From trade surplus to the dispute over the exchange rate quantitative analysis of RMB appreciation

From Trade Surplus to the Dispute over the Exchange Rate Quantitative Analysis of RMB Appreciation 9812hc_9789814723954_tp.indd 8/1/16 1:57 PM May 2, 2013 14:6 BC: 8831 - Probability and Statistical Theory This page intentionally left blank PST˙ws From Trade Surplus to the Dispute over the Exchange Rate Quantitative Analysis of RMB Appreciation Xin Li Dianqing Xu Beijing Normal University, China World Scientific NEW JERSEY • LONDON 9812hc_9789814723954_tp.indd • SINGAPORE • BEIJING • SHANGHAI • HONG KONG • TAIPEI • CHENNAI • TOKYO 8/1/16 1:57 PM Published by World Scientific Publishing Co Pte Ltd Toh Tuck Link, Singapore 596224 USA office: 27 Warren Street, Suite 401-402, Hackensack, NJ 07601 UK office: 57 Shelton Street, Covent Garden, London WC2H 9HE Library of Congress Cataloging-in-Publication Data Names: Xin, Li, 1982– author | Dianqing, Xu, 1945– author Title: From trade surplus to the dispute over the exchange rate : quantitative analysis of RMB appreciation / Xin Li (Beijing Normal University, China), Dianqing Xu (Beijing Normal University, China) Description: New Jersey : World Scientific, 2016 Identifiers: LCCN 2015040538 | ISBN 9789814723954 (alk paper) Subjects: LCSH: Balance of trade China | Foreign exchange rates China | Currency question China | Monetary policy China | China Economic policy 21st century | China Foreign economic relations Classification: LCC HF1014 X56 2016 | DDC 382/.170951 dc23 LC record available at http://lccn.loc.gov/2015040538 British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library Copyright © 2016 by World Scientific Publishing Co Pte Ltd All rights reserved This book, or parts thereof, may not be reproduced in any form or by any means, electronic or mechanical, including photocopying, recording or any information storage and retrieval system now known or to be invented, without written permission from the publisher For photocopying of material in this volume, please pay a copying fee through the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, USA In this case permission to photocopy is not required from the publisher In-house Editors: Suraj Kumar/Lixi Dong Typeset by Stallion Press Email: enquiries@stallionpress.com Printed in Singapore Suraj - From Trade Surplus.indd 21/1/2016 9:24:55 AM January 27, 2016 12:18 From Trade Surplus to the Dispute over the Exchange Rate 9in x 6in b2268-fm Preface This book is the fruit of the cooperation between Chinese and foreign scholars in various aspects Since 2005, some Americans have been accusing China of causing the trade deficit, with one wave surging after another Some well-known scholars have also accused China of manipulating the exchange rate, arousing a considerable explosion of international public opinion At the same time, many domestic scholars argue against the RMB appreciation The two sides stand by their own views and are passionate over their respective arguments The reason for this situation is the lack of quantitative research or the lack of elaboration of many extremely important indicators Some people even hastily give their opinions without understanding the basic definitions and connotations of the key data In its takeoff stage, China had several characteristics that other countries did not have Therefore, committing the mistake of notching the boat to find the sword is inevitable when applying the traditional trade theories Clearly, providing a platform and enabling the two sides to exchange views calmly is difficult without quantitative research; both sides could go to extremes during the debate It is either this or that without giving a convincing conclusion To be quantitative is to compromise; this is the only way to find a win–win solution in international trade In the summer of 2009, Professor Yao Yang, the Dean of the National School of Development, Peking University, proposed to conduct a quantitative research on the exchange rate of RMB and Sino-US trade Undoubtedly, this subject is very important and challenging To conduct such a large-scale quantitative research, critical technical difficulties must be resolved in advance v page v January 27, 2016 vi 12:18 From Trade Surplus to the Dispute over the Exchange Rate 9in x 6in b2268-fm Preface Conducting a quantitative research of the exchange rate of RMB requires establishing a Computable General Equilibrium (CGE) model with China as the core This model should include not only the main export markets of China, such as the United States and Europe, but also its real and potential competitors, that is, the Asian economic giants such as Vietnam, Thailand, and India Furthermore, the model must consider data not only on import and export trade but also those on labor employment, income, output, and price of different departments Therefore, establishing such a large-scale database is time-consuming and formidable, and dealing with a large amount of data is difficult In recent years, the proportion of processing trade in import and export in China has been increasing, accounting for nearly half of the foreign trade The customs statistics inevitably contains a large amount of repeated calculation Moreover, a considerable part of the property rights in the export commodities belongs to foreign investment The customs statistics objectively exaggerates the export surplus of China, as it only contains logistics data through the said agency and does not present the property ownership of the export commodities All these are well-known facts, but establishing their quantitative description is very difficult Fortunately, after years of efforts, Prof Chen Xikang of the Chinese Academy of Sciences and his team have developed a set of noncompetitive input–output tables that can effectively decompose the data on import and export processing trade, which is a necessary link in analyzing the current foreign trade of China Dr Wang Zhi of the U.S International Trade Commission and Prof Wei Shangjin of Columbia University have developed a set of models for analyzing the value-added in processing trade Their contributions lay the foundation for the present research Organized by Prof Chen Xikang, Dr Wang Zhi, and Prof Yao Yang and supported by the Major Programs of the Fundamental Research Funds for the Central Universities (#SKZZX2013009), the National School of Development at Peking University, the System Science Institute of China Science Academy, the Department of National Accounts National Bureau of Statistics of China, and page vi January 27, 2016 12:18 From Trade Surplus to the Dispute over the Exchange Rate 9in x 6in b2268-fm Preface vii the U.S International Trade Commission have made a concerted effort for three years (i.e., since 2009) to establish the continuous global input–output database, including the time series data from 1995 to 2007 The input–output data distinguish between processing and non-processing trades and ensure the endogenous balance of the Social Accounting Matrix (SAM) after separating processing trade from non-processing trade They realize a complete sector classification in accordance with the requirements of international trade research (48 sectors, including 27 manufacturing sectors and 18 service sectors) On the basis of the database, a global multi-sector computable general equilibrium model (GMCGE model), which is suitable for the analysis of international economic cooperation, has been developed The country samples contain 225 countries, including 29 Organization for Economic Co-operation and Development (OECD) countries and 10 major developing countries In terms of data size, the GMCGE model is considerably broader than the databases controlled by OECD, Global Trade, Assistance, and Production, and Basque Institute of Statistics The static CGE model has 65,026 equations and 74,620 variables, consisting of 38,376 exogenous variables and 36,244 endogenous variables The last chapter of this book briefly summarizes the basic conclusions of this research Dr Wang Zhi and I have been friends for many years He studied and developed the model technology with perseverance and forged ahead to the forefront of the study of the CGE quantitative model in the world He cooperated with Prof Wei Shangjin and made outstanding contributions to dealing with the import and export value-added chain Dr Marinos E Tsigas of the U.S International Trade Commission contributed substantially to the computer program During the research, Li Xin and I went to Washington, and Wang Zhi and Marinos E Tsigas went to Beijing twice We all cooperated to address all the difficulties we encountered Professors Chen Xikang, Yang Cuihong, Zhu Kunfu, and Jiang Xiumei of the System Science Institute of China Science Academy as well as Dr Qi Shuchang of the National Bureau of Statistics page vii January 27, 2016 viii 12:18 From Trade Surplus to the Dispute over the Exchange Rate 9in x 6in b2268-fm Preface worked rigorously on the non-competitive input–output tables Without their pioneering work, decomposing the data of processing and non-processing trade is nearly unthinkable Three years have passed, and now I can finally offer the preliminary results of this research to you Frankly, given such a difficult and large-scale research, this research report is far from its maturity, and further investigation and improvement are needed Nevertheless, this study is a major step toward the development of quantitative research on the exchange rate reform of RMB Professors Yao Yang, Zhou Qiren, Lu Feng, Huo Deming, Li Ling, and Wu Hemao of the China Center for Economic Research of Peking University provided me with support and encouragement in various aspects of this research I also want to express my sincerest gratitude to Wang Qishan, Zhou Xiaochuan, Yi Gang, Liu Guoguang, Wu Jinglian, and Tang Ming for their help and guidance Dr Li Xin and I would like to thank the Institute of National Accounts, Beijing Normal University and the National School of Development, Peking University for providing an excellent academic environment for this research Objectively, every individual can use his/her expertise and be encouraged to explore Moreover, I would like to extend my appreciation to Huron College of the University of Western Ontario for providing me with exemplary research conditions Although I already expressed my gratitude to my wife Guan Keqin, I will so again I am still convinced that without her logistics support, I would not have been able to write this book in such a short time In this book, we freely convey our own opinions in the hope that they will generate more discussions Committing mistakes is unavoidable, and thus I sincerely welcome the comments and advice of friends Xu Dianqing May 4, 2012 page viii February 3, 2016 10:19 From Trade Surplus to the Dispute over the Exchange Rate 9in x 6in b2268-fm Contents Preface v Chapter 1.1 1.2 1.3 1.4 1.5 1.6 1.7 Rapid Development of the Sino-U.S Bilateral Trade Why Trade Deficit in U.S Statistics is Higher than that in Chinese Statistics? Co-existence of Surplus and Deficit Repeated Calculation of Processing Trade in Customs Statistics Theoretical Model of the Value-added Approach Difference in Calculating China’s Trade between the Customs Frontier Method and the Value-added Approach Keeping Pace with the Times and Reforming the Foreign Trade Statistical Method Chapter 2.1 2.2 2.3 2.4 2.5 Overestimated Trade Surplus 13 17 22 33 On Trade Surplus from Property Rights Distinguishing between Capital Flow and Logistics in the International Trade Competitive and Non-competitive Input–Output Tables Shares of the Domestic and Foreign Capitals in Non-labor Compensation in Processing Trade Distinguishing Capital Flow by Country Sino-American Trade Surplus ix 35 36 40 42 46 55 page ix January 27, 2016 442 12:20 From Trade Surplus to the Dispute over the Exchange Rate 9in x 6in b2268-ch13 From Trade Surplus to the Dispute over the Exchange Rate 13.6 A Win–Win Free Trade Agreement is Better than a Lose–Lose Trade War Economic sanctions involve restrictions on finance, import, and export The success rate is only 17.9% for export restriction and 20% for import restriction, but the success rate of restrictions on both import and export is 20% Combining the restrictions on finance, import, and export increases the success rate to 40.3% Economic sanctions inevitably cause anti-sanctions on the other side; thus, both sides pay the price In fact, all economic sanctions force the other side to suffer economic losses at the expense of one’s own economic losses From the economic interest point of view, economic sanctions benefit no one but damage the attacker Considering the non-economic factors as more significant than economic factors causes economic sanctions to have an effect The “five commandments” of trade war are as follows: (1) Do not impose sanctions on large powers; (2) Impose sanctions on your friends; (3) The intensity of the sanction exceeds the limit of the other side; (4) Form a united front; and (5) Set a few goals only and win quickly The trade war between China and the U.S depends on the reasoning of both sides with regard to dealing with major international conflicts Generally, the U.S government considers if it will win, whereas the Chinese government considers if it can afford to lose in making decisions If the U.S loses even just a little, Americans are expected to quarrel bitterly Therefore, the U.S may lose not in business or in the battlefield but to itself As no alternative exists between the export products of China and the U.S., RMB appreciation is likely to promote U.S exports as well as U.S prices As a result, domestic production measured by physical output will slightly drop Significant RMB appreciation (e.g., by 10%, 15%, and 20%) reduces U.S residents’ consumption by 0.17%, 0.27%, and 0.37%, respectively, thus causing inflation pressure without any job opportunity created RMB appreciation most significantly impacts the U.S auto industry page 442 January 27, 2016 12:20 From Trade Surplus to the Dispute over the Exchange Rate 9in x 6in b2268-ch13 The Debate is Far From Over 443 The U.S.–China trade war does not contribute to increasing the U.S domestic production (physical production changes between −0.07% and 0.07%), driving the investment (which falls by 0.44% to 1.57%), stimulating consumption (price rises by 0.13%–0.18%), or increasing the domestic employment (3,000–15,000 jobs lost) The only advantage is that the trade deficit slightly declines (only by 0.05%–0.45%) This practice, which benefits no one but disadvantages the agent, is unreasonable Neither side gains in the trade war The U.S may lose and lose more significantly than China The key to prevent a trade war is to let the U.S right-wing forces know about the damage of a trade war to itself and to not anything rash Cooperation is better than confrontation, and free trade is better than a trade war Rather than engage in a trade war, a China–U.S free trade zone should be created If this zone is established in 2011, the growth rate of U.S goods export will rise by 1.7% and the import growth rate by 1.3% U.S exports to China will increase by about 17.2%, and U.S imports from China will increase by about 23.4% To promote U.S exports, CUS-FTA may create more than 480,000 new jobs in the U.S., increase the growth rate of the U.S economy by 0.18%, and increase the net benefits of the U.S by more than $28.1 billion After the implementation of CUS-FTA, China’s export growth rate measured by physical output will increase by 1.1% and the import growth rate by 1.21%; China’s exports to the U.S will increase by about 36.8%, and its imports by about 32.2%, increasing the growth rate of the economy by about 0.45% CUS-FTA can also provide China with about 800,000 jobs and more than $13.6 billion of net benefits Within five years of implementing CUS-FTA, the average growth rate of U.S exports measured by physical output will increase by 2.84% and that of the imports by 1.95% The average annual growth rates of U.S exports to and imports from China in the next five years will increase by 17% and 15%, respectively In other words, CUS-FTA will increase U.S exports to China 2.14 times and imports two times within five years Implementing CUS-FTA will create 285,600 jobs in the U.S in the first year, 363,500 in the second, 399,600 in the third, page 443 January 27, 2016 444 12:20 From Trade Surplus to the Dispute over the Exchange Rate 9in x 6in b2268-ch13 From Trade Surplus to the Dispute over the Exchange Rate 231,200 in the fourth, and 250,100 in the fifth, which is a total of 1.53 million jobs within five years In the long run, the export growth will increase the U.S economic growth rate by about 0.18% annually on average If free trade creates a win–win situation for both China and the U.S., why not agree on it? 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Surplus to the Dispute over the Exchange Rate 9in x 6in b2268-refs References 451 [98] Friedman, M (1957) A theory of the consumption function; NBER General Series Princeton: Princeton University Press, U.S [99] Hollis C and Moises, S (1975) Patterns of Development 1950–1970 UK: Oxford University Press, Oxford [100] Chong-En, B., Hsieh, C.-T and Qian, Y (2006) The Return to Capital in China, Brookings Papers on Economic Activity, No 2, pp 61–101 page 451 May 2, 2013 14:6 BC: 8831 - Probability and Statistical Theory This page intentionally left blank PST˙ws January 27, 2016 12:18 From Trade Surplus to the Dispute over the Exchange Rate 9in x 6in b2268-index Index D Demand Curve, 136 Double-edged Sword, 278 Dual Model, 247 A Administration of Foreign Exchange, 149 Asian Financial Crisis, 151, 429 Atlas Method, 59 E Economic Sanctions, 366 Economic Take-off, 227 Enhanced Purchasing Power Parity Approach (EPPP), 131 Enterprise Savings Rate, 194 Equilibrium Exchange Rate, 131 Equivalent Permanent Income Hypothesis, 192 Excessive Liquidity, 174 B Behavioral Equilibrium Exchange Rate Approach (BEER), 131 Bergsten, Fred, 106 Bernanke, Ben, 187 Broad Money, 170 C Capital Flow, 35 Capital-intensive Products, 163 China Economic Information Database, 211 Chong’en, Bai, 197 Classical Unemployment, 278 Cline, William R., 142 Co-integration Test, 80 Cold War, 364 Comparative Advantage, 298 Competitive Input–Output Model, 41 Computable General Equilibrium (CGE), 243 Consumer Price Index, 311 Currency Exchange Rate Oversight Reform Act of 2011, 36 Currency Manipulator, 36 Current Account, Customs Statistical Method, Cyclical Unemployment, 278 F 12th Five-year Plan, 237 13th Five-year Plan, 359 Federal Reserve System, 158 Feenstra, Robert, 14 Feng, Lu, 133 Final Consumption, 17 Financial Sanctions, 377 First-generation Effect, 226 Fiscal Expenditure, 200 Fiscal Revenue, 199 Foreign Direct Investment, 197 Foreign Exchange Reserves, 147 Foreign Trade Dependence, 103 Foreign-invested Companies, 12 Foreign-owned Enterprise, 44 Four Asian Economic Giants, 190 Frictional Unemployment, 277 453 page 453 January 27, 2016 454 12:18 From Trade Surplus to the Dispute over the Exchange Rate 9in x 6in b2268-index Index Fundamental Equilibrium Exchange Rate Approach (FEER), 131 G Gagnon, Joseph E., 273 Geithner, Tim, 118 General Equilibrium Growth Model, 215 General Trade, Gini Coefficient, 210 Global Financial Crisis, Global Multi-department Computable General Equilibrium Model, 243 Global Trade Analysis Project, 243 Government Budget, 253 Government Savings Rate, 194 Government-led Investment, 206 Gradual Adjustment, 350 Great Depression, 266 Gross Capital Formation, 175 Guoqing, Song, 133 H Harrod–Domar Model, 191 Haufbaver, Gary C., 381 Hausman Specification Test, 79 High-income Countries, 59 Household Savings Rate, 194 Hummels, David, 14 I Income Gap, 78 Income Tax, 78, 253 Input–Output Model, 247 Inter-regional Input–Output Table, 18 Intermediate Input, 17 International Comparison Project (ICP), 68 International Monetary Fund (IMF), 75 International Standard Industry Classification Code, 23 International Trade Theory, Intra-industry Trade, 37, 325 K Keynes’ Consumption Theory, 191 Koopman, Robert, 15 Koopman, Power, Wang, and Wei (KPWW) Method, 15 Krugman, Paul, 105 L Labor Compensation, 42 Labor Productivity, 70 Labor-intensive Products, 163 Levin, Carl, 363 Levin Sander, 36 Lewis Model, 247 Life Cycle Model, 213 Lifetime Consumption Theory, 192 Low-income Countries, 59 Lower Middle-income Countries, 59 M “Made in China”, 36 Marginal Propensity to Save (MPS), 188 Marshall Plan, 386 Marshall–Lerner Condition, 139 Mckinnon, Ronald I., 132 Mearsheimer, John J., 92 Middle-income Countries, 59 Minimum Wage, 212 Minimum Wage Law, 278 Mortgage Quota, 223 Multi-department Model, 247 Multinational Companies, 11 Mundell, Robert A., 132 N Nash Equilibrium, 131 National Bureau of Statistics, 105 National Council, 214 Neoclassical Growth Theory, 255 New Economic Geography, 82 Non-competition of Input–Output Table, 12 Non-labor Compensation, 42 Non-performing Loans, 240 page 454 January 27, 2016 12:18 From Trade Surplus to the Dispute over the Exchange Rate 9in x 6in b2268-index Index Non-tradable Sectors, 165 North American Free Trade Agreement, 405 O Oligopoly Market, 137 Organization of Petroleum Exporting Countries, P Partial Equilibrium Model, 243 Pension System Reform, 214 People’s Bank of China, 149 Per Capita GDP, 79 Perfectly Competitive Market, 136 Perkins, Dwight H., 62 Peterson Institute for International Economics, 105, 273 Planned Economy, 75 Pooled Least Square Method, 80 Population Density, 79 Primary Industry, 70 Processing Depth Coefficient, 98 Processing Trade, Production Chain, Profit Maximization, 136 Property Ownership, Public Debt, 138 Pugel, Thomas, 279 Pulling Effect, 82 Purchasing Power Parity, 59 Q Qiren, Zhou, 144 R Radical Adjustment, 350 Ramsey Model, 210 RAS Method, 23 Real Estate Market, 179 Real Exchange Rate, 135 RMB Exchange, 36 Romney, Mitt, 363 Rostow’s Theory, 224 455 S Sales Tax, 253 Savings Rate, 188 Seasonal Unemployment, 278 Secondary Industry, 70 Sex Ratio, 217 Sino-foreign Cooperative Joint Venture, 44 Sino-foreign Joint Venture, 44 Small- and Medium-sized Enterprises, 216 Social Accounting Matrix, 243 Social Insurance System, 213 Social Security Fund, 214 Solow Model, 247 STAN Structural Analysis Database, 23 Stanley Morgan, State Council Development Research Center, 143 State-owned Enterprise, 154 Statistical Discrepancy, Stiglitz, Joseph E., 132 Structural Unemployment, 277 Subramanian, Arvind, 89 Substitution Effect, 218 Substitution Theory, 192 Supply Curve, 136 Surplus Labor, 289 System of Material Product Balance (MPS), 73 System of National Accounts (SNA), 74 T Take-off Stage, 82 Tariff, 253 Tax Reform, 78 Tertiary Industry, 59 Tradable Sector, 166 Trade Deficit, Trade Imbalance, Trade Surplus, page 455 January 27, 2016 456 12:18 From Trade Surplus to the Dispute over the Exchange Rate 9in x 6in b2268-index Index Trade War, 347 Transaction Tax, 253 U U.S Central Intelligence Agency, 113 U.S Chamber of Commerce Statistics, UN Security Committee, 391 Unemployment Rate, 285 Unit Labor Cost, 334 United Nations, 60 Upper Middle-income Countries, 59 Urbanization Rate, 79 V Value-added Approach, 22 Value-added Statistics, 15 Value-added Tax, 253 Vector Auto-regression, 254 W Wall Street Daily, 186 World Bank, 60 World Development Index, 79 World Economic Outlook Database, World Trade Organization (WTO), 142, 255 X Xikang, Chen, 41 Y Yang, Yao, 87 Yongding, Yu, 133 Z Zhi, Wang, 15 page 456 ... overestimates the trade surplus in the industries page January 27, 2016 12:17 From Trade Surplus to the Dispute over the Exchange Rate 9in x 6in b2268-ch01 From Trade Surplus to the Dispute over the Exchange. .. 12:17 From Trade Surplus to the Dispute over the Exchange Rate 9in x 6in b2268-ch01 From Trade Surplus to the Dispute over the Exchange Rate Table 1.5: Proportion of the service and merchandise trade. .. 12:17 From Trade Surplus to the Dispute over the Exchange Rate 9in x 6in b2268-ch01 From Trade Surplus to the Dispute over the Exchange Rate Profit is calculated based on the value-added of each