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The Changing Trade Situation in China

 

By Scott Phillips

 

 

Introduction

 

With it’s December 2001 entry into the WTO, China took another giant economic step forward.  Previously many countries imposed harsh anti-dumping measures on China due to the belief that they were not a market based economy. ^[1]  Admission into the WTO gave China through implication and through force of treaty the opportunity to break down many of those barriers.  It also capped a myriad of market reforms that first started back in the late 1970s.  As a result the country has experienced an average of 8 percent GDP growth since 1980, and almost 10 percent annual growth over the last four years. ^[2]  With these reforms in mind, China is still working through some protectionist issues with regards to currency policy.  The country’s trade situation is also indicative of their current currency policies.

 

 

Reporting Improvements

 

Even though economic reforms started around 1978, it would still be almost 20 years before China would reform their economic reporting functions.  The key year was 1996.  Before this time, the Central Bank of China compiled financial information from a variety of sources including government agencies, other banks, and the Central Bank’s internal records.  Starting in 1996 the bank began reporting information in accordance with BPM5.  This made China’s economic BP information truly comparable with other countries for the first time.  Subsequently detailed economic comparisons before 1996 are problematic as they contain incomplete information on things such as FDI, travel statistics, etc.  These reforms, while primarily aimed at compliance with IMF and WTO reporting requirements, had the effect of also improving China’s reporting of currency and trade matters as well.

 

 

Trading Partners and Exports

 

The bulk of China’s export trade takes place with the United States, the European Union, and Japan.^[3]  With over a billion people, China naturally has a competitive advantage in labor and manufacturing.  So it is not surprising that China’s top 10 worldwide exports consist mostly of standardized manufactured goods, with some raw materials (appendix 1).

 

On the import side, China’s top importers still consist of the U.S and Japan.  However they also rely more on Asian countries for imports than on the EU.  China has undertaken an aggressive economic development strategy starting in the late 1970s.  Along with this growth has come the necessity of upgrading and building infrastructure.  This continuing need is very telling with respect to China’s top imports.  The top import consists of electrical machinery and equipment.  Raw materials accounts for an additional four catagories of most imported items.  Thus five of the top ten catagories are items that are used for building factories, roads, and other infrastructure (appendix 1).  This is striking as it clearly demonstrates that in the short term, China has used most of its import capacity to bring in materials for economic development with less emphasis on consumer goods.

 

 

Trade Alliances and Emerging Markets

 

By joining the WTO in December of 2001, China has committed to lowering trade barriers within their own country as well as undertaking various banking system reforms.  It is estimated that these reforms within the country will take two decades or more to fully implement.  In the meantime, the government has taken a fair amount of criticism for installing some reforms faster than others.  Critics charge that these reforms have generally focused around making it easier to accept FDI from other WTO members while retaining tight controls over capital flowing out of the country.  It is worth noting that while China has been receiving FDI for more than a quarter of a century, the amount invested per capita is still far lower than many developing and most developed countries. ^[10]  With this in mind, clearly it is in China’s best interests to reform further to draw more FDI investment.

 

The government is making in-roads however.  One area that the Chinese government has attempted to fix recently is the stability of their currency.  Recently unveiled rules are aimed that trying to encourage international use of the Chinese currency.  It is hoped that this activity will spur demand abroad for the Yuan and that it will see more use in foreign markets.  Also of note is China’s recent efforts to change the lending criteria of the state owned banks.

 

As seen by the aggregate Balance of Payment information (Appendix 2), the Balance on Goods has almost doubled since 2001 indicating a strong export presence.  China has benefited from falling trade barriers as a result of their entry into the WTO.  The country’s leadership was quick to take the lead in ramping up export of the industries in which China enjoys a competitive advantage.  However without further banking and FDI reform, China will not be able to change their factor endowments from labor towards a capital based economy. 

 

 

Prospects for Future Trade

 

After four years of blistering economic growth, one would expect some changes within the country.  For one, established trade models say that the people of China would see some welfare benefits with the increased amount of capital flowing into the country.  Market reports are starting to indicate that indeed changes are taking place that are consistent with previous economic predictions.  Among these changes:

 

• Average wage gains of 7 percent in 2004 and 8.3 percent in 2005.  Also evidence that employers are having to offer more generous benefit plans to attract experienced workers, however these increases were not counted as part of the wage gain.^[5]
• Increased demand for foreign “luxury” goods due to the influx of currency and the rise in wages. ^[5]
• Increased overhead for factories leading to increases in the prices for finished goods.^[6]
• Increasing size of the Chinese middle class as well as labor migrations from undeveloped rural areas to city centers.^[6]

 

The labor shortages mentioned above began in late 2004.  At the time the government believed that they were only temporary.  Now it is being viewed as a potential problem.  Over the long term wage increases and higher overheads will be inevitable.  This will inevitably lead to some companies looking elsewhere for cheaper labor.

 

Two other factors that could affect trade are also in play here.  The first is China’s currency policy.  Up until mid-2005 the Yuan was pegged to the dollar at a near static rate of 8.28 to the dollar.^[7]  Currently the Yuan does not trade at true market value.  Instead it is tied to a market basket of currencies, and the opening value of the Yuan is not allowed to fluctuate more than 0.3 percent at the start of any business day.  Pegging the Yuan to the dollar allowed China to keep the currency value artificially devalued in relation to demand.  A devalued currency in turn greatly assisted Chinese exporters by allowing them to sell their goods at a cheaper rate, thus inflating the trade gap with China’s largest trading partners.  Conversely, it has made both domestic and imported goods within China more expensive for Chinese consumers thus lowering the demand for both.  Part of the benefit of trade (consuming beyond their production possibilities frontier) is not being fully utilized.

 

The second factor that is currently influencing China is the rate of savings.  Currently the country as a whole is saving approximately ½ of it’s GDP (approx. 1.1 trillion dollars).^[8]  That’s 1.1 trillion dollars that is not being re-circulated in Chinese economy.  In 2004 the IMF, while recognizing that China “has good potential for sustained robust growth over the medium term,” also recognized that this high savings rate would be a potential hurdle to economic growth calling it “unsustainable” and “potentially excessive as it may hinder trade while propping up the currency account and masking some of the questionable lending practices of the national bank.”^[9]

 

 

 

 

 

Appendix 1

 

 

Table 6: China's Top Imports ($ million)
HS #	Commodity Description	2005	% Change*
85	Electrical machinery & equipment	174,839.8	22.9
84	Power generation equipment	96,374.8	5.2
27	Mineral fuel & oil	64,098.6	33.5
90	Optical & medical equipment	49,972.2	24.5
39	Plastics & articles thereof	33,323.5	18.8
28, 29	Inorganic & organic chemicals	32,836.1	18.1
72, 73	Iron & steel	31,905.2	12.4
26	Ore, slag, & ash	26,014.3	50.6
74	Copper & articles thereof	12,895.8	23.1
87	Vehicle & parts other than rail	12,312.8	-6.0
*Percent change over 2004 Source: PRC General Administration of Customs, China's Customs Statistics

 

 

Table 5: China's Top Exports ($ million)
HS #	Commodity Description	2005	% Change*
85	Electrical machinery & equipment	172,320.8	32.9
84	Power generation equipment	149,715.5	26.7
61, 62	Apparel	65,904.1	20.3
72, 73	Iron & steel	34,123.7	35.3
90	Optics & medical equipment	25,478.0	57.1
94	Furniture & bedding	22,363.5	29.1
95	Toys & games	19,123.6	26.7
28, 29	Inorganic & organic chemicals	19,064.0	36.8
64	Footwear & parts thereof	19,052.9	25.3
39	Plastics	17,783.3	35.7
*Percent change over 2004 Source: PRC General Administration of Customs, China's Customs Statistics

 

Appendix 2

 

 

 

	2,001	2,002	2,003	2,004
Current Account	17,401	35,421	45,874	69,659
Balance on Goods	34,017	44,166	44,651	58,982
Balance on Services	(5,933)	(6,783)	(8,572)	(9,698)
Balance on Income	(19,175)	(14,945)	(7,838)	(3,522)
Current Transfers	8,492	12,984	17,634	22,898
Capital Account	(54)	(49)	(48)	(69)
Financial Account	34,832	32,340	52,774	110,729
Direct Investment Abroad	(6,884)	(2,518)	0	(1,805)
Direct Investment in China	44,241	49,307	47,076	54,936
Portfolio Investment Assets	(20,654)	(12,094)	2,983	6,486
Portfolio Investment Liabilities	1,249	1,752	8,443	13,203
Other Investment Assets	20,813	(3,076)	(17,921)	1,979
Other Investment Liabilities	(3,933)	(1,029)	12,039	35,928
Net Errors and Omissions	(4,732)	7,794	18,422	27,045
Reserves and Related Items	(47,447)	(75,507)	(117,023)	(206,364)

 

Bibliography

 

1. China Daily. WTO Entry Boosts China’s Economy.  Staff report.  November 18, 2002

 

2. CIA World Factbook: China.  http://www.cia.gov/cia/publications/factbook/geos/ch.html

 

3. People’s Daily Online.  Business: China’s Top-Ten Trading Partners Named.  January 20, 2002. 

http://english.people.com.cn/english/200001/20/eng20000120X126.html

 

4. Encyclopedia of the Nations.  China: Balance of Payments.  Copyright 2006, Thomson Corporation. 

http://www.nationsencyclopedia.com/Asia-and-Oceania/China-BALANCE-OF-PAYMENTS.html

 

5. Salary rises for foreign firms continued in China.  Hewitt Associate Consulting Corp.  Annual China wage survey, 2005.

 

6. Labor Shortage in China May Lead to Trade Shift. New York Times.  Business Section, pg 3.  04/03/2006.

 

7. China Launches Currency Shake-up.  BBC News.  07/22/05

http://news.bbc.co.uk/2/hi/business/4703477.stm

 

8. The U.S. and China's savings problem.  CNNMoney.com.  03/08/2006

http://money.cnn.com/2006/03/03/news/international/chinasaving_fortune/index.htm?cnn=yes

 

9. “China’s Growth and Integration into the World Economy.”  IMF Periodic Report.  Edited by Eswar Prasad.  Copyright 2004, IMF.  Washington, D.C.

 

10. Capital Controls in China: Recent Developments and Reform Prospects.  Zhang, Zhichao.  Durham Business School, University of Durham.  Presented April 17^th, 2006.