The Impact of The Open-Door Policy on Productivity A Study of China Manufacture Industry Transform from Traditional to Modern

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International trade, as a major factor of the openness of an economic system, makes a significant contribution to a country’s economic growth. Chinese international trade has experienced rapid expansion and helped fuel the country’s dramatic economic growth which has enabled its targeting of a world market. Chinese international trade not only promotes economic growth, but it also contributes to the shifting of industrial manufacturing from traditional to modern. This research evaluates the extent of the relationship between Chinese economic openness with its industrial manufacturing changing from traditional to modern. The research starts with a review of concepts as well as a timeline tracing the evolution of the China’s trading policy. Afterwards, China’s trade performance is analyzed. A quantitative method is applied to analyze 15-years of data from year 2000 to year 2015. The study demonstrates that the indicators of the economy’s openness, FDI and the exports value, do not have direct effects on the manufacturing GDP. As a result, the degree of Chinese openness exerts only a partial impact on the switch in manufacturing types from traditional to modern. Limitations and future study implications are drawn from the empirical results. 

Chapter 1: Introduction

Considering the weight of the net exports within a country’s aggregate demand equation, both the value of imports and the value of exports are often used as a country’s economic performance indicators. A country’s ability to compete globally is facilitated by an economic policy that prioritizes trade while also maximizing domestic production. Countries all over the globe have sought to incorporate increased trade through exports that contribute to its total gross domestic product (GDP). Different industries will be able to capitalize on export value according to the specifics of their industry. As a result, international trade may have a differential impact dependent on the industry type.

Research conducted by Krugman (1979) and Markusen (1981) showed how trade could induce the pro-competitive effects within different market structure models. Their research indicated that competition effects amongst markets with different economic structures could be mediated by trade (Krugman, 1979; Markusen, 1981). At the same time, Marc and Gianmarco (2006)’s monopolistic competitive model concludes that the aggregate productivity would respond to the extent of a market’s integration through trade. The monopolistic competitive model would be significantly influenced by trade and thus impact a market’s level of integration (Marc and Gianmarco, 2006). There are numerous empirical studies on the relationship between economic reforms like trade liberalization and aggregate productivity (Amiti and Konings, 2007; Balakrishnan, Pushpangadan, and Babu, 2000; Bernard, Redding, and Schott, 2011; Edwards, 1993; Krishna and Devashish, 1998; Parick, 2006; Pavcnik, 2002; Topalova and Khandelwal, 2010; and Trefler, 1993). For example, in their case study of India’s economy, Krishna and Devashish (1998) found a positive relationship between trade liberalization and firm transformation. 

As such, this paper considers the manufacturing industries of Shenzhen to be representative of China as a whole. Shenzhen is one of the largest cities of China and has been selected as the primary source of information for the present research. Looking at historical background, China established its open-door policy through a gradual process that involved sequential steps aimed at moving away from its more traditional domesticated economic system toward a modern, internationally open market (Trading Economics). Those steps included negation, recognition, participation, integration, contribution, and development (Trading Economics). Through the past two decades, China has increased its global trade with the sale of hundreds of goods and services worldwide (Trading Economics). As a result, China has experienced a boom in its manufacturing industry with GDP growing an average of 55992.85 CNY HML since 1992 (Trading Economics). It is proposed that the growth of the manufacturing industry has directly resulted from the evolution of China’s open-door trade policy.

The majority of this study will be focused on ascertaining the answer of the following research question: How has the evolution in China’s open-door policy influenced the Chinese manufacturing industry? The present research reviews the extant literature to examine the effect of the open-door policy on quantitative measures of FDI and export value. In order to answer the research question, first, the parameters of the industry-level production functions will be recorded, including research and development expenditure, human capital, etc. Then, the ordinary least-square regression method will be utilized to examine the relationship between the changes in trade policy and the subsequent changes in firm transformation according to a suitable time scale. The research will seek to examine heterogeneities in the impact of the reform across different types of manufacturing firms. 

The following sections of the paper will be aimed at providing additional information and data to address the research question and proposed hypothesis. Chapter 2 reviews the literature investigating the evolution of China’s open-door trade policy. Chapter 3 proposes a quantitative empirical methodology along with providing the data used in the present research, while also indicating the similarities to and research gaps in the previous research on this topic. Chapter 4 provides a thorough analysis of the test results. Chapter 5 includes a discussion of the research limitations. Finally, Chapter 6 concludes with a summary of the research and a restatement of the most pressing findings. 

Chapter 2: Literature Review

The present research seeks to track the progression of China’s open door trade policy. The investigator proposes that opening China’s markets to international trade helped to establish an economic boom that continues with high growth in GDP and net exports. The present research is based on a time series, so this chapter will begin by examining the state of constant change in China’s manufacturing industry over the last 20 years. The review of the literature will discuss several relevant perspectives and theories based on China’s trade liberalization history.  

2.1 The Definition of Traditional Manufacturing

According to Lan Zou (1998), traditional manufacturing is defined as an economic system that centralizes the manufacturing industries whose structures and business operations are based on labor-intensive production of consumer goods as their principal products. Traditional manufacturing also makes its products available to a largely domestic market to the almost complete or partial exclusion of external markets, namely international trade (Lan Zou, 1998).

2.2 Chinese Traditional Manufacturing before 1990

Lan Zou (1998) emphasized that after the appearance of China’s 1978 open-door policy, the economy experienced an almost immediate shift that reflected the phenomena of international trade. There was a huge demand on the Chinese market for its manufactured goods, which was caused by a lack of affordable market supply throughout the rest of the global market (Lan Zou, 1998). As a result of this growth, a number of the original Chinese manufacturing firms had to increase their production efficiency in order to expand their supply to meet growing demand (Lan Zou, 1998). This expansion was attributed to the dramatic reform of Chinese economic policy, which also resulted in township enterprises that dominated local industries (Lan Zou, 1998). At the same time, two kinds of investment enterprises entered into the industrial markets referred to as heavy and light (Lan Zou, 1998). Heavy industrial prioritized manufacturing, while light industrial attempted to develop a mix of industries that did not rely exclusively on manufacturing (Lan Zou, 1998). According to Lan Zou (1998), the Chinese heavy industrial enterprise grew out of an extremely weak base; however, from 1959, heavy industrial has increased outputs beyond those of the light industrial enterprise. The initial changes from light to heavy industrial occurred between 1982 and 1986, right after China began establishing its open-door policies. By 1986, the output of heavy industrial enterprises had overcome the light industrial enterprises in a trend that continues today. Table 1 shows the comparison of outputs between light industrial enterprise industry and heavy industrial enterprise from 1949 to 1986 (China Statistical Yearbook, 1987).

(Table omitted for preview. Available via download).

According to Lan Zou (1998), Chinese political turmoil has caused a decrease in the heavy industrial enterprises since 1990, which have directly impacted the manufacturing industry. In 1967, the light industrial enterprise began to increase its expansion with more of its total value outputs moving to eclipse heavy industrial enterprises once again. Lan Zou (1998) concluded that the planned economic shift from traditional to modern caused a slowing in the development of the traditional manufacturing industry after 1949, but it did not completely obliterate it. This is attributed to China’s open door trade policy, which lowered the threshold value for market entries, especially for those with ownership pattern firms (Lan Zou, 1998). At the same time, the policy helped to generate several developing opportunities for manufacturers of consumer goods (Lan Zou, 1998).

2.3 China’s Reasons for Transferring from Traditional to Modern Manufacturing

Based on the database of the “China Statistical Yearbook 1980-1996” the output of the food industry and the furniture industry had increased tenfold in comparison to the current year’s price; however, their comparable relative ratio of changes still remained negative (Lan, 1998). This indicated that despite growth in these industries, the relative changes were still decreasing when compared to total growth. Prior to this realization, it was expected that all of China’s industries would benefit from the change in economic policy. However, the stagnation and decline of some industries reflected that the establishment of the open-door policy made significant improvements in some areas of China’s consumer goods industries proportional to their speed of development (Lan, 1998). The open door policy impacted manufacturing more than the food or furniture industry because of its rate of development, especially in exports to international markets. Table 2 compares the value outputs of different consumer goods industries from 1980 to 1985. The data illustrate a total growth in all consumer goods industries except food, spinning, printing, furniture, and papermaking (China Statistical Yearbook, 1996). On average, the growth in each industry ranged from -7.64 percent to .85 percent (China Statistical Yearbook 1996).

(Table omitted for preview. Available via download).

Prior to the establishment of the open door policy, Xingmin Yin (1998)’s study found that within the food industry, which could be considered one of the traditional manufacturing industries, the per capita output could not reach the standard price level of 400 yuan. But, after the open-door trade policy, the amount of 400 yuan was even more difficult to achieve and even decreased to a low standard of one yuan per person per day (Yin, 1998). So, while it was expected that the open-door trade policy would benefit all industries, some industries, like food manufacturing, was being dragged by the economic expansionary forces at work (Yin, 1998). As a result, the potential for widespread economic development was lost. Moreover, Lan Zou (1998) predicted that the traditional manufacturing industry would also face serious problems and challenges in its attempt to adapt to the new market parameters. 

2.3.1 The Oversupply of Chinese Traditional Manufacturing

The first problem that the traditional manufacturing industry faced was the oversupply of traditional manufacturing goods leading to an inventory backlog and immense pressure to reduce prices in order to divest of excess inventory supplies. 

Definition of oversupply

According to Jinzhou Chen (2014), one group of scholars defined oversupply as the economic conditions in which the supply of foods is greater than the demand of goods in the market. However, other scholars contend that there are two kinds of oversupply related to the difference between supply and demand (Jinzhou Chen, 2014). The first type of oversupply occurs when the supply is only slightly greater than the demand, which means that the supply satisfies the market demand, but also includes inventory in stock to guard against manageable risks and accidents (Jinzhou Chen, 2014). The scholars suggest that this type of oversupply does not have any negative impact on the market and actually benefits the strategic development of the economy by factoring in potential risks (Jinzhou Chen, 2014). However, another kind of oversupply occurs when the supply significantly exceeds the demand, such that the demand or foreseeable risks will never equal the amount of the supply (Jinzhou Chen, 2014). This kind of oversupply could potentially perform in two aspects; either the total supply will remain in excess of the total market demand for a specific period of time, or the total demand will be insufficient compared with the total supply indefinitely, regardless of time frame (Jinzhou Chen, 2014). 

In attempting to disrupt potential financial crises in an increasingly globalized world, the Chinese open-door trade policy created additional problems for its economy. The speed of global trading and the subsequent development of the economy were projected to facilitate demand and justify supply; however, in reality, it has declined significantly. Therefore, the demand for Chinese domestic market goods was distinctly insufficient to meet the generated supply. The oversupply of Chinese traditional manufacturing has been transferred from the global market to the local market, from the long-term to the short-term and from high-end industries to low-end industries. Despite this realization, according to ChinaIRN (2013), the domestic traditional manufacturing industries are generally oversupplying products, especially for those industries with high-energy consumption and high emissions, such as the steel industry, the cement industry, and the electrolytic aluminum industry. 

To that end, Yue Zhang (2012) stated that the average use ratio of the Chinese traditional manufacturing had only risen to an estimated 60 percent, which is not only lower than 78.9 percent, the level of developed countries, like America, but also lower than the global average level which achieves a level of 71.6 percent. The iron and steel industries are two of the key players contributing to the oversupply of traditional manufacturing (Yue Zhang, 2012). The output of Chinese iron and steel industries reached 680 million tons in 2011, which far exceeded the market demand for Chinese iron and steel that required only about 500 million tons (Yue Zhang, 2012). Compared to the Chinese iron and steel industries, the Chinese auto industry (much like Japan's auto industry) is also impacted by pressure from the oversupply of these interrelated manufacturing industries (Yue Zhang, 2012). The average use ratio of the Chinese auto industry has fallen from the 85 percent in 2010 to 70 percent in 2012, which is lower than the break-even point for the global auto market (Yue Zhang, 2012). 

Furthermore, Mingsi Li (2015) opined that although each area of China has followed the economic strategy that takes full advantage of local characteristics for development, the development of local Chinese manufacturing is still largely homogenous. Mingsi Li (2015) believed that improving the development of the local key industries might be possible through a series of local preferential economic policies rather than an international trade policy, such as through finance and taxation, interest rates, land pricing, and electricity pricing. Li (2015) suggested that local investments would result in the improvement of local industries, but may also lead to an inadvisable amount of overlapping investments and repeated constructions, and thus contribute to even more oversupply and structural imbalance in local Chinese traditional manufacturing. Based on information from State Statistics Bureau, in 2012, the rates of capacity utilization were lower than the global levels for the steel, cement, electrolytic aluminum, plate glass, and shipping industries (ChinaIRN, 2013). This indicates that despite the oversupply impacting the manufacturing industries, there is still significant potential to further increase outputs at such time that demand increases to allow for its justification. 

Exploring oversupply even further, Lan Zou (1998) analyzed 605 types of the major product demands in the market during the first half-year of 1999. This included the types of products that achieved a balance between supply and demand and were calculated at making up 27.6 percent of the total. The types of products that tended to be oversupplied made up 72.2 percent of the total (Lan Zou, 1998). This was explained by harkening back to the open-door policy, which served to increase the total income of Chinese people thus increasing their consumer power and rates of consumption, but causing demand to grow invariably (Lan Zou, 1998). Lan Zou (1998) explained that the development of the clothing industry, beverage industry, and furniture industry lead to the changes in the traditional demand structures of the Chinese market, but did not receive the expected amount of growth in demand, and thus led to an excess supply without a market to dispel the products in. This was the underlying foundation of the shift away from traditional manufacturing to modern manufacturing.

The Harms from the Oversupply of Chinese Traditional Manufacturing

First of all, the oversupply could lead to an excessive amount of waste in social resources and national assets through fraud and market fixing. The market supply provides the flow of cash and assets, so if the supply does not efficiently match the market demand, the capacity will be overstocked, and cash and assets invested will be difficult, if not impossible, to withdraw or produce any profit (Jinzhou Chen, 2014). Currently, local government and economic policy officials of China have attempted to clearly understand the potential risks of some projects and investment before beginning them. However, fraud in the handling of the government’s financial fund together with lobbying and pressing from project developers has allowed the progression of projects and investments determined to be of great risk and minimal benefit (Jinzhou Chen, 2014). As such, when it becomes apparent that an industry or product is experiencing an oversupply, these same officials and project developers pressure businesses to purchase the products at a low price despite the difficulty they will then experience in attempting to sell them in the market (Jinzhou Chen, 2014). Due to these market fixing practices attempting to rectify the problem of oversupply while actually contributing to its worsening, the imbalance between supply and demand causes a major loss in social resources and national assets (Jinzhou Chen, 2014).

Secondly, and related to the first harm, oversupply could increase the risks of finance. The majority of the oversupply comes from fraudulent or corrupt investments from government, which also come in the form of government guarantees and discount government loans (Jinzhou Chen, 2014). These loans are made in full knowledge that the supply does not correspond to the demand, and as a result, the supply and demand ratio remains imbalanced and inefficient (Jinzhou Chen, 2014). This further results in bad debt and dead loans, which are not easy to dispel, and which further undermine financial markets. 

Thirdly, the oversupply of Chinese traditional manufacturing could inhibit the development of the Chinese economy through the proliferation of inappropriate transactions from the Chinese government. Jinzhou Chen (2014) claimed, “the development of China’s economy mainly depends on extensive growth such as extending investment, expending resources and polluting the environment.” This kind of economic development model is unsustainable in the long-term and does not correspond with the requirements of sustainable development of economy practiced worldwide. Therefore, the problem of oversupply in various industries further promulgates the underdevelopment of industries (Jinzhou Chen, 2014). In trying to craft a solution, Jinzhou (2014) suggested that the risks involved in creating financial revenue based on expenditures of government and the uncertainty of social stability in China directly contributed to the oversupply, and as such, local Chinese governments need to mobilize manpower and domestic market influence to move material resources out of the market and into consumption. However, this solution focuses on the development of a micro-economy within the larger Chinese economy, which thus leads to a strategic move away from broader social financial and public management and public service (Jinzhou Chen, 2014). 

Finally, oversupply contributes to environmental damage without providing much financial justification. The amount of low-level and low-tech repeated construction of Chinese traditional manufacturing has created enterprises with high investment, moderate consumption, high pollution, and low-levels of efficiency (Jinzhou Chen, 2014). These enterprises severely damage the environment, such as the blue-green algae disaster of Taihu Lake caused by factory pollution (Jinzhou Chen, 2014). This is an example of an industry that required high investment, but results in average consumption, high pollution, and low-level efficiency (Jinzhou Chen, 2014). This model of oversupply that worsens environmental damage is replicated in steel factories, papermaking factories, and electrolytic aluminum factories to the detriment of the Chinese nation as a whole.

2.3.2 Low quality of Chinese traditional manufacturing enterprises

The quality of oversupplied products is another problem associated with traditional Chinese manufacturing. If the quality of the products being offered is seriously poor, then these products will not satisfy the market demand, even if the demand is there (Lan Zou, 1998). According to Rene T. Domingo (2003), global competitiveness begins and ends with quality of comparable products, more so than pricing.  Before attempting to meet human resource competitiveness or technical competitiveness, quality competitiveness must be consistently met (Domingo, 2003). Similarly Yuzhong Zhao (2009) explained how previous market considerations factored in price as the most important product feature above all other factors; however the current market situation steeped in oversupplied and poor quality products shows that customers begin to develop comparisons that weigh quality higher than price with a greater willingness to pay more for better quality rather than less for low quality products. Isaiah O. Ugboro (2000) proposed increasing quality requirements for oversupplied products as a way to increase customer satisfaction and demand. The belief is that a better quality product will generate its own demand rather than being relegated to excessive stocks that do not sell becaue of poor quality (Ugboro, 2000). Nevertheless, the oversupply of low quality products creates a series of negative influences that serve to decrease the competitiveness of firms and thus decrease their profitability while increasing production costs and damaging public reputation (Yuzhong Zhao, 2009). 

Looking at the firms who deal with oversupply, the quality of products or services could serve as the incentive or hindrance to the profitability of existing and developing companies (Yuzhong Zhao, 2009). One of the most important characteristics of the market situation at present is the growing trend of quality requirements and consumer demands for quality products (Yuzhong Zhao, 2009). Therefore, it tends to be more important for businesses to pay attention to the quality of products by making this a central aspect of its operations and production strategies (Yuzhong Zhao, 2009). Zhen He (2001), professor from the Management College of Tianjin University, has surveyed 42 firms operating within China’s domestic manufacturing market with support of the Plan 863. Based on his results, most of the firms passed the ISO9000 Quality Management System Certification; however the results of some of the firms were unsatisfactory and reflected their negligence of significant quality checks (Zhen He, 2001). Nearly 50 percent of the firms used the praetor chart, causal diagram, column diagram, control chart, and the process capability analysis in order to exert quality control. Zhen He’s (2001) research indicated room for improvement in quality management tools used by the domestic manufacturing enterprises of China, especially in comparison to foreign-funded enterprises or joint venture enterprises (Zhen He, 2001). 

From 2000 to 2005, the percent of passing scores form the Quality and Technology Supervision Bureau of China was 77.8 percent (Yuzhong Zhao, 2009). In an average sample of consumer goods, the passing score was only 79.9 percent (Yuzhong Zhao, 2009). In the first half-year of 2006, the General Administration of Quality, Inspection and Quarantine of the People’s Republic of China (AQSIQ) sampled 8,782 different types of products developed in China and manufactured by 7,927 enterprises in 152 categories total (Yuzhong Zhao, 2009). The percent receiving passing scores based on total samples was 78.4 percent (Yuzhong Zhao, 2009). Just one percent of defective production results in the loss of as much as 15 billion Yuan (Yuzhong Zhao, 2009). Conservative estimates suggest that defective, sub-quality products result in a loss of 300 million Yuan each year (Yuzhong Zhao, 2009). According to the final set of statistical data, the industrial industries added value would only be 735.547 billion Yuan (Yuzhong Zhao, 2009). Despite China’s development over the past 20 years since the open-door trade policy, Chinese traditional manufacturing has consistently produced low scores on the total quality check (TQC) method used in Japanese industries (Yuzhong Zhao, 2009).  The TQC method includes the ISO9000 Quality Management System Certification, as well as the Six Sigma management method (Yuzhong Zhao, 2009). Despite the efforts to improve quality, the continued low quality and lack of passing scores on quality checks indicate that traditional manufacturing could still result in significant losses in the development of the Chinese economy. 

2.3.3 Political factors of Chinese traditional manufacturing

Combined with oversupply and low quality, traditional manufacturing has also had to contend with unreasonable political policies impacting the traditional industries (Lan Zou, 1998). In the 1980s, the lack of supply in the Chinese domestic market resulted in policies that prioritized importing foreign supplies to meet the domestic demands (Lan Zou, 1998). This serviced to skew GDP by increasing imports while exports remained stagnant. However, in the 1990s, the growth of domestic productivity led to an excessive supply in the domestic market of China while foreign supplies were still being imported (Lan Zou, 1998). Political policy had failed to adjust in a timely fashion, and despite market improvements in production, foreign supply was still being imported at rates that furthered the oversupply of Chinese manufacturing products (Lan Zou, 1998). This resulted in further weakening Chinese domestic market demands while also not providing enough incentive for foreign market demands to fill the gap (Lan Zou, 1998). Yizhong Li, the president of the China Federation of Industrial Economics, the technical revolution was a key factor in the transition from traditional manufacturing to modern manufacturing with governments at all levels focusing on planning, issuing content, publishing information, and drafting political policy that supports this technical revolution in a way that benefits the domestic Chinese manufacturing industries and markets (CINN, 2015). 

2.3.4 Threats to Chinese traditional manufacturing from foreign products

The last problem that finalized the shift from traditional to modern is the competitiveness of imported products in the Chinese domestic market. According to Minyan Wang (2004), on December 11th, 2001, China joined the World Trade Organization (WTO). This took China’s open-door trade policy to its next and logical step. Lan Zou (1998) suggested that China joining the WTO further opened Chinese markets to an influx of large amounts of foreign retail markets, including the United States. This combined with the oversupply of low quality products manufactured domestically led to a dramatic threat to Chinese traditional manufacturing companies (Lan Zou, 1998). Traditional manufacturing companies were still not strategically employing quality control checks in a consistent and industry-wide application, and as such were rendered weak and unreliable in the face of foreign developed competition (Lan Zou, 1998). The reality was that Chinese products could not compete with high-quality foreign products if the market remained the same.

In general, Lan Zou (1998) thought that there were two main categories of problems facing Chinese traditional manufacturing. The first is the oversupply of the Chinese domestic market high-quality foreign products, which resulted from the open-door trade policy (Lan Zou, 1998). The second is the prevalence of low and poor quality products from the domestic traditional manufacturing companies, who still relied on less developed technologies for productivity (Lan Zou, 1998). According to the “Economic Daily 1999,” the investment required to make replacements and technical innovations of Chinese traditional manufacturing would occupy more than 50 percent of total investments in the 1980s (Lan Zou, 1998). However, this ratio has decreased to 48.4 percent in 1991, and further declined to 37.5 percent in 1998 (Lan Zou, 1998). The investment percentage increased in 1999, but then reduced even further to 28.1 percent in the same year (Lan, 1998). This indicates the potential for traditional manufacturing problems to be resolved through a modified economic policy.

Due to the problems of traditional manufacturing that Lan Zou (1998) believe resulted from the open-door trade policy of China, it would be reasonable to conclude that it was necessary and inevitable for China to transform its manufacturing industry from a traditional model which was no longer working to a modern model, which might be able to better contend with global influences.

2.4 Shenzhen and Chinese traditional manufacturing industries

According to Shuxing Tong (1999), the relationship between production complexity, salary levels, and the open-door trade policy could accelerate Chinese exports. This would involve labor-intensive products, as well as high-tech products (Shuxing Tong, 1999). Using Guangdong province of Shenzhen as an example, after the China open-door policy, the processing trade shifted from simple assembly and processing, to the development high technology assemblages and processing (Shuxing Tong, 1999). The growth of the computing industry and the communication equipment industry developed quickly to compete with foreign influences (Shuxing Tong, 1999). The processing trade of Guangdong province achieved the level of interlink and inter-infiltration with its products meeting the needs of multiple industry demands (Shuxing Tong, 1999). Moreover, the industries are continuing to experience upgrades and updates on a constant basis that pairs well with the development of the nearby industrial belt located near Zhujiang River (Shuxing Tong, 1999). 

Shenzhen, as the first city of China to implement the open-door trade policy, was one of the first “boom towns.” (Lan Zou, 1998; Shuxing Tong, 1999). However due to the geo-economics at work and the results of political policy, Shenzhen has also experienced increases of traditional manufacturing industries from areas such as Hong Kong and Macao (Shuxing Tong, 1999). Lan Zou (1998) explained that the status of Shenzhen’s traditional manufacturing after China joined the WTO symbolized the end of traditional manufacturing for the whole country. As the epicenter of the major economic shifts in China, Shenzhen is selected as the geographical research area in which to most effectively monitor and investigate the shift from traditional to modern manufacturing. 

Due to the currency devaluation of other newly industrialized countries in Asia, both the export-based companies and the domestic companies of Shenzhen had to face the difficult situation of increasing exports after China’s open-door trade policy. These difficulties compelled Shenzhen to make industrial structural re-evaluations, which gave strong support to the high technology and new technology industries (Lan Zou, 1998). On the other hand, Lan Zou (1998) pointed out that Shenzhen strengthened the technology industries links to traditional manufacturing by trying to bring the complexity of high technology to the traditional manufacturing industries in order to increase the technical content of those products and raise their competitiveness (Lan Zou, 1998). The present research will explore whether this move has been successful or not.

Although the Asian financial crisis created difficulties in Shenzhen exports to regional markets, it also created opportunities for Shenzhen’s businesses to process their technical transformations in market downtimes, especially in the areas of technological innovation and quality improvements (Lan Zou, 1998). According to the Shenzhen Economic Development Board, the Asian financial crisis has created positive opportunities for Shenzhen companies to bring in high technological equipment in order to improve their productivity at low costs (Lan Zou, 1998). 

In Shenzhen, the clothing industry, the timepiece industry, the furniture industry, and the mechanical industry are the four largest traditional manufacturing industries still in operation (Lan Zou, 1998). According to the statistical data collected by Lan Zou (1998), in 1997, the output of the mechanical industry increased by 154 percent.  Outputs of the clothing industry increased by 20 percent (Lan Zou, 1998). In 1997, the total output of the clothing industry, timepiece industry, furniture, and mechanical industries was $3.253 billion Yuan (Lan Zou, 1998). In the first 6 months of 1998, the total export value of these four industries was $7.264 billion Yuan, contributing to 60.67 percent of the total amount of exports from Shenzhen (Lan Zou, 1998). Therefore, these four traditional manufacturing industries could drive the majority of Shenzhen’s development. 

2.5 Shenzhen’s actions to facilitate the manufacturing transition

Based on the centrality of the four categories of clothing, timepiece, furniture, and mechanical industries in driving Shenzhen’s economic growth, it is no surprise that the local government has sought to maximize their development to increase their outputs even further. Shenzhen has adopted a series of measures to achieve the manufacturing transformation (Lan Zou, 1998). First, it has sought to combine the high technology industries with the traditional manufacturing industries, in order to improve the technical quality and the additional value of the products (Lan Zou, 1998) Secondly, Shenzhen focused on improving and encouraging the cooperation between enterprises and the scientific research institutes, as well as colleges and universities (Lan Zou, 1998). Based on the demands of the traditional manufacturing of Shenzhen, suitable talents must be recruited and developed to provide a steady stream of human resource capital (Lan Zou, 1998). Thirdly, Shenzhen declined the barriers to entering the market for industrial related engineers and broadened the restrictions on training abroad (Lan Zou, 1998). This move prioritized domestic markets over foreign markets. Fourth, Shenzhen encouraged companies to develop their own research and development departments to take on the investment and production costs with technological and quality improvements (Lan Zou, 1998). Finally, Shenzhen organized companies going abroad for learning, fostering, investigating, and cooperating with other similarly stationed organizations, in order to improve their own productivity, management levels, and product quality as well as building connections to expand both the domestic and foreign markets (Lan Zou, 1998). It is believed that these measures will aid Shenzhen, as a microcosm of China as a whole, in progression from traditional manufacturing models to modern manufacturing models that can withstand global competition.

2.6 Summary

The above literature review gives a macro-perspective by addressing issues related to traditional manufacturing in China including its history and progression over time, especially after the establishment of the open-door trade policy.  This section highlighted the necessity of moving the manufacturing industries from traditional to modern based on problems of oversupply, financial and government corruption, political policy, and foreign imports.  This section discussed one city, Shenzhen’s actions toward implementing China’s open-door trade policy and modifying its own policies to better achieve market targets. The remaining sections will begin investigating how China’s implementation of the open-door policy has facilitated the transformation from traditional manufacturing with its low-quality oversupplied products to modern manufacturing with high-tech competitive products.  

Chapter 3: Data and Methodology

The objective of the previous chapter was to indicate the progression of problems with Chinese manufacturing industries in the change from traditional to modern manufacturing. The extant literature clearly demonstrate the necessity of shifting from traditional to modern in order to eliminate poor quality, low-tech, oversupplied products. In order to further explore the relationship between the open door trade policy and the shift in Shenzhen’s manufacturing from traditional to modern, the current study will use quality of the products as an indicator of the transformation of Chinese manufacturing from traditional to modern as well as net exports and FDI. Data will be collected from the National Bureau of Statistics of China from a time period between 2000 and 2015.

Many previous studies use quantitative research methods to find the relationship between the open-door trade policy and shifts in productivity from traditional to modern. Quantitative research is concerned with the collection and analysis of data in numerical forms requiring the collection of large samples of data (Hughes). The present study will use quantitative research methods to collect and analyze data on China’s economic development after the open-door trade policy was implemented. The calculations of both the exports value and the foreign direct investment (FDI) value over time time will be presented using numerical methods. There are two continuous variables: the open door policy and product quality. Pearson’s correlation was chosen to identify the strength of the relationship between these two variables. According to Bryman and Bell (2007), Pearson’s correlation coefficient, or the r-value, lies between -1 and +1. Coefficients closer to +1 indicate a strong positive relationship between the two variables, whereas coefficients closer to -1 indicate a strong negative relationship between the variables.

3.1 Hypotheses

The null hypothesis (H0) indicates there is no relationship between the variables or there is a weak and statistically insignificant relationship. The alternative hypothesis (H1) indicates that there is a strong, statistically significant relationship between the variables.

H1: Firms with higher export values, in comparison to firms with lower export values, will most likely have higher quality products.

H0: Firms with higher export values, in comparison to firms with lower export values, will not have higher quality products.

H1: Firms with higher foreign direct investment values, in comparison to firms with lower FDI values, will most likely have higher quality products.

H0: Firms with higher foreign direct investment values, in comparison to firms with lower FDI values, will most likely not have higher quality products.

3.2 Definitions 

In this study, the following definitions will be used to guide and limit the research.

Traditional manufacturing. Traditional manufacturing refers to industries that rely only on traditional technology for production and solving problems, which is time–consuming and labor-intensive. This type of manufacturing tends to have lower productivity, lower efficiency, and lower quality. 

Modern manufacturing. Modern manufacturing is defined in comparison to traditional manufacturing and reflects a reliance on advanced technologies and equipment, which increase efficiency by better allocating resources and labor productivity with higher quality products.

3.3 Conceptual Framework

Under this section, a proxy index is established to measure product quality during the specified time period. Based upon past studies, the qualities of the products are mainly dependent on four usual aspects, including research & development expenditures, products satisfaction index, products consumption index, and human capital (Lucas, 1988). Under human capital, there are two sub-indices, which are, the educational index and employee’s happiness index (Lucas, 1988). The overall index can be further categorized into four objective sub-indices, the research and development expenditure, the products satisfaction index, products consumption index and the employee’s educational index, and one subjective sub-index, employee’s happiness index (Lucas, 1988). Since there are three main factors related to the quality of products, the following model would be used for this study: Q_it (Shenzhen)=f(R&D,PS,C,H)_it

Where ‘i’ stands for firm and ‘t’ stands for year. From the above model, the R&D refers to the research and development expenditure, the PS refers to the products satisfactions index, the C refers to the products consumption index, and finally the H refers to the contribution of human capital to growth. It is interesting to note that human capital factors into product quality as emphasized by Lucas (1988). For example, if an educated person could be counted as one unit of skilled labor force, then the problem of the contribution of skilled workers will be limited to their share within the total labor force (Lucas, 1988). As the theory of the positive externalities of human capital is explained, the more educated people are, the more productive they will be (Lucas, 1988). 

Furthermore, the data from the research and development expenditures as a whole for the manufacturing firms in Shenzhen over time and the trends of consumption of the manufacturing products will be analyzed quantitatively. Considering the relationship between the employee’s happiness index and their educational index, some researchers indicated there is a positive relationship between these two variables, as people with higher educational backgrounds will tend to reach higher income index levels, and hence have higher happiness level (Lucas, 1988). The quantitative research report of UNDP (2011) suggests that a minimum score of 0.8 or above for high-income groups tends to indicate higher happiness levels; comparatively, a score of 0.7 for middle-income group people tends to indicate a lower happiness level on a scale of 0 to 1. 

3.4 Measuring the Degree of Economic Openness

3.4.1 Measurements of Economic Openness

It is crucial to measure the openness of the Chinese economy in terms of degrees or numbers in order to quantify the open-door trade policy. Throughout economic history, the measurement of the openness of a country based on trade flows could be grouped as follow: Trade Ratios; Adjusted Trade Flow Measures, and Price-Based Measures. According to Lane David (2007), trade ratios (Export + Import / GNP) is the most widely used measure. This amounts to the use of a market exchange rate to convert China’s GNP to U.S. dollars which may reveal a rise in trade-GNP (Lane David, 2007). As such, the trade ratios method used within a country may not be appropriate and may involve some problems related to cross-country comparisons such as the euro-dollar exchange (Lane David, 2007). For example, smaller countries may have higher or lower ratios even when their trade is equally favorable based on their particular government’s policies (Lane David, 2007). At the same time, the market exchange rate value may not be adjusted and may overestimate the openness of an economy by underestimating a country’s true GNP value (Lane David, 2007). Additionally, the change in trade ratios has to be indicated by the change in the trade policies, but there is no theory supporting the idea that trade ratios reflect trade policies, therefore this method will not be used in the present research (Lane David, 2007). 

Furthermore, there is another commonly used method called the adjusted trade flow measure, which includes the use of deviations in the actual trade flows from the predicted free-trade flows (Eichengreen and Irwin, 1998). But, this requires highly accurate and specified data that is not always available. However, two of the models, the Hecksher-Ohlin factor model and the gravity model, would be able to fit in with the adjusted trade flow measure and help to produce more accurate data. According to Eichengreen and Irwin (1998), the gravity model is the “workhorse for empirical studies of [regional integration] to the virtual exclusion of other approaches.” It involves the use of bilateral trade flows (Eichengreen and Irwin, 1998). Examining the bilateral trade flows would allow the estimation of both trade creation and trade diversion effects (Eichengreen and Irwin, 1998). Therefore, many researchers like to use the gravity model not only because of its popularity but also its strong fit to the empirical data and their theoretical foundations. 

Lastly, the price-based measure captures trade policy by seeking price distortions in either goods markets or with exchange rates. Dollar (1992) constructed two indices, the “index of real exchange rate distortion” and the “index of real exchange rate variability.” These two indices are commonly used as an example of measurement using goods price distortion to construct trade policy (Dollar, 1992). The price-based measures rely on more accurate data than the adjusted trade flow measures. 

3.4.2 Quantitative Indicators of Trade Openness

Due to the absence or inaccessibility to some of the data required for the above-mentioned methods of measuring the degree of openness, none are appropriate for the present research. According to Wei’s research (1993), the net exports and FDI value could both be used as alternative measures of the degree of openness. Within the Chinese market, FDI could be considered a primary mechanism of transferring foreign management methods and worker discipline from developed countries into China (Wei, 1993). Net exports and FDI value illustrate the state of exports in simplistic and easy to understand terms based on data that is readily available. 

The FDI can enter into statistical regressions in two ways. Firstly, FDI refers to foreign direct investment, which means money outside the country that is invested in the domestic country. FDI would be entered either as a share of the city’s total investment or in absolute scale. If FDI does not reflect an infusion of capital into China, then the technology FDI brings cannot be attributed to China’s economic growth or statistically proportional to its share of China’s capital stock (Wei, 1993). Secondly, FDI does measure spillover effect across firms through interactions of managers or other people between the foreign-owned or managed firms and those that do not directly received the FDI. Suppose that all of the domestic firms who do not receive foreign direct investments directly will always obtain a consistent fraction of the benefits that FDI obtains through interactions with firms that do. If the foreign-invested firms account for a small fraction of the total output in China, then the FDI’s contribution to China’s growth rate would be proportional to the total foreign direct investment that the whole of China received (Wei, 1993). Generally speaking, the appearance of this spillover affect signals the existence of positive FDI across firms within China, even when FDI is relatively low (Wei, 1993). 

Moreover, exports enter the regressions in two ways. Exporting firms can learn new ideas of smart technology, marketing, or management from interacting with global buyers.  If the benefits of this learning are quantified, then the exports’ contribution will be proportional to the share of the exports in China’s total output. However, the newly learned ideas may be transferred to those non-exporting firms; therefore, as far as the spillover has been concerned, the benefits of exports are more closely related to the total exports of all the firms in China collectively than to the share of exports in the total manufacturing outputs.

It is crucial to note that an increase in Shenzhen’s exports, the foreign investment, exports, and the human capital may improve the entire nation’s productivity. But any such incline will simply be reflected in the intercept of regressions because it may not generate cross-city differences in growth. As explained above, the exports will enter into the regressions in two ways, either in absolute scale or as a percentage of the total output. At the same time, the FDI can enter into the regressions in two ways, absolute scale or as a percentage of total fixed capital investment. If the two measures of FDI are entered into the regressions separately, only the absolute scale of FDI is significant.

3.5 Exports

(Figures 1 and 2 omitted for preview. Available via download).

Peng Sun (2010) indicated that “Chinese international trade has expanded steadily since the implementation of the open-door policy in 1978”. As Figure 1 shows, China’s international trade volume grew quickly in the last 20 years, especially between year 2000 and year 2008 (Chinese Ministry of Commerce). Trade volume expanded with an annual rate of 18.1 percent (Chinese Ministry of Commerce). It increased from 20.64 billion dollars up to 2.56 trillion dollars from 1978 to 2008, indicating the increasing degree of the Chinese market’s openness.

Moreover, Lemoine and Unal-Kesenci (2004) believed that China’s overall trading structure has experienced obvious shifts with the rapid growth of foreign trade volume. In 1980, China’s primary goods accounted for nearly 51 percent of the total exports, while the manufactured goods accounted for no more than 50 percent. However, in 2008, this phenomenon made an unbelievable shifting, as the share of the primary goods dropped to just 5.4 percent of the total exports value, while manufactured goods accounted for nearly 95 percent of the total exports value as shown in Figure 2.

The above figures and analysis exploring China’s trading performance “indicate the rapid shift in the composition of exports from resource- and labor-intensive products to capital- and technology-intensive goods” (Peng Sun, 2010). These figures have provided the data for the relationship between the increasing openness - of the Chinese economy and the shift of the manufacturing industry from traditional to modern. China’s trading structure changed its focus from primary products to light industry and textile products in the early 1990s, to machinery and electronic goods with high technology currently (Peng Sun, 2010).

(Full document and references available via download).