t ^ ~~~~~Sept. jqq? |~~~~~~~~~~~~~~~~~~~~~~~ ,, _,, 9 ~~~~~~~~~~~~~i a'~~~~~~~~~.1 t8; zl>@F. ,,~I, 4. ' *E, (n T HE WVI4,IRLD B A N K C H I N A 2 0 2 0 CHINA ENGAGED C H I N A 2 0 2 0 S E R I E S China 2020: Development Challenges in the New Century Clear Water, Blue Skies: China's Environment in the New Century At China's Table: Food Security Options Financing Health Care: Issues and Options for China Sharing Rising Incomes: Disparities in China Old Age Security: Pension Reform in China China Engaged: Integration with the Global Economy 0 T H E W O R L D B A N K i3 W A S H I N G T CO N D . C CHINA ENGAGED INTEGRATION WITH THE GLOBAL ECONOMY W T H E W O R L D B A N K W A S H I N G T O N D . C Copyright ( 1997 The International Bank for Reconstruction and Development/THE WORLD BANK 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. All rights reserved Manufactured in the United States of America First printing September 1997 The World Bank does not guarantee the accuracy of the data included in this publication and accepts no responsibility whatsoever for any consequence of their use. The boundaries, colors, denominations, and other information shown on any map in this volume do not imply on the part of the World Bank Group any judgment on the legal status of any territory or the endorsement or acceptance of such boundaries. The material in this publication is copyrighted. Requests for permission to reproduce portions of it should be sent to the Office of the Publisher at the address shown in the copyright notice above. The World Bank encourages dissemina- tion of its work and will normally give permission promptly and, when the reproduction is for noncommercial purposes, without asking a fee. Permission to copy portions for classroom use is granted through the Copyright Clearance Center, Inc., Suite 910, 222 Rosewood Drive, Danvers, Massachusetts 01923, U.S.A. Cover photograph by Serge Attal/ Gamma Liaison. Cover insets (from left to right) by Vince Streano/Aristock, Inc.; Claus Meyer/ Black Star; Dennis Cox/China Stock; Dennis Cox/China Stock; Joe Carini/Pacific Stock; Erica Lansner/Black Star. ISBN: 0-8213-4079-4 Contents Acknowedgments vii Overview 1 Chapter 1 China in the World Economy 5 Integration with the world economy 5 Openness and growth 8 Chapter 2 Foreign Trade Institutions and Policies 11 Foreign trade institutions and trade barriers 12 China's trade reforms 13 Chapter 3 Integration with Global Capital Markets 19 Global financial flows to developing countries 20 Global integration of capital markets 23 Commercial borrowing and debt management 25 China's outward investments 26 Chapter 4 Global Effects of China's Integration to 2020 29 Evaluating how China's growing trade will affect the world 30 Effects of a slowly integrating China 36 Annex Changes in China's Tariffs, 1992-2005 39 This report uses Hong Kong when referring to the Hong Kong Special Administrative Region, People's Republic of China. 0 ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~v Acknowledgments his report summarizes an internal World Bank paper entitled "China in the World Economy" (International Economics Department) and was prepared by a team led by Dipak Dasgupta. The other main authors were Milan Brahmbhatt, Caroline Farah, and Kim Murrell (chapter 1), Christian Bach and Will Martin (chap- ter 2), Kwang Jun and Xiaoqing Yu (chapter 3), and T.G. Srinivasan (chapter 4). The team is grateful to Nicholas Hope (former director of the China and Mongolia Department at the World Bank) for conceiving this study and for his generous support. Overall support and com- ments from Uri Dadush, Kathie Krumm, Vikram Nehru, and Richard Newfarmer are gratefully acknowledged. The report also benefited from fruitful discussions with many Chinese government officials and analysts during a mission to China in January 1997. The mission team is thankful for the comments and information provided by a large number of Chinese officials, including Zhu Xian, vii Zhao Jie, Wu Jinkang, Hu Xuehao, Xia Zhihua Xiaopu (State Administration of Foreign Exchange); Lu (Ministry of Finance); Cao Yushu, HaoJu, Wang Xiduo, Hailin, Ma Lin, Zhang Zhiyong, Hu Jinmu, Zhen Hua, Wang Jianjun, Wu Qiang, Xiao Yanshun, Li Yunlin Jin Donsheng, Yuan Yuan (State Tax Bureau); Chang (State Planning Commission); Wang Zixian, Zhu Zhenmin (China International Trust and Investment Zhiping, Wang Zhihua, Chen Xin, Wang Yi, Deng Li, Corporation); Zhu Min (Bank of China); Gao Fulai Ding Wei, Zhao Yanxia, Wang Jing, Chen Wenjing, Li (China National Metals and Minerals Import and Jian (Ministry of Foreign Trade and Economic Export C(orporation); and Chen Jiaying, Chen Boyu, Cooperation); Jing Xuecheng, Zhang Xinze, Yang Xue Jinglian, Song Jianhua, Xie Wei, Zhao Kunsheng, Zaiping, Yao Keping, Yang Huisheng, Pei Chuanzhi, Lin Bifen, Chen Nenggeng, and Cao Dewang of Fujian Zhao Xiangeng, Chen Xin, Liu Xuemei, Wan Cunzhi, Province. We would also like to thank all of those who Zhan Hongdi (People's Bank of China); Kang Qiang, participated in the seminar on the mission's initial find- Liu Ping, Jiang Hao, Chen Zhenchong, Dong Yufan, Lin ings, and who provided valuable advice and comments, Daqiang, Zhang Yimin, Jin Hongman (Customs including the helpful comments received on initial drafts General Administration); Wang Wei, Li Zhi, Yu Dayong of the study. (Customs Tariff Commission); Tu Guangshao (China Assistance provided by Zhou Xiaobing and Li Sheng Security Regulatory Commission); Song Yuzhong, Wei of the World Bank's Resident Mission in China and by Dong, Wang Xu, Liu Dongsheng, Zhou Shuanghu Mei Hong, Pan Wenxin, and Fan Wenzhong of the (State Economic and Trade Commission); Chang Ministry of Finance is gratefully acknowledged. Xiaochun, Jia Xiaozuo, Zhao Jian, Cheng Zhanyin, The report was edited by Meta de Coquereaumont Guo Rongzi, Song Peiji, Shi Yonghong, Shen Qun (State and Paul Holtz, laid out by Glenn McGrath and Machinery and Electronics Import and Export Office); Laurel M[orais, and designed by Kim Bieler, all with Huang Hongbo, Liu Xin, Xie Hemin, Xu Honglin, Hao the American Writing Division of Communications Jinghua, Sun Qiumei, Zheng Haifeng, Fang Wen, Zhang Development Incorporated. viii China Engaged: Integration with the Global Economy Overview 000" hina was a closed economy until 1979. But as a w result of open-door policies and reforms, its relationship with the rest of the world has been trans- formed and its modernization and growth have acceler- ated. As China's integration with the world economy progresses over the next twenty-five years, the implica- tions will be enormous. According to a projection scenario, China's share in world trade could more than triple to 10 percent, making it a major engine of growth for world trade. China would become the second largest trading nation in the world. The economic welfare benefits-for China and its trading partners-of China's liberalization and entry into the mul- tilateral trading system would be large, with benefits to China alone estimated at more than $116 billion a year by 2005. Moreover, in a world of ever greater integration, benefits are expected in the form of rising wages in both industrial and developing countries. To realize the benefits, f:~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ however, China and its major trading partners will need The early phase of China's foreign trade reform encom- to further liberalize their trade and investment relation- passed the move from state monopoly to decentralized ships within the context of a rules-based multilateral system. Special economic zones and open coastal cities system, including China's accession to the World Trade led to greater openings for trade. Still, by the early Organization (WTO). 1990s China was falling behind other developing coun- tries in liberalizing its trade. China's recent offers of China in the world economy trade reforms are positive, however, and promise to bring large benefits. The pace of global integration-the widening and China's foreign trade institutions play an important intensifying of international linkages in trade, invest- role. But many are still oriented toward the direct con- ment, and finance-has accelerated since the mid- trol of trade, which will be increasingly incompatible 1980s. China's opening to the world economy since with a liberalized trade system. Moreover, China's cur- 1978 has made major contributions to this process. The rent trade policy regime has major inefficiencies. increase in China's trade to GDP ratio-from 10 per- Reforms are needed to dismantle nontariff barriers, cent in 1975-79 to 36 percent in 1990-94-was the remove restraints on foreign trade, eliminate export seventh most rapid among 120 countries. And the restrictions, and move import policies toward a trans- increase in its foreign direct investment (FDI) to GDP parent system with low tariffs and no quotas. ratio-from almost zero in 1975-79 to about 3.5 per- Recent offers by China as part of its WTO accession cent in 1990-94-was the sixth most rapid. process would move it far in that direction. The impact This greater openness in policies has paid rich divi- on industrial structure and overall welfare in China dends. China's faster and more efficient economic (and its main trading partners) would be very favorable. growth in the post-reform period is clearly associated A general equilibrium trade model shows that over the with increased openness. Rapid growth in trade has next ten to fifteen years there would be large gains for accelerated economic growth. And foreign investment, the clothing sector (a result of abolishing the Multi- attracted by the large pool of low-wage labor and a Fibre Arrangement), while reducing high import tariffs large and growing market, has encouraged faster spe- would bring a relative decline in the output of (capital- cialization in labor-intensive manufacturing and and technology-intensive) transport, machinery and increased employment and incomes, while reducing equipment, and other heavy manufacturing industries poverty. Even so, there remains much further potential (consistent with China's comparative advantage). for openness and for greater and more widely distrib- Variable aLnd relatively high rates of protection would uted productivity gains. China has essentially been remain for some sectors, however. Welfare gains from catching up with other developing economies in open- the proposed reforms would be large for China (equiv- ing to the world. Its 1990-94 its trade to GDP ratio was alent to 4 percent higher annual output than under the about the same as that of other large developing coun- baseline scenario) and significant for its major trading tries-but it was some 19 percentage points below the partners. average for its East Asian neighbors. Again, China's FDI to GDP ratio is higher than that for other large devel- Integration with global capital markets oping countries, but compared with the East Asian average, not markedly so. Portfolio flows-equities, China's growing integration with global capital mar- bonds, and other securities-to China were smaller (rel- kets is reflected in its large shares in cross-border flows ative to GDP) than to other Asian economies or Latin to developing countries: 40 percent of FDI flows, 10 America. percent of lending by banks, and growing portfolio flows. Foreign trade institutions and policies Sustaining and shifting the composition of its FDI flows will be important for China in achieving some of China's foreign trade has become an engine of eco- its priority development objectives: more investment nomic growth and an engine of growth in world trade. in infrastructure, faster technological progress, and 2 China Engaged: Integration with the Global Economy greater flows of investment to interior and poorer Global effects of China's integration provinces. To sustain FDI flows, China will need a sta- to 2020 ble macroeconomic environment and complementary reforms to improve the regulations and institutions gov- China's expected growth of about 7 percent a year erning FDI. And to shift the composition of these flows over the next twenty-five years will magnify its pres- toward priorities, China will need to improve the trans- ence in the world economy. China will account for parency of its investment regime, which investors per- some 40 percent of the increase in developing country ceive to be one of the most complex in the world. imports between 1992 and 2020, helping to drive Greater transparency in rules governing FDI and better growth in world trade. The implications of China's property rights for investors will attract a wider range growing role are favorable. Industrial countries will of FDI and ensure greater competition. This in turn benefit from China's rising demand for imports of would help ease the skewed geographical and sectoral capital- and knowledge-intensive manufactures and distribution of FDI inflows, bring in and disseminate services and primary products and from gains in better technology, and attract more investment in infra- terms of trade. Neighboring developing countries that structure sectors. Trade policy reforms would also be are not close competitors (Asia's newly industrialized important to bring FDI into more efficient areas and countries) are likely to experience equally significant provide greater benefits to the economy. gains. Pressures in domestic financial markets to integrate For countries that are close competitors of China faster with international financial markets are growing. (low- and middle-income Asian countries such as Such integration also promises to bring about greater effi- India, Indonesia, the Philippines, and Thailand), ciency in domestic financial intermediation. In that con- world market shares and volumes of trade will likely text, domestic financial sector reform will be important. continue to expand, but significant terms of trade This would include the domestic banking and nonbank losses are expected in their main exports of labor- financial sectors. And reforms in capital markets will be intensive manufactures. Net income gains, however, essential, to improve efficiency and stability. China should will still be large. For developing countries and regions move gradually, however, to integrate with global capital that do not directly trade much or compete with China markets and to establish full convertibility of its capital (Latin America, Sub-Saharan Africa, Europe and account. Experience shows that international capital Central Asia), there will be neither significant gains flows can be volatile and test governments' macroeco- nor major losses. Finally, the greatest adverse effects of nomic management. Weak financial and capital markets a slower integrating China would be in itself, although magnify these risks. Measures to improve commercial welfare losses for the rest of the world would also be borrowing and debt management would also be prudent. significant. Overview 3 China in the .fWorld Economy '''-'-'''''S~~~~~~~~~~~..... . ,..-~... ..... - d` tarting from a position of near-autarky, China -t-=p 09 has been catching up rapidly with other devel- oping countries in integrating with the global economy. Increased integration and openness have paid rich divi- dends in the way of faster growth. Still, there is much room for progress. Integration with the world economy A common indicator of economic integration is a coun- try's participation in international markets (as measured by international trade and foreign capital flows relative to GDP, for example). Using trade openness to measure a country's integration with the world economy is not with- out problems, however, especially in the case of China. The country's size, problems in comparing its GDP with other countries', exchange rate movements, and the importance of its processing trade make comparisons dif- ficult. A different approach is to define integration as the 5 I ; ^ absence of policy barriers to the mobility of products A scatter diagram of population and trade to GDP and factors. ratios in 1990-94 suggests that China has done well, but it is not a major outlier (figure 1.2). Trade openness Discussions of China's trade openness also frequently turn to the size of its GDP, which is thought to be under- In 1975-79 China's international trade was 10 percent estimated. Although it is true that developing country of GDP, the lowest among 120 countries studied.' By GDP can be underestimated because of the relatively 1990-94 this ratio had risen to 36 percent, placing low prices of nontradables, there are also data problems China in the top third. The increase in trade openness specific to China. The first issue can be addressed by between the two periods-1.7 percentage points a using purchasing power parity-adjusted estimates of year-was the seventh most rapid in the world. GDP, which correct for undervaluation of nontrad- But compared with its East Asian neighbors, the pace ables.2 Wlhen applied to China, this brings the ratio of of China's integration was less impressive (figure 1.1). trade to GDP down to about 10 percent (in 1995), sug- And in terms of level of integration China has essen- gesting an economy more open than India (6 percent) tially been catching up with other large developing but about the same as Brazil (10.5 percent). Nominal countries (populations of more than 100 million), none GDP is also thought to be underestimated. Thus China's of which (except Indonesia) had very open trade high trade to GDP ratio, calculated conventionally, may regimes. Consider China's trade to GDP ratio relative to be overestimating the openness of the economy. that of other large developing countries -Bangladesh, Brazil, India, Indonesia, Nigeria, and Pakistan. In Movements in the real exchange rate 1975-79 China's trade ratio was about 18 percentage points below the average for these countries; by Trade to GDP ratios are sensitive to movements in real 1990-94 it had risen to about the same level. exchange rates. Substantial depreciation of China's real official exchange rate (73 percent between 1980 and Country size and economy 1994) was associated with an increase in its trade ratio Big countries tend to trade less across their borders than small ones because they have a wider range of resources and more opportunities for efficient specialization and China's trade Level is in line with that of trade within the country. Is China special in that regard? other hiigh-popuLation economies, 1990-94 Trade/GDP F1 GUR£ t1 . (percent, log scale) Though rapid, China's gLobal integration Lags 60 * Singapore behind that of its East Asian neighbors Hong Kong Trade/GDP 50 (percent) 70 0 Nigera 60 4 * Indonesia 50Large _ H ChinaN 50deveLoping countries EatAi 30 G a 40 exduding China 3 f *United 30 B BraziL States 20 20 10 UChina * Myanmar 0 10 1965 1970 1975 1980 1985 1990 1995 4 6 8 10 12 14 Logarithm of population (thousands) Source: WorLd Bank staff estimates. Source: World Bank staff estimates. 6 China Engaged: Integration with the Global Economy in the reform period. In constant prices the ratio rose 1.2 percentage points a year between 1975 and 1994, TABLE 1.1 Share of goods sold at state-fixed prices, 1978-93 below the 1.7 points a year in nominal terms. This real (percent) rate of increase was the thirtieth most rapid among 120 countries studied, well below China's seventh place Year commodities Agricutura[ Cap ranking in nominal terms. 1978 97 94 100 A strong case can be made, however, that the fall in 1992 10 15 20 the real value of the yuan in the reform period was dif- 1993 5 10 15 ferent from the fluctuations in the yen and the dollar in Source: Lardy 1994. recent years and is a useful policy indicator of greater integration. Before reforms began, the exchange rate East Asia (Indonesia, Malaysia, Thailand) has been was a bookkeeping concept with little economic rele- especially adept in attracting the labor-intensive stages vance. Extreme imbalances between supply and of global and regional production. In China, however, demand for foreign exchange were kept in check by high tariffs and deep exemptions create artificial incen- tight exchange controls. Dismantling this system and tives for this type of trade. moving toward a market-based system (marked by uni- fication of the exchange rate system and real devalua- Trade policy tion of the official exchange rate) was a precondition for global integration. Since these reforms were accom- China's openness on trade policy was about the average plished by 1994, the yuan has appreciated in real terms. for all large developing countries in the early 1990s. That average, however, was strongly influenced by Processing and assembly trade South Asian countries, which traditionally have some of the world's highest levels of protection and have been The increase in China's trade to GDP ratio was espe- among the slowest in trade liberalization. China's tariffs cially rapid after 1984, when the State Council approved were substantially higher than those of other East Asian two schemes allowing duty-free import of components economies. Its nontariff barriers were around the mid- and raw materials for use in export industries. Processed dle of the range for all countries. exports under these schemes rocketed to 45 percent of merchandise exports by 1991 and were more important Prices in China's trade than were such products elsewhere in East Asia (Lardy 1994). The imported content of these In a market economy the closeness of domestic to inter- processed goods averages 90 percent of export value national prices of traded goods (expressed in a common (Lardy 1994, table 5.1; Fung 1996, table 14). currency) is often a preferred indicator of integration. In China, with its dependence on processed goods theory, these prices should differ only by the amount of exports, will tend to stand higher in rankings of global trade barriers, transportation costs, and differences integration based on the trade to GDP ratio than it across countries in the cost of nontraded inputs.3 Price would in rankings based on the share in GDP of value data that are sufficiently detailed and extensive to allow added that is exported or on the share of domestic con- such comparisons are rarely available, however. sumption that is supplied by imports, both of which are World prices had almost no influence on prices in better measures of integration. Still, the processing (or China before 1978, and there was a wide gap between outsourcing) trade that has flourished in China will domestic and international prices in the one year likely be of growing importance in world trade. Falling (1984) for which some comparative price data are telecommunications and transportation costs allow a available (Lardy 1992, 1994).4 Price reforms since the "slicing up of the value chain," enabling firms to locate mid-1980s mean that domestic prices for more than 90 various stages of production in countries with the percent of imported goods are now linked to (and appropriate comparative advantage (Krugman 1995). affected by) world prices (table 1.1). This link may The second wave of newly industrialized countries in imply a narrowing of price differentials, although trade China in the World Economy 7 FIGURE 1.3 FIGURE 1.4 Foreign direct investment in China has Portfolio capital flows to China skyrocketed in recent years remain limited Percentage of GDP Percentage of GDP 7 China 2.0 East Asia Latin America 6 1.5 5 4 1.0 3 Asia ~~~~~~~~~~~~~~~~~~~~~~China 0.5 2 0 a -0.5 1974 1978 1982 1986 1990 1994 1980 1L982 1984 1986 1988 1990 1992 1994 Source: World Bank data and staff estimates. Source: World Bank data. barriers and other costs continue to drive a wedge Portfolio flows between the two. During the 1980s portfolio capital flows were a phe- Foreign direct investment nomenon of high-income countries. Portfolio flows to developing countries picked up in the 1990s, but were Inflows of foreign direct investment (FDI) to China, vir- concentralEed. In only sixteen of seventy developing tually nonexistent before 1979, rose to 3.5 percent of countries surveyed (not including China)-mostly in GDP in 1990-94 (figure 1.3).5 In 1990-94 China's FDI East Asia, Latin America, and developing Europe-did to GDP ratio was the ninth highest among 120 countries portfolio flows exceed 0.5 percent of GDP in 1990-94. studied. The increase between 1975 and 1994-0.24 In these sixteen countries, however, portfolio flows percentage points a year-was the sixth highest. In 1996 averaged about 2 percent of GDP; in the other countries FDI inflows rose to an estimated $42 billion. flows averaged less than 0.1 percent of GDP. Continued Interpretation of cross-country data is more straight- restrictions and weak market infrastructure mean that forward for FDI than for trade. There is no correlation portfolio flows to China have been limited. Such flows between country size and FDI to GDP ratios. For China were negligible in 1980-84, rose to around 0.5 percent increased flows are in line with the steady liberalization of GDP in 1986-88, and collapsed in 1989 because of of FDI regulations since 1979, especially in the coastal political tensions. Flows revived modestly in the 1990s provinces. "Roundtripping," however, may account for (to 0.7-0.9 percent of GDP in 1993-94) before slipping some of the increase in the FDI to GDP ratio in recent back in 1995 and 1996 (figure 1.4). years.6 Moreover, FDI flows have been more volatile than trade. For many reasons, including the elimination Openness and growth of tax concessions for foreign investors in 1996 and the slowdown in the surge in transfers of labor-intensive There is a wealth of empirical evidence about the posi- assembly operations from neighboring countries, it is tive association between openness and economic likely that high FDI inflows in China in 1993-95 growth. A study of a group of countries examined over (6.0-6.5 percent of GDP) were exceptional and will fall 1970-89 found that, within the group of developing back to a level more sustainable in the long run. countries, open economies grew by 4.5 percent and 8 China Engaged: Integration with the Global Economy closed ones by 0.7 percent (Sachs and Warner 1995). Studies comparing pre- and post-reform growth sug- Among industrial countries, open economies grew at gest that China's economic growth accelerated after 2.3 percent and closed ones at 0.7 percent. Studies have reforms started in 1979 (Borensztein and Ostry 1996). also shown a link between faster integration and higher Remarkably, the improvement was achieved entirely by growth. Countries that have integrated fastest-that is, an improvement in total factor productivity growth- become more open in trade and investment-also of between 3.6 and 4.1 percentage points.7 A more achieved the most rapid growth in per capita GDP dur- recent study (World Bank 1997a) indicates that while ing 1983-94 (World Bank 1996). the absolute size of the total factor productivity Why do open and integrated economies grow faster? improvement may have been smaller (when corrected There are several reasons: for data problems and differing methodological * Allocative efficiency. Higher levels of output are approaches), it still accounts for a large part (about a achieved when countries specialize according to their third) of the faster overall growth since reforms began. comparative advantage. A study using data for twenty-three industrial sectors * Factor accumulation and investment. Trade liberal- in seven of China's coastal provinces concludes that ization accelerates investment by allowing access to big- four main factors contributed to faster growth, most ger markets, permitting greater exploitation of related to greater openness: increasing returns to scale, and encouraging imports of * Open-door policies, particularly in special economic previously unavailable or cheaper capital goods zones, were hugely successful in attracting more invest- (Murphy, Shleifer, and Vishny 1989). A recent cross- ment from overseas Chinese to the southeastern coast- country study suggests that the effect of more open as in the cases of Hong Kong (China) investors to trade policy working through higher domestic invest- Guangdong and, more recently, Taiwan (China) ment may be the most important channel for growth investors to Fujian. These provinces benefited not only (Wacziarg 1997). For China, rapid investment growth from the physical proximity to overseas Chinese com- since 1978-due to increased openness-appears to munities but also from their "relative backwardness" have had a big effect on growth. (Dollar 1992). - Knowledge spillovers. Knowledge spillovers are * Education has a positive effect on growth. There is likely in open economies because of the knowledge that an association between growth and the interaction is embodied in traded goods and machinery and FDI between local education and foreign investment, which that is attracted to those economies. can be interpreted as a proxy for foreign knowledge and * Improved income distribution. Returns to relatively suggests a strong complementarity between the two. abundant factors of production, such as labor in devel- The finding that openness provides a crucial channel by oping countries, will tend to be higher in open which developing countries learn faster from industrial economies. countries and the complementarities to education are * Government policy improvements. There is greater also suggested in cross-country studies (Coe, Helpman, pressure to maintain macroeconomic stability and and Hoffmaister 1994). smaller government in open economies. * Physical infrastructure (and coastal locations) not Rapid growth has been driven by the same basic fac- only eases information flows but also provides the focal tors in China as it has in all East Asian economies: high point for development of agglomerations (Shleifer rates of investment, financed by high domestic savings; 1991). This played a key role in China's growth. increases in education spending; and abundant labor * Growth, once initiated, has dynamic spillovers. On and its growth. In the post-reform period, market-dri- average, a 1 percentage point increase in growth of an ven investments and savings have responded to prof- industrial sector outside a region is associated with a itable investment opportunities, and human capital has 0.78 percentage point increase in growth of that indus- been deployed more efficiently as labor became more try within the region (Mody and Wang 1995). responsive to market forces. Moreover, foreign trade Another study that examined export-led growth and investment have played a bigger and more efficient effects in China's cities found that exporting and for- allocative role in the economy. eign investment were strongly associated with faster China in the World Economy 9 industrial and economic growth (Wei 1996). In 1980-90 Krugman, Paul. 1995. "Growing World Trade: Causes and more exports were positively linked to higher industrial Consequences." Brookings Papers on Economic Activity 1. Brookings Institution, Washington, D.C. growth, whereas in the late 1980s cross-city growth dif- Lardy, Nicholas. 1992. Foreign Trade and Economic Reform in ferences were better explained by foreign investment. China, 1978-1990. Cambridge: Cambridge University Press. -_____ 1994. China in the World Economy. Washington, D.C.: Institute For International Economics. Notes Lardy, Nicholas, and Fritz Machlup. 1977. A History of Thought on Economic Integration. New York: Columbia University 1. Trade is defined as exports and imports of goods and nonfactor Press. services as a share of GDP measured at market exchange rates. Mody, Ashoka, and Fang-Yi Wang. 1995. "Explaining Industrial 2. For more details, see Summers and Heston (1991) and World Growth in Coastal China." PSD Occasional Paper. World Bank, Bank (1997b). Washington, D.C. 3. Evidence on the Law of one price is summanzed in Rogoff (1996), Murphy, Kevin, Andrei Shleifer, and Robert Vishny. 1989. who notes, however, the persistence of Large differences in prices even "Industrialization and the Big Push." Journal of Political between countries (such as Canada and the United States) without Economy 97 (5). trade barrers, with excellent transport Links, and simiLar nontraded Ng, Francis, and Alexander Yeats. 1996. "Open Economies Work costs-a so-caLLed border effect. Better! Did Africa's Protectionist Policies Cause Its Marginal- 4. For thirty-nine individual goods domestic prices averaged 82 ization in World Trade?" Policy Research Working Paper 1636. percent of world prices, with a standard deviation of 52 percent (Lardy World Bank, Washington, D.C. 1992, table 4.2). Rogoff, Keineth. 1996. "The Purchasing Power Parity Puzzle." 5. We normaLize for GDP because, other things being equal, large Journal of Economic Literature 34 (June): 647-68. economies draw more FDI than smaLL ones. Sachs,Jeffrey, and Andrew Warner. 1995. "Economic Reform and 6. Some sources estimate that up to 20 percent of recent inflows the Process of Global Integration." Brookings Papers on were domestic capitaL that was roundtripping to take advantage of Economic Activity 1. Brookings Institution, Washington, D.C. incentives for foreign investors (UNCTAD 1995). Shang, Jin Wei. 1993. "Open Door Policy and China's Rapid 7. Borensztein and Ostry (1996) note that the estimate for totaL Growth: Evidence from City-Level Data." NBER Working factor productivity growth may be overestimated by 1 percentage Paper 4602. National Bureau of Economic Research, point because of the excLusion of human capitaL from the growth- Cambridge, Mass. accounting exercise. Shleifer, Andrei. 1991. "Externalities and Economic Growth: Lessons irom Recent Work." Background paper for World Developmient Report 1991. World Bank, World Development References Report Office, Washington, D.C. Summers, Robert, and Alan Heston. 1991. "Penn World Tables Borensztein, Eduardo, and Jonathan Ostry. 1996. "Accounting (Mark 5): An Expanded Set of International Comparisons, for China's Growth Performance." American Economic 1950-1988." Quarterly Journal of Economics 106(May): Review Papers and Proceedings 86(2): 224-28. 327-68. Coe, David, Elhanan Helpman, and Alexander Hoffmaister. UNCTAD (United Nations Conference on Trade and 1994. "North-South R&D Spillovers." IMF Working Paper Development). 1995. World Investment Report 1995. Geneva. WP/94/144. International Monetary Fund, Washington, D.C. Wacziarg, R. 1997. "Measuring the Dynamic Gains from Trade." Dasgupta, Dipak, 1993. "Why Some Regions Do Better Than Harvard University, Department of Economics, Cambridge, Others." In Amex Bank, Finance and the International Mass. Economy. New York: Oxford University Press. Wei, S. 1996. "Foreign Direct Investment in China." In T. Ito and Dollar, David, 1992. "Exploiting the Advantages of A. Krueger, eds., Financial Deregulation and Integration in East Backwardness: The Importance of Education and Outward Asia. University of Chicago Press. Orientation." World Bank, Policy Research Department, World Bank. 1996. Global Economic Prospects and the Washington, D.C. Developing Countries 1996. Washington, D.C. Fung, K.C. 1996. "Accounting for Chinese Trade: Some . 1997a. China 2020: Development Challenges in the New National and Regional Considerations." NBER Working Century. Washington, D.C. Paper 5595. National Bureau for Economic Research, . 1997b. World Development Indicators 1997. Cambridge, Mass. Washington, D.C. 10 China Engaged: Integration with the Global Economy Foreign Trade Institutions and Policies hina's foreign trade institutions play an impor- X $ 00 tant role in setting and implementing policies. Although enormous progress has been made, some of these institutions remain oriented toward direct control of trade, which will be incompatible with a liberalized trade regime. Moreover, China's trade regime has major ineffi- ciencies. Reforms are needed to dismantle the maze of nontariff barriers, remove restraints on foreign trading, eliminate export restrictions, move import policies toward a transparent system with low tariff rates, and abolish import quotas. Recent offers by China to reduce tariff and nontariff bar- riers would help greatly in making better use of its com- parative advantage and increasing its openness. They would also reduce the strong incentives to focus on pro- cessing trade that are inherent in the current system of high tariffs and deep exemptions. Still, high and varying rates of protection would remain for a number of manufacturing . g to~~~~~~~~~~~~~~~~~~~~~~~~~~~~1 industries. The impact of such reforms on the industrial Foreign trade rights structure and overall welfare in China (and its main trading partners) would be very favorable. A general Before reform, foreign trade in China was monopolized equilibrium model shows that there would be dramatic by ten to sixteen specialized foreign trade corporations gains for the clothing sector (a result of abolishing the (Lardy 1992). Since then, there has been a dramatic Multi-Fibre Arrangement), while reducing high protec- increase in the number of firms allowed to conduct for- tion would stimulate efficient growth in the labor-inten- eign trade. In 1994 the number of foreign trade corpo- sive apparel sector and the capital- and skill-intensive rations engaged in exporting was estimated at 9,400 transport equipment sector. and those in importing at 8,700.1 Thousands of big state enterprises now have direct trading rights. Foreign trade institutions and Foreign-affiliated enterprises (including joint ventures trade barriers and foreign-owned firms) also have rights to trade and are exempt from licensing on their products and inputs Eight institutions are involved in formulating or (MOFTEC 1994, p. 155). In 1994 joint ventures administering China's trade policies-the Ministry of accountecl for a third of China's imports and almost 20 Foreign Trade and Economic Cooperation, State percent of exports (table 2.1). Foreign-owned enter- Planning Commission, State Economic and Trade prises accounted for 12 percent of imports and 9 per- Commission, Customs Tariff Commission, Customs cent of exports. Given the large number of participants General Administration, National Machinery and in foreign trade, there seems little reason for China to Electronics Import and Export Office, State continue restricting access to trading rights. Such poli- Administration of Foreign Exchange (under the cies have already been abolished in Russia and all of the People's Bank of China), and foreign trade corpora- transition economies of Eastern Europe. tions. These agencies administer a set of complex and frequently overlapping controls over foreign trade (fig- Export controls ure 2.1). China controls the entry of enterprises into foreign trade (through foreign trade rights) as well as China's export taxes and controls appear to have trade itself. caused less economic damage than might be expected. FIGURE 2.1 Institutional structure for foreign trade in China 2 Institutions w rhe G Policies| Coni | Minsty f orig State Ptanning State Economic and Custorms Tariff Customs General People's Bank Trade and Economi'c Commission Trade Commission Commissiorn Administration of China Cooperation\ / l\ \ \ / ~~~~~Natb'onat Machinery \State Administration \ \ / ~~~~and Etectronics Import \of Foreign Exchange \ )t\ ~~~~~~and Export Office\I l tora doe Qu|a an Ertepene' 8. Trade cwntroLs Tl S | Forei'gn exchange| corporations I fdrdrsanhs4 [' 1 | 12 China Engaged: Integration with the Global Economy TABLE 2.1 13.4 percent on imports other than those for export Contribution of different firms to China's trade, processing. In 1994 exemptions for capital goods 1994 imports started being phased out. Exemptions for capi- tal goods used by foreign-funded enterprises and for Exporting Importing technical upgrading were abolished in 1996, subject to Share of Share of a one- to two-year grandfathering provision not ex- exports imports Type of firm Number (percent) Number (percent) tending beyond 1997. Foreign trade corporations 9,400 53 8,700 44 There are quotas for twenty-six general commodities State-owned enterprises 7,800 17 3,600 8 for which it is feared that excess imports could bring Joint ventures 30,000 19 64,800 34 Foreign-owned firms 9,730 9 23,239 12 serious injury to the development of domestic industry CoLLective and private firms 1,060 1 1,828 1 or damage to China's balance of payments. The State Other 520 0.2 5,378 1 Planning Commission determines the quota levels and Tota[ 58,500 100 107,513 100gq allocates them to provinces. There are quotas on fifteen Note: Some numbers may not add because of rounding. Source: ITC 1995, p. 22. machinery and electronic products (for example, auto- mobiles and refrigerators). They lead to rent-seeking, however, and make it diffi- Automatic import registration covers a wide range of cult for new exporters to enter some markets. Export imports, including oil, steel, copper, nonferrous metals, taxes are used to improve terms of trade for a few com- wool, polyester, tobacco, and cotton. Some of these modities in which China has a large market share or for products are also subject to state trading, some to des- which it wants to influence domestic prices. Export ignated trading, and some to quotas and licenses, while licenses are issued for goods subject to price some are otherwise unrestricted. While automatic coordination-that is, prices determined by the import registration is not intended as a nontariff barrier, Chamber of Commerce. The traditional means of allo- it could have this effect because it is contingent on a cating export quotas has been administrative, although market-need criterion (box 2.1). some are being allocated through bidding procedures China's VAT on imports and domestically produced on an experimental basis (Editorial Board of the goods is 17 percent (13 percent on selected goods). Almanac of Chinese Foreign Economic Relations and Exports are zero-rated and eligible for a rebate on the Trade 1995). VAT paid on inputs. The claims for rebates substan- tially exceeded expectations, however, and in 1995 the Import controls rebate on inputs purchased for export production was reduced to 14 percent and later to 9 percent. Thus the China's import policies include various tariff and non- VAT imposes an effective net tax on exports that com- tariff measures that result in high protection and deep ply with the law. Improvements in the administration of exemptions. The efficiency and performance of the the law that would raise the collection rate and allow a economy could be improved substantially by moving to return to zero rating for exports would substantially lower and more uniform protection. improve trade performance. Tariff exemptions have been widely granted for inputs used in exports, capital goods used in export pro- China's trade reforms cessing zones, and for technological upgrading. According to the Customs General Administration, During the 1980s and early 1990s developing countries exemptions for export processing covered 44 percent of began to lower protection rates. China, however, kept merchandise imports in 1995 and 45 percent in 1996. its average tariff at roughly the level of the early 1980s As a result tariff collections have fallen well below the (table 2.2). By the early 1990s China's average tariffs statutory rate. In 1996 the average tariff was 19.8 per- were among the highest in the world, exceeded only by cent, and a value-added tax (VAT) of 17 percent applied those in Egypt, India, Pakistan, and Thailand of the on most commodities. But collections of the VAT and comparator countries considered. Since then, there has customs duties were only 7.4 percent for all imports, or been a wave of further liberalization in developing Foreign Trade Institutions and Policies 13 BOX 2.1 - TABLE 2.2 Steel imports and trade barriers Weighted average most-favored-nation tariffs for large cleveloping countries, 1980-93 Steel is considered essential to China's economy and so has (percent) been subjected to import quotas. Following a Memorandum of Post- Understanding on Market Access with the United States, China Uruguay agreed to remove quotas by the end of 1993. Automatic import Country 1980-83 1984-87 1988-90 1991-93 round registration was introduced in 1994 to monitor steeL imports. BraziL - 50.2 28.4 14.7 11.7 However, registration requires severaL conditions, including China 31.9 29.2 29.2 30.6 16.6a that imports meet a market need. At the national level, three Egypt 30.4 30.6 22.9 31.0 - state foreign trade corporations hiave exctusive rights to import India 59.9 90.0 62.4 42.6 30.9 steel. At the provincial Level, fifty-five companies have the Indonesia 23.5 18.2 18.0 12.6 10.7 Korea, Rep. olf - 20.2 11.3 10.0 7.7 right to import steet to meet locaL needs. In addition, foreign MaLaysia 9.7 14.7 11.5 11.2 6.4 enterprises have rights to import steeL for their own use. Mexico 23.6 9.1 8.9 12.3 10.4 InrecentyearssteelimportshavefluctuateddramaticaLLy.In Pakistan 57.7 59.7 40.1 56.2 - 1995 they were less than haLf of 1993 (see table). Why? The dra- Thailand 24.8 26.9 38.0 36.9 26.1 maticincreaseinsteelimportsin 1993,stitlunderquota admin- Turkey - 21.9 19.0 9.0 2.8b istration, was partLy due to strong demand by foreign and a. Takes into accont the effects of China's 1S996 tariff reductions and the effects of the istration, wa pardy dm to trong dermnd y foTeign and most recent WorLd Trade Organization accession offer. processing enterprises; the price difference between world and b. Reflects Turkey's entry into a free trade agreement with the European Union. domestic markets drove those enterprises to increase steel Source: UNCTAD 1594; Finger, Ingco, and Reincke 1996; Harrison, Rutherford, and Tarr 1996. imports, which they sometimes resold on the domestic market at a profit The later decline in steel imports appears to have been influenced by the automatic import registration system rate a strong top-down element, which iS expected to together with restrictions on steel imported through speciaL reduce considerably the variability of the tariff regime; economic zones and foreign-invested enterprises. the standard deviation of the tariff schedule is expected to fall by 58 percent under the proposals. Imports of finished steel, 1990-96 (millions of tonts) Effective rates of protection 1990 1991 1992 1993 1994 1995 1996 Imports 3.7 3.3 6.2 30.5 22.8 14.0 16.0 The effective rate of protection provides a measure of Source: Dickson 19%6; China Daiy Busfriess Weekty, December 1-7, 1996. the incentives for expanding or contracting certain activities (Corden 1971). China has high and variable countries. China's tariff reductions to date and offered effective rates of protection in various manufacturing reductions under the accession process for the World industries (figure 2.2). Prospective reforms will lead to Trade Organization (WTO) promise to bring it more in substantial reductions in effective protection, although line with other large developing economies. rates will remain high in most heavy industries. China has committed itself to further trade liberal- ization and offered to reduce tariffs and eliminate most Nontariff blarriers nontariff barriers (see annex). Reductions in applied tariff rates announced at the November 1995 meeting Nontariff barriers applied include state monopoly trad- of the Asia-Pacific Economic Cooperation group (effec- ing, designated trading, the London Convention on tive in 1996) are selective. Tariffs fall sharply on coal Chemical IProducts, import licensing, quotas, and price and gas, textiles, apparel and leather, and heavy manu- tendering (table 2.3). These categories cover almost a factures such as transport equipment, fabricated metal third of China's imports (down from more than half in products, and machinery. These cuts reduce the trade- 1992). The nontariff barrier with the greatest coverage weighted average tariff from 28.1 percent to 19.8 per- is import licensing-more than 18 percent. State trad- cent and the unweighted average from 36 percent to 23 ing is the next biggest category, at 11 percent, while des- percent. Under China's current WTO accession pro- ignated trading covers more than 7 percent of imports. posal, the estimated average tariff in 2005 would fall to Import tendering also covers more than 7 percent, 16.2 percent. The proposed tariff reforms also incorpo- exclusively in machinery and transport. The tariff 14 China Engaged: Integration with the Global Economy China's falling but still variable rates of protection, 1992-2005 Percent 1,000 * Other manufacturing X Transport 800 ; Fabricated metal Nonmetaldic minerals 600 * Chemicals and plastics X Pulp and paper 400 Gas Machinery 200 Petroleum produs Peam Nonferrous metals 0 RL_ ~ ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~Coat 0 ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~Pnmary ferrous metaLs -200 U Wheat 1992 1996 2005 11 Paddy rice Source: World Bank staff estirmates. TABLE 2.3 Nontariff measures affecting China's imports in 1996 (percent coverage) London State Designated Convention on Import Price Import trading trading Chemical Products licensing Quotas tendering All Rice 100.0 0.0 0.0 100.0 0.0 0.0 100.0 Wheat 100.0 0.0 0.0 100.0 0.0 0.0 100.0 Coarse grains 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Nongrain crops 50.0 22.9 0.0 72.9 72.9 0.0 72.9 Livestock 0.0 72.7 0.0 72.7 72.7 0.0 72.7 Meat and miLk 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Other food products 37.2 0.0 0.0 32.9 31.7 0.0 38.4 NaturaL resources 46.6 12.8 0.0 0.0 0.0 0.0 59.5 Textiles 0.3 5.7 0.0 12.7 12.7 0.0 12.7 Wearing appareL 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Light manufactures 0.0 9.3 0.0 0.0 0.0 0.0 9.3 Transport industries 0.0 0.0 0.0 35.8 35.8 6.6 42.4 Machinery and equipment 0.0 0.0 0.0 9.2 9.2 20.4 26.8 Basic heavy manufactures 18.7 16.2 0.3 23.5 22.7 0.0 37.7 Services 0.0 0.0 0.0 0.0 0.0 0.0 0.0 TotaL 11.0 7.3 0.1 18.5 16.3 7.4 32.5 Note: Using 1992 trade weights. Source: World Bank staff calcutations using UNCTAD data and WTO 1996 data. equivalent of China's nontariff barriers (drawing on except for state trading, which is covered by special pro- International Comparison Project data) is estimated to visions under the WTO. Immediately on joining the average 9.3 percent for 1996. The phaseout of nontar- WMTO coverage of nontariff barriers would fall dra- iff barriers contained in China's WTO offer (see below) matically. After full phase-in, the only significant would reduce this to nearly zero. remaining measure would be state trading (mainly in As part of its negotiations for accession, China has agriculture), and overall nontariff barrier coverage committed to eliminating most nontariff barriers, would fall to 11 percent. Foreign Trade Institutions and Policies 15 TABLE 2.4 TABLE 2.5 Changes in industrial output under different Changes in welfare under different trade trade simulations simulations (percent) (percent) Baseline Change from baseLine Baseline Change from baseline Sector 1992-2005 UR C96 WTO CTW NTM Economy 1992-2005 UR C96 WTO CTW NTM Rice 39 0 1 1 2 1 China 138 0.4 5.9 7.1 10.6 12.4 Wheat 20 5 4 3 1 1 Hong Kong Coarse grains 47 3 5 4 6 6 and Taiwan, China 81 0.2 1.7 2.2 2.3 2.7 Nongrain crops 74 0 4 2 4 4 Korea, Rep. of, Livestock 113 2 9 11 18 20 and Singapore 104 8.9 9.4 9.7 9.5 9.6 Meat and miLk 80 13 20 19 17 20 Rest of ASEAN5 94 8.8 8.9 9.0 6.6 6.6 Other food products 88 -6 -11 -22 -25 -32 South Asia 51 2.1 2.1 2.1 1.2 0.9 NaturaL resources 248 4 4 8 -15 -8 Japan 35 1.0 1.2 1.3 1.3 1.4 Textiles 134 9 -18 -17 35 37 Australia Wearing appareL 142 4 88 103 469 494 and New Zealand 34 0.6 0.7 0.7 0.8 0.9 Light manufactures 177 2 19 22 2 16 NAFTAb 22 0.4 0.4 0.4 0.5 0.5 Transport equipment 773 -17 274 482 273 292 Western Europe 35 0.7 0.7 0.7 0.8 0.8 Machinery 354 -5 -2 5 -23 -44 Rest of workl 15 0.0 0.0 0.0 0.0 0.1 Other heavy Note: For explaniation of variables, see annex table A.4 manufactures 279 1 5 9 -7 1 a. Association cif Southeast Asian Nations. Services 224 -1 4 6 6 8 b. Canada, Mexico, and the United States. CapitaL goods 217 1 2 2 2 3 Source: World Bank staff estimates. Note: For explanation of variabtes, see annex table A.4 Source: World Bank staff estimates. expansion of the apparel sector. Given China's strong comparative advantage in these labor-intensive goods, Liberalization proposaLs and the strong repression of the sector by the MFA, the output of apparel would expand by close to 500 per- The implications of China's offers of tariff reductions cent, with the output of transport equipment still grow- were examined using a general equilibrium trade model ing by more than 230 percent. Abolishing nontariff of the world economy (Hertel 1997). The design of the measures (NTMs) reinforces the changes in the struc- simulations used to analyze these reforms is set out in ture of output generated by the tariff reductions. It annex table A.4. The proposed reductions are estimated should be noted that the reforms considered above to have substantial effects on China's industrial output would not cause output of any industry to decline. They and welfare (tables 2.4 and 2.5). The first four scenar- have their impact on industry structure primarily by ios (UR, C96, WTO, and CTW) deal only with the channeling new resources into the sectors where the effects of China's tariff liberalization, while the final sce- returns to the Chinese economy are greatest. nario (NTM) adds the estimated impact of the pro- Moreover, there will be substantial welfare benefits posed phaseout of nontariff barriers. to China from reforms (see table 2.5). The 1996 reduc- The dynamic growth of the Chinese economy results tions generate significant gains, as do the tariff reduc- in rapid expansion of capital- and skill-intensive sec- tions associated with the introduction of tariff bindings tors, such as transport equipment and machinery, rela- under WTO offers. The largest incremental gain, how- tive to agriculture and food products. The 1996 ever, comes from the elimination of the MFA quotas in liberalization package is expected to stimulate the wear- the CTW simulation, particularly when this is aug- ing apparel and transport equipment sectors by lower- mented by the proposed elimination of nontariff barri- ing their costs and expanding exports, although ers under the NTM scenario. expansion of apparel output is constrained by Multi- fibre Arrangement (MFA) quotas in the major markets. Implementing China's WTO tariff offer would fur- ther stimulate these two sectors. Following this, aboli- 1. This estimate, from ITC (1995), was based on the firm codes tion of China's MFA quotas would lead to a dramatic reported to the Customs General Administration, which distinguish 16 China Engaged: Integration with the Global Economy between subsidiaries of the foreign trade corporations authorized by ITC (International Trade Centre). 1995. Survey of China's Foreign the Ministry of Foreign Trade and Economic Cooperation. Trade: An Analysis of China's Export and Import Data at the Enterprise Level. Geneva. Krugman, Paul. 1993. "Protection in Developing Countries." In References Rudiger Dornbusch, ed., Policymaking in the Open Economy: Concepts and Case Studies in Economic Performance. New Anderson, J. 1995. "Tariff Index Theory." Review of Inter- York: Oxford University Press. national Economics 3(2): 156-74. Kueh, Y.Y. 1987. "Economic decentralization and foreign trade Bach, C., W. Martin, and J. Stevens. 1996. "China and the WTO: expansion in China." In J. Chai and C.K. 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"China's Special Economic Zones." In D. Wall, Washington, D.C.: World Bank. Jiang Boke, and Xiangshuo Yin, eds., China's Opening Door. Francois, J., and W. Martin. 1995. "Multilateral Trade Rules and London: Royal Institute of International Affairs. the Cost of Protection." Discussion Paper 1214. Centre for Wang, Hong. 1993. China's Exports since 1978. New York: St. Economic Policy Research, London. Martin's Press. Gros, D. 1994. "Comment on Russian Trade Policy." In C. World Bank. 1994. China: Foreign Trade Reform. Washington, Michalopoulos and D. Tarr, eds., Trade in the New Independent D.C. States. Studies of Economies in Transformation 13. Washington, WTO (World Trade Organization). 1994. The Results of the D.C.: World Bank. Uruguay Round of Multilateral Trade Negotiations. Geneva. Harrison, G., T. Rutherford, and D. Tarr. 1996. "Economic Impli- . 1996. "Annexes to the Draft Protocol of China's cations for Turkey of a Customs Union with the European Accession to the WTO." Geneva. 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Foreign Trade Institutions and Policies 17 Integration with Global Capital M4arkets na's sizable and growing financial integration with global capital markets is reflected in its large shares in cross-border flows to developing countries: 40 percent of foreign direct investment (FDI) flows, 1 0 percent of commercial bank lending, and rising portfolio equity and bond inflows. China will need to attract sustained levels of FDI inflows and a more balanced composition of flows to achieve some of its important development objectives: faster development of its physical infrastructure, more efficient and better technologies, and higher flows of investment to interior and poorer provinces. To sustain FDI flows, China will need a stable macroeconomic environment and complementary reforms to improve the regulations and institutions governing FDI. To shift the composition of these flows toward its development priorities, China will need to improve the transparency of its investment regime, which investors view as one of the most complex 19 in the world. Greater transparency in the rules governing (and hence FDI flows) because of greater competition FDI and better property rights for investors will attract a and contestability of product markets worldwide. wider range of FDI and ensure greater competition. This Greater competition and contestability are being dri- change wouldin turn help ease the skewed geographical and ven, in turn, by falling trade and investment barriers sectoral distribution of FDI inflows, bring in and disseminate and falling transport and communications costs. better technology, and attract more investment in longer- Diversification of institutional portfolios and financial gestation infrastructure sectors. Trade policy reforms would innovation are also leading to increased private flows be equally important to bring FDI into more efficient areas from developed to emerging markets. Rapid recovery and to transfer greater benefits to the economy. after the Mexico crisis suggests that investor interest in Pressures in domestic financial markets to integrate emerging rnarkets will continue. Moreover, with real with international capital markets will also grow over interest rates in industrial countries likely to remain time. Such integration will bring about greater efficiency moderate, flows should continue. And growth in world in domestic financial intermediation. In that context, trade and global production will promote continued financial sector reform of both domestic bank and non- large private flows-especially FDI-to developing bank financial institutions will be important to integrat- countries. ing more efficiently with global financial markets. And Most private capital flows have gone to countries reforms in capital markets will be essential to improve where progress on macroeconomic stabilization and their efficiency and stability. China should move gradu- structural and financial sector reforms has been great- ally, however, to integrate with global capital markets est. Institutional investors are leading the way in port- and to establish full convertibility of its capital account. folio flows. Global portfolio investment in emerging Experience shows that private capital flows can be markets may have reached $170 billion in 1995, with volatile and test governments' macroeconomic manage- U.S. institutional investors accounting for almost half. ment. Weak financial and capital markets magnify these risks. Measures to improve commercial borrowing and Benefits debt management would also be prudent. Increased private capital flows are associated with Global financial flows to higher growth in recipient countries (figure 3.2). FDI developing countries can provide an engine for growth through its contribu- The early 1990s saw a dramatic surge in private capital FIGURE 3.1 flows to developing countries. Although there was a tem- Private capital flows to developing countries porary slowdown in 1994-a result of the peso crisis in have surged in recent years Mexico and the rise in interest rates in industrial coun- Billions of U.S. dollars tries-private capital flows have grown rapidly since (fig- 250 ure 3.1). In the previous peak year of 1981 (before the debt OfficiaL ftm crisis) private flows were about 30 percent of the current Private fLows level (or about 50 percent once adjusted for inflation). Moreover, current flows are equivalent to about 14 per- cent of fixed investment in recipient countries, double the 150 rate before the debt crisis (and about three times higher than in 1990). There has also been a dramatic shift in com- 100 position, from bank lending to FDI and portfolio flows. Driving factors 5I | |. Long-term prospects for private flows remain bright. 1990 1991 1992 1993 1994 1995 1996 There is likely to be more globalization of production Source: WorLd Bank data. 20 China Engaged: Integration with the Global Economy tion to physical capital formation and, more important, percent of cross-border commercial debt flows. It also to human capital development, transfer of technology has begun to tap into growing portfolio investment and know-how, and expansion of markets and foreign flows, attracting 10 percent of international equity trade. Greater portfolio investments and capital market flows and 5 percent of international bond flows to integration generate benefits by lowering the costs of developing countries. Even with the build-up of large capital and increasing the efficiency of resource alloca- foreign exchange reserves and high domestic savings, tion. Causality can also work the other way, because sustained external flows will be important to support faster growth attracts more capital. China's development objectives. Prospects for further The spillover effects (or externalities) of FDI on the integration with world capital markets depend on host country work better in more open than in closed major policy improvements, however. economies because of greater competition and fewer China has seen a more than fivefold increase in cap- distortions. Opening up stock markets to foreign invest- ital inflows in the 1990s, led by FDI (figure 3.3). At $38 ment can help increase their efficiency. Competition billion in 1995 (and an estimated $42 billion in 1996), from foreign financial institutions promotes the import FDI accounted for 25 percent of domestic investment, of more sophisticated financial techniques, the adapta- 13 percent of industrial output, 31 percent of exports, tion of those techniques to the local environment, and 11 percent of tax revenues, and 16 million jobs (table greater investment in improving information process- 3.1). The effects can be even greater at the provincial ing and financial services. level. In Fujian Province, for example, foreign enter- prises contributed more than 20 percent of GDP and Financial flows to China employment and 58 percent of exports in 1996. But incentive policies favoring joint ventures have China's financial integration with the world economy- fostered inefficiencies such as roundtripping (some 20 measured by country risk ratings and by private capital percent of FDI according to some estimates; see chapter flows and their diversification-has improved markedly 1). High protection also has attracted inefficient (in since the mid-1980s. China now accounts for about 40 terms of scale and costs) investments, such as in auto- percent of FDI flows to developing countries and 10 mobiles. Moreover, FDI flows to China have been Larger private capital flows are associated Financial flows to China are booming with higher growth, 1990-95 Bilhns of US dollars Average private capitatflows (percentage of GDP) 60 12 m MaLaysia 50 Portfolio investment 10 ,/China 40 ~~~Private deb fow 40 8 30 6 EChina U ChiLe 4 PhiLippines mThaiLand 20 U Argentina Indonesia 2 8razi1 nPtr Turkey *Korea, Rep. of 10 Egyp * Co~~Lombia Vgyeneu ~ ndia 0 ~-a 00 2 4 6 8 10 12 1990 1991 1992 1993 1994 1995 1996 Average real GDP growth (percent) Source: WorLd Bank Debtor Reporting System. Source: WorLd Bank data. Integration with Global Capital Markets 21 TABLE 3.1 Foreign direct investment in China, 1991-95 Item 1991 1992 1993 1994 1995 FDI flows (billions of U.S. dollars) 4.4 11.2 27.5 33.8 37.5 Average amount per project (millions of U.S. dollars) 0.9 1.2 1.3 1.8 2.5 FOI as a share of gross domestic investment (percent) 4.5 8.0 13.6 18.3 25.0 Volume of exports by foreign affiliates (billions of U.S. dollars) 12.1 17.4 25.2 34.7 46.6 Share of exports by foreign affiliates in total exports (percent) 17 20.4 27.5 28.7 31.3 Share of industriaL output by foreign affiLiates in totaL industrial output (percent) 5 6 9 11 13 Number of empLoyees in FDI projects (milLions) 4.8 6 10 14 16 Tax contribution as share of total taxes (percent) .. 4.1 .. .. 11.2 Source: China Ministry of Foreign Trade and Economic Cooperation, State Tax Administration; UNCTAD 1996; Word Bank Data Reporting System. skewed toward coastal provinces. Twelve coastal China has tried to attract greater technological ben- provinces and municipalities-notably, Guangdong, efits by specifying formal technology transfer require- Shanghai, Fujian, and Jiangsu-have attracted more ments (such as use of the most advanced technology than 90 percent of all flows. The sectoral distribution available, local research and development, and access to also has been biased, dominated by processing of trad- patents or transfer of skills to local staff and firms). In able manufactures (and real estate), with few links to practice, hiowever, such requirements make little differ- the rest of the domestic economy. Finally, the bulk of ence. The best way to encourage foreign firms to bring FDI inflows come from a narrow source of mainly over- in advanced technologies is to maintain open and com- seas Chinese-owned firms, with Hong Kong, China, petitive markets, because competition forces firms to be accounting for 60 percent of recent inflows. more efficient (box 3.1). More open trade and invest- Cross-country evidence suggests that the most ment regimes, which are crucial factors in attracting important determinant of FDI flows is a stable macro- more foreign firms to invest, are also the best channels economic environment, complemented by strong for encouraging such competition. It is also vital to growth performance. To ensure continues flows, China encourage competition from all sources and to elimi- will also need to improve the regulatory and institu- nate any dliscrimination by type of foreign investors. tional framework for FDI and increase the transparency China needs to diversify its FDI sources. So far FDI of tax and foreign exchange rules. Special fiscal incen- inflows to China have been dominated by investment tives to attract FDI generally are unlikely to succeed and flows from overseas Chinese-owned firms. Diversi- would be costly. More important to multinational cor- fication will help make FDI flows more sustainable and porations are market size, economic growth, produc- bring wider benefits (for example, expanding global tion costs, skill levels, infrastructure development, production and marketing links to the source political and economic stability, and the regulatory economies of FDI). framework. China is moving toward leveling the play- Another challenge for China is to induce greater use ing field for domestic and foreign firms. Recent efforts of FDI in infrastructure development. This would bring to unify the tax system, eliminate import duty exemp- in better mranagement and improve service standards in tions for foreign affiliates, and restrict tax incentives at critical areas. Given the size and complexity of the pro- the province and city levels are all steps in the right posed investment program-$600 billion over the next direction. decade-traditional public supply and financing of China also needs a better policy framework for infrastructure will be inadequate. Although some infra- FDI-one that encourages firms to bring in best prac- structure projects have been promising, they have tices and know-how from world markets and dissemi- attracted only limited FDI. There are three reasons nate them throughout the economy. This means greater investors have shied away: transparency in the investment regime, more open trade * Enabling environment, and legal and regulatory policies, and better property rights for investors. restriction.s. Fewer projects have been implemented 22 China Engaged: Integration with the Global Economy than might otherwise have attracted investors because iopaiiE E t~ ~g~ t X _ X _ _of the weak institutional framework and the absence of enabling legislation. The perception of a cap on prof- f#~~pi f~reig~i iiwestnTeht ~itability also has hurt infrastructure proposals in China. Experience elsewhere suggests that governments should e teseceoH~r use comnpetitive bidding that gives priority to the cost of ~~ aj~~i~r i~~~pi~~~ ~ service or specifies an upper price (on power sales or ~~pp~ ~ road tolls, for instance). ~ d2~ i b4e~bth~eXpQrt m e~utnersProcedures and policy uncertainties. National and _~fltt~de ~¶U1~ Ei~I1 ,the~ S~S nWPPSItIWC ~11Ofl provincial decisionmaking and the division of responsi- b bilities for approving FDI projects have delayed foreign investment projects. Establishing a coherent national * Das W pta a ai 19~91 § strategy on FDI in infrastructure and clear decision- making rules will be crucial. . Performance by state-owned enterprises. Because full foreign ownership is not encouraged, FDI projects typi- E ; 1 g _ X cally involve state agencies. Performance obligations have been difficult to obtain from these agencies. Another problem is that project performance guarantees pi are not granted under Chinese policy, making commer- cial lending difficult. Improvements are also needed in laws and regulations relatng rgaes, loan secu- rycotact enforcement, and foreign exchange access. Many of these issues are being gradually resolved, and the number of foreign investment projects in power generation, ports, highways, and railways is edging upward. The Philippines is a good example of how improvements in the policy framework can lead to con- siderable investor interest in infrastructure. Global integration of capital markets Portfolio capital flows to China have been limited, but -~between 1992 and 1994 they climbed from negligible levels to about 0.8 percent of GDP. There was a drop in F ~~~~~~~~~~~~1995 following the Mexico peso crisis, but flows X - t t - revived quickly in 1996. Indirect investments in China's capital markets-through, for example, investment in companies listed on Hong Kong's (China) stock market with substantial Chinese assets-have been growing rapidly. There are likely to be greater pressures for fur- A X ther integration of China's capital markets with the rest ~~ ~opt~~ ~ ~ ~ ci~~4 ~ of the world. Such integration would improve the effi- ciency of financial intermediation. Thus the key policy Issues are how th autvhorities should respond to these ~~~- - ~~~~pressures for faster integration and how fast China j - - - -,=3'F -k g-=E E,x,gEe0-EgSk -kEs should open up its capital account. Integration with Global Capital Markets 23 The opening of exchanges in Shanghai in 1990 and lion in 1'990 to almost $4 billion in 1994. After a slow- in Shenzhen in 1991 marked the beginning of a securi- down in 1995 following the Mexico peso crisis, inter- ties market in China. To attract foreign portfolio national bond issues have picked up strongly (figure investors, a separate and limited class of B shares open 3.4). China has been rated investment grade by all the only to foreign investors was introduced in 1992. B major rating agencies. Still, China's securities market, shares have attracted about $2 billion in portfolio one of thie fastest growing in the 1990s, suffers from investment in seventy-two stocks listed on local serious distortions in pricing and market development. exchanges. Although foreign participation in B shares Share and bond prices are volatile. And relative to GDP, helped add liquidity, the large price discrepancy the development of China's capital markets remains far between A shares (which foreigners cannot own and behind that of other East Asian economies (figure 3.5). which command a high premium) and B shares under- The internationalization of China's capital markets mines the efficiency of China's capital markets. The needs to proceed gradually and in tandem with finan- price differential between the two also implies that there cial development. This process will take time. Banking is a large amount of capital inside China seeking a and financial sector reforms should include government home. Access of foreign investors to Chinese equities withdrawal from direct interventions in credit markets, has been enhanced with the introduction of H shares on elimination of interest rate controls, transformation of the Hong Kong (China) Stock Exchange for companies banks into commercial institutions, entry of private with large Chinese holdings. The authorities have also banking and financial institutions, and adequate permitted selected Chinese companies to issue accounting standards, corporate governance, and pru- American depository receipts (ADRs) and global depos- dential regulations. In the nonbank financial sector itory receipts (GDRs) to tap U.S. and other equity reforms need to include modern laws on institutions, markets. investor protection, information disclosure, and pru- Unlike stock markets, China's fixed-income securi- dential and regulatory oversight. Further development ties markets remain tightly closed to foreign investors. of domestic capital markets will come with increases in And it is unlikely that foreign investment will be per- efficiency, stability, and transparency. Different classes mitted in yuan-denominated debt instruments in the of equity ineed to be harmonized. Greater flexibility in medium term. But China's annual volume of new over- interest rates will help the orderly issue of fixed-income seas bond issues has grown fast, soaring from $130 mil- securities. Standards can be set for domestic credit rat- FIGURE 3.4 FIGURE 3.5 China's international bond issues have soared China's capital market development trails that since the early 1990s of its neighbors, 1994 Millions of U.S. dollars Percentage of GDP 4,000 300 Fixed rate 250 China Floating 25 mIndonesia ConvertibLe 250 Korea, Rep. of 3,000 o Other MaLaysia 200 Singapore Hong Kong 2,000 150 100 1,000 *---- 50. 1990 1991 1992 1993 1994 1995 1996 Stock market Bond market Source: World Bank data. Source: WorLd Bank data. 24 China Engaged: Integration with the Global Economy ing agencies, competition should be encouraged among _____ underwriters, and the regulatory regime and oversight should be strengthened. Stock exchanges alone should o ea Lcu el enforce eligibility criteria for listing. - de The convertibility of the yuan on the capital account should also come with the opening of domestic mar -a~~b b iit1io kets and integration with world markets, but China needs to approach financial liberalization with cautionves) (box 3.2). International experience shows that capital ~~co~ uk oes Ta itr~ ~e flows can be volatile and can test a government's oOl ~ i~~trfT~eur esrso macroeconomic management. More important, a weak financial sector magnifies the risks associated with capital flows, since banks may tend to get involved in riskier projects or undertake complex ~ epe~ ~ner~senk1~~aae ien- financial deals (such as in derivatives). from $a.e - Commercial borrowing and lO iPtan(neo}santa1 billion in 1990 to 512 billioa ine 1996, thnk toaeoaets inrae evefi = ~foinwddity debt management development Eve~~~~~~~~~~~~~~~~n ewith te strate bslu of exter~naleb (~to In--MK=t pargg China's improved creditworthiness has made it the main - b beneficiary of syndicated lending to developing countries, .i 8 accounting for about 10 percent of cross-border comiw mercial debt flows in 1996. Despite commercial banks' f - i a ;^ i^ ~ continued cautiousd ttitude toward emerging markets, =z t--e. -- d3 si-= -e international commercial loans to China rose from $2.9en billion in 1990 to $12 billion in 1996, thanks to increasedoegard o interan bonissues ref to project financing for infrastrsucture development. r a pi ons which amou sibe. irs, eterris reors wll oonmak th fo- aou $4 bilo in1996 (5 percentof thexdevelopin Even with the rapid build-up of exteral debt (to ceel anks and around $130 billion at the end of 1996), strong macro- t and in esent crions. These sti economic performance makes China's debt indicators act a m e s n goeakue (around 85 percent for debt to exports and 20 percent interain trust and investmen c es-incu for debt to GNP) very creditworthy. China's external acui f so ef30perenae debt indicators stand at less than half the developing h o ngvre country average and are among the lowest in the region. Roughly 58 percent of external debt is denominated in U.S. dollars, 21 percent in Japanese yen. With regard to international bond issues, reforms to Within this comfortable and conservative borrowing improve the current "window" system could be impor- framework, however, some important reforms are pos- tant. China's international bonds, which amounted to sible. First, enterprise reforms will soon make the for- about $4 billion in 1996 (5 percent of the developing eign borrowing plan redundant. But if state enterprises country total), are issued through selected banks and are to borrow abroad on their own account, they trust and investment corporations. These institutions should be required to meet certain criteria. These act as intermediaries, onlending to domestic users should include a modern corporate structure, use of (although some borrowing is for their own use). Three modern accounting systems, audit of accounts accord- international trust and investment companies-includ- ing to international standards, profitable operations for ing CITIC-are the most active, with strong balance the past three years or so, and a demonstrated ability to sheets accounting for some 30 percent of China's exter- service debt. nal bond issues (and more than half of nongovernment Integration with Global Capital Markets 25 bond issues). The procedures followed at these "win- * Benefits of overseas investment. Overseas invest- dows" do not necessarily ensure efficiency in the use of ments offer higher returns and other benefits, including such borrowing. Proceeds from foreign bond issues better access to markets (more than half of overseas may be administratively allocated, and onlending terms investments are trade related), natural resources (min- are not clearly defined. Overseas borrowing is supposed ing, forestry investments), and technology (manufac- to reduce costs, but the system has some disadvan- turing investments in the United States and Canada). tages-weak balance sheets of some intermediaries and, And foreian assets are a means of portfolio diversifica- for those who are excluded from windows, encourage- tion-of reducing risk and improving returns to assets. ment of offshore borrowing through foreign sub- * Economnic relationships. China's overseas invest- sidiaries. Since 1993 the authorities have been ments also helped strengthen its relationships with considering allowing domestic enterprises direct access other economies, such as those in Africa, and, most to overseas bond markets (provided they meet certain important, Hong Kong leading up to its reunification. well-defined criteria) and allowing international credit * Policy distortions. Chinese enterprises established rating agencies a bigger role in assessing the financial affiliates in Hong Kong so that they could invest in adequacy of borrowers. China as foreign firms, thereby taking advantage of tax There are also some issues that need careful consid- and other incentives. eration in the management of China's external debt. A potentially serious problem is the lack of adequate One is the monitoring of external debt through timely monitoring of outward investments. State funds have and accurate data collection and analysis by the sometimes been wasted on inappropriate projects: one- People's Bank. A clear framework needs to be devel- third of Chinese investments abroad are loss-making, oped for nonrecourse borrowing from foreign institu- according to some reports. New regulations are being tions to finance infrastructure. (The World Bank's drafted to provide a general framework in which future expanded guarantee program could be useful.) And overseas investment will be approved. There is an there is a need to integrate external debt management urgent need for procedures that establish clear rules, more closely with a public finance framework that con- especially transparency in control, accountability, and siders the total financing requirements (domestic and information; improve ownership structures, gover- external) of the public sector. nance, and management of state-owned enterprises; set regulatory or screening mechanisms to protect against China's outward investments large risks; and eliminate distortions in taxes, exchange rates, and credit markets that lead to roundtripping. Between 1989 and 1995 China's officially approved But there is a need to avoid centrally dictated invest- direct and portfolio investment abroad totaled $17 bil- ments, as they are unlikely to solve the performance lion. In 1995 China's outward investment accounted problem and could distort investments further. for about 2 percent of global capital flows, making it the eighth largest supplier among all countries and the Referen!ces largest outward investor among developing countries. Aitken, Brian, and Ann Harrison. 1993. "Does Proximity to But China's capital outflow is probably much higher Foreign Firms Induce Technology Spillovers?" World Bank, than the official figure. The largest outward investments Washington, D.C. are in Hong Kong (China). Blomstrom, M., R. Lipsey, and M. Zejan. 1992. "What Explains factors account for China's rising outward Developing Country Growth?" NBER Working Paper 4132. Several National Bureau of Economic Research, Cambridge, Mass. investments: . 1996. "Is Fixed Investment the Key to Economic * Macroeconomic. China's domestic savings have Growth?" Quarterly Journal of Economics (February). Borensztien. E., J. DeGregorio, and J. Lee. 1994. "How Does exceeded domestic investment needs, as reflected in a Foreign Direct Investment Affect Economic Growth?" IMF current account surplus of more than $20 billion in Working Paper WP/94/110. International Monetary Fund, 1996. Large capital outflows are an outcome of high Washington, D.C. Broadman, Harry, and Xiaolun Sun. 1996. "The Distribution of domestic savings, large foreign capital inflows, and high Foreign Direct Investment in China." World Bank, Washington, official reserves. D.C. 26 China Engaged: Integration with the Global Economy Buckberg, Elaine. 1993. "Emerging Stock Markets and Experience." World Bank, International Economics International Asset Pricing." In Stijn Claessens and Sudarshan Department, Washington, D.C. Gooptu, eds., Portfolio Investment in Developing Countries. Kim, E. Han, and Vijay Singal. 1993. "Opening up of Stock World Bank Discussion Paper 228. Washington, D.C. Markets by Emerging Economies: Effect on Portfolio Flows and Coe, David, Elhanan Helpman, and Alexander Hoffmaister. Volatility of Stock Prices." In Stijn Claessens and Sudarshan 1994. "North-South R&D Spillovers." IMF-Working Paper Gooptu, eds., Portfolio Investment in Developing Countries. WP/941144. International Monetary Fund, Washington, D.C. World Bank Discussion Paper 228. Washington, D.C. De Gregoiro, Jose, and Pablo Guidotti. 1995. "Financial Levine, Ross, and Sara Zervos. 1995. "Stock Markets, Banks, and Development and Economic Growth." World Development 23 Economic Growth." World Bank, Washington, D.C. (March): 433-48. Lipsey, R., M. Blomstr6m, and I. Krauis. 1990 "R&D by Fry, Maxwell. 1993. "Foreign Direct Investment in a Multinational Firms and Host Country Exports." In Robert E. Macroeconomic Framework: Finance, Efficiency, Incentives, Evanson and Gustav Ranis, eds., Science and Technology: and Distortions." Policy ResearchWorking Paper 1141. World Lessons for Development Policy. Boulder, Colo.: Westview Press. Bank, Washington, D.C. Sachs, Jeffrey, and Andrew Warner. 1995. "Economic Graham, Edward M. 1996. Global Corporations and National Convergence and Economic Policies." NBER Working Paper Governments. Washington, D.C.: Institute for International 5039. National Bureau of Economic Research, Cambridge, Economics. Mass. Husain,Ishrat,andKwang W.Jun. 1992. "Capital Flows to South UNCTAD (United Nations Conference on Trade and Asia and ASEAN Countries: Trends, Determinants, and Policy Development). 1996. World Investment Report 1996. Geneva. Implications." Policy Research Working Paper 842. World Wall, David. 1996. "Outflows of Capital from China." OECD Bank, Washington, D.C. Development Center Technical Paper. Organisation for IMF (International Monetary Fund). 1995. "Capital Account Economic Co-operation and Development, Paris. Convertibility." Occasional Paper 131. Washington, D.C. Wei, Shang-Jin. Forthcoming. "Foreign Direct Investment in Jun, Kwang W. 1993. "Effects of Capital Market Liberalization China: Sources and Consequences." In Takatoshi Ito and Anne in Korea: Empirical Evidence and Policy Implications." In Stijn Krueger, eds., Financial Deregulation and Integration in East Claessens and Sudarshan Gooptu, eds., Portfolio Investment in Asia. University of Chicago Press. Developing Countries. World Bank Discussion Paper 228. World Bank. Various years. Global Development Finance. (for- Washington, D.C. merly World Debt Tables) Washington, D.C. Jun, Kwang W., and Amitava Sardar. 1996. "International- . Various years. Global Economic Prospects and the ization of Emerging Capital Markets: Cross-country Developing Countries. Washington, D.C. Integration with Global Capital Markets 27 v4A 4:;~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ Global Effects of China' s Integration to 2020 =I3; ver the past twenty-five years China's GDP VW Xf=A0 growth averaged 10 percent a year and its share of world trade tripled to about 3 percent. While its pace of economic growth is expected to slow to more sus- tainable levels, China's role in the world economy in the next quarter century should increase further. Its share in world trade will more than triple by 2020 (to about 10 percent), and it is expected to become the second largest trading nation (after the United States). China will account for some 40 percent of the increase in all devel- oping country imports between 1992 and 2020 and serve as an engine of growth for world trade. According to our projections, the implications of China's growing trade and integration for the rest of the world are enormous: * Industrial countries will benefit from China's growth because of China's rising demand for imports of capital- and knowledge-intensive manufactures and services and primary products and because of significant terms 29 of trade gains as a result of its rising demand for such EvaLuating how China's growing trade products. will affect the worLd * For neighboring developing countries that are ahead of China and not close competitors (Asia's newly indus- There are three tools for evaluating the effects of trialized countries, such as the Republic of Korea), there China's growing trade integration on other countries: are likely to be significant gains all around. simple trade theory to inform us of the likely directions * For countries that are close competitors of China of change., an empirical model of multiregional trade, (low- and middle-income Asian countries such as and the historical record. Although all three approaches India, Indonesia, the Philippines, and Thailand), world are used, this chapter relies primarily on the Global market shares and volumes of trade will likely continue Trade Analysis Project (GTAP) database and model to expand, but significant terms of trade losses are projections of trade patterns for 2020, compared with expected in their main exports of labor-intensive man- the base year 1992.1 The assumptions underlying the ufactures. Net income gains, however, will still be model are set out in box 4.1. large. The projections reflect many assumptions, and the * For developing countries that do not directly trade increasing importance of China is only one part of a much or compete with China (those in Latin America, complex picture. It is nevertheless instructive to review Sub-Saharan Africa, and Europe and Central Asia), China's role as it might evolve under various scenarios. there will be neither significant gains nor major losses. Applying the economic growth, trade policy liberaliza- * If it were to integrate more slowly, the greatest tion, and transport cost reduction assumptions set out adverse effects would be on China itself, but there in box 4.1 yields a projection of world trade volume would also be significant welfare losses for the rest of growth under the baseline scenario of about 5.5 percent the world. a year in 1992-2020 (similar to that since the mid- BOX 4.1 Growth assumptions about the-world in 2020 To project the likeLy structure of worLd trade (and the changes in Bank forecawts up to 2005 are used and reflect long-term growth terms of trade} irl 2020, several assumptions are made about the potentiat of about 4.2-5.5 percent a year. primary sources of growth in the wortd's economies (World Bank * Baseline projections go beyond the Uruguay Round tariff 1997). reductions and abolition of the- Multi-Fibre Arrangement (by * Indusrialy mature economies are expected to grow 2.1-2.6 2005) by assuming that deveLoping country tariffs for manufac- percent a year, or at about the current long-term rates of growth, tures will average those of OECD countries by 2020. China's acces- as increases in human capitaL make up for the sLowdown in sion to the VWorld Trade Organization is also incorporated (on the growth of the Labor force.. Dynamic newly industrialized basis of Chria's ApriL,1997 offers). economies irn Asia (Hong Kong, China, Korea, Singapore, and * Services sector productivity gains are expected to be slower Taiwan, China) are assumed to confinue to grow vigorousLy, than for manufactures in aR countries and productivity in agri- aLbeit at a sLower pace of about 4.5 percent a year. These culture is assumed to rise faster than in nonagriculture. GLobal economies are unlikeLy to slow down to industrial country transport costs are assumed to fal 2 percent a year. Real export growth rates because of continued figh savings rates and sc5o0pe prces for energy and agricultural products are derived from spe- for capital deepening. High-income economies are expected to dat studies undertaken by the WorLd Bank. grow about 2.5 percent a year: * Under these growth assumitions China's share of world GDP * DeveLoping countries are expected to grow about 5.4 percent (maeasured at 1992 prices and market exchange rates) rises from a year, twice as fast as high-income economies. China is expected 1 percent in 1992 to nearly 4 percent in 2020. In purchasing to grow 7 percent a year, reflecting an easing of totat factor pro- power parity (PPP) exchange rate terms (but adjusting for LikeLy ductivity growth to 2-3 percent from the 4-5 percent during changes in PPP exchange rates as-China becomes richer), China's 1984-94. Other East Asian devetoping countries are expected to share of word GDP rises from 4 percent in 1992 to 8 percent in continue their current vigorous growth rates of slightly over 7 2020, when China becomes the second biggest economy in the percent a year for the next twenty-five years. For the rest of the world after the United States (whose share of worLd GDP is esti- wortd, current expectations about tong-term growth irt World mated at 19 percent). 30 China Engaged: Integration with the Global Economy TABLE 4.1 Trade growth and market shares, 1992-2020 (percent) Exports Imports Growth Share Growth Share rate, of world rate, of worLd Region 1992-2020 1992 2020 1992-2020 1992 2020 WorLd 5.5 100.0 100.0 5.3 100.0 100.0 High-income 4.0 76.5 51.6 4.3 74.3 56.6 OECD 3.5 67.8 40.4 4.0 65.3 45.3 NewLy industriaLized economies 6.5 7.4 9.7 6.3 7.2 9.4 Hong Kong (China) 6.0 1.3 1.5 5.7 1.8 1.9 Low- and middLe-income 8.1 23.5 48.4 7.3 25.7 43.4 China 10.0 3.0 9.8 10.2 2.8 9.9 Brazil 7.2 1.2 1.9 6.8 0.9 1.3 India 12.0 0.7 3.9 11.0 0.8 3.2 Indonesia 8.8 1.1 2.7 7.8 0.9 1.8 Transition economies 6.2 3.0 3.6 5.9 3.4 3.9 ASEAN3Y 9.6 2.8 8.4 8.6 3.0 7.0 Rest of South Asia 8.0 0.5 0.9 6.8 0.6 0.8 Rest of Latin America 6.7 2.8 3.9 5.4 3.5 3.5 Sub-Saharan Africa 6.7 1.7 2.4 5.3 2.1 2.1 Middle East and North Africa 6.4 5.2 6.6 5.4 5.9 6.0 Rest of worLd 9.4 1.5 4.2 8.1 1.9 3.9 Note: Exports and imports are in constant 1992 doLLars. a. MaLaysia, PhiLippines, and ThaiLand. Source: World Bank 1997. 1980s). The high-income OECD countries' share of of trade effects (as the prices of capital- and knowledge- world exports and imports falls from 65-70 percent in intensive products rise relative to prices of labor- 1992 to 40-45 percent in 2020, while that of develop- intensive products). There can be some adverse effects ing countries doubles to 45-50 percent (table 4.1). on industrial country employment and wages, however, China's share of global trade rises from 3 percent to if growing imports of labor-intensive manufactures dis- about 10 percent, and China becomes the second place unskilled labor and depress relative wages. largest trading country in the world, only slightly The Global Trade Analysis Project database and behind the United States (12 percent of world exports) model projections of trade patterns for 2020, when but much ahead of Japan (5 percent of world exports). compared with the base year 1992, broadly support Another measure of China's importance is that it con- these conclusions: tributes about 40 percent to the expected rise in total * Industrial country (North America, Western Europe, world imports by developing countries between 1992 and Japan combined) exports to China will grow about and 2020, serving as an engine of world trade. 6.5 percent a year. This increase will accelerate their overall annual export growth from roughly 3.5 percent Industrial countries (excluding China) to 3.7 percent (including China). While most of the export volume gains come from Trade theory suggests that the effects on industrial capital- and knowledge-intensive products and services, countries of trade with developing countries, such as a significant part originates with primary products China, are mostly favorable, except in special circum- (such as food grains) in which some countries (espe- stances.2 China's rapid growth and integration with the cially in North America) have a comparative advantage. global economy are expected to lead to faster growth in * There are also significant terms of trade gains, as the import demand for capital- and knowledge-intensive prices of industrial country exports improve relative to products and services from industrial countries. This the prices of labor-intensive manufactures imports. The rising demand may be accompanied by favorable terms cumulative gain between 1992 and 2020 is largest for Global Effects of China's Integration to 2020 31 Japan (14 percent), followed by the European Union attention because the rapid rise in the global integration (12 percent) and North America (8 percent). of developing countries in the past twenty-five years has * Industrial countries lose world market shares in coincided with three problems in industrial countries: labor-intensive manufactures (from about 56 percent in rising de-industrialization, unemployment, and wage 1992 to about 25 percent by 2020). Because much of inequalities. Coincidence does not, however, mean cau- the adverse impact on unskilled labor had already sation. Trade accounts for less than 0.5 percentage occurred by 1992, and the labor force in industrial point of the 15 percent drop in wages of U.S. unskilled countries has become more skilled, the relative wages of workers between 1973 and 1993; the rest is due to tech- unskilled workers will not deteriorate further. In fact, nical changes that are biased against unskilled labor the model suggests a small improvement in relative (Krugmarn 1994). Moreover, OECD trade with low- wages of unskilled labor in industrial countries between wage countries (China and other dynamic East Asian 1992 and 2020 (figures 4.1 and 4.2). countries) is small, accounting for 2 percent of the GDP The model's results of only small adverse effects of of OECD countries (OECD 1996a). Thus the observed increased labor-intensive exports from China and other effects were also small. Significant effects were confined developing countries on unskilled wages in industrial to a few industries, such as textiles, clothing, footwear, countries are not surprising. But the issue has attracted and electronic goods.3 FIGURE 4.1 FIGURE 4.2 Change in wages for unskiLled workers Change in wages for skiLled workers (cumulative percentage change in 2020 relative to 1992) (cumulative percentage change in 2020 relative to 1992) China China Indonesia Rest of worLd European transition economies ASEAN31 ASEAN3a Sub-Saharan Africa Hong Kong (China) BraziL Newly industrialized Asian economies Hong Kong (China) Sub-Saharan Africa Indonesia Brazil India India Rest of South Asia NewLy industriaLized Rest of world Asian economies European transition Rest of South Asia economies Rest of Latin America Rest of Latin America Japan North America EU15 EU1S North America Japan MiddLe East and Other OECD North Africa Middle East and North Africa _ Other OECD 0 50 100 150 200 250 -20 0 20 40 60 80 100 a. Malaysia, Phitippines, and Thailand. a. Malaysia, Phitippines, and Thailand. Source: WorLd Bank staff estimates. Source: World Bank staff estimates. 32 China Engaged: Integration with the Global Economy Most of the drop in U.S. manufacturing jobs occurred before Chinese exports penetrated the U.S. market Employment in textiles Penetration rate of Employment in clothing Penetration rate of manufacturing Chinese exports manufacturing Chinese exports (thousands) (percent) (thousonds) (percent) TextiLes Clothing 1,100 12 1,200 14 " Employment 1, / Employment 12 1,000 X 12 8 1,000 900 8 6 900 8006 Penetration rate 4 800 4 700 | | | 2 700 Penetration rate 2 600 * 0 600 I 0 1975 1980 1985 1993 1975 1980 1985 1993 Employment in Penetration rate of Employment in footwear Penetration rate of leather goods manufacturing Chinese exports manufacturing Chinese exports (thousands) (percent) (thousands) (percent) Leather goods Footwear 100 25 200 40 Penetration rate 80 _ --Employment 20 150 Employme30 60 15 N 100 N 20 40 10 20 Penetration rate 5 50 10 0975 I -0 0 Jo 1975 1980 1985 1993 1975 1980 1985 1993 Source: U.N. Industrial Development Organization and WorLd Bank data. There does appear to be an association between rising Developing countries penetration of Chinese exports to industrial countries and declining employment (figure 4.3). There have been Greater Chinese trade integration should also be three phases of growth in Chinese exports to industrial mostly favorable for other developing countries. A country markets, led by textiles in the early 1980s, fol- fast-growing China will import more goods that it lowed by clothing in the mid-1980s and more recently by cannot produce competitively, and countries able to leather and footwear products. The fall in industrial supply its markets will gain. Strong competition by country employment in each of these sectors began much China in labor-intensive manufactures, however, earlier, however, as China simply replaced earlier pene- could limit markets for other countries wanting to do tration by Hong Kong (China), Korea, Singapore, and the same. Even so, the results of alternative modeling Taiwan (China), and as a structural decline in employ- approaches suggest that the world economy can ment took place in labor-intensive manufacturing. absorb expansion of manufactured exports by all Global Effects of China's Integration to 2020 33 developing countries (Rodrigo and Martin 1996; 1992-94 for China's major exports (accounting for Martin 1993). about 80 percent of the total in 1992-94), China's advantage in toys, footwear, and travel goods remained Factor endowments and specialization. How will more or less intact. But in clothing and telecommunica- future trading patterns evolve? Among major develop- tions equipment other countries are closing in (India, ing countries, China is the most poorly endowed with the Philippines, and Indonesia). land except for Korea (table 4.2). Thus, assuming that land supply remains constant, China's specialization in Simulation results. Baseline projections suggest that labor-intensive manufacturing relative to agriculture is China's comparative advantage will strengthen in inter- expected to be the greatest. This will force China to mediate technology manufacturing (tables 4.3 and 4.4). import food and to move into manufacturing exports Together, mainland China and Hong Kong (China) are sooner to feed and create jobs for a growing population. expected to lose 16 percent of the world market for Its high savings rate enables the build-up of capital apparel (and the industrial countries, 19 percent). This needed to make the transition. At the same time, it will slack is picked up by India, Indonesia, the Philippines, lose market shares in primary products. and Thailand. More distant regions (Latin America and What manufactured goods China exports will also Sub-Saharan Africa) gain little. China also loses market depend on the quality of the labor force. With more shares across a range of primary agricultural prod- people educated up to the secondary school level than ucts-grains, livestock, and processed food. This partly to the tertiary level, and with low capital per worker, benefits industrial countries (those in North America), China is more likely to focus on low-skilled manufac- but also China's Asian neighbors (India, Indonesia, tures and light industry. Its closest competitors are Malaysia, the Philippines, and Thailand) and Latin India, Indonesia, the Philippines, and Thailand. With its America. weaker higher education base, China is unlikely to China is set to move up the value-added ladder by emerge as a major source of knowledge-based and com- gaining a 10 percent market share in light manufactures plementary skilled labor products. (such as leather, fabricated metal, and other products) and 8 percent in transport equipment and other Confirmation through revealed comparative machinery. In these sectors China's market share (and advantage. China's comparative advantage has been that of other lower-middle-income Asian countries) is studied using indexes of revealed comparative advan- expected to grow, displacing industrial countries and tage.4 Comparing these indexes for 1986-87 and Korea and Taiwan (China). In capital-intensive heavy TABLE 4.2 Factor endowments in China and selected other countries Cropland Phlysicat capitaL (hectares Labor force (thousands of 1995 Tertiary education per worker) (miLLions) U.S. dollars per worker) (years per capita) Country 1995 1995 2020 1995 2020 1995 2020 China 0.12 808.3 988.6 1.6 13.2 0.2 0.4 Indonesia 0.19 119.7 174.9 2.7 21.9 0.5 1.6 Korea, Rep. of 0.07 31.8 35.9 21.5 115.2 3.0 6.8 Malaysia 0.42 11.6 19.7 15.8 139.6 0.5 2.2 PhiLippines 0.20 40.1 72.1 3.0 27.2 2.7 5.0 Singapore 0.00 2.1 2.6 62.7 384.9 0.5 2.7 Thailand 0.58 39.9 53.9 7.9 73.2 1.3 3.1 BraziL 0.61 101.4 145.9 9.6 31.2 1.1 2.1 India 0.30 561.3 886.2 1.7 8.2 0.5 1.3 Japan 0.05 87.0 75.1 131.4 397.8 0.8 1.8 United States 1.09 172.3 200.2 73.0 - 2.1 3.5 Source: Ahuja and Fitmer 1995; World Bank staff estimates. 34 China Engaged: Integration with the Global Economy TABLE 4.3 Revealed comparative advantage indexes, China and comparators, 1986-94 (index: China = 100) CLothing TeLcommunications Toys Footwear TraveL goods (841) equipment (724) (894) (851) (831) Country 1986-87 1992-94 1986-87 1992-94 1986-87 1992-94 1986-87 1992-94 1986-87 1992-94 China 100 100 100 100 100 100 100 100 100 100 India 79 94 .. .. Indonesia 42 47 .. .. .. Malaysia 31 27 279 226 .. 11 .. PhiLippines 76 84 .. 90 22 19 85 20 14 19 ThaiLand 58 40 .. 74 18 27 128 36 32 27 Note: Numbers in parentheses are Standard InternationaL Trade Classification codes. Source: UN COMTRADE database. TABLE 4.4 World export market shares for Hong Kong and mainLand China, 1992 and 2020 (percent) 1992 Change to 2020 Industry Hong Kong China Hong Kong China Primary agricuLture 0.0 4.7 0.1 -2.5 Processed food 0.4 3.4 0.7 -2.8 _ OiL and gas 0.0 1.4 0.0 -1.4 Other energy 0.0 2.6 0.0 -2.0 Other natural resources 0.1 2.5 1.9 -2.0 Textiles 2.4 8.1 -1.5 3.1 Wearing apparel 9.8 16.9 -8.9 25.8 Light manufactures 1.4 6.5 2.2 10.4 Heavy manufactures 0.4 1.8 0.4 2.7 Transport, machinery a a t and equipment 0.9 1.5 1.3 13.1 w d o c Utility, housing, 3 and services 21.6 0.0 -6.9 0.0 Q~~~ep tS Other services 2.0 2.1 -1.2 1.8 Tu th r l tr sc TotaL 1.3 3.0 0.2 6.89 Source: GTAP database, version 3; World Bank staff projections. manufacturing (chemicals, rubber, plastics, paper, iron p and steel, an-Gd nonferrous metal) China gains some mar-202 3 ket share (4 percent), but industrial countries maintain their dominance. More intraindustry trade patterns can also be expected in China's overall trade, as can greater intensity of trade with its neighbors (box 4.2) $ Terms of trade effects. A rapid rise in exports of labor-intensive manufactures by China will depress cialhzation among these products (table 4.5). Expected their prices, while China's increased imports of primary losses are significant for East Asian and South Asian products and machinery and transport equipment will developing countries. Downward pressure on relative raise their prices. Thus the resulting terms of trade prices for products in which developing countries com- changes for any country will depend on its relative spe- pete intensely are confirmed by the historical record- Global Effects of China's Integration ro 2020 35 TABLE 4.5 The volume of world exports is 7.5 percent lower Changes in worLd market shares and terms of than the baseline in 2020, however. Losses to the rest of trade for deveLoping countries, 1992-2020 the world from slower growth in China would be over $100 billion a year in perpetuity (equal to 0.2 percent of Changes in world Cumulative their GDP in 2020). But this is a gross underestimate market share for change in all sectors terms of trade because the comparative static model does not account Country (percentage points) (percent) for a number of dynamic effects: a slower rate of capi- Republic of Korea, Taiwan tal accurnulation (and lower returns to capital) because (China), Malaysia I to 3 -3 to -g of reduced world trade and slower growth, lower effi- Asian developing countries (excluding newly ciency in the rest of the world as a result of lower com- industrialized economies) 0.3 to 2.8 -8 to -13 petition from China, and reduced investment Sub-Saharan Africa, opportunities in China. Latin America, rest of world -0.2 to 0.1 -3 to 4 Source: World Bank staff projections. Notes 2.5 percent a year in clothing and 1.5 percent a year in 1. The Global Trade Analysis Project provides data and a standard model for multicountry general equilibrium analysis. The project is footwear in the United States since the mid-1980s. maintained at Purdue University and is guided and supported by an However the volume gains from growing world trade international consortium that includes the World Bank, OECD, World and rising market shares more than offset such losses. Trade Organiization, and others. The description and applications of the modet are provided in Hertel (1997). The standard model is a comparative static modeL and does not include dynamic effects, such Effects of a slowLy integrating China as those from endogenous capital accumulation. It aLso does not include the effects of scale economies or imperfect competition. As result the standard models results are only a fraction of those that What are the implications for growth, trade, and wel- can be expected in reality. This chapter's results rely on a baseline fare in the rest of the world if China's integration pro- simulation provided by Professor Thomas Hertel and associates at ceeds more slowly than expected? Slower integration Purdue. 2. See Mluscatelli (1996) on the impact of newly industrialized could occur because of higher trade barriers put up by economies on industrial economies. China and by the rest of the world. Such a reversal from 3. A few economists such as Wood (1994. 1995) consider trade baseline trade policies is assumed to have its main with devetoping countries to be an important factor explaining the deteriorating situation of unskilled workers in jobs and relative impact by slowing productivity growth in China. This wages. Wood's argument is that new labor-saving technologies are is assumed to slow Chinese GDP growth from 7 percent themselves encouraged by low-wage competition, and that the exis- (in the baseline) to about 4 percent a year. The adverse tence of Large low-wage competitors depresses wages even though effects of such a slo down could be large.trade is small. effects of such a slow down could be large. 4. The reveated comparative advantage index is the ratio of the The welfare cost to China of a reversal from baseline share of a product in a country's total exports to the share of that trade policies and slower integration dwarfs the adverse product in world exports. An index greater than one for a product indi- cates a comparative advantage in exporting that product. impact on the rest of the world (although that impact is underestimated in the model). China forgoes welfare gains equivalent to $1.2 trillion (1992 U.S. dollars); the Refererices cost to the rest of the world is $107 billion. Regions not Ahuja, V., and D. Filmer. 1995. "Educational Attainment in directly competing with China (high- and low-income Developing Countries." Policy Research Working Paper 1489. countries) lose most when China's growth slows World Bank, Washington D.C. because their exports are lower, their terms of trade suf- Boltho, A., U. Dadush, D. He, and S. Otsubo. 1994. "China's Emergence: Prospects, Opportunities, and Challenges." Policy fer, and their domestic resource allocation worsens. Research Working Paper 1339. World Bank, Washington, D.C. China's closest competitors (countries in Asia and Chow P., A. Kellman, and Y. Shachmurove. 1994. "East Asian Brazil) collectively gain about $5 billion a year, as terms NIC Mar[ufactured Intra-Industry Trade, 1965-1990. " Journal of Asian Economies 5(3): 335-348. of trade improve and exports are higher for labor-inten- Hertel, Thomas, ed. 1997. Global Trade Analysis: Modelling and sive goods. Applications. Cambridge: Cambridge University Press. 36 China Engaged: Integration with the Global Economy Krugman, P. 1994. "Does Third World Growth Hurt First World Rodrigo, G. Chris, and Will Martin. 1996. "Can the World Prosperity?" Harvard Business Review (July-August): 113-21. Trading System Accommodate More East Asian-Style Martin, Will. 1993. "The Fallacy of Composition and Developing Exporters?" World Bank, Washington, D.C. Country Exports of Manufactures." The World Economy Wood, A. 1994. North-South Trade, Employment, and (March): 159-72. Inequality: Changing Fortunes in a Skill-Driven World. Muscatelli, A. 1996. "Flexibility, Structural Change, and the Oxford: Clarendon Press. Global Economy." University of Glasgow Discussion Paper in . 1995. "How Trade Hurt Unskilled Workers." Journal of Economics 9601. University of Glasgow. Economic Perspectives 9 (3): 57-80. OECD (Organisation for Economic Co-operation and World Bank. 1997. Global Economic Prospects and the Develop- Development). 1995. The OECD Jobs Study: Investment, ing Countries 1997. Washington, D.C. Productivity and Employment. Paris. Yeats, Alexander. 1991. China's Foreign Trade and Comparative .1996a. Trade and Labor Standards. Paris. Advantage. World Bank Discussion Paper 141. Washington, .1996b. "Vertical Intra-Industry Trade Between China and D.C. OECD Countries." OECD Development Center Technical Paper 114. Paris. Global Effects of China's Integration to 2020 37 Changes in China s Tariff s, 1992-2005 ANNEX TABLE A.1 Tariffs and offers for the GTAP sectors AppLied Applied Applied WTO Sector 1992 1995 1996 2005 Paddy rice -35.2 0.0 0.0 0.0 Wheat -12.9 0.0 0.0 0.0 Coa[ 15.0 12.0 6.0 6.0 OiL 2.0 1.5 1.5 1.5 Gas 33.6 29.7 12.5 12.5 Beverages and tobacco 124.1 74.0 66.6 53.7 Textiles 62.4 55.0 30.6 26.9 Wearing appareL 79.6 75.0 39.7 28.7 PuLp, paper 23.1 22.3 16.7 11.5 PetroLeum and coat products 12.3 10.6 9.0 9.0 ChemicaLs, rubber, and pLastics 22.2 20.4 14.4 12.5 NonmetaLLic mineraL products 35.7 28.8 21.7 17.7 Primary ferrous metals 12.8 12.6 9.5 8.3 Nonferrous metals 13.6 12.7 10.3 6.5 Fabricated metaL products 40.2 38.3 22.6 17.6 Transport industries 57.9 43.9 38.3 31.7 Machinery and equipment 26.1 22.7 16.2 13.5 Other manufacturing 66.3 58.2 42.2 29.0 Weighted average 31.2 28.1 19.8 16.2 Unweighted average 39.1 35.6 23.4 17.5 Note: The GTAP sectors are defined in terms of the InternationaL Standard IndustnaL Classification System. Source: World Bank staff estimates. 39 ANNEX TABLE A.2 ANNEX TABLE A.3 China's average tariffs by country/region The declining standard deviation of tariffs (percent) (percent) Applied Applied AppLied WTO AppLied AppLied Applied WTO Country or region 1992 1995 1996 2005 Sector 1992 1995 1996 2005 Australia 11.6 18.7 16.8 13.0 Paddy rice 0.00 0.00 0.00 0.00 Japan 38.1 32.5 22.8 19.3 Wheat 0.00 0.00 0.00 0.00 Korea, Rep. of 44.1 39.6 24.1 20.6 Coal 3.67 2.95 1.55 1.55 ASEAN 22.0 23.9 17.9 13.9 Gas 10.08 9.43 3.42 3.30 Hong Kong, China 44.8 39.7 25.5 20.3 Beverages and tobacco 50.18 30.79 19.38 21.24 Taiwan, China 41.4 37.5 23.4 19.2 Textiles 23.17 20.66 10.46 8.82 South Asia 19.9 19.3 11.8 9.4 Wearing apparel 11.45 9.83 4.26 2.57 Canada 5.9 54.0 51.4 31.1 Pulp, paper 19.35 17.60 15.31 8.69 United States 22.1 23.4 19.3 15.0 Petroleum and coaL products 8.74 8.07 3.71 3.54 Latin America Chemicals, rubber, and pLastics 19.32 14.40 10.61 7.37 and the Caribbean 12.6 17.8 15.1 10.5 Nonmetallic mineral products 20.01 18.45 14.38 8.67 European Union 33.3 29.3 22.4 18.5 Primary ferrous metals 7.44 7.37 4.81 4.36 Austria, FinLand, Sweden 20.5 21.4 16.5 11.6 Nonferrous metaLs 16.60 15.56 10.02 5.82 IceLand, Norway, SwitzerLand 21.4 18.8 13.2 10.8 Fabricated metal products 16.45 15.54 7.78 7.69 Central European Associate 20.3 18.7 15.4 13.2 Transport industries 50.18 37.05 27.96 24.38 Countries of the Machinery and equipment 21.94 17.68 11.85 9.50 former Soviet Union 13.4 17.7 16.2 9.5 Other manufacturing 22.70 20.29 14.12 8.19 Middle East and North Africa 15.6 12.4 9.8 9.2 Total 27.35 23.79 16.68 11.49 Sub-Saharan Africa 14.8 19.5 16.0 9.3 Note: The GTAi' sectors are defined in terms of the International Standard IndustriaL Rest of world 20.6 21.3 16.0 12.2 Classification System. Weighted average 31.2 28.1 19.8 16.2 Source: World 3ank staff estimates. Unweighted average 39.1 35.6 23.4 17.5 Source: WorLd Bank staff estimates. ANNEX TABLE A.4 Overview of simulations of China's tariff liberalization VariabLe BaseLine Projections to 2005. Shocks to factor endowments, popuLation, and total factor productivity in agriculture. ImpLicit totaL factor productivity in other sectors derived from GDP targets. No trade reforms, but 1992 import subsidies to agricuLturaL products removed, so these sectors are exposed to world market prices. UR Incorporates the effects of the Uruguay Round agreement (excluding China and Taiwan, China). C96 Shows the impact of trade liberalization in China as set out in the 1996 APEC tariff announcement. WTO Further liberalization in China as set out in the second Chinese offer to the WTO for 2005. CTW Same as for WTO but with abolition of Multi-fibre Arrangement quotas on textiles and wearing apparel for China, Hong Kong (China), and Taiwan (China). Source: World Bank staff estimates. 40 China Engaged: Integration with the Global Economy T H E W O R L D B A N K 1818 H Street, N.W. Washington, D.C. 20133 USA Telephone: 202-477 1234 Facsimile: 202- 477 6391 Telex: MCI 64145 WORLDBANK MCI 248423 WORLDBANK Cable Address: INTRAFRAD WASHINGTONDC World Wide Web: http://www.worldbank.org/ E-mail: Books@world bank.org Cover design by Glenn Pierce/The Magazine Group