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Chapter 19: Chinese International Economic Relations
(Written 1989; Revised 2006)
Like most other communist countries, China followed a policy of trade autarky through the 1970s. But beginning in the early
1970s, and especially with the reforms of the late 1970s, there was a considerable enlargement of trade. As we will see, China has
become one of the most open of the developing countries. By 2005, China was the third largest trading country in the world (after the
United States and Germany). Until 1979, China’s ratio of exports plus imports to GDP never exceeded 10%. (This ratio is called
“openness”.) By 2005, this ratio was 64%. In recent years, China has had a large trade surplus (China’s exports have exceeded its
imports), especially with the United States. This has led to some trade disputes between the United States and China. In this chapter,
we will first consider the socialist period prior to 1978. Then we will examine the Chinese reforms of international trade. China has
definitely entered the global economy and has become a major part of global production networks. Third, we will examine the trade
disputes between the United States and China. And finally, we will consider foreign direct investment into China.
(1) Foreign Trade through the 1970s
As mentioned above, throughout the socialist period, China practiced trade autarky. In part, the policy of trade autarky was
necessitated by political events: the Korean War, the Vietnam War, and the break with the Soviet Union. In part, the policy of trade
autarky was the result of ideological considerations, with Maoists believing that foreign trade could lead to a return to a capitalist
mentality and to dependence on the capitalist countries. And in part, the policy of trade autarky was necessitated by economic
considerations. First, the Chinese pricing system significantly undervalued agricultural products and overvalued industrial products.
Openness to trade would therefore have led to a distorted pattern of trade. Second, China faced a shortage of foreign exchange. This
would present serious problems whenever China incurred trade deficits. Third, openness to trade would make it much harder to
centrally plan the economy, as more variables would be outside of the control of the planners.
The policy of trade autarky resulted in foreign trade being incorporated into the central planning system. All foreign trade was
conducted by state monopolies, called foreign trade corporations. There were eight of these in 1970 and fourteen in 1974. These
corporations acted as agents for the Chinese enterprises in both imports and exports. They basically controlled all of the foreign
exchange. Domestic producers had no connection with the foreign firms; they were merely to fulfill their quotas set by the industrial
ministry and sell their production to the relevant foreign trade corporation. The individual enterprise could not revise its plans if the
international market had changed. Chinese producers also faced problems of uncertain supply of raw materials. They produced
products of poor quality, and provided inadequate servicing of their products. And, they produced products that were often subject to
foreign protectionism and that faced considerable competition from the Newly-Industrialized Countries (NICs) of East Asia,
especially Hong Kong, Taiwan, and South Korea. All of these factors made it impossible for China to rely on exports as the heart of
its strategy of development.
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Trade data show several features of Chinese foreign trade up to 1980. First, in relation to the size of the Chinese economy,
foreign trade was small, as would be expected from the policy of trade autarky. In 1970, “openness” (the ratio of export plus imports
to GDP) was only 5%. Second, through the end of the 1970s, China’s trade was basically in balance. Imports were limited by
export earnings so that the difference between exports and imports was virtually negligible. Third, China’s trade did seem to follow
the law of comparative advantage. China exported mainly primary products (foodstuffs and crude materials) and textiles and
imported mainly chemicals, intermediate goods, and capital goods for manufacturing. Fourth, in the 1950s, the majority of China’s
trade was with the Soviet bloc. In part, this was necessitated by the American embargo on trade with China imposed in December of
1950. Especially notable was the importing of 156 complete projects, which included blueprints and Soviet technical advisers. When
the break with the Soviet Union came in 1960, many of these projects were uncompleted. China had run large trade deficits with the
Soviet Union in the early 1950s and thus had incurred a large debt. The debt was paid even after the break in 1960 (it was fully paidoff by 1966). Following the break with the Soviet Union, machinery and equipment needed for economic development were imported
from Japan and Western Europe. Trade with Japan grew considerably despite conflict regarding Japan’s recognition of the Republic of
China (Taiwan). Trade with Hong Kong became especially important in this period. China was a major food supplier to Hong Kong
and thus ran a large trade surplus, which allowed it to earn a considerable part of its foreign exchange. (It also earned foreign
exchange from the remittances of overseas Chinese.) Trade with Britain, West Germany, France, and Canada grew as well. But trade
with the United States was still not allowed (although some American companies did trade with China through Canada). In the 1960s,
imports of food products rose considerably while imports of manufactured products became proportionally smaller.
The decade of the 1970s was one of considerable expansion of Chinese foreign trade. In September, 1971, China joined the
United Nations. In 1972 and 1973, obstacles to trade with Japan were removed and relations were opened with the United States. The
“pragmatists” in China, led by Deng Xiaoping and Zhou Enlai, believed that China could “save time” in its development by importing
needed technology from the West. The “radicals” led by the “Gang of Four”, opposed this. Therefore, while Chinese foreign trade
expanded 23% per year from 1972 to 1978, the full expansion of trade had to await the emergence of the leadership of Deng in 1978.
In this period, Japan became China’s leading trade partner and crude oil became a major Chinese export product.
(2) The Reforms of Foreign Trade Beginning in 1979
Beginning in 1979, China began a major expansion of foreign trade. The total value of China’s foreign trade grew from about $30
billion in 1979 to over $100 billion by 1988. This approached 20% of the GDP. By 2002, China was the 5th largest trading nation in
the world. By 2004, it was the 3rd largest.
The first step in reform began in 1978 when Hong Kong businesses were allowed to sign export processing agreements with
Chinese enterprises. In this system, the Hong Kong business could ship materials to a Chinese enterprise for processing. Shortly
thereafter, China created four new Special Export Zones along the coast near Hong Kong and Taiwan. In these zones, materials could
be imported tariff-free as long as they were processed and used to produce export products. (As we will see later, these were similar
to the Maquiladoras found along the American-Mexican border.)
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In the early 1980s, the number of companies allowed to engage in foreign trade expanded. By 1988, there were about 5,000 stateowned foreign trade corporations. In addition, some 10,000 manufacturing enterprises gained the right to export or import directly.
The township and village enterprises increased their exporting greatly. By the late 1980s, the central planning of trade began to be
dismantled. But while exporting was liberalized greatly, importing was not. In the late 1980s and early 1990s, China imposed high
tariffs (an average tariff of 43%) and substantial non-tariff barriers. (A World Bank study at the time found that 51% of Chinese
imports were subject to some non-tariff barrier.)
In 1986, China began the “Coastal Development Strategy”. All types of enterprises in the coastal provinces were now allowed to
take part in processing and assembly for export. Foreign-owned companies (typically from Hong Kong or Taiwan) were now allowed
to set up companies in the coastal provinces and import without restriction as long as the materials imported were processed and used
for export. Foreign-owned companies have been the main exporters in China; 58% of total Chinese exports in 2005 were done
by foreign-owned companies. Most trade still takes place in the coastal regions, enhancing the regional disparity in the standard of
living in China. China also joined the international financial community at this time, becoming a member of the International
Monetary Fund and also the World Bank.
The changes that occurred in the 1980s and early 1990s generated new problems. The expansion of investment spending, described
earlier, generated trade deficits. China’s trade and current account balances went into deficit as early as 1982. These deficits were
financed by reducing China’s international reserves and by borrowing from abroad. As of 1986, China had a foreign debt of $28
billion; this is large, but it did not cause the serious problems found in some other countries. The trade deficits created a new
constraint on economic growth. Faced with the deficits, the central government began an economic retrenchment (that is, reduced
spending). Part of this retrenchment was designed to make it harder to import. The retrenchment policies allowed the trade balance to
begin to improve in 1986. At that time, another expansion was beginning. This led to inflation and to a worsening trade balance.
Particularly in 1988, there was a very large rise in imports. This has led to another period of severe retrenchment in the late 1980s and
early 1990s. Thus, it appears that the new openness to foreign trade acted to enhance macroeconomic instability.
Despite this instability, beginning in the mid-1990s, China began to move in the direction of a fully open economy. Beginning in
1994, access to foreign exchange was made much more widely available. Any importer of goods or services could now purchase
foreign exchange directly. This was a major step in the direction of creating a free market in foreign exchange. However, the Chinese
government decided to have a fixed exchange rate against the U.S. dollar. The rate they chose was 8.3 renminbi to the dollar. (The
renminbi is the name of the Chinese currency. The basic unit of the renminbi is the yuan. One yuan is divided into 10 jiao. One jiao
is then divided into 10 fen.) The People’s Bank of China (the central bank) agreed to intervene in the foreign exchange market (buy or
sell dollars) in order to maintain this exchange rate. This fixed exchange rate will be the source of some dispute between the United
States and China, as we will see below, because this exchange rate overvalues the renminbi by 20% to perhaps 40%.
As part of becoming a fully open economy, China became a member of the World Trade Organization (WTO) in 2001. This gave
China better access for its exports to other countries’ markets. But in return, China was required to give other countries better access
to the Chinese market. It did so in a foreign trade law that went into effect in 2004. Under this law, trading rights were given to
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private companies, both domestic and foreign-owned. Foreign trade was no longer the monopoly of the state Foreign Trade
Corporations. Under this new law, tariffs were also lowered. The average tariff imposed by China, which had been 43% in 1992,
reached 9.4% in 2004. China has become a low tariff country. Ordinary Trade Imports rose dramatically with the accession to the
World Trade Organization. (Ordinary Trade Imports are all Chinese imports minus the imports attributable to the export processing
activities.) In 1997, Ordinary Trade Imports were only 4.1% of Chinese GDP. By 2004, they had reached 13% of Chinese GDP.
Overall imports increased from 5% of GDP in 1978 to 30% of GDP in 2005. This increase was largely caused by the new policies
China enacted as part of its accession to the World Trade Organization.
The accession to the World Trade Organization has also changed the composition of China’s trade. Prior to the mid-1980s,
China’s main export products had been natural resources such as oil. From the mid-1980s to the mid-1990s, the main Chinese exports
were labor-intensive manufactured goods. But since the mid-1990s, the main Chinese exports have been machinery and
electronic goods. However, textile quotas in the developed countries were reduced starting at the end of 2004. So we would expect
the proportion of China’s exports from Apparel and Garments to increase. Textiles are still important export products for China. And
increasingly, foreign apparel companies produced finished garments in China according to foreign designs and under foreign labels.
Composition of Chinese Trade in 2003 (Percent of Total)
Imports
Exports
Food etc.
Materials, Fuels
Chemicals, Plastics, and Iron/Steel
Industrial Machinery
Electronics, Telecom, Electrical Machinery
Clothing
Other
1.6%
16.1%
23.9%
12.6%
29.9%
0.3%
15.6%
4.2%
3.7%
14.1%
5.2%
34.2%
11.9%
26.7%
As we look at the trade disputes between the United States and China below, it is important to keep in mind that nearly all of the hightechnology electronic goods that China exports are produced under the Export Processing program. This means that these goods are
merely assembled in China. In 2005, foreign-owned companies were responsible for 88% of China’s high technology exports.
There were also some major changes in the direction of trade. The share of total trade involving the United States more than
doubled. Japan is still China’s largest trade partner. Based on a long-term agreement signed in 1978, China’s exports to Japan have
become mainly coal and crude oil. China’s imports from Japan have been mainly machinery, equipment, steel, chemicals,
automobiles, and other consumer durables. Some imports from Japan have involved entire plants, including steel mills; Japan has also
participated in the exploration of offshore oil. The other large trade partner for China has been Hong Kong, whose share of China’s
trade more than doubled. China’s exports to Hong Kong, which traditionally included food, raw materials, and textiles, expanded to
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include petroleum products, chemicals, and machines. Its imports included manufactured goods, machinery, equipment, and “hightech” goods—mostly produced elsewhere. (In 1997, Hong Kong reverted to Chinese sovereignty. However, it is to maintain its “free
market economy” for fifty years.)
In summary, China has moved from being a very closed economy to being an open economy. We would expect this trend to
continue. Given the enormous number of less-skilled workers in China, China would appear to have a comparative advantage in laborintensive manufacturing for several decades to come. Therefore, China has much to gain from its entry into the global economy.
(3) Economic Relations between China and the United States
In the early 1970s, the Nixon administration ended the embargo against China that had existed since 1950. Trade between the
United States and China began to grow. By the end of the 1970s, the United States already had become China’s third largest trade
partner, after Japan and Hong Kong. From 1972 to 1974, China imported mainly agricultural products from the United States,
especially grains. Then, in 1975, China virtually cut off all imports of grain, causing a major drop in American exports to China.
China took this action in part because of an improvement in the domestic grain supply. But more importantly, China was worried
about the trade deficits and the shortage of foreign exchange. In 1978, the situation reversed and United States-China trade took off.
Partly this reflected China’s decision to begin large-scale grain purchases from the United States again. But Chinese purchases of
American manufactured goods also grew. Chinese exports to the United States included a number of light industrial products, with
textile products predominating. China also sold some petroleum products to the United States. Despite these exports, China ran
persistent trade deficits with the United States in the 1970s.
In 1979, diplomatic relations were normalized between the United States and China. A comprehensive trade agreement was signed
in that year, leading to an increase in trade. In this agreement, the United States granted China most-favored-nation status. This means
that tariffs on products imported from China would be no higher than those on the products of the “most favored nation”. Chinese
imports from the United States were still mainly agricultural products. These declined when China’s grain harvests increased and then
increased when China’s grain harvests stagnated. However, imports of machinery and transport equipment increased considerably.
Chinese exports to the United States also grew considerably in the 1980s. These included the traditional textile products and crude
materials. But in the early 1980s, petroleum and petroleum products also became important export products. During the expansion
years of the 1980s, China ran a trade deficit with the United States. During the retrenchment phases, China was able to maintain
approximate trade balance with the United States.
With the expansion of trade relations since the 1980s, there came a number of trade issues. One main trade issue between the
United States and China has involved textiles and apparel. The textile industry is highly labor-intensive, giving China, with its
relatively low labor cost, a comparative advantage over the United States. Textiles have been an important industry in Chinese
development plans. American textile imports from China have been increasing considerably and apparel (with a higher value
added) has become a more important part of those imports. In the United States, the textile industry is in decline. Since 1960,
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employment in the industry has declined over 40%. Those workers affected are mainly older, women, minorities, and less educated.
The average wage was only 60% of the average wage in all of American manufacturing and was below the level needed to raise a
family of four above the poverty line. According to the United States International Trade Commission, trade in textiles and apparel
(with all countries) has reduced the number of jobs for Americans in those industries. More than half of the displaced workers end up
earning less after they change jobs. Textile companies in the United States are mainly located in the Carolinas and Georgia, states that
have had powerful Senators.
As a result of these problems and of the power of the Senators of the affected states, since 1974, the United States has had a Multifiber Agreement. This is negotiated on a bilateral basis with individual countries to set limits on textile imports. The United States
tried to arrange a bilateral agreement with China, but failed. So in 1979 and again in 1983, the United States unilaterally imposed
quotas on imports of Chinese textile products. China retaliated with a dramatic reduction in agricultural purchases from the United
States. Since then, there have been several attempts to impose severe import restrictions on Chinese textiles. The Multi-Fiber
Agreement was finally phased out as of 2006. It is expected that textile and apparel imports from China will rise dramatically. As
they do, there will be more attempts to gain protection from the people representing the affected states.
More recently, the disputes between China and the United States have become more general. The United States has had an
overall trade deficit that has reached over $900 billion per year. (This means that the United States imported over $900 billion
worth of goods more than it exported.) Of this, considerably more than $200 billion is an American trade deficit with China.
(Through November of 2006, the American trade deficit with China had already totaled $213 billion. It is likely to exceed $230
billion in all of 2006. As you can see in the table below, the American trade deficit with China has been increasing rapidly since the
late 1990s.) Indeed, China has a surplus with the entire world of about $150 billion, second only to Japan as the largest surplus
country.
American Trade Deficit with China
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006 (through November)
$ 49.7 Billion
$ 56.9
$ 68.7
$ 83.8
$ 83.1
$103.1
$124.1
$161.9
$201.5
$213.5
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One claim made by some Americans is that the United States has a large trade deficit with China because the Chinese
economy is not open to American products. (This is the same argument that was made against Japan in the 1980s – see Chapter
10.) However, the information provided above makes it hard to support this claim. The American trade deficit with China was
small until the middle 1990s and has grown greatly precisely in the years that the Chinese economy was becoming more and
more open. The Chinese average tariff rate, as noted above had declined from 43% to 9.4% by 2004. China has less import
protection that almost all developing countries. And as part of its accession to the World Trade Organization, China eliminated all
licensing requirements for imports and all import quotas in 2005. From 2000 to 2005, sales by American companies to China
increased 160% while sales by American companies to the rest of the world increased only 10%. One cannot support the claim that
the American trade deficit with China has increased because China’s market is closed to American products.
Another claim made by some Americans is that the United States has a large trade deficit with China because Chinese
labor is so cheap. And indeed Chinese labor is cheap by American standards; the average monthly wage in Chinese urban industry is
only about $120. If we add in bonuses and fringe benefits, an hour of labor in Chinese urban industry costs about $1 compared to $30
in American industry. But it needs to be understood that wages in China are low because productivity in China is low. Productivity
in China averages about 1/28 that of the United States. So even though labor costs per hour are low, labor costs per unit of the product
are not low. In addition, low-cost labor is only likely to be relevant for industries in which labor is a large share of the total
cost. So low labor cost would be a major explanation for the large amount of Chinese exports of products like shoes and apparel but
would not be an explanation for the large amounts of Chinese exports of semiconductors and microprocessors. In must also be kept in
mind that there are countries in Asia and Africa with wages as low as China’s wages. But these countries do not sell much to the
United States.
Some of the increasing trade deficit with China is simply a result of the way the statistics are calculated. China has increasingly
become the location for the final assembly of many goods, including electronic and information technology products. About 2/3 of
all of China’s exports to the United States are goods that are assembled from imported parts and components. These goods are
counted as exports from China. But some 2/3 of the value of these goods originated outside of China. Indeed, as the share of
American imports coming from China has increased, the share of American imports coming from the countries that used to do the
export processing (Hong Kong, Taiwan, Korea, and Japan) has decreased.
Yet another claim made by some Americans is that the United States has a large trade deficit with China because the
Chinese money (the renminbi) is undervalued. This has been a main aspect of the dispute with China in recent years. The Chinese
renminbi was probably overvalued through 1994. So its undervaluation is relatively recent. China set the exchange rate at 8.28 yuan
to one American dollar. Estimates have been made (as of 2005) that this exchange rate undervalues the Chinese renminbi by 20%
to as much as 40%. This means that the exchange rate should be somewhere between 5 and 6.6 yuan to the dollar. An undervalued
exchange rate increases China’s exports (because the Chinese products are artificially cheap for foreigners) and decreases China’s
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imports (because foreign products are artificially expensive for the Chinese). In a free market, the demand for the renminbi would rise
and the supply of the renminbi would fall. As a result, the renminbi would appreciate in value (to between 5 and 6.6 to the dollar).
However, China has blocked any increase in the value of the renminbi by intervening in the foreign exchange market, buying
$15 billion to $20 billion (and therefore selling renminbi) every month for the past several years. Because of China’s policy,
most other Asian countries have also intervened in the foreign exchange markets to prevent their currencies from appreciating against
the American dollar (in order to maintain their competitive position with China). The United States has a trade deficit with the world
(1/4 of which is with China) and now owes some $12 trillion to the rest of the world. The United States has to attract some $7 billion
every working day just to finance its trade deficit. This is not sustainable. American policy makers have pushed hard to get China to
appreciate its money and to change to a flexible exchange rate that responds to market forces. In 2005, they were able to persuade
China to change the exchange rate to 8.08 yuan to the American dollar. This was a very modest change in relation to what is needed to
eliminate the American trade deficits. In 2006, legislation was introduced in the Senate by Senators Grassley (R-Iowa) and Baucus (DMontana) to provide sanctions against China if it does not adjust its exchange rate substantially. These sanctions were not severe but
would hurt China some. Legislation was also introduced by Senators Schumer (D-NY) and Graham (R-South Carolina) that would
impose a surcharge on imports from China if it does not allow a substantial change in its exchange rate. This legislation has not yet
come to a vote. (It needs to be noted it has been estimated that if the renminbi appreciated by 20%, the American trade deficit would
decrease about $60 billion to $80 billion per year. This is less than 10% of the total American trade deficit but it a sizable part of the
trade deficit with China alone.)
Because of its recent global trade surpluses, in 2006 China became the world’s largest holder of foreign exchange reserves. Its
foreign exchange reserves total about $1 trillion. A major portion of these foreign exchange reserves are held in dollar
denominated bonds, especially government bonds. That is, when the People’s Bank of China buys dollars in the foreign exchange
market, it uses these dollars to buy American government bonds. Because it does so, the People’s Bank of China is a major financier
of the American budget deficit. There has been a fear of what might happen if China stopped buying American government bonds as
part of its foreign exchange reserves. The fear is that American interest rates would have to increase in order to attract someone
to buy these bonds. Higher interest rates in the United States would decrease American business investment spending and would also
decrease home building. With people buying fewer homes due to higher interest rates, the prices of homes would decline. Lower
home values would decrease consumer spending (many people have borrowed against the value of their homes to pay for consumer
items). If the effect were large enough, the United States could be thrown into a recession. (However, a recent study indicates that this
argument may be exaggerated. It estimates that Chinese purchases of American government bonds have only caused American
interest rates to decrease about ¼ of a percentage point, not enough to make a serious difference.) Nonetheless, being a large holder of
American government bonds does give China some substantial leverage in negotiations between the two countries.
While all of the issues discussed in this section are significant, perhaps the greatest friction in the American – Chinese
economic relationship has involved intellectual property protection. China has agreed to laws regarding intellectual property that
meet the requirements of the World Trade Organization. But enforcement of its laws has been inadequate. Piracy of software and of
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recorded entertainment has continued on a large scale in China. Trademark counterfeiting and patent infringement are rampant. In
2004, more than 60% of all the counterfeit goods seized by American customs authorities were of Chinese origin. The
company E-Bay operates the world’s largest market for counterfeit and pirated products. (Importing counterfeit products into
the United States risks having the products seized and possibly also a fine. But it never risks jail time. E-Bay has not been the subject
of any legal action by the American government.) China has pledged to increase its enforcement of intellectual property laws. But
China refuses to provide the information by which to assess whether it is doing so. What is likely to change Chinese behavior is that
the number of patent and trademark applications by Chinese companies has been increasing dramatically. These companies will be
demanders of better intellectual property protection from their own government.
Several other issues have become important as well in the American – Chinese economic relationship. As mentioned above, the
United States granted China “most-favored nation” status. However, under American law, “most favored nation” status requires that
the recipient allow free emigration by its citizens and that it be free of major human rights violations. Up to now, the United States has
stated that China complies with these provisions. However, there is much dispute regarding human rights conditions in China. Another
issue concerns American restrictions on exports of high-technology and strategic goods. As of 1981, products of a high technical level
could be sold to China. Also, arms could be sold to China. In export regulations on these “sensitive” goods, China is included in a
category with other “friendly” nations. China’s main interest has been in nuclear energy. With energy being a consistent bottleneck in
Chinese development, China decided to build twelve nuclear plants. Under an agreement reached in 1984, American companies were
allowed to bid on the contracts to build these plants. There was substantial disagreement within the United States over this agreement,
with many worrying that China will not use the nuclear material for peaceful purposes or that Chinese operation of these plants will
lead to a nuclear disaster.
As you can see, the economic relationship between the United States and China has been contentious. Yet none of these issues is
likely to lead to a conflagration or to a breakdown in the relationship. The relationship with China has come a long way since
President Nixon’s visit in 1972.
(4) Foreign Direct Investment in China
Along with the increased openness to trade came increased Chinese openness to foreign direct investment (meaning that the foreign
company actually owns or controls the assets located in China). Some $63 billion of foreign direct investment flowed into China in
each of 2004 and 2005, accounting for about one-third of all foreign direct investment that went into developing countries in
those years. Foreign direct investment has been the main method China has used to gain access to capital from abroad. (This means
that China has had little portfolio investment --- borrowing from abroad.) Much of this foreign direct investment has gone into
manufacturing and much has come from other East Asian countries, especially Hong Kong and Taiwan.
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In 1982, the new constitution made foreign direct investments legal. Joint ventures were now acceptable in every sector of the
economy; the minimum foreign participation was 25%, but complete foreign ownership was allowed. Most of the foreign direct
investments occurred in Special Export Zones (SEZs). As noted above, four of these were constructed, beginning in 1979. They were
located along the Chinese coast, in proximity to Hong Kong, Taiwan, and Macao. In 1984, a decision was made to create fourteen
more such zones. In these zones, the Chinese government invested heavily in infrastructure, including hotels, Western-style stores, and
so forth. In these zones, foreign companies were allowed to import equipment and raw materials basically duty-free. Income taxes
were either low or are not charged at all. Land could be leased for twenty years (fifty years in the case of educational, science, and
technological projects). After-tax profits, as well as foreign employees’ salaries, could be remitted abroad.
Foreign companies were attracted to these Special Export Zones by the cheap labor. While wages in these zones were much higher
than in other parts of China, they were about half the rates paid in Hong Kong. The foreign companies were also attracted by the
possibility of selling in the Chinese market. Most of their production was exported but a portion could be sold inside China. In fact,
while not allowed, the Special Export Zones were often entry points for foreign manufactured goods. Thousands of Chinese tourists
came to these areas to try to get foreign manufactured goods. Finally, the foreign companies were attracted to these zones by the
availability of good roads and other infrastructure, the availability of good accommodations, and the relative ease of entry and exit
procedures.
Chinese policy-makers had had several goals in mind in creating the Special Export Zones. First, the foreign companies were to
provide jobs, managerial training, and, most importantly, technologies. Second, the foreign companies were to provide needed
foreign exchange, since they were to produce primarily for export. Third, the zones were to be areas for experimentation and
testing of economic reforms. And fourth, the zones were designed to facilitate the eventual reunification of China with Hong
Kong (occurred in 1997) and Taiwan.
Between 1983 and 1988, there was over $11 billion of direct foreign investment in China. Yet, to that date, the experience was
disappointing for China. China had invested heavily in these zones. But the returns on its investment were low. Most of the foreign
direct investment had come from Hong Kong, with much of it in hotels, real estate, and tourist facilities. Those manufacturing plants
that were established were often labor-intensive facilities, using little advanced technology. The amount of managerial training was
minimal. Even the ability to earn foreign exchange was limited. As noted above, they are often entry points for foreign manufactured
goods, rather than being export zones. With the rise in incomes in China and the increased influence of Western ideas, Chinese
officials were not able to stem the explosion of consumption (much of it in “luxury goods”) that took place in these zones. The poor
performance of the Special Export Zones resulted from the fact that the problems of producing in these areas often outweighed the
benefits of the cheap labor, cheap land, or tax breaks. Labor productivity was low; workers were quite often unskilled and
“undisciplined”. Support industries were often missing. Shortages of electricity and transportation facilities created constant
bottlenecks to production. Coordinating production in relation to an economic plan was foreign to most Western managers. Finally,
the Western companies complained that they could not repatriate their profits on sales within China (they could repatriate their profits
earned in foreign exchange but could not convert profits earned in renminbi into dollars).
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Rather than abandoning these zones, the Chinese government tried to enhance their desirability to the kinds of companies that
would bring the desired benefits to China. In 1986, China promulgated new investment regulations. These gave the foreign companies
improved access to those crucial inputs controlled by the state --- water, electricity, communications, transportation, and so forth.
They tried to speed up the bureaucratic processes. And they gave the foreign companies greater authority. These changes
demonstrated the determination of the Chinese government to integrate China more into the global economy.
In the spring of 1992, Deng Xiaoping made a series of speeches designed to increase the confidence of foreign investors.
From that time onward, the amount of foreign direct investment began to increase greatly. More and more of the Chinese
market was opened to foreign investors. By 2004, the cumulative total of foreign direct investment in China had exceeded $500
billion. By 2003, there were some 100 special investment zones. Most (2/3) of this foreign direct investment now comes in the form
of wholly-owned subsidiaries (the foreign company does not have to share ownership with Chinese owners). Yet this new foreign
direct investment has provided some of China’s new capital goods and had done more to provide management experience and
technology. Just below half of all foreign investment in China comes from Hong Kong. Another large share comes from Taiwan and
from the various tax havens (such as the Cayman Islands). The United States, Japan, Canada and the EU have accounted for about
one-fourth of all the foreign direct investment in China. In recent years, foreign direct investment from both Japan and Korea has
increased greatly. Both have surpassed the United States.
As part of the increase in foreign direct investment, there has been created what is called the “China Circle”. Production has been
broken down into stages. The labor-intensive, low-skilled stages of production have been shifted to China. The technologyintensive, high value stages have been maintained in Hong Kong and Taiwan. For example, in the personal computer industry,
production of keyboards and power supply units were first to be transferred to China. Later as production became more standardized,
production of monitors and motherboards was transferred to China as well as a whole series of other IT products. In the meantime,
Taiwan has moved into production of technologically more sophisticated products while Hong Kong has moved into production of
services such as accounting, marketing, and finance.
Foreign investment into China has been different from that of other developing countries. First, a much higher percent of
foreign direct investment has been in manufacturing while a lower percent has been in services. This was partly the result of
restrictions that China has had on foreign direct investment in services. However, these restrictions have to be reduced greatly as part
of China’s entry into the World Trade Organization. Already, as of December of 2006, foreign banks are allowed to operate freely in
China. Second, as mentioned above, China has allowed very little portfolio investment. (Portfolio investment is the lending to
banks or governments in other countries.) This is the so-called “hot money” that was responsible for the Asian Financial Crisis of
1997. China has maintained strict controls on foreign borrowing. Because of China’s policy, China’s total foreign debt (and especially
the part that is risky short-term debt) has been relatively low. With low debt, China was spared most of the negative effects of the
1997 financial crisis. China has liberalized greatly with regard to foreign direct investment. But with accession to the World Trade
Organization, it is reasonable to expect much further liberalization in the years to come.
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(5) Conclusion
It is apparent from the description of this chapter, that China has changed its development strategy completely. From a policy of
trade autarky, China has embraced openness to the world economy. In its trade and investment policies, China has become an open
economy – probably the most open among the developing countries. This openness is likely to continue into the foreseeable future. It
is also apparent that this openness to the world economy has contributed greatly to the rapid economic growth that has been occurring
in China. However, the openness to the world economy and the rapid economic growth have also brought problems to China. The
next chapter, the last chapter of this text devoted to China, examines the results of China’s economic reforms and embrace of the
world economy in terms of the goals we have used to evaluate economies. We will see that there have been both great successes and
great problems. Both the successes and the problems teach us much about liberal market capitalism and about the new global
economy as ways of organizing society.