Can production subsidies explain China’s export performance?

Sourafel Girma, Yundan Gong, Holger Görg, Zhihong Yu , 8 July 2008

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China’s exports are booming and – somewhat surprisingly – not just in labour-intensive goods. As Yale trade economist Peter Schott writes in his recent Vox column, China exports an astonishingly wide range of goods – including many in high-tech sectors (Schott 2008).

Although some economists argue that this is an illusion – that China’s sophisticated exports are just assembled from sophisticated imported components (Branstetter and Lardy 2006) – it is difficult to deny that some Chinese firms are making their mark in high-tech industries. According to the WTO 2007 report, China’s export unit value index for manufactured goods rose by 3.6% in 2006, signalling a move away from reliance on the cheap exports.

Pushing its industry up the value-added change is a clear goal of the Chinese government at both the central and local levels. Tax incentives and other policies, like production subsidies, are used to actively upgrade companies’ product structure. But have these policies had any effect? For example, Görg, Henry and Strobl (2008) provide firm-level evidence that Irish production subsidies boosted the exports of already existing exporters but found no evidence that subsidies induced firms to begin exporting.

Our recent study addresses this question for China by examining firm-level data encompassing nearly a half million firms (more than 1.3 million observations) over a six year period from 1999 to 2005 (Girma et al. 2008). Critically, we have rare information on production subsidies received by Chinese firms.1

An overview of subsidies in China

Subsidies are aimed at encouraging activities that would otherwise not take place. Given the importance of exports in China’s economic growth, it is not unreasonable to assume that there might be a link between the substantial amount of subsides that the Chinese government provides and China’s remarkable export performance.

To the best of our best knowledge, there is no public information on direct export subsidies in China. However, data on subsidies for encouraging innovation or high-tech products and subsidies flowing into State-owned Enterprises (SOEs) are available from the China Fiscal Yearbooks. Table 1 shows the figures.

Table 1. National budgetary expenditure on industry (billion US$)

 

Year

Innovation funds and science & technology promotion funds

Subsidies to Lossmaking State Owned Enterprises

Additional appropriation for State Owned Enterprises' circulating capital

Total

Sum 1985-95

47.3
109.8
3.3
160.3
1996
6.3
4.1
0.5
10.9
1997
7.8
4.4
0.6
12.8
1998
7.7
4.0
0.5
12.3
1999
9.3
3.5
0.7
13.4
2000
10.5
3.4
0.9
14.7
2001
12.0
3.6
0.3
15.9
2002
11.7
3.1
0.2
15.1
2003
13.2
2.7
0.1
16.1
2004
15.0
2.6
0.2
17.8
2005
18.2
2.4
0.2
20.8
Total
159.0
143.6
7.5
310.1

Source: China fiscal yearbook, China statistical yearbook.

Among the three government budget expenditures located to firms, only the innovation and science & technology promotion funds are shared between state- and non-state owned enterprises. The two other resources (columns 2 and 3) are for SOEs only. The key facts in Table 1 are:

  • Between 1985 and 2005 subsidies amount to a total of $310 billion, $151 billion of which are directed at SOEs, with a whopping 95% of these loss-making SOE.
  • Over half of total subsidies are allocated to innovation and science & technology promotion funds. This is one indicator that the government is promoting innovation activities and focusing on developing firms with high-tech products with hope that it might help upgrade the industry structure and therefore enhance export performance.

As part of its WTO accession deal, the Chinese government committed to eliminating or substantially reducing subsidies, in particular, subsidies for loss-making state owned enterprises. The Table figures show a clear decline in the nominal value of such subsidies since China’s 2001 WTO membership – a decline that is even more marked as a share of value added, given the explosive growth of Chinese industrial production. Nevertheless, for 2005 $2.4 billion of such subsidies were reported.2

Research findings on production subsidies and export in China

Our research draws on a rich Chinese firm-level dataset from the manufacturing sector, which contains firms that account for about 85-90% of total output in most industries. Around 14% of the firms received production subsidies at some stage during the sample period. We find that export growth in privately owned firms has been remarkably strong in almost all sectors over the sample period – not just in labour-intensive sectors but also in high-tech sectors such as machinery and electronics.

  • Over the same period China has seen a recent shift in the nature of its exports towards more sophisticated products – in 1999 subsidies were highest in the textiles and ordinary machinery sectors. By 2005, firms in the instruments and measurement industry received by far the highest levels of subsidies
  • The results show that a doubling of production subsidies leads, on average, to a 2.1% increase in the level of exports.
  • The export-effect of production subsidies is more pronounced in more innovative and capital-intensive industries, especially for firms with previous export experience.
  • The firms that benefit most from subsidies are the innovative and profitable ones.

Policy applications

Maintaining exports is seen as key to China’s continued economic growth. The research supports those economists who have argued that subsidies have helped driving China’s export success, which has been at the heart of its recent economic boom. From our data and the research findings, we can see that China has largely reduced the scope of its subsidies at the firm level. The almost 10% average GDP growth rate in recent years suggests that China has made good use of its possibilities. Our paper finds that one way this phenomenal growth has been achieved has been via subsidies to close the technology gap with the West and enhance China’s export performance. Thereby many people have been brought out of poverty and into a thriving middle class. However, this research also raises a more challenging question about whether China needs to further adapt its trade practices and reduce such subsidies to fully comply with its WTO commitments.

Answering this question has a serious implication in light of China’s WTO commitment to stop subsidising domestic firms by 2005. Irrespective of the motive of local or central governments for extending production subsidies, the fact that subsidies foster export activity might lead to accusations of unfair trade practices. However, a more detailed analysis based on firm-level export data by commodity and destination country is needed to substantiate or refute such claims. Another important question concerns the welfare implications of such subsidies. Is the use of subsidies to foster export activity (intentionally or unintentionally) a good use of resources? Tackling this question clearly deserves further theoretical and empirical investigation.

References

Branstetter, L.G.and N. Lardy (2006) “China's Embrace of Globalization”. NBER Working Paper No. W12373

Eckaus, R.S. (2006) “China’s exports, subsidies to state owned enterprises and the WTO”, China Economic Review, 17, 1-13

Girma, Sourafel, Gong, Yundan, Gorg, Holger and Yu, Zhihong. (2008) “Can production subsidies explain China’s export performance: Evidence from firm level data

Görg, H., M. Henry and E. Strobl (2008) “Grant support and exporting activity”, Review of Economics and Statistics, 90, 168-174.

Lin, J. and Y. Li, (2002), “Export and Economic Growth in China: A Demand-oriented Analysis”, Peking University, China, Paper No. C2002008

Peter K. Schott (2008). “The Relative Sophistication of Chinese Exports”, Economic Policy, 23 (53), 5–49.

WTO, (2007), World Trade Report 2007: Six decades of multilateral trade cooperation: What have we learnt?

Footnotes

1 We are not considering export specific subsidies but general production related subsidies.

2 The explanation put forward by China is that central government faces difficulties in tracking down all sources and types of subsidies and that a large proportion of the subsidies have come from local government, although some researchers are highly sceptical (Eckaus 2006).

Topics: International trade, Productivity and Innovation
Tags: China, export performance, subsidies

Professor of Industrial Economics at Nottingham University

Research Fellow at the School of Economics, University of Nottingham

Professor of International Economics, Kiel Institute for the World Economy

Research Fellow at the School of Economics, University of Nottingham

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