VAT rebates for exporters a waste of money - the view from the 21st Century Business Herald
The collapse in demand in the US, EU and other trade partners from the end of 2008 on threatened to lay waste China’s export sector. With exporters a major driver of employment and growth the government stepped in with various supportive measures. The CNY ceased its upward movement against the dollar, the banks stepped forward with financing to meet companies’ cash flow needs, and the Ministry of Finance reintroduced and then increased VAT rebates on exported goods.
Extra cash in difficult times has doubtless helped some of China’s exporters keep their heads above water. But there are reasons to believe that neither a stable exchange rate nor VAT rebates have been much help. The reason is that the problem for China’s exporters is not competitiveness (cheaper goods of a similar quality from Vietnam and elsewhere eating into their market share) but rather weak demand (consumers in the US and EU spending less money).
An article in the 21st Century Business Herald takes this analysis one step further and argues that the cost to the Chinese government of export VAT rebates might outweigh the benefits. The author’s main argument is that the benefits of subsidising China’s exports depend on the elasticity of demand - that is - how much demand changes when prices change. This is my translation of some of the main points.
‘The elasticity of demand for China’s exports is about 0.65. That is to say that every time prices fall 1%, the quantity purchased will increase 0.65%.
So far this year the government has spent CNY800bn on export VAT rebates. Given the elasticity of demand for China’s exports, that means they have used CNY800bn in government spending to buy a CNY520bn increase in exports (CNY800bn*0.65 = CNY520bn).
What is more, 50% of China’s exports are produced by foreign firms - that means half of the benefits of the CNY520bn is going to foreigners.
Of course, increasing exports is also good for the rest of the economy - creating employment and demand for raw materials. Increasing exports has a multiplier effect on GDP which is estimated at 1.2. So for every 1 unit increase in exports the contribution to GDP is actually 1.2. Taking this into account, the impact of export VAT rebates on GDP is actually CNY624bn (CNY520bn * 1.2 = CNY624bn).
Spending CNY800bn for a mere CNY624bn increase in GDP is clearly not a good use of the government’s money. If the government had spent the CNY800bn directly in the domestic economy, the multiplier effect would have meant a CNY960bn addition to GDP - much more than you get by subsidizing exporters.
Some people might argue that subsidizing exporters is especially beneficial because of its impact on employment - protecting large numbers of jobs in the export industry. In fact, this depends on the price elasticity of demand for goods in labour intensive export sectors. In fact, demand for labour intensive export goods does not change much when the price changes, so even from the perspective of protecting jobs, export VAT rebates are not a good idea…’
It’s actually a rather long article which makes a number of other points - you can see it here.
A couple of points I take away from this. First, defining the national interest in trade is not easy. Not only are there different interests between consumers (who tend to benefit more from free trade) and producers (who sometimes benefit in the short term from protectionism), but also between foreign and domestic firms. China’s export subsidies might hurt firms in the US that have their market share eroded by cheaper Chinese goods, but they help US firms based in China who benefit from the subsidy.
Second, the author argues in favour of directing stimulus efforts into the domestic economy rather than toward the export industry. This would be consistent with rebalancing the economy toward domestic demand as a driver of growth and away from excessive reliance on foreign demand. Unfortunately, as the budget-busting spending on export VAT rebates so far this year demonstrates, it is a message the government is not yet ready to hear.
Finally, it’s interesting how the language of nationalism creeps into what is actually a rather technical economic paper. The author - who is from the Chinese Academy of Social Science - is not afraid to point to benefits to foreign firms in China of government subsidies as a negative aspect of policies. Clearly China has benefited enormously from wealth creation by foreign firms, but there is also a popular strain of discontent with their role in the Chinese economy, ranging from a scandal about Japanese businessmen participating in an orgy with Chinese prostitutes, I think in Shenzhen, to the widespread belief that its is foreign factories that are the main source of pollution on the mainland.