Discussion

PRC policymakers have noted that the PRC's trade surplus is too large and needs to be rebalanced. The PRC's surplus in recent years has been concentrated in processing trade. How would an appreciation of Asian currencies or of the yuan alone affect the PRC's processing trade balance?

The Marshall-Lerner condition implies that if exports initially equal imports an appreciation will reduce the trade balance if the sum of (the absolute values of) the demand elasticities for exports and imports exceeds one. If the current account is not initially balanced it is necessary to employ a general version of the Marshall-Lerner condition (see Appleyard and Field 2001). This condition states that an appreciation will reduce the trade surplus if:

Z < α₂₁ + Z α₁₁ (8)

where Z is the ratio of exports to imports, α21 is the price elasticity of imports, and α11 is the price elasticity of exports. According to the PRC Customs Statistics, processed exports exceeded imports for processing over the last five years by a ratio of 1.73 to 1. Z thus equals 1.73. The coefficient α21 in Table 3 averages 0.41. Thus, inequality (8) implies that an appreciation of the integrated exchange rate would reduce the trade surplus if the absolute value of the export elasticity is greater than 0.76. It is greater than this in all four cases in Table 4 and averages 1.16. This evidence indicates that a generalized appreciation in Asian supply chain countries would reduce the surplus in processing trade.

In the case of a CNY appreciation alone, the coefficient α21 in Table 5 averages 0.37. Thus, according to (8), an appreciation of the yuan would reduce the trade surplus if the absolute value of the export elasticity is greater than 0.79. It is greater than this in only one of the four cases in Table 4. Thus it is not clear than an appreciation of the yuan unaccompanied by appreciations in supply chain countries would reduce the surplus in processing trade.

How could a joint appreciation throughout East Asia be achieved? One way would be for the PRC to adopt an exchange rate 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. Market forces could then allocate these appreciations across supply chain countries based on their value-added in processing trade.

Even in the case of an exchange rate appreciation throughout Asia, however, the exchange rate elasticities in Tables 3 and 4 are not large. Thus the results in this paper imply that exchange rate changes alone may not substantially reduce the processing balance.

To consider other ways to reduce the surplus, it is helpful to look at national saving and investment in the PRC. These are plotted in Figure 3 [ PDF 17KB | 1 page ]. The figure shows that saving and investment began diverging after 2002. As the Asian Development Bank (ADB) (2009) reported, the shortfall of investment relative to saving was driven by an increase in corporate saving in the PRC. It rose from 17% of national disposable income in 2002 to 23% in 2007.

What caused corporate saving to rise so rapidly? The Asian Development Bank (2009) reported that after-tax corporate profits rose by 6% of GDP between 2003 and 2006. Part of this increase was due to rapid economic growth and rising output prices that increased the profitability of state-owned enterprises (SOEs) and private firms. Since SOEs typically do not pay dividends, higher profits directly increase the firms' gross saving.

Several other factors also contributed to high and rising saving rates among SOEs. Many have monopolies in various sectors, such as China Mobile in telecommunications and China National Petroleum Corporation in oil. As Xing (2009) discussed, the resulting monopoly profits contributes to high corporate savings, extraordinarily high compensation among executives at SOEs, and a skewed income distribution.

In addition, as Huang (2009) documented, factor market distortions provided a subsidy to producers of almost 2 trillion yuan (7% of GDP) in 2008. These subsidies include a yuan that is undervalued, artificially low land prices and real interest rates, administered prices for fuel and electricity, and environmental laws that are not rigorously enforced. These subsidies transferred resources to the corporate sector and increased their profitability. If these subsidies were removed and PRC enterprises faced higher prices for resources, land, electricity, and other items, then their global competitiveness would decline and this would reduce the production of tradables in the PRC.

Thus if policymakers in the PRC want to rebalance growth, exchange rate appreciations in Asia would probably have to be accompanied by other changes. These include deregulation, liberalization of factor markets, and the removal of policy distortions that favor the tradables sector over the non-tradables sector.

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