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International Monetary System

International Monetary System

DEFINITIONS OF THE INTERNATIONAL MONETARY SYSTEM

The international fiscal system is the set of policies, contracts, and associations that govern the manner of monetary strategies, their organization, exchange rates and the delivery of global liquidity. It is a connection to the worldwide financial scheme, whose process depends particularly on the modalities under which they provide funds. By many procedures, the US dollar remains to lead the international financial system (Farhi, Pierre-Olivier, &He´le`ne, 7).

Few attempts have been made to define it as a legal concept, but economists, political scientists, and politicians have explained their understanding of the idea regarding their disciplines or interests. Two of the most intensive efforts have been made by the executive board of the fund in chapter 2 of the annual report of the fund for 1965. These discussions took place before references to the international monetary system were included in the Fund's articles. In explaining the concept, they followed many approaches. One approach discusses the global financial system concerning its purposes. Article IV, unit 1 of the current sections of the Fund is close to this approach by referring to the essential purpose and the principal objective of the system

The 1973 Economic Report of the U.S president contained a discussion of the requirements that had to be met by an international monetary system that would facilitate the continued expansion of world trade. First, the system should be market oriented. The mechanism for balancing each country's total foreign exchange receipts and expenditures over the long run should minimize interference with an individual market transaction. Second, the settlement of payment balances among the states should b multilateral. Each country should be able to offset its deficits with some countries against its surpluses with others. To meet this objective, the ultimate settlement of claims in commonly acceptable reserve assets should be possible. Third, the system should be stable. International commerce often entails long-run commitments, and thus, stable expectations about conditions affecting the future profitability of international transactions were necessary

PROBLEMS

There are two major problems and one compilation facing the current global monetary scheme. The difficulties are the inability to prevent frequent international financial disasters and the probability of significant conversation rate misalignments. The collection arises from the creation of the euro. The rules recommended to evade or minimize global financial crises have a good chance of succeeding. The advocated to stop or diminish exchange- ratio misalignments would either not work or be unfeasible. The compilation in the operation of the international monetary system arising from the creation of the euro stems from the need to deal with asymmetric shocks within the union. There is the relationship between the ins and outs, the challenges posed by the future admission of the states of Eastern and Central Europe and the excess violability and misalignments that are likely to arise between the euro and the dollar. The law and most of the banking sector are in a state of insolvency. The central government collects only 6 percent of the gross domestic product in taxes and is unable to provide for even minimal administration services devoid of printing vast quantities of money, which led to an increase in prices of almost 100 percent during the past 12 months.

WEAKNESS IN CURRENT ARRANGEMENTS

Perhaps the most glaring shortcoming of the way in which international monetary system has worked I the floating-rate period has been the extreme exchange-rate unsteadiness that has happened. This instability is established both in greater day-to-day volatility of rates and in longer-lasting exchange rate swings. The resulting exchange-rate misalignments can have much more substantial implications for economic performance. For instance, the US dollar appreciated the roughly 7- percent in real effective terms in the first five yeas of the current decade, only to fall by an even larger amount in the subsequence three years. This development cannot be conducive to an optimal allocation of real economic resources either across countries or over time. Fundamental factors cannot change over a few years by amounts that would justify movements in relative prices of such magnitude (Baetens, and Jose´, 9).

A second shortcoming is the emergence of payment of banes that appear to be unsustainably large. A third source of dissatisfaction with the functioning international monetary system is the lack of discipline that it seems to permit in domestic policies. The absence of an exchange rate constraint means that domestic fiscal and monetary policies are free from some regulation that operated under fixed exchange rated. Perhaps the most obvious example is the US budget deficit, which continued to increase even as the US external deficit was growing.

SOLUTIONS

It is a belief that potential problems of the system are under three subheadings: adjustment, liquidity, and confidence. By change is meant the correlation of large and persistent deficits and surpluses in the balance-of-payments positions of counters. If the system allows or fails to reduce such imbalances, it presumably needs to reform. Liquidity means the international reserves f countries. The monetary system created either or excess or a deficiency of official reserves; it needs improvement.  Confidence means stability in the holdings of foreign reserves. This concept started when the US Treasury stood ready to convert dollars into gold for monetary authorities, and a run on the bank was considered possible. Even though such convertibility into goal no longer exists, shifts of official holdings of reserve currencies may occur. Of course, destabilizing movements of private funds are even more possible.

One possible approach to reforming the international monetary system is to introduce explicitly more fixity into exchange rate relationships through some kind or arrangement that establishes levels or ranges for variation among currencies. There are a variety of proposals of this type, covering the spectrum from fairly rigidly fixed rates to rather choose arrangements for target zones. What they have in common is the use exchange rate as a focal point for disco lining domestic policies and achieving international consistency. Despite the attractiveness of fixed rates as an analytical construct, they cannot be considered feasible at present. Target zone schemes also come in a variety of specific forms. They have become increasingly sophisticated over the years as their proponents adapted earlier plans to deal with objections or difficulties that were identified. Target regions, however, all contain the assortment of a suitable pattern for exchange-rate relationships among currencies. ; the establishment of bands of fluctuation around those relationships, the obligation to intervene in foreign-exchange markets and to adopt domestic policies so as to help prevent rates moving outside the established funds (Lavelle, 3).

Another approach is strengthening existing arrangements through enhanced coordination. There are several steps in the process of effective policy coordination. The first step is to improve the basis for national decision-making through sharing information. Such sharing, together with an improved understanding of how economies interact, enables governments to frame their individual policies with a better knowledge of trading partners. It contemplates the adoption of strongly expansionary policies, the authorities of that state might then loose a more restrained policy stance to add to domestic and international inflationary pressures (Wilkie, 240).

The second step in policy coordination is to make informed and mutually consistent choices about the trade-offs among economic objectives. Given the excess of targets over instruments, countries cannot simultaneously achieve all their financial goals. Further, the pursuit of a particular goal by one country has implications for the objectives of its trading partners. Exchange-rate stability, for instance, implies that inflation rates must be similar across countries. It is this essential for countries to reach a consensus on the relative emphasis to according to objectives such as exchange-rate stability, the balance of payments adjustment, inflation control and the promotion of economic growth. The third step is to adopt policies in individual countries so as to make them internationally consistent and mutually supportive.

Focusing on these three areas, there is scope for solid progress: strengthening the analytical basis for coordination, establishing an adequate objective standard to monitor developments and assess he needs for policy changes; and finding an appropriate forum for discussing sensitive issues of international economic management. Concerning the analytical framework, there is a need to develop common understandings about key international financial relationships, expressed in the language of everyday political discourse and not just in the language of econometricians.

 

Import Substitution

Import substitution refers to a system of protective tariffs against imports that compete with domestic manufacturers and the conscious encouragement of home industries that make the same sorts of goods. Import substitution industrialization occurs when protected some manufacturers begin to compete strongly enough with imports that they capture from their rivals not only the domestic market but also another market overseas, making protectionism no longer necessary (Hall et al., 42).

The import substitution may is known as the replacement of a domestic source of supply for a foreign source of supply. Thus, it implies:

  • The development of local source of supply where there is no domestic supply
  • An expansion of the domestic production if the domestic production is insufficient
  • Protection of the domestic industry against foreign competition if it is the competitive disadvantage of the local industry that is discouraging the domestic production

TYPES OF IMPORT SUBSTITUTION

  1. Absolute and Relative IS

Import substitution may be absolute or relative. Unlimited import substitution means an increase in the quantity of indigenous supply. Relative import substitution takes place when the growth in the domestic production results in an increase in the proportion of national production to the total domestic consumption.

  1. Direct and Indirect IS

Import substitution may be direct or indirect. Direct means replacement of the import of a commodity by the internal production of the same product. Indirect import substitution involves the imported product by a domestically produced substitute.

In the post-war period, several developing countries pursued import substitution led to development strategies. Weak growth that is resulting from such policies, however, led to a policy reorientation in the early 1960s. While one set of countries began giving more reasons for the export sector even while continuing with a moderate form of import substitution, another set of countries made a more fundamental shift in outward orientation (Cherunilam, 682).

Import substitution has its benefits. Within the context of development plans, a fashionable strategy for dealing with the problem of poverty was import substitution industrialization. For the rural areas, this approach only depends on the alienation from the urban centers. Since most of the raw materials utilized were themselves often imported, there was a little productive relation between activities in rural and urban areas. Hence, there were hardly any means of making growth in productivity in cities stimulate corresponding growth in the countryside. Rather, the effect of such increase was immediately transferred abroad regarding demand for more imports. Consequently, in at least three ways import substitution industrialization aggravated the already parlous conditions in the rural areas of underdeveloped countries.

First, in its effect on prices. For the industries to survive foreign competition most governments had to erect quite a high customs tariff against foreign goods and, because of the recently of the industrial culture, there is a serious problem of quality control, so locally produced manufactured goods tend to be priced above their real value. Invariably, urban wages are adjusted to reflect these artificial prices, but there is no corresponding mechanism for adjusting the prices paid to farmers to the level of that for manufactured goods from the city and to receive relatively low prices for agricultural produce sold to the city.

Second, the urban wages which are set to reflect the highly inflated prices of industrial produces became a source a distraction for the rural labor market. Unskilled and skilled farm hands are lured away from the farms by expectations of urban employment. Even where the prospects of securing urban jobs are not bright, the effect is to encourage demand for rural wages far above what is economical in the overall farm budget. The result is to aggravate the labor shortage situation.

Third, given these two situations, it is clear that the terms of trade between rural and urban areas in most underdeveloped countries are generally in the countryside. In other words, what import substitution industrialization has done is to accelerate the rate of capital transfer from the rural areas, and in the process, to intensify the pauperization of the rural populace.

PROBLEMS

There are primary defects of the policy of import substitution. First, the primary beneficiaries of the import substitution process have been the foreign firms who, well placed behind tariff falls, could take advantage of tax and investment incentives. After deducting interest, profit, royalty and management fees, mostly which are remitted abroad, the little that may be left over usually accrues to the wealthy local industrialist with whom foreign companies participate and who provide their administrative and economic cover. Second, the most import substitution has been made possible by the massive and often government subsidized transportation of capital goods and intermediate products by foreign companies. In the case of foreign companies, many of these are purchased from their parent and sister companies abroad, with two immediate results. A third detrimental effect of many of the import substitution strategies was its import in traditional primary product exports. To encourage local manufacturing through the import of cheap capital goods, foreign exchanges rates are often artificially overvalued. The overvaluing of exchange rates results in an increase in the prices of exports and fall in the prices of imports. Finally, import substitution in practice inhibited the industrialization. It reduces the competitive power of industries and increases the cost of production of the industries.

The dismissal experience with the shortcomings of import-substitution policies together with empirical research and the policy implications of new theoretical insights pointed to reform of trade policy. Advances in new theoretical insights led to reform of trade policy. Advances in theory and in the capacity to measure the effects of protectionist policies demonstrated just how dismissal the experience was. Especially telling were empirical research studies showing the costs of rent-seeking, high and erratic effective rates of protection, the import bias in effect exchange rates. Rent-seeking activity has no social value. It used time and resources even when legal, and some methods involved corruption, smuggling, and black markets. High effective rates of protection through the escalation of tariff rates on the degree of processing resulted in some cases in negative value added. Although the secure production of import exchanges was profitable in local currency, the value of inputs at world prices exceeded the value of the final product at world prices. The process of import substitution was socially inefficient (Meier, 86)

The significant drawbacks with import-substitution strategy include: the huge capital outlays required in setting up local businesses to create import exchanges. The greater lay-off which is likely to be brought about by the capital-intensive worth of the companies that may be set up, and the diseconomies of scale associated with creating industrial units to produce for small and limited local market. Moreover, the high independence of local producers of import alternates on imported money intermediate goods leads to a balance of payment problems. Further, the stability of local suppliers of import substitutes from opposition makes vendors lax and complacent, a condition which usually concludes in gross inadequacy in protected infant industries. Besides, the opportunity cost connected with the concentration of capitals on one industry are very high for an underdeveloped country, in fact, import exchange development can lead to the crushing of other critical sectors of a country's economy if it is pursued to the extreme. (Kyambalesa, 20).

The central tenet of import-substituting industrialization is that industry must grow at a faster rate than the primary sector f the economy. Because industry requires imported raw materials, its rapid growth means that the demand for imported inputs and hence for foreign exchange, will also grow very rapidly. The supply of foreign exchange, however, is provided by the primary sectors, which by design grow more slowly. The divergence in growth rates of the demand and supply of foreign exchange is suitable for a time because industry grows from a much smaller base than the primary sectors and because import substitution generates foreign exchange savings. The time comes, however, when industry's growth rate out rips the ability of the major areas to supply the necessary foreign exchange. At that point, a balance of payments crises arises (Kesselman et al., 107).

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