Are the traditional trade-exchange rate theorems relevant for developing countries facing entry costs in international markets?
ISBN: 978-82-7825-260-4 (fulltekst)
This paper investigates the relevance of traditional trade-exchange rate theo-
rem for developing countries facing sunk entry costs in international markets.
First the theorems analysing pricing of tradable goods and the trade balance
dynamics following exchange rate shocks are accounted for. Second the sunk
cost hysteresis model of foreign trade is described, including the possibility for
hysteresis both at the microeconomic and at the macroeconomic level. Third
the implications of sunk cost hysteresis for the predictions of the traditional
trade-exchange rate theorems are discussed, focusing on both pricing of trad-
able goods as well as short and long run trade balance dynamics following
exchange rate shocks. The paper argues that the sunk cost model provides
a microeconomic basis for trade dynamics that allows for non-linearities and
regime switches, something often seen in empirical anlysis. The predictions
of structural adjustment programs are however drawn from the traditional
theorems, lacking the possibility for non-linearity. The sunk cost model is
argued to push both pricing rules and trade balance dynamics closer towards
the empirical record, mainly by allowing for a state-dependent relationship
between exchange rates and foreign trade. When it comes to policy implica-
tions the paper argues in favour of context speci.c policy interventions and
against the one size .ts all approach of structural adjustment programs.