Chapter

12 The Impact of WTO Accession

Author(s):
Wanda Tseng, and Markus Rodlauer
Published Date:
February 2003
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Author(s)
Thomas Dorsey,, David Robinson,, Yongzheng Yang, and HARM ZEBREGS 

After 14 years of negotiations, China acceded to the World Trade Organization (WTO) on December 11, 2001. A key step in negotiation of the final agreement, the U.S.-China bilateral agreement, was reached on November 15, 1999, and is generally regarded as the core of the final agreement. Because this document was made public at the time the agreement was reached, whereas other bilateral agreements have not been, there has been greater opportunity to assess its impact, and some of the material referenced below is based on this bilateral agreement. More recently, an official summary by the WTO of the entire agreement has been released, and the first outside assessments of the entire agreement are now becoming available (WTO, 2001). Some additional information is available on the bilateral agreements with the European Union and with other countries, even though the texts of these agreements have not been made public. The summary of the key features of the agreement below is based on the WTO summary and, to a lesser extent, the U.S.-China bilateral agreement (Boxes 12.1 and 12.2 provide additional detail):

  • China will reduce tariffs on nonagricultural products (which account for 95 percent of its imports) to 8.9 percent by 2005, and tariffs on agricultural products to 15 percent by January 2004;1 eliminate quotas and nontariff restrictions on industrial products by 2005; introduce a new tariff rate quota system in agriculture; and provide full trading and distribution rights to foreign firms.

  • China will significantly expand market access in the services sector, among other things by eliminating geographic and other restrictions in most key industries by 2005; increasing foreign ownership limits in telecommunications to 50 percent by 2002; opening import-export, wholesale, and retail trade to foreign enterprises; opening the life insurance and securities businesses to foreign investment (for life insurance, allowing ownership of up to 50 percent on accession, and for securities, to 49 percent by 2003); and giving full national treatment to foreign banks (by 2005).

  • WTO members maintaining textile quotas under the WTO Agreement on Textiles and Clothing—including the United States, the European Union, and Canada—will eliminate quotas on China’s textile imports by January 1, 2005. This will put China on a par with the founding members of the WTO, but this opening is subject to special safeguard provisions through 2008. The United States has granted China permanent normal trade relations status, which was approved on December 27, 2001.

  • China will eliminate trade-related investment measures (such as minimum levels of domestic content of output, and minimum export requirements) and will not enforce any such requirements in existing contracts or agreements from the date of accession.

The European Union concluded its bilateral agreement on WTO accession with China on May 19, 2000. It has released a brief summary of the contents insofar as they affect EU exporters and investors. On trade in goods, the agreement provides for additional tariff reductions for products of particular interest to European exporters (alcoholic beverages, textiles, leather products, ceramics, glass, and machinery and appliances), liberalization of fertilizer import quotas and the silk export monopoly, and reductions in tariffs applied under agricultural tariff rate quotas for important European agricultural export products such as rape oil, pasta, butter, and olives. On trade in services, the agreement provides for acceleration of mobile telephone service liberalization by two years after accession, effective management control by foreign partners in 50–50 life insurance joint ventures, and other measures liberalizing trade in banking and insurance beyond the provisions of the U.S. bilateral agreement.

In addition to the United States and the European Union, some 35 other WTO members conducted bilateral negotiations with China, with results also reflected in the final agreement. As is standard practice with WTO accession negotiations (and had been standard practice in negotiations on accession to the General Agreement on Tariffs and Trade), this was followed by multilateral negotiations on China’s accession protocol to tie the bilateral agreements together and resolve some overarching issues. These multilateral negotiations also had to be completed before accession, and the process of modifying China’s laws and regulations to be consistent with China’s WTO obligations is well under way.

Box 12.1.Main Elements of China’s WTO Accession Agreement

Agriculture

China will:

  • Reduce average tariffs for agricultural products from 20 percent to 15 percent

  • Establish a tariff rate quota system for bulk commodities (including wheat, cotton, and rice), with quotas increasing over time, and subject to tariffs between 1 and 3 percent, and eliminate export subsidies on cotton and rice and limit subsidies on production to 8.5 percent of the value of farm output

  • Give foreign exporters the right to sell and distribute imported goods directly to consumers on the mainland, without going through state trading enterprises or other specified middlemen.

Industrial goods

China will:

  • Reduce average tariffs from 18½ percent in 1998 to 8.9 percent, mostly by 2004 but in no case later than 2010, with particularly large cuts for automobiles, high-technology products, wood, and paper

  • Eliminate quotas and nontariff restrictions within five years (and most in 2002–03); in the interim, base-level quotas will grow at 15 percent annually

  • Give foreign companies full trading and distribution rights for imported goods.

Services

China will:

  • In telecommunications, join the Basic Telecommunications Agreement, phase out all geographic restrictions on services in five years, and permit 49 percent foreign ownership in all telecommunications services within three years of accession

  • In insurance, phase out geographic and service restrictions over two to five years, permit 50 percent foreign ownership in life insurance and 51 percent ownership in nonlife insurance on accession (the latter rising to 100 percent in two years), and, for reinsurance and large-scale commercial risks, ensure completely open markets within five years of accession

  • In banking, allow foreign banks to conduct local currency business with Chinese enterprises after two years, and retail business after five years, and allow nonbank companies to offer automobile financing on accession

  • In the securities business, allow foreign firms to hold minority stakes in securities funds, with maximum shares rising from 33 percent initially to 49 percent after three years

  • In distribution and sales, allow foreign companies with existing domestic investments to undertake wholesale business with a Chinese partner on accession, allow foreign-invested retail business in a limited set of major cities on accession with all quantitative and geographic restrictions removed by January 2003, and allow foreign firms full access to import and export rights three years after accession

  • In other services, allow foreign firms with foreign majority control to provide a broad range of professional services, including accountancy, taxation, and management consultancy; allow foreign movie companies to form joint ventures for distribution of video and sound recordings; and allow 100 percent foreign ownership of hotels in three years.

Other WTO members will:

  • Eliminate import quotas on China’s textile and clothing exports maintained under the WTO Agreement on Textiles and Clothing by the end of 2004, subject to special safeguard provisions through 2008

  • Maintain current antidumping methodology (treating China as a non-market economy) for 15 years after accession.

This chapter discusses the potential impact of WTO accession on China, on the assumption that the U.S.-China agreement approximates the final terms of accession. Given the limited detail presently available, the analysis seeks only to review the impact in broad terms, focusing on the main channels through which China will be affected, the potential risks, and the policy implications.

Background

Over the past two decades, the opening of the external sector has been a key element of China’s economic reforms. The exchange rate regime has been unified, a national foreign exchange trading regime established, and the trade and foreign investment system substantially liberalized.

Since the mid-1980s an essentially dualistic system has emerged:

  • The regime for export processing, which covers goods produced entirely for export and is dominated by foreign invested enterprises (FIEs), is very liberal; imports of inputs and investment goods are duty free, and most enterprises can engage directly in foreign trade.

  • The system for other (“ordinary”) trade, however, remains quite restrictive. Tariff rates are relatively high and widely dispersed, and there are substantial exemptions and numerous and frequently overlapping nontariff barriers, including restrictions on trading rights and distribution (which must be undertaken by Chinese firms).

  • Foreign direct investment in the export-oriented manufacturing sector has been substantially liberalized (as is reflected in the rapid growth of processing trade), but significant constraints remain on investment in the services sector and in production for the domestic market. Foreign investment in telecommunications is essentially forbidden, activities of foreign insurance companies and banks are severely restricted, and distribution and trading rights are very limited.

Box 12.2.Financial Sector Components of China’s WTO Accession Agreement

Banking Sector

Currently, foreign banks are not permitted to do local currency business with Chinese clients (although a few can engage in local currency business with their foreign clients), and China imposes severe geographic restrictions on the establishment of foreign banks. China has made commitments to full market access in five years for foreign banks, as follows:

  • Foreign banks will be able to conduct local currency business with Chinese enterprises starting two years after accession.

  • Foreign banks will be able to conduct local currency business with Chinese individuals starting five years after accession.

  • Foreign banks will have the same rights as Chinese banks (that is, national treatment) within designated geographic areas within five years.

  • Both geographic and customer restrictions will be removed in five years.

Nonbank Financial Institutions

China has made commitments for nonbank foreign financial institutions to be able to provide automobile financing upon China’s accession. This, in combination with commitments regarding importation, distribution, sale, financing, and maintenance and repair of automobiles, will help open up this key sector to foreign competition.

Securities Business

China will permit minority foreign-owned joint ventures to engage in fund management on the same terms as Chinese firms. As the scope of business expands for securities firms, Chinese and foreign joint venture companies will benefit equally. Minority joint ventures will be allowed to underwrite domestic securities issues and underwrite and trade in foreign currency-denominated debt and equity securities.

Insurance Business

Currently, foreign companies may operate only in Shanghai and Guangzhou. Under the agreement:

  • Geographic limitations. China will permit foreign property and casualty firms to insure large-scale risks nationwide immediately upon accession and will eliminate all geographic limitations in three years.

  • Scope. China will expand the scope of activities for foreign insurers to include group, health, and pension lines of insurance, which represent about 85 percent of total premiums, phased in over five years.

  • Prudential criteria. China agrees to award licenses solely on the basis of prudential criteria, with no economic needs test or quantitative limits on the number of licenses issued.

  • Investment. China agrees to allow 50 percent ownership for life insurance. Life insurers may now choose their own joint venture partners. For nonlife, China will allow branching or 51 percent ownership on accession and form wholly owned subsidiaries in two years. Reinsurance is completely open within five years of accession.

On the export side, China receives most-favored-nation (MFN) treatment from most countries; the main constraints on its exports that will be affected by accession are quotas previously administered under the Multi-Fibre Arrangement, which will now fall under the WTO Agreement on Textiles and Clothing. China provides export subsidies on some agricultural products (mainly cotton and rice).

China’s trade and investment structure has the following characteristics:

  • Processing trade, mainly of labor-intensive textiles, apparel, and electronic goods, accounts for about 55 percent of total exports. About 47 percent of imports consist of inputs for the processing industry and investment goods for FIEs and export processing enterprises; these imports are largely exempt from tariffs.

  • Ordinary trade—conducted primarily by state-owned enterprises (SOEs) and collectives—accounted for 42 percent of total exports and about 44 percent of imports in 2000.

  • Tariff revenues in 1999 were about $4 billion, or 10 percent of ordinary imports. This is well below the weighted-average tariff of 18.7 percent, suggesting that there are significant additional exemptions or collection difficulties—including smuggling—in the system.

  • Foreign direct investment has been concentrated in manufacturing, with only 27 percent of inflows directed to the services sector.

The structure of China’s trade suggests that WTO accession will affect only about half of present trade flows, since the export processing sector is likely to be relatively unaffected in the short term. Moreover, the impact of tariff reduction may be less than the raw numbers suggest, to the extent that the protective effect of tariffs has been eroded through substantial exemptions or smuggling.

The Sectoral Impact

This discussion of the sectoral impact of the WTO accession agreement focuses on the implications for trade in goods and services and foreign direct investment flows, and for the financial sector and financial stability. Given the limited data and limited basis for extrapolation from experience in those sectors from which foreign investors are largely excluded, the analysis focuses primarily on a qualitative discussion of the affected sectors and their relative importance in the economy, as a backdrop for the quantitative projections later in the chapter.

On the trade side, as noted above, WTO accession will primarily affect ordinary trade flows that come in under the regular trade regime. The impact will depend on the phasing of the agreement, on the interaction between tariff reductions and the elimination of quantitative restrictions, and, last but not least, on the extent to which other barriers to trade remain.2 However, the main effects expected are as follows:

  • Initially, trade liberalization is likely to increase competitive pressures in the agricultural sector, in the automobile industry, and among some capital-intensive producers in the domestic market (including telecommunications and certain petrochemicals; see Lardy, 2002, and Box 12.3 for a summary of market views of gaining and losing industries). Given that these sectors account for relatively small proportions of output, exports, and imports, the impact on growth and the balance of payments may be relatively limited. However, because the agricultural sector is highly labor intensive (Table 12.1), the impact on employment may be more pronounced. Offsetting this would be a modest boost to ordinary exports (due to the lower cost of imported inputs) and diversification into high-value-added agricultural products for export; enterprises in the transportation sector would also benefit.

  • Liberalization in the services sector is likely to lead to a considerable increase in foreign direct investment. This would likely be concentrated in the telecommunications, insurance, securities, banking, and retail industries, and to a lesser extent in the manufacturing sector as manufacturing-related services are liberalized. Once liberalization of direct investment in the distribution sector has been completed, there is likely to be a further increase in imports, because the requirement that foreigners use Chinese distributors has been a major constraint on imports.

  • Beginning in 2005 the elimination of textile and clothing quotas will result in a substantial increase in textile exports. With textiles and clothing already accounting for 4¼ percent of GDP and 22 percent of exports, the impact on growth and exports could be substantial.3

  • Finally, as the effects of increased competition feed through into efficiency gains, total factor productivity (TFP) growth should rise. Although precise estimates are obviously difficult, cross-country evidence suggests that the impact could be significant: annual TFP growth in moderately outward-oriented countries is 2 percentage points higher than in moderately inward-oriented ones (IMF, 1993). Obviously, much will depend on the speed with which supporting reforms in the SOE and financial sectors are undertaken.

Table 12.1.Economic Structure of Sectors Affected by WTO Accession, 1995(In percent)
Sector and IndustryOutput as Share of TotalLabor Force as Share of TotalExportsImportsExports as Share of OutputOrdinary Exports as Share of OutputImports as Share of Domestic UseOrdinary Imports as Share of Domestic Use
Agriculture
Rice1.811.80.00.10.00.00.60.5
Wheat0.96.00.00.90.00.07.26.6
Other grain1.49.00.30.31.61.62.01.8
Cotton0.42.80.00.70.60.611.87.3
Industry
Textiles5.11.712.97.921.013.413.50.9
Apparel2.20.79.20.233.814.21.20.0
Automotive1.50.40.41.60.31.111.19.5
Chemicals7.71.99.514.510.66.314.76.2

Box 12.3.Market Views on Sectoral Winners and Losers

Once agreement was reached with the United States in mid-November 1999 on the terms of China’s accession to the WTO, investors moved quickly to reward potential winners and punish potential losers among companies listed on China’s two domestic stock markets and in Hong Kong SAR. The initial market reaction was generally favorable for listed firms in trade-dependent sectors (shipping, ports, civil aviation, railways, and coastal expressways) and for exporters of light industrial products (color television sets, textiles, toys, and shoes), but negative for companies in the services and high-technology sectors and for heavily protected primary and industrial producers (agriculture, automobiles, steel, and petrochemicals). In the immediate aftermath of the agreement, share prices of textile issues, port operators, and trading companies rose particularly sharply (by well over 10 percent in some cases), while those of automobile and telecommunications companies dropped significantly (in some cases also by well beyond 10 percent).

However, the price markups of the perceived winners proved short-lived, and profit taking quickly set in, eliminating or reversing most of the earlier gains by the end of 1999. This correction in part reflected the market realization that the benefits—as well as the costs—of WTO accession would take several years to materialize. Market reaction on the domestic A-and B-share markets was also weighed down by underlying concerns about the weak earnings outlook of Chinese corporations, and by the expectation that new listings would rise sharply on the A-share market in the near term as SOEs sought to raise cash to finance restructuring plans. (A-shares are denominated in local currency and available only to domestic investors; B-shares are denominated in dollars and until February 2001 were available only to foreign investors.) In Hong Kong SAR concerns over intensified competition on the mainland as a result of WTO entry, and the continued perception that most China-related companies were not managed to the same standards of transparency and competitiveness as other listed firms, eventually dampened investor sentiment.

There was also significant differentiation among companies within the losing sectors during this period. For example, although many automotive stocks fell sharply, companies with large truck and minibus operations—which are believed to be competitive—or with extensive domestic distribution networks were generally unaffected. Similarly, although agriculture is widely viewed as one of the biggest overall losers from accession, there was little impact on listed agricultural concerns, because the market believed the sector would continue to be protected. Further, although the telecommunications sector has been branded as a loser by many analysts, the share price of China Telecom (since renamed China Mobile) in Hong Kong SAR nevertheless continued to rise because of its strong near-and medium-term prospects. The company was adding new subscribers at a rate of 300,000 a month and seemed likely to remain the dominant player on the domestic market for many years to come. The picture was also mixed within the petrochemicals sector: naphtha and ethylene producers (who already faced low import duties) generally fared much better than polyester and plastic producers (who currently benefit from relatively high duties). Finally, although the steel sector has also generally been considered a loser, the market tended to view producers that had been affected by U.S. antidumping proceedings in the past—particularly those making cold rolled steel—as potential beneficiaries of WTO entry.

The reforms associated with China’s WTO accession include a substantial liberalization of the financial system: foreign banks will be allowed to conduct business in domestic currency with Chinese firms after two years, and with retail customers after five years. Restrictions on foreign participation in the securities business, on automobile financing by nonbank institutions, and in the fast-growing insurance business will also be substantially reduced (Box 12.2). Given the extremely small foreign market shares in these industries (at mid-1999, foreign banks accounted for 1.6 percent of bank assets), these represent potentially enormous changes.

With the assets of the Chinese banking system close to $1 trillion, the market share of foreign banks is likely to remain modest for a considerable period. In the initial stages, most foreign banks are likely to focus on servicing the renminbi needs of foreign companies, high-net-worth individual depositors, and perhaps a few domestic blue chip companies. The scope for this business will be constrained by the lack of a deposit base and the limited development of the interbank market. The main risk to domestic banks is that their best borrowers will migrate to foreign banks, thus worsening the overall quality of their portfolios.

With a few exceptions, foreign banks are unlikely to seek to develop retail networks of their own (which are very expensive) or, given the state of the legal and accounting frameworks in China, to start lending to riskier second-tier borrowers. One niche market that may prove attractive to foreign banks is electronic banking for high-income customers. The experience in other countries has been that foreign banks take equity shares in domestic banks (Box 12.4). It is unclear at this stage whether this will be permitted in China, but it has the potential to give foreign banks access to domestic currency and the Chinese banks access to foreign bank know-how and additional capital.

The Macroeconomic Impact

Some tentative estimates can be offered of the overall macroeconomic impact of WTO accession over the period 2002–05. It is assumed that the underlying stance of macroeconomic policies remains unchanged and that efforts at structural reform in the banking and SOE sectors are accelerated. Given the limited data, the estimates are based primarily on the IMF staff’s medium-term macroeconomic model, centered on a simple Cobb-Douglas production function and standard trade equations. Although the sectoral analysis of the previous section has been used where possible, the macroeconomic analysis depends importantly on a variety of key assumptions and should be treated as largely illustrative in nature.

Because China’s WTO membership became effective only in December 2001, it is assumed that there is little impact on the economy until 2002. Thereafter the main effects (Table 12.2) are the following:

  • Between 2000 and 2004 the external current account deteriorates compared with the baseline projection, but it rebounds in 2005 as textile and apparel exports rise sharply. Imports of goods and services are projected to rise by about 8 percent above baseline by 2005, reflecting the impact of the tariff reduction and increased foreign direct investment. Exports of goods and services increase by only 2¼ percent above baseline by 2004. However, exports increase by an extra 7¾ percent (relative to baseline) in 2005 because of the elimination of the textile and clothing quotas. As a result, the external current account deficit deteriorates by $21 billion (1½ percent of GDP) in 2004 but improves considerably thereafter.

  • The short-term deterioration in the current account is, however, partly offset by increased foreign direct investment in the services sector, which is assumed to almost double (relative to baseline) to $17 billion. Foreign direct investment in the manufacturing sector, however, initially falls as the reduction in tariff barriers eliminates the rationale for some of the inflows, but it rises above baseline in the medium term. Nevertheless, the overall balance of payments remains in surplus over the period.

  • GDP growth is about ¼ percentage point lower than the baseline in 2001, but thereafter it exceeds the baseline forecast by increasing amounts. Initially, the negative impact of trade liberalization on output—modeled by an assumed increase in the depreciation rate of the capital stock due to accelerated corporate restructuring—is only partly offset by the expansionary impact of increased foreign direct investment and higher exports. From 2003 onward, however, GDP growth is raised by faster TFP growth as restructuring begins to bear fruit, and in the later years by an increasing boost from the textile industry as textile and clothing quotas are abolished.

  • Although output falls only modestly, labor market pressures could increase in the short run, especially in the labor-intensive agricultural sector. Li and Zhai (1999) estimate that an additional 2 percent of the workforce (mainly in rural areas) will need to be reemployed in other sectors over the next five years.4 Although some rural workers with good land will be able to switch to higher-value-added crops, the World Bank’s assessment is that those on marginal land could be seriously adversely affected, increasing poverty and urban migration. In urban areas, given the already existing labor market pressures, the scope for reemployment will be limited until textiles and other emerging industries start to pick up.

  • At least in the initial period, the reforms associated with WTO accession may widen income disparities. The export-intensive coastal provinces gain, while the inland provinces, which contain the bulk of the state enterprises and agricultural production, lose. Rural-urban income disparities are also likely to increase.

  • The direct budgetary impact of tariff cuts is relatively modest. In the short run, the tariff cuts are likely to lower revenue by 0.1-0.2 percent of GDP, but this loss is modestly offset by the impact of rising imports and reduced smuggling. There will also, however, be additional expenditure pressures due to rising urban unemployment and possibly weakening rural incomes.5

Table 12.2.Differences Between WTO Accession and Baseline Scenarios
Difference200020012002200320042005
In real GDP growth (in percentage points)0.00.0–0.30.10.60.8
In CPI inflation (annual average, in percentage points)0.00.0–0.6–0.6–0.5–0.2
In current account balance (in billions of dollars)0.00.00.2–5.7–12.4–10.5
In change in reserves (in billions of dollars)0.00.0–0.7–4.7–13.0–2.9
Source: IMF staff estimates.Note: CPI, consumer price index.
Source: IMF staff estimates.Note: CPI, consumer price index.

Box 12.4.Opening to Foreign Banks: Experience in Other Transition Economies

The current situation in the Chinese banking sector has some similarities with the prereform situation in a number of transition economies in Eastern Europe, namely, the Czech Republic, Hungary, Poland, and the Slovak Republic. When these countries began to liberalize their banking systems, the balance sheets of the majority of their banks also showed substantial amounts of nonperforming loans, which had resulted from directed lending to SOEs under the command economy. Like China, these countries also lacked a credit culture and had weak bankruptcy laws. Hungary and Poland have since made considerable progress in restructuring and modernizing their banking systems; however, reforms in the Czech Republic and the Slovak Republic are lagging, and state-controlled banks still account for a significant share of banking sector assets.

In Poland and Hungary, foreign banks appeared on the scene in the early stages of restructuring. After an initial cleansing of balance sheets and partial recapitalization by the government, state banks were privatized, and in a number of cases the new owners—often foreign banks—made up the remainder of the recapitalization. When Poland commercialized its banks in 1991, “twinning” arrangements were put in place (with World Bank support) to facilitate the transfer of banking know-how and integrate the banks into the international banking system. In Hungary, the activities of banks with foreign ownership and the privatization of several banks after 1995 greatly facilitated the sound development of the entire banking industry. Competition and efficiency of the sector improved markedly, the range of services expanded, and their quality improved greatly.

In the Czech Republic, subsidiaries and branches of foreign banks have been catalytic in improving the scope and quality of banking services and promoting financial innovation. By rapidly increasing their market share, especially among prime borrowers—mainly foreign and exporting customers—they have been exerting pressure on domestic banks to improve their efficiency. In the Slovak Republic, where banking sector reforms have not advanced as far as in the other three countries, the foreign equity share in the banking sector has increased significantly, leading to increased competition.

In all four countries the entry of foreign banks seems to have had a positive impact on the domestic banking sector, by increasing competition, introducing new knowledge, and providing funds for recapitalization. However, increased competition and new prudential regulations (tighter provisioning requirements, higher capital adequacy ratios) have led banks to become more conservative in their lending.1 As a result, only large, highly creditworthy borrowers tend to have access to bank credit, whereas small and medium-size companies still face difficulties. For example, in the Czech Republic, branches of foreign banks mainly cater to foreign-owned and exporting companies.

1 This also occurred in the run-up to privatization, when banks cleaned up their balance sheets by reducing their exposure to risky borrowers to obtain funds for recapitalization or to increase the chances of attracting foreign investors. Another important factor in domestic and foreign banks’ lending behavior has been the legal framework. Bankruptcy laws in transition economies tended to favor debtors over creditors, contributing to risk aversion on the part of banks.

Table 12.3 compares these estimates with those of other analysts. Although the assumptions underlying the various estimates often differ, the projection of this chapter for the impact on GDP is close to the average of the estimates; however, the projections for export and import growth are at the low end of the range. This primarily reflects the fact that some analysts do not distinguish between processing and nonprocessing trade, as well as differences in the timing of the impact of textile liberalization (which some analysts assume will be fully felt by 2005).

Table 12.3.Estimates of the Domestic Macroeconomic Impact of China’s WTO Accession
Change in Indicator from Baseline at

Indicated Date (in Percent)
Source of EstimateGDPImportsExports
Rosen112 (long run)12 (long run)
U.S. International Trade Commission24 (2010)14 (2010)12 (2010)
Li and Zhai31.5 (2005)26 (2005)27 (2005)
Zheng and Fan40.6 (long run)5.5 (long run)9.1 (long run)
Walmsley and Hertel58.7 (2020)35.2 (2020)39.4 (2020)
This chapter1.8 (2005)8.6 (2005)7.7 (2005)
Sources: Rosen (1999), U.S. International Trade Commission (1999), Li and Zhai (1999), Zheng and Fan (2001), Walmsley and Hertel (2000), and IMF staff estimates.

Partial-equilibrium analysis based on China’s April 1999 offer (close to the U.S. bilateral agreement).

Based on China’s April 1999 offer, using China-WTO model.

Appears to be based on China’s April 1998 offer; includes full Multi-Fibre Arrangement liberalization by 2005.

Single-country general-equilibrium analysis based on China’s April 1999 offer. Analyzes tariff reductions only.

Based on China’s August 1998 offer. Analyzes tariff reductions and the removal of Multi-Fibre Arrangement quotas by 2005.

Sources: Rosen (1999), U.S. International Trade Commission (1999), Li and Zhai (1999), Zheng and Fan (2001), Walmsley and Hertel (2000), and IMF staff estimates.

Partial-equilibrium analysis based on China’s April 1999 offer (close to the U.S. bilateral agreement).

Based on China’s April 1999 offer, using China-WTO model.

Appears to be based on China’s April 1998 offer; includes full Multi-Fibre Arrangement liberalization by 2005.

Single-country general-equilibrium analysis based on China’s April 1999 offer. Analyzes tariff reductions only.

Based on China’s August 1998 offer. Analyzes tariff reductions and the removal of Multi-Fibre Arrangement quotas by 2005.

Although these projections are obviously very tentative, three broad conclusions that are relevant for policy can be drawn:

  • On the central scenario of this chapter, it seems unlikely that WTO accession will lead to significant pressures on GDP growth or the external accounts in the short run.

  • If developments were markedly less favorable than expected—for instance, if foreign direct investment did not increase at all—the overall balance of payments would still remain in surplus, although GDP growth would be somewhat slower (about ½ percentage point below baseline over 2002–04).

  • In the initial period, before the beneficial effects of faster TFP growth and the elimination of textile and clothing quotas are felt, labor market pressures may increase.

The Impact of China’s Accession on Other Countries

China’s sheer size means that its entry into the WTO will lead to significant changes in world trade and investment flows. China is already the world’s second-largest economy in purchasing power parity terms, as measured by the World Economic Outlook staff, and the eighth largest in terms of trade; its foreign direct investment inflow has been the world’s second largest (after that of the United States) in recent years.6 The recent increase of foreign direct investment into Hong Kong SAR also seems to have been linked to China’s WTO entry: many foreign investors have used Hong Kong SAR as a base to ready themselves for investment opportunities in China.

Countries will tend to benefit from China’s WTO accession in proportion to the degree of complementarity between their trade patterns and China’s. Countries whose import and export patterns are similar to China’s patterns of prospective trade growth will be adversely affected or benefit less. Countries whose export patterns are similar to China’s import demands, on the other hand, will be able to increase exports to China more than other countries and will compete less with China in the rest of the world. On the import side, a country that relies on the world market for the same products as China may have to pay higher prices for its imports.

China’s accession to the WTO is expected to make it more attractive to foreign investment, especially FDI. This may be detrimental to countries that compete with China for foreign capital. However, countries that have been competing with China for foreign direct investment often also invest in China. This is especially true of a number of countries in East and Southeast Asia. These countries should benefit from increased and better investment opportunities in China after its WTO accession. If some of these countries indeed lose FDI inflows, they should be at least partially compensated by improved returns on investment in China.7

The estimates of the impact of China’s WTO accession are based on a simulation of a global general-equilibrium model developed by the Global Trade Analysis Project (GTAP).8 This model is best suited to capture the medium-term static impact of China’s WTO accession; it does not include sophisticated modeling of capital markets. The simulated policy changes include tariff reductions and tariff rate quota commitments in agriculture; assumed cumulative productivity improvements of 2 percent in the merchandise sector and 4 percent in the services sector by 2006; and the abolition of Multi-Fibre Arrangement quotas on Chinese textile and clothing exports. The assumed productivity improvement is intended to capture the likely dynamic gains arising from, among other things, accelerated reform, increased technology transfer, and innovation and institutional changes. The simulation results are benchmarked against a baseline projection for 2006, which incorporates Uruguay Round trade reforms.9

The results show an overall gain in welfare for the rest of the world from China’s WTO accession. The industrial countries and the Asian newly industrializing economies benefit from China’s accession (Table 12.4), but the impact is quite small relative to their economies. The underlying factors that determine the benefits to these two groups of countries are quite different. The industrial countries benefit primarily from their own action: removing quotas on textile and clothing imports from China. Increased export opportunities in China also improve the economic welfare of the industrial countries but are of secondary importance.10 In contrast, the newly industrializing economies benefit primarily from the expansion of their exports to China, whereas they lose from the removal of the textile and clothing quotas on China, because these economies compete with China in textile and clothing as well as in other labor-intensive goods.

Table 12.4.Projected Impact of China’s WTO Accession, 2006
Country Group or RegionWelfare Change1

(In Billions of

1998 Dollars)
Change (in Percent)
In

GDP
In terms

of trade
In export

volume
In import

volume
Industrial countries10.40.020.20.60.6
Asian NIEs21.40.010.20.50.7
ASEAN3–1.2–0.03–0.30.0–0.5
South Asia–2.9–0.16–1.6–3.0–5.6
Latin America–0.30.00–0.10.2–0.2
N. Africa and Middle East–0.7–0.03–0.1–0.2–0.7
Southern Africa Customs Union4–0.0–0.01–0.10.0–0.3
Rest of Africa–0.10.000.00.1–0.1
Rest of world–0.3–0.01–0.1–0.1–0.3
Total (excluding China)6.20.010.10.40.2
Source: IMF staff simulation of the GTAP model.

Measured by equivalent variation, an approximate indication of the change in real consumption.

Newly industrializing economies (Hong Kong SAR, Republic of Korea, Singapore, and Taiwan Province of China).

Excluding Singapore.

Botswana, Lesotho, Namibia, South Africa, and Swaziland.

Source: IMF staff simulation of the GTAP model.

Measured by equivalent variation, an approximate indication of the change in real consumption.

Newly industrializing economies (Hong Kong SAR, Republic of Korea, Singapore, and Taiwan Province of China).

Excluding Singapore.

Botswana, Lesotho, Namibia, South Africa, and Swaziland.

Other regions listed in Table 12.4 tend to lose from China’s WTO accession, but in most cases the losses are marginal. Apart from South Asia, no region experiences a change in GDP in excess of 0.03 percent of GDP. Even South Asia suffers a GDP decline of only about one-sixth of 1 percent in 2006, although exports contract by 3 percent. Both South Asia and the ASEAN members (excluding Singapore) suffer from China’s increased competition in the textile and clothing industry because of their heavy reliance on exports of these two commodities.11 The greater competition leads to significant declines in the prices of these commodities. In addition, both regions are projected to be net importers of grain, whose relative price increases because of China’s increased import demand. (Table 12.5 shows projections of net exports by region and by industry.) The combined effects of these price changes are reflected in the deterioration of the terms of trade for the ASEAN members and South Asia. The Middle East and North Africa are also estimated to experience a small decline in GDP even though the region is less dependent than developing Asia on textile and clothing exports; its large net agricultural imports lead to a larger decline in its terms of trade than for other regions outside Asia. Despite significant exports to China, the region’s large mineral sector hardly benefits from China’s accession to the WTO, because China’s tariffs on these commodities are already low.

Table 12.5.Projected Net Exports by Region and Product Type Following China’s WTO Accession, 2006(In billions of dollars)
Product TypeChinaIndustrial CountriesNIEsASEANSouth AsiaLatin AmericaN. Africa

and

Middle East
SACURest of AfricaRest of World
Grain–0.722.4–3.8–3.6–2.5–1.8–8.00.0–1.1–0.9
Other food crops–14.4–2.3–14.93.7–7.546.3–5.71.78.4–15.4
Animal products–7.128.5–6.2–3.3–1.10.2–6.60.1–0.7–3.7
Other agricultural–5.53.1–2.6–1.7–2.1–0.50.40.14.14.7
Mineral products–2.0–146.9–36.87.4–6.031.1110.05.524.013.6
Textiles7.8–19.818.12.28.4–2.6–4.5–0.6–1.6–7.3
Clothing23.5–122.24.131.056.72.64.8–0.10.0–0.2
Machinery and equipment43.0161.342.70.5–18.4–54.8–72.7–13.7–16.4–71.6
Other manufactures54.223.3–20.0–14.0–19.4–15.6–15.07.8–8.57.2
Services–1.911.811.29.8–3.3–8.18.6–0.6–11.5–16.1
All goods and services96.9–40.7–8.132.04.8–3.311.10.1–3.1–89.7
Source: IMF staff simulation of the GTAP model.

Note: NIEs, newly industrializing economies; ASEAN, Association of South East Asian Nations; SACU, South Africa Customs Union.

Source: IMF staff simulation of the GTAP model.

Note: NIEs, newly industrializing economies; ASEAN, Association of South East Asian Nations; SACU, South Africa Customs Union.

Although the macroeconomic impact of China’s WTO accession is small, sectoral effects are substantial, especially in the textile and clothing industry (Table 12.6). All regions except the Asian newly industrializing economies and South Asia experience a decline in textile exports. For the former, textile exports increase significantly, largely because of increased demand by China following the expansion of its clothing exports. On the other hand, South Asia increases textile exports because of a large contraction of its clothing exports as well as increased demand for textile imports from China. Clothing exports contract considerably in every region, but only South Asia suffers a significant decline in overall exports as a result, because of its heavy reliance on clothing exports. The effect on production varies significantly across regions. ASEAN and South Asia, the two regions with the highest export dependency in the clothing industry, are affected most.

Table 12.6.Projected Change in Textile and Clothing Exports and Production Resulting from China’s WTO Accession, 2006(In percent)
ExportsProduction
Country GroupTextileClothingTextileClothing
Industrial countries–3.0–16.7–4.6–14.5
Asian NIEs16.6–24.19.3–11.9
ASEAN–3.7–33.1–12.1–24.1
South Asia4.0–19.9–2.7–17.6
Latin America–7.0–35.3–2.4–5.2
N. Africa and Middle East–8.2–30.7–6.3–12.1
SACU–6.7–23.7–1.8–14.8
Rest of Africa–9.6–35.1–2.7–9.5
Rest of world–6.7–35.0–3.7–11.7
Source: IMF staff simulation of the GTAP model.
Source: IMF staff simulation of the GTAP model.

There is considerable uncertainty over how China’s accession to the WTO will affect other developing countries’ textile and clothing exports. China will be subject to a special safeguard provision, which could be used to curb its export expansion until the end of 2008. Together with the transitional, product-specific safeguard mechanism and the antidumping provisions based on procedures against nonmarket economies, these contingent protection measures could seriously slow the expansion of China’s textile and clothing exports, thus reducing the pressure on other developing country exporters.12

The results presented in Table 12.4 do not fully capture the long-term impact of China’s WTO accession, particularly in the agriculture and mineral sectors. Despite China’s strong market access commitments in agriculture, the short-to medium-term impact on world agricultural prices is likely to be relatively small; however, the long-term impact could be much greater. It is widely accepted that China is losing comparative advantage in land-intensive agricultural commodities, especially grain (Zhang, 2000). Its commitment to relatively low tariff bindings means that this will translate into increased imports of these commodities in the long run. Although some countries that are net food importers may lose from this, net food exporters should benefit. Similarly, China’s energy imports have increased rapidly in recent years, and with continued rapid economic growth this trend is likely to continue. This may provide many income-poor but resource-rich countries in Africa and elsewhere with significant opportunities to increase their exports to China.

A more comprehensive assessment of the impact of China’s WTO accession would require more detailed modeling of foreign direct investment and services trade. The model used in this study does not incorporate foreign direct investment, and only a few barriers to services trade are taken into account. This tends to underestimate the benefits accruing to the rest of the world from China’s WTO accession, especially for the newly industrializing economies and ASEAN, but also for South Asia. India’s computer software companies, for example, have potential to invest in China or to export to China. According to a survey conducted by IMF staff, some Asian countries believe that they can increase their exports of financial and entertainment services to China (see Box 1 in Yang, 2002).

Any assessment of the impact of China’s WTO accession on other developing countries should also take into account the long-run gains in China’s growth prospects. As noted above, WTO accession and increased integration with the world economy will likely accelerate China’s growth. It has been shown that China’s growth and external opening (as opposed to the expansion of labor-intensive exports alone) in the past have been generally beneficial to its trading partners by improving their terms of trade and expanding the global market (Yang and Vines, 2001). A growing and more open Chinese economy should also play a larger role in smoothing global economic growth, as evidenced by the beneficial effects of China’s continued strong growth at the time of the Asian crisis and the recent global slowdown. Such stabilizing effects are particularly important for developing countries, which tend to suffer disproportionately from high volatility in commodity prices.

Conclusions

WTO accession will have important macroeconomic, social, and structural ramifications. In broad terms, accession will support the reform effort under way in China, adding urgency to the further acceleration of reforms. It promises to increase foreign direct investment, remove protection from inefficient industries, and spur the development of the legal and regulatory framework necessary for a market economy.

On the macroeconomic side, the projections reported in this chapter, although subject to large uncertainties, suggest that the short-term impact will be broadly manageable, aided by the improving external environment. It seems unlikely that GDP growth will fall sharply or that a major deterioration in the balance of payments will occur.

There could be an increase in unemployment and a widening of income disparities, which will require further efforts to strengthen the social safety net and to foster more balanced regional development. The authorities’ ongoing efforts to encourage private sector development will also assume increased importance.

Perhaps the greatest challenges, however, will occur on the structural side, particularly in the financial and SOE sectors. It is essential that the authorities move ahead rapidly with reforms in these sectors. Because an acceleration of structural reforms will have important fiscal implications, this will need to be accompanied by stronger efforts to bolster the fiscal position over the medium term, including through increased revenue mobilization and improvements to expenditure controls, which are at present very weak and subject to abuse.

China’s further integration into the world economy will also require adjustment in its trading partners. Developing countries that compete with China in labor-intensive manufactures will need to diversify their exports, most notably away from textiles and clothing, and agricultural importers may face increases in import costs. There will also be increased competition for foreign direct investment as China opens up further, but there will be opportunities for developing countries to expand their exports and investment in China. To seize upon these opportunities, developing countries need to continue with their structural reform efforts and facilitate the reallocation of resources and strengthen competitiveness.

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There is some uncertainty about the tariff reductions implied by WTO accession, because the average base rate of existing applied tariffs is not known with certainty, nor is it clear whether the new tariff levels are simple or weighted averages. For the purposes of this note, the following World Bank estimates of weighted-average tariffs in 1998 are used: 20 percent for agricultural products and 18½ percent for manufactures (corresponding simple averages are estimated to be 18 percent and 17½ percent).

In the short run, protection by local authorities—which is out of the control of central government—may limit the effect of the agreement. In addition, the behavior of SOEs and state trading organizations may be difficult to change: although the agreement includes a commitment that SOEs will make purchases and sales on purely commercial considerations, this may in practice be difficult to enforce, especially given the influence of local governments.

According to Martin, Dimaranan, and Hertel (1999), China’s share of the world textiles market could rise from 8½ percent in 1995 to 11 percent ultimately, and its share of the clothing market—where China has a major comparative advantage—from 20 percent to 60 percent. The U.S. International Trade Commission’s (1999) estimates of China’s share of the U.S. market are similar for textiles, but rather smaller for clothing, where the commission foresees a 20-percentage-point increase. On the other hand, as already noted, China’s textile and clothing exports to the United States will be subject to special safeguard provisions.

This comprises 13 million workers in rural areas (mainly producing rice, wheat, and cotton) and about 1¼ million workers in urban areas (mainly in the automobile and machinery industries).

An increase in urban unemployment by 1 million could cost about 0.1 percent of GDP in additional social services; the rural unemployed do not receive benefits. If agricultural procurement prices are reduced, budgetary subsidies for agriculture (0.8 percent of GDP) will in principle fall, but in practice there may be pressures to maintain rural incomes.

Notwithstanding the rapid growth of FDI inflows in recent years, China’s FDI per capita is moderate. Wei (2000) finds that, controlling for its size, China’s record in attracting FDI is less impressive than that of many other countries.

These investment-related benefits will accrue largely to industrial countries and some of the more advanced emerging market economies. Most other developing countries are not significant direct investors in China or other markets.

The model and its database are documented in Hertel (1997) and Dimaranan and McDougall (2001), respectively. The simulation was carried out using RunGTAP, which is solved with the GEMPACK software suite (Harrison and Pearson, 1996).

For a more detailed description of the simulation and a listing of the countries included in the regions used in the tables, see Yang (2002). The remainder of this section also draws heavily on that paper.

Although not separately estimated, Japan and some other net food-importing industrial countries will probably lose from increased agricultural imports by China. However, such losses are likely to be outweighed by their gains from increased exports to the Chinese market.

Caution is warranted in applying the regional results to individual countries within a region, as country characteristics may differ substantially.

The transitional safeguard will last for 12 years after China’s accession to the WTO, whereas the antidumping provisions will be valid for 15 years.

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