WTO Ministerial Section • Volume 12 • Number 19 • 28th May 2008
TPR Lauds China’s Rapid Growth But Calls for Addressing Economic Imbalances
China has enjoyed impressive economic growth since 2006 but faces challenges in the form of rising income inequality, a widening gap between savings and investment, as well as other economic imbalances, according to a review of the country’s economic policies conducted by the WTO.
China’s second Trade Policy Review (TPR), which was released by the WTO Secretariat last week, noted that the structural reforms, including trade liberalisation, that the country has enacted since its previous TPR in 2006 have significantly boosted the country’s economy, which reached a peak growth rate of over 11 percent in 2007. The review (WT/TPR/S/199) stated that China now ranks as the world’s third-largest economy, as well as its third-largest trader. Despite this increased stature and a rise in per capita income, the review pointed to several remaining challenges, including rising income inequality, a widening gap between savings and investment, and imbalances in growth driven more by investment and exports rather than by consumption.
Rapid growth and integration
China’s rise in per capita GDP from US$1,490 in 2004 to US$2,017 in 2006 was accompanied by a fall in poverty, as the number of people living on less than one dollar a day declined to 21.5 million people in 2006, down from 23.7 million in 2005. Real GDP growth in 2007 was 11.4 percent. Trade in goods alone constituted 65 percent of GDP and 13 percent of global trade in 2006. China continued to be a major recipient of foreign direct investment (FDI), the fourth largest in the world and largest among developing countries. Chinese overseas investment also grew to US$18.72 billion in 2007, more than ten times what it was just three years earlier.
On a less optimistic note, the report cited a widening gap between savings (comprising 54.4 percent of GDP) and investment (comprising 44.9 percent of GDP). However, an increase in revenues relative to expenditures led to a cut in the fiscal deficit from 1.3 percent of GDP in 2006 to 0.6 percent in 2007, and reduced public debt from 17.5 percent of GDP in 2005 to 16.3 percent in 2006.
The report also noted that China is suffering from a number of growing economic imbalances, including a reliance on investment and exports as sources of growth; inefficiency in allocation of capital owing to an under-developed capital market; and various forms of aid for manufacturing. Other negative impacts of economic growth include environmental degradation and a larger divide between urban and rural incomes.
However, the report acknowledged that China has taken steps since its previous review to increase the transparency of its economic governance, including establishing a bureau on corruption prevention and enacting legislation to regulate monopolies, bankruptcy proceedings, and property and tax law.
Export restrictions persist
Tariffs continue to be China’s primary trade policy instrument, although import duties accounted for only 3.3 percent of tax revenue in 2006. The report pointed to a reduction in China’s non-tariff barriers such as the number of tariff lines subject to automatic import licensing. Tariff rate quotas (TRQs) on soybean oil, palm oil, and some rapeseed oil were eliminated in 2006.
China granted most-favoured-nation (MFN) status to all WTO Members except El Salvador and some territories of EU member states. China’s average applied MFN tariff has held steady at 9.7 percent for the past two years, with average applied tariffs of 15.3 percent for agriculture and 8.3 percent for industry.
During the period under review, two free trade agreements (FTAs) concluded by China entered into force, the China-Chile FTA in October 2006 and the China-Pakistan FTA in July 2007, the same month that the services chapter of the China-ASEAN FTA also entered into force. Applied preferential tariffs in these bilateral deals range from 3.5 to 9.1 percent. Four additional two-way agreements - with Australia, the Gulf Cooperation Council, Iceland, and New Zealand - are currently in negotiations.
China continues to use various trade tools to promote investment in high technology, encourage innovation, and protect the environment (by, for example, reducing energy consumption). Such tools included tax incentives, non-tax subsidies, price controls, and various forms of “guidance,” including sector-specific industrial policies.
One interesting aspect of China’s trade policy is its use of export taxes, reduced VAT rebates, licensing requirements, and other trade measures to restrain, if not prohibit, exports of a considerable and growing number of products that use large amounts of natural resources and energy. A good example is China’s recent increase in interim duty rates on 142 tariff lines with a view to reducing exports of highly energy- and pollution-intensive products as well as those that consume large amounts of raw materials.
Agricultural support, energy price distortion
In a significant shift, China has recently moved from taxing agriculture to actively supporting farmers and farm productivity. According to the TPR report, China did away with most agricultural taxes in 2006, and farmers have been offered financial support since 2004. However, despite the additional aid from the government, agriculture’s contribution to GDP declined from 13.4 percent in 2004 to 11.8 percent in 2006, although it still accounts for 40 percent of employment (but only one-fifth of labour productivity).
Low agricultural productivity and continued labour surplus in the sector have helped fuel a growing divide between average incomes and living standards in rural and urban areas. In response, the government has sought to increase farm productivity by providing support for improved infrastructure, production technologies, and training. Moreover, to keep food prices stable and ensure adequate supplies, the government has intervened with subsidies, state trading, procurement, marketing and distribution, and TRQs, which have been maintained on cereals, sugar, wool, cotton, minerals and chemical fertilisers.
If agriculture is struggling, the industrial sector has flourished: manufacturing accounts for 92.4 percent of China’s merchandise exports. Although some incentives and export restrictions persist, in general the industrial sector is characterised by a relatively liberal trade regime,
While the large size of China’s industrial sector is partly responsible for the energy intensity of the country’s economy, the report also pointed out that price mechanisms for oil, coal, electricity and natural gas have artificially lowered prices, causing an overconsumption of energy. The second-largest energy user in the world, China is also the second-largest greenhouse gas emitter, thanks in large part to the fact that 70 percent of the country’s energy production comes from coal.
The report also noted that Chinese services sector has experienced a slower pace of liberalisation than have other parts of the economy, and that it still suffers from a lack of competition, restrictions on foreign investment, and a greater degree of state control.
Lack of access to external financing through capital markets also means that domestic firms continue to rely heavily on retained earnings (or funds raised from friends and family). However, the government has undertaken some initiatives to reform the banking sector as well as in service sectors such as telecommunications.
Challenges remain but good prospects for sustained growth
The report outlined a number of potential areas for reform. Specific recommendations include measures to lessen rural-urban income disparities, facilitate the movement of surplus farm labour into other activities such as services, encourage technological progress, raise expenditures on research and development, and increase spending on health, education, and pensions. Greater social services spending would also increase consumption and make people less reliant on savings, which in turn would reduce China’s reliance on exports as a driver of growth. Such a development could narrow the gap between gross domestic savings and investment and further reduce China’s current account surplus.
The report also called for a gradual dismantling of price controls and other impediments to the efficient allocation of land, energy, water, and other natural resources. Such changes would promote stronger environmental protection, especially if supplemented by market-based instruments that require polluters to pay for the damages they cause.
The report also highlighted the need for greater flexibility in exchange rates, which could help lower inflation and thus obviate the need for price controls and non-market measures.
While the report noted the World Bank’s prediction that China’s growth will slow to 9.6 percent for 2008, it forecasted that the Asian giant will be able to enjoy sustained economic growth in future, though at a slower rate as the country’s economy matures and labour force shrinks. Such continued growth could be fuelled by China’s vast human resources, high rate of investment in physical and, to a lesser extent, human capital, strong growth in labour productivity, and an increasingly market-oriented economy that is open to international trade and foreign investment (and associated technology).
US critical; China responds
During the review, the US raised concerns about a number of Chinese trade policies, including the country’s export restrictions on many commodities, its use of unique national standards where international standards already exist, its weak enforcement of intellectual property rights, and its increasingly restrictive investment regime. The US also urged China to take on a greater leadership role in the Doha Round, particularly in each of the three core areas of the negotiations - agriculture, industrial goods, and services.
China, however, in a response statement, pointed to the active role that it has played in the negotiations and asserted that under the mandate of placing development at the heart of the round, more attention should be paid to the interests of developing country Members throughout the DDA negotiations. It also called attention to the Chinese government’s first-ever donation to the WTO in February 2008 to support other developing country Members and enhance their capacity to participate in international trade. China also pointed out its grant of duty-free treatment to 41 least-developed countries for most products they were able to export, accounting for 97.9 percent of their total export volume to China in 2007.
ICTSD reporting.