1

Implications of the Euro Sovereign Debt Crisis for China: A CGE Analysis1

Qin Bao, Xiaoguang Yang

(Academy of Mathematics and Systems Science, Chinese Academy of Sciences,

Beijing, China, 100190)

Research Highlights

The on-going Euro sovereign debt crisis has brought a significant downturn to the

European economy, greatly decreasing its growth rate and increasing its

unemployment rate. With sharp declining domestic demands in countries in Euro zone

or EU, other countries have been troubled through the channel of international trade.

As a heavily export-oriented country, China is supposed to be greatly influenced by

the debt crisis broken out in Europe who is amongst the largest trading partners. In

this paper, a general equilibrium methodology is used to study the impacts of the Euro

sovereign debt crisis on China’s economy. A multi-sector computable general

equilibrium (CGE) model of China is built, which contains 28 production sectors and

commodities. The foreign sector is divided into 11 parts, including Germany, France,

Italy, UK, other countries of EU, US, Canada, Australia, Hong Kong, Japan and rest

of the world. The model is consisting of three main modules, i.e., international trade

module, output and demand module and a closure module. In the international trade

module, a double-level nested structure is applied following constant elasticity of

substitute (CES) functions and constant elasticity transformation (CET) functions.

The large-country assumption is used in the international trade module that China’s

domestic supply and demand will affect the world prices. The proposed model is

calibrated based on the social accounting matrix (SAM) in the year 2007. The Euro

sovereign debt crisis is captured by reducing a premium on exporting prices and

importing prices with countries in crisis to reflect the declining of external output and

demand in the proposed model. This treatment is in accordance with the basic

1 This study is supported by the National Natural Science Foundation of China under grant No.71241020 and No.71241016. Corresponding Author: Qin Bao, contacted information: baoqin@amss.ac.cn

2

assumption for general equilibrium that prices are endogenously adjusted to achieve

market equilibrium. Moreover, the on-going Euro sovereign debt crisis has affected

China mainly through its direct influence on imports and exports with European

countries as revealed by empirical studies. Taking different evolution paths of the

Euro crisis into consideration, nine crisis scenarios are set for simulations, which

assume different decreasing levels of the prices for different countries. The results

indicate that the crisis will have a significantly negative shock on China’s

international trade, larger on exports than on imports, and the impacts will be

increased with more countries involved in the crisis and more serious of the crisis.

The impacts on trade by industrial sector are closely related with characteristics of the

sector, i.e., sectors with intensive exports to Europe will have a larger shock.

Moreover, the crisis will have a negative impact on China’s overall economy and

decrease the welfare. By taking a robust test on large-country and small-country

assumptions and a simulation on the export rebate policy, the results also shed light on

policies: On the one hand, the increasing of the pricing power determination will

effectively reduce the negative effect of the crisis. On the other hand, a carefully

designed export rebate rate adjustment policy will mitigate the shock of the crisis

without greatly increasing the overall tax burden.

3

Implications of the Euro Sovereign Debt Crisis for China: A CGE Analysis

Qin Bao, Xiaoguang Yang

(Academy of Mathematics and Systems Science, Chinese Academy of Sciences,

Beijing, China, 100190)

Abstract:

Based on a multi-sector computable general equilibrium (CGE) model of China, this

paper studies the impacts of European sovereign debt crisis on China’s economy

under different scenarios, and simulates the effects of corresponding export debate

adjustment policy. The results indicate that the crisis will have a significantly negative

shock on China’s macro economy from both supply and demand side. Moreover, the

crisis will decrease China’s international trade, more for exports than for imports, and

the impacts will be increased with more countries involved in the crisis and more

serious of the crisis. The impacts on trade by industrial sector are closely related with

characteristics of the sector, i.e., sectors with intensive exports to Europe will have a

larger shock. The results also shed light on policies: On the one hand, the increasing

of the pricing power determination will effectively reduce the negative effect of the

crisis. On the other hand, a carefully designed export rebate rate adjustment policy

will mitigate the shock of the crisis without greatly increasing the overall tax burden.

Keywords:

European Sovereign Debt Crisis; International Trade; Computable General

Equilibrium Model; Policy Analysis

1. Introduction

The Euro sovereign debt crisis broke out in the late 2009, with downward of the

sovereign debt rank of Greek. The crisis was caused by multiple factors, including the

real-estate bubbles in U.S. and the subsequent global recession. The countries that are

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most influenced by the crisis are called PIIGS, including Portugal, Ireland, Italy,

Greek and Spain. The on-going Euro sovereign debt crisis has brought a significant

downturn to the European economy, greatly decreasing its growth rate and increasing

its unemployment rate. The two largest economy, i.e., German and France have shown

an obvious slowdown.

The solution for the Euro crisis has been discussed and policies have been

undertaken to solve the crisis. The solution will be a lasting process and it will take a

long time for the Europe to recover from the recessions. With sharp declining

domestic demands in countries of Euro zone or Europe, other countries in the world

have been troubled through the channel of international trade. As a heavily

export-oriented country, China is supposed to be greatly influenced by the debt crisis

broken out in Europe. Since Europe has been China’s largest trading partner, the crisis

has brought significant influence on China’s economy. For example, the ratio of

export to European to the total export has shown an obvious decrease. The lasting

crisis will cut down more the European demand, and the solution of the crisis, i.e., a

tighter fiscal policy will further decrease the economic demand. Thus it is both

important and urgent to study how the Euro crisis will affect China’s economy and the

possible mitigation policies.

In this paper, a general equilibrium methodology is used to study the impacts of the

Euro sovereign debt crisis on China’s economy. A multi-sector computable general

equilibrium (CGE) model of China is built, which contains 28 sectors and 11 foreign

accounts. The Euro sovereign debt crisis is captured by a negative premium on

exporting prices and importing prices with countries in crisis to reflect the declining

of external output and demand in the proposed model. Three crisis scenarios and each

with three assumptions for different evolutionary paths of the Euro crisis are set for

simulations, which assume different decreasing levels of the prices for different

countries. The results indicate that the crisis will have a significantly negative shock

on China’s whole economy as well as its international trade. The impact will be larger

on exports than on imports, and the impacts will be increased with more countries

involved in the crisis and more serious of the crisis. Sectors are affected differently,

5

and those with intensive exports to Europe will have a larger negative shock in

sectoral exports. By taking a robust test on large-country and small-country

assumptions and a simulation on the export rebate policy, the results also shed light on

policies: On the one hand, the increasing of the pricing power determination will

effectively reduce the negative effect of the crisis. On the other hand, a carefully

designed export rebate rate adjustment policy will mitigate the shock of the crisis

without greatly increasing the overall tax burden.

This paper is organized as follows: The literature review is provided in Section 2.

The model and the data and scenarios are described in Section 3. The results are

presented in Section 4. Section 5 provides the conclusion.

2. Literature Review

Ever since the US financial crisis, researchers have been studied the facts and

reasons of the crisis. However, since the crisis can be better reflected in financial

market, data for stock market, bond market and so on are used to study the

transmission and influence of the crisis. For example, Arghyrou and Kontonikas

(2012) analyzed the fundamentals and contagion of the EMU sovereign-debt crisis by

using the euro area government bond yield data. Chudik and Fratzscher (2012)

studied the global transmission of the crisis base on a VAR method. Grammatikos and

Vermeulen (2012) studied the transmission of financial and sovereign debt crisis to

fifteen EMU countries by using the data of stock prices, CDS spreads and exchange

rates. Long et al (2012) studied the impact of U.S. finaical crisis based on the method

of functional analysis of variance. These researches provide insights on the contagion

process of the Euro sovereign debt crisis, however, the empirical method is not

applicable for study the impacts of the crisis on the whole economy. Ziesemer (2010)

studied the impact of the credit crisis on developing countries by using an

error-correction model. Tagkalakis (2013) used the econometric analysis to study the

effects of U.S. financial crisis on fiscal debt in OECD countries. However, as for the

Euro crisis, there isn’t enough data.

Although the Euro crisis has been extensively studied, there are recently few

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studies about the impacts of Euro crisis on China’s economy. Strutt and Walmsley

(2009, 2011) used a dynamic global CGE model GDyn to study the impacts of the

global financial crisis for China. Tuan et al.(2010) studied the impact of global

financial crisis on China’s energy consumption absed on an input-output model.

Huang et al.(2011) studied the impacts of the global financial crisis on off-farm

employment and earnings in rural China. However, these researches didn’t specify the

Euro sovereign debt crisis and lacks a complete analysis of the impacts on the whole

economy. Some related literature studied the impacts of other crisis, like the U.S.

financial crisis, for example, Glodstein and Xie (2009) studied the spillover effect of

the U.S. credit crisis on Asia, however, the analysis wasn’t based on models.

Fidermuc and Korhonen (2010) analyzed the transmission of global financial crisis in

China and India from the perspective of business cycles.

The computable general equilibrium (CGE) method has been widely used in

economic simulations and policy analysis for China. For example, Liang et al. (2007)

used a CGE model to study the carbon taxation policy in China. Diao et al.(2012)

studied the global recession and China’s stimulus package policy based on a CGE

model. Bao et al.(2013) used CGE method to study the impacts of border carbon

adjustments on China. In this paper, the CGE method is also used to study the impacts

of the crisis on China’s economy. Moreover, the export rebate policy of China is

analyzed also based on the proposed CGE model.

By employing the CGE method to study the impacts of the Euro sovereign debt

crisis on China’s economy, this paper makes contributions in several aspects: Firstly,

this paper studied the Euro crisis based on a CGE method. Considering the Euro crisis

is still on-going and there is not enough data for econometric models. Secondly, this

paper depicts a whole picture of how the crisis will affect China, including its macro

economy, total international trade and sectoral international trade, which provide more

policy insights. Finally, the export rebate policy is studied based on the proposed

model, which suggests a proper policy undertaken will effectively mitigate the

negative impacts of Euro crisis on China.

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3. Model

3.1 Modules of the Model

A multi-sector CGE model is built to study the impacts of the Euro sovereign debt

crisis on China’s economy. There are three main modules in the model, which are

described below.

3.1.1 International Trade Module

The impacts of the Euro sovereign debt crisis on China will be transmitted mainly

through the international trade channel. To capture the different scenarios of the crisis,

the foreign accounts in the international trade module are divided into 11 regions, i.e.,

Germany, France, Italy, UK, other countries of EU, US, Canada, Australia, Hong

Kong, Japan and rest of the world. The structure of international trade module is

illustrated in Fig.1, which contains a double nested structure for both exports and

imports. Armington assumption (1969) is used which assumes imperfect

substitutability between domestic goods and foreign goods. Similarly, the

substitutability between foreign goods from different regions is assumed to be

imperfect.

OutputX

Domestic salesD

Total exportE

Total importM

DemandQ

CHINA

FOREIGN ACCOUNTS

regional importMM

regional exportEE

Fig. 1: Structure of international trade module

The international trade module includes both exports and imports. For exports, as

shown in Eq. (1), the sectoral output iX is used for export iE and domestic sales

iD following a constant elasticity transformation (CET) function.

8

1/, ,( )e e e

i e i i de i iX a E a Dρ ρ ρ= + (1)

where ,e ia and ,de ia are the share parameters of exports and domestic goods with

, , 1e i de ia a+ = . 1/ ( 1)e eσ ρ= − is the elasticity between exports and domestic goods.

The optimal strategy for export is derived from maximizing output sales

i i i iPE E PD D+ under the constraint described by Eq. (1), whereas iPE and iPD

are the export price and domestic price for commodity i, respectively

For import, the sectoral demand iQ is used for import iM and domestic sales

iD following a constant elasticity of substitute (CES) function as shown in Eq. (2). 1/

, ,( )m m mi m i i dm i iQ a M a Dρ ρ ρ= + (2)

where ,m ia and ,dm ia are the share parameters of imports and domestic goods with

, , 1m i dm ia a+ = . 1/ (1 )m mσ ρ= − is the Armington elasticity between the imports and

domestic goods. The optimal solution for import is obtained by minimizing the

demand expenditures i i i iPM M PD D+ under the constraint described by Eq. (2),

whereas iPM and iPD are the import price and domestic price for commodity i,

respectively.

The sectoral export ,i sEE and import ,i sMM from region s are similarly

determined by CET functions and CES functions, respectively. The optimal regional

export and import are derived from maximization of the total export sales and

minimization of the total import expenditures, respectively.

The export prices and import prices are assumed to be determined following a

large-country assumption, i.e., China’s supply and demand will influence the world

prices. Formally, sectoral world export price ,i sPWE and import price ,i sPWM for

commodity i from region s are determined by Eq. (3) and Eq.(4), and sectoral export

price i ,sPEE and import price i ,sPMM are determined by Eq.(5) and Eq.(6).

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( ),

,

1 ex

i si s i

i s

PWSE * +preexEE econ

PWE

σ

= (3)

( ),

, 1

im

i si s i

i s

PWMMM icon

PWSM * +preim

σ

= (4)

( )1i ,s i i ,sPEE * -esub PWE *ER= (5)

( )1i ,s i ,s iPMM PWM *ER* +mtax= (6)

where ,i sEE and ,i sMM are the regional export and import for commodity i from

region s, iPWSE and iPWSM are the fixed world export prices and import prices.

iecon and iicon are the transforming parameters for exports and imports, and exσ

and imσ are the elasticity parameters for exports and imports. ER denotes the

foreign exchange rate, while iesub and imtax are used to define export rebate rate

and import tariff rate. To capture the impacts of different developing scenarios of Euro

sovereign debt crisis, parameters spreex and spreim are used to define the relative

price change for the world fixed prices. It is assumed that the crisis will cause the

downturn of global demand, which will increase the prices.

3.1.2 Production and Final Demand Module

The production and final demand module describes the domestic output and

demand as shown in Fig. 2. The domestic output function is assumed to be a

double-nested production function. At the top level, the output for each sector is

composed by different intermediate inputs and value-added composite. The Leontief

function is used to assume no substitution amongst different inputs. At the second

level, the value-added composite is composed by capital and labor following a CES

function. As illustrate by Fig.2, the domestic demand is composed by a linear sum of

intermediate input, consumption of households and government as well as capital

formation.

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OutputX

Value-addedVAD

Intermediate inputINT

CapitalCAP

LaborLAB

DemandQ

Household consumptionCD

Government consumptionGD

Capital formationID

Fig. 2: Structure of production and final demand module

In the proposed model, there are three types of domestic agents, i.e., households,

enterprises and government. Each agent holds equilibrium between their income and

expenditure. For households, they get their income from the production factors they

possessed, i.e., labor and capital. They also get transfer income from enterprises,

government and foreign accounts. The disposable income after taxation will be

allocated to consumption and saving according to a fixed marginal prosperity of

savings. The households’ consumption for different commodity i will be determined

by an extended linear expenditure system (ELES) function. For enterprises, they gain

income from capital returns and government transfers. Their expenditure includes

income tax to government, transferring to households and savings. For government,

the income sources from various taxes, including production tax, income tax and tariff.

The expenditure of government includes transferring, export rebate, consumption and

saving. The government consumption on different commodity will also be determined

through an ELES function.

The gross economy status will be captured by both real and nominal gross domestic

product (GDP). The real GDP is calculated from the expenditure side, i.e., the sum of

domestic consumption, capital formation and net export. The nominal GDP is

calculated from the income side, i.e., the sum of labor income, capital returns and net

taxes.

3.1.3 Closure Module

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The closure module includes the equilibrium of factor markets and commodity

markets, as well as the choice of closure conditions. For the two factor market, i.e.,

labor and capital, it is assumed that both are clear. In the labor market, the total labor

is assumed to be fixed, while the wage can be adjusted. In the capital market, it’s

assumed that the capital return is fixed while the capital using can be adjusted. For

commodities, it’s assumed that the supply and the demand equals.

The closure condition for foreign accounts includes endogenous foreign savings as

well as exogenous exchange rate. The foreign savings are the net income of foreign

regions considering their exports, imports and transfers with China. For government,

the closure condition includes endogenous government surplus or deficit, and

exogenous tax rates. Moreover, the neoclassical closure condition is hold in the model

whereas the total investment equals the total savings.

3.2 Database and Calibration

The proposed CGE model is calibrated based on a social accounting matrix (SAM)

of the year 2007. The SAM provides a uniform data base for economic activities and

allocations. The data sources includes China national input-output (IO) table for 2007

(135 sectors), National Bureau of Statistics of 2008 and General Administration of

Customs of P.R. China. The production sectors and commodities are disaggregated

into 28 sectors as shown in Table 1. The regional imports and exports data for

different sectors are aggregated from the HS classification codes with references of IO

table’s categories. Table 1 Definitions of sectors and commodities

Codes Definitions AGR Agriculture M_C Mining and washing of coal P_G Extraction of petroleum and natural gas MIN Other mining and processing FOD Manufacture of food, beverages and tobacco products TEX Manufacture of textiles FUR Manufacture of textile-apparel, leather, fur, and related products

WOD Processing of timber; manufacture of wood, bamboo, rattan, palm and straw products; manufacture of furniture

12

PAP Manufacture of paper products and printings OIL Processing of petroleum and nuclear fuel COK Processing of coke RCM Manufacture of raw chemical materials and chemical products MCM Manufacture of medicines CMF Manufacture of chemical fibers RUB Manufacture of rubber and plastics NMM Manufacture of non-metallic mineral products MET Manufacture of metal products EQP Manufacture of general and special purpose machinery TRM Manufacture of transport equipment EEQ Manufacture of electrical and electronic equipment

CCO Manufacture of communication equipment, computers and other electronic equipment

MEA Manufacture of measuring instruments and machinery for cultural activity and office work

OTM Other manufacture ELE Production and supply of electric power and heat power GAS Production and supply of gas WTR Production and supply of water CNS Construction

TRP Transportation, storage, post telecommunication and other information-transmission services

OSR Wholesale and retail trades

The calibration of scale parameters, transform parameters and share parameters are

based on the SAM. The parameters of elasticity of substitution in international trade

module and production module are shown in Table 2. Table 2 Substitution parameters

Sectors/Commodities Between labor and capital Imports Exports AGR 0.2 4.9 5 M_C,P_G,MIN 0.3 5.6 6 FOD 0.56 5.6 6 ELE 0.63 3.8 4 CNS 0.7 3.8 4 TRP 0.84 4 4.5 OSR 0.63 4 4.5 others 0.63 5.6 6

3.3 Scenarios

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To capture the Euro sovereign debt crisis in China’s single-country multi-sector

CGE model, it is assumed that the world prices will be shocked as a result of the

global demands decreases due to the crisis. By a negative price premium, this

assumption will enable to make the crisis endogenously captured and transmitted.

This settings well considers the feature of CGE model, i.e., the equilibrium is brought

about by the adjustment of prices. Furthermore, it well depicts the transmission

channel of Euro crisis to China’s economy by its influence in international trade.

Three scenarios are set to assumed different evolutionary paths of the crisis, and

each with three different influence scales, as shown in Table 3. The assumptions are

referred to the actual decreases of export and import prices in both U.S. financial

crisis and in the early time of the Euro crisis. Table 3 Scenarios of Euro sovereign debt crisis

Scenarios Descriptions

Scenario A A1 preex = -3% and preim = - 1% for Euro zone countries A2 preex = -5% and preim = - 3% for Euro zone countries A3 preex = -8% and preim = - 5% for Euro zone countries

Scenario B B1 preex = -3% and preim = - 1% for European countries B2 preex = -5% and preim = - 3% for European countries B3 preex = -8% and preim = - 5% for European countries

Scenario C C1 preex = -3% and preim = - 1% for European countries and U.S. C2 preex = -5% and preim = - 3% for European countries and U.S. C3 preex = -8% and preim = - 5% for European countries and U.S.

4. Results and Analysis

4.1 Macro economy

The impacts of Euro sovereign debt crisis on China’s macro economy is illustrated

in Fig. 3. In general, the crisis will bring down China’s overall economy, with real

GDP decreasing from 0.876% to 3.936% in different scenarios. Another obvious

impact is that a larger and wider effect of the crisis on global demand will cause a

more severe effect. For example, with the same influence scale, i.e., the same decrease

in prices, when only Euro zone countries are affected, the impacts on China’s GDP is

smaller than if European countries are affected, and if both European countries and

U.S. are affected, the negative impacts will be the largest.

14

Fig.3 Impacts of Euro crisis on China’s real GDP (%)

The impacts of the Euro crisis on China’s demand and output are further shown in

Fig. 4. The impacts for scenario B and scenario C are similar as shown in Fig. 3, so

only impacts for scenario A is illustrated. It can be seen that both total output and total

demand will be decreased by the crisis, and the impacts are smaller than on GDP.

Both households consumption and government consumption will be decreased, and

the formal will be decreased more. However, total investment will be influence a little,

which can be omitted. The social welfare will also be influenced by the crisis, under a

Hick measurement, the welfare for rural households and urban households will be cut

down 44.3 and 122.1 billion RMB Yuan in scenario A2.

-4.500

-4.000

-3.500

-3.000

-2.500

-2.000

-1.500

-1.000

-0.500

0.000 A1 A2 A3 B1 B2 B3 C1 C2 C3

15

Fig.4 Impacts of Euro crisis on China’s macroeconomy in scenario A (%)

4.2 International Trade

4.2.1 Total Imports and Exports

As the Euro sovereign debt crisis affects China’s economy mainly through the

channel of international trade, the imports and exports will be directly influenced as

prices change as shown in Eq. (3) to Eq. (6). The impacts of the crisis on China’s

international trade are illustrated in Fig. 5. It can be seen that the crisis will cut down

China’s total export and import, and the negative impacts will be larger on exports

than on imports. For different scenarios, the impacts are similar with that on GDP, i.e.,

a greater and wider evolution of the crisis will cause a larger effect. For example, in

scenario A2, B2 and C2, the impacts on total exports will be -2.619%, -2.865% and

-5.101%, while on total imports will be -0.816%, -0.942% and -2.027%. It can be

seen that when the crisis will transmit to U.S. and affect its demand, the negative

effects on China will be much more increased. This is because both EU and U.S. are

amongst China’s largest trading partners.

-3.000

-2.500

-2.000

-1.500

-1.000

-0.500

0.000 total demand total output

households consumption

government consumption real GDP

total investment

A1

A2

A3

16

Fig.5 Impacts of Euro crisis on China’s international trade (%)

The crisis will be transmitted to international trade through prices. The price

changes as a result of the crisis are illustrated in Fig. 6 for scenario A2. It can be

found that when Euro sovereign debt crisis broke out and cut down Eurozone

countries’ demand, the trade prices between China and Eurozone countries will firstly

be decreased. Therefore the average world export price and import price will be

reduced by 0.819% and 0.712%, respectively. Under the large-country assumption,

China’s supply and demand will affect the world prices, and the average export and

import prices faced by China’s enterprises will be decreased by 0.823% and 0.724%.

In this way, the final export price and import price will be cut down by 0.429% and

0.416% respectively. Since the relative decrease of the trade prices are more than

domestic prices (-0.212%), the enterprises will choose to substitute domestic sales

rather than export, while the domestic demand will prefer more import goods. This

explains why the crisis will have a larger negative impact on export than on import.

-9.000

-8.000

-7.000

-6.000

-5.000

-4.000

-3.000

-2.000

-1.000

0.000 A1 A2 A3 B1 B2 B3 C1 C2 C3

total export

total import

17

Fig.6 Impacts of Euro crisis on China’s prices in scenario A2 (%)

4.2.2 Sectoral Imports and Exports

The impacts of the Euro crisis on sectoral imports and exports are similar with the

total trade, i.e., the influence will be increased with a wider and larger evolutionary

path. Moreover, the impacts will be different for different sectors, as illustrated in Fig.

7. For sector WOD, EQP, OTM, EEQ and CCO, the export will be seriously affected

by the Euro crisis, decreasing 3.528%, 3.445%, 3.161%, 3.123% and 3.054%

respectively. For sector MIN, M_G and OIL, the import will be greatly hurt by the

crisis, at about -2.349%, -2.127% and -2.117%, respectively.

-0.900

-0.800

-0.700

-0.600

-0.500

-0.400

-0.300

-0.200

-0.100

0.000

average PWE

average PWM

average PEE

average PMM average PE average PM average PD

18

Fig.7 Impacts of Euro crisis on China’s sectoral export and import in scenario A2 (%)

The sectoral characteristics are further analyzed to study the reason why some

sectors will be more affected. For exports, sectors with a higher ratio of export to

output and a higher ratio of export to Eurozone area to total export will be more

influenced. For imports, the influence will be opposite. As illustrated in Fig. 8 and Fig.

9, it can be observed obviously a positive relationship and a negative relationship. In

Fig.9, some sectors with a larger import to Euro countries are affected negatively,

such as MEA and CCO, this is because these sectors are processing trade and their

exports are greatly hurt by the crisis.

-4.000 -3.000 -2.000 -1.000 0.000 1.000 2.000 3.000

AGR

M_C

P_G

MIN

FOD

TEX

FUR

WOD

PAP

OIL

COK

RCM

MCM

CMF

RUB

NMM

MET

EQP

TRM

EEQ

CCO

MEA

OTM

ELE

CNS

TRP

OSR

import

export

19

Fig. 8 Impacts of crisis on sectoral export and sector characteristics in scenario A2

Fig. 9 Impacts of crisis on sectoral import and sector characteristics in scenario A2

5. Robust Tests and Policy Implications

5.1 The Large- and Small- Country Assumptions

To testify the robustness of the results, the large-country assumption is altered,

which is the most important assumption for our model. The assumption is employed

considering China’s importance in global market to influence the prices. For

comparison purpose, three other scenarios are designed as shown in Table 4. Table 4 Scenarios for large- and small- country assumption under crisis scenario A2

-4.000

-3.500

-3.000

-2.500

-2.000

-1.500

-1.000

-0.500

0.000 0 2 4 6 8 10 12 14 16

chan

ges

of e

xpor

ts (%

)

exports to Eurozone countries/output (%)

MEA

cco OTM

FUR

TEX

EEQ

EQP WOD

-3.000

-2.000

-1.000

0.000

1.000

2.000

3.000

4.000 0 1 2 3 4 5 6

chan

ges

of im

port

s (%

)

imports to Eurozone countries / demand (%)

MEA

TRM

EQP

cco

OTM

RCM

MIN

20

Scenario China’s Exports China’s Imports A2-BAU Large country assumption Large country assumption A2-T1 Small country assumption Small country assumption A2-T2 Small country assumption Large country assumption A2-T3 Large country assumption Small country assumption

The impacts of Euro crisis on China’s total exports and imports in different

scenarios are compared in Table 5. From the result it can be seen that the assumptions

will significantly affect the result. On the one hand, if the small-country assumption is

assumed for import, China will play as the import price taker, which means a more

decrease in import prices and a positive effect on import. On the other hand, if the

small-country assumption is made for export, as a price taker in export, China will

face a much more decrease in export prices, which will enlarge the negative impacts

of Euro crisis on China’s export. Therefore, for scenario A2-T1, i.e., small-country

assumption in both export and import, the crisis will have the most negative impact on

export and the most positive impact on import. Furthermore the worst case is that

when China is a price taker in export and a price determinant in import, as shown in

scenario A2-T2. Table 5 Impacts of crisis under different scenarios (%)

Scenarios total export total import A2-BAU -2.619 -0.816 A2-T1 -7.755 1.665 A2-T2 -7.069 -6.084 A2-T3 -2.405 1.025

5.2 Export Rebate Policy

To mitigate the negative impact of the Euro sovereign debt crisis on China,

especially China’s export, the export rebate policy is studied. The export rebate policy

is flexible and easy to commit, and has been used as the usual tool to coordinate

international trade. Three policy scenarios are assumed as shown in Table 6. Table 6 Policy scenarios for export rebate rate esub

Scenarios Definition PA esub is increased for each sector PB esub is increased only for manufacturing industries

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PC esub is increased only for the mostly shock ten sectors

The results of the export rebate policy are shown in Table 7, the crisis scenario A2

is taken as an illustration. It can be concluded that the export rebate rate adjustment

will effectively mitigate the negative impacts of the Euro crisis. Whatever policy

scenarios, they will all reduce the negative shock on China’s export, especially, for

scenario PB-2%, i.e., increasing esub by 2% for all manufacturing industries, the

positive effect on export will offset the negative effect due to the crisis. When taken

the whole economy into consideration, the effects of export rebate policy on real GDP

is calculated. It can be seen that the optimal policy will be increase esub only for

manufacturing industries by 1.5%. In this case, it will reduce the negative effect on

GDP from 1.533% to 0.954%. Table 7 Effects of export rebate policies in crisis scenario A2 (%)

total export total import real GDP scenario A2 -2.619 -0.816 -1.533

PA-1% -1.926 -1.381 -2.847 PA-1.5% -1.494 -1.283 -3.015 PA-2% -0.345 0.077 -1.669 PB-1% -1.484 -0.018 -1.249

PB-1.5% -0.615 0.262 -0.954 PB-2% 0.001 0.301 -0.962 PC-1% -2.151 -1.265 -2.387

PC-1.5% -1.492 -0.827 -1.967 PC-2% -0.595 -0.027 -0.971

6. Conclusion

The Euro sovereign debt crisis will influence China’s economy mainly through

international trade channel. This paper analyzed these impacts based on China’s

multi-sector CGE model and different evolutionary paths of the crisis. The Euro

sovereign debt crisis is captured by reducing a premium on exporting prices and

importing prices with countries in crisis to reflect the declining of external output and

demand in the proposed model. This treatment is in accordance with the basic

assumption for general equilibrium that prices are endogenously adjusted to achieve

market equilibrium. Moreover, the on-going Euro sovereign debt crisis has affected

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China mainly through its direct influence on imports and exports with European

countries as revealed by empirical studies.

Based on the proposed model, the impacts of the Euro crisis on China’s macro

economy, total exports and imports, and sectoral exports and imports are studied. The

results suggest that the crisis will have a negative impact on China’s overall economy

and decrease the welfare. The results also indicate that the crisis will have a

significantly negative shock on China’s international trade, larger on exports than on

imports, and the impacts will be increased with more countries involved in the crisis

and more serious of the crisis. Furthermore, the impacts on trade by industrial sector

are closely related with characteristics of the sector, i.e., sectors with intensive exports

to Europe will have a larger shock. Robustness tests are carried out and suggested that

the small- and large-country assumption will greatly affect the impacts of the crisis on

China. With an increasing of the pricing power determination, the negative effect of

the crisis will be effectively reduced.

The export rebate policies are also studied based on the proposed model. The

results suggest that although the crisis will have negative shock on China’s economy,

it can be mitigated effectively by proper policies. Two implications are revealed, one

is that a wider scope of the export rebate policy is not necessary and may bring

negative impact on the whole economy. The other is that if the adjustment of the tax

rate is too small, it may not useful to mitigate the negative shock of the Euro crisis.

These results provide significant insights for effective policy tools, i.e., a carefully

designed export rebate rate adjustment policy will mitigate the shock of the crisis

without greatly increasing the overall tax burden.

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