The appreciation of the Swiss franc in recent years has increased the average quality of Swiss exports. Paradoxically, this is not necessarily good news.
High quality exports have proved resilient
The Swiss Secretariat for Economic Affairs (SECO) recently published a set of studies on the economic impact of the strong Swiss franc. One of the papers shows that the average level of quality of Swiss exports has risen.
This sounds like good news. But on closer examination things are more nuanced, as the average quality can increase for two reasons. First, firms exporting low quality goods have lower profit margins and cannot bear the stronger Swiss franc. They thus stop exporting and the average quality of exports mechanically increases. Note that in this scenario the quality of goods of a given firm has not changed. Second, the pressure from a stronger exchange rate can induce firms to step up their effort of innovation to increase the quality of their products.
The study shows that the higher average quality reflects the first mechanism, namely a shift of export composition from medium to high quality goods, and not additional innovation. Nothing surprising here, this is exactly what international trade models predict, as the study clearly acknowledges.
Innovation is not necessarily a good thing
While the paper does not show a rise of quality at the level of individual firms, one could object that their innovation efforts were on other aspects. For instance, we often hear that the strong Swiss franc led firms to optimize their processes and increase productivity.
But such an effort is not necessarily good news. Imagine that you are walking down the street and suddenly a ferocious dog comes charging at you. You will likely run to get away from it, and after a hectic run you will reach a safe spot, but totally out of breath. A passer-by then says “it’s not that bad, at least you got to do some sport”. Would you thank him for such an insightful comment? Neither would I.
We can think of innovation through this metaphor. Any effort in research and development is an investment, with a cost and a benefit. A firm chooses its optimal innovation effort to balance these two, in the same way as I choose how much sport to do by comparing the sweating involved against the enjoyment I get. If the firm is faced with a stumbling block, such as a strong currency, it will react by increasing its innovation (the benefit is now higher), just as I decide to run to get away from the dog. However the firm would have gladly done without this problem.
We can apply this reasoning to any obstacle that a firm can face, not just a strong currency. I don’t recall ever hearing someone argue for new taxes or regulations on firms just because this would stimulate innovation.
A need for industrial policy?
My reasoning considers that firms have chosen their optimal level of innovation before encountering an obstacle. Maybe it is not so, and it would be better for society if firms invested more (maybe I don’t do enough sport after all).
A government intervention to support innovation would then be warranted. But a strong currency is quite a blunt way to get there. I would be much better to subsidize research and development for instance.
