HOW TRADE LIBERALISATION BOOSTS GROWTH IN CHINA: New evidence of the impact of tariff reductions on assembly firms” productivity

Reductions in input and output tariffs for firms engaged in ''processing trade'' contributed at least one percentage point per year of China''s growth rate over the first decade of the twenty-first century. That is one of the findings of research by Professor Miaojie Yu, published in the June 2015 Economic Journal. In contrast with previous work, the study finds that reducing output tariffs has had a greater effect on productivity improvement than reducing input tariffs for large Chinese trading firms.

Today the nature of international trade is no longer wine for cloth, the author notes. The world is characterised by both trade globalisation and production fragmentation. A particular form of this fragmented production technique is processing trade: the activity of assembling tariff-exempt imported inputs into final goods for resale in foreign markets.

The iPhone is the classic example: the different components of an iPhone are manufactured in Japan, Korea and the United States, from where they are shipped to China for final assembly at Foxconn, an exclusive iPhone assembler located in Shenzhen. All final assembled products are exported back to the United States and other markets.

In terms of its magnitude, processing trade in China merits special attention. It accounts for nearly half of China''s exports, exceeding the total exports of most countries. So a key question is how processing trade affects firms'' performance, and more generally, China''s overall rate of economic growth?

One important fact is that processing trade in China enjoys special treatment with zero import tariffs. Such a policy setting has rich implications for manufacturing firms'' performance. Economists understand that trade liberalisation, such as import tariff reductions, has two different effects on domestic firms'' productivity: one via tougher import competition from the final goods; and the other via cost savings from intermediate inputs.

Previous research finds that tariff reductions on both intermediate and final goods boost firm productivity. But the impact on firm productivity of input trade liberalisation is more important than that of output trade liberalisation as input tariff reductions could cause firms to import more variety with lower price and better quality.

In contrast with previous work, the new study finds that reducing output tariffs has had a greater effect on productivity improvement than reducing input tariffs for large Chinese trading firms in the new century. Using highly disaggregate Chinese manufacturing firm-level data, the research finds that a 10 percentage point fall in output (input) tariffs leads to a productivity gain of 9.2% (5.1%).

The positive impact of both types of tariff reductions on productivity improvement is weaker as a firm''s share of processing imports grows. 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 total imports in China, have zero tariffs.

Further tariff reductions on imported intermediate inputs have no impact on firms that engage entirely in processing trade, but they still have some impact on firms that engage in both processing and non-processing trade. As a 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.

Looking at the economic magnitude of these effects across the whole country, the study finds that import trade liberalisation contributes at least 14.5% to economy-wide productivity growth. Given that China had an annual growth rate of around 10% in the first decade of the twenty-first century, trade liberalisation contributed at least one percentage point of China''s overall GDP growth. In short, every year, trade liberalisation contributes to China with GDP similar to that of Ecuador in terms of its absolute value.

''Processing Trade, Tariff Reductions and Firm Productivity: Evidence from Chinese Firms'' by Miaojie Yu is published in the June 2015 issue of the Economic Journal. Miaojie Yu is at the China Center for Economic Research (CCER) at Peking University and is deputy editor of China Economic Journal.