Cheap Labor Meets Costly Capital: The Impact of Devaluations on Commodity Firms

This paper examines how devaluations affect the relative costs of labor and capital and therefore influence production, profitability, investment, and stock returns for firms in the 'crisis' country as well as competitors in the rest of the world. After developing these ideas in a small, open-economy model, the paper performs a series of empirical tests using information for about 1,100 firms in 10 commodity industries between 1996 and 2000. The empirical tests support the model's main predictions: 1) Immediately after devaluations, commodity firms in the crisis country have output growth rates about 10%-20% higher than competitors in other countries; 2) Immediately after devaluations, commodity firms in the crisis country have operating-profit growth rates about 15%-25% higher than competitors in other countries; 3) The effect of devaluations on fixed capital investment and stock returns (and therefore expected long-run output and profits) is determined by capital/labor ratios and changes in the cost of capital. For example, crisis-country firms have higher rates of capital growth and better stock performance after devaluations if they had lower capital/labor ratios and there was no substantial increase in their interest rates.