Volume 44, Number 175,
October-December 2013
Would a More Flexible Exchange
Rate Improve Competitiveness?
Guadalupe Mántey

In recent years, a variety of authors have proposed that inflation objectives in macroeconomic policy should be replaced by a stable and competitive real exchange rate (screr) that encourages growth through exports (eclac, 2012; Galinda and Ros, 2009; Frenkel and Taylor, 2009; Bresser-Pereira and Gala, 2008). These researchers argue that the priority objective of maintaining low inflation has led central banks to over-value exchange rates, sacrificing growth in income and employment. Appreciated exchange rates, they write, attract speculative capital flows that generate inflationary bubbles in asset markets, requiring monetary authorities to implement costly cleanups and, above all, discourage investment in the production of marketable goods.

They ascertain that by improving the commercial balance, an screr would reduce the need to take on external debt, preventing speculative attacks on the currency. To do so, the recommendation is to have a more flexible nominal exchange rate (Frenkel, 2008; eclac, 2012).

Although these authors acknowledge that maintaining an screr by adjusting the nominal exchange rate could have inflationary effects, they believe that these are mollified by active fiscal policy to regulate effective demand, because in developing countries, internal demand is not elastic with respect to interest rates (Galindo and Ros, 2008; Frenkel, 2008).

There are three problems with these proposals:

  • They ignore the financial effects of devaluation in countries with high liability dollarization.
  • The explanation for inflation is ambiguous. One the one hand, it acknowledges elevated exchange rate movements, supported by the structural theory of inflation, and, on the other hand, it maintains that inflation depends on the product gap, as postulated by the dominant theory.
  • Little attention is given to the distributive effects of the devaluation and its repercussions on growth.

The financial effects of devaluation on developing economies, as has been shown, are negative and of significant magnitude, because they apply a change to the resource pool and affect how companies make investment decisions.

The movement of the exchange rate to inflation is a complex phenomenon, because it depends on how distributive conflicts between internal and external agents with very different negotiating powers are resolved. For this reason as well, the effect of devaluation on investment and employment is difficult to predict.

In this work, a competitive real exchange rate is understood as the relationship between the price of marketable goods and those that are not marketable, to which the current account of the balance of payments is put into equilibrium. Under the assumption that labor costs are the most important factor in determining prices, the real exchange rate between two countries is normally represented by the relationship between their respective unit labor costs.

In the current world, with global markets and an international monetary system lacking an anchor and generating liquidity beyond the needs of global commerce, this interpretation of real exchange rates is questionable, especially for less developed countries. On this topic, Castaignts (2004) observed that the real exchange rate in these economies depends less on what happens in the production and distribution processes and more on what occurs in the financial markets. The dollarization of liabilities and capital flight are the most influential factors in determining exchange rates.

Researching the influence of relative vertically integrated unit labor costs (viulc)2 on the dynamics of foreign commerce for manufactured goods between Mexico and the United States, Ruiz Nápoles (2010) found that in the majority of activity sectors, viulcs had a low correlation with comparative advantages,3 and in some cases, the correlation was even high, a sign that the relationship was opposite to what was expected based on conventional theory. His research led him to conclude that with commercial opening, the specialization pattern of the Mexican economy has shifted from labor-intensive activities to input-intensive activities, which in his opinion, is due to the fact that technological progress is displacing salaries as the main factor in determining competitiveness.

2 Vertically integrated unit labor costs (viulc) measure direct and indirect labor inputs per unit of product, based on the inter-industrial relationships captured by the input-product matrix. Relative vertically integrated unit labor costs measure the relationship between direct and indirect unit labor costs in Mexico, and the same in the United States, for each manufacturing activity.

3 The comparative advantages shown were measured by dividing the share of one sector of exports from Mexico by the share of the sector in imports from the United States.

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PROBLEMAS DEL DESARROLLO. REVISTA LATINOAMERICANA DE ECONOMÍA, Volume 49, Number 194 July-September 2018 is a quarterly publication by the Universidad Nacional Autónoma de México, Ciudad Universitaria, Coyoacán, CP 04510, México, D.F. by Instituto de Investigaciones Económicas, Circuito Mario de la Cueva, Ciudad Universitaria, Coyoacán,
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