August 03, 2007
Revaluation and China's Multilateral Trade Balance: First Estimates
Yin-Wong Cheung, Eiji Fujii and I have just completed a paper entitled China's Current Account and Exchange Rate" for a conference on China's Growing Role in World Trade. This paper follows up on some of the issues I laid out in these posts: , , , and .
Figure 1: China's Current Account in billions of USD (blue, left scale) and Current Account to GDP ratio (red, right scale). 2006 and 2007 data are estimates and projections. Source: IMF, World Economic Outlook, April 2007 database.
We obtain several interesting results. First, the CNY is substantially below the value predicted by our cross country estimates. The economic magnitude of the mis-alignment is substantial – on the order of 50% in log terms. However, we also find that the misalignment is typically not statistically significant, in the sense of being more than one standard error away from the conditional mean.
Second, we find that Chinese multilateral trade flows do respond to relative prices -- as represented by a trade weighted exchange rate -- but that that relationship is not always precisely estimated. In addition, the direction of effects is different than expected a priori. For instance, we find that Chinese ordinary imports rise in response to a yuan depreciation. However, Chinese exports do appear to respond to yuan depreciation in the expected manner, as long as a supply variable is included. So, in this sense, Chinese trade is not exceptional.
Furthermore, Chinese trade with the U.S. appears to behave in a standard manner -- especially after the expansion in the Chinese manufacturing capital stock is accounted for. Thus, the China-US trade balance should respond to real exchange rate and relative income movements in the anticipated manner. However, in neither the case of multilateral or bilateral trade flows should one expect quantitatively large effects arising from exchange rate changes. And of course, our results are not informative with regard to the question of how a change in the CNY/USD exchange rate would affect the overall US trade deficit.
Finally, we highlight the fact that considerable uncertainty surrounds both our estimates of CNY misalignment and the responsiveness of trade flows to movements in exchange rates and output levels. In particular, our results for trade elasticities are sensitive to econometric specification, accounting for supply effects, and the inclusion of time trends.
In terms of new results regarding Chinese trade elasticities, we find the following:
- First, it is clear that the estimates are not robust to specification.
- Second, some of the key point estimates are not statistically significant.
- Third, some of the point estimates -- when statistically significant -- are counter-intuitive. In particular, the import elasticities result in problematic results.
For instance, consider a 10% appreciation of the CNY on a trade weighted basis. Using the point estimates from Table 4 in the paper, column 3 of Panels B and C for exports, one finds that Chinese real exports (in 2000$) decline from 952.3 billion (recorded in 2006) to 927.4 in the long run. On the other hand, using column 3 estimates from Panels B and D from Table 5 of the paper, one finds that Chinese imports fall also decline, from 581.6 billion to 510.5 billion. This means that the trade balance increases from 400.9 billion to 416.9 billion, in response to a 10% appreciation. (Note that parts and processing imports fall as total exports rise.)
The ordinary goods import price elasticity estimate of +2.6 drives this particular result. Alternative econometric specifications lead to different estimates. For instance, using a single equation error correction model, allowing for coefficient shifts with Chinese accession to WTO, leads to a statistically insignificant estimate of the price elasticity. In the 2000-06 period, the implied price elasticity is zero. Using this point estimate, then a 10% appreciation would actually lead to a shrinkage of the trade balance from 400.9 billion to 355.2 billion. This estimate of 45.7 billion (2000$) is somewhat less than the $88.6 billion current dollars reported in Marquez and Schindler (forthcoming; working paper version here). For context, the 2006 trade balance expressed in 2000$ was $401 billion.
These findings suggest that exchange rate policy alone will not be sufficient to reduce the Chinese trade balance, especially when taken in the context of a trend increase in China's manufacturing capacity.
Posted by Menzie Chinn at August 3, 2007 03:00 PMdigg this | reddit
What seems to have happened in Korea in response to currency appreciation may have implications for China as well. Total exports continued to grow and surprise strong despite continual KRW appreciation to date. This year Korea's goods exports have done particularly well, gaining global market share, despite the currency being at its strongest point since the Asian crisis and the non-oil trade surplus is at a record high. Korean manufacturing has just kept increasing productivity in response to the currency appreciation. However, it is clear currency appreciation has had a very significant impact.
First, the current account surplus has fallen sharply because of a collapse in the services balance to a huge deficit. Although Korea's manufacturing sector HAS been able to raise productivity, Korea's services sector has not and this is where the change in relative prices is being felt most.
Second, within the manufacturing sector the structure of production has shifted away from labor intensive and low value added goods to capital intensive production and goods with brand capital and proprietary technology.
The Korea experience leads me to wonder if something similar might happen in China. That is, we don't see a clear effect of yuan appreciation on total goods exports for years to come because the Chinese manufacturing sector just keeps raising productivity levels. However, there is nonetheless both a current account adjustment that results from services not being able to adjust and lots of pain in certain goods sectors such as agriculture. Perhaps the Chinese government is more concerned about these intraindustry effects than anything else because of the pressing need to ensure employment remains high in the rural and in the urban low skilled sectors of the labor force.
Posted by: ray at August 3, 2007 09:35 PM
So if you add in the introductory commentary, what we have here is a 52 page blog post. And on a topic that I have been interested in trying to learn more about. Sigh....
Posted by: russell120 at August 5, 2007 12:40 PM
Ray, good post. I agree that Korea is an interesting case study. Take Hyundai's car operations as an example. They've made simply stunning gains in design and quality in just the last 5 years. They have US manufacturing operations. They're going to very soon be competing with Acura, Infiniti, and Lexus with competitive product, not just Honda, Toyota, and Nissan as they now do.
And unlike those Japanese companies, they're competing without a cheapened currency.
You really have to have a lot of respect for the Koreans. I hope that the Chinese are watching and learning. They should be following the example of Korea, not Japan.
Posted by: Buzzcut at August 6, 2007 01:40 PM