Three essays on international trade and industrial policies

2020-05-15T08:46:59Z (GMT) by Xuan LUO

This dissertation consists of three chapters related to international trade and industrial policies.


The first chapter establishes that international trade and the market size affect institutional quality positively. Institutions, such as contract enforcements and rule of law, are arguably one of the most important determinants of economic development. I adopt an incomplete-contract approach to model institutions. Due to contract incompleteness, a firm can hold up its suppliers and distort production. When the effective market size facing firms is larger, due to trade liberalization, or increases in population or numbers of trading partners, benevolent governments have incentive to improve institutional quality to facilitate production to meet the larger demand. Interestingly, in my multiple-country framework, the competition in institutional quality also matters in a Nash-equilibrium sense. Institutional quality increases in trade-liberalized countries whereas those in the non-liberalized ones may decrease. This chapter also empirically shows the positive impact of real effective market size on institutional quality, supporting the model.


The second chapter finds that foreign direct investment (FDI) affects China’s industrial agglomeration negatively by utilizing the differential effects of FDI deregulation in 2002 in China on different industries. This result is somewhat counter-intuitive, as the conventional wisdom tends to think that FDI attracts domestic firms to cluster around them for various agglomeration benefits, technological spillovers in particular. To reconcile our empirical findings and the conventional wisdom, we develop a theory of FDI and agglomeration based on two counter-veiling force. Technology diffusion from FDI attracts domestic firms to be around them, but fiercer competition drives firms away. Our theory indicates that which force dominates depends on the scale of the economy. When the scale of the economy is sufficiently large, FDI discourages agglomeration. We find various evidence on this competition mechanism.


The third chapter studies the Chinese industrial subsidy policy from 1998 to 2007. Our industry equilibrium model establishes that the optimal policy should be positively correlated with various input distortions confronting firms. Based on this prediction, we evaluate the effectiveness of subsidy policy in China and document four stylized facts: (1) The efficiency of subsidy policy in China has grown by around 50% over the ten years, with a notable increase at the ascendance of Hu Jingtao into presidency; (2) Subsidy policy tends to have differential efficiency effect on the sector level, with more downstream sectors experiencing higher efficiency; (3) Provinces in the ‘Western Development Program’ received more subsidies compared to their eastern counterparts; (4) Labour and materials distortions have been properly corrected in the western regions, and materials distortion can explain most of the variation of subsidies in China. Finally we quantify the effect of the policy on welfare.


The dissertation comprises 3 papers, the following are available as working papers:


1. Market Size, International Trade, and Institutional Quality. 2019. Working paper.


2. Does foreign direct investment lead to industrial agglomeration? 2019. Working paper.