The fallacy of composition and contractionary devaluations: output effects of real exchange rate shocks in semi-industrialised countries

Abstract

This paper studies whether intra-developing country price competition has significant effects on the short-run growth of output in developing countries that are specialised in manufactured exports. Regression estimates using the generalised method of moments applied to annual panel data for 17 semi-industrialised countries in 1983-2004 show that these countries exhibit a ‘fallacy of composition’, in the sense that a real depreciation relative to competing developing country exporters increases the home country's growth rate at the expense of its competitors' growth. The results also suggest that real depreciations for these developing countries relative to the industrialised countries are contractionary.