Common Economic Problems of Countries
Currency devaluation is one of the most frequent problems that developing countries have to face when considering growth into international trade. ‘An upward shift in the supply of foreign exchange due to rising capital inflows tends to lead not to real exchange rate devaluation but to appreciation, which offsets liberalization’s incentives for traded goods production by reducing profits from exports and making imports cheaper.'(Taylor, 2000, p.43)
Developing countries trying to be competitive and to present a good setting for trade and investment, sometimes tend to overvaluate their currency, this is the first stage of currency devaluation. If they do not become competitive enough to raise the exports to a higher level than imports, they would need to establish currency devaluation measures in order to pay their international debt obligations. A current example of a country that suffers this problem is Argentina. In 1991 the government establish a new economic scenario on ‘an open economy’. They adopted a series of policies in order to achieve economic growth. The most important was the convertibility plan, which pegged the peso to the dollar at the one-to-one exchange rate. This worked at first, however the consequences were show years later.
The past year Argentina fell into a terrible economic crisis. After many years with an overvalued currency, they had to devaluate. They were not able to generate more exports than imports and the exchange rate was fixed too high. In addition, the foreign debts were growing at levels impossible to manage. The real exchange rate is an element that can make dramatic changes to a country’s economy. ‘Real exchange rate appreciation is pointed as a factor that contributed to the deterioration of the trade accounts’ (Aybar & Milman, 1999, p.39)
Most developing countries in the task of improving their economy, face the increase of imports rather than exports, because of the exchange rate appreciation. Under these economic circumstances, where the currency is overvaluated, it is cheaper and more profitable to import, than to rely on local production. Since the national market has been open, consumers have grown accustom to new and imported products. International firms, in most cases, can offer better quality and more competitive prices than local firms.
“Domestic firms may not survive when exposed to increased competition” (Morrissey & Filatotchev, 2000, p.5) In developing countries this is a serious problem, because local firms have to deal with the change in market behavior. They have to pass from a protective economic environment where it is not necessary to improve their business in order to continue in the market, to a competitive environment, where they are obligated to make substantial changes to remain in the market. Under this new panorama, in many developing countries small national firms have to close, because they are not able to compete in these new economic bases.
Colombia had to confront this problem when they made the decision to open their economy. In 1990, the government challenged the nation with important economic changes, and like other developing countries, many local companies where not ready for this economic transformation. In 1992, the government eliminated protectionism measures, allowing international firms to enter the country. Local firms where not prepared for this challenge, especially in the manufacturing sectors. The companies that were most affected by the import penetration suffered a fall in margins, in attempt to increase their productivity, many firms did not manage to recover and disappeared. “The generates a contraction of employment due to the crowding out of domestic production by imports”(Ocampo & Tovar, 2000, 36)
‘The capital inflows led to the expansion of banking credit’ (Ros & Lusting, 2000, p.4). This additional credit can stimulate investment increase. However, it can also prompt a ‘consumption boom’ (Taylor, 2000, p.44) The expansion of domestic money and credit, as well as government expenditures create a situation where the government is obligated to borrow money from international organizations, in order to keep the national reserve at a good level, causing an increase in foreign debt.
The economic conditions are all tied to each other, and that was shown in the Mexican Crisis. During the 90s this country’s situation was stable after a few programs that took it through a growth in international trade. However, ‘at the end of 1994, a year after NAFTA’s approval, the Mexican economy was in a financial crisis’ (Ros & Lusting, 2000, p.4) The crisis was a consequence of inadequate economic circumstance; the overvaluation of the peso was on top of them, with the large volatility of capital inflows.
The capital inflows as stated before, led to the growth of national banking credit. “Part of this credit expansion was channeled to the finance of new investment, but another, and possibly most significant part, ended up fueling a private consumption boom in the midst of an artificial atmosphere of bonanza.” (Ros & Lusting, 2000, p.4) Under these circumstances, it can be deducted that the growing indebtedness of households implied a decline in household savings, which helped to cause a terrible economic scenario in 1994.
As a result of internationalization and overvaluation of the currency, this country had a deficit in current account. This contributed to the decrease of profit of national companies. This adverse scenario caused an expansion of bank credit, as a consequence of the fall in business savings. The implications of all these events were the continuous accumulation of external liabilities. On December of 1994, the Mexican government was unable to overturn its debts, so they where forced to devaluate the peso, in order to reestablish the economy.