THE EVIDENCE FROM DEVALUATIONS The preceding discussion has shown the possible short-run effects of a

THE EVIDENCE FROM DEVALUATIONS The preceding discussion has shown the possible short-run effects of a

devaluation on the trade balance through the currency contract and pass- through periods. What does the evidence of past devaluations have to offer regarding the actual effects? Unfortunately, the available evidence suggests that the effects of devaluation appear to differ across countries and time so that no strong generalizations are possible.

Some authors show that devaluation improves the trade account in the short run, while others disagree. The reasons for such disagreement come from the fact that different researchers use different sample periods and different statistical methodology. Several researchers have focused on the manner in which producers in different countries adjust the profit mar- gins on exports to partially offset the effect of exchange rate changes. This appears to be an important factor in explaining differences in the pass-through effect across countries. For instance, if the Japanese yen appreciates against the U.S. dollar, the yen appreciation would tend to be passed through to U.S. importers as a higher dollar price of Japanese exports. Japanese exporters could limit this pass through of higher prices by reducing the profit margins on their products and lowering the yen price to counter the effect of the yen appreciation. This pricing to market behavior has been found to be especially prevalent among Japanese and German exporters but is much less common among U.S. exporters. For example, Joseph Gagnon and Michael Knetter (1995) analyzed automo- bile trade and estimated that a 10 percent depreciation of the dollar against the yen would result in Japanese auto firms reducing their prices so that the dollar price to U.S. importers would rise by only 2.2 percent. There was no similar evidence of U.S. auto firms reducing prices for exported autos in response to dollar appreciation. Thomas Klitgaard

Determinants of the Balance of Trade 239

through effects is another reason why the Japanese balance of trade may

be less responsive to exchange rate changes than the U.S. trade balance.

There is some evidence that the impact of devaluations may differ over the short run and long run depending upon what happens to labor costs relative to the cost of capital. Kristin Forbes (2002) has found that in the short run following a devaluation, firm output and exports tend to rise as the cost of labor in the devaluing country falls and firms take advantage of this to expand production and increase their export sales. However, over time, capital becomes more expensive to firms in the devaluing country if the risk associated with that country rises or interest rates rise. So the net effect of devaluation depends upon the mix of capital and labor utilized in a nation’s export industries. The evidence from a cross section of countries suggests that in countries where the ratio of capital to labor employed is low, devaluations are much more likely to result in export expansion and faster economic growth. But in countries where the capital/labor ratio is high, devaluations will tend to have little if any expansionary influence on exports and economic growth.