New Structuralist Exchange Rate Policy

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    New-Structuralist Exchange-Rate Policy and the Pattern of Specialization in Latin American Countries  Ariel Dvoskin, Germán David Feldman, and Guido Ianni Centro Sraffa Working Papers n. 28 February 2018 ISSN: 2284 -2845 Centro Sraffa working papers [online]  1 New-Structuralist Exchange-Rate Policy and the Pattern of Specialization in Latin American Countries Ariel Dvoskin a , Germán David Feldman b , & Guido Ianni a   a CONICET  –   IDAES/UNSAM b  IDAES/UNSAM Abstract The present article critically examines the transmission channels between the real ex-change rate and output growth adduced by the so-called New-Structuralist doctrine. It is shown that the assumptions under which the mechanisms work are highly restrictive, and hence, are generally inadequate to explore the problem of economic development in Latin American peripheral countries. In view of this, the potential risks associated with a policy of devaluation are warned. Keywords: Dual economies; Economic growth; New-Structuralism; Pattern of Special-ization; Real Exchange Rate JEL Codes: B22; E11; F43 1.   Introduction 1   In the last years, we have witnessed the emergence of a vast literature on development models for peripheral economies, known as «  New-Structuralism » 2  (henceforth, NS), 1  A  preliminary version of this article was presented at the 2nd New Developmentalism’s Workshop, ‘Theory and Policy for Developing Countries’, São Paulo, August 4 -5, 2017 and at Research Seminar of the Institute of Economics  –   Federal University of Rio de Janeiro (IE-UFRJ), August 8, 2017. We would like to thank the participants of both events for their comments and suggestions. We would also like to thank Saverio Fratini and an anonymous referee for their constructive comments and suggestions. All the remaining errors are ours. 2  The term «New-Structuralism» has been employed in the literature in a broader sense: it refers to the contributions of the Economic Commission for Latin American Countries (ECLAC) in different fields of economics, from the 1990 onwards (structural reforms, globalization, innovation, macroeconomic volatil-ity, etc; for a revision of this literature, see Bielschowsky, 2009). Here however, we will only discuss those works that, following ECLAC’s tradition, explore the link between exchang e rate policy and eco-nomic growth. The main proponents of this view are Ros and Skott (1998), Frenkel and Ros (2006), Ro-drik (2008), Razmi, Rapetti, and Skott (2012), Rapetti (2013, 2016), Neto and Lima (2017), Ros (2016), and Damill and Frenkel (2017).  2 which views the real exchange rate as the key  variable to achieve sustained economic growth. To formalize this view, NS has recourse to a « dual economy » model, a notion firstly introduced by Lewis (1954), and identifies two strikingly different productive sectors within a peripheral economy: a sector of high productivity, able to compete in the international markets at current prices (sector T, or the « tradable sector  » ) and a sec-ond sector of low productivity, which is forced to sell its output in the domestic market (sector NT, or the « non-tradable » sector). 3  The fact is that sector T, typically the indus-try, is also envisaged as the most dynamic sector in terms of job creation, innovation and productivity growth. In the short run, a rise in the exchange rate would accelerate economic growth mainly through its expansionary effects on employment and exports of sector T. In the medium run, the increase in the relative profitability of the most dy-namic sector would induce a rise of its share in output. Finally, in the long run, the higher average rate of profits would trigger a profit-led-growth path. 4  The objective of this article is to critically assess the transmission channels adduced  by NS. To this end, in section II we present a model for a small peripheral economy opened to trade and capital flows that will allow us a) to examine the mechanisms en-visaged by this literature to ascertain a relationship between distribution and growth and  b) to characterize the pattern of specialization of the economy as a particular problem of choice of techniques. In regard to objective a), we will see in section III that NS presents three kinds of limitations. First, when the so-called « short-term »  effects are addressed, a high real-wage elasticity of labour demand is assumed without sufficient justification, coupled with a demand for exports that is able to absorb any excess of production over internal consumption. Second, we also find problems with the « medium »  and « long-term »  mech-anisms. Here, not only is it assumed that investment demand is able to avoid any reali-zation problem, but, more generally, the approach is incompatible with the uniformity of returns on capital in an economy that is fully opened to capital flows. Finally, we show that the results in terms of employment and production are indeterminate  , since the possibility of wage inflation indirectly caused by devaluation (namely, through its effects on output and employment) may eventually revert the allegedly positive effects on growth. As regards objective b), the determination of the productive structure in terms of cost-minimizing technical choices will allow us to inspect, in section IV, the implica-   3  The taxonomy «Tradable vs. Non-Tradable» is misleading, since it may give the wrong impression that a particular sector intrinsically  belongs to one of these categories, when this classification actually depends on income distribution and technical coefficients. However, to keep the exposition as simple as  possible, in the main text we will stick to the standard terminology. 4  Actually, within this literature it is possible to identify a second position, known as «New-Developmentalism» (see Bresser; 2008; Oreiro et al. 2015), that inverts the productive structure of the economy: sector T produces and exports primary commodities and the industrial sector, potentially more dynamic, is unable to export its production. According to this view, the role of the exchange rate is to close the competitiveness gap of industry to boost an export-led growth path. We shall not discuss here the scopes and limits of this second position (we hope to do this in a future contribution).  3 tions of inverting   the pattern of specialization assumed by NS. In particular, the poten-tially drastic magnitude of devaluation necessary to boost the development of the indus-trial sector may sharply increase the domestic price of those goods that are already trad-able. If some of these goods are necessary  consumption goods (e.g. corn), or inputs of these goods (e.g. oil), as is the case for some Latin American economies, this rise may trigger wage resistance and possibly eliminate the initial reduction of labour costs in foreign currency. Curiously enough, this kind of wage inflation, in this case directly  caused by devaluation, has been ignored or neglected by New-Structuralist authors. Fi-nally, we shall see in section V that the attempt to use the exchange rate as an instru-ment to improve the international competitiveness of one particular sector may well have the undesired   effect of damaging another industry that was already competitive. Section VI concludes. 2. Analytical Framework  5   We follow New-Structuralist authors and conceive a small open economy with persis-tent unemployment and two productive sectors: an industrial sector (I) and a primary sector (C) (or services). The sectors distinguish themselves by two main features: i) the  productive methods employed and ii) the destination of production. Regarding the first aspect, NS scholars assume that commodity I is produced by la- bour and an imported capital good, while C requires labour and a fixed factor, typically land. Commodity prices can be represented by the following equations:     1 6   [1]        ∗ 1  [2] where    and    stand respectively, for the  supply prices  of commodities C and I. These  prices represent the minimum amount of money per unit of output that producers must receive to regularly (under « normal conditions » ) deliver each commodity on the market. Additionally, w  stands for the nominal wage rate, r   for the normal rate of profits,    and    are the unitary labour requirements of sectors C and I, k   is the unitary requirement of a capital good K,  ∗  is its exogenously given price and  E   is the nominal exchange rate. It is now convenient to introduce a second notion of price, which we shall denomi-nate demand   or  selling price . It represents the maximum amount of money that consum-ers are willing to pay for a commodity. Note that, since the domestic economy takes the international prices of C (  ∗ ) and I (  ∗ ) as given, once the level of the exchange rate is fixed, demand prices are univocally determined. Therefore, demand prices for commod-ities C (   ) and I (   ) are, respectively: 5  This section heavily draws on Dvoskin and Feldman (2017a) and (2017b). 6  Since land rent (both absolute and differential) will not play any role in the analysis, for simplicity we assume that land is free.
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