ON RECENT DEVELOPMENTS
China’s Entry Into the WTO:
How Will It Affect China and How Will It Affect Australia?
19 October 2001
When we planned to launch an Internet site we decided to continue issuing brief reports, distributed previously through newsletters, on current developments that are relevant to Australia-China business relations.
The format of the Internet-based “Chamber Reports” is likely to vary somewhat, but where appropriate we will use a question-and-answer style that is becoming a standard feature with contemporary information technology. Not all of the questions are “frequently asked”, though we hope that most are at least occasionally asked.
The format was chosen to allow efficiency in perusing the content. We refer to a number of information sources at the end and give links in the text to related documents on this Internet site. This allows the information to be layered so that the level of detail sought by each reader can be easily obtained.
We welcome further commentary or
“feedback” from readers.
The South China Morning Post (www.scmp.com) reported in an early Monday evening update (17 September, 7.31 pm Hong Kong time) that WTO negotiators were “clinking champagne glasses” as the last real barrier to China’s entry into the WTO was overcome. The Sydney Morning Herald (www.smh.com.au) conveyed the news on Wednesday morning.
The apparently final impasse concerned objections from the European Union, which were either withdrawn or modified, about preferential treatment being sought by a US insurer, American Insurance Group (AIG), to allow it to continue under a “grandfather clause” with 100 per cent ownership of subsidiaries in China. All other insurance companies must form joint ventures with Chinese insurance companies.
Last week Mexico secured approval to impose special import duties of up to 1,500 per cent for at least 6 years on a range of Chinese products including chemicals, toys, shoes and textiles if those products cause “material injury” for Mexican enterprises. This is not strictly within normal WTO rules since it allows Mexico to discriminate against China. All members of the WTO should be treated equally in relation to import restrictions.
It would seem that no other
concessions are being contested, so final approval could occur either during
or shortly after the WTO’s ministerial meeting in Doha, Qatar in November.
Most analysts agree that the “pain” will be worse than the “gain” for China at least until 2004. This is expected as the result of China’s agreement to begin the phase-in period for a reduction in tariffs from 21 per cent to 8 per cent, on the average, immediately after accession to the WTO.
Employment will decline in a number of China’s industries (mentioned in reference to subsequent questions) and redeployment of the retrenched workers is not likely to be completed until after 1993. Additionally, China’s trade surplus, which was US$32 billion in 2000, down slightly from US$36 billion in 1999, is certain to decline further in 2002.
Some analysts suggest that China’s imports might even exceed exports during the first year of membership. Although this is possible, if it occurs it cannot be attributed solely to the reductions in tariffs. Most of the projections for a decline in China’s rate of economic growth as a result of WTO membership are less than one-half of one per cent. That places it in the “modest effect” category, and cannot be easily distinguished from other influences on China’s economic growth.
The exchange rate for the yuan has remained firm at RMB 8.3 per USD since 1995, despite a plethora of predictions about a devaluation during 1997 and 1998. China’s level of currency reserves remains high, at more than US$163 billion, and inward foreign direct investment increased during the first half of this year in response to China’s anticipated entry into the WTO. Therefore, the risks of major external imbalances for China are relatively mild.
China’s consumers will of course benefit from the lower prices following the reduction in tariffs, though the effect of this on the economy as a whole is difficult to predict. China saves about 38 per cent of its current income, so the lower prices are not expected to be translated into a large amount of additional spending. The savings are of course channelled into investment, which adds to employment and income, but the process is sometimes slow. Chinese are typically cautious when confronted with uncertain economic conditions.
Thus, the overall or
economy-wide effects of trade liberalisation are not likely to be
substantial, even for the first two years.
There will be dislocations within specific sectors, however, which
could be substantial for groups of workers and for some enterprises.
The agricultural sector received the greatest amount of attention in the lead-up to WTO membership. The reasons are clear:
it employs about one-half of China’s workforce;
it accounts for one-fifth of national output;
it is endowed with a relatively small amount of
land that is suitable for cultivation (about 10 per cent of China’s total
land area compared to 20 per cent for the US); and
v it experiences frequent floods and droughts.
Based upon general patterns of productivity, it is expected that China’s agricultural production will shift away from the land-intensive products (cotton, grain and oil seeds) and shift into products that are less land intensive, but are nevertheless labour intensive (livestock, flowers, vegetables and tree crops).
Chinese negotiators, who were involved in the “round robin” series of bilateral discussions on the conditions for China’s entry, secured additional protection for the producers of land-intensive agricultural products, and this gives assurance that the shift away from this production will be orderly. More specifically, the schedule of tariff reductions on certain items may be halted if imports exceed a specified quota (this is referred to as the tariff-rate quota system or TRQ).
For individual items:
Wheat will continue be grown in areas that are well suited to it, but discontinued in other areas. This implies that China’s imports of grains will rise after WTO membership. The domestic price has already fallen with reductions in domestic production so WTO membership will add to that trend. Marginal wheat farmers will have time to shift to other production.
Maize is likely to experience some difficulties since the domestic price is higher than the border price as a result of government policy. China exports maize at international prices so the government suffers a loss from procurement at a price that is above the world price and exporting it at a lower price. Since a large share of maize production is used for livestock feed, a drop in the domestic price as a result of trade liberalisation will lower the domestic price of meat. The TRQ system, in this case, acts to protect the procurement/export system as well as the small landholder who produces maize.
Rice is not likely to be adversely affected by trade liberalisation. The reason: the domestic price of rice in China is relatively low and has been falling. In this case the TRQ system was put into place for food security and to give assurance that stable price levels can be maintained.
Soybeans do not come under the TRQ system. This is because the soybean price is close to the border price and is expected to remain at that level. No transitional protection is needed. It should be noted, however, that soybeans are production substitutes for maize, especially for the small landholder, so that a shift away from maize could be associated with increased production of soybeans. This could lower the price of soybeans and adversely affect producers’ incomes.
Cotton, oilseeds and sugar are more difficult to predict. China will probably import greater quantities of these products but a substantial amount of domestic production is expected after WTO membership. Better quality seeds are required for this to occur and improvements in the process of extracting the oil would be beneficial. The longer-term status of cotton and sugar in China remains uncertain.
Tobacco and all tree crops are expected to gain from trade liberalisation since the resources released from grain production can be used effectively for these products. The “gain” will of course be relatively slow for tree crops that require a substantial period for maturation.
Livestock production is expected to improve with lower costs for feed grains. The gene pool for most meat producing animals in China is relatively poor at the present time and steps are being taken to improve it by importing more breeding stock.
Until recently, China’s agricultural sector has been traditionally oriented and relatively slow to respond to major changes in methods of production. Nevertheless, provincial-level and county-level governments are gearing up to assist the transfer of resources and to improve the overall prospects for labour mobility within their respective jurisdictions.
The transfer of resources just described, as well as a transfer of labour away from the agricultural sector, would have occurred in China eventually without the liberalisation program associated with WTO entry. China’s land resources are simply insufficient to sustain one-half of the workforce with a socially satisfactory level of income growth.
The rate of urbanisation in
China is certain to increase during the next 20 years. The Chamber recognised this likely outcome
in several other publications. See
especially the discussion on Chamber’s Key Cities Strategy
and the Position Paper on
incentives for direct foreign investment.
Since the manufacturing sector does not have the benefit of the TRQ system, and the drop in tariffs will be substantial for some manufactured goods, the impact of trade liberalisation for the manufacturing sector is likely to be relatively rapid.
The “first-tier” of affected industries include the more capital-intensive industries such as motor vehicles, petrochemicals and minerals. Lower priced imports will substantially affect many of the older factories, resulting in a loss of employment and some loss in investment. The “second-tier” industries include energy, food processing and pharmaceuticals.
The medium-term or longer-term impact on these industries is likely to be favourable, since a number of existing enterprises in the “first tier”, and many in the “second tier”, will be able to compete successfully with imports when newer technology and better capital equipment is employed.
These enterprises have little incentive to lift their performance at the present time since they have been able to maintain a satisfactory market share in the absence of strong competitive pressures. With China’s large market, even relatively small shares are associated with substantial levels of output.
Another division or classification of enterprises in China is relevant. When the “open door” policy was officially announced in 1979, the emphasis on production for exports was intended as a means of increasing foreign exchange earnings. This, in turn, enabled China to import new capital equipment.
In addition, there were initial restrictions on the amount of output that could be sold on the domestic market by foreign-funded enterprises. This was intended to protect domestic enterprises, mainly state-owned enterprises, from the competitive pressures arising from multinational enterprises that were more experienced and had better technology.
Some of these restrictions on production for the domestic market were gradually lifted, but a tax incentive for foreign-funded enterprises continued. This tended to encourage two types of enterprises in China. One was based upon foreign technology, Western managerial skills and partial funding from foreign enterprises. This type of enterprise was export oriented, though an increasing amount of output could be sold locally.
The second type was the traditional state-owned enterprise that produced mainly for the domestic market, though over time some of these enterprises succeeded in exporting a substantial portion of their output. Even now, however, the two types of enterprises remain unequal in terms of their capacity to produce under globally competitive conditions. A question remains as to whether the export success of the domestically oriented enterprises could be attributed at least partly to implicit subsidies arising from higher prices on the domestic market.
It is generally recognised that many of China’s exports have a relatively high import content. This seems to be especially true for export processing activities. Thus, although these industries contribute substantially to the value of all exports, they also account for much of the imports. The value added by these industries is therefore relatively low.
The relevance of this to China’s WTO membership is that trade liberalisation will have little impact on export processing activities since imported components have always been duty free. Further trade liberalisation will affect the second type of enterprise and they are likely to feel the brunt of entry into the WTO.
It is hoped that increased competitive pressures will induce a greater amount of local sourcing for the imported components, thus raising the value added of the overall activity. It is also hoped that increased competitive pressures will improve the productivity of the state-owned enterprises so that the implicit subsidies, where they exist, will no longer be needed. Much of that will disappear anyway when the tariffs are reduced.
A third division or classification of enterprises in China adds further information. A number of medium-sized enterprises in China have demonstrated international competitiveness. This includes several manufacturers of televisions, two among about 10 motor vehicle manufacturers and Legend, which is China’s leading producer of personal computers. These and other similarly sized enterprises have been able to achieve competitive cost structures.
Most of the large-sized enterprises, on the other hand, have not been able to avoid: (a) over employment, (b) the social welfare burden that was previously placed on all state-owned enterprises, (c) full independence from government officials, and (d) modern managerial practices. These enterprises will be most affected by trade liberalisation.
To summarise, the most affected enterprises in China are likely to be the large state-owned enterprises that have not completely shed the cost burden of social welfare support for their employees. Medium-sized enterprises that have avoided or discarded this obligation will be less affected, and foreign-funded enterprises are not likely to be adversely affected. The latter, in fact, now have a potential to expand their output by producing more for the Chinese domestic market.
Heavy industries will be more
adversely affected than light industries.
Textiles and clothing are expected to benefit from WTO rules.
Services in China comprise only 30 per cent of GDP and this is relatively low on international standards for nations with an income per capita that is similar to China’s. This implies that the services sector is relatively underdeveloped.
The common argument as to why it is underdeveloped is that the government has heavily controlled the sector. Many services are supplied on a monopoly basis by one of the three levels of government in China. Finance, insurance, health care, transport, water supply and treatment and education are among the ones for which entry is restricted and prices are regulated.
Removing these restrictions and regulations would allow entry for more foreign-funded enterprises and this will bring competitive pressures that will not only influence the price of the services, but will also contribute to increased productivity through innovation and improved methods for the delivery of the services.
In the recent past, Chinese authorities have progressively relaxed the restrictions and regulations relating to many of the services, and improvements in productivity and prices have occurred. This is used as an indication that further relaxation, as agreed to in the negotiations for entry into the WTO, will achieve further improvements.
Financial services, including insurance, heads the list of projected growth areas. Foreign banks currently account for only 1.6 per cent of banking assets, so there is scope for rapid growth in turnover.
Foreign banks will be allowed to conduct renminbi business with Chinese enterprises and sometime in the future will be able to enter retail banking. The inability, for an unspecified period, to achieve a large renminbi depositor base by tapping household savings implies that foreign banks will need to import a large part of their funds.
We suspect, however, that this would have occurred without the restriction on retail banking for foreign banks since households in China are likely to follow traditional patterns in the management of their savings. Foreign banks will need to demonstrate reliability before they are able to capture a significant portion of such deposits.
Similarly, the extent to which large enterprises in China will transfer their banking business to foreign banks is uncertain. Large transfers by internationally oriented companies in China could undermine the quality of loans extended by domestic banks. This will place added pressure on China’s regulatory system.
The telecommunications sector will be progressively opened. This includes all parts of the sector, though Internet services and satellite services will continue to have some restrictions concerning foreign ownership. Perhaps the biggest change will be with transport and distribution since that has been controlled by the state sector for some time, and the concessions for WTO membership specify that all restrictions on the distribution of most products will be removed within 3 years.
Increased competition in the supply of services in China is certain to increase employment in that sector, thus picking up some of the workers that are likely to be made redundant in other industries. However, achieving a balance between employment-shedding and employment-creating is likely to be difficult:
Different skills are needed in the services sector,
compared to traditional manufacturing activities, so a period of training (or
retraining) will be required.
v The provision of a full range of services has long been considered a responsibility of local governments in China. Obtaining assurance that foreign suppliers will be able to provide an adequate level of service on an equitable basis for a large portion of the population may be difficult.
Implementation delays in opening
the services sector at the municipal level will also delay the process of
transferring resources away from the inefficient activities.
Estimates of the number of rural workers that will become redundant within a 5-year period range from 30 million to 120 million. None of these estimates, however, take into account the capacity to control the pace of retrenchment through the TRQ scheme. Additionally, within that period some redeployment within the agricultural sector is possible.
Estimates of redundancies in the manufacturing sector are limited to the “first tier” enterprises, and these range as high as 12 per cent of the current work force, or about 2.5 million workers using a relatively narrow definition of that tier. For the “second tier” industries, it is expected that an expansion of employment by foreign-funded enterprises will be approximately equal to the redundancies occurring from state-owned enterprises that cannot compete effectively.
Employment in the services sector is expected to increase, but this will vary considerable according to the type of service. European companies, in particular, have shown a keen interest in supplying transport and distribution services, so progress in opening that sector is likely to be rapid. This will lower retailing costs, but that will probably give a greater advantage to large retailers. In general, the employment-creating effects of a liberalisation of these services are not likely to be substantial until after 2003.
In the case of banking and financial services, there is evidence of over employment at the present time. Recruitment by foreign-funded enterprises will absorb some of this excess, thus contributing to a lower cost structure for domestic enterprises. So for these services, as well, net employment gains are not likely to occur until after 2003.
It therefore seems clear that
China will experience net employment losses during 2002 and 2003, as we noted
previously. The extent of the
employment losses will be moderate if the transfer of resources proceeds
smoothly, but could be substantial if this does not occur.
Australia will benefit. The most obvious source of this is the expected increase in exports of grain to China. The planned reduction in tariffs, combined with the agreed upon quotas that are part of the TRQ system, will hopefully lead to an orderly increase so that grain prices in Australia will remain stable. The desire for global price stability in grain was a principal motivating factor in WTO approval of the TRQ system for China.
Exports of cotton and oil seeds (or the edible oil itself) are also expected to increase.
Other agricultural products, and especially agricultural services, provide opportunities for Australian enterprises. Horticulture and livestock production in China will require international expertise for at least several years until globally recognised quality is achieved.
Opportunities in China’s manufacturing sector exist, but are less obvious and are generally associated with large-scale production, especially motor vehicles, petrochemicals and pharmaceuticals. Of the industries listed in connection with a previous question, only minerals, energy and food processing remain for reasonable consideration by Australian enterprises, apart from the possibility of “niches” within the other industries.
Opportunities also exist in the services sector, but none can be classified as obvious or “easy”. This should be neither surprising nor disappointing. The considerable amount of attention China received during the WTO negotiations was due to its attraction as an exceptionally large and growing market.
As we noted in previous publications, China cannot yet be considered a single market. It is a collection of many regional and municipal markets that are rapidly becoming integrated.
Opportunities have existed in China since the “opening up” process was formally announced in 1979. Opportunities arising from WTO membership are part of that process. Some commercial possibilities are better now than they were previously, while others have receded for one reason or another.
The major impact of WTO
membership for China is to underscore the fact that it will become an even
larger centre for global trade and production than it already is. That virtually guarantees further
opportunities, but they must be sought and seized. Otherwise they will become opportunities lost.
We consider a conference paper made available by the World Bank on its Internet site http://www.worldbank.org to be particularly useful. It is by Deepak Bhattasali and Masahiro Kawai and is entitled “Implications of China’s Accession to the World Trade Organisation”. Since it is dated 12 April 2001, it contains a compilation of recent studies and information that remains current.
Note that the World Bank changes the location of its Internet documents and removes them without notice from time to time. We suggest looking under the publications for China (select “countries and regions” on the home page) or use the search procedure for the authors’ names. Deepak Bhattasali is the Lead Economist, World Bank Resident Mission in Beijing and Masahiro Kawai is the Chief Economist, East Asia and the Pacific at World Bank headquarters in Washington, D. C. The names are therefore likely to emerge from the search procedure.
ChinaOnline, http://www.chinaonline.com maintains a file of WTO-related articles and commentaries. The latter are especially useful in giving an analysis of recent events.
The Chamber made a submission to the Minister for Trade, the Hon Mark Vaile MP on 3 April 2001 in response to his invitation to comment on WTO related issues. A summary of this is available in the publications index on this Internet site and the complete document can be obtained from http://www.accci.com.au/trade/wtocom.htm