China’s accession to the World Trade Organization (WTO) in December 2001 has advanced U.S. interests in many ways. For example, China certainly has had human rights problems. However, China’s free market reforms over the last two decades unquestionably have contributed to greater economic and political freedom for the Chinese people. Far from rewarding China for bad behavior, WTO accession has accelerated those reforms, and correspondingly, accelerated the liberalization of Chinese society.

Through expanded trade, WTO accession also has empowered China’s fast-growing entrepreneurial class to put greater pressure on Chinese authority from the inside out. This strategy is not unique. Once markets are liberalized, their political systems follow. The adage “open markets open minds” is true. To validate this, all one has to do is look at Mexico. Prior to the North American Free Trade Agreement (NAFTA), that country’s ruling party, the PRI, had a decades-long indisputable grip on the country. Since NAFTA implementation, the PRI power structure has dwindled considerably as demonstrated by the election of Mexican President Vicente Fox, a member of the National Action Party.

For a quarter-century, U.S. trade has helped change China by supporting economic freedom, human rights, access to information, higher living standards and the rule of law for the Chinese people. And, with today’s technology, this change will continue to accelerate. Through a policy of engagement the United States has infused ideas and values into Chinese society. On the other hand, to determine how well non-engagement or isolationist policies work, look no further than North Korea and Cuba: two countries where the United States has virtually no trade—and no influence.

Since the fear of “Red China” has subsided, an economic-based fear has emerged. Prior to acceding to the WTO, China already had access to U.S. markets. In fact, supporting China’s membership in the WTO did not change U.S. tariff rates on Chinese goods. Instead, WTO membership forced China to open its marketplace. Under the accession agreement, China agreed to cut average tariffs from 24 percent to 9 percent by 2005, further cut tariffs on U.S. priority goods to 7 percent by 2003, eliminate tariffs on high-technology goods by 2005, cut average agricultural tariffs by half, and remove China’s distribution monopoly, allowing U.S. firms to freely distribute their goods in China. With China’s population of more than 1.3 billion, the United States could not afford to be locked out of this emerging market.

Within a few years of China joining the WTO, the effects of Chinese tariff reductions on U.S. and third country goods already were evident. China’s increasingly strong demand for oil, industrial metals and other commodities, as well as semi-finished goods, boosted its import growth considerably. As a result, China has become the United States’ fifth largest export destination. If Hong Kong were added, China would be in fourth place. And from 1999 to 2004, U.S. exports to China increased nearly 10 times faster than U.S. exports to the rest of the world.

But China’s growing impact on the trade scene is not just affecting the United States. In 2004, China became the world’s third largest importer and exporter of merchandise trade, according to the WTO. In fact, its world imports reached $561 billion in 2004, $106 billion more than Japan’s. Its world exports rose to $593 billion, $28 billion more than Japan’s. But the large U.S. trade deficit with China, combined with the movement of U.S. manufacturing jobs there, has America scared.

In 2004, the U.S.-China trade deficit reached $162 billion, the largest among U.S. trade partners. This partly reflects a shift in U.S. imports of labor-intensive products away from higher-wage Asian countries to lower-wage China. The result: U.S. imports from China have risen while U.S. imports from the rest of Asia have flattened. Nevertheless, the U.S. deficit with China continues to be a major concern.

Global FDI, which continues to pour into China, also is raising eyebrows. In fact, in 2003, China attracted more FDI than the United States, according to The PRS Group, Inc., a publisher of political, economic, and financial risk ratings for 140 countries, based in East Syracuse, New York. And due to China’s new WTO-mandated reforms and trade liberalization measures, more FDI is anticipated to flow into China’s manufacturing industry, the sector which already receives the majority of capital. This may be at the expense of Asian developing countries, and perhaps Mexico and Central America. Another concern is that an increasing share of this investment is flowing into higher value-added sectors such as semiconductors.

A growing number of foreign component suppliers also are establishing facilities in China—a precursor to the emergence of an FDI-led integrated supply base. A strong domestic supply chain, something Mexico, for example, has not been able to establish, is another important factor helping to position China as an increasingly attractive destination for manufacturing FDI. Additional factors, including lower costs for labor, energy, water and taxes, as well as subsidized inputs, have led to a shifting of sourcing from Mexico to China for apparel, electronic products and telephone equipment, according to Ralph Watkins, U.S. International Trade Commission’s Program Manager for Production Sharing. As the demand for these products increases, more investment in Chinese plants and equipment is almost certain.

With the opening of China’s markets, U.S., European and other companies plan to export more goods to China in coming years. As this occurs, even more FDI is expected to flow into China for the purpose of establishing sales and service facilities. In turn, these companies likely will source more of their goods from within China.

Is China satisfying its WTO commitments? The opinions are mixed. China’s implementation efforts have been impressive, but its compliance has been uneven and incomplete. A sensitive issue that has received a great deal of attention is the Chinese piracy of U.S. intellectual property. In turn, the Bush administration has indicated that intellectual property protection is a top priority, among many others, and has called on the Chinese government to take specific measures to improve a situation that many believe is costing U.S. companies tens of billions of dollars each year. On July 22, 2005, the Bush administration also created a senior position to help combat intellectual property violations. The Office of the Coordinator for International Intellectual Property Enforcement will be located at the Department of Commerce.

Another very sensitive issue involves China’s practice of not allowing its currency (the yuan, also known as the renminbi), to float freely. For more than a decade, China pegged the yuan to the U.S. dollar. This provided financial stability, helping China to weather the Asian financial crisis in 1997 and 1998. However, on July 21, 2005 the Chinese government announced a change in its exchange rate regime from the fixed peg close to 8.28 per U.S. dollar to a managed float based on a basket of currencies. Upon this news, Donald Johnston, Secretary-General of the Organisation for Economic Co-operation and Development (OECD), a forum composed of 30 market democracies, said the measure is “in line with China’s determined efforts to build a market-based economy.” Although this represents only a modest adjustment, China is moving in the right direction. But the question begs, is it enough for now?

For quite some time, U.S. Congressional sources have declared the yuan to be considerably undervalued, which in turn, makes Chinese exports more attractive worldwide. In response, some U.S. politicians and various organizations have suggested that China should allow the yuan to float freely, assuming it will rise to a higher level. On the other hand, some economists believe that if this were to occur, the currency may become volatile due to China’s fragile financial sector, instability associated with the country’s transition to a market economy and difficult economic adjustments associated with WTO-mandated reforms. In turn, a widely fluctuating yuan could have a destabilizing effect and fall well below current levels, leading to a financial crisis.

Nevertheless, a revaluation of the yuan is likely to have little impact on the U.S. trade deficit. Why? If the yuan were to rise in value, U.S. companies would continue to seek low cost imports from other developing countries. In his June 23, 2005 testimony before the U.S. Senate Committee on Finance, Chairman Greenspan said, “An increase in the exchange rate of the renminbi, relative to the dollar, would likely redirect trade within Asia, reversing to some extent the patterns that have emerged during the past half century. However, a revaluation of the renminbi would have limited consequences for overall U.S. imports, as well as for U.S. exports that compete with Chinese products for third markets.” On the other hand, according to the Deloitte Research report, China at a Crossroads: Seven Risks of Doing Business, a revaluation would allow other Asian countries to become more comfortable in allowing their currencies to appreciate against the dollar, a move that would ultimately result in an improvement of the U.S. current account balance. How much? Economists suggest it would be minimal. (Interestingly, on July 21, 2005, Malaysia also announced a change to its foreign exchange regime to a managed basket float).

Although the full impact of a floating yuan is uncertain, many analysts agree that pegging the yuan to the dollar also has had negative consequences for China. In a May 2005 report to Congress, prior to China’s announcement of the new managed float based on a basket of currencies, the U.S. Treasury Department said the yuan’s peg “blocks the transmission of critical price signals, impedes needed adjustment of international imbalances, attracts speculative capital flows and is a large and increasing risk to the Chinese economy.” It also is widely agreed that the pegging policy has hurt low-cost global producers who compete with China for global marketshare.

The yuan-dollar pegging policy originally began when the dollar was strong and China was considered an economy in need of development aid. Now that China has become a stronger international player, especially in the manufacturing sector, and one that is seeking higher technologies, China’s new currency policy is welcome—with the hope that China allows for greater currency flexibility in the near future.

The most important issue, which perhaps is at the core of all concerns, revolves around China’s growing economic might. From 1980 through 1990, China’s GDP growth averaged 10.1 percent annually. From 1990 through 1999, it increased to 10.7 percent, among the highest in the world. And Chinese growth continues to be exceptional. As of 2004, China’s GDP was 14 percent of that of the United States and 4 percent of the world’s. But this is changing quickly. A Goldman Sachs report predicts China’s economy could exceed the United States’ by 2039.

Already the world leading supplier of labor-intensive sewn products, in 2003 China supplied 75 percent of U.S. imports of toys, dolls, games, sporting goods and bicycles; 68 percent of footwear and luggage; 63 percent of lamps; 42 percent of furniture; 41 percent of consumer electronics other than TVs; 35 percent of household appliances; and 29 percent of computer hardware, according to Watkins.

The World’s Factory: China Enters the 21st Century, a 2004 Deloitte Research report, indicated that China produced more than 50 percent of the world’s cameras, 30 percent of air conditioners and televisions, 25 percent of washing machines, and almost 20 percent of refrigerators.

Importantly, the January 1, 2005 elimination of world quotas on textiles and apparel will result in a greater shift of apparel and textile production away from numerous existing world suppliers to China. Why? The WTO estimates that the U.S. quota on Chinese imports of apparel had the equivalent effect of a 34 percent tax on Chinese imports, much higher than other suppliers, according to the Deloitte Research report China at Crossroads: Seven Risks of Doing Business. By eliminating this tax (assuming no change in barriers or currency valuation occurs), China’s share of U.S. apparel imports is anticipated to jump from 16 percent to 50 percent. In turn, China’s share of the U.S. apparel market is projected to rise from 5.4 percent to 22.5 percent. The report further notes that India’s share of this import market also is expected to rise dramatically, from 4 percent to 15 percent. Consequently, many other countries are predicted to experience a large drop in share of apparel exports to the United States, including Mexico, Bangladesh and the Philippines.

A 2005 Deloitte Research survey of 226 U.S.-based manufacturing multinationals with combined revenues of $500 billion revealed that over the next two years 55.7 percent of respondents plan to enter or expand marketing/sales operations in China, 57.1 percent plan to source goods there, 38.4 percent plan to conduct some manufacturing there, and 25.6 percent plan to conduct some engineering/R&D activity in China. It is expected that China will continue to move up the value chain, with higher technology products becoming an increasing share of its output and exports. How high up is unknown. However, investors indicate they continue to resist transferring their highest value-added operations to China.

Growing the Global Corporation: Global Investment Trends of U.S. Manufacturers, another Deloitte report, indicates that U.S. manufacturing FDI in developing countries, including China, was 32 percent in 1999, 25 percent in 2000, 22 percent in 2001, 7 percent in 2002 and 15 percent in 2003. Although currently relatively small, over time U.S. manufacturing FDI in China is expected to rise. As this occurs, China will become the world’s manufacturer for a large variety of goods. In the short-term, the primary objective of Chinese producers will be to make goods less expensively for global markets; in the longer-term, the main objective will be to supply the domestic market. Thus, as Chinese internal development continues to push westward across the country, domestic demand will skyrocket transforming China into one of the world’s biggest markets. Consequently, some analysts predict that much of Chinese production currently being exported will be consumed domestically. In turn, smaller developing countries will be delighted to pick up the export slack and satisfy global demand.

Although China’s political challenges are massive, its 1.3 billion consumers will continue to provide U.S. exporters and investors with tremendous opportunities. In terms of production sharing (the allocation of different stages of the manufacturing process to different countries), Chinese companies will increasingly team with U.S. manufacturers to produce more globally attractive products. Although this strategy is likely to continue to lead to lower-tech manufacturing jobs losses, it is anticipated to grow more jobs in capital-intensive manufacturing, product development, design, and marketing-related activities in the U.S. And according to the U.S. International Trade Commission, production sharing is responsible for generating new jobs and retaining those that would be lost due to intense foreign competition.

Overall, China is presenting new opportunities, as well as new risks. To remain competitive with China and the rest of the world, the American educational system must increasingly graduate skilled students who can compete in this new environment. According to the report, Keeping America Competitive: How a Talent Shortage Threatens U.S. Manufacturing, published by the National Association of Manufacturers, intense competition from the globalization of the manufacturing marketplace, changing demographics and the relentless advancement of technology have challenged U.S manufacturing. “The result has been a dramatic increase in the sector’s need for highly skilled, technically savvy employees who can fully exploit the productive potential of advanced technologies and support increased quality and product complexity. This need, in turn, has generated a talent shortage—from engineers and R&D professionals to skilled production workers and plant managers.”

About The Author John Manzella [Full Bio]

John Manzella, founder of the Manzella Report, is a world-recognized speaker, author of several books, and an international columnist on global business, trade policy, labor, and the latest economic trends. His valuable insight, analysis and strategic direction have been vital to many of the world's largest corporations, associations and universities preparing for the business, economic and political challenges ahead.




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