A recent seminar held by Prof.AC Jordaan from the University of Pretoria provided some insight into real exchange rate (RER) misalignments. The seminar was definitely more suited to the mathematical mind of the economic students, but it certainly created some food for thought for everyone present.
The debate mainly focussed on the effects of misalignments and not so much the cause of it, as that is very hard to determine. Emphasis was placed on under- and over-valuation of the RER and its effects. As stated by Prof.Jordaan, over valuation has the more threatening effects, especially in a South African context. The focus of this post would be to look at the counter measures to RER misalignment for the trade industry.
In South Africa we rely heavily on exports (as also pointed out by Prof.Jordaan) as a measure of keeping our current account deficit respectable or rather manageable to some degree. Another critically important role that exports play is that of sustaining, but also creating jobs.
Now where does RER misalignment come into play?
In short: over-valuation of the Rand would mean that we generate less profits when selling our goods abroad, which means that employment expansion is slower as companies have less surplus funds. However, before the products are even sold, they are produced at a higher foreign cost, as the Rand is strong and it is difficult to keep prices low in foreign markets. Take into account that we have relatively expensive labour and we sit with low levels of competitiveness, ceteris paribus. Under-valuation means that we pay much higher prices for the goods we import, which may lead to an increase in our current account deficit, ceteris paribus. However, under-valuation would also mean that our exports become more competitive abroad, which could increase exports, rendering under-valuation a lesser threat than over-valuation.
My attention is turned to the infamous government institutions. S.A. currnetly runs a floating exchange rate system. No intervention from government. Market forces determine the value of the Rand. The questions can now be asked: Should government do something? And if government does something, what should it be?
For a start fiscal and monetary policies can be adjusted to regulate the supply of money, inflation, supply of foreign exchange, demand, etc. These can be effective to a certain degree to maintain the value of the RER, but the risk is mismanagement. This can lead to greater negative RER misalignment effects. Another option to hedge yourself against the risk of RER fluctuations is to apply import controls and subsidise exporting industries.
An immediate concern would be the ineffective allocation of resources to protected industries, causing slow or no development in locally protected industries, as there is no real competition. This however can be countered by efficient research and development and effective management of these industries, i.e. a closer working relationship between these private sectors and government.
The other solution is to subsidise exports, to make us more competitive. Now, this may cross some boundaries set out by the WTO in terms of subsidising certain industries (Agreement on Subsidies and Countervailing Measures). However, the Doha round of the WTO was dismissed with no real certainty attained to subsidies and the role it may or may not play, so there might be room to push subsidies in certain industries. This would promote exports as producers would be hedged against over-valuation of the RER and allow our products to become more competitive and remain competitive when the RER fluctuates.
RER misalignments can have threatening effects on the South African economy. Government interference in controlling the RER is a definite possibility. It could have definite positive effects on South African trade as exports can become more competitive and that would directly impact the national economy (RER Misalignment and Economic Growth). The success of such interference would, however, be a function of the competence and efficacy applied by the governing authority (which seems improbable with current government competence). But if the right people are appointed into the right positions, the management of South Africa’s RER might just be a spark for some economic growth in a rather stagnate economy.
Such an appointment, however, is a totally different discussion…