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Impact of China's open-door policy on Pacific Rim trade and investment.

AN OPEN-DOOR policy has been Deng Xiaoping's most dramatic contribution to China's economic reform movement. The policy represented a rejection of the inward-looking, autarkic development strategies of the previous two decades. Adoption of an open-door policy and implementation of a series of reforms in its foreign trade system have transformed China into a new export competitor in Pacific Asia. Between 1970 and 1987, for instance, China's exports to her neighbors in the Asia Pacific region jumped by twenty times and her imports by fifty times! At the same time, foreign direct investment in China from Japan and the East Asian newly industrialized countries (NICs) rose rapidly, as did China's exports to Asia and the United States. This article examines how the entry of China into world markets has affected the pattern of trade and investment in Pacific Asia and speculates on the future role of China in Pacific Asia and the world.

ECONOMIC DYNAMISM IN PACIFIC ASIA AND CHINA

No region in the world has surpassed the remarkable economic performance achieved by the East Asian countries in the past three decades. Japan emerged first as a Pacific economic power, followed by the four East Asian NICs (those four "Little Dragons"), which in turn were closely followed by member countries of the Association of Southeast Asian Nations (ASEAN). Now it is China's turn. While the per capita income for the world grew only at a 1.5 percent annual rate between 1965 and 1988, and the U.S. grew at 1.6 percent, Japan's income growth was 4.3 percent, the Asian NICs ranged from 6.3 percent to 7.2 percent, and the ASEAN countries grew a little more than 4 percent (except for the Philippines with a poor growth rate of 1.6 percent).

Particularly noticeable is a per capita income growth rate of 5.4 percent experienced by China -- truly a remarkable success for a country whose population accounts for 22 percent of the world's population, but whose arable land accounts for only 7 percent of the world's total. Moreover, China has emerged as a major exporter of labor-intensive manufacturers and has successfully penetrated the markets of industrialized countries, especially the United States. In 1991, for instance, China's bilateral trade surplus with the U.S. amounted to almost $13 billion, the second largest after Japan's $43 billion surplus with the U.S.

CHINA'S ECONOMIC REFORM AND OPEN-DOOR POLICY

Perhaps one of the most significant elements of China's reform movement has been the renunciation of the "self-reliance mentality"(1) and the recognition of China's needs for foreign trade, investment and technology in order to modernize. This meant replacing the hard-line doctrine of self-reliance with an outward-looking policy of opening up the country to the outside world. The major goals of this reformist new doctrine are: (1) Fill the domestic savings gap necessary for economic development with foreign capital inflows; (2) bring in advanced foreign technology and managerial skills; (3) increase exports in order to expand foreign exchange earnings; and (4) increase industrial and agricultural productivity.(2)

As a first step toward achieving these goals, China in 1978 adopted an open-door policy toward foreign trade and investment. Before 1978, Chinese firms were practically sealed off from the world economy. The required levels of exports and imports were simply established by the government in its five-year economic plans. Foreign direct investment was severely restricted. Only the state-owned foreign trade corporations were allowed to have contact with foreign businesses and to carry out exporting and importing of goods.

As a first step to encourage foreign trade, the monopoly power of the twelve state-owned foreign trade corporations was reduced by allowing local authorities and enterprises to set up their own trading corporations. Later, these corporations were given expanded power and autonomy in management and independence in financial responsibilities.(3) Large private firms were also allowed to engage in trade directly. Furthermore, these local foreign trade corporations and private firms engaged in exporting were allowed to retain up to 25 percent of their foreign exchange earnings. The foreign exchange retention rights could extend beyond the 25 percent level for "key" export industries and for those provinces in which special economic zones (SEZs) are located.(4)

In 1979, a joint-venture law (the Law of the People's Republic of China on Joint Ventures Using Chinese and Foreign Investment) was enacted to encourage foreign investment and technology transfers and to establish SEZs with a variety of incentives for business firms to locate there and produce for export. Four SEZs were established in Shenzhen, Zhuhai and Shantou in Guangdong province and Xiamen in Fujian province. Later, in 1981, Hainan Island was designated as the fifth SEZ. In 1984, fourteen cities along China's Pacific coastline from Liaoning province in the north to Guangxi province in the south were declared open for foreign direct investment and technology. In 1985, this was followed by the opening up of three huge deltas in the Pacific coastal areas. Thus China appears to be opening up the entire Pacific basin to court the inflow of foreign investment and technology.

ECONOMIC IMPACT OF CHINA'S OPEN-DOOR POLICY

The impact of these open-door policy measures on China's trade and inflow of foreign direct investment and loans has been impressive. Between 1978 and 1990, China's total exports grew by almost 18 percent per year, from $8.8 billion to $60.9 billion, and so did her total imports, growing from $9.8 billion in 1978 to $52.3 billion in 1990 -- a sixfold increase in total volume of trade (exports plus imports) over the twelve-year period, from $18.6 billion in 1978 to $113.2 billion in 1990. China's successful entry into the world economy through open-door policy measures has transformed China into a major exporting country, now the fourteenth largest in the world and a major export competitor to the East Asian NICs and ASEAN countries in the Asia Pacific region.

China's Export Competitiveness

China's relatively low labor costs alone could not have caused this phenomenal growth in exports. China has overhauled its foreign trade system and sought to expand the role of market forces in trade and investment decisions and to promote manufactured exports. In addition, China has actively sought to improve the price competitiveness of Chinese goods in world markets through a series of devaluations of the yuan.(5)

The devaluation of the yuan has significantly increased the cost advantage for Chinese producers, enabling them to utilize the vast supply of inexpensive labor (in terms of dollars) and to expand the production and export of labor-intensive manufactured goods. In 1989, for instance, the earnings of Chinese workers were estimated to be only about one-fifth of that of workers in the manufacturing sectors of the East Asian NICs and only one-twentieth of the wage of comparable U.S. workers. This improved cost and price competitiveness has been successfully combined with a series of policy changes in the foreign trade sector in boosting China's exports.

Another mechanism used by China to finance imports of plant, equipment and technology has been the adoption of countertrade. China's then Vice Premier Deng Xiaoping is said to have initiated the idea of importing plant and equipment from the West for the development of China's oil and coal industries, and then paying for these imports with the resulting output from the plants.(6)

Open-Door Policy and Foreign Direct Investment

Liberalizing the rules governing foreign direct investment (FDI) has been one of the most important reforms that helped develop China's thriving export sector. Chinese firms were allowed to assemble and export goods made from imported parts and components, and the inflow of foreign capital and technology has enabled China's manufacturing sector to expand production for export. Between 1979 and 1990 the cumulative total FDI into China was estimated at $20 billion. The bulk of this inflow took place following the significant liberalization of the rules governing FDI in 1984. The East Asian NICs, led by Hong Kong, were the major investors in China, accounting for three-quarters of FDI. Foreign-owned firms are attracted to the SEZs and other open coastal cities to take advantage of the relatively low labor cost and the preferential treatment regarding import controls, taxes, foreign exchange retentions, and repatriation of profits.

As of 1990, more than 25,000 foreign-owned firms were reported to have contracted to invest in operations in China, and about 12,000 were in operation, all engaged in the assembly of imported parts and components for export. These foreign-owned firms have undoubtedly contributed significantly to the growth of China's exports in recent years. For example, in 1985 foreign-owned firms accounted for only about 1 percent of China's total exports, but their share of contribution rose dramatically to 17 percent by 1990. In 1990 alone, their exports accounted for almost three-quarters of the growth in China's exports.(7)

Changing Pattern of Trade and Investment in Pacific Asia

The phenomenal growth in China's exports, the growth of FDI in China and, in particular, the increasing importance of the East Asian countries as a major source of that FDI have undoubtedly affected the pattern of trade and investment in the Asia Pacific region and the U.S.-Asia trade relations as well.

Due mainly to her comparative advantage in labor-intensive manufactures, China has been able to penetrate successfully the markets of advanced economies, especially the United States, for such products as textile yarn, fabrics, apparel and clothing. All this, of course, has happened at the expense of the newly industrializing economies in Asia and Southeast Asia. China also has become a competitor to the East Asian NICs in the export of more skill-intensive and capital-intensive products, such as electric machinery, appliances and sound-recording equipment. Thus, in 1991 China's trade surplus with the U.S. was $12.7 billion, the second largest after Japan's surplus with the U.S. ($43.4 billion) but ahead of Taiwan's ($9.8 billion).
Table 1

U.S. Trade Balance with Pacific Asia, 1980-1991
(Billions of U.S. Dollars)

 1980 1985 1987 1990 1991(a)

Pacific Asia -15.0 -74.5 -98.4 -77.9 -74.2

China 2.7 0.0 -2.8 -10.4 -12.4

Asia without
China -17.7 -74.5 -95.5 -67.5 -61.8
Japan -10.1 -46.2 -56.3 -41.1 -42.7
Asian Nics -3.0 -22.2 -34.1 -19.9 -13.5
Others -4.6 -6.1 -5.1 -6.5 -5.6

a Estimates based on data for January through October.

Source: James Orr, "Evolution of U.S. Trade with China,"
Federal Reserve Bank of New York, Quarterly Review, Winter
1991/92, p. 49, Table 2.


This growing U.S. trade imbalance with China runs counter to the substantial progress the U.S. has achieved in recent years in reducing its trade deficits with other Asian countries. As is well known, Japan and the East Asian NICs were the major sources of the huge U.S. trade deficit with all Asian countries, which grew from $15 billion in 1980 to $98 billion in 1987. Since 1987, however, the overall U.S. deficit with the Asian countries excluding China fell by about $33 billion, largely due to the declining deficits with Japan and the East Asian NICs. As can be seen in Table 1, the $10 billion increase in the deficit with China since 1987, however, negated almost one-third of this improvement. In 1991, the U.S. deficit with China accounted for one-sixth of the U.S. trade deficit with Asia. Thus, China has become a potential source of the already serious U.S. trade conflicts with Asia.

Open-Door Policy and Foreign Aid Flows to China

The renouncement of the self-reliance mentality and opening up of the country to the outside world also meant utilizing foreign sources of funds as much as possible for a modernization drive. Once again, it was Vice Premier Deng Xiaoping, the architect of China's reform movement, who, during his first visit to Japan in 1978, publicly indicated China's interest in receiving official development assistance and loans from Japan. His request was met with great enthusiasm, and the loan negotiations progressed immediately and smoothly, thus setting the stage for long-term economic assistance by Japan for China's modernization efforts. China also returned to its seat at the World Bank and the IMF and began to borrow funds from those institutions.(8)

According to OECD estimates, the cumulative official financial aid flows to China from 1978 to 1988 amounted to $10.2 billion, exceeding the total private financial flows of $9.8 billion.(9) Japan has emerged as the largest donor of official aid, accounting for more than 33 percent of total financial aid receipts. Official aid from the U.S. has been nil because of the laws that forbid providing aid to the Communist countries.

A substantial portion of Japan's official development assistance (ODA) to China consists of three package loans in yen: 330 billion yen for 1979-84, 540 billion yen for 1985-89 and 810 billion yen for 1990-95. The third loan package was temporarily interrupted by the Tiananmen Square tragedy in June 1989. Japan, however, lifted its economic sanctions against China the following year. During his visit to Japan in April 1992, Chinese Communist Party Secretary Jiang Zemin was reported to have sought an additional loan of 700 billion yen from Japan, and his request was favorably received by the Japanese.(10)

CHINA'S FUTURE ROLE IN PACIFIC ASIA AND THE WORLD

China has been successful in courting foreign capital and technology through her open-door policy. This, combined with various reform measures, has contributed to a large increase in total factor productivity, thereby accelerating economic growth.(11) Few, however, could predict with certainty whether the reformists will be able to retain their political power and continue the reforms and open-door policy in the absence of Deng Xiaoping. Even if they could, the positive impact on economic performance of the continuous reform movement and open-door policy would be rather limited, compared to the experience of the first reform decade.

There are several reasons for such an assessment:(12)

1. Initially the open-door policy and reforms were introduced to induce the foreign capital and technology necessary to speed up China's modernization drive, and they were not intended to restructure China's socialist economic system. Further improvements in export performance and economic growth would require more difficult reforms that would necessitate a fundamental change in China's economic system. As long as China's leaders are determined to adhere to Marxist ideology, build up "socialism with distinct Chinese characteristics," and maintain "the planned economy combined with market forces,"(13) any setback in economic performance could easily force China's leaders to reverse their reform movement.

2. In spite of internal reforms and market liberalization measures introduced, numerous institutional and structural bottlenecks characteristic of a system of central planning and bureaucratic control remain intact in China.

3. The reform and opening-up policy have brought about disparities in economic development and living standards between the Pacific coastal regions and other inland regions. This increased regional inequity may pose a serious political problem in implementing the reform movement.

Notwithstanding these constraints, a strong possibility exists that China could still develop into a formidable export competitor and eventually emerge as a major economic player in Pacific Asia and the world. The impact of the first reform decade has already transformed China into a new potential source of trade conflicts between the U.S. and Asian countries. Further integration of China's economy through her open-door policy and reforms, even at a much slower pace than before, could develop a pattern of trade in which China exports labor-intensive products to North America (the United States in particular) and Western Europe, and imports capital and intermediate goods from Japan and the Asian NICs. Such a pattern of trade and investment is likely to create a new Pacific trade triangle in which China runs a trade deficit with Japan and the East Asian NICs, but could generate an even larger surplus with the United States, thus inviting further U.S.-Asia trade frictions.

With its huge population of 1.2 billion and rapid overall economic expansion, China has the potential to become a major economic power in the early part of the twenty-first century. Indeed, some economists forecast that by 2010 China's GNP would surpass that of Japan to rank second in the world.(14) Furthermore, Hong Kong and Taiwan and possibly even Singapore, all joined by overseas Chinese, will become economically more integrated with South China and other coastal regions, forming a greater Chinese-based economy of Asia and becoming a potentially powerful and dynamic engine of growth in the Asia-Pacific region and the world.(15)

IMPLICATIONS FOR U.S. TRADE POLICY TOWARD CHINA

This powerful trend in Pacific Asia -- China's successful entry into the world economy, emerging as a major economic power and the rise of the greater Chinese-based economy of Asia -- has by and large been ignored by most Americans, mainly because of their preoccupation with political challenges in Europe and the Middle East with economic challenges from Japan. For the past two decades, China's importance to the United States has been defined primarily as military rather than economic, and as such the United States has "no consistent strategy to deal with the rise of China as a major economic power."(16)

Even before the Tiananmen Square tragedy of June 1989, U.S. economic policies toward China restricted China's access to the U.S. market, denied GSP (Generalized System of Preferences) status for Chinese goods and forbade providing bilateral economic aid to China.(17) These specific policies are in conflict with the broad vision justifying the opening of "normal relations" in Sino-American affairs and the rationale for providing support for a modernizing China. Preoccupied with maintaining a bilateral security relationship with China as a counterweight against the threat of the Soviet Union, these short-sighted polices have simply diverted U.S. attention from more challenging and promising opportunities in economic matters. Worse yet, the Tiananmen tragedy has effectively stopped new large-scale U.S. investments in China and ignited a debate on issues of current U.S. policy toward China. A ballooning U.S. bilateral trade deficit with China has become a political issue, and the question of whether the U.S. should renew China's most favored nation trade status has turned the issue into an annual debate on human rights. With the new policies of President Clinton, there is fear outside the U.S. that a trade war is coming. And there is further unease that the Clinton Administration's "still unenunciated Asia policy may amount to little more than protectionism."(18)

With the collapse of the Soviet Union and the greater Chinese-based economy of Asia rapidly emerging as "a new epicenter for industry, commerce and finance"(19) in Pacific Asia, the focus of U.S. policy toward China should be redirected from security considerations to economic and trade matters. Such an effort should not be derailed by such stakeholder issues as human rights, prison labor and intellectual property rights. Instead, confronting China's new reality, Zuckerman reminds us thus: "The upsurge of anger over Tiananmen Square was right and necessary. But righteous indignation is not a policy. The Chinese, too, have cause for indignation -- over our sales of fighter planes to Taiwan, for example. What we must have now is a dialogue with China, encompassing weapons proliferation as well as human rights, trade practices as well as passports."(20) A U.S. trade policy toward China must recognize an emerging Chinese economic area that has the potential to become a powerful engine of world trade and economic growth in the early twenty-first century. In search for a long-term strategy toward Asia, the United States must also be patient. Malaysian Prime Minister Mahathir Mohamad thus reminds the new Clinton Administration: "Don't try to measure Asia by U.S. standards and values and expect us to change immediately. We will change, but not quickly."(21)

FOOTNOTES

1 In 1979 to a group of Japanese reporters Premier Zhao Ziyang thus declared, "The days of China's self-reliance are over."

2 Chien-Hsun Chen, "Modernization in Mainland China: Self-Reliance and Dependence," American Journal of Economics and Sociology, Vol. 51, No. 1 (January 1992), p. 60.

3 T.M.H. Chan, "Reform in China's Foreign Trade System," in J.S.H. Chai & C.K. Leung (eds.), China's Economic Reforms (Hong Kong: University of Hong Kong Press (1987)), p. 428.

4 James Orr, "Evolution of U.S. Trade with China," Federal Reserve Bank of New York Quarterly Review (Winter 1991-92), p. 51.

5 The Chinese currency was devalued by 40 percent in 1984 and by 14 percent in 1986. In 1988 the government established local foreign exchange swaps where business firms can trade foreign exchange at market prices. At the same time, the currency was devalued by 40 percent in order to mitigate the adverse effects of high domestic inflation on international price competitiveness. In 1991 the value of the Chinese currency was again adjusted downward by 10 percent, and all residents of China were permitted to trade in foreign exchange swaps.

6 This form of countertrade is referred to as a buyback or industrial compensation arrangement. Under this arrangement, the exporter of plant and equipment or a technology package is paid in the form of the "resultant output" from the plant and equipment exported. This is an alternative method of financing the acquisitions of long-term development projects and technology. See, Robert D. Dennis, "The Countertrade Factor in China's Modernization Plan," Columbia Journal of World Business, Spring 1982, pp. 67-75; Jong H. Park, "The Role of Countertrade in Third World Development and Cooperation," Journal of Third World Studies, Vol. VI, No. 2 (Fall 1989), pp. 198-225.

7 Orr, "Evolution of U.S. Trade with China," p. 51.

8 Dwight H. Perkins, "Reforming China's Economic System," Journal of Economic Literature, Vol XXVI (June 1988), p. 621.

9 OECD, Geographical Distribution of Financial Flows to Developing Countries (Paris: OECD, 1991).

10 David C. Cheng, "Japan's ODA and Its Role on China's Economic Reform," a paper presented at the Southern Japan Seminar, Atlanta, GA, May 1992, pp. 8-9.

11 National output has increased by 9 percent per year during the 1976-85 period, compared to 5 percent for the prereform period 1965-76. See Perkins, "Reforming China's Economic System," pp. 627-642.

12 Yung Chul Park, "The Little Dragons and Structural Change in Pacific Asia," World Economy, Vol. 12, No. 2 (June 1989), pp. 136-137.

13 Beijing Review, January 13-19, 1992, pp. 7-9.

14 David M. Lampton, "America's China Policy: Developing a Fifth Strategy," The China Challenge: American Policies in East Asia, Proceedings of the Academy of Political Science, Vol. 38, No. 2, edited by F.J. Macchiarola & R.B. Oxnam (New York: The Asia Society, 1991), p. 158.

15 John Wong, "Integration of China into the Asian-Pacific Region," World Economy, Vol. 11, No. 3 (September 1988), p. 352.

16 Nicholas R. Lardy, China's Entry into the World Economy: Implications for Northeast Asia and the United States (Lanham, MD: University Press of America, 1987), p. 49.

17 Lardy, ibid.

18 Karen House, "Malaysian Premier Says U.S. Policies Hurt Change for Global Growth, Stability," Wall Street Journal, March 29, 1993, p. A8.

19 Murray Weidenbaum, "Asia Poised to Take Center Stage," Atlanta Journal & Constitution, March 7, 1993, pp. C1-C2 and "The Shifting Roles of Business and Government in the World Economy," Challenge, January/February 1993, pp. 24-26.

20 Mortimer B. Zuckerman, "China's New Reality," U.S. News & World Report, March 15, 1993, p. 76.

21 House, ibid.
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Title Annotation:International Perspective
Author:Park, Jong H.
Publication:Business Economics
Date:Oct 1, 1993
Words:3927
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