With the development of globalization and the

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1 How Can Developing eloping Countries Benefit from Globalization: With the development of globalization and the emergence of the problems during the course of globalization, the disputes on the benefits of globalization are becoming more and more fierce. The dispute is focused on the question of whether developing countries can benefit from globalization. The Latin American countries that experienced debt crises in the 1980s and the Asian countries experienced financial crises in the late 1990s provided adverse evidence on this matter. The cry to fight globalization becomes stronger and stronger. Against this backdrop, the experiences of China have been used as a successful example to prove the benefits of globalization. It is obvious to all that China has benefited from the globalization. Well then how has China benefited from globalization, and what kinds of experience can China share with all the other developing countries? Generally speaking, the experiences of China can be summarized in the following areas: 1) to match degree of opening up with the development level; 2) to conduct reform in line with the level of opening up; 3) to attach great importance to introducing direct foreign investment. I. The Degree of Opening up Matches the Development Level The infant industry theory of F. List (1841) emphasizes the protection in the course of opening up of an economy. The emphasis on the protection in opening up means the opening up of foreign trade should match the development level of the economy. China s progressive opening up practice follows this principle. The Case of China Fan Gang, Zhang Xiaojing * 1. Opening up step by step The opening up of China is advanced step by step. First, the scale of opening up advances geographically, starting from special economic zones, economic and technological development areas, and coastal economic opening up areas to the opening up of areas along the nation's borders and large rivers and inland provinces to the development of western China for an allround purpose. Secondly, it is advanced gradually in various industries, from the manufacturing industry which has a higher competitive capability to the weak agriculture and service sectors, from the processing industry to primary industrial sectors and then to the infrastructure, financial, insurance and commercial fields. Corresponding to the order of industrial opening up is the opening up of the trade and finance fields. In the 1990s, the proportion of import and export in the country s GDP increased quickly and China has gradually formed an exportoriented economy. At the same time, the opening up in the financial field was slow. In 1996, China realized RMB convertibility under the current account, but so far there is no schedule for RMB s convertibility under capital account. Of course, China's accession to the WTO not only promoted the opening up of trade but finance as well. However, it did not consider the foreign investment in finance and insurance fields (far less than 1%, see table 3). Only until 2002 did China introduce the Qualified Foreign Institutional Investors (QFII) system and only those qualified foreign companies can get access to China s capital market. * Fan Gang, director, National Economic Research Institute, fangang@neri.org.cn; Zhang Xiaojing, associate professor, Institute of Economics, Chinese Academy of Social Sciences. xjzhang@neri.org.cn. China & World Economy Number 6,

2 2. Opening up under protection The opening up of China is under protection. If employing the dropping of the rate of tariffs to evaluate the scale of opening up, we can see that the opening up of trade is promoted gradually. According to the related analysis, with the dropping of the rate of tariffs, the level of protection is decreased step by step (Jin Rongxiang, Lin Chengliang, 1999). The overall tariffs have dropped to 12% in 2002 from 35.9% before These figures show that the opening up of China is under protection and the protection is reduced step by step. There are two factors that need to be pointed out on the trade protection of China: first, the protection is structural, i.e. there are large differences between different industries. For example, in 1994 the tariff of color TV was zero while the tariff for motorcycle was 120% (here not including the nontariff constraint). Secondly, in addition to tariffs, there were nontariff restrictions. The foreign exchange control and exchange rate subsidies are the key means of trade protection. For example, in 1994, the central government imported wheat, fertilizer, food oil and sugar and so on at the exchange rate of RMB5.8 per US dollar, while the fixed exchange rate was RMB8.6 per US dollar at that time. This is the typical exchange rate subsidy. In addition, before the unification of exchange rates in 1994, the home companies were allowed to establish a reserve quota account and keep a certain amount of foreign exchange income. The system was cancelled in January of However, the reserve quotas the companies held could still buy foreign exchange to import goods at the preunification official rate of RMB5.8 per US dollar. If one takes the nontariff measures that derived from foreign exchange control and exchange rate subsidies into account, the tariffs in 1994 actually would be twice as much as what was declared. The tariffs in 1994 were set at 21.74%, and the nontariff measures were up to 21.55% if they were to be converted into tariff rates (Zhang Shuguang, 1997). The trade protection policies are mainly aimed at imports. However, protection could also be imposed on exports. For instance, China employs the policy of tax rebate on exported goods, which is a kind of subsidy to export companies to enhance the competitive strength of domestic ventures. The main beneficiaries of export rebates were manufacturing companies. Generally speaking, in processing trade only those which use domestic raw materials can get export rebates. In the common trade exports, nonforeign trade companies accounted for nearly 80% of this. The status of common trade exports best reflects China's competitive power. While export rebates increased dramatically (the comprehensive export rebate was up to 15%), the competitive power of homemade production and common trade exports increased remarkably. (Fan Gang, 2002). Market access control is another example to reveal the practice of opening up under protection. The order of opening up from trade to finance reveals the aim of protection. As far as the developing stage of a country is concerned, normally the services industry comes after the establishment of manufacturing industry. And the industrial conversion practices of developed countries also observe the same law. Therefore, on the primary stage, by using the comparative advantage of labor, the developing countries can compete with the developed countries in terms of manufacturing, laborintensive manufacturing in particular. The practice of opening up these fields should not bring serious problems. Therefore, China opened up the trade industry first. But the services industry, especially the financial services industry is one of the weakest industries in China. Therefore, it has been opened to the outside world according to the related commitments set forth by the WTO, step by step. During the process of China s opening up, we have learned that protection on a certain level, when matched with a nation's development level, can lead to remarkable achievements. But there are questions which need to be further discussed. For example, the media emphasized that the scale of opening up should match the development level of China but what kind of opening up matches the development level? By whom is it decided? By the market or the government? Furthermore, protection can definitely lead to economic 4 China & World Economy Number 6, 2003

3 distortion. How to reduce the distortion as much as possible and improve overall effectiveness are questions the country must take into account when deciding how to set the protection level. II. Reform in Line with the Level of Opening up In China, opening up and reform always are mentioned in the same breath and never seem to be separated. Then why should we emphasize reform when maintaining an opening up policy? Only by reform can we improve the nation's absorptive capacity and benefit from the practice of opening up. 1. Theory explanation Threshold effect and absorptive capacity: Generally speaking, in order to give full play of opening up, a nation must possess a certain set of conditions, which is the nation's threshold. If a country could not meet the requirements of such a threshold, the function of opening up could not be fully exerted and could even cause problems. Some literature proved the existence of the threshold. For example, the promotion of FDI to growth depends on the level of the human resources of the developing country. If the human capital of a country can rise to a certain threshold, then the function of FDI can be fully exerted; otherwise, the active role of FDI to economic growth will be greatly reduced (Borenzstein, De Gregorio, and Lee, 1998). The threshold effect reflects the importance of absorptive capacity from another angle. We can evaluate the absorptive capacity of a country from facets such as human capital, financial development and management level. Therefore, in order to strengthen the absorptive capacity, reforms are needed. The coordination between opening up and reform: In addition, opening up can lead to a lack of synchronicity among various departments, which in turn can lead to the emergence of bottlenecks. The departments or systems that experienced slow development of reform or nonreformed departments or systems would constrain the development of those departments (e.g. foreign trade department) which have experienced rapid development. If no coordination exists among various systems, then disorder would emerge to reduce the effectiveness and the growth rate of economy (Fan Gang and Wing T. Woo, 2002). Therefore, the practice of opening up must match the institutional reform of other areas to produce better results. 2. The practices of China's reform Reform and opening up are promoted simultaneously and sometimes it is hard to distinguish which reforms are carried through especially for the practices of opening up and which are not. However, we still can learn from the following reform measures that without the matching reform it is inconceivable to promote the opening up and benefit from such moves. Reform of foreign trade administration system The foreign trade administration system reform mainly refers to the reform of the departments involved with opening up. The reforms that have been completed to this end include: breaking of the high monopoly in the foreign trade operation system; cancellation of the mandatory plan of the importing and exporting of goods; RMB's free convertibility under trade accounts; the remarkable reduction of statecontrolled and operated importing and exporting of goods; the remarkable reduction of tariffs; the reduction of importing and exporting quotas. The general principle of the foreign trade administration system reform is to develop an integrated, complete and standard system, which meets the requirements of WTO principles, with economic and legal means at the core and administrative means as secondary. In line with the principle, reforms in the future include: further decreasing the quantity, variety and scale of goods that are under the control of the state; regulate the market order to establish an equal, competitive environment. For example, cracking down on illegal trafficking and perfecting the administration of processing trade; levying taxes on the exported goods first and then providing refunds after China & World Economy Number 6,

4 collection; and enhancing the employment of international conventional means to protect the national industry (e.g. antidumping, the implementation of guarantee measures and so on), establishing a system of tracking, monitoring and feedback (employ a tracking system to replace the examination and approval process). Corporate reforms to improve the micro management The reform of the foreign trade administration system attaches great importance to regulating importing and exporting activities, creating an equal competitive environment, enhancing the motive power of the company to export goods; while the core factors in opening up are foreign trade companies, other home companies with which the foreign trade companies have ties are also considered important. Therefore, a matching corporate reform with the reform of the foreign trade system should come into being. In line with requirements put forward in the 13th National Congress to "promote the practice of the foreign trade companies to take full responsibility for their own profits and losses, liberalizing operations, integrating industry and foreign trade and promoting the employment of the agency system", in 1988, the state popularized the system of contract responsibility in foreign trade companies and carried through pilot projects in three foreign trade fields, namely light industries, processing and the garment industry. Starting from January 1, 1999, the state decided to readjust and reform the exchange rate system to excise dual exchange rate systems, unified foreign exchange retention rate, canceled export subsidies to foreign trade companies and obliged the entire industry of foreign trade to take full responsibility for their own profits and losses. The aforementioned reforms played an important role in areas such as perfecting the foreign trade industry incentive system and the improvement of operational benefits. But it is not viable only with reform in the foreign trade industry. If it is expected to drive the development of other industries, such practices of corporate reform must be aimed at perfecting the incentive system and improving micro management, which should be popularized to all companies. This is what China did. In addition, the corporate reform was not limited to employing the system of taking full responsibility for one's own profits and losses, but has continuously developed into establishing a modern corporate system from establishment of shareholding system by means of grasp the big and let go the small 1, to the recent establishment of the StateOwned Assets Supervision and Administration Commission of the State Council to conduct the ownership reforms. This will further promote stateowned enterprise reform. All of these reforms, from foreign trade enterprises to other ventures, from the manufacturing industry to the financial services sector (e.g. the recently planned shareholding reform for the commercial banks and the planned listing on the Stock Exchange), and the development of private economy seem to have no direct ties with opening up, but in fact they are aimed at improving China's absorptive capacity. Governmental institution reform to improve the macro management capability It is a miniature version of the opening up course of China from foreign trade to domestic trade, from separation to integration, which also reflects how the governmental institution reforms serve the mission of promoting the opening up. The Ministry of Foreign Trade and Economic Cooperation was set up about half a century ago to promote exports. In 2003, this ministry was merged into newly established Ministry of Commerce to integrate foreign trade and domestic trade to meet the requirements of opening up at the new stage since China's WTO accession. In three years after China's accession to the WTO, all domestic and foreign enterprises will be able to enjoy the right to trade automatically and foreign trade is no longer a privilege. The establishment of the Ministry of Commerce brought forth this historic trend. The newly founded Ministry of Commerce integrated the 1 This policy meant focusing on the restructuring the major enterprises and leaving the minor ones to fend for themselves. 6 China & World Economy Number 6, 2003

5 related functions of the former State Economic and Trade Commission, the State Development Planning Commission and the Ministry of Foreign Trade and Economic Cooperation, and are mainly responsible for the policies and regulations of market operation and circulation fields, system reforms, monitoring and analysis, international cooperation, organizing and coordinating the antidumping and countervailing and so on. Here, the governmental institution reform is replying to the call of the new historical stage of the opening up. At this time, the mission to be compatible with international conventions, establish and perfect a unified, open, competitive and orderly modern market system and improve the macro management capability of the government have become the new priorities instead of pure foreign trade many works can be fulfilled independently by the enterprises which have the right to conduct foreign trade. In addition, the establishment of the China Banking Regulatory Commission declared the independence of the regulatory function, which is to improve the macro management capability in the course of further opening up of the banking industry. All the reforms, including the foreign trade reform, enterprise reform and governmental institution reform, have the core objectives to coordinate the reforms and opening up, improve the absorptive capability and give full play to the opening up in promoting the development of national economy. some extent, avoiding the possible financial troubles caused by globalization. 1. FDIs and Portfolios From 1979 to 2002, China received US$ billion in foreign investment where FDIs made up 71.6% (US$ billion); foreign loans and other investments by foreign companies totaled US$ and US$ respectively. Although China has been the biggest receiver of FDIs in recent years in the developing world (ranking first in the world in 2002), it still lags behind the United States. In, only 6.4% of FDIs flowed into China a figure that stood at 16.9% for the United States (Table 1). According to a global portfolio investment survey by the International Monetary Fund (IMF), China receives far more FDIs than portfolios; it received a mere US$20 billion in portfolio investments in only 0.16% of the world s total while the United States attracted more than US$3 000 billion, making up 24.46%. (see Table 2). China s foreign investments have mainly consisted of FDIs, and the portfolios make up a very small proportion that can easily be neglected in the global context. As the Chinese financial industry opens to the outside world and the introduction of the QFII and other related measures, the proportion is expected to rise steadily. III. Stress the Importance of FDIs In its openingup policies, China has always regarded FDIs (foreign direct investments) as very important. For example, they can provide such factors in economic growth as capital, technology and even institutional arrangement. In comparison, portfolios lack such benefits and entail considerable risks that threaten the economic systems of recipient Countries as demonstrated by the Asian financial crises. China, therefore, favors FDIs to portfolio investments in its efforts to attract foreign investment. China receives FDI or globalizationrelated benefits while, to 2. Distribution of FDIs in China More than 60% of FDIs are pumped into the manufacturing industry while agriculture receives less than 2% and finance and insurance industries together obtain less than one percent. According to rough statis Table 1. Comparison of FDI Flows in China and the US China U.S. China U.S Source: UNCTAD, World Investment Report, China & World Economy Number 6,

6 China US Table 2. Comparison of Portfolio Investment Flows in China and the US (1997 and ) in million US$ Stocks Longterm debt Sortterm debt Total % of global Source: IMF, Global Portfolio Investment Survey, tics in, only 21.6% of foreign investment appeared in the services sectors, including transportation, storage, postal services, communications, wholesaling, retailing, catering, finance, real estate, social services, health care, sports, social welfare, education, culture, arts, broadcasting, scientific research and comprehensive technical services. With the exception of real estate, the proportion of foreign investment in the services sectors amounted to a little more than 10% (see Table 3). This distribution reflects the process of gradual marketaccess policies adopted by the Chinese government that placed the manufacturing industry before the services sectors in its openingup drive. 3. FDI Contributions As mentioned above, FDIs can benefit an economy in many ways. The following is an analysis of the contributing role of FDIs in China s exports, fixedassets investment and employment. Table 3. FDI in Chinese Industries (US$10,000) Industries Total Farming, forestry, livestock and fisheries Mining Manufacturing Production and Supply of electricity, gas and water Construction Geological prospects and waterconservancy management Transportation, storage, postal services and communications Wholesaling, retailing and catering Finance and insurance Real estate Social services Healthcare, sports and social welfare Education, culture, arts, broadcasting and film Scientific research and comprehensive technical services Other Absolute values Share in total FDI Absolute values Share in total FDI Absolute values Share in total FDI Source: China Statistics Yearbook, China & World Economy Number 6, 2003

7 Table 4. Share of ForeignInvested Companies in Chinese Exports ( ) First half Exports ($USD 100 million) % of Chinese total Increase in exports ($USD 100 million) % of Chinese total of Sources: China Customs, Customs Statistics, various issues. Exports: Chinese exports where foreigninvested companies have played a major role, especially in recent years have been expanding at a very high pace. As shown in Table 4, foreigninvested companies contributed up to 50.1% of the total exports in, and in the first half of 2003 the proportion reached 53.9%. Foreigninvested companies made an even bigger contribution to Chinese exports from the point of view of shares in exports increment. For example, in 1996 and 1998, FDIs were responsible for a huge proportion of the increase in exports since Stateowned companies experienced a drastic drop in exports. In 1996 and 1998, FDIs not only compensated this drop, but also drove up the previous year s exports. Apart from the extreme cases in 1996 and 1998 when Stateowned companies performed very poorly, the FDI contributions of total Chinese exports ranged between 60% 80%. A plausible conclusion would point to the critical role played by FDIs in forming China s exportoriented economy. Fixedassets investment: The FDIs contribution to fixedassets investment is demonstrated in the proportion of realized FDIs in the national fixedassets investment. As Table 5 suggests, between 1993 and, FDIs amounted to more than 10 % of the total fixedassets investment. It was only when the Chinese government adopted proactive fiscal policies, strengthened infrastructure construction and implemented urbanization which resulted in more domestic investments that FDIs began to constitute a smaller share of contributions to fixedassets investment. Nonetheless, FDIs still play an increasingly important role in forming Chinese investments. Employment: FDIs create jobs for Chinese workers. In recent years, the share of workers employed by foreigninvested companies in the total workforce have leveled off between 2.7% and 2.8 %. (See Table 6). Although a share of less than 3 % is seemingly negligible, it mitigates the issue of unemployment in China. Just imagine one percentage increase in unemployment that will translate into many Table 5. Shares of FDIs in FixedAssets Investment Realized FDIs in total social fixedassets investment (%) Sources: National Bureau of Statistics: China Statistics Yearbook, 2002 and China Statistics Abstract, 2003 Table 6. Role of ForeignInvested Companies in Urban Job Markets Urban Workforce (10,000) In foreigninvested companies (10,000) Share of Foreign Invested Companies in Total Urban Workforce (%) Source: National Bureau of Statistics, China Statistics Yearbook, China & World Economy Number 6,

8 economic and social problems, it is not difficult to understand the importance of the job creation by FDIs. IV. Conclusion From a political economic point of view, while governments of advanced countries, multinational corporations and international organizations such as the WTO and IMF are pursuing their own interests in a bid to promote worldwide globalization, as a world trend, globalization is largely a natural result of the development of the market economy. This means that developing countries have only one thing to consider: how they can participate in this trend, not how to escape it. An analysis of China s experience in opening up reveals in what way a developing country can benefit from globalization. It should: 1) realize that for developing countries the ultimate end is development, not just opening up or protection; 2) implement an openingup policy that fits the country s own level of development where domestic industries are protected from undue foreign competition and where trade is open to foreign participation before finance; 3) increase the country s abilities to absorb foreign capital and other advanced elements and maximize the benefits of opening up by carrying out reforms in line with the stages of opening up; 4) avoid risks posed by portfolio investments and take advantage of the benefits that FDIs can offer in capital formation, technological upgrading, management standards improvements by choosing FDIs over portfolio investments. While China has its own, unique characteristics, its experience is by no means perfect. However, China did not liberalize its entire economy, as some foreign experts and economists suggest, to receive its share of the benefits offered by globalization. This is an important element that is essential to the Chinese experience and worthy of being used as a reference by other developing countries. References Borensztein, Eduardo, José De Gregorio, and JongWha Lee, How Does Foreign Direct Investment Affect Growth? Journal of International Economics. Vol. 45 (June). pp Fan Gang, eds Followup Analysis on China s Macroeconomic Variables (in Chinese), National Economic Research Institute, Beijing. Fan Gang and Wing T. Woo, Phase in or Parallel? A Discussion on the Theories and Policies of Optimized Transformation. Working paper of National Economic Research Institute, China Reform Foundation (forthcoming). IMF, Global Portfolio Investment Survey, Washington: IMF. Jin Xiangyong and Lin Chengliang, Case Studies of Chinese Tariffs Adjustment and its Effective Protection Structure, (in Chinese). World Economy. Aug List, F. 1841, Das Nationale System der Politischen Oekonomie (Stuttgart: J. G. Cotta scher Verlag). Prasad, Eswar, Kenneth Rogoff, ShangJin Wei and M. Ayhan Kose, Effects of Financial Globalization on Developing Countries: Some Empirical Evidence. March 17, Washington: IMF. UNCTAD, World Investment Report, Geneva: UNCTA. Zhang Shuguang, Zhang Yansheng and Wan Zhongxin, Case Studies of Costs in Chinese Trade Protection, (In Chinese). Economic Research Journal. Feb China & World Economy Number 6, 2003