The path ahead for china economic relationship

Uncertain path ahead for China-US codependency

the path ahead for china economic relationship

Before rushing to reboot inter-Korean economic relations, it is imperative that . China's economic engagement with North Korea is a major factor that has with all concerned parties to seek agreement on a path forward. The growth of the United States stands between these two divergent paths. First, the economic relationship between the United States and China provides. China's global economic influence and power is unmistakeable. to this - ' China's economy needs to be put on the path of endogenous growth driven by . or more of high wage growth will fast-forward the drive by Chinese producers to raise.

The remaining columns show China's share ten years hence under various scenarios. The bottomline is that even under the slow growth scenario, China clearly emerges as the world's second largest economy in the next decade. This conclusion is further reinforced if the figures for Hong Kong's share of output are added to China's.

China's participation in international trade also has grown rapidly during the period of reform, and its share of world trade has risen from 0. Chinese economic reforms not only spurred an enormous growth in trade, but the reforms have transformed the commodity composition as well, aligning China's pattern of trade more closely with its true pattern of comparative advantage Table 2.

Between andthe share of exports accounted for by the light manufactures of SITC 8 rose from 16 percent to 47 percent. Similarly, imports of capital equipment SITC 7 rose from 25 percent to 42 percent during this period. In addition to its rapid emergence in goods markets, China has also become a major player in international capital markets.

China is now the leading developing country destination for foreign direct investment. Firms with foreign equity participation accounted for two-thirds of the increase in Chinese exports in and With regard to portfolio investment, external debt does not appear to be a problem: Much of Chinese finance is intermediated through Hong Kong, however, and a crisis of confidence surrounding the transfer of sovereignty or Chinese policy and administration in its aftermath could greatly complicate the situation for China and the region as a whole.

China is a major recipient of multilateral and bilateral official lending. The US appears to be isolated on this issue, though Japanese attitudes may be changing in light of its dispute with China over nuclear testing.

Environmental issues are likely to play an increasingly prominent role in China's economic relations. Already the US Exim Bank has refused to grant export finance to participate in the Three Gorges Dam project because of environmental concerns.

China is also predicted to emerge as a major source of hydrocarbon emissions in the 21st century due to its rapid growth and reliance on dirty coal for energy. If there were to be an international tax on hydrocarbon emissions, it would presumably fall heavily on China. It is not difficult to imagine China insisting on enhanced multilateral and bilateral concessional financing or increased access to developed country markets as quid pro quos for adherence to a strict anti-emissions regime.

US-China Economic Relations The rapid integration of China into the global economy has posed particular problems for high income countries, including United States. China has a rapidly growing aggregate bilateral trade surplus with the US, even according to Chinese data, and even when the miscounting of re-exports through Hong Kong are taken into account Table 3. Nor can this growing Chinese surplus be explained away as a function of the relocation of production from Hong Kong and Taiwan to China as was conceivable a few years ago Table 4.

These imports are almost wholly labor-intensive manufactures, and economic theory suggests that this exerts downward pressure on the wages of import-competing domestic low-skilled labor, if production in such activities is actually carried out domestically.

With respect to exports, as shown in the top panel, the industrial sector with the greatest dependence on exports to China was agricultural pesticides which exported 40 percent of domestic production to China. It was followed in turn by phosphatic fertilizers 33 percentstructural metal parts 16 percentwelding apparatus 14 percentnoncellulosic man-made fibers 12 percentand vitreous plumbing fixtures 10 percent.

The sectors listed in the upper panel of Table 4 might be described as mostly chemicals and capital goods. The import figures in the bottom panel of Table 6 are both larger, and in a sense, more systematic.

Sectors in which imports from China account for more than half of domestic consumption include dolls 75 percentrubber and plastic footwear 66 percentnarrowly defined miscellaneous manufactures which includes a laundry list of items such as cigarette lighters, umbrellas, and wigs percentleather wearing apparel 53 percentand leather gloves 51 percentall of which are simple light manufactures.

The Department of Commerce's survey of foreign direct investment provides a considerable amount of detail on US investment in China. Most of this activity was in the petroleum sector, wholesale trade, machinery and chemicals sectors. Unfortunately most of the data on intra-firm trade and the destination of sales is not reported to avoid disclosure of data for individual firms. As a consequence it is impossible to tell how much of affiliate output is exported back to the US, or conversely what share of US exports to China are from parents to Chinese affiliates.

What the data that is reported indicates is that for majority owned affiliates, 20 percent of output is sold to related parties, which is slightly lower than the average for US majority owned affiliates worldwide 75 percent.

In other words, intra-firm trade is probably somewhat less important in the case of US trade with China than with other countries.

Production by majority owned affiliates is exported to third countries at a noticeably lower rate 16 percent than the worldwide average 23 percent. The overall picture that emerges is for a pattern of investment which is probably a bit more geared to serving the needs of the host market, China, than is the case with other US direct investments around the world. A corollary is that intra-firm trade is probably not a big contributor to the bilateral trade imbalance.

US Policy Toward China The outside world has limited abilities to affect the development of the Chinese economy-the outcomes of the major economic policy issues that China faces will largely be determined internally. To give but one example: If the political leadership in China began to fear that centrifugal forces were pulling the country apart, there might well be a retrenchment of economic reform, and the Chinese government would become less responsive to the interests of foreigners and to fulfilling international obligations.

In such circumstances there would probably not be a whole lot that foreigners could do to reverse such a tendency. Contrary to recent calls to "contain" China, the overarching goals of US economic policy toward China are to promote political and economic liberalization within China which the Clinton Administration explicitly views as linkedintegrate China into global institutions, and pursue US commercial interests which the Administration largely identifies as exporters' interests.

The US also has strategic and political goals which may at times conflict with economic interests though there appears to be a lack of consensus in the domestic foreign policy establishment about prioritizing among these possibly conflicting goals as well as the effectiveness of alternative strategies and tactics to achieve them in the post-Cold War world. Policy is also influenced by the demands of a variety of domestic special interests import competing sectors, exporters, human rights activists etc.

As a consequence, US policy toward China is probably best regarded as a manifestation of competing interests in which no single goal predominates, and special interest groups may hold sway on particular issues. This sometimes gives the impression of an inconsistent policy, but to a certain extent this is probably inherent in the structure of the US political system and the lack of domestic consensus over goals, strategies and tactics in the post-Cold War world.

In the economic sphere, relations with China are played out in bilateral, regional, and global fora, and involve both trade and financial issues. There is obviously interrelationships between these different modalities, but for expository reasons, it is probably simplest to consider them separately in turn.

The first is proactively through US policies to encourage economic reform in China, and China's responsible integration into the international economy. The Administration regards technical assistance as the primary channel through which it can influence economic reform in China and by extension encourage political liberalization.

Among the avenues of technical assistance which have recently been created or revitalized has been the US-China Joint Economic Committee led by the Treasury Department, with working groups on financial reform and the foreign exchange system.

The Securities and Exchange Commission has a group that works on securities regulation, and the Treasury and the Federal Reserve Board have a group to provide assistance on banking regulation and the implementation of monetary policy. Private nongovernmental organizations such as the American Bar Association also engage in institution building.

New path ahead for China-US relationship -

The primary channel of economic cooperation is private business trade and investment, though. Similarly, bilateral intergovernmental relations are dominated by a second track of reactive trade conflict, largely a function of China's rapid growth, partially reformed economic system, and the complainant driven US trade policy making system.

the path ahead for china economic relationship

However, the potential for Sino-American economic conflict is likely to worsen. Table 7 reports the shares of US trade accounted for by different trade partners, and projections of how these shares might change obtained by plugging the Table 1 figures, estimates of per capita income, measures of distance and other factors into a gravity model of bilateral trade. Most Favored Nation Status Under the Jackson-Vanik Amendment to the Trade Act ofmost favored nation MFN status can be extended to nonmarket economies only if the President grants a waiver certifying that the country does not impede emigration.

The law was originally passed to encourage the Soviet Union to permit the emigration of Soviet Jews. President Clinton exacerbated this tendency, first by criticizing then-President Bush during the campaign, and then in by tying renewal of MFN explicitly to immediate improvements in human rights in China.

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The Executive Order signed by President Clinton in to extend MFN untilincluded a laundry list of human rights objectives as conditions for future renewal. Relations between the two countries continued to be rocky in Despite this, economists and business leaders successfully argued that revoking China's MFN and the ensuing retaliation would only hurt American exports while doing little or nothing for human rights.

The Chinese, for their part, made a number of superficial concessions on human rights while cultivating the support US business. Despite an outcry from many Congressmen, human rights activists and the press, the Administration decided to announce that China had met the minimum requirements necessary for renewal. The Administration's adopted the new line that encouraging China's economic liberalization and integration into the world economy would be the best way to pursue US foreign policy objectives of democratization, development and economic reforms in China Economic Report of the President, Although the renewal of MFN in was correct substantively, the apparent climbdown from the earlier statements of explicit conditionality made the President appear unsteady.

Soon after the MFN renewal, the US designated China as a priority foreign country under the Special intellectual property rights protection provision. Several reports were released criticizing China's human rights policy; the American public was particularly outraged when China imprisoned but later released human rights activist Harry Wu, a US citizen.

China also conducted large-scale military exercises off the coast of Taiwan in an effort to intimidate voters before the island's first democratic elections in which Lee Teng-hui scored a resounding victory. Evidence was uncovered that Chinese firms had sold Pakistan magnetic rings that could be used to enrich nuclear fuel which could be then used in the production of nuclear weapons, and were involved in smuggling illegal weaponry into the US.

And just as the intellectual property rights IPR dispute was reemerging as a hot political issue, it was time to renew China's MFN status for another year. MFN renewal in passed with little fanfare, but as tension on the trade, human rights, IPR and proliferation fronts increased, the debate over renewal in has become yet another forum for addressing American concerns.

As could be expected, the President announced that he would certify China's MFN status for another year, and the Administration has strenuously resisted Congressional efforts to link the MFN debate with human rights, the IPR issue, and proliferation concerns.

Even South Carolina Senator Ernest Hollings, a long-time opponent of China's MFN status, announced that he would switch his vote and support MFN extension on the grounds that the yearly Washington debate serves only to increase tension and harm US-China relations without accomplishing anything positive. Indeed, what is truly striking about the trade politics in the US is how MFN policy has been driven by exporters and investors, not import-competing interests.

US-China Economic Relations

Historically, the focal point of trade tensions has been protectionist demands by US light manufacturers. To cite one example, China's share of the US bicycle market increased from China circumvents its bilateral textile and apparel quotas, mainly by transshipping products through third countries which are also covered by bilateral quotas.

In other words, the Chinese substitute their products for the unfulfilled quotas of third countries. The main transshipment points are the high wage locations of Hong Kong, Taiwan, Macau, and Singapore. In other words, the Treasury figure implies that nearly 25 percent were transshipped.

A bilateral agreement on this issue was signed in January Government sources indicate that the problem appears to be getting worse, however. Even allowing for high re-export markups, these discrepancies are huge. The US Customs Service found that half of the 36 fastest growing apparel suppliers to the US market had no significant domestic production for export, but report a significant increase in imports from China. Kenya, for example has recently experienced a percent growth rate in apparel imports from China, and a percent growth in exports to the US.

Other countries, including Belize, the Czech Republic, Ecuador, and Qatar, exhibit similar triple-digit growth rates. Transshipping is currently subject to criminal prosecution, and Customs and the Justice Department have launched a major campaign to prosecute transshippers.

There was recently a major conviction involving a Chinese state-owned firm. In May the US cut China's cotton underwear quota by 35 percent and also reduced some other quotas because firms were illegally transhipping textiles though Hong Kong, mislabeling them as video rewinders and metal furniture. To investigate this question a constant market share CMS analysis was undertaken. The CMS approach is based on the idea that a particular country's share of world production is a function of its "competitiveness" where s denotes share, q production quantity, and c "competitiveness"; lower case letters indicate reporting country values, upper case world values.

Thus, in Equation 2changes in the reporter country's production are decomposed into two terms-the first indicating what the country's production would have been if it simply maintained its share of world production, and a second indicating gains or losses due to changes in share competitiveness.

Production, in turn, is also a function of the pattern of domestic consumption, exports, and imports, and changes in production will be affected by the commodity and geographical market partner composition of trade. So for example, countries specializing in exports to rapidly growing product markets or partner countries would experience faster export growth than competitors concentrated in slowly growing markets for a given level of relative competitiveness.

Their shares in those markets, however, would be constant as long as the underlying competitiveness factors remained unchanged.

Thus a more sophisticated model can be constructed by decomposing production into consumption, exports, and imports, and redefining the relationships in Equations 1 and 2 in terms of commodity- and geographic-specific markets 3 4 where i and j indicate product and partner respectively.

The first term on the rhs of Equation 4 is the CMS rate of consumption growth-the rate of production growth which would have occurred if the country simply maintained its market share in domestic consumption in each commodity market. The second term gives the change in production for domestic consumption due to changes in share-that is, changes in competitiveness.

The remainder of the terms in Equation 4 can be defined analogously. At the sectoral level the data were disaggregated to product categories at the 4 digit SIC level and three geographical markets-the US, China, and the rest of the world-were distinguished.

Applying the Department of Commerce figure for average labor productivity across the industrial sector, this would amount to a loss of less than one thousand jobs. This is not the end of the story, however. Export jobs pay on average 13 percent more than non-export jobs. Applying the export-related wage premium to the jobs figures one finds that the higher pay of the export jobs more than compensated for the slight reduction in total employment, and total compensation in the industrial sector was higher than expected, even with the Chinese competitiveness gains.

Whatever the Chinese gains in competitiveness, these gains have come almost exclusively at the expense of third country exporters, and the direct impact on the US economy has been minor. Export Controls US policy discourages exports to China. This discouragement takes the form of both generic export disincentives such as unfavorable tax treatment, and specific disincentives such as restrictions on the export of militarily sensitive products or the refusal of the Exim Bank to support participation of US firms in the Three Gorges Dam project.

the path ahead for china economic relationship

Richardson uses a gravity model similar to the one used to generate the bilateral trade volume estimates of Table 7 to estimate the impact of export disincentives. In other words, US exports to China for would have been something like twice their actual volume had it not been for export disincentives.

These estimates are subject to considerable uncertainty, the US export control regime has loosened with respect to China since Richardson's sample period, and the Chinese economy has grown by approximately one-half. Nonetheless, even if they are remotely accurate, they suggest that self-inflicted US export disincentives dwarf the impact of Chinese policies on US trade.

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Intellectual Property Rights Bilateral trade disputes between the US and China have not only involved merchandise trade. An important, possibly preeminent, source of conflict has been over the lack of intellectual property rights IPR protection in China. Early in its reforms, China proclaimed its commitment to protecting copyrights, patents, and trade secrets by signing the US-China Bilateral Trade Agreement of Throughout the s, the two countries used the Joint Commission on Commerce and Trade as a forum to discuss issues of compliance, and China even joined the Paris Convention for the Protection of Intellectual Property.

It pledged to treat computer software as literary works: It also promised to expand the definition of and increase the protection for pharmaceutical patents, an issue that had proved to be a major sticking point in the negotiations. Later that year China joined the Berne Copyright Convention and the Universal Copyright Convention, and in it took on additional responsibilities under the Geneva Phonogram Convention.

In Februaryafter a flurry of consultations, negotiators reached an agreement on the day before the tariffs were to be imposed. China agreed on specific enforcement measures to crack down on IPR infringement, to conduct frequent bilateral consultations, and to establish task forces to raid illegal manufacturers and improve border control.

China also promised to increase market access for US products by banning quotas on several goods and allowing US companies to set up new joint ventures. This last move was seen as important to counteract the implicit trade barrier to US goods caused by China's domestic sales of pirated goods. China's efforts focused on curbing sales of pirated goods at the retail level. Yet production, distribution, and exports have continued. Not only does domestic sales of pirated goods act as a barrier to US goods, China exports them to third country markets mainly Hong Kong, but also Southeast Asia, Eastern Europe and Latin America inflicting losses on American exporters to those markets as well.

For its part, Beijing has pointed out that in the last year it closed 7 CD plants that violated copyright laws and confiscated hundreds of thousands of bootleg CDs. It has also installed new government inspectors at CD factories. The trade associations that make up the IIPA use different methodologies to estimate losses to piracy in their respective markets.

Most share a common defect however in that they assume that the number of units sold in China would be the same regardless of price; in other words they assume that the price elasticity of demand is zero, as illustrated in the top panel of Figure 3. In this case industry losses are given by the rectangle EFGH, which the industry claims is A more conventional set of assumptions is shown in the lower panel of Figure 3.

Here, demand has some negative price elasticity so that it is downward sloping. Supply is upward sloping rather than infinite as the IIPA assumes. In the initial case, the producer surplus the area above the supply curve below the price line is triangle IJK. If the price is increased because of royalty payments, the supply curve shifts back along the demand curve to the new high price and low quantity combination P2, Q2. Producer surplus is the triangle LMN. The industry might argue that in this case, the supply does not really shift, rather protection of intellectual property rights in the form of royalties is like a tax, with the revenues going to the producing firms.

In this case producer surplus would be the trapezoid LMRK. Unfortunately, the determination of the Clinton Administration to pursue its IPR agenda, and the apparent unwillingness of the Chinese government to shut down pirate production as distinct from signing agreements to respect IPR means that the likelihood of actual punitive sanctions being imposed appears to be higher than in past disputes.

Past history suggests that Chinese negotiators will engage in brinkmanship, waiting until the final possible moment before reaching any agreement. Yet the emphasis on enforcement, as distinct from reaching new agreements, increases the likelihood that sanctions may be imposed. Even then, though China often agrees to US conditions, its track record of effective enforcement belies its procedure of superficial compliance. Its enforcement mechanisms are also less than required under the WTO both with respect to border measures and general procedures and remedies Subramanian, It would also move resolution of disputes from bilateral negotiations to an arguably less politicized multilateral setting.

Multilateral Issues While the US government has little direct influence on China's internal reforms, it has substantial ability to influence the terms on which China is integrated into global economic institutions, most notably the World Trade Organization WTO.

The US and other countries are understandably cautious on this issue because of China's enormous size and the likely precedential effect that the terms of China's accession will have on the protocols of approximately 20 other economies in transition which wish to join the WTO.

In the case of China, foreigners have encountered significant difficulties in a lack of transparency in the application of trade restrictions, as well as non-uniform application of trade policy in different parts of China. In these negotiations the US has tended to put more emphasis on obtaining access to the Chinese market this would be consistent with the US domestic political emphasis on exportswhile the EU has put more emphasis on securing liberal safeguard provisions to protect against imports from China.

Ironically, the US insistence on market access which is, after all, trade expanding and welfare-enhancing has been criticized in China, while the EU's demands for safeguards which restrict trade and reduce welfare has received less opprobrium.

Beyond these fundamental issues, the main points of contention regarding China's application to join the WTO have been whether China will enter as a developed or developing country and thereby the length of the transitional period granted for bringing domestic practices into compliance with WTO obligations as well as the issue of trading rights and state trading monopolies and the subsidization of state-owned firms.

China has argued that it should be allowed to enter the WTO as a developing country, and China is a developing country on any measure of per capita income. The United States has argued, however, that significant parts of China are sufficiently developed that it would be folly to permit China the additional leeway granted developing countries. China's case is complicated by the fact that Taiwan has indicated that it is prepared to join the WTO as a developed country.

The likely outcome will be to classify China as a developing country for some WTO obligations and a developed country for others. China maintains state trading monopolies, and unless foreigners are freely allowed to import and export, concessions on tariffs and other impediments to trade would be meaningless. US firms also argue that the "trade balancing requirement" of the current foreign exchange allocation system is in effect a nontariff barrier and a clear violation of the TRIMs agreement.

With regard to market access, the United States has asked China to join the "zero for zero" group which eliminated tariffs on construction equipment, medical equipment, steel, beer, distilled spirits, pharmaceuticals, paper, toys, and furniture, and which greatly reduced tariffs on chemicals and electronics. The European Union has requested that China bind industrial product tariffs at percent.

Although neither demand is likely to be satisfied, China will undoubtedly increase market access as part of its WTO accession, and has signalled some willingness to do so as noted below. With regard to investment, foreign investors have to go through a protracted administrative approvals process, which is subject to corruption, and the US has requested a streamlining of this process.

Such practices include contracting a state-owned business to be managed privately, use of state factory buildings for private production activities, and lease of locally owned agriculture land for housing development.

Thus, the boundaries between the state-managed economic system and market economy are becoming increasingly blurred. These dynamics of economic systemic change raise important questions for future South Korean economic engagement strategy—in particular, whether and how it can be designed to reinforce the marketization of the North Korean economic system, encourage policy reforms and institution-building to support a growing mixed economy, and provide direct benefits to the North Korean people.

Laws that have been adopted for North Korean Special Enterprise Zones SEZs are also very different from the agreements governing the operations of the KIC and are based on efforts to learn lessons from the experience of other countries use of SEZs to promote their economic development. Among other features, these include rights to set salaries and pay workers directly, opportunities to form joint ventures, access to financial and other services for investors, and legal protections against various risks.

Specifically, issues worth exploring are allowing or promoting direct payment to employees; direct joint ventures between South and North Korean enterprises; sourcing of inputs for production from North Korean suppliers in addition to South Korean suppliers; backward linkages to small and medium-sized North Korean enterprises and markets; and use of banking institutions for settlements. Sanctions In addition to the internal developments in the North Korean economy, the impact of bilateral and UN Security Council sanctions needs to be carefully assessed in shaping a reset of inter-Korean economic cooperation.

Even an effort to simply reopen KIC in the same form when it was closed in would be compromised by the tightening of sanctions last year, and the determination of the Trump administration to seek more severe and effective implementation of sanctions to add pressures on North Korea. One impact of sanctions has been to give North Korea greater incentives to seek cash transactions and non-transparent trade-using front companies willing to act as intermediaries with third parties.

Given past experience, cash for concessions in inter-Korean relations should not be resumed in this environment. On the other hand, sanctions are also creating incentives for both state and non-state North Korean actors to seek non-sanctioned economic activities to earn foreign exchange and to increase efficiency in domestic production and value-added in exports.

This may provide new opportunities for collaboration in KIC, rebuilding processing-on-commission trade, and the design of other inter-Korean economic ventures. A challenge for future economic engagement policy is how to select activities that do not run afoul of the sanctions regime or reinforce North Korean efforts to evade sanctions, while at the same time promoting non-sanctioned economic activities that support improvement in efficiency and equity in the changing North Korean economic system.

Inter-Korean Economic Cooperation and Denuclearization The short-term challenge for President Moon and his advisors is how to establish an inter-Korean economic engagement strategy that meshes effectively with the objective of successfully negotiating and implementing a broadly supported denuclearization and missile program agreement North Korea.

There are procedural and substantive aspects to this challenge, and both require open-minded consultations with all concerned parties to seek agreement on a path forward. Now is the time to incorporate a thoughtful economic dimension into the negotiations and consultation with concerned parties on a coordinated policy for providing economic incentives and modalities for meaningful progress on the political process that leads to a new security environment on the Korean peninsula.

In addition to advancing its own national interests, South Korea should advocate for North Korean membership in the IMF as an early step in the normalization process, both to demonstrate commitment of transparency in reporting national accounts and balance of payments that will be essential for future investment and Official Development Assistance from the international community, but also as a necessary step towards receiving investments from international development banks to spread the burden of financing that will be needed.

Ideally, the international community would eventually support an economic development strategy for North Korea that enables lifting of sanctions and integration in the international economy in which future evolution of inter-Korean economic relations should have a clearly defined role and benefit both Koreas.