The Pattern of Protection and Economic Growth: Evidence from Chinese Cities
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1 The Pattern of Protection and Economic Growth: Evidence from Chinese Cities Jing Cai (University of California, Berkeley) Ann Harrison (UC Berkeley, Wharton, and NBER) Justin Yifu Lin (World Bank) October 2011
2 Outline I. Why industrial policy: the rationale II. But does it work? A tour of the literature III. Two critical issues: What you promote How you promote Harrison and Rodriguez Clare (2010) Aghion, Dewatripont, Du, Harrison and Legros (2011) This paper
3 I. Why Industrial Policy?
4 Why this resurgence of interest in industrial policy? All 13 of the successful cases identified by the Growth Commission Report used industrial policy. All governments doomed to choose New openness to thinking about government intervention post crisis. Why? Failed orthodox laissez faire policies associated with crisis Perception (even at World Bank) that just relying on investment climate not enough Perceived success of (pro-industrial policy) China and generally more successful performance of developing countries throughout the crisis. In US, the Central Intelligence Agency views China s IP as a new secret weapon.
5 The rationale for industrial policy usually comes from a market failure, such as: Industry-level externalities, which mean that firms produce too little because they do not incorporate the gains to others when they increase their own output Complementarity between goods production and key inputs such as infrastructure, which require public provision Agglomeration economies, stemming from knowledge spillovers or labor market pooling imply firms could lower costs of production if they could all locate close together Imperfect competition. Aghion, Dewatripont, Du, Harrison, Legros show that with two dominant firms and competitive fringe, laissez faire leads to less competition, innovation and lower welfare Imperfect capital markets, which make it difficult to find financing for new projects (ex: SMEs lack collateral for loans) Implication: No government action means too little growth, innovation, or exploitation of agglomeration economies
6 II. But Does it Work? A Tour of the Literature
7 Skeptics Krueger and Tuncer (1982) If IP worked, more supported sectors should grow faster. Since they don t in Turkey, IP involved rent-seeking and didn t work Reply by Harrison (1984): in fact, promoted sectors grew faster Reply by Rodrik: shouldn t expect higher growth Beason and Weinstein (1996) Japan targeted wrong sectors Protected and supported sectors did not grow faster Howard Pack and K. Saggi (2006) Conclude IP doesn t work (India and software industry) Josh Lerner (2009)
8 Optimists: What and How you promote matters: Clemens and Williamson (2001): Target emerging sectors Nunn and Trefler (2006): Target skillintensive sectors Rodrik (2008) suggests under-valuing the exchange rate to promote tradeables Easterly et al (2009): manufactured exports Alfaro and Charlton (2010): FDI promotion, which targets high-tech sectors, leads to higher quality FDI and growth
9 III. Digging Deeper: What to promote and How
10 Should successful IP promote emerging, not declining sectors? USA China Bailing out sunset industries Promoting emerging sectors
11 Harrison and Rodriguez Clare (2010) in Handbook of Development Economics promote soft IP Hard industrial Policy: Tariffs Subsidies to specific sectors Tax breaks for foreign investors Domestic content requirements Soft Industrial Policy: Special Economic Zones offering lower cost infrastructure Roads and ports designed to increase trade? Special Credit for exporters (Trade Credit) Promoting clusters in order to export
12 Two Questions for Today What types of sectors do governments target for trade and tax policies? How do patterns of tariff and tax policies to promote industry affect productivity levels and growth within China?
13 This Paper Define a series of correlations within China to identify what sectors are targeted by local governments. Why China? (data, governance, city variation) Building on Nunn and Trefler (2006), we focus on the correlation between tariffs or tax holidays and industrial characteristics Focus on three types of sectors: Export intensive (EXP/SALES): export procurement/industrial sales Skill intensive (S/UNSK): #skilled workers /#unskilled workers, skilled workers are those with at least high school education R&D intensive: #high-level technicians and engineers/total workforce
14 Measures of Patterns of Interventions (Does what you promote matter?) Patterns of tariff policies are measured by: ω = Corr( Tariff, EXP / SALES ) rt jt jr0 jr0 ρ = Corr( Tariff, S / UNSK ) rt jt jr0 jr0 υ = Corr( Tariff, RDIntensity ) rt jt jr0 For example, the first correlation, which is between the industrycity level initial period export shares and current period tariffs for sector j in city r, measures whether tariff protection is biased towards export sectors in city r in year t. Explore alternatively impact of tariffs and tax holidays
15 Estimation Strategy Estimate the effect of patterns of policies on firm performance. Measures of performance: Total factor productivity estimated using four methods: Aw, Chen, and Roberts 2001 (AW), OLS, OLS with fixed effects, and Olley & Pakes 1996 (OP). Alternative measures of performance: firm productivity levels and growth rates Industry-city aggregate productivity levels Between measure of aggregate TFP: measures movement into new sectors and contribution to TFP
16 Estimation Strategy Firm-level estimation :
17 Estimation Strategy Industry-level estimation: The aggregate industry productivity is measured by: lntfp s lntfp = jrt it ijrt i
18 Data Chinese Industrial firms from NBS: annual survey of all enterprises with more than 5 million RMB sales Annual data for 1998 through 2007 Information on outputs and inputs, ownership Tax incentives based on deviations from statutory taxes, based on taxes paid/profits Tariff dataset from the World Integrated Trading Solution (WITS)
19 Summary Statistics: What Sectors are Promoted in China? Table 3.2 Patterns of Tariffs and Tax by Year, excluding alcohol and tobacco sectors Year Cor(Tariff, Export/Sales) Cor(Tariff, Export/Sales_07) Cor(Tariff, Skilled/Unskilled) Cor(Tariff, RD intensity) Cor(Tax, Export/Sales) Cor(Tax, Export/Sales_07) Cor(Tax, Skilled/Unskilled) Cor(Tax, RD intensity) Total Notes: All endowments are measured by industry-city level beginning or end of period values (2008 or 2007 for export intensity, 2004 for skill and RD intensity). Export intensity equals export procurement divided by industrial sales; the ratio between skilled workers (educations equivalent to or higher than senior high school) and unskilled workers is defined as skill intensity; RD intensity is defined as the share of high level technicians and engineers in total number of employees.
20 Effects of Patterns of Tariff on Firm-level Productivity Table 5. Effect of Patterns of Tariff Policy on Firm Productivity VARIABLES Firm Level lntfp (1) (2) (3) (4) AW OLS FE OP Correlation (Tariff, Export/Sales) *** *** *** (0.0137) (0.0120) (0.0121) (0.0120) Correlation (Tariff, Export/Sales)*(Year-1997) *** *** *** *** ( ) ( ) ( ) ( ) lntariff *** *** *** *** ( ) ( ) ( ) ( ) lntariff_input *** * *** *** ( ) ( ) ( ) ( ) Observations 1,138,927 1,283,212 1,283,212 1,283,212 R-squared Correlation (Tariff, Export/Sales_2007) *** *** *** *** (0.0122) (0.0114) (0.0111) (0.0110) Correlation (Tariff, Export/Sales_2007)*(Year-1997) *** ( ) ( ) ( ) ( ) lntariff *** *** *** *** ( ) ( ) ( ) ( ) lntariff_input *** ** *** *** ( ) ( ) ( ) ( ) Observations 1,243,970 1,393,922 1,393,922 1,393,922 R-squared
21 Table 5. Effect of Patterns of Tariff Policy on Firm Productivity (continued) VARIABLES Firm Level lntfp (1) (2) (3) (4) AW OLS FE OP Correlation (Tariff, Skilled/Unskilled) *** *** *** *** ( ) ( ) ( ) ( ) Correlation (Tariff, Skilled/Unskilled)*(Year-1997) *** * ** ( ) ( ) ( ) ( ) lntariff *** *** *** *** ( ) ( ) ( ) ( ) lntariff_input *** ** *** *** ( ) ( ) ( ) ( ) Observations 1,248,948 1,400,266 1,400,266 1,400,266 R-squared Correlation (Tariff, RD intensity) *** *** * * ( ) ( ) ( ) ( ) Correlation (Tariff, RD intensity)*(year-1997) *** *** ** ** ( ) ( ) ( ) ( ) lntariff *** *** *** *** ( ) ( ) ( ) ( ) lntariff_input *** ** *** *** ( ) ( ) ( ) ( ) Observations 1,248,916 1,400,219 1,400,219 1,400,219 R-squared Firm Fixed Effects Yes Yes Yes Yes Year Dummies Yes Yes Yes Yes
22 Estimation Results: Effects of Patterns of Tariff on Industry-City Aggregate Productivity Table 7. Effect of Patterns of Tariff Policy on Industry-City Aggregate Productivity VARIABLES Industry-City Level Aggregate lntfp (1) (2) (3) (4) AW OLS FE OP Correlation (Tariff, Export/Sales) 0.126*** *** *** *** (0.0260) (0.0167) (0.0219) (0.0212) Correlation (Tariff, Export/Sales)*(Year-1997) ** * * ( ) ( ) ( ) ( ) lntariff *** ** *** *** (0.0413) (0.0424) (0.0412) (0.0412) lntariff_input ** ** ** ** (0.112) (0.122) (0.115) (0.115) Observations 107, , , ,565 R-squared Correlation (Tariff, Export/Sales_2007) ** (0.0257) (0.0220) (0.0251) (0.0245) Correlation (Tariff, Export/Sales_2007)*(Year-1997) *** *** *** *** ( ) ( ) ( ) ( ) lntariff *** *** *** *** (0.0412) (0.0420) (0.0410) (0.0409) lntariff_input ** ** ** ** (0.112) (0.122) (0.114) (0.114) Observations 111, , , ,064 R-squared
23 Table 7. Effect of Patterns of Tariff Policy on Industry-City Aggregate Productivity (continued) VARIABLES Industry-City Level Aggregate lntfp (1) (2) (3) (4) AW OLS FE OP Correlation (Tariff, Skilled/Unskilled) *** *** *** *** (0.0218) (0.0136) (0.0168) (0.0164) Correlation (Tariff, Skilled/Unskilled)*(Year-1997) *** ( ) ( ) ( ) ( ) lntariff *** *** *** *** (0.0402) (0.0415) (0.0404) (0.0403) lntariff_input ** ** ** ** (0.111) (0.122) (0.115) (0.114) Observations 113, , , ,871 R-squared Correlation (Tariff, RD intensity) *** *** (0.0193) (0.0147) (0.0202) (0.0192) Correlation (Tariff, RD intensity)*(year-1997) * * ( ) ( ) ( ) ( ) lntariff *** *** *** *** (0.0402) (0.0415) (0.0403) (0.0403) lntariff_input ** ** ** ** (0.111) (0.122) (0.115) (0.114) Observations 113, , , ,830 R-squared Industry Fixed Effects YES YES YES YES Region Dummies YES YES YES YES Year Dummies YES YES YES YES
24 Estimation Results: Effects of Patterns of Tax Policies VARIABLES Table 8. Effect of Patterns of Tax Policy on Industry-City Aggregate Productivity Industry-City Level Aggregate lntfp (1) (2) (3) (4) AW OLS FE OP Correlation (Tax, Export/Sales) *** *** (0.0196) (0.0143) (0.0161) (0.0155) Correlation (Tax, Export/Sales)*(Year-1997) *** ** ( ) ( ) ( ) ( ) lntax *** *** ** ( ) ( ) ( ) ( ) Observations 101, , , ,660 R-squared Correlation (Tax, Export/Sales_2007) ** *** *** (0.0191) (0.0154) (0.0185) (0.0178) Correlation (Tax, Export/Sales_2007)*(Year-1997) *** *** *** ( ) ( ) ( ) ( ) lntax *** ** ** ( ) ( ) ( ) ( ) Observations 105, , , ,612 R-squared Correlation (Tax, Skilled/Unskilled) *** *** *** (0.0164) (0.0112) (0.0137) (0.0133) Correlation (Tax, Skilled/Unskilled)*(Year-1997) ** *** *** ( ) ( ) ( ) ( ) lntax *** *** ** ( ) ( ) ( ) ( ) Observations 107, , , ,972 R-squared Correlation (Tax, RD intensity) *** ** ** *** (0.0125) (0.0111) (0.0138) (0.0130) Correlation (Tax, RD intensity)*(year-1997) *** ( ) ( ) ( ) ( ) lntax *** *** ** ( ) ( ) ( ) ( ) Observations 107, , , ,932 R-squared
25 Results Summary Firm Level lntfp Table 9.1. Summary of Tariff Results Tariff Correlation (Tariff, Export/Sales) Correlation (Tariff, Skilled/Unskilled) Correlation (Tariff, RD intensity) AW - +/+ - / OLS - +/+ - + FE - +/+ - / OP - +/+ - / Industry-City Level Aggregate lntfp AW - +// - - OLS - +/- - - FE - +/- - - OP - +/- - - Annual Growth of Firm Level lntfp FE / +/+ + / Industry-City Level Aggregate lntfp Table 9.2 Summary of Tax Results Correlation (Tax, Export/Sales) Correlation (Tax, Skilled/Unskilled) Correlation (Tax, RD intensity) AW //- + + OLS // / + FE -/- + + OP -/- + +
26 Moving into higher productivity sectors: what matters? Can decompose Industry-city level growth into a within component and a between component which reflects structural change. Rodrik (2011) and McMillan and Rodrik (2010) show much of difference in Asian versus other regions growth is due to the between component Across Chinese cities, biggest determinant of between component of productivity growth is not driven by policies but by foreign investment, which encourages firms to move into high productivity sectors
27 Concluding Comments Net impact of tariffs negative because while interventions skewed towards sectors where China has a comparative advantage helped (measured by export intensity), the targeting was not strong enough Strong evidence that tax holidays led to higher growth when targeted at export-oriented, unskilled-intensive, and less R&D intensive sectors in China. Because targeting was stronger using tax holidays, and effect uniformly positive, net impact of this intervention has been positive on firm productivity growth Targeting exports, unskilled intensive sectors, and sectors not intensive in the use of R and D was a strategy consistent with China s comparative advantage As China s comparative advantage evolved, the benefits of such targeting fell.
28 Final Take-Aways Final goods and input tariffs have significantly negative effects on both firm and industry level productivity and growth; Tariff protection and tax reduction policies are most successful in a country like China during the period when targeted at exportables, unskilled-intensive, and less R&D intensive sectors. As China s comparative advantage has evolved, optimal targeting policies have also changed.
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