Real Exchange Rates and Productivity: Evidence From Asia

This paper examines a productivity-based explanation of the long run real exchange rate movements of six Asian economies. Using industry level data, we construct total factor productivities (TFPs) for the tradable and nontradable sectors. We …nd that (a) within each country the relative price of nontradable goods is cointegrated with the sectoral TFP di¤erential, and (b) the real exchange rates are cointegrated with the home and foreign sectoral TFP di¤erentials. Using the predicted real exchange rate as a measure of the "long-run equilibrium", we …nd that most Asian economies’real exchange rates are overvalued before the Asian Financial Crisis. Keywords: Nontraded Goods, Balassa-Samuelson Model, Cointegration JEL Classi…cation System: F31, F41 Corresponding author: Associate Professor, Department of Economics and Finance, City University of Hong Kong, Kowloon Tong, Hong Kong, E-Mail: [email protected]; Tel: +852-34429707; Fax: +852-34420284 yAssistant Professor, Department of Economics and Finance, City University of Hong Kong, Kowloon Tong, Hong Kong, E-Mail: [email protected]; Tel: +852-34427315; Fax: +852-34420284 zWe would like to thank, without implicating, Yoosoon Chang, Yin-Wong Cheung, Menzie Chinn, In Choi, David Cook, Charles Engel, Cheng Hsiao, Fred Kwan, Nelson Mark seminar participants at the Hong Kong University of Science and Technology, the Institute for Financial Management and Research and all the participants of the Conference on International Financial Markets and the Macroeconomy held at the Hong Kong Institute for Monetary Research for helpful comments. We are very grateful to Editor Masao Ogaki and two anonymous referees of this journal for their comments which improved the paper substantially. We also thank Yoosoon Chang and Nelson Mark for sharing their GAUSS code.