Tests of goods market integration between China and European countries: a nonlinear nonparametric approach

ABSTRACT

The validity of purchasing power parity (PPP) between two economies implies goods markets of the two are well integrated. This is a pre-condition for further economic convergence. This study examines validity of the PPP between China and European countries. Since the functional form of the cointegrating relationship may not be exact or linear, we adopt the nonparametric rank tests for analysis, without prior specification of the functional form. We also address the rank problems that occur in multivariate rank tests. The results indicate strong support for nonlinear PPP relationships between China and European countries, especially during the second subsample period. This indicates China’s rising economic power, particularly in the most recent decade. Although there have been disputes between China and Europe, these results suggest favorable prospects for closer economic cooperation between the two sides and the need for formulation of common policies to pursue an integrated market in the future.

KEYWORDS:

• PPP
• rank test
• China
• Europe

JEL CLASSIFICATION:

• C10
• F41

Acknowledgments

We gratefully acknowledge advice from editors and anonymous referees. The responsibility lies with the authors.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1. 18 out of 27 EU countries have signed the BRI MOU (Memorandum of Understanding) up to March 2022. 6 of them (Austria, Cyprus, Italy, Greece, Luxembourg and Portugal) are in Western Europe. The others are from East and Central Europe. There are also non-EU BRI members in Europe such as Albania, Serbia and Turkey.

2. PPP testing with the mixture of structural breaks and smooth transition adjustments is found in, for example, Bahmani-Oskooee, et al. (2013) and He et al. (2014).

3. The UK officially left the EU on 31 January 2020, but the UK and EU agreed to keep many things the same until 31 December 2020, to allow enough time to agree to the terms of a new trade deal (https://www.bbc.com/news/uk-politics-32810887). In this paper, the UK is still considered an EU member in the sample period.

4. Refer to the official website of the European Union available at: https://ec.europa.eu/info/euro-0_en for more details on adoption of the Euro.

5. The results for Model A (unreported) indicate weak evidence of cointegration, and this may be due to the rank problem.

6. The functional form for Model B becomes ${\mathrm{f}}_1({\mathrm{p}}_{\mathrm{t}}$) =$\mathrm{g}\left({\mathrm{e}}_{\mathrm{t}}\right)+\mathit{\hspace{0.17em}}{\mathrm{f}}_2\left({\mathrm{p}}_{\mathrm{t}}^{\ast }\right)+$ ${\mathrm{u}}_{\mathrm{t}}$.

7. Other divisions of subsamples applied to the data can be found in Table 4.

8. For Ireland, PPP is rejected during the full and the first subsample but is accepted in the second subsample.

9. The BRI countries in our sample that have PPP with China include Austria, Italy, Latvia, Lithuania, Luxembourg, Portugal, Hungary, Albania, Serbia and Turkey only.

Additional information

Funding

This work was supported by the Research Grants Council, University Grants Committee of the Hong Kong Special Administrative Region (UGC/FDS15/B06/20). The responsibility lies with the authors.