The Real Exchange Rate, Innovation and Productivity: A Cross-country Firm-level Analysis

We use firm-level data for a large set of countries for the period 2001-2010 to evaluate manufacturing firms’ responses to changes in the real exchange rate (RER). We find that, in East Asian emerging countries, real depreciations are associated with faster firm-level TFP and sales growth; higher probabilities to engage in R&D; higher probabilities to export and higher export intensity; lower probabilities to import intermediate inputs; lower import intensity; and higher growth of cash flow. We find no or less significant effects for firms from OECD and other developing countries, which are less export intensive, more import intensive, and face less credit constraints. To rationalize these findings, we structurally estimate a dynamic firm-level model of exporting, importing and R&D investment in a setup where some firms may be financially constrained in terms of financing R&D fixed costs. Real depreciations raise firm-level demand, thus increasing the profitability to engage in exports and R&D for all firms, but reduce it by increasing the cost of importing intermediates. Moreover, by increasing firms’ cash flow, depreciations also relax firms’ borrowing constraints, thus enabling more firms to overcome the fixed-cost hurdle for financing R&D. We decompose the effects of RER changes on productivity growth into these different channels and explain cross-country heterogeneity in the effects of RER depreciations in terms of differences in export intensity, import intensity and financial constraints.