financial crisis and bank runs, which have a recessionary impact on the real
7
economy.
Again, in front of this theoretical ambiguity it is difficult to make sense of the
common wisdom according to which unilateral devaluations provide a positive
strategic advantage on the international markets. Following the pioneeristic
work by Dornbusch (1987), I evaluate the strategic incentives to exchange rate
devaluations in a model where the incidence of exchange rate variations on
prices is endogenous. Strategic effects of devaluations emerge only when firms
produce at home, not if they directly produce in the foreign market. While
under barriers to entry competitive devaluations may be a bad idea to provide
a strategic advantage to domestic exporters, especially under price competition,
under free entry there is always a strategic incentive to depreciate the currency
to promote exports.
The rationale behind all these forms of exports promotion is always the same
as long as the adoption of these policies helps the domestic firm to be aggressive
in the foreign market, which is always the case when entry is free in this market.
Ultimately, the scope of export policy is just to conquer market shares abroad
and shift profits from firms of other countries toward domestic firms. If we
interpret globalization as the opening up of new markets to international com-
petition we can restate the main result as follows: in a globalized word, there
are strong strategic incentives to conquer market shares abroad by promoting
exports.
The paper contains a very general treatment in Section 1, where I introduce
the model and solve for the strategic incentives to promote exports in presence
of barriers to entry in the international market and with free entry. Sections
2 applies the general results to strategic trade policy: I wrote it in a way that
should be clear to the expert reader independently from the general treatment,
hence he or she may want to skip directly to this application at a first reading.
Section 3 applies the general results to a partial equilibrium model of exchange
rate policy. Section 4 concludes. Some extensions and technical details are left
in the Appendix.
1 The Model
To be as general as possible, I will adopt a model of the market structure I
have introduced in Etro (2002a, 2006a), use it to describe competition in a
international market and augment it introducing export promoting policies.
7See Obstfeld and Rogoff (1996) and Kruman and Obstfeld (2000) on the macroeconomics
of competitive devaluations. Notice also that also competitive devaluations induce perverse
retaliatory reactions and can induce contagion of financial crisis. The IMF broadly accepts this
negative view on competitive devaluations and tends to oppose them unless a fixed exchange
rate clearly appears unsustainable.