Main Findings

Productivity, R&D and Cost Reductions

Using the Swiss Innovation Survey (SIS), we study the effect of real exchange rate fluctuations on the three firm level outcomes productivity, R&D, and cost reduc-tions. The analysis yields several important insights:

• Effects on performance measures: Exchange rate appreciations clearly have a negative effect on total revenues and value added for firms with positive net exposure.

• Effects on cost reductions: Firms appear to respond to real appreciations with cost reductions. Net exposed firms are more likely to introduce pro-cess innovations that lead to significant cost reductions.

• Effects on productivity: Firms cannot fully compensate the lower revenues with cost reductions in the short and medium term. A 10% real apprecia-tion of the Swiss Franc decreases value added per employee by 1.3% and TFP (total factor productivity) by 2.2%.

• Effects on R&D expenditures: Overall, there is a negative effect of real ex-change rate appreciation on R&D expenditures. The economic significance is considerable; for a firm with average net exposure, a 10% real apprecia-tion of the Swiss Franc leads to a 17% decrease in R&D expenditures.

There is no empirical evidence that exchange rate fluctuations have an im-pact on firms’ decisions to enter/exit from R&D activities.

• Heterogeneous effects by profitability: The profitability of firms positively mediates the observed negative effect on R&D expenditures. In firms with only few financial resources, appreciations lower R&D expenditures. In contrast, firms with considerable financial means increase R&D expendi-tures if the exchange rate appreciates.

• Heterogeneous effects by firm size: Large, internationally exposed R&D intensive firms show the strongest negative reaction to exchange rate ap-preciations. In contrast, we also detected a segment of very small firms that increases its R&D expenditures in times of currency appreciation.

These firms are characterized by low levels of net-exposure, large R&D intensity, and relatively low levels of price competition (niche players).

• Appreciations vs. depreciations: The negative effect of exchange rate movements on R&D expenditures is largely symmetric: the positive ef-fects of real depreciations are of similar size as the negative efef-fects of real appreciations.

Investment

The effects of exchange rates on investment are studied using a Differences-in-Differences approach by comparing the evolution of investment of firms with dif-ferent net exposure before and in the two years following the “Franc shock”. The Franc shock is the strong appreciation of the Swiss Franc that followed the unex-pected abolition of the exchange rate floor of the Swiss Franc relative to the Euro in January 2015.

• Effects on total investment: Due to the Franc shock, firms with positive net exposure reduced gross fixed capital investment by roughly 15% in 2015 and by 12% in 2016 relative to not or negatively exposed firms.

• Different types of investment: Exposed firms reduce investment in machin-ery and equipment and construction investment in 2015 and 2016. They al-so substantially decrease R&D expenditures in Switzerland.

• Possible reasons for the negative effects: A central reason why exposed firms reduced investment in Switzerland appears to be the loss in financial capabilities. Another explanation is that larger manufacturers and firms that are experienced with foreign direct investments invest more abroad, both in production and in R&D units.

• Positive investments effects: the Franc shock triggered certain (small) addi-tional investment projects. In particular, the Franc shock appears to have induced exposed firms to renew their machinery and equipment.

• Effect on aggregate investment: Because we do not find evidence that firms with negative exposure invested more in 2015 and 2016 and because the Franc shock also exposed some firms with a high share of domestic sales to higher import competition, we estimate that nominal investment would have been up to 8% higher in the average firm participating in the KOF investment survey if the Franc shock had not occurred.

• Comparison to macroeconomic data: The adverse effects on investment are less apparent in macroeconomic data because the negative investment effects of the Franc shock are particularly pronounced in exposed manu-facturing and in small and medium-sized firms. Small and medium-sized firms do not have a large weight in macro data.

Aspects of Business Demography

We have analyzed the effect of exchange rate fluctuations on employment growth and the probability of exit from the market using business census data on the uni-verse of private manufacturing firms in Switzerland.

• Effects on employment growth: We found that the elasticity with respect to the real exchange rate fluctuations falls monotonically with the level of exposure, which is in line with theoretical expectations. For firms with a strongly positive net exposure, a 10% appreciation causes a reduction in labor demand by about 2.5% relative to non-exposed firms. This effect is found to be more pronounced for large firms with more than 50 employ-ees.

• Effects on firm exit: We document a significant impact of the real ex-change rate fluctuation on the probability of exit for firms with strongly positive net exposure: A 10% appreciation increases the annual exit proba-bility among these firms by 0.3 percentage points relative to non-exposed

firms. Further evidence suggests that the effect on the probability of exit is more relevant among smaller firms.