When Do Devaluations Pay?

Résumé

This paper turns to intermediate import dependence and proposes a relatively simple and tractable framework to examine how real devaluations affect firms' export decisions, their export performance, as well as aggregate trade flows. The model accommodates some well documented facts on the characteristics of exporters while taking into account trade in intermediate inputs, which is a salient part of global trade flows and more specifically the dependence on foreign intermediates which is an important feature of the verticalization of the production process at a global scale. The theoretical framework extends the seminal paper of Melitz (2003) by introducing trade in intermediate inputs and waiving the symmetry assumption, allowing countries to be different along several relevant dimensions. The main prediction of the model is that in the presence of trade in intermediate inputs, a country's relative dependence on imports of intermediates and the relative use of domestic versus foreign intermediates in the final production process (with respect to its trade partners) arise as key determinants of the firms' export status and export performance. In this context, exchange rate movements, or in general movements of relative prices, may yield results that come at odds with the predictions of traditional theories. The model provides conditions for which devaluations in fact deteriorate the devaluing country's relative cost-competitiveness, leading to a loss of export revenue and a negative adjustment along the extensive margin of trade.