Conclusion

The PRC's global current account surplus averaged 10% of GDP between 2007 and 2009. Economists and policymakers throughout the world have argued that the PRC needs to rebalance its economy and to rely less on exports. Many claim that an appreciation of the yuan would help to achieve these goals.

However empirical evidence on the effect of a CNY appreciation has been mixed for the largest category of exports, processed exports. These exports are assembled using parts and components produced in other countries. Since much of the value-added of these exports comes from other East Asian countries, Yoshitomi (2007) and others have argued that exchange rate changes throughout Asia should matter for processed exports.

This paper tests this hypothesis and finds evidence supporting it. The results indicate that an appreciation across East Asia would lead to a large drop in processed exports. An appreciation in the PRC or in other supply chain countries alone, however, would have a smaller effect on exports.

One obstacle to a generalized appreciation throughout East Asia is the PRC's de facto peg to the US dollar. Since Asian economies do not only cooperate within production networks but also compete in third markets, the PRC's peg puts pressure on other countries in the region to prevent their exchange rates from appreciating.

A solution to this impasse would be for the PRC to adopt a regime characterized by a multiple-currency, basket-based reference rate with a reasonably wide band. In this case, the huge surpluses generated within East Asian production networks would cause currencies in the region to appreciate together.

A joint appreciation would benefit East Asia in several ways. It would maintain greater intra-regional exchange rate stability, thus facilitating the flow of parts and components within regional production networks (Hayakawa and Kimura 2009). It would allow consumers in the PRC to import more from the rest of the world (Thorbecke 2009). Finally, it would help prevent unpleasant outcomes such as beggar-thy-neighbor policies and excessive reserve accumulation while also giving Asian firms an incentive to produce for domestic markets. If domestic markets rather than exports could drive job creation in Asia, not only would producers be less exposed to a slowdown in the rest of the world but also consumers in the region could enjoy more of the fruits of their labor.

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