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The real exchange rate and export growth: Are services different?

Increasingly, services form a larger and larger share a country’s exports. Do exchange rates matter as much for services and they do for goods exports? This column argues that they do. Distinguishing between traditional services (such as trade and transport, tourism, financial services and insurance) and modern services (such as communications, computers, information services) suggests that the effect of the real exchange rate is especially large for exports of modern services.

The role of exports in economic growth and, in turn, of the real exchange rate in export promotion features prominently in literature on development and globalisation (Rodrik 2009, Haddad and Pancaro 2010). Much of this literature dates, however, from an era when ‘exports’ meant ‘exports of merchandise‘. Today, ‘exports’ increasingly means ‘exports of services’. This raises the question of whether the emphasis in the earlier literature on the importance of a competitively valued exchange rate for promoting exports carries over to this new environment.

In recent research, we find it does (Eichengreen and Gupta 2012). When we distinguish traditional services (trade and transport, tourism, financial services and insurance) from modern services (communications, computer, information and other related services), the effect of the real exchange rate is especially large for exports of modern services. We find that the effect of real exchange rate changes on exports of modern services is 30 to 50% larger than that on merchandise and traditional services.

The real exchange rate and service exports

We analyse the determinants of the growth of exports of merchandise and services using data for 66 countries for which significant runs of data on exports of services are available in 1980-2009. Of these 66 countries, nine are low-income countries, 15 are low middle-income, 20 are high middle-income and 22 are high-income. The independent variables include the log per capita income (over the previous five-year period), country and time-fixed effects and the real exchange rate, where we consider four different measures of the real exchange1.

Our empirical results confirm the importance of the real exchange rate for export growth. In addition, we find that the effect of the real exchange rate is even stronger for exports of services than exports of merchandise. Indeed, it is largest for modern services (see Eichengreen and Gupta 2012).

Why does the real exchange rate impact exports of services so powerfully? It could be that services, and especially modern services, use fewer imports. It could be that these sectors have lower fixed costs of entry, making for a more elastic supply response. It could be that demand for these exports is more price elastic. Or it could be a combination of all of the above.

We obtain similar results with alternative measures of the real exchange rate. The effect of the real exchange rate on the growth of exports is broadly similar for developing and for developed countries.

Export surges

We also focus on periods when the growth of exports accelerated significantly ('export surges'). As Freund and Pierola (2012) have shown, surges provide additional identification. They are instances when export performance and their determinants are changing radically. They are when countries are overcoming obstacles that previously hindered export growth.

We identify surges using the Bai-Perron structural break technique. We define a surge when a pair of breaks points first to a significant acceleration and then to a significant deceleration of exports. In addition, we require the export growth rate to be at least 2% a year for three consecutive years. So defined, the surge lasts until the growth rate falls below 2% or until another structural break is identified.

We identified 81 episodes of surges in the exports of merchandise, 100 episodes of surges of traditional services and 80 episodes of surges in exports of modern services2. Typically, surges last four to five years.

We see in Figure 1 that surges in exports of services, both modern and traditional, tend to be preceded by real exchange rate depreciations, especially in developing countries.

Figure 1. RER and export surges in traditional and modern services

Note: 0 refers to first three years of the surges, positive values to years after the surge; and negative values to years before the surges.

Using an approach similar to Hausmann, Pritchett, and Rodrik (2005) we estimate regressions of the determinants of the timing of a surge in the exports of merchandise, traditional and modern services, focusing again on the real exchange rate. Consistent with our earlier analysis, we find real exchange rate depreciation has a positive and significant effect on the probability of a surge of both merchandise and services. Including other controls does not make much of a difference to the results.

Results also show that the volatility of the real exchange rate has a negative effect on the probability of an export surge. We also estimate Tobit regressions which make fuller use of the data, in the sense of distinguishing larger and smaller surges. We find a larger impact of the real exchange rate on exports of modern services than on traditional services and on traditional services than on merchandise (the coefficient of real exchange rate is about 50% larger for modern services).

Lessons for developing countries

Our results suggest that as developing countries shift from exporting primarily commodities and merchandise to exporting traditional and modern services, appropriate policies toward the real exchange rate become even more important.

This said, relying on an undervalued exchange rate to encourage the growth of exports of services, as of merchandise, has its limitations. 

  • Eichengreen (2008) and Haddad and Pancaro (2010) caution that depreciation/undervaluation can be deployed as a policy tool to spur growth only in the short term, because a country cannot maintain a depreciated real exchange rate indefinitely.
  • Potential costs include tensions with other countries, accumulation of foreign-exchange reserves on which capital losses may occur, and the fact that adjustment, when it occurs, may come in the form of inflation.

For a competitive real exchange rate to succeed in boosting exports it will have to be accompanied by strong institutions, sound macroeconomic policies, a disciplined labour force, high savings rates or other policies conducive to attracting foreign capital. Finally, for benefits to exceed costs, countries using real exchange rate depreciation to jumpstart exports and growth should have an exit strategy in mind and, ideally, in place.


Bai, Jushan and Pierre Perron (2003), “Computation and Analysis of Multiple Structural Change Models,” Journal of Applied Econometrics 18, 1–22.

Eichengreen, Barry (2008), “The Real Exchange Rate and Economic Growth,” Working Paper 4, World Bank PREM Network, Commission on Growth and Development.

Eichengreen, Barry and Poonam Gupta (2012), The Real Exchange Rate and Export Growth: Are Services Different? NIPFP Working Paper 112.

Freund, Caroline and Martha Denisse Pierola (2012), "Export Surges," Journal of Development Economics 97, 387-395.

Haddad, Mona and Cosimo Pancaro (2010), “Can Real Exchange Rate Undervaluation Boost Exports and Growth in Developing Countries? Yes, But Not for Long,” Economic Premise 20, World Bank PREM Network, June.

Hausmann, Ricardo, Lant Pritchett, and Dani Rodrik (2005), “Growth Accelerations,” Journal of Economic Growth 10, 303-329.

Rodrik, Dani (2009), “The Real Exchange Rate and Economic Growth,” Brookings Papers on Economic Activity 1, 365-412.

Servén, Luis (2003), “Real Exchange Rate Uncertainty and Private Investment in LDCs,” Review of Economics and Statistics 85, 492-492.

1 The first is the real exchange rate in purchasing-power-parity terms, from Penn World Tables, calculated in bilateral terms vis-a-vis the US. Second is exchange rate misalignment adjusted for the Balasa-Samuelson effect (as in Rodrik 2009). Third, we construct the bilateral real exchange rate vis-a-vis the US using data from the IMF’s International Financial Statistics (IFS) on nominal exchange rates vis-a-vis the US dollar and the consumer price index for the US and other countries. Finally, we obtain an estimate of the real effective exchange rate from IFS and the World Development Indicators of the World Bank. This measure has the advantage of being multilateral rather than bilateral, but its country coverage is more limited.

2 The average growth rate of merchandise exports is about 15% per annum during surges. In the year before the surge it is 0.4%, and it turns negative after the surge. The pattern of growth of exports of traditional services during surge episodes is quite similar to that of merchandise exports. Surges in exports of modern services are most pronounced, with the exports of modern services growing at roughly 25% per annum during the surge period. In the years before the surge, in contrast, the growth of modern service exports is less than 3 percent, and it turns negative after the surge.

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