There has been a strong emphasis on export promotion for economic development in the policy-making community, especially in developing countries. While many observers view the economic success of the countries in East Asia, most notably People’s Republic of China, as convincing evidence that an economy with a strong export sector can achieve successful economic development, some extend the argument and focus on the merits of intervening the foreign exchange market to bring about competitive currency values as one of the important ingredients of export-led growth. In this context, the possible downside of export promotion leading to misallocations of resources and macroeconomic mismanagement is often neglected.
Although very few policy makers question the positive link between currency depreciation and (net) exports, the academic literature is more of a mixed bag; some studies find a statistically significant correlation while others find no significant relationship (such as Duttagupta and Spilimbergo, 2004).
The weak empirical evidence has been debated by economists and somewhat reconciled by adding two more variables in the discussion. The first is the impact of the fixed cost of entering a foreign market. Dixit (1989) argue that exchange rate uncertainty can affect the fixed cost of becoming an exporter; when the level of uncertainty is high, a firm can delay its decision of entry to or exit from an export market since it waits for a more favorable exchange rate to arise. Roberts et al. (1995) and Roberts and Tybout (1997) find sunk cost hysteresis in market entry and exit using Columbian manufacturers’ data. More recently, Bernard and Wagner (2001) or Bernard and Jensen (2004) find hysteresis in the export status of German and American firms, respectively.
These findings are interpreted as evidence for the fixed cost of entering the export market. Besides exchange rate uncertainty, the needs for additional market research, modifications in the production process for localized products, and any other regulatory and socio-cultural difficulties to enter a foreign market can make high fixed costs for export market entry are highly plausible. All these high fixed costs blur the link between fluctuations in currency value and the performance of exports, and can help explain the J-curve effect in the macroeconomic context.
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An Analysis of the Effects of Financial Market Imperfections on Indian Firms' Exporting Behavior
