Paper: Conclusions were mixed. Increased trade with China has meant UK consumers and producers switching to lower prices goods and intermediate-goods, a deflationary impact (estimated at around 0.2pp of CPI for each 1% of GDP increase in trade with China, reaching a -1pp effect in 2004). Yet this switching effect may be off-set by Chinese domestic inflation, as wages and China in general grown has, and is likely to continue, experienced an appreciating exchange rate and appreciating wages, appreciation which is more rapid than inflation in the more developed economies where production was switched from, resulting in higher UK (and using the same principal, Western) inflation.
An important economic point is that inflation is primarily affected by inflation expectations and monetary policy. While the inflation rate may be affected by lower or higher costs in the short term, longer terms rates of inflation are not driven through short term effects (unless these effects affect inflation expectations).
Trade with China directly affects economic and monetary policy. A deflationary environment calls for lower short term interest rates - an inflationary environment calls for higher short term interest rates. Trade with China, and globalisation in general, increasing substantially over the past decade, may have led to, and may continue to lead to, a different level of interest rate. Should developing countries such as China experience price shocks the potential effect should be estimated and planned for.
Further, not addresses by the paper, trade with China may have had an effect on wealth expectations. Cheaper goods may lead to expectations of greater long term purchasing power, if future Renminbi and Chinese wage inflation do have an effect on finished product prices, and production is not (or cannot be) switched to another lower cost region, future UK (Western) purchasing power will be dampened.
Going beyond the scope of the paper:
Relocation of production from provinces where wage inflation is high to lower income provinces may be hindered by significantly increased logistics costs - many manufacturers have wage bills of just 10% of production cost - wages would have to increase significantly to justify sharply higher shipping costs,
As China moves up the value chain it may be able to supply increasing amounts of Value Added goods and services. This increase in Value Added may more than offset domestic wage price inflation, at least for a considerable amount of time. Moving up the Value China is both economicly desirable and is accelerated by the One Child Policy - a family's investment, especially more wealthy families in cities (those most affected by the policy), is in just one person,
China's growth is causing a global surge in commodity prices, driving up the price of plastics to phosphorus. While Western countries' dependence on oil, iron, etc, is likely less than at the time of the last oil shock, and many products dependent on commodities are manufactured in China (thus contributing to the above study) the effect of these price rises has likely been positive on Western levels of inflation.
The Paper in More Detail
There are various channels through which the growth in exports from China may have had an impact on prices in its industrialised country trading partners. The channels through which the first round effects of the emergence of a new large low cost exporter on the world trade scene could affect industrialised country inflation are set out below.
The ‘switching effect’ as domestically produced goods and imports from other countries are substituted for cheaper Chinese imports.
The ‘inflation effect’ stemming from lower or higher inflation in Chinese export prices than in export prices from other countries and/or UK domestic prices.
Lower production costs for both domestically produced goods and imported finished goods produced using Chinese inputs.
Given only 6% of UK imports come from China and imports are equivalent to roughly 20% of UK GDP the direct effect of Chinese imports on UK inflation may be small, but the actual effect may be larger depending on the size of the indirect channels which are set out below:
- Increased competition (and the threat of substitution) that will reduce inflation in domestically produced and imported goods that compete against Chinese imports.
The domestic income effect from the improved terms of trade offered by cheaper imports (and domestic goods) may stimulate domestic demand and prices. - The global income effect from China’s rapidly growing import demand may stimulate global aggregate demand and prices. This may be particularly true for commodity exporting countries.
Conclusions varied according to methodology used:
- Additive method: "used to calculate the impact on weighted world export price inflation and allow changes to be easily separated into the ‘inflation’ and ‘switching’ effects.
- However, they cannot account for the role of monetary policy or inflation expectations, and assume that the prices of goods and services not specifically modelled remain constant."
- Regression method: "can be used to estimate the impact on domestic import prices, and also the pass through to consumer and manufacturers’ prices. They can pick up the effects from a wider range of channels than additive measures, including indirect ones. Which effects are picked up will be determined by the specification of the regression and the choice of inflation measure as a dependent variable."
- The regression based method is more sophisticated than the additive method, but it's conclusions are dependent upon the specification of the equation. Importantly, no lag effect was used and dummy variables were used to account for changes in output gap, etc which the model found to be significant.
- Others papers (below) used different specifications but arrived at a similar result.
- The results suggest that China had a negative impact on UK weighted world export price inflation from 1997 to 2004, mostly due to the switching of the source of UK imports from other countries to China, and this effect grew to a maximum of -1pp per annum 2004.
- Consistent with this, panel regressions suggest that a 1pp increase in UK imports from China (and Hong Kong) was associated with an instantaneous 0.2pp lower consumer price index inflation in that category from 1997-2005, and 0.3pp lower manufacturers’ input price index inflation from 1999-2005.
- However, whilst panel regressions suggest that the switching of imports to China will lower CPI in that year, they also suggest that the existing import share from China has put upward pressure on CPI inflation due to higher inflation in exports from China than other UK trading partners. Overall, the results suggest that this upward pressure on inflation dominated the downward pressure; hence China had a positive impact on UK CPI inflation over the 1997 to 2005 period.
Source: http://www.chinaindepth.org/
posted by Alex Bowman
No comments:
Post a Comment