Publication: Exchange Rate Overvaluation and Trade Protection: Lessons from Experience
Date
2000-02
ISSN
Published
2000-02
Author(s)
Shatz, Howard J.
Tarr, David G.
Abstract
Despite a trend toward more flexible
rates, more than half the world's countries maintain fixed or
managed exchange rates. In the 1980s and 1990s, developing
countries as a group progressively liberalized their trade
regimes, but some governments defend their exchange rate in
actions that run counter to long-run plans for
liberalization. Without discussing the relative merits of
fixed and flexible exchange rate systems, the authors note
that exchange rate management in many countries has resulted
in overvaluation of the real exchange rate. Roughly twenty
five percent of the countries for which data are available
have overvalued exchange rates, with black market premiums
from 10 percent to more than 100 percent. After surveying
the literature, the authors present lessons from experience
about what has worked (or not) in response to crises
involving external shocks and external trade deficits - and
why. Trying to defend an overvalued exchange rate with
protectionist trade policies is a classic pattern, but
experience shows such protection does significantly retard
the country's growth, and delay its integration into the
world trading community. In fact, and overvalued exchange
rate is often the root cause of protection, preventing the
country from returning to more liberal trade policies that
allow growth and integration into the world community
without exchange rate adjustment. Most developing countries
have downward price and wage rigidities and, with an
external trade deficit, require some form of nominal
exchange rate adjustment to restore external equilibrium.
The authors present cross-country econometric and case study
evidence - citing examples from Argentina, Chile, Ghana, the
Republic of Korea, Malaysia, Turkey, Uruguay, and
Sub-Saharan Africa (including the CFA zone) - that
overvalued exchange rates reduce economic growth. Defending
the exchange rate, they show, has nor no medium-term
benefits, since falling reserves will eventually force
devaluation. Better to have devaluation occur without
further debilitating losses in reserves and lost
productivity because of import controls. After devaluation
the exchange rate will reach a new equilibrium, strongly
influenced by government and central bank policies.
Citation
“Shatz, Howard J.; Tarr, David G.. 2000. Exchange Rate Overvaluation and Trade Protection : Lessons from Experience. Policy Research Working Paper;No. 2289. © World Bank, Washington, DC. http://openknowledge.worldbank.org/handle/10986/22334 License: CC BY 3.0 IGO.”
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