What Are the Effects of Capital Flow Shocks on the Domestic Manufacturing Sector?

Abstract

What are the effects of capital flow shocks on the domestic manufacturing sector? We find that the share of the manufacturing sector output and investment increase in response to positive shocks to the capital flows surge episode. However, the share of the manufacturing sector employment declines and the Gini coefficient increases. Furthermore, a comparison of the sectoral output share responses shows although the share of the manufacturing sector output increases more compared to that of the construction, the wholesale and retail trade, catering and accommodation sectors. Its employment share declines while the share of these two sectors increases. The contrasting sector effects may be because the output growth in the construction, wholesale and retail trade, catering and accommodation sectors tends to be employment intensive. In addition, the manufacturing sector is highly sensitive to exchange rate movements and declines following the exchange rate appreciation shock. This reflects the dominating impact between the expenditure switching effects and the production costs hypothesis. Whereas, the construction sector tends to benefit more from capital flow surges episodes and asset price booms. The policy implications of these results are that a thorough understanding of the channels of transmission of capital flows surge on the different sectors of the economy is important. This will help policy makers to design appropriate policy responses to assist in the sector adjustment to various trade shocks.