Nber Working Paper Series Exporting Deflation? Chinese Exports and Japanese Prices

Between 1992 and 2002, the Japanese Import Price Index registered a decline of almost 9 percent and Japan entered a period of deflation. We show that much of the correlation between import prices and domestic prices was due to formula biases. Had the IPI been computed using a pure Laspeyres index like the CPI, the IPI would have hardly moved at all. A Laspeyres version of the IPI would have risen 1 percentage point per year faster than the official index. Second we show that Chinese prices did not behave differently from the prices of other importers. Although Chinese prices are substantially lower than the prices of other exporters, they do not exhibit a differential trend. However, we estimate that the typical price per unit quality of a Chinese exporter fell by half between 1992 and 2005. Thus the explosive growth in Chinese exports is attributable to growth in the quality of Chinese exports and the increase in new products being exported by China. David Weinstein Columbia University, Department of Economics 420 W. 118th Street MC 3308 New York, NY 10027 and NBER [email protected] Christian Broda University of Chicago Graduate School of Business 5807 South Woodlawn Avenue Chicago, IL 60637 and NBER [email protected] The spectacular growth of China in the last two decades has caused China to replace Japan as the major new source of US imports and destination for our exports. This perception has not gone unnoticed by Japanese who often bemoan the relative decline of the perceived importance of Japan with the phrase, “Japan Passing”. Much less well known in the US is how the rapid growth of trade with China is affecting the world’s second largest economy. The explosion of trade between Japan and China has had profound impacts on the Japanese economy and is frequently seen as a source of Japan’s persistent deflation. For example, in a now famous article in the Financial Times the Vice Minister and Deputy Vice Minister for International Affairs at the Japanese Ministry of Finance wrote, “The entry of emerging market economies such as China and other east Asian nations into the global trading system is a powerful additional deflationary force. Their combined supply capacity has been exerting downward pressure on the prices of goods in industrialised economies.... China is exporting deflation and its effects are not limited to neighboring Hong Kong and Taiwan.” This notion that China was exporting deflation by exporting goods at low prices was repeated by market analysts and policymakers both inside and outside of Japan. In this paper, we assess the impact that Chinese exports have had on Japanese prices in the years between 1992 and 2005. We start by showing that while the official Japanese import price index has fallen over this period, an import price index computed using the same methodology as the consumer price index would have resulted in substantial inflation over this period. This suggests that while the export of individual countries might have exerted deflationary pressures on Japanese prices, at the aggregate level (when measured using the same 1 Kawai, Masahiro and Haruhiko Kuroda, “Time for a switch to global reflation,” Financial Times, London, December 2, 2002, p. 23. 2 The idea that the presence of China might be reducing prices is also popular in the US. Broda and Romalis (2008) estimate the impact that China has had on the prices of goods paid by different income groups in America. Bergin and Feenstra (2007) argue that the rise in China’s share of US imports may explain the lower pass-through of exchange rates to US import prices. 2 methods) this pressure fades away as import prices have risen as fast as consumer prices. The fact that index number problems are sufficiently large in Japanese import price data to bias the numbers downwards by one percentage point per year could easily have confused policymakers and economists alike about how trade was affecting price movements in Japan. Despite this aggregate pattern, the notion that China might be exporting deflation may be warranted given the importance of China in Japan’s trade and the perception that Chinese products are falling in price. The rise in importance of China in Japan’s import and export structure over this period has been dramatic and has happened simultaneously with a sharp decline in the importance of the US. In 1992 the US exported three times as much to Japan as China; by 2005, China was exporting twice as much as the US. Moreover, between 1992 and 2005, the number of new imported varieties entering Japan rose by 32 percent and China played an enormous role in this expansion – accounting for 11 percent of the total. This is more than twice the level we observed in the US over a similar period. The fact that the US and China have traded places, or at least traded trade shares, is not a fact that is well-known in the US and is likely to dramatically alter Japanese-US relations in the future. Understanding the price impact of the expansion of Chinese exports is more complex. Although China plays a large role in Japanese imports, we find no evidence that import prices from China fell faster than those from other countries. In those categories where China already had a presence in 1992, we do not find that Chinese prices fell more rapidly than those of other exporters to Japan. Moreover, the impact of Chinese competition to other exporters is also small. There is no evidence that the entry of Chinese firms into new markets has any significant impact