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I. Introduction
The "competitive devaluation" - through which a country could improve its trading position by weakening its currency - has long captured the attention of policymakers. This idea was particularly attractive during the Gold Standard period of fixed exchange rates prior to First World War, but even today countries might view a depreciating currency as something of a boon to their export industries. But this benefit does not occur in every case. The "Marshall-Lerner" (M-L) condition, named after Alfred Marshall and Abba Lerner, provides a precise description of the specific conditions under which a devaluation or depreciation of a currency (under a fixed or floating regime, respectively) is expected to improve a country's trade balance.
This condition can be explained briefly as follows. A country's trade balance consists of the value of its exports minus the value of its imports. Each value is measured as a price times a quantity. If the country's currency is devalued, the resulting price decrease should increase the quantity of exports and decrease the quantity of imports, but the trade balance can only improve if the export or import quantities respond sufficiently to offset the deterioration in price. Thus, either export quantities must increase or import quantities must decrease. The M-L condition states that these elasticities (in absolute value) must sum to greater than one for a devaluation to be effective in improving a country's trade balance.
Because of this necessary condition, accurately measuring trade elasticities became extremely important for the assessment of trade policy. This review investigates this body of literature, with a focus on the empirical studies that have been performed over the last 50 years. It is interesting to note that many studies that claim to test the M-L condition do not actually obtain the necessary elasticities to do so. They may estimate either exports or imports, but not both; or they estimate a single equation for the trade balance. While we pay attention to these studies, because they (inaccurately or not) have become part of the "M-L" literature, we reserve the majority of our attention to those analyses that obtain price elasticities for both exports and imports. Finally, we re-test those estimates for which a standard error is available to see whether the sum of...