Journal of Economic Studies

Emerald Article: Impact of External Price Shocks on the Oil-based

Developing Economies
Ali F. Darrat, M. Osman Suliman

Article information:
To cite this document: Ali F. Darrat, M. Osman Suliman, (1990),"Impact of External Price Shocks on the Oil-based Developing
Economies", Journal of Economic Studies, Vol. 17 Iss: 6
Permanent link to this document:
http://dx.doi.org/10.1108/EUM0000000000148
Downloaded on: 24-01-2013
Citations: This document has been cited by 1 other documents
To copy this document: permissions@emeraldinsight.com
This document has been downloaded 182 times since 2005. *

Users who downloaded this Article also downloaded: *

Ali F. Darrat, M. Osman Suliman, (1990),"Impact of External Price Shocks on the Oil-based Developing Economies", Journal of
Economic Studies, Vol. 17 Iss: 6
http://dx.doi.org/10.1108/EUM0000000000148
Ali F. Darrat, M. Osman Suliman, (1990),"Impact of External Price Shocks on the Oil-based Developing Economies", Journal of
Economic Studies, Vol. 17 Iss: 6
http://dx.doi.org/10.1108/EUM0000000000148
Ali F. Darrat, M. Osman Suliman, (1990),"Impact of External Price Shocks on the Oil-based Developing Economies", Journal of
Economic Studies, Vol. 17 Iss: 6
http://dx.doi.org/10.1108/EUM0000000000148

Access to this document was granted through an Emerald subscription provided by PONTIFICIA UNIVERSIDAD CATOLICA DEL PERU
For Authors:
If you would like to write for this, or any other Emerald publication, then please use our Emerald for Authors service.
Information about how to choose which publication to write for and submission guidelines are available for all. Please visit
www.emeraldinsight.com/authors for more information.
About Emerald www.emeraldinsight.com
With over forty years' experience, Emerald Group Publishing is a leading independent publisher of global research with impact in
business, society, public policy and education. In total, Emerald publishes over 275 journals and more than 130 book series, as
well as an extensive range of online products and services. Emerald is both COUNTER 3 and TRANSFER compliant. The organization is
a partner of the Committee on Publication Ethics (COPE) and also works with Portico and the LOCKSS initiative for digital archive
preservation.
*Related content and download information correct at time of download.

Journal of
Economic
Studies
17,6
36

Impact of External Price

Shocks on the Oil-based
Developing Economies
Ali F. Darrat and M. Osman Suliman
Louisiana Tech University, and Grambling State University, Louisiana,
USA
The worldwide economic upheaval during the past decade has been, wholly
or partly, attributed to the famous OPEC price shock. One consequence has
been a revival of interest in the macroeconomic analysis of such an exogenous
OPEC shock. However, very little attention has been paid to the impact of
external price shocks on the OPEC economies themselves. A recent exception
is Pesaran (1984), who examines some macroeconomic policy issues in an oilexporting economy with foreign exchange control. However, Pesaran's model
specifies the demand for real balances (a major equation in the model) as being
interest-sensitive, which is irrelevant to most oil-based economies. Other studies
by Neary and Purvis (1982) and Buiter and Purvis (1983) are relevant only to
economies with matured (developed) financial markets. Earlier, Metwally and
Tamschke (1980) examined the impact of oil exports on economic growth in
several Middle Eastern countries, arguing that oil receipts had an insignificant
effect on the non-oil side of the countries studied. However, Metwally and
Tamschke's model lacks theoretical foundations and, due to its total neglect
of the demand side of the economy, its equilibrium analysis is only partial in
nature.
The present study examines the impact of export and import price changes
on the real side of oil-based developing economies within a general equilibrium
theoretic framework and makes contributions to the debate in several respects.
First, the model is based on a macroeconomic general equilibrium analysis.
As such, the model incorporates endogenous income and price responses and
takes explicit consideration of all sectors of the economy. Second, the model
has two traded goods (exports and imports) and a non-traded good. Most
previous studies in this area consolidated exportables and importables into one
class of "traded" good since any quantity of exportables may be exchanged
for importables at the relative price determined by the given terms of trade.
However, as pointed out by Black (1976), a fall in the terms of trade could change
the definition of "traded" goods. That is why this model uses two "traded
goods" in order to envisage fluctuations in the external terms of trade. Third,
The authors, whose names appear alphabetically, wish to thank W.E. Witte and two anonymous
referees of this Journal for many helpful comments. An earlier version of this article was presented
to the 1989 MAEF meeting in Jackson, Mississippi. Comments from the meeting participants
are gratefully acknowledged. Any remaining errors are solely our own.

the model directly considers the inherent open and small economy nature of
the oil-based economies[l]. In the model, although the ultimate burden of
adjustment falls on the endogenous domestic prices, some other structural
adjustments are also allowed. Thus, the adjustment process is based on the
neoclassical macro theory in conjunction with the structuralist micro view.
This article examines the extent of vulnerability (stability) of the real side
of the oil-based economies to external price disturbances in the polar, but
realistic, case where the economies are highly open (non-traded goods are
negligible). This approximates the situation of economies such as Saudi Arabia,
United Arab Emirates, and Kuwait. Interestingly, wefindthat the more open
the economy is, the more insulated the real side becomes against foreign price
shocks[2]. The remainder of the article is organised as follows. The next section
briefly outlines the model. The third section presents a theoretical analysis
of external price disturbances. Some empirical evidence is then reported in
the fourth section. Concluding remarks are provided in the fifth and final section.
The Structural Model
For simplicity, we assume that our small open economy exports only to one
country (UK) and imports only from one country (USA). The model comprises
the following equations:
Output:
X = X(Px, Pn)
x1
> 0, x2 < 0
(1)
s
x
n
N = S(P , P )
s1 < 0, s2 > 0
(2)
Demand:
I = I(Pm, Pn, Y) +
m1
< 0, m2 > 0, m3 > 0
(3)
d
m
n
N = D(P , P , Y)
d1
> 0, d2 < 0, d3 > 0
(4)
Y = PxX + PnN (5)
Prices:
Px =
+
s
(6)
m
P =
+
t
(7)
r =
(8)
Assets:
F =
(in dollars)
(9)
M = F + G - T
(10)
n
m m
G = P + P g +
sX
(11)
T =
+
tI
(12)
where the signs of the partial derivatives of the respective variables are given
at the side of the relevant equations, and a bar on any variable indicates

Oil-based
Developing
Economies

37

Journal of
Economic
Studies
17,6
38

exogeneity. The variables are defined as follows: X = supply of tradables

(exports); Ns = supply of non-tradables; I = domestic demand for imports
in nominal terms; Nd = domestic demand for non-tradables in nominal terms;
Y = nominal income; Pn_ = domestic price of non-traded goods; Px =
domestic price of exports; P = foreign price of exports; Pm = domestic price
of imports;
= foreign price of imports;
= real government expenditures
on imports;
= real government expenditures on non-traded goods; G =
nominal total government expenditures; T = nominal taxes; = real taxes;
t = import tariff, s = export subsidy; M = change in money supply; F
= change in foreign reserves;
= capital imports from the US;
= capital
imports from the rest of the world;
= nominal domestic exchange rate in
terms of the dollar;
= dollar price of the British pound; rs = nominal
domestic exchange rate in terms of the British pound.
Relationships (1) and (2) are output equations showing the supply functions
of tradable (exports) and non-tradable (domestic) goods. Supply functions are
specified in terms of the absolute prices of tradables and non-tradables to reflect
the fact that such economies place heavy emphasis on the tradable goods (oil)
relative to the smaller non-traded goods sector. Thus, prices in the two sectors
can be treated as independent. Furthermore, it is assumed that labour supply
(especially foreign) is infinitely elastic and hence wages can be assumed fixed.
In the above model, the import-competing sector on the production side and
export consumption on the demand side are assumed negligible[3]. We also
abstain from using imports as intermediate goods in order to focus on the impact
of external disturbances on the domestic economy.
The domestic demand functions, in nominal terms, are assumed to depend
on prices and nominal income in addition to government expenditure. The
demand functions are also assumed differentiable and homogeneous of degree
zero in the nominal variables. Hence, we can use prices of non-traded goods
as a numeraire. As equation (5) indicates, direct taxes are imposed explicitly
on non-traded goods, a significant portion of which is services. Deflating by
the prices of non-traded goods (Pn) is allowed by the zero-homogeneity of the
demand function. Moreover, Pn is used since the broader Consumer Price
Index measure is contaminated to a larger extent with heavy government
subsidies particularly in the oil-based economies. Equations (6) and (7) state
that domestic prices of traded goods are equal to the external (exogenous) price
times the relevant nominal exchange rate of home currency plus any
(endogenous) export subsidy and import tariffs[4].
The financial structure is described by equations (9)-(12). In the oil-based
economies, the banking system is rudimentary and largely under government
control. Each country has a central bank and a few commercial banks that provide
the primary source of financial intermediation. For the most part, other credit
facilities are drawn through government institutions which extend (typically
interest-free) long-term loans to the public.
The absence of diversified financial intermediaries has weakened the investment component of national income despite the availability of sufficient domestic

savings. Indeed, a high percentage of these savings are directly spent on imports
of final goods. This replacement of savings by imports suggests that the marginal
propensity to save is negligible while the marginal propensity to import is high.
In this case, the sum of the marginal propensity to import and the marginal
propensity to consume domestic goods should equal one. In the extreme case
of total openness (zero non-traded goods), the marginal propensity to import
becomes unity.
Capital mobility, in the Fleming-Mundellian sense, is very low in the oil-based
economies. There is a low substitutability between domestic and foreign
securities since thefinancialmarket is extremely thin and lacks any network
of security brokers and dealers. In addition, the forward market is non-existent.
Primary assets consist of high-powered money and physical capital stock. In
such situations, the financial market becomes unable to efficiently mobilise
savings. Consequently, monetary policy cannot easily induce accommodating
flows of funds to finance payments imbalances. As a result, our analysis
emphasises the goods market parameters in the equilibrium process. Important
among these parameters are the supply and demand elasticities of traded and
non-traded goods, the marginal propensity to spend and to save out of income,
and the degree of openness on the supply and demand sides. Furthermore,
in an economy where trade generates most of national income and where asset
substitutability is largely irrelevant, the assets market becomes rather negligible.
Equation (9) is a balance of payments relationship. It explains the change
in foreign reserves as the value of net exports plus the exogenous net value
of capital inflows. External balance under fixed exchange rate can be achieved
in this model, for example, by a system of trade controls which ensures that
net exports are equal to the exogenous net value of capital inflows. These controls
are modelled as endogenous adjustments of import-tariff (t) and of adjustable
subsidies (s) in the domestic price of oil exports. Consequently, the equality
between domestic and world prices is upset by these controls. This implies
that the bulk of external balance adjustments is attained through induced changes
in the domestic prices of traded goods.
Equation (10) in the system provides the budget constraint for the government
and for the banking system on a consolidated basis. In an economy where money
is the main (perhaps the sole) asset, the capital account in the balance of
payments is rather dormant and foreign reserves move primarily with
merchandise trade (X-I). The equation explains changes in money supply as
the sum of monetary changes resulting from debt monetisation and from policies
aiming at financing trade imbalances. Clearly, this equation assumes zero
sterilisation, a reasonable assumption in the context of underdeveloped capital
markets. Changes in government loans to the private sector cannot be treated
separately since they are government determined. These circumstances
endogenise money supply in the model. Money demand is also endogenous
as implied by the budget constraints of the public and private sectors. In
equilibrium, the change in excess demand for money is zero (by Walras' Law)[5].
As equation (10) implies, for Walras' Law to hold, any excess flow supply
(demand) for traded and non-traded goods shoud be equal to the excess flow

Oil-based
Developing
Economies

39

Journal of
Economic
Studies
17,6
40

demand (supply) for money. Thus, if available money stock exceeds the desired
holdings, then asset holders would want to increase their spending on traded
and/or non-traded goods such that a balance of payments deficit (and/or
government budget deficit) ensued to reduce their money holdings. Meanwhile,
to maintain the balance of payments constraint (and/or monetise government
deficit) the endogenous trade restriction (nominal taxes or government spending)
will move to offset any payments or government budget imbalances.
Equation (11) defines nominal government expenditures as the sum of
government expenditures in the traded and non-traded goods sectors. Nominal
taxes are given in equation (12) as the sum of direct taxes on non-traded goods
(e.g. port fees) plus indirect taxes in the form of import tariffs.
Equilibrium Conditions
The model contains 12 equations and 13 endogenous variables, namely: X, N,
I, Y, Pn, Pm, Px, F, M, G, T, t (or s), and r . The exogenous variables are:
and
s
(or t).
The solution of the model assumes that, in equilibrium, the oil economies
are constrained by a zero balance of payments (F = 0), allowing no feedbacks
from the balance of payments to the domestic money supply. Observe that,
besides the zero balance of payments constraint, another is M = 0 implying
that the government budget deficit is accommodated (monetised) by the
monetary authorities. Of course, one way of obtaining payments balance is
through adjustment of the endogenous tariff in the model[6].
Given F = 0, the model reduces to six equations in six unknowns: X, N,
Pn, IM, y, and t. The price equations (6) and (7) can be substituted for directly
in the supply and demand functions. Thus, we are left in equilibrium with
equations (1) to (5) and the external balance equation (9).
The six equilibrium equations are summarised below after normalising the
homogenous demand functions (using the domestic price of non-traded goods,
Pn, as a numeraire):
X = X(Px, Pn)
s

N = S(P , P )
m

IM = IM(P /P , 1, y) +
m

DN = D(P /P , 1, y) +
x

y = (P /P ) X + N F = 0 =
x

x1

> 0, x2 < 0

(13)

s1

< 0, s2 > 0

(14)

m1

< 0, m3 > 0

(15)

d1

> 0, d3 > 0

(16)
(17)

(18)

where P =
+ t; and IM = real imports.
In attempting to analyse the direction of change and the magnitude of stochastic
external price shocks on the real side of the economy, we should first decide
on a reasonable level of abstraction. First, for convenience, we assume that
the initial prices (including the exchange rate) are unity, while initial import
tariffs and the domestic oil price subsidies are zero[7]. In addition, all savings
are substituted for by imports making the sum of the marginal propensity to

import plus the marginal propensity to consume home goods equal to one (i.e.
m3 + d3 = 1). In the extreme case of total openness (N0 = 0), the marginal
propensity to import is also one. Further, cross effects between export output
and non-traded goods output are assumed to be zero. Finally, the responses
of real imports and real non-traded goods to changes in their own prices are
assumed to be of equal magnitudes (i.e. m1 = d1 in absolute value). This
derives from the equality of the marginal rate of substitution to the relative
price ratio. That is, Pm/Pn = 1 = -dN/dIM. This implies that dN = dIM,
or d1 = m1 (in elasticity form, this can be written as ndN0 = nmIM0, where
nd is the elasticity of demand for non-traded goods and nm is the elasticity of
the demand for imports).
External Price Disturbances
Differentiating totally the six equilibrium equations (13)-(18), rearranging in matrix
form, and using the signs of the respective partial derivatives, we can solve
for the endogenous variables in terms of the exogenous variables. That is (a
zero subscript indicates initial values):

(19)

The determinant of the Jacobian is:

(20)
The system is stable since the determinant is positive, and so are the system
eigenvalues[8]. Using the four assumptions, the determinant reduces to:
D = X0d1 > 0
= X0ndN0 > 0 (in elasticity form)

(20')

The Impact of Oil Price Shocks on the Oil-based Economies

Solving the above system for the percentage change in real variables in response
to the percentage change in foreign export price, we obtain the following
solutions:

Oil-based
Developing
Economies

41

Journal of
Economic
Studies
17,6

(21)
In elasticity form:
(21')

42

By the same procedure, the solutions for real non-traded goods, real income,
and real imports are simplified below in equations (22), (23), and (24),
respectively:
(22)

(23)

(24)

Clearly, foreign export prices will, ceteris paribus, have an unambiguous positive
impact on real exports. The magnitude of the impact depends on the export
supply elasticity. Because of the negligible non-traded goods sector and the
consequent zero cross effects between exports and non-traded goods, nontraded goods are completely immune to changes in foreign export prices.
However, the increase in real exports has an expansionary impact on real national
income. Real imports also increase through the income effect.
Observe that, as the non-traded goods sector shrinks and approaches zero,
the marginal propensity to import will subsequently approach unity and, as such,
the income effect on imports is exactly equal to the impact on real income.
Therefore, in open, oil-based economies, the substitution effect seems negligible
and the impact of foreign export price impinges on the domestic real sphere
mainly through the income effect. This result is consistent with Cooper (1971),
i.e. imports in developing countries depend primarily on income rather than
on relative prices. Therefore, consideration of the marginal propensity to spend
out of income (absorption)together with price elasticities are indispensable
in this case.
The above findings are also intuitively appealing. As the oil-based economies
become more open, their economies will be better insulated against external
export price shocks. Had these economies been less open, the external price
disturbances would have been exacerbated by the substitution effect. The
insigificance of non-traded goods eliminates the substitution effect rendering
real variations proportional to the income effect.

Note that, under the classical full employment case (Ex = En = 0) or

internal balance, exports are fully insulated against foreign oil price shocks.
Efficient (full) exploitation of the available oil resources would leave the oil-based
economies immune against any foreign export price shocks. National income
and imports would, however, still rise by the amount of initial exports.
The Impact of Foreign Import Price Shocks on the Oil-based Economies
The percentage responses of the real side of the economy to foreign import
price shocks are as follows:
= 0

(25)

= (IM0/X0)s2 > 0
= (IM0/X0)EnN0 > 0

(26)

(27)
= -IM0 < 0

(28)

Because of the absence of an import substitution sector on the production side

and since domestic consumption of exports is negligible, exports are neutral
to fluctuations in foreign import price. However, the demand for domestic
substitutes of imports (or non-traded goods) would rise, leading to an increase
in their real output by an amount equal to initial imports relative to initial exports
(or demand openness relative to supply openness) times the non-traded goods
supply response (i.e. IM0/X0 s2). Thus, the impact of import prices on real
income is divided into two parts: a positive component (IM0) which is equal
to the fall in real imports in response to a rise in their foreign price; and another
negative component as a result of the decrease in the demand for home goods
in response to an increase in the price of their domestic substitutes (imports)
by the amount of (IM0/X0)s2. The real income (employment) net impact is thus
ambiguous.
Interestingly, total demand openness (N0 = 0), which may approximate the
case of the oil-based economies, can unambiguously lead to an increase in real
income by the amount of the fall in real imports. Equation (27) above shows
that the less open the economy is, the smaller is the increase in real income.
Therefore, the income increase is undermined by the decrease in demand for
home goods as a result of their substitution effect with imports. The classical
full employment case (En = 0) yields the same type of result. Hence, in the
case of foreign import price, demand openness and full employment of resources
(or internal balance) are equivalent.

Oil-based
Developing
Economies

43

Journal of
Economic
Studies
17,6
44

Some Empirical Evidence

Notwithstanding the general problem of data limitations in the case of developing
countries, some empirical analysis may reveal some of our theoretical results.
These results suggest the existence of a cross-sectoral interdependence between
exports and import substitution on the one hand, and exports and non-traded
sectors on the other. The model also predicts no significant impact of oil exports
on non-oil sectors. Furthermore, the import-competing sector on the production
. side and export-consumption sector on the demand side are insignificant in the
oil-based economies. That is, the non-oil sectors are neutral to changes in export
price and output changes on the production side. On the demand side, however,
changes in export prices and output impinge on import consumption through
the income effect. The absence of strong substitution effects negates any
noticeable impact of export prices and output on non-traded sectors.
Likewise, the insignificance of import-competing production implies that export
supply is neutral to changes in imports' prices and output. Nevertheless, real
non-traded goods are expected to react somewhat to changes in real imports'
prices and consumption through the demand-substitution effect.
To test the above hypotheses in both the supply and demand sides, we
examined the impact of changes in oil output (exports) on manufactures (importcompeting production), imports, and non-traded goods and services. The impact
of changes in real foreign imports on non-traded goods was also examined. Recall
that this article aims mainly at studying the real effects of external price changes,
which depend primarily on the extent of the interrelationships between the
different production and consumption sectors. Hence, empirical examinations
of the impact of changes in real exports and real imports can provide useful
evidence on the real effects of changes in their external prices given by our
theoretical results[9]. Regression analysis of distributed-lag models have been
employed. Data limitations precluded an extensive empirical investigation of the
above issues across several oil-based economies[10]. Therefore, only annual
time series data over 1958-1982 from Saudi Arabia were employed in the empirical
testing[ll]. It should be noted that Saudi Arabia shares many of its economic
and institutional characteristics with several other oil-based economies,
particularly the Gulf States. Thus, the empirical results reached in this section
for Saudi Arabia are potentially relevant for other oil-based economies as well.
Application of the Chow (1960) test over several alternative breaking dates
suggested a structural break in the Saudi data around the year 1969. Therefore,
only the latter period (1970-1982) was used in subsequent regressions. In
addition, the 1970-1982 period.seems particularly interesting because it contains
the two main OPEC price shocks of the 1970s. To achieve stationarity, each
variable was expressed in a growth rate format (i.e.first-differencesin logarithm).
As Granger and Newbold (1974) point out, the first-difference operator can resolve
most of the serial correlation problem. This is evident in the scores of the DurbinWatson statistic across the equations. In view of the limited size of our sample,
the contemporaneous and two annual-lagged values were included in all
regressions.

Table I reports the regression results for the impact of real exports on importcompeting production. None of the coefficients on the real export variables is
statistically significant even at the weak 10 per cent level. This finding is
consistent with our theoretical implication that, on the production side, importcompeting output does not respond to changes in real exports. However, on
the demand side, results in Table II indicate that real imports do respond
significantly to changes in real exports at better than the 10 per cent level.
Conversely, Table III reveals no significant contemporaneous or lagged effects
of real imports on real exports. Taken together, the results of Tables II and
III suggest a unidirectional effect running from real exports to real imports.
This finding, too, is consistent with our theoretical model. Real exports impinge
on real imports' demand only through the income effect, thus making exports
immune to changes in foreign imports.
Turning now to the impact of real exports on real output of non-traded goods
and services, Table IV contains the empirical results for six non-traded"goods
and services arranged in descending order in terms of sectoral size. As the table

Oil-based
Developing
Economies

45

log Mpt = a0+a1log EXt+a2 log EXt_1+a3 log EXt_2+e1t

MP
EX
t
e1
a0
0.054*
(1.813)

= import-competing production (manufactures)

= real exports
= time (in years)
- white-noise error term
a1

a2

a3

0.080
(0.573)

-0.301
(-1.200)

0.372
(1.294)

R2

D.W.

0.34

1.04

1.96

Notes:*indicates significance at the 10 per cent level.

Values in parentheses beneath the coefficient estimates are t-statistics;
R2 is the coefficient of multiple determination; and F is an F-value to
test the hypothesis that all coefficients on the independent variables,
except for the constant term, are jointly zero.

Table I.
The Impact of Real
Exports on Importcompeting Production
(Manufacturing) in
Saudi Arabia,
Annual Data: 1970-1982

log IMt = b0 + b1 log EXt+b2 log EXt_1 + b3 log EXt_2 + e2t

b0

b1

b2

b3

0.670
(0.094)

1.322
(1.727)*

-0.739
(-0.605)

1.658
(1.771)*

See notes to Table I.

R2

D.W.

0.43

2.73

2.23

Table II.
The Impact of Real
Exports on Real
Imports (IM)
Consumption in Saudi
Arabia

Journal of
Economic
Studies
17,6

46

shows, the only sector that has significantly responded to changes in real exports
is the relatively small community services sector. The highly significant constant
term in the wholesale and retail sector regression indicates that a large portion
of this sector's output changes independently of growth in the export sector.
log EXt = c0 + C1 log IMt+c2 log IMt_1 + c3 log IMt_2 + e3t

Table III.
The Impact of Real
Imports on Real
Exports in Saudi
Arabia

5.156
(1.664)*

0.150
(1.415)

0.073

(0.656)

-0.039
(-0.356)

R2

D.W.

0.24

1.13

1.85

See notes to Table I.

log yit= d 0 +d 1 log EXt+d2 log EXt_1 + d3 log EXt_2 + e4t

yi = real output in the ith non-traded sector, i = l, 2 . . . 6.
Non-traded
goods sector
Construction
Utilities
(electricity,
gas, water)

Table IV.
The Impact of Real
Exports on Non-traded
Goods and Services in
Saudi Arabia

d0

d1

d2

d3

R2

F D.W.

-0.016
(-0.158)

0.114
(0.238)

0.836
(0.962)

0.674
(0.677)

0.48 1.99 2.03

0.190
(1.500)

-0.033
(-0.056)

-0.773
(-0.689)

0.279
(0.229)

0.24 5.99 2.60

Wholesale and
retail trade,
restaurants
and hotels

0.164
(7.346)**

0.160
(1.540)*

-0.090
(-0.479)

0.143
(0.664)

0.44 1.60 1.87

Transportation,
storage and
communications

0.333
(0.172)

0.255
(0.288)

-1.000
(-0.623)

1.115
(0.606)

0.12 0.26 1.97

Finance,
insurance, real
estate and
business
services

0.107
(0.020)

0.219
(0.448)

0.233
(0.264)

0.105
(0.104)

0.22 0.55 2.10

1.883
(1.830)*

0.43 1.51 3.14

Community,
social and
personal
services

0.006
(0.052)

0.820
-1.752
(1.650)* (-1.951)**

See notes to Table I. "indicates significance at the 5 per cent level.

Again, such afindingis compatible with the implications of our theoretical model.
The insignificance of non-traded (non-oil) sectors relative to the traded (oil)
sector, together with zero price (and output) cross- effects, has insulated nontraded goods and services sectors against changes in real exports.
Finally, Table V reports results pertaining to the effect of real imports on
output in six sectors of non-traded goods and services. Contrary to the case
of real exports, the results in Table V show that the largest three sectors
(construction, utilities, and wholesale and retail trades) have significantly
responded to changes in real imports. This indicates strong cross-price and
output effects between real imports and the three largest sub-sectors of nontraded goods and services. Real imports have also had some significant effects
on the smaller subsectors of transportation and finance, though the effect seems
temporary and fades away after the first year. All in all, the results suggest
that changes in the prices of foreign imports and the concurrent changes in
their demand have had important effects on the demand for non-traded goods
and services in the Saudi economy.

Oil-based
Developing
Economies

47

log yit = g0+g1 log IMt+g2 log IMt_1+g3 log IMt_2 + e5t
Non-traded
goods sector
Construction

g0
-0.046
(-0.344)

g1

g2

0.737
-0.135
-0.781
(3.355)** (-2.890)** (-0.449)

Wholesale and
retail trade,
restaurants
and hotels

0.285
-0.065
(6.144)** -(1.134)

Transportation,
storage and
communications

0.702
-0.868
-0.410
(1.659)* -(1.670)* (-0.709)

Community,
social and
personal
services

-0.143
-(0.664)

0.432
(1.301)

R2

D.W.

-0.594
0.694
0.88 13.99 2.14
0.666
(4.051)** (-3.248)** (2.917)**

Electricity, gas
water

Finance,
insurance, real
estate and
business
services

g3

0.614
(2.318)**

-0.290
(-0.712)

See notes to Tables I and IV.

0.66 3.87 2.08

0.775
(1.981)**

-0.201
0.002
(-3.162)** (0.028)

0.64 3.57 1.75

-0.524
(-0.698)

0.35 1.09 1.89

0.195
(0.066)

0.314
(0.819)

0.50 2.06 2.68

-0.433
(-0.954)

-0.166
(-0.282)

0.18 0.44 2.82

Table V.
The Impact of Real
Exports on Non-traded
Goods and Services in
Saudi Arabia

Journal of
Economic
Studies
17,6
48

Concluding Remarks
The main purpose of this study is to investigate the real impact of external
price shocks on the oil-based developing economies. To that end, an appropriate
macroeconomic general equilibrium model is presented and its theoretical
implications are derived and assessed. Empirical evidence deduced from a key
oil-based economy (Saudi Arabia) appears quite consistent with the model's
theoretical implications.
Importantly, we find that real imports are highly insulated against foreign import
price shocks, perhaps due to the insignificance of import-substitution and exportconsumption sectors. Moreover, due to the small size of non-traded (non-oil)
sectors, and the consequent zero cross-price effects between non-traded goods
and exports, non-traded goods sectors are found to be highly immune to price
changes of foreign exports. In the polar case of total openness (absense of nontraded goods sectors), the substitution effect vanishes and the income effect
dominates. In such a case, real changes depend crucially on the export supply
response to changes in export prices and on imports demand response to
changes in import prices.
Notes
1. The recent decline in oil prices and the failure of the OPEC countries to sustain higher
levels of prices through changes in export quantities indicate that these countries are
increasingly acting as price-takers in the world market.
2. According to the literature on "the optimum currency area", the higher the degree of
openness, the greater the impact of external shocks on the domestic economy.
3. Both Al-Bashir (1977) and Metwally and Tamasche (1980) support this assumption
empirically. For more theoretical and empirical elaborations, see Turnovsky (1976) and
Suliman (1984).
4. In Saudi Arabia, for example, import tariffs are being used as an instrument to control
local production of manufactures. Hence, they are virtually endogenous. For more on
this point, see, The Industrial Studies & Development Centre, A Guide to Industrial
Investment in Saudi Arabia, Riyadh (1977), p. 111.
5. The budget constraints of the private and government sectors are:
private:
PxX + PnN = PmIM + PnNd +
+ Md
government:
where,
Px =
F =
This implies

= Md - M5 = 0.
6. Evidence for this is indicated, for example, by the recent decline in the OPEC's imports
in response to the continuous decrease in oil prices.

7. The model is indifferent to the level of initial exogenous tariffs or subsidies. Hence,
for simplicity, we can arbitrarily choose an initial zero-level of restrictions such that initial
domestic prices are equal to unity. Note that the initial price of non-traded goods (Pn)
has already been assumed to equal unity in equations (13)-(18). Yet, in the equations
where it is important to differentiate between absolute and relative prices, we include
Pn explicitly for explanatory purposes. Later, the specific solutions of the model will
employ directly the assumption of unity for all prices.
8. In a six by six matrix, the latent roots' solution may require some simplifying assumptions
about the magnitudes of the different parameters. However, with the assumed positive
marginal propensities to import (m3) and to consume non-traded goods (d3); and given
that d1 = m1 (since P 0 m |P 0 n = 1 = -dN/dIM and both are positive, then the
eigenvalues are likely to be positive. For more on dynamic stability, see Takayama (1974,
pp. 367-72).
9. The impact of real exports on real income has been empirically examined by Metwally
and Tamschke (1980), and Al-Bashir (1977). The implications of our theoretical model
on that issue are consistent with their empirical results.
10. Of course, misspecification is always a possibility in any estimation. Thus, the adduced
empirical evidence is only meant to be suggestive. One may argue that a system estimation
like a VAR approach may be more appropriate, though data limitations prevented such
an exercise at this time.
11. The data for real exports have been taken from various issues of the International
Financial Statistics (IFS). Real imports have been derived by dividing the total value
of imports (FOB) taken from the IFS, by the index of manufactures in industrial countries,
the source of most of Saudi Arabia's imports. The data for manufactures and the nontraded goods sectors are based on the United Nations, National Accounts Statistics:
Main Aggregates and Detailed Tables. All time series data are available from the authors
on request.
References
Al-Bashir, F.S. (1977), Saudi Arabian Economy: 1960-1970, John Wiley and Sons, New York.
Black, S. (1976), "Exchange Policies for Less-Developed Countries in a World of Floating Rates",
Essays in International Finance, No. 119.
Buiter, W.H. and Purvis, D.D. (1983), "Oil, Disinflation and Export Competitiveness: A Model
of the 'Dutch Disease' ", in Bhandari, J. and Putnam, B. (Eds.), The International
Transmission of Economic Disturbance under Flexible Exchange Rates, MIT Press, Cambridge,
Massachusetts.
Chow, G.C. (1960), "Tests of Equality between Sets of Coefficients in Two Linear Regressions",
Econometrica, July, pp. 591-605.
Cooper, R.N. (1971), "Currency Devaluation in Developing Countries", Essays in International
Finance, No. 86.
Granger, C.W.J. and Newbold, P. (1974), "Spurious Regressions in Econometrics", Journal of
Econometrics, July, pp. 111-20
Metwally, M.M. and Tamschke, H.U. (1980), "Oil Exports and Econometric Growth in the Middle
East", Kyklos, pp. 499-522.
Neary, J.P. and Purvis, D.D. (1982), "Sectoral Shocks in a Dependent Economy: Long Run
Adjustment and Short Run Accommodation", Scandinavian Journal of Economics, pp. 229-53.
Pesaran, M.H. (1984), "Macroeconomic Policy in an Oil-Exporting Economy with Foreign
Exchange Controls", Economica, Vol. 51, pp. 253-70.
Suliman, M.O. (1984), "Appropriate Exchange Regimes and Trade Structure for Small, Open,
Developing Economies in the Context of Trade Controls", unpublished PhD Dissertation,
Department of Economics, Indiana University.
Takayama, A. (1974) Mathematical Economies, The Dryden Press, Hinsdale, Illinois.
Turnovsky, S.J. (1976), "The Relative Stability of Alternative Exchange Rate Systems in the
Presence of Random Disturbances", Journal of Money, Credit and Banking, pp. 29-50.

Oil-based
Developing
Economies

49