Q&A: Seven Questions on the Implications of Global Supply Chains for Real Effective Exchange Rates

AuthorRudolfs Bems
Pages8-10
IMF Research Bulletin
8
The real effective exchange rate (REER)—the
most commonly used measure of competitive-
ness—requires a conceptual update to reflect
the rise of global supply chains. This article
summarizes recent research that develops a
value-added REER, measuring competitive-
ness for value-added exports.
Question 1: What do we know about global supply
chains?
e term “global supply chains” broadly refers to t he shi
of production to a multi-stage arra ngement that can stretch
across countries. In recent dec ades we have seen a prolifera-
tion in global supply chain s, especially aer 1990. A common
way to measure global supply chain s is to estimate re-
exported import s, which have gradually increased to accou nt
for around one-fourth of global gros s exports. With these
networks, one can split gros s exports of a country into two
parts: (i) re-exported import s and (ii) exports of value added.
Proliferation of global supply chai ns leads to an increas-
ing “round-tripping” of goods across borders, as count ries
import intermediate inputs, a nd export new products aer
additional value is added to t he input. As a result, the share of
value-added exports i n gross exports falls , while the share of
re-exported imports rises.
Question 2: What are real effective exchange rates (REER)
measuring?
e question that motivates the const ruction of REER
indices is “How is demand for a country ’s output aected
by changes in prices of output relative to competitors?” e
framework that underlies R EERs (see Armington, 1969;
McGuirk, 1987) postulates that t he answer depends on three
factors. First, the deg ree of openness—if a country is closed
then changes in prices relat ive to competitors do not aect
demand for output. Second, an elastic ity of substitution,
which captures the sensit ivity of demand to changes in rela-
tive prices. Final ly, it depends on the REER, which su mma-
rizes relative price developments weighted by trade pat terns.
For our purpose, the key si mplifying assumption of the
conventional REER index is t hat countries produce goods
entirely at home and compete with each other i n various
markets. Because t here are no intermediate inputs, there is
no distinction bet ween a price of a country’s value-added
and gross output. e two are identica l. Similarly, there is no
distinction bet ween exports in value-added and gross t erms.
e two are, again, as sumed to be identical.
Question 3: Does the rise of global supply chains warrant
a rethinking of REERs?
Accounting for global supply chain s can alter our inter-
pretation of the state of the internationa l economy. Esti-
mates show that global supply chains c an change bilateral
trade ows. For example, in va lue-added terms, China’s
trade surplus wit h respect to the United States is roughly 25
percent to 40 percent smaller, because headli ne gross-trade
based surplus includes va lue added from other countries
(Johnson and Noguera, 2012a). Also, in value-added ter ms
the United States, not Germany, is France’s largest trade
partner. A more subtle point is that sec toral composition of
exports can ch ange: in value-added terms one half of U.S.
exports are ser vices. In gross terms serv ices account for one
third of ex ports.
Turning more specically to t he framework that moti-
vates REERs, a ll three previously mentioned ingredients ca n
in principle be aected by t he rise of global supply chains.
Most importantly, in the presence of globa l supply chains
(and intermediate inputs more generally) there is a multi-
tude of output prices and trade weights bec ause quantities
and prices in value-added ter ms and gross terms are dis-
tinct. Consequently, a question ar ises as to what are the most
appropriate prices, weights, and formula for the R EER.
Question 4: How to modify the REER that account for
global supply chains?
In a recent paper, Bems and Johnson (2012) account for
global supply changes by generali zing the framework that
motivates conventional REER s. In essence, they introduce
demand for intermediate inputs into the f ramework, in
addition to the nal dema nd. ey re-derive the REER index
with the same u nderlying motive, although the more general
framework allows for a more pointed question: “How is
demand for a country’s value added aected by changes in
Seven Questions on the Implications of Global Supply
Chains for Real Effective Exchange Rates
Rudolfs Bems
Q&A

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