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July 18th, 2002
To Have and Have Not
Debate: What the WTO Means for China

The World Trade Organization (WTO) is a 144-member organization that attempts to eliminate obstacles to international trade so that member countries derive the optimum economic benefit. Among its arsenal of weapons are anti-dumping actions, tariff elimination, subsidy regulation, and the standardization of trade rules.

Accession to the WTO will bring many changes to China. But not everyone agrees on what those changes are and what they will mean to China and the rest of world. In July of 2002 we asked two leading experts on China to discuss the country’s political and economic future.

Mark L. Clifford
Asia Regional Editor of BUSINESS WEEK and co-author of “China and the WTO”
Dr. Usha Haley
Univ. of Tennessee Professor of Management and author of “Asia’s Tao Of Business”

Debate Topics:

Economic Growth

In 2002, China bypassed Italy to rank as the sixth largest economic power in the world. Premier Zhu Rongji recently announced that China’s goal is to double GDP by 2010 and to sustain seven percent economic growth for the next five years. Will China be able to sustain economic growth to become an economic superpower that rivals the U.S.?

Mark Clifford’s Response: China has a good chance of meeting the growth targets laid out by Premier Zhu. But for China to become an economic superpower that rivals the U.S., it would require an extraordinary set of circumstances. The United States’s economy is currently seven times the size of China’s. A more pertinent question will be whether China can supplant Japan as the world’s second largest economy. Even that would require 20 more years of continued high growth in China and stagnation in Japan. One lesson of the Asian financial crisis is that it is extremely difficult to indefinitely sustain six to eight percent growth.

Dr. Usha Haley’s Rebuttal: Some differences in our conclusions derive from differing assumptions made about China’s GDP. Mark Clifford takes Chinese official figures at their face value, and I do not. In February 2002, the Chinese government said the economy had grown 7.3 percent in 2001. Only one province, Yunnan, declared that its product had grown more slowly than the national rate. However, taken together, the provincial figures produced a national growth rate about two percentage points higher than the official national growth rate! The Chinese National Bureau of Statistics uses sample surveys to estimate the country’s GDP and growth rate. The results have always contradicted provincial figures, and opinions vary as to their accuracy.

Dr. Usha Haley’s Response: My answer to whether very high economic growth can be sustained in China is a cautious no. China will benefit from continuing large inflows of foreign direct investment and higher exports as the global economy recovers. But this large country relies primarily on domestic engines of growth, which are sputtering. Growth over the past five years has depended on massive government spending and debt is escalating. Also, no easy sources exist for new growth. The government initially corrected Maoist follies, but must now get the marketplace to deploy labor and capital much more efficiently: Government policies still hamper both.

Mark Clifford’s Rebuttal: The shortcomings in China’s economy are clear. Deficit spending is a worry, and it is not indefinitely sustainable at current levels, but it’s too early to discount the high rates of return that are being generated by many public infrastructure projects. China’s public works spending parallels what the U.S. went through in the 1930s. More important, the restructuring of the economy and the continued growth of the private sector–which already accounts for more than one-third of the total economy–will drive growth. So, too, will a shift away from low-productivity agricultural activities into more productive areas, especially services.

Political Reform

The 16th Chinese Communist Party Congress, scheduled for September, is expected to feature a top power transition in China. Hopes for political reform are running high as Hu Jintao is expected to become president. Do you think that political liberation will occur under Hu and, if so, to what degree will these changes be an extension of WTO-related economic reforms?

Mark Clifford’s Response: Hopes for political reform under Hu are overblown. Because it will take some time for the new leadership to build legitimacy; the new leaders won’t want to handle something as unpredictable as political reform. Jiang Zemin’s influence is expected to continue and he is opposed to broad political change. If political change happens it will because it is forced on the leadership. Worryingly, there is very little evidence to suggest that the leadership has an exit strategy on political reform.

Dr. Usha Haley’s Rebuttal: I agree.

Dr. Usha Haley’s Response: China has entered a critical phase of its economic reforms, but hopes and fears raised by WTO accession and new leaders are probably misplaced. The way China is run is unlikely to change as a consequence, at least not for several years. In the short term, the handling of the final and most arduous phase of political reforms will change, though. The chances of failure will rise as Chinese leaders become absorbed in the politics of succession, and the consequences could result in the upheaval that Chinese leaders have struggled so hard to avoid since 1989.

Hu Jintao has stressed that he does not want to change the way China is run. “Leading officials must at all times be on their guard against the plots of Western hostile forces to ’split us up’ or ‘Westernize’ us,” he told party cadres in January 2000. Hu will also face a dearth of educated talent among his generation, who were influenced by the ideologically inspired violence of the Cultural Revolution, making them more open-minded in dealing with factional politics. Yet, this generation also experienced the collapse of communism in Europe and the 1989 upheaval in China, which convinced many that loosening the party’s grip on power could unleash violent upheaval. So far, it appears that many may prefer social democracy without the democracy.

Mark Clifford’s Rebuttal: One of China’s biggest medium-term challenges is political reform. There is little evidence that Hu Jintao and the other new leaders have any impulse for reform, or any understanding of why it is necessary, even if only for self-preservation. China needs to build modern institutions–starting with a fair legal system–to mediate the increasingly contentious disputes that are part of an increasingly sophisticated market economy. It’s shown few signs of doing so. The WTO can help, by bringing in a rules-based system to trade disputes, but it will take a long time before that spreads more broadly throughout society.

Human Rights

Many who disagreed with granting WTO membership to China cited its poor human rights record as the reason. At the annual meeting of the UN Commission on Human Rights in April 2002, no country criticized China’s human rights record. Now that China is a member of the WTO, will human rights continue to be an important issue in its relations with other countries? If so, how do you think Beijing will respond to future allegations of human rights violations?

Mark Clifford’s Response: Human rights will continue to be an issue between China and the West for many years to come. Beijing will continue to be defensive about its human rights record. By contributing to economic growth and helping to build more of a rules-based society, the WTO should contribute to the development of civil society in China. More trade and openness almost invariably leads to economic growth; that in turn should spur the development of more legal protection. We should beware of overdrawing the connection between trade and human rights–but walling countries off (such as North Korea) is clearly counter-productive.

Dr. Usha Haley’s Rebuttal: The WTO, increased trade and investment, should contribute to the development of civil society in China in the long run; in the short run, because of labor unrest and fear of losing political control, human rights violations in China may increase.

Dr. Usha Haley’s Response: I do not believe that there will be any substantial changes in how China handles human-rights issues. Most importantly, the central government does not feel nor has ever admitted that it has done anything wrong. The central government’s position is not exclusive to the Communist era and falls in line with the Confucian perspective followed by the Chinese for thousands of years: if you are not a part of the government, you have no right to criticize it.

Mark Clifford’s Rebuttal: There will, however, be changes at the margin. China’s recent decision to let 26 North Korean defectors go to South Korea–and a reported agreement to give future defectors passage to the South–reflects a growing sensitivity to international opinion. China is no longer walled off. The fact that video and still photos of North Korean refugees seeking shelter in the Japanese consulate in the northeastern city of Shenyang were flashed around the world almost immediately after the incident highlights the ability of those intent on spotlighting abuses. China will be on good behavior in the run-up to the 2008 Olympics.

Unemployment

Though official statistics give China a mere 3.6 percent unemployment rate, most independent economists put that number closer to 15 percent. At the same time, an additional 12 to 13 million new workers are expected to enter the labor market each year. As clashes with unemployed workers continue to rage, will China be able to create enough jobs to prevent widespread social unrest?

Mark Clifford’s Response: China’s only hope is that the fast-growing private sector will provide the jobs. The government needs to take the shackles off the private sector by reducing government involvement in the economy. It also needs to ensure that private companies have access to the capital markets by ensuring that state-owned enterprises do not enjoy preferential access to bank financing or the stock market. Progress has been made–as many as 35 million workers have been laid off from state-owned enterprises in the past five years without major social upheavals to date.

Dr. Usha Haley’s Rebuttal: As indicated in my answer, I do not believe that the private sector can grow fast enough to avoid social unrest, and fast growth will create other problems such as high inflation. China’s only hope of controlling social unrest rests on increasing political participation.

Dr. Usha Haley’s Response: China would need sustained double-digit growth to keep unemployment at bay. It has little chance of achieving that, nor would it want to do so, remembering the inflationary side effects of its double-digit growth spurt in the early 1990s. Even at the official rate of 7.3 percent, growth last year was insufficient to absorb the fast-swelling ranks of the unemployed. In the coming decade, China needs to create 8-9 million new jobs a year. The party’s best bet for avoiding destabilizing unrest would be to increase public participation in politics. However, many in the party fear that surrendering any power to the public might lead to a collapse reminiscent of the Soviet Union’s.

Mark Clifford’s Rebuttal: China faces extremely difficult choices as it gets to the truly hard part of the reform process. The sustained worker protests this spring were a potent reminder of simmering anger. WTO will push the process of reform and opening along and ensure that reforms are not bogged down halfway through the process. Much more attention will be paid to laid-off workers to ensure that discontent does not spill out into the streets in an uncontrollable fashion. The slowness with which China has built a social safety net, especially in the area of pensions, is a worrying sign.

Tariffs

In order for China to join the WTO, China promised to lower tariffs and abolish many quotas allowing foreign companies to compete more effectively with state owned enterprises. But will China really commit itself to free trade or will it impose non-trade barriers to protect weak domestic industries?

Mark Clifford’s Response: China has already reduced its tariffs dramatically during the 1990s. In fact, tariffs have been cut by three-quarters from their peak 20 years ago. Industrial tariffs now average 15 percent; they will fall to nine percent by 2006 — hardly an earth-shattering reduction. Promised tariff reductions–and the temptation to use non-tariff measures to limit imports–will be higher in the agricultural sector. Already, we are seeing worrying signs of that China is having difficulties fully complying with the letter and spirit of the WTO agreement.

Dr. Usha Haley’s Rebuttal: I agree that China is having difficulty complying with the WTO agreement’s letter and spirit in some key sectors – so is the United States.

Dr. Usha Haley’s Response: The terms of China’s accession to the WTO require China to open hitherto jealously guarded markets, such as banking, telecommunications and agriculture. In some sectors, the lowering of trade barriers will cause unemployment to rise, and in others it will create new job opportunities. Tariff barriers are the least of China’s problems: its own are already among the lowest of any developing country. Recognizing this factor however, one must also recognize that China, just as any government would and does, will try to reinterpret treaty agreements in a fashion more in line with the political hierarchy’s short-term political interests.

Mark Clifford’s Rebuttal: No additional comment.

Asian Neighbors

In a meeting with Asia-Pacific leaders in May, Prime Minister Zhu Rongji reassured leaders that China’s economic rise will also result in a boom for the rest of Asia and declared that “an economically developed China will pose no threat to any country or region.” But as China’s share of Asia’s exports in textiles, light machinery and other products continue to increase, should China’s neighbors worry about China’s rising economic power? Will they be able to compete effectively with China?

Mark Clifford’s Response: China is already emerging as an economic locomotive for the region. Exports from the rest of Asia to China are growing rapidly. If China’s growth spurs reform in ASEAN, particularly by ensuring a rapid implementation of the ASEAN Free Trade Area (AFTA), Southeast Asia will benefit. Korea, Japan and Taiwan already are profiting from China’s growth as they sell capital goods and other relatively sophisticated products. But Southeast Asia cannot afford to be complacent. Already, foreign direct investment increasingly is going to China rather than Southeast Asia.

Dr. Usha Haley’s Rebuttal: As indicated in my answer, Southeast Asia will not be able to compete directly with China on costs, but will need to continue to move up the ladder to higher-value added products.

Dr. Usha Haley’s Response: China’s economic rise will create problems for its neighbors. Chinese labor is too competent and has substantial cost advantages in too many product-markets not to affect is neighbors. However, poor protection of patents and copyrights, as well as a climate that prohibits free speech and interaction, will probably continue to inhibit high-level innovation and cutting-edge research. Those of China’s neighbors that can move quickly into more value-added product markets, and can move into product markets that better reflect and emphasize their own competitive advantages more completely, will be able to take advantage of China’s economic growth and to stimulate their own.

Mark Clifford’s Rebuttal: China is emerging as a locomotive, both for the region and for the world. China’s growth narrowly helped the world avoid recession in 2001. There will be losers, both within China and in other countries (even Mexico is feeling the sting of the China challenge), but an economically strong China is better than a weak China. The experience of South Korea and Taiwan in developing complementary trading relationships with China testifies to the positive impact of China’s rise as a trading power.

Financial Reform

Under WTO agreements, foreign banks will soon be able to offer services in China. Plagued by bad debts equivalent to 29 percent of GDP and the practice of handing out loans on the basis of guanxi or personal relationships, China’s own banks are long overdue for reform. Will China’s banking system be able to compete with these outside banks? What will the consequences be for failure?

Mark Clifford’s Response: China is taking steps to clean up bad debts (which according to private estimates are closer to 50 percent of GDP) by setting up asset management corporations. The pending sale of $1.6 billion in bad loans at less than 10 cents on the dollar to foreign investors is a breakthrough and evidence that authorities are getting serious about the problem. But bad loans continue to mount. Few governments take serious steps before there is a severe banking crisis. The looming bad-debt crisis will test Chinese authorities’ ability to stay ahead of the curve. Foreign banks will be niche players, but will accelerate reform in the domestic banking system.

Dr. Usha Haley’s Rebuttal: I have nothing to add to my answer. I do not believe that foreign banks will necessarily accelerate reform in the banking sector in China.

Dr. Usha Haley’s Response: China has a strong incentive to move quickly on bank reform. Two years after WTO entry, foreign banks will be allowed to do business with companies in the renminbi (”people’s currency” – ed.); five years after entry, they will be allowed to do renminbi business with individual Chinese. These changes could prompt a rush by individual savers and companies to withdraw deposits from state-owned banks and put them into more reliable foreign ones, which could result in a banking crisis. But in practice, this is highly unlikely to happen. Chinese-currency holders will be deterred from transferring their accounts to foreign banks because these will have far fewer branches than Chinese banks. The government requires foreign banks to provide operating capital of at least 600 million yuan ($73 million) for each branch that does business in renminbi. The high operating capital should discourage foreign banks from attempting to compete for small depositors.

Mark Clifford’s Rebuttal: No additional comment.

Foreign Businesses

Former U.S. Trade Representative Charlene Barshefsky, who successfully negotiated trade agreements with China, said in February 2000 that “China’s WTO accession is a clear economic win for the United States. Together with permanent NTR (Normal Trade Relations), it will open the world’s largest nation to our goods, farm products and services in a way we have not seen in the modern era.” As foreign businesses rush to invest in China, will their dreams of big profit from China’s huge potential market come true?

Mark Clifford’s Response: According to aggregate data, U.S. businesses make rates of return that are roughly comparable to other major developing countries. Plenty of businesses make money in China, but they usually don’t like to talk about it. Many companies have lost big sums because they were seduced by the myth of the China market. Those businesses that have done well in China have done so on the basis of sound business practices. As China continues to modernize and open, and as WTO brings in more of a rules-based regime, profitable opportunities for foreign businesses will increase greatly.

Dr. Usha Haley’s Rebuttal: Based on my research, I conclude that most companies that produce for China’s domestic market, rather than as part of global supply chains, have not made a profit in China. The reasons for companies not making profits stem from using faulty data (such as underestimating current market size and potential) or from regulatory risk (including unpredictable changes in governmental policy) and will likely not dissipate soon. A 1999 survey by the American Chamber of Commerce in China showed that 58 percent of its member multinationals had lower profit margins in China than in other global operations – yet, 88 percent had plans to expand!

Dr. Usha Haley’s Response: In the long-term, yes, for some foreign businesses, and some may even get truly substantial profits from the very beginning, but most will face disappointment in the short-term. Most foreign companies have failed to make a profit in China, yet most have plans to expand.

To date, and at least for the immediate and medium-terms, China’s huge markets are merely potentially huge – they are not huge now. Additionally, because so many companies are investing in China, competition in most industries will be fantastically cutthroat. The Chinese central government, because of sustained and planned investment in key industries such as semi-conductors and automobiles, is building enormous overcapacity in these industries.

Mark Clifford’s Rebuttal: Many companies are making serious money in China, as both anecdotal reports and aggregate data reported to the U.S. government shows. Companies often don’t want to talk about these profits, for fear of attracting attention from the tax office and other authorities. China is one of the few genuine growth markets in the world, though it will also be an extraordinarily competitive one.

Internet Use

Last year, Chinese authorities, fearing that the Internet would create a forum for political dissent, shut down 17,000 Internet cafes that failed to install software that would block restricted web sites and record user activities. With Internet usage doubling every six months in China, will Beijing continue to crackdown on Internet use and ban websites or will they encourage the Internet as a commercial medium?

Mark Clifford’s Response: Beijing is of two minds about the Internet. It knows that it must embrace the Net or be left behind. But it fears that the Net will subvert its ability to control information. This leaves Beijing without any good choices. As a result, it will continue to pursue a schizophrenic policy. This split policy could hurt the development of a more information-based society. But Beijing will not be opposed to commercialization of the Net if there is no politically or socially unsettling content involved.

Dr. Usha Haley’s Rebuttal: This desire to encourage the Internet as a commercial medium, and yet to curb its tendencies to fan political debate and free speech is not unique to China: other countries, such as Singapore, have tried to walk this tightrope.

Dr. Usha Haley’s Response: The Chinese central government will continue to crack down on any organization, institution or technology that it views as posing a threat to its continuing rule in China. China’s reformers are purely economic reformers, and have never seen any need, nor harbored any desire to create concomitant political reforms. As a commercial medium, China sees great potential in the Internet and is working assiduously to maximize its returns. To this effect, the government has invested heavily in building a substantial and sophisticated wireless Internet system to overcome the weaknesses in the present telecommunication system available in China.

Mark Clifford’s Rebuttal: No additional comments.

The Communist Party’s Future

Analysts claim that the Communist Party will lose much control as the number of state-owned enterprises, often run by Party officials, go out of business and private companies or those with foreign ownership increase in number. Allegations of corruption have also stirred the public’s anger and discontent with the Party. Do you think the Communist Party will survive these challenges? Will it maintain its one-party dominance?

Mark Clifford’s Response: The Communist Party cannot indefinitely maintain its monopoly on power. China needs institutions, such as courts, that can settle the disputes that are an inevitable part of a market economy. It needs a freer press and other parts of civil society that can expose corruption and other wrong-doing. The record of the past 23 years shows a strong and increasingly capable government that has met numerous challenges. But China will be virtually alone in the world if it manages both to become a modern developed nation and to maintain one-party rule.

Dr. Usha Haley’s Rebuttal: As indicated in my answer, I believe the Communist Party will lose economic power, but will maintain political power in China at least in the short and medium terms, as no alternatives exist or are allowed to exist.

Dr. Usha Haley’s Response: Although the Communist Party has increased membership to 64 million, the party is losing its grassroots appeal in rural areas where local officials’ corruption has bred resistance. The party is also losing popularity in industrial centers. According to party journals, only 17 percent of private firms employed party members in 1999 and only 3 percent had any kind of party organization. But even where the party has managed to gain a foothold in foreign and private enterprises, its role is far less important. In urban China, party activities may be confined to government institutions and departments where party membership remains a prerequisite for advancement. It will have political rather than economic power.

Mark Clifford’s Rebuttal: No additional comment.

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