Standard Chartered economist Stephen Green, one of the best China hands at any investment bank, offers a rather frightening essay in Businessweek suggesting that the majority of China’s 2005 trade surplus was, essentially, hot money.:
The export of fake goods out of China is commonplace whether you are talking about designer bags, blockbuster movie DVDs, or “Mont Blanc” pens. Many European and U.S. holidaymakers take these knock-offs home with them — some of them knowing they’re counterfeit; others are unaware. Underground Chinese firms spirit such goods out of the mainland on a much larger scale.
Now we may we have identified another fake: the supposedly gargantuan global trade surplus China enjoys with the rest of the world. Much of China’s trade surplus in 2005 was not trade at all, we think, but rather capital inflows (perhaps as much as $67 billion) disguised as trade. If so, this has major implications for China’s trade policies, the yuan, and the way the U.S. deals with China.
- Stephen Green also talk about other factors such as transfer price (booking more profit in lower tax jurisdiction such as HK) which distorted the trade figures. One major area he did not discuss is the tax incentive China has given to FDI manufacturing facilities. i.e these factories will typically receive 2 years of tax-exemption and another 3 years of half tax (i.e. 16.5%), counting from the first year of cumulative breakeven. So for factories in Year 1 and 2 it makes more sense to book the profit in China than in HK. In year 3-5 there is no real difference. Now that RMB is expected to appreciate, even MNC are trying to book the profit inside China and keep them as RMB in year 1-5 ! And a lot of the factories are in year -2 to 5.
There are actually more explanation, even to the pre-2000 numbers. Remember the VAT rebate for export? In China, the factory receives a rebate of the 17% VAT (i.e. the value added portion, = revenue - raw material cost) if the goods is exported, but not so if sold domestically. The factory owners would then ‘export’ the goods and smuggle them back for domestic consumption.
This policy is being phased out now, but it serves as one example for how one should look at China's trade numbers (or any number). It is not that the statistics are rigged, rather the businessmen are cunningly greedy and officials corruptedly co-operative. Here is how it works,
- A factory (buyer) needs a container of copper wire (or cotton thread). It intends to purchase it from a domestic factory (supplier).
- The two factories then make an arrangement that the copper is to be exported to HK. (Yes, HKSAR of PRC is considered a "foreign" destination under WTO or PRC custom)
- Upon arrival at the port (e.g. Shantou, Shenzhen, Xiamen, etc). The export certificate is issued. The supplier gets the 17% rebate using the certificate, and then rebate the discount to the buyer.
- How does the buyer get the goods?
- case 1: the container never really leaves the port, instead, it was leaves the fence and was sent directly to the buyer. The customer officers was bribed.
- case 2: the ship make a detour back to the port (or another port), the 20 ton container was over-filled to 30 tons (30 full tons in the export certificate for rebate), but the custom officer only record 10 ton when it is imported. Saving in tax? as much as 17% -(1/3) x import tariff, which is often less than 10% for these goods (though theoretically there is saving as long as tariff is small than 50% if Value-added = full value in the case of commodity) for this scheme to work.
- Result, China records a trade surplus to HK. US thought it had a trade deficit. But who the hell in US would import copper wire from China?