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Large devaluations, foreign direct investment and exports : a speculative note

  • Lederman, Daniel

One side-effect of the Global Financial Crisis of 2008-09 was the resurgence of a debate over exchange rates. The conventional wisdom dictates that real-exchange rate adjustments are needed in order to bring about changes in trade balances across countries. However, the literature on the effect of exchange rate fluctuations and currency under-valuations on exports is surprisingly ambiguous. This note explores for the first time the potential role of foreign direct investment as an intermediate variable in the process of trade adjustment after large real-exchange rate changes. Real-exchange rate devaluations might result in increases in foreign direct investment inflows, as investors can take advantage of changes in the foreign-currency value of domestic assets. If so, the response of exports will depend to some extent on the nature of such foreign direct investment inflows, with inflows motivated by"horizontal"foreign direct investment associated with negligible changes in export growth after devaluation. The author utilizes quarterly data on real effective exchange rates, foreign direct investment inflows and exports to explore the effects of large devaluations (defined as the largest observed quarterly real effective exchange rate devaluation) on foreign direct investment and exports from 1990 to 2010. The admittedly speculative evidence suggests that there were heterogeneous experiences regarding the timing and magnitude of subsequent changes in foreign direct investment and exports, but on average foreign direct investment inflows tended to precede export surges within two year horizons.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 5619.

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Date of creation: 01 Mar 2011
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Handle: RePEc:wbk:wbrwps:5619
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  1. Nicolas Berman & Philippe Martin & Thierry Mayer, 2009. "How do Different Exporters React to Exchange Rate Changes? Theory, Empirics and Aggregate Implications," Working Papers 2009-32, CEPII research center.
  2. David L. Carr & James R. Markusen & Keith E. Maskus, 1998. "Estimating the Knowledge-Capital Model of the Multinational Enterprise," NBER Working Papers 6773, National Bureau of Economic Research, Inc.
  3. Blonigen, Bruce A, 1997. "Firm-Specific Assets and the Link between Exchange Rates and Foreign Direct Investment," American Economic Review, American Economic Association, vol. 87(3), pages 447-65, June.
  4. Cesar Calderon & Tatiana Didier, 2009. "Will FDI be Resilient in this Crisis?," World Bank Other Operational Studies 11000, The World Bank.
  5. Gita Gopinath & Roberto Rigobon, 2008. "Sticky Borders," The Quarterly Journal of Economics, MIT Press, vol. 123(2), pages 531-575, 05.
  6. Freund, Caroline & Pierola, Martha Denisse, 2008. "Export surges : the oower of a competitive currency," Policy Research Working Paper Series 4750, The World Bank.
  7. Mark Aguiar & Gita Gopinath, 2005. "Fire-Sale Foreign Direct Investment and Liquidity Crises," The Review of Economics and Statistics, MIT Press, vol. 87(3), pages 439-452, August.
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