Short-term supply responde to a devaluation : a model's implications for primary commodity-exporting developing countries

The authors evaluate whether, in the short run, a devaluation could be contractionary in developing countries that export primary commodities. To do so, they use a model capturing the principal features of those economies. The two most important channels for transmitting the change in parity are (1) a supply effect with the supply response for tradables essentially a function of labor costs relative to the export commodity price, and (2) a demand effect, with the supply responds for the semitradabless essentially a function of the real wage. They simulated the model for a middle-income and a low-income country. The economic structure of the low-income country is less flexible (lower supply elasticity in production, lower elasticity of substitution between domestic production and imported inputs) than in the middle-income country. The model is meant not for use as a forecasting tool but to show the relative magnitude of various effects that are relevant in countries where the initial supply response to a devaluation would come mostly form increased production of an export commodity. In particular, the authors analyze the difference between the producer's response under"wrong"timing (the predevaluation price is the price signal on which production decisions are based) and under the presence of middlemen (rentiers in the export sector whose presence affects the devaluation's pass-through to procuders). Their findings: (a) For devaluation to succeed, there must be little wage indexing. Devaluation is more likely to be expansionary in the middle-income than in the low income country. (b) The devaluation's timing with the production cycle of the primary commodity export matters, especially in the middle-income country. (c) Debt relief is more effective where wage indexing is low and can help offset the negative effects of"wrong"timing by increasing output. But debt relief has an asymmetric effect on exportable and semitradables sectors, as the production of semitradables increases while that of exportable decreases. (d) With a tariff reduction, the devaluation implies more expansion in tradable. But this is not enough to compensate for the relative decrease in the growth rate of production of nontradables, so the growth of total output declines. (e) Finally unless the timing is"right,"the effects of redistribution (which income being"transferred"from producers to middlemen with a higher propensity to consume imported goods) can have contractionary effects that cannot be offset by debt relief.