Are Service Firms Affected by Exchange Rate Movements?

Abstract

There is a growing literature addressing the effects of exchange rate movements on manufacturing firms, but little similar analysis concerning firms in the service sector. As the service sector is the largest component of the Canadian economy and services are becoming increasingly tradable, the implication of international economy on service sector firms is an important, yet rarely explored, research question. This paper addresses the question by analyzing the effects of industry specific real exchange rate movements on the profitability, survival and sales of Canadian service sector firms. Using rich firm-level data that covers the universe of incorporated firms in Canada and service trade data, our empirical results show that real appreciations of the Canadian dollar reduce firm probability of survival, sales and profitability while depreciations have the opposite effect (a separate abstract on firm-level data is attached). In addition, the negative effect of real currency appreciations on firm survival is less pronounced for more productive firms. Our findings suggest a significant exchange rate effect on service firms similar to that found for manufacturing firms in earlier studies by Baggs and Brander (2006) and Baggs, Beaulieu and Fung (2009). When comparing the economic magnitude of the exchange rate effects on service sector firms to the effects on manufacturing firms, we find that, when facing an identical movement of the value of the Canadian dollar from the highest to the lowest level, service sector firms experience smaller increase in profit and sales but larger increase in probability of survival as compared to manufacturing firms. Acknowledgements: We are extremely

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