Econ - Chapter 16: International Trade

Chapter 16: International Trade

Introduction

1. 2005: World's 3rd largest trading nation (Exports are 64% of GDP)
2. Current degree of openess is exceptional for large continental economy
3. Insane trade growth in past 30 years
4. Trade is now fueled by FDI

Background

1. Open to trade mostly to Soviet bloc (48%) the rest to communist countries

1. High imports of machinery for big push and GLF.

1. Trade fell sharply due to industrialization failure and break up with Soviet Union

1. Relied on food imports from Canada, Australia and Argentina

1. Post CR, exports increased again for light industry and oil. Used foreign currency to import technology

1. Fell through after oil failed

Trade Reform

1. Introduction

1. Double Air Lock Soviet System

1. Air Lock 1: Centrally controlled foreign trade monopoly. 12 national foreign trade companies have monopoly over imports and eports
2. Air Lock 2: Foreign exchange system. Value of RMB is set and cannot be converted. Need government authorization to convert

1. Reason for Double Air Lock

1. Keep domestic and foriegn market seperate
2. Keep domestic prices stable

1. Problems

1. FTCs have to cross subsidize to balance prices. Profitable goods in foreign markets may not be set to be profitable in local markets as SOEs were made to be profitable
2. Caused by Import Substitution Industrialization (ISI) strategy to again protect SOEs.

1. Reasons for Reform:

1. Need foreign currency urgently

1. Initial Reform Steps

1. Guangdong and Fujian (1978-1979)

1. Trade links opened with these provinces to make use of their proximity to Hong Kong and Taiwan

1. Hong Kong firms allowed to sign export processing (EP) contracts with Chinese firms in Pearl River delta

1. EP is just outsourcing of work into China.

1. Creation of EP Zones (EPZs) 

1. Allows China to selectively promote exports within a ISI system.

1. Special powers given to Guangdong and Fujian incentivized local governments to promote trade further as they could retain foreign currency

1. Guangdong and Fujian grew quicker than all other areas in China.

1. Liberalizing the Foreign Trade System - Moving the Guangdong/Fujian experiment Nationwide

1. Devaluation

1. Devaluation say RMB drop from 1.5 to 3.5 ratio to USD.

1. Exporting became valuable
2. Importing was checked due to high cost

1. Coincide with dual exchange rate regime where producers outside the plan can sell foreign exchange earnings in less regulated secondary markets
2. Coincided with Japanese Yen appreciation

1. Demonopolizaition of Foreign Trade Regime

1. Number of companies allowed into foriegn trade expanded dramatically
2. FTCs were easier to set up and there were 5000 FTCs for every SOE
3. Direct import and export rights were granted to 10,000 manufacturing firms.
4. Target setting and contract system (From Chap 13) were applied.

1. Changes in Pricing Princples

1. Exposure to greater competition both local and foreign made FTCs more cost conscious. They began to work with C.A TVEs
2. World price signals were now transmitted into domestic economy
3. Agency System to Price Imports: Domestic Price = World Price + Commission paid to importer / distributor.
4. Trading companies now adapt to opportunities caused by world prices

1. Creation of Tarrifs and Other Trade Barriers

1. Fear of mistakes, import surges, currency debt caused policy makers to adopt barriers.
2. Similar to other highly protected developing economies (tarriff = 43%)
3. Non Tariff Barriers:

1. Limited extension of trading rights. Import only for your own production needs.
2. Trade only in a limited product range
3. Central government FTCs had monopoly on imports of sensitive commodities like grain

1. NTBs prevented domestic firms from participting in EP contracts

1. Import Substitution and Export Promotion

1. 1980s: From Planned Trading to Barrier filled Trading
2. ISI held some advantages for China:

1. Trading becomes more centered on profit making in world prices
2. Flexibility was created that helped in later domestic reforms. Easier to harmonize both foreign and domestic sectors
3. Tariffication allowed China to negociate with WTO about entry. They had something to lower and provide as an exchange.

1. To counter some antiexport measures, China allowed a partial system of rebates of VAT for exports. Banks also provided preferential interest rates for exporters
2. Also the creation of a seperate export processing regime allowed exporters to simply bypass old centralized foreign trade monopoly

A Dualist Trade Regime: The Export-Processing System

1. Coastal Development Strategy

1. All firms including TVEs can handle processing and assembly contracts
2. Foreign investors allowed to take control of components and raw materials that they imported duty free. (Cost advantage)

1. Export promotion trade grew quickly

1. Size of EPZs were huge and much larger than SEZs
2. This policy enabled China to tap the expertise of FIEs from export experts Hong Kong and Taiwan

1. FIE share of exports increased 
2. Domestic firms did not enjoy the same growth

Toward An Open Economy

1. Introduction

1. Reforms for WTO reduced the dualism in trade regime. Lure of WTO pushed many reforms through.

1. Currency Convertibility

1. Secondary 'swap' market established in 1994 for foreign exchange

1. Exchange rate now near unified
2. Better access to foreign currency

1. National taxation system moved to reliance on VAT

1. Takes advantage of the rule that rebates can be claimed by exporters on VAT.

1. No complete convertibility of currency yet probably also influenced by 1997 Asian crisis where China decided to prevent depreciating its currency

1. World Trade Organization Membership - Changes Adopted

1. Hampered by Tienanmen massacre
2. Hampered by dumping nature
3. Due to service orientated trade from developed countries, China had to grant broader and fairer access to its economy
4. China required to reduce duality of trading regime
5. Tariff rate quotas were introduced (tariffs reduced from 43% to 17% (1999) then 9.4% in 2004)

1. Openness (Total Trade to GDP) Revisited

1. Imports:

1. Imports as a share of GDP increased

1. Most trade came from EP share till the mid 1990s
2. OT surged after WTO membership

Outcomes: Rapid Growth & Structural Change

1. Exports

1. 1979-1985: Mostly petroleum
2. 1985-1995 : Coastal Development strategy and increased participation of FIE greatly increased trade. Export commodities mainly from light industry
3. 1996-2001: Trade growth slowed due to financial crisis + 30% appreciation in RMB. China begins focusing on domestic demand. VAT rebate reduced
4. 2002-Now: Second surge mainly in electronics and machinery exports. Garments continue to be robust

1. Imports

1. Capital intensive products: 66% of imports. Mostly targeted at overcoming lack of land endowment. Also for heavy process technology industries
2. Skill intensive products: Machinery for transport and electronics

1. High Technology Trade

1. Not a technology exporter. Tech is under EP, all China did was to process and package. Final stage of production only, thus non high tech.

Regional Composition of Trade Within China

1. Coastal benefits again

1. Easier to trade due to better location
2. Caused by policies like the Coastal Development Strategy

1. Lower Yangtze is eclipsed and resurges

1. 1980s giant sees share decline from 34% to 21% but swings forward in 1990s with FDI inflows
2. Resurges back to 38% and eclipses the southeast

1. Northern continues to decline steadily since 1980s

1. Dips below 20% in 2003

Conclusion

1. High trade to GDP ratios is due to economies being part of a global production network. Thailand, Malaysia and China included.

1. Trade to GDP ratio is thus a degree of openess and not a measure of the trade sector

1. China's differences from the rest of the world gives it tremendous C.A.

Chapter 17: Foreign Investment

Introduction

1. FDI pours in after 1992 and increasing steadily
2. China holds 33% of LDC FDIs
3. 3 Characteristics of FDI in China

1. FDI is China's main arm of accessing global capital
2. FDI goes into manufacturing instead of resource extraction
3. FDI comes from other East Asian economies

FDI in the Chinese Economy

1. First accepted in 1978 when China established SEZs
2. Policy became more localized and FDI seeped into individual regions
3. FDI floods in 1992

1. Caused by Deng Xiaoping's Southern Tour. China had already built some credibility with investors a decade before. The tour reassured investors after Tienanmen
2. China also allowed FDI into more sectors than just the manufacturing sector

1. Fits SEA pattern in reliance on continual FDIs
2. FDI impact is multifaceted:

1. Contribution to overall investment and structural change
2. Brings in management experience and marketing channels with technology

'Zones': The Gradual Liberalization of the Investment Regime

1. Every wave of liberalization is done via zones = Permission of incremental progress within a rigid system

1. Testbed crucial due to Nationalist mistrust of foreign involvement. Zones enhance credibility of reform process

1. Wave 1: SEZs went beyond normal Asian EPZs as they also serve domestic reforms and attract non local Chinese back to China

1. Teething problems include smuggling and corruption with FDIs leaking to surrounding areas like the Pearl River Delta

1. Wave 2: Economic and Technological Development Zones (ETDZs) encouraged aggressive bargaining and trade with foreign investors to facilitate investments
2. Wave 3: SEZs opened in Pudong (East Shanghai), smack in the center of China's heart.

1. Experiments allowed in housing and retail sectors

1. Wave 4: Extension to Western areas

The Investment Regime Today

1. Favourable:

1. Moderate taxes
2. Investment protection agreements
3. Apparatus for arbitration is available

1. Investment regime is decentralized and discretion is held by local government officials = favourable for high FDI intake.

1. Difficulties spring as it is not claer who has ultimate power to approve. Foreign investors have to navigate choppy inter-governmental relationships. Also hampered by some ineffective low quality governments.
2. Also problems with enforcing intellectual property rights

1. Contractual Joint Ventures (CJV)

1. Flexible agreements to share profit. Useful in investments that span multiple sectors
2. Largely illegal
3. Tailored for oil exploitation. 

1. Equity Joint Ventures (EJV)

1. A legal entity where foreign and local firms have a stake
2. Not successful due to differing aims for locals (employment, firm expansion, technology transfer) and foreigners (profit margin)

Sources of Investment in China

1. Group 1: Hong Kong, Taiwan, Macau and Free Ports / Tax Havens (60%)
2. Group 2: United States, Canda, Japan, EU (25%)
3. Group 3: Korea and Singapore
4. Special Focus - Hong Kong

1. Not foreign as it is part of China. But kept foreign due to different administration and development status
2. Hong Kong's development cycle sees the land too tiny for manufacturing firms prompting firms to enter China for production
3. Proximity to China also means that Hong Kong is very aware of policy shifts and exploit them quickly.
4. China signs 'Closer Economic Partnership' with Hong Kong - earlier access for Hong Kong firms to new zones

The China Circle - PRC, Hong Kong & Taiwan

1. Chinese officials sort to emulate the success of Hong Kong and Taiwan in their labor intensive manufacturing exports during the 1960s and 70s
2. When China opened up, HK and Taiwan's labor became more expensive and migrating manufacturing to China was an easy solution (Shoes and PCs later)

1. High FDIs between the circle funded the change

1. Proximity including common language and customs made things easy and kept costs low. Easy to spread production processs without high transportation costs.

FDI In Context

1. Sectoral Composition of FDI: The WTO Impact

1. High FDI penetration into manufacturing 
2. Services only stand at 27%

1. Caused by government safeguarding some services
2. FDI only find place in real estate services in China. Unlike other countries where FDI can find areas in retail, transport, communications and finance.

1. WTO commitments will reverse that in time

1. Modes of Capital Inflow

1. 1980s -1990: Funding came from governments and international organizations
2. 1990- now: FDIs dominate

1. Caused by slow financial markets
2. China reacts by placing limits on foreign borrowing leading to tiny foreign debt

1. China maintains the lid on capital account convertibility to prevent large sales of currency

1. But BOP shows that high amount of funds are still moved via other channels, this is seen in the large 'errors and omissions' section.
2. Capital controls do not work. Funds still flow freely when anticipating devaluation, etc just like in East Asian economies before 1997.
3. Better to legalize and open it to prevent greyness of the black market

Conclusion

1. China was smart to prevent 1997's crisis from affecting them by:

1. Ensuring long term commitment of FDI
2. Ensuring invested assets cannot be quickly liquidated.

1. China should liberalize capital account convertibility and allow FDI to flow into more sectors

Chapter 18: Macroeconomic Trends and Cycles