A study of the Marshall-Lerner condition in the least complex economies

Abstract: In the aftermath of the financial crisis where global aggregate demand is struggling, countries occasionally get accused of weakening their currency to gain competitiveness. The method of weakening the currency to gain competitiveness is explained by the Marshall-Lerner condition, which states that a devaluation in the long-term will strengthen the balance of trade. But is this policy always rational? And if not, which economies should avoid it? This study investigates whether the structure of the export industry can explain the varying response in the balance of trade from a devaluation. The Johansen Procedure with a Vector Error Correction Model is used to estimate long-run price elasticities of demand for exports and imports. The countries chosen are among the 30 countries with the lowest rank of economic complexity based on its output, listed by the Observatory of Economic Complexity. The exports of these countries are consisting of a single or a few goods, which enables for investigating how individual industries respond to a devaluation. The hypothesis is that there are differences between labour- and capital-intensive economies and that the former should respond more positive to a devaluation than the latter. The results indicate that there is a pattern, to the opposite of the hypothesis, where the capital-intensive economies respond more positive to a devaluation than the labour-intensive economies. This could be misleading due to underlying factors that should be controlled for to be able to produce reliable estimates. The Marshall-Lerner condition is fulfilled for two countries, Gabon and Niger, out of nine in the final sample.