73rd International Atlantic Economic Conference

March 28 - 31, 2012 | Istanbul, Turkey

The effects of devaluation on the allocation of tasks in global production networks

Saturday, 31 March 2012: 8:50 AM
Luca Macedoni, B.Sc. , Politecnico di Milano, Busto Arsizio, Italy
The emergence of the international fragmentation of production as a revolution in the international division of labor (Grossman and Rossi-Hansberg, 2008) has challenged several recognized paradigms of international economics, as the issue of global imbalances and trade statistics (WTO, 2011). This paper argues that international fragmentation of production modifies also the standard effects of nominal exchange rate variations.

In fact, it is argued that in a global production network involving more than two countries, which have different comparative advantages and produce a continuum of standardized fragments, a devaluation of the currency of the country that is importing fragments vis-à-vis the currency of the country that is exporting them, will not necessarily transfer the production of fragments from the latter to the former, as the conventional theory suggests. Using a three-country Ricardian model of fragmentation of production as a continuum of tasks, the paper shows that fragments will be transferred only if the two countries are producing sets of fragments close in the continuum; otherwise the fragments will be relocated among other countries leaving the specialization of the first one unchanged. As a consequence of the global integration, the number of fragments allocated in the other countries of the production network may change even if neither the exchange rates of those countries nor the productivities was modified. The main result of the paper is that a revaluation of the currencies of low-productivity countries in Emerging Asia will not generate the re-shoring of fragments to the high-productivity countries.

The thesis is tested using data of intermediate imports of high productivity countries at the four and eight digits level of the combined nomenclature. Different global production networks of Germany, Japan and China are subjected to empirical tests, assuming that the German comparative advantage is closer to the Japanese one than to that of China. Results of a cross industry time series model and of a simultaneous equation model indicate that a revaluation of the Yen would increase the share of fragments produced in Germany, while the effect of the Renminbi is not significant. In addition to that, the hypothesis that fragments will be transferred only from Japan to Germany is empirically verified.