IMBALANCES IN THE 1970s AND 1980s

In the period up to 1973,under the Bretton Woods system, external imbalances could and did
build up. But in general adjustment mechanism began the process of correction before
imbalances built up substantial proportions. There were basically two methods of correction;
domestic adjustment(deflation in deficit countries) or realignment of exchange rate, which was in
principle countenanced only when it was necessary to correct a fundamental disequilibrium.
The later action was regarded as a last resort there were still memories of counterproductive
competitive devaluations in the interwar period and was often resisted on political grounds. For
the exchange rate came to be seen as a sort of virility symbol. Governments therefore tended to
resist what was seen as an admission of weakness; this was particularly pronounced in the case
of sterling in the mid-sixties when the British economy laboured under what many regarded as
an uncompetitive exchange rate for three years before eventual devaluation in November 1967.
The final decision to devalue was adopted because the only alternative in the face of continued
external imbalance was substantial domestic deflation. This was a common dilemma for deficit
countries-the constraints on surplus countries have always been less clear-and one which led to
periodic questioning of the system. The system was criticised by many as being too rigid, with
professional economists increasingly coming to the view that flexible exchange rate system
would be more rational, removing balance of payments constraints and allowing a more
independent domestic policy. Others believed the failings of the system arose from the
unwillingness of governments to make the necessary domestic adjustments. In the end, it was the
US concern not to have its policies dictated by the needs of exchange rate stability which led the
Nixon administration to cease convertibility of gold at a fixed price. This led fairly quikly to the
end of the era of fixed exchange rates.
It is ironic that it was in the first years of flexible exchange rates, with their promise of an
end to balance of payment crises, that one of the largest external dislocations of the postwar
period took place. This was the oil shock, which destroyed the rather delicate balance between
the surpluses of the industrialised countries and the deficit of the developing countries which had
hitherto seemed likely to be sustained. Table 7.1 is summary table which indicates the evolution
current-account balances for the major industrialised countries and non-OECD zones over the
period since floating. It indicates the rise and fall of the OPEC surplus in the mid-1970s, which is

the first of the three imbalance episodes analysed below. The other two episodes, the developing
country debt crisis of the early 1980s and the imbalances among the major industrialized
countries since the mid-1980s, can also be seen in the global pattern indicated in table 7.1.
THE RISE AND FALL OF THE OPEC SURPLUSES
There have been two peaks to the OPEC surplus since the early 1970s. The first came in
1974, following the initial sharp rise in the price of oil, with the peak surplus of $67 billion
falling off relatively quickly and then passing into deficit in 1978. The second peak came in
1980, with their further sharp oil price rise which occurred following she start of the Iran-Iraq
war. On that occasion the peak surplus of $103 billion disappeared within two years. The
aggregate OPEC figures of course conceal diverse positions and behavior. At one extreme there
are countries like Saudi Arabia or the United Arab Emirate with massive reserves of oil, hence
enormous potential production and income, yet relatively small populations. They tended to
spend their enhanced oil revenues relatively slowly, even though the Saudis in absolute terms
have became very large spenders, and so were classed among a group of low absorbers. In fact
even the Saudis have managed to create certain problems for themselves by cutting back
production significantly in recent years in order, as swing producer, to keep the oil price up. At
the other extreme, there have been other countries with much larger populations, highabsorbing countries, that have generally used oil revenues to the full in the purchase of
consumer or investment goods from abroad. Some of those countries, such as Nigeria, Venezuela
and Mexico (which is outside OPEC) have, despite their oil resource, become problem debtors,
in the sense of having had to reschedule debt in recent years.