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

CERF and Alphametrics The starting point exchange rates cannot solve problems of global imbalance exchange rates cannot solve problems of global imbalance nominal exchange rate changes tend to be offset by changes in the price level nominal exchange rate changes tend to be offset by changes in the price level real exchange rates are closely related to the level and distribution of income in each country real exchange rates are closely related to the level and distribution of income in each country

CERF and Alphametrics Global imbalances - income Countries in the top 20% by per capita income receive 60% of world income Countries in the top 20% by per capita income receive 60% of world income Those in the bottom 50% receive less than 20% of world income Those in the bottom 50% receive less than 20% of world income Distribution of population and income by country, 2005

CERF and Alphametrics... and exports Countries in the top 20% by p.c. income produce 75% of world exports Countries in the top 20% by p.c. income produce 75% of world exports Those in the bottom 50% by p.c. income produce 7% of world exports Those in the bottom 50% by p.c. income produce 7% of world exports Distribution of world population, income and exports by country, 2005

CERF and Alphametrics Three views about how the imbalances may be resolved Market forces: low income countries will catch up provided their institutions do not obstruct globalisation Market forces: low income countries will catch up provided their institutions do not obstruct globalisation National interest: each country or country group must look after its own interests within the global market system National interest: each country or country group must look after its own interests within the global market system World government: market-driven globalisation must be complemented by structural policies to redistribute resources and promote convergence. World government: market-driven globalisation must be complemented by structural policies to redistribute resources and promote convergence.

CERF and Alphametrics Why exports matter so much The balance of payments identity and its implication for income The balance of payments identity and its implication for income X – m Y + K = R Y = [X + K-R] / m XK-RmY USA4,3342, ,807 China ,743 Africa $ per capita, 2005

CERF and Alphametrics The drivers of export performance Market control by international companies (global oligopoly) Market control by international companies (global oligopoly) Innovation and branding are the instruments of market control Innovation and branding are the instruments of market control Countries need a BBB rating to qualify Countries need a BBB rating to qualify CountryRating FranceAAA ChileAA MalaysiaA+ ChinaA IndiaBBB- BrazilBB+ TurkeyBB NigeriaBB VenezuelaBB- S&P, May 2007

CERF and Alphametrics Many countries have succeeded

CERF and Alphametrics Why many countries cannot succeed so easily They cannot provide the necessary human capital and infrastructure They cannot provide the necessary human capital and infrastructure Their income distribution is too unequal to provide political stability and security for global investors Their income distribution is too unequal to provide political stability and security for global investors

CERF and Alphametrics The exchange rate paradox High income countries have the highest real exchange rates High income countries have the highest real exchange rates

CERF and Alphametrics The slope has become steeper In 1970 the slope was 0.1 and there was very wide dispersion In 1970 the slope was 0.1 and there was very wide dispersion By the late 1990s the slope had increased to 0.3 and dispersion was much reduced By the late 1990s the slope had increased to 0.3 and dispersion was much reduced Since then the slope and dispersion have remained about the same Since then the slope and dispersion have remained about the same

CERF and Alphametrics The price of tradeables Unit labour costs and profit mark-up Unit labour costs and profit mark-up Components of unit labour cost Components of unit labour cost Equalisation of prices at market exchange rates Equalisation of prices at market exchange rates The profitability of exports The profitability of exports p = u (1 + m) u = w / b p = 1 s = 1 - u

CERF and Alphametrics Devaluation Unit labour costs are reduced relative to international prices Unit labour costs are reduced relative to international prices The gain to exporters comes at the expense of higher import prices The gain to exporters comes at the expense of higher import prices The cost is paid by wage-earners in the export sector and incomes in all other sectors The cost is paid by wage-earners in the export sector and incomes in all other sectors In the longer run these effects tend to unwind as domestic prices and incomes rise to compensate In the longer run these effects tend to unwind as domestic prices and incomes rise to compensate Real depreciation can also be achieved by productivity growth passed through into prices Real depreciation can also be achieved by productivity growth passed through into prices

CERF and Alphametrics Revaluation Profits in the tradeable sector are reduced Profits in the tradeable sector are reduced If exports are not sufficiently profitable the remedies are downward pressure on wages and rationalisation leading to job cuts If exports are not sufficiently profitable the remedies are downward pressure on wages and rationalisation leading to job cuts In the longer term the consequence is likely to be reduced growth of income and deflation In the longer term the consequence is likely to be reduced growth of income and deflation Real appreciation can also be achieved by low productivity growth passed through into prices Real appreciation can also be achieved by low productivity growth passed through into prices

CERF and Alphametrics The impact on non-tradeable sectors Available income has to be shared across the segment of the labour force that does not obtain employment in tradeable sectors Available income has to be shared across the segment of the labour force that does not obtain employment in tradeable sectors yn/yt = (1 – a) / a x et / en x 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)

CERF and Alphametrics The sharing mechanism Imperfect competition means that there are few barriers to entry as each business can attract local customers Imperfect competition means that there are few barriers to entry as each business can attract local customers Sharing is uneven and regulation may prevent some people from finding employment Sharing is uneven and regulation may prevent some people from finding employment

CERF and Alphametrics The price of non-tradeables The price of non- tradeables depends on productivity as well as the share of expenditure and employment The price of non- tradeables depends on productivity as well as the share of expenditure and employment Taking the price of tradeables as 1 Taking the price of tradeables as 1 pn = (1-a)/a et/en pn = (1-a)/a et/en x bt/bn x bt/bn (assuming 50% of income is spent on tradeables) Price of non- tradeables as per cent of tradeables Per cent of labour force in tradeable sectors bn/bt = 2/3 bn = bt

CERF and Alphametrics Purchasing power parity (PPP) PPP compares prices across countries PPP compares prices across countries In the general case if the price of tradeables is equalised In the general case if the price of tradeables is equalised ppp = 1/a x 1/(1 + en/et bn/bt) 1/(1 + en/et bn/bt) (assuming 50% of income is spent on tradeables) PPP Per cent of labour force in tradeable sectors bn/bt = 2/3 bn = bt

CERF and Alphametrics A wrong explanation Neo-classical economists expect differences in relative prices to derive from differences in productivity (Balassa and Samuelson) Neo-classical economists expect differences in relative prices to derive from differences in productivity (Balassa and Samuelson) ppp = 1/(a+(1-a)bn/bt) (assuming 50% of income is spent on tradeables) PPP Productivity in non- tradeable sectors

CERF and Alphametrics A wrong explanation (continued) Subsequent authors put the story the other way round by saying that as an economy modernises productivity in tradeables increases rapidly while productivity in non- tradeables stagnates Subsequent authors put the story the other way round by saying that as an economy modernises productivity in tradeables increases rapidly while productivity in non- tradeables stagnates This explanation is implausible today given the high level of automation in service industries in rich countries This explanation is implausible today given the high level of automation in service industries in rich countries

CERF and Alphametrics Inequality and migration Income generated by oligopolistic tradeable sectors is concentrated in specific locations, typically large cities. Income generated by oligopolistic tradeable sectors is concentrated in specific locations, typically large cities. This has caused massive inter-regional and rural- urban migration This has caused massive inter-regional and rural- urban migration

CERF and Alphametrics There is an end to the story As income rises a larger proportion is spent on services a larger proportion is spent on services tradeable production becomes more geographically dispersed tradeable production becomes more geographically dispersed internal income transfer systems are developed. internal income transfer systems are developed. Citizens of rich countries buy security through public investments in infrastructure, education and health designed to promote cohesion within their borders - financed by proportionate taxation. Citizens of rich countries buy security through public investments in infrastructure, education and health designed to promote cohesion within their borders - financed by proportionate taxation.

CERF and Alphametrics A global economy requires global government Standards of governance endorsed by rich countries at national level are not perceived as being necessary or relevant at the global level. Standards of governance endorsed by rich countries at national level are not perceived as being necessary or relevant at the global level. Government must be representative of people, not market power Government must be representative of people, not market power Executive bodies are subordinated to and accountable to the legislature Executive bodies are subordinated to and accountable to the legislature Compliance with the law is enforced by the judiciary Compliance with the law is enforced by the judiciary

CERF and Alphametrics Global governance Generalised preferences (GSP) and common standards are essential to counteract the dynamic of global markets Generalised preferences (GSP) and common standards are essential to counteract the dynamic of global markets How long will it take to reform the global governance system ? How long will it take to reform the global governance system ? Accountability of all UN institutions to the General Assembly Accountability of all UN institutions to the General Assembly Financial contributions based on ability to pay Financial contributions based on ability to pay International law to govern the conduct of international business International law to govern the conduct of international business