Governments around the world are increasingly resorting to industrial policy and subsidies to steer their economies. In 2023 alone, there have been 2,500 new industrial policies– of which 71 percent are trade distortive. Subsidies are by far the most popular instrument of industrial policy worldwide. Recent examples include the Inflation Reduction Act (IRA) and the Chips and Science Act in the US, the European Green Deal, and the Digital Europe program in the EU, and the so-called Made in China 2025 program in China. Amidst this flurry of new policies, the debate within policy and academic circles about the drawbacks and merits of industrial policy remains lively and with mixed takeaways. Regardless of the effectiveness of these interventions, in a companion paper we find evidence suggesting that subsidies can have important spillovers through their effects on trade flows.
China’s subsidies have multiple goals as identified by the authorities from promoting the green transition to increasing resilience and self-reliance. However, because of the peculiarities of the Chinese economic system and China’s rising role in the world economy, China’s subsidies have been the target of several complaints and retaliatory measures by its trading partners. Specifically, against a backdrop of lackluster domestic demand in recent years, China’s subsidies to its manufacturing sector are under close scrutiny because of their potential repercussions on the global markets of subsidized products. To analyze this issue, we empirically investigate the effects of China’s subsidies on its trade flows over the period 2009-2022. By assessing the importance of China’s subsidies in shaping its exports and imports, we intend to shed light on the implications that China’s industrial policy can have for its trading partners.
Our empirical approach builds upon and extends the design used in Rotunno and Ruta (2024). It exploits detailed data on subsidies and other policy instruments from the Global Trade Alert (GTA) database. For our sample period going from 2009 to 2022, these data provide information on the existence of subsidies at the product level implemented by China and other countries. The database, which tracks policy changes based on online sources (official government documents and firms’ financial reports), includes in its definition of subsidies to firms both monetary and in-kind transfers (e.g., state aid and preferential access to land and other factors of production), and policies that entail a transfer of risk to the government (e.g., loans and loan guarantees), and losses in government revenues (tax breaks). Importantly though, the database lacks information about the monetary value of subsidies, as well as ‘legacy’ subsidies introduced before 2009. These two limitations of the data are expected to attenuate our estimates of the impact of subsidies on trade flows. Intuitively, they imply categorizing as non-subsidized some products that actually received subsidies before 2009 and treating all subsidized products in the same way regardless of the size of the subsidy.
A first look at the data suggests that China is the largest user of subsidies measured by the number of policy interventions. By 2022 there were approximately 5,400 subsidy policies introduced since 2009 and in force in China, representing 95 percent of all GTA policies introduced by the country. These subsidies are concentrated in a few industries. Over the period, 20 percent of the sectors received over 50 percent of the subsidies. Importantly, the products and sectors that are targeted vary over time. In the earlier period of our sample, subsidies targeted more traditional industries such as mining of metal, paper and textile, while products such as solar panels, batteries and electric vehicles have been more frequent targets of new subsidies towards the end of the sample (possibly in relation to the Made in China 2025 industrial program), pointing to a shift in strategic sectors in China.
Our empirical analysis aims at assessing the trade effects of China’s subsidies. We use variation over time across subsidized and non-subsidized products and industries, and allow the effect of subsidies to differ between China and other countries in the sample. In our empirical specification, we add fixed effects controlling for the influence of time-invariant, product and country-specific factors, and dummies for the adoption of other GTA policies (e.g., import and export restrictions, local content requirements, government procurement policies). Because of possible endogenous selection into subsidies, other concomitant policy-driven and structural shifts, and retaliatory policies following China’s subsidies (which should bias downwards any export effect specific to China), we interpret the estimates as descriptive of the evolution in exports and imports of subsidized products relative to other products after the subsidy.
Our results point to significant effects of China’s subsidies on its trade flows. On the export side, exports of subsidized products are 0.9% higher (relative to non-subsidized products) after China’s subsidies– an effect that is not statistically different from that found for other countries. The magnitudes of these direct percent effects are economically meaningful. The export effect on total exports is equivalent to one sixth of the average yearly percent increase in product-level exports. This average effect masks significant heterogeneity across destination markets and sectors. Our estimates suggest that exports of subsidized products from China to other G20 emerging economies (G20 EMs) are 2.1% higher after the subsidy than exports of other products to the same destinations. Furthermore, the export effects of China’s subsidies vary considerably across sectors. Within electrical machinery– one of the new ‘strategic’ sectors– for instance, exports of subsidized products are found to be 7% higher than exports of other products after China’s subsidies.
On the import side, China’s subsidies are found to depress imports of targeted products relative to imports of non-subsidized products– an effect that is not found for other countries. Across origin countries, the implied effect on imports of subsidized products is stronger for Advanced Economies (AEs)– a 3% and 4.8% decrease in imports of subsidized products from G20 AEs and other AEs, respectively. Electrical machinery and metals are among the sectors where China’s subsidies have strong import-substitution effects. Our estimates therefore suggest that China’s subsidies have increased the country’s share in export markets and reduced its share in import markets of subsidized products.
The effects of China’s subsidies are amplified by supply-chain linkages—i.e. the ‘indirect’ effects of subsidies. We use China’s input-output table in 2007 to measure the exposure of downstream sectors to subsidies in upstream industries (through cost shares) and the exposure of upstream sectors to subsidies in downstream industries (through sales shares). As the input output table provides linkages by industry in China, we aggregate the subsidy and trade data at the industry level. The results reveal strong effects of subsidies propagating from upstream industries. More subsidies given to supplying industries are associated with higher exports in the buying industry. To appreciate the implied magnitudes of our estimates, consider the case of subsidies provided to the steel industry, which is the main supplier of inputs to the automotive industry (10 % of its total costs). The empirical results imply that increasing subsidies to steel by the number observed over 2015-2022 is associated with a 3.5% increase in exports of autos from China. These indirect effects are concentrated on exports to G20 AEs.
The findings on the indirect effects of subsidies are consistent with upstream industries expanding supply and lowering their prices following the deployment of subsidies. This upstream effect allows industries downstream to become more competitive in export markets. Results from import regressions point to a negative effect of upstream subsidies on imports in downstream sectors. This result suggests that upstream subsidies allow downstream industries to also expand domestically and substitute for imports. Finally, the effects of subsidies given to downstream industries on trade in upstream sectors are statistically significant and with the expected sign (negative on exports of the supplying industry), but weaker than the effects of subsidies upstream — a result that accords well with findings on the US and South Korea Lane.
As a third step in the analysis, we distinguish between the export price and quantity effects to contribute to the current debate on “overcapacity”. The heart of this debate is that, in a situation of slow growth in domestic demand, Chinese subsidies could create a mismatch between domestic demand and supply for certain products, leading to increased supply in world markets which manifests itself in higher export quantities and lower prices. Conceptually, the impact of a subsidy on export quantities and prices is more complex and can be interpreted in different ways. A positive effect on export quantities and a negative effect on export prices are consistent with a subsidy creating excess supply domestically and higher quantities and lower prices in export markets. However, larger export quantities and lower prices can also be the result of subsidized firms realizing efficiency gains and lowering export prices, leading to expansion in foreign markets. Moreover, other combinations of the price and quantity effects are suggestive of different dynamics. For instance, positive export price and quantity effects indicate that subsidies are contributing towards quality upgrading rather than excess supply, while negative export price and quantity effects could be rationalized by trading partners imposing countervailing duties or other trade remedies to offset the trade impact of the subsidies.
We contribute to this debate by assessing the direction in which China’s subsidies over the period of analysis have impacted export prices and quantities of targeted products, controlling for the influence of other factors such as macroeconomic policies and demand and supply shifts for specific products. We find evidence that China’s direct subsidies increased export quantities and lowered prices in certain heavy and construction-related industries such as metal products and furniture. For the electrical machinery industry, which includes products at the centre of recent trade controversies such as lithium(-ion) batteries and solar panels, we find evidence suggesting that direct subsidies contributed to quality upgrading (increases in export prices and quantities). We do not find evidence that subsidies reduced significantly export prices for this sector also when we account for the indirect effect of upstream subsidies on downstream exports, at least up to 2022. For autos, we find some evidence that the combination of direct and upstream subsidies has increased export quantities and reduced export prices in world markets. Finally, the point estimates for other industries are consistent with situations where subsidies lead to greater market concentration or inefficiencies (higher prices and lower quantities), or lower prices and quantities– the latter could be explained by the retaliatory policy responses of major trading partners.
This paper relates to the literature on the trade implications of industrial policy and, specifically, on the cross-border spillovers from China’s policies. There is a long-standing debate in economics on the potentially distortive effects of industrial policies on trade. The more recent literature has exploited historical data to identify the effects of industrial policy on trade and economic growth. Recent sectoral studies have found evidence that China’s policies led to significant reallocation of global market shares in the shipbuilding industry and in the lithium-ion battery Barwick and others (2024) industry. Other studies highlight the potential spillovers of China’s policies enacted under the country’s five-year plans. Cen, Fos, and Jiang (2024) find that China’s production and employment expanded in industries targeted by these plans (relative to other industries), while the opposite happened in the same US industries– these negative ‘direct’ effects on US industries were partly offset by positive effects through supply chain linkages. These effects of the China’s expansion in the world economy linked to industrial policy are reminiscent of the literature on the “China shock” in the 2000s. In counterfactual simulations, Ju and others (2024) find that China’s industrial policies raised welfare in both China and the US by targeting industries with relatively large external economies of scale. Our results that China’s subsidies increase the exports of targeted products and industries are also consistent with firm-level evidence from Girma and others (2009) and Girma, Görg, and Stepanok (2020).
We contribute to this literature in several ways. First, by exploiting comparable data across countries, we are able to put China’s experience with subsidies in a cross-country perspective. Second, by elucidating conceptually and empirically the mechanisms that can and cannot lead to effects of subsidies consistent with excess supply, we offer a first contribution to discuss these issues through the lenses of analysis and data. Needless to say, more data and especially sectoral studies would be needed to fully unpack these difficult questions.
The rest of the paper is organized as follows. Section II describes the data used in the analysis and presents some trends in China’s use of subsidies. In section III, we explain the empirical strategy and discuss the associated results on the direct and indirect trade effects of China’s subsidies. Section IV presents the results on the impact of subsidies on export prices and quantities, and section V concludes by summarizing the main findings and outlining some important avenues for future research on the role of China’s subsidies.
wpiea2024180-print-pdfTo read the summary as it was published on the International Monetary Fund webpage, click here.
To read the full working paper, click here.