austin-murphy-the-triumph-of-evil

240 THE TRIUMPH OF EVIL
the currency back up), an inelasticity of demand can sometimes result
in a currency devaluation actually causing a deterioration of the current
account situation (Goldstein and Khan, 1978), as explained earlier
in the chapter with the Russian ruble devaluation in 1991. In addition,
the inflation induced by the currency depreciation (Abuaf and Jorion,
1993) may eventually offset any competitive advantage created by the
initial devaluation, so that the same devaluation-inflation-devaluation
cycle explained earlier may occur (even when the initial devaluation
happens in a situation with a healthy current account). As a result, capital
controls can be very useful for avoiding such negative effects in these
cases, just as they can be employed to inhibit capital flight which sometimes
arises from investor fears of capital controls themselves (Deltas
and Stockman, 1993)
Malaysia has provided an empirical example in the 1997 Asian currency
crisis that at least some form of restriction on capital movements
can reduce the severity of a currency crisis (Phillips, 1999), just as
Russia had some success in averting another major economic catastro
phe by using informal capital controls after its second currency crisis in
1998 (Economist, 1999b ). China has demonstrated that currency crises
may be avoided altogether with permanent capital controls as long as
there is not a deficit in the balance of trade or current account (Roach,
1999).
However, under normal circumstances, capital controls only postpone
a real income or currency decline to a future date when the controls are
removed (or when all the local capital is owned by foreigners), and they
generally can not be used to solve the problem of an existing current
account deficit. In the meantime, capital controls may create inefficiencies
in capital allocation and counterproductive black markets as well
as discourage some productive foreign investment (Sheikh, 1976). As 3
result, capital controls can also cause an increase in the current account
deficit longer-term.
Changes in Relative Protectionism
One possible way to avoid a currency or real income decline when
the current account is in deficit is via a change in relative protectionis �
(Borkakoti, 1998). Protectionism includes not only the classical barners
of tariffs and quotas (Winkelmann, 1998), but also currency con-
CHAPTER 6 241
trois imposed for trade transaction purposes, multi-tiered exchange rates
provided to domestic businesses competing against foreign competi­
(designed to discourage the imports of non-essentials), and subsidies
tors (Kindleberger, 1968), as well as technical standard requirements
and business/legal systems that inhibit the distribution of imports (Hine,
1994). The developed countries of Western Europe (as well as Japan)
bad used protectionism (especially currency controls) very effectively
after World War II to generate fast economic growth without suffering
the negative side effects of current account deficits (Williamson, 1991 ),
but they have now achieved a level ofwealth that enables them to have
sufficient capital and mechanization to be internationally competitive
fore recently moved to a system of fully convertible currencies). On the
have not yet achieved an adequate level of international competitive­
without needing such severe restrictions on imports (and have there­
other hand, the level of protectionism for less developed countries that
ness (because of inadequate wealth and capital resources) remain gen­
�lve a BOP problem in those less developed countries, such trade bar­
erally higher than for developed countries (Anderson, 1995). In order to
ners must be increased relatively further (or be reduced relatively less
than in their export markets).
The removal of trade barriers is usually negotiated multilaterally
through organizations such as the World Trade Organization (WTO),
lander, and Viaene, 1998). Such negotiations generally result in greater
the European Union (EU), and NAFTA, or bilaterally (Bowen, Hol­
�v�ral� reductions in protectionism (which increase trade and produc-
(VJty tn the aggregate world economy) than would unilateral actions
Bagwell and Staiger, 1999).
Countries with lower levels of protectionism benefit more from any
g�eral agreement to proportionally reduce trade, but, since such coun­
tri�. have less in trade barrier reductions to offer, they have less bar­
Pin�g �wer in instituting such agreements. A good example of this
7ohahng problem is provided by New Zealand, which has been one
�the least protectionist countries in the world since the mid-1980s
its �Loughlin, 1993). As a result of New Zealand's free trade policies,
Zeal; : reques� to join NAFTA was rejected by the USA beca� se New
Olarbe d essentially had nothing to put on the table or offer m return
r, 1999). In other words, the reduction in North American trade