Order Code IB98014
CRS Issue Brief for Congress
Received through the CRS Web
China’s Economic Conditions
Updated May 21, 2003
Wayne M. Morrison
Foreign Affairs, Defense, and Trade Division
Congressional Research Service ˜ The Library of Congress

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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: 1979-2002
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
Severe Acute Respiratory Syndrome (SARS)
Reform of State Owned Enterprises
Reform of the Banking System
Infrastructure Development
Major Issues in China-U.S. Economic Relations
China’s Accession to the World Trade Organization
China’s Normal Trade Relations Status
Outlook for China’s Economy

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China’s Economic Conditions
SUMMARY
Since the initiation of economic reforms
cant impact on China’s economy. The level of
in 1979, China has become one of the world’s
Chinese trade protectionism will be greatly
fastest growing economies. From 1979-2002,
diminished over then next few years, and
China’s real GDP rose at an average annual
nearly all sectors of China’s economy (includ-
rate of 9.3%; it rose by an estimated 8.0% in
ing agriculture, manufacturing, and services)
2002. Many economists speculate that China
will increasingly be subject to great competi-
could become the world’s largest economy at
tion. Several of China’s heavily protected
some point in the near future, provided that
industries, such as autos, and certain agricul-
the government is able to continue and deepen
tural sectors, could be negatively affected by
economic reforms, particularly in regards to
China’s WTO membership. China’s labor-
its efficient state-owned enterprises (SOEs)
intensive industries, especially textiles and
and state banking system. Progress in reform-
apparel, will likely benefit significantly with
ing these sectors in recent years has been
China’s WTO accession. A major challenge
somewhat mixed.
for the government is to develop an adequate
social safety net to assist laid-off workers.
After many years of negotiations, China
became a member of World Trade Organiza-
China’s economy remained relatively
tion (WTO) on December 11, 2001. WTO
healthy in 2002, despite economic slowdowns
accession commits China to significantly
in other parts of the world. Foreign invest-
reducing a wide variety of tariff and non-tariff
ment continued to pour into China, and the
barriers over the next few years. Legislation
Chinese government effectively used public
(H.R. 4444) authorizing the President to grant
spending to boost the economy. However,
permanent normal trade relations (PNTR)
painful economic reforms will be necessary to
status to China (once it joined the WTO) was
keep the economic strong in 2003 and beyond.
enacted into law on October 10, 2000 (P.L.
In addition, the recent outbreak of a very
106-286). Following China’s WTO accession
contagious virus called Severe Acute Respira-
in December 2001, President Bush extended
tory Syndrome (SARS) in China (which has
PNTR status to China which became effective
subsequently spread to other countries as well)
in January 2002.
has raised serious health concerns over travel
to and from China, and therefore could poten-
If fully implemented, the terms of Chi-
tially have a negative short-term impact on the
na’s WTO accession will likely have a signifi-
Chinese economy.
Congressional Research Service ˜ The Library of Congress

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MOST RECENT DEVELOPMENTS
On April 17, 2003, China reported that real GDP increased by 9.9% in the first quarter
of 2003 over the same period in 2002. Later that month, the Chinese government admitted
that the outbreak of a very contagious virus called Severe Acute Respiratory Syndrome
(SARS) was more widespread and serious than had been previously acknowledged. Many
economists predict that SARS will have a negative effect on China’s economy in the short
run.
On January 9, 2003, the United Nations reported that in 2002, China had replaced the
United States as the world’s largest recipient of foreign direct investment.
On November 8, 2002, Chinese President Jiang Zemin formally proposed at the 16th
National Congress of the Chinese Communist Party that the Party constitution be amended
to allow private entrepreneurs to join the Party (based on Jiang’s “Three Represents” theory).
The amendment was adopted on November 11.
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.
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.
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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: 1979-2002
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 2002 growing at an average annual rate of 9.3%, making China one of the
world’s fastest growing economies. The World Bank estimates that China’s economic
reforms have raised nearly 200 million people out of extreme poverty. The Chinese
government estimates that real GDP rose by 8.0% in 2002.
Table 1. China’s Average Annual Real GDP Growth Rates: 1960-2002
Time Period
Average Annual % Growth
1960-1978 (pre-reform)
5.3
1979-2002 (post-reform)
9.3
1990
3.8
1991
9.3
1992
14.2
1993
13.5
1994
12.7
1995
10.5
1996
9.7
1997
8.8
1998 7.8
1999 7.1
2000
8.0
2001 7.3
2002 8.0
Source: Official Chinese government data.
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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%. 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 40.1% in 2001, 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 nearly $53 billion in 2002. It is estimated
that there are over 420,000 foreign-funded enterprises in China, with a cumulative level of
FDI of $448 billion. FDI in China in 2002 grew by nearly 13%, an impressive figure
considering that worldwide FDI in developing countries fell by over 25%, according to the
United Nations Conference on Trade and Development. Analysts predict that FDI will
continue to pour into China as investment barriers are reduced under China’s WTO
commitments and Chinese demand for imports continue to increase. The United Nations
estimates that in 2002, China replaced the United States as the world’s largest recipient of
FDI. The Chinese government predicts that FDI will reach over $100 billion by 2006.
Nearly half of FDI in China has come from Hong Kong. The United States is the
second largest investor in China, accounting for 8.9% ($45.9 billion) of total FDI in China
from 1979 to 2002 (see Table 2). U.S. FDI in China for 2002 was $4.4 billion, accounting
for 10.2% of FDI for that year. U.S. FDI in China in 2002 was over 22% higher than 2001
levels, while Taiwan’s FDI increased by over 33%.
Table 2. Major Foreign Investors in China: 1979-2002
($ billions and % of total)
Cumulative Utilized FDI:
Utilized FDI in 2002
1979-2002
Country
% Change
Amount
Amount
% of Total
% of Total
Over 2001
($billions)
($billions)
Levels
Total
448.2
100.0
52.7
100.0
12.5
Hong Kong
205.6
45.9
17.9
34.0
-6.4
United States
39.8
8.9
5.4
10.2
22.3
Japan
36.6
8.2
4.2
8.0
-3.7
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Cumulative Utilized FDI:
Utilized FDI in 2002
1979-2002
Country
% Change
Amount
Amount
% of Total
% of Total
Over 2001
($billions)
($billions)
Levels
Taiwan
33.2
7.4
4.0
7.6
33.2
Singapore
15.3
3.3
2.3
6.3
8.9
Source: Chinese government statistics. Top 5 investors according to cumulative FDI from 1979-2002.
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, 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 2001
was about $1.2 trillion; its per capita GDP (a commonly used living-standards measurement)
was $875. Such data would indicate that China’s economy and living standards were
significantly lower than those of the United States and Japan, considered to be the number
one and number two largest economies, respectively (see Table 3).
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 Japan are higher), the PPP
exchange rate raises the estimated size of Chinese economy to about $5.6 trillion,
significantly higher than Japan’s GDP in PPPs ($3.5 trillion), and about half the size of the
U.S. economy. PPP data also raise China’s per capita GDP to $4,300. The PPP figures
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indicates that, while the size of China’s economy is substantial, its living standards fall far
below those of the U.S. and Japan. The International Monetary Fund estimates that (using
PPP measurements) China could surpass the United States as the world’s largest economy
as early as the year 2007. Yet, even if that were to occur, it would take China significantly
longer to achieve U.S. standard of living levels.
Table 3. Comparisons of U.S., Japanese, and Chinese GDP and Per
Capita GDP In Nominal U.S. Dollars and PPP: 2001
Nominal GDP
GDP in PPP
Nominal Per
Per Capita GDP
Country
($Billions)
($Billions)
Capita GDP
in PPP
U.S.
10,082
10,082
36,300
36,300
Japan 4,148
3,450
32,636
27,200
China
1,179
5,560
923
4,300
Sources: DRI-WEFA, Country Outlook, First Quarter, 2002 and CIA, World Factbook.
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 $326 billion in 2002, while imports over this period grew
from $16 billion to $295 billion (see Table 4). China is currently the world’s 6th largest
trading nation (based on 2001 data). Despite the worldwide economic slowdown, China’s
exports in 2002 rose by 22.3%, while imports grew by 21.2%.
Historically, China has run trade deficits in some years and surpluses in others.
However, over the past 9 years, China has run trade surpluses; in 2002 that surplus was $30.5
billion. Merchandise trade surpluses and large-scale foreign investment have enabled China
to accumulate the world’s second largest foreign exchange reserves, estimated to have
reached $243 billion in June 2002.
Table 4. China’s Merchandise World Trade: 1979-2002
($ billions)
Exports
Imports
Trade Balance
1979
13.7
15.7
-2.0
1980
18.1
19.5
-1.4
1981
21.5
21.6
-0.1
1982
21.9
18.9
2.9
1983
22.1
21.3
0.8
1984
24.8
26.0
-1.1
1985
27.3
42.5
-15.3
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Exports
Imports
Trade Balance
1986
31.4
43.2
-11.9
1987
39.4
43.2
-3.8
1988
47.6
55.3
-7.7
1989
52.9
59.1
-6.2
1990
62.9
53.9
9.0
1991
71.9
63.9
8.1
1992
85.5
81.8
3.6
1993
91.6
103.6
-11.9
1994
120.8
115.6
5.2
1995
148.8
132.1
16.7
1996
151.1
138.8
12.3
1997 182.7
142.2
40.5
1998
183.8
140.2
43.6
1999 194.9
165.8
29.1
2000 249.2
225.1
24.1
2001 266.2
243.6
22.6
2002 325.6
295.2
30.4
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 2002 were Japan, the United States, Hong Kong, Taiwan,
and South Korea (see Table 5). Chinese data show the United States as China’s largest
destination for its exports and the fourth largest source of its imports.
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Table 5. China’s Top 5 Trading Partners: 2002
($ billions)
China’s Trade
Country
Total Trade
Chinese Exports
Chinese Imports
Balance
Japan 102.0
48.5
53.5
-5.0
U.S.
97.2
70.0
27.2
42.8
Hong Kong
69.3
58.5
10.8
44.7
Taiwan
44.7
6.6
38.1
-31.5
S. Korea
34.1
15.5
28.6
-13.1
Source: Official Chinese trade data.
Note: Chinese data on its bilateral trade often differ substantially from the official trade data of other countries
on their trade with China.
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
share of total Chinese exports grew from 15.3% in 1986 to an estimated 38.5.% in 2002.
A growing level of Chinese exports are from foreign funded enterprises (FFEs) in
China. According to Chinese data, about half of its trade in 2002 was conducted by FFEs.
A large share 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 significant 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 90% in 2000, 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 2001 included mechanical and electrical equipment, high tech
products, electronic integrated circuits and components, crude oil, plastics (see Table 6).
China’s major 2002 exports included mechanical and electrical products, high tech products,
clothing, textiles, and computers (see Table 7).
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Table 6. Major Chinese Imports: 2002
Commodity
Total
% of Total
% Change
($Billions)
Imports
Over 2002
Levels
Mechanical & electrical products
120.5
40.8
29.1
High-tech products
64.1
21.7
29.2
Integrated circuit & electronic components
16.6
5.6
54.6
Crude oil
11.7
4.0
9.4
Primary plastics
11.7
4.0
13.7
Total top 5
224.6
76.1
— .
Source: Official Chinese trade data.
Table 7. Major Chinese Exports: 2002
Total
% of Total
% Change over
Commodity
($Billions)
Exports
2001 Levels
Mechanical & electrical products
118.8
36.5
32.3
High tech products
46.5
14.3
46.1
Clothing and accessories
36.6
11.1
12.7
Textile yarn, fabrics, and their products
16.8
5.2
22.2
Automatic data processing machines
8.0
2.5
64.4
(computers)
Total top 5
226.7
69.6
—
Source: Official Chinese trade statistics.
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. DRI-
WEFA, a private international forecasting firm, projects China’s GDP will grow at an
average annual rate of over 7.0% over the next several years. At this rate, China would be
able to double its GDP every 10 years. However, economists caution 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-quarter 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.
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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, over 50% 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. This system promotes
widespread inefficiency in the economy because savings are generally not
allocated on the basis of obtaining the highest possible returns.
! China’s agricultural system is highly inefficient due to government
policies that seek to maintain a 95% self-sufficiency rate in grains, mainly
through the extensive use of subsidies and restrictive trade barrier. These
policies divert resources from more productive economic sectors and keep
domestic prices for many agricultural products above world prices.
! 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.
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In addition, the Chinese government does not accept the concept of private
ownership of land and assets in China
! 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 economic development in the hinterland,
and developing modern fiscal and tax systems to address various social
concerns (such as poverty alleviation, education, worker retraining,
pensions, and social security). Serious health care issues exist. In a 2002
report, the United Nations stated that China was on the verge of
“catastrophe that could result in unimaginable suffering, economic loss and
social devastation,” due to the rapid rise of HIV/AIDS in China. More
recently the SARS epidemic has brought into question the adequacy of
China’s public health care system, particularly in rural areas.
Severe Acute Respiratory Syndrome (SARS)
SARS, a new and deadly disease, is believed to have originated in Guangdong Province
in China around November 2002. It soon spread to other regions and subsequently to 17
countries (by mid-April 2003). Many foreign officials have blamed China for not being as
forthcoming as it should have been on the spread of the disease. Chinese officials have
subsequently pledged closer cooperation with international health agencies, such as the
World Health Organization (WHO), to fight the disease. The WHO estimates that by May
14, 2003, there were 5,124 SARS cases in China and 267 SARS-related deaths.
The rapid spread of the SARS virus has raised fears among Chinese officials over the
effects it could have on China’s economic development — a factor seen by the government
as critical to maintaining social stability. Fear of the virus has led to a dramatic fall in
international travel to and from China. The tourist industry in China has been particularly
hard hit, as foreign visitors have cancelled tours and hotel reservation. In addition, foreign
business representatives have postponed trips to China, effectively delaying orders for new
shipments, as well as the signing of new investment contracts. Consumer spending in China
has dropped in many cities, due to widespread fear of catching the virus. Many economists
predict that SARS will have a significant, but not devastating, effect on China’s real GDP
growth in 2003. For example, the Asian Development Bank estimates a 0.2% decline in
China’s projected real GDP growth in 2003 if SARS lasts for one-quarter (April-June) and
a 0.5% decline if SARS continues into the third quarter (i.e., lasts from April-September).
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
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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. This policy was re-
affirmed and expanded upon by Premier Zhu Rongji in March 1998. Under this plan, some
unprofitable SOEs would be closed, while others would be merged with more profitable
enterprises. Many firms would be allowed to issue stock in order to raise funds. SOEs
would also be released from the responsibility of providing subsidized housing. Finally, the
government announced that SOEs would no longer receive preferential treatment by state
banks for loans.
Reform of the SOEs over the past few years has been relatively uneven. On the one
hand, the government has sought to improve SOE efficiency by significantly reducing the
number of redundant workers (since 1998, over 26 million SOE workers were laid off) and
cutting back on the level of free services (such as education, housing, and health care) given
to remaining workers. Workers who have been laid off from SOEs have been encouraged
by the government to find jobs in the private sector or to start their own businesses.
Individuals starting their own businesses have been given tax breaks. Prior to China’s
WTO accession, the Chinese government announced plans to move ahead with further SOE
reform to make them even less reliant on government support. In many cases this involved
letting some SOEs go bankrupt, merging other firms together, and encouraging others to
raise funds on their own through the issuance of stock. However, the government also
increased pressure on state banks to extend more loans to SOEs in order for them to
modernize their operations. In December 2002, the Chinese government reported that SOEs
in 2002 had achieved “record profits,” however many analysts doubt the veracity of these
statements since most SOEs do not use modern accounting standards and many falsely report
making profits when in fact the firm lost money.
Reform of the Banking System
Chinese officials have indicated a desire to strengthen and reform its banking system.
In January 1998, the central government announced it would 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,
rather than political, 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, a slowdown in the economy during the
Asian financial crisis caused the central government to resume pressure on the state banks
to continue to lend money to money-losing enterprises. In preparation for WTO entry, the
government reaffirmed its commitment to making its banking system more responsive to
market forces. It has continued re-capitalizing the banks to enable them to write off bad
loans, financed largely by the issuance of government bonds. It also issued guidelines stating
that new loans should be based on commercial criteria. Many China analysts believe the
banking system to be the most unstable sector of China’s economy. One analysis by
Goldman Sachs estimated that China would need at least $290 billion to make its banking
system solvent.
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Infrastructure Development
The Chinese government’s concerns over the disruptive effects of economic reforms
and sluggish domestic demand have led the government to significantly boost spending on
infrastructure spending. 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, which has increased government budget deficits. It appears,
however, that infrastructure spending by the government has been a major contributor to
China’s economic growth over the past few years. However, the government is concerned
over the potentially destabilizing effects of increased debt. Efforts have been made in recent
years to improve tax collection with mixed success.
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, China’s most-favored-nation (MFN), or normal trade relations (NTR),
status, and the terms for China’s accession to the World Trade Organization (WTO). 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 to ensure that U.S. firms are given access to China’s growing markets.
China’s Accession to the World Trade Organization
China has made its accession to the World Trade Organization (WTO) a major priority.
On November 15, 1999, U.S. and Chinese officials reached a bilateral agreement on China’s
WTO bid. China completed its bilateral WTO negotiations when it signed an agreement
with Mexico on September 13, 2001, the last of the 37 WTO members that had requested
such an accord. On September 17, 2001, China completed negotiations with the WTO
Working Party handling its WTO application. China’s WTO membership was formally
approved by the WTO on November 10, 2001, and on November 11, China informed the
WTO that it had ratified the WTO agreements. As a result, China officially joined the WTO
on December 11, 2001.
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. Prior to January 2002, U.S. law (Title IV of the 1974
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Trade Act, as amended) required China’s NTR status to be renewed on an annual basis
(based on freedom-of-emigration requirements of the Jackson-Vanik amendment).
From 1980 (when NTR status was restored to China after being suspended in 1951) to
1989, the renewal of China’s NTR status was relatively noncontroversial and was relatively
unopposed by Congress. However, congressional concern over the Tiananmen Square
incident in 1989 and subsequent crackdown on human rights led many Members to support
legislation terminating the extension of China’s NTR status or to condition that status on
additional requirements, mainly dealing with human rights. While none of these measures
were enacted, many Members sought to use the annual renewal of China’s NTR status as a
focal point to express concerns, as well as to pressure the executive branch, over a wide
range of Chinese trade (e.g., trade barriers and failure to protect intellectual property rights)
and non-trade (e.g., human rights, prison labor, Taiwan security, and weapons proliferation)
issues. Several members opposed such linkage, arguing that it had little effect on Chinese
policies, and that the often rancourous congressional debate over China’s trade status
undermined long-term U.S.-Chinese relations and added uncertainty to the trade relationship.
In order to ensure that the WTO agreements would apply between the United States and
China once China gained admittance to the WTO, Congress passed legislation (H.R. 4444,
P.L. 106-286) granting authority to the President to extend permanent normal trade relations
(PNTR) status to China upon its entry to the WTO. (Additionally, the law contains a number
of provisions dealing with such issues as human rights, Chinese prison labor exports, and
Chinese compliance with WTO rules.) On December 27, 2001, President Bush issued a
proclamation extending PNTR status to China, effective January 1, 2002.
Outlook for China’s Economy
The short term outlook for the Chinese economy is difficult to predict, due largely to
uncertainties over the current state of the global economy. The cumulative or long-term
economic effects of SARS on the Chinese economy are difficult to predict since there are no
clear indicators when the virus will be effectively eradicated or controlled and because fear
of the disease has had a much bigger impact on economic activity than has the cost of
responding to the virus. Restoring normal economic activity in China will thus depend not
only on the ability of the Chinese government to check the virus, but also its ability to
convince its population as well as foreign businesspeople that it has in fact contained the
virus.
China’s economy has held up remarkably well in the face of economic slowdowns in
the United States and its other major trading partners. Foreign investment has continues to
pour into China, which has helped boost Chinese exports. In addition, the Chinese
government has continued a policy of boosting the economy through public spending. As a
result, China’s real GDP is projected to rise by around 7.8% in 2003. Long term growth
will be largely determined by the government’s ability to reform the SOEs to make them
profitable, and to reform the banking system to make it more responsive to market forces.
China’s efforts to join the WTO appear to represent a major commitment on the part of
the Chinese government to significantly reform its economy and provide greater access to
its markets. Some China observers believe that the Chinese government considers accession
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to the WTO as an important, though painful, step towards making Chinese firms more
efficient and able to compete in world markets. In addition, the government hopes that
liberalized trade rules will boost foreign investment in China, which has declined in recent
years. Economists argue that, over the long-run, greater market openness in China will boost
competition, improve productivity, and lower costs for consumers, as well as for firms using
imported goods as inputs for production. Economic resources will more likely be redirected
away from money-losing activities (such as SOEs) to more profitable ventures, especially
those in China’s growing private sector. As a result, China is likely experience more rapid
economic growth (than would occur under current economic policies). A study performed
by the Chinese government estimates that WTO membership would boost China’s GDP by
1.5% annually by 2005 and thereafter. On the other hand, however, the Chinese government
is deeply concerned with maintaining social stability. Many analysts warn that, if trade
liberalization were followed by a severe economic slowdown, leading to widespread
bankruptcies and layoffs, the Chinese government might choose to halt or delay certain
economic reforms, rather than risk possible political upheaval. An additional problem posed
by China’s WTO accession will be to get Chinese local and provincial governments to adhere
to WTO rules, since many of them impose a variety of protectionist policies to protect firms
under their jurisdiction.
On November 8, 2002, Chinese President Jiang Zemin formally proposed at the 16th
National Congress of the Chinese Communist Party that the Party constitution be amended
to allow private entrepreneurs to join the Party (based on Jiang’s “Three Represents” theory);
the amendment was adopted on November 11. This step reflects the Chinese Communist
Party recognition of the growing importance of the private sector to China’s economy, but
also poses a dilemma for the Party since private firms may pose a competitive threat to state-
owned firms (and could become a significant political force as well). Many economists
argue that increased competition from foreign firms, as well as from China’s domestic
private sector, may force the Chinese government to eventually choose between privatization
and bankruptcy to keep many unprofitable SOEs afloat.
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