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The Process of Foreign Trade System Reform and Current Policy Issue in China Essay

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Updated: Apr 18th, 2019

Introduction

After a 27-year rule Chairman Mao Zedong, in 1976, Deng Xiaoping took over the reins of power of The People’s Republic of China. The economic principle-guiding rule of Chairman Mao was the Great Leap Forward while Deng Xiaoping guiding principle was opening up the economy.

The policies were different on many fronts. Chief among them, while Chairman Mao emphasis was on a socialist economy, the focus of Deng was a market oriented economy.

In 1978, China’s total imports and exports of $20.6 billion ranked 32nd among all nations and accounted for less than one percent of global trade. In 2010, China’s total merchandise trade exceeded $3 trillion, 143 times the level of 1978. With an annual growth of 17.2 percent in exports and 16.4 percent in imports, China now accounts for 10.4 percent and 9.1 percent of global exports and imports.

To achieve this, China has undertaken massive economic reforms to spur investment and foreign trade. Moreover, China provided incentives for investment by foreign companies into the country (foreign direct investment). Deng’s model was a reflection of a similar model used by the Asian Economic tigers such as Singapore, whose rapid industrialisation growth was through trade/export led growth.

Mao Regime

Chairman Mao accession to power in 1949 was after multiple civil wars had taken place in the country. With socialist leaders such as Karl Marx and Lenin being among his source of inspirations, Chairman Mao had a purpose to steer China towards socialism. This was to unite the country to work together for a better future. Capitalism was a western ideology to him.

Over the course of close to three decades, under his great Leap Forward Plan, he led China through a period of the economic regression resulting in over 70 million fatalities. Policies and initiatives by Chairman Mao had a gearing towards, communal labour in agriculture, steel manufacturing and textiles. Trade did not fare much better than other economic sectors.

Economic planning set commodity trade patterns in Mao regime before 1976. The state import plans were, for example, by 90% of all the Chinese imports. This is because state run enterprises had monopolies over import and exports. Therefore, inclusion of these enterprises in government planning schedules led to a monopoly of trade.

In the Mao regime, imports of capital goods such as machinery were high due to inability of China to source them locally. For a nascent manufacturing industry, intermediate goods and raw materials were also in demand.

The state export plans also had a state and its enterprises monopoly. The exports were mainly agricultural and textiles. The result is a trade deficit with due to high import bill of expensive capital goods and a low export bill of cheap textiles and agriculture.

The country was unable to finance exports due to the foreign exchange reserves limitations from the year 1949 to 1976. Over this period, exports as a share of GDP had a reduction from 1.5% (1953) to 0.6% (1977).

Deng Trade Reforms (1978- 1995)

Market Reform

The market reforms were to transform the economy from a planned economy to a market oriented economy. It was a two-prong strategy. First, the state began a decentralisation of the economy.

Decentralisation led to a spread of resources, reduction of red tape, especially, in operating business and competition between provincial leaders to achieve growth within their provinces. The competition by provinces was necessary for later success of Special Economic Zones and transformation of public sector to become efficient.

Second target of market reforms was to transform public sector to become efficient. The achievement of this reform agenda was through privatisation and reinvestment in state run enterprises leading to massive layoffs, bankruptcies and gradual improvement of return on capital. Currently, state firms are among the largest drivers of outgoing foreign direct investment from China.

Particularly, impact of public sector reforms on trade was the government focus to eliminate monopolisation of state companies on trade. This is by abolishing of import substitution lists and promoting private companies involvement in foreign trade. The open system of foreign trade was an essential element in convincing private firms to set up base in China for exports.

Foreign Exchange Reform

In the Mao years, China had a high import intake of capital goods. To achieve the feat of satisfying the growing demand of capital goods under foreign reserves accumulation limitations, China overvalued its domestic currency. This essentially made imports cheaper.

However, it led to high demand for foreign exchange requiring the state to create an exchange control system. In the exchange control system, exporters had to give up their foreign exchange income to the state. Moreover, individuals had limited rights to hold foreign currency while there was a state regulation of capital outflows.

State reform of foreign exchange system begun by, allowing exporters to keep a share of their foreign exchange earnings. With a reduction of the need to contact the state to purchase foreign exchange, trade grew.

Eventual elimination of the control system was by making the currency convertible on current account transactions. Further, the state set in motion devaluation of its currency; by 1995, Chinese currency had lost more than 70% of its value from 1995.

Indirect Tax Rebates and import duty drawbacks

Developing countries reliance on indirect taxes to finance budgets more than direct taxes, the ratio improves with development. Therefore, in 1978, China being a developing country had high indirect taxes. This practice was a disadvantage to exports, which became expensive. To combat this, the state offered rebates for exports to cushion exporters from the high indirect taxes.

To promote its export manufacturing capacity, imports procured for export had rebates. The purpose of import rebates was to reduce the effect of tariffs and inflations on import. This was stimulation for an export boom driven processing imports to finished products. China set up 4 special economic zones to boost the rebates efforts.

Tariffs, non-tariff barriers and price liberalisation

In 1996, tariffs had dropped to 23% more than half the 1992 tariff rate, by the time China was on its path to the accession it had dropped to 15.3% in 2001.

Most products tariffs had reduced across the board, with tariffs majorly on agriculture and industry its bid to fuel these economic sectors. Non-tariff barriers reduced significantly post 1990. With a market economy, prices controls reduced significantly as protectionist policies by the state decapitated

Path To Wto Accession (1995 -2004)

The first China commitment to accession to world trade organisation was to eliminate goods trade tariffs or to reduce to a minimum by 2004. China set itself to reduce industrial tariffs to 9% and agricultural tariffs to 15% by 2005. The second commitment was in services sector.

China as per its commitment should open local service industry especially those with state monopolies. This includes retail, banking, insurance and telecommunication. In a five-year period, China was to eliminate state monopolies in these in sectors.

The third commitment was to improve trading regime by reducing discrimination of imports, export subsidies and agricultural subsidies. It was to additionally improve intellectual property rights.

Results Of Reforms

As the reforms took hold, export growth became increasingly concentrated in the labour-intensive industry. China has an advantage in this area than most countries especially due to its low tariffs, incentives to foreign direct investment, low wages and infrastructure development.

China early exports were mainly in agriculture, but this shifted increasingly into manufactured goods particularly light manufactures. This share of unprocessed goods dropped from 45 percent of total exports in the first half of the 1980s to 10 percent by 1999.

China fastest growing exports have been in the following key industries: textiles, apparel, footwear, and toys. From 1980 to 1998 exports of labour intensive manufacture of textiles, apparel, footwear, and toys rose from $4.3 billion to $53.5 billion. This is a ten-time increase.

The share of China total exports accounted for by these four product categories soared from 6.9 percent in 1980 to 29.1 percent by 1998. For each of these products, China captured a rapidly rising share of total world exports.

In textiles, China’s share of global trade grew twice from 4.6 (1980) to 8.5% (1998). In the apparel industry, the increase was greater than in textiles as China’s share of worldwide apparel trade exports grew from 4.0% (1980) to 16.7% (1998).

Toy production in China grew so rapidly than in the same period it grew from 2.3% to 17.9%. China’s footwear growth was greater than among the key industries growing from a paltry 1.9% of world trade to 20.7%.

However, in understanding the challenges of China’s economic growth, these same sectors face massive accusation against China at the World Trade Organisation. This is because of China’s apparent dumping of these goods in other countries according to her accusers.

Recently, light commercial industry has grown rapidly especially in consumer electronics such as radios, mobile phones, wiring devices among other light industries. However, earnings by China are mostly in assembly while most of earnings of the light commercial industry head back to foreign firms’ assembling home countries.

Challenges To China’s Trade-Led Growth

First, gross accusations of Currency manipulation were reported to the World Trade Organization; USA and European Union hold the view that China is manipulating its currency to favour itself by selling its exports cheaper than they should be, thus gaining an unfair advantage over its trading partners.

This is because the Chinese currency is under tight control of Chinese government. The United States claims China has undervalued its currency by over 40%. To reduce accusations, China in 2005 increased value of its currency by 30%.

China stands accused of excessive dumping of textiles by both developing and developed countries. The dumping suppresses local industry to the extent of closing down and loss of jobs. According to WTO rankings, since 2008, China exceeds a 35% contribution of total antidumping investigations on year to year measure. Antidumping investigations are not only in textiles but also to other Chinese exports.

Thirdly, China’s economic risk has a high link to its top ten-trade partners due to their high contribution of total foreign trade by China. China’s ten largest trading partners are Japan, the United States, the European Union, Hong Kong Special, South Korea, Taiwan, Australia, Russia and Canada.

In 2001, 87.3% of exports and 84.5% of imports were to these trading partners. Seven years later, the top 10 partners contribution to her total trade dropping to 80.7% (exports) and 72.3 (imports); it was still high and is an economic risk.

Fourthly, income inequality persists in China. Rural regions income inequality with urban regions has grown considerably due to investment focus in these regions. Rural regions focus is mainly agriculture, which is labour intensive and has low returns.

Fifth, environment destruction because of high pace of industrial growth reduces future environmental prospects and the country become susceptible to drastic climate changes. The environment destruction through pollution and energy use efficiencies has led to China being the number 1 consumer of petroleum worldwide. Sixteen out of twenty cities with highest pollution are Chinese.

China Current Economic Status

In the year 2012, China Gross domestic product was $12.38 trillion, up from $11.48 trillion the previous year. The economic growth rate was 7.8% down from 9.2%. GDP contribution of agriculture, industry and services was 9.7%, 46.6% and 43.7% respectively.

The labour force of 795.4 million people direction into these sectors was as follows: agriculture 36.7%, industry 28.7% and services 34.6%. Unemployment rate was 6.4% (2012) while the population below the poverty line was 13.4%. GDP – per capita (PPP) was $9,100, up from $8,500 (2011) and $7,800 (2010).

China’s current account balance of $170.8 billion brought about by $2.021 trillion exports and $1.78 trillion imports. Her greatest trade partners are inclusive of Japan, the United States, the European Union, Hong Kong Special, South Korea, Taiwan, Australia, Russia and Canada.

Foreign exchange reserves and gold were worth $3.549 trillion. Incoming foreign direct investment stood at $909.8 billion up from $711.8 billion. The outgoing foreign direct investment was at $465 billion up from $364 billion.

Trade Surplus Changes In China External Trade

First, decrease in terms of trade for China. At the beginning of Deng’s reforms, China exports were mainly in agriculture and textiles; gradually, however, dominance of machinery and capital goods exports grew. Production of machinery and capital goods require commodities and minerals, whose prices are skyrocketing due to the high demand by China along other emerging countries.

While this occurs, the increase in global manufacturing competition and efficiency leads to a price reductions. Therefore, China’s import bill as a proportion to its export bill is increasing thus reducing its trade surplus and terms of trade.

Secondly, an increase in minerals, raw materials and commodity imports bill. The trade surplus has been decreasing considerably due to increasing import bill of minerals and commodities. The increasing of imports since 2007 is a result of the stimulus package, which led to an increase in investment spending.

This is due to the stimulus’ incentives for infrastructure, relocation of manufacturing to poor provinces, and move to growth industries. Over the long-term, these efforts will accrue export benefits.

Thirdly, China has moderate Expectations of future Exports Growth. China exports have grown considerably over the last three decades to register 11% of the world total exports as at 2012.

However, efforts to grow the global market share higher will face hurdles, and will be more moderate as China embraces anti-dumping laws among other fair trade practices. Even, with a moderate growth rate, high-end manufacturing provides room for growth for the Chinese Economy.

Trade Surplus Changes In China’s Domestic Economy

First, a good demand gradually increased in the domestic consumer. Domestic demand principal component is the capital goods for investment. The growth of consumer goods percentage of total domestic import demand is low bit is rising. This is due to an increase in the middle class, resulting from three decades of growth.

With the government planning to invest more in housing and social security while boosting wages in provinces with low GDP per capita, growth of middle class will increase further. The increase in internal consumer demand will enable the country to shift from foreign trade led demand, which currently constitutes 50% of GDP. Imports of consumer goods are to rise over the future.

Secondly, a change in composition of investment. The investment in high-end production is increasing in China. There has been an increase in investment of wind turbines, shipbuilding, electrical trains and solar panels, among other high-end production.

Third, cost pressures increase due to the elimination of lucrative tariffs, and increasing middle class increases pressure on wage rise. The country in line with WTO regulations and pressure from its partners is cutting back on tariffs and subsidies.

Additionally, with a rising middle class and increase in GDP per capita, wages have been on the rise. However, the Chinese firms have been able to withstand the cost pressures through increases in operating scale, thus improving their operating margins.

Future China Economics

China will experience a gradual decline in its external surplus as costs rises internally and cost advantages, which were the initial attraction of investors shift to other developing countries. This will lead to shifts of light manufacturing and textiles to other countries especially in Africa and Latin America.

However, the production of high-end products will increase over the long term. Thus, industries to experience future growth include solar panel industries, wind power and automobile industry. The state is likely to invest in manufacturing of aircrafts and weapons, which it is a net importer. Shipbuilding will also subsequently grow in the future of China.

Furthermore, focus by the government on social security; housing and wages will improve living standards of the lower middle class and the poor fuelling domestic demand. This will be the driver for China next stage of economic demand, shifting gradually from a trade led demand.

Before, manufacturing in high-end consumer goods increases, China will be a net importer of consumer goods creating a further reduction in trade surplus. The sustenance of the Chinese growth rates even with the changing landscape of its economy will provide benefits to china.

Development of high products will come into competition with developed country products. Mineral rich countries will gain as China’s imports more, while its developing partners gain as industries shift from china.

Once China’s consumer good production industry has grown, it will face direct competition with developed nations of the U.S., France, Germany and Italy. It is in this horizon, which China will not have a safe transition to high end production as it meets more experienced players in this arena.

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