Exchange Rate Sensitivity of U.S. Trade Flows: Evidence from Industry Data

Abstract

1. IntroductionIn an effort to boost employment, a country could stimulate its exports and discourage its imports and thereby improve its trade balance. One policy that has received a great deal of attention in the literature is currency devaluation. By making exports cheaper and imports expensive, devaluation is said to improve the trade balance. The only condition required is that the sum of import and export demand price elasticities exceed unity (that condition, known as the Marshall-Lerner condition, is derived under the assumption of perfectly elastic supply of trade). Most previous studies that attempted to assess the Marshall-Lerner condition relied on price elasticities that were obtained by estimating aggregate import and export demand functions. These studies provided mixed conclusions as far as the effectiveness of devaluation or depreciation is concerned. Examples include Houthakker and Magee (1969), Khan (1974), Goldstein and Khan (1976, 1978), Wilson and Takacs (1979), Haynes and Stone (1983a, 1983b), Warner and Krienin (1983), Bahmani-Oskooee (1986, 1998), and Bahmani-Oskooee and Niroomand (1998). The mixed conclusion could be related to aggregation bias. When aggregate trade data are employed in import and export demand functions, significant price elasticity with one trading partner could be more than offset by an insignificant price elasticity with another trading partner, yielding an insignificant price elasticity.Because of aggregation bias, another body of the literature has emerged in recent years that concentrates on using trade data at the bilateral level. Examples in this latter group include Rose and Yellen (1989), Cushman (1987, 1990), Summary (1989), Marquez (1990), Haynes, Hutchison, and Mikesell (1986), Eaton (1994), Bahmani-Oskooee and Brooks (1999), Nadenichek (2000), and Bahmani-Oskooee and Goswami (2004). Except Bahmani-Oskooee and Goswami (2004), all other studies in this second group have estimated bilateral trade elasticities between the United States and her major trading partners and concluded that the real bilateral exchange rate is a significant determinant of bilateral trade balance, at least in some cases. Bahmani-Oskooee and Goswami (2004), who considered the bilateral trade flows between Japan and her nine major trading partners, found that in most cases Japanese exports are not sensitive to the real bilateral exchange rate, but her imports are. These studies as well as those in the first group estimate price elasticities in demand under the assumption that supply is perfectly elastic and then evaluate the Marshall-Lerner condition involving own-price coefficients in demand. Thus, evidence in these studies is limited because it assumes perfectly elastic supply of trade for both exports and imports.Although there is additional room to expand the literature in the second group by considering the experiences of countries other than the United States and Japan, in this paper we would like to open another avenue of research by investigating the impact of real depreciation of the dollar on imports and exports of 66 American industries, a disaggregation by industry rather than by country. Disaggregation by industry will avoid problems associated with petroleum imports, as does disaggregation by country (Rose and Yellen 1989).1 For this purpose, in Section 2 we outline the import and export demand functions for each commodity group along with the estimation method. In Section 3, we present the empirical results. Section 4 provides our summary and conclusion. Data definitions and sources are cited in an appendix.2. The Models and the MethodIn formulating any import and export demand function, it is a common practice to relate the volume of imports and exports to a measure of income and relative prices. The main purpose is to obtain estimates of import and export demand elasticities so that we can better judge the effectiveness of currency devaluation in increasing a country's inpayments and reducing outpayments. …