III. ESTIMATING CHINA’S SPILLOVERS: A SECTORAL TRADE ELASTICITIES APPROACH1
This chapter assesses the potential impact of an exchange rate appreciation on sectoral trade at a high level of disaggregation. Given the significant information requirements for highly disaggregated data, a partial equilibrium exercise is conducted and the long-run effects examined. The results suggest that a change in relative prices consistent with an appreciation of the RMB would, over time, facilitate a rebalancing of the economy and re-orient exports more toward regional partners and high-technology products.
1. Sectoral-level analysis. The impact of currency appreciation is often examined at the level of the overall economy or for highly aggregated sectors. This note analyzes the response of trade flows at the product level (HS2002, 6-digit) to changes in relative prices. Differences in import demand and substitution elasticities, and differences in the amount of imported intermediate goods in production, result in changes to the structure of trade.
2. Approach taken. The information requirements for a high level of disaggregation necessitate taking a simple approach. Complex interactions across products, sectors, and other variables (such as income) would compound the number of variables (e.g., elasticities) to be estimated, raising the data requirements even more. So instead, a partial equilibrium set up is used, with information from input-output tables (for a detailed description of the methodology and additional results, see Changing Patterns of Global Trade, IMF). A two-step approach is taken. The first step focuses on the import market of each economy. Changes in relative prices result in demand responses and shifts in the structure of trade at the product level that reflect differences in import demand and substitution elasticities as well as in the amount of imported intermediate inputs used in producing exports. An analysis of input-output tables shows in particular that the foreign content of Chinese exports has increased and is large for high and medium-high technology exports (Figure 1).2 The second step uses the input-output tables to determine the composition of import demand as a result of the shift in the structure of exports (as determined in the first step).
Figure 1.China: Foreign Content in Gross Exports
Note: LT: Low Technology; MLT: Medium-Low Technology; MHT: Medium-High Technology; HT: High Technology. Technology classification is based on OECD (2005). DVA: Domestic value added. OEA: Other East Asian countries.
Source: IMF staff estimates using OECD Input-Output tables, COMTRADE and OECD STAN.
3. Simulation. The simulation reflects an increase (decrease) in the relative price of Chinese exports (imports) that could stem from a 10 percent appreciation in the currency. For simplicity, full pass-through of nominal exchange rate changes to import prices in partner countries is assumed, although in practice exporting firms are likely to adjust profit margins, mitigating the impact on trade.
- Sectoral effects. The simulation points to significant changes in the structure of sectoral trade. High technology exports decline less than low technology exports, owing to the significant contribution of imported intermediate inputs (Figure 2). Among the largest export sectors, the share of machinery and electrical equipment (a high technology sector) increases, whereas the share of textiles (a low technology sector) declines marginally. Thus, an appreciation would support a continued upgrading of Chinese exports in terms of technological content. Reflecting China’s relative downstream position in the supply chain, imports of intermediate goods fall (while other imports increase) as overall exports decline in response to the appreciation (Figure 3).
- Supply chain effects. Trade with Asian trade partners is less sensitive to changes in relative prices, consistent with significant regional integration (Figure 4). Exports to the main Asian export destinations (Hong Kong SAR, Korea, and Taiwan Province of China) decline less, while exports to European countries (mainly to Italy, U.K., France, and Germany) decline more. This is consistent with both significant high technology exports to Asian countries and China’s integration within the Asian production chain.
- Aggregate effects. The effects on each sector can be aggregated and the effect on rebalancing computed. In total, Chinese exports would fall by about 11 percent and imports increase by 2 percent. Overall, the simulations suggest that the trade surplus could fall by more than 3 percentage points. However, these results need to be interpreted with caution owing to the partial equilibrium nature of the exercise.
Figure 2.Exports by Technology Content: Simulation of Appreciation
Note: High technology (machinery and electrical equipment; instruments, e.g., medical). Low technology (animal and vegetable products; foodstuffs; hides and skins; wood products; paper products; textiles; footwear; precious and semi-precious stones; misc. manufactures). Medium-low technology (mineral products; plastics and rubber; stone, plaster, cement; base metals). Medium-high technology (chemical products; transportation equipment; arms and ammunition).