Trade Liberalization Impact in China

Introduction

Since China began its economic transformation in 1979, China’s economy has grown sharply. However, this transformation is facing one of its biggest setbacks after 2008 because of the financial crisis. This paper will focus on the impact of trade liberalization on Chinese economy after 2008, because trade liberalization is a vital tool to transform China into market-oriented economy during the economic tranformation. Furthermore, other team members will touch on other aspects of transformation such as property rights, currency system, banking system and SMEs. This essay will first discuss the relationship between trade liberalization and economic growth in China. The following section will focus on the research about the effects of trade liberalization on China’s economy after 2008. The third part of the study will provide insight regarding implications for China’s trade liberalization post 2008. Finally, a summary of my entire study will be included at the end of the essay.

Literature review

Arguments for trade liberalization

International trade has increased sharply over the past four decades, which make the world marketplace become increasingly integrated. There are two points of view in trade liberalization. Proponents of trade liberalization stated that ‘Trade is an engine of growth’. Previously, removing non-tariff barriers and tariffs to trade can help productive resources to be used more efficiently. In this case, America need not try to produce their own silk, they can import them at cheap price from China when the trade market is most open; for the same time, China can sell silk at high price when the markets are filled with the greatest number of buyers. Moreover, trade openness increases competition from outside which forces domestic firms to be more efficient. According to Licandro and Navas-Ruiz (2007), trade liberalization causes indigenous firms to have to reduce costs, intensify innovation to compete with foreign companies. From the technology aspect, international trade boosts the exchange of knowledge and technology leading to growth, which is termed knowledge spillovers. Finally, exporting to other counties allow firms to decline costs by taking advantage of scale economies (Rogowsky et al., 2001). However, some opponents argued that trade liberalization causes trade imbalance. Santos-Paulino and Thirlwall (2004) pointed out that trade liberalization worsened the trade balance of developing countries during 1972-1997 and the growth of imports was faster than the growth of exports for a panel of 22 developing countries. In addition, as trade liberalization increases competition from outside which require firms to possess greater efficiencies and technologies, it reduces employment and domestic jobs (Rogowsky et al., 2001). In less developed countries, the increased competition from outside can also drive less competitive domestic firms away from their markets, which leads to local firms’ bankruptcy. Althougth there are bound to be disadvantages, the presence of benefits from trade liberalization such as growing international trade and investment increase world GDP are undeniable. According to National Intelligence Council (2000), trade liberalization will keep expanding while some countries fight against further liberalization. International capital flows should keep growing, especially for emerging market countries that increase their transparency.

The relationship bewteen trade liberalizaiton and economy in China

Since China began its transition reform in 1979, there have been some literature studies study on the relationship between trade liberalization and economy in China. According to Lardy (2003), there is an obvious positive relationship between trade openness and economic growth. Firstly, most trade in China swiched from centralized to decentralized, and became increasingly market-oriented. Moreover, after China entered the World Trade Organization in 2001, a majority of statutory tariff has been removed or reduced sharply, and the indirect taxes on export has been rebated, which boosted the import and export volume in China. Secondly, growing competition that was introduced into China’s domestic market resulted in its economic growth. Morrison (2009) pointed out that the trade liberalization increased the inflow of the foreign direct investment (FDI) that brought new technology and processes into China and promoted efficiency. Because of the trade and investment reforms, FDI became the most important source of economic growth and productivity in China. In 2007, there were 286.200 approved foreign –invested companies in China, which employed around 42 million people and occupied 31.5% of gross industrial output value ( Morrison, 2009). At the end of 2008, China has been one of the world’s largest destinations of FDI. Thirdly, according to Morrison (2009), after the trade liberalization, China transformed into a major trading power in the world. The import rose from $16 billion to $1,132 billion from 1979 to 2008, export grew from $14billion to $1,429 billion during the same period (see Table 1). According to statistics of WTO, total trade in goods accounted for around 65% of GDP in China in 2006. Obviously, most researchers agreed that trade liberalization provided a positive impact on Chinese economy.

Table 1. China’s Merchandise World Trade: 1079-2008 ($ billion)

source: Global Trade Atlas.

There are some reasons behind the dramatic increase of export and import volume after trade liberalization. Initially, one of the most important comparative advantages is low-cost labour force, abundance of land and rich natural resources. These factors attracted many foreign companies to invest in China. However, as skilled managers, engineers and technicians are severely lacking in China because of lack of education, the presence of cheap labour force alone may not attractive to foreign investors anymore. In order to address this, China’s technology gaps and labour qualification need to significantly improve (Organization for Economic Co-operation and Development, 2000). Another significant reason is China’s managed exchange rate (refer to another team member’s project which focuses on Chinese currency). The undervalued China’s currency leads to a large trade surplus in China. Furthermore, the market size and expectation for market growth in China are influential location advantage for FDI.

Nevertheless, trade liberalization has brought negative effects to China as well.Since China entered WTO in 2001, the average tariff for industrial goods and agricultural goods has been reduced, and non-tariff barriers were also abolished. Zhai Fan (2007) stated that despite China’s accession to WTO promoted its trade liberalization, it caused the income distribution situation to worsen. On one hand, it widened gap between the rural and urban areas. Farmers earned more when the agricultural products were protected by high tariff. After China’s entry to WTO, the disposable income of urban population went up by 1.2% while rural population increased only by 0.8%. On the other hand, regional gap was also widened. Benefits from China’s entry into WTO were more evident in coastal areas because trade expansion primarily takes place these areas and causes more production factors to flow there such as Guangdong province providing minimal impact on inland economy. Therefore, trade liberalization leads to inequable income distribution (Fan, 2007). Another concerning issue is that low cost advantages attract a great number of foreign investments resulting in overinvestment problems in China causing a scenario referred as economy bubbles (refer to another team member’s project which focuses on real estate in China). The problem also reduces arable land, large areas of farmland transfer to industrial use and commercial housing (Ching, 2007). It worsens the income inequality problem and decreases demand of agriculture products.

Trade liberalization impact on China after 2008

Trade liberalization vs. The economic crisis

Trade liberalization accelerates globalization process. According to Tapsell (1999), the worldwide reduction in trade barriers, tariffs and import quotas increase international trade and promotes globalization process. Nonetheless, globalization and liberalization are general preconditions of the current crisis which originated in America and spreaded to all over the world quickly. Smriti (2009) pointed out that “this crisis is uniquely a child of the neoliberal global”. The existence of global inequality brings natural resources, cheap labor, and capital of the developing world to developed countries. The U.S. middle-class consumption was paid by the world’s saving via financial markets. Finally, when the debt bubble burst in America, the global economy crashed. Since China started transition reform in 1979, America became the main export partner for China because of the low exchange rate and labour force. Thus, the crash of US economy damaged China’s trade severely.

Trade in China during the crisis

As I mentioned before, China became a major trading power in the world through trade liberalization. After the global financial crisis, China’s real GDP slowed to 9.0% in 2008 compared to a positive growth of 13% in 2007. It slowed to 7.1% in 2009 (Morrison, 2009). On the trade side, the performance of trade took place a dramatic decline because of the crisis. Li (2009) reported that the growth rate of exports and imports was 21.9% and 27.6% respectively during the first ten months of 2008. But they contracted 2.2 percent and 17.9 percent respectively in November. China’s exports reduced by 21.8 percent and imports by 25.4 percent during the first half of 2009. FDI flows also dropped by 12.6% from January- October 2009 (see Figure 1).

Figure 1: Monthly Percentage Change in China’s Trade and FDI:

April 2008 – October 2009

Source: China Customs Administration

There are some reasons why globalization and liberalization result in sharp reduction on trade performance during the financial crisis. First of all, the financial crisis in America declined demand for export products from China. The world bank estimated that one percent decline of decline in USA GDP’s growth rate can potentially reduce 4.75 percents of China’s export growth rate (He, 2010).Hence, the economic crisis resulted in many export oriented companies’ bankruptcy. (Refer to another team member’s project focuses on SME after 2008). Furthermore, in the opinion of Li (2009), the most important and worrisome reason is trade protectionism which will have a contagion effect and causes deterioration in the world trade environment. The opposite side of the trade liberalization is trade protection, which is the imposition of duties or quotas on imports in order to protect domestic industry against foreign competition. The global economic crisis triggered panic all over the world since 2008 causing many countries and regions to use various protection measures to restrict imports to protect themselves from the crisis. In recent years, these countries do not violate WTO obligations directly, they abuse legitimate discretion which are used to discriminate against foreign goods, investors and firms, they use of WTO-legal protection, such as antidumping measures to protect themselves (Baldwin and Evenett, 2008). For example, the US placed tariff 35% on US$1.8bn of tyre imports from China on September 2009. Moreover, on February 5, the US resorted to anti-dumping duties up to 231.4% on gift box and other types of ribbons from China (Emerging Markets Monitor, 2010). All these protection measures severely impact on China’s growth and led to adverse effects on China’s economic recovery. On one hand, it reduced Chinese export volume dramatically. For instance, in 2009, the US restricted import of poultry products from China, and set tariff 55% on certain passenger vehicle and light truck tires (Li, 2009). On the other hand, trade restrictions also have negative impact on import. Over 30% of China’s import is used to produce export products, thus when export is reduced because of trade protection, the import from other countries will also be declined accordingly. In addition, the trade protection increased unemployment rate in China. There are 80 million people employed by foreign trade sector, take the former example, the US protectionist measures directly affect many Chinese workers. Therefore, trade liberalization is an important issue for global economy recovery.

Implication for China’s trade liberalization after 2008

From the view of the WTO, the real solution to financial crisis is trade openness rather than trade protection. According to Baldwin and Evenett (2008), international trade plays an important role in combating the effects of the economic crisis. Trade is the mechanism which stimulates growth and transmits prosperity between countries. From the OECD analysis, a 10% rise in trade is associated with a 4$ increase in per capita income. However, further trade liberalization is more difficult than before in China. Firstly, China should fight against protectionism to promote trade liberalization. Hence, China imported $1.133 trillion worth of goods from other countries in 2008, which is an 18.5% increase over the former year. These imports are not only to lift China’s economy out of the crisis, but also to boost economic development of China’s trading partners (Chen, 2009). Since 2008, China did not adopted protection measures. In the contrary, the Chinese government has put forward a series of measures in order to stimulate domestic demand. For instance, China tried to boost FDI inflows by using several policies as follows. The government endorsed a $586 billion stimulus package to motivate economy and adjusted policies to attract foreign investment (Grigorova, 2009). Secondly, as the fixed exchange rate is in favour of China’s export, the appreciation of renminbi will remove this advantage. After 2008, the renminbi appreciated 15 to 20 percent which caused a sharp reduction in China’s surplus. Although the degree of undervaluation of the reminbi is very large, China will slow down the appreciation speed to stabilize trade liberalization process and steady output and employment of export-oriented industries (Lardy, 2010). Facing more difficulities than before, China will still continue the gradual trade liberalization in the future. The government will keep improving the transparency of the trade and investment policies and practices, strengthening trade-related laws, continue reducing regulatory and other barriers to trade. Moreover, China will quicken liberalization of China’s services industries such as banking, insurance and postal services (World trade oganization, 2010).

Conclusion

Generally, trade liberalization is beneficial for the Chinese economy. It opened China’s door to the world, brought competition and technology to China, and made China to become a big trading country. Low-cost labour force and fixed exchange rate attracted foreign investors and increased China’s GDP sharply. Nevertheless, trade liberalization also has negative effects, such as causing inequable income distribution, increasing unemployment rate and reducing rural land. In addition, from the research, trade liberalization is a part of precondition of the global economic crisis. Because of trade and investment placed internationally, the financial crisis that happened in America spread all over the world rapidly. Hence, most countries placed protectionism measures against other counties in order to protect them from the crisis causing adverse effects on the global economy. In China, these protection measures declined both export and import volume significantly, and increased unemployment rate as well. Obviously, trade protection cannot help the global economy recovery, but trade liberalization is the real solution to the financial crisis. Although it is a precondition of the crisis, trade liberalization is a tool to stimulate growth and transmit prosperity between countries. Although after 2008 China’s trade liberalization is confronted with decreasing global demand and currency appreciation pressure besides protectionism, China will contitue gradual trade liberalization in the future.