Transcript China*s External Economy: Issues, Challenges and Prospects

China’s External Economy:
Issues, Challenges and Prospects
by
Dr Charles C L Kwong
Associate Professor and Programme Leader
Economics Programme
School of Arts and Social Sciences
The Open University of Hong Kong
[Content of this seminar should not be quoted without prior
approval from the author.]
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This seminar aims to:

review China’s foreign trade reform and its impacts on
the Chinese economy

explain China’s rationale for entering World Trade
Organization (WTO)

examine China’s adaptation and trade pattern after
WTO admission

evaluate the recent trend of China’s foreign direct
investment

discuss the issues of appreciation, convertibility and
internalization of RMB

assess preliminarily the feasibility of linking Hong Kong
dollar to RMB
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1. Foreign Trade Sector during the
Pre-reform Period 1949-1978
1.1 The Trade Pattern
 1952-1960: about 67% of trade with communist
countries, 48% of China’s total trade was with Soviet
Union

Import of industrial materials such as steel and fossil
fuel, as well as machinery

All these imports were crucial for China to support its
industrialization during the First Five Year Plan (FYP,
1953-58).
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1. Foreign Trade Sector during the
Pre-reform Period 1949-1978
1.1 The Trade Pattern
 The Great Leap Forward (GLF, 1958-60) followed by
extensive famine and economic crisis forced the Chinese
government to minimize its imports in order to leave more
foreign exchange for grain imports.

China’s trade volume was further reduced after the political
and ideological conflict between China and Soviet Union in
the late 1950s and early 1960s. The trade volume with Soviet
Union was less than 1% of China’s total trade by 1970.

In 1970-71, China’s trade participation ratio (E + IM / GDP)
was only 5%.
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1. Foreign Trade Sector during the
Pre-reform Period 1949-1978
1.2 Foreign Trade System
 A highly centralized system that tightly controlled the
flows of goods and money.

Twelve foreign trade corporations (FTCs) were set up
to exercise monopolies over both imports and exports.

Foreign exchange rate was officially set and renminbi
(RMB) was not fully convertible. Individuals and
enterprises could not freely exchange RMB for foreign
currency.
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1. Foreign Trade Sector during the
Pre-reform Period 1949-1978
1.2 Foreign Trade System
 Imports and exports were determined by central authorities.
The ‘foreign trade plan’ was heavily affected by the
consideration of self-reliance and the speeding up of
industrialization, particularly for heavy industry.

Imports were minimized except for raw materials, products,
and technology which could not be produced by China. The
primary objective of imports was to source inputs needed for
domestic industrial development.

Exports were to earn enough foreign exchange to pay for the
necessary imports
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1. Foreign Trade Sector during the
Pre-reform Period 1949-1978
1.3 Repercussions of the Centrally Planned Foreign Trade System

Separation of producers and consumers (end-users): lack of
market information e.g. consumer preference), low in
competitiveness

Lack of foreign exchange: when China started to accelerate its
import of machinery and technology in 1978-79, its foreign
exchange was only US$0.167 billion in 1978, in contrast with
US$1,946 in 2008. 1

Overvalued currency: it reduced the costs of imports, but at the
same time decreased the competitiveness of China’s exports.
1
National Bureau of Statistics of China , Zhongguo Tongji Nianjian CD-ROM
2009 (ZGTJNJ CD-ROM hereafter, China Statistical Yearbook 1985),
(Beijing: Zhongguo Tongji Chubanshe), Table 19-10.
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2. Foreign Trade Sector during the
Post-reform: 1978 onwards
2.1 Reform in the 1980s and 1990s

Demonopolization of trading rights: decentralize
trading rights to local authorities, industrial ministries,
and production enterprises. Local governments and
special economic zones (SEZs) were allowed to set up
FTCs. The number of FTCs increased substantially to
5,000 and 10,000 enterprises were approved the direct
trading rights in imports and exports in 1988 Naughton
(2007: 384).
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2. Foreign Trade Sector during the
Post-reform: 1978 onwards
2.1 Reform in the 1980s and 1990s

Loosening of Foreign Trade Plan: By early 1990s, all
mandatory export planning is abolished and only 11
items of imports were still under foreign trade plan (Chai
1997: 142).

More Market–Oriented Pricing Principles:
decentralization of trading rights and profit motive.
Trading enterprises have to set prices according to world
prices in order to maintain price competitive.

Devaluation of RMB: to reflect a more realistic
exchange rate, but RMB is still not fully convertible.
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2. Foreign Trade Sector during the
Post-reform: 1978 onwards
2.2 Accession to World Trade Organization (WTO) 2001
The Path of China’s Accession to WTO
 China was one of the 23 founding members of General
Agreement on Tariffs and Trade (GATT, the predecessor of WTO)
in 1948.
 China lodged its application to join GATT in 1986, but failed.
 GATT was reinstituted from a set of rules and agreements into an
international trade organization covering not just traded goods,
but also service trade and intellectual property rights. WTO was
formally set up in January 1995.
 In December 1995, China resumed its effort to negotiate its WTO
membership. China was formally admitted into WTO in December
2001.
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2. Foreign Trade Sector during the
Post-reform: 1978 onwards
2.2 Accession to World Trade Organization (WTO) 2001
Why was China so eager to join WTO?

Economic growth: It was estimated that China’s GDP growth
would grow by 0.5 percentage point each year after entering
WTO. The fact turns out to be an average annual growth of 9.9
percent from 2001 to 2005.

Promote economic reform: pressure for further institutional
reform.
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2. Foreign Trade Sector during the
Post-reform: 1978 onwards
2.2 Accession to World Trade Organization (WTO) 2001
Why was China so eager to join WTO?

Enhance competition: exposing domestic enterprises to foreign
competitors, through which enhancing the efficiency of
domestic industries.

Participate in formulating international rules (a rule setter)
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2. Foreign Trade Sector during the
Post-reform: 1978 onwards
2.2 Accession to World Trade Organization (WTO) 2001
China’s commitments and adaptation to WTO

Dispute settlement
China has to follow WTO's dispute settlement system in case
of international trade disputes.
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2. Foreign Trade Sector during the
Post-reform: 1978 onwards
2.2 Accession to World Trade Organization (WTO) 2001
China’s commitments and adaptation to WTO
 Transparency
and predictability
China is committed to provide a more transparent and
predictable system for business dealings. Laws and regulations
including those not previously available to the public will be
regularly published. A 30-day period for obtaining information
and commentary is instituted prior to the implementation of
new laws and regulations.
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2. Foreign Trade Sector during the
Post-reform: 1978 onwards
2.2 Accession to World Trade Organization (WTO) 2001
China’s commitments and adaptation to WTO
 Tariffs
China has significantly reduced its tariffs on industrial products by
January 2005 to 8.9% (down from an average of 25%). Tariffs on
furniture, toys and beer are eliminated. Tariffs have been significantly
reduced on medical equipment, scientific equipment, motor vehicles,
cosmetics, distilled spirits, paper products, and textiles. Tariffs on
products (such as semi-conductors, computers and telecom
equipments) under the Information Technology Agreement which
China joined have been eliminated by January 2005.
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2. Foreign Trade Sector during the
Post-reform: 1978 onwards
2.2 Accession to World Trade Organization (WTO) 2001
China’s commitments and adaptation to WTO
 Service
Commitments
Market access restrictions has been liberalized in service
sector including telecommunications, insurance, banking, and
professional services such as accounting, legal and management
services.
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2. Foreign Trade Sector during the
Post-reform: 1978 onwards
2.2 Accession to World Trade Organization (WTO) 2001
China’s commitments and adaptation to WTO
 Trading
Rights and Distribution
The previous restriction on the number of companies that have the
right to import and export goods are relaxed. All enterprises in
China are granted full trading rights (except for limited products
reserved for trade by state enterprises). The previous prohibition on
foreign companies distributing products through their own
wholesale and retail systems or to provide related distribution
services, such as repair and maintenance are lifted under China’s
commitments. At accession, China also committed to allow foreign
service suppliers to distribute chemical fertilizers, processed oil and
crude oil.
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2. Foreign Trade Sector during the
Post-reform: 1978 onwards
2.2 Accession to World Trade Organization (WTO) 2001
China’s commitments and adaptation to WTO
 Import Licensing
China's import licensing system previously posed a trade
barrier. This is, to a large extent, relaxed. In the businesses
where licensing is still in place, it must comply with the
principles of national treatment and non-discrimination.
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2. Foreign Trade Sector during the
Post-reform: 1978 onwards
2.2 Accession to World Trade Organization (WTO) 2001
China’s commitments and adaptation to WTO
 Importation and Investment Approvals
The WTO Agreement on Trade-related Investment Measures
and the TRIPS (trade-related aspects of intellectual property
rights) Agreement will be followed to ensure an easier
application and application procedures for importation and
investment approvals.
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2. Foreign Trade Sector during the
Post-reform: 1978 onwards
2.2 Accession to World Trade Organization (WTO) 2001
China’s commitments and adaptation to WTO
 Trade-related Intellectual Property Rights
China has to protect intellectual property rights by full
implementation of the TRIPS Agreement.
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2. Foreign Trade Sector during the
Post-reform: 1978 onwards
2.2 Accession to World Trade Organization (WTO) 2001
China’s commitments and adaptation to WTO
 Technical Barriers to Trade
China will comply with WTO Technical Barriers to Trade (TBT)
Agreement (e.g. inspection, testing, domestic taxes, and other
measures). Technical regulations will be based on international
standards and will be applied equally to domestic and foreign
products.
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2. Foreign Trade Sector during the
Post-reform: 1978 onwards
2.2 Accession to World Trade Organization (WTO) 2001
China’s commitments and adaptation to WTO
 Taxes
China will ensure that its laws and regulations relating to
internal taxes (national, provincial and local) and import
charges comply with WTO rules, and are applied in a nondiscriminatory way.
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2. Foreign Trade Sector during the
Post-reform: 1978 onwards
2.2 Accession to World Trade Organization (WTO) 2001
China’s commitments and adaptation to WTO
 Subsidies
All subsidies on industrial goods prohibited under WTO rules
are not allowed.
Source:
http://www.agrifoodasia.com/English/acc_CN/cn_wto.htm
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2. Foreign Trade Sector during the
Post-reform: 1978 onwards
2.3 Post-WTO Period (2001 onwards)
2.3.1 Foreign Trade

Dramatic drop in tariff (Table 1) – China becomes one of the
countries with lowest tariffs.
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2. Foreign Trade Sector during the
Post-reform: 1978 onwards
2.3 Post-WTO Period (2001 onwards)
2.3.1 Foreign Trade
 China has reduced the coverage of import licenses from 1,247
in 1992 to 261 items in 1999. In terms of import volume, about
50 percent of imports were subject to import licenses at the
end of 1989s while such figures declined to 5 percent in 2001.

To align China’s laws and regulations with those of the WTO,
China has revised about 3,000 laws, regulations and sectoral
rules since its accession to WTO and China enacted the
Foreign Trade Law in 2004 to institutionalized the business
practices corresponding to WTO principles (Wu 2007: 6).

Though China has lowered its tariffs substantially, its trade
volume and trade surplus continue to grow after 2000 (Table
2).
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2. Foreign Trade Sector during the
Post-reform: 1978 onwards
2.3 Post-WTO Period (2001 onwards)
2.3.1 Foreign Trade

China has become the second largest manufactures
exporting countries in the world in 2005 (Table 3). It
indicates that China maintains its comparative advantages
of producing manufacturing products, in particular those
labour-intensive products.
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2. Foreign Trade Sector during the
Post-reform: 1978 onwards
2.3 Post-WTO Period (2001 onwards)
2.3.2 Foreign Investment

Foreign direct investment (FDI) from abroad rose to USD45.5
billion in 1998 from USD11 billion in 1992, representing an
annual increase of 26.7%. It declined in 1999, but then picked
up afterwards by an average growth of 10.6% for the period of
2000 to 2007, reaching USD82.7 billion in 2007.

After China’s accession to WTO, contrary to conventional
wisdom, the shares of FDI from major developed
region/countries such as Hong Kong, U.K. and the U.S.
demonstrate a gradual decline while respective share of
Taiwan indicates a rise from 8.8% in 1997 to 11.2% in 2006
(Table 4).
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Note (a): The total amount represents FDI inflows to non-financial
sectors only.
Note (b): Cayman Islands and British Virgin Islands are leading
offshore financial centers. Based on estimation, about 53% of the
total funds from these centers originated from Hong Kong whereas
about 37% from Taiwan. Adjustments were made to present a clear
picture of the source of the Mainland’s FDI inflows. The respective
amounts of Cayman Islands and Virgin Islands on the table represent
the remaining 10%, which originated mainly from the US, Singapore,
E.U., and South Korea.
Source: China Statistical Yearbook (various issues); Shik and Yim
(2008: 3)
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3. China’s Exchange Rate Regime
Date
1969
1972-1979
Major Changes
The Chinese currency was renamed as Renminbi (RMB).
China began to list an Effective Rate for RMB against US$
in 1972. Since then, the official rates were adjusted
periodically. RMB was appreciated from 2.04 yuan per US
dollars to 1.5 yuan per US$ in Dec 1979.
1980 onwards
1985-1993
RMB depreciation (see Table 6)
Dual track system-coexistence of official exchange rate
and a lower swap rate (8.7 yuan per US$ in 1993), which
was more close to the market rate. Swap centers were
originally set up in 1985 to allow enterprises to transact
foreign currency. By 1991, individuals were allowed to sell
foreign currency at swap centers.
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Date
1994-2004
2005-2008
2008
Major Changes
Abolition of the dual track system in 1994-since
then, China’s foreign exchange rate system became a
managed floating system. The RMB exchange rates
were primarily determined at swap centre, but
closely monitored by the government. Prior to 2005,
RMB devaluated continuously
On that 21July 2005, the People’s Bank of China
proclaimed – after a minor initial revaluation of
2.1% - a switch to a managing float regime with
reference to a basket of currencies, instead of
pegging to US dollar. RMB appreciated about 20
percent during this period.
RMB appreciated beyond the level 7 yuan per dollar
in April 2008. The Chinese government reinstituted
its peg with US$ within a permissible range in July
2008.
Note: The shaded boxes indicate periods of RMB appreciation.
Source: ‘Historical Exchange Rate Regime of Asian Countries’ from
http://intl.econ.cuhk.edu.hk/exchange_rate_regime/index.php?cid=8
(accessed on 28 April 2010); Chai (1997: 145); Hu et. al. (2010: 45)
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3. China’s Exchange Rate Regime
3.2 Can RMB appreciation reduce US unemployment rate?
The labour force in China and the US was 792.43 million and
154.59 million in 2008 respectively. 2 China has maintained its
comparative advantage over the US in producing labour
intensive product.

2
Ibid. Table 4-1; US data from
http://www.economagic.com/emcgi/data.exe/blsln/lns11000000:(rev)
(accessed on 28 April 2010).
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3. China’s Exchange Rate Regime
3.2 Can RMB appreciation reduce US unemployment rate?

The wage ratio between US and Chinese workers is 7.9:1, 3 which
indicates a huge gap in labour costs. If RMB appreciation could be
an effective mean to reduce trade imbalance between the US and
China, the extent of appreciation must be very substantial, say 2040%, as claimed by some American economists. 4 Table 6 shows
that the appreciation of RMB by about 20 percent from 2005 to
2008 could not effectively correct the trade imbalance.
3
Author’s calculation based on the data from Hu et. al. (2010: 43)
4
Paul Krugman has recently argued in a strong way that China should
substantially appreciate its currency. For a discussion of Krugman’s
viewpoints, see
http://www.economist.com/blogs/freeexchange/2010/03/chinas_currency
(accessed on 28 April 2010)
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3. China’s Exchange Rate Regime
3.2 Can RMB appreciation reduce US unemployment rate?

Further, such an appreciation will mean that the US
consumers have to pay higher prices for imports from
China. More importantly, if the US market is free and
rational, US importing enterprises will only source their
imports from other Asian countries such as India and
Vietnam. This trade diversion will not benefit the US
workers.
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39
Note: *US exports, imports and trade balance was in billion US$ from 1980
to 1984 while the figures from 1985 onwards were in million US$.
40
Source:
Exchange rates from Naughton (2007: 383); ZGTJNJ (1984: 415; 1985:
519); ZGTJNJ CD-ROM Table 17-2; and
http://en.wikipedia.org/wiki/List_of_Renminbi_exchange_rates
(accessed on 27 April 2010);
State Administration of Foreign Exchange of the People's Republic of
China and People's Bank of China (quoted from
http://www.chinability.com/Rmb.htm accessed on 27 April 2010).
Trade data are derived from U.S. Census Bureau
http://www.census.gov/foreign-trade/balance/c5700.html#questions
(accessed on 27 April 2010) and Ho (1993: 17.29)
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3. China’s Exchange Rate Regime
3.3 What are the impacts of RMB appreciation on
the Chinese economy?

Reduction in import price will increase China’s demand
for import, which increase the welfare of Chinese
consumers in terms of consumer surplus.
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3. China’s Exchange Rate Regime
3.3 What are the impacts of RMB appreciation on
the Chinese economy?

Reduction in import prices decreases the risk of import
inflation. Price reduction in primary products, in
particular raw materials, helps lower the costs of
production in China, through which lessens cost pushinflation. In 2007, 25.4 percent of China’s total imports
were primary products while the figure soared to 32
percent in 2008. 5 It indicates that China is increasingly
relying on imported raw materials.
5
Author’s calculation based on the data from ZGTJNJ CDROM Table 17-1.
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3. China’s Exchange Rate Regime
3.3 What are the impacts of RMB appreciation
on the Chinese economy?

RMB appreciation reduces China’s net exports and
foreign exchange reserves. It decreases the monetary
base in China, which results in lower money supply and
inflation.

Related to the previous point, RMB appreciation will
alleviate investors/speculators’ expectation on further
RMB appreciation. It can downsize massive inflow of
capital, or more specifically hot money, speculating on
RMB appreciation. It in turn reduces the risks of assets
inflation.
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3. China’s Exchange Rate Regime
3.4 Feasibility of linking Hong Kong dollar to RMB

If Hong Kong is to maintain its linked exchange rate
system, Hong Kong dollar should be pegged with a
stable international currency.

To become an international currency, it has to be
demanded by other countries as:
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3. China’s Exchange Rate Regime
3.4 Feasibility of linking Hong Kong dollar to RMB
 Settlement currency: as a medium and unit of account
(pricing) of international exchanges for goods and service.
China has recently signed a number of Swap agreements with
emerging countries such as Malaysia, Indonesia and Argentina.
The agreement stipulates a fixed amount of RMB and a fixed
amount of foreign currency. The two trading partners are
then entitled to exchange their currency at a fixed exchange
rate within a specified period of time to facilitate their
bilateral trade. It allows bilateral trade between China and its
trading partners to bypass US dollar (Murphy and Yuan 2009:
12). Swap agreement speeds up RMB internationalization at
bilateral and regional level, but fails to become a vehicle (or
settlement) currency for third-party trade.
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3. China’s Exchange Rate Regime
3.4 Feasibility of linking Hong Kong dollar to RMB

Investment currency: as a medium of exchange and
unit of account for international financial products.
There have been so far very limited financial products
denominated in RMB exchanged in international
financial markets.
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3. China’s Exchange Rate Regime
3.4 Feasibility of linking Hong Kong dollar to RMB

Reserve currency: held substantially by countries as foreign
exchange reserves. To become a reserve currency, it must
establish a sound financial system in which foreign countries
have high degree of confidence. More importantly, the
reserve currency country is likely to run a current account
deficit and foreign countries must have current account
surpluses so that the foreign countries can acquire the
reserve currency. China is probably reluctant to give up its
current account surpluses due to employment consideration.
In additional, Table 7 robustly indicates that the dominant
status of US$ as reserve currency was not much changed in
the past decades, though some fluctuations exist.
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3. China’s Exchange Rate Regime
3.4 Feasibility of linking Hong Kong dollar to RMB

To become an international currency, China must first
make RMB fully convertible. Before RMB can reach a
higher level of internationalization, pegging with it may
not be very appropriate as no country/region will peg
to a currency of lower circulation than its domestic
currency. Moreover, RMB stability is another
consideration. Is RMB a stable currency? Would it be
stable if it gave up its managed float system and allowed
RMB to be fully convertible?
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References

Ho, Yin-Ping (1993) ‘China’s Foreign Trade and the Reform of
the Foreign Trade System,’ in Cheng, Joseph Y S and Maurice
Brosseau (eds.) China Review 1993, Hong Kong: The Chinese
University Press, pp. 17.1-17.41.

Hu, Jinyan (2010) ‘Reactivating Foreign Exchange Reform’
Caijing, No. 260, pp. 41-47.

Ianchovichina, Elena, and Martin, Will (2004) ‘Economic
Impact of China’s Accession to the WTO’, in Bhattasali,
Deepak, Li Shantong and Will Martin (eds.) China and WTOWTO Accession, Policy Change and Poverty reduction Strategy,
Beijing: China Finance and economics Press.
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References

Joseph C. H. Chai, China: Transition to a Market Economy
(New York: Clarendon Press Oxford, 1997), p. 118

Murphy, Melissa and Yuan, Wen Jin (2009) ‘Is China
ready to Challenge the Dollar?: Internationalization of
the Renminbi and Its Implication for the United State,’
A Report of CSIS Freeman Chair in China Studies, Centre
for Strategic and International Studies, Washington
DC., pp. 1-21.

Naughton, Barry (2007) The Chinese Economy:
Transition and Growth, Cambridge: MIT Press, pp. 37992.
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References

Shik, Thomas and Yim, Joanne (2008) ‘Mainland China’s Inward
Foreign Direct Investment – the Past and the Future’,
Economic Focus, Hang Seng Bank.

Wu, Angang (2007) ‘Tentative Evaluation of China’s Accession
to WTO: Impact on World Trade Growth Pattern’, paper
presented at the International Conference on ‘China in 5
Years After WTO Accession: Sharing Experiences with Vietnam’
September 24 - 25, 2007 in Hanoi and September 27-28 in
Hochiminh City

For China’s WTO commitments, see
http://www.agrifoodasia.com/English/acc_CN/cn_wto.htm
(accessed on 31 October 2008)
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