Conclusion

This paper has unveiled an interesting pattern in the People's Republic of China's (PRC) processing trade. In a cross-section of PRC provinces, the average distance traveled by processing imports (import distance) is negatively correlated with the average distance traveled by processing exports (export distance). To explain this pattern, we have built on the recent literature on export-platform foreign direct investment to set up a three-economy industry-equilibrium model in which heterogeneous firms from two advanced economies, East and West, sell their products in each other's markets. Each firm can use two modes to serve the foreign market. It can directly export its products from its home economy. Alternatively, it can indirectly export to the foreign market by assembling its product in a third low-cost economy, PRC. By assuming that PRC is located in the geographical proximity of East, our model provides an explanation for the negative correlation between export and import distance for the PRC's processing trade: the inputs that PRC imports from the nearby East are processed into final goods and exported to the far-away West. Conversely, the inputs that PRC imports from the far-away West are processed into final goods and exported to the nearby East. Our model has also established two theoretical predictions relating the PRC's geographical location to its processing trade patterns. First, the PRC's processing exports are negatively affected by both an increase in import distance and a rise in export distance. Second, the PRC's processing exports to East Asian economies are more sensitive to export distance and less sensitive to import distance than its processing exports to non-Asian economies.

Using data on the PRC's processing trade, our empirical analysis has found support for the theoretical predictions of the model. Specifically, we found some evidence that the PRC's processing exports are negatively affected by import and export distance. Furthermore, we found a strong confirmation that processing exports to East Asian economies are more sensitive to export distance and less sensitive to import distance than processing exports to non-Asian Organisation for Economic Co-operation and Development (OECD) countries. The empirical evidence is consistent with the claim that the PRC's attractiveness as a laborintensive offshoring location is driven by, among other factors, its geographic location. Production networks centered in East Asia consider the PRC's proximity to input suppliers in the East Asian region to be a driving factor of their offshoring decisions. Conversely, production networks centered in the West deem the PRC's vicinity to East Asian markets as a main determinant of their offshoring decisions. This paper provides new insights into the PRC's role in world trade, which is of major concern to policymakers.

One limitation of our theoretical analysis is our assumption that downstream production stages are more footloose than upstream production stages. That is, we follow the literature on export-platform foreign direct investment by assuming that advanced country firms decide where to locate final assembly activities while taking the location of intermediate good production as a given. This assumption may not hold in all industries. In some cases, it may be that upstream activities are more footloose than downstream production stages. Contrary to our model, advanced-economy firms then may decide to move their upstream production stages to East Asia in order to be located in the vicinity of downstream production stages in the PRC. As our empirical analysis may also support this scenario, further empirical research is therefore required to analyze the relative footlooseness of the PRC's processing activities.

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