Trade Production Location and Equilibrium Rate of Exchange(in Japanese)

1. Theme of the Paper and Problems Setup The changes in the world economy, especially the impacts of China's full entry into the international economic system are expected to be substantial. However, the disagreements about the scale of these changes are divided into two groups: the first argues that these changes will stop at the present level, while the second suggests that this is the beginning of the fundamental transformation that will continue for 20-30 years. In the environment of these economic changes, the possibilities of hollowing-out of the Japanese industries, international location of production, the optimal policy of economic development and exchange rate in China and other problems come to the surface. Here, the issue of hollowing-out is interpreted as the problem of economic development and the changes in the industrial structure in Japan. Basing on the Ricardian model with many commodities, this paper estimates the comparative productivity of Japan with respect to China, of which market exchange rates are most deviated from purchasing power parity respectively, and analyzes the effects of technological progress and changes in relative labor costs on the industrial structure. In addition, on the basis of this analysis, the influences on export-competing countries that are now in the same development stage as China is explored. In connection with the optimal policy of the economic development and exchange rate, we take up the Chinese yuan rate and present analyses from the standpoint of the equilibrium rate of exchange. Under the present circumstances of a large trade imbalance and huge foreign currency reserves, the yuan has shown a large scale undervaluation, mainly due to the peg to the dollar since 1994. Consequently, before reaching a policy recommendation, it is necessary to analyze the relationship between the balance of payments equilibrium rate of exchange and the optimal exchange rate policy that exerts positive effect on the economic development. 2. Analysis and its Method First, in order to identify the factors contributing to the hollowing-out of industries and the trading patterns, we treat explicitly differences in relative production technologies as the main determining factor of trading patterns. In this vein we use the Ricardian model with multiple commodities, which emphasizes relative labor productivity as such a factor. Utilizing an international input-output table, Sino-Japanese commodity price differential statistics and others, we estimate the relative labor productivity between Japan and China by converting productivity of value added per capita of respective industries into a physical productivity per capita and evaluate the commodity based competitiveness. In addition we conduct comparative statics analyses and examine the impacts on the model system from shifts in labor cost and technological progress on to the trading pattern and international location of production. Second, considering the exchange rate as an instrument of the economic development policy, we examine the effects of the yuan's appreciation by estimating the equilibrium rate of balancing trade, the rate based on the purchasing power parity and the rate equilibrating the price differentials of respective commodities. Moreover, the impact of the the yuan's changes on the world economy are estimated quantitatively by utilizing a general equilibrium model (GTAP model). 3. Main Results of the Analyses (1) Although the Chinese economy opened with great speed and kept the average tariffs low during the 1990s the price in China moved away further from one that the purchasing power parity (PPP) suggests. This was confirmed by checking both the absolute purchasing power parity (the price level) and the relative PPP (the direction of change). Second, the trade between Japan and China proved to be strongly complementary as Japan and China export those goods with comparative advantage and import such goods as not. The relative price differentials are so large that even a substantial change in the exchange rate cannot stop Japan and China from trading a wide variety of goods with each other. (2) Following Dornbusch, Fischer and Samuelson (1977), the trading pattern based on the difference in relative productivity(Ricardian model with many goods) was successfully estimated. The analyses of comparative statics such as a case of the technological progress in China, a rise in labor cost in Japan and so on showed that individual adverse shift either in technology or labor cost will not cause significant effects on the Japanese economy; whereas simultaneous changes of such will create an extremely negative impact on the economy. Furthermore, there is a high possibility that effects of the appreciation and the depreciation of exchange may be asymmetric in industrialized countries: the former seems more harmful because exporting industries employ more than import-competing ones. (3) China's fixed exchange rate against the dollar after the sharp yuan devaluation in 1994 came to reveal a structural fracture. A fixed exchange rate regime reflects the productivity increases directly in lower export prices, which adds deflationary pressure on importing countries with an already low inflation rate. Under the unlimited supply of labor, so called the Harris=Todaro condition, an undervalued exchange rate policy in addition to the open market enables a country to realize an export-led rapid growth development for a considerable period. High growth produces high employment as well as huge trade surplus and foreign reserve. Nevertheless, there is not only concern about an export of deflation in the short term, but also there exists a fear of aggravating competition with export countries in the ASEAN in the medium-term. Furthermore, judging from the factor endowment of abundant labor in China, the shift of the major demand to the domestic-oriented one focused on labor intensive industries from the export-oriented, which are produced by capital intensive industries, will enhance overall production efficiency and this, in turn, will bring profits of the policy shift. The fact that the shift to the domestic demand increases GDP and has other benefits as employment enhancement was confirmed quantitatively by the general equilibrium model. 4. Conclusion Based on the results of the above analyses, the following policy implications are induced: 1) the analysis of the Ricardian model of trade implies that the Japanese-Chinese trade is complementary and the development of China is highly likely to generate benefits for Japan, 2) the hollowing-out of the Japanese industries due to international competition should be responded constructively by reallocation of the resources to those sectors with competitive edge, which results in further increases in the standard of living, 3) the fact that China utilizes more scarce production factors in export-oriented industries than in domestic demand-oriented ones implies that a shift from the export-led policy to the domestic demand-led development strategy through the exchange rate change (the yuan appreciation) creates significant merits.