Tuesday, September 3, 2013

The Mirage of Devaluation

The papers are full of the rupee crisis. India's worst economy in decades, supposedly.

The silver lining, according to this morning's FT, is that the fall in the rupee should eventually boost exports. After all, after the the 1997 Asian crisis, "countries like Thailand and Malaysia enjoyed export-led recoveries following wrenching devaluations." Is that so?

The devaluation part is right -- all these countries saw their currencies fall steeply when they abandoned their pegs in the second half of 1997, typically losing about half their value against the dollar. The supposed export-led recoveries are a different story.

Annual growth of export volumes and average rates for the decades before and after 1997, Malaysia and Thailand. Source: IMF.

The solid lines in the figure above are the annual growth rates of export volumes. The dotted lines are the average rates for the ten years prior to and following the 1997 crisis. As you can see, export growth was substantially slower after the crisis than before -- in both Malaysia and Thailand, export growth after devaluation was about half the previous pace. In Indonesia, whose currency fell even more, export growth essentially ceased -- from 8 percent annual rates before 1997 to less than 1 percent in the decade following. And these are volumes; given the devaluation, foreign exchange earnings did even worse. In Thailand, for instance, exports earnings in dollars were still lower in early in 2002 than they had been before the crisis, almost five years before. For Indonesia, export earnings were still at their pre-crisis levels as late as 2004. This is about as far from an export boom as you can get.

You can argue, I suppose, that without the devaluations export performance would have been even worse. But you cannot claim that faster export growth following the devaluations boosted demand, because no such faster growth occurred.

It's really remarkable how much the devaluation-export growth link is taken for granted in discussions of foreign trade. But in the real world, for whatever reason, the link is often weak or nonexistent.

Practical policymakers seem to have an easier time grasping this than economists. There's a reason why falling currencies are seen as major problems in much of the developing world, even though they supposedly should boost exports. And there's a reason, presumably, why the leaders of Syriza, hardly slaves to conventional wisdom, have ignored the advice from progressive American economists that Greece would be better off out of the Euro.


  1. If Greece re-introduced the drachma, it would presumably be pegged to the euro. That's the most orderly way to introduce it. They would not be free of the ECB until the new currency is widely adopted, and that wouldn't happen until nobody expects a devaluation, i.e. after the crisis has passed.

  2. Agree price is just one aspect. So the fact that the Rupee has depreciated doesn't mean exports will automatically improve. Indian producers still have to compete with other local and international producers abroad.

    There is still some effect although non-price effects are far more important.

    Greece is different though. If it exits, it has its own currency and the government has more powers with itself to protect the nation.

    1. Ramanan and Max-

      You are right, exit from the Euro involves much more than a devaluation. I only brought it up here because it is often asserted that *if* the the short-ru disruptions could be managed, a major advantage of going back tot he drachma would be that depreciation would solve Greece's external balance. As I have argued here before, that really shouldn't be counted on.

      And yes, it is true that having your own currency allows central banks to support the government debt market and act as lenders of last resort. So there could be a good case for going back to drachma, even if we don't think Greek exporters would benefit directly.

    2. Monetary sovereignty is not just about having your own currency. That's necessary but not sufficient. The currency has to be used as a unit of account - all the important prices in the economy have to be in terms of the currency.

      I'm saying that Greece *can't* devalue. That option is only available if you have your currency before the crisis hits.

      You can't say, "here's a shiny new currency, and by the way, we're going to devalue" - because if devaluation is fully expected, it will have no effect. It will be a change of numbers with no economic consequence.

  3. There was however a V or U shaped recovery in these countries. Which means that domestic demand in stead of (gross) exports must have done the trick. Which is way more difficult in a situation of 'internal devaluation' as 'external devaluation' does not lead to a decline of nominal wages, which means that 'domestic' purchasing power does not diminish while, at the same time, domestic products (i.e. products with a high content of domestically produced value added) on the domestic market become cheaper compared with imported products. In the case of internal devaluation, however, the whole idea is that domestic wages have to decrease...

    1. Right. What happened is that imports dropped very rapidly in the crisis and then slowed even more than exports in the recovery. This is what allowed these countries to accumulate surpluses in the period leading up to 2008. So yes, there was a shift from export demand to demand to domestic demand. Unfortunately, I don't know anything about the institutional specifics of how this was brought about, and I have not seen any good articles on it.

    2. Also, anon. -- please use a handle of some kind. Thanks!

  4. I have four questions abut this (actually two double questions):

    1) Nominal devaluation is just one of the components of the cost of labor, the other is inflation: if, as it happened in Italy before the euro, there is devaluation but also inflation, there is no reason the exports should boom.
    This is a big point in the "austerity" debate in europe: many economists believe that debtor countries have structural economic problems that makes them more inflationary, and that those structural flaws are what caused the umbalances to begin with, and thus should be corrected. From this point of view an exit from the euro makes few sense (hence the "moral hazard" thing).
    Obviusly those "structural solutions", in pratice, always mean that workers' bargaining power has to fall.
    Why do most economist of the pro-devaluation camp assume that real wage will fall in a devaluation (instead that jump up nominally)?

    1B) "What happened is that imports dropped very rapidly in the crisis and then slowed even more than exports in the recovery. [...]. So yes, there was a shift from export demand to demand to domestic demand."
    I assume that the fact that imports fell a lot means that real wages, in this case, really fell. How is this really an exit from the crisis (through a shift to domestic demand) instead than just a stable lower level of activity?
    For example if my wage is 100, then I'm fired during the crisis, then I get a new job with a wage of 50, the crisis from my point of view is hardly over.

    2) As far as I can understand, during the asian crisis Thailand had huge debts in its own currency, that was pegged to the dollar. When Thailand devalued, it also devalued the debt, it was a sort of "hidden bankruptcy". How much of the solution of the crisis was due to this "inflation jubilaeum"?

    2B) If (as I believe) most of the solution of the crisis depends on the "inflation jubilaeum" thing, wouldn't be better to have devaluation BUT also inflation in nominal wages, so that real wages stays the same? This would be better for the workers but also for those countries who export to the debtor nations (whereas if the solution of the crisis is "less consumption" this means that the crisis is shifted on the exporter nations).
    I think this was actually Minsky's solution, when he said that stagflation was what they had instead of a new great depression.

  5. RL-

    Yes, depreciations/devaluations are often inflationary, and that is presumably one of the reasons why they don't raise exports as much as people would naively expect.

    I also agree that "structural" solutions in the current debate do always mean a redistribution away fro workers. So the relative-price argument appears as the relatively progressive position. But it's important not to accept that framing uncritically; it's perfectly possible to talk about structural problems that are not about high wages and a strong welfare state. Probably the biggest ones in my mind are the related problems of (1) faster export growth requiring entry into new industries, which often requires coordinated private and public investment across a bunch of sectors simultaneously; and (2) the reluctance of the rich almost everywhere to tie up their wealth in long-lived fixed capital when holding it in financial form (or sometimes as land) is an option.

    On 1B and 2B, I think you are possibly overemphasizing the change in prices and ignoring the change in incomes. The reason imports fell so drastically in the crisis is not so much that real wages fell, as that employment and investment fell.

    I'm afraid I don't know how much of Asian debt was foreign vs. local currency denominated. Would be an important part of the story if I ever decide to to try to write about this beyond blogposts.

  6. fantastically important to get the why of forex dynamics
    clearly fixed in the mind
    its a game of contexts
    ie a historical process

    motives are clear but various

    start with
    this outcome
    a certain volley for serve
    in the forex arbitrage game
    which when the deval hits
    can increase corporate trading margins
    while in fact slowing penetration
    the secondary whys become key

    1. I've seen you make this argument before, in comments here and at Thoma's palce (and probably elsewhere). Have you ever developed it beyond blog-comment poetry?

      Not that I mind the poetry, it's the best.

  7. JW, Dean Baker, as you probably know, has the "strong dollar" as a theme of his manufacturing job loss story and some of his readers point out the futility trying boost exports with a weak dollar.

    From this post and comments, I get the sense that this a "one-way" relationship, going to a strong dollar definitely hurts exports but reversing the process may only have limited effects. Is that a correct characterization? -PJM

    1. As you probably saw in the following post, yes, I think there is some truth to this.

  8. A couple of things, one minor, one off-topic.

    1. There's a small typo in 3rd paragraph -- "when they abandoned their pegs in the second half of 2007" shd be 1997.

    2. I was trying to think of the name of the 19th cent political economist you used at one time as a pseudonym at CT. It wasn't Nassau Senior, or was it?

    1. LFC:

      Did you mean "Lemuel Pitkin"?


    2. Yup, Lemuel Pitkin, from A Cool MIllion. Not an economist of any sort (altho there is some interesting political economy in the book.)

      Thanks for pointing out the error, I've corrected it.

    3. yes, Lemuel Pitkin was the name I couldn't remember. (For some reason I thought it was the name of a 19th-cent economist. I will follow the Wiki link, thks.)

  9. How about import volumes, then? A current account imbalance can be solved by a FX devaluation as imports become more expensive. That will make the domestic market more competitive against imports, which helps

    Some countries that have large export sectors where the end demand is price-sensitive and the country's export prices at least partially depend on the domestic price level should see increasing demand for their exports. Some countries might, instead of higher volume, just put the improved competitiveness into prices - profits of the export sector.

    The short answer is "it depends"

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