- 18 -

where Dec is the outstanding public sector debt, & is the

Proportion of Dec paid off in the current period, and L is the

cG
public sector loan demand. The Center government is assumed to
finance its deficit solely by borrowing from the multinational
banking sector, which is the only creditor in this model.

The total Center demand for credit is the sum of the

private sector and the public sector demands for new loans:

(21)

Simultaneously the Center makes deposits out of current profits,
with the multinational banks. Center savings, which become
liabilities for the banking sector, can be expressed as follows:
S = Sowtw it SceTMK (22)
TIT. THE PERIPHERY ECONOMY
Gross domestic product at the Periphery, also measured in

Center currency, is the sum of the money values of each of its

sector's output:

POY pT PRERtP AHA (23)


- 39 -

a drop in the parameters 9; in the loan supply function for that
region (see equation (40) above). What will the consequence be?

Consider first a drop in Y. Even if terms stay fixed at the
Center, they definitely will rise in the Periphery, reducing the
Periphery's export demand, thus driving down production of
capital-goods. If terms become more harsh at the Center as
well--if the Center's supply curve for credit is displaced
upward--then the situation could be modified depending upon how
large the withdrawal from borrowing is by Center producers. This
would depend on the size of %%3 which reflects the elasticity of
Center producers' loan demand as the terms of loans change.

Retrenchment on credit in the Periphery alone will have a
similar effect as a decline in Y when terms are unchanged at the
Center. Now the fall in the parameters 9; will mean harsher terms
for the Periphery, less borrowing, less importation of
capital-goods, and less production worldwide.

Moreover, policymakers at the Center can produce a similar
result by refusing to bail out the banks. The paramete jPwill
fall, leading to a comparable chain of events. Or if the
Periphery's enterprises or government become delinquent on their
loan payments; i.e@.4 r, falls, this will lead to a similar
pattern of economic decline.

Of course; the magnitude of the effects is contingent on
the values of these parameters might take, but the direction of
the effects is unequivocally downward. It is just as plain that

greater liquidity will promote expansion in the world economy.


- 35 -

effect of newly generated profits on purchases of new capital
goods and the profit rate parameter itself--is less than unity.

Finally condition (449) sets limitations on the parameters
of the loan supply and demand functions for the Periphery. The
higher the elasticity of loan supply with respect to the terms,
the greater the tendency of Periphery producers to substitute
away from borrowed funds as current profits rise, and the weaker
the multinational banks' tendency to supply credit not absorbed
at the Center to the Periphery (in the limit, hyper-reluctance
would mean 9,50) the more likely condition (449) is to hold.

There are a host of alternative assumptions that would
yield a variety of signs on these summary symbols, but this set
of assumptions+-which is plausible--leads to the simplest of sign
patterns: all signs are positive.

With conditions (44a-g) in mind, we now can explore several
comparative statics exercises with the model. In addition to
determine what is happening in this model as we perturb a
particular exogenous variable we need only to ask what happens to
the equilibrium level of capital-goods; K,; since all of the other
three sectors' output and employment levels must move in the
direction.

(a) Greater optimism at the Center

If producers at the Center expect profits to increase in
the future; we can trace the effects by asking how a rise in w .
will affect the quantity of capital-goods produced today. By

taking the partial derivative of K* with respect to TM we obtain


- 44 -

Moreover; our model is qualitatively distinct from theirs.
Unlike them we do not have to make any specific assumptions about
returns to scale nor invoke diminishing returns to a fixed
factor. Unlike them we fully distinguish between international
movements of capital as commodities and as finance. We avoid
altogether, by our extreme Kaleckian assumption, their
characterization of the primary source of finance for undertaking
new investment as household's personal savings. Moreover, we
bypass entirely their tendency to solve their model "as a perfect
foresight, intertemporal equilibrium..." (Bruno and Sachs, 1982,
p. 2). The latter strikes us as a particularly odd assumption in
light of the buildup of "“nonperforming" loans owed to
multinational banks--unless, perhaps; the banks also are
suffering from stochastic shock!

Beenstock's (p.82) position has it that LDC indebtedness is
an “equilibrium phenomenon" associated with LDC
industrialization:

The steady growth of LOC indebtedness is not

brought about by oi] prices (although they may

be important in the short term) but by a

fundamental realignment in the world capital

market which reflects LDC industrialization.
Beenstock argues that "the rate of return on capital" in LDCs
rose relative to the developed countries at the start of the
1970s--an autonomous rise of sorts. Finance flowed to the LDCs in

search of the higher rate of return. According to Beenstock (p.


-12-

economy. We offer the following linear behavioral expression for

the aggregate loan demand by Center enterprises:

= - e_
bee Og7 4 TL t4 oT dgt. (14)

Te Ent

The a; parameters are all positive constants. %% represents
the autonomous or constant component of Center private sector
loan demand. The variablen. is the aggregate profits earned at
the Center. The negative sign on the parameter oy that PrecedesTM
is justified as follows: When more and more corporations face a
current profit squeeze they encounter cash flow problems. They
then seek greater liquidity through external finance. Therefore
the demand for credit bears a negative relationship to current
profits. The higher are current profits, the less likely
corporations are to seek external finance. We effectively treat
external and internal finance as substitutes.

On the other hand, ceteris paribus, when corporations hold
felicitous expectations about future profits they will be less
hesitant to take on additional debt today. Since © represents
anticipated profits tomorrow by Center producers, contingent on
making expenditures on capital-goods today, it functions as an
index of producers' optimism, perhaps Keynes' notorious "animal
spirits." 1; could depend on a host of considerations.

Corporations have to gauge the course of fiscal and monetary


- 54 -

REFERENCES

Aukrust; Odd (197) “PRIM I: A Model of the Price and Income
Distribution of An Open Economy" Review of Income and
Wealth, pp. 51-78.

Beenstock, Michael (1983) The World Economy in Transition
London: George Allen & Unwin.

Branson; William (1981) "The OPEC Surplus and U.S.-L.D.C.
Trade" NBER Working Paper No 791.

Bruno, Michael and Jeffrey Sachs (1982) "Adjustment and
Structural Change in the World Economy" NBER Working
Paper No. 852.

Darity, William Aw, Jr. (1982) "On the Long Run Outcome of the
Lewis-Nurkse International Growth Process" Journal

of Development Economics Vol.10 pp. 271-8.

Dod, David (1981) "Bank Lending to Developing Countries:
Recent Development in Historical Perspective"
Federal Reserve Bulletin, Vol. 67) PP»

Federal Reserves

Franko, Lawrence (1979), "Debt, Trade, and the Prospects for
World Economic Growth" in Lawrence G. Franko and

Marilyn J. Seiber (eds.) Developing Country Debt
New York: Pergamon Press.

Friedman, Irving (1978) "Emerging Role of Private Banks"
in Stephen S. Goodman (ed.) Financing and Risk in
Developing Countries New York: Praeger.

Heskell, Mitchell, Robert Pinkham and Doris Robinson (1982)
"The Empirical Consumption-Wage Bill Ratio"
Journal of Post Keynesian Economics Vol. 51 PP: 66-77.

Jencks; L. H. (1927) The Migration of British Capital
to 1875 New York: Alfred A. Knopf.

Kaldor, Nicholas (1976) “Inflation and Recession in the
World Economy" The Economic Journal vol. 86,
pp. 703-14.

Kalecki, Michal (1971) Selected Essays in the Dynamics
of the Capitalist Economy, 1933-1970 Cambridge:

Cambridge University Press.

Keynes; J. M. (1936) The General Theory of Employment,
Interest, and Money London: Macmillan.



-~ 52-

FOOTNOTES

*Darity is at the University of North Carolina at Chapel
Hill and Fitzgerald is at Cambridge University and the Institute
of Social Studies (the Hague). Darity is grateful to the Board of
Governors of the Federal Reserve for providing him with support
as a visiting scholar to extend this research effort. We both
thank Stanley Black, Pat Conway, David Evans, Al Field; Jorge
Espinoza-Garza, Geoffrey Harcourt, Bobbie Horn, Ronald Johnson,
Charles Kindleberger, Jan Kregel, Lance Taylor and two anonymous
referees for helpful comments on an earlier draft. This paper
represents the views of the authors and should not be interpreted
as reflecting the views of the Board of Governors of the Federal
Reserve system or other members of its staff.

‘it should be added that in our model the Center does not
import any final products from the rest of the world. This isy
obviously, not entirely accurate. However, the production of
finished goods in the developing countries is aimed primarily at
their domestic markets; not for export to the Center (see Reich;
especially, p. 45). We go a step further in slicing with Gccam's
razor by treating both the Center and Periphery as producing all
of their final goods domestically.

2The assumption that c,=1 is empirically defensible,
especially in light of a recent study by Heskel, Pinkham, and
Robinson (pp. 66-7). They found that the consumption-wage bill
ratio for the advanced industrial countries typically is close to
unity. For the United States over the period 1965 through 1978
they found the ratio to be highest in 1965 at 1.08 and lowest in
1970 at 1.01. The average level of the ratio was 1.03 "with a
small standard deviation of 0.021" (p. 67). The United Kingdom's
average over the same period was exactly unity. The trio conclude
(p. 66) that this general finding suggests that in “Westerr-type
economies" it is true that “either wage-earners do; in fact,
spend all of their income; or their taxes and savings are
directly offset by consumption expenditures out of capitalist
income." Our model is premised on the former assumption. In Third
World countries; the consumption-wage bill ratio typically is
much larger than one, possibly indicating large expenditures on
consumption by non-wage earners (landlords, rentiers, etc.).

Or it simply could mean extensive state subsidization of
consumption. .

Simplicitly (1-4, ) is the proportion of newly acquired
loans not used for capital-goods purchases. They may go toward
covering or refinancing existing debts.


- 50 -

provide the real rates of growth for each region as functions of

the growth rate of capital-goods production:

Yo = CoptCoyHowe Ik) /wI kK (49)

Yo= Copt op (How, IpR/ANI C(m

P W/R)CH wed

RW pksew) + MayK/RIK (50)

Since the rates of growth for each region move in the same
direction and simultaneously depend upon K, the relative rates of
growth depend upon the bracketed expressions. If they happen to
be equal then growth rates in each region will be equal. If the
Periphery's GDP is initially lower it will stay lower forever.

If the bracketed terms for the Periphery yield a larger
product than the bracketed term for the Center, the Periphery
will grow faster than the Center when the world economy is on an
upswing. However, it also will contract more strongly on the
downturn. For the Periphery to "catch up" the cyclical upswings
would have to be longer than the downswings.

If the bracketed terms for the Periphery yield a smaller
product than the bracketed term for the Center, the reverse will
be true. The Periphery will lose relative ground on the upswing
but gain relative ground on the downswing. Somewhat perversely to
"catch up" it would be necessary for worldwide recessions to

outlast worldwide waves of prosperity. Obviously; in either case,


-~ 22-

Periphery demand for credit by productive enterprises is

given the following linear specification:
e
= - - 2
L a) 4 +h Bat (32)
Total profits at the Periphery can be expressed as follows:

% = (Zp/(14Zp) )PReR + (Zy/(14Z,) PaeA (33)

Combining (31), (32), and (33) we obtain:

PERS (1-SppL(Zp/(14+Zp

+ C1V-Sp yg ECZA/ (142, P

+ £, Bab, 8) LIZ

))PR*R-T I

R
*#A-T,

R

A 1

7(14+Z,) PRR

A

R

e

+ (Zy/(14Z,) PAI + a &,
G

“EB at, +

Batp + Sp (34)

Using (26) and (30), equation (34) becomes:

PLRKY R(T -Spp) CL(ZR/ (142

+ J Qgt( Q) Mp WHE (G,

7147, )P

Rp) Ppeli PLeKy

co lwe Tap?

+ (T-Sh C0(Z, eH tw] CJ Preky

J Qt Q, *M,

A

HCG mT.

R

+

Ww
+ Sa-Twp? Trad + BB

EB CZ 40142.) Po#ld PLekytd Qy

R R R


- 40 -

(d) Changes in unit costs of production

Suppose the general wage rate at the Center, Wor is pushed
upward. The first effect is to raise all commodity prices. The
effect is direct at the Center and indirect in the Periphery via
the higher price to be paid for capital-goods imports. The second
effect; given constancy of the sectoral rates of profit; must be
to raise nominal profits in each sector. This will raise both the
direct sectoral demands for new capital-goods and the reserve
base at the multinational banks through associated increases in
saving.

Cost-push effects generally will be expansionary in a model
of this type where variations in nominal expenditures are
inherently non-neutral. As long as cost increases can be passed
on as price increases, the cost increase becomes a demand
stimulus. A much different story would have to be told if there
was an inverse relationship between, for example, the wage rate
and the profit.

But the general principle that a jump in nominal costs
means a jump in nominal expenditures spurring quantity increases
also illuminates the effects of a rise in wages in the Periphery
as well as the old policy chestnut--devaluation of the currency
in the Periphery. If w, goes ups output prices in the Periphery
will rise, again given constancy of the mark-up factors. This
means; in turn, that output prices at the Center will rise also

due to importation of R from the Periphery. The world economy's


The multinational banking system is depicted as drawing a
red line between the Center and the Periphery. The Center's
credit requirements always are met first. The banks offer the
Center an unlimited quantity of credit at a fixed set of terms (a
combination of interest rates and maturities). Thus, the volume
of lending to the Center is demand-determined. After the Center's
requirements are met the multinational banks then proceed to lend
the difference to the Periphery in a manner where the quantity of
credit supplied is positively related to the terms,

The paper proceeds in sections: (1) In the first section we
present the price structure for the four types of goods produced
internationally. (2) In the second section we model the Center
economy. (3) Next we model the Periphery economy. (4) In section
four we outline the determinants of the allocation of credit on
an international scale. (5) The fifth section integrates all the
preceding strands to present the full model and to put it through
its paces. (6) The sixth and final section illustrates the
implications of the model for the five questions raised at the
outset.

Since the dynamic thrust in the model appears to originate
with the production of capital-goods at the Center, there is a
self-conscious flavor reminiscent of models of “classical

' for example the ECLA school's structuralist

dependency,'
conception of the world economy. There is a Lewis-Nurkse flavor
(see Darity) to the model in the sense that expansion at the

Center means expansion in the Periphery, and contraction at the


- 33 -

all three of the remaining sectors' outputs are positively
related to the quantity of capital-goods produced at the Center.
When K is positive real GDP will be increasing in both the Center
and the Periphery. When K is negative production contracts ona
worldwide basis. We will inquire about what this implies for the
Periphery's chances of catching up below.

In the remainder of this section of the paper we
investigate a vriety of comparative statics exercises. These
exercises allow us to examine the effects on the world economy of
a variety of policy measures taken at both the Center and the
Periphery. It also enables us to present a representation of an
international "business cycle" based upon fluctuations in
producer optimism in both regions.

To produce results we have to establish, insofar as
possible, the signs of certain critical parameters in the model.
The particular summary symbols that need signing are X, Qi: J; Vs
U U U Cc, E E

E and E,.

2! Ugr zy? Eys Eps Egy 4
We will assume that the following conditions hold, which

1?

are sufficient to insure that all these summary symbols are

Positive:
See aon % ¢ 1 (44a)
Sow thy <1 (44b)
Sep ALY 61 (440)
Seq *ALY C1 (44d)
1> SK LZ sZt


- 19 -

Here P, is the Periphery's aggregate price index and y, is an
aggregate output index. With Ppt and Pat fixed, the rate of

growth of real GDP in the Periphery is:
Y, =opR to,A (24)

where op and G are the respective shares in nominal GDP for the
Periphery's export commodity and its agricultural output.

The demand for the Periphery's export is structurally
determined by production requirements at the Center; given the
scale of output at the Center:

R= Wot mo LK

Mew RK (25)
Using (11) and (19), equation (25) becomes:
R= J PLeKytd Qat( J Q tm HCG o-T 0) (26)

Jo= (mp He WoT tM + X > O, when X > Q.

Again, using extreme Kaleckian assumptions, the Periphery's

ome demand for its nontraded good can be expressed simply as:

PieA = woNa + Gy - Twa (27)


- 25 -

banks segment the market for loans between the Center and
Periphery--thereby offering the Center an unlimited supply of
credit (Figure 1) while offering the Periphery more credit only
at stricter terms (Figure 2).

The total new credit the multinational banks wish to make
available worldwide is contingent upon the inflow of deposits
into their coffers. These deposits are equivalent to the savings
out of profits from each of the four sectors in the model. The
total quantity of desired new lending, bos is a multiple, y, of
the new deposits:

+S, (38)

Lee Sou TS ey Tw SPRTMR Spal a?
Obviously, y can be interpreted as the deposit multiplier, and in
general will be considerably greater than unity.4 When there are
no reserve requirements the only limit on yis set by the bankers’
own nervousness about the risks associated with lending funds to
such an extent that they cannot meet their own liabilities.
Furthermore, equation (38) implies that the banks are indifferent
between the sources of their new deposits.
Out of this total desired volume of lending the

multinational banks first meet the Center's lending requirements.
As a result, the supply of credit to the Center Ly is determined

by the Center's demand for credit at the fixed terms toe:

Ss. e_ Do
LooFag7 tet oy agt #tlLog (39)


-21-

sector expenditure to encourage production of its export-good and
since agricultural output is derivative from the performance of
the export sector, it cannot do so with the A-sector either. In
contrast; since the Center uses K-goods at home, Center producers
are, in classic Kaleckian fashion, masters of their own fate. The
more they spend themselves on capital-goods, the higher their own
profits!
To proceed we specify the Periphery demand for capital

goods as follows:

PLeKye(1-Spp) (M-Trp)t(1-Spq) (TanT ag?)
E
+3) Lop typ (31)
The parameters S and S$ are the savings propensities out

PR PA
of Periphery profits. The Periphery enterprises, whether private

or public, also spend, on average, a fixed proportion of their
profits on acquisition of new capital goods. ObviouslYi ap is the
total profits generated in the export-goods sector, and Ts, is the

total profits generated in the agricultural sector while T and

aR

Tant? the respective sectoral profit rates. is the proportion
q

aL
of newly borrowed funds directed toward importation of

capital-goods, and Loo is the demand for credit from producers at

the Periphery. G is the Periphery government's expenditure on

KP
capital-goods.


- 34 -

CV-SoymAL Op ZZ OVA Z DCP ASP RH We Te (44e)

1> d- ~Sppo A, ZR J(14ZQ) PRe/PL®

+ (1- “Spa OZ, A142, dP, *H p“p 1 Ro (44)

9, + CB, (Zp/(1+Zp

+B, (Z,/(14Z, Pa tH p TRIPR EVIE |B >

+o, (Ly VFL dP, ervey (Y

))Pp *JP,. #V

vs ck weg ME g/142,))

PY FHW. TpXPL#VIE, By (49)
The first four conditions (44a-d) imply that the sum of the
savings rate out of each category of profits plus the marginal
propensity to "substitute" away from borrowed funds as profits
increase times the marginal propensity to spend borrowed funds on
capital-goods is less than unity. Intuitively, the left hand side
of inequalities (44a-d) constitute a measure of the extent to
which newly generated profits are channeled away from direct
expenditure on new capital goods. This diversion occurs both
because a portion of profits are deposits with multinational and
because profit growth leads to a substitution away from reliance
on borrowed funds; a fixed proportion of which otherwise would be
directed toward purchases of new capital-goods.

The intuition behind conditions (44e) and (44f), is less
obvious. Essentially it amounts to saying that a weighted average
of each region's commodity prices relative to capital-goods

prices--weighted primarily by terms that capture the net direct


- 16 -

Equation (19) can be interpreted as a quasi-reduced form
expression for the production of capital-goods in the current
period. It te is fixed at to* by the assumption that an unlimited
quantity of credit is available to the Center at the
competitively determined terms to* (see Figure 1 where Lo is the

overall Center demand for credit and L

is the supply) and if
the fiscal variables representing decisions by the Center's
Policymakers are taken to be autonomous, then the only endcgenous
variable in (19) is Kys the quantity of capital-goods demanded by
the Periphery. That provides the link to the structure of the
Periphery economy.

The parameter X is the capital-goods demand multiplier. In
straightforward fashion (19) indicates that an increase in the
autonomous component of Center private sector loan demand,
improved producer expectations of future profits, a rise in the
government's deficit in both wage-goods and capital-goods
expenditure, or an increase in export demand from the Periphery
all push up the production of capital-goods in the current
period.

To complete the construction of the model of the Center
economy we now need only the equation for the government's budget
deficit, BUD: which appears immediately below:

L (20)

BUD .=G, +G -T -T +6 0

KO [we nc we Se Ge “ca


PoYe = Pew + PK (5)

where P. is an aggregate price index and y. is an aggregate
output index. Under the short to medium term assumption that Py
and PE are cost-determined under the specifications of equations

(1') and (2'), the rate of growth of real GDP at the Center

simplifies to:

y. =o W +0.K (6)

where Ww and % are the respective shares in nominal GDP for
wage-goods and capital-goods. The dots over the variables
indicate percentage rates of change. In the context of this model
real growth in Center output is a weighted average of the growth
rates for each of the Center's productive sectors.

The demand for wage-goods is the sum of the proportions of
wages and profits, net of taxes; spent on consumption plus
government expenditure on wage goods, inclusive of transfer
payments. Therefore the equality condition between wage-goods
supply and demand will read as follows:

Put W = cy(WIN OWT) te" -T.

Fog TT Tye (6)

oO ¢c €1

1’ Sp! Sg


-31-

+ 9,6 YSpp)(Zp/(14Z yP #IP#VU, +957 Spy (Z,/ 0142, PA #H,

RR
*] *
+ 81 Spa (Z,/ (142, })P 3 HW tex VU,

+ 8, (Zy/ 01424) PQ *H, + 8 (Zy/ (142) Pa tHiw, TRIP #VU,

. 2
Ba E97 (Spt y MZ / AZ IPL RK, (VS HO) (ZS C1 AZ) PE XV

+ 94 (VSp gto ZZ C142 PAH WX

* *
* 8 (VScyta) Z,/ 142) )P, HW dy HP Vv

+ 9) BpplZp/(1+Zp) PpkJt9, YSpp(Zp/ (1 #Zp) PReIPLRVUS

+ gv Spy lZa/(1+ZQ) Pa tH iw, IpJt9y Spy (Za/(14Z 4) Pa tH Ww, TRIPE AVUg

+ By (ZR / C14, ))PRxtt 7 Zp/ 1 +Zp) PReIPL VU,

R

+B) (Zp/14Zq) Patt, TpJ+By (Zq/(14Zq) IP atta, TpIPy Vg

E, = 84 Y Spt MZ y/ 1 4Z I PE RVD, (VS p gt

a CZ /C14Z,) PAH wT XP EY

#9) Spa (Zp/(1#Zp) Pp tIP AVES, Spy (Za /(14Zq) Pq tH Wy RIP AY

+ By (Zyl (1+ Zag) Pee sP V+ By (Zp / 142.) Pa tHw, TRIP FV

K
The intuition behind the complicated expression in (43) is
quite straightfoward. The equation implies that ceteris
paribus stricter terms for loans at the Center, which reduce the
Center demand for credit, expand the supply for the Periphery
thus easing the terms for the Periphery. Similarly, improvements
in the Periphery's repayment rate (a rise in v,) or improved
expectations of “insurance” of loans to the Periphery (a rise in
j*) both shift the supply curve rightward, again easing terms.
Greater optimism on the part of producers at the Center or at the

Periphery stimulates their respective demand for loans; thereby

raising the terms faced by Periphery borrowers as well.


- 28 -

Substitution of (38) and (39) into (40) yields:
L* Fgt9) Y(Sont, +S. w w* Spr ThtSpaTTM,)
~ 9) A949, 4,7 .-3, GOT +9, ‘re *
D
“Slog +95 t p*datp +957 ptaqie (41)

which is the same as:


production at the Center but is not used at all in the Periphery
itself. The agricultural good is non-traded and consumed only at
the Center.

Note that it is irrelevant whether the Periphery export
good is viewed as a primary product (raw materials; petroleum, or
tropical produce) or as a manufactured intermediate good. What
matters is the assumption that demand in the Periphery is
"incomplete" in the sense that there is no demand for its own
export commodity at home. |

Following Kalecki the current period price of each of the
four goods can be treated as a mark-up over unit labor costs and
all other unit costs. For simplicity we make the extreme “one
hoss shay" assumption that capital-goods depreciate completely
and instantaneously at the end of each period. Capital-goods made
in the preceding period are used in the current period to make
the new output in each sector. They then disappear altogether.

The price equations for each sector follow:

_ P ;
Py = CZ Cw 1 tP awtPame, + id] a)
PL = (142, Cw 1, +P a, +Ppmg. +i, d J (2)

K Kem TAP et PRM Kt TI
P, = (14Z,)Cw, 1otP +igded (3)
R Rp Cw, TRtP, tipde

(4)

a
u

Pp .
A (14Z, 1 Cw Ty tPy Faitinda


Center means contraction in the Periphery. But unlike the
Lewis-Nurkse model the dependence is reciprocal between Center
and Periphery in this model. Nevertheless, the Periphery does not
have the capacity to spur its own growth by generating an
internal demand for its export good. This feature in particular
gives our model a historical specificity to the contemporary
world, although some aspects of the credit mechanism and the
movement of finance to the Periphery may evoke memories of
earlier episodes in global economic history (see, e.g9.; Leland
Hamilton Jenks on the movement of finance from Britain to the
rest of the word in the late 19th century.)

Our model bears some resemblance to the one advanced by
Nicholas Kaldor in his 1975 Presidential address to the Royal
Economic Society. It also has an affinity with the structuralist
models of "imported" inflation developed by some Scandinavian
researchers (see Aukrust and Edgren, Faxien,; and Odhner) in the

late 1960s.

I. THE INTERNATIONAL PRICE STRUCTURE

In our Center-Periphery model there are four goods produced
in the world economy. The Center produces capital-goods;, kK, and
wage-goods,; W. Capital-goods are utilized as an input in the
production of all four sectors' output. Wage-goods are not traded
and are consumed solely at the Center. The Periphery produces an
export good, Ry as well as an agricultural good, A. The Periphery

export good is used in both capital-goods and wage-goods


-17-

LoANS

Figure 1


-7-

> P i '
Pp* (14zp Cw, Tp tPy Iptipdpd (3')

*
"

Pa (14zy Cw, 1ytP aati a3 (4')

The stars indicte that equation (1') through (4') are
reduced form expressions for each of the prices. Prices are
entirely cost-based. The model altogether cordons off price
determination from quantity determination, as will be made even
clearer below.

Each z,. oF each sector's mark-up factor, can be
interpreted as the sectoral rate of profit. Since each is fixed
for the period of the model and each z, is strictly positive, all
sectors must generate a "surplus" above costs. Variations in
total profits will be attributable to fluctuations in quantities
sold but will not affect the sector by sector rates of profit.
Changes in total profits, however, can be associated with a high
degree of variance in the performance of individual enterprises
within a sector. When the total profits of a particular sector
falls due to a decline in the volume of sales, some firms may
find themselves achieving less than the sector-wide rate of

profit and even may go bankrupt.

Il. THE CENTER ECONOMY

Gross domestic product at the Center measured in Center

currency is the sum of the money values of each sector's output:


- 23-

+ (J QytmpyH CG - Td

-& 8
L 2 ACVAZ DIP AHH Cw, TRC PLaky

-T,

A
+ J Qyr(J Q) tmayH CG -T I+, wa?

& Br @ £8 ;
ee Lat *Skp (35)
Equation (35) can be simplified to:

Kyav CU, 1

+ UzQq-E 8 3th] (36)

+U (G,-TtU5(G “Ty?

VaP¥-(1-Spp~ & By) (2Zp/ (1422) PR J Pe

A A) P FHL, TRIPL

- e -“(1- “(V-
Ur E Both Bot, +Gpp a Scr) ar (1 Spr) a

Uys CV-Sp yg) (ZQ/ (1424) PH, - § By (Zp/ (142) PtH wip

(1-S YOZ A/C 4Z

Pa S81

Use C(1~-Spp-E 1B 7p) (Zp/(14Zp) PRe

+ (1~-Spq7 EB 1) (Za/(14Z,) Py tH EWEL

))Ppe

J (J Q,+Mp, HA)

R wee

Us C(1-s VZR/1+Z

PR eB 1 R

+ (1-Ap g7&) 81) (24/142) )P Hw LE]

The only remaining endogenous variable that needs to be
solved for is tocthe terms offered at the Periphery. This will
require specification of the supply of loans function for the
Periphery, which we present in the next section with our
characterization of the multinational banking system.

Ta complete our presentation of the Periphery economy we
need to provide the Periphery's goverment budget constraint. It
takes the following form:

BUD, =G,+G-p-T -Typt 5,0 L (37)

GP" -GP


International Finance Discussion Papers
Number 238

February 1984

A KALECKI-KEYNES MODEL OF- WORLD TRADE,
FINANCE, AND ECONOMIC GROWTH

by

William Darity, Jr.
E. V. K. Fitzgerald

NOTE: International Finance Discussion Papers are preliminary materials
circulated to stimulate discussion and critical comment. References in
publications to International Finance Discussion Papers (other than an
acknowledgment by a writer that he has had access to unpublished materials)
should be cleared with the author or authors.


- 46 -

Beenstock offes as one piece of empirical support for his
theory the observation that debt-service ratios did not display
unusually high levels for developing countries between 1970 and
1979. However, data from 1981 onward does reveal a marked rise in
the ratios--data which Beenstock did not have access to while his
manuscript was in preparation.

Since our model offers a cyclical explanation, relative
rates of profit need not change internationally for debt to grow
in the Periphery. As we showed in Section Sa, external debt can
build up in the Periphery on either the upswing or the downswing
of the world economy--depending on the type of regime that

prevails.

(b) Must the Center serve as the Periphery's engine of growth?
To the extent that expansion at the Periphery requires
successful exports of R to the Center, then expansion at the
Center is a prerequisite for growth in the Periphery. This is, as
we noted above, the Lewis-Nurkse effect in the model. In this
sense the Center must serve as the Periphery's engine of growth.
Can the Periphery escape? If it can develop internal uses for its
export good it can alter these circumstances. Expanded
"South-South" trade or the development of a petrochemical

industry in Saudi Arabia are examples of potential escape routes.

(oc) Can the Periphery serve as an engine of growth for the

Center?


- 10 -

We can rearrange (10) to derive an expression that
explicitly links the volume of wage goods produced to the volume

of capital goods produced:

WeH (wllLK + @ o-T) qq)
c cK wo owe

x=
m

1/(P, #-w_1) > 0
w cw

The term He . wooly “magnifies" K upward to give the output of

wage-goods as a partial function of the total production of
capital-goods in the current period.

The total capital-goods produced, K, is the sum of the
amount used at home in wage-goods production, Ky and in
capital-goods production, Kya as well as the amount exported to
the Periphery, Kyt

K=K + KL + K (12)

The supply and demand equality for capital-goods will be

expressed as follows:

PeKE C1 -Say) CmyoT yt C1 Say) Cm oT ak)*

LAA+P KytGee (13)

Atco tPF


Under (6) Twe is taxes taken from wages, Tow is taxes taken from

profits generated in the wage-goods sector; and Tv, is taken from

K

profits generated in the capital-goods sector. The terms andn,
are the total nominal profits from each sector and Ge is nominal
government expenditure on wage goods.

Each c; is the marginal propensity to consume out of each
category of income. In general Cy will be larger than either fo

or Cy We adopt the extreme version of Kalecki's simplification

that sets c, = 1 and Co = Cg = O which reduces (6) to:

Pu® We wNEmT ye + Ge (7)

As long as the gap separating c

1 from c, and c, is large this

2

simplification will not affect the analysis in an important way?

3

In equations (6) and (7) N is the total volume of

employment--i.e.; the sum of each sector's employment:

N =N +N (8)
c

which, via the technical coefficients; becomes:

N= Wy Wt Vk K (9)

Substitution of (9) into (7) yields:

K) + (Gy ocT, ) (10)

we

Pox W= w_(1 Wt?
w cow K


-~ 42 -

backfire. Otherwise, with profit rates unchanged elsewhere, a
higher profit rate in the Periphery's export sector boosts the
world economy.

This suggests that in this model price inflation is
generally beneficial from the standpoint of raising output and
employment. So why not push up all prices without limit? In fact,
there is no reason to cease and desist as long as the
multinational banks maintain a steady credit policy vis-a-vis the
world and the Periphery (i.e., Y and the 3,'s must remain
unchanged). Problems set in when the banks move toward a more
conservative posture with regard to their lending practices. It
is a stable climate of liquidity that accomodates the inflation
and preserves expansion.©

Of course; even with a stable climate of liquidity an
ultimate limitation remains on expansion. That limitation is the
barrier set when there is full employment of the labor force--or
no more labor is forthcoming to produce the additional output
mandated by the growth in demand.

In a stable climate of bank lending practice, if the Center
becomes less reliant on the Periphery's export good this is also
an i11 wind that blows no good from an employment and output
perspective. The parameters Mey and RK will decline, pushing
down Put and Pur when Zu and Ze remain fixed. The deflationary
contraction will set in worldwide. Similarly, the Periphery will
set off a downturn if it reduces its dependence on the Center's

capital-goods, enabling it to lower qe and/or Tat Productivity


- 30-

Substitution of (36) for Ky into (42) gives us an
expression for the loan supply in the Periphery where the only
remaining endogenous variable is toe Combining (26), (30), (32)
and (36) results in an expression for the loan demand where th
iS; again, the only remaining endogenous variable. By setting the
loan supply and demand equal we can solve for the reduced form
expression for the terms on loans made to the Periphery.
Adjustment in terms for loans at the Periphery clears the
international market for credit. We obtain the following messy
equation on these assumptions:
tec CEy-E, (Go -T “En (Ga-T,,

)-E,Q,-E,Ug? (43)

c fg, +0p y Zp/E1tZR IPR RIP AVS) (YS ppt RTT yp By L3

Pp

408) (zy /(14Z,) Pa tH we TRIPLE RVG, CY Spat
a CZ ZV FZ PH wT XP AVI & BQ)

_ _ e. 18)
E Qe 97997914 Q 497%] Me "8 Mgt eFtIytleg thep

_ 9 if e
937,794) Boh

- z
E129) CySpyet oy (ZZ C1 +Zp PL HXQ) #9 CYSop tay (CZ / C142) PL xVU,

+ (9) (ySpata, CZ /C1+Z DIP RH Dw TL XQ, +1)

+ a, VSpp(Zp/(1+Z,) Pe (IQ, +ma He)

+ 9) pp lZp/(1+Z,) PR eIP. VU, +9, YSp,(Z 7147, ) Py tH ow, I

A CIQ+m,

R Rw.)

# 9) Boal Zq/(14Zp) PatH, wi, Ip IP #VU +B (Zp/(14Zp) Pp (JQ) +tgyH. )
J

# 8, (Zp/(147p )PpeIPL FVU, 4B, (2 p/ (142g) Pp HH Wy 1p) (IQ, ta H. ?

+ By (Zp/(14Z,) Pa tHiw, TIPLE VU,
= 2 le
E,= 97 YSoy tay (27142, PL XV. U1 +9, Scat

ay CZ OFZ DP HH wT EXPL # VU,


-47 -

The Periphery can spur production at the Center by
importing larger quantities of capital-goods. If it could
independently raise its demand for imports it could stimulate its
own growth indirectly. This suggests; as Lawrence Franko (p. 292)
has indicated that LDCs could serve as an engine of growth for
the Center--as well as itselt.” But the financing of the
Purchases depends'on prior profits generated in the Periphery--or
access to additional credit, either for the producers or the
government, which means further dependence on the Center's own
profit-making experience and credit-seeking behavior. Ultimately;
easier credit is the mechanism that would sustain the Periphery
as a growth-leader for the Center; hence, greater indebtedness in

the Periphery as well.

(d) What is the worldwide impact of fiscal and monetary

Folicies pursued in either region?

What will be the worldwide effect of additional government
spending at the Center? Suppose it is additional expenditure on
capital-goods; perhaps in the form of subsidies to capital-goods
Producers to expand their operations. We can ask, how will K
change with respect to a change in Gig? But we also have to ask,
how will K change with respect to an increase in government

borrowing, a rise in L The total effect of the change in the

?
cG®
equilibrium level of capital-goods is given by the sum of the

following two partial derivatives:


- 29 -

s
uy FIA ty (YS ot oy CZ C1 HZ) PLEX Ca,ta,

(Gy enTwe dt PL#eKI

K Xx
+ 9, YS oy tay EZ Z C142 IP eH. Cw 1x CQ,+Q, Gente?

+ PRK 1+G) oT, 3

x we

+ 9) SpplZp/(14Zp) IPReCIPy ay +5 Qyt(J QytMpyH CGT.) 4
+ 9) SpalZ,/(1+Z,)IP,*H, Cw. 1, CIP #Ky tJ Qa

+ (0 QytmayH (Gy e-Tye II

- - e -
+ Ga-Tya29y 797 SMe TH AgtC* Sy heg

e
+ gat, tagr,tayk (42)

is)

Note that equation (42) displays several interesting
features. Those factors which increase absorption of credit by
the Center reduce the loan supply to the Periphery. For exampley
an expanded government deficit at the Center does not "crowd out"
the private sector's access to finance at the Center, but it does
“crowd out" the Periphery's access to finance. However; this
could be more than offset by the stimulative effects of
government spending on profits worldwide. A rise in nominal
profits anywhere in the world will raise the loans made available
to the Periphery, but an increase in anticipated future profits
at the Center will decrease the loan supply for the Periphery. A
rise in the terms offered to the Center (an upward parallel shift
in the horizontal Center loan supply schedule) will raise the

volume of loans made available to the Periphery.


Each P. is the current price of the respective sector's output.
Each Z; is the mark-up factor for the particular sector, while we
is the average nominal wage prevailing at the Center and Wp is
the average nominal wage prevailing in the Periphery. Sectoral
labor-output ratios are given by each Vi ij is the percentage of
each sector's outstanding nominal debt that comes due during the
current period--both interest payments as well as payments on
Principals and each q; is the sector's nominal debt-output ratio.
PO is the past period price of capital-goods; 9; is each
sector's ratio of old capital-goods to newly produced output.
Finally Tew and Mpa are the Periphery's export good to wage-goods
ratio and export good to capital-goods ratio in the Center's
Productive sectors. All nominal terms are measured in Center
currency.

Because of our short to medium term characterization of the

> Woy Tey Pho Gas

relevant period for the model, we treat z., w.
i i Pp i K i

Mew! Mae? ij and dq; as fixed. Substitution of (3) into a) and
(2) gives us a fully-determined set of output prices without any
reference to supply and demand:

tipdp) my

Q g
+ WI? q1')

= P
Poe = (+z Cw Vi tPy. at (1 tzp) (wel ptPy q

- P Po.
Pe (T4z, Cw. 1 +Py. at (14zp) (wi Tp tPy. Iptipda Mp,

+ id C2")


- 20 -

where G, is government spending on foodstuffs, inclusive cf
consumer subsidies; and Twa is taxes out of wages. Equation (27)

is equivalent to:

PARA = wet TpRtl A) + (Ga-Tya? (28)

which is, in turn, the same as:

A= an Cw VpRtGa-Tya? (29)

H. = 1/(P,#-w_1,A) > 0
Pp Pp

A A

Substitution of (26) into (29) yields:

A= He Cw, IplIPy#K y+ JQ,

+ (IQ, tmayH CGT) I+Ga-Ty a? (30)

The key remains determination of the Periphery's demand for
capital-goods from the Center, Kys which is the only endogenous
variable remaining in equations (25) and (30). Note that the
periphery's own demand for capital-goods stimulates home

production in both the R and A goods sectors via the stimulus to

Center production of K goods.
This is truly an interdependent world economy, but there is

an important asymmetry. The Periphery cannot engage in private


- 37 -

Paribus that the world economy rides a wave of expansion; a
series of periods where 7 declines will mean
ceteris paribus that the world economy slides into a downspin.
The product E_ BgE3 is significant from the standpoint of
determining when on the cycle there is a debt build-up in the
Periphery. TfE, B3E3 is less than one then the terms for the
Periphery become stricter as Center producers become more excited
about future profits. The loan build-up in the Periphery would
then occur when the world is in recession. Center credit demands
Presumably would weaken faster than profits decline, thus making
the "dumping" of credit on the Periphery pick up steam. However,
if E_ BgE3 is greater than one, more optimism at the Center means
easier terms for credit in the Periphery during the upswing. We
even can conceive of regime switches if the producté) BE, changes
magnitudes over time. Whether or not the process continues ina
stable cyclical fashion will depend in part upon rp! the
Periphery's repayment rate as its producers' indebtedness grows,
Note also that the magnitude of the stimulus to world
production provided by greater optimism at the Center depends

directly on the parameter aL is the proportion of borrowed

AL
funds channeled into purchases of new capital goods at the
Center. Tf ay is small, i.e., if a large proportion of borrowed
funds merely go toward refinancing all debts or paying off old
debts, then the stimulus will be small. A large value for Xe

implies, ceteris paribus, a larger stimulus.


- 38 -

(b) Greater optimism in the Periphery
Suppose enterprise managers in the Periphery become more

enthused about prospects for profits in the future, i.e.; T,

moves upward. What then? The derivative of K* with respect to Pp

takes the following form:

e ) (46)

K/n, = X+PL#E B(I-C Bg
Obviously this expression is ambiguous in sign as well. (Greater
producer optimism in the Periphery raises the Periphery's demand
for credit, thereby raising the terms faced by the Periphery. If
it raises the terms sufficiently, it might actually lead to a
reduced Periphery demand for exports from the Center thus
precipitating a worldwide decline in production. This would be
the case if the elasticity of demand for loans at the Periphery
with respect to the terms is exceptionally lage. Then we could
get the perverse result that CB, > 1 and a rise in , leads to an
international recession. But as 3 gets small the sign of (46) is
more likely to be positive, leading to the intuitively plausible

conclusion that greater optimism in the Periphery can provide

some stimulation to the world economy.

(c) Banking sector illiquidity
The multinational banks could retrench on their issue of
credit. They could retrench on a global basis which would mean a

drop inyor they could retrench in the Periphery which would mean


- 53 -

‘Presumably, Y would equal unity if the multinational banks
were faced with a 100 per cent reserve requirement.

this is the credit "push" effect in multinational lending.
It is compatible with Charles Kindleberger's view of
international banking practice but it is self-consciously at odds
with Irving Friedman's. Friedman claims the bankers passively
accept loan applications rather than go out "reaching" for loans.
The anecdotal evidence, at least, overwhelmingly favors the
Position that bankers do indeed push loans (e.g., Sampson).

Srhis is very much in the spirit of the sort of message
Kindleberger has tried to advance for years on the urgent
necessity of maintaining adequate liquidity in the world economy.

"Branko (p. 292) cites estimates from the LINK model that
suggested that in the late 1970s that a 3 per cent rise in the
annual growth rate in the LDCs would mean a1 per cent rise in
the OECD nations.


- 26 -

In contrast, the supply of loans to the Periphery, uo
takes the following form:

Lp Fata, (Le-L.")ta,t tag tags” (40)

The parameters 9g! 9,1 951 93 and 94 all are nonnegative
constants. 39 represents the autonomous or steady ongoing volume
of multinational bank credits issued to the Periphery, while 3)
is the coefficient weighting the residual volume of credit that
the banks wish to lend worldwide after meeting the Center's
requirements. The larger the volume of credit that the Center
fails to absorb; the more eager the multinational banks will be
to lend to the Periphery.” The term (L-L*) thus captures the
“redlining" behavior of the multinational banks. We assume ly >
Le always so that some funds are made available to the
Periphery.

Furthermore, equation (40) makes the supply of loans.to the
Peiphery bear a positive relationship with the terms, tot that
the banks can offer as well as with ror which is the overall
repayment rate on loans made to the Periphery. Finally, the term
i® is intended to capture the banks' expectations of receiving
what amounts, de facto, to insurance from the Center government
on their loans made to the Periphery. In the world we depict the
market clearing value th* always exceeds the terms offered to the

Center, t_#.
c


To pursue these matters, the model presented here
highlights the important role of international credit flows in
the chronological short to medium term. The model locates the
dynamic forces driving worldwide growth and distribution at the
Center through the use of a neo-Ricardian cost-determined trade
model with an international credit mechanism. Second, it permits
the modelling of financial flows through an international credit
mechanism not merely as automatic compensation for trade
imbalances left uncleared by relative price movements; i.e.)
terms of trade variations inclusive of exchange rate variations;
but instead as a result of shifts in the economic accumulation
balance at the Center (savings; investments, etc.). The Center is
“dominant” because of an asymmetry in the structure of
Center-Periphery trade. The Center utilizes (or "“consumes") its
own export commodity, but the Periphery only finds a market for
its export commodity at the Center. As a consequence, despite the
global interdependence this model depicts; the characteristics of
investment and income distribution at the Center are decisive in
determining the flows of world trade and finance.

Unlike many neo-Ricardian models this one, as mentioned
above; consciously adopts a short to medium term cast rather than
the more familiar long period equilibrium style. This makes it
Permissible for sectoral rates of profit to differ. In Kalecki's

sense, degrees of monopoly can differ across sectors.


~ 45 -

119) the growth in LDC debt is desirable since it will finance
economic development.

+++LDC indebtedness is not simply a dis-

equilibrium consequence of the behavior of world

oil prices which threatens the international

monetary system. It is an equilibrium or

structural consequence of LDC industrialization.

As such it should not be a cause for concern.

Indeed, attempts to frustrate this process in the

mistaken interest of world monetary stability

will undermine the legitimate spread of world

development.

We need not take such a felicitous view of the debt

build-up in our model. After all, as Charles Kindleberger (p. 6)
has pointed out, typically "...productive loans are not very

" In our model,

productive and do not stay long out of default..."
if a is very low only a small percentage of loans received by
Periphery producers will maker their way into purchases of
capital-goods. They can be used to meet previous debt obligations
by merely substituting one set of creditors for another, or
dissipated in many other ways. Moreover, although we do not model
this explicitly, government expenditure that relies upon borrowed
funds need not go to purchases of capital-goods or agricultural

output but could go instead to arms purchases or for bureaucrats’

perquisites.


~ 43 -

gains in any sector--declines in We Ver lps or Vyr7all have
similar adverse effects on employment and output. Cost-cutting

means cutting production in this model.

VI. SOME FINAL QUESTIONS
At last we are prepared to reconsider the questions posed

at the cutset of the paper. We take them one by one.

(a) Why the debt crisis?

This model offers quite different insights into the reasons
underlying the build-up of external debt in the Periphery from
those offered customarily. It ts a cyclical explanation rather
than the stochastic explanation offered by Sachs and Bruno or the
secular transition theory offered by Begnstock.

The Sachs-Bruno viewpoint has it that the rise in external
debt, especially in the group of countries that Lawrence Franko
(p. 292) somewhat ironically calls "the charmed circle of 10," is
due to their needs to finance balance of payments difficulties
brought on by the oi1 price shock. Sachs and Bruno, in
particular, have pushed this position in a series of papers; but
there are some unsatisfactory aspects to their argument, not the
least of which is Beanstock's (p. 117) complaint that "...LDC
borrowing on world capital markets was firmly established well
before the OPEC oi] price explosion. The LDC debt 'problem'

existed before 1974."


-13-

policy at the Center and their effects on interest rates,
subsequent changes in nominal wages, the paths of prices of
imported materials and exchange rates; as well as the price they
will receive during the next period for the forthcoming output of
wage- and capital-goods.

We treat 1 as "autonomous" to accomodate Keynes' emphasis
on the relentless intractability of "knowing" the future.
Strictly speaking the expectation 1° presumably has a nonzero
elasticity with respect to current profits. However we view the
relationshp as so volatile that we opt for the simplifying tactic
of treating expected profits as exogenous. It is the cyclical
swings in 1 that give us the cyclical swings in the Center
economy.

Finally te is the terms available for credit to Center
corporations. Its value is inversely related to the demand for
loans from the multinational corporations.

In addition, note that total profits at the Center can be

expressed as follows:
TM OF (LO FZ IP AWA Z E/T AZ) PRK (15)
Merging (13), (14), and (15) gives us:

P #KEC 1S ECL S14 Z) PL AK OT yd

K

+ CV-S_ EZ 14Z IP eWoT I


- 55 -

Kindleberger, C. P. (1978) "Debt Situation in Developing
Countries in Historical Perspective" in Stephen S
Goodman (ed.) Financing and Risk in Developing
countries New York: Praeger.

Reich, Robert (1983) "The Next American Frontier" The
Atlantic Monthly vol. + Pp. 43-58.

Sachs, Jeffrey D. (1981) "The Current Account and Macroeconomic
Adjustment in the 1970s" Brookings Papers on
Economic Activity Vol. 1, pp. 201-68.

Sampson, Anthony (1989) The Money Lenders Penguin Books.


-15-

C(1i-S_ CZ /014Z )(P #H_OCG -T OO)
cw ow w woe wo owe

-2d -
oy 2yZ OFZ CP FH CG Two?

~ OST TIS ew Taw AL %
FA agme “A agt HPL AKy tke 18)
Equation (18) can be simplified to take the following form:

K = X CQ,+Q, (G Ty TP eK] (19)

we

Qy = ALaQtA ym “A, agt +e

= 1-84 IT EOS ey Te wy

Q, = CHS. apa, (ZS TFL PAE
X= (Ppa (1-Syy) (ZS 4Z Py

- (1-8. 00Z 40142, )P #H wd
cw w w woeckK

tA, ay (Z

-1
pl UFZ DIP RHA % (Ly OFZ DIP HH Ow 9


A KALECKI-KEYNES MODEL OF WORLD TRADE,
FINANCE AND ECONOMIC GROWTH

by William Darity, Jr. and E. V. K. Fitzgerald*

Introduction

This paper employs a highly aggregative, two-region model
of the world economy to facilitate examination of certain
fundamental issues involving prospects for economic advance by
the non-industrial or industrializing nations (the Periphery).
These issues are considered in the context of a particular
structure of production and trade by the Periphery with the
advanced industrial nations (the Center). The issues include the

following:

a) How can the recent massive build-up of external debt
by the developing countries be explained?

(2) Must the Third World countries rely upon the old
metropolitan powers for their engine of economic growth?

(3) Can the Third World countries serve as an engine of
growth for the old metropolitan powers?

(4) What is the impact of fiscal and monetary policies
pursued in either region on the overall performance of
the world economy?

(3) Given the prevailing structure of the world economy, is
it reasonable to expect the poorer nations of the world

to “catch up" with the richer nations?


- 36 -

-Ch, a,

3 L°2 (45)

aK eS a® = C(1+P,#U

K X45) BCE

3
which, at first glance, is ambiguous in sign. The last two terms
in the sum in parentheses are a consequence of the effects of an
improvement in Center optimism on the terms offered to the
Periphey. The term § BCE, reflects the tendency of the rise in
Center producers' animal spirits to lower the terms by increasing
profits and leading, in turn, to a greater expansion in the total
credit made available at the Periphery. On the other hand; the
term -C reflects the tendency of Center producers to demand more
credit as their optimism increases thus reducing the credit
available to the Periphery. Which effect is stronger depends upon
whether the producté 18,6, is greater than or less than unity. If
it is greater, the terms become easier; if it is less then the
terms become stricter. But the overall effect on K* must also
include the direct effect of increased Center demand for
capital-goods as optimism spreads, given by the product
CT+P Ug) X. Presumably that product will ensure that the
derivative is positive and that greater optimism at the Center
spurs higher output and employment in capital-goods production
and, ultimately, worldwide.

We can then generate cyclical swings in the world economy
based upon upturns and downturns in producer optimism. A series

- e . . .
of periods where TM. increases will mean ceteris


~ 24 -

The deficit in the Periphery, BUD,» is also financed by borrowing
from the multinational banking system in the amount Lop: g, is
the proportion of the Periphery's outstanding debt paid off in

the current period and Dep is the Periphery government's

outstanding debt, including the indebtedness of public sector

enterprises. Therefore total loan demand in the Periphery, Lao
ist
LP B58, 1,48 91, °- bgt th (38)
Pp O°l p°2 Pp 3°p —~GP
Iv. The International Credit Mechanism

This section provides a highly simplified exposition of the
international credit mechanism focusing on the role of financial
intermediaries. The multinational banks generally are assumed to
prefer to lend to the Center. The political risks associated with
making new loans to the Periphery lead international lenders to
desire to distribute available credit to the Center first.

We could just as well argue that the multinational banks
follow a Branson-type scheme. Conceivably they could identify an
array of expected rates of return on projects across the globe
with the largest proportion of high expected rates, inclusive of
risk premia, being located in the Center and the lowest
Proportion being located in the Periphery. If investment declines
at the Center more high return projects are eliminated from the
Center's array. This will shift the attention of bankers to
projects lower on the ladder, resulting in a greater flow of bank

finance to the Periphery. But we opt for the assumption that the


ABSTRACT

Borrowing from the insights of Michal Kalecki and John
Maynard Keynes, this essay presents a highly-aggregative model of
the world economy that highlights the crucial role of
international credit flows in the short to medium term, The
Center nations (or the developed industrial nations) produce and
export a capital good that is used in all sectors of the world
economy while the Periphery (or the developing nations) produces
an export good that is used only in productive sectors at the
Center. The model also includes an international banking zone
that allocates credit to the Center and the Periphery--with a
preference for lending to the Center. The model displays certain
crucial features of international economic interdependence, while
simultaneously revealing the decisive role of investment and
income distribution at the Center in determining flows of world
trade and finance. In addition, the model facilitates exploration
of the consequences of the current massive levels of state
indebtedness held by Third World countries as well as the

contradictions of the current international "liquidity crisis."


- 48 -

3 a 3 =
Kes IG 49K ¥/ OL X + XP, #LVU,+5 8 CE

KC CG -1)Cg,] (47)

3

Typically, one would assume that the sign of the expression
on the right hand side of (47) will be positive regardless of the
sign of the term in brackets. As long as the first term, Xy
outweighs the remaining term, under our assumptions (44a-g) an
increase in the Center government's deficit to purchase new
capital goods stimulates the world economy. If; however, (E4713
is negative and the product B 83(E,- IC ,, is sufficiently large,
then the increase in credit demands at the Center to finance
purchases of new capital-goods excessively "crowds out"
expenditure on capital-goods in the Periphery. This could drive
Kx downward bringing W*¥, R¥, and A® down with it.

What about fiscal stimulation in the Periphery? Suppose the
Periphery government spends more on purchases of capital-gcods
imports? Then we will have:

dK#/ 9G, + OK¥/ OL = XPL*(V-& BAC) (48)
K PG K 3

Pp
In this case unambiguously the terms of loans worsen for the
Periphery. The Periphery government's own expenditures crowd out
borrowing and spending on capital goods out of borrowed funds by
producers. Whether or not this adverse effect is sufficient to
cause a contraction in the world economy depends on the term in
parentheses. The term V captures the direct stimulus to

capital-goods production from the additional expenditure. The


- 32-

V. The Full Model _ in Operation

The complete model now can be solved for all sectoral

quantities of output if we retrieve the following six equations:

t ,*aC CE GH EO GH T HEY (Ga-Typ) -EgQ gE gly] (43)
kysv PUG FU, (Gy-T FU, (GT) tU3 05% L83tpJ (36)
Kk =X CQ +O, (Gm TY HPL RK I (19)
We He (we lktG nT ye?) a1)
R= Moy tak (25)
A= H, (we TpRtGa-Tya) (29)

The model effectively reduces to six equations in six
unknowns. Working in sequence we obtain from (P3) first the
market-clearing value for to*s the terms at which loans are made
available to the Periphery. Substituting to into (36) gives us

the reduced form expression for K)*, the quantity of

x
capital-goods exported to the Periphery. Substitution of Ky® into
(19) yields the reduced form expression for the total amount of

capital-goods produced. Everything else follows directly since


-41-

Production moves upward for the same reasons it does when We goes
up.

Suppose the Periphery devalues its currency. This would
mean a lower price for the Periphery's export measure in Center
currency--or Pe becomes lower. Unless profit rates change
elsewhere; all other output prices must decline pulling down
sectoral profits and pulling down the world economy. Devaluation
simply does not promote growth in the Periphery in this model.

Consider the flip side of the coin. The Periphery seeks to
extract a higher rate of profit by forming a cartel in its export
sector, thereby pushing up Pre This "shock"--an oi1 price
"shock," for example--actually stimulates the world economy by
raising total profits everywhere, if profit rates remain
unchanged elsewhere.

If, however, the Periphery succeeds in raising its profit
rate for Rone might expect other sectors' profit rates to
decline. Then the outcome plainly is ambiguous. If profit rates
fall at the Center, for example, it is possible for total profits
there to decline. This would lower the Center's demand for
capital-goods, reduce the funds deposited with multinational
banks, and increase the Center's demand for credit since loans
and profits are substitutes. Whether or not the Periphery's
increased profits in the export sector compensate for its stiffer
access to credit would depend on the magnitude of the profit
gain. But if there is some inverse interdependence between

sectoral profit rates, it is possible for the cartel strategy to


-27 -

.
2
.*
3

Figure 2


-ll-

The terms Sow and Sex are the savings propensities out of profits
generated in wage-goods and capital-goods production. What is not
saved is spent on new capital-goods. There is no outright
hoarding taking place in this model. Profits either go toward
purchases of new capital-goods that will be used in production
during the next period or go toward savings. The savings flow;
which will be modeled in greater detail below, goes into deposits
with the multinational banks.

The short term character of our model means we assume
corporations have full information about current costs and prices
at the time they make their expenditure commitments on newly
produced capital goods. But they are uncertain about the costs
and prices they will face in the future period when they sell the
output they will make with the capital-goods purchased today.
Their uncertainty is "subjective" in Keynes' sense. As a
consequence; they follow a rule of thumb in dividing the use of
their profits between purchases and savings.

The parameter , is the proportion of newly borrowed funds

L
directed toward purchases of new capital-goods by Center
enterprises; and bee is the quantity of new credit they demand in
the current period.® The expression PLsky is the nominal demand
for capital-goods from the Periphery; and Geo is the nominal
expenditure by the Center government on new capital-goods.

It is the loan demand function that is the site of the

action that provides the dynamic forces propelling the Center


-~ 49 -

terme, BC captures the indirect loss due to the harsher terms for
credit in the Periphery.

Similar stories can be told about the conflicting effects
of increased expenditure on wage-goods by the Center's government
or agricultural goods by the Periphery's government. More
interesting is the possibility of pursuing expansionary monetary
Policy in either region, a possibility we have not modelled
explicitly. But suppose that the Center government could conduct
an open market operation where it “borrows” without necessarily
crowding out funds for the Periphery--then the purchases it makes
on goods will be unambiguously expansionary. The same will be
true for spending on commodities by the Periphery's government,
j.e., if the Periphery can raise government spending withou
raising its taxes. This possibility would depend upon the
relationship each region's central bank bears with respect to
purely domestic commercial banks, which are not modelled here, as

well as the multinational banking sector, which is modelled here.

Ce) Can the Periphery ever catch up?

In the world we have depicted here, can the Periphery ever
catch up? Specifically can it achieve the same level of GDP as
the Center?

Recall that all sectoral growth rates move in the same
direction as the growth rate for capital-goods production at the
Center. Using equations (6) and (24) and assuming that fiscal

policy in each region is not changing, the following expressions


- 51 -

if the swings are of similar lengths the Periphery will stay in
the same relative position.

Therefore, prospects for the Periphery to gain ground in
the context of this type of environment are dim at best. The
mechanisms of world trade, finance, and economic growth presented
here would tend to maintain persistent poverty for the poorer

nations, Such a structure precludes parity.


-~14-

+ A Ogr A ay COZ 1 4Z PRK

+ (Z 7142 PP ewdt ALOT

Ay gt +P Ky ten (16)

which, in turn, by using (11) is equivalent to:

PLeke (1-8 YC(Z AV4Z OP #K-T

kK K}

cK K

+ CVS EZ C1 4Z IP RH Cw I KAG HTT wi

+ ALM AL PL eK

a CZ C1 4Zy K

+ (ZS OFZ VCP HH Cw TL KAG HT

e
+A O57, AL gt +P K +G (17)

x “KC

Equation (17) can be rewritten as follows:

EPL em CVSaL CZs C142 PL

K

- V-Sy ZZ O14Z OP HH wel

+ AO CZ ES OVFZ IPL RHA CZ C1 FZ PL HH we 1d K =

\