Global Policy Forum

WTO Entry Signals a Seminal Shift in Chinese Thinking
about the Country's Economic Future

By G. Pierre Goad

Don't miss the forest for the trees. Ever since China and the United States reached agreement late last year on the terms for China's admission to the World Trade Organization, much attention has been focussed on the minutiae of the negotiations, such as whether foreigners will be allowed to own 49% or 50% of telecoms companies, and the likely difficulties of enforcing China's WTO pledges.

In paying so much attention to the details, there is a danger of losing sight of the broader importance of China's WTO membership. In macroeconomic terms this is a big deal. "This is a massive turning point for China," says Andy Xie, an economist at Morgan Stanley Dean Witter in Hong Kong. "I think this is such a massive undertaking that the reality will be much more complicated than we can anticipate now."

After a three-month lull, China's bid to join the WTO will be back in the news starting next month as the country wraps up its remaining bilateral accession negotiations with WTO members Mexico and Switzerland. With those last two agreements in hand, WTO staff will finalize the formal pact, or protocols, governing China's admission to the world trading system and present it to a general session of the Geneva-based agency. Barring last-minute hitches the deal should be wrapped up by October.

And then the squabbling will really begin. It's a safe bet that foreign firms will begin complaining almost immediately about Chinese backtracking on this or that market-opening pledge. Disputes over export surges such as the recent flood of Chinese garlic into South Korea will no doubt crop up regularly. And so what? Anticipating such problems shouldn't mask the obvious and dramatic change in how they will be handled: China will have to defend its trade policies within the WTO.

The macroeconomic significance of WTO membership, however, runs far deeper than requiring China to implement rules-based trade policies. The biggest direct beneficiaries of China's WTO membership will be Chinese consumers who will see more choices and lower prices for a wider range of goods, many economists say. In choosing consumers over producers China's leadership is opting for a different economic model than its neighbours. How to balance the interests of consumers and producers is a multiple-choice question and the correct answer changes over time, assuming there is one right answer.

What is clear, though, is that other fast-growing Asian economies chose to favour producers over consumers when they were at China's stage of development and in some cases still do so. Japan's producers, despite a decade of economic crisis, remain coddled and protected. South Korea's producers are under assault from a barrage of reforms unleashed by a sharper economic crash, but it still would be an exaggeration to say the country's consumers now have the upper hand.

Scholars at the Institute of International Economics, a Washington think-tank, say China's effort to join the WTO is really a decision to pursue a consumer-led economic model instead of the export- and investment-led development model that marked the rise of Asia's "miracle" economies in the 1970s and 1980s. China already has been shifting in that direction. Arguably, its economy is now more free than Japan's or Korea's in terms of openness to imports and investment. China is certainly more open to foreign trade and investment than India, a WTO member since the agency was founded in 1947 as the General Agreement on Tariffs and Trade.

China's WTO membership will cement the choice of a consumer-led development model and many related reforms and economic policies will flow naturally from that fundamental decision. Dong Tao, an economist at Credit Suisse First Boston in Hong Kong, says one huge difference between China and other large Asian economies will be the degree of foreign ownership. He says Chinese companies raised about $8 billion through foreign share offerings in the first half of this year and will likely raise another $4 billion to $5 billion in the second half. An additional $14 billion is in the pipeline for next year. Direct investment is recovering after a sharp slowdown with investment commitments rising to $24.2 billion in the first half of this year, up 25% from a year earlier, according to Chinese government figures. Cumulative foreign direct investment since economic reforms began in 1978 now exceeds $325 billion. All that adds up to significant foreign ownership of China's economy--with still more to come. "China could end up with 30% foreign ownership within five to six years," says Xie at Morgan Stanley.

Though it's not obvious now, the other major change that flows from choosing openness to foreign investment and consumers over producers is the need for a commercial banking system that is truly commercial. Whether state-owned or state-directed, banking systems have been a tool of government policy in much of Asia. Governments, directly or indirectly, have long grabbed consumer savings and directed credit to producers. China is no exception. But, China is an exception in that it hasn't had a full-blown banking crisis--yet. The rest of Asia, of course, shows how bad things happen to otherwise good economies when banking systems unravel.

Reform of China's financial system will come in several parts. WTO entry will require some changes while other reforms not strictly demanded by trade rules are needed to create a solvent, commercial banking system.

Unwinding the deadly tangle of loans by state-owned banks to state-owned enterprises is perhaps the greatest challenge facing China's leadership. The odds are China will, with a little luck, untangle its banking mess without facing a financial crisis. China's total public debt is about 40% of GDP. If existing trends in government revenue and loan performance continue--that is, if revenues remain about 15% of GDP and the proportion of bank loans turning sour holds at about 30% of outstanding loans--the government's debt-to-GDP ratio could reach 100% within 10 years, according to the economics team at Salomon Smith Barney. The solution is to reduce the flow of nonperforming loans and increase government revenues.

WTO membership and broader bank restructuring reinforce each other because both will, over time, discourage wasteful investment. WTO membership will make it more costly for firms to make bad or unproductive investments because they will face increased competition. Restructured or new banks will be more choosy when lending since they will worry more about getting repaid. One result is that the cost of money will rise in China, which is a good thing. The surviving state-owned enterprises will pay more for credit as banks put themselves on a commercial footing. Private enterprises will, in a sense, pay less because under the current system credit for smaller firms is hard to find at any price from the state-owned banks that hold most Chinese savings.

The macroeconomic effects of China's WTO entry include changes in merchandise imports and exports, of course. Studies have predicted that China's imports will rise more than its exports in the short term. The longer-run effects on trade are harder to predict. Southeast Asia is already facing increased competition from China in third markets. China's exports to the U.S., for example, grew at an annual average rate of 15.8% from 1995 through 1999 compared with 5.7% for the Association of Southeast Asian Nations. China's share of total Asian exports to the U.S. was 20.9% last year, up from 14.7% in 1995.

Trade figures show why China doesn't really have any choice but to adopt a consumer-led economic model. It's simply too big to copy the export-led model of its neighbours. South Korea's 47 million people exported $31.2 billion worth of goods to the U.S. last year. If Chinese exports per worker reached Korean levels, China would have exported $837 billion of goods to the U.S. last year--or 83% of worldwide exports to the U.S. That's not going to happen.

Instead, China will let its consumers drive growth. Oddly enough that's exactly the route chosen by the U.S. when it helped found the WTO's predecessor after a disastrous experiment with high tariffs and closed markets.

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