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A Chinese Economic Puzzle (Part One)

We talk to a leading Chinese economist who is building an international reputation by deftly deciphering China’s global economic role

By Li Jia Updated Apr.27

Yu Miaojie, a 40-year-old professor at Peking University’s China Center for Economic Research, has spent the past few years trying to reconcile China-specific economic phenomena with orthodox economic theory that seems to contradict them. One particular puzzle for Yu has been a paradox that has baffled other international economists: why has reducing tariffs on imported finished products in China has contributed so much to the country’s growth in productivity? In other developing economies, reducing tariffs on imported intermediate – not finished – goods has contributed more to productivity growth, as those items are used to create other products that can then be exported. This process is called “processing trade.” 
In a recent paper, Yu argued that China’s improvement in productivity, which was largely caused by the elimination of tariffs on imported components intended for processing trade, is not an economic exception, but proof of existing theory. On March 24, the UK’s The Economic Journal announced that his paper had won its annual Royal Economic Society Prize, an honor given to the best paper printed each year in the esteemed 125-year-old publication, which was edited by John Maynard Keynes from 1912 to 1944. Yu has become the first economist from the Chinese mainland, and the first solo economist of Chinese descent, to win the prize. 
NewsChina: What made your research project different from others’? 
Yu Miaojie: When other researchers have discussed the impact of trade liberalization on the productivity of a country’s domestic producers, they typically focus on the effect of lowering tariffs on imported final goods. For example, lower tariffs on cell phone imports could bring more iPhones into China. This would cause a pro-competitive effect among domestic cell phone manufacturers, motivating them to improve so they can keep up in a more competitive market, while driving out inefficient manufacturers at the same time. Both Chinese consumers and related industries benefit from this. 
However, processing trade – in which Chinese companies import intermediate products, such as tires for a car, and export the final outputs, or the cars – has accounted for nearly half of China’s total foreign trade for years. China now records about US$4 trillion in foreign trade every year. About US$2 trillion of it involves processing trade, which is huge. Lowering tariffs brings costs down for businesses engaged in the processing trade. However, there have been zero tariffs on such imports in China since the 1980s. Because there have been no tariffs from the start in this sector, there can be no tariff reductions, leaving a hole in previous observations by international analysts on the impact tariff changes have on productivity at the enterprise level. 
As a result, China appeared to be an exceptional case in international trade studies. In other emerging economies that also encourage processing trade, gradually reducing tariffs on imported intermediate goods has boosted productivity more than decreasing tariffs on imported final goods. However, once China’s zero-tariff policy that nurtures the country’s gigantic processing trade is taken into account, it is clear the significant cost-saving effect of the policy has been overlooked. The conclusion is that the use of better, cheaper intermediate imported goods in the processing trade has also contributed more to China’s upsurge in productivity than tariff reductions on final goods, making China no exception to the rule. 
My quantitative analysis shows that 42 percent of the growth in productivity in China’s manufacturers and about 15 percent of China’s economic growth as a whole came from trade liberalization in the decade following China’s World Trade Organization accession in 2001. These numbers prove that deep integration into the global value chain has made a significant contribution to China’s prosperity. 
The last two reasons contribute more to China’s productivity growth than the first two. Greenfield investment [mainly the building of manufacturing facilities in a foreign country] not only expands the overseas market, but also forces a company to improve the technology used in its overseas subsidiaries in order to survive in global competition. The progress made in its overseas operations will then spread throughout the entire company. For companies taking advantage of cheaper labor in their overseas factories, the money they save can then be spent on upgrading their domestic facilities. At the same time, some of these companies have had to close their factories in China. Those workers then have to find other jobs. Many of them have moved to the service sector, working in package delivery or opening online businesses. This has already happened, and has actually helped China’s service sector grow rapidly over the past few years. 
NewsChina: Do you think Chinese economists face biases in international academia? 
YM: There was probably bias about a decade ago, to some extent. For example, a grammatical error in a paper could call the academic competence of a Chinese scholar into question, but would be treated as no more than a different writing style in a paper by a Western academic. However, things have changed over the years. I certainly feel happy and lucky to have won [the Royal Economic Society Prize]. I was quite impressed by the openness of the review process. Academic rigor in a paper is everything. It does not matter where you are from. The candidates included some very prominent, world-class economists. 
There are several reasons for winning themore international recognition of Chinese economists nowadays. Firstly, solo researchers [like myself] have a higher chance of winning than teams of authors. Secondly, I am a Chinese economist addressing an economic issue specific to China, with practical significance. I don’t think I could have won the prize if I were doing research on the US economy or if I had done the research on China while abroad. Economists’ understanding of China, the second-largest economy and the largest emerging economy in the world, is still very limited, but is regarded as increasingly important by analysts around the world. Chinese scholars have firsthand information on what is going on in China, and are thus better at spotting the long-term, substantial issues most worthy of research. All of my research topics – growth, trade liberalization – resonated with China’s long-term economic reality. Then I narrowed down my focus on imports and productivity, which are very specific and as of yet underresearched. An economist should refrain from taking up too broad of an issue, or commenting on unfamiliar arenas. 
Once your topic is identified, the next step is to work on it in depth. In this regard, the training on conducting meticulous research that I received while studying abroad [as a PhD student at the University of California, Davis] was very helpful. I learned how important it is to build your propositions on empirical and quantitative analysis, using intense precision. All of the data in my paper are available for others to download, so the data can be cross-checked by colleagues around the world. You cannot convince others that you just feel your theory is true. You have to prove it with standard academic language and rigorous analysis. Given this, my own experience tells me Chinese and international economists can cooperate, each using their own advantages, to provide a better understanding of China’s economy to market observers and players. 
Given this, my own experience tells me Chinese and international economists can cooperate, each using their own advantages, to provide a better understanding of China’s economy to market observers and players.