or more than two decades, international economists have been trying to unravel the mysteries surrounding China-specific economic phenomena that seem to be at odds with orthodox economics.
The riddles have ranged from the paradox of China’s massive money supply yet low rate of inflation, as put forward in 1993 by international economist Ronald McKinnon, to the country’s miraculous rise from impoverished nation to economic powerhouse.
Yu Miaojie, a 40-year-old professor at Peking University’s China Center for Economic Research, has spent the past few years trying to solve a puzzle of his own: why reducing tariffs on imported final goods in China has contributed so much to the country’s growth in productivity. This is an apparent deviation from existing theory pointing to evidence in other developing economies, where reducing tariffs on imported intermediate goods – not final 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 talked to Yu about the theories and research that led to this accomplishment.
He highlighted the importance of China’s further integration into the global value chain, particularly through boosted imports and outbound investment. He also said he sees more potential for cooperation between Chinese and international economists, whose respective advantages can bring analysts one step closer to cracking the puzzle that is China’s economy.
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.
NC: Through its Made in China 2025 national strategy, China is trying to become a manufacturing power that is placed higher up in the global value chain. How could increased imports help realize this goal?
YM: As economist and Nobel laureate Paul Krugman has stressed, “Productivity is not everything, but in the long run it is almost everything.” Imports can contribute to China’s productivity in several ways. Firstly, upping the imports of quality intermediate products can improve the quality of final products made in China and give more choices to Chinese businesses engaged in processing trade. Besides, when one Chinese producer uses a better intermediate product imported from overseas, its competitors may immediately follow suit. In this way, the productivity of entire industries can be improved.
Secondly, importing capital goods, or materials used for production that do not require further processing, such as machinery, can help, say, shoe manufacturers to produce better shoes. Thirdly, importing more final products, as I touched on before, can spur competition and give consumers more options.
It also provides a chance for Chinese producers to study the quality gap between their products and the best ones in the world, and figure out how to catch up.
NC: Exports have been prioritized over imports in China for years. Do you think we should reassess the importance of imports?
YM: Yes. Actually, at least as far as processing trade goes, the lack of tariffs shows that imports have been given the same importance as exports in this regard. Generally, however, more efforts have been made on bolstering the country’s exports.
China currently has several opportunities to boost imports. Firstly, as the US is eyeing ways to up its exports significantly, China can take advantage of this and import more, which would help ease trade disputes, reduce its excessive foreign exchange reserves and improve businesses’ total factor productivity [the growth gained from efficient use of factors like labor, capital, raw materials and technology]. This would make everyone happy.
Building free trade areas [FTAs] with major trade partners is another important method. The agreement to upgrade the ASEAN-China FTA will take effect [in May 2016, a move which is expected to more than double the trade between China and the 10 ASEAN member states to US$1 trillion by 2020]. Negotiations are underway for the Regional Comprehensive Economic Partnership [which includes the ASEAN countries, China, Australia, South Korea, Japan, New Zealand and India]. Both trade partnerships are crucial for China’s imports.
ASEAN countries are some of China’s main sources for raw materials like rubber and wood. South Korea and Japan are China’s main suppliers for core intermediate products.
NC: China is not only a big international trader, but also, increasingly, an international investor. Can China’s outward foreign direct investment [FDI] improve productivity back in China?
YM: Absolutely. [For the first time,] China’s outward FDI exceeded its inward FDI in 2014 [if overseas investment via a third market is taken into account, according to China’s Ministry of Commerce]. China became the world’s third-largest outbound investor [in 2012]. This new phenomenon is worth researching.
Why are Chinese enterprises going abroad? The first reason is they are driven by a demand for resources, as seen in their iron ore mining projects in Australia, for example.
The second is they are acting as contractors to build roads and bridges in other countries.
Chinese businesses have been using these two channels of conventional outward FDI for years. The third is they are attracted by cheaper labor in less-developed markets in Southeast Asia and Africa. The fourth is they are eyeing expansion in developed markets like the US to circumvent high import tariffs during trade disputes.
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.
NC: In one of your recent papers on China’s outward FDI, you discuss a strange phenomenon.
Despite disadvantages in access to land and capital, China’s private enterprises have outperformed State-owned enterprises [SOEs] domestically. However, they are less productive than SOEs in overseas markets, even though those disadvantages do not exist in other countries. Why is this?
YM: This is also because of domestic discrimination against private companies. For example, let’s say there are two companies at the same level of productivity, one private and one State-owned. The private company would be much more motivated to go abroad to avoid unfair domestic competition, even if it may not be prepared enough to do so.
By contrast, the SOE feels much more comfortable staying in the domestic market. As a result, SOEs only venture abroad when they are strong enough, while some private companies are forced to try their luck on a fairer playing field before they are prepared for internationalization.
NC: 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 the award in my case, and factors contributing to more 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.