Devaluation, Profitability and Investment

Are the traditional trade-exchange rate theorems relevant for developing countries facing entry costs in international markets?

“…The paper shows how a temporary exchange rate shock can yield long run e¤ects even without relying on short run disequilibriums, as in Risager (1988) and Bo-Nielsen (1991). Lin and Tseng allows for a situation with monopolistic competition and increasing returns to scale, where …rms have to incur a …xed entry cost in order to export, that is a sunk cost framework.…”

“…Without focusing explicitly on savings, Risager (1988) considers the effects of a devaluation on investments, and shows how the short run trade balance e¤ect is uncertain, while the trade balance is una¤ected in the long run. The short run trade balance e¤ect is also analyzed by Bo Nielsen (1991), who analyses the e¤ect of a devaluation on investments when wages are sticky.…”

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“…Nevertheless, the current account could deteriorate if investment increases substantially (due to lower real interest rates) (Betts and Devereux 2000). Nielson (1991) and Risager (1988) stated that the devaluation of the exchange rates could worsen the trade balance if the devaluation substantially increase consumption and investment.…”

Devaluations and Consumption Smoothing

“…One such explanation focuses on booms in investment following a devaluation. Risager (1988) and Nielsen (1991) suggest that if a devaluation generates rational expectations of enhanced profitability in future periods, it can stimulate investment expenditure to the point it offsets a current account surplus. However, such an investment boom seems unlikely to be part of the initial impact of a devaluation, if the investment process involves lags or "time to build" and the real effects of a devaluation are short-lived.…”