When selling a product to foreign markets, exporters can use the currency of their home country, that of the destination country, or a third ‘vehicle’ currency. This decision plays a fundamental role in international economics. Related research has shown that the US dollar exchange rate is a major source of swings in global trade in goods – a ‘dominant currency pricing’ phenomenon – since most goods traded internationally are invoiced and sticky in US dollars (e.g. Gopinath et al. 2010, Gopinath et al. 2018, Gopinath et al. 2020, Gopinath and Itskhoki 2022).
Yet, looking at dominant currency pricing in international trade in services is also important for several reasons. First, global trade in services is big – it accounts for about a quarter of global gross trade flows and around 40% in terms of value-added trade. Second, global trade in services continues to grow, unlike global trade in goods which might have peaked amid backlashes against globalisation and higher risks of geo-economic fragmentation (Baldwin 2022a). Third, and relatedly, the future of globalisation might be in trade in intermediate services (Baldwin 2022b). Progress with digitech lowers technological barriers to such trade across borders with no need for physical interactions between producers and customers.
But perhaps the main reason why trade in services is of interest is that it is conceptually different from trade in goods (Francois and Hoekman 2010). Indeed, services are not storable. Moreover, many services are characterised by network externalities, tight regulations, and natural or policy barriers to entry. Finally, unlike exporters of goods, which often intensively use intermediate inputs internationally traded, services often include lower shares of imports and higher shares of domestic inputs, which tend to be priced in the producer’s currency, for example in the tourism sector.
In a recent paper (Amador et al. 2024), we analyse how firms choose the currency in which they price transactions in international trade of services. We examine whether dominant currency pricing differs between trade in goods and services, using direct evidence – hitherto unavailable –on patterns of currency choices in international transactions in services compared to goods.
First, we use a novel micro dataset with finely grained information about currency choices of Portuguese firms in extra-European Union (EU) transactions of services. This new dataset, from Banco de Portugal, comprises information disaggregated by firm, type of service, country of origin or destination, and time periods, which can be combined with a large set of firm-level characteristics. Second, we use a novel macro dataset with aggregate information about currency choices of exporters/importers in Portugal and six other countries (Belgium, Bulgaria, Czech Republic, Italy, Latvia, and Slovakia) to/from extra-EU destinations. This new dataset, collected by the European Central Bank, comprises information on the currency of import and export of services, disaggregated by country and type of service.
Our main empirical analysis focuses on the micro data for Portuguese firms. We explore which factors determine currency choices in their exports of services and their relative importance. We show that firm-level factors play a central role in the decision to choose between the domestic currency (the euro) and a foreign currency using a variance decomposition exercise – a finding consistent with theoretical models pointing to currency choice as an active firm-level decision. This is shown in Figure 1, which shows a variance decomposition of currency choices in exports of services in our sample of Portuguese firms. The figure shows the contributions of different components to the variance of a dummy variable which equals 0 if exports are priced in euro, and 1 if they are priced in another currency. The first bar shows the contributions of each component, with a full set of fixed effects. Subsequent bars exclude firm, country, product, and time fixed effects one at a time. Firm fixed effects account for almost half of the variance in the baseline specification. Moreover, contrasting that baseline specification with a specification excluding firm fixed effects (the second bar), the firm fixed effects in question help to shrink the residual substantially. This points to a central role played by firm-level differences as key determinants of the variation in currency choices, in line with theory.
Figure 1 Variance decomposition of currency choices in micro-data on exports of services of Portuguese firms
Source: Amador et al. (2024).
Notes: The figure shows the contributions of different components to the variance of a dummy variable which equals 0 if exports are priced in euro, and 1 if they are priced in another currency. The first bar shows the contributions of each component with a full set of fixed effects. Subsequent bars exclude firm, country, product, and time fixed effects one at a time.
We then explore the role of firm-level determinants identified by these models and find significant evidence that the mechanisms they discuss are relevant not only for trade in goods but also for trade in services. We find that larger firms, which tend to exhibit stronger strategic complementarities in price setting, are more likely to use foreign currencies in their exports of services. We also observe that firm exposure to foreign currency imports is significantly associated with the choice of foreign currencies to price exports of services. This suggests that – notwithstanding the fact that trade in services tends to rely less on imported inputs than trade in goods – strategic complementarities in price setting and real hedging motives emphasised in extant theoretical models are consistent with patterns observed in the services data.
Our central finding is on dominant currency pricing and the role of the US dollar in international trade of services. We obtain regression estimates on the micro data for Portuguese firms where the dependent variable is the share of export value of a particular product to a given country denominated each year in US dollars and a dummy variable equal to 1 if the product in question is a service, and 0 if it is a good. The regressions control for country-year fixed effects. Thus, the focus is on the variation in the share of the US dollar across products within country-year pairs, and the question is whether that share is systematically lower for services exports than for goods. The estimated coefficient on the Servicep dummy is negative and highly statistically significant, and points to lower prevalence of the US dollar in services than in goods exports of about eight percentage points. This provides strong evidence in favour of the hypothesis that the use of the US dollar as a vehicle currency in international transactions in services is extensive – but systematically lower than in international transactions of goods.
In addition, we tease out the underlying mechanisms for this finding and show that differences in use of the US dollar in services relative to goods decline in more open services sectors and in those where labour (instead of intermediates) accounts for smaller shares of production costs. This chimes with predictions of models (e.g. Mukhin 2022) according to which lower reliance on imported inputs weakens the role of input-output linkages and thereby coordination on one currency, such as the US dollar. It is also consistent with the prediction that, as market openness declines, lower shares of suppliers in destination markets are foreign, hence making it less likely that exporters coordinate on a vehicle currency.
As an external validity test, we complement these findings with evidence from macro data on seven EU countries. Here, too, we find that dominant currency pricing in US dollar is systematically lower in trade in services than in goods and that use of the euro (for Belgium, Italy, Latvia, Portugal, and Slovakia) or the domestic currency (for Bulgaria and the Czech Republic) is relatively more important. Figure 2 plots in the left panel the share of dominant currency pricing in US dollar in exports of goods (on the y-axis) against the share of dominant currency pricing in US dollars in export of services (on the x-axis). The right panel does the same for imports. That countries scatter above the 45-degree line (shown as a light grey line) testifies to the fact that the share of dominant currency pricing in US dollar is quasi systematically higher for goods than for services. This suggests that the evidence obtained from the micro data on Portuguese firms on the extent of dominant currency pricing in US dollar and the underlying mechanisms is not a figment of a particular country-case study, but a more general phenomenon.
Figure 2 Dominant currency pricing in US dollar in macro data: Services vs. goods
Source: Amador et al. (2024).
Notes: The figure plots in the left panel the share of dominant currency pricing in US dollar in extra-EU exports of goods (on the y-axis) against the share of dominant currency pricing in USD in export of services (on the x-axis) of Belgium (BE), Bulgaria (BG), Czech Republic (CZ), Italy (IT), Latvia (LV), Portugal (PT), and Slovakia (SK) in 2020. The right panel does the same for imports. The 45-degree line is shown as a light grey line.
Importantly, we provide evidence that allows us to refute that differences in the geography of trade between services and goods are enough to explain our findings. First, we rule out compositional effects, that is, differences in the use of currencies reflect differences in trade partners in services versus goods trade. In addition, we show that our findings are not explained by higher shares of intra-EU trade in services relative to goods – a feature which coupled with the existence of fixed costs of using multiple currencies, could explain lower prevalence of the US dollar in extra-EU trade. We show that intra-EU trade shares are, in fact, higher for goods than for services in our sample of countries – perhaps because of stronger presence of intra-EU production chains in goods relative to services.
These findings have implications for policy and future research. For instance, it is established in the literature that widespread US dollar-pricing in goods trade affects meaningfully the relationship between nominal exchange rates and other nominal and real variables, and therefore optimal policies. So, if the US dollar is less dominant in services trade because of different characteristics of services and services markets, this should translate into different impacts of shocks in services relative to goods trade. As economies diversify their exports to services, their sensitivity to shocks and optimal policies may change, as a result.
Authors’ note: The views expressed in this column are those of the authors and do not necessarily reflect those of the Banco de Portugal, the European Central Bank or the Eurosystem.
References
Amador, J, J Garcia, A Mehl and M Schmitz (2024), “Dominant currency pricing in international trade of services”, CEPR Discussion Paper 19020.
Baldwin, R (2022a), “Globotics and macroeconomics: Globalisation and automation of the service sector”, Challenges for monetary policy in a rapidly changing world, ECB Forum on Central Banking.
Baldwin, R (2022b), “The peak globalisation myth: Part 4 — Services trade did not peak”, VoxEU.org, 3 September.
Francois, J and B Hoekman (2010), “Services trade and policy”, Journal of Economic Literature 48(3): 642–692.
Gopinath, G, E Boz and M Plagborg-Møller (2018), “Global trade and the dollar”, VoxEU.org, 11 February.
Gopinath, G, E Boz, C Casas, F J Díez, P-O Gourinchas and M Plagborg-Møller (2020), “Dominant currency paradigm”, American Economic Review 110(3): 677–719.
Gopinath, G and O Itskhoki (2022), “Dominant currency paradigm: A review”, Handbook of International Economics 6: 45–9.
Gopinath, G, O Itskhoki and R Rigobon (2010), “Currency choice and exchange rate pass-through”, American Economic Review 100(1): 304–36.
Mukhin, D (2022), “An equilibrium model of the International Price System”, American Economic Review 112(2): 650–88.
