Third-Market Effects of Exchange Rates: A Study of the Renminbi

This paper estimates the effects of China’s exchange rate changes on exports of competitor countries in third markets. We derive an econometric specification which includes product and destination-specific indices of competition between China and its developing country competitors. Our empirical strategy allows us to exploit the variation--afforded by disaggregated trade data--across exporters, importers, product, and time to estimate the “third-market effect”. We find robust evidence for a statistically and quantitatively significant effect of China’s exchange rate on competitor country exports. In particular, a country’s exports of products that compete more closely with China tend to increase significantly more when the Chinese exchange rate appreciates. Our estimates suggest that a 10 percent appreciation of China’s real exchange rate can boost on average a developing country’s exports of a typical 4-digit HS product category to third markets by 1-2 percent. The magnitude of the third-market effect is consistent with the underlying theoretical model.