Processing trade and costs of incomplete liberalization: The case of China

Abstract

A major objective of policies promoting processing trade in developing countries is integration with global markets. A central feature of processing regimes is that firms do not have to pay tariffs on imported inputs as long as they are used exclusively in the production of goods for export. These firms are typically restricted from selling output using imported inputs on the domestic market. These restrictions can be viewed as a form of incomplete liberalization due to protectionist motives. Using data from China for 2000–2007 for 109 industries, we study the welfare effects of these measures. Counterfactual experiments imply total welfare losses of 2.2% for China due to the restriction on selling processing output domestically, and even larger loses of 5.7% for labor. Gains from only the tariff exemption for processing firms however are negligible.