Wednesday, October 22, 2008

China's Exports and the Oil Price

In this paper written with Faria, Mollick and León-Ledesma we tried to explain why oil prices are positively correlated with China's exports, a puzzling observation given that oil is an important input in China.

We postulated that, as a result of elastic labor supply and increasing labor productivity, China's exports lead to higher oil prices and at the same time are less affected by higher oil prices than the exports of China's competitors, meaning that China increases its competitive edge when the price of oil increases.

If the predictions of the model are correct, China's exports could fall more strongly than its competitors' exports during a world recession that is accompanied by falling oil prices, causing further reductions in oil prices. In other words, China's competitive advantage could be reduced when the price of oil falls.

This post by Smith indicates that our article's predictions may be validated soon:

One factor that the oil bulls have repeatedly invoked is demand from China. The figure I have seen oft cited is that Chinese demand will continue to rise at 7.8% per annum. ...

Chinese GDP growth and energy demand has fallen off even though exports are still robust. Thus a fall in exports will lead to a further reduction in growth and energy use. And the growth lever that Ting cites, 5%, is already below the 7%+ that was assumed until recently for China.

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