## _wp15158

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### I. INTRODUCTION — context and hypotheses
- Since the QQE2 announcement, the Japanese Yen has depreciated by a cumulative 36 percent against the dollar and about 25 percent in nominal effective terms.
- Since August 2011, the Won has appreciated against the Yen by 67 percent.
- Key policy chronology:
  - BOJ’s 2011 asset purchase program, expanded in April 2013 (Quantitative and Qualitative Easing; QQE).
  - October 2014: BOJ announced QQE2, precipitating further Yen depreciation.
- Research focus and hypotheses:
  - Limited price pass-through (pricing-to-market, PTM) may explain why large Yen depreciation has not generated expected export volume boosts.
  - Korean exporters may also exhibit limited PTM and use profits as a cushion.
  - The paper examines how exchange rate changes affected price pass-through (margin adjustment) and export volumes in the near term and over time, using data for Japan (1989 to 2013) and Korea (2001 to 2014) for selected sectors.
- Preview of high-level findings:
  - Limited pass-through and high correlation between profit margin and exchange rate movements consistent with historical PTM behavior.
  - If the weak Yen persists, Japan’s price competitiveness would strengthen over time, with sectoral heterogeneity.
  - Direct effect on export demand is limited, but persistent weak Yen would boost Japanese exporters’ profits lastingly, potentially strengthening long-term competitiveness.
  - Korea’s value chain integration with Japan can mitigate some negative effects, but likely only to a minor extent.

### II. HOW HAVE FIRMS RESPONDED SO FAR?
- Overall summary:
  - Pass-through of the weaker Yen and stronger Won to export prices (in contract currency terms) has been timid.
  - Export volume response has been muted.
  - Exchange rate movements have been largely reflected in exporters’ profit margins.

A. Price pass-through and export volumes — observed changes
- Export prices since September 2011:
  - Both Korean and Japanese exporters decreased export prices since September 2011.
  - Price cuts by Japan’s exporters somewhat higher than Korea’s in key sectors with high product similarity (metal, electronics, transportation equipment).
- Select numeric excerpts (Sep. 11 - Feb. 15 episode):
  - JPYUSD Export Prices change shown as -3.2 for Japan (Export Prices) and KRWUSD Export Prices change shown as -1.8 for Korea.
  - Korea Export Volume changes (KRWJPY): Overall -2.1; Metal -0.5; Electronics -10.2; Transportation -12.7.
  - Japan Export Volume changes (KRWJPY): Overall -3.2; Metal -0.5; Electronics -24.9; Transportation -15.6.
  - Table footnote area includes an Export Volume entry of -40.1 (Sep. 2011 to Feb. 2015 context).
- Aggregate trends:
  - Japan’s real export volumes continued to decline until late 2012, then stayed mainly stagnant.
  - Korea’s real exports largely traced a trend similar to the one before the Global Financial Crisis (GFC).

B. Profit margins, stock prices, and firm behavior
- Firms’ use of exchange rate movements:
  - Japanese exporters appear to have used exchange rate gains to decompress profits squeezed after the GFC.
  - Korean companies appear to have used profit and cash buffers to absorb exchange rate losses.
- Illustrative corporate figures:
  - Hyundai Motors’ operating margin (three quarter centered average) decreased by 19 percent over the sample period described.
  - Toyota’s operating margin increased by 63 percent over the same period.
  - Correlations:
    - Hyundai Motors’ quarterly operating margins correlation with KRWUSD = 0.8 since Q1 2012.
    - Toyota’s operating margins correlation with JPYUSD = 0.7.
    - Nikkei 225 and JPYUSD correlation = -0.98 from November 1, 2011 to April 22, 2015.
- Financial-market channel:
  - Liquidity from QQE may also have contributed to Japan’s recent stock market performance.
- Market shares:
  - Korea’s global market share increased from 2.6 percent in 2008 to 3.1 percent in 2010; since 2011 it has remained flat.
  - Japan’s global market share slid from 4.9 percent in 2008 (text truncated in source).

### III. World market share developments and sector patterns
- Korea:
  - Post-GFC boost to Korea’s market share stalled since 2011.
  - Gains continue in China, ASEAN, and the U.S., but slippages elsewhere offset them.
  - During 2008 to 2014, 86 percent of Korea’s total market share gain was made in China and ASEAN markets.
  - Korea expanded market share in electronics, offsetting flat or declining shares elsewhere.
  - Korea’s FVA sourced from Japan equals 5.1 percent of Korea’s overall exports.
- Japan:
  - Japan endured sharp losses in China and ASEAN where Korea continued to gain.
  - Japan’s visible benefit from the weak Yen was mainly in the Japanese market itself: since 2011 Korean exporters’ post-GFC gains in Japan have fully reversed.
  - Japan’s share in the Korean market fell rapidly during this period despite the weak Yen.
- Cross-country correlation:
  - Little correlation between market share movements for Korea and Japan in many markets; Japan also lost where Korea lost.
- Product-level observation:
  - Electronics drove Korea’s expansion; Japan’s market share declined across a broad range of products.

### IV. Pricing-to-market (PTM): empirical findings and sector heterogeneity
- Research question: Do exporters absorb exchange rate movements in profit margins (PTM) or pass them to prices, and how does that vary by country and industry?
- Methodology:
  - Marston (1990) framework; DOLS for long-run elasticity of relative profit margin to REER changes; ECMs for short-term elasticity and transition dynamics.
- Long-run elasticities (sectoral findings):
  - For Japanese manufacturers: a 10 percent depreciation of the Yen in real terms, all else equal, increases the relative profit margin by 3–5 percent in the long run.
  - Korean manufacturers’ relative margins show higher long-run elasticity to exchange rate movements (stronger tendency to PTM), except electronics.
  - Initial overshooting (short-run > long-run elasticity) tends to be larger for Korean manufacturers.
- Industry patterns:
  - Electronics and metal: initial overshooting evident for both Korea and Japan. Korean electronics exporters unwind overshooting more than Japanese counterparts and over time pass through more to prices.
  - Textile and transportation: Korea shows little overshooting in textiles and slow undoing in transportation (limited differentiation). Japan shows no perceptible overshooting in textiles and smaller tendency to PTM than Korea in both short and long run. In transportation, Japanese exporters show substantially larger overshooting than Korean counterparts (consistent with Japan’s emphasis on luxury cars).

Numerical example (Samsung Galaxy Note 4, Oct 13, 2014):
- Factory shipping price to Korea’s top 3 domestic carriers = 870,000 Won (excluding VAT).
- Shipping price to U.S. carrier AT&T = 825.99 dollars (excluding VAT) = 875,549 Won (1USD=1060KRW).
- Implied relative export markup (log(export price) minus log(domestic price)) = 0.6 percent on that day.
- Scenario: 5 percent appreciation of the Won → 1,007 Won/dollar. Exporter responses modeled:
  - No change in invoice price: entire 5 percent shock absorbed by relative profit margin (shrinks by 5 percent). With imported contents = 40 percent of marginal cost and marginal cost = 80 percent of price, and all imported contents invoiced in dollars and fixed short run, absolute export margin shrinks by only 2 percentage points because imported-content effect offsets 3 percentage points.
  - No change in relative markup: exporter raises export prices by 5 percent; relative profit margin remains at 0.6 percent. With same input assumptions, absolute margin would increase by 2 percentage points.
  - Realistic outcome likely intermediate between extremes.

### V. Export volumes — short-run vs long-run elasticities and simulations
- Estimation approach:
  - DOLS for long-run; ECM/OLS for short-run elasticities of export volumes to REER and to export prices.
- Main empirical findings:
  - Short-run elasticity of export volumes to REER is low for both Korea and Japan.
  - Elasticity increases in the longer run.
- Out-of-sample forecast (models estimated on 1989q1–2011q4; compare actual post-2012 volumes to predicted):
  - Large persistent gaps exist between actual export volumes and predicted levels.
  - About one quarter of the total gap may be attributed to slow or low response of price to exchange rate shocks.
  - Forecasts from relative margin regressions suggest traditional export price–REER relationship did not change; the price-response gap may close if Yen depreciation persists.
  - The portion of the gap reflecting slow or low response of export volumes to export price changes is difficult to predict; recent sharp pickup may signal closure or be transitory/structural.
- Simulation outcomes and scenarios:
  - If Japan’s export volumes fully return to equilibrium relative to export prices, volumes would increase by about 30–33 percent until end-2020.
  - Exchange rate scenarios have limited effect on the path: export volume at end of simulation horizon would be 3-4 percent less when assuming a full unwinding of the Yen’s depreciation since 2011q3 relative to baseline assumption of zero unwinding.
  - A permanent exchange rate shock could cause a permanent shift in profits: relative profit margins of Japanese firms would be 20 percent (permanently) lower than in the baseline if the Yen’s depreciation since August 2011 fully unwinds.
- Simulation assumptions:
  - 2015–2020 horizon: Japan’s trading partner GDP assumed to increase by 38 percent in line with IMF’s World Economic Outlook.
  - Baseline assumes current REER level locked in; alternative assumes depreciation since 2011q3 fully unwound over 8 quarters starting 2015q1.

### VI. Imported contents, value-chain linkages, and implications for Korea
- Korea’s foreign value added (FVA) in gross exports:
  - FVA accounts for 40 percent of Korea’s gross export value (placing Korea fifth among OECD countries on that metric).
- Country-sourced FVA shares (selected figures):
  - Korea’s FVA from Japan = 5.1 percent of Korea’s overall exports.
  - FVA from China = 4.8 percent; from the United States = 4.6 percent.
- Sectoral comparative FVA shares (In percent):
  - Overall FVA to gross exports: Korea 5.1; Japan 85.2; China 4.4; Indonesia 1.4; U.S. 0.9; Germany 0.8; France 1.8.
  - Electrical sector: Korea 6.8; Japan 82.2; China 6.3; Indonesia 4.1; U.S. 1.6; Germany 1.7; France 1.1.
  - Transport sector: Korea 6.8; Japan 85.9; China 6.9; Indonesia 3.0; U.S. 2.5; Germany 1.2; France 0.2.
  - Chemical sector: Korea 4.1; Japan 78.9; China 4.0; Indonesia 0.9; U.S. 0.8; Germany 0.7; France 0.9.
  - Logistics sector: Korea 2.4; Japan 93.2; China 1.5; Indonesia 1.5; U.S. 0.3; Germany 0.6; France 2.0.
  - Metal sector: Korea 6.1; Japan 80.5; China 3.5; Indonesia 1.6; U.S. 1.0; Germany 0.6; France 0.8.
- Implications:
  - Most gains from Yen depreciation would be soaked up by Japanese exporters given domestic value-added = 85 percent of Japan’s exports.
  - Korea’s large FVA share implies the negative competitive effects of a Won appreciation will be significantly offset through imported-cost channel; however, this imported-cost offset would do little to arrest negative competitive effects from the Yen’s depreciation.
  - OECD statistics indicate Japan is no longer the predominant upstream supplier to Korea in many sectors (China leads in electronics; Australia in chemicals; United States in logistics).

### VII. Exchange-rate correlations and drivers of the Won/Yen cross rate
- Correlation periods and magnitudes:
  - Jan-2000 to Feb-2006:
    - Correlation between cross rate and KRWUSD = 0.6.
    - Cross rate’s correlation with JPYUSD ≈ 0.
    - Correlation between JPYUSD and KRWUSD = 0.7.
    - Dec-2003 to June 2007: Won appreciated against Yen by 33 percent; KRWUSD accounted for about 60 percent of the appreciation.
  - Mar-2006 to Mar-2015:
    - Correlation between cross rate and JPYUSD = -0.9 (Yen-specific factors may have driven Won/Yen movements).
    - Nov-2011 to Feb-2015: Won appreciated against Yen by 40 percent; JPYUSD accounted for 97 percent of the appreciation.
  - Since September 2011, the Yen has depreciated against the Won by near 70 percent.

### VIII. Regression evidence (selected statistics)
- Japan export volume regression (DOLS) — REER specification:
  - REER_JPN coefficient = -0.561458; Std. Error = 0.089975; t-Statistic = -6.240179.
  - Y_STAR_JPN coefficient = 0.699512; Std. Error = 0.029046; t-Statistic = 24.082670.
  - C = 3.725076; Std. Error = 0.537375; t-Statistic = 6.931990.
  - R-squared = 0.996267; Adjusted R-squared = 0.991158.
  - Included observations: 91 after adjustments.
- Japan export volume regression (DOLS) — Export Price specification:
  - LOG(EP_JP_USD) coefficient = -0.299789; Std. Error = 0.141564; t-Statistic = -2.117690; Prob. = 0.0387.
  - Y_STAR_JPN coefficient = 0.753667; Std. Error = 0.033646; t-Statistic = 22.399690.
  - C = 2.314748; Std. Error = 0.763023; t-Statistic = 3.033654; Prob. = 0.0037.
  - R-squared = 0.984491; Adjusted R-squared = 0.974339.
  - Included observations: 92.
- Short-run D(REER_JPN) coefficients vary (examples: -0.11; -0.05; -0.09; -0.01) indicating weak short-run exchange-rate effects.
- Korea export regressions:
  - REER_KOR coefficient in one DOLS = -0.441861; Std. Error = 0.335386; t-Statistic = -1.317472; Prob. = 0.1913.
  - Y_STAR_KOR coefficient = 2.34795; Std. Error = 0.067425; t-Statistic = 34.823040.
  - Short-run D(REER_KOR) coefficients in ECM/OLS are small and often not statistically significant (example: -0.13; Std. Err. 0.07; t-Statistic -1.88).

### IX. Policy-relevant implications and dynamic considerations
- Limited short-run export volume response to Yen depreciation could mask longer-term shifts in competitiveness if the Yen remains weak persistently.
- Policy attention recommended on:
  - Monitoring profit-margin dynamics and their effects on non-price decisions (investment, R&D, outsourcing).
  - Assessing sectoral value-added structures given Japan’s high domestic content (85 percent) and Korea’s significant FVA share.
  - Accounting for exchange-rate cross-rate dynamics (KRWUSD vs JPYUSD) when evaluating bilateral competitiveness and drivers of Won/Yen movements.
- Dynamic outlook:
  - Exchange rate elasticities are low in the short run but build over time; price pass-through and volume responses expected to grow with a fairly long lag.
  - Persistent profit margin changes could lead to fundamental, hard-to-forecast non-price investment responses (e.g., more outsourcing by Korean firms; stronger product development by Japanese firms), affecting future productivity and output growth.

### X. Appendix 9 — Estimation of PTM (technical note) — model, sectoral DOLS and ECM results
- Framework and data:
  - Marston (1990) model; four export sectors — transportation, electronics, metals, textiles — covering about 40 percent of Japanese and Korean exports.
  - Two-step empirical approach: DOLS for long-run cointegrating relationships; ECM for short-run elasticities and adjustment speed.
- Japan DOLS long-run REER coefficients (standard errors in parentheses):
  - Transportation: -0.36 (0.04)
  - Textile: -0.43 (0.15)
  - Metal: -0.33 (0.27)
  - Electronics: -0.49 (0.08)
- Japan ECM error-correction coefficients (speed of adjustment; standard errors):
  - Transportation: -0.06 (0.02)
  - Textile: -0.10 (0.06)
  - Metal: -0.09 (0.04)
  - Electronics: -0.03 (0.02)
- Korea DOLS long-run REER coefficients (standard errors in parentheses):
  - Transportation: -0.56 (0.08)
  - Textile: -0.72 (0.08)
  - Metal: -0.51 (0.10)
  - Electronics: -0.13 (0.14)
- Korea ECM error-correction coefficients (speed of adjustment; standard errors):
  - Transportation: -0.01 (0.01)
  - Textile: -0.03 (0.01)
  - Metal: -0.04 (0.01)
  - Electronics: -0.02 (0.02)
- Interpretation:
  - Japan: a 10 percent real depreciation of the Yen increases Yen-denominated export prices by 3–5 percent relative to domestic prices; electronics show largest margin response.
  - Korea: higher long-run equilibrium elasticities (roughly 5–7 percent) in most sectors (except electronics), indicating stronger long-run margin adjustment.
  - Short-run: ECM terms negative and mostly significant; adjustment to long-run equilibrium typically completed within 20 quarters, with Japan showing faster adjustment than Korea.
- Out-of-sample findings (model estimated through 2011Q4; forecast 2012Q1–2014Q4):
  - Transportation and textile: Japanese exporters’ PTM behavior consistent with pre-Abenomics relationship.
  - Electronics: exporters appear to be passing more exchange rate gains through to export prices than in the past.
  - Metals: past pricing behaviors do not well predict current metal exporter behavior; interpretation less clear.
  - Similar out-of-sample exercise omitted for Korea due to limited REER shock to Won.

*Source: IMF staff working paper content as provided in the supplied PDF excerpt.*

### References .............................................................................................................

### _wp15158 - References .............................................................................................................

### I. INTRODUCTION
- Since the QQE2 announcement, the Japanese Yen has depreciated by a cumulative 36 percent against the dollar and about 25 percent in nominal effective terms.
- Since August 2011, the Won has appreciated against the Yen by 67 percent.
- Key policy and event chronology:
  - Bank of Japan (BOJ)’s 2011 asset purchase program, expanded in April 2013 (Quantitative and Qualitative Easing; QQE).
  - October 2014: BOJ announced another round (QQE2), precipitating further Yen depreciation.
- Hypotheses and research focus:
  - Limited price pass-through (pricing-to-market, PTM) may explain why large Yen depreciation has not generated expected export volume boosts.
  - Korean exporters may also exhibit limited price pass-through and use profits as a cushion.
  - The paper examines how exchange rate changes affected price pass-through (margin adjustment) and export volumes in the near term and over time, using data for Japan (1989 to 2013) and Korea (2001 to 2014) selected sectors.
- High-level findings previewed:
  - Limited pass-through and high correlation between profit margin and exchange rate movements consistent with historical PTM behavior.
  - If the weak Yen persists, Japan’s price competitiveness would strengthen over time, with sectoral heterogeneity.
  - Direct effect on export demand is limited, but persistent weak Yen would boost Japanese exporters’ profits lastingly, potentially strengthening long-term competitiveness.
  - Korea’s value chain integration with Japan can mitigate some negative effects, but likely only to a minor extent.

### Box 1. The Link between Yen and Korean Price Competitiveness
- Mechanisms by which the Won-Yen cross rate affects Korea’s export price competitiveness:
  - (i) Impact on Korea’s real effective exchange rate (REER), in proportion to Japan’s trade weight in Korea’s basket and export prices.
  - (ii) Correlations with Japan’s export prices, affecting Korea’s relative price competitiveness in third-country markets.
- Countervailing channel:
  - Yen depreciation could boost Korean exports if Japanese and Korean products are complementary via global value chain linkages.
- Longer-run non-price channel:
  - Persistent weak Yen could change relative profit prospects and feed into non-price decisions (e.g., R&D, production location, branding), altering competitiveness over time.

### II. HOW HAVE FIRMS RESPONDED SO FAR?
- Overall summary:
  - The pass-through of the weaker Yen and stronger Won to export prices (in contract currency terms) has been timid.
  - Export volume response has been muted.
  - Exchange rate movements have been largely reflected in exporters’ profit margins.

A. Price Pass-through and Volume Response
- Export price changes since September 2011:
  - Both Korean and Japanese exporters have decreased export prices since September 2011.
  - Cuts by Japan’s exporters have been somewhat higher than Korea’s in key sectors with high product similarity (metal, electronics, transportation equipment).
- Contextual considerations:
  - Price reductions occurred against a backdrop of declining prices of oil and electronic products, implying the pure exchange rate effect may be limited.
- Specific numeric excerpts preserved from tables and text:
  - The Yen has depreciated since August 2011 and the Won has strengthened, but the latest Won-Yen episode seems primarily driven by the Yen’s weakening (see Appendix 8).
  - Table 1 and Table 2 summarize percentage changes in exchange rates, export prices, and export volumes over various historical episodes and for the Sep. 11 - Feb. 15 episode:
    - For Sep. 11 - Feb. 15: JPYUSD Export Prices change shown as -3.2 for Japan (Export Prices) and KRWUSD Export Prices change shown as -1.8 for Korea in the table headers/context.
    - Korea Export Volume changes (KRWJPY): Overall -2.1; Metal -0.5; Electronics -10.2; Transportation -12.7.
    - Japan Export Volume changes (KRWJPY): Overall -3.2; Metal -0.5; Electronics -24.9; Transportation -15.6.
    - Percentage change in the Won-Yen Exchange Rate and the Export Volume of Korea and Japan from September 2011 to February 2015 includes an Export Volume entry of -40.1 (present in table footnote area).
  - Japan’s real export volumes continued to decline until late 2012, and then stayed mainly stagnant.
  - Korea’s real exports largely traced a trend similar to the one before the Global Financial Crisis (GFC).

B. Profit Margin and Stock Price
- Firms’ use of exchange rate movements:
  - Japanese exporters appear to have used exchange rate gains to decompress profits that had been squeezed after the GFC.
  - Korean companies appear to have used existing profit and cash buffers to absorb exchange rate losses.
- Illustrative corporate examples:
  - Car makers: Hyundai Motors’ operating margins decreased while Toyota and Honda experienced sharp pick-ups since 2013.
    - Hyundai Motors’ operating margin (three quarter centered average) decreased by 19 percent over the sample period described.
    - Toyota’s operating margin increased by 63 percent over the same period.
  - Correlations:
    - Hyundai Motors’ quarterly operating margins showed a correlation of 0.8 with KRWUSD since Q1 2012.
    - Toyota’s operating margins showed a correlation of 0.7 with JPYUSD.
    - Nikkei 225 index and JPYUSD correlation is -0.98 from November 1, 2011 to April 22, 2015.
    - Correlation between KOSPI and KRWUSD has been far less clear.
- Financial market channel:
  - Liquidity resulting from QQE may also be a contributing factor to Japan’s recent stock market performance.

C. What Happened to Market Shares?
- Headline market share dynamics:
  - Korea’s global market share increased from 2.6 percent in 2008 to 3.1 percent in 2010; since 2011 it has remained flat.
  - Japan’s global market share slid from 4.9 percent in 2008 to (text truncated at provided content).
- Research approach:
  - Market share analysis adopts a decomposition technique proposed by Ree and Choi (2014) to assess whether Korea’s post-GFC market share gains have unwound since August 2011 and whether any unwinding benefited Japan.

*Source: _wp15158 - References*

### 3.7 percent in 2014, with the weak Yen providing little cushion. Key findings are as follows:

### _wp15158 - 3.7 percent in 2014, with the weak Yen providing little cushion. Key findings are as follows:

### World market share developments
- The post-GFC boost to Korea’s market share gains have stalled since 2011; gains continue in three leading export destinations—China, ASEAN, and the U.S.—but are being offset by slippages elsewhere.
- Korea’s gains in China and ASEAN were large: during 2008 to 2014, 86 percent of Korea’s total market share gain was made in China and ASEAN markets.
- Japan endured sharp losses in China and ASEAN where Korea continued to gain.
- Japan also lost market shares elsewhere where Korea lost them too, indicating little correlation between market share movements for Korea and Japan.
- The weak Yen’s visible impact was mainly in the Japanese market itself: since 2011 Korean exporters’ post-GFC gains in Japan have fully reversed.
- Japan’s share in the Korean market fell rapidly during this period despite the weak Yen, possibly reflecting sluggish manufacturing investment in Korea (which tends to have high import contents from Japan).
- By product: Korea expanded market share in electronics, offsetting flat or declining shares in other leading export items; Japan’s market share declined across a broad range of products.

### How firms adjust to exchange rate shocks — profit margins and price pass-through (PTM)
- Research question: Do exporters absorb exchange rate movements in profit margins (PTM) or pass them to prices, and how does that vary by country and industry?
- Methodology: Use Marston (1990) framework; dynamic OLS (DOLS) for long-run elasticity of relative profit margin to REER changes; error correction models (ECMs) for short-term elasticity and transition dynamics.
- Key empirical findings:
  - Long-run effects of exchange rate shocks on relative profit margins are smaller than short-run effects, but more than zero.
  - For Japanese manufacturers, a 10 percent depreciation of the Yen in real terms, all else equal, increases the relative profit margin by 3–5 percent in the long run.
  - Korean manufacturers’ relative margins show higher long-run elasticity to exchange rate movements—thus stronger tendency to PTM.
  - Initial positive gaps between short-term and long-term elasticity (“overshooting”) tend to be larger for Korean manufacturers.
  - Significant variation in PTM transition dynamics across industries, with correlation between PTM and product differentiation:
    - Electronics and metal: initial overshooting is evident for both Korean and Japanese exporters. In electronics, Korean exporters unwind initial overshooting more than Japanese counterparts and over time pass through more to prices.
    - Textile and transportation: Korea shows little overshooting in textiles and slow undoing in transportation (limited differentiation). Japan shows no perceptible overshooting in textiles and smaller tendency to PTM than Korea in both short and long run. In transportation, Japanese exporters show substantially larger overshooting than Korean counterparts (consistent with Japan’s emphasis on luxury cars).

### Numerical example: Samsung Galaxy Note 4 and exporter responses to a 5 percent appreciation of the Won
- Data point: Factory shipping price of Samsung Galaxy Note 4 32 GB to Korea’s top 3 domestic mobile service carriers was 870,000 Won (excluding VAT) as of October 13, 2014. Shipping price to U.S. carrier AT&T on the same day was 825.99 dollars (excluding VAT), which amounts to 875,549 Won (1USD=1060KRW).
- Implied relative export markup (log(export price) minus log(domestic price)) was 0.6 percent on that day.
- Scenario: 5 percent appreciation of the Won brings rate to 1,007 Won/dollar. Exporter reaction possibilities:
  - No change in invoice price: entire 5 percent shock absorbed by relative profit margin, shrinking it by 5 percent (assume no change in domestic invoice price). If imported contents take up 40 percent of marginal cost and marginal cost is 80 percent of price, and all imported contents invoiced in dollars and fixed short run, then absolute export margin shrinks by only 2 percentage points because imported-content price effect offsets 3 percentage points.
  - No change in relative markup: exporter raises export prices by 5 percent; relative profit margin remains at 0.6 percent. With same import-content assumptions, absolute margin would increase by 2 percentage points.
  - Middle solution: exporters likely choose intermediate response between extremes.

### Export volumes: short-run vs long-run responses and out-of-sample analysis
- Estimation approach: DOLS for long-run and ECM/OLS for short-run elasticities of export volumes to REER (and alternative specification using export prices).
- Main findings:
  - Short-run elasticity of export volumes to REER is low for both Korea and Japan.
  - Elasticity tends to increase in the longer run.
- Out-of-sample forecast (models estimated on 1989q1–2011q4; comparisons of actual export volumes since 2012 to predicted paths):
  - Large persistent gaps exist between actual export volumes and levels predicted by the model (A+B in Figure 10).
  - About one quarter of the total gap may be attributed to slow or low response of price to exchange rate shocks (B).
  - The forecast from relative margin regressions suggests the traditional relationship between export price and REER did not change; B is likely to close if the Yen’s recent depreciation persists.
  - The portion of the gap reflecting slow or low response of export volumes to export price changes (A) is difficult to predict; recent sharp pickup in export volumes may indicate A is beginning to close, but it could be transitory or reflect structural changes (e.g., value-chain shifts, off-shoring, or changes in quality).
- Simulation (scenario analysis) using relative markup regressions and export volume regressions:
  - If Japan’s export volumes fully return to their equilibrium level (relative to export prices), export volumes would increase by about 30–33 percent until end-2020.
  - Exchange rate scenarios affect the path of export volumes to a limited extent: export volume at end of simulation horizon would be 3-4 percent less when assuming a full unwinding of the Yen’s depreciation since the third quarter of 2011 relative to the baseline scenario that assumes a zero unwinding.
  - A permanent exchange rate shock could cause a permanent shift in profits: relative profit margins of Japanese firms would be 20 percent (permanently) lower than in the baseline scenario if the Yen’s depreciation since August 2011 fully unwinds.
- Simulation assumptions:
  - During 2015–2020 horizon, Japan’s trading partner GDP is assumed to increase by 38 percent in line with IMF’s World Economic Outlook.
  - Baseline assumes current level of REER (and Yen-dollar exchange rate) is locked in; alternative assumes depreciation of Yen since 2011q3 is fully unwound over 8 quarters beginning from 2015q1.

### Imported contents, value-chain linkages, and implications for Korea
- Korea’s foreign value added (FVA) in gross exports is substantial: FVA accounts for 40 percent of Korea’s gross export value, placing Korea fifth among OECD countries on that metric.
- OECD value-added trade statistics suggest Japan is no longer the predominant player in Korea’s upstream supply chain:
  - In electronics, China has surpassed Japan as an upstream supplier for Korea.
  - In chemicals, Australia takes the lead; in logistics, the United States leads.
- Implication: The extent to which the Won’s appreciation offsets the competitive effects of the weak Yen depends on the share of Japanese-sourced imported contents in Korea’s exports; the paper examines how significant that offset would be in the context of the Yen’s depreciation against the Won.

*Source: IMF staff analysis contained in _wp15158.*

### 5.1 percent of Korea’s overall exports. This is

### _wp15158 - 5.1 percent of Korea’s overall exports. This is

### Key findings on value-added and trade channels
- Korea’s FVA (foreign value added) sourced from Japan equals 5.1 percent of Korea’s overall exports.
- FVA sourced from China equals 4.8 percent; from the United States equals 4.6 percent.
- Most gains from the Yen’s depreciation would be soaked up by Japanese exporters, given that domestic value-added contents account for 85 percent of Japan’s exports.
- Korea’s relatively large FVA to gross export ratio implies that the negative competitive effects of a Won appreciation will be significantly offset through the imported cost channel; however, this imported-cost offset would do little to arrest the negative competitive effects from the Yen’s depreciation.

### Pass‑through, prices, and profit implications
- A persistently large depreciation of the Yen would strengthen Japan’s price competitiveness through delayed responses of export prices.
- The extent and timing of price pass-through appear related to the degree of product differentiation.
- The direct boost from the weak Yen on Japan’s exports may be restricted because price variables contribute relatively little to driving export demand.
- Price pass-through effects can be partially mitigated by offsets from the costs of imported inputs.
- A persistently weak Yen could lastingly boost the profits of Japan’s exporters; if this coincides with a strong Won, Korean companies could suffer enduringly lower profits.
- Persistent profit margin changes could affect non-price decisions (for example, location of new capacity, R&D investment), which would drive underlying competitiveness beyond short-run price competition.

### Dynamic and longer-run considerations
- Japanese and Korean exchange rate elasticities are low in the short run but build up over time, with a fairly long lag—so price pass-through and volume responses are expected to grow as time passes.
- Persistent profit margin changes could lead to fundamental, hard-to-forecast non-price investment responses (examples given in the source: more outsourcing by Korean firms; better product development by Japanese firms), with implications for domestic value-added, future productivity, and output growth.

### Comparative sectoral FVA shares (selected figures reproduced from source table)
- Overall FVA to gross exports share (In percent): Korea 5.1; Japan 85.2; China 4.4; Indonesia 1.4; U.S. 0.9; Germany 0.8; France 1.8.
- Electrical sector (In percent): Korea 6.8; Japan 82.2; China 6.3; Indonesia 4.1; U.S. 1.6; Germany 1.7; France 1.1.
- Transport sector (In percent): Korea 6.8; Japan 85.9; China 6.9; Indonesia 3.0; U.S. 2.5; Germany 1.2; France 0.2.
- Chemical sector (In percent): Korea 4.1; Japan 78.9; China 4.0; Indonesia 0.9; U.S. 0.8; Germany 0.7; France 0.9.
- Logistics sector (In percent): Korea 2.4; Japan 93.2; China 1.5; Indonesia 1.5; U.S. 0.3; Germany 0.6; France 2.0.
- Metal sector (In percent): Korea 6.1; Japan 80.5; China 3.5; Indonesia 1.6; U.S. 1.0; Germany 0.6; France 0.8.
- (Sources cited in the original: OECD; and IMF staff estimates.)

### Exchange-rate correlations and driving factors for the Won/Yen cross rate
- From Jan-2000 to Feb-2006:
  - Correlation between the cross rate and KRWUSD was 0.6.
  - Cross rate’s correlation with JPYUSD was near zero.
  - Correlation between JPYUSD and KRWUSD was 0.7.
  - During Dec-2003 to June 2007, the Won appreciated against Yen by 33 percent, with the KRWUSD accounting for about 60 percent of the appreciation.
- From Mar-2006 to Mar-2015:
  - Correlation between the cross rate and JPYUSD jumped to -0.9, indicating Yen-specific factors (for example, monetary easing since late 2011) may have driven the Won/Yen cross exchange rate.
  - During Nov-2011 to [Feb]-2015, the Won appreciated against Yen by 40 percent, with the JPYUSD accounting for 97 percent of the appreciation.
- Since September 2011, the Yen has depreciated against the Won by near 70 percent.

### Empirical model and regression evidence (selected statistics from appendices)
- Japan export volume regression (DOLS) — REER specification:
  - REER_JPN coefficient = -0.561458; Std. Error = 0.089975; t-Statistic = -6.240179; Prob. not listed.
  - Y_STAR_JPN coefficient = 0.699512; Std. Error = 0.029046; t-Statistic = 24.082670.
  - C = 3.725076; Std. Error = 0.537375; t-Statistic = 6.931990.
  - R-squared = 0.996267; Adjusted R-squared = 0.991158.
  - Included observations: 91 after adjustments.
- Japan export volume regression (DOLS) — Export Price specification:
  - LOG(EP_JP_USD) coefficient = -0.299789; Std. Error = 0.141564; t-Statistic = -2.117690; Prob. = 0.0387.
  - Y_STAR_JPN coefficient = 0.753667; Std. Error = 0.033646; t-Statistic = 22.399690.
  - C = 2.314748; Std. Error = 0.763023; t-Statistic = 3.033654; Prob. = 0.0037.
  - R-squared = 0.984491; Adjusted R-squared = 0.974339.
  - Included observations: 92.
- Error-correction and short-run specifications show:
  - D(REER_JPN) coefficients vary (examples: -0.11; -0.05; -0.09; -0.01) with corresponding t-statistics indicating weak short-run exchange-rate effects.
  - D(Y_STAR_JPN) and its lags consistently positive and statistically significant (examples: 3.64 with Std. Err. 0.70; t-Statistics > 5).
- Korea export regressions (DOLS and ECM) indicate:
  - REER_KOR coefficient in one DOLS specification = -0.441861; Std. Error = 0.335386; t-Statistic = -1.317472; Prob. = 0.1913.
  - Y_STAR_KOR coefficient = 2.34795; Std. Error = 0.067425; t-Statistic = 34.823040.
  - Short-run D(REER_KOR) coefficients in ECM and OLS specifications are small and often not statistically significant (examples: -0.13 with Std. Err. 0.07; t-Statistic -1.88).

### Policy-relevant implications (drawn from source analysis)
- The limited short-run export volume response to Yen depreciation could mask longer-term shifts in competitiveness if the Yen remains weak persistently.
- Policy attention should consider:
  - Monitoring profit-margin dynamics and their effects on non-price decisions (investment, R&D, outsourcing).
  - Assessing sectoral value-added structures, given high domestic content in Japan’s exports (85 percent) and Korea’s significant FVA share.
  - Understanding exchange-rate cross-rate dynamics (KRWUSD vs JPYUSD) when evaluating bilateral competitiveness and the drivers of Won/Yen movements.

*Source: IMF staff working paper content as provided in the supplied PDF excerpt.*

### Appendix 9. Estimation of PTM—Technical Note

### Appendix 9. Estimation of PTM—Technical Note

### Model and estimation approach
- The analysis uses Marston (1990) framework: manufacturers produce locally, sell in domestic and export markets with differentiated prices; relative profit margins = export price − domestic price (marginal costs assumed equal).
- Data: four export sectors — transportation, electronics, metals, textiles — accounting for about 40 percent of Japanese and Korean exports.
- Two-step empirical approach:
  - Step 1: Dynamic ordinary least squares (DOLS, Stock and Watson 1993) to identify the long-run cointegrating relationship for relative profit margins.
  - Step 2: Error correction model (ECM) to obtain short-run elasticities and the speed of adjustment to long-run equilibrium.
- Explanatory variables in the DOLS specification (per sector i):
  - P_x,it (export price in domestic currency), P_d,it (domestic price, sectoral PPI), s_t (real effective exchange rate, REER), c_t (real production costs proxied by input price index of imported inputs), y_t (domestic manufacturing industrial production), y_t* (partner country demand series from IMF’s GAS-GEE).
- The only sign implied by the theoretical model is β_s (coefficient on REER), which is negative.
- DOLS includes leads and lags of first differences of explanatory variables; residuals tested for stationarity (ADF statistics reported).

### Long-run estimates and key statistics (Japan)
- Model fit and stationarity:
  - Adjusted R-Square: Transportation 0.95; Textile 0.93; Metal 0.97; Electronics 0.90.
  - Augmented Dickey-Fuller statistics (residuals): Transportation -4.12; Textile -7.47; Metal -3.05; Electronics -3.23.
- REER long-run elasticities (coefficients on Real Exchange Rate):
  - Transportation: -0.36 (standard error 0.04)
  - Textile: -0.43 (standard error 0.15)
  - Metal: -0.33 (standard error 0.27)
  - Electronics: -0.49 (standard error 0.08)
- Other DOLS coefficient highlights (standard errors in parentheses):
  - Imported Input Price: Transportation -0.44 (0.06); Textile -0.31 (0.09); Metal 1.68 (0.16); Electronics -0.92 (0.12).
  - Partner Country Demand: Transportation 0.00 (0.02); Textile -0.20 (0.48); Metal 1.48 (0.85); Electronics -0.16 (0.03).
  - Industrial Production: Transportation 0.08 (0.09); Textile 1.02 (0.32); Metal -0.85 (0.56); Electronics 1.63 (0.17).
- Error-correction coefficients (speed of adjustment to long-run; standard errors in parentheses):
  - Transportation: -0.06 (0.02)
  - Textile: -0.10 (0.06)
  - Metal: -0.09 (0.04)
  - Electronics: -0.03 (0.02)
- Interpretation: A 10 percent depreciation of the Yen in real terms, all else equal, increases Yen-denominated export prices by 3-5 percent relative to domestic prices (i.e., relative profit margins rise by 3-5 percent). Sectoral response: electronics respond most via profit margin adjustment; metals the least.

### Long-run estimates and key statistics (Korea)
- Model fit and stationarity:
  - Adjusted R-Square: Transportation 0.98; Textile 0.99; Metal 0.98; Electronics 0.98.
  - Augmented Dickey-Fuller statistics (residuals): Transportation -7.45; Textile -6.44; Metal -4.62; Electronics -5.86.
- REER long-run elasticities (coefficients on Real Exchange Rate):
  - Transportation: -0.56 (standard error 0.08)
  - Textile: -0.72 (standard error 0.08)
  - Metal: -0.51 (standard error 0.10)
  - Electronics: -0.13 (standard error 0.14)
- Other DOLS coefficient highlights (standard errors in parentheses):
  - Imported Input Price: Transportation -0.61 (0.12); Textile 0.08 (0.12); Metal -0.32 (0.15); Electronics 0.35 (0.21).
  - Export Volume: Transportation 0.28 (0.07); Textile -1.21 (0.08); Metal -0.49 (0.10); Electronics -0.53 (0.12).
  - Industrial Production: Transportation 0.91 (0.17); Textile 1.86 (0.17); Metal 1.34 (0.22); Electronics 0.30 (0.28).
- Error-correction coefficients (speed of adjustment; standard errors in parentheses):
  - Transportation: -0.01 (0.01)
  - Textile: -0.03 (0.01)
  - Metal: -0.04 (0.01)
  - Electronics: -0.02 (0.02)
- Interpretation: Korean manufacturers generally show higher long-run equilibrium elasticity, ranging from 5–7 percent (except electronics), i.e., Korean exporters (except electronics) tend to adjust more through profit margin adjustment in the long run.

### Short-run dynamics and speed of adjustment
- Estimated ECM terms are negative and mostly statistically significant, indicating reversion of relative export prices to the conditional mean defined by the cointegrating vector.
- Speed of adjustment: higher for Japan than Korea; almost all adjustments to long-run equilibrium are made within 20 quarters.

### Out-of-sample forecast (comparison of recent behavior to pre-2012 relationship)
- Forecast setup:
  - Model estimated using observations through 2011Q4 (period up to the start of steep Japanese REER depreciation).
  - Out-of-sample forecast horizon: 2012Q1 to 2014Q4.
- Findings:
  - Transportation and textile: recent Japanese exporters’ pricing-to-market behaviors are not different from predictions based on the pre-Abenomics long-run relationship.
  - Electronics: exporters appear to be passing more exchange rate gains through to export prices than in the past.
  - Metals: past pricing behaviors do not well predict current behaviors of metal exporters; interpretation is less clear than for electronics.
- Note: Similar out-of-sample exercise omitted for Korea because the Won experienced limited REER shock from the Yen (Japan’s relatively small weight as Korea’s trading partner).

*Source: Appendix 9. Estimation of PTM—Technical Note*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2015/_wp15158.pdf_