Trade options for a small open economy: The different impact of Taiwan exports to China and to other countries

Abstract

This study aims to explore advantageous trade arrangements for a small open economy. To discover the arrangement, the fundamental question to ask is how trade affects a small economy. Due to the differential factor mobility, the two main streams of trade theory—new economic geography and comparative advantage—make divergent predictions of trade effects. This study identifies the differences in factor mobility and distinguishes the differential impacts of exports to China and other countries on Taiwan’s manufacturing clusters. Using Taiwan’s 2006 and 2011 census data and trade statistics, this study applies the two-stage least squares method to test the differential impacts. The findings reveal that the growth in Taiwan’s exports to other countries significantly increased the employment level of manufacturing clusters in Taiwan. However, such effects have not been found for exports to China. The lack of response in Taiwan’s local employment to exports to China can be inferred as a short-term exhibition of the long-run core-periphery effect. The policy implication of this study is that trade involving low factor mobility is more beneficial than that involving high factor mobility for a small open economy. Thus, for a small economy, trade liberalization that will ‘not’ attract large factor outflows from the small economy is more desirable.