Social Preferences in the Open Economy: Restive Youth and the Real Exchange Rate

• In Event: Globalization and Social Unrest

Abstract

The real exchange rate is a key policy lever by which governments can influence the competitiveness of traded goods that are produced domestically, affecting the external balance and economic growth. Yet, despite the centrality of this instrument to macro-economic management, we do not fully understand the wide variation in real exchange rates and the considerable deviations we observe from a neutral, or fairly-valued real exchange rate. Further, there is an apparent disjuncture between theorizing and empirical testing. While scholars note that movements in the real exchange rate have broad, distributional effects, it has proved difficult, to date, to conceptualize how these distributional effects might be expressed as social pressures that affect policy outcomes. Thus, and by default, causal hypothesizing has focused on interest group mechanisms, and we have seen few, empirical analyses that attempt to connect outcomes for the real exchange rate to social preferences.
In this paper, I seek to advance our understanding of how broad, domestic interests might impact the open economy. I do so by focusing on the latent, distributional cleavage between older and younger generations, who differ in the strength of their identity as producers or consumers. Based on the life-cycle consumption hypothesis, I explain why younger actors, who wish to earn and save, favor the additional production associated with an undervalued real exchange rate, over the goal of price stability. Further, I bolster that theoretical derivation of interests with findings based on preferences between inflation and growth for different age groups, using recent Pew Global Survey data. These arguments support a hypothesis linking the size of the youth cohort, as a percentage of the overall population, to the under-valuation of the real exchange rate. The impact of youth preferences on policy, however, relies on the political influence of the young. I argue that this influence is higher in democracies or, in non-democratic contexts, where the young pose a revolutionary threat. This threat is identified from the vulnerability of capital cities to protest, based on the number of people within a day’s march of the capital. Based on both interests and influence, I hypothesize (and show) that the real exchange rate will be more under-valued as the youth share rises but that this relationship is observed only in democracies or where authoritarian incumbents are vulnerable. I close with a consideration off what these findings imply for the role of social preferences in explaining exchange rate politics and sustaining the open economy.

Author

• Lucy M. Goodhart, Brandeis University