The Effect of Trade Liberalization on Manufacturing Firms' Cash Savings: Precautionary Savings Motive or Investment Extrusion？
ZHANG Guofeng, WANG Yongjin, LI Kunwang
School of International Trade and Economics, University of International Business and Economics; School of Economics/ Collaborative Innovation Center for China Economy, Nankai University
Summary:
With access to the WTO, Chinese firms have more opportunities to export and invest because of lower import tariffs. At the same time, trade liberalization leads to higher pressure from import competition. How does such import competition affect firms' cash savings ratios？ Answering this question would not only help in understanding firms' cash savings behavior after admission to the WTO but also have real-world benefits in terms of activating the monetary stock and stimulating the real economy. However, the literature pays little attention to this issue. Theoretically, firms' cash savings ratios are affected by import competition through two channels. On one hand, firms will increase their cash savings, referred to as precautionary savings, to defend against the risks of import competition. On the other hand, more imports will increase competition for investment opportunities, especially when investment projects are similar between firms. If predatory investment happens, firms will lose investment opportunities; this weakens the motive to keep cash, and thus cash savings will decrease. However, the effect of trade liberalization on cash savings will depend on firm size. Large firms will keep more cash to execute the predatory pricing or entry barrier strategy. Meanwhile, the exit risk for less productive firms will increase under a more competitive market. Thus, less productive firms will keep more cash to manage operating risks. This paper discusses the effect of trade liberalization on manufacturing firms' cash savings ratios and, using a difference-in-differences method, explores the mechanisms and heterogeneous effects based on the quasi-natural experiment of China's admission to the WTO. The firm-level variables are mainly from the Annual Survey of Industrial Firms (ASIF) conducted by the National Bureau of Statistics of China from 1998 to 2007, and firm trade regime information is taken from China Customs Data over the period 2000-2007. The dataset of Chinese import tariffs is downloaded from the Trade Analysis Information System (TRAINS) and WTO website. Average tariffs are selected to measure the industry tariff level in this paper. Cash savings are calculated by eliminating inventory and account receivables from a firm's liquid assets, in line with the definition of cash and cash equivalents in the China Accounting Standards. To test for measurement errors in the cash savings index, we first merge the ASIF from 1998 to 2013 with Wind data of listed companies by firm name. Then, we compare the difference between the cash savings ratio measured in this paper and those published by the listed companies. We find that the cash savings ratio calculated in this paper is acceptable. This paper contributes to the literature in three respects. First, this paper is the first to study whether trade liberalization affects firms' cash savings, and we find that Chinese firms exhibit different cash saving behavior compared to firms in developed countries. Second, instead of focusing on listed companies, this paper uses ASIF data to avoid undervaluing the average cash savings of manufacturing companies. Third, this paper explores the mechanisms in detail to identify whether the main source of cash savings variation comes from changes in the precautionary savings motive or from changes in investment opportunities. First, we find that China's trade liberalization did not increase manufacturing firms' cash savings ratios but rather significantly reduced them as a result of decreasing investment. This finding is different from the conclusions for developed countries. Second, the effect of trade liberalization on firms' cash savings depends on the extent of market competition: lower tariffs will significantly reduce firm cash savings in competitive industries and highly concentrated areas. Third, import competition will erode the investment opportunities of domestic firms, especially small ones, thereby reducing their cash savings. The conclusions remain valid after a series of tests. These findings suggest that unlike in developed countries, the competition effect of China's trade liberalization has a negative impact on firm investment in the short term. How to deal with this unfavorable situation remains a substantial challenge for local manufacturing firms. Relaxing market access and opening up the service sectors are important tasks in the new pattern of China's overall opening up, as emphasized at the 19th National Congress of the Communist Party. In a subsequent study, we will explore another important issue related to China's opening up, that is, how the liberalization of service sectors, especially the financial sector, affects firms' cash savings and saving strategy.
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