International trading systems and practices

China WTO Membership

Based on the Heckscher-Ohlin/Factor Proportions theory of trade, what would be the expected effects of China's WTO Membership on China? On the United States?

The Heckscher-Ohlin/Factor Proportions theory of trade, which attempts to predict the pattern of trade in goods between the two countries, based on their differences in factor endowments. This model assumes that trade occurs because countries have different resources. As opposed to the Ricardian model of trade, which assumed that trade occurs because countries use their technological comparative advantage to specialize in the production of different goods. (Feenstra, 2007, 95-96). The Heckscher-Ohlin model is more appropriate here because it explains trade in situations where each country have the same technologies, which is generally true of China and the United States at this point.

The Heckscher-Ohlin model focuses on specific factors of production as the determinants of trade behavior. These factors are labor, capital, and land. (97). The model assumes that there are two countries, home and foreign, the economies of which are composed by capital (K), labor (L), and production (P). (97). In this situation, the Heckscher-Ohlin Theorem posits that each country will export the good that uses intensively the factor of production it has in abundance and will import the other good. (104). According to the Stolper-Samuelson theorem, an increase in the relative price of a good will cause the real earnings of labor and capital to move in opposite directions: the factor used intensively in the industry whose relative price goes up will find its earnings increased and the real earnings of the other factor will fall. (134). The HO model predicts real gains for the factor used intensively in the export good, whose relative price goes up with the opening of trade, and real losses for the other factor(s). (134).

In the case of China and the United States at the point before the WTO accession, China had an abundance of labor and a scarcity of capital relative to the United States. According to the HO model, the liberalization and increase of trade resulting from the WTO accession would cause an increase in the relative price of labor-intensive products such as shoes. This increase will cause the earnings of labor to increase, while the earnings of capital would fall.

The United States had an abundance of capital and scarcity of labor relative to China. Here, the opening of trade should cause an increase in the relative price of capital-intensive products such as computers. This increase should cause the earnings of capital to increase, while the earnings of labor would fall.

2. Under what circumstances would China's WTO membership lead to trade creation? Trade diversion?

Generally, China's WTO membership will lead to trade creation if its tariffs were level against all countries. WTO membership, through the Most-Favored Nation principle, would require China to apply its most favorable tariff to all member countries of the WTO. Under these circumstances, the uniform reduction in tariffs created by WTO membership would cause China to maintain all of the trade that it had before WTO accession, since no member country would be made more tariff-competitive than another member country, allowing China to choose goods from the most cost-efficient source. In addition, the uniform reduction in tariffs would cause China to start purchasing goods that it previously produced itself because of the artificial cost added by pre-WTO tariffs. These new purchases would be considered trade creation.

Trade creation refers to a situation where two countries within the customs union begin to trade with each other, whereas formerly they produced the good in question for themselves. Thus, the countries go from autarky to trading with zero tariffs, and they both gain. (Feenstra, Advanced International Trade, 6.24). Here, China's WTO accession would result in trade creation if it starts trading in goods that it had previously produced on its own as a result of the WTO's removal of trade barriers.

Trade diversion occurs when two countries begin to trade within the union, but one of these countries had formerly imported the good from outside the union. (6-24). It will be presumed that the goods that the country had formerly imported were the most cost-efficient goods. After the union, the country switches its imports from the most cost-efficient goods to less cost-efficient goods, resulting in a negative efficiency effect. (6.24-25). Here, trade diversion would occur if, after WTO accession, China stops purchasing a cost-efficient good from a tariff-neutral country to a less cost-efficient good in a WTO member country for which it has lowered tariffs as a result of its membership.

China must not be involved in any customs unions or regional trade agreements that give preferential tariffs to union/RTA-members over outsiders. Generally, customs unions and FTAs violate the MFN principle by treating members differently from outsiders. If China is in such a union or RTA, the presence of preferential tariffs would cause China to switch current, cost-efficient foreign trade to less cost-efficient foreign trade which is offset by new tariff reductions.

3. If you had been advising the Chinese government prior to WTO-accession, would you have recommended joining the WTO? Why? Why not? Did China benefit from the accession?

I would have recommended that China enter the WTO because of the increased export competitiveness it would bring to China.

WTO membership, through the Most-Favored Nation principle, would guarantee China the same trading privileges and market access enjoyed by current WTO members. (Harvard Case Study, 3). This would decrease tariffs on Chinese exports in key consumer markets such as the United States and the European Union. Being an export-oriented economy, increased market access to such countries would not only increase exports of current goods, but would also allow China to start exporting new types of goods to these countries because of the uniform reduction in tariffs.

WTO membership also has the potential to increase imports into China. As mentioned earlier, the Most-Favored Nation principle would also require China to apply its most favorable tariff to all member countries of the WTO. Although China, being an export-oriented economy, is not necessarily interested in increased consumer imports, it is interested in industrial imports that are used as inputs for goods that will eventually be exported. (Harvard 3). Countries such as the United States and Germany are still the leading producers of much of the industrial machinery that Chinese businesses need to become more efficient and expand. These companies are often limited in acquiring this machinery because of tariffs, thereby limiting domestic economic growth.

Besides reducing tariffs, China will also have to grant increased market access in other ways. First China will have to lift restrictions on foreign ownership of Chinese companies, eventually allowing full foreign ownership of Chinese companies after an initial transition period. Also, China will have to allow foreign companies to do business in now-restricted sectors of the Chinese economy.

China must take note of the competitive threats that will come with increased foreign access to its market. (9). The increased competition, however, is not necessarily bad for the Chinese economy. Rather, increased foreign competition could help to weed out many of China's inefficient state-run firms, which have survived until now because of preferential treatment. (3). Their presence have suppressed the development of more capable firms in the Chinese private sector. Once the WTO stops such preferential treatment, Chinese private firms will be able to capitalize on the void left by these state-owned enterprises.

It appears now that China did indeed benefit from WTO accession. It posted double-digit growth in the years following its accession, fueled by exports into the United States and the E.U. In addition, it managed to maintain and even increase its trade surplus by keeping its currency artificially devalued, making imports into China more expensive and Chinese exports to other countries even cheaper. This strategy, not prohibited by the WTO, allowed China to prevented the Chinese market from being flooded with foreign goods and services.

4, if you had been advising the U.S. government prior to WTO-accession, would you have recommended voting for against China's accession to the WTO? Why? Why not? Did the United States benefit from China's accession?

I would have recommended that the United States vote for China's accession to the WTO. The United States, as the world's biggest economy, absolutely needs access to the world's second-biggest economy in order maintain economic growth. Increased access to the huge Chinese market will provide a number of opportunities for the United States, which is endowed with superior capital and skilled labor.

The United States is much stronger than China in high-margin industries, such as computer electronics and professional services. American companies like Apple and Microsoft can produce high-tech consumer goods vastly superior to those produced in China, at a price competitive with Chinese products. Computer electronics is one of the United State's few export strengths and is a direction in which the United States wants to go.