Petrodollars and the Differential Growth Performance of Industrial and Middle-Income Countries in the 1970s

The paper attempts to account for the differential growth performance of the industrial countries and the middle income developing countries in the 1970s in terms of economic theory and some international cross-section comparisons. The theory of adjustment to supply price shocks in an individual country is coupled with the world equilibrium determination of capital flows and interest rates. The supply shocks suffered by the industrial countries during the first oil shock were compounded by relative real wage rigidity and contractionary macroeconomic response.The middle-income countries, at least initially, showed greater real wage flexibility and also followed a much more expansionary policy by borrowing the equivalent of the large OPEC surplus at very low or negative real interest rates. Their faster growth in output and productivity was attained at higher current account deficits and more accelerated inflation.At the time of the second oil shock this differential strategy could no longer be pursued by many of the middle income countries as the real costof foreign borrowing as well as that of domestic labour increased substantially