What I really don't like about the BoL stance on this devaluation question (yes, here I go again) is how extreme Governor Rimsevics is in denying its positive effects. I mean, I'd find BoL position to be a lot more credible if they said something like "yes, devaluation has some positive effects, but these are outweighed by the negative effects". What the Governor said, in effect, boiled down to devaluation not having any positive effect, and anyone who talks about it is dispensing "pseudo-advice". I suspect the BoL projections of the effect of devaluation simply assume away all of its positive effects. How can the resulting numbers be credible?

I am talking about two fallacies here: (i) denial of devaluations’ positive effect on exports; and (ii) denial of domestic demand substitution effects. Regarding exports, BoL says that devaluation would have little or no effect because demand in world markets is falling. However, this confuses shifts in demand curve for exports (falling incomes in the world) with movements along the demand curve (shifts in supply as a result of devaluation). Re substitution effects, all BoL is saying is that devaluation would result in inflation. They don’t like to mention that prices of imported goods would rise by more than prices of (largely) domestically produced goods. Thus, whatever is produced by domestic producers would, in effect, become cheaper compared to imports. As a result, we would see substitution, i.e. increase in demand for whatever is produced locally. This would lessen, if not stop, the rate of job loss and have a positive effect non tax revenues. Yet the BoL says that their estimate of price elasticity of demand for imports to be close to zero, i.e. a demand curve for imports being near vertical! Both (i) and (ii) are equivalent to saying that people (consumers and producers) don’t respond to changes in prices. Well, if that’s what you believe, don’t bother reading this blog and don’t bother listening to any economists. Moreover, if price mechanism doesn’t work, there is no point in having competitive markets – lets just go back to central planning.

Another highlight of the conference was a presentation by Anders Aslund. It’s worth mentioning that, of course, Professor Aslund was invited precisely because he opposes devaluation. However, it’s important to understand why he opposes it. In contrast to Governor Rimsevics, he does not deny devaluation’s positive effects. In fact, Prof. Aslund opposes devaluation precisely because it works. His point is that going the way of ‘internal devaluation’ forces the policy-makers to implement painful ‘structural reforms’, i.e. to fix the supply side of the economy. Aslund sees sort of a ‘governance failure’ in peace time, when a country is not able to push through the necessary reforms because of all sorts of political opposition. He sees a crisis as a God-send opportunity for a reform; the more crises you have – the better, the harder the crisis is – the better. Devaluation is bad because it ends the crisis quickly, and does not provide sufficient pressure for implementation of structural reforms. Now that’s a respectable intellectual argument against devaluation. If that’s your position – fine. I hope you understand all the implications, though. Crises are good and should happen more often. We should prolong this crisis and strive to make it harder. High unemployment is good. Suffering is good. Bring it on! Still excited? – you would make a good zealot.

There is also something I really did not like in Anders Aslund’s talk. I am talking about him invoking analogy with this ‘two islands paper’. In short, there are two extremely similar islands – Barbados and Jamaica. They started from very similar initial positions in 1960s but widely diverged in their economic performance. According to Anders Aslund at the conference, “the big difference is that they [Barbados] did not devalue.” But such a conclusion just does not follow from this paper! Check a short digest, or the paper itself. Especially, check Figure 1 in the paper. Jamaica’s sharp decline in GDP per capita took place in 1973, a year after People’s National Party came to power with a promise of “democratic socialism” and implemented “self-reliance” and “social justice” economic policies, i.e. heavy state intervention (p.7). Fans of industrial policy and “priority industries” – pay attention!

The ‘internal devaluation’ episode, that Prof. Aslund must be referring to, took place in the early 1990s when Barbados had a recession, turned to IMF for help, but refused to devalue. Barbados succeeded in reducing the wages, “achieving the same result as a devaluation”, and “the economy recovered quickly” (p.10). However, note the following from Figure 1 in that paper. First, the gap with Jamaica was already there by that time and was reduced by this ‘internal devaluation’ episode, rather than widened. Second, note what happened after recession started in 1990. A sharp fall in GDP per capita until 1993, and then a period of very low growth until about 1997. Not exactly an L-shape, but not exactly a U-shape either, and certainly not a V. What a great example!

To summarize, this paper just doesn’t prove Aslund’s point that Barbados did so much better [than Jamaica] because “they [Barbados] did not devalue”! Ok, Riga is not an intellectual center of any kind, but that’s not an excuse for Prof. Aslund to be so sloppy in his argument.