Project Appraisal and Foreign Exchange Constraints: A Rejoinder

Abstract

In their comment on Blitzer, Dasgupta and Stiglitz (I98I) (BDS) Dinwiddy and Teal (I987) (DT) state that 'many of the points made in this note apply to [Bell and Devarajan (i983)]. However ... for clarity we confine ourselves to commenting on only [BDS].' The purpose of this note is to point out that none of DT's criticisms of the BDS piece applies to our I 983 paper. In fact, we make essentially the same points using a somewhat more general model than DT. Our results are consistent with, but not subsumed by, those of DT, and are therefore sometimes at variance with those of BDS. DT's main claim is that BDS's assertion that the 'border price rule' fails to hold when commodity taxation is used as the equilibrating device is false. This stricture does not apply to our i 983 paper. For in every single case we consider, the relative shadow prices of the two tradeable goods are shown to be their relative border prices (see our equations (22) and (23), (28) and (29), and (33) and (34)). DT show that when commodity taxation is the equilibrating device, shadow prices are proportional to world prices (in contrast to BDS's claim). We derive the same result in the case when the tariff on one of the tradeable goods is the equilibrating device (p. 474). Moreover, DT's specific criticisms of BDS's treatment of the public sector's budget do not carry over to our model. Unlike BDS, we do specify how tax revenues are incorporated in the system (see our equation (I4)). Nor did we overlook the accounting relationship between the public sector budget deficit and the current account deficit.1 We state, '[T]he government's budget deficit or surplus registers an equal change in the government's net foreign assets through foreign borrowing or lending' (p. 46I). Hence endogenous foreign borrowing in our model arises precisely in the case when the public sector's budget constraint is not satisfied due to tax rates and public expenditures being exogenously given. To conclude, while DT make several valid criticisms about the BDS paper, their attempt to tar our I983 paper with the same brush is unwarranted.