Last week, I attended a conference organized by Eduardo Fernandez-Arias and Alessandro Rebucci at the Inter-American Development Bank. One of the panels focused on the impact of China on Latin America’s economy.
Originally, I’d thought that the linkages would have been quite limited, but in doing research for this talk, I’ve re-evaluated my views.
First, Alessandro Rebucci presented a paper which evaluated the implications of shocks to the Chinese economy, using a global VAR (GVAR) model (for more on GVARs, see the published article, and slightly different working paper here). The details of the model are contained in this paper (which differs slightly from the version implemented in the presentaiton). He and his coauthors found that the effect of shocks to Chinese GDP had increased over time. More surprisingly, they also found that a Chinese revaluation would slow growth in the US, Europe, Japan, as well as in Latin America.
Figure 1: Response to a one standard deviation shock to the China CPI adjusted exchange rate, from A. Rebucci, “The Importance of China for LA and the World
Economy” (April 23, 2010).
Figure 2: Response to a one standard deviation shock to the China CPI adjusted exchange rate, from A. Rebucci, “The Importance of China for LA and the World
Economy” (April 23, 2010).
The results are for a one standard deviation shock to the Chinese nominal exchange rate deflated by the Chinese CPI. A one standard deviation shock is about 4%. Such a shock would reduce Chinese GDP by 0.2% (log terms), and interestingly, induces a reduction in US GDP (of 0.06% on impact, essentially zero at the long horizon). Latin American output falls by 0.1% on impact, with some countries more affected than others. Chilean GDP falls by about half a percent in the long run.
All the graphs and figures above pertain to a 4% exchange rate appreciation. For the 20% figure often discussed, one would need to multiply by five.
Update, 27 April, 11:30am Pacific: Alessandro Rebucci kindly provided some additional intuition for this result [some minor edits -- MDC]:
Why is this a plausible transmission mechanism? China revalues, net exports go down. If domestic absorption does not expand enough to meet existing supply, overall growth decelerates. So not only is the composition of growth, but also is its level, affected. The implication is that a devaluation would have to come with policies supporting absorption in China to be neutral for the level of growth in China and by implications in the rest of the world. For a change in the real exchange rate of a country to have neutral effect on level of growth, the expenditure switching effect has to be accompanied by compensatory level changes that offset exactly the level implications of the change in relative prices. The simulation says that, historically, this has not been the case. There are at least three set reasons why this may happen: certain configurations of trade elasticities (see my WEO chapter on exchange rates and imbalances for the evidence on the fact that exchange rates alone cannot rebalance the world economy without a recession), perverse effects of different propensity to spend across the world (if foreign demand switch to countries with higher saving, overall demand and growth will be lower (but we know this is not the case), and finally, different monetary and fiscal responses to the shock (not enough expansion in China to make up for the fall in net export), too much of a response in depreciating countries because of concerns with the inflationary impact of the depreciation (again, not that relevant today). This leaves us with trade elasticities as the place to look for a better understanding of the likely impact.
Note: I discussed the indicated WEO chapter in this 2007 Econbrowser post.
Rather than focusing on the specific estimated impacts (which will depend upon the model specification), I think the results are of interest because they show that once one incorporates repercussion effects, one can get perhaps surprising results that would not occur in a partial equilibrium setting. (Another example of surprising results from a macroeconometric model is Fay Fair’s recent paper.)
Mauricio Cárdenas, Director of Brookings’ Latin American Initiative highlighted the linkages between Chinese industrial production and commodity prices; for the commodity exporting Latin American countries, this is perhaps the most important linkage.
Figure 3: Rolling correlation of commodity export prices and Chinese industrial production, from M. Cardenas, “China’s Economic Outlook: Implications for Latin America” (April 23, 2010).
Figure 4: Rolling correlation of commodity export prices and Chinese industrial production, from M. Cardenas, “China’s Economic Outlook: Implications for Latin America” (April 23, 2010).
If correlations were to remain high, then a sustained expansion in Chinese industrial production should keep Latin American export prices high as well.
In my presentation, I observed that commodity links were indeed rising.
Figure 5: Latin American and Caribbean non-fuel commodity exports to world (blue) and to East Asia (red), in billions USD. Source: UN, International Trade Statistics Yearbook 2008, as reported in M. Chinn, “China, Latin America and the World Economy” (April 23, 2010).
However, what this graph suggested is that, to the extent that Latin America was increasingly linked to production cycles in China, it was also exposed to increased volatility. That is, given that price elasticities of supply and demand for commodities are probably pretty low, slight shifts in Chinese demand for commodities could induce large swings in commodity prices (and hence Latin American export revenues).
In my mind, the big question is whether the upsurge in commodity demand prove durable if China rebalances its economy, and shifts its production more toward satisfying domestic consumption.