Trade, exchange rates and income distribution IPC, BrasiliaAlphametrics Co., Ltd. A research topic and reflection on global governance IDEAS Beijing

Trade, exchange rates and income

distribution

IPC, Brasilia Alphametrics Co., Ltd.

A research topic and reflection on global

governance

IDEAS Beijing

CERF and Alphametrics

The starting pointThe starting point

exchange rates cannot solve exchange rates cannot solve problems of global imbalanceproblems of global imbalance

nominal exchange rate changes nominal exchange rate changes tend to be offset by changes in the tend to be offset by changes in the price levelprice level

real exchange rates are closely real exchange rates are closely related to the level and distribution related to the level and distribution of income in each countryof income in each country


Global imbalances - Global imbalances - incomeincome

Countries in the Countries in the top top 2020% by per % by per capita income capita income receive receive 6060% of % of world incomeworld income

Those in the Those in the bottom bottom 5050% % receive less than receive less than 2020% of world % of world incomeincome

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Income Population

Distribution of population and income by country, 2005


... and exports... and exports

Countries in the top Countries in the top 2020% by p.c. income % by p.c. income produce produce 7575% of % of world exportsworld exports

Those in the Those in the bottom bottom 5050% by p.c. % by p.c. income produce income produce 77% % of world exportsof world exports

Distribution of world population, income and exports by country, 2005

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Income Exports Population


Three views about how Three views about how the imbalances may be the imbalances may be resolvedresolved Market forcesMarket forces: low income countries will : low income countries will

catch up provided their institutions do not catch up provided their institutions do not obstruct globalisationobstruct globalisation

National interestNational interest: each country or country : each country or country group must look after its own interests group must look after its own interests within the global market systemwithin the global market system

World governmentWorld government: market-driven : market-driven globalisation must be complemented by globalisation must be complemented by structural policies to redistribute structural policies to redistribute resources and promote convergence.resources and promote convergence.


Why exports matter so Why exports matter so muchmuch

The balance of The balance of payments identity payments identity and its implication and its implication for incomefor income

X – m Y + K = RX – m Y + K = R

Y = [X + K-R] / mY = [X + K-R] / m

X K-R m Y

USA 4,334 2,637 0.167 41,807

China 915 -88 0.475 1,743

Africa 309 -53 0.321 798

$ per capita, 2005


The drivers of export The drivers of export performanceperformance

Market control by Market control by international international companies (global companies (global oligopoly)oligopoly)

Innovation and Innovation and branding are the branding are the instruments of instruments of market controlmarket control

Countries need a Countries need a BBB rating to qualifyBBB rating to qualify

Country Rating

France AAA

Chile AA

Malaysia A+

China A

India BBB-

Brazil BB+

Turkey BB

Nigeria BB

Venezuela BB-

S&P, May 2007


Many countries have Many countries have succeededsucceeded

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70 75 80 85 90 95 00 05 10 15

TY Theil: income

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70 75 80 85 90 95 00 05 10 15

TH Theil: expenditure

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70 75 80 85 90 95 00 05 10 15

TED Theil: energy use

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70 75 80 85 90 95 00 05 10 15

TEP Theil: energy production

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70 75 80 85 90 95 00 05 10 15

TXM Theil: manufactured exports

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70 75 80 85 90 95 00 05 10 15

TXS Theil: service exports

Inequality measures Baseline Units: index


Why many countries cannot Why many countries cannot succeed so easilysucceed so easily

They cannot They cannot provide the provide the necessary human necessary human capital and capital and infrastructureinfrastructure

Their income Their income distribution is too distribution is too unequal to provide unequal to provide political stability political stability and security for and security for global investorsglobal investors


The exchange rate The exchange rate paradoxparadox High income countries have the highest High income countries have the highest

real exchange ratesreal exchange rates

Income per capita at market prices against real exchange rate, 2005

USA

Poland

Hong kong

Bangladesh

IndiaViet Nam

PhilippinesChina exc HK

ThailandArgentina

Pakistan

Other AfricaOther Asia

Kenya

Other MENigeria

Iraq

EcuadorJamaica

LebanonVenezuela

U. Arab Emirate

Kuw ait

Norw aySw itzerland

Qatar

2.00

2.50

3.00

3.50

4.00

4.50

5.00

5.50

-0.80 -0.60 -0.40 -0.20 0.00 0.20 0.40


The slope has become The slope has become steepersteeper

In 1970 the slope was 0.1 and there In 1970 the slope was 0.1 and there was very wide dispersionwas very wide dispersion

By the late 1990s the slope had By the late 1990s the slope had increased to 0.3 and dispersion was increased to 0.3 and dispersion was much reducedmuch reduced

Since then the slope and dispersion Since then the slope and dispersion have remained about the samehave remained about the same


The price of tradeablesThe price of tradeables

Unit labour costs Unit labour costs and profit mark-and profit mark-upup

Components of Components of unit labour costunit labour cost

Equalisation of Equalisation of prices at market prices at market exchange ratesexchange rates

The profitability of The profitability of exportsexports

p = u (1 + m)p = u (1 + m)

u = w / bu = w / b

p = 1p = 1

s = 1 - us = 1 - u


DevaluationDevaluation

Unit labour costs Unit labour costs are reduced are reduced relative to relative to international pricesinternational prices

The gain to The gain to exporters comes at exporters comes at the expense of the expense of higher import priceshigher import prices

The cost is paid by The cost is paid by wage-earners in the wage-earners in the export sector and export sector and incomes in all other incomes in all other sectorssectors

In the longer run In the longer run these effects tend these effects tend to unwind as to unwind as domestic prices domestic prices and incomes rise and incomes rise to compensateto compensate

Real depreciation Real depreciation can also be can also be achieved by achieved by productivity productivity growth passed growth passed through into through into pricesprices


RevaluationRevaluation

Profits in the Profits in the tradeable sector tradeable sector are reducedare reduced

If exports are not If exports are not sufficiently sufficiently profitable the profitable the remedies are remedies are downward downward pressure on wages pressure on wages and rationalisation and rationalisation leading to job cutsleading to job cuts

In the longer term In the longer term the consequence the consequence is likely to be is likely to be reduced growth of reduced growth of income and income and deflationdeflation

Real appreciation Real appreciation can also be can also be achieved by low achieved by low productivity productivity growth passed growth passed through into through into pricesprices


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The impact on non-The impact on non-tradeable sectorstradeable sectors Available income Available income

has to be shared has to be shared across the across the segment of the segment of the labour force that labour force that does not obtain does not obtain employment in employment in tradeable sectorstradeable sectors

yn/yt = (1 – a) / ayn/yt = (1 – a) / a x et / enx et / en

Per cent of labour force in tradeable sectors

Income per person

in non-tradeables

as per cent of

tradeables

(assuming 50% of income is spent on tradeables)


The sharing mechanismThe sharing mechanism

Imperfect Imperfect competition means competition means that there are few that there are few barriers to entry as barriers to entry as each business can each business can attract local attract local customerscustomers

Sharing is uneven Sharing is uneven and regulation may and regulation may prevent some prevent some people from finding people from finding employmentemployment


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160%

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The price of non-The price of non-tradeablestradeables

The price of non-The price of non-

tradeables depends tradeables depends

on productivity as on productivity as

well as the share of well as the share of

expenditure and expenditure and

employmentemployment

Taking the price of Taking the price of

tradeables as 1tradeables as 1 pn = (1-a)/a et/enpn = (1-a)/a et/en x bt/bnx bt/bn


Price of non-

tradeables as per cent of

tradeables


bn/bt = 2/3

bn = bt


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140%

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Purchasing power parity Purchasing power parity (PPP)(PPP)

PPP compares PPP compares prices across prices across countriescountries

In the general In the general case if the price case if the price of tradeables is of tradeables is equalisedequalised

ppp = 1/a xppp = 1/a x 1/(1 + en/et 1/(1 + en/et

bn/bt)bn/bt)


PPP


bn/bt = 2/3

bn = bt


A wrong explanationA wrong explanation

Neo-classical Neo-classical economists expect economists expect differences in relative differences in relative prices to derive from prices to derive from differences in differences in productivity (Balassa productivity (Balassa and Samuelson)and Samuelson)

ppp = 1/(a+(1-a)bn/bt)ppp = 1/(a+(1-a)bn/bt)0%

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140%

0% 200% 400% 600%


PPP

Productivity in non-tradeable sectors


A wrong explanation A wrong explanation (continued)(continued)

Subsequent authors Subsequent authors put the story the put the story the other way round by other way round by saying that as an saying that as an economy modernises economy modernises productivity in productivity in tradeables increases tradeables increases rapidly while rapidly while productivity in non-productivity in non-tradeables stagnatestradeables stagnates

This explanation This explanation is implausible is implausible today given the today given the high level of high level of automation in automation in service industries service industries in rich countriesin rich countries


Inequality and migrationInequality and migration

Income Income generated by generated by oligopolistic oligopolistic tradeable tradeable sectors is sectors is concentrated concentrated in specific in specific locations, locations, typically large typically large cities.cities.

This has caused massive This has caused massive inter-regional and rural-inter-regional and rural-urban migrationurban migration


There is an end to the There is an end to the storystory

As income risesAs income rises a larger proportion a larger proportion

is spent on servicesis spent on services tradeable tradeable

production production becomes more becomes more geographically geographically disperseddispersed

internal income internal income transfer systems transfer systems are developed.are developed.

Citizens of rich Citizens of rich countries buy security countries buy security through public through public investments in investments in infrastructure, infrastructure, education and health education and health designed to promote designed to promote cohesion within their cohesion within their borders - financed by borders - financed by proportionate proportionate taxation.taxation.


A global economy requires A global economy requires global governmentglobal government

Standards of Standards of governance governance endorsed by rich endorsed by rich countries at countries at national level are national level are not perceived as not perceived as being necessary being necessary or relevant at the or relevant at the global level.global level.

Government must be Government must be representative of representative of people, not market people, not market powerpower

Executive bodies are Executive bodies are subordinated to and subordinated to and accountable to the accountable to the legislaturelegislature

Compliance with the Compliance with the law is enforced by law is enforced by the judiciarythe judiciary


Global governanceGlobal governance

Generalised Generalised preferences (GSP) and preferences (GSP) and common standards are common standards are essential to counteract essential to counteract the dynamic of global the dynamic of global marketsmarkets

How long will it take to How long will it take to reform the global reform the global governance system ?governance system ?

Accountability of all Accountability of all UN institutions to UN institutions to the General the General AssemblyAssembly

Financial Financial contributions based contributions based on ability to payon ability to pay

International law to International law to govern the conduct govern the conduct of international of international businessbusiness

Documents

Trade, exchange rates and income distribution IPC, BrasiliaAlphametrics Co., Ltd. A research topic and reflection on global governance IDEAS Beijing