Exchange rate fluctuations and foreign sourcing
Department or Administrative Unit
In the literature on international trade theory, currency appreciation (depreciation) detracts from (adds to) the international competitiveness of a country by raising (lowering) the relative prices of its goods (Artus, 1974). What is the process by which currency appreciation leads to higher relative prices for a domestic manufacturer? To what extent do relative product prices increase following currency appreciation?
In addressing these questions, international trade theory has emphasized the case where a firm obtains all of its inputs from domestic sources (domestic sourcing) and those input costs are denominated in terms of the domestic currency. In recent years, however, firms increasingly have obtained inputs from foreign suppliers (foreign sourcing) whose costs are denominated in terms of a foreign currency.
The purpose of this article is to compare the impact of currency appreciation on a firm's costs and prices in two situations: (1) where a firm obtains all of its inputs from domestic suppliers and those input costs are denominated in terms of the domestic currency; (2) where a firm obtains some of its inputs from foreign sources and those input costs are denominated in terms of the foreign currency.
The article concludes that as foreign currency-denominated costs become a larger portion of a company's total costs, an appreciation of the domestic currency leads to a smaller increase in the foreign currency cost of the company's product and a larger decrease in the domestic currency-denominated cost of the firm's output, compared to the cost changes that occur when all input costs are denominated in the domestic currency. This has implications both for the international competitiveness effects of exchange rate changes and for their effects on domestic inflation rates.
Carbaugh, R., & Wassink, D. (1994). Exchange rate fluctuations and foreign sourcing. The International Trade Journal, 8(4), 435–446. https://doi.org/10.1080/08853909408523812
The International Trade Journal