Plant Scale and Exchange-Rate-Induced Productivity Growth Loretta Fung Department of Economics, University of Alberta Jen Baggs School of Business, University of Victoria Eugene Beaulieu Department of Economics, University of Calgary

Motivation Question: how do exchange rate movements affect shipments and productivity growth? Exchange rate fluctuations affect the competitive environment in which firms operate: Home currency appreciation: home firms face a more competitive environment. Home currency depreciation: home firms face a less competitive environment. How does this affect firm-level productivity?

Antecedents Growing empirical research on impact of exchange rate movements on real variables: Investment: Campa and Goldberg (1999), and Harchaoui, Tarkhani and Yuan (2005). Firm survival and size: Campbell and Lapham (2004) and Baggs, Beaulieu and Fung (2008). However, the exchange rate effects on firm productivity is rarely explored. Theory: Bernard, Eaton, Jensen and Kortum (BEJK 2003) Fung (2008)

Theoretical Background Productivity Growth of Continuing Firms Bernard, Eaton, Jensen and Kortum (2003): an appreciation of the home currency causes factor substitution and increases productivity. Fung (2008): where the exit rates are low, an appreciation of the home currency reduces firm scale of production and lowers the productivity of continuing firms (the scale effect). Scale effect: Effect of the Canada-US FTA: Prior to the FTA: Cox and Harris (1985) suggested that the scale expansion caused by the FTA may improve productivity. Head and Ries (1999) and Trefler (2004): Little scale effect.

Canadian Context In this paper, we study the exchange rate effects on Canadian manufacturing plants: Exchange Rates: A large appreciation against the US dollar in the late 1980s and early 1990s followed by a large depreciation in the rest of the1990s. Canadian manufacturers are both highly export oriented and import competing. Detailed, longitudinal, plant level data. The manufacturing sector exports about 40% of its total production to the United States alone and about 35% of manufacturing output consumed in Canada is imported from the United States.

Hypotheses: Two empirically testable hypotheses for surviving plants: An appreciation of the Canadian dollar reduces plant shipments and this effect is more pronounced for exporters. In the presence of increasing returns to scale, labour productivity should decrease with the reduction of shipments.

Data: Plant-Level Data Annual Survey of Manufactures (ASM) Database, 1987-1997. Annual data on industry affiliation, location, plant affiliation to multi-plant firms, shipments and value-added, materials, number of production and non-production workers and total payments to them, hours paid and hours worked for production workers, and ownership. Export data are available in years 1990, 1993, 1996 and 1997 for plants that filled out the long form (larger plants). We only use the plants that have export data available in at least one of the years (including non-exporters – i.e. zero exports). This data set is ideal for examining productivity because it consists of detailed data on plant production activity. However, there is no capital measures in this data set.

Data: Exchange Rates Owing to differences in the composition of trading partners, it is possible that exchange rate changes may affect industries to differing degrees. Trade weighted real exchange rates (TWRER): Weighted average of normalized real exchange rates of Canada’s top 10 trading partners for each industry at the 4-digit SIC level. Importance of top10: 90% of VT (overall)

US is the most important trading partner for almost all the industries. Overall weight of US: 75%

Table 2: Descriptive Statistics All Plants Exporter Non-exporter Significantly Diff’t at the 5% level? Number of Observations 189,653 112,399 77,254 Mean TWR exchange rate 100.57 100.07 101.30 YES Mean Plant Age 20.74 22.16 18.67 Mean Number of Employees 76.41 107.53 31.12 Mean Skill Intensity 11.95 19.49 0.73 NO Mean Labour Productivity 92,878 102,288 78,766 Mean Canadian Tariff Reduction (in year t) 0.66% 0.62% 0.70% Mean US Tariff Reduction (in year t) 0.30% 0.29% 0.31% Mean Foreign Ownership Dummy 0.16 0.21 0.08 Mean Multi-Plant Dummy 0.29 0.36 0.18 Mean Annual Industry Shipments Growth 1.07% 1.43% 0.54%

Empirical Analysis: Plant Scale Plant Shipments: f: plants; i: industry; t: year. ∆lnshipmentsft: change in log real manufacturing shipments. lnemploymentf0: plant initial size. ∆lnERit: Change in log trade weighted real exchange rates. Interactions: ∆lnER*Exportf and ∆lnER*Foreignf-1 ∆tariffit = tariffit-1 – tariffit: tariff changes xft-1: age, labour productivity,, export status (= 1 if exported at least once), ownership, and affiliation with multiplant firms. yit-1: industry concentration (CR4), industry sales growth, and real interest rates (skipped in the tables in presentation). Also include industry fixed effects (at the 3-digit SIC level) and trend. 60% of the plants are exporters 20% of the exporters are foreign-owned 80% of the foreign-owned plants are exporters.

Empirical Analysis: Plant Scale Summary of Results A real appreciation of the Canadian dollar reduces plant shipments on average. Plant Heterogeneity: The negative average effect is driven by the shipment reduction among exporters and foreign owned non-exporters. The shipments of domestic non-exporters are positively affected by appreciations of the Canadian dollar.

Empirical Analysis: Productivity Exchange rate  Plant scale  Productivity? Use 2SLS model: First stage: shipments are instrumented using the exchange rate, export status, industry sales growth, real interest rate (and terms interacting exchange rate with export dummy and with foreign ownership dummy). Second stage: estimating equation is specified as: ∆lnproductivityft: change in labour productivity (log of real manufacturing value-added per production worker). ln(shipments/employees)f0: log of initial labour productivity ∆lnskillft: skill intensity (based on relative total payments). xft-1: age, ownership, and multi-plant dummy. yit-1: CR4.

Empirical Analysis: Productivity Summary of Results Our findings suggest that, overall, a real appreciation of the Canadian dollar reduces plant shipments and it leads to a decrease in labour productivity. A depreciation has the opposite effect. The negative average scale effect on productivity is driven by exporters and foreign owned non-exporters. Our findings support the scale effect hypothesis.

Economic Significance How large is the economic magnitude? Average effect. Effects on plants with different ownership and export market participation status. Method: Benchmark: A hypothetical plant with all variables at means. Calculate the changes in shipment growth rate and resultant changes in productivity growth rate when large appreciation or depreciation of the Canadian dollar is introduced.

Economic Significance Average effect (all plants):

Economic Significance Plant reaction to exchange rate movements depend on their ownership and participation in the export market. Four groups of plants: Domestic non-exporters, Domestic exporters, Foreign non-exporters, and Foreign exporters.

Conclusions This paper investigates the effect of exchange rate on productivity via plant scale of production. Findings: A real appreciation reduces the shipments of surviving plants while a real depreciation has the opposite effect. This effect is driven by adjustment of shipments by exporters. The scale reduction induced by real appreciations has significant impact on productivity. The scale effect is economically significant. The direction and magnitude of it depend on plant ownership and export market participation.

Conclusions Three elements of aggregate productivity growth: Growth of continuing plants, Replacement of exits by entrants, and Market share reallocations. A real appreciation of the Canadian dollar affects productivity in two opposite directions: Surviving plants suffer from a reduction in the scale of production and productivity, causing a reduction in industry-level productivity. The exit of less productive firms shifts up the productivity distribution within an industry, leading to an increase in industry-level productivity (Baggs, Beaulieu and Fung, 2008). Directions of future research: To investigate the direction and magnitude of exchange rate effects on aggregate productivity growth. To assess the relative importance of the three elements.