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The Research of Exchange Rate Change, Export Structure and International Trade Welfare Effect , , GU Guoda ZHANG Zhengrong LI Danyu College of Economics Zhejiang University [email protected] , : Abstract This paper considers the status of REM’ evaluation, and conceives an imperfect- competition model to analysis the effect of exchange rate variability to trade structure, employment of export industries and the welfare of the country (modeling China) whose labor supply is infinity. Through the research, the paper finds that evaluation of the country’s currency is not propitious to enhance the export, employment of export industries, and the country’s welfare. The effect of exchange rate variability to different industries with different factors intensities is different. Exchange rate variability will change the trade structure of a country. The greatest extent of trade quantity been affected by exchange rate variability appears in the export industry of labor intensive, but with a certain quantity of capital factor. The employment and welfare of labor intensive industry is easy to be affected by exchange rate variability. Key words Exchange rate variability, Trade structure International trade welfare effect Employment of trade department : , , The research for international trade pattern and structure is a long lasting subject of international economics. In the Heckscher-Ohlin’s trade theory framework, the international trade structure is subject to the factors endowment of different country. 1 Paul Samuelson etc. constructed an two-factors, two-departments analytic model, which gradually became the base of modern international trade theory. 2 Nowadays, the flow and re-combination of factor endowments are gradually changing their status and amount in all kinds of countries, thus change the international trade structure all over the world, and augment the imbalance of the world economy. More and more researchers pointed it out that the imbalance of the world economy3 is up to the imbalance of trade structure of different countries, which mainly behaves as the trade surplus of Asia countries and the trade deficit of America. The imbalance of trade flow and structure reflects the status of re- combination of factor endowments of the whole world. The different amount and liquidities of different factors brings on the flow and structure change of factor-endowments, which induces the imbalance. Some researchers took the infinite supply capability of America’s dollar and the infinite supply capability of China’s labor factor as the cause of imbalance of the world economy.4 The exchange rate variability changes the comparative price of trade commodities. It can also change the comparative price of different factors in one country. Thus the comparative advantage of a country is changed with the change of capital/labor ratio in production. As to China, the export of corporations has account for 54.7%% of the whole export in 2005. And the outward processing trade has account for 54.7%. The international flow of capital and its combination with domestic labor has being the crucial causation of the increase of China’s export and economy. Low exchange rate of RMB has been spurring the inflow of capital and outflow of products in the latest 25 years. 1 Heckscher,E.F.1919. "The Effect of Foreign Trade on the Distribution of Income."Economisk Tilastirift. In Hechscher-Ohlin theory.Heckcher,E.F.and B.Ohlin. Cambrige, MA:The MIT Press,1991. 2 Jones,R.W.1965. "The Structure of Simple General Equlibrium Models." Journal of Political Economy.73:6,pp.557-72 3 Ricardo J. Caballero Emmanuel Farhi Pierre-Olivier Gourinchas An Equilibrium Model of “Global Imbalances”and Low Interest Rates NBER working paper, February, 2006 4Huamin: The spring mechanism of World Economy Imbalance and the choice of China,International economic Rreview : , 751 ( ) This paper’s analysis is based on the work of Dornbusch(1987), Venables 1990 ,and Jayant Menon 1996 . It is assumed as a two countries(A-B) and two factors (K: capital L: labor model.5 The labor’s price in country A is w . It is said that the labor supply in country A is infinite. The w can be regarded as the living cost or the minimum wage the government regulated. The labor factor can flow in the country freely without cost, but can not internationally. Capital’s price in country B is r . Anyone can get capital with the price r in country B. And capital factor can flow in the country and ( ) - ) internationally freely without cost, which means anyone in the country A can get capital with price Er , where E is the price of one unit of money in country B in country A. As to a firm of country A, it can get both infinite labor and capital with the prices of w and Er . Under the former assumptions, capital flows from country B to country A, and commodities flows from country A to country B, which is the cause of nowadays world economy imbalance. And the imbalance commodities trade factor content trade6 flows reflects on the imbalance of factors flow globally, and the process of the gradually utilizing labor in the country lack of capital. Go with the process, great manufacturing and exporting capability is engendered, take China as an ensample, if the global-widely flow of capital factor, technique factor and management factor needs no cost, the great manufacturing and exporting capability will not localized on the labor intensive industries only, but in all kinds of industries also. Now, we regard the different intensity of factor content for different commodity as the symbol of different trade commodity. The schematics of different factor content proportion of different trade commodities describes one country’s export structure. The export structure of country A is up to 3 matters as the following. The viscidity of capital flow internationally and its cost. The substitution extent of labors in different industries. The exchange rate, which denote the relative price of different countries. In this paper, we regard the capital can flow feely internationally without cost, and the labor can do all kinds of work in different countries, and analysis the effect of exchange rate variability on the trade structure and the welfare of export. ( ) ① 1 ① ② ③ ③ ② A model of the effect of exchange rate variability on the trade structure This paper takes an export industry which produces commodity i with the Cobb-Douglas production function as research object. We assume that all firms produce the same product in one country are all the same. One representative firm produce commodity i as the following: q = f ( k , l ) = Ak a l b For the convenience’s sake, we take function: q = A( (1) a + b = 1 , thus: with the profit-maximum condition w a a 鬃 ) l Er 1- a ,,we get the (2) As the assumption in Cournot’s model, we regard the price of commodity i in country B’s market is: p = a − bQ , a > 0, b > 0, Q > 0, a ٛ bQ (3) n In the all N firms which offer commodity i to the market of country B, b is the number of 5 Krugman P.R.,etc.: International economics, Beijing: Economic science publishing company, 2002 Elhanan helpman.1999,The structure of foreign trade” Journal of economic perspective,vol.1 no.2 spring,1999 6 752 n domestic firms of country B, they are all the same. And a firms are of country A. na + nb = N . The profit-maximum condition and the first order condition (FOC), we get: q= w r (1- a ) a 1 1 [ a - bnb qb - 鬃 ( ) ( )ٛ E a - 1 ] A wa 2bna 1- a (4) (4),we get the marginal effect of the change of exchange rate on the change of the country A’s export quantity of commodity i to country B. Thus, With function ¶( ¶Qa ) ¶E = - A- 2 ?D ¶A 0 (5) D is a positive constant value with the change of A . It means the more technology used in an industry, the effect of exchange rate variability on its export quantity is less. Different a ( 0 < a < 1 ) denotes the different content intensive in the export commodity, the bigger the a , the more capital intensive the commodity. We take the A of all commodities as the same constant value. Then we take a i i 1, 2 M as the representation of commodity i ,or industry i . From (11) we get the (= … ) , elasticity of exchange rate change to export quantity change, the equation is as the following: ¶Qa Qa e= = ¶E E E a - 1w( r (1- a ))a ( a - bQ(1- Qa 1 )) A(a w)a - w( r (1- a )) a ( )E a - 1 Q 1- a (6) ¶e > 0 ,it means the more the market volume of commodity i in country B, the more the effect ¶Q Qa of exchange rate changes to its export quantity. In the assumption, Q means the market share of ¶e commodity i from country A in country B, thus < 0 means the more the market share of Qa ¶( ) Q commodity i from country A in country B, the less the effect of exchange rate changes to country A’s export quantity. According to 6 we get the marginal change of ε when export structure changes when exchange rate fluctuates. ( ), α change, this show the changing of E a - 1r a w1- a 1 a a Er 1- a ?e 1 = 鬃 ( ) [ln( ? ) ] a 1- a A(a bnb qb ) w a ?a For g (a ) = ln( 0< a < a * , ¶( Er a 1 ) - ln( )w 1- a 1- a is descending when (7) a Î (0,1) , when ¶Qa ¶Q ¶Q ) ¶( a ) ¶( a ) ¶E > 0 ; 1 > a > a * , ¶E < 0 ; a = a * , ¶E < 0 . ¶a ¶a ¶a With different a , the extent of the increase (decrease) of export quantities when country A’s currency 753 devaluation (evaluation), thus the exchange rate variability changes the trade structure of country A. As Chinese status in quo,7 we get graph 2. It is shows that when a = a * = 0.273 , the extent of export quantity changes most when exchange rate changes. The effect of exchange rate fluctuation to country A's export structure 0 0.07 0.14 0.21 0.29 0.36 0.43 0.5 0.57 0.64 0.71 0.78 0.85 0.92 1 a (Factor intisity) : Graph 1 The effect of exchange rate variability to country A's export structure (the diagram of different extent of exports of different commodities with different factor intensities been affected by effect of exchange rate variability) The effect of exchange rate variability to the trade structure reflects the comparative prices changes of commodities and factors when the flow and re-combination of factor endowments are carrying through. The country with infinite labor could get capital factor under the international capital price. The evaluation (devaluation) of country A’s currency not only raises (reduce) the price of its product in international market, but also raise (reduce) the labor cost in name of currency B. The capital price in international market is not changes, but the comparative price in the domestic factor market of country is changed. Thus the ratio of capital and labor in production is changed too. Based on the former analysis, it is clear that the devaluation of its currency is in favor of the export of country A. Exchange rate variability affects different to the extents of different commodities with different factor intensities, thus changes the trade structure of country A. Overall, Exchange rate variability affects the labor intensity commodity’s export extent more than the capital intensity export commodity’s , and in favor of the increasing of the ratio of high- technique product in the export structure. The most affected export commodities is the labor intensive one but with certain capital factor · ( U (a = a * = 0.273) ). That is just the most mass export commodities of China, such as textile, clothing, shoes, and plastic product and so on. The pure labor intensive commodities are affected by 7 = We assume E=8, w 1000 and r =1000/8, Aa=1000000, and 754 a - bQ(1- Qa a )= 2. Q exchange rate variability too, such as farm produce of China. The affect to capital commodities are relatively low. 2 A model of the effect of exchange rate variability on the trade welfare Under the assumptions that the home country’s labor supply is infinite, and the capital supply internationally is infinite, the effect to a country’s welfare is not only including the change of the profit of firms (producer surplus), but also including the change of labor’s welfare from employment change ki0 when capital flow and the ratio of capital to labor is changed. This paper assumes that h = is the ki ratio of domestic capital and the inflow capital, and the price of international capital price is 1 ( r = 1 ), that means without manufacturing, the capital owners earn nothing. The labor employment of country A : in the commodity i exporting industry could be showed as Li = ( a - 1) E rw (1- a ) Er ) a ( a - bQb A(a w)a 2 Ab(a w) (8) Form (8), we know that the occupation of country A is changed positively when E changes. The devaluation of country A’s currency is in favor of the employment of country A. according to it, we get: ¶Li aE ( a - 1) rw (1- a )r = (a - bQb ) ¶E 2 Ab(a w)a A(a w)a (9) (9) means that when E increases (decreases), the employment of the commodity i exporting industry increases (decreases). Then according the former assumption, we simulate calculating and get the graph 4. The effect of exchange change to employment of exporting industries with different capital intensities 0 4 0 . 0 8 0 . 0 1 1 . 0 5 1 . 0 9 1 . 0 2 2 . 0 6 2 . 0 3 . 0 3 3 . 0 7 3 . 0 1 4 . 0 5 4 . 0 8 4 . 0 2 5 . 0 6 5 . 0 9 5 . 0 3 6 . 0 a(capital intensity) 755 7 6 . 0 7 . 0 4 7 . 0 8 7 . 0 2 8 . 0 5 8 . 0 9 8 . 0 3 9 . 0 6 9 . 0 : Graph 2 The effect of exchange change to employment with different capital intensity industries8 Thus, the whole employment change of A country’s exporting industries could be expressed as the following. Where there are M exporting industries, and Ai , αi , Qbi denote the corresponding parameters of commodity i exporting industry. ¶L M (1- a i )r = ? a ( ai ¶E i= 1 2 Ab i (a i w) aE ( a i - 1) rw biQbi a i ) (10) Ai (a i w) It is show that when the market of country B (international) is big enough, the devaluation of country A is in favor of the employment of country A. It is because that the exchange rate change not only change the commodities price and exporting quantity of country A, and change the quantity of capital inflow, which can combine the labor to produce and export, but also the rate of capital and labor in production, thus changes the factor content of exporting commodities. The whole welfare of exporting commodity i can be denoted as: ? bE h w r (1- a ) a [a - bQb ) ] Ea - 1( A(1- a ) wa 4 i rw a - 1 1 a (11) (1- a ) Erw(a w)- a E ( + [a - bQb ) ] 2 Ab A wa It is showed in (24) that the exchange rate variability could change the welfare to country when exporting commodity i to country B. The evaluation of country A’s currency go against the welfare which is behaved in both the labor welfare and the producer’s surplus. Then the total welfare of country 墩 = (a - bQ )( bh + (1- a )rw ) 4 2 Ab(a w) ¶E - a E aw A ( b4h r (1- a ) + r (12-Aba a)w A’s exporting commodity i to country B can be showed as: i a b a-1 1- a a a-1 From (12), and the assumptions, we get graph 5. 8 (1- a ) 2 a The assumption is the same as the above. 756 a ) (12) The effect of exchange rate change to the welfare of country different industries of different factor intensities 9 0 4 0 . . 0 0 0 3 1 . 0 7 1 . 0 2 2 . 0 3 53 93 34 74 25 65 6. 56 6 2 0 . . . . . . 0 . . . 0 0 0 0 0 0 0 0 a(capital intensity) 96 . 0 37 . 0 87 . 0 28 . 0 68 9. 59 9 . . 0 . 9 0 0 0 : Graph 3 The effect of exchange rate change to the welfare of country different industries of different factor intensities 9 From the above analysis, we know that the labor intensity industry is most affected by exchange rate variability. The evaluation of country A’s currency will both reduced the producer’s surplus and labor welfare. Thus the overall effect of exchange rate change to country A’s welfare could be expressed as the following. M 墩 = ? [( a ¶E i= 1 i - aiE 3 a i- 1 bi Qbi )( bi h i (1- a i ) rw )] + 4 2 Ai bi (a i w)a i w1- a i bh i a i r 2 (1- a i ) w(1- a i ) (13) a i- 1 ( )] r (1- a i ) + 2 Aba i a i a iai A 4 Conclusion In the status of world economy imbalance, one country’s “balance sheet” traditionally determined by trade balance has changed a lot. The capital flow, goes with the technique and management, has changed one country’s factor endowment dramatically. The high mobile factor flow form its wealthy country to the poor one is the marked character of the recombination and imbalance of world economy. The country have excessive weak mobile factors, that means labors, could get the combination of high mobile factor from abroad, and release the potential production capability, then improve both the national and international welfare. Exchange rate variability will change the relative price of commodities and factors internationally, which will also change the comparative cost of using different factor endowment when production is processing, thus the ratio of different factor in the production will 9 The assumption is the same as the above. 757 change, too. It means the employment and productivity will be changed by exchange rate variability. This paper models the country with infinite labor supply, which export quantity, export structure, employment and welfare through export changes when exchange rate changes. The paper finds that the evaluation of the country’s currency is not in favor of the increase of export quantity, employment and welfare through export. And it change the trade structure of trade, that percentage of the export of capital intensive commodities will raise, and the percentage of labor intensive commodities will fall, but the most affected commodities appears in the labor intensive industries with certain capital combination, such as the production of textile, garment, and shoes. And the most affected of labor employment export industry is the most labor intense one, the affected of the country’s welfare appears in the most labor intense industry, such as the agriculture in China. As far as China concerned, the imbalance of world economy is augmenting the press of evaluation of REM, and the export quantity, employment and welfare are changing. While the effects of exchange rate change to different industries are different, the government should treat differently to industries with different factor intensities in the course. 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[8]Krugman,P.R.,etc.:International economics,Beijing:Economic science publishing company,2002 [9]Ricardo J. Caballero Emmanuel Farhi Pierre-Olivier Gourinchas An Equilibrium Model of “Global Imbalances”and Low Interest Rates NBER working paper, February, 2006 : , 758