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Devaluation: A Rich Man’s Cure

29 January 2021 at 03:45 | 1376 views

Devaluation: A Rich Man’s Cure

How the Sierra Leone Government Missed the Opportunity to Save Sierra Leoneans from 42 Years of Poverty

By Mohamed A. Jalloh, USA

Editor’s Note: Originally published on April 11, 1979 in We Yone, Freetown, Sierra Leone

There have been debates in the press recently on the question of whether a devaluation of the Leone would enhance the economic development of this country.

Most of the articles have highlighted one or other of the probable effects of devaluation on the international sector of the economy, viz. Balance of payments, the capacity for imports and the competitiveness of Sierra Leone’s exports. However, it is my contention that the basic proposition has not yet been emphasized, namely, that given the present structure of the Sierra Leone economy (and indeed of most developing countries) a policy of devaluation would not only result in rapidly rising prices and a worsening unemployment problem, but would actually hinder what industrial activities there are at present in the country.

To arrive at this conclusion, one need only consider the nature of our economy and its reaction to the stimulus which a policy of devaluation would provide. But let us first consider the usual case for proposing devaluation of a country’s currency.

Devaluation is a common prescription to cure a balance of payments deficit which in simplest terms is the situation that results from a country spending more foreign monies than it receives. Since a country accumulates foreign reserves mainly by exporting its products or services, and it incurs expenditure on foreign goods mainly through its imports, it follows that a balance of payments deficit can only result from a country importing more than it exports. In this simple example, I am abstracting from flows of foreign currency into a country, or of local currency out of the country attracted by investment incentives, because these transactions have a negligible effect on our country’s balance of payments.

Thus, given a situation of deficient export earnings or excessive imports expenditure—so the argument runs—a policy of devaluation will bring about at least parity between import spending and export earnings by making the devaluing country’s currency cheaper in terms of other currencies and thus (a) stimulate demand by foreigners of the country’s exports because in effect exports are now less expensive and (b) reduce the country’s import bill since imports now become more expensive.

The combined effect of these two forces would, it is argued, ultimately bring the country’s foreign expenditure in line with its foreign income. Moreover, the reduced demand for imports would leave a gap which will be conveniently filled by goods produced by local industries, thus increasing the incomes and standard of living of individual local entrepreneurs. The nation too gains because larger incomes mean more taxes, and thus the government shares in the bonanza.

On the other side of the economic coin, exports are in effect now cheaper: therefore, more exports will be demanded by foreigners who will then be gratified by an increased production in the export sector of the economy and therefore increased incomes for export producers. Again, the government too is not left out of the windfall gains, for in will come more and more tax revenue as incomes continue to increase.

The picture which emerges, therefore, is that consequent upon devaluation there is increased prosperity for residents of the country and a stable currency which more nearly reflects the stable level of prices reigning in the economy. Everyone is happy because - so the classical capitalistic thinking goes - once standards of living are raised by increased economic development, levels of civic responsibility rise, and everyone will work for the perpetuation of the status quo.

On the face of it, the above seems to be a plausible argument and a certain cure. However, it will be appreciated that there are various assumptions underlying the above proposition which upon examination reveal that the devaluation cure is prescribed for a particular, precisely defined sick economy with specific reactions and reflexes, and whose constitution is radically different from our own economy.

To see this, witness the following:

In order that devaluation may result in a much reduced imports bill for a country, it must be the case and only the case that expenditure on imports by that country is on goods for which there would be an immediate reduction in demand consequent upon an increase in the prices of those goods. Economists would recognize here, the important concept of demand elasticity.

What then is the effect of the removal of this assumption?

The answer is that the chronology of events in set haywire and the final pattern in the economy then critically depends on the degree of responsiveness of the country’s demand for imports to changes in the prices of the same. In the limit, that is where any changes in the price of imports leaves the same quantity of imports as before being demanded, the policy of devaluation dismally fails in reducing the import bill.

But that is not all, for it actually worsens the situation by fueling a spiral of escalating internal prices for imported goods.

This conclusion is inescapable: devaluation, while having failed to reduce demand for imports, has also precipitated higher costs for importers who pass on these costs to the defenseless consumer.

And so prices rise. One might well examine the relevance of the above to Sierra Leone.

It is an undisputed fact that the bulk of imports by the people in this country is on manufactured items of food, clothing and allied commodities for which there are not yet available local producers. These are most necessary items and perhaps this goes to explain yet another unchallengeable fact, namely, that the public’s demand for imports is not significantly deterred by increases in the prices of the same.

The validity of this statement will be evident once it is recalled that the national leadership has had cause to plead repeatedly with the people of this country to turn to local foodstuffs to no avail. Having established this fact, it is easy to see that devaluation, far from resulting in increased prosperity for local entrepreneurs, actually creates hardship on the consumers - witness the present increasing trend in prices.

On a less strictly economic theme, let us examine the situation where in fact, because of devaluation, demand for some imports, local substitutes for which are available, falls. The facts of local manufacturers’ origins, even in this case where local producers should normally gain, lead to the conclusion that indigenous people will not benefit. The reason for this is that the local manufacturing industry is at present concentrated in foreign hands whose capacity for extraditing their profits is ravenous.

So, even in the unlikely situation that devaluation brings about a switch of demand to locally produced goods the result for Sierra Leone is not necessarily beneficial. In fact it could well lead to a net outflow of currency from the country, aggravating the very situation which the policy of devaluation is meant to cure.

There is still another reason for the import effect of devaluation to lead to rising prices in the local economy. To see this, note that the majority of manufacturing companies in this country rely heavily on imported primary input in the manufacturing process.

Devaluation thus increases the production costs of the local industry and this will not switch demand to the goods produced by these industries because the prices of those goods will rise with the increase in their production costs.

A familiar example of this tendency is to be found in the local cigarette industry. Even though the price of Benson and other imported cigarettes rose following the recent price escalations, the prices of locally produced cigarettes - e.g. State Express, themselves rose, and the pattern of demand was unaffected but the important result is now a higher overall prices for cigarettes, both imported and locally produced.

But this is not all.

The situation can be conceived where, because of the increased cost of imported inputs, the domestic manufacturing industry actually goes out of business with a resultant loss of much needed jobs which these industries provide.

How does this come about?

Consider the situation of a much increased cost of production for local manufacturers as a result of devaluation. Whether or not these manufacturers bear this additional cost or pass it on to consumers, will depend on the degree of elasticity of demand for those commodities by consumers. There is at present no evidence to lend credence to the proposition that an increase in the price of White by Washex will leave the demand for that detergent at its previous level.

This result becomes even more unlikely when it is realised that there are myriad imported substitutes for Whitex - Chlorox, and Milton for instance. So that, where there is a significantly increased cost of production above the increased cost of imported substitutes in the face of highly responsive consumer demand, the manufacturers - and not the consumers - will bear the cost. Their profits will be reduced, and the natural response will be to cut costs. And the factor most susceptible to reduction in this country is labour because, unlike the cost of raw materials, manufacturers (indeed many employers) are in a position to control their wage bill.

So the axe falls on the workers and the unemployment figure swells. Lower-priced manufactured imports thrive, and the country is bled of its meagre foreign reserves.

It comes to pass, therefore, that in the extreme devaluation produces a diametrically opposite result in Sierra Leone to the one predicted for it – namely, a deterioration of its balance of payments, a stultification of its infant manufacturing industry and an aggravation of its unemployment problem.

About the author:
Mohamed A. Jalloh (photo above), known to his many friends as Moh’m , wrote the above article warning the Sierra Leone Government of President Siaka Stevens that the IMF-World Bank’s proposed devaluation of the Sierra Leone currency, the Leone, was doomed to failure for reasons he clearly explained in the article, less than one year after he graduated with a B.Sc. (Hons) Econ. degree from Fourah Bay College in 1978. Twenty-two (22) years later, in 2001, the World Bank finally admitted in Accra, Ghana, that the IMF-World Bank’s Structural Adjustment Programs (SAPs), with devaluation as their central core, that they had successfully urged many African countries to adopt during those 22 years since Mohamed Jalloh’s published warning in 1979 had been a “mistake” and a failure.

Mohamed Jalloh was the youngest student ever admitted to Fourah Bay College’s in its then nearly 150-year history as the oldest institution of higher learning in sub-Saharan Africa. He was also the first Sierra Leonean to graduate from FBC with a joint major in economics and accounting. Upon graduation he was recruited by the Sierra Leone Produce Marketing Board (SLPMB) where, in 1992, he ended his exemplary 14-year service to his native Sierra Leone as the first head of the Economic Planning Department. Mohamed Jalloh, who currently also holds MBA and Master of Accounting degrees from Washington State University in the USA, subsequently immigrated to the USA where he has established a successful internationally-recognized career in financial services, investment management, and social security administration. See "Mohamed Jalloh: A Life of Historic Firsts"