China Exports

CHINA’S EXPORT SUBSIDIES BENEFIT WESTERN CONSUMERS TO THE DETRIMENT OF THEIR OWN PEOPLE

If China removed its export subsidies, consumers around the world would see their real income fall by 1% – but China’s national income would rise by 3%, according to research by Fabrice Defever and Alejandro Riaño, presented at the Royal Economic Society’s 2013 annual conference.

The study argues that a key, under-appreciated factor behind China’s economic growth is the wide range of government incentives aimed at encouraging Chinese firms to produce almost exclusively for the foreign market, something the authors call ‘pure exporter subsidies’.

These subsidies usually take the form of tax rebates that are conditional on a firm exporting all or most of its production. For example, until 2008, foreign-owned firms located in China and exporting more than 70% of their production enjoyed a 50% reduction in their corporate income tax rate, which could have been further decreased by locating in one of the numerous special economic zones.

The research finds that a direct consequence of these exporter subsidies is that one-third of Chinese manufacturing exporters sell more than 90% of their produce abroad – compared with just 1% of US exporters. The analysis suggests that to support such a large number of pure exporters, China’s total spending on these subsidies could be as much as 1.5% of GDP.

The study finds that China stands to gain 3% in real income if it decides to stop using this type of trade policy. But as imports from China would become more expensive without these subsidies, consumers in the rest of the world would experience a 1% loss in real income.

There is a wide consensus among economists that pure export subsidies are detrimental to an economy’s long-run health. The intuition is that foreign consumers benefit from lower prices at the expense of domestic consumers. The study also reveals that besides this detrimental effect, encouraging firms to export most of their production shields domestic producers in China from tougher international competition.

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China’s recent crowning as the world’s largest trading nation does not seem particularly surprising after witnessing the meteoric rise of its exports over the last decade. The means through which this goal has been accomplished, however, remain unclear. An instrumental factor behind this impressive growth that has not been much appreciated is the existence of a wide range of incentives in China targeted at firms producing almost exclusively for the foreign market – which these researchers call ‘pure exporter subsidies’.

The research to be presented at the Royal Economic Society’s 2013 annual conference suggests that China stands to experience a 3% gain in real income if it decided to stop using this type of trade policy. Conversely, as imports from China would become dearer without these subsidies, consumers in the rest of the world would experience a 1% loss in real income.

Although pure exporter subsidies are not easily observed directly, their implications are striking. A direct consequence of their use is that one third of Chinese manufacturing exporters sell more than 90% of their production abroad. To put this figure in perspective, less than 1% of U.S. exporters export such a high proportion of their output.

The quantitative analysis indicates that to account for such a large number of pure exporters, total expenditure on these subsidies could add up to 1.5% of China’s GDP.

In practice these subsidies usually take the form of tax rebates that are conditional on a firm exporting all or most of its production. For example, until 2008, foreign-owned firms located in China and exporting more than 70% of their production enjoyed a 50% reduction in their corporate income tax rate, which could have been further decreased by locating in one of the numerous special economic zones along the eastern seaboard.

Additional benefits include VAT rebates and lower tariffs on imported machinery and intermediate inputs, direct cash subsidies, discounted utility and land rental rates, and easier access to finance.

There is a wide consensus among economists that export subsidies are not beneficial for an economy, and pure exporter subsidies are no exception. The intuition is that an export subsidy is enjoyed by foreigners who get to purchase subsidised goods at a lower price at the expense of domestic consumers.

But this analysis reveals that besides this detrimental effect, encouraging firms to export most of their production effectively shields domestic producers in China from tougher international competition. Thus, pure exporter subsidies constitute a mercantilist trade policy, which boosts exports while simultaneously protecting China’s local industry.

This heightened protectionism is adding to the costs that Chinese consumers bear as a result of this set of policies. Heavy reliance on pure exporter subsidies leads to a concentration of manufacturing activity in China while a greater variety of cheaper manufacturing goods is enjoyed by consumers in the rest of the world.

While adverse economic conditions linger in developed countries, the pressure for China to reorient its economy towards its domestic market mounts – a sentiment that was echoed in the twelfth five-year plan unveiled by the Central Committee of China’s Communist Party in 2010.

At the same time, complaints by the US, the EU and other member countries at the World Trade Organization has also resulted in China scrapping various subsidies to pure exporters, most notably their favourable treatment in the corporate income tax code. This study indicates that this is indeed the right path for China to follow.

ENDS


Contact:

Fabrice Defever: fabrice.defever@nottingham.ac.uk

Alejandro Riaño: alejandro.riano@nottingham.ac.uk

RES media consultant Romesh Vaitilingam:
+44 (0) 7768 661095
romesh@vaitilingam.com
@econromesh

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