Exchange rate effects on the relationship between fdi and trade in the u.s. food processing

Agricultural & Applied Economics Association

Exchange Rate Effects on the Relationship between FDI and Trade in the U.S. Food Processing
Industry
Author(s): Munisamy Gopinath, Daniel Pick and Utpal Vasavada
Reviewed work(s):
Source: American Journal of Agricultural Economics, Vol. 80, No. 5, Proceedings Issue (Dec.,
1998), pp. 1073-1079
Published by: Oxford University Press on behalf of the Agricultural & Applied Economics Association
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EXCHANGE RATE EFFECTS ON THE RELATIONSHIP
BETWEEN
FDI AND TRADE IN THE U.S. FOOD
PROCESSINGINDUSTRY

MUNISAMY GOPINATH, DANIEL PICK, AND UTPAL VASAVADA

The effect of exchange rates on international vens), a majority of studies support the neg-
trade and, more specifically, on agricultural ative relationship between the dollar value and
trade flows has been documented by several FDI inflows into the United States (Caves,
studies.' Most studies agree that an appreci- Cushman 1985).
ation (depreciation) in the value of the U.S. The juxtaposition of these two strands of
dollar hurts (helps) U.S. agricultural exports. literature suggests that as the value of the dol-
An appreciation of the U.S. dollar raises the lar declines, exports increase and FDI out-
cost of U.S. products to foreign buyers and flows decrease. Effectively, FDI and trade
reduces their purchases.2 Although neglected may be substitutes and exchange rate move-
early on, the effect of exchange rate risk as ments can cause this substitution.4 In this ar-
measured by its volatility on trade flows was ticle, the exchange-rate-induced substitution
also found to be negative (Arize, Pick). hypothesis is tested for the U.S. food pro-
Parallel to this literature were the devel- cessing industry, which presents an interest-
opment and testing of theories on the rela- ing case study. The composition of global ag-
tionship between exchange rates and foreign ricultural trade has shifted toward high-value
direct investment (FDI). Using an imperfect- processed food products, which account for
capital-market approach, Froot and Stein two-thirds of the $381 billion global trade in
demonstrated that exchange rate movements agricultural products and commodities (Hen-
affect the relative-wealth positions of coun- derson and Handy). The U.S. share in global
tries and thus have a systematic effect on agricultural trade has fallen from 22% to less
FDI.3 To the extent that foreigners own their than 15%, and processed foods account for
wealth in non-dollar-denominated forms, a less than 40% of total U.S. agricultural ex-
depreciation of the dollar increases the wealth ports for the period 1962-94 (Gehlhar and
position of foreigners relative to domestic Vollrath). However, the United States ac-
agents. This lowers foreigners' relative cost counted for six out of ten of the world's largest
of capital and allows them to bid more ag- food-processing (multinational) firms. In ad-
gressively for domestic assets (Froot and dition, sales by U.S.-owned food-processing
Stein, p. 1194). While the empirical results of foreign affiliates are estimated to have reached
Froot and Stein have been questioned (Ste- $103 billion in 1994 (Neff et al.). Declining
export shares and the increasing role of U.S.-
Munisamy Gopinath is an assistant professor in the Departmentof owned multinational corporations (MNCs)
Agricultural and Resource Economics, Oregon State University. suggest some degree of substitution in the
Daniel Pick is an economist in the Markets and Trade Economics
Division, Economic Research Service, U.S. Departmentof Agricul-
food processing industry. This has been tested
ture. Utpal Vasavada is an economist in the Resource Economics at the aggregate level and at the firm level.
Division, Economic Research Service, U.S. Departmentof Agricul- For instance, Gopinath, Pick, and Vasavada
ture.
Thanks to Andy Jerardo, Mark Gehlhar, and Alisa Livensperger
found that exports and foreign sales by U.S.-
for their help in compiling the data. The authors benefited from based multinational firms are substitutes.
helpful comments by John Beghin, Bruce Blonigen, and Tom Worth. The purpose of this study is to test for the
1'Some studies focused on nominal exchange rate effects (e.g.,
Chambersand Just), while others looked at real exchange rateeffects effects of the real exchange rate and its vol-
(e.g., Cushman 1983, Batten and Belongia). atility on exports, outward FDI, and foreign
2 As Schuh notes, a rise in the dollar value not only discourages
exports, but also exerts pressure on the domestic import-competing
industries (automobile, textile, and others).
4 Lipsey provides a useful discussion on the effects of outward
3 See Cushman (1985) and Caves for other studies on exchange
rate effects on FDI. FDI on the broader economy.

Amer. J. Agr. Econ. 80 (Number 5, 1998): 1073-1079
Copyright 1998 American Agricultural Economics Association


1074 Number 5, 1998 Amer. J. Agr. Econ.

affiliate sales by the U.S. food-processing in- FDI,
dustry. The relevant question is whether the GNP o + P3ln Ri, + 321nVi, +
GNPj - P33
appreciation (depreciation) of the U.S. dollar
and its volatility has contributed to the ob-
served relationship between FDI and trade in Foreign + ylln R, + y2ln Vi
Salesi, =
this industry. Besides underscoring the im- GNP,
portance of the level and stability of exchange + Y"3 +
Uit
rates for trade and foreign investment, this
research has implications for policy, since ex- where i denotes country of destination and t
denotes time. The value Rit, is the real ex-
panding trade and/or foreign investment can
bring about changes in the distribution of in- change rate between the ith country's curren-
come to those engaged in food processing in cy and the U.S. dollar, Vi, is the volatility of
the United States. the real exchange rate, and 7 is a time trend.
The superscripts (e, f s) on the error terms
(u) reflect the respective exports, FDI, and
foreign sales equations.6
A Test of Exchange Rate Effects

Our test of the effects of exchange rates on Data Used in Empirical Estimation
exports, outward FDI, and foreign affiliate
sales is closely related to those carried out by Since developed countries account for more
Hooper and Kohlhagen (for exports), Froot than 75% of the total of 29 billion dollars of
and Stein, and Stevens (for FDI and foreign U.S. direct investment abroad in the food-pro-
sales). By maximizing the expected utility of cessing industry, our analysis focuses pri-
profits for both the exporter and the importer, marily on high-income countries for the pe-
with the transactions denominated in the re- riod 1982-95.7
spective currencies, Hooper and Kohlhagen The ten countries included in the analysis
derived the optimal quantity exported as a are Australia, Belgium, Canada, France, Ger-
function of income levels, factor costs, and many, Japan, the Netherlands, Italy, Spain,
real exchange rates and their volatility. Froot and the United Kingdom. Data on FDI vari-
and Stein argued that informational imperfec- ables were obtained from U.S. Department of
tions cause a divergence between external and Commerce. Annual estimates of the FDI po-
internal financing, with the former being more sition abroad for the food-processing industry
expensive. Hence, by systematically lowering (SIC 20) were available for the period 1982-
the wealth of domestic agents, a depreciation 95 from the Bureau of Economic Analysis in
of the U.S. dollar can lead to foreign acqui- electronic form. Data on sales by majority-
sitions of domestic assets. They tested for this owned foreign affiliates were taken from the
effect by normalizing FDI inflows on U.S. annual U.S. Direct Investment Abroad: Op-
erations of Parent Companies and their For-
gross national product (GNP) and regressing
it on real exchange rates.5 eign Affiliates for the 1982-95 period. The
We present the following three equations to data on prices (unit values) and quantities of
test the effects of the real exchange rate and exports of processed food products were ob-
its volatility on exports, outward FDI, and for- tained from Foreign Agricultural Trade of the
U.S., published by the Economic Research
eign affiliate sales by the U.S. (home country) Service of the U.S. Department of Agriculture
food processing industry. All three dependent
variables, exports, outward FDI, and foreign (ERS/USDA). Relative consumer price indi-
affiliate sales, in a host country are normalized ces (CPIs) and nominal exchange rates (for-
eign currency per U.S. dollar) were obtained
by its GNP.

(1) = ao0+ aln R, + a21n Vi, 6
See Arize for a discussion on the pros and cons of various mea-
Exportsi, sures of exchange rate volatility. Lothian and Taylor show that the
GNP,
real exchange rates are stationary. Although Froot and Stein do not
offer an explanation for including the time trend, we assume that
+ (37 + normalized exports, FDI, and foreign sales are stationary around a
Ui,
deterministic trend.
7 Latin American countries make up most of the remaining 25%
I A normalization
by GNP discounts FDI growth for income and of the FDI in the food-processing industry. However, these countries
factor cost changes. Since GNP is the sum of the returnsto factors, have undergone substantial currency depreciation, along with large
increases in factor prices are also reflected in GNP. inflation rates, which has greatly affected the quality of data.


Gopinath,Pick, and Vasavada ExchangeRate Effects 1075

Table 1. Pooled Regression Results on Exchange Rate Effects
Real
Exchange Volatility
Equation Constant Rate Measure Trend R2 d.f.
Export/GNP 0.00014a -0.000136a -0.00003a 0.000004 0.89 136
(31.1) (-15.2) (-4.11) (0.31)
Foreign Sales/GNP 0.0050a 0.00029a -0.00189a 0.00018a 0.17 136
(2.72) (4.27) (9.15) (3.40)
FDI/GNP -0.00196a 0.00116a - 0.00092a 0.00008a 0.27 136
(-3.30) (8.18) (-29.6) (2.38)
Note: Numbers in parentheses are t-values.
a
Significant at the 5% level.

Table 2. Effect of Exchange Rates on (Normalized) U.S. Exports
Real
Exchange Volatility
Countries Constant Rate Measure Trend DWa R2 d.f.
Australia 0.0008 -0.0006b 0.00003 -0.00001 1.83 0.22 9
(6.09) (-2.32) (0.83) (-1.90)
Belgium 0.0054 -0.0012b 0.00006 -0.00003 1.59 0.55 9
(2.63) (-2.16) (0.41) (-1.56)
Canada -0.0026 0.01558b -0.0003b 0.0002 1.82 0.88 9
(- 1.14) (2.30) (-1.49) (1.64)
France 0.0007 -0.0003b 0.00001 -0.00001 1.81 0.72 9
(3.57) (-1.99) (0.22) (-5.05)
Germany 0.0004 -0.00001 0.00003 -0.00001 1.78 0.35 9
(1.48) (-0.04) (0.43) (-1.44)
Italy 0.0013 -0.00014b -0.00004b 0.00006 1.37 0.18 9
(3.05) (-2.51) (-2.44) (1.82)
Japan 0.0005 0.0001 -0.00002 -0.00001 2.60 0.37 9
(1.01) (1.09) (-0.78) (-0.71)
The Netherlands 0.0017 0.0048b -0.00005 -0.00023 1.79 0.94 9
(1.16) (4.36) (-0.13) (-7.28)
Spain 0.0012 -0.0002 -0.0001 0.00001 1.18 0.67 9
(1.48) (-0.95) (-0.97) (1.00)
United Kingdom -0.0002 0.00014 -0.00015b 0.00004 2.12 0.60 9
(-0.88) (0.31) (-1.91) (1.64)
a Durbin-Watson statistic after
correcting for serial correlation.
"
SSignificant at the 10% level.

from the International Monetary Fund to de- ported in tables 2-4. Recall that by normal-
rive the real exchange rates between the cur- izing on GNP, we account for both income
rencies of the ten countries listed above and effects and, possibly, changes in factor costs
the U.S. dollar. A moving twelve-month stan- in exports, outward FDI, and foreign affiliate
dard deviation of the relative changes in the sales.8
real exchange rate was used to represent its Both Ri, and Vi, were replaced with their
volatility. one-period lags, Ri,_1 and Vi,,_-,respectively,

Estimation and Results 8 Overall, the U.S. dollar experienced lows as well as highs during
the sample period. Beginning in the early 1980s, the value of the
Table 1 presents the results from the pooled dollar appreciated until 1985-86. The late 1980s and early 1990s
saw the dollar fall in value. This pattern changed just after 1992,
time series and cross-section models, while and since then, the value of the dollar has increased relative to most
the results for individual countries are re- other currencies.



Table 3. Effect of Exchange Rates on (Normalized) Outward FDI by U.S. Multinationals
Real
Exchange Volatility
Australia 0.0025 0.0121b -0.0014c -0.0002 1.96 0.21 9
(0.76) (3.71) (-1.54) (-1.99)
Belgium -0.0292 0.01008b -0.0031b 0.0005 2.80 0.96 9
(-3.17) (3.89) (-4.47) (5.51)
Canada 0.0106 0.0197b -0.0007b -0.0004 3.01 0.93 9
(3.92) (3.24) (-2.12) (-3.94)
France -0.0049 0.0040c 0.0002 0.00027 2.26 0.29 9
(-0.88) (1.56) (0.25) (3.22)
Germany -0.0020 0.0034b -0.0008c 0.0003 2.40 0.77 9
(-0.88) (2.01) (-1.49) (5.40)
Italy -0.0098 0.0016c 0.00011 -0.00004 1.96 0.42 9
(-1.47) (1.62) (0.37) (-0.18)
Japan -0.0023 0.0005 -0.00004 0.00007 1.89 0.54 9
(-0.97) (1.16) (-0.41) (2.31)
The Netherlands 0.0136 0.0029 -0.0003 0.0007 1.57 0.43 9
(1.35) (0.29) (-0.18) (2.07)
Spain -0.0210 0.0044b 0.0012 0.0004 1.95 0.67 9
(-1.73) (1.93) (1.38) (2.93)
United Kingdom 0.0066 0.0062c -0.0014b -0.0001 2.66 0.75 9
(2.57) (1.63) (-2.56) (-0.14)
1
c

Table 4. Effect of Exchange Rates on (Normalized) Foreign Affiliate Sales by U.S.
Multinationals
Real
Exchange Volatility
Australia 0.0017 0.0041b -0.0001 -0.00008 1.99 0.35 9
(1.08) (1.66) (-0.25) (-1.24)
Belgium 0.035 -0.0006 -0.0005c 0.00013 2.61 0.81 9
(1.07) (-0.63) (-2.82) (2.88)
Canada 0.00043 0.0126c -0.0004b 0.00002 2.59 0.73 9
(0.23) (3.04) (-1.43) (0.35)
France -0.0020 0.00114c -0.00021 0.0001 2.08 0.79 9
(-1.18) (1.83) (-1.19) (1.91)
Germany 0.0002 0.00027 -0.00004 0.00004 2.17 0.79 9
(0.59) (0.83) (-0.43) (2.97)
Italy -0.00033 0.00002 0.00008b 0.00012 1.90 0.59 8
(-0.25) (0.10) (1.78) (1.99)
Japan 0.00001 0.00003 -0.00003 0.00001 1.89 0.55 9
(0.02) (0.32) (-1.02) (2.01)
The Netherlands -0.0044 0.0092c -0.0003 0.0001 2.26 0.42 9
(-0.80) (1.89) (-0.35) (0.71)
Spain -0.0009 0.00053 -0.00022 0.00004 1.95 0.05 9
(-0.41) (1.16) (-0.79) (1.52)
United Kingdom -0.0007 0.0057c -0.0012c 0.00020 2.37 0.86 9
(-0.63) (2.93) (-4.23) (0.77)
h Significant at the 10% level.
c


Gopinath, Pick, and Vasavada Exchange Rate Effects 1077

in order to account for the expectations as- of the real exchange rate and its stability for
sociated with exchange rates and their vola- agricultural trade flows.
tility. In the pooled model, we accounted for Real exchange rates have a positive effect
serial correlation, contemporaneous correla- on outward FDI and foreign sales by U.S.
tion between cross sections and heteroske- majority-owned multinational food compa-
dasticity by using two types of error struc- nies. That is, an appreciation of the U.S. dollar
tures. The Parks method specifies errors as: leads to an increase in outward FDI and the
resulting foreign affiliate sales. Our reasoning,
(2) Uit = piUi,t1 + Eit. which is in accord with Froot and Stein, is
that an appreciation in the U.S. dollar increas-
This model assumes a first-order autoregres- es the wealth of U.S. food processors relative
sive error structure with contemporaneous to foreigners and allows them to bid aggres-
correlation between cross sections and was sively for foreign assets through FDI. As other
used to estimate the export equations. How- studies have documented, the volatility in real
ever, we used the Da Silva method for the exchange rates has a negative effect on both
foreign affiliate sales and FDI equation, which outward FDI and foreign sales. Consistent
specifies errors as: with our hypothesis, these results suggest that
dollar appreciation has been a causal factor
+ b, + eit,
(3) uit = ai in the observed substitutability between FDI
where and trade in the U.S. food-processing industry
(Gopinath, Pick, and Vasavada).
ei = oE, + J1E,1 -. . + Et-m. The magnitudes of the above-mentioned ef-
This procedure is used to estimate a mixed- fects are also important. Note that the right-
variance-component moving average process hand side variables in the equations are in
for the errors. The moving average process of logarithms, while the left-hand side variables
order m for ei, should satisfy m - T - 1, where are shares in GNP of exports, outward FDI,
T is the total number of observations over and foreign sales for each country. By divid-
time. The order m was chosen to be three, ing the parameter estimates in table 1 by an
although the results did not vary much for m average of these shares (over all countries),
ranging from three to eight. This moving av- we obtain a measure of share elasticity. A 1%
erage process was chosen in addition to an rise in the real value of the U.S. dollar causes
error-component specification to account for a fall of 0.13% for normalized exports. In oth-
the possible lag involved in the FDI process er words, exports as a share of GNP fell by
leading to foreign affiliate sales. In the indi- 0.13% for every 1% rise in the real value of
vidual country analysis, an OLS procedure U.S. dollar. Outward FDI and foreign sales as
was used to estimate the parameters of all shares of GDP expanded by 0.54% and
three equations after accounting for serial cor- 0.04%, respectively, in response to a 1% in-
relation. crease in the real value of the U.S. dollar. The
Most of the parameter estimates of equation negative effect of the real exchange rate on
(1) reported in table 1 are significant at the U.S. processed food exports is accompanied
1% level. The R2 for the export equation was by the rise in the foreign affiliate sales of U.S.
0.89, while that for the foreign sales and FDI majority-owned MNCs.
equations were 0.17 and 0.27, respectively, Tables 2-4 report the parameter estimates
and similar in magnitude to those reported by for the normalized export, FDI, and foreign
Froot and Stein.9 The negative sign on the real sales equations for each of the ten countries.
exchange rate in the normalized export equa- This estimation, similar to that of Froot and
tion confirms the importance of real exchange Stein, was constrained by the available de-
rates in determining agricultural trade flows grees of freedom given the annual time series
(Batten and Beiongia, Pick). Moreover, the data for 1982-95. However, these results con-
negative effect of exchange rate volatility on firm earlier results from the pooled regres-
exports is consistent with previous studies as sions.
well. These results illustrate the importance The effect of the real exchange rate on ex-
ports was negative and significant for five of
the ten countries investigated (table 2). Of the
9 As FDI and foreign sales are often outcomes of intangibles rest, only one had a positive and significant
(knowledge capital, including trade secrets and brand names), it is
not surprisingthat exchange rates alone do not account for all of the coefficient (Canada). Three countries showed
variation in these variables. significant negative effects of real exchange



rate volatility on exports, while this effect was focus of the current research is on the impact
insignificant for the other countries. of real exchange rates, it may be interesting
Table 3 shows that in eight out of ten coun- to incorporate these measures into future stud-
tries, the effect of the real exchange rate on ies at a more disaggregated level.
foreign affiliate sales was positive and sig- Nontraditional variables affecting FDI in-
nificant, as expected. In most countries, for- clude environmental policy variables, mea-
eign affiliate sales were negatively affected sures of degree of openness, and measures of
by the volatility of exchange rates. However, riskiness of investment. For example, factors
this effect was significant for only five coun- such as the quality of the legal system, cor-
tries. Similarly, the effect of the real exchange ruption, presence of import restrictions, and
rate and its volatility on outward FDI was currency convertibility may affect the deci-
positive and significant for about half of the sion to invest abroad and sales by foreign af-
sampled countries (table 4). The results of the filiates (Wheeler and Mody).
country-wise analysis, given the degrees of
freedom constraint, provide some support for
our pooled regression results (table 1). References
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