George Alessandria, University of Rochester and NBER; Sangeeta Pratap, Hunter College and the Graduate Center, CUNY; Vivian Yue, Emory University, Federal Reserve Bank of Atlanta and NBER
May 2015
Why do exports not increase immediately after an exchange rate devaluation? This is an important question, because export dynamics have important consequences for growth and capital flows. We trace the dynamic path of exports after 11 large devaluations in emerging economies and find that they they peak in around three years after the devaluation. The extensive margin plays an important role in these dynamics, i.e. the increase in exports is largely fueled by exports of new products and by new firms. We also find that interest rates are important: export growth was more sluggish in episodes where interest rates also increased.
We explain these facts using a simple insight: Entering in an export market often requires a firm to incur very specific costs such as product standardization, certification, etc. which are independent of the scale of production. Such costs play an important role in explaining firm dynamics. In particular, a large devaluation may make it more profitable to export, but it takes time to build export capacity. An increase in interest rates makes it more expensive to amortize these costs and acts as a disincentive to exports.
Using this simple idea, we build a framework to measure the impact of devaluations, and the associated economic crises, on exports, capital flows and output in emerging economies. We find that these export specific costs lead to deeper contractions and stronger recoveries.