Prices Don't Matter: The Bizarre Case Against Lowering the Dollar/Yuan Exchange Rate
|Tuesday, 18 January 2011 05:43|
Harvard Law Professor Mark Wu argued that the value of the yuan against the dollar is no big deal in determining the U.S. trade balance in China in an NYT column. His argument is bizarre to say the least.
First he argues that the value of the yuan has little to do with the ability of the U.S. to export to China. He points out that exports to China grew at a more rapid rate in the years from 2002 to 2005 when the yuan did not appreciate than in the years from 2005 to 2008 when the value of the yuan rose by almost 20 percent against the dollar.
This is true, but the problem is that the very low base in 2002 makes percent change a very misleading measure. The increase in exports from 2002 to 2005 was $19.1 billion, from $22.1 billion to $41.2 billion. Exports increased by $28.5 billion from 2005 to 2008 to $69.7 billion. The more obvious metric would be the increase as a percent of U.S. GDP, which was considerably larger in the second period.
If one was just looking at percent changes then the near doubling of imports in the three years when the yuan did not rise in value is a striking contrast to the increase of just over 40 percent in the three years in which the yuan rose by 20 percent. Of course a full model would consider relative price changes and other factors, but it takes some serious data abuse to use export volumes to argue that exchange rates don't matter.
The other arguments are equally off-base. Wu claims that if the yuan rose against the dollar then we would simply import more from Cambodia, Vietnam and other countries. There are two problems with this argument. First the list of competing countries is not nearly large enough to replace China as a source of imports. If imports from China fell by a third, this would be roughly equal to Vietnam and Cambodia's combined GDP. The other flaw in this logic is that countries like Vietnam and Cambodia target the value of their currency against the yuan. When China abruptly raised the value of the yuan in 2005, a wide range of countries followed suit. It is likely that further increases in the yuan would also be matched by rises in other currencies leaving the relative valuation of their exports little changed. (If these countries were just interested in gaining more of a competitive advantage of the yuan, they could devalue their currency any day of the week.)
The final point that Wu makes is that only 15 percent of our exports compete directly against Chinese exports in third markets. This is likely true, but by itself this is already a large volume of trade. Furthermore, this percentage is rising rapidly as China moves into more upscale manufacturing sectors. The share of exports that compete with Chinese goods likely would have been close to zero five years ago.
In short, there is not much of a case here. Economists generally believe that relative prices matter and the exchange rate is a major determinant of relative prices. (Do tariffs of 20 percent matter? The Chinese sure think so.) Mr. Wu's column gives us little reason to discard standard economics.