PACIFIC FOCUS : Trade Shift May Slow China Economic Reform

The U.S. House of Representatives last week voted to eliminate China’s most-favored-nation status, which has kept tariffs on Chinese goods as low as those for most other U.S. trade partners. Those favoring elimination criticize China’s human rights record and controversial trade practices the Chinese have used to build a $10-billion trade surplus with America. The Senate has yet to vote, and President Bush may veto any move to eliminate China’s MFN status.

Nicholas Lardy, professor of economics and Chinese studies at the University of Washington, advised against elimination of China’s MFN status in recent testimony before a joint congressional committee. Lardy contends that America can encourage China to further liberalize its economy--and gain more access to Chinese markets--by maintaining MFN. Times Staff Writer George White sought Lardy’s views on economic reform in China.

Q. Let’s talk about structural change in the Chinese economy. What’s the trend?

A. The trend over the past 12 years on balance is extremely promising. In economic terms, China is reforming more than any socialist or formerly socialist country. And it has been far more successful than any other country in increasing its participation in the world economy.

Q. Can you provide examples?

A. First, China is moving from being an insignificant participant in the international trading system to being one of the top dozen or so trading countries in the world. China’s trade expanded from around $21 billion in 1978 to more than $115 billion in 1990. And secondly, China has begun to participate in financial markets--not only borrowing on commercial terms . . . but also making extensive use of funds from international financial institutions such as the World Bank and floating its own bond issues on international capital markets.

Thirdly, China has been successfully meeting international financial (debt) obligations.

Q. You’ve said China has been decentralizing its economy. Why is that significant?

A. Well, the decentralization has allowed the expression of all kinds of entrepreneurial activities in China in a way that we have not yet seen in the Soviet Union or in Eastern Europe. The best measure of that is the extent to which even manufacturing, traditionally the core of the socialist state-owned economy, has been decentralized. In China, about half of all industrial output is being generated by firms that are not under the direct control of the state government or provincial government. In other words, these are private firms--for example, collective township and village enterprises--that operate by and large in a much more market-like environment than state-owned enterprises.

In contrast, almost two years after the collapse of the communist regime in Poland, roughly about 90% or more of all (Polish) manufacturing is still in the hands of state enterprises.

Q. How has this decentralization affected China’s approach to conducting foreign trade?

A. Almost as dramatically. About half of all of China’s imports are now arranged on a decentralized basis. These firms decide largely on their own to buy and sell goods on international markets. They are able to use foreign exchange--currency from their export earnings or foreign (currency) exchange they can buy (in China)--to import goods no longer included in the (central government’s trade) plans. So the (central government’s) foreign trade plan currently only covers about half of China’s imports and exports.

Q. Still, Chinese “firms” are government-sponsored or controlled on some level, correct?

A. Yes . . . but consider when the reform process began--in 1978. At that time, there were only 12 trading companies--all directly controlled by the national government. Today there are roughly 5,000 corporations that are authorized to enter into international trade transactions, and most of them are administered by provincial and local governments.

Q. Is there any purely entrepreneurial activity in China’s foreign trade arena?

A. There is some. For example, firms that don’t have their own foreign trade (operation) can hire local foreign trade companies to act as their agent . . . for a fee.

Q. What’s occurring in the area of pricing and currency valuation?

A. It’s fair to say that China has . . . outperformed all of the socialist or former socialist countries with the possible exception of Poland. They have devalued the exchange rate twice in recent years--in 1989 and in 1990. The degree of overvaluation . . . of Soviet (currency) is substantially more than in the Chinese case.

China is basing the price of more and more of its goods on actual production costs or the prevailing world price. The state is also making a very substantial effort to eliminate the (government) subsidies that have made it possible to sell goods for less than the production cost or less than the import cost. The most dramatic example is the huge price increases they imposed two months ago on . . . wheat, flour, rice and edible vegetable oils. The prices of these commodities had been basically unchanged since the mid-1950s.

Q. Can you explain why that particular reform is important?

A. Well, it’s very important in the long run because it will allow a gradual freeing up of markets in the countryside, providing more incentives for production at the farm level.

Q. How will reforms affect U.S. trade if Congress does not revoke China’s MFN status?

A. Well, in the long-term it should mean that we would continue to see an expansion of Chinese trading activity, and the United States should certainly be a beneficiary of that expansion. We are the largest market for China’s exports, and I think we can expect to see--over time--a growth in our sales to China as well as a growth of our purchases from China.

Q. However, some contend that the U.S. trade deficit with China is too large--and growing.

A. Let’s look at the reasons for the size of that deficit. First, Western economic sanctions (implemented after the Chinese government’s June, 1989, Tian An Men Square crackdown on pro-democracy dissidents) substantially reduced China’s access to international capital markets in the second half of 1989.

To cope, China took steps to increase exports and to cut back on imports--all part of an effort to create a (trade) surplus sufficient to pay debts coming due in the early 1990s. Now that international financial organizations and commercial banks are again making some types of new loans to China, the Chinese don’t believe they need to create as large a surplus, and they plan to import more. China also experienced slower economic growth in 1989 and 1990, reducing their capacity to buy imports.

My expectation is that the Chinese trade surplus with the United States will begin to shrink in 1991 and shrink further in 1992.