Trade, exchange rates
and income distribution
A research topic and
reflection on global
governance
IPC, Brasilia
IDEAS Beijing
Alphametrics Co., Ltd.
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
CERF and Alphametrics
Global imbalances - income


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
Distribution of population and income
by country, 2005
100
80
60
40
20
0
0
10
20
Income
30
40
50
60
70
80
90
100
Population
CERF and Alphametrics
... and exports

Countries in the top
20% by p.c. income
produce 75% of
world exports
Distribution of world population, income
and exports by country, 2005
100
80
60
40

Those in the bottom
50% by p.c. income
produce 7% of
world exports
20
0
0
10
20
Income
30
40
50
Exports
60
70
80
90
100
Population
CERF and Alphametrics
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.

CERF and Alphametrics
Why exports matter so much

The balance of
payments identity
and its implication
for income
X–mY+K=R
Y = [X + K-R] / m
$ per capita, 2005
X
USA
K-R
m
Y
4,334
2,637
0.167
41,807
China
915
-88
0.475
1,743
Africa
309
-53
0.321
798
CERF and Alphametrics
The drivers of export
performance



Market control by
international companies
(global oligopoly)
S&P, May 2007
Country
Rating
France
AAA
Chile
AA
Innovation and
branding are the
instruments of market
control
Malaysia
A+
China
A
India
BBB-
Brazil
BB+
Countries need a BBB
rating to qualify
Turkey
BB
Nigeria
BB
Venezuela
BBCERF and Alphametrics
Many countries have succeeded
Inequality measures
Baseline
TY Theil: income
Units: index
TH Theil: expenditure
TED Theil: energy use
70
70
70
60
60
60
50
50
50
40
40
40
30
30
30
20
20
70
75
80
85
90
95
00
05
10
15
20
70
TEP Theil: energy production
75
80
85
90
95
00
05
10
15
70
TXM Theil: manufactured exports
70
70
60
60
60
50
50
50
40
40
40
30
30
30
20
70
75
80
85
90
95
00
05
10
15
80
85
90
95
00
05
10
15
TXS Theil: service exports
70
20
75
20
70
75
80
85
90
95
00
05
10
15
70
75
80
85
90
95
00
05
10
15
CERF and Alphametrics
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
CERF and Alphametrics
The exchange rate paradox

High income countries have the highest real
exchange rates
5.50
5.00
Qatar
Norw ay
Sw itzerland
USA
4.50
Hong kong
4.00
Poland
Argentina
Thailand
China exc HK
Philippines
3.50
3.00
Viet Nam
India
2.50
Bangladesh
2.00
-0.80
-0.60
Pakistan
U. Arab Emirate
Kuw ait
Lebanon
Venezuela
Jamaica
Ecuador
Other ME
Iraq
Nigeria
Kenya
Other Asia
Other Africa
-0.40
-0.20
0.00
0.20
Income per capita at market prices against real exchange rate, 2005
0.40
CERF and Alphametrics
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
CERF and Alphametrics
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
CERF and Alphametrics
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
CERF and Alphametrics
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

CERF and Alphametrics
The impact on non-tradeable
sectors

Available income
has to be shared
across the
segment of the
labour force that
does not obtain
employment in
tradeable sectors
(assuming 50% of income is spent on tradeables)
120%
Income per
person in
nontradeables
as per cent
of
tradeables
100%
80%
60%
40%
20%
0%
yn/yt = (1 – a) / a
x et / en
0%
20%
40%
60%
Per cent of labour force in
tradeable sectors
CERF and Alphametrics
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

CERF and Alphametrics
The price of non-tradeables
(assuming 50% of income is spent on tradeables)


The price of nontradeables 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
160%
bn/bt = 2/3
140%
Price of
nontradeables
as per cent
of
tradeables
120%
100%
80%
60%
bn = bt
40%
20%
0%
0%
20%
40%
60%
Per cent of labour force in
tradeable sectors
CERF and Alphametrics
Purchasing power parity (PPP)

PPP compares
prices across
countries
(assuming 50% of income is spent on tradeables)
140%
PPP
bn/bt = 2/3
120%
100%

In the general case
if the price of
tradeables is
equalised
80%
60%
bn = bt
40%
20%
0%
0%
ppp = 1/a x
1/(1 + en/et bn/bt)
20%
40%
60%
Per cent of labour force in
tradeable sectors
CERF and Alphametrics
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
140%
120%
100%
80%
60%
40%
20%
0%
ppp = 1/(a+(1-a)bn/bt)
0%
200%
400%
600%
Productivity in nontradeable sectors
CERF and Alphametrics
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 nontradeables stagnates

This explanation is
implausible today
given the high level
of automation in
service industries in
rich countries
CERF and Alphametrics
Inequality and migration

Income
generated by
oligopolistic
tradeable
sectors is
concentrated in
specific
locations,
typically large
cities.

This has caused massive
inter-regional and ruralurban migration
CERF and Alphametrics
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.
CERF and Alphametrics
A global economy requires
global government
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


Standards of
governance
endorsed by rich
countries at national
level are not
perceived as being
necessary or
relevant at the
global level.
CERF and Alphametrics
Global governance


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 ?

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
CERF and Alphametrics