China's WTO Accession: Economic Impact and Market Expansion

Introduction

On December 11, 2001, China officially became a member of the World Trade Organization (WTO), opening the country's doors to change and a new economy. One year after China's entry into the WTO, the country reported great success, showing better-than-expected economic growth and fulfillment of its WTO commitments, despite the shaky world economy.

The excellent performance of the Chinese economy was clearly demonstrated by its 8 percent growth rate for gross domestic product and the significant growth in trade and inflow of foreign direct investment. As a result of its entry into the WTO, financial experts forecast that China would become the fifth-largest trading country with an import-export volume worth US$600 billion and one of the most attractive areas for foreign direct investment, which exceeded US$50 billion in 2002 alone.

This paper discusses China's entry into the WTO and addresses the question of whether China's markets expanded following its accession.

History of China's Economic Structure

Following the death of Mao Zedong in 1976, it became apparent to China's political leaders that economic reform was desperately needed. During Mao Zedong's tenure as China's premier, he had pushed for many social movements, including the Great Leap Forward and the Cultural Revolution, which aimed to serve the people and maintain the class struggle.

By 1978, "Chinese leaders were searching for a solution to serious economic problems produced by Hua Guofeng, the man who had succeeded Mao Zedong as CCP leader after Mao's death" (Shirk, p. 35). Hua Guofeng had attempted to carry on the idealistic movements of Mao Zedong. However, his plans did not succeed. Instead, these movements pushed China into a state where "agriculture was stagnant, industrial production was low, and the people's living standards had not increased in twenty years" (Nathan, p. 200).

The stagnation of the people's standard of living troubled China's leaders. While "the gross output value of industry and agriculture increased by 810 percent and national income grew by 420 percent (from the 1950s to the 1980s)," the "average individual income increased by only 100 percent" (Shirk, p. 28).

While the Chinese Communist Party (CCP) aimed to improve economic conditions to help the people, it also knew that changes would strengthen the political party, which was rapidly losing support. According to Shirk (p. 23), restoring the CCP's political position required improving economic performance and raising living standards. Due to the fact that the errors made during the Cultural Revolution had decreased popular trust in the moral and political virtue of the CCP, the party knew it had to shift the basis of party legitimacy from "virtue to competence" (Shirk, p. 23). To accomplish this, the party would need to carry out a major economic reform.

This shift from "virtue to competence" would completely move the country away from an era of orthodox Chinese political theory. Confucius, in the fifth century BCE, had stated that those who best demonstrated great moral force should lead the country. As a result, for centuries, China had chosen its leaders based on tests of their moral virtue. After the Communist Party took power, Mao Zedong carried on this tradition, requiring Chinese citizens to demonstrate what he called "correct consciousness."

According to Shirk, the Chinese Communist Party viewed economic reform as a means of regaining its moral legitimacy even after Mao Zedong's death. By showing a more practical type of competence, China's leaders felt that the people of the nation would feel better served.

Initially, the new economy did not change radically. China was "still a state in which the central government retained the dominant power in economic resource allocation and responsible local officials worked for the interest of the units under their control" (Solinger, p. 103). However, changes were undoubtedly being made. According to Shirk, in rural areas, decollectivization was taking place: "decision-making power was transferred from collective production units (communes, brigades, and teams) to the family" (Shirk, p. 38) and "purchase prices for major farm products were increased" (p. 39).

By 1985, further reforms were called for. Long-term sales contracts between farmers and the government were created and maintained. In addition, in an effort to allow the market to determine prices, "city prices of fruit and vegetables, fish, meat, and eggs were freed from government controls so they could respond to market demand" (Shirk, p. 39). A "surge of private and collective industry and commerce in the countryside" (p. 39) also occurred. These changes enabled much of the population to engage in private enterprise and investment in family or group ventures. Rural villagers were also able to leave China's villages and move to urban areas, where they became involved in industrial sectors (Shirk, p. 40).

China's economy grew rapidly, causing major inflation and forcing the government to place price controls on products and services. At this juncture, China's leaders decided that it would be beneficial to join the world economy. They hoped to achieve this through two avenues: by expanding foreign trade, and by encouraging foreign companies to invest in Chinese enterprises. This policy, called the "Open Policy" (Shirk, p. 47), represented a drastic shift from the policies of Mao Zedong and from centuries of Chinese rule.

The new policy designated certain areas in China "as places with preferential conditions for foreign investment and bases for the development of exports" (Nathan, p. 99). It proved very successful in the areas where it was implemented (Shirk, p. 47). However, many Chinese people viewed this policy as nothing less than an avenue to "economic dependency" (Nathan, p. 50). When the policy was first implemented, many feared that it would pull China back toward its former semi-colonial status as "a market where the imperialist countries dump their goods, a raw material base, a repair and assembly workshop, and an investment center" (Nathan, p. 51).

However, it soon became apparent that the Open Policy would be successful, and resistance diminished. The Open Policy had an enormous impact on the success of the growing Chinese economy. It enjoyed such great success that by 1988, Chinese leaders decided to implement a new program called the "coastal development strategy." This strategy opened more of China to foreign investment, giving other countries access to China's market, which included about 200 million people at the time. By involving more foreign investors, "importing both capital and raw materials," and "exporting China's cheap excess labor power," the new policy was one of "'export-led growth' or 'export-oriented industrialization'" (Nathan, p. 99).

However, these policies presented China with many new difficulties. Inflation went out of control, prices doubled in the industrial zones, and commercial and residential rates escalated (Tyler, p. A8). As trade expanded globally and countries within geographical proximity and of similar cultural background allied themselves to compete on a global level, China showed that it might be successful in competing in global markets, which would stimulate the economies of almost all member states (Dorn, 1990, p. 42).

The effects of China's change in economic strategy were felt by nearly every nation involved in international trade. The change in the volume of imports and exports to and from China increased demand across many markets. With increasing foreign investment, the socialist republic continued to become more interdependent with the world economy. However, the impressive growth rate of China's economy was not an entirely flawless process. When China opened its economic borders, many of its systems were still inefficient.

In the 1980s and 1990s, China emerged as a major player in the global economy, and economists say that no other country has ever expanded its role so quickly (Lardy, 2001). Its foreign trade experienced rapid growth, from about $20 billion in the late 1970s to $475 billion in 2000. For much of the 1990s, China was the world's second-largest recipient of foreign direct investment, despite not being a WTO member (Lardy, 2001).

By the end of the 1990s, foreign direct investment in China accounted for almost a third of cumulative foreign direct investment in all developing countries, exceeding countries like Mexico and Brazil, which had opened their doors to foreign direct investment decades earlier. Chinese enterprises also became major overseas investors. In the mid-1990s, reports showed that China was "the largest outward investor among developing countries and the eighth largest supplier of outward investment among all countries" (Lardy, 2001).

The Decision to Enter the WTO

China also raised a substantial amount of capital on international bond and equity markets. Initially, most of this capital came from the sale of sovereign bonds. During the late 1990s, however, Chinese companies sought listings and raised billions of dollars on overseas equity markets (Lardy, 2001). Large Chinese companies — including China Mobile, PetroChina, Unicom, and Sinopec — collectively raised more than $15 billion through equity sales in New York and Hong Kong in 2000.

Still, this was not enough. China was not yet fully integrated into the world economy. High tariffs and various nontariff barriers kept the Chinese economy from full involvement in international competition. China controlled imports by placing limits on the type and number of companies authorized to carry out international transactions, imposing burdensome inspection and safety licensing requirements on imports, developing technical standards designed in part to protect domestic industries, discriminating against foreign goods in government procurement, and imposing high local content requirements on foreign and joint-venture firms producing in China. Certain sectors of the economy — such as distribution, telecommunications, and financial services — remained entirely or largely closed to foreign direct investment (Lardy, 2001).

Shallow integration was reflected in the significant role that foreign firms played in China's foreign trade. Foreign firms were able to establish operations in China after a joint venture law was passed in 1979, creating four special economic zones on the southeast coast in 1980. Initially, these firms did not contribute much to China's exports — it was not until 1985 that their share of total exports exceeded 1 percent. However, as foreign investment increased, so did the export share of foreign-invested firms, exceeding 10 percent by 1990.

By 2000, foreign firms — which accounted for approximately one-eighth of all manufacturing output — produced almost half of all of China's exports. However, these exports were assembled or processed mainly from imported parts and components, so their growth created only a limited demand for inputs produced by domestic firms. As a result, a large part of the foreign sector was considered "something of an enclave, with limited linkages to the domestic economy" (Lardy, 2001).

It took time for Chinese leaders to recognize that WTO membership was important to China's economic future (Lardy, 2001). The country's economy was growing rapidly and attracting significant foreign direct investment, so leaders were initially reluctant to absorb the costs of further opening the economy to international trade and investment.

In the 1990s, the international community added agreements covering information technology, basic telecommunications services, and financial services. China's WTO membership would therefore require liberalizing a greater range of domestic economic activity — including areas traditionally regarded as the most sensitive — than had previously been required of countries entering the WTO's predecessor organization, the GATT. China would be accepted into the WTO only if it made protocol commitments that substantially exceeded those made by any other member. The greater commitments China undertook would mean significant short-term economic costs, seen mainly through increasing unemployment in sectors that were bound to suffer under international competition (Lardy, 2001). The efficiency gains from restructuring the economy would likely be significant but would only be realized in the medium and longer term.

Many economists believe that China's decision to enter the WTO was based primarily on its promise to raise the standard of living for its people. The authenticity and efficiency of the government were constantly being tested, and Chinese leaders may have "accepted the stiff demands of the international community in an attempt to continue its ability to deliver rising living standards to the population" (Lardy, 2001). Joining the WTO would bring increased competition to China's domestic market, putting pressure on state-owned banks and enterprises and forcing them to undertake major structural reforms, ultimately resulting in a better standard of living for the Chinese people.

In April 1999, Premier Zhu Rongji traveled to the United States. At that time, Zhu and other Chinese leaders believed that WTO membership would promote domestic economic reform. In a meeting with US President Bill Clinton, Premier Zhu said, "the competition arising [from WTO membership] will also promote a more rapid and more healthy development of China's national economy" (Lardy, 2001). Many Chinese leaders supported this view, arguing that the globalization of production was the wave of the future and that China would benefit from greater participation in it, acknowledging that production of an increasing range of goods is global, not national.

While major products — including automobiles, aircraft, computers, and telecommunications equipment — are assembled in only a few locations, the parts and components for these goods are made across the globe based on comparative advantage (Lardy, 2001). Chinese leaders recognized that their liberal foreign investment regime and low-cost labor markets would present enormous opportunities to access cross-border production networks, and that "deeper participation in these global networks could provide a new and sustainable base for the continued growth and development of their domestic economy" (Lardy, 2001).

Chinese leaders also recognized that participating in a globalized economy requires not only substantially reduced tariffs, but also the development of a genuine market economy. According to Long Yongtu, Vice-Minister of Foreign Trade and China's chief global trade negotiator, "Countries with planned economies have never participated in economic globalization. China's economy must become a market economy in order to become part of the global economic system, as well as to effectively participate in the economic globalization process" (Lardy, 2001).

While China's economy before joining the WTO had been booming, growth had been slowing significantly in the late 1990s. China's GDP growth declined steadily for seven consecutive years during the mid-to-late 1990s. Analysts suggested that GDP growth had been overstated during the peak boom period. China's state-owned enterprise sector, which made up most of the domestic economy, was becoming increasingly inefficient and indebted, constrained by substantial pension and social welfare obligations (Lardy, 2001). Many businesses were forced to operate at a loss and produce large quotas of unsellable goods.

American leaders also played a major role in bringing China and the WTO together. President Bill Clinton initiated a campaign to win congressional approval for China's admission to the WTO (Baker, 2000). In a White House ceremony in 2000, Clinton called on Commerce Secretary William Daley to lead the push for congressional approval of so-called normal trade relations with China, clearing the path for ratification of a prior agreement between the US and China. "Bringing China into the WTO is a win-win decision. It will protect our prosperity, and it will promote the right kind of change in China," said Clinton (Baker, 2000).

The Asian financial crisis is widely seen as the decisive factor in China's decision to enter the WTO. While China was not severely affected due to its closed foreign exchange policies and large foreign exchange reserves, Chinese leaders recognized that many of China's large state-owned firms and financial institutions showed the same symptoms as those of Korea and other nations hit hard by the crisis. For China, economic reform and the development of a market economy represented a sound strategy for avoiding economic catastrophe.

Conclusion

Air Express: Several announcements by the State Postal Bureau (China Post) and the Ministry of Information Industry threatened to restrict the operations of international express delivery companies in China. China Post proposed a domestic monopoly for delivery of mail under 500 grams. This went against China's commitment not to "roll back" any aspects of its commercial environment as they existed at the time of accession.

Banking: A number of foreign banks received licenses for operations liberalized under China's WTO commitments. Foreign or joint-venture banks — including Bank of East Asia, Citibank, Hang Seng, HSBC, Standard Chartered, and Xiamen International Bank — received licenses. The right to offer loans to foreign companies and individuals was extended from pilot programs in Guangdong and Shanghai to Dalian in Liaoning and Tianjin.

Insurance: China's Administrative Regulations on Foreign Insurance Companies imposed high capital requirements that foreign companies viewed as burdensome. It also remained unclear how those requirements applied to branches of firms already established in the market.

Source: China Business Council. (July–August 2002). China-WTO Review. China Business Review, Volume 29, Number 4.

In addition to the obstacles noted above, China faced challenges in restructuring its governments at all levels (China Business Council, 2002). While many local governments welcomed WTO liberalization, some experienced major difficulties in implementing WTO requirements, mainly because of administrative inefficiencies. The Chinese government also anticipated significant personnel changes that could slow implementation efforts. Nevertheless, Chinese leaders continued to press local governments to make every effort to comply with WTO requirements.

When China joined the WTO, it experienced economic, social, and political advantages as well as disadvantages. Depending on the industry, the balance of advantages and disadvantages varied greatly. However, according to the statistics, the advantages generally outweighed the disadvantages. The new "two-way opening" presented challenges but brought more opportunities (Heng, 2002).

During the first year after WTO accession, China's foreign trade experienced record growth. From January 2002 to October 2002, exports grew by nearly 21 percent and imports grew by about 19 percent. Lowered tariffs and reductions in non-tariff measures led to increased imports, which affected domestic industries. However, as a WTO member, China began to benefit from its new rights. For example, the long-standing problem of most-favored-nation treatment in foreign trade was resolved, and the United States and Europe cancelled or reduced quota limitations on many competitive Chinese products. The trade environment improved and new export opportunities expanded.

In 2002, China's agricultural products significantly increased their trade surplus, and the agricultural industry achieved better-than-expected results. In the industrial sector, the textile, garment, electromechanical, and telecommunications equipment manufacturing industries all enjoyed short-term benefits in their export operations. Regarding imports, the automobile industry fared relatively well, while drastic increases in iron and steel and fertilizer imports placed pressure on domestic enterprises.

According to Minister of Foreign Trade and Economic Cooperation Shi Guangsheng, the challenges and impacts were expected to intensify as China opened further to foreign markets (Heng, 2002). Enterprises with high overhead costs, low technological capacity, and outdated management would face mounting pressure from WTO accession, and the government's economic departments would need to fundamentally change their approaches to management. China was expected to experience a period of adjustment for years to come, during which difficulties would inevitably arise.

China had only been a WTO member for a little over a year at the time of this analysis, making a full assessment of the impact on its economy premature. As China adjusted to its new status, the positive and negative influences exerted by WTO entry on different industries would continue to evolve. Industries that enjoyed short-term benefits might face long-term challenges, and vice versa. The development trends visible in the near term might prove quite different from those that would emerge in subsequent years.

For example, pressures created by the opening of the agricultural market were expected to eventually affect the industry as import growth accelerated. Experts therefore called for caution in predicting agricultural export performance over the following years. As Lu Zhongyuan, director of the macro-economic department under the Development Research Center of the State Council, observed: "Whether we [China] can pursue the good and avoid the harm and even turn disadvantages into advantages depends on whether we can show an enterprising spirit in adopting a strategy to cope with the situation, and take the limited transitional period as an important opportunity for diversifying the international market and effectively lowering the risks and costs resulting from WTO accession" (Heng, 2002).