Page 326 - DECO503_INTERNATIONAL_TRADE_AND_FINANCE_ENGLISH

International Trade and Finance

Notes How could this happen ? In the most popular nightmare scenario, the chain of causation leads from
defaults to the collapse of the U.S. banking and monetary systems to the collapse of economic activity.
But, as discussed earlier, this hypothesis assumes perverse actions by the bank regulators and
irresponsible behavior by the monetary authorities.
The analytical road from defaults by LDCs to another Great Depression does not have to pass through
the collapse of our banking and monetary systems. A very different chain of causation has been
hypothesized. It passes through the collapse of international trade.
Time magazine, in its 10 January 1983, cover story “The Debt-Bomb Threat,” reported :
The nations that buy many of the industrialized world’s goods are the same ones
that have borrowed so heavily. Any economic contraction on their part would
boomerang back in the form of less demand by them for imports. The resulting
deepening recession, so the theory goes, would further hurt the poorer countries,
and so on and on. Once started, the process would be difficult to stop. The
development dreams of the third world would come to a halt, stock markets would
tumble, unemployment would soar, and world economic conditions would rival
those of the 1930s.
To demonstrate that a lot is at stake, Time noted that :
More than 40 percent of U.S. exports of commodities and services and one American
manufacturing job in 20 hinge on sales to developing countries.
There is an element of truth in Time’s scenario, but its conclusion is much too dismal. No doubt
economic contraction in LDCs would compel a very painful adjustment in the United States. It would
not, however, lead to an unending downward spiral of economic activity. Trade with developing
nations would not cease if some repudiated their external debts. Even if it did, the effects on U.S.
production and employment and unemployment would be far from cataclysmic.
The figures presented by Time cannot be used as is in evaluating the magnitude of the effects decreased
exports to the developing world would have on total U.S. output and employment. Stating that 40
percent of U.S. commodity and service exports and one out of every twenty manufacturing jobs
“hinge on sales to developing countries” can be misleading.
First, the term “developing countries” is too broad. It includes OPEC members, countries that do not
find it difficult to service their debts, and countries whose external debts are largely to international
agencies and other official lenders, often at low concessional interest rates. On average, OPEC members
are creditor nations, and it is difficult to believe that those non-OPEC countries that can service their
debts or that receive loans at concessional rates will repudiate them. At most, trade with these countries
will fall only marginally, even if there are widespread loan defaults by other developing nations.
Second, it is difficult to believe that trade with nations that repudiate their external debts will be
reduced to zero. At least some trade-related financial arrangements will be continued. Some new
ones, with creditors as yet not involved, could be started; the slates of debtor nations will be wiped
clean by their defaults and thus it will be relatively less risky to lend to them now. Alternatively,
nations that default can use the money they get from exporting to finance imports on a cash basis;
they will no longer be paying interest. There also will be barter and so-called countertrade arrangements
where exporters accept goods from cash-short countries that can be exchanged for dollars or for
other goods.
Third, although one in twenty U.S. manufacturing jobs and 40 percent of U.S. exports may “hinge on
sales to developing countries,” today only one job in five in the United States is a manufacturing job
and exports are only 12 percent of GNP. Thus, only one in every hundred jobs and 4.8 percent of
GNP “hinge on sales to developing countries” (where .01 = .05 × .20 and .048 = .40 × .12).
Finally, it must be understood that in market economies contractions of some sectors are eventually
compensated for by expansions of other sectors. If trade declines, some of the resources previously
employed in export industries will relocate in industries that produce goods and services previously
imported, or close substitutes for them. There is an equilibrating mechanism at work, even though it
does not work instantly or painlessly.

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