Vertical trade and Chinaʹs export dynamics

This paper examines how Chinaʹs exports are affected by exchange rate shocks from countries that supply intermediate inputs to China. We build a simple small open economy model with intermediate goods trade to show that due to the intra-regional trade in intermediate goods, a devaluation of other Asian currencies does not necessarily hurt Chinaʹs exports, as imported intermediate goods could become cheaper. The effect of intermediate goods costs depends critically on the share of intermediate goods used in Chinaʹs export goods production and the degree of exchange rate pass-through in imported intermediate goods prices. If prices for intermediate goods are not very sticky, the effect through this channel could be large, and Chinaʹs exports could even benefit. We find that these findings do not depend on Chinaʹs choice of currency invoicing between the RMB and the US dollar or the choice between fixed and flexible exchange rate regimes.