The effect of China’s entry of the WTO

by Chung-Hsien Yu ,Dec 2006.
Exclusive Summary
China, one of the fastest growing economies in the world, had joined the World Trade Organization (WTO) for five years. To meet the accession agreement of the WTO and catch up the trend of globalization, Chinese government knew that the modification of its economic policies and trade policies was urgently needed. Then, Chinese government started to implement the idea of free economy and trade at early 2000s.
Due to the transformation of joining a more open market through the WTO, the economy of China had kept steady growth every year from 2000 to 2005. According to states, during this period, the total trade amount of China had increased almost three times. At the same time, the trade balance of China also increased from $24 billion in 2000 to $101 billion in 2005; the trade balance between China and the US increased from $83 billion in 2000 to $201 billion in 2005. According to the balance of payments theory, the Chinese currency, “Renminbi” (RMB) or “Yuan,” should have been appreciated to a certain higher value if there was no other significant intervention. Actually, the annual average exchange rate between the RMB and USD, however, remained at 8.277 Yuan per US Dollar between year 2000 and year 2004.
The Chinese government has adopted Managed Floating exchange rate system for more than a decade. Under the control of China’s central bank, the Yuan was tied with the US Dollar at a fixed rate that announced by the Chinese government. As a result, the value of the Yuan would not reflect the real purchasing power of China and had been undervalued. Therefore, the US government, on May 2005, was attempting to accuse China which manipulated its currency to gain its economic advantage. Under the pressure from many counties in the world, not only the US, Chinese government reformed its exchange rate regime to a currency-basket model and revalued the RMB against the US Dollar by 2.1 percent. As a result, the annual average exchange rate between the RMB and USD was shifted to 8.07 Yuan per US Dollar.
Therefore, China’s accession to WTO did bring about a challenge to the currency policy of China. This challenge is not only in the short-run but also in the long-run. And, the Chinese government is still trying to conquer the challenge which is to float the Chinese Yuan.

The WTO
“The World Trade Organization (WTO) is the only global international organization dealing with the rules of trade between nations. At its heart are the WTO agreements, negotiated and signed by the bulk of the world’s trading nations and ratified in their parliaments. The goal is to help producers of goods and services, exporters, and importers conduct their business.”[1] WTO was established in 1995, but it is the inheritor of the General Agreement on Tariffs and Trade (GATT) established in the wake of the Second World War, about 50 years ago. Now, there are 149 members which include all the major countries in the world.
In order to maintain the orderliness, fairness and freeness of trade, the WTO has several important functionalities which are “administering trade agreements, acting as a forum for trade negotiations, settling trade disputes, and reviewing national trade policies.”[2] Therefore, a WTO member can trade fairly with other members under the supervision of the WTO. If there is an argument between two members while doing the trade, the WTO will be acting a result for them. Base on these reasons, a WTO member is more willing to trade with another country which is a WTO member than not a WTO member. In other words, accession to the WTO will give a country more opportunities to trade with other countries allover the world. As a result, it will stimulate economic growth of the country and raise national incomes and personal incomes of the country by trading with more countries.
On November 1999, the United States and China signed an agreement on the terms of China’s WTO accession since the United States is one of the Quad which are the four largest WTO members and have the significant effect on the WTO’s decision making processes. Therefore, this agreement made China almost half way through its accession when China had decided to speed up the whole process of accession to the WTO at late 1990s.

China’s Accession to The WTO
On December 11, 2001, China formally became the 143rd member of the WTO. The China Business Review said, “In the five years since China joined the WTO, the country has changed in many positive ways. The ideas of market economy and trade and investment liberalizations have been integrated into popular thinking. More important, the Chinese public now widely accepts core WTO concepts such as transparency, accountable governance, and national treatment.”[3]
There are several benchmarks among those changes. First, Ministry of Foreign Trade and Economic Cooperation of China began to liberalize trading rights for foreign-invested enterprises, and State Economic and Trade Commission of China approved first foreign-invested wholesale enterprise in July 2001. At the same time, State Council of China brought China’s Equity Joint Venture (JV) Law into compliance with WTO rules. “These Regulations (JV) are formulated for the purpose of encouraging foreign joint venturers to establish in China Sino-foreign joint equity ventures involving Chinese and foreign investment and of promoting the balancing of their foreign exchange income and expenditure, to the advantage both of production management and the repatriation of legally earned profits by foreign joint venturers.”[4] As a result, China has brought in a lot capital from other counties and contributed to its economy.
Second, China removed 75 percent cap on foreign investment in many categories and reduced import tariffs on more than 4,800 tariff classifications to an average final duty bound rate of 8.8 percent.[5] By doing so, China lost a certain amount of tax income as well as the protection to its several domestic industries. The good thing is that China became a more open market for imports and the imports could stabilize the consumer price index to prevent the inflation of its rapidly growing economy.
Last but not least, China Banking Regulatory Commission allowed foreign banks to conduct the RMB operations for businesses in several major cities of China. The more institutions at which businesses can access the RMB, the more liquidity in the money market of the RMB, therefore, the interest rate will be maintained at a certain low level, which can encourage the investment in the domestic economy.
Due to these reforms, the country has grown rapidly after China’s WTO entry. China has become not only the fourth-largest economy in the world but also the world’s third-largest trading country after US and Germany. The total trade amount hit the record high at about $1,422 billion in 2005.
Despite China’s trade amount, the average amount of foreign direct investment (FDI) in China from 2002 to 2005 was about $42 billion which nearly twice the FDI amount at 2000. Owing to the open market principle of the WTO and the low labor cost in China, the country has become the most popular country which attracts huge international capital from foreign countries. With these international investments, China became the world’s manufacturing center. As a result, the exports of goods increased rapidly and there was $101 billion surplus in trade balance in 2005.
Since the United States is the largest trade country in the world, the trade balance between the US and China exceeded $200 billion at the end of 2005. Besides, because the US Dollar is the major currency and the US is the strongest economy in the world, the Chinese government held about $310 billion US Treasury bills [6] by using China’s exchange reserve which hit $819 billion at the end of 2005. Another reason for China holding a huge amount of US Treasury bills is related to China’s currency policy.

China’s Currency Policy
On December 18, 1993, the People Bank of China (PBOC), the central bank of China, formally announced that there was a new system for China’s foreign exchange system. This change is based on a “Managed Floating System” which means that the PBOC announced a daily exchange rate according to the demand and supply of the market. Then, the market exchange was allowed to float within certain limits, a range of plus or minus 0.25 percent.[7]
Here is how this system works: “The PBOC published an average RMB-to-US$ exchange rate every morning based on the prices quoted on the inter-bank foreign exchange markets on the previous day and listed the exchange rates for other major currencies based on exchange rate fluctuations in international foreign exchange markets. Designated foreign exchange banks could quote prices within a narrow range fixed by PBOC.”[8]
According to the RMB-USD exchange rate history, the exchange rate was fixed at 8.277 Yuan per US Dollar from 2000 to 2004 even though the trade balance grown more than 20 percent at China side per year since 2001. This means that the exchange rate was not really floating. Instead, the exchange rate of the RMB seemed to be “managed” by the Chinese government. In order to balance the demand and supply of the exchange market between the RMB and the US Dollar, the Chinese government invested a lot of assets in the United States and purchased about $50 billion, on average, US Treasury bills per year since 2001.[9] Therefore, the RMB can be pegged during this period.

The Concern of The US
The purchases of US Treasury bills made by China had maintained the US long-term interest rate low although Federal Reserve raised the short-term interest rate and expected to raise the long-term interest rate. According to a U.S. economist, “With long term interest rates capped, the Federal Reserve was in danger of inverting the US yield curve. An inverted yield curve is the best single economic indicator of a recession, something the Federal Reserve clearly wants to avoid.”[10]
From US consumers’ view, This pegging exchange rate strategy made the value of goods manufactured in China cheaper than in other countries. Therefore, it’s a benefit for the people who are importing goods from China. On the other hand, the US domestic manufacturers lost their competition to China’s manufacturers. As a result, a huge number of outsourcing or purchasing parts from China had let US Manufacturing suffer. The US has lost over 3.3 million manufacturing jobs from late 1990’s. To address this problem, the US government had set the higher tariffs on Chinese imports into the US to against the advantage of undervalued Yuan at 2004.
In order to prevent the further potential damage to US economy from China’s currency policy, the Bush administration responded to the public on May 2005. Although, the US government declined to accuse China of manipulating its currency for economic advantage, but said that it is likely to do so if China does not change its policy.

The Response of China
Finally, the exchange rate regime of China was changed to a currency-basket model which is to set the value of the Yuan according to a group of other currencies, and devaluated the RMB against the US dollar by 2.1 percent in mid-2005. But, it seems can not satisfy the expectation from all China’s trading partners since the RMB was thought undervalued about 30 to 40 percent against the US Dollar by them. A more flexible and free currency policy is actually needed to release the pressures from the world.
In fact, China is putting its all effort on moving its currency toward a fully market-determined exchange rate and trying to commit WTO agreements. For example, China has introduced several mechanisms and instruments to float the RMB, such as currency swaps and forwards, a market-making system, and over-the-counter trading of the RMB.

Conclusion
China’s accession to the WTO is just like the first step of an infant when china facing the world economy. For China, there are still a lot work has to be done and so many new things needed to learn. The floating exchange rate is also a new topic the Chinese government needs to study. Accordingly, the real purchasing power and the strength of Chinese economy will really surprise the world by floating the Yuan. Moreover, China would have the chance to take place the global economic leadership. However, a free floating Yuan will require the free movement of capital, people as well as goods in China. This revolution will become China’s biggest challenge in the near future.

[1] World Trade Organization. “THE WTO IN BRIEF Part 1”. http://www.wto.org/english/thewto_e/whatis_e/inbrief_e/inbr01_e.htm. Oct 2006.
[2] World Trade Organization. “THE WTO IN BRIEF Part 2”. http://www.wto.org/english/thewto_e/whatis_e/inbrief_e/inbr01_e.htm. Oct 2006.
[3] Yong, Wang. “China in the WTO: A Chinese View.” chinabusinessreview.com. Oct 2006. Page 43
[4] State Council of China. REGULATIONS OF JOINT VENTURES' BALANCE OF FOREIGN EXCHANGE REVENUE AND EXPENDITURE. January 1986. Article .
[5] Yong, Wang. “China in the WTO: A Chinese View.” chinabusinessreview.com. Oct 2006. Page 43
[6] Department of The Treasury of the U.S.http://www.treas.gov/tic/mfhhis01.txt. Oct 2006.
[7] Zhang, Peter G. Chinese Yuan (Renminbi): Derivative Products. River Edge, NJ, USA: World Scientific Publishing Company, Incorporated, 2004. p 86.
[8] Zhang, Peter G. Chinese Yuan (Renminbi): Derivative Products. River Edge, NJ, USA: World Scientific Publishing Company, Incorporated, 2004. p 86.
[9] Department of The Treasury of the U.S.http://www.treas.gov/tic/mfhhis01.txt. Oct 2006.
[10] Steidtmann, Carl. "Economist's Corner: Yuan Small Step for the Global Economy, Yuan Giant Leap for China." Consumer Business, Deloitte Research. July 2005.