South China Morning Post

Wednesday February 27, 2002

A land misunderstood

Jasper Becker in Beijing examines two studies that offer contrasting economic forecasts for the mainland now it is a member of the World Trade Organisation

AMERICAN SCHOLAR Nicholas Lardy takes a reassuring and often contrarian view of the impact of China's entry into the World Trade Organisation in a new study produced for the Brookings Institution in Washington.

'China already is more integrated into the world economy than is commonly understood,' he writes in Integrating China into the Global Economy, one of the most detailed investigations so far available.

Lardy, whose 1998 work China's Unfinished Economic Revolution raised a red flag over the mainland's dangerously unreformed banking system, argues that doomsayers are wrong. They have misunderstood the present and the future perils.

'The large role of transnational companies in generating exports reflects China's deep rather than shallow integration into the world economy,' he writes. WTO does not spell either domestic or international problems, or at least not bigger social or economic crises than already have emerged along the road to reform.

Earlier projections of the cost of WTO membership said eight million wheat farmers would lose their jobs along with many other workers in sectors such as rapeseed oil, natural rubber, plastics and rolled steel. 'These almost certainly overstate the challenges because the projections, based on conditions in the mid-1990s, fail to take account of the huge economic restructuring before WTO entry,' he writes.

Lardy believes those who fear China will be swamped by imports have ignored the aggressive restructuring of many industries, such as textiles, that already has taken place. And they should see that a large convergence of Chinese domestic prices and those on international markets already has taken place.

Largely in response to relative price changes, Chinese farmers already have been moving out of land-intensive horticultural crops into areas where they enjoy a comparative advantage. He quotes figures showing that the absolute numbers involved in agriculture peaked in 1991 at 390 million and have since dropped by an annual average of four million.

Lardy argues that the foreseeable impact of the structural transformation of the labour force, especially in agriculture, will not be greater than in the past decade or more. The Government has used WTO membership to accelerate the pace of agricultural reform. Lardy believes it has recognised that China has no comparative advantage in land-intensive grain production and that it does not intend to protect the farmers with ever-growing subsidies. By doing so, Beijing has rejected Japan's protectionist approach and will not wall off its grain sector in the future.

On the contrary, 'China's commitments to eliminate agricultural export subsidies on entry seem without parallel'. The mainland has made 'an important commitment to allow market mechanisms in domestic agriculture' and to let market incentives push farmers into other solutions. He foresees China becoming a major exporter of walnuts, apples, citrus fruits, strawberries, grapes, asparagus, processed tomatoes and many other crops.

Even in other sectors which have been heavily protected, Lardy thinks the dismantling of tariffs will not be all that threatening. Average tariffs are already low but remain high on key items such as principal commodities including cars and car parts.

Their existence, or any other non-tariff barriers that might be erected, will not be that important. For example, he says China has opted against the idea of nurturing a purely indigenous automotive industry, the way Japan or South Korea did. That means an industry is emerging which is dominated by joint ventures, so many in fact that excess capacity will be more important as a source of downward pressure on prices than tariff reductions on imports.

In the key banking sector, Lardy predicts that foreign competition will not take a large share of domestic currency deposits for a long time. 'The challenges to Chinese banks are less daunting than sometimes portrayed,' he says. The real problems with the banking system will remain elsewhere. The benefits of China's accession to the WTO, particularly from increased competition, could be lost, he warns, if the banks do not stop lending to inefficient state companies that are responsible for overproduction.

Assuming the best, Lardy even thinks that membership could bring about 'potential impressive gains in economic efficiency'. 'Indeed the gains are likely to be greater than those predicted in most published quantitative estimates, since those studies do not capture fully the likely effect of more foreign competition on domestic firms,' he writes. The prospects for generating employment are 'bountiful', he estimates. China could benefit from the phase-out of arrangements restricting world trade in textiles and apparel by Taiwan, Mexico and the European Union.

Lardy also argues convincingly that those who doubt China's commitment to the WTO philosophy of trade ignore the reality that the mainland concluded WTO was the best, if not the only, way forward. China's growth was 'almost certainly much slower than reported in official data', especially during the Asian financial crisis. For a government which has staked its legitimacy on delivering sustained improvements in consumption and living standards, this convinced the leadership it had to accelerate domestic reform.

'China's market access and other commitments are not only more far-reaching than those that governed the accession of countries only a decade ago, they exceed those made by any member that has joined the WTO since 1995,' Lardy believes.

This view makes him sceptical of those who suspect China will use non-tariff barriers as a protectionist tool. He says such measures as import registration, quality and safety standards appear to be little different from similar programmes used by many trading countries.

Lardy also chastises some parts of the United States Government for harbouring strong doubts about China's commitment to free trade and competition. He criticises Washington for hindering China's accession, saying it is the only advanced industrial country which has no systematic technical assistance programme to help China develop the capacity to meet its WTO obligations.

Lardy also urges Washington to drop the remaining Tiananmen sanctions, such as withholding some US Export-Import Bank loans and credit guarantees for China-related deals or abstaining from voting on China loans at World Bank meetings.

'These sanctions are largely symbolic. They send an incorrect message . . . and feed the impression the United States is more interested in imposing tough conditions on China's WTO entry than in assisting China's historic economic transformation,' he writes.

Within a decade, he predicts China will surpass Japan and Germany to become the world's second-largest trader but this will pose more of a competitive challenge for other Asian countries than the US.

Despite the protectionist mechanisms built into the WTO agreement, he thinks the US should not and need not use them. For instance, the special restrictions designed to curb big surges in apparel exports will not be necessary because the likely job losses in the US industry will be fewer than 30,000 over a 15-year period.

Gloomy outlook challenges rosy reform view

IF YOU WANT a book that plays devil's advocate to Nicholas Lardy's generally rosy view of China's prospects post-World Trade Organisation, then read William Gamble's cautionary work Investing in China - Legal, Financial and Regulatory Risk.

Gamble, who runs a consultancy on investing in emerging markets, has compiled a sombre and unflattering look at China's economic system.

'China is still a very dangerous place for foreign capital,' he says before illustrating all the risks.

He takes a hard poke at those who assume China will be able to function better under a rules-based system imposed through the mechanisms of the WTO.

'It won't work. Although the leadership in Beijing may be totally sincere in their promises to the WTO, their ability to carry out those promises may not exist,' he argues, detailing how the lack of an efficient legal infrastructure hinders change.

Gamble thinks that, at least in the short term, the negative effects of WTO membership will be destabilising. Gains in such industries as textiles, garments, shoes and toys could employ an extra 5.4 million workers over the next seven years but threats loom larger.

Changes posed an 'immense threat to jobs, social stability, government revenue and the [Communist] Party's economic power'.

Big government-run monopolies will fight tooth and nail to protect their interests, he warns.

The book examines the pitfalls of contract, the lack of a functioning bankruptcy system and the corruption that undermines attempts to allow judges and lawyers to play their roles.

'Readers will understand that litigation is futile,' Gamble writes after describing the efforts of investors to assert their property rights through the courts.

The book is particularly strong when countering optimism that China is finding solutions to its bad loans. Gamble argues that China is doing everything but that; instead of creating a functioning bankruptcy law it is trying every alternative such as mergers or supervised reconstruction.

He is sceptical that those loans and assets taken over by asset management companies will have any real value. Often the original management of companies is left in place and it is hard to sell off land or sack workers.

'The process is almost a parody of the method used to solve the American savings-and-loan crisis during the late 1980s,' he writes. Relying on soft or policy loans to keep state-owned enterprises afloat, is, he asserts, 'absolutely the worst method for dealing with insolvent enterprises'.

Asset management companies probably would never realise value on these debts but this had not discouraged government hopes: 'The Government's solution relies to a great extent on the gullibility of foreign investors.'

Gamble is equally blunt that the Government's strategy of keeping state-owned enterprises afloat by throwing more money at them through poorly regulated stock markets is not going to work in the long term either. He warns that bolstering the country's insolvent banks by issuing bonds or shares will not make them any better, just further plunder householders' savings.

From the point of view of investors, issuing bonds will make no difference.

'Instead of holding deposits in an insolvent bank, investors will be holding bonds in an insolvent bank,' Gamble writes. For those pondering the merits of buying China concept stocks or real estate, this is the book to read before taking the plunge.