Is China an open economy?

The remarkable economic growth of China caused by its economic transition towards a free market economy has brought fundamental changes that have become the subject of many disputes across the world about the potential integration of the Chinese economy with the rest of the world. Going further, some particular events like an accession to the World Trade Organisation, have made China a more open economy.

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First of all, the paper will examine the term “open economy” with the examples of the countries that have implemented the principles that make them “open”. In this section, the author will analyse the key features that define this type of economy, and in contrast, compare it with the so called ‘closed economy’. The second section will discuss the implementation of the Open Door policy by Deng Xiaoping, and the initial reforms that have begun the process of economic transformation. The third paragraph will concentrate on further key policies introduced by the Chinese government, that have contributed to the transition into the free market economy, with open trade, and increased inflow as well as the outflow of Foreign Direct Investments (FDI). It will contain the major economic indicators that will show the progress of the Chinese economy in terms of trade and common rules of a free market economy.

The fourth and the last section will provide the conclusions with the final answer whether China is a truly open economy, and if not what are the obstacles, and reforms to be implemented.

“Open economy” – definition

To understand whether China is an open economy or not, firstly it is necessary to provide an accurate definition of the “open economy”, and identify typical open economies from across the world. The existing literature provides us with various interpretations of the open economy, however, they share the same key features. Referring to the Financial Times lexicon an Open Economy is “an economy that allows free inflow and outflow of goods, services, capital and people. The opposite of a closed economy”[1]. We can also understand Open Economy as “one that is characteristically market-oriented, with free market policies rather than government-imposed price controls[2].” Finally, according to The Law Dictionary, an open economy is “a market economy with few barriers to trade, where imports and exports make up a large portion of the GDP.” It is important to add that the open economy exists only in theory because every government have some control over capital and labour [3]. Going further, Giancarlo Gandolfo distinguished two different types of economies. The first one is considered a small open economy, and it refers to the country that doesn’t have a huge influence on the rest of the world in terms of income, interest rate, or price level. This type of an open economy doesn’t relate to China. Although, the second type of large country model could be considered as the one that fits this country. We may assume that since China has become one of the biggest economies in the world, what happens within the country may affect other countries, and its actions cannot be neglected[4].

Open Economy has some key features that should be mentioned before the examples of typical open economies. First of all, foreign trade is a factor that heavily influences the GDP of the country, and generally, it helps to increase it. A country with an open economy has the advantage to export products at higher prices and getting cheaper products from imports. What’s more, access to international trade can enable a particular country to produce these goods in which it has a comparative cost advantage, and import these where it has a cost disadvantage. Open Economy also enables countries to transfer technology and adoption of innovations. Of course, there are some potential disadvantages of this model. In the Open Economy model, the countries are interdependent which increases the risk of fluctuations in the aspects like prices, employment, and income. What’s more, it can spread to other economies and cause instability within the country. In some cases, international capital flows led to the indebtedness of certain countries and going further incapability to repay the debts[5].

To measure the openness of the economy we may use the Open Markets Index (OMI) which was created by The International Chamber of Commerce (ICC). This index comprises four key indicators that are observed openness to trade, trade policy, FDI openness, and infrastructure for trade. The ranking is split into four categories, from the most open to the very weak openness. The findings have shown that Singapore and Hong Kong were classified as the most open markets in the world. Although, the biggest number of countries with above average openness comes from Europe. Surprisingly, USA and Japan are the countries classified far below the general expectations. What is important, China was ranked 59th in the same category as the USA, although at the bottom borderline. Trade policy is considered the weakest, and trade enabling infrastructure is the strongest[6].

“Open Door policy”, and its key reforms.

The origins of China’s extraordinary economic growth are moving us to the 1950s when under Mao’s leadership the Chinese government accepted some elements of the open-door policy which included technology imports, and foreign aid but mainly from the Soviet Union[7]. Although the extended set of policies that had the aim to open the country to the world has happened in 1978 under the rule of Deng Xiaoping. He has introduced several reforms that initiated the process of transition and ‘opening up the economy. Among many reforms taken by the Chinese government, the program of Open Door policy was one of the most important at the beginning of the transitional process[8]. Undoubtedly, the decision to join the international community in terms of open trade has resulted in positive outcomes for the economy.

Although, before 1979, China’s total trade/GDP ratio has never surpassed 10%[9]. According to Shang-Jin Wei, in 1989, China was ranked thirty-second place in the world export volume. More or less a decade later, it climbed to the thirteenth place, and its share in world trade has almost doubled[10]. By The Observatory of Economic Complexity, China has become the biggest exporter and the second largest importer in the world. In 2014, China exported $2.37 trillion and imported $1.53 trillion, which results in a positive trade balance of $834 billion [11]. To explain this extraordinarily quick growth of trade it is necessary to analyse decisions made by the government. Before the reforms were taken, the foreign-trade system in China was an imitation of the Soviet-style model. To describe it, we may use the term “double air lock’. The ‘first lock’ system had total control over the foreign trade, where twelve national companies created a monopoly over imports and exports. The ‘second lock’ was related to the foreign-exchange system, where the value of the renminbi was set arbitrarily, and it was nearly impossible for to exchange it by individuals. This system treated export as a necessary evil that was a requirement to pay for the imports. On the other hand, imports were mainly required to resolve the problems with a shortage of basic products[12]. To liberalise the foreign-trade system, the Chinese government has decided to introduce some as it turned out later effective policies. First of all, the government took the approach to devaluate its currency. This decision was made because the previous rate of the renminbi was unprofitable to export. What is interesting is the real value of the yuan which was established in 1986 and maintained until 2005[13]. The next crucial step to opening a trading system was demonopolization. Companies allowed to trade internationally were flourishing, and at many governmental levels, the FTCs were mushrooming. At the end of the 1980s, there were 5000 FTCs, although they were still state owned.

Next, Deng Xiaoping’s government has established several special economic zones and has simultaneously chosen coastal cities as the powerhouses of the country that would also attract foreign investment. Since its creation, the Special Economic Zones (SEZs) had several key functions. The first of them was to attract the inflow of foreign capital, new technologies, and necessary equipment for the development. Another reason was to begin the competition between different provinces. The next reason was prosaic, where the main objective was increased employment among young people. The SEZs were mainly treated as experimental units during structural reform[14]. In other words, SEZs created controlled capitalism within the centrally planned economy[15]. SEZs covered various industries such as education, tourism, culture and entertainment, and of course Research & Development. For foreign trade, the government imposed certain quantitative measures, that specified the number of products that had to be exported. It measured the openness of the SEZs. The attraction of foreign investment was the key issue for the transfer of technology and an inflow of physical capital[16]. To better understand the role of SEZs in contributing to the openness of the economy it could be better to give an example. When the SEZ was opened, Shenzhen was considered a small town heavily dependent on agriculture. Until 1979, Shenzhen’s share of GDP in the Guangdong Province accounted for more or less 1%. Throughout the decades, Shenzhen has grown from a population of 30,000 people to 8.6 million in 2007. The SEZ in this city had an average growth of 30% from 1980 until 2007 when its GDP reached almost $100 billion[17]. It wouldn’t be possible to achieve it without special policies such as lowered taxes to the level of 15%, whereas outside the SEZ taxes were at 33%. This policy created Shenzhen as the first, and the most important destination for foreign investors in the 1980s[18].

Going further, the used to be restrictions on imports and export were replaced by tariffs, quotas, and licensing[19]. From the early 1980s, newly implemented tariffs were set very high which was typical for the highly protected developing countries. The most severe non-tariff barriers were related to the trading rights. The internal market was dominated by FTCs which were state owned only. Each FTC was designated to one particular product range, and in many cases to the specified category of customers. Another relevant change in the foreign-trade policy introduced in the 1980s was import substitution and export promotion. Implementation of the new system that concentrates on high tariffs and multiple non-tariff barriers was once again typical for developing countries. From this point, we can start describing this partial reform as truly liberal which specifically for China turned out to be increasingly beneficial.

Another essential part of the “opening up” process in China was Foreign Direct Investment (FDI). What is important, until the 1970s, FDI practically didn’t exist. Of course, it is worth mentioning the joint ventures established with the Soviet Union that brought FDI into the country, but because the Sino-Soviet alliance collapsed it didn’t last that long. On the other hand, international investors were avoiding China because of the political and economic turmoil caused by Cultural Revolution[20]. The first guidelines for FDI in China were introduced in 1975, although they allowed only very limited types of foreign investment. In a state-dominated economy, joint ventures were severely restricted until July 1, 1979, when the Fifth National People’s Congress decided to adopt “The Law of the People’s Republic of China on Joint Ventures Using Chinese and Foreign Investment”[21]. Since then, the number of inward FDI has increased rapidly. In 1985, the FDI per annum accounted for less than $2 billion. However, in 2004, they reached $61 billion, which is thirty times those of 20 years earlier[22].

Undoubtedly the biggest supplier of FDI into China is Hong Kong and Taiwan (KHT). In the period from 1979 until 2001, HKT accounted for 56% of all of the FDI, whereas the Triad (European Union, US, and Japan) constituted only a quarter[23].

To understand China’s FDI we must divide them into two categories. The first one is horizontal FDI, and the second is vertical FDI. Horizontal FDI means the transfer of production to China to operate on the Chinese market, and vertical seeks the low-cost production in China to later export the products abroad. The majority of vertical FDI comes from Hong Kong and Taiwan in the first place, and then from Japan, and South Korea. The horizontal category consists of countries from North America and most of Western Europe to exploit the Chinese internal market[24]. To conclude, the impact of FDI on the Chinese economy brought mainly positive effects. First of all, opening up for foreign investors brought a massive amount of capital that has helped to develop the economy. Going further, it has created hundreds of thousands of new jobs, and that may be judged as one of the most prominent impacts of FDI on China.

Accession to WTO and the reforms from the 1990s – 1000 words

This section will describe China’s process of accession to the World Trade Organisation (WTO). This decision made by the Chinese government was crucial for the gradual process of opening up the economy to the world. Before China joined WTO in 2001, it had to fulfil the requirements defined as the WTO’s Basic Principles. According to the book written by Bhattasali, Li, and Martin we can distinguish five different principles: a) non-discrimination, b) market opening, c) transparency and predictability, d) undistorted trade, and e) preferential treatment for developing countries[25]. The first, of them, the principle of non-discrimination consists of two different principles that are The Most-favoured nation (MFN) principle which urges to treat other WTO members equally, and The National treatment principle tells about equal treatment of foreigners as well as locals[26]. China itself as a member of WTO is obliged to abide by all of the WTO agreements which include provisions requiring the application of both principles. It is worth mentioning that China should work on the elimination of the dual pricing system and phase out the period of three years the majority of restrictions imposed on foreign enterprises in import, export, and trade. Another principle, Market Opening is widely promoted by the WTO during multilateral trade negotiations that ought to lower the trade barriers between the members. Each new country is obliged to liberalise their trade systems during the accession process. That forced China to decrease the number of tariffs, and non-tariff barriers. In the partial answer to the question of the essay, China’s opening up of its services sectors to foreign competition is undoubted[27]. The next principle, Transparency and Predictability is one of the most essential WTO regulations. The trade policies and regulations should be made accessible to the governments, as well as traders. This also influences monitoring members’ trading practices and their impact on the WTO trading system. Before 2001 and accession to the World Trade Organisation, the Chinese administrative legal system was not designed for transparency. It can be said that transparency was one of the biggest concerns for China’s major trading partners. What’s more, this issue after 15 years since accession remains not transparent enough. Even if the legal framework exists, many legal enactments aren’t publicly accessible[28]. For China, there are four different obligations concerning transparency. (…)

Another principle is ‘Undistorted Trade” which raises the subject of antidumping, safeguards, and countervailing measures. If compared to the other members of WTO, China has to make more demanding commitments, which included stopping the subsidies for the agricultural exports, as well as for industrial goods, which in general have been allowed among the rest of developing countries. The current anti-dumping system has brought a lot of troubling implications for China’s access to export markets. More or less 70% of goods exported by China are the most vulnerable to anti-dumping measures. That puts this country in a much worse position than the other WTO members[29]. Despite it, China’s position is even worse because of transitional safeguard provisions. These provisions could be used by WTO members, and they work against the diversion of Chinese exports to other markets[30].

Another principle “Preferential Treatment for Developing Countries” provides a transition period for developing countries, and for these which are undergoing the transition process toward market economies. The main characteristic of this principle is its flexibility for all the developing countries in the implementation of all required agreements. China has not received the preferential treatment, and it had to negotiate transitional arrangements in its trade regime. For instance, China had to phase out some quotas and import licenses, and what’s more important China had to continue the process of opening up through the liberalisation of the rights for foreign investors to trade in China[31].

The last but not least principle is “Institutional Implications”. It has been 16 years since China became a WTO member. Undoubtedly, nobody would dispute that China’s membership in this organisation will not affect the functioning of the WTO’s system and other members. According to James Bacchus, since the accession, China considered an emerging leader has played a crucial role in the organization. The membership has led to decreased tariffs for Chinese goods and increased competitiveness across the world. We may assume that in the long-term future China will continue to open its economy. From the current perspective, protectionism that is commonly used by the Chinese government can be a solution for the moment, without the guarantee of lasting value-added growth. In recent years the PRC government has taken actions to restrict exports, and meanwhile implementing innovative policies that have favoured the domestic industry. Such practices are widely condemned by foreign traders and investors, who fear that China will ignore the international laws, and will take an approach toward a policy of protectionism[32].

China’s accession to the WTO has boosted the process of reform in the country. The gradual liberalisation of the economy has made China a very important player in international trade, equally in export and import. Thankfully with access to 143 markets across the world, Chinese producers, and exporters can improve their revenues. Analysing the last 20 years of transition, it can be noticed that China has made impressive strides at reform[33].

Conclusions

Taking the broad picture of China’s economic performance throughout the last 40 years the growth of international trade is unprecedented. No country could be compared in terms of trade growth[34]. According to Xiaojun Li, in 1978, “China’s total imports and exports of $20.6 billion ranked 32nd among all nations and accounted for less than one per cent of global trade.” Currently, we may describe China as a trading superpower, that is the world’s largest exporter, and 2nd largest importer in the world[35]. This wouldn’t happen without the reforms package that under Deng Xiaoping has opened the economy to the world. The major reforms taken in the 1990s in the banking sector, taxation, as well as exchange rates management have only accelerated to development of the economy, and have created China as a much more attractive country for foreign investment. The next step on the path of liberalisation was taken in 2001 when China joined WTO. China has broadened access to the market for foreign investors in the agriculture, manufacturing and service sectors by removing or lowering tariff barriers. Despite it, WTO has demanded a reform of many laws that were trade-related[36].

This incredible growth wouldn’t be possible without opening the economy to foreign investment. Concerning the Law Dictionary’s definition of the open economy which has been given in the first section of the essay, we may conclude that even if China is not fully integrated into the global economy, and still has trading barriers, overall it has a lot of characteristics of the open economy, and the foreign trade makes a huge share of Chinese GDP.

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