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Trade and Exchange Rate Policy for IndiaAuthor(s): Amiya Kumar Bagchi and Prabirjit SarkarSource: Economic and Political Weekly, Vol. 28, No. 38 (Sep. 18, 1993), pp. 2012-2013Published by: Economic and Political WeeklyStable URL: http://www.jstor.org/stable/4400171

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DISCUSSIONiTade and ExchangeRate Policy for India

AmniyaKumar BagchiPrabirjit Sarkar

'IN thelong runwe arealldead', thusspokeJohn MaynardKeynes.'Follow us and you benighted worship-persof regulation orpublicgood, youshalllive on milk and jioney, Coca Cola andhamburgers-if you survivc', thus pro-nounce Joshi and Little(1993).It is difficult to make out whether one issurprised more by the innocence or theinsouciance of the proposals of Joshi andLittle. The innocence is displayed by theirapparentlack of awareness that anythinghas happened, even in the area of main-stream economic theory, since the theo-rems on the second best propounded byJames Meade and Kelvin Lancaster andRichard Lipsey. (Most of the Bhagwati-Srinivasan or Little-Mirrlecsexercises aresimply variations on the second best theo-ries of thewelfare economics of the1950s.)The innocence is also displayed by theirapparentgnoranceof what hashappened oIndianexchange rates,balanceof paymentsandeconomicgrowth since the 1970s.(Notethat the only substantial references to theirown workby Joshi andLittleare to a bookpublished in 1970 and apaperpublished n1971.) But perhaps the insouciance is evenmore striking thanthe innocence. By sim-ply ignoring most of the actualproblemsofthe Indianeconomy in the 1970s and 1980s,or the actual geopolitical setting of theinternational conomy, theycome out withrecommendationswhich would have glad-dened the heart of a FredericBastiat, a J RMcCulloch or a Marquisof Salisbury.Given thefact thatmost of theargumentsofJoshi andLittle arebasedonfantasy,theywould hardly have been worth rebutting,except for the fact thatthey aresupposed tohave studied the problems of the Indianeconomy for quite a numberof years, andanythingcoming out of the west is consid-ered to be wisdom in official circles.

Firstof all, given the kind of assumptionthat Joshi and Littlc make about the longrun,why slhould hereheany tariffs(of even10 or 15 percent) on imports into India atall? With free trade, free mobility of capi-tal, freemigrationof labourbetween differ-ent countries, no problem of securing theborders, no military threatsanywlhcre,andwith minimal government, perhaps a polltax on all working adults (and all able-bodiedadultswould work insuch afriction-less, wisely governed world) would beenough. Then why do Joshi and Littlebother to take up the Chelliah Comimittce

proposalsatall? Afterall,whetherwe agreewith the proposalsof thatcommitteeornot,our agreementor disagreementmust takeinto accountthe fact that the proposalsaremeant for the actual situation n Indiarightnow. Joshi and Little's arguments havelittle bearing on the question of 'here andnow' in respectof policies governing im-portregulation,exportpromotion, xchangerateregimes or budgetarypolicies. Wewilldemonstratethe irrelevance of Joshi andLittle's arguments in the area of the ex-changerateregimeand letthe readersdrawthe obvious parallels n the case of the useof otherpolicy instruments.At the very outset of the oracularpro-nouncementby Joshi and Little,we meetthe following statement: "Sound macro-economic fiscal andmonetarypolicies to-getherwitha flexible exchangerate,ensurethe maintenanceof a viableoverall balancewith foreigners".This is a catch-all state-ment: apparently t should cover all pos-sible sins. For,afterall, 'with sound mon-etaryand fiscal policies', why should any-thing go wrong in the most perfect of allpossible worlds? But, in fact, Joshi andLittlearelivinginaMundell-Flemingworld.This is basically an 'insular economy' as

defined by McKinnon (1981), in whichcapital flows occur either on official ac-count only, or passively in response tocurrentaccounts deficits. There is no placein that worldfor asset-ownersdeliberatelychanging the composition of theirportfo-lios of domestic and foreign assets in re-sponse to changes in theirperceptions ofrelative profitability of different types ofassets. That s to say, it has no resemblanceto the world that has emerged since the1960s, of transnationalcorporations andbanks continually changingthe,composi-tion of theirportfolios andtheiroperationsas between assetsdenominated ndifferentcurrenciesorlocated n differentcountries,or of large volumes of funds continuallychanging hands as between different na-tions or regionsas speculators'moods andjudgments change. Virtually none of thepropositionsonwhichtheeasyassuranceofthe virtueof flexible exchange rates in en-suring greater internal stability is basedremainunchangedn thisworldofglobalisedcapital lows(see, forexample,Kenen1985;andFrenkelandMussa 1985).But, of course, Joshi and Littledescendfrom theirpreachers'pulpit to the postureof quotidianconsultants cn(dcringriendly

advice to an Indiangovernment pursuingwhat theyregardas an essentially soundbutsomewhat muddledsetof policies. Approv-ing of the flexible exchange rate ntroducedin India, they write, "There is no need tofear that the exchange rate may fail as aninstrument o maintain a viable balanceofpayments-provided, of course,thatmacro-economic policy gives it room to operate,that s, that there is no large general excessdemand for domestic output". It appearsfrom discussion elsewhere in their paper,that by 'flexible exchange rates' Joshi andLittle really mean a policy of devaluationwhenever a balance of payments deficitthreatens and believe that a sufficientlylargedevaluation of the rupee will alwayscure a balance of payments deficit.The implicit claim in their paper thatbefore July 1991 India had maintainedapolicy of fixed exchange rates is utterlyfalse. The nominal exchange rate of therupee in rupees perUSdollar)was fixed upto June 5, 1966; then it was raised to Rs7.50, andstayedat thatprice upto 1971-72,but from 1972-73, the price rose almoststeadily (with a break in the years from1977-78 to 1980-81 when the rupee appre-ciated in terms of US $ but not in terms ofSDR) to Rs 8.968 in 1981-82 andRs 17.943in 1990-91 [RBI 1993: Table 35]. Accord-ingtoastudyby HKPradhanundertaken nbehalf of the Export-ImportBank of India[EXIMBI1992], the index of therealeffec-tive exchange rateof the rupee (with base:1980 = 100) with thewholesale priceindexbeing used as the deflator for exchangeratesof themajortradingpartners,declinedfrom 129.21 in 1970 to 81.36 in 1988 andwith theconsumer price index as the defla-tor, from 147.23 in 1970 to 81.80 in 1988[EXIMBI 1992: Table 5.9], that is, by 37percent accordingto the firstmeasure,andby 44 per cent according to the second.While a policy of devaluation accordingtorequirementsof international ompetitive-ness or easing of currentamount deficitscancertainlybe adoptedfromtime to time,there is little justification for a blanketespousal of a policy of devaluation as abasic remedyfor balance of paymentdiffi-culties. At the riskof labouring heobvious,the following points can be made in theparticular ontextof the Indianeconomy inrecent times [Sarkar19921.The hoped-for expansion in exports re-sulting fromcurrcncydevaluationmaynotbe realised because of well known factorssuch as the inelasticity of globaldemand orcommodities, or competitive devaluationbyothercompeting countries. Thecomput-ingof partialelasticities of demandwithouttaking such a possibility into account runsup against the 'fallacy of composition'

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Undera regimeof liberalisation,theimportcomponent of many goods rises and whensubstantialdevaluation occurs, thedomes-tic cost of production of exportables alsorises. Even with competitive conditions,exporters may not then be in a position tocut their prices in foreign markets,in pro-portion to the rate of depreciation of thecurrency.With restrictivepractices inhomeimarkets-practices thatmay be facilitatedby endemic foreign exchange shortage-exporters may find it easier to exploit do-mestic ratherthanexport markets.Ina periodof global recession only thosegoods experience a fast rise in demandwhich are favoured by changes in taste ormajor changes in technology. Those goodsaretypically new goods, resultsof an inno-vative technology or an innovativeproductdifferentiation.People whose incomes risedemandthese buteven people experiencinga fall in income haveanurgeforsuch goodsor services.But they naturallyrequire newinvestment, and old productsand acilitiescannotbe used for theirproductionwithoutconsiderable modification. Hence largeamountsof investment have togo into theirproduction.Economic calculationsextend-ing over any length of time involve agreater degree of risk if exchange ratesbecome volatile. The required supply re-sponse may notbe forthcoming n thatcase.Joshi and Little seem also to have sleptthrough the whole series of attempts tostabilise the exchange rate mechanism(ERM)as a step towardsarrivingat a uni-fied EuropeanMonetarySystem. These at-temptshave failed in thecase of BritainandItaly butother countries are still persistingwith them,with the bands of tolerance forexchange ratevariations having been wid-enedfor theweakereconomies. Turbulencein exchange rates in a regime of virtuallyfreetrade underwhich the import ntensityof domestic production s likely to be quitehigh) is bound to affect most domesticprices, and thus disturb the macro-eco-nomic balances that the government andmonetaryauthorities eek toattain.There sconsiderable evidence that the import in-tensity of Indian manufacturesand of In-dianexports was going up duringthe 1980s[EXIMBI 1991]. The implication of suchdevelopments has also escaped the atten-tion of Joshi and Little.Finally, Joshi and L-ittle ake no accountof the protectionist policies heing pursuedin the G-7 countries-policies whose viru-lence shows no sign of declining. The ema-ciated theoretical frameworkof static corn-parative advantage cannot explain the re-surgence of interventionist industrial poli-cies in the US or the success of a numberofexplicitly interventionistJapanesepolicicsin building up their automnobi[e industry,their biotechnological expertise, theirsupercomputersndlthei well1-recoenised

lead in manyareas of militarytechnology.Just because the static version of thecom-parative advantage theory dogmaticallyembracedby Joshi and Little cannot takeaccountof thetheoreticallyandempiricallyrich iterature n thebuilding upand conse-quences of strategically utilising dynamiccomparative advantage (for references towhich see, among others, Krugman 1986;Porter1990; Bagchi1992), it does not meanthatothers need to follow these wise meninto the desert of passivity of industrialorexchange ratepolicy.We havealreadyreferred enerallyto thesuccess of industrialpolicies in the case ofJapan,and the casual dismissal of the SouthKorean uccesses byJoshi andLittlecan becounteredwithaplethoraof evidence to thecontrary.We merely here reiterate that the Japa-nese victory in the race for paritywith theUS in semi-conductor technology, for ex-ample,has beenunambiguouslyascribed opublic regulationand support [Sigurdson1983;Okimoto et al 1984and Borrus et al19861. The Japanesesuccess in importingtechnology andimporting t and then beat-ing theoriginaldevelopers in internationalcompetition has been replicatedby othereast Asian countries. In South Korea, pri-vate firms contractout research needs tostate-controlled or other laboratories andcollaboratewith them oradapting mportedtechnologytolocal needs. It hasmanaged oforge highly efficient instruments forupgradationand absorptionof technology[Bagchi 1987: Chapters3 and5].Lookingatthe historicalrecordof today'sdevelopedcountries,abroadgeneralisationcanbe made: all of themhad restrictedtrade regimes in place during the periodwhen they were experiencing trend accel-eration in economic growth. Even whenthey were practisingsuch restricted traderegimes, they were advocating free tradepolicies for others. The US and Europeanpolicy-makersaremore or less forcing theLDCs to introduce xternal rade iberalisa-tion, buttheirprotectionistbarriersarego-ing up in the shape of multifibre agree-ments, voluntary export restrainingagree-ments andstraight ubsidies of agriculture,steel and manyother ndustriesunder hreatfrom foreign competition [Bagchi 1992].The Indiangovernmentand ndustrialman-agers can tryto redesign ourincentive sys-tem, the system of macro-economic man-agement, and the system of industrialorganisation o as toallowan activistpolicyto be sustainableand produce positive re-sults. If Indian policy-makers must havewise men of the west to give thcm confi-dence, they should pay more heed to theadvice andcaution of Dornbusch 1990) oraylor(1991). Fol owingJoshi and 1ttle'sadvice woulldbe to condemn India to eco-nomic sitaenationn the medium term.

ReferencesBagchi, A K (1987): Public Intervention andInduistrial Restructiuring in China, IndiaandttheRepublic ofKorea; New Delhi, ILO-ARTEP.-(1982): On thte Political Economy of theChtoiceof a TradeRegime, Centre for Stud-ies in Social Sciences, Calcutta,OccasionalPaper No 131, February.Borrus, M L Tyson and J Zysman (1986):

'Creating Advantage: Hfow GovernmentPolicies Shape International Trade in theSemi-Conductor Industry' in P R Krugman(ed), Strategic TradePolicy andNew Initer-nationialEconomies,Cambridge, Mass, MITPress, pp 91-113.Dornbusch, R (1990): 'Policies to Move f68mStabilisation to Growth', Proceedings ofthe WorldBankAnnuialConference ot, De-velopment Economics, Washington D C,IBRD, pp 19-48.EXIMBI (1991): How Import-Intensive AreIndian Exports?, Export-Import Bank ofIndia, Occasional Paper No 16, Bombay,December.-(1992): Effective Exchange Rate of the Ru-peebyH KPradhan, Export-ImportBankofIndia, Occasional Paper No 21, Bombay,November.Frenkel, J A and M L Mussa (1985): 'AssetMarkets, Exchange Rates and the Balanceof Payments' in Jones and Kenen (1985:679-748).Jones, R W and P B Kenen (eds) (1985):Handbook ofInternationalEconomics, Vol2, International Monetary Economics andFinance, Amsterdam, North-Holland.Joshi, V and I M D Little (1993): 'FutureTradeand Exchange Rate Policy for India', Eco-nomic and Political Weekly, XXVIII (31),July 31, pp 1599-1605.Kenen, P B (1985): 'Macro-economic Theoryand Policy: Ilow the Closed Economy WasOpened'inJonesandKenen(1985: 625-678).Krugman, P R (ed) (1986): Strategic TradePolicy and the New International Econom-ics, Cambridge, Mass, MIT Press.McKinnon, R I (1981): 'The Exchange Rateand Macro-economicPolicy: ChangingPost-war Perceptions' Jouirnal of Economic Lit-erature, Vol 19, pp 531-37.Okimoto, D I, T Sugano and F B Weinstein(eds) (1984): Competitive Edge: The Semi-Conductor Industry in the USAandJapan,Stanford, Stanford University Press.Porter, M E (1990): The Competitive Advan-tage of Nations, Iondon, Macmillan.RBI(1993):India'sBalanceofPa)yments 1948-49 to 1988-89, Bombay, Department ofEconomic Analysis and Policy, ReserveBank of India.Sarkar, Prabirjit(1992): 'Rupee Depreciationand India's External Trade and Paymentssi nce 197 J',Econionic andPolitical Weekly,Vol XXVII, June 13-20, 1259-1266.Sigurdson, J(1983): Japan 'sHligh TechinologyRace. ThteInfornmationechlniologies,Lund,Resear-chPolicy Studies.Talor, L (1991): 'EconomicOpenness: Prob-lemsto thecCentury s endJ'n T Banuri(ed):EconomricL berali.sation:No Panacea, Ox-fordJ,Chu.rendon ress, 1(X)-148.

Economic and Political Weekly September 18, 1993 2013