Processing Trade, Firms Productivity, and Tariff Reductions Evidence from Chinese Products

Processing T rade,Firm Productivity,and T ari¤Reductions:

Evidence from Chinese Products

Miaojie Yu y

China Center for Economic Research(CCER)

National School of Development

Peking University

January3,2011

Abstract

This paper explores how processing trade,jointly with output and input tari¤reductions,can improve…rm productivity.Output tari¤reductions generate productivity gains via competition,

whereas input tari¤reductions do so by saving…rm’s cost.More importantly,processing…rms enjoy

extra gains from processing ing highly disaggregated Chinese product-level trade data and

…rm-level production data from2000–2006,after constructing…rm-level tari¤s based on product

information and controlling for possible endogeneity,I…nd that a10%output tari¤decrease gener-

ates a10%increase in…rm productivity gains,which is around twice higher than the productivity

gains from cutting input tari¤s.The logarithm of productivity of processing…rms,on average,is

.05higher than those of non-processing…rms.

JEL:F1,L1,O1,O2

Keywords:Processing Trade,Productivity,Firm Heterogeneity,Chinese Products

I thank Robert Feenstra,Lisa Cameron,Robert Elliott,Penny Goldberg,Munisamy Gopinath,Tomohiki Inui, Amit Khandelwal,Samuel Kortum,Mary Lovely,Devashish Mitra,Will Martin,Robert Staiger,James Tybout,Wei Tian,Shang-jin Wei,David Weinstein,Fredik Willhelmsson,Yang Yao and Zhihong Yu for their helpful comments and constructive suggestions.Financial support from the Chinese National Natural Science Foundation Grant(No.7100301) is gratefully acknowledged.I thank the excellent research assistance from Xu Zhang and Hao Zhang.However,all errors are mine.

y China Center for Economic Research(CCER),Peking University,Beijing100871,China.Phone:86-10-6275-3109, Fax:86-10-6275-1474,E-mail:mjyu@.

1Introduction

This paper investigates the in‡uence of processing trade and tari¤reductions on Chinese…rm pro-ductivity.Although the impact of tari¤reductions on…rm productivity has been widely explored in the literature,relatively little research has focused on the role of processing trade,as a type of trade liberalization on intermediate goods.

Processing trade is a popular trade pattern in many developing countries(especially China,Mexico, and Vietnam).A domestic…rm…rst obtains raw materials or intermediate inputs abroad and after some processing domestically it then exports the value-added…nal goods.To encourage processing trade, governments usually o¤er tari¤reductions or even tari¤exemptions on the processing of intermediate goods.In contrast to output tari¤reductions,which could foster…rm productivity by inducing tougher import competition,input tari¤reductions could generate…rm productivity via a variety of cost-saving behavior like learning e¤ects(Amiti and Konings,2007).In addition,processing trade can introduce high-quality imported intermediate inputs(Helpern et al.,2010).In addition,processing trade also provides more varieties choices to domestic…rms as in the love-of-variety story of Krugman(1979).As a result,processing…rms usually enjoy more productivity gains than those of non-processing…rms.In addition,FIEs have higher productivity possibly due to their superior international technology spillover (Keller and Yeaple,2009)or less…nancial constraints(Feenstra et al.,2010).

In the past decade,China’s foreign trade has grown dramatically.China has now replaced Germany as the largest exporter in the world.Indeed,the processing exports regime jointly with foreign invested enterprises(FIEs)has become the driving force of China growing exports.China’s processing exports has accounted for more than half of its total trade exports since1995.Simultaneously,the share of total exports by FIEs has also increased dramatically,from around20%in1992to around60%in2006. China’s foreign direct investment as a share of GDP once climbed to6%in1994before plateauing at 3%(Naughton,2006).In addition,China obeyed to its World Trade Organization(WTO)commitment after2001and has cut tari¤s from18.53%in2001to8.87%in2006.Finally,China’s average annual increase in total factor productivity(TFP)in the last decade has been around2.7%by estimating a gross output production function(Brandt et al.,2009).

Using highly disaggregated Chinese…rm-level production data and product-level trade data,in this paper I unravel the three channels of raising productivity gains from trade liberalization:the import