Exchange Rate Uncertainty and Trade between U.S. and Canada: Is There Evidence of Third-Country Effect?

Abstract

In a recent article, we assessed the impact of exchange rate uncertainty on the trade flows of 152 industries that trade between the United States and Canada. We found that, in the short run, trade flows of almost two-thirds of the industries were affected by exchange rate uncertainty. However, in the long run, less than one-third of the trade flows were affected. Almost all industries that were affected by exchange rate uncertainty were found to be small, except for road motor vehicles—which make up to 20% of both imports and exports. Exports and imports of this largest industry were adversely affected by exchange rate uncertainty.

We wonder how the results will change if we account for the “third-country effect,” especially the fluctuation of the U.S. dollar against the currency of the third member of NAFTA, Mexico. We find that, again, in the short run almost two-thirds of the industries are affected by exchange rate uncertainty. However, in the long run, only one-third of the trade flows are affected. The third-country effect seems to be present in the same number of industries, in the short run as well as in the long run.

Keywords:

• commodity trade
• exchange rate uncertainty
• third-country risk
• U.S.
• Canada

ACKNOWLEDGMENTS

Valuable comments of an anonymous referee as well as the editor are greatly appreciated. Remaining errors are ours.

Notes

¹Note that theoretical developments in the literature do support negative as well as positive effects. Some traders trade less in order to lower their exposure to uncertain prices and profits. On the other hand, some choose to trade more in order to make up for a possible decline in their future revenue.

²Note that Cushman's third-country effect received support in the results for other countries such as France, Germany, Japan, and the Netherlands.

³Different variants of (1) and (2) are estimated by different authors in order to learn about elasticities. For examples, see Yusoff (2010) and Ketenci and Uz (2010).

⁴For a detailed step-by-step explanation of the method, see Bahmani-Oskooee and Tanku (2008).

⁵For other applications of this method, see Bahmani-Oskooee and Kara (2005), Shahbaz et al. (2012), Halicioglu (2007), Wong and Tang (2008), and Chen and Chen (2012).

⁶For the share of each industry, see Bahmani-Oskooee and Bolhassani (2012).

⁷Note that there is no third-country risk effect in the results for the largest industry coded 732 (road motor vehicles).

⁸For exact method of constructing the ECM_t-1 , see Bahmani-Oskooee and Tanku (2008). For an additional discussion of this point, see Bahmani-Oskooee and Ardalani (2006).

⁹For a detailed explanation of CUSUM and CUSUMSQ tests and their graphical presentation, see Bahmani-Oskooee et al. (2005).

¹⁰For another industry-related study in this journal, see Fullerton et al. (2011).