A quarterly magazine of the IMF

September 2002, Volume 39, Number 3

On December 11, 2001, after 15 years of arduous negotiations, China became the 143rd member of the World Trade Organization (WTO). The opening of an economy as large as China's can be disruptive to some developing countries in the short run, but, in the long run, it should benefit not only China but also its trading partners.

China began to open up its economy in the late 1970s. In the early 1980s, it took steps to end its isolation, assuming the membership of Taiwan Province of China in the IMF and the World Bank, of which it had been one of the founding members. By 1986, it had launched a campaign to resume its contracting party status in the General Agreement on Tariffs and Trade (GATT), from which it withdrew in 1950.

As China moved from a centrally planned economy to a market-oriented one, it abolished trade plans, decentralized trade, slashed tariffs, unified the dual exchange rates in 1994, and removed exchange controls on current account transactions in 1996. These actions, together with other reforms, triggered the rapid expansion of China's foreign trade and investment inflows. Its exports grew from $10 billion in 1978 to $278 billion in 2000, making it the sixth largest trading nation in the world (from about the thirtieth in the late 1970s). The trade-to-GDP ratio increased from 10 percent at the beginning of reforms to about 40 percent in the late 1990s. China's total inflows of foreign direct investment (FDI) reached $47 billion in 2000, second in size only to those received by the United States.

China's motivation for joining the WTO is rooted in the realization that it needs an external impetus to overcome domestic obstacles to further reforms and protection of its trade interests if it is to sustain the rapid economic growth of the 1980s and 1990s. But many of its trading partners are worried. Some developing countries fear that global demand for their exports will shrink and that their FDI inflows will fall, given China's potential to pump out a seemingly unlimited supply of labor-intensive exports, and that FDI may bypass them for China's vast market. Some industrial countries worry that China's exports might flood their domestic markets.

Are these fears rational? They have certainly been exploited by some interest groups and, more important, they have resulted in the inclusion of a number of provisions in China's Protocol of Accession that derogate from the general WTO principle of nondiscrimination. It is inevitable that China's emergence as one of the largest players in the global economy will lead to shifts in world production, trade, investment, and employment. But the way in which its WTO accession and increasing openness, in general, affect other countries is a complex issue that needs to be examined in both the short and the long terms, and from the perspective not only of market access but also of the multilateral trading system.

What China is offering

China's own commitments are substantial, exceeding most expectations. In agriculture, it has pledged to bind all tariffs and reduce them from an average level of 31.5 percent to 17.4 percent. It will eliminate export subsidies and rapidly increase the volumes of tariff-rate quotas on most imports. In-quota tariff rates will be minimal (1-3 percent); above-quota tariffs for sensitive products (mostly grain) will be reduced from 80 percent to 65 percent—a level that might seem high but is moderate compared with those in the European Union and some Northeast Asian economies.

For industrial products, China has pledged to phase out quantitative restrictions, cut the average tariff from 24.6 percent to 9.4 percent by 2005, and sign the Information Technology Agreement, which will result in the elimination of all tariffs on telecommunications equipment, semiconductors, computers and computer equipment, and other information technology products.

The most far-reaching opening, however, is expected to take place in the services sector, which has largely been closed to competition. The restrictions hitherto facing foreign service providers in the areas of licensing, equity participation, geographic location, business scope, and operations will be relaxed or removed over time. China has promised to open its telecommunications, financial services, distribution, and many other industries to foreign service providers.

Besides market access, China has made other commitments that will increase the transparency of its trade and investment regimes. It has pledged to apply its trade policy uniformly across the country and to enforce only those laws, regulations, and other measures that have been published beforehand. China has also agreed to eliminate all prohibited subsidies (including those to state-owned enterprises), liberalize trading rights, and require state trading companies to conduct their operations in a commercial manner.

What it receives

As a result of China's WTO accession, the United States has granted China permanent most-favored-nation (MFN) status, removing a major source of uncertainty between the two countries (previously, MFN status was subject to annual renewal by the U.S. Congress). Several of China's trading partners will have to lift most of their quantitative restrictions on a range of products. Quotas on textiles and clothing will be phased out in accordance with the Agreement on Textiles and Clothing (ATC); other quotas will be phased out in accordance with negotiated schedules. And China can now resort to the WTO dispute settlement mechanism to protect its trade interests, as well as participate in multilateral negotiations on trade rules and future trade liberalization.

China's market access gains could, however, be eroded by three discriminatory provisions.

First, under the so-called transitional product-specific safeguard mechanism, which will be in effect for 12 years, China's trading partners may impose restrictions on Chinese imports based on "market disruption or the threat of market disruption," whereas, under the normal WTO standard, restrictions can be imposed on imports only if there is "serious injury" or a "threat of serious injury." In addition, if one country invokes the safeguard mechanism against China, other countries may also take action to prevent diversion of Chinese exports to their countries without establishing evidence of market disruption.

Second, although all quotas on China's textile and clothing exports are to be phased out by January 1, 2005, a special safeguard mechanism will be in place until the end of 2008. This mechanism allows importing countries to restrict imports from China when they result in market disruption.

Third, Chinese exporters can be hit with dumping charges that apply to nonmarket economies. Essentially, importing countries can use the prices or costs of similar products in third countries, instead of Chinese prices, to determine whether Chinese firms are dumping their products. China is already subject to more antidumping actions than any other country. Similar methodologies can be used to determine whether Chinese exporters are being subsidized.

Economic impact on China

There is no question that WTO accession will benefit Chinese consumers and lead to greater economic efficiency, even though some heavily protected sectors will suffer as trade barriers fall. Empirical studies estimate that welfare gains from the liberalization of merchandise trade are on the order of $4-30 billion a year for China and $20-56 billion for the global economy and that China's GDP increases range from 1.5 percent to more than 10 percent (see table). The benefits of services liberalization are difficult to quantify, but some studies suggest that, in the medium term, a one-third reduction of trade barriers could bring a welfare gain of $7-12 billion a year (see Yang, 2002, for a survey).

To reap these gains from accession, Chinese industries will have to undertake further structural adjustment. Studies indicate that China's labor-intensive industries (especially textiles and clothing) will expand, while heavily protected industries (such as automobiles and petrochemicals) will contract (see for example, Ianchovichina and Martin, 2001; and Lardy, 2002). Agriculture may also contract, largely because of the land-intensive grain industry, which is losing comparative advantage. (China still seems to have a comparative advantage in labor-intensive agricultural industries, such as fruits and vegetables.) The inefficient, state-dominated financial services sector is likely to experience intense pressure because of the entry of foreign firms.

As the effects of increased competition feed through the economy, productivity growth should rise. However, labor market pressures—about 500,000 jobs in the auto industry and 11 million jobs in the agriculture industry are expected to disappear—and income inequality could increase in the short run (Zhai and Li, 2000). Nevertheless, employment growth should pick up over time, as the positive effects on output growth of trade liberalization begin to be felt in the medium term.

Reverberations

Numerous studies have shown that industrial countries are likely to benefit from China's accession to the WTO (see table and references). Some industrial countries—notably the United States and Australia—will have improved access to China's agricultural markets; most are expected to increase their exports to China of capital and technology-intensive manufactures. Over time, the opening up of China's services sector should provide industrial countries with large trade and investment opportunities. Other significant gains will come from these countries' own commitments to removing trade barriers against Chinese exports, although the realization of these gains entails structural adjustment in labor-intensive industries, especially textiles and clothing.

There are concerns in some developing countries that they may lose from China's WTO accession because of the potential diversion of FDI to China and increased competition from China in export markets. There are also concerns that China's WTO accession may lead to a devaluation of the renminbi.

It does appear that there has already been some diversion of FDI flows to China at the expense of other developing countries—particularly the Association of Southeast Asian Nations (ASEAN). (ASEAN was the source, in the past, of a large share of FDI flows to China.) In the early 1990s, ASEAN accounted for about 30 percent of FDI in developing Asia, while China accounted for 18 percent; by 2000, ASEAN's share had fallen to only 10 percent, while China's had increased to 30 percent. The ASEAN economies' structural weaknesses, revealed by the Asian crisis of 1997-98, may be partly to blame.

Although China's entry into the WTO is expected to boost its attractiveness to foreign investors because it promises not only market opening but also increased policy transparency, better governance, and greater business predictability, FDI flows are unlikely to increase dramatically as a result. While foreign investment in the manufacturing sector will be consolidated as import barriers fall, FDI inflows will probably shift to the services sector, but this process is likely to be slow, not only because restrictions will be relaxed only gradually but also because foreign investors need time to familiarize themselves with this sector.

In the short run, as trade barriers are reduced, imports will probably grow more rapidly than exports. The expected increases in FDI inflows, however, should offset any pressure on the current account, leaving the overall balance of payments and the exchange rate essentially stable. Although a depreciation, in real or nominal terms, of the renminbi cannot be ruled out, the likelihood is small unless China fails to attract FDI or its trade account deteriorates drastically, as a result of either failures in domestic reform or some extraordinary external shock (such as a large depreciation of the yen or the U.S. dollar).

Regardless of the prospects for FDI flows and short-term renminbi movements, Asian developing countries are sure to face increasing competition from Chinese exports of textiles and clothing when the quotas under the Multifiber Arrangement (MFA) are eliminated at the beginning of 2005 if the special safeguard mechanism mentioned above is not invoked too often. Other labor-intensive manufactured exports, such as low- and medium-tech electronics, are also likely to expand. But as these exports increase, so will imports.

Among developing countries, the newly industrialized economies of Asia are likely to gain the most from China's WTO accession. They have already invested heavily in China, and their exports are competing with China's to a lesser extent. Low-income Asian countries may also benefit if their exports are complementary to China's. India, for example, has the potential to export computer software and other information technology-related services, in addition to textiles and chemical products, to China (exports from India to China have tripled over the past six years). Of course, exports from China of manufactured goods to these countries are also likely to increase.

Studies that provide estimates of the welfare effects show that, whereas the more advanced developing countries in Asia gain, the less advanced ones tend to lose in the short to medium term, albeit mostly only slightly (see, for example, Ianchovichina and Martin, 2001). In the long run, however, a China that is growing more rapidly as a result of its WTO accession should benefit all of its trading partners, especially when benefits other than market access are considered.

Beyond market access

China has come a long way in opening up its economy, but some of the most difficult adjustments still lie ahead, especially in the highly protected industries, where state-owned enterprises tend to be concentrated, and in the services sector. It will inevitably experience some difficulties in implementing its commitments as interest groups try to delay reforms and capacity constraints emerge. China must now step up its institution building and rebuilding—including dismantling remaining central planning institutions, formulating policies consistent with WTO agreements, amending laws inconsistent with WTO rules, and imposing uniform rules throughout the country. It also needs to strengthen social safety nets and narrow economic and social disparities between regions, which will require huge fiscal resources. And, without question, it will have to increasingly adhere to the rule of law.

In the years ahead, China's increasing openness holds many promises not just for industrial countries but also for the developing world. First, stronger trade and investment ties will provide its Asian neighbors with a more stable external environment, as long as its business cycles are not synchronized with those of Japan, North America, or Europe. Second, as a major trading nation and WTO member, China will be able to exert greater influence over the multilateral trading system. It will likely press for reform of WTO antidumping rules, guard against attempts to use labor and environmental issues as disguises for protectionism, and possibly push for reduction of agricultural subsidies. Third, its WTO accession will provide an impetus for economic and structural reform in the region. Supachai Panitchpakdi, the Director-General Designate of the WTO, has characterized China's WTO accession as a "wake-up call" that should rouse other countries to accelerate their reforms. And, if other Asian countries continue with their reforms, it will not be long before China feels pressure to accelerate its own. Such reform competition can only enhance economic performance both in China and in the rest of developing Asia.

This article is based on "China's Increasing Openness: Threat or Opportunity?" a paper presented by the authors at the Trade Policy Issues Workshop organized by the Asian Development Bank Institute in Singapore on February 25-March 1, 2002; and Yongzheng Yang, 2002, "Entering the WTO: China Is Coming Out" (unpublished; Washington: International Monetary Fund).

References:
  Elena Ianchovichina and Will Martin, 2001, "Trade Liberalization in China's Accession to the World Trade Organization," World Bank Policy Research Working Paper No. 2623 (Washington); http://econ.worldbank.org/resource.php?type=5
  Nicholas R. Lardy, 2002, Integrating China into the Global Economy (Washington: Brookings Institution Press).
  Supachai Panitchpakdi and Mark L. Clifford, 2002, China and the WTO: Changing China, Changing World Trade (Singapore: J. Wiley & Sons (Asia)).
  Terrie L. Walmsley and Thomas W. Hertel, 2000, "China's Accession to the WTO: Timing Is Everything," Global Trade Analysis Project Working Paper No. 13 (West Lafayette, Indiana: Purdue University); http://www.gtap.agecon.purdue.edu/resources/res_display.asp?RecordID=403
  ——— and Elena Ianchovichina, 2001, "Assessing the Impact of China's WTO Accession on Foreign Ownership," paper presented at the Fourth Annual Conference on Global Economic Analysis, Purdue University, June 27-29, West Lafayette, Indiana; http://www.gtap.agecon.purdue.edu/resources/res_display.asp?RecordID=649

  Zhi Wang, 1997, "China and Taiwan's Accession to the World Trade Organization: Implications for US Agriculture and Trade," Agricultural Economics, Vol. 17 (December), pp. 239-64.

  Fan Zhai and Shantong Li, 2000, "The Implications of Accession to WTO on China's Economy," paper presented at the Third Annual Conference on Global Economic Analysis, Melbourne, Australia, June 27-30; http://www.monash.edu.au/policy/conf/cnprog1.htm