Global Value Chain Participation and Firms' Responses to Exchange Rate Fluctuations

• Published date: 01 September 2024
• Author: Chun Jiang,Fuwei Sun,Zhida Zhang
• Date: 01 September 2024
• DOI: http://doi.org/10.1111/cwe.12548

©2024 Institute of World Economics and Politics, Chinese Academy of Social Sciences

China & World Economy / 53–86, Vol. 32, No. 5, 2024 53

Global Value Chain Participation and Firms’

Responses to Exchange Rate Fluctuations

Chun Jiang, Fuwei Sun, Zhida Zhang*

Abstract

Greater participation in global value chains (GVCs) has highlighted the impact of

exchange rate shocks on international trade. This paper examines how such participation

influences firms’ responses to exchange rate movements, focusing on the relationship

between firms’ pricing and value-added in exports. This study, using detailed Chinese

firm-level data, demonstrates that firms with a high degree of GVC participation reacted

to currency appreciation by lowering their export prices more substantially and reducing

their export volumes less. This is mainly attributable to the “cost-hedging effect” within

the marginal cost channel and the “pricing inhibition effect” within the markup channel.

By categorizing export firms by trade models and product types, this study further

demonstrates that processing trade firms at the low end of the value chain and those with

low product differentiation were more inclined to absorb exchange rate shocks. This study

adds to the existing theoretical framework and provides strong evidence for China in

deepening GVC integration and supporting the development of high-quality export firms.

Keywords: exchange rate elasticity, exchange rate fluctuations, exchange rate pass-

through, firm response, global value chain participation

JEL codes: F14, F15, F31

I. Introduction

The effect of exchange rate shocks on international trade has been particularly

interesting to scholars and politicians because dramatic exchange rate fluctuations

in the real world introduce uncertainty into international trade, which is crucial to

economic growth in many countries. A significant body of literature has used aggregate

data to examine the connection between exchange rate changes and exports (Baum and

Caglayan, 2010). However, aggregate data alone may not provide the detailed evidence

*Chun Jiang, Professor, Center for Economic Development Research, Wuhan University, China. Email:

jiachun@whu.edu.cn; Fuwei Sun (corresponding author), PhD Candidate, Economics and Management

School, Wuhan University, China. Email: flysun@whu.edu.cn; Zhida Zhang, PhD Candidate, Economics

and Management School, Wuhan University, China. Email: zhida93@163.com. The authors are grateful for

support from the National Social Science Fund of China (No. 15ZDC020).

Chun Jiang et al. / 53–86, Vol. 32, No. 5, 2024

©2024 Institute of World Economics and Politics, Chinese Academy of Social Sciences

54

needed to understand the specific price and quantity responses of firms to such shocks.

A study by Berman et al. (2012) on heterogeneous firm characteristics made up for this

defect in aggregate research. Their study showed that the responses of prices and volumes

of firms were highly correlated with firms’ performance. High-productivity firms had

lower exchange rate pass-through (ERPT) and weaker volume response. This finding

was further echoed by Li et al. (2015), who reached a similar conclusion. Othe r scholars

approached the issue from various angles, examining import intensity (Amit i et al.,

2014), market share (Antoniades and Zaniboni, 2016), product quality (Bernini and

Tomasi, 2015; Ch en and Juvenal, 2016; Auer et al., 2018), price competition (Auer and

Schoenle, 2016; Amiti et al., 2019), destination income (Zou et al., 2022), and export

modes (Bolatto et al., 2022).

The global value chain (GVC) also has a profound impact on international trade.

Global value chain trade accounts for approximately 60 percent of world trade (ADB,

2021). Within the GVC production system, exporters commonly rely on imported

intermediate inputs such as raw materials, spare parts, and semi-finished products to

manufacture goods. This reliance exposes firms to significant exchange rate risk and

subsequently influences their export adjustments in response to exchange rate variations.

This situation gives rise to several important questions: Does GVC participation affect

firms’ response to exchange rate fluctuations? How do firms with different levels of

GVC participation adjust their export prices and quantities in response to exchange rate

changes? What is the mechanism through which GVC participation influences these

adjustments?

Previous studies have explored the above issues on a preliminary basis from a macro

perspective. Research based on cross-country panel data has suggested that countries with

a hi gh degree of GVC participation have lower export elas ticity in response to exchange

rate swings (Ahmed et al., 2015; Fauceglia et al., 2018). Another study by De Soyres et al.

(2021) focused on the quantity response and revealed that the exchange rate elasticity of

export quantity decreased as the share of foreign value added in exports increased. Some

researchers have investigated the relationship between GVC participation and ERPT.

For example, Georgiadis and Gräb (2019) found that the higher the degree of GVC

participation, the lower the extent of ERPT. Hagemejer et al. (2022) and Firanchuk (2021)

also supported the above point, but they focused on the nonlinear impact and the country-

specific differences in GVC participation, respectively. These macro-level studies give

much attention to the strength of the effect of GVC participation on the export elasticity or

ERPT, overlooking its underlying mechanisms and transmission channels.

This paper contributes to the existing literature in two ways. First, it supplements

the relevant theoretical basis and mechanism for existing macro-level studies by

©2024 Institute of World Economics and Politics, Chinese Academy of Social Sciences

Firms’ Responses to Exchange Rate Fluctuations 55

constructing a theoretical model that explains how GVC participation affects exporters’

heterogeneous responses to exchange rate changes, further decomposing these reponses

into the marginal cost and the markup channels. In the marginal cost channel, GVC

participation affects the elasticity of export price to exchange rates through the cost-

hedging effect of imported intermediate inputs, which is conceptually consistent

with Amiti et al. (2014) and Wang and Yu (2021) on the principle of imported

inputs. In the markup channel, the degree of GVC participation affects the elasticity

of export price to exchange rates by influencing firms’ pricing ability and pricing

strategy. The paper also specifically identifies the mechanism of the marginal cost

channel based on the differences in the use of imported intermediate inputs between

processing and ordinary trade firms, and the mechanism of the markup channel based

on the differences in firms’ pricing strategies for differentiated and homogeneous

products. These approaches offer robust and compelling evidence for our theoretical

mechanism.

Second, this paper presents new evidence on the diverse responses of export firms to

changes in exchange rates. It explores the impact of GVC participation on firms’ export

response to the exchange rates from a new perspective – the value-added viewpoint.

Specifically, the degree of a firm’s GVC participation determines the proportion of value

added in its exports that comes from overseas versus the portion generated by the firm

itself. This allocation of value added in exports influences the value generated by firms

in the GVC, which, in turn, significantly impacts their pricing power in the value chain

and their pricing strategies in response to exchange rate fluctuations.

Our theoretical model of how GVC participation influences a firm’s response

to exchange rate fluctuations is based on the framework of Berman et al. (2012) and

Chatterjee et al. (2013). From the model, we derived several theoretical predictions.

Specifically, GVC participation has a positive impact on the export price elasticity in

response to exchange rate swings. This is largely attributable to the cost-hedging effect

within the marginal cost channel and the pricing inhibition effect within the markup channel.

There is also a negative impact of GVC participation on the export quantity elasticity in

response to exchange rate fluctuations. The impact of GVC participation on the elasticity

of export value is ambiguous as it depends on the relative strength of the price and quantity

responses.

To examine the validity of our theoretical predictions empirically, we utilized the

Chinese micro-firm and trade data set covering the period 2000–2013 to analyze the

impact of GVC participation on the response of export price and quantity to exchange

rate fluctuations. The results provided strong confirmation of our theoretical predictions.

Several exciting findings are as follows.