Download ARVIND SUBRAMANIAN: Exchange Rates, Foreign Capital, and

Exchange Rates, Foreign Capital,
and Development
Arvind Subramanian
Peterson Institute for International Economics, Center
for Global Development, and Johns Hopkins University
XXV Meeting of Latin American Network of Central
Banks and Finance Ministries
May 17, 2007
Outline
• What is development about?
• Modes of escape from under-development
• Exchange rate, especially avoiding overvaluation,
can play a very useful role
• Foreign capital limits the ability to influence real
exchange rate
• Other policies for boosting domestic savings?
What is Development?
• Development is ultimately about doing
different and more sophisticated (high “valueadded”) things
• Important stylized fact: Countries first
diversify on their way to development and
specialize only later, much later (Imbs and
Wacziarg, 2003)
• And doing different things can itself boost
growth (virtuous circle)
.05
.1
.15
.2
Development is about diversification
1970
1980
1990
2000
Year
Asia
India
Latin America
China
• Subramanian, 2007 based on Imbs and Wacziarg, 2003
And diversification can help growth
.4
Diversification Index
.3
AS
.2
BH
MP
OR
.1
JK
GJ
UP
PJRJ
KL
WB
DLMHAP
TN
KK
0
HY
1
2
3
4
Average annual growth rate of NSDP per capita 1980-2000(%)
• Kochhar et. al., 2006
5
Modes of Escape
• Three or four different patterns of escape from
underdevelopment
• Manufacturing
– China, East Asia, Mauritius, Tunisia, Chile?
• Services
– India
• Commodities (escaping the natural resource curse)
– High endowment per capita (Dubai, Saudi Arabia, Brunei,
Kuwait)
– Not very high endowment per capita but reasonable initial
institutions (Botswana, Chile?, Indonesia??)
Escape through manufacturing
Chart 1. Manufacturing Exports to GDP (1960-2005)
(in percent)
40
30
Manufacturing Exports to GDP
Asia
20
China
10
Latin America
Sub-Saharan Africa
India
0
1960
1965
1970
1975
1980
1985
Year
1990
1995
2000
2005
Tradables and exchange rates
• Combine diversification and modes of escape: Empirically, new and
different things are largely tradables, typically manufacturing but also
agricultural (Chile) and services (India)
• Important distinction not necessarily manufacturing versus services
but non-commodity tradables versus others
• Many reasons for why tradables might be important and why they are
prone to being under-produced
– Tradables are institutions-intensive
• What are the mechanisms for and determinants of doing new and
different things, i.e. for tradable manufacturing and services?
• Many determinants: human capital; institutions etc. but exchange
rate an important one
Alternative Instruments
• Compare three policy instruments: industrial policy/protection; trade
preferences and exchange rates
• Conventional industrial policy: picking winners; rent-seeking and
administrative costs; credible withdrawal; market test
• Trade preferences: minimizes rent-seeking and administrative; but
uncertain value subject to depreciation based on external factors
(Mauritius, Mexico)
• Exchange rate has the following virtues:
– Helps all tradables not just import-competing of exports
– Avoids costs (rent-seeking, corruption, picking winners and
losers) of industrial policies
– Is self-targeting and rewards efficient performance
– Is self-eliminating (trend appreciation)?
Exchange Rates (overvaluation) and Growth
Chart 3. Exchange Rates: Exchange Rates: Deviation from Long-Run Equilibrium (1960-2000)
(+ deviation signifies overvaluation)
60
40
Sub-Saharan Africa
Overvaluation
20
Latin America
0
-20
Asia
-40
-60
1960
1965
1970
1975
1980
Year
• Johnson, Ostry, and Subramanian, 2007
1985
1990
1995
2000
Overvaluation and growth—contd.
• Defining overvaluation (Johnson, Ostry and
Subramanian, 2007)—departure of country’s
exchange rate from very long run PPP rate
• Africa: Average overvaluation=18 percent
compared with -17 percent for Sustained Growth
countries
• Econometric evidence:
– A 1 percentage point overvaluation reduces long run
growth by about 0.1 percent (Prasad, Rajan and
Subramanian, 2007, and Rodrik, 2007). Symmetric?
– Overvaluation reduces the growth of manufacturing
exports (Rajan and Subramanian, 2005 and Prasad,
Rajan and Subramanian, 2007)
-20
-30
-2
-40
0
2
4
Overvaluation (percent)
6
8
-10
Overvaluation and growth—contd.
-10
-5
0
5
10
T
Real per capita GDP growth
• Prasad, Rajan and Subramanian, 2007
Overvaluation
15
-1
.04
0
.02
-.5
growth
.06
0
.08
.1
.5
Some country examples: China
50
60
70
80
period_code...
log undervaluation
• Rodrik, 2007
90
growth
100
.01
-.2
0
.02
.2
growth
.03
.4
.6
.04
Some country examples: India
50
60
70
80
period_code...
log undervaluation
90
growth
100
Is the real exchange rate susceptible to policy?
• The RER is an endogenous variable: determined in
equilibrium by the balance between saving and
investment
• Less foreign savings and more domestic savings, the
less overvalued the exchange rate and hence greater
growth
Figure 6. Current Accounts, Investment and Growth in Developing Countries
Average Per Capita GDP Growth
3.00
2.00
1.00
Above Median
0.00
Below Median
Above Median
Below Median
Investment/GDP
Current Account/GDP
-6
-4
-2
0
2
4
Growth and the Current Account Balance over
Time: Non-parametric Relationship
-5
0
5
10
Average current account balance to GDP
1970-79
1990-97
1985-97
1999-04
15
Foreign Savings and Growth
• Foreign capital makes real exchange rate
management difficult (level not volatility). Leads
to appreciation and lower growth
– Impact of foreign aid on exchange rates and exports
(Rajan and Subramanian, 2005)
– Impact of private capital on exchange rates and
exports (Prasad, Rajan and Subramanian, 2007)
• Sterilized intervention
– Recent experiences of China and India
100
Foreign capital and Overvaluation, 1970-2004
50
NGA
TZA
ISR
TUR
KOR
IRN
GHA
UGA
VEN
ARG
BRA
CYP
0
PAN
JAM
CHN
MEX
CMR
MDG
SEN CIV CHL
HND
URY
CRI
ETH
JOR
DOM
MWI
KEN
ZAF
MLI
DZA
COL
THAPER
EGY
MAR
GTM
RWA
GUY
ECU
TUN
IND
IDN
SLV
PAKPRY
LKA
BGD ZWE
PHL
-50
ZMB
SLE
TTO
MYS
BOL
MUS
HTI
-.02
-.01
0
.01
.02
Residuals of average net fdi flows to GDP
coef = 837.49992, (robust) se = 363.32526, t = 2.31
.03
Domestic Savings
• For Latin America, genie is out of the
bottle, so need to focus on domestic
savings
• Government savings: Fiscal policies may
need to be even stronger than suggested
by normal macroeconomic/fiscal criteria
• Private savings
Conclusions
• Development—doing different things and
fostering tradables--requires keeping an
eye on the real exchange rate.
• Challenge is how? Probably a variety of
things
• Especially challenging for Latin America
with open capital accounts