The Theory of Balance-of-Payments Adjustment: Comment

TlE adjustment process used to be described in theoretical literature in terms of an automatic mechanism. This automaticity is largely (but not wholly) absent today, and discussion of this issue is better framed in terms of (1) when national policy makers should take measures to eliminate imbalances; (2) what measures are most appropriate and under what circumstances; and (3) what the division of responsibility should be among countries, for when there are any imbalances there must be at least two. The first of these questions, when national policy makers should take measures to eliminate imbalances, is not usually asked explicitly, although it arises frequently enough in practice. It is not self-evident that imbalances always ought to be eliminated as quickly as possible; on the contrary, there will be many occasions in which rapid adjustment is costly to surplus or deficit country, and the best course of action is compensatory finance from surplus to deficit country. The lending facilities of the IMF offer one source of such finance; and national reserves can be used for the same purpose. Emminger points to the practical difficulties of making a correct assessment. If it is decided that an imbalance should be eliminated, a variety of measures are at hand, none of them satisfactory as devices for general use in all cases. If changes in exchange rates are to be avoided, they come down basically to reductions in domestic demand (or increases by countries in surplus), restrictions on international transactions (or removal of restrictions by countries in surplus), and exhortations or stronger measures to improve the competitiveness of a country's products in world markets. Both Scitovsky and Emminger turn to interregional payments adjustment within a country for enlightenment on how the process might work smoothly, effortlessly, and, it would seem, painlessly. In search of the solution to this riddle, Scitovsky focuses on the ready acceptability of regional financial assets in the national capital market. So long as a region holds such assets-indeed, so long as its credit is good-the region can finance its deficit by sale of financial claims. It would seem to avoid the hard choice among alternatives mentioned above. In fact, interregional adjustment even in a country with a well-developed national capital market probably involves far more pain than Scitovsky's analysis implies, and in particular it involves substantial deflation in deficit regions, substantial inflation in surplus regions. "Depressed areas" are a familiar phenomenon in most countries. This term is itself ambiguous. Sometimes it means simply an area which is backward by modern standards. But more often it also means an area in which average incomes are low in part because workers and plant are idle or only partially employed. Whenever such areas have higher than average unemployment levels, depression is a manifestation of an ex ante regional balance-of-payments deficit at full employment. Depressed incomes and employment prevent the deficit from materializing. Sales of assets outside the region merely help to cushion the fall in economic activity; and if it persists, the movement of capital may even become perverse, capital moving out of the region and inducing further depression. On the other hand, surplus areas experience expansion which spills rapidly over into imports from other regions. This expansion will result in an "inflation" of factor incomes and other local costs even if price increases are limited by stiff import competition. Why is this reliance on Keynesian income adjustments tolerated by regions within a country but not between countries? There are, I think, three reasons: 1. There is the absence of perception.