The exchange rate policy helps a country to monitor the exchange ratio of its currency in relation to the base currency, the dollar. Mostly, exchange rates are controlled by the market forces because most countries allow their currencies to float freely in the market (Gerschenkron, 1966). However, there are few cases when exchange rates are controlled by governments through legal barriers as is the case in China and South Korea. Free floating exchange rates help to keep inflation rates at watch because they encourage trade activity both at the domestic and international markets.
However, artificially controlled exchange rate may have harmful effects on the local market. Inflation targeting nations who seek to cushion themselves against volatile financial markets by fixing artificial caps for their currency end up destroying domestic production in the primary industries such as agriculture (Chenery, 1961). For example, a country that overvalues its currency against the base currency will occasion great losses to producers of export goods because it will lower the prices of both domestic goods. This will ultimately discourage mass production while encouraging imports for industrial capital goods that are used as raw materials in import-substitution industries.
Overvaluation of the currency will shift wealth from primary producers to importers of industrial capital goods. Such a scenario also opens loopholes for parallel currency markets that allow large overvaluation taxes to wealthy investors who circumvent the formal exchange system (Gerschenkron, 1966). On the contrary, countries may undervalue their currency in order to boost domestic production and make their exports very competitive at the international market. For example, China undervalues its currency against the dollar hence creating an incentive for local manufacturers and producers to venture into the international. This strategy has put China in the world’s limelight as one of the leading exporter and importer in the world.
the development economists pessimistic about the developmental prospects of the agricultural sector
Development economists were pessimistic about the developmental prospects of the agricultural sector because they reasoned that traditional peasants did not invest in modern production methods. Traditional peasants proved very difficult to transition into modern development policies that demanded them to diversify into other sectors such as industrial in order to enjoy the benefits of dynamic external economies (Chenery, 1961, p.24). Specifically, Chenery (1961) reasons the pessimism among development economists was partly as a result of the fact that industrial sectors are more likely to enjoy the benefits of dynamic external economies than the agricultural sectors due to factors such as internal economies of scale, high demand elasticity, efficiency in operations, ability to deploy modern technology, and training effects.
In essence, the industrial sectors are more likely to experience productivity change than the agricultural sectors because policies changes such as urban bias, import-substituting industrialization, and overvalued currency work to their favor. For example, industrial capital goods importers can streamline their production functions because they enjoy government subsidies, protection from domestic and international competition, controlled labor, and cheap credit facilities from the government.
