Transfer problem

The transfer problem refers to the possibility that a debtor country might end up better off after making payments to its creditor countries. It was a subject of debate between John Maynard Keynes and Bertil Ohlin in the 1920s, regarding the issue of the ability of German reparation payment after World War I. In general terms, it refers to the effect of transfer of income on the donor's terms of trade. The reversal of capital flows force countries to go from a current account deficit to a current account surplus.

The transfer problem exists because of internationals payments and the real exchange rate. As we do not live with the same currency, they will always be questions about values and price and so exchange rate between currencies and countries. In capital movements: Theoretically a “perfect” movement of capital, so a buyer buying something to a seller, must be buying real resources like goods, against money. For example, if a country A wants to invest 10 million of euros in a country B. The exchange between the host and the borrowing country should be exchanging “real resources” which have for worth € 10 million. The transfer problem comes when the value is not same between the price paid and the goods sold. The main point of the international transfer in order to avoid this transfer problem is that the price given for the buy of goods by a foreign country is exactly the value of the goods sold by the host country. But value is subjective. As Warren BUFFET said, “price is what you pay, value is what you get.”. As said earlier the first clear example of transfer problem was after World War I, especially between France and Germany. It then appeared in the seventies with the sharp increase of the petroleum prices. The countries that exported petrol at that time experienced an example of the transfer problem. Where they were unable to import equals values and then had been leading to deflationary period. The next example was in 1985, where the United States of America received a lot of foreign investments and at the same time they had huge trade deficits. And this has affected the transfer of goods.

To study the transfer problem, we must assume that both investing and host countries are using a fixed exchange rate and that in these countries there is a situation of full employment. In order to allow the transfer of resources, you need an increase the taxes in the investing country. So, thanks to this, the spending of the investing country is reduced. The other solution could be to decrease the taxes in the receiving country, so their expenditures will go up. And as the expenditures in the investing country are lower it will lead to a decrease in imports.

On the other side, the increase of expenditure in the receiving country can lead to an increase in importations. As we supposed at the beginning that the balance of trade is at equilibrium between the two countries, now because of the spending and the change in importations, what could happen is a trade surplus in the investing country and the contrary in the receiving country (so a trade deficit). The fact that there is a disequilibrium at the balance of trade for the two countries is the transfer of real resources.

In order to know if the transfer of real resources for financial resources is adjusted or not completely adjusted we need to look at the magnitudes of marginal propensities to import in the countries of the transfer. Let’s call this magnitude of marginal propensities “m”.

Then they are three scenarios.

The first one when there is complete adjustment. The sum of the countries’ marginal propensities to import is equal to 1. So, m of country A + m of country B = 1. This shows a perfect adjustment and that the financial transfer has exactly the same value of the real resources. The second scenario is when the sum of the two marginal propensities to import are lower than 1. So, m of country A + m of country B < 1. This illustrates an incomplete adjustment where the real resources value less than the financial transfer. The third and last scenario is when the sum of the two marginal propensities to import are higher than 1. So, m of country A + m of country B > 1. This is not a perfect adjustment but over-complete adjustment where the transfer of goods is bigger in value than the financial transfer.

For the investing country, its trade balance should improve and get better but if the contrary happens then the adjustments have a perverse effect. In a situation like this, then the transfer of goods went the other way around, from the receiving country to the investing country.

References

• Barry W. Ickes. (2009). The Transfer Problem
• Yves Balasko, (2014). The transfer problem: A complete characterization
• Paul R. Krugman, Maurice Obstfeld. (2006) International Economics: Theory and Policy. (7th edition). Pearson. ISBN 0-321-27884-4.