Real Effective Exchange Rate and Export Sophistication: A Dynamic Panel Data Analysis

Abstract

In recent years, a new strand of the literature argued that not the quantity, but the quality of exports is at the core of economic growth and development. Therefore, strategies aiming to improve the quality of exports should be a major concern for policy makers. One of the most important policy tools that could affect exports and their quality is the real effective exchange rate. However, connections between the quality of exports and real effective exchange rate have not been fully explored. Based on a panel data of 57 countries for the years between 2005 and 2015, this paper investigates the relationship between export sophistication and real effective exchange rate. Using a novel database of export sophistication, taking into account two different real effective exchange rate indices and utilizing a dynamic panel data methodology, namely system GMM, this paper shows that an appreciation in real effective exchange rate improves the sophistication of exports. In addition, empirical results also show that the initial income of countries, foreign direct investment, human capital, and domestic savings positively affect export sophistication, whereas population growth decreases the sophistication of exports.