Deriving competitive advantage from real exchange rate changes

Abstract

PurposeThis paper seeks to argue that any competitive advantage realized by a firm that produces domestically and exports to a foreign market due to a real depreciation (appreciation) of the domestic (foreign) currency is purely transitory and thus not sustainable. Diversification of manufacturing operations across a number of countries and appropriate production rescheduling in light of real exchange rate changes are required to transform the character of this competitive advantage from merely transitory to sustainable.Design/methodology/approachAnalytic proof is provided of the dependence of an exporting firm's real profit margin on the real exchange rate. A simple contemporaneous and one‐period lagged model of the current account balance is then posited to argue that real exchange rates exhibit mean‐reversionary behavior.FindingsThe Marshall‐Lerner condition, which is a mainstay of balance‐of‐payments models is shown to imply that real exchange rates exhibit mean‐reversionary behavior. Extensive empirical evidence is cited that accords with this theoretical conclusion. Thus, any gain in competitive advantage due to a change in real exchange rates that accrues to a firm with a single manufacturing operation is merely transitory and not sustainable.Practical implicationsTo position itself to achieve sustainable competitive advantage from changes in real exchange rates, a firm must maintain a global supply chain diversified across many countries. With the flexibility provided by such disparate plant locations, production schedules can be adjusted in response to real exchange rate changes, to wit, increased (reduced) manufacturing should be programmed in countries whose currencies have experienced real depreciations (appreciations). Owing to oscillating real exchange rates, these requisite production schedule adjustments are expected to be perpetual.Originality/valueThe algebraic formulation of the firm's inflation‐adjusted profit margin's dependency on the real exchange rate and the analytical proof that the Marshall‐Lerner condition implies mean‐reversionary behavior in real exchange rates are both novel. The implications with regard to competitive advantage are likewise original.