In this paper, we use a new panel of county-level data to present the first evidence of the effect of China’s accession to the WTO in 2001 a policy shift that removed uncertainty over the tariff rates that Chinese exporters would face in the U.S. market on structural transformation and growth.
The identification strategy exploits variation across industries in the size of the gap between the MFN tariffs and the higher tariffs that Chinese producers risked exposure to prior to WTO accession, as well as variation across counties in the baseline composition of employment.
Our results suggest that counties that benefited most from the reduced tariff uncertainty show substantial expansion following WTO accession.
Employment and GDP in the secondary sector increase, while the agricultural sector contracts. Importantly, we observe not only a decline in employment in the agricultural sector but also a decline in output, a result inconsistent with predictions of the surplus labor hypothesis.
We also observe a substantial increase in GDP per capita. Moreover, these patterns are observed only after 2001, suggesting that they do reflect the hypothesized channel of reduced tariff uncertainty and are not evidence of ex-ante differences in observable characteristics.
This paper is the first to analyze the impact of the reduction in tariff uncertainty on structural transformation at the local level in China and joins limited literature evaluating the role of enhanced trade access in stimulating growth in developing countries.
This evidence highlights the importance of securing access to developed country markets for developing countries that pursue export-driven growth strategies.
Understanding the implications of U.S. trade for Chinese growth may contribute to a more complete understanding of the global impact of China’s rise as a global manufacturing powerhouse over the past two decades.
Background and Conceptual Framework
Over the past two and a half decades, China has experienced a process of remarkable structural transformation accompanied by rapid economic growth.
The share of total employment in the agricultural sector fell from 60% in 1990 to 28% in 2015, and this sectoral shift was matched by unprecedented growth in nonagricultural output. At the same time, China also experienced a rapid rise in manufacturing exports, increasing from 2% to 19% of global manufacturing exports.
While this transformation can be traced back to the onset of market-oriented reforms in 1979, the pace of the structural shift accelerated following China’s accession to the World Trade Organization in 2001.
China’s record of growth has generated a robust debate about its causes. While some analysts argue that trade liberalization stimulated economic growth (Sun & Heshmati, 2010; McMillan, Rodrik, & Verduzco-Gallo, 2014).
There is relatively little direct evidence of this relationship, and more generally Goldberg and Pavcnik (2016) conclude in a review that there is only limited empirical evidence of the relationship between trade policy and growth.
By contrast, a large literature argues that internal policy reforms, particularly the reform of state-owned enterprises and the creation of Special Economic Zones, were crucial in enabling China to increase productivity and realize its comparative advantage in manufacturing (Song, Storesletten, & Zilibotti, 2011; Autor, Dorn, & Hanson, 2016).
Evidence suggests that the reduction of domestic tariffs had a large, positive effect on the manufacturing sector (Manova & Zhang, 2017; Brandt et al., 2017), but there is almost no empirical evidence about the effects of trade liberalization on other economic sectors or on the process of structural transformation writ large.
At the same time, a growing literature has analyzed the determinants of structural change in the developing world, primarily focusing on “push factors,” or positive shocks to agricultural productivity. There has been only limited empirical exploration of the role of trade liberalization, arguably among the most important pull factors that can stimulate the substitution of productive factors out of agriculture.
Given that productivity is much lower in agriculture compared to nonagricultural production in developing economies, this substitution has important macroeconomic implications (Gollin, Lagakos, & Waugh, 2014; McMillan et al., 2014).
Analyzing trade liberalization in China, the focus of this study represents a valuable opportunity to evaluate the effects of an exogenous pull shock on structural transformation in the context of a fast-evolving economy in which a range of reforms was contributing to a rapid flow of labor out of the agricultural sector.
In this paper, we provide new evidence around the effects of China’s WTO accession on structural change and growth at the local level, analyzing a newly assembled panel of approximately 1,800 counties observed between 1996 and 2013.
China’s WTO membership significantly reduced uncertainty about U.S. trade policy for China, generating a substantial increase in both total Chinese exports to the United States and total exports, as evident in figures 1c and 1d (Handley & Limão, 2017; Pierce & Schott, 2016).
At the same time, aggregate shifts in labor allocation patterns emerged: primary employment, previously roughly stagnant at the national level, began to contract at a rate of 3.5% annually after 2002, and the annual growth rate of secondary employment nearly tripled.
Given this evidence, we utilize an identification strategy that allows us to examine the effects of cross-sectionally varying shocks generated by the reduction in uncertainty and present evidence that these shocks led to significant growth in exports and foreign direct investment in more exposed regions.
This in turn stimulated a reallocation of productive factors from agriculture into manufacturing and services and generated a significant increase in county-level output.
More specifically, China’s Most Favored Nation (MFN) status in the United States required annual renewal by Congress prior to 2002, a process entailing considerable risk; if the renewal had failed, Chinese exports would have been subject to the much higher rates reserved for nonmarket economies.
The United States permanently granted Normal Trade Relations (NTR) status a U.S. term for MFN status—to China in October 2000, tied to its WTO membership and effective as of January 1, 2002 (Handley & Limão, 2017). By contrast, the status of Chinese exports in other markets did not change.
Our empirical design utilizes variation across industries in the gap between the NTR tariffs and the non-NTR rates, in conjunction with variation across counties in the composition of employment by industry reported in the 1990 census.
The interaction of these two sources of variation generates a county-level variable capturing the exposure of local industries to tariff uncertainty before 2001; the county is an important unit of analysis in the literature on the Chinese economy, corresponding to a local labor market with defined fiscal and economic policies (Chen & Kung, 2016).
If this uncertainty is a significant barrier to exporting, more exposed counties should experience more rapid export expansion and substitution into the secondary sector after 2001.
Our primary results suggest that counties more exposed to tariff uncertainty prior to 2001 experienced significantly faster growth in exports, greater expansion in the secondary sector, greater contraction in the primary sector, and more rapid increases in total and per capita GDP following WTO accession, conditional on county and province-year fixed effects.
Comparing a county at the median level of uncertainty ex ante to a county characterized by the minimum level of uncertainty, the more exposed county shows evidence of an increase in exports of around .20 log points and increases in secondary, total, and per capita county GDP of around .04 log points.
This export-driven expansion also has ancillary effects on other sectors: productive factors shift out of agriculture, agricultural production declines, tertiary output expands, and there is some evidence of in-migration. Using firm-level data, we document that more exposed regions also experience an increase in value-added per worker in manufacturing and a corresponding rise in wages.
Importantly, the evidence of contraction in agricultural output in counties more exposed to positive export shocks inducing factor substitution into nonagricultural production is inconsistent with the predictions of a classic surplus labor model.
Rather, this pattern is consistent with other recent work arguing that stocks of surplus labor in rural areas have largely been depleted as China reaches the Lewis turning point (Zhang, Yang, & Wang, 2011; Kwan, Wu, & Zhuo, 2018).
We present additional evidence that the decline in agricultural output is accelerating as labor continues to substitute into new sectors, and that this decline is also larger in areas that have experienced an agglomeration of positive shocks to export-oriented production in multiple counties within a prefecture.
Moreover, the magnitude of the implied effects is substantial; our findings suggest that reduced trade uncertainty accounted for approximately 10% of total output growth during this period and that substitution of productive factors into nonagricultural production generated an increase of at least 10% in aggregate productivity.
Clearly, a range of other pull factors during this period—including substantial manufacturing growth driven by a major restructuring of state-owned enterprises—contribute to the observed process of structural transformation, but we argue that enhanced access to advanced markets represents a nontrivial contribution.
While an analysis at the level of the local economy is not directly informative about the magnitude of macro-level shifts, it does enable us to analyze the causal factors shaping these shifts with more precision.
Our paper is the first to estimate the causal effects of enhanced access to U.S. export markets on structural transformation and growth at the local level in China.
It is also one of the first to provide evidence on the employment and GDP effects of enhanced access to advanced country markets in a developing country. Accordingly, this project serves to address the evidence gap identified by Goldberg and Pavcnik (2016) about the relationship between trade, growth, and structural transformation in the developing world.
In addition, we contribute to several specific bodies of literature. First, a number of studies have sought to identify the impact of trade liberalization on the Chinese manufacturing sector, focusing on industries or firms as the unit of analysis, and primarily analyzing variation in tariff levels.
Although our findings complement these studies, our paper differs significantly in its focus on structural transformation and county-level growth. In the literature, Brandt and Morrow (2017) and Manova and Zhang (2017) show that reduced tariffs have also resulted in increased access to imported inputs.
Brandt et al. (2017) demonstrate that both input and output tariff cuts have implications for productivity and mark-ups, but those effects are heterogeneous for incumbent firms vis-a-vis new entrants and also for state-owned vis-a-vis private firms.
Bai, Krishna, and Ma (2017) and Khandelwal, Schott, and Wei (2013) analyze the impact of the removal of export restrictions and MFA quotas on export growth and manufacturing productivity at the firm level, respectively. Recent work has also found that the diminished trade policy uncertainty following China’s WTO accession has boosted patent applications (Liu & Ma, 2020) and stimulated entry into export-oriented production (Feng, Li, & Swenson, 2017).
Second, our study contributes to the literature on trade liberalization in developing countries by presenting evidence on the employment and GDP effects of the elimination of trade policy uncertainty in China. A number of papers have analyzed the effects of domestic tariff cuts on regional labor market outcomes in Brazil (Chiquiar, 2008; Kovak, 2013; Dix-Carneiro & Kovak, 2017), but existing studies evaluating the effects of expanded access to developed country markets largely focus on Vietnam.
Exploiting shocks generated by a bilateral trade agreement, McCaig (2011) finds that the U.S. tariff cuts reduced poverty in Vietnam, and McCaig and Pavcnik (2018, 2016), analyze the reallocation of labor between household businesses and the formal sector. Another paper analyzes the effect of China’s WTO accession on internal migration, but it uses only prefecture-level data (Facchini, Mayda, & Zhou, 2019).
Third, our results are consistent with theoretical literature that predicts a reallocation of workers from less income-elastic sectors such as agricultural production into more income-elastic sectors, including manufacturing in response to increased access to export markets.
Open-economy models with nonhomothetic preferences predict that lower trade costs result in productivity gains and higher income growth, shifting expenditure toward income-elastic sectors (Matsuyama, 2009, 2019; Herrendorf, Rogerson, & Valentinyi, 2014).
More generally, open economy models of structural change predict that declining trade costs can induce labor reallocations across sectors (Uy, Yi, & Zhang, 2013; Cravino & Sotelo, 2017), but previous empirical work has generally found limited evidence of intersectoral labor reallocation in response to trade shocks, particularly in the short run.
Our empirical specification allows us to capture the factor reallocation effects generated by declining implied trade costs at the level of local labor markets over a relatively long period of time.
Finally, extensive literature analyzes the effects of Chinese imports on manufacturing in developed economies (Autor et al., 2013, 2016). The identification strategy employed in this paper is closely related to Pierce and Schott (2016) and Handley and Limão (2017), examining the effects of trade policy uncertainty on manufacturing employment and consumer prices in the United States.
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China’s WTO Accession
China’s accession to the WTO in 2001 entailed both new trade access benefits for the Chinese economy and a commitment to additional, liberalizing domestic reforms. However, both the benefits and the reforms were largely phased in gradually and did not result in any discontinuous jumps in 2001.
It is useful to highlight the most important policy changes that China implemented as part of this process, including reduced import tariffs, the relaxation of export licensing rules, and fewer barriers to foreign investment. Additional details are provided in section A1.1 in the appendix.
First, Chinese import tariffs had already been sharply cut prior to 2001 (from a weighted average of over 45% in 1992 to approximately 13%). WTO accession entailed further cuts, but these shifts were small in magnitude (Bhattasali, Li, & Martin, 2004).
Second, restrictions on direct exporting were previously substantial, and firms that were not granted licenses to export directly were required to export via partners. By 2004, all firms were allowed to export freely (Bai et al., 2017).
Third, prior to WTO accession, China had generally implemented relatively attractive policies to draw in foreign investment, subject to performance requirements for foreign firms; these requirements were eliminated following 2002 (Long, 2005).
What about changes in the tariffs imposed by trading partners? Figure 2b shows fluctuations in tariffs over time for China’s most important trading partners: the NTR tariffs imposed by the United States and the average tariff rates imposed on Chinese exports by the European Union, Japan, Korea, and Taiwan.
We again construct these rates as weighted averages of industry-level tariffs, utilizing the shares of total exports constituted by each industry’s output in 1996 as weights. There is no evidence of any dramatic shifts in tariff rates at the point of China’s WTO accession. Despite their gradual nature, however, all of the preceding shifts in trade policy are relevant in understanding structural change during this period, and we include these variables in our empirical specifications.
Importantly, there was a discontinuous jump in one important dimension of China’s market access in 2001: the tariff uncertainty faced in the U.S. market. Prior to WTO accession, the United States granted China NTR tariff rates on a discretionary basis subject to annual congressional renewal.
Failure of that renewal would have triggered the imposition of much higher tariffs, originally set by the Smoot-Hawley Act, and designated for nonmarket economies. Hence, although the tariff applied to Chinese imports remained low because China’s NTR status was never withdrawn, the required annual approval generated considerable uncertainty.
Using media and government reports, Pierce and Schott (2016) document that firms perceived the annual renewal of MFN status as far from guaranteed, particularly in periods of political tension in the early 1990s.
In October 2000, Congress passed a bill that granted permanent NTR status to China, effective as of January 1, 2002. Growth in China’s total exports showed a parallel trend (figure 1d), consistent with the hypothesis that the increase in exports to other markets was minimal; we further substantiate this point in subsequent robustness checks.
Again, a number of policy shifts during this period shaped economic outcomes. However, we preferentially focus on reduced trade uncertainty given that the previous literature has highlighted that this shift had a major impact on the U.S. market and given the discontinuous nature of the reduction in uncertainty.
We also present evidence that while the other reforms implemented during this period had a meaningful impact on local economic outcomes in China, the effect of reduced tariff uncertainty generally proves to be the largest in magnitude.
Our analysis allows us to separately identify the impact of tariff uncertainty vis-a-vis levels by exploiting the fact that tariff uncertainty varies only comparing the pre-and-post period, and is proxied by the difference between low tariff rates and the counterfactual high rates specified by the U.S. tariff schedule. By contrast, realized tariff levels imposed by both the United States and other trading partners vary continuously over time.
The reduction of tariff uncertainty can affect structural change through several channels. First, it creates incentives for Chinese firms to increase their exports to the U.S. market. A large literature has established that price uncertainty (in this case, generated by tariff uncertainty in the destination market) generates an option value of waiting, decreasing investment (Bloom, Bond, & Van Reenen, 2007).
When tariff uncertainty is reduced, firms facing positive demand in the destination market, primarily manufacturing firms, have a greater incentive to make irreversible investments required to enter foreign markets (Handley & Limão, 2015, 2017).
Given that industries differ in their exposure to tariff uncertainty, those with greater exposure ex ante will face a greater decline in the option value of waiting for post-WTO accession. Exports from these tradable industries and counties with a greater concentration in these exposed industries will differentially increase.
Source: Erten, B., & Leight, J. (2021). Exporting out of agriculture: The impact of WTO accession on structural transformation in China. Review of Economics and Statistics, 103(2), 364-380.