The international competitiveness of Chinese manufacturing firms and the exit of the renminbi–dollar peg

Abstract

This paper evaluates the implications of a shift from a pegged to a floating exchange rate regime for the international competitiveness and the economic behavior of Chinese manufacturing firms. Using a conceptual framework that characterizes the relationship between the exchange rate regime and the potential source of a firm's competitive advantage, it yields two key analytical results. First, Chinese manufacturing firms may increase their reliance on a low-margin pricing strategy as the exchange rate regime shifts towards a more flexible one. As a corollary, a low-margin pricing strategy may discourage Chinese manufacturing firms from undertaking costly research and development (R&D) activities, and investments in human capital development. Second, Chinese manufacturing firms have the incentive to employ various wage restraint measures under a floating exchange rate regime at least in the short term. These key analytical results provide insights into a number of policy-relevant issues that may arise at the firm-level. It concludes by providing some general directions on the timing of a complete transition to a floating exchange rate regime.

Keywords:

• China
• international competitiveness
• exchange rates
• international monetary system

JEL codes:

• F23
• F31
• F32
• F33

Acknowledgments

I would like to thank an anonymous referee for providing constructive comments and corrections, and Sharlene Morgan for proof-reading the earlier drafts of this paper. All remaining errors are mine.

Notes

1. A notable exception is McKinnon (2007) who strongly objects to the floating of the RMB.

2. For the purpose of this analytical exercise, I will conveniently ignore the inherent challenges that may be involved in estimating the ‘equilibrium’ exchange rate of countries in transition such as China (Dunaway and Li 2005, 2006).