Currency Devaluation and Global Outsourcing

This paper models the production allocation choices of a multinational enterprise (MNE) in a three-country framework -- a northern country and two southern countries. The products made in the southern countries are of lower quality, and have higher substitutability than those between the south and the north. We investigate how exchange rate changes affect production, employment, profits and welfare, and find that currency devaluation from different countries gives a rise to contrasting and unconventional results. In particular, a currency appreciation in the southern country (X) producing the lowest-quality good with the lowest wage may reduce production (employment) in the north, while an appreciation in the other southern currency (Y) always raises production in the north. A northern depreciation against both southern currencies may increase production in country X, but always reduces that in country Y. These arise because the MNE shifts production to minimize costs. Under such global outsourcing, northern welfare always falls following currency appreciation in southern countries.