The Integration of China in the Global Economy

Table of Contents

List of Abbreviations

List of Figures

List of Tables

1 Introduction

2 China’s Integration in the global economy
2.1 China’s foreign trade policy in transition
2.2 The phases of the Chinese reform and opening policy
2.2.1 Beginnings of the opening policy
2.2.2 Strategy of export orientation
2.2.3 Expansion of opening policy and the will of joining the “World Trade Organisation (WTO)”
2.3 Further export orientation and the WTO- entry
2.4 Structures and characteristics of the Chinese foreign trade
2.5 Foreign Direct Investments in China
2.6 Future Prospects of the Chinese foreign trade policy
2.6.1 The development of the Chinese monetary regime
2.6.2 Regional economic integration
2.6.3 China’s Going - Out Strategy and FDI outflows
2.7 China’s changing role in the 21st century
2.7.1 WTO regulations vs. own interests
2.7.2 The global Financial Crisis
2.7.3 Xi Jinping and the economic realignment
2.8 Setting the strategic course for the future
2.8.1 China's rise to technological leadership
2.8.2 China’s development into a global investor
2.8.3 China's active transformation of international conditions
2.8.4 The downside of global interconnection

3 Conclusion

4 Bibliography

List of Abbreviations

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List of Figures

Figure 1: People’s Republic of China and its special economic zones (SEZ)

Figure 2: Inward FDI flows in China 1979-201

Figure 3: Countries of origin for FDI in China in 2008

Figure 4: The percent change of Chinese annual real GDP growth

Figure 5: China’s Real Annual GDP Growth: 2007-2018 and Projections

List of Tables

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1 Introduction

■ ‘cross the river by feeling the stones” - Deng Xiaoping (1970) When the Chinese government under Deng Xiaoping initiated the Chinese policy of "open­ing up to the outside world" in 1978, no one could have foreseen the dynamics with which this modernization course would continue or that it would change China's influence on world markets and its perception in the international environment so markedly (Fischer, 2007, p.332). The opening policy in the 80s and 90s was characterized by a step-by-step development according to the principle: crossing the river from stone to stone (FAZ, 2016). Thus, China gradually developed from one of the poorest nations to today's second largest economy, to which a significant role is attributed worldwide (Tagesschau, 2019). Not only as a location for investment, but also as an international competitor for markets and re­sources (Fischer, 2007, p.332).

The aim of this paper is to trace China's increasing integration in the world economy. In this context, the developments of the country’s foreign trade policy as well as those of the trade and the investments will be examined. Subsequently, the future prospects of China's foreign trade will be the focus of attention, with particular reference to the country's mon­etary regime, its Going-out strategy and the regional economic integration in Asia. The following remarks will be devoted to the key events that have paved the way for China's changing role in the global economy in the 21st century. Finally, the most recent, forward­looking measures taken by the Chinese government will be discussed, which are essential for strengthening China's international presence and its competitiveness. After a brief in­sight into the downside of China's global interconnection, the work is rounded off by a conclusion.

2 China’s Integration in the global economy

2.1 China’s foreign trade policy in transition

In the years between 1949 and 1976 the focus of the Chinese foreign trade policy was mainly on self-sufficiency. Exports were only seen as a means of generating foreign ex­change income to pay imports, and trade was the responsibility of a negligible number of state-owned monopoly companies (Delisle and Goldstein, 2019). In addition, Chinese pro­ducers were bound to state-fixed domestic prices and any “foreign direct investment (FDI)” was prohibited because the People' s Republic interpreted it as a dependency on foreign countries. In the mid-1970s, the importance of foreign trade changed gradually. Imports in China increased and the government introduced reforms. Between 1978 and 1979, these reforms ultimately caused the government to abandon its previous policy of economic iso­lation (Fischer, 2007, p.333). The course was set for the modernisation of the economic system and the “opening of the state to the outside” (Merics, 2018).

2.2 The phases of the Chinese reform and opening policy

2.2.1 Beginnings of the opening policy

The opening of the state and the associated opening policy can be divided into 3 phases. The first phase took place between 1978 and 1986/87 (Huotari, 2018). State-owned foreign trade companies were founded, local authorities and large production companies were granted foreign trade rights, and the number of products allowed for foreign trade was sig­nificantly increased. At the same time, the first “Special Economic Zone (SEZ)” was es­tablished in the city of Shenzhen, followed by three further SEZs named Xiamen, Shantou and Zhuhai in the provinces of Guangdong and Fujian (Delisle and Goldstein, 2019). All these zones were located on the coast (see figure 1) and offered foreign investors the op­portunity to produce at world market conditions by taking advantage of the attractive Chi­nese low wages and tax conditions. In April 1984, the Chinese government opened another 14 coastal cities to foreign investors and increasingly abandoned its aversion to foreign loans (Fischer, 2007, pp.333-334).

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Figure 1: People’s Republic of China and its special economic zones (SEZ) (source: United States Depart­ment of Agriculture (2010), figure 4, p.7)

2.2.2 Strategy of export orientation

The beginnings of the second phase of the opening policy from 1987 onwards were marked by the introduction of the strategy of export orientation. Responsibility contracts were con­cluded with foreign trade companies based on target agreements for foreign exchange rev­enues, export costs and export efficiency. Furthermore, from 1988 onwards, the entire coastal region was actively transformed into an export-oriented economic region. Thus, in 1989, the island of Hainan was granted the status of the fifth SEZ (see figure 1). The pro­motion of the export economy was decisive for increasing FDI, especially from Hong Kong and Taiwanese investors in the export processing industry. Due to the growing importance of FDI, the share of products processed in the “People's Republic of China (PRC)” of total exports rose from 27% in 1987 to 55.3% in 2002 (Fischer, 2007, pp.334-335).

2.2.3 Expansion of opening policy and the will ofjoining the “World Trade Or­ganisation (WTO)”

The third phase of the opening policy began in 1992 and ended with the country's accession to the WTO in 2001. Apart from expanding the strategy of export orientation, the govern­ment endorsed an import substitution policy for certain industries and goods. Furthermore, the competitive effects on domestic industries caused by the opening of the market were to be limited through high import duties and know-how. The liberalization of foreign trade was reflected in particular in the number of Chinese firms admitted to foreign trade. While at the end of the 1980s only 5000 companies were admitted, the number had risen to 35000 by the end of 2001. China's foreign trade grew by about 13% annually in the 1990s. The changes in the opening of foreign trade were also reflected in a sharp increase in FDI after 1992 (Fischer, 2007, pp.335-336). In order to better regulate them, the “negative list” was introduced for the first time, listing those industries in which foreign investments were restricted or prohibited (Mondaq, 2018). Moreover, the Asian financial crisis also occurred in the third phase of the opening policy. As a result of the crisis that took place in 1997, the growth of FDI from Taiwan, Japan and Hong Kong fell from 60% (1997) to 48% (2000). In response to the consequences of the crisis and the continuing decline in domestic de­mand, China sought to join the WTO from the end of 1998 (Fischer, 2007, p.337).

2.3 Further export orientation and the WTO- entry

China finally managed the accession to the WTO on 11 December 2001 and was appointed as 143rd member ofthe organisation (WTO, 2001). This accession was preceded by many years of negotiations to guarantee the successful adaptation of Chinese foreign trade policy to the WTO principles. Therefore, China's foreign economic policy efforts focused on im­plementing the concessions made in the course of the accession. Between 2001 and 2007, these included the protection of intellectual property and additional liberalisation steps in foreign trade, such as the opening of further industries to foreign investment in the service sector (Fischer, 2007, p.337). Besides the opening of the own market, the commitments for the WTO accession also included special regulations. One of those regulations prohibited China's recognition as a market economy within the next 15 years after its accession. Con­tinuing to treat China as an economy with strongly planned economy characteristics made it easier for trading partners to substantiate anti-dumping accusations against Chinese com­panies and to impose higher tariffs on excessively cheap imports from the country (IREF, 2019; SPIEGEL, 2016). This was one of the reasons why China demanded its recognition as a market economy after its WTO accession. Despite the lack of market economy drivers, the PRC actually managed to win this recognition from WTO members in December 2016 (BID ,2019). On the one hand, the WTO entry pushed China's integration into the world economy forward, but on the other hand it eradicated the experimental character of the Chinese foreign trade policy. The opening phases carried out so far were only applied on a broader scale when they had proved their success in a certain period of time both spatially and sectorally. With the membership in the WTO, however, this staggered economic open­ing was no longer possible (Fischer, 2007, p.338).

2.4 Structures and characteristics of the Chinese foreign trade

The success of China's reform and opening policy since 1978 put the PRC in the centre of world trade. Rather than less than 2.4% of the global “Gross Domestic Product (GDP)” and a marginal role in global trade in 1980, the PRC now (2019) contributes about 18.2% to the global GDP (Statista, 2019). China's world imports and exports have also experi­enced a turnaround over time. Both world imports and exports quadrupled by 2017, to 12.7% and 16.2% respectively. In view of this increasing foreign trade efficiency, China has held the title of "world export champion" since 2009 and is currently considered the second largest import nation after the United States (bpb, 2019). An important indicator in the context of the foreign trade position of the PRC of China is the “balance of trade (BOT)”, which is the comparison of all goods imports and exports of an economy in a given time period (Debitoor, 2019). China's BOT with the world has changed over time, how­ever, after the opening policy from 1992 onwards, it showed a constantly growing surplus. In 1994 this surplus was initially US$ 5,392,654.34. In 2000 it rose again to US$ 24,108,819,98 before peaking at US$ 359,247,579,98 in 2018. This development once again highlights the country's special potential in the export sector. Given the foreign trade structures, the shares of individual countries and continents in China's trade volume and their importance as trading partners should also be examined. In 1992 East Asia/Pacific, Hong Kong, Europe/Central Asia, Japan and North America ranked among China's most important trading partners (see table 1). In 2018, the constellation of the partners remained largely unchanged, although the percentages had altered (see table 2).

Table 1: China Import/Export Partner Share 1992 (own illustration, source: WITS (2020))

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Table 2: China Import/Export Partner Share 2018 (own illustration, source: WITS (2020))

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For a more complete assessment of China's foreign trade position, the goods structure of imports and exports over time is also useful. In 1985, the import structure consisted of 87.5% industrial goods and 12.5% primary goods (mainly raw materials). In 2005, the first category fell to 77.6% and the second category increased to 22.4%. In contrast, the goods structure of exports changed considerably. Whereas in 1985 exports consisted of 50% primary and 50% industrial goods, the shares in 2005 were about 6.4% and 93.6% respec­tively. Of major importance for the structure of Chinese foreign trade is the processing trade, which accounted for 55% of exports in 2005 (Fischer, 2007, p.342). The export structure is thus an indicator of China's industrial development and its comparative ad­vantages of labour-intensive products. In 2018, 26.6% of exports were attributable to goods originating from the electronics sector, which means that today’s export structure is more dominated by know-how-intensive goods (Weltexporte, 2019).

2.5 Foreign Direct Investments in China

FDIs in China have undeniably been one of the greatest success stories of the past. Whereas the inflow of FDI remained at a moderate level in the 1980s, it increased explosively from 1992 onwards as a result of China's reform and opening policy. The first FDI boom was halted by the negative consequences of the Asian crisis after 1997/98. But the next FDI boom followed right at the beginning of the new millennium. This was due to the liberali­sation processes initiated by China in the context of its WTO accession, which were in­tended to open up a wider field of activity, a better structure and distribution of investments for foreign investors (Taube, 2006, pp.230-231).

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Figure 2: Inward FDI flows in China 1979-201 (source: Research Gate (2014))

An analysis of the regions of origin of these foreign investments reveals the importance of both Hong Kong and Taiwan in terms of FDI inflows to China. Before Hong Kong was returned to the PRC, countless Taiwanese companies invested in China via third countries. Hong Kong was one of these third countries and offered investors excellent preferential conditions -especially tax conditions- for direct investments. Other well-known tax havens were the Virgin Islands, the Cayman Islands and Samoa. Further elementary countries of origin included South Korea, Singapore and Japan (see figure 3).As a result, in the years following China's accession to the WTO (2001-2008), FDI in China could be attributed in particular to investors from Asia and Latin America, rather than to investors from the USA or Europe (Friedhelm, Frank, Heckl, 2010, p.76).

Due to the continuous growth of FDI in China, the country is nowadays considered the second largest recipient of FDI after the USA. The composition of the FDI countries of origin has mostly remained the same. While the worldwide FDI inflows in China in 2008 were still around US$ 116 billion, they rose to US$ 137 billion by 2019 (South China Morning Post, 2020). Apart from the liberalisation processes of the opening policy, this can especially be explained by the increased establishment of “free trade areas (FTA)” and the rapid development of the high-tech sector. Investments were mainly concentrated in the manufacturing industry, real estate, rental business, wholesale and retail trade, research, transport, electricity and construction (Deutsche Bank, 2019).

2.6 Future Prospects of the Chinese foreign trade policy

After the successes of the Chinese opening policy, China sought to introduce further strat­egies to consolidate its foreign trade success. As a result, foreign trade policy negotiations were dominated by the following topics in particular: the Chinese monetary regime, the integration of the country in the Asian region and the Going-Out strategy. The policy in these areas was fundamentally decisive in determining how foreign countries would assess the country's position in the world over the long run (Fischer, 2007, p.346).

2.6.1 The development of the Chinese monetary regime

One instrument to ensure the continued success of China's foreign trade consisted of re­forms in exchange rate setting and currency convertibility. Prior to the opening policy, the Chinese “Renmibi (RMB)” was considered to be heavily overvalued. This decreased the competitiveness of domestic production companies and thus also restricted their exports to foreign markets. In order to stimulate foreign activities, a low “internal exchange rate” was introduced at the beginning of the reforms in 1978. At that time, countless companies ben­efited from the low exchange rates of the RMB on the black market (Klenner ,2006, p.60). In order to stop these exchange transactions, the government gradually devalued the official exchange rate until 1994, when it merged with the "internal exchange rate". At that time, all trade transactions were subject to the strict system of foreign exchange management. The requirements of this system made it difficult for both domestic and foreign companies to access and handle foreign exchange (Fischer, 2007, p.346). In addition, the rigid ex­change controls prevented foreign investors from investing in China. To counteract this issue, the government established swap markets from 1980 onwards, which are generally considered to be exchange markets with strict access controls. Initially, only companies with foreign capital had access to these markets, where the Chinese State Council set a market rate for the RMB in addition to the official exchange rate. The establishment of this rate represented a change from the former merging of the currencies to a multiple cur­rency system. The fact that only companies with foreign capital were permitted access to the swap markets had a considerable impact on the foreign trade transactions of Chinese companies (Klenner, 2006, p.63). For this reason, the Chinese government started to grad­ually devalue the RMB during the second half of the 1980s. Consequently, the exchange rate was RMB 8.62 / US$ in 1994. This enormous devaluation dramatically increased the price competitiveness of Chinese export goods. Between 1996 and 2005, the RMB was subject to only minor exchange rate fluctuations due to its linkage to the US dollar. It basically stagnated at a value of 8.277 RMB/US$ (Fischer, 2007, p.347). This changed when the PRC was increasingly urged by its foreign trade partners to revalue the RMB. The pressure came especially from the USA, which had a high trade deficit with China. They accused the country of misusing the undervalued currency to boost exports. In July 2005, the “People's Bank of China (PBoC)”, responded to this market pressure by revalu- ating the RMB to 8.11 RMB/US$. Since then it has been tied to a basket of currencies and no longer to the US$. To this day, China's monetary policy is the subject of critical negoti­ations (Fischer, 2007, p. 348).

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