Will China soon be making not only cheaper, but also better, products than everyone else?

Alyson Ma, Bruce Blonigen 13 November 2007

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The opening of China and its breathtaking ascendancy to major-player status in world markets has led to significant hand-wringing by the rest of the world on many fronts. The huge outflow of cheap unskilled-labour-intensive products from China and its ramifications for wages and welfare in both developed and other less-developed countries has been a primary concern.

Recently, new hand-wringing concerns have been raised by various commentators. As it turns out, the composition of China’s exports is much closer to that of OECD countries than its level of per-capita income would suggest.1 This has substantial implications not only for China’s ability to sustain its growth, but also for real wages of all workers in developed countries, not just unskilled ones.

A significant factor behind this surprising export sophistication by China may be the role of industrial policy to promote technologically-advanced industries. While it is well known that the Chinese government has historically had preferential tax treatment and free trade zones for foreign firms, it also often negotiates technology transfer arrangements with foreign firms. These are either through restrictions that limit FDI to joint venturing with a domestic partner or simply offering quid pro quo arrangements of technology transfer from the foreign firm to domestic ones in exchange for the foreign firm’s ability to sell to the huge Chinese market.2

A prime example of how this may be successful is a case in the auto industry. The Chinese government has always required foreign automakers to partner with domestic producers. Shanghai Automotive (a Chinese-owned firm) recently announced plans to start up its own factory to produce a luxury sedan after jointly producing autos in China with General Motors and Volkswagen for many years.3

The X-factor in all of this is China’s large and growing domestic market. It may be precisely the pivotal factor allowing China the leverage to wring out important and significant technology transfer concessions from foreign firms. China’s predecessors (such as Japan, Korea, and Taiwan) did not have this same advantage when pursuing their own industrial policies for growth in previous decades. Thus, one wonders if the upcoming growth of China will make the previous Asian miracles look pedestrian.

While the scenario we have just laid out is plausible, recent evidence suggests otherwise. China’s ability to gain technology from foreign firms and develop its own productive sophistication has actually not been that significant. First, while China’s range of exported products overlaps more with OECD countries than other less-developed countries, China sells these more-sophisticated products at a very large discount relative to competitors.4 This suggests that they are breaking into these “sophisticated” categories with relatively low-quality offerings. Interestingly, the Chinese discount in these products relative to OECD countries has been growing over time, not diminishing.

Second, if one looks at firm-level productivity data, foreign-owned firms in China are currently nine times more productive than their Chinese-owned counterparts! Growth-accounting exercises suggest that foreign firms are responsible for 20% of China’s GDP and 40% of its recent growth using only 3% of its labour force.5 These numbers highlight a significant vulnerability of China, particularly if there is little technological improvement taking place due to foreign presence. Foreign firms could ultimately switch to even lower-cost countries, taking their sophistication and productivity with them.

Even more direct evidence on Chinese-owned firms’ ability to “catch up” with foreign-owned firms can be found by analysing China’s trade statistics, which actually keep track of exports by various types of enterprises in the Chinese economy. These data provide a number of interesting patterns. First, the share of Chinese exports accounted for by foreign firms has been increasing significantly over this period, particularly in sophisticated goods that are exported to OECD countries, even though the level of foreign investment as a percent of the Chinese economy has stayed roughly the same.6

Second, from 1997 to 2005 the patterns for relative quality (or sophistication) changes between foreign-owned and Chinese-owned firms proxied by the export price (unit value) gap between the two firm types are not in China’s favour. The export price gap between foreign-owned and Chinese-owned firms has grown over this period as well, suggesting that the relative sophistication of products from Chinese-owned firms has been actually falling. Further analysis, however, finds that a significant reason for this is the rapid increase in sophistication of products being exported by foreign-owned firms. In other words, foreign-owned firms are dramatically increasing the sophistication of the products they export over this period. After accounting for this continual introduction of higher quality goods by foreign firms, one finds that Chinese-owned firms are closing the price gap by about 12% within three years time. Thus, there is evidence of some modest “technology transfer” occurring, but nothing dramatic.7

There are also a few other pieces of evidence from the analysis of Chinese trade data that argue against any effective role for Chinese industrial policy in these areas. First, price/quality gaps do not close at all for sectors targeted by the Chinese government for foreign investment encouragement or for ones where foreign firms are restricted to have a domestic partner. Second, price/quality gaps do not close more in high-technology sectors that are supposedly being targeted by the Chinese government.

Conclusions

It is easy to spin a story that the unique form of governance in China, as well as its huge market potential, allow it to extract rents and technology from foreign competitors, thus allowing it to grow even faster and longer than most would have imagined possible. The evidence, however, indicates otherwise. It does not suggest that there have been strong technology spillovers from foreign to domestic firms in China to date. China’s industrial policies may have been successful in attracting foreign investment, but not necessarily in increasing the sophistication of its own firms through technology transfer. For example, although the Lifan Group (a Chinese-owned firm) will begin exporting midsize sedans, it is doing so by purchasing ready-made plants from Brazil.8

Of course, there is more work that can and will be done to explore these issues. For example, the available evidence has mainly looked for possible spillovers with the same industry (or product) line (i.e., horizontal), whereas there may be significant technology transfer vertically from foreign-owned firms to Chinese-owned input suppliers (and vice versa). In the end though, it seems unlikely that government policies will be able to substantially enhance technology spillovers that would naturally occur and, of course, there is always the possibility that they could get in the way as well.

Footnotes

1 For example, see Dani Rodrik, What’s So Special About China’s Exports?, NBER Working Paper No. 11947 (2006).

2 Rosen, Daniel H. Behind the Open Door: Foreign Enterprises in the Chinese Marketplace. Washington, DC: Institute for International Economics. (1999).

3 Chinese Partner of G.M. and VW to Offer its Own Cars, New York Times, p. C3. (April 11, 2006)

4 Peter K. Schott K, The Relative Sophistication of Chinese Exports, NBER Working Paper No. 12173; also see his see recent Vox column.

5 Whalley, John, and Xian Xin. China’s FDI and Non-FDI Economies and the Sustainability of Future High Chinese Growth, NBER Working Paper No. 12249 (2006).

6 Bruce A. Blonigen and Alyson C. Ma, Please Pass the Catch-up: The Relative Performance of Chinese and Foreign Firms in Chinese Exports, 1997-2005, NBER Working Paper No. 13376 (2007)

7 A couple other recent studies of firm-level data in China find limited evidence of technology transfer as well: Hale, Galina, and Cheryl Long. What Determines Technological Spillovers of Foreign Direct Investment: Evidence from China. Federal Reserve Bank of San Francisco Working Paper. (2006), and Chen, Huiya, and Deborah L. Swenson. Multinational and the Creation of Chinese Trade Linkages. NBER Working Paper No. 13271. (2007)

8 Feenstra, Robert C. and Alan M. Taylor. International Economics. Worth Publisher, forthcoming

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Topics:  International trade

Tags:  China, technology spillovers, foreign investment, government policies

Associate Professor of Economics at the University of San Diego

Knight Professor of Social Science, Department of Economics, University of Oregon

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