Balance of Payments Adjustment Theories - 2 | Economics Optional Notes for UPSC PDF Download

Theory of Policy Mix

• Policy Mix is the mix of the monetary and fiscal policies are made by a nation’s policy makers regarding managing the country’s economy.
• The Fiscal policies encompass the taxes and the subsidies and the monetary policies encompass the interest rates and the money supply. The elected legislatures control the fiscal policy and the independent central banks take care of the monetary policies.
• Different tools are used to achieve the goals of low unemployment, stable prices, moderate interest rate, and more. There are times when the monetary and fiscal policy works together. However, there are also times when fiscal and monetary policies push in a different direction.

Floating Rates and their Implications for Developing Countries: Currency Boards

• A currency where the price is determined by supply and demand factors relative to other currencies is called a floating exchange rate. Floating exchange rates in developing countries must be suspected to have a deleterious effect on the trends of exchange.
• Floating exchange rates between key currencies have zero effect on a developing country as long as it trades with a particular country or currency area alone.

Implications of Floating Rates in developing countries

• Floating exchange rates are unlikely to have very strong inflationary effects. This is because the foreign trade of the developing countries will be affected by flexible rates to a limited extent only.
• The export trade of the developing countries is described by the predominance of primary products. Most developing countries derive the majority of their export earnings from one or a few raw materials, and the prices of these are a rule stated in foreign currencies and determined outside the borders.
• The exporters and importers run greater risks because the developing countries do not have any functioning forward exchange markets. They are without any technical and personal prerequisites for setting up forward markets.
• The elasticities about developing countries are such that devaluation will as a rule neither help to expand exports nor reduce imports. Hence, the balance of payments will not improve as desired.

Trade Policy and Developing Countries

• Trade policies are the regulations and the agreements that control the imports and the exports of a country. It is important to understand that the per capita income of different developing countries is not the same and varies according to their economic conditions.
• Trade can head to the full utilization of the otherwise underemployed domestic resources. This means, through trade, a developing nation can move from an inefficient production point inside its production frontier.
• With unutilized resources because of inadequate internal demand, to a point on its production frontier with trade. By increasing the size of the market, the trade makes the possible division of labor and economies of scale.
• International trade is the vehicle for the conveyance of new ideas, new technology, and new managerial and other skills. Trade also stimulates and promotes the international flow of capital from the developed to the developing countries.
• In several large developing nations, such as Brazil and India, the importation of the newly manufactured products has stimulated domestic demand, until the efficient domestic production of these goods became attainable.
• International trade is an outstanding antimonopoly weapon because it stimulates greater efficiency by domestic producers to meet the foreign competition.

Trade Blocks and Monetary Unions

• Trade blocs are one of the most important phenomena of the Global economy. It also leads to an unstable situation. Trade Blocs have turned extremely controversial over the past years, both from an economic as well as a political point of view.
• The phenomena of Trade can be compared with that of ‘Multilateralism’, which was pioneered by the United States after World World II. It involves not picking and choosing the trade bloc members. It tried to agree on the trade and the investment matters with all the countries in the world.
• The US proposed an organization known as the General Agreement on Tariffs and Trades (GATT) and brought together as many countries as possible. It came up in 1947.
• However, multilateralism had its limit and it became difficult to deal with it simultaneously in the negotiations that included more than a hundred countries. WTO replaced the GATT but GATT still exists as WTO’s umbrella treaty. This opened the gates for trade blocs.

Blocs are a group of countries that agrees to one or more of the following:

• Reduce tariffs for certain goods.
• Remove internal trade barriers.
• Coordinate the external trade policies.
• Allow the free movement of capital.
• Allow for the free movement of labor.
• Coordinate indirect tax policy.
• Coordinate regulatory and competition policies.
• Merge treasuries and fiscal policies.
• Merge banking supervision and resolution policies.

Trade Blocs include the countries that are:

• At a similar level of development.
• Geographically closer or adjacent.
• With similar trade regimes.
• Sharing a desire to organize regionally.

The first trade bloc of the world came up in 1834. Currently, there are 302 trade blocs registered with the World Trade Organisation. This means that the world of trade has become very complicated over the past years.
A monetary union is when the intergovernmental agreement involves two or more states sharing the same currency.

WTO: TRIMS, TRIPS, Different Rounds of WTO Talks

• World Trade Organisation is an international body that deals with the rules of trade between different countries. Most of the world has signed to the policies and the agreements of the World Trade Organisation. The main goal of WTO is to help the producers of the goods and services, exporters, and importers conduct their business.
• TRIMs is an agreement that mentions the rules that apply to the domestic regulations that a country applies to foreign countries. It is often a part of industrial policy. It concluded in 1994, under the WTO’s predecessor, and came into force in 1995.
• TRIPS helps to set down minimum standards for the regulation by the national governments of different forms of intellectual property, as applied to the nationals of other World Trade Organisation member nations. It is an international agreement between the member nations of the World Trade Organisation.

Speculative Attacks

• A speculative attack is an extensive selling of domestic currency by foreign and domestic investors to procure foreign currencies. Often this type of behavior by the players in the foreign exchange market is aimed to make a profit from the exchange rate movements.
• Usually, a speculative attack is associated with fixed exchange rate systems where the central banks meddle in the foreign exchange market by supplying foreign currencies.

Conclusion

• The trade relations between the two countries can either help to boost the economy of both, either bring them both down. Trade wars can be an example of the cold wars between the nations.
• Countries around the world have registered themselves with the World Trade Organisation to benefit from its policies and maintain relations with other countries. Trade is an essential part of any economy and the growth of a nation.
• Balance of Payments helps to maintain the equilibrium between the money that flows into and outside the country.