Trade as an engine of creative destruction: Mexican experience with Chinese competition

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Abstract

This paper exploits the surge in Chinese exports from 1994 to 2004 to evaluate the effects of a competition shock from a low wage competitor for producers in an important middle-income country, Mexico. We find that this shock causes selection and reallocation at both firm and product levels and that its impact is highly heterogeneous at the intensive and extensive margins. Sales of smaller plants and more marginal products are compressed and are more likely to cease, whereas those of larger plants and core products seem relatively impervious to the shock. This implies a reallocation in terms of market shares within firms and between firms. We also show that the impact of expanded access to cheaper Chinese intermediate inputs has a similar effect, with larger plants benefiting more from the availability of cheaper imported inputs.

Highlights

► Chinese competition affected Mexican producers in a asymmetric manner. ► Smaller plants and less important products are more negatively affected. ► It is important to take into account the role of intermediate inputs. ► The input-channel reinforces the asymmetric effect of the Chinese export shock. ► Competition from China leads to a reallocation towards larger plants and products.

Introduction

Between 1990 and 2007 Chinese exports grew from 62 billion US dollars to 1.2 trillion USD, at the staggering average rate of about 20% per year. China became the world's largest exporter in 2009, and the second largest economy of the world in 2010. The emergence of China and its impact on producers worldwide has been a focus of attention for both policy-makers and researchers, and, at least among the former, has generally led to expressions of deep concern and calls for protection.2

While no set of countries is entirely insulated from competition from China, one might expect the effects to be most immediate on those middle-income countries whose established positions in manufactured markets have come under threat. This is the focus of this paper, in which we examine the impact of Chinese competition on Mexican manufacturing firms.3 We do not claim that the results we derive pertain to all middle-income countries, but we believe that they have a relevance wider than just Mexico, if only as hypotheses that might be considered by policy-makers and researchers in other countries.

Methodologically, the paper aims to close two gaps in the literature. First, we provide a careful investigation of the causal impact of competition on the intensive and extensive margins of Mexican firms, using detailed plant-level and plant–product-level data over time. Moreover, we recognize that competition may be felt as strongly in export markets as at home, and hence evaluate these causal links not only for Mexican firms serving their home market but also for those serving its main export market — the USA. On both markets we find strongly heterogeneous effects of the competitive shock on the extensive (exit and survival) and intensive (sales) margins, which provide evidence of resource reallocation between firms and of product reallocation within plants as competition obliges them to focus on their core competencies.4 Second, we show that, similar to the effect of competition, the effect of the increasing availability of cheaper Chinese intermediate inputs is highly asymmetric; however, taking this into account does not alter our main results on the effect of competition.

We reach these results by treating the emergence of China onto world markets as a quasi-natural experiment of a strong and sudden surge in the competition facing Mexican manufacturing producers. As depicted in Fig. 1, Chinese exports to Mexico and the United States increased substantially in terms of both value and share during the period considered. China's share of Mexican imports grew from around 0.5% in 1994 to 8% in 2004 — a factor of 16. This growth was primarily driven by the intensive margin, see Amiti and Freund (2010). In comparison, the import shares from Africa and Oceania to Mexico changed by a factor of 1.04, from other Asian countries by a factor of 1.35 and from South America by a factor from 1.41, while those of North America and Europe fell by factors of 0.96 and 0.84. In value terms, all these continental groups increased their exports to Mexico. This does not suggest that China has crowded out other developing country imports, but rather that China appears to be the larger part of a broad tendency raising the importance of developing countries in Mexican imports. This sizable growth was matched by a relatively moderate increase in trade flows in the opposite direction: the share of Chinese imports from Mexico increased from 1.9 to 2.8% from 1994 to 2004.5 Hence we interpret the situation at hand as essentially a unilateral trade shock and not a mutual trade expansion.

The situation is similar in the USA — the third-country market where Mexico has confronted Chinese competition so strongly. China's share of total imports more than doubled from 6.5% in 1996 to 13.4% in 2004 (USITC Trade Online), while the corresponding expansion factors for Mexico were 1.15, for developing Asia 1.46, other Latin America 1.09, for Europe 1.05 and for developed Asia 0.64. In both cases we would argue that the broad thrust of Chinese export growth was largely unanticipated and exogenous to the countries we study. While those countries' import policies had to be permissive to imports (and in a few specific cases were less than perfectly so), the increases in Chinese output and exports were generated by China's internal policy changes which induced huge growth in productivity and investment, massive inflows of FDI and large increases in the labor force available to manufacturers.6

Turning to the effect on export markets, Mexico is one of the countries that is likely to be most strongly affected by Chinese competition, given that within NAFTA Mexico has had a comparative advantage in the production of labor intensive goods and that China's exports to the USA have increased so strongly. di Giovanni et al. (2011) estimate that Mexico is the seventh most technologically similar country to China. Given that over 85% of Mexican exports go to the United States, Chinese expansion in the US market will have been a major shock to Mexican exporters; and given, in turn, that Mexico's export to GDP ratio varied from 14% (1994) to 25% (2004) such competition is clearly likely to be a major issue for the Mexican economy as a whole.

The objective of this study is to provide an example of how trade can work as a force of creative destruction that leads to competition enhancing readjustments within and between firms. For this reason we focus on both reallocation between firms and within firms at the product level. We analyze how the rise of China affected production patterns in Mexico, and show that larger plants and core products are relatively shielded from the adverse effects that this competition generates. We interpret the size effect as a productivity effect, since size and productivity are strongly correlated, but we do not have the data required to make this link formally. Additionally, we show that it is important to take into account the role of intermediate inputs as an additional channel through which the expansion of Chinese exports could influence Mexican firms, and that this channel reinforced the asymmetric effect of the Chinese competition shock.

The rest of the article is organized as follows. Section 2 discusses the empirical and theoretical context of our study. Section 3 describes the data and our empirical strategy. Section 4 describes the principal results, while Section 5 provides some additional robustness checks and extensions. Finally, Section 6 concludes.

Section snippets

Related literature

Our work is related to several areas of research. First, there exist a large number of studies that rely on sectoral trade flow data to assess the competitive threat from Chinese exports to Latin American producers (Freund and Ozden, 2006, Hanson and Robertson, 2007, Lederman et al., 2008, Soloaga et al., 2007, Devlin et al., 2006, Lall et al., 2005). Other studies have evaluated the impact of Chinese exports on wages and employment for various parts of Latin America, see Levinsohn (1999) and

Data and empirical strategy

The main source of data is the Monthly Industrial Survey (EIM) data on Mexican plants provided by the Mexican Institute of Statistics (INEGI). This dataset covers about 85% of all Mexican industrial output.10

Product level

We start by considering a simple transition matrix. Table 2 focuses on plants in 1994 and tracks their development over time. Block 1 refers to firms facing below median competition from China and block 2 to those facing median and above competition, where competition is measured by the change in China's share of Mexican imports between 1994 and 2004. The blocks report the probabilities of firms starting with n products in 1994 (along the rows) finishing with m products in 2004 (the

Robustness and additional findings

To demonstrate the robustness and plausibility of our results, we perform various robustness tests. A first concern is that some plants and products did not face any competition from China during the period analyzed, which could generate noise in the results. To address this concern we rerun the results at plant level separately for the 20% of plants most affected by competition and the 20% least affected, measured by mean competition. When we rerun estimations similar to the second columns of

Conclusions

The substantial rise of Chinese exports in recent decades provides us with a quasi-natural experiment to evaluate the impact of a surge in competition on the extensive and intensive margins of firms at both the plant and the product levels. In this study we analyze the impact of such competitive pressures on Mexican manufacturing firms on both the domestic market and the export (US) market at sectoral, plant and product level.

We find that the surge of exports from China challenged Mexican

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    The authors are grateful to Gerardo Leyva and Abigail Duran for granting us access to INEGI data at the offices of INEGI in Aguascalientes under the commitment of complying with the confidentiality requirements set by the Mexican Laws. Special thanks go to all INEGI employees who provided assistance and answered our questions, in particular to Gabriel Romero, Alejandro Cano, Araceli Martinez, Armando Arellanes, Ramon Sanchez, Otoniel Soto, Candido Aguilar, and Adriana Ramirez. We also thank Christian Hansen for his help with the implementation of the quantile IV regressions and Philippe Aghion, Tibor Besedes, Chad Bown, Ana Cusolito, Judith Dean, Aaditya Mattoo, Guy Michaels, Emanuel Ornelas, Stephen Redding, Daniel Sturm as well as the participants at the seminars of ETSG, USITC, Penn State, Boston University, University of Vienna, London School of Economics, St Andrews University, FREIT, the World Bank trade seminar, the Econometric Society World Congress and the University of Kent for helpful comments. The views contained in this paper are of the authors and not necessarily those of the World Bank. The financial support of the World Bank's Research Support Budget is gratefully acknowledged.

    1

    Prof Winters is also associated with CEPR, IZA and GDN.

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