Order Code IB98014
CRS Issue Brief for Congress
Received through the CRS Web
China’s Economic Conditions
Updated January 12, 2006
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: 1979-2005
Causes of China’s Economic Growth
Measuring the Size of China’s Economy
Foreign Direct Investment in China
China’s Trade Patterns
China’s Major Trading Partners
Major Chinese Trade Commodities
Major Long-Term Challenges Facing the Chinese Economy
Outlook for China’s Economy and Implications for the United States

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China’s Economic Conditions
SUMMARY
Since the initiation of economic reforms
Many economists contend that China’s policy
in 1979, China has become one of the world’s
of pegging its currency (the yuan), which
fastest-growing economies. From 1979 to
forces the government to trade yuan for dol-
2005 China’s real GDP grew at an average
lars (to keep the peg at about 8.3 yuan to the
annual rate of 9.6%. Many economists spec-
dollar), could boost the level of inflation in
ulate that China could become the world’s
China at some point in the future. They also
largest economy at some point in the near
contend that the sharp increase in the mone-
future, provided that the government is able to
tary supply (due to the peg) may induce Chi-
continue and deepen economic reforms, par-
nese banks to make bad loan decisions and
ticularly in regard to its inefficient state-
thus increase the level of non-performing
owned enterprises (SOEs) and the state bank-
loans. Secretary of Treasury John Snow stated
ing system. In addition, China faces several
that China’s currency peg posed a risk to its
other difficult challenges, such as pollution
economy and that of its trading partners. On
and growing income inequality that threaten
July 21, 2005, China announced that it would
social stability.
appreciate its currency to the dollar from 8.28
to 8.11 and replace its dollar peg with “a
Trade continues to play a major role in
managed float exchange rate regime” with
China’s booming economy. In 2005, exports
reference to a basket of currencies.
rose by 28.4% to $762 billion, while imports
grew by 17.6% to $660 billion, producing a
China’s economy continues to be a con-
$102 billion trade surplus. China is now the
cern to U.S. policymakers. On the one hand,
world’s third-largest trading economy after the
China’s economic growth presents huge
United States and Germany. China’s trade
opportunities for U.S. exporters. On the other
boom is largely the result of large inflows of
hand, the surge in Chinese exports to the
foreign direct investment (FDI) into China,
United States has put competitive pressures on
which totaled $61 billion in 2004 and an
many U.S. industries. Many U.S. policy-
estimated $58 billion in 2005. Over half of
makers have argued that greater efforts should
China’s trade is accounted for by foreign-
be made to pressure China to fully implement
invested firms in China.
its WTO commitments and change various
economic policies deemed harmful to U.S.
China experienced some inflationary
economic interests, such as its currency policy
pressures in 2004, fueled in part by specula-
and its use of subsidies to support its state-
tion in real estate, over-investment in certain
owned firms. In addition, recent bids by Chi-
industries, and rising costs for energy and raw
nese state-owned firms to purchase various
materials. The government responded by
U.S. firms have raised concerns among Mem-
raising interest rates and using administrative
bers over the impact such acquisitions could
controls to slow investment in certain sectors.
have on U.S. national and economic security.
Congressional Research Service ˜ The Library of Congress

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MOST RECENT DEVELOPMENTS
On January 9, 2005, the Chinese National Bureau of Statistics made major revisions to
its estimates of China’s GDP from 1993-2004. The new revisions indicate that China’s
economy grew significantly faster than previously recorded.
On November 21, 2005, the International Monetary Fund urged China to adopt greater
flexibility in its currency policy in order to obtain balanced growth and development and to
help reduce global trade imbalances.
On July 21, 2005, the Chinese government announced major reforms to its currency
policy. It stated that China’s currency (the renminbi or yuan) would no longer be pegged to
the dollar but instead would be a managed float regime with reference to a basket of
currencies (including the dollar), and that the exchange rate of the U.S. dollar against the
yuan would be adjusted from 8.28 to 8.11 yuan per U.S. dollar, an appreciation of 2.1%.
On June 22, 2005, CNOOC, a Chinese company, made a $18.5 billion bid to purchase
Unocal, a U.S. energy company. News of the bid raised concern among several Members,
many of who contended that the deal threatened U.S. national security. On August 2, 2005,
CNOOC withdrew its bid, citing strong political opposition in the United States. On January
10, 2006, CNOOC announced it had reached $2.3 billion deal to purchase a 45% stake in a
block of offshore Nigerian oil fields.
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 undertook large-scale
investments in physical and human capital during the 1960s and 1970s. As a result, by 1978
nearly three-fourths of industrial production was produced by centrally controlled state-
owned enterprises according to centrally planned output targets. Private enterprises and
foreign-invested firms were nearly nonexistent. 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
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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 along the coast for the purpose of attracting foreign investment, boosting exports, and
importing high technology products into China. Additional reforms, which followed in
stages, sought to decentralize economic policymaking in several 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: 1979-2005
Since the introduction of economic reforms, China’s economy has grown substantially
faster than during the pre-reform period (see Table 1). In January 2006, China made major
revisions to its GDP data for 1993-2004. The revisions indicated that, based on new
estimates of growth in the service sector, the size of China’s economy and its GDP growth
were significantly higher than previously estimated. For example, real GDP growth in 2004
had been originally measured at 9.5%, but the revised figure puts this rate at 10.1%. Overall,
the size of the economy in 2004 was estimated to be nearly 17% higher than previously
thought. Based on these revisions, China’s average annual real GDP is estimated to have
grown by 9.6% between 1979 and 2005; it grew at by estimated 9.8% in 2005.
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Table 1. China’s Average Annual Real GDP Growth Rates, 1960-2005
Average
annual
Time period
% growth
1960-1978 (pre-reform)
5.3
1979-2005 (post-reform)
9.7
1990
3.8
1991
9.3
1992
14.2
1993
14.0
1994
13.1
1995
10.9
1996
10.0
1997
9.3
1998 7.8
1999 7.6
2000
8.4
2001 8.3
2002 9.1
2003
10.0
2004 10.1
2005 (estimate)
9.8
Source: Official Chinese government data.
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 initiated
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 state-owned enterprises (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 (these now account for half of Chinese domestic savings). As
a result, savings as a percentage of GDP has steadily risen; it reached 49% in 2004, among
the highest savings rates in the world.1
1 In comparison, the U.S. savings rate was 10.7% in 2004. Savings defined as aggregate national
savings by the public and private sector as a percentage of nominal GDP. (Economist Intelligence
Unit database.)
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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 caused largely by a reallocation of resources to more
productive uses, especially in sectors that were formerly heavily controlled by the central
government, such as agriculture, trade, and services. For example, agricultural reforms
boosted production, freeing workers to pursue employment in the more productive
manufacturing sector. China’s decentralization of the economy led to the rise of nonstate
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, foreign direct investment (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 2005
is estimated at about $1.9 trillion; its per capita GDP (a commonly used living-standards
measurement) was $1,460. Such data would indicate that China’s economy and living
standards are significantly lower than those of the United States and Japan, respectively
considered to be the number-one and number-two largest economies (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 on the basis of 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 from $1.9 trillion (nominal
dollars) to $8.1 trillion (PPP dollars), significantly larger than Japan’s GDP in PPPs ($4.0
trillion), and about 65% the size of the U.S. economy. PPP data also raise China’s per capita
GDP to $6,210.2 The PPP figures indicate that while the size of China’s economy is
substantial, its living standards fall far below those of the U.S. and Japan. China’s per capita
GDP on a PPP basis is only 14.7% of U.S. levels. Thus, even if China’s GDP were to
overtake that of the United States in the next decade or two, its living standards would
remain substantially below those of the United States for many years to come.
2 These data are estimates from the Economist Intelligence Unit and were made before China’s
January 2006 revisions to its GDP data (discussed on page 2).
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Table 2. Comparisons of United States, Japanese, and Chinese GDP
and Per Capita GDP in Nominal U.S. Dollars and PPP, 2005
Nominal GDP
GDP in PPP
Nominal Per
Per Capita GDP
Country
($ billions)
($ billions)
Capita GDP
in PPP
United States
12,473
12,473
42,180
42,180
Japan
4,605
4,021
36,150
31,560
China
1,912
8,116
1,460
6,210
Source: Economist Intelligence Unit Data Services. 2005 data are estimates.
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.
Foreign Direct Investment in China
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 $61 billion in 2004 (it was estimated at $58
billion in 2005). The cumulative level of FDI in China stood at about $618 billion at the end
of 2005. 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 continues
to increase.
Based on cumulative FDI for 1979-2004, about 43% of FDI in China has come from
Hong Kong. The United States is the second-largest overall investor in China, accounting
for 8.5% ($48.0 billion) of total FDI, followed by Japan ($46.8 billion), Taiwan ($39.6
billion), and the British Virgin Islands ($36.9 billion) and South Korea ($25.9 billion) (see
Table 3).3 U.S. FDI in China for 2004 was $3.9 billion, accounting for 6.1% of FDI for that
year, and ranked 5th after Hong Kong, the British Virgin Islands, South Korea, and Japan.4
During the first 10 months of 2005, the top foreign investors in China (in terms of realized
FDI) were Hong Kong, the British Virgin Islands, Japan, South Korea, and the United States.
Actual U.S. FDI in China was down by 24% over the same period in 2004, although
contractual FDI was up by 10.5%.
3 According to the Chinese Ministry of Commerce, major U.S. investors in China (based on 2003
sales volumes) include Motorola ($5.8 billion in sales volume), General Motors ($2.2 billion), Dell
Computer ($2.1 billion), Hewlett Packard ($1.3 billion), and Kodak ($0.6 billion).
4 The British Virgin Islands is a large source of FDI because of its status as a tax haven. Much of
the FDI originating from Hong Kong comes from non-Hong Kong investors, such as Taiwanese.
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Table 3. Major Foreign Investors in China: 1979-2004
($ billions and % of total)
Cumulative Utilized FDI:
1979-2004
Utilized FDI in 2004
Amount
Amount
Country
($ billions)
% of Total
($ billions)
% of Total
Total
563.8
100.0
64.0
100.0
Hong Kong
241.6
42.9
19.0
29.7
United States
48.0
8.5
3.9
6.1
Japan
46.8
8.3
5.5
8.6
Taiwan 39.6
7.0
3.1
4.8
British Virgin Islands
36.9
6.5
6.7
10.5
South Korea
25.9
4.6
6.2
9.7
Source: Chinese government statistics. Top six investors according to cumulative FDI from 1979 to 2004.
China’s Trade Patterns
Economic reforms have transferred China into a major trading power. Chinese exports
rose from $14 billion in 1979 to $762 billion in 2005, while imports over this period grew
from $16 billion to $660 billion (see Table 4). In 2004, China surpassed Japan as the
world’s third-largest trading economy (after the United States and Germany). China’s trade
continues to grow dramatically: From 2002 to 2005, the size of China’s exports and imports
more than doubled. In 2005, exports and imports rose by 28.4% and 17.6%, respectively.
China’s trade surplus, which totaled $32 billion in 2004, tripled to $102 billion.
Table 4. China’s Merchandise World Trade, 1979-2005
($ billions)
Trade
Year
Exports
Imports
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
1986
31.4
43.2
-11.9
1987
39.4
43.2
-3.8
1988
47.6
55.3
-7.7
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Trade
Year
Exports
Imports
balance
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
2003 438.4
412.8
25.6
2004
593.4
561.4
32.0
2005
762.0
660.1
101.9
Source: International Monetary Fund, Direction of Trade Statistics, and official Chinese statistics.
Merchandise trade surpluses, large-scale foreign investment, and its peg to the U.S.
dollar have enabled China to accumulate the world’s second largest foreign exchange (after
Japan). As seen in Figure 1, China’s accumulation of foreign exchange reserves has been
particularly acute over the past few years. China’s total reserves reached $769 billion at the
end of September 2005, up nearly 50% over the same period in 2004.
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Figure 1. China’s Foreign Exchange Reserves,
1990-September, 2005
($ in billions)
$800
$769
$700
$609.9
$600
$500
$408.2
$400
$291.1
$300
$215.6
$200
$149.2 $157.7 $168.3
$132.8
$107
$100
$76.4
29.6
34.7
$20.6 $22.4 $32.9
0
1991
1993
1995
1997
1999
2001
2003
Sept 2005
1990
1992
1994
1996
1998
2000
2002
2004
Source: Official Chinese government data.
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 2004 were the European Union (EU), the United States,
Japan, Hong Kong, and the 10 nations that constitute the Association of Southeast Asian
Nations (ASEAN) (see Table 5). China’s largest export markets were the United States,
Hong Kong, and the EU, while its top sources for imports were Japan, the EU, and Taiwan
(the United States ranked sixth).
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
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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 33.1% in 2004.
A growing level of Chinese exports is from foreign-funded enterprises (FFEs) in China.
According to Chinese data, FFEs were responsible for 57% of Chinese exports in 2004,
compared with 41% in 1996. 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 is likely exported to the United States.
Table 5. China’s Top Five Trading Partners: 2004
($ billions)
Trade
Balance as
Total
Chinese
Chinese
China’s trade
Reported by
Country
trade
exports
imports
balance
Partner
European Union
177.3
95.9
63.4
32.5
-90.7
United States
169.7
125.0
44.7
80.3
-162.0
Japan 167.9
73.5
94.4
-20.9
-20.5
Hong Kong
112.7
100.9
11.8
89.1
-3.9
ASEAN*
105.9
42.9
63.0
-20.1
N/A
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.
* Association of Southeast Asian Nations (ASEAN) member countries are Indonesia, Malaysia, the Philippines,
Singapore, Thailand, Brunei, Cambodia, Laos, Myanmar, and Vietnam.
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 constitute an
increasingly larger share of China’s trade. A large share of China’s imports, such as raw
materials, components and parts, and production machinery is used to manufacture products
for export. For example, China imports cotton and textile-production machinery to produce
textile and apparel items. A substantial amount of China’s imports is comprised of parts and
components that are assembled in Chinese factories (major products include consumer
electronic products and computers), then exported.
China’s top five imports in 2004 were electrical machinery and parts; boilers,
machinery, mechanical appliances, and parts; crude oil; plastics; and organic chemicals (see
Table 6). China’s top five exports in 2004 were boilers, machinery, mechanical appliances
and parts; electrical machinery and parts; apparel; furniture, bedding, and lamps; and optical,
photo, and medical equipment and parts (see Table 7).
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Table 6. Major Chinese Imports, 2002-2004
($ billions)
2004/2003
Commodity
2002
2003
2004
% change
Electrical machinery and equipment and
parts; sound recorders and reproducers,
26.4
41.9
61.4
46.8
television recorders and reproducers,
parts and accessories.a
Boilers, machinery, mechanical
appliances, and parts.b
21.2
29.8
38.6
29.5
Crude oil
12.8
19.8
33.9
71.1
Plastics
17.4
21.0
28.1
33.4
Organic chemicals
11.2
16.0
23.8
48.8
Source: Global Trade Atlas.
a. Electronic integrated circuits and micro-assemblies and parts constitute a large share of these imports.
b. Office machines and automatic data-processing machines (such as computers) and parts constitute a large
share of these imports.
Table 7. Major Chinese Exports, 2002-2004
($billions)
2004/2003
Commodity
2002
2003
2004
% change
Boilers, machinery, mechanical
50.9
83.4
118.3
41.8
appliances, and parts
Electrical machinery and equipment and
parts; sound recorders and reproducers,
65.2
89.0
129.7
45.7
television recorders and reproducers,
parts and accessories
Apparel
36.6
45.8
54.8
19.7
Furniture, bedding, and lamps
9.9
12.9
17.3
34.3
Optical, photo, and medical equipment
7.4
10.6
16.3
53.9
and parts
Source: Global Trade Atlas.
Major Long-Term 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.
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.
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! State-owned enterprises (SOEs), which account for about one-third of
Chinese industrial production, put a 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 condition of many SOEs makes it difficult for
the government to reduce trade barriers out of fear that doing so would lead
to widespread bankruptcies among many SOEs.
! The banking system faces several major difficulties due to its financial
support of SOEs and its 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 number 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. Ernst
& Young estimates that the level of nonperforming loans by Chinese banks
in 2002 was $480 billion (equal to about 43% of China’s GDP).5 The high
volume of bad loans now held by Chinese banks 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 the 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.
! Public unrest over pollution, government corruption, and growing
income inequality poses threats to social stability. The Chinese
government reported that there were over 74,000 protests (many of which
became violent) involving 3.8 million people in 2004 (up from 53,000
protests in 2003) over such issues as pollution, government corruption, and
land seizures. Pollution in China continues to worsen, posing series health
risks to the population. The Chinese government often disregards its own
environmental laws in order to promote rapid economic growth. According
to the World Bank, 16 out of 20 of the world’s most polluted cities are in
China, and the direct costs to the economy (such as health problems, crop
failures and water shortages) is estimated to be hundreds of billions of
dollars yearly. The Chinese government estimates that there are over 300
million people living in rural areas that drink unsafe water (caused by
chemicals and other contaminants). Toxic spills in China in recent months
have threatened the water supply of millions of people. Rising income
inequality, particularly between people living in the urban coastal and those
5 Ernst & Young Asia Pacific Financial Solutions, Nonperforming Loan Report, Asia, 2002.
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living in the inner rural regions of China, has become another source of
tension. A number of protests in China have stemmed in part from
frustrations among many Chinese (especially peasants) that they are not
benefitting from China’s economic reforms and rapid growth, and
perceptions that those who are getting rich are doing so because they have
connections with government officials. Protests have broken out over
government land seizures and plant shutdowns in large part due to
perceptions that these actions benefitted a select group with connections. A
2005 United Nations report stated that the income gap between the urban
and rural areas was among the highest in the world and warned that this gap
threatens social stability. The report urged China to take greater steps to
improve conditions for the rural poor, and bolster education, health care, and
the social security system.
! The lack of the rule of law in China has led to widespread government
corruption, financial speculation, and misallocation 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 the rule of law in China limits competition and
undermines the efficient allocation of goods and services in the economy.
Outlook for China’s Economy and Implications
for the United States
The short-term outlook for the Chinese economy appears to be positive, but it will likely
be strongly influenced by the government’s ability to reform the SOEs and banking system
to make them more responsive to market forces, to fully implement its WTO commitments,
and to assist workers who lose their jobs due to economic reforms (in order to maintain
social stability). Global Insight, an economic forecasting firm, projects that China’s real
GDP will average 8.0% over the next five years, indicating that China could double the size
of its economy in less than 10 years.6 The Economist Intelligence Unit projects that China
will become the world’s largest exporter by 2010 and the world’s largest economy by 2020.
China’s rise as an economic superpower is likely to pose both opportunities and
challenges for the United States and the world trading system. China’s rapid economic
growth has boosted incomes and is making China a huge market for a variety of goods and
services. In addition, China’s abundant low-cost labor has led multinational corporations to
shift their export-oriented, labor-intensive manufacturing facilities to China. This process
has lowered prices for consumers, boosting their purchasing power. It has also lowered costs
for firms that import and use Chinese-made components and parts to produce manufactured
goods, boosting their competitiveness. Conversely, China’s role as a major international
manufacturer has raised a number of concerns. Many developing countries worry that
6 Global Insight, China: Interim Forecast Analysis: Economic Growth, December 15, 2005.
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growing FDI in China is coming at the expense of FDI in their country. Policymakers in both
developing and developed countries have expressed concern over the loss of domestic
manufacturing jobs that have shifted to China (as well as the downward pressures on
domestic wages and prices that may occur from competing against low-cost Chinese-made
goods).
Many analysts contend that China’s currency policy, despite reforms undertaken in July
2005, is having a negative impact on the economies of many of its trading partners by
artificially making its exports cheaper, and imports more expensive, than they would be
under a floating system. They have urged China to move toward a floating exchange rate
regime as soon as possible, contending that such a move would benefit China’s economy and
those of its trading partners.7 Chinese officials have expressed concern that further currency
reforms, if implemented too quickly, could prove disruptive to the economy. A number of
bills have been introduced in Congress to address Chinese currency policy, including some
that would impose a 27.5% tariff on Chinese goods unless China appreciated its currency to
market levels.8 Failure by China to implement further reforms to its currency regime could
prompt Congress to take up currency-related legislation. On the other hand, some analysts
have raised concerns that China’s move toward a managed float tied to a basket of currencies
may diminish China’s purchase of U.S. Treasury securities, which could affect U.S. interest
rates.
China is attempting to establish and promote companies that can compete globally,
especially in advanced technologies. In some cases, China has attempted to purchase large
foreign companies. For example, in December 2004, Lenovo Group Limited, a computer
company primarily owned by the Chinese government, purchased IBM’s personal computer
division. In June 2005, the China National Offshore Oil Corporation (CNOOC) made a bid
to buy a U.S. energy company, UNOCAL, for $18.5 billion, although strong opposition in
Congress forced CNOOC to withdraw its bid. China’s possession of large currency reserves
and desire to become a world leader in the production of a variety of goods and strategic
commodities will likely lead the Chinese government to expand efforts to take over major
international corporations. Many Members charge that China’s use of extensive subsidies
to support state-owned firms, especially to fund takeover bids, threatens U.S. economic
interests and may violate its WTO commitments.

China’s rapid economic growth and continued expansion of its manufacturing base are
fueling a sharp demand for energy and raw materials, which is becoming an increasingly
important factor in determining world prices for such commodities. China is now the
world’s second largest consumer of oil products (after the United States) at 6.7 million
barrels per day, and that level is projected to double to 13.4 million barrels per day by 2025.9
According to the U.S. Energy Information Administration, around 40% of world oil demand
growth over the past four years came from China and this demand is “a very significant
7 For a discussion of this issue, see CRS Report RS21625: China’s Currency Peg: A Summary of
the Economic Issues, by Wayne Morrison and Marc Labonte.
8 For a listing of these bills, See CRS Issue Brief IB91121,China-U.S. Trade Issues, by Wayne M.
Morrison.
9 Global Insight, Global Petroleum Outlook Forecast Tables (Long-Term), January 2005.
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factor in world oil markets.”10 China has also reportedly become the largest consumer of
steel, cement, and copper.
Some U.S. policymakers have expressed concern over China’s rising ownership of U.S.
government debt, due to fears that China might attempt to use its holdings as leverage in its
dealings with the United States on economic and/or political matters. China is the second
largest foreign holder of Treasury securities (after Japan), and both the level of those
holdings and China’s share of total foreign holdings have increased sharply over the past few
years. These went from $51.8 billion in 1999 to $252.2 billion as of September 2005.
China’s U.S. Treasury securities holdings as a share of total foreign holdings over this period
have grown from 4.1% to 12.1%. China’s Treasury securities holdings as a percent of total
privately held U.S. Treasury securities rose from 1.6% to 6.4%. Some have raised concerns
that threats by China to halt future purchases, or to sell existing holdings, could cause the
value of the dollar to depreciate in world markets (raising import prices), increase U.S.
interest rates, lead to a decline in U.S. stock and bond markets, and possibly cause the U.S.
economy to slow. However, any such disruption to the U.S. economy would also hurt
China’s economy since about a third of China’s exports go to the United States.
10 U.S. Energy Information Administration website at [http://www.eia.doe.gov/].
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