Exchange Rates and Trade Balances: Effects of Intra-Industry Trade and Vertical Specialization

Abstract

To examine how changes in relative national prices affect trade flows, this study estimates the impact of changes in industry-specific effective real exchange rates on industry-level trade balances, exports, and imports. We analyze the variations in industry-specific intra-industry trade and vertical specialization, which may both govern the long-run relationship between real exchange rates and trade flows. We employ sample information from 13 manufacturing industries across five Asian countries from 2001 to 2015. Rather than country-level aggregate measures, we use disaggregated industry-specific real exchange rates, which provide better measures of relative national prices and may help to uncover different responses that are masked by aggregate data. Fixed-effect estimations reveal that greater price competitiveness, as measured by depreciation in industry-specific effective real exchange rates, increases industry-level trade balances. We find that the elasticity of industry-level trade balances with respect to industry-specific real exchange rates declines as vertical specialization increases. There is also some limited evidence that this elasticity increases as intra-industry trade increases. Taken together, our findings suggest that global supply chains are more important than intra-industry trade in examining the response of trade balances to real exchange rate changes. Importantly, these heterogeneous impacts imply that policies regarding exchange rate management may be of limited potency and will affect different industries in different ways.

International Trade of Ecowas Member Countries

“…In contrast, the decrease in the share of merchandise exports in the GDP of the economy reflects the lower intensity of the observed economies' exports. 19…”

“…The Ivory Coast trades in agricultural products for the oil and smaller ships. These are mainly import-oriented countries 19 Osabuohien, E. (2007), 'Trade Openness and Economic Performance of ECOWAS Members-Reflections From Ghana And Nigeria', African Journal of Business and Economic Research, vol. 2, pp.…”

Sectoral Real Exchange Rates and Manufacturing Exports: A Case Study of Latin America

“…According to theoretical models (Chen & Juvenal, 2016) and previous empirical findings ( Thorbecke & Smith, 2010;Torres García et al, 2018;Neumann & Tabrizy, 2021), the responsiveness of exports to RER movements can differ significantly between sectors. One important reason for this sectoral heterogeneity is that exports of low technology products tend to respond more to RER movements, on the grounds that they can be substituted easier than more complex products and that they tend to have a lower cost share that is paid in the currency of the destination country -they rely more on local labor and less on imported inputs and have lower distribution costs.…”

“…The use of fixed effects models is common in papers that study the impact of RER movements on exports (e.g. Ahmed et al, 2015;Li et al, 2015;Chen & Juvenal, 2016;Neumann & Tabrizy, 2021). The advantage of this methodology is that it allows to control for both unobservable heterogeneity across individuals that is constant over time ( ) and country specific factors that change annually ( ).…”

“…With regard to trade, Byrne et al (2008) stress the importance to consider sectoral price indices when deflating export values, and they find that an increase in relative sectoral price differences affects bilateral US trade negatively. Lee & Yi (2005), Dai & Xu (2013), Sato et al (2013) and Neumann & Tabrizy (2021) go a step further and calculate sectoral REER using industry-level producer price indices. They find that in China, Japan, Korea, Malaysia and Indonesia important differences exist regarding the impact of RER movements on sectoral competitiveness and trade balances.…”