Foreign Investment and Vertical Specialisation: An Analysis of Emerging Trends in Chinese Exports

This paper contributes to the literature on the role of foreign direct investment and vertical specialisation in China’s growth trajectory. Globalisation of the world economy, together with well-developed physical infrastructure, and falling costs of transport and communications, has led to a significant increase in foreign investment into China to take advantage of its comparative advantage in labour intensive activities. Initially foreign investment came to simple assembly line (such as textile, clothing, electronic goods), but gradually China attracted FDI to sophisticated manufacturing industries (such as, ICT products, office and medical equipments etc), giving rise to vertical specialisation in its exports. Over one quarter of Chinese exports appears to be due to the expansion of back-and?forth transactions in vertically fragmented cross-border production process. Our analysis suggests that foreign input content in Chinese exports is high and rising. When the share of ‘foreign value-added’ in Chinese exports is taken into account the ‘actual trade balance’ is much lower than what ‘raw trade balance’ would indicate. As expected, share of foreign input content (vertical specialization) is high in Chinese exports of high-tech industries (such as, communications equipment, computers and other electronic equipment manufacturing etc) and low in labor-intensive industries such as (food and tobacco, textile, leather products, footwear etc). China’s increased involvement in global production network as an assembly centre has created an opportunity for other countries and countries in the region to benefit from its rapid integration with the world economy as its imports of parts and components have grown dramatically and most of these imports come from advanced economies such as US, Europe and newly industrialised economy. Clearly, China’s success story has led to win-win situation, improving welfare globally. As China is committed to continue to integrate with the world economy, its involvement in processing trade will continue. However, China will require to upgrade skills of its workforce through appropriate human capital development policy, otherwise higher wages (for semi-skilled workers) can wipe out its comparative advantage in low-end assembly trade brought about by globalisation. Policy makers in China should also need to think carefully how to embark on industrial upgrading to sustain growth.