2018/9/2

1

1 Introduction: History and Methodology

Chinese Foreign Trade

EMAE630002 Fall 2018

Prof. Dazhong CHENG

Department of World Economy, Fudan University

chengdz@fudan.edu.cn

http://homepage.fudan.edu.cn/dzcheng/

An old Chinese saying goes: “A workman must first sharpen his tools if he is to do his work well.”

―“工欲善其事,必先利其器”

In China, we have an ancient saying: “Take copper as a mirror, you can tidy up your clothes; take people as a mirror, you will know what you do is right or not; take history as a mirror, you are aware how the dynasties rise and fall.”

―“以铜为鉴，可以正衣冠；以人为鉴，可以明得失；以史为鉴，可以知兴替。”

2018/9/2

2

Outline

1. Brief history of Chinese foreign trade

2. Analytical tools for analyzing Chinese foreign trade

3. Summary

4. Questions

1. Brief history of Chinese foreign trade

1.1 China has a long history of five thousand years

1.2 Ancient China: a large country but with very low income level

1.3 Foreign trade before the Great Geographical Discovery

1.4 Forced opening-up of China by Western powers

1.5 China’s centrally-planned economy: 1949-1978

1.6 China’s opening-up (foreign trade regime reform) since 1978

1.7 Chinese foreign trade performance since 1978

2018/9/2

3

1.1 China has a long history of five thousand years.

197819491911184015th

century

Geographical

Discovery

China perspective

Global perspective

Opium

war

End of Qing

Dynasty

Founding of

new China

Reform and

opening-up

21st-2nd century BC (Xia, Shang, Zhou); 221-206 BC (Qin); 206BC-220AD (Han); 220-589 (Empire disintegrated); 589-617 (Sui); 618-906 (Tang); 906-960 (Empire disintegrated); 960-1127 (Song); 1127-1279 (Southern Song); 1279-1368 (Yuan); 1368-1644 (Ming); 1644-1911 (Qing); 1911-1949 (Kuomintang ruling); 1949- (New China)

WWII1776

USA

5th

century

Middle Ages

2001

Entry into

WTO

1991Dissolution

of the Soviet

Union

Industrial RevolutionIMF, GATT,

World Bank

Global

financial

crisis

2008

Years 0 1000 1500 1600 1700 1820 1870 1913 1950 1973 1998

GDP shares of the world total (%)

China 26.2 22.7 25.0 29.2 22.3 32.9 17.2 8.9 4.5 4.6 11.5

India 32.9 28.9 24.5 22.6 24.4 16.0 12.2 7.6 4.2 3.1 5.0

Japan 1.2 2.7 3.1 2.9 4.1 3.0 2.3 2.6 3.0 7.7 7.7

UK 1.1 1.8 2.9 5.2 9.1 8.3 6.5 4.2 3.3

France 4.4 4.7 5.7 5.5 6.5 5.3 4.1 4.3 3.4

Germany 3.3 3.8 3.6 3.8 6.5 8.8 5.0 5.9 4.3

Italy 4.7 4.4 3.9 3.2 3.8 3.5 3.1 3.6 3.0

Spain 1.9 2.1 2.2 1.9 2.0 1.7 1.3 1.9 1.7

US 0.3 0.2 0.1 1.8 8.9 19.1 27.3 22.0 21.9

Russia/USSR

1.5 2.4 3.4 3.5 4.4 5.4 7.6 8.6 9.6 9.4 3.4

1.2 Ancient China: a large country but with very low income level

Per

capita

GDP

(internati

onal

dollar in

1990)

China 450 450 600 600 600 600 530 552 439 839 3117

India 450 450 550 550 550 533 533 673 619 853 1746

Japan 400 425 500 520 570 669 737 1387 1926 11439 20413

UK 714 974 1250 1707 3191 4921 6907 12022 18714

France 727 841 986 1230 1876 3485 5270 13123 19558

Germany 676 777 894 1058 1821 3648 3881 11966 17799

Italy 1100 1100 1100 1117 1499 2564 3502 10643 17759

Spain 698 900 900 1063 1376 2255 2397 8739 14227

US 400 400 527 1257 2445 5301 9561 16689 27331

Russia/USSR

400 400 500 553 611 689 943 1488 2834 6058 3893

World 444 435 565 593 615 667 867 1510 2114 4104 5709

2018/9/2

4

Period 0-

1000

1000-

1500

1500-

1820

1820-

1870

1870-

1913

1913-

1950

1950-

1973

1973-

1998

Annual

compound

growth

rates of per

capita GDP

(%)

China 0.06 0.00 -0.25 0.10 -0.62 2.86 5.39

India 0.04 -0.01 0.00 0.54 -0.22 1.40 2.91

Japan 0.01 0.03 0.09 0.19 1.48 0.89 8.05 2.34

UK 0.27 1.26 1.01 0.92 2.44 1.79

France 0.16 0.85 1.45 1.12 4.05 1.61

Germany 0.14 1.09 1.63 0.17 5.02 1.60

Italy 0.00 0.59 1.26 0.85 4.95 2.07

Spain 0.13 0.52 1.15 0.17 5.79 1.97

US 0.36 1.34 1.82 1.61 2.45 1.99

Russia

/USSR0.00 0.04 0.10 0.63 1.06 1.76 3.36 -1.75

World 0.00 0.05 0.05 0.53 1.30 0.91 2.93 1.33

Table continued

Madison, A., Chinese Economic Performance in the Long-Run, Published by the OECD Development

Centre, Paris, 1998, Table 2.2 a, b.

Zhang Qian in Early Han Dynasty

(206 BC-8 AD)

Zheng He in Ming Dynasty

Christopher Columbus (Italian) found the American New World in 1492.

Vasco da Gama was a Portuguese explorer and the first European to reach

India by sea. His initial voyage to India (1497–1499) was the first to link

Europe and Asia by an ocean route, connecting the Atlantic and the Indian

oceans and, in this way, the West and the Orient.

Ferdinand Magellan was a Portuguese explorer who organized the Castilian

(Spanish) expedition to the East Indies from 1519 to 1522, resulting in the

first circumnavigation of the Earth by Juan Sebastián Elcano.

1.3 Foreign trade before the Great Geographical Discovery

(the 15th-16th century)

2018/9/2

5

1. In the 4th and 5th century Chinese junks

appeared in Siam (Thailand), Ceylon (Srilanka),

and India, and by the 8th century Canton

(Guangzhou) had established itself as the center of

sea-going trade with the Arab merchants from the

Persian Gulf.

2. Trade routes with Japan and

Korea, as well as the Philippine

Islands were established by the

12th century

3. By the early 1400s a Ming

dynasty (1344-1644) admiral

commandeered expeditions

from China going west to as far

as West Africa.

4. In the year 1517, the Portuguese

were the first to reach China, and in

1557 they were allowed to settle in

Macao

5. The Spanish reached China in 1575, the

Dutch in 1604, and the British in 1637.

The latter two nations established a lasting

interest, with the Dutch gaining a hold on

Taiwan and British traders operating out of

Zhousan (in Zhejiang), Xiamen (in Fujian),

and Guangzhou (in Guangdong).

Basic facts about China’s foreign trade before the Geographical DiscoveryWolfgang Keller, Ben Li, and Carol H. Shiue, China’s Foreign Trade: Perspectives from the Past 150 Years, NBER Working

Paper No. 16550, November 2010.

1.4 Forced opening-up of China by Western powers

• First Opium War in 1840 between Qing Dynasty and UK

• The Treaty of Nanjing (1842) ushered in the era of the Treaty

Port System (通商口岸,see next slide), which lasted from 1842

until 1948.

The creation of the Chinese Maritime Customs (CMC)

Service emerged out of this vacuum of power. The CMC was

founded in 1854 by the foreign consuls in Shanghai to collect

maritime trade taxes that were going unpaid due to the

inability of Chinese officials to collect them during the Taiping

Rebellion(1844-1860).

• The legacy of the forced opening of China by Western powers,

however, is controversial.

While some say it slowed down her growth, others hold that

China would have actually benefited from the increase in

trade—had it not arrived through gunboats.

2018/9/2

6

Treaty Port

China’s Foreign Trade, 1865 to 1940

Source: Keller, et al (2010)

Trade deficit

stable Great Depression

2018/9/2

7

1870 1913 1929 1950 1973 1998

China 0.7 1.7 1.8 2.6 1.5 4.9

India 2.6 4.6 3.7 2.9 2.0 2.4

Japan 0.2 2.4 3.5 2.2 7.7 13.4

The US 2.5 3.7 3.6 3.0 4.9 10.1

France 4.9 7.8 8.6 7.6 15.2 28.7

Germany 9.5 16.1 12.8 6.2 23.8 38.9

Netherlands 17.4 17.3 17.2 12.2 40.7 61.2

The UK 12.2 17.5 13.3 11.3 14.0 25.0

Portugal 3.8 8.1 5.0 3.0 5.0 23.5

Mexico 3.9 9.1 12.5 3.0 1.9 10.7

Brazil 12.2 9.8 6.9 3.9 2.5 5.4

World 4.6 7.9 9.0 5.5 10.5 17.2

Table The ratio of export value to GDP

from 1870 to 1998 (%): 1990-price

Source: Madison (2001).

Q: Why did the Industrial Revolution happen in Europe

and the West but not in China?

• In ancient times, China scored brilliant achievements in science

and technology; its four great inventions [paper, printing, the

compass and gunpowder] played a major role in advancing world

civilization.

• Needham, Joseph (1900-1995) (a British scientist, historian and

sinologist known for his scientific research and writing on the

history of Chinese science): “The Needham Question”: why had

China and India been overtaken by the West in science and

technology, despite their earlier successes?

Landes, David S., Why Europe and the West? Why Not China? The Journal of

Economic Perspectives, Vol. 20, No. 2 (Spring, 2006), pp. 3-22.

2018/9/2

8

1.5 China’s centrally-planned economy: 1949-1978

1949 1966 1976

1958 1960

Great Leap Forward

1978

Cultural

Revolution

A planned economy

Reform and opening to the

outside world:

A socialist market economy

time

20021989

Deng XiaopingJiang Zemin

Hu Jintao

Mao Zedong

2013

Xi Jinping

Political and economic isolation, hostile

relations with both the U.S. and the Soviet

Union, and wars with Korea and India.

General feature of old economic system

Agriculture: collective system—people’s

communes, brigades and production teams;

very limited private plots and free markets or

rural trade fares.

Industry: socialized, Soviet-style system, state-

run (at national and provincial levels) material

allocation system, enterprises with no autonomy.

Almost no role of the market; isolated from the

outside world.

Old economic

system-- Soviet-style

system of centralized

bureaucratic control

over the economy

2018/9/2

9

Commodity

composition of

foreign trade

Old foreign

trade

system

Economic

consequences

Foreign trade took place within the context of aplanned economy and therefore nearly all trade wassubject to very exacting quantitative guidelines.

The State Planning Commission’s import plan coveredmore than 90% of all imports. The export plan wassimilarly comprehensive, specifying the physicalquantities of more than 3,000 individual commodities.

Prior to 1978, a handful of foreign trade corporations(FTC) owned and controlled by the Ministry of ForeignTrade were responsible for carrying out the import andexport plans.

Organization of

foreign trade

Pricing of

traded goods

Separation of domestic and world prices. Overvalued RMB and lower prices of imported

machinery, equipment and industrial raw materials.

Role of the

exchange rate &

exchange control

Neither exports nor imports were sensitive to exchange rates or relative prices.

But the exchange rate played a major role in subsidizing certain categories of imported goods.

Multiple exchange rate systems

The composition of Chinese trade had little

connection to Chinese comparative advantage, with

capital-intensive goods, including refined petroleum

products, playing a large role in Chinese exports

well into the early 1980s.

Role of the exchange rate and exchange control

Fixed and overvalued

Exchange rate

Implicitly subsidizing

the imports

Harming the producers

of export goods

Intra-firm cross-subsidies and

inter-firm financial transfers (FTCs)

Excess demand for foreign

exchange vis-a-vis supply

Rigid exchange control

system was endogenous

Import

substitution

strategy

2018/9/2

10

Economic consequences of old system

The volume of Chinese trade, relative to world trade, declined

sharply from 1.5% in 1953 to 0.6% in 1977, and became one of the

world’s most isolated economies prior to 1978.

The incremental capital output ratio (ICOR) (indicating investment

efficiency) rose from 1/4 in the 1950s to 1/3 in the 1970s. The rise of

ICOR was due to the shift of domestic production into ever more

capital-intensive sectors (self-sufficiency and the third front strategy).

Output growth rate fell significantly from 8% in the 1950s to 6% in

the 1970s.

Improvements in real living standards were quite modest: policy and

terms of trade biased against agriculture.

Severe restrictions on rural to urban migration, to prevent urban

unemployment.

Persistent shortage of foreign exchange.

1.6 China’s opening-up (foreign trade regime reform)

since 1978

20

The primary stage of socialism

The three stages of the economic development of China (see the next slide)

The reform of the command economy

Opening to the West

The enhancement of science & technology and the treatment of intellectuals

Material incentives, the promotion of achievement, and let some get rich

Necessary conditions for economic modernization: order and stability, party

dictatorship, ideological solidarity, socialist democracy, and rejection of

western democracy

Marxism-Leninism Soviet economic model

Mao’s Thought and

economic strategy

Deng Xiaoping Thought DXP Theory:

transforming Marxism-Leninism into a developmental nationalist ideology

Deng: the chief engineer of the reform and modernization of Chinese socialism

2018/9/2

11

21

Since 1978, economic policy reform has been incremental and

ultra-pragmatic – “crossing the river by feeling the stones,” in

Deng Xiaoping’s imagery.

Rural reform began in 1979:

household responsibility system

Urban-industrial reform began in 1984:

management responsibility system

Old economic system

Foreign trade

system

Target:Well-functioning market system or

full-fledged market socialism

Four essential features:

• Inputs and outputs must be available for purchase and sale on the market.

• Enterprise or farm decision makers must behave in accordance with the

rules of well-functioning markets -that is, they must approximate some form

of profit-maximizing behavior.

• The markets faced by enterprise managers must be competitive.

• Prices on a well-functioning market must reflect long-run relative scarcities.

• Gradual shift of resource-allocation mechanisms from central planning to market forces

• Gradual shift of development strategies from an inward to an outward orientation

2018/9/2

12

A focus on foreign trade system reform:

1979 (1) 1984 (2) 1987 (3) 1994 (4) 1998 (5) 2001 (6)

time

Post-WTO

period

After the

Eastern Asian

financial crisis

Foreign exchange

regime reform (Part 8)

Improving the

operational

efficiencies of

FTCs---CRS

Separating government

functions from FTC

management

• Decentralization of foreign

trade administration

• Devaluation of domestic

currencies

• Establishment of SEZs to

encourage foreign

investment (Section II)

New trade mode: processing trade

Tariff and NTBs reduction

Impact of trade reform

State monopoly of foreign trade has been abolished and replaced by

competition among a large number of decentralized FTCs and

enterprises.

Direct control through the central plan on exports and imports has

been replaced by a number of administrative and indirect regulatory

measures, including licensing, taxation and tariffs.

Domestic prices of tradable commodities have increasingly been

determined by market forces and gradually linked to the world

market. World market signals have begun to impact upon the

domestic producers and consumers.

The foreign exchange regime has completed its transition from rigid

centralization to the partial convertibility of the RMB on the current

account.

2018/9/2

13

1.7 Chinese foreign trade performance since 1978

The rise of China has been a major feature of the global

economic landscape over the past more than three decades.

China has become the second largest global economic

power in 2010, overtaking Japan in terms of the size of its

GDP at market exchange rates.

China has become the second largest exporter in the world,

overtaking Germany in 2009.

In 2017, Chinese merchandise exports (2263bn$) account for

13% of the world total (No. 1 exporter in the world),

merchandise imports (1842bn$) 10% (No. 2 importer in the

world) .

Processing trade is important.

Foreign invested firms conduct more trade.

0

500

1000

1500

2000

2500

3000

3500

4000

Ch

ina

Pe

r ca

pita

GD

P_

2005

US

D

19601962

19641966

19681970

19721974

19761978

19801982

19841986

19881990

19921994

19961998

20002002

20042006

20082010

20122014

year

26

Stage 1

Stage 2

Stage 3

US$250 US$500

US$1000

The goal of first stage was the doubling of China’s per capita GNP from US$250 in 1980 to US$500

by 1990. (This objective was accomplished ahead of time by 1988.)

Stage two’s goal was another doubling of the per capita GNP to US$1000 by the year 2000, when

China would ”have shaken off poverty and achieved comparative prosperity.”

The last stage would conclude by the year 2030 or 2050. With its industrialization completed, China

would achieve parity with moderately developed countries.

Deng Xiaoping’s

Three-Step Strategy

2018/9/2

14

China’s trade growth and trade level (bn USD)

Deng’s Southern Tour

Accession to WTO

2008: Global

financial crisis

Leading world exporters and importers of merchandise,

2016-2017 (US$ billion)

2018/9/2

15

Leading world exporters and importers of commercial services,

2016-2017 (US$ billion)

China’s Processing and Ordinary Trade (% of Total Exports or Imports)

Source: CEIC

0

10

20

30

40

50

60

70Imports: OrdinaryTrade

Imports: Processingand Assembling

Imports: Processingwith ImportedMaterials

Imports: other

0

10

20

30

40

50

60

70

Exports: Ordinary Trade

Exports: Processing andAssembling

Exports: Processing withImported Materials

Exports: other

2018/9/2

16

China’s Trade Balance by Mode (US$bn)

Source: CEIC

-40

-30

-20

-10

0

10

20

30

40

Balance: OrdinaryTrade

Balance: Processingand Assembling

Balance: Processingwith ImportedMaterials

0

10

20

30

40

50

60

70

80

90

100

Imports: SOEs Imports: FFEs Imports: POEs and others

0

10

20

30

40

50

60

70

80

90

100

Exports: SOEs Exports: FFEs Exports: POEs and others

0

10

20

30

40

50

60

70

80

90

100

Exports: FFEs-Contractual JV Exports: FFEs-Equity JV Exports: FFEs-FOE

%: Import / total import

Notes: FFEs includes Sino-foreign contractual JV, Equity JV and FOEs

Trade Structure by Ownership

%: Export / total export

2018/9/2

17

Source: calculation based on CEIC database.

Decompose China’s trade balance by ownership (USD bn)

WTO accession

2. Analytical tools for analyzing Chinese foreign trade

The traditional approach

“New” trade theory

Heterogeneous firm trade models

Trade theories

and approachesChinese foreign trade?

2018/9/2

18

2.1 The traditional approach: gains from specialization

Adam Smith (“An Inquiry into the Nature and Causes of the Wealth of Nations”, 1776): specialization and division of labor; law of absolute advantage (free trade on the basis of absolute advantage )

David Ricardo (“Principles of Political Economy and Taxation”, 1817): law of comparative advantage

Heckscher-Ohlin model (1910s-1930s. “Interregional and International Trade” by B. Ohlin, 1933): points out that international trade is driven by differences between countries’ relative factor endowments.

If specialization efficiency outweighs transaction costs

Deepening of specialization and division of labor

Economic development and growth

Expansion of market (domestic and international)

Adam Smith’s Law

The role of institution?

Compare China and other countries?

Evolution: domestic trade → international trade

2018/9/2

19

The Ricardian model and its extensions point to technological differences as the source of comparative advantage.

• The Ricardian model assumes that labor is the only factor of production. Under this assumption, the only possible source of comparative advantage is differences between countries in labor productivity.

Ricardian Theory:

A country exports the good which it has comparative advantage in production. At least one country completely specializes in its comparative advantage good.

Heckscher-Ohlin model (or factor-proportions theory):

• Points out that international trade is driven by differences between countries’ relative factor endowments

• Shows that comparative advantage is influenced by:

Relative factor abundance (refers to countries)

Relative factor intensity (refers to goods)

• Because it takes into account more than one factor, it also has implications for the internal distribution of income.

Heckscher-Ohlin-Samuelson Theorem: Each country will export the good that uses its abundant factor intensively.

2018/9/2

20

The HOS theorem postulates a triple relationship between following variables:

Relative abundance of internationally

homogeneous factor

Factor-intensity determined by internationally identical

technology

Direction of trade (exports and

imports)

2.2 “New” trade theory: gains from economies of scale, product variety and increased competition

The “new” trade theory is motivated to a large extent by the observed importance of intra-industry trade and of trade between similar countries (in terms of technology or resources) that traditional models had difficulties in explaining.

How to measure the intra-industry trade: Grubel-Lloyd Index (GL=1-

[|X-M|/(X+M)]) and others

2018/9/2

21

How to explain intra-industry trade?

Economies of Scale and

Imperfect Competition

Product differentiation and

Demand specification

Economies of Scale, Imperfect Competition, and Trade

Models of trade based on comparative advantage (e.g. Ricardianmodel) used the assumptions of constant returns to scale and perfect competition:

– Increasing the amount of all inputs used in the production of any commodity will increase output of that commodity in the same proportion.

In practice, many industries are characterized by economies of scale or increasing returns to scale:

– Output grows proportionately more than the increase in all inputs.

– Average costs (costs per unit) decline with the size of the market.

2018/9/2

22

Market structure:

• Monopoly (Microsoft?)

• Perfect competition (agriculture goods)

• Oligopoly (automobiles, aircrafts)

• Monopolistic competition (many others: brand name clothing?)

Imperfect competition

– Firms are aware that they can influence the price of their product.

• They know that they can sell more only by reducing their price.

– Each firm views itself as a price setter, choosing the price of its product, rather than a price taker.

– The simplest imperfectly competitive market structure is that of a pure monopoly, a market in which a firm faces no competition.

The monopolistic competition model can show how trade leads to:

– A lower average price due to scale economies

– Availability of a greater variety of goods due to product differentiation

– Imports and exports within each industry (intra-industry trade)

Horizontal differentiation

Vertical differentiation

Hotelling-Lancaster

Dixit-Stiglitz

Falvey-Kierzkowski

Product differentiation and demand specification

2018/9/2

23

• Krugman model (1979, 1980): 2008 Nobel Laureate

• Lancaster model (1980)

• …….

LaborN goods

IRS

M. competition

identical

endogenous

4 points different from

the traditional models

P. Krugman

JIE, 1979

AER, 1980

2.3 Recent developments: productivity gains

Recent firm-level empirical evidence shows that:

• most firms, even in traded-goods sectors, do not export at all;

• of those firms that export, only a few export a large fraction of their production;

• firms that export are different from non-exporters in a number of ways (they are bigger, more productive, pay higher wages and are more capital and skilled labor intensive than non-exporters);

• trade liberalization raises industry productivity.

2018/9/2

24

China U.S.A.

Textiles

Computers

Who

Airplane

Computers

Who

Export, FDI, Outsourcing

Intra-industry trade

Inter-industry trade

2.4 A summary of trade theories and approaches

3. Summary

Review the history of Chinese foreign trade

Comparing China and the rest of the world

Ancient China

Planned economy

Opening-up policy

Review analytical tools for analyzing Chinese foreign trade

Different theories and approaches for analyzing international trade and Chinese foreign trade

2018/9/2

25

4. Questions

Why is foreign trade (hence open-door policy) important for

an economy?

How did China realize the transition from import substitution

regime to export promotion regime? Why?

What are the driving forces behind China’s foreign trade

development?

What about the bilateral trade between China and YOUR

country?