# Manufacturing export prices for the G7.

MANUFACTURING EXPORT PRICES FOR THE G7

The Institute World Model, GEM, has equations for manufacturing export prices for each of the G7 countries. The long-run solutions to the equations are all of the simple form:-- PXG = [gamma].sub.0.WPXG[gmma].sup.1.(PD/RX)[gmma].sup.2.sup.e..sup.W where PXG: manufacturing export prices in dollars WPXG: competitors export prices in dollars PD: domestic wholesale prices in domestic currency RX: domestic currency units per dollar

These equations have recently been re-estimated over the period 1965Q1 to 1987Q3. In that estimation we imposed the condition that the equation is homogenous of degree one in its arguments, WPXG and PD/RX, by assuming that [gmma].sub.1 + [gmma].sub.2 = 1, and we included dynamic elements in all the variables. The general form we estimated was (lower case indicates logs). and we produced a parsimonious form by sequentially eliminating the dynamic elements.

The long-run characterics of the equation are given in table 1. The higher the weight on domestic prices the less influence there is on export prices from overseas prices. The US equation is very simple, in that only domestic prices affect export prices, reflecting both the size of US industrial production and the small proportion of the production which is exported. Japan and Germany also displayed a rather small role for world prices in the long-run solution, which is not surprising given the size of their industrial sectors. France appears to be the most open of these seven economies. The high weight on Canadian domestic prices may reflect the direct influence of US wholesale prices on Canadian prices, rather than indicate a low degree of openness. The law of one price would suggest that, in the long run, only world prices would determine export prices. None of the countries studied displayed this property, reflecting the heterogenous nature of the goods traded and differing degrees of market power. In no case was the law of one price form of the equation statistically better than the form chosen.

The dynamic properties of the equations can be summarised by the mean lags reported in table 2. We did not choose to impose the same lag structure on domestic prices as on exchange rates. Exchange rate changes may initially be seen as less permanent than changes in domestic prices, and hence a permanent change in exchange rates may take longer to be embedded in prices than does a change in domestic prices. This does indeed appear to be the case for Germany, France, italy and the UK. Response times to changes in world prices appear to be lowest in the open economies of Italy and the UK, and longest in the relatively closed German economy. We have also not chosen to impose homogeneity of degree one on the coefficients of the dynamic part of the equations, although it would appear to be a valid restriction for all economies except Japan, where a change in world inflation rates does seem to have a long-run effect on Japanese export prices.
COPYRIGHT 1989 National Institute of Economic and Social Research
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