China in the global economy - Jessica Leight - Home€¦ · I China’s foreign trade increased...

China in the global economy

Jessica Leight

Williams Department of Economics

March 13, 2016

Introduction Background Exporting and firm performance The China Syndrome China and the developing world

Introduction

I The reform period in China was also characterized by a progressive,and ultimately dramatic, opening to foreign trade and investment.

I China’s foreign trade increased from $21 billion to 1978 to morethan $1.1 trillion in 2004, when China became the world’s thirdlargest trading economy.

I Foreign investment has also poured into China.

I Both phenomena have had major implications for the globaleconomy, including the United States - something that one of theresearch papers this week will analyze.

Introduction

Trade liberalization

I Trade reform was not as rapid as some other changes in the earlyyears; up through 1992, average tariff rates were at 43%.

I Beginning in 1992, tariffs declined rapidly, as did quantitativerestrictions on trade.

I In addition, there were broad exceptions to any import restrictionsfor firms that were exporting goods (and thus importing rawmaterials, parts or components) or for firms that were wholly orpartly foreign owned.

Declining rates of protectionism

Exchange rate policy

I Over the same period, the government gradually devalued theofficial exchange rate.

I In 1995, the government effectively pegged the exchange rate at 8yuan to the dollar; this was the culmination of a real devaluation inwhich the Chinese currency lost around 70 percent of its valueagainst the dollar in real terms, substantially enhancing thecompetitiveness of China-based export operations.

I Very controversial in the U.S.!

I In 2005, China began a crawling (but still government-controlled)currency appreciation (increased by about 25% since then).

Sources of FDI

Liberalization of FDI

I In 1979, a law on joint ventures was passed allowing foreign firms tooperate broadly in China for the first time since the late 1950s; atthe same time, four special economic zones were established inwhich foreign firms were offered preferential tax treatment.

I This program was expanded further in 1984, and in 1986 theso-called “22 Regulations” were implemented that madeforeign-investment enterprises eligible for lower taxes and gave themincreased managerial autonomy.

I Tight controls on the remittances of profit were also lifted.

I Initial investment in the 1980s included large numbers of HongKong- and Taiwan-based investors, but over time more firms fromJapan, the U.S. and Europe also began to invest.

China’s entry into the WTO

I Branstetter and Lardy provide a detailed discussion of the process bywhich China entered the WTO in 2001 and the reforms made inpreparation for this process; they note that reforms were ongoing,and thus the impact of the WTO per se has not been as large assome might have predicted.

I Today, China is the most open large developing economy; theaverage statutory tariff on industrial products is 8.9 percent, muchlower than comparable economies (Argentina, Brazil, India andIndonesia).

I A recent focus has been liberalization of services, particularly banksand insurance.

Structure of Chinese exports

I The pattern of Chinese exports has also experienced a dramaticevolution over the reform period, shifting from predominantly crudeoil, refined petroleum and apparel, to consumer electronics, officeequipment and computers, and communications equipment.

I Globally, China is now the second-largest producer of those items.

I However, the authors also note that China imports most of thehigh-value-added parts and components that go into consumerelectronics; it primarily provides relatively low-wage “assemblyservices”, consistent with its underlying comparative advantage.

I China may well gradually increase the technological sophistication ofits exports, but this process is still in the early stages.

Imports and exports of high-tech goods

U.S.-China trade

Trade displacement

Trade displacement, cont.

Park et al., Exporting and firm performance

I This is an interesting paper that seeks to unpack channels by whichparticipation in export markets in fact leads to greater economicgrowth in developing countries.

I While it is generally the case that more productive firms enter exportmarkets, there is little systematic evidence as to whether or not thisis a causal relationship.

Park et al., Exporting and firm performance

I This is an interesting paper that seeks to unpack channels by whichparticipation in export markets in fact leads to greater economicgrowth in developing countries.

I While it is generally the case that more productive firms enter exportmarkets, there is little systematic evidence as to whether or not thisis a causal relationship.

Why is exporting beneficial?

I If exporting increases productivity (because, for example, firmsinnovate to deliver high-quality products desired by more affluentconsumers abroad), then increasing participation in trade could havesubstantial benefits for domestic growth.

I This paper is relatively technical, so I want to review some of thekey methodological points.

Why is exporting beneficial?

I If exporting increases productivity (because, for example, firmsinnovate to deliver high-quality products desired by more affluentconsumers abroad), then increasing participation in trade could havesubstantial benefits for domestic growth.

I This paper is relatively technical, so I want to review some of thekey methodological points.

Identification strategy

I The identification strategy in this paper seeks to exploit relativeshocks to Chinese firm’s export volumes induced by the Asianfinancial crisis: firms exporting to other Asian countries thatexperienced sharp devaluations of their currency saw large declines inexports.

I The fundamental equation of interest identifies the causal impact ofchanges in export value on changes in firm outcomes.

∆Yit = δ + β∆Eit + εit

I The challenge is that export value is endogenous, and thus theyinstrument for export value with a measure of the exchange rateshock experienced by the firm’s (pre-crisis) trading partner countries.

Identification assumption

I What is the identification assumption?

I Under what circumstances would this identification assumption beviolated?

I Note they control for pre-crisis variables in both 1994 and 1995 toaddress some of the concerns.

Measuring productivity

I The exchange rate shock (SHOCKINDEX ) is defined as theweighted average real depreciation experienced by a firm’s precrisistrade partners, where the weights correspond to the share of a firm’s1995 exports that went to each country.

I I.e., if a given firm exported half its products to the U.S. and half toThailand, the exchange rate shock would be the mean of realexchange rate depreciation in the U.S., and real exchange ratedepreciation in Thailand.

Measuring productivity

I The exchange rate shock (SHOCKINDEX ) is defined as theweighted average real depreciation experienced by a firm’s precrisistrade partners, where the weights correspond to the share of a firm’s1995 exports that went to each country.

I I.e., if a given firm exported half its products to the U.S. and half toThailand, the exchange rate shock would be the mean of realexchange rate depreciation in the U.S., and real exchange ratedepreciation in Thailand.

Measuring exchange rate shocks

I Firm-level productivity is measured as the residual from theestimation of a production function, using both OLS (as follows)and some more sophisticated specifications.

yit = β0 + βl lit + βkkit + εit

I What is the intuition behind this variable? What are the potentialdisadvantages of using this measure?

Measuring exchange rate shocks

I Firm-level productivity is measured as the residual from theestimation of a production function, using both OLS (as follows)and some more sophisticated specifications.

yit = β0 + βl lit + βkkit + εit

I What is the intuition behind this variable? What are the potentialdisadvantages of using this measure?

Exchange rates and exports: A graphical summary

First stage

I The first stage has the following firm.

∆Eit = α0 + α1SHOCKINDEXi98 + Ψit

∆Eit = α0 + α1SHOCKINDEXi98 + β′(SHOCKINDEXi98 ×Wi95)

+ γ′Wi95 + Ψit

I To evaluate how strong the first stage is, let’s briefly return to someof the key definitions of two-stage least squares.

First stage

I The first stage has the following firm.

∆Eit = α0 + α1SHOCKINDEXi98 + Ψit

∆Eit = α0 + α1SHOCKINDEXi98 + β′(SHOCKINDEXi98 ×Wi95)

+ γ′Wi95 + Ψit

I To evaluate how strong the first stage is, let’s briefly return to someof the key definitions of two-stage least squares.

Evaluating a weak instrument problem

I What is an F test?

I An F test can often be used to test the significance of an entireregression; this is the F-test we’re interested in here.

I A low F test generally suggests that the regression is not significant,while a higher F test suggests more significance; the exact criticalvalue will vary depending on the number of coefficients estimated.

I Econometric research has shown that we want the first stage intwo-stage least squares estimation to have an F statistic of ideallyaround 10, or at minimum, 5.

I Recall the formula for the estimated coefficient in a two-stage leastsquares specification.

ρ0 =Cov(Yi ,Zi )

Cov(Xi ,Zi )

I If the relationship between Xi , the explanatory variable, and Zi , theinstrument, is weak, what does this imply for this formula?

I Research has shown the bias can be worse in 2SLS with weakinstruments, compared to simple OLS.

I What F-statistics do we observe here?

ρ0 =Cov(Yi ,Zi )

Cov(Xi ,Zi )

ρ0 =Cov(Yi ,Zi )

Cov(Xi ,Zi )

ρ0 =Cov(Yi ,Zi )

Cov(Xi ,Zi )

First stage

Second stage

I Estimating equation can be written as follows:

∆Yit = γ + βPred∆Eit + γ′Wi95 + εit

where the predicted variable is generated from the first stage.

I Exclusion restriction: shock index is uncorrelated with ongoing timetrends or other shocks affecting changes in firm performance.

Second stage

I Estimating equation can be written as follows:

∆Yit = γ + βPred∆Eit + γ′Wi95 + εit

where the predicted variable is generated from the first stage.

I Exclusion restriction: shock index is uncorrelated with ongoing timetrends or other shocks affecting changes in firm performance.

Discussion questions

I What effect do the authors find of exporting on firm performance?

I What tests do they perform to test the exclusion restriction?

I What evidence do the authors present about the channels throughwhich exporting affects firm performance?

Introduction

I In recent years, the impact of increased exports from China on theU.S. economy - particularly on U.S. manufacturing - has been ahotly contested topic in political debate.

I This is true more than ever in 2016!

I Examining the expansion of China in the global economy alsorequires us to understand how the global economy is impacted, andwho is winning and losing.

I Another research paper of interest examines the impact of increasedimport competition from China on local labor markets in the U.S.

Introduction

Autor et al., Local effects of import competition

I This is an interesting recent paper that seeks to analyze the effect ofrising Chinese import competition between 1990 and 2007 on U.S.local labor markets.

I The authors compare across different local labor markets in the U.S.that are more or less exposed to increasing competition fromChinese imports, based on their pre-period concentration of industry.

I Intuitively: areas that specialize in producing, for example, furniture,textiles and footwear will be particularly hard-hit by the increase inChinese imports; areas that specialize in producing semiconductorswill be less affected.

Autor et al., cont.

I The authors want to use this comparison to generate quantitativeestimates of the impact of trade on employment and wages.

I Again, this is a highly technical paper.

I I’ll explain the basics of the instrumentation strategy.

Autor et al., cont.

Motivation

Measuring exposure to import competition

I The authors want to generate a region-specific measure of to whatextent the local labor market is exposed to Chinese exports; note iwill be region, j will be industry, and u denotes the whole U.S.

I The expression of interest IPW is the change in Chinese importexposure per worker in a region, where imports are apportioned tothe region according to its share of national industry employment.

∆IPWuit =∑j

LijtLujt

∆Mucjt

I NoteLijt

Lijtis the fraction of national employment in sector j that is to

be found in region i.

I ∆Mucjt is the observed change in U.S. imports from China fromindustry j over the period; this is weighted by the total number ofworkers in the region, Lit .

∆IPWuit =∑j

LijtLujt

∆Mucjt

I NoteLijt

∆IPWuit =∑j

LijtLujt

∆Mucjt

I NoteLijt

∆IPWuit =∑j

LijtLujt

∆Mucjt

I NoteLijt

Understanding this measure

I There are two sources of variation in this measure: variation in howimportant manufacturing is to local employment, and variation inhow labor-intensive manufacturing is.

I Most variation of interest is the latter.

I Is IPWit plausibly exogenous? If not, why not? What if there is apositive change in imports of shoes from China because more peoplewant to buy shoes, overall? How might this latter shock affect ashoe-producing region?

I The authors instrument for IPWit with a similarly constructedvariable that is constructed using contemporaneous industry-levelgrowth of Chinese exports to other high-income markets, andlagged employment levels.

∆IPWoit =∑j

Lij,t−1

Luj,t−1

∆Mocjt

Li,t−1

I (Remember the previous definition):

∆IPWuit =∑j

LijtLujt

∆Mucjt

I They use lagged employment levels since they are not plausiblyaffected by expected China trade.

∆IPWoit =∑j

Lij,t−1

Luj,t−1

∆Mocjt

Li,t−1

∆IPWuit =∑j

LijtLujt

∆Mucjt

∆IPWoit =∑j

Lij,t−1

Luj,t−1

∆Mocjt

Li,t−1

∆IPWuit =∑j

LijtLujt

∆Mucjt

Intuition for the identification strategy

I If Chinese exports in a specific area (e.g., shoes) are simultaneouslyincreasing to the U.S. and other industrialized markets, what doesthis suggest about the underlying cause of the increase? Probablyincreasing productivity in China, lower trade costs, or both.

I What is the implied exclusion restriction using this specification?Increases in the relative competitiveness of Chinese imports affectslocal labor markets only via competing with local manufacturingindustries.

Intuition for the identification strategy

I If Chinese exports in a specific area (e.g., shoes) are simultaneouslyincreasing to the U.S. and other industrialized markets, what doesthis suggest about the underlying cause of the increase? Probablyincreasing productivity in China, lower trade costs, or both.

I What is the implied exclusion restriction using this specification?Increases in the relative competitiveness of Chinese imports affectslocal labor markets only via competing with local manufacturingindustries.

Potential sources of bias

I What if product demand shocks are correlated across high-incomecountries (e.g., all of a sudden both in Europe and U.S. we startbuying Chinese-made shoes rather than Vietnamese-made shoesbecause that is the new fashion fad)?

I What if there is a common technological shock in high-incomecountries that negatively affects their labor-intensive industries?

Potential sources of bias

I What if product demand shocks are correlated across high-incomecountries (e.g., all of a sudden both in Europe and U.S. we startbuying Chinese-made shoes rather than Vietnamese-made shoesbecause that is the new fashion fad)?

I What if there is a common technological shock in high-incomecountries that negatively affects their labor-intensive industries?

Graphical summary of the results

Imports from China and manufacturing employment

Summarizing results

I The larger the increase in imports, the larger the decline inmanufacturing employment.

I Next, the authors add a range of demographic controls to see if theresults are robust.

Summarizing results

I The larger the increase in imports, the larger the decline inmanufacturing employment.

I Next, the authors add a range of demographic controls to see if theresults are robust.

Main results: Adding controls

I What other impacts do the authors find, moving beyondmanufacturing employment?

I How does government policy seem to interact with the observedshocks from Chinese imports?

I Do you believe these impacts will be persistent?

Discussion questions, cont.

I Economists would describe this as a classic example of comparativeadvantage: low-skilled manufacturing relies primarily on low-skilledlabor, and is profitable only if labor is cheap.

I Cheap labor is no longer a comparative advantage in the U.S.; hence,manufacturing has disappeared.

I Do you agree? How can we balance these costs in the U.S. againstthe gains in China?

Expanding our focus

I We have seen one paper that analyzes the impact of greater tradeon China, and one paper that analyzes the impact of greater tradeon the U.S.

I What about third countries - particularly developing countries thatmight also be seeking to export to the U.S. and other rich markets?

I A recent paper by Mattoo et al. (researchers at the World Bank, theIMF and the Center for Global Development) has analyzed thisquestion.

I The paper is entitled “Beggar-thy-neighbor effects of exchangerates? A study of the renminbi”.

Expanding our focus

Empirical strategy

I The core idea of the paper is ingenious, and is based on four typesof variation: importer, exporter, product and time.

I Consider two trading countries that compete with China (i.e., donot trade directly, but seek to export the same good to a thirdmarket - e.g. the U.S.).

I China produces TVs. Brazil and Malawi also produce TVs, andcompete with China in the U.S. market, but Brazil is a largercompetitor.

I What happens when the renminbi depreciates?

Empirical strategy

Empirical strategy, cont.

I If the renminbi depreciates, Chinese exports of TVs to the U.S. willincrease.

I Malawi’s exports of TVs to the U.S. will decrease; Brazil’s exports ofTVs to the U.S. will decrease even more. Relatively speaking, Brazilis hurt much more by the depreciation than Malawi.

I The fundamental idea of the paper is to regress exports on theinteraction of the exchange rate between the renminbi and countryj’s currency (j would be the U.S.), and the degree of competitionbetween country i’s exports (Brazil) and China’s exports of productp (TVs) in market j.

Graphical depiction

Estimating equation

I Again: i refers to the exporting country (developing countriescompeting with China), j refers to the importing country (this is theU.S. and other rich countries that are the major importers in theworld), p refers to the product, and t refers to time.

I The fundamental equation of interest is

lnVijpt = βIijp × lnE cjt

where E is the exchange rate and I is an index of competitionbetween country i and China for importing country j and product p.

I There are a number of ways to define the index of competition, butthe simplest is the share of all products that country i exports tocountry j that China also exports.

Estimating equation

Example

I If Brazil exports 100 products to the U.S., and China also exports75 of them, then the degree of competition would be .75.

I If Malawi exports 100 products to the U.S., and China also exportsonly 10 of them to the U.S., the degree of competition would be .1

Example

I If Brazil exports 100 products to the U.S., and China also exports75 of them, then the degree of competition would be .75.

I If Malawi exports 100 products to the U.S., and China also exportsonly 10 of them to the U.S., the degree of competition would be .1

China’s exchange rate fluctuations

Average competition with other regions

Identification

I The advantage of this specification, using importer-exporter-product-time variation, is that you can add many fixed effects.

I They have fixed effects for importer-exporter-time, importer-product-exporter, importer-product-time, exporter-product -time.

I This controls for many obvious sources of bias.I If trade relations are just changing between the U.S. and China, they

control for it.I If U.S. consumers suddenly like Chinese TVs less, they control for it.I If U.S. consumers suddenly like Brazilian TVs more, they control for

Identification

Identification, cont.

I Let’s look again at the specification.

lnVijpt = βIijp × lnE cjt + νjpt + sipt + γijt + βijp + εijpt

I What is the expected sign of β? Negative.

I When China’s exchange rate (yuan per dollar) increases, that meansa depreciation. China’s exports are more competitive. Otherdeveloping country’s exports will decrease.

I And importantly, other countries’ exports will decrease more if theywere competing more with China initially.

Primary results

Variation with respect to degree of competition

Summing up

I A 10 percent depreciation of the renminbi reduces a developingcountry’s exports at the product-level on average by 1.5-2 percent.

I However, the effect can be larger (as much as twice as large) forcountries that compete closely with China.

I Countries that compete closely with China are largely Asiancountries: Nepal, Bangladesh, Philippines, Vietnam and Cambodia.

I These are all countries that are significantly poorer than China, andwhose path to growth via exports is largely blocked by China.

Summing up

China in the global economy - Jessica Leight - Home€¦ · I China’s foreign trade increased...

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