metadata: authors: 0: author: International Economics Department
count: World
docna: 0: docna: Can the industrial countries return to rapid growth?
docty: Policy Research Working Paper
subtopic: Private Sector Economics,Private Sector Development Law,Inflation,Employment and Unemployment,Macroeconomic Management,Marketing,Energy Demand,Energy and Environment,Energy and Mining
teratopic: Poverty Reduction
abstracts: cdata!: This paper presents the discussions that
            took place at a seminar about the major global economic
            issues in the context of the long-term prospects for the
            industrial economies. Most participants agreed that growth
            rates are not likely to return to well over 2.5 percent in
            the medium run - unless some policy yet to be defined
            emerges - and that this slow down will particularly hurt
            developing countries. The meeting ended with a concensus
            that something must be done to stabilize exchange rates.
repnme: repnme: Can the industrial countries return to
            rapid growth?
display_title: Can the industrial countries return
            to rapid growth
listing_relative_url: /research/1989/08/437010/can-industrial-countries-return-rapid-growth
topicv3: Private Sector Development m1326060 1921,Current Account m1326278 1135,Energy and Extractives m1326595 507,Inflation m1326709 0870F4727ACED1CF8525815C00471347,Unemployment m1504051 2747
publishtoextweb_dt: 2010-07-01T00:00:00Z
historic_topic: Poverty Reduction
origu: Policy Plan & Prog Review Dept
no_of_pages: 63
model_extractions: **Plc,Planning, ajnd Research**

**Inentonal Economic Anaiyslki and Prosp.cs**

In January 1988 the International Economic Analysis and Prospects Division of the Intemational Economics Department held a one-day round table seminar on the prospects for economic growth in the industrial coantries in the 1990s. Following are highlights from the discussion:

[after the war] with the rcsult that wage expectations became unrealistic relative to underlying productivity growth, with the result thzt wage earners and unions in many countries essentially forgot that they also had a kind of responsibility for what happened to real wages and thereby demand for labor.

_Andrea Boltho:_ Even if, in an ideal world, Japanese savings ought to be exported to Latin America, we are not in that ideal world: we are in the presence of major imbalances. whatever intertemporal shifting might lead one to expect. Is it, iherefore, inevitable that the next few years (1989-91) will see a recession? And if we see a recession, will it be coupled with inflation - or will we at least be able to avoid one or the other of these two possibilities?

What would bring us to a higher growth rate? The only thir,g that the Fund has to recommend is policies of deregulation. Frankly, I am far from convinced. For one thing, the 1950s and the 1960s were almost certainly a period in which regulations increased, in which the Welfare State became more "oppressive," in which labor legislation got more binding. Yet our growth went on and on and on, apparently unperturbed.... it doesn't look as if these micro distortions were quite as important as people tried to make them out to be. [On the other hand, one kind of deregulation] has had extremely serious negative consequences for our growth perfornance: deregulated [foreign] exchange markets.

_Fleinminzg Larsen,:_ Expansionary fiscal pDlicies perhaps w"erc pursued a bit too long _Jean Baneth:_ Growth is like a bicycle. if it slows down too much, it may fall. And I personally believe that hecause of both political and social restraints, as you fall below or try ,o stay at 2.5 percent, the long-term outcome may in fact be much slower growth.

_Leslie Lipschitz:_ One of the problems might well be that Americans understand very little of the problems of Europe and are not persuasive in talking about Europe, i I suspect vice versa -that sometime when one listens to this debate, it sounds like a dialogue of the deaf.

_Steve Marris:_ None of our models take into account the interreaction between price elas.icities and income elasticities. You know, what every other country has learned is that if you combine an undervalued exchange rate with r recession, miracles happen. They happened in Brazil; they happened in Mexico; they used to happen from time to time in France. There is every likelihood that they could happen in the United States.

I suppose what we need is a crisis serious enough [that we can] lock the govemments into a better managed exchange rate system, but not so serious that the whole thing brcaks down and there is nothing left to manage.

Economic Analysis and Prospectsand Prospects

> This paper is a product of the lnI.7.aiiaI Economic Analysis and Prospectsand Prospects Division, International ELo1omiics Dcpaiiment. Copies are available free from the World Bank, 1818 H Strect NW, Washinigton DC 20433 Please contact Jackie Queen, room S7-212, extension 33740 _(55_ pa!-P' .

The PPR Workin4 Paiper Series disseminates the findings of work undei **wa. ar. lt,'-** ' Pi r ning, and Rcsearch **'** •icv. Compiex. An objectivc c f the serics is to get _ihese_ findings out quickly, cvCTI if _p,c_ **_'._** iatio-s arc less tCan rfull polished. The finding'., intlrpretations, and conclusions in these papers do not necessarily represent official pohr)y of the Bank.

Produced a; the PPR Dissemination Center
- _Andrea Boltho - Professor of Economics, Magdalen College, Oxford, U.K._

- _Colin Bradford_

- _Professor of Economics, Yale University_

- _Stephen Harris_

- _Sr. Fellow, Institute for International Economics_

- _Paul O'Brien_

- _Economist, Balance and Payments Dlv., OECD, Paris Office_

- _Goran Ohlin_

- _Asst. Secretary General, Department of International Economic and Social Affairs, United Nations_

- _George Perry_

- _Sr. Fellow, Brookings Institution_

# **_INTERNATIONAL MONETARY FVND_**

- _Flemming Larsen_

-

- _Division Chief, Current Studies, Research Department_

- _Leslie Llpschitz_

- _Divislon Chief, European Department_

- _Massimo Russo_

- _Director, European Department_

# **_WORLD BANK_**

- _Paul Armington_

- _Division Chief, International Economic Analysis and Prospects Division_

- _Jean Baneth_

- _Director, International Economics Department_

- _Francis Colaco_ - _Sr. Economlc Advisor, Sector PolLcy & Research_

- _ShahroKh Fardoust_ - _Economist, International Economic Analysis and Prospects Division_

- _Johannes Linn_ - _Staff Director, World Development Report_

-

- _Desmond McCarthy Senior Economist, Latin America & Carribean Department_

-

- _Francisco Sagasti Chief, Strategic Planning Division_

- _Andrew Steer - Chief Officer, Risk Management & Financlal Policy_

-

- _Eugene Versluysen Senior Economist, World Development Report_

- _D.C. Rao_ - _Director, Risk Management & Financial Policy Department_

_(i)_
**_INTERNATIONAL ECONOMICS ANALYSIS AND PROSPECTS DIVISION_**

# **_PREFACE_**

_In January 1988, the International Economic Analysis and Prospects Division (IECAP) of the International Economics Department, as a part of its ongoing research activity on global prospects, held a one-day, informal, round-table seminar to evaluate various views concerning prospects for economic growth_<sup>_in_</sup> _the Industrial countries during the decade of the 1990s. The seminar was titled: Can The Industrial Countries Return To Rapid Growth?_ _This volume contains_ **_the_** _main body of the discussions chat took place at that seminar. The participants, whose name list appears below, were invited by Mr. Jean Baneth, Director of International Economics Department, from a cross section of international organizations and private research institutes._<sup>_The_</sup> _meeting was held at the Bank and was chaired by Mr. Baneth._ _The following set of background papers were sent to each invitee, prior to_ **_the_** _meeting, in order to help organize_ **_the_** _discussions around a given theme: Andrea Boltho, Can We Return to RaDid Growth?, Division Working Paper No. 1987-4, IECAP, World Bank, December 1987; subsequently a revised version of this paper has been released as a PPR Working Paper, WPS 9, World Bank, June 1988._ _World Bank, World Development Report 1988, Draft, December 1987._ _Paul Armington and Shahrokh Fardoust, a C.omment on the Outlook in the Light of Professor Boltho's Paper, mimeographed, IECAP, World Bank, January 1988; a revised and updated version this paper, retitled Long-Term Prospects for the World Economy, will soon be released by IECAP._ _The editing has been kept to a minimum, and what is reported here is nearly identical to the actual deliberations during the meeting. Nevertheless, in order for the document to be more readable, three types of changes have_<sup>_been introduced_</sup> _to the original document, which was based on the sound recording of_<sup>_the seminar._</sup> _All discussijns not directly concerned with the main cheme have_<sup>_been taken out;_</sup> _unfinished or incoherent sentences have been edited, .nainly by the participants themselves; other changes have been put in brackets [ J; and, finally, an attempt has been made to identify the sources of some of the items that_<sup>_were referred_</sup> _to by the participants at the meeting (i.e., reports, published scholarly_<sup>_arti-_</sup> _cles, etc.). The result is a document that contains a_<sup>_number of interesting_</sup> _and stimulating discussions about the major global economic issues in the context of the long-term prospects for the industrial economies. We hope_<sup>_that this, and_</sup> _other similar produccs planned for future release, will be found_<sup>_useful by the_</sup> _Bank staff._ _The initial editing and the arrangement of the text were done bv Shahrokh Fardoust; Jacquelyn Queen was responsible for_<sup>_the word processing and_</sup> _the production of the document._ _International Economic Analysis and Prospects Division_ _(i.)_
# **_TABLE OF CONTENTS_**

|**_SPEAKER_**|**_MAJOR TOPICS_**|**_PAGE NO._**|
|---|---|---|
|**_AndreaBoltho_**|_Can_**_We_**_Return to Rapid_**_Growth?_**|_1_-<br>_7_|
|_Goran Ohlin_|_Investment-Technology and Structural Change_|_8_- _11_|
|_Leslie Lipschitz_|_Current Account Imbalances_|_11_- _13_|
|_Massimo Russo_|_Role of LDCs in Imbalances_|_13_- _14_|
|_George Perry_|_Payments_<br>_Imbalances_|_14_- _15_|
|_Paul O'Brien_|_Policy Coordination and Inflation Threat_|_15_- _17_|
|**_Colin_**_Bradford_|_Smooth Transition from Imbalances to_<br>_Long-TermGrowth_|_18_- _19_|
|_D.C. Rao_|_Systems Shocks_|_19_|
|_Andrea Boltho_|_Definicion of System Shock_|_19 - 20_|
|_F temming Larsen_|_Reduction of the Imbalances and the_<br>_Long-Term Growth_|_21_- _24_|
|_Jean Baneth_|_The Triffin Paradox and Sustainability_<br>_of the Payments Imbalances_|_24_- _25_|
|_Paul Armington_|_The 21⁄2 percent Solution_|_25_- _26_|
|_Leslie Lipschitz_|_Policy Coordination_|_27_|
|_Stephen Marris_|_Inflationary Recession and Exchange Rate_<br>_Instability_|_28- 32_|
|_Goran Ohlin_|_What Will be of Importance in the 1990s?_|_34_|
|_Johannes Linn_|_On the Role of Technology_|_35- 36_|
|_Goran Ohlin_|_Structural Change_|_36- 37_|
|_Andrea Boltho_|_On the Determinants of Long-Run Growth_|_37- 39_|
|_Stephen Marris_|_The "Liberal Market" Economy and the_<br>_Feed-back from the LDCs_|_39_- _40_|
|_Andrea Boltho_|_Export-Oriented Economies_|_40_- _41_|

(iii)
# _TAB_ **_L_** _OF CONTENTS (cont'd)_

|**_SPEAKER_**|**_HAJOR_**_TOPICS_|_PAGE NO._|
|---|---|---|
|_Colln Bradford_|_Multiple Locus for Growth_|_41_- _42_|
|_Goran Ohlin_|_In the Role of Financial Markets_|_43_- _44_|
|_Andrew Steer_|_Linkage Between OECD and Developing Countries_|_44_- _45_|
|_Eugene Versluysen_|_High and Low Growth Scenarios_|_45_|
|_Leslie Lipschitz_|_Growth in Germany_|_66_-<br>_48_|
|_Stephen Marris_|_Prospects for the European and Developing_<br>_Developing Countries_|_48- 51_|
|_Paul Armington_|_North-South Linkage_|_51- 52_|
|_Andrea_<br>_Boltho_|_More on the_<br>_Long-run_<br>_Prospects_<br>_for_<br>_Growth_<br>_in theLDCs_|_52 - 53_|
|_Jean_<br>_Baneth_|_Summary of_<br>_the Meeting_|_53 - 55_|

(Iv)
1

# **_PROCEEDINGS_**

# _PAR T r1_

_(Morning session lO:am)_ _MR. BANETH: The main document around which I would like to structure the meeting is Professor Boltho's attempt at describing the constraints on growth and what he sees as the means for accelerating it in the industrial countries; and the economic, social_<sup>_and_</sup> _political implications for the developing countries if we could accelerate growth, or indeed if it slows further._

**_Can We Return_ to** **_Rapid Grovth_**

_PROF. BOLTHO: I don't expect any of you to have read my paper because it is immensely long. So I will briefly_<sup>_summarize_</sup> _it first and then mention some of the possible issues which we mighc discuss this morning and this afternoon. The paper is an attempt_<sup>_at_</sup> _seeing what the constraints on long-term growth may be. It takes_<sup>_a_</sup> _historical approach. It goes back in time quite far. It makes a very convenient assumption at the outset which is to ignore virtually all the real important problems. The issues of the dollar, of the deficits, of the imbalances, of debt are swept under the counter, which is very convenient, but obviously dangerous, and it concentrates on the conditions for rapid growth thereafter. In other words, it assumes that in some way or another we will_<sup>_be_</sup> **_able_** _to get out of the present mess in a non-defined time horizon, five years, eight years, possibly twenty-five years. And it says, well, let's assume that we can get out of the various imbalances which beset the world economy today,_<sup>_can we then_</sup> _get back to a growth trend that is about the 2 to 2-1/2_<sup>_percent per_</sup> _annum that we have been experiencing since the second oil shock?_ _Now I admit that while it is convenient, it is a dangerous assumption if only because the transition, the way_<sup>_in which we gec_</sup> _out of present day imbalances will color the future growth prospects of the world._ _The ocher assumption which I make, in looking at_<sup>_longer-_</sup> _term g,owth, is a very simple one_ -- _a justified one -- which_<sup>_is chat_</sup> _investment is the main engine of long-term growth._<sup>_It is when_</sup> _investment accelerates that growth accelerates as well. For individual countries, exports can take that role; exports_<sup>_can be an engine_</sup> _of growth, but I am not interested in the experience_<sup>_of individual_</sup> _countries. I am interested in the experience of all the_<sup>_industrial-_</sup> _ized countries at the same tirie._ WP/PROC/SF:J **sa**
_2_ _The reasons why I am such a strong believer in the virtues of investment are spelled out in the paper. And, in turn, investment, which determines longer-term growth is strongly linked with technological progress, and is a function of optimistic expectations. be these of profits or be Liese of future demand. I don't want co enter into the Keynesian v .sus Neo-classical controversy. I just say that, in fact, the two tend to be correlated over the cycle and over the medium-run anyway._ _Therefore, it is optimistic expectations that generate upswings in investment, and it is upswings in investment, in turn, which lead to acceleration (or deceleracions in the opposite case) in the growth path of the world economy._ _What are these expectations function of? Well, there the field is more open, as far as I am concerned. There are various views on what may generate favorable expectations. One of chem is the idea that we are subject to virtually inevitable cycles in optimism, pessimism, investment activity and so on, which have gone under the name of Kondratieff cycles._ _rmportance of System Shocks_ _But there are two other views which I think are more interesting, one of which would stress the importance of deregulated markets and spontaneous market forces, very much the present policy orthodoxy in stimulating entrepreneurial activities. The other one, on the other hand, would stress what I call system shocks, but I do not only want to call them system shocks, special impulses which appear from time to time, often in an ad hoc way, which can come from wars, from change in trading regimes, but also importantly from economic policies._ _So it is really between these two, in a sense, opposite views, I think, that the debate may be placed._ _What does the empirical evidence show, if anything? I don't think it shows that much. It shows what Paul Armington and Shahrokh Fardoust call in thelr paper the sort of ineluctability of 2-1/2 percent per annum. If I take the Angus Maddison's data for 16 industrialized countries [see Phases of Capitalist Development, Oxford University, Press, 19821, which go back at least a century and possibly a bit more, one finds that indeed over most of the time che growth rate of industrialized countries has been roughly 2-1/2 percent per annum. And I have trled with a certain amount of ingenuity. I think, to find periods of acceleration and deceleration within this long-run historical experience and basically, apart from the obvious 1950s and 1960s, which are a clear exception to the general trend because of very sharp sudden acceleration, I can at best come up with two periods of very mild acceleration in the 1850s and 1860s and again at the end of the 19th century. The accelerations are mild;_
_3_

**_the_** _periods are very removed. The lessons, thorefore, we can draw from them may be very limited._

_In the choice among: Kondratieff, spontaneous market forces, and system shocks (whlch_ **_I_** _don't test econometricaUy) -- I dismiss Kondratleff if only because I find very little regularity that one can observe_ **_in_** _the cycles. There miay be some price regularities, but clearly it is not quantity regularity._ _In any case, none of the explanatlons I have come across for the presumed regularity of such cycles seem to hold much water._ _Between, these sort of shorthand titles of spontaneous market forces versus system shocks, I find that at best the "spontaneous school", a sort of dercgulated market school, can no doubt provide some explanation for the Industrial Revolution of Britain in the 18th Century, and possibly for the acceleration of the 1850s and 1860s. By the turn of the century already, I think the role of economic policies but also possibly of gold discoveries and colonial adventures becomes more important, and possibly also protectionism becomes more important. For the_ **_'50s_** _and '60s my reading of the evidence (biased as it may be) is strongly in support of the idea that economic policies played an extremely important role._ _Physical factors were no doubt permissive, but similarly permissive physical factors that exissted in prior periods of economic history -- abundant labor, cheap technology, cheap energy -- had not generated super rates of growth of the order of magnitude of 4-1/2 to 5 percent. What was different on this occasion, to my mind, was the much greater role that government policies were taking in preserving employment, preventing business cycles and, in many countries, trying_ **_to_** _accelerate growth._ _And my view that system shocks matter is also confirmed in a paper by Reynolds in the Journal of Economic Literature [June 1987, pp. 649-698] on the experience of developing countries, again a longrun brush history of developing countries -- which suggests that for virtually all those developing countries which shifted the growth tempo from a fairly steady to an acceleration of growth tempo, to a much more rapid growth in per capita incomes, this is associated with exports on the one hand but with some political shock or other on the other. So the real system shocks doesn't seem to be applicable only to my very broad brush vie^v of the industrialized countries' accelerations through time, but could also fit individual experience -- not as a group, bur of individual experience - - of a large number of developing countries which Reynolds looked at in detail._

**_The SupplySide..._**

_So much for the past. Now what aboc_t the futu.'e? Does anv of this suggest thac we are stuck with a 2-1/2 percenc or even less growth forever? Or does any of this suggest that we could return to a faster growth rate of output and activity at some future dace?_
4 _One issue that often preoccupies economists is the issue of whether the supply would be there. Could the Industrial countries (once ve get rid of the U.S. deficits and so on) actually grow at 4 percent? Is the labor there? Is the capital there? Is the technology there? Are the savings there? My biased conclusion is that most of these problems have been overstated._ _On the labor front, I would have thought that there was a fair amount of avallable labor In most of our economies. I mean, the United States today may be an exceptlon in that It Is close to full employment; but then the growth problem is more an European and, perhaps, Japanese problem than It is an American problem, at least ac present. In Western Europe in particular, to my mind, there are ample supplies of labor. Take the British example, as a case for an extremely rigid labor market. In Britain, the natural unemployment had risen par _ Passu with the actual unemployment, to about 3 million. Over the last year, British growth has been very rapid by international standards. Unemployment has fallen rapidly and sharply, and there have been no upward pressures on wages. Wages have grown rapidly but they were growing already beforehand while the British economy was not growing rapidly. There has been no upward Inflationary pressure and labor has been reabsorbed into the economy._ _On the capital side, there may be need for a bit more caution, if only because ten or fifteen years of slow growth have led to a shortfall of investment and hence to capacity problems. Again, Britain doesn't seem to be evidencing these capacity problems, -- nor Japan, whose growth has also accelerated significantly apparently thanks to a fiscal boost. But the rates of capacity utilization at present, for instance, do not suggest that the margins of spare capacity are as large as one might have expected after ten or fifteen years of slow growth._ _Nonetheless, my prudence ought to be colored by experience of the 1950s and 1960s, for instance, when we were running very close to full capacity utilization. Capacity was fully utilized in all the OECD economies for a long-run of years. Yet, we could go on growing at 4 to 5 percent. Demand just created its investment needs and the capacity that went with it. With the large margins of spare capacity we have now, one would think that the scope for expansion was there. And, as expansion took place, because of the accelerator mechanisms, the investment would then follow._ _Raw materials..._ _On the raw materials' side, I would doubt that there can be very many problems for p;imary products other than oil. And even for oil, I would have thought the chances of OPEC sharply raising prices again are remote unless we really were to accelerate to an inconceivably rapid growth rate, to 4 or 5 percent for ten years. Then, no doubt, we might face problems in the oil market again. But this is clearly not on the cards. And perhaps influenced by the present oil market situation, I predict that oil will not be a major constraint on future growch._ WPIPROC/SF:Jsq
_5_ _On the physical slde, the other Issue often mentioned_ **_Is_** _technology. We all thlnk that technology_ **_Is_** _frightfully Important, but we don't know how to measure_ **_It._** _We don't know whether it is there or not. Casual empiriclsm and journalistic reports will suggest that there_ **_Is_** _plenty of technoloS;' available. We are innovating in robots and flexible manutacturing systems, electronics, telecommunicatlons, etc. But I am not sure that that cuts much Ice._

**_Scientific a-.d Technological Factors..._**

_Whether we would be hittlng problems on the Innovation, In the technology_ **_froutler Is_** _-- to my mind, an open Issue. I am struck by some of the evidence I have seen w'hlch suggests that even technological innovations are strongly Influenced by the pace and the spesd of demand Itself. The application of Inventions tend to follow th. cycle, Investment, and seem to be a function of demand forces._ _So that if we were able to accelerate a bit, technology may well adapt to the acceieration, just as when a relatlvely low output growth may be leading to a relatively low rate of Innovation and structural 4ange._

**_All_** _these are Izally types of physical bottlenecks -- labor, capital, raw materials and technology. But there are some less physical bottlenecks. One such bottleneck is savings. The possibility that even If we did wish to invest, and even if ootimistic expectations materialized, we would be_ **_hitting_** _an availability of savings bottleneck, whLch would drive up interest rates and/or inflation and therefore frustrate the attempt at growing at a faster rate._

_True to my unreconscructed Keynesianism, I consider savings_ **_to_** _be a function of income. And_ **_If_** _income grows, savings grow. But I must admit that the recent U.S. experience has thrown some doubt in my mind about the universal validity of this proposition._ _Looking at past experiences of acceleration in growth rates, virtually anywhere higher savings followed. This seems to have been the case even for the Uniced States through the 1950s and the 1960s. But_ **_in_** _the early 1980s, United States investment grew rapidly, Government expenditure, of course, grew rapidly as well, while savings, despite rapid income growth, did not follow suit, and hence you had the well-known absorption of savings from the rest of the world._ _There are some arithmet._.s in my paper fPPR Working Paper, WPS 9], which suggests that if we wanted to get back to the investment ratios of the early 1970s, the very peak ratios we ever recorded, and if U.S. savings were not to move from the savings achieved at present over the last cycle, over the last few years, then the rest of the world, the rest of the OECD area would have to increase its gross savings ratio to GDP to levels very rarely recorded in the past. Therefore, it wouldn't be totally unfeasible to get back to an investment ratio like that of 1973, but it would be difficult._ WPlPROC/SF:jsq
_6_

# **_Physical_** _constraInts to_ **_growth?_**

_Where_ **_does_** _thls_ **_dlscussion lead me on this_** _sort of physical constralnts_ **_to growth?_** _Most of them, I thlnk, have probably been overplayed. I._ **_is_** _typical of periods of slowdown and of recession to suggest that structural dlfficulties,_ **_rigidities_** _and shortcomings have beset the world economy. That was sald durlng the so-called Great Depression of the '70s and '80s of the last century. It was deflnitely sald In the 1930s. Everybody kept arguing that in no way could we ever get out of slow growth. It_ **_Is_** _being argued again in the 1980s._ _I would have thought that both the experience of those few countries which gre,. rapidly In the course of the '30s_ **_as_** _they changed their policies, as well as the experiences of the_ **_'50s_** _and '60s suggest that these fears are not fully justified. Nonetheless there may be some truth to some of these fears and hence there may be a need for caution in any stlmulation of_ **_activity_** _or in any system shock which we may want to impart to_ **_the_** _system. But I don't think the case_ **_is_** _that important and that strong_ **_as_** _a lot of contemporary orthodoxy would lead one to believe._ _If one assumes that the supply potential_ **_Is_** _there, at least for a rate above the 2-1/2 percent which we have been experiencing_ **_for_** _a long time, say, 3 co 3.5 percent, Ideally 4, how can we_ **_get_** _to it? Now one problem is the physical capacity. The next problem is: What sort of either policies or other events can get us back to relatively rapid growth?_ _One idea, of course, would be just a return to Xeyneslanstimulated policies. I see there a much more Important constraint, not a physical one, but in a sense one of attitudes. Keynesian pollcies now are surrounded by a very large degree of skepticism. People don't believe in their efficacy. Even when their efficacy to my mind_ **_is_** _supported by both British and Japanese experience in 198688 period, nonetheless there is profound skepticism about them; hence, the chances of regenerating activity just by returning to more expansionary policies, larger budget deficits and so on, are very limited._ _Another possibility -- and thls now goes back to the transition phase itself --_ **_is_** _an orderly transition from the present problems. If we can get out of the present mess possibly in a cooperative fashion (i.e., a gradual and orderly unfolding of the global payments imbalances) combined with a much higher degree of optimism, we could generate the system shock which to my mind is essential for a return to high growth._ _In other words, just as growth in the 1950s and 1960s was very rapid, thanks partly (or largely to my mind) to a regime change, a move from basically laissez-faire government policies to much more interventionist in the macroeconomic field by government policies, a regime change could occur in the late 1980s where we move from basic._

**WP/PROCISF:Jsq**
_7_ _ally, national soverelgnty over governmenc policy co a much larger degree of international cooperation in government policy. This could be the system shock of the 1990s and could get us out of the present problems, in an orderly fashion._ _If the transition is disorderly, I.e., inflationary, as Paul Armington suggests, or is achieved via a much more profound recession than presently on the cards, then I would have thought that the chances for growth in the 1990s are that much dimmer, that much worse, capacity or no capacity, because the policy background would be so much less favorable._ _Therefore, to my mind the issues are, on the one hand, this broad idea of whether the capacity is actually there, and growth can go beyond the 2-1/2 percent rate; secondly, what is the nature of the transition process. Is it liKely to be favorable, orderly, smooth or, as I fear, is it instead going to generate inflation or recession, or conceivably both? And thirdly, if that were the case, what other system shocks, if one believes in the system shock idea, would be necessary or desirable to get us back to a faster growth path at a later stage, towards che end of the 1990s?_ _MR. BANETH: Perhaps we can, in fact, take as not yet fully resolved the short-term cransition problem, and start the discussion on the nature of the short-run problem and how we could get out of it._ _I have a great deal of sympathy with Boltho's analysis and his findings, including the conclusion. It is that conclusion which generates profound pessimism. It is difficult to see the leadership or thb. policies or the social attitudes, which In fact will allow us to return to faster growth. There are a couple of issues that I would like us to discuss here. One is the social consequences in the industrial countries if we do not return to faster growth. Fifteen years ago there was a general expectation that if unemployment reaches, say, 5 percent in Europe, there is going to be a catastrophe. And to use a French expression, some people have referred to the Divine Surprise, that you could go above 10 percent and not get revolution._ _But I personally am not convinced that these things happen immediately and without lags, and the fact that we had only limited harmful political and social consequences in the short-run does not necessarily mean that this can continue._ _Obviously, for us of greatest interest is the impact of all this on developing countries. There was a lot of talk of decoupling growth. Is that likely to happen? What is the interaction both ways? How do the developing countries contribute to this process, negatively through debt crisis and other negative system shocks, or_ WPlPROC/SF:jsq
_8_ _perhaps positively through generating the demand whlch can provide the burst of acceleration in growth rates?_ _Complex of_ _Complex of MR. OHLIN: I would like to organize my comments under Investment three headings to make it simpler rather than to follow the [Boltho] Technology and paper as a wnole. Those would be, first of all, the complex of Structural investment and technology and structural change; secondly, the role Change of policies; and thirdly, the international system and its imbalances._ _Let us start then with growth and our understanding of it. There is, in the paper, a devastating survey of growth theory and attempts to understand growth in the past. It makes it perfectly clear how little consensus there really is on the interpretation of historical growth, but also, for that matter, on the post-war Golden Age. The author cites a great many divergent views._ _He may have gone a bit too far in the assumption that all these views are borne equal, and there might be a bit more consensus about what the important ideas are and what th'e less important ideas are. Nonetheless, the basic impression of great intellectual confusion prevails._ _This must be of particular importance for those of us in international organizations who are supposed to know and are expected to tell countries what they can do to get more growth. The fact is that no one knows very much about it, and thi: ought to make for a great deal of humility._ _Let me return to the assertive rather than to the destructive aspects of the paper. If I understand Boltho correctly, he says that in generally stable conditions, with an ample supply of labor and other requirements met -- including the supply of entrepreneurs -- growth should be pretty automatic if investment is incited by expectations. And as far as the irregularities that we have observed in the past go, they should be understood to have resulted from disruptions, some of which might stem from economic policy._ _This is pretty close to a neo-classical approach. The difficulty I have with this is over the approach to the nature of growth and the sources of growth. One should not, it seems to me, dismiss technology as assiduously as Boltho tries to do. He raised the question of technology, but he nonetheless concludes that one can afford to disregard it._ _I think he is rightly ridiculing the fatalistic approach to Kondratieff, but I think that is flogging a dead horse. Nonetheless, when Schumpeter named the Kondratieff cycle, there was more to it than just reference to Kondratieff._

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_9_ _What Schumpeter very imaginatively incorporated in his conception of growth in technology is worth retaining. And Boltho doesn't really raise this in his paper. He cites Schumpeter on the decline of capitalism, not on the importance of entrepreneurs. Schumpeter's idea of the link between the growth and the cycle, for instance, was meant to relate to the consequences of major technological breakthroughs. He suggested that one could make a distinction between fundamental ones, which would pervade the economy completely, by changing the sources of energy and so forth, and less important ones. That seems to me to make a lot of sense._ _And above all, the conclusion that he drew is one that I think is surprisingly neglected, and that was that the introduction of technological breakthroughs in some area or other was bound to be followed by problems of absorption and by a great deal of competition between the old and the new technology and, therefore, a slowdown in growth with rising unemployment._ _What interests me in this approach is the plausibility and realism that I find in such an approach to technology as distincc from the idea of simply putting it into a production function and assuming that it wi.'l have a smooth and even impact on factor productivity._ _So on this score I think Boltho has underestimated the role of technology. While it is difficult to measure the role of technology as Boltho argues, that seems to me to be beside the point. There are lots of things in economics that can't be measured._ _I have been intrigued by the iniportance that Boltho has attached to growth policies or macroeconomic policies in general in determining growth. I think I might buy in the short-run the idea that policies can do a lot to slow down growth and hold investment back._ _But that seems to me to ignore another common sense observation of a historical nature, which Boltho does comment on, namely the role of institutions, the role of microeconomic aspects, which is a very big black box. To that Boltho adds the legal system, government regulation, educational policy, technology policy, and foreign investment policy. I think these deserve considerable attention here, not just in developed countries but quite parcicularly in developing countries._ _In the paper by Reynolds [JEL, June 1987] the conclusion was that over 150 years the only conclusion one could draw of growth that what really mattered most of all was political stability and good public administration. This is of course not much if one wants to say something interesting about growth. But it is a minimalist approach._ WPIPROC/SF:jsq
10 _I think ore could probably say more than that. It is often said that we don's have controlled experiments and so forth, but we have a fantastic array on which to base comparative studies, and above all we d., have these remarkable instances of successful growth and government promotion of growth -- Germany in the 19th century, Japan in this century, the new NICs and so forth._ _The Germans and the Japanese in the times of their glory didn't have any macroeconomists around at all, and their approach was totally different. They went out to look at other countries in the world and see what they were doing and to adapt their institutions to their own conditions. Ana they had programs. common sense programs for modernization of their countries. These were essentially political institutions._ _Simon Kuznets, for all his work on growth, was always very careful to insist that he didn't understand it at all. And he was very close to this minimalist view. He did think that it was important to emphasize the convergence, the confluence of changes in different parts of society, economic, political and institutional and so forth, and our mutual support to influence them. I chink some of this Kuznetsian perspective is helpful also when we look to the future._ _Present Policy Now I come to the problem of external payments imbalances. Challenges: Prof. Boltho hints towards the end of his paper that the presumption The Massive for what he is saying is that we get over these Imbalances, that we Imbalances.., unwind these imbalan-ces, and that nothing can really happen before we have done that._ _e Well, I am beginning to react against this sort of 'zonventional wisdom. I don't think that the issue is how we are going to unwind the imbalances. I think the question is how they are going to be reduced to a level where they are sustainable, where the financing of deficits and flows, which by historical standards are not all that great and which by any approach to growth are not very difficult to understand, will again be possible._ _And this leads me to say something about the premise that we are in a situation with imbalances which are widely agreed to be unsustainable. Precisely why is not always made clear._ _It seems to me there are two fundamental dimensions to this question of sustainability. One relates to the debtor side. If interest rates are much higher than the rate of growth of repayment capacity and this lasts for a very long time, then obviously arithmetically you are in a hopeless situation. At che same time, there is a case for bridging finance when this is not going to be so in the lending phase._ WP/PROC/SF: jsq
_11_ _In the 1960s, I remember that In the OECD and here at the World Bank we talked now and then about the point of no return beyond whlch we couldn't go in financing deficits If the situation was unpropitious. It might be wise to take a look at that kind of problem again._ _But the other dimension to sustainabillty relates to the stability of the international system and the degree of risk that creditors are willing to assume, and the assessments they make of the future. Ts it likely that the repayment capacity is going to remain as low as it Is and so forth. This Is where stability in general and institutional arrangements are fundamental to the molding of the expectations that you, I think, quite correctly found so essential to investment._ _I would reverse the order, and say that we are not likely to unwind the imbalances and thereby return to stability. We are going to have to find stability In order to live with the imbalances, not necessarily at the present magnitude, but it is unreasonable to assume that we are going to be able to get rid of them terribly quickly._ _MR. BANETH: Can one live with the imbalances, unwinding or not, and to what extent? Which precedes what? Are there ways of unwinding them which promote stability, and what are those ways?_ _More on current MR. LIPSCHITZ: I found Professor Boltho's presentation account quite fase-inating. The strongest evidence for your [Bolthol being an_ **_imbalances_** _unreconstructed Keynesian was, perhaps, the absence of any intertemporal considerations, intertemporal constraints of any sort, in the discussion. This is unusual on this side of the Atlantic._ _The theme of anything I would say about both the current imbalances and about longer-term questions of growth would be che need to take explicit account of intertemporal constraints. It is quite difficult to disentangle what is going on within the industrial world: two sorts of things are happening in concert. One is clearly a set of imbalances that were generated by unwise government policies, perhaps to a large extent in the United States, which created international imbalances that are unsustainable. (Incidentally, because of the longer-term consequences, the intertemporal constraints, I wouldn't characterize the U.S. policies of late as a Keynesian success story.) We have got that sort of imbalance. The other sort of imbalance is something thac we characterize as incernational imbalance, but at least in a large part, to my mind, it is intertemporal balance. Let me be more specific._ _To the extent that in Japan, and to a lesser extent Germany, one can characterize high national savings ratios as befing in part an anticipation of demographic trends, one can't possibly_

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_12_ _characterize them as imbalances. If_<sup>_you save a lot now because of_</sup> _lmpendlng retlrement, that is,_<sup>_intertemporally,_</sup> _an optimal decision; It Is not an imbalance In any sense._<sup>_Once you have saved a lot, the_</sup> _question is what to do with your_<sup>_savings. Now it would be wonderful_</sup> _If you found Investment opportunities at home, but if it turns out that there are better investment_<sup>_opportunities In Korea or Taiwan or_</sup> _somewhere else 'n the world, It_<sup>_is In no sense an imbalance to puc_</sup> _your savings into those countries and_<sup>_to run large current account_</sup> _surpluses. I would characterize that positively as an equilibrating economic phenomenon._ _So I would say that these are at least_<sup>_parts of the large_</sup> _surpluses we see in the surplus countries that_<sup>_aren't in any sense_</sup> _imbalances. They are an equilibrating process._<sup>_Of course, disen-_</sup> _tangling that from the effects of the Reagan fiscal_<sup>_shock is awfully_</sup> _difficult. But what I would plead here is that we do try_<sup>_and disen-_</sup> _tangle them, and we distinguish real imbalances from optimal intertemporal decisions._ _I was surprised at the characterization of growth as being driven chiefly by Investment. I thought that long-term_<sup>_growth was_</sup> _explained, to a significant extent, by total factor productivity (which is a name for what we cannot explain_<sup>_by the contributions of_</sup> _capital and labor). And when you look at that in different periods, I would have thought we could attribute it to technology,_<sup>_to entre-_</sup> _preneurship or the growth of entrepreneurship, and_<sup>_to what the_</sup> _psychologists call hygiene factors, that is, the cleaning_<sup>_out of_</sup> _restrictive regulatory practices._ _If it is correct that total factor productivity_<sup>_explains_</sup> _a large part of growth, I think you have attributed too much_<sup>_impor-_</sup> _tance to investment and demand forces. But, more_<sup>_generally, if one_</sup> _thinks that growth will proceed over_<sup>_the longer-run by means of_</sup> _government-generated demand shocks, one has co ask: Where do you start from and where do you end up?_ _Policy If you start from very low budget deficits and very_<sup>_low_</sup> _Reforms... government-debt-to-GNP ratios, you can rely on fiscal stimulus for quite a while. But if you start from anywhere_<sup>_like where we are now,_</sup> _how do you do it? We have situations in_<sup>_countries that we are mark-_</sup> _ing as possible engines for growth,_<sup>_like Germany or like much of_</sup> _Europe, where government debt/GNP_<sup>_ratios are awfully high and are_</sup> _projected to increase further. We have a situation where monetary_<sup>_stimulus is not_</sup> _effective because yield curves are_<sup>_already very steep: while govern-_</sup> _ments can push down short-term interest_<sup>_rates, the long rates don't_</sup> _go down because of skepticism in the_<sup>_markets of the long-run impact_</sup> _of expansionary monetary policies. Moreover, it_<sup>_is the longer-term_</sup> _rates that influence the interest-sensitive componencs of demand._ WPIPROC/SF:Jsq
_13_ _Jo if you are starting from where we are now, I don't know how you can assign so large a_ **_role to the_** _government. If you_ **_are_** _scarting from some position of a better relationship, becter sorr of_ **_scock_** _relationship between government finances and the economy, chen_ **_che_** _critical question is: How do we_ **_get_** _from here_ **_co_** _there?_ **_But_** _even if one starts there, can one characterize_ **_a_** _steady_ **_state,_** _which is driven entirely by government intervention? When we know that if government deficits grow larger, eventually we have a problem of the debt being so large that it exhausts the discrecionary capacity for the government to operate fiscal policy._ _Let me make one plug, though, for the sort of shock that I think can generate growth over the medium term, and_ **_it_** _is something that Boltho downplays, and that is the "hygiene factors" shock, the getting rid of regulatory rigidities. I know that has been a term that has been thrown around rather loosely in the last few years. When we don't know what to do with macro policies,_ **_it_** _is very popular_ **_to_** _say that there must be something regulatory or structural we can change._

# **_Japan and Germary_**

_But I think there is more to it than that. In Japan, for_ **_example,_** _if one looks at the agricultural sector and the interaction_ **_between_** _land prices and construction activity, there is an enormous capacity for deregulation which would generace construction, boost home ownership and lift the standard of Japanese housing. When one looks at Germany, what one sees_ **_is_** _evidence of very high preference for leisure rather than consumption. Germany seems incapable of generating sustained growth on private domestic impulses. But there is also tremendous regulation of the non-traded goods' sector. Germans can't buy because shops are closed half_ **_the_** _time. They can't have sales in shops; they can't have aggressive marketing in the retail sector because of outmoded restrictive regulations. The domestic land transportation sector_ **_Is_** _completely tied up by regulation. An elimination of these impediments would simply have to generate some capacity for additional investment, some dynamism._ _This is the sort of government-generated stimulus which do not lead to steady state problems over: the longer term and which could, I think, raise cotal factor product:ivity and growch potential._ _Role of LDCs_ _MR. RUSSO I will continue on this same vein, and I think the paper of Andrea [Boltho] dismisses a bit lightly the question of the LDCs' role in deciding what is che appropriate pattern of present current account deficits and surpluses and whac is a desirable surplus._ _Japan and Germany have faced similar situations. High government debt creates constraints in some European countries. These countries are unwilling or unable to increase their debt and._ WP/PROCISF: **jsq**
_14_ _therefore, they have to reduce their primary deficits and therefore the counterpart of that is perhaps in the external current account. There is also an intertemporal issue here._ _With these considerations in mind, a desirable pattern of current accounts may well Imply surpluses of Japan and Germany and smaller deficits of the United States but larger deficits of the LDCs. The fact that 70 percent of trade takes place within the OECD I don't think is sufficient consideration for setting the LDCs aside. In addition, issues concerning the exchange rate regime and policy coordination are also very Important. What we see now is internatlonal mistrust rather than coordination. Countries are not prepared to change their policies because they don't trust what the policies of :he other are going to be and their effect. As a result we make agreements and declarations, which naturally are broken very quickly or are modified very quickly._ _But unless we get to a judgment about what Mr. Lipschitz has underlined, i.e., what Is the appropriate position both within the OECD and of the OECD vis-a-vis the LDCs, I find it very difficult that agreements can be sustained. And unfortunately, the political cycle is such that makes this agreement very difficult._ _MR. PERY_: A number of interesting things have been said, and I want to commenc on a couple of them. I would stress that the paper we are discussing is worth everybody's reading._ _More on the Imbalances..._ _The idea of what has to come first is one that does concern this group, whether all of these so-called imbalances have to be settled before you can deal with growth. And I do think that is backwards. The imbalances are a product of stagnating economies and that, if you ask if there is any way out, you really need to get out of stagnation in order to deal with some of these imbalances._ _It is also true that what constitutes an imbalance is a little ambiguous, and we tell the story whichever way it fits best. If some countries really need to save a lot, that is not an imbalance. If they want to consume in the next century, that is not an imbalance._ _But we know that that isn't really what is going on. We know that the U.S. didn't deliberately set out to have the current account position it now has. It stumbled and fell into it out of ignorance not design. I don't think there is anybody who would make any other case for the position of the U.S. current account._ _But, more importantly, some of the places where savings ought to go, places which in a world of capital mobility we would regard as having the highest potential for using that capital, are unable to borrow._ WPIPROCISF: **Jsq**
_15_ _It would be higialy productlve in an economist's sense to_ **have** _a lot more investment pouring into Latin America, and that can't be done for the obvious reasons under currene arrangements._ _So I don't think we can Just sit back and say what we observe is what everyone intended or what is best. We do have co thlnk of these things as problems that have arisen and ask what mighc help ouc. You need to have a lot of expansion In order to alle-'iace some of these financial problems that exist._ _And the idea tnat you can talk about growth once you have dealt with financial pro')lems really is backwards. It is an attitude and a point of view thac can only worsen some of the issues that we are talking about._ _Once again we know what will scimulate economies and what will slow them down. There are some barriers. I think they are selfinflicted barriers, that are probably relatively important in parts of Europe. I think of them mainly as barriers in the labor market and Institutional arrangements that make expansion a little more difficult. I think even those are endogenous and would mele in the face of stronger expansion. So I am really siding wich Boltho's conclusions._ _Not only am I siding with him, but arguments to the contrary seem to be based on little or no evidence. At the risk of sounding a bit too simplistic, I think che direction in which everything has to go is clear. The policical will is quite anocher matter, and I agree that Europe is in the midst of a political situation that makes nobody anxious to do the right thing. That doesn't mean that we shouldn't recognize it._ _MR. O'BRIEN: Addressing directly the Boltho paper, I think there are two areas I would like to talk abouc. One is again a general discussion of imbalances, consequences of unwinding or not, and che role of cooperacive behavior in that, and then also I would like to make some comment on where inflation fits into che whole thing, including its relationship with the imbalances._ _It is clear that there are four areas where it is important how you unwind the imbalances. One is where you are going co starc from, in terms of capacity utilization and unemployment, when the new growth starts, if it ever does. Secondly is what is actually done to the attitude to risk-taking and investment during a prolonged period of uncertainty. The third is the state of the world trading system, given the pressures for protection that the imbalances generate._ _But fourch is the functioning of financial markecs which are spending a long time worrying about short-term flows consequent or not knowing what is happening with the imbalances, and at the beginning of an upturn it would be nice if financial markets had some_ WP/PROCISF:Jsq
**_16_**

**_tralning_** _in thinking about the long-term rather than simply the short-term._

**_Cooperative As_** _to whether there is a feasible route after the policy Imbalances, I think_ **_it Is_** _worthwhlle recalling where they came from,_ **_solutions..._** _and that this relates to tne possibility_ **_of_** _having a cooperative solution, I think._

_The imbalances come from lrbalanced policies and the imbalanced policies come from differing views in dlfferent countries, partly about what are the underlying problems and partly about what the appropriate methods for dealing with chem are, so that one has had over the last six, seven,_ **_eig;t_** _years, a variety of policles._ _Taking the example of what has happened_ **_from_** _the end of 1986 onwards in terms of the apparent development of cooperation,_ **_it_** _strikes me that this is actually being the development of occasionally sophisticated ways of hiding the fact that everybody actually disagrees on what they are meant to do, whlle producing statements to the effect that they agree._ _Maybe a quicker way and a better way to resolve the imbalances would be to admit that cooperative solutions aren't going to work, because we don't actually agree on what the cooperative solution_ **_is,_** _and, further, [policy-makers may eventually] let the exchange rate pattern take the consequences [because] of the underlying savings-investment imbalances._ _And maybe, rather than a cooperative solution, [a major change] might then provide the system shock that Boltho is talking about, rather than trying to keep the current system going as long as possible on a cooperative basis._ _I would also like to mention that I think the role of inflation and the possible danger of inflation in an eventual secular upcurn may be understressed in Boitho's paper._ _But will growth go beyond 2-1/2 percent towards the mid1990s? If not, we will have unemployment remaining high and capacity utilization not increasing beyond the current levels. And although we have this low growth picture in the medium-term outlook, the inflation picture that is thought, by country experts within the OECD to be consistent with this unemployment outlook, is one in which inflation doesn't decelerate any further._ _Inflation threat..,._ _But why, despite such a high level of unemployment, is inflation not going down at a faster rate? Two explanations are possible among the many. One is the hysteresis argument, that che equilibrium (in the inflation sense) rate of unemployment follows the actual rate of unemployment around._ WP/PROC/SF:jsq
_17_ _Another argument which was suggested to ra.ionalize what we think has been happening and is going to happen in the lnflation/unemployment relationship, is that somehow there is actually a floor, at the moment, to what wage inflation can be. Custom and practice say that wages will not grow by less than such and such, depending on the country, just because people have got used to high wage rate growth, from a period of prolonged high inflacion; they think in terms of reducing wages to a particular level._ _Those two rationallzations are attempts at interpreting recent hlstory and our forecasts. But in terms of the revival of growth, they clearly have different implications, and particularly if hysteresis is the correct explanation or at least has more of the explanation ccntained in it, then any kind of increase In the rate of growth which is sufficient to reduce actual unemployment will increase inflation, and to return to a sustained level of relatively low unemployment will result in a permanently higher rate of inflation. Even if hysteresis works both ways, then the inflation rate ought to stabilize eventually, but it will be permanently higher._ _On the other hand, if the floor argument is the correct way to interpret what is going on, that is perhaps a bit more optimlstic. Inflation needn't rise until the floor ceases to be a binding constraint._ _But although in that case one might characterize it as being more optimistic than the hysteresis argument, I think it is still a pessimistic view since it is saying that nothirng has really changed however you characterize the inflation and growth trade-off. Nothing has really changed over the last period of recession from what we had before. None of the problems have been solved._ _And I think this would bring us back to where the Imbalances came from. I described the imbalances as coming from a confusion of policy responses. These responses were to economic stagnation. Where did the stagnation come from? Boltho discusses whether it was real wages, demand, a few other things, but really focussing on the former two kinds of alternatives. He suggests that while too high real wages might have something to do with the problem in the mid to late 1970s that most of it was due to relatively low aggregate demand growth._ _Now it is my recollection that one of the more important reasons for that low aggregate demand growth was actually a response to a perceived wage problem, nominal wage growth perhaps, or the level of real wages. In other words, one could argue that the imbalances in part come from a structural inflation problem in the OECD economies._ WP/PROC/SF:Jsq
_18_ _PROF. BRADFORD: To summarize Professor Boltho's paper in a concise way so as to be able to make some remarks, the question. I guess, ls: What does thls longer-run historical perspective give us? And I think It gives us some useful Insights._ _I thlnk the problem Is when he gets down to what could be done that It is not clear to me that the longer-term perspective is so helpful. Basically what you examined, it seems to me, is a set of Issues that had to do with: one, whether or not there were any physical capacity constraints to longer-term faster growth, and you came up with the conclusion that, no, there were no physical constraints._ _Smooth transition from Imbalances t' long-term growth?_ _The longer-term perspective leads to, I think, a hopeful Inquiry into whether or not it Is possible to get what you called an ordinary or smooth transition from the current set of Imbalances to a longer-run growth path and to explore positive system shocks as a mechanism for getting there and to meeting the kind of expectational Investment-growth linkage that you find there._ _I have some difficulties with that, because it seems to me that the nature of the world economy since 1973 at least is quite the contrary from what It had been prior to 1973. I think what we see is not a smooth path but rather, a sequence of disequilibria. In fact what you have is a klnd of Jolt to the system which sets up some disequillbrium forces, which have led to over-correction in a next phase, and on and on. So that rather than there being some conver-gence back to a smoother path, what you really have is eratic trends and more cycles._ _During this period, despite all the academic fussings and debates about macroeconomics, there has beer-, as we all know, an extraordinary consensus, ln analytical economics and internationally, about the one fundamental cause of world Imba.aices, namely the U.S. fiscal deficit. And what we see there is, I 1-hink, the place where the crucial capacity question comes to bea-, and that physical constraints are not the dilemma. The real capacity constraint is a political one._ _If you believe that the world economy since 1973 has some intrinsic and policy-induced sequences of disequilibria, and if you think that where we are short on capacity In the world economy today Is on the political side, then the more logical conclusion to draw is that perhaps the way to change to a regime toward greater international coordination Is not by some sort of positive policy whiplash, which doesn't seem to be in the offlng, but rather by a negative system shock, namely a further downturn of sufficiently dramacic dimensions to induce a political change._ _Otherwise, I think, the scenario that you paint, where you have actually assumed away the imbalances, one of long-term sluggish stagnation or stagflation, is perhaps the more likely scenario. But_ WPlPROC/SF:jsq
_19_ _I don't see us vaultlng to higher growth from a positive regime change but rather from a negative downturn, and that inducing regime transformation._ _MR. RAO. I am having some trouble understanding what exactly the system shock thesis Is. I might put forvard two alternative hypotheses or descriptlons of it, and I wonder which one we are really talking about._

**_Systems_** _If one accepts the statement that in the 1950s and 1960s_ **_shocks........._** _growth was somehow stimulated by some system shock -- and I see the definition of the system shock here as being more skillful macroeconomic management and Bretton Woods and all of that -- and now we see In recent years some sort of stagnatlon settIng in. Are we observing the natural running down of the effect of any shock so that the present stagnation is simply the netural plateauing after the initial response to the stimulus provided by a shock? Alternatively, are we seeing the unwinding of the improvements that brought about the 1950s and the 1960s growth?_

_In this second interpretation, we are seeing not a shock and a plateauing, but rather an improved -egime that had good results backsliding to a less appropriate or salubrious regime for international growth, and if that Is the case -- then I think Professor Bradford's thesis is that a sort of negative shock might be what we are looking for. In other words, you sink so low, you hit rock bottom and then everyone is jolted in realizing how bad things can get and then say, well, you have got to do something about this, which is the sort of political shock that I think Professor Bradford was referring to._ _So I would like to know which of these hypotheses one is talking about. My next question is: looking at [the assumption in Professor Boltho's paper), the data of GDP weights for 1965, 1985 and 2000, one sees developing country weights going from 16 percent in 1965 to 22 percent in 1985, but being projected to grow to 33 percent in 2000._ _Now that, If it happens, would itself be a shock -- notr just a shock in realizing that this is what is happening, but also a shock to the international system because surely, if developing countries go from 22 to 33 percent of world GDP (excluding Eastern Europe and USSR), they must be doing something to the international system which would constitute somewhat of a shock to the system._ _PROF. BOLTHO: I can answer these questions and I can answer some points that have been raised in the discussion, particularly by Goran Ohlin and Leslie Lipschitz._ WP/PROC/SF: **Jsq**
_20_ _Definftion of_ **_system shock..._** _On what_ **_Is_** _the system shock, I haven't defined_ **_It_** _myself. I am not quite sure there is a scale to elther of the two lnterpretatlons you have put forward, though I suppose a mixture of the two_ **_mlght_** _do. But speclflcally taking_ **_the_** _posltlve shock of the 1950s, the international monetary system and domestic_ **_policies,_** _why did they collapse? The slmpllstic explanation_ **_ls:_** _there were negative shocks, the two_ **_oil_** _shocks in quick successior, plus the shock of the mld-1980s, the_ **_big_** _external payment Imbalances developing. Surely that can counterbalance any posltive policies._ _But I thlnk there_ **_Is_** _more to it than that in the sense that the success of the 1950s and 1960s was carrying the seeds of its own destruction in two ways: a domestlc way, through acceleration of inflatlon and full employment together with conflicting claims, too ambitlous policies, too much fine-tuning, hence an acceleration of Inflation, which even if we hadn't had the_ **_oll_** _shock would almost certainly have led us into a much more restrlctive stance in late 1970s or early 1980s._ _The second set of problems which the system was creating were international and financial In nature and led to the breaking up of Bretton Woods. This idea of the dollar remaining a reserve currency forever, nobody worrying about_ **_it,_** _even though everybody was accumulating It was too good to last. Hence, both mainstays of the system were doomed from the start. Expansionary policies were going to have to give way to restrictive policles because of accelerating inflatlon. An international monetary system, which was thought to be_ **_very_** _stable, had a strong potential for falling apart. In fact, it fell apart even before the_ **_oil_** _shock because of the so-called Triffin Inconsistency wlthin_ **_It._** _To that were then added the effects_ **_of_** _the two_ **_oil_** _shocks and everything else._ _The figures that Mr. Rao was referring to (i.e., a sharp Increase In the share of developing countries in the world output by_ **_the_** _year 2000) are purely illustrative. In no way was that meant to be a projection of likely growth rates. All I was trying to do was to show that, even under extremely favorable assumptions for the LDCs, to my mind it was unlikely that the LDCs would take over the role of major locomotive in the world economy. I was trying to defend my emphasis, the focus of my paper, which is entirely on the OECD countries._ _I admit that actually_ **_If_** _the LDCs did grow as rapidly as that, that could create some adjustment problems, possibly some favorable side effects for the world economy at large. Now if I may, just on the Imbalances more generally, start off with one of the points Leslie Lipschitz made, which I don't treat in the paper, thac is the Idea of an Intertemporal balance._

**_WP/PDC/ISF7:Jsq_**
_21_

**_Intertemporal_**

**_Intertemporal I would like to comment on four points that have actually imbalances..,_** _been raised In connectlon with the Issue of lntertemporal Imbalances. On the one hand,_ **_it_** _is argued that the Germans and the Japanese, because of their respective characteristics, save a lot. It just happens that twenty years ago the Germans and the Japanese were saving as much, and possibly_ **_more,_** _wlthout probably really thinklng about these demographic problems at the beginning of the next century or by the year 2020._

_Thus the foresight_ **_Implicit_** _In thls attitude I flnd somewhat far-fetched. But quite apart from that, are these positions really balanced ones? Leslie Lipschltz suggests that_ **_If_** _the Japanese want to Invest in Korea and Taiwan, well that_ **_Is_** _flne. But Korea and Taiwan save a lot themselves, and In fact, they have got current account surpluses. They happen to be putting_ **_It_** _all In the United States. K.owever, the US as a debtor country may not want_ **_It._** _There is also a problem on the creditor's side because the Germans and the Japanese don't like the real exchange rate implications of their huge surpluses. Moreover, there_ **_Is_** _a problem of the allocation of these savings. Even_ **_If_** _there was this intertemporal balance which one might want to maintain, then the money shouldn't be going to the United States;_ **_It_** _should be going to the LDCs, but of course_ **_It_** _won't. And crowning_ **_It a711,_** _there is_ **_this_** _enormous exchange market uncertainty, which tends to be driven_ **_by_** _day- to-day considerations._ _Even if, in an Ideal world, Japanese savings ought to be exported to Latin America, we are not in that Ideal world; we are In the presence of major imbalances, whatever intertemporal shifting might lead one to expect._ _Is it, therefore, inevitable that the next few years, 1989, 1990 will see a recession? And if we see a recession, will_ **_It_** _be coupled with inflation, or will we at least be able to avoid one or the other of these two possibilities?_ _MR. LARSEN: I was very stimulated by Professor Boltho's conclusion that there seemed to be a consensus that the issue of the imbalances and their resolution are ab"'olutely essential for the long-term outlook. But if you would allow me to be a little provocative, I think I would probably dissent to a degree, from that_ **_vlew._**

**_Resolution of_** _It is, of course, quite possible that the resolution of_ **_the imbalances_** _the Imbalances ultimately might result in slowdown in growth. I don't and_ **_the long-_** _think it is necessarily inevitable that it will. This is, of course, term growth... very difficult to judge, but I think a much more important question is: Will such a cyclical event, which I would consider it to be, necessarily affect the long-term growth path of the world economy, of the industrial countries or the developing countries?_

**WP/PROCISF:Jaq**
_22_ _And is the point where I am beglnning to have some dlfficultles with the emphasls on the imbalances. That is, if we look at- the very long-term growth trend, the possible growth path for the world economy, I really doubt that these imbalances and the resolution of them are all that Important._ _It is, of course, possible chat the imbalances or their resolution might lead to some policy mistakes, particularly in the area of protectionism. If that were the case, I would definitely share the concern that this might reduce the potential rate of growth._ _But otherwise, in the absence of such policy mistakes that could seriously interfere with the functioning of the markets across the world economy, I think at least it is useful to examine the hypothesis that the resolution of the imbalances might have only a short-term impact on growth. If you are looking at the average growth rate for the next three, four, five years, this is a very important factor to keep in mind, and it is important in its own right because it could seriously damage, for example, the management of the debt situation if growth in the industrial countries were to decline significantly for a couple of years. Going beyond that, however, I really doubt that it is all that important._ _Now what then determines growth over the medium-term? We honestly do not know very much about it. And I think we have to be extremely careful in entertaining either too optimistic or too gloomy expectations._ _Ne:'ertheless, I cannot help feeling that I am very impressed by the empirical fact, as it is, which was also noted and stressed by Andrea Boltho in his introductory remarks, that there seems to be a secular growth trend which is not all that different from the growth rates we have been experiencing in the 1980s [in the industrial countries]._ _Now what exactly that means I would not be able to explain. But I cannot help but being very impressed by that observation. The question then arises, of course, why did we do so much better during the Golden Age, from the end of the World War II till about 1973?_ _I think the answer to our expectations for c.te medium-term or for the long-term future obviously must depend, to a very large extend, on the conclusion that one arrives at in examining the possible reasons for why we did so much better over those twenty to twenty-five years._ _The catch-up hypothesis_ _Boltho has looked at a number of possible explanations. I think personally I would pzobably agree with most of the factors that have been mentioned, although I would perhaps attribute a larger weight to the question of the catch-up hypothesis, the process_ WP/PROCISF: **Jsq**
_23_ _whereby Japan and Europe gradually caught up with best practice technology, as it had evolved in the Vnted States over the preceding thirty, forty years, together perhaps with the stimulus and the posltive shock, in a sense, due to the combination of post-war reconstruction and the liberalization of international trade, the reduction of trade barriers._ _It Is, of course, quite possible that the Keynesian consensus, as Boltho describes It, dld also contribute. There were very high growth expectations. Governments actively sought co smooth out the cycle and to stimulate growth. But in examining and coming out with a hypothesis of the possible contribution of this Keynesian consensus, I would also take into account some of the problems that followed after the war. Expanslonary flscal policies perhaps were pursued a bit too long wlth the result 'hat wage expectations became unrealistic relative to underlying productivity growth, with the result that wage earners, unions in many countries essentially forgot that they also had a kind of responsibility for what happened to real wages and thereby demand for labor._ _To adjust these expectacions again was obviously associated with enormous costs. So, in discussing and trying to measure the impact of the Keynesian consensus, there was probably a positive impact during those twenty-five years, but I would deduct from that some of the subsequent adjustment costs that were associated with adjusting expectations downward to a more sustainable level._ _As a basis for looking ahead, given that I think it is not unreasonable to make the claim that there is not much more of a productivity gap -o close between the major countries. I think it is safe to start out with the assumption that maybe the underlying secular trend, wherever it comes from, may have reasserted itself. Raising growth And the question then becomes: Are there factors that relative to its would allow us, temporarily perhaps, to ra,se growth relative to this trend... underlying trend of perhaps 2-1/2 to 3 percent -- are the faccors that would allow us to raise growth relative to that or are chere factors that would tend to suggest that growth might accually turn out co be weaker than this trend?_ _I believe that it is the positive factors which will emerge -- and it is mainly the positive factors you have been looking at_ - _- I would agree- with most of what Boltho has said -md what he has written in his interesting paper. But I would also very much emphasize the possible gains that might arise from further trade liberalization, particularly in the area of agricultural policies. This could provide a significant boost to potential upward growth in Japan, in Europe and in the United States._ _I would also, in general, emphasize the contribution of micro policies to structural reforms, although it is hard co quancify or measure them._ WPIPROCISF: **jsq**
_24_ _One example of how tills could influence and stimulate growth is, of course, in the area of labor markets. It is importanc to distinguish between the kind of pollcies that might stimulate the underlying growth path, raise total factor productivity and polIcies that could help us to better absorb some of the under-utilized resources in the labor market._ _That is, create some kind of level shifts if labor markets began to function better, which presumably would be associated with low inflation, and would allow policies to become if not more expansionary then, certainly in many countries, become less restrictive. So while this may not, over a longer period, raise the underlying growth race, I think it might temporarily allow us to grow at a faster rate than the underlying potential rate of growth._ _However, it is very important also to look at the other side of that coin, the opposite side. I think there are some uncertainties and risks. And just to mention a few, I think, for example, that there is a major risk that we underestimate the pressure on demographic consumption and, therefore, the potential impact on the aggregate factors... investment ratios in the industrial countries, and to some extent also in developing countries. Alchough for other reasons, because or demographic developments, in the industrial countries linked to the aging of populations, this is going to become a very critical factor in determining how the overall pie is being shared and therefore how much of aggregate income will be invested in the future._ _And if there were no other factor, I would definitely say that in the case of Japan, this would clearly suggest that the aggregate savings ratio and investment ratio and therefore, potential growth rate necessarily would have to be reduced in the future relative to what was experience in the 1950s and 1960s._ _Environmental damage..._ _Likewise, the one area where I believe a lot of research is necessary and probably will be done in coming years is the question of how the environmental constraint is going to affect the productivity of capital. How large a share of new investment in the years ahead will be reserved, so to speak, to try to limit the degree of further environmental damage._ _There may well be other reasons to be concerned that we may not even be able to maintain this underlying long-term secular growth trend in the future._ _MR. BANETH: Growth is like a bicycle. Lf it slows down too much, it may fall. And I personally believe that because of both political and social restraints, as you fall below or try to stay at 2.5 percent, the long-term outcome may in facc be much slower growth._ WP/PROCISF:Jsq
_25_

**_The Triffln I would like to come_** _back_ **_to_** _a couple of issues. One of_ **_paradox... them is the broadening_** _of the Triffin paradox Andrea Boltho referred to; what is its impact on the slowdown? And how does one resolve the current disequillbrla?_

_By broadening, I mean very roughly that what Triffin said is that the dollar exchange system was not tenable because it was built on the accumulation of deficits of one country, and at some point the financing of that would stop._ _But the desire for surpluses has not necessarily stopped. The problem was sort of circumvented in the 1970s by the dei'eloping countries becoming suddenly very desirable borrowers. Everybody at the time agreed that they were creditworthy, but we know how that ended. To some extent in the 1980s the U.S. came back and played the same role, but who can play the role now?_

**_SustaInability_** _If the surplus countries argue, in a sense, that disequi-_ **_of the_** _payments librium_ **_Is_** _desirable -- which is to some extent normal partly because imbAlances... of the aging of populations and partly for other reasons -- that to some extent, surpluses are desirable, how can one find corresponding solvable deficits, deficits which make this situation tenable?_

_If it is in fact tenable, what is the financing innovation, the financing mechanism which will allow us to go on in the mediumrun, without reducing the deficit?_ _The question is: How do we render this current situation sustainable, either by building up the financial means of maintaining the same deficits, or by reducing the imbalances, or by a combination of the two? And what are the implications of this for long-term growth in general? I see a common thread in the various statements. That is that the mounting of inflationary pressures through structural changes (possibly generated_ **_by_** _the Keynesian consensus) in fact prevent the appllcation of sufficiently stimulative macroeconomic policies, or pushes towards more restrictive macroeconomic policies. What are the relations of this to the unwinding of deficits?_ _MR. ARMINGTON: I would just add a footnote that perhaps there is a golden rule lurking in the woodwork here -- a 2-1/2 percent solution for growth. We just didn't do enough work on economic history to appreciate that ten years ago._

**_the 2-1/2_** _But just to throw out a question about that: it is true percent that there was a reasonable consensus, ten years ago, that the growth solution... trend of industrial countries was at least 3-1/2 percent. For example, the 1979 World Development Report was not outside the range of commonly-discussed estimates at that time, projecting an average growth rate in the 1980s of 3-1/2 percent to 4-1/4 percent. Now we_

WP/PROC/SF:jsq
_26_ _are talking about a full percentage point less than that, as the percelved underlying trend for the future._ _Were we just too optimistic at that time about technical progress? (We were probably not that far wrong on population growth.) Or are we now being too pessimistic?_ _MR. PERRY: What do we do about some of these imbalance issues on the realistic assumption that growth alone doesn't get us out of them?_ _More on the_ _More on the The overhang of the dollar is another imbalance, and it is Imbalances.., also a very serious problem. It inhibits investment a great deal to have the kind of currency instabilities that we have had. I think that we have had an experiment which has failed, basically, and_ it _has failed because the dollar went up much too high, and then it threatened to go down too low._ _If you look at what is happening to investment, just "prospects' for conducting normal expansions, this currency instability has turned out to be a serious problem._ _The initiative that ought to be taken over the medium-run has to do with finding a new way of dealing with exchange rates other than the experiment we have had. We need a more realistic answer than hoping for more government cooperation, which is sort of a medium-run hope presented in the paper by Boltho._ _But there is a short-term answer, whlch Is attempting to stabilize the dollar at the present level. It would probably be constructive and ought to be successful and ought not to involve perverse policies on the part of the U.S._ _We are just beginning that experiment in stabilization and, anywhere around present exchange rates, the markets will cooperate if governments will convince them. They are determined. Markets are not closely bounded by fundamentals, and when we economists try to model this thing as though there are fundamentals and you can't fight them, we miss the point, which is that neicher we nor the market can estimate such fundamentals well at all._ _All the markets are chasing is what is going to happen next month. It is not really hard to convince them that what is going to happen next month is a stable dollar. Doing that would be a genuinely constructive step to take in the present context._ _If you can establish that, I think you can look forward to both lower real interest rates and better investment prospects. If the instability that we have seen in exchange markets continues, because what I am suggesting isn't pursued vigorously enough to succeed, then things like a collapse of equity markets, and ongoing_

**WPIPROCISF:Jsq**
_27_ _reluctance about Investing, are likely to continue to plague us. The calamity scenario runs off of currency instability at this moment of tlme._ _MR. LIPSCHITZ: I would like to comment on some of the points made._ _I think Perry Is exaggerating a bit In saying there is no evidence agalnst the view that demand stlmulus could solve our problems. It seems there Is a mountain of evldence In the literature on why unemployment Is high, trying to separate classical from Keynesian aspects of the present unemployment problem._ _debt/GNP ratios..._ _On the other questions raised: First, on flscal stimulus in Europe, why should it be that debt/GNP ratios or fiscal positions of the sort we have In the United States now, give rlse to alarm, but similar ratios for Germany, for the Netherlands, for the Scandinavian countries, do not give rise to alarm?_ _Pollcy_ **_co-_** _On monetary policy, anyone who has looked at what has ordinatIon.., happened over the last five years must be skeptical about the choices of monetary policy pushing us out of slow growth. We know in Europe that it is the long-term interest rates tha. affect interestsensitive components of demand. We have seen central banks push down short-term rates and the long-term rates rise or stay constant in response. This Indicates skepticism on the part of markets. The broad question that has been raised, is how we set up a system of policy coordination that will work. What are the gains from coordination? In the last few years, we have witnessed a great deal of optlmism on coordlnation slo1wly give way to somewhat less sanguine expectations about the gains from a coordinated effort at exchange rate stabilization._ _Clearly, attempts at stabilizing the dollar in the way George Perry suggested, haven't worked very well at all times. In most instances markets just haven't found policies credlble._ _But one of the problems might well be that Amerlcans understand very little of the problems of Europe and are not persuasive in talking about Europe, and I suspect vice-versa; that sometimes when one listens to this debate, it sounds like a dialogue of the deaf. On the question of the system per se, of course there is a wealth of literature on how we should set up a new monetary system, literature around the EMS question, wriK by Ron McKinnon on a new fixed-exchange-rate system with symmetric policy responses so that the U.S. doesn't have a free ride._ _The problem with a lot of that literature is that it has dealt exclusively with financial shocks rather than real shocks. What work there has been on policy coordination in the face of real shocks Is, I am afraid, still at a rather primitlve stage._
28

# _PART II_

_(Afternoon Session: 2:30 p.m.)_ _MR. BANH: I would like Mr. Steve Marris to continue hls analysis [that he started during lunch] of slightly gloomy shortrun to the buoyant medium/longer-run outlook for the world economy._ _Inflatlonary recession in the Unlted States..._ _MR. MARRIS: Let me try to look beyond the hard landing. This is something I am starting to try and think about. You always need to be counter-cyclical in our business. So my next book is probably going to be about the dangers of the dollar going up too soon and too muchl But taking up where I left off I believe that the beginnings of an inflationary recession in the United States are inevitable. What exactly is the timing I am not sure, and this recession, of course, is an unusual recession for the United States because it is ecternally generated. That means that there are three things which a;..e completely out of line with NBER cyclical indicator approach to recessions._ _The recession starts with interest rates going up rather than going down. It starts with inflation staying up or going up rather than coming down. On the other hand, it also has built into it a very strong boost to the economy coming from the lower dollar._

**_Do_** _Jones to The configuration that it points to is a recession, which "1000'_ **_plus_** _In the financial markets of the world starts looking rather horrible. something... It is generated, in fact, by financial phenomena. The Dow Jones goes down to "1,000" or so. Interest rates peak, go up. The long term Long-term rates rate, I maintain, will go up to 12 or 13 percent, and this incredible will rise.., euphoria in which this country [the United States] has been living for quite a while will blow up._

_But precisely because the whole thing is unrolling fairlv slowly and because the dollar has already been down far enough for long enough to be giving a strong boost, we are now getting anywhere between 1/2 to 1 percent of GNP per annum improvement in real terms in the external balance, and I think it's absolutely inevitable that_ it _will continue for another two to chree years._ _The recession may start as a sharp one and look racher nasty, but it will be short-lived. And then we get to the feedback onto the political scene._ **_U.S. budget_** _I am confidently predicting that the U.S. budget deficic_ **_deflcit will be_** _will be eliminated within the next -- I mean, action will be caken_ **_eliminAted..._** _which will lead to the elimination of the U.S. budgec deficic --_

**WP/8OLTHO/SF:Ig**
29 _18 months to three years, because the market will demand a policy change: wlth the Dow Jones at "1,000" and Interest rates up, che deficlt wlll have to be ellmlnated._ _So part of my scenario is that (a) we wlll have a recession in the United States; and (b) that the natural forces are such that there is a potential for a strong recovery, and that eventually is consolidated by exactly the Thatcher phenomena, i.e. that a convincing package of budget cuts by enabllng one to sort of stabilize the dollar, get down interest rates and generally convince people that what is wrong is being fixed; this will lead, In fact, to a strong recovery In the United States._ _So within a time horizon of two years out (1990-1991,', 1 am really rather optimlstic about the U.S. I think that the U.S. economy is indeed still a very flexible and dynamic economy, which is being remarkably borne out by what is happening In the manufacturing sactor. In particular, I find remarkable the speed of the swingaround in that sector._ _Now having said that, there is In my view one enormous sort of Damocles hanging over the U.S. economy. A recession is golng to do wonders for the trade balance. If you go back and look in my book [Deficits and the Dollar: The World Economy at Risk], you will find that in the "hard-landing" scenario In which the dollar goes down not very much more from where it is now, and there is a relatively mild U.S. recession, the U.S. trade current account goes from minus 150 to plus 50 in the space of three years, and that is with perfeccly ordinary elasticities in the model._ _And, in fact, I think that Is an underestimate. Part of that result is, of course, because imports are so much higher than exports before the recession. But the other thing is that I am convinced that none of our models take into account the interreaction between price elasticities and income elasticities. You know, whac every other country has learned is that If you combine an undervalued exchange rate with a recession, miracles happen. I mean, they happened in Brazil; they happened in Mexico; they used to happen from time to time in France. And I think there is every likelihood that they could happen in the U.S._ _Fluctuation of So the really frightening thought is that somewhere out exchange there, 18 months to 2 years from now perhaps, the dollar is going to rates... start shoocing up. Jusc remember that the dollar was still at its trough in the third quarter of 1980 and it went up against the Deutsche Mark by about 40 percent in the next 12 months. And within 12 months the forecasts by the foreign exchange markets were that the dollar was going to go down. In other words, within 12 months people thought the dollar had gone up too far, or at least it was not far off the level at which it should have been._ WP/BOLThO/SF:Ig
30 _And it can move unbelievably fast. There are people all over the world walting to buy up America. And when the trade deficit has gone down -- [although not in the beginning - but at some point, it_ **_will]_** _-- by a half or when it suddenly gets to zero, money is going to come pouring_ **_In_** _from all over the world into the U.S. And that, in my view, if we now want to get to the transition from the short-run into the medium run, is the crucial linking policy issue, because I think there is a very serious risk that the dollar will go up too soon and too much. and, in other words, the dollar will not stay down long enough at a sensible level to really reindustrialize America and reestablish a basis for the dollar as the world's currency and for the United States' economy as a sort of linchpin of the world economy._ _I suppose, what we need is a crisis serious enough to actually be able to find a moment where we can lock the governments into a better managed exchange rate system, but not so serious that the whole thing breaks down and there is nothing left to manage._

**_And_** _the story there is absolutely open. I don't think we know what the end of that story is. But I think that it is, in terms of the longer-run of the world economy, a key one, because if I now move outside the United States the most encouraging thing is the way Japan has been able to turn potential domestic demand into actual domestic demand. And it is really becoming quite dramatic._

**_Yen could rise_** _to 80?..._

_And we have this picture of Japan and the whole of Southeast Asia in really very good shape. So that is one strong point in the world economy. I still think that the Yen at some point could rise to 80 [against the dollar] but the Japanese have shown their pragmatic attitudes to all these things. [They have taken a leaf out of Mrs. Thatcher's book.] And if they use all these proceeds from NTT to just simply boost demand, that is quite a lo. of demand they can give themselves over the next year or two. So, they may pull through, and that means that the whole of Southeast Asia is all right._ _If we come to Latin America and the desert countries, my all too simplified view is this: The debt crisis was caused by three things -- high U.S. interest rates, a recession in the North, and a strong dollar. . What is now going to hit them is a blip in U.S. interest rates, but that will not last very long, because once the U.S. economy is clearly in recession, U.S. interest rates will come down. And looking further ahead,_ **_If_** _something is done with the budget deficit, not only will U.S. interest rates come down, but we might get back to a sensible level of U.S. real interest rates bv the beginning of the next decade._ _There is going to be a recession in the North, but the U.S. economy is going to have to start to grow well within two years, and_ WP/8OLThO/SF:19
31 _that Is the most important market for_<sup>_[the debtor] countries. Of_</sup> _course, in the longer-run, It Is always_<sup>_the good thing for a debtor_</sup> _country to see a depreclatlon in the_<sup>_currency of Its creditor._</sup> _The debt calculus..._ _And if you do any of the debt calculus,_<sup>_with the dollar_</sup> _where it is now, there Is a cash flow_<sup>_problem in the short-run with_</sup> _a recesslon and temporary bllp In_<sup>_U.S. Interest rates, but if you go_</sup> _out to the recovery phase, you will_<sup>_flnd that all the debt lndlcators_</sup> _for the largest debtor countries are back where they_<sup>_were before the_</sup> _crisls started; they are back to mid-1970s levels In_<sup>_terms of debtl_</sup> _export ratios and so on._ _Disequilibrium within Europe..._ _That leads me to Europe, and there I think is_<sup>_a very_</sup> _Interesting story. I suggest to you that there is as blg_<sup>_and as_</sup> _dangerous a disequilibrlum within Europe as there has been between the U.S. and the rest of the world._ _When we had the meeting of the Group of 33, 1 had the impression that some part of the Improvement_<sup>_in the German trade_</sup> _position was not due to U.S. but was due to the rest of_<sup>_Europe. [I_</sup> _asked if anybody in the room could to give an estimate_<sup>_of how much_</sup> _the improvement in the German trade balance_<sup>_had been, at the expense_</sup> _of the rest of Europe.] Somebody who has_<sup>_followed the figures fairly_</sup> _regularly, said, "Oh, yes, you are quite right;_<sup>_it must be something_</sup> _like at least 25 to 30 percent. Which is roughly_<sup>_the sort of idea I_</sup> _had in my mind._ _The_ **_German_** _trade surplus..._ _[I then went back and got the figures:] Researching the figures, it showed from 1983 to the first half_<sup>_of :987 nearly 80_</sup> _percent of the improvement in the German trade balance was_<sup>_at the_</sup> _expense of the rest of Europe. That is equivalent_<sup>_to nearly one_</sup> _percent of the GNP of the rest of Europe._ _Use a foreign trade multiplier of two, and_<sup>_you have [up to_</sup> _1988] a break on growth in the rest of Europe, coming from Germany, of che order of two percent of GNP._ _The time trend of this is interesting._<sup>_This really only_</sup> _started after the dollar started going_<sup>_down, and it has been_</sup> _accelerating ever since, because in fact_<sup>_the EMS has been shielding_</sup> _the Deutsche Mark and it has been pulling_<sup>_up all the ocher_</sup> _currencies. The other European economies_<sup>_have also, curiously_</sup> _enough, because off the defense provided by the_<sup>_EMS, been able co grow_</sup> _faster than Germany. So we had_<sup>_this amusing situation of four_</sup> _locomorives of Europe -- Portugal, Spain, Italy and the United Kingdom. [Anybody knows that that_<sup>_can't last very long.]_</sup> _I was very glad to see chat our colleagues_<sup>_at the OECD had_</sup> _picked this up in their latest outlook_<sup>_[December 1987], and they have_</sup> _put in the figures I didn't have, which_<sup>_show that if you split Europe_</sup> _into Germany and the rest, the rest of Europe_<sup>_struggled into a small_</sup>

**WP/BOXXTO/8F:g**
32 _current account surplus in 1987, when the United States was running a current account deficit of_ **_$160_** _blllion._ _And that even in the OECD's proJection, which has a fairly modest improvement in the U.S. current balance -- I think it comes_ **_down to $110 billion by 1989_** _-- by that time Germany is still running a large surplus and the rest of Europe is in very substantial deficit._

**_Germany and the_** _[Ic should be noted that] Germany, via the EMS, in my view._ **_EMS_** _.. ._ **_......_** _exerted a very valuable deflationary or anti-inflationary effect on Europe, in the first half of the 1980s. I think_ **_it_** _was necessary, and it did indeed work. The EMS at that point was a vehicle through which the Bundesbank imposed anti-inflationary discipline on the rest of Europe, and that was probably what was needed._

_From the monent that the dollar [started to go) down, [the situation] has turned around. The EMS has been a mechanism which has been shielding Germany from the consequences of its extremely cautious economic policies and, of course, what this means is that. if Germany really wishes: [it could) go on with low growth, and .ts generally pessimistic view about its demographic position and everything else. That is its own right. But the issue of whether the rest of Europe is prepared to do the same I think is now becoming rapidly a central issue._ _In fact, 1988-89 may be [the period] in which it is Europe that suddenly emerges as one of the major stress points in the world economy, unless Germany begins to grow at a faster pace._ _It seems to_ **_tuie_** _that It is very clear now that we have this massive disequilibrIuw within Europe. And the question is: How long can Germany go_ **_oin_** _like this? And what happens when the rest of Europe reaches the end of its tether?_ _MR. BANETH: How does the unwinding of the U.S. deficit come about as long as you don't have the unwinding of the surplus in Europe (Germany)?_

**_Dollar, DM and_** _Yen..._

_MR. MARRIS: There are two things. If you look at German economic policy over the last few months (latter part of 1987 and early 1988), it has been directed exclusively at trying to maintain the EMS. And indeed they have made concessions to the French in operating their interest rate policy and so on, because the only thing which will change German policy is the breakdown of the EMS._ _And equally, it seems to me, the only way in which a significant reduction of the U.S. deficit can come about, without leading to a real mess-up in Europe, is through at least a 15 percent_ WP/IOCTHO/SF:lg
**33**

_appreclatlon of the Deutsche Mark (DM) against the other European currencles, even_ **_If_** _the Germans were to take a more expansionary action._ _There_ **_Is_** _a grldlock of political and economic bottlenecks there, which_ **_It_** _seems to me are bound to blow up once_ **_the_** _current nominal value of the U.S. current_ **_deflcit_** _begins to fall at the same rate as the real one._ _MR. ARMINGTON: That also probably Implies a fairly large appreciation of the DM against the dollar. I mean the breakdown of the EMS_ **_Is_** _not Just going to change currencies within Europe, but the DM_ **_is_** _going to be exposed as the key undervalued currency._ _MR. HARRIS: The Yen, of course, was fully exposed, and_ **_the_** _effective Yen has gone up probably nearly 35 percent by early 1988, whereas the trade weighted DM went up about 10 or 12 percent, because it was living off the rest of Europe._ _MR. BANMTE7: I find there_ **_is_** _a bit of inconsistency between your rather optimistic prediction about_ **_the_** _unwinding of the U.S. deficit, and your pessimism concerniaig the unwindlng of the corresponding German surplus. How would the developing countries get out of (if only they survive) "the 500 degree heat of the furnace" for a couple of years._ _Again, I don't think that_ **_Is_** _fully consistent with some of the rest of the story, including the impact of the likely rebound of the U.S. dollar, and the likely slowdown in growth and corresponding impact on primary commodity prices._ _MR. MARRIS: Unless something is done to stop the dollar rebounding, then we are in trouble. If something is done to stop the dollar rebounding, (I still would say that I think) che conditions for a decade of four percent growch in the world economy, in the industrial economies, a new "golden period", not necessarily as long, are very good. I think the general underlying conditions for resumed fast growth in the world economy are excellent._ _The maln reason I ended w.tth that digression on Europe is that the questicn of whether It can be done without Europe somehow putting its act together is relevant; well I am not sure. Europe is four times more important as an importer of commod.-ties than che United States. It is particularly important in a set of triangular trade relations with the developing countries, convinced that I could put together my optimistic scenario for the '990s without assuming that somehow or other, at the end of the line, the Europeans_ WP/IOLTHO/SF:lg
34 _straighten_ **_out_** _their mess. And, you know, I am much less optimistic [about that than I am about the_ **_U.S.]_** _MRfl._ **_BAM_** _:_ **_ZI_** _thlnk this leads us back to some of the questions which were opened earlier: In particular about Profes;or Boltho's assumption on the endogenelty of technical change, or the absence of a problem In technologles._ _MR. OHLIZ: Could I perhaps say Just a few words about why I think this might be Important for the 1990s._

**_What will be of importance in the 1990s?_**

**_What_** _I have In mind is that there are certain imporcant analogies with the 1920es' and the 1930s in the magnitude and the extent of structural change, and the sectoral differences_<sup>_in_</sup> _manufacturing, and the whole high-tech business, the difference between high-tech and smokestack industries._

_The reason why I thought it was worthwhile brlnging_<sup>_this_</sup> _question up was that we are all aware of the pervasive importance of_ **_the_** _electronic technological revolution. It affects_<sup>_everything._</sup> _There is no point In looklng Just at the high-tech industry_<sup>_Itself_</sup> _because_ **_it_** _has a productivity enhancing effect elsewhere._ _And the point about this Schumpeterian perspective which I briefly referred earlier, is that, after this period_<sup>_in which new_</sup> _technology slows thlngs down or displaces more Jobs than_<sup>_it creates,_</sup> _when that whole process of absorption is over, you come_<sup>_back_</sup><sup>**_co_**</sup><sup>_the_</sup> _productivity enhancing effect of technological growth. And this is after all the whole point._ _Benefits of So on that view briefly sketched of the 1990s, the benefits_ **_technological_** _of technologlcal change in the 1980s are reaped in the 1990s essenchange... tially, i.e. they are not reaped right away. It takes_<sup>_some time to_</sup> _absorb them._ _If you look at industry after industry, you_<sup>_find an_</sup> _enormous retooling, obsolete technologies, also the capital equipment being replaced with modern electronically-guided equipment and so forth, and it is very similar to the whole thing in_<sup>_the 1920s, which_</sup> _was referred to as structural rationalization and_<sup>_so forth. The_</sup> _merger business is also part of that, the tremendous_<sup>_reshaping of the_</sup> _organizational structure of important branches, a_<sup>_new pattern of_</sup> _concentration, new companies taking over and so forth._ _I think there is evidence of this kind, but it is obviously not easily measured. You have_ **_to_** _take a different_<sup>_kind of view from_</sup> _that which one can do with simply active statistics._ WP/6OLTHO/SF:Ig
35 _MR. VERSLUYSE: I have a question on this impact of technology. It was mentioned that there Is a new pattern of concentration In Industry. I thought that the main beneficlal Impact of micro-computer technology In the 1980s was to enable firms to reap the benefits of Increasing returns to scale without having to have a large-scale industry._ _If you look at a lot of statistics, particularly in Japan, but I think also In the U.S., the momentum for the increase of employment in industry has in fact been in small companies. This may diminish the volatility of employment. Unemployment will continue to Increase in the major smokestack Industries, out will b6 partly offset by modernized new small enterprises. The increments in productlon come from small companies._ _MR. MARRIS: I think the one thing I am impressed by is that the electronic technological revolution is, it seems to me, the nicest one we have ever had. It is so general. It is both product Innovation and process Innovation. it can be used anywhere. It has this characteristic which is that it can stimulate competition and decentralization. You know, it Is not like most of the big driving forces which would displace geographically -- where people have to shift from agriculture to industry or move from Europe to America._ _It seems to me we are on the leaf of the lucky with this one, and, as long as we keep the world going at a reasonable pace, this one will work out extremely well, and probably be pretty highly productive._ _MR. ARMINGTONV: If we do wind up with, say, 2.5 percent growth characterizing the whole of the 1980s, that performance, in retrospect, may turn out to be considerably better than we would have expected without reference to a technological foundation for it. In the 1980s, the demand side, the policy side, and the monetary side have not been conducive to growth. Given that, the question is how did we manage to do as well as 2.5 percent, if this is near our view of the long-term growth trend for the future? It may be that we will wind up looking for some difficultto-measure reason why we managed to get as much as 2.5 percent annual growth in the 198Cs, and hence come back to the technological revolutlon as a supportive factor. If so, well, then, of course, there Is a potential for 3.5 percent, or even 4 lorcent growth In the 1990s, if you can get through some of the problems that Mr. Marris is talking about._

**_More on_**

**_More on_** _MR. LINN: How much of a normative dimension is chere :echnology... to the discussion of technology? I am a bit worried that It doesn't_

WP/80LTHO/SF:Ig
36

**_get_** _us anywhere In terms of Informing what should be done in the next two or three years [1988-1990] in terms of policy, because I suspect that pollcy prescriptions for the next two or three years or even outer years are going to be pretty much the same, whatever we believe Is in fact on technological opportunities._

_Successful technology policies, whatever they are, may jack up our estimates of potential growth rates by 1/2 percent, maybe even 1 percent in other outer years, but my impression is it is not a very fruitful ground for policy discussion. Would that be a biased view? What can we do in terms of a policy perspective? The best thing we can probably do is to make sure investment takes place so that new technology gets embodied. And that means that we have to somehow cr&"k up investment, bring interest rates down. Incidentally, that Is a general question I would like to discuss in the long-term outlook, what happens to interest rates, real interest rates, which is not something that Boltho really looks at [In his paper). But that may in fact we one of the crucial policy variables that affect technological absorption and implementation._ _MR. BANETH: I think the policy implications are indirect, and we are not going to discuss very much how one would promote technological change or its embodiment except through investment._ _But very much in the background and indeed In the forefront of German reluctance, up to now, to stimulate the economy is, at least at the verbal level, the argument that "we are close to, or indeed above, our potential growth rate." And if you want to work that further, it has to imply the lack of available teehnology to embody in the capital. You have no increase in the labor supply, and basically you can have a 1.5 percent per annum productivity increase because, no matter how much investment you have, that's about all the technological change you can embody in it._ _Conversely, if there is a general feeling that in fact you do have the technology available for embodying into capital, which is not yet embodled, you can have faster change, and this removes one constraint on policy. One could then have faster growth without inflation. Indeed, if you do have these autonomous pressures on wages, if wages are marching forward at a certain rate, then you might in fact have a negative tradeoff between growth and inflation, if the technology is available._ _Structural MR. OHLIN: There are two points. I think the negative chang....... one is the rapidity of the thing. The acceleration of structural changes, the rapidity or the acceleration of structural changes in the 1970s and 1980s, for that matter you can go back almost to the_ WP/BOLTHO/SF:Ig
37 _end of the 1960s, give rise everywhere to policies which ostensibly were meant to promote this. Industrlal policy was the name of the game for a long time, and that turned into, In most cases, devices for actually slowing down structural change, from trying to promote and beef up the sectors that were threatened. And we know what excesses of subsidies that led to. So structural change was actually slowed down rather than stepped up._ _The other point which Is related to this Is the question of what happens to this process of structural change with the kind of exchange rate fluctuations that we have had and the misalignment phenomenon that has been talked about so much._ _Well, we know that people closed down capacity in the U.S. in the days of the high dollar, and the question of the costs of this kind of premature adjustment to a level (whlch turns out, a few years ago, to be totally unrealistic) does ralse some very serious questions of cost-benefit for che adjustment of capacity and the appraisal of competitiveness and so forth. You don't know what you are adjusting to._ _PROFESSOR BOLTHO: I will try to reply to some of the points on the longer-run growth issue starting with Mr. Ohlin's comments._ _Determinants of The growth process is very complic.ted; there are a number long-run of ("N") factors at work that determine the long-run growth rates of rowt....... industrialized economies. But If 'N" were a very large number, would we cross our arms and forget about it?_ _That is why I was trying -- as I have done in my paper -- to be perhaps assertive by stressing the role of Investment, and I am going to stick to my view, partly because I am not just looking at 150 years of growth; I am trying to look at periods of acceleration, during which some of those forces which Goran Ohlin mentioned I don't think played that much of a role. That is particularly true of the sort of micro policies, the human capital, the efficient administration, which are a common feature, more or less a common feature of all the economies I am looking at, a feature which has progressed steadily through tlme._ _Such a fairly steady movement which can't explain sudden decelerations or accelerations. There must be something else at play -here. That something else could indeed be technology a la Schumpeter. There I think it is a question of how one interprets the evidence._ _My reading of the evidence does not suggest that there are such non-linearities in technology. There may be inventions but noc in adaptation of technology._ WP/BOLTHO/SF:1
38 _I don' t think technology Is a sort of permanent two percent trend or "N" percent trend which never changes. I think It is very closely llnked to the business cycle (i.e. the absorption of technology into the economy). So It is not exogenously given in the way neo-classical theory would assume. But at the same time, It is not something that varies very sharply because of factors other than the cycle._ _So I still have got to find something, and this something, In my case, Is investment. This then brings me to future growth, and to Flemming Larsen's point that perhaps 2.5 percent per annum, is the underlying long-term trend. You know, we have had it for 150 years with the exception of 20 years; we will be stuck with it forever._ _That to me is far too fatalistic. It may turn out to be true, but I don't think there is any particular reason why 2.5 pe.cent growth should be the norm for industrialized countries._ _What could improve on that performance? Steve Marris sounded much more optimistic than I actually would have sounded, and he is talking, r presume, about 4 percent some time in the next decade._ _What could bring us to such a higher growth rate? The only thing that the Fund has to recommend, as both Flemming Larsen and Leslie Lipschitz have been saying, is policies of deregulation. That is the one thing which they seem to consider could bring about the expected acceleration in growth._ _Frankly, I am far from convinced. For one thing, the 1950s and the 1960s were almost certainly a period in which regulations Increased, in which the Welfare State became more "oppressive"; in which labor legislation got more binding. Yet our growth went on and on and on, apparently unperturbed by [these events). What I am not saying is that it doesn't look as if these micro distortions were quite as important as people tried to make them out to be. I don't want to say that if one reforms agricultural policies in Japan or Europe or America, that won't be a good thing. On the contrary such reforms may bring about a host of benefits to tha industrial countries. But we can't quantify this and in my opinion their contribution to the growth performance is perhaps not that significanr._ _On the other hand, if you wanc, the one particular deregulation which has just been mentioned has had extremely serious negative consequences for our growth performance. I am thinking of deregulated [foreign] exchange markets. We have now got floating exchange rates which go up and down all over the place in real terms and they generate the negative effects on investment and on the tradable sector, which Steve Marris was just mentioning._ WP/BOLTHO/Sf:lg
39 _So there may be some forward seeps that: one can make In the deregulation area, but It really has been put at the forefront of policy concerns to a totally unwarranted degree._ _What to my mind would be much more important -- and there I Joln Steve Marris -- and by far the most successful transition, is one In which we come out of the present imbalances with a different International monetary system whlch has a much greater degree of stability in exchange rates, and combine that with some growth stimulus from the fiscal policy side of a concerted kind. Thls may regenerate those more optimistic expectations which to my mind, even if they are not an explanation of long-term growth for two centuries, are definitely an explanation for specific episodes of acceleration or for that matter deceleration._ _HR., MARRIS: Basically I very much agree with Andrea Boltho that we are not golng to get self-levitating growth, that somehow you have got to have demand and have optimistic expectations about the future growth of demand. That I think is crucial._ _The 'liberal" What I feel is that we are still in a too industriocentric market view of the world, that the really important things that have economy... happened in the realm of ideas over the last ten, fifteen years has been in the developing parts of the world. [These countries) have learned a great deal about the necessary types of economic policies to produce development. There has been an absolutely astonishing revolution or export of the liberal market economy to just about every country in the world, Including even the Soviet Union, although that will take time._ _PNow the one thing we know is that in those parts of the world, you only have to get things half right. I have always said this: If you put a national frontier around almost any piece of the earth, whether it has natural resources or not, if you then put in it a population that is poor and starving, has some minimum of education, and provide It with some degree of political stability and a sensible sort of "liberal" market economy outlook, you have a miracle. I mean, every time, it has been done, It has produced a miracle._ _I think probably "liberal" is the wrong word. Nevertheless, freer markets seem to be leading to democracy too, which is even more surprising, and that may be in fact :he weakness, because maybe the democracies will blow up. But it is the economic policy that relies on getting both the key macroeconomic and the key microeconomic prices right. And we get miracles -- even if we can only achieve 2.5 percent growth in the industrialized countries._ WP/8OLThO/Sf:Ig
40 _I would like to pursue this issue of the feedback; of the Importance of the developing economies for the industrial economies._

**_Feedback from_** _the LDCs..._

_First we have the small, medium-sized economies which in effect are industrial countries except by classification. That is Korea, Taiwan, Hong Kong, Singapore are Industrial countries by every crlterion except the fact that they weren't there ten years ago._ _And, indeed, once you put them in the industrial countries and you look at the industrial countries' growth performance in the 1980s, you will find a slightly different number, not terribly different because, as industrial countries go, these are still not very large economies._

**_Diversity wl thin the LDCs..._**

_Then you have the macroeconomies, India and China, where half the population of the developing world are doing reasonably well. But their connections to the rest of the world, I think, are not very strong. They are not very strong in the financial sense or_ **_in_** _terms of international trade. Nevertheless, there are some connections and feedbacks._ _Then I think we have a very heterogenous group of all the rest, which in weight is dominated by_ **_che_** _highly-indebted countries_ **-** _- simply because you have to be a fairly large economy to become highly indebted. Now what is the feedback we are expecting from these various groups in the rest of the decade, in the 1990s?_ _PROFESSOR BOLTHO: Well, partly in response to Steve Marris: sure, there is a lot of world out there. But there aren't a lot of miracles. There are a few miracles in some countries which are doing very well, and a few which are doing reasonably well. An awful lot of them are not doing well at all. And I wouldn't necessarily draw that simple parallelism between export or marketoriented policies and success._

# **_Export-oriented_**

_The cases which have often been looked at, South Korea and Taiwan, show now that there is a certain amount of market orientation, but in the 1_<sup>_9_</sup> _50s and 1960s there was very little trace of it. It was much more a Japanese type, highly intervencionist strategy that was being followed. And conversely, you can take much more market-orienced economies like several in Latin America -- Argentina and Chile -- and they are hardly miracle stories._ _economies..._ _I am not denying that in certain circumstances, markec orientation can do the trick and certain deregulations can help, but I don't think it is a blanket recommendation that can be made to everybody._ _In any case, quite a lot of these success stories have been export-led. Weli, that is a well-known old argument now. Can every-_ WP/BOMTHO/SF:g
41 _body be export-led vis-a-vls, basically, the United States?_ **_It_** _has been the United States which has been sucking-in the imports, which again leads me to the feedback issue._ _These countries, the really successful ones, have grown in the 1980s mainly because of the U.S. Can they change their growth pattern to something much more domestically determined? I see no trace of it in any of the smaller very successful countries. And, therefore, I find it difficult to see them [having an impact on the North.]_

- _Japan is beginning to do it. Japan benefitted from the_

- - _rest of the world for a very long time. It is now beginning to provide a feedback, mainly via the LDCs, directly, and also for Europe or America._

_So I would be skeptical about the feedbacks from_ **_the_** _small very successful ones. The large and the reasonably successful ones, as Steve Marris says, are autarchic, particularly_ **_China,_** _which is both the largest and among the most successful._ _There again, the feedback seems very limited. The ones which are much more open and less successful, what feedback can expect from them? Unless they can generate a self-sustained domestic growth process -- there again perhaps the only other possible country would be Brazil. As I have emphasized in my paper, (Can we Grow Rapidlv?], whatever the dynamism of Southeast Asia, I find it unlikely that these countries [the Asian NIEs] are going to be che growth pole or the locomotive of the world economy. They may perhaps_ **_be_** _able to grow relatively rapidly on their own, for a long cime._ _MR. BANETH: What would it take to be a growth pole? Should there be only one [pole at any given time?]_

**_Multiple_** _locus..._

_PROFESSOR BRADFORD: One of the things that has concerned me in this discussion is: Isn't the search for a single engine of growth part of the problem? Part of the juncture we face, I think, unless one is more optimistic than I think we can be, is that either the world economy turns towards a return to the trilateral center and growth pole of the world economy between Japan and the U.S. and Europe, or ic continues on this path that it has been on from the early 1970s, by incorporating progressively more economies into che world economy that is, by increased openness in which case there really isn't a single locus for growth stimulus in the world economy, but a multiple locus._ _And that is why a systemic cooperative solution is the one that works and why the models that try to limit a focus on the large_ WP/SOLTHO/SF:tg
42 _economles do not show the full impact of a cooperative solution on the world economy as a whole, because there are indeed not just three loci, if you like, but rather, in this conception, there are as many as 25 or so economies which, either because of their_<sup>_size or because_</sup> _of the ratio of their trade shares to GDP, are crucial to the_<sup>_overall_</sup> _outcomes of global economic growth._ _So it is a much more diffuse process than the_<sup>_one of seek-_</sup> _Ing where the center of gravity of world economic growth is, because in fact there isn't one, but there are multiple_<sup>_centers._</sup> _MR. LINN: Maybe that distinguishes the post-war period from the other periods of growth, namely that if you look_<sup>_at the data_</sup> _on GDP growth rates, everybody grew very rapidly_<sup>_at the same time,_</sup> _the developing countries as well as the industri.l economics._<sup>_While_</sup> _in the earlier periods, the Americans were growing most_<sup>_rapidly in_</sup> _the late 19th century._ _So the question is: Was it coincidental that_<sup>_halppened?_</sup> _Is it something that won't come back? Will you have_<sup>_these smaller_</sup> _growth poles (such as East Asia), but they won't_<sup>_be able to pull the_</sup> _world along in the future? Or is there a way_<sup>_through coordinated_</sup> _policies to get everybody to come back up to a, say, 3.5_<sup>_percent [per_</sup> _annum] growth rate together? One group of 25 percent_<sup>_of world GDP,_</sup> _one relatively small group, growing at 4 or 5 percent_<sup>_[perannuml_</sup> _isn't going to do the trick._ _MR. BANETH: I would like to come back actually to something which Steve Marris said, about the movement_<sup>_in the weight_</sup> _of the developing countries in the world economy. If we focus our attention on the impact of developing countries on the industrial countries, then I believe_<sup>_the answer_</sup> _tends to be: relatively limited, because there are a_<sup>_lot of develop-_</sup> _ing countries that are so small that even together chey_<sup>_don't weigh_</sup> _much in the international economy._ _If we look at the Impact of the rest of the world_<sup>_on some_</sup> _of the developing countries, I think we get_<sup>_a somewhat more positive_</sup> _answer. While Mexico or Brazil or Korea, may_<sup>_not have much of an_</sup> _impact on the United States today, they may play a role._<sup>_Their_</sup> _weight relative co the weight of Africa is not very dissimilar_<sup>_to_</sup> _the weight Europe had relative to Africa 30 years ago._ _And in that sense, they may be increasingly replacing this particular growth impulse In terms of demand_<sup>_for primary commodities_</sup> _and the rest._ WP/BOLTHO/SF:19
43

**_Financial_** _markets.,.._

_MR._ **_OHLI_** _I do miss the question of what the transnationalization of many Important and particularly dynamic sectors in the world economy means, and this whole perspective_<sup>_of the erosion_</sup> _of the national state._ _I don't know_ **_how_** _seriously to take_ **_It_** _and how far to_<sup>_go._</sup> _But I do think that to discuss things In terms of national_<sup>_units as_</sup> **_If_** _nothing had happened is rather difficult._ _There_ **_Is_** _no major company in the world now that_<sup>_isn't_</sup> _producing all over the place, and it allocates according to what it finds useful. Does this only mean that markets become more effective, or does it add some new dimension?_ _Similarly, we have referred to the new financLal market and the fact that they tend to drive the exchanAe rate system. But we haven't really incorporated the implication.I of this and_ **_Its_** _tendency to reduce the importance of national policymaking, especially in the monetary field._ _Some people who write about this perhaps overplay_ **_Lt._** _Nonetheless, I think_ **_If_** _we are talking about the problem of how to get more stability into exchange rates, we have to come to grips with the fact that we have a totally different financial market in the world than we used to, and that we have been assuming or hop,ng that coordination of national or macroeconomic policies could do it._ _There are lots of references, especially in the Armington/ Fardoust paper, to this, and In the draft of the paper for the World Development Report. It seems to me that these discusslons lead one to the conclusion that it is totally unlikely that some sophisticated coordination could come about._ _You have said as much, Jean (Baneth). You don't believe that governments would be able to do it. But I haven't heard anybody suggest what else we think might possibly be adopted._ _There is a reference_ **_to_** _the hope or fact, in the Armington/ Fardoust paper, that these necessary institutional changes will come about or history will somehow produce them. Can we guess In what direction they would have to go?_ _I would think they would have to go in the direction of a return to some kind of standard. We were in the global economy before the First World War._ **_We_** _are returning to a global_<sup>_economyin_</sup> _a way, and yet of course we can't have a gold standard._<sup>_So what kind_</sup> _of standard could there be?_ _I must say I have been amazed at the discovery that in the U.S. Treasury people have been quietly studying commodity standards_ WP/8OLTHO/SP:1
_44_ _for decades, and the other day [Robert] Heller wrote in The Wall Street Journal about the possibility of a commodity standard._ _There are lots of other people around who feel that sooner or later something like that will have to be taken seriously again, as it was at various times in the past, for instance, at the first UNCTAD when Kaldor and Hart presented a detailed technical proposal, for a commodity standard._ _MR. O'BRIEN: A more concrete point then is: [supposing that] we have in the technological developments of the 1980s the seeds of faster growth in the 1990s, then is that actually good for the non-OECD countries, for the non-industrialized countries? The gap between where they are and where the industrialized countries are_ **_is_** _great enough at the moment for them_ **_to_** _work a miracle without ac.ually having to catch up on yet another advance in the OECD countries._

**_Linkage between OECD and developing_** _countries..._

_MR. STEER: On the linkage between OECD growth and developing countries, I would be interested to know whether people_ **_think_** _that the Armington and Fardoust kind of numbers make sense, because Professor Boltho said just a minute ago that in the old days all the fast-growing developi.._ :ountries really did it because we were growing in the OECD countries through trade, and now they have got to learn how to do it without the industrial countries._

**_But_** _unless you look at the numbers that are presented in this paper by Armingeon and Fardoust, in fact you_ **_see_** _that even under a rather gloomy OECD economic situation, the 2.5 percent solution,_ **_7ou_** _have got trade growing, if they are right in volume terms and you have got the terms of trade improving._

_You have got trade growing at almost exactly_ **_the_** _same rate, well, slightly lower but not much lower than in the 1965 to 1986 period, in 1990s._ _I mean, if these numbers are right, we really must nip in the bud Professor's Boltho's idea that the developing countries should not rely on OECD and trade._ _Now these numbers may be quite wrong. In the 1965 to 1987 period you have got an average 3.3 percent [per annum] GDP growth in OECD, which permitted export volumes of the developing countries to grow by 4.2 percent [per annum]; you have got a much lower OECD growth in the projected period [of about 2.8 percent per annum], leading to no lower growth in LDC's export volume._ WP/EOLTHO/SF:Ig
45 _Now you have got terms of trade improving for developlng countries, not as much as they did apparently Li the 1965 to 1986 perlod, but, it still looks pretty good._

**_Hlgh_** _and_ **_Low_** _Grovth Scenarios..._

_MR. VERSIWJYSEN: My lnterventlon Is more out of parochial self-Interest for the WDR (World Development Report 1988). To the extent we make projections [which are not forecasts] in the WDR, I could see a base case emerging where a recession doesn't necessarily take place, but world economy gets locked Into a low growth scenario In the near-term, which Is then extrapolated in the longer term through the end of the century also in low growth. It is difficult to see how high growth can result after a period of low or no growth._ _This may sound paradoxical, but then if we have a low case and a high case deviation from the central scenario, I could see the high case even more paradoxical, subject zo a number of qualifications; that the high case would in fact presuppose in the short-run a recession, but a recession which can then only lead to a high case without the qualifications of technology and possible other systemic shocks. But where will the main systemic shock come from? Out of a recession come two things: that the individual OECD countries would not try each to grow out of the recession on its own but in a concerted fashion, and that, somehow, greater flnancial disclpllne, potentially through greater aggravation In the financial m&Jkets, particularly the foreign exchange markets, would put checks and balances on the likelihood that the dollar would bottom out in the very near future and then start escalating again within the next 18 months._ _So in a sense the shock that comes out of the recession should be a systemic shock which also brings about, galvanizes the wisdom and the ability of the various governments to actually cooperate with one another._ _MR. LARSEN: Obviously, the question of the linkage between growth in the developing countries and in the industrial countries is an extremely crucial aspect of this whole discussion._ _More on the_ _More on the I wonder if it would not be useful to begin perhaps to_ **_linkage......._** _explore the possibility that the link may be less strong than we believed in the past. And, indeed, as I read the numbers, I think it will be very difficult to defend the hypothesis that high growth in the industrial countries is a necessary and sufficient condition for high growth in the developing countries._ _Indeed, I think high growth in the industrial countries is neither a necessary nor a sufficient condition. I .hink what is interesting to examine is the kind of trade performanc che develop-_ WP/SOLTHO/SF:Ig
_46_ _Ing countries had when growth was hlgh In the Industrial countries. I thlnk_ **_It Is_** _rather dlsappolntlng that their actual growth rate was only 4.2 percent given that world trade growth over this period must have been signlficantly higher._

**_Exchange rates of developing countries..._**

_Now I wonder_ **_if_** _this does not have something to do with the fact that, durlng this period, developlng countries' exchange rates generally were extremely overvalued and became increasingly so, which essentially distorted the relative price structure in these countries._ _MR._ **_BiANETH:_** _We have just completed a research project looking at oil-Importing developing countrles' exchange races from 1960 to 1984 in real terms [Adrian Wood, "Global Trends In Real Exchange Ratos, 1960 to 1984",_ **_World_** _Bank Discussion Papers, 35, 1988], which shows that with only a few exceptions they were on a devaluing trend, in real terms, relative to those of industrial countries. And that_ **_Is_** _until 1985 when the dollar [began to fall.]_ _MR. LARSEN: I agree that they were on a devaluing trend, but I believe that they may still have been overvalued._ _In other words, if the exchange rate problem is being corrected, I think that there_ **_is_** _a significant potential for the developing countries' trade to expand but It doesn't follow necessarily that there is significant scope for expanding their shares of world markets as much as Japan expanded_ **_its_** _share of the world market previously or as the Asian ;JIEs are expanding_ **_their_** _share now._ _In order for them to be able to do that, it is necessary that investment be stepped up again. On my recollection,_ **_IMF_** _figures show that the investment ratio in the developing countries fell very sharply in the first half of the 1980s compared to the previous period._ _What kind of policies are needed to increase the investment ratio again in order to allow these countries to exploit their potential and to build up an export potential?_ _I think that is at least as important a question as the question of the pull from the industrial countries._ _MR. LIPSCHITZ: Andrea Boltho has raised the point of whether we can get internally-generate_ **_d_** _emand growth in the LDCs? And I think Steve Marris raised the point of whether we can get internally-generated demand growth in Europe, given its current structure._ WP/COLTHO/SF:19
_47_

**_Grovth in Germany..._**

> _Flrst, the Issue in Europe -- and Germany has been the_ **_focus_** _of the discussion_ **_-- Is_** _that, growth in Germany has relied on export Impulses or fiscal Impulses that could not be sustained. Can we get Internally-generated growth, that_ **_is_** _sustainable in Germany?_

_From where we are now, fiscally, I don't see that we can have government-generated growth over the longer-run in Germany. Therefore we should seek to get growth lmpulses that originate spontaneously in the private sector. To do this, it will be necessary to deregulate a ver"' regulated economy._ _It's not that I belleve that there_ **_Is_** _an enormous amount of addltional growth that can be achieved by deregulation. But only that the deregulation of markets is the only thing I can see that could generate a higter rate of sustainable growth without relying on ever-growing fiscal deficits._ _If you believe chat fiscal deficits are self correcting, look at the U.S. over the last few years and see if you_ **_still_** _believe_ it. _The second point raised_ **_[by_** _Steve_ **_Marris]_** _in this connection -- and again here I am looking at Europe's contribution to growth_ **_-i-_** _s the exchange rate system, the EMS in particular. There_ **_Is_** _the Idea that Germany rldes on the back of the EMS. It gets tremendous competitive gains; It shelters itself from fluctuations in the dollar. This view, however,_ **_is_** _Incomplete._

**_We_** _have a situation now where much of the world is looking for a stable nominal anchor -- and there is an apparent desire for one hard currency. Thus, we have the interesting situation of everyone complaining about_ **_the_** _Deutsche Mark, yet the Swiss, the Austrians and now the United Kingdom are pegging to it and using this peg as their credible financial policy._

_If you want a credible anti-inflationary threat, you need to peg to a rock; you can't peg to a marshmallowJ If you say they should peg to Italian monetary policy, that would be a marshmallowl So, sure, there_ **_Is_** _a cost In having a very hard Deutsche Mark at the center of the EMS, but there_ **_is_** _also the benefit of believable financlal stability._ _The thlrd point_ **_Is_** _whether we could find demand policies that would generate stronger domestic demand in Europe. Well, what does one want here? In 1986 and 1987, terms of trade gains generated much additional purchasing power [3 to 4 percent of GDP]. These gains were coupled with tax cuts [another one percent of GDP] and yet there wasn't much in the way of a demand response._ WP/9OLTHO/SF:1
48 _Clearly, there Is some structural problem here. It Is not simply that households and corporations lack purchasing power. but that they aren't uslng It. Thus far, atleast Increases in real Income are going malnly Into savlng rather than Into spending. It seems to me this is prima facle evldence of a structural problem that needs to be addressed and corrected._ _Prospects for the European countries..._ _MR. MARI$: Well, I would love to respond on Europe and Germany, but I think taking a global view, as I said, I am not sure whether we may not have to lower our expectation of Europe. It Is an interesting question._ _I want to come back to the global picture, and take the Boltho's historical perspective. You know, when civillzation was in only very small bits across the world, you could have a gold discovery or the opening up of the West or something like that. That was a dynamic factor which pulled parts of the world along._ _We have got a much bigger and more diverse world now and, therefore, I think that it Is more likely to be ideas rather than events that are going to have an important influence on the future._ _I do believe that the Keynesian idea -- you could even have an historical determinist's view of the evolution of the Keynesian idea and l think Boltho keeps harking back to this -- p.ayed an enormous part in the golden era of the 1950s and 1960s. Like all of these Ideas, they belong to an age and point in time, and they deteriorate in value when they have been successful, which is the case there._ _The developing world..._ _Now I think that there is a new idea; it [really] isn't new at all, but Its day has come in the developing world. It may be said that it is Prebisch (Raul) turned upside down. It is that prices are important, that there are certain key macroeconomic prices you must get right. And we talked about exchange rates here. There is a complete revolution, I think, in the recognition at leaat among the establishments of almost all Latin American countries, really in all countries, even the Chinese, that governments should get out of the business of production. There is a new view of the division of responsibilities. It's not new to us, but it is new to them. In the majority of the world it is a new thought, that the government's role is not one of producing but rather regulating or providing public goods and so on._ _I am enormously struck by the fact that in Latin America import-substitution, the old view, and the views of the role of the state are completely discredited, and that the technocrats are all speaking the same language, virtually._ WP/BOLTHO/SF:tg
49

**_Latin_** _America..._

_Then that doesn't mean that that is the answer because you have got to have che political stabillty, you have got to get the politlcal establishment prepared to have the courage to follow this through. And if you look at Latin America, you can see those parts of the world where it is not being carried out. I find Mexico extremely exclting. There has been a blg change in Mexico since 1982, its [manufactures) exports have increased by 40 percent [in 1985-87 period]._ _And there is a fuindamental belief In the future of some of these [large) developing countries, which is not what you find in Europe Lhese days. But I think the frightening thing in a sense is that this [rap'd economic change] has been associated with a move towards democracy in a number of countries. Democracies are extremely fragile and some of the pain associated with switching frcm paternalistic economic policies to [a new mode] of economic policy may be more than some of these democracies can take. But I maybe wrong._ _But still I think there is a great deal of optimism about these changes; but that wouldn't be enough. However, I am still optimistic about the U.S. The great thing about the U.S. is thac it is flooded with people from all over the world who want to work extremely nard, and who are keeping wages down and who work at night. A large number of these new emigrants happen to have high IQs and they are coming out of MIT and every-where, winning all the science prizes. The country is just incapable of being either governed or regutlated enough to do great damage to its Internal dynamics, and it is going to survive, as long as it keeps its macroeconomics right, and that of course is a big consideration._ _Now this leads me to the question of coordination. I find myself extremely uneasy with what I regard as idealized sort of views that emerge from the papers presented here and from some of the things said. Perhaps if we are lucky, we will need a more or less 1930s' recession to lead to a situation in which we could do a major rebuilding of the institutional and political structure necessary for coordination. At the moment, I don't think that is what we are headed for. So it's going to be much more messy, a bit-by-bit business._ _Yen/dollar liaison..._ _One element in it I think is emerging, which is that there will be a Yen/dollar liaison. Lately [early 19881, the relations between the U.S. and Japan have become so integrated that it is very likely that the political interests on both sides will be sufficient to lead to a situation in which both countries are prepared to do whatever is necessary to prevent that exchange rate from fluctuating as It has in the past. If that were true, an awful lot of the developing world is going to forget about Europe and is going to peg into that in some way or another. And that is one scenario._ 0 W /90LTHO/8F:tg
50 _You could have an optimistic scenario for Europe._ **_I_** _said I had written_ **_it_** _off, but I wouldn't entirely. First, taking Germany itself, you know thls rock onto which Europe has locked itself was. I argued, very valuable in the flrst half of the 1980s. It is now_ **_like_** _a rock_ **_wh.ch_** _Is being tied to somebody's leg and they have been thrown Into the river, and, they have to decide whether they are golng to untie_ **_It_** _or not._

**_More on Europe..._**

_There are_ **_two_** _things. One is that I think there is one factLon in Germany which has not accepted the view, the generally depressed view, of future slow growth. When I talk to German businessmen, they don't accept the Idea that they are condemned to technological backwardness and to the loss of all their world markets and all the rest of it. Indeed, they are not yet technologically backward. So far they are not too worried or they haven't been for the last twelve months because they have been wiping up_ **_the_** _rest of Europe. But I believe that the reaction from the German business community, if and when EMS breaks down, will be virulent._ _The other thing is that there is one ambitious country left in Europe and that is France. And I just don't think France is going to_ **_sit_** _down and tie itself to this pessimistic view of the world. I am extremely impressed by the very substantial structural improvement that is taking place in the French economy. Profits are up; inflation_ **_is_** _down. There has been an immense amount of restructuring. There is a lot of technological change going on._ _Now, there are problems like the French educational system and a good many other things. But I don't think that Europe_ **_Is_** _going_ **_to_** _go down the drain without at least trying, and I think it is going to_ **_be_** _very interesting to see whether it could put its act together, which wlll be very difficult._ _A_ **_more managed financial_** _system..._ _To sum up, I think that it is reasonable to suppose that the troubles we are going to go through in the short-run will generate enough of a move to a somewhat more managed financial system, and that is now a new standard or fixed rates or even John Williamson's target zones. It may be something much more pragmatic than that, which is the sort of agreement between the President of the United States and the Prime Minister of Japan, that we will work together on this and there may be some point at which the Europeans come rushing in and say, "Hey, we would like to join in this too", which is what happened, of course, when the "Group of Two" started meeting. Thus, the ideal outcome is enough trouble ahead to make sure that the lessons have been learned and that we get the minimum necessary degree of greater financial stability._ _Furthermore,_ **_if_** _we look at what can be done, or is being done, in terms of policy reforms we may revise_ **_our_** _view of the link between the developed and the (developing]. The interesting thing is that_ **_[it_** _used to be the case that] with good growth in the North,_ WP/eccfTMo/SF:ig
51 _we_ **_(had]_** _good growth in the South, even In parts of Latin America when they ware following the most awful policies._ _Now it may well be that with less good growth in the North but wlth better policies In the de7eloping countries, they can grow just as well if not better. The world is changing. It may well be that (developing countries] will become the dynamic force which is helping us along, not necessarily immediately, but if considering twenty years out, it seems perfectly possible._ _MR. BANETH: I would like the IECAP representatives to answer on the specific technical questions on the investment ratios and the linkages in the projections._ _MR. FARDOUST: The historical figures on investment ratios for the developing countries, partlcularly for the 1980s, are heavily influenced by the performance of China and India._ _For many countries, however, there has been an extraordinary decline in the investment ratios. The disaggregated figures show a collapse in Latin America and Sub-Saharan Africa in the early 1980s, while, by and large, the East Asian countries -- even if one excludes China -- maintained their investment ratios. Our baseline projections show that_ **_If_** _real Interest rates begin to decline and world trade and commodity prices recover in the next few years, both imports and investment ratios in many developing countries will begin_ **_to_** _improve in the 1990s._

**_More on the North-South linkage..._**

_MR. ARMINGTON: On_ **_the_** _question of the linkage between export volume growth of the developing countries and_ **_GDP_** _growth of the Industrial countries, I have a couple of points to make. Basically, our projections of developing country exports come from our socalled central case, which essentially is a report on the Country Economists' Survey [the long-term survey of the Bank's country specialists.]_ _Looking at historical data, as Andrew Steer pointed out, our baseline projections for export volume growth of 4.2 percent tper annum) from 1986 to 1995, for developing countries, looks a bit high_ **_developing_** _in relation to either their_ **_GDP_** _growth of 4.0 percent [per annum] or_ **_countries'_** _real GDP growth of industrial countries of 2.5 - 2.8 percent [per_ **_exports..._** _annum]. That is the point at issue here._ _That figure of 4.2 percent essentially is the aggregation of what the country economists say is, in effect, their export supply forecast, given the policy sets that they are assuming. It is also heavily weighted by_ **_the_** _export performance of the NIEs._ WP/BOLThO/SF:1g
52 _HR. BAmEH: The crucial question is whether the pattern of Imports, whlch will prevail In industrlal countries in the 1990s, wlll be broadly that of the 1950s/1960s when they had imports Increasing at about the same rate as GNVP, or of the 1970s and indeed, give or take a few periods, 1980s, where Imports into the industrial countrles were Increasing much faster than GDP; and whether you can have a continuatlon of that pattern of rapidly increasing imports with relatively slower GDP growth. Is that compatible wich the polltics and economics of the case?_ _MR. ARI : The baseline scenario for the industrial - countrles, showing output growth of 2.5 2.8 percent in the next decade, Is probably a fairly pessimistic scenario, particularly in light of llberalization policies that may be in the pipeline._ _So It could very well be, as Mr. Larsen and others have suggested, that sufficiently favorable domestic policies, supportIng export growth well in the developing countries, could overcome all evils and produce export growth in excess of 4 percent. It is really possible._ _MR. LARSEN: With this kind of growth projection for the Industrial countries and developing countries, assuming that you would have world trade growing by something like 4, 4.5 percent, your export projection for the developing countries i.mplies that they will barely maintain their market shares today, which I should have thought Is highly unlikely._ _MR. BANETH: I chink you have to separate this between manufactures, where they have been consistently increasing their market shares, and primary commodities, where trade is growing less fast than overall trade and the effects are differentiated._ _PROFESSOR BOLTHO: Onto the longer-run now. The purpose of this meeting, I think, to some extent was to see what the prospects for growth to the end of the century were likely to be. I am not sure that much consensus has been reached. Mr. Baneth will be summlng up later, but let me suggest a couple of points thac have been made or might be relevant._ _Long-run Basically, the issue was about OECD, but Stephen Marris prospects for has made several very important and interesting comments on the LDCs. growth and the I think he would agree, however that even if the LDCs' growth goes on LOCs... being relatively rapid and possibly accelerates, any feedback on the industrial countries will have to wait for the next century. For the_

**WPIUOLTHO/SFIg**
53 _world economy as a whole thls cannot be all that significant through the next ten years. It will be good for the LDCs, but not much more than that._ _When It comes to the industrial countrles, apart from a remark by Harris at one stage, which he didn't follow up, according to which in fact he was rather optimistic and he thought that the 1990s, once transition Is over, could generate fairly rapid growth, (four percent growth, I think was a figure that was suggested)_<sup>_most_</sup> _of the other comments have been actually fairly gloomy._ _On the one hand, Flemmlng Larsen, suggested the inevitability of 2.5 percent because of the historical record. Several other people, including myself, were probably pessimistic not because_<sup>_of_</sup> _inevitability but because we saw that the probability of a recesslon, perhaps not serious enough to generate a new consensus and_<sup>_a_</sup> _completely reformed International monetary system, butt serious enough to erode confidence yet further -- a bit like the 1974-75 recession generated a lower growth path, which then was lowered further because of the 1980-82 recession._ _A new recession in 1989, 1990, 1991 could have a further negative effect on investment propensities, on confidence and so on. Now that is taking the gloomiest view, which would_<sup>_really limit the_</sup> _industrial countries' growth in the 1990s to two percent_<sup>_or possibly_</sup> _less._ _There may be compensating effects here. There may particularly be the much greater dynamism of Japan and the United_<sup>_States_</sup> _vis-a-vis Europe, so that Europe sinks even further,_<sup>_Japan and the_</sup> _United States manage a good deal better. I don't think_<sup>_that a_</sup> _consensus has been reached at this meeting that for_<sup>_the OECD we_</sup> _should be expecting much more than 2.5 percent [growth per_<sup>_annum) for_</sup> _whatever reason. The LDC's may be a different story._ _MR. BANETH: I don't think we have on the whole the feeling that innovation and technological change are going to be bottlenecks for future growth. So to come to Boltho's issue of_<sup>_whether there is_</sup> _a physical constraint on growth in the industrial countries,_<sup>_we may_</sup> _disagree as to how much that constituted a constraint_<sup>_in the 1980s._</sup> _But I think the general feeling here is that it_<sup>_will not be a_</sup> _constraint in the 1990s._ _Nev growth In the U.S...._ _I think we see, some of us with greater strength than others, several institutional constraints. Perhaps the most optimistic view is that somehow new growth will emerge in the_<sup>_U.S., because_</sup> _of its national dynamism, and in Japan and developing_<sup>_countries._</sup> _Whether these impulses will support a higher growth in_<sup>_Europe, that_</sup> _is a problem for the Europeans; but they really will_<sup>_constitute a_</sup> _fairly dynamic growth in the 1990s for the rest of_<sup>_the world. I_</sup> WP/8OlTHO/SF:1q
54 _think we have seen that there is general consensus that widely gyratlng real interest and exchange rates have constituted a constraint on Investment._

**_But_** _there is [alsol a consensus that something needs be done to_ **_stabilize_** _exchange rates to some extent, at least to get the Investment going, to boost confldence of private Investors._

**_The issue of_** _the huge_ **_surpluses..._**

**_Problems with 2.5 percent nsolution"..._**

_I don't think we have handled very much the issue of financial mechanism. Is there a need for such a huge surpluses by_ **_some_** _countries? Some of these economies are fairly strongly geared to such surpluses. I think Boltho kept referrlng to thls sort of mechanism in Asian NIEs. There Is perhaps also a broader mechanism of the sort at play in Europe and Japan. And If you need surpluses, you need deficits; you need, in some sense, solvable deficlts to compensate for the surpluses._ **_We_** _will have to consider further whether the Triffinian dilemma, enlarged to the world economy and to a different system, is stlll plagulng us. I happen to believe that_ **_it_** _is._ _Despite the insistence placed on the remaining structural constraints, I do not think we got very much, in terms of the growing structural rigiditLes having caused the slowdown. I think what some are saying,_ **_is_** _that removing some of the remaining or existing structural rigidities, is one of the few places where one can get a boost. I wouldn't disagree with that; I don't think anybody would disagree with it even if we might discuss how much of a boost it will give. I don't think we had very much support for the theory that somehow these rigidities were mounting and that is what caused the slowdown. I think there would be general agreement with a characterization that one needs lots of good conditions. For fast growth one needs a good shock to initiate it, and then one needs lots of good developments for the growth process to continue. And if any one of these good conditions disappears, one will have a much slower growth._ _And because one needs lots of them, the general feeling, with the possible exception of Marris, thinking about the recovery period, is that we are not likely -- to come back to growth rates well in excess of 2.5 percent in the medium-run -- unless some policy yet to be characterized and defined emerges. It is not a conclusion of the discussion, but my own intimate conviction, that 2 percent is not a stable outcome._ _I don't believe that politically and socially for Europe, but also for the rest of the world, in some sense, that is a stable outcome. I don't think that whatever is left of the international economic system, including some free flow of capital, and to a very limited extent of labor, and to a very marked extent of goods, will survive, over the medium-run under the social, political pressures of that slow growth rate._ WP/9OILrO/SF:Ig
55 _So, In effect, whlle in an economic sense I see that as belng the most likely outcome, and nothing which we have sald during this meetlng changed that feellng, I thlnk the 2.5 percent outcome Is not golng to work over the 1990s._ _I see the consequences of a slowdown, of the recession, both socially and politically, for countrles which now have 10 percent unemployment; for a trade system which now Is under serious stress as contrasting to a sort of dynamic momentum in the 1960s, I see the consequences of the slowdown for the developing countries, where the debt problem has been heavy for the past seven years, where democratic regimes are under heavy pressure. So I see that the recession could have much more severe consequences than perhaps Boltho Is forecasting._ WPI/BOLTHO/SF:I
pPl2 Working Paper Series

||Iffla|Author|_Dat_|Contact<br>for paper|
|---|---|---|---|---|
|WPS191|Openness, Outward Orientation, Trad<br>Liberalization and Economic Perform|e<br>-|||
||ance in Developing Countries|Sebastian Edwards|June 1989|M. Ameal<br>61466|
|WPS192|Inflation, Price Controls and<br>Fiscal Adjustment: The Case of<br>Zimbabwe|Ajay Chhibber<br>Joaquin Cottani<br>Reza Firuzabadi<br>Michael Walton|April 1989|A. Bhalla<br>60359|
|WPS193|Voluntary and Involuntary Lending:<br>A Test of Major Hypotheses|Peter Nunnenkamp|June 1989|L. Chavarria<br>33730|
|WPS194|Efficient Debt Reduction|Jeffrey Sachs|May 1989|L. Chavarria<br>33730|
|WPS19|5How Has the Debt Crisis<br>Affected Commercial Banks?|Harry Huizinga|May 1989|L. Chavarria<br>33730|
|WPS196|A Review of Alternative Debt<br>Strategies|Eugene L. Versluysen|May 1989|E. Hadjigeorgalis<br>33729|
|WPS197|Differentiating Cyclical and<br>Long-Term Income Elasticities||||
||of Import Demand|Fernando Clavijo<br>Riccardo Faini|May 1989|K. Cabana<br>61539|
|WPS 198|Equity in Unequal Deductions:<br>Implications of Income Tax Rules in<br>Ghana and Nigeria|Chad Leechor<br>Robert Warner|May 1989|A. Bhalla<br>60359|
|WPS199|Private Sector Assessment: A Pilot<br>Exercise in Ghana|Samuel Paul|May 1989|E. Madrona<br>61712|
|WPS200|Women and Development: Objectiv<br>Framework, and Policy Interventions|es,<br>T. Paul Schultz|April 1989|J. Klous<br>33745|
|WPS201|How Much Fiscal Adjustment Is Enou<br>The Case of Colombia|gh?<br>William R. Easterly|June 1989|R. Luz|
|WPS202|A Cross-Section Analysis of Financia|l|||
||<br>Policies, Efficiency and Growth|<br>Alan H. Gelb|||
PPR Working Paper Series

||tah|D|Contact<br>fo|
|---|---|---|---|
|WPS203 Optimal Commodity<br>Taxes Under<br>Rationing|Nanak Kakwani<br>RanJan<br>Ray|June 1989|M. Felix<br>33724|
|WPS204 The Impact of Labor Costs on<br>Manufactured<br>Exports in Developin<br>Countries: An Econometric<br>Analysi|g<br>s Luis Riveros|May 1989|FL Luz<br>61762|
|WPS205 What Determines<br>National Saving?<br>A Case Study of Korea and the<br>Philippines|Sang-Woo<br>Nam|May 1989|R. Luz<br>61762|
|WPS206 The Effects of Single-Sex<br>Schoolin<br>on Student Achievement<br>and Attitud|g<br>es|||
|in Nigeria|Valerie E. Lee<br>Marlaine E. Lockheed|May 1989|C. Cristobal<br>33640|
|WPS207 Occupational<br>Training Among<br>Peruvian Men: Does ft Make a<br>Difference|Ana-Maria<br>Arriagda|May 1989|C. Cristobal<br>33640|
|WPS208 Effective Primary Level Science<br>Teaching in the Philippines|Marlaine<br>E. Lockheed<br>Josef ina Fonacier<br>Leonard J. Bianchi|May 1989|C. Cristobal<br>33640|
|WPS209 Can the Industrial Countries<br>Return to Rapid Growth?|Intemational<br>Economics<br>Departmen<br>and Intemational<br>Eoonomic<br>Analysis and<br>Prospects Division|August 1989<br>t|J. Queen<br>33740|
|WPS210 Notes on Cash-Flow<br>Taxation|Roger H. Gordon|June 1989|A. Bhalla<br>60359|
|WPS211 Coffee Pricing Policies in the<br>Dominican<br>Republic|Panos Varangis|May 1989|D. Gustafson<br>33714|
|WPS212 Beyond the Debt Crisis: Afternativ<br>Forms of Financing|e Lessard|||
|WPS213 Conditionality<br>and Debt Relief|Stijn Claessons<br>Ishac Diwan|June 1989|S. King-Watson<br>33730|
|WPS214 Adjustment<br>and the Labor Market|Peter R. Fallon<br>Luis A. Riveros|June 1989|R. Luz<br>61762|