China’s industrial and foreign trade policies: what are they and how successful have they been?

 

    China’s industrial and foreign trade policies:

    what are they and how successful have they been? 

    Introduction 

    This paper briefly considers two major questions about China’s industrial and foreign economic policies. First, what is the best way to describe China’s economic growth model, particularly as it relates to international trade and investment? And second, how successful has this model been, not only in generating high GDP growth, but in respect of three other criteria:

    a) acquisition of technology and development of innovative capacity;

    b) development of competitive domestic firms; and

    c) acquisition of political power in the international trading system.  

    The conclusion is that China’s economic growth model shares the goals of a classical East Asian developmental state, but at the policy level is severely constrained by the paradoxical task of dismantling the old communist economic system while maintaining the Communist Party’s absolute monopoly on political power. To the extent that the exigencies of political stability make it difficult to execute economic reform, an unusually high degree of openness to foreign investment and trade is required as a catalyst for economic reform. This model, which differs markedly from those employed by other Asian countries, has been highly successful at generating economic growth and facilitating the import and diffusion of technology. However the relative dearth of domestic innovation and internationally prominent Chinese firms is a persistent source of anxiety for policy makers.

    In the last two decades China has claimed its place as a major center of trade andmanufacturing activities in the world. The Chinese economy has demonstratedunprecedented growth through its national policy of reform and opening up to theoutside world following Maoist isolationism and disarray stemming from theCultural Revolution. But while this has led to tremendous social welfare gains inChina and has contributed to global trade in significant ways, Chinese manufacturers have also had to confront its trading partners in the advanced industrialized world over a mounting range of causes of trade friction. For example, not only were Chinese manufacturers and authorities increasingly presented with antidumping suits initiated by China’s major trading partners, they also have had to respond to Washington’s pressure to revalue the Chinese currency, the RMB, and have clashed head to head with the United States over its protective duties on products such as furniture, semiconductors, and automobile parts. The tone and genre of US trade relations with China seem to have harkened back to the height of US– Japan trade relations in the 1980s. It is not an exaggeration to say that China has become one of the main rivals of the United States in the area of trade policy and that China is likely to remain at the center of US trade policy in the years to come. These growing causes of trade friction between China and the US raise important questions both about the sources of these conflicts and the future orientation of US–China trade relations. They also raise questions about the process of trade policymaking in China which, up until now, has remained rather opaque to outside observers. Existing studies of China’s interactions with its major trading partners have examined how China bargained with the US on the basis of the assumption of a unitary actor (e.g. Mertha and Pahre, 2005). They have also treated Chinese foreign trade policy as a case study of the making of Chinese foreign policy in general or focused on the implications of China’s accession into the World Trade Organization (WTO) for the Chinese economy and society. Relatively little scholarly attention has been devoted to the domestic politics behind China’s behavior in the world trading system.1 This question is nevertheless of vital importance as it directly bears on the future of China’s role in regional and global trade relations. It is therefore important to address this lacuna in order to understand how China does and will continue to respond to trade challenges from abroad. This volume represents a collective effort to unpack the domestic politics of trade policymaking in China and tackles questions about the emerging forces shaping China’s foreign trade policy. Its emphasis on how domestic actors shape China’s behavior in the international trade realm promises to offer a novel perspective on China’s international economic relations. Specifically, this project addresses the following questions:

    • What is the domestic political process of trade policymaking in China? Is it

    changing? If so, in what ways?

    • What kind of formal institutional changes have been necessary for a formerly

    centrally planned economy such as that of China to make such a transition?

    • What is the changing pattern of trade policy lobbying in China?

    • How did institutional reforms such as decentralization and administrative

    reorganization affect China’s trade policymaking process and outcomes?

    • To what extent does domestic politics in China influence the outcome of 

    China’s bilateral disputes and China’s activities in the rules-based international trading system? While the processes and changes described in this book are still tentative and ongoing, they nevertheless capture major dimensions of the making of trade policy zin China and provide us with a first cut into this important issue. 

    Description of the model

    China’s economic development model, while combining elements of other models, is a unique amalgam reflecting various peculiarities of Chinese state and society. It also depends to a significant degree on China’s sheer size, which makes it virtually unique – India being the only country in the world with anywhere near the same population and hence potential market size. Comparisons with the experiences of other countries are thus of limited value. To describe the Chinese model, we will look at it from three angles: the post-communist emerging market, the East Asian developmental state; and the free-market liberal state. Although China conforms to none of these ideal types, it embraces important elements of each.  

     Post-communist emerging market. Beginning in 1978, China gradually abandoned most elements of the Soviet-style planned economy it had set up in the 1950s and 1960s. A key difference between this reform effort and those of eastern Europe and the former Soviet Union in the years after 1989 was that in China the Communist Party succeeded in maintaining its grip on political power, and this grip remains undiminished to this day. Thus China is an almost unique example of a post- communist economy with continuing Communist Party government (Vietnam is the other instance).

     

    The most significant effect of this difference between China and other post-communist economies came in privatization of state-owned enterprises. Instead of the varieties of mass privatization executed in eastern Europe and many of the states of the former Soviet Union, China deliberately avoided privatization and focused on deregulating prices and creating competitive markets. There was no large scale privatization effort until after the 1997-98 Asian financial crisis; and even then this privatization focused on smaller enterprises while leaving the main, centrally-controlled state enterprises untouched. Almost a decade later, the state sector still controls around 40 percent of business-sector output2 and state firms dominate many key industries, including aviation, shipping, steel, oil, chemicals, telecoms, coal, metals and power generation. China has a huge number of private companies but they are mostly tiny; there no large private business groups able to exercise political influence at the national level. Meanwhile the party-state, which has shown a surprising degree of resilience, has done an impressive job of restructuring and rationalizing the largest state enterprises, evidently with the view of keeping these business groups firmly in state hands, but at greatly increased levels of profitability and global competitiveness. 3

    One of the biggest unknowns of China’s future development path is how the relationship among the party-state, the top-tier state enterprises, and the rapidly growing private sector will play out. Although there is significant debate on this subject, it seems clear that at present the party-state has no intention of divesting itself of the 150 or so largest state enterprise groups.4 Thus the central government intends to continue exercising control over substantial elements of the national economy through direct ownership of operating companies. Meanwhile, private-sector companies will increasingly be encouraged, as they are the principal engine of job-creation, as well as the main mechanism for meeting demand in consumer markets.

    This raises the question of what occurs when the interests of the entrenched state sector and the up-and-coming private sector conflict. Up to now, such conflicts have been minimal. This is partly because policy has roughly divided the economy into sectors where state dominance is presumed and barriers to private-sector players are high, and other sectors where competition is virtually unrestricted. State enterprises can survive in these latter sectors but only by competing on more or less equal terms with their private competitors.5 This policy in effect creates separate spheres of operation for private firms and “strategic” state enterprises.

    A second strategy is co-optation of private entrepreneurs, either through financial mechanisms or by membership in the Communist party. An example of the former is telecommunications firm Huawei, which in 2004 received a concessional Rmb10 billion (US$1.2 billion) line of credit from the China Development Bank, a state policy-lending institution. Co-optation via Communist party membership, long an informal practice, was re-instituted on a formal basis in 2002 when a 13-year-old ban on inducting entrepreneurs was eliminated from the Party constitution.6

    These methods serve present political purposes fairly well. One consequence, however, is that the state has a fairly clear interest in discouraging the emergence of the large family conglomerates that are characteristic of Chinese commercial culture everywhere else in Asia.7 This poses a potential problem for the future. What happens when these sorts of conglomerates start to grow, as they must, out of the small-scale private business groups that exist today? Do the new tycoons begin to insist on an autonomous political role free of Party interference? Can a new accommodation be reached? Or will the state insist on restricting or dismantling these groups as they become too big, with a resulting cost in economic efficiency?

    2. East Asian developmental state. In broad terms, China clearly shares certain key characteristics with Japan in the 1950s and 60s, and with South Korea in the 1970s onwards. Economic growth is driven by a high savings rate, large state investments in infrastructure, rapid transfer of population from agricultural to manufacturing employment, and export-oriented industries.

    A key difference, however, is that the effective level of protection for domestic enterprises in most sectors is far lower in China than in its east Asian neighbors, and the participation of foreign companies in both the domestic market and in export trade is much higher. As will be seen below, this has important implications for China’s technological development path. It also means that China has not yet developed what might be called the “clientelist” type of capitalism, different varieties of which prevail in many Asian economies. In Japan, clientelism took the form of cartels orchestrated by the government, which kept domestic prices high and ensured fat corporate profit margins. In southeast Asia, the standard form was the granting of monopoly concessions for key commodities to favored entrepreneurs, who used the cash flow thus derived to build up diversified family-controlled conglomerates. In China, as noted above, the main mechanisms of accommodation between state and private sector have been the creation of separate spheres of activity, and ad hoc forms of co-optation. Because of the highly competitive nature of most markets, cartels are ineffective, and commodity extraction is seen as inherently a state activity. The main consequence is that China has not so far fostered either internationally competitive and technologically advanced multinational firms (as in Japan or Korea), or internationally prominent family-run conglomerates (as in southeast Asia).  
 

    Figure 1  

    3. Liberal free-market state. Because of its extraordinary degree of openness, it is tempting to imagine that China is headed toward some version of a liberal, free-market state. And it is true that in downstream manufacturing industries from which state players have exited, China is characterized by an astonishing degree of competition, which in many cases includes not only dozens or hundreds of Chinese companies but also the major players from virtually every other country in the world.

    This state of affairs results from the fact that Chinese economic reform, since its inception in 1978, has been explicitly a process not only of domestic reform (gaige) but also of opening-up to the global economy (kaifang). The relentless ubiquity of the phrase gaige kaifang in official parlance over the past quarter-century has perhaps dulled the understanding of the momentousness of this word choice. The clear implication is that domestic reform is impossible without openness; and because the phrase was enunciated by Deng Xiaoping himself it is politically impossible to jettison it. Reformers have used openness as a tools to spur domestic reforms that otherwise would have been far more difficult or even impossible, most notably via China’s accession to the WTO in December 2001.

    China’s degree of openness is illustrated first by Figure 1, which shows exports, imports and total trade as a percentage of GDP. These figures are quite high for a large economy: China’s total trade ratio, 64 percent of GDP, is about triple that of Japan or the United States (although similar to Germany’s). Notably, growth in both imports and exports rose steeply right after WTO accession. In the four years since, trade has grown at more than double the rate of nominal GDP, whereas in the preceding eight years trade and GDP grew at about the same rate on average.  
 

    Figure 2

    Foreign enterprise share of China’s export and trade balance  

    

    Unique to China among large trading nations is the enormous share of exports and the trade balance accounted for by foreign invested enterprises (FIEs), as shown in Figure 2. At 58 percent and 55 percent respectively in 2005, these figures are without doubt far and away the highest for any major economy, although definitional differences make direct comparisons hard. Moreover, the foreign share of both has risen steadily.

    The major risk of the openness strategy, from the Chinese point of view, is that China’s economy could wind up being “Latin Americanized,” with many market sectors controlled by foreign firms. In his study of the Chinese auto sector, Eric Thun notes that efforts to create an internationally competitive Chinese automaker have

    thus far fared poorly, and suggests that the Chinese auto industry does indeed face some risk of repeating the fate of Mexico’s, which – in part because of the market-

    opening North American Free Trade Agreement – is entirely controlled at both the assembly and the component level by multinational firms.9

    Although fear of domination by foreign multinationals remains a potent political force – even if one which, in the end, is usually trumped by the forces of openness – it is unlikely that large swathes of Chinese industry will end up being dominated by foreigners. The main reason is the sheer size of the country. The lure of this potential market enables China to impose significant entry fees on multinationals, such as technology transfer, mandatory joint ventures, or limitations of business scope. In one way or another these barriers provide breathing space for Chinese competitors.

    Perhaps the best way concisely to sum up the Chinese development model is as a symbiosis of the three types indicated above. The goals of Chinese development are patterned on the classic East Asian developmental states, Japan and South Korea: China’s leaders would like to see rapid economic growth, heavily reliant on exports and rapid technological advance, with a stable administration of elite technocrats playing a substantial coordinating role.10 However the methods for achieving these goals are dictated by China’s peculiar status as a post-communist economy with a continuing Communist government. Unlike South Korea and Japan, China must gradually dismantle the constricting apparatus of the planned economy. This process of dismantling, however, must not threaten the rule of the Communist Party itself, and carries the additional condition that the party-state must remain in direct control of large chunks of the economy through ownership of dominant enterprises in strategic sectors. Left to the mercy of purely domestic forces, such a complicated and contradictory reform process would most likely run aground. Thus a high degree of market openness is essential as a catalyst, to ensure that structural reforms continue without which economic development and technological advance are impossible.

     It is important to recognize that technocratic governance exists in China mainly as an ideal. The practical reality of Chinese policymaking is fragmented and politically constrained, with most policies emerging as compromises between semi-autonomous central government ministries, or as the result of tortuous negotiations between the center and local governments, over which Beijing has at best imperfect control.  

    Measuring success

    Having defined as best we can the nature of the Chinese economic development model, we can now make a brief survey of how successful the model has been. In terms of economic growth the question is easy to answer. Between 1980 and 2005 China’s GDP grew by an annual average rate of 9.6 percent. No other country (including Japan, South Korea and Taiwan) has ever sustained that rate of GDP growth for such a long period of time. It is not within the scope of this paper to disentangle the various contributions of policy, demographics, and other factors to growth; it is sufficient to suggest that in the context of such spectacular growth, it is inconceivable that policy played a negative role, and it is probable that it played a strongly positive one.

    Impact on technology and development of competitive domestic firms

    But as we have noted, it is not the goal of Chinese policy to create economic growth pure and simple. Other policy goals include the creation of domestic technology capacity, and the development of internationally competitive Chinese firms. On both of these counts China’s success is ambiguous.

    To understand this it is necessary to go back to China’s trade figures. Between 1980 and 2005 China leapt from being a negligible trader to the world’s third biggest trading nation, behind only the US and Germany. This was accomplished in large measure by policies designed to attract export-oriented foreign direct investment. These policies were enormously successful; as noted above foreign enterprises accounted for well over half of China’s exports in 2005, and the foreign share has been rising. Moreover, as shown by Figure 2, the foreign contribution to China’s trade surplus, quite modest in the 1990s, became dominant in recent years. The most likely explanation is that foreign enterprises were heavy importers of capital equipment in the 1990s, as they were installing their factories. While these imports continue, they are now outweighed by the production value of exports from the installed base.

    Two additional points need to be made. First, the role of processing trade. More than half of China’s trade is processing – i.e., final assembly of imported materials and components. Processing’s share of total trade has not declined appreciably in recent years, nor has the local value-added component of processing increased significantly (see Figure 3). Chinese trade growth, and by extension overall economic performance, are quite reliant on this relatively low value-added processing trade 

    Figure 3  

    China’s processing trade  

    

    Source: Ministry of Commerce

    .

    When one turns to goods classified as high-tech, the picture is even more stark. In 2005, 88 percent of China’s high-tech exports were generated by foreign firms – and 67 percent by wholly owned foreign firms, in which there is no formal mechanism for technology transfer to a local partner. FIEs are now significant net exporters of technology goods, while domestic firms continue to be net importers (see Figure 4). On a more qualitative basis, there is little evidence that Chinese firms are producing significant innovation in core technologies, manufacturing process, or design – either in high tech goods or in any other sector. The primary Chinese comparative advantage continues to be production at low cost and on a large scale. Chinese companies that have demonstrated international competitiveness, for instance steel producer Baosteel, telecoms equipment maker Huawei, and auto components maker Wanxiang, have done so not on the basis of new technology or innovative manufacturing process, but mainly by their ability to manufacture to an acceptable standard at very low cost. There are a large number of such companies, mainly small and medium sized manufacturers.