Thu, Feb 26, 2009 - Page 8 News List

Devaluation can’t solve everything

By Chuang Yih-chyi 莊奕琦

THE VALUE OF the New Taiwan (NT) dollar has fallen repeatedly in recent days. Coming at this particular time, can the NT dollar’s devaluation help boost Taiwan’s exports and remedy the country’s economic downturn? This is a pertinent question that merits discussion.

Domestic demand has been slack since 2000. Over the past five years, private consumption and investment have grown at an average of just 1.84 percent and 3.52 percent per year respectively. During the same period, however, overseas demand for Taiwan’s exports has performed better, growing by an annual average of 8.94 percent, thanks to which the economy has grown by an average of 4.5 percent each year over the past five years.

However, the financial tsunami of the third quarter of last year has spread around the globe and made its influence felt in the real economy. The squeeze on credit has cut effective demand below what is needed, with a strong negative effect on the global economy as demand from the US, Europe and other advanced economies for goods made in developing countries falls. Taiwan is a clear example, its exports having plunged 3.68 percent in the fourth quarter of last year.

Exports were the last remaining engine driving Taiwan’s economic growth, but now that engine has stalled. As calls for salvaging the economy get louder, some people hope that the devaluation of recent days will help by boosting exports.

Economic theory tells us that, under suitable conditions (the so-called Marshall-Lerner condition), devaluation can indeed boost exports and improve the balance of trade in the long term. In the short term, however, it will produce what is known as the J-curve effect, meaning that exports will dip before they rise. To begin with, the volume effect outweighs the price effect, actually causing a fall in net exports following devaluation.

In the short term, then, devaluation is not effective in boosting exports. In practice, whether devaluation will have the benefit of revitalizing Taiwan’s depressed economy needs to be further considered in terms of supply and demand.

Regarding the demand side, the current fall in exports is caused by the drop in demand abroad, which in turn is caused by the credit crunch, because when people and companies can’t get credit, their purchasing power falls. In such a situation, although devaluation produces a relative fall in export prices, this will not necessarily lure overseas buyers to purchase more goods exported from Taiwan. In other words, the effect of falling incomes may outweigh that of falling prices.

From the supply side point of view, currency devaluation will cause a relative rise in the prices of imported raw materials, and therefore in production costs. It will cause domestic prices to rise, which clearly will not encourage domestic consumption. Therefore, it can only cause Taiwan’s already flagging domestic consumption to go from bad to worse.

Furthermore, devaluation will cause a rise in the price of imported machinery, which is not good for domestic investment. Besides, as economies in East Asia are moving toward integration, intra-industry trade is increasing rapidly, and incoming materials processing and original equipment manufacturer (OEM) production are commonplace.

Under such conditions, as currency devaluation causes import costs to rise and export prices to fall, value added in these modes of production will be reduced, and so will manufacturers’ profit margins. This will make it hard for manufacturers to keep going, and will even cause some export-oriented manufacturers in Taiwan to go under, which will in turn cost more people their jobs.

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