Despite the multitude of differences in the national political economies throughout
Eastern Europe, Africa, Latin America and the Middle East, most countries in these
regions have shared one surprising characteristic: overvalued exchange rates. The
majority of states in the developing world have used their policy instruments to keep their
real exchange rates above market value. Although there are exceptions to this general
trend, particularly among Asian countries, the average currency in the developing world
was overvalued by nearly 20% in the post-Bretton Woods period.
Why, despite their
myriad differences, have so many developing countries converged on this policy choice?
This paper aims to answer this question.
Currency overvaluation is a puzzling outcome. Overvaluation acts
simultaneously as an export tax and a subsidy on imports,
and thus hurts both export-
oriented and import-competing sectors, who are typically viewed as the two most
important actors shaping foreign economic policy.
This has led numerous analysts to
predict that undervalued currencies are universally desired.
It is unimaginable from
most political economy perspectives that a government would unilaterally reduce its
tariffs on all products for all countries and concurrently request all foreign governments
to raise tariffs on all of its products, so why does the equivalent of this happen so
regularly in the form of currency overvaluation? Theories of IPE must confront this
anomaly.
A second reason why currency overvaluation is so puzzling is that it contributes
to a host of injurious outcomes: low economic growth
, speculative
1
The data are described below. Even in the 1990s, currencies remained overvalued on average by 4%.
2
Broz and Frieden 2001: 333.
3
See Alt et al 1996; Bailey et al 1997; Gilligan 1997; Milner 1988.
4
Henning 1994; Destler and Henning 1989: 118; Moravcsik 1998: 287; Stein 1982: 308; Milner 1997: 57;
Gilpin 2001: 90.
5
Dollar 1992; Easterly 2001b; Acemoglu et al 2003.
6
Crystal 1994.
2
Convention