Industry‐specific exchange rate volatility and intermediate goods trade in Asia

AuthorShajuan Zhang,Junko Shimizu,Kiyotaka Sato,Nagendra Shrestha
Published date01 February 2016
DOIhttp://doi.org/10.1111/sjpe.12112
Date01 February 2016
INDUSTRY-SPECIFIC EXCHANGE
RATE VOLATILITY AND
INTERMEDIATE GOODS TRADE
IN ASIA
Kiyotaka Sato*, Junko Shimizu**, Nagendra Shrestha* and Shajuan Zhang*
ABSTRACT
This study empirically analyses the impact of industry-specific real exchange
rate volatility on intra-Asian trade of intermediate goods at an industry level. In
contrast to the recent studies, our empirical results reveal that the exchange rate
volatility has significantly negative effect only on two industries: general machin-
ery and electrical machinery. However, no significant effects are found on the
intermediate goods trade of other machinery industries. Such different impacts
of the exchange rate volatility across industries reflect the growing intra-firm
trade and the choice of invoice currency, which is related to the characteristics
of the traded goods.
II
NTRODUCTION
Asian trade has been increasing remarkably as a result of active investment
and trade by foreign multinational companies (MNCs) based not only in the
North American and European countries but also in Japan and other Asian
countries. The MNCs located in mainland China and Association of South-
east Asian Nation (ASEAN) countries, on the one hand, import higher-skilled
parts/components and capital goods from Japan and other Asian countries
and, on the other hand, export finished goods to the North American and
European countries. Asia is thus characterized by a ‘triangular’ trade with
growing cross-border production fragmentation in the region.
Meanwhile, Asian countries have sought regional monetary and exchange
rate coordination, particularly after the 199798 currency crisis. Given this
rapid progress of economic integration through trade and investment, regional
exchange rate stability has gained increased attention. However, it is not nec-
essarily clear whether the exchange rate volatility affects intra-regional trade
based on the production network.
This study employs a new industry-breakdown data of the bilateral real
exchange rate (RER) to investigate the extent to which RER volatility affects
*Yokohama National University
**Gakushuin University
Scottish Journal of Political Economy, DOI: 10.1111/sjpe.12112, Vol. 63, No. 1, February 2016
©2016 Scottish Economic Society.
89
the intra-regional trade of intermediate goods in Asia. No clear empirical or
theoretical consensus exists whether the exchange rate volatility has a negative
or positive impact on international trade.
1
One possible relationship between the RER volatility and trade is related to
the role of ‘sunk costs’. Clark et al. (2004) stated that a firm’s trade is less
responsive to the short-run exchange rate volatility, given a large investment
of exporting firms in foreign markets to build marketing and distribution net-
works and/or to set up production facilities. Recent growth of intra-regional
trade has been influenced by MNCs. Once a production network is estab-
lished, intra-firm trade will grow wherein its relation-specific nature may miti-
gate the exchange rate risk of intermediate goods transactions along the
production chain. This is particularly the case for larger MNCs with an
oligopolistic nature that tend to expand global production and sales networks
and where exchange rate risks from their trade transactions are concentrated
and efficiently managed in their head office (Ito et al., 2012). Another key fac-
tor is the choice of invoice currency. Asian trade is typically invoiced or con-
tracted in US dollars rather than in local currencies (Sato, 2003; Ito et al.,
2012). As long as both exports and imports are invoiced in US dollars, MNCs
in Asia are less affected by the exchange rate volatility, at least in nominal
terms.
Recent empirical studies, however, have found that the exchange rate
volatility has significantly negative effect on intra-Asian trade (e.g. Thorbecke,
2008; Hayakawa and Kimura, 2009; Chit et al., 2010; and Tang, 2014). These
studies focused on a particular industry (electronic components in Thorbecke,
2008), and the difference between final and intermediate goods (Hayakawa
and Kimura, 2009; and Tang, 2014). However, these studies did not thor-
oughly examine the industry difference in responsiveness of intermediate
goods trade to the exchange rate volatility.
This study differs from previous studies in three respects. First, we use a
more detailed industry-breakdown data for empirical analysis. Specifically, we
focus on six industries: general machinery, office machinery, electrical machin-
ery, communication equipment, transport equipment and precision instru-
ments.
2
Second, we construct a new dataset of the industry-specific bilateral
RERs to evaluate whether and how the impact of exchange rate volatility on
trade of intermediate goods differs across industries. The aggregate exchange
rate, typically used in previous studies, cannot capture differences in both
price level and inflation across industries. Third, as the final processed exports
are destined for countries outside the Asian region, not only the exchange rate
but also the world demand for Asian exports of finished goods are considered
1
Clark (1973), for instance, theoretically demonstrated the negative impact of the
exchange rate volatility on international trade, while Franke (1991) indicated that a positive
relationship can exist between the exchange rate volatility and trade.
2
The industry classification is based on the two-digit level of the International Standard
Industrial Classification (ISIC) Rev.3. As argued by Kimura et al. (2007), production and
distribution networks of these industries are qualitatively and quantitatively the most impor-
tant in Asia.
90 K.SATO,J.SHIMIZU,N.SHRESTHAANDS.ZHANG
Scottish Journal of Political Economy
©2016 Scottish Economic Society

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