The balance of payments adjustment policy in Korea : devaluation vs uniform export subsidy and import tariff

Abstract

Economists have suggested a variety of policies for the adjustment of balance of payments. The broad policies of adjusting internal demand or changing the foreign exchange rate to adjust the balance of payments have been categorized as expenditure changing and expenditure switching. Expenditure changing comes from varying the level of national income mainly through monetary and/or fiscal policy. Expenditure switching uses the foreign exchange rate to divert domestic and foreign expenditure between home and foreign goods. A change in uniform rates of export subsidy and import tariffs is often said to be identical with a foreign exchange rate change in its effects on the balance of payments. The main purpose of my study is to search for the most satisfactory policy tool to attain a more favorable balance of payments adjustment. I set the hypothesis that changing the foreign exchange rate is the best among these alternative policy tools. I compare the policy effects of monetary and/or fiscal policies with those of the foreign exchange rate change through a theoretical analysis. The opinion that the foreign exchange rate change and a uniform change in rates of export subsidy and import tariffs are identical is analyzed theoretically as well as tested empirically using Korean data. They are identical on three assumptions: First, the subsidy-tariff scheme must be applied to all international transactions, not only to merchandise transactions. Second, the elasticities of exports and imports with respect to subsidy and tariff changes must be equal to the elasticities of exports and imports with respect to foreign exchange rate change. Third, there must not be any inefficiency or corruption in the bureaucracy controlling the subsidy and tariff. Even if the second and third assumptions are met, the first is denied by the existence of international capital movements and the debt service transactions associated with them. In this case, the interest rate differential between local and foreign financing and the potential gap between the social and private cost of foreign borrowing plays the essential role in comparing the effects of the two policies. The theoretical discussion shows that the change of foreign exchange rate is better than monetary and/or fiscal policy as long as the foreign sector's fluctuations are not temporary phenomena. It is also found that changing the foreign exchange rate is better than the uniform subsidy-tariff scheme, when the latter is applied only to merchandise transactions, because of the foreign capital flow and its effects on merchandise transactions. The empirical test using Korean data for the period from 1962 to 1973 supports the theoretical conclusion of the advantage of changing the foreign exchange rate over the subsidy-tariff scheme. A non-uniform subsidy-tariff scheme, the subsidy on exports exceeding the tariff on imports, has been applied to merchandise transactions in Korea. The effects of foreign capital inflow on imports, which is the main point in the theoretical discussion are supplemented by the fact that the elasticities of several categories of exports with respect to foreign exchange rate change are higher than those with respect to the subsidy-tariff. The empirical findings show that the balance of payments would have improved by 3.5 billion dollars more with the use of exchange rate policy than with the use of the uniform subsidy-tariff scheme during the period studied.