We recount East Asiaâ€™s experience with foreign direct investment (FDI). We document that, contrary to the Rybczynski theorem, capital flows in the region cause the host countryâ€™s labor-intensive industry to expand and its capital-intensive industry to decline. We also present narrative evidence that sheds light on how FDI is affected by the hostâ€™s countryâ€™s locational advantages, whether Asian FDI is footloose, and how the PRC has become the center of Factory Asia. Finally, we show that the evolution of production networks in the region can be explained partly by changes in the service cost of linking geographically separated production blocks relative to the cost saving arising from slicing up the value chain.

https://www.econstor.eu/bitstream/10419/53595/1/663992591.pdf

Understanding Foreign Direct Investment in East Asia

This paper considers how exchange rates affect East Asian trade. The evidence indicates that exports produced within regional production networks depend on exchange rates throughout the region while labour-intensive exports depend on exchange rates in the exporting country. These results make sense since the majority of the value-added of processed exports come from imported parts and components while most of the value-added of labour-intensive exports comes from the domestic economy. Recent findings also indicate that imbalances between China and the US are a major outlier and that an appreciation of the Chinese yuan (CNY) is necessary to reduce these imbalances.

/pdf/the-effect-of-exchange-rate-changes-on-trade-in-east-asia-3llsblav3z.pdf

The effect of exchange rate changes on trade in east asia

China's trade surplus is entirely in processing trade. Processed exports are final goods produced using parts and components coming from East Asian supply chain countries. Many claim that because much of the value added of China's processed exports comes from East Asian countries, exchange rates in supply chain countries should affect China's processed exports and the renminbi should not. To investigate these issues, this paper disaggregates processed exports into their two main categories—processing with imported materials (PWIM) exports and processing and assembly (PAA) exports. For PWIM exports, much of the value added comes from China, while for PAA exports, most of the value-added comes from supply chain countries. Dynamic ordinary least squares (DOLS) results indicate that East Asian exchange rates affect both types of exports and that the renminbi significantly affects PWIM exports but not PAA exports. Since PWIM exports are now six times the value of PAA exports, these results indicate that the renminbi matters for aggregate processed exports.

/pdf/investigating-china-s-disaggregated-processed-exports-35t92wtq4k.pdf

Investigating China's Disaggregated Processed Exports: Evidence that the RMB matters

We provide evidence from the electronics industry in East Asia supporting Kojima's (1973) hypothesis that FDI moves from capital-exporting countries' disadvantaged industries into host countries' advantaged industries. These results imply that FDI and trade are complementary, unlike in Mundell's (1957) model where they are substitutes. The results also indicate that exchange rate volatility deters trade, implying that reductions in the service link costs between production blocks can promote fragmentation. These findings imply that host countries in East Asia can receive technology transfers by lowering service link costs.

Understanding FDI and production networks in East Asia

This paper is an empirical investigation of the relationship between exchange rate volatility and international trade, focusing on East Asia. It finds that intra-East Asian trade is discouraged by exchange rate volatility more seriously than trade in other regions because intermediate goods trade in production networks, which is quite sensitive to exchange rate volatility compared with other types of trade, occupies a significant fraction of trade. In addition, this negative effect of volatility is mainly induced by the unanticipated volatility and has an even greater impact than that of tariffs.

The Effect of Exchange Rate Volatility on International Trade: The Implication for Production Networks in East Asia

This paper, through interviews with 12 major Japanese firms, has revealed new "stylized facts" of the Japanese firms' strategy of currency invoicing, foreign exchange risk managements, and price-setting in recent years It is also investigated whether these stylized facts are consistent with what has been theoretically and empirically found in the literature First, the amendment of Foreign Exchange and Foreign Trade Control Law in 1998 had significant impact on the foreign exchange risk management of Japanese firms Electronics and automobile companies pursue the most efficient settlements of trade transactions under the amended law, and currency invoicing is one of the most important strategic variables to optimize their foreign exchange risk managements Second, as intra-firm trade has been increasingly a major part of their external trade, Japanese electronics and automobile companies have a strong tendency to choose local currency invoicing in exports to advanced countries, while US dollar invoicing has been increasing when exporting to East Asian countries Such an invoicing strategy aims at stabilizing the local currency (or US dollar) price of their exports in local markets, which conforms to the pricing-to-market (PTM) behavior discussed in the literature Third, the recent increase in US dollar invoicing in East Asia can be attributed to (i) US dollar's dominant role of world financial and foreign exchange transactions, (ii) the importance of the US markets as a final export destination, and (iii) the increasing intra-firm transactions as Japanese firms has established regional production networks Fourth, the currency invoicing and price-setting strategies are affected by competitors in global markets where it is hard to pass-through exchange rate risks to importers due to the strong market competition Since US dollar invoicing is now dominant in the East Asian markets, not only Japanese parent companies but also local affiliates in East Asia will take exchange rate risks against the US dollar if the dollar fluctuates unstably As the intra-regional trade keeps growing, it will become more important for East Asian countries including Japan to stabilize the exchange rate not vis-a-vis the US dollar but between the regional currencies This aspect will have important implications for new strategy of optimal exchange rate risk management and, hence, establishing regional currency arrangements such as a common currency basket in East Asia

Currency Invoicing and Foreign Exchange Risk Management: A Case Study of Japanese Firms (Japanese)

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Currency Invoicing and Foreign Exchange Risk Management: A Case Study of Japanese Firms (Japanese)