Background and Motivation
Swiss firms are regularly subjected to considerable fluctuations in exchange rates.
These strong currency movements are linked to the fact that Switzerland is a small open economy and that the Swiss Franc is a “safe haven” currency. In times of economic turmoil and financial distress in other countries, the Swiss franc usually appreciates. A striking example of the exchange rate exposure of Swiss firms was the strong and sudden appreciation of the Swiss franc that followed the unexpected abolition of the currency floor that the Swiss National Bank (SNB) had entertained relative to the Euro. In the immediate aftermath of the SNB’s announcement on January 15 2015, the Franc appreciated by around 15% against the Euro.
The persistent appreciation of the currency had a strong negative impact on reve-nues of Swiss firms that sell a high proportion of their sales abroad and do not profit much from the decline in the price of imported intermediate inputs. How did these firms react to the loss in competitiveness? A recent survey among medium-sized and large firms conducted by the SNB (2015) provides some insights on the way in which negatively affected firms responded to the appreciation. The most frequent measures are related to reducing prices of domestic inputs and increasing purchases of imported intermediate inputs. Furthermore, a substantial fraction of firms respond by increasing their innovation efforts and optimizing their produc-tion processes. Despite these measures, about one in five firms reports that they are forced to dismiss workers and reduce investments, respectively. While the evi-dence of the survey is rather qualitative due to the small sample, it suggests that exchange rate swings have considerable short- and medium-term consequences on workers and firms in Switzerland with potential long-term implications for produc-tivity and growth.
Research Questions and Focus
This report presents a comprehensive empirical investigation as to how exchange rate movements affect the size, investment, research and development activities, innovation driven production cost reductions, measured performance and the sur-vival of Swiss firms. More specifically, the research questions are as follows: How do exchange rate movements affect firms’ spending on research and development (R&D) and fixed capital as well as their efforts to reduce costs? What is the impact on labor productivity within firms? Do exchange rate movements have an impact on aspects of business demography such as employment growth and the survival of firms? In analyzing these questions, we also explore the heterogeneity of the
ex-change rate effects across different groups of firms, for example by the degree of international exposure, firm size and price-cost-margins.
Empirical Approach and Data
Following the recent literature, the empirical approach of this report is based on the notion that domestic firms are heterogeneous in their degrees of exposure to ex-change rates depending on (i) how much they export, (ii) how many intermediate inputs they purchase from abroad, and (iii) to what extent their domestic market is affected by import competition. The effects of exchange rate swings can then be identified by comparing changes in outcomes with changes in exchange rates be-tween groups of firms with different degrees of exchange rate exposure. To study the range of outcome variables suggested by the research questions above, the empirical analyses in this report exploit three different firm-level panel datasets:
the Swiss Innovation Survey (1995–2015) and the Investment Survey (2011–
2017), both conducted by the KOF Swiss Economic Institute, as well as the Busi-ness Census Statistics (1995–2014) from the Swiss Federal Statistical Office. To study the effects of exchange rate movements, we construct industry-specific real effective exchange rates to take into account the heterogeneity of Swiss industries with respect to the composition of their trading partners.
Implications for Economic Policy
The results of this report may be of interest to economic policy makers for two reasons. First, the results provide a quantitative assessment of the impact of ex-change rate movements on relevant aspects of business activities such as invest-ment and innovation. These activities are intimately linked to productivity and growth and therefore have a bearing on structural changes in the economy in the long run. Second, the empirical findings provide information on the importance of the (partly offsetting) transmission channels through which exchange rates operate.
Besides the policy perspective, the report may also provide a contribution to the international academic literature that seeks to understand the impact of exchange rates and international competition on firm-level outcomes.
Structure of the Report
This report is structured as follows. In Section 0, we review the related academic literature that examines the exchange rate effects on innovation, investment, productivity and business demography. Section 3 contains a discussion on the the-oretical transmission channels, running from exchange rates to the various firm-level outcomes, which have been studied and developed in theoretical economic
models. Section 4 provides an overview over the various data sources and explains the construction of the industry-specific exchange rates.
In Section 5, we study the impact of exchange rate swings on firm-level labor productivity, firms’ spending on R&D and their efforts to reduce costs. The analy-sis exploits the rich information in the Swiss Innovation Survey, a panel dataset based on a representative sample of 6’000 Swiss firms which covers the period from 1996 to 2015.
Section 6 investigates the effects of the sharp appreciation in 2015 on firms’ in-vestment activities. This appreciation, often referred to as the “Franc shock”, was sudden and unexpected and changed the environment of Swiss firms with interna-tional exposure. Using the KOF Investment Survey from 2011 to 2017, we analyze how the Franc shock influenced firms’ spending on machinery and equipment, construction, R&D, and foreign direct investment in 2015 and 2016.
In Section 7, we deal with the effect of exchange rate movements on two business-demographic outcomes: within-firm employment growth and the probability of exit from the market. The analysis is based on business census panel data that co-vers the unico-verse of the Swiss manufacturing sector from 1995 to 2014 and ex-ploits information on the firms’ degree of export and import activities.
Finally, Section 8 contains concluding remarks.