Many of the business elites in Venezuela worry that replacing the bolivar with the U.S. dollar would remove Venezuela’s ability to devalue its domestic currency against the dollar, and that the inability would make Venezuela uncompetitive.
The elites’ worries are unfounded. But many believe that a country can devalue its way to prosperity, because the siren song of the devaluationists is repeatedly asserted in certain elite circles. In fact, the repetition of assertions is not a substitute for sound reasoning and evidence.
As it turns out, the idea that the devaluation of a domestic currency produces competitiveness and prosperity, even though it has a ring of plausibility, is simply a fallacy.
If devaluations resulted in prosperity, Venezuela would be one of the most prosperous countries on the planet. Since 2007, the bolivar has witnessed a maxi-devaluation, losing virtually all of its value (99.9999%) against the U.S. dollar. During the same period, Venezuela’s economy has collapsed, with GDP per capita plunging from an index of 100 to 37.22. This is not prosperity, but impoverishment.
Just how could business elites who have made fortunes repeat the currency devaluation fallacy? It is because many of them practice what the late David Henderson, Chief Economist of the OECD, called Do-It-Yourself-Economics (DIYE). DIYE is a shorthand term for lazy thinking by lay people, in which half-baked theories and ill-conceived nostrums are casually thrown around and frequently repeated. The resulting fallacies have nothing to do with economic theory or empirical evidence.
The serious work that has been done on currency devaluations shows the currency devaluation fallacy for what it is: a fallacy. Although there is a relationship between devaluations and exports, the relationship is negative, not positive, as businessmen and women who practice DIYE repeatedly assert. Evidence from Ecuador fits the pattern found in serious economic research.
After the Ecuadorian sucre lost 75.6% of its value against the U.S. dollar from 1998 until the first week in January 2000, and the economy imploded, President Jamil Mahuad announced on January 9th that Ecuador would mothball the sucre, put it in a museum, and replace it with the U.S. dollar.
Since dollarization, Ecuador’s exports have grown more rapidly than its GDP, and what was a mini-petrostate has become an export-led economy, with non-oil exports growing at an annual compound growth rate of 7.1%/yr, nearly twice as fast as the solid GDP growth rate of 4.3%/yr. One of Ecuador’s non-oil exports that has boomed and is worth mentioning is prawns. Since dollarization, Ecuador’s prawn industry has replaced all of its international competition. It now provides employment for 1.6% of Ecuador’s population and contributes 6% to the country’s GDP, that is more than the automobile industry contributes to Germany’s economy. As they say, a table of facts is worth 1,000 words.
It’s time to put the currency devaluation fallacy in the rubbish, where it belongs.
