Introduction

The United States (US) current account deficit as a percent of gross domestic product (GDP) grew from 2% in 1997 to 4% in 2002 to 6% before the financial crisis that began in October 2008. The US ran large trade deficits with East Asia, oil-producing countries, and the rest of the world. Since the crisis began, however, America's deficit with most regions has fallen while its deficit with the PRC has remained intransigent.

Table 1 [ PDF 47.6KB | 1 page ] shows exports, imports, and the trade balance between the US and the rest of the world before and after the Lehman Brothers shock in September 2008. Exports and imports both exhibited sharp drops beginning in October 2008. The sample is thus divided into the year before the crisis erupted (October 2007–September 2008), the first year after the Lehman shock (October 2008–September 2009), and forecasts for the second year after the Lehman shock (October 2009–September 2010). For non-East Asian countries, the deficit fell by 76% during the post-crisis period, equaling US$227 billion between October 2008 and September 2009. For the PRC, it fell by less than 12% and equaled $237 billion in the same period. Columns (7) through (9) indicate that this pattern is continuing during the second year after the crisis. The US deficit with the PRC since October 2008 roughly equals the US deficit with all non-East Asian countries together.

Figures 1 and 2 highlight the unusual nature of the PRC's exports to the US. Figure 1 [ PDF 46.5KB | 1 page ] presents predicted and actual multilateral exports and imports for the 31 largest exporting countries in 2007, just before the crisis. The results were obtained from a gravity model described in Appendix 1 [ PDF 50.6KB | 1 page ]. Figure 2 [ PDF 50KB | 2 pages ] presents data from 2007 on predicted and actual exports of the PRC to 31 countries and predicted and actual imports of the US from 31 countries. The figures indicate that PRC exports, US imports, and especially PRC exports to the US are clear outliers in the global economy.

Given the distinctness of these imbalances, this paper begins by examining the factors affecting PRC exports to the US. The findings indicate that a 10% appreciation of the yuan would cause the PRC's exports to fall by 10% or maybe a little more. On the other hand, the results indicate that a decrease in income in the US would not cause a large drop in the PRC's exports. This evidence is supported by recent experience. During the 2008–2009 crisis, the yuan remained tightly pegged to the dollar. As Table 1 shows, a once-in-a-generation crisis barely reduced the PRC's exports to the US. If policymakers want to reduce imbalances between the PRC and the US, a real appreciation of the yuan is thus probably necessary.¹

This paper then presents aggregate import and export elasticities for the US and Asian countries that were estimated using a consistent methodology. Results from a dynamic ordinary least squares (DOLS) model indicate that trade elasticities for aggregate US exports and imports are small. Thus exchange rate changes alone may not be sufficient to significantly reduce America's global trade deficit.

These estimates, though, are subject to the aggregation bias first discussed by Orcutt (1950). They can also be distorted by the nature of Asian trade. For example, many of the imports into Asian countries are parts and components that are used to produce goods for re-export to the rest of the world. An exchange rate appreciation that reduces a country's exports can also reduce its demand for imported goods that are used to produce exports. This can cause the estimated exchange rate coefficient in import equations to be biased toward zero (see Kamada and Takagawa 2005).

This paper thus supplements the aggregate estimates of exchange rate elasticities with a review of previously published results. The evidence indicates that: (i) a depreciation of the dollar alone may not be sufficient to substantially reduce America's global current account deficit; (ii) sophisticated exports produced within regional production networks depend on exchange rates throughout the region; (iii) labor-intensive exports from developing Asian countries are strongly influenced by each country's own exchange rate; (iv) developing Asian countries compete extensively with each other in exports to third markets; (v) a currency appreciation in developing Asia would increase capital and consumption goods imports; and (vi) exchange rate volatility deters parts and components trade in Asia.

Two policy implications flow from these findings. First, if the US current account deficit needs to be reduced in the future, absorption-reducing policies such as fiscal consolidation would probably be required. The expenditure-switching effect of a dollar depreciation may not be large enough to significantly reduce America's trade deficit. Second, a joint appreciation throughout East Asia would be beneficial for the region and the world. It would help to maintain exchange rate stability within the region, facilitating the flow of capital goods and parts and components among Asian countries. It would increase the purchasing power of consumers in the PRC and other countries. It also would help reduce Asia's over-reliance on exports to the US and Europe. Finally, it would help overcome prisoner's dilemma problems that arise because the fear of losing competitiveness relative to Asian trading partners sometimes prevents countries in the region from allowing their currencies to appreciate.

One way for East Asian countries to appreciate together 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. Market forces could then allocate these appreciations across supply chain countries as a function of the size of their surpluses in processing trade.

The next section investigates the factors affecting the PRC's exports to the US. Section 3 reports export and import elasticities for the US and selected Asian countries estimated using a consistent methodology. Section 4 concludes the paper.

Download this Paper [ PDF 247.9KB| 28 pages ].

Comment(s)

There are [0] comment(s) for this entry. Post a comment.