Effects of Trade with Centrally Planned Economies on Exchange Rates and Prices in Market Economies

Abstract

The purpose of this chapter is to study how trading with a centrally planned economy (CPE) that has no functioning price system and an inconvertible currency can affect the exchange rates, outputs, prices and welfare in market economies (MEs). In an earlier article, I have discussed how the macroeconomic behaviour of an ME having trade with a CPE differs from the behaviour of MEs trading only with other MEs (Tolonen 1988). The framework used was one of three countries (two MEs and one CPE) and three goods. In MEs, there were Keynesian unemployment and fixed exchange rates between MEs. As a case study, the Finnish trading experiences with the Soviet Union were discussed. One of the results was that an increase in this trade leads to an increase in Finnish production and employment. The reason is that with bilateral clearing account arrangements (or, more generally, with a zero balance of payments target in the CPE), an increase in Finnish imports from the Soviet Union leads to a rise in Finland’s exports to the Soviet Union. This kind of reasoning has clearly affected the purchasing practices of the Finnish government, especially Finnish state-owned companies. A preference is often given to imports from the Soviet Union instead of ME sources. Examples such as railway equipment, nuclear plants and military hardware quickly spring to mind. The most recent discussion concerns the acquisition of a new generation of fighter planes for the Finnish air forces. The choice seems to be between the Soviet MIG-29 and the Swedish JAS. The former has been promoted by presenting the employment generating reasons mentioned above.