SOAS Research Online

Abstract

Recent research has developed and tested a theoretical framework for analysing the macro and micro economic effects of temporary positive external trade shocks in small open developing economies (Bevan et al., 1990). The findings, termed ‘construction boom theory’, suggest that the extent to which a boom’s transient windfall income is converted into a permanent income gain depends upon the savings responses of the public and private sectors and their ability to allocate savings among different fixed and financial assets. The nature of the economic policy regime plays a crucial role. An extensive system of controls over prices, interest rates, imports and foreign asset purchases is likely to induce a sub-optimal allocation of the windfall resources and to depress rates of return to saving and thus permanent income gains. Moreover, an inappropriate macroeconomic policy response during the boom (especially an excessive expansion of public spending, rapid growth of the money supply and an appreciation of the real exchange rate) may have very serious adverse consequences for external and internal macroeconomic imbalances during and/or following the end of the boom. Macroeconomic problems include excessively large construction booms, declining tradeables output, over-extended public sectors, unsustainable public deficits, overvalued exchange rates and inflation. Many of these problems ultimately contributed to the need for the structural adjustment programmes (SAPs) which have been under way in much of sub-Saharan Africa for well over a decade. The aim of this article is to assess these SAPs from the standpoint of whether the reforms have left adjusting countries in a better position to manage temporary positive external trade shocks or commodity price booms in three important respects: diversifying the economy; efficiently saving and investing boom income; and appropriately managing the macro-economy in the face of a positive trade shock.