Trade and FDI Policy Issues Concerning China, the U.S.

and

Japan After China's Accession to the WTO

Shujiro Urata, Waseda University

Japanese paper for Session 2

Foreign trade has been an engine of economic growth for many countries in the world. In particular, for the countries in East Asia such as the NIEs, ASEAN, and China expansion of foreign trade played a crucial role in achieving rapid economic growth. Indeed, one of the reasons behind the recent economic crisis in East Asia was a slowdown in the growth of export expansion. Experiencing a decline in export earnings with sustained level of imports, countries began to accumulate foreign debt. Increasing foreign debt gave a signal to foreign investors that foreign debt-ridden countries were likely to have difficulty in repaying the debt. Foreign investors concerned with the collection of their invested funds withdrew their funds from the countries in question, leading to a substantial depreciation of their currencies or emergence of the currency crisis. The currency crisis triggered financial and economic crises.

Before the crisis, rapid economic growth was achieved by many East Asian economies. Various factors including sound macroeconomic policies and abundance of highly educated labor force have been argued to contribute to rapid economic growth. Among these factors, expansion of exports and foreign direct investment (FDI) has contributed significantly to rapid economic growth of the East Asian economies. The importance of FDI was particularly notable for rapid economic growth during the period between the mid-1980s and the mid-1990s.

FDI brought in to host countries not only financial resources for fixed investment, but also technologies and managerial know-how, which were used to improve technological and managerial capabilities of the host countries. Developing countries are short of technologies and managerial know-how and, therefore, FDI contributed significantly to economic growth of the host countries. In addition to these beneficial impacts of FDI on the host countries, FDI enabled the host countries to utilize various networks such as sales and procurement networks and information networks created by multinational firms undertaking FDI. Through these networks, the host countries could expand exports by utilizing high-quality parts and components and up-to-date technologies. Successful East Asian economies based on rapid expansion of FDI and foreign trade were able to attract new FDI, which in turn led to economic growth through the expansion of fixed investment and exports. Indeed, it was the creation of an FDI-trade-fixed investment nexus that has led to rapid economic growth of East Asian economies.

It is important to note that it was liberalization in trade and FDI policies that started this mechanism. Rapid technological progress in communication and transportation sectors promoted globalization of companies through FDI and foreign trade, but without liberalization policies the growth mechanism based on the expansion of FDI and exports would not have been realized and high growing East Asian economies would have remained relatively stagnant.

The preceding discussions pointed out the importance of free and open FDI and foreign trade regimes for promoting economic growth not only in East Asia but also in other parts of the world. The following discussions will address some key issues on foreign trade and FDI facing the U.S., China and Japan. The discussions examine the issues, which are likely to be picked up in the next round of WTO negotiations, which are scheduled to start next year. In the discussions, I assume that China's accession to the WTO will be realized before the next round beings.

Next WTO Round

The completion of the Uruguay Round contributed significantly to the liberalization of foreign trade regimes. The notable accomplishments include significant tariff reductions, the implementation of the GATS (General Agreement on Trade in Services), TRIPs(Trade Related Aspects of Intellectual Property Rights), and TRIMs (Trade Related Investment Measures). Furthermore, the multilateral trading system was strengthened by the successful establishment of the WTO and by strengthening the dispute settlement mechanism.

GATS and Agreement on agricultural trade, two most controversial agreements in the Uruguay Round, are scheduled for review in year 2000. In addition to these built-in issues, the new round should take on new issues such as competition policies and investment, in light of drastic and rapid changes in the world economy. One of the most notable changes in the recent decades is rapid globalization of economic activities involving the firms, individuals, and the governments. Globalization has advanced at tremendously high speed, thanks to remarkable technical progress in communication and transportation sectors. Liberalization of foreign trade and FDI regimes also contributed to the globalization trend. Another important change in the world economy is an expansion of service activities, reflecting a shift in demand patterns from manufactured products to services. The Uruguay Round introduced new measures to deal with newly emerging trends, but they are not sufficient to provide a free and open trade and investment environment.

Trade policies

As was noted above, import tariffs have been reduced greatly through a series of GATT multinational negotiations. As to the tariff rates on industrial products, the average tariff rate on industrial products in major world markets declined from approximately 40 percent at the time of the establishment of the GATT to 4.7 percent at the end of the Tokyo round. Despite such remarkable reductions in tariff rates on industrial products, there still remain high tariffs on industrial products in developing countries and on selected products in developed countries. Specifically, the average trade-weighted tariff rates (concession rates) for some selected developing countries are high as shown by the following statistics: the Philippines (24%), Indonesia (37%), and Brazil (31%). Another problem concerning tariffs in developing countries is that a large portion of their tariffs are not bound, that is to say, they have not accepted legal commitment not to raise tariffs in the future above the bound level.

China has made significant efforts to liberalize trade in industrial products. According to the USTR on the Market Access and Protocol Commitments (USTR home page), China will reduce average tariffs from the 24.6% average in 1997 to 9.44%. In addition, all tariff reductions would be bound. Industrial countries including Japan, the U.S., and the EU maintain high tariffs on certain industrial products. Among them, labor-intensive products such as textile products enjoy significantly high tariffs around 20 percent for these countries. In order to promote trade expansion, tariffs on industrial products have to be reduced. Quantitative restrictions, which have greater trade-restraining effect than tariffs, should be dropped.

The Uruguay Round took on the issue of trade liberalization in agricultural goods for the first time in the GATT’s history. The fact that the Uruguay Round produced an agreement on liberalization on agricultural products was an accomplishment in itself. However, there remains significant room for improvement such as further reduction in tariff rates and the elimination of import quotas and export subsidies.

Concerning liberalization in agricultural trade China has made significant progress in its discussions with the U.S. According to the USTR (home-page), China’s commitments in this area would move China toward a system based almost entirely on tariffs, with extremely low tariff rates (1-3%) in most bulk commodities. More specifically, the commitment reduces tariffs to levels below those of most American trade partners; binds tariff concessions; eliminates quantitative restrictions on imports; requires use of science-based SPS (Sanitary and Phytosanitary) standards; reduces the role of state trading enterprises for key commodities; and eliminates export subsidies. Considering China’s huge commitments, Japan should make much effort to liberalize trade in agricultural products. For example, tariffication of import quota on rice was a step forward for liberalization as a result of the Uruguay round, but extremely high tariff rate of 600 percent needs to be reduced.

Turning to the issues on trade in services, GATS will be reviewed in the next round. In light of rapid globalization of services industry, further liberalization should be achieved through expansion of the scope of GATS, as well as revision of the content of WTO Member's specific commitments regarding market access and national treatment. Developed countries such as the U.S. and Japan have relatively few sectors for which commitments have not been made in comparison with developing countries. Some of the sectors for which commitments have not been made include courier services and social health services for Japan, and maritime transport and internal waterways for the U.S. In addition to new commitments, It is important to develop the rules on safeguards, government procurement, and subsidies, since GATS has only basic rules on MFN and national treatment.

China today is among the markets most closed to services exports anywhere in the world. (USTR home page) However, China has made substantial efforts to liberalize trade in services. According to USTR, China's commitments on services are comparable to those of most WTO members. They include commitments in all major service categories, reasonable transitions to eliminate most foreign equity restrictions, agreed to accede to the Basic Telecommunications and Financial Services Agreements, and full "grandfathering" of current market access for U.S. service providers.

FDI policies

FDI policies have been incorporated in TRIMs in the WTO, but TRIMs concern only small part of policies affecting FDI. In light of few restrictions concerning FDI policies in the U.S. and in Japan, in this section I discuss some FDI policies adopted in China, which should be dealt with appropriately to achieve freer FDI regime.

One of the most serious problems concerning government policies toward FDI in China is instability and inconsistency in the application of policies. Under unstable policy environment foreign firms hesitate to undertake FDI. There have been several instances of the changes in fiscal measures applied to foreign firms, depending on FDI inflow situation. When FDI inflows were low, preferential tax treatment was given to foreign firms. However, such preferential treatment was abandoned when local enterprises faced difficulty in competing against foreign firms. One example is import tariff policy on imports by foreign firms. Import tariffs on machinery imports by foreign firms were exempted in the early 1990s to attract FDI, but tariff exemption was dropped in the late-1990s when local firms suffering from strong competition from foreign firms put political pressure on the government to change the policy.

Another example of unstable tax policies toward foreign firms is concerning value added tax (VAT). China introduced VAT in 1994. Internationally, it is common practice to refund VAT paid when exporting products are made of taxed parts and components. The Chinese government not only has changed the refund rates several times, but also have applied different refund rates to different products. There have also been cases where different local governments have applied different VAT refund practices.

The Chinese government has imposed strict regulation on foreign exchange transactions to prevent smuggling and fraudulent foreign currency outflows. Specifically, foreign currency remittances of over $100,000 concerning import settlement have been strictly regulated, and early repayment of debt in foreign currency has been banned. Although these measures may contribute to reduce illegal activities, they preclude foreign firms from carrying out their business efficiently.

Competition policies

The importance of competition policies for the expansion of foreign trade and investment has been increasing for several reasons. Firstly, the importance of border measures such as tariffs and quantitative restrictions for limiting trade has declined, thanks to several multilateral trade negotiations and the establishment of the WTO. In contrast, domestic measures such as government policies and private business practices have increased their importance in affecting the volume of trade. Under such a new trading environment, competition policies, which influence the impact of government measures and the behavior of private businesses, have increased their importance for establishing a free and open trading environment. Secondly, as the presence of multinational firms in foreign markets has increased through active foreign direct investment, various problems related to competition policies have emerged. For example, some multinational firms have faced various anti-competitive measures such as government regulations and cartels involving local private firms in the host markets. Naturally, such an anti-competitive environment limits the scope of business activities by multinational firms. Thirdly, it is important to note an increasing importance of competition policies for restraining anti-competitive behavior of multinational firms. Some multinational firms have expanded their operation through various means such as mergers and acquisitions, to result in an increase in their market power in the global market. The increase in market power enables multinational firms to exploit the market by practicing anti-competitive measures. Competition policies are needed to deal with such anti-competitive behavior by multinational firms, in order to maintain competition.

The U.S. and Japan have conducted competition policies based on competition laws, while China has not yet enacted competition laws. China is expected to enact competition laws to establish an environment, under which competition is promoted. It is important to include national treatment, MFN, and transparency in the application of competition laws.

Some of the important issues that the U.S. , Japan and other WTO members should discuss include the followings. It is important to identify and evaluate the impact of various anti-competitive practices on trade and investment. General principles, possibly like the non-binding competition principles of APEC, should be sought and agreed upon. Based on general principles, international competition rules have to be established. In establishing international competition rules, convergence of competition laws among the WTO members should be sought. Once general principles and competition rules are established, the WTO members decide on the rules concerning the procedure for proper enforcement of the competition laws.

Being closely related to competition policies, the issues concerning Anti-dumping Agreement should be discussed in the next round. The anti-dumping measure is an exception to the rule of non-discrimination and the rule on imposing tariffs that exceed the bound rates. As such, in order to maintain the free and open trading system, anti-dumping measure should be applied in strict conformity with the rules set forth in the Agreement. However, in reality, there have been a number of cases where anti-dumping measures appeared to have been abused as protectionist measures. Abuse of anti-dumping measures largely results from a lack of clarity in the provision on anti-dumping measures such as the method of identifying injury and determining the dumping margin.

Environment

To promote sustainable economic development and growth, environmental problems have to be properly dealt with. Although there appears to be a consensus on such perception among the countries in the world, different views on the application of trade restrictions for the purpose of protecting environment between developed countries and developing countries have been presented. Developed countries argue in favor of imposing trade restrictions to preserve environment, while developing countries are concerned with the abuse of trade restricting measures for industry protection under the disguise of environmental protection. In existing WTO agreements, environmental issues are addressed to in Article XX on 'general exceptions'. Specifically, Article XX states that nothing in this Agreement shall be construed to prevent the adoption or enforcement by any contracting party of measures relating to the conservation of exhaustible natural resources if such measures are made effective in conjunction with restrictions on domestic production or consumption. Several issues have to be examined regarding the existing WTO agreements. First, it is not clear if the agreements provide an adequate base for preventing unfair, unilateral, and protectionist measures disguised under the name of environmental protection. Second, there exist various multilateral environmental agreements (MEAs) such as the Washington Treaty and the Montreal Protocol. Consistency has to be established between the WTO on the one hand and other MEAs on the other hand. It is to be emphasized that proper balance has to be struck between trade expansion and environmental protection in dealing with environmental issues in the WTO.

Concluding Comments

In this note I argued that there exist a number of issues to be dealt with in the next round of WTO negotiations and in other fora such as APEC, in order to establish a free and open trade and FDI regime. I took on the following issues: trade policies (industrial and agricultural tariffs and GATS), FDI, competition policies, and environment. Because of limited space I could not discuss other important issues, including TRIPs, government procurement, regional integration, safe guard, and dispute settlement.