Third World Quarterly: Taylor & Francis, LTD

Third World Quarterly
OPEC Capital Surplus Funds and Third World Indebtedness: The Recycling Strategy
Reconsidered
Author(s): Fehmy Saddy
Reviewed work(s):
Source: Third World Quarterly, Vol. 4, No. 4 (Oct., 1982), pp. 736-757
Published by: Taylor & Francis, Ltd.
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FEHMYSADDY
Fun
s and
Surp
us
Capita
OPEC
Indebtedness: the
World
Third
reconsidered
strategy
recycling
Introduction
The first rhetorical round of the New InternationalEconomic Order(NIEO) came
to an end at the CancutnSummit Conference last October. An agreement was
reached to pursue 'global negotiations' at the United Nations. Whether the new
forum will open up better prospects or merelyoffer itself as a launchingpad for the
second round of rhetoric and recriminations remains to be seen. The Eleventh
Special Session of the UN General Assembly, held in August 1980, considered a
New International Strategy (NIS) for the Third Development Decade in which the
objectives of the first two decades were affirmed more vigorously. But optimism
does not seem warranted and only little hope exists that better results will be
attained. The United States' misapprehension about what it considers to be the
demand of developing countries for a global economic welfare system financed by
the industrialisedcountriescasts doubt on its willingnessto be more forthcomingin
future negotiations. Moreover, the developing countries are in a much weaker
position now than they were in the 1970s, and conflicts of interest among them
have been drawn more sharply. Therefore, while negotiations on trade, energy,
raw materials, development finance and monetary issues will be pursued at the
United Nations, innovative thinking and a search for solutions must continue
outside the North-South framework.
Ironically, one of the major problems that developing countries have come to
face during the past decade finds its origin - and to a large extent its solution within the South itself. It concerns the tremendous transfers of financial assets
from the oil-importing to the oil-exporting countries over a short period of time.
The quadrupling of the prices of oil in 1973-4and the doubling of these prices again
in 1978-9 resulted in current account deficits for all oil-importing countries, but
their effect was hardest on the less developed countries (LDCs). In response to
these increases, the industrialised countries (ICs) have, adopted deflationary
policies that resulted in reversingtheir negative currentaccounts. However, these
policies failed to curb inflation and instead produced stagflation, unemployment
Author'sNote: This researchwas conducted in the Fall semester of 1981at The School of International
Service, The American University, where he was Visiting International Research Affiliate. He would
like to thank Calvin De Pass, John W Tuthill and Howard M Wachtel for theircomments on an earlier
draft of this paper.
October 1982 Volume 4 No. 4

OPEC CAPITAL SURPLUS FUNDS AND THIRD WORLD INDEBTEDNESS
and reducedgrowth. These effectswerein turnpassed on to the oil-importing LDCs

which had benefited from economic liberalisation in the 1960s and increased
exports to the ICs. The combined effects of increased oil prices, substantial
reduction of their exports, depressed market prices for their raw materials and
manufactured products and increased costs of their imports, due to inflation,
reduced their terms of trade. The only alternative left for them in orderto maintain
their economies was to rely on borrowing from the international capital markets.
Thus, the problem of Third World indebtedness was born.
In addition, the OPEC countries pursued investment and trade policies that
have benefited the ICs and adverselyaffected the oil-importing LDCs. The bulk of
the oil revenues were spent on purchases from the ICs to finance the development
programmes of the oil-exporters. The few oil-exporting countries that were left
with some capital surpluses preferredto invest them in the ICs as well. Although
substantial aid and 'soft' loans were extended to the oil-importing LDCs through
multilateral institutions and by bilateral arrangements, the gap left by the
reduction of their terms of trade and soaring oil bills could only be filled by
increased indebtedness.
This paper will focus first on the indebtedness problem of oil-importing LDCs,
which is bound to worsen further in the future if the policies of both the oilexporters and the ICs continue their present course. Second, it will review the
arguments in regardto their responsibility for Third World indebtedness. Third, it
will discuss the investment policies of the capital surplus oil-exporters and assess
their effects. Fourth, it will present some arguments in favour of increased
investments in the oil-importing LDCs. Finally, it will conclude with a brief note
on proposals that have been advanced on the problem of recycling and investment.
The IndebtednessProblem
Indebtedness is not new to developing countries. Debt-financed development has
been pursued by many countries, both developing and industrialised. The United
States relied on imported capital to finance its infrastructureand build its industry
in the 18th Century.' Alexander Hamilton spoke in defence of foreign investments
which increased the wealth of nations.2 Of the developing countries, Brazilfloated
its first 'Eurobond' on the London marketin 1824and was followed by other Latin
American countries.3 However, nothing resembling the scale of borrowing that
took place in recent years has ever occurred before. The magnitude of borrowing
and the constraints it has placed on the economies of oil-importingLDCs threatena
serious crisisin internationalfinancialobligations with adverse effects on the world
economy.
1 John A Matheison, 'North-South Imbalances',BulletinofAtomic Scientists, 38 (1) January 1982,p 1.
As recounted by Edwin in his introduction to James A Gathings, InternationalLa," and American

Treatmentof AlienEnemyProperty, Washington, DC: American Council on Public Affairs, 1940, p
vii.
I Jeff Frieden, 'Third World Indebted Industrialisation:International Finance and State Capitalism
in Mexico, Brazil, Algeria and South Korea', InternationalOrganisation35 (3) Summer 1981,p 410.
737

THIRD WORLD QUARTERLY
The seriousness of the indebtedness problem has been recognised by

multilateral development agencies, many governments and concerned analysts,
with varying degrees of alarm. While the countries of the Organisation of
Economic Cooperation and Development (OECD) view it with 'neither
complacency nor undue alarm',4the World Bank is careful not to pass a uniform
judgment on all borrowing countries.5Others, however, are more alarmist. Some
believe that developing countries cannot escape the prospect of default and that
the recycling mechanism that was used in the 1970s is no longer adequate.6Others
have likened the indebtednessproblem to a ticking internationaltime-bomb which
will require 'concerted attention and action' in order to be defused.7 Former
President of the World Bank Robert McNamara has declared that 'over the next
five to six years, the deficits more and more are going to be concentrated in the
developing countries ... these current account deficits cannot be sustained
indefinitely by external financing.8
Structureof Indebtedness
The indebtedness problem acceleratedafter the first increase of OPEC oil pricesin
1973-4, and continues its upward movement.9 The question whether the oil price
increases were the primary reason for the increased indebtedness of the oilimporting LDCs will be discussed below. Nevertheless, these countries were
forced to supplement their deficits by external borrowings which have come to
take new forms. The main features of the new borrowings departed from familiar
'External Debt Statistics for Developing Countries: Latest Trends', Organisation for Economic
Cooperation and Development, Development Cooperation Directorate, September 1981, p 3.
Wor/dDevelopmentReport 1981, Chapter 5. The World Bank: Washington, DC, 1981.
6 Chandra S Hardy, 'Adjustment to Global Payments Imbalances: a tripartite solution', Working
Paper No. 5, Overseas Development Council, Washington, DC, September 1981, p 2.
Mathieson, op cit, p 1.
8 Hobart Rowen, 'The Third World Still Has A Friend in Robert McNamara', InternationalInvestor,
September 1981, p 156.
The indebtedness problem and the role of multinational banks in 'recycling'the surplusfunds to the
Third World are the subject of an ever-widening literature. See, for example, Harold Van B
Cleveland and W H Bruce Brittain,'Are the LDCs in Over Their Heads?',ForeignAffairs 55 (3) July
1977 pp 732-50; Cheryl Payer, 'Third World Debt Problems: The New Wave of Defaults', Monthly
Review 28 (4) September 1976 pp 1-19; Karin Lissakers, 'International Debt, The Banks and US
Foreign Policy', a staff paper prepared for the Subcommittee on Foreign Economic Relations, US
Senate, Washington, DC, US/GPO, 1977; Jonathan David Aronson (ed), Debt and the Less
Developed Countries, Boulder, Colo.: Westview Press, 1979; Laurence G Franco and Marilyn J
Seiber (eds), Developing Countries Debt, New York: Pergamon Press, 1979; David Beck,
'Commercial Bank Lending to the Developing Countries', Federal Reserve Bank of New York
QuarterlyReview1(2) Summer 1967, pp 1-8; Howard M Wachtel, The NelwGnomes:multinational
banks in the ThirdWorld,Pamphlet No. 4, Washington, DC: Transnational Institute, 1977, and 'A
Decade of International Debt', TheoryandSociety 9 (3) May 1980pp504-18; Paul Watson,Debtand
the Developing Countries:new problems and newtsactors, Washington, DC: Overseas Development
Council, Paper 26, NIEO Series, 1978; Miguel Wionczek (ed), LDC External Debt and the World
Economy, Mexico City: El Colegio de Mexico, 1978; Special Issue on 'International Indebtedness
and World Economic Stagnation', World Development 7 (2) February 1979 pp 91-224; and
International Monetary Fund, 'External Indebtedness of Developing Countries', Occasional Paper
No. 3, May 1981.
738

patterns that they had taken in earlier years thus substantially affecting the
capacity of oil-importing LDCs to service their debts.
The World Development Report 1981shows that the total debt of oil-importing
LDCs increased from $86.6 billion in 1971 to an estimated $524 billion in 1981
(Table 1). The rate of borrowing increased from 16 per cent per year in 1971to 24
per cent in 1975, the year following the first oil price increases. It registered a
further increase of 27 per cent per year in 1978, but since 1980 has stabilised at 15
per cent.'0
A marked shift in the source of borrowing has taken place over the past decade.
While the Official Development Assistance of the OECD countries more than
doubled between 1971and 1978 (by increasing from $24.7 billion to $61.0 billion),
borrowing from OECD's capital markets increased by more than twelve-fold
(from $16.1 billion to $209 billion - excluding export credits). Borrowing from
international organisations, such as the WorldBank,InternationalMonetaryFund
(IMF), and regionaldevelopmentbanks increasedsixfold (from $10.0 billion to $65
billion). OPEC countries emerged as an important source of lending by extending
credits from less than half a billion in 1971 to $23 billion in 1981.
Another feature of the indebtedness of the oil-importing LDCs is the declining
percentage of borrowing at concessional rates and the increasing percentage of
borrowing at rates prevailing on the international capital markets. While fixed
interest rates charged on concessional loans increased from 4.2 per cent in 1972to
6.2 per cent in 1981, the floating interest rate"Icharged on the expanding loans in
the capital market increased from 7.9 per cent to 18.0 per cent during the same
period (Table 2).
The burden that developing countries face in servicing their debts is shown in
Table 3. The total debt service in 1971amounted to one-eighth ($10.9 billion out of
?86.6 billion); in 1981 the percentage increased to just under one-fifth ($111.7
billion out of $524.0 billion). The debt service on bilateraland multilateralOfficial
Development Assistance has remained low ($5.9 billion out of $118.0 billion).
However, the debt service on commercial loans and export credits increased from
their lowest levels in 1971($8.5 billion out of $47.4 billion - or less than one-fifth),
to their highest levels in 1981 ($100.8 billion out of $368.0 billion - or almost onethird).
These statistics, however, may be misleading because they do not distinguish
between developing countries at different stages of development. Table 4 shows
that the bulk of the debts were accumulated by 79 Middle Income Countries
(MICs) and a group of 11 Newly Industrialised Countries (NICs). Both groups
accounted for $341 billion of the total debt in 1981. Thirteen OPEC countries
accounted for $94 billion, while the remaining 55 Low Income Countries (LICs)
10 The increased rate of borrowing in
1978was due to temporary decline in the rate of interest, and the

purpose of borrowing was to pay prematurely earlier debts which had been accumulated at higher
rates. WorldDevelopmentReport 1981, p 59.
11;Floating interest rate is expressed as a margin above the London Interbank Offered Rate (LIBOR),
called the spread, which includes allowances for risk, commission, etc. The spread is normally 0.5 per
cent, but it has gone up occasionally to 2.0 per cent, as in the case of recent borrowings by Brazil.
739

accounted for $89 billion. But it is also significant that the higher the income level
and the larger the debt of a country the harder its debt service. Therefore, there
seems to be little comfort in the fact that because the ability of the MICs and
NICs to expand their exports is better than the LICs, they can afford to service
their debts."2Considering the present policies of the industrialised and OPEC
countries, further deterioration of the terms of trade of oil-importing LDCs is
expected to reduce their ability to service their debts.
Allocation of Responsibility
Since 1973 it has become customary to distinguish between the oil-exporting
countries as a sub-category of the Third World and single out the capital-surplus
oil-exporters as a separate category not included among developing countries. I3
In delineating these categories the implication is that oil pricing and investment
allocation policies affect the health of the world economy. This implication is
sometimes misplaced because none of these policies operates outside the domain
of the economies of the ICs. The increased indebtedness of oil-importing LDCs
and the measures required to correct the financial imbalances are, to a large
extent, the result of decisions made in the ICs.
Argumentsof Industrialised Countries
The ICs have argued that the quadrupling of oil prices by OPEC countries in
1973-4 produced the first 'shock' to the world economy and must account for the
spiral of inflation that ensued. The economic consequences of the sudden oil
price increases left a deep impact on the oil-importing LDCs in particular. In
1974 the ICs suffered a current account deficit of $11.6 billion, while one year
earlier they had realised a $19.3 billion surplus. The oil-importing LDCs
increased their current account deficits from $11.5 billion in 1973 to $36.9 billion
in 1974 (Table 5). On the opposite end of the scale the OPEC countries increased
their current account surpluses from $6.6 billion in 1973 to $67.8 billion in 1974.
The immediate effect of the quadrupling of the oil prices was an increase in the
inflation rate in the ICs which soared to double-digit heights in 1974 and 1975.
The ICs have also pointed out that every time the price of oil rises by $1 a barrel
the oil-importing LDCs have to find nearly $2 billion more to pay for their oil
imports. The indirect effects are even worse since 'higher oil prices mean slower
growth in the industrialised world which buys two-thirds of all LDCs' exports.
So the non-oil LDCs have been unable to fill the hole which dearer oil has
punched in their current accounts.'4 The ICs have further argued that the high
rate of inflation they experienced prior to the oil price increases, together with the
slump in the prices of raw materials of the oil-importing LDCs, could not have
resulted in such large current account deficits had the oil prices remained
12 'External Debt Statistics. .. ', op cit. p 4.
'3 The oil-exporting developing countries comprise 20 countries. The capital-surplus oil exporters
14
number six and are not counted as developing countries. WorldDevelopmentReport 1981, viii.
'Rich Banks and Poor Countries', The Economist, (London) 3 November 1979, p 92.
740

relatively stable. These arguments are compelling and are widely accepted
except, of course, by the OPEC countries.
Argumentsof OPEC Countries
While recognising the adverse effects that higher oil prices have had on both the
ICs and the LDCs, OPEC countries like to cite their own statistics. They have
argued that the oil prices were kept unrealistically low by the major oil companies
for many years and, at times, they were even reduced.'5 For example, a recent
OECD study revealed that, in 1970, Saudi Arabia was selling its oil for $1.30 a
barrel, which represented a decline of 50 per cent in real terms of its value in
1950.16 In spite of the slight increase in the prices of oil in 1970 the (real) value of
the oil revenues decreased between 1970 and 1973 due to inflation in the ICs and
the devaluation of the US dollar in 1972. In addition the sharp increase in the
prices of food and manufactured products more than offset the increase in oil
prices.'7 The oil-importing LDCs suffered from the deterioration of their terms
of trade with the ICs in equal measure with the increase in the prices of oil. Table
5 shows that their terms of trade declined by 8.0 per cent in 1974 and again by 9.5
per cent in 1975. This decrease affected their current accounts, which went from a
deficit of $36.9 billion in 1974to a deficit of $45.9 billion in 1975. The blame must
be shared by both the ICs and OPEC countries together.
The oil-exporting countries have also argued that no serious harm was actually
done to the majority of the oil-importing LDCs since they were more than
compensated for their increased oil bills. The Organisation of Arab Petroleum
Exporting Countries (OAPEC) published a report in which it provided the
following calculation:'8 out of 1,050 million tons of oil imported by developing
countries between 1974 and 1976, 563 million tons, or 53 per cent, were reexported in the form of either crude oil or refined products. The remaining 487
million tons were the LDCs' net imports. Of this, five countries (Argentina,
Brazil, India, South Korea and Taiwan) imported more than 50 per cent. The
report contends that these countries have strong and diversified economies, and
that they were among the countries which succeeded in maintaining high growth
rates in spite of the oil price increases. In addition, during this period (1974-6)
OPEC countries committed $18.5 billion in aid to the LDCs. This amounted to
66.1 per cent of the total $28 billion these countries accumulated as current
account deficits. If the five countries mentioned above were excluded from the
Loring Allen, 'OPEC Speaks Out: an interview with Ali M Jaida', WorldReview,,March 1979, p 42.
Cited by Hardy, op. cit. p 14.
17 The prices of food and services from the OECD countries have increased to such a level that OPEC
countries' imports reached $79.3 billion in 1978, something they could afford to pay and even realise
some current account surpluses. Oil-importing LDCs were in no position to do so. Petroleum
Intelligence Service, 10 July 1979, p 1.
'Report on the Relationship Between the Financial Aid of OPEC Countries and the Financial
Burdens of the Developing Countries Resulting from the Correction of Oil Prices Since 1973',
OAPECBulletin, October 1979, pp 15-25 (in Arabic).
15
16
741

calculation of the oil import-aid ratio, the percentage of OPEC aid commitments
to the rest of the LDCs would be 134.4 per cent.
The Muted Controversy
Statistics can be creative; but they can also be deceptive. However, the glaring
reality remains that Third World indebtedness was the making of both the ICs
and OPEC countries. The deflationary policies that the OECD countries have
pursued since 1974 resulted in some improvements in their current accounts but
have also retarded their economic recovery. These improvements were accomplished by increasing their exports to OPEC countries and decreasing their
imports from the oil-importing LDCs. A large part of the burden of adjustment,
therefore, was shouldered by the latter, which benefited neither from the
expanded markets of OPEC countries nor from their accumulated capitalsurpluses. These surpluses were concentrated in the Western banking system
which lent them to the LDCs at high interest rates, thus further affecting their
economic imbalances.
The symbiotic relationship that developed between the oil exporters and the
ICs in the second part of the 1970s may explain the muted controversy over who
caused the indebtedness of the oil-importing LDCs. In fact, the second 'shock'
that OPEC delivered to the world economy in 1979 was anticipated and did not
raise the cries that were voiced after the first oil price increases in 1973. A number
of factors may explain this restrained reaction.
First, the steady decline in the value of oil in real terms was bound to make
price adjustments a necessity. The real value of oil declined by one-third between
1974 and 1978, and OPEC countries' current account surpluses decreased from
$67.8 billion to $5.0 billion during the same period. Meanwhile, the prices of
goods imported by OPEC countries soared, thus increasing the cost of their
development programmes. The ICs failed to heed OPEC countries' calls for
taking effective measures to control inflation, which was eroding the value of
their oil capital surpluses (Table 5).
Second, the price of oil in the parallel ('spot') market was increasing rapidly in
relation to the price of contracted oil. The increase was necessary to bring OPEC
oil prices to that level, which was also the level at which oil produced by
industrialised countries (UK, Norway and Canada) and other developing
countries (Mexico) was sold. In addition, the increase in the prices of oil could
stimulate interests in developing alternative sources of energy.
Third, the balance of trade of the ICs with OPEC countries registered significant improvements in the preceding years. This experience demonstrated that
there was no reason to be alarmed at OPEC's increased revenues. Most of the
revenues have been spent on purchases of goods and services from the ICs and
the remaining surpluses have been invested there. Besides, any increases in oil
prices could, as in the past, be offset by increasing the prices of exports.
Fourth, OPEC countries, particularly the capital surplus oil exporters have
displayed a sense of responsibility in cooperating with international lending
742

instititutions.'9 They have also responded positively to the ICs' needs and
recommendationsincludingmaking largercontributionsto developingcountries.20
The muted reactionto the second oil price 'shock', however, has resolvednone of
the problemsthat have afflictedthe worldeconomy since 1973.In fact, it has allowed
the policies pursued by the ICs to continue. More than two years have already
passed since the second 'shock' was administered, and no substantive changes of
policy have been taken by the ICs to alleviate the problems of inflation, slackening
growth and unemployment. However, this muted reaction may no longer be
possible, considering the prospects for growth and development in a world
characterised more and more by interdependence. As it was put recently by
Jacques de Larosiere, IMF Executive Director, 'the increase in international
economic interdependence has brought with it a new element of vulnerability.
Countries expanding trading and other economic links have become increasingly
exposed to external economic and financial developments that are beyond their
control'.21Although developing countries are more dependent on international
trade for their growth than the ICs, their reduced level of trade and slackening
economies will have an increasingly important impact on the prospects for
economic recovery in the industrialised countries. Therefore, the relationship
between the ICs and OPEC countries, to the exclusion of the developing world, will
not serve the interests of both in the long run. OPEC's diversification of trade and
investment to the developing countries is a matter of necessity, not choice.
Investmentof Capital Surpluses

It is difficult to estimate the amount of the capital-surplus oil funds with any
measures of accuracy. Measuredby the currentaccount surpluses of Saudi Arabia.
Kuwait, Libya, Iraq, Qatar and the United Arab Emirates (UAE) between 1973
and 1980, the capital-surplus oil funds are estimated at some $350 billion. But they
could be twice that level.22Others estimate they will reach $500 billion by 1982.23
In spite of the increasedindebtedness of oil-importing LDCs, aid from the ICs as a percentageof their
Gross National Products (GNPs) declined from 0.30 per cent in 1974 to 0.22 per cent in 1977. This
was well below the recommended target of 0.7 per cent for the UN Second Development Decade. By
comparison, OPEC members committed 8.2 per cent of their GNPs in aid in 1974,the first yearafter
the oil priceincreases;see Organisationfor Economic Cooperation and Development, Development
Assistance Directorate, Flow ofResourcesfrom OPECMemberstoDeveloping Countries,Document
No. DD. 403, 6 December 1975, Table 2, p 8. The estimated figures of Official Development
Assistance of OECD countries in 1980 is $26.6 billion, or 0.37 per cent of their GNPs; for OAPEC
countries they are $6.798 billion, or 2.34 per cent. WorldDevelopmentReport1981, Table 16,Official
Development Assistance from OECD andOPEC Members, pp 164-5.See also 'Arab Institutions for
Development Aid Have Rapidly ExpandedTheir Activities',IMFSurvey, 5 February l979,p 37;and
'Arab Monetary Fund Loan Operations Begin With Payments Assistance for Five Members',IMF
Survey, 20 August 1979, pp 249-50.
20 OPEC countries received praiseby the new presidentofthe World Bank, A W Clausen.Addressto the
Boardof Governors,World Bank, Washington, DC, 29 September 1981.
21 EconomicCooper-ation
and WorldStability, International Monetary Fund, Washington, DC, August
1981, p 9.
22 Hardy, op. cit. p 18.
23 'Morgan Guarantee Warnson Massive OPEC Revenues',InternationalHeraldTribune10December
1979, p 1.
9
743

'Secrecy theorists,' however, contend that the surpluses are much larger, but their
accurate figuresare known only to the capital-surpluscountries and some Western
governments, particularly the United States.24
The capital surpluses are the result of over-production of oil. Under normal
conditions it is in the interests of the oil exporters to produce only enough to meet
the requirementsof theirdevelopment. For example, Saudi Arabia's development
requirementscan be met by producing only 4.5 million barrelsof oil per day. Yet, it
produces more than twice as much. The reason it produces more than it needs is to
help - together with other oil exporters - meet the world demand for oil. Any
cutback in production will result in driving the price of oil even higher which will
further worsen prospects for the world economy. The oil producers themselves
would suffer the consequences as well, because inflation spurred by oil price
increases would drive up the prices of imported goods and reducethe value of their
capital surpluses.25
If the obligation to maintain currentlevels of oil production -andconsequently
the accumulation of large capital surpluses - is inescapable, then they must find
ways to protect theirsurplusesagainst inflation and currencydevaluation. In overproducing the oil exporters 'are depleting a non-renewable asset and exchanging
an asset (oil) which is appreciating in value for financial assets which are
depreciating in value.'26Any investment strategy, therefore, must be at least as
profitable as if the oil had been kept underground. This goal, however, has been
elusive in spite of the tremendous increases in the prices of oil since 1973.
The Harvest of the 1970s
The recycling strategies that the capital-surplusoil exporterspursued in the 1970s
focused on the industrialised countries. There was, and still is, a general belief that
only the Western economies have the width and depth to absorb their surpluses.
There are other considerations, but they are less important than the basic premise
of the Western markets' viability.27Even after the development of a sophisticated
banking system in the capital-surplus countries they have not ventured on any
significant scale outside the industrialised economies. It will be worthwhile,
therefore, to look briefly at the results of these investments since the recycling
mechanism was initiated. What gains and losses have accrued by this mechanism
'Saudi-American Finances - That Secret Agreement: final confirmation and assessment of its long
term importance', InternationalCurrencyReviewt12 (1) 1980, pp 7-24.
25 There are other reasons for the over-production of oil, which are political and economic. For
example, the ability of Saudi Arabia to increase itsproduction from 8.5 to 11.5million barrelsof oil a
day alleviated the shortages in the world oil market that developed after the Iranian Revolution and
impeded other OPEC members from raising the price of their oil. This capability is translated into
political power. In addition, Saudi Arabia fears that substantial increases of oil prices would
accelerate the process of developing alternative sources of energy by the ICs and ultimately result in
depressing the prices of oil.
26 Hardy, op. cit. p 3.
27
These considerations are discussed at length in Fehmy Saddy and Antun Harik, 'Investment of
Surplus Oil Funds in the Third World: Latin America', Arab-LatinAmericanRelations: Energy,
Trade and Investment, Fehmy Saddy, (ed)., New Brunswick, N.J.: Transaction Books, 1982.
24
744

to the capital-surplusoil exporters, the industrialisedcountries and the developing

world?
1. Capital-Surplus Oil Exporters
Table 6 shows that the investable surplusesvaried from $59 billion in 1974to $20
billion in 1977. There was a net deficit of$7 billion in 1978when some oil producers
had to draw on their deposits or borrow to pay for their expanded purchases. The
investable surpluses rose to, $68 billion in 1979 and again to $73 billion in 1980.
Most of the capital surpluses were invested in short-term bank deposits and
securities in the Euromarket or in long-term US Treasury bills and UK securities.
In addition, other investments were placed in the stock markets and in real estate.
The rateof returnon these investments ranged between zero and-3.4 percent per
year during the 1972-9 period.28The reasons for this negative return appear to be
inflation and the depreciation of the US dollar in which oil payments are made.
These reasons are explained by one economic analyst as follows:
The annual increase in Eurodollar deposit rates between 1972 and 1979 was 10.8 per
cent, compared with the annual averageincreasein import prices of 14.2per cent, and
in OECD domestic prices of 10.5 per cent... In addition to a low or negative yield, it
appears that the purchasingpower of OPEC's dollar assets has also eroded because of
the decline in the real effective exchange rate of the US dollar against the currenteffective exchange rate of the US dollar against the currencies of 15 other major
countries.29
2. The Industrialised Countries

The Eurodollar markets attracted most of the investable surpluses because of
higher interest rates, minimum restrictions, and easy access to the surpluses when
needed. The Euromarketsexpanded in the 1970swith increased involvement of US
banks. The purpose of this involvement was to help absorb or 'recycle' the capital
surpluses.
The expansion of US banking overseas, particularly in developing countries,
helped to connect the Euromarket with these countries, as lending to them became
the cornerstone of the petro-dollar 'recycling' strategy.30 In 1965, only 11
American banks had branches in other countries. The number reached 125 banks
in 1975, with 732 branches operating in 59 countries. Wachtel reports that 'taking
just the 20 largest US banks (which account for 82 per cent of the total number of
foreign branches and 92 per cent of total foreign assets), foreign assets account for
about 35 per cent of their total assets.'3' Some of the largest US banks even have
more than 50 per cent of their assets in overseas branches.
One indication of the profitability of'recycling' for US multinational banks is to
compare the earnings from their overseas operations with their earnings at home.
28 Much of this discussion relies on Hardy op. cit. pp 18-19.
29 ibid.
3
31
Much of the statistical data and evaluation thatfollow aredrawn from HowardMWachtel,TheNew
Gnomes:multinationalbanks in the ThirdWorld,(Pamphlet No. 4), Washington, DC: Transnational
Institute, 1977.
ibid, p 8.
745

By 1976, the external assets of the eight largest US banks32 accounted for 45 per
cent of their total assets, compared with 16 per cent for all US banks. International
earnings accounted for 95 per cent of the increase in their total earnings during the
1970-75 period.33 Wachtel composes the following profile of US banking
operations, drawn from such authoritative sources as TheNew York Times and the
investment house Salomon Brothers:
A substantial portion of the total earnings of the 12 largest US banks come from
earnings on loans made outside of the United States. In 1975, 63 per cent of total
income for these 12 largest banks originated in their foreign branches,upfrom 23 per
cent in 1971 and 43 per cent in 1974. For severalof these large banks, nearlyall of their
earnings in 1975 was derived from foreign branch activity. For example, Chase
Manhattan received an astounding 82 per cent of its 1975 earnings from foreign
activities; First National Bank of Chicago, 63 per cent; and First National Bank of
Boston, 80 per cent. Salomon Brothers, an investment house which employed
William Simon before he became Secretary of the Treasury under Nixon and Ford,
recently reported that the 'growth in international earnings has accounted for 95 per
cent of the total earnings increase' in the largest banks since 1970. The dynamic
growing sector of banking activities had definitely shifted from the United States
during this period. From 1970-1975credit expanded by only 9 per cent in the United
States; in contrast, international credit grew two-and-a-half times as rapidly, about
30 per cent. Earnings in the international capital marketexpanded about 36 per cent
during this same period while domestic earnings declined by 9 per cent from 19701975, according to the Salomon Brothers report.34
3. The Oil-Importing LDCs
The negative return on investments of surplus oil revenues and the profitability
of international banking were the result of the 'recycling' mechanism. Both
would have been justified had developing countries shared in the losses and
gains. Their increased indebtedness meant, in fact, that they shared in the former
but not in the latter, unless borrowing at high interest rates and the creation of
debt-servicing problems could be considered- successful management. But this is
exactly how it has been perceived. The intermediation of the international
banking system has received praise on the premise that it prevented a deeper
world recession.35 However, such intermediation was carried at a high cost for
both the capital-surplus oil producers and the oil-importing LDCs. The acute
indebtedness and debt servicing problems of the latter have come to threaten an
even deeper world recession and the prospect of wholesale defaults for the first
time since the 1930s. Measured by these results, the forms which the recycling
strategy has taken could no longer be sustained without further sacrifices by all
developing countries. In the final analysis, this will defeat the very purpose of
recycling by negatively affecting the industrialised as well as the capital-surplus
countries.
32
33
3
3
Citicorp, Bank of America, Chase Manhattan, ManufacturersHanover, BankersTrust, Chemical,

Morgan Guarantee, First Chicago, and Continental Illinois.
Chandra S Hardy, 'Commercial Bank Lending to Developing Countries:supply constraints', World
Development7 (2) February 1979, p 190.
Wachtel op. cit. p 9.
WorldDevelopment Report 1981, p 50.
746

Investment in the Third World

In concluding the discussion on external financing for adjustment and growth,
the World Development Report of 1981 recommends improvement in the access
of developing countries to stable flows of non-concessional credits. It states, in
specific terms, that 'direct placement by the oil exporters in developing countries
must be encouraged, and the international financial institutions should play
a larger role in intermediation - directly or in cooperation with the private
banks.'36
Direct investments by the capital-surplus oil exporters in the Third World

must be encouraged because of sound economic considerations and not only as a
matter of concern for the plight of developing countries. The arguments
presented here emphasise the stability and viability of developing countries.
Furthermore, a strategy of investment diversification is in the interest of all
countries because of their interdependent economic relations.
Stability of Developing Countries
The first concern of investors is political stability. To a large extent, defining
stability is a matter of perception, even when objective criteria are developed as
measurements. Paul Watson, a US banker, quotes Harry C Wallich of the Board
of Governors of the Federal Reserve Board as saying:
Practitioners(of the analysisof the economic,financialand politicalsituationsof
the individualdebtorcountry)arethe firstto pointout thatanalysisof countryrisk
is not a science.I hesitateto call it an art;perhapsit maybe dignifiedwiththeterm
'craft'."
Currently, assessments of the stability of developing countries are produced by

Western specialists and thus reflect Western views and perceptions. The missing
question in these assessments is: stability or instability in relation to which
countries? International relations are marked by various shades of friendship
and hostility for a host of reasons. Western investors have good reason to fear the
expropriation of their assets by developing countries. Western involvement in the
Third World may justify the negative reaction against foreign investments that
were generated after independence. However, the same does not hold true for
investments placed by the capital-surplus oil exporters who are themselves
developing countries and who share with the investment-recipient countries in
the Third World their caution and misapprehensions. It is worthwhile to note
that there is no precedent of expropriation by a developing country of the assets
of another developing country. Changes of government, therefore, are much less
of a political risk for the capital-surpluscountries than for Western interests with
a questionable record in the Third World.
In any case, the instability of developing countries is often exaggerated by
Western financial circles which have frequently used it as a lever in negotiations
with borrowers. In spite of the claim of the instability of developing countries, the
36
3
ibid.
Debt and The Developing Countries: newuproblems and new!actors, Washington, DC: Overseas
Development Council, Development Paper 26, NIEO Series, April 1978, p 45.
747

Western banking system was able to place some $350 billion in developing
countries during the span of a few years. For example, Brazil has been cited by
investors as a risk-laden country because of its large external debt which
amounted in 1981 to some $60 billion. Yet Citicorp's portfolio outstanding in
Brazil in 1977 was over $2 billion, which amounted to 35 per cent of its net
income for that year.38 Inspite of its Jarge debt, Brazil's ability to borrow on the
international market does not seem to have been diminished. A further evidence
of the politics of risk analysis is provided by the following account:
A year ago (1978) some bankers stated publicly that 50 per cent of their LDCs
exposure had some form of external guarantees. Subsequent US Federal Reserve
Board survey (FED) data show that only 6 per cent of the claims on foreigners by
US banks carry external guarantees ... Market analysts feel that much of what
banks say about the risks in their LDC portfolios is self-serving.39
Problems of IndustrialisedCountries
The investment experiences of the capital-surplus countries during the 1970s
have demonstrated that the political and economic stability of the industrialised
countries is no less shaky than that of developing countries. On the political
plane, the recent US-Iranian crisis reveals that dealing with the powerful is a
mixed blessing, to say the least. The extraterritorial reach of US jurisdiction by
which Iranian deposits in branches of US banks overseas were 'frozen' make the
investments
of capital-surplus
countries subject to political considerations.
Given the tenuous state of affairs between the United States and some Arab oil
producing countries, the possibility of the US freezing their assets, whether in the
United States or in branches of US banks overseas, cannot be discounted as a
political risk. In addition, the US government and Congress have been producing
a multiplicity of legislation and regulations that negatively affect Arab
investment and trade.40These political risks have, in fact, been at work in OPEC
countries' decisions to reduce their deposits in US banks.4'
On the economic plane, the industrialised countries continue to be unable to

put their house in order: inflation still seems uncontrollable; a sluggish economy
is characteristic of most of them; and social upheavals resulting from
unemployment and stagnation are on the rise. Consider the US economy, the
strongest in the Western world, in 1982. The national debt has risen to $1,079
trillion, an increase of $94 billion over a year ago. This debt 'amounts to $4,694
for every man, woman and child in the country.'42The budget deficit amounts to
$109 billion which imperils economic recovery.43The unemployment rate of 9
38
3
40
41
42
43
Hardy, op. cit. p 191.

Ibid., p 193.
See, in particular, Public Law No. 95-52, Title 11,91 Stat. 235, Export Administration Amendments
(1977), amending 50 USC ? 2401 et seq. (1970); Henry J Steiner, 'International Boycotts and
Domestic Order:American involvement in the Arab-Israeliconflict', TexasLaii Review(54)1976, pp
1355-1410;and note, 'US Regulation of Direct Foreign Investment:current developments and the
Congressional response', VirginiaJournalof InternationalLaw (15) 1975, pp 611-47.
'OPEC Nations Reduce Deposits in US Banks', Net York Times, 19 January 1982, p Dl.
'Senate Passes Bill for Debt of $1 Trillion', WashingtonPost, 30 September 1981, p 1.
'Volker Cautions That Big Deficits Imperil Recovery',NewrYork Times, 27 January 1982, p 1.
748

per cent is rising without any indication of government intervention to check it.
Meanwhile, an ambitious armaments programme of over ?200 billion is under
way to be financed by diminishing tax collections.
The economic problems of the industrialised countries, however, are
structural and not only related to ineffective economic policies. As W Arthur
Lewis has indicated, growth in the ICs will continue to be low in the coming years
as their economies pass through a cyclical decline. Recovery will ultimately come
after structural adjustments are made, either by more efficient production or
technological breakthroughs.44
Viability of Developing Countries
In spite of two oil price 'shocks', increasedindebtedness, anddeterioration intheir
terms of trade, the developing countries were able to maintain an average growth
rate of 2.7 per cent throughout the 1970s. This was higher than the averagegrowth
rate of 2.5 per cent achieved by the industrialised countries.45The growth rate of
some MICs has reached higher levels than the average growth rate for all
developing countries. The NICs in East Asia and Latin America particularly
demonstrated a strong ability to withstand the world economic recession and
maintained high levels of exports. On the whole, outward-looking countries in the
Third World were willing to take the risk of heavy externalborrowing to maintain
their pace of development, and as a result they have fared better than the inwardlooking countries.46These countries are particularly viable for investment by the
capital-surplus oil exporters. Direct investment would help them reduce their
borrowing on the international capital markets and allow them to manage their
debts more effectively. The injection of capital investment in these countries would
stimulate further growth with benefits for both investors and capital recipients.
Conclusion
The discussion of indebtedness has indicated the tremendous risks to the world
economy that have been created by the financial imbalances of developing
countries. In spite of cautious optimism about the ability of developing countries
to ward off the prospects of default, these prospects cannot be ignored. The
indebtedness problem is not receiving the concern it requires from multilateral
development institutions, industrialised governments and capital-surplus countries, and no concerted efforts have been made to bring it under control.
The investment policies that the capital-surplus oil exportershave pursuedhave
fallen within the general strategy of 'recycling.' Essentially, what this strategy
accomplished was the transformation of OPEC's surpluses into debts to
developing countries through the Western banking system, which reaped the
4
4
46
'The Slowing Down of the Engine of Growth', AmericanEconomicReviewv(70), September 1980 pp

555-64.
WorldDevelopmentReport 1981, Table 1-1, Growth of GNP per person, by region, 1960-90, p 3.
Ralph C Bryant, 'Notes on the Analysisof Capital Flows to DevelopingNations and the "Recycling"
Problem', World Bank Staff Working Paper No. 476, Washington, DC, August 1981.
749

benefits. The economic results of this strategy were disadvantageous to both the
capital-surplus and oil-importing developing LDCs. Moreover, the 'recycling'
strategy helped to deepen further the dependence of both on the ICs.
It was the liberal 'fix' of the early 1970s that provided the necessary logic and
rationale for the recycling strategy. In its simplest form it meant that attention
must be given to the ICs because of the adverse effects any curtailment of their
growth would have on the LDCs. In a sense, this argument implies that what is
good for the ICs is good for the rest of the world. Therefore, the recycling
mechanism was structured for the purpose of helping the Western economies
recover their strength. The experience of the last decade has proven the recycling
strategy inadequate. Neither the capital-surplus oil exporters nor the oilimporting LDCs benefited from recycling:theformer byderiving negative returns
on their investments, the latter by increasing their indebtedness to an alarming
level. The benefits that accruedto the ICs weresubstantial. However, the recycling
strategy failed to bring about recovery for their economies. In fact, the Western
economies continue to face serious difficulties manifested in persistent stagflation,
unemployment and declining productivity. One analyst has commented on this
state of affairs by saying that 'controversy rages both about the causes of this
"stagflation" and the appropriate policy reaction to it. Economists' views about
macroeconomic theory and policy are in a greaterstate of disarraythan at any time
in living memory.'47
In spite of the structuredfavouritism in the recycling strategy toward the ICs,
achievements have been meagre. The developing countries, which seem to have
taken the brunt of recycling in terms of increased indebtedness, deterioration in
terms of trade, and curtailedexports, fared better. If this is any indication it is that
they are more viable economically and are better candidates for future growth.
Investment of capital surpluses in these countries is at least as viable as in the ICs.
There has been a recognition of the limitation of recyclingas it was administered
in the 1970s. It is again the liberal 'fixers' who are leading the way. They contend
that the prospects of default in the Third World would pose intolerable risks to the
world economy. To ward off such a prospect, some of the capital surplusesmust be
invested directly in developing countries. The Western banking system has
reached its limits in terms of its ability to continue its lending to the Third World.
Direct investments by the capital-surplusexporters in developing countries would
help the latter service their debts while relegating to the former a larger
responsibility in assuming the risks. However, they contend that the largestpart of
the capital surpluses must be invested in the ICs to help them 'reindustrialise'more
efficiently.48 It may seem odd to argue that the capital surpluses of some
developing countries must be used to reindustrialise the industrialised countries
when these surplusescould be used more efficiently in the developing world. If the
liberal argument is adopted, double industrialisation would have been carriedout
in the Westerncountries at the expense ofthe developing countries, once by the use
47
ibid., p 58.
48 Hardy,op. cit., pSI.
750

of their raw materials and again by their capital surpluses.

Therefore, enlightened self-interest, not immediate short-term benefit, is
indispensable to correct the present world economic imbalances within a
framework of balanced interdependence.49The recycling strategy in the 1980s
must make the developing countries the focus of its attention. This amounts to the
recognition that genuine interdependence is a system of shared risks and
responsibilities. It also indicates that the economic viability of the whole depends
on the viability of its parts.
See Fehmy Saddy, 'A New World Economic Order: the limits of accommodation', Inteinational
Journal 34 (1) Winter 1979, pp 16-38.
751

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00
Table 6
OPEC's InvestmentPortfolio
1974 1975 1976
1977 1978
1979 1980*
Currentaccount surplus
Less
Official transfers
Official loans
69
32
(US $ billions)
38
1
29
76
2
8
10
3
10
13
3
8
11
2
7
9
2
6
8
3
5
8
Investiblesurplus
Of which:
Bank deposits
Short term securities
Total short-term assets
59
19
27
20
-7
68
73
29
8
37
10
10
12
-2
10
13
-1
12
4
-1
3
37
4
41
25
1
26
1
7
14
2
13
-6
4
13
0
4
8
-4
-2
7
-15
-1
13
15
6
9
32
Long-term securities (a)

Other identified (b)
Unidentified
* January-June 1980.
(a) UK and US government securities only.
(b) Portfolio investment n.i.e., foreign direct investment, loans, etc.
Sources: Bank of England, 1980; and data from World Bank Finance Department.
Adopted from Chandra S Hardy, 'Adjustment to Global Payment Imbalances: A
Tripartite Solution.' Working Paper No. 5, Washington, DC: Overseas Development
Council, September 1981.
757


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OPEC CAPITAL SURPLUS FUNDS AND THIRD WORLD INDEBTEDNESS

and reducedgrowth. These effectswerein turnpassed on to the oil-importing LDCs

As recounted by Edwin in his introduction to James A Gathings, InternationalLa," and American

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