A simplified analysis for Chinese Exchange Rate

By: Lian Shengchun
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By the Stolper-Samuelson theorem, we know that a change in the price of a good changes, in the same direction and more than proportionally, the price of the factor used intensively in the good’s production.

This theory indicate that if a country A is abundant in factor endowment X and is scarce in factor Y, by specialization in production X factor intensively and participated in international trade with country C who is abundant with factor Y and specialized its production in industry that factor Y is intensively used. Then we can conclude that the price of the input factor X in country A would rise as the production specialized and factor X intensively used while the price of input factor Y would rise in country C as the production specialization happened and the factor Y were intensively used.

With the inspiration from Stolper-Samuelson theorem, we would further assume that if the production specialization declined and the price dropped, the input factor intensively used in this industry would drop at the same direction and more than proportionally.

Now we will use this theorem to analyze the impact of the exchange rate shift on Chinese economy and income distribution.

For a long time the US government followed the argument which was originated by the ill-disposed Japanese government at year 2002 that the contrived undervalued Chinese currency  pegged to the dollar has given an unjust competitive advantage to the Chinese export so the Chinese currency should be appreciated. Does this make sense? No!

From these statistic data we can conclude that: firstly, the products China export of large proportion was labor intensive; second, the competitive advantage of Chinese port comes from its abundant labor resources and low wage condition.
The competitiveness of Chinas manufactured products mainly comes from the countrys low labor cost. According to calculation by the World Labor Organization, Chinas labor cost (Rural average income 317$) in manufacturing industry is just 2.2 per cent of the US (Average income 35000$) figure.

What would happen if the exchange rate shifts from one dollar against 8.27 Yuan to one dollar against 6.02 Yuan that is an appreciation of 25% to the Chinese currency?

For example, formerly a labor intensive export product of 8.27 Yuan in the United States would sell at one dollar, but now its price should rise to 1.25 dollar as the exchange rate changed. With such a price the Chinese product would lose its competitive advantage. Then what would happen? As a result, the price of this product would still be one dollar on sale but its domestic price would drop to 6.02 Yuan. The labor intensive industry can do it by lower the price of the intensively used input factor labor. As there are so many unemployed people and undeveloped area in China, such a situation would actually happen. The result was illustrated by the following table.

By the Stolper-Samuelson theorem implication if the domestic price of the export labor intensive product dropped 25% from 8.27 Yuan to 6.02 Yuan in China, the price of the intensively used input factor labor resource would drop in the same direction and more than proportionally. That means that the welfare of the low income community in China would worse off more than 25% if the Chinese exchange rate shift happened.

Does China’s currency appreciation would solve the US trade deficit problem? Absolute not! Because the Chinese export accounts no more than 10% of the United States international trade. A 25% appreciation accounts only 2.5% of the US international trade. The RMB appreciation has very limited effect on solving the trade deficit problem of the United States.

Our conclusion is: firstly, the appreciation of the RMB would worse off the welfare of the low income community and would make the distribution unfair problem even more serious in China. Secondly, the appreciation of RMB has very limited effect on solving the trade deficit problem of the United States.

                             80M×1000$↑=1000B$↑×8%