How Would an Appreciation of the RMB and Other East Asian Currencies Affect China s Exports?

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1 How Would an Appreciaion of he RMB and Oher Eas Asian Currencies Affec China s Expors? Willem Thorbecke* George Mason Universiy and RIETI Gordon Smih** George Mason Universiy January 2008 Forhcoming in he Review of Inernaional Economics Keywords: Global imbalances; exchange rae elasiciies; China JEL classificaion: F32, F41 Acknowledgemens: We hank he associae edior (Menzie Chinn) and wo anonymous referees for exremely valuable commens. We also hank Yujiro Hayami, Akira Kawamoo, Kozo Oikawa, Keijiro Osuka, Yasuyuki Sawada, Ichiro Takahara, Ryuhei Wakasugi, Masaru Yoshiomi, and seminar paricipans a GRIPS-FASID, RIETI, and he 2007 WAFA Annual Conference for many helpful commens. * Corresponding Auhor, RIETI, Kasumigaseki, Chiyoda-ku, Tokyo, , Japan; Tel.: ; Fax: ; ** Deparmen of Economics, MSN 3G4, George Mason Universiy, Fairfax, VA 22030, U.S.; Tel.: (703) ; Fax: (703) ;

2 How Would an Appreciaion of he RMB and Oher Eas Asian Currencies Affec China s Expors? Absrac: China s global curren accoun surplus equaled 9 percen of Chinese GDP in 2006 and 12 percen of GDP in he firs half of Many argue ha an RMB appreciaion would help rebalance China s rade. Using a panel daa se including China s expors o 33 counries we find ha a 10 percen RMB appreciaion would reduce ordinary expors by 12 percen and processed expors by less han 4 percen. A 10 percen appreciaion of all oher Eas Asian currencies would reduce processed expors by 6 percen. A 10 percen appreciaion hroughou he region would reduce processed expors by 10 percen. Since ordinary expors end o be simple, labor-inensive goods while processed expors are sophisicaed, capial-inensive goods, a generalized appreciaion in Eas Asia would generae more expendiure-swiching owards U.S. and European goods and conribue more o resolving global imbalances han an appreciaion of he RMB or oher Asian currencies alone. 1. Inroducion China's global curren accoun surplus equaled 9 percen of Chinese GDP in 2006 and 12 percen of GDP in he firs half of The Chinese governmen, in is fiveyear plan, acknowledged he need o rebalance is economy. Many have argued ha an appreciaion of he renminbi would help o achieve his goal. How would an appreciaion of he RMB affec China s rade? As he IMF (2005) discusses, few sudies repor he responsiveness of China's expors and impors o exchange rae changes. Mann and Plück (2005), using a dynamic panel specificaion and disaggregaed rade flows, repor ha price elasiciies for U.S. impors from China are wrong-signed and ha price elasiciies for U.S. expors o China are no saisically significan. Thorbecke (2006), employing Johansen MLE and dynamic OLS echniques, finds ha he long run real exchange rae coefficiens for 1

3 expors and impors beween China and he U.S. equal approximaely uniy. Cheung, Chinn, and Fujii (2007), using dynamic OLS mehods, find ha an appreciaion of he RMB increases U.S. expors o China bu does no affec China s expors o he U.S. Marquez and Schindler (2007), using an auoregressive disribued lag model and China s shares in world rade, repor ha a 10 percen appreciaion of he RMB would reduce China s share of world expors by half a percenage poin and China s share of world impors by a enh of a percenage poin. Marquez and Schindler (2007) find ha disaggregaing Chinese rade ino ordinary rade and processing rade produces beer esimaes. Ordinary expors are produced primarily using domesic inpus. Processed expors are produced hrough inricae producion and disribuion neworks cenered in Eas Asian counries. Japan, Souh Korea, Taiwan, and muli-naional corporaions (MNCs) in ASEAN expor sophisicaed echnology-inensive inermediae goods and capial goods o China for assembly by lower-skilled workers. The finished producs are hen expored hroughou he world. These processed expors accouned for 53 percen of China s oal expors in Because of hese rading neworks, Chinese value-added in processed expors is smaller han he value of inermediae goods impored from oher (primarily Asian) counries. Thus one would no expec a unilaeral RMB revaluaion agains he counries purchasing final expors o affec impor prices in he imporing counries currencies as much as a generalized appreciaion of Asian currencies agains he counries purchasing final expors. 2

4 Rahman and Thorbecke (2007) compare he effecs on China s expors of 1) a unilaeral RMB appreciaion and 2) a join appreciaiom among supply chain counries agains counries purchasing processed expors. Resuls obained using generalized mehod of momens echniques indicae ha a join appreciaion would significanly reduce China s expors while a unilaeral appreciaion would no. Rahman and Thorbecke s paper, however assumes ha one can consider a change in he bilaeral RMB exchange rae holding he rade-weighed exchange rae in he res of Eas Asia consan. While his is possible o do mahemaically, i may no be possible economically given he fac ha hese variables move closely ogeher. 1 This paper akes a differen ack. I consrucs a single inegraed exchange rae variable o measure changes in he relaive foreign currency coss no jus of China s value-added bu of China s enire oupu of processed expors. I also assumes ha ordinary (non-processed) expors are affeced by he RMB exchange rae, since hey are produced primarily using domesic inpus. The resuls indicae ha if he RMB appreciaed by 10 percen agains imporing counries hen ordinary expors would decline in he long run by 11 or 12 percen. The effec on processed expors would depend on wha happened o exchange raes in he res of Asia. If he RMB appreciaed by 10 percen agains imporing counries and exchange raes in he res of Eas Asia remained he same hen processed expors would fall by 4 percen. If he RMB remained unchanged bu he res of Eas Asia appreciaed by 10 percen agains counries purchasing final goods hen processed expors would fall by 6 1 We are indebed o Prof. Menzie Chinn for his poin. 3

5 percen. If boh he RMB and oher Eas Asian currencies appreciaed by 10 percen hen processed expors would decline by 10 percen. 2 Thus an RMB appreciaion alone would primarily affec ordinary expors. These end o be simple, labor-inensive goods such as oys and exiles. If he goal of an RMB appreciaion is o resolve imbalances beween China and he res of he world (especially he U.S. and Europe), a reducion in ordinary expors would no be helpful. A reducion in ordinary expors from China o he res of he world would be replaced by an increase in labor-inensive expors from oher counries on lower rungs of he ladder of comparaive advanage. An appreciaion in he res of Eas Asia alone would also be insufficien o cause a large decline in processed expors. A generalized appreciaion in boh China and he res of he region would be necessary o produce a large drop in he expor of capial-inensive, echnologically-sophisicaed processed expors. Thus a generalized appreciaion would be needed o swich expendiures owards U.S. and European goods and rebalance world rade. 3 The nex secion surveys China s posiion in he global supply chain. Secion 3 presens our empirical framework. Secion 4 conains he resuls. Secion 5 concludes. 2 This is rue assuming all impors for processing come from oher Eas Asian counries. 3 The expendiure-swiching effec of exchange rae changes depends on he degree of exchange rae passhrough o radable prices. The IMF (2005) esimaes ha a 10 percen RMB appreciaion would raise he foreign currency prices of China s expors by 5 percen. Vigfusson, Shees, and Gagnon (2007) repor ha 10 percen currency appreciaions would raise he foreign currency prices of he Asian NIEs expors by 7 percen and of Japan s expors by 5 percen. Thus he degree of exchange rae pass-hrough should be sufficien o permi exchange rae appreciaions in Asia o reduce expors. 4

6 2. China s Posiion in he Global Supply Chain Eas Asia is characerized by inricae producion and disribuion relaionships, consiuing par of a global riangular rading nework. Japan, Souh Korea, Taiwan and MNCs locaed in ASEAN produce sophisicaed echnologyinensive inermediae goods and capial goods and ship hem o China for assembly by lower-skilled workers. The finished producs are hen expored hroughou he world. These producion and disribuion neworks have promoed economic efficiency and helped o make Eas Asia as a whole (no jus China) a major manufacuring cener. While neworks are common in oher pars of he world (e.g., pars and componens expored from he U.S. for assembly in Mexico), fragmenaion in Eas Asia is paricularly elaborae and well-developed. I involves complicaed combinaions of inra-firm rade, arms-lengh ransacions, and ousourcing (see Kimura and Ando, 2005). These neworks have allowed firms o exploi comparaive advanage by slicing up long producion processes and allocaing he producion blocks creaed in his way hroughou Asia. These rade-fdi linkages have led o produciondisribuion neworks in Eas Asia ha can be characerized as verical inra-indusry rade (VIIT). VIIT differs boh from he exchange of final goods emphasized by radiional rade heory for verical iner-indusry rade beween he Norh and he Souh (e.g., beween capial goods and apparel) and for horizonal inra-indusry rade beween he Norh and he Norh (e.g., beween wo differeniaed ypes of auomobiles). As Fukao e al. (2002) and Yi (2003) discuss, he producion processes of an indusry 5

7 (e.g., he elecronics indusry) can be spli ino fragmened producion blocks ha are locaed in differen counries and he new VIIT is essenially based on differences in facor endowmens in he fragmened producion blocks beween developing, emerging, and developed economies in he region. Table 1 shows China s role in his riangular rading srucure. The daa are aken from China s Cusoms Saisics, which disinguishes beween impors and expors linked o processing rade and ordinary impors and expors. 4 Impors for processing are goods ha are brough ino China for processing and subsequen reexpor. Processed expors, as classified by he Chinese cusoms auhoriies, are goods ha are produced in his way. Impors for processing are impored duy free and neiher hese impored inpus nor he finished goods produced using hese impors normally ener China s domesic marke. By conras, ordinary impors are goods ha are inended for he domesic marke and ordinary expors are goods ha are produced primarily using local inpus. Table 1 shows ha in percen of China s impors were for processing. Of his percen, abou seven-enhs came from oher Eas Asian counries. By conras, only one-wenieh each came from he U.S. and from he EU. Table 1 also shows ha in percen of China s expors were processed expors. Of his 53 percen one-quarer wen o he U.S., anoher one-quarer wen o Eas Asia (excluding Hong Kong), one-quarer wen o Hong Kong (largely as enrepô rade), and one-sixh wen o Europe. Since inermediae inpus are impored primarily from Eas Asia bu no from Europe and he U.S. and since processed expors are expored hroughou he world, 4 The websie for China s Cusoms Saisics is 6

8 China ends o run rade deficis wih Asia bu rade surpluses wih Europe and he U.S. As Table 1 shows, China s defici wih Eas Asia (excluding Hong Kong) in 2006 equaled $100 billion and is surpluses wih Europe and he U.S. equaled $76 and $153 billion, respecively. China s surplus wih Europe and he U.S. was acually larger han he official saisics indicae because of he disorionary effecs of enrepô rade hrough Hong Kong. Kwan (2006) argues ha, because of enrepô rade, impor daa are much more accurae han expor daa. When Chinese firms ransship goods hrough Hong Kong, he Chinese governmen ofen does no know he final desinaion of he goods. They hus record hese goods as being expored o Hong Kong. On he oher hand, when he goods arrive a heir ulimae desinaion he imporing counry records he goods as coming from China. Kwan hus advocaes using impor daa from boh rading parners o calculae bilaeral rade balances. 5 Using his approach, China s surplus wih Europe in 2006 increased from $76 billion o $93 billion. China s surplus wih he U.S. increased from $153 billion o $243 billion. $243 billion far exceeds China s overall 2006 surplus of $177.5 billion. Thus, for China is o rebalance is economy, i mus reduce is surplus wih Europe and especially wih he U.S. 3. The Empirical Framework Bilaeral and Weighed Exchange Raes 5 A more sophisicaed approach would ake ino accoun adjusmens for c.i.f. f.o.b facors and for he value added by Hong Kong middlemen. See Fung and Lau (2003). 7

9 Mos of he value-added for Chinese processed expors comes from oher (primarily Eas Asian) counries. Therefore a unilaeral appreciaion of he RMB agains he counries purchasing final expors would no affec he coss of Chinese processed expors measured in he imporing counry s currency as much as a generalized appreciaion in Eas Asia. A generalized appreciaion in Asia agains he counries purchasing final expors, as Yoshiomi (2007) discusses, would essenially change he relaive foreign currency cos no jus of China s value-added bu of China s enire oupu of processed expors. This should have a much larger effec on China s processed expors han a unilaeral appreciaion of he RMB. China s share of he oal coss (is value-added in processing rade) equals he difference beween he value of China s processed expors (VPE ) and he value of impors for processing from all supply chain counries ( i VIP i, ): VA = ( VPE VIPi, ) / VPE = 1 VIPi, / VPE, Chin, i i (1) where VA Chin, equals China s value-added in processing rade. Each year we use daa on he oal value of processed expors and he oal value of impors for processing, obained from China Cusoms Saisics, o calculae China s value-added. To calculae he share of oal coss for oher supply chain counries we collec annual daa from China Cusoms Saisics on impors for processing from 33 counries over he period. 6 For each year we include every counry ha supplies a leas one percen of he oal value of impors for processing from he 33 counries. For hese 6 The counries are: Argenina, Ausralia, Ausria, Belgium, Brazil, Canada, Denmark, Finland, France, Germany, Greece, Hong Kong, Indonesia, Iceland, Ireland, Ialy, Japan, Luxembourg, Malaysia, Mexico, he Neherlands, New Zealand, he Philippines, Porugal, Russian Federaion, Singapore, Souh Korea, Spain, Sweden, Taiwan, Thailand, he Unied Kingdom, and he Unied Saes. 8

10 counries we deermine weighs (w i, ) by dividing heir conribuion o China s impors for processing by he amoun of impors for processing coming from all he counries supplying a leas one percen of he oal. We hen use hese weighs o find he weighed exchange rae ( wrer j, ) for a counry j ha purchases China s processed expors by calculaing he inner produc of he weighs and he bilaeral real exchange raes beween he counries supplying impors for processing and counry j: wrer j, = wi, i rer i, j,, (2) where rer, i, j is he bilaeral real exchange rae beween supply chain counry i and counry j purchasing he final processed expors. We combine wrer j, wih he bilaeral exchange rae beween China and counry j ( rer Chin, j, ) weighed by China s value-added in processing rade. This allows us o calculae a single inegraed exchange rae ( irer j, ) measuring how exchange rae changes affec he enire cos of China s expors of processed goods o counry j: irer = VA rer + ( 1 VAChin, ) wrerj, j, Chin, Chin, j,. (3) To calculae irer in his way i is necessary o measure exchange raes using a common numeraire. We can do his by employing he real exchange rae variables consruced by he Cenre D Eudes Prospecives e D Informaion Inernaionales (CEPII). These variables compare observed exchange raes o PPP ones, and exceed 100 when he currency is overvalued. They are hus comparable boh cross secionally and over ime. These variables are obained from he CEPII-CHELEM daabase. 9

11 We recalculae China s value-added, he weighed exchange rae, and he inegraed exchange rae each year. Unlike China s processed expors, China s ordinary expors are produced primarily using local inpus. We hus employ he bilaeral RMB exchange rae ( rer Chin, j, ) o explain China s ordinary expors o counry j. Idenifying Trade Elasiciies I is difficul o esimae price elasiciies for China s rade because he RMB has no flucuaed very much. Boh he real effecive exchange rae and he bilaeral RMB rae agains he dollar have been relaively sable in recen years. To circumven his problem we look a China s expors o 33 counries over he period. While he U.S. dollar/rmb exchange rae has no changed very much, here has been subsanial variaion boh cross-secionally and over ime in he real RMB exchange rae relaive o he 33 counries. This approach should hus help o idenify in an economeric sense how exchange rae changes affec China s mulilaeral expors. Following he imperfec subsiues model of Goldsein and Khan (1985), we represen expors as: ln x = α 1 ln er + α 2 ln rgdp * (4) where x represens real expors, er represens he real exchange rae, and rgdp * represens foreign real income. 7 7 Equaion (4) is derived by assuming ha he quaniy of China s expors demanded by oher counries depends on income in he oher counries and he price of China s expors relaive o he price of domesically produced goods in hose counries and ha he quaniy of expors supplied by China depends on he expor price relaive o China s price level. By equaing demand and supply one can derive (4) (see, e.g., Chinn, 2005). 10

12 I is sandard in he lieraure o ake he real exchange rae and real income as given when esimaing rade equaions (see, for example, Rose and Yellen, 1989). This approach may be subjec o simulaneous-equaion and omied-variable bias. If he elasiciy of supply is infinie, however, i is possible o idenify he parameers in equaion (4). In he case of China here are reasons o believe ha he perfec supply elasiciy assumpion may be reasonable. Firs, China has abou 200 million redundan laborers. 8 This large pool of workers seeking employmen in he expor secor may enable Chinese exporers o increase supply a consan prices. Second, as he IMF (2005) argues, he supply of impors for processing will vary one for one wih he demand for processed expors. Marquez and Schindler (2007) presen formal evidence supporing his asserion. They repor ha he coefficien on impors for processing is nearly always one in regressions where he dependen variable is China s processed expors. Thus boh labor and sophisicaed inermediae goods end o flow elasically ino China s expor indusries o accommodae increases in demand in he res of he world. Following Marquez and Schindler (2007) and Cheung, Chinn, and Fujii (2007) we do invesigae he relaionship beween impors for processing and processed expors. We do his by including Chinese impors for processing relaive o GDP in one of our specificaions. Choice of Deflaors 9 8 China has beween 150 and 200 million redundan rural laborers, 7-8 million new workers joining he labor force each year, and 14 million urban workers who are unemployed or underemployed. We are indebed o he Chinese Academy of Social Sciences for hese daa. 9 We are indebed o an anonymous referee for he analysis in his secion. 11

13 There is no price index for China s expors over our sample period. If we had daa on expor prices, expor volume could be represened as: x = XV Px, (5) where XV is he nominal value of expors and Px is he price of China s expors. If insead of Px we use a proxy Px hen expor volume can be represened as: x XV = Px. (6) Assuming: Px = Px θ, (7) where θ is he approximaion error, hen one ges: x XV XV XV = = = θ = θ x Px Px Px θ. (8) Taking logs yields: 12

14 ln x = lnθ + ln x. (9) Equaion (4) implies: ln x = lnθ + α ln er + α ln rgdp 1 2. (10) Since θ is no direcly observable we need o make an assumpion abou i. We assume ha θ depends on China s capial sock: θ = AK α 3. (11) This implies ha: ln x = ln A + α ln er 1 + α ln rgdp 2 α ln K. 3 (12) We hus esimae equaions of he form (12). 10 Daa and Economeric Mehodology Our dependen variable is eiher processed or ordinary expors from China o 33 counries. These daa are obained from China s Cusoms Saisics and are measured in U.S. dollars. We deflae he expor daa in hree ways. Firs, following Chinn (2006), we deflae Chinese expors using he U.S. Bureau of Labor Saisics (BLS) price deflaor for impors from non-indusrial counries. Chinn finds ha his series closely maches he 10 A second raionale for including he capial sock in equaion (12) is provided by Cheung, Chinn, and Fujii (2007). They argue ha he Chinese capial sock in manufacuring helps o conrol for supply side facors. 13

15 BLS price deflaor for impors from China, which became available in Second, we use he Hong Kong expor price deflaor. Since many of Hong Kong s expors are reexpors from China, his measure may be a useful proxy for Chinese expor prices. Third, following Eichengreen e al. (2004), we use he U.S. consumer price index o deflae China s expors. This measure would be appropriae if he bundle of goods and services expored from China corresponds o he bundle purchased by U.S. consumers. The resuls repored below are similar regardless of which deflaor we use. Our independen variables include he inegraed real exchange rae ( irer i ) when he lef hand side variable is processed expors and he bilaeral RMB real exchange rae ( rer Chin, i ) when he lef hand side variable is ordinary expors. We also use real income in he imporing counry ( rgdp ), he Chinese capial sock in manufacuring ( K ), Chinese i impors for processing relaive o Chinese GDP (imgdp ), and a WTO dummy variable ha akes on a value of 1 afer China joined he WTO. 11 As discussed above, irer i is consruced using real exchange rae daa obained from he CEPII-CHELEM daabase. Daa on rer Chin, i and rgdpi are also obained from CEPII-CHELEM. An increase in eiher ireri or rer Chin, i represens an appreciaion of he exchange rae. The Chinese capial sock daa have been consruced by Bai, Hsieh, and Qian (2006). Daa on China s impors for processing are obained from China s Cusoms Saisics. We esimae he model using dynamic ordinary leas squares (DOLS). DOLS involves regressing he lef hand side variable on a consan, he righ hand side variables, 11 Garcia-Herrero and Koivu (2007) posi ha China s WTO accession began affecing China s rade afer i became cerain ha China would join he WTO in he beginning of We hus se he WTO dummy variable equal o one beginning in

16 and lags and leads of he righ hand side variables. The individual expor equaions have he form: x i, = β + β er 0 1 i, + β rgdp 2 i, + β K + β Time + β WTO p j= p Δer i, j + p j= p Δrgdp i, j + p j= p ΔK j + μ + u i i, = 1, L, T; i = 1, L, N. (13) Here represens real expors (eiher processed or ordinary) from China o counry i, x i, er i, represens eiher he inegraed real exchange rae ( irer i, ) or he bilaeral real exchange rae beween China and counry i ( rer Chin, i, ), rgdp i, equals real income in he imporing counry, K denoes he Chinese capial sock in manufacuring, Time is a ime rend, WTO is he WTO dummy variable, μ is a counry i fixed effec, and p represens he number of leads and lags. x,, er,, rgdp,, and K are measured in i naural logs. x,, er,, and rgdp, vary boh over ime and across counries and K only i i i varies over ime. In one specificaion for processed expors we also include Chinese impors for processing relaive o Chinese GDP ( imgdp ). By esimaing a log-linear model we are assuming ha he elasiciies are consan. An alernaive would be o esimae a linear model and assume ha he marginal propensiy o impor is consan. Marquez (1999) has argued persuasively ha as economies become more open o rade he marginal uiliy of impors and hus he associaed income elasiciy falls. As a general proposiion he is clearly correc. In our case, however, mos of he counries we use are Eas Asian or OECD counries ha were open o impors hroughou our sample period. Impors from China, hough, were a i i i 15

17 miniscule share of expendiures a he beginning of he sample period and an enormous share a he end. Because of his we hink ha imposing a consan marginal propensiy o impor from China would do violence o he daa. On he oher hand, given he srong demand for impors from China ha coninued unabaed unil 2005, here did no appear o be a significan decrease in he marginal uiliy of hese goods over our sample period. Thus we assume ha he income elasiciy of demand raher han he marginal propensiy o impor remains consan. Following Cheung, Chinn, and Fujii (2007) and Marquez and Schindler (2007), we begin our esimaion in Our daa se exends o To preserve degrees of freedom we use one lead and lag in he DOLS esimaion. Our panel includes annual expors o 33 counries Resuls Table 2 presens he resuls for ordinary expors and Table 3 for processed expors. In boh ables resuls are presened using all hree deflaors. The findings are similar including and excluding he capial sock and he ime rend. We hus repor resuls only from our preferred specificaion including he capial sock and excluding he ime rend. The oher resuls are available upon reques. In Table 2 for ordinary expors he coefficien on income, while always posiive, is small. The elasiciy esimaes range from 0.53 o These values are less han he income elasiciies we repor below for processed expors. This is probably because, 12 The counries are: Argenina, Ausralia, Ausria, Belgium, Brazil, Canada, Denmark, Finland, France, Germany, Greece, Hong Kong, Indonesia, Iceland, Ireland, Ialy, Japan, Luxembourg, Malaysia, Mexico, he Neherlands, New Zealand, he Philippines, Porugal, Russian Federaion, Singapore, Souh Korea, Spain, Sweden, Taiwan, Thailand, he Unied Kingdom, and he Unied Saes. 16

18 compared wih processed expors, ordinary expors conain more simple labor-inensive goods (e.g., exiles and oys) ha have lower income elasiciies. The exchange rae elasiciy, on he oher hand, is large. The coefficien on he bilaeral exchange rae is of he expeced negaive sign, indicaing ha an appreciaion of rer, Chin, i reduces ordinary expors. The coefficien is saisically significan in all hree specificaions, and ranges in value from o This elasiciy may be large because profi margins for ordinary expors are hin, and hus cos increases arising from exchange rae changes cause a large drop in oupu. Thin profi margins may also explain he coefficien on he WTO dummy variable. I is posiive and saisically significan in all hree specificaions, wih values ranging from 0.19 o These resuls imply ha, conrolling for oher facors, ordinary expors rose abou 20 percen higher following China s accession o he WTO. Favorable access o overseas markes evidenly led o a large increase in ordinary expors. Finally, he Chinese capial sock variable is posiive and saisically significan. The coefficiens range from 1.59 o These values are no far from hose repored by Cheung, Chinn, and Fujii (2007). They repored values of his coefficien beween 1.83 and Table 3 presens he findings for processed expors. The income elasiciy is posiive and saisically significan in all hree specificaions. Coefficien values range from 2.30 o The relaively high income elasiciy probably reflecs he fac ha processed expors conain many sophisicaed, high-ech goods such as digial cameras and lapop compuers ha consumers are more likely o purchase as heir incomes increase. 17

19 The coefficien on he inegraed exchange rae is of he expeced negaive sign, indicaing ha an appreciaion of irer reduces processed expors. The coefficien is saisically significan in every specificaion, wih values ranging from o The coefficien on he WTO dummy variable is posiive in wo specificaions and negaive in one. In all hree cases he coefficien is small and no saisically significan. These resuls imply ha China s WTO accession did no lead o an increase in processed expors. Finally, he Chinese capial sock variable is always posiive and saisically significan. The coefficien values range from 0.99 o Cheung, Chinn, and Fujii (2007) repored slighly higher values of hese coefficiens, ranging from 1.52 o Table 4 presens resuls wih impors for processing relaive o Chinese GDP used in place of he WTO dummy variable. The coefficien on his variable is posiive in all hree specificaions bu never saisically significan. The coefficiens on he oher variables remain saisically significan. One inerpreaion of hese findings is ha expor demand is driven by exchange rae and income changes, and impors for processing vary passively wih expor demand. Thus impors for processing do no have an independen effec on processed expors. A second inerpreaion is ha imgdp does no have explanaory power because i represens aggregae impors for processing while he lef hand side variable represens processed expors o specific counries. Maybe irer and rgdp have more explanaory power han imgdp because hey ake on differen values boh across counries and across ime while imgdp only akes on differen values across ime. In any case, he resuls are consisen wih he hypohesis ha changes in irer 18

20 and rgdp ha affec he demand for processed expors will in urn affec he flow of impors for processing ino China. For insance, a generalized appreciaion in Eas Asia ha reduced China s processed expors would reduce China s impors of inermediae goods from he region. 13 Ineresingly, he coefficien on he exchange rae is no very differen if he inegraed exchange rae is replaced wih he bilaeral exchange rae beween China and he counries purchasing processed expors. The coefficien values for he bilaeral exchange rae range from o and he oher coefficiens are almos unchanged. We neverheless believe ha he specificaion wih he inegraed exchange rae is preferable o he specificaion wih he bilaeral exchange rae. As he IMF (2007) and Yoshiomi (2007) discuss, exchange raes in all supply chain counries and no jus he bilaeral exchange rae should affec China s processed expors. In addiion, a specificaion wih irer allows us o say wha would happen in a siuaion like he presen where exchange raes in oher Asian counries such as Souh Korea and Thailand appreciae much more han he RMB does. For he inegraed exchange rae he exchange rae elasiciy is approximaely equal o uniy. In addiion, China s value-added in processed expors equaled 37 percen in Thus a 1 percen appreciaion of he RMB alone agains he counries purchasing final expors would reduce processed expors by 0.4 percen (=0.37*1.0). A 1 percen appreciaion in he res of Eas Asia alone agains he counries purchasing final expors would reduce processed expors by 0.6 percen. 14 A 1 percen appreciaion in 13 We are indebed o an anonymous referee for his poin. 14 This is rue assuming ha all impors for processing come from oher Eas Asian counries. 19

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