The Saga of the Swiss Franc: the Increase in the Value of the Franc and its Implications

Minimal effects on competitiveness

In a core study, Peter H. Egger (KOF), Johannes Schwarzer (CEP – Council on Economic Policies) and Anirudh Shingal (World Trade Institute) looked at the effects of the increase in the value of the franc on employment within Swiss municipalities over the years 2001 to 2014. The study focused on three central forms of impact of the increase in the value of the franc. First, heavy pressure on prices from foreign competitors increased competitive pressure on the national market. Secondly, exporters have been experiencing increased competitive pressure on foreign markets. Thirdly, competitive pressure on national sellers operating on the domestic market and foreign markets has been eased by a fall in the prices of foreign input products.

In theoretical terms, it may be assumed that the first two forms of impact result in a compression of national and foreign demand for Swiss goods and services, while the third dynamic operates in the opposite direction and has a positive effect on the Swiss economy. The net effect of the three dynamics is dependent upon how strongly foreign demand responds to changes in the prices of Swiss products, how changes in prices impact the consumption of foreign products, and how intensively foreign input products are used by national industry.

However, a summary consideration of the employment trend in more than 2,200 Swiss municipalities does not confirm the correlations mentioned above for the period covering 2001 to 2014: if the median change is considered, the number of persons employed only fell over the period 2001 to 2005, a period of relative currency stability. However, the summary overview masks the international integration with the local economy. If a trade-weighted exchange rate specific to the municipality is used, the hypotheses set out above are confirmed: employment fell by 1.1 per cent as a result of the first factor, and by 1.2 per cent as a result of the second. On the other hand, employment increased as a result of the third factor, due to cheaper foreign inputs, by more than 2.1 per cent.

Overall, the variations in the exchange rate led to average employment losses within Swiss municipalities between 2001 and 2014 of around 0.14 per cent. Cheaper foreign inputs more than offset the competitive pressure on exports. The franc shock therefore has to be treated in more nuanced terms: the increase in value has had an effect not only on exports but also on imports. However, the investigation ended in 2014, meaning that the effects of the January 2015 shock are not covered. Instead, the two other KOF studies address the post-January 2015 period.

Negative effects on industry

In a second KOF study, Daniel Kaufmann (University of Neuenburg and KOF Research Professor) and Tobias Renkin (University of Zurich and KOF) investigated the effects of the “franc shock” of 15 January 2015 on prices and employment within the industrial sector. The study shows that the prices of products sold on the national market, as well as the prices of exports denominated in Swiss francs, fell only slightly. On the other hand, the prices of exports denominated in euros fell, as did import prices, even faster and more significantly (in terms of their value in Swiss francs). A reason for this differential development may be that prices do not change much in the currency in which they are set. This is an indication of so-called price rigidities.

It is apparent from an analysis of the effects on employment that, two years after the increase in value, industrial businesses had reduced employee numbers by more than 4 per cent. The gradual fall in employment was associated with an immediate fall in the number of vacant positions. This means that businesses have reduced employment primarily through natural fluctuation and not by large-scale dismissals. On the other hand, the authors did not find any indications that sectors or firms with low productivity had been especially affected by the increase in value. This appears to refute the view that the shock caused by the appreciation in value led above all to a reduction in employment by unproductive firms, and thus an increase in average productivity.

Negative effects on research and development expenditure

Productivity was also investigated in the third KOF study, which also examined in particular the effects of the increase in value on spending on research and development, investment and business demographics. In order to investigate the correlations, the team of authors comprised of Boris Kaiser (B,S,S.), Michael Siegenthaler, Andrin Spescha and Martin Wörter (all from the KOF) relied on the fact that the impact of an increase in the value of the currency on a firm's innovation and investment is dependent upon the so-called net exposed position, i.e. the difference between exports and imports as a proportion of turnover.

The authors estimate that the franc shock at the start of 2015 reduced investment in 2015 and 2016 by firms with a positive net exposed position by around 12 to 15 per cent on average. Exposed firms held back on investing both in construction and equipment as well as in research and development (R&D). In particular medium and large-scale investment projects of small and medium-sized enterprises were specifically affected. That exchange rate fluctuations have a strong negative effect on spending on R&D by exposed firms, as also confirmed in an analysis based on various KOF innovation surveys over a period of twenty years (1996–2015). For example, enterprises with an average net exposure reduced their R&D spending by 17 per cent as a result of an increase in the value of the franc of 10 per cent. This means that growth in R&D spending in Switzerland would have been higher in recent years had the franc shock not occurred.

Overall, the studies show that increases in the value of the franc have a short-term negative effect both on investment and also on R&D spending by exposed firms. Over the medium term, this is likely to impact the competitiveness of the firms affected. The negative effect of increases in the value of the franc on R&D spending is apparent for major firms with international exposure. Since this segment is of particular significance for the economy as a whole, extended periods of appreciation could thus impair the attractiveness of Switzerland as a location for businesses. Since manufacturers are suffering from above-average exposure, extended periods of appreciation could also accelerate de-industrialisation.