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China’s Economic Conditions
Updated January 12, 2006
Wayne M. Morrison
Foreign Affairs, Defense, and Trade Division
CONTENTS
SUMMARY
MOST RECENT DEVELOPMENTSBACKGROUND AND ANALYSIS
An Overview of China’s Economic Development
China’s Economy Prior to ReformsThe Introduction of Economic Reforms
China’s Economic Growth Since Reforms: 1979-2005Causes of China’s Economic GrowthMeasuring the Size of China’s EconomyForeign Direct Investment in ChinaChina’s Trade Patterns
China’s Major Trading PartnersMajor Chinese Trade Commodities
Major Long-Term Challenges Facing the Chinese EconomyOutlook for China’s Economy and Implications for the United States
IB9801401-12-06
China’s Economic Conditions
SUMMARY
Since the initiation of economic reformsin 1979, China has become one of the world’sfastest-growing economies. From 1979 to2005 China’s real GDP grew at an averageannual rate of 9.6%. Many economists spec-ulate that China could become the world’slargest economy at some point in the nearfuture, provided that the government is able tocontinue and deepen economic reforms, par-ticularly in regard to its inefficient state-owned enterprises (SOEs) and the state bank-ing system. In addition, China faces severalother difficult challenges, such as pollutionand growing income inequality that threatensocial stability.
Trade continues to play a major role inChina’s booming economy. In 2005, exportsrose by 28.4% to $762 billion, while importsgrew by 17.6% to $660 billion, producing a$102 billion trade surplus. China is now theworld’s third-largest trading economy after theUnited States and Germany. China’s tradeboom is largely the result of large inflows offoreign direct investment (FDI) into China,which totaled $61 billion in 2004 and anestimated $58 billion in 2005. Over half ofChina’s trade is accounted for by foreign-invested firms in China.
China experienced some inflationarypressures in 2004, fueled in part by specula-tion in real estate, over-investment in certainindustries, and rising costs for energy and rawmaterials. The government responded byraising interest rates and using administrativecontrols to slow investment in certain sectors.
Many economists contend that China’s policyof pegging its currency (the yuan), whichforces the government to trade yuan for dol-lars (to keep the peg at about 8.3 yuan to thedollar), could boost the level of inflation inChina at some point in the future. They alsocontend that the sharp increase in the mone-tary supply (due to the peg) may induce Chi-nese banks to make bad loan decisions andthus increase the level of non-performingloans. Secretary of Treasury John Snow statedthat China’s currency peg posed a risk to itseconomy and that of its trading partners. OnJuly 21, 2005, China announced that it wouldappreciate its currency to the dollar from 8.28to 8.11 and replace its dollar peg with “amanaged float exchange rate regime” withreference to a basket of currencies.
China’s economy continues to be a con-cern to U.S. policymakers. On the one hand,China’s economic growth presents hugeopportunities for U.S. exporters. On the otherhand, the surge in Chinese exports to theUnited States has put competitive pressures onmany U.S. industries. Many U.S. policy-makers have argued that greater efforts shouldbe made to pressure China to fully implementits WTO commitments and change variouseconomic policies deemed harmful to U.S.economic interests, such as its currency policyand its use of subsidies to support its state-owned firms. In addition, recent bids by Chi-nese state-owned firms to purchase variousU.S. firms have raised concerns among Mem-bers over the impact such acquisitions couldhave on U.S. national and economic security.
MOST RECENT DEVELOPMENTS
On January 9, 2005, the Chinese National Bureau of Statistics made major revisions toits estimates of China’s GDP from 1993-2004. The new revisions indicate that China’seconomy grew significantly faster than previously recorded.
On November 21, 2005, the International Monetary Fund urged China to adopt greaterflexibility in its currency policy in order to obtain balanced growth and development and tohelp reduce global trade imbalances.
On July 21, 2005, the Chinese government announced major reforms to its currencypolicy. It stated that China’s currency (the renminbi or yuan) would no longer be pegged tothe dollar but instead would be a managed float regime with reference to a basket ofcurrencies (including the dollar), and that the exchange rate of the U.S. dollar against theyuan would be adjusted from 8.28 to 8.11 yuan per U.S. dollar, an appreciation of 2.1%.On June 22, 2005, CNOOC, a Chinese company, made a $18.5 billion bid to purchaseUnocal, a U.S. energy company. News of the bid raised concern among several Members,many of who contended that the deal threatened U.S. national security. On August 2, 2005,CNOOC withdrew its bid, citing strong political opposition in the United States. On January10, 2006, CNOOC announced it had reached $2.3 billion deal to purchase a 45% stake in ablock of offshore Nigerian oil fields.
BACKGROUND AND ANALYSIS
An Overview of China’s Economic Development
China’s Economy Prior to Reforms
Prior to 1979, China maintained a centrally planned, or command, economy. A largeshare of the country’s economic output was directed and controlled by the state, which setproduction goals, controlled prices, and allocated resources throughout most of the economy.During the 1950s, all of China’s individual household farms were collectivized into largecommunes. To support rapid industrialization, the central government undertook large-scaleinvestments in physical and human capital during the 1960s and 1970s. As a result, by 1978nearly three-fourths of industrial production was produced by centrally controlled state-owned enterprises according to centrally planned output targets. Private enterprises andforeign-invested firms were nearly nonexistent. A central goal of the Chinese governmentwas to make China’s economy relatively self-sufficient. Foreign trade was generally limitedto obtaining only those goods that could not be made or obtained in China.
Government policies kept the Chinese economy relatively stagnant and inefficient,mainly because there were few profit incentives for firms and farmers; competition wasvirtually nonexistent, and price and production controls caused widespread distortions in theeconomy. Chinese living standards were substantially lower than those of many other
developing countries. The Chinese government hoped that gradual reform wouldsignificantly increase economic growth and raise living standards.
The Introduction of Economic Reforms
Beginning in 1979, China launched several economic reforms. The central governmentinitiated price and ownership incentives for farmers, which enabled them to sell a portion oftheir crops on the free market. In addition, the government established four special economiczones along the coast for the purpose of attracting foreign investment, boosting exports, andimporting high technology products into China. Additional reforms, which followed instages, sought to decentralize economic policymaking in several sectors, especially trade.Economic control of various enterprises was given to provincial and local governments,which were generally allowed to operate and compete on free market principles, rather thanunder the direction and guidance of state planning. Additional coastal regions and citieswere designated as open cities and development zones, which allowed them to experimentwith free market reforms and to offer tax and trade incentives to attract foreign investment.In addition, state price controls on a wide range of products were gradually eliminated.
China’s Economic Growth Since Reforms: 1979-2005
Since the introduction of economic reforms, China’s economy has grown substantiallyfaster than during the pre-reform period (see Table 1). In January 2006, China made majorrevisions to its GDP data for 1993-2004. The revisions indicated that, based on newestimates of growth in the service sector, the size of China’s economy and its GDP growthwere significantly higher than previously estimated. For example, real GDP growth in 2004had been originally measured at 9.5%, but the revised figure puts this rate at 10.1%. Overall,the size of the economy in 2004 was estimated to be nearly 17% higher than previouslythought. Based on these revisions, China’s average annual real GDP is estimated to havegrown by 9.6% between 1979 and 2005; it grew at by estimated 9.8% in 2005.
Table 1. China’s Average Annual Real GDP Growth Rates, 1960-2005
Averageannual
Time period% growth 1960-1978 (pre-reform)5.31979-2005 (post-reform)9.719903.819919.3199214.2199314.0199413.1199510.9199610.019979.31998 7.81999 7.620008.42001 8.32002 9.1200310.02004 10.12005 (estimate)9.8
Source: Official Chinese government data.
Causes of China’s Economic Growth
Economists generally attribute much of China’s rapid economic growth to two main
factors: large-scale capital investment (financed by large domestic savings and foreigninvestment) and rapid productivity growth. These two factors appear to have gone togetherhand in hand. Economic reforms led to higher efficiency in the economy, which boostedoutput and increased resources for additional investment in the economy.
China has historically maintained a high rate of savings. When reforms were initiatedin 1979, domestic savings as a percentage of GDP stood at 32%. However, most Chinesesavings during this period were generated by the profits of state-owned enterprises (SOEs),which were used by the central government for domestic investment. Economic reforms,which included the decentralization of economic production, led to substantial growth inChinese household savings (these now account for half of Chinese domestic savings). Asa result, savings as a percentage of GDP has steadily risen; it reached 49% in 2004, amongthe highest savings rates in the world.1
1
In comparison, the U.S. savings rate was 10.7% in 2004. Savings defined as aggregate nationalsavings by the public and private sector as a percentage of nominal GDP. (Economist IntelligenceUnit database.)
Several economists have concluded that productivity gains (i.e., increases in efficiencyin which inputs are used) were another major factor in China’s rapid economic growth. Theimprovements to productivity were caused largely by a reallocation of resources to moreproductive uses, especially in sectors that were formerly heavily controlled by the centralgovernment, such as agriculture, trade, and services. For example, agricultural reformsboosted production, freeing workers to pursue employment in the more productivemanufacturing sector. China’s decentralization of the economy led to the rise of nonstateenterprises, which tended to pursue more productive activities than the centrally controlledSOEs. Additionally, a greater share of the economy (mainly the export sector) was exposedto competitive forces. Local and provincial governments were allowed to establish andoperate various enterprises on market principles, without interference from the centralgovernment. In addition, foreign direct investment (FDI) in China brought with it newtechnology and processes that boosted efficiency.
Measuring the Size of China’s Economy
The actual size of the China’s economy has been a subject of extensive debate amongeconomists. Measured in U.S. dollars using nominal exchange rates, China’s GDP in 2005is estimated at about $1.9 trillion; its per capita GDP (a commonly used living-standardsmeasurement) was $1,460. Such data would indicate that China’s economy and livingstandards are significantly lower than those of the United States and Japan, respectivelyconsidered to be the number-one and number-two largest economies (see Table 2).Many economists, however, contend that using nominal exchange rates to convertChinese data into U.S. dollars substantially underestimates the size of China’s economy.This is because prices in China for many goods and services are significantly lower thanthose in the United States and other developed countries. Economists have attempted tofactor in these price differentials by using a purchasing power parity (PPP) measurement,which attempts to convert foreign currencies into U.S. dollars on the basis of the actualpurchasing power of such currency (based on surveys of the prices of various goods andservices) in each respective country. This PPP exchange rate is then used to convert foreigneconomic data in national currencies into U.S. dollars.
Because prices for many goods and services are significantly lower in China than in theUnited States and other developed countries (while prices in Japan are higher), the PPPexchange rate raises the estimated size of Chinese economy from $1.9 trillion (nominaldollars) to $8.1 trillion (PPP dollars), significantly larger than Japan’s GDP in PPPs ($4.0trillion), and about 65% the size of the U.S. economy. PPP data also raise China’s per capitaGDP to $6,210.2 The PPP figures indicate that while the size of China’s economy issubstantial, its living standards fall far below those of the U.S. and Japan. China’s per capitaGDP on a PPP basis is only 14.7% of U.S. levels. Thus, even if China’s GDP were toovertake that of the United States in the next decade or two, its living standards wouldremain substantially below those of the United States for many years to come.
2
These data are estimates from the Economist Intelligence Unit and were made before China’sJanuary 2006 revisions to its GDP data (discussed on page 2).
Table 2. Comparisons of United States, Japanese, and Chinese GDP
and Per Capita GDP in Nominal U.S. Dollars and PPP, 2005
CountryUnited StatesJapanChina
Nominal GDP($ billions)
12,4734,6051,912
GDP in PPP($ billions)
12,4734,0218,116
Nominal PerCapita GDP
42,18036,1501,460
Per Capita GDP
in PPP
42,18031,5606,210
Source: Economist Intelligence Unit Data Services. 2005 data are estimates.
Note: PPP data for China should be interpreted with caution. China is not a fully developed market economy;the prices of many goods and services are distorted due to price controls and government subsidies.
Foreign Direct Investment in China
China’s trade and investment reforms and incentives led to a surge in foreign directinvestment (FDI), which has been a major source of China’s capital growth. Annual utilizedFDI in China grew from $636 million in 1983 to $61 billion in 2004 (it was estimated at $58billion in 2005). The cumulative level of FDI in China stood at about $618 billion at the endof 2005. Analysts predict that FDI will continue to pour into China as investment barriersare reduced under China’s WTO commitments and Chinese demand for imports continuesto increase.
Based on cumulative FDI for 1979-2004, about 43% of FDI in China has come fromHong Kong. The United States is the second-largest overall investor in China, accountingfor 8.5% ($48.0 billion) of total FDI, followed by Japan ($46.8 billion), Taiwan ($39.6billion), and the British Virgin Islands ($36.9 billion) and South Korea ($25.9 billion) (seeTable 3).3 U.S. FDI in China for 2004 was $3.9 billion, accounting for 6.1% of FDI for thatyear, and ranked 5th after Hong Kong, the British Virgin Islands, South Korea, and Japan.4During the first 10 months of 2005, the top foreign investors in China (in terms of realizedFDI) were Hong Kong, the British Virgin Islands, Japan, South Korea, and the United States.Actual U.S. FDI in China was down by 24% over the same period in 2004, althoughcontractual FDI was up by 10.5%.
3
According to the Chinese Ministry of Commerce, major U.S. investors in China (based on 2003sales volumes) include Motorola ($5.8 billion in sales volume), General Motors ($2.2 billion), DellComputer ($2.1 billion), Hewlett Packard ($1.3 billion), and Kodak ($0.6 billion).
The British Virgin Islands is a large source of FDI because of its status as a tax haven. Much ofthe FDI originating from Hong Kong comes from non-Hong Kong investors, such as Taiwanese.
4
IB9801401-12-06
Table 3. Major Foreign Investors in China: 1979-2004
($ billions and % of total)
Cumulative Utilized FDI:
1979-2004
CountryTotalHong KongUnited StatesJapan
British Virgin IslandsSouth Korea
Amount($ billions)
563.8241.648.046.836.925.9
% of Total
100.042.98.58.37.06.54.6
Utilized FDI in 2004Amount($ billions)
64.019.03.95.53.16.76.2
% of Total
100.029.76.18.64.810.59.7
Source: Chinese government statistics. Top six investors according to cumulative FDI from 1979 to 2004.
China’s Trade Patterns
Economic reforms have transferred China into a major trading power. Chinese exportsrose from $14 billion in 1979 to $762 billion in 2005, while imports over this period grewfrom $16 billion to $660 billion (see Table 4). In 2004, China surpassed Japan as theworld’s third-largest trading economy (after the United States and Germany). China’s tradecontinues to grow dramatically: From 2002 to 2005, the size of China’s exports and importsmore than doubled. In 2005, exports and imports rose by 28.4% and 17.6%, respectively.China’s trade surplus, which totaled $32 billion in 2004, tripled to $102 billion.
Table 4. China’s Merchandise World Trade, 1979-2005
($ billions)
Year1979198019811982198319841985198619871988
Exports
13.718.121.521.922.124.827.331.439.447.6
Imports
15.719.521.618.921.326.042.543.243.255.3
Tradebalance
-2.0-1.4-0.12.90.8-1.1-15.3-11.9-3.8-7.7
Tradebalance
-6.29.08.13.6-11.95.216.712.340.543.629.124.122.630.425.632.0101.9
Year198919901991199219931994199519961998
Exports
52.962.971.985.591.6120.8148.8151.1183.8
Imports
59.153.963.981.8103.6115.6132.1138.8142.2140.2165.8225.1243.6295.2412.8561.4660.1
20042005
593.4762.0
Source: International Monetary Fund, Direction of Trade Statistics, and official Chinese statistics.
Merchandise trade surpluses, large-scale foreign investment, and its peg to the U.S.dollar have enabled China to accumulate the world’s second largest foreign exchange (afterJapan). As seen in Figure 1, China’s accumulation of foreign exchange reserves has beenparticularly acute over the past few years. China’s total reserves reached $769 billion at theend of September 2005, up nearly 50% over the same period in 2004.
Figure 1. China’s Foreign Exchange Reserves,
1990-September, 2005
($ in billions)$800$700$600$500$400$300
$200
$100
1990
1992
1994
1996
1998
2000
2002
2004
Source: Official Chinese government data.
China’s Major Trading Partners
China’s trade data often differ significantly from those of its major trading partners.This is due to the fact that a large share of China’s trade (both exports and imports) passesthrough Hong Kong (which reverted back to Chinese rule in July 1997 but is treated as aseparate customs area by most countries, including China and the United States). Chinatreats a large share of its exports through Hong Kong as Chinese exports to Hong Kong forstatistical purposes, while many countries that import Chinese products through Hong Konggenerally attribute their origin to China for statistical purposes. According to Chinese tradedata, its top five trading partners in 2004 were the European Union (EU), the United States,Japan, Hong Kong, and the 10 nations that constitute the Association of Southeast AsianNations (ASEAN) (see Table 5). China’s largest export markets were the United States,Hong Kong, and the EU, while its top sources for imports were Japan, the EU, and Taiwan(the United States ranked sixth).
U.S. trade data indicate that the importance of the U.S. market to China’s export sectoris likely much higher than is reflected in Chinese trade data. Based on U.S. data on Chineseexports to the United States (which, as noted, do not agree with Chinese data), and Chinese
data on total Chinese exports, it is estimated that Chinese exports to the United States as ashare of total Chinese exports grew from 15.3% in 1986 to 33.1% in 2004.
A growing level of Chinese exports is from foreign-funded enterprises (FFEs) in China.According to Chinese data, FFEs were responsible for 57% of Chinese exports in 2004,compared with 41% in 1996. A large share of these FFEs are owned by Hong Kong andTaiwan investors, many of whom have shifted their labor-intensive, export-oriented, firmsto China to take advantage of low-cost labor. A significant share of the products made bysuch firms is likely exported to the United States.
Table 5. China’s Top Five Trading Partners: 2004
($ billions)
TradeBalance asReported byPartner
-90.7-162.0-20.5-3.9N/A
CountryEuropean UnionUnited StatesHong KongASEAN*
Totaltrade177.3169.7112.7105.9
Chineseexports
95.9125.073.5100.942.9
Chineseimports
63.444.794.411.863.0
China’s tradebalance
32.580.3-20.989.1-20.1
Source: Official Chinese trade data.
Note: Chinese data on its bilateral trade often differ substantially from the official trade data of other countrieson their trade with China.
* Association of Southeast Asian Nations (ASEAN) member countries are Indonesia, Malaysia, the Philippines,Singapore, Thailand, Brunei, Cambodia, Laos, Myanmar, and Vietnam.
Major Chinese Trade Commodities
China’s abundance of cheap labor has made it internationally competitive in many low-cost, labor-intensive manufactures. As a result, manufactured products constitute anincreasingly larger share of China’s trade. A large share of China’s imports, such as rawmaterials, components and parts, and production machinery is used to manufacture productsfor export. For example, China imports cotton and textile-production machinery to producetextile and apparel items. A substantial amount of China’s imports is comprised of parts andcomponents that are assembled in Chinese factories (major products include consumerelectronic products and computers), then exported.
China’s top five imports in 2004 were electrical machinery and parts; boilers,machinery, mechanical appliances, and parts; crude oil; plastics; and organic chemicals (seeTable 6). China’s top five exports in 2004 were boilers, machinery, mechanical appliancesand parts; electrical machinery and parts; apparel; furniture, bedding, and lamps; and optical,photo, and medical equipment and parts (see Table 7).
Table 6. Major Chinese Imports, 2002-2004
($ billions)
Commodity
Electrical machinery and equipment andparts; sound recorders and reproducers,television recorders and reproducers,parts and accessories.a
Boilers, machinery, mechanicalappliances, and parts.bCrude oilPlastics
Organic chemicals
200226.4
200341.9
200461.4
2004/2003 % change
46.8
21.212.817.411.2
29.819.821.016.0
38.633.928.123.8
29.571.133.448.8
Source: Global Trade Atlas.
a. Electronic integrated circuits and micro-assemblies and parts constitute a large share of these imports.b. Office machines and automatic data-processing machines (such as computers) and parts constitute a large
share of these imports.
Table 7. Major Chinese Exports, 2002-2004
($billions)
Commodity
Boilers, machinery, mechanicalappliances, and parts
Electrical machinery and equipment andparts; sound recorders and reproducers,television recorders and reproducers,parts and accessoriesApparel
Furniture, bedding, and lampsOptical, photo, and medical equipment and parts
Source: Global Trade Atlas.
200250.9
200383.4
2004118.3
2004/2003 % change
41.8
65.236.69.97.4
89.045.812.910.6
129.754.817.316.3
45.719.734.353.9
Major Long-Term Challenges Facing
the Chinese Economy
China’s economy has shown remarkable economic growth over the past several years,and many economists project that it will enjoy fairly healthy growth in the near future.However, economists caution that these projections are likely to occur only if Chinacontinues to make major reforms to its economy. Failure to implement such reforms couldendanger future growth.
!
State-owned enterprises (SOEs), which account for about one-third ofChinese industrial production, put a heavy strain on China’s economy. Overhalf are believed to lose money and must be supported by subsidies, mainlythrough state banks. Government support of unprofitable SOEs divertsresources away from potentially more efficient and profitable enterprises.In addition, the poor financial condition of many SOEs makes it difficult forthe government to reduce trade barriers out of fear that doing so would leadto widespread bankruptcies among many SOEs.
The banking system faces several major difficulties due to its financialsupport of SOEs and its failure to operate solely on market-based principles.China’s banking system is regulated and controlled by the centralgovernment, which sets interest rates and attempts to allocate credit tocertain Chinese firms. The central government has used the banking systemto keep afloat money-losing SOEs by pressuring state banks to provide low-interest loans, without which a large number of the SOEs would likely gobankrupt. Currently, over 50% of state-owned bank loans now go to theSOEs, even though a large share of loans are not likely to be repaid. Ernst& Young estimates that the level of nonperforming loans by Chinese banksin 2002 was $480 billion (equal to about 43% of China’s GDP).5 The highvolume of bad loans now held by Chinese banks poses a serious threat toChina’s banking system. Three out of the four state commercial banks arebelieved to be insolvent. The precarious financial state of the Chinesebanking system has made Chinese reformers reluctant to open the bankingsector to foreign competition. Corruption poses another problem forChina’s banking system because loans are often made on the basis ofpolitical connections. This system promotes widespread inefficiency in theeconomy because savings are generally not allocated on the basis ofobtaining the highest possible returns.
Public unrest over pollution, government corruption, and growingincome inequality poses threats to social stability. The Chinesegovernment reported that there were over 74,000 protests (many of whichbecame violent) involving 3.8 million people in 2004 (up from 53,000protests in 2003) over such issues as pollution, government corruption, andland seizures. Pollution in China continues to worsen, posing series healthrisks to the population. The Chinese government often disregards its ownenvironmental laws in order to promote rapid economic growth. Accordingto the World Bank, 16 out of 20 of the world’s most polluted cities are inChina, and the direct costs to the economy (such as health problems, cropfailures and water shortages) is estimated to be hundreds of billions ofdollars yearly. The Chinese government estimates that there are over 300million people living in rural areas that drink unsafe water (caused bychemicals and other contaminants). Toxic spills in China in recent monthshave threatened the water supply of millions of people. Rising incomeinequality, particularly between people living in the urban coastal and those
!
!
5
Ernst & Young Asia Pacific Financial Solutions, Nonperforming Loan Report, Asia, 2002.
living in the inner rural regions of China, has become another source oftension. A number of protests in China have stemmed in part fromfrustrations among many Chinese (especially peasants) that they are notbenefitting from China’s economic reforms and rapid growth, andperceptions that those who are getting rich are doing so because they haveconnections with government officials. Protests have broken out overgovernment land seizures and plant shutdowns in large part due toperceptions that these actions benefitted a select group with connections. A2005 United Nations report stated that the income gap between the urbanand rural areas was among the highest in the world and warned that this gapthreatens social stability. The report urged China to take greater steps toimprove conditions for the rural poor, and bolster education, health care, andthe social security system.
!
The lack of the rule of law in China has led to widespread governmentcorruption, financial speculation, and misallocation of investment funds. Inmany cases, government “connections,” not market forces, are the maindeterminant of successful firms in China. Many U.S. firms find it difficultto do business in China because rules and regulations are generally notconsistent or transparent, contracts are not easily enforced, and intellectualproperty rights are not protected (due to the lack of an independent judicialsystem). The lack of the rule of law in China limits competition andundermines the efficient allocation of goods and services in the economy.
Outlook for China’s Economy and Implications
for the United States
The short-term outlook for the Chinese economy appears to be positive, but it will likelybe strongly influenced by the government’s ability to reform the SOEs and banking systemto make them more responsive to market forces, to fully implement its WTO commitments,and to assist workers who lose their jobs due to economic reforms (in order to maintainsocial stability). Global Insight, an economic forecasting firm, projects that China’s realGDP will average 8.0% over the next five years, indicating that China could double the sizeof its economy in less than 10 years.6 The Economist Intelligence Unit projects that Chinawill become the world’s largest exporter by 2010 and the world’s largest economy by 2020.China’s rise as an economic superpower is likely to pose both opportunities andchallenges for the United States and the world trading system. China’s rapid economicgrowth has boosted incomes and is making China a huge market for a variety of goods andservices. In addition, China’s abundant low-cost labor has led multinational corporations toshift their export-oriented, labor-intensive manufacturing facilities to China. This processhas lowered prices for consumers, boosting their purchasing power. It has also lowered costsfor firms that import and use Chinese-made components and parts to produce manufacturedgoods, boosting their competitiveness. Conversely, China’s role as a major internationalmanufacturer has raised a number of concerns. Many developing countries worry that
6
Global Insight, China: Interim Forecast Analysis: Economic Growth, December 15, 2005.
growing FDI in China is coming at the expense of FDI in their country. Policymakers in bothdeveloping and developed countries have expressed concern over the loss of domesticmanufacturing jobs that have shifted to China (as well as the downward pressures ondomestic wages and prices that may occur from competing against low-cost Chinese-madegoods).
Many analysts contend that China’s currency policy, despite reforms undertaken in July2005, is having a negative impact on the economies of many of its trading partners byartificially making its exports cheaper, and imports more expensive, than they would beunder a floating system. They have urged China to move toward a floating exchange rateregime as soon as possible, contending that such a move would benefit China’s economy andthose of its trading partners.7 Chinese officials have expressed concern that further currencyreforms, if implemented too quickly, could prove disruptive to the economy. A number ofbills have been introduced in Congress to address Chinese currency policy, including somethat would impose a 27.5% tariff on Chinese goods unless China appreciated its currency tomarket levels.8 Failure by China to implement further reforms to its currency regime couldprompt Congress to take up currency-related legislation. On the other hand, some analystshave raised concerns that China’s move toward a managed float tied to a basket of currenciesmay diminish China’s purchase of U.S. Treasury securities, which could affect U.S. interestrates.
China is attempting to establish and promote companies that can compete globally,especially in advanced technologies. In some cases, China has attempted to purchase largeforeign companies. For example, in December 2004, Lenovo Group Limited, a computercompany primarily owned by the Chinese government, purchased IBM’s personal computerdivision. In June 2005, the China National Offshore Oil Corporation (CNOOC) made a bidto buy a U.S. energy company, UNOCAL, for $18.5 billion, although strong opposition inCongress forced CNOOC to withdraw its bid. China’s possession of large currency reservesand desire to become a world leader in the production of a variety of goods and strategiccommodities will likely lead the Chinese government to expand efforts to take over majorinternational corporations. Many Members charge that China’s use of extensive subsidiesto support state-owned firms, especially to fund takeover bids, threatens U.S. economicinterests and may violate its WTO commitments.
China’s rapid economic growth and continued expansion of its manufacturing base arefueling a sharp demand for energy and raw materials, which is becoming an increasinglyimportant factor in determining world prices for such commodities. China is now theworld’s second largest consumer of oil products (after the United States) at 6.7 millionbarrels per day, and that level is projected to double to 13.4 million barrels per day by 2025.9According to the U.S. Energy Information Administration, around 40% of world oil demandgrowth over the past four years came from China and this demand is “a very significant
7
For a discussion of this issue, see CRS Report RS21625: China’s Currency Peg: A Summary ofthe Economic Issues, by Wayne Morrison and Marc Labonte.
For a listing of these bills, See CRS Issue Brief IB91121,China-U.S. Trade Issues, by Wayne M.Morrison.
9
8
Global Insight, Global Petroleum Outlook Forecast Tables (Long-Term), January 2005.
factor in world oil markets.”10 China has also reportedly become the largest consumer ofsteel, cement, and copper.
Some U.S. policymakers have expressed concern over China’s rising ownership of U.S.government debt, due to fears that China might attempt to use its holdings as leverage in itsdealings with the United States on economic and/or political matters. China is the secondlargest foreign holder of Treasury securities (after Japan), and both the level of thoseholdings and China’s share of total foreign holdings have increased sharply over the past fewyears. These went from $51.8 billion in 1999 to $252.2 billion as of September 2005.China’s U.S. Treasury securities holdings as a share of total foreign holdings over this periodhave grown from 4.1% to 12.1%. China’s Treasury securities holdings as a percent of totalprivately held U.S. Treasury securities rose from 1.6% to 6.4%. Some have raised concernsthat threats by China to halt future purchases, or to sell existing holdings, could cause thevalue of the dollar to depreciate in world markets (raising import prices), increase U.S.interest rates, lead to a decline in U.S. stock and bond markets, and possibly cause the U.S.economy to slow. However, any such disruption to the U.S. economy would also hurtChina’s economy since about a third of China’s exports go to the United States.
10
U.S. Energy Information Administration website at [http://www.eia.doe.gov/].
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