China-US Trade War And Trade Talk [1st Edition] 9811537844, 9789811537844, 9789811537851

This book focuses on the current tension between China and the US on trade imbalance and discusses China’s opening-up st

496 110 4MB

English Pages 268 Year 2020

Report DMCA / Copyright

DOWNLOAD FILE

Polecaj historie

China-US Trade War And Trade Talk [1st Edition]
 9811537844, 9789811537844, 9789811537851

Table of contents :
Contents......Page 5
Part I Articles......Page 12
1 Introduction......Page 13
2.1 Tariff Reductions......Page 14
2.2 Economic Zones and Industrial Parks......Page 16
2.3 Processing Trade......Page 17
3 Intensive Margin of Opening-Up (2001–17)......Page 19
3.2 Export Processing Zones......Page 20
3.3 Establishment of Pilot Free Trade Zones......Page 21
3.4 New-Economy Pilot Cities Experiment......Page 23
4.1 ASEAN–China Free Trade Agreement......Page 24
4.2 Regional Comprehensive Economic Partnership......Page 25
4.3 Belt and Road Initiative......Page 26
4.4 Free Trade Ports Experiment......Page 27
4.5 Greater Bay Area......Page 28
5 Conclusions......Page 29
1 Introduction......Page 31
2 Comparative-Advantage-Following and Processing Trade......Page 33
3 Trade Liberalization and Firm Performance......Page 35
4 Deeper Opening Up Against Financial Crises......Page 40
5 All-Around Opening Up and Trade Globalisation......Page 43
3 Understanding the Recent Sino-U.S. Trade Conflict......Page 46
2 How the Trump Administration Views the Sino-U.S. Trade Imbalance......Page 47
3 Sino-U.S. Trade Imbalance Does not Hurt the U.S. Economy......Page 51
4 Comparative Advantage Determines the Sino-U.S. Trade Imbalance......Page 53
5 China’s Value-Added Upgrading Is the Consequence of Economic Development......Page 58
6 Cooperation Is the Only Solution to the Sino-U.S. Trade Imbalance......Page 59
1 Introduction......Page 62
2.1 Bilateral Trade Relationship......Page 66
2.2 Bilateral Trade Flow and Trade Imbalance......Page 67
2.3 Bilateral Trade Structure and Trade Dispute......Page 68
2.4 Current Trade Conflicts......Page 70
4.1 Tariff Increases......Page 71
4.2 Sectoral Bilateral Trade Between the United States and China......Page 72
4.3 Case 1: Unilateral U.S. Tariffs with Balanced Trade......Page 74
4.5 Case 3: U.S.—China Retaliatory Tariff War with Ongoing Trade Imbalance......Page 77
5 Concluding Remarks......Page 81
1 Introduction......Page 82
2 U.S.-China Trade Dispute......Page 83
3 Trade Liberalization and Non-tariff Barriers......Page 87
4.1 Achievement......Page 88
4.2 Challenges......Page 89
4.3 Recent FDI Reform......Page 91
5.2 Reform for Competitive Neutrality......Page 92
6.1 China Is not a Currency Manipulating Regime......Page 95
6.2 Discussion on Wage Bargaining......Page 97
7 Conclusion......Page 98
1 A Historic Task of the New Era: Developing Free Trade Ports......Page 99
2 Key to Building a New Pattern of Increased Opening: Developing the Guangdong-Hong Kong-Macau Greater Bay Area......Page 100
3.1 Promoting the Pilot Project for the New System of Open Economy......Page 102
1 Introduction......Page 104
2.1 New De-globalization Threat to the World Trade......Page 106
3 Free Trade Ports: The Next Step in China’s Reform and Opening up......Page 107
4 Functional Orientation for the Construction of China’s Free Trade Ports......Page 109
5 International Experience and Domestic Exploration......Page 110
6 Singapore Port......Page 111
7 Shanghai Yangshan Free Trade Port Area......Page 113
8 Comparison Between the Shanghai Free Trade Port and International Free Trade Ports......Page 114
9 Path for the Construction of Free Trade Ports in China......Page 121
1 To Further Widen Market Access......Page 123
2 To Improve the Investment Environment for Foreign Investors......Page 124
3 To Strengthen Protection of IPR......Page 125
4 To Take the Initiative to Expand Imports......Page 126
9 Potential Impact of China–U.S. BIT on China’s Manufacturing Sectors......Page 128
1 Literature Review......Page 130
2 Assumptions on the Scenarios of China–U.S. BIT, Focusing on Manufacturing......Page 131
3.2 FDI’s Overall Impacts on Performance of Domestic Firms......Page 132
3.3 FDI’s Impacts on Specific Industries......Page 133
3.4 The Effects of Changes in Policies on Scale or Shares of FDI......Page 137
4.2 Protection Measures in the Long-Run......Page 140
5.1 Suggestions for Domestic Firms......Page 141
6 Conclusions......Page 142
Appendix......Page 143
1 Introduction......Page 149
2 Literature Review......Page 153
3 Impacts of RMB Swap Agreements on Bilateral Trade......Page 154
4 Concluding Remarks......Page 161
5 Notes......Page 162
Appendix......Page 163
1 Introduction......Page 164
2 Literature Review......Page 165
3.1 Data......Page 166
3.3 Benchmark Estimates......Page 168
3.4 Alternative Measure of Firm Performance......Page 169
3.5 Robustness Checks......Page 170
4 Policy Suggestions......Page 173
6 Notes......Page 174
1 The Remarkable Achievements of Chinese Foreign Trade......Page 176
2 From a Wider and Deeper to an All-Around Opening Up Over Four Decades......Page 177
3.1 From the Import Substitution Strategy to an Export-Oriented Strategy......Page 178
3.3 Opening Up Deeper Amid the Global Financial Crisis......Page 179
4 Policy Suggestions for the All-Around Opening Up Strategy......Page 180
13 China’s Opening-Up Policies: Achievements and Prospects......Page 181
1 Expanding the Extensive Margin of Opening, 1978–2000......Page 182
1.2 Relaxing Market Access for Foreign Direct Investment......Page 183
1.3 Reducing Import Tariffs......Page 184
1.4 Encouraging the Processing Trade......Page 185
1.5 Comments on the Stage of Extensive-Margin Opening......Page 186
2.1 Accession to the WTO......Page 187
2.2 Expanding Market Access for FDI......Page 188
2.3 Relaxation of Outward FDI......Page 189
2.4 Establishment of Pilot Free Trade Zones......Page 191
2.6 Comments on the Stage of Intensive Margin of Opening Up......Page 192
3.2 Free Trade Ports Experiment......Page 194
4 Policy Recommendations......Page 195
5 Conclusion......Page 197
Part II Columns and Media......Page 199
1 By Li Jia......Page 200
15 Booming Chinese Investment a Key Factor in Fighting African Poverty......Page 206
16 Minor U.S. Trade Sanctions on China Possible, Experts Say......Page 208
17 China Slashes Tariffs on Range of Consumer Goods......Page 211
18 Evaluating the Burden of a U.S.-China Trade War......Page 213
19 Sino/US Trade War Could......Page 217
20 Chip Wars—Tech Rivalry Underlies U.S.-China Trade Conflict......Page 219
1 A Controversial Firm......Page 220
2 Ongoing Trade Tensions......Page 221
3 ‘We Can Bear This Kind of Loss’......Page 222
22 China Engages U.S. to Deescalate Trade War......Page 223
23 Exporting Trade Turbulence......Page 224
24 Trump Threatens Tariffs on All Chinese Goods......Page 228
25 US Firms Express Optimism in China’s Import Expo......Page 230
1 G20 Meeting?......Page 232
1 No Surprise......Page 234
2 Deadline......Page 235
28 The American Consumers Are Going to Pick up the Bill as Consumer Goods Become the Next Target......Page 236
2 US Declaration of China as Currency Manipulator Roils World Markets......Page 238
4 US Stocks Plummet as China Announces Two-Pronged Trade War Retaliation......Page 239
5 China Suspends Purchases of US Farm Products in Retaliation for Tariffs......Page 240
30 Yuan Depreciation to Slow, May Reverse......Page 241
31 Late-September China-US Meeting Likely......Page 243
32 Speaks at the Yenching Academy......Page 245
33 China Will Never Manipulate Its Currency......Page 249
1 Enforcement......Page 251
1 Signing Next Year......Page 253
2 Largest Win-Win Agreement......Page 254
3 Counter Protectionism......Page 255
36 China’s Faster Growth Will See Yuan Go up to 6.0 Against Dollar......Page 256
37 RRR Cut to Reduce Financing Problems for Companies......Page 258
1 Fodder, Pork Imports......Page 259
References......Page 261

Citation preview

Miaojie Yu

China-US Trade War and Trade Talk

China-US Trade War and Trade Talk “China’s tremendous growth over the past several decades has greatly expanded its role in the world economy. Neighboring countries in Asia, those in Africa, as well as in Europe and the United States are all tied to China through global production chains. Professor Yu Miaojie provides us with an insightful analysis of how this system has evolved and how it is being challenged by the trade war with the United States. These topics are important to all those interested in the state of the world economy and in what the future might bring.” —Robert C. Feenstra, Distinguished Professor, University of California, Davis “Professor Yu has produced a masterful account of the economics underlying the US-China trade conflict. Central to the trade tensions are asymmetric flows of trade and capital between the countries. This timely book unpacks these flows and provides a thorough analysis of how these imbalances arose and how an unsuccessful resolution of the conflict would affect China, the US and the rest of the world. It is essential reading for those who want to understand the origins and possible future directions of the trade war.” —Gordon Hanson, Peter Wertheim Professor, Harvard University “This objective and authoritative study of current US-China trade conflict is a must read for anyone who wants to understand the roots and likely evolutions of one of the most important issues in our time.” —Justin Yifu Lin, Chair Professor, Peking University; Former Chief Economist, the World Bank “With tempers flaring on both sides of the Pacific and a China-US trade war rearing its ugly head, it is time to step beyond the rhetoric and listen to the voices of reason. Professor Yu is one of those rare voices. Trained in the United States and senior faculty at China’s premier Peking University, he has established himself as China’s leading authority on international trade and the current China-US trade war. In a series of essays, he puts the current trade war in context and provides a way past the rhetoric and towards dialogue.” —Daniel Trefler, J. Douglas and Ruth Grant Chair Professor, University of Toronto “This is the book on China trade that every China-watcher and every trade economist keeps on her book shelf. The book not only gives a comprehensive analytical account of China’s transformation from an autarkic economy to a major world trader, it also covers the still-ongoing US-China trade war and the ambitious Belt-Road Initiative, and speculates insightfully on the internationalization of the RMB. A first-class book by a first-class economist.” —Wing Thye Woo, Distinguished Professor, University of California, Davis; Research Professor, Sunway University, Kuala Lumpur

Miaojie Yu

China-US Trade War and Trade Talk

123

Miaojie Yu China Center for Economic Research (CCER), National School of Development (NSD) Peking University Beijing, China

ISBN 978-981-15-3784-4 ISBN 978-981-15-3785-1 https://doi.org/10.1007/978-981-15-3785-1

(eBook)

© Springer Nature Singapore Pte Ltd. 2020 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. This Springer imprint is published by the registered company Springer Nature Singapore Pte Ltd. The registered company address is: 152 Beach Road, #21-01/04 Gateway East, Singapore 189721, Singapore

Contents

Part I: Articles 1

2

China’s Trade Development and Opening-Up Policy Design over the Past Four Decades . . . . . . . . . . . . . . . 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Extensive Margin of Opening-Up (1978–2000) . . . . . 2.1 Tariff Reductions . . . . . . . . . . . . . . . . . . . . . . . 2.2 Economic Zones and Industrial Parks . . . . . . . . 2.3 Processing Trade . . . . . . . . . . . . . . . . . . . . . . . 3 Intensive Margin of Opening-Up (2001–17) . . . . . . . 3.1 Accession to the WTO . . . . . . . . . . . . . . . . . . . 3.2 Export Processing Zones . . . . . . . . . . . . . . . . . 3.3 Establishment of Pilot Free Trade Zones . . . . . . 3.4 New-Economy Pilot Cities Experiment . . . . . . . 4 All-Around Opening-Up . . . . . . . . . . . . . . . . . . . . . 4.1 ASEAN–China Free Trade Agreement . . . . . . . 4.2 Regional Comprehensive Economic Partnership 4.3 Belt and Road Initiative . . . . . . . . . . . . . . . . . . 4.4 Free Trade Ports Experiment . . . . . . . . . . . . . . 4.5 Greater Bay Area . . . . . . . . . . . . . . . . . . . . . . 5 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . . . . . . .

3 3 4 4 6 7 9 10 10 11 13 14 14 15 16 17 18 19

Processing Trade, Trade Liberalization, and Opening-Up: China’s Miracle of International Trade . . . . . . . . . . . . . . . 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Comparative-Advantage-Following and Processing Trade . . 3 Trade Liberalization and Firm Performance . . . . . . . . . . . . 4 Deeper Opening Up Against Financial Crises . . . . . . . . . . 5 All-Around Opening Up and Trade Globalisation . . . . . . .

. . . . . .

. . . . . .

. . . . . .

. . . . . .

. . . . . .

. . . . . .

21 21 23 25 30 33

. . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . . . . . . .

v

vi

3

4

5

Contents

Understanding the Recent Sino-U.S. Trade Conflict . . . . . . . . 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 How the Trump Administration Views the Sino-U.S. Trade Imbalance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Sino-U.S. Trade Imbalance Does not Hurt the U.S. Economy 4 Comparative Advantage Determines the Sino-U.S. Trade Imbalance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 China’s Value-Added Upgrading Is the Consequence of Economic Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Cooperation Is the Only Solution to the Sino-U.S. Trade Imbalance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

.... ....

37 38

.... ....

38 42

....

44

....

49

....

50

The Day After Tomorrow: Evaluating the Burden of Trump’s Trade War . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Overview of the Trade Relationship Between the United States and China . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.1 Bilateral Trade Relationship . . . . . . . . . . . . . . . . . . . . . . 2.2 Bilateral Trade Flow and Trade Imbalance . . . . . . . . . . . 2.3 Bilateral Trade Structure and Trade Dispute . . . . . . . . . . 2.4 Current Trade Conflicts . . . . . . . . . . . . . . . . . . . . . . . . . 3 Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Quantifying the Effects of Tariff Increases . . . . . . . . . . . . . . . . 4.1 Tariff Increases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2 Sectoral Bilateral Trade Between the United States and China . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.3 Case 1: Unilateral U.S. Tariffs with Balanced Trade . . . . 4.4 Case 2: U.S.—China Retaliatory Tariff War with Balanced Trade . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.5 Case 3: U.S.—China Retaliatory Tariff War with Ongoing Trade Imbalance . . . . . . . . . . . . . . . . . . . 5 Concluding Remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

... ...

53 53

. . . . . . . .

. . . . . . . .

57 57 58 59 61 62 62 62

... ...

63 65

...

68

... ...

68 72

The Status of China’s Market Economy and Structural Reforms: Essentials Behind the China-U.S. Trade War . . . . . . . . . . . . . . . 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 U.S.-China Trade Dispute . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Trade Liberalization and Non-tariff Barriers . . . . . . . . . . . . . . . 4 China’s Inward FDI: Achievement, Challenges, and Recent Reform . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.1 Achievement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2 Challenges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.3 Recent FDI Reform . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Leveling the Playing Field Between SOEs and Private Firms . . .

. . . . . . . .

. . . .

. . . .

73 73 74 78

. . . . .

. . . . .

79 79 80 82 83

Contents

5.1 Development of SOE and Private Firms . . . . . . . . . . 5.2 Reform for Competitive Neutrality . . . . . . . . . . . . . . 6 Further Discussion on China’s Status on Market Economy 6.1 China Is not a Currency Manipulating Regime . . . . . 6.2 Discussion on Wage Bargaining . . . . . . . . . . . . . . . . 7 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

7

8

9

vii

. . . . . .

. . . . . .

. . . . . .

. . . . . .

83 83 86 86 88 89

.. ..

91 91

.. ..

92 94

..

94

... ...

97 97

... ...

99 99

. . . . . .

Three Tasks for Building an All-Around Opening-Up Strategy . 1 A Historic Task of the New Era: Developing Free Trade Ports . 2 Key to Building a New Pattern of Increased Opening: Developing the Guangdong-Hong Kong-Macau Greater Bay Area . . . . . . . . 3 Major Work in Building a New Pattern of Increased Opening . . 3.1 Promoting the Pilot Project for the New System of Open Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . China’s Free Trade Ports: Effective Action Against the Threat of De-globalization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Theoretical Framework for the Establishment of Free Trade Ports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.1 New De-globalization Threat to the World Trade . . . . . . 3 Free Trade Ports: The Next Step in China’s Reform and Opening up . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Functional Orientation for the Construction of China’s Free Trade Ports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 International Experience and Domestic Exploration . . . . . . . . . 6 Singapore Port . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Shanghai Yangshan Free Trade Port Area . . . . . . . . . . . . . . . . 8 Comparison Between the Shanghai Free Trade Port and International Free Trade Ports . . . . . . . . . . . . . . . . . . . . . 9 Path for the Construction of Free Trade Ports in China . . . . . . Expanding Opening Up: China’s Olive Branch to Globalization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 To Further Widen Market Access . . . . . . . . . . . . . . . . . . . . . . 2 To Improve the Investment Environment for Foreign Investors 3 To Strengthen Protection of IPR . . . . . . . . . . . . . . . . . . . . . . . 4 To Take the Initiative to Expand Imports . . . . . . . . . . . . . . . .

. . . . . .

. . . 100 . . . .

. . . .

. . . .

102 103 104 106

. . . 107 . . . 114 . . . . .

Potential Impact of China–U.S. BIT on China’s Manufacturing Sectors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Literature Review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Assumptions on the Scenarios of China–U.S. BIT, Focusing on Manufacturing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 BIT’s Open Market Requirements to China’s Manufacturing Sector and Its Impacts on Relevant Industries . . . . . . . . . . . . . .

. . . . .

. . . . .

117 117 118 119 120

. . 123 . . 125 . . 126 . . 127

viii

Contents

3.1 Impacts of FDI on Domestic Firms . . . . . . . . . . . . . . . . 3.2 FDI’s Overall Impacts on Performance of Domestic Firms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.3 FDI’s Impacts on Specific Industries . . . . . . . . . . . . . . . 3.4 The Effects of Changes in Policies on Scale or Shares of FDI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Suggestions on Negotiation Strategy . . . . . . . . . . . . . . . . . . . 4.1 Make It Firm and Steadfast that China Is Serious in Joining BIT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2 Protection Measures in the Long-Run . . . . . . . . . . . . . . 4.3 Gradual Lifting Process of Protection for Certain Vulnerable Sectors . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.4 Cooperating in BIT Negotiation with the Domestic Reform . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Suggestions to Manufacturing Firms Regarding How to Face the Challenges of BIT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.1 Suggestions for Domestic Firms . . . . . . . . . . . . . . . . . . 5.2 Suggestions for Government . . . . . . . . . . . . . . . . . . . . 6 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . 127 . . . . 127 . . . . 128 . . . . 132 . . . . 135 . . . . 135 . . . . 135 . . . . 136 . . . . 136 . . . . .

. . . . .

. . . . .

. . . . .

136 136 137 137 138

10 RMB Internationalization and Belt and Road Initiative 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Literature Review . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Impacts of RMB Swap Agreements on Bilateral Trade 4 Concluding Remarks . . . . . . . . . . . . . . . . . . . . . . . . . 5 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . . . .

. . . . . . .

. . . . . . .

. . . . . . .

. . . . . . .

. . . . . . .

. . . . . . .

. . . . . . .

. . . . . . .

145 145 149 150 157 158 159

11 Exceptional Performance of Chinese Outward Direct Investment Firms . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Literature Review . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Data and Empirics . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1 Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2 Empirical Results . . . . . . . . . . . . . . . . . . . . . . 3.3 Benchmark Estimates . . . . . . . . . . . . . . . . . . . . 3.4 Alternative Measure of Firm Performance . . . . . 3.5 Robustness Checks . . . . . . . . . . . . . . . . . . . . . 4 Policy Suggestions . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . . . . . . . . .

. . . . . . . . . . . .

. . . . . . . . . . . .

. . . . . . . . . . . .

. . . . . . . . . . . .

. . . . . . . . . . . .

. . . . . . . . . . . .

. . . . . . . . . . . .

. . . . . . . . . . . .

161 161 162 163 163 165 165 166 167 170 171 171

. . . . . . . . . . . .

Contents

ix

12 Forty Years of Opening Up Has Greatly Benefited China’s Foreign Trade . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 The Remarkable Achievements of Chinese Foreign Trade . . . . . 2 From a Wider and Deeper to an All-Around Opening Up Over Four Decades . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Key Practices of Reform and Opening Up During the Past Four Decades . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1 From the Import Substitution Strategy to an Export-Oriented Strategy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2 Trade Liberalization and WTO’s Influence . . . . . . . . . . . . 3.3 Opening Up Deeper Amid the Global Financial Crisis . . . . 4 Policy Suggestions for the All-Around Opening Up Strategy . . . 13 China’s Opening-Up Policies: Achievements and Prospects . 1 Expanding the Extensive Margin of Opening, 1978–2000 . . 1.1 Setting Up Open Economic Zones and Industrial Parks 1.2 Relaxing Market Access for Foreign Direct Investment 1.3 Reducing Import Tariffs . . . . . . . . . . . . . . . . . . . . . . . 1.4 Encouraging the Processing Trade . . . . . . . . . . . . . . . 1.5 Comments on the Stage of Extensive-Margin Opening 2 Focusing on the Intensive Margin of Opening, 2001–2017 . . 2.1 Accession to the WTO . . . . . . . . . . . . . . . . . . . . . . . . 2.2 Expanding Market Access for FDI . . . . . . . . . . . . . . . 2.3 Relaxation of Outward FDI . . . . . . . . . . . . . . . . . . . . 2.4 Establishment of Pilot Free Trade Zones . . . . . . . . . . . 2.5 New-Economy Pilot Cities Experiment . . . . . . . . . . . . 2.6 Comments on the Stage of Intensive Margin of Opening Up . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Features of the All-Around Opening Up . . . . . . . . . . . . . . . 3.1 Belt and Road Initiative . . . . . . . . . . . . . . . . . . . . . . . 3.2 Free Trade Ports Experiment . . . . . . . . . . . . . . . . . . . 3.3 Greater Bay Area . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Policy Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . 173 . . 173 . . 174 . . 175 . . . .

. . . .

175 176 176 177

. . . . . . . . . . . . .

. . . . . . . . . . . . .

. . . . . . . . . . . . .

. . . . . . . . . . . . .

. . . . . . . . . . . . .

179 180 181 181 182 183 184 185 185 186 187 189 190

. . . . . . .

. . . . . . .

. . . . . . .

. . . . . . .

. . . . . . .

190 192 192 192 193 193 195

Part II: Columns and Media 14 Trade Talk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 199 1 By Li Jia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 199 15 Booming Chinese Investment a Key Factor in Fighting African Poverty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 205 16 Minor U.S. Trade Sanctions on China Possible, Experts Say . . . . . 207 17 China Slashes Tariffs on Range of Consumer Goods . . . . . . . . . . . 211

x

Contents

18 Evaluating the Burden of a U.S.-China Trade War . . . . . . . . . . . . 213 19 Sino/US Trade War Could . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 217 20 Chip Wars—Tech Rivalry Underlies U.S.-China Trade Conflict . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 219 21 Trump’s Latest Tweets Create Another Twist in U.S.-China Trade Talks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 A Controversial Firm . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Ongoing Trade Tensions . . . . . . . . . . . . . . . . . . . . . . . . . . 3 ‘We Can Bear This Kind of Loss’ . . . . . . . . . . . . . . . . . . .

. . . .

. . . .

. . . .

. . . .

. . . .

221 221 222 223

22 China Engages U.S. to Deescalate Trade War . . . . . . . . . . . . . . . . 225 23 Exporting Trade Turbulence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 227 24 Trump Threatens Tariffs on All Chinese Goods . . . . . . . . . . . . . . . 231 25 US Firms Express Optimism in China’s Import Expo . . . . . . . . . . 233 26 China-US Deal Likely by Mid-Year: China Advisors . . . . . . . . . . . 235 1 G20 Meeting? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 235 27 Extension Over Concessions for China . . . . . . . . . . . . . . . . . . . . . . 237 1 No Surprise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237 2 Deadline . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 238 28 The American Consumers Are Going to Pick up the Bill as Consumer Goods Become the Next Target . . . . . . . . . . . . . . . . . 239 29 Depreciation Was Not Deliberated, but Rather a Result of ‘Market Panic’ Triggered by the US . . . . . . . . . . . . . . . . . . 1 Currency War . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 US Declaration of China as Currency Manipulator Roils World Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 China Exchange Rate Drop Could Continue in 2020 to Offset US Tariff Impact . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 US Stocks Plummet as China Announces Two-Pronged Trade War Retaliation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 China Suspends Purchases of US Farm Products in Retaliation for Tariffs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . 241 . . . 241 . . . 241 . . . 242 . . . 242 . . . 243

30 Yuan Depreciation to Slow, May Reverse . . . . . . . . . . . . . . . . . . . . 245 31 Late-September China-US Meeting Likely . . . . . . . . . . . . . . . . . . . 247 32 Speaks at the Yenching Academy . . . . . . . . . . . . . . . . . . . . . . . . . . 249 33 China Will Never Manipulate Its Currency . . . . . . . . . . . . . . . . . . 253

Contents

xi

34 A Deal Between China and the US Could Feasibly Be Signed by the End of December . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 255 1 Enforcement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 255 35 Commented on the Third RCEP Summit 1 Signing Next Year . . . . . . . . . . . . . . . . 2 Largest Win-Win Agreement . . . . . . . . 3 Counter Protectionism . . . . . . . . . . . . .

. . . .

. . . .

. . . .

. . . .

. . . .

. . . .

. . . .

. . . .

. . . .

. . . .

. . . .

. . . .

. . . .

. . . .

. . . .

. . . .

. . . .

. . . .

. . . .

. . . .

257 257 258 259

36 China’s Faster Growth Will See Yuan Go up to 6.0 Against Dollar . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 261 37 RRR Cut to Reduce Financing Problems for Companies . . . . . . . . 263 38 China Readies Washington Trip, Phase 1 Signing . . . . . . . . . . . . . 265 1 Fodder, Pork Imports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 265 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 267

Part I

Articles

Chapter 1

China’s Trade Development and Opening-Up Policy Design over the Past Four Decades

China’s opening-up in the past four decades has gone through three waves: the extensive margin of opening-up (1978–2001), the intensive margin of opening-up (2001–2017), and all-around opening-up (since 2017). This paper explores these three stages of the country’s economic reform. China’s gains from trade have been inspired by different economic factors. Before the turn of the century, the large trade volume was due to the realization of comparative advantage based on the country’s factor endowment. However, after its accession to the World Trade Organization, China’s gains from trade have been due, in large part, to the realization of economic scale effects associated with the larger market.

1 Introduction China began to reform its economy in 1978. In the past four decades, reform and opening-up have been two essential keywords for understanding China’s economic development. Economic reform played a more important role than opening-up in the first two decades. Opening-up, characterized by international trade, is widely believed to have been more substantial in boosting economic growth in the past two decades, or more precisely, since 2001 when China acceded to the World Trade Organization (WTO). Due to its opening-up policies, China has become the largest trading country in the world. In 2017, its foreign trade registered RMB 27.79 trillion (or equivalently US$4.28 trillion), with exports of RMB 15.33 trillion and imports of RMB 12.46 trillion. Since 2009, China has replaced Germany as the largest exporter in the world. In addition, since 2015, China has replaced the United States as the largest importer as well. In the past four decades, China’s foreign trade volume has increased 204-fold, whereas its gross domestic product (GDP) has only increased 34-fold. In this regard, China has already successfully exhibited a miracle of foreign trade. The realization of this foreign trade miracle can be classified in three steps: the extensive margin of opening-up (before 2001), the intensive margin of opening-up © Springer Nature Singapore Pte Ltd. 2020 M. Yu, China-US Trade War and Trade Talk, https://doi.org/10.1007/978-981-15-3785-1_1

3

4

1 China’s Trade Development and Opening-Up Policy Design …

(2001–2017), and all-around opening-up (since 2017) after China’s Communist Party (CCP) announced the establishment of a new era of all-around opening up in China in its 19th National Congress. The driving forces of China’s foreign trade in each phase have been substantially different. Particularly, the first phase of the surge in foreign trade before the new century was due to comparative advantage based on the country’s factor endowment. China is a labor-abundant country and its labor costs are relatively cheap. Accordingly, China exported labor-intensive products and served as the largest ‘world factory.’ However, since China acceded to the WTO, the cost of labor has been increasing significantly and no longer exhibits cost-saving advantages compared with many other countries, like Vietnam and other East Asian countries. Indeed, the most fundamental driving force of China’s export boom is the realization of increased market size à la Krugman’s (1979) increasing returns-to-scale. This scale effect has been more pronounced in recent years after China initiated its all-around trade liberalization and opening-up. The rest of the paper is organized as follows. Section 2 explores the historical development of the extensive margin of the opening-up process. Section 3 reviews the dynamic evolution of the intensive margin of opening-up. Section 4 examines the recent development of all-around trade liberalization and opening-up. Section 5 takes a step forward to explore the economic rationale of the three phases of China’s opening-up policy design and concludes.

2 Extensive Margin of Opening-Up (1978–2000) China’s opening-up strategy before its accession to the WTO included three important actions: reducing tariffs, setting up special economic zones and other industrial parks, and promoting processing trade. This section describes these economic reforms and discusses their impacts.

2.1 Tariff Reductions Before the economic reform, China adopted the import substitution strategy by setting high import tariffs and other nontariff barriers against foreign products. In 1992, the 14th Congress of the CCP announced that it would set up a market economy. Since then, China began actively cutting its import tariffs. The simple import tariff in early 1992 was still 42% and was reduced to 35% in 1994 during the WTO Uruguay Round negotiations (Fig. 1). During the next 3 years, China cut its import tariffs another 50% or so. At the end of 1997, the simple import tariff was reduced to around 17%. The most important reason for taking such a big step in opening-up was that China hoped to accede to the WTO as soon as possible; in 1994, China was still only an observatory member, rather than a formal member, of the WTO.

2 Extensive Margin of Opening-Up (1978–2000)

5

Fig. 1 China’s simple average import tariffs. Source World Bank

After its accession to the WTO, China’s simple import tariff was reduced from around 15% to around 10% in 2006. There are two types of import tariffs: output tariffs, which govern the import competition faced by industries or firms, and input tariffs, which capture the cost-saving effects faced by sectors or firms. China’s industrial output tariff was reduced from 21.4% in 2000 to 10.27% in 2006, whereas the manufacturing firm-specific output tariff was reduced from 15.57 to 7.46% (Yu 2015). Using import values as weights to measure input tariffs in each industry, industrial input tariffs were reduced from 15.73% in 2000 to 7.71% in 2006 (Chen et al. 2017). When China reduces its import tariffs, its major trading partners, which are mostly WTO members, cut their import tariffs against Chinese products as well. Since a firm could export multiple products to different countries, it is important to construct firmspecific foreign external tariffs for Chinese manufacturing firms (Lileeva and Trefler 2010; Yu 2015). Firm-level foreign external tariffs were reduced only from 7.71% in 2000 to 6.90% in 2005. The reason why firm-specific foreign tariffs were not cut much was that China’s most important export destinations were high-income countries. Such countries usually already had low import tariffs (Rodriguez-Lopez and Yu 2017). Trade liberalization has been very significant for the Chinese economy. To understand the country’s economic development, it is essential to understand the realization of firm productivity, since ‘productivity is not everything, but almost everything’ by Paul Krugman. It has been widely accepted that trade liberalization fosters firm productivity. In the past decade, trade economists have sought to understand which tariff reductions contribute the most to firm productivity. Using Indonesian firm-level data, Amiti and Konings (2007) find that input trade liberalization (i.e. the cost-saving effect) has a higher impact on firm productivity than output trade liberalization (i.e. the import competition effect). Particularly, the effect of input tariff cuts on firm

6

1 China’s Trade Development and Opening-Up Policy Design …

productivity is twice higher than that of output tariff cuts. Similarly, Topalova and Khandelwal (2011) find that the impact of input tariff cuts on Indian firm productivity is around nine times higher than that of output tariff cuts. Yu (2015) also finds that input trade liberalization plays an important role in boosting firm productivity for ordinary firms, whereas the impact is the opposite for non-ordinary (i.e. processing) firms. This is because processing firms in China enjoy special tariff treatment in the sense that they are exempt from the import duty. Overall, trade liberalization has contributed to around 14.5% of Chinese firm productivity growth in the new century.

2.2 Economic Zones and Industrial Parks The establishment of China’s special economic zones was one of the most important implementations of the opening-up policy. Before 2000, the establishment of the special economic zones can be classified in three waves. The first wave was the adoption of four cities as the first special economic zones, or the ‘point’ phase. In early 1980, the four cities chosen were Shenzhen, Zhuhai, Shantou in Guangdong, and Xiamen in Fujian province. Shenzhen was chosen because of its excellent geographic location—it is a small village near Hong Kong. A similar rationale applies to Zhuhai, which is a small town located along the western Pearl River near Macau. Shantou was chosen because of its strong network of connections with Chinese immigrants in East Asian countries. Similarly, Xiamen was chosen because it is close to Taiwan province. The second wave of the establishment of economic zones included many coastal cities from Dalian, a northern coastal city in Liaoning province, to Beihai, a southern coastal city in Guangxi province. The cities are all connected to become a ‘line.’ Indeed, this line phase included several steps of the opening-up. (1) In 1984, the Chinese government set up 14 coastal cities, including Dalian, Qinhuangdao, Tianjin, Yantai, Qingdao, Lianyungang, Nantong, Shanghai, Ningbo, Wenzhou, Fuzhou, Guangzhou, Zhanjiang, and Beihai. (2) Shortly after that, China established 11 new national economic development zones, including Dalian, Qinhuangdao, Tianjin, Yantai, Qingdao, Lianyungang, Nantong, Ningbo, Fuzhou, Guangzhou, and Zhanjiang. These 11 cities coincide with the original 12 coastal cities, because only a small area in each city, rather than the entire city, was opened in each step of the reforms. Thus, the special economic zones and industrial parks were not overlapping. (3) In 1985, the Chinese government established three special economic deltas: Pearl River, Yangtze River, and South Min River. (4) In 1988, China opened up Jiaodong Peninsula (in eastern Shandong province) and Liaodong Peninsula (east of Liaoning province). Perhaps the most important milestone was opening up the whole Hainan island, which is the second largest island after Taiwan. (5) In 1991, the government set up four bonded areas in Waigaoqiao of Shanghai, Futian and Shatoujiao of Shenzhen, and the Port of Tianjin. Thus far, China has successfully extended its economic zones from a few points to a whole line of cities along the east coast (Map 1).

2 Extensive Margin of Opening-Up (1978–2000)

7

Map 1 China’s industrial zones. Source Author’s compilation

The third wave of the establishment of economic zones extends the zones and parks from the cities along the east coast to the central and even western provinces. Particularly, the government set up 25 high-tech industrial development zones in Shenyang, Tianjin, Wuhan, and Nanjing. In short, in 1992 China had already established six special economic zones (the first four zones, Hainan, and Pudong in Shanghai), 54 national-level economic and development zones, 53 high-tech industrial parks, and 15 bonded zones (Naughton 2018). All these zones—special economic zones, economic deltas, economic and development zones, and even high-tech development zones—had very similar policy designs. Particularly, foreign firms located in the zones were exempt from corporate tax in their first 3 years. In their fourth and fifth years, they had to pay a corporate tax rate of only 17%, which was half the tax rate on Chinese domestic firms. This policy lasted for around three decades. After 2012, foreign firms had to bear the identical 25% corporate tax rate as domestic firms. In addition, wholly owned foreign firms and subsidiaries were permitted in all types of zones. Recent studies, such as Lin et al. (2018), recognize the positive impacts of the establishment of the industrial parks and economic zones on manufacturing firm productivity.

2.3 Processing Trade Processing trade is a key for understanding China’s trade development over the past four decades. As is mentioned in Dai et al. (2016), the iPhone is a perfect example of

8

1 China’s Trade Development and Opening-Up Policy Design …

China’s processing trade. Foxconn, a famous iPhone assembler in Shenzhen, imports intermediate components of smart phones from Japan, Korea, and the United States. After producing the final products domestically, Foxconn exports back to the United States and other foreign markets. There are more than 16 types of processing trade in China. Two of the types are most important: processing with assembly and processing with imports. Processing with assembly requires local processing firms to sell all their products to the same foreign firms that provide the intermediate inputs. This was the most popular type of processing trade in the 1980s. By contrast, firms engaged in processing with imports can sell their final goods to foreign firms different from their original imported intermediates suppliers. This type of processing trade became increasingly popular after the 1980s. Since the mid-1990s, processing trade has accounted for more than half of China’s total trade (Tian and Yu 2012). After the global financial crisis in 2008, the proportion of processing trade has decreased, due in large part to the incremental labor cost in China. However, processing trade still accounted for around one-third of China’s total trade in 2017 (Fig. 2). Processing trade has played a positive and important role in China’s economic development over the past four decades. First, processing trade created huge job opportunities in the manufacturing sectors. However, different from ordinary exporters, processing exporting firms are less productive, as firms are not required to have any technology to engage in processing activities like assembly. On average, processing exporters are even less productive than non-exporters. Accordingly, Chinese exporting firms are less productive than non-exporting firms. This situation is

Fig. 2 China’s processing trade. Source China’s Customs Yearbook (various years)

2 Extensive Margin of Opening-Up (1978–2000)

9

Fig. 3 Productivity of Chinese exporting firms. Source Dai et al. (2016). TFP = total factor productivity

known as the ‘puzzle’ of Chinese exporting firms. It is due, in large part, to processing trade accounting for half of China’s total exports. Processing firms are the least productive compared with ordinary exporters and non-exporters (Dai et al. 2016) (Fig. 3). Industries that are intensively engaged in processing trade are labor-intensive. Processing trade thus absorbs many workers in those industries. Particularly, China had around 780 million workers in total in 2008. Among these, there were around 103 million manufacturing workers and 231 million workers in secondary industries. The four major processing industries included household appliances; toys; clothing, footwear, and hats; and leather goods. The four industries employed 13.2 million workers in 2009 and 16.2 million workers in 2014. Second, processing trade has contributed to China’s deep integration into the global division of labor. Accordingly, China has been a non-substitutable ‘world factory.’ Of course, this also implies that China naturally has maintained a high global trade surplus. Indeed, around two-thirds of China’s trade surplus is generated from its processing trade.

3 Intensive Margin of Opening-Up (2001–17) Since the turn of the new century, China has focused more on its intensive margin of opening-up. That is, China is not very much interested in the extensive margin of its opening-up, like the expansion of various special zones or industrial parks. Instead, it is more interested in exploring new opening-up policies. In the new century, before 19th Congress of the CCP, four important events characterized the features of the intensive margin: accession to the WTO, establishment of export processing zones (EPZs), establishment of the free trade pilot zone, and new-economy pilot cities.

10

1 China’s Trade Development and Opening-Up Policy Design …

3.1 Accession to the WTO China was one of the 23 founding members of the General Agreement on Tariffs and Trade (GATT), which was established in 1947. After China gained political independence in 1949, mainland China lost its membership and had to re-apply to join this world’s largest multilateral agreement. China and Hong Kong formally applied to join GATT in 1986. It turned out that it was a long March for China’s accession to the WTO. After many rounds of bilateral and multilateral negotiations, in 2001 China eventually joined the WTO, the successor of GATT, in 1994, as its 143rd member. It took China 15 years to accede to the WTO. By contrast, Hong Kong joined the GATT immediately in 1986. Why did it take so long for China to accede to the WTO? Certainly many factors mattered, such as the size of the economy, time of application, and status of the market economy. It takes more time for a large country to negotiate. It also makes sense that an applicant must negotiate with more existing WTO members if this applicant applies late. And whether an applicant’s economy is a market economy matters for existing members to accept it. However, Wong and Yu (2015) argue that the duration of the accession process also depends on whether the new applicant has a similar political regime as most of the existing and powerful members. Particularly, if an applicant has a similar political regime as the United States, it is much easier and hence takes less time for the country to join the GATT/WTO. Nevertheless, China’s accession to the WTO has brought huge mutual benefits to China and the rest of the world. Since the turn of the century, especially after 2004, the cost of labor in China has increased dramatically and the country’s population dividend has shrunk fast. Compared with many East Asian countries, China no longer has significant comparative advantage on the labor-intensive margin. A significant part of China’s foreign markets has been taken over by countries such as Vietnam and Bangladesh. Thanks to the accession to the WTO, China has established trade relations with many countries and enjoys the scale effects of a large market. Simultaneously, Chinese firms have been able to realize greater profits by lowering their fixed costs with the large market. As a result, China has maintained its position as the world’s factory in the new century. By the same token, China’s accession to the WTO has been beneficial for the rest of the world, which has enjoyed cheaper products made by China.

3.2 Export Processing Zones Just before China’s accession to the WTO, the government decided to establish EPZs to promote processing trade. Since then, China has set up more than 60 EPZs. Different from the earlier special economic zones and industrial parks, such EPZs were spread all over the country (Map 2). They are located not only in eastern coastal cities, but also western inland cities, like Urumchi, Xinjiang province. In terms of

3 Intensive Margin of Opening-Up (2001–17)

11

Map 2 China’s export processing zones. Source Author’s compilation

trade volume, the Kunshan zone, Jiangsu province, is the largest EPZ. Only processing firms are allowed to enter the EPZs. They also enjoy special tariff treatment. Particularly, firms in the EPZs are treated as ‘inside the territory but outside the customs,’ as they are exempted from import duty. Recent studies, such as Fernandes and Tang (2012) and Lin et al. (2018), find that firms in the EPZs have spillover effects on their neighboring firms.

3.3 Establishment of Pilot Free Trade Zones In 2013, the government set up a pilot free trade zone (FTZ) in Shanghai. The area is not large (i.e. its initial area is only around 29 km2 ), but its economic impact is potentially huge. The whole landscape of the establishment of the pilot FTZ can be summarized as 1 + 3 + 7 in three steps. First, the government set up the first pilot FTZ in Shanghai in September 2013. Second, it was extended to three other FTZs in large coastal provinces in April 2015: Guangdong, Tianjin, and Fujian. Third, in September 2016, the government set up seven more coastal and inland pilot FTZs in Liaoning, Shaanxi, Henan, Hubei, Chongqing, Sichuan, and Zhejiang (Map 3). The objective of the pilot FTZs is to copy and paste to other non-FTZ places if those places are ready to perform the reform.

12

1 China’s Trade Development and Opening-Up Policy Design …

Map 3 China’s pilot free trade zones and cities. Source Author’s compilation

Based on the country’s earlier experiment with special economic zones, the government implemented four roles for the pilot FTZs. First, the pilot FTZs aim to promote further trade and investment facilitation. More or less, this is consistent with the development of EPZs. For goods within the pilot FTZs, the government requires ‘release the first line, but hold up the second line.’ The idea is that the imported intermediate goods used in the FTZs will be tariff exempted (i.e. released from the first line), but the final products that use such intermediate inputs cannot be sold outside the zones to China’s domestic market (i.e. hold up the second line). Second, the pilot FTZs aim at promoting China’s ‘negative list’ investment mode. Different from its previous ‘positive list,’ the new negative list investment mode has fewer regulations or restrictions on foreign investment in China. If the products or sectors are listed, foreigners are not allowed to invest in those areas. In other words, foreigners may invest in anything not shown on the list. This gives foreign investors huge room to invest in new industries or sectors. It turns out that this policy design has been the most successful policy reform. As it was so successful in all 11 FTZs, in 2018, the Chinese government decided to spread this policy to the whole country. Third, the pilot FTZs aim to promote a further push to China’s financial reform. Particularly, the FTZs aim to promote financial innovation with convertible capital projects and offer more financial services. It turns out that this reform so far has had only limited effects. It is not difficult to understand its limited impact, as FTZs account for only a tiny proportion of China’s area. Different from the trade reform,

3 Intensive Margin of Opening-Up (2001–17)

13

the financial reform indeed cannot be separated clearly inside and outside the FTZs. Thus, it is difficult to perform a financial experiment in a small area and then copy it to the rest of the country. Fourth, the pilot FTZs require local governments to reduce bureaucratic procedures and simplify the process of doing business within the zones. Particularly, the FTZs emphasize the implementation of after-event supervision rather than before-event approval.

3.4 New-Economy Pilot Cities Experiment Different from the establishment of the pilot FTZs, the opening-up via the neweconomy pilots in 12 cities is less well-known. In 2015, the government decided to choose 12 cities located in five city-groups as well as some coastal cities to experiment with the so-called ‘new-economy pilot.’ This experiment has lasted for 2 years but could be extended based on the performance of this new reform. The experiment is being conducted by local municipal governments, but also the Ministry of Commerce and National Development and Reform Council provides advice. Jinan, the capital of Shandong province, is the largest among the 12 cities. Zhangzhou, a coastal city in Fujian province, was chosen mainly due to its strong connections with Taiwan province. Fangchenggang, a coastal city in Guangxi province, was chosen because it is the neighbor of one of the special economic zones in Vietnam. The government hopes to develop the bilateral border trade by setting up this new-economy zone. The other eight cities are located around China’s five major metropolitan areas. Particularly, Dalian, in Liaoning, and Tangshan, in Hebei, are the two northern cities closest to the Beijing–Tianjin–Hebei metropolitan area. In addition, Xi’an was chosen because it is the largest city in Northwestern China. Chongqing was chosen because it is one of the core cities among the Chengdu–Chongqing mega cities. By the same token, Wuhan and Nanhang were chosen because they are two large cities in Central China. Finally, Pudong, in Shanghai, and Suzhou, in Jiangsu, are connected to the Yangtze River Delta economic belt. The objectives of this pilot reform are to establish a new mechanism for market allocation of resources, form a new model of economic operations and management, form a new pattern of openness in all directions, and create new advantages in international cooperation and competition. Different from the FTZs, the central government does not provide any specific policies to all the new-economy zones. Instead, all the cities can ask the central government to authorize any kind of special policy treatments, if they find that such policies are necessary and important for them to develop their local economy. The experiment of these new-economy zones focuses on six areas. First, it aims at exploring the new management mode of the government. Second, it aims at exploring the coordination of various industrial parks. Third, it hopes to explore new ways to encourage foreign direct investment. Fourth, it aims at promoting high-quality

14

1 China’s Trade Development and Opening-Up Policy Design …

exports of domestic products. Fifth, it seeks significant improvement of financial services. Sixth, the zones should focus on promoting all-around opening-up in the regions. After 2 years of the experiment, the independent evaluation panel led by the National School of Development at Peking University is satisfied with the 12 cities’ new-economy reforms. Particularly, the panel recognized that the reforms have successfully improved local economic development and been helpful in the supply-side structural reform. The reforms are also helpful in promoting the One Belt, One Road initiative.

4 All-Around Opening-Up In 2017, the CCP’s 19th Congress proposed that China will aim to promote allaround opening-up. Indeed, this all-around opening-up strategy is based on China’s previous opening-up milestone achievement of the Belt and Road Initiative (BRI) and the Association of Southeast Asian Nations (ASEAN)–China Free Trade Agreement (ACFTA) and its successor, the Regional Comprehensive Economic Partnership (RCEP). This section reviews these important events and describes China’s free trade ports and the Greater Bay Area.

4.1 ASEAN–China Free Trade Agreement China and 10 ASEAN countries established the ACFTA in 2010. It is the largest free trade area (FTA) in the world in terms of population and the third largest in terms of GDP. It took around a decade for China and the ASEAN countries to establish this FTA. In 2002, both sides signed the framework agreement to establish the ACFTA in 2010. Two years later, China and six of the ASEAN countries (i.e. Singapore, Brunei, Indonesia, Malaysia, Thailand, and Vietnam) reached the early harvest agreement to set a zero tariff for more than 600 products mutually in 2004. At the end of 2015, China and most of the ASEAN countries had already implemented zero tariffs for most of their tradable goods. Inspired by Trefler (2004), Wang and Yu (2018) find that the establishment of the ACFTA has had a significant positive effect on the Chinese economy. Particularly, they analyze the short-term (employment and wage) and long-term (productivity) economic effects of tariff reduction for Chinese enterprises during the important establishment period of the ACFTA from 2001 to 2007. First, the establishment of the FTA had positive short-term economic effects on Chinese firms due, in large part, to the increased use of capital goods and complementarity between capital and skilled workers. Second, China’s import tariff reductions had a weak negative effect on China’s productivity. Third, overall China experienced welfare gains from the establishment of the ACFTA, as trade creation was greater than trade diversion.

4 All-Around Opening-Up

15

These findings are broadly consistent with Trefler’s (2004) findings in the context of the North American Free Trade Agreement. Meanwhile, Yu and Gao (2018) find that, under the framework of the ACFTA, the ASEAN countries and China have made headway in trade and investment facilitation and infrastructure cooperation, which in turn has created more job opportunities and increased regional welfare. As a result, the ACFTA is found to have reduced the poverty rate in the ASEAN countries, especially the low-income ASEAN countries (i.e. Cambodia, Laos, Myanmar, and Vietnam).

4.2 Regional Comprehensive Economic Partnership The ACFTA is not the ultimate goal of the ASEAN countries and China. Instead, both sides aim to enlarge the regional free trade agreement. The goal is to cover all 16 countries in the Asia-Pacific region, which includes the 10 ASEAN countries and six other countries (China, Japan, Korea, India, Australia, and New Zealand). This is the so-called RCEP, which can be regarded as a high-profile Asian FTA in the new century. The objective of the RCEP is to build a modern, comprehensive, high-quality, and mutually beneficial economic partnership agreement and establish an open trade and investment environment in the region. It aims to facilitate the expansion of regional trade and investment and contribute to global economic growth and development. During the 19th ASEAN Summit held in November 2011, the RCEP was introduced by ASEAN leaders. RCEP negotiations were formally launched in November 2012 at the ASEAN Summit in Cambodia. The 22nd Round of negotiations was held in Singapore from April 28 to 8 May 2018. Prospective RCEP member states account for a population of 3.4 billion, with total GDP of US$21 trillion, around 30% of global GDP. The combined GDPs of China and Japan make up more than half that amount. Once it is signed, the RCEP will be the world’s largest trade bloc. RCEP negotiations cover the following areas: trade in goods, trade in services, investment, economic and technical cooperation, intellectual property, competition, dispute settlement, e-commerce, small and medium-size enterprises (SMEs), and other issues. In addition, the RCEP recognizes the importance of being inclusive, especially to enable SMEs to leverage the agreement and cope with the challenges arising from globalization and trade liberalization. SMEs constitute a significant share of the business establishments across all RCEP participating countries and are important for every country’s economic development. At the same time, the RCEP is committed to providing fair regional economic policies that mutually benefit ASEAN and its FTA partners.

16

1 China’s Trade Development and Opening-Up Policy Design …

4.3 Belt and Road Initiative The BRI, which was initiated by the Chinese government in 2013, is devoted to improving regional cooperation and connectivity on a transcontinental scale. The initiative aims to strengthen infrastructure, trade, and investment links between China and the other BRI countries. Currently, 64 countries are actively involved in the BRI. These include 10 ASEAN countries, 18 countries in Western Asia, 8 in South Asia, 5 in Central Asia, 7 in the Commonwealth of Independent States, and 16 in Central and Eastern Europe. The economic scale of the BRI is large. Even excluding China, which accounts for one-sixth of world’s population and around 10% of world GDP, the BRI trade bloc accounts for more than two-fifths of the world’s population and nearly a fifth of world GDP. According to the World Bank’s estimates, the BRI trade bloc also accounts for around 75% of known energy reserves. Moreover, bilateral trade between other BRI economies and China accounts for more than one-quarter of China’s total exports of US$2 trillion. The scope of the initiative is still taking shape—recently, the BRI has been interpreted to be open to all countries as well as international and regional organizations. The BRI consists primarily of the overland Silk Road Economic Belt, linking China to Central and South Asia and onward to Europe, and the Maritime Silk Road, linking China to the nations of Southeast Asia, the Gulf countries, North Africa, and on to Europe. Regarding bilateral trade and investment, China’s trade with its partners located on the Maritime Silk Road, like the ASEAN 10 countries, is much larger than that with those located on the overland Silk Road Economic Belt. In addition to trade and foreign direct investment, the BRI also concentrates on infrastructure projects. As one of the largest infrastructure and investment projects in history, the BRI addresses the ‘infrastructure gap’ and thus has the potential to accelerate economic growth across the involved countries. The initiative calls for integration of the countries into a cohesive economic area through building infrastructure, increasing cultural exchanges, and broadening trade and investment. The BRI indeed is financially strongly supported by the Asian Infrastructure Investment Bank (AIIB), led by China and the Silk Road Fund. The AIIB was first proposed by China in October 2013. It is a development bank dedicated to lending for infrastructure projects. As of 2015, China announced that more than RMB 1 trillion (US$160 billion) of infrastructure projects were in planning or construction. The Silk Road Fund was first announced in November 2014 by China. As a fund, its role is to invest in businesses rather than lend money for projects. Clearly, AIIB and the Silk Road Fund contribute to fostering economic connectivity within the BRI framework. Recent studies, like Zhang et al. (2018), also find evidence that the BRI indeed promotes the internationalization of the renminbi.

4 All-Around Opening-Up

17

4.4 Free Trade Ports Experiment The notion of free trade ports was first brought up in a report to the 19th National Congress of the CCP. Chinese President Xi Jinping explicitly pointed out that the country will allow more freedom to reform the pilot FTZs and explore the establishment of free trade ports. As introduced by Tian et al. (2018), a free trade port is a port area within the territory of a country or region that is not subject to the usual customs control, with free access to overseas goods and funds. The main feature of a free trade port is that, from the perspective of administrative supervision, it is outside the customs jurisdiction of the country. A free trade port has the features of a port and an FTZ, with many trade-related functions, including product processing, logistics, and warehousing. But it is a more open platform than an FTZ. Practically, the construction of free trade ports will help FTZs advance toward the goal of being a more transparent institutional environment, like Singapore and Hong Kong. Meanwhile, breakthroughs in the areas of trade facilitation measures, ship fuel prices, financial support, customs supervision, and inspection and quarantine are necessary for free trade ports. As a result, free trade ports will be able to respond better to the profound changes in the global environment. The most successful international free trade ports can be used to identify some major common characteristics. First, greater trade facilitation and an efficient legal system in a free trade port create higher mobility of labor and capital, attracting a large amount of transit shipments and multimodal transportation. Second, most international free trade ports have undergone industry and trade upgrading and have good financial, logistical, and legal systems, allowing them to develop various types of trade. Third, free trade ports are not only logistics and transportation centers, but also headquarters economies. Fourth, the development of free trade ports is based on the industry structure of the surrounding areas. Finally, the administrations of free trade ports are empowered by central governments. Compared with international free trade ports, there is still much room for China to improve in the construction of its free trade ports, including attracting trade, talent, and finance. To begin, it is necessary to improve the convenience for businesses engaging in trade in the ports. For example, a secure and effective electronic customs clearance system is needed to speed up the integration of customs and simplify its procedures. Furthermore, developing a more livable environment and better services for businesspersons and international talent is a necessary step for free trade ports to improve the fluidity of personnel as well as the ability to attract talent. Last but not least, the ports should continue to adhere to the relevant policies on openness and improve efficiency in cross-border foreign exchange settlement. All these measures will support re-export trade financially, reduce trade risks for enterprises, and encourage more international companies to establish headquarters in the free trade ports.

18

1 China’s Trade Development and Opening-Up Policy Design …

4.5 Greater Bay Area As discussed in Yu (2018c), the 19th CCP report pointed out ‘promoting the formation of a new pattern of all-around opening-up.’ If the BRI and RCEP construction are treated as the key content of the new pattern of all-around opening-up, the Guangdong–Hong Kong–Macau Greater Bay Area (GBA) indeed is an important domestic carrier of the BRI. Thus, the construction of the Guangdong–Hong Kong–Macau GBA is the most urgent task of China’s opening-up. The GBA includes nine municipal areas, Hong Kong, and Macau. The nine municipal cities are on the east and west banks of the Pearl River: Shenzhen, Dongguan, Huizhou, Guangzhou, Foshan, Jiangmen, Zhaoqing, Zhongshan, and Zhuhai. In this sense, the GBA coincides with the Pearl River Delta, which is identified as the best economic development zone in China, along with the Yangtze River Delta. So far, the detailed development scheme has not been formally released by the Chinese central government. But it is widely believed that development of GBA should focus on the following perspectives. First, it is essential for the GBA to focus on manufacturing industries rather than services industries only. As the world’s largest ‘world factory,’ China’s strong manufacturing base can effectively avoid unsteady and low economic development. Today, Guangdong province, where the GBA is located, accounts for one-third of the country’s exports. The coordinated development of the three industries—manufacturing, services, and finance—is the guarantee of China’s sustainable economic development. To build the Guangdong–Hong Kong–Macau GBA, the real economy and the financial economy should be combined, focusing on the real economy. The services industry can play an auxiliary role to boost the GBA economy. The second important task for construction of the GBA is to focus on innovation. Today, China is transforming from a manufacturing power to an innovation power. The Guangdong–Hong Kong–Macau GBA should play a key role in the construction of an innovative country. Indeed, Shenzhen, one of the four core cities in the GBA, has already become the capital of China’s innovation hub. The research and development (R&D) intensity of Shenzhen, defined as R&D over firm sales, was as high as 4.1%, higher than the 2.6% in the Guangdong–Hong Kong–Macau GBA and 2.4% in Organisation for Economic Co-operation and Development countries. The third objective is to achieve institutional innovation. It is interesting that the GBA enjoys the regional system features of ‘1 + 2 + 3 + 4.’ That is, one country, two systems (socialism in mainland China and capitalism in Hong Kong and Macau), three different customs (Mainland China, Hong Kong, and Macau), and four core cities located in the GBA (Guangzhou, Shenzhen, Hong Kong, and Macau). China’s manufacturing development is mixed with its industrial clusters. As shown in Map 4, among China’s current industrial clusters, almost every industrial prefectural city has its own dominant industry with strong competitive advantage. Thus, similar to other regional development, it is essential for cities in the GBA to develop that are industries consistent with their own comparative advantages based on their factor endowment and economic structure. For instance, Hong Kong certainly is an

4 All-Around Opening-Up

19

Map 4 China’s industrial clusters. Source Compiled by Lifang Co. Ltd.

international finance center, international trade center, and international services center. As the capital of Guangdong province, Guangzhou should work hard to become a cultural center, transportation hub, and trade center. Shenzhen can be classified as the R&D and innovation center. Macau, along with its neighbor, Zhuhai, and the western inland city Zhaoqing, can be identified as a tourism city and services center. Finally, the other five cities—Dongguan, Huizhou, Foshan, Zhongshan, and Jiangmen—should make every effort to become high-end manufacturing centers. Fourth, the GBA should pay more attention to its ecological environment. Similar to the Xiongan New Area, the Guangdong–Hong Kong–Macau GBA is identified as a national strategy as well as a millennium plan. A good ecological environment is one of the guarantees for sustainable economic development. Compared with the other inland areas, the current ecological environment of the GBA is in good shape according to the China Geological Survey. Therefore, it is important for local governments in the GBA to maintain the good ecological environment.

5 Conclusions This paper has described China’s international trade development and opening-up policy design over the past four decades since the country began its economic reform.

20

1 China’s Trade Development and Opening-Up Policy Design …

Overall, there have been three waves of the opening-up policy design: extensive margin, intensive margin, and all-around opening-up. It is essential to understand the most important driving forces of China’s international trade over the past four decades. As argued in the paper, China’s labor cost has been increasing over the past several years. Although the cost of labor is still lower than that in developed countries such as the United States, European Union, and Japan, China’s labor cost is increasing. This has been especially true since the global financial crisis when China surpassed the Lewis turning point. China’s growing role in international trade before the country’s accession to the WTO was driven mainly by the realization of comparative advantage based on cheap labor. This was especially true for labor-intensive industries, where the cost of labor cost is one of the most important input factors. Moreover, cheap labor, to some extent, affected the incremental exports of machinery and transport equipment. This is because China’s foreign trade in machinery and transport equipment is mainly conducted through processing trade, which essentially takes advantage of the low cost of labor. By contrast, after the global financial crisis, China’s international trade collapsed, possibly due to weak foreign demand and export credit constraints (Feenstra et al. 2014). The volume of foreign trade returned to its previous level in 2013. In 2009, China became the world’s largest exporter. The main driving force of China’s incremental international trade is, in large part, the realization of scale economics with the large international market, according to the increasing returns-to-scale theory of Krugman (1979) and Melitz (2003). One piece of evidence of this is that the proportion of processing trade keeps decreasing whereas total trade volume is increasing. Thus, the traditional comparative advantage theory cannot explain this new phenomenon. In this paper, I have abstracted away China’s development of inward and outward foreign direct investment, due to the space constraint. Yes, this aspect of the country’s development is equally important for understanding the whole landscape of China’s opening-up policy design. I leave the topic for future research.

Chapter 2

Processing Trade, Trade Liberalization, and Opening-Up: China’s Miracle of International Trade

Understanding the role of international trade is the key to understanding China’s miraculous economic growth. This paper reviews the literature on international trade in the context of China, with a focus on processing trade, trade Liberalization, and firm performance to provide a better understanding of China’s experience opening up over the past 4 decades.

1 Introduction China began to reform its economy in 1978, and that economy has continued to grow rapidly over the past 4 decades. That such a large economy can achieve such long-term sustainable development has been seen as a miracle. One of the obvious features of this miracle is that China has participated deeply and extensively in the global international trading system. Due to its opening-up policies, China has become the largest trading country in the world. In 2018, its foreign trade was valued at $4.62 trillion, with exports of $2.48 trillion and imports of $2.14 trillion. China replaced Germany as the largest exporter in the world in 2009, and the US as the largest importer in 2015. Over the past 4 decades, China’s foreign trade volume has increased 204-fold, whereas its gross domestic product has only increased 34-fold. In this regard, China has already successfully achieved a miracle of foreign trade. Thus, to understand the miracle of China’s economic growth, it is necessary to understand what role international trade has played in this process. The realisation of this foreign trade miracle can be broken into four steps: the extensive margin of opening up (before 2001), the intensive margin of opening up (2001–2008), deeper opening up against financial crises (2008–2017), and all-around opening up (since 2017) after China’s Communist Party announced the establishment of a new era of all-around opening up in China in its 19th National Congress. This article is joint with Mr. Huihuang Zhu, a Ph.D. student at UCLA, and originally published by the ERIA in 2020. © Springer Nature Singapore Pte Ltd. 2020 M. Yu, China-US Trade War and Trade Talk, https://doi.org/10.1007/978-981-15-3785-1_2

21

22

2 Processing Trade, Trade Liberalization, and Opening-Up: China’s …

The first stage is the extensive margin of opening up. During this period, the main feature of China’s international trade has been the utilisation of the country’s huge labour force, which provides China with comparative advantages in labourintensive industries and processing trade. Along with the decline of trade barriers between countries all over the world, the development of transportation and communication technologies, and the separation of production processes, China began integrating into the global value chain and taking advantage of its abundant labour force. A typical example of this integration is China’s preferential trade policy of importing intermediate goods with zero tariffs to encourage processing trade production. Firms who participated in the processing trade specialised in tasks requiring labour-intensive production. At the same time, by participating in processing trade and importing intermediate goods and capital goods, Chinese firms are gradually becoming familiar with production technology and gaining experience from foreign companies, which further improves their production and operation efficiency. The second stage is the intensive margin of opening up. The main feature of this period has been trade Liberalization in China and dramatic change in Chinese firms’ performance, product market, and intermediate market. On the one hand, opening up has brought intensive import competition, making domestic firms and companies reduce inefficiency and improve product quality to become more competitive. On the other hand, the reduction of import tariffs allows domestic companies to purchase high-quality intermediate goods and capital goods, allowing them to save costs and upgrade technology. At the same time, export trade Liberalization (for example, the removal of the Multi-Fiber Arrangement) expanded Chinese firms’ foreign markets. These market scale effects can stimulate enterprises to increase investment, research and development (R&D), innovation, and export. Furthermore, along with the increased labour costs, the proportion of processing trade (a relatively low value-added trade mode) is gradually decreasing, and ordinary trade has begun to dominate. The third stage is deeper opening up against the financial crisis. The global financial crisis in 2008 had significant negative impacts on the economic development of the global economy, especially in developed economies. Demand from major developed economies has been weak, and the mode of relying mainly on exports to drive China’s economic growth is no longer feasible. Thus, Chinese firms began to find new advantages, including quality, brand, service, and so on. On the other hand, the Government of China also implemented several actions to encourage local firms to improve product quality, provide first-class service to their customers, and, at the same time, attract multinational companies to invest in China. The fourth stage is the all-around opening up. The 19th National Congress of the Communist Party of China in 2017 pointed out that China’s economy has shifted from a high-speed increase stage to a high-quality development stage, and improving the supply quality has become a top priority. At the same time, trade protectionism and anti-globalisation forces are on the rise. Against this background, the government proposes to build a new pattern featuring all-around opening up, thus promoting the development of both the Chinese and global economies. Specific measures to be undertaken include (i) further widening market access, (ii) improving the investment

1 Introduction

23

environment for foreign investors, (iii) strengthening protection of intellectual property rights, and (iv) taking the initiative to expand imports. In doing so, China will send a message to the world that China’s door will not be closed and will only open even wider. The rest of this paper is organised as follows. Section 2 focuses on processing trade, which is the key to understanding Chinese exports. Section 3 mainly focuses on trade Liberalization and firm performance. Section 4 reviews the deeper openingup solutions against the financial crisis. Section 5 introduces all-around opening up and trade globalisation, and provides suggestions.

2 Comparative-Advantage-Following and Processing Trade Before take-off, China adopted a heavy industry-oriented development strategy, a comparative-advantage-defying development strategy. Lin and Yu (2009) found that a development strategy that prioritised heavy industry (which is a comparativeadvantage-defying strategy) distorted product and factor prices, and had to rely on a highly centralised planned resource allocation mechanism. Thus, before the reform China adopted a distorted macroeconomic policy, which included suppressing interest rates, over-valuing domestic currency, adopting an import-substitution strategy, setting up ‘price-scissors’ against peasants, and restricting labour migration. Since the 1978 economic reform, China abandoned the heavy industry-oriented development strategy, adopting the comparative-advantage-following (CAF) development strategy based on its factor endowments. Where does China’s comparative advantage lie? Yao and Yu (2009) found that a low dependent rate1 and low urbanisation rate contribute significantly to China’s large labour force and low wages. This provides China with a long-term advantage in labour-intensive industries. Tian et al. (2013) used cross-country data and a gravity model to show that a large labour population has a positive effect on a country’s imports and exports. Ma et al. (2014) found that firms become less capital-intensive but more productive after exporting, compared to non-exporters with similar ex-ante characteristics. After its economic reform, China adopted a CAF development strategy. The government realised that processing trade is an ideal way to implement the CAF strategy given that China is a labour-abundant country. Indeed, processing trade is one of the main causes of the high level of intra-industry trade among the capital-intensive industries mentioned above (Lin and Yu 2009). The General Administration of Customs reports 16 specific types of processing trade in China. Of these, the two most important are processing with assembly and processing with inputs. Both types of processing trade are duty free but they are characterised by an important difference. 1 According

to Chinese statistical yearbook (2008), the dependent rate of China in 2007 was only 0.4. This number was not only lower than the average dependent rate in east Asia, but also one of the lowest dependent rates all over the world (Yao and Yu 2009).

24

2 Processing Trade, Trade Liberalization, and Opening-Up: China’s …

For processing with assembly, a domestic Chinese firm obtains raw materials and parts from its foreign trading partners without any payment. However, after local processing, the firm must sell its products to the same foreign trading partner by charging an assembly fee. By contrast, for processing with inputs, a domestic Chinese firm pays for raw materials from a foreign seller. After local processing, the Chinese firm can then sell its final goods to other foreign countries (Yu 2015). Compared with ordinary imports, processing imports in China accounted for just a small proportion of total imports in the early 1980s. However, as shown in Fig. 1, China’s processing imports increased dramatically in the early 1990s and began to dominate ordinary imports in 1992, when China officially announced the adoption of a market economy. Going forward, processing imports accounted for more than 50% of the country’s total imports (now decreased to one-third of total trade). Interestingly, processing imports with assembly were more popular in the 1980s because most Chinese firms lacked the capital needed to import. Since the 1990s, processing imports with inputs have become more prevalent. Due to the prevalence of processing trade, the literature has revisited some international trade theory, one of the main findings of which is the paradox of Chinese exporter’s productivity. The firm-level trade literature finds that exporters are exceptional performers for a wide range of countries and measures (Melitz 2003). Paradoxically, the one documented exception is the world’s largest exporter, China. Dai et al. (2016) show that this puzzling finding is entirely driven by firms that engage only in export processing—the activity of assembling tariff-exempted imported inputs into final goods for resale in foreign markets. They document that processing exporters are less productive than non-processing exporters and non-exporters, and perform

Fig. 1 Ratio of processing trade export in total export Source China’s customs. Author’s own compile

2 Comparative-Advantage-Following and Processing Trade

25

more poorly in many other aspects such as profitability, wages, R&D, and skill intensity. Furthermore, accounting for processing exporters explains the abnormality in exporter performance in China documented in the previous literature. Although processing trade accounts for half of China’s exports, processing firm productivity is lower than that of non-processing (i.e. ordinary) firms and even lower than nonexporters. Once they drop processing firms, Chinese exporters are more productive than non-exporters, meaning that the paradox disappears. Low fixed costs of processing exporting and trade and industrial policies favoring processing exporters are both responsible for the low productivity of processing exporters. Tian and Yu (2015) find rich evidence that a reduction in input trade cost for large trading firms leads to an increase in export intensity (i.e. exports over total sales). This impact is more pronounced for ordinary firms than for hybrid firms that engage in both processing and ordinary trade since ordinary imports enjoys free-duty treatment in China. Declining input trade costs not only increase the probability of a firm’s being a new exporter (i.e. extensive margin) but also lead to higher export intensity (i.e. intensive margin). The other one is how input and output tariffs affect a firm’s productivity. Yu (2015) shows that reducing output tariffs has had a greater effect on productivity improvement than has reducing input tariffs for large Chinese trading firms in the twenty-first century. Such results are primarily attributable to the special tariff treatment afforded to imported inputs by processing firms as opposed to non-processing firms in China. Processing imports, which account for half of the total imports in China, have zero tariffs. He documents that further tariff reductions on imported intermediate inputs have no impact on firms that engage entirely in processing trade but still have some impact on firms that engage in both processing and non-processing trade. As the firm’s processing share grows, input tariff reductions have a smaller impact on productivity gains. Similarly, as a firm’s processing share increases, the share of domestic sales decreases accordingly; and the pro-competition effects from the reductions in output tariffs are hence weaker.

3 Trade Liberalization and Firm Performance China’s accession to the World Trade Organization (WTO) has had a profound influence on the world economy. However, this step took China far longer than it did other economies. As one of the 23 contracting parties to the GATT, it took China 15 years, from 1986 to 2001, to accede to the WTO. Wong and Yu (2015) observe this interesting phenomenon and argue that the level of democracy of an applicant country affects the time it takes to gain General Agreement on Tariffs and Trade (GATT)/WTO accession. They find that most GATT/WTO members are democratic. More interestingly, democratic regimes seem to take less time to accede to the GATT/WTO than do non-democratic regimes. For example, Hong Kong acceded to GATT in 1986 immediately after its application. In contrast, Congo took more than 26 years to accede to the WTO. In addition, democratising countries also suffer from the length of time spent in attempting to accede to this large global trading organisation.

26

2 Processing Trade, Trade Liberalization, and Opening-Up: China’s …

Democracy also has an impact on economic performance and export. Giavazzi and Tabellini (2005) provide evidence that countries that liberalise and then democratise perform much better than countries that do the reverse. Eichengreen and Leblang (2008) argue the existence of two-way positive causality between trade openness and democracy using historical data from 1870–2000. Yu (2010a) documents that democracy affects trade through different channels. First, democratisation in the exporting country can improve product quality and reduce trade costs, increasing bilateral trade. Second, democratisation in the importing country may increase trade barriers and thus reduce imports. After China’s accession to the WTO, along with the significant reduction in applied tariff rate (Fig. 2), China’s exports, firm performance, industrial structure, and factor market have undergone huge developments. According to the empirical findings of other countries, import trade Liberalization mainly affects firms in one country through two following channels: one is the intense competition caused by trade Liberalization in the final goods market; the other is the effect of tariff reductions on imported intermediate inputs (Amiti and Konings 2007; Goldberg et al. 2010; Topalova and Khandelwal 2011). On the one hand, import trade Liberalization and tariff reductions make it easier for foreign companies and their products to enter the domestic market, leading to greater competition for domestic companies and products. This will force domestic firms to reduce inefficiency in operations, markup and product price to better cope with the competition. On the other hand, tariff cuts have enabled many companies to purchase better quality intermediates at lower prices, which permits cost savings and quality upgrades. Amiti and Konings (2007) analyse Indonesian firm-level data and find that firms gain at least twice as much from the reduction of input tariffs as from the reduction of

Fig. 2 Applied tariff rate, simple mean, all products. Source The World Bank Data

3 Trade Liberalization and Firm Performance

27

output tariffs. Furthermore, Topalova and Khandelwal (2011) find that Indian firms could gain 10 times as much from input tariff reduction as from output tariff reduction in several industries. They argue forcefully that the primary reason for this result is that access to better intermediate inputs through the reduction of input tariffs is more important than the procompetitive effect of the reduction of output tariffs. In addition to the commonality with the trade Liberalization process in other developing countries, many studies use Chinese firm-level data to study how trade Liberalization affects firm productivity. Firstly, trade Liberalization can boost firm productivity through different channels. Yu et al. (2013) investigate the linkage between firm productivity and product complexity. First, they adopt the Olley and Pakes (1996) approach to address two empirical challenges: simultaneity bias and selection bias caused by ordinary least squares. Then, the estimation results suggest that trade Liberalization significantly increases productivity for firms that produce complex goods. In contrast, they find that trade Liberalization has the opposite effect on the productivity of producers of simple goods. Secondly, trade Liberalization can boost firm total factor productivity through R&D and innovation. Dai and Yu (2013) argue that absorptive capacity developed through pre-export R&D investment is crucial for learning to occur. They estimate the instantaneous and long-term productivity effects of starting to export on the universe of Chinese manufacturing firms during 2001–2007 using propensity scorematching techniques. The baseline results show that, while the productivity effect of exporting is weak and transient for all firms on average, it is large and lasting for firms with pre-export R&D. For firms without pre-export R&D, exporting has no significant productivity effect, even instantaneously. In addition, the productivity effect of exporting increases with the number of years of pre-export R&D investment, suggesting that firms involved in intentional and persistent R&D activities enjoy greater learning effects than do firms only accidentally involved in R&D activities. They suggest that policies that encourage firm R&D and other absorptive capacitybuilding activities should be combined with trade Liberalization to reap the full growth benefits of openness. Tian and Yu (2017) also find strong evidence that input trade Liberalization due to the WTO accession significantly fosters firm R&D activity. Furthermore, trade Liberalization can boost firm total factor productivity by increasing import variety. Li and Yu (2014) use Chinese firm-level data to confirm the positive effect of imported intermediate goods on firm productivity. The results are primarily attributable to spillover and competition effects from imported goods. However, they find that the impact of imported intermediate inputs on firm productivity becomes weaker as firms produce more complex products. Differentiated products, which account for four-fifths of total products, to some extent bear less pressure from severe competition but enjoy fewer benefits from foreign imports penetrating the domestic market than do homogeneous products. However, the growth in productivity of firms that produce heterogeneous goods is slower than that of firms that produce homogeneous goods when product complexity requires more imported intermediate goods. If a homogeneous intermediate input is imported, firms will find

28

2 Processing Trade, Trade Liberalization, and Opening-Up: China’s …

it easier to adopt its up-to-date technology because homogeneous products are less technology-specific than heterogeneous products. Finally, Yu and Yuan (2016) have also found that the reduction of final tariffs has led to a decline in firms’ production cost, and the reduction of tariffs on intermediate goods has led to an increase in firms’ production cost. As a firm’s processing share increases, the impact of the reduction in tariffs on firms’ markup will be smaller. Yu and Li (2016) investigate the impact of trade Liberalization on the quality of imported inputs within narrow product categories. They follow the model in Khandelwal (2010) to estimate the quality of inputs imported to China. To estimate the impact of both input tariff reductions and output tariff reductions, they choose processing trade, which is free from both tariffs, as a control group. By implementing the difference-in-difference method, they find evidence to support the argument that trade Liberalization promotes the quality of imported inputs in ordinary trade relative to processing trade. Yu and Li (2015) study the impact of imported intermediate inputs and imports of final goods on the firm by taking product complexity into account. After controlling for the endogeneity of imported intermediate inputs, they confirm that firms could benefit from imports. Further, they find the imports could improve the productivity of firms that produce homogeneous goods, but has little effect on those produce complex goods. To explain this heterogeneous effect, market concentration is introduced, and the result reveals that the import competition effect weighs more in homogeneous industry while the import spillover effect is more important to heterogeneous industry. The low impact of imports on firm productivity in heterogeneous industry could be explained by a weak import spillover effect due to low R&D efficiency. Yu and Zhi (2016) find that, in the short term, import Liberalization of final goods allows more foreign firms to export to the domestic market, intensifying domestic market competition and thus reducing the profitability of pure domestic selling firms. However, in the long term, since firms can choose whether to enter or exit the market, some domestic reigning firms will choose to exit, allowing the firms that remain in the market to enjoy higher profitability in equilibrium. Trade Liberalization also affects within-firm income inequality. Chen et al. (2017) develop a Mincer (1974)-type approach to investigate the impact of input trade Liberalization on firms’ wage inequality between skilled and unskilled workers (or skill premium). When controlling for product-market tariffs in a firm’s industry, they find robust evidence that reduced input tariffs in a firm’s industry are associated with a higher skill premium at firms with more skilled workforces. This effect is more pronounced at ordinary (non-processing) firms. They also provide evidence that reduced input tariffs in a firm’s industry are associated with higher value added and profits at firms with more skilled workforces. Rodriguez-Lopez and Yu (2017) also find a link between trade Liberalization and firm employment. They document a phenomenon that reductions in Chinese and foreign final-good tariffs are associated with job destruction in low-productivity firms and job creation in high-productivity firms. In contrast, the net effect of reductions in Chinese input tariffs is limited to job destruction in low-productivity ordinary exporters. Moreover, Brandt et al. (2017) observe the effects of the trade Liberalization that accompanied China’s WTO accession on the evolution of markups and productivity

3 Trade Liberalization and Firm Performance

29

of Chinese manufacturing firms. They show that cuts in output tariffs reduce markups but raise productivity, while cuts in input tariffs raise both markups and productivity. They highlight several mechanisms operating in liberalised sectors that help explain our findings in the Chinese context. Liberalised sectors saw an increase in the exit of private firms and more frequent replacement of management in badly performing state-owned firms. Lim et al. (2019) use both econometrics and a calibrated structural model to disentangle the mechanisms via which trade affects innovation, focusing on scale effects (impact on market size) and competition effects (impact on markups). They find that both scale and competition effects are important for understanding how trade affects innovation in China. In particular, scale effects of trade on innovation are positive in the aggregate, whereas competition effects are negative. However, when firms can innovate to escape competition, greater competition induced by lower trade barriers can lead firms to increase innovation rather than reduce it. In addition to trade Liberalization and reductions in import tariffs, Chinese firms also experienced export trade Liberalization, which has greatly expanded the international market faced by Chinese firms. Khandelwal et al. (2013) examine Chinese textile and clothing exports before and after the elimination of externally imposed export quotas. Both the surge in export volume and the decline in export prices following quota removal are driven by net entry. This outcome is inconsistent with a model in which quotas are allocated based on firm productivity, implying the misallocation of resources. Removing this misallocation accounts for a substantial share of the overall gain in productivity associated with quota removal. Feng et al. (2017) study how a reduction in trade policy uncertainty affects firm export decisions. Using a firm-product level dataset on Chinese exports to the US and the European Union in the years surrounding China’s WTO accession, they provide strong evidence that the reduction in trade policy uncertainty simultaneously induced firm entries to and exits from export activity within fine product-level markets. In addition, they uncover accompanying changes in export product prices and quality that coincided with this reallocation: firms that provided higher quality products at lower prices entered the export market, while firms that provided lower quality products at higher prices prior to the changes exited. To explain the simultaneous export entries and exits, as well as the fact that new entrants are more productive than exiters, they provide a model of heterogeneous firms that incorporates trade policy uncertainty, tracing the effects of the changes in policy uncertainty on firm-level payoffs and the resulting selection effects. Despite the substantial reduction in tariff rates, recent literature notices a new aspect—non-tariff measures (NTMs)—that is gaining more importance than ever in control, and sometimes hampering the flow of international trade. NTMs are defined as ‘policy measures, other than ordinary customs tariffs, that can potentially have an economic effect on international trade in goods, changing quality traded, or prices or both’ (United Nations Conference on Trade and Development [UNCTAD] 2013). Ing et al. (2019) have identified and collected all currently enforced NTMs in China, and provide a brief overview of the diverse types of NTMs that exist in China based on national laws and regulations.

30

2 Processing Trade, Trade Liberalization, and Opening-Up: China’s …

4 Deeper Opening Up Against Financial Crises The global financial crisis has had far-reaching repercussions on cross-border economic activity. After a sharp and sudden collapse in international trade in the last quarter of 2008, world trade flows declined by about 12% in 2009 according to the WTO (Chor and Manova 2012). This exceeded the estimated loss of 5.4% of world gross domestic product during the same period. The contraction in exports was especially acute for small open economies, several of whom saw their trade volumes in the second half of 2008 fall by up to 30% year-on-year. This trade decline contributed to the spread of recessionary pressures to countries which had little direct exposure to the US subprime mortgage market where the crisis originated. By exploiting the variation in the cost of capital across countries and over time, as well as the variation in financial vulnerability across sectors, Chor and Manova (2012) show that credit conditions were an important channel through which the crisis affected trade volumes. They notice that countries with higher interbank rates and thus tighter credit markets exported less to the US at the peak of the crisis. This effect was especially pronounced in sectors that require extensive external financing, have limited access to trade credit, or have few collateralisable assets. Exports of financially vulnerable industries were thus more sensitive to the cost of external capital than exports of less vulnerable industries, and this sensitivity rose during the financial crisis. In the context of China, credit constraints faced by exporters played a significant role in the fall in exports. Manova et al. (2013) use China’s customs data to provide firm-level evidence that credit constraints restrict international trade and affect the pattern of multinational activity. They show that foreign affiliates and joint ventures in China have better export performance than private domestic firms in sectors that are more financially vulnerable. These results are stronger for destinations with higher trade costs, and are not driven by firm size or other sector characteristics. These findings are consistent with multinational subsidiaries being less constrained by liquidity because they can access foreign capital markets or funding from their parent company. Feenstra et al. (2014) examine why credit constraints for domestic and exporting firms arise in a setting where banks do not observe firms’ productivities. To maintain incentive compatibility, banks lend below the amount that firms need for optimal production. The longer time needed for export shipments induces a tighter credit constraint on exporters than on purely domestic firms. Using Chinese firm-level data, they find that the credit constraint becomes more stringent as a firm’s export share grows, as the time to ship for exports is lengthened, and as there is greater dispersion of firms’ productivities, reflecting more incomplete information. Accompanied by the export pressure caused by the global financial crisis, the increase in China’s labour cost and appreciation of the renminbi also eroded China’s export competitiveness significantly, especially in labour-intensive industries. We focus on three main solutions to expand trade volume. The first of these is to increase the firm’s R&D. Dai et al. (2018) find that competition plays an important role in

4 Deeper Opening Up Against Financial Crises

31

providing incentives for firm innovation. They use the appreciation of the renminbi exchange rate during 2005–2007 as a natural experiment and exploit its differential impact on Chinese manufacturing firms with different export exposures. The appreciation reduced exports and imposed greater competitive pressure on exporters relative to non-exporters. In response, exporters increased innovation activities more than did non-exporters. Using a difference-in-difference approach, they find that the R&D expenditure of exporters increased by 11% more than that of non-exporters during the appreciation period, and the new product development of exporters increased by nearly 1.5 times more than that of non-exporters. The second solution is to upgrade the quality of exported goods. First it is necessary to examine how Chinese manufacturers’ export quality has evolved since 2000. Zhang and Yu (2017) developed a new method to estimate export quality and avoid pitfalls in the literature. Using China’s manufacturing firm data and customs data from 2000– 2006, they estimate firm-product-destination-year level export quality and find that the overall export quality of Chinese manufacturers has increased by 15%. The quality gap between foreign and domestic firms has narrowed, with domestic firms exhibiting quality convergence. Export quality increases for most industries are higher in highincome destinations and are negatively associated with both export and import tariffs. Surviving varieties contribute to most of the aggregate export quality upgrading, while low-quality existing varieties facilitate the aggregate export quality upgrading. On the other hand, low-quality entering varieties hamper this upgrading. Ing et al. (2018) estimate micro-level firm-product-destination-year export quality for China (2000–2013). As shown in Table 1, from 2000–2013, the quality of Chinese exports increased by 30%. Their findings show that a firm will produce and export a higher Table 1 Quality distribution, China 2000–2013 Year

Mean

Median

0.75 Quantile

0.25 Quantile

2000

1.217

1.072

1.677

0.550

2001

1.242

1.111

1.714

0.579

2002

1.242

1.105

1.704

0.588

2003

1.247

1.111

1.724

0.587

2004

1.293

1.151

1.772

0.621

2005

1.335

1.191

1.817

0.664

2006

1.383

1.232

1.882

0.684

2007

1.371

1.210

1.881

0.650

2008

1.444

1.267

1.968

0.689

2009

1.449

1.275

2.007

0.666

2010

1.470

1.297

2.038

0.689

2011

1.493

1.303

2.063

0.684

2012

1.558

1.351

2.184

0.687

2013

1.588

1.360

2.218

0.702

Source Ing et al. (2018)

32

2 Processing Trade, Trade Liberalization, and Opening-Up: China’s …

quality product to a place with higher consumer preferences when the relative cost of shipping is higher than the unit production costs. They also show that better quality goods are more likely to be sold to high-income destinations. When they decompose the aggregate weighted-average export quality into the intensive and extensive margins, they find that the intensive margin plays a major role in Indonesia’s exports, while the extensive margin plays a major role in China’s exports. Cui and Yu (2018) study the effect of the exchange rate on the domestic value-added ratios of processing exports via two channels: substitution and markup. First, home currency depreciation leads to an increase in domestic value-added ratios by affecting each firm’s imported and domestic intermediate inputs (the substitution channel). Second, home currency depreciation improves exporters’ profitability and results in higher domestic value-added ratios of processing firms (the markup channel), as exports become more competitive with depreciation. Using Chinese firm-level production data and product-level trade transaction data, they find that processing firms’ domestic value-added ratios increase significantly through the two channels in response to firmlevel nominal effective exchange rate depreciation. The markup channel contributes almost 39% of the variation in domestic value-added ratios in response to changes in the exchange rate. The third solution is to increase outward foreign direct investment (FDI). In the past decade, the sharp increase in outward FDI from developing countries has been phenomenal, and this is especially true for China. The UNCTAD World Investment Report (UNCTAD 2015) shows that outward FDI flows from developing economies have already accounted for more than 33% of overall FDI flows, up from 13% in 2007. Furthermore, despite the fact that global FDI flows plummeted by 16% in 2014, multinational corporations (MNCs) from developing economies invested almost $468 billion abroad in 2014, an increase of 23% over the previous year. As the largest developing country in the world, China has seen an astonishing increase in its outward FDI flows in the past decade. In 2015, China’s outward FDI reached the level of 9.9% of the world’s total FDI flows, making China the second largest home country of FDI outflows globally. In addition, manufacturing outward FDI from China is becoming more important in China’s total outward FDI flows, having increased from 9.9% in 2012 to 18.3% in 2016. Chen et al. (2018) examine how domestic distortions affect firms’ production strategies abroad by documenting two puzzling findings using Chinese firm-level data from manufacturing firms. First, private MNCs are less productive than stateowned MNCs, but are more productive than state-owned enterprises overall. Second, there are disproportionately fewer state-owned MNCs than private MNCs. They also built a model to rationalise these findings by showing that domestic discrimination against private firms incentivises them to produce abroad. The model shows that selection reversal is more pronounced in industries with more severe discrimination against private firms, which receives empirical support. Liu et al. (2018) use unique data on Chinese manufacturing firms over the sample period 2002–2008. They find that MNCs are generally more productive after they conduct outward FDI, but this productivity effect varies depending on the parent firm and investment strategy heterogeneity. Their results suggest that MNCs without state ownership but with stronger

4 Deeper Opening Up Against Financial Crises

33

absorptive capability gain higher and more sustainable productivity effects, and such gains are higher for MNCs investing in Organisation for Economic Co-operation and Development countries than elsewhere.

5 All-Around Opening Up and Trade Globalisation Since the 2008 global financial crisis, there has been a new wave of trade protectionism headed by the US, casting a shadow on the world economy. The current situation arises from the stagnation of the Doha negotiations, the failure of the Transatlantic Trade and Investment Partnership, negotiations among Western countries, the Brexit negotiations, the Trump regime’s abolition of the Trans-Pacific Partnership, renegotiation of the North American Free Trade Agreement, and the recent trade war between the US and China, which would result in a tremendous shock to world markets. Widespread protectionism could lower global output, making worldwide economic recovery difficult. One the one side, Trump’s trade war will have a huge impact on the world economy. To answer this question, Guo et al. (2018) use Eaton and Kortum’s (2002) multi-sector, multi-country general equilibrium model with inter-sectional linkages to forecast how exports, imports, output, and real wages would change if Trump’s threat of 45% tariffs is carried out. To consider plausible scenarios, they evaluate the case of unilateral action on the part of the US, as well as a scenario where China retaliates by imposing an equally high 45% tariff on its imports from the US. In all of the scenarios, the calibration exercise suggests that a trade war triggered by high US import tariffs will lead to a collapse in US–China bilateral trade. In all of the scenarios, the US will experience large social welfare losses, while China may lose or gain slightly depending on the effect of the trade war on the US–China trade balance. Globally, some small open economies may experience small benefits, while other countries may suffer collateral damage. On the other hand, China has implemented multiple methods to minimise the impact of Trump’s trade war also determine to open up to the outside world. The first of these is the construction of the free trade port. By definition, a free trade port is a port area within the territory of a country or region that is not subject to the usual customs control, with free access to overseas goods and funds. The main feature of a free trade port is that it is outside the control of the customs authority of a country. It has the features of a port and a free trade zone, with many trade-related functions, including product processing, logistics, and warehousing. Geographically, a free trade port is part of the territory of a country, but from the perspective of administrative supervision, it is outside the customs jurisdiction of the country. As shown in Fig. 3, there are 13 free trade pilot zones and twelve pilot cities in China. Tian et al. (2018) suggest three areas to promote the development of free trade ports. First, it is necessary to improve convenience for businesses engaging in trade in the ports. Second, the ports must take steps to improve the fluidity of personnel as well as their ability to attract talent. Finally, the process of improving the ports’ financial

34

2 Processing Trade, Trade Liberalization, and Opening-Up: China’s …

Fig. 3 Map of the free trade pilot zones and pilot cities. Source The author’s own compliance

systems presents an opportunity to deepen financial reform and improve market openness. Moreover, the government should establish a financial leasing system, so that it can provide sufficient capital support for all businesses in ports and encourage more international companies to establish headquarters in the free trade ports. The second method is the One Belt, One Road initiative (BRI). The BRI, which was initiated by the Chinese government in 2013, is devoted to improving regional cooperation and connectivity on a transcontinental scale. The initiative aims to strengthen infrastructure, trade, and investment links between China and the other BRI countries. Currently, 64 countries are actively involved in the BRI. These include 10 ASEAN countries, 18 countries in Western Asia, 8 in South Asia, 5 in Central Asia, 7 in the Commonwealth of Independent States, and 16 in Central and Eastern Europe. Yu (2018a) finds that if China chooses to import more intermediate goods from the EU and ASEAN countries, or countries alongside the BRI instead, the price of the intermediate goods would be more competitive, and the Chinese people can also access cheaper finished goods. The third is method is the internationalisation of the. Starting from around 2005, the Government of China has pursued a variety of initiatives designed to encourage wider use of the renminbi. As shown in Fig. 4, these efforts sped up after the global financial crisis in 2008 and have made great progress since 2009. This progress peaked in 2015 and has since slowed in some aspects since 2016. The progress of

5 All-Around Opening Up and Trade Globalisation

35

Fig. 4 China’s bilateral swap values and numbers. Note Data of swaps under CMI are from the Bank of Japan. Data of other swaps are from the People’s Bank of China (2016). Swap agreements under CMI are mostly denoted in United States dollar values. Zhang et al. (2018) use CNY8.00 = $1.00 as the exchange rate to estimate their renminbi values

renminbi internationalisation can be categorised into four fields: renminbi trade settlement, renminbi-denominated investment, renminbi bond issuance, and renminbi currency swaps and direct trading (Eichengreen and Kawai 2014). Zhang et al. (2018) examined the effects in gravity equation and found a significant positive effect of swap agreements on trade. In their benchmark model, the negotiations of the swap agreement would improve 30.4% of bilateral trade values between China and its partners. For BRI countries, the effect is even stronger. This effect is both statistically and economically significant. They believe that renminbi swap agreements support economic integration between China and BRI countries by facilitating bilateral trade. The fourth method is the construction of the Pearl River Greater Bay Area (GBA). If the BRI and Regional Comprehensive Economic Partnership constructions are treated as the key content of the new pattern of all-around opening up, the Guangdong–Hong Kong–Macau GBA indeed is an important domestic carrier of the BRI. Thus, the construction of the Guangdong–Hong Kong–Macau GBA is the most urgent task of China’s opening up. Yu (2018b) suggests that the development of the GBA should focus on the following perspectives. First, it is essential for the GBA to focus on manufacturing industries rather than services industries only. Second, the construction of the GBA should focus on innovation. The third objective is to achieve institutional innovation. Fourth, the GBA should pay more attention to its ecological environment.

Chapter 3

Understanding the Recent Sino-U.S. Trade Conflict

To understand Sino-U.S. trade relations and the trade imbalance, this article interprets the trade imbalance between China and the United States from the Trump administration’s perspective. It analyses the development of the Sino-U.S. trade conflict by examining Sino-U.S. trade data. The Trump administration claims that the Chinese government’s subsidies for exporters and high import tariffs are the main causes of the Sino-U.S. trade deficit, resulting in the loss of nearly three million jobs in the U.S. manufacturing industry. The Trump administration therefore argues that limiting Chinese exports to the United States by imposing high tariffs can resolve the trade deficit, keeping China in the middle and low end of the global value chain. The article finds that U.S. statistical accounting of the trade volume between the two countries ignores important features of re-exports and overestimates the size of the trade deficit. Reducing China’s imports cannot directly increase U.S. employment, and China’s exports provide the United States with low-price and high-quality products. Chinese investors tend to invest the trade surplus in the United States by purchasing U.S. Treasury bonds, benefiting the U.S. economy. China’s large trade surplus mainly comes from labor-intensive products, while in capital-intensive products the surplus in value-added is small. In addition, China’s tariff policies are in line with the World Trade Organization’s rules, and the United States also limits Chinese investments due to “national security” concerns. China’s upgrading to the middle and high end of the global value chain is an inevitable consequence of economic development. Therefore, China and the United States should increase the size of bilateral trade and rebalance Sino-U.S. trade toward a sustainable direction by seeking economic and trade cooperation via trade negotiations.

This is a joint work with Dr. Rui Zhang, Assistant Professor at Aarhus University, Denmark and originally published in the China Economic Journal, 2019. © Springer Nature Singapore Pte Ltd. 2020 M. Yu, China-US Trade War and Trade Talk, https://doi.org/10.1007/978-981-15-3785-1_3

37

38

3 Understanding the Recent Sino-U.S. Trade Conflict

1 Introduction In March 2018, the U.S. Trump administration triggered a trade conflict with China by planning to impose a 25% tariff on $50 billion worth of imports from China starting on July 6, 2018. China reacted to this unilateral trade measure by imposing higher tariffs on $50 billion worth of imports from the United States, based on the rule of “Equal Size and Equal Proportion.” On July 24, the Trump administration threatened to impose higher tariffs on another $200 billion worth of imports from China. On August 1, the Trump administration continued to threaten to impose a 25% tariff on all imports from China (around $510 billion, according to U.S. statistics). On September 18, the Trump administration announced a 10% tariff on $200 billion worth of imports from China. China reacted by imposing 5–10% tariffs on $60 billion worth of imports from the United States and filing additional charges against the U.S. trade measures on Chinese goods at the World Trade Organization (WTO). Since then, the escalating trade conflict has moderated, and trade talks between the two countries have been in progress since the meeting between President Xi and President Trump at the Group of Twenty Summit on December 1, 2018. However, all these Chinese and U.S. trade measures have posed serious challenges for the normal bilateral trade and cooperation relationship between China and the United States and cast a shadow on the current global trade system. The ongoing Sino-U.S. trade conflict continues to escalate, because the Trump administration aims to resolve the Sino-U.S. trade imbalance. Therefore, to understand the nature of the trade imbalance between China and the United States, it is extremely important to forecast future potential trade conflicts between the two countries. To understand Sino-U.S. trade relations and the causes of the conflict, it is useful to start by evaluating the Sino-U.S. trade imbalance from the perspective of the Trump administration and analyzing the validity of its views and arguments. This paper is organized as follows. Section 2 outlines the core views of the Trump administration toward Sino-U.S. trade relations and provides comprehensive analysis of the arguments raised by the Trump administration. Section 3 argues that the Sino-U.S. trade imbalance does not hurt the U.S. economy. Section 4 analyzes the fundamental causes of the Sino-U.S. trade imbalance and evaluates the validity of the Trump administration’s accusations that China’s trade policies are unfair. Section 5 provides evidence of China’s upgrading along the global value chain in the long run. Section 6 concludes.

2 How the Trump Administration Views the Sino-U.S. Trade Imbalance Since China joined the WTO in 2001 and became its 143rd member, the volume of trade between China and the United States has continued to expand. China and the United States have benefited enormously from deepening trade liberalization.

2 How the Trump Administration Views the Sino-U.S. Trade …

39

However, the United States also continues to run a trade deficit in the Sino-U.S. trade relation. The Trump administration holds four views on the growing trade imbalance between China and the United States. (1) In bilateral trade between China and the United States, the surplus benefits China, and the deficit hurts the U.S. economy. (2) The main causes of the Sino-U.S. trade imbalance are the Chinese government’s subsidies for Chinese exporters and unfair tariff policies. (3) To solve the trade imbalance between China and the United States, the only solution is to suppress China’s exports by imposing high tariffs on Chinese exports to the United States. (4) The goal of resolving the Sino-U.S. economic and trade imbalances is to force China to continue specializing in the low-value-added segments of the global value chain, so that the United States can maintain its monopoly market power in the high-value-added segments of the global value chain. “Made in China 2025” aims to build up and strengthen China’s capacity as a global trade power. Keeping China from achieving this goal has become the main motivation for the United States’ continued expansion of the trade conflict. This is the most important view of the Trump administration, which believes that doing so can prevent the Chinese economy from catching up with the U.S. economy. The Trump administration claims that the United States has been hurt significantly by the Sino-U.S. trade imbalance. As shown in Fig. 1, since China’s accession to the WTO, trade between China and United States has been increasing over time. The bilateral trade volume between China and the United States has surged, from $98 billion in 2001 to $524 billion in 2016, at an annual growth rate of 14%. China and the United States have thus become each other’s most important trading partners. Meanwhile, the trade imbalance between China and the United States has also grown. According to the statistics of the General Administration of Customs of Sino-U.S. Bilateral Trade, 1984-2018 700.00 600.00

US$, billions

500.00 400.00 300.00 200.00 100.00 0.00 -100.00 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014 2017

Imports from the US

Exports to the US

Fig. 1 Sino-U.S. bilateral trade. Source CEIC database

Trade surplus

40

3 Understanding the Recent Sino-U.S. Trade Conflict

China, the U.S. trade deficit with China was $275.8 billion in 2017. According to U.S. statistics, the trade imbalance between China and the United States is even larger. The United States reports $516 billion worth of imports from China and $150 billion worth of exports to China in 2017, resulting in a deficit of $370 billion. The discrepancy between the two countries’ measures of the deficit hinges on how to measure China’s exports. China’s statistical agency does not include Hong Kong’s exports to the United States in China’s total exports to the United States. This is because exports from Hong Kong are mainly re-exports from not only mainland China, but also, to a large extent, from many other Association of Southeast Asian Nations countries to the United States. In contrast, the U.S. statistical agency simply includes all exports from Hong Kong in calculating the total exports from China to the United States, ignoring the large proportion of re-exports, and therefore tends to overestimate the size of the trade imbalance between China and the United States. Nevertheless, the difference in statistical accounting practices between China and the United States does not affect the share of the Sino-U.S. trade imbalance in the total U.S. deficit. Regardless of the statistical method, the Sino-U.S. trade deficit accounts for two-thirds of the total U.S. trade deficit. Table 1 reports the two industries featuring the largest Sino-U.S. trade imbalances, textiles and mechanical and electronic equipment, as well as the industry that is subject to the most antidumping and countervailing investigations, steel and aluminum. Moreover, the Trump administration is concerned about the labor market consequences of the Sino-U.S. trade imbalance. According to the estimates of Autor et al. (2013), across various zones in the United States, the U.S. manufacturing industry has lost nearly three million jobs due to import competition from China. Similarly, Pierce and Schott (2016) find that U.S. manufacturing industries that are more exposed to China’s exports, due to the United States granting Permanent Normal Trade Relations status to China, have seen larger declines in manufacturing employment. In short, the Trump administration holds an ingrained “Mercantilist” view—that a trade surplus is always beneficial for a country, while a trade deficit will definitely impair a country’s welfare. Such a view is not without political basis. Using U.S. election data, Autor et al. (2016) find that regions that have been hit harder by import competition from China have been more politically polarized in congressional elections, and, more importantly, those regions have shifted toward the Republican candidate in presidential elections. The Trump administration tends to blame the Chinese government’s large subsidies for exporters and high tariffs for the huge bilateral imbalance in Sino-U.S. trade. First, the Trump administration believes that the Chinese government has provided a large amount of export subsidies to export firms. In particular, because China has initiated a clear-cut industrial policy plan, “Made in China 2025,” a considerable number of high-tech sectors are heavily subsidized, especially integrated circuits and machines and equipment used to produce semiconductors and integrated circuits. As a result, the subsidies effectively lower the production cost of these industrial products, undermining the advantages of U.S. firms competing within the same product segments in the international market. Second, the Trump administration argues that China’s high import tariffs have significantly hampered U.S. exports to China. For

2 How the Trump Administration Views the Sino-U.S. Trade …

41

Table 1 Sino-U.S. bilateral trade, selected industries, 1993–2016 (US$, billions) Year

Steel Exports

Textile Imports

Exports

Mechanical and electronic equipment Imports

Exports

Imports

1993

3.3

0.2

2.9

3.8

1994

3.2

0.9

4.6

4.5

1995

3.2

1.4

5.5

5.1

1996

3.2

1.1

6.5

5.6

1997

3.6

1.0

8.3

5.4

1998

3.8

0.4

10.5

6.5

1999

4.0

0.2

12.5

8.0

2000

4.6

0.3

16.4

9.2

2001

4.6

0.3

18.0

11.4

2002

5.4

0.4

26.2

11.2

2003

7.2

1.1

39.4

11.4

2004

9.1

2.3

56.7

15.5

2005

16.7

2.1

72.8

16.8

2006

19.9

3.0

92.6

21.4

2007

22.9

2.4

107.9

23.7

2008

6.92

1.22

23.3

2.6

113.5

26.2

2009

1.51

0.90

24.6

1.7

104.7

22.3

2010

1.63

0.63

31.5

3.1

132.9

28.7

2011

2.58

0.65

35.1

4.2

150.0

29.5

2012

2.88

0.57

36.2

5.0

163.4

29.0

2013

2.75

0.58

39.0

3.8

169.3

38.3

2014

4.02

0.69

41.9

2.5

182.9

38.3

2015

2.85

0.58

44.8

2.0

179.9

35.7

2016

1.71

0.45

42.4

1.3

172.9

31.3

Source CEIC database Note The values are for China’s exports to and imports from the United States

example, China’s import tariff on automobiles is 25%, while the U.S. average import tariff on automobiles is 2.5%. Third, the Trump administration accuses China of restricting the maximum shareholding of foreign investors, especially U.S. investors, to 25%. Fourth, the Trump administration believes that China lacks effective intellectual property protection and even instructs state-owned enterprises to acquire U.S. companies, to “plagiarize” their high-tech technologies. Based on such an understanding, the Trump administration has moved toward the United States imposing high tariffs on imports from China, to balance and compensate the trade imbalance between the two countries. By doing so, the United States can continuously maintain its position in the high-value-added segments of

42

3 Understanding the Recent Sino-U.S. Trade Conflict

the global value chain, monopolizing and dominating the two ends of the “smile curve” of the global value chain.1 Thus, the United States aims to keep China in the low-value-added segments of the global value chain and specializing in the middle segments of the “smile curve.” The four arguments above constitute the Trump administration’s core views on the current trade imbalance between China and the United States, as well as the administration’s starting point in designing trade and diplomatic policies. The first three core views of the Trump administration are only held by the administration itself and its few core supporters. The majority of the economists around the world are clearly opposed to these views, because they deviate from basic facts or fundamental economic rationales. However, the last core idea—that China should remain at the low-value-added segments of the global value chain while the United States should keep its monopolistic position in the high-value-added segments of the global value chain—is not only held by the Trump administration, but also by some U.S. economists. It is therefore critical to analyze and evaluate the causes and consequences of the Sino-U.S. trade imbalance to disentangle facts from opinions.

3 Sino-U.S. Trade Imbalance Does not Hurt the U.S. Economy Since China’s accession to the WTO, the Sino-U.S. trade imbalance has continued to widen. But the trade imbalance between China and the United States does not hurt the U.S. economy. Instead, if the U.S. government can properly design and apply its relevant policies, the Sino-U.S. trade imbalance could benefit the United States, for the following three reasons. First, China’s expanding exports provide U.S. consumers with many products at low prices and good quality. The Chinese manufacturing sector covers almost the whole industrial chain. Within the U.S. imports from China, consumer goods account for about 32%, intermediate products account for about 27%, and capital goods account for about 41%. If the United States imposes high tariffs on Chinese products, the amounts imported from China will be significantly reduced. In such a case, the United States would have to substitute imports from other countries for imports previously from China, which would significantly increase U.S. domestic prices. Amiti et al. (2019) and Fajgelbaum et al. (2019) find that import tariff burdens are completely passed through to domestic consumers. The resulting aggregate real 1 The concept of “smile curve” was first proposed by Stan Shih, the founder of Acer Inc. According

to Shih’s observation, in the personal computer industry, the left and upstream end of the value chain focuses on technology and patent, the middle segment of the value chain refers to manufacturing and assembly, and the right and downstream end of the value chain concentrates on marketing and branding. Usually, the left and right ends are of higher value-added, while the middle segment is of lower value-added. Therefore, a smile curve is formed when one relates a segment’s value-added to its position in the value chain.

3 Sino-U.S. Trade Imbalance Does not Hurt the U.S. Economy

43

income loss is $1.4 billion per month, according to Amiti et al. (2019), or an aggregate welfare loss of $7.8 billion, according to Fajgelbaum et al. (2019). In an earlier study, Amiti et al. (2017) find that China’s WTO entry reduced the U.S. price index of manufactured goods by 7.6% over 2000–2006. More broadly, as discussed by Feenstra (2018), opening up to trade can improve an importing country’s welfare by increasing product varieties, facilitating creative destruction, fostering competition, and lowering market power. Costinot and Rodriguez-Clare (2018) find that the U.S. gains from trade are equivalent to 2–8% of U.S. gross domestic product (GDP). Second, taking a step back, reducing imports from China would not necessarily create more jobs in the United States. For example, the United States pays $10 for a shirt produced by China, $12 for a shirt produced by Vietnam, and $13 for a shirt produced by United States itself. Because China’s price is the lowest, China possesses the distinct comparative advantage in shirt production, and the United States imports shirts from China. The Trump administration blames China for “robbing” jobs in the United States and the decline in manufacturing employment. However, if the United States imposes a 25% tariff on China, the price of a shirt made in China would be $12.5, which is higher than the price of a shirt made in Vietnam ($12), so the United States would divert its imports of shirts from China to Vietnam, rather than shift the demand to U.S. domestic producers. Such a trade diversion effect hampers the creation of U.S. domestic jobs by imposing higher tariffs only on China’s products. Moreover, with global input-output linkages nowadays, U.S. manufacturers rely heavily on imported intermediate inputs to produce. Imposing higher tariffs on China’s products would thus potentially reduce U.S. employment, by increasing the imported input costs of U.S. manufacturing firms. For example, Wang et al. (2018) find that intermediate inputs imported from China help downstream U.S. firms to expand their employment through the global supply chain, especially employment in the service sector. Summing the negative competition effect of imports on the own and upstream industries and the positive supply chain effect of imports on the downstream industries, the net effect of imports from China on U.S. employment turns out to be positive 1.27% across U.S. regions. This finding overturns the conventional perception that increases in imports from China negatively impact the U.S. labor market. Fort et al. (2018) document that the decline in U.S. manufacturing employment started in the late 1970s, and one-fourth of the manufacturing decline is explained by firm exit. They find that the decline in manufacturing employment has been driven by not just trade, but also technology (such as automation). Lee and Yi (2018) use a multi-country general equilibrium model to show that the decline in trade cost between China and the United States led both countries to specialize in their sectors of comparative advantage, increasing the skill premia in both countries. Therefore, trade opening also causes distributional effects, and the U.S. government should also use redistributive mechanisms to ameliorate the inequality induced by globalization. Lyon and Waugh (2018) find that a progressive tax system is valuable in redistributing the gains from trade across different workers. Third, and more importantly, China reinvests most of the trade surplus from SinoU.S. bilateral trade back into the United States. The U.S. trade deficit was caused by

44

3 Understanding the Recent Sino-U.S. Trade Conflict

China's Holdings of U.S. Debt, 2001-2018 1,400.00

45.00%

1,200.00

40.00% 35.00%

1,000.00

30.00%

800.00

25.00%

600.00

20.00% 15.00%

400.00

10.00%

2018

2017

2016

2015

2013

2014

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

0.00% 2002

5.00%

0.00 2001

200.00

Mainland China's holding of US debt (billion US) share of total US debt share of China foreign reserve Fig. 2 China’s holdings of U.S. debt, size and share. Source Wind Economic Database

the large amounts of Chinese exports to the United States. But once China receives the trade surplus, it needs to invest the surplus abroad to increase the value of its reserve assets. China has spent most of its foreign reserves on purchasing U.S. Treasury bonds, which are usually recognized as one of the safest assets. Figure 2 shows that since China’s accession to the WTO, the U.S. Treasury bonds held by investors from mainland China have accounted for more than 5% of the U.S. debt in total. This proportion exceeded 8% before the financial crisis. Meanwhile, the U.S. Treasury bonds held by investors from mainland China accounted for more than 35% of China’s current account balances over the years. From this perspective, China is the United States’ creditor, and the United States is borrowing China’s wealth and resources. Therefore, the United States has benefited twice from its trade relations with China: U.S. consumers and firms enjoy the low prices of Chinese products, and the U.S. economy borrows from China to develop its own economy.

4 Comparative Advantage Determines the Sino-U.S. Trade Imbalance The Trump administration claims that the bilateral trade surplus was caused by Chinese government subsidies for exporters or unfair trade policies. But the key source of the trade imbalance between China and the United States is comparative advantage due to the difference in factor endowments. The following analysis disentangles different types of exports: labor-intensive products and capital-intensive products.

4 Comparative Advantage Determines the Sino-U.S. Trade …

45

China's TFP Level and Growth, 1998-2014

8.00%

0.5 0.45 0.4 0.35 0.3 0.25 0.2 0.15 0.1 0.05 0

6.00% 4.00% 2.00% 0.00% -2.00% -4.00% -6.00% 1998

2000

2002

2004

2006

China TFP relative to US (US=1)

2008

2010

2012

2014

China TFP growth in %

Fig. 3 China’s total factor productivity relative to the United States. Source Penn World Table 9.0

For labor-intensive products, China’s trade surplus arises from its advantage of low labor costs. The cost of labor in China is only $750 per month; in the United States, it is about $4200 per month, more than five times higher than in China. However, as shown in Fig. 3, China’s labor productivity has reached 45% of that of the United States. In other words, for a labor-intensive product, China has obvious comparative advantage. Such a comparative advantage has led to a large trade surplus in China’s labor-intensive products. For capital-intensive products, a large trade surplus is the inevitable consequence of the division of the global value chain. The United States is in the upstream of the industrial chain, and the United States, South Korea, and other countries export a large number of intermediate input products of parts and core components to China. China processes and assembles all these intermediate products into final products, leveraging its comparative advantage in the labor-intensive tasks (Fig. 4). China then exports the final products to the United States, the European Union, and other places. Therefore, although China runs a huge trade surplus in the statistics, the actual valueadded attributed to China is small. Take the iPhone 4 as an example. The price of the finished product exported from China to the United States is $179, but China’s value added is only $6.5. The other $172.5 is from raw materials and intermediates produced by various countries around the world. Therefore, based on the analysis above, China’s trade surplus is an inevitable consequence of economic development and the division of the global value chain, and it is closely related to the income gap between China and the United States. It is not caused by China’s subsidies to its domestic companies. Even if China and the United States did not implement any strategic trade policies, the Sino-U.S. trade imbalance would remain, not only from the past two decades, but also in the future for a long period of time.

46

3 Understanding the Recent Sino-U.S. Trade Conflict

Share of Processing Exports in Total Exports, 1993-2018 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 Processing with assembly

Processing with inputs

All processing

Fig. 4 China’s processing exports. Source CEIC database

Here we analyze the four arguments that the Trump administration usually uses to accuse China of unfair trade policies. The first argument is that the Sino-U.S. trade imbalance is due to the high tariffs that China imposes on U.S. imports. For example, China imposes a 25% tariff on automobiles produced in the United States, while the United States only imposes a 2.5% tariff on China-produced automobiles. However, although the numbers are all correct, this argument is invalid. The reasons are as follows. First, China’s 25% tariff on U.S. automobiles before July 1, 2018 was clearly stipulated when China joined the WTO, and it was also agreed by the United States. Thus, China is acting in accordance with the WTO rules. According to the WTO regulations, developing economies can impose higher tariffs on imports. China’s GDP per capita in 2017 was about $9400. According to the World Bank’s categorization, China is still a developing economy. Therefore, although China’s economy has developed rapidly in the 40 years of reform and opening up, it has not yet become a developed economy. Of course, when China fully develops to a high-income economy in the future, its tariffs should also be reduced to the level of developed economies accordingly. Second, if the United States has any issues with China’s tariff policies, it should initiate a complaint with the WTO Dispute Resolution Committee. For the United States to raise its tariffs unilaterally violates the WTO regulations and undermines the effectiveness of the WTO dispute resolution mechanism. Third, compared with other developing economies, China’s import tariff on automobiles is not high, and the U.S. tariff on automobiles is not lower than the tariffs imposed by other developed economies. For example, Japan’s import tariff on automobiles is already zero.

4 Comparative Advantage Determines the Sino-U.S. Trade …

47

Simple Average Applied Tariff, Manufactured Products, 1992-2016 45 40

tariff in %

35 30 25 20 15 10 5 0

1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

Fig. 5 China’s simple average applied tariff. Source World Bank

Fourth, the tariff on automobiles is an exception in the import tariff gaps between China and the United States. As shown in Fig. 5, China’s average tariff across more than 6000 imported products is 7.8%, while the average U.S. tariff is 3%. Therefore, the actual gap in average tariffs between China and the United States is not as large as what the Trump administration claims. The second argument of the Trump administration is that the Chinese government has provided a large amount of export subsidies for exporters. Mainly, the Trump administration claims that China has subsidized the key manufacturing industries that China intends to develop in the future. This argument is obviously invalid. First, the WTO does not prohibit its member states from providing industrial subsidies. In contrast, subsidies for certain industries, especially green industries, are even encouraged. The WTO requires that its member countries be transparent about their industrial subsidies, and China complies with this requirement. In particular, Chinese above-scale manufacturing firms explicitly report the amounts of subsidies received from the state in their financial statements. By contrast, the United States has frequently used such industrial subsidies as well. Second, the United States usually imposes non-tariff barriers, such as export subsidies, to protect its own industries. For example, in the U.S.-Japan trade war in the 1980s, the United States directly imposed high tariffs on Japan’s motorcycles exported to the United States, to protect the Harley-Davidson. Similarly, the United States imposed a voluntary export restraint to limit the quantity of Japanese vehicles exported to the United States in the early 1980s. Before 2005, the United States, together with the European Union and Canada, imposed import quotas on certain textile and clothing products produced by developing economies. The United States has also used strict import quotas for white sugar, to protect its sugar production industry. Recently, the Trump administration issued a subsidy of $12 billion to agricultural products in response to the Chinese government’s high tariff on U.S. soybeans.

48

3 Understanding the Recent Sino-U.S. Trade Conflict

The third argument of the Trump administration in accusing China of unfair trade policies has to do with China’s shareholding restriction on foreign-invested companies, especially U.S. investors, which is 25% at maximum. As for this complaint, the bottom line is that China has always been willing to attract foreign direct investment. In 2015, foreign direct investment in China amounted to $135 billion. In the first 35 years of China’s reform and opening up, foreign investors in China mostly enjoyed so-called “super national treatment.” To be specific, foreign-invested companies in China can enjoy the preferential policy of “Exemption for Two Years, Discount for Three Years.” That is, in the first two years of their establishment, foreign-invested enterprises are exempted from paying interest and taxes, and in the following three years, they enjoy a discounted interest and tax rate of 17%, which is half the regular corporate tax rate. Therefore, the shareholding restriction is consistent with the rationale of “Gradual Reform.” More importantly, the investment restriction is not particularly targeted at U.S. investors. By contrast, the United States has often conducted administrative intervention on Chinese companies’ investments in the United States and frequently refused those investments for reasons of “national security.” The usual argument from the United States is that Chinese companies would obtain advanced technologies from the acquired companies. However, in international investment, obtaining the advanced technologies of another company is exactly the purpose of mergers and acquisitions. Entrepreneurs are not philanthropists, and the goal of mergers and acquisitions is to maximize expected profits, a purely commercial behavior that should be respected by a market economy. Of course, in certain cases that really involve national security issues, the United States should take actions on the acquisition, given that it would affect the country’s national security. However, this does not always seem to be the case. Two years ago, when a Chinese company acquired a pork-selling company in California, the U.S. government refused the transaction due to concerns about national security, which is extremely confusing and unreasonable. In addition, the United States has long refused to allow Chinese state-owned enterprises to acquire U.S. companies. Recently, the U.S. government has intensified its stipulations, by refusing any investments or acquisitions if the participating Chinese companies have any committees of the Communist Party of China. Obviously, such an action goes beyond the scope of economic disputes. Furthermore, many private enterprises from China have been blocked by the United States because of “national security” concerns. The failure of Sany Heavy Industry, which is a private enterprise, to acquire U.S. companies last year is another example. Finally, the fourth argument of the Trump administration is to accuse China of poor intellectual property protection. Admittedly, China’s intellectual property protection is not as strong as that in the United States, and many areas need further strengthening. However, two caveats should be recognized. First, the protection of intellectual property rights is closely related to the income and development stage of an economy. Intellectual property protection in high-income countries is relatively complete, while intellectual property protection in low- and middle-income countries is still catching up. For example, a textbook of “Principles of Economics” sells for

4 Comparative Advantage Determines the Sino-U.S. Trade …

49

about $100 in the United States, but the same package of contents sells for around $26 in Hong Kong, with the notice “Not Sold in the US or Canada.” Because firms realize that per capita income in Asia is generally lower than that in the United States and Canada, they need to implement “pricing to market.” Second, China’s intellectual property protection has made great progress and advancement since China’s accession to the WTO. Compared with countries at a similar per capita income level, China’s current intellectual property protection is remarkable.

5 China’s Value-Added Upgrading Is the Consequence of Economic Development The Trump administration’s motivation for launching a large-scale trade conflict with China is to keep the United States in the high-value-added segments of the global value chain and China in the low-value-added segments. Clearly, such an idea reflects typical thoughts of historical nihilism and hegemony. First, from a historical perspective, the United States was not always in the highvalue-added segments of the global value chain. In 1894, the United States surpassed the United Kingdom in industrial output and became the world’s largest industrial country. Even so, the U.S. economy did not stand out among world economies by reaching the high-value-added segments of the global value chain until after World War II. In other words, the United States did not reach the high end of the global value chain in the very beginning, and its rise in the value added of industrial products took a rather long period of time. By the same token, it is unreasonable for the United States to restrict China and other countries from upgrading along the global value chain. Second, if China manages to upgrade from the low end to the middle and high end of the global value chain, the United States will not suffer losses but rather gain from China’s upgrading. The economic rationale is that increases in market size will reduce the fixed costs of all exported products, incentivizing manufacturers to increase outputs and thus achieve economies of scale in production. Third, it is not viable for China to stay in the middle and low end of the global value chain in the future. China has become the “world’s factory” of global industrial products, mainly thanks to its relatively low labor costs compared with advanced economies such as the United States, Europe, and Japan. However, China does not show significant comparative advantage in costs of labor when compared with Southeast Asian countries. As indicated in Fig. 6, the wages of blue-collar workers (represented by manufacturing workers) and white-collar workers (represented by manufacturing managers) in China are already at the high end of those in Southeast Asian countries. Currently, China is still exporting a large number of labor-intensive products to Europe and the United States. This is not because China still possesses comparative advantage in labor-intensive products compared with Southeast Asian

50

3 Understanding the Recent Sino-U.S. Trade Conflict

Wages of Manufacturing Manager and Worker Bangladesh Laos Cambodia Myanmar Sri Lanka Pakistan Vietnam India Philippines Indonesia Thailand China Malaysia Taiwan Singapore South Korea Hong Kong New Zealand Australia 0

1000

2000

3000

4000

5000

6000

7000

8000

wage of manufacturing worker (US$ per month) wage of manufacturing manager (US$ per month)

Fig. 6 Comparing costs of labor: white-collar and blue-collar workers

countries, but simply because Southeast Asian countries with lower labor costs than China have relatively small export scales and are currently not able to take over the whole of China’s huge market shares in the developed economies. Fourth, China has the capacity to upgrade along the global value chain. This can be seen by examining the export quality improvement of China’s industrial products, especially after 2000 (Yu 2015; Ing et al. 2018). As indicated by Fig. 7, the median export quality index of Chinese manufacturing exports increased from 1.07 in 2000 to 1.36 in 2012, an increase of around 27%. Therefore, China has been offering products with not only low prices, but also high quality. According to the observation of the increasing quality of China’s manufacturing exports, China’s value added in its exports should also be rising, which is a natural outcome of economic development.

6 Cooperation Is the Only Solution to the Sino-U.S. Trade Imbalance The Trump administration seems to believe that by imposing high tariffs on China’s exports, the United States can resolve the large Sino-U.S. trade imbalance and, at the same time, expand employment. However, such measures will not work, for several reasons. First, if the United States imposes high tariffs on imported products, China

6 Cooperation Is the Only Solution to the Sino-U.S. Trade Imbalance

51

Median China Export Quality Index, 2000-2013

1.4 1.35 1.3 1.25 1.2 1.15 1.1 1.05 1 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Fig. 7 Median China export quality index. Source Ing et al. (2018)

and other countries will certainly retaliate by imposing high tariffs on U.S. products, triggering a large-scale trade conflict and trade war. In this case, on the one hand, consumer prices in the United States will rise and consumer surplus will decrease accordingly. On the other hand, exports from the United States to China will be hampered, reducing domestic manufacturing production and employment. Second, high tariffs on Chinese products cannot bring back lost jobs to the United States. Instead, high tariffs on Chinese products would increase the employment opportunities in other Southeast Asian countries through trade diversion. Guo et al. (2018) find that the Sino-U.S. trade war will cost the United States an economic loss of about 0.7% of its total GDP, which amounts to around $200 billion today. Compare the trade policies of the Trump administration and the Obama administration. The Obama administration also tried to reduce the Sino-U.S. trade imbalance, but it adopted more sensible measures and policies. In contrast to the Trump administration, the Obama administration did not impose high tariffs or trade barriers on Chinese exports. Meanwhile, it also aimed to facilitate China’s imports from the United States. Therefore, from the perspective of the United States, Obama proposed the plan of “doubling imports within five years.” The advantage of this plan is that both China and the United States have increased economies of scale and trade, making the “pies” bigger. By expanding the size of trade, the gains from trade of the two countries also increase. The Chinese government has always promoted such types of economic and trade cooperation to rebalance Sino-U.S. trade. In short, the four main misunderstandings of the Sino-U.S. trade imbalance induced the Trump administration to trigger and expand the recent Sino-U.S. trade conflict. The trade imbalance between China and the United States has resulted from the differences in factor endowments and global value chain positions of the two

52

3 Understanding the Recent Sino-U.S. Trade Conflict

countries. Therefore, escalating the Sino-U.S. trade conflict cannot resolve the SinoU.S. trade imbalance. The only solution to the Sino-U.S. trade imbalance is to achieve trade cooperation through effective trade negotiations and other dispute resolution mechanisms.

Chapter 4

The Day After Tomorrow: Evaluating the Burden of Trump’s Trade War

During his U.S. presidential campaign Donald Trump threatened China with the imposition of high import tariffs on its exports to the United States. To evaluate the repercussions of such an action, this paper uses Eaton and Kortum’s 2002 multisector, multi-country general equilibrium model with inter-sectional linkages to forecast how exports, imports, output, and real wages would change if the Trump’s threat of 45% tariffs is carried out. To view plausible scenarios, we evaluate the case of a unilateral action on the part of the United States, as well as a scenario where China retaliates by imposing an equally high 45% tariff on its imports from the United States. In addition, since the high U.S. trade deficit with China is a factor which underpins calls for tariff action, we explore simulations where the trade balance is restored to balance as well as a scenario in which the trade balance is unchanged. In all of the scenarios, the calibration exercise suggests that a trade war triggered by high U.S. import tariffs will lead to a collapse in U.S.-China bilateral trade. In all of the scenarios, the United States will experience large social welfare losses, while China may lose or gain slightly depending on the effect of trade war on the U.S.China trade balance. Globally, some small open economies may experience small benefits, while other countries may suffer collateral damage.

1 Introduction During his bid for the U.S. presidency, Donald Trump injected strong calls for protectionism. Following his election, Trump used his inaugural speech to call for “America First” and for “Buy American, Hire American”. He also started to carry his campaign pledges breaking the trade ties of the United States with its neighboring countries and main trade partners. For instance, Trump formally withdrew the United States from the Trans-Pacific Partnership (TPP), an agreement among 12 countries across three continents that took nearly ten years to negotiate under his predecessor, the former U.S. President Barack Obama. He also signed an executive order to build a wall along the Mexican border and threatened Mexico to pay for its construction by paying taxes © Springer Nature Singapore Pte Ltd. 2020 M. Yu, China-US Trade War and Trade Talk, https://doi.org/10.1007/978-981-15-3785-1_4

53

54

4 The Day After Tomorrow: Evaluating the Burden of Trump’s Trade …

on its exports to the United States. He ordered his team to initiate a renegotiation of the North American Free Trade Agreement (NAFTA) between the United States, Mexico, and Canada. These actions, along many others, have dispelled any remaining doubt over the sincerity of President Trump’s promises during the election campaign. In the recent meeting of G20 finance ministers and central bankers, the financial leaders of the world’s biggest economies dropped a pledge to keep the global trade free and open, thereby acquiescing to the increasingly protectionist United States. In light of the administration’s protectionist actions, it is important to ask whether the U.S. will pull the trigger on a trade war against the country’s main trade partners, such as China? China has been among a primary target of President Trump’s campaign and administration. In his Monessen, Pennsylvania speech on 28 June 2016, Trump condemned China’s entry to the World Trade Organization (WTO) as a catastrophe for U.S. manufacturing workers. Later, when he met with the editorial board of The New York Times in January 2016 he proposed the idea of imposing 45% import tariffs on China’s exports to the United States. In his well-known tweet, President Trump also described China as the “grand champions” of currency manipulation to boost her exports. Since it is no longer implausible to imagine the outbreak of a trade war between the U.S. and China, it is important to evaluate how such a conflict would affect the U.S. and China, as well as other countries. To forecast the economic implications of a trade war, we adopt Eaton and Kortum’s (2002) multi-country and multi-sector general equilibrium model which is modified to include inter-sectoral linkages of the form proposed by Caliendo and Parra (2015). Through this exercise, we are able to examine the changes in the exports, imports, output, and real wages of 62 major economies in response to a hypothetical 45% tariff levied by the United States on its imports from China. We consider three possible tariff hike scenarios involving the agriculture, mining, and manufacturing sectors. In the first scenario, the United States increases its import tariffs to 45% on all imports from China and all countries have balanced trade. Balanced trade might well be one of the goals of a trade war as the U.S. government has for a long time blamed China for its large trade surplus.1 In the second case, we assume China retaliates by also increasing its tariffs on its U.S imports to 45%, again evaluating the impacts under the assumption of balanced trade. In the third case, we consider a situation in which both China and the United States impose high tariffs to each other, though trade imbalances for all countries remain unchanged. For simplicity, we name those three cases above as (1) Unilateral U.S. tariffs with balanced trade, (2) U.S.-China retaliatory tariff war with balanced trade, and (3) U.S.-China retaliatory tariff war with ongoing trade imbalance, respectively. Our exercise shows that in all scenarios, high U.S. import tariffs lead to a catastrophic collapse in bilateral trade. In the case of “Unilateral U.S. tariffs with balanced trade,” for half of China’s 18 tradable sectors, exports to the United States fall by more than 90%. These sectors include textiles, metal products, computers, and electrical equipment. In the next two cases, the trade war between China and the United 1 For

simplicity, we assume all countries achieve trade balance after the trade war starts. We will also consider the case in which trade imbalance remains.

1 Introduction

55

States leads to a similar collapse in bilateral trade. In these scenarios the dramatic decline in trade includes agriculture, mining, and petroleum products, in addition to computers and electrical equipment. The consequence of a trade war which substantially impairs bilateral trade will be a slump in output and significant decline in social welfare. In the case where both countries engage in trade war, that is “U.S.-China retaliatory tariff war with balanced trade”, China’s output in textile and computer products is predicted to fall by 6.29% and 14.26%, respectively. At the same time, the output declines in the U.S, agriculture and food industries will amount to 1.14% and 4.18%, respectively. To measure social welfare loss, we use changes in real wages before and after the trade war, which accounts for the effects of a rising price index. In the first two scenarios, the United States suffers large losses while China only bears a small welfare loss. By our calculation, the United States experiences welfare losses of 0.66% and 0.75%, respectively, compared with China’s maximum loss of 0.04% in the case of “Unilateral U.S. tariffs with balanced trade”. In the third case with unbalanced trade, China experiences the largest losses (−0.37%) while the losses of the United States are the second largest (−0.32%). Some other countries in Asia may gain slightly from the diversion, while other advanced economies may experience collateral damage due to spillover effects transmitted through input-output linkages and the general equilibrium effects of the trade war between the two largest global economies. Our study highlights the important role of the trade imbalance in the evaluation of the consequences of a Sino-U.S. trade war. The trade imbalance matters because one country may finance its consumption through trade deficits when their labor and tariff revenue income is lower in value than their total expenditure. Thus, a country with a trade deficit receives a net income transfer from other countries. Since we use a static trade model to simulate the effects of tariff changes on output and trade, the trade balance is exogeneously determined by assumptions. For simplicity, we consider two possibilities: the trade war restores trade balance or maintains the current trade imbalance. The reality would be in between, but these two possible scenarios explain why the United States is put in a disadvantage due to the current large trade deficits, and China may gain slightly from the trade war if trade achieves rebalance. Given the current United States-China trade imbalance, the presumption of whether the trade war leads to trade balance or not has different implications for the two countries. If the trade war leads to a trade balance, the United States must export more and import less to move from a trade deficit to balanced trade, while China needs to reduce its exports more than it reduces its imports to achieve balance. In other words, the United States will not receive the net income transfer, which acts a negative income shock. This shock may be further increased if China hikes its tariffs. In contrast, since China will not need to pay for the net income transfer, the reduction in its trade surplus with the United States may alleviate the negative effect of trade war on its economy. Thus, in this case social welfare loss will be even larger for the United States, while China may evev gain slightly if the positive income effect dominates, as shown in the “U.S. versus China with balanced trade” case. In contrast, if the trade war does not have any effect on the current trade imbalance, China will

56

4 The Day After Tomorrow: Evaluating the Burden of Trump’s Trade …

effectively continue to pay the income transfer while the United States maintains its external borrowing, even the trade war reduces overall trade. Thus, China may be hurt more than the United States by the trade war, as shown in the case of “U.S. versus China with imbalanced trade.” Our analysis implies that trade balance might not be a desirable target for the United States if it launches a trade war against China while planning to maximizing U.S. social welfare. Admittedly, the quantitative effects of Trump’s trade war on output and social welfare are less striking than those on bilateral trade. However, our calculation of welfare loss is rather conservative and likely to underestimate the effect of the possible trade war on output and social welfare. One key assumption in our model is that all economies function well without any other frictions, aside from trade costs. Given that labor is freely mobile across all sectors within each country, the sectoral reallocation between tradable and non-tradable sectors, together with the import substitution among different source countries, can offset the effects of unilateral import tariff hikes imposed by the other country. Moreover, the presence of input-output linkages also diminishes the effects of unilateral tariff hikes. However, in reality these adjustments may not be smooth, in which case the impact of trade war on the world economy will be magnified. Finally, though a trade war is likely to trigger a tsunami in global financial markets, these effects are not accounted for in our framework. One of the most popular approaches for evaluating the possible consequences of a trade war is the traditional Computational General Equilibrium (CGE) model, which fully specifies a parametric model of preferences, technology, and trade costs with ad hoc parameters. Our approach differs from this model by following the recent development in quantitative trade models, largely triggered by the seminal work of Eaton and Kortum (2002). The extension of the Eaton and Kortum (EK) model into a multiple-sectors with input-output linkages and other features has become the workhorse model for counterfactual analysis. This approach is suitable for analyzing trade policy changes and offers at least three significant advantages over the traditional CGE models or the recently developed CGE model with Melitz (2003)-type firm heterogeneity (Petri et al. 2012) for the following reasons. First, the EK model offers more parsimony by including a limited number of parameters. The latest version of the GTAP model has approximately 13,000 parameters that cannot be estimated, whereas researchers who adopt new quantitative trade models generally use data to estimate the key parameters before conducting counterfactual analysis. Second, the new quantitative trade models have appealing microtheoretical foundations. For example, one does not need to assume that each country produces one distinct good—the so-called “Armington” assumption—to do quantitative work in international trade. Third, although the CGE model combined with Melitz (2003) can capture firm heterogeneity, it is not only difficult to generate a sectoral gravity equation with macro implications but also intractable to identify a rich set of related fixed costs using the actual data. By contrast, the EK model can deliver gravity equations that even incorporate a country’s trade deficit/surplus. Many recent studies have applied or extended the EK framework to analyze various topics, including the evaluation of the possible gains from a trade agreement, technological changes, and infrastructure improvement. For example, Donaldson

1 Introduction

57

(2010) applied the EK model to empirical data and assessed the gains from railroad construction in colonial India. Caliendo and Parro (2015) extended EK framework to include input-output linkage and evaluated the gains from NAFTA.2 Dekle et al. (2008) showed that the EK framework can also be used to analyze hypothetical cases, such as how much the U.S. GDP needs to adjust to eliminate its high current account deficits. The rapid development in this approach provides suitable tools for us to evaluate the possible outcomes of a trade war triggered by the largest economy in the world. The remainder of this paper is organized as follows: Sect. 2 reviews the bilateral trade relationship between the United States and China, the dynamics of the bilateral trade, and the current trade conflicts. Section 3 presents our model, data, and calibration method. Section 4 shows the calibration results. Section 5 presents the concluding remarks with discussions on trade policies.

2 Overview of the Trade Relationship Between the United States and China 2.1 Bilateral Trade Relationship At the establishment of the People’s Republic of China (PRC, or China) in 1949, the United States retained its diplomatic recognition of Taipei instead of Beijing. The diplomatic and economic interactions between the United States and China were at their lowest level during the following years of the Cold War since conflicts in ideology and national security interests greatly impeded bilateral trade between these nations. Following the China-Soviet border conflicts in the late 1960s, both China and the United States began to realize the potential benefits of normalizing a bilateral relationship. In June 1971, U.S. President Nixon ended the legal barriers of trade with China, and his ice-breaking visit to China in 1972 further provided a pathway to the thawing of trade relations between the two countries. Following China’s 1978 market-oriented economic reforms, the United States started to grant China “Most Favored Nation” (MFN) tariffs in January 1980 subject to annual renewal.3 MFN status implies that a country provides another partner with the same tariff treatment as it does under obligation to other countries who are formal 2 Di

Giovanni et al. (2014) adopted a similar framework to evaluate the gain from China’s trade integration with the world market and its fast technological changes. A few recent studies have introduced labor migration into the EK framework and explored the impact of goods and labor market frictions on economic growth and gain from trade (Galle et al. 2015; Caliendo et al. 2015; Tombe and Zhu 2015). 3 The Jackson-Vanik Amendment of 1974 which denied preferential trade policies to some countries was often targetted at communist countries. While the application of this amendment was waived by U.S. presidents, the amendment required an annual congressional renewal of China’s MFN status.

58

4 The Day After Tomorrow: Evaluating the Burden of Trump’s Trade …

members of the World Trade Organization (WTO), or its predecessor agreement, the General Agreements on Trade and Tariffs (GATT). MFN status significantly liberalized China’s access to the US market, since it supplanted the otherwise high tariffs that were levied on non-WTO countries. The United States soon became the second largest importer for China and China’s third largest partner in 1986. In the same year, China applied for GATT membership while the United States was also interested in China’s further trade and FDI liberalization. Thus, the annual waiver of the Jackson-Vanik Amendment and the congressional renewal of China’s MFN status came to an end in 1999, and the United States granted China “Permanent Normal Trade Relations,” thereby paving the road for China to join the WTO in 2001. The decade and a half following China’s accession to the WTO has been a honeymoon for the two countries, and their bilateral trade has grown much faster than before. The United States and China have become each other’s most important trade partner, though trade conflicts have continued. For instance, China’s large trade surplus and inflexible exchange rate have been criticized frequently by the U.S. government. The United States has also accused China of dumping textile, steel, and other manufactured products at unfairly low prices. The Bush and Obama administrations imposed quotas and high tariffs on the imports of Chinese textile and other low-end industrial products to protect U.S. domestic industries. However, these trade conflicts have not reversed the movement towards freer trade. Thus, the 2017 start of the Trump administration brings concerns for the prospects of further liberalization due to Trump’s open support of protectionism.

2.2 Bilateral Trade Flow and Trade Imbalance We examine three aspects of Sino-U.S. trade, namely, bilateral trade flows and trade imbalance, bilateral trade structure and trade dispute in key industries such as steel, and current trade conflicts. The trade volume between China and the United States has grown rapidly over the last three decades, especially following China’s accession to the WTO in 2001. The bilateral trade volume has surged from 97 billion USD in December 2001 to more than 524 billion USD in 2016, which implies an average annual growth rate of 11.11%. The annual growth of bilateral trade volume between these two countries has slowed down since 2008 partly due to the 2008–09 global financial crisis (GFC) that hindered the global economy. The China-U.S. trade volume also shrank by 6.26% in 2016, the first time with a negative growth since 2009. While exports edged down by 5.13% in 2016, imports decreased by 9.79% following a 5.91% decline in 2015. The fast-growing trade volume between the United States and China has been accompanied by a persistent bilateral trade surplus in China’s favor. As shown in Table 1, China’s trade surplus reached 260.37 billion USD in 2015 from only 30 billion USD in 2000. This unbalanced trade eventually resulted in a long-lasting dispute in Sino-U.S. relations. However, as the bilateral trade volume growth slowed

2 Overview of the Trade Relationship …

59

Table 1 Bilateral trade between the U.S. and China Year

Trade flows, billion USD

Growth rate, percent

MUSA,CHN

MUSA,CHN

MCHN ,USA

MCHN ,USA

2000

52.14

22.36

2001

54.32

26.20

4.17

17.17

2002

69.96

27.23

28.79

3.91

2003

92.51

33.88

32.23

24.44

2004

124.97

44.65

35.09

31.78

2005

162.94

48.73

30.38

9.14

2006

203.52

59.22

24.90

21.52

2007

232.76

69.86

14.37

17.96

2008

252.33

81.50

8.41

16.66

2009

220.90

77.46

−12.45

−4.95

2010

283.37

102.06

28.28

31.76

2011

324.56

122.14

14.54

19.68

2012

352.00

132.88

8.45

8.79

2013

368.48

152.55

4.68

14.81

2014

396.15

159.19

7.51

4.35

2015

410.15

149.78

3.53

−5.91

2016

389.11

135.12

−5.13

−9.79

Source CEIC Note: MUSA,CHN denotes the total imports of the U.S. from China. MUSA,CHN + MCHN ,USA denotes the total trade volume. MUSA,CHN − MCHN ,USA denotes China’s trade balance

down recently, the trade surplus growth also started to cool down. China’s bilateral trade surplus narrowed by 2.45% to 253.99 billion USD in 2016, thereby reflecting a tendency toward a more balanced bilateral trade structure.

2.3 Bilateral Trade Structure and Trade Dispute Table 2 presents bilateral trade flows on three main sectors: steel, textiles, and machines and computers. Machines and computers are China’s leading exports to the United States accounting for 44.45% (173 billion USD) of its total exports in 2016. These products are followed by textiles, which represented 11% (42.42 billion USD) of China’s exports to the United States. However, China’s exports in traditional competitive industries shrank in recent years in accordance with the slowing pace of bilateral trade. Specifically, China’s exports of machinery and computers, as well as textile products decreased by 3.89% and 5.35% in 2016, respectively.

60

4 The Day After Tomorrow: Evaluating the Burden of Trump’s Trade …

Table 2 Bilateral trade flows on selected sectors (Billion USD) Steel Year

j

MUSA,CHN

Textiles j

MCHN ,USA

j

MUSA,CHN

Machines and computers j

MUSA,CHN

MCHN ,USA

j

j

MCHN ,USA

1993

3.31

0.23

2.93

3.84

1994

3.16

0.86

4.60

4.53

1995

3.17

1.35

5.53

5.13

1996

3.23

1.13

6.52

5.59

1997

3.57

0.99

8.34

5.37

1998

3.80

0.42

10.48

6.54

1999

3.98

0.24

12.48

8.02

2000

4.56

0.31

16.39

9.20

2001

4.57

0.35

17.99

11.38

2002

5.43

0.44

26.24

11.17

2003

7.19

1.08

39.39

11.42

2004

9.06

2.31

56.68

15.46

2005

16.67

2.11

72.79

16.84

2006

19.87

3.00

92.55

21.38

2007

22.90

2.42

107.85

23.72

2008

6.92

1.22

23.28

2.60

113.48

26.17

2009

1.51

0.90

24.60

1.71

104.72

22.32

2010

1.63

0.63

31.45

3.06

132.90

28.74

2011

2.58

0.65

35.06

4.18

150.01

29.45

2012

2.88

0.57

36.18

4.96

163.37

28.96

2013

2.75

0.58

38.95

3.82

169.34

38.31

2014

4.02

0.69

41.88

2.53

182.86

38.30

2015

2.85

0.58

44.79

1.98

179.89

35.67

2016

1.71

0.45

42.42

1.28

172.87

31.26

Source CEIC j Note: MUSA,CHN denotes the imports of the U.S. from China in sector j. The statistics of steel has been available since 2008, as the product “steel” was classified in the group of “iron and steels” before 2008

In terms of China’s imports from the United States, machines and computers were also in first place, accounting for 23.13% (31.26 billion USD) of China’s total imports in 2016.4 This proportion reflects the intra-industry trade and the global production integration between these two countries. Therefore, a trade war is likely to have adverse effects on related industries. Steel products have provoked ongoing and tense trade arguments between the United States and China. The United States has criticized China’s official support of steel and aluminum products claiming China has distorted the global markets 4 The

proportion of machine and computer imports also dropped in recent years from 25.11% in 2013 to 23.13% in 2016.

2 Overview of the Trade Relationship …

61

and dumped 100 million tons of steel into the global market. Between 2011 and 2015 the United States filed 29 anti-dumping and 25 anti-subsidy investigations against Chinese companies, of which, 11 anti-dumping and 10 anti-subsidy were concentrated on the steel industry.

2.4 Current Trade Conflicts In the past two decades and especially following China’s WTO accession in 2001, both the United States and China realized significant gains resulting from their trade liberalization and expanding bilateral markets. However, after President Trump’s inauguration, the potential for trade dispute has intensified. First, the U.S. government blamed its long period of slow GDP growth, weak employment growth, and sharp net loss of manufacturing employment on the China’s accession to the WTO. The U.S. government also argued that multilateral trade agreements (e.g., WTO rules) should be limited to countries that pursue free-market principles and implement transparent and functional legal and regulatory systems. Second, the United States has criticized China for its unequal treatment of foreign companies with measures in favor of domestic firms and state-owned enterprises (SOEs), including: (i) state-driven industrial policies that groom domestic firms, particularly favoring SOEs; (ii) government procurement process that is biased toward domestic firms, such as the “secure and controllable” policy for information and communication technology; and (iii) techno-nationalism under the auspices of “Made in China 2025.” In response to these criticisms, China has denied adopting the “secure and controllable” policies to limit foreign trade and notified the WTO Technological Barrier to Trade committee. In the case of the “Made in China 2025” initiative, the Chinese government promised to provide equal opportunities to foreign and domestic enterprises to strengthen the role of the market. Third, the United States named China as a significant market barrier for their exporting firms. Specifically, the United States alleged that China has imposed export restraints (e.g., quotas and licensing) to benefit domestic downstream firms at the expense of foreign competitors. The United States also accused China of using antimonopoly law investigations to protect its domestic industries. Fourth, intellectual property rights have become a hot topic in recent years. The United States complained that its enterprises are often required to transfer their technology as a condition to secure investment approvals. The United States also criticized the poor protection and enforcement of trade secrets by the Chinese government.

62

4 The Day After Tomorrow: Evaluating the Burden of Trump’s Trade …

3 Data We follow Caliendo and Parro (2015) to build a multiple-country and multiplesector model with rich input-output linkages across different sectors.5 Then we rely on the most updated 2015 edition of the OECD Inter-Country Input-Output database (ICIO) to simulate the model. The OECD ICIO 2015 data provide a complete inputoutput matrix for the 34 ISIC Rev. 3 sectors of 61 countries and the rest of the world (ROW) in 2011. Our sample covers 34 OECD countries and 17 non-OECD emerging economies.6 In particulary, our sample includes BRICS (Brazil, Russia, India, China, and South Africa), the four Asian dragons (Korea, Taiwan, Hong Kong, and Singapore), the four Asian emerging tigers (Indonesia, Malaysia, Philippines, and Thailand), and even low-income Asian countries like Cambodia and Vietnam. We drop the last sector (private households with employed persons) because this sector does not provide intermediate inputs for production in other sectors and its output is equal to 0 for half of the countries in our sample.7 In the end, we obtain a sample of N = 62 countries and J = 33 sectors (18 tradable sectors and 15 service sectors).8 The two datasets, OECD ICIO (2015) and OECD STAN ISIC REV3 (2011), provide information on bilateral trade flows, bilateral expenditures, share of value added, shares of materials (intermediate input) in production, and shares of final consumption for each country and each sector. The elasticity of substitution across sectors are taken from Table 1 in Caliendo and Parro (2015). Given these values, we can simulate the model and calculate the changes in output, trade flows and welfare given tariff changes.

4 Quantifying the Effects of Tariff Increases 4.1 Tariff Increases Due to the fact that we use 2011 trade and production as our base year, the countries in our sample are all WTO members and impose MFN tariffs on one another. The sectoral mean or median of MFN tariffs are all less than 3% for all but three sectors,

5 Please

see Caliendo and Parro (2015) for details on basic setup and relative changes in equilibiria of the model. 6 Please see OECD ICIO (2015) for the 61 countries and 34 sectors. The remaining sample countries that are not identified in the text. We also list the main 18 tradable sectors in the following tables and 15 service sectors are not specified in the text. 7 Half of countries do not collect the data on this sector. 8 Athukorala and Khan (2016) suggests that the American relative prices of parts and components are remarkably less sensitive to changes in relative prices compared with that of final goods. For this reason, it would be beneficial to use even more disaggregated industrial data in future research.

4 Quantifying the Effects of Tariff Increases

63

namely, agriculture (3.47%), food (8.07%), and textiles (8.77%). Therefore, we treat the initial tariff as equal to 0 for all countries and sectors.9 President Trump threatened to impose high tariffs of up to 45% on products imported from China in order to offset “currency manipulation”. In this paper, we consider an extreme case in which the United States imposes this tariff on all imports from China. An alternative but equivalent interpretation is that President Trump labels China as a currency manipulator and forces the Chinese currency to appreciate its currency by roughly 45%. Consider an increase from a zero tariff to a 45% United j States tariff rate on all Chinese goods, τˆUSA,CHN = 1.45. We follow Caliendo and Parro (2015) to solve for the equilibrium. First, we guess a vector of relative wages w, ˆ and then we plug wages in the equilibrium conditions to solve the changes in the   j  ˆ and good price Pˆ n w ˆ . Second, we solve the changes unit cost for production cˆ jn w j   in bilateral import shares πni w ˆ . Finally, we solve for the total expenditure in each   ˆ , and then verify if the trade balance holds. If not, we adjust our guess sector Xjn w w ˆ until we achieve the equilibrium condition.

4.2 Sectoral Bilateral Trade Between the United States and China Before we discuss the effects of a tariff increase on trade flows and output, we discuss the relative tradability of the U.S. and Chinese production across different sectors. Table 3 presents the Sino-U.S. bilateral trade flows in 18 tradable goods sectors in 2011. Particularly, the table presents the shares of bilateral import over the total imports and exports in each sector for the United States and China. The second M

j

column, USA,CHN , provides the share of U.S. imports from China in sector j over the j MUSA U.S. total imports in sector j. Two sectors, namely, computers and textiles, have the largest sectoral import shares; both above 45% and China is the United State’s largest trading partner in each of these sectors. Electrical equipment and minerals are the next two largest sectors of U.S. imports from China. Notably, these four sectors are also among the most important sectors of Chinese export to the United States. The M

j

, shows the share of U.S. imports from China in sector j relative third column, USA,CHN j ECHN to Chinese total exports in the same sector. It indicates that China intensively exports to the United States in the computer, wood, plastic, papers, and textiles sectors. By contrast, China intensively imports from the United States in the paper, other transport (such as aircraft), and agriculture (fourth column) sectors. Moreover, about 18% of the total agricultural exports of the United States are consumed in China (fifth 9 Admittedly,

China’s current average import tariff is around 9%. Therefore, a hypothesized 45% high import tariff against China is similar to the effective 36% import tariff against the same country, which is a typical number of China’s special safeguard tariffs imposed by the United States in the past years.

64

4 The Day After Tomorrow: Evaluating the Burden of Trump’s Trade …

Table 3 The sectoral bilateral trade flows in 2011, percent j

Sector

j

MUSA,CHN

MUSA,CHN

j MUSA

j ECHN

j

MCHN ,USA j MCHN

j

MCHN ,USA j

EUSA

Agriculture

2.34

6.24

21.93

18.07

Mining

0.13

4.50

0.71

6.13

Food

7.63

15.17

13.61

7.69

Textiles

45.61

23.89

6.21

8.40

Wood

27.85

26.90

13.08

16.45

Paper

14.48

24.58

43.91

15.70

Petroleum

1.67

6.07

6.20

2.08

Chemicals

7.77

12.93

11.17

9.59

Plastics

25.88

25.82

6.77

6.64

Minerals

31.79

16.57

13.20

11.60

Basic metals

3.53

4.84

3.57

9.96

Metal prod.

28.23

19.92

11.01

5.25

Machinery n.e.c.

20.67

20.39

8.86

8.18

Computer

47.06

29.04

5.88

16.52

Electrical

31.18

21.61

6.02

11.61

Auto

5.43

23.47

8.17

5.73

Other transport

7.44

4.27

27.83

5.18

30.02

24.83

15.55

2.76

Others

Source OECD ICIO (2015) and OECD STAN ISIC REV3 (2011) j

Note:

MUSA,CHN j

MUSA

j

(or

MUSA,CHN j

ECHN

): Imports of the United States from China in sector j over the total

imports of the United States in sector j (the total exports of China in sector j) in 2011

column). In sum, the strength of export capability in the United States and China varies across sectors. For further perspective, Table 4 displays sector-level ratios of imports and exports relative to gross output and the relative output shares in the world for China and the United States. These data show that U.S. imports of textiles, computers and electrical equipment are very high compared with domestic output. These goods are mainly exported by China (shown in Table 3). The U.S. imports from China as a share of all U.S. imports in these three sectors (the second column in Table 3) are all above the China’s sectoral GDP share in world GDP (the last column in Table 4), respectively. The third column of Table 4 shows that United States export advantages are concentrated in in the other transport, machinery n.e.c., and computer sectors. On the production side the United States is responsible for more than 20% of the world output of the paper, petroleum, and other transport sectors. In contrast, China has a different trade structure and production pattern. First, China imports and exports heavily in a number of sectors including computers which

4 Quantifying the Effects of Tariff Increases

65

Table 4 Summary statistics on trade and output percent j

j

Mi /Yi

Sector

j

j

Ei /Yi

j

j

Yi /Yw

U.S. Agriculture

j

j

Mi /Yi

j

j

j

j

Ei /Yi

Yi /Yw

China

7.51

14.48

8.02

3.86

0.91

25.28

Mining

52.90

6.43

9.95

29.81

0.81

18.68

Textiles

141.96

25.87

3.25

2.69

20.83

44.79 42.66

Wood

15.49

7.26

8.37

1.79

3.14

Paper

4.49

12.03

26.30

8.67

5.34

13.04

Petroleum

11.80

15.53

20.56

7.24

4.52

14.85

Chemicals

23.40

24.26

14.98

13.79

9.31

22.67

Plastics

25.04

13.29

10.39

4.02

7.74

33.67

Minerals

17.21

9.70

5.67

1.06

4.09

45.79

Basic metals

33.99

12.72

7.23

6.77

4.73

37.82

Metal prod.

13.79

10.78

14.39

3.74

14.23

19.77

Machinery n.e.c.

43.87

36.64

9.11

9.65

12.67

31.97

Computer

86.95

35.13

10.02

33.55

47.92

29.48

Electrical

68.91

26.28

5.84

6.95

13.64

42.57

Auto

42.42

21.10

12.00

7.93

5.25

22.40

Other transport

14.38

37.82

20.08

8.04

28.60

17.60

Source OECD ICIO (2015) and OECD STAN ISIC REV3 (2011) j

j

j

j

Note: Mi /Yi and Ei /Yi denote the import share and export share in country i’s output respectively, j

and Yi /Yw denotes the output share of country i in the world

is suggestive of involvement in global value chains and processing trade. Second, China produces much more output than the United States in all sectors, aside from the paper, petroleum, and other transport sectors. Based on Tables 3 and 4, we can draw three conclusions about Sino-U.S. production and trade patterns in 2011. First, the United States and China together produce more than 40% of the world tradable goods on average and specialize in different sectors. Second, the total trade of these two countries represents more than 20% of the world trade on average. Third, the trade in the textiles, computer, electrical equipment, machinery N.E.C., and other transport sectors is essential to understand the Sino-U.S. trade relationship.

4.3 Case 1: Unilateral U.S. Tariffs with Balanced Trade We first discuss how output and trade would be affected if President Trump unilaterally imposes a 45% import tariff on Chinese goods, under the assumption that all countries achieve balanced trade afterward. In this case, China’s exports to the United

66

4 The Day After Tomorrow: Evaluating the Burden of Trump’s Trade …

States face higher tariffs, but China does not raise its tariffs on its imports from the United States, which in fact facilitates trade rebalancing between the two countries. Table 5 presents our calibration results regarding changes in output, imports, exports, and bilateral trade between the United States and China. First and as expected, U.S. imports from China in most sectors plummet. Bilateral imports in half of 18 sectors decline by more than 90%. This also leads to a significant decline in sectoral imports for the United States For example, imports in the petroleum, textiles, wood, and computer sectors decline by more than a quarter. To compensate for the fall in imports, domestic production in the United States increases, Table 5 Changes in trade and output—Case 1, percent Sector

j

YUSA

j

MUSA

j

EUSA

j

MUSA,CHN

j

YCHN

j

MCHN

j

ECHN

j

MCHN ,USA

2.37

−8.04

7.29

−97.80

0.83

0.49

−1.63

8.57

Mining

12.31

−4.11

15.90

−99.55

2.22

−5.66

3.84

14.63

Food

−3.42

−11.03

1.94

−75.37

1.32

0.93

−10.12

3.31

Textiles

24.85

−29.34

4.84

−95.69

−6.51

−3.78

−21.30

1.24

Wood

5.46

−28.42

6.66

−99.06

−0.68

−3.90

−23.53

7.54

Paper

5.48

−19.57

14.01

−99.86

−2.84

1.10

−21.75

11.24

Petroleum

14.47

−45.05

60.96

−100.00

2.45

−26.62

17.27

61.40

Chemicals

1.85

−8.19

2.71

−78.54

−2.39

−2.93

−9.55

0.21

Plastics

4.94

−12.42

0.93

−61.17

−3.31

−3.28

−14.96

−1.94

Minerals

6.55

−18.63

2.09

−70.31

1.03

1.01

−10.56

2.99

Basic metals

6.81

3.07

2.40

−78.33

−0.87

−1.81

−2.41

0.25

Metal prod.

7.65

−24.63

5.08

−94.69

−3.09

−3.27

−16.94

3.49

Machinery n.e.c.

−3.05

−18.28

2.32

−62.37

−0.26

0.16

−11.30

1.18

Computer

31.84

−27.53

8.24

−96.05

−14.67

−7.68

−25.63

0.47

Electrical

22.24

−18.27

9.72

−99.32

−2.43

−4.82

−17.97

6.08

Auto

−0.28

−3.96

0.85

−65.33

0.55

0.38

−14.26

1.00

3.58

1.46

1.66

−37.59

1.03

1.51

−1.43

1.67

−0.07

−27.89

3.00

−84.91

−4.83

0.07

−19.96

2.59

7.98

−16.71

8.37

−83.11

−1.80

−3.23

−11.23

7.00

Agriculture

Other transport Others Average

Source Authors’ calculations j j j j Note: YUSA , MUSA , EUSA , MUSA,CHN denotes the sector j’s output, imports, exports, and imports from China in the United States

4 Quantifying the Effects of Tariff Increases

67

particularly in the computer, textile, and electrical equipment sectors, which heavily rely on imports from China before the tariff hike.10 The United States exports increase moderately due to the effects of trade rebalancing. By contrast, the high unilateral U.S. tariff hike has a catastrophic effect on Chinese exports which fall by roughly 13%, with the greatest impacts occuring in the textile, wood, and computer sectors. This tariff shock also leads to a significant decline in China’s sectoral gross output. For example textile and computer sector output decreases by 6.51% and 14.67%, respectively. China’s total imports also decrease heavily in the petroleum and computer sectors by 26.62 and 7.68%. The China’s imports from the U.S. increase in 17 sectors because of trade rebalance. In particular, China’s imports from the U.S. in the petroleum sector increase heavily because the U.S. petroleum production increases 14.47% and also takes a very large share in the world petroleum (20.56% in Table 4). We use the real wage to measure social welfare in each country. By this measure, Table 6 shows that the United States experiences a 0.66% welfare loss, while China also encounters a welfare loss at the much smaller magnitude of 0.04%. On first glance, this result may appear to be counter-intuitive; however, since trade rebalance prevents U.S. residents from financing their consumption by borrowing abroad, the welfare decline occurs as U.S consumption demand and the real wage in turn are depressed. In contrast, the trade rebalancing benefits the Chinese as they do not need to save for other countries, which partially offsets the negative effect of trade war on Table 6 Changes in real wages—Case 1, percent wn /Pn , percent

Rank

Name

wn /Pn , percent

Rank

Name

1

Singapore

2.58

53

France

−0.35

2

Luxembourg

2.17

54

Costa Rica

−0.37

3

Ireland

2.04

55

Cambodia

−0.39

4

Brunei

1.90

56

Romania

−0.51

5

Iceland

1.42

57

Tunisia

−0.57

6

Malaysia

1.40

58

India

−0.65

7

Switzerland

1.19

59

USA

−0.66

8

Norway

1.19

60

Portugal

−0.66

9

Saudi Arabia

1.12

61

Greece

−0.99

10

Netherlands

1.08

62

Turkey

−1.12

38

China

−0.04

Source Authors’ calculations Note: wn /Pn denotes real wages in country n 10 Column

j

j

YUSA (LUSA ) presents the changes in the U.S. output (labor). We use Cobb-Douglas production function with labor and intermediate inputs for all sectors. The changes in sectoral labor inputs are equal to the output changes minus the changes in nominal wage. Since wage is equalized in all sectors within country, the changes in labor shares across different sectors in a country is proportional to the sectoral output changes. This result holds for all cases.

68

4 The Day After Tomorrow: Evaluating the Burden of Trump’s Trade …

Chinese domestic production. If we do not impose trade rebalance and assume that trade imbalance remains the same, then the United States real wage would decline by 0.28% and Chinese real wage would drop by 0.21%. While some countries are also harmed due to their participation in global value chains and due to general equilibrium effects, some small countries, such as Singapore and Luxembourg benefit as the unilateral tariff hike leads to trade diversion. China might increase its exports from those countries in response to the sharp decline in its exports to the United States. Finally, since the U.S. produces more and expands its exports small importing countries will benefit from the lower prices as the prices of goods in equilibrium fall.

4.4 Case 2: U.S.—China Retaliatory Tariff War with Balanced Trade Next, we consider the case when China chooses to retaliate by increasing its tariff to 45% on its imports from the United States. As with the first scenario, we assume that all countries achieve trade balance afterward. Our calibration results in Table 7 show that the bilateral trade between the U.S. and China collapses due to the trade war. The bilateral imports in half of 18 sectors drop by more than 90%. The collapse of trade is particularly pronounced in the sectors where countries have their comparative advantage, U.S. exports of agriculture, wood, paper, and computers, and China’s exports of textile, computer, and electrical products. Overall, the imports of the United States and China decrease by 17% and 6% respectively. While the declines in imports in two countries are consistent, their exports show sharp differences due to trade rebalancing. U.S. overall exports rise by 9% to achieve trade balance, while Chinese exports fall by 15%. In this scenario, the United States faces more severe challenges than China because it needs to boost its exports to restore trade balance. As shown in Table 8, the real wage in the United States decreases by 0.75%, which represents a larger welfare loss than the first case. By contrast, China actually gains slightly. In this case the real wage increases by 0.08%, because the income effect driven by trade rebalancing outweighs the the negative effect of import tariff hike in the United States

4.5 Case 3: U.S.—China Retaliatory Tariff War with Ongoing Trade Imbalance The previous two cases show that trade rebalancing plays an important role in reshaping the trade pattern, output, and real wage for the United States and China. Thus, we consider the third case where trade remains unbalanced and the United States and China both increase their bilateral import tariffs against each other to 45%.

4 Quantifying the Effects of Tariff Increases

69

Table 7 Changes in trade and output—Case 2, percent j

j

j

j

MUSA,CHN

j

j

YCHN

MCHN

j

ECHN

j

Sector

YUSA

MUSA

EUSA

MCHN ,USA

Agriculture

−1.14

−10.67

−10.12

−97.94

2.45

−18.69

−4.84

Mining

14.05

−4.75

11.64

−99.57

1.93

−2.75

−0.27

−99.44

Food

−4.18

−11.85

−3.47

−75.81

2.28

−7.84

−10.80

−72.45

Textiles

−97.27

23.80

−30.31

−1.40

−95.84

−6.29

−7.72

−22.47

−96.40

Wood

3.75

−30.15

−9.12

−99.11

0.38

−14.44

−25.56

−98.90

Paper

3.12

−22.26

−0.26

−99.88

2.30

−41.50

−25.71

−99.81

Petroleum

16.51

−50.34

72.33

−100.00

2.32

−26.74

2.23

−100.00

Chemicals

−0.30

−9.58

−4.20

−79.08

−0.67

−9.16

−10.28

−77.61

Plastics

4.02

−13.27

−2.94

−61.73

−2.46

−6.12

−15.42

−62.96

Minerals

5.43

−19.47

−6.04

−70.80

1.69

−7.64

−11.04

−70.45

Basic metals

4.72

1.35

−5.20

−78.88

−0.13

−3.21

−2.98

−79.13

Metal prod.

6.48

−26.16

1.03

−94.89

−2.35

−11.83

−18.20

−94.46

Machinery n.e.c.

−4.52

−18.98

−2.32

−62.84

0.56

−3.90

−11.66

−58.59

Computer

27.49

−29.13

−4.97

−96.24

−14.26

−9.67

−26.98

−96.88

Electrical

19.87

−19.95

0.11

−99.36

−1.95

−8.06

−19.90

−99.35

Auto

−1.27

−4.65

−2.89

−65.76

1.42

−3.66

−14.72

−64.25

3.05

0.89

−0.34

−38.04

1.60

−8.99

−1.55

−38.69

−0.60

−28.69

1.50

−85.29

−4.13

−11.03

−21.01

−83.27

6.68

−18.22

1.85

−83.39

−0.85

−11.27

−13.40

−82.77

Other transport Others Average

Source Authors’ calculations Note See table notes in Table 5

Table 8 Changes in real wages—Case 2, percent Rank

Name

wn /Pn , percent

Rank

Name

wn /Pn , percent

1

Singapore

2.63

53

France

−0.35

2

Luxembourg

2.17

54

Costa Rica

−0.37

3

Ireland

2.04

55

Cambodia

−0.40

4

Brunei

1.93

56

Romania

−0.51

5

Malaysia

1.47

57

Tunisia

−0.57

6

Iceland

1.42

58

India

−0.65

7

Switzerland

1.19

59

Portugal

−0.67

8

Norway

1.17

60

USA

−0.75

9

Saudi Arabia

1.13

61

Greece

−1.00

10

Netherlands

1.07

62

Turkey

−1.12

37

China

0.08

Source Authors’ calculations Note: wn /Pn denotes real wages in country n

70

4 The Day After Tomorrow: Evaluating the Burden of Trump’s Trade …

Table 9 Changes in trade and output—Case 3, percent j

j

MUSA

j

EUSA

j

MUSA,CHN

j

YCHN

j

MCHN

j

ECHN

j

Sector

YUSA

MCHN ,USA

Agriculture

−3.97

−2.13

−20.56

−97.49

0.24

−28.55

0.66

Mining

−3.49

−0.94

−9.41

−99.50

2.46

−6.56

3.63

−99.59

Food

−0.27

−4.78

−6.58

−73.30

−0.56

−12.17

−9.07

−74.62

Textiles

−97.84

20.83

−19.80

−12.03

−95.05

−5.65

−13.20

−17.45

−96.97

Wood

1.16

−20.36

−20.66

−98.90

−1.12

−21.54

−18.13

−99.14

Paper

−3.14

−9.81

−20.36

−99.83

4.75

−51.70

−14.86

−99.86

Petroleum

−3.02

5.11

−9.93

−100.00

4.22

−40.04

35.44

−100.00

Chemicals

−79.15

−1.20

−4.31

−8.55

−77.70

−1.45

−11.27

−8.46

Plastics

1.84

−13.25

−4.32

−61.40

−3.39

−7.59

−15.26

−64.46

Minerals

1.99

−19.40

−9.42

−70.31

−1.46

−12.05

−10.56

−72.78

Basic metals

0.00

−0.45

−8.81

−78.72

−1.68

−6.11

−2.30

−80.58

Metal prod.

2.22

−21.45

−6.82

−94.33

−3.07

−16.18

−14.55

−95.26

Machinery n.e.c.

−0.07

−8.97

−5.70

−57.96

−1.48

−6.81

−10.12

−60.77

Computer

12.19

−25.21

−19.23

−95.98

−13.14

−11.53

−24.86

−97.39

Electrical

4.59

−15.29

−16.75

−99.27

−2.71

−13.20

−15.40

−99.50

Auto

−0.65

−1.81

−4.71

−64.24

−1.06

−6.72

−14.05

−66.23

Other transport

−0.43

−2.78

−2.50

−40.11

−0.30

−11.63

−1.76

−40.70

Others

3.58

−17.61

−3.63

−82.40

−4.06

−16.40

−16.30

−85.02

Average

1.79

−10.18

−10.55

−82.58

−1.64

−16.29

−8.52

−83.88

Source Authors’ calculations Note See table notes in Table 5

More specifically, we assume the United States maintains trade deficits while China remains in trade surplus as before the trade war. Tables 9 and 10 present our calibration results, demonstrating three differences compared with the case 2 in previous subsection. First, although bilateral imports decrease dramatically as in case 2, China suffers more than the United States in this case, as is shown in Table 11. The reason is that China needs to maintain the trade surplus as before and the United States can still increase its consumption and imports by running trade deficits. Second, the U.S. exports increase in case 2 to restore trade balance despite the trade war, while in case 3 they are depressed by the tariff hike in China. The United States and China both lose in this case as they become the two largest losers in the trade war. The real wage in China and the United States decrease by 0.37% and 0.32%, respectively. China experiences larger losses in this case because

4 Quantifying the Effects of Tariff Increases

71

Table 10 Changes in real wages—Case 3, percent Rank

Name

wn /Pn , percent

Rank

Name

wn /Pn , percent

1

Cambodia

0.22

53

Canada

−0.01

2

Costa Rica

0.11

54

South Africa

−0.01

3

Singapore

0.09

55

Korea

−0.02

4

Viet Nam

0.08

56

Saudi Arabia

−0.02

5

Mexico

0.06

57

Australia

−0.02

6

Israel

0.05

58

Brunei

−0.03

7

Cyprus

0.04

59

Chile

−0.03

8

Italy

0.04

60

HongKong

−0.04

9

Taipei

0.03

61

USA

−0.32

10

Estonia

0.03

62

China

−0.37

Source Authors’ calculations Note: wn /Pn denotes real wages in country n

Table 11 Comparison of the three tariff policies, percent China Var.

Case 1

U.S. Case 2

Case 3

Case 1

Case 2

Case 3

−0.68

−0.07

−1.36

−0.72

−1.08

−0.11

0.01

0.38

−0.42

−0.74

−0.98

0.42

Exports

−12.96

−14.70

−10.61

11.39

9.25

−6.68

Imports

−4.17

−6.09

−10.60

−15.05

−16.68

−6.70

Nominal wage

−0.03

0.46

−0.79

−1.39

−1.73

0.10

Real wage

−0.04

0.08

−0.37

−0.66

−0.75

−0.32

Output Price index

Source Authors’ calculations Note This table compares the output, price index and trade for China and the U.S. for the three policy experiments

the country needs to maintain its large trade surplus while losing its largest marketthat is, the United States. By contrast, the United States slightly improves compared with their situation in case 2 because the U.S. can still maintain its consumption through external borrowing by running trade deficits. However, if we take into account China’s future return on their current saving and the United States’ future payment on its current debt, the welfare loss would be smaller for China and larger for the United States

72

4 The Day After Tomorrow: Evaluating the Burden of Trump’s Trade …

5 Concluding Remarks This paper examines the possible effects of a U.S.-China trade war on international trade, output, and social welfare. Through the use of a standard multi-country and multi-sector general equilibrium model we evaluate the effects of high U.S. tariffs, as were proposed in Donald Trump’s campaign for the U.S. presidency. We simulate three different scenarios depending on whether China chooses to retaliate and whether the U.S.-China trade imbalance is eliminated. In any of the scenarios we find that the trade war will lead to a collapse in bilateral U.S.-China trade. As a consequence the United States will suffer from social welfare welfare losses, while China will also experience social welfare losses if the trade imbalance remains. However, the first two cases imply that China’s best defensive move, given the risk of a trade war with the U.S. is to reduce the total trade surplus and the share of imports she purchases from the U.S. Thus, our findings have important policy implications. On one hand, the U.S. should try to credibly commit to continued WTO-based trade with China since the tariff threat against China leads to further deterioration of the real wage and welfare. On the other hand, China’s focus on “One-Belt-One-Road” (OBOR) countries might be particularly fruitful given China’s already large trade volumes with these countries. Consequently, China can increase its import from non-U.S. countries to reduce the potential losses tied to a trade war with the United States. Two possible extensions merit special considerations. The first is the evaluation of trade policy in the context of regional trade agreements and regional integration. In particular, China is currently active in the pursuit of regional trade agreements, such as the ongoing regional comprehensive economic partnership (RCEP) and the OBOR initiative. For this reason, if the United States were to launch a protectionist action against China, it might also take action against China’s associated trading bloc partners. In turn, the trade war could expand further if China and its partners were to impose trade barriers not only on the United States, but also in the trade bloc partners of the U.S. Second, this paper does not discuss the exchange rate adjustments in which would be triggered by a trade war, but which may play an important role in reshaping the trade imbalance(Woo 2008).11 Nonetheless, our case studies under a number of trade balance scenarios may still shed light on the consequences of a trade war which coincides with an ongoing trade imbalance or a subsequent trade balance. A careful treatment of this question will require the endogenization of the exchange rate and trade imbalance. However, the analysis of this question is reserved for future research.

11 We

thank Professors Wing Thye Woo and Fukunari Kimura for these insightful suggestions.

Chapter 5

The Status of China’s Market Economy and Structural Reforms: Essentials Behind the China-U.S. Trade War

This paper investigates the most essential issues behind the ongoing U.S.-China trade war. In addition to the apparent bilateral trade imbalance, China’s status as a non-market economy, as labelled by the Trump administration, is one of the most fundamental reasons that the United States triggered the U.S.-China trade war. Accordingly, America’s most pressing request is to urge China to implement further structural reform. This paper argues that the current Chinese economy is quickly becoming a modern market economy with a unique Chinese character. This is evident from the ongoing structural reform to create a competitive environment between state-owned enterprises (SOEs) and private enterprises, and through a further opening-up of the market by guaranteeing a wider and deeper market access for inbound foreign direct investment (FDI).

1 Introduction The ongoing U.S.-China trade conflict involves two areas: trade imbalance and structural issues. The U.S. government is asking China to reduce the bilateral trade imbalance by reducing Chinese import tariffs and various non-tariff barriers. More importantly, the United States is urging China to address possible related structural issues. For example, the United States is urging China to create a level field of competition for SOEs and private firms, to implement and enforce intellectual property rights in China, and to eliminate regulations on forced technology transfer, all of which will create a better environment for FDI. It is worth stressing that the American request for structural reform is based on the investigation of China’s status as a non-market economy, released by the U.S. Department of Commerce (USDOC 2017), after China’s 15-year accession to the

This article is originally published in Asian Economic Papers, 2020. © Springer Nature Singapore Pte Ltd. 2020 M. Yu, China-US Trade War and Trade Talk, https://doi.org/10.1007/978-981-15-3785-1_5

73

74

5 The Status of China’s Market Economy and Structural …

World Trade Organization (WTO). The USDOC concluded that China is a nonmarket economy for two reasons: the state’s role in the Chinese economy and its nexus with markets, and the substantial distortions in the private sector. Along with this, in the current U.S.-China trade talks, the U.S. government insists that China implements structural reforms associated with its non-market economy. Evidently, the U.S. request for structural reforms in China is based on its justification that China is a non-market economy. The USDOC report based China’s status as a non-market economy on six related factors: (1) Whether or not China’s currency (RMB) is convertible to other foreign currencies, and more importantly, whether the Chinese government is inclined to depreciate the RMB to generate competitive advantage?; (2) the blue-collar workers in China do not have sufficient bargaining power in wage determination; (3) the limited access of the foreign firms because they are usually not permitted to hold wholly-owned business plants in China; (4) the state still plays a fundamental role in the Chinese economy and private firms cannot compete fairly with SOEs; (5) the extent of the role of industrial policy in China; and (6) the influence of administrative law and the lack of regulatory transparency. Admittedly, these observations appear, to correctly identify, to some extent the features of the Chinese economy. However, it is important to stress that the report’s conclusion regarding China being a non-market economy is based on a comparison with an extremely matured and perhaps highest standard market economy like the United States. If we carefully examine the current Chinese economy, even from the perspective of input factor markets that the U.S. government has focused upon, it would be fair to say that China is quickly approaching the standards of a mature market economy. To shed light on this view and better understand the U.S.-China trade war and the associated structural reform requested by the United States, it is necessary to investigate the factors that have caused the United States to conclude that China is not yet a market economy. This is the task that the present paper picks up. However, we will not systematically explore all six factors mentioned above due to space limitations. Instead, we will focus on the two most important and substantial factors: the role of the state vis-à-vis SOEs and private firms; and the issue of market access of FDI investment in China. The rest of the paper is organized as follows. Section 2 starts with a discussion about the U.S.-China trade conflict. Section 3 examines the trade liberalization in China, including both tariff reduction and non-tariff-barrier eliminations. Section 4 explores the level playing field between SOEs and private firms. Section 5 provides further insights on China’s status as a market economy. And Sect. 6 concludes.

2 U.S.-China Trade Dispute To fully capture the ongoing U.S.-China trade war, we need to understand the cause and consequence of the U.S.-China bilateral trade imbalance.

2 U.S.-China Trade Dispute

75

As interpreted by Liu and Woo (2018) and Yu and Zhang (2019), the Trump administration’s position can be summarized by the following three key points: First, in U.S.-China bilateral trade, China has a trade surplus whereas the United States has trade deficit. Second, how should the bilateral trade imbalance be interpreted? The Trump administration believes that it is because China has an export subsidy on its exporting goods and China imposes high tariffs against imports from the United States. Third, what is the solution to reducing the trade imbalance between the two countries? The Trump administration suggests that the only solution is for the United States to restrict China’s imports by imposing high tariffs on China’s exporting goods. As argued by Yu and Zhang (2019), the above-mentioned points are inaccurate or misunderstand the essential tenets of U.S.-China. bilateral trade. First, it is true that China keeps a huge trade surplus from the bilateral trade with the United States. As seen in Fig. 1, the trade surplus emerges in the early 1990s and then increases to USD 330 billion in 2018. The U.S.-China bilateral trade surplus is the most important source of China’s total trade surplus. In 2004, the bilateral trade surplus was around 2.4 times higher than China’s total trade surplus. In other words, China had a trade deficit with many other trading partners. The U.S.-China trade surplus ratio to China’s total trade surplus declines over time, but still maintain a high plateau of 88.1%. By contrast, the U.S.-China trade imbalance is also the most important source of American trade deficit. The U.S.-China trade deficit ratio to American total trade deficit increases over time and registered at 36.4% in 2018.

Fig. 1 China-U.S. bilateral trade, 1992–2018 (bn). Source CEIC dataset

76

5 The Status of China’s Market Economy and Structural …

However, a trade surplus itself is not necessarily good for China while a trade deficit itself is not necessarily bad for the United States, as also pointed out by Liu and Woo (2018). To better understand this point, we need to recognize that China uses most of its incremental current account surplus generated by the trade surplus with the United States to re-purchase American treasury bills, bonds, and assets. Indeed, China is the United States largest creditor. China’s trade surplus is not necessarily good for the Chinese economy due to, in large part, the related import inflation induced by the trade surplus. China’s central bank requires Chinese firms to sell its earned trade surplus to the central government.1 In this way, more Chinese yuan (RMB) will flow into the market. The exact magnitude is enhanced due to the well-known monetary multipliers. For instance, if Chinese firms sell USD 150 billion to China’s central bank, by assuming the exchange rate to be around 6.7 between RMB and USD, there will be around 1000 billion RMB flow into the first commercial bank. If the required reserve ratio is 20%, the increased currency in the Chinese economy will be five times higher than the original amount, which means the induced monetary injection will be 5000 billion RMB. Given that China’s broad money supply (i.e., M2) is roughly 180 trillion RMB, this will generate an inflationary pressure of about 3%. This gives the Chinese government a strong incentive to reduce the U.S.-China trade surplus. Just as the trade surplus is not necessarily good for China, the American trade deficit is not necessarily bad for the United States. This is especially true due to the privilege of the U.S. dollar’s sovereignty tax. As a return of China’s exportable goods, Chinese firms earn U.S. dollars back. Pursuant to Chinese regulations, Chinese firms are required to sell half of its foreign reserve to China’s central bank—the People’s Bank of China. However, once the Chinese government holds a huge amount of U.S. dollars, it seeks to invest it worldwide. Currently, it seems that the most attractive investment is still the U.S. treasury bills, bonds, and securities. As seen in Fig. 2, China is the largest holder of U.S. bonds. China’s global share of U.S. securities increased from 6% in 2000 to around 20% in 2017 and reached a peak of more than 25% in 2010. China itself holds one- quarter of U.S. bonds whereas the other three quarters of China’s total bond is held by 200 countries. Second, the bilateral trade imbalance is essentially due to the comparative advantages of the two countries based on their respective factor endowments. China is a labor abundant country and hence its labor cost is relatively cheap. Accordingly, China has a comparative advantage in labor intensive industries such as garments and textiles. In contrast, China’s trade surplus on capital intensive industries is due to its engagement in the processing trade. This is consistent with the observation that most industries with a trade surplus are industries that engage intensively in the 1 This is especially true before 2006 in which The PBoC required that all firms have to exchange their

US dollar earning obtained from international trade for RMB. During 2006–2012 PBoC allowed large firms or experienced firms to retain USD earnings but small firms are still required to sell their earned US dollars to the states. After 2012, PBoC phased out such a regulation (See related announcement in State Administration of Foreign Reserve of China on Apr. 16, 2012). But many Chinese firms still self-select to exchange earned US dollars for RMB due to the expectation of RMB appreciation.

2 U.S.-China Trade Dispute

77

Fig. 2 China’s investment in American treasury bonds. Source CEIC dataset

processing trade (see, for example, Yu 2015; Dai et al. 2016). Processing trade is a popular and important mode of trade in China where she imports raw materials or intermediate inputs from other countries, and then re-exports the final goods to other countries after local assembly (Tian and Yu 2015; Dai et al. 2016). Processing trade accounted for around one-a half of China’s total exports before the 2008–09 global financial crisis (GFC) and today still accounts for one-third of China’s total export by registering around USD 700 billion, as seen from Fig. 3. Suppose that both China and the United States do not adopt any strategic trade policies, China will still have its trade surplus. The trade imbalance is a natural result of the economic structures and the respective factor endowments of both countries.

Fig. 3 China’s processing trade as a share of export, 1993–2018 (%). Source China’s customs, author’s own calculations

78

5 The Status of China’s Market Economy and Structural …

3 Trade Liberalization and Non-tariff Barriers

45 40 35 30 25 20 15 10 5 0

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

In 1992, the simple average of China’s tariffs was 39.7%. It fell to 7.5% in 2017 and could fall even further with the setup of regional and bilateral free trade areas (Fig. 4). Ing et al. (2019) indicated that there are around 7332 non-tariffs measures (NTMs) in China. China has 29 regulatory agencies that are responsible for issuing and enforcing regulations related to NTMs. The top five agencies focus mainly on food safety, animal and human health, product safety and quality, and environment protection. As shown in Table 1, these top agencies that issue and enforce NTMs are: Standardization Administration of PRC (SAC); General Administration of Quality

Fig. 4 China’s import tariffs (1992–2017) (Simple average %). Source Yu and Zhang (2019)

Table 1 China’s non-tariff measures Ranking

Issuing agencies

% of total number of NTMs

Number of NTMs

1

Standardization Administration of China (SAC)

48.69

3565

2

General Administration of Quality Supervision, Inspection and Quarantine (AQSIQ)

28.28

2071

3

Ministry of Commerce

4.67

342

4

Ministry of Agriculture

4.66

341

5

General Administration of Customs

3.74

274

6

Others

9.96

739

Number of Total NTMs

100

7332

Source Ing et al. (2019), Authors’ own calculation

3 Trade Liberalization and Non-tariff Barriers

79

Supervision, Inspection and Quarantine (AQSIQ); Ministry of Commerce; Ministry of Agriculture; and General Administration of Customs. Yu (2015) has shown that trade liberalization significantly boosts Chinese firm productivity. Particularly, aside from processing export, input trade liberalization has a stronger impact on fostering firm productivity than output trade liberalization. Similarly, China’s NTB elimination has had a positive impact on promoting firm efficiency (Luo and Yu 2019).

4 China’s Inward FDI: Achievement, Challenges, and Recent Reform 4.1 Achievement China is the second largest destination for FDI in the world. In 2018, China’s inward FDI amounted to USD 135 billion and accounted for around 11.2% of the global inward FDI, as reported by Ministry of Commerce of China.2 In 2018, China’s FDI to GDP ratio was around 2% of China’s GDP of USD 13.2 trillion. In the past four decades, China’s inward FDI experienced an incredible increase. It is also important to distinguish between scheduled inward FDI and realized inward FDI. In fact, the realized inward FDI is smaller than the scheduled inward FDI due, in part, to the sudden financial challenge faced by foreign firms or potential adverse international conditions or changes in China’s investment environment (Fig. 5).

Fig. 5 China’s inward FDI (1997–2018). Source CEIC dataset

2 See

http://english.mofcom.gov.cn/article/statistic/.

80

5 The Status of China’s Market Economy and Structural …

In the past 40 years, there were more than 960,000 foreign firms that invested in China. China’s accumulated realized inward FDI amounted to more than USD 2.1 trillion. Before China’s move to establish the socialist market economy in 1992, the value of inward FDI was only around USD 4.37 billion. After more than one decade and just before China’s entry into the WTO in 2000, China’s realized FDI recorded a ten-fold increase and stood at USD 40.7 billion. By 2012, China’s inward FDI had reached a plateau of USD 120 billion. In 2014, the ratio of China’s FDI to global FDI was 10.5%. It reached a new peak in 2018 with an amount of USD 135 billion.

4.2 Challenges The declining trend of China’s FDI to GDP ratio over the last two decades, especially after China’s accession to the WTO in 200, is a major challenge. One reason for this decline is that the growth rate of GDP is higher than that of inbound FDI. Another possible reason is the existence of some hurdles to invest in China. In particular, the U.S. government blames China’s inward FDI policy. The U.S. complaints focus on the following issues. First, foreign investment in many industries face restrictions on equity share or the form of corporate joint venture (CJV) or equity joint venture (EJV). Such sectors include agricultural sectors, telecommunication services, banks, insurance companies, and medical institutions. The Chinese government released a document called “Foreign Investment Catalogue”. The most recent version was revised in 2017. The catalogue includes three categories of foreign investment: encouraged, permitted, and restricted. The U.S. government complains that the 2017 amendment of the catalogue still has too much restrictions on foreign investment. For instance, 28 industries are still classified as restricted sectors, as shown in Table 2. Second, foreign investment in China is plagued with a bureaucratic, onerous, and time-consuming and complicated processes. FDI is often required to get the approval of several different government authorities. A wholly foreign-owned investment, for example, is usually required to get dual approval from both the Ministry of Commerce (MOFCOM) and National Development and Reform Commission (NDRC). The MOFCOM is interested in whether the investment fits with the development of China’s national economy whereas the NDRC focuses more on whether the potential investment has a substantial adverse impact on public interests. Some investments are now permitted to file solely with MOFCOM, but such investment still needs to seek approval from other Chinese government agencies. Third, “forced technology transfer” is a longstanding concern of foreign investors in China. The USDOC complains that some foreign investors are forced to transfer their advanced technology to Chinese partners. In practice this mainly happens in EJV sectors such as electric vehicle and drug industries. As Chinese local governments may provide procurement preferences to technology localization, foreign investors consequently face a trade-off between losing a significant market share and forced technology transfer.

4 China’s Inward FDI: Achievement, Challenges, and Recent …

81

Table 2 Restricted industries by foreign investment 1. R&D, breeding and cultivation of rare and peculiar species and production of relevant propagation materials including superior genes in crops, animal husbandry and aquatic sectors in China

15. Radio stations, TV stations, radio and TV channels and transmission networks at all levels on-demand radio and TV broadcasting and installation of ground receiving facilities of satellite TV broadcasting

2. Selection and breeding of transgenic crop, animal and aquatic species as well as the production of their transgenic seeds

16. Development and application of technologies in respect of human stem cells, gene diagnosis and treatment

3. Consultation on Chinese legal affairs

17. Surveying and mapping on geographic and geological information

4. Prospection and exploitation of tungsten, molybdenum, tin, antimony and fluorite

18. Exploitation of wild animals and plants originating from China and protected by the State

5. Rare earth prospection, exploitation and mineral processing

19. Compulsory education institutions

6. Radioactive minerals prospection, exploitation and mineral processing

20. News agencies

7. Processing of Chinese medicines and production of traditional Chinese medicine patent drugs with secret formulas

21. Internet news information services, online publishing services, online audio-visual program services, venues to provide internet access and internet culture-related services

8. Smelting and processing of radioactive minerals as well as nuclear fuel production

22. Edit, production and publication of audio-visual products and electronic publications

9. Arms and ammunition manufacturing

23. Fishing of aquatic products of sea areas and inland waters within China

10. Chinese art paper and ink ingot production

24. Production companies of radio and TV programs

11. Air traffic control

25. Films-making companies, film distribution and marketing companies

12. Postal service companies and domestic courier business of delivering letters

26. Edit and publication of books, newspapers and periodicals

13. Wholesale and retail of tobacco, cigarettes, leaf tobacco and other tobacco products

27. Auction of cultural relics and cultural relic shops

14. Social research

28. Institutes of humanities and social science

Source China’s Foreign Investment Catalogue (2017 Amendment)

However, the relatively poor performance of some foreign firms may not be because of the Chinese government’s intervention, but because of a poor understanding of the Chinese market. For instance, U.S. companies like Amazon and E-bay have performed relatively poorly because they are not able to understand the Chinese market as well as their domestic counterparts Alibaba or Tencent.

82

5 The Status of China’s Market Economy and Structural …

4.3 Recent FDI Reform In March 2019 China’s national congress conference passed a new law on FDI which will be enforced in January 2020, as reported by China’s State Council. It combines the three previous laws on FDI: The act of China and foreign equity joint venture; the act of China and foreign corporate joint venture; and the foreign whollyowned foreign firms. The new foreign investment law clearly defines how foreign investors are identified First, a foreign investor is one who establishes a foreignfunded firm solely or jointly with any other investors. Second, a foreign investor is one whom acquires property shares, equity, or stock share or any other similar ownership within China. Third, a foreign investor is one who solely or jointly with any other investors develop a “green-field” new investment project. The new FDI act also clearly identifies that firms from Hong Kong, Macau, and Taiwan are classified as “foreign firms” and can enjoy all the rights mentioned in the new FDI law. The most important features of China’s new investment law are rules on market pre-entry national treatment and the negative list. In particular, a foreign investor is guaranteed to have the same rights and access to the same beneficial policies that the Chinese government gives to Chinese firms in the same industry. There exceptions, are clearly classified in the investment “negative list”. For industries or business activities that are mentioned on the negative list, the Chinese government is not required to give the same access or equal rights to foreign investors. In early discussions, the Chinese government also promised that it will reduce the content and the length of the negative list. Second, the new FDI law simplifies the procedure and entry threshold of foreign investment in China. Before this act, if a foreigner was interested in investing in China, he had to seek permits and approval from related Chinese government agencies. Particularly, a foreigner had to take three steps to establish a firm in China: first, the investor had to submit all required documents to the government department. The designated department, which usually is the national development and research commission of the different tiers of China’s government, will check whether the firm’s contract and its business activities abide with the requirement. Next, the government will verify and file the firm’s exact investment areas. After that, the potential firm had to seek industrial permission to ensure that its investment project was not on the prohibited list. And if everything is satisfied, the firm was allowed to register in the system and start its business operation. In contrast, under the new act the foreign investor only needs to ensure that his investment is not on the prohibited list. Third, the new act strengthens the promotion, protection, and management of the new firm by establishing a complete FDI service system. The Chinese is government also trying to establish a dispute settlement system for foreign firms. It also ensures that foreign firms have the same rights to participate in Chinese government procurement programs. Furthermore, foreign firms also have identical rights as Chinese domestic firms to engage in the establishment of industry standards. Most importantly, the new act clearly emphasizes that foreign firms cannot be forced to transfer related technology.

5 Leveling the Playing Field Between SOEs and Private Firms

83

5 Leveling the Playing Field Between SOEs and Private Firms 5.1 Development of SOE and Private Firms A hot debate is whether the Chinese economy today exhibits a phenomenon of “state strike back and private retreats”. Scholars holding this view argue that SOEs today are much larger and more profitable than private firms (Lardy 2014, 2018) and employ more workers than private firms. Admittedly, this observation fits with the reality of the Chinese economy in recent years, especially after the GFC. However, if a longer period is examined, a different picture of “state retreats and private forward” becomes evident. Particularly, the SOEs accounted for two-thirds of the Chinese economy prior to China’s WTO accession in 2001 but has shrunk to around less than 40% today. In 2018, private firms in China contributed one-half of China’s total corporate tax, 60% of China’s GDP, and accounted for 70% of China’s technology innovation. Moreover, private firms also generated more than 80% of China’s urban employment and they comprised 90% of China’s total firms. Today there are around 34 million firms in China. Everyday around 18 thousand new firms register to start their business, as reported by China’s National Development and Reform Council (NDRC). Meanwhile, SOEs are mostly concentrated in the upstream and service industries and still maintain an influential impact on the Chinese economy. Since 1998, China’s government has adopted a strategy of “grasp the large and let the small go”. Large firms are maintained and consolidated into SOEs, but small firms are allowed to privatize. A new government agency called the State-owned Assets Supervision and Administration Commission (SASAC) was established to supervise the largest 102 central-controlled SOEs and their subsidiaries. According to the USDOC, in 2017, the largest 115 Chinese firms on the Global Fortune 500 are state-owned, though the famous Huawei is an outstanding exception. Of these 115 giants, 48 are directly governed by central SASAC. SOEs are still the leading firms in several key areas such as aerospace, automotive, banking and finance, energy, and telecommunications, as reported by the SASAC.

5.2 Reform for Competitive Neutrality In recent Chinese national congress conferences, the government emphasized that China will forcefully enforce six-related policies to guarantee a competitive neutrality between SOEs and private firms. As recently released by China’s National Development and Reform Council, such policies include: (1) Reducing tax and phasing-out administrative fee by RMB 2 trillion (Or equivalently USD 300 billion);

84

(2) (3) (4) (5)

5 The Status of China’s Market Economy and Structural …

Encouraging direct investment from capital markets; Simplifying the administrative procedure; Easing the market access by using investment negative list; and Forcefully protecting property rights, especially for private firms.

First, China’s environment for doing business in 2018 improved significantly. This can be seen from China’s ranking in the doing business index. China ranked 93 in 2017 and moved up to 46 in 2018, as shown in the doing business report of the World Bank (2019). Perhaps the essential way to improve the environment of doing business in China is to simplify the administrative procedures. China’s government emphasizes separating government permits from the business license nationwide. A number of government permits have to be abolished to reduce the duration of setting up new businesses. Also, various types of industrial production permits were phased-out by over one-third. Second, China’s National Congress emphasized wider and deeper market access for foreign firms in March 2019. China will not only allow external opening-up but also emphasize internal opening-up. Particularly, SOEs, private firms, and foreign firms will be treated equally on factor access, market entry permission, business operating, and even government procurement. The investment negative-list system will be implemented forcefully. And government also aims to substantially shorten the length of the negative list. Third, regarding SOE reform, China is committed to actively and systematically push the reform of ownership. A mixture of both state-owned and private ownership will be highly encouraged. Accordingly, consumers can better share the related reform dividend. Moreover, some industries with natural monopoly features such as electricity, gas, and railway must open up their competitive business branch to allow private firms to enter. Fourth, another key reform, emphasized in the official central government working report in Mach 2019 by Premier Li Keqiang. mentioned in China’s government statement (2019) is that China will reduce the burden of the corporate value-added tax and social security payments by RMB 2 trillion (equivalent to USD 300 billion), which is much higher than the tax and payments reductions of RMB 1.3 trillion in 2018. The most important category of tax and fee reductions is of the value-added tax. Based on the previous round of tax and fees reduction in May 2018, the government dropped the value-added tax rate on manufacturing industries from 16 to 13% and dropped the rate on firms in the transportation and construction industries from 10 to 9%. Although the tax rates of both production and service industries still remain at 6%, China’s government now allows tax reductions on more items in those industries. Table 3 lists such reform outcomes. Fifth, regarding pension reform, the government reduced the coverage of urban employee pension required of employers (firms). Such proportions used to vary by province and ranged from around 19 to 20%. After the reform, the coverage was reduced to 16% universally. This reform is particularly important and beneficial to firms in labor-intensive industries given that such firms only have a thin margin of

5 Leveling the Playing Field Between SOEs and Private Firms Table 3 Reform on cutting value-added tax rates and social security payments

85 2018 (%)

2019 (%)

Manufacturing sectors

16

13

Transportation and construction sectors

10

9

6

6

Service sectors

Source Chinese Government Work Report (2019)

profit due to increasing labor costs in China. Since private firms concentrate largely on labor-intensive industries, this new policy benefits private firms as well. Sixth, this round of reform also emphasizes the incremental role of direct financing. Currently, indirect financing plays a more important role than direct financing. When firms are short of working capital, the conventional and most important financing channel is to borrow from commercial banks. As mentioned above, an interesting phenomenon is that private firms borrow from banks much less than SOEs do. In fact, the share of indirect financing by private firms is only around 30%. Moreover, private firms have to pay a higher interest rate than SOEs. The annual interest rate premium is around 9–13% (Chen et al. 2019). Therefore, an increase of the share of direct financing can significantly reduce the financing cost of private firms. This is achieved by several financing approaches such as issuing bonds by firms, equity financing, and transferring from bond to equality share. The government even encourages private firms to issue corporate bonds if such bonds are designed to finance firm innovation. To further support China’s innovation, China adopted a low corporate income tax rate of 15% for high-tech firms, which is 10% lower than for non-high-tech firms. China also encouraged big leading firms to setup research institutes and engage in innovation. Indeed, 28 out of the world’s 500 big leading firms are Chinese private firms.3 Furthermore, it is important to note that 90% of artificial intelligence (AI) firms are private firms (see, e.g., McKinsey Global Institute 2017). Most of those AI innovation are driven by market demand. Indeed, AI-oriented private firms in China, like Baidu, Tencent, Alibaba, and iFlytek, are closely tied to China’s government plans to develop AI software and hardware systems to handle language processing autonomous driving.4 Seventh, another helpful policy is that China has adopted an active monetary policy by dropping its required reserve ratio. In March 2019, the PBoC dropped the deposit reserve ratio by 1%, which will increase long-term capital by around RMB 800 billion. The required reserve ratio for private firms and small firms is even lower than that for all firms. Eighth, another financial challenge faced by private firms is that they bear the burden of heavy accounts receivable. Such credits are owed by local government 3 See,

e.g., https://www.scmp.com/business/companies/article/3019632/first-china-has-morecompanies-fortune-global-500-list-us. The complete list of Global 500 can be found from https:// fortune.com/global500/2019. 4 See https://www.marketwatch.com/story/china-is-overtaking-the-us-as-the-leader-in-artificialintelligence-2019-02-27.

86

5 The Status of China’s Market Economy and Structural …

Table 4 Major reform for competitive neutrality Reform

Detailed policy arrangement

1.

Market access

SOE and Private firms are treated equivalently on factor access, market entry permission, business operating, and even government procumbent

2.

SOE reform

A mixture of both state-owned and private ownership will be highly encouraged

3.

Tax and fee cut

Reduce firm’s burden on corporate value-added tax and social security’s fee by RMB 2 trillion

4.

Pension

Drop from 19% (20%) to 16%

5.

Finance and loan

Increase share of direct financing. Encourage private firms to issue corporate bonds if such bonds are designed for firm innovation

6.

Monetary policy

Drop deposit reserve ratio by 1% to increase long-term capital around RMB 800 billion

7.

Debt and account receivable

Requires central and local government must clear a half of the debt borrowed from private firms in the end of this year

Source China’s State Council (2019)

or SOEs. To address this challenge, the government now requires central and local governments to clear one- half of the debt borrowed from private firms by the end of 2019. The accounts receivable of private firms mainly focuses on construction projects. Indeed, until January 2019, both government departments and large SOEs have already cleared the debt owed to private firms to the tune of more than RMB 160 billion. Last but not least, the Chinese government work report (China’s state council 2019) also emphasizes issues in implementation. Although the central government also emphasizes equal treatment and competitive neutrality between SOEs and private firms, in practice local governments do not implement such policies. To address this issue, the central government has stressed that governments at all levels cannot purposely choose policies skewed toward their own interests. It is recognizing the importance of inspecting government inspectors as well. Table 4 lists the important reforms discussed above.

6 Further Discussion on China’s Status on Market Economy 6.1 China Is not a Currency Manipulating Regime Thus far, we have shown that China has implemented and enforced many policies to create a level playing field between private firms and SOEs, as well as to guarantee

6 Further Discussion on China’s Status on Market Economy

87

easy market access for FDIs. As mentioned previously, the USDOC report on China’s status as a non-market economy also complains that China inclines to manipulate its own currency by depreciating the RMB against U.S. dollar. We now go to examine whether this is the case. Admittedly, the Chinese Yuan (RMB) is still not a free convertible currency in the sense that China’s capital account is still not freely convertible. However, China’s current account has already been convertible for around two decades. Since 1994 China maintained a fixed exchange rate against the U.S. dollar for around a decade. One U.S. dollar was fixed as being equivalent to 8.27 RMB during 1995–2005 period (Liu and Woo 2018). Since July 2005 China adopted a managed floating exchange rate regime. Up to August 2019, the RMB has already appreciated to around more than 15.5% given that today one U.S. dollar converts to around 7 RMB. The U.S. Department of Treasury (USDOT) has investigated three times (i.e., January 2017, October 2018, and May 2019) if China has an intention to manipulate its currency against the U.S. dollar. According to the criteria set by USOT itself, to label a country as a manipulating currency regime, the surplus country must satisfy the following three criteria. Firstly, the surplus country’s current account surplus to GDP ratio must be always higher than three percent for several continuous years. Secondly, the surplus country has seriously intervened foreign exchange rate markets for own currency depreciation in the past six months. Finally, the surplus country keeps total trade surplus with more than USD 20 billion. By carefully examining these three criteria mentioned above, only the third criterion applies to China given that China’s total trade surplus is more than USD 20 billion. However, some other countries like both Germany and Japan also keep trade surplus with more than USD 20 billion. Such countries are not labelled as “currency manipulators” as well. However, it is important to stress that the first two crucial indices do not apply to China indeed. China’s ratio of current account surplus to GDP was more than three percent only in 2015 (i.e., 3.1%). For all other years in the twenty-first century, China’s ratio of current account surplus to GDP vary between 1.6 and 1.8% over years, which were much lower than the threshold of three percent.5 Moreover, there is no hard evidence to show that the Chinese government intervene the foreign market for RMB depreciation. By carefully reviewing RMB exchange rate variation and PBoC’s response. One may conclude that the Chinese government indeed take actions, if any, to support for RMB appreciation. For example, when RMB depreciate to 1:6.97 in late September 2018, the PBoC indeed advised markets to support for RMB appreciation by asserting that China has no incentives for RMB’s further depreciation. Perhaps because of these observations, the USDOT concluded three times, correctly, that China is not a currency manipulating regime. Unfortunately, on 7 August 2019, the Trump administration mistakenly labelled China as a currency manipulating country without any further formal and necessary investigation. 5 Trump

administration lower the criterion to two percent in early 2019. But even so, China’s ratio of current account surplus to GDP is still lower than this threshold.

88

5 The Status of China’s Market Economy and Structural …

It is also worthwhile to discuss whether China has an incentive to depreciate the RMB to give an export competitive advantage. Those who advocate this view see a pretty fast RMB depreciation during the current U.S.-China trade war. In June 2018 just before the first round of the trade war, one dollar was convertible to around 6.5 RMB. Only after four months, in mid- September 2018 when the second round of the trade war was launched, the RMB depreciated by more than five percent— 1 dollar was converted to RMB 6.97. However, it is important to stress that RMB depreciation was not engineered purposely by China. Instead, the sharp depreciation was mainly because the market did not foresee the U.S.-China trade war and the prevailing uncertainty. In its own interest, China has no incentive to depreciate RMB even though it seems that a depreciation of the RMB can foster Chinese exports in the short run. Indeed, RMB depreciation is politically unfavorable as well, given that China is promoting the Belt and Road Initiative (BRI). RMB depreciation would harm the interest of ASEAN countries that have export structures similar to China. China is putting much effort in promoting the Regional Comprehensive Economic Partnership (RCEP). The support from ASEAN countries is key to the success of RCEP. From this perspective it is easy to understand why China has no incentive to depreciate its currency.

6.2 Discussion on Wage Bargaining One last debate is whether the blue-collar workers have wage bargaining power in the Chinese economy. People who are skeptical observe that labor unions seems not to play a key role in the wage bargaining process. In addition, workers seem not to have more bargaining power compared to management. However, if we consider the Chinese economy against the background of globalization, it is easier to understand the role of labor unions in China. China is a labor abundant country and it exports a labor intensive product, which is consistent with the prediction of Heckscher– Ohlin theorem. Accordingly, the price of labor-intensive products such as textiles and garments will increase due to trade globalization. Blue-collar workers, as the abundant factor, benefit from trade liberalization. This classical Stolper-Samuelson (1949) prediction finds its empirical verification in China. The cost of China’s bluecollar has already risen to USD 750 per month, which is more than triple the rate from a decade ago. Compared to other labor abundant countries in east Asia, Chinese bluecollar labor cost has already risen four times higher than that in Bangladesh whereas the Chinese white-collar wage rate is twice as high as that in Bangladesh, as seen in Fig. 6. Admittedly, the rise of labor cost is also due to the relative shortage of labor in urban regions. Still, the strong labor demand is the most important driving force pushing up the wages of Chinese blue-collar workers (Chen et al. 2017). Given the sharp increase in wages, it does not provide much incentive for labor unions to press management to further increase in their wages.

7 Conclusion

89

Fig. 6 International comparison of labor costs in manufacturing sectors. Source Data are from CEIC database. Note Data are in 2014

7 Conclusion This paper investigates the essential issues behind the ongoing U.S.-China trade war. In addition to the apparent bilateral trade imbalance, the fundamental reasons that the United States triggered the trade war was based on the claim that China was not a market economy as defined by the Trump administration. Therefore, the U.S. government has requested that China focuses on the following structural reforms: further opening-up its agricultural and service sectors, providing more market access for foreign investment, and creating a competitive environment where both SOEs and private firms can compete on an equal footing. This paper argues that, in large part, the current Chinese economy is quickly approaching a modern market economy with some unique Chinese characteristics. The ongoing efforts include attempts to create a competitive neutrality between SOEs and private enterprises, and to push for a further opening-up of the Chinese economy by guaranteeing a wider and deeper market access of inbound FDI.

Chapter 6

Three Tasks for Building an All-Around Opening-Up Strategy

The 19th National Congress of the Communist Party of China (CPC) report states that a new pattern of increased reform and opening-up should be fostered in China. To this end, I believe China’s efforts should be focused on three aspects: (i) deepening the reform of free trade zones and accelerating the development of free trade ports; (ii) constructing an appropriate top-level design and prioritizing the development of the Guangdong-Hong Kong-Macau Greater Bay Area; (iii) continuously improving the experimental work for building a new, open economy.

1 A Historic Task of the New Era: Developing Free Trade Ports Building free trade ports answers the need to develop an open economic system. In terms of China’s reform process, it also represents a historic task brought about by this new era. In fact, China took a gradual approach to opening-up starting from a few individual cities to a few dozen and, eventually, to a network of them. In the early 1980s, four coastal cities, Shenzhen, Zhuhai, Shantou, and Xiamen, were opened to the outside. In the mid-1980s, 14 more cities were “opened up,” along with the establishment of six economic deltas. The opened cities were located along China’s Eastern coast. After Deng Xiaoping’s Southern Journey, national level or hi-tech open zones were established in many provincial capitals in Eastern and Central China. As a result, the “Opened Cities” formed a tightly interlaced network. At the beginning of the twenty-first century, China was allowed to enter into the WTO. In order to further “open,” sixty export processing zones were established. After the global financial crisis in 2008, China’s first pilot free trade zone was developed in Shanghai in 2013. Then, more zones emerged in Guangdong, Tianjin, and Fujian, followed with those in Liaoning, Zhejiang, Henan, Hubei, Chongqing, Sichuan and Shaanxi. As a result, a new pattern of “opening-up” took shape, with

© Springer Nature Singapore Pte Ltd. 2020 M. Yu, China-US Trade War and Trade Talk, https://doi.org/10.1007/978-981-15-3785-1_6

91

92

6 Three Tasks for Building an All-Around Opening-Up Strategy

pilot free trade zones evenly distributed among Eastern, Central and Western China including landlocked and coastal areas. Free trade ports are more open than pilot free trade zones. In simple terms, they are ports reserved by the Chinese government for the free entry and exit of overseas commodities, capital, or vehicles. Free trade ports share two key differences with pilot free trade zones. First, free trade ports provide more open and flexible policies for the trade of goods, i.e., unconditional admittance, no need for licensing and examinations, and register by recording. Second, in addition to the trade of goods, the sole domain of pilot free trade zones, free trade ports allow more freedom for personnel flow and supporting financial services. In fact, the success of a free trade port lies in the fast and convenient mobility of people, capital and goods. Third, free trade ports are commonly built on the basis of pilot free trade zones. In a few cases, however, they can also take root directly in well-developed ports. Moreover, as a broad concept, the free trade port includes coastal and border ports, as well as well-developed inland airports. For example, Chengdu, the largest city in Western China, is capable of becoming a free trade airport, due to its strong economic foundations, and its strategic position as the leading player in China’s Western Development Drive and an important node along the Silk Road Economic Belt. In order to spur the development of free trade ports, reform must be carried out in three areas. First, China must facilitate port trading in goods, improve port infrastructure, and build an IT-based logistics network. Also, a safe and efficient electronic clearance system must be put in place in major ports. Second, human mobility must be increased. In order to benefit the travel and residence of foreigners working in China, we must standardize the work permit system and design an efficient talent visa system. Furthermore, we must attract hi-tech and innovative talents with preferential treatment. Third, financing must be made easier. In order to facilitate foreign exchange settlement, we must implement policies related to opening capital accounts in free trade zones on a pilot basis. In addition, a supporting financial lease system must be built, in order to provide adequate funds to trade activities within ports.

2 Key to Building a New Pattern of Increased Opening: Developing the Guangdong-Hong Kong-Macau Greater Bay Area At present, urbanization and industrialization are the necessary requirements for growing China’s economy; developing five city clusters and industrial clusters offers the key to industrialization. Though occupying only half of China’s land, the five

2 Key to Building a New Pattern of Increased Opening: …

93

city clusters are home to about 40% of its population, 70% of its universities, and 60% of its GDP. Among the five clusters, the Guangdong-Hong Kong-Macau Greater Bay Area stands out, as it is nearly fully developed. Problems with other city clusters are evident. The development of Beijing-Tianjin-Hebei Area is led by the mega-cities Beijing and Tianjin, while the place between them (Langfang City) remains poorly developed. The city clusters along the middle and lower reaches of the Yangtze River only include the metropolises of Wuhan, Changsha, and Nanchang. Further, Chengdu and Chongqing are still separated in many ways, although they and their surroundings form a cluster. Among the five clusters, only the Yangtze River Delta can rival the GuangdongHong Kong-Macau Greater Bay Area. In further analysis, the nine cities (Guangzhou, Shenzhen, Zhuhai, Foshan, Huizhou, Dongguan, Zhongshan, Jiangmen and Zhaoqing) and the two SARs (Hong Kong and Macau) of the bay area have a strength unmatched by the delta. As a mature market economy and a global financial hub, Hong Kong can provide the scale effect to the nine cities. In addition, it can serve as a reference for their further development with its advanced experience in operating and managing a market economy. The development of the bay area depends largely on the following: First, the cities within the area should foster their core competitiveness. In order to develop the area, we should highlight regional differences and cultivate the core competitiveness of the nine cities. Second, the cities should be encouraged to develop vertically. In other words, to avert disorderly competition and possible overlapping projects, industries with core competitiveness should be nurtured in different cities, based on their existing competitive industries and local conditions. Two aspects deserve our special attention. First, we should continue to exploit Hong Kong’s advantages in finance, logistics, accounting and offshore trade. We should also use Hong Kong as an example for the nine bay-area cities in institutional design, management, and operation. Dongguan and Huizhou should focus on industrial transfer, transformation, and upgrading. Shenzhen should move towards a strategic position as the most advanced tech innovation center in China and even in Asia. Second, the development of the bay area should not be limited to Eastern China. Foshan, Zhuhai, Zhongshan and Jiangmen, which lie along the west bank of the Pearl River, should seize the opportunity and boost the growth of white household appliances (like refrigerators) and other high-end manufacturing. As a provincial capital, Guangzhou should make increasing efforts to develop trade and culture. Located in the most inland part of the bay area, Zhaoqing is rich in tourist attractions and related infrastructure. As President Xi said, “lucid waters and lush mountains are invaluable assets.” Zhaoqing should aim to become the “garden” of the bay area by building a strong tourist industry and an advanced agricultural base. Second, the success of the bay area lies in a rational, top-level design. The future of the bay area should not rely on over concentration of goods and services in Hong Kong and Macau, as well as manufacturing plants in the Pearl River Delta. Otherwise, urbanization and industrialization would be two isolated paths instead of merging together and supporting each other.

94

6 Three Tasks for Building an All-Around Opening-Up Strategy

In my opinion, Hong Kong, Shenzhen, and Guangzhou should support each other and become a jewel of the bay area. Both the Huangpu Customs of Guangzhou and the Qianhai Pilot Free Trade Zone of Shenzhen can be upgraded as a free trade port. Meanwhile, Hong Kong would retain its distinctive comparative advantages as the world’s most successful free trade port and one of the world’s six financial hubs. Third, we should ensure the free flow of production factors. In terms of policy, if the bay area were to become a world-class, hi-end trade system, production factors, especially human resources, should be allowed to move freely in the area. Currently, it is rather inconvenient for bay area residents to visit or work in Hong Kong and Macau. In the future, those residents should be given the right to easily settle in Hong Kong and Macau with the help of a more convenient visa policy. If state regulations allow, more foreign exchanges can be reserved for bay area companies, and more flexibility can be implemented to specific institutional arrangements. In addition, the management model of pre-establishment national treatment (PENT) with a negative list should be fully implemented to attract more foreign capital. If the regulations on “national treatment” differ from one type of enterprise to another, a low threshold should be set.

3 Major Work in Building a New Pattern of Increased Opening 3.1 Promoting the Pilot Project for the New System of Open Economy In 2016, the Chinese government asked twelve regions nationwide to build a new open economy system on a pilot basis. President Xi Jinping and Vice Premier Wang Yang paid special attention to the pilot project, and made specific arrangements a number of times. The twelve pilot cities fall into three categories: provincial capitals (Jinan, Nanchang, and Xi’an), coastal and border cities (Dalian, Zhangzhou, and Fangchenggang), and cities of the five Chinese city clusters (Tangshan, Suzhou, Dongguan, Wuhan, and Chongqing). The pilot open economy city (zone) differs from the pilot free trade zone in two aspects. First, the free trade zone pursues an outside-in reform, while the pilot open economy zone reforms itself from the inside. Second, the pilot open economy zone is bigger. In the pilot free trade zone, the scope of free trade does not expand until the pilot part has become well developed. By contrast, the pilot open economy zone covers a larger area when it is established (i.e., the 8000-km2 zone in Jinan City, the capital of Shandong Province). The openness of the pilot open economy city lies in its four new guidelines and six exploratory efforts. The guidelines are: (i) building a new mechanism, in which the market plays a decisive role in distributing resources; (ii) creating a new model of economic operation and management with the invisible hand of the market and

3 Major Work in Building a New Pattern of Increased Opening

95

the visible hand of government; (iii) shaping a new pattern of increased opening; (iv) giving new core competitiveness to our products in international cooperation and competition. In order to implement the guidelines, we require six exploratory efforts: First, building a new model of operating and managing an open economy. The major associated task is to rapidly streamline administration and delegate power to lower levels, in order to simplify approval procedures, improve one-stop services, and adopt list management. Second, fostering a new mechanism of coordinated opening for different zones. Coordinated development should be achieved among special economic zones, economic deltas, economic development zones, hi-tech zones, bonded zones, export processing zones, free trade zones and open economy zones. In addition, a balance should be struck in regional development by growing the five city clusters, which is home to open economy zones. Third, creating a new way of international investment and cooperation. Investing overseas is equally as important as attracting foreign investment. When Chinese companies go global, they should learn to seek mergers and acquisitions in addition to greenfield investment. They should also increase vertical investment, while expanding horizontal investment, and establishing R&D service centers abroad. Fourth, setting up a new quality and efficiency-oriented system of foreign trade. The key to the system is to raise the added value of products, and this relies mainly on public innovation and entrepreneurship. Public innovation requires process improvement and product innovation. The innovation of final products might originate from universities and other large research institutes. Process innovation depends mainly on the efforts of the public. Fifth, introducing new financial services for the open economy. At present, China is the world’s second largest service trader, with a total trade volume of over USD600 billion. Sixth, shaping a new pattern of increased opening. When we further open to the outside world by promoting the Belt and Road Initiative, we should carry out reforms in the target industries, regions, and destinations. For instance, China’s foreign trade is dominated by the US and the EU. However, the EU’s economy is now sluggish. The BRICS show strong growth momentum, and it is imperative to build the BRICS free trade area.

Chapter 7

China’s Free Trade Ports: Effective Action Against the Threat of De-globalization

With sluggish external demand and increasing trade protectionism by the USA and the European Union, China is facing severe challenges in implementing its deeper, ongoing reforms. To respond actively to such challenges, the Communist Party of China’s 19th National Congress proposed to “promote a new pattern of all-around opening up”. In particular, the establishment of free trade ports is considered an important means to realize deeper integration with the world economy. This paper discusses the background, the motivation, the possible challenges as well as a feasible path for the successful implementation of free trade ports in China. Based on the international experience, the construction of free trade ports in China requires freer trade in goods, high mobility of talent and free capital flow.

1 Introduction Since the 2008 global financial crisis, there has been a new wave of trade protectionism headed by the USA, casting a shadow on the world economy. The current situation arises from the stagnation of the Doha negotiations, the failure of the Transatlantic Trade and Investment Partnership, negotiations among Western countries, the Brexit negotiations, the Trump regime’s abolition of the Trans-Pacific Partnership, renegotiation of the North American Free Trade Agreement, and the recent threat of a trade war between the USA and China, which would result in a tremendous shock to world markets. Widespread protectionism could lower global output, making worldwide economic recovery difficult. China is the largest exporter in the world, and, indeed, it has become one of the major beneficiaries of deepening globalization. However, the country faces domestic and external challenges. On the demand side, it is facing weak external demand from its major trading partners. US protectionism against China has worsened the world The original article is joint with Prof. Wei Tian, Ms. Zhuxi Xu, and Mr. Huihuang Zhu and published in China and World Economy (2018). © Springer Nature Singapore Pte Ltd. 2020 M. Yu, China-US Trade War and Trade Talk, https://doi.org/10.1007/978-981-15-3785-1_7

97

98

7 China’s Free Trade Ports: Effective Action Against the Threat …

economic situation, because the USA and China have mutually become the largest trading partners in the world. On the supply side, China’s demographic dividend is shrinking. The increasing aging of the population has become a major concern in Chinese society. As other resource constraints, such as land and the environment, have gradually tightened, the overall cost of labor in the manufacturing sector has increased substantially, which, in turn, has weakened China’s export competitiveness. Although the sluggish external demand and intensifying trade protectionism of Western countries has cast a shadow on China’s growth momentum, the path for economic reform is clear. First, China should continue to open its domestic markets to increase the volume of trade. Second, China need to promote industrial transformation to maintain competitiveness in the global economy. An ideal way to kill two birds with one stone would be to establish free trade ports in Chinese mainland. The notion of free trade ports was first brought up in a report to the 19th National Congress of the Communist Party of China. Chinese President Xi Jinping explicitly pointed out that it is necessary to promote the formation of a new path to full liberalization.1 Specifically, the country will allow more freedom to reform the pilot free trade zones (PFTZ) and explore the establishment of free trade ports. In the keynote speech at the opening ceremony of the 2018 annual meeting of the Boao Forum for Asia, President Xi emphasized the implementation of trade and investment liberalization and facilitation policies, and the exploration of building free trade ports with Chinese characteristics.2 However, a “free trade port” is a relatively new concept in China. It is natural to ask: What is a free trade port? How would it be different from the free trade zones (FTZs) in coastal and inland China? How would a free trade port help the local economy? Finally, what conditions are required for the development of a free trade port? These are issues that deserve exploration. However, the current literature on free trade ports mainly focuses on the construction and development experience of foreign free trade ports in developed countries (regions) and is mostly outdated. Research on the motives and applicable path for building free trade ports with Chinese characteristics is limited. Therefore, in this paper, we attempt to answer the above questions. We aim to show that building free trade ports would be an effective action against the threat of de-globalization. The rest of the paper is organized as follows. Section 2 reviews the emergence of de-globalization in the new era, followed by a discussion of how de-globalization affects trade and economic welfare and a theoretical interpretation of the necessity to establish free trade ports. We suggest that the further economic reform will help increase China’s trade volume in the face of an unfavorable world trade environment. Apart from presenting a theoretical justification, we also discuss a path for establishing China’s free trade ports. Section 3 compares the development stage and characteristics of China’s free trade ports with those of more mature international free trade ports, such as Singapore port and Shanghai PFTZs. Section 4 offers some policy suggestions for the development of international free trade ports in China. 1 See 2 See

http://cpc.people.com.cn/n1/2017/1028/c64094−29613660.html. http://cpc.people.com.cn/n1/2018/0410/c64094−29917187.html.

2 Theoretical Framework for the Establishment of Free Trade Ports

99

2 Theoretical Framework for the Establishment of Free Trade Ports 2.1 New De-globalization Threat to the World Trade According to the classical Ricardian trade theory and the neoclassical Heckscher– Ohlin model, exporting and importing countries can benefit from free trade. Empirical evidence shows that globalization, indeed, promotes economic growth, regardless of the different econometric specifications adopted (Dreher 2006). For China, increased integration with the global economy has contributed to sustained growth in international trade. China has been playing an increasingly important role in regional specialization since its accession to the World Trade Organization (WTO), and its economic development has contributed to its trade partners’ economic growth. However, history tells us that each time when the global economy slows down dramatically or a global economic crisis erupts, the prospects for globalization become gloomy. Under the impact of economic crises, developed countries have undergone profound changes. The domestic contradictions in developed economies are intensifying. Problems such as unequal distribution of social wealth, lack of job opportunities and refugee crises become more prominent during an economic downturn and can lead to regime changes. All these changes can trigger a new wave of de-globalization, with unilateralist trade protection policies reemerging. Following the financial crisis in 2008, world trade slowed tremendously and the overall international economic situation has not yet fully recovered. According to the IMF (2017), the growth rates of world GDP in 2015 and 2016 were 3.4 and 3.2 percent, respectively, and the GDP growth rates of developed economies were only 2.1 and 1.7 percent, respectively. The growth rates of the world trade volume were 2.6 and 2.3 percent, respectively, even lower than the world GDP growth rate. Commodity prices continued to below. Developing countries whose economic growth is highly dependent on export trade are more vulnerable to protectionist policies in the tide of reverse globalization. Therefore, for developing countries to maintain the momentum of economic growth under the unfavorable new world economic situation and safeguard their own interests in international trade will inevitably require corresponding adjustments of their domestic economic structure. Guo et al. (2018) find that a US–China trade war would generate substantial losses in output and social welfare, measured as real wages. China must consider how to deal with the enhanced trade disputes trigged by US President Trump. In the long term, to minimize welfare loss, China should continue to open up its domestic markets for its most important trading partners, like countries in the European Union and the Association of South-East Asian Nations (ASEAN) 10 countries. Specifically, China could import more from the European Union and the One Belt One Road countries to reduce its domestic prices and, hence, increase the real income of consumers.

100

7 China’s Free Trade Ports: Effective Action Against the Threat …

3 Free Trade Ports: The Next Step in China’s Reform and Opening up Thus far, we have argued that it is necessary for China to push for a new path to all-round opening up. Before its accession to the WTO in 2001, China had already set up many special economic zones, industrial zones and export processing zones. At present, the country’s special economic zone with the highest degree of openness is a PFTZ. The Shanghai PFTZ was launched in 2012, and the Guangdong, Tianjin and Fujian FTPZs in 2015. The four PFTZs focus on different areas, such as opening up investment, trade and finance, encouraging entrepreneurship and innovation, as well as carrying out interim and post-establishment administration. The four PFTZs have had some prominent achievements. Building on the successful experience of the first two batches of PFTZ, on 31 March 2017, the State Council officially released the development plan for the third batch of seven new PFTZs3 followed by Hainan and Xiongan, forming a “1 + 3 + 7 + 2” “geese” pattern. Meanwhile, as discussed in Yu (2018), in 2016 the Chinese Government selected 12 cities nationwide to build a new open economy system on a pilot basis. The 12 pilot cities are: coastal and border cities, including Dalian, Fangchenggang, Shanghai and Zhangzhou; provincial capitals, including Jinan, Nanchang and Xi’an; and five Chinese city clusters, including Chongqing, Dongguan, Suzhou, Tangshan and Wuhan. On 13 April 2018, President Xi Jinping announced the decision to develop the island of Hainan into a PFTZ and gradually explore and promote the establishment of a free trade port with Chinese characteristics. In becoming a PFTZ, Hainan will be granted more autonomy in developing a law-based and international business environment, as well as a fair, open, unified and efficient market environment. The extensive open practices of the FTZs in various areas has not only contributed to the rapid growth of China’s economy, but also have resulted in the accumulation of valuable experience for China in establishing effective market mechanisms. In the new era, the trial FTZs were given greater autonomy in enacting reform and in the development of free trade ports. Why does China need free trade ports? This is because expanding the trade volume requires freer trade in goods, high mobility of talent and free capital flow. Moreover, Free trade ports can closely relate to the development of the cities where the ports are located and their surrounding areas. By definition, a free trade port is a port area within the territory of a country or region that is not subject to the usual customs control, with free access to overseas goods and funds. The main feature of a free trade port is that it is outside the control of customs of a country. It has the features of a port and an FTZ, with many trade-related functions, including product processing, logistics and warehousing. Geographically, a free trade port is part of the territory of a country, but from the perspective of administrative supervision, it is outside the customs jurisdiction of the country. 3 Seven

new PFTZs are Liaoning PFTZ, Zhejiang PFTZ, Henan PFTZ, Hubei PFTZ, Chongqing PFTZ, Sichuan PFTZ and Shaanxi PFTZ.

3 Free Trade Ports: The Next Step in China’s Reform and Opening up

101

For commodity trade, it is vital to reduce various kinds of costs. Good infrastructure is important for guaranteeing port-clearing efficiency. Limao and Venables (2001) find that poor infrastructure accounts for 40% of predicted transport costs for coastal countries and up to 60% for landlocked countries. Clark et al. (2004) also find that port efficiency is an important determinant of shipping costs. They demonstrate that improving port efficiency from the 25th to the 75th percentile reduces shipping costs by 12%. A free trade port must be a cargo hub that can facilitate international trade and logistics information collection and sharing, with resources allocated effectively. Supply and demand information in each link of the supply chain can be matched accurately on the platform provided by the free trade port. Efficient regulatory mechanisms are designed to minimize trade costs. Taking the speed of customs clearance as an example, Hu (2014) finds that each 10% improvement in import clearance time in a FTZ will lead to a 5.68% fall in the volume of agricultural trade within the FTZ. If the cost of trade cannot be reduced effectively, there will be no chance for quick circulation of merchandise trade flow, and the port itself will be at a disadvantage in terms of international competition. The goal of free trade ports is to integrate ports and cities, by improving multimodal transport systems, service coverage and functional interaction between ports and cities. Through integrated development, an open and efficient free trade port city can be formed, which, in turn, can promote economic growth in a region. Human resources are an important factor in economic development. To promote trade, specialized, high-skilled personnel and international talent are particularly valuable. Studies show that increasing the number of undergraduate students will enhance the local economy significantly. Hunt and Gauthier-Loiselle (2010) find that a 1-percentage point increase in the share of immigrant college graduates in the population increases the number of patents per capita by 9–18%. Meanwhile, hightechnology workers generate large spillover effects. Rosenthal and Strange (2008) find that spatial concentration of employment enhances productivity, and the benefits of spatial concentration are driven by proximity to college–educated workers. Furthermore, the inflow of high-technology talent can dramatically improve the level of technological innovation. Kerr and Lincoln (2010), using US H-1B visa data, find that higher H-1B admissions increases immigrant science and engineering employment and patenting by inventors with Indian and Chinese names in cities and firms dependent upon the program relative to their peers. Most specifications of this study find limited effects for native science and engineering employment or patenting. Despite the introduction of certain preferential policies, the lack of professionals and international talent has always been a focal point for the development of PFTZs in China. According to the Human Resources Bureau of the Shanghai FTZ, the shortage of professional and technical personnel in the Shanghai FTZ reached 48% in 2014. A free trade port would provide more opportunities and guarantees for the career development of international talent and professionals. Thus, it would be far more attractive than a FTZ. Apart from human resources, capital is another crucial factor for economic growth. Xiang and He (2016) find that the establishment of the PFTZ has had a significantly

102

7 China’s Free Trade Ports: Effective Action Against the Threat …

positive impact on capital flows in Shanghai. In the service sector, Latorre et al. (2017) find that the impact of more foreign multinationals in services is positive for China. Javorcik (2004) provides strong evidence of positive productivity spillovers from foreign direct investment between foreign affiliates and their local suppliers in upstream sectors. With less restrictions on the financial market, the free trade ports will be the frontier of a new round of financial market liberalization. A free trade port is a more open platform than a FTZ. From a theoretical perspective, the construction of free trade ports will enhance the institutional environment of China’s opening-up reforms, promote the country’s economic transition from relying on the demographic dividend to the “system dividend,” and enable better response to the profound changes in the global environment. Practically, the experiences of predecessors, such as Singapore and China’s Hong Kong Special Administrative Region, may help FTZs advance toward the goal of being a more transparent institutional environment. The world’s major free trade centers, such as Dubai and New York, are defining themselves as international free trade ports or global logistics centers, because this practice is an effective way to drive regional growth in the trade, finance and service sectors. Breakthroughs in the areas of trade facilitation measures, ship fuel prices, financial support, customs supervision, inspection and quarantine are necessary for free trade ports. Free trade ports in China could become centers for the exchange of global goods, talent and capital, providing a steady stream of new momentum for economic development.

4 Functional Orientation for the Construction of China’s Free Trade Ports The development of free trade ports serves as an experiment for institutional innovation. China still has a long way to go in many aspects, such as loosening capital control and controlling the movement of people, to promote trade and investment facilitation, and to simplify and unify investment standards. Therefore, the free trade ports need an effective management system and legal framework so that the impacts of external shocks on the onshore market remain controllable. The construction of free trade ports will be important to stimulate institutional innovation. The innovation in the free trade ports will be greater than the Shanghai and other FTZs in Chinese mainland, given that the free trade ports are larger compared with the FTZs. Therefore, the local governments will have greater rights for policy innovation, which will amplify the effects of new policies. The free trade ports will also play a significant role in boosting the economic development of Chinese mainland. Trade ports, such as Chinese Hong Kong and Singapore, belong to a separate customs territory. However, the free trade ports to be established in Chinese mainland will be special regulatory areas in the same customs territory. To this end, one of the main aims of the free trade ports is to advance the development of the Chinese mainland economy. At the same time, the development

4 Functional Orientation for the Construction of China’s Free Trade Ports

103

of free trade ports needs to rely on related hinterland economic support. There are many places in the world where transportation is convenient but no free trade port has been formed. The main reason is the lack of strong support from the hinterland. The hinterland has the ability to provide goods, talent and capital continuously to the free trade ports, thus bringing about greater demand for re-export, construction and bonded workers. At the same time, the free trade port will play a leading role in upgrading to high-value links in the global value chain. For example, the development of the complete international service support system that a free trade port requires, including intermediaries, such as finance and law companies for all aspects of production and life, can promote a more complete production chain coordinated with the surrounding regions and help the regional economy to develop and upgrade. With such mutual activities, most international trade centers have gradually changed from traditional ports of goods trading to international capital and information transition centers, like London, New York, Tokyo, Singapore and Chinese Hong Kong. They have gradually developed into world offshore trade centers and become centers of global trade.

5 International Experience and Domestic Exploration Most of the mature international free trade ports are in developed countries and regions with a long maritime history and sound capital markets. Various countries and regions have developed free trade ports with different characteristics according to their particular conditions and strategic considerations (e.g. the integrated free trade port in Singapore, the free trade ports in Hamburg, Germany, Busan and South Korea, and industrial FTZs such as Rotterdam of the Netherlands). Chinese Hong Kong became a free trade port while it was colonized by the UK. After more than 100 years of development, it has become a leader in international logistics and trade, and a global financial center. It is also a model for the construction of free trade ports in Chinese mainland. Over 90% of Chinese mainland’s foreign trade is shipped by sea. With the development of the economy and deepening of the opening-up reform, port construction has made great progress in Chinese mainland. China (including Hong Kong) has 7 of the world’s 10 largest container ports (Table 1). However, many container ships choose to fuel in Singapore due to the price gap and other extra services. To achieve a higher level of openness and acquire a proactive position in foreign trade, the major PFTZs in Chinese mainland are constantly exploring new paths of further reforms. Some bonded port areas are also actively seeking transformation. Although the construction of China’s free trade ports has already relied on certain infrastructure and policy support, the specific path for deepening reforms remains unclear. By looking at mature international ports, such as in Singapore and China’s most advanced PFTZ in Shanghai, we attempt to identify a path for the successful launch of free trade ports in China.

104

7 China’s Free Trade Ports: Effective Action Against the Threat …

Table 1 Top ten world container ports (TEU, millions) Rank

Port

2011

2012

2013

2014

2015

1

Shanghai, China

31.74

32.53

33.62

35.29

36.54

2

Singapore

29.94

31.65

32.6

33.87

30.92

3

Shenzhen, China

22.57

22.94

23.28

24.03

24.2

4

Ningbo-Zhou Shan, China

14.72

16.83

17.33

19.45

20.63

5

Hong Kong, China

24.38

23.12

22.35

22.23

20.07

6

Busan, South Korea

16.18

17.04

17.69

18.65

19.45

7

Qingdao, China

13.02

14.5

15.52

16.62

17.47

8

Guangzhou harbor, China

14.42

14.74

15.31

16.16

17.22

9

Jebel Ali, Dubai, UAE

13

13.3

13.64

15.25

15.6

10

Tianjin, China

11.59

12.3

13.01

14.05

14.11

Source World shipping council, available from: http://www.worldshipping.org/about-the-industry/ global-trade/top-50-world-container-ports/ Note TEU, twenty-feet equivalent unit

6 Singapore Port In 1969, Singapore established the first FTZ in the Jurong Pier Industrial Zone. Singapore gradually developed into a highly open free trade port. There are eight FTZs in Singapore currently, which are managed by Singapore Port Group Limited, Jurong Harbor Sdn Bhd and Changi Airport Group, respectively. As a country with zero tariffs, Singapore’s free trade ranks second in the world in terms of port’s trade volume (Table 1). It is in the center of South-East Asia and has become an important channel for world trade. The facilitated trade in goods depends on an intelligent logistics system, an information-based management approach, and low-cost anchorage, warehousing and transit options. Singapore attaches great importance to infrastructure construction. According to the World Economic Forum’s 2016–2017 Global Competitiveness Index,4 Singapore ranks second in infrastructure construction. Maintaining the efficiency of logistics was the key for Singapore to become a trade center. To facilitate trade, as early as 1989, the Singapore Government took the world lead in the development of a trade management electronic platform for customs, tax and security, with 35 other government agencies now connected to this network for enterprises to provide a one-stop customs clearance service. With this unified system, companies only need to submit an electronic file. The declaration and audit procedures related to import and export trade can be completed within the network, and can, in some cases, be completed within 10 s.

4 See

https://cn.weforum.org/reports/2016–2017.

6 Singapore Port

105

Furthermore, Singapore provides special tax relief and financial support for hightechnology, high-value-added enterprises, regional headquarters, international shipping companies, export companies, and other special industries and service industries. Singapore has already become the world’s main location for logistics companies. Among the world’s top 25 logistics companies, 20 have set up regional or global headquarters in Singapore (e.g. DHL, Dexun, Shan Nine Air and Cink Logistics). As an important part of its trading system, Singapore has signed more than 20 free trade agreements with various regions and countries, including China, the USA, ASEAN, New Zealand, India and Japan. Based on these free trade agreements, Singapore-based exporters and investors can enjoy multiple benefits, such as tariff concessions, faster access to markets and access to intellectual property protection. Advanced infrastructure, efficient information management and preferential taxation policies mean that Singapore is unrivaled in facilitating the trade of goods. From the point of view of talent accumulation, the Singapore Government has set up a “citizen and population group” in the Prime Minister’s Office to take charge of overseas immigration projects. The government has passed the following policies: Contact Singapore, the Foreign Talent Settlement Plan, Professional and Technical Talents and the Investment Residency Program. A series of policies to attract entrepreneurs to settle in Singapore and to increase the reserve of technical talent has enabled Singapore to have continuous innovation. The Singapore Government’s policy of free entry and exit has greatly facilitated the movement of international personnel and the development of transnational businesses. In the 2017 Passport Index, which ranks global passport freedom, Singapore is positioned first along with Germany.5 The development of commerce and trade in a free trade port requires a liberalized financial environment. According to the Global Financial Centres Index (19th) report released by the Z/Yen Group in London in 2016, Singapore surpassed Chinese Hong Kong to become the third largest international financial center, and is the largest financial center in Asia. Singapore also has the third largest international foreign exchange market. Its modern communications equipment is directly connected with the New York Clearing House Interbank Payment System and the European Society for Worldwide Interbank Financial Telecommunications system. Therefore, the procedure of currency settlement is simple. A relaxed currency exchange mechanism and a well-developed leasing system attract foreign investment and there is adequate financial support for trade activities. Singapore’s sound financial system has powered the city’s economic and trade development, providing an excellent model for the regulation and liberalization of China’s financial market.

5 See

https://www.passportindex.org/byRank.php.

106

7 China’s Free Trade Ports: Effective Action Against the Threat …

7 Shanghai Yangshan Free Trade Port Area China Shanghai FTZ’s bonded area, formally founded in 2013, consists of the Waigaoqiao FTZ, the Waigaoqiao Free Trade Logistics Park, the Yangshan Free Trade Port Area (YSFTPA) and the Pudong Airport FTZ. The customs area of the YSFTPA is 14.16 km2 , which accounts for 49.2% of the total area of the Shanghai FTZ. Endowed with an excellent deep-water coastline and shipping lanes, the YSFTPA benefits from the policies of both the PFTZ and the Comprehensive Test Zone for Development of International Shipping, and is one of the most competitive international shipping and off-shore service areas in China. The All-round and In-depth Reform and Opening-up Plan on China Shanghai FTZ, issued by the State Council in March 2017, pointed out that the establishment of free trade port zones in YSFTPA, Pudong Airport FTZ and other areas under special customs supervision marks the reform of YSFTPA entering a new stage. As the first free trade port area, the YSFTPA has been exploring innovation over 2014–2017 and has made tremendous achievements. For business services, the YSFTPA has advanced infrastructure and core technology and has become the biggest automated container terminal in the world. For logistics, it has developed domestic market channels, connecting the port with Shanghai by a cross-sea bridge. The YSFTPA has formed a business system based on information technology to conduct cross-border e-commerce. Under the guidance of the policy “Two years exemptions and three years 50%-reductions,6 ” the YSFTPA provides tax breaks for logistics enterprises, trade enterprises, and their operation centers. Giving full play to the advantage of “import, export and transit trade,” the port area is also committed to exploring the high-end consumer goods market to build a professional and international bulk commodity trade platform. The Shanghai FTZ has established various programs, such as the “Leading Talents Program” and the “Youth Talents Program” in finance, and the policy of “Permanent Residency for Foreigners” to attract more talent in various industries. In 2015, the Ministry of Public Security issued 12 policies on immigration and visas that would benefit the Shanghai Technology and Innovation Center. At the end of 2016, the Chinese Government proposed the “new ten” policy,7 providing a more convenient immigration environment for the exchange of talent. As the most developed financial center in China, Shanghai FTZ continues to provide financial support for cross-border investment and trade. The FTZ also made efforts to promote interest rate marketization and to deepen foreign exchange reforms. As a result of these measures, the number of products on the list of exclusions has been reduced from 190 to 122, and approximately 90% of the national industries 6 “Two

years exemptions and three years 50%-reductions” policy means that a foreign-invested company can enjoy business income tax exemption for the first 2 years and a 50% reduction for the next 3 years. 7 The “new ten” policy includes ten different new policies to attract high-technology talents to work and live in Shanghai. For the detail of this policy, see http://www.pudong.gov.cn/shpd/InfoOpen/ Detail.aspx?Id=780227.

7 Shanghai Yangshan Free Trade Port Area

107

have implement pre-establishment national treatment. The China Banking Regulatory Commission has encouraged Chinese and foreign banks to engage in business in the FTZ. The China Securities Regulatory Commission has invited securities and futures institutions to establish subsidiaries in the FTZ, and the China Insurance Regulatory Commission has proposed establishing a pilot professional health insurance institution funded by foreign capital. To strengthen the cross-border financial services to adjust to a more open environment and to prevent financial risks more effectively, the zone has already opened approximately 60,000 free trade accounts that promote the two-way opening up of capital projects and expand the cross-border use of the RMB.

8 Comparison Between the Shanghai Free Trade Port and International Free Trade Ports Although there is not a strict common definition of a free trade port, a definition can be found by looking at the most successful international free trade ports and FTZ. Some of their major common characteristics can be identified, which may shed light on the path for the development of China’s free trade ports. Table 2 highlights the development history and major policies of four international ports. From Table 2, we can identify some common characteristics of the free trade ports. First, greater trade facilitation and an efficient legal system in a free trade port create higher mobility of labor and capital, attracting a large amount of transit shipments, such as value-added services, import and export containers loading and unloading, and multimodal transportation. For example, in Hong Kong, most commodities (except liquor, tobacco, methanol and several other goods) are exempt from tariffs and additional taxes. Most products can pass through customs without submitting paperwork. Customs declarations can be completed through electronic channels within 14 days after the goods are exported or imported, and the cost of goods passing through is only half that in the OECD countries. These factors reduce business costs for enterprises and facilitate small and medium-sized enterprises’ participation in international trade activities. Second, most international free trade ports have undergone industry and trade upgrading and have good financial, logistical and legal systems, allowing them to develop various types of trade. They are usually offshore financial centers, such as Hong Kong, and have mature capital markets and international clearing services, which enable them to upgrade from low-value-added processing trade and entrepot trade to the rapidly expanding offshore trade in response to increasing labor and capital costs. At the same time, international free trade ports usually have a high level of investment facilitation. For example, in Hong Kong, foreign capital generally enjoys 100% ownership. The procedures for establishing a company are quick; the registration can be completed within 1 h and there is no minimum capital stock

108

7 China’s Free Trade Ports: Effective Action Against the Threat …

Table 2 Policies and development of four major international free trade ports Hong Kong

Singapore

Colon

Dubai

History and development

Since 1840, from a single re-export port and processing center to a free trade zone with diversified economic and trade structure

Since 1969, including 7 free trade zones (1 airport, 6 sea ports), from an international goods and distribution basis to a highly open free trade port, then to a comprehensive technology free trade zone

Since 1948, the world’s second largest free trade port; re-exporting dominates

Rashid Port is a traditional container port, built in the 1960s; Jebel Ali Port, built in 1985, is a multi-function zone, including logistics, warehousing, importing and exporting, production and processing

Firm registration

3-step online application, certificate issued within 1 h; no restriction on registration capital; no capital verification

4 documents and certificate issued within 3 days; capital required over 0.1 million Singapore dollars

No minimum investment requirement; 6–7 documents, such as social contracts or tax records are required; at least 5 Panamanian employees; at least 60% of imports re- exported

Procedure for investment can be completed within 7 days; customs, banks, post and telecommunications, transportation and public security, are under unified management

Investment admittance

Equal treatment for all investors in almost all industries; 100% holdings allowed; conditional admittance for gambling, telecommunications and radio

No admittance limit for most industries; finance, insurance, and securities need to be put on record; no foreign capital share limit except retail, news and publication

No admittance limit in processing

100% foreign holdings allowed; no restriction on domestic employment

(continued)

8 Comparison Between the Shanghai Free Trade Port …

109

Table 2 (continued) Hong Kong

Singapore

Colon

Dubai

Capital and foreign exchange

Any currency allowed for trade settlement; no restrictions on currency trading or international capital flows; profits freely remitted

Any currency allowed for trade settlement; no restrictions on currency trading and international capital flows; profits freely remitted

US dollar as major currency for trade; no capital control; profits freely remitted

Allowing profits to be remitted abroad; no limit on currency exchange

Customs supervision

Declaration complete within 14 days after export or import

Efficient online customs system for applications, declarations, approvals and controls

One unified form for imports, exports and re-exports

Declaration complete within 24 h

Tax preference

Zero tariff except alcohol, tobacco, hydrocarbon and methanol; no value-added tax or business tax; no tax on personal investment income; the main taxes are profit (15–16.5%), salary and property taxes

Unified business income tax for domestic and foreign firms (17%); partial tax exemption for the first 0.3 million in income; zero tariff except alcoholic beverages, tobacco, petroleum and motor vehicles

Business income tax 2–5%, capital tax 1%

Tariff free for processing intermediates and capital goods; exemption of business income tax for 15 years; no personal income tax

requirement. Fully-opened financial markets allow enterprises to convert foreign exchange and mobilize capital freely inside and outside Hong Kong. Third, free trade ports are not only logistics and transportation centers, but are also associated with a large headquarters economy. The agglomeration effect of finance, insurance, design and high-technology industries, and the preferential policies help the free trade ports to encourage the establishment of headquarters of foreign enterprises, foster service trade and offshore trade, and provide a strong motivation for trade and economic growth. For example, the Singapore Government has adopted several measures, including a concessionary international trade plan and rewards for business and multinational headquarters, to encourage foreign enterprises to set up headquarters or regional headquarters in Singapore. Dubai has more than half of

110

7 China’s Free Trade Ports: Effective Action Against the Threat …

the free economic zones of the United Arab Emirates and attracts many multinational enterprises to move their headquarters there. This can be attributed to FTZ policy measures such as that: foreign capital can be wholly owned by enterprises registered in the FTZ; capital and profit remittances are not restricted; and foreign enterprises can enjoy exemption from business taxes for 50 years, be totally exempt from personal income taxes and pay zero import and export tariffs. Fourth, the development of free trade ports is based on the industry structure of the surrounding areas. For example, the Dubai Government has attached great importance to the joint development of ports and industry. The Port of Jebel Ali, attaching great importance to the development of trade, logistics, and information and high-technology industry, has established an FTZ. In 2014, there were more than 1225 global multinational corporations and enterprises entering the Jebel Ali FTZ. These enterprises have set up production and logistics centers in the FTZ, which has promoted the growth of Dubai’s import and export goods. Beginning in 1995, the “Dubai Internet City” was built in the Jebel Ali FTZ. This is the main project in place by the Dubai Government for developing the network economy. In 1999, it completed the preparatory work for the feasibility study, including planning and formulation of relevant laws and regulations. The construction project included, for instance, an Internet university and a software development center. By the end of 2000, the construction of infrastructure in the city was basically completed. After the completion of the Dubai Internet City, there were 30 world famous information technology companies, including Microsoft, Siemens and IBM, with 300 senior managers. Finally, the administration of free trade ports are empowered by central government. The ports of Hamburg, New York, Singapore and Hong Kong were all first legislated before setting up districts to ensure the healthy development of the free trade port with strict laws and regulations. In addition to the national legislation, the local government formulated corresponding regulations for activities in the free trade port. Port administrations are authorized by the government to manage and coordinate the overall affairs of the FTZ, to invest and build the necessary infrastructure, and have the right to examine and approve projects. In particular, they make plans to promote the economic development of the surrounding cities, especially in relation to finance, insurance, trade and intermediaries. The New York and Singapore ports have specialized operation companies, which operate in a market-oriented manner, and have powerful government regulators. For example, the Dubai Port Authority was established in 1991, directly under the leadership of the Dubai local government, to manage Dubai ports. At the same time, it is an independent port management organization and an independent accounting system. The Jebel Ali FTZ has relatively independent power: (i) it can acquire and rent land, and operate and manage factories, warehouses and other social infrastructure (e.g. reservoirs, water, communications and transportation); (ii) it can has jurisdiction over enterprises, can introduce public utilities and services in the FTZ, and can approve the use of facilities, such as land, plants and port facilities; (iii) it can impose fees on businesses and public utilities; and (iv) it can sign loan contracts with organizations outside the zone and establish other management institutions as needed. Through

8 Comparison Between the Shanghai Free Trade Port …

111

the comparison of the Shanghai PFTPZ and other international free trade ports, it can be concluded that many ports in Chinese mainland are not merely bonded trade areas or FTZs; their functions are enlarging, and they are developing into free trade ports. However, there is still much room for Chinese free trade ports to improve, for instance through improvements in operating systems, establishing support services and the construction of related industries. Table 3 shows differences in functions and operating systems between the PFTZs in Chinese mainland and international free trade ports. Through comparison, the capabilities of the ports in Chinese mainland can be comprehensively evaluated in the aspects of attracting talent, investment and trade, which will help to reveal the condition of the ports and guide their future development. International free trade ports should have complete infrastructure, advanced logistics, information management system, user-friendly declaration and clearance processing, preferential tax policies, and low costs for calling, storage and transshipment. After more than 20 years of development, the ports in Chinese mainland are becoming increasingly competitive. On 13 February and 1 March 2017, the world’s largest 4,50,000-ton supertanker, TI Europe, called at Daxie port in Ningbo and Dalian port. On 27 March, the world’s biggest container ship, Mitsui Osk Achievement (MOL Triumph), was put into service and it was decided that it would follow the Dalian–Europe lane. It would call at ports in Tianjin, Yangshan, Ningbo, Zhoushan and Yantian, indicating that the infrastructure and operational efficiency of the ports have gained the recognition of the international community. However, there are also some problems that need to be solved, such as intelligentize-based and information-based level of logistic companies is relatively low; the imbalance between the development of the ports in coastal developed areas and those in developing areas infrastructure and logistics; and the connection between each port is weak. In the World Bank’s 2014 Business Environment Report, Singapore’s cross-border trade facilitation level ranks first among the world’s 189 economies. Specifically, Singapore has a free system of trade settlement, the least restrictions on investors and investment capital, and a comprehensive shipping service system. For the ports in Chinese mainland, there are no automated and electronic customs declaration and clearance services available, lead to the low efficiency of customs. Although the ports in Chinese mainland have many preferential tax policies (e.g. tax reductions), which have already attracted increased foreign capital, compared with the Singapore and Busan ports, which are well-known for their tax exemptions and low call fees, Chinese ports still have a long way to go. With the deepening of globalization, increasing numbers of talented workers are choosing to come to China. There are many preferential policies in place to attract talented workers to the free trade ports. However, the number of scientific, professional and versatile workers still cannot not meet that required with the fast development of the ports. The proportion of foreign high-technology professional talent is still low among employees. The development of supporting infrastructure and services has been unbalanced among different regions in China. Moreover, because of historical and diplomatic factors, Chinese mainland passports are not used as widely as Chinese

112

7 China’s Free Trade Ports: Effective Action Against the Threat …

Table 3 Differences in functions and operating systems between the pilot free trade zones in chinese mainland and international free trade ports

Function

Operating systems

Chinese mainland

Chinese Hong Kong

Singapore

Rotterdam

Type

Free trade pilot zone

Free trade port

Free trade port

Free trade port

Positioning

Experimental field of opening up

Center of international logistics, finance, trade and sightseeing

Center of international logistics, finance, trade and sightseeing

Sustainable, effective, secure and clean port with multi-functions and high technology

Functions

Transportation, trade, storage, logistics and processing

Trade, international transshipment, fully-opened domestic financial market

Trade, international transshipment, storage, logistics, container distribution, financial services, and sea and air transport

Dealing with dry bulk containers, liquid bulk containers and container cargo; the center of storage, transportation and selling, collection, distribution and reprocessing

Infrastructure

Fully automated wharf

Urbanized free trade port with complete support services

Short distance between port and airport

Informatization and integration of the port by establishment of public information platform

Customs declaration and clearance

“Entry first, clearance then”; “separate batches and inspected collectively”

Documents required and sample inspection

Electronic trade management, clearance as fast as 10 s

Clearance in 24 h (except Sunday); storage before clearance; companies’ accounting reports and inventory data required (continued)

8 Comparison Between the Shanghai Free Trade Port …

113

Table 3 (continued)

Law and regulation

Chinese mainland

Chinese Hong Kong

Singapore

Rotterdam

Null

The Basic Law and Sales of Goods Ordinance

Preferential polies on free shipment and trade and the Special Law

Tariff Law of the European Union and the Netherlands; Tax Law and policies on Rotterdam port’s development, operation and logistics management by the Netherlands

Hong Kong, Singaporean and South Korean passports. Although the Chinese mainland passport has scored higher in the Passport Index recently, it still ranks behind those countries and regions, and ranked 64th on Passport Index for 2017. The low fluidity of immigration hinders international trade. For example, the length of a valid visa for immigrant workers to Chinese mainland is relatively short.8 To solve all these problems, China’s central and local governments are seeking to improve immigration management in bonded areas and FTZs, to create a more open and effective environment for those with the skills needed for free trade ports. Finally, international free trade ports require fewer formalities, better exchange mechanisms and financing, and more complete and flexible rental systems. For example, Hong Kong is the only integrated city for offshore and local businesses in Asia in terms of having a unified free exchange system for both business types. With the most open currency market in the world, Hong Kong offers freedom of investment and financing and free flow of funds across the border. However, because of the short history and low level of openness of the Chinese mainland financial market, with the exception of the Shanghai port, the coastal ports in China lack well-established financial systems. Thus, it is difficult to promote the development of trade and business in the port areas. China is still a developing country and although it has signed bilateral reciprocal swap agreements with several countries, and the RMB has joined the Special Drawing Rights basket, the Chinese Government maintains a relatively prudent attitude toward finance, especially capital account liberalization. It is experimenting in the Shanghai FTZ to promote the reform of the financial system, focusing on convenience, free exchange, cross-border use of the RMB, and free rein of interest rates and foreign exchange.

8 For

example, the length of a valid visa for a Vietnamese worker is only 1 month. See http://www. gxswt.gov.cn/htmlcontent/zwgkdetail/429aa457-f1df-4e61-9654-b80995113146.

114

7 China’s Free Trade Ports: Effective Action Against the Threat …

9 Path for the Construction of Free Trade Ports in China Even though economies are becoming increasingly interdependent, trade protectionism still exists. The trend of de-globalization may not be an obstacle to trade and business development in China; conversely, de-globalization probably an opportunity for China to deepen reforms. China is actively seeking solutions to the challenges and putting forward strategies involving new opening up strategies. The Chinese Government is deepening the FTZ reform and improving the functionality of free trade ports to push the opening-up reform to a new stage. Although China has a way to go in relation to economic openness and liberalization, the economy is developing and foreign trade is expanding. Now is the best time for China to develop free trade ports. China has a vast domestic market and is enjoying policy dividends from the Belt and Road Initiative, for example. China has gained much practical experience from developing comprehensive bonded areas and PFTZs. These necessary software and hardware facilities, such as negative list for market access, will be helpful for the development of free trade ports. However, compared with international free trade ports, there is still much room for improvement, such as in trade, talent and finance. Therefore, the Chinese Government should focus on policies in these three areas to promote the development of free trade ports. First, it is necessary to improve the convenience for businesses engaging in trade in the ports. “Fast trade” requires a simplified approval process. “Convenient trade” requires a complete logistics system and informationized, comprehensive management. Improvement in these areas will enable a low-cost environment for manufacturing and delivery, to ensure that all products flow into the world market in an effective way. The Chinese Government should provide preferential policies for goods trade. China should build an integrated, international, standardized transportation network that combines river ports, sea ports, highways, railways and aviation. It should build a large-scale, intelligent and multi-functional information network, and a secure and effective electronic customs clearance system to speed up the integration of customs and to simplify its procedures. The ports in underdeveloped areas should ensure the implementation of the policy of “inside the territory while outside customs” and “free entry into China’s territory while strict inspection before entering the domestic market, free entry and exit in the FTZ while separate management of people and goods”.9 For the ports in developed areas, a more competitive offshore taxation system should be explored. Second, the ports must take steps to improve the fluidity of personnel as well as their ability to attract talent. Such initiatives would help in developing a more livable environment and better services for business persons and international talent. To achieve this, the first step is to regulate the license system for foreigners working in China and to establish an effective visa system for talent to entry, exit and residency in China. The second step is to spare no effort to attract high-technology talent to the ports in underdeveloped areas. These steps would help to improve the environment and infrastructure, improve public services, and establish international 9 See

http://www.customs.gov.cn/publish/portal0/tab46391/info343506.htm.

9 Path for the Construction of Free Trade Ports in China

115

working standards to tackle the difficulties of attracting and retaining talent in the local economy. Finally, the ports need to improve the convenience of finance temperately. The process of improving the ports’ financial systems presents an opportunity for deepening financial reform and improving market openness. In this process, the Chinese Government can gain experience in risk prevention and management. The ports should continue to adhere to the relevant policies on openness and improve efficiency in cross-border foreign exchange settlement. All these measures will support re-export trade financially and reduce trade risks for enterprises in ports. Moreover, the Chinese Government should establish financial leasing system, so that it can provide sufficient capital support for all businesses in ports and encourage more international companies to establish headquarters in the free trade ports.

Chapter 8

Expanding Opening Up: China’s Olive Branch to Globalization

After four decades of reform and opening up, China must decide where to lead her future efforts. Threatened by the rising trade protectionism, the world is eager to know whether China will stick to the path of opening up. In his impressive keynote speech at the opening ceremony of Boao Forum for Asia (BFA) Annual Conference 2018, President Xi Jinping spoke highly of reform and opening up policy, which profoundly changes China and deeply influences the world. Besides, the president explicitly expressed China’s determination to open up to the outside world by putting forward a four-pronged approach. It can conclude from President Xi’s speech that the last four decades were only a prelude to China’s reform and opening up, which will be a basic national policy that China will stick to in the years to come, only the focus will be shifted to the construction of a new pattern that features all-round opening up. In his speech, President Xi set specific measures in four aspects, namely, (1) to further widen market access, (2) to improve the investment environment for foreign investors, (3) to strengthen protection of intellectual property rights (IPR), and (4) to take the initiative to expand imports. In doing so, Xi sends a clear message to the world that China’s door of opening up will not be closed and will only open even wider. China will not deflect from the path of opening up due to the trade frictions with the U.S. The four measures mentioned by President Xi are conducive not only to China’s reform and opening up, but also to the global multilateral trade cooperation.

1 To Further Widen Market Access This is a significant approach for China to continue promoting multilateral trade cooperation and increasing openness in an active stance. At present, results from the Doha Round negotiations have fallen short of expectations, because the developing countries are over-protective of their service sectors, so are the developed countries of their agricultural sectors. President Xi states that it is necessary to further widen market access. To break it down in the service sector, © Springer Nature Singapore Pte Ltd. 2020 M. Yu, China-US Trade War and Trade Talk, https://doi.org/10.1007/978-981-15-3785-1_8

117

118

8 Expanding Opening Up: China’s Olive Branch to Globalization

especially the financial sector, China will raise foreign equity caps in the banking, securities and insurance industry, ease restrictions on the establishment of foreignfunded financial institutions in China and expand their business scopes. With more capital inflows into the domestic service industry, China is more determined to promote multilateral trade cooperation. Besides, the WTO can also share the fruits of China’s open market, which will contribute to the success of the Doha Round of negotiations. To widen market access, it means that more foreign banks, enterprises and service providers, especially those from the developed countries, will enter into China, directly competing with Chinese counterparts. Those under-performing and less competitive companies of China will be phased out during the opening process, while the well-established ones can be greatly empowered and strengthened by an easilyaccessible market, and are more likely to succeed in the competition by establishing joint ventures with foreign companies or through other means of cooperation. Let’s take the banking industry as an example. It is too early to determine whether foreign banks have positive or negative impacts on Chinese banking industry, and it is inappropriate to jump to conclusion. However, if the Chinese banks conduct in-depth cooperation with foreign banks by learning their managerial and operational experience, especially in terms of cost reduction, efficiency improvement and global expansion, they can surely scale new heights and become stronger and more competitive. On manufacturing, China has basically opened up this sector only with a small number of exceptions on automobiles, ships and aircrafts. For example, in the automobile industry, China used to place a 50% equity ceiling on foreign automakers. If the equity caps are removed, foreign enterprises can engage in deeper cooperation with Chinese enterprises.

2 To Improve the Investment Environment for Foreign Investors China will complete the revision of the negative lists on foreign investment in the first half of this year, and implement across the board the management system based on pre-establishment national treatment and negative lists. This system is important for China to further open up to the outside world and to optimize the investment environment. China will enhance alignment with the international economic and trading rules, increase transparency, strengthen property rights protection, uphold the rule of law, encourage competition and oppose monopoly. By adopting negative lists, the government gives free rein to both domestic and foreign enterprises in their niche markets, as long as they engage in lawful activities. This practice is conducive to improving the investment environment in China, and it has delivered tangible results when piloted in the 11 free trade zones.

2 To Improve the Investment Environment for Foreign Investors

119

Now the negative list has become a widely adopted practice. The idea of negative list enjoys wide support in that it gives China a leg up to go global and improves the investment environment in China in real terms. China released the first negative list in the Shanghai Pilot Free Trade Zone. This list sets out administrative measures applicable to foreign investment and investors to which “national treatment” is not granted. As one of the measures to open up, the negative list is put into good practice in the Shanghai Pilot Free Trade Zone, with its results witnessed by all. It is clearly written in The Report of the 19th National Congress of the Communist Party of China and The Report on the Work of the Government in 2018 that the negative list shall be implemented across the board and in all industries.

3 To Strengthen Protection of IPR In his speech, President Xi emphasized that IPR protection is the centerpiece of the system for improving property rights protection, and it will provide the biggest boost to enhancing the competitiveness of the Chinese economy. IPR protection is the requirement of foreign enterprises, and even more so of Chinese enterprises. This year, China aims to reinstitute the State Intellectual Property Office to step up law enforcement, significantly raise the cost for offenders and fully unlock the deterrent effect of relevant laws. China encourages normal technological exchanges and cooperation between Chinese and foreign enterprises, and protect the lawful IPR owned by foreign enterprises in China. Meanwhile, China hopes foreign governments will also improve protection of Chinese IPR. Two things in terms of IPR protection need to be paid attention to. First, it should admit that the developed countries do a better job in IPR protection both in terms of the efforts they have devoted and the comprehensiveness of their measures. However, it is also undeniable that China has made solid progress in protecting IPR. Since the reform and opening up, the awareness of IPR has developed from none and grown stronger and stronger. Enterprises used to take no count of protecting IPR, now they attach great importance to it. Second, it is imperative for us to correctly define and tell the differences between the developing countries and developed countries in terms of IPR protection requirement. Why is that important? Protecting IPR comes at a lower cost in developed countries, because its per capita income is higher than that of the developing countries, where enterprises are running at a higher cost. With this in mind, the disparity of IPR protection in developing and developed countries makes sense. An example is, the very same textbook is priced higher in Western developed countries than in Asia-Pacific countries, where people have lower income and pay less for IPR. Foreign and domestic enterprises share the same desire for strong protection of IPR. In the era of innovation-driven development, to protect IPR is to protect the lifeline of a company, and is undoubtedly the most effective way to make the Chinese economy more competitive in the international arena.

120

8 Expanding Opening Up: China’s Olive Branch to Globalization

However, strengthening the protection of IPR is bound to harm the interests of special groups. Domestic reform is imperative when the cost of IPR infringement is too high to bear. Only in this way can the IPR be well protected.

4 To Take the Initiative to Expand Imports China is the second largest importing country in the world with an annual gross import worth USD2 trillion, accounting for nearly 20% of its GDP. It goes without saying that China is a world-leading importer. In his speech, President Xi stated that “China does not seek trade surplus; we have a genuine desire to increase imports and achieve greater balance of international payments under the current account”. There are two major advantages for China to expand imports actively: First, the Chinese people will have access to more kinds of consumer goods; second, the Chinese enterprises are provided with more sophisticated and quality intermediate goods and capital goods. A wider choice of consumer goods lowers the prices in the domestic market and increases people’s well-being. Downstream manufacturers also have more choices. The good news is, home-grown and imported intermediate goods are often complementary. When used properly, they will produce a Schumpeter effect to reinforce each other. This is why China take the initiative to expand imports. China has come a long way in expanding imports. The upcoming China International Import Expo is the most eloquent proof of it. As early as 2017 when the China-U.S. trade friction was yet to escalate, the Expo has come into the agenda. It means that China does not expand imports for the sake of it. Rather, it is a long-term development strategy for China. If China chooses to import more intermediate goods from the EU and ASEAN countries, or countries alongside the Belt and Road instead, the price of the intermediate goods would be more competitive, and the Chinese people can also get cheaper finished goods. In this way, the world can benefit as well. For instance, in 2017, China alone has contributed more than 30% to the world’s economic growth. It is fairly reasonable to say that no other country in the world can play a role as significant to the world economy as China. In this sense, China is the engine of the world economy. At the same time, China is striving to shift its role from a trader of quantity to a trader of quality. What’s important here is that China needs to increase the added value and the quality of the exports. To become a trading powerhouse in real terms, China needs to ensure that the exports are as good as those made by other major exporting countries such as the U.S., Japan and Germany. Only in this way can China shift its role successfully. The key to industrial upgrading is to transform the processing-based export model. China has lost its comparative advantages of labor cost over Southeast Asian countries. However, the labor cost in China is merely one-fifth of that of the U.S., while the total factor productivity equals nearly a half of that of the U.S. The comparative advantage seems rather obvious. This is why China keeps exporting large quantities of labor-intensive products to the U.S.

4 To Take the Initiative to Expand Imports

121

But things are more gloomy in terms of the added value. Although the China-U.S. trade surplus totaled USD274 billion in 2017, China gets a very thin slice of the trading profits. Let’s take the smart phone as an example. IPhone 4 is exported at USD179 from China, and USD500 in the U.S. (premiers and shipping costs included). USD179 looks attractive, but it is far from being lucrative as China pockets only USD6.5 for each iPhone 4 imported. In other words, despite the very huge trade surplus, the profit is extremely low. China hopes developed countries will stop imposing restrictions on normal and reasonable trade of hi-tech products and relax export controls on such trade with China. For a long time, the U.S. government, especially the Trump administration that advocates “America first”, has been imposing restrictions on hi-tech exports to China. In January 2010, President Barack Obama announced the National Export Initiative (NEI), with a goal of doubling exports by 2015. The NEI advocates the insourcing of the advanced manufacturing, while attaches equal emphasis to the export of hi-tech manufactured goods. Under this Initiative, China can acquire necessary technology through expanding imports of U.S. made intermediate goods. Unfortunately, the Trump administration forsakes the NEI and takes the opposite approach. While complaining about the high trade deficit with China, the Trump administration deliberately turns a blind eye to its trade surplus in the service sector. The truth is, the U.S. is reluctant to export hi-tech products with high added value to China, yet it has no comparative advantage over China in labor-intensive goods. So here comes the trade deficit, and the U.S. has only itself to blame for such a high trade deficit. Under the regulations of the WTO, developing countries are allowed to charge different tariffs from developed countries. China will significantly lower the import tariffs for automobile. I believe this move gestures China’s willingness to open wider and embrace the world. With an ever-growing average income, China is expected to join the ranks of developed countries by 2020. According to the WTO regulations, when that day comes, the tariffs on automobile will be slashed significantly. The tariff system is often agreed and made by multiple parties through consultation. By taking the initiative to lower tariffs on automobile, China has fully demonstrated the open-mindedness of a major country. To conclude, President Xi’s speech at the BFA reflects the broad mind of the Chinese nation, its goodwill and commitment to opening up. China hopes other major trading nations to take the lead in facilitating global trade through combined efforts, and to foster an international environment that is favorable for cooperation and brings win-win outcomes.

Chapter 9

Potential Impact of China–U.S. BIT on China’s Manufacturing Sectors

This article finds that the overall effect of the foreign direct investment (FDI) and thereby the China–U.S. bilateral investment treaties (BIT) on Chinese manufacturing sector is positive, which raises the productivity and profitability of the firms, using various econometric models and other evidence. The manufacturing sector as a whole has already opened up to the world economy and needs to continue this process. The industries in the manufacturing sector do not need to be protected, except for in limited fields related to national security, scarce natural resources and well-defined strategic sectors. Gradual lifting of the protection may be needed in the short-run for a small number of vulnerable sectors. A moderate relaxing of the current restrictions will increase FDI in manufacturing from all countries by 4–8% under different assumptions. This effect will be small when only considering FDI from the USA. Domestic firms need to update their technology, reduce costs and learn management skills from their foreign competitors, while using the national treatment terms in BIT to enter the fields that are not open to domestic firms under current regulations. Domestic firms also need to set up firm-level global strategies and reallocate firms’ resources according to the changing investment environment, taking advantage of profit opportunities outside the domestic markets. China has been the world’s leading manufacturer of steel, garments, cement, chemical fertilizers and many other products in the past 30 years. At the same time, China has become a preferred destination for the relocation of global manufacturing facilities and manufacturing has been the most important field of foreign direct investment (FDI) in China. The cumulated FDI in all sectors, actually used, reached $117.6 billion in 2013 and $119.6 billion in 2014. However, FDI in the manufacturing sector has grown much more slowly than that in other sectors in recent years (Fig. 1). The USA has been an important investor in China’s manufacturing industry in the past 20 years. Table 1 gives data of FDI from the USA to China in the past This paper is joint with Fan Zhang, Professor at National School of Development of Peking University, and published in China Economic Journal, 2016. © Springer Nature Singapore Pte Ltd. 2020 M. Yu, China-US Trade War and Trade Talk, https://doi.org/10.1007/978-981-15-3785-1_9

123

124

9 Potential Impact of China–U.S. BIT on China’s Manufacturing Sectors

Fig. 1 FDI in the manufacturing sector, actually used, China, 2000–2014, $ million. Note No manufacturing data in 2004 and 2014. Source National Bureau of Statistics of China

Table 1 U.S. direct investment in China, actually used, in all sectors, 2000–2014, $ million

Total

U.S.

U.S./total (%)

2000

40,715

4384

10.8

2001

46,878

4433

9.5

2002

52,743

5424

10.3

2003

53,505

4199

7.8

2004

60,630

3941

6.5

2005

60,325

3061

5.1

2006

63,021

2865

4.5

2007

74,768

2616

3.5

2008

92,395

2944

3.2

2009

90,033

2555

2.8

2010

105,732

3017

2.9

2011

116,010

2369

2

2012

111,716

2598

2.3

2013

117,586

2820

2.4

2014

19,562

2371

2

Source National Bureau of Statistics of China

14 years, which did not change much since 2005. The shares of U.S. FDI decreased dramatically from 10.8% in 2000 to 2.0% in 2014. The China–U.S. bilateral investment treaties (BIT) are focused on market access of foreign investment, which requires a raft of China’s domestic reforms. Since manufacturing is more open to FDI than that in the service sector, BIT will have less overall impact on China’s manufacturing sector.

9 Potential Impact of China–U.S. BIT on China’s Manufacturing Sectors

125

Based on the assumed scenarios of China–U.S. bilateral investment treaties, this article will explore the possible impacts of BIT on China’s manufacturing sector, and then give suggestions on the Chinese Government’s strategies in BIT negotiations and counter-measures in practice, as well as the strategy domestic firms could adopt to deal with the competition that comes with BIT.

1 Literature Review A large body of literature of international economics focuses on the fundamental factors that drive FDI behavior. Melitz (2003) developed a theoretical model of monopolistic competition with heterogeneous firms to explain the decision of FDI, which becomes the cornerstone of the literature examining the role of heterogeneity in FDI. Helpman et al. (2004) generalized Melitz (2003) to explain horizontal FDI. Melitz’s (2003) framework has been used in explaining different issues, including trade liberalization, technology adoption (Bustos 2005), complex integration strategies (Yeaple 2003), variable markups (Ottaviano et al. 2002) and so on. The empirical literature on FDI examines the internal and external factors that determine the FDI by multinational enterprises. Firm characteristics are used to explain FDI activities (Morck and Yeung 1992; Navaretti and Venables 2004). External factors are also examined by different researchers, including the effects of exchange rates (Froot and Stein 1991; Campa 1993; Blonigen 1997; Lipsey 2001), taxes (Hartman 1984, 1985; Swenson 1994; De Mooji and Ederveen 2003), institutions (Wei 2000a, b), trade protection (Gtubert and Mutti 1991; Kogut and Chang 1996) and so on. Many empirical researches are about the effects of FDI on the performants of Chinese firms, including researches on the effects on different industries (Zhang and Zheng 1999; Cheung 2010), different source countries (Jiang and Zhang 2011; Shiau et al. 2013), location choices (Sharma et al. 2014), inward FDI (Liu et al. 2014) and outward FDI (Buckley et al. 2007; Deng 2013). Based on data of 220 cities in China from 2003 to 2009, using threshold panel regression estimation, Li and Liu (2012) find significant threshold effects of FDI on China’s environment. Their tests from income threshold show that, in the middle-income stage, FDI generates degradation of local environment quality. Although there are a large number of researches on FDI in general, the literature specifically about BIT is relatively limited. Cui (2013) introduces the content of the 2012 version of the U.S. BIT template and gives suggestions on China’s strategy in U.S.–China BIT negotiation. Huang and Zhou (2013) discuss China’s new strategy of open-up to the world, including making progress in China–U.S. BIT negotiations. Liang and Yan (2013) point out the core issues of the China–U.S. BIT negotiations and difficulties of the negotiations due to the institutional factors. Pan and Tang (2013) introduce the national security investigation mechanism of the U.S. Government. Wang (2013) examines the new version of the U.S. BIT template and discusses the difference between the two sides. Yao (2013) discusses the risks of China–U.S. BIT

126

9 Potential Impact of China–U.S. BIT on China’s Manufacturing Sectors

for China in the long run, including the internationalization of the domestic policy and the liberalization of the capital account. On the U.S. side, Bergsten (2005) argues that, to respond to the challenges and threats in the world, the USA should alter its priorities in the Doha Round to an important degree by placing even greater emphasis on reduction of agricultural subsidies and extensive liberalization of service markets. The Peterson Institute for International Economics and the China Development Research Foundation (2015) has a discussion on the U.S.–China BIT, including the U.S. national security investigation process, implications of the China–Japan–Korea investment agreement for U.S. policy (Schott and Cimino 2015), China’s state-owned enterprises and competition policy (Miner and Hufbauer 2015), the USA’s service export (Jensen 2015) and China’s manufacturing industry (Zhang and Yu 2015).

2 Assumptions on the Scenarios of China–U.S. BIT, Focusing on Manufacturing BIT aims to extend the principle of national treatment, under which foreign firms are treated the same as domestic firms. In China’s World Trade Organization (WTO) accession agreement, that goal was met with a list of industries in which national treatment would apply. The great progress in BIT is to switch to a “negative list” approach, which allows only the businesses specified in the treaty to be exempted. Our baseline assumption assumes that BIT will be a moderate revision of the current catalogue of industries for guiding foreign investment prepared by the Chinese Government. The current list of restricted and prohibited industries in this catalogue is shown in Appendix Table 8. The current list of restricted and prohibited industries in manufacturing is the result of considering the following factors by the Chinese Government: (1) national security and political reasons (e.g. arms production); (2) scarce resources (e.g. rare earth metal smelting); (3) natural monopoly (e.g. gas and water production); (4) control of low-scale firms’ entry or over-capacity in some industries; and (5) toxic, harmful and environmental pollution. Some of the protection measures reflect the interests and pressure of domestic firms. In this article, our baseline scenario for forecasting includes: (1) national treatment is given to all foreign investors in all sectors except sectors in the negative list; (2) moderate reductions in the products or sectors in the negative list and moderate improvements in investment revenue transfer and implementation terms; and (3) moderate improvement in the dispute settlement clauses.

3 BIT’s Open Market Requirements to China’s Manufacturing …

127

3 BIT’s Open Market Requirements to China’s Manufacturing Sector and Its Impacts on Relevant Industries The impacts of BIT on China’s manufacturing sector are quite similar to that of China’s joining the WTO in 2001. Although some of the industries face negative impacts, China’s experience of joining the WTO tells us that overall the opening up to the outside world will induce higher growth and productivity in the manufacturing sector, even for those industries that were predicted to become losers before joining the WTO, for example the automobile manufacturing industries. In this article, we will analyze the impacts of BIT on Chinese domestic firms and the impacts of policy changes on FDI, using firm-level data and econometrics models.

3.1 Impacts of FDI on Domestic Firms We first investigate the impacts of FDI on domestic firms’ productivity, profitability and export propensity. FDI has two major impacts on firms in the domestic market. The positive impacts are that FDI will bring technology, management skills and capital to China, which will increase Chinese firms’ productivity and profitability. The negative impacts are that FDI will intensify competition and may crowd out some Chinese firms in the field. This research will do econometrics analysis to find out the effects of FDI on firms’ performants in domestic markets, using a large firm-level dataset created by China’s National Bureau of Statistics (NBS) 2000–2008. The main dataset includes over 2 million firm-level observations from 2000 to 2008. The dataset is collected by the National Bureau of Statistics of China. It includes all state-owned firms and non-stateowned firms with sales over RMB 5 million per year. The dataset provides 80–150 firm-level financial indicators, for example, output, sales, fixed investments, number of workers, exports and so on. We clean the dataset following Feenstra et al. (2014) by eliminating observations in which: (1) firms have less than eight employees; (2) fixed assets exceed total assets; (3) current assets exceed total assets; (4) there is no identification number; and (5) no starting time.

3.2 FDI’s Overall Impacts on Performance of Domestic Firms First, we find that, overall, FDI has a positive impact on firms’ productivity and profit.

128

9 Potential Impact of China–U.S. BIT on China’s Manufacturing Sectors

We first used a regression to estimate the effects of FDI on firms’ productivity, profitability and export propensity, using the full sample of China’s firm-level data in manufacturing from 2000 to 2007. Specifically, in the model the dependent variable is ln (TFP), profit/sales and export/sales, where TFP is total factor productivity. The explanatory variables are foreign invested enterprise (FIE, dummy showing whether the firm is foreign invested), and share of the sales of FIE in four-digit industries. The estimated coefficients show how much, on average, FIE performance is higher than the non-FIE. Fixed effects of year and firm are controlled. The results of estimation are presented in Table 2. The coefficients of FIE and FIE share are all positive and significant as more variables are controlled. We also estimate the regressions with TFP estimated by other methods, which support the results presented here. Next the performance of FIEs from the U.S. investments is estimated. We calculated the share of FDI from the USA in total FDI in China in 2013 (a), and the share of FDI from the USA in total FDI in China in the sampling period (b). Assuming after signing BIT, the share of FDI from the USA increases by t%, then the effects of the U.S. FDI on manufacturing firms’ TFP (EUS ) will be a EUS = t α b

(1)

where α is the coefficient of FIE estimated in our previous regression in Table 2. Using Eq. (1), we estimated EUS under different assumptions as shown in Table 3. Since the share of FDI from the USA has decreased dramatically in recent years, the effect of BIT on firms’ productivity is lower than the average of all foreign investors. We also estimated the effects of FDI on firms’ profitability and export propensity. The results are presented in Table 4. The results in Table 4 show that FIEs have a positive effect on firms’ profit rate, when export, SOE, labor and asset are controlled. On the other hand, the relation between export propensity and FIE is not significant. To check the robustness of the relation between productivity and FIE, we also estimated models using alternative methods (Levinsohn–Petrin Approach; Levinsohn and Petrin 2003) to calculate TFP, which received similar results. The results show that, overall, FDI improves the performance of Chinese manufacturing firms.

3.3 FDI’s Impacts on Specific Industries Figure 2 and Table 5 show the basic conditions of selected manufacturing industries, from which readers can see the size of the industry, the FIE and non-FIE production, and the share of foreign capital. The last column in Table 5 gives us the number of current restricted and forbidden industries/products in the catalogue for the guidance of FDI.

N

2,096,406

0.01

FE firm

Ob

R-squared

0.06

2,096,406

Y

Y

(3)

0.07

1,661,369

N

N

0.05

1,661,369

Y

Y

0.017*** (18.56)

0.113*** (283.67)

0.015*** (14.39)

−0.049*** (−93.66)

0.07

1,272,206

N

N

0.04

1,272,206

Y

Y

0.010*** (7.65)

0.023***

(14.41)

0.016***

(12.93)

0.016***

(−5.32)

−0.018***

(14.49)

0.025***

(3.12)

0.012***

(6)

(15.09)

(233.48)

0.109***

(−76.02)

−0.046***

(37.75)

0.060***

−0.023*** (−7.81)

0.029*** (20.81)

0.060*** (51.47)

0.024*** (16.24)

(60.03)

0.101***

(5)

0.054***

(2.67)

0.008***

(4)

(52.55)

(64.67)

0.096***

0.05

1,661,369

Y

Y

0.04

1,272,206

Y

Y

0.002*** (25.12)

0.002***

(7.51)

0.010***

(14.38)

0.016***

(12.80)

0.016***

(−5.18)

−0.018***

(14.54)

0.025***

(2.88)

0.011***

(8)

(32.32)

(18.55)

0.017***

(14.23)

0.015***

(−7.60)

−0.022***

(16.24)

0.024***

(2.37)

0.007**

(7)

Notes FIE in this regression does not include investment from Hong Kong, Taiwan and Macao. TFP calculated using the Olley–Pakes (OP) approach, robust t statistics are reported in parentheses. Columns (5), (6) and (8) use the sample from 2001–2007 (since there are no data on research and development expenditure in 2000, 2004 and 2008, we use the average of 2003 and 2005 for the research expenditure in 2004). FIE is a dummy indicating whether a firm is foreign invested; FIE share is the share of FIE in total sales for four-digit industries; Export shows whether a firm engaged in export; SOE indicates whether a firm is state owned; labor is total number of employees in a firm; asset is total value of asset in a firm. ***, ** and * show significance at the 1, 5 and 10% level, respectively. FE—fixed effect

N

E year

FIE share

Research

Log (Asset)

Log (Labor)

SOE

Export

(4.42)

(148.21)

FIE

(2)

0.013***

(1)

0.191***

Dependent Var.: In TFP

Table 2 Effects of FDI on performance of firms, productivity, China

3 BIT’s Open Market Requirements to China’s Manufacturing … 129

130

9 Potential Impact of China–U.S. BIT on China’s Manufacturing Sectors

Table 3 Estimates of the effects of BIT on firms’ productivity Assumed increase in U.S. FDI after BIT assignment

Coefficient from Table 2

EUS (%)

1.5 times

0.013

0.7

2 times

0.013

0.9

Notes The share of U.S. FDI in China reduced from an average of 6.8–2.4% from 2000–2007 to 2013. The coefficient from Table 2 is the sum of coefficients of FIE and FIE share in last column of Table 2

Figure 2 shows that FIE production accounts for a large percentage in computer and communication equipment (industry code 39) and automobile (36). Econometrics analysis shows that the direct impact of FDI on firms’ productivity is positive for almost all industries. However, the indirect impacts of FDI (the effect of the share of FDI in an industry on firms in that industry) on some industries are negative. (Lack of space forbids further discussion on these regressions for each industry). Most of the industries in the manufacturing sector are already opened up to the world market and do not need protection in BIT. However, some of the industries are vulnerable when facing the competition of FIEs, including: China’s comparative advantage is changing as labor costs are rising in China. Therefore, there may be less FDI over time in labor-intensive industries, as global firms shift to lower-wage economies elsewhere. This is not the result of the signing of a BIT. For example, the textile industry is one of these labor-intensive industries. As China’s comparative advantage changes, labor costs increase and these laborintensive industries have lost their advantages gradually as the economy transfers to capital- and technology-intensive sectors. FDI helped this structural change. The labor-intensive firms are vulnerable to FDI competition. What the government needs to do is to help these firms upgrade their products, but not to set protection measures in BIT. The second group of industries or sub-industries is vulnerable to the competition of the foreign investments due to the large technology gaps. These industries or subindustries are in capital- and technology-intensive sectors but have large technology gaps compared with the world technology frontier. These firms may need some temporary protection measures in BIT in the short-run. The third group of industries will face environmental problems caused by FDI and need some regulations to control the size of damages, for example the chemistry industry. BIT or domestic regulations are needed to prohibit FDI in the chemistry industry which causes serious environmental pollution.

(1.24)

Y

2,251,355

0.001

FE firm

Ob

R-squared

0.001

1,684,364

Y

Y

0.001

1,684,364

Y

Y

Y

0.00

1,278,782

Y

0.00

2,195,895

Y

Y

0.00

1,654,682

Y

0.00

1,654,682

Y

Y

0.00

1,278,782

Y

Y

(−2.24)

Y

−0.635**

(1.88)

0.012*

(−0.45)

−0.063

(0.63)

0.083

(−0.26)

−0.079

(37.46)

38.529***

(−1.57)

−0.600

(1.74)

(1.86)

0.012*

(−0.51)

−0.073

−0.072 (−0.51)

(0.57)

(0.57)

0.072

(−0.26)

−0.078

(37.63)

38.517***

(−1.57)

−0.599

12.783*

(0.41)

(1.02)

(1.84)

8.485*

(−0.12)

(−0.26) 0.073

−0.080

(37.63)

38.517***

(−1.55)

−0.594

(−2.78)

0.099

(1.50)

(1.50)

(0.22)

0.078

−3.104

0.191

16.118

16.120

(0.64)

(0.64)

(−4.09) 11.026

(−4.10)

11.041

−9.655***

(1.11)

(1.42) −17.181***

(1.42)

−17.229***

41.652

(2.59)

4.185***

40.912

(2.29)

2.303**

Export propensity

Notes FIE in this regression does not include investment from Hong Kong, Taiwan and Macao. In this table, the division of industry is according to the two-digit industrial code in “Classification of national economic industries” (GB/T 4754–2002, the second edition). The division of industry before 2003 is according to “Classification of national economic industries and code” (GB/T4754) and is transferred to the second edition. TFP is calculated using augmented OP approach, t statistics are reported in parentheses. ***, ** and * show significance at the 1, 5 and 10% level, respectively. The sample period used in columns (4) and (8) is 2001–2007 (since there are no data on research expenditure in 2000, 2004 and 2008, we use the average of 2003 and 2005 for the research expenditure in 2004). Sales profit rate = operating profit/total industry output * 100. See notes under Table 2 for meanings of variables

Y

FE year

Research

FIE share

Log (Asset)

Log (Labor)

SOE

40.916

(2.38)

26.644

FIE

Export

2.375**

Sales profit rate

Dependent Var.

Table 4 Effects of FDI on performance of firms, profitability and export propensity, China

3 BIT’s Open Market Requirements to China’s Manufacturing … 131

132

9 Potential Impact of China–U.S. BIT on China’s Manufacturing Sectors

Fig. 2 Size of production, manufacturing, 2007. Source Firm dataset by NSB. See Table 5 for names of the industries

3.4 The Effects of Changes in Policies on Scale or Shares of FDI To explore the impacts of protection policies on FDI in China, we did a regression in which the dependent variable is the level of foreign capital in the industry and the explanatory variables are total sales in the industry and the dummies for protection policies. We use a four-digit industry-level dataset collected from the manufacturing firm database. In our model, the dependent variable is foreign capital. Explanatory variables are the policy variable Forbidden (dummy, restricted and forbidden products/industries in the catalogue for the guidance of FDI), total sales in the industry and the concentration level of the industry or Herfindahl–Hirschman Index (HHI). We transfer the products in the catalogue into four-digit industries. The estimated coefficients of the variable Forbidden shows how much more foreign capital will be created if China eliminates one restriction item. The last fixed effect regression in Table 6 shows that if the FDI in a four-digit industry is forbidden or restricted, the total foreign capital will be reduced by RMB 1176 million. Using the coefficients estimated in our regression, we calculated the scale of extra FDI from the USA into China when BIT reduced the protection under different scenarios. The regression results show that if 10 out of 51 restricted and forbidden items are lifted (scenario I), total FDI from all countries in manufacturing will increase 4.2% (Table 7). Since the USA accounts for only 2.4% of total FDI, the effect of China–U.S. BIT on FDI from the USA will be trivial. These estimate effects may increase if considering other possible contents in BIT, for example, tax law changes and improvement in the dispute settlement clauses.

3 BIT’s Open Market Requirements to China’s Manufacturing …

133

Table 5 Shares of foreign capital and restrictions, manufacturing, 2007 Industrial code

Name of industry

Share of foreign capital (%)

FIEs* share, in numbers of firms (%)

Number of restrictions and forbidden items, 2011

13

Processing of food from agricultural products

29.0

12.7

2

14

Manufacture of foods

35.4

19.5

1

15

Manufacture of beverage

34.1

13.9

3

16

Manufacture of tobacco

0.4

4.8

1

17

Manufacture of textile

24.4

15.5

3

18

Manufacture of textile wearing apparel

43.0

35.8

0

19

Manufacture of leather

47.8

30.7

0

20

Processing of timber

19.7

12.8

0

21

Furniture

42.5

27.1

0

22

Paper

32.0

14.9

0

23

Printing

30.1

13.4

1

24

Products for culture and education

45.3

34.5

4

25

Processing of petroleum

14.1

8.7

2

26

Chemical materials and products

28.7

14.5

10

27

Medicine

27.0

15.9

7

28

Chemical fibers

42.3

19.6

2

29

Rubber and plastics

37.2

22.1

1

30

Non-metallic mineral products

18.3

10.7

0

31

Ferrous metals

20.5

7.4

4

32

Non-ferrous metals

18.0

10.8

4 (continued)

134

9 Potential Impact of China–U.S. BIT on China’s Manufacturing Sectors

Table 5 (continued) Industrial code

Name of industry

Share of foreign capital (%)

FIEs* share, in numbers of firms (%)

33

Metal products

31.1

17.2

2

34

General purpose machinery

31.5

15.7

2

35

Special purpose machinery

25.6

19.0

1

36

Automobile

51.4

20.6

0

37

Transportation equipment

27.4

15.0

0

38

Electrical machinery

36.8

21.7

0

39

Computer and communication equipment

79.2

45.6

1

40

Instruments

43.8

27.0

0

41

Other manufacturing

41.6

29.3

0

42

Recycling of waste

21.1

17.7

0

Ave.

32.6

19.1

1.7

Total

Number of restrictions and forbidden items, 2011

51

Source Firm dataset by NSB and catalogue for the guidance of FDI by Ministry of Commerce 2011 Table 6 Regression results: effects of policy variables on FDI Dependent Var.: foreign capital

OLS

FE

Total sales

0.0346**

0.0334**

0.0300**

0.0300**

Forbidden

−962,826**

−1,069,518**

−1,164,730**

−1,176,522**

HHI

−739,410

2,025,509**

FE two-digit industries

Y

FE year

Y

Y Y

Obs.

2747

2747

2747

2747

R2

0.4265

0.4424

0.4327

0.4333

Notes *, ** significant at 10 and 5% level. Sample: 2002–2007. Total sales—total sales of the four-digit industry. Foreign capital—total amount of foreign capital in the four-digit industry. Forbidden—dummy which is 1 if the four-digit industry is restricted or forbidden from FDI

3 BIT’s Open Market Requirements to China’s Manufacturing … Table 7 Estimates of the effects of BIT on FDI under different scenarios

135

%U.S. in total FDI, all industries, 2013

2.40%

Estimated coefficient ($1000/restriction item)

1,176,522

Coefficient/2013 FDI in manufacturing

0.424%

Effect on FDI, scenario I

4.236%

Effect on U.S. FDI, scenario I

0.102%

Effect on U.S. FDI, scenario II

0.203%

Notes Scenario I: lifting 10 out of 51 restricted and forbidden items. Scenario II: lifting 20 restricted and forbidden items

To sum up, the basic logic behind the models above is that policy determines the inflow of FDI (Table 6), and FDI improves the performance of Chinese firms (Table 2).

4 Suggestions on Negotiation Strategy The negative list in BIT can be based on current the Foreign Investment Industry Guidance Catalogue established by the Chinese Government, with moderate revisions. Base on the above research, we have some suggestions for China on its negotiation strategies of BIT with the United States.

4.1 Make It Firm and Steadfast that China Is Serious in Joining BIT In the long-run, BIT is beneficial for Chinese firms to improve their productivity and profitability. Therefore, Chinese negotiators must make it firm and steadfast that China is serious in joining BIT with the USA through negotiations.

4.2 Protection Measures in the Long-Run The Chinese side also needs to negotiate to keep some of the protection measures in the treaty in the long-run for industries with a natural monopoly and for national security reasons. However, the number of these protected industries should be limited. Protection measures should be in limited fields, including: 1. fields related to national security, for example, production of military weapons; 2. fields related to scarce natural resources, for example, processing of rare metals.

136

9 Potential Impact of China–U.S. BIT on China’s Manufacturing Sectors

4.3 Gradual Lifting Process of Protection for Certain Vulnerable Sectors In the short-run, however, joining BIT will hurt some of the Chinese firms or industries, even though it is beneficial for Chinese firms to improve their productivity and profitability in general. Studies on industries show that firms in some of the manufacturing industries, especially those with large gaps in technology, will be harmed in the short-run. Therefore, there may need to be a gradual lifting of the protection in a small number of industries.

4.4 Cooperating in BIT Negotiation with the Domestic Reform BIT and domestic regulations have different functions, and needed to be treated separately. Some of the restrictions on FIEs’ activities can be done by domestic regulations, when the FIEs are given national treatment. Therefore, items already restricted by domestic regulation can be removed from the negative list of BIT, for example, capacity requirements for petroleum refinery equipment. The Chinese Government will use the requirement of BIT to reform domestic administration, the judicial system and the state-owned enterprises. To do that, the domestic law and regulation need to cooperate with the foreign economic policies.

5 Suggestions to Manufacturing Firms Regarding How to Face the Challenges of BIT The numerous entries of multinationals have threatened local Chinese companies’ existing market positions. China’s joining BIT may make domestic firms face more intensive competition from FIE in certain fields.

5.1 Suggestions for Domestic Firms Domestic firms need to make contingency plans to meet the challenges of BIT. They need to update their technology, reduce costs and learn management skills from their foreign competitors. Domestic firms need to do research on BIT and gain benefit from it, for example, using the national treatment terms in BIT to enter the fields that are not open to domestic firms under current domestic regulations. Domestic firms also need to learn

5 Suggestions to Manufacturing Firms Regarding …

137

how to use legal means, including the dispute settlement clauses in BIT, to protect their interests.

5.2 Suggestions for Government The government should provide more detailed information to firms about the changes made by BIT and provide financial support to assist firms to make their structural adjustments. In the fields of gradual lifting of protection, the government should make it clear that the protection will be gradually lifted and the firms need to prepare for the competition from FIE in the near future.

6 Conclusions Using various econometric models and a large firm-level dataset, we find the overall effect of FDI and thereby BIT on Chinese manufacturing sector is positive for firms in the domestic market. As evidence shows, FDI raised the productivity and profitability of the firms significantly in the manufacturing sector. A moderate relaxing of the current restrictions on FDI will increase FDI in manufacturing from all countries by about 4%. This effect will be smaller when only considering FDI from the USA in manufacturing. China’s manufacturing sector as a whole has already opened up to the world economy and that process needs to be continued. The industries in the manufacturing sector do not need to be protected, except for fields related to national security, scarce natural resources and well-defined strategic sectors. Gradual lifting of protection may be needed in the short-run for a small number of vulnerable manufacturing industries. Domestic firms need to update their technology, reduce costs and learn management skills from their foreign competitors. They need to learn to gain benefits from BIT, using the national treatment terms in BIT to enter the fields that are not open to domestic firms under current domestic regulations. Acknowledgements This article is based on research on U.S.–China’s BIT supported by the Peterson Institute for International Economics and China Development Research Foundation. Thanks for comments by the anonymous reviewers, Nicholas Lardy, Jeffrey Schott, Adam Posen, Pieter Bottelier, Lu Mai, Fang Jin, Chen Cheng, Cheng Xiaofeng, Wang Jiao and Yu Jiantuo. Thanks for research assistance by Yuan Dong, Cui Xiaomin, Gong Zheng and Wei Jinlin.

138

9 Potential Impact of China–U.S. BIT on China’s Manufacturing Sectors

Appendix See Table 8 Table 8 Current list of restricted and prohibited industries, manufacturing, 2011 Fields

Regulations

Restricted

Farm and sideline food processing

Processing of edible oils

X

X

Production of biological liquid fuels (ethanol fuel, biodiesel)

X

X

Alcohol, drinks and refined tea manufacturing

Production of yellow rice wine (“huangjiu”), famous and high-quality Chinese spirits

X

X

Processing and production of green tea with Chinese traditional handicraft, processing and production of special tea (including white tea, yellow tea, oolong tea, dark tea, pressed tea, etc.)

Prohibited

Equity controlled by Chinese party

X

Tobacco products manufacturing

Processing and production of leaf tobacco (i.e. threshing and redrying)

X

Printing and reproduction of recorded media

Printing of publications, equity controlled by Chinese party with minimum registered capital of RMB 10 million

X

Oil processing, coking and nuclear fuel processing

Atmospheric and vacuum distillation (