Functional upgrading in China's export processing sector

Abstract

Functional upgrading occurs when a firm acquires more sophisticated functions within an existing value chain. In this paper, we analyze if there is evidence of this type of upgrading in China's export processing regime by investigating dynamics in the relative prevalence of Import & Assembly (IA) versus Pure Assembly (PA) processing trade over the period 2000–2013. Firms in both regimes provide similar manufacturing services to foreign companies, but IA firms also conduct the sophisticated tasks of quality control, searching, financing and storing imported materials. Consistent with a trend of functional upgrading, we show that the share of IA trade in total processing trade has increased rapidly during the period 2000–2006, both overall and within product categories. Furthermore, we find that this trend has gone hand in hand with improvements in a sector's labor productivity and unit values. Against expectations, we find that this process has slowed down notably during the period 2006–2013.