Objectives
All developed countries currently suffer from a serious trade deficit with China, but the size of this deficit varies across countries. Since China’s competitiveness relies to a large extent on its low-cost production, competing with China based on a low price strategy is no feasible option for developed countries. In order to improve its international competitiveness a developed country may opt for improving the quality of its products instead. In this paper we study the relationship between product quality in internationally traded goods and the ability to cope with Chinese competition for a set of OECD countries. We focus on Chinese competition both in the domestic market and in third-country markets, and distinguish between the main manufacturing sectors.
Data and Methods
We proceed by splitting up bilateral trade flows into extensive and intensive margins, reflecting respectively the importance of variety and volume of trade (see Hummels and Klenow, AER 2005). We further measure the degree of quality in traded goods based on detailed unit-values data from highly disaggregated trade flows (in line with Schott, QJE 2004). For each OECD country we relate these quality indicators to the country’s (sectoral) export relationship with China, and to its (sectoral) export performance relative to China in third-country markets.
Results
Our findings suggest that in most sectors high-quality production may improve a country’s international competitiveness, enabling it to "beat" China. These results imply that the best strategy to deal with the Chinese dragon is quality-upgrading rather than any kind of defensive strategy.