Exchange rate misalignment and total factor productivity growth in case of emerging market economies

Abstract

This paper examines the impact of exchange rate misalignment on total factor productivity growth in case of 15 emerging market economies using the annual data from 1990 to 2014. First, this study through panel cointegration test found a long-run cointegrating relationship between RER misalignment and TFP growth. Second, the DOLS results indicated that RER misalignment has negatively affected the TFP growth in the majority of the countries within the EMEs and the group as a whole too. Third, we found bi-directional panel long-run and short-run Granger causality between real exchange rate misalignment and total factor productivity growth. Finally, in order to check the robustness, the dynamic panel data results showed that RER misalignment has negatively affected the TFP growth, which is consistent with our results derived from the DOLS. Further, when we decomposed the series into pre and post global financial crisis periods, this study found that real exchange rate misalignment did not affect the TFP growth in the pre-global financial crisis, but it has significantly adverse impact on TFP growth after the global financial crisis periods.

Appendix

1.1 Measuring capital stock

The physical capital stock data are not readily available in case of emerging countries. Thus, following Easterly and Levine (2003), we use a Perpetual Inventory Method (PIM) to compute capital stocks. Specifically, let K(t) is the real capital stock in period t. Let I(t) equal the real investment rate in period t. The real investment is defined as gross fixed capital formation at constant 2005 US$. Let d equal the depreciation rate, which we assume equals 0.07. Thus, the capital accumulation equations state as:

K(t) = (1-d) K(t-1) + I(t). To make an initial estimate of the capital stock, we make the assumption that the country is at its steady-state capital-output ratio. Thus, in terms of steady-state value, let k = K/Y, let g = the growth rate of real GDP, Y is the real GDP and let i = I/Y. Then, from the capital accumulation equation plus the assumption that the country is at its steady-state, we know that k = i/[g + d]. Thus, if we can obtain a reasonable estimate of the steady-state values of i, g and d, then we can compute a reasonable estimate of k. Then, using the calculated value of k, an initial estimate of capital stock (k) multiplied with initial GDP(Y) can be obtained. In order to work out the initial estimate of k, we assume the steady state capital output ratio (d) = 0.07. We construct the steady-state growth rate (g): a weighted averaged of the countries average growth rate during the first ten years of which we have output and investment data and the world growth rate. The world growth rate is computed as 0.0234. Based on Easterly et al. (1993), we give a weight of 0.75 to the world growth rate and 0.25 to the country growth rate in computing an estimate of the steady-state growth rate for each individual country. We then compute i as the average investment rate during the first ten years for which there are data. Thus, with values for d, g, and i for each country, we estimate k for each country. To reduce the influence of business cycles on estimates of Y, we use the average real GDP value between 1989 and 1991 as an estimate of initial output. Thus, the capital stock, for example, in 1990 is given as Y*k.