Exchange Rates and Economic Policy in the 20th Century by Derek H. Aldcroft Ross E. Catterall

Author:Derek H. Aldcroft, Ross E. Catterall [Derek H. Aldcroft, Ross E. Catterall]
Language: eng
Format: epub
Tags: Business & Economics, Economic Conditions
ISBN: 9781840142648
Google: R4SwAAAAIAAJ
Publisher: Ashgate
Published: 2004-01-15T01:30:00+00:00

Simulations of effective protection of capital

The case that exchange rates create microeconomic costs does not rely solely upon barriers to trade, it also relies upon an argument that the same barriers also create impediments to investment. As discussed in the fourth section, the most appropriate way to measure the effect of these barriers on investment incentives is through their impact on the profitability of different industries. The effective protection of capital provides such a measure. As with trade barriers, the impact on profitability should, on average, be as low as possible, since this would minimise any deterrent to investment. Dispersion should also be low, since substantial variations across industries in the effect on profits would provide arbitrary incentives to invest in one industry at the expense of another. Finally, for the same reasons as for effective rates of protection exchange rate barriers will differentially affect investment to supply the domestic market and investment to supply export markets. That is, anti-export bias continues to apply.

To assess the impact of exchange rate barriers on investment incentives, Table 4.3 reports simulations of the effective protection of capital for a sample of UK industries in 1990. The UK input-output table for 1990 was used for the analysis and the same set of assumptions as outlined above (pp. 142–3) was employed. Note, however, that no simulations are provided for 1989. This is because the UK input-output table for 1989, unlike that for 1990, does not provide any decomposition of value added. Returns to capital could not, therefore, be separately identified.

The results of Table 4.3 suggest that the impact of exchange rate barriers is likely to have a stronger effect on profits and, hence, investment than value added. In itself this is an unremarkable finding: profit margins account for a smaller share of the final product price than value added, and any policies affecting both prices and costs will be magnified more in their effect on profits than for value added.

The results do, however, highlight an important limitation of the effective protection analysis. As reported above, the average effective rate of protection for the domestic market under the core scenario was 4·5 per cent. When measured solely in terms of the returns to capital rather than value added, this becomes 21·4 per cent. That is, the impact of exchange rates on value added, according to the base scenario, can reasonably be argued to have been marginal but cannot be argued to be marginal in terms of the impact upon returns to capital. Even for the more realistic scenario 3, the simulations suggest that exchange rate barriers lower returns to capital, on average, by about 9 per cent. This makes a much stronger case that exchange rates have a significant and adverse impact and, given that future returns to capital are of key importance to investment decisions, arguably a more pertinent case.

Moreover, the dispersion of rates is also significantly higher for effective protection of capital than for value added. Under the core scenario (scenario 1) the sample standard deviation was 12·2 per cent and, under scenario 3, 4·8 per cent.

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