BOOK REVIEWS

China's Accession to the WTOEffects and social challenges

On September 19th 2000, the US Senate gave final approval to a bitterly contested bill granting permanent normal trade relations (PNTR) to China, despite stiff opposition from organised labour and human rights groups. This final Senate vote came four months after a seriously divided House of Representatives approved the bill. Democratic Senator Daniel Moynihan of New York called it one of the most important votes since World War II. The passage of the bill finally removed the major hurdle that stood in the way of China joining the WTO in the near future. Why is opinion so divided about China’s accession to the WTO both inside and outside of China, and what are the implications of this accession, if it happens, for major trading partners such as the US, for potential trade competitors among developing countries like Korea and for China itself? The ramifications of the liberalisation of China’s trading activities will be positive and negative. This paper will look briefly at the implications of China’s accession to the WTO for the US and Korea. Its major focus, however, will be on the implications for China, and the issues and challenges confronting the Chinese economy.

Policy changes following China’s admission to the WTO

As a result of PNTR and China’s entry into the WTO, the US government will have to end its twenty-year annual ritual of reviewing China’s progress in the areas of human rights and labour, as well as its trading status. The US, as a member of the WTO, will not have to make any changes to its trade policies. It will simply have to guarantee Chinese goods and services the same low-tariff access to the US market as it has been doing for other WTO members, i.e., the most favoured nation (MFN) status. However, China has already been enjoying this status even though it was a status that was subject to annual review. From now on, China will enjoy that status permanently without undergoing this annual review by the US. In other words, China may only save some annual transaction costs in accessing the US market. Major new action required on the part of the US will be to include China in the phasing-out of quotas and other non-tariff barriers on textiles and apparel imports from China in accordance with the WTO Agreement on Textiles and Clothing (ATC) by January 1st 2005. But what will the US gain from China’s joining the WTO?

China will have to significantly reduce its tariffs, remove non-tariff barriers (NTBs), especially those on agricultural and service imports, and strengthen protection of intellectual property rights. The NTBs include licensing and quotas, tendering restrictions, differential treatment between domestic products/ services and imports, lack of transparency of legislative provisions, regulations and procedures, lack of independent and impartial review and settlement of trade disputes, exclusive trading rights among state entities, incentive payments by sellers, technology transfer requirements, local content requirements, trade and foreign exchange balancing requirements, etc. The Chinese government agreed to open up a wide range of markets from agriculture to telecommunications under the terms of the landmark Sino-US Trade Agreement of November 1999. A similar agreement was also made with European Union (EU) countries in May 2000. Consequently, US opportunities to export to and invest in China will in theory increase considerably. If the deal is so good for the US, does China gain net benefits from joining the WTO? If not, why is China so interested in joining the WTO?

This article shows that the economic benefits of China’s entry into the WTO are relatively small compared to the overall size of the economies and trades involved. It also shows the importance of non-economic benefits and that China will have to pay economic adjustment costs, which are so large that implementation of the trade agreements will actually take much longer, and will pose great political risk to China’s leaders.

Effects on the US

Economic effects on the US

The political importance of PNTR and China’s admission to the WTO is indirectly supported by the relatively small economic benefits that will accrue to the US Despite the large size of China’s economy (seventh largest in the world with a population of 1.3 billion), its total GDP of US$ 1.1 trillion is only 14% of US GDP. US-China trade in 1998 was estimated at US$ 89 billion, which is less than 1.15% of US GDP (Table 1).

Table 1 - US’s major trading partners and the role of China, 1998

Source: FMI, Direction of Trade Statistics Yearbook, 1999.

Economic effects on the US economy of China’s entry into the WTO can best be analysed in accordance with the action that China will have to take with regard to its trade policy. First, the economic impact of the removal of NTBs is difficult to isolate since Chinese NTBs operate as part of an industrial policy. However, the impact of the removal of NTBs on the US economy can be estimated on the basis of measuring NTBs in tariff equivalents. Studies of protectionist regimes in China show that the tariff equivalent level of NTBs in China (22.1%) is comparable to the average level of tariffs (21.7%) (Table 2), and so is the impact of removing the NTBs on the US economy. In fact, the removal of all NTBs will probably have a greater impact than the tariff reductions themselves. The average tariff level after China’s admission to the WTO will be about 10%, and the net reduction in the average tariff will be only about 7% since in 1997 China slashed import duties on average to 17%.

Table 2 - Tariffs and tarrif equivalent of non-tariff barriers

Source: Sazanami et al., Measuring the Costs of Protection in Japan, IIE, Washington DC, 1994 ; Kim, Measuring the costs of Visible Protection in Korea, IIE, Washington DC, 1996 ; et Zhang et al., Measuring the Costs of Protection in China, IIE, Washington DC, 1998.

The relative importance of removing the NTBs is also confirmed by the US International Trade Commission (USITC). A USITC study found that the effects of eliminating NTBs in 25 products, covering only 30% of China’s imports, in conjunction with a hypothetical 50% cut in China’s tariffs, would effectively double the positive impact of the tariff reductions on such variables as growth in US GDP and terms of trade((1). The US Embassy in Peking estimated that China’s current barriers to US service suppliers alone result in US$ 3 to US$ 5 billion in lost sales each year.

Second, the USITC study also found that by 2005 the impact on the US economy of the April 1999 tariff reductions offered by China will likely be positive, but minor in terms of growth in US GDP, total exports and imports, consumption and wages. Even when the dynamic effects of the tariff reductions, such as productivity growth and capital accumulation associated with China’s trade liberalisation, is considered, the impact on those economic variables are still small (less than 0.05%). A more significant impact is found on US-China trade flows. Owing to the tariff reductions in China, US exports to China would likely be about 10% higher immediately (US$ 2.7 billion). This level is similar to the estimate (US$ 3.1 billion) made by the International Institute of Economics (IIE), which has been strongly supportive of China’s entry into the WTO((2). The US sectors most positively affected by China’s trade reforms would be agriculture, food and beverages, paper and pulps, chemicals, rubber and plastics, other transport equipment, and machinery and equipment. A fully dynamic analysis shows a much larger gain (US$ 13 billion by 2005) as competition takes hold in the Chinese marketplace and foreign direct investment increases following China’s trade liberalisation, which would stimulate US exports as well((3). Goldman and Sachs Corporation estimates that China’s trade will nearly double from US$ 324.0 billion in 1998 to US$ 600.0 billion in 2005. And Foreign Direct Investment (FDI) will also double from US$ 45.0 billion to US$ 100.0 billion. The US, as well as EU countries, would increase their direct investment in China, especially in heavy and infrastructure industries and information technology, finance and other service industries, which have so far been closely guarded from foreign competition (Table 3). The IIE also estimates that the induced increase in world exports to China would be US$ 21.3 billion((4).

Table 3 - FDI inflows to China by country, 1990-1997 (million)

Source: OCDE, International Direct Investment Statistics Yearbook, 1998.

As trade liberalisation in China will help make its export sectors more competitive, US imports from China are also estimated to be set to increase almost 7% (US$ 4.4 billion) by 2005. As a result, the US trade deficit with China (about US$ 43 billion in 1998) will increase (Figure 1). However, the USITC study estimates that the overall US trade balance will remain unaffected since US bilateral trade balances with other trading partners will likely improve.

Figure 1 - US trade with China

Source: FMI, Direction of Trade Statistics, 1996 and 1999.

Third, the USITC study found that the overall impact of China’s participation in the ATC would be positive. The economy-wide welfare gains for the US in terms of increases in household consumption could amount to about US$ 2.4 billion in 2006, while GDP could increase by US$ 1.9 billion in the same year. These results would occur among lower-priced textiles and clothes imported into the US and efficiency gains from factor reallocation in the US economy. The USITC study also suggests that inclusion of China in the ATC quota phase-out will likely have a small impact on US imports of textiles and a large impact on US imports of apparel.

However, three qualifications should be made of the increases in US imports of textiles and apparel. One is that US import increases in textiles and apparel will probably have adverse effects on the manufacturers and workers in the US textiles and apparel industries. Some estimates have been made that American job losses will stand at 870,000 over the next ten years((5). Although such estimates may be overstated, almost three-quarters of US imports from China consist of apparel, virtually all of which are covered by some type of quota. Although apparel products in China are of low to medium quality, they are becoming increasingly more high-value goods. Apparel production in China is highly labour-intensive, and China has an abundant supply of skilled and low-cost labour.

Another is that these increases will come at the expense of other suppliers to the US market and will have relatively small net negative effects on the US textiles and apparel industries. A study estimates that about 76% of the increases in China’s exports to the US market beyond its traditional constant market share in 1997 actually displaced third-country exports to US markets((6), meaning that only 24% of China’s exports in textiles and clothing industries would create net negative effects on the US

Still another qualification is that the adverse effects of the removal of the quotas are likely to be accelerated only after the end of the phasing-out period (December 31st 2004) because the quota growth rates for China will remain low up to the time the quota system is completely phased out. China’s share in the US textile market would increase slightly, to about 11% by 2010. However, China’s share of the US apparel market would rise by about 18 percentage points, reaching to 30% of the US import market((7).

Finally, US capital-intensive exports to China would increase by more than US$ 300 million a year after elimination of the quota restrictions in 2005. This is because the expansion of China’s production and trade in labour-intensive manufactures will likely result in a higher demand for capital-intensive manufactured goods in China.

In summary, China’s accession to the WTO will have only a small impact on US macroeconomic variables such as GDP, total exports and imports, and terms of trade. Although it will have positive effects on US-China trade flows, the impact is relatively small compared to total US trade and GDP. By 2005, China’s admission to the WTO will have a positive effect equivalent to some US$ 6 to US$ 10 billion or about 0.7% of US exports. US imports will also increase by about US$ 5 billion or 0.7%. Rather than the economic benefits, non-economic benefits, such as the political and security implications of China’s accession to the WTO, appear to be more significant.

Non-economic effects on the US

Indeed, some analysts emphasise the political overtone of the PNTR bill over its economic implications((8). Perhaps this is why Senator Moynihan called it the most significant vote since World War II. US leaders seem to believe that it is critically important to engage a rising superpower in the global leadership structure on a timely basis. A failure to integrate China now would risk a repeat of the historical follies in connection with Germany and Japan before and after World War I, which resulted in an international security disaster((9). In his contribution to the New York Times after the Senate vote on the US-China PNTR bill, US President Bill Clinton also called the attention of the reader to the non-economic benefits of the bill. He sees China’s joining the WTO as a means of bringing China into the international system and in line with international institutions. Just as China has joined the nuclear non-proliferation movement and added its voice to the prohibition of the production of bio-chemical weapons, China has indicated its willingness to work within the framework of the international trade system. Through China’s accession to the international system, he expects that China will assimilate itself into the world order and that this will narrow the differences between China and the rest of the world in non-economic fields((10).

US Trade Representative, Charlene Barshefsky, made the political and security points more explicitly: “The accession of China to the World Trade Organization will deepen and speed a process that has been of enormous importance to peace and security in the Asia Pacific region…”((11). Rather than emphasising the economic implications, she focused on the non-trade issue of peace and security. Her focus may underscore the US concern expressed in a recent report by the US Joint Chief of Staff, “Joint Vision 2020”. It sees China as a hypothetical enemy and reviews ways to increase US military forces in the Asia Pacific region as part of the US’s drastic shift in its world-wide security and defence strategy.

A Hong Kong legislator also sees the economic opening eventually leading to greater freedom and the end of communism in China. Impartial rules of trade among nations could thus help convince China of the importance of equal rights under the law in the domestic sphere, too((12).

Effects on Korea

The economic benefits that will accrue to Korea, China’s largest trading partner among developing countries, would be significant. As a member of the WTO, Korean exporters will also benefit from China’s tariff reductions and the removal of NTBs. A study by the Bank of Korea estimates that by 2005 Korean exports to China would increase by US$ 2,700 million, while Korean imports from China would rise by only US$ 300 million. This will further improve Korea’s trade balance with China by 50% or US$ 2,400 million on top of the current surplus of US$ 4,800 million in 1999 (Figure 2). However, the positive effects on the overall trade balance would be much more modest, about US$ 1,400 million since imports from third countries would also increase by about US$ 1,000 million to produce the increased exports to China. Therefore, the net effects on the Korean trade balance will be an increase of about US$ 1,400 million, or 1% of total exports in 1999((13).

Figure 2 - Korea trade with China

Source: IMF, Direction of Trade Statistics, 1996 and 1999.

This Bank of Korea analysis does seem optimistic. It starts with the premise that trade relations between China and Korea are not competitive, but are, rather complementary. While the mainstay of Korean exports is skills-intensive and heavy and chemical industry manufactures (70% of total exports), China’s export sector is led by labour-intensive light industry products, such as textiles, apparel, footwear, toys and travel accessories (40% of total exports) (Table 4). However, China’s export structure is changing rapidly, especially with the restructuring of industries as a result of active foreign direct investment. For example, textile products are catching up to the Korean level in terms of their share in total exports (5.0% as against 7.3%), and electrical and electronic products have been rapidly becoming China’s major export items (12.8% in 1995 to 16.9% in 1999).

Table 4 - Export competition between Korea and China by commodity, 1999

Source: Chung and Lee, 2000.

The Bank of Korea analysis also assumes that while Korean export markets in third countries will lose due to the improvement in China’s competitiveness following its trade liberalisation, the losses will be equally offset by the expansion of Korean export markets in third countries owing to the expansion of international trade after China’s entry into the WTO. This rather optimistic assumption was adopted because Korean exports, which are in competition with Chinese products in third markets, account for only 18% of total Korean exports to third countries. However, China will benefit indirectly from increased foreign direct investment, technological transfer and management improvement as a result of its trade liberalisation, and this will further strengthen its international competitiveness. Moreover, low-priced Chinese goods will pound Korea’s export markets in third countries, especially in those labour-intensive manufacturing products such as apparel, footwear, toys, travel accessories and furniture. The sum of the two effects may be much greater than the expansion of Korean exports in third markets. A study suggests that as a result of China’s technological development following its entry into the WTO, Korea’s major export items (such as electrical and electronic products, machinery and steel products) will lose share in the US market by between 0.1 and 1.5 percentage points by 2002((14). Moreover, Chinese exports’ share in the US markets has been on a steady increase (6.1% in 1995 to 7.8% in 1999), while Korean exports’ share in the US markets has been declining (3.3% in 1995 to 2.6% in 1998).

Therefore, it would be prudent to consider the USITC’s more conservative estimates of an increase in Korean exports of US$ 2,200-US$ 2.400 million and an increase in imports of US$ 600-US$ 700 million, with a consequent trade balance improvement of US$ 1,600-US$ 1,700 million. If the increased imports from third countries are assumed to be at the same level of US$ 1,000 million, the net positive effects of the trade with China would be only US$ 600-US$ 700 million, or less than 0.5% of total exports in 1999. This level of trade balance is only half the Bank of Korea estimates((15).

Effects on China

Positive effects

The most significant ramifications of China’s accession to the WTO will still be for China itself. With its accession to the WTO, on the one hand, the Chinese economy would cease to slow down and would get back on to the fast-growth track owing to the liberal trade regime, expanded export market and resumption of foreign direct investment. Goldman Sachs estimates that as a result of the reduction in tariffs and the removal of NTBs, China’s trade with other countries would double from US$ 324 billion in 1998 to US$ 600 billion by 2005. It also suggests that as a result of the improved domestic and external environment, foreign direct investment to China will increase from US$ 45 billion in 1998 to almost US$ 100 billion by 2005((16). The State Council’s think tank, the Development Research Centre, estimated that WTO membership would boost China’s economic growth by 1.53% in 2005, and exports by 26.9% and imports by 25.8%((17).

American analysts, however, expect a much more modest increase in China’s GDP and trade. The USITC estimates that in 2005 China’s total exports would increase by 12%, taking into account growth effects, and its total imports would increase by 14%. While China will have to open up its domestic markets further by reducing tariffs and removing NTBs, China already has access to major export markets like the US, which is China’s largest export market and accounts for 21% of its total exports (Table 5). The inclusion of China in the WTO Agreement on Textiles and Clothing would increase China’s competitive edge in its labour-intensive major exports by cutting customs duties between 10%-30% and all quotas, as well as 6%-7% of export costs for transhipment of exports through non-restricted countries. However, these positive effects would come mostly after the end of the quota phase-out period, i.e., December 2004. Moreover, capital-intensive imports would increase sharply as the expansion of China’s exportation of labour-intensive manufactures would accelerate the demand for capital-intensive goods such as machinery and equipment. Furthermore, the former export products manufactured by foreign enterprises will be sold in the domestic markets, taking up the domestic enterprises’ market share, and reducing export volumes. At present, much of the exporting activity is carried out by foreign-invested enterprises. For example, in Weihai, a city in Shandong province, foreign-invested enterprises are responsible for 50% of the total export volume((18). In sum, growth in China’s exports and imports would be much more modest, and China’s exports would not expand as much as its imports. Moreover, the USITC study also found that by 2005 China’s economy would grow by 4% as a result of trade liberalisation, taking into account the efficiency gains that would include further investment and thereby expanded production((19).

Table 5 - China’s major trading partners and the role of the US, 1998

Source: FMI, Direction of Trade Statistics Yearbook, 1999.

The positive economic effects of China’s admission to the WTO would provide a timely fillip to reverse the downward economic trend. The world’s greatest economic miracle in the last two decades was the growth record of the Chinese economy. Since 1978, China has implemented limited but open trade and investment policies. Thanks to the open door policy, together with sound macroeconomic policies, the Chinese economy grew at an average annual rate of almost 10% in the 1990s. However, the economy topped out in 1992, when growth reached 14%. Since then, China’s economy has slowed for seven consecutive years, and this has had negative impact on several economic fronts, but most ominously on the labour market. The unemployment rate rose sharply into double digits, especially after the onset of the Asian financial crisis, creating both social and political concerns (Figure 3).

Figure 3 - China GDP growth

Source: China Statistical Publishers, China Statistical Yearbook, 1999.

As a result of resumed economic growth in China, free market economy, and equal treatment of national and non-national enterprises, foreign enterprises will be encouraged to invest and compete in China more, in particular in newly open areas such as finance, telecommunications, distribution and professional services. Consequently, employment opportunities would expand, and people’s living standards would rise again. Together with these, advanced technology, management skills, and a market-oriented new business culture and entrepreneurship would also be developed, creating private sector-led economic growth.

Negative effects

On the other hand, China’s accession to the WTO will lead Chinese enterprises to suffer the double loss of protection of high customs duty and quota-based import restrictions, and confront fierce international competition. The impact of the competition will be felt particularly in such capital-intensive industries as the automobile, shipbuilding, machine and instrument manufacturing and petrochemical industries, where China is relatively disadvantaged in terms of efficiency. Agriculture, especially grain sectors, are also likely to be adversely affected by cheap North American farm products. Bankruptcy among enterprises and unemployment will be unavoidable. This negative impact would be most severe among small and medium township and village enterprises (TVEs) and state-owned enterprises (SOEs). While 6,600 large and medium-sized SOEs made a loss in 1997, by 1999 this number had fallen by 63% to 1,910. However, the amount of the losses sustained fell only 13 %. Surplus labour in SOEs was laid off to the figure of 6.1 million in 1999, following the 6.0 million laid off in 1998, which is greater than the total urban unemployment recorded for 1997. The government estimates 12 million more will be made redundant in 2000. Only about two-thirds of workers made redundant from SOEs find jobs, often in the same SOEs or their subsidiaries((20).

SOEs currently account for about 70% of total assets, 62% of total capital, 50% of output value, 54% of investment in fixed assets of China’s industrial sector, 60% of country-wide employment and 44% of urban employment. However, they have been continuously earning a low rate of return or making losses, incurring a high level of debts in the state-owned banks, which, in turn, threatens the onset financial crisis. Some 80% of the country’s bank loans are to SOEs, and a large portion of these loans (as much as 25% of GDP), will never be repaid((21).

In fact, some analysts see China’s accession to the WTO as a powerful tool to force a speeded reform of China’s SOEs. “Premier Zhu Rongji has tried virtually every possible means to transform China’s ailing state sector, ranging from management restructuring, technological upgrading, and mergers to labour layoffs (xiagang) and outright closure, but mostly without conspicuous success. By opening up SOE-dominated sectors such as automobile, petrochemicals and other heavy industries to fierce foreign competition, Zhu hopes to succeed in forcing SOEs to change for the better through the working of the market mechanism”((22). Premier Zhu Rongji must be confident that China’s economy has become much stronger and is resilient enough to stand any potential shock from joining the WTO, and that WTO membership could be beneficial to China in speeding up its domestic reform process, especially reform of the SOEs.

However, not everyone would make such a sanguine judgement. Because the provinces are financially autonomous, the central government has to persuade provincial governments and SOE management to undertake the reform. Moreover, although the positive effects may outweigh the negative effects in the long run, the adjustment process in the short and medium terms would be turbulent. Unemployment in urban areas is expected to rise in 2000 by a total of 8 million above the official figure of 6.5 million in 1995. The urban unemployment rate is currently estimated at between 8%-9%, compared with the official statistics of 2.74% in 1997. In addition, there is a floating population of about 100 million, who left rural areas in search of jobs in urban areas((23).

The prospects for foreign direct investment in China will also depend on the outcome of the Chinese economy’s adjustment process in the aftermath of its accession to the WTO. The prospects for the foreign direct investors would also differ depending on their objectives and the nature of their investment in China. Many analysts indicate that there are broadly two groups of foreign direct investment in China. One group (such as Korea, Japan, Hong Kong, Taiwan) tries to take advantage of China’s relatively lower wage rates vis-à-vis those of the source country. Another group (such as the US and EU countries) attempts to increase its share in what is potentially the largest market in the world. The first group would benefit more if the adjustment process takes a longer period of time and there is a high level of unemployment, since wage rates would be maintained at a low level. However, the second group would benefit more if the adjustment process is smoother and takes a shorter period of time. Wage rates would rise because of the increasing demand for skilled workers. And domestic consumption would be maintained at a robust level. Depending on the economic prospects for China, foreign enterprises investing directly in China will have to change their strategies as well. Therefore, we need to look more closely at the potentially negative impact of China’s accession to the WTO on the Chinese economy.

Social challenges and risks for China

China has enjoyed high rates of economic growth since 1991 without incurring a high level of inflation and any balance of payments problems (Figure 3). Through 1994, growth rates registered were greater than 12%, and total trade (exports and imports) expanded sharply from less than 30% of GDP to more than 42% (Figure 4). Although China was negatively affected by the Asian financial crisis in 1997 and the effects have continued, it successfully staved off critical contagion. The major reason for this lucky situation was that China was a relatively large and insulated economy. Its trade and capital account were not open and liberalised. Foreign direct investment was the mainstay of the foreign capital inflows, restricting more volatile portfolio equity investment flows and commercial bank loans. The major commercial banks are state-owned, and the level of government debt is low((24). However, the central government recently realised that the Chinese economy can no longer sustain a high level of growth and employment with weakened domestic consumption and international competitiveness.

Figure 4 - China total trade as % of GDP

Source:The World Bank datasheet, Global Development Finance and World Development Indicators. This datasheet can be found at: http://www.worldbank.org/research/growth/GDNdata.htm

The major issue facing the Chinese economy since 1998 has been how to cope with slow growth and weakened domestic demand in the midst of the Asian crisis and the global economic slow-down. The growth rates of GDP and domestic consumption slowed from more than 10% in the first half of the 1990s to less than 10% in the second. In particular, real household income rose less in rural areas than in urban areas in both 1997 and 1998, which was a reversal of the trend of the previous few years((25). This slow growth in rural consumption is significant in the context of China. Contrary to the situation in many advanced countries, the size of total consumption in the rural areas has been equal to that in the urban areas. The rural sector in China accounts for about 50% of GDP. The agricultural sectors represent some 20% of GDP and the non-agricultural sectors in the rural areas account for another 30%. For the overall economy to recover and for the promotion of employment, therefore, it is essential that the same growth rates be maintained in rural areas as in urban areas. The rural work force accounts for 70% of the national work force, and any increased release of labour in the rural areas would aggravate the urban unemployment situation. It would be a challenge for the Chinese government to hold on to the rural labour force despite declining rural income and consumption. The hukou (residence control) system has helped in the past, but the government has relaxed the system somewhat recently.

A slow-down of the overall economy and China’s accession to the WTO will accentuate the need to address the social agenda. The issue of weakened domestic consumption has now become more challenging mainly because China has to turn towards external demand and investment. This requires the Chinese economy to strengthen its international competitiveness and carry out enterprise reform, meanwhile minimising any adverse impact on financial sectors, the labour market, and workers’ living standards. With the advent of its admission to the WTO, the Chinese government will also have to open its economy to the fully. As a result of severe competition between imported goods and services and domestically produced goods and services with foreign direct investment in China, SOEs will be continually forced to rationalise their operations. Rationalisation of SOEs has highlighted the number of workers that have been made redundant from then and has already produced a large number of unemployed workers. In the course of the accentuated enterprise rationalisation and adjustment, it is inevitable that enterprises will lay off an enormous number of workers. The central government will therefore be faced with the challenges of having to encourage state enterprises to reform on the one hand, but of having to find ways to minimise unemployment and maintain workers’ living standards on the other. Besides the rapid increase in numbers, the unemployment problem has become particularly serious in China for several reasons. First, the social safety net is weak; second, funding of social protection schemes remains inadequate and requires a greater amount of fiscal resources; and, finally, the social protection schemes do not adequately target poverty groups or worse affected areas such as the central and western regions.

After becoming China’s premier in March 1998, Zhu Rongji laid out an ambitious reform agenda to reform the country’s SOEs, the financial sector, and the government structure within three years. And the government has made serious efforts to initiate the reform agenda. For example, in SOE reform, the government put a great deal of funding into management restructuring, technological upgrading, mergers and acquisitions, and worker layoffs. These reform efforts, however, have not yet shown any truly positive results. In the SOE sector, almost 2,000 large and medium-sized firms made net losses in 1999. The government has only begun to address the weaknesses in the sector. Moreover, the progress of the financial sector reform has been constrained by the lack of progress in the SOE reform. It is for this reason that the Chinese government is alleged to be using its accession to the WTO as a strategic instrument for forcing the reform of its SOEs.

In the course of reforming its SOEs, however, China will have to bear considerable short-term adjustment costs. Because of the decline in rural consumption in recent years, labour absorption by the rural sectors has weakened considerably. During the period 1990-94, employment in rural agricultural sectors declined at a rate of 1.5% per year, and rural secondary sectors absorbed the rural labour force at a rate of 7.1% per year. By contrast, during the period 1994-97, employment in rural primary sectors declined at 0.2%, but rural industrial sectors absorbed the labour force only at a rate of 2.7% per year (Table 6). In 1997 rural industrial employment dropped 4%. In 1998, it plunged 18%, leaving a reservoir of unemployed youth in the countryside((26). In the urban areas, employment growth has not been sufficient to absorb the natural growth in the urban labour force, migration away from rural areas, and workers involuntarily disengaged by SOEs, TVEs and other non-SOEs. During the period 1994-97, urban primary sector employment declined at 18.5% per year, but urban industrial sector employment expanded only at 2.6% per year (Table 6). As a result, urban unemployment now stands at a historically high level of around 8%-9% (about 16 to 18 million workers).

Table 6 - Annual average growth rate of GDP and employment (%)

Source: China Statistical Publishers, China Statistical Yearbook, 1999

The greatest question with regard to the unemployment problem is whether it will improve with China’s accession to the WTO. Despite the slowing economic growth in recent years, the Chinese labour market has demonstrated a certain resilience. While China’s GDP grew at an average annual rate of 14% during the period 1991-94, urban employment rose at a rate of 2.7% (Table 6). However, when GDP grew at a much slower rate of 6.5% during the period 1994-97, urban employment rose at a higher annual rate of 3.1%. While industrialisation progressed continuously in China (from 42% to 50% of GDP), the urban labour absorption elasticity actually increased from 0.12 in the years 1991-94 to 0.48 in the years 1994-97. This is contrary to the labour market trend in many developing countries, where a decline in labour absorption elasticity in the industrial sector was often offset by employment growth in the service sector. In China, labour absorption elasticity declined sharply in the primary sector (from –0.83 to –4.63), but increased in the industrial sector (from 0.05 to 0.33), as well as in the tertiary sector (from 1.27 to 2.07).

However, this increased capacity for absorbing the labour force in the industrial sector does not seem to be the result of an intensive use of labour, but is rather an indication of surplus labour in the sector, particularly in SOEs. The increase in urban employment during the period 1994-97 was greater in SOEs, compared to collectively owned units, TVEs, and other types of enterprises. In fact, urban employment levels have declined in collectively owned units since 1992, but in SOEs only from 1996, and the SOEs’ share of employment declined more slowly than the share of collectively owned units (Table 7).

Table 7 - Urban employment by type of economic units (%)

Source: China Statistical Publishers, China Statistical Yearbook, 1999.

In the face of the fierce international competition likely to result from China’s accession to the WTO, it would be a great challenge for China to continue to harbour the surplus labour in the industrial sector, especially in SOEs, and still maintain as high a level of growth in the future as in the period 1991-94. New foreign direct investment enterprises would be able to absorb some of the surplus workers laid off by SOEs. In particular, the foreign direct investment in the labour-intensive sectors of the economy would be able to absorb the redundant workers laid off by SOEs. However, a large part of this investment would be concentrated in the capital-intensive infrastructure and heavy industry sectors. As mentioned above, the most common type of foreign direct investment would outweigh in the future depends on the speed of adjustment and the prospects for the Chinese economy and the labour market.

It would therefore be useful to make projections as to the unemployment levels in 2000 and 2003, and ascertain whether they are socially and politically acceptable to permit the SOE reform as it is presently envisaged by the government. A fundamental assumption adopted in this exercise is that the labour force will increase at the same rate as in the past six years, and that the rural labour force will be fully employed, i.e., no increase in the urban influx of rural workers. At the same time, it is assumed that labour absorption elasticity in the future will be maintained at the same level as the average absorption elasticity during the period 1991-97, which covers both more rapid and slower economic growth sub-periods. Labour absorption elasticity indicates the rate of the increase in employment in response to the rate of GDP growth by economic sector in rural and urban areas. The official urban unemployment level would therefore vary according to the level of the rate of growth of GDP. If the GDP growth rate becomes relatively high (12% per year) as a result of China’s joining the WTO, there would be full urban employment in both 2000 and 2003. However, if the economy grows more or less at the same rate as in recent years (9% per year), the official urban unemployment level would rise from 2.7% in 1997 to 3.3% in 2000 and 3.7% in 2003 (Table 8).

Table 8 - Employment by sector (‘000 persons)

Source: China Statistical Publishers, China Labour Statistical Yearbook, 1999, and projections.

Further, if the growth rate is relatively low, at 5% per year, the official level of urban unemployment would be 7.9%. Since the official unemployment rate is currently lower than the estimated actual unemployment rate by about five to six percentage points, the estimated market unemployment rates would be 13%-14% and 17%-18% in 2000 and 2003, respectively. At these levels, the growth in employment would be inadequate to absorb even the natural growth of the urban labour force of 2.1-2.2 million persons, which could put social and political stability in jeopardy. Wage rates would be suppressed for quite some time, and living standards would not improve sharply as envisaged by the government. Under these circumstances, it would be a real challenge for the government to carry out the SOE rationalisation as announced, i.e., 12 million xiagang in 2000 and a higher level in the ensuing years.

With the advent of China’s accession to the WTO, everyone seems to be better off. Both advanced countries like the US and the middle income countries like Korea are set to reap economic benefits in terms of growth in trade. However, the relative size of such benefits in the total economy seems small, in particular for the US. A more important benefit for the US and other members of the WTO may be the introduction of a new rising economic and military power into the rule-based democratic and market-based international economic and political system. China, of course, would benefit the most economically through the opening of its economy and by improving its efficiency through the expansion of trade and an increase in foreign direct investment. The economic benefits from WTO membership would provide the Chinese government a timely policy tool to reverse the slowing economic trend and get the economy back on to a faster growth track.

For Chinese leaders, however, China’s accession to the WTO will be a tremendous challenge. In return for the benefits that China wants to gain, the Chinese economy will have to pay considerable adjustment costs in terms of rationalisation of its enterprises, in particular its SOEs, and relatively high incidences of unemployment. This is the reason why the whole world will have to be particularly vigilant during the implementation stage of China’s membership at the WTO. The adjustment of the Chinese economy and the implementation of China’s commitment to free trade and investment may take not only a much longer period of time than currently envisaged, it may also ba a bumpy and winding road. Undoubtedly, the Chinese leaders will be facing a big economic and political gamble. So will the world. The gamble may pay off, but it is likely to be at a considerable cost.