This article appeared in the online and print Business Report on 7/7/2011 under the title “Weakening the rand not the way to wealth“. As is usually the case when I dispel the weak-currency-creates-growth-and-prosperity myth, it elicited some rather passionate responses. Enjoy.
International trade is one of the most misunderstood issues in economics. The common misguided narrative goes something like this: exports are good and imports are bad, therefore exports should be promoted by industrial policies, while imports should be curtailed as much as possible by industrial policies.
This is the basic thinking behind the poorly conceived New Growth Path and the Industrial Policy Action Plan proposals.
It is also the reason why the likes of Cosatu and the SACP, and indeed many business owners, argue for a weaker exchange rate in the hope of achieving this supposedly laudable goal of export maximisation and import minimisation.
But rather than arriving at a worthy goal, these policies would lead us into an economic gaol. The promotion of exports and demotion of imports, and its close cousin, the promotion of the substitution of imports with locally produced goods, has long been thought to be the key to prosperity.
Good Accounting Doesn’t Always Make For Good Economics
Conventional Keynesian macroeconomic accounting tells us that exports add to gross domestic product (GDP) and imports subtract from it. Like a necessary evil, so the theory goes, imports are supposed to be tolerated but kept to a bare minimum. Trade surpluses are said to be the route to boosting GDP and national wealth, and, in the misleading Keynesian framework, you can see why this fallacy arises.
But this is wrong on so many levels.
For one, when we apply the “global test” to this idea, it is obvious that not all countries can simultaneously weaken their currency and run trade surpluses (unless we start trading with Martians). So under this false line of thinking, for some countries to benefit, others must lose out.
This creates an immediately antagonistic global trade arena, with countries fighting trade wars, raising protectionism, and devaluing their currencies.
This is the world of zero-sum, hostile trade relations, which Adam Smith in his 1776 tome, The Wealth of Nations, deplored when he wrote:
“(Trade restrictions), by aiming at the impoverishment of all our neighbours, tend to render that very commerce insignificant and contemptible.”
More fundamentally, what the Keynesian formulation of trade and GDP ignores is the primary and essential characteristic of trade: that any mutually agreed transaction is a beneficial action for both parties. Thus imports must by definition be welfare-enhancing actions, not zero sum.
Yes, in the Keynesian framework, there is an outflow of money, but what is not apparently accounted for in this deficient paradigm is the inflow of a good or service, and not just any good or service, but a good or service which the buyer values higher than holding money (or else they would not have made the trade).
Subtracting imports from GDP might look correct to an accountant, but to an economist it is clear that imports are unambiguously welfare enhancing.
The Trap of the Seen vs. the Unseen
Moreover, when we try to substitute imports with local goods by means of forced policies such as subsidies or import tariffs, we are making the bizarre case that artificially higher prices and lower quality goods will benefit the domestic economy!
These policies may benefit a narrow group of domestic producers, but what about all the extra income being spent on these more expensive goods that could have been spent elsewhere. It is easy to see a thriving protected industry, but what remains tragically unseen are the industries that were never able to thrive and the jobs that were not created by the income that was not diverted elsewhere.
Finally, we need to understand that our currency is nothing more than a medium of exchange and store of value. If we try to weaken the rand we are doomed only to create false dawns of prosperity before prices adjust and destroy our money illusions. A policy of rand weakness to boost exports and growth is the epitome of economic short-sightedness. Empirical evidence backs this up overwhelmingly.
South Africa’s large trade deficit from 2003 to 2009 was not the result of a strong rand, bad industrial policy or an unproductive economy. It was caused by excessive growth in private debt. Prior to the debt binge, South Africa ran trade surpluses, and after the credit crunch, when banks stopped lending and households stopped borrowing, the trade account quickly returned to relative balance and even surplus.
If there remains any tendency for trade deficits in South Africa, it is because debt levels are still growing, and for that we have to thank a moderate uptick in private borrowing and, most of all, government borrowing, which has sky-rocketed since 2008.
The Reserve Bank Done It
Recently the Reserve Bank expressed concern about rising imports. This is ironic, not only because imports are not the evil they are made out to be, but because excess imports over exports are the result of excessive debt growth, a variable controlled by the central bank and the commercial banks under its regulatory ambit.
Between January 2003 and January 2009, the central bank printed out of thin air about R32 billion of new notes and coins. It was upon these notes and coins that banks expanded fractional credit to the private sector, and this led to deep and persistent trade deficits over this period.
This simple insight seems to elude many economists. Since January 2009, the central bank has created about R11bn in new money, presumably to make it easier for banks to keep lending money and to curtail rand strength. Thus, if there is any persistent trade deficit to fret about, the source remains the central bank.
South Africa’s problem is not too many imports, but too much debt, and this debt is allowed to flourish off a base of money printed out of thin air by the central bank, which is government mandated.
Perhaps the greatest irony of all, and one that confirms the futility of these wrong-headed policies, is that in order to weaken one’s currency to supposedly boost exports, a central bank must print money and allow credit expansion, which leads to rising imports, not rising exports!
Imports are not a scourge, but debt can be. The road to prosperity is paved with open borders to free trade and a sound monetary regime, not protectionism and currency devaluation. Policies to boost exports and substitute imports are folly.
Real productivity – the kind that lasts and builds real and sustainable wealth – cannot be legislated or printed into existence. It is time to end our trade delusions and abandon the policy means and methods by which we perpetuate our nagging and debilitating poverty. It is time for the state to take a serious approach to economic reform, and it can start by making sure the central bank stops printing new money out of thin air and thereby making our commerce “insignificant and contemptible”.