Academic journal article Contemporary Economic Policy

Does Appreciation of the Renminbi Decrease Imports to the United States from China?

Academic journal article Contemporary Economic Policy

Does Appreciation of the Renminbi Decrease Imports to the United States from China?

Article excerpt

1. INTRODUCTION

Exchange rate movement and its pass-through to changes in domestic prices have been topics of wide concern among economists. However, few studies have empirically investigated the relationship between exchange rate movements and trade flow. This paper fills this gap by investigating the effect of the appreciation of the Chinese Renminbi (RMB) on imports to the United States from China.

Today, China has replaced Mexico as the second-largest trading partner with the United States. In July 2005, China abated its fixed exchange rate to the U.S. dollar but pegged its currency to a basket of currencies. Since then, the RMB has appreciated by about 20% against the U.S. dollar, from 8.3 to 6.8 RMB per dollar. Simultaneously, China's bilateral trade surplus from the United States decreased from US$232 billion in 2006 to US$114 billion in 2008. This raises the question: has the RMB appreciation decreased the imports to the United States from China?

The economic intuition behind this question seems straightforward: The appreciation of the RMB resulted in more expensive Chinese exports; consequently, exports diminished while imports increased. However, answering the question is riot, by any means, trivial. It is widely recognized that bilateral trade volumes are affected by the trading, countries' gross domestic product (GDP), declining trade costs, and trade liberalization (Feenstra 1998). The appreciation of the RMB would have a pass-through effect on American import prices, which in turn would affect the amount of imports to the United States from China. By this means, the exchange rate has an effect on the domestic import price similar to that of tariffs, which has been recognized as the symmetry hypothesis between tariffs and the exchange rate (e.g., see Feenstra 1989). Therefore, the effect of exchange rate movements on bilateral trade remains an empirical issue.

The gravity model is perhaps the only one model that can successfully explain the growing trade volumes. In its simplest version. the gravity model suggests that the bilateral trade volume is directly proportional to the trading countries' GDP (Tinbergen 1962). I therefore adopt a theoretical gravity model with general equilibrium to access the effect of appreciation of the RMB on Sino-U.S. bilateral trade. The innovation of this paper is that I explicitly introduce the exchange rate into the theoretical gravity framework; hence I am able to estimate the effect of the yuan's revaluation on imports to the United States from China. (1) Extensive analysis suggests that the revaluation of the Chinese yuan significantly reduced imports to the United States from China. Chinese exchange rate movements are helpful in reducing the bilateral Sino-U.S. trade imbalance and accordingly in avoiding a possible trade war between the two countries.

This paper joins a growing literature on exchange rates and trade. As introduced by Goldberg and Knetter (1997), there are three related strands in the mainstream literature about exchange rates and goods prices. They cover the pass-through of exchange rates. the law of one price, and pricing-to-market. Feenstra (1989) finds that the symmetry hypothesis between tariffs and exchange rates is easily supported using Japanese and U.S. data. This seminal work also suggests that there is a symmetric response of import prices to changes in import tariffs and bilateral exchange rates.

Regarding the previous research on the Sino-U.S. trade and exchange rate. Thorbecke and Zhang (2006) estimate that the Sino-U.S. real exchange rate in the long run is around a unit. By including China's 33 main trading partners. Thorbecke and Smith (2010) rationalize that the appreciation of the RMB helps to rebalance China's trade. In particular, a 10% RMB appreciation leads to a decrease of 12% in ordinary exports and 4% in processing exports. The asymmetric effects of RMB appreciation on processing trade and ordinary trade are also explored by Mann and Plueck (2007). …

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