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Grahan B i r d
=^'Research A s s o c i a t e ,
OEI and S e n i o r
Lecturer,
U n i v e r s i t y of Surrey
O i l TJorking Papers p r e s e n t i n p r e l i m i n a r y form
r e s u l t i n g from r e s e a r c h undertaken under t h e
a u s p i c e s o f t h e I n s t i t u t e . Views e::pressed a r e those
o f t h e a u t h o r s and do n o t n e c e s s a r i l y r e f l e c t t h e
vie-7 o f ODI. Comments a r e welcomed and
addressed t o t h e a u t h o r s .
iror].
llovemher 19 B l
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lei; CI Dii'i
Dn/0.0''MENT INSTITUTE,
^*L/I!Cg OF PA^^SNTr- STABILISATT.OM POLKT': IN m^mJTIlJ'l
COUIITP.IES'''
The
balance of payfsnts
i s a prime exaronle o f an a r e a i n w h i c h g o v e r n -
ments have t o mahe p o l i c y d e c i s i o n s i n an environment o f u n c e r t a i n t y .
To p o l i c y makers t h e u n c e r t a i n t y must a t times seem almost
pervasive.
At present
totally
t h e r e i s no agreed and c o n s i s t e n t t o d y o f t h e o r y
upon w h i c h i t i s p o s s i b l e c o n f i d e n t l y t o base p o l i c y , i n s t e a d t h e r e a r e
a range o f o f t e n a p p a r e n t l y
c o n f l i c t i n g t h e o r e t i c a l approaches a v a i l a b l e
t o p o l i c j ' makers i n c l u d i n g t h e e l a s t i c i t i e s approach, t h e a b s o r p t i o n
approach and t h e monetary approach.
not e x c l u s i v e l y i n t h e c o n t e x t
To t h e s e , and - o a r t i c u l a r l y though
of developing
c o u n t r i e s , may be added t h e
s t r u c t u r a l approach.'
A l t h o u g h t h e r e i s a l a r g e and gro^n-ng l i t e r a t u r e Trhich d e a l s - r i t h these
v a r i o u s approaches i n i s o l a t i o n t h e r e i s a s c a r c i t y o f work ^'hich
compares, e v a l u a t e s , and indeed attempts t o i n t e g r a t e t h e a l t e r n a t i v e
approaches.
The problem o f c h o o s i n g t h e a p p r o p r i a t e
p o l i c y or p o l i c i e s
i s made more d i f f i c u l t by t h e f a c t t h a t t h e t h e o r i e s d i f f e r n o t o n l y
i n terras o f emphasis o r t h e q u a n t i t a t i v e importance a t t a c h e d
to certain
r e l a t i o n s h i p s - though d i f f e r e n c e s o f t h i s k i n d do e x i s t - b u t a l s o
i n terms o f t h e d i r e c t i o n a l o r f n a l i t a t i v e r e l a t i o n s h i p s im^^lied
between v a r i a b l e s .
for
These d i f f e r e n c e s can be q u i t e f u n d a m e n t a l .
example, a c c o r d i n g
to the conventional
absorption
Thus,
approach r i s i n g
n a t i o n a l income tends t o be a s s o c i a t e d v/ith a d e t e r i o r a t i o n i n t h e
b a l a n c e o f pa5n:aentc, T / h i l e a c c o r d i n g
result m
t o t h e monetary approach i t w i l l
a b a l a n c e o f pa',nT\ents improvement."
1. T h i s paper c o n s t i t u t e s a c h a p t e r o f a p r o j e c t e n t i t l e d The ITIF
and Economic Management i n P o v e l o p i n g C o u n t r i e s based a t ODI i n
London, I t i s t h e r e f o r e d e s i g n e d t o be r e a d n o t i n i s o l a t i o n b u t
i n conjunction w i t h the other chapters.
P a r t i c u l a r l y relevant
are Chanters 3 and 6.
2
T h i r l w a l l (10^0) has, f o r i n s t a n c e , p r o v i d e d a w e l l reasoned and
l a r g e l y s t r u c t u r a l e x p l a n a t i o n o f b a l a n c e o f pa^rments problems
i n t h e Units^I Kingdom.
3
To be more p r e c i s e t h e a b s o r p t i o n approach p r e d i c t s t h a t economic
groT/'th w i l l l e a d t o a d e t e r i o r a t i o n i n t h e c u r r e n t a c c o u n t ,
s h o u l d t h e c a p i t a l account improve s u f f i c i e n t l y t h e o v e r a l l
b a l a n c e o f pajnnents may improve and t h e p r e d i c t i o n s o f t h e two
t h e o r i e s may b,e r e c o n c i l e d . The monetary approach, as w i l l be
seen l a t e r , does n o t see any s i g n i f i c a n c e i n t h e d i s t i n c t i o n
between t h e c u r r e n t and c a p i t a l a c c o u n t s .
The purpose of t h i s chapter
integrating exercise.
context
i s n o t , hoTTever, t o p e r f o r m such a
Much l e s s a m b i t i o u s l y i t s e t s o u t , i n the
of the d i f f e r e n t t l i e o r e t i c a l models,, to examine the v a r i o t i s
p o l i c y options
t h a t are a v a i l a b l e t o d e v e l o p i n g
t o a c h i e v e b a l a n c e of payinents e t n i i l i b r i u n .
c o u n t r i e s i n attempts
The p o l i c i e s
include
d e v a l u a t i o n , dei-iand management, and c o n t r o l s of v a r i o u s t y p e s , a l l
o f w h i c h have f r e q u e n t l y f e a t u r e d i n TIF programiaes, e i t h e r i n terms
of t h e i r encouragement or discouragement.
P r i o r to t h i s
examination,
S e c t i o n I reminds us of some of the d e f i n i t i o n a l problems a s s o c i a t e d
w i t h the b a l a n c e of pa^teients^ and
r e l a t e s b a l a n c e of pa'VT'ients concepts
to the v a r i o u s t h e o r i e s , w h i l e S e c t i o n I I examanes the
nature
of the p o l i c y problem..
The
chapter
underlying
s e t s out t o p r o v i d e
t L e o r c t i c a l and e m p i r i c a l backdrop to subsequent c h a p t e r s
i n v e s t i g a t e the
TIF•.•3
i.nvolvenent w i t h
pajTients
policy in
a
which
developing
countries.
A
Pee Chapter n, I C i l l i c k (1?«1), f o r d e t a i l s of the c o n t e n t s of
Fund programmes, see a l s o Reichmann (1:'7C) and Ileichmann and
D t i l l s o n (1P7G).
5
These were e x p l a i n e d and d i s c u s s e d
i n Chapter 2, K i l l i c k (I'^^O).
I
DEFHIITIONf; AND T1IE05ETIG.AL COmiTEPPASTS
As n o t e d i n Chapter 2, o v e r a l l t h e b a l a n c e o f na^TTients always
balances.
in nature.
Pay.".ents problems
are therefore e s s e n t i a l l y compositional
The b a l a n c e o f ^-a^iTnents i s u s u a l l y d i v i d e d i n t o the c u r r e n t
account and t h e c a p i t a l a c c o u n t , T-rith t h e l a t t e r Veinp s u b d i v i d e d i n t o
l o n g term and s h o r t term a c c o u n t s .
D i f f e r e n t t h e o r i e s tend t o f o c u s
on d i f f e r e n t cortnonents o f t h e b a l a n c e o f payments.
The e l a s t i c i t i e s
approach, f o r example, f o c u s o e s on t h e c u r r e n t a c c o u n t , where changes
i n r e l a t i v e p r i c e s e x e r t th.eir impact on t h e f l o v ; o f goods and s e r v i c e s .
Emphasis i s p l a c e d on t h e shape o f t h e demand and s u p p l y s c h e d u l e s
f o r f o r e i g n exchange ^^ithput much, a t t e n t i o n b e i n g g i v e n t o t h e e f f e c t
t h a t p o l i c i e s such as d e v a l u a t i o n may have on t h e l o c a t i o n o f t h e
schedules.
To a s i g n i f i c a n t though perhaps l e s s e r e x t e n t the a b s o r p t i o n
approach a l s o emphasises
t h e c u r r e n t account c o n c e n t r a t i n g on t h e
r e l a t i o n s h i p between incosie and i m p o r t e d goods and s e r v i c e s ,
though
i n t h i s c a s e a t t e n t i o n i s f o c u s s e d on t h e l o c a t i o n o f t h e demand and
s u p p l y s c h e d u l e s f o r f o r e i g n exchange r a t h e r t h a n t h e i r
elasticities.
The s t r u c t u r a l approach h i g h l i g h t s t h e d i s t i n c t i o n between t r a d e and
c a p i t a l f l o f ' s , paying p a r t i c u l a r a t t e n t i o n t o the s t r u c t u r e of production
and t r a d e .
I n sharp c o n t r a s t , the monetary approach s t r e s s e s the
i r r e l e v a n c e o f decomposing t h e b a l a n c e o f payments and t h e r e f o r e makes
l i t t l e d i s t i n c t i o n between t h e c u r r e n t and c a p i t a l a c c o u n t s .
The
monetar]'' approach does n o t c o n c e r n i t s e l f w i t ' i such p a r t i a l b a l a n c e s
^.Thich
are l e f t l a r g e l y unexplained.
f l o w s , w h i c h under o t h e r approaches
become t h e c e n t r e o f a t t e n t i o n .
Under t h i s approach
have an o n l y minor
'accommodating'
significance,
The b a l a n c e o f pa3nnents
i s seen a s
r e f l e c t i n g t h e i n t e r a c t i o n between t h e demand f o r and s u p p l y o f money
w i t h r e s e r v e changes b e i n g t h e m.eans b y w h i c h monetary e q u i l i b r i u m i s
maintained.
The monetary approach i s then b o t h broad and narrow.
I t i s broad i n t e r a s o f t h e l e v e l o f a g g r e g a t i o n used
b u t i s narrov/
i n terms o f i t s i d e n t i f i c a t i o n o f t h e causes o f b a l a n c e o f pajtrients
problems.
From t h e vieT<Tpo5.nt o f most p o l i c y makers i n d e v e l o p i n g c o u n t r i e s
the l a c k o f conern over t h e c o m p o s i t i o n o f t h e b a l a n c e o f payments
may b e a weakness o f t h e monetary approach.
To them t h e d i s t i n c t i o n
betvjeen t h e c u r r e n t and c a p i t a l a c c o u n t s i s a v a l i d and u s e f u l one i.n
assessinn; the f o r e i g n exchange gap, r e q u i r e d c a p i t a l
inflotvs,
i n d e b t e d n e s s , debt s e r v i c e r a t i o s , and the c a p a c i t y f o r economic
growth and s t r u c t u r a l cliange w i t h i n the economy.
v l l i i l e s t r o n g l : ' i n f l u e n c e d by the monetary approach the E i T i s n o t
i n d i f f e r e n t about the c o m p o s i t i o n o f the b a l a n c e o f payments.
The
Fund has s e t s p e c i f i c t a r g e t s f o r t h e c u r r a n t and b a s i c b a l a n c e s i n
i t s programmes as w e l l as imposing l i m i t s on the e x t e n t t o w h i c h
c o u n t r i e s may
take on a d d i t i o n a l d e b t , (see Chapter 6 ) .
I t i s primarily
concerned ^ d t h e n c o u r a g i n g c o u n t r i e s t o a c h i e v e a ' v i a b l e ' b a l a n c e
o f payments whereby any c u r r e n t account d e f i c i t may be f i n a n c e d
'on
a s u s t a i n a b l e b a s i s , by net c a p i t a l i n f l o w s on terms t h a t a r e c o m p a t i b l e
T<rith the development and growth p r o s p e c t s o f the c o u n t r y ' ( G u i t i a n
1980).
^ f i t h i n the c a p i t a l account the Fund t a k e s i n t o c o n s i d e r a t i o n
the a v a i l a b i l i t y o f b o t h l o n g term and s h o r t term c a p i t a l i n f l o w s .
II
TIIE IIATURE OF TliK POLICY PB.OBLEJ*
The b a s l a p o l i c y c h o i c e between a d j u s t n e n t and f i n a n c i n g
In p r i n c i p l e , a paytaents d e f i c i t may i n i t i a l l y e i t h e r be f i n a n c e d
by r u n n i n g do^m d o m a s t i c ^ l l y h e l d i n t e r n a t i o n a l r e s e r v e s and by
i n t e r n a t i o n a l b o r r o w i n g o r be c o r r e c t e d through t h e p u r s u i t o f
adjusttient p o l i c i e s ,
' ^ l i i l s t f i n a n c i n g i s a p p r o p r i a t e when t h e
d e f i c i t i s t r a n s i t o r y i t i s i n a p p r o p r i a t e as an e x c l u s i v e p o l i c y
when t h e d e f i c i t i s p e r s i s t e n t and r e f l e c t s fundamental d i s e q u i l i b r i u m ;
i n t h i s circumstance f i n a n c i n g c o n s t i t u t e s only a short t e r m . p a l l i a t i v e
and adjustment i s a l s o r e q u i r e d .
F i n a n c i n g and adjustment a r e , o f
c o u r s e , by no means m u t u a l l y e x c l u s i v e and i t i s l i k e l y t h a t a
c o m b i n a t i o n o f them w i l l be pursued.
The g r e a t e r t h e degree o f
f i n a n c i n g t h e l e s s r a p i d need be t h e r a t e o f adjustment.
The economic t h e o r y u n d e r l y i n g the c h o i c e o f t h e c o m b i n a t i o n o f
f i n a n c i n g and adjustment speed has been developed
(see,
i n the l i t e r a t u r e
f o r example, C l a r k (1970) and b i r d (ID'^O) and has been
summarised by ' T i l l i a n s o n (1973) and by B i r d (l'^78).
In b r i e f the
optimum c o m b i n a t i o n o f f i n a n c i n g and adjustment ' n i l be a c h i e v e d
where t h e m a r g i n a l r a t e o f s u b s t i t u t i o n between c u r r e n t and f u t u r e
expenditure equals t h e i r marginal r a t e of t r a n s f o r m a t i o n .
d e f i c i t o f s i m i l a r s i z e t h i s may n o t l e a d t o t h e same
of p o l i c i e s i n an I d c as i t would i n a developed
Idcs encounter
Given a
combination
country.
Eince
r e l a t i v e l y high f i n a n c i n g c o s t s , other things being
e q u a l , they w i l l be encouraged t o make r e l a t i v e l y g r e a t e r use o f
adjustment.
On t h e o t h e r hand, i f t h e s o c i a l m a r g i n a l p r o d u c t i v i t y
of r e s o u r c e s i s h i g h e r i n I d c s t h i s w i l l a c t t o reduce t h e n e t c o s t s
a s s o c i a t e d x d t h f i n a n c i n g and t i i l l t h e r e f o r e encourage them t o make
g r e a t e r use o f i t j t h i s w i l l a l s o be t h e case i f Idcs possess a
r e l a t i v e l y strong preference f o r current expenditure.
HoTiever I d c s may be p r e c l u d e d from u s i n g t h e i r
theoretically
optimui'a c o m b i n a t i o n o f f i n a n c i n g and adjustment by the e x i s t e i i c e
of a c o n s t r a i n t on t h e a v a i l a b i l i t y / o f f i n a n c e and they may t h e r e f o r e
be f o r c e d t o a d j u s t more r a p i d l y than t h e y would w i s h .
Case s t u d y
e v i d e n c e c o l l e c t e d by D e l l and Lawrence (1980) i s r e l e v a n t here
s i n c e i t does seem t o c o n f i n i i t h a t t h e speed and c o s t o f adjustment
aire i n v e r s e l y r e l a t e d t o t h e a v a i l a b i l i t y o f i n t e r n a t i o n a l f i n a n c e .
F u r t h e r m o r e , t h e r u d i m e n t a r y n a t u r e o f f i n a n c i a l system.s and tbie
l a r g e p e r c e i v e d u n c e r t a i n t y i n most Idcs does n o t e a s i l y
permit
monetary p o l i c y t o be used as a means o f i n d u c i n g c a p i t a l i n f l o w s
to
o f f s e t c u r r e n t account d e f i c i t s .
o f t h e IlfF i s i n t r i g u i n g .
I n t h i s context the p o s i t i o n
On t h e one hand t h e Fund p r o v i d e s an
a d d i t i o n a l source o f f i n a n c e and t h e r e f o r e , i n p r i n c i p l e , e n a b l e s
c o u n t r i e s t o d e f e r a d j u s t m e n t ; a t t h e same t i m e , however, a p r o p o r t i o n
of i t s resources
a r e a v a i l a b l e o n l y on c o n d i t i o n t h a t a s u i t a b l e
adjustment s t r a t e g y i s approved and p u t i n t o e f f e c t .
As r e p o r t e d i n
c h a p t e r 5, t h e r e i s e v i d e n c e t o suggest t h a t such c o n d i t i o n a l i t y
d e t e r r e d I d c s fros? making drawings on t h e Fund d u r i n g t h e 1970s.
This
r e l u c t a n c e may r e f l e c t : the b e l i e f e i t h e r t h a t the speed o f adjustm.ent
being requested
by t h e Fund i s t o o r a p i d , g i v e n the o t h e r macroeconor.ic
p o l i c y o b j e c t i v e s t h a t a c o u n t r y may have, o r t h a t t h e s p e c i f i c
adjusti^ient p o l i c i e s favoured
by t h e HrF a r e regarded as i n a p p r o p r i a t e .
I n e i t h e r c a s e , t h e c o u n t r i e s concerned w i l l T^here p o s s i b l e tend t o o p t
for
a l t e r n a t i v e s o u r c e s o f f i n a n c e and f o r a slower
d i f f e r e n t p a t t e r n of adjustment.
speed, o r a
I f o t h e r sources o f i n t e r n a t i o n a l
f i n a n c e a r e u n a v a i l a b l e t h e o p t i o n o f a slower r a t e o f adjustment i s
f o r f e i t e d - indeed w i t h o u t Fvmd f i n a n c e t h e speed o f adjustment w i l l ,
i n p r i n c i p l e , have t o be even more r a p i d t h a n i t would be w i t h i t and
t h e o n l y b e n e f i t from r e j e c t i n g t h e Fund as a source o f f i n a n c e
w i l l be f e l t i n terras o f t h e freedom o f c h o i c e w i t h r e s p e c t t o t h e
n a t u r e o f t h e c o r r e c t i v e p o l i c i e s adopted.
may be a v o i d e d
i s illusory.
Any b e l i e f t h a t a d j u s t m e n t
C o u n t r i e s w h i c h postpone payments c o r r e c t i o n
w i l l e v e n t u a l l y be f o r c e d t o adopt p o l i c i e s w h i c h a r e l i k e l y t o have
a high welfare
The
cost.
o b j e c t i v e s and c o s t s o f a d j u s t m e n t
I t i s one o f t h e i n e s c a p a b l e a s p e c t s o f b a l a n c e o f payraents t h e o r y
that
i n a s i t u a t i o n where r e a l d o m e s t i c o u t p u t cannot be i n c r e a s e d t h e
c o r r e c t i o n of a d e f i c i t e n t a i l s a r e d u c t i o n i n domestic a b s o r p t i o n
i,e.
consumption and/or i n v e s t m e n t .
T h i s w i l l be t h e case even i f
the dem.and by f o r e i g n e r s f o r d o m e s t i c o u t p u t r i s e s , s i n c e t h i s
demand may be met, i n c o n d i t i o n s o f low s h o r t r u n s u p p l y
only i f the resources
Greater
elasticity
dem-anded by f o r e i g n e r s a r e f r e e d by r e s i d e n t s .
a b s o r p t i o n o f d o m e s t i c and f o r e i g n o u t p u t by f o r e i g n e r s
c l e a r l y involver. Iblsrer a b s o r p t i o n o f domestic and f o r e i g n
by r e s i d e n t s .
I r r e s p e c t i v e o f whether t h e i n i t i a l
b a l a n c e o f payments p o l i c y i s t o reduce domestic
output
impact o f any
expenditure or
t o s'.'itch e x p e n d i t u r e from abroad, c o r r e c t i o n o f the d e f i c i t w i l l ,
i n these c i r c u m s t a n c e s be a c h i e v e d o n l y i f t h e r e i s a r e d u c t i o n i n
r e a l domestic e x p e n d i t u r e .
I f t h i s r e d u c t i o n i n dom.estic
i s n o t a c h i e v e d , t h e d e f i c i t w i l l n o t be c o r r e c t e d .
domestic
output can be i n c r e a s e d i t i s m i s g u i d e d
expenditure
Thus u n l e s s
t o imagine
that the
c o r r e c t i o n o f a b a l a n c e o f payments d e f i c i t may i n some sense be c o s t l e s s ,
A r e d u c t i o n i n dop.estic expen('.iture may be a c h i e v e d by means o f
p u r s u i n g a range o f ' e x p e n d i t u r e r e d u c i n g ' p o l i c i e s such as c o n t r a c t i o n a r y
monetary and f i s c a l p o l i c y T.'hich, Vy l o w e r i n g d o m e s t i c
income, s e r v e t o
reduce e x p e n d i t u r e on a l l goods, t r a d e d and n o n - t r a d e d .
The p r e a t e r t h e
income e l a s t i c i t y o f demand f o r t r a d e d goods, t h e s m a l l e r w i l l be t h e
fall
i n income t h a t i s needed i n o r d e r t o b r i n g about the r e q u i r e d f a l l
i n payments t o f o r e i g n e r s . E x p e n d i t u r e - r e d u c i n g p o l i c i e s , i n as much
as they reduce the demand f o r i m p o r t s , can be s u f f i c i e n t on t h e i r ox-m
to
correct a d e f i c i t .
I n a d d i t i o n , and t o t h e e x t e n t t h a t e x p e n d i t u r e -
r e d u c i n g p o l i c i e s a l s o induce a f a l l
i n the p r i c e o f d o m e s t i c a l l y
produced goods, they w i l l encourage a s w i t c h i n domestic
e x p e n d i t u r e away from f o r e i g n output and towards domestic
and f o r e i g n
output.
The r e s o u r c e s n e c e s s a r y t o meet t h i s e x t r a demand f o r domestic
'.Ti.ll
output
have been f r e e d by t h e r e d u c t i o n i n domestic e x p e n d i t u r e , p r o v i d e d
only that the expenditure reductions a f f e c t
e x c l u s i v e l y non-traded
goods.
t r a d e d goods and n o t
However, i n t h e case o f I d c s t h e r e xa^.y
be a low degree o f s u b s t i t u t a b i l i t y betr^een e x p o r t goods, import goods
and non t r a d e d goods; demand r e d u c t i o n may t h e r e f o r e n o t i m m e d i a t e l y
r e l e a s e e:q)ortable output i n Idcs where t h e p a t t e r n o f e x p o r t s does
n o t match t h a t o f domestic
o f adjustment
absorption.
T h i s w i l l slow do\m t h e p r o c e s s
s i n c e changes i n the s e c t o r a l p a t t e r n o f o u t p u t w i l l be
r e q u i r e d from t h e non t r a d e d goods t o t r a d e d goods s e c t o r s .
A t r a n s f e r o f ejcpenditure from r e s i d e n t s t o f o r e i g n e r s i s more
c o n v e n t i o n a l l y e n g i n e e r e d by means o f ' e x p e n d i t u r e - s w i t c h i n g ' p o l i c i e s
such as d e v a l u a t i o n , w h i c h a r e d e s i g n e d t o lower t h e i n c e n t i v e f o r
r e s i d e n t s t o buy f o r e i g n goods and r a i s e t h e i n c e n t i v e f o r b o t h
r e s i d e n t s and f o r e i g n e r s t o buy domestic
goods.
Such a s w i t c h i n
r e a l e x p e n d i t u r e may be encouraged by changing
domestic
the p r i c e of
output r e l r t i v e t o t h a t o f forfesign o u t p u t .
Unlike expenditure-
r e d u c i n g p o l i c i e s , hoxrever, e x p e n d i t u r e - s ' E t c h i n g p o l i c i e s on t h e i r
oT.Ti may be i n s u f f i c i e n t t o c o r r e c t a d e f i c i t .
Although, i n conditions
where t h e r e i s u s a b l e spare c a p a c i t y the a d d i t i o n a l demand f o r e x p o r t s
and import
s u b s t i t u t e s induced by a f a l l i n t h e r e l a t i v e p r i c 6 o f
domestic o u t p u t may be n e t i n r s a l term!| i n c o n d i t i o n s o f f u l l capacity;'
u t i l i s a t i o n any e x t r a demand c r e a t e d by t h e e x p e n d i t u r e - s w i t c h i n g
p o l i c i e s w i l l s i m p l y generate
i n f l a t i o n , unless action Is simultaneously
t a k e n t o f r e e t h e r e s o u r c e s needed t o meet t h e e x t r a demand.
as x d l l be seen l a t e r e 3 r p e n d i t u t e - s \ r i t c h i n g p o l i c i e s may
be
Hot-rever,
themselves
demand-deflationary.
A c c o r d i n g t o t h a monetary tirsproach, a paj'nents d e f i c i t w i l l be
c o r r e c t e d o n l y i f t h e monetary d i s e q u i l i b r i u m , a s s o c i a t e d w i t h i t i s
also corrected.
This n e c e s s i t a t e s e i t h e r a r e d u c t i o n i n the r e a l
s u p p l y o f money o r a r i f e i n tVie r e a l demand f o r money.
A fall in
t h e r e a l sui)ply o f money may be b r o u g h t about e i t h e r by a f a l l i n t h e
nominal
s u p p l y o f mone^ o r by a r i s e i n t h e General p r i c e l e v e l ,
A r i s e i n t h e r e a l demand f o r money may be brought about through a r i s e
i n t h e l e v e l o f r e a l n a t i o n a l income o r throuph a s t r e n g t h e n i n g i n
any p r e f e r e n c e f o r money as opposed t o o t h e r a s s e t s .
The monetary approach thus concurs w i t h t h e a b s o r p t i o n approach t h a t
u n l e s s r e a l Income i s r i s i n g f a s t enough t o induce an adequate i n c r e a s e
in
t h e r e a l demand f o r raoney the d e f l a t i o n a r y i m p l i c a t i o n s o f a d e f i c i t
w i l l have t o be a c c e p t e d i f t h e b a l a n c e o f pajnaents i s t o be improved.
I t emerges t h a t any government s e t t i n g o u t t o f/Ckieve payments
adjustment a t z e r o c o s t i s l i k e l y t o be t h w a r t e d i n a l l b u t l i m i t e d
circumstances.
Af C r o c k e t t (1981) observes
'bialance o f payments
e q u i l i b r i u m is a c o n s t r a i n t w h i c h cannot be escaped, even i f i t s
achievement r e q u i r e s s a c r i f i c e s i n terms o f economic development'.
The more a p p r o p r i a t e o b j e c t i v e o f p o l i c y makers i s t o a c h i e v e a
specified
improvement i n t h e b a l a n c e o f payments a t minimum c o s t
and w i t h an accept«ible d i s t r i b u t i o n o f t h i s c o s t .
I t i s n o t enough
t h a t p o l i c i e s s h o u l d T?ork i n t h e narrow sen.«e o f r e d u c i n g t h e
d e f i c i t ; they s h o u l d do t h i s w h i l e i m p o s i n g t h e l e a s t p o s s i b l e
damage ori economic growth, enplojA^.ent and income d i s t r i b u t i o n .
In
p r a c t i c e i t i s a t t h i s j u n c t u r e t h a t d i s a g r e e i a e n t over b a l a n c e of
payinents p o l i c y tends t o a r i s e /
The causes of b a l a n c e of pa^'vients d i s e q u i l i b r i u m
In
o r d e r t o a s s e s s the a p p r o p r i a t e n e s s of a l t e r n a t i v e p o l i c y measures
i t i s c l e a r l y i m p o r t a n t f o r p o l i c y makers t o know something
causes of the problem.
about the
As w i l l be seen l a t e r t h i s i s not t o argue
t h a t p o l i c i e s u n r e l a t e d t o the fundamental
causes w i l l f a i l t o work
i n the narrow sense o f i i s p r o v i n g the b a l a n c e o f payments but s i m p l y
t h a t they may
not be tb.e most a p p r o p r i a t e ones.
F o r ti'.e purpose o f c l a s s i f i c a t i o n the causes of d i s e q u i l i b r i a may
be
d i v i d e d i n t o those t h a t a r e , i n e s s e n c e , endogenous t o the i n d i v i d u a l
c o u n t r y and those t h a t are exogenous.
Alternatively a distinction
be dravm between those causes t h a t r e l a t e t o the s t r u c t u r a l
of
may
characteristics
t h e economy and impinge mainly' on s u p p l y , and those t h a t r e l a t e t o
domestic a b s o r p t i o n o r f i n a n c i a l p o l i c y and impinge m a i n l y on demand.
S t r u c t u r a l : e x p o r t i n s t a b i l i t y and terms of t r a d e . ^
Structural
causes b a s i c a l l y r e l a t e
t o the
tyne and
n a t u r e of non
and, i n p a r t i c u l a r , t r a d e d goods and the e f f i c i e n c y w i t h w h i c h
are produced.
Two
traded
these
c e n t r a l a s p e c t s of the s t r u c t u r a l e x p l a n a t i o n of
b a l a n c e of pa-/ments d i s e q u i l i b r i a i n I d c s are f i r s t , commodity
i n s t a b i l i t y and the a s s o c i a t e d i n s t a b i l i t y of e x p o r t r e c e i p t s
and
iiaport pa^^Tuents, and second, adverse movements i n the terras o f t r a d e .
E x p o r t i n s t a b i l i t y comprises b o t h v a r i a t i o n s i n the p r i c e s of p r i m a r y
c o i a r i o d i t i e s , and the l e v e l of e x p o r t c o n c e n t r a t i o n on these p r o d u c t ^ .
Evidence does seem t o c o n f i r m t h a t many p r i m a r y p r o d u c t s are s u b j e c t t o
a h i g h degree of i n s t a b i l i t y , and t h a t a p e c u l i a r f e a t u r e of I d c s i s
t h e i r r e l a t i v e l y h i g h degree of e x p o r t c o n c e n t r a t i o n on a few p r i m a r y
products.
F u r t h e r m o r e , a l t h o u g h the p r e c i s e d e t a i l s depend on the
p a r t i c u l a r i n s t a b i l i t y i n d e x used and the c o u n t r i e s and time p e r i o d
s t u d i e d , I d c s , as a group, g e n e r a l l y do seem t o encounter g r e a t e r
i n s t a b i l i t y i n t h e i r e x p o r t e a r n i n g s than do developed
countries.
6
A g a i n C r o c k e t t (1981 ) argues t h a t 'the c h o i c e of demand management
measures w i l l be the p r i n c i p a l f a c t o r d e t e r r a i n i n g the t r a n s i t i o n a l
l o s s o f output i n v o l v e d i n a s t a b i l i s a t i o n programme,'
7
T h i s s e c t i o n draws h e a v i l y on Chapters 3 and 4 o f B i r d (1978)
w h i c h c o n t a i n s a much f u l l e r e x p o s i t i o n o f the i s s u e s r a i s e d h e r e .
and, as a r e s u l t , t l i e i r b a l a n c e o f pa^ir'.ents tends t o be r e l a t i v e l y
unstable.
T u r n i n g t o t r e n d s i n the terms o f t r a d e t h e r e i s a commonly h e l d
b e l i e f t h a t those o f I d c s have been s u b j e c t t o a l o n g r u n d e t a r i . o r a t i o n
r e f l e c t i n g the f a c t that on balance Idcs are e x p o r t e r s of primary
p r o d u c t s and i m p o r t e r s o f manufactured
f i n a l goods, and t l i a t p r i m a r y
p r o d u c t p r i c e s have f a l l e n r e l a t i v e t o those o f manufactured
goods.
Such a f a l l c o u l d be generated by d i f f e r e n t i a l income e l a s t i c i t i e s
of
demand f o r p r i m a r " and manufactured
goods,
3y assuming t h a t t h e
income e l a s t i c i t y o f demand f o r ) i a n u f a c t u r e 3 i.s g r e a t e r than, t h e income
e l a s t i c i t y o f demand f o r p r i m a r y p r o d u c t s , i t mj.glit be a n t i c i p a t e d
t h a t , o t h e r t h i n g s b e i n g c o n s t a n t , t h e p r i c e s o f manufactured
would r i s e f a s t e r than the p r i c e s o f prim^ary commoditiea
of
goods
i n t h e wake
TTorid i n c o n e growth, a l t h o u g h t o some e x t e n t , t h e d i f f e r e n t i a l
e f f e c t s o f TTorld income growth o n t ' e p r i c e s o f p r i m a r y
and n a n u f a c t u r e d goods mav be tem'-ered by d i f f e r e n t i a l
. . .
commodities
price
*2
elasticities. '
S i n c e n o s t I d c s e x e r t l i t t l e c o n t r o l o v e r e i t h e r t h e demand o r
s u p p l y d e t e r m i n a n t s o f t h e i r comraodity terr.'/f. o f t r a d e these
become a l a r g e l y exogenous v a r i a b l e i n the s h o r t r u n .
Furthermore
s i n c e d i f f e r e n t i a l movements i.n the terms o f t r a d e
amongst I d c s r e f l e c t t h e d i f f e r e n t commodity c o m p o s i t i o n o f t h e i r
e x p o r t s and i m p o r t s and the d i f f e r e n t i a l p r i c e movements o f these
commodities
fail
i t vAyXit be a n t i c i p a t e d t h a t e m p i r i c a l e v i d e n c e v/ould
t o p r o v i d e an unambiguous p i c t u r e .
P i r d (1979) r e p o r t s j u s t
such a n b i ' p j i t y , w i t h s i g n i f i c a n t v a r i a t i o n s t o be found
g Tliere i s a l a r g e l i t e r a t u r e on a l l a s p e c t s o f ejq-ort i n s t a b i l i t y .
B o t h the t h e o r y and e v i d e n c e r e l a t i n g t o e x p o r t i n s t a b i l i t y has
been r e v i e w e d iaore f u l l y by t h e a u t h o r e l s e w h e r e , see B i r d ( 1 9 7 8 ) .
Some d i s c u s s i o n i s a l s o und&rtaken i n Chapter 2 o f t h i s book.. Tlie
t r e a t m e n t g i v e n here i s t h e r e f o r e c o r r e s p o n d i n g l y c u r s o r y ; t h e
r e l a t i v e l y s m a l l amount o f space devoted t o t h e t o p i c s h o u l d n o t
however be i n t e r p r e t e d as i m p l y i n g t h a t i t i s r e l a t i v e l y
unimportant.
9 F o r t h i s t o be p o s s i b l e , hox^ever, t h e income e l a s t i c i t y o f demand
f o r p r i m a r y p r o d u c t s would have t o be p o s i t i v e .
depending on t h e p a r t i c u l a r terms o f t r a d e measure used, and
c o u n t r i e s , commodities and time p e r i o d s s t u d i e d .
The c o n c l u s i o n
i s r e a c h e d , however, t h a t a s u b s t a n t i a l number of Idcs have e x p e r i e n c e d
adverse movements i n t h e i r coi;im.odity terras o f t r a d e .
of
The i m p l i c a t i o n s
t h i s f o r t h e i r balance of pay.Tnents depends on t h e p a r t i c u l a r
c o n f i g u r a t i o n o f the d e t e r i o r a t i o n as w e l l as on the v a l u e s o f f o r e i g n
trade e l a s t i c i t i e s ,
b r o a d l y s p e a k i n g where i m p o r t and e x p o r t demand
i s p r i c e i n e l a s t i c a d e t e r i o r a t i o n i n t h e commodity terms o f t r a d e
w i l l be t r a n s l a t e d i n t o a d e t e r i o r a t i o n i n t h e b a l a n c e of payments.
As f a r as p r i c e e l a s t i c i t i e s a r e concerned
evidence confirms t h a t
v e r y much hangs on t h e p a r t i c u l a r commodity i n v o l v e d though i t does
seem t o be t h e case t h a t t h e p r i c e o l a s t i t i t y
i n t o developed
o f demand f o r i m p o r t s
c o u n t r i e s becomes g r e a t e r t h e l e s s 'crude' and the
more p r o c e s s e d a r e the i m p o r t s .
Given that Idcs' exports are l a r g e l y
made UP o f 'crude' comiaodities i t might be concluded t h a t t h e i r e x p o r t
p r i c e e l a s t i c i t i e s v ; i l l be r e l a t i v e l y low. Flian (197''') c o n f i r m s the
e x i s t e n c e of p r i c e i n e l a s t i c demand f o r e x p o r t s , f i n d i n g
elasticity
to be g r e a t e r than 1 f o r o n l y f o u r of t h e f i f t e e n Idcs he s t u d i e d .
However, he a l s o d i s c o v e r e d t h e o f t e n assumed p r i c e i n e l a s t i c i t y of
demand f o r I d c s ' imports t o be l a r g e l y unfounded.
e l a s t i c i t y vras one o r more.
For t e n Idcs p r i c e
I n a d d i t i o n t o h a v i n g an i n d i r e c t e f f e c t
on p r i c e s t h e income e l a s t i c i t y of demand f o r e x p o r t s w i l l have a
d i r e c t e f f e c t on the income terrasof t r a d e .
Indeed
some s t r u c t u r a l i s t s
argue t h a t i t i s d i f f e r e n c e s between t h e income e l a s t i c i t y ' o f demand
for
e x p o r t s and t h a t f o r i m p o r t s t h a t i s a t t h e h e a r t o f I d c s '
payments problems.
T h i s v ; i l l have an i m p o r t a n t b e a r i n g on t h e p o t e n t i a l
success o f adjustment p o l i c i e s such as d e v a l u a t i o n aimed a t a l t e r i n g
relative prices.
Though r e l a t i v e l y h i g h p r i c e e l a s t i c i t i e s maybe a
n e c e s s a r y c o n d i t i o n f o r b a l a n c e o f payraicnts improvement t h e y may n o t
be s u f f i c i e n t .
Resources
need t o be s h i f t e d i n t o p r o d u c i n g goods f o r
which t h e income e l a s t i c i t y of demand i s a l s o r e l a t i v e l y h i g h .
E v i d e n c e suggests t h a t w i t h few e x c e n t i o n s the income e l a s t i c i t y o f
demand f o r I d c s e x p o r t s i s g e n e r a l l y l e s s , and o f t e n c o n s i d e r a b l y l e s s
than one, and t h a t i t i s r a t h e r below t h e incop.e e l a s t i c i t y o f demand
for
10
i m p o r t s , ^'^
See B i r d (1970) f o r f u l l e r d i s c u s s i o n and a t t r i b u t i o n o f t h e
evidence.
Other s t r u c t u r a l
causes
A t t e m r t s t o a l t e r the s t r u c t u r e of p r o d u c t i o n and t r a d e no as t o
remedy any s e c u l a r d e t e r i o r a t i o n i n the b a l a n c e of payments or t o
reduce i t s v u l n e r a b i l i t y t o e x o " e n o u s l y ~ p e n e r a t e d i n s t a b i l i t i e s
r e s u l t i n g from s h o r t f a l l s i n e x p o r t demand or s u p p l y v i c i s s i t u d e s
are l i k e l y t o be hampered by the low degree o f s t r u c t u r a l m o b i l i t y
t h a t i s u s u a l l y a s s o c i a t e d w i t h I d c s ; added t o w h i c h t r a d i n g p a t t e r n s
may r e f l e c t w e l l d e f i n e d h i s t o r i c a l and p o l i t i c a l t i e s w h i c h a r e
d i f f i c u l t t o break and w h i c h may y i e l d o t h e r b e n e f i t s f o r the c o u n t r i e s
concerned.
Even where such changes can be a c h i e v e d i t i s u n l i k e l y
t h a t t h e y ' ^ d l l be brought about d u r i n g a s h o r t time span except i n
a m i n o r i t y o f c a s e s , and even X7here a s h i f t away from the p r o d u c t i o n
of p r i m a r y p r o d u c t s and towards the p r o d u c t i o n o f manufactures i s
a c h i e v e d , i t may n o t a u t o m a t i c a l l y irtftrove t h e b a l a n c e o f payments,
vrtiether i t does depends c r u c i a l l y on the e f f i c i e n c y w i t h w h i c h the
goods a r e produced.
i J l i i l e many of t h a newly i n d u s t r i a l i s i n g
(HICs) have demonstrated c o n s i d e r a b l e a b i l i t y t o produce
countries
competitively
and t o reap t h e b e n e f i t s i n terms o f t h e i r b a l a n c e o f payments, t h i s
need n o t always be the c a s e .
O t h e r d o m e s t i c s t r u c t u r a l weaknesses may
g e n e r a t e payments d i f f i c u l t i e s .
F r e q u e n t l y s i n g l e d out a r e d e f i c i e n c a s i n the f i s c a l system t h a t
encourage a m i s a l l o c a t i o n of r e s o u r c e s , f o r example between a g r i c u l t u r a l
and i n d u s t r i a l s e c t o r s , exchange
c o n t r o l s t h a t encourage h i g h c o s t
import s u b s t i t u t i o n and p e n a l i s e e x p o r t s , and t h e a c t i v i t i e s o f
m u l t i n a t i o n a l s w h i c h t h r o u g h the use o f t e c h n o l o g y i n a p p r o p r i a t e t o
the c o n d i t i o n s found i n Idcc and t r a n s f e r p r i c i n g p o l i c i e s w h i c h
m i n i m i s e d o m e s t i c government revenue, e x e r t n e g a t i v e e f f e c t s on h o s t
countries.
Uowaver, w i t h o u t g e t t i n g e m b r o i l e d i n t h e s e d i v e r s e
and c o m p l i c a t e d i s s u e s , i t i s d i f f i c u l t t o see how
domestic
s t r u c t u r a l f e a t u r e s o f t s i i s k i n d can be e a s i l y used t o e x p l a i n
i n s t a b i l i t y i n the b a l a n c e of payments.
They seem more s u i t e d
t o an e x p l a n a t i o n o f g e n e r a l p a y r s n t s weakness.
The monetary approacl^
By c o n t r a s t the monetary apnroach pays l i t t l e a t t e n t i o n t o such
structural features.
I n s t e a d t h i s approach e x p l a i n s the b a l a n c e
of payraents e x c l u s i v e l y i n terms of d o m e s t i c monetary d i s e q u i l i b r i u m .
In comifarison t o the a b s o r p t i o n apparoch, T^hich may be p r e s e n t e d
i n p u r e l y ' r e a l ' terms and t o vrhich monetary a s p e c t s nay be appended
i f d e s i r e d , the monetary approach views such a s p e c t s as the essence
of
the n a t t e r .
Most corimonly p r e s e n t e d on the assumption o f f i x e d
exchanp.e r a t e s , the monetary' approach assumes t h a t the n o m i n a l
demand f o r money i s a s t a b l e and l i n e a r l y homogeneous f u n c t i o n o f
nominal incone.
I t goes on t o p o i n t out t h a t the n o m i n a l s u n n l y o f
Eonc;y i s the prodvict of the money m u l t i p l i e r and the monetary base,
w i t h the l a t t e r c o r a p r i s i n g a domestic component c o n s i s t i n g of d o m e s t i c
c r e d i t c r e a t e d by the monetary a u t h o r i t i e s and an i n t e r n a t i o n a l
component c o n s i s t i n g of the dome?5tic h o l d i n g s o f i n t e r n a t i o n a l r e s e r v e s .
G i v e n a tendency toward e q u i l i i r i u m i n the monetary s e c t o r o f . t h e
economy and assuming a c o n s t a n t money^ m . u l t i p l i e r , i t f o l l o w s t h a t
changes i n r e s e r v e s ( t a k e n as the measure o f the s t a t e o f the b a l a n c e
of payments) s t r i c t l y r e f l e c t any imbalance between the change i n
the
d o m e s t i c deinand f o r raoney and the change i n the s u p p l y o f
domestic c r e d i t .
An excess demand f o r money w i l l be met by a x^et
i n f l o w o f r e s e r v e s , i . e . a b a l a n c e payments s u r p l u s , w h i l e an e x c e s s
c r e a t i o n o f d o i a e s t i c c r e d i t w i l l be r e f l e c t e d by a pay;Tnents
deficit.
I t i s the change i n reserve?: w h i c h r e s t o r e s monetary e q u i l i b r i u m ;
once s t o c k e q u i l i b r i u m has been r e s t o r e d the f l o r ' o f r e s e r v e s w i l l
cease.
The monetary approach t h e r e f o r e views b a l a n c e of payments
problems as e s s e n t i a l l y t r a n s i t o r y and s e l f - c o r r e c t i n g , p r o v i d i n g o n l y
t h a t the a u t h o r i t i e s do n o t s t e r i l i s e
the e f f e c t s o f changes i n r e s e r v e s
by means o f compensating changes i n domestic c r e d i t c r e a t i o n .
In
t h i s 5;enee b a l a n c e o f payments p o l i c y as such i s n o t r e q u i r e d a p a r t
frota the s t r i c t
control of credit creation,
•feasures such as
d e v a l u a t i o n and exchange c o n t r o l s a r e viewed as o n l y i n f l u e n c i n g the
b a l a n c e of payments v i a t h e i r monetary r e p e r c u s s i o n s .
positive contribution " i l l
T h e i r only;
be t o speed up a c o r r e c t i v e p r o c e s s t h a t
^Tould have t a k e n p l a c e i n any c a s e .
C l e a r l y , whether a payments
imbalance w i l l c o r r e c t i t s e l f and h o - l o n g :;uch c o r r e c t i o n w i l l
are
c r u c i a l l y important p o l i c y questions.
take
F u r t h e r m o r e t h e monetary approach suggests t h a t the c o r r e l a t i o n
c o e f f i c i e n t o f changes i n r e s e r v e s on d o n e s t i c c r e d i t c r e a t i o n i s
unity.
The i m p l i c a t i o n i s t h a t e x c e s s i v e d o m e s t i c c r e d i t c r e a t i o n
w i l l have no p o s i t i v e l o n g term e f f e c t on o u t p u t and employment and
w i l l i n s t e a d be c o m p l e t e l y o f f s e t by a l o s s o f r e s e r v e s .
Similarly,
i t f o l l o w s t h a t t o reduce the r a t e o f c r e d i t c r e a t i o n i n o r d e r t o
improve the b a l a n c e
o f pa>".aents w i l l have no a d v e r s e e f f e c t or. these
v a r i a b l e s , though an isr>rovement i n t h e b a l a n c e
o f payments w i l l
c l e a r l y i m p l y a r e d u c t i o n i n t h e n e t i m p o r t a t i o n o f goods and
s e r v i c e s and t h e r e f o r e reduced domestic a b s o r p t i o n .
Again,
such
i s s u e s a r e h i g h l y r e l e v a n t t o p o l i c y makers.
A t t h i s stage i t i s r e l e v a n t t o draw a d i s t i n c t i o n between work
done on t h e monetary approach by t h e Fn?" and by o u t s i d e academics.
S i g n i f i c a n t l y a g r e a t d e a l o f r s f i e a r c h on t h e m.onetary approach
to the balance
of payTients has emanated from t h e BIF's R e s e a r c h
Department and has been conducted i n t h e c o n t e x t o f d e v e l o p i n g
countries.
this.
Ilhomberg and H e l l e r (1977) suggest f o u r r e a s o n s f o r
F i r s t , many Idcs l a c k e d tb.e d e t a i l e d n a t i o n a l a c c o u n t s
needed f o r t h e a p p l i c a t i o n o f I'eynesian a n a l y s i s , w h i l e
financial
d a t a were f a i r l y e a s i l y a v a i l a b l e . A t t h e same time o n l y
aggregative
payments d a t a c o u l d be o b t a i n e d and t h i s r u l e d o u t an approach
based on e l a s t i c i t i e s .
The monetary approach t h e r e f o r e suggested
i t s e l f almost by d e f a u l t .
Second, a n a l y s i s based on monetary
aggregates '^as n o t e x c e s s i v e l y complex and c o u l d be u n d e r t a k e n
swiftly.
I t "as t h e r e f o r e s u i t a b l e f o r t h e s h o r t d u r a t i o n o f v i s i t s
by Fund m i s s i o n s .
T h i r d , the scope f o r Idcs t o adopt s t e r i l i s a t i o n
p o l i c i e s was l i m i t e d , and f o u r t h , many I d c s , p a r t i c u l a r l y i n L a t i n
A m e r i c a , a l r e a d y r e l i e d h e a v i l y on monetary p o l i c y as a major
instruraent o f payraents
control.
I t i s an i n t e r e s t i n g q u e s t i o n as t o whether t h e Fund's v e r s i o n o f
the monetary approach may be l e g i t i m a t e l y d i f f e r e n t i a t e d
v e r s i o n s presented
by academics, as suramarised,
e d i t e d by F r e n k e l and Johnson (1976),
from
s a y , i n t h e volume
T h i s i s s u e merges i n t o t h e
w i d e r one, d i s c u s s e d i n Chapters 5 and 6, o f whether t h e Fund may
f a i r l y be d e s c r i b e d as ' r a o n e t a r i s t ' . U n f o r t u n a t e l y n e i t h e r i s s u e
i s c l e a r c u t , not l e a s t because t b e r e may be d i f f e r e n c e s between the
r e s e a r c h '•rriti.ngs o f Tund ^tp-ff. and ''hat i s done by the Fund i n
practice.
To the e x t e n t t h a t i t i s w i s e t o impute an a n a l y t i c a l
framework t o the p o l i c i e s s u p p o r t e d by the Fund, t h e s e vrould seem
t o f i t i n t o the broad t r a d i t i o n of the monetary
approach (see
c h a p t e r 6) under t^hich, on the b a s i s o f f o r e c a s t s f o r the demand
f o r money, domestic c r e d i t c r e a t i o n i s f i x e d at a l e v e l c o n s i s t e n t
w i t h the a t t a i n m e n t o f a s p e c i f i c b a l a n c e of payraents t a r g e t .
P.owever, i t seems t o be the case t h a t the Fund's approach i s r a t h e r
more e c l e c t i c thari t h a t o f academic m o n e t a r i s t s and may
i n t o o t h e r (Keynesian) a n a l y t i c a l frameworks.
also
The Fund has
fit
also
shown s i g n i f i c a n t l y more concern v r i t h the s h o r t r u n and w i t h
adjustment
paths t h a n have o t h e r v e r s i o n s j W h i c h have c o n c e n t r a t e d on l o n g term
e q u i l i b r i u m m.odels.
The Fund v e r s i o n i s t h e r e f o r e of c o n s i d e r a b l y
more r e l e v a n c e t o p o l i c y makers, as indeed i s i t s i n t e n t i o n .
C£ c e n t r a l s i g n i f i c a n c e here i s the t r a p s m i s s i o n mechanism t h r o u g h
• T'lich d o r . c s t i c c r e d i t e x p a n s i o n a f f e c t s the b a l a n c e o f payinents.
I n p r i n c i p l e t h e r e a r e a number of p o s s i - b i l i t i e s .
S t a r t i n g from
a s i t u a t i o n of nonetary e q u i l i - ; r i u t t h e c r e a t i o n of c r e d i t at a
r a t a i n e x c e s s of the growth i n demand f o r money v i l l have the irtriediate
e f f e c t of c r e a t i n g e x c e s s r e a l cash b a l a n c e s ; the i m p l i c a t i o n s of
t h i s s i t u a t i o n i ^ i l l depend on the way i n w h i c h i n d i v i d u a l s and
attem.pt t o d i s p o s e o f t h e i r e x c e s s h o l d i n g s .
firsts
The o p t i o n s a r e t o s-^end
them on d o m e s t i c and f o r e i g n r e a l and f i n a n c i a l a s s e t s .
Spending
them on f o r e i g n a s s e t s w i l l have a d i r e c t impact on the b a l a n c e of
payments, e i t h e r on the c u r r e n t account where e x p e n d i t u r e i s on r e a l
a s s e t s o r on the c a p i t a l account where e x p e n d i t u r e i s on f i n a n c i a l
assets.
Spending them on d o m e s t i c r e a l a s s e t s t r i l l e i t h e r r a i s e
r e a l o u t p u t '^here t h e r e i s spare c a p a c i t y o r w i l l r a i s e the domestic
price level.
I n the l a t t e r caf:e an adverse e f f e c t on the c u r r e n t
account v r i l l a l s o be i m p l i e d
(assuming a f i x e d exchange r a t e ) .
Spending thv'.n on d o m e s t i c f i n a n c i a l a s s e t s w i l l , i n the s h o r t r u n
a t l e a s t , tend t o reduce i n t e r e s t r a t e s , and t h i s w i l l have an
adverse e f f e c t on. the c a p i t a l account and perhaps on the c u r r e n t
account as i T e l l .
Tlie monetary
approach c o n v e n t i o n a l l y c o n c e n t r a t e s
on t h e d i r e c t impact on i m p o r t s and p l a y s down any l a s t i n g
on r e a l o u t p u t and employment.
influence
T h i s i s p a r t i c u l a r l y t r u e o f the
academic v e r s i o n s a s s o c i a t e d w i t h M u n d e l l and
Johnspn"- b u t i t a l s o
a p p l i e s t o the e a r l y work i n the Fund (see, f o r example, P o l a k ,
1957).
More r e c e n t Fund r e s e a r c h , f o r example by Khan and
Knight
(1980), emphasises t h a t a t t e n p t s t o i n p r o v e the b a l a n c e
of payments
by c r e d i t p o l i c y may
e f f e c t s on
impose s i g n i f i c a n t and u n d c e i . d b l e
o u t p u t , employment and f a c t o r income, p a r t i c u l a r l y i n the
run.
A g h e v l i and R o d r i g u e z (1979) f u r t h e r c o n f i r m t h a t monetary
r e s t r a i n t may
have a n e g a t i v e i n f l u e n c e on r e a l v a r i a b l e s and
a l s o suggest t h a t t h i s may
run.
short
s t i l l be s i g n i f i c a n t even i n the
they
long
There a r e some s i m i l a r i t i e s , then between t h i s work and
the
c o n v e n t i o n a l K e y n e s i a n v i e w w h i c h , w h i l e n o t n e c e s s a r i l y a t odds w i t h
the b a s i c a n a l y t i c a l approach u n d e r l y i n g monetary models, tends
t o emphasise those a s p e c t s o f the t r a n s m i s s i o n mechanism t h a t r e l a t e
t o the e f f e c t s on o u t p u t and employment.
The
r a t h e r more, and
perhaps i n c r e a s i n g l y , e c l e c t i c i n t e r p r e t a t i o n o f the b a l a n c e
payments to be found i n the Fund i s c l e a r l y r e f l e c t e d i n a
r e v i e w o f the monetary approach p u b l i s h e d i n the IMF
criticisms
be made o f the s t r o n g and r e s t r i c t i v e assumptions u n d e r l y i n g
c o n v e n t i o n a l monetary models.
ll
recent
Survey
( B l a c k w e l l , 1 9 7 8 ) . F u l l c o g n i z a n c e i s shown here o f the
t h a t may
of
In p a r t i c u l a r , Blackwell c r i t i c a l l y
S i g n i f i c a n t l y the t i t l e o f B l a c k w e l l ' s a r t i c l e i s 'Monetary Approach
t o B a l a n c e o f Payments Needs B l e n d i n g w i t h Other L i n e s o f A n a l y s i s ' .
B l a c k w e l l s p e c i f i c a l l y argues t h a t the e l a s t i c i t i e s and a b s o r p t i o n
approaches s h o u l d n o t be d i s c a r d e d , 'on the c o n t r a r y , the e x p e r i e n c e
o f the Fund s u g g e s t s t h a t , w h i l e an almost o v e r r i d i n g p r i o r i t y must
o f t e n be g i v e n to monetary c o n s i d e r a t i o n s i n p a r t i c u l a r circuiastancesi,
b a l a n c e d d i a g n o s e s and p r e s c r i p t i o n s u s u a l l y r e q u i r e c l o s e a t t e n t i o n
t o the problems o f r e s o u r c e use on w h i c h the a b s o r p t i o n approach
f o c u s e s , as T<rell as emphasis on r e a l i s t i c exchange r a t e p o l i c i e s
based ( i n p a r t ) on judgements r e g a r d i n g e l a s t i c i t i e s . ' He a l s o
p o i n t s out t h a t w h i l e , ' p r i c e s and wages have become much more v a r i a b l e , even under c o n d i t i o n s o f c o n s i d e r a b l e s l a c k , than would be
i m p l i e d by a " p u r e " K e y n e s i a n m o d e l . . . r e a l o u t p u t and employment
c l e a r l y remain more v a r i a b l e i n response t o p o l i c y a c t i o n s o r o t h e r
exogenous f a c t o r s than a "purS monetary model might suggest.
T h i r l w a l l (1980) p r o v i d e s a p a r t i c u l a r l y cogent summary c r i t i q u e o f
the monetary approach. He argues t h a t b a l a n c e o f pajrments
d i s e q u i l i b r i u m i s q u i t e c o n s i s t e n t w i t h ex a n t e e q u i l i b r i u m i n the
money market. When these p o i n t s a r e combined w i t h what he f e e l s a r e
the u n r e a l i s t i c assumptions made c o n c e r n i n g the demand f o r money
f u n c t i o n , the d e t e r m i n a t i o n o f o u t p u t , the absence o f s t e r i l i z a t i o n
and so on he concludes t h a t t h e r e i s l i t t l e o f m e r i t l e f t i n the
monetary approach t h a t was not a l r e a d y a v a i l a b l e i m p l i c M y i n the
a b s o r p t i o n approach, and t h a t i t i s 'not v e r y u s e f u l and a l m o s t
c e r t a i n l y m i s l e a d i n g , f o r the u n d e r s t a n d i n g o f the causes o f b a l a n c e
o f pajnaents d i f f i c u l t i e s . '
i n v e s t i g a t e s s i x premises u n d e r l y i n g t h e monetary approach:
and
(1) t h e t i n e d i m e n s i o n o f t h e t h e o r e t i c a l mechanism;
(2) t h e ass'imptions w i t h r e s p e c t t o the income v e l o c i t y
o f money;
(3) the unduly sharp dichotoiir/ between "money" and o t h e r
f i n a n c i a l claims;
(4) t h e analogous d i s t i n c t i o n between " r e s e r v e s " and o t h e r
external assets;
(5) t^ne broad assumptions u s u a l l y made about c a p i t a l
m o b i l i t y , t h e s u b s t i t u t a b i l i t y o f goods and s e r v i c e s
produced i n d i f f e r e n t c o u n t r i e s o r s e c t o r s , and t h e
e x i s t e n c e o f f u l l employment c o n d i t i o n s ;
(6) t h e scope f o r s y m m e t r i c a l a p p l i c a t i o n o f " s t e r i l i s a t i o n "
policies,
Ke f i n d s a l l such assumptions w a n t i n g i n c e r t i a n r e s p e c t s a n d argues
t h a t t h e r e i s c o n s i d e r a b l e need f o r q u a l i t a t i v e judgement t o
supplement t h e use o f e c o n o m e t r i c models, t o a l l o w f o r such f a c t o r s
as ' s o c i o - p o l i t i c a l
acceptability'.
E v i d e n c e a l r e a d y reviewed
i n chapter
3 by Sharpley
(I'^BO) c o n f i r m s
t h a t such c r i t i c i s m i s n o t w i t h o u t e m p i r i c a l s u p p o r t .
However, any
i d e a t h a t t h e t h e o r e t i c a l debate o v e r t h e causes o f payraents
d i s e q u i l i b r i a may q u i c k l y be r e s o l v e d b y e m p i r i c a l i n v e s t i g a t i o n has
been s h o - ^ t o b e e r r o n e o u s .
?%ch 'Tork has been c a r r i e d o u t on t e s t i n g
monetary models i n t h e c o n t e x t o f d e v e l o p i n g c o u n t r i e s b u t as y e t
no c l e a r consensus has emerged.
F o l l o - ' i n g a comprehensive r e v i e w o f
a l l t h e major e m p i r i c a l s t u d i e s up t o 1! 77 K r e i n i n and O f f i c e r (1978)
c o n c l u d e t h a t t h e evidence i s i n c o n c l u s i v e , even though, i n t e r e s t i n g l y ,
the Fund has i n the p a s t shovm a tendency t o view most o f i t s ovm
research
(FJiomberg
findinRS
as b e i n g b r o a d l y s u p p o r t i v e o f a monetary approach
and H e l l e r , 1977).
Part of the d i f f i c u l t y i s that
c o n s i s t e n c y w i t h t h e t i o n e t a r y approach does n o t a u t o m a t i c a l l y ^ i m p l y
i n c o n s i s t e n c y w i t h a l t e r n a t i v e approaches.
A given s e t of r e s u l t s
i s t h e r e f o r e open t o more t h a n one i n t e r p r e t a t i o n .
Indeed, even
the e x t e n t t o w h i c h
t h e monetary
a
g i v e n s e t o f r e s u l t s supports
approach i s o f t e n u n c l e a r - f o r i n s t a n c e t h e o f t e n n e g a t i v e
inter-
p r e t a t i o n g i v e n by K r e i n i n and O f f i c e r t o s p e c i f i c f i n d i n g s does
not always t a l l y
more,
there
is
with
t h a t g i v e n by t h e o r i g i n a l a u t h o r s .
t h e problem t h a t even
where
a strong
Further-
connection
i s d i s c o v e r e d between t h e s u p p l y o f c r e d i t and t h e b a l a n c e
o f payments
t h i s does
n o t o f i t s e l f i r i n l y the d i r e c t i o n o f c a u s a t i o n :
d o m e s t i c monetary d i s e q u i l i b r i u m m.ay sintply be a symptom, o f b a l a n c e
of payments d i s e q u i l i b r i u m , ( T b i r l w a l l ,
Even uhere c a u s a t i o n i s e s t a b l i s h e d ,
of why
1978).
the more fundamental q u e s t i o n
a p o l i c y o f excess c r e d i t was pursued i n the f i r s t p l a c e i s
not e x p l a i n e d .
The i m p l i c a t i o n i s t h a t any p o l i c y n o t based on an
u n d e r s t a n d i n g o f these u n d e r l y i n g f a c t o r s w i l l i t s e l f
In
fail.
terri:s o f the prime causes o f b a l a n c e of payments problems
i n Idcs
t h e r e i f some e v i d e n c e t o r^unport t h e argument t h a t t h e s e have been
r e l a t i v e l y l i t t l e to do x f i t h domestic monetary e x c e s s e s and much more
to do x}ith exogenous f a c t o r s beyond the c o n t r o l o f I d c s ( D e l l
13
Lawrence, 1980
and c h a p t e r s 2 and 6)
.
and
This view c o n t r a s t s s h a r p l y
w i t h the one t h a t , a t l e a s t u n t i l r e c e n t l y , was
a p p a r e n t l y h e l d by the
Fund, namely t h a t o v e r l y e x p a n s i o n a r y domestic demand p o l i c i e s a r e
the m.ost coraion cause o f payments d e f i c i t s .
may,
These c o n f l i c t i n g views
o f c o u r s e , s i m p l y r e f l e c t the d i f f e r e n t time p e r i o d s and
different
c o u n t r i e s s t u d i e d , but i f t h i s i s the case the c o n c l u s i o n cannot
be a v o i d e d t h a t t h e r e i s no unique cause o f d i s e q u i l i b r i a .
Unless
one b e l i e v e s t h a t the a p p r o p r i a t e n e s s o f p o l i c i e s i s independent
the causes o f the problem, t h i s c l e a r l y has s i g n i f i c a n t
of
implications.
The U'iF has g e n e r a l l y seemed t o v i e w the d i s t i n c t i o n between exogenous
12. H a v i n g s t u d i e d c e r t a i n c a u s a l r e l a t i o n s h i p s i m p l i e d by the
monetary approach t o the b a l a n c e o f payraents f o r f o u r I d c s ,
K i n c a i d and Nakajima (197C) conclude t h a t ' f o r the time p e r i o d s
t e s t e d , t h e assur.iption o f a u n i d i r e c t i o n a l c a u s a l r e l a t i o n s h i p
l e a d i n g from d o n e s t i c c r e d i t e x p a n s i o n t o changes i n n e t f o r e i g n
a s s e t s ... i s v a l i d f o r A r g e n t i n a , the P h i l i p p i n e s , and T h a i l a n d , '
w h i l e , 'the e v i d e n c e f o r r-exico does n o t tmpport the aforem.entioned
causality/''.
13. I t i s i n t e r e s t i n g t o note t h a t under the monetary approach an
exogenously generated i n c r e a s e i n p^rices v r i l l r a i s e the nominal
demand f o r r;;oney and, i f unaccompanied by an e q u i v a l e n t i n c r e a s e
i n domestic c r e d i t , w i l l l e a d t o a b a l a n c e o f pavements s u r p l u s
and n o t the d e f i c i t t h a t i s more t r a d i t i o n a l l y suggested. Note
a l s o t h a t as K r e i n i n and O f f i c e r (197S) p o i n t o u t , 'the t r a d i t i o n a l
• p r e d i c t i o n r e f e r s s t r i c t l y t o the c u r r e n t account component o f
t h e b a l a n c e o f payments and can be r e c o n c i l e d w i t h the m o n e t a r i s t
r e s u l t v i a the c a p i t a l account'.
anrt eiidogencus causation, as r a t h e r u n h e l p f u l and has p r e f e r r e d
to emphasise the d i s t i n c t i o n beto-reen temporary and permanent
payments problems,
Althoup:h the d u r a t i o n o f a d e f i c i t i s
c l e a r l y n o t independent of i t s c a u s e s , such emphasis appears t o
g i v e o n l y a secondary importance t o c a u s a t i o n .
In c o n c l u s i o n of t h i s sub s e c t i o n t h e r e would p r o b a b l y be a consensus
t h a t t h e monetary approach has e s t a b l i s h e d t h a t r a p i d c r e d i t e x p a n s i o n
i s l i k e l y t o r e s u l t i n paymtents d e f i c i t s and t h a t sound
financial
p o l i c y i s n e c e s s a r y f o r the a v o i d a n c e of b a l a n c e o f pay^ments
disequilibria.
There would be l e s s agreement, however, on i:^hether
monetary p o l i c y i s s u f f i c i e n t t o a c h i e v e a g i v e n payments t a r g e t
and on t>Thether i t r e p r e s e n t s a l e a s t c o s t s o l u t i o n i n t e r n s o f
l o s s e s o f emnloynnent
and o u t p u t .
There i s a groxj-ing atiU3unt o f
e v i d e n c e , much o f w h i c h s i g n i f i c a n t l y comes from the Fund's
R e s e a r c h Department, w h i c h suggests t h a t i t may
not.
cm
Ill
BALANCE OF PAYIEITS STA'4ILISATI0!I POLICIES: TEEOP.Y
A i S EVIPENCE
T h i s s e c t i o n exarainas a ranga o f s p e c i f i c l;alance o f pajnnents
p o l i c i e s availai'le to Idcs,
S i n c e d e v a l u a t i o n has f e a t u r e d as a
coraponent o f EIF prograrrimes and has been t h e source o f c o n s i d e r a b l e
p u b l i c d i s c u s s i o n between t h e E4F and Idcs a good d e a l o f a t t e n t i o n
i s f o c u s s e d on t h i s p a r t i c u l a r i n s t r u i a e n t , though o t h e r
policies
such as d o m e s t i c demand management (reviewed more f u l l y i n c h a p t e r
and c o n t r o l s a r e a l s o d i s c u s s e d .
3)
I t w i l l be seen t h a t economic
t h e o r y does n o t p r o v i d e an unambiguous guide t o t h e ways i n w h i c h
the v a r i o u s p o l i c i e s w i l l a f f e c t t h e b a l a n c e
o f pajiments o r even
a c l e a r i n d i c a t i o n o f whether they ^ n l l a f f e c t i t a t a l l .
Indeed,
as a l r e a d y n o t e d , one c o n c l u s i o n t h a t emerges from t h e monetary
approach g i v e n t h e assumptioi:^ on w h i c h i t i s b a s e d , i s t h a t i n
the l o n g r u n no p o l i c y i s r e q u i r e d s i n c e b a l a n c e
b r i a are s e l f - c o r r e c t i n g .
o f payments d i s e q u i l
The o n l y r e l e v a n t o u e s t i o n i n t h e c o n t e x t
of t h i s approach i s whether c o u n t r i e s have enough time t o p e r m i t
the a u t o m a t i c
adjustment mechanism t o work.
D s v a l u a t i o n : t h e e l a s t i c i t i e s approach
D e v a l u a t i o n has t r a d i t i o n a l l y been d e f i n e d as f a l l i n g i n t o the
category; o f e x p e n d i t u r e - s w i t c h i n g p o l i c i e s .
I n many c a s e s ,
therefore
i f i t is a n t i c i i a t e d t h a t d e v a l u a t i o n w i l l f a i l t o c o r r e c t a d e f i c i t
i t i s t o be a n t i c i p a t e d t h a t o t h e r forms o f e x p e n d i t u r e - s w i t c h i n g
p o l i c y w i l l a l s o be i n e f f e c t i v e ; i t may be u s e f u l t o bear t h i s p o i n t
i n mind.
Devaluation operates
i n a way tTlilch i n c r e a s e s t h e d o m e s t i c
p r i c e and/or reduces t h e f o r e i g n c u r r e n c y p r i c e o f e x p o r t s .
currency
It
generates p r i c e i n c e n t i v e s "'hich tend t o lower do'^astic demand f o r
i m p o r t s , r a i s e do:>estic demand f o r and s u p p l y o f import s u b s t i t u t e s ,
i n c r e a s e f o r e i g n demand f o r e x p o r t s , and/or lower t h e d o m e s t i c
der...and f o r and i n c r e a s e t h e p r o d u c t i o n o f e x p o r t s .
The r e s p o n s e s
t o these p r i c e changes depend on a range o f demand and s u p p l y
elasticities,
A o r line i s s u e o f i n t e r e s t i s whether d e v a l u a t i o n i n I d c s
cause t h e t h e o r e t i c a l l y a n t i c i n a t e f ! - j r i c e changes,
imports
will
' ' i t h regard t o
i t i s h i g h l y improbable tha-: any i n d i v i d u a l I d c w i l l be a b l e
to i n f l u e n c e t h e f o r e i g n p r i c e o f i t s im'^orts, s i n c e i t s demand f o r
any p a r t i c i l a r import v - i l l r e p r e s e n t o n l y a s n a i l f r a c t i o n o f t h e
t o t a l w o r l d demand f o r t h e p r o d u c t .
Even s o , the d o m e s t i c p r i c e o f
i m p o r t s may n o t r i s e t o t h e f u l l e x t e n t o f t h e d e v a l u a t i o n , o r may
even f a l l i f d e v a l u a t i o n i s accompanied by the removal o f import
c o n t r o l s t h a t p r i o r t o d e v a l u a t i o n served t o m a i n t a i n import p r i c e s
at a r t i f i c a l l y high l e v e l s .
Indeed t h e o v e r a l l impact o f d e v a l u a t i o n
has been found t o depend s i g n i f i c a n t l y on tlie p r e c i s e c h a r a c t e r i s t i c s
of c o n t r o l s (Krueger,
i n Idcs.'''''*
197G).
C o n t r o l s a r e , o f c o u r s e , v e r y common
ICrueger c o n f i r m s on t h e b a s i s o f s t u d i e s o f t e n I d c s
that devaluation r e s u l t s not only i n increased
'liberalisation', i.e.
the use o f t h e raarket mechanism i n p l a c e o f q u a n t i t a t i v e r e s t r i c t i o n s ,
but a g r e a t e r r i s e i n t h e p r i c e o f exportable?; as compared T-ith
importable?
an.' t h e r e f o r e a r e d u c t i o n i n t h e import
s u b s t i t u t i o n bias
o f t e n a s s o c i a t e d w i t h c o n t r o l s (see t h e l a t e r s e c t i o n on exchange
controls).
14 ? o r a f u l l c a t a l o g u e o f t h e 5.mport c o n t r o l s used by I d c s , see t h e
HIE's Annual Report on Exchange R e s t r i c t i o n s . Over r e c e n t y e a r s ,
q u a n t i t a t i v e irsport c o n t r o l s have been used b y , i n t e r a l i a ,
A r g e n t i n a , BangJadeeh, C h i l e , Colombia, vTamaica, I n d i a , M e x i c o ,
N i g e r i a , Peru and 'i'akistan; import surcharges and taxes by P o l l v f a ,
P ' r a s i l , Cameroon, C o s t a l l i c a , Ecuador, Ghana, I s r a e l , Kalr.'d,
l i e : d c o , P a k i s t a n , Panama and Uruguay; systems o f advance iw-port
depcs:Its by B o l i v i a , B r a z i l , C h i l e , Colombia, Greece, K o r e a ,
Maviritip.s and Z a i r e ; c o n t r o l s o v e r import paynmep.ts by A r g e n t i n a ,
C h i l e , t h e Dom.inican F i a p u b l i c , E t h i o p i a , I n d o n e s i a , P e r u , S i e r r a
Leone ana .''aire; r e s t r i c t i o n s on c u r r e n t i n v i s i b l e s by A f g h a n i s t a n ,
A r g e n t i n a , B a n g l a d e s h , B r a z i l , C h i l e , Colombia, C y p r u s , E g y p t ,
Ghana, Guyana, I s r a e l , J a m a i c a , L e s o t h o , l l a l t a , P a k i s t a n , P e r u ,
the P h i l i p x ' i n e s , S i e r r a Leone, T a n z a n i a and Z a i r e ; and .gome form
o f m . u l t i p l e - c u r r e n c y p r a c t i c e by A r g e n t i n a , A f g h a n i s t a n , B r a z i l ,
liurraa, Colombia, Ghana, I n d o n e s i a and U e p a l .
With r e g a r d t o e x p o r t s , nuch depends on the si,<?nificance of the I d c
as a s u p p l i e r of the p a r t i c u l a r e x p o r t .
IJhere i t a c c o u n t s f o r o n l y a
s m a l l p r o p o r t i o n of the t o t a l w o r l d s u p p l y o f a p r o d u c t , i t i s u n l i k e l y
t h a t the f o r e i g n - c u r r e n c y e x p o r t p r i c e w i l l a l t e r as a r e s u l t o f
d e v a l u a t i o n , s i n c e t h i s p r i c e w i l l be l a r g e l y determined by
i n t e r p l a y o f s u p p l y and demand i n the w o r l d market.
the
I n these c i r c u m -
s t a n c e s d e v a l u a t i o n w i l l i n s t e a d tend to r a i s e the p r i c e o f e x p o r t s i n
terms o f the r e l e v a n t domestic c u r r e n c y .
A g a i n , hoxrever, a r i s e i n t h e
d o m e s t i c - c u r r e n c y p r i c e of an e x p o r t ^rbich i s a l s o consumed d o m e s t i c a l l y
i s not a u t o m a t i c a l l y i m p l i e d by the c o n s t a n c y o f the f o r e i g n - c u r r e n c y
price.
F o r i n s t a n c e , the exchange a u t h o r i t i e s may
a l l o w export
p r o d u c e r s a l e s s b e n e f i c i a l exchange r a t e , thus e f f e c t i v e l y t a x i n g the
w i n d f a l l i n c r e a s e i n p r o f i t s t h a t would o t h e r , r i s e have been a s s o c i a t e d
\ixth d e v a l u a t i o n , o r the a u t h o r i t i e s may
15
tax.
d i r e c t l y impose an e x p o r t
Even where prodticers do have.some c o n t r o l o v e r the f o r e i g n c u r r e n c y
p r i c e of a c o t i n o d i t y t h e i r p r i c i n g p o l i c i e s w i l l be i n f l u e n c e d by
e s t i m a t e d s i z e o f demand and s u p p l y e l a s t i c i t i e s ,
i n s t i t u t i o n a l arrangements,
the
as t.rell as by
such as the e x i s t e n c e of i n t e r n a t i o n a l
commodity agreements, trhich d i s c o u r a g e s i g n a t o r i e s from expanding
their
market share through p r i c e c o m p e t i t i o n .
I f , as seems l i k e l y
i n a l l but r a t h e r e x c e p t i o n a l c a s e s , r e l a t i v e
p r i c e changer, do r e s u l t from d e v a l u a t i o n , such t h a t domestic
becomes cheaper
output
i n r e l a t i o n t o f o r e i g n o u t p u t , the s u c c e s s of the
d e v a l u a t i o n i n i m p r o v i n g the b a l a n c e of pajnaents depends on the
to
these p r i c e changes.
responses
I n the case of j.nports, the demand i n I d c s
i s o f t e n asTumerl t o be p r i c e - i n e l a s t i c , r e f l e c t i n g the
developmental
n a t u r e o f i m p o r t s though, as noted e a r l i e r , e m p i r i c a l e v i d e n c e c h a l l e n g e s
t h i s assu^lption.
On the e x p o r t s i d e , the f o r e i g n - c u r r e n c y p r i c e o f e x p o r t s w i l l
not
u s u a l l y f a l l as a r e s u l t of d e v a l u t i o n . T/here the f o r e i g n - c u r r e n c y
p r i c e o f e x p o r t s remains
c o n s t a n t , the d o m e s t i c - c u r r e n c y e q u i v a l e n t
15 F o r exai.T3ple, d u r i n g 1975-7 Burma e s t a b l i s h e d an e x p o r t - p r i c e
e q u a l i s a t i o n fund i n t o w h i c h i s p a i d the revenue from t a x e s l e v i e d
on the STirplus o f e x p o r t e a r n i n g s o v e r domestic e x p o r t c o s t s .
The
fund i s used t o f i n a n c e l o s s e s on u n p r o f i t a b l e e x ] i o r t s .
w i l l r i s e and the i s s u e of c r u c i a l s i g n i f i c a n c e i n a s s e s s i n g
the
r e l e v a n c e of d e v a l u a t i o n becomes the e l a s t i c i t y o f s u p p l y o f e x p o r t s . '
T h i s e l a s t i c i t y , which i s o f course
l i a b l e to v a r y over t i m e , v r i l l
denend on a number o f f a c t o r s : i t w i l l tend to be h i g h e r the s h o r t e r
the g e s t a t i o n p e r i o d of p r o d u c t i o n , the g r e a t e r the domestic consumption
o f the good, the g r e a t e r the degree o f u n u t i l i s e d c a n a c i t y , the
the a v a i l a b i l i t y o f investment f i n a n c e , and
resources.
greater
the g r e a t e r the m o b i l i t y o f
C i r c u m s t a n c e s v a r y as between i n d i v i d u a l I d c s , but
there
i s some r e a s o n to b e l i e v e t h a t shor^t run s u p p l y e l a s t i c i t i e s may be
17
'
' •f a i r l y low i n I d c s . ' Supply i n e l a s t i c i t y t h e r e f o r e c o n s t i t u t e s a
m.ajor impediment t o the e f f i c a c y o f d e v a l u a t i o n and,
i n d e e d , any
form
of e x p e n d i t u r e - s w i t c h i n g p o l i c ' s as a method o f payments adjustment.
Such i n e l a s t i c i t y does not imply f u l l employment but r e f l e c t s a •
g e n e r a l d i f f i c u l t y i n expanding the o u t p u t o f e x p o r t s
s u b s t i t u t e s , f o r example because of s t r u c t u r a l
Even though the success
and
import
inflexibilities.
of a l l e x p e n d i t u r e - s w i t c h i n g measures
depends on the same b a s i c f a c t o r s , a s i r n i f i c a n t
made w i t h r e s p e c t t o the s e l e c t i v i t y
d i s t i n c t i o n may
of v a r i o u s such
be
instruments.
In most Idcs d e v a l u a t i o n w i l l i n i t i a l l y e x e r t a f a i r l y u n i v e r s a l
i n f l u e n c e upon the d o m e f i t i c - c u r r e n c y p r i c e o f a l l t r a d e d poods.
L e a v i n g a s i d e p o s s i b l e i n f l u e n c e s on tha c a p i t a l account the impact
o f d e v a l u a t i o n on the demand f o r f o r e i g n exchange depends on
d o m e s t i c - p r i c e e l a s t i c i t y o f demand f o r i m p o r t s .
The
the
impact on
the
s u p p l y of f o r e i g n exchange depends i n the f i r s t i n s t a n c e on the f o r e i g n p r i c e e l a s t i c i t y o f demand f o r e x p o r t s i f the d e v a l u a t i o n causes a
change i n the f o r e i g n p r i c e , and on the e l a s t i c i t y o f s u p p l y with, r e s p e c t
to i n c r e a s e d p r o f i t s i n the e x p o r t s e c t o r i f i t i s o n l y domestic p r i c e s
t h a t change.
For commodities s u b j e c t t o v e r y s m a l l
elasticities
d e v a l u a t i o n w i l l do l i t t l e t o improve the foreign-exchange
position.
16 The absence of a f o r e i g n - p r i c e e f f e c t need not p r e c l u d e an e x p a n s i o n
i n e x p o r t denand where the i n c r e a s e d p r o f i t s o f d o m e s t i c s u p p l i e r s
f i n a n c e an improvement i n the q u a l i t y o f the e x p o r t good. Such
q u a l i t y e f f e c t s a r e , however, u n l i k e l y t o be r e l e v a n t t o many of
the p r i m a r y - p r o d u c t e x p o r t s o f I d c s .
17 N a s h a b i b i (19';0) draws a t t e n t i o n t o the s p e c i f i c i n s t a n c e where a
q u i t e l a r g e i n c r e a s e i n the s e l l i . n g p r i c e o f a g i v e n crop w h i c h
however s t i l l l e a v e s i t s p r o d u c t i o n l e s s p r o f i t a b l e than t h a t of
a l t e r n a t i v e crops may nave l e s s e f f e c t on o u t p u t than a s m a l l e r
p r i c e i n c r e a s e t h a t changes the p r o f i t a b i l i t y r a n k i n g .
Such l i m i t e d e m p i r i c a l e v i d e n c e arj i s a v a i l a b l e on I d c p r i c e
e l a s t i c i t i e s suggests t h a t e l a s t i c i t y pessimism may
be
misplaced.
As mentioned e a r l i e r , i n a study o f f i f t e e n Idcs o v e r the p e r i o d
1-*51~6^', IChan (1?74) found t h a t the v a l u e s of f o r e i g n t r a d e
e l a s t i c i t i e s were c o n s i s t e n t w i t h d e v a l u a t i o n i m n r c v i n g
o f paynrents.
the b a l a n c e
T h i s c o n c l u s i o n does n o t , o f c o u r s e , n e c e s s a r i l y r mean
t h a t d e v a l u a t i o n w i l l a c t u a l l y improve the t r a d e b a l a n c e ,
since
s u c c e c s i n tJiese terms r e q u i r e s the s a t i f a c t i o n o f a number o f
conditions.
The
other
f i r s t i s t h a t d e v a l u a t i o n w i l l g e n e r a t e changes
i n the r e l a t i v e p r i c e s of t r a d e d and n o n - t r a d e d goods.
Evidence
on t h i s n a t t e r i s p r o v i d e d by Cooper ( l ^ T l a and b) an.l C o n n o l l y
and T a y l o r
(l?7f.b).
In a ptudy o f tv'enty-four d e v a l u a t i o n s
over the n e r i o J 1^5^-65, Cooper n o t e s t h a t i n twenty cases
was
i n Idcs
devaluation
accompanied by some s u b s t a n t i a l m.easure o f exchange reform, o r
l i b e r a l i s a t i o n , ^Ath
from, and was
the r e s u l t t h a t the e f f e c t i v e d e v a l u a t i o n
u s u a l l y l e s s t l i a n , the n o m i n a l d e v a l u a t i o n .
by K r u e ^ a r (1973),
reflecting
differed
Even
though the e f f e c t i v e d e v a l u a t i o n u s u a l l y v a r i e d as between
and exTtorts, as confirmed
trade
imports
different
r a t e s of t a r i f f s and e x p o r t s u b s i d i e s f o r d i f f e r e n t t r a d e d
goods,
d e v a l u a t i o n , p r a c t i c a l l y alx-zays generated a r e l a t i v e r i s e i n the d o m e s t i c
p r i c e of traded
goods as a v h o l e , a t l e a s t i n i t i a l l y .
Connolly
and T a y l o r c o n f i r m t h i s f i n d i n p ; . ' ^ " l i l s t d e v a l u a t i o n appears to b r i n g
about a moderate i n c r e a s e i n the o v e r a l l p r i c e l e v e l , the r i s e i t
causes i n the t r i c e s o f t r a d e d goods i s s u b s t a n t i a l . For t h e
devaluations
eight
s t u d i e d by C o n n o l l y and T a y l o r , o v e r the two-year p o s t -
d e v a l u a t i o n p e r i o d the p r i c e s o f t r a d e d goods rose by an amount
a p p r o a c h i n g the e x t e n t o f d e v a l u a t i o n , w h i l s t p r i c e s i n g e n e r a l
l e s s than h a l f as much.
rose
L'scond, the r . u b s t i t u t i o n e f f e c t away' from
imports roay ''-.e n e u t r a l i s e d i f a d d i t i o n a l e x p o r t e a r n i n g s
and t h e r e f o r e i m p o r t s , t o r i s e .
cause income,
l«o doubt i t i s f o r reasons such as
these t h a t an i n c r e a s e i n in^.ort.9 has been observed f o l l o w i n g
devaluation
(BhagT.Tat and O n i t s u k a .
1^'74), and why
the u l t i m a t e improve-
ment i n the b a l a n c e of payments i s s m a l l when compared w i t h
equilibrium' e l a s t i c i t i e s
'partial
(Behtmam, 1978>,
C l e a r l y , the s u c c e s s of d e v a l u a t i o n i n i n c r e a s i n g e a r n i n g s
of
f o r e i g n , exchange i s c r u c i a l l y dependent on the e l a s t i c i t y o f
supply.
export
U n f o r t u n a t e l y , there i s l i t t l e p r e c i s e em.pirical evidence
r e l a t i n g to export supply e l a s t i c i t i e s i n Idcs.
In a study,
c a r r i e d out by BhagtJat and Onitsxika (1374), o f p o s t - d e v a l u a t i o n
e x p o r t p e r f o m a n c e i n a nvmber of n o n - i n d u s t r i a l c o u n t r i e s , i t
eiaerged t h a t i n the t a a j o r i t y of cases e x p o r t e a r n i n g s and volumes
did
grow f o l l o w i n g d e v a l u a t i o n .
THiere l i t t l e o r no e x p a n s i o n i n
e x p o r t s r e s u l t e d , o r where a d e c l i n e o c c u r r e d , SJ^^ecial
'•'ere u s u a l l y found t o e x i s t .
The response
circumstances
of exports to d e v a l u a t i o n
appears, however, t o depend v e r y much on the l e v e l o f development,
the type of e x p o r t , and the c o n c e n t r a t i o n and s t r u c t u r e of t r a d e .
F o r the s m a l l , l e a s t - d e v e l o n e d c o u n t r i e s w h i c h e x p o r t l i t t l e
than t r e e c r o p s , the e x p o r t - s u p p l y response
apparent
other
t o d e v a l u a t i o n i s not v e r y
and e a r n i n g s seem t o be more r e s p o n s i v e t o v a r i a t i o n s i n
TTeather and extraneous
developed
f l u c t u a t i o n s i n w o r l d demand.
F o r the more
Idcs vrhich e x p o r t a g r i c u l t u r a l goods w i t h s h o r t e r g e s t a t i o n
p e r i o d s , m i n e r a l s o r manufactured goods, the supply; response
e x p o r t s t o d e v a l u a t i o n appears t o be somewhat g r e a t e r .
i n t e r m e d i a t e - t e r a responses
of
Significant
t o changes i n r e a l e f f e c t i v e exchange
r a t e s are c o n f i n ^ e d by v i r t u a l l y a l l c o n t r i b u t e " t o the
Bhag'/ati p r o j e c t , w i t h the responses
Krueger/
of n o n - t r a d i t i o n a l exports
u s u a l l y b e i n g s t r o n g e r than those of t r a d i t i o n a l e x p o r t s .
It is
n o t e d , however, t h a t a r e a l i s t i c exchange r a t e does not p r o v i d e a
s u f f i c i e n t e x p l a n a t i o n of r a p i d and s u s t a i n e d e x p o r t growth.
D e v a l u a t i o n ; the a b s o r p t i o n and monetary approaches
M i i l e the e l a s t i c i t i e s approach f o c u s s e s on the e x p e n d i t u r e s w i t c h i n g
a s p e c t s of d e v a l u a t i o n , the a b s o r p t i o n approach f o c u s s e s on i t s e f f e c t s
on the l e v e l of r e a l ex|>enditure.
The monetary approach c o n c e n t r a t e s
on the monetary r e p e r c u s s i o n s of d e v a l u a t i o n .
Holding other things constant, there i s e m p i r i c a l evidence to
the v i e w t h a t d c i v a l u a t i o n w i l l reduce r e a l e x p e n d i t u r e
F i r s t , i t i s p o s s i b l e t h a t a demand-deflationary
er.anate from the t r a d i n g s e c t o r .
respond
(Cooper,
1971).
influence w i l l
H i e r e e x p o r t e a r n i n g s do not
t o d e v a l u a t i o n , b u t , at the same time and becauwe o f
i n e l a s t i c dem.and domestic
ctirrency e3q>enditure on i m p o r t s i n c r e a s e s ,
t h e r e w i l l be a n e t r e d u c t i o n i n aggregate
output.
support
defend
Where, however, the d o m e s t i c - c u r r e n c y
for donestic
value of export
e a r n i n g s r i s e s then the i n c r e a s e i n domestic-currency''
export
r e c e i p t s w i l l tend t o o f f s e t the i n c r e a s e i n d o m e s t i c - c u r r e n c y
import payraents and t h e r e w i l l be no n e t dem.and-deflationary
Second, d e v a l u a t i o n has a r e d i s t r i b u t i v e e f f e c t on income.
effect.
This
may o c c u r b o t h bettreen t h e t r a d i n g and n o n - t r a d i n g s e c t o r s and
between t h e f a c t o r s o f p r o d u c t i o n .
Its precise results w i l l
on a range o f v a r i a b l e s and m^ay change o v e r t i le.
i n c l u d e : t h e response
depend
The k e y v a r i a b l e s
of money wages i n the t r a d i n g and n o n - t r a d i n g
s e c t o r s t o t h e e x t r a p r o f i t a b i l i t y w h i c h d e v a l u a t i o n induces i n
the t r a d i n g s e c t o r ; t h e import c o n t e n t o f t r a d e d and n o n - t r a d e d
goods; t h e respon,''e i n the n o n - t r a d i n g s e c t o r t o h i g h e r wage and
import c o s t s ; the f a c t o r i n t e n s i t i e s i n and t h e ownership o f t h e
v a r i o u s s e c t o r s ; and t h e degree of f a c t o r n o b i l i t y .
o f s c e n a r i o s may be iroagined.
A number
S i n c e v^age and p r o f i t r e c i p i e n t s
may d i f f e r i n t h e i r m a r g i n a l p r o p e n s i t i e s t o spend, d i f f e r e n t
s c e n a r i o s w i l l have d i f f e r e n t impacts on domestic
expenditure.
Assuming, f o r in;Ttancek that,money wages i n b o t h t h e t r a d i n g and
n o n - t r a d i n g s e c t o r s r i s e l e s s than t h e g e n e r a l p r i c e
level,
perhaps because o f mon^y i l l u s i o n , r e a l xrages w i l l f a l l .
Assuming,
f u r t h e r t h a t t h e r e i s a lower p r o p e n s i t y t o spend out o f p r o f i t s
than o u t o f -.'ages, domestic
exp'enditure w i l l a l s o f a l l .
This
d e f l a t i o n a r y r e d i s t r i b u t i v e e f f e c t o f d e v a l u a t i o n seens t o have
operated
t o a p a r t i c u l a r l y marked degree i n t h e case o f t h e A r g e n t i n e
d e v a l u a t i o n of 1959, xrijere t h e s h i f t of r e a l income t o lando^mers,
who had a lo'/er p r o p e n s i t y t o spend t?ian t h e urban vrorkers, from
whom t h e r e a l income was d i v e r t e d , nerved t o generate
a decline i n
IP.
import demand a d d i t i o n a l t o t h e p r i c e - i n d u c e d d e c l i n e " and t h e r e
•
i s l i t t l e doubt t h a t a d e f l a t i o n a r y r e d i s t r i b u t i v e e f f e c t has a l s o
o p e r a t e d i n o t h e r d e v a l u a t i o n s , a l t h o u g h investment
higher r r o f i t "
it.
s t i m u l a t e d by
i n the traded-goods s e c t o r may tend t o n e u t r a l i s e
Of c o u r s e , t h e i n c r e a s e i n p r o f i t s may be t r a n s f e r r e d t o the
governr'.ent, and the e f f e c t on aggregate
demand ^ r i l l then depend on
how governments use t h e i r i n c r e a s e d revenue.
F t e d i R t r i b u t i o n a p a r t , the h i g h e r t h e average p r o p e n s i t y t o import
and t h e lower the p r i c e e l a s t i c i t y o f demand f o r i i o p c r t s , t h e
g r e a t e r w i l l tend t o be t'te d e f l a t i o n a r y impact o f d e v a l u a t i o n . I f
e x p e n d i t u r e r e d u c t i o n i s n e c e s s a r y i n o r d e r f o r d e v a l u a t i o n t o be
18
F o r a thorough e x p o s i t i o n o f t h i s , see D i a z - A l e j a n d r o
(1965).
s u c c e s s f u l , tlie e x t e n t t o '^^'hich h i g h e r i m p r r t p r i c e s a r e d e f l a t i o n a r y
w i l l be s i g n i f i c a n t .
I n c r e a s e d e x p e n d i t u r e vjay, 'lowever, r e s u l t from
a t t e n r t s by e:q)orters t o expand t h e i r c a p a c i t y i n o r d e r t o produce more
e x p o r t s , and t h i s may tQ a c e r t a i n e x t e n t o f f s e t t h e d e f l a t i o n a r y impact
o f h i g h e r import p r i c e s .
T h i r d , i f t h e r e a r e ad v a l o r e m t a x e s on ex''orts and i m n o r t s ,
devaluation
t r i l l tend t o r e d i s t r i b t i t e income from, t h e p r i v a t e s e c t o r t o t h e
government and i f , as Krugman and T a y l o r (1973) argue, t h e government
has a s a v i n g propensit'' o f u n i t y , aggregate demand v r i l l f a l l i n the
fihort r u n .
''.part from i t s impact on t h e o v e r a l l l e v e l o f ireal f a c t o r r e w a r d s ,
d e v a l u a t i o n may a l s o cause a change i n r e l a t i v e f a c t o r rev;ards, depending
on t h e f a c t o r i n t e n s i t i e s o f d i f f e r e n t s e c t o r s , and ma3; thus generate a
movement o f f a c t o r s between s e c t o r s .
tend t o be r a t h e r immobile t h e i n i t i a l
I n t h e case o f I d c s trhere f a c t o r s
r e d i s t r i b u t i o n o f income towards
p r o f i t s i n t h e e x p o r t s e c t o r may p e r s e v e r e ,
The permanence o f the
r e d i s t r i b u t i o n x r i l l c r u c i a l l y depend on whether those e x p e r i e n c i n g a
r e l a t i v e l o s s r e c o g n i s e v?hat has happened, and have t h e povrer t o r e v e r s e
it.'^'
I f , f o l l o i v i n g a d e v a l - i a t i o n , a l l f a c t o r rewards a r e m a i n t a i n e d
t h e i r p r e - d e v a l u a t i o n r e a l l e v e l s , then d e v a l u a t i o n w i l l
fail
at
to exert
an impact on e x p e n d i t u r e .
A f o u r t h p o t e n t i a l and i n c r e a s i n g l y s i g n i f i c a n t source o f demand d e f l a t i o n
w h i c h might be induced by d e v a l u a t i o n a r i s e s from d e b t - s e r v i c i n g .
D e v a l u a t i o n w i l l t c i s e the d o m e s t i c c o s t s o f s e r v i c i n g any g i v e n
e x t e r n a l o b l i g a t i o n expressed
remaining
i n f o r e i g n c u r r e n c y and, o t h e r
c o n s t a n t , w i l l e x e r t a r e d u c i n g e f f e c t on domestic
things
expenditure.
Krugman and T a y l o r (1^71) r e a c h the c o n c l u s i o n on the b a s i s o f t h e o r e t i c a l
a n a l y s i s and ' c a s u a l e m p i r i c i s m ' t h a t i n I d c s a d e f l a t i o n a r y impact on
aggregate demand and r e a l o u t p u t from d e v a l u a t i o n i s 'more than a remote
p o s s i b i l i t y ; i t i s c l o s e to a presumption'.
They r ' a i n t a i n t h a t t h i s
19 F o r a f u l l d i s c u s s i o n o f t h e income r e d i s t r i b u t i v e e f f e c t s o f
d e v a l u a t i o n i n I d c s , see I l n i g h t (1976).
I ^ i g h t argues t h a t an
approach w h i c h emphasises s e c t o r a l income d i f f e r e n c e s and 'nonmarket p r e s s u r e s by socio-economic groups' i s a p p r o p r i a t e t o I d c s .
v i e w i s a t odds vrith t h e o r e t i c a l treatments
devaluation which 'generally conclude that
of
currency
i t s t i m u l a t e s economic
a c t i v i t y ' , l a r g e l y as a r e s u l t o f the assumed ex-port
responsiveness
w h i c h i n f a c t does not seem to e x i s t i n I d c s .
A s i m u l a t i o n model
for
(1P"0) c o n f i r m s
M a l a y s i a c o n s t r u c t e d by A h l u v r a l i a and L y s y
d e v a l u a t i o n may
have a d e f l a t i o n a r y / r a t h e r than e x p a n s i o n a r y
on economic a c t i v i t y , though the model a l s o c o n f i r m s
that
effect
t h a t whether
t h i s i s so depends on the v a l u e s assumed f o r the r e l e v a n t demand
and s u p p l y e l a ^ r t i c i t i e r , .
deflationary effect.
Cooper (1971) a l s o f i n d s e v i d e n c e
C e r t a i n l ^ ^ i t would seem l e s s than
of a
axiomatic
then t h a t d e v a l u a t i o n w i l l h a v e ^ j r i a n s i o n a r y e f f e c t on economic
20
activity. '
may
'Tiiere e:rpenditure r e d u c t i o n i s r e q u i r e d
devaluation
then be dotibly b l e s s e d .
Although,
expected
f o r t h e reasons j u s t i d e n t i f i e d , d e v a l u a t i o n might be
t o h a v e ari e x p e n d i t u r e - r e d u c i n g
iripact, r e a l
expenditure
r e d u c t i o n w i l l be a c h i e v e d o n l y i f the a p p r o p r i a t e monetary p o l i c y
i s s i m u l t a n e o u s l y pursued.
The monetary approach sees the monetary
i m p l i c a t i o n s o f d e v a l u a t i o n as b e i n g c r u c i a l , though, as
noted,
i t a l s o sees d e v a l u a t i o n as u n n e c e s s a r y p r o v i d e d
tim.e ( i . e . f i n a n c i n g ) i s a v a i l a b l e f o r a u t o m a t i c
occur.
According
The
thereby
enough
c o r r e c t i o n to
to t h i s apwronch tb.e raechanisxr. by w h i c h d e v a l u a t i o n
a f f e c t s the balance of
l e v e l and
already
payment;-- i s by r a i s i n g t h e d o m e s t i c p r i c e
i n c r e a s i n g the demand f o r n o m i n a l money b a l a n c e s .
r e a l s u p p l y o f domestic c r e d i t i s reduced and monetary s e c t o r
e q u i l i b r i u m i s maintained
by an i n f l o w o f r e s e r v e s .
t h a t d e v a l u a t i o n induces a payments s u r p l u s i t may
To the
extent
therefore lead
to problems ^ ' i t h i n f l a t i o n v i a i t s e f f e c t on the money s u p p l y ,
as e v i d e n c e
d r a x m from B r a ; s i l ( F i s h l o w r e f e r r e d t o i n K r u i 5?-;'r
C h i l e (Behnaan 1976)
and
I s r a e l ( M i c h a e l y 1975)
confirri's.
1978)
However,
20 S t a r t i n g from a p o s i t i o n of s t o c k e q u i l i b r i u m the m.onetary
approach d e n i e s t h a t d e v a l u a t i o n can b r i n g about a l a s t i n g improvement i n the b a l a n c e o f payments ^iince any r e l a t e d i n c r e a s e s i n
the demand f o r money w i l l be p e r f e c t l y o f f a e t by an e q u i v a l e n t
i i n c r e a s e i n the s u p p l y o f money v i a a d d i t i o n a l i n t e r n a t i o n a l
r e s e r v e s . P r i c e s r i s e i n p r o p o r t i o n to the s u p p l y o f money
l e a v i n g b o t h monetary s e c t o r e q u i l i b r i u m and t h e b a l a n c e o f
payments, i n r e a l t e r n s , as they were b e f o r e t h e d e v a l u a t i o n .
i n t h e o r y , once stcc!: e c u i l i ' r i u a has h s c n achieved
this inflow
ceases." " As a r e s u l t t h e e f f e c t o f d e v ; r l u a t i o n i s p u r e l y t r a n s i t o r y ,
R e l a t i v e p r i c e changes pla'' no s i g n i f i c a n t r o l e i n the n o n e t a r j '
approach.
The
domestic p r i c e s o f t r c d e d goods a r e assumed t o r i s e
by t h e f u l l e.^:tent o f t h e d e v a l v a t i o n , ' f-nd t o the e;::tp.r!.t t h a t
there
i s any s v ; i t c h i n g e f f e c t i n t h e c o n t e x t o f the monetary' apvroach t h i s
i s i n t e r n a l 3Xi\ i s betwe?in t r a d e d and non trridad goods r a t h e r than
betv'een it-p'orts an/.l Gxrsorts.
The monetarv approach t h e r e f o r e
s h a r p l y l i t b the e l a s t i c i t i e s apnroach.
contrasts
I t mav, however, be more
e a s i l y r e c o n c i l e d w i t h t h e a b s o r p t i o n approach s i n c e b o t h p o i n t t o the
e f f e c t o f d e v a l u a t i o n on r e a l e>'per.diture,
t'le forraer r e l y i n g on thi?-
bein.'-: produced v i a a r e d u c t i o n i n r e a l balavicas.
21 Tbi:v i s n o t t o argue ths.': d e v a l u a t i o n v r i l l n^'.ver be a s s o c i a t e d
^ i t h i^conomic growt'., n o r ?o C r o c b e t t {V'ii>.) m a i n t a i n s i s i t the case
t h a t s t r o n g measures t o iruprove t u a payiaents s i t u a t i o n , backed by
a d e i u a t e c o n s c n r u a , > d l l necesQ?:ril':'' c-'^.use develop;;isnt t o s u f f e r ,
•le argues r a t h e r t h a t ' f o l l o w i n g the 197?-'A o i l p r i c e 5,ncreases,
a nuvAer o f c o u n t r i e s in /^sin ador te;" firns tusnpures t o r e s t r a i n
d o m e s t i c demand, and sought to s w i t c h o u t p u t t o exportr. throtr;.a
a l l o w i n g t h e i r e f f e c t i v e e:i;cb.inge r a t e t o d e p r e c i a t e , .-^s a r e s u l t
(!:ry i t a l i c s ) J K o r e a , the "•^public o f C h i n a , T h a i l a n d ^TA Singapore
a l l m a i n t a i n e d s a t i s f actor^,'- g r c ' t h r ^ t e s in the p e r i o d 1 9 7 4 - ? ' ' , *
I'rueger ( 1 9 7 ' ) a l s o d i s c o v e r s t h a t t h e e f f e c t o f d e v a l u a t i o n on
economic •'.rowt''; depends c r ' - i c i a l l y c a what b.a'-pens t o ex^^ort earnin;ys
••.hor-gh The f i n d s v e r y l i t t l e e v i d e n c n t o s u g p s s t t h a t d e v a l u a t i o n
l e a d s t o 'severe r e c e s s i o n o f prolong?.'-'' d u r a t i o n . ' -'h-2 p o i n t s out
t h a t the. imnedi."'-..-'. p e r i o d follo"'-'.nn d e v a l u a t i o n tends t o be p a r t i c u l a r l y /
d i f f i c u l t sjid s i g n i f i c i n t s i n c e t h e l i b e r a l i s a t i o n o f imports tends
t o have a q u i c k e r e f f e c t on the b a l a n c e o f payirienr.s tbr.n does the
e x t r a i n c e n t i v e t o e;:port. F a i l u r e t o s u r v i v e tlar^ d i f f i c u l t
p e r i o d f r e q u e n t l y re-sults i n t h e r e - i m p o s i t i o n o f r u a n t i t a t i v e control<^
arui a r s t r e a t : from I D ' e r a l i s - t i o n . Krueger advocater^ t h a use o f a
c r a w l i n g neg f o l l o w i n g d e v a l u a t i o n t o r e t a i n the smutching i n c e n t i v e s
c r e a t e d by i t .
22 The 'law o f one p r i c e ' sometimes invoked -^ritbin t h e monetary
approach, d e n i e s c o u n t r i e s the p o G s i b i l i t y r o f 'mal:ing' t h e i r orm
p r i c e l e v e l . l i r e i n i n and O f f i c e r ' 1 ' ' 7 3 ) h c ' e v e r found no e v i d e n c e
t o support t h i s s o - c a l l e ' l 'lavT'; on t h i s sea a l s o R l a c k w e l l ( 1 9 7 8 ) .
I n g e n e r a l the n o n e t a r y approach i s f i r j u t i l l y C i s ^ d r ^ s i v e o f a l l
expenditure-crltchinp
Tr^osuraSj
i n c l u d i n g t a r i f f s , quotas and
er-xhange
c o n t r o l s , s i n c e they are a l l seen as er:ert5_ny o n l y a t r a n s i s t o r y i m p a c t
on
the b a l a n c e o f pa/i^ants by r a i s i n g t l i e n o m i n a l devaand f o r money above
i t s domestic supply.
but
even quotas and
T a r i f f s c l e a r l y ? rai.oe doviiestic p r i c e s
exchange c o n t r o l s , by r e s t r i c t i n g the volume of
i m p o r t s i n d i r e c t l y tend to r a i s e
the d o m e s t i c p r i c e o f i m p o r t s
through s u b s t i t u t i o n , the ' t e n e r n l p r i c e l e v e l .
that devaluation
directly,
and,
Tlie t r a d i t i o n a l v i e w
i s i n h e r e n t l y i n f l a t i o n a r y , r a t h e r than m e r e l y r a i s i n g
tb.e p r i c e l e v e l once, and
K r u e g e r (197.8).
f o r a l l , has,
ho^-ever, hee.n c h a l l e n g e d
by
E v i d e n c e i n many cases snpgestc^! t h a t t h e r e are
'.'orking i n tb'^ o p p o s i t e d i r e c t i o n , p a r t i c u l a r l y where n r i o r to
exchan:'e c o n t r o l s ha\'G
countries
bean n^-?,!',
rtudied i n her p r n y ^ c t
f.actors
devaluation
S r u e g e r c o n c l u d e s t h a t f o r the
'the
ten
c o n t r i b u t i o n of exchange r a t e
cbapges '.as vriry s n a i l comr-ared t o o t h e r t y p e s o f i n f l a t i o n a r y
As3m:'ing ^o"e
presPureE*.
infla;:>pnary
impetus from d e v - i l u a t i o n ,
t h r e e o t h e r .juesf-ions rel.-.t.? to f i r s t , the s ' z a
irtpetus as coKrparrju w i t h
of t h i s i n f l a t i o n a r y
the BIZP. o f the d e v a l u a t i o n ,
c o m p a r a t i v e e f f e c t s on laoney wages and
p r i c e s and
second,
the
tb.erefore r e a l wages,
ST.d t h i r d , the e f f e c t on t.'\e r e a l s u p p l y of money.
It is difficult
t o i s o l a t n the q u - ^ n t i t s t i v e i n f l u e n c e of d e v a l u a t i o n
p r i c e s and wage-;.
Evi'lence r-reser.ted by Cooper (1971a and b)
however, at-per.r t o s u b s t a n t i a t e
months a f t e r a d e v a l u a t i o n ,
t-^.e c l a i i ' t b a t , f o r t h e
l e s s than the sit'.e o f tbe r'evaluatio;^.
C o n n o l l y and
folio-ring
Taylor
(i:-?'^::.).
devalnatfon.
Tbe
per
the
sectors,
'superior o r g a r - i f a t t o n o f frarker.G i n m a n u f a c t u r i n g ,
f.;!ignific,':rit f a l l
in
uso
become doT.'irrardly i n f l e x i b l e and
e f f e c t i v e n e s s of -lavaluation.
frequently
r e a l rrages.
Of c o u r s e , xrbere an. I d c ^aakas e x t e n s i v e
wager.; ' i l l
17.9
t'_'-it, f o l l o ' j i n r devalu,-?.tion, money t,;ages
i t s e e L'T rea30i-j.able t o coi^clude t h a t devalui^.tion i ?
with
consur.ier
s e c t o r r i s e r ^ t b e r fast^-r than i n other
i n o a r t becau.^^e o f the
associated
fall
cent ' ' b i l n t m a n u f a c t u r i n g wages ror;e by
ascu'-'.ntion
i n the '.annufacturing
by
T a k i n g s i x t e e n d e v a l u a t i c n s i n Irtcs i t
p r i c e s ro\'e 'ry 2.2.9
Cm
considerably
I t " I s c see";- t - n t r ^ a l wages
a v a r a g s , i n the y e a r a f t e r devnlu-.^tion
cent.
twelve
fir.din" i s confiraed
t r a n s p i r e s t h a t , on
per
does,
first
tbe ri^'.e i n p r i c e s an-1 images i s
on
In terms o"
of wage i n r c x a t i o v i r e a l
t h i s T - . - i l l reduce
the
it-^i impact on monetary
v a r i a b l e s i t seens amo"5t unbrsOTm f o r t b e nor. ip?.l s;v " l y o f rioney
to f a l l
f o l l o w i u r . J.evaluation (Cooper l ? 7 1 a and b ) .
It does a^near,
however, t h a t i n c e r t a i n cases t h e r e a l s u p p l y o f wcney f a l l s a f t n r
d e v a l u a t i o n , and i n about h a l f t h e casef? i n v e s t i g a t e d by C o n n o l l y
and T a y l o r d e c r e a s e s i n t h e r a t e o f prorrth o f d o n e s t i c c r e d i t c C T r e s s e d
as a p e r c e n t a g e o f tb.e money s t o c k o c c u r r e d
i n the year a f t e r
Indeed, i n a c l e a r m a j o r i t y o f d e v a l u a t i o n s
they s t u d i e d t h e r e
over t h e t-ro y e a r s
devaluation.
occurred,
followi.np, d e v a l u a t i o n , d e c r e a s e s i n t h e r a t e o f
growth o f domestic c r e d i t .
Taking
t h e raoney s u p p l y as a ^'hole, however,
Krueger (1*^73) f i n d s t h a t i n c r e a s e s i n t b e rstQ o f exTJansion. o f the
money s u p p l y f o l l o w i n g d e v a l u a t i o n cxco-eded recuctioris; and t h a t i n
m^.ny cases t h i s -/as an imnortcint f a c t o r i n e x p l a i n i n g t".\e subsequent
a c c e l e r a t i o n i n tbe r a t e o f i n f l a t i o n .
Thir. p a r t l y o c c u r r e d
d i r e c t respcnso t o a pa;p:ap.nts i r >rovement induced
as a
by d e y a l u a t i o n ,
but i t may'' a l s o r e s u l t where d e v a l u a t i o n , e r p e c i a l l ^ ' -Ir c o m b i n a t i o n
w i t h t r a d e l i b e r a l i s a t i o n reduces ;;;nvernrant
exT-enditurm,
thereby
revenue r e l a t i v e t o
i n c r e a c i n g tbe f i s c a l d e f i c i t .
eiCfect on t h e ; " i - c a l b a l a n c e i s 'P'pisltive o r n e g a t i v e
on i u d i v i d u a l c o u n t r y
1-,'hether t h e
depends, however,
circumstances,.
f e v a l u a t i o n ; the d i r e c t evidence
Devaluation
i n I d c s t,>,ay b e e v a l u a t e d e m p i r i c a l l y a t two l e v e l s .
A t the
f i r s t and as above the p o t a n t i a l s u c c e s s o f d e v a l u a t i o n may be
i n v a s t i g a t e d b y examining whether tb.e c o n d i t i o n s r e q u i r e d f o r r.ucceaaful
devaluation e x i s t .
A t t h e second, and more d i r e c t l y , the a c t u a l iiapact
c f d e v a l u a t i o n on the b a l a n c e o f payraents o;" those Idcs w h i c h have
nads u s e o f i t may be e-;:anined.
Coopar (1971a and b ) d i p c c v e r a
that
:'u a'-out 75 p e r ce-nt o f cases t h e b a l a n c e o f pa^L-^ents on c u r r e n t a c c o u n t ,
measured i n f o r e i g n c u r r e n c y ,
and
imprcvas i n t b e y e a r f o l l o - ^ i n g d e v a l u a t i o n ;
t h a t i n 90 p a r c e n t o f ca^-es e i t h e r t h e c u r r e n t account o r t b e c a p i t a l
a c c o u n t o r both
prove.
I n tbf. few i n s t a n c e s cjbere d e v a l u a t i o n
f a i l e d t o b r i n g a r o u t an improvement s p e c i a l >'eature3, such ac e x t e n s i v e
i m p o r t I r - e r a l i c a t i o n , see"ed to I.e. s i g n i f i c a n t .
2" The i n f l o w o f c a p i t a l t i i g b t be r a s p o n s i v a t o d e v a l u a t i o n where
d e v a l u a t i o n serves t o improve c o n f i d e n c e , e:KVpn6 o - ^ n o r t u n i t i a n
f o r i n v e s t r e n . t , and reduce t h e l e v e l o f import and r e l a t e d c o n t r o l s .
An e x p a n s i o n i n investr-ent 'sight b.o': e v e r a l s o tend t o i n c r e a s e the
import o f c a p i t a l goods, w h i l s t a l i f t i n y o f i m p o r t c o n t r o l s would
tend t o have a g e u a r a l l y e x p a n r i v e impact on i m p o r t a t i o n .
Merely
t o observe t h a t i n most cases the b a l a n c e
of oayTtients improves
a f t e r a d e v a l u a t i o n does not of course n e c e s s a r i l y i m p l y t h a t the
pay/m-ents p o s i t i o n altrays improves because of the d e v a l u a t i o n ;
f a c t o r s nay l;e a t work.
period preceding
I n some cases the b a l a n c e
other
of payments i n the
d e v a l u a t i o n m i g h t , f o r i n s t a n c e , have been p a r t i c u l a r l y
poor because of a bad h a r v e s t i n a key c a s h c r o p , a temporary phenomenon
or even because of a n t i c i p a t e d d e v a l u a t i o n .
A g a i n , the b a l a n c e
of
payments n i g h t have improved a? a r e s u l t of the p u r s u i t of d e f l a t i o n a r y
domestic p o l i c i e s r a t h e r than d e v a l u a t i o n , or because of an e x p a n s i o n
i n ^Torld demand.
I n g e n e r a l however i t i s hard t o b e l i e v e t h a t
these
f a c t o r s can e x p l a i n the s y s t e m a t i c s t a t i s t i c a l r e l a t i o n s h i p d i s c o v e r e d .
/ixi estim.ate of the i n f l u e n c e of d e v a l u a t i o n on the b a l a n c e
may
of payments
be nade by t r y i n g t o f o r n an o p i n i o n on xrhat the payments p o s i t i o n
vrould have been i n the absence of d e v a l u a t i o n .
t h a t Idcs would have m a i n t a i n e d
tlieiv
I f i t i s r i g h t t o assume
p r e - d e v a l u a t i o n market shares
the vTorld markets f o r t h e i r exportr,, and would have e x p e r i e n c e d
e.'cpanriion i n i m p o r t s as determined ty
in
an
the i n t e r a c t i o n between the growth
i n r e a l incone and the income e l a s t i c i t y of demand f o r i m p o r t s , i t would
appear t h a t : i n most cases d e v a l u a t i o n r e s u l t e d i n h i g h e r e x p o r t s
lower i m p o r t s
(Cooper I'^Tla
and
and
b).
An a l t e r n a t i v e approach, t o e v a l u a t i n g the impact of d e v a l u a t i o n i s t o
r e g r e s s changes i n tbe b a l a n c e
of payments on the r a t e of d e v a l u a t i o n .
Such regres'sions suggest t h a t d e v a l u a t i o n does cause a s i g n i f i c a n t
improvement i n tbe b a l a n c e
of payments of I d c s , but t h a t the
of payments f a i l s t o improve t o an e x t e n t even approaching
balance
the n o m i n a l
e x t e n t of the d e v a l u a t i o n over a one o r two-year p o s t - d e v a l u a t i o n
^eriod.
d e g r e s s i o n a n a l y s i s f u r t h e r suggests t h a t d e v a l u a t i o n w i l l
c o n s i d e r a b l y iiore e f f e c t i v e i n improving
the b a l a n c e
o f paynaents i f
accompanied by ' c o n t r a c t i o n a r y ' monetary p o l i c y ( C o n n o l l y and
1?76).
be
Taylor,
T h i s i s a p a r t i c u l a r l y i n t e r e s t i n g o b s e r v a t i o n when i t i s
compared Tdtb the c o n c l u s i o ^ i reached by Krugraan and T a y l o r ( 1 9 7 3 ) t h a t
d e v a l u a t i o n s h o u l d i n many cases be accompanied by measures t o i n c r e a s e
demand.
A l t e r n a t i v e .OTn'.tching instrui':ientf?
The
p r i n c i p a l -purpose of d e v a l u a t i o n as c o n v e n t i o n a l l y p r e s e n t e d
t o g e n e r a t e r e l a t i v e p r i c e changes w h i c h s w i t c h e x p e n d i t u r e
is
away from
i m p o r t s and s w i t c h p r o d u c t i o n i n t o e x p e r t s and import
substitutes
m-th. t h e i n t e n t i o n of improvin", tbe b a l a n c e o f payments.
As alread'/
n o t e d , s i g n i f i c a n t i n d e t e r m i n i n g the s u c c e s s o f d e v a l u a t i o n i s a
range of demand and s u p p l y e l a s t i c i t i e s .
However d e v a l u a t i o n i s b u t
one means by w h i c h r e l a t i v e p r i c e changes m y
has
be brought about, and
been c r i t i c i s e d as b e i n g i n s u f f i c i e n t l y s e l e c t i v e i n i t s e f f e c t s
since i t f a i l s to discriminate
Other e x p e n d i t u r e s w i t c h i n g
b-etween i n d i v i d u a l s e c t o r s
or industries.
p o l i c i e s a r e a v a i l a b l e which c a n , i n
p r i n c i p l e , e x p l o i t the p o t e n t i a l g a i n s from p r i c e
aris].ng from d i f f e r e n t i a l e l a s t i c i t i e s .
discrimination
Tiiesa a l t e r n a t i v e s
include
t a r i f f s and o v e r t m.ultiple exchange r a t e s as w e l l as domestic t a x e s
and
s u b s i d i e s w h i c h , i n e f f e c t , c r e a t e m u l t i p l e rater..
From a
t h e o r e t i c a l a n g l e such approaches have c o n s i d e r a b l e a p p e a l s i n c e i t
seems h i g h l y improbable t h a t s i m i l a r e l a s t i c i t i e s e x i s t a c r o s s a l l
sectors.
Thus, even f o r a d e v e l o p i n y c o u n t r y where o v e r a l l p r i c e
e l a s t i c i t i e s a r e low - suagep.ting t h a t d e v a l u a t i o n w i l l he u n s u c c e s s f u l some form of m u l t i p l e
payments p o s i t i o n .
exchange p r a c t i c e maybe a>le t o Improve t h e
F u r t h e r m o r e , i t might be expected t h a t
selective
measures may be m.ore e f f e c t i v e as a means o f moving r e s o u r c e s i n t o
sectors v i t h high p o t e n t i a l g r c t h ,
as r e f l e c t e d by incone e l a s t i c i t y
of demand.
T a k i n g t h e e x a n ^ l e of f o r m a l r.i.ultiple exchange r a t e s , i n c i r c u r i s t a n c e s
where t h e p r i c e e l a s t i c i t y of dem.and f o r a p a r t i c u l a r import i s l o w ,
a r e l a t i v e l y h i g h exchange r a t e viould be a p p l i e d
i n v o l v i n g t h i s import.
For transactions
the p r i c e e l a s t i c i t y of demand i s h i g h ,
to transactional
i n v o l v i n g an import f o r which
t h e exchange r a t e would be
r e l a t i v e l : ; - low and fewer u n i t s o f f o r e i g n c u r r e n c y would he a c q u i r e d
by s a c r i f i c i n g one u n i t o f d o m e s t i c c u r r e n c y . , -fhere the f o r e i g n
p r i c e o f a coriraodity i s f i x e d from t h e poi.nt of v i e w o f any i n d i v i d u a l
Idc then a r e l a t i v e l y b i g b exchange r a t e " o u l d be a p p l i e d
to transactions
i n v o l v i n g corimodities w h i c h p o s s e s s l o t ' s u p p l y e l a s t i c i t i e s - ' i t h
r e s p e c t t o t h e domestic c u r r e n c y p r i c e , and a r e l a t i v e l y low exchange
r a t e would be a p p l i e d t o t r a n s a c t i o n s
i n v o l v i n g coramorHties w h i c h
p o s s e s s h i g h supply/ e l a s t i c i t i e s .
ThR a l t e r n a t i v e i s t o a c h i e v e a g r e a t e r degree of d i s c r i m i n a t i o n
t h r o u g h u s i n g thf^ f i s c a l s-'stem (Gcbydlowsky, 1981).
However, where
i n c e n t i v e s t o c e r t a i n k i n d s of import s u ' ^ s t i t u t i o n and
p r o m o t i o n are p r o v i d e d
export
i n t h i s xray t h e r e i s tha i m p o r t a n t
of the e f f e c t on the f i s c a l b a l a n c e .
T h i s c l e a r l y depends on
p r e c i s e c o n f i q u r a t i o n of sub-sidies and
i n i t i a l l y i n v o l v e s , net e x p e n d i t u r e
f u t u r e t a x revenue i f e x p o r t
question
the
t a x e s , but even i f the scheme
on s u b s i d i e s t h i s may
be o f f s e t by
l e d economic growth i s encouraged as a
result.
The
argument t h a t a t a x / s u b s i d y
scheme i s i n f e r i o r t o
devaluation
beaause i t i s l i k e l y t o be a p p l i e d o n l y t o a subset o f c u r r e n t
t r a n s a c t i o n s and
i s vmlikel-;' t o bp a p p l i e d u n i f o r r a l y (Laker
is illegitimate
(,„• ;
m u l t i p l e r a t e s i s t o =.
account
1991)
. /atext s i n c e the whole purpose of e f f e c t i v e
a the p e r f e c t r i a u l a t i o n of
devaluation,
However, o t h e r c r i t i c i s m s of e f f e c t i v e r ^ l t i p l e r a t e schemes are
legitim.ate.
number and
F i r s t , there i s the p r o b l e m of i d e n t i f y i n g the optimum
level
. r a t e s , or taxes and
subsidies.
Second, t h e r e
are the a d m i n i s t r a t i v e c o s t s of ii-'plementing the schemes.
Laker,
dravring on the evi..i-ci'ce of Bha<y'ati and D a s a i (1970), quotes
India's
ex}7erience as a model of the a d m i n i s t r a t i v e cumbersomeness of such
schemes, i l l u s t r a t i n g h i s p o i n t by n o t i n g t h a t , 'the
c o v e r i n g tbe sc'iemes f o r e n g i n e e r i n g
f o r example, comprised >^.?. pages.'
goods and
regulations
cheT-dcal
products,
To m i n i m i s e the p r a c t i c a l
TTith m u l t i p l e exchange r a t e s S t r e e t a n
(1971) has
difficulties
surrgested t h a t i t
would be f e a s i b l e t o e s t a b l i s h a system, of d u a l exchange r a t e s under
w h i c h one
r e l a t i v e l y h i g h exchange r a t e would be e s t a b l i s h e d f o r
i n t r a d i t i o n a l primar'' e x p o r t s
and e s s e n t i a l i m p o r t s , b o t h o f w h i c h
he assiuaes are s u b j e c t t o i n e l a s t i c demands; and
a l o i t e r r a t e would
be used f o r t r a d e i n m a n u f a c t u r e d , i n f a n t i n d u s t r y
and
trade
exports,
f o r ' i n e s s e n t i a l ' i m p o r t s where the p r i c e e l a s t i c i t y of demand
i s high.
T h i r d , t h e r e are o p p o r t u n i t i e s f o r c u r r u p t i o n , e v a s i o n
and
misuse t o w h i c h the use of e f f e c t i v e m u l t i p l e r a t e schemes g.ive r i s e .
A l t h o u g h o f t e n d i f f i c u l t t o document t h e r e i s enough e v i d e n c e t o
c o n f i r m the e x i s t e n c e of such problerv'? and
that t h e i r s i g n i f i c a n c e
i n c r e a s e s o v e r time*
(Bbagt/ati and D e s a i , 1970,
a l s o K i l l i c k , 1978).
Problems of the type
Bhagt>Tati, 1966,
see
l i s t e d above seem t o
be s u f f i c i e n t l y i r a p o r t a n t as t o l e a d t o the f r e q u e n t
abandonment
o f m u l t i p l e r a t e schemes vrhere t h e y have been t r i e d ,
(Laker,
1981).
The
c h o i c e bet"'OP.n s v i t c h i n r - and c r e d i t c o n t r o l s
The monetary apnrcach c l e a r l y / vie* s de-^-aluation a s , i n e f f e c t , an
instrrffsent o f monetary p o l i c y .
Accordinp. t o t h i s v i e w d e v a l u a t i o n
w i l l o n l y improve t h e s h o r t r u n b a l a n c e
o f payments i f i t i s
accompanied b y domestic measxares w h i c h '^revent an o f f s e t t i n g
i n t h e c r e a t i o n o f dosaaotic c r e d i t .
impact on tbe b a l a n c e
increase
Indeed, i n p r i n c i p l e , a s i m i l a r
o f payrsents c o u l d be induced by;' a r e d u c t i o n
i n t h e c u - p l y o f domestic c r e d i t or an i n c r e a s e i n t b e demand f o r
money.
I n t h i s sense monetary p o l i c y ; m.ay be seen as n o t o n l y a
complement t o d e v a l u a t i o n b u t as an a l t e r n a t i v e
t o i t . As a l r e a d y
n o t e d , t h e r e i s a s t r o n p t h e o r e t i c a l argument t h a t over the l o n g r u n
credit control w i l l
induce an imr'.rovement i n t h e b a l a n c e
o f payraents.
Of g r e a t e r p r a c t i c a l r e l e v a n c e , however, a r e the q u e s t i o n s o f the
len'^tb, o f time r e q u i r e d f o r such a p o l i c y t o work, and t b e a v a i l a b i l i t y
of a l t e r n a t i v e " o l i c i e s w h i c h
will
speed up t b e p r o c e s s
o f adjustment
or reduce t h e ' ^ e l f a r e c o s t s a s s o c i a t e d w i t h i t .
B a s i c a l l y , i n c i r c u n s t a n c e s w!:ere t b e m a r g i n a l
s o c i a l co'it o f
r e d u c i n g t h e nominal s u p p l y o f c r e d i t i s g r e a t e r than the m a r g i n a l
s o c i a l c o s t o f i n c r e a s i n g tho
noBpinal
demand f o r rioney by; means
o f d e v a l u a t i o n , d e v a l u a t i o n w i l l be the p r e f e r r e d p o l i c y ,
on t h i s , althoug!'. i n theory
building',
d e v a l u a t i o n and a r e d u c t i o n i n the no-'iinal
s u p p l y o f moneyy p r o v i d e a l t e r n a t i v e n e c h a n i s n s f o r r e d u c i n g t h e r e a l
sirpT^ly
o f rooncy, c o u n t r i e s a r e u n l i k e l y / t o
be
i n d i f f e r e n t about which
p o l i c y " they u s e . One r e a s o n f o r t h i s r e l a t e r . t o t h e s t r u c t u r a l and
d i s t r i b u t i o n a l consequences o f d e v a l u a t i o n as compared w i t h
those
a s s o c i a t e d w i t h a r e d u c t i o n i n the nominal s u p p l y o f money.
Devaluation
may encourage gro-'tli t o be l e d by t b n f o r e i g n t r a d e s e c t o r .
A
r e d u c t i o n i n tbe n o m i n a l s u p p l y o f money, on tbe o t h e r hand, i s
l i k e l ' " t o l e a v e r e l a t i v e price:; unchanged and i s tb.erefore u n l i k e l y
to b r i n g about s t r u c t u r a l cbangas..
o c c u r , however, ina.s-'iuch as r e l i a n c p
Ttructural
chanyes
Viiay
on bank c r e d i t varie.n a c r o s s
s e c t o r s and f i r m s .• an i n c r e a s e i n tbe c o s t o f c r e d i t w i l l
problemr f o r those
create
f i r m s r e l i a n t cn i t . I f they a r e domestic as
opposed t o i n t e r n a t i o n a l , and a r e c o n c e n t r a t e d
manufacturing
still
i n say i n f a n t
indu.''.tryr, c o n t r a c t i o n a r y c r e d i t p o l i c i e s may have
narked adverse consequences f o r economic devclopm.ent; as d i s c u s s e d
i n chapter
3.
A
second
reason
why
governments are
betT'een d e v a l u a t i o n
of eacl/'output,
in
employanent
STTitching e^q^enditure
contraction
tbe
other
and
inflation.
If devaluation
effects
is successful
o u t p u t , i t w i l l tend t o
towards d o n e s t i c
I n c o m p a r i s o n b y r e d u c i n g a g g r e g a t e demand m o n e t a r y
causes
output
to
fall
and
unerarloyment
to r i s e .
hand, - r b i l s t a c c o r d i n g t o t b e m o n e t a r y a p p r o a c h
works b y n e a n s o f r a i s i n g t h e p r i c e l e v e l and
monetary
indifferent
c r e d i t r e s t r i c t i o n s r e l a t e s to the
and
r a i s e eroploynent.
u n l i k e l y t o be
c o n t r a c t i o n tends
to
devaluation
real
reduci.ng
the p r i c e
lower
On
balances,
l e v e l . I t
follovTS t h a t t b e c h o i c e bet'Teen d e v a l u a t i o n and monecc. y c o n t r a c t i o n
be i n f l u e n c e d b y t h e c u r r e n t r a t e s o f u n e m p l o y m e n t and
•'ill
and
To
the
rone e x t e n t
neutralised
by
tbe
by
inflationary
this
that
f r o m an
alternatives
with
The
must
consequences of
a l s o be
any
level
(see
c a s e be
of
devaluation
technically
monetary p o l i c y
reduced and
are
the
by
deficit
this
allovdng
24
I t nay
in
be
any
denandt,
of
The m o s t
course
not
I f tbe
-^ell
efficient
the
of
one
the
socio-political
understood,
of
and
through
be
i t may
contraction
donestic
prove
which
i n l a c s because of
rate
be
demand
technical feasibility
not
the
course,
is
the
credit
m,ay
lov?
expansion
the
not
the
only a l t e r n a t i v e
A l l that i s r e q u i r e d i n order
to
t h a t t h a e x c e s s r e a l s u p p l y o f money ir
laaj be a c h i e v e d
m-oney s u p p l y .
increase
rinilarly
than monetary
to d e v a l u t i o n .
s u p p l y a t a g i v e n l e v e l and
or
and
difficult
contraction i s , of
tbe
devaluation
may
3).
chapter
correct
donestic
c e n t r a l c o n t r o l over
ilonetary
crawling
p r i n c i p l e , be d e a l t w i t h
in
considered.
piore a c c e p t a b l e p o l i t i c a l l y
in
devaluation
incomes p o l i c y ,
political
objectives.
of
point of view nay
economic
to p o l i c y
effects
f o r a gradiial or
managament o f
i s chosea.
respect
inflationary
c o n . ^ e c u s n c e s may,
appropriate
policy
cost
opting
accoT"anying
the
vith
govtrtroents p r i o r i t i e s
inflation
demand
e o u a l l y w e l l by
holding
the
money
a l l o ' - r i n r t h e demand f o r money t o r i s e ,
f o r money t o
rise
more r a p i d l y t h a n
S i n c e e c o n o m i c gro'Ttb w i l l n o r r . i a l l y c a u s e
an
t h e demand f o r money, t h e f a s t e r t h e economy i s grofring
noted,
however, t h a t ' t b e
r e l e v a n t monetary aggregate w i l l
o f payrnient';;
or i n f l a t i o n .
In t h e f o r m e r c a s e i t 1411
be d o m e s t i c c r e d i t
c r e a t i o n w h i l e i n t h a l a t t e r i t \ ' i l l be tbe money s u p p l y d e f i n e d
t o i n c l u d e f o r e i . g n a s s e t s bicld by t h e b a n k i n g s y s t e m .
depend on wheti:.er the f o c u s o f a t t e n t i o n i s the b a l a n c e
25 These p r e f e r e n c e s n a y
long-terra trade-off.
be i n t e r - t e m p o r a l i n t h e car.e o f a
zero
the l e s s l i k e l y i t irs t h a t a o n e t a r y c o n t r a c t i o n o r d e v a l u a t i o n
w i l l be r e q u i r e d .
to
I n t h i s way t h e s t r u c t u r a l an-' n o n e t a r y
t h e b a l a n c e o f payraents bocone i n t e g r a t e d .
approaches
The i s s u e becomes
one o f c h o o s i n g bett'een a p o l i c y o f r e d u c i n g monetary demand t o a
l e v e l c o n s i s t e n t vTith r e a l o u t p u t and one o f r a i s i n g p r o d u c t i o n t o
p.eat n o m i n a l demand.
Tha s t r u c t u r a l approach '-^laces emphasis on t h e
d e f i c i e n c y o f d o n e s t i c o u t p u t i n d e v i s i n g b a l a n c e o f paynents
nolicy?.
Tlie q u e s t i o n then i s Trbether output i s independent o f
monetary f a c t o r s .
R i v e n t h e e x o g e n e i t y o f o u t p u t i n t h e monetary
model, a s t r u c t u r a l s o l u t i o n t o a b a l a n c e o f paytnents d e f i c i t i s
q u i t e c o n s i s t e n t w i t h tb>-: monetary approach,
a c c o r d i n g t o t b e s t r u c t u r a l approach
/ t the sarae t i m e ,
f i n a n c i a l p o l i c y i r b i c b does
n o t h i n g t o remedy s t r u c t u r a l c'aficienc-ias w i l l
simply conceal tbe
u n d e r l y i n g payments p r o b l e r i s i n c e i t f o r e g o e s t h e o p p o r t u n i t y o f
achieving e q u i l i b r i u n at a higher l e v e l of output.
.and
Even where
e c o n o n i c growth i s s l o * ' / cannot be a c c e l e r a t e d t b e demand f o r
money may s t i l l be i n c r e a s e d f o r example by i n c r e a s i n g t h e r a t e
of
mteraPt
on money h o l d i n g s .
26 A c c o r d i n g t o t b e monetary approach, of c o u r r e , t b e r e a l r a t e o f
i n t e r e s t i s seen as e f f e c t i v e l y g i v e n . 'Jc'^innon (l'?73) and
! apur (1975) have suggested t h a t i n I d c s and e s p e c i a l l y d u r i n g
tbe i n i t i a l s t a g e s o f a s t a b i l i s a t i o n programme, a p o l i c y o f
increas5.ng tbe i n t e r s s t r a t e pa:'f: on raonear b o l d i n p s might be
a b e t t e r way o f c r e a t i n g monetary equili.brium. than would be a
p o l i c y o f rediAcing t h e r a t e o f g r o - t h o f t h e raoney .-supply. The
r e a s o n they g5.ve i s t h a t , w h i l s t a r e d u c t i o n i n t h e money s u p p l y
(or r a t e o f groiTth o f t h a noney s u p p l y ) w i l l a d v e r s e l y a f f e c t
r e a l o u t p u t , t h r o u g h i t s impact on fir;ES wbiicli r e l y on t b e
a v a i l a b i l i t y o f bank c r e d i t , a r i s e i n t h e i n t e r e s t r a t e on
money h o l d i n g s w i l l i n d u c e an i n c r e a e e i n t h e dem.and f o r r e a l
mon«y b a l a n c e s , a r e l a t e d i n c r e a s e i n t h e s u p p l y o f r e a l bank
c r e d i t a v a i l a b l e t o f i r m s , and bence an i n c r e a s e i n r e a l output.'
T h i s argument i n f a c t begs a s e r i e s o f q u e s t i o n s . F o r e:;ample,
r r h i l s t an admiiiir.tared i n c r e a s e i n t h e r a t e o f i n t e r e s t on money
h o l d i n g s may induce an increap-e i n t h e r e a l s u p p l y o f bank c r e d i t ,
i t rcay a l s o , i f r e f l e c t e d i n s.n i n c r e a s e i.n t b e c o s t o f bank c r e d i t ,
l e a d t o a r e d u c t i o n i n t h e demand f o r bank c r e d i t .
Furthermore,
s i n c e an i i i c r a a s e i n money h o l d i n g i m p l i e s a r e d u c t i o n i n domestic
consumption, t h e demand f o r bank c r e d i t may f a l l .
Again these
i s s u e s a r e r e v i e w e d i n Chapter 3.
"
Of
3S
coTirse, even where the demand f o r raoney would e v e n t u a l l y
rise
to e c i u a l i t y i / i t h tbe s u p p l y or where the s u p p l y of raoney c o u l d ,
t i m e , be reduced t o e q u a l i t y x j i t h demand, f o r as l o n g as the
supply
o f roone" exceeds the d8r.and a ^ajments d e f i c i t T - i l l e x i s t , and
w i l l have t o be f i n a n c e d .
importantly
The
over
this
c h o i c e o f adjustment p o l i c y i s t h e n
r e l a t e d t o the tim.e-scale o f a d j u s t w e n t .
In
Idcs'
c i r c u m s t a n c e s t!ie knowledge t h a t a^!iu.?tmant would e v e n t u a l l y
occur
a u t o m a t i c a l l y ' assuviing o n l y t h a t c o u n t r i e s d e s i s t from> s t e r i l i s a t i n g
the n'onetary r e n e r c u s s i o n G o" a d e f i c i t , i s o f m i r e l y academ.ic
interest.
Such c o u n t r i e s do not have the o p t i o n o f w a i t i n g f o r thfe
l o n g run to cone.
Anotl^ier i m p o r t a n t a s p e c t o f the c o n t r o l o f m.nnetar'.' a g g r e g a t e s fro'^v
tbe v i e w p o i n t
o f the b a l a n c e of payments r e l a t e s t o the p r e c i s e methods
and
instrumaats
by '.yhicb t a r g e t s are a c h i e v e d .
may
have d i f f e r e n t s t r u c t u r a l r a m i f i c a t i o n s and
i.r>iplications f o r the b a l a n c e of payments.
the government has
Differen*" instruraents
therefore d i f f e r e n t
Thun l i m i t i n g c r e d i t t o
d i r e c t implications for f i s c a l p o l i c y since
government i s l i k e l y to be r e l i a n t on the b a n k i n g sy/stera to
i t s budget d e f i c i t s .
respects
the
finance
Indeed as \ms shoTTi i n c h a p t e r 3 i n c e r t a i n
f i s c a l d i s e q u i l i b r i u m nay
be viewed a- a more fundamental
27
cause o f b a l a n c e of r:ayA;iC:!nts d e f i c i t s than monetary
I'eyj'ond tbe s o c i a l and
betr/een v a r i o u s
p o l i t i c a l dimensions o f f i s c a l a c t i o n s the
t a x and
o f income, the p a t t e r n of demand and
the
choice
e x p e n d i t u r e measures w i l l have an impact
the br.lance o f p a y r e n t s t h r o u g h t h e i r e f f e c t s on tbe
by m a i n t a i n i n g
disequilibrium.
availability
relative prices,
of c r e d i t f o r
on
distribution
''^urthex-nore,
investment rather than
f o r c o n s u n n t i o n a more marked i n p r o v e t i e n t i n the b a l a n c e c f pay^rients,
^ ani^ indeed the r a t e o f economic c^rovrtb, may
be
be
i.nduced t h a n would
the cane i f p o l i c y were to show no d i s c r i m i n a t i o n i n tbe use
f i n a n c e , thougb, a p o l i c y o f
this
type raa-;' be more d i f f i c u l t
of
to
implement p o l i t i c a l l y .
27 F o r f u r t h e r a n a l y s i s o f tba f i f ; c a l approach to the b a l a n c e o f
paynents see fhar^-ley (1Q?1) and M i l e (I97r-,). L a k e r (1981) shows
how f i s c a l p o l i c y may be used to generate b o t h p a r t i a l and
g e n e r a l e q u i l i b r i u m e f f e c t s s i ' a i l a r t o t h o s e of d e v a l u a t i o n .
I t i s then c l e a r l y a n i s t a k e
t o r e g a r d monetary c o n t r o l as a one-
d i m e n s i o n a l , u n s u b t l e and i n f l e x i b l e apyroacb t o the b a l a n c e o f
payraents.
Exchange c o n t r o l s
Controls
Idcs i n a t t e r p t n t o d e a l v j i t h
have been e : s t e n 3 i v s l y used
t h e i r nayments d i f f i c u l t i e s , though they a r e u n n o p u l a r w i t h t h e Fund
w h i c h iieer; them as i n t e r f e r i n g w i t h t h e p u r s u i t o f a l i b e r a l
of t r a d e and paymients, and as d i s c o u r a g i n g
adjustvaent.
system
Generally
s p e a k i n g t h e phrase ' c o n t r o l s ' r e f e r s t o some form o f exchange
c o n t r o l whereby f o r e i g n exchange r e c e i p t s bava t o be s u r r e n d e r e d t o
the monetary a u t h o r i t i e s -^ho, i n a d d i t i o n , have t o s a n c t i o n a l l
f o r e i g n e xhange pa^rients,
c a p i t a l account t r a n s a c t i o n s
Exchange c o n t r o l s may a l s o be imposed on
such as o v e r s e a s i n v e s t m e n t .
29 K r i i e g e r (1973) c a t a l o g u e s a v a r i e t y o f i n s t r u m e n t s t h a t may be
used i n o p e r a t i n g
regimes, these i n c l u d e ;
Guarantee depo'^its, v a r y i n g
o f import l i c e n s e s .
i n ac£»unt f o r d i f f e r e n t
categories
T a r i f f s and s u r c h a r g e s .
Licenses for d i f f e r e n t categories
c r i t e r i a and p r o c e d u r e s .
o f i m p o r t s a l l o c a t e d by d i f f e r e n t
P r o h i b i t e d l i s t s , f r e e l i s t s , and r j p e c i a l exemptions.
F.egulation
and l i c e n s i n g o f e x p o r t s .
V a r i o u s i n c e n t i v e s , sometimes p r o j e c t - s p e c i f i c , t o encourage
private capital infloirs.
R e s t r i c t i o n s on t h e r e p a t r i a t i o n o f p r o f i t s and d i v i d e n d s o f
forei-ai-OT/ned f i r m s .
Import r e p l e n i s h m e n t schemes a p p l y i n g
Rebates on i m p o r t d u t i e s f o r
t o some
exports.
exports.
Rights granted to exporters to r e s e l l part of t h e i r f o r e i g n
exchange e a r n i n g s .
P-pecial regimes f o r government e n t e r p r i s e s .
M u l t i p l e exchange r a t e s , i n c l u d i n g s p e c i a l t o u r i s t r a t e s ,
exT:ort s u b s i d i e s , and s p e c i a l im.port c a t e g o r i e s s u b j e c t t o
'- exchange a u c t i o n .
Subsidies
f o r c a p i t a l goods i m j j o r t s .
Loxr-intarest loans f o r c e r t a i n classes of transactionrs.
The
debate over c o n t r o l s u l t i m a t e l y binRes on an assessment of
e f f i c i e n c y o f the market r.ecbanism and
the
r a i s e s t h a whole range of
i s s u e s a s s o c i a t e d w i t h government i n t e r v e n t i o n .
Those who
believe
i n the r e l a t i v e e f f i c i a n c y o f the p r i c e s y s t e n as a T'ay o f a l l o c a t i n g
s c a r c e r e s o u r c e s oppose c o n t r o l s an-^ p r e f e r market r e l a t e d p o l i c i e s ,
w h i l e those who
emphasise iimrket f a i l u r e i n the a r e a of monopoly,
e x t e r n a l i t i e s , and
income d i s t r i b u t i o n , are more l i k e l y to f a v o u r
controls.
More s p e c i f i c a l l y , c o n t r o l s are seen by t h e i r a d v o c a t e s as h a v i n g a
number of advantages over o t h e r o o l i c i e s such as d e v a l u a t i o n
o r demand
d e f l a t i o n , of w h i c h the f o l l o w i n g are the most s i g n i f i c a n t .
First,
c o n t r o l s e x e r t a prompt, d i r e c t and p r e d i c t a b l e e f f e c t on
They do not r e l y on t':e i n t e r m e d i a t i o n
on the e x i s t e n c e
payments,
imports.
o f a p r i c e change and
therefore
of p r i c e e l a s t i c demand t o improve the b a l a n c e o f
f'econd, they nay be imposed s e l a c t i v e l y , a l l o w i n g
a u t h o r i t i e s to d i s c r i n i n a t e between i m p o r t s .
w i l l be e x e r c i s e d
against
the
Normally d i s c r i m i n a t i o n
the importati.on o f ' i n e s s e n t i a l ' consumer
goods w h i c h a r e r e g a r d e d ar; making a minimuri c o n t r i b u t i o n
economic d e v s l o p n e n t .
F r o n the
vieTp^oint
of development,
therefore,
c o n t r o l s appear as a means of raakitig the most e f f i c i e n t use
scarce
f o r e i g n exchange.
c o n t r o l s do not valy
i n i m p o r t s and
paaanents.
of
T h i r d , as compared " i t h demand d e f l a t i o n ,
on a f a l l
i n n a t i o n a l income t o induce a
fall
t o b r i n g about an improvement i n the b a l a n c e o f
Furthertaora,
the a l l o c a t i o n o f import l i c e n c e s may
be
used
t o finaure t h a t a g i v e n improvement i n the b a l a n c e of payments has
minim\im a d v e r s e e f f e c t on
A g a i n s t thi,? a p p a r e n t l y
the
the
poor.
s t r o n g case a number of counter-arguments
npy
be p r e s e n t e d .
F i r s t , i n many I d c s t h e r e nay be l i t t l e
for
c u t t i n g s^own on I n e s s e n t i a l s even i f i t were p o s s i b l e t o i d e n ' t i f y what
i m p o r t s are i n e s s e n t i a l .
scope
Second, c o n t r o l s i n n l y a complex
a d m i n i s t r a t i v e system w h i c h , even i f i t wcrks a s . i n t e n d e d , w i l l
be
e^q.')enr>ive i n r e s o u r c e c o s t s .
Further,
w i l l not work as i n t e n d e d and
that i n p r a c t i c e 'national o b j e c t i v e s '
w i l l n o t be s e r v e d .
F a r t of tbe problem, h e r e i s t h a t the
encourages c o r r u p t i o n and
( K i l l i c k , I???-.
t h e r e i s tbe danger t h a t i t .
tbe p r o v i s i o n of i n a c c u r a t e
F u r t h e r m o r e , i t 'wMl
system
information
tend to l e n g t h e n the
lag
-
Al
-
between the need f o r p a r t i c u l a r i m n o r t s a r i s i n g and t h a t need
a c t u a l l y b e i n g met.
Such d e l a y s w i l l cause s h o r t a g e s and the under
u t i l i s a t i o n of c a p i t a l .
i n d i r e c t l y encourage
The l a t t e r may
also result i f controls
f i r m s t o b u i l d l a r g e r than optimum s c a l e p l a n t s
i n o r d e r to o b t a i n e x t r a a l l o c a t i o n s o f f o r e i g n . excaanf;e; e v i d e n c e
a g a i n s u g g e s t s t h a t some f i r m s i n I d c s have behaved-in such a way
( S t e r n and F a l c o n , 1970).
Furthermore by a d v e r s e l v a f f e c t i n g tbe
Cro--:'th of e x p o r t e a r n i n g s c o n t r o l s may
i n p a r t i c u l a r accentuate
excess c a p a c i t y i n tbe i n d u s t r i e s u s i n g i m p o r t e d m . a t e r i a l s ,
(rhagTC'ati, 1978).
of
However, Tihag^rati c o n c l u d e s t h a t the o v e r a l l
c o n t r o l s on excesr; c a p a c i t y may n o t be
effect
substantial.
Tb.e moct fundamental c r i t i c i s m , o f c o n t r o l % i i s t h a t tbey suppress
29
r a t h e r than c u r e a paypients problem.
An i m p l i c a t i o n o f t h i ^ i s
t h a t , s h o u l d tb.e c o n t r o l s be removed, the - r o b l e m w i l l
a g a i n become
a p p a r e n t ; as a r e s u l t , once i n t r o d u c e d c o n t r o l s a r e r a r e l y abandoned.
Even
f t h e r e i s an u x i d e r l y i n g improvenant
i n tbe b a l a n c e o f pajToents
due, s a y , to an inirrovement i n the cor^imodity terms o f t r a d e , o t h e r
f a c t o r s encourage
t b e i r r e t e n t i o n , such as tbe p r o t e c t i o n o f l o c a l
i n d u s t r y o r the c o n t i n u a t i o n o f tiie b e n e f i t s wTdch c o n t r o l s
generate f o r p o w e r f u l i n t e r e s t groups.
\:orrying s t i l l
may
The s i t u a t i o n may be m.ore
i f c o n t r o l s , f a r from 5.mprovin^ the u n d e r l y i n g
paynaents p o s i t i o n , a c t u a l l y make i t worse.
The c h i e f purpose
of
c o n t r o l s i s to reduce i m p o r t s below what they would other-rise have
been a t a g i v e n exchange r a t e to s h i f t do^mwards the deraard f o r
f o r e i g n exchange.
T h i s e f f e c t i s a c h i e v e d n o t by r e d u c i n g the
i n c e n t i v e to import b u t by f r u s t r a t i n g i t .
''either do
do a n y t h i n g to r a i s e the in.c<?.ntive t o e x p o r t .
controls
Indeed, because
c o n t r o l s s e r v e t o defend on ovar-^'alued exchange r a t e they)
d i s c r i m i n a t e a g a i n s t e x p o r t s by k e e p i n g tbe p r o f i t a b i l i t y of e x p o r t i n g ,
e x p r e s s e d i n domestic c u r r e n c y , below wr.at i t would be w i t h a lower
exchange r a t e .
A l t h o u g h , in p r i n c i p l e , the adverse e f f e c t
on
e:rport performance might be n e u t r a l i s e d through a system of e x p o r t
2? E m p i r i c a l e v i d e n c e suggests t h a t t h e r e i s no guarantee t h a t
c o n t r o l s w i l l improve the b a l a n c e of payments; i n d e e d Krueger
(1975) found t h a t i n the case o f Turkey the b a l a n c e o f payraents
a c t u a l l y d e t e r i o r a t e d f o l l o w i n g the i r r . o s i t i o n o f c o n t r o l s .
s u b s i d i e s e v i d e n c e suggests t h a t , i n p r a c t i c e , these are
p r o b l e m a t i c a l , not
themselves
l e a s t because they o f t e n tend t o d i s c r i m i n a t e i n
f a v o u r of h i g h c o s t and r e l a t i v e l y i n e f f i c i e n t e x p o r t s , and
more e f f i c i e n t t r a d i t i o n a l e x p o r t s
The
( S t a e l i n , 1974
against
, F r a n k e n a , 1975),
apparent advantage of c o n t r o l s t o d i s c r i m i n a t e a g a i n s t i n e s s e n t i a l
im.r)orts may
t u r n out t o be a mixed b l e s s i n g s i n c e , a l t h o u g h such
d i s c r i m i n a t i o n may
h e l p t o keep dovm the p r i c e s of ' e s s e n t i a l s ' and
t h e r e f o r e be of a t l e a s t s h o r t term b e n e f i t t o consumers, by
r a i s i n g the r e l a t i v e p r i c e of i n e s s e n t i a l s t h r o u g h r e d u c i n g
supply
t h e i r domestic production
w i l l be encouraged.
effectively
their
As a r e s u l t
c o n t r o l s have an 'import s u b s t i t u t i o n b i a s ' p u s h i n g an economy towards
i m p o r t s u b s t i t u t i o n r a t h e r than e x p o r t e x p a n s i o n , ' T h i s i s the major
underlying
theme of the Ehapwati'
and
Krueger'
volumes where i t
a l s o found t h a t i m p o r t s t i b s t i t u t i o n i s not the b e s t development s t r a t e g y
since exports
a r c a more e f f i c i e n t engine f o r s u s t a i n a b l e growth,
Ho!/ever, i t may
s t r a t e g y f o r any
be t h a t the p o t e n t i a l s u c c e s s of an e x p o r t e x p a n s i o n
i n d i v i d u a l Idc may
d e c l i n e as more Idcs t r y t o
follow i t .
A g a i n , as f a r as d i s t r i b u t i o n a l consequences are c o n c e r n e d , e v i d e n c e
from the Bhagrjati-Krueger
p r o j e c t suggests t h a t c o n t r o l s have the
e f f e c t of promoting c a p i t a l i n t e n s i v e i m p o r t s u b s t i t u t i o n , r a i s i n g
the c a p i t a l - l a b o u r r a t i o (as d u t i e s on the i m p o r t a t i o n of
goods are k e p t low t o p r o t e c t i n v e s t m e n t ) and
I'Jhile, i n p r i n c i p l e , c o n t r o l s m.ay
i n c r e a s i n g unemployment,
narrow income i n e q u a l i t i e s by
d i s c r i m i n a t i n g against staple a g r i c u l t u r a l exports
whether these e x p o r t s
capital
depending
on
are based on l a r g e o r s m a l l l a n d h o l d i n g s ,
same source s u g g e s t s t h a t such i n s t a n c e s are i n f a c t q u i t e few
the
and
t h a t income d i s t r i b u t i o n i s i n the l o n g r u n d e t e r m i n e d l a r g e l y by
v a r i a b l e s o t h e r t h a n the t r a d e and payments ref'ime.
At the same t i m e , l i c e n c e s have the e f f e c t of g r a n t i n g an economic
r e n t t o t h o s e r e c e i v i n g tbe l i c e n c e s , a r e n t t h a t , a c c o r d i n g
some o b s e r v e r s ,
r e c i p i e a i t s w i l l be w i l l i n g t o share w i t h
to
officials
3'> Ho'Tever t h e r e i s e v i d e n c e t o suggest t h a t i n the case of South
Korea the e x t e n s i v e use of e x p o r t s u b s i d i e s i m p a r t e d an e x p o r t
b i a s , ( F r a n k , K i n and T'estphal),
who i s s u e the l i c e n c e s .
The r e n t t o l i c e n c e e s r e f l e c t s an
a d d i t i o n a l c o s t t o consumers and m i l i t a t e s a g a i n s t
e f f i c i e n c y and e q u a l i t y .
competition,
To o f f s e t t h e s e d i s t r i b u t i o n a l
consequences o t h e r measures may, i n p r i n c i p l e , be
introduced,
i n c l u d i n g p r i c e c o n t r o l s , t a x e s on import l i c e n c e s , o r t h e a u c t i o n i n g
of l i c e n c e s so t h a t t h e r e n t i s t r a n s f e r r e d t o the government.
However, t h e r e i s no guarantee t h a t p r i c e c o n t r o l s w i l l be e f f e c t i v e
and
they a r e c e r t a i n l y n o t u n p r o b l e m a t i c ; t a x e s on l i c e n c e s w i l l n o t
do a n y t h i n g
t o reduce t h e f i n a l
p r i c e p a i d b y consumers; n e i t h e r
w i l l the a u c t i o n i n g o f l i c e n c e s w h i c h i s "also subjae£'to o t h e r
as e v i d e n c e on t h e i r use i n B r a z i l c o n f i r m s ( K i l l i c k , 1980).
"difficulties
Structuralist prescriptions
C t r u c t u r a l i s t s put emphasis on i m p r o v i n g the b a l a n c e o f payTiients
by r a i s i n g aggregate s u p p l y and by changing t h e c o m p o s i t i o n of
aggregate demand r a t h e r t h a n by r e d u c i n g
demand.
Thus a t t e n t i o n i s f o c u s s e d
productive
used.
t h e l e v e l of aggregate
on p o l i c i e s t h a t w i l l r a i s e
p o t e n t i a l and t h e e f f i c i e n c y w i t h w h i c h r e s o u r c e s a r e
By t h e i r v e r y n a t u r e such p o l i c i e s tend t o be m i c r o -
economic r a t h e r than macroeconomic, and r e l a t e g e n e r a l l y t o r e l a t i v e
p r i c e s and i n d i v i d u a l s e c t o r s o f t h e economy, such as a r i c u l t u r e ,
where supply' b o t t l e necks a r e seen as a major cause o f d i s e q u i l i b r i u m ,
S t r u c t u r a l p o l i c i e s may i n v o l v e changing-the ovmershin o f the
factors of production,
degree o f c o m p e t i t i o n
and
A
f a c t o r m o b i l i t y , wage b a r g a i n i n g , t h e
and monopoly, t h e a c t i v i t i e s of m u l t i n a t i o n a l s ,
t h e d i s t r i b u t i o n of o u t p u t between consumption and i n v e s t m e n t ,
probleiB
w i t h p o l i c i e s o f t h i s k i n d i s t h a t they tend t o e x e r t
t h e i r impact on t h e b a l a n c e of payments o n l y i n the l o n g r u n , and
may, i n d e e d , have an adverse e f f e c t i n t h e s h o r t r u n . S t r u c t u r a l
p o l i c i e s t h e r e f o r e need t o be accom.panied by. demand management
p o l i c i e s t o ensure t h a t aggregate demand does n o t exceed any g i v e n
l e v e l of aggregate s u p p l y ,
of s t r u c t u r a l p o l i c i e s ) .
(see c h a p t e r ?> f o r f u r t h e r d i s c u s s i o n
IV
CONCLUSIONS
In t r y i n g t o d e v i s e a b a l a n c e of paymients p o l i c y a governaent
f i r s t has t o determine
whether the d e f i c i t i s temporary o r permanent.
T h i s , i n t u r n , e n t a i l s a s s e s s i n g the causes o f the
deficit.
A l t h o u g h d i f f e r e n t t h e o r i e s l a y emphasis on d i f f e r e n t a s p e c t s of
c a u s a t i o n - and i n the case o f the inonetary approach e x c l u s i v e
emphasis on one aspect - i t i s s e n s i b l e f o r a c o u n t r y ' s
to
l o o k a t a l l dimensions
o f the b a l a n c e of payraents,
TT^iere t h e
d e f i c i t appears t o be temporary c o r r e c t i v e measures may
needed and the d e f i c i t may
be f i n a n c e d .
authorities
not
be
However, f o r many I d c s
s u f f i c i e n t f i n a n c i n g i s not a v a i l a b l e so t h a t c o r r e c t i v e p o l i c i e s
w i l l have t o be pursued
even f o r temporary d e f i c i t s .
G e n e r a l l y s p e a k i n g c o r r e c t i v e p o l i c i e s w i l l be r e q u i r e d e i t h e r
i f t h e d e f i c i t i s permanent o r i f s e l f c o r r e c t i o n i s l i k e l y too be
slow g i v e n a c o u n t r y ' s access t o f i n a n c e .
Thus, v/hile some v e r s i o n s
o f the monetary approach s t r e s s the l o n g r u n a u t o i a a t i c c o r r e c t i v e
mechanista c o n s t i t u t e d by the f i n a n c i a l f l o w s i n d u c e d hj
payments
d i s e . - u i l i b r i a , the IIlF's a t t e n t i o n t o s h o r t r u n adjustment p a t h s
and p o l i c i e s i s o f more p r a c t i c a l r e l e v a n c e .
The next i s s u e r e l a t e s t o the c h o i c e of p o l i c y .
s a i d i n t h i s paper t o suggest
Enough has been
t h a t a s t a n d a r d p o l i c y o r package o f
p o l i c i e s i s u n l i k e l y t o be a p p r o p r i a t e f o r a l l I d c s i n a l l c i r c u m s t a n c e s ;
p o l i c y s h o u l d be made t o match s p e c i f i c c o u n t r y c o n d i t i o n s .
Similarly,
however, i n an
environment of
slow economic gro^7th
i n d i v i d u a l p o l i c y o r package of n o l i c i e s w i l l
of
pajTnents
improve the
few c i r c u m s t a n c e s
i s to minimise
to
balance
u n l e s s the c o u n t r y a c c e p t s t h a t adjustment i n v o l v e s
r e a l c o s t s i n terms o f consumption and/or i n v e s t m e n t .
necessary
no
i s there a zero cost o p t i o n .
In very
Tbe p o l i c y p r o b l e m
t h e c o s t s o f adjustment x'hile s t i l l a c h i e v i n g t h e
improvement i n the b a l a n c e o f payraents.
the debate over ' g r a d u a l i s m ' v e r s u s
'shock
T h i s l e a d s on
treatment'.
G r a d u a l i s t s argue t h a t ' b y s p r e a d i n g adjustment over a r e l a t i v e l y
l o n g p e r i u d of time the a s s o c i a t e d w e l f a r e c o s t s may
a minimum.
By c o n t r a s t
those
that t h i s w i l l i n f a c t minimise
be k e p t t o
^^ho f a v o u r r a p i d adjustment argue
c o s t s over the l o n g r u n , e s p e c i a l l y
where e x p e c t a t i o n s a r e r a t i o n a l r a t h e r than a d a p t i v e .
T u r n i n g t o s p e c i f i c p o l i c i e s fev/ would deny t h a t monetary r e s t r a i n t
i s necessary to bring
All
about an iriproveraent
i n t h e b a l a n c e o f payments.
b a l a n c e o f p a y n e n t s t h e o r i e s suggest t h a t an o v e r l y
rapid
e x p a n s i o n i n d o n e s t i c c r e d i t w i l l have a n adverse e f f e c t on t h e
e x t e r n a l b a l a n c e and t h e r e does n o t appear t o be any e v i d e n c e
w i t h t h i s view.
at issue.
inconsistent
The imnortance o f sound monetary p o l i c y i s then n o t
S i m i l a r l y , there i s l i t t l e
doubt i n p r i n c i p l e t h a t
credit
p o l i c i e s may be c o n c e i v e d t h a t x,rill improve t h e b a l a n c e o f payments.
The
s t r i c t e r and more r e s t r i c t i o n a r y a r e these p o l i c i e s t h e more
r a p i d w i l l tend t o be t h e improvement.
the degree o f r e l i a n c e
I n s t e a d , What i s a t i s s u e i s
t h a t s h o u l d be p l a c e d on monetary p o l i c y
alone.
T h i s i s s u e i n v o l v e s fjo i n t e r - r e l a t e d a s p e c t s : whether monetary n o l i c y
i s c a o a b l e o f d e a l i n g w i t h t b e b a s i c causes o f t h e p r o b l e m ; and
whether
there are a l t e r n a t i v e
i n s t r u m e n t s w h i c h would be more e f f i c i e n t
i n a c h i e v i n g t h e improvement a t lower c o s t .
A c c o r d i n g t o t h e monetary
approach c r e d i t policy/ does s t r i k e a t t h e r o o t cause o f t h e problem.
A c c o r d i n g t o t h e s t r u c t u r a l approach, however, i t w i l l do l i t t l e t o
improve t b e u n d e r l y i n g e c o n o n i c s i t u a t i o n , and may make i t worse by
i n i t i a l l y d i s c o u r a g i n g b o t h t h e i m p o r t a t i o n o f developmental goods and
the e x p a n s i o n o f e j q ) c r t s .
Cince monetary p o l i c y e x e r t s i t s prime
e f f e c t on a b s o l u t e r a t h e r than r e l a t i v e p r i c e s
incentive
i t w i l l create
little
f o r t h e r e a l l o c a t i o n o f r e s o u r c e s , though t h e manner i n w h i c h
monetary p o l i c y i s o p e r a t e d w i l l have s t r u c t u r a l consequences.
A
s t r u c t u r a l approach i s i n one sense c o n s i s t e n t w i t h t h e monetary
approach s i n c e i f s t r u c t u r a l changes r a i s e r e a l output and income
t h e y w i l l a l s o r a i s e t h e demand f o r noney.
o n l y l^ecomes i n c o n s i s t e n t
.Ttructural
The s t r u c t u r a l approach
x/ith t h e monetary approach where such
changes r e q u i r e a d d i t i o n a l
government e x p e n d i t u r e , a l a r g e r
f i s c a l d e f i c i t and a more r a p i d r a t e o f c r e d i t c r e a t i o n
run.
i n the s h o r t
Tbe problein i s then t h a t s t r u c t u r a l p o l i c i e s may take more time
t o have t h e i r e f f e c t s
than
ir- a v a i l a b l e .
A t t e n t i o n t h e n f o c u s s e s on
m i n i m i s i n g any s t r u c t u r a l damage t h a t n a y be done ^^erhaps by i n t r o d u c i n g
greater discrimination
or q u a l i t a t i v e control
into credit
policy.
Some s t r u c t u r a l change ' r i l l be encouraged through the r e l a t i v e
effects
price
o f d e v a l u a t i o n which r a i s e the p r o f i t a b i l i t y of producing
t r a d e d goods.
A t tbe same time t h e r e a r e c i r c u n s t a n c e s i n x^hi.ch
demand
d e v a l u a t i o n m.ll e x e r t a s h o r t r u n / d e f l a t i o n a r y e f f e c t , althoxi<;h t h e
e f f e c t of d e v a l u a t i o n i n raisi.ng p r i c e s i s c o n s i s t e n t w i t h at l e a s t
a m i l d v e r s i o n o f the monetary approach.
Roth i n terms o f t h e o r y
and e v i d e n c e d e v a l u a t i o n appears on b a l a n c e t o be a u s e f u l i n s t r u m e n t
in developing countries.
Domestic
i n e f f i c i e n c y and
structural
i m m o b i l i t y , as w e l l as a f a i l u r e t o adopt a p p r o p r i a t e e x p e n d i t u r e
measures, may,
however, f r u s t r a t e i t s b e n e f i c i a l impact on the b a l a n c e
of payments, and i t s e f f e c t i v e n e s s w i l l v a r y betTieen c o u n t r i e s .
As w i t h a l l forms o f demand management, the n e g a t i v e e f f e c t s on
v a r i a b l e s may
be m i n i m i s e d by measures d i t e c t e d torrards i n c r e a s i n g
aggregate s u p p l y , aiid i n th'':3 sense management o f demand and
a r e complementary and not a l t e r n a t i v e
C o n t r o l s may
pay^Tnents,
real
supply
policies.
e x e r t a s i g n i f i c a n t s h o r t terra impact on the b a l a n c e of
However, they do l i t t l e t o r e s o l v e the u n d e r l y i n g causes o f
a pay^aents d e f i c i t and seem i n d e e d o f t e n t o m i l i t a t e a g a i n s t e x p o r t
expansion.
V a r i o u s p o l i c y t o o l s such as e x p o r t s u b s i d i e s ,
m u l t i p l e exchange r a t e s and p r e f e r e n t i a l c r e d i t may
tariffs,
a l s o be used t o
c o r r e c t s t r u c t u r a l problems, but these ma;" i.nvolve c e r t a i n
microeconomic
d i s t o r t i o n s and r e s o u r c e m i s a l l o c a t i o n s - though i t s h o u l d be reifiembered
t h a t second b e s t s o l u t i o n s may
and i n any case are d i f f i c u l t
be
a p p r o p r i a t e i n Idc c o n d i t i o n s -
t o implement s u c c e s s f u l l y .
U n d e r l y i n g a l l d i s c u s s i o n of the b a l a n c e o f paja^ients are
two
r e l a t i o n s h i p s : f i r s t between f i n a n c i n g pay/raents and the speed of
and second between the speed and c o s t s o f a d j u s t m e n t .
adjustment:
B a l a n c e o f paytnents
p o l i c y i n I d c s i s u s u a l l y conducted i n a s i t u a t i o n where the amount
of
finance available dictates r e l a t i v e l y rapid adjustnent.
t u r n tends t o r u l e out c e r t a i n s l o w e r a c t i n g p o l i c i e s and
problem becomes t h a t o f m i n i m i s i n g adjustment
the necessary f i n a n c e .
the
the
costs,and a t t r a c t i n g
I f I d c s ' b a l a n c e o f payraents problems
terra t h e y need l o n g term f i n a n c e .
tbe ItlF,
This i n
are long
I n n a n y cases what they have got i s
However, f i n a n c e f r o n the Fund i s e s s e n t i a l l y temporary,
and
b a l a n c e o f payments t h e r e f o r e has t o be nade v i a b l e o v e r a s h o r t
p e r i o d o f t i m e , and t h i s i m m e d i a t e l y im.po3es s t r i c t
range o f s t a b i l i s a t i o n p o l i c i e s which n a y be
used.
c o n s t r a i n t s on the
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