Results

Table 1 [ PDF 22.7KB | 1 page ] reports the results from estimating equation (4). The first two columns report the results for exports deflated using the Hong Kong, China unit value index, the next two columns for exports deflated using the US producer price index (PPI), and the last two for exports deflated using the US consumer price index (CPI). Columns (1), (3), and (5) report the results excluding a time trend, and columns (2), (4), and (6) present results including a time trend.

The coefficients on rest of the world income and the integrated real exchange rate are of the expected sign and statistically significant in every specification. The coefficient on the stock of FDI, while always positive, is only statistically significant in one case at the 10% level. The coefficients on the other variables are never statistically significant.

The coefficients on rest of the world income vary from 7.60 to 9.90. They remain large and statistically significant whether or not a time trend is included. These values imply that a 1% drop in rest of the world income will reduce China's processed exports by between 7.6 and 10%.

These values seem large. They could be influenced by specific events in the sample period, such as the large increase and subsequent fall in rest of the world income and in detrended and deseasonalized exports associated with the dot-com bubble and its subsequent burst in 2000.

On the other hand, these coefficients are very consistent with experiences that occurred during the global financial crisis immediately after the sample period. Between the third quarter of 2008 and the first quarter of 2009, real processed exports fell by 50%. Rest of the world income fell by 4% over this period, while the other variables exhibited little change. If the fall in exports during the crisis is due to the fall in income, then the results reported in Table 1 would understate the impact. Chinn (2009), using an error-correction model to explain the fall in US imports during the crisis, reported an income elasticity of 6.93. Similarly Ahmed (2009), using a first difference specification to explain the PRC's processed exports, found an income elasticity of 6.29.

The coefficients on the integrated exchange rate vary from -2.61 to -3.38. They remain large and statistically significant whether or not a time trend is included. These values imply that a 1% appreciation of exchange rates across supply chain countries including the PRC would reduce the PRCs processed exports by between 2.6 and 3.4%.

One explanation for why these values are large is that an appreciation across all supply chain countries would have a larger effect than an appreciation that is a subset of the supply chain countries. For instance, an appreciation of the Japanese yen could cause Japanese MNCs to shift production from Japan to the PRC and an appreciation of the yuan could cause MNCs to shift production back to Japan. If all currencies appreciate together, however, this source of savings disappears.

Support for this explanation comes from Table 2 [ PDF 23.3KB | 1 page ]. The table reports the coefficients on the yuan exchange rate and on the exchange rates in other supply chain countries separately. The coefficients indicate that a 1% appreciation of the yuan would reduce processed exports by about 1% and a 1% appreciation of exchange rates in other supply chain countries would reduce exports by about 2%. A joint appreciation would thus reduce exports by the amount indicated in Table 1.

Table 3 [ PDF 22.1KB | 1 page ] reports results including only the real effective exchange rate of the yuan and not the exchange rates in countries supplying parts and components. The coefficient on the yuan is negative, indicating that an appreciation of the CNY would reduce processed exports. However, the coefficient is only significant when the time trend is excluded. In addition, the coefficient on rest of the world income now takes on the wrong sign in half of the cases. These weaker results probably reflect the fact that the model is misspecified when only the CNY exchange rate is included and exchange rates in the countries supplying most of the value-added are excluded.¹⁰

An important implication of the results presented here is that a generalized appreciation in both the PRC and East Asia would produce a large drop in processed exports. These results make sense since much of the value-added of the PRC's processed exports comes from East Asian supply chain countries. A generalized appreciation would also produce a larger drop than an appreciation in other supply chain countries or in the PRC alone.

A second implication of the results reported here is that a slowdown in the rest of the world would significantly reduce processing trade. The income elasticity for processed exports is large. A downturn outside of Asia would thus cause a large drop in the PRC's processed exports. This in turn would decrease the flow of intermediate goods from the rest of Asia into the PRC, reducing employment and output throughout the region. To a large extent this is what happened during the 2008–2009 global financial crisis.

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