Market Impediments and Regulatory Arbitrage: Evidence from the Chinese Firms' Trade Figures

This study uses reported trade figures from China, Hong Kong, and Thailand to examine the relationship among market impediments, trade-figure irregularities, and tax-induced regulatory arbitrage. The empirical findings, consistent with our tax-induced regulatory arbitrage models and the round-tripping phenomenon (that is, moving funds across the mainland Chinese border through trade, typically to Hong Kong or an offshore tax haven, before re-entering China as foreign direct investment) in China, provide support for several conclusions. First, the spurious flows of funds to and from China, via the underreporting of exports and the overreporting of imports, closely follow the preferential tax incentives accorded to foreign investors. Second, the underreporting of exports is negatively related to export tax rebates. Third, the overreporting of imports is negatively related to import tariffs. Finally, both of these two appear to be most prevalent in state-owned enterprises.