The Tendency of the Exchange Rate toward Overvaluation

Abstract

Economic theory and common sense tell us that middle-income countries are supposed to gradually catch up, that is, to achieve the level of development of rich countries. In the past thirty years, several countries, particularly fast-growing Asian countries, have borne out this prediction, but to achieve such an outcome, they adopted national development strategies that I have called, in the previous chapter, new developmentalism and compared with the policies that characterize conventional orthodoxy or the Washington Consensus. The question that then arose for me was which among the policies forming new developmentalism are the strategic ones: those that will more effectively and rapidly bring about fast growth. Although not playing down the importance of the main supply variables affecting the rate of growth (education, technological progress, and infrastructure investment), I understand that the decision to grow with domestic savings and that the macroeconomic policy variables on the demand side – a strict fiscal policy, a moderate interest rate, and a competitive exchange rate – are the key ones. To come to this conclusion, I observed what was happening in the dynamic Asian countries – which policies were strategic in their growth process. The observation did not leave any doubt. On the other hand, institutional reforms are not so urgent as people usually presuppose. Long-term institutions are correlated to the level , but not to the rate , of economic development; the rich countries are also those with more elaborate and well-regarded institutions, but it is impossible to link institutional reforms to the rate of growth.