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Exchange Rates

The Growth Report, str. 49-51

Commission on Growth and Development

Exchange Rates

In the developing world, most governments and central banks feel they cannot afford to take their eye off the foreign value of their currency. But efforts to shepherd exchange rates are as controversial as industrial policies. Indeed, they can be thought of as a form of industrial policy. If a government resists an appreciation of the currency, or if it devalues, it is, in effect, imposing an across-the-board tax on imports and providing a subsidy to exports.

Economists have lined up equally passionately for and against such policies. Max Corden describes them as a kind of protectionism. Others, such as Bela Balassa, thought they held the key to development. This is how John Williamson, a fellow at the Peterson Institute for International Economics, has described Balassa’s position: “give [a country] an exchange rate suffi ciently competitive that its entrepreneurs are motivated to go and sell on the world market, and it will grow. Give it too much easy money from oil exports, or aid, or capital infl ows, and let its exchange rate appreciate in consequence, and too many people with ability will be diverted from exporting to squabbling about the rents, and growth will be doomed.”19

Many of the countries that enjoyed sustained, high growth have shared Balassa’s exchange rate convictions at various times. To keep the currency competitive, they have regulated the amount and type of capital fl owing across their borders. They have also accumulated foreign reserves in the central bank. A mixture of the two policies was normal.

The use of exchange rates for “industrial policy,” that is to maintain export competitiveness, has the advantage of being neutral between industrial sectors. It does not make big demands on government discretion and expertise. However, it has its own costs and risks.

For one thing, these policies can limit the amount of capital a country imports from overseas. This raises the cost of capital, which will tend to reduce investment. Indeed, these policies create an interesting trade-off. They make investment in the export sector more appealing. But they simultaneously make capital less readily available.20

Second, management of the exchange rate is sometimes used as a substitute for productivity-enhancing investments in education and human capital or for other crucial elements of a growth strategy, such as inbound knowledge transfer. When used in this way, it results in growth, purchased at the price of very low wages commensurate with equally low productivity levels.

Third, where surplus labor is no longer available, or labor unions are strong, an undervalued exchange rate may lead to higher pay demands and a wage-price spiral that is detrimental to sustained growth prospects.

At best, management of the exchange rate can be used for two purposes. One is to tip the balance slightly in favor of exports in the early stages of growth, to overcome informational asymmetries and other potential transitory frictions. The other is to prevent a surge of capital infl ows (which may be transitory) from disrupting the profi tability and growth of the export sectors.

If pursued to extremes, holding the exchange rate down will result in a big trade surplus. This is not in the country’s own interest, as it involves forsaking current consumption in order to lend to foreigners. Nor will surpluses go down well with the neighbors. By keeping its currency cheap, a country makes its trading partners’ currencies more expensive. When a large country like China does this, it does not escape notice. Trade partners, who feel China’s exporters enjoy an unfair advantage, may threaten to retaliate with tariffs. That is in no one’s interest.

Is “export promotion” a polite term for crude mercantilism? In the 18th century, some European powers thought the goal of economic statecraft was simply to sell more to foreigners than you bought from them, resulting in a trade surplus and an infl ow of gold bullion.

The case of high-growth economies is different. To catch up with the advanced economies, countries will need to increase the size of their export sector, so that exports as a percentage of GDP will increase. But that is only one side of the ledger. On the other side, imports can and should also increase. The goal of an export-led strategy is not to increase reserves or to run a trade surplus. It is to increase exports to enable incremental productive employment, larger imports, and ultimately faster growth. (See also our discussion of the “adding-up” problem in part 4.)

The more a country earns from its exports, the more it can afford to benefi t from imports, especially the equipment and machinery that embody new technologies. If, on the other hand, exports fl ag, the shortage of foreign exchange will limit what a country can buy-in from abroad and hamper its progress.

As with other forms of export promotion, exchange rate policies can outlive their usefulness. If the currency is suppressed by too much or for too long, it will distort the evolution of the economy by removing the natural market pressure for change. The cheap currency will tend to lock activity into labor-intensive export sectors, reduce the return to upgrading skills, and eventually harm productivity as a result. Like other industrial policies, a keenly priced currency is supposed to solve a specifi c, transitory problem. Eventually, as an economy grows more prosperous, domestic demand should and usually does play an increasingly important role in generating and sustaining growth. Exchange rate policy should not stand in the way of this natural evolution.

19 Williamson, John. 2003. Review of “Too Sensational” by Max Corden. Journal of Economic Literature

41(4): 1289–90.

20 Williamson, John. 2003. “Exchange Rate Policy and Development.” Initiative for Policy Dialogue.

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