Forex: Devaluation and Income Distribution

Devaluation is likely to bring gains for groups that get their income by making and selling goods and services that enter international trade.

For both exporters and import-competing groups, devaluation means a chance to compete more advantageously against their foreign counterparts. A drop in the value of the Canadian dollar, for example, would give Canadian wheat exporters a better chance to undercut U.S. wheat prices a bit in U.S. dollars, while still receiving higher Canadian dollar prices that enable them to buy more in Canada.

Import-competing groups would also be favored, since devaluation or depreciation tends to force Canadian buyers to pay more for the competing foreign product. To be sure, devaluation is also likely to mean that import-competing groups must also pay more for any traded goods and services that they wish to consume, but this cost-of-living effect is almost sure to be outweighed by their direct income gains.

Devaluation, on the other hand, is almost certain to hurt somebody, however, even when it does not worsen the terms of trade. The group likely to be hurt will be the group that receives its income by selling nontraded goods and services.

It also means a higher cost of living for such groups such as civil servants, teachers, construction workers, garage mechanics, and landlords.

As sellers of goods and services not entering international trade, they experience no income gains from the devaluation until some of the extra purchasing power from the traded-sector groups trickles their way. Meanwhile, they must pay more for importable and exportable goods and services.

The redistributive power of devaluation, and the limits on it, can be seen by studying national experiences after large sudden devaluations--- one such dramatic experience was that of Argentina in the wake of its government's December 1958 decision to let the peso drop radically before pegging at a new par value.

This decision to devalue was accompanied by other policy moves--- the government temporarily tightened up on the money supply help that the inflation whose runaway rates had made the devaluation unavoidable. That being said, it also removed certain price controls, yet retained other price ceilings, most notably the ceiling on residential rents.

Yet, what happened across 1959 is nonetheless interpreted as roughly the effect of devaluing the nation's currency more rapidly than the general rate of domestic price inflation, and the rise in the relative prices of traded goods should have been accompanied by a shift in income distribution toward the groups tied most closely to producing traded goods.