Economists have identified - and resolved - a seeming paradox regarding how competition from China affects the price and volume of products that are exported from other countries into the United States. The findings shed new light on the complex dynamics of international trade and how the effects of trade competition vary drastically for poor nations compared to their wealthy counterparts.
"The price of products facing heightened market competition from China decrease more than products that are not facing as much competition from China - that's not surprising," says Hamid Firooz, co-lead author of a paper on the work and an assistant professor of economics in North Carolina State University's Poole College of Management. "But our study identifies two interesting effects regarding the export of those high-competition products from other countries.
"First, the price of those exports goes down. Second, the quantity of those products being exported into the U.S. actually goes up. And both of those effects - lower prices and increased exports - are more pronounced for poorer nations than for wealthy ones.
"This creates a mystery," Firooz says. "If prices in the U.S. market are going down because China is competing in the marketplace, and those prices are going down more for exports from poorer countries, the conventional wisdom would be that the products being made in poorer countries are similar to the products being made in China - whereas richer countries are making products that are distinct from the Chinese products. But if poorer countries are in more direct competition with China compared to wealthy countries, why would exports from poor countries increase more relative to rich ones? It seems like a paradox, and we wanted to find out what was going on."
To explore the issue, the researchers drew on international trade data from 1992 through 2005, detailing the unit price and quantity of exports into the U.S. from 197 countries across thousands of different product categories.
The researchers then used an empirical model to precisely document what they were seeing in terms of export prices and quantities, and developed a theoretical model in an attempt to understand what was driving that behavior.
"The theoretical model showed that 'quality upgrading' was the primary driver for this phenomenon involving exports prices and quantities," says Firooz. "The main reason wealthy countries reduced prices and increased exports less than poor countries was because manufacturers in rich countries were better able to increase the quality of their goods compared to manufacturers in poor countries. In other words, businesses in rich countries responded to increased competition from China by increasing the quality of their products.
"By the same token, manufacturers in poorer countries were less likely to have the resources necessary to upgrade product quality," says Firooz. "That means they were more likely to respond to increased competition by cutting prices. And decreased prices led to greater consumer demand, which explains the increased quantity of exports from poorer countries."
The researchers then tested the quality upgrading mechanism identified by the theoretical model to see if it matched what they saw in the export data.
"We found that the results of the theoretical model fit the data," says Firooz. "It explains what was going on.
"These findings are interesting, because we both identified and solved an international economic mystery. But the findings also highlight the role that quality upgrading can play in international markets. This underscores the importance of access to capital and equipment and raises questions about everything from labor productivity to wage inequality. These are promising areas for future research."
The paper, "Cross-Country Heterogeneous Response to Competition: Theory and Evidence from Trade Data," is published in the Review of Economics and Statistics. Co-lead author of the paper is Hamed Atrianfar at JPMorganChase.
