Question

Discuss the success of Marshall-Lerner condition in Turkey, refering to the exchange rate elasticity of imports and exports.

Answer 1

Marshall lerner condition is a phenomenon which is satisfied when the absolute sum of a country's export and import demand elasticities (demand responsiveness to price) is greater than one. If it is satisfied, then if a country begins with a zero trade deficit then when the country's currency depreciates (e.g., it takes fewer yen to buy a dollar), its balance of trade will improve (e.g., the U.S. will develop a trade surplus with Japan). The country's imports become more expensive and exports become cheaper due to the change in relative prices, and the Marshall-Lerner condition implies that the indirect effect on the quantity of trade will exceed the direct effect of the country having to pay a higher price for its imports and receive a lower price for its exports.

In the case of Turkey, export-led growth policies which are applied in Turkey after 1980 increased foreign trade volume rapidly, however this situation caused the emergence of current account deficit problem. Economic and political crises which arise from the liberalization of capital movements in 1989 led to increase in current account deficit problem. In particular, the increase in current account deficit quickened after 2001 crisis. In discussions about current account deficit which is one of the most important economic problems of Turkey in recent years, it was frequently claimed that Turkish Lira is overvalued and currency adjustments may decrease current account deficit. However the increase in export and the decrease in import after appreciation of foreign currencies depends on demand and supply elasticity of exported and imported goods.

According to the Elasticity Approach, when a country depreciates its currency, offsetting of balance of payments depends on demand elasticity of exported and imported goods. Depreciation affects balance of payments in three ways: firstly the decrease in the amount of imported goods because of the increase in the prices of these goods; secondly increase in export because of the decrease in the prices of exported goods; and thirdly lower revenue from one exported good because of depreciation. Net results of these three impacts depend on export and import elasticity. It was found that the elasticity of exports and imports with respect to the exchange rate is very low in short run, that is Marshall-Lerner condition cannot be fulfilled, however the elasticities are high in the long run and sum of the elasticities may be higher than 1 (one). Thus, devaluation will increase the foreign trade deficit in the short run. In recent studies, it is asserted that the impacts of changes in foreign exchange rates on balance of trade cannot be explained with elasticity which is calculated by seeing only the changes in the prices and quantities of goods and so income effect should be added to the model. This study is based on the export and import functions which were used in the ‘Long-Run Price Elasticities and the Marshall–Lerner Condition revisited’ study of Mohsen Bahmani-Oskooee and Farhang Niroomand in 1998.

According to the estimation results of export and import demand functions of Turkey, this study in which the validity of Marshall-Lerner Condition in Turkey was analysed supports Marshall-Lerner Condition because the elasticity of export and import demands is higher than 1. However, in the short run, a statistically significant relation between the variables could not be found. Consequently, it was found that currency adjustments (devaluation) may be effective in reducing current account deficit in the long run. Thus, we can say that marshall lerner condition indeed helped turkish economy in long run and settle down its current account deficit.