Real Exchange Rates and Competitiveness: The Political Economy of Skill Formation, Wage Compression, and Electoral Systems

Abstract

A major puzzle in the open economy literature is why some countries have persistently higher real exchange rates than others. Even more puzzling is the fact that countries with high real exchange rates are strong export performers. We solve both puzzles with a model that integrates two central debates in the comparative political economy of advanced economies: one linking wage bargaining, incomes policy, and competitiveness, and the other linking partisanship, political institutions, and redistribution. We bring the two together by emphasizing the role of skill formation. We argue that union centralization is necessary for wage restraint and training on a large scale, but this in turn requires a political coalition that subsidizes such training. When both are present, wage restraint generates external competitiveness, whereas wage compression pushes up sheltered prices and hence the real exchange rate, and vice versa. We test the argument on data on export performance and real exchange rates.