Beggar-Thy-Neighbor or Beneficial Spillover:Effect of Exchange Rates on GVC Trade

5th IMF‐WB‐WTOJointTradeResearchWorkshopNovember30,2016

GeeHeeHong(IMF)

(withKevinCheng,DulaniSeneviratne,RachelvanElkan(allIMF))

1

Motivation

2

Conventional Wisdom on Exchange Rate Policy and Trade:

‘Beggar-Thy-Neighbor’ : Competitive devaluation or a weaker currency spurs exports and economic growth of depreciating country at the expense of other countries

However, not so clear with GVC production structure as:

A country’s imports and exports are not substitutes, but complements in GVC structure

International Fragmentation of Production Process

3

Main Questions

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GVC Feature: Production and exports require imports of intermediate goods.

Key Question:

Q1. How do GVC-related Exports and Imports respond to changes in exchange rates?

Q2. Does Beggar-Thy-Neighbor Effect hold in the GVC trade structure?

Q3. What determines the (value-added) exchange rate elasticities of GVC-related trade?

Value-added of this paper

Beggar-Thy-Neighbor or Beneficial Spillovers?

• Provide a theoretical underpinning for result that a real appreciation can: (i) reduce exports of DVA; and (i) reduce imports of FVA.

• Spill-forward and spill-back. Position in the production chain is not important; rather, what matters is how large is your contribution!

• Empirically, using DVA and FVA components separately, we find that

– Real appreciation reduces exports of DVA (a conventional result ) AND reduces imports of FVA (contrary to traditional theory).

– A larger foreign contribution to gross GVC-related exports dampens the response of DVA and FVA to REER changes.

5

Model Set-Up

6

3Country‐Modelofa‘Snake’GVCStructure:

• Grossoutput:Qi(i=1,2,3),whereQ3isfinalproduct• DomesticValue‐Added:Vi(i=1,2,3)• ForeignValue‐Added(Backward‐Linkage):Q(i‐1)• CESProductionFunction(w/commonelasticityofsubstitution)

Country 1 Country 2 Country 3

V1=Q1 FVA:Q1

DVA:V2

Country 2 Export:Q2

Country 1 Export:Q1

FVA:Q2

DVA:V3

Final Output:Q3

Model

7

Production Technology (CES Technology) is the share of country i’s contribution in gross output of j, ∑

: Price of gross output of country i: Price of value-added of country i in own currency:

: in country j’s currency

Final Good:

Model: Real Depreciation and DVA

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Proposition (Standard Beggar-Thy-Neighbor).Arealdepreciationwillincreasedomesticvalue‐addedofGVC‐relatedgrossoutputandexports.Theelasticityissmallerifimportcontentingrossoutputislarger.

Proof. ProfitMaximization:

Log‐Linearization:

PriceIndex:

Rewriting(9),

and .

Model: Real Depreciation and FVA

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Proposition (Beneficial Spillover).Ifacountry’sownvalueaddedcontributiontogrossoutputissufficientlylarge,arealdepreciationinthatcountrywillraisetheamountofvalueaddedbyothercountriesinthechain.Therefore,adownstreamcountrythatexperiencesarealdepreciationwillimportmorefromtheupstreamcountry,eventhoughtheupstreamcountry’srealexchangeratehasappreciated—beneficial spillback.

Proof. ProfitMaximization:

ScaleEffect:

Own-price effect

Cross-price effect Scale effect

Model: Real Depreciation and FVA (Continued..)

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Proof (continued….)

:

).

Model: Real Depreciation and FVA (Continued..)

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Corollary (beneficial spill forward). If the contribution of the upstream country’s domestic value-added to the final product is sufficiently large, a real depreciation in the upstream country may raise the value-added produced by the downstream country, even though the downstream country has experienced a relative real appreciation.

Data Description

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Data Set: OECD-WTO TiVa Database from 1995-2014 (Duval et al. (2015))

Key Variable Description:

Construction of REER : (Bayoumi et al. (2005), weights based on DVA in exports)

Share of FVA in GVC-Related Exports:

Empirical Strategy

BaselineRegression:

Novelty:• DistinguishesGVC‐relatedtradeandnon‐GVC‐relatedtrade• UseVA‐weightedREER

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Results

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Table. Response of Trade to the Real Exchange Rate(1) (2) (3) (4) (5) (6)

VARIABLESGross

ImportsGross

ExportsImports

(FVADD)Exports

(DVANon-GVC)Imports(FVAX)

Exports(DVAGVC)

Lagged Log (REER-Value-added-based) 0.253 -0.604* 1.235** -1.102** -1.390*** -1.670***(0.663) (-1.841) (2.287) (-2.378) (-2.822) (-3.527)

lagged log(REER) x lagged (FVA/DVA+FVA) -0.003 0.013** 0.027*** 0.026***(-0.443) (2.150) (3.166) (3.330)

Lagged Log (Demand) 0.709*** 1.110*** 0.884*** 0.795*** 1.108*** 0.758***(4.716) (9.257) (3.089) (6.446) (5.961) (4.470)

Time FE Y Y Y Y Y YCountry FE Y Y Y Y Y YAdditional controls Y Y Y Y Y YClustering Country level Country level Country level Country level Country level Country levelObservations 690 690 690 690 699 699R-squared 0.909 0.846 0.451 0.689 0.733 0.681Source: IMF staff estimates.

*** p<0.01, ** p<0.05, * p<0.1

Gross Trade GVC-related exportsOther Trade

Note: REER stands for real effective exchange rate. Specification— log (Exports [Imports] volume)c,t = αt +αc + α1log(REER)c,t-1 +α2interaction term + α3log(Demand)c[w],t-1 + αilog(Controls)c,t + ɛt. Additional controls included in the specifications are log of real stock of FDI, FVA share, tariffs, output gap. Demand is prox ied by GDP. Robust t-statistics in parentheses.

Results

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Table. Exchange Rate Competitiveness in GVCs(1) (2)

VARIABLES Gross imports Gross exports

Lagged Log (REER-Value-added-based) 0.253 -0.604*(0.663) (-1.841)

lagged log(REER) x lagged (FVA/DVA+FVA) -0.003 0.013**(-0.443) (2.150)

Lagged Log (Demand) 0.709*** 1.110***(4.716) (9.257)

Results

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Table. Exchange Rate Competitiveness in GVCs(3) (4)

VARIABLES Non-GVC imports Non-GVC exports

Lagged Log (REER-Value-added-based) 1.235*** -1.102***

(2.287) (-2.378)

lagged log(REER) x lagged (FVA/DVA+FVA) n/a n/a

Lagged Log (Demand) 0.884*** 0.795***

(3.089) (6.446)

Results

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Table. Exchange Rate Competitiveness in GVCs(5) (6)

VARIABLES GVC imports (FVA) GVC exports (DVA)

Lagged Log (REER-Value-added-based) -1.390*** -1.670***

(-2.822) (-3.527)

lagged log(REER) x lagged (FVA/DVA+FVA) 0.027*** 0.026***

(3.166) (3.330)

Lagged Log (Demand) 1.108*** 0.758***

(5.961) (4.470)

Impact on GVC-trade elasticities

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-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

22 30 38 46 54 62 70 78

GVC T

rade E

lastici

ty

FVA Share in GVCs (percent)

GVC Exports (GVC-related DVA)

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

22 30 38 46 54 62 70 78

GVC Tra

de Elast

icity

FVA Share in GVCs (percent)

GVC Imports (FVA)

GVC Trade Elasticities (with 90 percent Confidence Intervals)

Impact on (overall) Elasticities

-1.5

-1.0

-0.5

0.0

0.5

1.0

0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1

Total

DVA e

xport

elast

icity

Weight of GVC-related DVA in total DVA (range=0-1)

s=25 s=50 s=75

Total DVA Exports Elasticity given a Change in DVAgvc Weight

Impact on Net Trade Balance

0

5

10

15

20

25

30

35

40

1 2 3 4 5 6 1 2 3 4 5 6

Frequ

ency

Trade Balance (in percent of GDP)

Frequency Distribution: Impact on the Net Trade Balance of a 10Percent Real Depreciation(Based on actual FVA shares and GVC trade weights in the sample of countries)

1995 2011

Conclusion

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• GVCs alter the responsiveness of trade to exchange rate changes;

• Responsiveness depends on a country’s contribution to the final GVC product.• Higher FVA in your exports dampening

• Complicate assessments of impact of exchange rate changes on trade.

• Beggar-Thy-Neighbor or Beneficial Spillover?-> A real depreciation may not be a bad thing for your GVC trading partner.

Supplementary Slides

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Breakdown of Gross-trade data

Gross Exports Gross Imports

DVA FVATraditional Imports (not

re-exported)DVA related

to GVCs

DVA related to traditional

exports

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Decomposition

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0

10

20

30

40

50

60

70

1995 2011 1995 2011 1995 2011 1995 2011 1995 2011 1995 2011 1995 2011 1995 2011

Asia ASEAN Euro area Full sample Asia ASEAN Euro area Full sample

Non-GVC-related imports Non-GVC-related DVA in exports GVC-related DVA in exports GVC-related FVA in exports

Decomposition of Gross Exports and Imports, 1995 vs. 2011(In percent of GDP)

DVAFVA

Gross Exports ImportsSources: OECD-WTO TiVA database; and IMF staff estimates.

Data Description

25

0

10

20

30

40

50

60

70

1995 2011 1995 2011 1995 2011 1995 2011 1995 2011 1995 2011 1995 2011 1995 2011

Asia ASEAN Euro area Full sample Asia ASEAN Euro area Full sample

Non-GVC-related imports Non-GVC-related DVA in exports GVC-related DVA in exports GVC-related FVA in exports

Decomposition of Gross Exports and Imports, 1995 vs. 2011(In percent of GDP)

DVAFVA

Gross Exports ImportsSources: OECD-WTO TiVA database; and IMF staff estimates.