Rethinking Bretton Woods | Thu, May 26, 2011
Last April, in a submission to the WTO Working Group on Debt, Trade and Finance (“the WTO Working Group”), Brazil called for consideration of the relationship between exchange rates and international trade. “Macroeconomic dynamics between exchange rate and foreign trade is an issue that is yet to be better understood and addressed in international forums, against the background of the international crisis triggered in 2008,” the document reads.
This is not the first time that the issue of exchange rates and trade is raised at the WTO Working Group, since such body was established in implementation of mandates emerging from the WTO Doha Ministerial meeting of 2001.
Throughout meetings held by the Working Group in 2002, its first year of deliberations, the relationship between exchange rate volatility and trade (or competitiveness) was raised many times. At the end of that year, in a summary of potential areas that the Working Group should focus on, the Chairman identified “the effects of financial and exchange rate instability on trade, drawing on the lessons to be learned from the financial crises experienced by emerging economies in the 1990's.”
Noting the relevance of the connection between exchange rates and the Working Group’s mandate, a letter the International Working Group on Trade-Finance Linkages addressed to the WTO in 2003 prominently called for “the creation of a mechanism for ensuring the coordination of macroeconomic and exchange rate policies among currency reserve countries. This mechanism should take into account the impact of dramatic exchange rate fluctuations and misalignments on the trade performance and debt-service obligations of developing country economies. “
The elusive nature of the task of defining this issue for treatment in the WTO in a way that would meet consensus, however, soon became apparent at those Working Group discussions. The United States reportedly stated “the Group could be informed by relevant institutions about what they were doing, but it was not for the WTO to deal with exchange rate matters.” India’s view was that the Working Group should not refer to exchange rates. Malaysia considered the exchange rate volatility and trade a priority, while the European Community expressed interest on “a study being undertaken on the longer-term trade and exchange rate impact on exchange rate manipulation to promote exports, drawing upon case studies.” Canada stated interest “in examining the correlation between trade flows, capital account liberalization and exchange rate volatility, in particular in countries enforcing exchange controls.”
Eventually the IMF was requested to produce a study that, delivered in 2004, generally downplayed the importance of the connection. Upon hearing the conclusions, the US said “if the relationship was not very robust, and domestic policy was often the cause of such volatility, then this was not a major policy concern for enhancing trade.” Asked whether the study had taken into account the impact on small- and medium-sized enterprises, the IMF representative responded that it had not, and that the study would have probably come out differently if it had.
In a following meeting that year, UNCTAD argued that the exchange rate was determinant for competitiveness but it was so influenced by volatile capital flows, showing this was an example of incoherence between the trade and financial systems. Brazil, China and other delegations expressed support for UNCTAD’s perspective but it was arguably the beginning of the end for the consideration of this issue in the WTO Working Group. Being a non-negotiating group, it lost ground to preparations for the WTO Hong Kong Ministerial in the following year, and the Working Group’s agenda never quite recovered the breadth it had in the first couple of years after its establishment.
Brazil’s proposal this year calls for a two-pillar work program in 2011-12. The first pillar would involve querying the influence of exchange rates on trade, whether the short term fluctuations or the long term misalignments. The second would involve for taking stock of how the coherence mandate of the WTO has been implemented as regards to this interplay between exchange rate and trade.
If one wanted to be optimistic about the future of this work plan it would be enough to look at the significant changes in the surrounding environment, compared to the first time this agenda was brought up in the WTO Working Group. The initiative comes on the throes of a global financial crisis that reinvigorated debate on the international monetary system. The French Presidency of the G20 has decided to make such reform its top priority item. The study conclusions by the IMF in 2004 have also been generally discredited by other empirical research, including a recent survey of transnational executives that, compiled by McKinsey Institute, contains undeniable evidence of the impact of exchange rate volatility on investment and location decision-making by firms.
Nevertheless, although it is possible to speak of a post-crisis reform agenda, the reality is that the interests of developing countries have been largely absent from it. The average share of exports in GDP in developing countries is almost double that of developed countries. This accounts for the relatively greater role that trade played in channeling the impacts of the 2008-09 crisis in developing countries. It also explains why the consequences of post-crisis reforms on developing countries’ trade are a crucial factor in any reform project that claims to be sensitive to the interests of those countries. But whatever consequences post-crisis financial reforms will have on trade have not been a major consideration in the design of such reforms so far, to say the least.
The international monetary system discussion is no exception. Acknowledging the impacts of monetary system reforms on trade and development should have been a high priority and, yet, it is the case that Brazil’s submission of last month comes to fill a gap in the international debate.
One example of this omission is the recent reconsideration capital controls received in the IMF. As emerging countries have to deal with rising capital inflows, the IMF has admitted that capital controls may be an acceptable measure to keep inflows in check, under a number of conditions. However, in the view of some experts, the IMF’s analytical work to determine when capital controls could proceed fails to acknowledge the role that large capital inflows have on countries’ trade profile.
In recent presentation at an IMF-convened seminar, economist Roberto Frenkel explained that even a transitory appreciation in the real exchange rate can have lasting effects on a country’s manufacturing capacity, and lead to a dismantling of physical, organizational and human capital for it. The IMF’s approach, conversely, relies on indicators regarding the financial system and the tendencies of the current account, mostly focusing on whether exchange rates are in or out of equilibrium. But this leaves for secondary or no consideration the evolution of the real exchange rate. “This orientation prioritizes the reduction of risks of external and financial crises but neglects the risks of Dutch Disease,” Frenkel concludes.