Annex 2A


Annex 2A: The Salter-Swan-Model

1. Model assumptions

The Salter-Swan-model has been developed by two Australian economists Salter and Swan in
thel950s. It serves two purposes: first, it helps to understand the role and interaction of
critical factors inducing macro-economic disequilibria, and second it provides a framework in
which the rationale behind and the likely consequences of policy interventions, including
policies subsumed under 'adjustment', can be analysed.

At the core of the model is the distinction between tradablee' and 'non-tradable' goods and fy
services. Tradables comprise all goods and services produced in an economy which are
actually or potentially imported or exported. Non-tradables are goods and services which do
not cross country borders, either because transport costs prohibit the export or the import of a
good, or due to the virtually non-tradable nature of the goods in question (e.g. public services,
land, housing, construction, local specialities which are nt traded on the world market,
highly perishable products). Most agricultural products, including food crops which are M
(partly) imported as well as cash crops for export, belong to the category of tradables. /^,

The most notable difference between tradables and non-tradables arises from the process of
price formation. In an open dependent economy (dependent means that a country is a price
taker on the world market), the price of tradables is assumed to be determined by world
market prices (expressed e.g. in US-$), 'translated' through the exchange-rate into
domestic market prices (for details see Annex 2B on the exchange rate-price-market
mechanism below). The prices of non-tradables are assumed to be determined by domestic
supply and demand.

The tradable-non-tradable distinction on which the model is based helps us to capture
important aspects of macro-economic processes of price formation and production response.
It is, however, not free of conceptual ambiguity. In practice, a large range of products cannot
be clearly assigned to one of the classes but are characterized by different degrees of
'tradability'. Even within a country, the same product may be a tradable at one place (close to
the border, the main trading or consumption centres), and non-tradable at another place (in
remote and inaccessible areas). The fact that most goods fall somewhere in between the
extreme cases of tradables and non-tradables has consequences on the process of price
formation which will be discussed at the end of this chapter.

The major assumptions, on which the model are based, are in summary (for details see
references):

1) Three types of a commodities are produced: an exportable (x), an importable (m), and a
 non-tradable (n).
 2) The prices of tradables (Px and Pm) are given by the world market, translated through a
 fixed nominal exchange rate (equalling the real exchange rate in the initial equilibrium
 situation, see Annex 2B on exchange rate price-market-mechanism below) into domestic
 market prices. The price of the non-tradable (Pn) is determined by domestic supply and
 demand.


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