An (Un)Happy Birthday? China's WTO Accession One Year Later

By Jean-Marc F. Blanchard, Ph.D.

One year ago, China embarked on an uncertain journey when it became a member of the World Trade Organization (WTO). Pessimists argued forcefully that China's existing economic problems coupled with the high demands of the WTO would cause China irreparable economic and, in its wake, political harm.

At the time, China's economic problems included slower rates of economic growth than it enjoyed over the past two decades, high un- and under-employment, inefficient and unprofitable state-owned enterprises (SOEs), a troubled state-owned banking sector, and government budget deficits. The doubters predicted that WTO accession would aggravate these problems by requiring China to open its protected agricultural, manufacturing, and service sectors, to lower tariff and nontariff barriers, and to adhere to international intellectual property right standards.

Several analysts even asserted that WTO-fueled increases in imports and larger numbers of foreign corporations operating in China would bankrupt many SOEs, massively increasing agricultural unemployment, and engendering bank runs. In tandem, these changes would bring about severe political turmoil and perhaps the collapse of China (see the review of The Coming Collapse of China in this KWR International Advisor).

Earlier this month, this vision of a troubled future for China seemed to receive affirmation when 2,000 unemployed textile workers in China’s Northeastern Heilongjiang province blocked a major railway line and cut off traffic to protest unemployment, corruption, and the arrest of follow protestors. Moreover, the economic problems noted above have not disappeared.

It is indisputable that China suffers from serious economic and political problems, but the WTO has not yet brought China to the brink of collapse or anything close to it. The pessimists were wrong in their views about how disruptive the WTO actually would be. Moreover, they incorrectly assumed that economic problems would translate directly into political strife.

Analysts forecast job losses in the tens of millions as a consequence of China’s membership in the WTO. In actuality, however, many of these losses had already occurred as a result of the Chinese government’s efforts to close unneeded factories, lay-off surplus labor, and terminate relatively smaller money-losing SOEs. In addition, as the economist Nicholas Lardy has observed, China had been reducing or eliminating protectionist barriers throughout the 1990s. This meant that WTO accession did not produce vastly higher levels of imports and foreign competition. Furthermore, the Chinese already had allowed the prices of many goods sold domestically to equalize with the prices of goods on international markets.

The WTO not only has imposed less pain on China’s economy than the pessimists predicted, it also has brought about gains. It has promoted greater productivity, opened previously closed exporting and partnership opportunities, and facilitated further inflows of foreign capital and technology. The pessimists also seem to have neglected the fact that the Chinese government had a variety of strategies at its disposal to counter the effect of WTO-induced unemployment. These strategies are manifested by its further empowerment of the private sector, the enlargement and improvement of its financial and capital markets, and the selective fulfillment of its WTO obligations. It also can embrace strategies like appreciating its currency.

Forced to lend in large amounts to unprofitable SOEs, China’s banking sector has accumulated at least a 40-50 percent ratio of non-performing loans to assets. Since the assets of China’s four big state-owned commercial banks run around $1 trillion, this means that the Chinese government has about $400-500 billion of bad loans that must be resolved. This is an incredible 40-50 percent of GDP and is sustainable only because the Chinese populace has lacked alternatives and believes the government fully backs their deposits. Pessimists argued that the arrival of foreign banks would cause a huge outflow of deposits leading to a banking crisis that would overwhelm the Chinese government.

The WTO has and need not tip the banking system from its current equilibrium to a state of crisis. That is because foreign entrants are and will be constrained in the amount of deposits they can take due to regulatory requirements. It is also unlikely that foreign banks will want hundreds of millions of small depositors. The number of high-quality lending opportunities in China also will serve to restrict the amount of deposits that foreign banks seek.

China’s banking woes are daunting, but the government has been addressing them. Increased economic growth has helped as have requirements for the Big Four to set aside increased loan loss reserves. Going forward, China can sell stakes in the Big Four, tap into international capital markets to recapitalize and restructure the Big Four, sell off larger stakes in SOEs that burden its banks, and collect special taxes to stabilize its banking system.

Even if the WTO increases unemployment or banking difficulties over time, the Chinese government can move to reduce unemployment and stabilize the banking system. Although it is unlikely they can eliminate these problems, it is another matter to conclude this will mean the collapse of China or even significant political instability.

The domestic tranquility the U.S. enjoyed during the 1930s Great Depression highlights that more than unemployment is needed to foment major political instability. Political fallout from unemployment in China has and is likely to be controlled as the government can directly aid, albeit in limited ways, the unemployed with welfare schemes. It will be very difficult to organize the unemployed for sustained action as they partly blame “the market” for their unemployment. The government can also enact political reforms to allow the unemployed to vent their anger, and can also utilize coercive tools to repress the unemployed.

The political consequences of banking crises are more uncertain since a nationwide banking crisis would present more severe management problems than a local or regional crisis. In any event, Turkey’s recent banking crisis and South Korea’s banking woes in the late 1990s demonstrate that banking crises do not necessarily translate into political crises. Before that stage is reached, the government can pay individuals whose money is at risk, or has been lost. They can also ease credit, or take steps to deflect blame.

There is no doubt China has real economic problems and that the WTO has presented new challenges and intensified others. It is unlikely, however, to bring about an economic catastrophe. Furthermore, it is fallacious to assume that China’s economic problems will lead to significant political turmoil. Doubters raise the possibility of unforeseen events such as a war over Taiwan to challenge more sanguine assessments. Nevertheless, it is hard to envision many of these “unforeseen” scenarios. Furthermore, the Chinese leaderships’ intelligence, willingness, and desire to tackle these problems bode well. Dreams of a vast China market may be unfounded, but a paralyzing fear of economic and political chaos is equally unwarranted.