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Balance of Payments Solutions (SUPPLY-SIDE MEASURES (Consequences (1) Fall…
Balance of Payments Solutions
SUPPLY-SIDE MEASURES
Improve competitiveness of exports via structural changes
Useful if the root cause of current account deficit is due to loss in comparative advantage
This is done through
1)
R&D and
2)
training for workers to increase productivity
Consequences
1)
Fall in cost of production and increases in export competitveness
2)
More FDI inflow
3)
Rise in productivity of economy
4)
Increase in export revenue, improvement in current account and BOP improves, ceteris paribus
Limitations
1)
There is no guarantee that R&D will succeed
2)
Takes a long gestation time
3)
Difficult to change mindset of workers
EXPENDITURE SWITCHING MEASURES
Devaluation
Definition: The government unilaterally declares the lowering of the fixed exchange rate to improve export revenue and reduce import expenditure.
Results in
1)
Improvement in competitiveness
2)
Increase in net export revenue (X-M) and improvement in balance of trade and current account
3)
BOP improves assuming Marshall Lerner Condition holds
LIMITATIONS
1)
Marshall Lerner Condition may not hold
2)
J-curve effect may occur
3)
Retaliation by trade partners
4)
Low degree of import substitution
5)
PES inelastic by local producers
6)
Trade off: Import price push inflation
Tariffs
Consequences
1)
Increase in price and decrease in quantity demanded of imports
2)
Increase in domestic production and employment
3)
Increase in net exports revenue (X-M) and improvement of balance of trade and current account
4)
BoP improves assuming Marshall Lerner Condition holds
Limitations
1)
Increase in consumer welfare loss
2)
Retaliation from trade partners
3)
PED of imports may be price-inelastic and thus lack domestic close substitutes, making it difficult for consumers to switch to cheaper domestic goods
4)
Trade off: forgoes benefits of free trade
5)
Sheltering of domestic firms breeds inefficiency and complacency
Quotas
Consequences
1)
Increase in price and decrease in quantity demanded of imports
2)
Increase in net exports revenue (X-M) and improvement in balance of trade and current account
3)
BOP improves assuming Marshall Lerner Condition holds.
Limitations
Trade partners may retaliate
Hidden export subsidies and import restrictions
Limitations
1)
Strain on the government's budget and increase in opportunity cost
2)
Breeds complacency and inefficiency among local producers
Consequences
1)
Decrease in price and increase in quality of exports
2)
Increase in price and competitiveness of exports
3)
Increase in demand for exports
4)
Improvement in net exports revenue (X-M) and improvement in Balance of Trade and current account
5)
BoP improves assuming Marshall Lerner Conditions holds
Voluntary Restraint Agreements
Results in decrease in volume of trade in specific goods
EXPENDITURE REDUCING MEASURES
CONSEQUENCES
1)
Rise in interest rates and subsequent fall in investment and consumption levels
2)
Fall in AD
3)
Falling national income by multiplier effect
4)
Leading to a fall in GPL and a fall in the price of exports
5)
Price competitiveness of exports increase
6)
Increase in export revenue and fall in import expenditure
7)
Increase in net export revenue (X-M) and improvement in balance of trade and current account
8)
BOP improves assuming Marshall Lerner Condition holds through/
LIMITATIONS
1)
Income-elastic demand for imports
2)
Causes a fall in economic growth and rise in unemployment
Contraction fiscal and monetary policies
:warning:AIM: To decrease domestic spending on imports and to export out excess goods
CONCLUSION
1)
Expenditure Switching measures and Expenditure Reducing Measures are short-term measures
2)
Long term SS policy is needed to improve productivity and increase export competitiveness
3)
Multi-pronged approach of ESM, ERM and SS policies is needed.
4)
BoP is volatile and unpredictable due to globalization. Hence, creating new comparative advantage instead of protectionism is imperative. Free trade encourages greater efficiency, competition and larger market.