Dynamic linkages between real exchange rates and real unit labour costs: evidence from 18 economies

ABSTRACT

The article examines the long-run behaviour of real exchange rates based on the premises of classical political economy. Specifically, it investigates the dynamics between real exchange rates and real unit labour costs of tradable commodities for 18 developed and developing economies. The analysis is carried out by applying recent methods of panel data, while the short- and long-run dynamics are estimated based on the cross-sectional autoregressive distributed lag model. Our findings confirm the presence of short- and long-run effects of real unit labour costs on real exchange rates. Consequently, new and more effective foreign exchange rate policies may be designed.

KEYWORDS:

• Real exchange rates
• absolute cost advantage
• international competition
• real unit labour costs
• CS-ARDL models

JEL CLASSIFICATION:

• F10
• F14
• J30
• O24

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1. Within the same analytical framework, New Trade Theory argues that the presence of oligopolies, increasing returns to scale and different trade policies prevent ‘free trade’ to establish the desired trade balance between the economies (Milberg 1994).

2. The increase of the trade deficit in the US economy after the abolition of the Bretton-Woods regime questions, in a notable way, the principle of comparative advantage according to which free trade is the basic mechanism that brings about the trade balance.

3. We need to clarify that competition, domestic and international, takes place between capitals and not between countries (economies) as it is presented by the mainstream theory of international trade.

4. The concept of regulating capital contributes to the analysis as it dialectically connects the two distinct moments of competition, intra- and inter-industry. As a result, the presence of different profitability within industry and the Law of One Price coexists with the Law of the Tendential Equalization of the Rates of Profit (Tsaliki and Tsoulfidis 2015; Tsoulfidis and Tsaliki 2005, 2019).

5. When the relative vertically integrated unit labour cost changes in favour of an economy, in fact the relative socially necessary labour time needed for the production of the commodity decreases; therefore, the economy’s terms of trade improve, that is, its currency depreciates.

6. Similar results present the studies of Casey (1996) for Canada, Ruiz Nápoles (1996) for Mexico and Roman (1997) for Spain.

7. The countries are: Australia, Brazil, Canada, China, France, Germany, Ireland, Italy, Japan, S. Korea, Mexico, Netherlands, Norway, Singapore, Spain, Sweden, UK and USA.

8. The sources of data and the estimation of the variables are presented in Appendix A.