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The economic and social effects of real exchange rate

─ Evidence from the Chinese provinces

Ping HUA Clermont Université, CNRS, Université d'Auvergne, Centre d'Etudes et de Recherches sur le

Développement International, BP 10448, F-63000 CLERMONT-FERRAND, France Tel : 00 33 1 39 14 81 25

Email: P.Hua@u-clermont1.fr

for

«INTERNATIONAL CONFERENCE ON SOCIAL COHESION AND DEVELOPMENT

20-21 January 2011, Paris, France OECD Development Centre, with the financial support of Fundación

Internacional y para Iberoamérica de Administración y Políticas Públicas (FIIAPP)

Abstract

Real exchange rate exerts different economic and social effects. If a real appreciation exerts

positive effects on economic growth by exerting pressure on efficiency improvement and

technological progress via workers’ motivation, education and capital intensity, it exercises negative

effects by deteriorating the international competitiveness in tradable sector and thus by destructing

employment.

An econometric model is estimated by using the GMM system estimation approach and panel

data for the 29 Chinese provinces and over the period from 1987 to 2008. The results show that the

real exchange rate appreciation had a negative effect on the economic growth, higher in coastal than in

inland provinces, contributing to a minimizing of the gap of GDP per capita between two kinds of the

provinces. They show moreover that the real exchange rate appreciation acted negative effects on

employment.

Key words: China, economic growth, real exchange rate.

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1. Introduction

Since several years, China suffers more and more from international pressure in favour

of the renminbi revaluation. However, the Chinese government has not surrendered to this

insistent pressure because of the increased numbers of social unrests. Recently the primary

minister Wen argued that “forcing Beijing to revalue its currency would lead to a disaster for

the world, because many of exporting companies would have to close down, migrant workers

would have to return to their villages. If China saw social and economic turbulence, then it

would be a disaster for the world.”

The worries of the Chinese government are comprehensive because an important

empirical literature on export-led growth1 found the negative impact of real exchange rate

overvaluation on per capita growth rates; and this is particularly true for developing countries:

the more overvalued the currency, the lower the per capita growth rate. Dollar (1992) and

Benaroya and Janci (1999) argue that the relative undervaluation of the Asian currencies

compared with those in Latin America and Africa explained the higher growth in Asian

region. Hausmann et al. (2005) showed that real exchange rate depreciation is one of the

factors associated with the growth acceleration. Eichengreen (2008) argues that a more

depreciated real exchange rate together with weak exchange rate volatility favours growth

process. Rodrik (2008) and Berg and Miao (2010) argues that not only are overvaluations bad

but undervaluation is good for growth, particularly in developing countries. MacDonald and

Vieira (2010) found that a more depreciated (appreciated) real exchange rate helps (harms)

long-run growth especially for developing and emerging countries.

The worries of the Chinese government are all the more comprehensive that the

literature emphasizes that the main channel through which real exchange rate exerts on

growth is the size of the tradable sector (especially industry), particularly for developing

1The real exchange rate does not normally feature in economic growth models.

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countries. As the tradable sector suffers disproportionately from the institutional and market

failures in developing countries, the depreciation of real exchange rate increases the relative

profitability of investing in tradables, and acts in second-best fashion to alleviate the

economic cost of these distortions; and inversely (Rodrik, 2008).

The existing literature is mostly based on the data of cross countries. It does not allow

incorporating the special characters of each country and thus analysing the precise channels

through which real exchange rate acts on economic growth2. China provides an interesting

country case study. China’s economic growth has increased very rapidly since the beginning

of its transition towards a market economy in 1978. The annual growth rate of the real GDP

per capita (2000=100) was on average 9.4 % from 1979 to 2009,3 contributing significantly to

the reduction of global income poverty by lifting over 200 million people out of $1 per day

poverty in the past three decades (World Bank, 2009). It is higher starting from 1994, passing

from 8.0 % per year over the 1979-1993 period to 10.7 % over the 1994-2009 period. The

speeding up of the economic growth is different according to the Chinese provinces4. It is

2 Few papers identified the precise channels through which the growth effect of real exchange rate is generated.

Rodrik (2008) explained that one channel is the size of the tradable sector (especially industry). Montiel and

Servén (2009) show that saving is unlikely the mechanism through which the real exchange rate affects growth.

3 See figure 3 in section 2.2.

4 China is composed of 22 provinces (Hebei, Liaoning, Jiangsu, Zhejiang, Fujian, Shangdong, Guangdong,

Hainan, Shanxi, Jilin, Heilongjiang, Henan, Anhui, Hubei, Hunan, Jiangxi, Gansu, Shaanxi, Sichuan, Guizhou,

Yunnan et Qinghai), four autonomous municipalities under the direct control of central government (Beijing,

Tianjin, Shanghai and Chongqing) and five autonomous regions (Guangxi, Inner Mongolia, Ningxia, Xinjiang

and Tibet). In our econometric analysis, the autonomous region of Tibet is absent short of statistics, the statistics

of Chongqing, created in 1997, are included into those of Sichuan, which lead to restrain 29 provinces in a large

conception in terms of "province".

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more pronounced in inland provinces5 with its annual average growth rate passed from 7.6%

to 9.98% than in costal provinces6 (from 9.3% to 10.1%).

The growth acceleration since 1994 has been accompanied by a reversal of the

exchange rate policy of China. After a long period during which the Chinese government has

systematically devalued the renminbi vis-à-vis the dollar, in 1994 it decided to stabilize and in

2005 to progressively revalue it. This policy led to a depreciation of real effective exchange

rate of the Chinese currency against the currencies of its trade partners during the first period,

especially strong from 1990 to 1993, and an appreciation during the period from 1994 to

1998, and in 2001, 2008 and 20097. It is therefore interesting to investigate the role of the real

exchange rate in this growth acceleration, stronger in inland provinces than in coastal

provinces. Has the appreciation of the real exchange rate contributed to speeding up or slow

down the growth acceleration in China, and inversely? Is this contribution different in the two

kinds of the provinces?

No study, to our knowledge, analysed yet the growth impact of the real exchange rate

in China. Most of the studies on China’s exchange rate policy analysed the misalignment of

the renminbi (see Cline and Williamson, 2007 for a review); while a few studies analysed the

effects of real exchange rate in real economy8. The objective of this study is to analyse the

5 Inland provinces, eighteen in total, are: Shanxi, Jilin, Heilongjiang, Henan, Anhui, Hubei, Hunan, Jiangxi,

Gansu, Shaanxi, Sichuan, Guizhou, Yunnan, Qinghai, Guangxi, Inner Mongolia, Ningxia and Xinjiang.

6 Coastal provinces, eleven in total, are: Beijing, Tianjin, Hebei, Liaoning, Shanghai, Jiangsu, Zhejiang, Fujian,

Shandong, Guangdong and Hainan.

7 See figure 2 in section 2.1.

8 Guillaumont Jeanneney and Hua (1996) and Hua (1996) showed positive effects of the real depreciation on

China’s exports. If the real appreciation decreased China’s manufacturing employment (Hua, 2007), it decreased

however the urban-rural and coastal-inland income inequality (Guillaumont Jeanneney and Hua, 2001) and

boosting labour productivity (Guillaumont Jeanneney and Hua, 2010).

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impact of real exchange rate on economic growth by investigating the precise transmission

channels through which real exchange rate acts on growth. The issue of the possible impact of

the real exchange rate on economic growth is an important one at this time a widespread

currency war9 is in prospect (Cline and Williamson, 2010); and the main objective of the

Chinese government is to keep a high growth rate to create enough employment.

The rest of this study is the following. In section 2, after the presentation of the

evolution of China’s exchange rate policy and of its economic growth, a statistical analysis

shows a negative relationship between real exchange rate and the economic growth in China,

stronger in coastal than in inland provinces. To understand this negative relationship, we

present in section 3 how theoretically real exchange rate variations may exert (positively or

negatively) multiple effects on economic growth. We identify three kinds of transmission

channels through which real exchange rate influences economic growth: 1) input factors

(employment, education and capital intensity) channels, 2) tradable sector channels (exports,

FDI and industrial sector) and 3) efficiency channels. We explain that if a real appreciation

exerts positive effects on economic growth by acting pressure on efficiency improvement and

technological progress via workers’ motivation, education and capital intensity (rarely studied

in the literature), it exerts negative effects by deteriorating the international competitiveness in

tradable sector and by destructing employment (traditional argument). Consequently, the sign

of the total effects of real exchange rate on economic growth is theoretically ambiguous and only an

empirical analysis can reveal it. From this theoretical analysis we draw our estimating strategy.

We define a function of economic growth which includes the real effective exchange rate

beside more traditional factors which are themselves supposed to depend on the real exchange

rate. In section 4, we estimate these functions by using a panel data which combine the

9 Guido Mantega, Financial Minister of Brazil, said “We’re in the midst of an international currency war, a

general weakening of currency.”

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temporal dimension represented by annual data 1987-2008 and the spatial data represented by

the 29 Chinese provinces. In conclusion we draw some policy implications.

2. Real exchange rate and economic growth in China: the evidence of styled facts

A descriptive approach of the evolution of China’s exchange rate policy and of its

economic growth suggests that the real exchange rate appreciation acts a negative impact on

the economic growth, higher in coastal provinces than in inland provinces; and that the

reversal of the exchange rate policy from currency depreciation to appreciation contributed to

slow down the acceleration of economic growth more sensible in coastal than in inland

provinces.

2.1. China’s nominal exchange rate policy and the evolution of its real exchange rate

China’s exchange rate regime

China’s exchange rate regime is the fruit of a long evolution from two exchange rates

to a unique rate which remains tightly managed until now. During the first years of 1980s, the

exchange rate policy played a little role, because foreign trade was largely planned. It is only

since 1984 that national foreign trade societies should take international prices into account to

fix the sale price of imported goods and the purchasing price of exported goods (Guillaumont

Jeanneney and Hua, 1996).

From 1981 to 1993 the export societies have benefited from a foreign exchange

retention system. They could sell some of their foreign exchanges obtained from exports at an

administrated rate of the dollar higher than the official rate (simultaneously applied to planned

importations and capital transactions). At the end of 1986, the administrated rate became a

swap market rate which was determined in the foreign exchange market, even still under the

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State’s control. The export societies continued to deliver one part of the foreign currencies

obtained from their exports to the People’s Bank of China at the official rate, and sold another

part, proportional to their retention quota, to the foreign exchange market at the swap rate.

The foreign exchange retention rate has progressively increased up to 80% in 1993, so well

that the swap rate became the principal rate for trade transactions at this time.

From 1985 to 1993, the Chinese government devalued the two exchange rates against

the dollar several times. These devaluations were not realized simultaneously most of the

time. Often, one of the two rates stayed stable and played the role of a monetary anchor. It

contributed thus to slow down inflation, and favoured the real depreciation of exchange rate

(Guillaumont Jeanneney and Hua, 1996, Guérineau and Guillaumont Jeanneney 2000). The

nominal and real depreciations vis-à-vis the dollar were in fact large (respectively 53 % and

37% for the official rate over the period from 1990 to 1993) (figure 1).

On 1st January 1994, China radically changed its policy. The double exchange rate

system was suppressed; the swap rate became the unique official rate for all transactions. The

last one was officially a managed floating, but in fact strictly pegged to the dollar and

maintained stable since then. On 21 July 2005, the Chinese authorities decide to revalue the

renminbi of 2.1% vis-à-vis the dollar, to switch from the dollar peg to a basket10, and to allow

the currency to float more freely11. Since this date, the renminbi was progressively revalued

against the dollar. From 2005 to 2009 the renminbi appreciated of 17% in terms of dollars and

its real bilateral rate appreciated of 18 % (Figure 1). The Chinese authorities have undertaken

several reforms to improve the functioning of the exchange market permitting some flexibility

in the short run, but the rate until now remains tightly managed.

10 The basket of currencies is undefined (like Singapore does). The four main currencies in the basket are the US

dollar, the euro, the yen and the won.

11 The US dollar against the RMB is allowed to float within a band of 0.3 percent around precedent daily rate.

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The evolution of the real effective exchange rate of China as a whole

Real exchange rate conditions the international competitiveness of a country relative

to its trade partners, and exerts multiple effects on real economy. It is the key variable in this

study. It can be approximated by a real effective exchange rate index, calculated here as the

product of China’s nominal effective exchange rate (weighted average of the renminbi

exchange rates against the currencies of the main foreign trade partners of China) and the ratio

of consumer price index of China to the weighted average consumer price index of the same

main trade partners. According to this definition, a rise of the real effective exchange rate

corresponds to an appreciation of the Chinese currency.

The nominal effective exchange rate depends on the relative variations of the different

bilateral exchange rates of the renminbi against the currencies of the main foreign trade

partners and therefore it evolved differently from the bilateral exchange rate against the

dollar. The evolution of the real effective exchange rate of the renminbi is different from that

of the nominal one, due to the price differential between China and its partners which was

positive during the depreciation period.

From 1987 to 1993, the real effective exchange rate decreased at an annual rate of 7 %

on average with a total depreciation of 43% during the seven years12. The drop was

particularly strong in 1993 (17 %)13. From 1994 to 1998 the real effective exchange rate

appreciated strongly (at an annual rate of 9% on average, i.e. 52 % during the whole period of

these five years). Since then, it experienced some weak depreciation as the nominal one

except for the year 2001, when it appreciated of 6.4%. The real exchange rate appreciated

12 From 1979 to 1993, the real effective exchange rate decreased at an annual rate of 7.7 % on average per year

with a total deprecation of 72% during fifteen years.

13 The drop was even more important in 1981 (44%) when the foreign exchange retention system and the double

exchange rate system were introduced and 1986 (29%) when the administrated rate became a swap market rate.

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again in 2008 (12%) and in 2009 (6%) (figure 2). This led a total real appreciation of 62.5%

during the period from 1994 to 2009, i.e. at an annual rate of 1.59% on average.

The evolution of the real effective exchange rate of the Chinese provinces

The change in real effective exchange rate varied from one province to others in

China. This disparity results from two factors (Guillaumont Jeanneney and Hua, 2001, 2002).

The first one is the diversity of their foreign trade partners, as each province tends to trade

more with its border countries14. Therefore the weighting of the foreign currencies is

different. The second factor is a considerable difference between provinces’ inflation15. From

1987 to 2009, average annual rate of inflation has ranged from 5.7% in Henan province to

8.0% in Beijing municipality. These differences are themselves due to several reasons: the

differences in Chinese provinces’ production and consumption patterns and external trade, the

fiscal and monetary policies largely decentralised in China and very different from one

province to another (Guillaumont Jeanneney and Hua, 2004).

From 1987 to 1993, the annual average depreciation of the real effective exchange rate

in Chinese provinces varied from 6.9% for Guizhou to 2.8% for Beijing, while during the

period from 1994 to 2008, the average appreciation varied from 1.14 % for Guangdong to 3 %

for Qinghai (Table 1)16. The real depreciation during the period from 1987 to 1993 as well as

the real appreciation during the recent period from 1994 to 2008 has been slightly lower in the

14 Guillaumont Jeanneney and Hua (2002) reported in this same review the share of imports of each province

from the 20 main partners (see appendix A, pages from 153 to 156).

15 as illustrated in the figure reported in Guillaumont Jeanneney and Hua (2002, page 135) .

16 One exception concerns Yunnan which did not experience an appreciation of its real exchange rate during the

recent period, mainly due to inflation less high than that of Myanmar as its 4th most important partner; the share

of Myanmar in the total import of the Yunnan province is equal to 6.8% and the inflation was 1528 % in

Myanmar over the period from 1994 to 2007.

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coastal provinces than in the inland provinces: the annual average rate of depreciation was

4.41 % in coastal provinces against 4.84% in inland provinces and the real appreciation was

1.77% in the coastal provinces against 2.01% in the inland provinces. According to the impact

of the real exchange rate upon economic growth, these differences might have contributed to

increase or decrease the growth gap between the two kinds of provinces.

2.2 Economic growth in China as a whole and in the provinces

The evolution of the economic growth in China as a whole

The economic growth is calculated in this study as the ratio between the GDP

expressed in 2000 constant prices and total population. Figure 3 shows the evolution of

economic growth in China as a whole since 1978, the year which marked the beginning of

China’s economic reforms inside the country and of its openness policy to the outside. The

economic growth in China increased dramatically, passing from 1 267 yuans per capita in

1978 to 20 296 yuans in 2009. It is multiplied by sixteen over the 31 years, which corresponds

to an annual average growth of 9.4 %. From 1987 to 2009, the economic growth was weak

only in two years (2.8% in 1989 and 3.7% in 1990); while during the other years it was at

least 7.8%. The economic growth slowdown during these two years was probably due to the

break in the reforms after the student movement in Tiananmen Square. China’s economic

growth accelerated from 8.01% during the period 1979-1993 to 10.68% during the period

from 1994-2009.

The evolution of the economic growth in the Chinese provinces

The economic growth did not increase at the same rate in the different Chinese

provinces as in the different periods. The annual average rate of economic growth varied from

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7 % for Qinghai to 12 % for Zhejiang during the period from 1979 to 2009. The economic

growth varied from 5.5% for Qinghai to 12.1% for Guangdong during the period from 1987

to 1993 and between 7.3% for Xinjiang and 14% for Inner Mongolia from 1994 to 2009 (table

1).

All the Chinese provinces (except Fujian, Guangdong, Hainan and Xinjiang) have

experienced an acceleration of economic growth since 1994, but at a different rate (table 1).

The speeding up of the economic growth is more pronounced in inland provinces with its

annual average growth rate passed from 7.6% during the 1987-1993 period to 9.98% during

the 1994-2009 period than in costal provinces (from 9.3% to 10.1%). The economic growth

was more than doubled in three inland provinces (Anhui, Qinghai and Inner Mongolia) and in

one coastal province (Tianjin) because their economic growth is particularly weak. On the

contrary, among the four provinces which did not meet the growth acceleration during the

recent period, Guangdong and Hainan suffered from the strong deceleration of the economic

growth which passed respectively from 13% to 9.7 % and from 13% to 7.8%.

This provincial discrepancy of economic growth is not surprising as the factors of

economic growth have not evolved similarly in the different provinces and in the different

periods. In a general way, we observe a higher economic growth in coastal than in inland

provinces during the period of the real depreciation, while this high gap of economic growth

diminished strongly during the second period of the real appreciation (table 1). The coastal

provinces benefit from many coastal advantages relative to tradable sector: they have a

dynamic industrial sector producing more light industrial goods and largely oriented towards

outside; receive more FDI, and suffer from less constraint of credits and foreign exchanges in

order to import machines and equipments17 and have more private industrial enterprises and

17 Fleisher and Chen (1997) showed that the weak presence of foreign direct investment in the inland provinces

contributed to explain the productivity gap relative to coastal provinces.

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attract more educated labour. The real depreciation may have stimulated these coastal

advantages, leading a higher economic growth in coastal than in inland provinces; while the

real appreciation has probably exerted negative effects on the coastal advantages, and may

have slowed down the growth more important in coastal than in inland provinces.

Consequently, it is expected that the growth elasticity of real exchange rate is higher in

coastal than in inland provinces.

2.3. Real exchange rate and growth: the evidence of stylized facts

The figure 4 presents the relationship between the real exchange rate appreciation and

economic growth in China over the period from 198718 to 2009. We observe a negative

relationship between the real appreciation and the growth rate of real GDP per capita. During

the years when the renminbi appreciated, the economic growth slowed down. Inversely,

during the years when the renminbi depreciated, the economic growth increased.

The figure 5 shows the relationship between the real effective exchange rate and real

GDP per capita on average over the period from 1987 to 2008 for the Chinese provinces. As

waited, we observe that the negative impact of real exchange rate appreciation on the real

GDP per capita is stronger in coastal provinces than in inland provinces. The strong

depreciation during the period from 1987 to 1993 may have stimulated the economic growth

more importantly in coastal provinces than in inland provinces; while during the recent period

from 1994 to 2009, the real appreciation may have slowed down the economic growth

stronger in coastal provinces than in inland provinces. Consequently, the real depreciation of

the renminbi may have contributed to an increasing gap of economic growth between the two

categories of the provinces (at an annual average rate of 9.3% for coastal provinces and 6.4%

for inland provinces); while the real appreciation may have slowed down the real GDP per

18 when the swap market rate replaced the administrated one.

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capita divergence between the two categories of the provinces (respectively 10.8% and

9.98%). This satisfying evolution might be due to the reversal of the exchange rate policy in

1994, all the more that the depreciation and the appreciation of the real exchange rate are

larger in inland provinces than in coastal provinces (Table 1).

The fact that the real appreciation of the renminbi exchange rate slowed down the

economic growth acceleration particularly marked in coastal provinces and inversely, incites

us to identify the transmission channels through which the real exchange rate could have been

acting on economic growth in the two categories of the Chinese provinces during the last

twenty years. This is the objective of the next section.

3. Why has real exchange rate appreciation affected negatively economic growth in

China: a theoretical analysis

The factors that could affect economic growth are numerous in an economy in

transition towards a market economy such as China, where economic policies and productive

structures have dramatically changed. A plethora of literature argues that China’s economic

growth can be explained by the rapid expansion of the industry (Lin and Liu, 2008), the

external openness with the development of manufactured exports (Fu and Balasubramanyam,

2005; Kraay, 2006) and foreign direct investments1 and the promotion of the private sector in

disfavour of the sector of state-owned enterprises (SOEs) (Jefferson and Su, 2006 ; Dougherty

et al., 2007). The role of employment and human capital is generally recognized as positive

factors of growth (Fleisher and Chen, 1997; Zhu, 1998; Wang and Yao, 2003). All these

factors may be potentially affected by real exchange rate, and thus may be transmission

channels through which its growth impact passes. Finally, the real appreciation may exert a

direct action on work efficiency by modifying the real remuneration of workers and

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exacerbating competition (Guillaumont Jeanneney and Hua, 2010).

We explain that if a real appreciation exerts positive effects on economic growth by

acting pressure on efficiency improvement and technological progress via workers’

motivation, education and capital intensity, it exerts negative effects by deteriorating the

international competitiveness in tradable sector and by destructing employment.

Consequently, the sign of the total effects of real exchange rate on economic growth is

theoretically ambiguous and only an empirical analysis can reveal it. From this theoretical

analysis we draw our estimating strategy. We define a function of economic growth which

includes the real effective exchange rate beside the above mentioned factors which are

themselves supposed to depend on the real exchange rate.

3.1. Real exchange rate and the size of tradable sector

Real exchange rate measures the relative price of domestic goods relative to foreign

ones and is an indicator of international competitiveness of a country. The most traditional

argument in favour of a negative effect of real appreciation upon economic growth is based on

the assumption that real exchange rate appreciation deteriorates the competitiveness of

enterprises vis-à-vis their foreign competitors and therefore decreases exports. This

deterioration diminishes thus the profits of the exports sector (which roughly means industry

of manufactured goods in the case of China) in favour of services and agriculture, largely

protected from foreign competition (Guillaumont Jeanneney and Hua, 2002). It decreases

industrial self-financing and the will to invest in the industrial sector, and more generally in

the tradable good sector. If this last one is the most efficient and innovating, real appreciation

may act negatively on growth, beyond its impact on mainly exporting firms. Real appreciation

is particularly bad for growth in developing countries because it does not allow promoting the

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small and inefficient tradable sector, which suffers disproportionately from the institutional

and market failures (Rodrik, 2008).

The negative effect of real appreciation on the growth also channels through the

decrease of foreign direct investments (FDI). In China, as in other developing countries,

foreign investments are concentrated in the sector of tradable goods. Foreign firms bring

technological improvements and their know-how to China. This positive action occurs

through the creation of foreign companies or joint-ventures that are more productive than

domestic firms, suppliers or customers of the foreign enterprises (Sun, 1998). Hale and Long

(2007) and Liu (2008) explain that FDI diffusion or spill over effects are not necessarily

positive. However many studies show that this positive effect exists in China, in particular in

the manufactured sector where the main part of foreign direct investments go19.

Finally, as the stated-owned enterprises are mainly in the heavy industry and the

public services and, being protected from outside competition, they mainly produce non-

tradable goods, real appreciation favours them. The private, collective and foreign firms are

freer in workers’ hiring and in their management than state-owned enterprises and generally

more productive. Henceforth, real appreciation exerts a negative impact on growth by

increasing the relative importance of state-owned enterprises.

In China, the tradable sector is particularly concentrated in coastal provinces, whose

exports represented 91% of the total exports in 2009. As the size of tradable sector is much

important in coastal provinces than in inland provinces, it is expected that the negative effect

19 Sun, Hone and Doucouliagos (1999) have used data relative to 28 manufactured sectors in the 29 Chinese

provinces in 1995 and have shown that trade and financial openness is a factor of industry efficiency. Later, Li et

al. (2001) and Buckley et al. (2002) have evidenced the diffusion effect of FDI to Chinese manufactured

enterprises thanks to data of the industrial census, and Liu et al. (2001) to electronic enterprises with data

relative to 41 sectors in 1996 and 1998. FDI spill over has also been captured thanks to data relative to the

performance of Chinese towns in 1990 and 2002 (Madariaga and Poncet, 2007).

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of real appreciation is more sensibly in coastal provinces than in inland provinces; and

inversely.

3.2. Real exchange rate and workers’ effort

A real exchange rate appreciation increases real remuneration of non-qualified work

expressed in tradable goods20. We suppose that this increase induces an efficiency

improvement of workers in a country where the wages of unskilled workers are still low

(Guillaumont and Guillaumont Jeanneney, 1992). As early as 1957, Leibenstein stressed that

in developing countries a labour remuneration that is too weak might spoil workers’ health

and their working capacity and showed that the motivation of workers acts on the efficiency,

what he called the “X-efficiency” (Leibenstein, 1957, 1966).

This hypothesis appears relevant in the case of China. Although the proportion of the

poor population (with an income no more than one dollar a day21) has been decreasing rapidly

since 1978 (still 16.6% in 2001, it passed to 10.3% in 2004, and to 4% in 2007), China has the

highest number of poor population in the world after India (World Bank, 2009). The

population just over the line of poverty remains highly vulnerable, notably in inland provinces

where the wages are significantly lower than in coastal provinces. The impact of a real

appreciation on workers’ effort could be thus stronger in inland provinces than in coastal

ones.

Second, a real appreciation could push firms to improve their technical efficiency in a

context of monopoly or collusive oligopoly (Krugman, 1989). The argument is the following:

managers only benefit from a part of the profit induced by a better management or a stronger

20 In terms of tradable goods and in terms of consumption goods which include the two kinds of goods.

21 Exactly 2.15 and 1.08 dollars by measuring the expenditures in 1993 international prices (World Bank World

Development Indicators, 2004).

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effort since a part of the profit goes to the owners of the enterprise. In the case of monopoly,

managers do not choose the exertion which maximizes the profit for such reasons as a

preference for leisure over work, involvement in seeking out other profitable opportunities,

and the power and satisfaction gained from having an excess number of employees (Baldwin,

1995). As Marshall said, the better profit of a monopoly is a quiet life.

In a situation of oligopoly (due to foreign competitors and competitors localised in

other provinces), the managers will choose a higher level of effort by eliminating excess

labour or possibly by introducing labour-saving techniques that were not fully exploited prior

to the competitive disturbance. They do so not only because this behaviour may increase the

profit in the short run, but also because the decrease of costs dissuades competitors from

entering into the market and thus avoids a fall in the price. Due to this strategic yield, there

exists an additional benefit induced by the effort which may push management effort near to

its optimum22.

In a more general manner, in any market structure, the intensification of foreign

competition due to currency real appreciation is favourable to the productivity of

manufactured firms as some of them are obliged to close the less performing factories or even

to disappear; it is a kind of Schumpeterian “creative destruction” benefiting to the most

performing enterprises. This argument is realistic for China: under the pressure of the

renminbi appreciation since 1994, and notably since China’s adhesion into the WTO in 2001,

the Chinese firms have been more and more exposed under high foreign competition and a

large number of firms (notably public ones) were obliged to reform their management or to be

closed.

22 Voir Krugman (1989) p. 133.

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Besides the above direct favourable impact of a currency appreciation on workers and

managers’ efficiency, a real appreciation may affect economic growth by acting positively on

the education level and the capital labour ratio, but negatively on employment.

3.3. Real exchange rate, capital intensity, human capital and employment

A real appreciation reduces the relative cost of imported capital goods and increases

wages relative to capital price. It induces a more capitalistic production, encourages

technological innovations (Leung and Yuen, 2005) and thus increases growth. It increases the

real remuneration of workers expressed in tradable goods. We may suppose that the rise in

wages incites young people to increase their education level and that it slows down the

emigration of the most skilled workers (Harris, 2001). China has endured a significant brain

drain and we observe in present time some Chinese educated workers coming back thanks to

a better remuneration. The improvement of the education level of workers is recognised as

being an important factor of economic growth (Fleisher and Chen, 1997; Hua, 2005; Liu and

Li, 2006).

Finally, a real appreciation of exchange rate acts on employment via the relative cost

modification of imported inputs and workers, via export activities and via the efficiency in the

use of labour. Firstly, it decreases the cost of imported inputs and leads to higher real wages

expressed in tradable goods. This leads the switching of factors from workers to imported

inputs, and is unfavourable to employment by increasing labour productivity. Secondarily, a

real appreciation decreases the competitiveness of national societies, and thus the tradable

activities. It is unfavourable to employment in tradable sector. Thirdly, a real appreciation

exerts pressure on efficiency improvement by increasing international competition and real

wages, and thus a favourable to employment. Using the panel data of the 29 Chinese

19

provinces for the period 1993-2002, Hua (2007) showed statistically significant negative

effects of the real appreciation of the renminbi on manufacturing employment.

Table 2 summarizes the multiple effects that the real exchange rate variation is

supposed to exert on economic growth in China. It distinguishes the effects of real exchange

rate variations on the workers’ efforts (here named direct effect) from the effects passing

through the channels relative to the size of tradable sector and to the production factors, which

are themselves affected by the real exchange rate (here called indirect effects). Three effects

of the rise of the real exchange rate (or of its appreciation) on the economic growth are

positive (work effort, capital/labour ratio, education level), while the five (exports, foreign

direct investments, employment, relative importance of industrial production and of state-

owned enterprises) are negative (cf. the third column of the table 2). The total action of the

real appreciation of exchange rate on economic growth is therefore theoretically uncertain.

The sole econometric estimation may reveal it.

3.3 The model to be estimated

From the above theoretical analysis, we estimate an economic growth function in

which we introduce the real exchange rate, together with other explanatory variables of

economic growth such as capital intensity, employment ratio, education, exports, industry,

FDI and public investments. We also introduce the level of a real GDP per capita lagged one

period to test an eventual convergence effect of economic growth between provinces.

Moreover, we suppose that the direct efficiency effect of the real exchange rate which exerts

through the workers’ effort is all the more relevant that the workers are poor. Since the

proportion of poor workers is higher in inland provinces than in coastal provinces, we test

whether these direct effects are conditional to the geographical position of provinces, by

20

introducing a dummy variable for coastal provinces and its interaction term with the real

exchange rate. As all the control variables are added into the equation, the coefficient of the

real exchange rate measures only the effects that we do not capture by the intermediary

variables and notably the direct effects on work effort, according to the second line of the

table 2.

itititititititititINaXaEDUaEMaKLaREERaayyy lnlnlnlnlnlnlnlnln 65432101 ++++++=−= −

•

ittiitititit CREERaCayaSOEaFIa εγη ++++++++ − *lnlnlnln 11101987

Which can be in return written as following

ititititititit INaXaEDUaEMaKLaREERaay lnlnlnlnlnlnln 6543210 ++++++=

ittiitititit CREERaCayaSOEaFIa εγη +++++++++ − *lnln)1(lnln 11101987

Where y :per capital real GDP,

REER: real exchange rate,

KL : capital intensity,

EM: share of employment

EDU : education level,

X : export share,

IN: share of industrial production,

FI : contribution of foreign direct investments to gross formation of fixed capital,

SOE: relative importance of state-owned enterprises,

C: coastal provinces

The variables, except for dummy one, are expressed in logarithms so that the

coefficients represent elasticities. The disturbance term consists of an unobservable provincial

fixed effect that is constant over time iη , an unobservable period effect that is common across

provinces tγ and a component that varies across both provinces and periods which we assume

21

to be uncorrelated over time itε .

The expected elasticity signs of all variables in the equation are positive, except for

that of public enterprises share and of the interaction term between the real exchange rate and

the coastal dummy which are expected negative. The direct growth effect of real exchange

rate is estimated by a1 for inland provinces, and a1+a11 for coastal provinces.

In the second step, we look for the growth effects of the real exchange rate which exert

indirectly via the other variables that we have supposed explaining the growth: capital

intensity, employment, education, exports, industrial production, foreign direct investments

and state-owned enterprises (according to the second part of Table 2, line 2 and column 2).

With this aim in view, we must estimate the impact of the real exchange rate on these factors.

We add a dummy variable, which is equal to 1 for coastal provinces, to capture their

comparative advantages as we explained before.

We estimate separately the following equations.

111210 ittiitit CbERbbKL εγη +++++= (2)

222210 ittiitit CcERccEM εγη +++++= (3)

333210 ittiitit CdERddEdu εγη +++++= (4)

444210 ittiitit CeEReeX εγη +++++= (5)

555210 ittiitit CfERffIN εγη +++++= (6)

666210 ittiitit CgERggFI εγη +++++= (7)

777210 ittiitit ChERhhSOE εγη +++++= (8)

The expected elasticity signs of equations 2, 4 and 8 are positive, while the rest of

equations are negative.

We can then calculate the indirect effect of the real exchange rate on economic growth

22

as the sum of the products of economic growth elasticity relative to each intermediary

variable multiplied by its corresponding elasticity relative to the real exchange rate (table 3).

4. The growth impact of real exchange rate in China: an econometric analysis

We present successively variable calculation, estimation method and the results.

4.1. Estimation period and calculation of variables

The panel estimation concerns the twenty-nine provinces and covers the period from

1987 to 2008, during which the real effective exchange rate either depreciated or appreciated

(see figure 2). The panel is unbalanced, with some provinces having more observations than

others. The means and standard deviations of the variables are provided in table 4, while their

sources are given in annex 1.

Per capita real GDP is calculated as real GDP (2000=100) divided by population. The

real effective exchange rate indices of the Chinese provinces are calculated on the basis of

year 2000=100, as the ratio of consumer price index of the considered province to the average

consumer price index of its fifteen foreign trade partners23 (defined by geographical import

origins in 199824), all prices being converted into the same currency as following:

∏=

=15

1

)(i i

j

ijji

P

PNERREER

α .

where REER represents the real effective exchange rate of the renminbi,

23 We unfortunately had to eliminate several ex-Soviet Union countries due to a lack of data on exchange rates.

24 This is the only year for which we obtained China’s General Administration of Customs data on import origin

for different provinces. We therefore suppose that each province kept the same partners throughout this period.

We also used real effective exchange rates, supposing that the weights of each province are the same as national

averages for China; this is not an ideal hypothesis given China’s size and the specializations of each province, as

confirmed by econometric results (not presented here).

23

NERij is the nominal bilateral exchange rate of the renminbi in terms of currency of

foreign partner i with i=1…..15.

Pj corresponds to consumer price indices of the Chinese province j.

Pi corresponds to consumer price indices of the country i

iα is the weight of each partner calculated as a relative share of the imports of the

provinces j from its foreign partner i relative to the total of imports from its fifteen main

partners in 1998, with ∑=

=15

1

1i

iα .

Consequently, an increase of the real exchange rate corresponds to an appreciation of

the Chinese currency or a decrease of the relative price of tradable goods. Given that from

1987 to 1993, China used two exchange rates, i.e. official rate and swap rate, the renminbi-

dollar exchange rate is calculated for this period as a weighted average of these two exchange

rates, taking part of imports financed by swap exchange market for weighting. The calculated

weighted pre-1994 nominal exchange rate of the renminbi to the dollar is not equal for each

province because swap rates differed between provinces. The data on provincial swap rates

are available in Khor (1993). Although all the Chinese provinces shared the same single

nominal exchange rate from 1994 on for the rest of the estimation period, their real effective

exchange rates have evolved at different rates because provinces have different foreign trade

partners and inflation rates. In fact, each province tends to trade more with its border

countries, leading the diversity of their foreign trade partners. Therefore the weighting of the

foreign currencies is different. The second factor is a considerable difference between

provinces’ inflation due to the differences in Chinese provinces’ production and consumption

patterns and external trade, the fiscal and monetary policies largely decentralised in China and

very different from one province to another (Guillaumont Jeanneney and Hua, 2004).

Capital intensity is the ratio of capital stock divided by the number of employees. We

24

use the inventory permanent method to calculate the capital stock25, as

ttt IRKRKR +−= −1)05.01( , where KR and IR represent respectively the capital stock and the

investment (i.e. gross fixed capital formation) in constant prices and the annual depreciation

rate is supposed 5 % as in preceding papers (Wu, 2001; Lin and Liu, 2008 and Zheng and Hu,

2006). We suppose that the initial capital stock in 1965 is equal to the real investment that

year. This hypothesis does not influence capital stock calculation since 1986, because all the

capital stock in 1965 has been amortized in 1985. Since capital depreciation data is available

since 1993 for each province, the capital stock over the period from 1993-2007 is calculated

as tttt DRIRKRKR −+= −1 , where DR represents real depreciations, which are equal to nominal

depreciations deflated by the price index of the investment in fixed assets. Thus, the

depreciations of capital are different for each province and for each year, while preceding

studies supposed a depreciation rate of 5% for all the provinces and each year.

The real gross fixed capital formation is deflated by two series of prices (100=2000),

which are successively available: the “price index of gross fixed capital formation,” drawn

from historical data of National Accounts, available until 1995, and the “price index of

investment in fixed assets” available since 1992, in China Statistical Yearbook. The first

series is used for the period from 1972 to 1992 and the second for the following years. This

combination is not a drawback, as in the overlapping years the two price series differ only

marginally, as observed also in Holz (2006, p. 8).

25 Holz (2006) and Chow (2006) present an interesting debate on capital stock estimates for China. Instead of

using capital depreciation, Holz suggests evaluating the value of replacement with several complex but

disputable conventions. Chow defends that subtracting depreciated capital instead of using replacement value

allows one to take into account, not only equipment depreciation, but also quality deterioration and costs of

maintenance and repair when the equipments are used beyond amortization period. We have followed traditional

method as in Chow’s paper and most of the studies. Holz does not calculate capital stock for the Chinese

provinces.

25

Employment ratio is the share of employed population relative to total one. Education

is calculated as the ratio of the total number of graduates from secondary and higher level

education to total population. The education data for 1982, 1990 and 2000 are respectively

obtained from the 4th and 5th Population Census of China. The data for other years is obtained

from the annual sample survey on population changes.

The exports are reported to GDP and foreign direct investments to gross fixed capital

formation. The share of industrial production is calculated as the part of the secondary sector

(except for construction) in the GDP. The share of state-owned enterprises is the ratio of their

investment to the total investment of enterprises.

4.2. Econometric method

The Levin-Lin-Chu panel unit root test is applied to all the variables. The results of

these tests lead to reject the null hypothesis of non-stationarity (see table 4). The principal

potential econometric problem is the endogeneity of explanatory variables, a difficulty that is

met in all the estimations on macroeconomic data due to simultaneity bias (we recall the

double causality of the real exchange rate and the growth), to measurement errors of variables

which are a particularly serious problem in China, and to the risk of omitted variables.

Moreover the introduction of the lagged dependent variable renders the OLS estimator biased

and inconsistent, as the lagged dependent variable is correlated with the error term even in the

absence of serial correlation between itε .

As a precaution against the risk of simultaneity of the dependant and explanatory

variables, we have lagged one year all these explanatory variables, i.e. real exchange rate and

the other traditional determinants of economic growth, in the estimations. Moreover, we

treated both the endogeneity problem and the problem of structural heterogeneity of the

26

provinces by using the system estimator of the one-step Generalized Moment Model (GMM)

of Blundel & Bond (1998). This GMM system estimation approach combines an equation in

levels in which lagged first-difference variables are used as instruments and a first-difference

equation in which the instruments are lagged variables in levels26. The use of the lagged

variables at least of two periods for endogeneous variables as instruments permits a consistent

estimation of the parameters even in the presence of measurement error and endogenous

right-hand-side variables (such as capital intensity, employment ratio, industrial share,

education, export ratio, FDI ratio, and relative importance of SOEs in this study) (Roodman,

2009a, b). These lagged variables were completed by the addition of one instrumental

variable, which is the difference between the province’s per capita GDP and the average per

capita GDP of its foreign trade partners. This instrument results from the Balassa-Samuelson

hypothesis (Guillaumont Jeanneney and Hua, 2002). The validity of the instruments is tested

by using the Hansen over-identification test, and by verifying the sensitivity of estimated

coefficients to reductions in the number of instruments (Roodman, 2009a, b). The results do

not allow us to reject the hypothesis on their validity. The instruments are therefore

independent of error terms.

4.3. Results of econometric estimations

The econometric results are reported in tables 5 and 6. Before estimating respectively

the direct and indirect effects of the real exchange rate on real GDP per capita, we regress the

last one only on the real exchange rate lagged one period and the coastal dummy variable,

dropping the other determinants of the real GDP per capita in order to obtain a first rough

26 Blundel and Bond (1998) showed that this estimator is more powerful than the first-differences estimator

derived from Arellano and Bond (1991), which gives biased results in small samples with weak instruments.

27

estimation of the total effect of real exchange rate (column 1 Table 5)27. Then we add the

interaction term between the real exchange rate lagged one period and the dummy variable of

coastal provinces (column 2 in table 5), in order to see if there exists a difference between

both kinds of provinces as the theoretical arguments suggest. The obtained results show that

the real appreciation of the renminbi could exert a negative effect on economic growth, and

that this effect would be more important in coastal provinces than in inland provinces.

The direct effect of the real exchange rate is estimated by adding the traditional

determinants of economic growth (columns 3 in table 5) and the interaction term between the

real exchange rate and dummy variable of coastal provinces (column 4 in table 5). All

coefficients are statistically significant with expected signs. The coefficients of the real

exchange rate in columns 3 and 4 represent its direct impact on economic growth, that not

passing through intermediary variables. This effect has been identified as the sum of an

incitation of real appreciation for workers and managers to make more effort. As expected,

the coefficient of the real exchange rate is positive and equal to 0.08 for the inland provinces,

and to zero for coastal provinces, as the coefficient of the interaction term between the real

exchange rate lagged one period and the coastal dummy is negative and equal to -0.08

(column 4). This result was anticipated as income per capita is notably lower in inland

provinces than in coastal provinces so that the improvement of the work remuneration has

probably a stronger impact on the behaviour of the workers in inland provinces. Indeed the

GDP per capita in inland provinces is equal to 45% of the GDP per capita in coastal provinces

in 2009.

We can also see from table 5 that all intermediary variables lagged one period have

positive effects on economic growth, except for the importance of state-owned enterprises.

The per capita real GDP is all the more elevated than the employment ratio, education and

27 The result may be biased by missing explanatory variables.

28

capital intensity are important. The elasticities are respectively estimated to 0.20, 0.34 and

0.13 (column 4 of Table 5). Second, the progressive openness to the outside of the Chinese

economy appears as a factor of economic growth, as the coefficient of export ratio, industry

share and FDI ratio are significantly positive (respectively 0.07, 0.04 and 0.01). Third, the

economic growth is all the less high than the share of state-owned enterprises investments is

important (coefficient equal to -0.09). Finally, again as expected, economic growth is on

average higher in coastal provinces than in inland ones. The coefficient of the lagged variable

is inferior to the unity so that economic growth is faster when the initial level is lower, in

conformity with the usual convergence effect of the growth theory.

Table 6 presents the estimation of the intermediary variables in function of the real

exchange rate and the coastal dummy. It indicates, as expected, that the geographical position

of the provinces (border of the sea) has a significant and positive impact on all the variables,

apart from the importance of public enterprises which are concentrated in inland provinces.

Again as expected, table 6 also indicates that real exchange rate exerts positive effects

on capital intensity, by decreasing the relative price of imported equipment goods, on

education by increasing its benefits and on the relative investment of state-owned enterprises

which produce chiefly non-tradable goods; inversely a real appreciation exerts negative

effects on export rate, industrial production share, foreign direct investment ratio and

employment ratio, by diminishing international competiveness, while real depreciation exerts

inverse effects. Thus all these variables are effectively transmission channels of the real

exchange rate to economic growth.

Calculation of the total effect of the real exchange rate on economic growth is given in

the last column in table 3. As it resorts from table 6, the real exchange rate exerts a positive

effect on capital intensity and education (with the estimated coefficients of 0.15 and 0.08

29

respectively), which themselves influence positively on economic growth (with the estimated

coefficients of 0.13 and 0.34 respectively); this leads to an impact of the real exchange rate

which is equal to 0.02 for capital intensity and 0.03 for education (table 3). Inversely the real

appreciation exerts a negative effect on employment ratio, export ratio, industrial production

share and FDI (with the estimated coefficients of -0.11, -1.27; -0.05, -2.36) which themselves

influence positively economic growth (with the estimated coefficients of 0.20, 0.07; 0.04,

0.01); consequently, the indirect effects of the real exchange rate via employment ratio, export

ratio, industrial production share and FDI ratio are negative and equal respectively to -0.02, -

0.09, -0.002 and -0.02. Finally, the real appreciation favours the state-owned enterprises (with

the estimated coefficient of 0.75) which are a negative factor of the economic growth (with

the coefficient of -0.09): the indirect effect of the real exchange rate via SOEs is equal to -

0.07 (table 3).

In summary, the negative effect of real exchange rate through employment, exports,

the industrial production share, foreign direct investments and state-owned enterprises

prevails over the positive impact of an overvaluation of the real exchange rate through the

capital intensity, the education level and efficiency. The total effect is thus sensibly different

from the direct effect. The negative impact of a real appreciation now appears in both

categories of provinces; it is a higher in coastal provinces (-0.16) than in inland provinces (-

0.08), due to the direct effect which mainly holds in the last ones.

Not only the coefficients of the real exchange rate are significant, but the elasticity

values also show that the results are economically relevant. During the period of the real

depreciation from 1987 to 1993, the annual average growth rate of real exchange rate

depreciation was 4.84 % in inland provinces and 4.41% in coastal provinces (table 2). the

annual average economic growth rate has been increased by 0.15 % (0.03*4.84%) in inland

30

provinces and 0.49 % (0.11*4.41%) in coastal provinces. During these seven years, the higher

economic growth rate in coastal than in inland provinces increased the relative gap of their

GDP per capita (ie. the ratio of GDP per capita in coastal provinces to GDP per capita in

inland provinces) which passed from 1.97 in 1987 to 2.27 in 1993 (figure 6), i.e. an increase

of 1.95% per year on average28, knowing that the real GDP per capita was 4 122 yuans in

coastal provinces, and 2 095 yuans in inland provinces in 1987.

Inversely, during the period of the real appreciation and stabilization from 1994 to

2008, the annual average growth rate of real exchange rate appreciation was 2.01 % in inland

provinces and 1.77% in coastal provinces (table 2). The annual average economic growth rate

has been slowed down by 0.06 % (-0.03*2.01%) in inland provinces and 0.19 % (-

0.11*1.77%) in coastal provinces, minimizing thus the gap of economic growth in coastal

than in inland provinces, which passed from 2.37 in 1994 to 2.28 in 2008 (figure 6), i.e. a

decrease of 0.14% per year on average29.

Thus, the phases of the real depreciation of the renminbi significantly contributed to

increase the ratio of the GDP per capita in coastal provinces to that in inland provinces, while

inversely, the phases of the real appreciation contributed to decrease it. The real appreciation

seems to be a factor of reduction of income inequality in China, and inversely30.

However, this favourable effect of the real appreciation is socially less visible than the

employment destruction resulting from real exchange rate appreciation. The real exchange

rate appreciation of 12% in 2008 and of 6% in 2009 destructed about 175 298 jobs in 2008

28 2.28/2.37= 0.96, which corresponds to a growth rate of the ratio of the GDP per capita of coastal provinces to

the GDP per capita of inland provinces equal to -0.14%.

29 2.27/1.97= 1.15, which corresponds to a growth rate of the ratio of the GDP per capita of coastal provinces to

the GDP per capita of inland provinces equal to 1.95%.

30 Guillaumont Jeanneney and Hua (2001) have shown that the real appreciation has contributed to decrease

urban-rural income inequality.

31

and 88 093 jobs in 2009, knowing its elasticity of employment ratio estimated to -0.11 (table

6).

5. Conclusion

This study contributes to the literature by analysing the effects of real exchange rate on

economic growth in China. The analysis of this relationship, which appeared particularly

opportune in the case of China, showed that the real appreciation has exerted negative effects

on the economic growth, which are higher in coastal provinces than in inland ones.

While international pressure in favour of the renminbi revaluation is becoming more

and more insistent, it is topic to know that, if the overvaluation may contribute to the decrease

of the per capita GDP gap between coastal and inland provinces, it also destructs jobs

particularly in tradable sector. Consequently, the Chinese government may continue to adopt

a progressive revaluation policy while exports, industry and FDI are slowed down by the

revaluation of the renminbi and economic growth mainly depends on outside oriented

industry sector. A step by step revaluation policy would be allowing the induced growth by

productivity improvement and human capital to compensate the loss of international

competitiveness and the job creation in non tradable (service) sector by shifting the Chinese

growth model to go towards a domestic consumption-led one.

32

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Figure 1. Evolution of inflation, nominal and real bilateral exchange rates (against dollar) in

China (2000=100)

0

20

40

60

80

100

120

1401

97

81

97

9

19

80

19

81

19

82

19

83

19

84

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

(co

nsu

mer

pri

ce, r

eal

bil

ater

al r

ate)

0

1

2

3

4

5

6

7

8

9

10

(ofi

cial

rat

e)

consumer price real bilateral exchange rate official rate

NB: here a rise of the exchange rate means a depreciation of the renminbi against dollar and vice-

versa.

Source: China Statistical Yearbooks.

40

Figure 2. Evolution of nominal and real effective exchange rates in China

0

20

40

60

80

100

120

140

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

(RE

ER

, 10

0=

20

00

)

0

50

100

150

200

250

300

(NE

ER

, 10

0=

20

00

)

real effective exchange rate nominal effective exchange rate

NB. A rise of the curb is appreciation of renminbi and a fall is depreciation.

Sources. China Statistical Yearbook, IMF International Financial Statistics, and Khor (1993).

41

Figure 3. Evolution of real GDP per capita in China and its growth rate

0

5000

10000

15000

20000

25000

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

(rea

l G

DP p

er cap

ita)

-4

-2

0

2

4

6

8

10

12

14

16

18

(gro

wth

rat

e)

real GDP per capita growth rate

Source : China Statisacal Yearbooks

42

Figure 4. Real exchange rate appreciation and economic growth in China, 1987-2009

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

19971998

1999

2000 200120022003

2004

2005

2006

2007

2008 2009

24

68

10

12

(re

al per-

capita G

DP

gro

wth

)

4.2 4.4 4.6 4.8ln(real effective exchange rate)

lngy Fitted values

NB. A rise of real effective exchange rate means the appreciation and inversely.

Sources. China Statistical Yearbook, IMF International Financial Statistics, and Khor (1993).

43

Figure 5. Real exchange rate appreciation and economic growth in Chinese provinces over the

period from 1987 to 2008 on average

Beijing

Tianjing

Hebei

Liaoning

Shanghai

Jiangsu

Zhejiang

Fujian

Shandong

Guangdong

Hainan

8.5

99

.51

01

0.5

ln(r

ea

l p

er-

ca

pit

a G

DP

)

4.4 4.45 4.5 4.55 4.6ln(real effective exchange rate)

lyk Fitted values

coastal provinces

Shanxi

Inner MongoliaJilin

Heilongjiang

Anhui Jiangxi

Henan

Hubei

Hunan

Guangxi

Sichuan

Guizhou

Yunnan

Shannxi

Gansu

QinghaiNingxia

Xinjiang

88

.28

.48

.68

.89

ln(r

ea

l p

er-

ca

pita

GD

P)

4.4 4.45 4.5 4.55ln(real effective exchange rate)

lyk Fitted values

inland provinces

NB. A rise means the appreciation of renminbi and a fall is the depreciation.

Sources. China Statistical Yearbook, IMF International Financial Statistics, and Khor (1993).

44

Figure 6. Evolution of real GDP per-capita in coastal and inland provinces and their ratio

0

5000

10000

15000

20000

25000

30000

350001987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

(yu

ean

s, 2

00

0)

0

0,5

1

1,5

2

2,5

3

coastal provinces inland provinces coastal/inland

45

Table 1: Nominal and real effective exchange rates, inflation and economic growth in the

provinces (annual average rate of variations, %)

1987-1993 1994-2009

Province

Nominal effective exchange rate

Real effective exchange rate

Consumer price index

Real GDP per-capita

Nominal effective exchange rate*

Real effective exchange rate*

Consumer price index

Real GDP per-capita

Beijing -8.11 -2.81 12.73 7.53 2.35 2.32 3.13 7.55

Tianjing -9.96 -4.44 10.98 5.20 0.96 1.60 2.38 11.02

Hebei -10.23 -6.43 9.07 8.65 0.78 1.40 2.29 10.63

Liaoning -10.67 -4.79 10.61 6.49 1.00 1.97 2.30 9.95

Shanghai -10.29 -2.85 12.46 7.09 0.86 2.27 2.79 8.57

Jiangsu -10.53 -4.74 10.67 9.98 0.77 1.88 2.49 11.89

Zhejiang -4.89 -4.77 10.54 9.78 0.98 1.57 2.45 11.15

Fujian -8.91 -4.59 10.18 11.24 0.75 1.73 2.25 10.79

Shandong -10.58 -3.20 10.16 9.46 0.93 2.07 2.55 11.75

Guangdong -9.42 -4.81 11.07 13.17 0.64 1.14 1.76 9.65

Hainan -7.05 -5.13 13.65 13.22 0.93 1.42 1.67 7.77

Coastal (simple

average) -9.15 -4.41 11.10 9.26 1.02 1.77 2.37 10.07

Shanxi -8.83 -5.04 10.43 5.40 1.93 1.94 2.77 10.55

Inner Mongolia -8.01 -5.48 12.49 6.50 1.58 2.54 2.86 14.07

Jilin -10.03 -5.31 10.80 6.45 1.66 1.96 2.41 10.29

Heilongjiang -10.32 -5.34 10.83 5.86 1.67 2.17 2.13 9.37

Anhui -9.93 -6.77 10.63 4.33 1.34 1.98 2.57 10.59

Jiangxi -7.83 -5.66 9.63 7.31 3.62 2.12 2.40 9.92

Henan -9.73 -4.11 8.57 7.40 0.82 1.94 2.65 10.95

Hubei -9.78 -5.05 10.67 5.96 1.29 1.73 2.73 10.70

Hunan -9.03 -2.88 11.20 5.89 1.54 2.49 3.16 10.42

Guangxi -1.06 -3.45 10.46 7.90 1.04 1.37 2.26 9.95

Sichuan -6.02 -4.49 10.50 7.61 2.39 2.73 3.17 10.88

Guizhou -6.97 -6.91 10.04 5.51 1.65 2.46 3.04 9.10

Yunnan -5.63 -4.96 10.62 7.87 1.37 -0.94 3.07 8.31

Shannxi -6.91 -4.87 10.21 7.55 3.14 1.63 2.66 9.17

Gansu -9.69 -4.71 10.17 6.95 1.38 2.72 3.04 9.74

Qinghai -10.12 -3.64 10.75 3.62 1.22 2.99 3.58 9.42

Ningxia -8.96 -5.41 11.02 5.16 1.00 1.96 2.78 8.93

Xinjiang -9.47 -3.06 10.48 8.26 1.02 2.30 2.70 7.33

Inland (simple

average) -8.24 -4.84 10.53 6.42 1.65 2.01 2.78 9.98

Note: * for 1994-2008 period.

Source: China Statistical Yearbooks.

.

46

Table 2: Expected impacts of real exchange rate increase (or appreciation) on economic

growth

Impact of exchange rate on intermediary variables (a)

Impact of intermediary variables on growth (b)

Impact of exchange rate on economic growth (c)=(a)*(b)

→− export ratio →+ →−

→− Industry share →+ →−

→− FDI ratio →+ →−

size of tradable sector →+ SOE ratio →− →−

→+ capital Intensity →+ →+

→− employment →+ →−

Indirect impacts via transmission channels

production factors

→+ education →+ →+

Direct impacts Via « work effort » of workers and managers →+

Total impact of real exchange rate →?

47

Table 3: Direct and indirect effects of real exchange rate on economic growth

Effects categories Coefficients according to equations 1 to 8

Direct effects

In inland provinces a1 0.08

In coastal provinces a1+ a11 0.00

Indirect effects in all provinces

via capital intensity a2b1 0.02

via employment ratio a3c1 -0.02

via education a4d1 0.03

via exports/GDP a5e1 -0.09

via industrial production share a6f1 -0.002

via FDI/GFCF a7g1 -0.02

via SOE’s investment ratio a8h1 -0.07

Total effects

In coastal provinces 18171615141312111 hagafaeadacabaaa ++++++++ -0.16

In inland provinces 181716151413121 hagafaeadacabaa +++++++ -0.08

48

Table 4. Means, standard deviation and Levin-Lin-Chu stationarity Test of variables

Mean Standard

deviation

Panel t-

statistics

P-

value

Real GDP per capita in yuans 2000 8079.16 7709.34 -9.655 0.00

Real exchange rate index 2000 100.70 31.01 -8.089 0.00

Capital intensity in yuans 2000 29159 37476 -8.002 0.00

Employment/population (%) 50.03 5.80 -6.135 0.05

Education (%) 37.92 11.51 -8.998 0.01

Export ratio (%) 12.38 15.31 -7.483 0.00

Share of industrial production (%) 38.20 10.02 -7.123 0.04

FDI/GFCF (%) 6.29 8.65 -10.31 0.00

SOEs’ investment ratio (%) 58.05 17.81 -6.573 0.05

49

Table 5. Effects of real exchange rate on economic growth: 1987-2008

1 2 3 4 5

Per capita real GDP lagged one period 0.66***

(8.81)

0.66***

(8.78)

0.66***

(8.78)

Real exchange rate lagged one period -1.63**

(2.12)

-1.04**

(-2.45)

-0.02

(-1.03)

0.08*

(1.80)

-0.03**

(-2.46)

Real exchange rate lagged one period *

coastal provinces

-0.21*

(1.99)

-0.08**

(-2.12)

-0.08**

(-2.12)

Coastal provinces 0.81***

(6.24)

1.79***

(3.66)

0.02

(0.48)

0.88**

(2.00)

0.88**

(2.00)

Capital intensity lagged one period 0.15**

(2.86)

0.13**

(2.47)

0.13**

(2.47)

Employee/population lagged one period 0.17*

(1.96)

0.20**

(2.04)

0.20**

(2.04)

Education lagged one period 0.29***

(4.47)

0.34***

(4.70)

0.34***

(4.70)

Exports/GDP lagged one period 0.05**

(2.76)

0.07***

(4.67)

0.07***

(4.67)

Industrial production share lagged one

period

0.04

(1.10)

0.04*

(1.95)

0.04*

(1.95)

FDI/GFCF lagged one period 0.01*

(2.08)

0.01*

(1.78)

0.01*

(1.78)

SOEs’ investment ratio -0.08***

(-3.88)

-0.09***

(-3.66)

-0.09***

(-3.66)

Number of observations 654 654 654 654 654

Arellano-Bond test for AR(2) 0.43 0.32 0.64 0.35 0.35

Hansen test of overid. Restrictions: 0.20 0.24 0.56 0.61 0.61

Notes. - t-statistics corrected for heteroskedasticity by the while procedure are reported in parentheses.

-*, ** and *** indicate significance at the 10%, 5% and 1% levels of confidence, respectively.

50

Table 6: Estimation of the channelling variables of the real exchange rate to economic growth: 1987-2008

1 2 3 4 5 6 7

Capital intensity Employment/

Population

Education Export ratio Industrial

production share

FDI ratio SOEs’

investment

ratio

Real exchange rate 0.15***

(4.62)

-0.11***

(-7.24)

0.08***

(5.15)

-1.27***

(-11.4)

-0.05*

(-2.01)

-2.36***

(-13.1)

0.75***

(3.57)

Costal provinces 0.59***

(3.11)

0.07*

(1.98)

0.22**

(2.58)

1.48***

(7.60)

0.29***

(3.30)

1.94***

(7.10)

-0.32*

(-1.76)

Trend 0.10***

(28.3)

0.002

(1.19)

0.04***

(7.50)

0.04***

(7.50)

0.004*

(1.72)

0.12***

(9.72)

-0.02***

(-6.20)

Number of

observations

654 654 654 654 654 654 654

Arellano-Bond test

for AR(2)

0.32 0.54 0.87 0.13 0.74 0.94 0.59

Hansen test of

overid. Restrictions

0.14 0.11 0.97 0.09 0.97 0.96 0.78

Notes. - t-statistics corrected for heteroskedasticity by the while procedure are reported in parentheses.

-*, ** and *** indicate significance at the 10%, 5% and 1% levels of confidence, respectively.

51

Annex 1: Definitions and sources of variables

Names of variables Calculation method Source

Per capita real GDP Real GDP expressed in 2000 constant prices divided by

total population

China Statistical Yearbooks,

several editions.

Real effective

exchange rate

Ratio of consumer price index (2000=100) of province to

the average consumer price index of its fifteen foreign

trade partners, converted into the same currency. The

renminbi-dollar exchange rate is calculated for the 1986-

1993 period as a weighted average of official rate and swap

rate, taking part of imports financed by swap exchange

market for weighting.

- IMF, International

Financial Statistics

-IMF, Direction of Trade

- Khor, 1993

- China Statistical Yearbook,

several editions

- China Customs Statistics

Share of industrial

production

Ratio of industry in secondary sector except for

construction to GDP

China Statistical Yearbook,

several editions

Capital intensity Capital stock divided by employed population. The

inventory permanent method is used to calculate the capital

stock. The real gross fixed capital formation is deflated by

two series of prices (100=2000), successively available: the

“price index of gross fixed capital formation,” and the

“price index of investment in fixed assets” available since

1992. The first series is used for the period from 1972 to

1992 and the second for the following years.

- Historical Data on China’s

Gross Domestic Production

Accounts (Zhongguo Guorei

ShengShang Zongzhi

Hesuan Lishi Ziliao)

-China Statistical Yearbook,

several editions

Employment share Number of employment divided by total population China Statistical Yearbook,

several editions

Investment ratio of

state-owned

enterprises

Investments in fixed assets of state-owned enterprises

divided by total investment

China Statistical Yearbook,

several editions

Export ratio Exports divided by GDP China Statistical Yearbook

several editions

IDE ratio Foreign direct investments divided by gross formation of

fixed capital

China Statistical Yearbook

several editions

Education Number of persons having received at least secondary

education divided by total population

China Statistical Yearbook

several editions