Domestic trade and energy productivity in China: An inverted U-shaped relationship

Boosting domestic trade and increasing energy productivity are both main objectives of China's new normal in economic development. A relative increase in the share of domestic trade in the GDP tends to be accompanied by a relative contraction in the share of international trade. In raising energy productivity, given the important role of frontier technology embedded in international trade, there is a theoretically optimal share of domestic trade in the GDP. A particularly interesting issue is whether there is a nonlinear relationship between domestic trade and energy productivity. Based on panel data of 285 prefectural cities in China over the period 2004 to 2013, this paper first extends hyperbolic distance specifications within a parametric stochastic framework to the analysis of energy productivity and further examines the causal relationship between domestic trade and the growth of energy total factor productivity (TFP). We find that domestic trade indeed has an inverted U-shaped effect on the growth of energy TFP. This finding is robust to various checks, including using the interaction between the density of small rivers and the exchange rate as an instrument and alternative calculations of the growth of energy TFP. Furthermore, the finding echoes the strategy proposed by the Chinese government to build a new development pattern with a large domestic cycle as its mainstay and in which a dual domestic and international cycle would be mutually promoting.