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New Marshall-Lerner conditions for an economy with outward and two-way foreign direct investment

Paul Welfens ()

International Economics and Economic Policy, 2019, vol. 16, issue 4, No 3, 593-617

Abstract: Abstract The international debate about trade imbalances often puts the focus on the role of domestic GDP/foreign GDP and the role of real exchange rate changes – with respect to the latter adjustment channel, the standard question is whether or not the Marshall-Lerner condition is fulfilled. While recent trade literature has focused on exchange rate pass-through the role of FDI has not been much discussed. With outward foreign direct investment (FDI) and inward FDI becoming increasingly important, the question about the real exchange rate impact on the trade balance has to be restated as imports are proportionate to real gross national income and this indeed implies a new Marshall-Lerner condition. It is shown that with outward cumulated FDI, the modified condition is stricter than the traditional case and with both outward FDI and inward FDI, the elasticity requirement is ambiguous. “FDI globalization” might go along with unpleasant trade imbalance problems so that additional empirical research is needed as well as stronger international policy cooperation as high trade balance deficits/high trade balance surplus positions could be rather difficult to correct through exchange rate adjustments only. Looking at the import elasticities for all partner countries of the US – or country x – together is quite misleading for policymakers.

Keywords: Trade balance; Foreign direct investment; Real exchange rate; Macroeconomics; Economic policy (search for similar items in EconPapers)
JEL-codes: E22 E61 F10 F21 F31 F40 F41 (search for similar items in EconPapers)
Date: 2019
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DOI: 10.1007/s10368-019-00450-5

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International Economics and Economic Policy is currently edited by Paul J.J. Welfens, Holger C. Wolf, Christian Pierdzioch and Christian Richter

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