Theories Concerning Disequilibrium in balance of Payments
There arc broadly the following!! three main theories, which explain how a discipline ium in balance of payments is caused:
(il Classical Theory of Pncc Theory.
I;;) Keynesian Theory or Income Theory.
I;j;) Demonstration Effect Theory.
This theory explains dequalinium the balance of payment country in of relative .1rice structures. A country i, likely to have all adverse hnlancc of payments if her cost and price structure is relatively hi!!hn as pared with that of her trading partners. This theory as umcx that there exists a significant clement of sustainability between the home-made goods and 0f reign goods. If this is so, then the consumers in the country whose cost and price structure is relatively higher will substitute home-made goods by foreign’ goods. This will increase the imports of the country significantly and thus create balance of payments problem for the country. loan Robinson, Harrod and Haberler were mainly responsible for developing this theory. By using Keynesian tools, these economists came to the conclusion that tile disequilibrium in the balance of payments of a country can be explained in terms of relative incomes. According to this theory, a country would face a disequilibrium in the balance of payments if her income is rising faster than that of her trading partners.This theory assumes that imports arc a function of income, i.e., with an increase in income, import. of a country would rise. Therefore. if the income of a country is rising faster than that of her trading partner countries, her imports are bound to increase faster, which in turn will give rise to a disequilibrium in her balance of payments.
This theory was propounded. chiefly by Ranger Nurkse. it was suggested Nurkse and also by MacDougal, that the high standards of living of the advanced countries had the effect of inducing the developing countries also to raise theirs. The aspirations of these countries to imitate the Ii ving standards of the advanced countries, resulted in their undertaking heavy investment programmes and in huge imports of luxury items. In other words, the standards of living of advanced countries serve as a ‘demonstration model: for the less developed countries, The result of this is a fantastic increase in their imports, which in turn Creates balance
of payments problems for them. Cuncluxiuu. No single theory can explain the
disequilibrium in the balance of payments of a developing
economy, Thcre arc a number of factors operating
simultaneously which cause this disequilibrium.
The main causes are.
(i) Ambitious development programmer necessitating lilac-scale imports of machinery, plant and equipment, raw materials and technical know how
(ii) Exports lagging behind owing to low level of productivity ill agro-based industries and competition and stagnant or declining demand for traditional ex- PI)r1S. and increased domestic consumption.
(iii) Food imports owing to high elasticity of demand lor food and increase ill population.
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