The Efficiency of the Global Markets for Final Goods and Productive Capabilities

Slow mean reversion of real exchange rates is commonly considered a result of border frictions that remain despite integration of financial and goods markets. This paper shows that even if border frictions decline, a contemporaneous decline in output shock variance can in fact slow down mean reversion. It proposes a new method of estimating border cost from time-series data only, without relying on within-country variation. Applying this method to the real exchange rate of final goods and a novel measure of the real exchange rate for productive capabilities, such as technology and know-how, gives very differential border cost estimates. During the years 1974–2008, a relocation reduces productive capability by 22% for the average country pair, whereas final goods by only 15%. The real exchange rate for final goods takes more than two years to revert to purchasing power parity, more than twice as long as productive capabilities.