Asymmetric Trade Reform and External Adjustment: Theory and Evidence from China

Abstract

This working paper is written by Qing Liu (Tsinghua University), Kang Shi (The Chinese University of Hong Kong), Junjie Tang (The Chinese University of Hong Kong) and Juanyi Xu (The Hong Kong University of Science and Technology).

This paper quantifies the effects of China’s trade reform on its current account dynamics following WTO accession in 2001. We first present cross country evidence to show that the adjustment of China’s current account adjustment to WTO accession differs from the experience of other countries, exhibiting a distinct humpshaped pattern. We then document some institutional facts and firm-level evidence and argue that asymmetric trade reform between the exporting and importing sectors in China may help to explain this hump-shaped pattern. Motivated by these facts, we develop a two-country dynamic Melitz model and apply it to the Chinese economy. We estimate that trade reform accounts for 47.6 percent of the accumulated trade surplus in 2001-2010 and contributes to the hump-shaped dynamics of China’s trade balance and real exchange rate. Finally, we apply this model to estimate the welfare losses arising from the U.S.-China trade war since 2018.

Keywords: current account, global imbalance, trade reform, exchange rate

JEL Classification: F15, F31, F32, F41