STATEMENT TO THE HOUSE COMMITTEE ON WAYS AND MEANS

Hearings on Accession of China and Taiwan to the World Trade Organization

By Nicholas R. Lardy Senior Fellow, Foreign Policy Studies The Brookings Institution, Washington, D.C.

September 19, 1996

It is very much in the long term interest of the United States, as well as important to the world trading system, that China soon become a member of the World Trade Organization (WTO). China, already the 10th largest producer of export goods, is the largest trading country in the world that is not already subject to the disciplines of the WTO. Indeed, never before in the history of the WTO or its predecessor, the General Agreement on Tariffs and Trade (GATT), has such an important trading country not been a member of the principal international body governing relations among trading nations.

There are at least two reasons China's membership in the WTO would serve US interests. First, the protocol governing China's accession to the WTO would not only provide for an elimination of non-tariff trade barriers and a very substantial reduction in tariffs but would also delineate the further systemic economic reforms to bring China into compliance with WTO standards. Some have described such a protocol as bringing China into the world trading system on a "commercially viable basis." Most importantly, the protocol would require that such steps be taken on a time specific schedule. China has reduced tariff and nontariff barriers significantly in recent years, but the timing of these steps has been entirely at China's discretion.

Second, bringing China into the WTO will provide a way for the United States to address inevitable trade frictions with China on a more multilateral rather than purely a bilateral basis. Recent history suggests that multilateral negotiations within an agreed international framework provide a structure that is more productive than bilateral negotiations followed by unilateral pressures and sanctions. The new dispute resolution procedures of the WTO, to which the United States contributed so much, are particularly important in this regard.

While such a protocol is in our interest, the history of negotiations over the past ten years shows that an agreement can not be achieved simply by offering China membership in the WTO. The process of China becoming a member of the WTO is already the most extended on record. China first formally indicated its desire to become a contracting part of the General Agreement on Tariffs and Trade (GATT), the predecessor to the WTO, in July 1986. Seven months later it submitted a memorandum describing its foreign trade regime, a key step in the accession process. A GATT Working Party was appointed in June 1987 and the first meeting of the Working Party took place in February 1988. Since that time the Working Party has met formally almost two dozen times, and China also has conducted extensive bilateral negotiations on the WTO with its main trading partners. Thus the accession process started more than a decade ago and formal talks on China's accession to the GATT/WTO have been going on for nine years.

Negotiations for China's accession have been of record length for two closely interrelated reasons. First, as a transition economy there are some features of its trading system that are not compatible with the GATT/WTO system, which was created to facilitate trade among market economies. Although China has transformed dramatically many aspects of its domestic economic system, this transformation has been protracted. China has found it particularly difficult to dismantle the barriers that continue to protect significant portions of a state-owned industrial sector that grew up during a period of relative autarky, when international cost competitiveness was irrelevant. On the other hand, the United States, Europe, and Japan insist that China dismantle these barriers as a precondition for membership in WTO.

The second reason for China's protracted entry into the WTO is that the benefits China would attain through WTO membership are relatively modest. China's size and geopolitical influence are both sufficiently large that the single most important economic benefit associated with membership in the WTO--permanent most-favored-nation (MFN) trading status in the markets of member countries--was bestowed by all countries, except the United States, in advance of even any indication on China's part that it was interested in participating in the GATT system. And the United States has provided MFN status for China on a year-by year basis for more than fifteen years. With the principal benefit of membership already in hand, what is the incentive for China to incur the considerable costs of domestic restructuring and adjustment that would inevitably accompany the dismantling of their remaining import barriers? In short, the costs of conforming to expectations of the West on openness to trade are relatively high for China while the gains from membership in the GATT/WTO are relatively small.

What is the solution to this apparent standoff, reflected in the lack of progress achieved in the most recent meetings of the Working Party? The central issue is not whether China becomes a member of the WTO on "commercially viable terms" but rather the length of time that China is given for meeting such terms. Some have argued that China must meet such terms as a precondition for membership. I believe that approach will result in China remaining outside the WTO indefinitely.

The appropriate analogy is buying a house. We want China to buy the "house," i.e. to come into compliance with the expectations of the established international trading system. We should not lower the price of the house, i.e. allow China to be a member on concessionary terms. In particular the international community should not agree to China joining the WTO as a "developing country," a status that automatically would provide it with the longest possible time periods for coming into compliance with some standards and would exempt China entirely from a few standards. What we should do is lower the down payment on the house to a level that is politically affordable to China. That means coming into compliance with many but not all WTO standards as a precondition for membership. And it means a "mortgage" of sufficient duration to allow China to come into compliance with those criteria that it is unable to meet at the outset.

Specifically, China should be allowed in a few cases relatively long phase-in periods for the dismantling the barriers protecting it's most sensitive industries. Long phase-in periods for some sectors would allow China to spread the very substantial costs of adjusting to international competition over a longer period of time, thus making them politically more manageable. The international community however, should insist on more rapid reduction of trade barriers in less sensitive sectors and immediate reforms with respect to transparency, trading rights, and other systemic features of China's trading system. The latter reforms would be of considerable immediate benefit to firms that seek to trade with or invest in China. In short, the down payment should be reduced but it should still be substantial.

The main criticism of this approach is that it runs the risk that once China is a member it may not fulfill its obligations under the protocol and would in effect be given a free ride. This perspective overlooks three elements. First, the US government will still have available all of the tools provided for in US trade law. The US government will still be able to investigate Chinese trade practices under the provisions of Section 301 of the US Trade Act and impose sanctions, if warranted. Disagreements over intellectual property rights can also be addressed unilaterally, if conditions warrant. In addition, surges in exports of Chinese goods to the United States that either cause or threaten to cause serious injury to the US industry can be addressed under the Agreement on Safeguards of the Uruguay Round Treaty. That agreement allows countries to impose quantitative restrictions on imports under certain conditions.

Second, the protocol governing Chinese accession can be written to embody very tight reviews of the progress China makes over time in coming into full compliance with the time specific commitments set forth in the protocol. These periodic reviews could be conducted under the provisions of the Trade Policy Review Mechanism set forth in the Final Act of the Uruguay Round, supplemented or modified as specified in the protocol in order to provide more assurance of compliance.

Third, China's record in its participation in international organizations provides some basis for confidence that China would meet the obligations specified in any protocol it signed. One example is China's relationship with the International Monetary Fund (IMF). When China joined the IMF in 1980 its foreign exchange system was extremely distorted. The value of the domestic currency was highly overvalued and China was nowhere close to meeting its obligations under Title VIII of the IMF Charter, which limits the ability of members to "impose restrictions on the making of payments and transfers for current international transactions."

Over the next 15 years China undertook a series of important reforms of its foreign exchange system. These steps included several major devaluations, the introduction of a secondary swap market for some types of foreign exchange transactions, increased access to foreign exchange for Chinese with approval to travel abroad, the unification of the foreign exchange market at the beginning of 1994, and the introduction of convertibility for trade transactions (also at the beginning of 1994). The culmination of this process was earlier this year when China announced that by allowing foreign firms access to the interbank market to purchase foreign exchange for in order to be able to remit profits, it would achieve convertibility on all current account transactions. At almost every step the role of the IMF in providing guidance and advice was critical. This example suggests that China has established a credible record in meeting the obligations inherent in membership in major international economic organizations.

In addition to allowing China longer phase in periods to meet WTO standards, the United States should take the lead in insuring that the economic benefits that China would receive from membership in the World Trade Organization are at least somewhat proportional to the very real costs that still will be associated with coming into compliance with WTO standards over time. Two possibilities seem most obvious. The first would be for the United States to provide China, upon its entry into the WTO, with the benefits of the phase-out of the Multifiber Agreement (MFA) specified in the Uruguay Round Trade Agreement. Assuming that the United States will invoke Article XIII (Non-Application of Multilateral Trade Agreements between Particular Members) of the WTO, unless there is a separate provision to that effect, China will not be eligible for the phase out of the MFA in the US market.

Second, the United States should pledge to repeal, at a specific point in the future, the Jackson-Vanik Amendment, as it applies to China, so that Chinese goods would be eligible for most-favored-nation treatment in the US market. This repeal should be made conditional on China's living up to the specific provisions agreed to in the protocol governing its membership in the WTO.

In summary China's membership in the WTO would serve US interests. But China's trading partners have already conveyed the principal benefit associated with WTO membership and the domestic economic costs to China of coming into compliance with international trade standards will be high. Given this unfavorable benefit to cost ratio, China is not likely to agree to membership under a formula that requires them to meet all international trade standards as precondition. Thus the United States should take the lead both in drafting a protocol that provides long phase-in periods to mitigate the costs China will face in restructuring its domestic industries to meet the full force of international competition and in taking other steps that would increase the benefits China would receive in exchange for agreeing to an acceptable WTO protocol.


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