The New York Times

Tuesday, November 16, 1999

A Victory for China's Prophets of Change

By SETH FAISON

HANGHAI, China -- Though the immediate effects of China's landmark trade agreement with the United States may be mixed, the deal is a major victory for Prime Minister Zhu Rongji, an advocate of reform who has been under fierce fire from conservative opponents in recent months.

When he came to office in March 1998, Zhu promised to shut down the bulk of China's nonperforming state-run industries within three years. Those efforts, however, have been stymied, first by President Clinton's rejection of Chinese trade concessions last April, then by the wave of nationalism fired by NATO's bombing of the Chinese embassy in Yugoslavia.

Now, Zhu has a new quiver of arrows for his campaign. Once China enters the World Trade Organization, he and other reformers will be able to point to international guidelines when challenged by officials suspicious of openness and market-based competition.

Since the trade deal fell apart in April, Zhu's influence had been in decline as he faced criticism that he tried to give too much away.

Under attack by conservatives led by his predecessor Li Peng, who is now legislative chief, Zhu offered to resign twice last spring, political insiders say. Yet President Jiang Zemin, who political analysts believe uses Zhu as a lightning rod for criticism, has both assumed more control over reform efforts himself and protected Zhu.

Monday's trade deal is expected to breathe new life into the reform process. Overall, several economists said, more open trade will have a broadly beneficial effect on China's economy, even if it causes greater unemployment as a result of factory closings.

Various sectors of China's economy will be affected differently by the agreement. The auto and oil sectors will be forced into a painful restructuring, while apparel and textiles will gain access to exports. But, economists and political analysts say, the overall effect of liberalizing trade will inevitably spur long-term economic growth and benefit reformers.

"Unquestionably, it strengthens the hand of Zhu and other reformers," said Qu Hongbin, an economist at the Bank of China International. "On the macro-level, this is a major plus for China."

While Jiang regards better relations with the United States as one of his major achievements, Zhu is even more closely identified with the pro-American sentiment that favors greater openness -- best characterized by entry into the World Trade Organization.

Since China's leadership decided 13 years ago that it would seek membership in the trade body, the issue has been when and on what terms. With China's economic growth slowing, some conservatives have argued that a wrenching restructuring might better be put off.

Reformers have countered that China badly needs a boost in foreign investment. Membership in the trade organization would also give a palpable boost to China's investment environment, which has soured in recent years as many foreign businessmen grapple with thorny obstacles to making money here.

Yet even with Monday's deal, change is not expected to come overnight. Despite the agreement for the gradual opening of China's capital markets -- banking and insurance, for instance -- many obstacles remain in financial services. A major restraint is the continuing central control on China's currency, the yuan, also known as the renminbi, or "people's money."

The yuan cannot be freely traded for dollars or other international currencies because China's leaders fear their financial system is not yet strong enough to bear sudden, heavy inflows or outflows of currency. For banks, that makes doing business difficult.

"Even if we are allowed to make loans in renminbi, we have first to borrow renminbi from Chinese banks and the spread is too thin to be profitable," said Julia Wang, chief representative for the National Bank of Canada in Shanghai. "Obviously, entering WTO is a step forward, but it is only one step that Chinese banks have to take."

A few years ago, Chinese officials spoke about the possibility of making their currency freely convertible by 2000, but after the Asian financial crisis of 1997 they started saying it would be many more years away.

For foreign investors already in China, its move toward membership in the trade body is seen as a mixed blessing. An executive at General Motors in China said recently that, in his view, an international company's enthusiasm for China's entry could probably be measured in inverse proportion to the size of its investment in China.

The larger the investment, the more negative a foreign business here is likely to feel about greater competition. General Motors has invested more than $2 billion in China, a large chunk of it in an auto-assembly plant in Shanghai that began manufacturing a new version of the Buick for the China market.

Since the auto sells for about $36,000, it will not be competitive once steep import duties are reduced. Monday's agreement calls for the reduction of auto import duties to 25 percent, from 80 percent to 100 percent, by 2006.

Foreign investors with smaller investments to date, however, are more likely to benefit from the gradual opening of trade barriers. So will efficient Chinese companies, which generally favor faster reform and freer trade.

Oil and petrochemical industries may be adversely affected, though they have already been subject to a certain level of international competition. Import tariffs have been so high that a vast business in smuggling oil has blossomed over the past decade.

According to a study by the China International Capital Corp., an investment bank that is a joint venture between the government and Morgan Stanley Dean Witter, on the effects of possible membership in the trade body, four major international suppliers exported 14.9 million tons of light diesel oil to China in 1998. But Chinese customs only recorded 6.7 million tons legally entering the country.

"Ironically, widespread smuggling has also helped domestic firms to prepare for the realities of WTO membership," wrote Shawn X. Xu in the report. "In order to evade import tariffs and value-added tax, smugglers have been importing large amounts of foreign goods through illegal channels and selling them substantially below market prices."

Another part of the economy that is likely to be heavily affected by trade organization membership is agriculture. By phasing out import quotas and licenses and reducing import tariffs slightly, compliance with the trade body's regulations will dramatically open China's market to agricultural imports. Xu estimates that agricultural imports will double in a few years.

A large unanswered question is how well China's government would be able to carry out the trade body's requirements.

"Of course, the government could rely solely on administrative means to push reforms through," wrote Xu. "However, absent a credible backup or threat, the stick might not be as effective as a carrot, for people do not believe in the government's ability to enforce its policies."