Applied Economics Letters, 2013, 20, 452–456

J-curve disparity between the goods

sector and the services sector:
evidence from Australia
Albert Wijeweeraa,* and Brian Dolleryb
a
Business School, Southern Cross University, Tweed Heads, NSW, Australia
b
UNE Business School, University of New England, Armidale, NSW,
Australia

The J-curve effect phenomenon suggests that the currency devaluation

would worsen the trade balance in the short run, but improve it in the
long run. This article uses quarterly Australian data over the period 1988
to 2011 to examine whether J-curve effects are different between the two
main components of the trade account: the goods sector and the services
sector. Using the bound testing approach to cointegration and error
correction modelling, we find some evidence to support the J-curve
phenomenon, but the impact of real exchange rate on the trade account
seems complex. While the services sector displays a J-curve effect, the goods
sector response is quite the opposite: it has a positive response in the short
run, but a weak negative response in the long run.
Keywords: J-curve; bound testing approach; trade account; Australia

JEL Classification: F31

I. Introduction II. The Analysis of the J-Curve Phenomenon

This article explores whether the J-curve effect varies
between the services sector and the goods sector in
Australia. While many empirical studies have examined
this phenomenon, to our knowledge, no published arti-
cle has examined whether the J-curve effect is different
between the two main components of the trade account:
the goods sector and the services sector. One would
expect a stronger J-curve effect from the services sector
compared with the goods sector, because the services
sector contraction in areas such as education, shipping,
insurance and the like may be more rigid and has longer
lag effects relative to the goods sector. As illustrated in
Fig. 1, the goods sector and the services sector appear to
follow different paths to each other for most of the time.
This anomaly is worthy of investigation. While there
are some studies that have used disaggregated trade
data, they have mostly disaggregated data into trading
partners and not into trade account components per se.
*Corresponding author. E-mail: albert.wijeweera@scu.edu.au
In a seminal article, Magee (1973) suggested that,
following devaluation, the trade balance will keep
deteriorating in the short run, but will improve in the
long run. He described this phenomenon as the J-
curve effect. Magee attributed this behaviour to
many factors, such as adjustment lags in currency
contracts, periods of pass through and sluggish quan-
tity adjustments. This line of thought prompted many
researchers to empirically examine the J-curve effect
for various countries with mixed results. Details of
these studies and their specific findings have
been omitted in this article because of space limita-
tions. Interested readers are referred to an excellent
Applied Economics article ‘The J-curve: A Literature
Review’ by Bahmani-Oskooee and Ratha (2004).
Several studies have also employed Australian data
to examine the J-curve phenomenon (see, e.g. Arndt

452 Applied Economics Letters ISSN 1350–4851 print/ISSN 1466–4291 online # 2013 Taylor & Francis
http://www.tandfonline.com
http://dx.doi.org/10.1080/13504851.2012.707765
J-curve disparity between the goods sector and the services sector
1.2
1.1
Export to import ratio
1.0
0.9
0.8
0.7
0.6
1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
Year
Fig. 1. Australian time trend for goods and services sectors:
1988–2011
Note: TBG, trade balance in the goods sector; TBS, trade
balance in the services sector.
and Dorrance, 1987; Flemingham, 1988; Bahmani-
Oskooee and Wang, 2006).
III. Model
The theoretical framework for dealing with the
J-curve effect derives largely from Rose and Yellen
(1989). In this article, we follow the empirical model
used by Bahmani-Oskooee and Wang (2006). The
relationship between the trade balance and its deter-
minants is given by the following equation:
logðTBt Þ ¼ a þ b log YAUS;t þ  log YROW;t
þ l log RERt þ et
where TBt is the ratio of Australia’s nominal exports
to its nominal imports, YAUS,t is the Australian Gross
Domestic Product (GDP), YROW,t is rest of the world
income and RERt is the real bilateral exchange rate
between the Australian dollar and the US dollar. We
use quarterly data from Q1-1988 to Q2-2011 to esti-
mate the model. Data for these variables were
obtained from sources such as Australian Bureau of
Statistics, World Development Indicators, and Inter-
national Financial Statistics. Since Equation 1 provides
only long-run elasticities, we use the Autoregressive
Distributed Lag (ARDL) model to estimate both the
short-run and long-run coefficients. The ARDL model
is given by the following equation:
X
n1

logðTBt Þ ¼ a þ
k¼1
X
n4
þ lk
logðRERtk Þ þ a þ b log YAUS;t
k¼0
453
where
refers to the first difference of each respective
variable and ut is the disturbance term. Equation 2 is an
error correction model. However, instead of using an
error correction term, the linear combination of lagged
variables has been included in the equation. We use
three lag periods in each and note that the chosen lag
length is sufficient to approximate the data-generating
TBG process using the Akaike Information Criterion.
TBS
IV. Results
We estimated Equation 2 for two major components of
the trade account. Model 1 is for the goods sector
balance and the Model 2 is for the services sector
balance. The results for the goods sector and the
services sector are shown in Tables 1 and 2, respec-
tively. We have highlighted the results for the exchange
rate variable and the long-run relationships. As the
results show, two of the short-run coefficients obtained
for
log(RER) are significant at the 10% critical value.
This suggests that there is statistical evidence to sup-
port the proposition that depreciation of the Australian
dollar has short-run effects on the goods sector balance
of the trade account. However, the finding of a short-
run effect does not necessarily support the existence of
the J-curve because we do not have statistical support
for a significant long-run relationship between the
goods sector balance and the real exchange rate. As
the results show, the long-run coefficient is statistically
insignificant at conventional levels.
ð1Þ As far as the other coefficients are concerned, the
relationship between the goods sector trade balance
and the Australian income is negative. This is what we
expected because as Australian income rises, imports
will increase, which in turn worsens the goods sector
trade balance. It is interesting to note that the rest of
the world income does not seem to be a significant
variable, although it has the anticipated sign. This
could be attributed to the low-income elastic nature
of some of the goods that Australia exports.
The services sector seems to behave differently from
the goods sector. For instance, short-run estimates on
the coefficients of the
log(RER) are not statistically
significant at conventional levels. However, at least
one coefficient is statistically significant at a slightly
higher level of significance. Thus, we cannot strongly
X
n2   Xn3  
ok
logðTBtk Þ þ bk
log YAUS;tk þ pk
log YROW;tk
k¼0 k¼0
ð2Þ
   
þ  log YROW;t þ l logðRERt Þ þ ut
454 A. Wijeweera and B. Dollery
Table 1. Results for the goods sector

Variable Coefficient SE t-Statistic Probability

C 0.17 0.20 0.84 0.41

log(TB-1) –0.06 0.12 -0.49 0.63

log(TB-2) 0.26 0.11 2.29 0.02

log(YAUS) 1.68 0.77 2.17 0.03

log(YAUS,-1) -0.36 0.75 -0.48 0.63

log(YAUS,-2) -0.92 0.73 -1.25 0.21

log(YROW) 0.30 0.25 1.19 0.24

log(YROW,-1) 0.58 0.24 2.38 0.02

log(YROW,-2 -0.42 0.25 -1.67 0.10

log(RER) 0.28 0.14 1.94 0.06

log(RER-1) 0.25 0.15 1.76 0.08

log(RER-2) -0.02 0.15 -0.15 0.88
log(TB-1) -0.27 0.09 -2.97 0.00
log(YAUS,-1) -0.07 0.11 -0.67 0.50
log(YROW,-1) 0.07 0.11 0.60 0.55
log(RER-1) -0.07 0.06 -1.09 0.28
Adjusted R2 0.31

Notes: All these variables have been defined in Equation 1. Negative

subscripts of the variables represent lagged values. For instance, log
(RER-1) means logarithm of one period lagged real exchange rate. Long-
run results and results relating to the exchange rate are shown in the box.

Table 2. Results for the services sector

Variable Coefficient SE t-Statistic Probability

C -0.46 0.38 -1.21 0.23

log(TB-1) -0.09 0.10 -0.83 0.41

log(TB-2) -0.53 0.10 -5.48 0.00

log(YAUS) 0.34 0.81 0.41 0.68

log(YAUS,-1) -1.89 0.78 -2.42 0.02

log(YAUS,-2) 0.02 0.75 0.03 0.98

log(YROW) 0.39 0.27 1.44 0.15

log(YROW,-1) 0.23 0.27 0.84 0.40

log(YROW,-2) -0.41 0.25 -1.64 0.11

log(RER) -0.04 0.15 -0.27 0.79

log(RER-1) 0.00 0.16 0.03 0.98

log(RER-2) -0.24 0.16 -1.45 0.15
log(TB-1) -0.25 0.11 -2.36 0.02
log(YAUS,-1) -0.09 0.11 -0.83 0.41
log(YROW,-1) 0.14 0.13 1.11 0.27
log(RER-1) 0.19 0.09 2.26 0.03
Adjusted R2 0.50

Note: Long-run results and results relating to the exchange rate variables
are given in the box.

reject the existence of short-run effects of the real
exchange rate on the services sector balance of the
trade account. The real exchange rate exerts a highly
significant effect on the services sector balance of the
trade account. The impacts are not only significant,
but also have the anticipated effects of improving the
services sector of the trade balance. We thus have
negative coefficients for the early lags, followed by
positive coefficients for the long-run effects suggesting
J-curve effects in the case of the services sector. These
contrasting findings of no J-curve effects for the goods
sector, but reasonably strong evidence of the J-curve
effects in the services sector need to be investigated in
greater depth and warrant further research.
There are two method-specific tests to confirm the
robustness of our findings. The first is the bound test
for the long-run coefficients. As shown by Pesaran et al.
(2001), the results based on Equation 2 are valid only if
the level variables are, in fact, a part of the model. We
perform the F-test to test the null hypothesis that
J-curve disparity between the goods sector and the services sector
b =  = l = 0 or no level relationship exists between
the variables under consideration. Pesaran et al. (2001)
suggest a bound testing approach for the F-test in
making the decision. Critical values are given for two
bands: upper bound assuming I(1) variables and lower
bound assuming I(0) variables. The upper bound value
for our specification is 3.77 and the F-test statistics are
outside this range for both the goods and services sector
balances so that we can draw conclusive inferences
from the results based on the error correction modelling
framework shown in Equation 2.
455
The second diagnostic test involves estimating the
ARDL model substituting an error correction term
for the variables in levels. The significance of the
error correction term is considered as a further proof
for the long-term relationship between the chosen
variables. As shown in Pesaran et al. (2001), this
method is advisable in the subsequent estimation of
short-run dynamics because it has a more parsimo-
nious specification than the version given in
Equation 2. The model with an error correction term
is given by the following equation:

X
n1 X
n2   Xn3  

logðTBt Þ ¼ a þ ok
logðTBtk Þ þ bk
log YAUS;tk þ pk
log YROW;tk
k¼1 k¼0 k¼0
ð3Þ
X
n4
þ lk
logðRERtk Þ þ rECTt1 þ ut
k¼0

Table 3. Error correction results for the goods sector trade balance

Variable Coefficient SE t-Statistic Probability

C -0.02 0.02 -1.19 0.24

log(TB-1) -0.06 0.12 -0.48 0.63

log(TB-2) 0.28 0.11 2.60 0.01

log(YAUS) 1.66 0.77 2.16 0.03

log(YAUS,-1) -0.17 0.72 -0.23 0.82

log(YAUS,-2) -0.85 0.70 -1.20 0.23

log(YROW) 0.44 0.23 1.95 0.05

log(YROW,-1) 0.66 0.23 2.89 0.01

log(YROW,-2) -0.33 0.24 -1.37 0.18

log(RER) 0.33 0.14 2.35 0.02

log(RER-1) 0.21 0.14 1.50 0.14

log(RER-2) -0.08 0.14 -0.60 0.55
ECTG-1 -0.26 0.09 -2.87 0.01
Adjusted R2 0.31

Note: ECTG-1 is the one-period lag residuals from Equation 1 using goods
sector trade balance data.

Table 4. Error correction results for the services sector trade balance

Variable Coefficient SE t-Statistic Probability

C 0.04 0.02 2.61 0.01

log(TB-1) -0.02 0.11 -0.17 0.86

log(TB-2) -0.48 0.10 -5.05 0.00

log(YAUS) 0.13 0.77 0.16 0.87

log(YAUS,-1) -1.90 0.74 -2.57 0.01

log(YAUS,-2) 0.23 0.72 0.33 0.75

log(YROW) 0.07 0.24 0.30 0.77

log(YROW,-1) -0.58 0.24 -2.37 0.02

log(YROW,-2) -0.50 0.24 -2.11 0.04

log(RER) -0.17 0.14 -1.21 0.23

log(RER-1) 0.03 0.15 0.17 0.86

log(RER-2) -0.25 0.15 -1.68 0.10
ECTS-1 -0.27 0.10 -2.77 0.01
Adjusted R2 0.52

Note: ECTS-1 is the one-period lag residuals from Equation 1 using service
sector trade balance data.
456
where ECTt-1 is the one-period lag residuals saved
from Equation 1 and ut is the disturbance term. The
choice of the second-order lag is based on the Akaike
Information Criterion. The results of the error correc-
tion models for the goods and services sectors are
shown in Tables 3 and 4, respectively.
Borders have been drawn around the estimates
related to the error correction terms in Tables 3
and 4. The error correction term for the goods sector
trade balance equation is -0.26. This is significant at
5% level. Its value suggests that, after a shock in the
goods sector, approximately 26% of the deviation is
corrected within one quarter. The results are even
stronger for the services sector of the trade balance.
The error correction term for the services sector is
significant at 1% level and converges to the equili-
brium at a faster rate of 27% in the first quarter.
V. Summary and Conclusion
This article has employed an error correction mod-
elling approach, together with an ARDL specifica-
tion, to estimate the short-run and long-run
behaviour of the Australian goods/services sector
trade balance in response to exchange rate deprecia-
tions. We found some evidence of the existence of
J-curve effect in the services sector. However, in line
A. Wijeweera and B. Dollery
with ex ante expectations, we found no statistical
support for the J-curve phenomenon for the goods
sector. These results are in accord with the intui-
tively plausible assumption that depreciation may
help to improve the services sector component of
the trade account in the long run, but not the goods
sector component. Hence, studies based on aggre-
gate data alone may not be helpful in policy analy-
sis and policy prescription.
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Bahmani-Oskooee, M. and Wang, Y. (2006) The J-curve:
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