Opportunities and difficulties from China’s WTO accession

TDR 2002’s examination of the likely effects of China’s accession to the WTO suggests that membership in the global trade club could generate both enhanced export and industrialization prospects as well as potential economic and social disruption for the Asian giant.

by Chakravarthi Raghavan

GENEVA: While expanded trade and increased flows of FDI are among the expected benefits for China from its accession to the WTO, the country is, despite its successful export expansion in manufacturing, not immune to the kind of difficulties experienced by countries that shifted rapidly from import substitution to outward orientation, according to the UN Conference on Trade and Development.

In a chapter devoted to China’s accession to the WTO, the UNCTAD Trade and Development Report, 2002 has noted that Chinese exports had been growing at more than twice the world average for over a decade, and its exports now account for 4% of world trade, with a heavy emphasis on labour-intensive products. Given China’s demographic and economic size, its accession to the WTO implies a significant change in the trading environment that will affect countries in different ways.

While there have been concerns raised that its low wages give China a big competitive advantage in international trade, and these concerns have been heightened by its accession, TDR 2002 says that once productivity differences are accounted, China’s advantage is less clear.

UNCTAD’s analysis suggests that China would remain a strong competitor in some traditional labour-intensive goods, such as clothing and footwear, and in assembly operations in high-tech sectors. UNCTAD concludes that the second-tier East Asian newly industrializing economies (NIEs) and other middle-income emerging markets such as Mexico are likely to face the stiffest competition from the China exporters.

As for China, the trade liberalization implicit in its accession would bring some benefits in the shape of gaining permanent normal trade relations status with the US and eventual elimination of discriminatory, WTO-inconsistent measures against Chinese exports.

The TDR  notes that China is not liberalizing out of failure, unlike other developing countries where the liberalization decision was prompted by failure to establish competitive industries behind high barriers. Liberalization in China is taking place after a successful export expansion in manufactures, and is associated with a sound balance-of-payments (BOP) situation and international reserves.

However, this does not mean that China would be immune to the kind of difficulties experienced by other developing countries that shifted rapidly from import substitution to outward orientation.

The report sees particular problems arising for the state-owned enterprise (SOE) sector as well as the agricultural sector  - as different from the  highly competitive and export-oriented labour-intensive production sector dominated by foreign funded enterprises (FFEs).

The SOEs account for 50% of China’s exports, but their production is mostly oriented to the domestic market. A rapid dismantling of trade barriers and removal of subsidies could expose the SOEs to foreign competition, and may undermine their export performance as well as lead to a surge in imports. This may create problems, not so much for the BOP but for employment and living standards of the workers, who cannot be easily redeployed to more competitive, export-oriented labour-intensive manufacturing. Nor would such a course be advisable, says UNCTAD, since this would flood the markets abroad and provoke contingency protection measures and mechanisms like transitional, product-specific safeguards included in the Chinese accession protocol.

Much will depend also on how the Chinese exchange rate is managed, though China is better placed than most other developing countries in terms of its BOP position and reserves. In a number of developing countries, import liberalization was combined with liberalization on the capital account, bringing in short-term capital flows that financed the trade deficits but exerted upward pressure on the exchange rate, weakening the country’s competitiveness and export performance, and leading eventually to payments difficulties and financial crises. China is better placed in this regard.

However, how China would handle these problems would affect the outcome not only for itself but also for its trading partners. Trade liberalization may result in a surge in imports of certain resource-based products and those with high technology intensity, and will benefit countries with a competitive advantage in these goods. It may also benefit Chinese entry into new markets and make post-accession China a more attractive location for FDI linked to international production networks.

Disruptive impacts

Citing some of the projections (based on computable general equilibrium models) about the effects of Chinese accession and liberalization, UNCTAD cautions that such models assume away the problems that in reality determine the outcomes. For example, it is generally assumed that the labour market would remain in equilibrium and that labour would shift rapidly among sectors in response to new incentive structures. In reality, such shifts are extremely problematic, hence the extreme reluctance of industrial countries to remove entry barriers to labour-intensive manufactures and agricultural commodities.

China is also entering the WTO while undertaking reforms of the SOEs, which hold an important place in the Chinese economy. Removal of subsidies and reduction of tariff and non-tariff barriers may  put pressure on these enterprises to improve efficiency. However, big-bang liberalization could be socially disruptive, particularly in the hinterland where many SOEs are located.

According to one study, China’s accession to the WTO could cause unemployment to rise as high as 25 million over the period 2001-2006.

As the experiences of some developing countries show, sudden dismantling of support and protection to domestic industry could have serious repercussions on employment and could even cause deindustrialization, particularly in industries that face competition from mature industries of more advanced countries. It would also be difficult to quickly shift labour to export sectors. Adjustment to a new set of incentives is never instantaneous but a time-consuming process. Also, for a large country like China, there is the further risk of flooding markets in labour-intensive products, particularly if restrictions on market access in industrial countries persist.

Export surge

It is generally expected that Chinese accession would generate a surge in exports. This would have implications for other developing countries competing with China both in their own markets and in those of major industrialized nations. Simulations suggest that changed incentives could lead to a significant expansion of exports in a number of sectors (electronics, apparel, leather products and other light industries), but it is the market access rather than productive potential and competitiveness of China that would determine export performance. If market access conditions do not improve, TDR 2002 doubts that changed incentives would easily translate into rapidly rising export revenues.

While this applies to traditional labour-intensive manufactures, trade could expand rapidly in sectors linked to international production networks. There are already some indications of a rapid increase in FDI flows into China. Some of the investment is motivated by the desire to establish a commercial presence for collaboration with domestic industries. A surge in FDI could result in increased two-way or three-way trade in sectors involved in such international production networks.

The share of foreign firms in total Chinese exports reached 48% in 2000, up from just 2% in 1986. However, the report cautions against expecting too much from TNCs. Much of their activity is heavily import-dependent, accounting for half the value of their exports, and with $20 billion of profit remittances, the TNCs are well in excess of their export surplus of $2 billion. Their reinvested profits of $12 billion are not sufficient to make foreign firms a positive contributor to China’s current account, nor can these firms fill the employment gap created by any import surge.

Attempts of China to meet deficits from the FFE sector by simply relying on new FDI flows would be similar to engaging in an unsustainable process of Ponzi financing, cautions the report.

However, Japanese FDI in China may involve not simply relocating labour-intensive processes but also migration of a variety of large-scale industries, including capital- and skill-intensive ones, and China may thus be “leapfrogging” the development process seen in the South-East Asian countries and moving much more rapidly up the ladder.

The Chinese economy also has the potential to develop self-contained, technology-intensive large-scale manufacture, and such a process could establish mutually reinforcing links with FDI.

As for the trade prospects, countries with export structures similar to that of China will probably face the greatest competitive pressure.

UNCTAD suggests that certain characteristics of the Chinese economy allow greater scope for managing rapid liberalization compared to many other developing countries.

In middle-income countries, a substantial reduction in tariffs and quantitative restrictions on imports often releases pent-up demand for consumer goods, notably durables such as cars and home appliances, leading to a surge in imports. The greater the inequality in income distribution at the time of liberalization, the greater the surge in such imports. In China however, the demand for and growth of such consumer imports could be limited. And since Chinese industry is much less oriented towards production of luxury goods, China has considerable scope to use domestic taxation, including excise and value-added taxes, as also credit mechanisms to deter such imports.

Nevertheless, the structure and competitiveness of Chinese industries is such that serious injury may be caused, particularly in sectors in which the more advanced of China’s trading partners have a competitive edge. However, a full and transparent application of safeguard measures by China would not cause serious impediments to exports of most developing countries.

A Chinese shift to high-value-added, supply-dynamic products through a new strategy aimed at replacing imported parts and components with domestically produced ones could generate sufficient foreign exchange earnings without pushing trade/GDP ratios to unsustainable levels. It would also help avoid the problem of fallacy of composition and provide more space for less developed exporters of manufactures.

With its abundant supply of educated labour, technicians, engineers and scientists, China might have the potential to leapfrog the industrialization process, rather than continuing to rely on absorbing surplus labour in relatively low-value-added, labour-intensive manufactures, UNCTAD suggests. (SUNS5011)

From TWE No. 279 (16-30 April 2002)