Chapter 9. Effect of the Exchange Rate on Employment 263
9.4 Main Reasons for the High Unemployment Rate
Unemployment can be divided into the following categories according to different causes: frictional unemployment, structural unemploy- ment, cyclical unemployment, seasonal unemployment, and classical unemployment.
Frictional unemployment is caused by people who give up their original work but cannot find a suitable one immediately as enterprises cannot hire the right employees in a short period of time because of incomplete information in the job market.
Structural unemployment is caused by economic structural changes or production technology innovation. In the process of eco- nomic development, some industries expand while others decline.
Labor flows from the traditional departments to the modern ones or from the departments with low productivity to those with high productivity. The labor flow process causes some workers to lose jobs.
Structural unemployment generally lasts longer than frictional unem- ployment.
278 From Trade Surplus to the Dispute over the Exchange Rate
Cyclical unemployment is related to the economic cycle. Economic growth must be characterized by advancing in a wave-like manner, and the economic growth rate should fluctuate up and down. When the economic growth rate drops, the total demand decreases (includ- ing the domestic consumer demand and import demand) and so does the labor demand of some departments. As a result, the working population is greater than the number of positions provided by all departments, resulting in a surplus labor force and increased unem- ployment rate. The workers are able and willing to work, but they cannot find jobs immediately (i.e., voluntary unemployment).
Relative to the three kinds of unemployment, seasonal unem- ployment does not affect all industries and is common in the low- technology industry. For example, enterprises employ more workers to complete a contract before the major holidays and lay them off after the holidays to reduce long-term cost.
Similar to seasonal unemployment, classical unemployment is not unemployment in the real sense. Economists of a British classical school in early 20th century regard labor as a factor of production whose price (i.e., Adam Smith’s natural price) is determined by the market equilibrium condition. Classical unemployment occurs when wages are pushed up artificially (e.g., minimum wage legislation) and the labor supply is greater than the demand or when wages are higher than the marginal products of the workers and some workers will be laid off.
The current high unemployment in the U.S. is a combination of classical unemployment, cyclical unemployment, and structural unemployment. It is closely related to the decline of U.S. traditional manufacturing industries. The too high labor costs seriously weaken the competitiveness of manufacturing industries. As a result, multi- national companies have to build factories overseas to make money while the American job market shrinks. To restore the competi- tiveness of manufacturing industries, the wage level cannot rise too rapidly and cannot grow faster than the GDP. The minimum wage law is a double-edged sword that protects the interests of the low- income group while reducing employment opportunities. Therefore, it is necessary to find a suitable compromise between this opposing
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pair. Clearly, any government is not expected to greatly reduce the minimum wage, but it has to adjust it gradually over a long period of time. Thomas Pugel points out inInternational Economicsreprinted in 2011 that if the U.S. wage level does not change, raising the trade barriers will not increase the employment opportunities for the U.S.7 The current high unemployment in the U.S. is related to the finan- cial crisis in 2008. The U.S. government must reform the financial system, repair the banks’ credit mechanism, and recover the normal operation of the financial system as soon as possible. Many American economists are very clear about this point. The high unemployment rate in the U.S. is caused by internal factors. If the U.S. government attempts to shift the blame to others rather than determine its own problems, reducing the unemployment rate will be difficult, as it will significantly increase.
9.5. Analysis of the Relationship between Exchange Rate and Employment from the Perspective of System Engineering
Many domestic and foreign scholars agree that the fluctuation of the real exchange rate is one of the most important factors affecting employment.
Branson and Love (1987) report an empirical study on the U.S.
manufacturing industry using seasonal data in 1970 and 1986 and find that dollar appreciation will significantly lead to the reduction in output and employment. The effect of the exchange rate adjust- ment on employment is significant in the durable goods production department.
Burgess and Knetter (1998) and Belke and Gros (2002) study the employment in European countries as well as the effect of exchange rate fluctuations on employment. Their conclusions are largely con- sistent, that is, the wide fluctuations of the exchange rate will reduce employment and increase the number of unemployed.
7See Thomas Pugel (2011).International Economics, 15th Edition. U.S.: McGraw-Hill Higher Education.
280 From Trade Surplus to the Dispute over the Exchange Rate
Klein et al. (2000) study the U.S. manufacturing industry data and find that the appreciation of the dollar will dramatically reduce jobs, but its depreciation has no significant effect on the unemploy- ment rate and job mobility.
The study of Goldberg and Tracy (2001) finds that the dollar appreciation will lead to the sharp decline of wages and employment in the manufacturing industry.
Ansgar and Leo (2002) take Germany as an example and find that employment is negatively correlated with the exchange rate fluctu- ations. The wider the exchange rate fluctuates, the greater will be the value of waiting caused by delaying investments. As a result, the demand for labor will be reduced.8
Hausmannet al.(2004) examines South American countries, such as Argentina, Brazil, and Chile, and concludes that currency deval- uation will promote manufacturing industry employment.
Since 2004, many domestic scholars have studied the relationship between the RMB exchange rate and employment from multiple per- spectives.
Wan and Xu (2004)9 shows that exchange rate flexibility affects the price of export products, changes the export enterprises’ invest- ment decisions, leads to changes in the production scale of enter- prises, and reduces the demand for labor. According to their study, the RMB exchange rate appreciation will suppress the growth of employment and increase the burden of enterprises. In their opinion, allowing the RMB exchange rate to appreciate sharply is inadvisable, although the foreign exchange management and foreign trade system should be adjusted to adapt to the increasingly open and competitive market.
8Quoted from Wan and Xu (2004). Exchange rate adjustment and its impact on employ- ment in China — research based on theories and experience.Economic Research Journal, Vol. 588, No. 2, pp. 39–46. (in Chinese)
9Wan J. and Xu T. (2004). Exchange rate adjustment and its impact on employment in China — research based on theories and experience. Economic Research Journal, Vol. 588, No. 2, pp. 39–46. (in Chinese)
Effect of the Exchange Rate on Employment 281
Ding Jianping and E Yongjian (2005)10 establish two department models, namely, the trade department and the non-trade department, and test the relationship between the real RMB exchange rate and wage. According to them, no integration relationship exists between the real wage and the real exchange rate of these two departments.
The depreciation of the real RMB exchange rate will increase the employment of the trade department significantly but will have no influence on that of the non-trade department.
Zhang Bin and He Fan (2005)11 point out that RMB appreciation will reduce jobs in the trade department yet increase the number of jobs in the non-trade department, which offsets its effect to some extent on the trade department.
Fan Yanhui and Song Wang (2005) study the data of China’s manufacturing industry and conclude that the appreciation of the real RMB exchange rate will reduce jobs in the manufacturing indus- try, which can be offset by an increase in exports and investment in the industry.
Sha (2010)12 conducts an empirical analysis on the employ- ment effect of the real effective RMB exchange rate with a vector auto-regression model and finds that fluctuations of the real RMB exchange rate have a weak negative influence on the quantity of employment. In the long run, an increase in real effective RMB exchange rate by 1% will make the quantity of employment fall by 0.18%. The main reasons are as follows: First, China’s economy has become increasingly open and has a high foreign dependency degree. A considerable part of the national economy is exposed to the exchange rate risk, and the enterprise operating performance and demand for labor are easily affected by the fluctuation of the exchange rate. Second, with technical progress, the decline of exports
10Ding and Yongjian (2005). The real exchange rate, wages and employment — an empirical study on China’s tradable sector and non-tradable sector.Journal of Finance
& Economics, Vol. 31, No. 11, pp. 41–49. (in Chinese)
11Zhang and Fan (2005). How to adjust rmb’s exchange rate policy: Objective, schemes and timing.International Economic Review, No. 3–4, pp. 17–22. (in Chinese)
12Sha, W. (2010). The effects of RMB real effective exchange rates on employment based on var model.Commercial Research, Vol. 394, No. 2, pp. 187–190. (in Chinese)
282 From Trade Surplus to the Dispute over the Exchange Rate
caused enterprises to substantially reduce the demand for labor, although their demand for capital shows only a small decrease.
Third, the higher the degree of the export enterprise scale econ- omy is, the lesser the enterprises are affected in their demand for labor caused by the change in exchange rate when adjusting the investment level. Chinese export enterprises have a very low degree of scale economy because of the low economic management level, which makes their demand for labor easily affected by changes in the RMB exchange rate.
According to a study conducted by the Central University of Finance and Economics in 2010, the profit rate of small and medium enterprises is not high. The profit rate of nearly 57% of small and medium enterprises is within 5% above tax, 28% between 5% and 10%, 9.57% between 10% and 15%, and only 5.4% higher than 15%.
In the textile, clothing, shoe, hat, and other labor-intensive indus- tries, the profit rate of 84.07% of export enterprises is within 5%.
If the RMB appreciates rapidly, export enterprises will face severe pressure to survive.
In recent years, many papers have studied the relationship between export, exchange rate, and employment, some of which are insightful and novel. However, note that some studies only take the matter on its own merits without conducting a quantitative analy- sis. Those that conducted a quantitative analysis applied the partial equilibrium method and did not analyze the complicated relationship in the fluctuations between the exchange rate and the unemployment rate from the perspective of system engineering. The partial equilib- rium analysis is known to require a series of specific assumptions. Pre- vious studies have different assumptions; therefore, their conclusions also vary. In some cases, they even contradict each other. Conducting a partial equilibrium analysis is like a blind man feeling an elephant:
he only feels what he touches and ignores everything else.
Many studies have create diametric analysis of the relationship between employment and exchange rate in different industries using annual or quarterly data to estimate the exchange rate elasticity coefficient of employment and assess the degree of impact of the coef- ficient on employment. Note that the analysis of the exchange rate
Effect of the Exchange Rate on Employment 283
adjustment effect on the unemployment rate using macro data has significant limitations. The exchange rate fluctuations have different effects on different industrial departments, different technical content departments within the industry, and different forms of trade such as processing trade and general trade. The exchange rate adjustment is conveyed to the unemployment rate through a complicated relation- ship (Fig. 9.2). Moreover, different departments will encounter gains and losses in the exchange rate adjustment. Therefore, if only the exchange rate adjustment effect on the overall unemployment rate is considered, analyzing the strength of the exchange rate adjustment effect and proposing meaningful policy suggestions will be difficult.
In Fig. 9.3, (+) means that RMB appreciation promotes the employment of this department, (−) means that RMB appreciation has a negative effect on the employment of the department, and (?) means that its effect is unclear. For example, RMB appreciation
Appreciation of the Exchange Rate
Service (+) Manufacturing (?)
Orders in the Domestic Market (−)
Orders in the International Market (?)
Import substitute for some domestic
tradable commodities
Processing Trade (?)
Products of Low-tech Content (the share of the world market depends on the unit labor cost) (−) General Trade (−)
Products of High-tech Content (importing the intermediate-input products is cheap; the appreciation is
good for exports) (+)
Figure 9.3: Transmission of the RMB appreciation effect on the domestic employment market.
284 From Trade Surplus to the Dispute over the Exchange Rate
promotes the employment of the service industry, but it has a dif- ferent effect on manufacturing industries, which should be analyzed separately.
In the market economy, the demand for labor depends on the mar- ket order. Changes in the RMB exchange rate have different effects on the domestic market compared than on the international market.
Generally, in the domestic market, the declining price of import commodities after RMB appreciation will increase the import demand while reducing the domestic demand for similar products.
Import commodities will replace the domestic ones, squeeze the orders in the domestic market, and subsequently reduce domestic employment.
In the international market, foreign trade is composed of general trade and processing trade. When analyzing the RMB exchange rate effect on employment, distinguishing the different ways of trade (i.e., processing trade and general trade) and the types of products in the same manner of trade is necessary.
Many people believe that RMB appreciation and the relatively increasing prices of commodities made in China lead to the loss of overseas orders, which is true for general trade. RMB apprecia- tion can reduce job opportunities in general trade, but its effect on processing trade is not necessarily the same. As the competitiveness of labor-intensive products in the international market depends on unit labor cost, RMB appreciation will not change the domestic labor cost. However, it will increase the selling price of commodities in the international market, thus weakening the competitiveness of these commodities and resulting in a negative effect on the employ- ment of these departments. However, for the high-tech content prod- ucts in processing trade, a large number of parts and raw materials come from overseas. RMB appreciation reduces the input costs and enhances competitiveness, resulting in the creation of jobs. The dif- ferent effects of RMB appreciation on the employment of different departments (i.e., processing trade and general trade) and differ- ent products (depending on labor intensiveness) make observing the degree of impact of the exchange rate adjustment on the labor market according to the quantity of employment difficult.
Effect of the Exchange Rate on Employment 285
People usually make judgments based on the current public opin- ion. Information from the network and the media can be useful, but it should be treated with caution, as the departments that lose jobs are the loud ones and those that have jobs remain silent and gloat. On many occasions, the current public opinion cannot comprehensively reflect the truth. Therefore, establishing the CGE model, including all departments and all factors of production, to comprehensively and quantitatively analyze the exchange rate adjustment effect on employment is necessary.