Thursday, April 24, 2008

Microfinance and Women

While poverty has swept the world with its innumerable causes, women have felt a majority of the effects. Seven out of ten of the poorest people in the world are women (Feinstein). The gender gap that exists in third world countries or least developed countries (LDCs) has significantly affected the entire economy and development of these countries. With the introduction of microcredit, a program innovated first in Bangladesh, families and particularly women have been able to break some of the barriers to producing income and cash flow. Though a relatively new idea, the programs have been so successful that they have expanded to approximately 70 countries and 100 million families, including those in the first world (Murali and Padmanaban). The idea of microcredit must be expanded and differentiated in order to appropriately address the needs of the people of each country. The potential for microcredit to empower women and help them achieve economic success of their own is great, with the assistance of governments and possible changes in the institutional structures within the countries.

Countries that experience less economic opportunity than others have several contributing factors. On the supply side of development, there may be impediments to free trade and international exchange—such as tariffs, quotas, voluntary export restraints, barriers to intellectual property rights, and export subsidies in other countries.There may also be causes such as natural disasters, war, and economic sanctions against a particular country that make it difficult or practically impossible to develop economically. The functional infrastructure of the country will also significantly affect the country’s ability to develop. The natural business cycles of the world economy and of the business within the country will affect the country’s economic health. If the country has a natural resource abundancy and is specializing in the production of natural resources or agricultural goods for production, they may also be affected by changes in the natural weather patterns and trends.

However, families are equally affected by demand side factors of development, such as the lack of skills, training, education, and literacy- all of which expand an individual’s human capital and therefore income potential. The lack of purchasing power based on the inability to create a steady stream of income will impede the individual to participate in the marketplace. Similarly, individuals and families need capital and assets, which comes from the ability to save and borrow money (Feinstein).

The causes for women’s impoverishment are directly related to these general causes of poverty. Generally, if employment is available, the jobs will go to the men first and foremost (Murali and Padmanaban). Societal discrimination will determine the roles that men and women play- and will affect the ways in which they obtain income as well. Through different cultural standards, women may be expected to not play a part in the income-making process. In many developing countries, society demands that women are responsible for nonmarket work inside of the household and are subordinate to men. Regional differences may also contribute to whether women have income-making opportunities or not. For example, a woman in a more urban area will find it easier to break the societal norms and find employment than a rural town where women continue to live by the laws of their community and are less in touch with the rest of the world. Women have a difficult time breaking into the work force in developing and developed countries because of their lack of role models and established networks in the employment fields (Kay). A woman would be reluctant to train for and pursue an occupation in which men are the dominant force behind, as men would likewise be reluctant to train a woman for their particular field and increase competition against them while going against societal norms.

Perhaps also, the work that is available is more geared to a certain gender. If there is only difficult, manual labor available, there will be less demand for women because men are seen to be comparatively better at physical labor than women. The availability of banking institutions for women will greatly decrease their economic power and their ability to make income. People in first world countries depend on financial institutions to save and borrow money- whether for inside the household or for starting and maintaining a business. When these tools are taken away from a particular group of people, they will feel the economic consequences.

Consider Bangladesh-- amidst a horrible famine in 1976. Muhammad Yunus, an economics professor at Chittagong University, was observing people trying to survive throughout this time and noticed a woman with three children making bamboo stools for a living. He loaned her a small amount of money in an experiment to see what might happen. To his surprise, she paid it back in full along with several other people he loaned money to in the same fashion. The people he loaned money to were able to invest in their business and make considerably higher profits, as well as having the ability to pay back the loan. Yunus began to work with local banks and then started the Grameen Bank. The bank would eventually grow to South America, Africa, Asia, and the United States. Repayment of loans from the Grameen Bank is at 98.4%, much higher than commercial banks, and loans are given without collateral most times. The Grameen Bank is geared towards offering loans to women: 97% of the 7.31 million borrowers are women (Yunus).

The Grameen Bank and the microcredit movement have been designed specifically for women and their potential for developing the third world, as well as impoverished areas of developed countries. Indeed, the idea of development without the use of an entire half of the population is absurd and irrational. However, these programs work extremely well with women because of the way that the groups function and are designed. A case study of Rotating Savings and Credit Associations (ROSCAs)—essentially microcredit programs—in the town of Karatina in Central Kenya displays a number of different reasons why women would be preferable to men for microcredit programs (Johnson).

Women tend to repay loans more reliably because of the social shame of no repayment of the loan. Loans are given through a group of women that are collectively responsible for the repayment of all of their loans. If one of the group members fails to pay back a loan, the other women are responsible for splitting the cost of the loans or being cut off from the loan institution (Johnson). One woman in the Karatina study explained that it was “… Embarrassing to go to a gitati [microcredit group] without money… You are going to spoil your name and people will be fearing you—seeing you as someone who doesn’t pay”. This creates substantial pressure for women to repay their loans, fearing the disappointment of the entire group. Women tend to work better in social networks together than men, and tend to take out smaller quantities and lower amounts of loans than men, making them more desirable to creditors. Many women also prefer single-sex ROSCAs as they are able to work more efficiently with women and they are able to save their money without informing their husbands (Chester and Kuhn).

Microcredit programs tend to be less effective for men because men behave in a different manner in groups. Many of the groups attempted with men have failed. On a number of occasions, physical violence has broken out between members of the group. The men felt subordinated by the rules of the loans and the strictness of attending meetings. In addition, they acted in a more competitive way, keeping problems to themselves and maintaining a level of mistrust between one another. As one man in Kenya explained, “Men are proud and do not trust each other. Every man is clever. You know someone is going to mess you up” (Johnson).

Apart from these reasons, women are a better investment because their social returns have such a higher potential. Women do not have access to loans that men might have, so it is more reasonable to invest in women.

With the ability to obtain capital and invest, women and entire countries have noticed the effects of lending money to women. Most of the effects are evident in LDCs but developed countries have also used microfinance programs and seen success from their programs. There have been some negative effects that have been noted and analyzed by journalists and economists that must also be addressed.

The most obvious result of these small loans is the ability for women to make their own income. Previously, men were the sole bread winners in many of the economies where microcredit is used. For example, women in Jdeideh, Jordan from an impoverished mountainside village grossed $500,000 in 1994 weaving rugs and selling them. This provided a livable wage for as many as 1,600 workers who were involved in the project (Glain). With this improved income, many women were able to purchase more and more of a decisive voice in the purchases of the family. The bargaining power of women is greatly increased when they are creating their own income—that is, they have more of a say in the way that money is spent within the household. Men who were working more than one job were sometimes able to quit one of their jobs. As men were the sole breadwinners, there was now less to support their families when another income-producer was contributing to the family income. Women are also found to spend their money more on their children (Goetz and Gupta) and will therefore change the structure of what is supplied and demanded in these countries. Women enrolled their children in school between 47% and 61% more with a 10% increase in borrowing (Khandker). Children therefore will have a greater chance for education and will continue to develop the economy with their increased human capital due to this education. Women also tend to encourage their daughters more in education than men will, perhaps causing a decreased gender gap within education and therefore earnings (Kabeen). The total income of the family is undeniably improved, and the consumption equilibrium of the family would shift, demonstrating a greater overall satisfaction (Goetz and Gupta). The community would experience a greater income as well, with so many of its families participating in the loan programs which would increase their income.

The community and the family would theoretically have more income to invest in sanitation, nutrition, health insurance, savings, and education. The community would advance its culture by the specialization of particular trades of the micro-businesses. Take, for example, the Bani Hamida’s Women’s Weaving Project, which utilized ancient rug-making techniques and developed these skills within the community. The weaving of these rugs had been on its last years, but was revived by the employment of this program (Glain).

The societal standing of women has found itself to change when women are perceived to have greater value based on their success. Women felt included in the community, as before the credit, women felt outside of the “orbit of community life” and “excluded from its social events and from everyday forms of hospitality” (Simanowitz and Walker). One woman, when asked if her situation has gotten worse or better since she took out a microloan, replied, “Have things improved for us? Listen, when you have no money, there is nobody, but when you ave money, you suddenly have so many friends and acquaintances. Money is all. All that time, when we had no food, nothing to neat, no one wanted to give us anything” (Kabeen).

This perceived increase in value also helped women within their families. Family members and husbands felt a greater affection towards women that were successful in these programs, and there was less financial tension between the husband and wife. Women feel more self-worth and empowerment through having the opportunity to create a business or be part of something that was creating income. Women feel good about being able to help out their families and being able to be self-sufficient in case anything happened with their family or husband. Many women chose to open their own savings accounts and life insurance plans for this reason. Although divorce is still socially unacceptable in many developing countries, women have the opportunity with their own income to create a “divorce within the marriage”, that is, to separate all of the finances within the marriage so that each person is independent of on another (Johnson). Though studies on domestic abuse conflict, many find that violence is decreased with the introduction of the woman’s income. Perhaps this is because of the alleviation of the pressure on men to be the only breadwinners, or because of the increased value that the woman is given with her own income.

Sometimes the microcredit programs fall short, however of what they intend to accomplish. For example, microcredit works on a demand-side argument that hopes that working with individuals will help the economy of the country as a whole. However, very often this is not the case. Microcredit cannot change the societal institutions that support gender discrimination. In order for women to be liberated within the market, larger institutional changes need to take place. Though credit is important for development, many argue that it will not solve poverty or will empower women alone (Feiner). Even the loans may not empower women as much as they seem to. Many loans are co-signed by a male, usually a husband, or are controlled secretly or overtly by the husband. Therefore, loans are not truly empowering women, but are only placing more control in the hands of the men of the country.

In addition, because the Grameen Bank and similar microcredit banks earn profit, they may be said to have interests that do not coincide with the impoverished—many argue that the interest rates that these banks charge are usurping the poor. Although a counterargument points out that because the Grameen Bank borrows from other sources, the interest rate adds up and the final amount that is being borrowed covers this cost as well as the cost of administering a large number of small loans. The banks can, however, use microcredit to their own advantage and there is the opportunity for maximizing their own utility rather than the utility of the poor. Sometimes the power of microcredit can be misused, as well.

In Beirut, Lebanon, an intelligent economist and world-branded terrorist Hussein al-Shami uses microcredit programs to develop the funds of the Hezbollah group. Hezbollah is named a terrorist organization by the United States because of their supposed connection to violent terrorist acts. These microcredit loans are also given to women but do not encourage their empowerment by the nature of the organization (Higgins).

As the study of the Jordanian women weaving rugs addressed, sometimes the free market is a cruel force and can put a project out of business just as easily as it had given the project success. Women will put their hard work into the business and may not receive economic benefit to their labor. In the case of the Jordanian weaving project, the women were so successful that they attracted fierce competition that would utilize cheap labor from Egypt in order to drive down their prices. Many other groups were funded by international aid organizations for the same purpose of economic development. The women who began the project were unable to lower their prices and the demand for their products dropped significantly. One woman explained, “It was so hard to compete. We had to do everything by hand. It’s like having the government in the market, and the NGO is the government” (Glain).

In first word countries, the effects of microcredit programs are very different. The only two Grameen-affiliated programs in the United States are located in Dallas and Harlem. Though these programs have had a successful experience, it is a difficult process for one to receive a loan—including classes and strict rules. Those that make it through this process have found success in their new businesses. Veronica Rivera, a woman from Mexico City, was enrolled in the Dallas microfinance program- called the PLAN fund. She began her own janitorial company and is now grossing $100,000 a year. The program has helped her understand the intricacies of owning a business, such as taxes and payroll accounts (Hall). Though this is a very different account from the developing world, these microfinance programs seem to have a positive effect, particularly on women, even in developed countries.

Similarly, banking designed specifically for women, has become a recent trend in developed countries. In the United Kingdom and Germany, bankers have realized that women are an enormous customer group, and it would be unreasonable to ignore them. The Raiffeisenbank Gastein in Germany has reached many women looking for banking for managing household finances or managing their businesses. In the UK, the private bank Coutts has been attempting to attract more women to its business. Indeed, a 2006 Centre for Economic Business Research study predicts that 53% of millionaires in 2020 will be women. The report also estimates that there are 448,000 women currently in the UK who are classified as being of “high net worth”. The banks support female entrepreneurship and empowerment of women through control of their financial services. Supporting women’s economic development also leads to greater gains in the country’s economic welfare, even when considering first word countries. In Canada, women’s self-employment grew 43% in the last ten years, and has contributed to approximately $18 billion dollars to Canada’s economic growth (Odoi). Lending banking services to women and encouraging self-employment among women is lucrative for banks, is empowering to women, and is effective for encouraging growth in the entire economy.

Case studies worldwide have come up with success stories concerning the microcredit programs and their ability to advance the social and economic status of women. In the Niger Delta, for example, the United Nations Development Fund for Women has joined forces with Micro Credit Finance Institutions in the region to encourage entrepreneurship and to give the women of the area capital that they can start businesses with. The training that they have been able to receive gives the women valuable computer skills and management skills—as well as naturally organizing the women into cooperatives. The program has been so successful that identical projects are finding themselves implemented in other parts of the state (Ilbom).

In the mostly Muslim area of Narathiawat in south Thailand, the effects of female entrepreneurship have truly shown what microcredit can do for the individual woman, women in groups, and women advancing their communities. Several groups were started to produce certain products, such as embroidery. Funds were given to each group and the women have successfully marketed and sold their products. With this growth, women have been able to be more in touch with the world around them through computer technology and from trading with nearby regions. According to the study that was conducted regarding these groups, the women were more empowered within their household to be major decision-makers. Many women also went on to work with the structure of the community and address certain political issues they found relevant during their entrepreneurship (Kay).

Perhaps the most successful of countries for advancing women through microcredit is India. A case study in Haveli Tauka in western India reports that 3000 women were given the chance to utilize small loans for their development. The program was successful and women reported income through activities such as goat rearing, jewelry making, and farming and vegetable cultivation. According to the article, “the poorest of the poor have been helped to break the barrier of poverty and gain economic independence” (Fernandes). Along with the loans, the women have been given training in empowerment and “capacity building”—setting unlimited goals for women and their advancement.

Where the idea for microcredit began is also an excellent example of how it has helped women. The country of Bangladesh uses small loans to provide credit to the rural areas of the country. Groups have been so successful in this country because people can choose which groups they would like to work with and can have support and guidance through these groups. Groups also make the repayment rate very high—for the Grameen Bank, women recovered loans at 99.4% in 1994. This is unheard of in commercial banking institutions. Though the societal standards looking down upon women who leave their households for work in the labor market have not changed significantly, women can achieve income of their own working in the household and not forgoing nonmarket work. Women’s nonland assets increased 2% for each labor hour worked, with a 10% increase in borrowing from the Grameen Bank. Credit given to men in this study does not have any impact on their purchasing power or their advancement.

Women have the potential for incredible economic growth through microcredit programs. Though these programs are not substantial enough to lift women and countries out of poverty alone, they are a brilliant idea for helping to ease the pain of the impoverished. Banking services are essential for economic growth and need to be available for all people- especially women in developing countries. Microcredit programs must be designed differently for women in third and first world countries. The programs must change according to each country’s specific needs and development goals.

Adam Smith's Dynamic Equilibrium

Adam Smith’s intention in writing An Inquiry into the Nature and Causes of the Wealth of Nations was to explain the accumulation and definition of wealth of a society. In doing so, Smith described a liberated economic system in which a society could maintain internal balance while constantly changing and moving towards equilibrium and perfect justice. Smith’s portrait of a relatively stable economy would also have the tendency to grow its wealth and productivity.

Smith did not have the original idea of a self-maintaining society, but rather gave a clear voice to the concept of harnessing the power of a marketplace and of individual’s self interest to continually move toward this goal. The ancient Greek philosophers described an ideal state—of social and economic equilibria. This would be achieved through, for example, Plato’s caste system in which all occupations were decided at birth—a socially immobile division of labor. However, Plato’s system implies that men are naturally better or worse because of a preposition to a particular trade. Adam Smith’s ideal state gives more equality to the abilities of man, as most differences are developed through culture and education. The Greeks also held the belief that self interest was contrary to economic growth. Aristotle desired a system where a just price would be maintained through honesty of the purchaser and seller, not of their self-love. Similarly, the Mercantilists believed that self-interest was destructive to the wealth of the nation—for example, that certain personal luxuries should not be encouraged because it was against the well-being of the nation. Adam Smith expanded on previous political and economic philosophers by allowing self-interest to have a place in serving the greater good of the nation and establishing a societal balance which promoted relative harmony and morality.

This balance derived from self-interest is a product of an innate and universal desire for wealth and the dismantling of rules and regulations that hinder the potential of a free market system. With these two assumptions, competition is allowed to freely provision economic goods to all levels of society. Self-interest will lead to the division of labor. Each person cannot produce what he or she needs individually, and it is in each person’s best interest to truck, barter, and exchange the surplus of one’s products with another. This self-interest leads to unintended social cooperation. Due to the liberated market, the effectual demand of each good will ration the quantity of production of commodities. A relatively harmonious system is created in which people’s needs are met via the market mechanism. What Smith terms the “market” price of a good, its exchangeable value, will tend to converge with the “natural” price, its value in labor, in the long run as well. This occurs because if there is freedom to produce and to consume, it will be impossible to sell a good above its natural price for any amount of time, as there will always exist another producer offering a lower price, pushing the high seller out of the market. Both the natural and the market prices are constantly changing; the market price fluctuating greatly and the natural price theoretically decreasing in the long run because of increased productivity due to the expansion of the division of labor.

Wages and profits will tend to converge towards equilibrium levels in the long run. In the short run, Smith admits they may be “suspended a good deal” from natural levels, but this is only temporary. Therefore, individuals will not, in the long run, be working for more or less compensation than their counterparts in the same occupation. Smith argues this in Book I, Chapter 7 by stating that if in any area, there is an occupation that seems to be very attractive due to its high wages or profits, more people will crowd into it and will eventually balance the wages so that they are comparable to the levels of other similar occupations.

The market’s ability to ration economic goods and equalize occupations is under the assumption that actions do not violate natural laws of justice. These laws of justice are enforced by the government, whose only roles are to provide defense, public works, and a system of law and order. The government should not interfere with the market, not because politicians are inherently evil, but because they could not possibly do as much good as the market is capable of achieving. In this way, Smith’s economic welfare is contained by the government but also allowed to flourish within the dictates of justice. This maintains reasonable, but not perfect, order within the society. The society is constantly moving towards equilibrium, and may obtain it only briefly, but Smith was not describing a static system in which there will be a Utopian state through the division of labor and the free market mechanism. He was, however, describing a system of constant change under which relative order and justice exist.

Once this stability is achieved and maintained, the society may develop its division of labor into other sectors and continue to grow its wealth. The society moves from a primitive sort of society, where agriculture is the focus, to a manufacturing society, which will in turn eventually lead to commerce between other nations. This is also one of the functions of the market. With a liberated market, capital will flow into the appropriate areas—those with the most profit potential. Agriculture is the most “safe” investment, next being manufacturing, and so on: “…as the capital of the landlord or farmer is more secure than that of the manufacturer, so the capital of the manufacturer being at all times more within his view and command, is more secure than that of the foreign merchant” (Smith). In this way, the market may control the appropriate flows of capital due to expected returns and expected risk. As the society moves away from a primitive society, the extent of which the nation may specialize and divide labor increases. The most ideal society that Smith describes uses a sophisticated division of labor, in which there is professional differentiation of labor, and is the most effective. Therefore, productivity is increased and profits will be expected to increase. The growth of the nation cannot exceed the market capacity, keeping it within reasonable levels. Smith defines wealth as the amount of necessities and luxuries an individual has. The increased productivity will therefore lead to higher output and more “stuff” for each person. The market sparks growth that propels the economy forward towards, though never reaching, an optimum level of production and consumption.

As the society reaches a level where it can utilize the division of labor on an international level, the nations involved move continually towards an international equilibrium. Prices and wages begin to balance on a larger scale in the long run, and economic goods are provisioned to all levels of society for all countries involved in the trade. Just as the division of labor was beneficial to nations internally, it is also useful on a global scale. The benefits of trade are evident in Book II, Chapter IV in Wealth of Nations, as Smith notes the costs of production can be decreased by purchasing cheaper goods in foreign countries. The country’s total income is increased by allowing international commerce. Restricting trade only negatively affects the potential harmony that could be achieved through a liberated market by creating monopolies and unjust provisioning of economic goods.

Wealth is also created by the accumulation of capital from year to year. The productive class—mostly manufacturers, will produce more than what is necessary for the subsistence of both the productive and unproductive classes. What is set aside and saved for the next year may be used to generate more productive labor and to purchase new machinery and tools. This will maximize output and will continue to expand the nation’s productivity. Saving is natural, according to Smith in Book II, Chapter III of Wealth of Nations, because it betters one’s own condition and each person is constantly seeking to maximize their well-being: “the principle which prompts to save, is the desire of bettering our condition, a desire which, though generally calm and dispassionate, comes with us from the womb, and never leaves us till we go to the grave” (Smith). It is not, however, the accumulation of capital which expands wealth, but it is the connection that capital has to the division of labor as a nation is constantly moving towards its optimum productivity.

Adam Smith may have been arguing a direction for European economies of his time, but unintentionally set forth a self-sustaining economic system that could adapt to changes easily, contributing greatly to economic equilibrium analysis. Smith’s system had a tendency to align society’s needs and wants with what was produced, as well as providing relatively just prices, wages, and profits.


Chandra, Ramesh. Adam Smith and Competitive Competition. Online Source. .

Fleischacker, Samuel. On Adam Smith’s Wealth of Nations: A Philosophical Companion. Princeton University Press: Princeton, 2004.

Heilbroner, Robert. The Essential Adam Smith. Norton & Company: New York, 1986.

Myers, ML. Adam Smith’s Concept of Equilibrium. Journal of Economic Issues: September 1976. Volume 3, Issue 3, pp 560.

Schumpeter, Joseph. History of Economic Analysis. Oxford University Press: New York, 1976.

Smith, Adam. An Inquiry Into the Nature and Causes of the Wealth of Nations. Liberty Fund: Indianapolis, 1981.

Vivenza, Gloria. Adam Smith and the Classics. Oxford University Press: New York, 2001.

An empirical study on the Turkish J-Curve and the Marshall-Lerner Condition

The Turkish economy has suffered several shocks to its economy over the past 30 years. These shocks have led policymakers to multiple devaluations of the new Turkish lira as an attempt to bring the country out of its increasing current account deficit. The extent and frequency of these devaluations has not led to a surplus in Balance of Payments as expected. Possible explanations for the cause of a “perverse reaction” to devaluation are an unsatisfied Marshall-Lerner condition and a multiple devaluation shifting the J-curve to the right under the Kulkarni hypothesis.

Using simple Ordinary Least Squares regression methods, I will test the effect that a change in exchange rate has on the trade balance for the Turkey since 1980, during which several international trade reforms were implemented. I predict that I will find that the multiple devaluations of the Turkish Lira have led to an indefinitely negative trade balance, rather than a trade balance surplus as policymakers had desired. This perpetually negative trade balance is also potentially due to the consumers and investors’ expectations of devaluation.

Since 1947, Turkey has experienced a negative current account balance. In the 1950s, like most of the rest of the world, the Turkish Lira was fixed, in this case with the United States Dollar. Gross National Product growth was very unstable during this time period, due to large fluctuations in output. The currency appreciated 13% from the period of1953-1959 but did not help the trade balance, as exports fell from 7.6% of GDP in 1953 to 2.0% of GDP in 1958. The Turkish government faced a debt of approximately 1 billion USD in 1958, and devaluated the currency in August of the same year in an attempt to bring the economy out of a negative trade balance. The devaluation was partnered with more liberalized trade policies, though Turkey was still a much-closed economy.

In the 1960s, the currency was particularly overvalued due to inflationary pressures, but the time period was also associated with a reduction in the current account deficit as exports rose from15% of GDP in 1971 to 30% of GDP in 1972. The deficit reduction may have been a result of extensive import substitution policies, which also included a heavy emphasis on investment in manufactured and capital goods. However, producers still relied on importing raw materials for production. In 1973-1974, Turkey suffered from oil shocks that made oil more expensive to import and therefore increased the trade deficit, followed by a second oil shock in 1979. Also in the 1970s, Turkey’s domestic spending started to increase, leading to further terms of trade deterioration. Turkey’s inflation rate remained high, sometimes past 100%, but never reached hyperinflationary levels.

Turkey failed to negotiate a stabilization agreement with the International Monetary Fund in 1978 and 1979, but in 1980, policymakers turned what had been an import-substitution policy into an export-oriented growth policy. These trade reforms were led primarily by the Deputy Prime Minister Turgut Őzal, also the leader of a military regime that took over Turkey during a short time period of 1980-1983. Őzal’s reforms included export incentives such as tax rebates and favorable credit terms. Some restrictions on imports were lifted to encourage trade as well, such as quotas. The Turkish lira was considered overvalued and a devaluation policy was set in place. The country also moved towards a freer exchange rate system, though it was still relatively controlled by the government. Industrialization accompanied the movement of 1980, though it had been taking place along with the import-substitution policies already in place. Turkey began moving from a primarily agricultural exporter to an industrialized goods exporter. As a result of the 1980 reforms, foreign investors also became more confidence in the Turkish economy, which helped to turn the low foreign direct investment from $100 million USD in 1987 to $800 million in 1992.

When the military regime fell and parliamentary democracy returned in 1983, more currency devaluations were instituted. Even though previous devaluations were not particularly effective, policymakers in this time were much more optimistic about the demand elasticities of imports and exports, and thus determined that devaluation of the domestic currency would create a surplus in the balance of trade for Turkey. In 1987, Turkey experienced a mini-crisis where inflation was accelerating out of control, to the extent that real interest rates on deposits were becoming negative. Therefore, people fled from the devalued Turkish Lira and invested in dollar currencies. As a result of the excessive inflation, the Turkish government tightened monetary policy in February of the next year. The government successfully stabilized the currency but slowed growth in the process. The current account in 1988 and 1989 was in surplus temporarily. The 1990s began with a short period of high inflation and growth, creating an increasing current account deficit. In the early 1990s, fiscal policy in Turkey created higher inflation by increasing government spending, leading to an annual inflation rate of 73% in 1993. This further deteriorated the terms of trade and deteriorated the value of the Turkish lira. In 1991, the real GDP per capita was decreasing by 1% annually, along with rising inflation. The Turkish economy faced a mini-crisis in 1994 and the Turkish lira had depreciated by 76% against the US dollar (World Bank and OECD). From 1999-2001, the Turkish government worked with the International Monetary Fund to stabilize the economy by reducing inflation and restoring external balance. Unfortunately, this plan failed in2001 as it resulted in sharp devaluations of the lira, and did not help to control inflation or the trade balance.

Today, Turkey depends heavily on imported oils and fuel, accounting for 20.5% of total imports in 2006.Significant oil shocks during the past decades have helped to further push Turkey into a current account deficit, as oil became more costly. Turkey is also a large importer of mechanical machinery, road vehicles, iron, and steel. Turkey’s major exports include clothing and textiles—accounting for 21.3% of total exports in 2006, whereas road vehicles, iron, steel and electronic machinery are also major exports. Turkey’s main trading partner is the EU, which accounts for 51% of her exports and 45% of her imports, mostly from Germany. Other trading partners include the United States, Middle Eastern countries, and South Asian nations.

The “Marshall-Lerner condition” was theorized in the early 1990s by Alfred Marshall and Abba Lerner to explain why currency devaluations may not lead to a favorable effect on the trade balance of a country. In simple economic theory, currency depreciation will make a domestic country’s goods cheaper to foreign countries, and thus increase exports and create a surplus on the domestic country’s current account. Under a free market system with floating exchange rates, an overvalued or undervalued currency will self-adjust itself via the market mechanism. However, the Marshall-Lerner condition proves that this will only occur if the sum of the demand elasticities of imports and exports are greater than one, and generally holds true for small open economies. This is because in order to have a favorable trade balance after devaluation, import and export demand must be able to effectively respond to the change in exchange rate.

Mohsen Bahmani-Oskooee in his 1998 studies on the Marshall-Lerner condition and J-curve hypothesis found that the Marshall-Lerner condition holds true in most of the 30 developed and developing countries that were tested (Bahmani-Oskooee 101-109). However, Bahmani-Oskooeealso found that in the case of India—always the exception—her elasticities of demand for imports and exports satisfied the Marshall-Lerner condition but the trade balance has deteriorated in the short and long term. Other studies have conclusively proven that the M-L condition continues to be important in determining if devaluation will have a positive effect on balance of trade, if no other factors counteract the positive effects of devaluation. One of these offsetting effects could be if there is a relative increase in income domestically compared to the income of the rest of the world, which would create a higher demand for imports and offset the devaluation effects on balance of trade.

The J-Curve hypothesis states that initially, devaluation will lead to a deterioration of trade balance because the quantity of imports will remain the same for a period of time, and will cost more to domestic consumers. There will have been existing contracts before the devaluation that must be carried through even with the devaluation. Imports will be more valuable as exports remain of approximately the same value. Goods prices do not adjust overnight, and during the period of time that prices are adjusting, there will be a negative trade balance. After producers and consumers adjust their demand to the new currency rates, exports will be more desirable to foreign nations and the trade deficit will turn into a surplus in the long–run. This is under the assumption that the Marshall-Lerner condition holds true. Junz and Rhomberg in their 1973 research study concluded that in order for trade balance to become positive, the lags in recognition, decision, delivery, and placement must be considered.

Studies have found mixed results testing the validity of the J-Curve hypothesis. In Andrew K. Rose’s study in 1990, there was found to be no association between exchange rate and trade balance for developing countries. Rose’s study was somewhat unique because most J-Curve empirical studies only focus on industrialized countries. Empirical evidence has show that the J-Curve hypothesis may hold true for countries such as Egypt, Indonesia, Greece, Korea, Japan, and Spain—that is, after a devaluation of domestic currency, each country experienced a short-term negative trade balance followed by a long-term positive trade balance (Kulkarni 52-63). Some studies that employ disaggregate data have found that the J-Curve may not be apparent if the positive effects of devaluation in one country is offset by negative effects to its trading partners (Halicioglu 3).

Similarly, expectations of devaluation have a considerable effect on whether there will be a positive reaction in exports and imports. If devaluation is unexpected, devaluation is seen to be highly effective, while the opposite is true as well. Sellers will look to make contracts in currencies that are expected to appreciate, so that they will gain more from a transaction, though buyers will want to engage in economic contracts under which the currency is expected to deteriorate, as their costs will be minimized. The theory of rational expectations, therefore, contributes to the hypothesis that multiple devaluations will lead to an increasingly negative trade balance.

Professor Kishore G. Kulkarni tested the hypothesis that multiple devaluations will lead to a perpetual trade deficit for Ghana and found that subsequent devaluations of the Ghanaian Cedi led to a long period of deterioration of terms of trade in the period of1983-1989. In countries that experience only a single devaluation, the effects are more align with the traditional J-Curve hypothesis (Kulkarni 41-51).

There is limited research on the impact of devaluations on Turkey’s trade balance. The research that has been conducted either used bilateral or aggregate data, sometimes with conflicting results. The benefit of bilateral data is that it can show how one country’s trade balance affects another’s. Bilateral trade studies on the J-Curve also more often find positive effects of devaluation in the long-run. A 1997 study found that in the 1970s, there was no relationship between trade balance and exchange rates in Turkey and in the 1980s there existed a negative relationship (Brada et al.). Another study in 2001 discovered a lag of one year after devaluation for trade balance to begin to have a positive behavior, looking at long-run aggregate data (Kale). Independent studies by Bahmani-Oskooee and Rose found no relationship in Turkey between exchange rates and terms of trade. A1991 study on devaluations concluded that a higher exchange rate may be contractionary if it is anticipated (Agenor), while unanticipated devaluations have a greater chance of producing a positive effect on output and economic activity.

For testing the hypothesis of multiple devaluations leading to a perpetual trade deficit in Turkey, I have found trade statistics from Turkey’s 12 major trading partners—Austria, Belgium, Canada, Denmark, France, Germany, Holland, Italy, Japan, Switzerland, the United Kingdom, and the United States. These were Turkey’s most significant trading partners in 2005 according to International Monetary Fund statistics. I have used data from the IMF’s International Financial Statistics database, from World Bank statistics, and from the Organisation for Economic Co-operation and Development Surveys of Turkey. Due to the multiple devaluations chasing rising inflation in Turkey particularly from 1980 onwards, I will attempt to find a relationship between trade balance and exchange rates between the time period of 1980 and 2006.

If we assume that trade balance is a function of the domestic country’s GDP, the trading partner’s GDP, and the real exchange rate, we can assume a linear-logged model for the relationship. The variables are logged in order to make them unit-free. The Ordinary Least Squares static regression model that I will use to fit the data is as follows:

Log(TB)=a₀+β₁log(Y)+β₂log(avgY*)+β₃log((avgP*/P) (ER))+e

Where TB is the annual nominal difference between exports and imports in Turkey, a₀ is the autonomous annual change in trade balance, Y is Turkey’s annual nominal GDP, Y* is the averaged annual and nominal GDP for Turkey’s 12 major trading partners, P* is the averaged Consumer Price Index for Turkey’s trading partners, P is the domestic Consumer Price Index, and ER is the exchange rate expressed in terms of the Turkish Lira’s purchasing power when compared to the IMF’s Special Drawing Rights unit. The SDR is a weighted unit term in the IMF’s IFS to determine exchange rates—it is derived from a basket of currencies as an international reserves unit. The value e is a random error term. I have logged the variables to attempt to keep elasticities relatively constant and to control the large units of these variables.
The estimated value of the coefficient β₁ is expected to be negative, as Turkey’s imports are expected to increase with a rise in domestic income via the import function M=a₀+b₁Y, and therefore will result in a negative trade balance. The estimated value of the coefficient β₂ is expected to be positive, as a rise in foreign income will result in a positive trade balance due to increased exports. However, the estimates for β₁ and β₂may be negative if import-substitution goods are the cause of an increase GDP. The coefficient β₃ is of particular interest to this test because it will assist in determining whether exchange rate, adjusted for price levels, has a positive or negative effect on trade balance. If the partial derivative ∂/∂ER[TB] is negative in the short run, and positive in the long run, the J-Curve hypothesis holds true. If the estimated β₃ is negative in the long-run, the Kulkarni hypothesis that a series of devaluations leads to an indefinitely negative trade balance may be an accurate explanation. I expect the multiple devaluations of the Turkish Lira will cause the trade balance to be indefinitely negative.
I will also test to see if foreign direct investment is affected by Turkey’s currency deterioration. I am expecting that investment in Turkey will decrease with currency devaluation, particularly because of the instability of the Turkish economy and the expectations of further devaluations. I will hold interest rate constant during the test because I would like to isolate the changes in GDP and exchange rate to respective changes in exports and imports.

Finally, I will test the Marshall-Lerner condition and find a value for elasticities of demand for exports and imports in Turkey during the time period of 1980-2006. I will do this by testing the import elasticity function M=a₀+β₁((P*/P)ER) where a₀ is the level of autonomous imports, P* is the foreign country’s price level, P is the domestic country’s price level, β₁ is the amount that imports are expected to change with respect to a one unit change in adjusted exchange rate, Y is the domestic income, and β₂ is the amount that imports are expected to change with respect to Y.

β₁ is expected to be negative because as exchange rate increases (exchange rate here is expressed as domestic currency units/foreign currency units), the domestic currency loses value and thus imports will be expected to decline, as they are more expensive for domestic consumers. β₂is expected to be a positive value, because as the domestic country’s income increases, they will be able to purchase more imports. Similarly, I will test an export elasticity function where X=a₀+β₁((P*/p)ER)+β₂Y*, the only difference in independent variables being the foreign country’s GDP as the value of Y*. The coefficient β₁is expected to be positive as prices become more appealing to foreign consumers. The coefficient β₂ is expected to be positive as well, because as foreign country’s income increases, their demand of the domestic country’s goods will increase as well, leading to a greater value for exports.

The statistical analysis package that was used for this test was SAS, Version 9.1. Data used, program details and output are attached to the end of this paper. I am using aggregate data rather than bilateral trade between Turkey and her trading partners.

The results from testing the a regression expressing trade balance in terms of foreign and domestic income and exchange rates, produced the following results:

[6.22824][.09131][.73519][.44] [s.e]

The estimated β value shows that as Turkey’s GDP increases, the estimated, averaged value of trade balance decreases. This was expected, as Turkey’s income decreases, that there should be a positively increasing demand for imports and therefore a deterioration of the terms of trade. The positive estimated value of β₂ is negative, which was unexpected. This means that as a foreign country’s GDP increases, the trade balance deteriorates even further. This may be due to import-substitution goods in other countries or the sensitivity of unit measurements in the data. The estimated value for the coefficient β₃ is positive, which means that in the long-run, devaluation of the Turkish Lira has a positive effect on trade balance according to the statistics that I have obtained.

To test the accuracy of these regressions, I conducted a 95% confidence interval for the estimated value of β₃. I found that the estimated value of β₃ for the Trade Balance equation was between .77986 and 2.58562. This allows me to state with 95% certainty that the true value for β₃ is positive, and therefore exchange rate deterioration has a positive effect on trade balance in the long-run. The adjusted R-squared value obtained from this regression was .7883, out of 1, and helps to explain how well the data fits the regression model.

When I isolated the years 1980-1990 and performed the same test, I derived the following regression:

Log(TB)=-35.82520 -.28647Y-.11370Y*+2.30724((P*/P)Log(ER))+e
[15.47301][.54657][.2.57417][.94041] [s.e.]

The negative value of b₁ shows that as domestic GDP increases, the trade balance deteriorates, which is in line with traditional international economic theory, as imports are expected to increase as domestic income rises. The value of b₂ is negative, which was unexpected, because as foreign income increases, they will demand more of Turkey’s products and exports should increase. The positive value of b₃ is of particular interest because it is of positive value and a greater value than the b₃for the long-term regression. Running a confidence interval for the value of b₃ in this short-term regression, I can say with 95% certainty that the true value of β₃ lies between .377518686 and .4.23696132. Therefore, it can be concluded that the derivative of a change in exchange rate with respect to trade balance is positive in the short-term. That the value of b₃ is greater than in the previous regression assumes that the trade balance was even more responsive to devaluation in the 1980s than over the long-term. Therefore, the devaluations and policy reforms of 1980 were relatively effective in turning the negative trade balance around. However, this does not support the theory of a J-curve, as the partial derivative ∂/∂ER[TB] is positive in the short and long terms.

The analysis of 1990-2006 shows similar results to the long-term regression model, but with a positive value for Y*, more aligned to traditional economic theory that exports should increase as foreign GDP also increases. The value for ∂/∂ER[TB] is again positive at 1.88340.

When testing the foreign direct investment changes with respect to exchange rate, the data obtained is estimated in the following regression:

Log(FDI)=65.83022-4.16918((P*/P) (ER))+e
[40.39278][2.92040] [s.e.]

The negative coefficient of b₁tells us that as exchange rate deteriorates, the foreign direct investment will also decrease. As the domestic currency is devaluated and is cheaper in real terms, there will be less investment and less confidence in the currency, thus making direct investments deteriorate as well. It seems reasonable that the number of devaluations of the Turkish Lira have created negative expectations for the rational investor, and even if exchange rates were to appreciate, investment would most likely be slow to recover because of the history and expectations of devaluation. The overall values of foreign direct investment have increased steadily for the years 1980 to 2006 (see Figure 2), showing an increasing confidence in the Turkish economy, despite the series of devaluations of the Turkish lira.

From testing the Marshall-Lerner condition, the import elasticity function that was used for the test gave the following result:


This function shows that as the price level changes by one unit value, the volume of imports are expected to decrease by .06581. When fitting the data to the export elasticity of demand function, I found the following equation:


This function tells us that the coefficient for the percent change in price with respect to the quantity exports is .04226. When this is added to the coefficient for the percent change in price with respect to the quantity of imports, the absolute values for the elasticities add up to .10807. Since this value is not greater than 1, the Marshall-Lerner condition is unsatisfied and according to theory, the devaluation of currency will not lead to a long-term trade surplus. Although short-term elasticities were not analyzed, it should be assumed that the long-run elasticities of demand for imports and exports are more accurate than short-term, as elasticity is dependent upon time and the availability of substitute goods. However, this is not to say that the elasticity of demand for imports and exports were not larger during the time of devaluations, such as the sharp devaluations of 1980, 1994, and 2001.

Through this primitive study, it may be assumed that the trade deficit for Turkey has been narrowing throughout the past 27 years. Devaluation of the Turkish lira has been shown to have a positive relationship between trade balance, even though the Marshall-Lerner condition was not satisfied. If the Marshall-Lerner condition was in fact satisfied, perhaps Turkey might have been able to free itself from a perpetually negative trade deficit. It may also be concluded that investors are less likely to be interested in the Turkish economy if it is devaluating its currency. Expectations of devaluation are also likely to decrease the confidence in the Turkish lira and in investment in the country—as shown by the larger value of ∂/∂ER[TB] when devaluations were effective in 1980, rather than a smaller value of ∂/∂ER[TB] when the devaluations could have been expected and therefore had a lesser positive effect on trade balance. However, because of the results of the f-test performed on the regression, there may be other facts affecting trade balance that should be considered.

The Kulkarni hypothesis holds loosely for these results. The trade balance was perpetually negative, perhaps due to the subsequent devaluations of the lira as Kulkarni suggests, but devaluations had a positive effect on trade balance in the long-run.

Units Measurements Used:
GDP For all countries= Billions/National Currency
CPI=Unit Measure
ER=Purchasing power of Turkish Liras/SDR (market rate, end of period)
Exports and Imports=Millions/USD

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