IMF Blog IMF Blog

Asia’s Supply Chain and Global Rebalancing

Much of the debate over global rebalancing has focused on the U.S.-China trade imbalance. But that’s missing the bigger picture.

With the growth of cross-border supply chains—a signature feature of Asia’s trade in recent decades—it would be misleading to focus on bilateral imbalances and exchange rates.

Instead of specializing in producing certain types of final goods, Asian exporters increasingly have specialized in certain stages of production and become vertically integrated with each other. So, as Asia’s economies strive to rebalance their growth models, we need to understand better how the regional supply chain affects the way exchange rates and shifts in global demand work.

Illustrating the inputs

Take, for example, the iPad and its rising popularity in the United States.

According to PC Magazine "while final assembly is in China, most of the components seem to be actually manufactured in other Asian [economies]," including Korea, Japan, and Taiwan Province of China.

It would be misleading, in assessing imbalances, to focus solely on the end producer. The exporting country’s price competitiveness depends on both the value of its own currency and also on the value of its suppliers’ currencies.

The shifting hub

Some fast facts on the degree of regional trade integration give a sense of how important it is to account for exchange rates of both the exporting country and its suppliers.

The Asian supply network is increasingly centered on China.

For all major Asian economies, Japan remains the second most important source of intermediate inputs after China. And, in the short run, other countries may not be able to easily replace Japanese production of many high-end electronics and capital goods. If production disruptions in Japan following the tragic earthquake and tsunami persist, say beyond the Fall, the resulting supply shortages could have significant spillovers to production elsewhere in Asia

Because of Asia’s high degree of vertical integration, the cost of intermediate inputs can account for a significant share of exporters’ total cost. In value added terms, we estimate that the imported content in exports ranges from about 10 percent in Japan to 40 percent in the smaller open economies, such as Malaysia.

Taking account of the supply chain

A more comprehensive approach to thinking about imbalances and exchange rates might provide a clearer picture of what’s required to achieve global rebalancing.

To account for importance of suppliers in cost competitiveness, we estimate an “integrated effective exchange rate.” This builds on the concept of the conventional effective exchange rate, which measures changes in a country’s exchange rate as a weighted average of the bilateral exchange rates with its trading partners. The integrated exchange rate also factors in supplier economies’ exchange rate movements.

Accounting for vertical trade integration also affects the way we measure global demand imbalances. For example, if we adjust the U.S.-China trade imbalance to reflect the original suppliers of the imported inputs in China’s exports to the United States, we find that China’s trade surplus to the U.S. shrinks and that of most other Asian economies increases.

The bottom line? Asia’s high degree of vertical integration means that a durable reduction in imbalances requires adjustment across all major Asian economies and currencies.