A VARIETY OF ELEMENTS is likely to be taken into account in establishing a set of multiple exchange rates for export proceeds. Some multiple rates appear to have as one of their objectives the avoidance of the inflationary pressures which would be generated if all exporters were given the advantage of a generally depreciated rate. Some emerge from the desire to subsidize particular exports, or from the attempt to gain government revenue by widening the margin between the buying and selling rates. Others may be traced to balance of payments pressure and indicate a conscious attempt to adjust export rates to the supply possibilities for various types of product. Still others may be regarded as devices for taxing particular companies or groups of companies in lieu of other forms of taxation. In any single country, more than one of these purposes may be involved, especially where there are several buying rates. It is, however, convenient to make a general analysis separately of each of the elements that may help to explain a given system of multiple rates.


A VARIETY OF ELEMENTS is likely to be taken into account in establishing a set of multiple exchange rates for export proceeds. Some multiple rates appear to have as one of their objectives the avoidance of the inflationary pressures which would be generated if all exporters were given the advantage of a generally depreciated rate. Some emerge from the desire to subsidize particular exports, or from the attempt to gain government revenue by widening the margin between the buying and selling rates. Others may be traced to balance of payments pressure and indicate a conscious attempt to adjust export rates to the supply possibilities for various types of product. Still others may be regarded as devices for taxing particular companies or groups of companies in lieu of other forms of taxation. In any single country, more than one of these purposes may be involved, especially where there are several buying rates. It is, however, convenient to make a general analysis separately of each of the elements that may help to explain a given system of multiple rates.

A VARIETY OF ELEMENTS is likely to be taken into account in establishing a set of multiple exchange rates for export proceeds. Some multiple rates appear to have as one of their objectives the avoidance of the inflationary pressures which would be generated if all exporters were given the advantage of a generally depreciated rate. Some emerge from the desire to subsidize particular exports, or from the attempt to gain government revenue by widening the margin between the buying and selling rates. Others may be traced to balance of payments pressure and indicate a conscious attempt to adjust export rates to the supply possibilities for various types of product. Still others may be regarded as devices for taxing particular companies or groups of companies in lieu of other forms of taxation. In any single country, more than one of these purposes may be involved, especially where there are several buying rates. It is, however, convenient to make a general analysis separately of each of the elements that may help to explain a given system of multiple rates.

In a number of countries which have multiple currency practices, certain foreign companies are exempted from the obligation to surrender to the local authorities their exchange proceeds from exports. The companies, however, need a certain amount of local currency to cover their local operating expenses. Where there is no unitary exchange rate, a decision has to be made about the rate at which this local currency will be provided in exchange for part of the companies’ exchange proceeds. In a few such countries, e.g., Ecuador, the buying rate fixed for this purpose is the same as is applied to proceeds from the majority of exports. In others, however, the foreign companies are required to convert, at a special appreciated1 rate, such part of their exchange proceeds as is required to purchase the local currency which they need. Chile, Syria, and Venezuela are current examples of such a situation, and the exchange systems of Bolivia, Iran, and Lebanon have in the past also included elements of a similar kind.

In some of these countries, the foreign companies exploiting a natural resource supply a substantial portion of the country’s total foreign exchange receipts, and exchange relations with them are, therefore, of considerable importance for the country concerned. The difference between the appreciated rate at which the foreign companies are required to purchase their local currency and the effective buying rate for other transactions may be fairly small. For example, in Venezuela it is about 7 per cent of the rate applied to the oil companies. In Chile, on the other hand, the spread is very large; the rate now applying to most exports is more than five times the rate applying to purchases of local currency by the large copper companies. As considerable amounts are involved, and especially where the deviations from other buying rates are substantial, the practice may also be important for the foreign companies, as well as for the countries in which they operate. This aspect of multiple rate practices should be examined in order to have a clear idea of the problems involved and of the effects which are likely if the practice should be eliminated.

Nature of the practice

Where an appreciated rate is applied to the purchase of local currency to cover local operating costs, these costs are raised by the increased cost to the companies of acquiring local currency. The rate can thus be regarded as equivalent to a flat-rate tax on the domestic expenses of the company. The appreciated rate is, however, only part of the complex of financial relations between the company and the government. These financial arrangements arise either because the government of the country controls subsoil rights and, by definite concession agreements, grants exploitation rights to foreign companies, or because it selects foreign companies for special treatment on account of their size and relative efficiency, or, in effect, on account of their ability to pay special taxes. On the other hand, the companies are large, and at first because of their willingness to risk substantial amounts of capital, and later because of their importance in the economy, they have considerable bargaining power vis-à-vis the local government. Thus, the financial provisions cannot be regarded as being imposed unilaterally on the company by the government.

In Venezuela, Iran, Syria, and Lebanon, the relations between the oil companies and the governments are (or were) formalized in concession agreements. Although these vary considerably in detail, their principal financial provisions are similar. They provide for payments, either in kind or in foreign exchange, by the companies to the government—usually royalties, income tax, and miscellaneous exploration fees—and, in return, usually exempt the companies from other forms of local taxation and from compliance with certain foreign exchange regulations applicable to other exporters. These agreements have been adjusted from time to time in favor of the governments, partly in recognition of the decreased risk borne by the company as it proceeds beyond the exploration stage, and partly as a result of the improvement in the country’s bargaining power as the resource is further developed. Where unfavorable buying rates are used for transactions with the foreign concessionaires and where there are written concession agreements, the agreements do not, as a rule, specify the exchange rate applicable to company transactions. Thus, any tax revenue arising from the disposal of exchange acquired at the appreciated rate is revenue over and above that provided for in the concession agreement. Both the companies and the governments are, however, aware of this, so that the existence of this source of revenue may have been taken into account in past negotiations and is likely to be taken into account in any future changes in the agreements.

In countries other than those in which oil companies operate, e.g., Chile, there may be no formal concession agreement between the government and the company. Nevertheless, the government regards company taxation as a special problem and, in view of their size, the companies are often consulted before the government changes the financial provisions that affect them. Thus, in all cases the unfavorable rate must be regarded as only part—and sometimes, as in Venezuela, a minor part—of the financial relations between the government and the company.

No general statement is possible about the extent to which the use of special rates for foreign company transactions has been associated with balance of payments difficulties, although the use of an appreciated rate probably means that the country derives more exchange from the companies than it would if a uniform, more depreciated rate were used. In Venezuela, there was for a considerable time a payments surplus on current account with practically no effective restrictions on payments. In Chile, on the other hand, payments difficulties have led to both depreciation and restrictions on imports. If the unfavorable rate for foreign companies were eliminated, but substitute tax measures were used to bring in from the companies the same amount of revenue previously given by the exchange spread,, the exchange receipts of the countries would be unaffected. Only if elimination of the appreciated rate without any substitute measure were being considered would the effect on exchange receipts be substantial in some countries, and in these cases the effects on the government budget probably would be equally serious.

Economic basis for incidence of this practice

The decision to apply special exchange rates to the transactions of foreign companies has no doubt in each case been dependent in part upon the special historical circumstances of the country concerned. The attitudes of the governments, as well as the nature and position of the companies, have played a part in determining whether appreciated rates shall be retained, and are also likely to affect the extent to which such practices are used in future. Certain generalizations may, however, also be made about the conditions that have favored the adoption of these practices, though in any particular country not all of these conditions may be completely satisfied. Historically, the adoption of special exchange rates for foreign company transactions has been in most cases an expedient which has made more acceptable the depreciation of the exchange rate for other transactions. While for most transactions the rate has been allowed to depreciate, it has been thought convenient to maintain it for foreign company transactions at the former level, partly in order to prevent a decline in exchange receipts. However, the taxation and exchange receipts elements involved in the use of unfavorable rates have also tended to have increasing importance from the point of view of monetary and fiscal policy. Thus, although the “partial” depreciation started as a response to balance of payments pressure, the maintenance of a special rate for foreign companies usually soon came to be associated with budgetary difficulties.

The outstanding characteristics of the countries which apply unfavorable rates to foreign companies are usually those associated with a comparatively low level of economic development. In such circumstances, the foreign company tends to stand apart from the rest of the economy, with unique standards of production, accounting, and pricing policy. In some cases, primitive producing units, many of which may not enter the money economy at all, may play an important, and sometimes even a predominant, role in the rest of the economy. As a result of the contrast, the relations between the two kinds of unit and the world may also be vastly different. As a consequence, an exchange rate which provides a satisfactory link with the international community for one sector of the economy may not be satisfactory for the other. This is the basic explanation of the ability of the foreign companies to operate under the apparent handicap of a sharply appreciated rate. In their international economic relations, moreover, these countries are likely to be dependent upon relatively few exports, which are the products of primary industry. Also, their revenue systems have to be adjusted to existing tax potentials and customary expenditure patterns, and thus are unlikely to be particularly suitable for taxing foreign companies. The simple administrative structure of the tax system favors the establishment of taxes which vary with some easily measurable index.

A second general feature is that the countries which have adopted this practice are relatively small and that the primary natural resource being exploited requires large capital investment. The smallness of the country means that the foreign companies have special importance for the prosperity of the economy, both directly through the employment they provide and indirectly through their contribution to government revenue. Heavy investment is required partly because the producing unit must necessarily be large to compete in world markets, and partly because the underdeveloped nature of the economy frequently means that considerable outlays for transportation, power, etc., are required.

A third characteristic is the dominant role of the foreign companies in the general balance of payments position. When foreign companies play a small role in the domestic economy and in the balance of payments position, changes in the exchange rate can easily be considered without singling out these companies for special treatment. On the other hand, when they are responsible for the larger part of the country’s export receipts, it is scarcely possible to consider a change in the exchange rate without taking special account of the individual positions of the companies. This has meant that, when the exchange rate was changed, the foreign companies were often given a rate different from that used for other transactions.

A fourth characteristic is that postwar economic conditions have been particularly favorable for the commodities produced by the firms concerned. Petroleum companies are involved in the majority of cases, while mining and fruit companies are also important. Countries with resident foreign companies producing commodities, e.g., gold, which have not been subject to favorable conditions have not applied special rates.

A fifth feature is that the companies concerned operate under monopoly or quasi-monopoly conditions. Entrance to the industries is restricted in a number of ways—because the existing companies have their raw materials covered by concession agreements, because large amounts of capital are required, or because marketing and transportation problems have led to vertical integration. Because of this quasimonopoly position, the countries in which the companies are resident do not benefit from any tendency to bid up the prices of the natural resources used by the companies. As a consequence, taxation of the companies appears to be one of the most effective ways of benefiting from their existence.

The factors which have been enumerated above should not be interpreted as implying that there is any hard and fast line to be drawn between countries which have adopted special exchange rates for foreign company transactions and those which have not. In general, however, there is no strong inducement to resort to this practice in more highly developed economies, where there is no sharp differentiation between the economic efficiency of the various productive units. In such economies foreign companies are not in an especially favorable position for paying appreciated rates for domestic currency, and as the taxation system is likely to be well developed, and so constructed that the foreign companies can be taxed in the same way as other companies, there is no need to use the exchange system as an instrument of taxation. In a more diversified economy, moreover, exports are likely to consist of a wider group of commodities, so that fluctuations in export earnings will not be so closely associated with the operations of certain foreign companies. Finally, where the importance of foreign companies in the balance of payments positions of the countries concerned is not outstanding, there is no strong inducement to accord unfavorable treatment to them. When the exchange receipts earned by the foreign companies are less important, the rates applied to the foreign companies are only a minor issue when changes in the exchange rates are considered; thus, the foreign companies are less likely to be singled out for special treatment.

Effects of the Special Rates

Not only the general economic characteristics of the countries using special exchange rates for transactions with foreign companies, but also the effects of these special rates should be examined. A discussion of the distinction between the use of appreciated rates for foreign companies and their use for some major export product which is produced domestically will throw further light on some of the issues involved and will also provide a basis for distinguishing between these practices for policy purposes.

Contrast with other uses of appreciated export rates

Many countries with multiple buying rates apply appreciated rates to their chief export products. Insofar as the problem is that of a major export product or group, the question arises as to whether it is materially affected by the fact of foreign ownership. In other words, is there any significant difference between a situation such as that of Colombia or Thailand where coffee or rice are produced and exported by local citizens, and that of Venezuela or Chile where petroleum or copper and iron are produced and exported by foreign companies? In both cases, a single export accounts for a large proportion of the country’s exchange earnings, and exchange from the export is subject to a penalty rate indicating considerably lower costs than are involved in other export industries.

Taxation of the nonresident exporter adds to the foreign exchange resources of the country to the extent that the tax is not shifted to local factors of production or to domestic consumers of the companies’ products. The increased exchange available may be used to finance additional imports with their attendant deflationary effects. If, however, government expenditures rise as a result of the tax receipts in the form of foreign exchange, the deflationary impact of the increased exchange sales may be offset. When, on the other hand, the export is made by local firms, there is no effect on the distribution of incomes as between countries unless the tax can be shifted forward. A tax upon local exporters has direct anti-inflationary effects, as exporters’ incomes are kept lower than they would otherwise be. The anti-inflationary effect of the tax may be approximately offset in the same fashion as a tax on foreign producers, if government expenditures rise by the amount of the increase in tax revenue.

The difference in the division of income as between countries also has important implications for other tax considerations. In general, to tax the income of a foreign concessionaire is politically easier than to tax the income of a local producer. In many cases, also, taxes on a foreign company can be administered more easily and more successfully simply because the tax source is a single firm or a small group of firms.

If the country receives an important part of its exchange receipts from the conversion of exchange by a foreign company, it may find that rising prices abroad have a particularly serious effect on its exchange position.2 Since the company’s conversion of foreign exchange to meet local production costs varies mainly with the changes in the volume of its production, rising prices abroad have only an indirect impact on the country’s exchange receipts. If increasing export prices expand domestic receipts from exports other than those of the foreign company, demand for imports, and therefore for foreign exchange, is likely to increase by a proportionately greater amount than the increase in total exchange receipts. The seriousness of this will be moderated to the extent that the company also pays taxes, e.g., income tax, which vary with the company’s position, because under these circumstances exchange receipts will rise as the export proceeds of the company increase. The opposite trends develop if prices abroad fall; payments by the company fall only if production is reduced and the real value of exchange increases as the prices of the country’s imports fall.

Another difference which may be of some importance, depending upon the structure of the country, is the timing of receipts by the exchange control authorities. When a foreign company is involved, royalty payments may be made at intervals, and tax payments are likely to be concentrated at the end of the financial year. In contrast, when local producers are involved, surrender of export proceeds corresponds with the actual export, and thus the flow of exchange may be quite regular, depending upon the seasonal factors involved. This difference is not likely to create problems unless import demand tends to be concentrated at particular times and exchange reserves are very low, so that interim financing is difficult.

The chief difference which emerges from this comparison is that the direct anti-inflationary impact of an unfavorable rate for local producers of a major export has no counterpart in the application of a penalty rate to foreign concessionaires. In the latter case, tax revenue is also involved, but it means primarily a redistribution of income and exchange between countries. The anti-inflationary results of such a tax follow indirectly from the larger imports which can be financed with the exchange derived rather than from any reduction in domestic incomes. This means that, if a distinction is to be made between these two cases, the analysis must be carried beyond the simple fact that both measures result in revenue to an analysis of the effects of the revenue collection.

Effects on other countries

Appreciated rates for foreign companies appear to do little harm to the commercial interests of other countries; in fact, they may favor them. Studies made of some of the individual countries indicate that these rates have minor effects on the distribution of the expenditures of the foreign companies between domestic and foreign sources. In most cases, the greater part of local expenditure is for labor, while foreign expenditure is for goods not produced domestically. Thus, in these cases, the appreciated rate reduces local expenditure by the companies only to the extent that it affects the margin between the use of capital equipment and of labor as productive factors. In any event, the preference is in favor of foreign countries and against the interests of local producers.

The appreciated rate is accepted by the foreign company as a datum in its decisions as to the relative proportions of domestic labor and imported capital to be used in the productive process. A less appreciated rate might result in more labor and less capital being employed. Thus, from the point of view of productivity considerations, the appreciated rate can be regarded as having some distorting effects. On the other hand, if full employment has been attained and there is an inflationary situation, as the result of, for example, a development program, the government may regard the diversion of labor from the foreign companies as a positive advantage. Because the appreciated rate raises the costs of domestic factors, production costs will be higher than they would be with a less appreciated rate, and under some conditions this may have some effect on international prices. The exchange rate may also affect the decision of foreign companies as to the location of investment and the rate of exploitation, although this would be so only if the tax elements of the rate could be regarded as additional tax burdens. More specifically, oil companies may operate in one field in preference to another or may develop fields at varying rates in response to differences in costs which depend in part upon the exchange rates available to them. On the whole, however, the exchange rate is likely to be a relatively minor factor in making such decisions.

The use of penalty rates for transactions with existing companies probably does not discourage to any significant extent the entrance of new foreign firms, because entrants are free to negotiate with regard to the rate to be used by them. In Venezuela, for example, the recently established foreign-owned iron companies use the commercial export rate, while in Chile the rate for new capital is much more depreciated than the rate applicable to the conversion of foreign exchange by existing companies for working purposes. Penalty rates for existing companies may lead new firms to fear discriminatory treatment in the future, but this is probably of little significance. In only one case, in Iran, has evidence been found of the classification of other exports at the penalty rate in order to avoid complaints of discrimination by the foreign company. Thus, this harmful effect is not sufficiently widespread to require consideration from the standpoint of general policy.

The conditions which the companies are able to enforce in determining the currencies to be used in payment for their exports are another factor to be taken into account in assessing the effects of penalty rates on other countries. In each case where an unfavorable rate is applied to a foreign company, the rate applies only to local costs and the individual company is free of surrender requirements. Nevertheless, U.S. companies demand payment for their exports in U.S. dollars, while British companies operate in conformity with the sterling area exchange arrangements. If the surrender of exchange proceeds to the government of the country in which the company is resident were required, the government would establish surrender requirements in accordance with its own purposes rather than those of the companies. Thus the regulations probably would be formulated to accord with the payments requirements of the countries, including the need to supply the foreign company with exchange for remittance of profits. In the case of U.S. companies, the government might be prepared to accept some non-dollar receipts, depending upon its payments requirements and market conditions for the product. During 1951, for example, copper companies in Chile were selling a certain amount of copper to Chileans for U.S. dollars, and this copper, after being processed, was exported to Europe where the prices were higher. For British companies, if the country required surrender of dollar proceeds for all of the exports of the company and supplied sterling to the company for remittance of profits, sterling receipts under present arrangements would be replaced by dollar receipts. This might change the pattern of the country’s imports, the currency composition of profit remittances, and the currency required for payment of the company’s exports. Thus the effects of the existing practices are to simplify substantially the operations of U.S. firms and to permit sterling area payments arrangements to extend to companies outside the sterling area itself.

Effects on the country where the companies are resident

Conversion at the appreciated rate applicable to the foreign companies involves a tax on all company expenditures within the country. To the extent that these payments are fixed in amount in local currency, the unfavorable rate increases the country’s exchange receipts. In some cases, however, imports can be substituted for domestically produced commodities, while in others intensified use of imported capital goods can reduce dependence on domestic factors. These factors tend to make the company’s demand for local currency less inelastic. It is, however, difficult to determine how far these effects are important, and probably in all cases any depreciation of the rate applied to the companies, which was not accompanied by a substitute tax, would result in the country’s losing exchange.

A spread between the rate applied to foreign companies and other buying rates means that the foreign companies have a stronger incentive to operate in the foreign exchange black market; it is, however, unlikely that they will do this, because, among other reasons, the scale of their transactions—if they were to be significant for the company—would be great enough to have very noticeable effects on the black market rate, and so be immediately evident to the exchange control authorities.

The absence of surrender requirements for the companies may be regarded as a means of simplifying exchange control in the sense that the company avoids the need for acquiring central bank permission for remittance of profits. The company may be required to convert U.S. dollars to obtain local currency, and this assures the country of hard currency receipts. On the other hand, any foreign expenditures made by the companies escape scrutiny by the exchange or trade control authorities and thus are not subject to the same criteria as other foreign exchange expenditures. If companies were to be required to surrender exchange and to operate within the existing structure of exchange rates and controls, they might purchase their own imports from different sources, depending upon the exchange position of the country, its payments agreements, etc. In some cases, the country may receive sterling from the foreign company and thus grant preference to imports from countries which accept sterling in payment. If surrender requirements were imposed in these cases, it might be possible under some circumstances for the country to increase its dollar receipts.

Another effect of the present exchange requirements is central bank acquisition of all exchange sold by the company. The bank can regulate the flow of this exchange to the market and thus prevent undue accumulations of exchange in the hands of commercial banks and individuals which might exert downward pressure on the rates. However, this is probably only an incidental benefit from the use of the appreciated rate, and similar results could be obtained by exchange control.

The major effect on the country is the substantial revenue obtained by the government from the sale of exchange acquired from the company at an appreciated rate. Part of the exchange acquired is used by the government for its own imports. This can be regarded either as a subsidy provided by the foreign company for government imports, or as a means of reducing government expenditures by buying cheap exchange from the company. Revenue is transferred to the government as a result of the central bank’s profit from the sale of the remaining exchange at a higher import rate. There is no reason why this revenue should be regarded in a different way from other government receipts, and, therefore, no special consideration need be attached to government disposal of it.

Tax considerations

Since the use of special rates for foreign companies results in revenue for the government, consideration of the revenue obtained plays an important part in any assessment of this type of practice. The issues involved can best be discussed by comparing this type of taxation with the income tax. The comparison is purely for illustrative purposes and is not meant to imply either that the income tax is the only substitute, or that under all circumstances it is the best of the alternatives. Further more, the problem to be considered is the form of taxation—the level of taxation being assumed to remain constant over a period of time.3

One of the obvious advantages of an unfavorable buying rate as a taxation device is the simplicity of its administration. The central bank merely sells domestic currency to the foreign company, and, when it disposes of the exchange at a higher rate, a profit accrues which either can be retained by the central bank or turned over to the government. If the exchange is used for government imports, both the tax and the subsidy to government imports are purely automatic. Because the foreign company’s needs arise quite regularly, the central bank receives a steady inflow of foreign exchange.

In contrast to this, an income tax might present considerable administrative difficulty. In some cases, the government is not sure what the company’s income is. This may be partly the result of the intransigence of the company, or it may arise from the difficulty of isolating the income attributable to operations within the country. In any case, some governments fear that the companies would evade income tax. Another result of the substitution of other forms of taxation would be that revenue would accrue to the Finance Ministry and would appear in the budget as general revenue. This might have serious effects on the earnings position of the central bank and make it financially dependent upon the government. Moreover, expenditure might be affected, if the source of the revenue were more apparent, particularly where the exchange is used, in effect, to subsidize government imports. The revenue would accrue in the form of receipts from income tax, and, if subsidies were to be given to government imports, funds would have to be appropriated directly to the departments concerned. Finally, if the income tax were paid in quarterly installments or at the end of the year, the timing of the government’s receipts of foreign exchange might be less convenient.

Another semi-institutional factor which may be of some importance is that, in some countries which impose an income tax in combination with royalty payments, the rates are based on the proposition that an equal division of profits between the company and the government is “fair” and “reasonable”. Since the unfavorable buying rate represents an additional levy on the company, incorporation of it in the income tax would require breaking the rule of equal sharing in profits. It would appear, however, to be only a matter of time before some other division, e.g., sixty per cent-forty per cent, will become equally acceptable, especially since the unfavorable rate presently has the same effects.

The present system of penalty buying rates produces a steady stream of revenue dependent chiefly upon the level of operations of the company. If an income tax were used to produce about the same amount of revenue, receipts might vary considerably from year to year as a result of fluctuations in the earnings of the company. Thus, dependence on the appreciated rate as a tax device tends to stabilize the level of government receipts. It also tends to place a highly variable tax load on the foreign company, becoming heavier relative to income as prices for the products sold by the company fall and lighter as export markets improve. Its effects are thus the opposite of the countercyclical effects usually desired in a tax. This variation in the tax load has the further effect of introducing instability into the financial relations between the company and the country, because it raises the question of the appropriateness of the tax burden on the company whenever the company is operating in exceptionally profitable or exceptionally unprofitable situations.

The recent trend has been for exchange profits to grow. If the central bank’s average selling rate is depreciated, the profits from the sale of exchange purchased at a fixed rate will increase. With an income tax, there would be no accidental changes in revenue as the central bank’s average selling rate fluctuated. To the extent that the selling rate tends to depreciate steadily, the larger revenues which would result from a fixed buying rate would be foregone by the use of an income tax. It is questionable, however, whether changes in the average selling rate in response to the over-all balance of payments position and the measures designed to counter payments pressure should be the determinant of the level of taxation.

Some of these effects of an appreciated rate would not arise if the same amount of revenue were derived from an income tax. The present rate practice may favor imports by the companies at the expense of purchases from domestic sources, the importance of this depending largely upon the size of the spread and the composition of the company’s imports. In addition, the unfavorable rate can be regarded as a direct flat-rate tax on costs. As such, it tends to reduce the level of operations of the companies, and may favor production in other countries where such taxes are not imposed. In contrast, an income tax would have no effect on the distribution of company expenditures between domestic and foreign sources. Thus, as a result of the elimination of the unfavorable rate, the company’s demand for both labor and domestic products might rise. Although, as has been noted above, it is not easy to determine how far these considerations are of practical importance, this increase might conceivably be significant for companies planning further capital investment or for companies which import commodities produced domestically. Moreover, the income tax would have no effect in the short run on the company’s scale of output. The income tax would be paid out of earnings, which the company would attempt to maximize without regard to the tax. Under these circumstances, the output of the companies would probably be larger. On the other hand, heavy income tax might in the long run lead to diversion of investment to other countries, or to other industries, and so curtail output.

Exchange rate considerations

When a country with an appreciated rate for foreign companies is considering the unification of its rate structure by means which will depreciate the rate applied to foreign companies, the loss of exchange revenue which is likely to be involved, if this action is taken by itself, must be taken into account. Similarly, when a country with a unified rate is considering the possibility of general depreciation, it is likely to pay special attention to the loss of exchange which will result from depreciation of the rate applicable to the foreign company. If other tax measures are ignored, it appears to be a general rule that, within practical limits, the exchange earnings derived from the company tend to vary directly with the degree of appreciation of the rate applied to its transactions. Thus, from this point of view, there is considerable advantage for the country in maintaining an appreciated rate, or in introducing multiplicity when depreciation is necessary.

If, on the other hand, there are alternative forms of taxing the companies and these are included in the new financial relations with the company, depreciation of the rate applicable to the company in order to unify the rate need not result in any loss of exchange revenue, since all taxes are commonly paid in foreign exchange. Thus, as far as exchange receipts are concerned, there is no apparent difference between the appreciated rate and a depreciated rate with an offsetting tax. Moreover, the basic position of the company remains unchanged, the reduced cost of domestic expenditures being offset by larger tax payments.

The situation is somewhat different if the foreign company is a fairly important source of exchange and the country is considering depreciation in order to ease payments pressure. Under these circumstances, there will be a strong inducement to introduce multiplicity through depreciating all the rates except the one applicable to the foreign company. Since the general presumption is that the factors creating the need for depreciation—e.g., domestic inflation or depressed foreign markets—apply to both domestic and foreign companies, there would appear to be no basis, so far as exchange considerations are concerned, for treating the foreign companies differently from other trading interests.4 Under these circumstances, the establishment of an appreciated rate would mean increased taxation. Such an increase in taxation arising because the government wishes to depreciate the rate applicable to other transactions would appear to be purely fortuitous, and without any relation to traditional taxation criteria. The problem of general depreciation plus compensatory taxation is not likely to arise in many cases, since tax limits are provided under the financial arrangements between the company and the government.

In essence, the argument here is that failure to depreciate the foreign company rate in accord with other rates represents increased taxation of the foreign company. This increased taxation does not result in an increased financial burden on the company, but it means treatment less favorable than that granted to other firms in the economy. While there is no apparent reason why foreign firms should not be the object of special taxation, the linking of variations in this type of taxation with changes in the exchange rate does not appear to be appropriate.

Another aspect of exchange rate policy which is of rather limited application is concerned with the effects on other industries in the economy of an exchange rate which is suitable for the foreign company. If the exchange rate is established in such a way as to provide approximate balance between current foreign exchange payments and receipts, and if the foreign company is large relative to the rest of the economy, the rate may be so low as to prevent the development of other export industries or of import-competing industries. The situation in Venezuela could be represented in this way. The rate which applies to the oil companies, while apparently tolerable for them under present circumstances, is evidently too appreciated to encourage other export industries or to stimulate domestic import-competing industries in spite of very high tariff protection. This reflects the great discrepancy in relative efficiency between foreign and domestic firms and raises the issue as to whether the exchange rate should be set in relation to the foreign company. Depreciation would make exporting more profitable and result in higher local prices for imports—both of which might encourage the expansion of domestic production. Thus, the general problem arises as to whether development of domestic industry and diversification of exports are sufficient grounds to warrant depreciation even though no payments difficulties would arise at a rate appropriate for the foreign companies.5

The effect of the exchange rate on the payments position may not be a very helpful criterion in this case because there may be a whole range of rates which are compatible with payments equilibrium. As the rate depreciates, proceeds from domestic exports may rise and expenditures for imports fall, thus offsetting the loss of exchange from the foreign company. This may occur through a considerable range of rates, depending upon the response of domestic producers to more favorable rates and the reaction of importers and producers selling import-competing goods. If compensatory tax measures are imposed on the company, even the exchange receipts from that source may be left unchanged and so the range of rates compatible with payments equilibrium may be very wide.

If compensatory tax changes are excluded, depreciation of the rate through the range compatible with payments equilibrium, while it may aid domestic industry, involves the disadvantage of less favorable terms of trade with the foreign company. Moreover, to the extent that depreciation creates inflationary pressure, there arises a need for control measures, in the absence of which the stimulating effects of the depreciation would be lost. Alternative forms of assistance to domestic industries, such as direct or indirect subsidies, might achieve the same results without creating the problem of possible inflation and without losing tax revenue from the company. If compensatory taxes were arranged with the foreign company, however, there would be no loss of revenue for the government, i.e., no deterioration in the terms of trade between the company and the government.

Since depreciation in order to stimulate domestic industry may have both advantages and disadvantages, each decision has to be made in the light of the circumstances of the particular case. Depreciation has the advantage of providing a uniform effect on all industries within the economy, and of permitting price and income developments to determine the further development of the economy. On the other hand, great care has to be exercised to be sure that development is, in fact, being retarded by the current exchange rate and that conditions are favorable for the expansion of domestic production in response to a more depreciated rate. It appears likely that in many cases the obstacles to the development of domestic agriculture and industry are much greater than could be overcome by a moderate depreciation.


Mr. Woodley is a graduate of the University of Saskatchewan, the University of Toronto, and Cornell University. He was formerly an economist in the Exchange Restrictions Department of the Fund, and since the beginning of 1953 he has been a member of the Secretariat of the North Atlantic Treaty Organization.


Any use of the words “depreciated” and “appreciated” with reference to one of a series of multiple rates involves an implicit judgment as to the level of the equilibrium rate. This implicit judgment determines whether the spread of the rates should be regarded as a tax (subsidy) on exports or as a tax (subsidy) on imports. For the countries under discussion—with the possible exception of Venezuela—the rates applied to foreign company transactions are obviously far below an equilibrium rate.


Other forms of taxation on the companies may be such as either to compensate for this effect or to accentuate it.


In Chile and Venezuela, where there is an income tax on the operations of foreign companies, elimination of the appreciated rates should produce a partially compensating increase in income tax receipts. A more favorable buying rate would reduce the companies’ costs and consequently should produce an equivalent increase in profits. Thus, if the income tax rate is 50 per cent, half of the revenue lost as a result of the removal of the unfavorable rate may be recovered, on the assumption that the companies’ costs fall by an amount equal to the tax reduction. An equivalent income tax as used here means one which produces revenue equal to the receipts from the unfavorable rate, including the revenue resulting from the larger tax base.


Although the exchange rate affects only local costs for the foreign company while it affects receipts for local producers, this difference does not suggest that conditions leading to depreciation would have effects on foreign companies which differ markedly from those on domestic companies.


This problem is somewhat similar to the one discussed early in the postwar period as to whether variations in employment should be included in the concept of an equilibrium rate of exchange. The consensus appeared to be that an equilibrium rate had to be defined as one that equilibrated current payments with full employment domestically.