.02 ρ = − .78
Imports from other less developed countries (LDC)

Agriculture (2.72)
⎛ ImAg ⎞⎟
log ⎜⎜⎜ ⎟⎟ = −.925 log (DAgUK ) + 0.76T − 4.786
⎝ YAg ⎟⎠
(3.029) (2.981) (3.754)
R 2 = .99 DW = 2.64 ρ = − 1.004
Oil Not available

Coal (2.73)
⎛ ImCoal ⎞⎟
log ⎜⎜ = −.175T + 1.432
⎜⎝ YCoal ⎟⎟⎠
(1.059) (1.411)
R = .78 DW = 1.19 ρ = − .28
2

⎛ ImCap ⎞⎟
log ⎜⎜⎜ ⎟=
⎜⎝ YCap ⎟⎟⎠
⎛ pCapUK ⎞⎟
.836 log (DCapUK) + .672 log ⎜⎜ ⎟⎟ − .059T − 7.142
⎜⎜ ⎟
(4.152) (1.337) ⎝ pCapw ⎠ (1.468) (3.187)
R 2 = .94 DW = 1.46 ρ = .33
⎛ ImCon ⎞⎟
log ⎜⎜ =
⎜⎝ YCon ⎟⎟⎠
⎛ pConUK ⎞⎟
.563 log (DConUK) + 1.004 log ⎜⎜⎜ ⎟ − .088T − 2.993
(3.227) (3.343) (2.405) (2.778)
R = .99 DW = 3.39 ρ = .12
2
Vehicles Not available

Textiles (2.76)
⎛ ImTex ⎞⎟
log ⎜⎜ =
⎜⎝ YTex ⎟⎟⎠
⎛ pTexUK ⎞⎟
1.178 log (DTexUK) + .703 log ⎜⎜⎜ ⎟ − .079T − 8.644
(2.971) (3.479) (3.644) (3.869)
R 2 = .98 DW = 2.87 ρ = − .42

⎛ ImChem ⎞⎟
log ⎜⎜ =
⎛ pChemUK ⎟⎞
1.376 log (DChemUK) + .743 log ⎜⎜⎜ ⎟ + .063T − 13.753
⎜⎝ pChemw ⎟⎟⎠
(2.663) (3.258) (2.002) (3.745)
R 2 = .98 DW = 1.50 ρ = −.75
The above equations are only a part of the complete set of equations
of the model. In order to save space we have to leave out a large part
of the model. The equations we have not described are (a) the import
and export equations for other blocks; and (b) the set of identities to
describe national income accounts along with the trade balance equa-
tions for each block. The solutions for these complete sets of equa-
tions will give us performances of the foreign trade sectors and of the
domestic sectors of the UK under alternative assumptions regarding the
exogenous variables, that is, the price of various commodities for dif-
ferent blocks or countries. All equations are estimated with a variety of
functional forms and the equations presented in this section have the
functional forms, which satisfy all statistical criteria best.
The Direction of Trade and the Structure of Existing

Protection in the UK
In this section we describe the present direction of trade in the UK and

the existing system of tariff and non-tariff protection so as to provide a
necessary background to the analyses of the simulated structure of trade
and its impact on the domestic economy, as given in the next section.
Table 2.1 provides the distribution of British exports and their percent-
age share for the years 1980, 1985 and 1988 for four specific groups of
the developing countries, South-East Asian NICs, Latin American NICs,
India and other developing countries, for some specific commodity
groups.
The exports of chemicals and industrial raw materials show the
percentage share is more or less stable for most regions except in the
other developing areas where the percentage went up in 1985 to 13.45
per cent from 3.34 per cent in 1980, but then declined again in 1988 to
7.33 per cent. For capital goods, all the regions show a decline in the per-
centage share. For consumption goods the decline is quite sharp for other
developing countries (from 14.96 per cent in 1980 to 6.92 per cent in
Table 2.1 Distribution of the UK exports
UK exports (percentage shares of

total)
1980 1985 1988
Chemicals and industrial raw materials

Brazil, Mexico 1.06 1.52 0.85
SE Asia 2.24 1.54 2.01
India 1.12 1.00 1.76
Other developing countries 3.34 13.45 7.33
Capital goods
Brazil 2.29 2.21 1.32
SE Asia 2.44 2.92 1.32
India 1.16 1.04 0.95
Consumption goods
Brazil 0.46 0.62 0.43
SE Asia 1.84 1.79 2.13
India 0.42 0.35 0.48
Textiles
Brazil 0.16 0.22 0.13
SE Asia 3.08 1.99 2.16
India 0.20 0.09 0.11
Vehicles
Brazil 0.96 1.08 1.23
SE Asia 2.47 2.12 2.52
India 0.75 1.25 0.53
1988); for India and for Brazil and Mexico there is a declining ten-
dency, whereas with South-East Asia there is a marginal increase. For
textiles all regions show rapid decline particularly for other develop-
ing countries. For the vehicle industry, except for Brazil and Mexico,
shares for all other regions are declining. The general tendency is
that the export shares for the newly industrializing countries are not
improving at a significant rate, whereas for other developing coun-
tries the share has declined very sharply. Inspection of the import
share for these regions suggests an explanation of these results.
Whereas the newly industrializing countries continued to grow over
this period so that their share decreased but not at a rapid rate, the
other developing countries failed to grow and their share has regis-
tered a very sharp decline. The import shares for the different areas
are given in Table 2.2
Import shares for the various regions of the world vary widely for
different commodities. For agricultural commodities the share for the
other developing countries declined sharply from 24.62 per cent in
1980 to 18.62 per cent in 1988, whereas the share for the EEC was
increased from 12.13 per cent in 1980 to 46.79 per cent in 1989.
For consumption goods both the Latin American and the South-East
Asian NICs have gained some ground marginally, whereas the shares
of India and other developing countries have declined. In the case of
chemicals and industrial raw materials the share of India and Latin
American NICs gained only marginally but the other developing
countries lost substantially from 28.03 per cent in 1980 to 9.06 per
cent in 1988.
Table 2.2 Origins of the UK imports
UK imports (percentage shares

of total)
1980 1985 1988
Agriculture
SE Asia 0.82 0.42 0.64
India 2.92 1.91 1.77
ECC 12.13 46.97 46.79
Consumption goods
SE Asia 9.75 11.76 11.79
India 1.17 1.16 1.19
Textiles
SE Asia 19.17 23.82 18.65
India 4.49 2.50 3.60
Chemicals and industrial raw materials
Brazil 1.01 1.07 1.48
SE Asia 0.79 0.69 0.74
India 0.38 1.34 0.72
If we combine the experience of the import shares of chemical indus-

trial raw materials and textiles on the one hand and the employment
share of these two specific commodities on the other hand, we can see
(in Table 2.3) that in both cases the shares of all developing countries
have either declined or improved only marginally, but the employment
shares of both textile and industrial raw materials has declined in the
UK. Whereas the import of industrial raw materials is allowed with little
tariff restriction, textiles are subjected to the most stringent tariff and
quote restrictions. The argument given by the developed countries is
that textile imports can reduce domestic employment opportunities.
Table 2.3 shows that employment shares have declined in a number of
sectors (like agriculture, capital goods, vehicle and consumption goods)
in which the import share of the developing countries for the UK mar-
ket is either more or less constant or on a sharp declining path. The tariff
policies of the UK (as well as the EEC) are diverse, that is, the treatments
of different developing countries are different. Whereas Mexico and
some ex-colonies of France and Belgium (members of the LOME confer-
ence) enjoy the Generalized System of Preference (GSP) with minimum
de facto limitations, Brazil, South Korea, Singapore and Hong Kong
enjoy GSP with some de jure or de facto limitations. Other developing
countries and Taiwan and India have no preferential treatment at all.
Thus, it is not surprising that where the imports of South-East Asia,
Brazil and Mexico are either increasing (however marginally) or con-
stant, the import shares for the developing countries and India are
declining, not only for manufactured goods but also for agricultural and
industrial raw materials. In the next section we see how the alternative
trade policies can influence the import and export shares of these vari-
ous countries and blocks. We proceed by comparing the base solution
Table 2.3 Structure of employment, UK (percentage share of total)
1980 1985 1988
Food and agriculture 5.65 4.97 4.91

Chemicals and industrial raw materials 4.64 4.13 3.90
Capital goods 16.28 15.06 14.57
Consumption goods 11.94 10.75 10.53
Vehicles 3.77 3.36 3.43
Textiles 3.014 2.34 2.19
Transport and services 51.75 56.79 57.96
(i.e. the same policies would continue) with the case of a liberated
regime and an import controlled regime in which selective controls are
placed on imports from some developing countries.
Results of the Simulation
We have performed three different simulations on the model: (a) a

liberated trade scenario; (b) import control scenario; along with (c) a
base forecast assuming all the instrument variables follow their past
trends. In each case we have solved the model simultaneously to derive
the future pattern of exports and imports of every commodity group
included in the model and the resultant employment pattern. We
present in this section the results for certain important commodities/
sectors for certain specific blocks/countries and the future employment
structures in each specific case of simulation.
In the base forecast we have made the following assumptions. The
output of the UK would grow at a rate of 1 per cent per year. The out-
put of all other countries would follow their trends except for Brazil
and Mexico where we have assumed a growth rate of 7.5 per cent per
year. These assumptions are important only to the extent of providing
the initial guess for the iteration to be followed because, as one can
understand, all these variables would be affected by the solutions of
the model. In the same way all foreign investments, or trade balance
in the initial guess, follow their past trends. In simulation 1 (liberalized
scenario) we assume that the UK reduces its tariff restrictions on manu-
factured imports from the developing countries. So, in that simulation
we have implemented a 30 per cent cut in the import price of consump-
tion goods, textiles and chemical imports from four different blocks: (a)
Brazil and Mexico; (b) SE Asian NICs; (c) India; and (d) other developing
countries. This would be more than equal to a 30 per cent cut in the
tariff rates on those products. We leave all other variables unchanged.
In simulation 2 (import control scenario) we have assumed a general
purpose tariff restriction. In our model we have assumed an increase of
30 per cent of import prices leaving all other variables the same as in the
base forecast. (In order to simulate the import control scenario we have
assumed 30 per cent increases in the import prices on capital goods,
consumption goods, textiles, chemicals and vehicles coming from all
countries except the ECC.)
The basic results do not give uniform pictures. The effects of liberali-
zation or import control are diverse and different for different countries
and for different commodities. Similarly the employment effects are
different for the different sectors of the domestic economy.
For capital goods exported to all four markets the liberalized regime
provides the maximum potential for the growth of British exports com-
pared with the forecast on the import control regime. The difference is
most marked for Brazil, Mexico and India, whereas for other developing
countries the difference is not very significant. Because of the empha-
sis on industrialization in countries like Brazil, Mexico and India, any
improvements in the balance of payments will encourage imports of
capital goods. At the same time these countries have developed some
amounts of capital goods industries; any import control by the UK will
lead to reductions in the foreign exchange earnings of these countries
heading to a sharp reduction in imports of capital goods.
Exports of consumption goods show a slightly different picture.
Whereas all other markets show increases in British exports for all the
years under the liberalization regime compared to the import control
regime or the base forecasts, the exports to India do not fluctuate very
much. The absolute difference between the two simulated regimes for
consumption goods export is most prominent for the other developing
countries. The explanation is that, because the industrializing countries
are not developed enough to satisfy domestic demand, a liberalized
regime by improving the balance of payments situation can stimulate
their import demands in a significant way.
In the case of vehicles in the Brazil−Mexico market the import
control regime is associated with the decline in the real value of
exports, whereas under the liberalized regime it registers a very modest
increase in real terms over the years. However, the difference between
the export levels under the import control regime and the liberalized
regime is staggering. In the case of India, export levels do not change
under the alternative regimes. For the other developing countries the
difference between the regimes is modest. The reason can be that India
does not import many vehicles from the UK so the impact of alterna-
tive tariffs regimes would be insignificant. Both the Latin American
and the South-East Asian newly industrializing developing countries
have a small but growing vehicle industry. So, from these two blocks
quite vigorous reaction can be expected. While for the other develop-
ing countries the reaction would not pay off because their bilateral
balance of payment condition with the major competing countries in
the developed world would not be any better than the bilateral balance
of payments condition with the UK, even if there will be reduction in
imports from the UK.
The experiences of exports of these three major items show that
the liberalized regime by stimulating the balance of payment situa-
tions (and consequently the rate of growth of national income of the
developing countries) can increase the prospects for the British exports.
The improvements are particularly marked:
t In the case of capital goods in all markets.

t In the case of vehicles only in the market of Latin American and the
South-East Asian markets.
t In the case of consumption goods in all markets except India.
The reactions during an import control regime are severe:
t In the case of capital goods in all markets (particularly in India)

except in the other developing countries.
t In the case of consumption goods in almost all markets except in
India.
t In the case of vehicles in the Latin American and the SE Asian newly
industrializing countries.
Table 2.4 gives the detailed results regarding imports of four major
commodities under alternative import control regimes. In the case of
agricultural commodities the liberalized regime does not improve the
shares for the developing countries (including newly industrializing).
Table 2.4 Effects of different import control regimes on imports of the UK
1990 1991 1992 1993 1994 1995 1996
B 0.870 0.865 0.861 0.860 0.863 0.870 0.877

CH L 0.871 0.864 0.866 0.867 0.867 0.869 0.874
I 0.870 0.865 0.862 0.862 0.864 0.869 0.877
B 1.095 1.086 1.076 1.071 1.079 1.085 1.091
AG L 1.095 1.074 1.071 1.065 1.062 1.059 1.056
I 1.095 1.074 1.071 1.066 1.063 1.063 1.058
B 3.273 3.251 3.247 3.301 3.271 3.281 3.27
K L 3.273 3.250 3.248 3.351 3.293 3.295 3.30
I 3.273 3.249 3.249 3.250 3.275 3.275 3.27
B 2.369 2.360 2.361 2.356 2.359 2.360 2.3
M L 2.369 2.361 2.360 2.361 2.361 2.362 2.36
I 2.369 2.362 2.363 2.362 2.361 2.360 2.3
B 0.495 0.481 0.475 0.470 0.467 0.461 0.46
TX L 0.495 0.480 0.452 0.435 0.421 0.4141 0.40
I 0.495 0.494 0.492 0.490 0.490 0.489 0.48
Note: CH = chemicals and industrial raw materials; AG = agriculture and food; K = capital goods;
M = consumption goods; TX = textiles; B = base forecast; L = liberalized regime; I = import control
regime).
On the contrary, under the import control regime imports from all
three blocks, except India, register gains in absolute amount. Imports
from the EEC are higher under the liberalized regime than under the
base forecast, whereas these imports are less under the import control
regime than under the base forecast. Agricultural commodities are not
subjected to the tariff or quota restrictions under the import control
scheme, so the developing countries will try to increase the exports of
agricultural commodities in order to compensate their losses in other
commodities. Because the import control regime cannot affect imports
from the EEC in any significant way, the share of EEC would continue
to increase along with the absolute amount of its export.
In the case of imports of consumption goods the amount imported
from the Latin American and the other developing countries shows
a dramatic decline in the case of import control regime as compared
to that from countries under either the liberalized regime or the base
forecast. But the losses are not serious in the case of South-East Asia and
almost insignificant in the case of India. The reason may be that the
share of the consumption goods imported from India or South-East Asia
in the total imports of consumption goods are either constant or on a
declining trend, so the restriction on imports would not affect the result
very much; whereas the liberalization can help South-East Asia but not
India, because of its inability to generate a large exportable surplus of
consumption goods.
Textiles exhibit very interesting results; except for the other devel-
oping countries, import control regime shows absolute decline in the
amount of textile imports from all the other three blocks. The other
developing countries surprisingly generate small gains over the years
under import controls, although these are always less than the gains
obtained in the liberalized regime. In the liberalized regime both India
and South-East Asia show massive increases in the amount of textile
exports. The Latin American countries have doubled their amount in
six years from 1990 to 1995, but the absolute amount of exports are
still very small compared to amounts imported from the other blocks.
In the case of chemicals and industrial raw materials import controls
do not have any significant negative impacts on exports from the other
developing countries, Latin American NICs or India, but in the case of
South-East Asia the negative impact is quite serious. In the liberalized
regime, gains are more marked for the other developing countries and
South-East Asia, whereas the impact of liberalization has a significant
impact on the imports from India, Brazil and Mexico. The results show
that the level of imports was never higher under the import control
regime (except for the few years for India) than under the liberalized
regime or in the base forecast. So the claim that under the import con-
trol regime, because of the increased growth prospects of the domestic
economy, imports from the developing countries would be increased in
a significant way cannot be true.
The gains from the developing countries under the liberalization
regime system are in most cases positive. Whilst under the import
control system there would be increased demand in the UK because of
expansion of the domestic output, those extra demands can be met by
the exports from other OECD countries without any difficulties or from
countries with GSP preference like Brazil, Mexico and other developing
countries, whereas South-East Asian countries or India would have to
face restrictions.
The net impact of these changes in exports and imports on employ-
ment can be seen in Table 2.4, where the major industrial sectors have
been analysed. We can see that even in the base forecast all sectors,
except for capital goods, experience reductions in employment. The
result is partially due to the reduced sectoral growth of outputs in those
sectors and also because of the increasing role of the service sector
in employment, which is the natural phenomenon of any advanced
industrialized economy. The question is whether import control helps
employment, as is claimed by the proponents of controls. The answer is
positive for the few initial years but not always. In the case of chemicals,
import controls generally create more jobs than the base forecast, but
less jobs than in the liberalized regime. In the case of the agricultural
sector, both the liberalized regime and import control regime implies
less employment than in the base forecast. In the case of capital goods,
import controls mean less employment from 1983, but under the liberal-
ized regime after 1992 the gains in employment would be substantial.
In the case of the consumption goods sector, however, import controls
can create more employment than otherwise, although the liberalized
regime can also create more employment than the base forecast. In the
case of textiles, import controls can more or less stabilize an otherwise
declining industry, but the role of import controls would be to maintain
employment rather than to create new employment. In the liberalized
regime the employment suffers a great deal in relative terms but not in
an absolute sense.
The employment effects of tariff liberalizations do not support the
level of anxiety on this issue that are apparent in some developed coun-
tries. On the contrary, except for the textiles and consumption goods
sectors, there will be gains in employment. In the case of consumption
goods the gain will be there in later years. The import control by
itself creates more employment only in the early years. Whether it
can prevent the decline of job prospects is questionable. If we leave
every other variable unchanged, a reduction in tariff would not create
more employment in every sector. On the contrary, it may create more
employment in certain cases. The model is highly sensitive to the vari-
ables such as prices and output of various countries. If we simulate an
alternative price structure using different tariff rates the foreign trade
sector will expand or contract depending upon the direction of tariff
changes. Expansion of trade due to tariff reductions leads to increasing
export revenues for the recipient countries, which will stimulate their
ability to import. As a result the net employment effects on various
industrial sectors of the UK will depend upon the strength of those
sectors on Britain’s exports and also on the relative competitiveness of
those sectors to combat import penetrations.
We have simulated a partial equilibrium model of international trade
to see the pacts of trade liberalization on the sectoral employment in the
UK. Our results show that the increased stimulation that the balance of
payments and the purchasing power of the developing countries would
receive under a liberalized regime would enhance export prospects of the
UK and, as a result, the sectors that are of old-technology type, where
the knowledge of the technology is already available in the newly indus-
trializing developing countries, may lose. However, the overall effects
of import controls on employment prospects are not that attractive
compared to those of a liberalized regime. The clue to this result may be
found in the very nature of import controls. By import control its pro-
ponents suggest some restraint on the growth of imports of finished and
semi-finished manufactures (Yeats, 1979), when imports will anyway be
reduced by being priced out of the market at the margin (Cable, 1977).
It is unthinkable that the victim countries would not react by reducing
their imports from the UK in the same manner (Cline, 1978).
It also rules out the impact of the bilateral balance of payments on
exports and imports or the effects of foreign investments. Our model
has captured some of these details and so we come up with results that
a liberalized regime can, in certain cases, create rather than destroy
domestic employment prospects if we take into account both the direct
and indirect stimulations it can create for the developing countries. Our
study shows that an import control regime can help only in the short
term, but at a great cost in every field. The employment cost of a liber-
alized regime is only short-term and it is marginal, but the gains in the
long run from a liberal tariff policy would be substantial.
3
Structural Reforms in China
The purpose of this chapter is to explain China’s growth experiences in

terms of its international policy. We can demonstrate that the country’s
progress since it has introduced economic reforms in 1976 was mainly
due to its exchange rate policy, which has changed the direction of
China’s trade as well.
China’s national income statistics are highly unreliable, thus we
have to judge the country’s economic performance mainly on the data
published by international organizations. In particular, data on China’s
external sector can be verified by the international participants within
the external sector of China. Thus, we have to judge the success of
China on the level of foreign exchange reserves.
The analyses of Western organizations, such as the OECD or the
World Bank, that China’s dramatic improvements since 1992 are due
to the introduction of the market system and that future develop-
ments depend on large-scale privatizations of the state industries,
should be discounted within the context of an institutional frame-
work of a multi-level state and rural collective institutions (OECD,
2000). China is still a planned economy and the state has the
supreme authority to sanction any industrial or commercial activity.
‘Market’ in the true sense of the term does not exist, because the
state must be the majority partner in all companies. The power of
the state is now a little diffused, with local municipalities and village
authorities able to act as the representative of the state. However,
private sector is nothing but an extension of the state—the owners
of the private enterprises are related to the various functionaries of
the state, the military and the Communist Party. Thus, it is not clear
what definition of the market OECD or the World Bank normally use
in the case of China.
50
Structural Reforms in China 51
Chinese reforms were launched in the late 1970s with the aim of
replacing the centrally planned economy with a decentralized economy.
An open invitation was issued to foreign capital, mainly in those days
from the overseas Chinese of Hong Kong, Singapore and Taiwan. There
has been a significant reduction in the number of key commodities
that are allocated centrally. However, China never had any open-door
trade policy, such as that advertised by Western organizations. Chinese
policy was not very different from that of South Korea and Japan, where
devaluation of the exchange rate in order to make exportable products
and services as cheap as possible for world market was the fundamental
idea. However, there is a difference. South Korea and Japan could not
invite their diasporas to come and invest as there were no Japanese or
Korean diasporas. Conversely, Chinese diasporas worldwide played a
significant role in the early years of the liberalization process to infuse
capital and to set up marketing networks for Chinese products globally.
The exchange value of the domestic currency had a 50 per cent devalu-
ation to start with and again in 1994 it had a 40 per cent devaluation.
As a result, manufacturing products from other newly industrializing
developing countries were wiped out by the Chinese low-priced exports.
There were a series of devaluations in 1985, 1986, 1989 and 1990, in
addition to 1994 (Lardy, 1992; Hussain, Sternand Stiglitz, 2000; Yao,
2009; Liao, 2009; Yang and Zhao, 2014).
The broad thrust of the reforms moved China decisively into the
external sector and the world market. Initial success of the mainly
overseas Chinese-owned factories provoked interest from Japan, which
since 1985 had been suffering from a very high exchange rate for the
Yen. Japan’s low-technology manufacturing industries started moving
to China in order to take advantage of the low wage costs and very
low exchange rate of the Yuan. The real flood of Japanese investment
began in 1990 after the massacre of the 8000 students demanding basic
democratic rights in Tiananmen Square in Peking. Japanese investors
were assured of very strict discipline among the Chinese workers, who
still have no human rights.
The spirit of a market economy, whatever that may be, had nothing
to do with the economic advancement of China. Japan, since the Meiji
period until 1945, and both Taiwan and South Korea, until the 1990s,
had military dictatorships and prospered economically while work-
ers were treated like semi-slaves and the general population had no
democratic rights. There were other examples in Europe, such as Hitler’s
Germany and Mussolini’s Italy during the 1930s, where dictatorship
and absence of any trade unions or human rights resulted in dramatic
economic growth. Thus, China is one such example of economic suc-

cess of a militaristic dictatorship, but not an example of a laissez-faire
capitalist one.
The shares of central government revenue and expenditure as a per-
centage of GDP have fallen significantly during the reform period (Yao,
2009); however that does not imply any relaxation of state control but
instead decentralization. During the reform period the dominance of
the central government-owned enterprises has significantly decreased.
The most significant change has been the rise in the industrial output
produced by the collective sector. This sector consists largely of enter-
prises under the administrative control or ownership of local-level
governments at the provincial, city, township and village levels (Liao,
2009). Urban collectives owned by provincial and city governments
were features of the pre-reform period, but the rise of rural collective
industries in townships and villages has been a notable feature of the
reform period (Yang and Zhao, 2014).
Local governments have been able to promote and support local
industries within their jurisdictions with resources made available
by fiscal decentralization and the growth of extra-budgetary funds.
Sufficient resources are now at the disposal of local government offi-
cials. Township and village governments are the post-reform adminis-
trative units that replaced the commune and the brigade respectively.
Rural enterprises owned by township and village governments (TVEs)
account for 75 per cent of China’s rural industrial output and 60 per
cent of rural industrial employment (Huang, 1993).
The local state has in some ways replaced the market and inter-
vened to foster industrialization. This supports List and Gerschenkron’s
theory of ‘late developments’—that the contradictory pressures acting
upon late developers required the intervention of the state (List, 1885;
Gerschenkron, 1962).
East Asian countries, in particular South Korea and Taiwan, have
used and adapted this theory to illustrate the important role of the
state in East Asian developments (Amasden, 1989; Wade, 1990; Bowles
and Dong, 1994). These countries have designed a set of policies to
uphold a national developments ideology, as Japan did before them. In
China, the provinces and lower-level governments are also interested in
actively sponsoring growth in regions on which their personal fortunes
depend. The characteristics of China’s industrial economy thus demon-
strate a very active state machinery with decentralized units in towns
and villages to promote industrial activity geared to revenue prospects
from exports. However, China’s economy is still agricultural, so it is
important to discuss reform in the agricultural industry, where the main

burden of the economy, the employment of the people, still lies.
Reforms in Chinese Agriculture
In China the population is not yet urbanized. Prior to the 1980s

China’s agriculture was organized as collective farms with three-level
management systems: the commune, brigades and production teams.
Production teams used to be the basic units of production and distri-
bution (Bowles and Dong, 1994; Hart-Landsberg and Burkett, 2005).
The commune system was replaced by the household-responsibility
system (HRS) during the reform period. Under the HRS, village land
was contracted to individual households for a certain number of years.
However, it is not justifiable to give credit for the reformation of
Chinese agriculture to the liberalization towards the market. According
to Andreas (2008), reforms in the agricultural sector started during the
days of Mao in the early 1970s. Each household organized production
independently and retained all of its output or sales proceeds after
paying its share of agricultural tax, selling a quota of output to the
state and meeting the obligation to its team’s public accumulation and
welfare funds. The distinguishing feature of China’s land-tenure system
in the post-reform period is the separation of individual user rights
from other ownership rights, which remain ‘collective’ (Hart-Landsberg
and Burkett, 2005). The village collective has the right to allocate land
among its members, the right to lease land to outsiders or sell land to
the state, as well as the right to claim rental income from the land.
These village collectives are also important for rural industrial activi-
ties. In 1992, the income generated by rural collective and co-operative
organizations accounted for 45 per cent of the total income of China’s
rural economy. The other 55 per cent came from household agricultural
production and self-employment (Tingjun, 1993).
The Chinese way is to promote mainly state-controlled communal
regions where the private sector is also state-controlled. China is there-
fore not a market economy at all but more of a fascist state—and it will
probably be like that for the foreseeable future. Economic growth has
helped China to achieve a strong military power and dictate its terms
on the rest of Asia. China has allowed selective foreign investment with
very large obligations to export. It has not allowed any multination-
als to capture its domestic market. The country encouraged mainly
overseas Chinese and Japanese investments in the beginning, fol-
lowed by European and American multinational companies much later.
China’s export products are mainly produced by various multinational

companies.
Effects of Alternative Monetary-Fiscal and Exchange

Rate Policy
During the reforms introduced in 1978–9, China initiated a policy

regime where monetary-fiscal policy is an indirect instrument for man-
aging various decentralized economic activities and supporting the state
industries. At the same time exchange rate policies were used to expand
the role of the foreign trade sector in the national economy (Chen,
2009; Zhigang and Shijie, 2009). The purpose of this section is to evalu-
ate alternative policy regimes in China.
There is significant repressed inflation in China. The rapid growth
of money supply in recent years has created excess demand in the
economy and fuelled inflationary expectations (Felderstein and Ha,
1988; Chow, 1987, 1993; Szapary, 1989; Breslin, 2007). The reforms
have contributed to rapid economic growth, with gross national prod-
uct (GNP) increasing by an average of 10 per cent over the last decade
(Mingtai, 2004). With more resources being left in the hands of enter-
prises and households, money has become a store of value. Inflow
of foreign capital is highly significant in increasing the monetary
flow in the economy. The main source of excess monetary growth is
the large budget deficit created to support the state industries whose
profits are falling and to provide subsidies to the workers to protect
them from inflation (Burdekin and Siklos, 2008; Hart-Landsberg and
Burkett, 2005).
China’s Monetary System since the Reform
In 1984, the People’s Bank of China (PBC) was transformed into a cen-
tral bank. In 1981 treasury bonds were introduced to borrow money
from the people and to reduce the growth of money in the economy.
In 1985 specialized banks were allowed to issue bonds as well. In addi-
tion, enterprises were allowed to issue securities, to borrow from the
commercial banking system and to retain a significant part of their
earnings. Like in most other developing mixed economies, PBC has
four main instruments to control the monetary sector: credit ration-
ings, reserve requirements of the commercial banks, interest rates and
lending to the commercial banking system (Burdekin and Siklos, 2008;
Mingtai, 2004).
Since 1983, monetary policy was expansionary to fuel economic

growth. Increases in financial autonomy of organizations since 1984
were responsible for huge growth in demand for finance. Chinese mon-
etary policy has no long-term or even a medium-term plan. It reacts
according to events and, as a result, relaxed monetary policy one year
can be followed by tight monetary policy the next and then the follow-
ing year a relaxed monetary policy again (Breslin, 2007; Burdekin and
Siklos, 2008). As real income rises, the demand for money increases; and
as expected inflation rises, the demand for money decreases (Mingtai,
2004; Zhigang and Shijie, 2009).
Until 1987, the main source of monetary growth was an increase
in PBC credit to banks. Increased foreign reserves and reduction of
reserves by banks have become important sources of money growth in
recent years. The National Credit Plan has also intensified the influence
of local authorities over monetary policy (Burdekin and Siklos, 2008;
Hart-Landsberg and Burkett, 2005) and the effectiveness of interest
rate policy is constrained by the administrative setting of prices (Chen,
2009; Mingtai, 2004).
Fiscal Policy since the Reform
Before 1978, the government was responsible for all investments and
working capital of the enterprises. In turn organizations used to trans-
fer their profits to the government. A scheme to retain some profit and
taxations of profit was introduced in 1978. Since 1986, all enterprises
pay income tax instead of profit transfer. However, the tax system is
discretionary. Medium and large enterprises pay 55 per cent tax, while
for others taxation depends on circumstances and the desirability of
the product. The government is no longer responsible for capital invest-
ment for all enterprises (Mingtai, 2004; Zhigang and Shijie, 2009).
However, budget deficits are rising, whereas before the reform balanced
budget was to be the norm.
Currently, borrowings by the government from the central bank
constitute a large part of the monetary expansion. In China, due to
recent regional decentralization, local authorities set the effective tax
rate through the establishment of quota profits and the rate of taxation
of above-quota profits. They are not willing to share that revenue with
the central government. Since 1988, local authorities remit to the gov-
ernment a given amount of revenue and retain the rest; these systems
have weakened government control over the fiscal policy (Lardy, 1992;
Perkins, 1988; World Bank, 1990).
A Macroeconomic Policy Model for China
In this chapter, an econometric model of the economy of China is

described and estimated. We provide in this section the explanation
of the structural econometric equations. The model is a synthesis of
the Keynesian and Monetarist approaches, along with some special
characteristics of the economy of China. There are important dif-
ferences between the national income accounting in China and the
standard national income accounting system in the market econo-
mies of the Western world. In China, GDP is approximated using a
concept called Net Material Production (NMP), which refers to the
value added in five material production sectors: industry, agriculture,
construction, transport and commerce. The value added in each of
these sectors is the gross value of output of each sector minus the
value of intermediate inputs and depreciation of fixed assets. All
activities and services contributing to the production of physical
goods are classified as material, while all other services are classified
as non-material (e.g. finance, insurance, real estate, business services,
public administration, defence, education, health and other personal
services).
Thus:
GDP = NMP + value of non-material services + depreciation of

fixed assets.
Personal consumption refers to the consumer goods used by individu-

als. It excludes rent, financial services and other non-material services.
Public consumption includes expenditure on fuel, power, office articles,
books and equipment used by the government, national defence, cul-
tural, educational, health sectors, non-profit institutions in economic
construction sectors, people’s organizations and other non-production
units and depreciation of buildings used by these organizations. It
excludes capital expenditure on equipment and construction by the
army. Net investment includes capital formation in the defence sector
and includes all newly added fixed assets in material and non-material
sectors and inventories (Basu, 1995, 1996).
In Eqn (3.1), the consumer’s price index is determined by the money
supply (M2 in standard macroeconomics). Other price deflators are
considered as proportional to the consumer price index. Price defla-
tor of the material GDP (i.e. PNMP) is determined by the consumer
price index and the supply of notes and coins in circulation (Ml in
standard macroeconomics). Whereas PNMP is influenced by cost (here

it is CPI), CPI itself is influenced by demand factors, because it was
observed in recent years despite very strict price control measures
(Basu, 1996, 2000).
In Eqn (3.8) real private consumption is explained in terms of real
GDP and lagged real private consumption. In Eqn (3.11) real invest-
ment is determined by changes in the GDP. There are several dummies
to include exogenously influenced changes in the objectives of the
planning authority. In the foreign sector, total export was divided up
according to the direction of exports. Exports to Hong Kong are taken
as exogenous as they depend on the political developments in that area
and the corresponding infrastructure developments in China itself.
Exports to the USA, in Eqn (3.17), are influenced by US GDP and the
exchange rate between US$ and RMB (or Yuan as the Chinese currency
is called now). The dummy includes the exogenous changes in the US
trade policy and its impacts on Chinese exports to the US market. In
Eqn (3.18) the GNP of the OECD countries is explained. International
price of exports is determined by the exchange rate and other exog-
enous factors and the price of exports is considered (in Eqn (3.24)) to
be the price deflator of the NMP, the most important component (Basu,
1996, 2000).
Exports to Japan, in Eqn (3.19), are influenced by Japan’s GDP and
the relative price of Chinese exportable products and services in the
Japanese market. Exports to Canada, in Eqn (3.20), are influenced by
the real GDP of Canada, because price effects are found to be statis-
tically insignificant. The USA, Japan and Hong Kong are the major
sources of imports for China. Thus, China’s total imports have four dif-
ferent categories, according to the sources. Price of importable products
and services, in Eqn (3.25), is determined by the price of exportables in
the OECD countries (PEXG$IND) and the exchange rate between the
US$ and RMB (or Yuan). Imports are determined, in Eqns (3.28), (3.29),
(3.30) and (3.31), mainly by their domestic demands and by the prices
of imports relative to the domestic prices. Dummy variables for the
USA refer to the improvements in the economic relationship between
China and the USA; there are two dummies for Japan, the first refers
to the political changes and the second refers to the economic rela-
tionship between China and the USA; both of which can affect foreign
trade as Japan is the most important trading partner for China (Basu,
1996, 2000).
In the national income identities, variables are arranged according
to the national income accounting system in China. Government
revenue is influenced by the profit tax imposed by the government on

the enterprises. Government expenditure is described in Eqn (3.48) as
the addition of domestic investment, government consumption and
expenditure on the non-material services minus any foreign invest-
ment. The econometric model is given here (explanations of the nota-
tions are in the appendix).
Consumption:
Consumer price index
CPI = 0.411 + 0.611. CPI(t−1) + 0.0003M2 (3.1)
(3.41) (2.98) (2.94)
R2 = 0.87 R-bar-squared = 0.87 DW = 2.71 ρ = 0.37
Price deflator, government consumption

PCG = PCG(t−1). CPI/CPI(t−1) (3.2)
Price deflator, private consumption

PCP = PCP(t−1). CPI/CPI(t−1) (3.3)
Public consumption expenditure

CG = CGR.PCG (3.4)
Public consumption expenditure
CP = CPR.PCP (3.5)
Consumption expenditure
C = CP + CG + NMSERV (3.6)
Real consumption
CR + CPR + CGR + NMSERVR (3.7)
Real private consumption

log CPR = −0.418 + 0.931 log (CPR(t−1)) + 0.104 log GDPR (3.8)
(2.48) (3.71) (2.03)
Investments:
Price deflator, domestic investment
PIDOM = PNMP (3.9)
Real domestic demand
IDOMR = INETR = CCONR (3.10)
Investment
INET = INETR.PIDOM (3.11)
Real investment
INETR = 0.542 INETR(t−1) + 0.270[GDPR(t−1) − GDPR(t−2)]
(2.89) (2.51)
+19548.0 DUMINETR−2222.2 DUMINETR2 + 19733.3 DUMINETR3
(3.01) (1.95) (1.83)
+0.183[CPR + EXNIAR-MNIAR + CGR] (2.79) (3.12)
Capital stock
KSTOCK = KSTOCK(t−1) + INET (3.13)
CCON = 0.015. KSTOCK(t−1) (3.14)
Real capital
CCONR = CCON/PNMP (3.15)
Price deflator, national material product (3.16)

PNMP = 0.352 + 0.667 CPI + 0.0003M1
(2.79) (2.35) (3.51)
Exports:
Exports to the USA
EXUSA$ = −817.874 + 0.0005GNP$US−607.264 DUMEXUS + 337.284RX
(1.84) (2.57) (1.71) (2.35) (3.17)
Exports to the rest of the world

EXROWNA$ = −678.704 + 0.0007 GNP$IND(t) + 0.575 EXROWNA$(t−1) (3.18)
(1.71) (2.35) (3.07)
Exports to Japan
EXJNS$ = 3511.19 + 0.00348754 GNP$JP−5.697(PEXNIA)/[(RXJP)(WPIJP)]
(1.85) (2.54) (2.87)
–1319.18DUMMYEXJ+1199.03DUMMYEXJ2 (3.19)
(1.37) (1.51)
Exports to Canada
EXCNNS$(t) = –2.525 + 1.055EXCNNS$(t–1) + 0.000018GNPR$CNN$(t)
(3.01) (1.87) (2.11) (3.20)
Exports to the world (US$)

EXNIA$ = EXUSNS$ + EXJNS$ = EXHKNS$ + EXROWNS$ +
EXCNNS$ (3.21)
Exports to the world
EXNIA = EXNIA$.RX (3.22)
Real exports to the world
EXNIAR = EXNIA/PEXNIA (3.23)
Export prices
PEXNIA = PNMP (3.24)
Imports:
Import prices
Log PMNIA = 0.275 + 1.0011 log(PEXG$IND.RX) (3.25)
(1.89) (2.47)
Real imports
MNIAR = MNIA/PMNIA (3.26)
Imports
MNIA = MNIA$.RX (3.27)
Imports from the USA

MUSNS$ = −6386.32[(PMNIA/RX)CPI]
(2.30)
+1593.34 DUMMYMUS + 0.036(GAP/RX) (3.28)
(1.98) (1.78)
Imports from Japan

MJNS$ = 0.049. (GAP/RX)−6862.24[(PMNIA/RX)/CPI]
(3.01) (2.79)
–1311.50 .DUMMYMJ + 6079.52 .DUMMYMJ2 (3.29)
(2.35) (1.90)
Imports from the rest of the world

MROWNS$ = 0.0559(GAP/RX)−4353.66[(PMNIA/RX)CPI]
(1.79) (3.23)
+7377.86 DUMMYMROW (3.30)
(2.01)
Imports from Hong Kong

MHKNS$ = 0.021(GAP/RX)−4088.8[(PMNIA/RX)/CPI]
(3.01) (2.79)
+2806.12DUMMYMHK (3.31)
(2.85)
MNIAS$ = MJNS$ + MHKNS$ + MROWNS$ (3.32)
Debt:
Foreign debt outstanding
DTDISST&LT=DTDISST&LT(t−1)-BOPCA$+[FX$-FX$(t−1)]-
BOPKEQ$ (3.33)
Identities and aggregate income determinations:

Money supply, M2
M2 = M1 + MQ (3.34)
Exports prices
PEXNIA = PNMP (3.35)
Export of goods, US$
BOPEXG$ = −7.236.1 + 1.01 EXNIA$
(3.70) (2.31) (3.36)
R = 0.87 R-bar-squared = 0.85 DW = 1.75 ρ = 0.56
2
Net material product

NMP = CG + CP + INET + EXNIA = MNIA + STATNMP (3.37)
Real non-material services

NMSERV = SERV%NMP.NMP/100 (3.38)
Real domestic demand
GAPR = CR + IDOMR + STATNMPR (3.39)
Consumption expenditure
C = CP + CG + NMSERV (3.40)
Real gross domestic product

GDPR = GAPR + EXNIAR (3.41)
Current account balance of payments, US$

BOPCA$ = BOPEXG$ − BOPMG$ + BOPEXS$ − BOPMS$ + BOPTR$ (3.42)
Real gross national product

GNPR = GAPR + EXNIAR − MNIAR (3.43)
Public budget balance
GBAL = GREV − GEXP (3.44)
Real exchange rate

RRX = [(RX/1.498). WPI$]/[CPI/1.161] (3.45)
Net service balance of payments

BOPNETBAL$ = BOPEXS$ − BOPMS$ (3.46)
Domestic absorption
NIA = CP + CG + INET (3.47)
GEXPR = IDOMR + CGR + NMSERV − FI (3.48)
Stability: all positive real roots are less than unity, so the system is
stable.
Simulation of Alternative Policies
In this section we evaluate two types of experiments: (a) comparison of

the actual performances of the economy since 1987 and a forecast based
on alternative economic policies; and (b) comparison of different simu-
lations of the Chinese economy for the period 1987–95. In this way, we
can examine the importance of some key macroeconomic variables on
the performances of the economy and the direction of trade during the
formative years of China after the reforms.
The purpose of these simulations is to see the impact of certain key
variables, such as exchange rate, fiscal balance, money supply and
domestic investment, on the economy of China. However, the real
economy has behaved quite differently than our simulations suggest.
Tables 3.1 and 3.2 show the actual performances. Assumptions used
in experiments 1 and 2 regarding the public fiscal balance, exchange
rate and money supply are given in Table 3.3. Experiment 1 assumes
a gradual devaluation of the exchange rate, continuation of high rate
of growth of money supply and budget deficit to stimulate the econ-
omy. Experiment 2 assumes a tight money supply, fixed exchange
rate and a lower rate of budget deficit. Results in Tables 3.4 and 3.5
show the simulated performances of the economy under these two
experiments.
Table 3.1 China—historical data: 1985–90
1985 1986 1987 1988 1989 1990
Real GDP and its components — % change year ago
GDP 12.3 9.3 9.4 8.9 4.3 3.8

Domestic demand 13.2 6.8 6.6 9.9 4.4 −1.6
Gross domestic 24.6 6.8 6.6 – – –
Consumption 14.4 5.9 4.9 – – –
Exports of goods 29.1 24.1 29.7 2.7 22.5 23.9
Imports of goods 67.7 −5.6 −6.8 10.7 22.6 −9.8
Real per capita 11.1 7.9 8.1 7.1 2.7 2.6
GDP
Nominal GDP — levels in billion US$
GDP 260.19 254.261 300.347 376.531 336.864 333.199
Domestic demand 273.313 263.401 302.002 381.846 342.484 324.034
Current account −11.417 −7.034 0.3 −3.802 −4.317 11.998
Trade balance −13.123 −9.14 −1.661 −5.315 −5.62 9.165
Merchandise 25.108 25.756 34.734 41.054 43.22 51.519
exports
Merchandise 38.231 34.896 36.395 46.369 48.84 42.354
imports
Service balance 0.0531 1.551 1.901 1.22 0.64 1.451
Prices — % change years ago
Consumer price 11.8 7 8.8 20.7 16.3 1.41
index
GDP deflator 3 8.4 7.8 15.1 8.9 5.9
Financial Indicators
Money supply 23.18 27.8 18.53 19.96 6.32 20.14

(Ml) %
Money supply 35.47 30.23 25.34 20.66 18.65 28.86
(M2) %
Exchange rate 3.2 3.72 3.72 3.72 4.72 5.22
(RMB/$)
Gov’t balance/ 0.25 −0.74 −0.71 −0.56 −0.58 −0.51
GDP (%)
Foreign 6.68 5.26 6.08 7.22 3.72 8.21
investments (US$
billion)
Key ratios (%)
Investment/GDP 35.3 35.6 34.6 – – –
Domestic Savings/ 29.6 31 32.2 – – –
GDP
Table 3.2 Investment, savings and foreign investment
Investment/GDP Savings/GDP Foreign investment/GDP

(%) (%)
1980 34.5 34.2 –

1981 30.9 30.9 –
1982 31.1 32.5 –
1983 32.5 32.8 0.45
1984 34.1 33.6 1.25
1985 35.3 32.3 2.56
1986 35.6 33.7 2.06
1987 34.6 32.2 2.02
1988 – – 1.91
1989 – – 1.1
1990 – – 2.46
Source: World Bank.
Table 3.3 Policy assumptions—simulation 1 and 2
1987 1988 1989 1990 1991 1992 1993 1994 1995
Simulation 1
Money 22 16.8 16.5 16.1 16.2 16.4 16.2 16.3 15.3
supply
(Ml) % chya 23.2 16.9 16.7 16.6 16.5 16.6 16.5 16.4 15.5
money
(M2) % chya 3.72 4.4 4.9 5.3 5.5 5.6 5.7 5.8 5.89
exchange
(RMB/%)
Gov’t −0.8 −0.8 −0.8 −0.8. −0.8 −0.2 −0.3 −0.4 −0.4
balance/GDP
Simulation 2
Money supply 16 12 12 12 12 12 12 12 12
(Ml) %
Money supply 17 13.5 12.5 12 12 12 12 12 12
(M2) %
Exchange rate 3.3 3.3 3.3 3.3 3.3 3.3 3.3 3.3 3.3
(RMB/$)
Gov’t balance/ −0.6 −0.4 −0.4 −0.4 −0.4 −0.4 −0.4 −0.4 −0.4
GDP (%)
Table 3.4 Chinese economy, simulation 1
1987 1988 1989 1990 1991 1992 1993 1994 1995
Real GDP and its components — % change year ago*

Gross Domestic 8.1 7.7 7.6 7.9 7.5 7.2 6.9 7.1 7.1
Product
Domestic 5.5 5.4 6.1 6.7 7.2 7.2 7.1 7.2 7.2
demand
Consumption 4.8 4.6 5.4 6.0 6.7 6.9 6.9 7.1 7.0
Private 4.5 4.7 5.6 6.2 7.0 7.4 7.4 7.7 7.5
Government 2.2 3.5 3.7 3.5 3.2 3.3 3.2 3.0 3.1
Gross domestic 5.5 5.6 6.0 6.6 6.9 6.5 6.2 6.2 6.5
investment
Exports of 28.1 27.1 19.1 15.0 9.9 7.8 7.7 7.5 7.7
goods
Import of 4.9 20.0 15.9 10.7 10.5 9.2 10.9 9.9 10.0
goods
Real pre-capita 6.9 6.4 6.5 6.8 6.3 6.0 5.8 5.9 5.9
GPD
Nominal GDP — levels in billions of US dollars
Gross Domestic 274.6 258.6 261.7 276.5 305.7 345.6 391 443.1 501.2
Product
Domestic 281.1 265.6 269.0 283.3 312.7 353 398.8 451.6 510.5
demand
Pre-capita 256 238 239 250 273 305 341 383 428
GDP ($)
Prices — % change year ago

GDP deflator 4.8 3.4 4.7 5.9 6.7 7.4 7.7 7.7 7.2
Consumer price 6.5 6.7 7.0 7.4 7.4 7.7 7.8 7.8 7.2
index
Terms of trade −2.8 −5.2 −1.6 −1.4 1.5 2.1 3.6 2.6 2.5
Population
Population 1.07 1.09 1.10 1.11 1.12 1.13 1.15 1.16 1.17
billions
% chya 1.2 1.2 1.0 1.1 1.1 1.1 1.1 1.1 1.1
Foreign sector — millions of current US dollars
Current account −3306 −3671 −3827 −3249 −3284 −3368 −3782 −4052 −4538
balance
Trade balance −5062 −5400 −5542 −4932 −5010 −5114 −5326 −5778 −6220
Merchandise 35476 40681 46332 52683 59752 68051 77595 88548 101114
exports
Merchandise 40538 46081 51873 57615 64761 73165 82922 94326 107334
imports
Service balance 1351 1267 1184 1079 1034 967 877 759 608
Foreign debt 27070 30738 34471 37410 40543 43894 47598 51969 56986
1987 1988 1989 1990 1991 1992 1993 1994 1995
Gross Domestic 6.6 7.5 7.2 6.9 7.3 7.2 7.2 6.9 6.8
Product
Domestic 6.8 7.2 6.8 6.6 7.2 7.0 7.0 6.9 7.1
Demand
Consumption 6.6 6.8 6.7 6.4 6.9 6.9 7.0 6.9 7.0
Private 4.5 4.6 5.7 6.3 7.2 7.6 7.7 7.9 7.9
Government 2.1 3.1 3.5 3.3 3.1 3.0 3.0 2.9 2.9
Gross Domestic 7.1 8.0 7.0 7.0 7.8 7.1 7.0 7.0 7.1
Investment
Exports of 8.5 6.2 8.6 7.6 7.4 8.9 7.8 6.8 6.6
Goods
Import of Goods 9.2 4.5 5.3 5.6 6.9 7.3 6.4 7.0 8.3
Real Per-capita 5.7 6.1 6.2 6.0 6.1 6.0 6.0 5.7 5.7
GPD
Nominal GDP — levels in billions of US dollars

Gross Domestic 218.2 243.3 270.8 300.8 335.2 345.6 145.6 462.2 514.1
Product
Domestic 222.2 247.1 273.8 303.1 312.7 337.5 417.3 464.2 517.3
Demand
Per-capita 204 225 248 273 273 301 365 401 441
GDP ($)
GDP deflator 3.8 3.4 3.9 3.9 4.1 4.1 4.0 4.0 4.0
Consumer 4.2 6.7 4.4 4.4 4.4 4.5 4.5 4.5 4.5
price index
Terms of trade −2.6 −5.2 −2.0 −1.4 2.5 2.7 3.9 3.5 3.5
Current account −2639 −2521 −1794 −1248 −1332 −1030 −814 −1211 −2553
balance
Trade balance −3996 −3788 −2978 −2364 −2366 −1997 −1691 −1970 −3161
Merchandise 29433 31938 35409 39409 42754 47383 52093 56866 62025
exports
Merchandise 33424 35726 38387 41417 45120 49380 49380 58837 65186
imports
1. % chya = per cent change year ago.

2. * Per cent change calculated from levels in 1960 RMB.
3. Exchange rate is period average.
Comparison of the History and Simulation 1
Comparisons of the historical performances, as in Tables 3.1 and 3.2,

with the results obtained in simulation 1 in Table 3.4, showed that
the money supply rate in the historical period was much higher than
was assumed in the simulation (Basu, 1996, 2000). Rates of growth of
money supply in the historical path were 20.6 per cent in 1988 and 28.8
per cent in 1990; corresponding rates in simulation 1 were 16.9 per cent
in 1988, 16.6 per cent in 1990 and 15.5 per cent in 1995. The budget
deficits, as a percentage of the GDP, were assumed, in simulation 1, to
reach 0.8 in 1987, and continue to be so until 1991; thereafter it was
reduced to 0.2 in 1992 and 0.4 in 1995.
In the historical path budget deficit as a percentage of the GDP was
0.7 in 1986 and 0.5 from 1988 to 1990. The higher rates of growth of
money supply and budget deficit has stimulated the economy further,
as we can see that the gap between investments and domestic savings
are not always filled up by foreign investments (Basu, 1996, 2000).
Exchange rates in simulation 1 have a moderate but steady devaluation.
In 1987 the exchange rate was 3.72 RMB/US$1, it was 5.5 in 1991 and
5.8 in 1995. The historical path suggests 3.72 RMB/US$1 in 1988 and
5.22 in 1990. Thus, the major differences between the historical path
and the assumptions in simulation 1 are regarding the rate of growth
of money supplies and budget deficit. The result shows that, whereas
in the historical periods the rate of growth of real GDP was 9.4 in 1987
and the nominal GDP was US$300.3 billion in 1987, simulation 1
suggests a lower figure for both (8.1 per cent and US$274.6 billion). In
1990, the actual GDP was US$333.199 billion, whereas in simulation
1 it was US$305.7 billion. The domestic demand shows similar results.
There are differences in the trade balances. In the historical path, trade
balance in 1988 and 1989 were not significantly different from those
in simulation 1. In 1990 the historical figures were distorted by the fact
that the Chinese authority, due to significant inflationary pressure, had
decided to reduce imports, although the restriction could not last long.
The current account deficit in the balance of payments over the histori-
cal path shows a smaller deficit or even surpluses, whereas in simulation
1 corresponding figures are much higher (Basu, 1995). This is due to the
fact that over the historical path exports went up significantly, whereas
imports did not. The exports in simulation 1 would reach US$52.6
billion in 1990, actual export was US$51.5 billion; imports in simula-
tion 1 in 1990 would be US$57.6 billion; actual imports were US$42.3
billion. The improved performance of exports was due to a number of
factors: increased demand through Hong Kong and from Japan and
Taiwan, increased market penetration in the US and unprecedented
exports of weapons to countries in the Middle East. Foreign invest-
ments in the special economic zones were major factors in stimulat-
ing exports of manufactured products (Kueh, 1992). However, on the
negative side, price inflation, however suppressed, is much higher over
the historical path than along simulation 1. The consumer price index
went up by 20.7 per cent in 1988 and 16.3 per cent in 1989, the rate
of inflation in 1992–3 could be as high as 30–40 per cent (Basu, 1996,
2000). Over expansions of the economy have created an inflationary
spiral; the current regime is trying to contain that using contractionary
fiscal and monetary policies, but success may not be achievable without
sacrificing the rate of growth, which is now fuelled by excessive mon-
etary growth both domestic and foreign (because of increased portfolio
investments in China by Western and Japanese institutional investors).
Comparison of Simulations 1 and 2
In simulation 2, the money supply is assumed to grow at a slower rate

throughout the period (Tables 3.3 and 3.5 and Figs 3.1–3.6). The rate of
growth of M2 would be 12 per cent in 1990, and continues to be so until
1995; comparatively, the rate of growth of M2 in simulation 1 would be
16.6 per cent in 1990, and continue more or less the same until 1994.
Budget deficit as a percentage of GDP was 0.4 per cent in 1990 and for
the rest of the period under consideration. So, in simulation 2 we assume
a strict monetary and fiscal policy regime; however at the same time
we assume a fixed exchange rate of 3.3 RMB/US$1 for the whole of the
period. Hence, the purpose of this experiment is to see, given the similar
rate of investment, what effect a strict monetary policy regime with fixed
exchange rate may have on the overall performance of the economy.
From the comparison of simulations 1 and 2, we see that the rates of
change of real GDP are not dissimilar. In simulation 1, the real rate of
growth of the GDP would be 7.9 per cent in 1990, 7.2 per cent in 1992
and 6.8 per cent in 1995. In simulation 2, it would be 6.9 per cent in
1990, 7.2 per cent in 1992 and 6.8 per cent in 1995. Rate of growth of
exports in real terms, in simulation 1, would be 15 per cent in 1990, 7.8
per cent in 1992 and 7.7 per cent in 1995. In simulation 2, it would be
7.6 per cent in 1990, 8.9 per cent in 1992 and 6.6 per cent in 1995. The
efforts of slower export growth in simulation 2 would be compensated
by the slower rate of real imports. As a result, the deficit in the current
GDP DOMESTIC DEMAND
GDP and Domestic Demand—China

(% Change from a year ago)
15
10
–5
72 74 76 78 80 82 84 86 88 90 92 94 98
Figure 3.1 Simulation 1, GDP and domestic demand, China
account of the balance of payments would be US$1.7 billion in 1990,

US$1.3 billion in 1992 and US$2.5 billion in 1995; whereas in simula-
tion 1 the deficit would be US$3.2 billion in 1990, US$3.3 billion in 1992
and US$4.5 billion in 1995. The effect of the higher current account
deficit in simulation 1 would be subdued by the increased rate of infla-
tion in that simulation. Both the GDP deflator and the consumer price
index would register much higher inflationary levels in simulation 1
compared to simulation 2. We can also see that the rate of growth of
real domestic investment in simulation 2 is always at a higher level than
Current Account Balance

and as % GDP—China
(Billions of US dollars)
6 4
3 2
Billions
US Dollars
1
0 0
As % of –1
GDP
–3 –2
–3
–6 –4
–5
–9 –6
–7
–12 –8
70 72 74 76 78 80 82 84 86 88 90 92 94 96
Right Scale: As % of GDP.
Left Scale: Billions of US dollars.
Figure 3.2 Simulation 1, current account balances, China
those in simulation 1. The rate of growth of real domestic investment

in simulation 1 would be 6.6 per cent in 1990, 6.5 per cent in 1992 and
6.5 per cent in 1995. The corresponding rates in simulation 2 should be
7 per cent in 1990, 7.1 per cent in 1990 and 7.1 per cent in 1995. The
higher rate of growth of real investment in simulation 2 has maintained
the growth of the real GDP despite the slower rate of growth of exports
and a higher level of balance of payment deficits. A fixed exchange
rate would depress the flow of the money supply due to foreign earn-
ings in terms of domestic currency. At the same time, strict domestic
monetary policy will depress the domestic money supplies. Strict fiscal
policy would reduce the possibilities of increased money supply due to
budget deficits. A combination of all these factors would mean a lower
Consumer prices—China
10
–2
70 72 74 76 78 80 82 84 86 88 90 92 94 96
Figure 3.3 Simulation 1, consumer prices, China
rate of inflation, which would increase the real rate of investment, in

turn stimulating the real rate of growth of the GDP. So long as the high
rate of growth of investment can be maintained, it would be possible
to have a non-inflationary (i.e. about 4.5 per cent inflation rate) rate
of growth of the economy at about 7 per cent per year. It is possible to
achieve a higher rate of growth, but the cost would be a much higher
rate of inflation.
The higher rates of growth over the historical path compared to the
simulations are due to two factors indicated in the model: very high
rate of money growth and extraordinary growth of exports. Monetary
growths have stimulated inflationary expectations and, as a result, high
rates of growths were accompanied by high rates of inflations. The
growth of exports is due to a number of factors, of which are exogenous
GDP DOMESTIC DEMAND

GDP and Domestic Demand—China
15
10
–5
72 74 76 78 80 82 84 86 88 90 92 94 96
Figure 3.4 Simulation 2, GDP and domestic demand, China
to the model. The very low rate of wages for the Chinese labour force
has initiated a flood of foreign investors, who are taking advantage of
this competitiveness. China’s recent economic growth is spectacular;
however there are fears that the economic boom could soon turn dis-
astrous. Although China’s GNP is growing at a respectable rate, funda-
mental reforms in the economy are yet to take place. Deregulation of
grain prices is happening only on a trial basis, but abolition of subsidies
has not yet occurred. Potential inflation is there under the surface of
a growing economy fuelled by China’s increasing deficit financing
and subsidy policy. The reforms introduced in 1978–9 have initiated a
policy regime where monetary-fiscal policy is no longer an instrument
Current Account Balance

and as % of GDP—China
6 4
3 2
Billions
US Dollars
1
0 0
As % of
−1
GDP
−3 −2
−3
−6 −4
−5
−9 −6
−7
−12 −8
70 72 74 76 78 80 82 84 86 88 90 92 94 96
Right Scale: As % of GDP.
Left Scale: Billions of US dollars.
Figure 3.5 Simulation 2, current account balances, China
to support physical plans but an indirect instrument to manage aggre-

gate demand and to allocate resources. At the same time, exchange rate
policies were used to expand the foreign trade sector’s contribution to
the national economy.
One additional simulation was carried out to examine the effect of
a higher degree of depreciation of the exchange rate on the national
economy. The assumption regarding the exchange rate in simulation
1 is replaced here by the historical exchange rate, as in Table 3.6, for
the period 1987–95; the rates for the period 1987–92 have not deviated
much from the assumed path. However, in the years after 1992, the
historical exchange rate has depreciated much faster than the assumed
exchange rate.
Consumer Prices—China
10
−2
70 72 74 76 78 80 82 84 86 88 90 92 94 98
Figure 3.6 Simulation 2, consumer prices, China
Table 3.6 Historical exchange rate 1987–95
1987 1988 1989 1990 1991 1992 1993 1994 1995
Exchange
rate 3.72 3.72 4.72 5.22 5.43 5.75 5.8 8.44 8.30
(yuan/US$)
The results of this simulation, given in Table 3.7, show that up to the
year 1992 there is no change on the final outcomes, because the his-
torical exchange rate was not any different from the assumed exchange
rate. Since 1993, China’s exchange rate has had some depreciations;
the effects are felt on both exports and imports in the new simula-
tion. Exports have expanded, the overall trade has deteriorated a little
1987 1988 1989 1990 1991 1992 1993 1994 1995
Gross Domestic 6.6 7.5 7.2 6.9 7.3 7.2 7.2 6.7 7.1
Product
Domestic 6.8 7.2 6.8 6.6 7.2 7.0 7.0 6.8 7.1
demand
Gross domestic 7.1 8.0 7.0 7.0 7.8 7.1 7.0 7.0 7.1
investment
Export goods 8.5 6.2 8.6 7.6 7.4 8.9 7.8 7.5 8.2
Import goods 9.2 4.5 5.3 5.6 6.9 7.3 6.4 8.5 8.7
GDP deflator 4.8 3.4 4.7 5.9 6.7 7.4 7.7 7.8 7.4
Consumer price 6.5 6.7 7.0 7.4 7.4 7.7 7.8 8.2 8.9
index
Terms of −2.8 −5.2 −1.6 −1.4 1.5 2.1 3.6 2.2 2.1
trade
Foreign sector — Millions of current US dollars
Current account −3306 −3671 −3827 −3249 −3284 −3368 −3782 −4363 −4878
balance
Trade balance −3062 −5400 −5542 −4932 −5010 −5114 −5509 −5932 −6729
Merchandise 35476 40681 46332 52683 59752 68051 79031 92635 112302
exports
Merchandise 40538 46081 51873 57615 64761 73165 84540 98567 119031
imports
Service balance 1351 1267 1184 1079 1034 967 831 688 531
and the balance of payments was affected negatively. Because China’s

needs for imports are great, devaluation will not contract imports
significantly. The efforts of devaluations on the rate growth of real
exports are highly positive and, as a result, the real rate of growth of
the GDP has achieved a higher magnitude in 1993 in this new simu-
lation compared to simulation 1. The real rate of growth of the GDP
is a little less in 1994 in the new simulation, because of the higher
import costs. However, in 1995 it has recovered to the same level as
was achieved in simulation 1. The result shows that the structural fac-
tors, such as high savings rate and exceptionally high rate of growth
of money supply, are more important than the depreciations in the
exchange rate. Depreciations in the exchange rate of course stimulate
exports, but the economy depends crucially on imports of capital
equipments and raw materials; thus a compression of imports through
devaluation of the exchange rate can only happen if it is associated
with lower rate of growth of money supply, lower savings rate and lower
rate of investment.
In this model, experiments were carried out to examine the effect of
monetary and fiscal and exchange rate policies on the performance of
the Chinese economy. We have seen that the very high ratio of invest-
ment to the GDP is characteristic of the economy and, so long as it can
be maintained, even a fixed exchange rate cannot reduce the rate of
growth of the economy below 7–8 per cent per year. Devaluation can
help the economy in a different way, by expanding the contribution
of the foreign trade in the total GDP, thereby increasing China’s ability
to import more in order to expand and maintain the productive capac-
ity of the economy. We can also see that the recent upsurge of growth
was fuelled by excessive monetary growth due to the price controls.
Rationing inflationary pressures were contained but inflation could
still be a serious issue and can create more problems if the economy
slows down. Unprecedented growth of exports (and of imports as a
result) was due to the deliberate policy of the government to export
‘anything and everything’ and to the natural advantages China has in
terms of very low wage rates and the absence of any trade unions or
workers’ rights. Foreign investments are attracted to taking advantage
of that particular aspect of the labour market. We have also seen from
the simulations of the economy that it is possible for China to have
moderate inflation and to have a modest rate of growth of the GDP
(about 7–8 per cent per year) if money supply rate can be moderated
along with systematic devaluations, while maintaining or even reduc-
ing the fiscal deficits.
China’s Foreign Trade
The purpose of this section is to analyse the structure and the direction
of foreign trade in China during early globalization (Basu, 1995). Until
recently, China’s trade record was very impressive. Exports volume
grew at an average rate of 12 per cent per year between 1980 and 1991.
China’s share of world trade has doubled in a decade. Merchandise trade
as a ratio of GNP increased from 12.8 per cent in 1980 to 38 per cent in
1992. China, since its reform programme in 1978, has gradually disman-
tled its restrictive trade regulations, allowed a substantial depreciation
of the exchange rate and invited foreign investors and the private sector
to take advantage of the very low wage rate (Feldenstein and Ha, 1988;
Chow, 1987, 1993; Szapary, 1989). The result is that the share of labour-
intensive manufacturing in total exports rose from 36 per cent in 1975
to 74 per cent in 1990, while the share of capital intensive manufactur-

ers fell from 50 per cent to 19 per cent over the same period. In 1990,
20 per cent of exports came from foreign companies; another 20 per
cent was contributed by the cooperative sector.
In 1976, China started the fifth Five-Year Plan (1976–80) and a new
Ten-Year Plan (1975–85). In line with the modernization drive, the
‘open door’ policy was started. Since the late 1970s, foreign contracts
were recognized as the only way to import high-technology and equip-
ment. The fifth (1976–80) and the sixth plan (1981–5) emphasized the
light manufacture export industry and the growth of exports (average
annual) was 14.9 per cent and 22.4 per cent respectively. In the seventh
plan (1986–91) the emphasis was to transform the state-controlled
directly-planned economy to an indirectly-planned decentralized econ-
omy (Perkins, 1988; Lardy, 1992). The plan encourages indirect controls
such as interest rates, income tax and exchange rate as contra-cyclical
measures. The main interest was on exports. It was claimed in the
plan documents that ‘except for a few major commodities vital to
the national economy and the people’s everyday life. Wherever there
are conflicts between exports and domestic sales, priority was given to
the needs of exports’. As a result, China has started exporting anything
and everything including nuclear power stations and advance weapons
of every type (e.g. missiles) to any country that is prepared to pay.
Direction of Trade
During the early years of planning, the Soviet Union was China’s most
important trading partner. However, the relationship practically ceased
during the 1980s, being replaced by first Japan and then the USA. Since
the beginning of the open door policies during the fifth Five-Year Plan
(1976–80), China’s total exports to the USA rose sharply, particularly
since the USA granted China the Most Favored Nation (MFN) tariff
treatment in 1980.
During the sixth Five-Year Plan (1981–85) Japan’s share gained sub-
stantially, mainly due to huge Japanese aids and loans granted to China.
China had some difficulties in the balance of payments during the
period 1980–90. As a result, US share in Chinese imports fell, although
the Japanese share has increased once again. China’s trade policy is
to promote exports in order to pay for imports to sustain economic
growth. The share of trade for a particular country in China’s trade
would depend on China’s growth prospects and the comparative price
advantages offered along with other financial packages provided by
Table 3.8 Country share for China
1970 1978 1982 1990 1998
Exports (as % of total Chinese exports)

USA 0.0 2.72 7.72 9.26 20.7
Japan 10.0 17.26 21.96 20.63 16.2
EEC 11.78 9.59 8.63 15.3
Soviet Union 10.25 4.08 5.01 1.0
(or former)
Imports (as % of total Chinese imports)
USA 0.0 6.48 22.78 14.49 12.10
Japan 27.46 27.90 20.64 30.42 20.10
EEC 17.70 11.00 11.71 14.80
Soviet Union 8.60 6.62 5.80 2.6
Source: IMF; China Statistical Bureau.
that country. The following equations are proposed to explain China’s

foreign trade sector.
(a) Export to country X = f (Dummy, GNP of X, Exchange rate

of RMB and X, PEXNIA/WPI of X) where PEXNIA is the price
of exportable, WPI of X = wholesale price indices in X. Thus,
PEXNIA/WPI is the price of exportable relative to the prices in X,
‘Dummy’ variables should take into account the ‘opening’ up of
a specific country’s market to China (i.e. granting of MFN status),
international political development affecting the relationship
between China and the country X, and political developments
in China which significantly affect China’s international trading
position.
(b) Import from country X = f (Dummy, GNP of China, Exchange rate,
PMNIA/CPI) where PMNIA is the price of importable in RMB and
CPI is the consumer price index in China. Thus, PMNIA/CPI is the
relative price of Chinese importable relative to the domestic price in
China. Once again ‘Dummy’ variables reflect political and economic
development in China vis-à-vis country X. In the next section, the
export functions of China are estimated for the USA, Japan and the
rest of the world (Eqns 17–32).
Japan and the USA are the most important importers of Chinese
products.
Export to Hong Kong, which is the most important channel, is con-

sidered to be exogenous, because these exports are used for re-exports
from Hong Kong to the rest of the world and they depend on the for-
eign firm’s operation in Hong Kong. Import functions were estimated
for the USA, Japan, Hong Kong and the rest of the world. As China’s
foreign trade sector is linked to the national economy, and exports are
designed to finance imports to promote growth of the domestic econ-
omy, it is essential to analyse the behaviour of the foreign trade sector in
relation to the rest of the economy. The complete model for the Chinese
economy and the foreign trade sector is described in the Appendix.
Simulation of Alternative Policies
In this section we evaluate two types of experiments using two sets of

policy variables for the period 1987–95. The purpose of these simula-
tions is to examine the impacts of certain key variables, such as the
exchange rate, fiscal balance, money supply and domestic investment,
on the macro economy of China. Assumptions used in simulations 1
and 2, regarding the public fiscal balance, exchange rate and money
supply, are given in Table 3.9. Simulation 1 assumes a gradual devalu-
ation of the exchange rate, continuation of a high rate of growth of
money supply and budget deficit. Simulation 2 assumes a tight money
supply, fixed exchange rate and a lower rate of budget deficit. Results
in Tables 3.9 and 3.10 show the comparative performances of the econ-
omy under these two experiments of trade regimes.
From the equations of the foreign trade sector, Eqns (17)–(32), we can
see that real output plays a significant role in explaining exports and
imports. Prices of exports and imports are important factors as well.
However, in certain cases (i.e. export to the USA, ‘rest of the world’ and
Canada) these are not significant determinants. In the case of imports,
prices of imports play a very important role.
The comparisons of simulations 1 and 2 show, in Tables 3.9 and
3.10, that the rates of change of real GDPs under these two policy
regimes are different. In simulation 1, the real rate of growth of
the GDP should be 7.9 per cent in 1990, 7.2 per cent in 1992 and
7.1 per cent in 1995. In simulation 2 it should be 6.9 per cent in 1990,
7.2 per cent in 1992 and 6.8 per cent in 1995. The effects of slower
exports growth in simulation 2 will be compensated by the slower rate
real imports. As a result, the deficit in the current account of the bal-
ance of payments in simulation 2 should be US$1.28 billion in 1990,
US$1.03 billion in 1992 and US$2.55 billion in 1995. In simulation 1,
Table 3.9 The Chinese economy, simulation 1
1987 1988 1989 1990 1991 1992 1993 1994 1995
Real GDP and its components — % Change year ago*
Gross 8.1 7.7 7.6 7.9 7.5 7.2 6.9 7.1 7.1
Domestic
product
Prices — % Change year ago
GDP 4.8 3.4 4.7 5.9 6.7 7.4 7.7 7.7 7.2
Deflator
Consumer 6.5 6.7 7 7.4 7.4 7.7 7.8 7.8 7.2
Price Index
Foreign Sector — Millions of current US dollars
Current −3.306 −3.671 −3.827 −3.249 −3.284 −3.368 −3.582 −4.052 −4.538
Account
Balance
Trade −5.062 −5.400 −5.542 −4.932 −5.010 −5.114 −5.326 −5.778 −6.220
balance
Merchandise 35.476 40.681 46.332 52.683 59.752 68.051 77.595 88.548 101.114
Exports
Merchandise 40.538 46.081 51.873 57.615 64.761 73.165 82.922 94.326 107.334
Imports
Foreign 27.070 30.738 34.471 37.410 40.543 43.894 47.598 51.969 56.986
Debt
the deficit should be US$3.24 billion in 1990, US$3.36 billion in 1992

and US$4.53 billion in 1995. The effect of higher current account
deficits in simulation 1 would be intensified by the increased rate of
inflation in that simulation. Both the GDP deflator and the consumer
price index would register much higher inflationary level in simula-
tion 1 than in simulation 2.
The rates of growth of real domestic investments in simulation 2 are
always at a higher level than those in simulation 1. The rate of growth
of real domestic investment in simulation 2 would be 6.6 per cent in
1990, 6.5 per cent in 1992 and 6.5 per cent in 1995. The higher rate
of growth of real investment in simulation 2 means higher growth of
the real GDP but slower rate of growth of export and a higher level
of balance of payment deficits. A fixed exchange rate would reduce
the money supply, in terms of domestic currency, from the inflows of
foreign funds. A strict fiscal policy would reduce the possibility of hav-
ing an increased money supply due to budget deficits. A combination
Table 3.10 The Chinese economy, simulation 2
1987 1988 1989 1990 1991 1992 1993 1994 1995
Real GDP and its Components — % change year ago*

Gross Domestic 6.6 7.5 7.2 6.9 7.3 7.2 7.2 6.9 6.8
Product
GDP Deflator 3.8 3.4 3.9 3.9 4.1 4.1 4 4 4
Consumer 4.2 4.3 4.4 4.4 4.4 4.5 4.5 4.5 4.5
Price Index
Foreign Sector — Millions of current US dollars
Current −2639 −2521 −1794 −1285 −1332 −1030 −814 −1211 −2553
Account Balance
Trade −3990 −3788 −2978 −2364 −2366 −1997 −1691 −1970 −3161
balance
Merchandise 29433 31938 35409 39053 42754 47838 52093 56866 62025
Exports
Merchandise 33424 35726 38387 41417 45120 49380 53784 58837 65186
Imports
Exports to USA 2.6 2.9 3.5 4.1 4.7 5.4 6.0 6.7
(% share) (8.8) (9.1) (9.9) (10.5) (10.9) (11.5) (11.5) (11.8)
Exports to 7.7 8.4 9.0 9.7 10.5 11.4 12.3 13.3
Japan
(% share) (26.2) (26.3) (25.4) (24.8) (24.5) (24.0) (23.6) (23.4)
Exports to Rest 19.2 20.7 22.9 25.2 27.5 30.6 33.8 36.9
of World*
(% share) (65.3) (64.9) (64.7) (64.4) (64.2) (64.5) (64.8) (64.8)
Imports 4.8 5.7 6.7 7.8 9.2 10.7 12.4 14.5

from USA
(% share) (10.8) (11.8) (12.7) (13.4) (14.3) (15.0) (15.6) (16.4)
Imports 9.4 10.3 11.4 12.5 13.8 15.2 16.7 18.2
from Japan
(% share) (21.2) (21.4) (21.6) (21.5) (21.5) (21.3) (21.0) (20.6)
Imports from 21.1 22.4 23.8 25.4 27.3 29.6 32.2 35.2
Rest of World*
(% share) (47.6) (46.5) (45.1) (43.7) (42.5) (41.5) (40.6) (39.9)
of all these factors would mean a lower rate of inflation, which would
increase the real rate of investment. That in turn would stimulate the
real rate of growth of the GDP. So long as the high rate of growth of
investment can be maintained, it is possible to have a non-inflationary
(about 4.5 per cent price-inflation rate) rate of growth of the economy
at about 7 per cent per year. It is possible to achieve a higher rate of
growth, but the cost would be a much higher rate of price-inflation.
In simulation 1 the US share of total Chinese exports should go up

from 10.6 per cent in 1987 to 11.7 per cent in 1990 and to 13.9 per cent
in 1995. In reality it went up to 20.7 per cent in 1998 (see Table 3.8).
However, Japan’s share of Chinese exports should decline from
13.3 per cent in 1987 to 12 per cent in 1990. In reality it went up to
20.63 per cent in 1990 but declined to 16.2 per cent in 1998. At the
same time, the share for the rest of the world should fall from 41.7 per
cent in 1987 to 37.4 per cent in 1995. This is because of the increased
share of Hong Kong.
About 70 per cent of exports from Hong Kong are Chinese exports.
Thus, China can use Hong Kong’s growing share in the US market.
The share of US imports to China would go up in this simulation from
10.8 per cent in 1987 to 13.4 per cent in 1990 and to 17.2 per cent in
1995. In reality it was 14.5 per cent in 1990 and 12.1 per cent in 1998.
At the same time, Chinese imports from the rest of the world would be
reduced. The share of the rest of the world in Chinese exports would
decline from 47.6 per cent in 1987 to 45.7 per cent in 1990 and to
39.0 per cent in 1995. The share of Japan in Chinese imports would
be almost static. In this simulation, the exchange rate would decline
gradually. These exchange rate depreciations would stimulate Chinese
exports to the USA in particular and to some extent to Japan, but not
for the rest of the world. The increased export revenue would stimulate
Chinese imports from the USA, but the shares of the rest of the world
and Japan would not react to the exchange rate depreciation. Japan’s
share in Chinese imports in reality was about 20 per cent in 1982 and
also in 1998.
In simulation 2, a strict monetary-fiscal regime along with the fixed
exchange rate regime can have different impacts on the direction of
Chinese exports and imports. The US share in Chinese exports would
increase steadily from 8.8 per cent in 1987 to 10.5 per cent in 1990
and to 11.8 per cent in 1995. The share of the rest of the world is
almost static. Japan’s share would decline from 26.2 per cent in 1987 to
24.8 per cent in 1990 and to 22.9 per cent in 1995.
The share of Japan in Chinese exports in simulation 2 is much
higher than in simulation 1. The share of the USA is more or less
the same as before. The share of the rest of the world is significantly
higher than that in simulation 1. Thus, not only will a depreciation
of the exchange rate increase exports, but the structure of the share
of exports will change dramatically. The market in the USA is thus
proved to be very elastic with respect to the Chinese exchange rate
depreciation.
In the case of Chinese imports the US share would increase in simula-

tion 2. Just like in simulation 1 the shares of Japan and the rest of the
world would decline only slightly. The results are not dissimilar to those
obtained in simulation 1. However, if we compare the magnitude of
these shares in Chinese imports, we can see that compared to simula-
tion 2, the share of Chinese imports for the USA, Japan and the rest of
the world would decline in simulation 1.
Hong Kong’s share in Chinese imports would be higher under a
depreciation exchange rate than under a fixed exchange rate regime.
A significant number of Chinese companies are subcontractors for Hong
Kong companies, therefore it will be advantageous for China to import
via Hong Kong when the exchange rate is in depreciation. Instead of
foreign exchange transactions a barter trade can be arranged, which
would save expensive foreign exchanges.
We have seen, in the case of export share for Japan and the rest of the
world, that a fixed exchange rate regime provides higher level of share
than a regime with depreciating exchange rates. On the other hand,
the share of Hong Kong and of the USA would be enhanced under a
depreciating exchange rate system. The thrusts of Chinese exports are
always accompanied by an upsurge of Chinese imports. Direct exports
to the USA and indirect exports to the USA via Hong Kong are sensi-
tive to the exchange rate movements. Increased exports to the USA
should be accompanied by increased imports from the USA if China
wants to avoid the risk of retaliations. At the same time, the Japanese
market is linked to China on the basis of real economic growth and
institutional links with the Japanese companies and their inflexible
keiretsu system of supply chain management, where a large number
of smaller firms—both Chinese and Japanese—are linked with major
Japanese companies and Japanese banks in a fixed relationship. Thus,
the effects of exchange rate changes on the trade relationship are not
always significant.
Asian Financial Crisis of 1997–8 and China
China’s role in contributing to the Asian financial crisis of 1997–8

was downplayed by the IMF and World Band analysis (Basu, 1997;
Basu and Miroshnik, 1999, 2000). The development strategy based on
exports, supported by open access to the US and European markets,
along with imports controls again tolerated by the Western powers, has
helped Japan, Korea, Taiwan and Hong Kong to achieve extraordinary
economic growth. This model was adopted in Indonesia, Malaysia,
Singapore, Thailand and to some extent the Philippines since the

mid−1970s and has caused high economic growth in those countries
as well. However, it has also led to developments of excess capacities in
East Asia, particularly when China decided to follow similar policies
since the mid−1980s. China as a late comer but with very low wages
has decided to attract foreign investment with the exclusive purpose (at
least in the beginning) of exporting. It has used both various export sub-
sidies and exchange rate devaluations to promote its exports and drive
out exports of the ASEAN countries from the markets of the developed
countries. That helped pave the way towards the crisis of 1997–8.
Since 1990, China has devalued its currency several times—in 1994
by about 50 per cent, causing tremendous price reductions for Chinese
exportable goods. ASEAN countries are unable to cope when they have
to maintain a stable currency to attract foreign investments. China was
not interested in short-term investments. China’s very low wage costs
and the potential huge domestic market were incentive enough for
foreign investors. During 1997 and early 1998 when South-East Asian
countries were experiencing difficulties in maintaining their exports,
Chinese exports were increasing at some fantastic rates (Table 3.11 gives
the corresponding export growth figures for some affected Asian coun-
tries). These differences became more acute during 1998.
Table 3.12 provides detailed analysis of how China had destroyed
export markets for some of the South-East Asian countries. Exports
and imports grew steadily until 1995 in East Asia. In 1996, the year
before the currency crisis, growth in exports and imports slowed drasti-
cally to 4.2 per cent and 4.9 per cent respectively. Both China and the
Philippines gained; although the gains of the Philippines were only
marginal. While competition from China in the Japanese market was
limited to a few products, in the US market it was more evident. As a
Table 3.11 Export growth rates in East Asian economies (unit: %)
1997 1998
1 2 3 4 5 6 7 8 9 10 11 12 1 2 3
South −9.0 −5.3 −3.1 7.1 4.5 9.6 19.3 14.0 13.4 5.2 3.8 1.7 −0.3 19.9 6.6
Korea
Thailand 3.1 −7.6 2.3 2.2 −1.5 −5.1 5.8 0.7 9.9 10.7 −0.5 −1.4 −11.8 −4.9 −10.5
Malaysia 6.6 6.3 5.5 −1.6 1.1 1.2 4.5 2.5 0.9 −2.6 −2.4 −11.0 −23.2 8.9 −12.9
Indonesia 17.8 10.7 3.3 3.7 11.8 6.8 12.7 8.8 8.7 1.9 5.0 0.5 −2.2 −6.5 11.5
China 27.6 13.8 35.0 30.0 25.0 25.3 25.1 13.4 23.4 17.1 23.0 4.7 8.4 23.5 9.5
Source: JETRO.
Table 3.12 Trade destructions caused by China

(Categories of goods whose exports to the US fell by over US$1 million in
1995−96 and whose exports by China to the US increased.)
(Unit : US$ Million)
Categories of Goods Exported Decrease in Increase

Malaysia in China
Malaysia Skirts, knitted, synthetic fibres 3.130 2.230

Nightshirts, pajamas, of cotton 5.040 43.230
Clothing for infants, synthetic fibre 3.820 4.810
Men’s or boy’s overcoats, car coats, 2.170 31.960
capes etc
Women’s or girl’s overcoats, 1.180 11.640
car coats etc
Tin alloys 3.600 7.560
Fittings for loose-leaf binders 7.740 22.120
Lamps 1.110 121.160
Thailand Frozen fish 5.180 22.890
Silicon dioxide 1.340 7.380
Tubes, pipes, hoses, of plastic 1.980 2.440
Gloves 3.810 13.860
Footwear 2.310 28.780
Soles for footwear 1.790 12.700
Seats etc 1.720 19.210
Source: M.I.T.I; JETRO.
result labour-intensive exports from South-East Asia, such as footwear

and clothing, had suffered immensely because of Chinese competition
(Basu, 1997; Basu and Miroshnik, 1999, 2000).
There was another dimension to the issue however. Countries that
suffered from the financial crisis had followed a logically untenable
position. They had either fixed or pegged (against US$) currencies and
yet, at the same time, had convertibility of both current and capital
accounts with no restrictions on short-term capital flows. These caused
high rate of growth of money supply, uncompetitive exchange rates and
ultimate capital flights, which became contagious. Malaysia understood
that early enough to impose exchange control and to make its currency
non-convertible in the capital account. As a result, it came out of the
Asian crisis quite successfully without much social cost. China had not
suffered at all because it had maintained exchange controls. Its balance
of payments accounts were non-convertible. It followed a cautious
money supply policy and, above all, it had devalued its currency in
1994 by 40 per cent.
If we extend the policy simulations to include the results for the

period 1996–8 it is possible to examine whether the simulated policies
could have any impacts on the Chinese economy, similar to those that
have affected some of the Asian economies very seriously. A devaluation
route in simulation 1 simulates the economy, and can achieve higher
rate of growth of the GNP and increases the US share in China’s exports.
Japan’s share is unaltered. Balance of payment situations improve sig-
nificantly. A stable currency route in simulation 2 can achieve a mod-
est rate of growth and unaltered balance of payment situation. The US
share in China’s exports remains the same, while that of Japan improves
slightly.
Exports do not grow significantly as they would in simulation 1.
However, in simulation 2 there is no indication that any financial cri-
sis, like the Asian crisis of 1998, would emerge. The reason is that, in
simulation 2, money supply growth was kept at a low rate along with
a nearly fixed exchange rate and unaltered exchange control system.
China was not affected by the contagious outflows of foreign funds and
a meltdown of the exchange rate, because its balance of payment was
not convertible. Thus, it is not possible for a foreign company or insti-
tutional investor to withdraw money easily. China’s trade with the USA
was highly influenced by the exchange rate. The lower exchange rate of
China promoted Chinese exports to USA at the expense of exports from
other low-income countries in Asia in the US market. China’s exports to
Japan, on the other hand, depended on long-term factors. These exports
are promoted by some Japanese trading companies, who produce in
China and export to Japan. Operations of this kind are less influenced
by the very short-term fluctuations of the exchange rate. Thus, Japan’s
share in China’s exports is more stable.
In this section, attempts are made to analyse China’s foreign trade
sector and the direction of trade in particular. A model of national
income determination was constructed, along with the foreign trade
sub-model, to analyse the directions of trade. Two alternative policy
regimes are considered in terms of two simulations we have created.
From the analysis of the simulations, we can see that the exchange rate
and monetary-fiscal policies can have significant influences on the role
of the foreign trade sector of China. A flexible monetary-fiscal policy
along with steady devaluations can expand the role of the foreign trade
sector by stimulation of both exports and imports. However, at the
same time, the direction of trade could have changed. The roles of the
USA and Hong Kong (an indirect route for the USA) could expand, at
the expense of Japan and the rest of the world. If China had followed
a restricted regime with a fixed exchange rate and restricted monetary-
fiscal policies, institutional links with Japan and rest of the world other
than the USA and Hong Kong would have enhanced. However, in that
case, the role of the foreign trade sector in China’s economic develop-
ment could not be as significant as it is now.
Appendix A
BOPCAS CURRENT ACCOUNT BALANCES, USSMILL

BOPEXGS EXPORTS OF GOODS, USSMILL
BOPMGS IMPORTS OF GOODS, USSMILL
BOPNETSB ALS NET SERVICE BALANCE, USSMILL
BOPTBALS TOTAL TRADE BALANCE, USSMILL
BOPTBALHKS TRADE BALANCE WITH HONG KONG, USSMILL
BOPTBALJPS TRADE BALANCE WITH JAPAN, USSMILL
BOPTB ALUSS TRADE BALANCE WITH THE US USSMILL
CS CONSUMPTION EXPENDITURE, USSMILL
C CONSUMPTION EXPENDITURE, RMB MILL
CCON CAPITAL CONSUMPTION, RMB MILL
CCONR REAL CAPITAL CONSUMPTION, RMB MILL, 1960 PRICES
CC PUBLIC CONSUMPTION EXPENDITURE, RMB MILL
CP PERSONAL CONSUMPTION EXPENDITURE, RMB MILL
CPI CONSUMER PRICE INDEX, 1960=1
CRP REAL PRIVATE CONSUMPTION, RMB MILL, 1960 PRICES
CR REAL CONSUMPTION, RMB MILL, 1960 PRICES
DTDISST&LT FOREIGN DEBT OUTSTANDING, USSMILL
EXCNNSS EXPORTS TO CANADA, USSMILL
EXGS EXPORTS OF GOODS (FOB), USSMILL
EXJNSS EXPORTS TO JAPAN, USSMILL
EXNIAS EXPORTS TO WORLD, USSMILL
EXNIA EXPORTS TO WORLD, RMB MILL
EXNIAR REAL EXPORTS TO WORLD, RMB MILL, 1960 PRICES
EXROWNSS EXPORTS TO REST OF WORLD, USSMILL
EXUSNSS EXPORTS TO THE UNITED STATES, USSMILL
FXS FOREIGN EXCHANGE RESERVE, USSMILL
GAP DOMESTIC DEMAND, RMB MILL
GAPR REAL DOMESTIC DEMAND, RMB MILL, 1952 PRICES
GBAL GOVERNMENT BUDGET BALANCE, RMB MILL
GDPS%N PER CAPITA GDP, USS
GDPS GROSS DOMESTIC PRODUCT, USSMILL
GDP GROSS DOMESTIC PRODUCT, RMB MILL
GDPR REAL GROSS DOMESTIC PRODUCT, RMB MILL, 1960
PRICES
GEXPR REAL GOVERNMENT EXPENDITURES, RMB MILL, 1960
PRICES
GNPS&CH GROSS NATIONAL PRODUCT, USSBILL

GNP GROSS NATIONAL PRODUCT, RMB MILL
GNPR REAL GROSS NATIONAL PRODUCT, RMB MILL, 1960 PRICES
GVAO GROSS OUTPUT VALUE, AGRICULTURE, RMB MILL
GVIAO GROSS OUTPUT VALUE, AGRICULTURE & INDUSTRY, RMB
MILL
GVIQ GROSS OUTPUT VALUE, INDUSTRY, RMB MILL
IDOMS DOMESTIC INVESTMENT, USSMILL
IDOM DOMESTIC DEMAND, RMB MILL
IDOMR REAL DOMESTIC DEMAND, 1960 PRICES, RMB MILL
INET INVESTMENT, RMB MILL
INETR REAL INVESTMENT, RMB MILL, 1960 PRICES
JQAG GROSS OUTPUT VALUE INDEX, AGRICULTURE, 1952=1
JQIND GROSS OUTPUT VALUE INDEX, INDUSTRY, 1952=1
JRXS INDEX OF RMB-US DOLLAR EXCHANGE RATE, 1980=1
JRXTW EFFECTIVE EXCHANGE RATE (1980=1)
JRXTWR REAL EFFECTIVE EXCHANGE RATE (1980=1)
KSTOCK CAPITAL STOCK, RMB MILL
MCIFS IMPORTS FORM WORLD, USSMILL
MGS IMPORTS OF GOODS, USSMILL
MHKNSS IMPORTS FROM HONG KONG, USSMILL
MJNSS IMPORTS FROM JAPAN, USSMILL
MNIA$ IMPORTS, NIA, USSMILL
MNIA IMPORTS, NIA, RMB MILL
MNIAR REAL IMPORTS, NIA, RMB MILL, 1960 PRICES
MROWNSS IMPORTS FROM REST OF WORLD, USSMILL
MUSNSS IMPORTS FROM THE UNITED STATES, USSMILL
BOPEXSS EXPORTS OF SERVICE, USSMILL, IMF
BOPKEQS BALANCE OF PAYMENTS, TOTAL FOREIGN INVESTMENT,
USSMILL
BOPMSS IMPORTS OF SERVICES, USSMILL, IMF
BOPTRS BALANCE OF PAYMENT, TRANSFER PAYMENT, USSMILL
CGR REAL PUBLIC CONSUMPTION, RMB MILL, 1960 PRICES
DUMEXUS DUMMY VARIABLE
DUMGLEAP DUMMY VARIABLE
DUMINETR DUMMY VARIABLE
DUM1NETR2 DUMMY VARIABLE
DUMINETR3 DUMMY VARIABLE
DUMM YEX J DUMMY VARIABLE
DUMMYEXJ2 DUMMY VARIABLE
DUMMYMHK DUMMY VARIABLE, IMPORTS FROM HONG KONG
DUMMYMJ DUMMY VARIABLE, IMPORTS FROM JAPAN
DUMMYMJ2 DUMMY VARIABLES, IMPORTS FROM JAPAN
DUMMYMROW DUMMY VARIABLE, IMPORTS FROM THE US
DUMMYMUS DUMMY VARIABLE, IMPORTS FROM THE US
EXHKNSS EXPORTS TO HONG KONG, USSMILL
FX%M MONTHS WORTH OF IMPORT COVERAGE OF FOREIGN
EXCHANGE RESERVES
GDPSIND GROSS DOMESTIC PRODUCTS, INDUSTRALIZED NATIONS,

USSMILL
GEXP GOVERNMENT EXPENDITURES, RMB MILL
GNPSUS GROSS NATIONAL PRODUCT, USA
GNPJP GROSS NATIONAL PRODUCT (OR GROSS NATIONAL
EXPENDITURE), JAPAN
GNPRUS REAL GROSS NATIONAL PRODUCT of USA, MILL,
1982 USS
GREV GOVERNMENT REVENUE, RMB MILL
JCPIOCH CONSUMER PRICE INDEX (1980=1) - CHINA
JCPICN CONSUMER PRICE INDEX (1980=1) - CANADA
JCPIFR CONSUMER PRICE INDEX (1980=1) - FRANCE
JCPIGY CONSUMER PRICE INDEX (1980=1) - GERMANY
JCPIIT CONSUMER PRICE INDEX (1980=1) - ITALY
JCPIJP CONSUMER PRICE INDEX (1980=1) - JAPAN
JCPIUK CONSUMER PRICE INDEX (1980=1) - UNITED KINGDOM
JCPIUS CONSUMER PRICE INDEX (1980=1) - UNITED STATES
JRXSCN EXCHANGE RATE PER US DOLLAR - CANADA
JRXSFR EXCHANGE RATE PER US DOLLAR - FRANCE
JRXSGY EXCHANGE RATE PER US DOLLAR - GERMANY
JRXSIT EXCHANGE RATE PER US DOLLAR - ITALY
JRXSJP EXCHANGE RATE PER US DOLLAR - JAPAN
JRXSUK EXCHANGE RATE PER US DOLLAR - UNITED KINGDOM
MQ MONEY SUPPLY, QUASI-MONEY, RMB MILL
M1 MONEY SUPPLY, Ml, RMB MILL
N POPULATION, MILLION
PEXGSING INDEX OF EXPORT PRICES - INDUSTRIALIZED NATIONS
RMEUR03NS THREE-MONTH EURO-DOLLAR RATE
RX EXCHANGE RATE, RMB PER US DOLLAR
RXJP YEN DOLLAR EXCHANGE RATE
SERV %NMP RATIO OF NON MATERIAL SERVICES TO NET MATERIAL
PRODUCT
STATNMP STATISTICAL DISCREPANCY, NET MATERIAL PRODUCT,
RMB MILL
STATNMPR STATISTICAL DISCREPANCY, REAL NET MATERIAL PRODUCT,
RMB BILL
WPISIND INDEX OF WHOLESALE PRICES - INDUSTRIALIZED NATIONS
WPIJP WHOLESALE PRICE INDEX, ALL COMMODITIES - JAPAN
NMP NET MATERIAL PRODUCT, RMB MILL
NMPR REAL NET MATERIAL PRODUCT, RMB MILL, 1960 PRICES
NMSERV NON-MATERIAL SERVICES, RMB MILL
NMSERVR REAL NON-MATERIAL SERVICES, RMB MILL, 1960 PRICES
PC CONSUMPTION DEFLATOR, 1960=1
PCG PRICE DEFLATOR, GOVERNMENT CONSUMPTION, 1960=1
PCP PRICE DEFLATOR, PRIVATE CONSUMPTION, 1960=1
PEXG PRICE INDEX, EXPORTS OF GOODS, 1960=1
PEXNIA EXPORT PRICES, 1960=1
PGDP PRICE INDEX, GDP DEFLATOR, 1960=1
PGNP GDP PRICE DEFLATOR, 1960=1

PIDOM PRICE DEFLATOR, DOMESTIC INVESTMENT, 1960=1
PMG PRICE INDEX, IMPORTS OF GOODS, 1960=1
PMNIA IMPORT PRICES, 1960=1
PNMP PRICE DEFLATOR, NATIONAL MATERIAL SERVICE, 1960=1
RRW REAL EXCHANGE RATE, RMB PER USS
VOLA VOLATILITY INDEX, FIVE-YEAR MOVING AVERAGE OR
EUROBOND RATE
M2 MONEY SUPPLY, M2, RMB MILL
NIA NATIONAL INCOME AVAILABLE, RMB MILL
4
Structural Reforms in India
Reforms in Indian economic management started in 1985 took a dif-

ferent shape in 1991–2. Faced with acute balance of payments deficits,
due mainly to two international factors beyond India’s control, demise
of the Soviet Union and the war against Iraq, India had accepted loans
from the IMF. India received a massive loan from the World Bank to
help turn India into a capitalist economy, abandoning its planning
system. Domestic factors behind the crisis were excessive government
consumptions financed by debts starting from 1985. The collapse of the
Soviet Union had wiped out about 20 per cent of India’s export market
and an important source of imports. Imports from the Soviet Union had
been paid for with India’s own currency and with very long-term inter-
est free credit terms, therefore avoiding foreign exchange rates.
Iraq’s invasion of Kuwait and the subsequent sanctions by the UN
on Iraq have wiped out the remittances income of the Indian workers
employed in these countries. India’s export earnings from these coun-
tries and investments in infrastructure related to oil field development
in Iraq were diminished. Combined effects of all these factors had cre-
ated a severe balance of payments problem when India had very little
foreign currency to satisfy its import requirement in 1991–2. The loans
from the IMF imposed structural adjustment programmes, with the
aim to replace the planned economy of India with a market economy.
Joining the WTO in 1995 imposed a number of constraints affecting the
structure of public policy in India.
Globalization and India
The main thrust of the reform package for India was to open up the
economy for the world market, that is, to globalize the economy. The
91
doctrine of globalization was suggested by Western economists and

sustained by every international financial and trade organization. The
argument was that globalization would stimulate growth in world out-
put and spread technological knowledge across the world. Continuous
growth of world trade and financial transaction has occurred through-
out the world since 1950, which is more significant than the growth
of world output. During 1980–92, ‘the annual growth rate of financial
assets among the OECD countries outpaced the growth rate of their
real economies by more than two-to-one’ (Diwan, 1997). Trade in for-
eign exchanges in worldwide stock markets was more than 50 times
that of goods and services (see Figures 4.1 and 4.2). Finance capital was
reflected in the stock market transactions. Real economy is measured in
terms of output growth and as a result growth in employment. There
is some evidence that the stock market has thrived, whereas the real
economy has lagged behind. In the USA, for example, increased profit-
ability of the American companies can be the result not of increased
investment or improved productivity but of stagnant wage rates and
falling costs of labour as a whole. During 1989–94, when profit rates
were high, the average US male worker’s hourly wage declined 1 per cent
per year and wages fell or stayed the same for 80 per cent of men and
70 per cent of women. We can see this throughout the world. Finance
capital has become a source of increased income for some, but has cre-
ated wealth and income inequalities for societies throughout the world.
According to the UNDP’s World Development Report, 1994 the richest 20

percent of world’s population had an average income 32 times that of the
poorest 20 percent in 1970. Two decade later, in 1991, this ratio has virtu-
ally doubled; from 32 to 61 percent. While the poorest 20 percent received
2.3 percent of the world income in 1970, twenty one years later this share
fell down to 1.4 percent. (Diwan, 1997)
Simultaneously, finance capital continued to grow and the interna-

tional economy stood still. In the 1980s the growth rate was low while
both new technology and finance capital increased.
In 1996, the rate of growth of world exports in volume terms fell to
only 4 per cent, from 8.5 per cent in 1995. This slow down of exports
volume growth occurred despite a slight increase in world output
growth. The decline in growth rate has also extended to commercial ser-
vices, which is considered the dynamic high-productivity sector. High
growth economies of South-East Asia are particularly affected. In those
countries growth has been mercantilist in orientation, based on export
Structural Reforms in India 93
oriented policies that have used both domestic savings and foreign capi-
tal in increasing capacities. Seven of the top ten exporting countries in
the 1990s were from East Asia: Malaysia, China, Philippines, Thailand,
Singapore, Korea and Indonesia. These countries suffered the most in
1996. For Asia as a whole, the rate of growth of exports (in volume)
went down from 9.5 per cent in 1955 to only 2.5 per cent in 1996. For
East Asian countries such as Hong Kong, Korea, Malaysia, Singapore,
China and Thailand decline in growth of exports (volume) was from
14.5 per cent in 1995 to 3.5 per cent in 1996. Misallocations of resources
in favour of speculative activities in the real-estate sector, overvalued
exchange rates, increasing competition from China and recession in
Japan are some of the explanations for these dramatic events. Thus, the
Uruguay Round of trade liberalization and the WTO could not promote
trade always. The world has witnessed a similar situation in the pro-
longed recession that began in 2008, after the collapse of the speculative
markets in the USA and the UK, which later spread all over the world.
At the same time, despite the lofty declarations of the Uruguay
Round and negotiations by the GATT and the WTO, there has been a
de facto increase in protectionism in the developed countries, either
by utilizing the ‘transition period’ clauses in the GATT treaties or by
circumventing WTO rules, or even in some cases by openly flouting the
rules. Anti-dumping measures are now commonly used against exports
from developing countries. The WTO allows such measures only if it
is clearly established that exports are being sold at prices substantially
below the domestic cost of production for a sustained period. However,
anti-dumping measures have tended to be imposed often well before
investigations are completed or before the country concerned has a
chance to respond. This has been especially so for items like textiles,
steel, wire products, certain pharmaceuticals and chemical products.
Similarly, ‘rules of origin’ being imposed in the USA and elsewhere are
being used to deny countries the advantages of market access. Despite
the clear restrictions on quantitative restrictions in the WTO, developed
countries have continued to use them. Subsidies, for example in agricul-
ture, remain very high in several OECD countries; thus the subsidy on
sugar is estimated to be as high as 48 per cent in OECD countries. The
phasing out of the Multi-Fiber Arrangement (MFA), which controlled
world textile trade, did not take place until 2005, in practice it was
delayed even further. Indian exports of textiles, steel and pharma-
ceuticals are already suffering from the protectionist measures like
anti-dumping duties in the USA and the EEC. Facing this protectionist
challenge is difficult because of complications, tedium and the expense
of the WTO dispute settlement mechanism, which appears equitable

but structurally favours developed countries that have both financial
and legal resources available to engage in long drawn-out disputes.
Even after a dispute is resolved, the redressal is not automatic and may
be greatly delayed. Developing countries are induced and sometimes
compelled to open up their domestic markets to provide free access to
international capital, with the expectations of improved access to the
markets of developed countries. These expectations are not yet fulfilled
in these unequal multilateral treaties. Powerful vested interests, particu-
larly of the multinational companies in developed countries, not satis-
fied with the existing privileges of the WTO, wanted to abridge further
the sovereign rights of the developing countries by including labour
standards and a multilateral agreement on investment by which foreign
firms would be treated on a par with the domestic firms.
The WTO agreements require changes to be made in the Indian
Patent Act of 1970. Such changes especially target the Indian drug
industry, which has built up a base for production of almost all bulk
drugs from the basic stages using innovative process technologies.
A major role was played in this by the Indian Patent Act of 1970, which,
while allowing process patents, debarred product patents in the area of
drug production as well as other areas vital to Indian self-reliance. The
WTO forced India to change its patent act to include product patenting
for a period of 20 years. This means that Indian drug production bases
built up over years become meaningless. The main reason is that, since
the closure of the Soviet-built public sector pharmaceutical companies
in India, as it stands, the drug industry is not in a position to invest in
technologies for developing new products. The required investment for
new product development far exceeds the total turnover of most Indian
companies. Anticipating changes in the Patent Act, many multinational
companies have already closed down their research and development
facilities in India.
The same impacts were felt in Brazil, Mexico and Argentina during
the 1970s after changes in their Patent Acts (Evans, 1979; Mytelka,
1987). Multinational drug companies are also reducing their bulk
production of drugs in India, in anticipation of further relaxations of
import restrictions. Imports of drugs will increase profits for the mul-
tinational companies, yet at the same time will make India dependent
on them. That situation used to prevail in India before 1970, when drug
prices were the highest in the world. Thereafter, because of the public
sector drug manufacturing firms, prices came down sharply. However,
the reform programme and the pressure from both the WTO and the
WHO (World Health Organization) have killed off public sector drug
manufacturing companies.
The WTO rules also imply removal of quantitative import restrictions
on agricultural products, except for a few items. At the same time, the
Indian government will be obliged to minimize subsidies to the agri-
cultural sector. However, developed countries will be able to maintain
and enhance their agricultural subsidies as they have created a number
of loopholes (or new schemes) by which they can give direct cash
payments, deficit payments (the gap between the target price and the
guaranteed intervention price) and various other transfer schemes. For
all OECD countries direct payments went up by 23 per cent of total
producer subsidy equivalent in 1995. The EEC increased direct pay-
ments by 25 per cent in 1994. As a result, total transfer has remained
unchanged, more or less. There are other imaginative accounting pro-
cedures to hide actual subsidies. The official AMS (aggregate measures
of subsidy, which is reducible under WTO rule) in the USA amounted
to about US$25 billion in 1994, whereas the total amount of trans-
fer was about US$90 billion. The USA will reduce AMS, not the total
transfer. Total transfer, taking all OECD countries together, was about
US$335 billion in 1994. The subsidy equivalent per full-time farmer
was US$15,899 in 1994. The annual income of an average Indian
farmer is about US$377. India thus was far below the OECD countries
regarding subsidy at the time of the creation of the WTO, but the same
WTO along with the IMF and the World Bank asked India to reduce or
eliminate subsidies to provide affordable food for the poorest people.
Simultaneously, agricultural imports posed a real threat to the Indian
farmers and also undermined India’s self-sufficiency on food grains.
There are demands on India, both from the IMF and the WTO, for
a full capital account convertibility. Although the crises in East Asia in
1998 and those since 2008 in the USA and Europe have dampened the
international financial institution’s enthusiasm to press ahead with
financial liberalization at present, in the near future they will demand it
as the price for India’s membership of these institutions. India’s reform-
oriented policy makers have started to create public opinion in favour
of it. The Approach paper of the Ninth Plan has clearly stated its objec-
tive to achieve full capital account convertibility. Experience of capital
account convertibility for the developing countries and countries under
reforms are negative. Latin America, Russia and East Asian countries
have experienced debt burdens and near collapse of their economies as
a result of full convertibility of their currencies and capital account con-
vertibility. At the same time, China has managed to protect its economy
from these excesses. There is little evidence to suggest that capital

account convertibility can induce greater inflow of foreign investment.
China is the biggest recipient of foreign investment even without it,
while capital account convertibility has created greater volatilities in the
economies of Thailand, Indonesia, Mexico and Russia. In Latin America
debt burden during the 1970s was caused by capital flights, which were
allowed in a regime of full convertibility of currency. The equivalent to
trillions of US Dollars have been flown out of Russia since 1992, because
of absence of any control on capital flights.
Macroeconomic Performances during the Reform
The economic reform programme was introduced in 1991, when India’s

balance of payments situation was extremely critical. The central ele-
ments of these reforms are:
t De-licensing of investment and production in most industries.

t De-control of business decisions on location and technology transfer,
although not of decisions to lay off workers or close operations—the
so called ‘exit’ policy.
t Lifting of many import controls, although not those on imports of
consumer goods, while lowering tariffs to their peak of 40 per cent
in 1998.
t Encouragement of foreign direct investment with majority control,
except in a few consumer goods industries.
t Opening up of additional sectors to private investors, including
power, steel, oil refining, air transport, telecommunications, ports,
mining and pharmaceuticals.
t Liberalization of capital market, with entry of private mutual funds
and foreign institutional investors.
t Reforms of the tax system, with lower rates and a simpler structure.
The result of these reforms on the Indian economy was at best mixed.
The growth rate of the real GDP grew less than 5 per cent up to 92–3, fol-
lowed by a very high growth rate between 1994 and 1996; but thereafter
it went down. The recent slow-down of the economy is the result of two
major factors: (a) slower rate of growth of agricultural output; and (b)
lack of export growth, possibly due to the depressing atmosphere of the
set up of the East Asian countries and uncertainties elsewhere.
The Eighth Plan period was from 1992 to 1997, the years of the
first phase of the reforms. Before we discuss details of the economic
performances during the reform period (i.e. the Eighth Plan period) we
should analyse in short the basic targets of the plan. Actual GDP growth
rates in the periods 1981–5, 1986–91 and 1991–6 were 5.6 per cent,
5.9 per cent and 4.5 per cent respectively. The average GDP growth
rate during 1992–6 was 5.3 per cent, which provoked much optimism
for the government to assume the growth rate for the Ninth Plan as
6.2 per cent. However, that was before the crisis in East Asia and the recent
crisis in the USA and Europe. Growth prospects are now greatly reduced.
The domestic savings was projected to rise from 23.7 per cent of GDP in
the Eighth Plan to 25.2 per cent in the Ninth Plan and to 27.2 per cent
in the accelerated version of these plans. The corresponding invest-
ment rates are 25 per cent, 26.9 per cent and 29.6 per cent, with the
current account deficit being 1.3 per cent, 1.7 per cent and 2.4 per cent
of the GDP. The ICORS (incremental capital–output ratios) assumed in
the baseline and accelerated Ninth Plan variants are 4.3 per cent and
4.2 per cent, almost identical to the ICOR of 4.2 per cent assumed for the
Eighth Plan. The actual ICOR was 3.9 per cent in 1981–6, 3.8 per cent
in 1986–91 and 5.3 per cent in 1991–6. The actual average rates of sav-
ings and investment were 22.7 per cent and 23.8 per cent in 1991–6,
lower than 23.7 per cent and 25 per cent assumed during the Eighth
Plan period.
There was optimism in the projections for balance of payments
and public sector finance. The Dollar value of exports was assumed to
grow at 15.5 per cent and 18 per cent in the baseline and accelerated
version of the plan. These were considerably larger than the growth
rates achieved in the past. According to the assumptions of the plan,
the growth of imports had to be contained to 11.4 per cent and 15.3
per cent per annum in those two versions. The actual growth of Dollar
value of exports in 1996–7 was 5.3 per cent; actual growth of imports in
1996–7 was 6.3 per cent. Public sector savings have declined continu-
ously from 3.6 per cent of GDP in 1981–6, to 1.9 per cent in 1986–91
and to 1.3 per cent in 1991–6. However, in the Ninth Plan it was
expected to rise to 2 per cent in the baseline and to 3.8 per cent in the
accelerated scenario. It was not clear how these could be achieved.
Economic Performances in the First Phase of Reform

Period: 1991–7
We can see that primary and secondary sector’s annual growth rates
during 1992–6 were at 2.5 per cent and 6.3 per cent compared with 3.7
per cent and 6.3 per cent during 1986–91. However, the tertiary sector
grew faster at a rate of 6.8 per cent during the reform period. We can
see from the disaggregated sectoral growth patterns that only the trade,
hotel and restaurant sector performed better during the reform period
but some of the crucial sectors, such as agriculture, mining, construc-
tion and public administration and defence, performed much worse
during 1992–6 than during 1986–91 (Basu, 2000).
Agricultural Sector
In the reform programme, since fiscal deficits were within strict con-
straints along with reductions on tax rates, excise duties and general
tariffs on imports, government expenditures on agricultural develop-
ments were curtailed. There was also a preference for cash crops and
agricultural exports as opposed to the food grain production. The area
under food grain went down. Between 1991 and 1995 the gross area
under food grain went down by about 3.3 per cent or by 4.3 million
hectares. Between 1990 and 1995 total food grain production grew at
an annual rate of about 2 per cent, which was about 2.7 per cent during
the previous period of 1986–91. Production was stagnated particularly
after 1995. At the same time there were efforts to undermine the public
distribution system by raising the prices and curtailing availabilities of
food grain. Table 4.1 gives the per capita availability of food grain dur-
ing 1988–95. The data show that the per capita availability fell since
1991 and recovered only a little in 1995.
There are pressures on India to abandon restrictions on imports
of food grain and to lower tariffs at the level suggested by the WTO.
Combinations of these would provoke large scale imports of food grains,
which may undermine agricultural growth when at the same time there
are attempts to significantly reduce subsidies to the agricultural sector.
Table 4.1 Per-capita daily availability of

food grain (grams)
1988 448.5
1989 494.5
1990 476.4
1991 510.1
1992 468.8
1993 462.7
1994 469.5
1995 501.9
Source: Economic survey, 1995–96.

Table 4.2 Annual growth in food grains production (per cent)
Year Rice Wheat Pulses Food grain
1967–68 to 1995–96 2.90 4.72 0.93 2.67

1980–81 to 1995–96 3.35 3.62 1.21 2.86
1990–91 to 1996–97 1.52 3.62 1.07 1.70
Source: Economic survey, 1997–98.

Notes: Based on index numbers; base: 1981–82 = 100.
However, there is some hope, because gross domestic investments in

agriculture increased considerably during the reform period, which may
in the future increase production levels.
Capital Formations
As a proportion to GDP, gross domestic capital formation (GDCF)

increased from 20 per cent in 1989–90 to 23 per cent in 1995–6.
However, the growth rate of GDCF is less during 1992–6 than it was
during 1986–91 or 1982–5. Agriculture, mining, registered manufac-
turing, transport (except railways) and communications, banking and
finance all have improved rate of growth of GDCF, but unregistered
manufacturing (mainly small-scale industries), electricity, gas and water
have experienced decline in investment. It shows that one of the main
arguments for reform—that it would stimulate investments all round—
is not yet proven.
Gross capital formation (GDF) in the public sector as a percentage of
GDP was reduced after the reform. Public sector’s share (40.4 per cent)
in GCF during 1992–5 was less than any other period since 1961. The
share of infrastructure in GDCF was reduced sharply from 37 per cent in
1986–7 to 26 per cent in 1995–6. The share of the corporate sector went
up and its growth rate was also very impressive during the reforms.
However, much of these are going into the tertiary sector, because the
growth rate of private sector’s GDCF in registered manufacturing rose
only by 3 per cent.
Foreign firms’ share in GDCF remained low, at 10 per cent during
the reform. During 1992–6, the ratio of gross fixed assets to total uses
of funds for the foreign private sector was about 13 per cent less than
that for the Indian private sector. The amount of approved foreign
investment was quite impressive, about Rs956.9 billion, but the realized
amount is only a fifth of that. Unlike that of China, reforms had not
initiated a flood of foreign investments.
After the recent economic downturns in 2008, the flow has dried up.
Thus, the contribution of foreign investment in capital formation is still
not impressive.
Fiscal policy in India before the reform
In India monetary and fiscal policies used to be interlinked. Given

the planned expenditures the government tries to raise the money
either by taxation or by borrowing. The deficit has to be financed
by either foreign borrowing or by direct money creation. Thus,
budget deficit increases money supply and reductions in the
budget may lead to reductions in planned investment expenditures
and future growth of the economy.
By the standard of most developing countries India before the
reform has followed until 1985 a responsible macroeconomic policy.
There was no hyperinflation or debt crisis. The volatility of growth
rates during the planned economy had largely reflected the natural
instability of the agricultural output.
The budget of 1985 initiated a new direction in Indian foreign
trade policy. Import controls were relaxed and simplified. Exporters
had received massive concessions for imports of intermediate goods.
The new trade policy was designed to liberalize the economy in gen-
eral to initiate a more outward oriented economic regime. However,
in 1991, the demise of the Soviet Union, which used to supply most
of India’s import needs without any need for foreign currency and
accounted for about 20 per cent of India’s exports, the first Gulf war
and the resultant trade embargo against Iraq—another major export
market for India, had created serious balance of payments problems.
Subsequently under the direction of the IMF, most industries were de-
licensed, import policies were further liberalized, and the rupee was
made partly convertible bringing in about 42 per cent devaluation
in 1993 from its 1990 level. Most restrictions on foreign investments
were removed too.
The IMF conditionality, imposed upon a number of developing
countries undergoing ‘reforms’ have concentrated on two major
macroeconomic policies: an adequate exchange rate management
and demand discipline. The latter is to be achieved through fiscal
restraint and limited expansion of domestic credit. The theory is
that wage-price flexibility may create full employment, and private
savings and investments would not be affected by budgetary cuts.

As private sector deficits may imply deficits in the current account
of the balance of payments, practical effects of any reductions in
the public sector deficit should be reflected in the improvements in
the current account of the balance of payments. Inflation is to be
controlled through monetary policy so that political temptations of
exchange rate overvaluations do not arise. However, some required
adjustment policies, including exchange rate devaluations, increased
indirect taxes and reductions in subsidies imply a temporary accel-
eration of inflation.
One immediate impact of devaluation is to raise government
receipts by expanding the local values of the bases for both import
tariffs and export taxes. These positive impacts of devaluation on
government resources can be diluted to the extent that trade taxes
are specific rather than ad-valorem and to the extent that there
are exemptions from import duties. The comparative effects of the
planned fiscal policies and those implemented during the ‘reform’
period import components of public expenditure. The item of
public expenditure which is all in foreign exchange is debt service
on foreign borrowing. Such outlays have been growing rapidly
and can be quite large particularly if account is taken not only
of central government obligation but also of debts guaranteed by
government.
To analyse these issues in a comprehensive way, a structural
econometric model for India is constructed in this chapter. This
model can be transformed into a state-space model and the method
of adaptive optimization can be applied. Analysis of the time-
varying parameters of the model, implications for fiscal policy
dynamics, comparative effects of the planned fiscal policies and the
historical fiscal policy are given later. The question whether it was
necessary to liberalize the economy by taking away the planning
process is raised here. To prove the desirability of the reform process
we have to demonstrate that some extraordinary improvements
have taken place during the reformed period. This chapter has
examined this issue by solving an adaptive control model for the
Indian economy for the period of structural adjustment and com-
pared the results with the actual performances of the economy
during the same period.
(Source: Basu, 2000)
Table 4.3 Money supply, GNP and price

levels: 1985–1997, (annual % changes)
1986−87 13.5 4.5 8.8

1987−88 16.5 8.7 9.4
1988−89 18.0 5.6 6.2
1989−90 11.3 4.9 8.7
1990−91 11.2 0.5 13.9
1991−92 18.2 4.6 11.8
1992−93 15.0 3.5 6.4
1993−94 18.4 6.0 10.2
1994−95 22.3 7.6 10.2
1995−96 13.2 7.0 9.0
1996−97 10.6 4.5 8.7
1997−98 15.8 6.4 13.8
Source: IMF.
Table 4.4 Some important ratios
Year Budget Domestic Domestic Tax Public

deficit/ debt/GNP borrowing revenue/ expenditure/
GNP public GNP GNP
expenditure
1985 8.5 4.2 48.0 13.7 16.5

1986 9.3 4.5 49.0 14.3 17.8
1987 8.4 4.6 41.0 14.4 18.0
1988 8.4 4.6 43.0 14.0 17.8
1989 6.6 4.7 34.0 15.3 17.4
1990 8.0 4.9 44.0 13.7 17.5
1991 5.0 4.9 28.0 14.7 14.7
1992 5.0 4.8 28.0 14.5 14.5
1993 7.0 5.2 41.0 12.8 12.8
1994 6.0 5.0 35.0 13.3 13.4
1995 6.0 4.8 31.0 13.4 13.4
1996 4.9 4.7 31.5 12.7 14.9
1997 4.9 4.9 32.1 12.7 15.3
Source: IMF.
Industrial Development
The aim of the reform process was to remove any traditional bias against
exports, and transfer resources towards the trade sector. A number of
measures were taken at the behest of the international organizations
to remove obstacle of imports and thereby improve the quality and
exportability of Indian products. These policies should have promoted
industrial growth.
Table 4.5 Financial policies, 1985–97 (Rupees billions)
Year Public Tax Budget Domestic Foreign

expenditure revenue deficit borrowing borrowing
1985 430.7 361.2 −222.5 208.9 13.7

1986 518.1 420.7 −272.0 258.5 19.4
1987 597.1 480.8 −278.8 244.4 32.7
1988 700.6 554.6 −330.9 300.9 25.1
1989 769.8 675.8 −292.3 262.5 29.9
1990 924.6 723.6 −434.6 407.0 31.8
1991 1050.5 892.1 −358.2 304.4 54.2
1992 1189.3 1004.6 −399.0 340.5 53.2
1993 1363.7 1011.7 −605.3 564.7 50.7
1994 1561.3 1257.4 −316.7 553.8 39.5
1995 1743.2 1444.1 −583.9 539.3 44.6
1996 2010.6 1717.1 −668.8 634.3 29.9
1997 2305.8 1864.5 −741.9 740.1 10.9
Source: IMF.
The experiences showed that the industrial growth rate declined

immediately after the reforms; then moved upwards until 1997 before
declining. The annual growth rate of the manufacturing sector during
1992–6 was lower than the period before reforms, 1986–91. It was 8.9
per cent in 1986–91 and 6.9 per cent in 1992–6. The growth rate of total
manufacturing in the national accounts was 7.5 per cent in 1986–91
and 6.6 per cent in 1992–6. The growth rate of unregistered industries
(mainly small scale sector) suffered more. Capital goods industries also
suffered heavily, but what is most surprising is that even consumer
durable goods industries suffered. During the reforms, due to the
relaxed industrial policies and increasing demands, it was expected that
the consumer durables sector would expand rapidly. In India, perhaps
these demands were met by imports and assembling imported parts,
rather than by domestic productions. Apart from basic metals and trans-
port equipment, no other sectors have seen impressive growth during
the reform period. The growth rate of industry fell further in 1997–8
along with the lower growth rate of the GDP. Thus, the record of the
reform process is not very impressive so far.
The expectation was that the public sector contributions would
decline in the reform period, because emphasis lay on creating supply-
side incentives for the private sector and eventually eliminating the
public sector. However, the share of the public sector in the GDP rose
to 24.8 per cent during 1995–6. The share of the public sector in the
manufacturing industries rose also. At the same time, the profitability of

the public sector undertakings (PSUs) increased and their share in fiscal
deficits declined. Simultaneously, efforts to privatize and disinvestments
in the public sector went on. About 25 per cent of the overall paid-up
capital of the public sector—worth about Rs153 billion—had been sold
off already by 1997. These were all highly profitable enterprises. In
fact, the idea that the public sector was a drain on government finance
was not true: most of the PSUs were making impressive profits, even
those in the so-called non priority areas like hotels. In 1995, 130 profit-
making PSUs contributed Rs250 billion to the government exchequer,
paid about Rs14 billion worth of dividends to the government and
made profits worth Rs120 billion. Comparatively, the total loss of the
109 loss-making PSUs was Rs50 billion. The bulk of the loss-making
PSUs were actually private sector units taken over by the public sec-
tor in order to prevent job losses. Again, 1500 private enterprises were
declared sick and received assistance from the public financial institu-
tions worth Rs400 billion. Thus, the so-called efficiency of the private
enterprise is a debatable issue in India. The real purpose of the disinvest-
ment and privatization of the PSUs is to fill up the gap in the govern-
ment’s fiscal deficits, which rose due to the reductions of tax rates and
tariff rates during the reform period.
The infrastructure sector suffered a lot and, as a result, contributed
to the rising cost of production for its domestic industries. Most of the
sectors within the infrastructure industries experienced decline during
the reform process. This is because of the reduction in public projects on
the expectation that, in the absence of public sector, private initiatives
will have more opportunities to develop the infrastructure industries.
The result is disappointment, except for the telecommunications sec-
tor. The target for electricity production during the 1992–7 period was
30,538 MW, but in reality only 1800 MW was added during this period.
Government’s capital expenditure went down from 30 per cent of total
expenditure in 1992 to 24 per cent in 1996. That resulted in neglect
for the basic infrastructure industries. As the private sector has failed
to invest, the widening gap between the supply and requirements of
infrastructures has raised the question of viability of future industrial
growth.
A Quantitative Evaluation of the Reform
A number of authors have recently examined the performances of

the developing countries under the IMF and World Bank induced
structural adjustment programme to reform the economy towards a

full-scale market system (Bird, 2007; Dollar and Kraay, 2004; Dollar and
Svensson, 2000; Santos-Paulino, 2005; Santos-Paulino and Thirlwall,
2004; Winters, 2004). The method of their analyses, in most cases, was
cross section studies of the developing countries. These studies have a
number of problems; the most important being that different develop-
ing countries have different starting points for their reform programme.
Different mixtures of policy programmes were used in different situa-
tions—thus making these types of cross section studies merely techni-
cal exercises. Studies, which are based on analysis of a specific country
(De-Castro, 2006; Diaz-Alijandro, 1985; Fölster and Henrekson, 2001;
Muscatelli and Tirelli, 2005), have not yet used the simulation method
to compare two different policy regimes, one under the reform and
another not.
The Indian economy had gone through a transitional phase during
1990–6 where the old planning mechanisms were being replaced to
make way for a liberalized economy. Despite the policy planners having
accepted the IMF-induced ‘structural adjustment programme’, a large
section of the public has not received much benefit of this liberalization
or economic growth. According to a recently published report on condi-
tions of work and promotion of livelihoods in the unorganized sector
(Sengupta, 2008) 77 per cent of the population should be considered to
be poor by any definition.
In India, the government used to regulate the private sector by vari-
ous means such as licenses, investment quotas, tax-subsidy rates, inter-
est rates and a number of monetary controls. Understanding the targets
of the government, the private sector generates its own expectations of
fulfilling those targets, as well as possible changes to various policies.
‘In a mixed economy planning has to take into account how the private
sector formulates and revises its expectations regarding various govern-
ment policies and their possible impacts on the endogenous variables
or target variable in the economy’ (Basu, 1996). Thus, the best public
policy design should be to guide the private sector towards the planner’s
goals while taking into account the private sector’s response.
In this section we examine whether a mixed economic planning, with
a planning authority controlling the public sector and trying to direct the
private sector using monetary-fiscal-exchange rate policies, can perform
as efficiently as a pure capitalist economy, as predicted by reform sup-
porters. Simulated historical conditions, along with some policy regimes,
are used to examine this issue. This is done in an adaptive control model
to explore how the economy might have behaved during 1990–6 if the
authority had replaced quantitative restrictions on the private sector with

financial controls rather than privatizing and liberalizing the public sec-
tor. In this framework, the model’s parameters and its probability struc-
ture will change continuously as the optimization process progresses,
thereby adapting the parameters of the model to the planned solutions.
This, in a way, reflects the mixed economic plan, where the private sector
reacts to the government’s goals, which in turn will modify the param-
eters of the model and change the policies (Basu, 1996, 2000).
This method is applied to optimize the econometric model of India,
which is described later. A comparison is made between the simulated
history and the actual history to examine the relative efficiency of the
planned mixed economy that India used to have against the liberalized
economy.
The Method of Adaptive Optimization
It is assumed that the dynamic econometric model can be converted to

an equivalent first order dynamic system of the form
+ Cu
x i = Ax + Dz
+ e
i -1 i i i (4.1)
Where x i is the vector of endogenous variables, u i is the vector of

control variables, zi is a vector of exogenous variables, ei is the vector
of noises that are assumed to be white Gaussian and A , C and D are
coefficient matrices of proper dimensions. It should be noted that a
certain element of zi is 1 and corresponds to the constant terms. The
parameters of the above system are assumed to be random. Shifting to
period i + 1, we can write
x i +1 = Ax + Dz
+ Cu + e
i i +1 i +1 i +1 (4.2)
Now we define the following augmented vectors and matrices.
⎡ x i ⎤ ⎡ x i +1 ⎤ ⎡e ⎤
xi = ⎢ ⎥ , xi +1 = ⎢ ⎥ , ei +1 = ⎢ i +1 ⎥ ,
⎢u i ⎥ ⎢u i +1 ⎥ ⎢ 0 ⎥
⎣ ⎦ ⎣ ⎦ ⎣ ⎦
⎡ A 0⎤ ⎡ ⎤ ⎡ ⎤
A = ⎢⎢ ⎥ , C = ⎢C ⎥ , D = ⎢ D ⎥
⎥ ⎢ ⎥ ⎢0⎥
⎢⎣ 0 0⎥⎦ ⎢⎣ I ⎥⎦ ⎢⎣ ⎥⎦
Hence (2) can be written as
xi +1 = Axi + Cu i +1 + Dzi +1 + ei +1 (4.3)
Using the linear advance operator L(−1), such that L yi = yi + k and defin-
k
ing the vectors u, z and ε from
ui = Lu i
zi = Lzi
εi = Lei
Then Eqn (3) can take the form
xi +1 = Axi + Cui + Dzi + εi (4.4)
which is a linear control system formulation and an adaptive optimal

control problem of the general form can be formulated as
1 1 T −1
min J = || xT − xT || 2QT + ∑ ||xi − xi || Q2 (4.5)
2 2 i =1 i
Subject to the system transition equation seen in Eqn (4). T indicates

the terminal time of the control period, {Q} is the sequence of weight-

ing matrices and xi (i = 1, 2,…,T) is the desired state and control trajec-
tory according to our formulation. The solution to this problem can be
obtained according to the minimization principle by solving the Ricatti-
type equations (Astrom and Wittenmark, 1995).
KT = QT
(4.6)
Λi = − ( EiC’Ki +1C )−1 ( EiC’Ki +1 A)

(4.7)
Ki = Ei A’Ki +1 A + Λ’i ( EiC’Ki +1 A) + Q i

(4.8)

hT = − QT xT
(4.9)
hi = Λi ( EiC Ki +1 D )zi + Λi ( EiC )hi +1
’ ’

+ ( Ei A’Ki +1 D )zi + ( Ei A’ )hi +1 − Q i xi
(4.10)
g i = − ( EiC’Ki +1C )−1[( EiC’Ki +1 D )zi + ( EiC’ )hi +1 ]

(4.11)
xi* = ⎡⎣ Ei A + ( EiC) Λi ⎤⎦ xi* + ( EiC) g i + ( Ei D )zi

(4.12)
ui* = Λi xi* + g i
(4.13)
* *
Where ui (i = 0,1,...,T – 1), the optimal control sequence and xi+1 ,
the corresponding state trajectory, constitute the solution to the stated
optimal control problem.
In the above equations, Λi is the matrix of feedback coefficients and
gi is the vector of intercepts. The notation Ei denotes the conditional
expectations, given all information up to the period i. Expressions like
EiC’Ki +1C , EiC’Ki +1 A , EiC’Ki +1 D are evaluated taking into account the
reduced form coefficients of the econometric model and their covari-
ance matrix, which are to be updated continuously along with the
implementation of the control rules. These rules should be readjusted
according to ‘passive learning’ methods. It is noted however that the
joint densities of matrices A, C and D are assumed to remain constant
over the control period. The reduced form coefficients and their covari-
ances matrix have to be updated, since the control is adaptive and the
agents are adjusting their expectations.
Updating method of reduced-form coefficients and their

covariance matrices
The updating technique of the reduced form coefficient matrix and
their covariance matrix is as follows.
Suppose we have a simultaneous-equation system of the form
XB’ + U Γ’ = R
(4.14)
Where X is the matrix of endogenous variable defined on EN × En and

B is the matrix of structural coefficients, which refer to the endogenous
variables, and is defined on En × En. U is the matrix of explanatory
variables defined on EN × Eg and Γ is the matrix of the structural coeffi-
cients, which refer to the explanatory variables, defined on EN × Eg. R is
the matrix of noises defined on EN × En. The reduced form coefficients
matrix ∏ is then defined from:
∏ = −B−1Γ (4.14a)
Goldberger et al (1961) have shown that the asymptotic covariance

matrix, say Ω of the vector π̂ , which consists of the g columns of matrix
Π̂ can be approximated by
⎡⎡ ˆ ⎤ ⎤ ⎡⎡ ˆ ⎤ ⎤
Π Π
= ⎢⎢ ⎢⎢ ⎥⎥ ⊗ Bˆ ’ ⎥⎥ ’ F ⎢⎢ ⎢⎢ ⎥⎥ ⊗ Bˆ ’ ⎥⎥
( ) ( )
−1 −1
Ω
⎢⎢ Ig ⎥ ⎥ ⎢⎢ Ig ⎥ ⎥
⎣⎢ ⎣⎢ ⎥⎦ ⎥⎦ ⎢⎣ ⎢⎣ ⎥⎦ ⎥⎦ (4.15)
Where ⊗ denotes the Kroneker product Π̂ and Β̂ are the estimated

coefficients by standard econometric techniques and F denotes the
asymptotic covariance matrix of the n+g columns of ( ΒˆΓˆ ) which
assumed to be consistent and asymptotically unbiased estimate of ( Β Γ ).
Combining (4.14) and (4.l4a) we can write
BX ’ = − ΓU ’ + R’ ⇒ X ’ = − B−1ΓU ’ + B−1 R’
⇒ X ’ = ΠU ’ + W ’ (4.16)
where W ’ = B−1 R’ .
Denoting the ith column of matrix X ’ by xi and the ith column of
matrix W ’ by wi, it is possible to write
⎡u1i 0 ... 0 u2 i 0 ... 0 u gi 0 ... 0 ⎤

⎢ ⎥
⎢0 u1i ... 0 0 u2 i ... 0 0 ugi .... 0 ⎥⎥
⎢
⎢ . . . . . . . . . ⎥⎥
xi = ⎢⎢ π + wi
⎢ . . . . . . . . . ⎥⎥
⎢ ⎥
⎢ . . . . . . . . . ⎥
⎢ ⎥
⎢⎣ 0 0 ... u1i 0 0 ... u2 i ... 0 ..... u gi ⎥⎦ (4.17)
where uij is the element of the jth column and ith row of matrix U. The
vector πEng, as mentioned earlier, consists of the g column of matrix ∏.
Equation (4.17) can be written in a compact form, as
xi = Hiπ + wi, i = 1, 2,...,N (4.17a)
where xi ∈ E , wi ∈ E and the observation matrix Hi is defined on En × Eng.

n n
In a time-invariant econometric model, the coefficients vector π is

assumed random with constant expectation over time, so that
πi+1 = πi, for all I (4.18)
In a time-varying and stochastic model
πi+1 = πi + εi (4.18a)
where εi ∈ E ng is the noise.

Thus, it is possible to rewrite (4.17a) as
xi+1 = Hi+1 πi+1 + wi+1 (4.19)

i = 0,1,…, N−1
we assume the following:
(a) The vector xi+1 and matrix Hi+1 can he measured exactly for
all i.
(b) The noises εi and wi+1 are independent discrete white noises
with known statistics, that is,
E( εi ) = 0; E(wi+1) = 0
E( εi wi+1 ) = 0
’
E( εi εi ) = Q1 δij where δij is the Kronecker delta, and

’
E(wi W ’ ) = Q2δij
i
The above covariance matrices are assumed to be positive definite.

(c) The state vector is normally distributed with a finite covariance
matrix.
(d) Regarding Eqns (18a) and (19), the jacobians of the transfor-
mation of εi into πi+1 and of wi+1 into xi+1 are unities. Hence, the cor-
responding conditional probability densities are:
p(πi+1 | πi) = p( εi )
p(xi+1| πi+1) = p(wi+1).
Under the above assumptions and given Eqns (18a) and (19), the prob-
lem set is to evaluate
E(πi+1 | xi+1) = πi+1

*
and
cov (πi+1 | xi+1) = Si+1 (the error covariance matrix)
where xi+1 = x1, x2, x3,…, xi+1
The solution to this problem (Lazaridis, 1980; Basu and Lazaridis, 1986)
is given by the following set of recursive equations, as it is briefly shown
in the Appendix.
πi*+1 = πi* + Ki +1( xi +1 − H i +1πi* ) (4.20)
Ki +1 = Si +1 H i’+1 Q 2−1
(4.21)
Si−+11 = Pi−+11 + H i’+1 Q 2−1 H i +1

(4.22)
Pi−+11 = (Q1 + Si )−1

(4.23)
The recursive process is initiated by regarding K0 and H0 as null matrices

and computing π0 and S0 from
*
π0* = π̂ i.e. the reduced form coefficients (columns of matrix Π̂ )

S0 = P0 = Ω
The reduced form coefficients, along with their covariance matrices,

can be updated using this recursive process and at each stage a set of
‘Riccati’ equations should be updated accordingly so that adaptive control
rules can be derived. Once we estimate the model using the FIML (full
information maximum likelihood) method, we can obtain both the struc-
tural model and probability density functions along with all associated
matrices mentioned above when describing the method. We first convert
the structural econometric model to a state-variable form according to Eqn
(4.l). Once we specify the targets for the state and control variables, the
objective function to be minimized, the weights attached to each state
and control variables, then it is a matter of calculation to obtain the opti-
mization results for the entire period using Eqns (4.6)—(4.13). Thereafter,
we can update all probability density functions and all other associated
matrices using Eqns (4.20)—(4.23), which will effectively update the coef-
ficients of the model in its state-variable form. We can repeat the optimiza-
tion process over and over as we update the model, its associated matrices
and probability density functions, and use those as new information.
The Policy Model
We describe in this section a model of the Indian economy. The model

is adapted from the IMF and World Bank adjustment policy model
(Khan, 1976; Khan and Montiel, 1989), but without any explicit invest-
ment or consumption function. Instead there is a combined absorption
function as defined here.
Domestic absorption reflects the behaviour of both the private and
public sector.
( A / P )t = a0 + a1 E(Y / P )t − a2 E( IR)t − a3 XRt + u1t (4.24)
where, At is the value of domestic absorption, Pt is the domestic price

level, Yt is the national income, IRt is the market interest rate, XRt is
the exchange rate between the rupee and the dollar, ut is distributed
normally with zero mean and a given variance σ2. E signifies the expec-
tation operator.
The relation between the national income and absorption can be
defined as follows
Yt = At + Rt (4.25)
The government budget deficit (BDt) is defined by Eqn (3)
BDt = (Gt + LRt + PFt) − (TYt + GBSt + AFt + FBt) (4.26)
EXRt is the exchange rate, TYt is the government tax revenue, Gt is the
public consumption, GBSt is the government bond sales, LRt is the net
lending by the central government to the states (which is not part of
the planned public expenditure) and Rt is the changes in the foreign
exchange reserve reflecting the behaviour of the foreign trade sector.
PFt is the foreign payments due to existing foreign debts, which may
include both amortization and interest payments, AFt is the foreign
assistance, which is an insignificant feature, FBt is the total foreign
borrowing assuming only the government can borrow from foreign
sources. We assume AFt and LRt as exogenous, whereas FBt, Gt and TYt
as policy instruments. PFt depends on the level of existing foreign debt
and the world interest rate WIRt, although a sizable part of the foreign
borrowing can be at a concessional rate.
t
PFt = a4 + a5
∑
r =−20
FBr
+a6(WIR/EXR)t (4.27)
Government bond sales (GBSt) depends on its attractiveness reflected

on the interest rate (IRt), the ability of the domestic economy to absorb
(At), the requirements of the governments (Gt), the alternative sources of
finances reflected on the tax revenue (TYt) and government’s borrowing

from the central bank, that is, NDAt, the net domestic asset creation by
the central bank.
GBSt = a7 + a8 At + a9 IRt + a10 Gt − a11TYt − a12 NDAt

(4.28)
Monetary Sector1
We assume flow equilibrium in the money market, that is,
ΔMDt = ΔMSt (4.29)
Where MDt is the money demand, MSt is the money supply. The stock
of money supply depend on the stock of high-powered money and the
money-multiplier, as follows
MSt = ⎡⎣(1 + CD) / (CD + RR)⎤⎦ t (ΔR + NDA)t

(4.30)
(ΔRt + NDAt) reflect the stock of high-powered money and the expres-
sion within the square bracket is the money multiplier, which depends
on credit to deposit ratio of the commercial banking sector (CDt) and
the reserve to deposit liabilities in the commercial banking sector (RRt).
Whereas NDAt is an instrument ΔRt depends on the foreign trade sec-
tor. However, the government can influence CDt and RRt to control the
money supply. RRt, which is the actual reserve ratio, depends on the
demand for loans created by the private sector and commercial banks’
willingness to lead. Actual reserve can be influenced by the statutory
reserve limit set by the central bank. As in the case of India, the actual
reserve is always at a higher level than the statutory reserve limit, so
we accept that the reserve ratio for a developing country is mainly
influenced by demand factors such as the market rate of interest and
national income. We assume that the desired reserve ratio RRt is a func-
tion of national income and market interest rate.
RRt* = a13 + a14 Yt + a15 IRt

(4.31)
The commercial banks may adjust their actual reserve ratio to the
desired reserve ratio with a lag.
RRt* = a ( RRt* − RRt*−1 )
(4.32)
1
This section is from Basu, 2000.
where 0 < α < 1; we can rewrite (8) as follows
RRt* = αa13 + αa14Yt + a15 IRt + (1 − a) RRt −1

(4.33)
The ratio of currency to deposit liabilities with the commercial bank

system is affected by the opportunity cost of holding currency as meas-
ured by the market interest rate and national income representing the
domestic economic activity. Following Khan (1976) the sign of the coef-
ficient for the current national income should be positive and that for
the lagged national income should be negative.
CDt = a16+a17IRt+a18Yt−a19Y t −1 (4.34)
The demand for money is assumed to be a function of the money mar-

ket interest rate and the national income.
( MD)t = a20 − a21 ( IRt ) + a22 (Yt ) (4.35)
The money market rate of interest (IR) is determined by the supply of

money, national income and the central bank discount rate.
IRt = a23 − a29 ( MSt ) + a29 (Yt ) + a26 (CI t ) (4.36)
The domestic price level depends on domestic economic activity, (par-

ticularly changes in the agricultural sector) and the import cost (IMCt).
The import cost in turn depends on the exchange rate (EXRt) and world
price of imported goods (WPMt). We assume the desired price level (Pt)
is represented by the following equation:
Pt* = a27 − a28 ( At ) + a29 ( IMCt ) (4.37)
The desired price level reflects the private sector’s reaction to their
expected domestic adsorption of the expected import cost. Suppose the
actual price will move according to the difference between the desired
price in period t and the actual price level in the previous period
ΔPt = β ( Pt* − Pt −1 ) ; 0 < β < 1 (4.38)
Thus, we get
Pt = β a27 − β a28 ( At ) + β a29 ( IMCt ) + ( I − β ) Pt −1

(4.39)
The import cost (IMCt) is represented by the following equation
IMCt = a30 − a31( EXRt ) + a32 (WPM t )

(4.40)
The exchange rate EXRt can be an instrument variable whereas world

prices of imported goods (WPMt) is an exogenous variable.
The balance of payments (R) is equal to the changes in the stock of
international reserve, that is,
Δ Rt = Xt − IMt + Kt + PFTt + FBt − PFt + AFt (4.41)
when Xt is the value of exports, IMt is the value of imports, Kt is the

foreign capital inflows, PFTt is the private sectors transactions, FBt is
the foreign borrowing, PFt is the foreign payments by the central bank
and AFt is the foreign aid and grants; where Xt, PFTt, Kt, and AFt are
exogenous.
Import IMt is determined by the national income, and the import
cost i.e.
IMt = a33 + a34Yt − a35 ( IMCt )

(4.42)
The above analytical structure was estimated using expected values

of each variable, with expectations being adaptive. The estimated
parameters were used as the initial starting point for the stochastic
control model. The model was estimated using FIML (full information
maximum likelihood) method. Das and Cristi (1990) have analysed in
detail the condition for the stability and robustness of the time-varying
stochastic optimal control system. The condition is that the dynamic
response multipliers of the model should have slow time variations. The
estimated response multipliers of this model satisfy conditions of slow
time-variations (Tsakalis and Ioannou, 1990; Das and Cristi, 1990).
Dynamic Analysis of the Model and Comparative

Performances of the Economy
The policy model used in this analysis is a revised version of the so-
called Fund–Bank adjustment policy model of the World Bank and
the IMF as elaborated by Khan and Montiel (1989, 1990). The model
defines balance of payments and money stock according to the ‘mon-

etary approach’ (Berdell, 1995; Humphrey, 1981; Khan, 1976). There is
no explicit investment or consumption function; instead there is one
combined absorption function, as it is in the ‘new Cambridge model’ of
the UK economy (Godley and Lavoie, 2007; Godley and Lavoie, 2002;
Cripps and Godley, 1976), where a combined consumption-investment
function of the UK economy was postulated.
The rationale here is that private investments before the reform used
to be controlled by various means employing licenses and quotas. It
was the planning commission who ultimately used to decide the nature
and composition of private investment. Consumptions of essential
commodities by the poorer section of the population, which means
the most part of the population, were controlled through the rationing
system that still exists for the poorest members of society. Nonessential
consumptions were influenced by various taxes and quota restrictions.
Therefore, a standard private investment or consumption based on
the market behaviour cannot be estimated for the economy. Instead
it is convenient for us to accept that domestic absorption can reflect
the combined response of both private and public investments and
consumptions to the planned target for national income, set by the
planning commission, and to various market forces, represented by
money-market interest rates, and exchange rates. The money-market
interest rates (money-market interest rates are different from the lend-
ing rates of the commercial banks which until recently were controlled
by the Reserve Bank of India) in this model can be controlled by dis-
count rates of the monetary authority and by direct interventions of the
Reserve Bank of India. Exchange rates under a managed floating system
can fluctuate according to the influences of the balance of payments.
Table 4.6 Fiscal dynamics
Periods 1 2 3 5 7
dP .14849 .15603 .16536 .18078 .16455

dG
dY 0.3572 .03203 .03001 .02058 .00733
dG
dP –.15549 –.15688 –.16281 –.16655 –.14832
dTY
dY –.03590 –.02691 –.02470 –.01676 –.00402
dTY
dGBS .00403 .00568 .00499 .00558 .01033
dG
Table 4.7 Debt ratios and foreign borrowings: history (%)
Year (Total debt)/ (Foreign debt)/ Foreign debt/ Foreign bor-

GNP GNP total debt rowings
rupees billions
1984 .45 .070 .153 13.8

1985 .48 .069 .143 13.7
1986 .52 .069 .133 19.4
1987 .53 .070 .131 32.7
1988 .53 .066 .123 24.6
1989 .55 .063 .114 26.0
1990 .55 .059 .107 31.8
1991 .54 .059 .111 54.2
1992 .54 .060 .111 53.2
1993 .57 .060 .104 50.7
1994 .58 .054 .098 39.5
1995 .52 .051 .095 44.6
Source: Central statistical organization (Government of India) and IMF.
Comparative Performances of the Simulated Planned

Solution and the Actual Performance during the
Adjustment Period2
Historical data relevant for the analysis are in Table A1 in the Appendix
A. The target paths are given in Table A2 and the experimental solu-
tions are given in Table A3. Target paths are according to the judgments
regarding the potentials of the Indian economy and the constraints it
faces. Figures 4.1–4.6 give the comparison between the historical paths
and the simulated paths for some important variables in the model. In
the target path, national income and domestic absorption are expected
to grow at a rate of 6 per cent a year. Foreign borrowing should be stable;
as a result its share in the national income should be reduced. Public
expenditures should go up financed by increased tax revenues and gov-
ernment bond sales. Newly created money stock should grow at a rate
of 11 per cent and major banking instruments like CD, RR, CI and con-
sequently IR should be stable over time. Budget deficits should be more
or less stable. Thus, its share in the national income should go down.
A comparison of the historical experiences during the reform since
1991 and the experimental solution demonstrates that until 1993
growth of the GNP in the experimental solution are superior to the
2
This section is from Basu, 2000.
Historical Planned
Rs billions
7000
6000
5000
4000
3000
2000
1000
0
1990 1991 1992 1993 1994 1995 1996
Figure 4.1 Comparisons, GNP
Historical Planned
Deficits Rs billions
500
450
400
350
300
250
200
150
100
50
0
1990 1991 1992 1993 1994 1995 1996
Figure 4.2 Comparisons, public budget

Historical Planned
(FB-FP) Rs billions
50
45
40
35
30
25
20
15
10
5
0
1990 1991 1992 1993 1994 1995 1996
Figure 4.3 Comparisons, net foreign borrowing
Historical Planned
Rs billions
500
450
400
350
300
250
200
150
100
50
0
1990 1991 1992 1993 1994 1995 1996
Figure 4.4 Comparisons, government bond sales

Historical Planned
Rs billions
1200
1000
800
600
400
200
0
1990 1991 1992 1993 1994 1995 1996
Figure 4.5 Comparisons, government expenditure
Historical Planned
Rs billions
1000
900
800
700
600
500
400
300
200
100
0
1990 1991 1992 1993 1994 1995 1996
Figure 4.6 Comparisons, tax revenues

actual performance obtained during reform. Although for the later years
since 1996, the government suggests higher rates of growth for the GNP,
it was not clear what would be the source of this additional growth.
The industrial sector since 1996 until 2000, in particular, has stagnated.
Agricultural growth is not significant at all. Perhaps the service sector is
the only growth factor during the recent years.
The experimental solution gives much more importance to the gov-
ernment expenditures, bond sales, net domestic asset creations by the
central bank with reduced interest rates and reserve ratios in the com-
mercial banks; however budget deficits would go up slightly. In recent
years balance of payments deficits are worse than those in the experi-
ment. This shows a basic characteristic of the Indian economy that the
economy depends crucially on the public activity. The slowdown in
the industrial sector during the period between 1992–6 can be directly
attributable to the reduced activities and curtailments of public invest-
ments under the reform programme.
Price level under the experiment demonstrates lower rate of inflation
than the historical experience. This is due to the reduced level of inter-
est rates and reserve ratios which can stimulate domestic productions
in the private sector and increase the level of output, which can in turn
achieve lower inflation rates. Monetary policy in the experiment is
expansive to support a growing economy. Net domestic asset creation
by the central bank has a higher rate of growth than those in recent
history. Interest rates are lower, reserve ratios are lower too, and as a
result, ‘credit to deposit’ ratios are higher, which helps growth of the
real economy.
The contractionary policy followed during the reform period results
in a lower credit to deposit ratio. Hence, expansion of the private sec-
tor was not as it was expected from the reform. At the same time, in
reality public investments have suffered. The industrial recession from
1996 to 2000 was the result of these two factors. Even with expansion-
ary monetary policy, the rate of inflation is lower in the experiment
due to higher rate of growth of the real economy and a lower rate of
devaluation. Devaluation is the cornerstone of the reform programme;
the objective was to expand exports. The result was a much higher cost
of imports. India’s imports are mainly essential items, so it is not pos-
sible to reduce these even if the rate of devaluation is high. The result of
devaluation is increasing costs of raw material; crude petroleum is one
such item, which can increase the rate of inflation.
As inflation is also the result of shortages in a developing economy,
expansionary monetary and fiscal policy, by increasing real output can
reduce inflation. The reform programme on the other hand has used
the logic of demand managements to reduce inflation, which is not
valid for an economy like India’s. In the above experiment, government
expenditures, bond sales and budget deficits are higher compared with
those achieved during the reform period. These are highly desirable for
a growing economy.
The idea that contractionary fiscal policy can automatically stimu-
late the economy by making more room for the private sector is not
valid in India or in a growing economy, where growth of the private
sector depends in many ways on the expansions of the public sector.
Contractions in the public sector means, in this type of framework,
contractions in the private sector too, which can explain the slowdown
of growth in the industrial sector during the early stages of the reform
programme and stagnation in the small and medium-sized industries
during the reform until about 2000.
In the external sector, the balance of payments situation did not
improve during the reform period, the amounts of deficits in the bal-
ance of payments in fact increased in some cases. In the experiment
given above, the rate of devaluation is much slower and the deficit
in the balance of payments is lower in magnitude. India’s exports
increased due to devaluations only for a short period. Afterwards they
stagnated while cost of imports went up and up. The resultant foreign
debt and borrowing are higher as a result during the reform period
compared with those in the experiment given above. The expectation
that reforms would bring floods of foreign direct investments has yet
to be fulfilled; although in recent years there have indeed been floods
of short-term portfolio investments, which have artificially stimulated
the economy by having much higher growth rates but these can dam-
age the economy in the longer run, as they may disappear suddenly
and create a speculative bubble.
We have also seen budget deficits grow at alarming rates, and they will
grow further. If we want to reduce these we need to reduce the growth
rate, which may make the debt situation worse in the future. The usual
solvency criteria suggest that the rate of growth of the economy should
be more than the interest rate to be paid on public debt. If we assume
that rates of growth of public revenues will follow rates of growth of the
economy, it is possible for the economy to sustain itself with a growing
public debt. However, with growing public debt, the primary deficit
may outstrip the revenues and then financial crisis may emerge. It is
possible however for India to approach the problem from several angles.
There is a need to increase the tax base of the economy. Public subsidies,
which are not designed for the poor, should be curtailed. Efforts should
be made to collect payments due on the defaulted bank loans of the

large private sector firms; the total amount of unpaid bank loans for
large private sector corporations is now more than Rs150 billion, which
seriously undermines the viability of the banking sector.
Comments
The goal of the reform process is to create a liberalized economy in India

by removing the mixed economic system that used to prevail. The result
of that reform has not yet touched the majority of the people positively.
Instead there is a growing fear that all previously existing benefits will
be lost, because of the increased privatization process and the resultant
corruption that has accompanied this process. The expectations of a
high level of inflow of foreign direct investments to substitute public
investments have not been met yet, but only the portfolio investments
are coming to India. A phase of very high growth in the economy
started in 2004, after India removed the restrictions on the entry of
these short-term foreign portfolio investments. That created a bubble
economy, which has disappeared after the financial crisis and reces-
sion of the Western economies since 2008. Reform has created massive
scams since 1993 and therefore become unpopular. In view of that, it
is important to examine what could have happened if India had main-
tained the mixed economic system and what type of monetary fiscal-
exchange rate policies would be most suitable. As we can see from the
experiment, the mixed economic system—where the private sector is
regulated through monetary-fiscal policies—could perform better than
the so-called reform programme.
Appendix A
Notations:
A Domestic absorption, in constant price
AF Foreign receipts (grants etc.), US$ million
BD Government budget deficits, in constant price
CD Credit to deposit in the commercial banking sector
CRB Cumulative foreign borrowing, i.e. foreign debt over a period of
20 years
CI Discount rate of the Reserve Bank of India
FB Foreign borrowing, US$ million
G Government expenditure, in constant price
GBS Government bond sales, in constant price
IM Value of imports, in constant price
IMC Import price index (1990=100)
IR Interest rate in the money–market

K Foreign capital inflows, US$ million
LR Lending (minus repayments to the states), in constant price
MD Money demand, in constant price
MS Money supply, in constant price
NDA Net dometic asset creation by the Reserve Bank of India,
constant price
P Consumer price index (1990=100)
PFT Private foreign transactions, US$ million
PF Foreign payments, US$ million
R Changes in foreign exchange reserve, US$ million
RR Reserve to deposit ratio in the commercial banking sector
TY Government tax revenue, in constant price
T Time trend
WPM World price index of India’s imports (1990=100)
WIR World interest rate, average of European and US money market rate
EXR Exchange rate (Rupee/US$)
X Value of exports, in constant price
Y GNP, in constant price
Table A1 Historical data for all variables in the model
Rupees billions, 1990 prices
Year Y BP G TY LR
1990 5279.9 –123.147 924.0 723.6 239.5

1991 5298.9 –85.240 917.5 779.1 182.8
1992 5552.7 –93.076 952.2 804.3 178.9
1993 5825.4 –42.368 1010.1 749.4 194.9
1994 6295.3 –51.494 1047.1 843.3 217.7
1995 6766.1 –182.164 1091.5 904.2 185.5
Year FB-FP GBS NDA IR CI CD RR

% % ratio ratio
1990 31.8 407.0 1.006.3 15.57 10.0 .75 .15

1991 47.3 265.5 1.011.3 19.35 12.0 .69 .15
1992 42.6 272.6 931.7 15.23 12.0 .69 .14
1993 37.5 418.3 942.7 8.64 12.0 .66 .15
1994 26.5 371.4 791.9 7.14 12.0 .62 .15
1995 27.9 337.7 822.3 15.57 12.0 .66 .16
1996 17.2 365.2 1285.7 11.04 12.0 .62 .12
(continued)
Table A1 Continued
Year P P EXR GDP BD

(CPI) Rate of Rs/US$ deflator rupees
index growth index billion
%
1990 100.0 17.50 100.0 –434.61

1991 113.9 13.9 22.74 114.5 –312.82
1992 127.3 11.7 25.92 124.9 –319.45
1993 135.4 6.4 30.49 135.0 –448.37
1994 149.5 10.4 31.37 149.1 –413.61
1995 164.5 10.1 32.43 159.7 –365.62
1996 179.2 8.9 35.43 173.7 –385.03
CPI = consumer price index.

Source: Central Statistical Organization (Government of India).
Table A2 Target
Year Y BP G TY LR
1990 5000.0 –70.0 1301.0 650.0 198.0

1991 5325.0 –63.0 1321.0 692.0 228.0
1992 5671.0 –56.0 1288.0 737.0 243.0
1993 6039.0 –54.0 1337.0 785.0 259.0
1994 6431.0 –51.0 1389.0 830.0 273.0
1995 6849.0 –47.0 1485.0 890.0 293.0
1996 7294.0 –43.0 1487.0 948.0 312.0
1997 7768.0 –43.0 1500.0 1009.0 332.0
Year FB-FP GBS NDA IR CI CD RR

% % ratio ratio
1990 29.0 350.0 850.0 9.5 9.0 .75 .12

1991 30.0 372.0 798.0 9.5 9.0 .80 .10
1992 33.0 396.0 850.0 9.5 9.0 .82 .10
1993 35.0 422.0 905.0 9.5 9.0 .84 .10
1994 37.0 450.0 1.025.0 9.5 9.0 .86 .10
1995 39.0 479.0 1.090.0 9.5 9.0 .86 .10
1996 42.0 510.0 1.000.0 9.5 9.0 .86 .09
1997 45.0 543.0 1.160.0 9.5 9.0 .86 .09
(continued)
Table A2 Continued
Year P EXR
Index Rs/US$
1990 100 17.0

1991 108 20.0
1992 116 20.0
1993 126 20.0
1994 136 22.0
1995 148 22.0
1996 160 22.0
1997 165 22.0
Source: Central Statistical Organization (Government of India)

[Targets are created by author’s own observations on the corresponding targets of the Indian
Planning Commission and the actual achievements of the economy over the historical
period.]
Table A3 Simulated planned solutions
Year Y (Rate of BP G TY FB-FF

growth %)
1990 5162.16 –98.07 877.56 672.16 27.34

1991 5345.41 (3.55) –74.83 908.72 748.35 29.01
1992 5558.69 (3.99) –61.14 1000.56 750.38 26.15
1993 5883.32 (5.84) –58.83 941.33 764.83 24.29
1994 62.3.37 (5.44) –45.82 1054.57 818.84 22.08
1995 6535.25 (5.35) –41.74 1176.34 849.58 20.68
1996 6908.41 (5.71) –37.54 1174.43 941.45 20.70
Year GBS NDA IR % CI % CD Ratio RR Ratio
1990 344.86 878.56 6.0 8.5 .84 .13

1991 370.38 908.72 5.7 8.5 .76 .12
1992 378.30 944.97 5.8 7.7 .78 .12
1993 398.72 941.33 5.8 7.3 .78 .10
1994 422.86 992.54 5.2 6.8 .81 .08
1995 434.93 1045.64 5.3 6.6 .83 .08
1996 450.94 1105.34 5.3 6.5 .84 .09
Year P Index Rate of BD EXR Rs/

growth % US$
1990 100.0 –361.34 16.5

1991 109.9 9.9 –374.18 17.1
1992 122.1 11.1 –377.99 18.4
1993 127.7 4.6 –405.94 19.7
1994 138.3 8.3 –434.23 20.9
1995 148.6 7.4 –444.39 22.5
1996 157.9 6.3 –455.95 23.6
5
Structural Reforms in Nigeria
Nigeria is the eighth largest oil exporter in the world with the second
largest oil reserves in Africa.
Nigeria rebased its GDP from 1990 to 2010, resulting in an 89% increase
in the estimated size of the economy. As a result, the country now boasts
of having the largest economy in Africa with an estimated nominal GDP of
USD 510 billion, surpassing South Africa’s USD 352 billion. The exercise
also reveals a more diversified economy than previously thought. Nigeria
has maintained its impressive growth over the past decade with a record
estimated 7.4% growth of real gross domestic product (GDP) in 2013, up
from 6.7% in 2012. (Barungi et al, 2014)
Although Nigeria depends on its oil sector for overall growth and bal-
ance of payments, the oil sector’s growth performance was less impres-
sive with 3.4 per cent, −2.3 per cent and 5.3 per cent estimated growth
rates in 2011, 2012 and 2013, correspondingly. The country’s important
doldrums-based oil industry produces around 2 million barrels of crude
oil per day. Oil investment has been held back by the failure to pass a key
reform bill. Onshore oil pipelines are being eaten away by theft of crude
oil as well as export figures. Nigeria was previously a major crude oil
exporter to the USA, but the country’s share of US oil imports dropped
from 11 per cent to 5 per cent in the year 2013. Nigeria’s economy has
achieved consistently high growth of about 6 per cent per year over
the last ten years. This has largely been due to its non-oil sector. The
slow recovery of the global economy puts Nigeria’s economic growth
at risk. Negative growth of the oil sector, which provides 95 per cent
of foreign exchange earnings and about 80 per cent of budgetary rev-
enues, along with any decline in the international price of oil, may
127
also continue to hinder overall growth. Nigeria refused to follow its IMF
programme in April 2002, after failing to meet spending and exchange
rate targets. However, in November 2005, it won approval from the
Western lenders for a debt-relief deal that eliminated US$18 billion
of debt in exchange for US$12 billion in payments—a total package
worth US$30 billion of Nigeria’s US$37 billion external debt. Economic
growth was strong during 2007–12, because of global crude oil prices.
A drop in oil production or oil prices could trigger a downturn in
Nigeria’s domestic consumption and hamper non-oil growth. The coun-
try’s fiscal and monetary policies, which have so far supported growth,
came under increasing pressure in 2014.
The purpose of this chapter is to investigate the effects of the struc-
tural adjustment programme (SAP) in Nigeria. The country has one of
the strongest and largest economies in Africa and the adjustment pro-
gramme should, theoretically, have worked out, due to the immense
oil revenue Nigeria could generate. A number of authors have studied
adjustment policies and their ex post effects (Hussain and Thirlwall,
1984; Killick, 1984; Goldstein, 1986; Kiguel and Liviatan, 1992; Lizondo
and Montiel, 1989; Calvo, 1991). The ex ante analyses are mainly in
terms of theoretical justifications or critiques of the adjustment policies
(Khan, Montiel and Haque, 1990; Sau, 1993). In this chapter, an attempt
to merge these two types of evaluations—ex ante and ex post—is made.
A model for Nigeria was constructed—incorporating all the pos-
sible recommendations suggested by the IMF and realistic assumptions
regarding the exogenous variables, given the situation of the world
in 1986, the year of the initial implementation of the SAP. Then these
exante forecasts were compared with recent history. The forecasts made
in 1986 appear to be clear enough to show that the standard monetary-
fiscal policy was adequate to provide a solution to the balance of pay-
ments crisis. However, there could be costs in terms of reductions in
private consumption and serious cyclical movements in the economy.
These monetary fiscal policies were not implemented however and, as a
result, Nigeria experienced an unexpected serious debt problem.
Debt Problem
For the developing countries, the most severe consequence of this debt
crisis was the perverse change of sign in the international flow of funds.
Despite their traditional standing as capital importers, developing
countries are being forced to transfer a large proportion of their export
resources to other countries. These net resource transfers benefit mainly
Structural Reforms in Nigeria 129
the USA, whose massive absolute external gaps are unparalleled in con-
temporary economic history.
Back in 1974, commercial banks responded to the large OPEC sur-
pluses by recycling the funds at competitive credit market floating
interest rates. Banks knew that the official risk was then superimposed
on the commercial ones and never overlooked the possibility that a
few countries might face balance of payments problems because of bad
economic management. Since the debtor countries pursued their poli-
cies independently of each other, the possibility of a global debt crisis
seemed unlikely on the basis of the law of large numbers. But we know,
from the experiences of the 1930s, that this neat picture may collapse
and a debt crisis may emerge as a result of a dramatic decline in world
trade and economic activity.
Competitive recycling may survive, as long as the rate of growth of
exports of debtor countries exceeds international interest rates. In this
case, indications of a reduced debt–export ratio and improved credit
standing can be achieved, even with a more than complete debt service
rollover. Historical evidence after the Second World War suggested that
the rates of growth of international trade tended to exceed interest
rates. Non-oil-exporting developing countries, in particular, expanded
the Dollar value of their exports at average annual rates of 10.3 per cent
between 1963 and 1973 and 21.1 per cent between 1975 and 1980,
more than passing the rollover test. Hence, until 1980, few doubts
were cast on the validity of competitive recycling (Simonson, 1985;
Cline, 1983). The mixture of tight monetary and loose fiscal policy in
the USA since 1981 pushed the international debt problem into a trap.
A crisis emerged as a result of the abrupt escalation of the debt–export
ratios and a series of events, including the loan defaults of Poland, the
Mexican moratorium of late 1982 and the collapse of the oil price in
1985–6. These spilled over to a general breakdown of confidence in
developing country debts and led to a hurried retreat of commercial
banks from lending to such nations. Since competitive recycling was
based on rollover, debtor countries soon became illiquid and had to
apply for widespread rescheduling arrangements.
Nigeria, as a major oil-exporting country, has suffered from over-
optimism regarding future oil revenue. It has borrowed heavily, even
in the early 1980s—its debt/GDP ratio was about 25 per cent in 1985.
However, since then, due to the fall in the price of crude petroleum, it
went up to about 60 per cent in 1987, when the IMF initiated the SAP
for Nigeria, in the face of a stagnant economy with mounting infla-
tion. However, Nigeria has so far failed to implement the conditions
suggested by the IMF regarding its fiscal and monetary policy, although
it has implemented the exchange rate devaluations. The adjustment
programme has not halted the increase in the net volume of Nigeria’s
debt. The sudden increase in Nigeria’s oil revenue, due to the Gulf
War in 1991, helped the debt situation and the total volume started to
decline; however the debt burden was overpowering. Interest payments
on a percentage of exports stood at 40 per cent in 1993, although, with
rescheduling, they were reduced to 20 per cent. However, that had
imposed the burden for a prolonged period.
Appropriate Exchange Rates for Developing Countries
The question is how the IMF could cope with this situation. IMF condi-
tionality has concentrated on two major macro policy aspects: adequate
exchange rate management and demand discipline. The latter is to be
achieved through fiscal restraint and a limited expansion of net domestic
credit. The theory is that wage price flexibility leads to full employment
equilibrium and that private savings and investment should not be affected
by budgetary cuts. Since a public sector deficit would imply a deficit in the
current account of the balance of payments, the effect of any reduction in
the public sector deficit would be in terms of improvements in the current
account of the balance of payments. Inflation should be controlled through
monetary policy, so that the political temptation of exchange rate over-
valuation does not arise. (Basu, 1995, 1996, 2006)
What should be the appropriate level of devaluation under such struc-

tural constraints? The size and nature of the external shocks faced by
open economies could determine the optimal degree of exchange rate
flexibility. With an adjustable peg, the exchange rate of the domestic
currency is kept constant against a single foreign currency or an average
of foreign currencies.
An alternative is to include in the price-setting rule more continu-
ous reference to some set of variables or indicators, an exchange rate
regime using a form of crawling peg or gliding parity. The practicabil-
ity of this policy can be questioned, because of the lack of timely price
data. The solution can be that the current inflation rate can be esti-
mated from the known price data, using an autoregressive technique.
However, this crawling peg method may not be enough to maintain
an external balance. As economic conditions or circumstances facing
a developing country change—terms of trade shock, for example—in
order to affect alteration in the real exchange rate for an external
balance adjustment there may be a call for change in exchange rate

and other policies.
The formal objective of the IMF-supported adjustment programme is
to create a viable balance of payments in the medium term. The formu-
lations of exchange rate policies in such programmes not only take into
account the overall stance of domestic and foreign policies, but also
prospective internal and external conditions over the medium term.
Evaluation of the level of responsiveness of the elements of the
balance of payments to exchange rate changes (elasticity analysis) is
integral to the formulation of exchange rate policy and the use of elas-
ticity is frequently implicit. The size and speed of the domestic supply
response are dependent on the extent to which it results from:
• Putting previously idle resources to use.

• Increased productivity through a more intensive use of resources.
• The movement of resources from the non-tradable to the tradable
sector.
• The movement of resources within the tradable goods sector. (Basu,
1995, 1996, 2000).
In the analysis given here, a number of scenarios with different types of

exchange rate regimes are considered for Nigeria’s economy.
A Structural Model for Nigeria
Nigeria usually earns more from exports than it spends on imports,

unless oil prices are low. Only since 2000, due to the significant rise of
the international price of crude oil, has Nigeria managed to pay back
its debt and achieve a respectable rate of growth of the economy with
surplus balance of payment. According to the OECD, ‘weaknesses in the
oil sector have increased macroeconomic risks’. Oil accounts for close to
90 per cent of exports and roughly 75 per cent of consolidated budget-
ary revenues. As the economy depends on oil, any decline in the inter-
national price of oil could turn Nigeria once again, as it did during the
1980s and 1990s, into a debt ridden country. This is why it is important
to go back to the economy of the 1990s to examine what options will
be available if that situation of high debt burden should occur again.
Nigeria started its life as a politically unstable, poor country in Africa,
plagued by civil war. In 1974, the increase in the price of crude petro-
leum boosted the country’s economy beyond its wildest expectations
and the large revenue generated from oil exports during the 1970s
resulted in Nigeria becoming one of the richest countries in Africa.

Things quickly turned sour, because of ill-judged use of revenue within
the country. The rate of growth of the economy was negative for a sub-
stantial period, with the upturn in world petroleum markets leading to
sudden revivals in 1990–1 (Basu, 1995, 1996, 2006).
During the early 1980s, Nigeria’s balance of payments deficit was
alarming—the debt service/GDP ratio reached about 40 per cent in
1984. The economy was acutely constrained by the heavy debt service
burden (Figures 5.1 and 5.2). In 1986, at the suggestion of the IMF, the
government began to implement its SAP. In 1992–3, annual inflation
rose to 45 per cent, the budget deficit more than doubled since 1989
to over 12 per cent of GDP and the exchange rate practically collapsed
(in 1993, it declined to 30 Naira per US$). Combined falling oil prices
and exchange rate depreciation lead to a reduction in the average
real income per head from $1,000 in 1980 to $290 in 1991, making
Nigeria one of sub-Saharan Africa’s poorest countries. The adjustment
Ex-oil Total
0.14
0.12
0.10
Growth Rate
0.08
0.06
0.04
0.02
0.00
1990 1995 2000 2005 2010

Year
Figure 5.1 Nigeria, growth in aggregate GDP, 1990–2010

Source: calculations based on World Bank data.
0.14
0.12
Dollar/Naira exchange rate
0.10
0.08
0.06
0.04
0.02
0.00
19 0
19 1
19 2
19 3
19 4
95
19 6
19 7
19 8
20 9
00
20 1
20 2
20 3
20 4
20 5
20 6
20 7
20 8
20 9
10
9
9
9
9
9
9
9
9
9
0
0
0
0
0
0
0
0
0
19
19
20
Year
Figure 5.2 Nigeria, Dollar/Naira exchange rate, 1990–2010

Source: calculations based on IMF data.
programme included a massive devaluation of Nigeria’s currency, from

1.2 Naira/US$1 in 1986 to 4.2 Naira/US$1 in 1987. Public expenditure
was reduced. Government borrowings from the banking system were
highly restricted. Interest rates on lending were raised to 15 per cent
in 1987, with the target growth of money supply restricted to approxi-
mately 11 per cent. According to the IMF, the success of the adjustment
programme could be measured in terms of its effectiveness on the
liquidity squeeze and the suppression of consumer demand. Although
the latter was visible, because of deteriorating economic situations,
erractic monetary policies prevented the former from materializing. The
adjustment programme also expected a substantial inflow of foreign
investment, which never appeared (Basu, 1995, 1996, 2006).
Despite being Keynesian in nature, the structural model estimated
here includes certain characteristics (mainly regarding the effects
of money supply on prices) that are strongly suggested by the pro-
ponents of the adjustment policy (Khan and Knight, 1981). The
equation structure was estimated by 2SLS using annual data from
the period 1960–86. Eqn (5.1) describes government consumption
in terms of total government expenditures, which is an exogenous
policy variable. Eqn (5.3) explains real private consumption in

terms of real balance (M2/CPI) of the economy and the real GDP.
M2 is a policy variable, therefore real private consumption can be
controlled by the real money supply, which is a realistic descrip-
tion of an economy where the government dominates all economic
activities by controlling the oil revenues. Eqn (5.4) explains real
merchandise imports in terms of real GDP and the relative price of
imports in terms of domestic price. Most of the imports are non-
competitive, hence significant impact of prices on real imports can-
not be expected. Eqn (5.5) describes government revenue in terms
of the revenue from crude oil exports, which is the major source of
revenues—although there is a growing non-oil manufacturing sector
and traditional depressed agricultural sectors. Eqn (5.7) explains real
investments in terms of real GDP and changes in the real absorp-
tion. Eqn (6) signifies that consumer price indices are influenced
by money supply (M2) and import costs are reflected by the import
price. Export of crude petroleum dominates the economy, however,
crude oil exports depend on the quota of oil production and exports
are determined by the OPEC and the international price of crude
petroleum. Eqns (5.11), (5.12) and (5.13) explain interest payments
in terms of Eurodollar interest rate and on the level of existing debt.
Eqn (5.14) explains the level of debt in terms of balance of payments
deficits which is the main cause for indebtedness as the oil revenue
cannot match the public expenditure much of which is imported.
Identities define various types of debts, authorization, interest pay-
ments and also various price indices. The equations of the model are
as follows (figures within the brackets are the corresponding t-ratios;
notations are given in the appendix):
Government consumption (nominal) (5.1)

CGt = 348.472 + 0.439 GEXPt
(1.85) (2.01)
R2 = 0.98, R2 = 0.96, DW = 2.32, p = 0.38
Government consumption (real) (5.2)

CGRt = CGt/PCGt
Private consumption (real) (5.3)

logCPRt = 0.177 + 0.526 log CPR^ + 0.124 log (M2t/CPIt) + 0.379
logGDPRt
(1.89) (1.32) (1.91) (2.01)
R2 = 0.99, R2 = 0.97, DW = 1.87, p = 0.27
Merchandise imports (real) (5.4)

logMGRt = −16.549 + 2.229 log GDPRt − 0.346 log(PMGt/CPIt)
(2.51) (3.01) (1.25)
R2 = 0.93, R2 = 0.91, DW = 2.37, p = 0.42
Government revenue (5.5)

GREVt = 73.688 + 0.285 (QOILt x 365 x PEXCRUDEt/RXt) + 0.061 GDPt
(1.97) (3.01) (2.52)
R2 = 0 95, R2 = 0.93, DW = 1.95, p = 0.32
Consumer price index (5.6)

logCPIt = 1.279 + 0.658 log PMGt + 0.362 log[(M2t + M2t_1)/2]
(1.53) (2.79) (3.51)
R2 = 0.97, R2 = 0.93, DW = 1.95, p = 0.32
Domestic investment (real) (5.7)

IDOMRt = −42.886 + 0.296 GDPRt_1+ 0.233 (GDPRt + MNIARt − GDPRt_1
− MNI ARt_1)
(3.01) (1.89) (2.31)
R2 = 0.96, R2 = 0.92, DW = 2.31, p = 0.51
Service imports (excluding interest payments) (5.8)

BOPMSNINT = −1.264 + 0.253 BOPEXG
(1.89) (2.01)
R2 = 0.94, R2 = 0.89, DW = 2.31, p = 0.25
Crude oil exports (real) (5.9)

EXGOIL = (QEXGOIL/1 .91066) x 13,632.3
Crude oil exports ($). (5.10)

EXGOIL$ = QEXGOIL X 365 x PEXCRUDE
Interest payment (medium and long-term debt) (5.11)

INTLTGt = −1.520 + 0.725 [(RMGFCMt/l 00) x DTDISLTNGt_1]
(3.01) (2.96)
R2 = 0.95, R2 = 0.92, DW = 1.89, p = 0.25
Private interest payment—all creditors (5.12)

INTLTNGt = 7.499 + 0.672[0.01 x RMEUR03NSt x DTDISLTNGt_1]
(1.53) (2.52)
R2 = 0.94, R2 = 0.91, DW = 2.01, p = 0.31
Interest payment (medium and long-term debt)—private creditors (5.13)
INTLTPt = −2.067 + 1,036[(RMEUR03NSt/100) x DTDISLTPt_1]
(2.78) (3.61)
R2 = 0.92, R2 = 0.88, DW = 1.89, p = 0.42
Total debt outstanding and disbursed (5.14)

DTDISST&LTt = 5.867 + 0.703 DTDISST&LTt_1 − 0.102 BOPCAt
(1.81) (2.31) (3.05)
R2 = 0.94, R2 = 0.91, DW = 1.77, p = 0.53
Following identities are added to the above equations to create the

complete model. The equation structure was estimated by 2SLS, using
annual data from 1960 to 1996.
BOPCA = BOPEX − BOPM = BOPTR
BOPEXG = EXGOIL + EXGOTH
EXNIA = BOPEXG + BOPEXSRX
EXNIAR = EXNIA/PEXNIA
MNIAQ = MNIAR x PMNIA
GDPR = CPR + CGIR + IDOMR + EXNIAR − MNIAR + GDPDISCR
DDP = CP + CG + IDOM + EXNIA - MNIA + GDPDISC
GAP = GDP − EXNIA + MNIA
EXGR = EXGOIL + EXGOTH
EXG = BOPEXG x RX
GAPR = CGR + CPR + IDOMR
PGDP = GDP/GDPR
IDOM = IDOMR x PIDOM
PEXG = EXG/EXGR
PCPt = PCPt_1 x (CPIt/CPIt_1)
CP = CPR x PCP
INTST&LT = INTLT+INTST
DTSLT = AMORTLT + INTLT
PGAP = GAP/GAPR
BAL = GREV − GEXP
DTSST = INTST + AMORTST
DTSST&LT = DTSLT + DTSST
CR = CPR + CGR
C = CP + CG
AMORTST&LT = AMORTST + AMORTLT
BOPEX = BOPEXG + BOPEXS
BOPM = MNIA/RX
DTDISLTP = DTDISLT − ( DTDISLTG + DTDISLTNG)
AMORTLTGt = SCHEDAMORTLTG x DTDISLTGt−1
AMORTLTPt = SCHEDAMORTLTP x DTDISLTPt−1
AMORTSTt = DTDISSTt−1
PEXGOTHt = PEXGOTH t−1 x PMCOMODt/PMCOMODt−1
PMGt = PMG t−1 x (PEXGt x RXt)/(PEXGt−1 x RXt−1)
AMORTLT = AMORTLTG + AMORLTP + AMORTLTNG

INTLT = INTLTG + INTLTP + INTLTNG
INTST = RMEUR03NS X DTDISST/100
(Basu, 1995, 1996, 2006)
Experiments on Policy Simulations
Analyses of the future policy packages were carried out using three dif-
ferent simulations of the Nigerian economy (Table 5.1). Wherever data
were available, comparisons were made with the actual behaviour of
the economy since 1987 (Basu, 1995, 1996, 2000).
In simulation 1, the adjustment programme, as suggested by the IMF
and World Bank, was imposed on the model. According to this, public
expenditure was reduced by 20.3 per cent in 1987; then it was allowed
to grow by 8 per cent in 1988, 24.2 per cent in 1990 and 13.3 per cent
in 1995. A devaluation of the currency was also assumed as part of the
monetary policy. The Naira was devalued from 1.20/US$1 in 1986 to
4.20/US$1 in 1987, 6.00/US$1 in 1991 and 6.80/US$1 in 1995. Money
supply, due to the devaluation, would increase initially; subsequently,
it would be stabilized.
In simulation 2, a regime of more fiscal restriction and less devalu-
ation of the currency was assumed. According to these assumptions,
public expenditure was reduced by 39.4 per cent in 1987; then it was
allowed to grow by 7.4 per cent in 1988, 17.6 per cent in 1989 and 12.5
per cent in 1995. Devaluation was milder according to this simulation;
the Naira was 2.40/US$1 in 1987, 3.80/US$1 in 1990 and 5.00/US$1 in
1995.
In simulation 3, a very moderate policy regime was assumed. Public
expenditure was assumed to grow by 8.4 per cent in 1987, 17.6 per cent
in 1988, 17.4 per cent in 1990 and 15.6 per cent in 1995. The exchange
rate was set to depreciate to only Naira 1.70/US$1 in 1987, 2.30/US$1
in 1988, 3.40/US$1 in 1990 and 4.60/US$1 in 1995.
In contrast with these simulations, recent historical experiences
(Table 5.2) show that the exchange rate went through a more drastic
devaluation and, as a result, the rate of monetary growth in the econ-
omy was much higher than anticipated, but government consump-
tion was reduced significantly. The most important assumptions in
the simulation were those regarding crude petroleum production and
exports. Historical experience is not significantly different from our
assumptions, although, due to the Gulf War, revenue from oil exports
in 1991–2 showed a dramatic increase. This raised both the foreign
Table 5.1 Simulation assumptions—Nigeria
1987 1988 1989 1990 1991 1992 1993 1994 1995
Simulation 1
Government policy — % change from a year ago
Government expenditure 20.3 8.0 22.2 24.2 19.5 16.3 17.5 11.9 13.3
Government revenue 28.4 25.7 18.6 24.2 19.8 21.3 15.7 13.2 13.4
Money supply (M2) 57.1 26.3 23.2 22.0 25.8 22.1 17.7 18.3 30.7
Exchange rate (Naira/$) 4.20 4.80 5.50 5.80 6.00 6.20 6.40 6.60 6.80
%chya* 250.0 14.3 14.6 5.5 3.4 3.3 3.2 3.1 3.0
Foreign reserves ($m) 1,600 1,569 1,763 1,983 2,249 2,629 2,898 3,198 3,359
Simulation 2
Government expenditure 39.4 7.4 17.6 25 20 19.4 16.3 12 12.5
Money supply (M2) 44 19.4 22.2 23.9 28.6 22.8 17.6 19 34.2
%chya* 100.0 20.8 17.2 11.8 7.9 7.3 2.3 4.4 6.4
Simulation 3
Government expenditure 8.4 17.6 15.0 17.4 18.5 9.4 20.0 7.1 15.6
Money supply (M2) 48.7 20.2 18.0 19.8 25.3 21.9 16.5 18.7 32.3
%chya* 41.7 35.3 21.7 21.4 8.8 10.8 2.4 4.8 4.5
(continued)
Table 5.1 Continued
1987 1988 1989 1990 1991 1992 1993 1994 1995
Other indicators
Crude oil production 1588 1793 1885 2006 2112 2150 2150 2112 2100
(mbld)
Oil export (mbld)** 1238 1400 1572 1706 1712 1750 1750 1712 1700
Oil price ($/B) 18.0 18.2 19.2 20.5 22.6 24.7 26.8 29.9 33.5
Industrial GNP growth 2.7 2.8 2.9 2.9 3.0 3.1 3.2 3.3 3.4
(%chya)***
Three-month Eurodollar 3.1 6.4 5.6 6.5 6.8 6.9 6.9 6.9 6.9
rate
* Percentage change from a year ago.

** Crude and refined oil products.
*** Refers to US, Japan, Canada, UK, Germany, France and Italy.
Table 5.1a Movement of policy instruments, 1985–92
1985 1986 1987 1988 1989 1990 1991 1992

Government 6.6 5.7 19.77 – – – – –
expenditure
Government −11.0 6.1 −8.01 – – – – –
revenue
Money supply 9.0 2.0 17.71 43.9 20.36 33.8 41.1 –
(M2)
Exchange rate 1.0 1.35 4.01 4.53 7.36 8.04 9.91 17.29
(Naira/$)
Foreign reserves 1,167 1,081 1,165 651 1,766 3,864 4,435 –
($m)
Other indicators
Crude oil 1.47 1.50 1.30 1.42 1.68 1.77 1.86 1.89
production (mbld)
Oil export (mbld)* 1.36 1.20 1.23 1.37 1.58 1.67 1.75 1.77
Oil price ($ib)** 25.6 14.9 17.6 18.0 18.5 22.5 26.5 20.5
* Crude and refined oil products.

** Annual averages of Saudi crude in Rotterdam.
Source: IMF, International Financial Statistics; UN, Monthly Bulletin of Statistics.
exchange reserves and the surplus in the balance of payments, which

were beyond our expectations.
If we compare the result of simulation 1 and the historical data (Tables
5.3–5.5 and Figures 5.3–5.5), we can see that the balance of payments
has behaved in the way predicted, that is, after some initial deficits, it
shows a surplus; real exports and imports (in terms of domestic cur-
rency) show dramatic swings, due to the volatility of the exchange rate.
The exchange rate changes have also affected price movements; both
the wholesale price index and the GDP deflator have shown serious
cyclical movements. Private consumption and government consump-
tion were both affected badly, although domestic investment shows
an improvement. On the whole, due to the healthy growth of crude
exports (which has nothing to do with the devaluation), and dramatic
reductions in domestic consumption and imports, GDP shows steady
growth, as predicted by simulation 1 (Basu, 1995, 1996, 2000).
Simulation 4 attempts a different type of experiment, in which the
exchange rates in simulation 1 are replaced with historical exchange
rates, as experienced by Nigeria in the years 1987–92. Otherwise, all
other policy assumptions were maintained as in simulation 1. The result
of that experiment is given in Table 5.6.
Table 5.2 Summary table—Nigeria historical data
1985 1986 1987 1988 1989 1990 1991 1992
Real GDP and its components — % change from a year ago*

Gross domestic product 7.86 3.24 −0.47 9.91 7.38 8.19 4.49 4.25
Domestic demand 6.04 −2.17 −11.32 13.97 −12.16 5.54 −11.58 42.11
Consumption private 5.67 −7.45 −7.4 19.07 −15.11 −1.46 −17.53 51.9
Government 1.57 5.14 −34.38 3.19 −24.72 6.35 4.2 4.93
Gross domestic investment 18.06 49.89 −17.48 −19.33 35.26 57.86 10.59 20.68
Exports of goods 21.24 −19.57 111.52 −12.18 105.46 27.81 31.21 −12.94
and services (NIA)
Imports of goods 18.02 28.25 40.34 −7.62 40.64 45.26 12.49 51.21
and services (NIA)
Real per capita GDP 4.28 −8.1 −3.68 6.14 7.33 4.67 1.14 –
Nominal GDP — levels in millions US dollars
Gross domestic product 88,512.40 59,480.60 27,153.30 32,062.40 30,543.10 32,417.50 29,147.50 26,345.90
Domestic demand 84,575.30 52,041.80 23,772.80 29,076.80 22,734.70 23,509.40 17,927.20 22,056.70
Exports of goods and services 13,576.40 7,035.10 74,843 7,054.10 12,902.00 16,157.90 18,285.80 13,783.70
(NIA)
Import of goods and services 7,035.90 5,814.20 4,103.90 4.68.4 5,093.70 7,249.80 7,065.60 9,9,494.50
(NIA)
Per capita GDP ($) 929.7 603.9 267.7 305.5 290.8 298.7 259.9 –
Price — % change from a year ago
GDP deflator 4.38 −2.0 50.5 21.9 43.8 7.0 6.2 51.2
Consumer price index 5.48 5.4 11.3 54.5 50.4 7.4 13.0 44.5
(continued)
Table 5.2 Continued
1985 1986 1987 1988 1989 1990 1991 1992
Population
Population (millions) 95.2 98.48 101.41 104.96 105.02 108.54 112.16 –
Current account balance 2,623 371 −69 −194 1,090 4,988 1,203 –
Trade balance 5,735 2,535 3,448 2,626 4,178 8,653 4,441 –
Merchandise exports 13,369 6,599 7,545 6,897 7,970 13,585 12,254 –
Merchandise imports −7,634 −1,063 −4,097 −4,271 −3,692 −4,932 −7,513 –
Service balance −2,851 −2,027 −3,135 −2,962 −3,213 −3,749 −3,982 –
Financial indicators
Money supply (M2) %chya 8.38 −4.26 17.7 43.9 29.3 33.8 41 –
Principal exchange rate 0.89 1.34 4.01 4.53 7.36 8.04 9.90 17.29
Naira/$
Foreign exchange reserves 1,667 1,081 1,165 651 1,766 3,864 4,437 967
($ million)
%chya = percentage change from a year ago.

*Percentage change calculated from levels in 1975.
Nominal money supply at end of period.
The exchange rate used to convert national income accounts (NIA) data to US dollars is the principal exchange rate, which is a period average. During periods
when this rate is overvalued, the dollar equivalents are over-estimates. Foreign exchange reserves, excluding gold, at end of period.
Source: IMF.
Table 5.3 Simulation 1
1987 1988 1989 1990 1991 1992 1993 1994 1995

Gross domestic product −1.8 1.1 2.7 3.8 4.7 5.0 3.4 1.8 2.4
Domestic demand −9.7 0.7 1.8 4.3 5.4 5.3 5.0 3.7 4.9
Consumption −4.4 1.7 1.8 4.2 5.7 5.9 5.3 4.3 5.5
Consumption private −3.0 1.6 2.2 3.4 5.0 5.4 4.8 4.0 5.2
Consumption government −11.6 2.0 −0.3 8.8 9.0 8.1 8.0 5.4 6.8
Gross domestic investment −28.5 −3.7 2.0 4.7 4.3 2.4 3.4 1.0 1.6
Exports of goods 9.5 9.8 13.8 9.5 1.5 2.5 0.3 −1.7 −0.3
and services (NIA)
Imports of goods 2.0 −1.5 1.2 5.1 4.6 3.0 10.0 10.6 15.1
and services (NIA)
Real per capita GDP −5.2 −2.4 −0.9 0.2 1.0 1.3 −0.2 −1.8 −1.1
Nominal GDP — levels in millions of US dollars**
Gross domestic investment 37,765 42,133 45,435 50,669 56,613 64,336 70,679 76,323 82,811
Domestic demand 37,091 41,135 43,750 48,697 54,156 61,040 67,801 73,949 81,380
Exports of goods 9,235 10,274 12,039 13,902 15,284 16,856 18,111 19,581 21,604
and services (NIA)
Imports of goods 10,167 10,457 10,974 11,929 12,827 13,560 15,234 17,207 20,173
and services (NIA)
Per capita GDP ($) 368 397 413 444 479 526 557 581 609
Prices — % change from a year ago
GDP deflator 138.1 26.1 20.4 13.3 10.4 11.9 9.6 9.4 9.2
Consumer price index 140.3 25.6 18.5 12.6 9.3 10.9 9.4 8.6 8.4
Terms of trade 2.4 −2.7 −0.9 1.2 4.7 4.4 3.5 6.2 6.9
(continued)
Table 5.3 Continued
1987 1988 1989 1990 1991 1992 1993 1994 1995
Population
Population (millions) 102.5 106.2 110.1 114.0 118.1 122.4 126.8 131.4 136.1
%chya 3.6 3.6 3.6 3.6 3.6 3.6 3.6 3.6 3.6
Current account balance −1,158 −433 715 1,472 1,807 2,645 2,227 1,724 781
Trade balance 1,642 2,560 3,674 4,866 5,312 6,018 5,300 4,960 4,465
Merchandise exports 8,797 9,888 11,591 13,322 14,621 16,167 17,423 18,900 20,919
Merchandise imports 7,156 7,327 7,917 8,456 9,309 10,149 12,123 13,940 16,454
Service balance −2,574 −2,744 −2,610 −2,893 −2,855 −2,723 −2,422 −2,586 −3,034
Interest payments 1,171 1,237 1,035 1,121 1,049 928 776 659 600
Net transfers −225 −250 −350 −500 −650 −650 −650 −650 −650
Foreign debt 23,571 23,024 21,503 19,751 18,211 15,945 13,987 12,563 12,123
Money supply (M2) %chya 57.1 26.3 23.2 22.0 25.8 22.1 17.7 18.3 30.7
Exchange rate Naira/$ 4.200 4.800 5.500 5.800 6.000 6.200 6.400 6.600 6.800
%chya 250.0 14.3 14,6 5.5 3.4 3.3 3.2 3.1 3.0
Foreign exchange 1,600 1,569 1,763 1,983 2,249 2,629 2,898 3,198 3,539
reserve — $ million
Government balance GDP (%) −2.9 −1.8 −1.9 −2.0 −2.1 −1.9 −2.0 −2.0 −2.0

*Percentage change calculated from levels, in 1980 Naira.
**This series is distorted for the period prior to the discrete adjustment to the exchange rate (with the introduction of a dual system) by the serious over-evaluation
of the official rate. Nominal money supply at end of period; Exchange rate is period average; Foreign exchange reserves, excluding gold, are at end of period.
1987 1988 1989 1990 1991 1992 1993 1994 1995

Gross domestic investment −1.3 3.3 0.6 0.4 2.7 3.9 3.3 1.1 0.7
Domestic demand 5.3 5.0 −1.0 −0.5 2.4 3.7 5.9 3.7 3.0
Consumption 13.7 6.7 −1.3 −1.0 2.3 3.9 6.2 4.1 3.5
Consumption private 0.8 3.4 2.3 2.0 3.6 4.1 4.2 3.6 4.4
Consumption government 79.6 16.2 −10.5 −9.6 −1.9 3.2 13.1 5.9 0.7
Gross domestic investment −24.9 −4.4 1.2 2.4 3.0 2.8 3.8 1.1 0.2
Exports of goods −10.9 11.4 16.0 11.4 2.7 3.4 0.5 −1.2 0.3
and services (NIA)
Imports of goods 93.1 8.8 −2.6 −1.2 1.4 2.6 12.5 10.6 9.6
and services (NIA)
Real per capita GDP −4.7 −0.3 −2.9 −3.1 −0.8 0.3 −0.3 −2.4 −2.8
Domestic demand 44,945 48,442 50,011 53,643 57,896 64,131 70,740 76,253 82,125
Exports of goods 8,968 10,065 11,861 13,761 15,173 16,764 18,025 19,510 21,560
and services (NIA)
Imports of goods 13,518 15,199 15,414 15,897 16,665 17,581 20,270 22,948 25, 890
and services (NIA)
Per capita GDP ($) 411 419 428 452 477 517 540 554 572
GDP deflator 51.2 23.5 23.2 21.8 15.0 15.9 7.1 9.8 12.9
Terms of trade 10.6 −3.2 −2.2 −0.1 3.7 3.7 3.3 5.8 6.4
(continued)
Table 5.4 Continued
1987 1988 1989 1990 1991 1992 1993 1994 1995
Population
%chya 3.6 3.6 3.6 3.6 3.6 3.6 3.6 3.6 3.6
Current account balance −4,776 −5,383 −3,903 −2,636 −2,142 −1,466 −2,896 −4,088 −4,981
Trade balance −1,956 −2,116 −444 1,631 2,547 3,379 1,953 1,953 1,259
Service balance −2,594 −3,018 −3,109 −3,767 −4.039 −4,195 −4,198 −4,198 −5,590
Interest payments 1,234 1,545 1,564 2,017 2,251 2,415 2,566 2,566 3,163
Net transfers −225 −250 −350 −500 −650 −650 −650 −650 −650
Foreign debt 27,189 31,591 34,689 37,045 39,453 41,299 44,464 48,852 54,173
%chya 100.0 20.8 17.2 11.8 7.9 7.3 2.3 4.4 6.4

*Percentage change calculated from levels, in 1980 Naira.
**This series is distorted/or the period prior to the discrete adjustment to the exchange rate (with the introduction of a dual system) by the serious over-evaluation
of the official rate.
Exchange rate is period average.
Foreign exchange reserves, excluding gold, at end of period.
1987 1988 1989 1990 1991 1992 1993 1994 1995

Gross domestic investment 6.7 5.5 6.1 5.3 4.7 4.0 3.8 1.2 2.3
Domestic demand 4.7 3.9 3.3 3.2 5.5 3.6 6.6 3.5 5.2
Consumption 7.4 6.7 4.9 4.5 5.9 4.2 5.8 3.7 5.2
Consumption private 9.2 7.2 5.6 4.5 5.4 4.8 4.8 3.9 5.3
Consumption government −3.6 2.8 −0.6 4.5 9.4 14.3 14.3 2.6 4.7
Gross domestic investment −5.9 −8.6 −4.9 −4.0 2.9 12.1 12.1 2.0 5.1
Exports of goods
33.4 16.9 19.4 14.8 3.9 1.1 1.1 −0.6 0.6
and services (NIA)
Imports of goods
89.3 4.7 4.2 4.3 7.0 13.8 13.8 9.5 13.9
and services (NIA)
Real per capita GDP 3.0 1.8 2.4 1.7 1.1 0.2 0.2 −2.3 −1.3
Domestic demand 57,816 62,445 63,885 66,404 71,496 77,708 87,034 93,728 102,098
Exports of goods 14,315 16,416 19,632 23,096 25,693 28,597 30,914 33,618 37,303
and services (NIA)
Imports of goods 9,901 10,798 11,696 12,717 14,935 14,935 17,589 19,932 23,510
and services (NIA)
Per capita GDP ($) 630 656 660 673 704 747 792 818 852
GDP deflator 19.2 38.4 19.6 21.9 12.5 17.1 8.4 10.8 10.3
Terms of trade 25.4 −5.8 −3.6 −1.7 3.5 3.2 3.2 5.7 6.5
(continued)
Table 5.5 Continued
1987 1988 1989 1990 1991 1992 1993 1994 1995
Population
%chya 3.6 3.6 3.6 3.6 3.6 3.6 3.6 3.6 3.6
Current account balance −4,220 −4,277 −3,727 −3,237 −3,705 −3,188 −5,343 −6,872 −9,428
Trade balance −1,556 −1,210 −488 792 800 1,584 −434 −1,253 2,716
Service balance −2,440 −2,818 −2,890 −3,529 3,856 −4,122 −4,259 −4,970 −6,064
Interest payments 1,111 1,372 1,368 1,793 2,078 2,347 2,631 3,056 3,638
Net transfers −225 −250 −350 −500 −650 −650 −650 −650 −650
Foreign debt 24,615 27,911 30,832 33,789 37,761 41,328 46,941 54,112 63,882
%chya 41.7 35.3 21.7 21.4 8.8 10.8 2.4 4.8 4.5
%chya - percentage change from a year ago.

*Percentage change calculated from levels in 1980 Naira.
**This series is distorted for the period prior to the discrete adjustment to the exchange rate (with the introduction of a dual system) by the serious
over-evaluation of the official rate.
Exchange rate is period average.
Foreign exchange reserves, excluding gold, at end of period.
35
30
Other private
25
London Club
20
Structural adjustment Multilateral
begins
15
10
Official bilateral
5
0
1982 83 84 85 86 87 88 89 90 91 92
Figure 5.3 Nigeria’s medium and long-term debt by creditor group (US$ billions)
If we compare the results with those obtained in simulation 1, we see

that the inflation rate is much higher, due to a greater rate of devalu-
ation; private consumption has a worse fate, while domestic invest-
ment is not improved. The current account shows better volumes of
surpluses, while exports have expanded, together with considerable
reductions in imports. The overall result, as shown by the real rate of
GDP growth, signifies that the historical rate of devaluation was not
necessary and that such dramatic cyclical features in the exchange rate
can cause more harm than good—whereas a gradual rate of devaluation,
as suggested by simulation 1, can stabilize the economy without reduc-
ing growth prospects.
If we compare the results obtained in simulation 4 with the histori-
cal path of the economy, we see that, due to the dramatic change in
the money supply and the unexpected changes in the international
economy (i.e. the Gulf War), overall economic growth is not worse.
However, both consumption and investment have severe cyclical pat-
terns, caused by the cyclical patterns in export revenue. Inflation rates
are much worse, per capita income has fallen considerably, and imports
are not reduced. Thus, although balance of payments surpluses may
disguise the facts somewhat, the economy’s prospects cannot be good,
10 150
5
100
50
–5
–10 0
80 82 84 86 88 90 92 94 96 80 82 84 86 88 90 92 94 96
a. Real GPD growth % per annum b. Consumer price inflation % per annum
15 80
10
60
Trade
5
40
0
20
–5
Current
Services
–10 0
80 82 84 86 88 90 92 94 96 80 82 84 86 88 90 92 94 96
c. Balance of payments US$ billion d. Debt percent
Figure 5.4 Nigeria—history

Notes: US Current account also includes transfers. Debt service ratio Debt/GDP.
Source: calculations based on World Bank data.
10 150
5
100
50
–5
–10 0
80 82 84 86 88 90 92 94 96 80 82 84 86 88 90 92 94 96
15 80
10
Trade 60
40
20
–5
Current Services
–10 0
80 82 84 86 88 90 92 94 96
80 82 84 86 88 90 92 94 96
c. Balance of payments US$ billion d. Debt/GDP percent
Figure 5.5 Nigeria—simulation 1

Note: current account also includes transfers.
1987 1988 1989 1990 1991 1992

Gross domestic product −0.5 0.8 1.3 4.8 3.6 2.8
Consumption −8.7 0.9 −2.3 7.1 4.3 −1.3
Consumption private −7.5 0.5 −1.7 5.8 2.1 0.1
Consumption government −15.7 1.5 −3.5 9.5 9.7 −2.5
Gross domestic investment −28.5 −5.1 −2.1 3.1 3.5 4.5
Exports of goods and services 10.1 9.5 18.7 12.5 9.5 9.7
(NIA)
Imports of goods and services 2.1 −3.9 0.5 1.2 3.9 5.5
(NIA)
Current account balance −1.158 −565 621 1,927 2,561 2,703
($ million)
Consumer price index 141.5 29.1 24.1 22.5 23.5 24.5
given a very high deficit in the service balance of the current account of
trade, which is the result of high debt service obligations.
The reforms’ effects on the economy over the historical periods show
that the economy can improve its performance in the external sector,
but that there is a serious cost in terms of private consumption. Nigeria
depends on imported items for most of its consumption—therefore a
huge devaluation can lead to significant reductions in private consump-
tion. The positive aspect of this picture lies in the improvements in
domestic investment and reductions in balance of payments deficits.
In simulation 1, real gross domestic product would contract in 1987
and grow very slowly in 1988, so the short-term performances of the
economy would be depressing. However, in the medium and longer
terms, increased oil prices and production would enable real output
to grow comfortably. In simulation 2, real GDP would also contract.
It would grow satisfactorily in the medium term, but, in the long
run, it would slow considerably; thus fiscal stringency, as suggested in
simulation 2, can be less efficient and can restrict growth in the long
term more than a more intensive devaluation. In simulation 3, where
contra-cyclical fiscal and monetary policies are assumed, output growth
was satisfactory. However, this particular policy package can intensify
balance of payments deficits and increase the debt burden.
Real domestic investment in simulation 1 was reduced by 28.5 per
cent in the first year of adjustment (1987) and by 3.7 per cent in 1988.
10 150
5
100
50
–5
–10 0
80 82 84 86 88 90 92 94 96 80 82 84 86 88 90 92 94 96
15 80
10
Trade 60
5
40
20
–5
Current Services
–10 0
80 82 84 86 88 90 92 94 96 80 82 84 86 88 90 92 94 96


10 150
5
100
50
–5
10 0
80 82 84 86 88 90 92 94 96 80 82 84 86 88 90 92 94 96
15 80
10
60
Trade
5
40
0
20
–5
Current
Services
–10 0
80 82 84 86 88 90 92 94 96 80 82 84 86 88 90 92 94 96

Subsequently, it would revive. Historical data suggests real investment

declined by 17.5 per cent in 1987 and 19.3 per cent in 1988, reviving
dramatically afterwards. In simulation 2, it would also contract for the
first two years of adjustment, but its medium-term and long-term per-
formances would be better than those in simulation 1. In simulation 3,
domestic investment would contract for a prolonged period, and it
would revive only in the long run. This is because of much higher infla-
tion rates in the policy package, arising out of increasing budget deficits,
due to contra-cyclical fiscal policy.
In the historical data, price inflation for the first few years, due to
devaluations, was excessive. In simulation 1, we see the same picture,
although gradually it would die down. In the historical data, because of
sudden increases in the rate of devaluations and the high rate of growth
of money supply, the rate of inflation has a cyclical pattern. In simula-
tion 2, fiscal stringency means that the rate of inflation is much lower
than that in simulation 1. In simulation 3, the lower rate of devalua-
tion, coupled with a higher level of budget deficits, has the result of a
lower rate of inflation at the beginning of the reform programme, but
there would be more intensive inflation in the medium and long term,
compared with those in simulation 1.
Real exports in the historical data show dramatic swings, due to
a varying rate of devaluation and jumps in the world price of crude
petroleum. In simulation 1, imports will grow slowly. Historical data
allows cyclical movements in imports. In simulation 2, imports may
be stimulated by the lack of appropriate depreciations of the exchange
rate in the beginning, but they will slow down afterwards. The bal-
ance of payments deficits would increase initially; in the long run, the
situation gets worse in simulation 2, which shows that fiscal restraint
cannot improve the trade sector without appropriate devaluations. In
simulation 3, imports are at higher levels and deficits in the balance of
payments are higher too, due to the lack of proper devaluations. Both
the historical experience and simulation 1 show that vigorous devalua-
tions would be needed to reduce imports in order to maintain stability
in the foreign trade sector.
Foreign debt follows the experiences of the balance of payments.
Since 1986–7, Nigeria’s foreign debt (medium and long terms) rose from
US$27 billion to US$34 billion in 1991, although, due to the sudden
increase in revenue from oil exports because of the Gulf War in 1991, it
fell to US$28 billion in 1992. If there were no adjustment (simulation 3),
total debt would have reached US$34 billion in 1990 and US$64
billion in 1995. The debt service/exports ratio would be 105 per cent in
1990 and 140 per cent in 1995, which implies that, in that case, Nigeria
would be unable to maintain its debt obligations.
If we had a lower level of devaluation with fiscal restraints (simula-
tion 2), the debt service/export ratio would have reached 117 per cent
in 1990 and 12.6 per cent in 1995, which also implies default on debt
obligations. In the case of significant devaluations with fiscal restraints
(simulation 1), the debt service/exports ratio would be 72 per cent in
1990 and 32 per cent in 1995, which shows gradual and significant
improvements in the debt situations.
Comments
Structural adjustments have been impeded by the debilitating drain on

resources, due to growing external debt since 1986. The external debt
in 1992 was about 100 per cent of Nigeria’s GDP; more than 60 per
cent of this debt is now owed to members of the Paris Club of govern-
ment creditors. Without rescheduling, interest payments would average
US$6 million a year by 1993–6, consuming 36 per cent of Nigeria’s total
export revenue, compared with an average 19 per cent for all develop-
ing countries in 1992 and 30 per cent for severely indebted countries.
A sustainable solution requires outright debt reduction, using either the
enhanced ‘Toronto’ terms or the more generous ‘Trinidad’ terms, which
were proposed in 1991 but have never been applied by the Paris Club.
The Trinidad terms imply a one-off reduction of two-thirds of eligible
debt and an extended repayment period. Without substantial debt
relief, Nigeria has had little chance of sustaining an IMF programme.
Poverty and unemployment remain prominent among the major
challenges facing the economy (Basu, 1995, 1996, 2006).
Nigeria faces an ongoing challenge of making its decade-long sustained

growth more inclusive. One reason for this is that the benefits of economic
growth have not trickled down sufficiently to the poor. (Barungi et al, 2014)
The unemployment rate in Nigeria is approximately 24 per cent. Some

70 per cent of the population are involved in the agricultural industry
(Adeyinka et al, 2013). The lowest 10 per cent of wage earners in the
country have just 1.8 per cent of the national income, while the high-
est 10 per cent hold 38 per cent. The inefficient (largely subsistence)
agricultural sector has failed to keep up with a very fast growth in
population, and Nigeria, having been a large net exporter of food in
the past, now has to import food from other countries. The country’s
oil-rich economy continues to endure terrorism, political instability
and weak macroeconomic management (Barungi et al, 2014). The

Nigeria debt crisis during the 1980s and 1990s can be attributed to
both exogenous and endogenous factors, such as the nature of the
economy, economic policies, depending on oil, dwindling foreign
exchange receipt and the origin of Nigeria external debt dated back to
1985. The external debt was low until it rose astronomically in 1978
because of Nigeria’s involvement in the international capital market.
Debt service payments were within management limits until 1982, but
became unmanageable in 1983 because of the relative importance of
private lending (Ajayi and Oke, 2012). During the 1900s, with the
heavy burden of external debt and declining trend in world oil prices,
Nigeria was facing a serious balance of payment problem and negative
net foreign exchange flows.
We have seen from Nigeria’s historical experience and the policy
simulations that, in order to solve the debt and trade crises, strong
devaluations, along with fiscal restraints, were needed. Nigeria has
not followed the recommendations of the reform programme fully. Its
money supply growth was excessive during the reform programme. The
reform programme could achieve some expected results on the balance
of payments and the rate of growth of GDP, but investment and private
consumption can suffer much as a result. As far as the external sector
is concerned, fiscal restraint is an ineffective substitute for devaluation.
The absence of a reform programme would have worsened the balance
of payments and debt situations. However, reform programmes have
serious contractionary effects as well (Basu 1995, 1996, 2006).
Appendix
Tracking performances of major macro-variables

The tracking performances of the major macro-variables of the model
are as follows:
Variable name Mean square error
GDP 5.04
CP 4.89
CG 7.35
IDOM 6.79
PGDP 5.42
PCP 3.87
MG 4.37
EXG 5.42
DTDISST&LT 5.81
Stability analysis
The real characteristic roots of the system of equations are found to be
within unity, so we can conclude that the system can be stable.
Notations:
BOPTR$: Balance of payments - unrequited transfers -

$ millions - Nigeria
DTDISLTG: Debt outstanding and disbursed - medium and
long term - official creditors - $ - Nigeria
GEXP: Government expenditure - Naira millions
- Nigeria
PEXCRUDE: Average price of crude oil - $/barrel - world
PMCOMOD(IND): $ commodity prices index, 1960 = 1 -
industrial countries
QEXGOIL: Crude oil exports - barrels a day millions -
Nigeria
QOIL: Production of crude oil barrels a day millions -
Nigeria
RMEUR03NS(US): Three month Eurodollar rate - per cent
p.a. - US
RMGFCM(US): Average market yield on ten-year government
bonds - per cent p.a. - US
RX: Exchange rate - period average - Naira per
$ - Nigeria
SCHEDAMORTLTG: Amortization schedule - long-term debt -
official creditors - Nigeria
SCHEDAMORTLTP: Amortization schedule - long-term debt -
private creditors - Nigeria
AMORTLT: Amortization medium and long term -
$ millions
AMORTLTG: Amortization - medium and long-term debt-
official creditors - $ millions - Nigeria
AMORTLTNG: Private amortization - all creditors - Nigeria
AMORTLTP: Amortization - medium and long-term debt -
private creditors - $ millions - Nigeria
AMORTST&LT: Total amortization - $ millions - Nigeria
AMORTST: Amortization - short-term debt - $ millions -
Nigeria
BOPCA$: Balance of payments - current account -
BOPEXG$: Balance of payments - merchandise exports -

BOPEXS$: Balance of payments - service exports -
BOPMG$: Balance of payments - merchandise imports -
BOPMSS: Balance of payments - service imports -
BOPMSNINT$: Balance of payments - service imports
excluding interest payments - $ millions -
Nigeria
C: NIA - total consumption - Naira millions -
Nigeria
CG: NIA - general government consumption -
Naira millions - Nigeria
CGR: NIA - real government consumption - 1980
Naira millions - Nigeria
CP: NIA - private consumption - Naira millions -
Nigeria
CPI: Consumer prices - index (all items), 1980 = 100 -
Nigeria
CPR: NIA - real private consumption - 1980 Naira
millions - Nigeria
CR: NIA - real total consumption - 1980 Naira
millions - Nigeria
DTDISLT: Debt outstanding and disbursed - medium and
long-term - $ millions - Nigeria
DTDISLTNG: Private debt outstanding (disbursed only) - all
creditors - Nigeria
DTDISLTP: Debt outstanding and disbursed medium and
long term - private creditors - $ millions -
Nigeria
DTDISST&LT: Total debt outstanding and disbursed -
DTDISST: Debt outstanding and disbursed - short term -
DTSLT: Debt service - medium and long-term debt -
DTSST&LT: Total debt service - $ millions - Nigeria
DTSST: Debt service short term - $ millions - Nigeria
EXG: Merchandise exports - millions - Nigeria

EXGOILS: Crude oil exports - $ millions - Nigeria
EXGOTH: Other merchandise exports - Naira millions -
Nigeria
EXGR: Real merchandise exports (fob) - 1980 Naira
millions - Nigeria
EXNIA: NIA - total exports - Naira millions - Nigeria
EXNIAR: NIA - total exports - 1980 Naira millions -
Nigeria
GAP: NIA - domestic demand - Naira millions -
Nigeria
GAPR: NIA - real domestic demand - 1980 Naira
millions - Nigeria
GDP: Gross domestic product - Naira millions -
Nigeria
GDPR: Real gross domestic product - 1980 Naira
millions - Nigeria
GREV: Government revenue - Naira millions - Nigeria
IDOM: NIA - gross fixed capital formation - thousands
Naira - Nigeria
IDOMR: NIA - gross domestic investment - 1980 Naira
millions - Nigeria
INTLT: Interest payments - medium and long-term
debt - $ millions - Nigeria
INTLTG: Interest payments - medium and long-term
debt - official creditors - $ millions - Nigeria
INTLTNG: Private interest payments - all creditors -
Nigeria
INTLTP: Interest payments - medium and long-term
debt - private creditors - $ millions - Nigeria
INTST&LT: Total interest payments - $ millions - Nigeria
INTST: interest payments - short-term debt -
MG: Merchandise imports (fob) - Naira millions -
Nigeria
MGR: Real merchandise imports - 1980 Naira millions -
Nigeria
MNIA: NIA - total imports - Naira millions - Nigeria
MNIAR: NIA - total imports - 1980 Naira millions -
Nigeria
M2: Money and quasi-money - Naira billions –

Nigeria
PCG: Price deflator - government consumption -
index, 1980 = 1 - Nigeria
PCP: Price deflator - private consumption - index,
1980 = 1 - Nigeria
PEXG: Merchandise export prices - index, 1980 = 1 -
Nigeria
PEXGOTH$: US$ price of other exports - index, 1980 = 1 -
Nigeria
PEXGOTH: Price of other exports - index, 1980 = 1 -
Nigeria
PEXNIA: Price deflator - total exports - index, 1980 =
1 - Nigeria
PGAP: Price deflator - domestic demand - index,
1980 = 1 - Nigeria
PGDP: Price deflator - gross domestic product - index,
1980 = 1 - Nigeria
PIDOM: Price deflator - gross domestic investment -
index, 1980 = 1 - Nigeria
PMG: Merchandise import prices - index, 1980 = 1 -
Nigeria
PMNIA: Price deflator - total imports (nia) - index,
1980 = 1 – Nigeria
6
Structural Reforms in Egypt
Egypt has had fluctuating economic fortunes for the last two decades.
Due to the rapid increases in the international price of petroleum,
Egypt’s balance of payments situation has eased over the last few years.
Prior to 1986, these oil prices had been the source of Egypt’s rapid ten-
year growth. Since 1986, the country has had serious balance of pay-
ments problems; as a result of which its foreign debt has grown, with
severe macroeconomic imbalances. Between 1986 and 1992 the per
capita income of Egypt grew only by 10 per cent and, in the early 1990s,
the country began to undertake a serious macroeconomic stabilization
programme. Fiscal stringency and privatization were undertaken in
some areas and foreign investment flows increased. Rate of growth of
real GDP also increased, from 1.9 per cent in 1991–2 to about 5 per cent
in 1995–6. During the same period, inflation fell from 21.1 per cent to
7.2 per cent. The fiscal balance, foreign reserves and external debt also
improved (Table 6.1).
Recent economic development in Egypt has shown the virtue of
step-by-step policy changes. The gradual reform of the economy has
caused rifts with the IMF and Western donors, but has benefited the
economy in a number of ways since 1991. Inflation rate has slowed
down and budget deficit was lowered, foreign exchange reserves went
up. However, the opinion of the IMF still is that the exchange rate is
overvalued and can undermine future economic prospects. The com-
parative low rate of foreign direct investments, according to the IMF, is
due to the slow adoptions of structural adjustment policies.
Amid the political turmoil, economic growth remains weak with a
high fiscal deficit and gross public debt (domestic and external) rising
to nearly 100 per cent of GDP at the end of June 2013. Low growth
rates posed the danger of fuelling social frustration as they could not
162
Structural Reforms in Egypt 163
Table 6.1 Selected macroeconomic indicators of Egypt, 2000–10
Current Foreign GDP GDP per Gross fixed Total

account direct growth capita capital reserves
balance investment, (annual growth formation in months
(% of net inflows %) (annual (% of GDP) of imports
GDP) (% of GDP) %)
2000 −1 1 5 3 19 7
2001 0 1 4 2 18 7
2002 1 1 2 0 18 8
2003 5 0 3 1 16 9
2004 5 2 4 2 16 7
2005 2 6 4 3 18 7
2006 2 9 7 5 19 7
2007 0 9 7 5 21 7
2008 −1 6 7 5 22 6
2009 −2 4 5 3 19 7
2010 −2 3 5 3 19 7
deliver the numbers of jobs and opportunities needed. Unemployment

reached over 13 per cent in June 2013. The Gulf States have pledged a
large amount of exceptional financial assistance for Egypt’s transitional
period. In mid-2013, Saudi Arabia, the UAE and Kuwait pledged an aid
package totalling around US$17 billion—including cash grants of US$5
billion, in-kind grants of US$4 billion, interest-free deposits with the
Central Bank of Egypt (CBE) of US$5 billion and project financing of
around US$3 billion.
Recent data show that the government debt has increased substantially
after 2011 to finance the budget deficit, particularly in Egypt where official
data show that the ratio of total (domestic and external) government debt
to Gross Domestic Product (GDP) ratio remains elevated at 88.8 percent at
the end of March 2014, about 9 percentage points higher than its level at
the end of the 2010 financial year. (Mottaghi, 2014)
Egypt spends seven times more on fuel subsidies than it does on health. In
2013, Yemen spent a third of its revenue on general food and fuel subsidies.
According to the World Bank, rising fiscal deficits have forced these gov-
ernments to tap into their foreign reserves, particularly in Egypt where the
latest data show that net international reserves reached US$16.7 billion at
the end of June 2014, less than half of total reserves prior to the revolution.
Egypt is experiencing a deep economic crisis. (World Bank, 2014)
Since 2013, after the ousting of President Mohamed Morsi, Egypt’s

economic growth was just above 2 per cent in both the 2011–12 and
2012–13 fiscal years. In 2012–13, the main contributors to the GDP
were the private consumption (81.2 per cent of GDP) and the govern-
ment consumption (11.7 per cent of GDP). However, both domestic
investments (14.2 per cent of GDP) and exports (17.6 per cent of GDP)
stagnated.
Similar dismal pictures are apparent in manufacturing (15.6 per cent
of GDP), trade (12.9 per cent), tourism (3.2 per cent), agriculture (14.5
per cent of GDP) and mining (17.3 per cent).
The budget deficit, in 2012–13 was 13.7 per cent of GDP, and it was
about the same in 2013–14. Egypt’s total public debt was 99 per cent
of GDP in 2006–7. Public domestic debt was 87.1 per cent of GDP in
June 2013, with 8.4 per cent of GDP going towards interest payments
on debts. Egypt’s balance of payments had a surplus (US$237 million)
in 2012–13, supported only by massive aid of US$16 billion from the
Arabian Gulf Cooperation Council, without which the economy could
have collapsed (Muthuthi, 2014).
The foreign currency of Egypt has declined seriously in recent years,
creating serious difficulties in paying for its essential imports of food
and fuel. About 45 per cent of Egyptians live below the poverty line of
less than US$2 per day. Foreign direct investment is at a very low level,
with the exception of the energy sector. The level of unemployment is
very high, particularly for the young people. Egypt has received only a
bare minimum of relief from the Arabian Gulf countries, although the
amount is huge. That shows just how serious Egypt’s economic condi-
tion is, but foreign aid cannot help while the country has no viable
economic policy (Cook, 2014).
To understand the root of the problem it is essential to go backwards
to analyse why structural adjustment policy has failed in Egypt. Over
the last decade, structural adjustment programmes initiated by the
World Bank and the IMF are being implemented in a number of coun-
tries (Hussain and Thirlwall, 1984; Harrigan and Mosley, 1991; Kiguel
and Liviatan, 1992; Lizondo and Montiel, 1989; Calvo, 1991). In Latin
America there was some success, however these programmes have cre-
ated serious cycles of economic activities. In Africa, the experience
shows, the success is restricted mainly on the external side, whereas the
domestic economy has not performed as expected (Harrigan and Mosley,
1991; Khan, Montiel and Haque, 1990; Sau, 1993; Killick, 1984). After
nearly a decade the adjustment programme has had enough time to
work and we are in a position to compare and contrast the experiences

since 1987 with the simulated policies. We can compare alternative
economic policies and their possible effects on the economy to examine
whether any alternative policy structure would have obtained different
results. It will be possible to demonstrate that an appropriate mixture of
traditional monetary-fiscal-exchange rate policy would be sufficient for
the economy of Egypt to stabilize; there was no need for the privatiza-
tion programme, which has become the corner stone of any World Bank
and IMF stabilization programme.
Objective of the Adjustment Programme
According to the IMF, the structural adjustment programme’s objective

is to provide for an orderly adjustment of both macroeconomic and
structural imbalances in order to foster economic growth while bring-
ing about a balance of payments position that is sustainable in the
medium term (IMF, 1978). A reduction in the current account deficit
can be achieved through a combination of policies: reducing domestic
absorption and increasing output. Experience shows that increased
production cannot be achieved through these indirect policies, but that
domestic absorption tends to decline rapidly as a response (Basu, 1995,
1996, 2006). Simultaneously, demand management policies are utilized
to control the monetary expansion of the economy, by reducing credit
flows or increasing interest rates. The purpose of the demand manage-
ment policy is to bring domestic expenditures in line with domestic
output, that is, to maintain internal balance. If internal balance is
restored while an external balance still persists, further utilization of
demand management policies can bring about contractions in domes-
tic output. To combat this problem ‘expenditure switching’ policies
through exchange rate adjustments are needed.
Many African countries have failed to achieve the expected results
from their adjustment programmes. Yet, with the normal time profile
of the IMF credit (three to five years), it is difficult to achieve the kind
of results the IMF expects. Even the now disused extended fund facility
(EFF) offered a firm profile of four to ten years. Paris Club procedures for
the rescheduling of official debt also require an IMF agreement before-
hand (Basu, 1995, 1996, 2000).
Many of the ills in developing countries, particularly in Africa, have
been blamed on IMF conditionality. The IMF can be criticized for not
taking enough account of structural rigidities and the distribution of
income in its development of the phasing and dimensions of country-

level policy packages (Killick, 1984). Particularly controversial are the
efficacy of IMF and World Bank recommended measures such as:
• Massive devaluation and/or floating exchange rate.

• Increased nominal interest rate.
• General liberalization of import controls.
• Generalized expansion of primary commodity exports.
• Sale of large scale public enterprises to the private sector (Basu 1996).
Short-term balance of payments arithmetic imposes forced adjustment,

which makes the investment required for recovery implausible and also
damages the limited and painfully accumulated existing capital stock.
Even worse, it results in unnecessary current output losses and underu-
tilization in the essentially non-traded sector. In the typical sub-Saharan
African problem countries real exchange rate devaluation might be nec-
essary. However, the issue is quite separate in the North African region,
because these countries have Arab ties and access to finance from oil-
rich countries. A sustained change in the real effective exchange rate is
not so easy to attain. A single once-for-all nominal devaluation, typi-
cally preferred by the IMF and the World Bank, may or may not be the
most effective means of reaching a desired and sustainable level for the
real exchange rate, even assuming that such a level was agreed. Floating
rates or auction systems may not be the optimal means of sustaining
appropriate real exchange rates (Basu, 1995, 1996, 2000).
As discussed in Chapter 5, the objective of the IMF-supported adjust-
ment programme is to bring about a viable balance of payments in the
medium term.
A Structural Model for Egypt
Egypt’s economic problems were due to its massive foreign debt, which
had financed the country’s economic expansion until the mid 1980s
when the sudden decline in the real price of crude petroleum slowed
down economic expansion of the Middle East. The most important
source of Egypt’s foreign exchange is the remittance of Egyptian workers
in several Middle Eastern countries. The slow-down of the Middle East
had reduced the remittance payments considerably. The result was a cri-
sis in the external sector. The debt to GDP ratio in 1985 was 46 per cent,
the debt service to export was 59 per cent and the foreign exchange
import coverage was reduced to only one month. As a result, Egypt
had to accept the IMF-induced adjustment programme in 1986. While
the size of the IMF assistance programme in 1986 was modest, its real
value lay in the encouragement it gave to Egypt’s creditors to resched-
ule a portion of its foreign debt. The IMF programme required Egypt
to reduce substantially demand in the economy and to begin tackling
some of its outstanding structural problems, such as the tangled sys-
tem of explicit and implicit subsidies that cost the government about
US$6 billion a year. The need for a gradualist approach was accepted
by the IMF, provided that progress was to be made on two basic objec-
tives relating to deficit financing and monetary growth. One of Egypt’s
commitments to the IMF was to reduce its fiscal deficit from the 15 per
cent projected in the 1986–7 budget to 13 per cent in 1987–8, with the
aim of eventually phasing it out altogether. No timetable was set for its
total elimination. Further important conditions were also set: to restrict
monetary expansion severely and to unify the exchange rates within a
year, with a massive devaluation. Agreement with the IMF made avail-
able a standby credit of US$3.25 million—a similar amount was issued
in 1993. New finance of US$700 million was made available from the
bank’s club of creditors in 1987. Egypt’s military debt of US$4.6 billion
to the USA was rescheduled, and later forgiven altogether. The World
Bank had extended loans worth US$345 million at a concessionary rate
and it was willing to lend between US$800 million and US$1 billion
annually at the commercial rate.
A policy model to analyse the structure of the Egyptian economy is
described in what follows. This model is used to simulate alternative
economic policies under alternative assumptions regarding monetary-
fiscal and international trade policies (Tables 6.2, 6.3, 6.4, 6.5, 6.6, 6.7,
6.8 and 6.9 and Figures 6.1, 6.2, 6.3 and 6.4). The structural model
given here was estimated to evaluate this adjustment programme and
any alternative policy packages that could be available at that time.
The structural model follows the Fund–Bank adjustment policy model
(Khan and Knight, 1981). The equation structure of the model is as
follows:
Amortization (long and medium term), official creditors (6.1)

AMORTLTG(t) = 53.244 + 0.066DTDISLTG(t−5)
(1.85) (2.01)
Amortization (long and medium term), private creditors (6.2)

AMORTLTP(t) = 0.523DTDISLTP(t−3) + 1.181(DTDISLTP(t−1) − DTDISLTP(t−2))
(1.87) (2.01)
Interest Payments (long and medium term), official creditors (6.3)

logINTLTG(t) = −4.353 + 1.103 log(DTDISLTG(t−1))
(3.21) (2.52)
Dues from Suez Canal (6.4)

logJSUEZ(t) = −6.586 + 1.666log(MGR$WD)(t) − 0.847log(PSUEZ$WPIUS)(t−2)
(2.72) (1.87) (1.85)
+ 0.203SUEXDUM
(1.35)
Consumer prices (6.5)

CPI(t) = 3.271 + 0.001M2(t) − 0.000019GDPR(t) + 0.963CPI(t−1)
(1.35) (2.71) (1.89) (3.71)
Wholesale prices (6.6)

Changes in WPI(t) = 0.881 + 0.856 (Changes in CPI(t))
(2.97) (1.95)
Government consumption (6.7)

CG(t) = −819.851 + 0.887CG(t−1) + 0.106GEXP(t)
(2.03) (2.78) (3.01)
Private consumption (6.8)

CPR(t) = 11259.71 + 0.75CPR(t−1) + 0.313GDPR(t) − 0.188GDPR(t−1)
(1.34) (4.45) (3.81) (2.81)
Domestic investment
IDOMR(t) = 896.71 + 0.841IDOMR(t−1) + 0.751GDPR(t) + 0.683GDPR(t−1) (6.9)
(4.37) (3.01) (3.21) (4.88)
Total interest payments (6.10)

logINTST&LT(t) = −1.175 + 0.896log(INTLT)(t) + 0.205log(DTDISST&LT(t−1))
(3.05) (2.31) (1.79)
+ 0.162log(RMEURO3NS)(t)
(1.91)
Total amortization (6.11)

AMORTSLT&LT = −1148.80 + 0.169DTDISST&LT + 144.374RMEURO3NS
(3.70) (2.35) (1.70)
Debt outstanding and disbursed (long and medium term) (6.12)

DTDISLT = 2627.66 + 0.582DTDISST&LT
(2.91) (1.87)
Debt outstanding and disbursed (total) (6.13)

DTDISST&LT(t) = 7975.69 + 0.625DTDISST&LT(t−1) − 0.439BOPCA(t)
(3.41) (2.05) (1.89)
Total foreign exchange reserve excluding gold (6.14)

FX$(t) = 0.59FX$(t−1) − 0.809BOPEXCH$(t) + 0.323BOPCTPT$(t)
(1.89) (2.57) (3.51)
Import price (6.15)

PIMWT$ = 5.347 + 29.352PMCOMD
(3.21) (1.71)
Finance$ = 734.263 + 1.020BOPKEQ$ (6.16)

(4.01) (1.37)
Imports (6.17)
MNIA(t) = 0.84MNIA(t−1) + 0.821GDP(t)−0.698GDP(t−1)
(4.15) (3.79) (2.87)
Exports (6.18)
EXNIA(t) = 0.828EXNIA(t−1) + 3958.86EXR(t)
(4.01) (3.56)
In addition the following identities and definitions are added to the model.
PEXOIL$ = 3.15047 × PEXCRUDE
PMNIA(t) = PMNIA(t−1)[(WPI$ × XRX)(t)/(WPI$ × RX)(t−1)]
BORTRP = BOPTROTH + BOPTRREM

INTLT = INTLTP + INTLPG
PCG(t) = PCG(t−1)(CPI(t)/CPI(t−1))
PCP(t) = PCP(t−1)(CPI(t)/CPI(t−1))
BOPCA$ = BOPTRP$ + BOPEX$-BOPM$
AMORTLT = AMORTLTP + AMORTLTG
DISLT = INTLT + AMORTLT
BOPKEQ = −(BOPCA + BOPKSTOTH + BOPEXFIN + BOPCTPT + BOPNE&0 +
BOPEXCH)
BOPEX = EXNIA/RX
GDP = CG + CP + IDOM + EXNIA-MNIA
DTSST&LT = INTST&LT + AMORT&LT
BOPBASBAL = BOPCA + BOPKEQ
BOPEXS = BOPEXOTH + BOPEXSSUEZ
BOPM = MNIA/RX
GBAL = GREV-GEXP + GTR
There are several equations describing the external sector and the struc-
ture of the foreign debt. Eqn (6.1) explains amortization of long- and
medium-term official loans in terms of total long- and medium-term
private foreign debt. Eqn (6.2) explains amortization of long- and
medium-term private foreign debt. Eqns (6.3) and (6.10) explain inter-
est payments in terms of existing debts and international interest
rate (mainly in the Euro currency market). Eqn (6.5) is explained by
the real GDP and the money supply, indicating the demand pressure.
Wholesale price index will follow the consumers. This is a realistic
assumption given Egypt’s high population pressure and the influx of
consumers’ powers sustained by other Middle Eastern oil producing
countries. Nominal government consumption in Eqn (6.7) is explained
by the government expenditure, which is a policy variable and lagged
government consumption indicating prior commitments. Eqn (6.8)
explains real private consumption as a function of real GDP. Eqn (6.9)
explains real domestic investment in terms of real GDP. Eqns (6.12) and
(6.13) explain total foreign debt mainly in terms of foreign exchange
earnings (BOPEXCTI$ and BOPCTPT$) and international capital flows
(BOPKEQ$). Eqn (6.17) explains nominal imports in terms of a nominal
GDP. Most of the imports are essential items, so they impact on the
exchange rates because the Egyptian non-oil exports normally face a
highly competitive international market. The equation structure was
estimated using the 2SLS procedures.
GDP, % change on previous year

7.5
5.0
2.5
+
0
−
2.5
5.0
2004 06 08 10 11*
Years ending June
Official reserves, $bn

38
36
34
32
30
28
26
J J A S O N D J F M A M
2010 2011
Figure 6.1 Egypt, GDP and foreign exchange reserve

Source: Central Bank of Egypt.
Real GDP Growth

(Per cent p.a.)
History Forecast
30
20
10
–10
80 82 84 86 88 90 92 94 96
Consumer price inflation

(Per cent p.a.)
History Forecast
25
20
15
10
5
80 82 84 86 88 90 92 94 96
Egypt’s balance of payments

History Forecast
6
4
2
0
Trade
–2
Current Services
–4
–6
–8
80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95
Figure 6.2 Egypt, simulation 1

Real GDP Growth

(Per cent p.a.)
History Forecast
30
20
10
–10
80 82 84 86 88 90 92 94 96

(Per cent p.a.)
History Forecast
25
20
15
10
5
80 82 84 86 88 90 92 94 96

History Forecast
6
4
2
0
Trade
–2
Current Services
–4
–6
–8
80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95

*Current account also includes transfers.
Real GDP Growth

(Per cent p.a.)
History Forecast
30
20
10
–10
80 82 84 86 88 90 92 94 96

(Per cent p.a.)
History Forecast
25
20
15
10
5
80 82 84 86 88 90 92 94 96

History Forecast
6
4
2
0
–2
Current
–4 Services
–6
–8
80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95

Table 6.2 Historical data, Egypt 1987–1991
1987 1988 1989 1990 1991
Real GDP and its components (% change)

Gross domestic product 604 5.4 4.9 5.7 1.07
Private consumption 13.2 7 12.7 3.3 −2.5
Government consumption −6.1 3.3 −2.2 −5.8 −7.3
Fixed capital formation −4.3 26.9 −13.2 −5.2 −12.3
Exports of goods and −6.8 44.9 −7.7 22.2 54.8
services, NIA
Imports of goods and −3.5 63.8 0.4 3.7 5.2
services, NIA
Consumer price index 19.6 17.6 21.3 16.8 19.8
(%change a year ago)
Money supply (M2) 14.9 12.8 9.2 16.6 8.1
(%chya)
Current account balance (US$M) −246 −1048 −1309 184 1903
Table 6.3 Historical data, Egypt 1992–1997
1992 1993 1994 1995 1996 1997
Real GDP and its components (% change)

Gross domestic product 0.04 2.8 3.9 4.5 5.1 5.8
Private consumption 0.38 0.01 5.1 6.6 3.6 4.4
Government consumption 4.2 0.35 6 1.8 8.8 4.2
Fixed capital formation −13.9 −1.7 7.3 −3.2 2.9 12.6
Exports of goods and 8.8 −1.3 −14.1 0.4 1.2 2.7
services, NIA
Imports of goods and −7.3 −0.6 −4.9 −9.4 11.6 2.2
services, NIA
Consumer price index 13.7 12.1 8.5 15.7 7.3 4.9
(%change a year ago))
Current account balance 2812 2299 31 −254 −192 −711
(US$M)
Principal exchange rate 3.33 3.37 3.39 3.39 3.38 3.38
(£/US$)
Foreign exchange reserve 10810 12904 13481 16181 17398 18665
(US$M)
Table 6.4 Policy assumptions, simulation 1
1987 1988 1989 1990 1991 1992 1993 1994 1995
Government Real government consumption 1.4 1.0 1.0 1.2 1.9 2.5 2.7 2.9 3.0
policy Money supply (M2) 15.5 15.5 15.5 15.5 16.0 16.0 16.0 16.0 16.0
(% chya) Principal exchange rate 2.18 3.20 3.50 3.70 3.90 4.20 4.20 4.20 4.30
(Egyptian pounds/US$)
Secondary exchange rate 1.70 3.00 3.20 3.50 3.50 3.50 3.50 3.50 3.50
Other Crude oil exports (% chya) 4.0 4.0 4.0 2.0 1.0 1.0 1.0 1.0 1.0
indicators Cotton exports (% chya) 5.0 6.0 5.0 5.0 6.0 5.0 4.0 3.0 3.0
Oil price (US$ per barrel) 18.0 18.2 19.2 20.5 22.6 24.7 26.8 29.9 33.5
Industrial GNP growth (% change) 2.7 2.8 2.9 2.9 3.0 3.1 3.2 3.3 3.4
Three-month Eurodollar rate 6.1 6.4 5.6 6.5 6.8 6.9 6.9 6.9 6.9
% chya ≡ percentage change a year ago. Refers to U.S., Japan, Canada, U.K., Germany, France and Italy.
1987 1988 1989 1990 1991 1992 1993 1994 1995
policy Money supply (M2) 15.5 15.5 15.5 15.5 16.0 16.0 16.0 16.0 16.0
% chya ≡ percentage change a year ago.
1987 1988 1989 1990 1991 1992 1993 1994 1995
Policy Money supply (M2) 15.5 15.5 15.5 15.5 16.0 16.0 16.0 16.0 16.0

Table 6.7 Policy simulation 1 of the Egyptian economy
1987 1988 1989 1990 1991 1992 1993 1994 1995
Real GDP Gross domestic product 4.3 5.9 5.4 6.2 5.4 4.7 3.6 4.1 4.3
and its Domestic demand −0.9 2.7 4.9 6.2 4.5 4.0 2.8 3.6 3.6
components Consumption −2.3 0.7 2.9 3.0 3.2 3.2 3.5 3.5 3.6
(% change) Private −3.4 0.5 3.5 3.6 3.6 3.4 3.8 3.7 3.8
Government 1.4 1.0 1.0 1.2 1.9 2.5 2.7 2.9 3.0
Fixed capital formation 2.7 5.7 8.7 11.8 6.3 5.3 2.4 3.8 3.6
Exports of goods and services, 6.4 8.6 8.3 8.0 7.0 6.8 6.5 6.0 6.0
NIA
Imports of goods and services, −11.4 −5.4 5.8 8.1 2.9 3.4 3.1 3.8 3.0
NIA
Real per capita GDP 1.5 3.0 2.6 3.3 2.5 1.9 0.7 1.3 1.5
Nominal Gross domestic product 26275 22776 24580 26771 29087 31935 35729 40703 46030
GDP Domestic demand 27479 23598 25398 28228 30875 33119 36714 41088 45406
(US$M) Exports of goods and services, 8386 9182 10167 11064 11733 12977 14150 15874 17927
NIA
Imports of goods and services, 9591 10003 10985 12521 13522 14161 15135 16258 17304
NIA
Per capita GDP ($) 512 432 454 481 508 542 590 654 720
Prices GDP deflator 46.0 20.2 12.0 8.4 8.6 12.9 8.0 9.4 11.0
(% chya) Consumer price index 11.6 105 10.3 9.9 10.2 10.3 10.3 10.3 9.9
Wholesale price index 10.8 9.9 9.7 9.4 9.6 9.7 9.7 9.7 9.4
Terms of trade 37.4 −8.5 −1.5 −4.4 −5.6 2.3 −1.3 2.2 3.0
% chya 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8
(continued )
Table 6.7 Continued
1987 1988 1989 1990 1991 1992 1993 1994 1995
Foreign Current account balance −1043 1819 2165 2169 1140 1739 2354 3203 4406
sector Trade balance −3959 −1966 −1923 −2218 −2696 −2592 −2440 −2286 −2020
(US$M) Merchandise exports 3965 4428 4927 5503 6118 6797 7502 8357 9351
Merchandise imports 7924 6393 6850 7721 8814 9388 9942 10643 11372
Service balance −426 183 444 345 −84 −26 28 303 697
Interest payments 1178 1296 1233 1233 1223 1363 1425 1539 1670
Foreign debt 23100 18694 15899 15637 18035 19408 19310 18805 18037
Financial Money supply (M2) (% chya) 15.5 15.5 15.5 15.5 16.0 16.0 16.0 16.0 16.0
indicators Principal exchange rate 2.18 3.20 3.50 3.70 3.90 4.20 4.20 4.20 4.30
(pounds/US$)
(pounds/US$)
Foreign exchange reserve ($M) 1008 1060 1113 1166 1218 1271 1324 1376 1429

† Percentage change calculated from levels in 1975 Egyptian pounds.
Nominal Money Supply at end of period. The exchange rate used to convert National Income Accounts data to US dollars is the Principal Exchange
Rate, which is a period average.
During periods when this rate is overvalued, the dollar equivalents are over-estimates. Foreign Exchange Reserves exclude gold at end of period.
1987 1988 1989 1990 1991 1992 1993 1994 1995
and its Domestic demand −1.5 1.8 4.2 6.1 4.4 3.3 1.9 2.9 2.9
components Consumption −2.7 0.4 2.6 2.8 2.6 2.3 2.7 2.7 2.9
(% change) Private −3.7 0.3 3.2 3.4 3.1 2.7 3.2 3.1 3.3
Government 0.7 0.6 0.5 0.8 0.8 1.0 1.2 1.4 1.6
Gross domestic 0.7 4.2 6.8 11.6 7.0 4.7 0.7 3.0 2.9
investment
Exports of goods and 6.6 8.6 8.3 8.0 7.0 6.8 6.6 6.1 6.1
services, NIA
Imports of goods and −8.8 −2.6 3.8 4.9 1.9 3.8 1.6 2.5 2.1
services, NIA
(US$M) Exports of goods and 8358 9158 10148 11054 11725 12996 14139 15864 17918
services, NIA
Imports of goods and 10560 10794 11711 12824 13960 14989 15786 16734 17775
services, NIA
Per capita GDP ($) 599 504 514 510 533 586 638 707 784
(% chya) Consumer price index 11.6 10.5 10.3 9.9 10.2 10.3 10.3 10.3 9.9
Terms of trade 27.8 −3.9 −2.1 −3.4 −7.2 0.1 −1.2 2.3 2.4
(continued )
Table 6.8 Continued
1987 1988 1989 1990 1991 1992 1993 1994 1995
% chya 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8
Foreign Current account balance −1432 1070 1482 1702 820 1227 1776 2794 4098
Service balance −433 67 325 242 −151 −117 −75 242 669
Foreign debt 23634 20139 17806 17332 19211 20481 20567 20021 19016
Financial Money supply (M2) 15.5 15.5 15.5 15.5 16.0 16.0 16.0 16.0 16.0
indicators (% chya)
Principal exchange rate 1.70 2.40 2.70 3.20 3.40 3.40 3.40 3.40 3.40
(pounds/US$)
(pounds/US$)
Foreign exchange 1008 1060 1113 1166 1218 1271 1324 1376 1429
reserve ($M)

1987 1988 1989 1990 1991 1992 1993 1994 1995
and its Domestic demand 3.3 4.7 4.3 3.8 5.7 3.9 3.5 3.8 3.8
components Consumption 3.1 4.2 4.2 3.6 3.6 3.5 3.3 3.5 3.6
(% chya) Private 3.1 4.4 4.4 3.9 3.8 3.7 3.5 3.6 3.7
Government 3.4 3.7 3.7 2.7 3.0 2.7 2.4 2.9 3.1
Exports of goods and 4.9 8.5 8.2 7.9 7.1 6.8 6.6 6.1 6.1
services, NIA
Imports of goods and services, 1.8 5.6 5.3 4.6 4.2 3.1 2.5 2.6 2.5
NIA
(US$M) Exports of goods and 8269 9049 10044 10952 11622 12880 14069 15814 17887
services, NIA
Imports of goods and services, 14028 14827 15468 16486 19345 20181 21007 21863 22880
NIA
Per capita GDP ($) 993 982 1046 1106 1254 1366 1482 1624 1784
(% chya) Consumer price index 12.9 12.9 13.1 13.2 13.5 13.6 13.6 14.1 14.3
Terms of trade 11.1 0.7 3.5 −0.9 −12.0 2.5 1.0 4.4 4.5
% chya 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8 2.8
(continued )
Table 6.9 Continued
1987 1988 1989 1990 1991 1992 1993 1994 1995
Foreign Current account balance −3261 −2256 −2088 −1797 −3453 −3777 −3211 −2233 −955
Service balance −623 −434 −261 −326 −854 −1011 −974 −679 −272
Foreign debt 26157 26765 27244 27589 30312 33006 33937 33640 32565
Financial Money supply (M2) (% chya) 15.5 15.5 15.5 15.5 16.0 16.0 16.0 16.0 16.0
indicators Principal exchange rate 1.00 1.10 1.20 1.30 1.28 1.36 1.44 1.53 1.62
(pounds/US$)
(pounds/US$)
Foreign exchange reserve ($M) 905 958 1011 1063 1116 1169 1221 1274 1326

Experiments on Policy Simulations
Three alternative simulations of the Egyptian economy have been used

to analyse future policy packages and comparisons are made, wherever
data is available, with the actual behaviour of the economy between
1987 and 1995. In simulation 1, the adjustment programme suggested
by the World Bank and the IMF was imposed on the model. According
to that model, two different exchange rates (secondary and official)
would be equalized gradually. The principal exchange rate would
undergo massive devaluation to start with and would subsequently be
devalued gradually. Money supply would be kept more or less constant
at a rate of 15.5 per cent per year. Real government consumption would
be reduced significantly and allowed to grow only after 1992. In simu-
lation 2, instead of devaluation, a drastic fiscal adjustment is assumed.
Accordingly, the exchange rate would depreciate at a very slow rate, but
the real government consumption would grow only at a rate of 0.7 per
cent in 1987 compared to 2.3 per cent in 1986 and its rate of growth
would remain very low until 1992. Money supply would grow at a con-
stant rate of 15.5 per cent until 1992. In simulation3, we assume that no
adjustment had taken place. There would be a very mild adjustment in
the exchange rate, that is, it would remain artificially high. Real govern-
ment consumption would grow at the usual high rate.
We now compare the results of the alternative policy assumptions
and analyse the historical developments. Because of its strategic impor-
tance, Egypt was allowed to implement the adjustment programme in a
very different way than that which the IMF and World Bank normally
demand. Drastic devaluation was postponed until 1989. Money supply
was restricted, there were significant reductions in the government
consumptions, but other forms of government expenditure, that is,
public investments and military expenditures, were allowed to grow.
Real private consumption has increased at a significant rate; as a result,
despite the fall in real capital formation and government consump-
tions, real GDP grew. The expansion of the private consumption was
financed by service exports, which basically include remittance of
Egyptians working in other oil-rich Middle Eastern countries. The sud-
den increases in exports, and thus in turn imports, can be explained
by the upturn of the Middle East economies in 1988. Similarly, service
exports were increased massively in 1990–1 because of the Gulf War.
The result of these influxes of financial power was that, despite the
moderate rate of growth of domestic money supply, price inflation rate
was quite high.
Egypt’s dependency on remittances and export of services is very

clear from the external accounts. The half-hearted reform has not initi-
ated any improvements in the trade sector, with the trade balance in
deficit for the period from 1987 to 1991. However, the balance of pay-
ments deficit has improved since the Gulf War of 1991. This surplus
can be short lived, because it is not due to any internal strength of the
economy but mostly dependant on the ups and downs of the econo-
mies in the Middle East, particularly that of Saudi Arabia, which has
suffered from financial imbalances. Lack of domestic investments has
diminished the export sectors, particularly the cotton and petroleum
sectors. There were drastic devaluations in 1991. The net result of the
half-hearted reform until 1994 is a low rate of growth of the economy,
chronic trade deficits (except for 1990–2), dependency on Saudi Arabia
and Kuwait for service exports, lack of domestic investments and
uncontrolled inflation until 1995.
Simulation 1 shows a different picture. According to that, although
government consumption should be reduced drastically, domestic
investment would be reduced for the initial year only, thereafter it
would grow at a steady rate. There were some reductions in the private
consumptions in the short run, but thereafter it would show modest
growth. Real output would grow in a cyclical way. The reason can be
found in the fluctuations of the real fixed investments, which would
increase by 8.2 per cent in 1989 and 11.1 per cent in 1990, but only
by 1.7 per cent in 1993 and again by 3.6 per cent in 1995. The cause
of this cyclical feature is the variations in the terms of trade, which in
the case of Egypt can affect domestic investment by controlling the
cost of imports upon which Egypt’s further industrialization depends.
Budget deficit in this simulation was reduced in 1988. However, it was
allowed to grow modestly from 1989 onwards. Although GDP deflators
will go up significantly, the consumer price index will grow modestly
due to Egypt’s structure of subsidies. As a result, the budget deficit will
persist as it will be quite difficult politically to dismantle the subsidy
structures.
On foreign trade, the adjustment programme in simulation 1 shows
growing export earnings in the short run, but in the longer run it would
be modified. Crude oil exports would rise moderately, cotton exports
would grow very slightly, there would be a decline in Suez Canal earn-
ings in real term due to the merger of the secondary and principal
exchange rates. Imports would decline in the short run because of
increasing cost in terms of foreign exchange, but from 1990 it would
grow after the initial adjustments. The combined effects of these would
be reduced deficit in the balance of payments and surplus by 1995.

Thus, the combined effects of devaluation and financial management
would have a beneficial effect on Egypt’s external sector. The result
would be a reduction in Egypt’s debt burden. According to this solution,
foreign debt would have come down to US$15.6 billion in 1990 from
US$23.1 billion in 1987. Total debt service as a percentage of exports,
which was 67 per cent in 1987, would be reduced to 38 per cent in 1990
and 30 per cent in 1995.
As opposed to that, simulation 2 provides an alternative picture where
fiscal stringencies are substituted for drastic devaluations. The rate of
growth of real GDP in the short run is lower than in simulation 1,
however, in the longer run these are not dissimilar. The stimulus of
devaluation would occur in the longer run. In the short and medium
term fiscal stringencies would adversely influence growth performance.
Domestic investments are strongly influenced by adverse fiscal meas-
ures and a higher rate of devaluation cannot help investments. Price
inflation in this policy package is modest—it performs less well com-
pared to that under simulation 1.
However, in simulation 2, the balance of payments in later years
would show a surplus, but the magnitudes of the surplus are less than
those under simulation 1. Thus, fiscal measures cannot be a substi-
tute for devaluations as far as the external sector is concerned. This
is also reflected in the foreign debt performances. The debt service
to export ratio declines from 62 per cent in 1987 to 47 per cent in
1990, and to 34 per cent in 1995. However, simulation 1 provides a
better picture than these. In simulation 3, we assume that there were
no adjustments, real government consumption was not reduced and
exchange rates were depreciated at a very mild rate. As the money
supply was stable, there was no sudden downturn in 1987–8. The rate
of growth of the GDP was maintained at the same level as before, but
the long-term performances would be worse than those suggested by
simulation 1. The explanation can be provided in terms of domes-
tic investment, which has performed better under simulation 3,
but its medium and long run performances are worse than those
under simulation 1. Under simulation 3, rate of inflation would be
worse, due to the higher rate of growth of government consumptions.
Simulation 3 makes the current account worse—trade deficit would
increase because of lack of export growth and increasing imports.
Foreign debts would grow and it would soon be unsustainable. Thus,
growth of the GDP in this simulation would be at the expense of the
external sector.
Comments
The working of the model can be summarized as follows. In the

Keynesian tradition fiscal expansions can stimulate the economy,
whereas the expansion of money supply according to the recent
adjustment policy models can have a number of effects. It can induce
inflationary surges and, as a result, can reduce the real income growth.
Thus, the fiscal expansion when monetized can have dual and contra-
dictory effects on the economy. The exchange rates can affect exports
in this model directly. Hence, the working of the policy instruments in
this model follows a synthesis of traditional Keynesian monetary-fiscal
adjustment and the so-called monetary approach to the balance of pay-
ments, which is the theoretical foundation of the adjustment policy
models.
The dispute between the IMF and the World Bank and the Egyptian
government was on the speed and nature of structural reforms. In con-
crete terms this means privatization of the public sector industries; in
ideological terms this has been part of the state’s social contract with
the people. The fear that privatization will cause mass unemployment
has slowed down the reform process, although since 1991 Egypt has
been pursuing the traditional stabilization policies through monetary-
fiscal policies. The massive devaluation in 1991, along with the Gulf
War, helped Egypt to improve its balance of payments. Foreign invest-
ments flows have also been encouraging since 1992. However, serious
privatization only began in 1996. Public utilities are not privatized yet
and the government still controls banks, insurance companies and sev-
eral important industrial companies.
The simulations of the model presented here do not include any
structural reform policies like privatization. The thrust of the analysis
is in terms of traditional stabilization policies through monetary-
fiscal-exchange rate instruments. In fact, serious privatization in
Egypt started after 1997, when the economy was already stabilized.
The experiments in this chapter show that an appropriate mixture
of monetary-fiscal policies can achieve successful stabilization of the
economy without the need for privatization, which in the case of Egypt
has brought back a deteriorating balance of payments situation since
1999. Within the confines of the assumed paths of the exogenous vari-
ables, the Egyptian economy could have stabilized and prospered with
an appropriate set of usual monetary and fiscal policies. Egypt has not
implemented the prescriptions of the IMF and World Bank. Its present
economic performances, which are not satisfactory, are due to the fact
that historical paths of the exogenous variables are different from the
assumed path used in this model. Thus, the cause of the economy’s
unsatisfactory performance is the unfavourable movement of the exog-
enous path rather than non-acceptance of the IMF and World Bank’s
prescriptions.
As Soliman (2004) noted:
Over the last thirty years, the Egyptian state has increasingly given its citi-
zens less money and fewer social benefits while simultaneously demanding
more taxes and resources. This has lead to a weakened state—deteriorat-
ing public services, low levels of law enforcement, poor opportunities for
employment and economic development—while simultaneously inflated
the security machine that had sustained the authoritarian regime.
During the 30 years of Mubarak’s reign, even with generous foreign

aid, the Egyptian treasury ran deficits. The USA paid Egypt about
US$64 billion between 1979 and 2011, almost US$2 billion per year,
in accordance with the Camp David accords. Most of these sums
were devoted to military equipment rather than infrastructural devel-
opment. Egypt invested surprisingly little in developing its roads,
schools, health care systems and other social benefits, but it also failed
to develop a strong economy that could pay back loans and generate
a surplus.
This failure stems largely from the fact that the authoritarian Egyptian
regime boasted a corrupt system, in which special interests and crony-
ism dominated both the remaining state-owned enterprises, and the
newer ‘liberalizing’ economic sector. Little was invested in social neces-
sities, and even less in social benefits. The exception, investment in the
tourism sector, was marked by erratic choices, modest commitments
and decisions to raise additional revenues for such investment by
increasing taxes on those who could least afford it.
Burdened with huge fiscal obligations, and completely unable to
generate sufficient employment for a population increasing by more
than one million per year, the government began to cut public services.
Thus, declining amenities became linked to poor job opportunities and
economic development issues that were unsolvable through top-down
or entrepreneurial efforts. Although the deficit has not risen signifi-
cantly, it has been too large for some time—now 11 per cent of GDP.
Comparatively, Turkey’s deficit is 3 per cent of GDP. In Egypt, where a
strong government is needed, as regulator, enforcer of contracts and
guarantor of competition, it is weak.
Notations:
AMORTLT Amortization - Medium and long term (US$M)
AMORTLTG Amortization - Medium and long-term
debt-official creditors (US$M)
AMORTLTNG Private amortization - all creditors
AMORTLTP Amortization - medium and long-term debt-
private creditors (US$M)
AMORTST Amortization short-term debt (US$M)
AMORTST&LT Total amortization (US$M)
BOPCA$ Balance of payments - current account (US$M)
BOPCTPT$ Balance of payments - private earnings (US$M)
BOPEXG$ Balance of payments - merchadise exports
(US$M)
BOPEXS$ Balance of payments - service exports (US$M)
BOPFXCH$ Balance of payments - foreign payments (US$M)
BOPKEO$ Balance of payments - total foreign
investment (US$M)
BOPMG$ Balance of payments - mercandise
imports (US$M)
BOPMS$ Balance of payments - service imports (US$M)
BOPMSNINT$ Balance of payments - service imports excluding
interest payments (US$M)
BOPNETSBAL$ Balance of payments - net services
balance (US$M)
BOPTR$ Balance of payments - unrequited
transfers (US$M)
C Total consumption (US$M)
CG General government consumption (US$M)
CGR Real government consumption - 1980 (US$M)
CP Private consumption (US$M)
CPI Consumer prices index (all items), 1980 = 100
(US$M)
CPR Real private consumption - 1980 (US$M)
CR Real total consumption - 1980 (US$M)
DTDISLT Debt outstanding and disbursed - medium and
long term (US$M)
DIDISLT%GDP Ratio of medium and long-term debt to gross
domestic product (%)
DTDISLTG Debt outstanding and disbursed - medium and
long term - offcial creditors (US$M)
DTDISLTNG Private debt outstanding (disbursed only) - all
creditors
DTDISLTP Debt outstanding and disbursed - medium and
long term-private creditors (US$M)
DTDISST Debt outstanding and disbursed - short

term (US$M)
DTDISST&LT Total debt outstanding and disbursed (US$M)
DTDISST&LT%GDP Ratio of total debt outstanding and disbursed to
gross domestic product (%)
DTS%EX Ratio of total foreign debt service to total
exports (US$M)
DTSLT Debt service - medium and long-term debt
(US$M)
DTSTL%EX Ratio of long-term debt service to total exports
DTSST Debt service short term (US$M)
DTSST&IT Total debt service (US$M)
EXG Merchandise exports (millions)
EXGOIL$ Crude oil exports (US$M)
EXGOILR Real crude oil exports - 1980 (millions)
EXDGOTH Other merchandise exports (millions)
EXGOTH$ Other merchandise exports (US$M)
EXGOTHR Real other merchandise exports - 1980 (millions)
EXGR Real merchandise exports (FOB) - 1980 (millions)
EXNIA Total exports (millions)
EXNIAR Total exports - 1980 (millions)
FINANCE$ Financial inflows (US$M)
FX$ Total reserves excluding gold (US$M)
GAP Domestic demand (millions)
GAPR Real domestic demand - 1980 (millions)
GBAL Government deficit (-) or surplus (millions)
GBAL%GDP Ratio of government deficit to GDP (%)
GDP Gross domestic product (millions)
GDPR Real gross domestic product - 1980 (millions)
GDPS Gross domestic product (US$M)
GDPS%N Gross domestic product per capita (US$M)
GEXP Government expenditure (US$M)
GNPR@WD Real gross national product - index, 1960 =
1-world (USA, Japan and Europe)
GREV Government revenue (millions)
IDOM Gross fixed capital formation (thousands)
IDOMR Gross domestic investment - 1980 (US$M)
INTLT Interest payments - medium and long-term
debt (US$M)
INTLTG Interest payments - medium and long-term
debt - official creditors (US$M)
INTLTNG Private interest payments - all creditors
INTLTP Interest payments - medium and long-term
debt - private creditors (US$M)
INTST Interest payments - short-term debt (US$M)

INTST&IT Total interest payments (US$M)
INTST&LT%EX Ratio of total interest payments to total exports
JRX Exchange rate - index,1980 = 1
JSUEZ Dues from Suez Canal (US$M)
MBASE Monetary base - (US$B)
MG Merchandise imports (FOB) (millions)
MGCIF$ Merchandise imports (CIF) (US$M)
MGR Real merchandise imports - 1980 (millions)
MNIA Total imports (millions)
MNIAR Total imports - 1980 (millions)
MQR$WD Merchandise imports, world (US$M)
M2 Money and quasi-money (US$M)
N Population (US$M)
PC Price deflator - government consumption - index,
1980 = 1
PCP Price deflator - private consumption - index,
1980 = 1
PEXCRUDE Average price of crude oil - US$ per barrel - world
PEXG Merchandise export prices - index, 1980 = 1
PEXGOTH Price of other exports - index, 1980 = 1
PEXGOTH$ US$ price of other exports - index, 1980 = 1
PEXNIA Price deflator - total exports - index, 1980 = 1
PGAP Price deflator - domestic demand - index, 1980 = 1
PGDP Price deflator - gross domestic product - index,
1980 = 1
PIDOM Price deflator - gross domestic investment - index,
1980 = 1
PIIMWT$ Price index of imports, world, 1980 = 1
PMCOMOD Price index of world commodities, 1980 = 1
PMCOMOD@IND US$ commodity prices - index, 1960 = 1 -
industrial countries
PMG Merchandise imports prices - index, 1980 = 1
PMGS@WD US$ import prices - index, 1960 = 1 - world
(US, Japan and Europe)
PMNIA Price deflator - total imports - index, 1980 = 1
PSUEZ$ Price of Suez facilities, index, 1980 = 1
QEXGOIL Crude oil exports - barrels a day, millions
QOIL Production of crude oil - barrels a day, millions
RATIODTSHRT Ratio of short total foreign debt
RMEURO3ND@US Three month Eurodollar rate - percent p.a. -US
RMEWURO3NS@US Three month Eurodollar rate - percent p.a. -US
RMGFCM@US Average market yield on 10 year government
bonds - percent p.a. -US
RX Exchange rate - period average - Naira per US$

SCHEDAMORTLTG Amortization schedule - long-term debt - official
creditors
SCHEDAMORTLTP Amortization schedule - long-term debt - private
creditors
STATR NIA - real statistical discrepancy - 1980 Naira,
millions
TOT Terms of trade - index, 1980 = 1
WPIS@WD US$ wholesale prices = index, 1960 =
1 - world (US, Japan and Europe)
WPIUS Wholesale price index, US 1980 = 1
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Index
References to figures are shown in italics. References to tables are shown in

bold.
adaptive optimization, method of, capital goods industries and

101, 106–11 exports, 21
adjustment policy model (Fund– education and skill-intensive
Bank), 111–12, 115–16, 167 exports, 11
see also structural adjustment liberalization and labour market
programmes (SAPs) trends, 9
advanced economies, see developed Patent Act and WTO, 94
countries ASEAN countries
Africa and China’s exports-based
Chinese investments, 9 development strategy, 84–5,
employment patterns and IMF- 84, 85
funded programmes, 5–6 see also South-East Asian countries
infant mortality rates, trends in, 11 Asia
liberalization and labour market employment patterns and
trends, 8–9 IMF-funded programmes, 6
privatization, net gains from, 13 exports, falling growth rate of
school gross enrolment ratios, (1996), 93
trends in, 11 exports and gross domestic product
structural adjustment programmes, (1980–2000), 5
1, 10, 164, 165 infant mortality rates, trends
see also North Africa; Sub-Saharan in, 11
Africa liberalization and labour market
aggregate measures of subsidy (AMS), trends, 9
USA, 95 school gross enrolment ratios,
agriculture trends in, 11
China, 53–4 social sector expenditures,
India, 95, 98–9, 121; annual growth composition of, 10
in food grains production, 99; see also Central Asian countries;
per-capita daily availability of East Asian countries; South Asian
food grain (grams), 98 countries; South-East Asian
Nigeria, 156 countries
subsidies in OECD countries, 93, 95 Asian financial crisis (1997–8), 95
AMS (aggregate measures of subsidy), and China, 83–6, 84–5
USA, 95
Amsden, A., 9 Baldwin, R. E., 23
anti-dumping measures, against Bangladesh, liberalization and labour
exports from developing market trends, 9
countries, 93 Bank of America, exposure to
Argentina derivatives, 19
207
208 Index
banks Central Asian countries, poverty

Chinese banks, 54–5 rates, 8
competitive recycling and oil Chile
crises, 129 and American mining companies
lending and liberalization of (1973), 3
financial markets, 17 education and skill-intensive
see also financial markets exports, 11
Barungi, B., 127, 156 liberalization and employment, 6, 9
Basu, D., 105, 130 China
Bengal, tax collection by East India banks, 54–5
Company (1757), 3 budget deficits, 55, 67
Bentham, Jeremy, 4 capital account convertibility, 95–6
Bhatia, A., 13 Chinese diasporas and liberalization
Biwater, 13 of trade policy, 51, 53
Bolivia competition from, 10
liberalization and labour market consumer prices: simulation 1, 71;
trends, 9 simulation 2, 74
privatization of water supplies, 14 current account balances:
Brazil simulation 1, 70; simulation 2, 73
and Generalized System of devaluation (of exchange rate), 51,
Preference (GSP), 43 75–6, 84, 85
liberalization and labour market economy: simulation 1, 65, 80;
trends, 9 simulation 2, 66, 81; simulation
Patent Act and WTO, 94 3, 75
UK exports to, 41, 41 exports: to Canada, 57; country
UK imports from, 42, 43 share of, 78; growth rates of, 84,
and UK tariff policy (simulation 93; to Hong Kong, 57, 68, 79, 82,
exercise), 45, 47, 48 83; to India, 2; to Japan, 57, 68,
Britain, see United Kingdom (UK) 77, 78, 82, 86; to Middle East, 68;
budget deficits to Taiwan, 68; to USA, 57, 68, 77,
China, 55, 67 78, 82, 83, 86; volume of, 76–7;
Egypt, 188 and WTO, 7
India, 122–3 exports-based development strategy
Nigeria, 132 and ASEAN countries, 84–5
see also debts foreign investments, 3, 64, 67, 99
GDP (gross domestic product), 54,
Cambridge, UK, ‘new Cambridge 56, 67, 69, 72, 76
model’ of UK economy, 116 historical data (1985–92), 63
Campbell-White, O., 13 historical exchange rate (1987–95),
Camp David accords, 188 74
Canada, Chinese exports to, 57 imports: country share of, 78; from
capital account convertibility, 95–6 Japan, 78, 78, 82; from USA, 77,
capital formations (India), 99–100 78, 78
money supply, GNP and price levels inflation, 54, 68, 76
(1985–1997), 102 investments: foreign investments,
capitalism 3, 67, 99; investment, savings
and colonialism, 1 and foreign investment, 64;
see also globalization investments in Africa, 9; Japanese
capital market liberalization, 20 investments, 51, 53
Index 209
and Japanese keiretsu system, 83 Das, M., 115

Korean-owned companies, 14 debts
liberalization and labour market and derivatives, 18
trends, 9 East Asian countries, 95
mixed economic system, 54 Egypt, 162–3, 164, 166–7
and multinational companies, 53–4 and full capital account
Nippon Steel’s production in, 2 convertibility, 95–6
‘open door’ policy, 77 India, 117
policy assumptions (simulation 1), Latin America, 95, 96
64 Nigeria, 128–30, 132, 149, 155–7
poverty rates, 8 Russia, 95
private sector, 50, 53 see also budget deficits
structural reforms: background Deraniyagala, S., 15
and issues, 50–2; China and deregulation, 15, 20
Asian financial crisis (1997–8), see also liberalization; privatization
83–6, 84–5; Chinese agriculture, derivatives, 17–20
53–4; fiscal policy, 55; foreign Deutsche Bank, exposure to
trade, 76–9, 78; macroeconomic derivatives, 19
policy (econometric) model devaluation (of exchange rate)
for China, 56–62, 87–90; China, 51, 75–6, 84, 85
monetary-fiscal and exchange developing countries, 130–1
rate policy, 54; monetary system, Egypt, 167, 187
54–5; simulation of alternative India, 100–1, 121, 122
policies, 62, 63–6, 79–83, 80, Nigeria, 133, 133, 149, 152, 157
81; simulations 1, 2 and 3 North Africa, 166
comparison, 67–76, 69–74, 74, 75; Sub-Saharan Africa, 166
summary and conclusions, 86–7 developed countries
taxes, 55 privatization policies, 11–12
Tiananmen Square massacre, 51 protectionism, 22, 93–4
trade destructions caused by China, trade liberalization, 21–2
85 see also tariff policy and
and trade liberalization, 16 employment structure (United
trade with EEC, 78 Kingdom)
trade with Soviet Union, 77, 78 developing countries
trade with USA and impact on US anti-dumping measures against
industries, 4 exports of, 93
see also econometric model (China) and capital account convertibility,
Citibank, exposure to derivatives, 19 95–6
Cline, W., 23 competition for foreign
colonialism investments, 3
and capitalism/globalization, 1–2 credit support programmes and
and multinational companies, 3–4 government controls on interest
competitive recycling, and oil crises, rates, 14–15
129 cross section studies of, 105
Côte d’Ivoire, privatization of water debt crisis consequences, 128–9
and electricity services, 13 devaluation (of exchange rate),
credit support programmes, and IMF/ 130–1
WTO, 15 exports and gross domestic product
Cristi, R., 115 (1980–2000), 5
210 Index
developing countries – continued debt, 61–2

and Generalized System of exports, 59–60
Preference (GSP), 43 imports, 60–1
liberalization and reduced social investments, 58–9
expenditure, 9–10 simulation of alternative policies,
manufactured exports and trade 62, 63–6, 79–83, 80, 81
restrictions, 21–2 simulations 1, 2 and 3 comparison,
and multinational companies, 94 67–76, 69–74, 74, 75
poverty rates, 8 econometric model (United
privatization and weak governance, Kingdom), see tariff policy and
14 employment structure (United
privatization as requirement for Kingdom)
funding from international economic growth
organizations, 12 and dictatorship, 51–2
and protectionism from developed trade-off between growth and
countries, 22, 93–4 equity, 7
UK exports to, 40–2, 41 economy
UK imports from, 42–3, 42 free market economy and IMF/
and UK tariff policy (simulation World Bank, 1
exercise), 45–8 multilateral model of world
and world trade studies, 23 economy: algebraic framework,
dictatorship, and economic growth, 24–6; commodities considered,
51–2 24; country/blocks considered,
direct payments, vs subsidies, 95 24; input-output matrix, 26–7;
Diwan, R., 92 theoretical structure, 27–8
national economies and
East Asian countries multinationals, 3–4
and capital account convertibility, planned economy and IMF/World
95 Bank, 1
debts, 95 real economy vs financial assets, 92
export growth rates, 84 education
exports, falling growth rate of gross enrolment ratios, trends in, 11
(1996), 93 and skill-intensive exports, 10–11
exports-based development strategy, and structural adjustment
83–4 programmes, 10–11
foreign investments, 3 EEC, see European Economic
manufactured exports and trade Community (EEC)
restrictions, 21 EFF (Extended Fund Facility), 4
national developments ideology, 52 Egypt
poverty rates, 8 aid: from Gulf States, 163, 164;
Eastern European countries from USA, 188
poverty rates, 8 budget deficit, 188
privatization and employment, 14 debt, 162–3, 164, 166–7
East India Company, tax collection in devaluation (of exchange rate), 167,
Bengal (1757), 3 187
econometric model (China) fiscal policy, 188
about equations, 56–8 foreign investments, 164, 187
about notations, 87–90 GDP, 162, 164, 184; and foreign
consumption, 58 exchange reserve, 171
Index 211
historical data (1987–91 and tariff policies, 43

1992–97), 175 trade with China, 78
inflation, 162, 184 exchange rates
macroeconomic indicators China, 54
(2000–10), 163 developing countries, 130–1
military debt to USA, 167 exchange rate management and
poverty, 164 demand discipline conditionality
privatization, 187 (IMF), 100–1, 130–1
remittance payments, 166, 184–5 see also devaluation (of exchange
structural reforms: background and rate)
issues, 162–5, 163; experiments exports
on policy simulations, 184–6; anti-dumping measures against
objective of adjustment developing countries’ exports, 93
programme, 165–6; structural developing countries’ manufactured
model, 166–70, 171–4, 175–83, exports and trade restrictions,
189–92; summary and comments, 21–2
187–8 education and skill-intensive
unemployment, 163, 164 exports, 10–11
World Bank loans, 167 exports and gross domestic product
see also structural model (Egypt) (1980–2000), 5
employment exports-based development strategy
impact of IMF-supported (East Asia and China), 83–5
programmes on, 5–7, 5, 6 falling growth rate of world exports
impact of import controls on, 22, (1996), 92–3
44–9 ‘rules of origin’ (USA), 93
impact of privatization on, 14 see also under separate countries or
liberalization and labour market regions
trends, 8–9 Extended Fund Facility (EFF), 4
see also tariff policy and
employment structure (United FDI (foreign direct investment), 15,
Kingdom); unemployment 17, 96
Enlightenment thinkers, and see also foreign investments
colonialism, 4 Fiat (Togliatti, Russia), 14
ENRON, 13 finance capital, and inequality, 92
equity financial assets, vs real economy, 92
trade-off between growth and financial crises
equity, 7 Asian financial crisis (1997–8), 95;
see also inequality and China, 83–6, 84–5
Ethiopia, liberalization and labour financial crisis (2008), 18, 20, 93,
market trends, 9 95
European countries financial crisis (early 1990s/late
privatization policies, 11–12 1980s), 2
see also Eastern European countries financial markets
European Economic Community deregulation, 15, 20
(EEC) derivatives, 17–20
and developing countries’ liberalization of, 17
manufactured exports, 21 Fine, B., 15
direct payments vs subsidies in Finland, and manufactured exports
agriculture, 95 from developing countries, 21
212 Index
fiscal policies Germany

China, 55 economic growth under Hitler,
Egypt, 188 51–2
India, 100–1, 116 return of privatized public services/
see also taxes resources into public ownership,
food grain (India) 17
annual growth in food grains Gerschenkron, A., 52
production, 99 globalization
per-capita daily availability of and capital market liberalization, 20
(grams), 98 first and second phases of, 1–2
foreign direct investment (FDI), 15, and India, 91–6
17, 96 and inequality between countries, 8
see also foreign investments see also liberalization
foreign investments Goldberger, A. C., 109
China, 3, 64, 67, 99 Goldman Sachs, exposure to
East Asia, 3 derivatives, 19
Egypt, 164, 187 government credit support
foreign direct investment (FDI), 15, programmes, and IMF/WTO, 15
17, 96 Greece
India, 99–100, 122, 123 financial crisis and derivatives, 18
Nigeria, 133 and manufactured exports from
foreign trade developing countries, 21
China, 76–9, 78 gross domestic product, see GDP
Indian foreign trade policy, 100 (gross domestic product)
see also trade gross enrolment ratios, 11
free market economy, endorsement of see also education
by IMF/World Bank, 1 growth
free trade, 4 and dictatorship, 51–2
see also trade liberalization trade-off between growth and
Fund-Bank adjustment policy model, equity, 7
111–12, 115–16, 167 GSP (Generalized System of
see also structural adjustment Preference), 43, 48
programmes (SAPs) Guatemala, liberalization and labour
market trends, 9
gambling instrument, as financial Guinea, privatization of water and
product, 17–20 electricity services, 13
GATT (General Agreement on Trade Gulf States, aid package to Egypt, 163,
and Tariff), 1, 21, 93 164
see also World Trade Organization
(WTO) Hitler, Adolf, 51–2
Gauss-Sidel method, 28 Hoeven, R. van der, 9, 11, 14
GDP (gross domestic product) Honduras, liberalization and labour
China, 54, 56, 67, 69, 72, 76 market trends, 9
Egypt, 162, 164, 171, 184 Hong Kong
and exports (1980–2000), 5 Chinese exports to, 57, 68, 79, 82,
India, 96–7 83
and inequality between countries, 8 and Chinese invitation to foreign
Nigeria, 127, 132 capital, 51
Generalized System of Preference exports, falling growth rate of
(GSP), 43, 48 (1996), 93
Index 213
exports-based development strategy, and Iraq’s invasion of Kuwait, 91, 100

83 mixed economic system, 105–6, 123
and Generalized System of money supply, GNP and price levels
Preference (GSP), 43 (1985–1997), 102
household-responsibility system Patent Act (1970) and WTO, 94–5
(HRS), 53 poverty rates, 8, 105
human capital formation private sector, 104, 105–6, 121, 122,
changes in, 9–11; composition of 123
social sector expenditures, 10; privatization and ENRON, 13
trends in gross enrolment ratio and Soviet Union’s demise, 91, 100
and infant mortality rate, 11 structural reforms: background on
reforms, 91; fiscal policy before
ILO (International Labour reforms, 100–1; globalization
Organization), liberalization and and India, 91–6; method of
increasing poverty, 9 adaptive optimization, 101,
IMF, see International Monetary Fund 106–11; policy model, 111–15;
(IMF) policy model dynamic analysis
imports and comparative performances
impact of import controls on of economy, 115–17, 116–17,
employment/unemployment, 22, 118–20, 121–3, 124–6; reforms,
44–9 central elements and impact of,
see also under separate countries or 96–7; reforms, first phase of and
regions economic performances (1991–97),
India 97–8; reforms, quantitative
agriculture, 95, 98–9, 121; annual evaluation of, 104–6; reforms
growth in food grains production, and agricultural sector, 98–9,
99; per-capita daily availability of 98–9, 121; reforms and capital
food grain (grams), 98 formations, 99–100, 102; reforms
budget deficits, 122–3 and industrial development,
capital account convertibility and 102–4, 103, 121, 122; summary
IMF/WTO, 95–6 and comments, 123
debt ratios and foreign borrowings trade with UK and impact on textile
(history), 117 industry (19th century), 4
devaluation (of exchange rate), and UK tariff policy (simulation
100–1, 121, 122 exercise), 45, 46, 47–8
Eighth Plan (1992–97), 96–7 World Bank/IMF loans, 91
exports: of capital goods industries, WTO membership, implications
21; to UK, 42–3, 42 of, 91
financial policies (1985–97), 103 see also policy model (India); tariff
fiscal policy, 100–1, 116 policy and employment structure
foreign investments, 99–100, 122, (United Kingdom)
123 Indonesia
foreign trade policy, 100 capital account convertibility, 96
GDP, 96–7 export growth rates, 84
and Generalized System of exports, falling growth rate of
Preference (GSP), 43 (1996), 93
IMF/World Bank loans, 91 exports-based development strategy,
imports: textiles imports from 83
China, 2; from UK, 40–2, 41 liberalization and labour market
inflation, 121–2 trends, 9
214 Index
industrial development and poverty trends, theoretical

India, 102–4, 121, 122; financial views on, 7–8
policies (1985–97), 103 trade policy and liberalization, 4
inequality Trade Restrictiveness Index (TRI), 4
created by finance capital, 92 Washington Consensus, 15
inequality between countries and see also Fund-Bank adjustment
globalization, 8 policy model; structural
liberalization and increasing adjustment programmes (SAPs)
equality, 9 Iraq, impact of invasion of Kuwait on
and social unrest, 7 India, 91, 100
trade-off between growth and Italy, economic growth under
equity, 7 Mussolini, 51–2
infant mortality rates, trends in, 11
inflation
Japan
China, 54, 68, 76 Chinese exports to, 57, 68, 77, 78,
Egypt, 162, 184
82, 86
India, 121–2
Chinese imports from, 78, 78, 82
Nigeria, 132–3
exports-based development
interest rate control, and IMF/WTO,
strategy, 83
15
investment in China, 51, 53
International Monetary Fund (IMF) keiretsu system, 83
and China’s role in Asian financial national developments ideology, 52
crisis (1997–98), 83
Nippon Steel’s production in
economic reform programmes
China, 2
(1980s), 1
recession and impact on Asian
and Egyptian economic
export growth rate (1996), 93
development, 162
JPMorgan Chase, exposure to
exchange rate management and
derivatives, 19
demand discipline conditionality,
100–1, 130–1
Extended Fund Facility (EFF), 4 keiretsu system (Japan), 83
and free market economy, 1 Kenya, liberalization and labour
and government credit support market trends, 9
programmes and interest rate Keynes, John Maynard, 7, 56, 133,
control, 15 187
IMF-supported programmes: impact Khan, M. S., 114, 115–16
of on employment patterns, 5–7, Korea, see South Korea
5, 6; impact of on the poorest, 7; Kuwait
role of trade policy, 4 aid package to Egypt, 163
and India: agriculture, 95; capital impact of invasion by Iraq on India,
account convertibility, 95; loans 91, 100
to, 91
Monitoring of Fund Arrangements labour market trends
database (MONA), 5 and liberalization, 8–9
and multinational companies, 4 see also employment;
Nigeria’s debt-relief package, 128 unemployment
and planned economy, 1 ‘late developments’ theory, 52
Poverty Reduction and Growth Latin America
Facility (PRGF), 4 capital account convertibility, 95, 96
Index 215
debts, 95, 96 export growth rates, 84

infant mortality rates, trends in, 11 export growth rates, falling of
liberalization and employment, (1996), 93
6–7, 6 exports-based development
liberalization and labour market strategy, 83
trends, 9 trade destructions caused by
poverty rates, 8 China, 85
return of privatized public services/ Mao, Zedong, 53
resources into public ownership, market
16–17 capital market liberalization, 20
school gross enrolment ratios, free market economy, 1
trends in, 11 market system and China, 50
social sector expenditures, method of adaptive optimization,
composition of, 10 101, 106–11
structural adjustment programmes, Mexico
10, 164 1982 moratorium, 129
trade liberalization, effects of, 15 and capital account convertibility,
UK exports to, 40–2, 41 96
UK imports from, 42–3, 42 exports: of capital goods industries,
and UK tariff policy (simulation 21; to UK, 42, 43
exercise), 45, 46, 47 and Generalized System of
see also tariff policy and Preference (GSP), 43
employment structure (United imports, from UK, 41, 41
Kingdom) liberalization and employment, 6
Lee, E., 6, 9 liberalization and labour market
Lewis, W. E., 23 trends, 9
liberalization Patent Act and WTO, 94
capital market liberalization, 20 trade liberalization, effects of, 15
and employment, 6–7, 6 and UK tariff policy (simulation
of financial markets, 17 exercise), 45, 47, 48
and inequality/poverty, 9 MFA (Multi-Fiber Arrangement), 93
and labour market trends, 8–9 MFN (Most Favored Nation) tariff
and social expenditure, 9–10 treatment, 77
trade liberalization, 4, 11, 14, Middle East
15–16, 20; and employment, Chinese exports to, 68
21–2, 44–9 exports and gross domestic product
and trade-off between growth and (1980–2000), 5
equity, 7 poverty rates, 8
and trade unions’ decline, 9 Mill, John Stuart, 4
see also deregulation; globalization; mixed economic system
privatization China, 54
List, Friedrich, 52 India, 105–6, 123
LOME conference countries, and see also private sector
Generalized System of Preference models, see econometric model
(GSP), 43 (China); policy model (India);
Londono, J. L. L., 10 structural model (Egypt);
structural model (Nigeria); tariff
Malaysia policy and employment structure
and Asian financial crisis (1997–8), 85 (United Kingdom)
216 Index
MONA (Monitoring of Fund Nigeria

Arrangements database), 5 agricultural industry, 156
Monetarism, 56 budget deficit, 132
monetary approach, 116, 187 debt, 128–30, 132, 155–7; medium
monetary-fiscal policy, China, 54 and long-term debt by creditor
monetary system, China, 54–5 group, 149
Monitoring of Fund Arrangements devaluation (of exchange rate), 133,
database (MONA), 5 149, 152, 157
Montiel, P. J., 115–16 Dollar/Naira exchange rate
Morgan Stanley, exposure to (1990–2010), 133
derivatives, 19 foreign investments, 133
Morsi, Mohamed, 164 GDP, 127; 1990–2010 period, 132
Most Favored Nation (MFN) tariff historical data (summary), 141–2,
treatment, 77 150
Mottaghi, L., 163 inflation, 132–3
Mubarak, Hosni, 188 liberalization and labour market
Multi-Fiber Arrangement (MFA), 93 trends, 9
multilateral model of world economy movement of policy instruments
algebraic framework, 24–6 (1986–92), 140
commodities considered, 24 oil sector/exports, 127–8, 129–30,
country/blocks considered, 24 131–2, 134
input-output matrix, 26–7 structural reforms: background and
theoretical structure, 27–8 issues, 127–8; debt problem,
multinational companies 128–30; exchange rates for
and China, 53–4 developing countries, 130–1;
and colonialism, 3–4 structural model, 131–7, 132–3,
and developing countries’ sovereign 157–61; structural model and
rights, 94 experiments on policy simulations,
employment policies of, 14 137, 138–48, 140, 149, 149–51,
and governments/states, 12 152, 152, 153–4, 155–6; summary
and IMF/World Bank, 4 and comments, 156–7
multinational drug companies and unemployment, 156
change in Indian Patent Act, 94 see also structural model (Nigeria)
and national economies, 3–4 Nippon Steel, 2
owned by foreign governments, 16 NMP (Net Material Production), 56
and second phase of globalization, 2 North Africa
Mussolini, Benito, 51–2 devaluation (of exchange rate), 166
exports and gross domestic product
national economies, and (1980–2000), 5
multinational companies, 3–4 poverty rates, 8
nationalism notations (for models)
vs free market economy, 1 China, 87–90
and globalization, 2 Egypt, 189–92
national developments ideology, 52 India, 123–4
neo-liberal economic reforms, 20 Nigeria, 158–61
Net Material Production (NMP), 56
‘new Cambridge model’ of UK OECD (Organisation for Economic
economy, 116 Co-operation and Development)
Nguyen, T., 23 on China’s ‘market system,’ 50
Index 217
on Nigeria’s oil sector and target paths, 125–6

macroeconomic risks, 131 Portugal, and developing countries’
OECD countries manufactured exports, 21
agricultural subsidies, 93, 95 poverty
and Chinese exports, 57 in Egypt, 164
financial assets vs real economies, 92 and IMF/World Bank-supported
and import controls, 22 programmes, 7
and world trade studies, 23 in India, 8, 105
oil and liberalization, 9
Nigeria, 127–8, 129–30, 131–2, 134 and privatization, 14
oil crises and competitive recycling, world poverty trends (1990s),
129 7–8
oligarchs, increasing power of, 7 Poverty Reduction and Growth
‘open door’ policy (China), 77 Facility (PRGF), 4
Poverty Reduction Strategy Papers
Panama, liberalization and labour (PRSPs, World Bank), 12
market trends, 9 private sector
Paris Club (of government creditors), in China, 50, 53
156, 165 efficiency of, 13, 104
Patent Acts, and WTO, 94–5 in India, 104, 105–6, 121, 122, 123
People’s Bank of China (PBC), 54–5 see also mixed economic system
Perroni, C., 23 privatization
Peru as economic reform, 11–17, 20
education and skill-intensive in Egypt, 187
exports, 11 see also deregulation; liberalization
liberalization and labour market protectionism, in developed
trends, 9 countries, 22, 93–4
Philippines public utility sectors, privatization of,
exports, falling growth rate of 11–13
(1996), 93 Puerto Rico, privatization of water
exports-based development strategy, service and Vivendi, 13
84
planned economy, IMF/World Bank’s quantitative studies of world trade, 23
criticisms against, 1
Poland, loan defaults, 129 real economy, vs financial assets, 92
policy model (India) regime changes, and multinational
about notations, 123–4 companies, 3
description of, 111–15 regulation, and privatization, 12
dynamic analysis of and remittance payments, from Egyptian
comparative performances of workers, 166, 184–5
economy, 115–17; debt ratios and Ricardo, David, 4
foreign borrowings (history), 117; Rodrik, D., 15
fiscal dynamics, 116 ‘rules of origin’ (USA), 93
historical data for variables in Russia
model, 124–5 and capital account convertibility,
simulated planned solutions and 95, 96
actual performance during debt, 95
adjustment period, 117, 118–20, privatization and employment, 14
121–3, 124–6, 126 see also Soviet Union
218 Index
SAPs, see structural adjustment see also tariff policy and

programmes (SAPs) employment structure (United
Saudi Arabia, aid package to Egypt, Kingdom)
163 South Korea
school gross enrolment ratios, 11 export growth rates, 84
see also education exports, falling growth rate of
Shoven, J., 23 (1996), 93
Singapore exports-based development strategy,
and Chinese invitation to foreign 83
capital, 51 and Generalized System of
exports, falling growth rate of Preference (GSP), 43
(1996), 93 Korean-owned companies in China,
exports-based development strategy, 14
84 national developments ideology, 52
and Generalized System of and trade liberalization, 15–16
Preference (GSP), 43 trade policy, 51
liberalization and labour market Soviet Union
trends, 9 demise of and impact on India, 91,
skill-intensive exports, and education, 100
10–11 trade with China, 77, 78
slave trade, 3 see also Russia
social expenditure Spain, and developing countries’
composition of social sector manufactured exports, 21
expenditures, 10 Sri Lanka, liberalization and labour
impact of liberalization on, 9–10 market trends, 9
social indicators, trends in gross Stone, R., 26
enrolment ratio and infant structural adjustment programmes
mortality rate, 11 (SAPs)
social unrest, and inequality, 7 background, 1, 10–11, 104–5, 164–6
Soliman, S., 188 Egypt, 164–6, 167, 184, 185, 187–8
South Asian countries India, 91, 105
IMF-funded programmes and Nigeria, 128, 129–30, 131, 132, 133,
employment patterns, 6 137
liberalization and labour market see also adjustment policy model
trends, 9 (Fund–Bank)
light manufacturing products structural model (Egypt)
industries, 21 about notations, 189–92
poverty rates, 8 analysis of model, 166–70; GDP and
South-East Asian countries foreign exchange reserve, 171;
and China’s exports-based historical data (1987–91), 175;
development strategy, 84–5 historical data (1992–97), 175;
exports, falling growth rate of policy assumptions (simulation 1),
(1996), 92–3 176; policy assumptions
trade destructions caused by China, (simulation 2), 177; simulation
85 1, 172, 178–9; simulation 2, 173,
UK exports to, 40–2, 41 180–1; simulation 3, 174, 182–3
UK imports from, 42–3, 42 experiments on policy simulations,
and UK tariff policy (simulation 184–6
exercise), 45, 46, 47, 48 summary and comments, 187–8
Index 219
structural model (Nigeria) agricultural subsidies, 93, 95

about notations, 158–61 AMS (aggregate measures of
analysis of model, 131–7; Dollar/ subsidy), USA, 95
Naira exchange rate (1990–2010), sugar subsidy (OECD counties), 93
133; growth in aggregate GDP Sziráczki, G., 14
(1990–2010), 132
experiments on policy simulations, Taiwan
137, 140, 149, 152, 155–6; Chinese exports to, 68
historical data (summary), 150; and Chinese invitation to foreign
movement of policy instruments capital, 51
(1986–92), 140; Nigeria historical exports-based development strategy,
data (summary), 141–2; Nigeria’s 83
medium and long-term debt by and Generalized System of
creditor group, 149; simulation 1, Preference (GSP), 43
143–4, 151; simulation 2, 145–6, national developments ideology, 52
153; simulation 3, 147–8, 154; Tanzania, liberalization and labour
simulation 4, 152; simulation market trends, 9
assumptions, 138–9 tariff policy and employment
structural revolution, meaning of structure (United Kingdom)
derivatives, 17–20 background and issues, 21–3
globalization and inequality econometric model: equations
between countries, 8 not described, 40; exports to
human capital formation, changes India, 34–5; exports to newly
in, 9–11; composition of social industrialized Latin American
sector expenditures, 10; trends in countries (NIL), 32; exports to
gross enrolment ratio and infant newly industrialized South-East
mortality rate, 11 Asian countries (NIA), 33–4;
IMF-supported programmes: impact exports to other less developed
on employment patterns, 5–7, 5, countries (LDC), 35; imports
6; impact on the poorest, 7; role from India, 37–8; imports from
of trade policy, 4 less developed countries (LDC),
labour market developments, 8–9 39–40; imports from newly
multinational companies and industrialized Latin American
national economies, 3–4 countries (NIL), 35–6; imports
privatization as economic reform, from newly industrialized South-
11–17 East Asian countries (NIA),
trade-off between growth and 36–7; UK demand/consumption,
equity, 7 29–30; UK exchange rate, 31; UK
world poverty trends (1990s), 7–8 investment functions, 30–1; UK
Sub-Saharan Africa labour requirement functions,
devaluation (of exchange rate), 166 28–9
exports and gross domestic product methods of analysis: literature,
(1980–2000), 5 23; multilateral model of world
IMF-funded programmes and economy, 24–8
employment patterns, 6 present direction of UK trade and
poverty rates, 8 existing protection: exports,
social sector expenditures, 40–2, 41; imports, 42–3, 42;
composition of, 10 structure of employment,
subsidies 43–4, 43
220 Index
tariff policy and employment UNCTAD (United Nations Conference

structure (United Kingdom) on Trade and Development),
– continued 10–11, 21
results of simulation: effects of unemployment
import control vs liberalized in Egypt, 163, 164
regime on UK imports, 44–8, 46; and import controls, 22, 44–9
impact on employment, 48–9 in Nigeria, 156
taxes and privatization, 14, 20
tax collection by East India see also employment
Company in Bengal (1757), 3 United Arab Emirates (UAE), aid
see also fiscal policies package to Egypt, 163
Thailand United Kingdom (UK)
and capital account convertibility, 96 derivatives markets, 17
export growth rates, 84 exports, 40–2, 41
exports, falling growth rate of financial crisis (2008), 93
(1996), 93 imports, 42–3, 42
exports-based development strategy, imports of coal, 2
84 ‘new Cambridge model’ of UK
liberalization and labour market economy, 116
trends, 9 privatization of utilities, public
trade destructions caused by China, assets and railways, 16
85 trade with India and impact on
third world countries, see developing Indian textile industry (19th
countries century), 4
Tiananmen Square massacre (China), see also tariff policy and
51 employment structure (United
Tokyo Round, 23 Kingdom)
Toronto terms, 156 United Nations Conference on Trade
trade and Development (UNCTAD),
free trade, 4 10–11, 21
trade policy in IMF-supported United States (USA)
programmes, 4 AMS (aggregate measures of
trade restrictions and developing subsidy), 95
countries’ manufactured exports, and Chile, impact of American
21–2 mining companies (1973), 3
Trade Restrictiveness Index (TRI), 4 and China: Chinese exports, 57,
world trade studies, 23 68, 77, 78, 82, 83, 86; Chinese
see also foreign trade; trade imports, 77, 78, 78; free trade
liberalization with China and impact on US
trade liberalization, 4, 11, 14, 15–16, industries, 4
20 and developing countries’ debt
and employment, 21–2, 44–9 crises, 129
trade unions, decline of and and Egypt: Egypt’s military debt,
liberalization, 9 167; US aid to Egypt, 188
Trinidad terms, 156 financial crisis (2008), 18, 93
and Nigeria, oil imports, 127
UAE (United Arab Emirates), aid profitability as result of falling
package to Egypt, 163 labour costs, 92
Index 221
return of privatized public services/ Poverty Reduction Strategy Papers

resources into public ownership, (PRSPs), 12
16–17 and poverty trends, theoretical
‘rules of origin’ for exports, 93 views on, 7–8
and unregulated derivatives trade policy and liberalization, 4
markets, 17 Washington Consensus, 15
US Treasury and Washington World Bank-supported programmes,
Consensus, 15 5–6, 7
updating method of reduced-form see also Fund-Bank adjustment
coefficients and their covariance policy model; structural
matrices, 108–11 adjustment programmes (SAPs)
Uruguay, education and skill-intensive World Health Organization (WHO),
exports, 11 and Indian Patent Act (1970), 95
Uruguay Round, 23, 93 World Trade Organization (WTO)
US Treasury, Washington Consensus, and African structural reforms, 5–6
15 and anti-dumping measures against
developing countries’ exports, 93
van der Hoeven, see Hoeven, R. van and Chinese exports, 7
der creation of, 1
Venezuela, liberalization and labour and falling growth rate of world
market trends, 9 exports (1996), 93
Vivendi, 13 and government credit support
programmes and interest rate
control, 15
Washington Consensus, 15
and India: agriculture, 95, 98;
Western Hemisphere, exports and
capital account convertibility, 95;
gross domestic product
Indian Patent Act (1970), 94–5;
(1980–2000), 5
India’s membership, 91
Whalley, J., 23
WHO (World Health Organization), and multinational companies, 4
and poverty trends, theoretical
and Indian Patent Act (1970), 95
views on, 7–8
Wigle, R., 23
and privatization, 14
World Bank
and protectionism in developed
and China: China’s role in Asian
countries, 93–4
financial crisis (1997–98), 83;
rules-based system for trade
‘market system’ and Chinese
regime, 50 relations policy, 4
see also Fund-Bank adjustment
economic reform programmes
policy model; GATT (General
(1980s), 1
Agreement on Trade and
and Egypt: on Egyptian economic
Tariff); structural adjustment
crisis, 163; loans to Egypt, 167
and free market economy, 1 programmes (SAPs)
world trade studies, 23
and India: agriculture, 95; loans to
India, 91
and multinational companies, 4 Zimbabwe, privatization of water
and planned economy, 1 project and Biwater, 13

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Structural Revolution in International Business Architecture

Typeset by MPS Limited, Chennai, India.

List of Tables viii

1.1 Exports and Gross Domestic Product, 1980–2000 5

4.3 Money supply, GNP and price levels: 1985–97 102

3.1 Simulation 1, GDP and domestic demand, China 69

An economic reform programme was started by the International

colonization. During that phase, companies were subservient to the

Multinational Companies and National Economies

The Role of Trade Policy in IMF-Supported Programmes

The overall objectives of IMF-supported programmes are to achieve

Extent and Focus of Trade Policy Conditions

This section examines the overall trends in structural conditions related

Effects on Employment Patterns

A strange result has emerged in Africa where, since the introduction of

Table 1.1 Exports and Gross Domestic Product, 1980–2000

1980–2000 1980–90 1990–2000

(average growth rate %)

Source: Word Economic Outlook (World Bank).

Table 1.2 Sub-Saharan Africa: evolution of employment in the formal sector

Country 1990 1995

Kenya 18.0 16.9

Table 1.3 Informal employment as percentage of labour force (non-agricultural)

1990 1991 1992 1993 1994 1995 1996 1997

Source: UNILO (1998).

Despite positive growth rates, liberalization measures in Latin

Trade-off between growth and equity

World Poverty Trends over the Last Decade

Has Globalization Increased Inequality between Countries?

It seems that globalization has increased inequalities between countries

Labour Market Developments

Changes in Human Capital Formation

Liberalizations had negative effects on social expenditure in the public

countries was to reduce expenditures on health, education and social wel-

Table 1.4 Composition of social sector expenditures (percentage of GDP)

Asia Latin America(a) Sub Saharan Africa(a)

Before During After Before During After Before During After

Note: a = Only countries with data for the post-adjustment period.

Table 1.5 Trends in the selected social indicators

Indicator Asia Latin America(a) Africa(a)

Before During After Before During After Before During After

Note: a = only countries with data for the post-adjustment period.

educational attainment is a necessary but not a sufficient condition for

Thus, a slowdown in primary, basic, secondary and vocational educa-

Privatization as Economic Reform

Trade liberalization means the removal of restrictions on import tariffs,

these industries with the declared aim to increase efficiency or to

In Africa, Campbell-White and Bhatia (1998) found that only the

In order to achieve their guaranteed rates of return, private firms have to

Privatization had demonstrably harmed the poor, either through loss of

Economic growth and structural change do not necessarily mean

Deraniyagala and Fine (2001) observed that there is little justification

manufacturing industries, including automobile, electrical appliances

Gambling Instrument as a Financial Product

Derivatives are financial contracts whose price is derived from that of

Capital market liberalization, a result of globalization and trade liberal-

Developing countries, those who started their industrialization in the

The efforts to liberalize the markets of the developed countries are

exports and imports. The exports and imports of various commodi-

The Methods of Analysis

In recent quantitative studies of world trade (Cline et al, 1978; Whalley,

We describe, in what follows, a multilateral model of the world econ-

1. Agriculture, food and drinks: traded, C

The algebraic framework of the model is as follows: