China’s Reliance on The World Market – Economics Essay
China at this moment is experiencing the transition of its grain trade policy from a policy of self-sufficiency to that of somewhat greater reliance on the world market. On June 1 this year, Premier Wen Jiabao announces that China has listed liberalization of grain
trading and pricing and offering subsidies to grain growers as among China’s priority tasks for reforming its grain distributing system. (1) Earlier this year, it is reported that China’s grain output falls for five years in a row to 431 million tons last year from a record high of 512 million tons in 1998 while its farmland is also down 7 percent from 1998 to about 100 million hectares. (2) To encourage production, China for the first time in its history directly subsidizes its rural grain farmers: about 1.2 billion US dollars from its grain risk fund is used to directly subsidize individual rural households. Such subsidy is just one policy in the package of massive supporting measures, which also includes setting minimum grain purchasing prices, strictly protecting farmland and lowering agricultural tax. Such measures affect hundreds of millions of grain farmers in 13 provinces, accounting for 69 percent of China’s grain production. (3) Also China begins to liberalize its strictly-controlled and inefficient grain system to break state-owned enterprises’ long-held monopoly over the grain market. Private grain companies now can buy grain directly from farmers and resell or process them, which was unimaginable years ago when the central government held a complete monopoly over the grain market. (4) This paper will look into why China, as a WTO member now, goes for such dramatic policy change, examine the policy tools that China adopts most recently in the progressive liberalization of its grain trade and how they will impact the local and international communities.
Agricultural resources put China at a disadvantage in producing grain from a comparative economic advantage standpoint. (5) The per capita arable land and water resource levels in China are much lower than world averages (6), and the demand on the land for other crops, particularly for vegetables and fruits, is great. (7) So, even though technologically China is able to feed its people, the self-sufficiency grain policy is irrational from an economic standpoint. Despite the relative success of government controls, with domestic grain costs increasing and domestic grain prices surpassing those of the world market as early as in 1994, Chinese scholars began to question the rationality of the self-sufficiency policy. (8)
Moreover, self-sufficiency carries a heavy social cost. It is possible to make simple estimates on the social cost of grain self-sufficiency. According to Long (9), a net loss of social welfare USD 6.59 billion in the year 2020 will occur—assuming that the demand for grain has no price elasticity and there is no price margin. If there is a price margin of, say, 20%, the net loss of social welfare will go further up to USD 13.52 billion.
In Mid-1998, China instituted a price support program for grain. (10) The price support policy had two prices—a higher protection price for quota grain and a lower reservation price for any amount of grain that a farmer may have wished to sell. The state grain bureaus that purchased the grain were required to sell the grain to the marketing system at a price that covered their costs as well. The intention was that the price support policy would have no budgetary cost and that consumers would pay the full cost incurred in bringing grain to the retail shop. Of course, there should be no objection to that since urban consumers have far higher incomes than the grain producers, and there is no reason why their consumption of grain should be subsidized. But neither is there any reason why consumers should pay more for their grain than if they were served by an efficient marketing system. (11)
If the policy functioned as planned, consumers would pay higher prices than necessary. To permit the grain bureaus and subsequent grain handlers to cover their costs, private traders were prohibited from buying directly from farmers. The reason for this action can only be that the private sector can move grain from the farmer to the consumer at significantly lower cost than the state enterprises that, once again, were given a monopoly in the marketing of grain. If this were not the case, there would have been no reason to give the grain bureaus the monopsony in purchases from farmers. If the grain bureaus promptly paid the farmers the specified prices and accepted all the grain farmers offered, as the policy said they should, private traders would have had to pay same prices as the grain bureau paid for grain in excess of the quota. (12)
In fact, government losses in the purchase and sale of grain went up sharply since the program implemented. In 1995-1996 (April to March), the cost to the government was 19.7 billion renminbi (RMB); in 1996-1997, 40 billion RMB; and in 1997-1998, in excess of 100 billion RMB. (13) The losses in 1997-1998 exceeded the total expenditure urban consumers made in purchasing grain in 1997. According to the urban household survey, the per capita expenditure on grain by urban household survey, the per capita expenditure on grain by urban consumers was 238 RMB (14). With an urban population of 370 million (15), a total expenditure of 100 billion RMB would equal a per capita cost for the urban population of 270 RMB, or somewhat more than the average expenditure on grain 1997.
While realizing the heavy costs of self-sufficiency and the apparent benefit of grain liberalization, Chinese leaders worry about a number of factors that inhibits China’s movement toward greater reliance on grain imports: food security, farmer unemployment, long-term foreign payment ability, as well as economic efficiency. Since the international community has significant influence over these factors, analysis of China’s grain policy suggests how the international community can promote China’s full engagement in the international trading system following is accession to the WTO.
China has a long history of farmer rebellions, most of them were triggered by famine; the disastrous famine of the early 1960’s left an indelible imprint on China’s psyche. (16) The lowest requirements for the food safety are that nobody, particularly the poverty-stricken population, starves to death due to the short supply of grains and that the grains issue can not influence the social stabilization. Chinese leaders doubt whether China’s food security can be ensured by relying on the world market, especially records show that the main grain exporting countries have poor policy records, and specifically in times of domestic crises, they may transfer internal shocks to importing countries. Also, since China is a country of vast population, Chinese leaders are concerned that a grain embargo will be used by main exporters as a political weapon against China.(17) It is not until China’s accession to WTO that they finally gradually let go such uncertainties.
The general commitments inherent in WTO membership include unconditional most-favored-nation treatment required by Article I of GATT—that member will not discriminate between members. Another basic condition is national treatment required by Article III of GATT—that imports can not be discriminated against other than through border priced-based measure such as tariffs. (18) Under this commitments and condition China can seek tighter disciplines on the use of export restrictions by food exporters to ensure the security of supply. The risk of grain embargos is greatly reduced. And China can increase the extent it relies on world markets as its source of grain. Increasing the security of supply would also be in the in the interest of the exporting countries, which face demands greatly diminished by China’s lack of confidence in the security of supply.
Even when members of main grain exporting countries do not honor the WTO agreement and decide to use embargo against China, any grain embargoes have only short-term effects due to the high elasticity of grain supply. Supplier countries that do not participate in an embargo can easily increase their production to provide China with grain over time.
Moreover, with an apparently high ratio of grain stock to grain consumption, China is definitely safe from famine in case grain embargo is used against it. (19) The volume of grain stocks is an important index used to measure whether a country is safe or not in terms of grains. In general, the proportion of carry-over stocks of grains at the end of a grains year in the estimated total consumption of grains during the next year will be taken as the grains stocks safety coefficient. The UN Food and Agriculture Organization holds that the lowest scope for a country’s grains stocks safety coefficient is 17~18 percent. If the coefficient is smaller than that, in combination with the analysis on other factors, it can be regarded that this country is not safe in terms of grains. (20) For China, even when grain prices fluctuate in a large range, the safety coefficient of the grains stocks is still higher than 18 percent, the lowest value for the country’s grain stocks safety coefficient. (21)
Underemployment and unemployment has always been a problem in China’s rural area. Whether grain liberalization will aggravate unemployment has been a subject of controversy. Those who advocate for liberalization argue that Chinese grain farmers can adapt themselves to more grain imports by converting agricultural activities to higher value-added and labor-intensive production as in Japan, South Korea and Taiwan. (22) As high value-added crops are more labor-intensive than grain, such a transition will provide a solution to the unemployment problem. Some also suggest the superabundance of rural labor can be dealt with by transferring most of them to non-agricultural sectors especially to the service sector. Such arguments are valid only when there are enough markets for higher value-added and labor intensive goods. However, China faces barriers in its exporting markets, and the extent of the barriers can be better understood by examining the duty burden that China faces in the export markets. It is clear that China faces some substantial tariff barriers and high tariff rates on its high value-added and labor-intensive agricultural products such as vegetables, fruits and fish products. The average tariff rate faced by China on its agricultural product exports is four times as high as the average tariff faced on its exports of other products. (23)
The absence of reliable assurance of food security has been precluding China from opening up to the world grain market. To provide reassurance to China and boost Chinese confidence in the world grain market, greater market access from the international community therefore must be provided for China’s labor-intensive agricultural goods as well as other labor-intensive goods such as textiles.
Skeptics of China’s grain liberalization also question China will be able to afford to import a large amount of grain. Since 1999 China has more than USD 140 billion in its foreign exchange reserve, the second highest in the world. (24) However, it is not clear if, in the long run, China will be able to sustain surpluses in its exchange reserve.
There are several reasons behind such a pessimistic forecast. First, the rapid growth of China’s export is mainly attributable to “Processing trade”, in which countries import inputs and re-export processed goods. Between 1980 and 1997, normal exports did not increase as much as the average GDP growth. (25) The exports of “processing trade are mainly labor-intensive goods with value-added ratio of 10-15 %. (26) Because China has not realized processing trade industries are in fact “rootless industries”: The plants that produces goods for processing exports move to other countries due to the increase in the labor cost in China, as what had happened in Japan and East Asian Dragons. Unlike its predecessors, however, China will have difficulty in adopting the model of exporting higher value added intermediate inputs. Second, the long-term prospect of China’s capital account balance is ambiguous. As a result of its open-door policy, China has been the second largest foreign direct investment (FDI) host since 1993. (27) Although decreasing profitability may prevent FDI from rising in the future, foreign investment in service sectors, such as telecommunication, banking and insurance, will rise if China lifts its restrictions on foreign investments. At the same time, the tremendous expansion of outward investment and illegal capital outflow explains why China’s foreign exchange reserve increased only slightly despite years of huge surplus.
Given China’s unpromising outlook for its exchange reserve, some policy makers are pessimistic about China’s long-term balance of payment, although they tend to have confidence in China’s short-term balance of payment surplus. However, according to Long (28), such a view is not warrant as the expenditure in grain imports is predicted to be at most accounting for 2.5% of the exports by 2020. So there has to be other reasons other than balance of payment that make Chinese still uncertain about their ability to pay for grain imports. As China is on its path of rapid industrialization, imports of machinery and transportation equipment, raw materials, and high value services will inevitably increase rapidly with continued economic growth. Grain imports will have some crowding-out effects on other imports if foreign is a scarce resource and the opportunity cost of grain imports will be higher than nominal cost. (29) Still, even if China faces difficulties in keeping its balance of payment, the Chinese currency can depreciate and lower domestic grain prices, reducing or halting grain imports at any time it
The shift in the use of procurement prices as a means of taxing agriculture to a means of providing support suggests that policy transformation is well under way in China in light of food consumption change. China realizes the fact that over the past several decades the grain consumption structure has been changing: First, per capita grain consumption has been falling slowly since the early 1990s, offsetting some of the effects of population growth; second, the urban households consume much less grain than rural households. (30) Nevertheless, due to the expanding consumption in feed grains, seed and industrial input, research results suggest that the total grain demand will be growing at an average rate of 1.2 % between 1996 and 2020 and 1.1 % between 1996and 2030. (31) In order to be accurate, the above forecasts of grain demand take numerous factors into consideration, such as the urbanization rate, the consumption trends in the past 10 to 15 years and food consumption habits of neighboring countries in East Asia, etc. All of these factors indicate that per capita grain demand will only grow slowly (1.2 % and 1.1%) even if the Chinese economy further develops. (32)
However, policies to increase prices received by farmers, like price support, even when successful, have limited effect on the returns to labor and capital engaged in agriculture. (33) Chinese officials did not learn from the similar serious and expensive agricultural policy errors made by the United States and the European Community until recently. (34) Rather than wasting money through high storage costs and payment to government employees, they realize that giving grain farmers direct subsidy and lowering agricultural tax do increase the income of farm people much more—even though the government still applies price support, i.e., setting minimum purchasing prices. Such measures are implemented because increasing rural incomes is one of China’s prioritized commitments.
While incomes have grown and poverty in rural China has been reduced substantially over the last 20 years, the income gap between rural and urban China has widened. (35) This has contributed to social tensions in rural areas and has become one of the major concerns for the government. While agriculture contributes almost one half to rural incomes, agricultural policy measures alone will have a very limited impact on rural incomes if they are not integrated with a wide range of other policies. In particular, the policy agenda has to include labor market reform to soften labor migration restrictions; education reform to provide the rural population with sufficient skills to compete on labor markets; fiscal policy reform combined with local administration reform to diminish the government-imposed burdens on rural households; and social policy reform to reduce the gap in access to social benefits between the rural and urban populations.
China’s comprehensive reforms over the last 20 years have transformed its trade regime along with the economy as a whole. The reforms of the domestic economy have greatly increased the importance of market, rather than planning, in the allocation of resources. In fact, China has agreed to phase out restrictions on trading rights for most products. However, a small percentage of imports remains covered by the traditional monopoly trading system. Grain is a case in point. While such a system is allowed under GATT rules, there appears to be a strong case for, at minimum, reforming its operating procedures. It is because this system appears to involve the worst of both worlds—the poor information flows typical of command planning systems and the exploitation of market participants typically associated with poorly regulated markets.
China realizes the importance of coordinating its domestic circulation system with the foreign trade system. Despite China’s commitment to distributing grain import quotas to private enterprises, the monopoly trading system will not allow it. Implemented in 1998, China’s domestic grain circulation system ensures the monopoly of the grain bureau by permitting no state-owned or private enterprises except the state grain bureau to purchase grain directly from farmers. If other enterprises can directly buy cheaper grain from the world market and sell at prices lower, the monopoly of the grain bureau will break down. Granting import quotas, thus, is not viable under the monopoly system to achieve the goal. For a broader distribution of import quotas, a reform of domestic circulation system is essential. That’s why, as mentioned in the first paragraph, China has started to progressively expand the scope of quota distribution to include private enterprises. Such a new move signifies an irreversible market reform of the country’s grain industry.
As a member of the WTO, China controls over grain by the application of tariff rate quota. In accordance with China’s promise on its entry into the WTO, during the transitional period, the tariff-rate quota for imported grains in 2004 will be no more than 22.15 billion kilograms; it is anticipated that the dependence on foreign trade will be 4.4 percent at most. During several years in the future, the annually average dependence on foreign trade in terms of grains will be 5 percent. (36) As the ratio of grain imports to total demand will expand to 10% or more by 2020, the amount of China’s grain import requirement will be about 60 million tons or more, significantly lower than 200 million tons suggested in the free trade scenario. (37) So with partial reliance, domestic grain prices would be higher than those of the world market, but lower than what would be if it adopted free grain trade.
Although main grain exporters may prefer China to adopt grain trade policy than anything else, it is least likely to take effect. First, agricultural goods are far from being freely traded in the world. Even the United States, the largest exporter of agricultural goods, has a substantial level of government intervention when it comes to agriculture— not to mention Canada. In this international framework, China can hardly go so far as to liberalize grain trade as a developing country. Second, free trade in grain does not constitute China’s national interest. China will not only exposed to the possible shock of price fluctuations in the world market, but also face the risk of serious rural unemployment, even in the absence of man-made attacks such as grain embargos. Third, other grain importers might not want China to adopt a free trade policy: The importing countries may object to the international pressure to open up their agricultural markets.
Therefore it is understandable why Chinese government on the one hand let go of the old regime and progressively allows market force to take charge of its grain trade; on the other hand, however, it is still heavily involved by exerting powerful policy tools onto the market during the transition from planning-based regulations to free trade.
As the world’s leading importer and exporter of grain, China has influenced the world grain market in many ways even with its long-held policy of grain self-sufficiency. As China now further liberalizes its grain trade, it will provide a larger market for grain exporters. There is no doubt that China, as the largest grain producer and consumer grain in the world, will become more powerful in affecting world food security. The question is how.
China affects world food security through the price volatility it causes in the world market. There are two reasons for price volatility in the world market. First, almost every country, including China, imports to take advantage of the world market to stabilize its own domestic market. Almost no country relies solely on imports. Rather, countries vary the amount of grain imports according to the changes in their domestic grain prices. For this reason, the share of imports in the domestic market relative to domestic production is fairly small in most cases. Second, variations in the amount of imports in individual countries affect the world market prices since the world market is small relative to the total grain production. China swaps different varieties through the world market, and its enormous variations in import volumes usually affect world market prices.
With China changing its trade policy and increasing its grain imports, the variations in China’s imports will be reduced substantially, mitigating the price volatility in the world grain market.
Some researches pay attention to China’s grain imports and its impact on grain prices in the world market. Some researchers were alarmed by the prospect of China’s rising imports and its potential harmful effects on some of the poor grain importers. (38) However influential in policy-making, this view lacks credibility. Variation in China’s imports causes price shocks in the world grain market because suppliers can hardly anticipate the changes and adjust their production in time. If China relies more on grain imports, its import requirement will become more transparent and more predicable. Moreover, as mentioned earlier grain is an elastic commodity, main exporters will be able to expand their production to meet China’s increased import needs. Therefore, in the long-run the price of the world grain market will not soar even with China’s new grain policy.
Besides direct economic benefits, the international community will also gain security benefits from China’s grain trade liberalization. China has been deeply involved in the global economy since the late 1970s as suggested by the amount of foreign trade in China. The twenty-year history of China’s integration into the international economy reveals that China has chosen to play under the current international rules along with the West, rather than to establish a new international framework that would challenge the existing rules. China has been involved with international organizations including the United Nations, the World Bank, the IMF and, eventually, the WTO. With deeper economic integration with the world market, the Chinese have realized the importance of interdependence and cooperation with other countries.
Such a policy change will have important implication for China’s foreign policy. International and regional peace and stability will become a higher priority for China. When dealing with international affairs, China will be more cooperative with main grain exporting countries such as the United States. Consequently, the prospect of international cooperation will have positive consequences to certain extent for international security.
Because grain is an important strategic good, a transition in grain trade policy will have important implications for China’s domestic and foreign policies. Because China is an indispensable player in the world grain market and a rising power in international affairs, China’s policy transition will also have major consequences for the international grain market and world security. Now, as it is liberalizing its grain trade, China requires smooth policy transition to bring a win-win situation to both China and the international community. If done successfully, both China and the international community will benefit from the policy change. Grain importers will gain a stable market for their product, a reduction in budget subsidies on agricultural goods, and a more predictable and reliable partner. China will be able to feed its people with lower costs and strengthen its international competitiveness. The policy transition, however, is dependent not only on China’s domestic circumstances but also on what the international community will do. In the international efforts to promote peaceful transition, the United States, Canada and Australia—the three major grain importers for China—should play a key role.
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