Agriculture Reference
In-Depth Information
market, pushing up the domestic interest rate and crowding out private
investment. Indeed, the home interest rate rises by more than the expected
long-run return on nstalled captal and so the volume of nvestment falls.
Under policy 2, the rise in income taxation reduces pressure on the domestic
capital market so that the rise in the home interest rate is smaller, as is,
therefore, the fall in real investment. This mitigates, but does not reverse,
the contracton n GDP that occurs under polcy 1.
In the absence of effective capital controls, the ranking is reversed:
policy 1 outperforms policy 2. This is because net inflows on the capital
account are now perfectly elastc at the nternatonal nterest rate (plus
an exogenous country rsk premum). The added government borrowng
therefore draws n addtonal savng from abroad and does not crowd out
new private investment in the short run. Net inflows on the capital account
and domestc nvestment ncrease substantally: the more so under polcy 1.
The expanded deficit under policy 1 therefore mitigates the depreciation of
the real exchange rate. There is a smaller deflation and, while ever wages
adjust more slowly than product prices, this retards real wages more and
hence accelerates employment and GDP growth. Thus, the tax mix switch
of polcy 2 s contractonary by comparson wth polcy 1 when captal
controls are lfted. Yet both gve superor results wthout captal controls
than ether does n ther presence.
Sectoral mpacts n the short run
The key determnant of the sectoral mx of changes n the economy
s the sze of the short-run real deprecaton that occurs followng the
trade reform. When capital controls are tight, this real depreciation is
comparatively large. Traded sectors, such as light manufacturing, are
advantaged, while non-traded services sectors, such as construction
and dwellings, are disadvantaged. When capital controls are ineffective,
manufacturng gans are smaller and the non-traded servces sectors
benefit. Across the board, however, and for reasons that match those
given in addressing the long-run simulation results, agriculture and food
processing are disadvantaged by the reforms. Interestingly, however, it is
only n the case when captal controls are retaned and the exchange rate
