1) Exchange rates have a short-term impact on trade balances but a weaker link in the medium and long run, as structural factors are more influential. 2) Structural factors like uneven financial development, social safety nets, trade reforms, and demographic changes like rising sex ratios can significantly impact savings rates and trade balances. 3) Trade reforms in labor abundant countries can paradoxically increase trade surpluses through general equilibrium effects, as returns to capital fall and incentivize capital outflows. Exchange rates are not always the best tool to correct trade imbalances.

1. Exchange Rate and Trade Imbalance
Shang-Jin Wei
Columbia University Business School
Chazen Institute of International Business

2. Exchange Rate and Trade
• Separate effect on trade vs effect on trade
balance
• A country’s trade balance is tightly linked to a
country’s current account balance, which, as a
matter of accounting identity, has to be equal
to the difference in the country’s national
savings and national investment, or the
country’s net capital outflows

3. • Since others have discussed
extensively about the effect
of exchange rate on trade, I
will concentrate my remarks
on trade balance
• The intense discussion in
the policy circles on the so-
called current account
imbalances

4. What causes trade (or current
account) imbalance?
Candidate explanations:
Nominal exchange rate policy
Structural factors that affect savings (and
investment)

5. What causes trade (or current
account) imbalance?
Candidate explanations:
Nominal exchange rate policy
Most talked about but perhaps least relevant
structural factors that affect savings (and
investment)
Uneven financial development
Uneven social safety net
A rise in the sex ratio in certain countries
Trade reforms in certain countries

6. The role of nominal exchange rate policy
• Common confusion
– Real exchange rate vs nominal exchange rate
– If nominal exchange rate is fixed, relative inflation rates across
countries could still cause the RER to adjust
• Can one engineer a sustained departure of the real
exchange rate (RER) from its long-run equilibrium?
– Maybe for 2-3 years for an over-valued RER
– Key: goods prices (and nominal wages) are sticky downward
– However, very hard to maintain an under-valued RER for the
same duration because prices can go up more easily than down.
– The literature in empirical international finance suggests that
the RER converges to the equilibrium level relatively quickly.
This is especially true if the required correction is an increase in
the value of the RER

7. Example: In the short run, trade balance responds to
change in exchange rate

8. However, in the medium-run and long-run, the
link is much weaker
• Japanese yen is on a floating exchange rate
regime
• Japan has not intervened in the exchange rate
market since 2004 (until more recently)
• Yet, Japanese trade balance and current
account have been in surplus in most years

9. • This tells us a few things:
– Despite the short-term correlation between
nominal exchange rate and real exchange rate, the
medium-term correlation is close to zero
– There are likely structural factors in the Japanese
economy that cause the country to run a trade
(and current account) surplus
– A flexible exchange rate does not guarantee the
disappearance of a trade surplus (or deficit)

10. The role of nominal exchange rate policy
• What about international evidence on a change
in the nominal exchange rate regime?
• Does a change in the exchange rate regime from
a peg to a floating system speed up the current
account adjustment?
• Menzie Chinn and S.J. Wei, 2012, “A faith-based
initiative meets the evidence: Does a more
flexible exchange rate facilitate current account
adjustment”? Review of Economics and Statistics

11. • No strong and robust support for the notion that a
more flexible exchange rate regime produces a faster
convergence of current account to its long-run
equilibrium
• True for both developing and developed countries
• True after excluding China from the sample
• Reference: Chinn and Wei, 2012, RESTAT

12. Structural factors
underlying trade imbalance
– A rise in the sex ratio
– A wave of major trade reforms
– Uneven financial development across countries
– Uneven social safety net across countries

13. Sex ratio imbalance and current account imbalance
• A rise in the sex ratio for the
pre-marital age cohort in
several countries (e.g.
Singapore, Vietnam, Korea,
China) takes place about the
same time as a rise in these
countries’ trade surplus and
current account surplus

14. • What’s the connection between the
sex ratio and trade balance?
• Why did the rise in the sex ratio in
China start around 2002 (just when
its current account surplus became
more prominent)?
• How strong can the effect be?

15. Percentage of Chinese counties
with Ultrasound B machines
source: Chen, Li, Meng (2010)
• What’s the connection between the
sex ratio and trade balance?
– Competitive savings for the marriage
market
• Why did the rise in the sex ratio in
China start from 2002?
– spread of ultrasound B + family
planning policy
• How strong can the effect be?
– A strong biological urge implies a strong
economic effect (50% of the increase in
Chinese savings since 1990)
Sex ratio and saving rate in China:
1975- 2005
0
20
40
60
80
100
Percent
of
Counties
with
Ultrasound
Device
1975 1980 1985 1990 1995
Year

16. More Rigorous Evidence
from households and regions in China
• “The competitive savings motive: evidence from
rising sex ratios and savings rates in China”
– S.J. Wei and X.B. Zhang, Journal of Political
Economy, 2011
– Household-level evidence
• Saving for children a key reason for
savings, especially when having a son
• A combination of having an
unmarried son and living in a region
with a high sex ratio -> high savings
rate
– Cross regional evidence
– Quantitative effect: 50-60% of the rise
in savings
– The rise in the sex ratio also triggers a
rise in the corporate savings rate
– So national savings becomes higher
Sex ratio and saving rate in China:
1975- 2005

17. Trade reforms and trade balance
• Counter-intuitive result
– Or a case of a general equilibrium effect overturns a partial
equilibrium intuition
• Partial equilibrium intuition:
– Example: When China reduces import barriers, its imports
would go up and trade surplus would go down
• General equilibrium result:
– When China reduces import barriers, this puts downward
pressure on domestic return to capital, and hence an
incentive to send part of the domestic savings to foreign
countries. This means it would increase trade surplus.
– This is accomplished by having the exports to expand at a
faster rate than imports

18. Trade reforms and trade balance
• Logic :
– China is a labor abundant country
– It has strong comparative advantage in labor-intensive products
– Trade reforms reduce the domestic price of capital intensive
good
– This tends to reduce the domestic return to capital (“The
Stolper-Samuelson theorem”)
– … and creates an incentive for capital outflows (or a rise in the
current account surplus)
Reference: Ju, Shi, and Wei, 2012, “trade reforms and current
account imbalances: does the general equilibrium effect
overturn the partial equilibrium intuition?”

19. More than a coincidence: China’s WTO accession and
the rise of its current account surplus

20. • Interestingly, the same conceptual framework
indicates that the end of the MFA quotas in
the U.S. per se has a tendency for the U.S. to
increase its trade deficit:
– End of MFA quotas reduces the prices of
garments/textiles (labor intensive products)
– This by itself tends to raise the return to capital in
the U.S. (again, the Stolper-Samuelson theorem)
– … and creates an incentive for the US to import
capital (i.e., to run a current account deficit)

21. Cross country evidence
• Identify trade reform episodes
– A reduction in average tariff rate by 3 pct pts or
more within 2 years
– An increase in imports/GDP by 3 pct pts within 3
years
• Check if k-intensity has increased
• Check if CA/GDP has increased

22. Trade reforms that tend to reduce a country’s capital
intensity tends to generate a current account surplus

23. • Some implications
– Asking a labor abundant country to do more market
access reforms could induce the country to have a
bigger not a smaller trade surplus
– The part of trade balance generated by trade
reforms tend to die out once the reforms are
completed

24. • There are other structural factors that could
also generate a current account imbalance
– Uneven financial development
– Uneven social safety net
– …

25. Policy Lessons
• Exchange rate policy may have played a smaller role in
the patterns of trade (current account) imbalances
than commonly assumed
• Not all trade imbalances need a policy correction
– For example, some trade imbalances may be generated by
efficient trade reforms
• Some trade imbalances are socially inefficient, but
exchange rate is not the appropriate tool for correction
– For example, the part of trade imbalance generated by a
sex ratio imbalance is indeed inefficient, but the exchange
rate correction could make things worse

26. • For references or detailed presentation of the
theories and evidence discussed here, one
might check out
– www.nber.org/~wei