Real Exchange Rate Policy and Non-Traditional Exports in Developing Countries

In this paper I estimate a non-traditional export performance equation for a panel of 60 developing countries. As an input to the export model, I also estimate a panel regression model of the real exchange rate (RER) for the same countries. The RER estimation allows derivation of indexes of equilibrium RER (ERER) and RER misalignment (RERMIS), which were subsequently used in the export equation, as proxies for the profitability of the export sector. As determinants of export performance, the RER effects are accounted for by two channels: RER misalignment and RER variability. In addition to the RER-based variables, the export model also accounts for other non- incentive factors, such as human capital, imports of machinery (a proxy for investment in capital goods) and external demand. While the first two were found to be robustly associated with non-traditional exports, the latter was not. Moreover, the estimated effects of regional dummies suggest that, ceteris paribus, the ratios of non-traditional exports will tend to be higher in both of East Asia and Latin America compared to Sub-Saharan Africa. To the extent that these dummies reflect other supply constraints not explicitly accounted for by the model (such as market imperfection, technological capabilities, etc.), appropriate state interventions may be necessary for supporting sustained and diversified export expansion. Finally, our results also suggest that Dani Rodrik's interpretation of the phenomenal export expansions in Korea and Taiwan were only partially supported by the wider experiences of developing countries. Rodrik argues that the key factor behind the success of the export-oriented strategies of these two countries was a sustained rise in private returns to capital, and not increased export profitability; the former was engineered by the two governments through a range of strategic interventions to build capabilities and to resolve market failures in modern sector production. Our results corroborate the view that imports of (or investment in) capital goods, basic capabilities, and maybe some strategic interventions to resolve market failures, are important for successful export-orientation; but they also suggest that export promotion and export diversification require a supportive structure of incentives, especially appropriate and stable real exchange rates.