The Impact of Foreign Firms on the Sophistication of Chinese Exports

Recent studies find that China exported goods of relatively high product sophistication, which are not compatible to China’s economic development level. In this paper we use detailed product-level and firm-level data to examine the determination of product sophistication level of Chinese exports in the period 1998-2005, in particular the role of foreign firms. In our study we distinguish between wholly-owned, majorityowned and minority-owned foreign firms, and between HMT (Hong Kong, Macao, Taiwan) and non-HMT foreign firms. We find that the increasing presence of whollyowned non-HMT foreign firms and the decreasing presence of minority-owned non-HMT foreign firms in China have a positive effect on China’s export sophistication, accounting for about 20 percent. We find China’s WTO entry contributed a large positive effect to growth of product sophistication of China’s exports. We also identify a number of factors that have made China increasingly difficult to raise its export sophistication. Our study examines several other hypotheses related to China’s export sophistication. We find that export sophistication is positively associated with the development level of China’s exporting regions in 1998-2001, but this location effect disappeared in 2002-2005. We do not detect much of an effect from domestic competition except that Chinese industries’ falling degree of market concentration had some negative impact on China’s export sophistication growth in 2002-2005. We find however that China’s export sophistication is positively related to the degree of foreign competition in the export market. While traditional comparative advantage variables do not appear to have significant effects in our panel-data regressions, we find that their effects are absorbed in firm identity variables or industry fixed effects. This finding is consistent with recent trade models of firm heterogeneity that show comparative advantage endogenously determined by organizational characteristics of firms.