Free Essay on Chinese Economics - China's Trade Liberalization

The Chinese economy has undergone a radical transformation since 1978. Before 1978, China used to be a command economy, where the government controlled economy activity with no significant private sector. Mao Zedong, the then leader of the Communist Party, led the revolution of China from a market to a nonmarket command economy. In 1966, the Cultural Revolution started in resulted in a decade-long economic and social turmoil. The meeting of the Central Committee of the Communist Party held in December 1978 is a defining moment of Chinese rapid economic transformation. Deng Xiao Ping instituted reforms to modernize Chinese market and open it to the world. In December 1990, the Shanghai was reopened, 40 years after its closure. In 2001, China joined the World Trade Organization after 15 years of negotiations and reforms. The reforms significantly contributed to the growth of the Chinese economy. Between 1978 and 2012, the Chinese GDP grew at annual rate of 9.4%. This has propelled it to become the second largest economy in the world. China contributed 17% of the world's gross domestic product in 2014 while the US produced 16%. (O'Brien 2017). It is set to overtake the US as the world's largest economy by the year 2032 (O'Brien 2017).

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This paper explains the impact of China's accession to the WTO and trade liberalization on the economy. This is an interesting area since there are still debates on whether trade liberalization is beneficial or not. Most countries are yet to liberalize their markets fully. It has become more interesting following the following the actions of President Trump to impose tariffs on Chinese imports and the subsequent retaliation by China. It is essential to evaluate the success China has attained during the 17 years of WTO membership. Besides, some analysts have argued that Chinese economic data is manipulated and does not reflect the real picture of the Chinese economy. The essay is based on secondary research by analyzing past academic studies as well as reviewing relevant economic statistics and events. It evaluates the impact of trade liberalization on the overall economy and its constituent sectors.

Impact of Trade Liberalization

The WTO promotes free and open trade globally. It requires countries wishing to join to adhere to its rules that are aimed at ensuring open trade. These include the removal or reduction of tariffs and non-tariff barriers to trade. Before the reforms, China implemented protectionist policies aimed at increasing exports while limiting imports. In the early 1990s, China's import tariffs on essential items were as high as 140% (Xu and Chang 2002). In 1992, its protection rate on finished consumer goods averaged 65%. A series of import reductions from 1992 led to the liberalization of the market. It reduced import tariffs on 225 products from 45% to 30% in January 1992. It followed this by the reduction of import surcharge on 14 products (Xu and Chang 2002). It also cut tariffs on 2818 items, including 200 agricultural products, in 1994 as part of the market access agreement with the US. During the Asia-Pacific Economic Cooperation Summit in November 1995, China reiterated its commitment to trade liberalization by announcing that it had lowered tariffs on 4,000 products from 35.9% to 23%. Between 1997 and 2000, it further reduced import tariffs from 23% to 15% (Xu and Chang 2002).

China also reduced non-tariff barriers to trade. It had limited trade through import licensing, and controls as well as mandatory import plan. 1247 (17.5%) items were subject to import quotas and other non-trade tariffs in 1992. China pledged to reduce these to 240 by the end of 2000 as part of the agreement with the US. In 1993, it abolished all import substitution lists. By April 1996, China had cut its non-tariff barriers to less than 6%. The accession to the WTO also prompted the reform of the exchange rate regime. Before 2005, China operated a fixed exchange rate regime. In 1994, it set the Yuan at 8.28 to the dollar, and the central bank intervened to keep the value stable. On its joining the WTO, China promised to reform its exchange rate regime gradually. Two years later, it was facing increased pressure to allow its currency to rise as its trade surplus with the US surged. A low value of the domestic currency encourages exports and discourages imports thereby improving the country's balance of trade. In 2005, it revalued the Yuan by 2.1% and shifted from the fixed exchange regime to a managed float. The new regime values tie the Yuan to a basket of currencies and permit its daily rate to fluctuate around a daily reference rate. The band has changed from plus (minus) 0.3% in 2005 to plus (minus) 0.2% in 2014.

Impact of Trade Liberalization on Exports and Imports

The removal of trade barriers promotes exports in two ways. First, it allows domestic firms to access cheaper and high quality factors of production. Lower input prices improve the productivity of local firms thereby increasing exports. According to Zhao and Zhang (2016, 129), there is sufficient evidence that input liberalization has had a significant impact on export product scope. Their study determined that Chinese firms in differentiated product scopes expanded their product lines as a result of input liberalization as it enabled them to access cheaper and high quality inputs (Zhao and Zhang 2016). However, firms with non-differentiated product scopes do not expand their export product lines significantly even with input liberalization.

Input trade liberalization also affects prices and quality of exports. Firms can take advantage of free trade of inputs to access necessary factors of production and improve the quality of production for exports. High quality exports enable exporters to charge premium prices in the international market. A study by Bas and Strauss-Kahn (2015) found that Chinese input trade liberalization affects firms differently. Chinese firms importing under the processing regime face fierce competition and take advantage of lower input price to reduce their export prices (Bas and Strauss-Kahn 2015). The study further determined that most firms take advantage of lower input prices to upgrade the quality of both inputs and exports. However, firms importing under the ordinary regime pay import tariffs and consequently increase their export prices. The competition effect has also contributed to product quality upgrades among Chinese firms. Fan, Li, and Yeaple (2013), indicate that trade liberalization has led to increased competition in both the domestic and international markets. Chinese firms have reacted by improving the quality of their products to match those of foreign firms. Improved product quality has also been a significant driver of export since the country's accession to the WTO.

China's exports have grown significantly since its accession to the WTO and trade liberalization. Exports more than quadrupled between 2000 and 2007, rising from 20% to 35% of the total GDP (Berger and Martin 2013, 65). Although its imports have also grown since its accession to the WTO, it still maintains a substantial balance of trade. In 2016, Chinese global exports totaled $2.06 Trillion while imports were $1.32 Trillion. Its balance of trade was a surplus of $738 billion (TheGlobalEconomy.com 2018). With a GDP of $11.2 Trillion, exports contributed 19% while net exports contributed 6% of the total GDP (TheGlobalEconomy.com 2018). Its main exports are computers, broadcasting equipment, integrated circuits, telephones, crude petroleum and cars among other products. The United States, Hong Kong, Japan, South Korea and Germany, are the primary export destinations for Chinese products. This tremendous growth has been facilitated by the country's membership to the WTO. The membership has allowed China access to WTO members' domestic markets. It is now the world's largest export economy.

The growth in exports is a result of several factors such as undervalued exchange rate, low cost of production, reforms of state-owned companies, and capital subsidies, among other variables. The Peoples Bank of China has maintained the ability of the Chinese Yuan to prevent the economy from external macroeconomic shocks. Although it shifted to the managed float regime, the exchange rate is still being manipulated. The central bank determines the daily reference rate and allow the Yuan to fluctuate 2% above or below the reference rate. Lower values if the Yuan implies that Chinese products are relatively cheaper than foreign products thus increasing exports and limiting imports. In 2016, the Chinese renminbi joined the IMF's elite club of reserve currencies (Ganguly 2016). However, critics argued that China does not meet the requirement of operating a free exchange rate regime.

China has also leveraged its resource availability and low cost of production to expand its exports. The cost of production is relatively lower in China than in most developed countries such as the US. This enables Chinese firms to charge lower prices thereby making them highly competitive in the international market. For instance, Chinese solar panel-makers incur a lower cost than their US counterparts. Consequently, most Americans buy imported solar panels. This prompted the US government, both Trump and Obama administrations, to impose import tariffs on imported solar panels from China. Most multinational firms, including US firms, have established production plants in China to exploit cheaper inputs and the larger market for commodities. The reforms of state-owned companies in China has enhanced efficiency thereby increasing their productivity. Capital intensives also benefit the heavy industry such as steel thus improving productivity and increasing exports. These measures have resulted in its growth to become one of the largest exporters of steel and machinery.

Effect of Trade Liberalization on Manufacturing

The manufacturing sector is a critical sector of any economy. A strong manufacturing sector leads to positive economic growth and low unemployment rates. Reduction of output tariffs increased the productivity of manufacturing firms but lower their markups or profitability (Brandt et al. 2017). However, input tariff reductions improved both total factor productivity and markup. Reforms instituted in the Chinese manufacturing sector improved resource allocation by converting state-owned enterprises into profitable ventures. Although open trade resulted in the exit of some private manufacturers, this implied efficient resource allocation to more productive firms thereby enhancing total factor productivity. Brandt et al. (2017) also cite a decline in agency costs and effective selection of new firms in sectors that were most liberalized, as some of the contributors to increased manufacturing productivity. However, input tariff cuts reduce markups due to increased competition.

Input tariff cuts, on the other hand, had no substantial impact on the productivity and profitability of the Chinese manufacturing sector (Brandt et al. 2017, 25). This is because imported inputs constitute a small percentage of the total intermediates used in the Chinese manufacturing sector. Nonetheless, low-cost inputs provided firms additional resources to invest in productivity-enhancement projects.

The Chinese manufacturing sector grew due to internal and external reforms carried out by the government in the run-up to China's accession to the WTO. Firstly, the government liberalized foreign direct investment thereby promoting FDI flows to the economy. Inward FDI flows led to an increase in the number of foreign multinationals in the country. This enhanced learning and technology spillovers that benefited Chinese manufacturing firms. Besides, the government reduced the size...