|Author Name||Willem THORBECKE (Senior Fellow, RIETI)|
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This Non Technical Summary does not constitute part of the above-captioned Discussion Paper but has been prepared for the purpose of providing a bold outline of the paper, based on findings from the analysis for the paper and focusing primarily on their implications for policy. For details of the analysis, read the captioned Discussion Paper. Views expressed in this Non Technical Summary are solely those of the individual author(s), and do not necessarily represent the views of the Research Institute of Economy, Trade and Industry (RIETI).
Rogoff (2020) noted that exchange rates have remained "eerily" stable during the COVID-19 pandemic. He predicted that volatility will reemerge and that the U.S. dollar will depreciate towards its mean. The Eurozone and South Korea run large current account surpluses year after year. These surpluses could cause the euro and the Korean won to appreciate. How would appreciations affect firms in France (a Eurozone member) and Korea?
Appreciations could affect export volumes (if firms pass through exchange rate changes to foreign currency export prices) or margins (if firms keep export prices constant). Either way they will impact firm profitability. To investigate how appreciations affect profitability this paper examines the exchange rate exposures of French and Korean firms. Finance theory indicates that stock prices equal the expected present value of future cash flows. Examining the response of stock returns to exchange rates can thus shed light on how appreciations affect firms.
Another risk facing French and Korean companies comes from the coronavirus pandemic. Fear of infection makes consumers reticent about transactions requiring face-to-face contact. Uncertainty restricts investment. Even if these pernicious influences recede, they could return if the virus mutates or if cases surge.
One would expect French and Korean firms to be impacted differently. The Korean strategy for fighting coronavirus succeeded better. As of 31 January 2021, France had 1,100 deaths per million people and Korea had 27 deaths per million people. Figure 1 shows that Korea's success compared to France's at fighting the virus is mirrored in better performance for the Korean stock market compared to the French stock market. News of the crisis starting on 19 February 2020 caused aggregate stock prices to fall by 40% in Korea and by 47% in France. Korean stock prices then recovered and on 21 January 2021 were more than 30% above their pre-crisis levels. French prices on 21 January 2021 had yet to regain their value on 19 February 2020.
The results indicate that France's leading semiconductor firm, STMicroelectronics, is exposed to appreciations. Its second leading firm, Soitec, is also exposed. For STMicroelectronics, a 10% euro appreciation is associated with a 3.4% drop in stock returns. When the French semiconductor industry aggregated together on a value-weighted basis, a 10% appreciation is still associated with a 3.4% drop in stock returns. Thorbecke (2019) found that a 10% Japanese yen appreciation caused Japanese semiconductor stocks to fall by 3.1%. He also found that yen appreciations during the Global Financial Crisis, by damaging the profitability of Japanese firms and restricting their ability to invest in capital and innovation, caused Japan to lose its comparative advantage in producing electronic parts and components. Given the need for massive investment in the semiconductor industry to remain competitive, French semiconductor firms face a similar risk if the euro appreciates.
The risks are even greater for Airbus, France's leading aerospace company. The Conseil National de Productivité (2019) highlighted aerospace as an industrial sector where France has strong non-price competitiveness. However, the results indicate that Airbus's stock is down 36% since the COVID-19 crisis hit. Five-sixth of this drop is driven, not by the macroeconomic environment but by firm-specific responses during the crisis. The airline industry has collapsed and with it demand for new aircrafts. Airbus is also the firm most exposed to appreciations of all the firms examined, with a 10% euro appreciation causing a 4.8% drop in its stock. A large euro appreciation coming on the heels of the COVID crisis could devastate Airbus.
On the other hand, strong brands such as LVMH, L'Oréal, Hermès, Christian Dior, and Rémy Cointreau are either unexposed or only slightly exposed to appreciations. These firms have pricing power (see. e.g., Goldstein, 2021). Rémy Cointreau shares also increased 33% during the crisis, Hermès gained 20%, LVMH gained 19%, and L'Oréal gained 8%. Idiosyncratic rather than macroeconomic factors drove these gains. The crisis harmed lower paid service workers much more than workers in advanced sectors who could work from home (see, e.g., Dingel and Neiman, 2020). These wealthier consumers ordered goods online and sustained the demand for French luxury products. In addition, the recovery in China benefited these companies.
The findings are nuanced for Korea. Many firms in Korea gain from appreciations. Only seven of those investigated are harmed by appreciations, including flagship firms such as Hyundai Motors, Kia Motors, LG Electronics, and Samsung Electronics. The effect is smallest for Samsung. This is partly because Samsung is one of the strongest brands in the world and has pricing power in some of its products. Korea has also succeeded much better than France at controlling the spread of the coronavirus. This has contributed to a stronger macroeconomy in Korea than in France. The macroeconomic environment caused every Korean firm investigated to post gains during the 19 February 2020 to 19 January 2021 period. Thus Korean firms are in better shape than French firms and the Korean economy is less exposed to appreciations than the French economy.
Several policy lessons flow from these findings. One is that luxury brands help stabilize the French economy in the face of exchange rate shocks and the pandemic. Many luxury brands outsource production to Eastern Europe or Asia. This risks a decay of knowledge in France. In addition, with French young people reeling from the coronavirus crisis, it is an opportune time to provide apprenticeships and nurture craftsmen in France. Also labor costs will be lower because of the crisis. Luxury brands can take a page from Asia. Industrial clusters have emerged in Japan, China, Taiwan, and other places where upstream and downstream firms congregate and workers interact. This agglomeration provides an environment where young people and even experienced workers can acquire knowhow and gain human capital. Keeping production in France also helps to preserve quality and maintain strong brands.
A second policy lesson is that appreciations harm French knowledge-intensive companies such as Airbus, STMicroelectronics, and Dassault Systèmes. Given the damage already caused to the economy by the pandemic, a large appreciation would inflict a double whammy. France should lobby against large Eurozone current account surpluses that could generate appreciations. Since current account surpluses reflect excesses of saving over investment, one way to lower current account surpluses is for Eurozone countries with decaying infrastructure to spend on this.
While France cannot control the spending of other countries, it can act to control the costs it imposes on firms. A reduction in costs would act like a depreciation to improve price competitiveness. The Conseil National de Productivité (2019) noted that taxes on French businesses are distortionary and higher than in European partners. Tax reform could help French companies confront international competition.
Finally, there is a danger in a crisis of continuing to finance unprofitable firms. As the pandemic changes the economic landscape, some firms that survived before the crisis may no longer be viable or may need to be scaled down. The experience of Japan in the 1990s indicates that keeping zombie companies on life support only increases long-term costs. It is better to reallocate resources to promising sectors. The results in this paper indicate that firms in green industries in both France and Korea have done well in spite of the pandemic. Policymakers should consider providing incentives for workers to retrain and relocate to sustainable industries.
- Conseil National de Productivité. 2019. Productivité et Compétitivité: Où En Est la France Dans la Zone Euro? Paris: Conseil National de Productivité.
- Dingel, J., and Neiman, B. 2020. How Many Jobs Can Be Done at Home? NBER Working Paper No. 26948. Cambridge, Mass.: National Bureau of Economic Research.
- Goldstein, S. 2021. Here are the European Stocks with Pricing Power to Benefit When Pandemic Ends, According to Citigroup. Barrons. 20 January.
- Rogoff, K. 2020. The Calm Before the Exchange-Rate Storm? Project Syndicate Weblog. 10 November.
- Thorbecke, W. 2019. Why Japan Lost Its Comparative Advantage in Producing Electronic Parts and Components. Journal of the Japanese and International Economies, 54, 101050.