The book reference is Herman Daly and John Cobb: FOR THE COMMON GOOD:
REDIRECTING THE ECONOMY TOWARD COMMUNITY, THE ENVIRONMENT, AND A SUSTAINABLE
FUTURE. (Whew!) (Boston: Beacon Press, 1989)
Daly picked up his fixation with capital mobility from Culbertson, it appears,
and this has become something of a correct line with the anti-free-trade
community. It is clear, however, that even under a system of perfectly mobile
capital, a sufficiently favorable exchange rate can convert absolute
disadvantage into comparative advantage. (This trick is performed in every
intro trade text.) The real questions pertain to the likelihood that such
exchange rates will emerge, the efficacy of the exchange rate mechanism taken
in isolation, and the costs of relying on currency movements to balance trade.
Here I get nervous, because the issues are complicated and I have vowed not to
spend too much time on the net. Maybe the best approach would be to summarize
my views in a very abrupt way, and if anyone is interested in looking at a
particular point in more detail we can go into it.
(1) Forces do not exist which automatically balance trade. This is true
empirically, since many countries are chronic deficit or surplus traders. The
culprit, of course, is the capital account. Capital and debt assets are
desirable and can be sold as readily as goods for current use.
(2) Exchange rates are determined by a combination of "real" and "speculative"
factors. Neither operates in such a way to generate conditions conducive to
comparative advantage.
(3) Central bank control over exchange rates is limited. Moreover, exchange
rates are also responsive to macro policies, and the policies needed to
achieve comparative advantage may be disadvantageous on other grounds.
Incidentally, *real* exchange rates are even more difficult to target.
(4) In practice, a variety of mechanisms are employed to counteract trade
deficits and avert foreign exchange crises. These include not only
devaluation, but also wage repression and general austerity.
(5) The effectiveness of devaluation depends on the relevant elasticities. To
the extent that countries adopt the advice to specialize their elasticity of
imports falls.
(6) The issue of historical time and the J-curve is also relevant. Countries
often delay action until a foreign exchange crisis threatens. Under such
circumstances devaluation may make the short-run problem worse.
The upshot of all this is that exchange rates can't be expected to play the
role assigned to them in the textbooks, and for this reason--and not capital
mobility--the world is governed more by absolute than comparative advantage.
Peter Dorman
