Trade, exchange rates and income distribution

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

2. The starting point • exchange rates cannot solve problems of global imbalance • 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

3. Global imbalances - income Distribution of population and income by country, 2005 • 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

4. ... and 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 Distribution of world population, income and exports by country, 2005

5. Three views about how the imbalances may be resolved • 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 • World government: market-driven globalisation must be complemented by structural policies to redistribute resources and promote convergence.

6. Why exports matter so much • The balance of payments identity and its implication for income X – m Y + K = R Y = [X + K-R] / m $ per capita, 2005

7. The drivers of export performance S&P, May 2007 • Market control by international companies (global oligopoly) • Innovation and branding are the instruments of market control • Countries need a BBB rating to qualify

8. Many countries have succeeded

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

10. The exchange rate paradox • High income countries have the highest real exchange rates

11. The slope has become steeper • 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 • Since then the slope and dispersion have remained about the same

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

13. Devaluation • Unit labour costs are reduced relative to international 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 • 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

14. Revaluation • 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 • 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

15. The impact on non-tradeable sectors (assuming 50% of income is spent on tradeables) • 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 Income per person in non-tradeables as per cent of tradeables Per cent of labour force in tradeable sectors

16. The sharing mechanism • 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

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

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

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

20. 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 • This explanation is implausible today given the high level of automation in service industries in rich countries

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

22. There is an end to the story As income rises • a larger proportion is spent on services • tradeable production becomes more geographically dispersed • 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.

23. 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. • Government must be representative of people, not market power • Executive bodies are subordinated to and accountable to the legislature • Compliance with the law is enforced by the judiciary

24. Global governance • Accountability of all UN institutions to the General Assembly • Financial contributions based on ability to pay • International law to govern the conduct of international business • 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 ?