98014: China's Economic Conditions

Wayne M. Morrison
Foreign Affairs, Defense, and Trade Division

December 1, 1999

CONTENTS

• SUMMARY
• MOST RECENT DEVELOPMENTS
• BACKGROUND AND ANALYSIS
• An Overview of China's Economic Development
• China's Economy Prior to Reforms
• The Introduction of Economic Reforms
• China's Economic Growth Since Reforms: 1979-1998
• Causes of China's Economic Growth
• Measuring the Size of China's Economy
• China's Trade Patterns
• China's Major Trading Partners
• Major Chinese Trade Commodities
• Major Challenges Facing the Chinese Economy
• Chinese Economic Initiatives Announced in 1998
• Reform of State Owned Enterprises
• Reform of the Banking System
• Infrastructure Development
• Major Issues in China-U.S. Economic Relations  
• Trade
• China's Normal Trade Relations Status
• China's Accession to the World Trade Organization
• China and the Global Financial Crisis
• Outlook for China's Economy

SUMMARY

Since the initiation of economic reforms, beginning in 1979, China has become one of the world's fastest growing economies. Over the past 10 years, China's GDP has grown at an average annual rate of nearly 9.4%. Some economists have speculated that China could become the world's largest economy at some point in the near future. The level and extent of future economic growth will likely depend on the ability of the Chinese government to make significant new reforms. Nearly one third of China's industrial production comes from government state-owned enterprises (SOEs), many of which lose money and must be supported by the government through the banking system. In 1998, Chinese officials announced major new initiatives to reform money-losing state-owned enterprises and China's banking system. However, the slowdown in the Chinese economy in 1998-1999 appears to have delayed the implementation of some of these reforms.

The global financial crisis has negatively affected Chinese economy, especially exports, which rose by only 0.5% in 1998 (after rising by 20.9% in 1997), and by 2.1% from January-September 1999 over the comparable period in 1998. China has sought to boost exports by offering tax rebates to various industries, such as textiles and steel. A key concern among many of China's trading partners is that China will devalue its currency to make its exports more competitive in international markets. Many analysts believe such a move would lead to a new destructive round of currency devaluations throughout East Asia and could undermine economic recovery in the region.

China's economy has also suffered from a significant drop in foreign direct investment, caused in part by the global financial crisis, and a fall in domestic demand. The Chinese government has attempted to stimulate the economy by substantially increasing government spending on infrastructure projects and continuing financial support for SOEs.

China is currently negotiating to become a member of the World Trade Organization (WTO), the international body that sets most trade rules. China has sought WTO membership under terms that would allow it to maintain protection for certain sectors and to implement trade reforms over time. However, the United States and certain other WTO members have contended that China is a large economic and trading power and thus must substantially reform its trade regime in order to gain WTO membership.

Major progress on China's WTO accession was achieved on November 15, 1999, when the United States and China signed a WTO bilateral trade agreement. China agreed (upon its accession to the WTO) to reduce tariffs and non-tariff barriers, remove investment restrictions, provide trading and distribution rights for foreign firms, and open various service sectors to foreign competition. China must complete negotiations with other WTO members before a vote can be taken in the WTO to admit China.

China's accession to the WTO could, in the short run put additional strains on money-losing enterprises in China (due to increased foreign competition) and would likely force many of them into bankruptcy. However, in the long run, trade liberalization will likely promote greater economic efficiency in the Chinese economy, producing faster economic growth and higher living standards.

MOST RECENT DEVELOPMENTS

On November 15, 1999, the United States and China signed a bilateral WTO trade agreement that would require China, upon its accession to the WTO, to remove tariff and non-tariff barriers on trade in agriculture, industrial products, and services.

On July 27, 1999, the House, by a vote of 170 to 260, failed to pass H.J.Res. 57, a measure to terminate China's NTR status.

On April 8, 1999, Chinese Premier Zhu Rongji met with President Clinton. While no final agreement on China's WTO accession was reached during Zhu's visit, U.S. negotiators indicated that significant progress was achieved in resolving key issues, such as Chinese barriers to agriculture, services, and various industrial products. However, the accidental NATO bombing of the Chinese embassy in Belgrade on May 7, 1999, led China to temporarily suspend the WTO talks. On September 11, 1999, the two countries officially resumed the WTO talks.

BACKGROUND AND ANALYSIS

An Overview of China's Economic Development

China's Economy Prior to Reforms

Prior to 1979, China maintained a centrally planned, or command, economy. A large share of the country's economic output was directed and controlled by the state, which set production goals, controlled prices, and allocated resources throughout most of the economy. During the 1950s, all of China's individual household farms were collectivized into large communes. To support rapid industrialization, the central government during the 1960s and 1970s undertook large-scale investments in physical and human capital. As a result, by 1978 nearly three-fourths of industrial production was produced by centrally controlled state-owned enterprises (SOEs) according to centrally planned output targets. Private enterprises and foreign invested firms were nearly non-existent. A central goal of the Chinese government was to make China's economy relatively self-sufficient. Foreign trade was generally limited to obtaining only those goods that could not be made or obtained in China.

China's real GDP grew at an estimated average annual rate of about 5.3% from 1960-1978. However, government policies kept the Chinese economy relatively stagnant and inefficient, mainly because there were few profit incentives for firms and farmers, competition was virtually nonexistent, and price and production controls caused widespread distortions in the economy. Chinese living standards were substantially lower than those of many other developing countries. The Chinese government hoped that gradual reform would significantly increase economic growth and raise living standards.

The Introduction of Economic Reforms

Beginning in 1979, China launched several economic reforms. The central government initiated price and ownership incentives for farmers, which enabled them to sell a portion of their crops on the free market. In addition, the government established four special economic zones for the purpose of attracting foreign investment, boosting exports, and importing high technology products into China. Additional reforms followed in stages that sought to decentralize economic policymaking in several economic sectors, especially trade. Economic control of various enterprises was given to provincial and local governments, which were generally allowed to operate and compete on free market principles, rather than under the direction and guidance of state planning. Additional coastal regions and cities were designated as open cities and development zones, which allowed them to experiment with free market reforms and to offer tax and trade incentives to attract foreign investment. In addition, state price controls on a wide range of products were gradually eliminated.

China's Economic Growth Since Reforms: 1979-1998

Since the introduction of economic reforms, China's economy has grown substantially faster than during the pre-reform period (see Table 1). Chinese statistics show real GDP from 1979 to 1998 growing at an average annual rate of 9.8%, making China one the world's fastest growing economies. According to the World Bank, China's rapid development has raised nearly 200 million people out of extreme poverty.

Table 1. China's Average Annual Real GDP Growth: 1960-1998

Sources: Official Chinese government data reported by the World Bank, World Development Report (various issues), and DRI/McGraw-Hill, World Economic Outlook, various issues.

Causes of China's Economic Growth

Economists generally attribute much of China's rapid economic growth to two main factors: large-scale capital investment (financed by large domestic savings and foreign investment) and rapid productivity growth. These two factors appear to have gone together hand in hand. Economic reforms led to higher efficiency in the economy, which boosted output and increased resources for additional investment in the economy.

China has historically maintained a high rate of savings. When reforms were begun in 1979, domestic savings as a percentage of GDP stood at 32% (nearly as high as Japan's at the time). However, most Chinese savings during this period were generated by the profits of SOEs, which were used by the central government for domestic investment. Economic reforms, which included the decentralization of economic production, led to substantial growth in Chinese household savings (which now account for half of Chinese domestic savings). As a result, savings as a percentage of GDP has steadily risen; it was 42.7% in 1998, among the highest savings rates in the world.

China's trade and investment reforms and incentives led to a surge in foreign direct investment (FDI), which has been a major source of China's capital growth. Annual utilized FDI in China grew from $636 million in 1983 to $45.6 billion in 1998, making China, in recent years, the second largest destination of FDI (after the United States). Total utilized FDI at the end of 1998 reached $268.6 billion. About two-thirds of FDI in China has come from Hong Kong and Taiwan. The United States is the third largest investor in China, accounting for 8.1% ($17.2 billion) of total FDI in China from 1979 to 1998. U.S. FDI in China in 1998 totaled $3.9 billion, or 11.9% of total FDI in 1998.

Several economists have concluded that productivity gains (i.e., increases in efficiency in which inputs are used) were another major factor in China's rapid economic growth. The improvements to productivity were largely caused by a reallocation of resources to more productive uses, especially in sectors that were formally heavily controlled by the central government, such as agriculture, trade, and services. For example, agricultural reforms boosted production, thus freeing workers to pursue employment in more productive activities in the manufacturing sector. China's decentralization of the economy led to the rise of non-state enterprises, which tended to pursue more productive activities than the centrally controlled SOEs. Additionally, a greater share of the economy (mainly the export sector) was exposed to competitive forces. Local and provincial governments were allowed to establish and operate various enterprises on market principles, without interference from the central government. In addition, FDI in China brought with it new technology and processes that boosted efficiency.

Measuring the Size of China's Economy

The actual size of the China's economy has been a subject of extensive debate among economists. Measured in U.S. dollars using nominal exchange rates, China's GDP in 1998 was $968 billion; its per capita GDP (a commonly used figure to measure and compare a nation's living standard) was $769. Such data would indicate that China's economy and living standards were significantly lower than those of the United States, Japan, and Germany. In nominal U.S. dollars, China's 1998 GDP was about 45% the size of Germany's, 23% that of Japan's, and 11% that of the United States. China's nominal per capita GDP was only 2.4% that of the United States (see Table 2).

Many economists, however, contend that using nominal exchange rates to convert Chinese data into U.S. dollars substantially underestimates the size of China's economy. This is because prices in China for many goods and services are significantly lower than those in the United States and other developed countries. Economists have attempted to factor in these price differentials by using a purchasing power parity (PPP) measurement, which attempts to convert foreign currencies into U.S. dollars based on the actual purchasing power of such currency (based on surveys of the prices of various goods and services) in each respective country. This PPP exchange rate is then used to convert foreign economic data in national currencies into U.S. dollars.

Because prices for many goods and services are significantly lower in China than in the United States and other developed countries (while prices in Germany and Japan are higher than those in the United States), the PPP exchange rate raises the estimated size of Chinese economy to $4.6 trillion, higher than Japan's GDP in PPP ($3.0 trillion) and Germany's ($1.6 trillion), and slightly over half the size of the U.S. economy. PPP data also raise China's per capita GDP to $3,701; however, this figure falls far below the PPP per capita GDP levels of the major developed countries (for example, its only 12% of U.S. levels).

The PPP data appear to indicate that, while the size of China's economy as a whole is quite large and currently could be the world's second largest, its living standards are quite low. (To illustrate, the World Bank estimates that nearly 30% of China's population live below the international poverty level of $1 per day.) The International Monetary Fund estimates that (using PPP measurements) China could surpass the United States as the world's largest economy as early as the year 2007. Yet, even if that were to occur, it would take China significantly longer to achieve U.S. standard of living levels.

Table 2. Comparisons of U.S., Japanese, German, and Chinese GDP and Per Capita GDP In Nominal U.S. Dollars and PPP: 1998

Source: DRI/McGraw Hill. World Economic Outlook, Volume I 1st Quarter, 1999, p.A-27.

Note: PPP data for China should be interpreted with caution. China is not a fully developed market economy; the prices of many goods and services are distorted due to price controls and government subsidies.

China's Trade Patterns

Economic reforms have transferred China into a major trading power. Chinese exports rose from $14 billion in 1979 to nearly $184 billion in 1998, while imports grew from $16 billion to $140 billion. China's ranking as a trading power rose from 27^th in 1979 to 10^th in 1998. China's trade volume fell slightly in 1998 over 1997, due largely to the affects of the global financial crisis; exports rose by 0.5% (afer rising by 20.9% during the previous year), while imports dropped by 1.5%. Historically, China has run trade deficits in some years and surpluses in others. Over the past 5 years, China has run trade surpluses; in 1998 that surplus totaled about $44 billion (see Table 3). Merchandise trade surpluses and large-scale foreign investment have enabled China to accumulate the world's second largest foreign exchange reserves, which totaled $145 billion at the end of 1998. During the first nine months of 1999, China's exports increased by 2.1%, while imports rose by 19.3%, over the comparable period in 1998.

Table 3. China's Merchandise World Trade: 1979- September 1999
($Billions)

Source: International Monetary Fund, Direction of Trade Statistics and official Chinese statistics.

China's Major Trading Partners

China's trade data often differ significantly from those of its major trading partners. This is due to the fact that a large share of China's trade (both exports and imports) passes through Hong Kong (which reverted back to Chinese rule in July 1997, but is treated as a separate customs area by most countries, including China and the United States). China treats a large share of its exports through Hong Kong as Chinese exports to Hong Kong for statistical purposes, while many countries that import Chinese products through Hong Kong generally attribute their origin to China for statistical purposes.

According to Chinese trade data, its top five trading partners in 1998 were Japan, the United States, the European Union (EU), Hong Kong, and South Korea (see Table 4). Chinese data show the United States as China's second largest destination for its exports and the third largest source of its imports. China's trade with many of its Asian trading partners fell in 1998, while trade with the United States and the EU rose.

Table 4. China's Top 10 Trading Partners: 1998
($Billions and % Change over 1997)

Source: Official Chinese trade data.

*U.S. trade data on U.S.-China trade differ significantly with Chinese trade data.

**China and Taiwan do not maintain direct trade links. Most trade takes place via Hong Kong.

U.S. trade data indicate that the importance of the U.S. market to China's export sector is likely much higher than is reflected in Chinese trade data. Based on U.S. data on Chinese exports to the United States (which, as noted, do not agree with Chinese data), and Chinese data on total Chinese exports, it is estimated that Chinese exports to the United States as a percentage of total Chinese exports grew from 15.3% in 1986 to an estimated 38.7% in 1998. This would indicate that the United States is by far China's largest export market. The importance of the U.S. market for China's exports appears to have increased markedly in 1998, likely due to the effects of the global financial crisis (i.e., U.S. imports from China have continued to rise, but imports by several East Asian economies from China have fallen).

A growing level of Chinese exports are from foreign funded enterprises (FFEs) in China. According to Chinese data, the share of total Chinese exports produced by FFEs totaled has risen from 0.1% in 1980 to 44.1% in 1998. Many of these FFEs are owned by Hong Kong and Taiwan investors, many of whom have shifted their labor-intensive, export-oriented, firms to China to take advantage of low-cost labor. A large share of the products made by such firms are exported to the United States.

Major Chinese Trade Commodities

China's abundance of cheap labor has made it internationally competitive in many low cost, labor-intensive, manufactures. As a result, manufactured products comprise an increasingly larger share of China's trade. The share of Chinese manufactured exports to total exports rose from 50% in 1980 to 89% in 1998, while manufactured imports as a share of total imports rose from 65% to 84%. A large share of China's manufactured imports are comprised of intermediates (e.g., chemicals, electronic components, and textile machinery) used in manufacturing products in China. Major Chinese imports in 1998 included electrical machinery, textile products, specialized machinery, plastics, and telecommunications and recording equipment (see Table 5). China's major exports included articles of apparel and clothing, electrical machinery, textiles, office machines, and telecommunications and recording equipment (see Table 6).

Table 5. Major Chinese Imports: 1998

Source: Official Chinese trade statistics

Table 6. Major Chinese Exports: 1998

Source: Official Chinese trade data.

Major Challenges Facing the Chinese Economy

China's economy has shown remarkable economic growth over the past several years, and many economists project that it will enjoy fairly healthy growth in the near future. Standards and Poor's DRI, a private international forecasting firm, projects China's GDP will grow at an average annual rate of about 7 percent between 1999 and the year 2005. Economists caution, however, that these projections are likely to occur only if China continues to make major reforms to its economy. Failure to implement such reforms could endanger future growth.

• State-owned enterprises (SOEs), which account for about one-third of Chinese industrial production and employ nearly two-thirds of urban workers, put an increasingly heavy strain on China's economy. Over half are believed to lose money and must be supported by subsidies, mainly through state banks. Government support of unprofitable SOEs diverts resources away from potentially more efficient and profitable enterprises. In addition, the poor financial state of many SOEs makes it difficult for the government to reduce trade barriers out of fear that doing so would lead to wide-spread bankruptcies of many SOEs.
• The banking system faces several major difficulties due to its financial support of SOEs and failure to operate solely on market-based principles. China's banking system is regulated and controlled by the central government, which sets interest rates and attempts to allocate credit to certain Chinese firms. The central government has used the banking system to keep afloat money-losing SOEs by pressuring state banks to provide low interest loans, without which a large share of the SOEs would likely go bankrupt. Currently, about 70% of state-owned bank loans now go to the SOEs, even though a large share of loans are not likely to be repaid. The high volume of bad loans now held by Chinese banks (estimated to total $250 billion) poses a serious threat to China's banking system. Three out of the four state commercial banks are believed to be insolvent. The precarious financial state of the Chinese banking system has made Chinese reformers reluctant to open its banking sector to foreign competition. Corruption poses another problem for China's banking system because loans are often made on the basis of political connections. In many cases, bank branches extend loans to firms controlled by local officials, even during periods when the central government has attempted to limit credit. Such a system promotes widespread inefficiency in the economy because savings are generally not allocated on the basis of obtaining the highest possible returns. In addition, inability to control the credit policies of local and provincial banks has made it very difficult for the central government to use monetary policy to fight inflation without causing major disruptions to the economy.
• Infrastructure bottlenecks, such as inadequate transportation and energy systems, pose serious challenges to China's ability to maintain rapid economic growth. China's investment in infrastructure development has failed to keep pace with its economic growth The World Bank estimates that transportation bottlenecks reduce China's GDP growth by 1% annually. Chronic power shortages are blamed for holding China's industrial growth to 80% of its potential. Transportation bottlenecks and energy shortages also add inflationary strains to the economy because supply cannot keep up with demand.
• The lack of the rule of law in China has led to widespread government corruption, financial speculation, and mis-allocation of investment funds. In many cases, government "connections," not market forces, are the main determinant of successful firms in China. Many U.S. firms find it difficult to do business in China because rules and regulations are generally not consistent or transparent, contracts are not easily enforced, and intellectual property rights are not protected (due to the lack of an independent judicial system). The lack of rule of law in China limits competition and undermines the efficient allocation of goods and services in the economy. In addition, the Chinese government does not accept the concept of private ownership of land and assets in China
• High trade barriers are maintained by the government in large part to protect domestic firms from foreign competition. Such policies have two main negative effects: First, they give domestic firms less incentive to improve productivity and efficiency. Second, restricting competition raises prices and product choices for Chinese consumers of both domestic and imported goods.
• A wide variety of social problems have arisen from China's rapid economic growth and extensive reforms, including pollution, a widening of income disparities between the coastal and inner regions of China, and a growing number of bankruptcies and worker layoffs. This poses several challenges to the government, such as enacting regulations to control pollution, focusing resources on infrastructure development in the hinterland, and developing modern fiscal and tax systems to address various social concerns (such as poverty alleviation, health care, education, worker retraining, pensions, and social security).

Chinese Economic Initiatives Announced in 1998

At a news conference in March 1998, newly appointed Chinese Premier Zhu Rongji outlined a number of major new economic initiatives and goals for reforming China's economy and maintaining healthy economic growth, including:

• In 1998, achieve a GDP growth rate of 8%, keep inflation below 3%, and not devalue China's currency.
• Respond to the effects of the Asian financial crisis by expanding domestic demand, especially through increased spending on infrastructure, and by maintaining the pace of previously planned economic reforms.
• Reform and restructure loss-making medium-and-large-sized state-owned enterprises (SOEs) to make them profitable. Reorganize the banking system to increase the regulatory and supervisory power of the central bank and make commercial banks operate independently. Substantially reduce the size of the government and reorganize the remaining government institutions. All three goals are to be obtained within three years
• Commercialize government housing, reform the health insurance system, improve the system the for circulating grain, rationalize the system for approving investment and finance projects, and improve tax collection.

In July 1998, the government ordered the Chinese People's Liberation Army (PLA) to divest itself of its business holdings, estimated to total 15,000 enterprises, by the end of the year. In October, a similar order was issued for enterprises directly controlled by the Communist party and state bureaucracies.

Zhu Rongji's economic plan has been viewed by many analysts as representing the most significant restructuring of the economy to date, since it would substantially reduce the size of the government and diminish its control over various sectors of the economy, dismantle much of the remaining "iron rice bowl" of cradle-to grave benefits for government and SOE workers, enable banks to make loans on a commercial, rather than political basis, and force a large share of SOEs to operate according to free market principals. Implementation of such policies would take China significantly closer towards a functioning market economy.

Reform of State Owned Enterprises

The Chinese leadership has been talking about undertaking major reforms of unprofitable SOEs for the past several years, but has been hesitant to act due to concerns that reforms would lead to widespread bankruptcies and cause political instability. However, the Chinese government has acknowledged that support of SOEs has put a heavy drain on the economy and cannot be maintained indefinitely. As a result, reform of SOEs has been made a top priority. In September 1997, Chinese President Jiang Zemin stated that China would take steps which, if implemented, would essentially privatize (although referred to by the Chinese as "public ownership") all but 1,000 out of an estimated 308,000 SOEs by cutting off most government aid and forcing them to compete on their own. Under this plan, some unprofitable SOEs will be closed, while others will be merged with more profitable enterprises. Many firms will be allowed to issue stock in order to raise funds. Another source of revenue for SOEs will come from workers who will be allowed to purchase their own homes, and SOEs will be released from the responsibility of providing subsidized housing. The central government has stated that it plans to maintain support and control of 1,000 large and medium-sized enterprises deemed as key industries, but to reorganize and restructure them into large conglomerates in the hope of making them more competitive.

It is not clear how the Chinese government intends to deal with the problem of displaced workers (likely to total several millions) when and if the SOE reform plan is fully implemented. Chinese officials may be anticipating that continued rapid economic growth will provide new jobs for most displaced workers and that overseas investors will play a major role in restructuring the SOEs by becoming joint owners.

Reform of the Banking System

Chinese officials have indicated a desire to strengthen and reform its banking system.

On January 16, 1998, the central government announced it would attempt to implement new reforms to enhance the power of the central bank over the provincial and state banks and to improve the management systems of all Chinese banks. Such reforms would attempt to lessen the power of local officials to pressure banks into making "bad loans." In addition, the government has indicated that banks will be allowed to make bank loan decisions based on commercial, considerations. Finally, on March 2, 1998, the government announced plans to issue bonds to recapitalize the state banks to enable them to write off bad loans. Chinese officials claim their long-term goal is to develop a modern banking system similar to that of the U.S. Federal Reserve system. However, due the precarious nature of its banking system, Chinese officials appear hesitant to allow foreign banks to expand their operations in China, due to concerns that doing so would force many Chinese banks into bankruptcy.

Infrastructure Development

The Chinese government anticipates that banking and SOE reforms will lead to widespread layoffs. Stimulating domestic demand, especially through infrastructure development, is viewed as a key mechanism to re-employ workers displaced by reforms. Chinese officials announced in February 1998 their intentions to spend $750 billion on infrastructure development over the next 3 years; in September 1998, Chinese officials indicated that $1.2 trillion would be spent. Many analysts, however, have questioned China's ability obtain funding for such a massive financial undertaking in such a short period of time. The issuance of government bonds has become a major source of finance for infrastructure. However, such policies will likely increase the size of the central government's budget deficit. It is also likely that China hopes to attract foreign investment for much of its infrastructure needs.

Major Issues in China-U.S. Economic Relations

China's growth as a major economic and trading power has expanded U.S.-China commercial ties, although disputes have arisen over a number of issues, such as trade investment barriers and China's most-favored-nation (MFN), or normal trade relations, status. The World Bank projects that by the year 2020, China will be the world's second largest trading economy after the United States. China's continued rapid growth has increased concerns among U.S. policymakers that China's trade regime must be brought in compliance with multilateral rules in the World Trade Organization (WTO) for U.S. exporters to gain adequate access to the Chinese market.

Trade

Total trade between China and the United States rose from $4.8 billion in 1980 to $85.4 billion in 1998, making China the 4th largest U.S. trading partner. China has become a major supplier to the U.S. market of a variety of low-cost U.S. consumer goods, such as toys and games, textiles and apparel, shoes, and consumer electronics, while China has been a major buyer of U.S. aircraft, fertilizers, and machinery. In recent years, U.S. imports from China have far exceeded U.S. exports to China (in 1998, U.S. imports from China totaled $71.2 billion while U.S. exports to China were $14.3 billion). As a result, the U.S. trade deficit with China has surged, reaching nearly $57 billion in 1998 and could reach $66 billion in 1999. U.S. officials claim that China's widespread and pervasive use of trade and investment barriers and restrictions for the relatively lackluster growth of U.S. exports to China, while Chinese officials argue that U.S. export controls substantially diminish U.S. export sales to China. (For a more detailed examination of major trade issues, see CRS Issue Brief 91121, China-U.S. Trade Issues).

China's Normal Trade Relations Status

On July 22, 1998, President Clinton signed into law P.L. 105-206 (a bill to reform the Internal Revenue Service), which contained a provision replacing the term "most-favored nation (MFN) status" with the term "normal trade relations" (NTR) in U.S. trade law. This change was made to help dispel the belief of some that the term "MFN status" indicates a preferential trade status, when in fact it indicates the trade status afforded by the United States to all but a handful of countries. Under current U.S. law, China's MFN (NTR) status must be renewed on an annual basis. In recent years, several attempts have been made in Congress to pass legislation to revoke, partially revoke, or add new conditions to, the renewal of China's MFN (NTR) status. None of these bills have been enacted.

A withdrawal of China's MFN (NTR) status would result in a substantial increase in the applicable rates and amounts of customs duties assessed on most U.S. imports from China. Imports from China would be assessed tariffs according to "Column 2" non-MFN (NTR) rates of duty in the U.S. Harmonized Tariff Schedule (HTS), which are generally significantly higher (up to 10-fold in some instances) than those under "Column 1-General" MFN (NTR) treatment. These higher tariffs would likely result in higher prices for U.S. consumers of the affected items and subsequently a decrease in U.S. imports of various Chinese products. A 1996 study by the International and Business and Economic Research Corporation, an organization that supports continued MFN (NTR) treatment for China, concluded that terminating China's MFN (NTR) status would raise the effective U.S. duty on Chinese imports from 5.9% to 44.1%, resulting in roughly $27 billion to $29 billion in added costs to U.S. consumers. China would likely respond by retaliating against U.S. exports to, and investment in, China.

On June 3, 1999, President Clinton announced his decision to renew China's NTR status. On July 27, 1999, the House, by a vote of 170 to 260, failed to pass H.J.Res. 57, a measure to terminate China's NTR status.

China's Accession to the World Trade Organization

China has made its accession to the World Trade Organization (WTO) a major priority for a number of reasons. First, it would represent international recognition of China's growing economic power. Second, it would enable China to play a major role the development of new international rules on trade in the WTO. Third, it would give China access to the dispute resolution process in the WTO, reducing the threat of unilateral trade sanctions against China or other unilateral restrictions on Chinese exports (such as textile quotas and antidumping duties). Fourth, it would make it easier for reformers in China to push liberalization policies if they could argue that such steps are necessary to fulfill China's international obligations. Finally, China hopes it would gain it permanent MFN (NTR) treatment from the United States.

Several arguments have been made by policymakers of current WTO member countries for allowing China into the WTO. First, China is the largest economic and trade power not a member of the WTO. The World Bank projects that China's share of world trade will account for 10% of the world's trade by the year 2020 and that China will become the world's second largest trading nation after the United States. Hence, it is argued that China's trade is too significant to remain outside multilateral trade rules. Second, WTO membership would require China to reduce a wide variety of trade barriers and, hence, would likely create substantial new trade opportunities in China. Third, once China is in the WTO, it would be required to provide extensive information about its trade regime, which would make it very difficult for China to impose new trade and investment barriers. Fourth, the United States (and other WTO members) would be able to bring trade disputes to WTO dispute resolution instead of having to rely on threats of unilateral trade sanctions. Finally, China's accession might enable Taiwan to eventually join the WTO (as a separate customs territory). China has insisted that Taiwan can get into the WTO only after China does.

On November 15, 1999, U.S. and Chinese officials announced that they had reached a bilateral agreement on China's WTO bid. Published reports summarizing the agreement indicate that China would make several major reforms:

• Provide full trading and distribution rights (including the ability to provide services auxiliary to distribution) for U.S. firms in China.
• Cut tariffs from an overall average of 22.1% to 17%. Overall agricultural tariffs for U.S. priority products would fall from 31.5% to 14.5% by 2004. Overall industrial tariffs would fall from an average of 24.6% to 9.4% by 2005 ( tariffs on U.S. "priority industrial products" would fall to 7.1% by 2003). Tariffs on information technology products (e.g., computers, semiconductors, and telecommunications equipment) would be reduced from an average level of 13.3% to zero by the year 2005.
• Establish a tariff-rate quota system for imports of agricultural bulk commodities (such as wheat, corn, cotton, barley, and rice), i.e., imports up to a specified quota level would be assessed a low tariff (1-3%), while imports above a certain level would be assessed a much higher tariff rate. In addition, private trade in agricultural products will be permitted for the first time.
• Phase out quotas and other quantitative restrictions (some upon accession, many within two years, and most within five years), eliminate unscientifically based sanitary and phytosanitary restrictions, and end export subsidies.
• Open service sectors (many of which are currently closed to foreign firms), including distribution, value-added telecommunications, insurance, banking, securities, and professional services.
• Reduce restrictions on auto trade.
• Provide fair treatment for foreign firms operating in China, including the elimination of technology transfer, local content, and export performance requirements.
• Accept the use by the United States of certain safeguard, countervailing, and antidumping provisions (over transitionary periods) to respond to possible surges in U.S. imports from China of various products, such as textiles, that might cause or threaten to cause market disruption to a U.S. industry.

The conclusion of the U.S.-China WTO trade agreement has given new momentum towards completing China's WTO accession process. China must complete negotiations with a few other WTO members, including the European Union, as well as the WTO Working Party, which is handling China's WTO accession bid, before a vote can be taken in the WTO on China's membership. If and when this process is completed, Congress would have to decide whether to pass legislation to grant permanent NTR to China. Without such a change in U.S. law, the United States would be unable to give "unconditional" MFN status to China and hence, prior to China's WTO accession, would be forced to invoke Article XIII in the WTO, the non-applicability clause. Invoking Article XIII would technically prevent the United States and China from applying the WTO agreements to one another.

China and the Global Financial Crisis

Since mid-1997, several East Asian economies (notably South Korea, Thailand, and Indonesia) and since 1998, Russia and Brazil, have experienced significant financial difficulties, including substantial currency devaluations (as investors have transferred funds overseas), significant declines in stock market prices, and falling economic growth. Other Asian economies, including Japan, Hong Kong, Singapore, the Philippines, and Malaysia have also experienced varying degrees of financial difficulties as well.

China's economy has remained relatively stable in the face of the global financial crisis, (although export growth slowed and FDI in China fell) compared to the economies of most East Asian countries for a variety of reasons: its currency (the yuan) is not fully convertible; it maintains over $145 billion in foreign exchange reserves; its foreign debt is relatively small compared to other Asian nations; its financial institutions are tightly controlled by the central government; and because most foreign investment in China is direct, rather than portfolio, investment. However, China's economy slowed in 1998, especially its exports, which rose by only 0.5% over the previous year. In addition foreign investment in China has dropped sharply.

The Chinese government has taken several steps in response to the global financial crisis. First, Chinese officials have publicly declared on a number of occasions that China will not devalue its currency. Second, the government has expanded export financing and has expanded export tax rebates for several industries adversely affected by the Asian financial crisis, such as textiles. Third, the government has placed tighter controls over foreign exchange to halt currency smuggling. Finally, the government has issued billions of dollars worth of new bonds to finance infrastructure development to stimulate domestic spending. These efforts have enabled China's economy to maintain relatively healthy economic growth. However, according to Standard & Poor's DRI, GDP growth will slow from 7.8 percent in 1998 to 6.0 percent in 1999.

Outlook for China's Economy

Despite the relatively shaky state of the Chinese economy, the Chinese government appears to have shown greater willingness to reform China's economic and trade regimes in order to obtain WTO membership. For China, greater market openness would boost competition, improve productivity, and lower costs for consumers, as well as for firms using imported goods as inputs for production. Economic resources would be more likely redirected away from money-losing activities towards more profitable ventures, especially those in China's growing private sector. As a result, China would likely experience more rapid economic growth (than would occur under current economic policies). Greater openness would also boost foreign investment in China, and increase trade flows (both exports and imports). Goldman Sachs estimates that WTO membership would double China's trade and foreign investment levels by the year 2005 and raise GDP by an additional 0.5% per year.

In the short run, however, widespread economic reforms (if implemented) could result in disruptions in certain industries, especially unprofitable SOEs, due to increased foreign competition. As a result, many firms would likely go bankrupt and many workers could lose their jobs. How the government handles these disruptions will strongly determine the extent and pace of future reforms. The central government appears to be counting on trade liberalization to boost foreign investment and spur overall economic growth; this would enable laid-off workers to find new jobs in high growth sectors. However, the Chinese government is deeply concerned with maintaining social stability. If trade liberalization was followed by an economic slowdown, leading to widespread bankruptcies and layoffs, the central government might choose to delay (or even rescind) certain economic reforms rather than risk possible political upheaval.

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