Partha Sen

Deterioration of the terms of trade and capital accumulation: A re-examination of the Laursen-Metzler effect

This paper analyzes the effects of both a permanent and a temporary deterioration In the terms of trade on a small open economy. The model, based on intertemporal optimization, emphasizes the labor-leisure choice and the role of capital accumulation There are two main conclusions to be drawn from the analysis. The first 1s that in all cases the transitional dynamics depends critically upon the long-run response of the capital stock to the deterioration m the terms of trade. This has been shown to consist of a substitution effect, which is negative, together with an income effect, which is positive. Secondly, since the steady state equilibrium depends upon the initla1 conditions of the economy, a temporary shock, by altering these initial conditions for some later date when the shock ceases, leads to a permanent effect on the economy. In the case where the substitution effect dominates, a deterioration in the terms of trade leads to a short-run reduction in investment and a short-run current account surplus, contrary to the Laursen-Metzler effect. However, when the long-run income effect dominates, the deterioration m the terms of trade leads to a short-run investment boom, accompanied by a short-term current account deficit. The Laursen-Metzler effect prevails, although it is driven by investment, rather than by savings behavior.

Tariffs, Capital Accumulation, and the Current Account in a Small Open Economy

This paper analyze these effects of a tariff in an intertemporal optimizing model, emphasizing the role of capital accumulation. Three types of increases in the tariff rate are considered: (i) unanticipated permanent; (ii) unanticipated temporary; (iii) anticipated permanent. There are two main general conclusions to be drawn from the analysis. The first is that the introduction (or increase) of a tariff is contractionary, both in the short run and in the long run. In particular, employment is reduced both in the short run and in the long run, so that there is no significant intertemporal tradeoff, as obtained by previous authors. The fail in the long-run capital stock causes an immediate reduction in the rate of investment, which in turn leads to a current account surplus. While this response of the current account is in accordance with much (but not all) of the existing literature, the mechanism by which it is achieved, namely the decumulation of capital, has not been previously considered. Also, the fact that the declining capital stock is accompanied by an accumulation of foreign bonds means that the savings effect of the tariff is unclear, depending upon which influence dominates. This ambiguity of savings is, however, very different from those occurring in other studies. The second major conclusions stems from the fact that the steady state depended upon the initial stocks of the assets. As a consequence, a temporary tariff, by altering these initial conditions for some later date when the tariff is removed, leads to a permanent effect on the economy.

Privatization in a Small Open Economy with Imperfect Competition

We look at privatization in a general equilibrium model of a small, tariff-distorted, open economy. There is a differentiated good produced by both private and public sector enterprises. A reduction in government production in order to cut losses from such production raises the returns to capital and increases the tariff revenue, which are welfare improving. However, privatization also leads to lower wages and possibly fewer private brands. This lowers workers’ welfare, which may make privatization politically infeasible. Privatization can improve workers’ welfare with complementary reforms, e.g., attracting foreign investment or trade liberalization.

The Possibility of Welfare Gains with Capital Inflows in a Small Tariff‐Ridden Economy

Capital inflows with full repatriation give rise to welfare improvement possibilities in a small tariff distorted economy when imperfect competition and increasing returns are allowed for in one sector of a two sector model. This is in contrast to the Brecher-Alejandro proposition that capital inflows with full repatriation are necessarily Immiserizing for a small tariff-ridden economy. We find that welfare gains chances are greater (a) the higher the expenditure share of the capital intensive differentiated good (b) the lower the substitutability between brands and (c) the lower the share of tariff revenue in national income.

Imported input price and the current account in an optimizing model without capital mobility

Abstract This paper analyses the effect of an oil-price increase in an economy which cannot borrow in the international capital markets. Current-account surpluses and deficits are matched by reserve changes at the central bank. It is shown in an optimizing setup that an unanticipated oil-price increase worsens the current account and lowers the real interest rate contrary to models which assume perfect capital markets.

Terms Of Trade And Welfare For A Developing Economy With An Imperfectly Competitive Sector

The effect of terms of trade on the welfare of a small open economy is analyzed. It exports a homogeneous good and imports some brands of a differentiated good. It also produces some brands of the differentiated good which are not traded. A terms-of-trade deterioration causes resources to move to the nontraded, import competing sector. The economys income rises and the price index for the differentiated good falls, resulting in higher welfare. This accords well with the experience of developing economies of East and Southeast Asia. Copyright 1998 by Blackwell Publishing Ltd

Welfare-improving debt policy under monopolistic competition

Abstract We analyse the effects of debt policy in an overlapping generations model with monopolistic competition. Debt crowds out capital and raises interest rates but unlike competitive models this is welfare-improving for all generations if the elasticities of substitution in production are low. In a non-competitive model, the social marginal product of capital could be negative while the rate of interest exceeds the population growth rate (the latter two are non-negative), and profits exceed investment.

Capital Flows and Exchange Rates: The Indian Experience

This paper examines the relationship between real exchange rate and the level as well as volatility of capital flows for the Indian economy for the period 1993Q2 to 2010Q4. Other variables include fiscal policy, monetary policy and external balance indicators. Estimation results indicate that the variables are co-integrated and each Granger-causes the real exchange rate. The generalized variance decompositions show that determinants of the real exchange rate, in descending order of importance include net capital inflows and their volatility (jointly), government expenditure, money supply and the current account surplus. An analysis on similar lines is also performed for the foreign exchange reserves held by the Reserve Bank of India.

Terms-of-Trade Shock and the Current Account in a Monetary Economy

Over the period 1973-81, the terms of trade of non-oil developing countries deteriorated at about 2 per cent per annum. This was accompanied by an increase in current account deficits in excess of 3 per cent above what they had been in the previous decade. (See Khan and Knight, 1983, for a discussion; these authors find the terms-of-trade shocks the major cause of the deficits.) This has led to a renewal of interest in the effects of changes in terms of trade for a small open economy. The conventional wisdom, first put forward by Laursen and Metzler (1950) and Harberger (1950), emphasized the fact that a terms-of-trade worsening lowered real income, which in turn lowered savings and worsened the current account-the Laursen-Metzler Effect. The recent reappraisal was initiated by Obstfeld (1982). He showed, in an infinite-horizon-optimizing framework with perfect capital mobilizing, that if the discount rate was a function of the level of utility, surpluses, and not deficits, accompany an unanticipated and permanent terms-of-trade worsening. The long-run level of the discount rate is tied down by the given world rate of interest. This in turn fixes the long-run level of utility. The terms-of-trade shock tends to lower the level of utility and agents save to offset this. Across steady states there is only a substitution effect. On the other hand, if the discount rate is fixed and equal to the world interest rate, then the economy adjusts to the terms-of-trade shock by immediately lowering real expenditure by the same amount as the decline in real income so that the current account is always balanced. Svensson and Razin (1983) showed that in a two-period framework this does not necessarily happen. For the infinite-horizon case they showed that, if preferences were separable over time and the discount rate was increasing in instantaneous utility, then Obstfelds results were indeed obtained. In a two-period overlapping-generations model, the results could be modified owing to the fact that human wealth and non-human wealth are not perfect substitutes and a terms-of-trade shock affects these differently. (See Matsuyama, 1988, for a discussion.) But it is still true that an unanticipated permanent terms-of-trade shock has a one-shot effect on the current account unless some ad hoc costs of adjustment are introduced (see e.g. Persson and Svensson, 1985, and Matsuyama, 1988). The uncertain lifetime model (see e.g. Frenkel and Razin, 1988, and Matsuyama, 1987) generates non-trivial

Tariffs and Welfare in an Imperfectly Competitive Overlapping-Generations Model

The effect of a tariff is analyzed in a two-sector model in an uncertain-lifetimes framework. One of the sectors is monopolistically competitive. It is shown that while a tariff leads to a consumption boom and possibly a current-account surplus, its welfare effects depend on whether the homogeneous good or the differentiated good is exported by the small open economy. Welfare improves if the differentiated good is nontraded but deteriorates if the homogeneous good is nontraded. Copyright 2001 by Blackwell Publishing Ltd