Market Impediments, Trade, and Foreign Direct Investment: Evidence from China's Round-Tripping

Abstract

This study uses reported exports and imports figures of China-Hong Kong and China-Thailand trade to examine the relations among trade, foreign direct investment flows, and tax-induced market impediments. The empirical results, largely consistent with theoretical models, support several conclusions. First, the spurious transfer of funds to and out of China, via under-reporting exports and over-reporting imports, closely follows the preferential tax incentives such as tax breaks to foreign investors. Second, exports under-reporting is negatively related to rebates for export. Third, imports over-reporting is negatively related to import tariffs. Finally, under-reporting of exports and over-reporting of imports appear to be most common in state-owned firms.

Keywords: Trade flows, foreign direct investment, round-tripping, regulatory arbitrage

JEL Classification: F18, F23, F34