China and the WTO: The First Two Years

China joined the World Trade Organization (WTO) in December, 2001. This event—the culmination of years of difficult negotiations and compromise—was historic. China’s membership meant the largest economy outside of the international trading system was brought into a regularized process of meeting timetables and following rules with respect to a vast array of trade, investment and governance activity. The extent and interrelationships of these commitments, if successful, will result in a major liberalization of not only China’s foreign trade regime, but of the economy overall.

From the WTO members’ point of view, negotiations with China over what was required for membership were especially difficult for two reasons. First, members were concerned that China’s economy was not a market-based system. Since the development of certain sectors of China’s economy were quite advanced but were often dominated by state-owned companies and state trading monopolies, members feared unfair competition in these areas. Second, members were not confident that China’s central government would be able to enforce the terms agreed upon. Because of the strength of sector-based ministries, and weakened control of the central government over localities, members worried that the Chinese officials who made the commitments would not have sufficient power to ensure compliance.

One and a half years after joining, China’s and the world’s attention is indeed on compliance. Economic malaise, job loss, and trade imbalances in many parts of the world have caused analysts and politicians, in developing and developed countries alike, to look for reasons for these problems. Many economies are reluctantly adjusting to changes caused by China’s impressive entry into international markets. At the same time people in China are dealing with the wrenching transition that has been going on for two decades, which received added impetus from WTO induced liberalization.

China’s WTO Commitments

While the negotiations for China’s entry into WTO were complex, implementation of the agreements will be even more so. The number of individual commitments and extent of market liberalizing goals are both vast. The U.S. General Accounting Office (GAO) has identified over 700 commitments for trade regime reform and over 7000 goods and services for market access liberalization (www.gao.gov).

China’s WTO agreement deals with eight areas: trade framework, import regulation, export regulation, trading rights and industrial policies, agriculture, services, intellectual property rights, and safeguards and other trade remedies. The agreements also vary by type, and include issues related to definitions, reporting, transparency, laws and regulations, guidance, adherence to WTO, and nondiscrimination. Further, some of the agreements have a phase-in timetable stretching to 2016. China’s commitments regarding intellectual property rights and export regulation, however, were all due to be implemented upon accession, and the trade framework commitments were to be completed by the end of 2002. The commitments regarding the process of standardizing the technical barriers to trade as part of the import regulations were to be finished by the end of 2003. Each of the other four categories has longer phase-in periods before being complete, but a substantial part of these commitments were to be completed upon becoming a member as well.

WTO Adjustment: Compliance in the First Two Years

The first year of China’s membership in WTO progressed relatively smoothly and did not generate serious criticism from domestic players or other WTO members. WTO members, including U.S. officials, generally congratulated China on its progress during year one.¹ Many of the required tariff reductions had been met early and there was a flurry of activities related to the adjustment, including training and the passing of new laws and regulations. The China Society for WTO Studies, a non-governmental academic institution, released a positive analysis of China’s compliance. Their China WTO Report-2003 reportedly said that the intellectual property rights provisions had been “basically” met, and that China had strictly implemented its other obligations.² Benefits of membership, such as inflows of foreign direct investment, were emphasized in the domestic press.³ The first annual review of the WTO Transition Review Mechanism went forward without major controversy, although the level of information sharing was apparently less than expected by some of the participants.⁴

Foreign and domestic players expected year two to be more difficult, and they were right.⁵ A confluence of circumstances came together to create widespread discontent globally concerning China’s progress with meeting WTO commitments and the country’s international economic strategy generally. Internally, the Chinese government was dealing with a major leadership transition from Jiang Zemin to Hu Jintao, and the outbreak of a new virus, SARS, created a major health crisis for several months. Despite SARS, China’s economy grew at an annual rate of about 8% in 2002 and 2003. This growth fueled increasing amounts of imports of inputs and raw materials, which was a stimulus for many countries, but simultaneously large inflows of foreign capital into manufacturing in China helped stoke fears of massive job losses elsewhere. China’s pegged currency, which many analysts estimated was overvalued by at least 20 percent, and the large trade surplus with the U.S., led to strident calls by U.S. interests for Chinese officials to revalue the renminbi.

Against this backdrop, the normally scheduled evaluations of China’s WTO compliance progress went forward. Within China, the stance taken by the Chinese leadership was positive overall concerning China’s compliance progress. After the leadership change at the 16th Party Congress in October, 2002, press reports stressed that WTO commitments would be a high priority for President Hu Jintao and Premier Wen Jiabao.⁶ Lu Fuyuan, the Commerce Minister, was quoted as saying China has fulfilled its commitments in various ways, such as meeting the tariff reduction schedule on time or sometimes ahead of schedule.⁷ When information about new policy measures was announced, the fact that the measures were WTO compliant was often part of the press release.⁸ By fall, 2003, however, in the face of serious criticism from numerous quarters in the U.S., a Foreign Ministry spokesman stressed the seriousness with which China was taking its commitments, but also said that some “problems and unexpected difficulties” had been encountered.⁹

Of the individual WTO member countries, by far the most serious evaluation of China’s progress in meeting commitments has been undertaken by various public and private interests in the U.S. The conclusions of these in-depth analyses, especially for the second year ending December 11, 2003, have been quite negative for the most part. Key criticisms focused on lack of transparency and enforcement of intellectual property rights, slow movement to open international trading rights and the domestic distribution system to foreign companies, missed deadlines on issuing rules for foreign offerings of finance in the automobile industry, improper non-tariff barriers on agricultural products, unreasonably high capital requirements for foreign companies setting up operations in banking, insurance and telecom, and a whole list of commitments scheduled to be completed by December, 2003, that appear far from the end goal.

Beyond specific aspects of the WTO agreement that may be behind schedule, numerous interest groups within the U.S. have made serious public complaints against a wide range of trade and economic policies in China. For example, the U.S.-China Economic and Security Review Commission held hearings in September, 2003, on China’s industrial, investment and exchange rate policies (www.uscc.gov). On the basis of information collected during the hearings, the Commission issued recommendations to Congress to address alleged currency manipulation, export subsidies, dumping practices, unfair industrial policies, and private sector transfer of technology and research and development centers from the U.S. to China. The Commission interpreted these activities to be in conflict with WTO in principle if not specifically according to the letter of the Protocol. The National Association of Manufacturers also testified in Congress and issued various reports on their analyses of the damage China’s policies have had on manufacturing jobs in the U.S.(www.nam.org).

China’s Response and Context

Good international relations and an attractive business environment are important goals for China’s central leadership. The success of China’s economic reforms and growth are critically dependent on the global economy, and the U.S. economy in particular. As deadlines for particulars in the WTO agreement to be met by the end of 2003 approached, and as international political pressure rose over currency and trade imbalance issues, some concessions were hastily made.

In late 2003, China’s Ministry of Commerce and other governing bodies announced a number of decisions that addressed some of the WTO members’ concerns. For example, in the automobile industry, during the lead-up to membership, Chinese negotiators wanted to cushion the entrance of foreign firms into this sector to give Chinese companies more time to prepare. One victory for foreign firms was that foreign non-bank financial entities could begin to offer financing for purchases of automobiles along with Chinese firms, and that this was agreed to as of the date of joining. The rules for car finance companies, however, were not issued and Chinese banks were able to profit from the rapid growth of this type of lending. Meanwhile companies such as Ford, General Motors and Volkswagen had prepared to take advantage of this market opening. Finally, in October 2003, the Central Banking Regulatory Commission issued rules covering local and foreign business participation, and indicated that the rules for implementation would be published soon after.¹⁰ The timing of this announcement might have been coincidental, but it nonetheless signaled some progress at a crucial time.

In response to pressure concerning China’s large and growing trade surplus with the U.S., in late 2003 Chinese officials announced several moves to mitigate possible protectionist measures by the U.S. Congress. During a visit to Beijing in late October by the U.S. Commerce Secretary, Donald Evans, Chinese Premier Wen Jiabao promised to encourage Chinese companies to increase their imports from the U.S.¹¹ The proposed increase in purchases of U.S. goods came on top of the “Going Out” policy that was designed to encourage large Chinese companies to invest abroad, and new regulations allowing Chinese citizens to spend more foreign exchange to travel and study. Premier Wen met with a delegation of U.S. company representatives and the U.S.-China Business Council to discuss their concerns over market access. Chinese officials also announced that they would lower the value added tax rebate on exports beginning in January 2004, which would have a similar effect as raising the value of the Chinese currency by making exports more expensive.

Concessions on the currency issue were another matter. Officials indicated that floating the Chinese currency was premature given institutional and financial weaknesses in the banking system. While a flexible currency remains an explicit goal, the experiences of the Asian crisis made Chinese policy makers more cautious about opening the capital account and accepting the volatility and uncertainty of flexible exchange rates.

In line with these concerns, analysts and policy makers have been focusing on how to best restore the viability of the financial system and move ahead with reforms that would support financial strength in the future. The non-performing loan burden in the state banking system did not improve as much as had been hoped after moving bad debt to asset management companies in the late 1990s. Further reforms with respect to currency, interest rate determination and privatization of financial services all hinge on a solution to non-performing loans and assets in the state sector. To this end the state banks are being re-capitalized, and the State Council has decided to promote several dozen viable state companies to compete on international markets but to privatize much of the rest.¹²

These moves to push reforms further are in line with the decisions announced as part of the 3rd Plenary Session of the Chinese Communist Party in October 2003, to complete China’s transition to a market economy.¹³ The more progress that can be made to establish a sound market economy, the less of an issue the WTO commitments and trade imbalances will become. In addition, Chinese officials are pressing the U.S. to relax export restrictions on certain technology and information related products, and to move towards granting China the status of a market economy, which would be beneficial to China within the U.S. anti-dumping framework. These moves would be almost routine if the state-based parts of China’s economy were subject to market competition or were privatized completely.

In the current climate of intense global competition and shrinking manufacturing sectors, China faces tremendous pressure to meet its commitments on time and in full. The list of monitors is long, and transparency itself is increasing as part of the adjustment process. Ultimately success in compliance will be tied closely to success in establishing a market economy.