Order Code RL33534
CRS Report for Congress
Received through the CRS Web
China’s Economic Conditions
July 12, 2006
Wayne M. Morrison
Specialist in International Trade and Finance
Foreign Affairs, Defense, and Trade Division
Congressional Research Service ˜ The Library of Congress

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China’s Economic Conditions
Summary
Since the initiation of economic reforms in 1979, China has become one of the
world’s fastest-growing economies. From 1979 to 2005 China’s real GDP grew at
an average annual rate of 9.7%; it grew by 9.9% in 2005. During the first quarter of
2006, China’s real GDP grew by 10.2%. Many economists speculate that China
could become the world’s largest exporter within the next few years and the largest
economy within a few decades, provided that the government is able to continue and
deepen economic reforms, particularly in regard to its inefficient state-owned
enterprises (SOEs), the state banking system, and fixed exchange rate system. In
addition, China faces several other difficult challenges, such as pollution and growing
income inequality, that threaten social stability.
Trade continues to play a major role in China’s booming economy. In 2005,
exports rose by 28.4% to $762 billion, while imports grew by 17.6% to $660 billion,
producing a $102 billion trade surplus. China is now the world’s third-largest trading
economy after the United States and Germany. China’s trade boom is largely the
result of large inflows of foreign direct investment (FDI) into China, which totaled
$60 billion in 2005. Over half of China’s trade is accounted for by foreign-invested
firms in China.
China’s economy continues to be a concern to many U.S. policymakers. On the
one hand, China’s economic growth presents huge opportunities for U.S. exporters.
On the other hand, the surge in Chinese exports to the United States has put
competitive pressures on various U.S. industries. Many U.S. policymakers have
argued that greater efforts should be made to pressure China to fully implement its
World Trade Organization (WTO) commitments (especially in terms of protecting
U.S. intellectual property rights) and change various economic policies deemed
harmful to U.S. economic interests, such as its currency policy and its use of
subsidies to support its state-owned firms.
This report replaces IB98014, China’s Economic Conditions, by Wayne M.
Morrison, and will be updated as events warrant.

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Contents
An Overview of China’s Economic Development . . . . . . . . . . . . . . . . . . . . . . . . 2
China’s Economy Prior to Reforms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
The Introduction of Economic Reforms . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
China’s Economic Growth Since Reforms: 1979-2006 . . . . . . . . . . . . . . . . 3
Causes of China’s Economic Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Measuring the Size of China’s Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Foreign Direct Investment in China . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
China’s Trade Patterns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
China’s Major Trading Partners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Major Chinese Trade Commodities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Major Long-Term Challenges Facing the Chinese Economy . . . . . . . . . . . . . . . 10
Outlook for China’s Economy and Implications for the United States . . . . . . . . 12
List of Figures
Figure 1. China’s Foreign Exchange Reserves: 1990-March 2006 . . . . . . . . . . . . 8
List of Tables
Table 1. China’s Average Annual Real GDP Growth Rates, 1960-2006 . . . . . . . 3
Table 2. Comparisons of United States, Japanese, and Chinese GDP and Per
Capita GDP in Nominal U.S. Dollars and PPP, 2005 . . . . . . . . . . . . . . . . . . 5
Table 3. Major Foreign Investors in China: 1979-2005 . . . . . . . . . . . . . . . . . . . . 6
Table 4. China’s Merchandise World Trade, 1979-2005 . . . . . . . . . . . . . . . . . . . 7
Table 5. China’s Top Five Trading Partners: 2005 . . . . . . . . . . . . . . . . . . . . . . . 9
Table 6. Major Chinese Exports, 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Table 7. Major Chinese Imports, 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

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China’s Economic Conditions
The mercurial rise of China as a major economic power within a time span of
only 26 years is often described by analysts as one of the greatest economic success
stories in modern times. From 1979 (when economic reforms were first introduced)
to 2005, China’s real gross domestic product (GDP) grew at an average annual rate
of 9.7%. The Chinese economy in real terms was 11 times larger in 2005 than it was
in 1979, and real per capita GDP was 8 times larger. By some measurements, China
is now the world’s second largest economy and some analysts predict China will
become the largest within a decade.
China’s economic rise has led to a substantial increase in U.S.-China economic
relations. Total trade between the two countries has surged from $4.9 billion in 1980
to $289 billion in 2005. For the United States, China is now its 3rd largest trading
partner (2005), its 4th largest export market and its 2nd largest source of imports.
Many U.S. companies have extensive manufacturing operations in China in order to
sell their products in the booming Chinese market and to take advantage of low cost
labor for manufacturing products for exports. These operations have helped U.S.
firms remain internationally competitive and have supplied U.S. consumers with a
variety of low cost goods. China’s large-scale purchases of U.S. Treasury securities
have enabled the Federal government to fund its budget deficits and keep U.S.
interest rates relatively low.
However, the emergence of China as a major economic superpower has raised
concern among many U.S. policymakers. Some express concern over the large and
growing U.S. trade deficits with China, which have risen from $10.4 billion in 1990
to $202 billion in 2005, and are viewed by many Members as an indicator that U.S.
commercial relations are imbalanced or unfair. Others claim that China uses unfair
trade practices (such as an undervalued currency and subsidies to domestic
producers) to flood U.S. markets with low cost goods, and that such practices
threaten American jobs, wages, and living standards. A more recent concern has
been efforts by Chinese state-owned firms to acquire U.S. companies and China’s
accumulation of U.S. Treasury securities. Congressional concerns over perceived
negative China’s economic practices have led to the introduction of numerous bills,
including some that would impose sanctions against China unless it reformed its
currency policy and others that would apply U.S. countervailing laws on Chinese
products deemed to have been subsidized by the government.
This report provides background on China’s economic rise and current
economic structure (such as GDP, trade and foreign investment), and describes
Chinese economic policies that are of concern U.S. policymakers.

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CRS-2
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 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.

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CRS-3
China’s Economic Growth Since Reforms: 1979-2006
Since the introduction of economic reforms, China’s economy has grown
substantially faster than during the pre-reform period (see Table 1).1 From 1960 to
1978, real annual GDP growth was estimated at 5.3% (a figure many analysts claim
is overestimated, based on several economic disasters that befell the country during
this time, such as the Great Leap Forward and the Cultural Revolution). During the
reform period (1979-the present), China’s average annual real GDP grew by 9.7%;
it grew by 9.9% in 2005. During the first quarter of 2006, real GDP grew by 10.2%
over the same period in 2005. Since economic reforms were begun, the size of the
economy in real terms has increased eleven-fold, and real per capita GDP (a common
measurement of living standards) has gone up eight-fold.
Table 1. China’s Average Annual Real GDP Growth Rates, 1960-
2006
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
9.9
2006 (first quarter)
10.2
Source: Official Chinese government data.
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%, and the overall size of the economy in 2004 was
estimated to be nearly 17% bigger.

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CRS-4
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 nearly 50% in 2005, among the highest savings
rates in the world.2
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 $2.3 trillion; its per capita GDP (a commonly used
living-standards measurement) was $1,700. 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).
2 In comparison, the U.S. savings rate was about 10% in 2005. 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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CRS-5
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
$2.3 trillion (nominal dollars) to $8.4 trillion (PPP dollars), significantly larger than
Japan’s GDP in PPPs ($3.9 trillion), and about 67% the size of the U.S. economy.
PPP data also raise China’s per capita GDP to $6,386. The PPP figures indicate that,
while the size of China’s economy is substantial, its living standards fall far below
those of the U.S. and Japan. China’s per capita GDP on a PPP basis is only 15.2%
of U.S. levels. Thus, even if China’s GDP were to overtake that of the United States
in the next few decades, its living standards would remain substantially below those
of the United States for many years to come.
Table 2. Comparisons of United States, Japanese, and Chinese
GDP and Per Capita GDP in Nominal U.S. Dollars and PPP, 2005
Nominal GDP
GDP in PPP
Nominal Per
Per Capita
Country
($ billions)
($ billions)
Capita GDP
GDP in PPP
United States
12,458
12,458
42,130
42,130
Japan
4,571
3,914
35,880
30,720
China
2,262
8,359
1,700
6,386
Source: Economist Intelligence Unit Data Services and Global Insight.
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 $72.4 billion. in
2005 3 The cumulative level of FDI in China at the end of 2005 stood at about $633
3 Chinese officials recently revised its 2005 FDI total from $60.3 billion to 72.4 billion,
(continued...)

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CRS-6
billion 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 1979-2005 about 42%of FDI in China has come
from Hong Kong. In 2005, Japan replaced the United States as second largest overall
investor in China. The United States ranked third accounting for 8.2% ($51.1
billion) of total FDI. Other major investors include the British Virgin Islands,
Taiwan, and South Korea (see Table 3).4 U.S. FDI in China for 2005 was $3.1
billion (compared to $3.9 billion in 2004), accounting for 5.1% of FDI for that year,
and ranked 5th after Hong Kong, the British Virgin Islands, Japan, and South Korea.5
Table 3. Major Foreign Investors in China: 1979-2005
($ billions and % of total)
Cumulative Utilized FDI:
1979-2005
Utilized FDI in 2005
Amount
Amount
Country
($ billions)
% of Total
($ billions)
% of Total
Total*
632.8
100.0
72.4
100.0
Hong Kong
259.5
41.8
17.9
29.7
Japan
53.3
8.6
6.5
10.8
United States
51.1
8.2
3.1
5.1
British Virgin
45.9
7.4
9.0
14.9
Islands
Taiwan 41.8
6.7
2.2
3.3
South Korea
31.1
5.0
5.2
8.6
* Total FDI figures reflect revisions China made to its FDI data for 2005. However, data for
individual country investors (amounts and percent of total) reflect China’s previous FDI estimates.
Revised FDI total by country have not yet been released.
Source: Chinese government statistics. Top six investors according to cumulative FDI from 1979
to 2005.
3 (...continued)
claiming previous estimates excluded FDI in the banking, insurance, and securities sectors.
(See, People’s Daily, June 9, 2006). However, revisions were not made for previous years.
4 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).
5 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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CRS-7
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
1985
27.3
42.5
-15.3
1990
62.9
53.9
9.0
1995
148.8
132.1
16.7
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.
Data for the first three months of 2006 indicate that China’s rapid trade growth
is continuing, although at a slightly slower pace than 2005 levels. During this period,
exports and imports rose by 26.6% and 24.8%, respectively over the same period in
2005.

Merchandise trade surpluses, large-scale foreign investment, and its peg to the
U.S. dollar have enabled China to accumulate the world’s largest foreign exchange
reserves. 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 $875.1
billion at the end of March 2006, more than double the level China had at the end of
2003. Many analysts contend China’s reserves could hit $1 trillion by the end of
2006.

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CRS-8
Figure 1. China’s Foreign Exchange Reserves: 1990-March 2006
($ in billions)
$1000
$875.1
$818.9
$800
$609.9
$600
$408.2
$400
$291.1
$215.6
$200
$149.2 $157.7 $168.3
$132.8
$107
$76.4
29.6
34.7
$20.6 $22.4 $32.9
0
1991
1993
1995
1997
1999
2001
2003
2005
1990
1992
1994
1996
1998
2000
2002
2004
March 2006
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 large share of China’s trade (both exports and imports)
passing 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 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 32.0% in 2005.
A growing level of Chinese exports is from foreign-funded enterprises (FFEs)
in China. According to Chinese data, FFEs were responsible for 58% of Chinese
exports in 2005, 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-

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CRS-9
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: 2005
($ billions)
Trade
China’s
Balance as
Total
Chinese
Chinese
trade
Reported by
Country
trade
exports
imports
balance
Partner
Hong Kong
246.8
124.5
122.3
2.2
-4.7
European
Union
219.3
143.7
75.6
68.1
-132
United States
211.6
162.9
48.7
114.2
-201.6
Japan 184.5
84.0
100.5
-16.5
-28.5
ASEAN*
130.4
55.4
75.0
-19.6
N/A
Sources: Official Chinese trade data and Global Trade Atlas.
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 (Burma), 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 (and cotton) 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 exports in 2005 were (1) automatic
data processing machines and units, (2) garments and clothing accessories, (3) textile
products, (4) parts of data processing machines, and (5) radio telephone handsets (see
Table 6). China’s top imports were (1) electronic integrated circuits and micro-
assemblies, (2) crude oil, (3) liquid crystal display panels, (4) steel products, and (5)
plastics (see Table 7).6
6 Rankings differ according to which trade classification is used and at what digit level.

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CRS-10
Table 6. Major Chinese Exports, 2005
($ billions and % change over previous year)
Percent Increase over
Amount
2004
Automatic data processing machines and
74.5
28.6
units
Garments and clothing accessories
73.4
20.0
Textile products
40.9
23.9
Parts of data processing machines
27.7
20.4
Radio telephone handsets
19.7
44.8
Source: China’s Customs Statistics. Estimated, based on January-November 2005
data.
Table 7. Major Chinese Imports, 2005
($ billions and % change over previous year)
Percent Change over
Amount
2004
Electronic integrated
circuits and micro-
79.3
32.0
assemblies
Crude oil
47.2
43.5
Liquid crystal display
26.8
27.5
panels
Steel products
25.0
20.7
Plastics
24.1
18.6
Source: China’s Customs Statistics. Estimated, based on January-November 2005 data.
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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CRS-11
! 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. 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 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

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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.7
! 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, increase the
flexibility of its exchange rate policy, 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 7.8% over
the next 10 years, indicating that China could double the size of its economy in less
than 10 years.8 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
7 China’s Human Development Report 2005.
8 Global Insight, China: Interim Forecast Analysis: Economic Growth, December 15, 2005.

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their competitiveness. Conversely, China’s role as a major international
manufacturer has raised a number of concerns. Many developing countries worry
that 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.9 For example,
China’s accumulation of large foreign exchange reserves has forced it to increase the
money supply, which may eventually lead to inflationary pressures on the economy.
In addition, many analysts contend that easy money policies have led to over-
investment in certain economic sectors. However, 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. 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 currency reforms may induce China to diminish its purchases 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
9 For a discussion of this issue, see CRS Report RS21625, China’s Currency: A Summary
of the Economic Issues, by Wayne M. Morrison and Marc Labonte.

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million barrels per day by 2025.10 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 factor in world oil
markets.”11 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
$265.2 billion at end of February 2006. China’s U.S. Treasury securities holdings
as a share of total foreign holdings over this period have grown from 4.1% to 11.9%.
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 Global Insight, Global Petroleum Outlook Forecast Tables (Long-Term), January 2005.
11 U.S. Energy Information Administration website at [http://www.eia.doe.gov/].

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