Protectionism Through Exporting:Subsidies with Export Share Requirements in China

ABCDE 2014

Fabrice Defever1, Alejandro Riano2

1 University of Nottingham, GEP, CEP, and CESifo2 University of Nottingham, GEP, CFCM, and CESifo

June 2, 2014

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Motivation

“In certain zones, companies are apparently only allowed tolocate when they enter obligations to export a certain minimumpercentage amount of their production. [C]an China pleaseexplain how such practices are compatible with the obligationsresulting from the accession protocol [?]”

Questions by the European Communities with regard to China’s Transitional Review Mechanismat the Committee on Subsidies and Countervailing Measures. World Trade Organization,September 21, 2004.

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Export intensity distribution: Chinese mfg. exporters

01

23

De

nsity

0 .2 .4 .6 .8 1

Export-Intensity

China

Source: NBS Annual Manufacturing Survey, 2000-2006

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Export intensity distribution: large developing countries

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23

De

nsity

0 .2 .4 .6 .8 1

Export Intensity

Argentina Colombia Kenya Mexico Poland Russia South Africa Ukraine

Countries without Export Share Requirements

Countries with Export Share Requirements

Bangladesh Brazil Egypt

Ethiopia India

Indonesia Morocco Pakistan

Philippines Thailand

Turkey Vietnam

Source: World Bank Enterprise Surveys, 2002-2012. Each country has the same weight

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Findings

Between 30 and 50% of Chinese mfg exporters benefits from subsidies withESR

They coexist with regular exporters and domestic firms across all mfg.industries

China would stand to experience a 6.55% increase in real income if iteliminated all subsidies with ESR

If it only eliminated export requirements, it would achieve 45-67% of thatgain

However, 3.5% of the least productive firms would exit

Unlike unconditional export subsidies, subsidies with ESR increase aggregateexports while protecting the domestic market

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Background

China’s dual trade policy regime: a heavily protected domestic economycoexisting with a system of export-oriented enclaves

Feenstra (1998): ‘one country, two systems’

Subsidies with ESR can be found in local, city, prefecture, provincial andnational-level regulations

Most of these policies target:

- Foreign-Invested Enterprises (FIEs)- Processing Trade Enterprises (PTEs)- Firms located in Free Trade Zones (FTZs)

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Corporate income tax rates, 1991-2008

National Special Coastal Yangtze and Pearl Industrialtax rate Economic Development Economic Parks∗

Zones Zones ZonesExport/sales ratio

Foreign-Invested EnterprisesBelow 70% 30% 15% 24% 24% 15%Over 70% 15% 10% 10% 10% 10%

Production EnterprisesBelow 70% 30% 15% 15% 15% 15%Over 70% 30% 10% 10% 10% 10%

∗ Industrial Parks includes “Economic and Technological Development Zones”,“High-Technology Industrial Development Zones” and “Export Processing Zones.”

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A Simple Model of ESRs

Firms at Home face the following iso-elastic demand function in market i:qi = Aip

−σi , i ∈ {H,F}

Production: q = ϕl, taking wH as given

Fixed cost of operation fd > 0 (+fx > 0 if exporting)

Optimal prices: pdH = pxH = σσ−1

wH

ϕ and pxF = τpxH

Firms with productivity ϕ ∈ [ϕ∗d, ϕ

∗x) operate domestically, firms with

ϕ ≥ ϕ∗x become exporters

All exporters have export intensity (EI):

ηxH =τ1−σAF

AH + τ1−σAF.

No firm would find it optimal to have EI greater than ηxH

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A Simple Model of ESRs, cont’d

Subsidies with ESR: the government of H offers firms the subsidy package(sr, sf ) subject to EI ≥ η

The problem of a firm receiving subsidies with ESR is:

πcH(ϕ) = maxpcH ,p

cF

{(1 + sr)

(AH(pcH)1−σ +AF (p

cF )

1−σ)−wHϕ

(AH(pcH)−σ + τAF (p

cF )

−σ)− (1− sf )(fd + fx)wH

}

subject to:AF (p

cF )

1−σ

AH(pcH)1−σ +AF (pcF )1−σ ≥ η.

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Coexistence of all three types of firms

ϕ∗d

ϕ∗x

ϕ

sr

ϕ(sr, sf )ϕ(sr, sf ) ϕ

sr

ϕ∗c(sr, sf )

ϕ∗c(sr, sf )

ϕ(sr, sf )

constrained exporters

domestic firms

regular exporters

constrained exporters

regular exporters

domestic firms

(i) sf < fxfd+fx (ii) sf > fx

fd+fx

s1r s2r s1rs2rsr

ϕ(sr, sf )

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Implications of the model

We can back out the unobserved subsidies sr and sf using data on:I shares of different types of firms,I productivity premia between firm types

Constrained exporters can be more/less productive than domesticfirms

But we should expect regular exporters to be the most productivegroup of firms

It is straightforward to accommodate multiple subsidies with ESR

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Data

We use the Annual Survey of Chinese Manufacturing Firms from theNational Bureau of Statistics (NBS) in China for 2000-2006

The dataset includes SOEs and privately-owned enterprises with sales above5 million Chinese Yuan

The survey covers approx. 95% of China’s industrial output and 98% of itsmanufacturing exports

The final sample consists of 1,100,600 firm-year obs. with 386,185 differentfirms

A 70%-ESR exporter is a firm with EI ∈ [0.7, 0.975)

A 100%-ESR exporter (‘pure exporter’) is a firm with EI ∈ [0.975, 1]

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Data, cont’d

Subsidies with ESR target mainly:

- Foreign-invested enterprises (FIEs)- Processing-trade enterprises (PTEs)- Firms located in Free-Trade zones (FTZs)

The NBS data allows us to identify FIEs but not PTEs

A FIE is a firm with positive level of foreign capital, but that does notsatisfy the requirement to be considered a PTE

We merge the NBS data with transaction-level customs data from theChinese General Administration of Customs

A PTE is a firm that sells ≥ 90% of its exports through the processing traderegime

FTZs are identified as prefecture-level cities promoted as Special EconomicZones, Coastal Development Zones and cities belonging to the Yangtze andPearl River Delta Economic zones

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Summary statistics

NBS Mfg. Survey, 2000-2006 Matched Data, 2000-2006Number of % Number of %

obs. obs.

Domestic firms 793,494 72.10 793,494 83.90Exporting firms 307,106 27.90 152,217 16.10

Total 1,100,600 100 945,711 100

% of exporters by firm type and location:

PTE FIE Neither TotalFIE nor PTE

In a FTZ 22.66 36.11 25.57 84.34Outside a FTZ 1.40 5.34 8.92 15.66

Total 24.06 41.45 34.49 100.00

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Export intensity distribution by firm type and location

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Identifying constrained exporters

Firm shares:

Regular 70%-ESR Pureexporters exporters exporters

NBS Manufacturing Survey 50.49 24.94 24.56Matched Data 50.82 25.56 23.62

Processing Trade Enterprises (PTE) 31.36 29.78 38.86Foreign-Invested Enterprises (FIE) 50.07 26.46 23.47In a Free Trade Zone (neither PTE nor FIE) 61.47 23.67 14.85Outside a Free Trade Zone (neither PTE nor FIE) 76.25 15.37 8.37

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ESR-exporter premia: taxes

Comparison group: All domestic firmsIncome tax VAT Sales Tax

as share of value-added

70%-ESR -0.576a -3.311a -1.108a

(0.023) (0.044) (0.022)100%-ESR -0.688a -3.483a -1.153a

(0.022) (0.048) (0.025)

Comparison group: Regular exporters70%-ESR -0.461a -2.346a -0.242a

(0.025) (0.047) (0.024)100%-ESR -0.572a -2.519a -0.286a

(0.024) (0.052) (0.026)

year, 4-digit sector and prefecture-city f.e.

# observations 1,100,600 1,100,600 1,100,600# firms 386,185 386,185 386,185R2 0.066 0.129 0.186

Standard errors clustered at the firm-level.17 / 26

ESR-exporter premia: size and productivity

Comparison group: All domestic firmslog sales TFP LP TFP OLS

70%-ESR 0.683a 0.463a 0.118a

(0.007) (0.006) (0.005)100%-ESR 0.505a 0.334a 0.048a

(0.007) (0.006) (0.005)

Comparison group: Regular exporters70%-ESR -0.297a -0.213a -0.079a

(0.009) (0.007) (0.005)100%-ESR -0.475a -0.341a -0.150a

(0.009) (0.007) (0.006)

year, 4-digit sector and prefecture-city f.e.

# observations 1,100,600 1,100,600 1,100,600# firms 386,185 386,185 386,185R2 0.165 0.223 0.280

Standard errors clustered at the firm-level.

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ESR-exporter premia: Productivity (by firm type)

TFP LPcomparison group:

domestic firms each type of reg. exporter

70%-ESR× FIE 0.552a(0.011) -0.205a(0.014)× PTE 0.855a(0.018) -0.060a(0.024)× Neither FIE nor PTE 0.592a(0.013) -0.246a(0.015)

100%-ESR× FIE 0.456a(0.012) -0.301a(0.015)× PTE 0.569a(0.016) -0.347a(0.023)× Neither FIE nor PTE 0.474a(0.015) -0.364a(0.017)

year, 4-digit sector and prefecture-city f.e.

# observations 945,711# firms 348,660R2 0.272

Standard errors clustered at the firm-level.

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General equilibrium

Two symmetric countries with population of size L

Firms pay a sunk cost fe to draw ϕ from a Pareto distributionG(ϕ) = 1− ϕ−a

Production technology is the same as before

Only China uses subsidies with ESR ⇒ firms in the rest of the World onlyoperate domestically or as regular exporters

Subsidies are financed through lump-sum taxation

Two ESR: 70% and 100%

The Chinese government offers two sets of subsidies: (s70r , s70f ) and

(s100r , s100f )

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Benchmark calibration

Fixed parameters: Li = fe = 1; σ = 3; a = 2.76

Calibrated parameters:

Parameter Description Valuefx/fd Relative Fixed cost of exporting 1.60τ Transport cost 1.42s70r 70%-ESR Exporters - sales subsidy 0.107s70f 70%-ESR Expoters - fixed cost subsidy 0.357

s100r 100%-ESR Exporters - sales subsidy 0.332s100f 100%-ESR Exporters - fixed cost subsidy 0.598

Targets:

Statistic Data ModelShare, regular exporters 0.141 0.134Share, 70%-ESR exporters 0.070 0.070Share, 100%-ESR exporters 0.068 0.068Export intensity, regular exporters 0.280 0.301Productivity premia 100%-ESR exp/domestic firms 0.397 0.375Productivity premia 70%-ESR exp./100%-ESR exp. 0.138 0.135

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Counterfactual experiments

Variable Autarky Export-Share Laissez-

Sales Fixed Cost

Requirements Faire

Subsidy Subsidy

Subsidies/GDP, China 0.000 0.031 0.000

0.031 0.031

Exports/GDP, China 0.000 0.266 0.234

0.258 0.256

Price index, China 100 94.40 90.90

89.85 90.96

Price index, ROW 100 87.05 90.90

84.60 85.89

Exit cutoff, China (ϕ∗H) 100 108.30 110.08

113.07 111.74

Exit cutoff, ROW (ϕ∗F ) 100 112.14 110.08

112.04 111.79

Wage, China 100 100 100

100 100

Wage, ROW 100 97.60 100

94.80 96.03

Welfare, China 100 103.50 110.05

107.89 106.51

Welfare, ROW 100 112.02 110.05

112.07 111.80

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Counterfactual experiments

Variable Autarky Export-Share Laissez- Sales Fixed CostRequirements Faire Subsidy Subsidy

Subsidies/GDP, China 0.000 0.031 0.000 0.031 0.031Exports/GDP, China 0.000 0.266 0.234 0.258 0.256Price index, China 100 94.40 90.90 89.85 90.96Price index, ROW 100 87.05 90.90 84.60 85.89Exit cutoff, China (ϕ∗

H) 100 108.30 110.08 113.07 111.74Exit cutoff, ROW (ϕ∗

F ) 100 112.14 110.08 112.04 111.79Wage, China 100 100 100 100 100Wage, ROW 100 97.60 100 94.80 96.03

Welfare, China 100 103.50 110.05 107.89 106.51Welfare, ROW 100 112.02 110.05 112.07 111.80

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Conclusions

We document the widespread use of subsidies with ESR in China; a largeshare of exporters in China benefit from them

These subsidies are quantitatively large, and might explain why China, aswell as other countries using subsidies with ESR, exhibit a stark bimodalexport intensity distribution

This stylized fact cannot be explained by the workhorse models ofinternational trade with heterogeneous firms

Subsidies with ESR have fostered China’s aggregate exports while at thesame time providing greater protection for domestic firms than an orthodoxtrade liberalization reform

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Share of constrained exporters across industries

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Export intensity distribution - excluding FIEs

01

23

De

nsity

0 .2 .4 .6 .8 1

Export-Intensity

China

All Exporters

Excluding foreign affiliates

(Other than Hong-Kong Macao and Taiwan)

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Export intensity distribution - excluding foreign affiliates

01

23

De

nsity

0 .2 .4 .6 .8 1

Export Intensity

Excluding foreign affiliates

Countries without Export Share Requirements

Countries with Export Share Requirements

All Exporters

All Exporters

Excluding foreign affiliates

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