Global value chain and its impact on the linkage between exchange rate and export: Cases of China, Japan and Korea

Abstract

The link between exchange rate and trade has been studied for a long time, but there is no consensus about their relation. This paper tests the old argument, whether depreciation of real effective exchange rates (REERs) raises exports. We differentiate the test with earlier studies by employing a new measurement of REER and incorporating the effect of GVCs. We measured REER at industry level with value‐added trade weights. We analysed the topic with LSDV and system GMM for China, Japan and Korea since these counties are known to participate actively in GVCs. Our main finding is that exchange rate has significant impact on trade for three countries. However, the movement of elasticity of export to REER varies by country. While the elasticity in China decreased over time, Korea and Japan experienced increasing patterns between mid‐1990s and mid‐2000s and decreasing trends afterwards. This study also tests whether the level of incorporation in GVCs causes a change in elasticity. The results show that growing participation in GVCs lowers the elasticity of export to REER in absolute value. However, this result is only statistically significant in Korea.

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“…The researchers speculated that growing fragmentations in the production process had weakened the effect of exchange rate changes on regional trade in Asia. Furthermore, Bang & Park (2018) proved that participation in GVC decreased the exchange rate elasticity of exports in South Korea by 33%. However, the effect was not statistically significant for Japan and China.…”

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