About the Special Report

How much competitiveness did China lose because of currency appreciation since 2010? The conventional effective exchange rate (EER) index for RMB shows a 31% appreciation against China’s trading partners. But we argue the conventional EER is misleading. A depreciation of Korean Won would help to lower costs of Chinese cell phone makers who import Korean memory chips. This “supply chain” effect is ignored in the conventional EER index. We develop a new EER index for RMB. We utilize our proprietary processing trade model to correct for such supply-chain bias. The adjusted EER index suggests that China’s true price competitiveness loss between 2010 and 2015 was only some 19%, or 60% of what was indicated by the conventional EER. We also develop the first set of sector EER indices in the market. The difference across sectors is huge: the automobile EER index appreciated by 32.5% since 2010, while the cell phone EER index only appreciated by 12.5%. This is in part because Chinese cell phone manufacturers heavily depend on imported parts from Korea, Taiwan, and Japan. Therefore, depreciation of these currencies actually helped Chinese cell phone exporters. The appreciations of some sector EER indices (cell phone and computer) are in fact smaller than RMB’s bilateral appreciation against any of China’s major trade partners. This highlights that, due to the existence of global supply chains, it is indeed possible for a country like China to benefit, on a net basis, from bilateral depreciations of its trade partners’ currencies. We believe our EER indices provide better—more accurate, more complete and more update-to-date—measures for China’s competitiveness. They have important market and policy implications: