Asian growth versus African growth

Here is a chart that has got me thinking. It shows the relationship between currency undervaluation and growth spurts in two sets of economies: those in Asia, and those in Africa. Basically, it depicts the "typical" (average) trend in under- or over-valuation in the ten years preceding and ten years following the onset of growth accelerations in the two regions. (See here for how growth accelerations are defined and their timing determined.)

Notice the difference?

In Asia, growth accelerations are preceded by a period of sustained increase in undervaluation, which is maintained during the period of high-growth. In Africa, by contrast, growth accelerations are preceded by growing overvaluation; the currency always remains in the overvalued zone (= negative undervaluation).

Here is the simplest explanation. In Asia, growth is typically engineered by increasing the profitability in manufacturing and other tradables. But in Africa the typical growth spurt is preceded by aid inflows and other transfers, which appreciate the exchange rate, and render future growth less sustainable. This is the so-called Dutch disease.

Africa has been having a good few years recently. To my mind, the key question with regard to sustainability of growth has to do precisely with the real exchange rate: is the real exchange under- or overvalued, and has it been appreciating or depreciating?

UPDATE: Luis Enrique is smart! (See comments below.)

Comments

[Luis Enrique]

That is fascinating.

An incidental point: "But in Africa the typical growth spurt is preceded by aid inflows and other transfers"

So how do we reconcile that sentence with the research you feature below showing no relationship between aid and growth? Is it that the aid growth relationship exists in the Africa subsample, but not elsewhere? Or is it the "other transfers" that are stimulating growth - if so can you tell us a bit more about those "other transfers?"

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[Luis Enrique]

hang on - I withdraw my question. If these are instances of growth acceleration then they can be be the ones where aid works and the cases where aid does not work / harms are out of the sample. Duh.

[ben]

I would like to see more about (even unsustainable) growth episodes in Africa being driven by aid inflows. It seems like that would be big news if you could show it empirically.

[Ed]

If an undervalued currency is so good for economic growth why is it not the policy of choice in developing countries? Japan, East Asian Tigers, and China have all played this game to promote growth. And they have played it well. If this is such a powerfull policy why are other developing countries not making use of it? There must be a catch.

[a student]

Ed, I suspect one catch is that wealthy elites like over-valued currencies because it makes all those nice foreign luxuries much cheaper. It can also create nice profit making opportunities for those who can buy foreign exchange at the official rate and sell it at the black market rate. Although, it is an empirical question how important this is.

[random african]

being part of african elites to an extend, i can say without empirical evidence that buying power of elites is an important factor.

but then, i have to say that i'm using a quite large definition of what the african elite is.
i basically include the politically powerful african middle class: everyone who has a job in the formal economy.

however, even without the elites and the middle class, one has to remember how wide the imported products consumption is be it because of a lack of local industry (textile, rice) or because they simply consume goods that can't be produce locally (bread made from wheat).
so politically, you'd be hard-pressed to find many supporters of a devaluation.

is there any study of the effects of the January 1994 devaluation of the CFA Franc ?

[random african]

also, between the CFA Franc radical radical case, the Naira, the Cedi and all the countries that went through IMF's structural adjustment, artificial overevaluation policies have been at least partially and temporarly given up.
why didnt they produce the same effect as in Asia ?

[happyjuggler0]

Overvalued currencies (via fiat) are great for non-export companies in countries with high nominal interests rates in the local currency. They can usually manage to borrow at a significantly lower rate this way, and mint a fortune.

Great, that is, until the currency is forced to devalue for flow of funds reasons. Then it is a disaster for everyone except those who export or who engaged in captial flight before the devaluation. Then the overall economy becomes a disaster area.

Guess which category "the elite" belong in regarding ability to borrow in foreign currencies at low (relatively speaking) nominal interest rates?

Guess which category "the elite" belong to: those who get there money out before the government devalues, and those who are stuck.

Aside from Dutch disease (or more likely, in addition to it), I would expect that crony capitalism countries make up virtually all of those countries with artificially high currencies. Of course evidence of this wouldn;t prove anything, since crony capitalism, as well as outright kleptocracy, is one of the big reasons why poor countries are poor.

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I'm confused about one thing: why not fight Dutch Disease by printing more money? If the money supply is increased, you'll have inflation but you'll also devalue your currency which I take it is a good thing if you're fighting Dutch Disease?

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