FDI Liberalization as a Source of Comparative Advantage in China

Three features of China’s trade patterns suggest that elements beyond factor abundance explain its export performance. The high penetration in world markets of labourintensive products has been accompanied by: (i) a high share in exports of productivityadvanced foreign-owned enterprises (FIEs), (ii) a high penetration of FIEs in labourintensive sectors, and (iii) a relative high sophistication of China’s exports. We show that FDI liberalization endogenously introduces Ricardian features to an otherwise standard endowment-based trade model, strengthening China’s natural comparative advantage in labour-intensive products. We discuss how capital accumulation, productivity growth, rural-urban migration, incentives for foreign investment and distortions in financial markets affect this bias. We conclude that policies enhancing domestic firms’ production, through productivity growth or capital market distortions, implicitly support the capital-intensive sector. In contrast, policies that encourage FDI, like greater access to China’s capital and labour market would shift China’s comparative advantage even further towards labour-intensive products.