Much of the debate over global rebalancing has focused on the U.S.-China trade imbalance. But that’s missing the bigger picture.
With the growth of cross-border supply chains—a signature feature of Asia’s trade in recent decades—it would be misleading to focus on bilateral imbalances and exchange rates.
Instead of specializing in producing certain types of final goods, Asian exporters increasingly have specialized in certain stages of production and become vertically integrated with each other. So, as Asia’s economies strive to rebalance their growth models, we need to understand better how the regional supply chain affects the way exchange rates and shifts in global demand work.
Illustrating the inputs
Take, for example, the iPad and its rising popularity in the United States.
According to PC Magazine "while final assembly is in China, most of the components seem to be actually manufactured in other Asian [economies]," including Korea, Japan, and Taiwan Province of China.
It would be misleading, in assessing imbalances, to focus solely on the end producer. The exporting country’s price competitiveness depends on both the value of its own currency and also on the value of its suppliers’ currencies.
The shifting hub
Some fast facts on the degree of regional trade integration give a sense of how important it is to account for exchange rates of both the exporting country and its suppliers.
The Asian supply network is increasingly centered on China.
- China now accounts—directly or indirectly—for about half of all imports of intermediate inputs within Asia, a share that has doubled since 1995.
- For many of its Asian trading partners China has become the single most important destination of intermediate goods exports.
- And China accounts for 20-25 percent of all capital goods exports from Japan and Korea, a fourfold increase from a decade earlier.
- China’s role as a supplier has also grown rapidly. It now accounts for nearly 30 percent of intermediate goods exports within Asia, up from 15 percent a decade earlier.
For all major Asian economies, Japan remains the second most important source of intermediate inputs after China. And, in the short run, other countries may not be able to easily replace Japanese production of many high-end electronics and capital goods. If production disruptions in Japan following the tragic earthquake and tsunami persist, say beyond the Fall, the resulting supply shortages could have significant spillovers to production elsewhere in Asia
Because of Asia’s high degree of vertical integration, the cost of intermediate inputs can account for a significant share of exporters’ total cost. In value added terms, we estimate that the imported content in exports ranges from about 10 percent in Japan to 40 percent in the smaller open economies, such as Malaysia.
Taking account of the supply chain
A more comprehensive approach to thinking about imbalances and exchange rates might provide a clearer picture of what’s required to achieve global rebalancing.
To account for importance of suppliers in cost competitiveness, we estimate an “integrated effective exchange rate.” This builds on the concept of the conventional effective exchange rate, which measures changes in a country’s exchange rate as a weighted average of the bilateral exchange rates with its trading partners. The integrated exchange rate also factors in supplier economies’ exchange rate movements.
- In the case of China, for example, the integrated exchange rate has appreciated more slowly than the conventional one in recent years. As the currencies of China’s important supplier economies, in particular Korea, have depreciated, this has dampened the rise of input costs for Chinese exports.
- Likewise, Korea’s conventional effective exchange rate has depreciated by about 25 percent since the global financial crisis, but its integrated exchange rate has depreciated much less. In this case, the currencies of Korea’s key suppliers, including Japan, have appreciated and raised the cost of inputs in Korea’s exports.
- By contrast, Japan’s integrated exchange rate tracks more closely the conventional one, reflecting the relatively high local content in Japanese exports.
Accounting for vertical trade integration also affects the way we measure global demand imbalances. For example, if we adjust the U.S.-China trade imbalance to reflect the original suppliers of the imported inputs in China’s exports to the United States, we find that China’s trade surplus to the U.S. shrinks and that of most other Asian economies increases.
The bottom line? Asia’s high degree of vertical integration means that a durable reduction in imbalances requires adjustment across all major Asian economies and currencies.