The Effect of Exchange Rate Changes on Trade in East Asia

East Asia is characterized by intricate production and distribution networks. Higher skilled workers in Japan, South Korea, and Taiwan produce sophisticated technology-intensive intermediate goods and capital goods and ship them to China and ASEAN for assembly by lower skilled workers and reshipment throughout the world. These networks have promoted economic efficiency and functioned as an engine of growth. They have also been accompanied by large trade imbalances with the U.S. that could cause Asian currencies to appreciate against the dollar. This in turn would alter relative exchange rates in Asia, given the variety of exchange rate regimes in the region. This paper investigates how such exchange rate changes would affect trade within Asia and between Asia and the U.S. The results indicate that exchange rate changes can cause significant declines in exports of intermediate and capital goods from developed Asia to developing Asia. This evidence implies that exchange rate appreciations in developed Asia relative to developing Asia would disrupt the complimentary relationship that exists between these countries in the trade of sophisticated technology-intensive goods. The results also indicate that exchange rate elasticities for trade between Asia and the U.S. are not large enough to lend confidence that a depreciation of the dollar would improve the U.S. trade balance with Asia. This evidence implies that policymakers in the U.S. should not expect too much from an appreciation of Asian currencies and should focus instead on shortfalls of saving relative to investment if they are concerned about their trade imbalances.