China's foreign exchange regime and its impact on exports and growth

Abstract

Exchange rate devaluation has been used as a policy instrument to promote China's exports in recent years. The consequences of devaluation are affected by foreign trade and exchange controls and the macroeconomic environment. This study analyses the characteristics of the Chinese foreign exchange regime and macroeconomic policy. Due to inflation and foreign trade and exchange controls, official exchange rate devaluation was unsuccessful during 1985-90 in terms of the real effective exchange rates measured in this study. Comparing the real effective exchange rates for exports with imports, economic incentives were still biased towards import substitution. Technology and productivity differentials between China's export and nonexport sectors and beneficial externalitites generated by export production and import activities are investigated to analyse the effect of an exportlimport expansion on the economy following a devaluation/import liberalisation. Empirical results from this study suggest higher marginal and total factor productivities and technological progress in the export sector than in production for the domestic market and positive externalities from export and import activities. A computable general equilibrium model of the Chinese exchange rate regime 1 developed to analyse the short-run and long-run effects of exchange rate devaluation. Simulated results from this model indicate that the impact of devaluation on the Chinese economy is twofold. The model points to a number of major beneficial effect on both macroeconomic and sectoral variables, including a decreasing gap between the secondary market exchange rate and the official rate, an increase in two way trade, an improvement in the trade balance and real GDP and absorption growth, an increase in real wage rates and a decline in import prices. On the other hand, simulated results also show that a devaluation results in a rise in the relative price level and thus affects international competitiveness. Simulated results indicate that the problems arising from devaluation can be reduced by the introduction of labour intensive production techniques and measures to improve capital productivity. Another approach involves total factor product,ivity increases which flow from export expansIon. The results also demonstrate that appropriate macroeconomic policies are essential to achieving favourable consequences for devaluation. On the basis of quantitative and descriptive analyses, policy implications are drawn out for the Chinese economy, including economic liberalisation, structural adjustment and reform measures to achieve macro and micro dynamic efficiency. Show more