China’s,Developing,Open,Economy:,Myths,and,Realities_China and sex

　　Abstract: Both academia and actual economic sectors have certain misunderstandings regarding the development of China’s open economy. Since its accession to the WTO, China has in fact had an open economy and not an “export-oriented” economy. China’s trade imbalance in the global economy is merely a result of economic disparities between the world’s more- and less- developed regions combined with the rational optimization of resources. The current situation, wherein China appears to be heavily export-oriented, stems naturally from the real economy moving towards a dynamic equilibrium against a backdrop of economic globalization and deepening international specialization. We have concluded that domestic consumption and external demand reinforce each other, and the development of an open economy in China is therefore not at odds with expanding domestic consumption.
　　Key words: open economy, export-oriented economy, global economic imbalance, domestic consumption and external demand
　　JEL Classifications: E00, F00
　　The recent global financial crisis had a large impact on China’s opening economy; the crisis triggered a number of controversies within academic circles and the business world about China’s development into an open economy. One common argument maintains that this crisis has exposed the vulnerabilities of China’s export-oriented economy. According to this perspective, China should replace its export-oriented strategy with one reliant on domestic consumption; this would lessen the current global economic imbalance that stems from China’s large trade surplus and the US’ large trade deficit.
　　This view has already made its mark on Chinese policy, with negative results. This debate raises questions about how or whether China should adjust its opening-up strategy and also whether China still stands to benefit from globalization. As these are significant questions, we believe that this issue deserves thorough review, serious thinking and much discussion in order to figure out exactly how China’s development as an open economy should proceed.
　　1. Is China’s Economy “Export-oriented”?
　　The three main drivers of economic growth are investment, consumption and exports. According to statistics, net exports have contributed strongly to China’s GDP growth every year since 1994 (with a few exceptions). Obviously, exports have played a vital role in China’s economic growth. This is why many scholars and experts define China’s economic strategy as “export-oriented” and continue to publish articles and papers on whether or not such a strategy is sustainable. However, we believe the assumption that China’s economy is primarily “export-oriented” needs to be reevaluated. 　　An export-oriented strategy is a trade strategy, generally following a period of import substitution, which calls for incentives and preferential policies to be adopted by developing countries in order to increase the international competitiveness of their finished and semi-finished industrial goods. The intention of this strategy is to accumulate much-needed capital by encouraging exports.
　　In the history of China’s opening-up, certain stages of development have indeed been characterized by import substitution and export-oriented strategies. At the inception of reform and opening-up in the 1980s, both import substitution and export incentivization were main tenets of Chinese trade policy. The fundamental purpose of import substitution is to import advanced foreign technologies and equipment for domestic industrial development. These policies can be observed in China in the large percentage of China’s imports that are either technology or equipment. As for export incentivization, China was initially pushed to encourage exports because of a shortage of foreign exchange reserves. Judging from the actual effects, it was China’s focus on exports and not its import substitution policies that pushed industrial development forward in the early years of opening-up. In China, those industries that have become internationally competitive are those that have been historically less protected by the government, such as the manufacture of televisions, refrigerators and washing machines. Heavily protected industries have failed to develop as well or become as competitive internationally, a typical example being the automobile industry.
　　Since the 1990s and especially after the establishment of a socialist market economic system in 1992, China’s reform and opening-up program has moved at a much faster pace. Given the superior performance of the export sector in the 1990s, China shifted towards an export-oriented industrialization strategy and trade policy, putting a premium on the introduction of foreign capital. Export growth driven by foreign capital became emblematic of China’s opening-up policy in the 1990s. In addition to providing “supernational treatment” to foreign capital, the export-oriented strategy set strict limits on both the scope of foreign investment, which was only allowed in certain industries, and also the proportion of sales allowed in the domestic market. Lured by an abundant labor force, cheap land, sufficiently plentiful natural resources, limited social costs and generous incentives, foreign-funded enterprises entered China on a massive scale. Most foreign investment went to the export sector, fueling the boom of exports and export-related industries. The contribution of net exports to China’s GDP in this era mainly came from the net exports of foreign-funded enterprises. It is fair to say that China’s strategies for foreign capital and trade during this period were indeed export-oriented. 　　As the world went through massive industrial restructuring and relocation during the 1990s, China became a center for global manufacturing and processing by leveraging its labor endowment and creating an attractive investment environment that gave China a specific and much-needed role in the international division of labor. Though Chinese exports’ tremendous growth was driven largely by foreign direct investment, WTO entry then ushered China into a new era entirely. But the game has changed since the 1990s. Now there is neither an external environment conducive to an export-oriented economy, nor does China have any remnant export-oriented policies.
　　In the post-WTO era, China’s proactive and policy-initiated opening-up and economic reform gave way to passive and institutional opening-up; the export-oriented strategy of the past was replaced and ceased to exist. In the pre-WTO era, China was able to decide for itself how, when and to what degree it would open-up; once it entered the WTO, however, it lost much of this autonomy. Now China’s economic opening is driven by policy, through, for example, policy preferences for particular regions, administrative authorization for foreign trade, foreign capital approval and new policies on capital introduction.
　　After its entry to the WTO, China’s economy has become fully integrated into the global economy. As an official member of the WTO, China must abide by WTO rules on international trade that are accepted by all WTO member states. These trade rules include non-discrimination, increased freedom, higher predictability, an environment more conducive to competition, the elimination of tariff and non-tariff barriers, the opening-up of markets under a multilateral framework of free trade, and liberalization of trade policies for the goods, services, investment and finance industries. As a developing country, China is still entitled to a certain degree of preferential and protective treatment for certain domestic industries within the WTO framework, but these rights are highly restricted. In conforming to WTO regulations, China’s opening-up has already shifted from an active to a passive stage.
　　China’s original policy-driven approach to opening-up conflicted with WTO regulations, and therefore China’s experienced a shift from policy-driven to institutional opening-up. Great efforts were made to establish a socialist market economic system, improve the legal system, create a market environment of fair competition for both local and foreign-funded enterprises, and put into place government and corporate operational mechanisms that meet WTO requirements while also being in line with China’s socialist market economic system. With the transition from proactive opening-up to passive and institutional opening-up, the environment that brought about China’s original strategy of export-oriented opening vanished. 　　The justification for an export-oriented policy environment has disappeared as well. The very intention of such a policy was to address the problem of foreign exchange shortages and to promote industrialization, but those goals have already been met. Today, China’s forex reserves already exceeded USD 3.2 trillion. Today, most of China’s exported finished goods are labor-intensive, and some industries actually have excess capacity. The export-oriented policies that were meant to promote industrialization are therefore no longer necessary as their goals have already been met.
　　Since July 21, 2005, China has used a managed floating exchange rate mechanism based on market supply and demand and with reference to a basket of currencies. Over this time period, the Renminbi has appreciated against the US dollar by nearly 30 percent. Since July 1, 2007, China has also adjusted its export tax rebate policies for 2,831 commodities, canceled tax rebates for 553 commodities and reduced tax rebates for 2,268 commodities. All of these steps push China further away from an export-oriented economy.
　　As for the opening of its domestic market, China has decreased import tariffs every year since 2002, meeting its 2010 tariff reduction goals as required by its WTO commitments. Its domestic market is also increasingly open to various sectors, including services. From all of this it should be clear that China’s economy is more open than it is export-oriented, and we hope that academics and stakeholders alike can evolve their understandings of this issue and refrain from falsely labeling China’s economic strategy as somehow “mercantilist”. Such derogative terms can be used to attack China and, more importantly, may cause policy deviations that impede the development of a truly open economy in China.
　　2. What Is the True Nature of the Current Global Disequilibrium?
　　In the developed world, China’s trade surplus is often blamed for causing global economic imbalances. According to some economists in developed economies, the US’ large trade deficit and China’s large trade surplus are the leading causes of the current and pernicious global economic disequilibrium. This deficit/surplus relationship is blamed for most of the Sino-American trade spats and sparring over exchange rate concerns. This argument, though false and biased, has enticed many Chinese scholars. One who supports this theory will typically say that China’s foreign trade imbalance has not only caused a “global economic imbalance” but also resulted in other consequences that harm China’s national interests, such as trade friction and excess liquidity. This “unsustainable” situation, these scholars argue, means that China must reverse its current trade surplus. 　　Ideological disputes aside, one reason for this argument is that the nature of the global economic imbalance is by-and-large misunderstood. Under pressure from the international community, China has worked to balance its trade flows over the years by increasing imports; the effects of these policies, however, are limited. This indicates that conventional international economic theories cannot sufficiently explain the causes and repercussions of foreign trade imbalances. To understand this issue, then, we must look at the new and unique characteristics that have arisen with the advent of the current international division of labor.
　　Since the 1990s, the intra-product division of labor has become increasingly more significant. Intra-product division of labor refers to the division of labor across the different steps of processing, wherein parts and components of one product are produced in different places at separate times. The work of making one product is divided along the value chain of a final product, with work being done separately across the globe. This new set of divisions means that conventional international industrial sourcing gave way to the decomposition and global deployment of industrial chains and production processes. The relocation of entire industrial structures gave way to the relocation of individual value-adding processes, and different countries became responsible for different parts of the value chain. Each step of production and processing provides additional value to the final product, and it is therefore natural for the traditionally-measured trade surplus to pile up and be overstated in countries where intermediate processing activities take place. In this sense, the appearance of a large global economic imbalance is no more than an aberration, an anomaly that results from the imperfect virtual economy. The optimization of global resources leads to this perceived but ultimately misleading imbalance.
　　This is precisely how China’s foreign trade imbalance has ended up appearing so large. Due to the intra-product division of labor and the comparative advantage of an abundant labor force, China has become home to much of the labor-intensive processing and assembly activities that once took place in developed countries. In this way, China has been integrated into the international division of labor, primarily due to the activities of multinational firms, and has developed a surplus of processing trade and a trade surplus for foreign-funded enterprises. 　　Another inevitable result of this global economic transformation is an increase in dependence on exports. With the intra-product division of work, intermediate products have to go through multiple rounds of cross-border transitions before the completion of a final product. In other words, the development of international production networks inevitably brings about the frequent trade of intermediate products and a superficial excess dependence on exports for countries that process these intermediate products. This dependence does not, however, imply that China is exposed to the risks of over-relying on external markets in the conventional sense.
　　The question, then, is why this global economic imbalance has given rise to long-term trade surpluses in developing countries such as China. At a deeper level, this phenomenon is actually a result of economic globalization combined with the economic disparities between the developed and developing countries; one could also think of this division as existing between the Northern and Southern Hemispheres. The economic integration of these two regions of the world has led to greater efficiency and an increase in total world supply. But the achievements of economic globalization have not been shared equally across all regions and economic development levels. Backed by superior political and economic conditions, developed countries have maximized their access to the benefits of trade and investment and even used monopolistic power in certain industries to secure favorable trade conditions. As a result, the dividends of economic globalization are increasingly seized by developed countries. Developing countries, on the other hand, have benefited much less from globalization, even encountering the phenomenon of “poverty-afflicted growth”. Due to increasing gaps between developed and developing countries, demand from the latter is sluggish, and world economic growth has to be driven by consumption in the former. With the world’s total supply exceeding its total demand, a global economic imbalance has emerged. But the nature of this global economic imbalance is actually a problem of uneven development between the developed and the developing countries.
　　Uneven development between these two economic worlds is one outcome of economic globalization that stands in the way of further global economic development. With the rapid adaptation of the intra-product international division of labor enabled by global production networks, every country is responsible for or representative of a specific production process and stage. Therefore, the successful creation of a final product depends on the sustainability of each and every production process in the global value chain. Lower levels of economic development in the developing world have become a bottleneck that impedes economic globalization. Further sustainable growth of the world economy cannot be achieved if developing economies are not able or allowed to narrow the gap between themselves and with developed economies through more rapid growth. Understanding this, the essence of the global economic imbalance, is a prerequisite for approaching and addressing the uneven development of China’s foreign trade. Only by understanding the realities can misguided policies that hinder the development of an open economy in China be avoided. 　　3. Should Chinese Economic Development Be Driven by Domestic Consumption?
　　The upsurge of China’s trade growth and its share of world trade over the past two decades have aroused extensive discussion among academics on the “riddle of China’s trade growth”. Many scholars believe that, as China emerges as one of the world’s largest economies and trading nations, its massive trade growth is bound to disrupt the international market equilibrium and cause intense trade frictions.
　　Meanwhile, the rapid growth of exports in China is increasingly constrained by energy needs, natural resource availability and environmental responsibilities. These issues combine to make export-driven growth in China unsustainable in the long term. During the current global financial crisis in particular, rising protectionism and sluggish demand have presented major problems for China’s open economy. Many scholars believe that this crisis has fully exposed the vulnerabilities of China’s export-driven pattern of economic development, and that such a pattern should be replaced by one fueled by domestic consumption.
　　This question can be divided into two smaller questions. First, does external demand still play an important role in China’s economic development? How much does China still need to rely on demand from outside its own borders? Second, do domestic consumption and external demand run in parallel, or is their relationship one of mutual substitution? First, let us look at the role of external demand in China’s economy. The four drivers of economic growth are consumption, investment, government spending and net exports. The sum of the first three is what we call domestic total demand or domestic consumption, while net exports refers to total exports minus total imports. Here, net exports refer to the external demand that is at the center of this discussion, or the demand for exports within the total demand figure. It refers to the portion of commodities that a country sells to other countries. Other factors held constant, an increase in external demand means an increase in exports and has a positive effect on a country’s economic growth. The same is true for any other country or region at any other point in time. Nevertheless, the significance of exports can vary during different stages of economic development.
　　The US’ experiences suggest that imports and exports are an important means for achieving full industrialization. Between 1870 and 1914, the United States maintained robust growth in exports and imports save for a few years. Its share of finished goods in global trade rose constantly, peaking at 15 percent in 1900 and stabilizing at around 13 percent throughout much of the early 20th century. It is fair to say that the sustained growth of exports has played a pivotal role in industrialization in the U.S. 　　The rapid growth of exports is inevitable in China, a country that has yet to fully industrialize. More importantly, given the evolution of the international division of labor discussed earlier, the implications of exports, or external demand, have been transformed. Under the current, intra-product international division of labor, the significance of exports exceeds the superficial statistical significance of national income identity. Under conventional trade and labor patterns within a given industry, external demand stimulates output and economic growth through multinational transactions. Under the international division of labor, these relationships change, and external demand becomes a vehicle that enables global production.
　　The reason for this shift is that intermediate products need to flow across international borders multiple times before a product is completed. Therefore, relying on external demand is not the result of sluggish domestic consumption but rather an inevitable outcome of a country’s participation in the global division of labor. Negligence of external demand actually means underestimating the importance of a country’s participation in this global system and the access to inputs of production that such a system provides. To wean oneself off of external demand means to forfeit the opportunities presented by economic globalization, which would be a particularly costly decision for a country like China.
　　But stimulating domestic consumption does not somehow run counter to participating in the global division of labor system. Actually, these two development goals can create synergies, with one increasing the potential of the other to stimulate growth. It is imperative for China to focus on domestic demand in order to counteract the short-term impact of the financial crisis and subsequent decline in international demand. This does not mean that China should roll back the progress it has made to build an open economy, nor should China begin to rely exclusively on domestic consumption as its primary engine of growth. There is no denying that some industries can achieve economies of scale and flourish by focusing exclusively on China’s massive domestic market; this fact does not, however, mean that domestic demand and exports are somehow at odds. Both theoretically and practically, the relationship between these two factors is interdependent, even symbiotic, and certainly not contradictory.
　　Its engagement with global markets has done a great deal of good for China beyond the pulling effect of net exports on growth. Even more importantly, the flow of intermediate products and factors across China’s borders has intensified the spillover effect of knowledge and skills, enhanced the correlation between industries in China, strengthened corporate technology, improved efficiency, and expedited technological progress, industrial restructuring and upgrades. 　　By engaging in the current international division of labor model, China has leveraged its particular comparative advantage and enhanced the competencies of its large, low-skilled labor force. With more jobs and higher incomes, domestic consumption picked up as a result of Chinese engagement with this system. The vigorous development of its open economy over the past thirty years has dramatically improved the living standards of Chinese people, and this fact alone is an excellent illustration of how external demand has a positive effect on domestic consumption. Empirical evidence has proven that the development of exports is conducive to economic development through leveraging domestic and international resources and markets. The steady growth of external demand in the post-crisis era is crucial for increasing domestic consumption.
　　Domestic consumption has a positive effect on external demand as well. Scholars of international economics have already conducted research on the importance of domestic consumption to exports and external demand. According to Staffan B. Linder’s preference similarity theory (1961), potential exports are somewhat dependent on domestic demand. To be more precise, one prerequisite condition for a product to be a potential export is that demand for the product as a domestic consumer or investment good (capital good) must first exist. This is often referred to as the “support of domestic market”.
　　There are three factors supporting this theory. First, limited access to information prevents businesspeople from becoming aware of the potential demand for a product if there is no preexisting local consumption. Second, even if investors in a country accurately forecast the potential overseas demand for a product, a lack of familiarity and experience with such a product makes it difficult to manufacture as a marketable good. Third, even if a good is successfully manufactured, physical distance from the market makes it difficult and costly for manufacturers to correctly adjust product quality and specifications in order to achieve commercial success. These reasons help explain why manufacturing activities are first targeted at the domestic market before a product can develop as an exportable good.
　　According to Michael Porter’s theory (1998) on national competitive advantage, domestic demand is vital for export competitiveness. Sophisticated and fastidious domestic buyers can force manufacturers to improve the quality of their products and services. Furthermore, domestic demand can force manufacturers to conduct forward-looking R&D and expand capacity. The growth of domestic demand and the number of independent buyers can also provide manufacturers with diversified decision-making inputs. 　　Domestic consumption and external demand are both indispensable components of a nation’s economy; it is simply inaccurate to define a nation’s economic growth as entirely or primarily driven by one or the other. In today’s globalized world economy, the only option is to develop a synergetic relationship between domestic consumption and external demand in order to achieve strong and sustainable economic growth.
　　4. Concluding Remarks
　　We have concluded that China’s perceived over-reliance on exports and external demand is actually an outcome of the modern international division of labor and the optimal allocation of global resources. This “export-driven” pattern of growth has become prominent in China because of global industrial restructuring and a global value chain that is dominated by multinational firms. But China’s economy is not actually “export-oriented”, and its reliance on exports does not imply excessive external risk as many claim. China’s uneven foreign trade balance derives instead from the global North-South, developed-developing economic disparity. Due to the flow of knowledge and resources across borders and the intra-product division of labor, the very implications of relying on external demand have changed. External demand is significant in China’s current stage of development not only because of job creation but also because of the promotion of technological progress and industrial restructuring. Given all of these considerations, China’s fundamental economic strategy should be to increase its economic openness, leverage domestic and international markets and resources, and embrace all opportunities that arise from economic globalization.
　　References
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　　[2] Ren, Zeping, and Baojun Zhang. 2011. “The Compare of Economic Growth Mode in China: Domestic Demand and Foreign Demand.” Reform (2):14-20.
　　[3] Yao, Yang, and Miaojie Yu. 2009. “Labor, Demography, and the Export-oriented Growth Model in China.” Journal of Financial Research (9): 1-13.
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