Blog Post

Exchange Rates and GVCs

Since mid-July, when the Fed suggested its willingness to continue with its quantitative easing policy, the Euro quickly began to appreciate against the dollar, reaching a 8 percent increase at the end of October (from 1.28 to 1.38 dollars per Euro). This shift has now been partly reversed by the ECB decision to cut again […]

By: Date: January 8, 2014 Topic: Macroeconomic policy

Since mid-July, when the Fed suggested its willingness to continue with its quantitative easing policy, the Euro quickly began to appreciate against the dollar, reaching a 8 percent increase at the end of October (from 1.28 to 1.38 dollars per Euro). This shift has now been partly reversed by the ECB decision to cut again the interest rates, but it was not painless for firms: in most cases, quarterly reports by European multinationals, which now heavily rely on exports as a source of gain given the sluggish continental demand, showed a downward revision of earnings. Most of these Multinational Enterprises (MNEs) blamed the “strong euro” as one of the reasons for the negative reporting season.

The latter gave rise to a debate on the possibility that the ECB could adopt a policy of more explicit management of the exchange rate, avoiding it to be completely determined by the market or influenced by the actions of other Central Banks in the world. For those supporting this policy stance, the ECB should aim at preventing an excessive appreciation of the euro against other currencies, thus avoiding stifling the weak recovery currently emerging in Europe. On the other hand, the ECB President reiterated that exchange rates ‘are not an objective of monetary policy’.

This debate clearly relies on the assumption that there is a clear causal relationship between exchange rates and competitiveness. However, given the complex reality of the global economic environment, this assumption should be treated with caution.

Looking at figures presented in a recent research by Barclays, in fact, there does not seem to be a strong statistical relationship in Europe between corporate profits and the level of the exchange rate, neither this relationship seems to be different, as it should be, in sectors more exposed to international competition (such as manufacturing) and sectors that are typically non-tradable (such as personal services).

But how is it possible that a euro strengthening against the dollar does not automatically hinder European exports?

This happens because, in a world characterized by global value chains and international fragmentation of production, companies that produce on a global scale are partially protected from the effects of fluctuations of the exchange rate in the domestic market.

To understand this concept, we can refer to a very simple example:  tracking the global value chain of an electronic toothbrush manufactured by a well-known European MNE, one finds that the toothbrush is assembled with components sourced from manufacturing facilities located in ten different countries over three continents, with seven different currencies. The production of any other industrial good is not very different, with more complex products (such as cars) having more complex and globally articulated value chains.

What role would play the exchange rate of the euro alone in determining the competitiveness of this product? And how about the case in which the product is assembled outside of Europe, in order to produce as close as possible to the target market (as it happens with large part of the production of German cars sold in Asia)?  What role does the euro play in determining the profitability of these firms?

In these cases a strong euro might actually have an effect, but purely from an accounting point of view: since profits from production abroad are recorded in local currency, but are consolidated at the parent level in euro, a sudden appreciation would reduce the value (expressed in euro) of foreign profits, even in the absence of structural effects on the local sales (or competitiveness) of the companies considered. Clearly, not all companies are large multinationals involved in these global production chains: SMEs might tend to sell through direct exports from their home country, rather than through production facilities located outside Europe. Moreover, not all European multinationals produce outside of Europe, although they might be sourcing inputs internationally. In all these cases, the potential effect of an appreciation of the single currency would be very heterogeneous across firms.

To this extent, a recent study by Amiti et al. (2012) shows that, in a very open economy like Belgium, a stronger exchange rate is indeed reflected in a proportional loss of competitiveness. But the same study also shows how large international companies are able to painlessly absorb almost 50 percent of the fluctuation in the exchange rate. This is because the largest exporters are also the largest importers: when hit by an exchange rate shock in their destination market, they can face a compensating movement in the marginal costs when importing their intermediate inputs.

Indeed, EFIGE data allows us to go further in assessing the relevance of an exchange rate movement for the external competitiveness of a country.

First, as shown in a recent Bruegel publication, which analyses the extent of firms’ participation in global value chains, large international companies in each country represent about 70-80 percent of the value of export. Thus, given the finding reported for Belgium, it is conceivable that a large part of the exports of a European country is actually partially isolated from the exchange rate effect.

Table 1.a

Firms that export and import at the same time

Country

Share of total exports

Share of total imports

Austria

80%

81%

France

95%

83%

Germany

51%

78%

Italy

90%

91%

Spain

79%

72%

Hungary (non euro-area)

81%

91%

UK (non euro-area)

94%

94%

Source: Bruegel on the basis of EFIGE data.
Note: Both the value of exports and imports are expressed in terms of firms’ turnover. Imports are imports of materials (intermediate goods).

In particular Table 1.a shows that firms that engage simultaneously in both export and import activities account for the majority of export turnover in each country as well as for the bulk of imports[1]. On top of this, these companies are also likely to be engaged in some kind of foreign production activity, such as FDI or outsourcing, thus adding a degree of complexity to the scenario of potential exchange rate effects.

Table 1.b

Firms that export, import and produce abroad at the same time

Country

Share of total exports

Share of total imports

Austria

64%

14%

France

48%

39%

Germany

23%

17%

Italy

33%

15%

Spain

15%

9%

Hungary

1%

2%

UK

10%

9%

Source: Bruegel on the basis of EFIGE data.
Note: Both the value of exports and imports are expressed in terms of firms’ turnover. Imports are imports of materials (intermediate goods).

In addition, firms that export, import and produce abroad (through FDI or outsourcing) at the same time, although few in numbers[2], still account for a considerable share of the total value of exports and imports. (Table 1.b)

The other finding that can be gathered from EFIGE data is that SMEs tend in a more than proportional way to export within the euro area, rather than outside it. This is a second reason for which a potential movement in the euro exchange rate might not play a large role on external competitiveness.

Table 2.a

Pure exporting firms by country and size

Size class

Austria

France

Germany

Italy

Spain

SMEs

74%

83%

64%

89%

87%

Large

26%

17%

36%

11%

13%

Total

100%

100%

100%

100%

100%

Source: Bruegel on the basis of EFIGE data. Note: SMEs: 10-49 employees. Large: 50 – >250 employees. Pure exporting firms are those firms that engage in export activities only (ie do not import or produce abroad). The value of exports is expressed in terms of firms’ turnover

SMEs account for the majority of purely exporting firms, i.e. those not engaging in other types of international activities (Table 2.a). At the same time, their share of total export value is lower than that of large firms, with some degree of heterogeneity across countries (Table 2.b).

Table 2.b

Export value (pure exporters only) by size and country

 

Austria

France

Germany

Italy

Spain

SMEs

3%

37%

16%

48%

20%

Large

97%

63%

84%

52%

80%

Source: Bruegel on the basis of EFIGE data.

Moreover, if we look at the main destination country of their export activities, we can underscore how both SMEs and large firms are euro-zone-oriented, as most of the firms claim the first destination of their export activities is a euro-zone country (Table 2.c).

Table 2.c

Share of firms among pure exporters with a euro zone country as a first destination[3] for exports: by country and size

Size class

Austria

France

Germany

Italy

Spain

SMEs

75%

55%

50%

57%

74%

Large

84%

52%

56%

69%

78%

Source: Bruegel on the basis of EFIGE data. Note: SMEs: 10-49 employees. Large: 50 – >250 employees. Pure exporting firms are those firms that engage in export activities only (ie do not import or produce abroad).

This basic evidence allows us to claim that, even though SMEs are less prone to engage in global value chains and complex strategies, and thus in principle are more exposed to the effects of exchange rate fluctuations, their relatively limited share of the total export volume in any given country, as well as the Euro-orientation of 50% or more of their exports, are all additional factors that tend to further dampen the effects of a “strong euro” on the export volume of a country.

To sum up, in today’s global world, the relationship between exchange rate and competitiveness is in principle rather complex. Moreover, the evidence now available thanks to detailed firm-level data on the international activities of European firms (EFIGE) allows to cast more than a reasonable doubt on the overall effect of an exchange appreciation on the volume of exports of a given country. Hence, a debate on how to improve efficiency, innovation and integration along global value chains of European firms would probably be more effective in driving competitiveness rather than a discussion on the levels of the exchange rate.

This article has been translated and integrated from the Italian version published on “Il Foglio” on 8th November 2013Excellent research assistance by Francesca Barbiero is gratefully acknowledged.

References

Barclays, Global Macro daily of 5th November 2013, Focus ‘Has the strong EUR hurt euro area corporate earnings?’ by G. Felices and A. Stewart.

Veugelers, R., Barbiero, F., Blanga-Gubbay, M. (2013), “Meeting the manufacturing firms involved in GVCs” in ‘Manufacturing Europe’s future’, Blueprint 21, Bruegel

Amiti, M., Itskhoki, O. and Konings, J. (2012) ‘Importers, exporters, and exchange rate disconnect’, Working Paper Research 238, National Bank of Belgium.

Altomonte, C., Aquilante, T. and Ottaviano, G. (2012) ‘The triggers of competitiveness: the EFIGE cross-country report’, Blueprint 17, Bruegel


[1] We impose a threshold to make sure that a firm is a “substantial” exporter (importer). For more details, see Veugelers et al. (2013).

[2] Firms simultaneously engaging in export, import and production abroad (FDI or outsourcing) represent 11% of the total number of substantial exporters in Austria, 14% in France, 11% in Germany, 8% in Italy, 5% in Spain, 3% in Hungary and 9% in UK.

[3] This represents the share of exporting firms answering to the question "What are the top three destinations of your export activities?" and indicating as the first destination a euro-zone country.


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