On the Channels of Foreign Direct Investment to Exchange Rate Pass-Through Strategies: An Analysis from Spatial Panel Data

Piriya Pholphirul

doi:10.5539/ibr.v2n4p140

Abstract

Exchange Rate Pass-Through and Pricing-to-Market behavior is an important consideration in International Economics and Industrial Organization Theory. The goal of this paper is to provide both theoretically and empirically justified definition of Foreign Direct Investment (FDI) effect on extent of exchange rate pass-through. In the theoretical part, the Cournot fashion of international duopoly market is constructed to explain reaction functions between a local firm in a host country and a foreign multinational. Preliminary results of theoretical framework indicate that FDI will have an affect on the lowering degree of exchange rate pass-through and generates higher degree of Pricing-to-Market behavior. We estimate the model of exporters with multi-destination by observing samples of five U.S. exporting industries based on 4-digit SIC index. We approach the ideas of spatial econometrics with belief that disturbance terms are possible to spatially correlate across countries, based on geographic proximity measurement. The estimated results show that all types of foreign direct investments have an affect on the lowering degree of pass-through while Joint Venture generates the most significant prediction and Division generates the least. The effect of having the first foreign operation in local markets is not significant to the degree of pass-through.

Highlights

Following the collapse of the Bretton Woods exchange rate system in the 1973, there has been a considerable increase in empirical researches on the relationship between exchange rates and goods prices
Two of the most striking studies are “Exchange Rate Pass-Through” which refers to the response of import prices to exchange rates and “Pricing-to-Market” which refers to price discrimination across export markets induced by the exchange rate volatility
Because the nonzero markup is a deviation against the perfect competition condition, incomplete exchange rate pass-through validates the shift towards models of imperfect competition

Summary

Introduction

Following the collapse of the Bretton Woods exchange rate system in the 1973, there has been a considerable increase in empirical researches on the relationship between exchange rates and goods prices. In regards to the U.S data from the Bureau of Economic Analysis (BEA) in 1998, 68% of U.S international trades are made within and by the multinational firms and their affiliates, which provides the evidence that foreign direct investment and degree of multinationals should have an effect on export firms’ pricing strategies These motivations build up the ideas to extend more on the scope of allowing capital to become mobile across countries in real sector and how that would affect on firms’ Pricing-to-Market behavior and degree of exchange rate pass-through. Another recent research paper from Yoshida (2001) estimates that firms set their own distribution agent affect on reducing pass-through effect of yen on Japanese export prices The results from these three articles seem to support my future research that outward foreign direct investment and capital outflow are likely to decrease the degree of exchange rate pass-through, which increases the degree of markup in local-currency pricing strategies that multinational firms should have.

The Empirical Specification

Results

Policy Debates