IB98014: China's Economic Conditions

Wayne M. Morrison

Foreign Affairs, Defense, and Trade Division

September 21, 2000

CONTENTS

• SUMMARY
• MOST RECENT DEVELOPMENTS
• BACKGROUND AND ANALYSIS
• An Overview of China's Economic Development
• China's Economy Prior to Reforms
• The Introduction of Economic Reforms
• China's Economic Growth Since Reforms: 1979-1999
• Causes of China's Economic Growth
• Measuring the Size of China's Economy
• China's Trade Patterns
• China's Major Trading Partners
• Major Chinese Trade Commodities
• Major Challenges Facing the Chinese Economy
• Recent Chinese Initiatives to Reform the Economy
• Reform of State Owned Enterprises
• Reform of the Banking System
• Infrastructure Development
• Major Issues in China-U.S. Economic Relations
• Trade
• China's Normal Trade Relations Status
• China's Accession to the World Trade Organization
• Outlook for China's Economy

SUMMARY

Since the initiation of economic reforms in 1979, China has become one of the world's fastest growing economies. From 1979-1999, China's GDP grew at an average annual rate of 9.7%. Some economists have speculated that China could become the world's largest economy at some point in the near future. The level of future economic growth will likely depend on the ability of the Chinese government to make significant new reforms. Nearly one third of China's industrial production comes from government state-owned enterprises (SOEs), many of which lose money and must be supported by the government through the banking system.

The global financial crisis, which began in mid-1997, negatively affected the Chinese economy (although not as severely as other economies in East Asia) during 1998 and the first half of 1999. China's real GDP growth slowed from 8.8% in 1997 to 7.8% in 1998. China's exports rose by only 0.5% in 1998 after rising by 20.9% in 1997. In addition, foreign direct investment declined sharply.

China sought to boost its exports by giving tax rebates to various industries, such as textiles and steel. The government sought to boost lagging domestic demand through large increases in public spending, especially for infrastructure projects. Economic recoveries in several East Asian economies and strong economic growth in the United States helped boost China's exports by 6.0% in 1999. Real GDP grew by 7.1% in 1999.

China is currently negotiating to become a member of the World Trade Organization (WTO), the international body that sets most trade rules. Major progress on China's WTO accession was achieved on November 15, 1999, when the United States and China signed a WTO bilateral trade agreement. China agreed (upon its accession to the WTO) to reduce tariffs and non-tariff barriers, remove investment restrictions, provide trading and distribution rights for foreign firms, and open various service sectors to foreign competition. Many analysts believe that such reforms, if fully implemented, could produce substantial new trade and investment opportunities for U.S. firms.

Opinions differ on the implications of China's accession to the WTO. Some observers charge that the Chinese government cannot be trusted to fully implement its WTO commitments, due its desire to protect certain industries and fears that employment disruptions could result from increased competition. Other observers contend that China's leaders are seeking WTO membership because it would force China to undergo the types of economic reforms needed to ensure continued healthy economy growth. Hence, it is argued, that it is within China's own economic interests to abide by its WTO commitments. Such observers contend that WTO membership will dramatically transform China's economy by strengthening the rule of law in China, expanding the development of the private sector, and diminishing the government's control over the economy.

For the WTO agreements to apply between the United States and China, Congress would (before China joins the WTO) have to pass legislation granting permanent normal trade relations (PNTR) status to China; currently that status is renewed annually. The House has passed PNTR legislation and the Senate is expected to take up the measure shortly after Labor Day.

MOST RECENT DEVELOPMENTS

On September 19, the Senate (by a vote of 83 to 15) passed the House-passed version of H.R. 4444, a bill that would grant PNTR status to China upon its WTO accession

On July 14, 2000, the Chinese government reported that real GDP during the first half of 2000 grew by 8.2%, and that exports had surged by 38.3%, over the comparable period in 1999.

On May 19, 2000, the European Union and China reached an agreement relating to China's bid to join the WTO.

On May 17, 2000, the House Ways and Means Committee passed H.R. 4444 (amended) and the Senate Finance Committee passed S. 2277. Both bills would extend PNTR status to China upon its accession to the WTO. On May 24, 2000, the House passed an amended version of H.R. 4444 by a vote of 237 to 197).

BACKGROUND AND ANALYSIS

An Overview of China's Economic Development

China's Economy Prior to Reforms

Prior to 1979, China maintained a centrally planned, or command, economy. A large share of the country's economic output was directed and controlled by the state, which set production goals, controlled prices, and allocated resources throughout most of the economy. During the 1950s, all of China's individual household farms were collectivized into large communes. To support rapid industrialization, the central government during the 1960s and 1970s undertook large-scale investments in physical and human capital. As a result, by 1978 nearly three-fourths of industrial production was produced by centrally controlled state-owned enterprises (SOEs) according to centrally planned output targets. Private enterprises and foreign invested firms were nearly non-existent. A central goal of the Chinese government was to make China's economy relatively self-sufficient. Foreign trade was generally limited to obtaining only those goods that could not be made or obtained in China.

China's real GDP grew at an estimated average annual rate of about 5.3% from 1960-1978. However, government policies kept the Chinese economy relatively stagnant and inefficient, mainly because there were few profit incentives for firms and farmers, competition was virtually nonexistent, and price and production controls caused widespread distortions in the economy. Chinese living standards were substantially lower than those of many other developing countries. The Chinese government hoped that gradual reform would significantly increase economic growth and raise living standards.

The Introduction of Economic Reforms

Beginning in 1979, China launched several economic reforms. The central government initiated price and ownership incentives for farmers, which enabled them to sell a portion of their crops on the free market. In addition, the government established four special economic zones for the purpose of attracting foreign investment, boosting exports, and importing high technology products into China. Additional reforms followed in stages that sought to decentralize economic policymaking in several economic sectors, especially trade. Economic control of various enterprises was given to provincial and local governments, which were generally allowed to operate and compete on free market principles, rather than under the direction and guidance of state planning. Additional coastal regions and cities were designated as open cities and development zones, which allowed them to experiment with free market reforms and to offer tax and trade incentives to attract foreign investment. In addition, state price controls on a wide range of products were gradually eliminated.

China's Economic Growth Since Reforms: 1979-1999

Since the introduction of economic reforms, China's economy has grown substantially faster than during the pre-reform period (see Table 1). Chinese statistics show real GDP from 1979 to 1999 growing at an average annual rate of 9.7%, making China one the world's fastest growing economies. According to the World Bank, China's rapid development has raised nearly 200 million people out of extreme poverty.

Table 1. China's Average Annual Real GDP Growth Rates: 1960-1999

Sources: Official Chinese government data reported by the World Bank, World Development Report (various issues), and DRI/McGraw-Hill, World Economic Outlook, various issues.

Causes of China's Economic Growth

Economists generally attribute much of China's rapid economic growth to two main factors: large-scale capital investment (financed by large domestic savings and foreign investment) and rapid productivity growth. These two factors appear to have gone together hand in hand. Economic reforms led to higher efficiency in the economy, which boosted output and increased resources for additional investment in the economy.

China has historically maintained a high rate of savings. When reforms were begun in 1979, domestic savings as a percentage of GDP stood at 32% (nearly as high as Japan's at the time). However, most Chinese savings during this period were generated by the profits of SOEs, which were used by the central government for domestic investment. Economic reforms, which included the decentralization of economic production, led to substantial growth in Chinese household savings (which now account for half of Chinese domestic savings). As a result, savings as a percentage of GDP has steadily risen; it was 42.7% in 1998, among the highest savings rates in the world.

China's trade and investment reforms and incentives led to a surge in foreign direct investment (FDI), which has been a major source of China's capital growth. Annual utilized FDI in China grew from $636 million in 1983 to $45.6 billion in 1998 (but dropped to an estimated level of $40.5 billion in 1999), making China, in recent years, the second largest destination of FDI (after the United States). Total utilized FDI at the end of 1999 reached $308 billion. About two-thirds of FDI in China has come from Hong Kong and Taiwan. The United States is the third largest investor in China, accounting for 8.0% ($24.6 billion) of total FDI in China from 1979 to 1999.

Several economists have concluded that productivity gains (i.e., increases in efficiency in which inputs are used) were another major factor in China's rapid economic growth. The improvements to productivity were largely caused by a reallocation of resources to more productive uses, especially in sectors that were formally heavily controlled by the central government, such as agriculture, trade, and services. For example, agricultural reforms boosted production, thus freeing workers to pursue employment in more productive activities in the manufacturing sector. China's decentralization of the economy led to the rise of non-state enterprises, which tended to pursue more productive activities than the centrally controlled SOEs. Additionally, a greater share of the economy (mainly the export sector) was exposed to competitive forces. Local and provincial governments were allowed to establish and operate various enterprises on market principles, without interference from the central government. In addition, FDI in China brought with it new technology and processes that boosted efficiency.

Measuring the Size of China's Economy

The actual size of the China's economy has been a subject of extensive debate among economists. Measured in U.S. dollars using nominal exchange rates, China's GDP in 1999 was $997 billion; its per capita GDP (a commonly used figure to measure and compare a nation's living standard) was $790. Such data would indicate that China's economy and living standards were significantly lower than those of the United States, Japan, and Germany. In nominal U.S. dollars, China's 1999 GDP was about 47% the size of Germany's, 23% that of Japan's, and 11% that of the United States. China's nominal per capita GDP was only 2.3% that of the United States (see Table 2).

Many economists, however, contend that using nominal exchange rates to convert Chinese data into U.S. dollars substantially underestimates the size of China's economy. This is because prices in China for many goods and services are significantly lower than those in the United States and other developed countries. Economists have attempted to factor in these price differentials by using a purchasing power parity (PPP) measurement, which attempts to convert foreign currencies into U.S. dollars based on the actual purchasing power of such currency (based on surveys of the prices of various goods and services) in each respective country. This PPP exchange rate is then used to convert foreign economic data in national currencies into U.S. dollars.

Because prices for many goods and services are significantly lower in China than in the United States and other developed countries (while prices in Germany and Japan are higher than those in the United States), the PPP exchange rate raises the estimated size of Chinese economy to $5.6 trillion, higher than Japan's GDP in PPP ($2.9 trillion) and Germany's ($1.7 trillion), and slightly over half the size of the U.S. economy. PPP data also raise China's per capita GDP to $4,228; however, this figure falls far below the PPP per capita GDP levels of the major developed countries (for example, its only 12.5% of U.S. levels).

The PPP data appear to indicate that, while the size of China's economy as a whole is quite large and currently could be the world's second largest, its living standards are quite low. (To illustrate, the World Bank estimates that nearly 30% of China's population live below the international poverty level of $1 per day.) The International Monetary Fund estimates that (using PPP measurements) China could surpass the United States as the world's largest economy as early as the year 2007. Yet, even if that were to occur, it would take China significantly longer to achieve U.S. standard of living levels.

Table 2. Comparisons of U.S., Japanese, German, and Chinese GDP and Per Capita GDP In Nominal U.S. Dollars and PPP: 1999

Source: DRI/McGraw Hill. World Economic Outlook, Volume I 1st Quarter, 2000, p.A-27.

Note: PPP data for China should be interpreted with caution. China is not a fully developed market economy; the prices of many goods and services are distorted due to price controls and government subsidies.

China's Trade Patterns

Economic reforms have transferred China into a major trading power. Chinese exports rose from $14 billion in 1979 to nearly $195 billion in 1999, while imports grew from $16 billion to $166 billion. China's ranking as a trading power rose from 27^th in 1979 to 10^th in 1998. In 1999, China's exports rose by 6.0%, while imports increased by 17.7%. Historically, China has run trade deficits in some years and surpluses in others. Over the past 7 years, China has run trade surpluses; in 1999 that surplus was $29.1 billion (see Table 3). Merchandise trade surpluses and large-scale foreign investment have enabled China to accumulate the world's second largest foreign exchange reserves, estimated to total $155 billion at the end of 1999.

Table 3. China's Merchandise World Trade: 1979- 1999
($Billions)

Source: International Monetary Fund, Direction of Trade Statistics and official Chinese statistics.

China's Major Trading Partners

China's trade data often differ significantly from those of its major trading partners. This is due to the fact that a large share of China's trade (both exports and imports) passes through Hong Kong (which reverted back to Chinese rule in July 1997, but is treated as a separate customs area by most countries, including China and the United States). China treats a large share of its exports through Hong Kong as Chinese exports to Hong Kong for statistical purposes, while many countries that import Chinese products through Hong Kong generally attribute their origin to China for statistical purposes.

According to Chinese trade data, its top five trading partners in 1999 were Japan, the United States, the European Union (EU), Hong Kong, and South Korea (see Table 4). Chinese data show the United States as China's second largest destination for its exports and the third largest source of its imports.

Table 4. China's Top 10 Trading Partners: 1999
($Billions)

Source: Official Chinese trade data.

Note: Chinese data on its bilateral trade often differ substantially from the official trade data of other countries on their trade with China.

*China and Taiwan do not maintain direct trade links. Most trade takes place via Hong Kong.

Table 5 lists official Japanese, EU, and U.S. data on their respective trade with China for 1999. These data differ sharply with Chinese data on its trade with these trading partners.

Table 5. Japanese, EU, and U.S. Trade with China: 1999*
($ Billions)

*Official government data on trade with China.

U.S. trade data indicate that the importance of the U.S. market to China's export sector is likely much higher than is reflected in Chinese trade data. Based on U.S. data on Chinese exports to the United States (which, as noted, do not agree with Chinese data), and Chinese data on total Chinese exports, it is estimated that Chinese exports to the United States as a percentage of total Chinese exports grew from 15.3% in 1986 to an estimated 42.0.% in 1999. This would indicate that the United States is by far China's largest export market.

A growing level of Chinese exports are from foreign funded enterprises (FFEs) in China. According to Chinese data, the share of total Chinese exports produced by FFEs rose from 0.1% in 1980 to 44.1% in 1998. A large share of these FFEs are owned by Hong Kong and Taiwan investors, many of whom have shifted their labor-intensive, export-oriented, firms to China to take advantage of low-cost labor. A significant share of the products made by such firms are exported to the United States.

Major Chinese Trade Commodities

China's abundance of cheap labor has made it internationally competitive in many low cost, labor-intensive, manufactures. As a result, manufactured products comprise an increasingly larger share of China's trade. The share of Chinese manufactured exports to total exports rose from 50% in 1980 to 90% in 1999, while manufactured imports as a share of total imports rose from 65% to 84%. A large share of China's manufactured imports are comprised of intermediates (e.g., chemicals, electronic components, and textile machinery) used in manufacturing products in China. Major Chinese imports in 1999 included (1) electrical machinery and parts, (2) mineral fuels and related materials, (3) primary plastics, (4) office machines and automatic data processing machines, and (5) iron and steel (see Table 6). China's major 1999 exports included (1) articles of apparel and clothing, (2) electrical machinery, equipment, and parts (3) footwear and parts, (4) vehicles, aircraft, and ships, and (5) toys (see Table 7).

Table 6. Major Chinese Imports: 1999

Source: Official Chinese trade statistics

Table 7. Major Chinese Exports: 1999

Source: Official Chinese trade data.

Major Challenges Facing the Chinese Economy

China's economy has shown remarkable economic growth over the past several years, and many economists project that it will enjoy fairly healthy growth in the near future. Standards and Poor's DRI, a private international forecasting firm, projects China's GDP will grow at an average annual rate of about 6.7 over the next 15 years. Economists caution, however, that these projections are likely to occur only if China continues to make major reforms to its economy. Failure to implement such reforms could endanger future growth.

• State-owned enterprises (SOEs), which account for about one-third of Chinese industrial production and employ nearly two-thirds of urban workers, put an increasingly heavy strain on China's economy. Over half are believed to lose money and must be supported by subsidies, mainly through state banks. Government support of unprofitable SOEs diverts resources away from potentially more efficient and profitable enterprises. In addition, the poor financial state of many SOEs makes it difficult for the government to reduce trade barriers out of fear that doing so would lead to wide-spread bankruptcies of many SOEs.

• The banking system faces several major difficulties due to its financial support of SOEs and failure to operate solely on market-based principles. China's banking system is regulated and controlled by the central government, which sets interest rates and attempts to allocate credit to certain Chinese firms. The central government has used the banking system to keep afloat money-losing SOEs by pressuring state banks to provide low interest loans, without which a large share of the SOEs would likely go bankrupt. Currently, about 70% of state-owned bank loans now go to the SOEs, even though a large share of loans are not likely to be repaid. The high volume of bad loans now held by Chinese banks (estimated to total $250 billion) poses a serious threat to China's banking system. Three out of the four state commercial banks are believed to be insolvent. The precarious financial state of the Chinese banking system has made Chinese reformers reluctant to open its banking sector to foreign competition. Corruption poses another problem for China's banking system because loans are often made on the basis of political connections. In many cases, bank branches extend loans to firms controlled by local officials, even during periods when the central government has attempted to limit credit. Such a system promotes widespread inefficiency in the economy because savings are generally not allocated on the basis of obtaining the highest possible returns. In addition, inability to control the credit policies of local and provincial banks has made it very difficult for the central government to use monetary policy to fight inflation without causing major disruptions to the economy.

• Infrastructure bottlenecks, such as inadequate transportation and energy systems, pose serious challenges to China's ability to maintain rapid economic growth. China's investment in infrastructure development has failed to keep pace with its economic growth The World Bank estimates that transportation bottlenecks reduce China's GDP growth by 1% annually. Chronic power shortages are blamed for holding China's industrial growth to 80% of its potential. Transportation bottlenecks and energy shortages also add inflationary strains to the economy because supply cannot keep up with demand.

• The lack of the rule of law in China has led to widespread government corruption, financial speculation, and mis-allocation of investment funds. In many cases, government "connections," not market forces, are the main determinant of successful firms in China. Many U.S. firms find it difficult to do business in China because rules and regulations are generally not consistent or transparent, contracts are not easily enforced, and intellectual property rights are not protected (due to the lack of an independent judicial system). The lack of rule of law in China limits competition and undermines the efficient allocation of goods and services in the economy. In addition, the Chinese government does not accept the concept of private ownership of land and assets in China

• High trade barriers are maintained by the government in large part to protect domestic firms from foreign competition. Such policies have two main negative effects: First, they give domestic firms less incentive to improve efficiency. Second, restricting competition raises prices and limits product choices for Chinese consumers.

• A wide variety of social problems have arisen from China's rapid economic growth and extensive reforms, including pollution, a widening of income disparities between the coastal and inner regions of China, and a growing number of bankruptcies and worker layoffs. This poses several challenges to the government, such as enacting regulations to control pollution, focusing resources on promoting economic development in the hinterland, and developing modern fiscal and tax systems to address various social concerns (such as poverty alleviation, health care, education, worker retraining, pensions, and social security).

Recent Chinese Initiatives to Reform the Economy

At a news conference in March 1998, newly appointed Chinese Premier Zhu Rongji outlined a number of major new economic initiatives and goals for reforming China's economy and maintaining healthy economic growth, including:

• Respond to the effects of the Asian financial crisis by not devaluing China's currency, expanding domestic demand (especially through increased spending on infrastructure), and maintaining the pace of previously planned economic reforms.

• Reform and restructure loss-making medium-and-large-sized state-owned enterprises (SOEs) to make them profitable. Reorganize the banking system to increase the regulatory and supervisory power of the central bank and make commercial banks operate independently. Substantially reduce the size of the government and reorganize the remaining government institutions. All three goals to be obtained within three years.

• Commercialize government housing, reform the health insurance system, improve the system the for circulating grain, rationalize the system for approving investment and finance projects, and improve tax collection.

Zhu Rongji's economic plan was viewed at the time by many analysts as representing the most significant restructuring of the economy to date, since it called for a significant reduction in the size of the government and diminished control over various sectors of the economy, dismantling of much of the remaining "iron rice bowl" of cradle-to grave benefits for government and SOE workers, the commercialization of bank loans, and significant restructuring of the SOEs. Implementation of such policies would take China significantly closer towards a functioning market economy. Progress of these reforms is discussed below.

Reform of State Owned Enterprises

The Chinese leadership has been talking about undertaking major reforms of unprofitable SOEs for the past several years, but has been hesitant to act due to concerns that reforms would lead to widespread bankruptcies and cause political instability. However, the Chinese government has acknowledged that support of SOEs has put a heavy drain on the economy and cannot be maintained indefinitely. As a result, reform of SOEs has been made a top priority. In September 1997, Chinese President Jiang Zemin stated that China would take steps which, if implemented, would essentially privatize (although referred to by the Chinese as "public ownership") all but 1,000 out of an estimated 308,000 SOEs by cutting off most government aid and forcing them to compete on their own. This policy was re-affirmed and expanded upon by Premier Zhu Rongji in March 1998. Under the government's proposed plan, some unprofitable SOEs would be closed, while others will be merged with more profitable enterprises. Many firms would be allowed to issue stock in order to raise funds. Another source of revenue for SOEs would come from workers who would be allowed to purchase their own homes, and SOEs would be released from the responsibility of providing subsidized housing. The central government indicated plans to maintain support and control of 1,000 large and medium-sized enterprises deemed as key industries, but would reorganize and restructure them into large conglomerates in the hope of making them more competitive. Premier Zhu Rongji indicated that these reforms would be implemented within three years. However, the economic slowdown experienced in 1998 and early 1999 caused the government to slow down the pace of SOE reform, due to concerns that massive layoffs would result.

Reform of the Banking System

Chinese officials have indicated a desire to strengthen and reform its banking system.

In January 1998, the central government announced it would implement new reforms to enhance the power of the central bank over the provincial and state banks and to improve the management systems of all Chinese banks. Such reforms would attempt to lessen the power of local officials to pressure banks into making "bad loans." In addition, the government has indicated that banks will be allowed to make bank loan decisions based on commercial, considerations. Finally, on March 2, 1998, the government announced plans to issue bonds to recapitalize the state banks to enable them to write off bad loans. Chinese officials claim their long-term goal is to develop a modern banking system similar to that of the U.S. Federal Reserve system. However, the slowdown in the economy caused the central government to resume pressure on the state banks to continue to lend money to money-losing enterprises.

Infrastructure Development

The Chinese government's concerns over the disruptive effects of economic reforms and sluggish domestic demand have led the government to significantly boost spending on infrastructure spending. Chinese officials announced in February 1998 their intentions to spend $750 billion on infrastructure development over the next 3 years; in September 1998, Chinese officials indicated that $1.2 trillion would be spent. Many analysts, however, have questioned China's ability obtain funding for such a massive financial undertaking in such a short period of time. The issuance of government bonds has become a major source of finance for infrastructure, which has increased government budget deficits.

Major Issues in China-U.S. Economic Relations

China's growth as a major economic and trading power has expanded U.S.-China commercial ties, although disputes have arisen over a number of issues, such as trade investment barriers, China's most-favored-nation (MFN), or normal trade relations(NTR), status, and the terms for China's accession to the World Trade Organization (WTO). The World Bank projects that by the year 2020, China will be the world's second largest trading economy after the United States. China's continued rapid growth has increased concerns among U.S. policymakers that China's trade regime must be brought in compliance with multilateral rules to ensure that U.S. firms are given access to China's growing markets.

Trade

Total trade between China and the United States rose from $4.8 billion in 1980 to estimated level of $94.9 billion in 1999, making China the 4th largest U.S. trading partner. China has become a major supplier to the U.S. market of a variety of low-cost U.S. consumer goods, such as toys and games, textiles and apparel, shoes, and consumer electronics, while China has been a major buyer of U.S. aircraft, fertilizers, and machinery. In recent years, U.S. imports from China have far exceeded U.S. exports to China (in 1999, U.S. imports from China totaled $81.8 billion while U.S. exports to China were $13.1 billion). As a result, the U.S. trade deficit with China has surged, reaching nearly $69 billion in 1999. U.S. officials claim that China's widespread and pervasive use of trade and investment barriers and restrictions for the relatively lackluster growth of U.S. exports to China, while Chinese officials argue that U.S. export controls substantially diminish U.S. export sales to China. (see CRS Issue Brief IB91121, China-U.S. Trade Issues).

China's Normal Trade Relations Status

On July 22, 1998, President Clinton signed into law P.L. 105-206 (a bill to reform the Internal Revenue Service), which contained a provision replacing the term "most-favored nation (MFN) status" with the term "normal trade relations" (NTR) in U.S. trade law. This change was made to help dispel the belief of some that the term "MFN status" indicates a preferential trade status, when in fact it indicates the trade status afforded by the United States to all but a handful of countries. Under current U.S. law, China's MFN (NTR) status must be renewed on an annual basis. In recent years, several attempts have been made in Congress to pass legislation to revoke, partially revoke, or add new conditions to, the renewal of China's MFN (NTR) status. None of these bills have been enacted.

A withdrawal of China's MFN (NTR) status would result in a substantial increase in the applicable rates and amounts of customs duties assessed on most U.S. imports from China. Imports from China would be assessed tariffs according to "Column 2" non-MFN (NTR) rates of duty in the U.S. Harmonized Tariff Schedule (HTS), which are generally significantly higher (up to 10-fold in some instances) than those under "Column 1-General" MFN (NTR) treatment. These higher tariffs would likely result in higher prices for U.S. consumers of the affected items and subsequently a decrease in U.S. imports of various Chinese products.

On June 2, 2000, President Clinton issued a waiver to continue in effect China's NTR status for another year, pending Congressional action to extend permanent NTR status to China. On July 13, 2000, the House Ways and Means Committee reported out adversely by voice vote H.J.Res. 103 (Rep. Dana Rohrabacher), a measure that would effectively terminate China's NTR status. That measure was defeated in the House on July 18, 2000, by a vote of 281 to 147.

China's Accession to the World Trade Organization

China has made its accession to the World Trade Organization (WTO) a major priority for a number of reasons. First, it would represent international recognition of China's growing economic power. Second, it would enable China to play a major role the development of new international rules on trade in the WTO. Third, it would give China access to the dispute resolution process in the WTO, reducing the threat of unilateral trade sanctions against China or other unilateral restrictions on Chinese exports (such as textile quotas and antidumping duties). Fourth, it would make it easier for reformers in China to push liberalization policies if they could argue that such steps are necessary to fulfill China's international obligations. Finally, China hopes it would gain it permanent MFN/NTR treatment from the United States.

Several arguments have been made by policymakers of current WTO member countries for allowing China into the WTO. First, China is the largest economic and trade power not a member of the WTO. The World Bank projects that China's share of world trade will account for 10% of the world's trade by the year 2020 and that China will become the world's second largest trading nation after the United States. Hence, it is argued that China's trade is too significant to remain outside multilateral trade rules. Second, WTO membership would require China to reduce a wide variety of trade barriers and, hence, would likely create substantial new trade opportunities in China. Third, once China is in the WTO, it would be required to provide extensive information about its trade regime, which would make it very difficult for China to impose new trade and investment barriers. Fourth, the United States (and other WTO members) would be able to bring trade disputes to WTO dispute resolution instead of having to rely on threats of unilateral trade sanctions. Fifth, China's accession would require it to strengthen the rule of law in China, which could further promote the development of the private sector in China, while reducing government control over most sectors of the economy. Finally, China's accession might enable Taiwan to eventually join the WTO (as a separate customs territory). China has insisted that Taiwan can get into the WTO only after China does.

Conversely a number of arguments have been made to keep China out of the WTO. First, it is argued that China is not a market economy and that its economic and trade regimes are inconsistent with WTO rules; hence, China should be kept out of the WTO until it has first adopted a fully market-oriented economy. Second, it is unclear if the Chinese government would fully implement its WTO commitments, due to its desire to the promote the development of certain industries and its concerns that reforms could lead to wide-spread layoffs and political instability. Third, once a WTO member, China may oppose U.S. initiatives to further liberalize world trade. Fourth, many U.S. labor groups argue that China's membership in the WTO would result in increased exports to the United States, which could suppress U.S. wages and cost jobs in certain industries. Finally, many human rights groups oppose China's WTO entry until it first improves its human rights policies.

On November 15, 1999, U.S. and Chinese officials reached a bilateral agreement on China's WTO bid. The entire agreement was made public by the Clinton Administration on March 14, 2000. Upon its accession to the WTO, China would make several major reforms:

• Provide full trading and distribution rights (including the ability to provide services auxiliary to distribution) for U.S. firms in China.

• Cut overall average tariffs for U.S. priority products would fall from 31.5% to 14.5% by 2004. Overall industrial tariffs would fall from an average of 24.6% to 9.4% by 2005. Tariffs on information technology products would be reduced from an average level of 13.3% to zero by the year 2005.

• Establish a tariff-rate quota system for imports of agricultural bulk commodities (such as wheat, corn, cotton, barley, and rice), i.e., imports up to a specified quota level would be assessed a low tariff (1-3%), while imports above a certain level would be assessed a much higher tariff rate. In addition, private trade in agricultural products would be permitted

• Phase out quotas and other quantitative restrictions (some upon accession, many within two years, and most within five years), eliminate unscientifically based sanitary and phytosanitary restrictions, and end export subsidies on agricultural products.

• Open service sectors (many of which are currently closed to foreign firms), including distribution, value-added telecommunications, insurance, banking, securities, and professional services.

• Reduce restrictions on auto trade (such as tariffs and quotas).

• Provide fair treatment for foreign firms operating in China, including the elimination of technology transfer, local content, and export performance requirements.

• Accept the use by the United States of certain safeguard, countervailing, and antidumping provisions (over transitionary periods) to respond to possible surges in U.S. imports from China of various products, such as textiles, that might cause or threaten to cause market disruption to a U.S. industry.

The conclusion of the U.S.-China WTO trade agreement has given new momentum towards completing China's WTO accession process. China must complete negotiations with a few other WTO members, including the European Union, as well as the WTO Working Party, which is handling China's WTO accession bid, before a vote can be taken in the WTO on China's membership. Many analysts argue that current U.S. trade law requiring an annual renewal of China's NTR status (based on the conditions set forth by the Jackson-Vanik amendment to the 1974 Trade Act, as amended) is inconsistent with WTO rules, which require members to afford each other "unconditional" MFN treatment. Unless U.S. law was changed to give PNTR status to China, the United States, prior to China's WTO accession, would be forced to invoke Article XIII in the WTO, the non-applicability clause. Invoking Article XIII would technically prevent the United States and China from applying the WTO agreements to one another. If this were to occur, it is not clear whether U.S. exporters and investors in China would receive the full benefits of the trade concessions China will make to get into the WTO. A 1979 trade agreement between the United States and China requires the two nations to afford each other MFN treatment. However, some trade analysts have argued that the 1979 agreement is very broad and does not specifically address many issues that will be included in China's WTO protocol of accession, such as trading rights and trade in various services. If China failed to give U.S. firms equal treatment, the United States would be unable to use the WTO dispute resolution mechanism, but instead would have to rely on unilateral pressure against China. Due to the uncertainty that would likely govern U.S.-China trade relations if Article XIII was invoked, the Clinton Administration has urged Congress to pass legislation granting PNTR status to China as soon as possible.

On May 17, 2000, the House Ways and Means Committee passed H.R. 4444 and the Senate Finance Committee passed S. 2277; Both bills simply would have granted PNTR status to China upon its accession to the WTO. On May 24, 2000, the House passed an amended version of H.R. 4444 that contained provisions dealing with a wide variety of congressional concerns. The amended bill would establish a Congressional-Executive commission to monitor and report on China's human rights and labor practices, create a special government task force to halt U.S. imports of products from China using prison labor, codify the anti-import surge provisions of the November 1999 U.S.-China WTO trade agreement, and require the U.S. Trade Representative (USTR) to report annually on China's compliance with its WTO commitments.

The Senate approved a motion to proceed with the consideration of H.R. 4444 on September 7, 2000. Several Senators offered amendments to the bill dealing with such issues as weapons proliferation and China's human rights policies. None of these amendments passed, and the Senate approved the bill on September 19, 2000, by a vote of 83 to 15.

Outlook for China's Economy

The long term outlook for the Chinese economy remains mixed. China has been able to weather out the effects of the Asian financial crisis, although this has done at the cost of delaying economic reforms to the SOEs and the banking system. Continued support of money-losing SOEs draws resources away from more potentially productive enterprises, and thus undermines future growth. China's commitment to join the WTO appears to represent a major commitment on the part of the Chinese government to significantly reform its economy and provide greater access to its markets. Some China observers believe that the Chinese government views accession to the WTO as an important, though painful, step to making Chinese firms more efficient and able to compete in world market (by exposing them to competition from abroad). In addition, the government hopes that liberalized trade rules will attract more foreign investment to China.

Economists argue that over the long-run greater market openness in China would boost competition, improve productivity, and lower costs for consumers, as well as for firms using imported goods as inputs for production. Economic resources would be more likely redirected away from money-losing activities towards more profitable ventures, especially those in China's growing private sector. As a result, China would likely experience more rapid economic growth (than would occur under current economic policies). Goldman Sachs estimates that WTO membership would double China's trade and foreign investment levels by the year 2005 and raise real GDP growth by an additional 0.5% per year.

In the short run, however, widespread economic reforms (if implemented) could result in disruptions in certain industries, especially unprofitable SOEs, due to increased foreign competition. As a result, many firms would likely go bankrupt and many workers could lose their jobs. How the government handles these disruptions will strongly determine the extent and pace of future reforms. The central government appears to be counting on trade liberalization to boost foreign investment and spur overall economic growth; this would enable laid-off workers to find new jobs in high growth sectors, especially in China's growing private sector. However, the Chinese government is deeply concerned with maintaining social stability. If trade liberalization were followed by a severe economic slowdown, leading to widespread bankruptcies and layoffs, the central government might choose to halt certain economic reforms rather than risk possible political upheaval.

Return to CONTENTS section of this Issue Brief.