China's Economic Conditions

Updated July 15, 1998

Wayne M. Morrison
Economics Division, CRS

Since the initiation of economic reforms, beginning in 1978, China has become one of the world's fastest growing economies. Over the past 10 years, China's GDP has grown at an average annual rate of nearly 10%. Some economists have speculated that China could become the world's largest economy at some point in the near future. However, future economic growth will likely depend on the ability of the Chinese government to make significant new reforms. Chinese officials have recently announced major new initiatives to reform money-losing state-owned enterprises and China's banking system. It remains to be seen whether such reforms will be implemented on a wholesale or piecemeal level.

China's emergence as a global economic and trade power has created economic opportunities for China's trading partners, but has presented several challenges as well. On the one hand, China's economic growth has made it an increasingly important trading partner for many nations. On the other hand, China's trade barriers, failure to adopt most multilateral rules on international trade, and the relative absence of the rule of law for business activities have often proved to be major barriers for doing business in China and have been the cause of growing tensions with various trading partners, especially the United States.

Currently, China is the largest economic power that is not a member of the World Trade Organization (WTO), the international body that sets rules for most international trade. China has sought WTO membership, but has consistently argued that it should be given fairly lenient terms for joining the WTO. The United States and certain other WTO members contend that China is a large economic and trading power and, hence, must make major reforms to its trade regime before joining the WTO. Chinese officials contend that China is a developing country and should be allowed to enter the WTO under conditions which would allow it to adopt reforms over time. They contend that U.S. demands for trade liberalization are too severe because they would cause widespread bankruptcies of many state-owned firms, leading to widespread layoffs and social unrest.

The current economic and financial crisis in Asia has begun to affect the Chinese economy. Chinese officials have raised concerns that the devaluation of several Asian currencies (including the Japanese yen) is making many Chinese exports less competitive in international markets. U.S. officials have urged China not to devalue its currency out of concern that it could lead to a new round of currency devaluations in Asia and further deepen the financial crisis there. The Asian financial crisis could affect the pace and extent of future Chinese economic reforms.

The growth of China's economy and the pace of reforms have been of great concern to Congress. Some Members view the sluggish growth in U.S. exports (and the rising U.S-China trade imbalance) in recent years as an indicator that Chinese markets are relatively closed to most U.S. goods and services; they argue that the United States should support China's membership in the WTO only if it agrees to significantly open up its markets to U.S. goods and services. Congressional support, or lack thereof, for China's WTO membership will likely determine whether it will eventually vote to extend permanent most-favored-nation (MFN) treatment to China.

MOST RECENT DEVELOPMENTS

On June 25, 1998, President Clinton began his summit visit to China.

On June 3, 1998, President Clinton recommended the renewal of China's MFN status for an additional year.

On April 23, 1998, following discussions with Chinese officials in Beijing, USTR Charlene Barshefsky announced that U.S.-China talks on China's accession to the WTO were "back on track."

On March 10, 1998, Chinese Premier Zhu Rongji outlined several new major initiatives and goals for China's economy, including eliminating several government ministries, restructuring state-owned enterprises, and reforming the banking system. On February 1, 1998, Chinese Vice Premier Li Lanqing stated that China would not devalue its currency (in response to devaluation of currencies that have occurred in other Asian countries) to boost exports. He further stated that China's economy would grow by 8.0% in 1998, and announced that China would spend $750 billion over 3 years on infrastructure development.

 

BACKGROUND AND ANALYSIS

An Overview of China's Economic Development

China's Economy Prior to Reforms

Prior to 1978, China maintained a centrally planned, or command, economy. A large share of the country's economic output was directed and controlled by the state, which set production goals, controlled prices, and allocated resources throughout most of the economy. During the 1950s, all of China's individual household farms were collectivized into large communes. To support rapid industrialization, the central government during the 1960s and 1970s undertook large-scale investments in physical and human capital. As a result, by 1978 nearly three-fourths of industrial production was produced by centrally controlled state-owned enterprises (SOEs) according to centrally planned output targets. Private enterprises and foreign invested firms were nearly non-existent. A central goal of the Chinese government was to make China's economy relatively self-sufficient. Foreign trade was generally limited to obtaining only those goods that could not be made or obtained in China.

China's real GDP grew at an estimated average annual rate of about 5.3% from 1960-1978. However, 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 raise economic growth and living standards.

The Introduction of Economic Reforms

Beginning in 1978, China launched several economic reforms. The central government initiated price and ownership incentives for farmers, which enabled them to sell a portion of their crops on the free market. In addition, the government established four special economic zones for the purpose of attracting foreign investment, boosting exports, and importing high technology products into China. Additional reforms followed in stages that sought to decentralize economic policymaking in several economic sectors, especially trade. Economic control of various enterprises was given to provincial and local governments, which were generally allowed to operate and compete on free market principles, rather than under the direction and guidance of state planning. Additional coastal regions and cities were designated as open cities and development zones, which allowed them to experiment with free market reforms and to offer tax and trade incentives to attract foreign investment. In addition, state price controls on a wide range of products were gradually eliminated.

China's Economic Growth Since Reforms: 1979-1997

Since the introduction of economic reforms in 1978, China's economy has grown substantially faster than during the pre-reform period (see Table 1). Chinese statistics show real GDP from 1979 to 1997 growing at an average annual rate of 9.9%; over the past 5 years, it grew by 11%, making China one the world's fastest growing economies. In real terms, China's 1978 GDP doubled by 1986, tripled by 1991, quadruped by 1993, and quintupled by 1995. According to the World Bank, China's rapid development has raised nearly 200 million people out of extreme poverty.

 Causes of China's Economic Growth

Economists generally attribute much of China's rapid economic growth to two main factors: large-scale capital investment (financed by large domestic savings and foreign investment) and rapid productivity growth. These two factors appear to have gone together hand in hand. Economic reforms led to higher efficiency in the economy, which boosted output and increased resources for additional investment in the economy.

China has historically maintained a high rate of savings. When reforms were begun in 1978, domestic savings as a percentage of GDP stood at 32% (nearly as high as Japan's at the time). However, most Chinese savings during this period were generated by the profits of SOEs, which were used by the central government for domestic investment. Economic reforms, which included the decentralization of economic production, led to substantial growth in Chinese household savings (which now account for half of Chinese domestic savings). As a result, savings as a percentage of GDP has steadily risen; it was 42% in 1996, among the highest savings rates in the world.

China's trade and investment reforms and incentives led to a surge in foreign direct investment (FDI), which has been a major source of China's capital growth. Annual utilized FDI in China grew from $636 million in 1983 to $45.3 billion in 1997, making China, in recent years, the second largest destination of FDI (after the United States). Total utilized FDI at the end of 1997 reached $223.1 billion. About two-thirds of FDI in China has come from Hong Kong and Taiwan. The United States is the fourth largest investor in China, accounting for 7.8% ($17.3 billion) of total FDI at the end of 1997.

Several economists have concluded that productivity gains (i.e., increases in efficiency in which inputs are used) were another major factor in China's rapid economic growth. The improvements to productivity were largely caused by a reallocation of resources to more productive uses, especially in sectors that were formally heavily controlled by the central government, such as agriculture, trade, and services. For example, agricultural reforms boosted production, thus freeing workers to pursue employment in more productive activities in the manufacturing sector. China's decentralization of the economy led to the rise of non-state enterprises, which tended to pursue more productive activities than the centrally controlled SOEs. Additionally, a greater share of the economy (mainly the export sector) was exposed to competitive forces. Local and provincial governments were allowed to establish and operate various enterprises on market principles, without interference from the central government. In addition, FDI in China brought with it new technology and processes that boosted efficiency.

Measuring the Size of China's Economy

The actual size of the China's economy has been a subject of extensive debate among economists. Measured in U.S. dollars using nominal exchange rates, China's GDP in 1997 was $957 billion; its per capita GDP (a commonly used figure to measure and compare a nation's living standard) was $769. Such data would indicate that China's economy and living standards were significantly lower than those of the United States, Japan, and Germany. In nominal U.S. dollars, China's 1997 GDP was about 45% the size of Germany's, 23% that of Japan's, and 12% that of the United States. China's nominal per capita GDP was only 2.6% that of the United States (see Table 2).

Many economists, however, contend that using nominal exchange rates to convert Chinese data into U.S. dollars substantially underestimates the size of China's economy. This is because prices in China for many goods and services are significantly lower than those in the United States and other developed countries. Economists have attempted to factor in these price differentials by using a purchasing power parity (PPP) measurement, which attempts to convert foreign currencies into U.S. dollars based on the actual purchasing power of such currency (based on surveys of the prices of various goods and services) in each respective country. This PPP exchange rate is then used to convert foreign economic data in national currencies into U.S. dollars.

Because prices for many goods and services are significantly lower in China than in the United States and other developed countries (while prices in Germany and Japan are higher than those in the United States), the PPP exchange rate raises the estimated size of Chinese economy to $4.4 trillion, higher than Japan's GDP in PPP ($3.0 trillion) and Germany's ($1.6 trillion), and slightly over half the size of the U.S. economy. PPP data also raise China's per capita GDP to $3,560; however, this figure falls far below the PPP per capita GDP levels of the major developed countries (for example, its only 12% of U.S. levels).

The PPP data appear to indicate that, while the size of China's economy as a whole is quite large and currently could be the world's second largest, its living standards are quite low. (To illustrate, the World Bank estimates that nearly 30% of China's population live below the international poverty level of $1 per day.) The International Monetary Fund estimates that (using PPP measurements) China could surpass the United States as the world's largest economy as early as the year 2007. Yet, even if that were to occur, it would take China significantly longer to achieve U.S. standard of living levels.

Table 2. Comparisons of U.S., Japanese, German, and Chinese GDP and Per Capita GDP In Nominal U.S. Dollars and PPP: 1997

Country

Nominal GDP ($Billions)

GDP in PPP ($Billions)

Nominal Per Capita GDP

Per Capita GDP in PPP

U.S.

8,081

8,081

30,136

30,136

Japan

4,190

2,969

33,214

23,543

Germany

2,109

1,637

25,692

20,890

China

957

4,429

769

3,560

Source: DRI/McGraw Hill. World Economic Outlook, Volume 2, 1st Quarter, 1998, various pages.

Note: PPP data for China should be interpreted with caution. China is not a fully developed market economy; the prices of many goods and services are distorted due to price controls and government subsidies.

 

 

China's Trade Patterns

Economic reforms have transferred China into a major trading power. Chinese exports rose from $14 billion in 1979 to an estimated $183 billion in 1997, while imports grew from $16 billion to $142 billion. China's ranking as a trading power rose from 27th in 1979 to 10th in 1996. Historically, China has run trade deficits in some years and surpluses in others. Over the past 4 years, China has run trade surpluses; in 1997 that surplus reached an estimated $40 billion (see Table 3). Merchandise trade surpluses and large-scale foreign investment have enabled China to accumulate the world's second largest foreign exchange reserves, estimated to have reached nearly $140 billion at the end of 1997.

 

China's Major Trading Partners

China's trade data often differ significantly from those of its major trading partners. This is due to the fact that a large share of China's trade (both exports and imports) passes through Hong Kong (which reverted back to Chinese rule in July 1997, but is treated as a separate customs area by most countries, including China and the United States). China treats a large share of its exports through Hong Kong as Chinese exports to Hong Kong for statistical purposes, while many countries that import Chinese products through Hong Kong generally attribute their origin to China for statistical purposes.

According to Chinese trade data, its top five trading partners in 1997 were Japan, Hong Kong, the United States, the European Union (EU), and South Korea (see Table 4). Chinese data show the United States as China's second largest destination for its exports and the fourth largest source of its imports (after Taiwan).

Significant differences in how trade flows are calculated between China and its major trading partners; this has resulted in substantially different measurements of bilateral trade balances. For example, U.S. trade data for 1997 indicate that it had a $49.7 billion trade deficit with the United States, but Chinese trade data indicate that it had $16.4 billion trade surplus with the United States.

Major Chinese Trade Commodities

China's abundance of cheap labor has made it internationally competitive in many low cost, labor-intensive, manufactures. As a result, manufactured products (as opposed to primary products, such as food and live animals, raw material, and mineral fuels) comprise an increasingly larger share of China's trade. The share of Chinese manufactured exports to total exports rose from 50% in 1980 to 84% in 1994, while manufactured imports as a share of total imports rose from 65% to 86%. A large share of China's manufactured imports are comprised of intermediates (such as chemicals, electronic components, and textile machinery) used in manufacturing products in China. Major Chinese imports in 1997 included textile products, electric machinery, mineral fuels, specialized machinery, and primary plastics (see Table 5). China's major exports in 1996 included clothing, textiles, electric machinery, telecommunications and recording equipment, and office machines (see Table 6).

Major Challenges Facing the Chinese Economy

China's economy has shown remarkable economic growth over the past several years, and many economists project that it will enjoy robust growth in near future. Standards and Poor's DRI, a private international forecasting firm, projects China's GDP will grow at an average annual rate of 7.2% between 1998 and the year 2015; this means that China will likely double its GDP every 10 years. Economists caution, however, that these projections are likely to occur only if China continues to make major reforms to its economy. Failure to make such reforms could diminish the prospects for continued rapid growth. China faces several challenges which could threaten future growth:

State-owned enterprises (SOEs), which account for about one-third of Chinese industrial production and employ nearly two-thirds of urban workers, put an increasingly heavy strain on China's economy. Over half are believed to lose money and must be supported by subsidies, mainly through state banks. Government support of unprofitable SOEs diverts resources away from potentially more efficient and profitable enterprises. In addition, the poor financial state of many SOEs makes it difficult for the government to reduce trade barriers out of fear that doing so would lead to wide-spread bankruptcies of many SOEs.

The banking system faces several major difficulties due to its financial support of SOEs and failure to operate solely on market-based principles. China's banking system is regulated and controlled by the central government, which sets interest rates and attempts to allocate credit to certain Chinese firms. The central government has used the banking system to keep afloat money-losing SOEs by pressuring state banks to provide low interest loans, without which a large share of the SOEs would likely go bankrupt. Currently, about 70% of state-owned bank loans now go to the SOEs, even though a large share of loans are not likely to be repaid. The high volume of bad loans now held by Chinese banks (estimated to total $250 billion) poses a serious threat to China's banking system. Three out of the four state commercial banks are believed to be insolvent. The precarious financial state of the Chinese banking system has made Chinese reformers reluctant to open its banking sector to foreign competition. Corruption poses another problem for China's banking system because loans are often made on the basis of political connections. In many cases, bank branches extend loans to firms controlled by local officials, even during periods when the central government has attempted to limit credit, due to inflation concerns. Such a system promotes widespread inefficiency in the economy because savings are generally not allocated on the basis of obtaining the highest possible returns. In addition, inability to control the credit policies of local and provincial banks has made it very difficult for the central government to use monetary policy to fight inflation without causing major disruptions to the economy.

Infrastructure bottlenecks, such as inadequate transportation and energy systems, pose serious challenges to China's ability to maintain rapid economic growth. China's investment in infrastructure development has failed to keep pace with its economic growth The World Bank estimates that transportation bottlenecks reduce China's GDP growth by 1% annually. Chronic power shortages are blamed for holding China's industrial growth to 80% of its potential. Transportation bottlenecks and energy shortages also add inflationary strains to the economy because supply cannot keep up with demand.

The lack of the rule of law in China has led to widespread government corruption, financial speculation, and mis-allocation of investment funds. In many cases, government "connections," not market forces, are the main determinant of successful firms in China. Many U.S. firms find it difficult to do business in China because rules and regulations are generally not consistent or transparent, contracts are not easily enforced, and intellectual property rights are not protected (due to the lack of an independent judicial system). The lack of rule of law in China limits competition and undermines the efficient allocation of goods and services in the economy.

High Trade barriers are maintained by the government in large part to protect domestic firms from foreign competition. Such policies have two main negative effects: First, they give domestic firms less incentive to improve productivity and efficiency. Second, restricting competition raises prices and product choices for Chinese consumers of both domestic and imported goods.

A wide variety of social problems have arisen from China's rapid economic growth and extensive reforms, including pollution, a widening of income disparities between the coastal and inner regions of China, and a growing number of bankruptcies and worker layoffs. This poses several challenges to the government, such as enacting regulations to control pollution, focusing resources on infrastructure development in the hinterland, and developing modern fiscal and tax systems to address various social concerns (such as poverty alleviation, health care, education, worker retraining, pensions, and social security).

Recently Announced Chinese Economic Initiatives

Newly appointed Chinese Premier Zhu Rongji outlined a number of major new economic initiatives and goals for reforming China's economy and maintaining healthy economic growth during at a news conference on March 19, 1998. Among these initiatives and goals were:

In 1998, achieve a GDP growth rate of 8%, keep inflation below 3%, and not devalue China's currency.

Respond to the effects of the Asian financial crisis by expanding domestic demand, especially through increased spending on infrastructure, and by maintaining the pace of previously planned economic reforms.

Reform and restructure loss-making medium-and-large-sized state-owned enterprises (SOEs) to make them profitable. Reorganize the banking system to increase the regulatory and supervisory power of the central bank and make commercial banks operate independently. Substantially reduce the size of the government and reorganize the remaining government institutions. All three goals are to be obtained within three years

Commercialize government housing, reform the health insurance system, improve the system the for circulating grain, rationalize the system for approving investment and finance projects (i.e., make such decisions based on market considerations), and improve tax collection.

Zhu Rongji's economic plan builds on the Deng Xioping strategy which sought to establish a rudimentary market system with a gradual but extensive integrative program of reform. Zhu's reforms, if implemented, could constitute the most significant restructuring of the economy to date, since it would substantially reduce the size of the government and diminish its control over various sectors of the economy, dismantle much of the remaining "iron rice bowl" of cradle-to grave benefits for government and SOE workers, enable banks to make loans on a commercial, rather than political basis, and force a large share of SOEs to operate according to free market principals. These steps, if implemented, would take China significantly closer towards a functioning market economy.

Reform of State Owned Enterprises

The Chinese leadership has been talking about undertaking major reforms of unprofitable SOEs for the past several years, but has been hesitant to act due to concerns that reforms would lead to widespread bankruptcies and cause political instability. However, the Chinese government has acknowledged that support of SOEs has put a heavy drain on the economy and cannot be maintained indefinitely. As a result, reform of SOEs has been made a top priority. In September 1997, Chinese President Jiang Zemin stated that China would take steps which, if implemented, would essentially privatize (although referred to by the Chinese as "public ownership") all but 1,000 out of an estimated 308,000 SOEs by cutting off most government aid and forcing them to compete on their own. Under this plan, some unprofitable SOEs will be closed, while others will be merged with more profitable enterprises. Many firms will be allowed to issue stock in order to raise funds. Another source of revenue for SOEs will come from workers who will be allowed to purchase their own homes, and SOEs will be released from the responsibility of providing subsidized housing. The central government plans to maintain support and control of 1,000 large and medium-sized enterprises deemed as key industries, but to reorganize and restructure them into large conglomerates in the hope of making them more competitive.

It is not clear how the Chinese government intends to deal with the problem of displaced workers (likely to total several millions) when and if the SOE reform plan is implemented. Chinese officials may be anticipating that continued rapid economic growth will provide new jobs for most displaced workers. They also appear to be hoping that overseas investors will play a major role in restructuring the SOEs by becoming joint owners and financing and management assistance to such firms, thus enhancing the efficiency of their operations.

Reform of the Banking System

Chinese officials have indicated a desire to strengthen and reform its banking system. On January 16, 1998, the central government announced it would attempt to implement new reforms to enhance the power of the central bank over the provincial and state banks and to improve the management systems of all Chinese banks. Such reforms would attempt to lessen the power of local officials to pressure banks into making "bad loans." In addition, the government has indicated that banks will be allowed to make bank loan decisions based on commercial, considerations. Finally, on March 2, 1998, the government announced plans to issue bonds to recapitalize the state banks to enable them to write off bad loans. Chinese officials claim their long-term goal is to develop a modern banking system similar to that of the U.S. Federal Reserve system. However, due the precarious nature of its banking system, Chinese officials appear hesitant to allow foreign banks to expand their operations in China, due to concerns that doing so would force many Chinese banks into bankruptcy.

Infrastructure Development

The Chinese government anticipates that banking and SOE reforms will lead to widespread layoffs. Stimulating domestic demand, especially through infrastructure development, is viewed as a key mechanism to re-employ workers displaced by reforms. Chinese officials announced in February 1998 their intentions to spend $750 billion on infrastructure development over the next 3 years, although many analysts have questioned China's ability obtain funding for such a massive financial undertaking in such a short period of time. It is likely that China intends to attract foreign investment for much of its infrastructure needs. However, Chinese restrictions on ownership, profits, and operational control of major projects, China's demands for subsidized financing and sharing of technology, and uncertainties over obtaining approval from Chinese officials at the central and local levels have made foreign investors reluctant to invest in major Chinese infrastructure projects.

Major Issues in China-U.S. Economic Relations

China's growth as a major economic and trading power has expanded U.S.-China commercial ties, although disputes have arisen over a number of issues, such as trade investment barriers and China's most-favored-nation (MFN) status. The World Bank projects that by the year 2020, China will be the second largest trading economy after the United States. China's continued rapid growth has increased concerns among U.S. policymakers that China's trade regime must be brought in compliance with multilateral rules in the World Trade Organization (WTO) for U.S. exporters to gain adequate access to the Chinese market.

Trade

Total trade between China and the United States rose from $4.8 billion in 1980 to $75.4 billion in 1997, making China the fourth largest U.S. trading partner. China has become a major supplier to the U.S. market of a variety of low-cost U.S. consumer goods, such as toys and games, textiles and apparel, shoes, and consumer electronics, while China has been a major buyer of U.S. aircraft, fertilizers, and machinery. In recent years, U.S. imports from China have far exceeded U.S. exports to China (in 1997, U.S. imports from China totaled $62.6 billion while U.S. exports to China were $12.8 billion) As a result, the U.S. trade deficit with China has surged, reaching nearly $50 billion in 1997. U.S. officials have raised concern over the relatively flat level of U.S. exports to China over the past few years (they grew by only 2.0% in 1996 over the previous year and by 6.7% in 1997). U.S. officials have blamed China's widespread and pervasive use of trade and investment barriers and restrictions for the relatively lackluster growth of U.S. exports to China (For a more detailed examination of major trade issues, see CRS Issue Brief 91121, U.S.-China Trade Issues).

The United States is an important economic partner for China. One calculation indicates that the United States is by far China's largest export market and that its importance has grown sharply over the past several years. Based on U.S. data on Chinese exports to the United States (which, as noted above, 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 percentage of total Chinese exports grew from 15.3% in 1986 to 34.3% in 1997 (see table 7).

China's Most-Favored-Nation (MFN) Status

Under current U.S. law, China's MFN status must be renewed on an annual basis. In recent years, several attempts have been made in Congress to pass legislation to revoke, partially revoke, or add new conditions to, the renewal of China's MFN status. None of these bills have been enacted.

A withdrawal of China's MFN status would result in a substantial increase in the applicable rates and amounts of customs duties assessed on most U.S. imports from China. Imports from China would be assessed tariffs according to "Column 2" (non-MFN) rates of duty in the U.S. Harmonized Tariff Schedule (HTS), which are generally significantly higher (up to 10-fold in some instances) than those under "Column 1-General" (MFN treatment). These higher tariffs would likely result in higher prices for U.S. consumers of the affected items and subsequently a decrease in U.S. imports of various Chinese products.

The precise economic effects of higher U.S. (non-MFN) tariffs on various Chinese products are difficult to ascertain, due to the problems involved in determining who would bear the ultimate costs of the higher tariffs, and how such costs would affect the quantity of Chinese-made products supplied and demanded in the United States. A 1996 study by the International and Business and Economic Research Corporation (an organization that supports continued MFN treatment for China), concluded that terminating China's MFN status would raise the effective U.S. duty on Chinese imports from 5.9% to 44.1%, resulting in roughly $27 billion to $29 billion in added costs to U.S. consumers. Products hardest hit by increased tariff levels would include textiles and apparel, toys, shoes, and machinery. China might respond to a cutoff of its U.S. MFN status by imposing trade sanctions against U.S. products and restricting U.S. investment in China. In addition, Hong Kong, which accounts for about half of China's trade and has established export-oriented production facilities in China, would likely be deeply impacted by a U.S. cut-off of China's MFN status. The Hong Kong government estimates that such a cut-off would reduce its trade by up to $33.9 billion and reduce income by $4.5 billion.

China's Accession to the WTO

China has made its accession to the WTO a major priority for a number of reasons. First, it would represent international recognition of China's growing economic power. Second, it would enable China to play a major role the development of new international rules on trade in the WTO. Third, it would give China access to the dispute resolution process in the WTO, reducing the threat of unilateral trade sanctions against China or other unilateral restrictions on Chinese exports (such as textile quotas and antidumping duties). Fourth, it would make it easier for reformers in China to push liberalization policies if they could argue that such steps are necessary to fulfill China's international obligations. Finally, China hopes it would gain it permanent MFN treatment from the United States.

Several arguments have been made by policymakers of current WTO member countries for allowing China into the WTO. First, China is the largest economic and trade power not a member of the WTO. The World Bank projects that China's share of world trade will account for 10% of the world's trade by the year 2020 and that China will become the world's second largest trading nation after the United States. Hence, it is argued that China's trade is too significant to remain outside multilateral trade rules. Second, WTO membership would require China to reduce a wide variety of trade barriers and, hence, would likely create substantial new trade opportunities in China. Third, once China is in the WTO, it would be required to provide extensive information about its trade regime, which would make it very difficult for China to impose new trade and investment barriers. Fourth, the United States (and other WTO members) would be able to bring trade disputes to WTO dispute resolution instead of having to rely on threats of unilateral trade sanctions. Finally, China's accession might enable Taiwan to eventually join the WTO (as a separate customs territory). China has insisted that Taiwan can get into the WTO only after China does.

Several policymakers have opposed China's accession to the WTO due to concerns that China's economic and trade regimes are currently incompatible with WTO rules. They argue that China's WTO membership could undermine the WTO as an institution (especially if China entered under relatively easy terms) and could diminish the prospects for future trade liberalization agreements under the WTO. Other opponents argue that China's WTO membership should be opposed until China improves its human rights practices.

Negotiations have been held over the past several years over the terms of China's accession to the WTO. China has consistently claimed that it is a poor country and should be given fairly lenient terms for joining the WTO, which would enable China to gradually implement reforms. The United States and several other WTO members have argued that China is a major economic and trade power and must be made to bring its trade regime into full compliance with WTO rules before joining or be in compliance within a few years after joining. China contends that implementing reforms too quickly would force several Chinese firms into bankruptcy, leading to widespread layoffs and social unrest. China has further argued that it should be allowed to develop and protect industries deemed essential for China's future economic development. The United States has countered that economic and trade reforms, not protectionism, are the best measures to ensure long-term Chinese economic growth and development.

Some progress has been made on China's WTO accession over the past year. China has reduced its average tariff rate from 42.1% in 1996 to 17% as of October 1997. At the October 1997 U.S.-China summit, the two sides agreed to "intensify" the WTO talks, and China pledged it would participate in the Information Technology Agreement to eliminate tariffs on information technology products. China and most WTO members appear to have agreed that China needs to submit a planned package of reforms that would be adopted before China's WTO accession ("a down payment"), along with a detailed description of tariff and non-tariff barriers that would be reduced or eliminated within a specific period of time. Details for phasing such barriers on specific products are still being worked out. No major breakthrough on China's WTO bid was achieved at the June 1998 U.S.-China summit.

The Financial Crisis in Asia

Since mid-1997, several East Asian economies, notably South Korea, Thailand, and Indonesia, have experienced significant financial difficulties. Such difficulties have included substantial currency devaluations (as investors have transferred funds overseas), and significant falls in stock market prices. Other Asian economies, including Japan, Hong Kong, Singapore, the Philippines, and Malaysia have also experienced varying degrees of financial difficulties as well. The financial crisis also seriously weakened (or exposed weaknesses) in the financial institutions (such as banks) of several Southeast Asian countries, raising concerns that a drop in investor confidence could seriously undermine future economic growth in the region.

China has been relatively immune from the effects of the Asian financial crisis, mainly because its currency (the yuan) is not fully convertible; it maintains over $140 billion in foreign exchange reserves; its foreign debt is relatively small compared to other Asian nations; its financial institutions are tightly controlled by the central government; and because most foreign investment in China is direct, rather than portfolio, investment.

The most significant response by the Chinese government to the Asian financial crisis so far has been a number of recent public declarations that it will not devalue the yuan. Several analysts have argued that a Chinese currency devaluation could lead to several new rounds of currency devaluation among Southeast Asian economies and would likely significantly deepen the financial crisis. In addition, several Chinese government officials have pledged not to let the Asian financial crisis halt the pace of economic reforms. In recent weeks, however, some Chinese officials have expressed concern over the sharp depreciation of the Japanese yen against the U.S. dollar and have warned that China might be forced to devalue its currency if the yen continued to slide. Such warnings may have contributed to the U.S. and Japanese government intervention in the exchange markets on June 17, 1998 to prop up the yen.

Outlook for China's Economy

Chinese officials predict that China's economy will continue to expand at healthy levels in the near future; they predict real GDP to grow by 8.0% in 1998. However, many analysts predict the Asian financial crisis will slow China's economic growth in 1998. Chinese data for the first quarter of 1998 indicate that the economy is growing at an average annual rate of 7.2%. Standard & Poor's DRI, a U.S. economic forecasting firm, projects that China's GDP will grow by only 5.0% in 1998, a significant slowdown from growth experienced over the last several years. Several analysts have warned that, should the Asian financial crisis continue and worsen, and start to seriously hurt China's export sectors (and thereby slowing overall economic growth), the Chinese government may move to depreciate the yuan. A slowing economy could also make it harder for the government to open the economy to foreign competition, and to cut off financial aid to unprofitable SOEs, because fewer jobs would likely be available in other sectors of the economy for Chinese workers displaced by resulting bankruptcies. In addition, many Chinese officials appear to believe that it was the "openness" of the East Asian economies that made them susceptible to the current financial crisis in Asia; this may cause China's leaders to be more cautious in implementing further economic reforms. Such a response could further complicate China's accession to the WTO and would aggravate U.S.-China commercial relations.