Export Hysteresis, Capacity Constraints, and Uncertainty: A Smooth Transition Analysis for Euro Area Member Countries

Abstract

We argue that, under certain conditions described by a sunk cost hysteresis model, firms consider exports as a substitute for domestic demand. This is valid also on the macroeconomic level where the switch from the domestic market to the export market and vice versa takes place in a smooth manner. Areas of weak reaction of exports to changes in domestic demand are widened by uncertainty. Our econometric model for six euro area countries suggests domestic demand and capacity constraints as additional variables for export equations. We apply the exponential and logistic variant of a smooth transition regression model and find that domestic demand developments and uncertainty are relevant for short-run export dynamics particularly during more extreme stages of the business cycle. A substitutive relationship between domestic and foreign sales can most clearly be found for France, Greece, and Ireland (exponential smooth transition regression (ESTR) model) and France, Portugal, and Italy (logistic smooth transition regression (LSTR) model), providing evidence of the importance of sunk costs and hysteresis in international trade between the member states of the Economic and Monetary Union (EMU). What is more, our empirical results are robust to the inclusion of a variable measuring European policy uncertainty. In some cases (Italy, Greece, and Portugal) the results underscore the empirical validity of the export hysteresis under uncertainty model.