Abstract: In the late 1990s, the percentage of “sophisticated” products, such as electronics and machinery, in China’s total exports has begun to increase while the percentage of goods with lower technological requirements in production, such as apparel, has begun to decrease. This paper explains the two reasons that contribute to the increase in China’s exports of electrical and electronic products from 1993 to 2008: processing trade and industrial upgrading. Data on China’s trade with other East Asian countries and foreign direct investments from these countries show that processing trade is the more influential factor; Chinese government policies during this period have helped induce such FDI-led processing trade. Industrial upgrading has occurred in rare cases of technological spillovers from foreign firms with a presence in China and in cases of state-sponsored research and development in various local Chinese firms. Although both factors have contributed to this change in China’s export structure, the increase in the volume of processing trade is the more dominant factor.

Introduction

It is a well known fact that China’s exports have increased drastically since the beginning of the 1990s. From $91.7 billion in 1993 to $1.4307 trillion in 2008, the increase is staggering (United Nations Statistical Division). However, it is not simply the dollar value of the exports that has changed, but also China’s export composition. In the late 1990s, the percentage of “sophisticated” products, such as electronics and machinery, in China’s total exports has begun to increase while the percentage of goods with lower technological requirements in production, such as apparel, has begun to decrease (Cui and Syed 9). There are many potential reasons behind this phenomenon, and the existing literature on this subject provides many different interpretations.

In the existing literature discussing the factors that have changed China’s export composition, there are two main camps of opinions. One group believes that the change in export composition is due to industrial upgrading in China. The most prominent voice in this group is Dani Rodrik, who specifies that government policies create economic environments that are conducive to shifting the export structure toward high-tech products. In other words, “factor endowments and ‘other economic fundamentals’” cannot fully explain this phenomenon of industrial upgrading (Rodrik 4). His argument is based on the assumption that in a developing country, investors considering entry into “new, non-traditional activities face considerable uncertainty about the costs of operation” (Rodrik 5). These early entrants bear all the costs of failures. On the other hand, if they succeed, they will provide technology and information spillovers as other firms emulate these early investors. As a result, innovative investments must be prompted by non-market forces, namely, the government. Once the first entrants succeed, new firms will enter immediately. Thus, according to Rodrik, strategic government policies have prompted the increase in more sophisticated exports.

The other group believes that the change in export composition is not caused by a change in the export production structure. Rather, the trends of Foreign Direct Investments (FDI) inflow as well as those of exports and imports to China suggest that no significant industrial upgrading occurs; the increasing sophistication in China’s export bundle is due to the fact that multinational corporations export sophisticated components from their home countries to China, which then assembles these components to be exported to other countries, such as countries of the European Union and the U. S. (Liang 108). In other words, China ends up in substantial processing trade in export production, focusing on the labor-intensive steps that do not require sophisticated technology (Liang 106). Like Rodrik, experts of this opinion point to the Chinese government’s policies as an influential factor contributing to the current export structure; specifically, this situation is caused by China’s policies on imports and on FDI, which end up encouraging FDI-led processing trade. For example, some intermediate inputs are imported duty-free (Liang 107). Before this duty-free policy, although imported materials used in production by foreign invested enterprises (FIE) have been taxed, tax exemptions and rebates can be used on exports that utilize these imports. This policy has directly promoted an environment favorable to processing trade (Liang 107).

Exports of Electrical, Electronic Products

Exports of electrical and electronic products, the dependent variable in this paper, take up a significant portion of China’s sophisticated exports and have increased percentage-wise from 1993 to 1998. Two independent variables help explain this increase; the more important contributing factor is the increase in processing trade, and the less influential variable is industrial upgrading. These two factors directly influence the increasing percentage of electronics in exports, but it must be noted that each factor is a situation created by numerous other factors, which in turn have their own causes, resulting in a chain of causations. Thus, the two main factors are in actuality two chains of causations. The data on electronics is retrieved from the UN Comtrade database. The commodities are categorized according to two-digit HS1992 codes. Out of the 97 categories, three categories have always been in the top-four in terms of percentages of total exports from years 1993 to 2008; these categories are “electrical, electronic equipment,” “articles of apparel, accessories, knit or crochet,” and “articles of apparel, accessories, not knit or crochet” (United Nations Statistical Division). The two categories of apparel are combined into one because, for the purposes of this paper, it is not necessary to distinguish knit apparel from non-knit. First, I have compared the percentages of apparel in total exports to the percentages of electrical and electronic equipments (“electronics” for brevity) over the years 1993 to 2008. It is important to compare the export trends of electronics to those of apparel because both categories are prominent in China’s exports.  Figure 1 suggests that before 1995, apparel was slightly more dominant than electronics, but in the following years, electronics have grown at a much faster rate than apparel although apparel certainly has continued to grow. Shown as percentages of total exports in figure 2, the contrast between apparel and electronics is glaring. The percentage of electronics exhibits a continual upward trend while the percentage of apparel exhibits a downward trend. Why do exports of electronics increase much faster than exports of apparel while both are top categories of export commodities? To answer this question, I draw on insights from the existing literature by combining the opinions of the two camps.

Chain I: Processing Trade

The increase in processing trade (in dollar value and percentages) is the main reason for the increase in the percentage of electronics in total exports. While China is exporting an increasing amount of electronics, it does not participate in much value-added production. In fact, China’s overall processing trade increased both in dollar value and in percentage of total trade (Liang 110). In table 1, processing exports increased from 40.9% of total exports in 1990 to 54.7% in 2005. Granted, there is a possibility that the trends in overall processing trade may not apply to the category of electronics. However, the increase in processing trade with little value-added production can also be interpreted through the relationship between high-tech imports and exports in figure 3. As shown, the imports and exports of high-tech products display a nearly perfect correlation although in recent years, from 2003 or so, exports have grown faster than imports. The reason for this pattern of processing trade and the correlation in imports and exports of sophisticated products is the Asian production network. More specifically, the countries of the Asian production network are increasing their FDI in China. Foreign invested enterprises (FIE) over all make up over 70% of the total processing trade in China while countries or regions such as Hong Kong, Taiwan, Japan, South Korea, and Singapore claim approximately 60% of all FDI to China from the late 1990s until 2008 (Liang 110, United Nations Statistical Division). For comparison, the U.S. contributes less than 5% of the total FDI that China receives (United Nations Statistical Division). Most of the firms from these Asian countries are efficiency-driven; the products that are assembled in China are eventually exported to other countries, mainly Western European countries and the U.S (Liang 108). Electronics are particularly prominent commodities. Unfinished electronic or electrical components dominate the top-ten commodities exported to China from the Asian countries (Lee et al. 4). Unfinished products imply a future step of assembly into finished products in China. These Asian countries have sharply increased their FDI into China particularly after China joined the World Trade Organization (WTO) since 2001 (figure 4). For instance, Hong Kong, the largest contributor of FDI out of these Asian countries, doubled its FDI between 2005 and 2008, seen in figure 4. The reason for the increase in FDI is that after China joined the WTO, China has become more integrated into the global economy, and Chinese goods can enter more markets. Taking advantage of this condition combined with China’s cheap labor costs, efficiency-driven foreign Asian firms create subsidiaries in China through joint ventures with domestic firms or as wholly foreign-owned firms.

Chain II: Industrial Upgrading

The second reason that results in higher percentages of electronics in exports in recent years is industrial upgrading. Although not prevalent, some industrial upgrading has occurred. As seen in table 1, the value-added rate in China’s over all processing trade has increased from 17.8% to 34.2% in 2005, which means the expansion of the processing trade also correlates with value-added production. However, in the case of electronics production for exports, industrial upgrading is far less influential than the increase in processing trade because industrial upgrading is still rather limited. This is mainly due to the fact that FIE’s, “particularly wholly foreign-owned enterprises, monopolize high-tech production and generate little spillover to their local counterparts” (Liang 110). It also does not help the domestic industry when wholly foreign owned enterprises “tend to adopt higher-level technologies than joint ventures” (Xu 8). This means that whatever technology that spreads to domestic firms may not even be the latest technology. However, this does not mean that no technology transfers to the domestic firm at all. It merely suggests that the process through which the technology is transferred is inefficient. Industrial upgrading should theoretically occur through two channels, though both are related and influence each other. One is through government policies. The second is through technology spillovers unguided by government policies. The first reason is differentiated from the second in that the former intentionally transfers knowledge to domestic firms and market while the latter may be unintentional or driven purely by market forces. However, due to the monopolizing behaviors of wholly foreign-owned enterprises, the first reason, government policies, has far more real effects on industrial upgrading while the so-called spillovers effects are not prominent.

The Chinese government’s policies aiming to induce industrial upgrading target two groups: the domestic firms and foreign investors. To help purely domestic firms, the government pours money into R&D. While the majority of state-sponsored firms fail, some do achieve success, notably Lenovo (Rodrik 14). This method of helping domestic firms is highly inefficient since most investments are wasted on failed operations, and industrial upgrading achieved through this method is not widespread at all. However, efficiency of state sponsorship is unrelated to the topic of this paper; the result of state sponsorship is what matters. In face of prominent brand names like Lenovo and Haier, one cannot deny that some industrial upgrading has in fact occurred through state sponsorship. As for foreign investors, the central government and the local governments use both carrots and sticks in attracting FDI, such as giving tax breaks and requiring foreign investors to enter into joint ventures with domestic firms. (On top of such requirements, government policy has also promoted the proliferation of economic and technological development zones and high-tech industrial zones. Their share of China’s exports “has risen from less than 6% in 1995 to about 25% in 2005 (Wang and Wei 226).) For instance, in consumer electronics, fully foreign firms are rare in China. Instead, the industry is mostly composed by joint ventures, followed by non-FDI domestic firms (Rodrik 14). The government has made recent changes to export and import policies to discourage processing trade, which in turn promotes industrial upgrading. For instance, a regulation passed in September 2006 removes export tax rebates for a list of prohibited products under processing trade; such products are “primarily low-value-added, high-energy consumption, and high-pollution products” (Liang 114).

Conclusion

Given the current data, it is clear that processing trade is the dominant reason for the increase in percentage of electronic product exports in the past 16 years. Increasing FDI from such East Asian countries goes toward low-value-added production in China instead of contributing to industrial upgrading. The strong correlation between imports and exports of sophisticated products demonstrates that China imports unfinished sophisticated parts from other East Asian countries, and then it simply assembles the parts without adding much value in this portion of the production chain. Very little industrial upgrading has occurred because technological spillovers from foreign firms are rare, and because the Chinese government’s method of inducing sophisticated research and development is highly inefficient. While industrial upgrading is not very prevalent currently, the trend is increasing. Over time, one may see less processing trade between China and other Asian countries and more sophisticated production in China. However, we must wait a few years to see new developments, particularly because of new policies aimed to restrict processing trade.

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