Renminbi Appreciation and China's Industrial Upgrading

Abstract To identify the macroeconomic environment that has enabled China's industrial upgrading during a period of persistent renminbi appreciation, we construct a two‐country New Keynesian model of industrial upgrading with a global production network, endogenous firm entry, and a directed quality frontier. We show that renminbi appreciation promotes industrial upgrading without hurting real economic growth in the longer run. This holds true especially through four channels. First, the quality threshold for firm entry is lower to allow for more firms participation and thus greater product varieties (quality threshold channel). Second, upstream skill‐based production uses more imported inputs of higher quality (imported input channel). Third, there is substantial global demand towards the exports of high‐quality inputs (global demand channel). Fourth, domestic inputs are competing against imported inputs to broaden the scope for competition in the upstream product market to incentivize quality upgrading (scope for competition channel).