Aid Flows and the International Transfer Problem in a Structuralist North- South Model

Author(s): Rob Vos

Source: The Economic Journal, Vol. 103, No. 417, (Mar., 1993), pp. 494-508
Published by: Blackwell Publishing for the Royal Economic Society
Stable URL: http://www.jstor.org/stable/2234789
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The Economic Journal, 103 (March), 494-508. ( Royal Economic Society I993. Published by Blackwell
Publishers, io8 Cowley Road, Oxford OX4 iJF, UK and 238 Main Street, Cambridge, MA 02I42, USA.

AID FLOWS AND THE INTERNATIONAL TRANSFER

PROBLEM IN A STRUCTURALIST NORTH-SOUTH
MODEL*
Rob Vos

Increasing and competing claims for world financial resources have raised
questions about the adequacy of global savings (e.g. IMF iggia). This
increased demand for savings is associated with the reconstruction in the
Middle East after the Gulf War, the costly unification process in Germany, the
economic transformation in Eastern Europe and the former USSR republics
and capital finance requirementsof the developing countries and comes on top
of the sizeable investment requirements in the industrialised countries, while
the supply of savings is increasingly eroded by almost world-wide falling
savings rates. Ex post, world investment should equal world savings, but ex ante
imbalances will trigger adjustments in interest rates, world market prices and
other macroeconomic variables and affect economic growth and development.
The current tendency towards an ex anteexcess demand for global savings is
putting upward pressure on interest rates in international capital markets,
which is commonly believed to affect private investment demand yielding
recessionarytendencies in the industrialisedcountries. In this context, increased
aid transfersto developing countries to satisfy their capital requirements may
allow for increased productive investment leading to output growth, but this
gain may be offset by lower export opportunities and falling terms of trade if
growth rates fall in the industrialised world and by higher debt-service costs
due to the rise in world interest rates. This reiterates,the relevance of the classic
'transfer problem': is there a secondary burden in the form of demand
deflation and terms of trade losses falling on either the transferringor recipient
economy?'
The purpose of this paper is to assesssuch global interactions focusing on the
impact of increased aid flows from industrial to developing countries. This
assessment is based on policy simulations using a small structuralist general
equilibrium model of North-South interactions (STAC). The theoretical
foundations of this model can be found in Vos (i99i). The model builds on a
recent tradition of North-South trade models (Findlay, i980, I984; Taylor,
i98i, I99I; Marquez and Pauly, i987). While such trade models typically
leave an accommodating role for international finance (i.e. set equal to
endogenous trade balances), the STAC model highlights a more independent
role of international capital flows. Central hypotheses are that the global
* I am indebted to Paul Mosley, David Vines and an anonymous referee for helpful comments on a draft
of this paper. They cannot be blamed for any remaining errors.
1 See e.g. Krugman and Baldwin (I987), Eaton (I989), Reisen and Von Trotsenburg (I988) and Vos
(I99I) for recent summaries and reformulationsof the classic transfer problem.

[ 494 ]
 AID FLOWS, INTERNATIONAL TRANSFER PROBLEM 495
capital market is segmented and developing countries face credit-rationing
rules set by official (governments) and private creditors (banks) in the
industrialised countries, thus incorporating theories of international lending
under sovereign risk (Eaton et al., I986) and oligopolistic behaviour of the
international bank firm (Darity and Horn, I988; Devlin, I989; Vos, i99i).
Aid flows in this model are assumed to be determined from the supply side,
based on political decision-making processes in the Northern donor countries
(cf. Mosley, I985, I987; Vos, I99I).
Simulation exercises for an increase in aid flows up to the level of the DAC
target of 0-7 % of GNP of the industrialised countries show great sensitivity to
the way in which these transfersare financed. The model results suggest that
deficit financing under monetary constraints (i.e. the aid transfer is financed
through increased public borrowing in the industrial countries) may trigger a
global recession and a secondary burden is to be carried by the recipient
countries through a strong decline in their terms of trade offsetting the income
effects of the aid transfer. The deflationary effect on the world economy is
transmitted through financial markets and higher world interest rates.
Financing of the aid transfer through tax increases or budget cuts can help to
avoid such recessionary effects and even set the world economy on an
expansionary path with developing countries witnessing real income gains,
despite some terms of trade losses.2
Section I summarisesthe main features of the model and Section II discusses
the global impact of increased aid transfers under different financing
assumptions. Some tentative policy conclusions are drawn in Section III.

I. A STRUCTURALIST MODEL OF TRADE, AI-D AND CAPITAL FLOWS

The model is highly aggregate. It distinguishes three regions only: North,

South and a third region of major oil exporters (MOE). The complete model
description can be found in the Appendix. Fig. I gives an overview of the model
set out in a World Accounting Matrix framework.3The current accounts in the
table columns (I-3 and 7) specify the trade links, asset related factor incomes
and payments and consumption demand in each region. The capital accounts
(4-6) identify national savings (Si) and domestic investment (Ii) balances and
sources and uses of international financing.
The modelling of the commodity markets is traditional (and probably old-
fashioned), but is along the lines of a recent generation of North-South models
(see particularly Findlay, I 980, I 984 and Taylor, I 98 I). The model developed
here follows in its basic set-up that of Taylor (I98I), assuming complete
specialisation in trade, with the South producing a flex-price composite
2
See Vos (1992a) for a discussion of the global demandeffects of enhanced aid transfersfrom North to
South using a linear model of the world economy based on a WorldAccounting Matrix, including IO country
groups and their actual composition of trade. In this fixed-price model system, the conclusions about the
global macroeconomic sensitivity of the way in which aid transfersare financed are confirmed, but at the
same time there seem to be relevant global welfare and distributional implications depending on in which
donor country the transfersare to be sourced and how the transfersare being allocated.
3 See Vos (I989, I992a), and Luttik (I992) for elaborations of global accounting rules in a WAM
framework.

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 496 THE ECONOMIC JOURNAL [MARCH

Overview of STAC Model

7. Con-
i. North 2.South 3. MOE 4. North 5. South 6. MOE sumption
i. North, N MSN + iw BS MON IN (I -t N)YQN
2. South, S OMNS+i _WSIS -- WsQs/qs
3. MOE, 0 lMNO+iw Jo IO (I-s0) VQO
4. North, N SN \DCN+Z\JN A\Js A\JO
5. South, S SS __ BS+ AFS
6. MOE, 0 sO
7. Con- (I -tN) YQN (s Qs/qs (i -sO) iQO
sumption

See Appendix Table i for full model specification and Table 2 for explanation of symbols.
Fig. i.

primary commodity, the North a fix-price manufactured product, and a region

of oil producers only producing oil at a fixed price which is used as an
intermediate good for production in the North. In other words, commodity
market adjustment is structurally different between the regions. Following
existing North-South models, also the behavioural specification of the
economies is structurallydifferent. The South is assumed to be characterisedby
labour-surplus conditions 'a la Lewis (I954) with the real wage fixed at an
institutionally determined subsistence level, while output is constrained and
determined by available capital and foreign exchange (since investment goods
must be imported from the North). The Northern commodity market is
demand-constrained and price formation is a function of oligopolistic firm
be>haviour(as in Taylor, i98i), which is also assumed to be crucial -in line
with the Kaleckian approach - in determining the real wage and in
determining private savings and investment behaviour.
Northern demand for the Southern commodity, OMNS' is a function of
Northern disposable income ((I-tN) QN) and the relative price of the
Southern and Northern commodities, i.e. the terms of trade of the South (0).
As indicated, the Southern economy is assumed to be foreign-exchange
constrained and therefore import demand in the South (MSN) is a direct
function of its import capacity: export revenues, OMNS,plus net external
borrowing (aid flows, AFBs,plus borrowing from commercial banks, ABS) less
interest payments on external debt, (i + xs) iw Bs,4and less private foreign asset
acquisition (or 'capital flight') net of repatriated returns, (AJS- iw Js), (see
equation 6 in Appendix Table i):
MSN = OMNS+AFs?+ ABs-(I +xS) iwBs (AJs iWJS) (I)

The key addendum of the STAC model is the inclusion of a segmented world
capital market. Two main types of flows from North to South: aid and bank
credits. After some theoretical reflection, aid has been assumed to be
determined exogenously by political decisions of Northern donors (Vos, 1991;
' Where x5 is the spread in developing country debt over the world interest rate (LIBOR), iw, and BS

is the outstanding external debt of the South.

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1993] AID FLOWS, INTERNATIONAL TRANSFER PROBLEM 497
chapters 5-6). The bank market has more complex behavioural rules and the
model also specifies deposit demand, including Southern private demand for
foreign assets, along the lines of the more convincing studies available thus far
on the determinants of 'capital flight' (ibid.). The basic characteristics of the
supply side of the model's international bank loan market rest on assumptions
about bank firm behaviour leading to maximisation of the volume of lending
subject to constraints of credit rationing rules for Southern borrowers and
imperfect creditworthiness assessment. This merges literature on oligopolistic
firm behaviour in international lending (Darity and Horn, I 988; Devlin, I 989)
and portfolio models of lending under sovereign risk and imperfect information
(Stiglitz and Weiss, I 98 I; Eaton et al., I 986). On the demand side operate three
agents the Northern government, Northern private firms and Southern
borrowers, each with different behavioural rules. Northern government credit
demand is a function of its fiscal deficit (assuming tight monetary policies),
Northern firms demand credit as a function of their investment needs but are
sensitive to interest rate changes, while the Southern borrowers manage
external borrowing as a function of foreign exchange requirements, but may
default on debt service payments if a critical payment capacity constraint
(conceived by the model as a liquidity, rather than as a solvency constraint) is
surpassed. Obviously, a debt crisis may be an intrinsic result of such a loan
market structure. Details are not spelled out here, as the focus is on the impact
of increased aid flows (for simplicity perceived as full grants, i.e. non-debt
creating).
It is relevant to note that, for simplicity's sake, it is assumed that all regions
operate in a single currency area and that the money market and inflation are
not explicitly modelled. All variables are expressed in real terms, that is in
terms of the Northern commodity which is the numeraire of the model system.
In the present specification, the model does not allow to simulate effects of
exchange rate adjustment or monetary policies.
Modelsolution
The model has three commodity markets and a world credit market. The oil
market is assumed to have supply adjusting automatically to demand at a fixed
price. The primary commodity market is price clearing, i.e. for the terms of
trade, 0, since the Northern commodity is the numeraire in the system. The
asset market (bank credits and the Northern government bonds) eventually
clears for the interest rate,i). With three of the four markets clearing, also the
Northern commodity market must in principle come to an equilibrium
(through demand adjustment, QN). Leaving aside the automatically adjusting
oil market, the model solution will thus depend on the interactions between the
Southern and Northern commodity markets and the global capital market.
Market clearing functions may be expressed in their general form as:
Southern commodity market:
dO9
dt =f[EDs(QN,~ T, 0)],
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Northern commodity market:

dtN
dt f [EDN(Q N) 'W) 0)]

Global capital market:

diw _JE ( 0)].
dt f [EDB
( N) 'W)

The commodity market specifications essentially determine the model as being

demand-driven from the North. This is reflected in the trade multiplier in
North-South interactions and reflects the Keynesian and structuralist
properties of the model, i.e. the multiplier becomes smaller with a higher
Northern savings rate (SN), higher OPEC savings (so) and higher raw material
costs (0) (leading to a lower Northern real wage and demand) and it becomes
larger with a higher Southern savings rate (ss) and Northern propensity to
consume the Southern good (0)).' The trade multiplier determines how much
of any increase in Northern output will be transferredinto higher Southern
welfare through trade expansion. Southern growth may expand with
expansionary Northern fiscal policies, Southern net capital transfers(rationed
credits less the debt service burden, which depends on the interest rate and
accumulated foreign debt), but tends to fall with the accumulation of foreign
assets.
Model Calibration
The simulations with the STAC model presented below are mainly illustrative
from which only tentative conclusions can be drawn, since the quantitative
structure created for the model was not based on a complete econometric
estimation of the main behavioural relations. Rather, a set of parameter values
was imposed on the model derived from various data sources and econometric
studies by others. Appendix 2 gives the basic parameter values used for the
simulations presented below. For the chosen parameter values and start values
of stock variables, the stability conditions of the Jacobian of the reduced form
of the model hold for the base year.6
ModelSensitivity
The key adjustment mechanisms of the model are the strong sensitivity of
Northern demand to the interest rate and the flexible price adjustment of the
Southern commodity. Northern investment demand is a positive function of
firm profitability and capacity use (following a Kaleckian framework) and a
negative function of the real interest rate (which can be found theoretically in
Tobin's q-framework). Northern private savings increase with higher interest
rates, but only through the income effect of higher returns on wealth holdings.
If net financial wealth is large, an interest rate increase may have a significant
stimulating effect on savings. In the model's initial situation this impact is
I See Vos (I99I: chapter 7) for an analytical derivation of the trade multiplier in this model.
6 See Vos (i99i) for further details on the data sources and on the stability conditions of the model.

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assumed to be modest, such that an ex anteglobal capital market disequilibrium
requires a large interest rate adjustment to get to a new equilibrium.7
A fiscal expansion in the North will put upward pressureon the interest rate
as it leads to an exanteexcess demand for global credit flows. This puts offsetting
tendencies in motion to the initial demand impulse created by the fiscal
expansion. Northern private investment demand may be stimulated through
the accelerator mechanism, but this would put even more upward pressureon
the interest rate and the 'crowding out' effect may become predominant. A
global recession is a possibility as stagnating Northern demand will also affect
demand for Southern exports and, given the flex-fix price asymmetry between
Southern and Northern commodity market adjustment, lead to a deterioration
of the Southern terms of trade. Reduced import capacity in the South, in turn,
will hit back on Northern demand, deepening the recessionaryeffect. A weaker
crowding out effect would result if it could be assumed that Northern private
savings show a strong response to interest rate changes, but this does not seem
to be supported by most theoretical notions or by the available empirical
evidence.8

II. MODEL SIMULATIONS: AID FLOWS TO o07?O OF NORTHERN GNP

The objective is to assesswithin the present model frameworkthe global impact
of an increase in aid flows from North to South. Can there be a 'global free
lunch' of aid stimulating world trade and income along the lines suggested by
policy views such as the Brandt Commission Report (I980)? Or, would this
lead to strong trade-offs given the structural features of the world economy?
Three model simulations are reported. All relate to a (permanent) increase
in aid transfers from North to South, AT',, to the DAC target of o0700 of
Northern GNP (up from baseline o03%), but for which the resourcesare freed
under different Northern government budget regimes. Since the model does
not include a money market, the options for financing the aid increase are:
I. Bond-financed aid transfer.
II. Tax-financed aid transfer.
III. Budget-cut financed aid transfer, i.e. other Northern government
expenditures are lowered at the size of the aid increase.
Results are shown for four central model variables: the terms of trade (0), real
incomes in South (OQs)and North (QN) and the Southern savings rate. They
are shown in Figs. 2a-d and are expressed as percentage deviations from the
baseline.
7 A weak Northern savings responseto the interest rate is broadly consistent with the assumptionsof other,
empirical, global macroeconometric models. McKibbin and Sachs' MSG2 model (McKibbin and Sachs,
I99I) assumes rather interest-rate inelastic supply and demand curves for global savings, implying large
interest changes are required to restore global capital market equilibrium. IMF's MULTIMOD (Masson et
al. I 988, I 990) initially assumed a very high elasticity (about 6-o) of Northern Private savings to interest rate
changes and a much lower responseof investment demand. A recent re-specificationand re-estimation of the
related structural equations of this model has reset these elasticities in line with those of MSG2 (IMF I99I b).
8 See Vos (I992 b) for a review of theoretical and empirical issues. See also footnote 7.

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The outcomes are highly suggestive. Bond-financed aid transfers towards the
South appear to have a global deflationary impact similar to that of the
scenario of Northern fiscal expansion sketched in the previous section. The
critical factor is that the additional credit demand by the Northern government
pushes up the world interest rate, which affects Northern private investment
demand and thus Northern output (see Fig. 2 a, where the D -line is the result
of Simulation I) .9 This in turn reduces demand for Southern exports leading to
a fall in the terms of trade for the South (Fig. 2b) and subsequently also in
its real income (Fig. 2 c). The fall in the terms of trade is not only a consequence
of the recessionary trend in the North following a bond-financed aid transfer,
but also of the model's optimistic assumption that the increased aid transfer
(net after the endogenous increase in interest payments on external debt) will
lead to increased productive, public investment expanding the supply of the
Southern commodity.
These mechanisms lead to a 'crowding out' of Southern savings (Fig. 2d
shows the fall in the savings rate vis-a-vis the baseline savings rate), i.e. a
negative link between aid and national savings is found, not so much due to the
fact that aid has been used to increase government consumption, as contended
by some frequently quoted studies (e.g. Griffin, I970), but due to international
transmission effects which affect the Southern terms of trade and output.
The global impact of increased aid flows is highly sensitive to the way in
which these are financed. This is clearly shown when comparing the results of
the 'bond-financing' case, with the cases in which the enhanced transfer is
funded out of tax increases (the + line in Figs. 2 a-d) or budget cuts (* line).
As the figures indicate, both financing options show very similar results. It
appears that in these scenarios the world economy may indeed embark on a
'Brandtian'-scheme of a mutually reinforcing interaction between aid and
trade as real incomes in both North and South go up, despite the falling terms
of trade for the South in the medium run. The terms-of-trade effect results
because of the traditional assumption about structural global asymmetry
caused by the lower income elasticity of the demand for the Southern
commodity (Prebisch-Singer). The expansionary impact on the Northern
economy is, however, not a pure trade effect. The tax increase, respectively the
budget cut were assumed to be of the same size as the aid increase (i.e. o04 %0
of Northern income). However, after taking into account global general
equilibrium effects the Northern government budget deficit is reduced which
allows for a lower interest rate and 'crowds in' Northern private investment.
In other words, if the Northern government would target a balanced budget,
the required tax increase or the budget cut could be less than the size of the aid
transfer. Of course, under the present model assumptions, this would yield
lower Northern output growth and thus also stimulate the Southern economy
9 The model leads to 'instantaneous' adjustment of the world interest rate, that is the initial excess
demand on the world capital market caused by the aid transfer injection pushes up the interest rate but
depresses Northern investment demand and output within the same period. Step-by-step analysis of the
iteration process of the model suggest an initial upward effect on the world interest rate of about 05
percentage points. At convergence the equilibrium interest rate is only slightly higher than in the baseline
case (about o-i percentage points), but is reached at a lower Northern equilibrium output.
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STAC: Impact on real income North. QN

(percent deviation from baseline)

5-1

-2
-3
24
-5

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

o Bond financed o Budget cuts + Tax financed

-1
-2 STAC: Impact on real income South. Qs
(percent deviation from baseline)
-3
-4
-5

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

o Bond financed o Budget cuts + Tax financed

Fig. 2 (a). STAC Model: impact of an increase in official aid transfersfrom North to South to DAC
target on Northern output, QN. (b). STAC Model: impact of an increase in official aid transfers
from North to South to DAC target on Southern output, QS.

to a lesser extent and the tendency in the terms of trade to fall would be
stronger.
Remarkably enough the substitution of national savings for foreign savings
is even larger in these cases compared to the case of 'bond-financing', which
is explained by the fact that the aid transfer to the South increases with the
output expansion in the North so that in the cases of tax-financing and budget-
cut financing much larger transfers flow to the South.
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 502 THE ECONOMIC JOURNAL [MARCH
STAC: Aid increase, terms of trade effect, 0
(percent deviation from baseline)

-1
-2
-3
-4
-5
-6
-7
-8
-9
-10 _ I , , , , , , , , -- - 1
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
0 Bond financed o Budget cuts + Tax financed

STAC: Impact on private savings rate South, Ss/aQs

(absolute deviation from baseline)
2-

04

-1

-2

-3
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

o Bond financed o Budget cuts + Tax financed

Fig. 2 (C). STAC Model: impact of an increase in official aid transfersfrom North to South to DAC
target on Southern terms of trade, 0. (d). STAC Model: impact of an increase in official aid
transfersfrom North to South to DAC target on southern savings rate, S5/6Q5.

The STAC model lacks details to assess adequately what would be the
impact on the developing region if the option of increased development
assistance would compete with other additional demands for international
finance, e.g. for the reconstruction of the Middle East and/or the trans-
formation process in Eastern Europe and the former Soviet Republics.
Nevertheless, some directions could be indicated. In the case of the Middle East
finance may be drawn from private capital markets (either through
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 I993] AID FLOWS, INTERNATIONAL TRANSFER PROBLEM 503
withdrawals of assets, Jo, or, bank lending). This is likely to lead to a higher
world interest rate with recessionary effects on the North, which are unlikely
to be fully compensated by the positive effects on trade. In this scenario the
South is likely to be doubly hit as it will be confronted with higher interest rates
and falling terms of trade. The global impact of officially sourced capital
transfers from North to Eastern Europe could be assessed in terms of the
consequences of a change in Northern fiscal policies similar to the simulations
discussed above, while use of the private capital market might trigger a world
recession if the 'crowding out' effect of higher interest rates on Northern
private investment exceeds the demand stimulus from increased import
demand in Eastern Europe.

III. CONCLUDING REMARKS

This paper started out with referencesto the fearsvoiced by institutions like the
IMF and the World Bank that increasing demands for world savings may have
a destabilising and recessionaryimpact on the world economy. The main thrust
of this paper has been to share such concerns. The simulations of increased aid
transfers to O0700 of industrialised country GNP (i.e. an increase of 04 00
percentage points) are modest compared to recent estimates of additional
capital requirements of developing countries to reach modest growth targets
(see e.g. Fishlow, I987; Taylor, Iggo; Jepma, I990), while the IMF estimates
that additional demands for world savings for the reconstructionin the Middle
Lgast,German unification and reform in Eastern Europe and the former
U.S.S.R. would add to an annual flow of another o-4-o-6 0 of industrialised
country GNP. As the model simulations show, the impact of an additional aid
transfer of a size which is only slightly more than one day of work in the
industrialised countries is already quite significant.
The studies on the additional capital requirements for LDCs all rest on the
assumption that foreign capital inflows will complement domestic savings and
hence will stimulate growth. Global interactions are not taken into account.
The analysis of this paper has emphasised the global interactions and shows
that without attention given to a proper management of the financing of the
additional transfers global repercussions may be negative and distributed
unevenly. According to the model presented in this paper, bond financing of
the aid transfer under monetary restraint, meaning increased government
borrowing in the industrialised countries, may cause a world recession and
subsequently confront the recipient countries (rather than the transferring
country) with a secondary transferburden in the form of falling terms of trade.
The model suggests this secondary burden might offset entirely the positive
income effects of the aid transfer. Such a pessimistic scenario seems avoidable
if the governments of the industrial countries would off-load the pressureon the
global capital market by (internationally coordinated) fiscal adjustment, i.e.
through additional taxation or budget cuts. A tendency towards terms of trade
losses for the developing countries following the aid transfer remains, but can

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 504 THE ECONOMIC JOURNAL [MARCH
be sufficiently mitigated if Northern financial policies can keep the region's
growth rate at an adequate level.
The model presented here obviously suffers from a lack of detail and
particularly oversimplified global trade interactions and the scope for
adjustment in the developing countries. A sound empirical basis for a more
disaggregated world model is currently being laid through the construction of
consistent World Accounting Matrices (WAMs) (see Luttik, 1992; Vos, I989,
1992 a). The research task ahead is of course the combination of the WAM data
framework into a much more detailed and elaborate global CGE model
framework for which the STAC model could serve as a starting point. More
solid and specific policy conclusions will be possible from there.
Institute of Social Studies, The Hague

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countries.' Journalof Development Economics,vol. 25 (i), pp. 89-IO4.
Masson, P. et al. (I988). 'MULTIMOD - Multi-region econometric model.' In Staff Studiesfor the World
Washington:IMF, pp. 93-II4.
Outlook.
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Masson, P., Symanski, S. and Meredith, G. (I990). MUL TIMOD MarkII: A revisedandextended model,IMF
Occasional Paper No. 71. Washington: IMF.
McKibbin, W. and Sachs, J. (I99I). Macroeconomic Interdependenceand Cooperation in the WorldEconomy.
Washington: The Brookings Institution.
Mosley, P. (I 985) . 'The political economy of foreign aid: A model of the market for a public good.' Economic
Development and CulturalChange,vol. 33 (I), pp. 373-93.
Mosley, P. (I987). OverseasAid: Its DefenceandReform.Brighton: Wheatsheaf Books.
Reisen, H. and von Trotsenburg, A. (i 988). TheBudgetary and TransferProblemof MajorDebtorCountries. Paris:
OECD Development Centre.

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Stiglitz, J. and Weiss, A. (i 981 ). 'Credit rationing in markets with imperfect information.' American Economic
Review,vol. 7I (2), pp. 393-4I0.
Taylor, L. (I98I). 'North-South trade and Southern growth: bleak prospects from the structuralist point
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Taylor, L. (I990). 'Foreign resource flows and developing country growth: a three-gap model.' In Problems
of DevelopingCountries in the 9ggos(ed. F. D. McCarthy). World Bank Discussion Papers 97. Washington:
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APPENDIX I

Table I
STAC Model: StructuralEquations

South
(I) Qs = (Ws(LS + Lsg) + MNs Supply-demand balance for Southern com-
modity
(2) Qs = OSpKs + OSg Ksg Production function
where:
k= KsI/Ksg; O-sp=QslKs;
o(sg = (iI-,) kQslKs
(3) Ls = Qslqs Southern employment in export sector
(4) Rs = (i -(ol/qs)
0Qs Southern profits
(5') DEFs = Fs+ ABsg = Southern fiscal deficit and financing
OWs Lsg + (I + xs) iw Bsg + Isg -ts Rs
(6) MSN = OMNs+ AF-s+ ABs AJs
- Southern imports and net transfer from
-(i +Xs) i1wBsg - I +X5) iwBsp+iw Js abroad
(7) SS = S5(i -ts) Rs +iw Js- (i +xs) iw Bs, Southern savings
(8) Is = SS-A Js + (ABs- ABsg) Southern investment (finance constrained)
Major oil-exporters
(9) Q0 = mNO QN Actual oil production
(Io) MON = mON VQO Import demand
(I I) + iw JO
AJo = sOVQO Real savings and current account balance;
SO = (I -mON)

North
(I 2) I = (I + r) (wN/qN + vmNO) Northern mark-up rule and real wage
where: qN = QN/LN and PN = I determination
(I 3) QN = CN + IN + GN + MSN + MON -OMNS Northern supply-demand balance
(I 4) CN = (I -t) YQN Northern consumption
where: demand
Y= ['N/qN + (I -SN) 7(N/NqN + VmNO)]
(I 5 a) OMNS = (, -tN) YQN +AO Northern demand for Southern good
(I 5 b) CNN = CN- OMNS = (I -') (I -tN) YQN -AO Northern consumption home good
(i6) IN = [gON+g1N(r+ U) -g2N (I +XN) iw] KN Northern investment demand
(I 7) rN = I- ((wN/qN +vmNO)] QN/KN Northern profit rate
(i 8) U = QN/KN Northern capacity utilisation parameter
(I9) SN = SN(I -tN) [r(wOf/qN+VmNO)] QN Northern savings
+ (I +xs) iw(Bsg+Bsp) +iwDCN-iw(Jo+ Js)
(20) DEFN = ADCN= GN + iWDCN Fiscal deficit and financing
-tN (I -vmNO) QN + AS

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506 THE ECONOMIC JOURNAL [MARCH

Table i (cont.)
STAC Model: Structural
Equations
World financial system
(2 I) ABs = AJN+ AJO+ AJ5 -ADCN World bank credit supply
(22) AJN = JON JN +J1N (iW-rN) -1SN Northern demand for deposits
(23) AJs =jos Js +jjs(iw -rs)- SS Southern demand for deposits
where: rS = RSIKS
(24) ABdN = blN IN Northern private sector demand for bank
credits
(25) ABsg = [(i + xs) iw Bsg] - (MNS) -AFs Southern public sector demand for
international bank loans
where:
= [(i +xs) wBsg/(lOMNs + ABg+Bsg S)]rax Limit to debt-servicing capacity set by
Southern government credit rationing to
Southern government
if: ABs < ABdsg, then ABsg = AB8
if: ABs > ABdsg then ABsg = ABd
and further, Default option, Southern government
if: (i + xs) iw Bsg/(OMNs + ABsg + ANs) > Q" then,
if
ABsg < o, set ABsg = o
then, if (i + Xs) iw BSg/OMNs + AFUS)> Q
set (i +xs) iwBsg = tl(OMNs + AFs)
(26) ABS = bls[(Bs/OMNS)emaxY, (Bs/OMNs)_1] ABs Supply-determined bank credit flows to
the South
(27) AB"N+ ABs = ABs Global credit market equilibrium
End-of-year stock variables
KN+1 = KN +IN Physical capital stock, N
Ks+= Ks+is Private physical capital stock, S
Ksg+1 = KS+Isg Public physical capital stock, S
BN =BN + ABdN Outstanding bank debt, N
BN+1 = BN +AABsg Outstanding public sector bank debt, S
BSP = BSP+ (ABs- ABsg) Outstanding private sector bank debt, S
B Bs+1 +B Outstanding bank debt, S
DCN = DCN + ADCN Domestic government debt, N
Ji -J +AJ, (i = N, S, 0) Total bank deposits by region

Table 2
List of Variables

Endogenous variables
AB8 Net total commercial bank credit flow
ABN Net commercial bank credit demand of Northern borrowers
ABS Net commercial bank credit flow to Southern borrowers
ABdg5 ABg Net commercial bank credit demand (and realised demand) of Southern government
CN Consumption demand, North
ADCN Northern government debt (net flow)
IN Private investment in North
IS Private investment in South
Isg Public investment in South
iw World interest rate
AJN Bank deposits, North (flow)
AJS Bank deposits, South (flow)
AJo Bank deposits, Oil-exporters (flow) (equals savings, Oil-exports)
LS Employment in commodity production, South
MNS Imports of North from South
MON Imports of Oil-exporters from North
MSN Imports of South from North
QN Output Northern commodity
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I993] AID FLOWS, INTERNATIONAL TRANSFER PROBLEM 507

Table 2 (cont.)
List of Variables
QO Output,oil
QS Output, Southern commodity
RN' rN Northern profits and profit rate
RS rs Southern profits and profit rate
SN Northern savings
Ss Southern savings
u Northern capacity utilisation parameter
0 Relative price (terms of trade) Southern commodity (in units of Northern commodity)
(N Real wage, North (in terms of Northern commodity)
Other endogenous variable labels (not used in model solution)
CNN Northern consumption demand for Northern commodity
DEFN Fiscal deficit, North
DEFS Fiscal deficit, South
LN Employment, North
Exogenous variables
A Constant term in Northern consumption function
BN Beginning-of-period outstanding commercial bank debt, North
BS Beginning-of-period outstanding commercial bank debt, South
BS9 Beginning-of-period outstanding commercial bank debt, public sector, South
B5P Beginning-of-period outstanding commercial bank debt, private sector, South
DCN Beginning-of-period Northern government debt (outstanding)
AFs Official aid flows from North to South
GN Government expenditures, North
(Bs/IOMNS)emax Creditworthiness indicator, South
JN Beginning-of-period bank deposits, North (stock)
iS Beginning-of-period bank deposits, South (stock)
JO Beginning-of-period bank deposits, Oil-exporters (stock)
KN Beginning-of-period capital stock, North
KS Beginning-of-period private capital stock, South
KSg Beginning-of-period public capital stock, South
LSg Public sector employment, South
XN Mark-up determining interest-rate spread on bank loans to North
Xs Mark-up determining interest-rate spread on bank loans to South
Exogenous parameters and coefficients
blN Northern credit demand parameter
bis Response (confidence) parameter to South's creditworthiness
goN Constant in investment demand function North
91N Profit response parameter investment demand function North
g2Na,. Interest-rate response parameter investment demand function North
Constant in deposit demand function (i = N, S)
Response parameter deposit demand function (i = N, S)
k Ratio of Southern private to public capital stock
MNO Import propensity of oil consumption North
MON Import propensity of oil exporters' demand for Northern commodity
qN Labour productivity North
qs Labour productivity South
SN Savings rate North
so Savings rate oil-exporters
Ss Savings rate South
tN Tax rate North
ts Tax rate South
a Income propensity to consume Southern good in North
'0S Output-capital ratio South
8 Distributional parameter Southern production function
r Mark-up rate Northern price formation
(Os Real wage South
v Relative price of oil (in terms of Northern commodity)
Policy determined cap on debt servicing to foreign exchange availability in South,
determining upper bound of Southern demand for bank loans
508 THE ECONOMIC JOURNAL [MARCH I993]

APPENDIX 2
Parametersfor STAC model
Table 3 gives the parameter values and start values for the stock variables for the base
run of the STAC model. See Table 2 for the variable and parameter description.
Parameter values were derived from the WAM data management system and existing
empirical global models. A detailed discussion is given in Vos (I99I: Chapter 8). In
Table 3, tf[ is the share of aid flows to the South as a proportion of Northern output,
i.e. AFas = tIN QN'
Table 3
List of base run valuesfor exogenousparametersand variables

Exogenous parameters
biN 0o525
bis o0425
gN o03Io
gON 0' Io0
glN 0'200
g2N 2'800
JON 0o050
Jos 0'I00
J1N I-000
Jis 0700
MNO 0035
MON ?0350
qN I 0'000

qs o0400
SN 0-400
o-650 (= - mON)
so
Ss 0250
tN 0300
ts O'I00
tN 0?003
XN O0I00

xs o0400
a 0o036
?Sp 0o250
OSSg o'i6o
T 0o400
(OS ooo8o
V I-000
0-050

(BS/9MNS)emax 2000

Initial values of stock variables and constants

A go
BN 7000
BSg 200
BSP Is50
DCN 3000
JN 1000

JO 6oo
is 300
KN 6o ooo
KS 5000
Ksg 2 500
Lsg I50

C) Royal Economic Society I993