Empirical tests of the Marshall‐Lerner condition: a literature review

Purpose - The Marshall‐Lerner (M‐L) condition, which stipulates that a devaluation or depreciation of its currency will improve a country's trade balance only if the sum of the absolute values of a country's import and export price elasticities are greater than one, is a fundamental tenet of international economics. The purpose of this study is to survey the literature that has tested the M‐L condition, examining in particular whether previous studies' results are statistically significant. The authors then conduct their own estimation of 29 countries' trade elasticities, over the past few decades. Design/methodology/approach - While mostly a review paper, the paper also applies statistical techniques in two ways. First, the authors uset‐tests on previously‐published statistical results to see if the sums of their elasticities are significantly greater than one. The authors also apply the recently developed ARDL cointegration method, which has a number of attractive statistical properties, to estimate 29 countries' long‐run import and export elasticities and test the M‐L condition using recent data. Findings - The authors re‐estimation using previous studies' coefficients and standard errors shows that, although the point estimates in many studies suggest that the M‐L condition is met, it really is not met in half of the cases. This lack of evidence is confirmed with the authors' own empirical tests. Research limitations/implications - Not only does this paper collect the relevant literature in a way that will assist future researchers on the topic, these findings suggest that support for the M‐L condition is much weaker that commonly thought. This therefore makes an important contribution to thinking regarding the potential benefits of devaluation, and to economic theory in general. Practical implications - Policymakers who hope to improve their countries' competitive position could benefit from learning that this policy is indeed less effective than might be supposed. This could lead to the implementation of more effective economic policies. Originality/value - As a literature review, the originality of this paper is that it collects relevant studies into one single paper. The statistical analyses allow the reader to re‐interpret these studies' findings in a new light.