Trade and Exchange Rate Competition in East Asia

• In Event: International Monetary and Financial Governance

Abstract

Exchange rate manipulation—the active devaluation of a currency through intervention in the foreign exchange market—is a frequent trigger of international commercial disputes. It is also uncommon, as it is disliked by citizens and importers because of the loss of purchasing power it entails, benefits those with investment abroad at the expense of those with savings at home and is a blunt tool to boost export competitiveness. The notable exception is a group of East Asian countries, from Japan and Korea to Thailand, that undertake frequent and often large interventions to devalue their currencies. What explains their unusual policy choice?

In this paper, we provide evidence that exchange rate depreciations are undertaken at the behest of export industries, and that this motivation is reinforced by a competitive dynamic between countries. As lobbying activities in East Asian countries are not directly observably, we first focus on the cases of Japan and Korea and construct a proxy measure of lobbying by exporters using news reports. We use quantitative text analysis (transformer models) to classify daily reports of industry demands in the two leading financial newspapers, the Japanese Nihon Keizai Shimbun and the Korean Hankyung, over 25 years. We find evidence that mounting public pressure to intervene precedes action, suggesting that organized economic interest groups are the primary beneficiaries and the likely supporters of foreign exchange intervention. We show that our measure greatly improves existing models to predict foreign exchange intervention.

We then use a panel model to show that export similarity and intervention by competitor countries in East Asia predicts interventions: When neighboring rivals tinker with their exchange rates, others follow suit, leading to competitive devaluations. A combination of industry lobbying and regional competition helps explain the East Asian anomaly of currency devaluation.

Authors

• Mark S. Manger, University of Toronto

• Nicola Nones, University of Toronto