Made in China; Created in China: Super Processors and Two-way Heterogeneity

The existing literature on China has traditionally identified processing exporters as inferior in terms of productivity and engagement in R&D. In this paper, we show that processing exporters are often as good as other exporters, and that there exists a special breed of firms that are active in both ordinary and processing exports. These mixed firms are superior to other firms in multiple dimensions, and are instrumental in driving China’s export boom in 2000-2006. Importantly, being mixed is not due to selling multiple products or exporting to multiple destinations; using a unique transaction-level data on Chinese exports with brand information, we find that processing and ordinary transactions differ in terms of brand-ownership, suggesting that processing firms are specialized in supplying tasks to other firms with established brands. To explain these stylized facts, we build on Antras et al. (2017) and Bernard et al. (2017) to develop a model of firms that are heterogeneous in their branding and manufacturing ability. In this model, firms optimize their production and sourcing behavior, and this generates the ranking among different types of firms that we observe in the data. The model produces an endogenous mass of suppliers, the increase of which reduces the marginal cost of production for all brands. The model provides a natural explanation for China’s processing-export promoting policy, which we evaluate by focusing on China’s expansion of export processing zones in 2000-2006. We find that promoting processing trade leads to creative destruction not only for processing firms but also for ordinary firms, ultimately increasing aggregate productivity.