How do countries grow, reach higher levels of productivity, competitiveness and promote welfare? Again, what is the relationship between exchange rate, exports and growth? For decades economists have been grappling with these issues and peer into the ‘black box’ to get answers. Often, it is rake’s progress as ostensible certainties a la Washington Consensus morph into disasters. It’s not the economists who are to blame. Economies change and move fast. Globalisation has integrated them somewhat; but has hit roadblocks in recent years. There are still large-value supply chains, with China as the fulcrum, evolved by multinationals. Newer trade patterns emerge and some, including China, turn inwards. These changing patterns suggest newer equilibria, especially in currency relations.
It is this tricky territory that Surjit S. Bhalla has ventured to travel and offer solutions. He wishes to take a contrarian view of ‘export promotion’ through ‘exchange rate management’ as opposed to the traditional protectionist approach or import substitution. He claims that he “does so by exploring the critical role in economic growth of currency undervaluation, and economic growth by giving authorities the ability to improve their economy’s competitiveness by reducing the production costs of their exports and making them cheaper in foreign markets.” These are not new. Bhalla had put forward these views in an earlier article in Cato Journal in 2008. This book is an enlarged version.
Though the book makes for forbidding reading densely populated with data — statistical and econometric regressions and graphs — the themes developed are neither balanced nor esoteric. Bhalla manages Oxus Investments, an investment consultancy firm, and this professional background is evident in the handling of data. At the same time, the reviewer cannot overcome the nagging doubt that data handling has been selective and tailored to suit a priori conclusions. Much of the data relate to the post-bubble era, i.e. post 1980s, and to Brics countries. Their relationship may not be representative of others or establish universal causality. Across the pages, the author ends up with several assertions which a seasoned economist will avoid.
For example, he says “currency valuation exerts an independent influence on growth, in addition to the effects on growth occurring via investment.” Comparing differential flows of investment between India and China, he avers that it “may have been due to their different exchange rate policies.”
It is difficult to go along with this assessment. As an investment analyst, he should know the volatility of rate militates against capital flows and stability of exchange rates plays a greater role in promoting them. There are other factors like infrastructure which go into the phenomenon of “China price” attracting FDI. Sadly, Bhalla makes undervaluation the “single trick pony” to redeem developing countries from stagnation. Elsewhere, he says, “Theoretically, it is not easy to follow a policy of deliberate currency undervaluation, because it involves changing the terms of trade, and not just for the short term.” This is contrary to his own main theme laboured in the book.
Though he has dealt with the China issue at other places, he does not refer to the long battles which China had to wage with the U.S., later with the IMF and much later in G-20 with some other developing countries. Nor does Bhalla refer to the “currency wars” set in motion by the Quantitative Expansion (QE) policies of the U.S. Fed, ECB and the Bank of England. And yet, he says (p.225), “A country can devalue its way to prosperity, sometimes at the expense of other nations!”
Bhalla is a familiar face on TV shows on the “reform process” and is a defender of faith. He believes in the refurbished Washington Consensus and believes that government policies can work. Indeed, he is no renegade — he adds, “Policy matters only when all the appropriate conditions are in place and the government is well intentioned.” Who decides the conditions or the good intention of the government? Big business or foreign rivals in trade?
The book bases its major theme on the bedrock of what is known as Balassa-Samuelson hypothesis (B-S-H) on currency values posited in 1964. The hypothesis ruled the field for some years and economists in the IMF held on to it with biblical attachment while determining “misalignment” of currencies. In those years when par value was the rule, it was sin to engage in currency manipulation. Since then, there have been major developments. With the flotation of currencies after 1972 under Smithsonian Agreement countries have the sovereign right to fix the currency rates. The IMF is no longer the arbiter but a mute onlooker from the sidelines.
More importantly, there has been a flood of literature based on later research which questions the B-S-H. A Staff Paper of the IMF took the view that “there is little empirical evidence on whether Balassa-Samuelson effects can successfully explain long-run movements in the real exchange rate in developing countries.”
For India, a Reserve Bank of India study assessed that “productivity differential, foreign assets, terms of trade and openness are main determinants of real exchange rate.” One OECD study done in 2011 did not find any support for B-S-H based on current trade data. It is odd that contrary to available evidence based on a plethora of research on exchange rates, Bhalla takes the line that real exchange rate can be influenced by nominal (policy) exchange rate.
It is difficult to categorise this book. It is not an investment analyst’s guide to recent trends in currency rates and their impact on trade and growth. It is not an economist’s study of linkages between them. Its statistical base is questionable even as its theoretical base is weak.
It is unrealistic in its policy prescription as it fails to factor in the recent and serious developments in the currency front. Its policy prescription of “devaluing to prosperity” is a recipe for fueling more currency wars.