The WTO: China’s bitter medicine

China officially became the 143^rd member of the WTO in December of 2001. This bold entry into a new economic landscape has serious implications for China and her peoples. Considering the precarious condition of large state owned enterprises in China, one may wonder why the WTO and why now? However, reading the intentions of the Communist Party officials in Beijing is somewhat like peering behind the curtains that obscure the Wizard of Oz. Even as you try and look inside, you can never be exactly sure what the old wizard is up to. Surely the potential for massive layoffs that stringent WTO rules may trigger must give the always paranoid Communist Party great pause. Reduced tariffs and slashed subsidies could have a devastating impact on the Chinese economy.

On the other hand, foreign competition may invigorate a weak domestic sector at the very same time WTO rules create new opportunities for certain sectors that are predicted to flourish in the years to come. Perhaps reform minded party officials truly understand the long term benefits of the markets even as they risk turmoil from unemployed agitators. It is very hard to know with such a secretive government. This paper does not seek out the intentions of the party politburo wizards so much as it seeks a more thorough understanding of the Chinese economy as it enters into the WTO. Largely this paper will argue that the WTO is the bitter medicine China must swallow in order to complete the transition from socialism to capitalism. To this end we will examine the Chinese economy on many levels.

The health of the state owned enterprises (SOEs) will be looked at, as will the viability and dynamics of the smaller rural industries. Comparisons to other industrializing latecomers are inevitable, so the Russian and Eastern European models will be juxtaposed to the Chinese situation. Sectors that are expected to flourish and others that may wither will be covered, and finally, the often overlooked financial and banking sector will be probed for their significance within the great dance that is “the Chinese economy.”

Although ascension to the WTO is indeed a sea change for China, in many ways the path to WTO membership had already been paved, particularly in the 1990s. Again, it is extremely difficult to know the true aims of the Chinese government. Certainly their Communist command/control underpinnings would present an argument that statist ideology has always been and always will be a central element to any economic strategy they undertake. However, in actuality, much of what was witnessed in the 1990s Chinese economy could be considered an embracement of neoliberal theory. There was certainly a turn to the markets, even as the state held a steady hand on most key elements of the economy. China throughout much of the 1980s and 1990s has been in a state of transition, never quite at ease with the structures of capitalism. This transition has taken the path of both the “convergence school” and the “experimentalist school” in building its economic foundations. The former entails choosing a foreign model and altering it as needed by an active state (Woo 110). The later is a faith-in-market approach, where the state relies on the market to build institutions through naturally occurring market evolution.

Some economists would argue that China has adopted one or another of these tracks when in actuality elements of both have been adopted. Thus, the transition period between strict socialism and WTO ascension has exhibited a “dual track” nature. Indeed, there were dual markets of tightly controlled state assets exhibiting the classic command and control structures of input, output and price control, operating right along side more relaxed market structures the likes of private industry. Moreover, there were dual pricing structures. Although this afforded great opportunity for corruption (cheap plan inputs sold at market price), the government increasingly moved towards price flexibility. This Chinese “gradual” approach to price flexibility can be seen as advantageous to the “big bang” approach witnessed in Poland and Russia (Woo 114). Those “shock price” liberalizations led to deep troubles in the heavy industrial sector as higher prices set in.

And, it is exactly the Chinese heavy industrial sector that many consider most precarious today. Although, economists certainly have varied and even antagonistic opinions of just where SOE reform has come thus far. Witness the exchange of arguments forwarded by Jefferson, Rawski, and Zheng (1994), and Woo, Fan, Hai and Jin (1994). Their competing mathematical formulas for value added deflators in relation to CPI (and ongoing argumentation) reveal that accurate data in the world of Chinese SOE is certainly no given (Woo 123). If the true nature of value added deflators can’t be agreed on by respected economists, imagine what other pitfalls belie! Bickering economists aside, there are definite conclusions to be made in regard to Chinese SOEs as China enters into the WTO.

As China moves to eliminate tariff barriers and allow foreign competition to battle their own SOEs it does so in a dynamic new economic landscape. Peter Nolan and Jin Zhang term this most recent economic era as nothing less than “the most revolutionary epoch in the world business history” (5). This global business revolution’s most salient characteristics spell trouble for Chinese SOEs. Significantly, from the 1980s onward mergers and acquisitions have skyrocketed in both numbers and scale (Noland and Zhang 5). In sectors such as petrochemicals, automobiles, pharmaceuticals (amongst many others) an increasingly small number of global giants master their respective markets. North America is by far the leader in this phenomenon. Unfortunately, developing nations are at a huge disadvantage in this global shakedown.

China is no less so. Consider oil companies. Recent mergers have created monster companies that dwarf China’s PetroChina. Refining, exploration and extraction require the kind large investment that will increasingly force SOEs like PetroChina to seek joint ventures with these global giants if they hope to survive. This is also true of the Aerospace market. Mergers in this sector have produced mega companies such as Boeing and Lockheed Martin (Noland and Zhang 15). Modern aircraft are extremely complex as is the supply chain that facilitates the finished product. Airbus alone has 1,500 suppliers worldwide. Supply chain linkages and other forward and backward linkages are going to be extremely difficult for Chinese SOEs to develop in a fashion that can compete with the predatory giants.

Even so, Chinese SOEs are not all lying down dead in the face of WTO policy. Although many SOEs may indeed wither and die in the face of such massive oligopoly, some will survive and truly compete. Less pessimistic than Nolan and Zhang, Aimin Chen of Indiana State University sees a weakened position for SOEs in the overall economy with only the efficient firms surviving. (83) Chen notes that Chinese firms, like their international counterparts, are consolidating. This consolidation has led to greater profits. Moreover, sectors producing labor intensive products may actually benefit from WTO policy because of increased access to markets abroad. Guy Shaojia Liu and Wing Thye Woo take an even deeper look at specific sectors in China Economic Review, 2001 137-161. They go to great pains in producing their mathematical “market-share testing principle” tool to find which kinds of firms will emerge stronger or weaker in the face of WTO policy. (137)

Liu and Woo believe “most” studies of China’s markets are far too broad. Thus, they develop a model drawn from three other economists, combining the three’s formulas for cost efficiency, market share concentration and R&D’s, respectively, on effect of market share. Any combination of one or more of these three factors control market share growth (according to Liu and Woo). This tool is designed to predict market share in a tariff free environment. However, China’s two markets (domestic and export) are very different, and eventually will become one (Liu and Woo 145). This greatly undermines their market share tool, as they well admit. It could even be argued that Liu and Woo’s model is entirely convoluted in consideration of the major changes that will unfold as tariffs plummet. Even so, they do their best to refine the tool’s ability to predict eventual market share of specific sectors. Their conclusions are worth sharing.

In refining their model, Liu and Woo separate the Chinese market into four segments of varying degrees of insulation from foreign competition as they stand today. One example case within these segments (that offers encouragement) is the China Shipbuilding Industry Group Company (CSIGC). China’s ship building sector operates in a world market open to competition. Any nations wanting to try their hand at building and selling ships are relatively free to try. Chinese shipbuilding has operated in a market with tariffs barriers of only 8%. In this low tariff market, foreign firms from Japan and South Korea have been able to compete with CSIGC. More importantly, in consideration of the WTO’s impact on other sectors, foreign competition actually forced CSIGC to become much more efficient; cutting costs and increasing productivity (Liu and Woo 145). Because China’s shipbuilding sector has already been operating in a post-WTO type of market, it is positioned quite well to compete in a true WTO environment.

Another example case is the household appliance sector. Chinese owned makers of refrigerators, televisions and washing machines have actually increased their market shares from the 1980s onward. In the case of Chinese domestic TV manufacturers, from 15% in 1983, to 81% in 1997 (Liu and Woo 147). Although, a 35% tariff on color televisions certainly contributed to those figures. However, even though tariffs have been quite high in this sector, competition has driven firms to public funding, resulting in a more healthy, mixed ownership structure. Elimination of such high tariffs cannot be understated, although Liu and Woo may well have good reason to be optimistic about this sector. Again, it is the emergence of foreign competition that is driving the sector to greater health.

An example of Chinese industry operating within the extremely protected segment of the Chinese market is the auto industry. The Chinese automobile industry operates behind tariff barriers of 30% to 100%. Some believe the reduction in tariffs will kill this industry in its infancy. However, the sector has also turned to foreign partnerships, resulting in transfer technology and at least a chance to develop into competitive industry (Liu and Woo 155). It is clear that many SOEs will be faced with competition they will not be able to withstand, the automobile industry included. Indeed, it is possible that millions will be out of work as companies simply shut their doors. Even so, many others will restructure, dilute state ownership and brace themselves against the coming tide of foreign competition. Those that are most efficient will have ample opportunities in the ever growing domestic market and abroad. Even in this gloomy environment of shuttered factories and massive layoffs, some sectors should actually flourish in the WTO environment.

It is important to note that just as China’s markets will open to foreign competition (due to WTO provisions), many foreign markets will be newly opened to a flood of Chinese produced goods. The sector most likely to reap the rewards of WTO accession is that of Chinese apparel. Apparel production is projected to increase 263 percent in the next ten years, and from 9 to 20 percent of the entire world market by as soon as 2005 (Martin and Ianchovichina 1207). This will also translate into job creation and higher wages. Moreover, China will move forward from simply producing semi-finished apparel products to be completed in Hong Kong and other localities. Moving up the “value-added” chain in regard to this sector will also help to create jobs (Yeung 631). Even so, it may require foreign capital and foreign competition. A foreign business presence can invigorate other sectors too.

At any rate, job creation of any kind is imperative, as there will be a many jobs lost in the agricultural sector as WTO policy cuts tariffs there. This sector has been greatly protected from foreign competition through tariffs and other measures, namely quotas and subsidies (Chen 91). The low level of technology and mechanization in Chinese farming will seriously disadvantage Chinese agriculture in regard to outside competition. China’s comparative disadvantage in so many agricultural products may well force state enterprise to purchase in bulk on the world market. Average agricultural tariffs will eventually drop to 17.4 percent. Although, some products such as grain will drop to only 65 percent. Considering the continued high agricultural tariffs in Europe and other countries, this is not as high as it may seem. China will continue to consolidate land (to scale upward) and modernizes farming. However, farm labor will continue to hemorrhage.

Ideally, labor will continue to transfer from agriculture to other sectors, as needed. There has already been a considerable transfer of labor in China, as out of work farmers fill the ranks of the secondary and tertiary work force (Woo 117). China’s pre-WTO market policies have already pulled China away from a peasant economy to a much more diverse economy. This new economy is in part fueled by low technology firms which grew in share of GDP even as agriculture’s share of GDP plummeted from 41% in 1978 to 18% in 1998 (Woo 117). These now famous township and village enterprises (TVEs) have been a large part of China’s economic success to date. Exports drove the rural TVE development (Zweig 122). The seemingly endless supply of cheap rural Chinese labor also brought international firms to the Chinese countryside.

Thus, long before WTO ascension, rural China had taken on an internationalized economic face. Although state bureaucrats often favored SOEs in regard to FDI accessibility, joint ventures with foreign partners have proliferated amongst the TVEs. Despite the hindrances by bureaucrats, local leaders who understood the value of these TVEs courted further FDI, undermining state authority and furthering the globalization of China’s rural industry (Zweig 160). TVEs will likely remain an important engine for overall growth in the Chinese economy, even as WTO induced foreign competition settles in for business. More likely to lose substantial market share than the rural TVE industry is the telecommunications sector. Even so, the opportunity for partnerships and technology transfer will abound.

In this sector, China has signed the far reaching “Information Technology Agreement” effectively eliminating all tariffs on telecommunications equipment and related products (Adhikari and Yang 2). The sector, throughout the 1990s has been key to China’s access to technology. China invested enormous capital in its drive to create a telecom system (Oberg 100). Also, foreign partnerships were encouraged in the form of joint ventures, and significantly, wholly owned foreign companies. Before WTO terms set in, China could exact technology transfer demands on such ventures and companies. WTO guidelines will have serious implications in this regard. No longer will China simply be allowed to force companies to hand over technology. This is no less so for the telecom sector.

As early as 2005 this sector will have zero tariffs. However, foreign operation will be limited to 50 percent in value added service, and 49 percent in the rapidly expanding mobile phone market (Oberg 102). This mixed ownership structure in the segments of the telecom market that wield such huge potential will allow both rapid growth and a check on complete foreign dominance. Foreign capital and technology will be essential to ramping up the telecom infrastructure in the Chinese hinterland, an absolute necessity to further growth there. Thus, China’s move to integrate the telecom sector should have more positive consequences than negative. However, all of the sectors and cases looked at thus far in this paper must be examined within the overall structure of the Chinese financial sector. A weak banking system could spell disaster for the entire economy.

To date, it has been impossible to know the true extent of banking liability on the Chinese economy as “transparency in banking” is the exception, not the rule in China. Non-performing loans and continued shabby bank practice greatly undermine economic reform. Four state-owned commercial banks (SOCBs) dominate Chinese banking. Asset to liability ratios for these banks are rather poor. Estimates range from 40 to 50 percent of their loans falling into the nonperforming column (Bonin and Huang 1078). Dud loans were all too often the result of pouring capital into profitless SOEs. In regards to this weak banking sector, the WTO will bring new challenges. Handled with care, the WTO influence on Chinese banking can lead the sector to greater solvency, stem corrupt loan practice and open new doors for foreign players.

Already WTO considerations have influenced a program for transferring bad debt to asset management companies (AMCs). Other reform moves, such as debt to equity swaps are also promising. Considering the dismal state of Japanese banking, and the near refusal to address the problem there, some of the more recent banking reforms in China look fairly forward in comparison. Moreover, the entry of foreign banks can add value to the Chinese economy at the same time their competition further drives the Chinese banks to reform. A look to what has happened in other countries where foreign banks entered the markets reveals that the domestic banks will certainly lose market share. However, the positives of such competition outweigh the bad (Bonin and Huang 1080). Foreign banking has moved boldly into Poland, Hungary and the Czech Republic. By 1998 foreign banks held 63 percent of the banking assets in Hungary.

Data concludes that foreign competition in these three countries reduced poor loan practice in the overall sector (Bonin and Huang 1081). Also, the growth of foreign banking is often a slow enough process that domestic banks have time to respond positively. Many of the domestic banks in these Eastern European nations have been bought by foreign banks. Thus, in either attracting foreign buyers, or competing against them, banks had little choice other than reform. China’s banks are currently initiating reform on at least some levels in preparation for further integration into the global markets. Recapitalization of banks and restructuring assets has been a priority. However, as of yet, there has not been substantial enough movement in this regard (Bonin and Huang 1088).

AMCs alone are not suitable to reform banking as they lack the proper autonomy to do so. Further independence will be required of AMCs or any other supervision bureau. Also, listing the big four on the stock market would further induce reform through the kind of discipline required of stock market actors and should be a priority (Bonin and Huang 1089). Transparent banking procedure should become the norm and dud assets should be reallocated or sold, not simply papered over. Even lacking all the proper reform steps to date, China’s banks are at least making some headway in the reform process. Moreover, the foreign banks that will compete along side the domestic banks will invigorate the process based on the experience in other countries.

Bank reform is only a process. The real value that will come from WTO induced bank competition will be in the services and financing they will offer. A strong banking structure, foreign or otherwise is essential for economic growth. In this light, the WTO will be a definite boon to banking in China. Thus, banking, like most other sectors in the Chinese economy will have serious and painful side effects from the WTO rules they have pledged to follow. However, if handled properly, there can be tremendous opportunity for growth and prosperity.

Conclusions:

The tariff reductions and liberalized trade policy the WTO brings to China are quite substantial and significant. Many will be fully implemented as soon as 2005. For over twenty years China has moved cautiously and slowly in regard to economic reform. Such caution could be justified considering the misery seen in Russia where greater faith in the markets saw life savings erased over-night, heavy industry devastated and millions thrown out of work with little social safety net. Now China looks poised for a much less cautious, less deliberate approach to the next stages of economic reform. Indeed, the far reaching WTO provisions will accelerate the process and remove control of the economy further from the whims of the party leaders.

This paper, and the overwhelming majority of its source material, argues that the long-run results of WTO ascension will be extremely positive, if not essential for China. However, economists are a funny breed. It is rather easy to put pen to paper and talk of “transfer of labor” and all the lot without actually considering the sobering reality of such terms. In fact, the WTO guidelines will mean millions of people losing jobs. 500,000 in the auto industry alone and 11 million in Agriculture (Adhikari and Yang 5). Not every out-of-work auto worker or farmer will report to the nearest upstart enterprise and begin their new duties in the new economy. Many will be on the street and may even starve. SOEs will be extremely vulnerable to the groundswell of expected international competition.

At a time when global consolidation has produced multinationals of immense scale and proportion, China has but five companies on the Fortune 500, and not one in the Financial Times top 500 (Nolan 47). Chinese industry is at a huge disadvantage to these mega-companies. Even so, the most efficient may survive. Chinese shipbuilding has already been operating in a low tariff environment and is positioned well in the post-WTO landscape. Foreign partnerships and other joint ventures will invigorate others. Moreover, profitless SOEs can no longer be allowed to consume so much precious capital. Shutting down many SOEs will be the only way to extricate this kind of poison out of the Chinese economy.

Unlike the SOEs, the apparel sector will see marked increase in global market share and a move to value added production. This sector should see a large increase in job creation even as there is new competition from other latecomer economies such as Bangladesh. Any sector that can create jobs will be essential as China’s comparative disadvantage in agriculture will surely lead to millions of unemployed farm workers. Already the Chinese economy has seen a transfer of labor from agriculture to the rapidly growing TVEs. This sector has largely been the engine to China’s most recent and startling economic growth. The WTO will not impede this growth, and hopefully the TVE sector can proliferate in the Chinese hinterland.

High technology such as computers and telecom will see enormous growth in the next few years, much of it driven by foreign competition and partnerships. Again, ideally such infrastructure can reach the sorely neglected hinterland so these Chinese have the same kind of opportunities of those nearer the coast. All of this is predicated on a sound financial footing. Crumbling banks are no foundation for moving forward into the next century. Stiff WTO rules and the opening of this sector to foreign banking has already led to supervision and reform. Much more will be needed in this regard before Chinese banking can be given a clean bill of health. However, the initial moves are promising and the lessons of Eastern Europe portend that foreign competition in banking will be a positive, even as domestic banks lose market share.

Finally, what does Chinese WTO membership status mean from the perspective of the United States? Japan has often been the target of unfair trade practice by US representatives. However, China has also been a thorn in the side of American trade for years, as the markets there have been extremely sheltered. The 2002 United States Trade Representative report to Congress gives largely favorable reviews to Chinese WTO compliance to date. (5) The report acknowledged that China’s historic move to the WTO was extremely complex and that difficulties will continue. Even so, there are certain sticking points the US would like to see more movement on. Intellectual property rights need further attention, especially in enforcement (USTR 35). Moreover, the legal system in China is less than ideal as a venue for dispute settlement on any level.

These issues aside, there is great hope for long term business prosperity for US companies in China. Peter B. Hale, director of the Office of Policy Coordination, United States Department of Commerce, extolled in a roundtable before the Committee on Small Business in the Senate, March 7, 2001, “In summery, we do believe the premise of this session that China’s WTO accession will create new business opportunities for the U.S. businesses, both large and small, and we think that with hard work, perseverance, and so on, that the rewards in the market as it opens with the WTO membership will become very impressive” (47). Hale is likely right on the mark, and more importantly for millions of poor Chinese, there will be newfound opportunities for them too.

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