Controlled Open Economies: A Neoclassical Approach to Structuralism

Controlled Open Economies: A Neoclassical Approach to Structuralism

Controlled Open Economies: A Neoclassical Approach to Structuralism

Controlled Open Economies: A Neoclassical Approach to Structuralism

Synopsis

This book develops macroeconomic theory for small open economies characterized by the sort of controls which make much of existing neoclassical economics inapplicable to developing countries. It distinguishes between sustainable combinations of policies and incompatible control regimes. The authors analyze the changes needed to maintain compatibility and the consequences of failing to do so. They also consider optimal investments in response to a temporary shock. The second half of the book contains an analysis of two temporary trade shocks in Africa, in both compatible and incompatible control regimes, demonstrating the applicability of the theory. It shows that in a compatible regime, the regime and the fiscal response to changes in revenue may make the reaction to a shock grossly inefficient. Under incompatibility, an economy exposed to a negative shock may go into steep decline, while responses to conventional policies may be reversed.

Excerpt

Most modern macroeconomics originates in America. Applied work uses American data, and theoretical work assumes an economic structure consistent with the salient features of the United States. Even for the analysis of other developed market economies this has proved unsatisfactory: these economies behave differently and face different problems, as the following examples illustrate. The relationship between unemployment and wages, which has long been indeterminate on US data, has recently been found to be robust in virtually all other developed market economies ( Beanet al., 1986). The relationship between inflation and the exchange rate in small open economies, irrelevant for the United States, was pioneered in Sweden and Australia. The analysis of permanent terms of trade shocks, 'Dutch Disease', again irrelevant for the United States, was pioneered by Australian, Dutch, and Irish economists. For developing countries the problems posed in applying modern macroeconomics are far more severe because economic structures are so different. Financial markets are often virtually absent, many economies are small, open, and periodically hit by temporary trade shocks, and most of them are heavily regulated by government controls wholly unfamiliar in America.

Because of this evident gap between modern macroeconomics and the characteristics of many developing countries two mutually hostile approaches have coexisted. Modern neoclassical macroeconomists, to the extent that they have worked on developing countries, have tended to make little concession to different economic structures; meanwhile, 'structuralists' have paid great attention to the particular features of the economies they have studied, but have not attempted to demonstrate rigorously how these features affect the applicability of 'orthodox' policy advice. Instead they have tended to use ad hoc theories. The lack of attention to institutional characteristics in the neoclassical approach and the absence of viable micro-foundations in the structuralists' theories have tended to make the exchanges between the two polemical. Meanwhile, many developing economies have experienced dramatic macroeconomic events, and have embarked upon large policy experiments, in an alarming vacuum of comprehension. This vacuum has arisen because both the structuralist and neoclassical critiques are right: theory must be tailored to structure to be applicable, but an atheoretic approach is inadequate. We are convinced that the misgiving of most structuralists that 'orthodox' policies are inappropriate in developing economies is at least . . .

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