Exchange rate fluctuations, plant turnover and productivity

•We examine the relationship between productivity and exchange rates.•We estimate productivity while controlling for simultaneity and unobserved prices.•A dynamic, structural model of entry and exit used to analyze industry productivity•Plants with low productivity are more likely to exit when currency appreciates.•Movements in exchange rates can affect productivity through the selection effect.

In a small open economy, fluctuations in the real exchange rate can affect plant turnover, and thus aggregate productivity, by altering the makeup of plants that populate the market. This paper develops a structural model that captures the effect of plant-level productivity and real exchange rate fluctuations on plant entry and exit decisions, and how this, in turn, affects average industry productivity. Using plant-level data for a single industry, the model's dynamic parameters are estimated in two-stages using the Nested-Pseudo Likelihood algorithm and the Method of Simulated Moments. Simulations of the model are used to investigate the effects of shocks to the exchange rate process on productivity. The results suggest that, given the mechanisms highlighted in the model, transitory and permanent depreciations have similar long-term effects on average industry productivity.