Paper Review: The Relative Sophistication of Chinese Exports

China has been playing a key role in the world trade system by its improving exports capability during the last quarter century, which is also associated with China’s rapid growth. How does such marvel happen and what’s the special about Chinese exports? On the other word, how can Chinese exports account for such a huge market share and achieve high product penetration in United States compared to other competitors? The paper is written by Peter K. Schott, an Associate Professor of Economics at the Yale School of Management, who estimates the relative ‘sophistication’ of Chinese exports to the United States through two dimensions, which is the main section of the paper. The first one is Chinese export bundle compared to those of OECD countries and other United States trading partners, which are relatively skill or capital abundant and have similar endowments, respectively. Secondly, Schott uses prices within product categories to examine whether there is a premium or discount relative to China’s development level and the exports from OECD countries, where China’s development level is measured by per capita GDP.

The whole analysis of this paper is under the guide of factor proportions framework which is strongly related to the multiple cone equilibrium of Heckscher-Ohlin model by using Lerner Diagram which combines unit value isocosts and unit value isoquants with the assumption of two- factor version1, labor and capital. Heckscher-Ohlin theory states that a country will export the final good which makes relatively intensive use of the production factor that is relatively abundant in this country, which is consistent with the theory of comparative advantages which says a country will export the final good which has comparative advantages, such as higher production or lower cost compared to the other goods produced in this country relative to another country. As we all know that China is a typical labor-abundant country with its huge population, which results in the predomination of manufacturing exports from China.

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The basic methodology used in this paper is the regression model under the OLS assumption. The data were mainly focused on manufacturing product because its greatest market share. Schott introduced two concepts before he ran regression, one is the market share of region r in year t and industry i, which is the ratio of imports from region r to the total imports from all the countries in year t and industry i in United States, denoted by MStri, and the other is export similarity index (ESI), which is defined by Finger and Kreinin (1979) to merge both market share and product penetration, and ESItcd =∑min (Stpc, Stpd), where Stpc(Stpd) means the share of country c’s(d’s) exports in manufacturing product p in year t. But Schott made a small amendment of using region-level other than country-level in order to compare China with OECD, Asia (excluding China) and Latin America, which are all regions. Data show that China’s ESI with other regions has grown over time, especially the similarity with the OECD.

In the first regression, Schott used ESItc as dependent variable and regressed it on Xtc and CHINAtc (ESItc =αt +βXtc +γCHINAtc +εtpc), in which Xtc is a country characteristic including capital abundance and skill abundance represented by per capita GDP and the share of population attaining secondary or higher education, while CHINAtc is a dummy variable with the value of 1 if the product is from China, and αt is a year fixed effect. In the second regression, Schott exploited the same methodology as the former, just changing the dependent variable, see below,

log(utpc) =αtp +βXtc +γCHINAtc +εtp, where utpc is the unit value of product p from country c in year t and αtp is a year-product fixed effect. The outcomes statistically identified the significance of these two equations as shown above, which implied that the countries’ ESI with the OECD and export prices are positively related to countries’ per capita GDP and skill abundance, at the same time, China’s ESI with the OECD is even higher than other countries with similar endowments, but Chinese export prices relative to its per capita GDP and skill abundance is declining over time.  Schott also performed another comparison (UVRtpc= utpc/utpCHINA) to measure the relative prices between China and OECD, which is consistent with the lower Chinese prices.

In the conclusion sector, Schott emphasized two main sources of the relative sophistication of Chinese exports, one is the higher ESI with OECD, and the other is the lower prices relative to its per capita GDP, which have been tested in two regressions and is also consistent with the factor proportions framework as a theory basis. One thing is worthwhile to point out that, the conclusion is under the assumption of two-factor version only including labor and capital, as well as perfect competition without considering tariff, non-tariff barriers and other trade costs, which means countries’ exports to United States accurately reflect their domestic production, however, these restrictions do exist in reality. As a result of that, we can only roughly estimate the relative sophistication, but which is significant enough for us to explain the advantages of Chinese exports. For manufacturing product that is labor-intensive, China’s abundant labor because of huge population leads to lower cost, and then a relatively lower price makes its exports more attractive. Further more, China’s higher ESI with OECD but lower prices relative to OECD reinforces its sophistication.

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