mechanism linking such policies to subsequent economic growth, relying primarily on the econometric evidence presented in Hausmann, Pritchett and Rodrik (2005).

# _C. Exchange Rates and FDI_

Another literature analyzes the link between exchange rates and FDI. One strand has focused on an empirical regularity, namely that FDI seems to rise during and after severe balance of payments crises. Krugman (2000) was perhaps the first to coin the term “fire-sale FDI” to describe this phenomenon, but several contemporary theoretical and empirical treatments have provided further support to this notion.<sup>6</sup> Blonigen (1997) advanced our understanding of the link between exchange rates and FDI by proposing a theoretical model in which FDI seeks to acquire “firm-specific” assets, and finds support in data on Japanese acquisitions of U.S. companies during 1975-1992. Aguiar and Gopinath (2005) further pursue the hypothesis that FDI in pursuit of mergers and acquisitions increased during liquidity crises (and devaluations) experienced by East Asia during 1996-1998 and concluded that this effect was particularly prominent in the tradables sector, thus suggesting that FDI might in fact be a stepping stone for the recovery of trade after such crises. World Bank observers have taken this literature seriously, and some have concluded that we can expect an uptick in FDI in the aftermath of the 2008-09 crisis (see, for example, Calderón and Didier 2009).

# _D. Vertical versus Horizontal FDI_

One of the most cited articles in the FDI literature is Carr et al. (2001), which introduced the terms “horizontal” and “vertical” multinational enterprises (MNEs). The former refers to MNEs with foreign affiliates that sell final goods in the host market, whereas vertical MNEs exploit international differences in factor endowments or relative factor costs to export final goods elsewhere. The original motivation for these authors was the emergence of the so-called “new trade theory,” which argued that economies of scale can explain the rise of intra-industry trade during the second half of the twentieth century. They argued that an uncomfortable fact about intra-industry trade was that it was dominated by MNEs. Be that as it may, our interest here is solely due to the contrasting predictions regarding trade flows of the two motivations for FDI: vertical FDI is more likely to result in new international trade flows, especially exports from the host country, whereas horizontal FDI seeks to overcome international trade costs by shifting production and sales into the host country. Hence, if exchange rate devaluations affect FDI, the nature of this new FDI will thus affect the extent to which exchange-rate changes affect exports in a reduced-form model.

# **III. Data**

Quarterly data on REERs, FDI and exports of goods and services come from databases maintained by the International Monetary Fund (IMF). The REER is defined by the IMF as the trade weighted real exchange rate, based on the ratio of indexes of consumer prices between pairs of trading partners.<sup>7</sup> The series cover

> 6 Krugman’s paper was widely circulated about three years prior to its publication in an edited volume in 2000. However, Blonigen (1997) predated the Krugman’s working paper.

> 7 An alternative index of real exchange rates often used in the literature is the ratio of price indexes found in the Penn World Tables, in which the United States is the benchmark. However, these data are available only in annual frequencies, not quarterly, which might be a significant disadvantage for the empirical analysis in this case. However, it is worth noting that using annual averages of the REER index and the annual data from the Penn World

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