Chapter 9. Effect of the Exchange Rate on Employment 263
9.9 Effect of the Exchange Rate Adjustment
We have to keep pace with the times. The same is true in economic theory research. If traditional trade theories are applied to explain the effect of China’s exchange rate on imports, exports, and employ- ment, greater difficulties will arise.
In traditional trade theory, the definitions of import and export are clear, that is, exports are homemade commodities, and imports are commodities made in other countries. However, a considerable part of foreign trade in China belongs to processing trade. With the development of economic globalization, the traditional inter-industry trade has been largely replaced by a new form of intra-industry trade.
Many enterprises import raw materials and spare parts and export them after processing and assembly. Large numbers of multinational companies build factories in China. In 2011, the imports and exports of processing trade totaled to $1.3052 trillion, an increase of 12.9%
from that of last year.
The exchange rate adjustment has different effects on general trade and processing trade. In general trade, all intermediate inputs are from domestic production, and changes in the exchange nearly have no effect on the intermediate inputs. Similar to the exposition of traditional trade theory, the appreciation of the RMB exchange rate improves the export prices of general trade, leading to the decline of the international market demand and the reduction of exports.
As a result, domestic production and jobs must be reduced. How- ever, a considerable part of the intermediate inputs in processing trade is from overseas. After RMB appreciation, the international
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competitiveness of these processing industries is enhanced because of the drop in import input prices (i.e., raw materials, spare parts, technical patent, etc.), which is beneficial for the processing trade departments to expand the overseas market. Thus, the demand for labor of these departments is growing.
The production process is a value-added process. The produc- tion of processing trade is divided into two parts, namely, domestic production and foreign production. The production stages of dif- ferent products are different in domestic and foreign production.
The growing proportions of the added values are also different. The effect of the exchange rate adjustment on processing trade employ- ment is closely related to the domestic value-added shares of this product.
For example, the value-added process of labor-intensive products with low high-tech content occurs mainly in the country and depends on the labor input. Changes in the exchange rate have little effect on the intermediate inputs. After RMB appreciation, the rising export prices should weaken the competitiveness in the international market and subsequently cause order reduction, production shrinkage, and job decline. For products with high-tech content and capital-intensive products, the proportion of imported intermediate inputs is large, whereas the labor input is small. After RMB appreciation, the input cost is reduced, enhancing the competitiveness of these products in the international market. Therefore, RMB appreciation is likely to increase exports, expand production, and provide more employment opportunities.
Table 9.2 lists the proportion of imported intermediate inputs relative to the total intermediate inputs in China’s processing export products in 2007.15 The proportion of imported intermediate inputs of low-tech content export products, such as wood processing and textile, is small, whereas that of the high-tech content departments, such as general and special equipment, instrument and meter, and
15As the Board Economic Classification of the UN cannot completely distinguish between the processing production and the final consumption purpose of import products, the degree of impact of the exchange rate appreciation on the demand for labor of the processing trade department may be overestimated.
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Table 9.2: Proportion of imported intermediate inputs relative to the total intermediate inputs in processing export products (%).
Wood processing
& furniture
Papermaking, printing, stationery
and sporting
goods Textile
General and special
equipment
Transportation equipment
Electrical machinery
&
equipment
Communication equipment, computer and
other electric equipment
Instrument, meter, culture and
office equipment
48.95 57.27 66.18 92.25 80.25 81.10 66.44 73.05
Source: 2007 China’s non-competitive input–output table (made by the Department of National Economic Accounting, National Bureau of Statistics).
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others, is large. After RMB appreciation, job opportunities in general trade industries decrease, whereas those in processing trade indus- tries increase.
The CGE model is adopted to simulate the effect of RMB appre- ciation on the employment of general trade and processing trade departments. The simulation results show that if the real RMB exchange rate appreciates by 1%, 2%, 5%, 10%, 15%, and 20%, the demand for labor in China’s general trade will correspondingly drop by 0.44%, 0.89%, 2.25%, 4.22%, 4.61%, and 7.07%. At the same time, the demand for labor in processing trade will increase by 0.05%, 0.11%, 0.28%, 0.57%, 0.59%, and 0.87%, respectively. As the labors are mainly concentrated in general trade departments, the appreci- ation of the real RMB exchange rate by 1%–20% will cause China’s current employment to decrease by 0.34%–5.48%.
Note that the job reduction in the simulation above may be over- estimated. The static CGE model has very strict assumptions, that is, the whole economic system is in a general equilibrium state at the starting point of the simulation, and the marginal cost of pro- duction is consistent from country to country. Thus, as long as the exchange rate changes, the export order immediately shifts. Clearly, this assumption is not realistic. The real world is not in a theoretical equilibrium state. Labor productivities and wage levels vary among different countries, leading to the great difference in unit labor costs of different countries. For example, the average wage of the manu- facturing industry in China is 2.2 times higher than that in India, China’s labor productivity in many departments is three to four times higher than that of India. In these departments, China’s unit labor cost is lower than that of India. In the market competition, the unit labor cost is the decisive factor for transferring the orders of these products.
RMB appreciation causes China’s export prices to increase. If the range of increase cannot completely offset China’s unit labor cost advantage relative to its competitors, the orders of the product will not be transferred to other countries, and its effect on the job market is limited. Many labor-intensive products made in China have obvi- ous comparative advantages. Even if the RMB appreciates greatly,
298 From Trade Surplus to the Dispute over the Exchange Rate
they cannot bridge the gap. Therefore, the exchange rate adjustment does not necessarily cause the orders to transfer right away.
In static CGE simulation, all adjustments are completed in the current period without considering the production capacity of dif- ferent countries. The industry adjustment is a dynamic development process that is not easy made. Capital, labor, and infrastructure construction are the necessary conditions to expand capacity. Even if the external market has the demand, it is also necessary to raise funds, invest construction, train employees, and construct the sup- ported transport, energy, and infrastructure to expand the capacity effectively. All these take time.