THE UNIVERSITY OF CHICAGO INTERNATIONAL TRADE, PRODUCTIVITY AND GROWTH IN OPEN ECONOMIES A DISSERTATION SUBMITTED TO THE FACULTY OF THE DIVISION OF THE SOCIAL SCIENCES IN CANDIDACY FOR THE DEGREE OF DOCTOR OF PHILOSOPHY DEPARTMENT OF ECONOMICS BY HUA CHAI CHICAGO, ILLINOIS JUNE 2013 UMI Number: 3568528 All rights reserved INFORMATION TO ALL USERS The quality of this reproduction is dependent upon the quality of the copy submitted In the unlikely event that the author did not send a complete manuscript and there are missing pages, these will be noted Also, if material had to be removed, a note will indicate the deletion UMI 3568528 Published by ProQuest LLC (2013) Copyright in the Dissertation held by the Author Microform Edition © ProQuest LLC All rights reserved This work is protected against unauthorized copying under Title 17, United States Code ProQuest LLC 789 East Eisenhower Parkway P.O Box 1346 Ann Arbor, MI 48106 - 1346 Copyright c 2013 by HUA CHAI All Rights Reserved To my dear wife Yayun Pan and daughter Deborah Erya Chai TABLE OF CONTENTS LIST OF FIGURES vi LIST OF TABLES vii ACKNOWLEDGMENTS viii ABSTRACT ix CHAPTER I REAL EXCHANGE RATE UNDERVALUATION ALLOCATION IN CHINA: THEORY 1.1 Introduction 1.2 A Simple Model 1.2.1 Basic Setup 1.2.2 Equilibrium with Capital Account Policies 1.2.3 TFP E¤ect 1.2.4 Equilibrium with Sectoral Subsidies 1.2.5 Short-Run Analysis AND RESOURCE 10 11 CHAPTER II REAL EXCHANGE RATE UNDERVALUATION AND RESOURCE ALLOCATION IN CHINA: QUANTITATIVE EXPLORATION 2.1 A Quantitative Model 2.1.1 The Environment 2.1.2 Distortions 2.1.3 Equilibrium 2.1.4 General Equilibrium E¤ects 2.2 Quantitative Analysis 2.2.1 Estimating Distortions 2.2.2 Observables and Parameters 2.2.3 Results 2.3 Conclusion 16 16 16 18 19 23 24 25 27 29 33 CHAPTER III INTERNATIONAL TRADE AND TECHNOLOGY DIFFUSION: A MODEL OF LEARNING-BY-EXPORTING 3.1 Introduction 3.2 Model 3.2.1 Technology and preference 3.2.2 Learning and technology di¤usion 3.2.3 Evolution of the technology frontier 3.2.4 Equilibrium 3.3 A Numerical Example 3.4 Conclusion 34 34 36 36 37 41 42 46 47 iv A APPENDIX FOR CHAPTER I AND CHAPTER II A.1 Proof of Proposition A.2 Deriving equilibrium conditions in "changes" A.3 Equilibrium with sectoral subsidies A.4 Algorithm for Solving the Quantitative Model 49 49 49 51 53 B APPENDIX FOR CHAPTER III 54 C FIGURES 55 REFERENCES 63 v LIST OF FIGURES 3.1 Equilibrium Dynamics 48 C.1 C.2 C.3 C.4 C.5 55 56 57 58 59 Private Firms’Share of Industry Sales Private Firms’Share of Industry Value-Added Private Firms’Share of Industry Fixed Investment Shares of Domestically-Funded Fixed Investment by Results of Varying Trade Balance vi Industry LIST OF TABLES 2.1 2.2 2.3 2.4 2.5 Estimated Distortions at Sector Level Results without Distortions Results with Distortions Alternative Parameter Values Results with Average Distortions 26 29 30 30 31 3.1 Parameter Values 3.2 Steady State 47 47 vii ACKNOWLEDGMENTS I am deeply grateful to my main advisor and the chair of my thesis committee, Professor Samuel Kortum, for his invaluable advice and guidance, and continual support and encouragement I am also deeply indebted to Professor Robert Lucas and Professor Ralph Ossa, for their patience and generous help since even before the beginning of this thesis project to its completion I also thank Nancy Stokey, Thomas Chaney, Chang-Tai Hsieh, Zheng Michael Song, and Kerem Cosar for their extremely helpful comments and suggestions at various stages of this project I am also grateful to all the fellow students in the International Economics Working Group at the University of Chicago, whose kind support, open discussions and constructive criticisms have bene…ted my research greatly and prepared me better for the job market I also thank my loving wife for being so considerate, tolerant and supportive Without her help in every possible way, the completion of this dissertation would have been much more di¢ cult Financial support from the University of Chicago Social Science Fellowship, the JapanIMF Scholarship for Advanced Studies, and the Margaret G Reid Memorial Fund Dissertation Fellowship are gratefully acknowledged All remaining errors within this dissertation are my own viii ABSTRACT This thesis studies aggregate productivity and growth of developing countries in open economies with access to international trade with a focus on China It is divided into three chapters Chapter argues that real exchange rate undervaluation improves resource allocation in the Chinese economy The gain in allocative e¢ ciency results from two institutional features of China’s "state capitalism": (1) State-owned enterprises (SOEs) are generally favored by the government over private …rms; (2) Private …rms dominate the tradable sector, while SOEs retain strong presence in the non-tradable sector These facts jointly point to potential resource misallocation between the tradable and the non-tradable sectors Real exchange rate undervaluation mitigates this misallocation by raising the relative price of tradable goods, inducing resources to be reallocated toward the tradable sector Foreign exchange reserve accumulation is a major instrument used by the Chinese government to keep a competitive real exchange rate To make quantitative assessments of this policy, in chapter I develop a two-sector EatonKortum model of international trade with two types of …rms and type-and-sector speci…c distortions I estimate distortions from Chinese industry-level data, and calibrate the model to match aggregate trade ‡ows and sectoral spending data for the year 2007 Quantitative results suggest that reserve accumulation depreciates the real exchange rate by a moderate 4%, compared to a reference point with balanced trade, and the resulting improved resource allocation raises China’s real GDP in 2007 by 1% I show that alternative policies that can also generate real undervaluation, such as a moderate consumption subsidy on tradable goods, could deliver positive TFP e¤ects without the need for a high trade surplus Chapter is a theoretical exploration of how international trade facilitates international technology di¤usion In particular, it formalizes the notion of "learning-by-exporting" by embedding learning in an Eaton-Kortum type trade model with Bertrand competition Exporting …rms can learn from international best practices at an endogenously chosen learning intensity The model is able to generate the so-called "catch-up growth" where an econix relative technological sophistication 0.8 0.6 0.4 0.2 0 20 40 60 80 100 time learning intensity 20 40 60 120 140 160 120 140 160 20 15 10 80 time 100 Figure 3.1: Equilibrium Dynamics Thirdly, some assumptions are made purely for tractability and not justi…ed on economic grounds, for example, the assumptions about exit rate The weird result regarding constant trade share is an undesirable feature of the model and does not have any empirical support 48 APPENDIX A APPENDIX FOR CHAPTER I AND CHAPTER II A.1 Proof of Proposition It is straightforward to show that Y can be expressed in terms of parameters as: L Y = 1+ " (1 ) (1 + ) (1 Di¤erentiate with respect to dY = d (1 ) (1 )+ + (1 ) (1 + ) (1 )+ # : and rearrange terms: ) (1 + ) (1 )+ (1 + ) (1 + ) (1 )+ 1 The sign of this derivative depends on the term in the brackets It is positive if and only if >1 If < (1 1+ 1 : ) = ; then the right-hand side is greater than Since can not exceed one, the above inequality does not hold and the derivative is negative If > (1 ) = ; the derivative is negative for inequality and becomes positive as A.2 smaller than the right-hand side of the surpasses it Deriving equilibrium conditions in "changes" Here I show how to derive the system of equations Denote the counterfactual value of a variable with prime, and the ratio of the counterfactual value to factual value with a "hat" 49 L : For example, 'im = ! m i Pm Pi 'i0 m = !m i0 Pm P i0 !1 " !1 " In this case equation (2.15) ' ^ im is obtained straightforwardly by taking the ratio of the two equations Similarly write X Pi = i ! m Pm " i0 " m X P i0 = ! m Pm m ! 1 " ! 1 " Taking the ratio and using (2.1) and (2.15) yields: P^ i = = i " X ! m Pm i " ^m P P i " m k ! k Pk ! 1 " X " i i ^ ' P m !11 " = i " X ! m Pm " Pi m i P^m " !11 " m m For sectoral prices, write j PT = @ j0 PT = @ N X i=1 N X i=1 " " dij dij ri ri0 T T wi wi0 T T 50 PTi T T PTi0 T # 1= T # 1= i A T i A T BT BT Taking ratio, and using the equation (2.4) to derive (2.13) j P^m ji N dm ri BX B = B @ m wi1 PN i=1 " N X ji = @ Dm m m ji ri i=1 dm r^i m w^ i 1= i Pm m m m m wi i P^m i m m r^i m m w^i1 i Pm m m 1= m i P^m m 1= i m # 1= m A i=1 Equation (2.19) is derived similarly And the linear system of equations (2.16) is simply derived by rewrite the counterfactual value as the product of their factual value and "change", i0 = X i X ^i e.g Xm m m: A.3 Equilibrium with sectoral subsidies Note that here i = + ti P i C i + Z i : Xm m m m m ti i ; a fraction of m goes to the government, the remaining Of sectoral spending Xm 1+tim 1+tim goes to the producers For sector m; total sales of intermediate variety producers are given by: i = Sm X ji Dm j A fraction (1 j Xm : i + tm m ) of sales net of output tax in sector m is spent on materials: i Z i = (1 + tim Pm m m) X i; y i; m ! i ; Sm and the rest is value-added in sector m; country i: Hence country i0 s aggregate value-added 51 C C C A (GDP) is given by Yi = X m " (1 X m) i; y i; m ! # i : Sm Aggregate consumption spending in country i is, by an accounting identity, equal to aggregate value-added in country i minus trade surplus: P iC i = Y i + T i T Bi: The share of consumption spending in sector m; country i; 'im ; is derived from the consumer’s problem, and is given by: i Pm Pi i Ci Pm m = !m i P Ci 'im !1 " : In each sector, the output of sectoral composite good is divided between consumption i = + ti P i C i + + ti P i Z i : and materials in production, i.e Xm m m m m m m X i = 'i Xm m (1 m) m + (1 m) X X y;i; m y;i; m i; m ! i; m X ji Dm j ! X ji Dm j j Xm i + tm j Xm ; i + tm T Bi + T i5 Rewrite the system in terms of changes Here we denote ^im = + ti0 m : Also assume tim = 0: j P^m = @ N X i=1 ji Dm " r^i P^ i = m X w^ i m i 'im ^im P^m m 52 m i ^im P^m " ! 1 " # 1= m A i ^im P^m P^ i ' ^ im = X i i X i = 'i ' ^m Xm m ^m (1 m) m B i + 'im ' ^ im 'im ' ^ im T B i Td (1 wi Li w^ i m) = X X y;i; m X y;i; m l;i; 1+ m ri K i r^i = k;i; 1+ m A.4 y;i; m X i; m ! X ji j j ^ m j Xm Xm ^ m j ti0 m i X ^i + Xm m i0 + tm m ! X ji j j i; ^ m m j Xm Xm ^m j y;i; m X !1 " X (1 i; m) m m m X i; m m m m X ji j j ^ m j Xm Xm ^ m j X ji j j ^ m j Xm Xm ^m j Algorithm for Solving the Quantitative Model Due to the presence of distortions, the standard algorithm as developed in Alvarez and Lucas (2007) does not apply I make initial guess of changes in factor prices and update within the system This includes …ve steps Guess r^i ; w^ i : i from (2.13); Compute P^ i from (2.14); Compute ' Compute P^m ^ im from (2.15); ^ is from (2.16), in terms of r^i and w^ i : Solve the linear system of equations in X Use market clearing conditions (2.17) and (2.18) to update r^i ; w^i : Iterate until convergence 53 APPENDIX B APPENDIX FOR CHAPTER III Derivation of equation (3.16) CRRA utility function implies r E_ = E Since e = E=ws ; then e_ w_ S r + = e wS : Since in equilibrium vS = awS ; we have v_ S w_ = S; vS wS which yields e_ v_ S r + = e v_ S : Use this to get rid of terms involving vS : v_ S = (r + ) vS (1 e !) ; a we have e_ r = e (r + ) + (1 54 e !) : a APPENDIX C FIGURES Figure C.1: Private Firms’Share of Industry Sales Data source: Annual Survey of Industrial Production, National Bureau of Statistics of China Industries are aggregated at 2-digit ISIC Revision level The tradable industries consist of mining and manufacturing industries, covering ISIC Rev.3 code 10 - 37 55 Figure C.2: Private Firms’Share of Industry Value-Added Data source: Annual Survey of Industrial Production, National Bureau of Statistics of China Industries are aggregated at 2-digit ISIC Revision level The tradable industries consist of mining and manufacturing industries, covering ISIC Rev.3 code 10 - 37 56 Figure C.3: Private Firms’Share of Industry Fixed Investment Data source: China Statistics Yearbook (2008) 57 shares of domestically funded fixed investments in urban area, by sector, 2007 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 State 0.1 Non-state Figure C.4: Shares of Domestically-Funded Fixed Investment by Industry Data source: China Statistics Yearbook 2008 58 capital labor 0.04 0.02 0.6 0.5 -0.02 0 -0.01 -0.02 0.4 0.05 0.1 0.15 trade balance to GDP ratio Real GDP 0.01 Change in Real GDP Share of Capital and Labor in the Tradable Sector 0.05 0.1 0.15 trade balance to GDP ratio change in PV of consumption Change in Real Exchange Rate Real Exchange Rate 0.05 0.1 0.15 trade balance to GDP ratio w elfare 0.05 0.1 0.15 trade balance to GDP ratio 1.01 1.005 0.995 0.99 Figure C.5: Results of Varying Trade Balance 59 REFERENCES [1] Alvarez, F., F Buera, and R Lucas Jr (2008): “Models of idea ‡ows,” [2] Alvarez, F., R Lucas, et al (2007): “General Equilibrium Analysis of the EatonKortum Model of International Trade,”Journal of Monetary Economics, 54(6), 1726–1768 [3] Banerjee, A., and E Duflo (2005): “Growth Theory through the Lens of Development Economics,”Handbook of Economic growth, 1, 473–552 [4] Bank, W (1993): The East Asian Miracle: Economic Growth and Public Policy Oxford University Press New York [5] Bernard, A., J Eaton, J Jensen, and S Kortum (2003): “Plants and productivity in international trade,”American Economic Review, 93(4), 1268–1290 [6] Boyreau-Debray, G., and S Wei (2005): “Pitfalls of a State-Dominated Financial System: The Case of China,” [7] Brandt, L., T Tombe, and X Zhu (2010): “Factor Market Distortions Across Time, Space and Sectors in China,”unpublished, University of Toronto [8] Caselli, F., and W Coleman II (2001): “The US structural transformation and regional convergence: A reinterpretation,”Journal of Political Economy, 109(3), 584–616 [9] Cheung, Y., M Chinn, and E Fujii (2010): “Measuring renminbi misalignment: where we stand?,” [10] Clerides, S., S Lach, and J Tybout (1998): “Is Learning by Exporting Important? 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However, this can be countered by increasing the trade surplus The above equation clearly shows that productivity and output are increasing in ; which is because higher trade surplus results in a "temporary" undervaluation of the real exchange rate, inducing labor to be reallocated toward the tradable sector, thereby correcting the misallocation of labor These results imply that in an economy with severe distortions,... not available at the industry level for the non-tradable industries, except for a few of them 1 for a much higher share in investment Even in industries where its share of investment is lower than private …rms, the state sector tends to hold a signi…cant portion In terms of aggregate sales of non-tradable industries, private …rms and SOEs split the market roughly half-and-half according to my estimates.3... assume cross-sector di¤erences in productivity, but relaxing this assumption does not change any of the qualitative results There are no intrinsic reasons for international trade since there is only one tradable good The existence of a tradable sector is to allow for inward and outward transfers of goods (trade de…cit and trade surplus) Perfect competition is assumed in both sectors throughout Utility... goods in sector m; of intermediate varieties Denote Pm country i Production of each intermediate variety u in sector m; country i; involves capital, labor and sectoral composite good: i (u) = xi (u) qm m i (u) km m i (u)1 lm m m where m is the share of value-added in output in sector m; i (u)1 zm m ; m is the value added based i (u) is the amount of sector m composite good used as inputs in capital intensity,... gain in aggregate productivity? I 13 answer these questions by examining the TFP e¤ects of real exchange rate undervaluation Since the size of the labor force is …xed, the e¤ects on aggregate TFP and on GDP are equivalent GDP can be expressed as the sum of value of sectoral outputs: Y = L T + PN L N : Rewriting the above equation using equations (1.10) and (1.11), I obtain: Y = 1 LT L wL 1 + : Taking... enterprises’share of industry sales in twenty-eight 2-digit tradable industries Private …rms contribute more than 80% of industry sales in all but a few industries Overall, the private sector accounts for more than 90% of sales in tradable industries Figure C.2 and Figure C.3 look at two di¤erent measures –private …rms’share of industry value added and domestic …xed investment respectively The patterns... decreases in the tradable sector The pace of the decrease in MPL is faster when labor stock in the tradable sector is relatively small, that is, when is small As increases, inducing more labor to be allocated to the tradable sector, the decrease in MPL slows down Therefore, the negative TFP e¤ect dominates for lower ; and is outweighed by the positive e¤ect when gets bigger These results imply that in an