Trade Liberalization and Economic Development: Evidence from China's WTO Accession

We study the effect of improvements in foreign market access brought by China’s WTO accession on Chinese local economies. We exploit cross-city variation in these improvements stemming from initial differences in sectoral specialization and exogenous cross-industry differences in US trade liberalization that originate from the elimination of the threat of a return to Smoot-Hawley tariffs for Chinese imports. We find that Chinese cities that experience greater improvement in their access to US markets following WTO accession exhibit faster population, output and employment growth as well as increased investment and FDI inflows. The benefits of WTO membership for Chinese local economies are augmented by significant local spillovers. These spillovers operate both from the tradable to the non-tradable sector and within the tradable sector. Within the tradable sector, spillovers are transmitted primarily via labor market linkages. We find important local demand linkages from the tradable to the nontradable sector. Most local service sectors benefit from trade liberalization. In particular, our evidence suggests that increased investment demand caused by trade liberalization drives financial sector growth. We find little effect of trade liberalization on local wages. Alongside our results on population and employment, this indicates that local labor supply elasticities are high in our setting. Our findings can be explained by a Lewis model of urbanization that combines geographic mobility with an abundant reserve of labor.