Devaluation and the balance of payments adjustment in a developing economy: an analysis relating to Jamaica: 1954–72

Abstract

Jamaica is a small, open and structurally dependent export propelled country. The island spans an area of 4411 square miles and has a population of nearly 2 million. Measured at 1965 prices the Gross Domestic Product (GDP) increased from $297m(J) in 1954 to $912m(J) in 1972; or, grew at an average rate of around 5% per annum. 1 1 For purposes of conversion $2(J) = £1 (UK) Unemployment averaged around 20%, and is increasing explosively. Exports are concentrated in three commodities: bauxite–alumina, sugar and bananas. Together these three commodities averaged 76% of total commodity exports between 1954 and 1972. Tourism is the second largest earner of foreign exchange, increasing from $11.4m in 1954 to $107.9m in 1972. On the other hand the economy is heavily dependent on imports for capital goods, raw materials, fuels and intermediate goods for its import substitution and industrialization programmes, also consumer goods to complement domestic supply, or, in some cases, to meet the entire requirement of domestic demand. For the period 1954–72 the import coefficient (M/GNP) averaged 48%, which suggests that any policy aimed at reducing imports, as for example, devaluation can be both inflationary and contractionary. 2 2 A useful discussion of this point is contained in Cooper (1971) and Krugman and Taylor (1978). The export coefficient (XGNP) increased from 29.5% in 1954/55 to 39.5% in 1971/72, averaging 37% for 1954–72. The trade balance has rapidly continued to deteriorate. In 1954/55 commodity exports accounted for 77.5% of the value of commodity imports, but, by 1971/72 this share fell to 59.7% and has continued to fall since 1972. The increasing deficits in the trade balance had to be financed with earnings from tourism, foreign direct investment, loans and grants, or, recourse to the International Monetary Fund (IMF). The plan of this paper is as follows: In Section I the effects of devaluation are discussed and the reason for adopting the ‘elasticities’ approach is shown. In Section II the theoretical outlines of the model are presented. In Section III the estimation problems are briefly discussed. The empirical results are presented in Section IV and discussed; and, finally in Section V it is determined whether the Marshall-Lerner condition of exchange rate stability is satisfied.