The mechanics of real undervaluation and growth

Available from: 
October 2013
Paper author(s): 
Juan M. Wlasiuk (Universidad Adolfo Ibáñez)
Macroeconomics and Monetary Policy

Lacea 2013

Is it true that a competitive exchange rate is behind China's success? The media and policy makers often mention that China manipulates its real exchange rate (RER) in order to improve its exports and boost growth. This view, however, is not supported by the most prominent economic models, which do not predict a positive relationship between real undervaluation and economic growth. I propose a 3-sector model with labor market frictions that explains how a policy aimed at increasing domestic savings and depreciating the RER can, at the same time, generate real growth through a reallocation of workers from a low-productivity traditional sector into a high-productivity manufacturing sector. The policy is particularly effective in countries with relative abundance of labor, scarcity of agricultural resources, and high barriers for the entry of workers into the manufacturing sector. Empirically, I verify that higher real undervaluation (measured as deviations from PPP) is positively associated with GDP and manufacturing growth in countries with lower per capita agricultural land and higher rural population. The relationship vanishes and even becomes negative in the opposite cases. Finally, I propose a simple methodology for the identification of real depreciations exogenously induced (i.e. that are not related to changes in productivities or in terms of trade). I find that, during the last 20 years, such episodes have been mainly observed in East Asian developing countries.


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Research section: 
Lacea 2013 annual meeting
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