Deng Jianpeng | Dutch Disease Caused by Processing Trade

December 2-3, 2022, hosted by the Center for International Finance and Economics Research (CIFER) of the National Institute of Financial Research, Tsinghua University.Academic Symposium on "2022 International Trade Disputes and the Restructuring of Globalization"The event was successfully held.Assistant Professor, School of Business, Shanghai University of Finance and EconomicsDeng JianpengAttendees wereCIFER Researcher, Lecturer at the School of Statistics, Beijing Normal UniversityLu BingHostTrade Structure Sub-Forum 7Sharing with collaborators (as shown below) on the topic of《Dutch disease caused by processing trade》(Processing-Trade-Induced Dutch Disease)The article.

Deng JianpengShe holds a PhD in Economics from Pennsylvania State University and is an Assistant Professor at the School of Business, Shanghai University of Finance and Economics. Her main research areas are international trade, economic growth, and economic geography.Journal of International Money and FinanceA paper has been published.

Deng Jianpeng

The article proposes a quantifiable general equilibrium model to study the impact of tariff reduction and exemption policies on the long-term economic benefits of developing countries.The model proposed in the article has two features1. The proportion of domestic value added in processing trade is significantly lower than that in general trade and domestic sales; 2. The scale of intermediate goods production in a country is increasing. The larger the country, the larger the scale of intermediate goods production, which in turn lowers the cost of the final products.

Under these two characteristics, tariff reductions will cause labor to shift from industries with high domestic value-added to industries with low domestic value-added in foreign trade, leading to less use of domestically processed intermediate goods. This reduces the scale of domestic intermediate goods processing and negatively impacts the country's economic development, a phenomenon commonly known as "Dutch disease." The article uses Chinese data to verify the reliability of this conclusion. The results show that tariff reductions in processing trade would decrease China's real income by 1.45%.

Many developing countries use processing trade to stimulate their economic development. For example, Foxconn imports components from various countries, processes them into iPhones in China, and then exports the finished iPhones abroad. In this process, China adopts a policy of reducing or exempting tariffs on imported components, which is a typical "two ends abroad, large-scale import and export" model. After World War II, countries such as South Korea, Japan, China, Vietnam, Mexico, and Honduras successively promoted economic growth by developing processing trade. The effects varied from country to country, and some countries may have over-exported, affecting their domestic economic and trade development and leading to phenomena such as the Dutch disease. Currently, there is no research on the inhibitory effect of tariff-reduced processing trade policies on the domestic economy. Therefore, this article constructs a model to quantify the impact of tariff-reduced processing trade policies on domestic economic development.

The data used in the article is2005 China Customs data. This data provides detailed import and export transaction information, including company name, import/export code, product code, transaction amount, quantity, destination or country of origin, etc. In addition, the database also provides information on processing trade and general trade.

To illustrate how tariff-free processing trade leads to the Dutch disease, this paper establishes a two-dimensional equilibrium model. This model considers a processing trade system where firms can enjoy duty-free imports of intermediate goods while exporting their final products.At the national level, select N countries to trade with each other. Assume that the first country has two modes of trade: processing trade with tariff reductions and general trade, while the other countries only have general trade. Then, study the impact of the first country adopting processing trade, defined as follows:

At the firm level, assume that firms in the first country have two production modes: a high domestic value-added mode (general trade R) and a low value-added mode (processing trade B). The production function is as follows:

Under the above model, companies in Country 1 can choose between general trade and processing trade. This article simulates the company's choice by constructing a production cost function:

By constructing profit and pricing models for enterprises, we can characterize their decision-making processes.

The final impact model of processing trade on country one is as follows:

When the administrative costs of processing trade are low, companies will choose to engage in processing trade; when the administrative costs of processing trade are high, companies will choose to engage in general trade; when the administrative costs of processing trade are in the middle range, companies will generally choose to participate in both.In practice, the administrative costs of processing trade are generally at the middle value, with...2005Based on Chinese customs data from that year, a model was used to calculate the welfare loss caused by the Dutch disease resulting from the reduction of processing trade tariffs.-2.32%) exceeded the welfare increase brought about by the increase in the variety of imported intermediate goods.1.06%）。

Many developing countries have been encouraging processing trade to boost economic growth, but with mixed results. Currently, no research directly studies the welfare impact of the "Dutch disease" caused by processing trade. This paper establishes a quantifiable general equilibrium model to quantify the intrinsic relationship between processing trade and the development of the "Dutch disease." The study shows that when tariff-free processing trade increases, reliance on foreign intermediate goods processing exceeds domestic sales and ordinary exports. Tariff exemptions shift labor from producing high-DVAS domestic goods and ordinary export products to producing low-DVAS processed export goods, leading to a reduction in the scale of domestic intermediate goods production and thus triggering the Dutch disease.

This model does not consider all the impacts of the processing trade mechanism, such as stimulating technological progress and broadening trade categories, and therefore does not mean that processing trade will necessarily inhibit economic development. The article provides a warning for such development policies: as the scale of tariff-free processing trade increases, the administrative costs of tariff reductions may outweigh the economic growth benefits, thus leading to the Dutch disease phenomenon.

Xu Xiaocong

Assistant Professor, School of Business, Nanjing UniversityXu XiaocongThe commentary on the article noted that current research on processing trade focuses more on its actual effects, with fewer articles examining the impact of policy mechanisms. Existing research on these mechanisms also tends to focus on the benefits of processing trade. This article, however, examines the potential negative impacts of processing trade from a novel perspective and offers a more comprehensive analysis.Xu Xiaocong proposed based on the articleTwo policy recommendations：1The article's model is quite complex, considering the impact of processing trade in one industry. In reality, it involves multiple industries, with significant differences and correlations between them, which may lead to a difference between the final total impact and the results of a single-industry study.2The article makes many counterfactual analyses; perhaps it's worth considering further consideration regarding the addition of...How significant will the tariff reduction policy be after industrial and trade products no longer need to be entirely exported?