Since CEPR's first conference on `Macroeconomic Interactions between North and South', held at the University of Sussex in September 1987 and reported in issue 22/23 of this Bulletin, researchers have increasingly applied to North-South interactions the techniques developed to analyse monetary, fiscal and trade linkages in the industrialized countries. A conference held in Oxford on 23/24 April, drew on the best papers presented at CEPR's three Rockefeller-funded conferences held since 1989 in London, Rio de Janeiro and Seoul. 28 participants from 22 institutions discussed the trade and macroeconomic linkages between less developed countries that are partly dependent on primary commodities and the industrialized economies of the North. The conference was organized by David Vines, Fellow and Tutor in Economics at Balliol College, Oxford, and a Research Fellow in CEPR's International Macroeconomics and International Trade programmes. Financial assistance for this conference from the Rockefeller Foundation and the Brookings Institution is gratefully acknowledged.

The Elasticities Debate
The first session was devoted to the controversy surrounding the export demand elasticities of Asia's Newly Industrialized Economies (NIEs): whether their remarkable economic performance can be explained by high income elasticities of demand, high price elasticities or both. Vito Antonio Muscatelli and Andrew Stevenson (University of Glasgow) presented `NIE Export Performance Revisited: The Estimation of Export Demand Elasticities, and the Role of Product Innovation and Growth'. Their empirical model of export demand drew heavily upon recent theories of international trade that emphasize product innovation and imitation as well as the growth of productive capacity. Their estimations using cointegration techniques over quarterly data for 1973-89 indicated that the traditional view that the NIEs' income elasticities of demand are high proves quite robust once demand and supply effects are properly isolated, while their price elasticities of demand were quite low in a number of cases.

In `Export Growth and the Terms of Trade: The Case of the Curious Elasticities', James Riedel (Johns Hopkins University, Washington) provided a thought-provoking and plausible counter-view. He maintained that economies like Hong Kong must be regarded as `small countries'. They specialize in producing low-cost homogeneous goods and their performance therefore relies heavily upon price competitiveness rather than growth of world income; the low price elasticities recorded in other studies are therefore implausible. He also reported work with Premachandra Athukorala in which they had estimated price equations, rather than export volume equations, under the assumption that these economies are price takers in world markets. Their estimates for South Korea over 1977-90 supported the view that the NIEs are indeed `small countries', which implies that export volumes are supply constrained, so conventional export volume equations are misspecified.

David Currie (London Business School and CEPR) supported Riedel and Athukorala's approach by pointing to the influence of multinational firms' location decisions on international trade flows and the ease with which they can relocate in response to variations in relative costs of production that reflect supply conditions.

North-South Interactions
John Helliwell (University of British Columbia) presented `Convergence and Growth Linkages Between North and South', written with Alan Chung. They sought to identify the conditions that enable a developing country to embark upon a period of sustained growth that offers the prospect of convergence towards the income and productivity levels of richer countries. They used an empirical model which allowed convergence of per capita GDP, possible returns to scale and cross-country differences in rates of investment in human and physical capital. Comparing countries' growth performance over 1960-85, they looked for evidence for `conditional' convergence of output towards steady-state growth.

Helliwell reported firm evidence of such convergence in the OECD, but only weak evidence for Africa and none for Asia or Latin America. There were also strong correlations between real incomes and real exchange rates for the OECD and Asia, a weaker positive correlation for Africa and a negative correlation for Latin America. He concluded that models of production structures must take account of both human and physical capital accumulation; patterns and experiences of growth differ significantly across the developing countries, and the linkage of trade and productivity growth need not apply universally.

In `Economic Interactions Between Mexico and the United States (The Interactions of Modeling or the Modeling of Interactions)', Jaime Marquez (Federal Reserve Board, Washington) used the Fed's multi-country model (MCM) to examine monetary and fiscal linkages between developed and developing countries, focusing on the example of Mexico and the US during 1982-7. His analysis suggested that Mexico's economic performance is sensitive to changes in US policy: a US fiscal contraction with M2 targeting lowers US interest rates and hence Mexico's external debt servicing, which stimulates GDP even though exports to the US fall with US real GDP. Implementing the same US fiscal contraction with pegged US interest rates eliminates these beneficial effects and accentuates the reduction in US real GDP, which in turn reduces Mexico's income. Marquez stressed that the effects of policy changes in the North and South vary across countries in both sign and magnitude, which illustrates the dangers of treating developing countries as a single bloc.

Beatriz Armendariz de Aghion (LSE) suggested updating and extending the paper to consider the effects of recent developments such as the Brady Plan and the introduction of the NAFTA.

`Adjustment with Growth' in the South
Chris Allen (London Business School), T G Srinivasan (University of Glasgow) and David Vines presented `Analysing External Adjustment in Developing Countries: A Macroeconomic Framework', which simulated developing countries' possible adjustment paths in response to external shocks. They had built regional econometric models for Latin America, Africa, the Asian NIEs and the rest of Asia using a macroeconomic framework which synthesized `LDC macroeconomics' (which emphasizes the monetary approach to the balance of payments and the two-gap growth model) with modern orthodox macroeconomics. The resulting dynamic model has three slowly adjusting state variables prices, financial assets and capital and can be used to explore short- and long-run responses to external shocks and domestic policy changes.

In `Dynamic Response to External Shocks in Classical and Keynesian Economies', Klaus Schmidt-Hebbel and Luis Serven (World Bank) used a dynamic general equilibrium model which nests three prototype economies: a neoclassical case with frictionless, instantaneous clearing in goods, assets and labour markets; a `full employment' economy with groups of liquidity-constrained consumers and investors; and a `Keynesian bench-mark' with liquidity-constrained agents in which wage rigidity causes temporary deviations from full employment. Their simulations to examine the impacts of permanent and temporary external shocks, both anticipated and unanticipated, illustrated three points. First, both permanent and temporary external shocks lead to long-run changes in productive capacity and real output. Second, while a favourable permanent shock may increase steady-state capital and output, it may also cause a current account deficit in the short run. Third, market imperfections may have major consequences for the economy's dynamic response to exogenous shocks, since they will amplify cyclical responses.

David Currie welcomed the authors' incorporation of sluggish components into a fully-specified model with forward-looking behaviour. He suggested further simulations should examine the effects of alternative government financing rules on the sensitivity to changes in parameter values, and he expressed surprise that the differences between transitory and permanent components were so small.

In `Macroeconomic Adjustment in Thailand: an Econometric Dissection', David Vines and Peter Warr (Australian National University) provided an account of the extraordinary rate and stability of Thailand's economic growth during 1970-90. This success has been remarkable not just by the standards of economies in Africa and Latin America but also relative to most of its Asian neighbours. They described their recent work on estimating an econometric model, intended to simulate the process of adjustment to external shocks.

Warwick McKibbin (Brookings Institution) maintained that the construction of a macroeconometric model for an individual country should start with a coherent theoretical structure and then include its particular institutional features. He questioned the theoretical rationale for the VinesWarr investment schedule but recognized the huge data problems they faced. Christian Petersen (World Bank) noted that obtaining reliable parameter estimates was much easier for total investment than for disaggregated public and private sector investment.
Trade Linkages: Commodities

In his paper, `Commodity Prices and Macroeconomic Policies in the Industrial Economies', George Alogoskoufis (Athens School of Economics and CEPR) developed a general equilibrium model of North-South interactions in which the relative price of industrial goods and primary commodities and the world interest rate equilibrates world output, labour and asset markets. A fiscal expansion in the North raises the real interest rate, which does not fully offset the rise in demand in the North but also reduces demand in the South; it also reduces the relative price of commodities, which also reduces (increases) supply in the South (North). Alogoskoufis sketched extensions of the basic model to incorporate sluggish price adjustment and Keynesian features in the industrial countries.

David Vines then presented Annalisa Cristini's paper, `Primary Commodity Prices and Economic Performance', which provided an empirical counterpart to the Alogoskoufis paper. Her macroeconometric model illustrated the complex interplay between primary commodity, financial, OECD labour and OECD and LDC product markets. Simulation exercises suggested that the operation of the non-oil primary commodity markets significantly determined the effects of oil shocks in the North. The response of the primary commodity markets accounted for at least 50% of the overall increase in unemployment following an oil shock, with wage resistance and capital market effects accounting for the rest.

Participants expressed scepticism about the implied positive correlation of primary commodity prices and oil prices, although the paper noted that this correlation was observed in past experience. Peter Warr warned of the danger of regarding the South as a collection of commodity-producing economies. Many developing countries now have significant manufacturing sectors, so it might be more accurate to describe the Alogoskoufis and Cristini models as comprising global manufacturing and commodity-producing sectors.

In `Commodity Stabilization Funds: A Review of Selective Issues', Andrew Powell (University of Warwick) discussed stabilization funds, which have been advocated for many countries seeking insurance against external shocks and adverse commodity price movements in particular, in the broader context of commodity risk management. While there is now broad agreement that the substantial costs of international commodity price stabilization schemes may outweigh their benefits to member countries, Powell considered the case for measures designed specifically for individual countries, which may include stabilization and hedging techniques, which should be viewed as complements rather than substitutes. For commodities in private hands, private insurance markets should be able to provide the necessary risk management without the need for public intervention; but when such markets do not exist, intervention is justified both on account of externalities and for political economy reasons.

Global Scenarios
In their paper, `The Global Implications of Shocks in the OECD: A Comparison of Results from Multi-Country Models', Ralph Bryant (Brookings Institution) and Warwick McKibbin exhaustively compared the simulation results for a standardized set of shocks on a number of global models and produced confidence intervals around consensus outcomes in each case. Focusing on the transmission of shocks within the OECD area and their impact on the non-OECD economies, they considered shocks reflecting changes to fiscal and monetary policies, for the US acting alone and for all the OECD countries undertaking similar policies symmetrically, and a global shock to oil prices.

In `Should Clinton Cut the Deficit or is there a Global Paradox of Thrift?', Chris Allen and David Vines used the GEM model to assess the effects of cutting the US budget deficit. They maintained that faced with a weak economy and domestic financial disequilibrium, the Clinton Administration should avoid a short-term fiscal retrenchment since this would risk a further, long-lasting recession. But a credible announcement of a future deficit reduction programme, contingent on an improved state of the US economy, would improve future economic prospects for the US and the rest of the world. They emphasized the importance of industrialized countries' monetary policies, which under floating exchange rates can make all the difference between a global Keynesian collapse and an orderly return to US fiscal equilibrium. The US also has a special importance for developing countries since most of their debt is denominated in dollars and many peg their exchange rates to the dollar. The impact of external demand shocks on different groups of developing countries also depends critically on their flexibility of domestic supply.

In `The Impact of US Deficit Reduction on the Asia-Pacific Region', Warwick McKibbin examined the differential impact of a US debt reduction programme on the dynamic Asian economies of Hong Kong, Singapore, South Korea and Taiwan (the ANIEs), and on Indonesia, Malaysia, the Philippines and Thailand (the ASEAN 4). While a gradual but credible deficit reduction programme of the type announced by the Clinton Administration will dampen the negative impact of US and other industrialized economies' government spending cuts and reduce world interest rates, Asia will experience a more sustained negative shock. McKibbin reported that this will hurt the ANIEs more than the ASEAN 4; the latter rely more on trade with Japan rather than the US, and they will benefit more from the fall in interest rates since their debt burden is greater. In the longer term, the US deficit reduction and higher savings rate yield a permanent rise in the global capital stock and raise output across all economies. The ASEAN 4 will also benefit more than the ANIEs from a Japanese fiscal expansion. Switching the global fiscal policy mix to contract in the US and expand in Japan will therefore benefit low-income economies within the Asia-Pacific region far more than their high-income neighbours.

Presenting `The Impact of Worldwide Military Spending Cuts on Developing Countries', written with Daniel Hewitt, Tamim Bayoumi and Steven Symansky (IMF) used the Multimod model to treat cuts in military expenditure as transfers to consumption expenditure; they found that a 20% world-wide cut in military expenditure will raise developing countries' welfare by $1.45 trillion. This also has important consequences for trade, since cuts in military imports allow increases in non-military imports, which in turn raise export ratios and real commodity prices. Countries with close bilateral trade links with the US gain the most, as US demand for their exports rises considerably. Of the various regions, Africa gains the most, even though it has lower current military expenditure than some others.

In `Effects of a Rise in G-7 Real Interest Rates on Developing Countries', Christian Petersen and T G Srinivasan found that an adverse interest rate shock is particularly serious for lower-middle-income countries because of their high indebtedness. For a five-year rise in real interest rates of 100 basis points, growth rates fall by 0.3% per year in the medium term. Latin America is hurt the most, with reductions in national growth rates of more than 0.5%, while North and West Africa suffer reductions in growth rates of around 0.4-0.5%. Asia seems more robust towards such shocks. When secondary effects stemming from terms-of-trade losses are incorporated, the debt stock of the lower-middle-income economies increases by almost $100 billion over ten years. Without policy adjustments to increase the less developed countries' savings ratios, this situation could become unsustainable.
In `Simulating Global Policy Scenarios: The Effects of Alternative LDC Closure Rules', Charles Soludo (UN Economic Commission for Africa, Addis Ababa) examined the effects of shocks emanating from the North on the South and also their effects within their countries of origin and cross-border transmission to other industrialized countries. He reported simulations of a fiscal contraction in the North and a shock mimicking an external debt forgiveness programme, under different assumptions about fiscal closure rules in North and South. His results indicated that a US fiscal contraction would encourage greater medium- and long-run growth, for both the US and the rest of the world including the developing economies. Debt forgiveness also encourages substantial medium- and long-term growth, but the alternative closure rules concerning developing countries' exchange rate policies significantly affect its impact. Soludo concluded that alternative policy regimes in the developing world may have non-negligible effects on the transmission of policy shocks among industrial economies, but his model did not converge, so these results must remain preliminary.

Conclusions
Conference participants agreed that they had come a long way since the 1987 Sussex conference, when they set themselves the objective of introducing into North-South interactions the techniques used to analyse monetary, fiscal and trade linkages among industrial countries. This had largely been achieved, and understanding of the effects of economic developments in the North on developing countries had improved considerably.

'North-South Linkages and International Macroeconomic Policy' edited by David Vines and David Currie.
Available from CUP
ISBN (hardback) 0 521 46234 7