An Empirical Study of the Relationship between Exchange Rate Misalignments, Economic Complexity and Export Diversification

This study examines the influence of real exchange rate (RER) misalignments on economic complexity and export diversification across a range of countries, utilising a panel vector autoregression (VAR) methodology. Our research extends to an extensive panel (1962 to 2019) encompassing 151 countries. We employ the metric devised by Rodrik (2008) concerning RER misalignment – adjusted for the Balassa-Samuelson effect – and correlate this measure with export diversification, drawing upon the literature centred on the product space tradition (Hausmann and Hidalgo, 2014). Contrary to prevailing assumptions that RER misalignments universally enhance exports and economic complexity, our findings reveal a nuanced and varied relationship. The analysis indicates that RER deviations can profoundly affect the structure of national economies, directing export diversification in unforeseen ways and not consistently leading to increased complexity. Furthermore, the effects of RER misalignments are enduring, with the potential to spur long-term technological advancement and the development of advanced production capacities. Recognising the intricate dynamics of the global economic system, this paper contributes to the discussion on exchange rate policies and economic development, proposing future research to further explore this complex relationship. It seeks to provide valuable insights for policymakers and academics on the subtle effects of exchange rate dynamics on economic growth strategies.