DeLisle Worrell Governor, Central Bank of Barbados created waves in his previous speeches on state of economics.
In a post on voxeu,he argues devaluation will not work for Greece. And his idea is being a small open economy, Greece will face huge challenges in case it exits from Euro and lets Drachma devalue:
If Greece leaves the euro, it can devalue its currency and start an export-led recovery – or so the popular argument goes. This column provides some hands-on insights from another small open economy, Barbados. It argues that for these economies that rely heavily on imports, devaluation will never be a viable option.
The central idea is import demand is huge and with depreciation this leads to inflation. And being a small economy, they cannot really gain much from depreciating currency as their exports a fraction of world export demand.
In reality, exchange-rate depreciation always depresses output in small open economies, because there is zero elasticity of substitution between internationally traded goods and services and domestically produced goods and services, either in consumption or in production. There are no expenditure switching effects of a devaluation; devaluation “works” by depressing real income and imports, by enough to eliminate the excess demand for foreign exchange.
There are well over a hundred countries in the world that are smaller than Greece by population or similar measure, including Barbados where I am Governor of the Central Bank. It is now reluctantly accepted at the IMF, the World Bank and in international policy circles, that these small open economies are disproportionately affected by global shocks that raise import prices and cut demand for their exports, and it is costly for them to build resilience to adverse influences from abroad.
What is still not fully acknowledged in the debate on the current Eurozone crisis, a debate largely driven by those in large economies, is that small open economies cannot make up for lost export demand in an international recession by switching to local demand, through currency depreciation. That is because the range and scope of their imports vastly exceed those of the exports of small economies. Economies of scale and scope in information and communication are universal and these economies have found that they have the human and material resources to be internationally competitive in only a handful of activities (see Carter 1997).
Small open economies are price takers:
We should bear in mind that the small open economy is a price taker in the international markets in which it sells, so it cannot increase its competitiveness by reducing its prices, only by increasing capacity and productivity. What is more, currency depreciation tends to reduce the growth potential of the economy, because it introduces an additional uncertainty which acts as a deterrent to the investment needed to build production capacity.3 Much is made of the fact that currency depreciation increases the profitability of exporters by reducing the real cost of domestic value added, without acknowledging that this is an miserable strategy – the country may sell more abroad, but it earns less real income by doing so.
Hmmm..
These econs are different:
The essential point missing from the recent debate, is that small open economies are different: international economic shocks hit them especially deep and hard, and in the short term they have little choice but to absorb the blows and try to remain on their feet. Above everything, they should protect the value of the currency, by allowing the shock to feed through to a fall in real income. If there is to be active fiscal management, it should be in the service of maintaining the exchange rate anchor by matching import spending to foreign exchange inflows. Targeting the money supply or inflation, with a flexible exchange rate – the conventional policy prescription – produces a worse result. There is no additional foreign exchange earned or saved, real income falls by as much as is necessary to balance the external accounts in any event, and exchange rate depreciation imposes an avoidable inflation penalty that becomes entrenched in expectations.
Strategies for sustained growth are possible for small open economies, whatever the state of health of the international economy, precisely because their share of demand is so small, and they can market selectively in the areas where demand is least cyclical. To be sustainable, growth strategies must be crafted on the basis of the comparative advantages which human and material endowments offer to each small economy, and should include exploiting of market niches and moving up the value chain.
Governor Worrell made these points earlier as well.
His ideas may be worth looking at for small open economies, but Greece is different. Whatever little I have read, Greece is hardly a small open economy as we understand the term. Greece and even Eurozone is just such a crazy idea..
Like this:
Like Loading...
Mostly Economics 