Short - term supply response to a devaluation : a model's implications for primary commodity - exporting developing countries

The success of devaluation depends on the "right" timing of the primary export commodity's production cycle and on the absence of middlemen who affect the devaluation's pass through to producers.

Boccara and Nsengiyumva evaluate whether, in the short run, a devaluation could be contractionary in developing countries that export primary commodities. To do so, they use a model capturing the principal features of those economies.

The two most important channels for transmitting the change in parity are (1) a supply effect with the supply response for tradables essentially a function of labor costs relative to the export commodity price, and (2) a demand effect, with the supply response for the semi tradables essentially a function of the real wage.

They simulate the model for a middle income and a low income country. The economic structure of the low income country is less flexible (lower supply elasticity in production, lower elasticity of substitution between domestic production and imported inputs) than in the middle income country.

The model is meant not for use as a forecasting tool but to show the relative magnitude of various effects that are relevant in countries where the initial supply response to a devaluation would come mostly from increased production of an export commodity. In particular, Boccara and Nsengiyumva analyze the difference between the producer's response under "wrong" timing (the pre devaluation price is the price signal on which production decisions are based) and under the presence of middlemen (rentiers in the export sector whose presence affects the devaluation's pass through to producers).

Their findings:

For devaluation to succeed, there must be little wage indexing. Devaluation is more likely to be expansionary in the middleincome than in the lowincome country. The devaluation's timing with the production cycle of the primary commodity export matters, especially in the middle income country. Debt relief is more effective where wage indexing is low and can help offset the negative effects of "wrong" timing by increasing output. But debt relief has an asymmetric effect on exportable and semi tradable sectors, as the production of semi tradables increases while that of exportables decreases. With a tariff reduction, the devaluation implies more expansion in tradables. But this is not enough to compensate for the relative decrease in the growth rate of production of non tradables, so the growth of total output declines. Unless the timing is "right," the effects of redistribution (with income being "transferred" from producers to middlemen with a higher propensity to consume imported goods) can have contractionary effects that cannot be offset by debt relief.

This paper --- a product of the Country Operations Division, Western Africa Department --- is part of a larger effort in the region to prepare for devaluation of the CFA franc. Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Mather Pfeiffenberger, room J9261, extension 34963 (36 pages)