Exchange Rates And Trade In East Asia
Exchange Rates and Trade in East AsiaWillem Thorbecke,RIETIPresentation at the Asian Development Bank9 April 2012
Overview This presentation will consist of 6 parts: 1) East Asian Production Networks 2) A Specific Example: The Global ValueChain for Notebook PCs 3) Triangular Trading Patterns In East Asia 4) China’s Role in Regional Supply Chains 5) Evidence on Exchange Rate Changes andProcessing Trade 6) Policy Implications
1) East Asian Production Networks Fragmentation in East Asia isparticularly sophisticated and welldeveloped compared to networks inthe rest of the world (e.g., parts andcomponents exports from the U.S. forassembly in Mexico) Involves complicated combination ofintra-firm trade, arm’s lengthtransactions, and outsourcing.
Definition of Production NetworksBy a lead firm’s “cross-border production network”(CPN) we mean the inter- and intra-firm relationshipsthrough which the firm organizes the entire range ofits business activities: from research anddevelopment, product definition and design, to supplyof inputs, manufacturing (or production of a service),distribution, and support services. We thus includethe entire network of cross-border relationshipsbetween a lead firm and its own affiliates andsubsidiaries, but also its subcontractors, suppliers,service providers, or other firms participating incooperative relationships, such as standard setting orR&D [research and development] analysis.Borrus et al. (2000)
Vertical Intra-Industry Trade These networks have allowed firms to exploit comparativeadvantage by slicing up production processes and allocatingthe production blocks throughout Asia.The production-distribution networks thus created can becharacterized as vertical intra-industry trade (VIIT).VIIT differs from the exchange of final goods for verticalinter-industry between the North and the South (e.g.,between capital goods and apparel) and for horizontal intraindustry trade between the North and the North (e.g.,between two differentiated types of automobiles).VIIT makes it possible to exploit differences in factorendowment in the fragmented production blocks betweendeveloping, emerging, and developed economies in theregion
2) A Specific Example:The Global Value Chain forNotebook PCs(1)The lion’s share of international production of notebook PCs takesplace in the Yangtze River Delta of China
A Specific Example:The Global Value Chain forNotebook PCs (continued)(a) In late 2001, the government of Taipei,China de-regulated“outgoing” FDI from notebook PC companies in Taipei,Chinainto China(b) Taipei,China’s Original Design Manufacturers (ODMs) had toaccompany professional suppliers in China to provide training(2) Multi-layered production networks(a) high-value added suppliers of OS (Microsoft) and MPU (Intel)(b) internationally well-known branded makers (HP, Apple,Toshiba, etc.)
A Specific Example:The Global Value Chain forNotebook PCs (continued)(c) Taipei,China’s professional suppliers,consisting of(i) 50 100 relatively large scale firms(ii) up to ten thousand employees per firm(iii) highly professional suppliers of connectors,batteries, switches, displays, etc.(d) a large number of producers of basic industrialmaterials(i) several thousands of small-medium scale firms(ii) varying number of employees averaging a fewhundreds(iii) engaging in casting, forging, plating, moduleassembling, etc: these are manufacturing base
A Specific Example:The Global Value Chain forNotebook PCs (continued)(3) Handling great uncertainties and risks(a) High degree of uncertainties:(i) extremely rapid technological changes(ii) volatilities of market demand(iii) ever shorter product-cycles(b) Adopt literally real time management systemsregarding every aspect of production and transactionarrangements: “build to order” systems, through theuse of ITCs(c) Some Taipei,China’s assembly firms have kept inventorieslean by processing 98 percent of order within 3 days.Productivity growth within this value chain has beenamazing.
3) Triangular Trading Patterns inEast Asia In general, Japan, Korea, Taipei,China, andMNCs located in ASEAN produce sophisticatedtechnology-intensive intermediate goods andcapital goods and ship them to China andASEAN for assembly by relatively low skilledworkers. The finished products are thenexported largely to the West. Theseproduction and distribution networks havepromoted economic efficiency and helped tomake East Asia as a whole (not just China)the manufacturing center of the world.
Intermediate Goods Trade in EastAsia FDI flows into a country areassociated with increases inintermediate goods exports to thatcountry. Examining the flow of intermediategoods can shed light on the evolutionof triangular trading patterns in Asia.
50ChinaBillions of US Dollars4030ASEAN20South Korea& Taipei,China1008486889092949698000204060810Value of Japanese Intermediate Goods Exports to East AsiaNote: ASEAN includes Malaysia, the Philippines, Singapore, and Thailand.Source: CEPII-CHELEM Database.Value of Japanese Intermediate Goods Exports to East Asia (Billions of U.S. 9.112.126.338.736.948.9ASEAN .727.4S.Korea Taipei,China
8070Billions of US dollars6050China4030ASEAN20Japan10South Korea& Taiwan08486889092949698000204060810Value of Intermediate Goods Exports from SouthKorea and Taipei,China to East Asia.Note: ASEAN includes Malaysia, the Philippines, Singapore, and Thailand.Source: CEPII-CHELEM database.Value of S. Korea’s and Taipei,China’s Intermediate Goods Exports to East Asia (Billions ofU.S. 72.3ASEAN 43.610.413.515.520.217.423.1S.Korea Taipei,China0.53.45.810.19.89.013.6
50Billions of US Dollars40China30ASEAN20South Korea& lue of Intermediate Goods Exportsfrom ASEAN to East Asia.Note: ASEAN includes Malaysia, the Philippines, Singapore, and Thailand.Soure: CEPII-CHELEM database.Value of ASEAN 4’s Intermediate Goods Exports to East Asia (Billions.of U.S. ASEAN 43.011.718.523.224.320.429.4S.Korea Taipei,China1.15.012.315.316.715.919.4
28South Korea &Taipei,ChinaBillions of US 060810Value of Intermediate Goods Exports from China to East AsiaNote: ASEAN includes Malaysia, the Philippines, Singapore, and ThailandSource: CEPII-CHELEM DatabaseValue of China’s Intermediate Goods Exports to East Asia (Billions of U.S. 2.03.811.118.015.319.3ASEAN 40.61.32.17.613.411.915.4S.Korea Taipei,China0.51.83.59.921.518.525.8
200Billions of US Dollars160China120ASEAN80South Korea& termediate Goods Exports from East Asiaas a Whole to Individual Countries or Regions.Note: ASEAN includes Malaysia, the Philippines, Singapore, and Thailand.Source: CEPII-CHELEM DatabaseValue of Intermediate Goods Imports of Individual East Asian Countries and Regionsfrom East Asia as a Whole (Billions of U.S. 15.7161.9ASEAN 415.847.554.667.982.769.695.9S.Korea Taipei,China13.231.841.759.274.064.286.1
500Billions of US 8South Korea &Taipei,China00 02 04 060810Final Electronics Goods Exports from ASEAN, China,Japan, and the NIEs.Note: ASEAN includes Malaysia, the Philippines, Singapore, and Thailand.Source: CEPII-CHELEM DatabaseFinal Electronics Exports from East Asian Countries to the 6.3414.7ASEAN 415.847.554.667.982.769.695.9S.Korea Taipei,China13.231.841.759.274.064.286.2
Final Demand Primarily fromoutside of AsiaNote: Asia includes 14 countries for which data is available: Hong Kong, China; Japan; People's Republic of China; Republic ofKorea; and Taipei,China (Northeast Asia); Indonesia; Malaysia; Philippines; Singapore; Thailand; Viet Nam (Southeast Asia ),Bangladesh; India; Pakistan (South Asia). Source: ADB staff estimates from Global Trade Analysis Project (GTAP) version 7.Data refers to the world economy in 2007.
600Billions of US Dollars500400Rest of the World300200East Asia ex-Japan100Japan08486889092949698000204060810Final Electronics Exports from East Asia to Japan, theRest of East Asia, and the Rest of the World.Note: East Asia ex-Japan includes China, Malaysia, the Philippines,Singapore, South Korea, Taipei,China, and Thailand. Rest ofthe World includes all importers other than Japan and EastAsia ex-Japan.Source: CEPII-CHELEM Database.Value of Final Electronics Goods Exports from East Asia to the World (Billions of U.S. 6.136.839.735.649.9East Asia ex-Japan13.032.053.690.7107.991.4109.5Rest of the World79.6134.6194.1338.4455.7400.2496.4Japan
Triangular Trading Patterns in EastAsia Intermediate goods produced in Japan, Korea,Taipei,China, and by MNCs located in ASEAN flow toASEAN countries and China for assembly and re-export. The lion’s share of the final goods flows outside of Asia. China has become especially important as an exporter offinal goods in recent years.
4) China’s Role in Regional SupplyChains Given the growing importance of China in regionalproduction networks, further study is warranted. China’s Customs Statistics distinguishes betweenimports and exports linked to processed trade andordinary imports and exports. Imports for processing are goods that are broughtinto China for processing and subsequent re-export.Processed exports are the goods that are producedthis way. Neither the imports nor the finished goodsnormally enter China’s domestic market. Ordinary imports are goods intended for the domesticmarket and ordinary exports are goods that areproduced using local inputs.
900800Billions of US Dollars700600Processed Exports500400300Imports for Processing2001000949698000204060810Figure 8. China's Imports for Processing and Processed Exports.Source: CEIC Database.Value of Imports for Processing and Processed Exports (Billions of U.S. Dollars)1993199720002008200920102011Imports for d Exports44.399.7137.7675.3587.1740.5835.6
Figure 8 China’s processed exports and imports forprocessing have soared, interrupted only by abrief decline in 2009. Processed exports equaled 741 billion in 2010and 836 billion in 2011, about half of China’stotal exports. The figure also indicates that the gap betweenprocessed exports and imports for processingbegan increasing after 2004, leading to asurplus in processing trade of almost 370billion in 2011.
Table 1. China’s ProcessingTrade, 2007-20102007200820092010S. KoreaTaipei,ChinaASEAN4JapanSingaporeImports for Processing (%)Hong 1116.2015.5314.782.402.282.182.38Processed Exports alance in Processing Trade (billions of U.S. 155.23130.20117.61141.31
Table 1 (top panel) In 2010, 60 percent of imports for processingcame from South Korea, Taipei,China, Japan,and ASEAN is large. In addition, 16 percent of imports forprocessing into China come from China (Xing,2011). Thus more than 75 percent of China’simports for processing come from East Asia. Only 5 percent each comes from the EU andthe US.
Table 1 (middle panel) Table 1 shows that 20 percent ofprocessed exports go to East Asia and80 percent go outside the region. 22percent each go to Hong Kong and tothe US, 17 percent goes to Europe,and 17 percent goes to the rest of theworld.
Table 1 (bottom panel) Since parts and components come primarily from EastAsia and not from the West and finished products goprimarily outside of East Asia and especially to the West,China runs deficits of about 100 billion with East Asiaand surpluses of 150 billion with the US and Hong Kongand 100 billion with Europe. Many of the goods exported to Hong Kong and Singaporeare re-shipped to the US and Europe. Taking account ofthis, China’s surplus with the US and Europe would beeven larger. Using US data, which treat Chineseentrepôt trade through Hong Kong and Singapore ascoming from China, China’s trade surplus with the US in2011 equaled 300 billion. Thus China’s processing trade remains dependent ondemand from the West and especially from the US.
Figure 6a: China's Imports for Processing by Country and Region160000140000Millions of Dollars120000S. Korea Taipei,China1000008000060000JapanASEAN 5EuropeU.S.Hong 20100Source: China Customs Statistics.Note: ASEAN 5 includes Indonesia, Malaysia, the Philippines, Singapore, and Thailand.
Figure 6b: China's Processed Exports by Country and Region180000160000Millions of Dollars140000120000U.S.Hong Kong1000008000060000EuropeJapanS. Korea Taipei,ChinaASEAN 00Source: China Customs Statistics.Note: ASEAN 5 includes Indonesia, Malaysia, the Philippines, Singapore, and Thailand.
Figure 6c. China's Trade Balance in ProcessedGoods by Country and Region200000100000S. Korea TaiwanJapan50000ASEAN 19941992Millions of Dollars150000Hong Kong-100000-150000Source: China Customs Statistics.Note: ASEAN 5 includes Indonesia, Malaysia, the Philippines, Singapore, and Thailand.
5) Exchange Rate Changes andProcessing Trade The majority of the value-added ofprocessed exports comes from other(primarily East Asian countries). A generalized appreciation in EastAsia would thus have a larger effecton the foreign currency cost ofprocessed exports than a unilateralRMB appreciation.
Imperfect Substitutes Framework The quantity of China’s exports demandeddepends on income in the other countriesand the price of China’s exports relative tothe price of domestically produced goods inthose countries. The quantity of exportssupplied by China depends on the exportprice relative to China’s price level. By equating supply and demand we canderive export equations:ext α10 α11rert α12yt ε1t (1)
Identification of Trade Elasticities Infinite supply elasticity would make it possible toidentify the parameters in equation (1). China has150 to 200 million redundant rural laborers. Largepool of workers should enable Chinese exporters toincrease supply at constant prices. In addition, IMF (2005) states that imported inputsfor exports into East Asian processor economiesshould vary one-for-one with processed exports.Thus sophisticated intermediate and capital goodstend to flow elastically into China’s processed exportindustries to accommodate increases in demand in therest of the world.
Weighted Exchange Rates We need to capture China’s value-added and thevalue-added coming from other countries. Following Tong and Zheng (2008), China’s valueadded in processing trade (VA) can be calculated by:VA (VPE – VIP)/VPEwhere VPE is the value of processed exports and VIPis the value of imports for processing.
Value of Imports for Processing The lion’s share of imports for processingcome from ASEAN, Japan, South Korea,and Taipei,China. The two other leadingsuppliers are Germany and the U.S. Foreach of these countries we calculateweights wi each year by dividing eachcountry’s imports for processing by thetotal imports for processing coming fromthe nine major suppliers together.
Integrated Exchange Rate We can use the weights on imports forprocessing and China’s value added tocalculate an integrated exchange rate index(irer) for China’s processed exports:irert irert-1(chinareert/chinareert-1)VAt (reeri,t/reeri,t-1)(1-Vat)witwhere chinareer is China’s real effectiveexchange rate, reeri is the real effectiveexchange rate for supply chain country i.An increase in chinareer, reer, and irer allrepresent exchange rate appreciations.
2008Q 12007Q 22006Q 32005Q 42005Q 12004Q 22003Q 32002Q 42002Q 12001Q 22000Q 31999Q 41999Q 11998Q 21997Q 31996Q 41996Q 11995Q 21994Q 31993Q 41993Q 1Log R eal E xchange R ateFigure 3a. Integrated Real Effective Exchange Rate Index for the EntireValue of China's Processed Exports4.74.654.64.554.54.454.4
Figure 3b. Chinese Real Effective Exchange Rate and Weighted RealExchange Rate for Supply Chain CountriesLog R eal E xchange R ate4.8C hinese Real Effective Exchange Rate4.74.64.54.4W eighted Real Exchange Rate for Supply C hain C ountries4.34.2Source: International Monetary Fund, Bank for International Settlement, and calculations by the author.Note: An increase in the real exchange rate corresponds to an appreciation.2008Q 12007Q 22006Q 32005Q 42005Q 12004Q 22003Q 32002Q 42002Q 12001Q 22000Q 31999Q 41999Q 11998Q 21997Q 31996Q 41996Q 11995Q 21994Q 31993Q 41993Q 14.1
Deflating Exports Exports from the China CustomsStatistics are measured in dollars.Following previous researchers,exports were deflated in three ways: 1) The Hong Kong export pricedeflator. 2) The U.S. producer price index. 3) The U.S. consumer price index.
Other Explanatory Variables Real income in Europe, North America, Japan, SouthKorea, and Australia. Since the lion’s share of exportsgo to high income countries, this should help capturedemand factors in importing countries. FDI Stock. 84 percent of processed exports wereproduced by foreign-invested enterprises. Thus theFDI stock may be an important explanatory variable. A WTO dummy variable.
Estimation Following Cheung, Chinn, and Fujii,estimate model using DOLS. Include two leads and two lags in theestimation.
Equation to be Estimated Xt β0 β1 irert β2 rgdpt β3 FDI β4WTOt β5 TIME Φ 1,k irert-k Φ 2,k rgdpt-k Φ 3,k Φ FDIt-k ui,twhere:Xtrepresents real processed exports from China to theworld,irert represents either the integrated real exchange ratergdpt equals real income in higher income countries,FDIt denotes the stock of FDI,Time is a time trend, andWTO is a dummy variable.3,k
DOLS Estimates of China’s Processed Exports overthe Period 1993-2008IndependentHongVariablesKong unitvalue(1)Rest of the7.93***World GDP(0.36)Integrated-3.09***RER(0.38)FDI Stock-0.13(0.09)WTO-0.01Dummy(0.03)TimeExports deflated by:HongPPIPPIKong .02)U.S. CPIU.S. .04)0.00(0.02)Adjusted .740.72ARCH0.480.470.410.330.630.63No. ofobservation585858585858Serial IndependenceHeteroskedasticityNote: DOLS (2, 2) esimates. Heteroskedasticity-consistent standard errors are in parentheses.*** (**) [*] denotes significance at the 1% (5%) [10%] level.aProbability values from a Lagrange Multiplier test for the null hypothesis that there is no fourth order serial correlation.bProbability values from a Language Multiplier test for the null hypothesis o
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