Tuesday, December 11, 2007

Exchange Rates, Intersectoral Reallocation and Highway Beautification

The NY Times reports that several European automakers are considering opening more US factories:
The dollar’s falling value is making European automakers eager to build more vehicles in the United States, even as American car companies continue to shift production to other, lower-cost countries.

Fiat, the Italian carmaker, is the latest company to suggest that it may build a plant in the United States. Its chief executive, Sergio Marchionne, told Automotive News Europe for an article published Monday that its sports car brand, Alfa Romeo, needs a North American plant to be profitable. Alfa Romeo is returning to the United States next year after a 13-year absence.

This is a good example of how exchange rate movements can induce a reallocation of resources (and the presence of adjustment costs means that the exchange rate movements are larger, as I demonstrated here). If someone leaves a retail job to work at the Fiat factory, that's a shift of labor from nontradable to tradable production, induced by the dollar's weakness (a US dollar currently sells for 0.68 Euros).

The investment by Fiat would be another manifestation of the financial inflow that is the flip side of the trade deficit - the countries that we have trade deficits with are mostly getting financial assets (stocks and bonds) in return for the goods they're sending us, but in this case the inflow would take the form of foreign direct investment. The accumulation of US assets by foreigners means that our "net income from the rest of the world" is likely to become increasingly negative over time, opening up a gap between GNP and GDP. In this case, the output of the Fiat factory would add to US GDP, but some of the profits (the capital income) would go back to Italy, contributing to Italian GNP.

That is, if the factory gets built - and I hope it does; that Alfa-Romeo looks like a seriously sweet car.

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