Exchange Rate Appreciation and Manufacturing Investment
An interesting article just published by my friend Robert Blecker (American University) reinforces our concerns regarding the long-run impact of the loonie’s recent appreciation on the size and competitiveness of Canada’s manufacturing industry.
Here’s the formal citation & abstract:
The Economic Consequences of Dollar Appreciation for US Manufacturing Investment: A Time-Series Analysis
Author: Robert A. Blecker a
|Affiliation:||a American University, Washington, DC, USA|
This article analyses the effects of the real value of the dollar on investment in US domestic manufacturing using aggregate data for 1973-2004. Econometric estimation shows a negative effect that is much larger than has been found in any previous study. The exchange rate affects investment mainly, although not exclusively, through the channel of financial or liquidity constraints, rather than by affecting the desired stock of capital. Counterfactual simulations show that US manufacturing investment would have been 61% higher and the capital stock would have been 17% higher in 2004 if the dollar had not appreciated after 1995.
Blecker extends previous research on business investment by including BOTH current cash flow (proxying the liquidity constraint faced by investing firms, in the Fazzari tradition) AND the exchange rate itself (via its influence on expected future profitability, trading off reduced cost competitiveness at home and abroad, against reductions in the cost of imported inputs). He finds a very strong negative correlation between real appreciation and manufacturing investment, due mostly to the liquidity channel.
The U.S. dollar appreciated against its trading-partner currencies by about 25% between 1995 and 2002 (measured on a trade-weighted basis). Blecker’s coefficients suggest this reduced the flow of manufacturing investment by over 35%, and the end-point (in 2004) manufacturing capital stock by 15%.
In contrast, our currency (again, on a trade-weighted basis) has appreciated ove 40% in real terms since 2002. That would imply a decline (versus the counterfactual base case) in manufacturing investment of closer to 50%. We haven’t (thankfully) seen anything like that yet. But Blecker’s evidence suggests clearly that Canada’s manufacturing sector will pay a very large, very long-lasting price for this epidose of appreciation.