Comment on “Industry‐specific Real Effective Exchange Rates and Export Price Competitiveness: The Cases of Japan, China, and Korea”

Abstract

Sato et al. (2013) represents a significant contribution to the literature. The novelty of their paper lies in the construction of a new dataset on industry-specific real effective exchange rates (REER) on a monthly basis from January 2005 to the present. The authors have convincingly demonstrated that REER differs not only between countries, but also across industries, a finding that would have slipped through the net of aggregate data analysis. The authors have used the industry-wise producer price index (PPI), instead of consumer price index (CPI), not only because the latter includes nontradables, but also because the former tends to vary across industries, reflecting interindustry differences in costs arising from differences in their exposure to exchange rate changes. In this context, industries with large import content are more sensitive to exchange rate changes than those with a large domestic content. It, thus, makes considerable sense to use the industry breakdown PPI data. However, exchange rate changes, in purchasing power parity (PPP) terms, can only be explained by the inflation differential. According to PPP, a currency with a relatively lower inflation rate would appreciate vis-a-vis currency with a higher inflation rate. Seen in these terms, one might still argue that CPI is more relevant for explaining exchange rate appreciations and depreciations, be they in nominal or real terms. The spotlight on the electric machinery industry is revealing. The results show that the Japanese electric machinery REER exhibits the largest depreciation among Japanese industries. This finding suggests that Japanese electric machinery should be enjoying substantial export price competitiveness. On the contrary, the Japanese electric machinery firms are suffering from worsening business performance and tougher competition in the export market. The explanation given by the authors is that Japan’s competitors in the electric machinery industry, especially the Korean firms, enjoy a much larger REER depreciation, and hence stronger export price competitiveness. This is further supported by the results of a factor decomposition analysis that attributes the Korean electric machinery export price competitiveness to a significant drop in domestic producer prices in Korea during the won appreciation period.