new economic geography and tax competition in the prc: a firm-level data analysis with policy...

7/27/2019 New Economic Geography and Tax Competition in the PRC: A Firm-Level Data Analysis with Policy Implications

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ADB EconomicsWorking Paper Series

New Economic Geography and TaxCompetition in the PRC: A Firm-LevelData Analysis with Policy Implications

Minsoo Lee

No. 297 | January 2012


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ADB Economics Working Paper Series No. 297

New Economic Geography and Tax

Competition in the PRC: A Firm-Level

Data Analysis with Policy Implications

Minsoo Lee

January 2012

Minsoo ee is enior conomist in the Macroeconomics and inance esearch ivision, conomics and

esearch epartment, Asian evelopment Bank. he author accepts responsibility for any errors in thepaper.


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Asian evelopment Bank

AB Avenue, Mandaluyong City

1550 Metro Manila, hilippines

www.adb.org/economics

2012 by Asian evelopment Bankanuary 2012

155-5252

ublication tock o. 124550

he views expressed in this paper

are those of the authors) and do not

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of the Asian evelopment Bank.

he AB conomics orking aper eries is a forum for stimulating discussion and

eliciting feedback on ongoing and recently completed research and policy studies

undertaken by the Asian evelopment Bank AB) staff, consultants, or resource

persons. he series deals with key economic and development problems, particularly

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methodological issues relating to project/program economic analysis, and statistical data

and measurement. he series aims to enhance the knowledge on Asias development

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availability of statistical data and development indicators for monitoring development

effectiveness.

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journals or chapters in books. he series is maintained by the conomics and esearch

epartment.


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Contents

Abstract v

. ntroduction 1

. heory and nstitutional Background

. Models and Methodology 5

A. ax Competition Model 5

B. Conditional ogit Model

. ata 8

. mpirical esults 9

A. &-ntensive irms and ifferent ype of xporters 9

B. eterogeneity in rigin of nvestment unds 12

C. rocessing raders versus ormal raders 15

. olicy mplications 18

. Conclusion 20

eferences 21


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Abstract

uring 2000200, nearly 4,0005,000 new foreign and domestic enterprises

entered the export industry of the eoples epublic of China C) yearly,

with geographic concentration along the coastal areas. his paper empirically

analyzes the spatial determinants of new entrants by applying traditional

comparative advantage analysis, new economic geography of agglomeration

WKHRU\DQGWD[FRPSHWLWLRQWKHRU\E\UHVRXUFHRZPRGHO7KHKHWHURJHQHLW\RI

UPRZQHUVKLSDQGWUDGHW\SHHQKDQFHVWKHXQGHUVWDQGLQJRILQYHVWPHQWORFDWLRQ

decisions. rocessing traders differ substantially from nonprocessing traders

in response to changes in wage cost, level of development in infrastructure,DQGSUR[LPLW\WRWKH3DFLFFRDVW7KHSUHVHQFHRIIRUHLJQLQYHVWHGHQWHUSULVHV

FUHDWHVDEHDFRQHIIHFWRQVXEVHTXHQWIRUHLJQDQGGRPHVWLFLQYHVWRUV7KH

SDSHUDOVRQGVWKDWDJJORPHUDWLRQSOD\VDJUHDWHUUROHIRULQYHVWRUVVSHFLDOL]LQJ

in the processing goods trade and highly skill-intensive or research and

GHYHORSPHQWLQWHQVLYHSURGXFWLRQ%HQHWVIURPUHGXFWLRQLQWKHYDOXHDGGHG

tax rate and corporate income tax rate play an evident role for foreign investors

and ong ong, China and aipei,China investors in processing trade sector.

he Cs policy makers intend to transform the internationalization process

through attraction of foreign investment toward localization by reducing the

processing good trading portion and by increasing the supply of domestically

produced intermediate inputs for their exports. As the C moves up the high-value supply chain, expands its domestic market, and exports skill-intensive

goods, processing goods traders may consider new locations or business

models.


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I. Introduction

ver since the eoples epublic of China C) opened up its economic door to the

rest of the world in the late 190s, two economic aspects have been the center of

discussion by many academics, researchers, and policy makers in the world. hey are

the Cs inward foreign direct investment ) and its exports. hose two issues were

reemphasized when the C joined the orld rade rganization in 2001.

ach year, during 2000200, nearly 4,0005,000 new foreign and domestic enterprises

entered into the Cs export industry with geographic concentration along the coastal

areas. he heterogeneity of new enterprises in ownership is apparent. n the nation as a

ZKROHGXULQJIRUHLJQLQYHVWHGUPVDFFRXQWIRU+RQJRQJKLQDDQG

RU7DLSHLKLQDLQYHVWHGHQWHUSULVHVDQGKLQHVHSULYDWHFRPSDQLHV7KH

QXPEHURISURFHVVLQJJRRGVH[SRUWHUVDPRQJQHZHQWUDQWVVWDQGDWDSSUR[LPDWHO\

3URFHVVLQJJRRGVH[SRUWYDOXHLQWKH3FRQVWLWXWHVDERXWRIWRWDOH[SRUWVLQ

DQGKDVVWHDGLO\GHFOLQHGIURPIURPWR

raditional comparative advantage analysis is based on a level of regional development

VXFKDVLQIUDVWUXFWXUHLQKLJKZD\VUDLOZD\VDQGZDWHUZD\VSURGXFWLRQFRVWVDEXQGDQFH

RILQSXWVODERUODZVhukouKRXVHKROGUHJLVWUDWLRQV\VWHPHGXFDWLRQOHYHOKXPDQ

FDSLWDOZDJHOHYHOWUDQVSRUWDWLRQFRVWVSUR[LPLW\WRWKHFRDVWDFFHVVWRUDZDQG

LQWHUPHGLDWHPDWHULDOVDQGSURGXFWLRQFRVWV7KHQHZHFRQRPLFJHRJUDSK\WKHRU\RI

DJJORPHUDWLRQSURYLGHVVLJQLFDQWH[SODQDWRU\SRZHUWRWKHSUHVHQFHRIVLPLODUUPV

VXSSOLHUUPVRUFRQVXPHUVLQDSDUWLFXODUUHJLRQZKLFKFDXVHVWKLVORFDWLRQWREHFRPH

more attractive to future investors.

ocal government policy makers in the C strategically determine their tax rates

to attract new foreign investments to their region for additional tax revenue and new

HPSOR\PHQWZKLFKFDQEHGHVFULEHGE\WKHWD[FRPSHWLWLRQZLWKUHVRXUFHRZPRGHO

olicy makers provide preferential tax treatment and/or lower regulatory burdens and

often implement special policies such as special economic zones and hi-tech zones.

here are a number of policy variables, such as capturing overall levels of tax andregulatory burdens or special policies, designed to attract foreign investors.

his paper discusses the Cs inward and exports by raising the topic of the spatial

determinants of new foreign- and domestic-invested enterprises that enter the export

LQGXVWU\([SODQDWRU\IDFWRUVRIVSDWLDOGHWHUPLQDQWVRI'LGHQWLHGLQWKLVSDSHUDUH

categorized according to three economic theories traditional comparative advantage


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analysis, new economic geography of agglomeration effects, and tax competition theory

E\UHVRXUFHRZPRGHO

his paper provides rich empirical results by mapping and merging two separate data

VRXUFHVLQGXVWU\GDWDDWWKHUPOHYHOIURPWKH3VQGXVWULDO(QWHUSULVHV'DWDEDVHSURYLGHGE\WKHDWLRQDO%XUHDXRI6WDWLVWLFVDQGUPOHYHOH[SRUWLPSRUWGDWDIURPWKH

xport/mport atabase provided by the C Customs). n particular, new enterprises

DUHFDWHJRUL]HGEDVHGRQWKHLURZQHUVKLSIRUHLJQLQYHVWHG+RQJRQJKLQDDQGRU

7DLSHLKLQDLQYHVWHGKLQHVHSULYDWHRZQHGDQGVWDWHRZQHGDQGDUHGLVWLQJXLVKHG

EHWZHHQUPVVSHFLDOL]LQJLQSURFHVVLQJWUDGHDQGQRUPDOWUDGHRGULN$PLW\DQG

UHXQGXUWKHUPRUHWKHSDSHUVHSDUDWHVUPVDFFRUGLQJWRWKHHGXFDWLRQOHYHO

RIWKHLUHPSOR\HHVDQGSUR[\UHVHDUFKDFWLYLW\E\VHOHFWLQJUPVWKDWHPSOR\ZRUNHUV

ZLWKSRVWJUDGXDWHTXDOLFDWLRQV7KLVSDSHUVKRZVWKDWWKHVHVXEVDPSOHVGLVSOD\

economically meaningful differences.

RUHLJQLQYHVWHGSURFHVVLQJWUDGHUPVSXWPRUHZHLJKWRQSUR[LPLW\WRWKH3DFLFFRVWand increase in average wages than normal traders do, and the presence of foreign-

invested enterprises creates a beacon effect in agglomeration to all other types of export

enterprises. nvestors from ong ong, China and aipei,China are the most inclined

WRDJJORPHUDWHZLWKFRPSDQLHVWKDWDUHDOVRIURP+RQJRQJKLQDDQG7DLSHLKLQD

DQGWHQGWROHDVWRFNWRJHWKHUZLWKIRUHLJQLQYHVWHGUPVDQGVWDWHRZQHGHQWHUSULVHV

3ULYDWHKLQHVHLQYHVWRUVDUHJUHDWO\LQXHQFHGE\WKHSUHVHQFHRIVWDWHRZQHG

LQFXPEHQWUPV

alue-added tax rate that is strategically determined by local government policy makers

LQXHQFHVWKHORFDWLRQFKRLFHRIIRUHLJQLQYHVWRUVRUHLJQLQYHVWHGSURFHVVLQJJRRGV

WUDGHUVDUHSDUWLFXODUO\VHQVLWLYHWRWKLVSUDFWLFHDQGKLQHVHSULYDWHLQYHVWHGUPVDUHthe least sensitive.

he method of the analysis in this paper suggests useful information for policy makers

and market entrants. Marginal effects and predicted changes are calculated, induced

either by a certain percent change in each explanatory variable in the empirical

DQDO\VLVLQXHQFLQJWD[UDWHVDQGODERUFRVWVRUE\LQGXFLQJPDUNHWHQWU\E\SLRQHHULQJ

LQFXPEHQWUPVRQVXEVHTXHQWPDUNHWHQWUDQWVLQYDULRXVVXEJURXSVVRPHRIZKLFK

PD\EHSDUWLFXODUO\GHVLUDEOHWRSROLF\PDNHULQWHQWLRQVRQDFTXLULQJQHZWHFKQRORJ\IURP

foreign-invested enterprises via technology and management knowledge spillover effects

in their province.

2 | ADB Economics Working Paper Series No. 297


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II. Theory and Institutional Background

he new economic geography theory in the international trade theory framework

introduced by rugman 1991) may be the most relevant to the spatial determinants of

'QPRQRSROLVWLFPDUNHWVWUXFWXUHVHFRQRPLHVRIVFDOHSXVKPDQXIDFWXULQJUPVto locate in the region with larger demand while minimizing transportation costs. he

HFRQRPLFUHJLRQVZLWKWKHPRVWSURGXFWLRQEHFRPHPRUHSURWDEOHDQGDWWUDFWHYHQ

PRUHSURGXFWLRQDFWLYLWLHV7KHJHRJUDSKLFFKRLFHRIH[SRUWLQJUPVLVEDVHGRQWKH

DJJORPHUDWLRQDVVRFLDWHGZLWKVLPLODULQGXVWU\W\SHVRILQFXPEHQWUPVDQGLQWHUDFWLRQRI

economies of scale with transportation costs proximity to coast). eographic production-

FRQFHQWUDWLRQORZHUVWKHSUREDELOLW\RIODERUVKRUWDJHVQFXPEHQWUPVFDQVSLOORYHU

informational, technology, and knowledge externally.

he Cs dynamic policy changes seem to follow Alfred Marshalls concept regarding

industry localization internationalization toward localization or processing trades to

QRUPDOWUDGHVRQFHQWUDWLRQRIIRUHLJQLQYHVWHGUPVLQDORFDWLRQJHQHUDWHVODERU

PDUNHWVIRUDVSHFLFLQGXVWU\RFDOODERUPDUNHWVVXSSO\ORZVNLOOHGODERUDQGIRUHLJQ

SURFHVVLQJWUDGHUVLPSRUWVRSKLVWLFDWHGLQSXWVKRZHYHUORFDOSURGXFHUVZLOOUHSODFH

intermediate imports and instead start producing sophisticated inputs in the near future.

$JJORPHUDWHGIRUHLJQUPVZLOO EHQHWIURPLQIRUPDWLRQDQGNQRZOHGJHVSLOORYHUVZKLOH

GRPHVWLFUPVFDQEHQHWIURPWHFKQRORJ\DQGSRVVLEOHNQRZOHGJHVSLOORYHUVIURP

foreign-invested enterprises.

DUOWRQVDUWLFOHDQH[FHSWLRQDOO\VLJQLFDQWSDSHUFRQFHUQLQJHFRQRPLF

JHRJUDSK\HPSKDVL]HVORFDWLRQDQGHPSOR\PHQWRIQHZUPVXWLOL]LQJDQHFRQRPHWULF

model with discrete and continuous endogenous variables. Carlton concludes that taxes

DQGVWDWHLQFHQWLYHSURJUDPVGRQRWDIIHFWDUPVGHFLVLRQ

Amiti and avorcik 2008) analyze new economic geography of agglomeration effects in

C. hey use aggregated provincial-level data to generate measures of intermediate

goods and consumer market access using recent Chinese inputoutput tables. Access

WRVXSSOLHUVDQGPDUNHWVLVWKHPRVWLQXHQWLDOVSDWLDOGHWHUPLQDQWVRIDUPVORFDWLRQ

choice. u and wen 2005), however, contend that there is no evidence of strong

agglomeration from foreign investors in the C but conclude that comparative

DGYDQWDJHDQGJRYHUQPHQWSROLF\DUHPRUHLQXHQWLDOIDFWRUVIRUDUPVVSDWLDOGHFLVLRQ

DVH[SODQDWLRQVRIWKHHPHUJLQJSDWWHUQRIUPORFDWLRQVYHUVHDVKLQHVHLQYHVWRUV

located along the coast show sensitivity to policy and cost differentials compared to

C investors. n inland provinces, on the other hand, there seems to be no difference

between the two groups of investors. Boermans et al. 2009) use factor analysis with

aggregated data and emphasize the major role of institutions, labor costs, and market

access.

New Economic Geography and Tax Competition in the PRC: A Firm-Level Data Analysis with Policy Implications | 3


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A seminal paper by ead and ies 199) formulates a theoretical monopolistic

competitive model of self-reinforcing . he paper explains that open door policies

made inward on a large scale to the C feasible and their empirical results,

comprised of 91 foreign ventures that entered between 1984 and 1991 in 54 cities,

LOOXVWUDWHFRQVLGHUDEOHDJJORPHUDWLRQHIIHFWVWKDWPDJQLHGWKHDGYDQWDJHFRQIHUUHGE\the privileged status of some cities such as special economic zones and high-tech zones.

arallel literature explores decisions in particular industries in the C by investors from

different countries. akasugi 2005) demonstrates that location choice of apanese

HOHFWURQLFVDIOLDWHVLQWKH3PDLQO\GHSHQGRQWKHOHYHORIKXPDQUHVRXUFHVKDQJ

and ark 2005) use data for orean investors in the C, indicating an importance

of network externality. Belderbos and Carree 2002) examine apanese manufacturers

ORFDWLRQVLQWKH3DQGVKRZVLJQLFDQWHFRQRPLFJHRJUDSK\RIDJJORPHUDWLRQ

HIIHFWVKHQVHPSLULFDODQDO\VLVRQ7DLSHLKLQDVJUHHQHOGLQYHVWPHQWLQ

WKH3HPSOR\HGDQHVWHGORJLWPRGHOZLWKUPOHYHOGDWDZKLFKLQGLFDWHGWKDWWKH

DJJORPHUDWLRQHIIHFWIURPWKHLQFXPEHQWUPVKDVEHFRPHPRUHDSSDUHQWRYHUWLPHEXWits relative strength varies across sectors.

([SODQDWRU\YDULDEOHVLGHQWLHGE\WKHDERYHPHQWLRQHGVWXGLHVW\SLFDOO\IDOOLQWRWKUHH

FDWHJRULHVPHDVXUHVRIDUHJLRQDOOHYHORIGHYHORSPHQW+XDQGZHQQHZ

economic geography theories Amiti and avorcik 2008) of agglomeration effects with the

SUHVHQFHRIVLPLODUUPVLQWHUPHGLDWHJRRGVVXSSOLHUVDQGFRQVXPHUVLQDSDUWLFXODU

UHJLRQPDNLQJDORFDWLRQPRUHDWWUDFWLYHWRIXWXUHLQYHVWRUVDQGSROLF\YDULDEOHVFDSWXULQJ

overall levels of tax and regulatory burden or special policies designed to attract foreign

investors ead and ies 199).

Many studies in new economic geography analysis have omitted some obviousJRYHUQPHQWSROLF\YDULDEOHVDPHDVXUHRIDUPVWD[EXUGHQRURWKHUSUHIHUHQWLDO

treatment variables.

Cheng and wan 2000) divide tax reduction in the C into four levels as to provincial

VFRSHZLWKWKHFRQFOXVLRQWKDWWD[UHGXFWLRQLVWKHPRVWLPSRUWDQWIDFWRURI'LQRZ

here have been a large number of government regulations on tax reductions at the

central and local government level since 1984. hese tax breaks and tax reduction

SROLFLHVKDYHPDLQO\WZRWDUJHWV7KHUVWLVFRUSRUDWLRQLQFRPHWD[HJXODWLRQVLQWKH

VRIIHUFRUSRUDWLRQLQFRPHWD[UDWHIRUIRUHLJQLQYHVWHGFRPSDQLHVLQYDULRXV

HFRQRPLFDQGWHFKQRORJ\GHYHORSPHQW]RQHVFRUSRUDWLRQLQFRPHWD[UDWHIRU

FRPSDQLHVLQFRDVWDOHFRQRPLFRSHQ]RQHVZLWKH[SRUWVFRQVWLWXWLQJPRUHWKDQRIWRWDORXWSXWRUDQH[HPSWLRQLQFRUSRUDWLRQLQFRPHWD[LQWKHUVW\HDUVRILWVRSHQLQJ

and reduction by half of income tax in the following 5 years. he second is value-added

tax, which is the main resource of tax revenue. here are regulations offering various

UDWHVRIYDOXHDGGHGWD[UDWHVIRUUPVLQWKHSURFHVVLQJLQGXVWU\DGPLWWHGE\ORFDO

authority. alue-added tax revenue in the C is shared by central and local government



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ZLWKUDWLRVRIDQGUHVSHFWLYHO\7KHUHLVDOVRVDOHVWD[DQGDQDGGLWLRQDO

accounting item including sales tax, property tax, goods and services tax, resource tax,

land value increment tax, urban maintenance and construction tax, and surcharge for

education and local education expenses.

ew legislation in 1994 made local governments more independent units motivated to

PD[LPL]HWKHLUSROLWLFDODQGHFRQRPLFEHQHWVDVWKH\FRPSHWHWRDWWUDFWJUDQWVDQG

valuable factors to their regions ian and oland 1998). his competition among local

DXWKRULWLHVEHFRPHVDIRFXVRIWKHRUHWLFDOZRUNRZLQJWKUHHOLWHUDWXUHVWD[FRPSHWLWLRQ

literature, welfare competition literature, and spillover effects literature.

ith little power on the legislation of taxation, local governments in the C practice

tax break policies in order to reduce tax for grants, expand tax-favored zones such as

economic and technological development zones or high-tech industrial zones, or lower

VWDQGDUGVRIWD[EUHDNTXDOLFDWLRQVIRUFRUSRUDWLRQVZKLFKPDNHVWD[FRPSHWLWLRQQR

longer observable or measurable by tax rates announced in legislative documents. axreduction by local governments should be conducted mostly by using tax break policies,

which vary over regions and industries.

he most important motivation for tax reduction is to attract , and this is mentioned

in a multitude of research papers. Brueckner 2002) illustrates this tax competition

SKHQRPHQRQE\WKHUHVRXUFHRZPRGHO:LOVRQVVXUYH\SDSHUSURYLGHVDZLGH

range of ideas about the tax competition model.

III. Models and Methodology

A. Tax Competition Model

ocal governments levy taxes on a mobile tax base foreign and domestic investments)

by choosing their tax rates strategically with particular attention to other local government

WD[UDWHV7D[FRPSHWLWLRQPRGHOVDUHPRVWO\ZLWKLQWKHIUDPHZRUNRIWKHUHVRXUFHRZ

model summarized by Brueckner 2002) in the review of government interaction. his

model is followed by this paper, which uses an empirical model according to tax reaction

function. he general form of tax reaction function can be generated from various tax

competition theoretical models, as shown in the seminal work by Brueckner and aavedra2001).

ach local government chooses its tax rate tjand considers the amount of foreign

investments resource) within its borders. istribution of foreign investments in provinces

depends on tWKHUHIRUHjth local government decision on tax rate is indirectly affected by



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tj vector ofts for the n-1 other local governments). he local governmentjs objective

function is

V t s X j j j, ;( ) ,

where sjLVDQDPRXQWRILQRZRIIRUHLJQLQYHVWPHQWLQWRjth province andXj is the vector

of provincejs characteristics. istribution ofsj is affected by t.

s H t t X j j j j= ( ), ;

7KHUHIRUHWKHUHGXFHGIRUPRIWKHUHVRXUFHRZPRGHOFDQEHGHULYHGDV

V t H t t X X V t t X j j j j j j j j, , ; ; , ; ( )( ) ( )

rovincejVRSWLPDOWD[UDWHDVDUHDFWLRQIXQFWLRQIURPWKHUVWRUGHUFRQGLWLRQWDNHVWKH

form of

t R t X j j j= ( ) ; .

B. Conditional Logit Model

n connection with the comparative advantage theory and new economic geography of

DJJORPHUDWLRQDQDO\VLVWKLVVWXG\DGRSWVWKHPRGLHGDGGLWLYHUDQGRPXWLOLW\PRGHOE\

VXEVWLWXWLQJH[SHFWHGSURWV3 for utility . uppose an investor ichose one province

amongjDOWHUQDWLYHVWKHQH[SHFWHGSURWVIRUDQLQYHVWRUiof choosing alternativej

y ji =( )

is given by

E V V CA NEG t ij ij ij ij ij j ij ( ) = + = ( ) +H H, , ,

where Vij LVWKHGHWHUPLQLVWLFSDUWRIH[SHFWHGSURWVDQGHij represents a random

part Mcadden 194). it can be expected that investors choose one province among

j J= 1, , so as to maximize ij . he probability of choosing any one alternative j isHTXLYDOHQWWRWKDWWKHDOWHUQDWLYH\LHOGVJUHDWHUH[SHFWHGSURWVWKDQDOORWKHUDOWHUQDWLYH

choices

p y j k j V V k jij i ij ik ik ij ij ik = = = = Pr Pr , Pr , H H

n order to solve for these choice probabilities, an appropriate joint distribution of the

UDQGRPSDUWVPXVWEHVSHFLHGFDGGHQSURYHVWKDWWKHIROORZLQJH[SUHVVLRQ

F G e ei iJ

i iJH H HH

11, , exp , , ( ) = ( )( )



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is the cumulative distribution function of a multivariate extreme value distribution for any

function GWKDWLVQRQQHJDWLYHKRPRJHQHRXVRIGHJUHHRQHDQGIXOOOVDQXPEHURI

additional regularity conditions Mcadden 198). ifferent choices ofG yield different

models. he choice probabilities can be calculated given that the random parts of

H[SHFWHGSURWVDUHGLVWULEXWHGDFFRUGLQJWRIXQFWLRQ FMcadden 198)

p y j i j F V V V Vij i j J = = =( ) = + +(Pr : , , ,investor s choice H H H1 2 1 ))

= ( )

+

+ + +

d

e G e e e G e eV V V V VJ

H

H H H H H H

11 2 1 1, , , exp ,

VV V Ve dJ2 1, , +

+

( )( ) H H,

ZKHUHWKHVXEVFULSWVWRDQG*GHQRWHWKHUVWGHULYDWLYH6LQFH*LVKRPRJHQHRXVRI

degree 1, its derivative 1 is homogeneous of degree zero. herefore

p y j e G e e e e e G e e eij i j V V V V V V VJ j J= =( ) = ( ) Pr , , , exp , , ,H H1 2 1 2 (( )( )

+

dH

=( )( )

eG e e e

G e e e

V

V V V

V V V

j

J

J

11 2

1 2

, , ,

, , ,

,, , , .j J{ }1

Assume that the errors Hj are iidwith eibull distribution, then

p y je

e e eij i

V

V V V

ij

i i iJ

= =

( )=

+ + +Pr

1 2

6LQFHDOORIDOWHUQDWLYHVSHFLFH[SODQDWRU\YDULDEOHVYDU\DFURVVDOWHUQDWLYHVFRQGLWLRQDO

logit model is most suitable for this case.

p y jCA NEG t

CA NE ij i

CA ij NEG ij t ij

CA ik NEG

= =( ) =+ +( )

+Pr

exp

exp

E E E

E E GG tik t ik k

J+( )= E1

he standard maximum likelihood estimation can be used if the choice probabilities

DERYHDUHFRUUHFWO\VSHFLHG6LQFHWKHPRGHOLVQRQOLQHDULQWHUSUHWDWLRQRIWKHHVWLPDWHGFRHIFLHQWVLVQRWVWUDLJKWIRUZDUG7RJDXJHWKHPDJQLWXGHRIHVWLPDWHGHIIHFWVWKH

marginal effects of changes in explanatory variables on choice probabilities have to be

FDOFXODWHG%\PXOWLSO\LQJZLWKWKHFRHIFLHQWHVWLPDWHDQGGLYLGLQJE\WKHSUREDELOLW\

these marginal effects can be converted into elasticities. Cameron and rivedi 2005)



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illustrate that the closed form expression of the marginal effects in the conditional logit

model is

= ( )

p

x p i pij

ik

ij ijk ik E,

wherei

ijk is an indicator variable that for an investor i takes on the value 1

LINDQGRWKHUZLVHWLVFOHDUIURPWKHDERYHIRUPXODWKDWWKLVGHQLWLRQLPSOLHV

WKDWIRUH[DPSOHDSRVLWLYHUHJUHVVLRQFRHIFLHQWPHDQVWKDWDPDUJLQDOLQFUHDVHLQWKH

covariatexik will lead to a rise in the predicted probability of option k being chosen, but

to a fall in the predicted probability of any other option being chosen.

IV. Data

hree major data sources are utilized for empirical analysis. he ational Bureau of

6WDWLVWLFVSURYLGHVDQQXDOUPOHYHOLQGXVWU\GDWDVHWVKLQHVHQGXVWULDO(QWHUSULVHV

'DWDEDVHFRQWDLQLQJLQIRUPDWLRQRQDOOUPVRSHUDWLQJLQPDQXIDFWXULQJVHFWRUVZKRVH

DQQXDOUHYHQXHLVJUHDWHUWKDQPLOOLRQ\XDQ$QH[WHQVLYHDUUD\RIUPOHYHOYDULDEOHV

LVLQFOXGHGLQWKLVGDWDVHWVXFKDVDUPVRZQHUVKLSFRPSRVLWLRQRIHPSOR\PHQW

FRUSRUDWHLQFRPHWD[DPRXQWYDOXHDGGHGWD[DPRXQWUPVORFDWLRQHWFQGXVWU\GDWD

in 2004 contains the established date of each company. ew economic geography of

DJJORPHUDWLRQHIIHFWVLQRWKHUZRUGVDQLQXHQFHRIWKHSUHVHQFHRIVLPLODUUPVLQ

FHUWDLQORFDWLRQVRQQHZHQWUDQWVORFDWLRQGHFLVLRQVFDQEHWHVWHGE\SURSHUO\GHQLQJ

DQLQFXPEHQF\$OOH[SRUWLQJUPVWKDWHQWHUHGWKHPDUNHWSULRUWRZLOOEHFRXQWHG

as incumbents from the perspective of a new market entrant in 2004. ncumbency

statistics are constructed at the 4-digit armonized ystem )-code level associated

ZLWKWKHRZQHUVKLSRIUPVIRUHLJQLQYHVWHG+RQJRQJKLQD7DLSHLKLQD+7RZQHG

VWDWHRZQHGDQGKLQHVHSULYDWHRZQHG7KHRZQHUVKLSVWDWXVLVGHQHGDVDPDRULW\

share of capital.

he eoples epublic of China Customs records monthly export/import data at the

transaction level, including sector information in the form of 8-digit -codes, among

other variables like unit value, type of enterprises, commodity code, etc. his study maps/

merges ndustry data and Customs data by matching the company names, and then theVXEVDPSOHRIH[SRUWLQJUPVIURPWKHPHUJHGGDWDVHWDUHUHVHUYHGIRUWKHDQDO\VLV

(DFKUPVH[SRUWWUDQVDFWLRQGRFXPHQWHGLQWKHH[SRUWLPSRUWGDWDVHWKHOSVWRLGHQWLI\

LWVPDLQHOGRIEXVLQHVVHVWDEOLVKLQJLWVVHFWRULGHQWLW\7KHGLVDJJUHJDWLRQOHYHOLV

at 4-digit -codes and all exports of products in the same 4-digit -code group are

WUHDWHGDVHTXLYDOHQW



17/31

7KH>3HRSOHVHSXEOLFRI@KLQDXVWRPV6WDWLVWLFVFODVVLHVHYHU\WUDQVDFWLRQRIRZ

of goods based on two trade types processing and normal trade. rocessing trade

insinuates a low-value added step in the supply chain of a sophisticated product. igh-

technology intermediate imports are assembled by low-skilled local workers to produce

VRSKLVWLFDWHGQDOH[SRUWJRRGVPDLQO\VKLSSHGWRDGYDQFHGHFRQRPLHVHYHUWKHOHVVthe assembling work performed by local workers contributes limited prospects of skill

upgrading or technology/knowledge spillover for the C to move up the high value

supply chain, expand its domestic market, and export skill-intensive goods. odrik 200)

points out that the behavior of processing traders is therefore both of scholarly interest

and relevant for policy makers.

$GLIFXOWFKDOOHQJHLVWRFRQVWUXFWDPHDVXUHRIDFFHVVWR LQWHUPHGLDWHJRRGVXSSOLHUV

due to the lack of reliable information. evertheless, processing traders yield useful

insights on this aspect. rocessing traders are largely autonomous from local intermediate

JRRGVSURGXFHUVRWKHUWKDQODERUWKHUHIRUHRQHFDQVXFFHVVIXOO\DEVWUDFWIURPWKHLVVXH

of access to intermediate goods suppliers by analyzing processing traders separatelyfrom nonprocessing traders. ormal traders might have generated a strong network of

intermediate goods suppliers, since incumbent enterprises presumably made location

their consideration in choosing intermediate goods suppliers.

heAnnual Statistical Yearbook of [the Peoples Republic of] China contains extensive

control variables at the province level. A range of variables at the province level is

collected to model comparative advantage analysis of a market entrants location choices.

QDGGLWLRQDURXJKGLVWDQFHEHWZHHQDSURYLQFHVPDLQFLWLHVDQGWKH3DFLFFRDVWLV

measured.

V. Empirical Results

A. R&D-Intensive Firms and Diferent Type o Exporters

irms in the high-skill-intensive production industry that employ workers with postgraduate

GHJUHHVDUHXVHGDVDSUR[\IRU'LQWHQVLYHUPDFWLYLW\ZLWKUHVSHFWWRWHFKQRORJ\

knowledge upgrading and spillovers.

RGHOLQ7DEOHSURYLGHVWKHEDVHOLQHVSHFLFDWLRQFRPSULVLQJWKHZKROHVDPSOHVDQGRGHOH[KLELWVUHVXOWVIRU'LQWHQVLYHUPV$VRSSRVHGWRWKHRYHUDOO

HQWHUSULVHV'LQWHQVLYHUPVSXWPRUHYDOXHRQWKHFROOHJHJUDGXDWHSRSXODWLRQDQG

DUHVHQVLWLYHWRERWKYDOXHDGGHGDQGFRUSRUDWHWD[UDWHVQFXPEHQW'LQWHQVLYHUPV

attract new, similar types of companies through the agglomeration effect.



18/31

Table 1: Conditional Logit Model: All Firms and R&D Intensive Firms

Variables

Model (1): All Firms Model (2): R&D-Intensive Firms

Estimates Marginal

Efects

Std. dev. Predicted

Change*

Estimates Marginal

Efects

Std. dev. Predicted

Change*

wage_manuacturing 0.00 0.00 3016 3.02 0.00 0.00 3008 3.61[22.617] [27.590] [7.283] [8.512]

GDP per capita 0.00 0.00 4910 1.47 0.00 0.00 4777 0.96[21.764] [16.826] [5.012] [4.656]

waterway 6.53 0.50 0.07 3.57 6.15 0.79 0.07 5.65[51.405] [38.069] [20.745] [22.473]

highway 0.97 0.07 0.21 1.56 1.30 0.17 0.21 3.52[9.630] [9.076] [5.398] [5.063]

high school pop 7.78 0.60 0.04 2.6 8.35 1.08 0.04 4.66[12.188] [15.387] [6.547] [8.074]

college pop 0.59 0.05 0.03 0.15 7.55 0.97 0.03 3.26[0.677] [0.666] [4.789] [5.859]

proximity 0.00 0.00 686 18.93 0.00 0.00 686 18.11[57.455] [41.952] [17.935] [21.379]

value added tax rate 1.18 0.09 0.07 0.62 0.73 0.10 0.07 0.65[4.784] [4.939] [1.508] [1.533]corp income tax rate 1.65 0.13 0.02 0.29 3.77 0.49 0.02 1.1

[3.202] [3.175] [3.395] [3.295]incumbent frms 0.01 0.00 65 3.58 0.01 0.00 51 5.22

[62.528] [31.150] [26.089] [16.116]Sample size 495673 89217LL 41282 7988Chi2 33203 4868Pseudo R2 0.29 0.23

* Predicted changes (in %) induced by a 1 standard deviation increase in the explanatory variable.Note: Figures in the square bracket are z-statistics.Source: Author's calculations.

RGHOVDQG LQ7DEOHVKRZDQDO\VHVIURPWKHKHWHURJHQHLW\RIUPVLQWKHLU

trade type, according to whether they predominantly focus on processing trade or normal

trade. rocessing trade has been at the center of debates about the sophistication level

of the Cs exports odrik 200, ang and ei 2008). rocessing trade is largely

dependent on a limited range of local inputs, mainly labor. rocessing traders import

sophisticated intermediate goods, and only assembly and related low value-added

production processing take place locally. herefore, processing traders are relatively less

dependent on intermediate goods supplier networks, while they are particularly sensitive

to factors like labor costs, value added tax rate, regional development in infrastructure,

DQGSUR[LPLW\WRWKH3DFLFFRDVW



19/31

Table 2: Conditional Logit Model: Processing Traders versus Normal Traders

Variables Model (3): Processing Traders Model (4): Normal Traders

Estimates Marginal

Efects

Std. dev. Predicted

Change*

Estimates Marginal

Efects

Std. dev. Predicted

Change*


GDP per capita 0 0 4963 2.98 0 0 4886 0.98[17.388] [15.144] [13.511] [10.665]

waterway 4.99 0.56 0.07 3.96 7.55 0.40 0.07 2.87[19.295] [23.580] [50.721] [26.129]

highway 3.78 0.42 0.21 8.88 0.12 0.01 0.21 0.13[18.170] [15.932] [1.030] [1.027]

high school pop 3.82 0.43 0.04 1.84 12.08 0.64 0.04 2.8[3.043] [2.897] [16.203] [21.596]

college pop 33.63 3.75 0.03 12.52 10.09 0.54 0.03 1.81[17.142] [12.808] [10.476] [14.975]

proximity 0.00 0.00 686 30.32 0.00 0.00 686 13.17[26.313] [55.907] [51.245] [27.258]

value added tax rate 3.61 0.40 0.07 2.76 0.67 0.04 0.07 0.24[7.601] [7.883] [2.261] [2.317]

corp income tax rate 2.32 0.26 0.02 0.58 1.23 0.07 0.02 0.15[2.418] [2.395] [1.981] [1.968]

incumbent frms 0.01 0.00 75 4.44 0.01 0.00 60 2.36[28.221] [25.095] [50.676] [21.206]

Sample size 154008 341665LL 11207 29534Chi2 13531 20752Pseudo R2 0.38 0.26


Comparing results between processing traders and normal traders supports intuition.

rom the regression results, there is indeed a difference in agglomerative effects. A new

processing trader tends to select a location where other processing traders are operating.

n fact, the predicted response to a 1 standard deviation increase in the number of

LQFXPEHQWVLQWHUPVRIFKRLFHSUREDELOLWLHVLVLQWKHFDVHRISURFHVVLQJWUDGHUV

URXJKO\SHUFHQWDJHSRLQWVDERYHWKHUHVSRQVHRIQRUPDOWUDGHUVRUPDO

WUDGHUVLQWKHLUORFDWLRQFKRLFHVDUHXQOLNHO\LQXHQFHGE\DUHGXFWLRQLQHLWKHUYDOXH

added tax rate or corporate income tax rate while processing traders seriously consider

WKHEHQHWIURPYDOXHDGGHGWD[UDWHUHGXFWLRQ7KHVDPHKROGVIRUSURFHVVLQJWUDGHUV

sensitivity to distance from the coast. A 1 standard deviation increase in the distance

IURPWKH3DFLFFRDVWLVDVVRFLDWHGZLWKDPRUHWKDQUHGXFWLRQLQFKRLFHSUREDELOLW\ZKHUHDVWKHUHGXFWLRQIRUQRQSURFHVVLQJWUDGLQJUPVLVDERXW

he obtained results for the infrastructure variables show that there is a large effect

of well-developed road infrastructure on the location decisions of processing traders.

$VWDQGDUGGHYLDWLRQULVH LQURDGVSHUDUHDUDLVHVWKHFKRLFHSUREDELOLW\E\

ZKHUHDVWKHHIIHFWLVLQVLJQLFDQWIRUQRUPDOWUDGHUVZKLFKFRQIRUPVWRH[SHFWDWLRQVWKDW



20/31

processing traders are particularly sensitive to transportation costs, and complements

WKHODUJHFRHIFLHQWHVWLPDWHIRUWKHGLVWDQFHIURPWKHFRDVW$WWKHVDPHWLPHKRZHYHU

a comparable estimate is obtained for the waterway density of a provincea rise in

waterway density has an effect of roughly the same magnitude for both processing and

normal traders.

verall, it is noticeable that the model seems to do a better job at predicting the choices

RIORZYDOXHDGGHGSURFHVVLQJUPVGLVSOD\LQJDPXFKEHWWHURYHUDOOPRGHOWZLWKD

SVHXGRVTXDUHGRIFRPSDUHGWRRWKHUVDPSOHV+LJKYDOXHDGGHGUPVPLJKWEH

more dependent on highly specialized input factors say, college graduates of a certain

subject, or intellectual property rights), and therefore their choice propensities may yield

predictions less accurate by broad provincial level aggregate variables.

B. Heterogeneity in Origin o Investment Funds

n order to shed more light on the heterogeneous agglomerative processes in the CsH[SRUWLQGXVWU\WKHLQFXPEHQWUPVDUHGLYLGHGE\WKHLURZQHUVKLSRULJLQIRUHLJQLQYHVWHG

+RQJRQJKLQD7DLSHLKLQDLQYHVWHG+7VWDWHRZQHG67DQGKLQHVH

SULYDWHRZQHG3LQFXPEHQWUPVXUWKHUDQDO\VLVZLWKIRXUVXEJURXSHGLQYHVWRUV

EDVHGRQWKHLURZQHUVKLSDOORZVRQHWRH[DPLQHZKLFKUPVOLNHO\SOD\DVLJQLFDQW

DJJORPHUDWLYHOHDGLQJUROHIRUVXEVHTXHQWUPVLQWKHVDPHRZQHUVKLSRULJLQDQG

different origin to their location decision. or example, foreign investors might follow other

IRUHLJQUPVRUWKHSUHVHQFHRIVWDWHRZQHGUPVPLJKWVKRZDVWURQJDJJORPHUDWLYH

effect to Chinese private investors.

able introduces separate incumbent counts depending on investor origin. or the

IRUHLJQLQYHVWHGVDPSOHZDJHDQGSUR[LPLW\YDULDEOHVDUHWKHPRVWLQXHQWLDOIDFWRUVWRQHZHQWUDQWVIROORZHGE\OHYHORILQIUDVWUXFWXUHGHYHORSPHQW%HQHWVIURP

the reduction in value added tax rate are also taken critically by foreign investors while

an incentive from corporative income tax provided by local policy makers is considered

somewhat to a lesser extent.



21/31

Table 3: Conditional Logit Model: Foreign Firms and Hong Kong, China/Taipei,China

Firms

Variables Model (5): Foreign-Owned Model (6): Hong Kong, China/

Taipei,China-Owned

Estimates MarginalEfects

Std. dev. PredictedChange*


Std. dev. PredictedChange*


GDP per capita 0.00 0.00 5057 1.01 0.00 0.00 4833 2.9[13.481] [8.602] [13.783] [11.800]

waterway 7.17 0.31 0.07 2.2 7.38 0.97 0.07 6.88[26.881] [16.281] [22.978] [21.786]

highway 1.57 0.07 0.21 1.43 0.31 0.04 0.21 0.84[8.261] [6.643] [1.165] [1.168]

high school pop 11.17 0.48 0.04 2.09 7.15 0.94 0.04 4.05[8.853] [11.842] [5.398] [4.836]

college pop 9.71 0.42 0.03 1.41 50.36 6.61 0.03 22[6.216] [9.015] [20.445] [13.251]

proximity 0.00 0.00 686 14.61 0.00 0.00 686 34.02[32.301] [15.715] [20.999] [53.876]



Incumbent_CP 0.01 0.00 26 0.66 0.00 0.00 27 0.97[14.244] [9.124] [5.345] [5.115]

Incumbent_ST 0.02 0.00 3 0.29 0.00 0.00 3 0.07[4.038] [3.878] [0.374] [0.374]

Incumbent_HT 0.00 0.00 33 0.12 0.01 0.00 35 2.36[1.990] [1.859] [13.869] [13.375]

Incumbent_FN 0.02 0.00 20 1.82 0.01 0.00 21 1.74[26.019] [10.406] [7.192] [6.955]



$OOIRXU+6OHYHO LQFXPEHQWVWDWLVWLFVDUHVLJQLFDQWDQGWKHODUJHVWDJJORPHUDWLRQ

HIIHFWLVDVVRFLDWHGZLWKIRUHLJQRZQHGLQFXPEHQWUPV7ZHQW\DGGLWLRQDOIRUHLJQRZQHG

LQFXPEHQWVLQDSURYLQFHZRXOGLQFUHDVHWKHFKRLFHSUREDELOLW\E\DERXWDQGWKH

HIIHFWRIKLQHVHSULYDWHUPVLVFRPSDUDEOH+RZHYHUWKHDJJORPHUDWLRQHIIHFWRI+7

LQYHVWHGUPVLVQHJDWLYHLQRWKHUZRUGVIRUHLJQLQYHVWRUVDUHOHVVOLNHO\WRFKRRVHD

location where -invested companies are operating. ew foreign investors seem to

consider enterprises from ong ong, China and aipei,China as competitors while they

LQWHUSUHWWKHSUHVHQFHRIRWKHUIRUHLJQUPVDVSRWHQWLDOFRUSRUDWLYHEXVLQHVVSDUWQHUVRU

WKH\UHFRJQL]HWKHYDOXDEOHH[SHULHQFHRILQFXPEHQWIRUHLJQUPVRSHUDWLQJLQDVLPLODU

industry sector in the C.



22/31

Table 4: Conditional Logit Model: Chinese Private Firms

Variables Model (7): Chinese Private Firms

Estimates Marginal

Efects

Std. dev. Predicted

Change*

wage_manuacturing 0.00 0.00 3009 3.01[11.434] [14.028]

GDP per capita 0.00 0.00 4874 1.95[13.114] [10.252]

waterway 3.38 0.31 0.07 2.23[14.531] [17.384]

highway 0.56 0.05 0.21 1.08[3.507] [3.391]

high school pop 7.64 0.71 0.04 3.07[7.324] [9.234]

college pop 0.65 0.06 0.03 0.2[0.498] [0.508]

proximity 0.00 0.00 686 16.33[31.890] [23.249]

value added tax rate 0.26 0.02 0.07 0.16[0.713] [0.719]corp income tax rate 1.69 0.16 0.02 0.35

[2.044] [2.006]Incumbent_CP 0.02 0.00 26 4.06

[43.597] [16.823]Incumbent_ST 0.05 0.01 3 1.44

[11.628] [10.001]Incumbent_HT 0.00 0.00 26 0.35

[3.235] [3.389]Incumbent_FN 0.01 0.00 15 1.79

[13.416] [9.910]Sample size 208699LL 17378

Chi2 14018Pseudo R2 0.29


n Model ), investors show a preference in their entry decision for a province with a

large high school graduate population, but a strong restriction for a province with a large

college graduate population. Most of investors in the C mainly seek low-skilled

laborers while some foreign investors may need intermediate-level managers with college

degrees. he obtained result for the wage variable, however, is somewhat puzzling with a

positive sign. n one hand, provincial individual income level greatly affects the locationGHFLVLRQVRILQYHVWRUVIURP+RQJRQJKLQDDQG7DLSHLKLQD%HQHWVIURPWKH

reduction in both value-added tax rate and corporate income tax rate are taken intensely

by investors from ong ong, China and aipei,China.

he results also reveal a much stronger pattern of the agglomeration effect to foreign-

invested companies and enterprises from ong ong, China and aipei,China while the



23/31

FRHIFLHQWIRUVWDWHRZQHGLQFXPEHQWVLVLQVLJQLFDQWLPSO\LQJWKDWWKHSUHVHQFHRIVWDWH

owned enterprises hardly provides investors from ong ong, China and aipei,China

ZLWKPXFKLQXHQFHLQWKHLUORFDWLRQFKRLFH

n contrast, Cs ) seem to behave similarly as foreign-invested companies in locationdecision choice associated with infrastructure-related variables but somewhat differently

toward tax incentives. Most domestically invested exporters are normal traders about

FRQVLGHULQJFRUSRUDWHLQFRPHWD[UDWHPRUHVHULRXVO\WKDQYDOXHDGGHGWD[

7KHDJJORPHUDWLRQHIIHFWDVVRFLDWHGZLWKIRUHLJQLQYHVWHGUPVLVVLPLODUWRWKDWIRUWKH

IRUHLJQRZQHGVXEVDPSOHDQGWKHHIIHFWRI3VLVWKHPRVWVLJQLFDQWZKLOH+7

LQFXPEHQWVKDYHDQHJOLJLEOHHIIHFW+RZHYHUWKHSUHVHQFHRIVWDWHRZQHGUPVKDVD

sizable effect on the co-location of Cs.

n summary, using results from Models 5) to ), it can be observed that the presence

RIIRUHLJQLQYHVWHGH[SRUWHUVKDVDVLJQLFDQWEHDFRQHIIHFWZLWKWKHVWURQJHVWOHDGLQJUROHLQDJJORPHUDWLRQIRUQHZLQYHVWRUVFRPLQJIURPWKH3+RQJRQJKLQD

7DLSHLKLQDDQGIRUHLJQFRXQWULHVLQWKH3VH[SRUWLQGXVWU\RUHRYHUSULYDWHO\

LQYHVWHGKLQHVHHQWHUSULVHVVKRZVRPHWHQGHQF\IRUFRORFDWLRQZLWKVLJQLFDQW

DJJORPHUDWLYHLQXHQFHH[HUWHGE\RWKHUKLQHVHSULYDWHRZQHGLQFXPEHQWUPV

C. Processing Traders versus Normal Traders

he last empirical results provide comparison analysis between processing traders and

normal traders in different ownership origins. he subsamples in each investment origin

are further split into processing traders and normal traders. rom Models 8A and 8B) in

able 5, foreign investors in the processing and normal trade sectors behave analogouslyin location choice with respect to infrastructure and proximity to the coast but the absolute

PDJQLWXGHRIHDFKHOHPHQWLVPRUHVLJQLFDQWZLWKLQYHVWRUVLQWKHSURFHVVLQJJRRGV

trade sector than those in the normal goods trade sector. As expected, processing traders

are more sensitive to an incentive in the form of value added tax reduction than from

corporate income tax reduction. oreign investors in both the processing trade sector and

normal trade sector show a tendency to agglomerate with incumbent foreign companies.

n particular, the latter likely cluster together with privately-owned Chinese incumbents

while the former shows the opposite.



24/31


(oreign-owned rms)

Variables

Model (8): Foreign-Owned

A: Processing Traders B: Normal Traders

Estimates Marginal

Efects

Std.

dev.

Predicted

Change*

Estimates Marginal

Efects

Std.

dev.

Predicted

Change*


GDP per capita 0 0 5030 2.01 0 0 5080 0.51[13.267] [7.353] [6.016] [4.571]

waterway 5.91 0.33 0.07 2.34 8.88 0.28 0.07 2[14.255] [12.345] [24.640] [10.653]

highway 2.32 0.13 0.21 2.72 1.01 0.03 0.21 0.68[7.732] [5.643] [4.052] [3.588]

high school pop 4.81 0.27 0.04 1.15 16.07 0.51 0.04 2.21[2.335] [2.745] [9.897] [10.730]

college pop 8.34 0.46 0.03 1.55 21.07 0.67 0.03 2.25[2.966] [2.374] [10.824] [13.712]

proximity 0.01 0.00 685.8 21.19 0.01 0.00 686 10.01[21.402] [12.132] [23.885] [10.588]



Incumbent_CP 0.00 0.00 26 0.02 0.01 0.00 26 0.73[0.126] [0.126] [16.979] [7.414]

Incumbent_ST 0.01 0.00 3 0.17 0.03 0.00 3 0.33[1.152] [1.145] [5.016] [4.362]

Incumbent_HT 0.00 0.00 36 0.15 0.00 0.00 30 0.11[1.373] [1.290] [1.685] [1.550]

Incumbent_FN 0.02 0.00 22 2.78 0.02 0.00 18 1.04[19.780] [8.179] [14.849] [6.570]



Models 9A and 9B) exhibit the results for investors from ong ong, China and

aipei,China in processing and normal trade sectors able ). nvestors in the processing

WUDGHVHFWRUDUHVHQVLWLYHWRYDOXHDGGHGWD[UDWHZKLOHWKHFRHIFLHQWRIFRUSRUDWH

LQFRPHWD[UDWHLVLQVLJQLFDQW6XUSULVLQJO\LQYHVWRUVIURP+RQJRQJKLQDDQG7DLSHLKLQDLQWKHQRUPDOWUDGHVHFWRUDUHQRWLQXHQFHGE\DQ\WD[LQFHQWLYHQYHVWRUV

from ong ong, China and aipei,China in the processing and normal trade sectors

seem to agglomerate with incumbent foreign-invested and -invested companies.

nvestors in the normal trade sector show a tendency to choose a province with

incumbent Chinese privately invested companies while investors in the processing trade

VHFWRUDUHXQOLNHO\WRRFNWRJHWKHUZLWKSULYDWHO\RZQHGKLQHVHLQFXPEHQWV



25/31


(Hong Kong, China/Taipei,China rms)

Variables

Model (9): Hong Kong, China/Taipei,China-Owned


Estimates Marginal

Efects

Std.

dev.

Predicted

Change*

Estimates Marginal

Efects

Std.

dev.

Predicted

Change*


GDP per capita 0.00 0.00 4905 3.43 0.00 0.00 4760 1.9[11.095] [10.940] [7.963] [6.771]

waterway 7.68 0.92 0.07 6.53 8.70 0.86 0.07 6.13[13.934] [13.054] [20.842] [17.879]

highway 1.48 0.18 0.21 3.74 0.80 0.08 0.21 1.67[3.163] [3.194] [2.464] [2.427]

high school pop 15.99 1.91 0.04 8.25 1.19 0.12 0.04 0.51[7.984] [9.203] [0.662] [0.679]

college pop 92.16 11.03 0.03 36.72 19.91 1.97 0.03 6.57[22.706] [39.666] [6.314] [4.947]

proximity 0.00 0.00 686 29.08 0.00 0.00 686 29.84[10.869] [9.425] [18.864] [30.889]



Incumbent_CP 0.01 0.00 27 2.19 0.01 0.00 28 1.4[5.460] [5.311] [9.438] [8.023]

Incumbent_ST 0.01 0.00 4 0.31 0.01 0.00 3 0.32[1.036] [1.036] [1.651] [1.639]

Incumbent_HT 0.01 0.00 37 3.17 0.00 0.00 34 0.87[11.846] [10.067] [4.893] [5.078]

Incumbent_FN 0.01 0.00 22 1.37 0.01 0.00 19 1.05[3.747] [3.673] [4.109] [3.920]



3ULYDWHO\RZQHGKLQHVHUPV$LQWKHSURFHVVLQJWUDGHVHFWRU7DEOHDUHTXLWH

sensitive to corporate tax incentives. nvestors in both the processing and normal trade

sectors reveal a strong agglomeration effect associated with all types of incumbents

except incumbents. or processing traders, foreign incumbents have the mostVLJQLFDQWDJJORPHUDWLRQHIIHFWZKLOHKLQHVHSULYDWHO\LQYHVWHGLQFXPEHQWVDJJORPHUDWH

normal traders of privately invested entrants 10B).



26/31


(Chinese private rms)

Variables Model (10): Chinese Private Firms



Std.dev.

PredictedChange*


Std.dev.

PredictedChange*


GDP per capita 0.00 0.00 4928 4.93 0.00 0.00 4867 1.95[6.408] [5.999] [11.353] [8.907]

waterway 3.13 0.49 0.07 3.51 4.07 0.35 0.07 2.46[3.835] [3.343] [16.619] [17.984]

highway 1.93 0.30 0.21 6.38 0.46 0.04 0.21 0.82[3.629] [3.500] [2.736] [2.659]

high school pop 5.40 0.85 0.04 3.7 9.00 0.76 0.04 3.32[1.631] [1.546] [8.144] [10.635]

college pop 17.92 2.82 0.03 9.47 2.49 0.21 0.03 0.71[4.720] [3.975] [1.770] [1.918]

proximity 0.00 0 686 29.29 0.00 0 686 14.75[9.739] [15.956] [29.888] [20.469]



Incumbent_CP 0.01 0.00 28 3.87 0.02 0.00 26 4.01[8.399] [7.353] [42.971] [15.156]

Incumbent_ST 0.05 0.01 4 3.19 0.05 0.00 3 1.3[4.570] [4.413] [10.784] [9.132]

Incumbent_HT 0.00 0.00 37 0.64 0.00 0.00 25 0.18[1.297] [1.263] [1.551] [1.597]

Incumbent_FN 0.02 0.00 21 7.47 0.01 0.00 14 1.29[11.235] [8.658] [9.700] [7.667]



VI. Policy Implications

or governors in the C whose most decisive achievements are judged by increasing

gross domestic product in the region, attracting new foreign and domestic direct

LQYHVWPHQWLVEHQHFLDOLQVSXUULQJHFRQRPLFJURZWKJHQHUDWLQJPRUHHPSOR\PHQW

expanding the tax base, and boosting resident income. ocal policy makers encourage

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production technologies in related industries by means of technology and management

knowledge spillover. Correspondingly, policy makers prefer to train and produce a highly



27/31

VNLOOLQWHQVLYHODERUIRUFHWKDWZLOOKHOSPHHWWKHGHPDQGIRUKLJKTXDOLW\REVDVKLJKO\

sophisticated, technology-based, and &-intensive foreign and domestic) enterprises

enter their province. herefore, provincial planners tend to pay particular attention to

WKHHIIHFWRIWKHLUSROLFLHVDQGDFWLRQVRQWKHEHKDYLRURIUPVWKDWDUHOLNHO\WRHQJDJH

LQ'DFWLYLW\UPVWKDWIRFXVRQKLJKTXDOLW\WHFKQRORJ\GHYHORSPHQWDQGUPVWKDWZLOOSURGXFHVRSKLVWLFDWHGQDOJRRGVLQWKHKLJKWHFKQRORJ\EDVHGLQGXVWU\7KHUHIRUH

they may want to attract foreign-invested enterprises with high technology, as the

knowledge and technology transfer induced by their market entry will clearly be welcome

externalities.

ome explanatory variables analyzed in the empirical section are explicitly and/

RULPSOLFLWO\FRQWUROOHGDQGLQXHQFHGE\SURYLQFLDOOHYHOSROLF\FKRLFHVQSDUWLFXODU

SROLF\PDNHUVZRXOGOLNHWRXQGHUVWDQGKRZYDULDWLRQVLQWKHLUORFDOSROLF\LQXHQFH

WKHPDUNHWHQWU\GHFLVLRQVRIFHUWDLQJURXSVRIUPVRUH[DPSOHKLJKZD\VSHUDUHD

and length of inland waterways are infrastructure-related policy variables that can be

LQXHQFHGE\EXLOGLQJPRUHKLJKZD\VPDNLQJPRUHULYHUVVXLWDEOHIRUFRPPHUFLDOWUDIFor constructing canals. An upgrade to the waterway and highway infrastructure in the

SURYLQFHLVSUHGLFWHGWRKDYHDVLJQLFDQWHIIHFWRQWKHHQWU\GHFLVLRQVRISURFHVVLQJ

goods traders see Model in able 2). A 1 standard deviation increase in waterways

DQGKLJKZD\VZLOOUDLVHFKRLFHSUREDELOLWLHVE\DERXWDQGUHVSHFWLYHO\7KHVKDUH

RIKLJKVFKRROJUDGXDWHVDQGFROOHJHJUDGXDWHVLQWKHSRSXODWLRQFRXOGEHLQXHQFHGE\

province-level policies aimed at encouraging higher education.

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particular infrastructure upgradefor example, building additional highwaysand setting

it in relation to the expected effect. or example, suppose that 5,000 new enterprises

enter the Cs export industry every year, and an increase of the choice probabilityE\ZRXOGUHVXOWLQDQH[SHFWHGDGGLWLRQDOUPV7KHH[SHFWHGEHQHWVRIVXFK

DGGLWLRQDOLQYHVWPHQWFRXOGEHFRPSDUHGWRWKHFRVWRIVSHFLFSROLF\LQWHUYHQWLRQV

he average wage level in the manufacturing sector is related to policy in important

ZD\VWKHIRUPXODWLRQDQGLPSOHPHQWDWLRQRIODERUODZVLQFOXVLYHRIWKHPLQLPXPZDJH

the restriction of domestic migrant workers for example, hukouV\VWHPDQGWKHVWDQFH

WDNHQE\SROLF\PDNHUVLQODERUGLVSXWHVDOOLQXHQFHWKHIDFWRUSULFHRIODERUVLQJWKH

Model 8A), a 1 standard deviation increase to the average wage in manufacturing sector

ZLOOUHGXFHFKRLFHSUREDELOLWLHVE\DERXWQHVWDQGDUGGHYLDWLRQLV\XDQSHU

year, or 252 yuan per month. his is a sizable wage increase and its predicted effect is

relatively large. verall, investors seem sensitive to the average wage rate in a province.aking oxconn for example, the wage level for its low-skilled workers increased by

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Chengdu in ichuan province in 2011.



28/31

HGXFWLRQLQWD[UDWHVSDUWLFXODUO\YDOXHDGGHGWD[EULQJVDVLJQLFDQWLQXHQFHWR

investors from foreign countries and ong ong, China/aipei,China in their location

choice. An interesting policy implication is given by Models 8) to 10). he agglomeration

effect of foreign-invested enterprises seems notably strong for foreign-invested processing

traders, - invested companies, and private Chinese investors in the processing tradeVHFWRU+RVWLQJIRUHLJQLQYHVWHGHQWHUSULVHVLQRQHORFDWLRQFRXOGDWWUDFWVXEVHTXHQW

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be developed, then our results suggest that it might kick-start this industry by hosting a

number of foreign-invested enterprises to locate in a particular location. he presence of

IRUHLJQLQYHVWHGLQFXPEHQWUPVZRXOGUDLVHWKHSUHGLFWHGSUREDELOLW\RIPDUNHWHQWU\

RIRWKHUIRUHLJQUPVLQWKHSURFHVVLQJH[SRUWLQGXVWU\E\DERXWDQGWKDWRISULYDWH

KLQHVHLQYHVWRUVE\URXJKO\7KH3VLQGXVWU\VWUXFWXUHLVVWLOOURRWHGLQORZ

VNLOOHGODERULQWHQVLYHPDQXIDFWXUHGJRRGVSURGXFWLRQDQGKLJKO\VRSKLVWLFDWHGQDOJRRGV

are mostly assembled by foreign-invested enterprises. olicy makers in the C need

WRQGZD\VWRDFKLHYHDVXEVWDQWLDOOHYHORIWHFKQRORJ\VSLOORYHUIURPIRUHLJQLQYHVWHG

enterprises operating in high-technology industry areas to local producers manufacturingLQWHUPHGLDWHJRRGV7HFKQRORJ\VSLOORYHUFDQEHDFTXLUHGWKURXJKLQWHUQDWLRQDOL]DWLRQRI

KRVWLQJIRUHLJQLQYHVWHGUPVSURGXFLQJKLJKVNLOOHGWHFKQRORJ\JRRGVDIWHUZKLFKORFDO

producers that obtained high-technology skills will be encouraged to gradually replace the

foreign-invested processing goods traders through internalization/localization in production

of sophisticated manufactured goods.

imilarly, the presence of state-owned enterprises in a certain industry will attract more

privately invested Chinese companies Models 10A and 10B) and foreign normal goods

traders Model 8B). hese increases only apply to the subpopulation of investors active in

WKLVSDUWLFXODUSURGXFWFODVVVRWKDWWKHQXPEHURIUPVWKDWFDQEHLQGXFHGWRHQWHULQ

this way may still be small. t suggests that a state-owned infant industry may still play aOLPLWHGOHDGLQJUROHWRGHYHORSVSHFLFWDUJHWLQGXVWULHV

VII. Conclusion

he most important result of this study is the proof of a basic concept that heterogeneity

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decisions in the C. rocessing traders differ substantially from nonprocessing traders

in response to changes in wage cost, level of development in infrastructure, and proximityWRWKH3DFLFFRDVW3UHVHQFHRIIRUHLJQLQYHVWHGHQWHUSULVHVFUHDWHVDEHDFRQHIIHFWRQ

VXEVHTXHQWIRUHLJQDQGGRPHVWLFLQYHVWRUV

7KHPRVWEDVLFFRQFOXVLRQIURPWKHHPSLULFDODQDO\VHVLVWKDWSUR[LPLW\WRWKH3DFLF

coast and new economic geography of agglomeration effect and the presence of

LQFXPEHQWUPVLQWKHVDPHSURGXFWFODVVDUHWKHVWURQJHVWGHWHUPLQDQWVRIDQLQYHVWRUV



29/31

location choice in the Cs export industry. Agglomeration also plays a greater role

for investors specializing in processing goods trade and highly skill-intensive or &

intensive production. irms with a higher educated workforce agglomerate more than

others.

6LPLODUO\SURFHVVLQJWUDGHUPVGLVSOD\VWURQJHUDJJORPHUDWLYHEHKDYLRUWKDQ

nonprocessing traders. Moreover, processing traders are more sensitive to the wage

level and value proximity to the coast more. A wide range of industrial policies designed

WRDWWUDFWFOXVWHUVRIOHDGLQJUPVPD\EHXVWLDEOHRQWKHVHJURXQGV$PRQJLQYHVWRUV

of different origin, ong ong, China and aipei,China investors seem the least driven

by agglomeration. nvestors from ong ong, China and aipei,China, by contrast, tend

WRFRORFDWHZLWKRWKHUUPVIURPWKHVDPHUHJLRQZKLOHIRUHLJQLQYHVWHGUPVVHHPWR

EHQHJDWLYHO\LQXHQFHGE\WKHSUHVHQFHRI+RQJRQJKLQD7DLSHLKLQDLQFXPEHQWV

RUHLJQLQYHVWHGLQFXPEHQWUPVKDYHDYHU\ODUJHHIIHFWRQVXEVHTXHQWSULYDWHKLQHVH

investors in processing trade sector, and have a sizable effect on other foreign investors

and investors from ong ong, China and aipei,China.

%HQHWVIURPUHGXFWLRQLQYDOXHDGGHGWD[UDWHVDQGFRUSRUDWHLQFRPHWD[UDWHVSOD\

an evident role for foreign investors and investors in the processing trade sector.

owever, since 2008, a number of provinces started dismantling preferential labor

laws, export subsidies, favorable value-added tax rates, and corporate tax rates to low-

skill-intensive foreign enterprises including processing goods traders. olicy makers

have publicly stated their goal that the C will dynamically transform its comparative

advantage from low-skill-intensive to high-tech industry concentrated. olicy makers in

the C intend to transform the internationalization process through attraction of foreign

investment toward localization by reducing the processing good trading portion and by

increasing the supply of domestically produced intermediate inputs for their exports. Asthe C moves up to the high value supply chain, expands its domestic market, and

exports skill-intensive goods, processing goods traders might consider new places or new

business models.

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About the PaperMinsoo Lee analyzes the spatial determinants of new foreign and domestic enterprisesin the export industry of the Peoples Republic of China (PRC) by applying new economicgeography of agglomeration theory, tax competition theory by resource flow model,and comparative advantage analysis. He finds that agglomeration plays a greaterrole for foreign investors specializing in the processing goods trade and highly skill-

intensive or research and development-intensive production, and that benefits fromreduction in the value added tax rate and corporate income tax rate play an evidentrole for foreign investors and Hong Kong, China and Taipei,China investors in theprocessing trade sector. As the PRC moves up the high-value supply chain and transformsthe internationalization process through attraction of foreign investment towardlocalization by reducing the processing goods trading portion and increasing thesupply of domestically produced intermediate inputs for their exports, processing goodstraders may consider new locations or business models.

About the Asian Development BankADBs vision is an Asia and Pacific region free of poverty. Its mission is to help its

developing member countries reduce poverty and improve the quality of life of theirpeople. Despite the regions many successes, it remains home to two-thirds of theworlds poor: 1.8 billion people who live on less than $2 a day, with 903 millionstruggling on less than $1.25 a day. ADB is committed to reducing poverty throughinclusive economic growth, environmentally sustainable growth, and regionalintegration.

Based in Manila, ADB is owned by 67 members, including 48 from the region. Itsmain instruments for helping its developing member countries are policy dialogue, loans,equity investments, guarantees, grants, and technical assistance.

Asian Development Bank6 ADB Avenue, Mandaluyong City1550 Metro Manila, Philippineswww.adb.org/economicsISSN: 1655-5252Publication Stock No. WPS124550

January 2012

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