Guest Contribution: “Do Traditional Models or the Dominant Currency Paradigm Explain China’s Export Behavior?”

Today, we are pleased to feature Willem Thorbecke, a Senior Fellow at Japan’s Research Institute of Economy, Trade and Industry (RIETI), as our guest contributor. The opinions expressed are solely his own and do not necessarily reflect those of RIETI or any other institutions he is associated with. This report seeks to explore the question: do traditional economic models or the dominant currency pricing paradigm better explain China's export behavior?

Traditional economic models assume that exchange rates influence exports by affecting the pricing of products in the importing countries. If a country's currency depreciates relative to the currencies of its trading partners, its exports become cheaper and more attractive, leading to an increase in demanded quantities. The Dominant Currency Pricing Model, on the other hand, posits that the majority of global trade happens in USD, regardless of the countries involved.

Therefore, changes in bilateral exchange rates between countries other than the U.S. do not significantly impact the purchasing power of importers or the export volumes of exporters.

Challenges to the Dominant Currency Pricing Model have been raised by scholars such as Tenrenryo (2019) and McLeay and Tenreyro (2026). They argue that exchange rates have little impact on export prices when denominated in USD and that a depreciation of the exporting country's currency can actually increase its profitability by raising export prices in local terms. This, in turn, can lead to increased exports and a greater willingness to expand production capacity.

In our investigation, we focused on the period between 1995 and 2008, a time when China's exports were primarily invoiced in USD. We found that China's economy was characterized by increased labor availability, elastic increases in imported inputs, and the ability to produce value-added goods at relatively low costs. Our methodology involved estimating trade elasticities using fixed effects models, incorporating real GDP and bilateral real exchange rates as explanatory variables.

Our results suggest that traditional models, which emphasize the role of exchange rates in determining export volumes, may be more appropriate for explaining China's export behavior during this period. The heavy intervention of the Chinese government in the foreign exchange market, as well as the fixed exchange rate regime, further complicates the relationship between exchange rates and exports.

The findings of our study emphasize the need for policymakers and economists to consider both traditional models and alternative paradigms when analyzing and forecasting China's export behavior.