Investment, the real exchange rate, and Dutch disease: A two-period general equilibrium model of Cameroon

Abstract

This paper examines the structural adjustment problem of a developing country with a finite foreign-exchange surplus and develops a method of evaluating choices among the possible sectoral and macroeconomic policies for such a country. Traditional treatment of this adjustment, commonly known as “Dutch disease,” considers the composition of output between traded and nontraded goods but does not include the trade-off between consumption and investment. This study adds the investment dimension by incorporating two-period optimization in a multisectoral computable general equilibrium (CGE) model for Cameroon. Unlike other CGE models, the composition of aggregate demand responds to factor prices driving investment decisions. The structure of output and trade similarly respond to macroeconomic forces, not just to relative prices. The model is used to test the impact of foreign-capital inflow, tariff policy, and policy toward public firms. Simulation results point out the key role of import substitutes, manufactures in this case. The pattern of the investment response indicates that this sector is likely to contract in the short run and expand in the near future. However, public firms, also producing import substitutes, are unlikely to succeed in an investment boom, even with credit distribution biased in their favor. Tariff protection for manufactures raises the price of investment goods and heightens credit demands, but does encourage the domestic sector. On the macroeconomic side, we note a significantly greater impact of the interest rate on investment than on savings. These results conform with empirical observation.