WHAT IS Competitive Devaluation
Competitive devaluation is a specific scenario in which one nation matches an abrupt national currency devaluation with another currency devaluation. In other words, one nation is matched by a currency devaluation of another. This occurs more frequently when both currencies have managed exchange-rate regimes rather than market-determined floating exchange rates.
BREAKING DOWN Competitive Devaluation
Competitive devaluation is a series of sudden currency deprecations between two national currencies as a result of the the two nations making tit-for-tat moves in order to gain an edge in international export markets. Economists view competitive devaluation as being harmful or deleterious to the global economy, because it may set off a round of currency wars that could have unforeseen adverse consequences, such as increased protectionism and trade barriers. At the very least, competitive devaluation can lead to greater currency volatility and higher hedging costs for importers and exporters, which can then impede a higher level of international trade.
Many economic scholars consider competitive devaluation a “beggar-thy-neighbor” type of economic policy, since in essence it amounts to a nation attempting to gain an economic advantage without consideration for the ill effects it may have on other countries. Economists use the term “beggar-thy-neighbor” for economic policies enacted by one country in order to address its own economic situation, while it in turn makes the economic situation worse for other countries, turning those neighboring countries into “beggars.” Though economists usually deploy the term in reference to international trade policy that ends up hurting a country's trade partners, in competitive devaluation the term applies primarily to currencies. Economists trace the origin of such policies to attempts to combat domestic depression and high unemployment rates through increasing the demand for the nation’s exports via trade barriers and competitive devaluation.
What Is Appealing about Competitive Devaluation?
A country may engage in competitive devaluation because the act of currency devaluation or depreciation improves a nation’s export competitiveness. By lowering the cost of goods exported from that nation, the country becomes more appealing to overseas buyers. Because it makes imports more expensive, currency devaluation can positively impact a nation’s trade deficit. Currency devaluation forces domestic consumers to look for local alternatives to imported products, which then provides a boost to domestic industry. This combination of export-led growth and increased domestic demand usually contributes to higher employment and faster economic growth.
However, a country should be wary about the negatives of currency devaluation. Currency devaluation may lower productivity, since imports of capital equipment and machinery may become too expensive. Devaluation also significantly reduces the overseas purchasing power of a nation’s citizens.