Impact of WTO Membership on Chinese Economy and Finance ―― CGE Analysis*

Zhai Fan

（Comprehensive Department, Ministry of Finance）

After 15 years of hard negotiations, China has now become a full member of WTO. Joining WTO is an important step for the Chinese economy to converge with the world economy and will have significant impact on the Chinese economy and society. As an important component of macro economic management, financial policy and management will also face a huge challenge. This article uses the Computable General Equilibrium (CGE) model for Chinese economy to give a qualitative analysis of the impact of WTO membership on the Chinese economy and finance, as well as of the long and mid-term pressures and challenges for the financial policy under the new economic environment.

The content of this article is as follows: Section 1 gives an introduction to the CGE model for Chinese economy and the simulation plan design used in this article; Section 2 analyzes the impact of WTO membership on the whole economy, industries, regions, income distribution and fiscal revenue through the description of the key quantitative simulation results; Section 3 discusses the main policy adjustments in response to the WTO impact and the fiscal expenditure pressure resulting from these adjustments; Section 4 uses a long and mid-term financial framework to analyze the long and mid-term sustainability of the Chinese finance; and the last part is a summary of the article.

1. Method of Study－CGE Because of the complicated connections between different sectors and

organizations in economic activities, a CGE model for the Chinese economy is used in this article as the main analyzing tool to give a comprehensive analysis of the impact of WTO membership on the economy as a whole and on various sectors. CGE model is a widely used policy analysis tool. In the framework of general equilibrium theory, it gives a clear and detailed definition of the production and demand functions of various economic entities, thus reflecting the interdependence and interaction between different regions, sectors and markets and providing numerical estimates of the impact of relevant policy changes on economic efficiency *This part of the article is based on the thesis co-authored by the author and Professor Tom Hertel. The author

appreciates the help of Mr. Ray Brooks in forming the mid-term financial framework. The views in this article

are of the author and not of the unit he is working for. This is the first draft of the article, comments on which are

welcome. Please contact the author at fzhai_99@yahoo.com before any quotation from the article is used.

and income distribution. This model has provided a unified analysis framework to help decision-makers in comprehensive analysis of the economic and social effects of policy changes. The economic relations revealed by CGE are more extensive than those by partial equilibrium or macro econometric models.

Estimating the economic impact of trade liberalization is a main aspect of CGE model application. In recent years, as promoted by the World Bank and other international organizations, many studies have used CGE model to analyze and estimate the impact of trade liberalization of the Uruguay Round. The CGE model used in this article is a multi-sector dynamic model targeting the Chinese economy, which gives consideration to some structural features of China’s foreign trade, such as the distinction between common trade and processing trade. We have used this model to analyze the impact of China’s WTO membership (State Development Research Center, 1998; Li Shantong and others, 2000; Zhai and Li, 2001; Zhai and Wang, 2002). The model used in this article is the latest version of the model, in which we have redesigned the simulation plan for WTO membership based on the actual final agreements for China’s entry into WTO and made a relatively detailed description of the labor market, reflecting the division of urban and rural labor markets in China (Hertel, Zhai and Wang, 2002).

An important characteristic of this model is the description of two different trading systems, namely the common trade and the processing trade. As early as 1986-1987, China established dual trading systems. One was export processing (or export promotion) system which was very open and preferred by most foreign-funded enterprises and some export-oriented domestic enterprises; and the other was the traditional and gradually reformed common trading system. Since 1990s, processing trade has grown rapidly, now taking over 50% of the total export. Obviously, it is very necessary to give a clear description of the dual trading systems in the model if we wish to analyze China’s foreign trade activities and different trade liberalization measures.

In the model, production activities are described with a multi-level CES production function, the residents’ demand is described with an ELES system, and all the other final demands are described by fixed expenditure index functions. In import demand, we have adopted the Armington Hypothesis, i.e. domestic products and imported products are imperfect substitutes. In terms of export, correspondingly, export demand and domestic demand are imperfect substitutes. The hypothesis is described in this model by the CET function. For import we adopted the small country hypothesis, i.e. the international price of imported goods are not influenced by the Chinese import demand. The export demand is described with a demand curve with fixed elasticity and the price elasticity is relatively high, showing the limited influence of Chinese export on the international market price.

All commodity and factor markets are cleared out through price adjustments. The model divides the labor forces into 6 categories based on urban or rural source and education level. Urban labor can move freely among sectors, while rural labor’s move between agricultural and non-agricultural sectors is not totally free. The rural labor can move to urban sectors only with certain costs paid. The wage difference between urban and rural labors is caused, to a certain degree, by such costs.

Such a Chinese CGE model has a simple recurrence dynamic structure, and the dynamic feature originates from the accumulation of production factors and changes

of productivity. In the dynamic simulation, the static model gives several single-period equilibriums for the years between 1997 and 2010. Between different periods, some parameters are updated in the dynamic blocks connecting the periods. The updates of parameters are either based externally on the basic trends or deducted from the solutions of the previous periods. In the model, population, labor and labor productivity are externally based, while capital growth rate is decided internally by saving/investment relationship in the model.

In policy analysis, the CGE model estimates the impact of external influence or policy change through comparing the economic equilibrium under the given policy framework and that with certain external influence or policy change. We first build a benchmark growth scenario for the next decade without trade reform and other reforms, which will serve as the reference frame for comparison. The benchmark scenario assumes that without joining WTO, China will not conduct any trade liberalization reform and will maintain the policy of self-sufficient food supply. Then we simulate the scenario of China’s entry into WTO to make the comparison. The latter scenario assumes that, on the basis of the benchmark growth scenario, China joined WTO in 2001 and will complete the policy changes in the following 5 areas by the year 2007: (1) Reduction of tariff on industrial goods; (2) Reduction of tariff on agricultural goods and introduction of tariff quota mechanism; (3) Phased abolition of Multi-Fiber Agreement (MFA) quota on Chinese export of textile and costumes;（4）Trade liberalization on service industry;（5）Abolition of loss subsidies for enterprises. Due to limited data and simulation-building techniques, our model dose not include some other important aspects related to the membership of WTO, such as opening service trade, IPR protection and guarantee of market access. However, the comparison of the simulation results of the two scenarios will give us a clearer understanding of some major aspects of the impact of China’s WTO membership.

Box 1：Market access commitments for China’s WTO membership China’s market access commitments for WTO membership covers the following

aspects: (1) Reduction of tariff on industrial goods and abolition of non-tariff barriers. In

2005, the average tariff for industrial goods will reduce from the current 17% to 9.4%, and the tariff reduction on automobile, electronic and communication products, furniture, tobacco, etc. will be over 75%; At the same time, the non-tariff administration measures on automobile, finished-product oil, fertilizer, rubber and some mechanical and electrical products will phase out between 2000 and 2005；

(2) The average tariff level on agricultural goods will drop from 22% to 17%, and a tariff quota mechanism will be put on some large-scale import products, such as wheat, rice, corn, cotton, vegetable oil and sugar, which is to levy a low tariff of 1%－3% on the imported goods within the quotas and a high tariff of over 40% for those exceeding the quota. From 2000 to 2005, the quota amount will gradually increase and the tariff for extra-quota goods will be gradually reduced;

(3) Providing market access to service industry. In 2005, the geographical restrictions for most service sectors will be abolished and the ceiling for foreign capital share in joint ventures will be raised in telecom, insurance, securities and some other sectors. Foreign banks will get full national treatment after 5 years of China’s WTO membership.

(4) Abolition of loss subsidies for certain sectors and enterprises. Besides, in terms of China’s export market, the MFA quota on Chinese textile and

costume export by the developed countries will be phased out. Before 2005, Chinese textile and costume export to the North American and EU markets will enjoy the same treatment as other developing countries, which means the accelerated growth of quota amount and the final abolition of export quota in 2005. This is the content of the Textile and Costume Agreement of the Uruguay Round, the main benefit developing countries have gained from the Round and the main improvement for China in terms of international trading environment after joining WTO.

2. Impact of China’s WTO Membership――Simulation Results Analysis 1) Economic growth and trade expansion

Table 1 gives the simulation results of main macroeconomic impacts. Joining WTO will give China a big efficiency benefit. This benefit is from two aspects, namely the effects of resource reallocation and of internal growth. The former is improvement of allocation efficiency resulted from resource reallocation according to comparative advantage and the latter reflects the “overflow effect” brought by expansion of foreign trade and attraction of foreign investment, since they can promote market competition and the introduction and absorption of technologies, thus benefiting the improvement of technological level and productivity. Simulation results in Table 1 show that, only considering the resource allocation effect and compared with the benchmark scenario of no WTO membership, China’s actual GDP will increase by 9.1 billion yuan (1997 price) when China’s WTO commitments are fully realized in 2007, or 0.56%1 over the benchmark scenario. As a result, GDP

1 This result is smaller than our previous simulation result, which was 1.2%-1.5% GDP growth rate due to WTO

growth rate will increase by 0.1% annually between 2002 and 2007. If the internal growth effect of foreign trade and investment expansion is considered, we estimate WTO membership will make China’s GDP growth rate raise over 0.5% annually in the next 10 year.

Table 1 Macroeconomic impact of China’s WTO membership, 2007 (% of change compared with benchmark scenario)

WTO membership Social Benefit (% of GDP of the year)

0.63

GDP 0.56 Consumption 1.25 Investment 0.08 Export 15.15 Import 14.40 Revenue -0.67 Urban Resident Income 1.21 Rural Resident Income 0.80 Trading Conditions -1.34 Actual Exchange Rate 1.16 Source: simulation results

In 2007, due to WTO membership, China’s resident consumption will increase 1.25%, a benefit for the consumers brought by trade liberalization. WTO membership will hardly cause investment expansion because of its result of revenue reduction, which in turn will cause larger fiscal deficits and relative reduction of total investment2. China’s WTO membership will result in a large trade expansion, an increase of 15.15% and14.4% for export and import respectively.

Such general equilibrium results are determined by the interaction of many factors. Usually, benefits in GDP originate from efficiency improvements due to resource reallocation based on comparative advantages. But two other factors also contribute a lot to GDP growth: (1) Elimination of high protection will cause actual exchange rate devaluation, thus improving international competitiveness of Chinese products; (2) Abolition of “Multi-Fiber Agreement”will further improve Chinese textile and costume industry competitiveness, resulting in export expansion of such sector which are of comparative advantages in China.

Big trade expansion is due to, on the one hand, reduction of import protection, and on the other, structural features of the Chinese foreign trade. As mentioned above, processing trade is now taking over half of China’s total trade, therefore, China’s export contains a large amount of import. Growth in export will cause corresponding increase in import, hence devaluation pressure on the currency and

membership. There are mainly two reasons：first, in the previous simulation, we assumed a larger reduction of

import protection for agricultural products; second, we didn’t consider the rigidity of labor market, assuming

agricultural labor can move freely between urban and rural areas. 2 We will discuss in detail the impact on fiscal revenue later in the article.

further growth of export. This feature explains, to a certain extent, the rapid growth of China’s trade dependence in the past and the huge trade expansion as a result of WTO membership.

2) Restructuring and labor movement The overall economic efficiency benefits are not equally distributed among

different sectors and large structure adjustments will be caused by WTO membership. Picture 1 lists all sectors with over 2% of output adjustments. It can be seen that, due to abolition of restrictions on China’s export into developed markets, textile and costume sectors will be the main beneficiary of WTO membership, with an output expansion of 17% and 41% respectively. However, some other highly protected sectors and some agricultural sectors (such as automobile, wool, vegetable oil) will get relatively large impacts, resulting in reduction of output compared with benchmark scenario. In the agricultural sector, due to the slow increase of import quota on wheat and cotton, the average annual growth rates between 2002 and 2007 will be 7% and 4.7% respectively. In 2007, the import quotas for these two agricultural products will still have realistic constraining effects.

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Chart 2. Employment readjustment among various sectors as a result of the WTO entry (2007) Structural readjustment will inevitably cost a lot. Among which, the replacement and transfer of labor forces may constitute the major costs. In particular, there is a high concentration of employment in the Chinese agricultural sector today. The shrink of agricultural sector indicates that some agricultural labor forces have to be transferred to the industrial and service sectors. Compared with the benchmark situation, from 2002-2007, China’s entry into the WTO will result in 2,2 million agricultural labor forces transferred from planting to other sectors. In addition, there are about hundreds of thousands to millions of labor forces leaving auto, mechanical and steel and iron sectors. The elimination of quotas in the “Multi-fabric Agreement” and the expansion of global textile market are of great significance to the transfer of the agricultural labor forces in China. Because textile and clothing are labor-intensive industries, their growth contributes to more job opportunities for non-skilled workers. The simulated experiment results also show that in comparison with the benchmark situation, WTO entry will result in additional 4.5 million employees. The past two decades of reform and opening up practice has witnessed more than 100 million agricultural labor forces transferred to non-agricultural sectors. Therefore the labor forces readjustment as a result of the WTO entry is bearable. However the structural unemployment in the readjustment period might give a rise to the overall unemployment for some time. 3) Income distribution and regional gap Although China’s entry into the WTO can promote its economic growth and bring benefits to China as a whole, the income distribution situation might become worse. This is mainly reflected in the widening gap between the rural and urban areas. The costs for agricultural protection will gradually increase in the process of industrialization. It is true that import protectionism can give a rise to farmers’ income, but this cannot be sustained. The WTO entry will hit the Chinese agricultural sector to some extent, which will lead to less income for rural people than urban

people. According to our simulated experiment results, although some agricultural labor forces can move to other sectors after the WTO entry, in comparison with the benchmark situation, the disposable income of rural population only increases by 0.8% while that of urban population increases by 1.2%. Since the income gap between the rural and urban population is very wide, the WTO entry will have a negative impact on the income distribution situation in China. Regional gap also affects income distribution. China’s entry into the WTO might result in a wider regional gap. We have made simulated analysis between Guangdong province and other parts of China. The result shows that Guangdong will get about half of the overall benefits brought by the GDP growth. China’s foreign trade volume usually comes from the coastal area. Among which, Guangdong province accounts for 40% of the total. Because the coastal area is mainly engaged in processing trade, its exporting parts have little connection with the inland economy and some feedstock such as raw material are usually imported. The exporting parts in the coastal area only rely on the cheap inland labor forces. In the foreign trade scenario, trade expansion after the WTO entry mainly takes place in the coastal area. In fact, such trade expansion can have tiny impact upon inland economy and can trigger little inland demand. On the contrary, it will lead to the flow of more production factors from the inland to the coastal area. As a result, the regional economic gap will become wider and wider. In addition, foreign investment tends to flow to the coastal area because this part boasts sound infrastructure, rich human resources, large population and strong market impacts. Therefore the coastal area will get the lion share of benefits after the WTO entry while inland provinces, especially those major agricultural provinces will be negatively affected. 4) Impacts on fiscal revenue Charter 2 has listed the simulated experiment results of impacts on fiscal revenue. Although the WTO entry promotes the economic growth, it will negatively affect fiscal revenue because of tariff cut and increasing export tax rebate. Fiscal revenue in 2007 will be less than that under the benchmark situation. In 2007, the average tariff rate will be reduced by 60%. But since import will increase by 14% in comparison with the benchmark situation, the average tariff rate will be reduced by 50%. Increasing import will lead to increasing import VAT, which will increase by 9.3% in 2007 in comparison with the benchmark situation. But import VAT will not grow as fast as import volume because there will be more import of agricultural products with low VAT rates. VAT, individual income tax and other taxes will increase to some extent because of production expansion and individual income growth. But corporate income tax will slightly fall. The major reason is that various non-tariff barriers are to be eliminated after the WTO entry. So some state-owned foreign trade companies can not obtain rents by leveraging its monopoly. That’s why their profits decline and corporate income tax falls slightly. Export surge will give an increase to export tax rebate, which is 18% higher than that under the benchmark situation. We make the assumption that subsidies for loss-making businesses will be eliminated in 2005. So that is to say, subsidies for loss-making businesses will be reduced to zero after the WTO entry. The above-mentioned structural features of income changes will have different impacts on the central and local fiscal revenue respectively. Since tariff is collected and export tax rebate is paid by the central government, the WTO entry will have a negative impact on the centra fiscal revenue. In 2007, in comparison with the benchmark situation, the local fiscal revenue will increase by 3.5% while the central will decrease by 4.1%.

Table 2 Impacts on fiscal revenue (2007)

Benchmark Situation

(10B RMB, price in

1997)

WTO Scenario

(10B RMB, price in

1997))

WTO Scenario :

Benchmark situation (%)

Fiscal revenue 259.3 257.6 -0.7

Central 142.2 136.4 -4.1

Local 117.1 121.2 3.5

Tariff 16.9 8.6 -48.9

Import VAT 27.9 30.5 9.3

Corporate income tax 42.6 42.1 -1.1

Individual income tax 17.0 17.2 1.1

VAT 88.3 89.2 1.0

Other taxes 84.7 85.0 0.4

Subsidies for

loss-making businesses

-5.4 0.0 -100.0

Export tax rebate -12.9 -15.2 18.0

Sources: simulated experiment results 3. Countermeasures and policy readjustment after the WTO entry The above analysis of the WTO entry’s impacts on China indicate that China will embrace many opportunities while meeting challenges in its economic and social development such as labor forces transfer, income distribution and gaps among regions. The government plays an important role in seeking opportunities and meeting challenges. The government should make pro-active readjustments to domestic policies with a view to minimize the negative impacts brought by the WTO entry. The following policy readjustments are necessary. Firstly a key challenge is the transfer of agricultural labor forces. It is not viable for an economy with more than 50% of agricultural labor forces to practice agricultural protectionism so as to guarantee the increase the farmers’ income and realize modern agricultural production. To that end, the only way out is to transfer agricultural labor forces from agriculture to the second and tertiary industries, from the rural area to the urban area. This is also a pre-condition to industrialization and modernization in China. Because the WTO entry will ensure more labor-intensive exports from China to those developed countries, it creates favorable conditions for the labor forces transfer in spite of pressure. In the following bilateral and multilateral negotiations, China should guard against any new discriminating measures of the developed countries so as to give full play to its own comparative advantages in cheap labor forces. What’s more, relevant economic and social conditions should be available for agricultural labor forces transfer at an early date so as to ensure smooth transfer and minimize the hit to the whole society. There are many effective ways to promote agricultural labor forces transfer. For example, China should reduce barriers restricting free flow of labor forces between the rural and urban areas in such aspects as the household registration system, education, medical care, social security and housing. China should step up infrastructure construction and urbanization. And China should also invest in education in the rural

area to enhance people’s education level there. Secondly no matter from the perspective of the urban-rural income gap or the gap between the coastal and inland areas, the WTO entry will probably worsen the current income distribution situation in China. One important way for improvement is to encourage the development of labor-intensive industries, seek a favorable international market for labor-intensive exports and support agricultural labor forces transfer. As far as the regional economic development is concerned, the central government should strengthen the trade link between the coastal and inland areas by means of improving infrastructure facilities and reducing domestic business costs so as to promote domestic economic integration. At the same time, the current fragmentation between export parts and domestic economy should be eliminated so that foreign trade can be better leveraged to stimulate domestic economy. What’s more, domestic taxation policies should play a more important role in income redistribution. China should improve its individual income tax system and inter government departments transfer payment system with a view to narrow the increasing income gap and ensure equal share of benefits brought by trade liberalization among various groups of interests. Thirdly since some sectors and businesses will be negatively affected after China’s entry into the WTO, the government should also leverage some industrial policies to shore up some capital and technology-intensive industries so as to facilitate the industrial upgrading and offset the negative effects resulting from trade liberalization. Such industrial policies should be functional rather than sector-preferential. That is to say what these policies should do is not to just offer subsidies or protection but to offer helps for the disadvantaged in such forms as financing, technology development, commercialization of research results and encouragement of businesses merge in some sectors featured by scales of economy. Fourthly an improved social security system is also crucial to minimize those negative impacts. A nationwide unemployment and pension system can shoulder social burdens for businesses, promote rational flow of labor forces and lower readjustment cost in the labor market. No doubt the current social security system cannot be adaptable to the new post-WTO scenario because it is characterized by fragmentation among various regions and forms of ownership. Fifthly although the WTO entry only has a tiny negative impact upon the overall fiscal revenue, its impacts on the central and local revenues differ. Therefore reform in the central—local fiscal revenue relations is necessary. In order to assess the impacts of these supplementary policy readjustments, we have also made two simulated experiments by means of the CGE model. Focusing on the widening urban-rural income gap, these two experiments study the impacts resulting from barriers reduction for labor forces flow and investment in rural basic education. The first one makes an assumption that fewer barriers may lower costs of labor forces by 40%. On that basis, the second one is about making investment in rural basic education. It is assumed that from 2002 to 2007, there will be additional 20 million rural labor forces receiving middle school education. Table 3 has listed the macro-economic impacts as a result of these two supplementary policy readjustments. We can see that these practices will not only promote economic growth but also contribute to narrowing the urban-rural income gap. Table 3 Countermeasures and policy readjustments upon China’s entry into the WTO---Impacts on macro-economy, 2007 (as a proportion to the benchmark situation)

WTO entry＋reducing

barriers for labor

forces flow

WTO entry＋reducing barriers

for labor forces flow＋

investment in rural basic edu

Social benefits (proportion of

GDP % ) 0.82 1.12

GDP 0.78 1.14

Consumption 1.99 2.00

Investment 0.61 1.30

Fiscal revenue -0.48 -0.46

Income of urban population 1.17 -0.44

Income of rural population 1.43 4.61

Sources: simulated experiment results There is no doubt that the supplementary policy readjustments upon the WTO entry can help us not only minimize the negative impacts upon the China’s economy and society but get benefits as well. However we must make sure that these readjustments are supported by corresponding government expenditures. In fact, China’s fiscal spending is more challenged than revenues. No matter in the transitional or post-transitional period, China’s economy will therefore be in the process of reform and readjustment. The government should do more to improve economic environment, readjust economic relations and promote social fairness. This will lead to more spending in administration, social security and income redistribution. Specifically speaking, the prospective fiscal expenditure increase might be incurred in the following areas: With respect to foreign-related economy, the WTO entry will increase the administrative

costs in the customs, quarantine, examination of whether up to the tech and environment standards as well as IPR protection. In addition, additional fiscal spending is required because of increasing communications with the outside world, more economic disputes as well as the build-up of an international negotiation and consultation system and relevant supporting means.

Structural unemployment is inevitable at the early stage of the WTO entry. This calls for more services from the government in unemployment security and labor forces education and training. So more fiscal spending is necessary.

The widening regional gap is in need of stronger inter-government payment, which might result in increased fiscal expenditure.

More agricultural subsidies are needed to protect farmers’ interests in the short term although this practice is not viable to ensure farmers’ income in the long term.

The perspective worsening income distribution situation calls for more social security expenditure such as poverty assistance.

The accelerated urbanization resulting from inflow of rural population needs more pubic investment in urban infrastructure facilities.

The opening of the financial sector will impose more pressures upon domestic banking sector. So state-owned banks need more financial support.

Although it is hard to get the exact figure for fiscal expenditure, the above-mentioned fiscal burdens will be quite challenging to China’s fiscal policies and administration because of some

weaknesses in the current China’s fiscal system. The next chapter is to further elaborate the sustained impact on the China’s fiscal system under a mid and long-term fiscal framework. 4. WTO entry and China’s mid and long-term fiscal sustainable development The discussion of the challenges to the China’s fiscal system upon the WTO entry should be put into a broad picture of its reform and opening up. The past two decades has witnessed the remarkable success of China’s economic reform, which is characterized by separation of powers and gradual process. However problems do occur. Among which, there are two problems which are closely relevant to the fiscal policies. Firstly separation of powers in the reform of the old planned economy does boost the enthusiasm of local governments and businesses, but it reduces the resources under the control of the central government. In addition, since there is no clear understanding towards the respective roles of the government and market, the government withdraws from not only some important social policy areas such as education, public health and infrastructure, etc. but also some economic sectors. That’s why there is substantial insufficiency of public services in some key areas. Secondly the gradually progressive reform hides rather than solves those inherent contradictions and problems, which get interwoven and prevent various measures from taking effects. Finally the economic development comes to a halt. The ill production structure in SOEs, the large amount of bad loans in the banking sector and the huge debts in the social security system are all historic legacies. These interwoven problems cannot be solved by any individual department, but become debts and responsibilities assumed by the government in the end. China’s reform has entered a new stage after two decades of development. Reform at this stage should be comprehensive and resolute. The WTO entry will be sure to make this task more urgent. However should it be the opening-up policies and domestic reform as required by the entry or the domestic policy adaptation to the entry, all the practices are in line with our institutional reform and socialist market economy endeavor. The WTO entry will not change the fundamental direction of our economic reform and development. But the forthcoming challenges enable people to have a clearer picture of the current hidden problems and exert heavier pressure upon the government in going ahead with reform and policy readjustment. In this sense, the WTO entry steps up China’s economic reform. In order to meet the challenges upon the WTO entry and to push forward the economic reform, China should firstly find solutions to the government public service absence and the remaining problems of the old system. To that end, increasing fiscal spending is necessary, which will threaten the Chinese mid and long-term fiscal sustainability. In order to analyze the Chinese mid and long-term fiscal sustainability upon the WTO entry, we make use of the mid and long-term fiscal framework3 and come up with several possible fiscal prospects. Firstly we take a look at the benchmark situation without any policy reform. It is assumed that in the future fiscal spending will not increase and there is no important taxation readjustment, but the current pro-active fiscal policy will gradually recede. As a result, the long-term fiscal revenue and spending will come to a balance. This is a conservative fiscal prospect without any reform. The second benchmark situation is put into the scenario of the WTO

3 Column 2 introduces the prediction of population change and economic growth under the mid and long-term

fiscal framework.

entry. It is assumed that the government will, in line with the new post-WTO situation and further reform, spend more in education, social security and infrastructure and assume the accumulated responsibilities as a result of some historic factors, eg. pension hidden debts. How much is the Chinese fiscal hidden debt remains controversial. (Lardy, 2001). Table 4 lists our estimation of the overall fiscal debt in China (including various hidden debts and contingent debts) on the basis of our study. So we can see that the overall debt in China will account for more 15% of the GDP if the quasi-fiscal debts in the social security system and banking sector are entailed. In our mid-term fiscal situation upon the WTO entry, we entail the underestimated China’s quasi-fiscal debts by assuming that the government has identified these debts and decided to pay the interests. In addition, we have also made other assumptions: the fiscal spending on unemployment security in proportion to GDP will increase by 0.2% from 2003 to 2010, while the spending on education, medical care and infrastructure will increase by 1.5% respectively over the some period.

Column 2: prediction of mid and long-term population change and economic growth The mid and long-term economic growth depends on the supplying side, such as labor resources growth, capital accumulation and productivity enhancement, etc. In the next 20 years, the Chinese population will increase at a low rate and the growth rate will gradually decrease. The natural growth rate will fall from 1% to 0.62% from 2000 to 2010 and further down to 0.47% from 2010 to 2020. From 2000 to2010, the number of labor forces will increase at a high rate while the percentage of non-working forces continues to fall. This is conducive to the fast economic growth within the ten years. However after 2010, the number of labor forces increase will slow down and finally come to a halt. What’s more, the percentage of non-working forces will increase. In particular, the number of senior citizens will climb fast. Then China will become an aging society, which will leads to a slow economic growth.

Population growth in China， 2000－2050

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15岁以下

15-64岁65岁以上

We also make an assumption that the productivity will make the same progress in the next 20 years as in the past years from 1980 to 2000. That is to say, the productivity of all production factors will continue to increase by 2.5-3% every year. Based on this assumption and the above-mentioned prediction, we have simulated the economic growth in China from 2000 to 2020 by using CGE model. The results show that within these twenty years, the annual average growth

rate will reach 7.3%. From 2000 to 2010, GDP growth rate will be 7.9% while reduce to 6.6% in the second 10 years. Sources: Review and Prediction of China’s Economic Growth, 1979-2020, China development Publishing House, 2000

Table 4 Scale of China’s overall fiscal debts，2001（as a proportion to GDP %））

Lower estimation Higher estimation

Treasury bonds* 20.1 －

Foreign debts 4.8 －

Quasi-fiscal debts 124.3 154.4

NPLs in State-owned banks 48.2 70.3

Pension hidden debts 63.0 71.0

unpaid debts of grain

production enterprises 2.7

－

Fiscal debts of rural

governments at all levels 2.2

－

Bonds issued by other public

departments** 8.2

－

Overall debts 149.2 179.3

*including 270 billion RMB special treasury bonds and treasury bonds transferred from the central to local government used for supplementing banking capitals **Mainly bonds issued by policy banks and the railway department Sources: government fiscal statistics, foreign debts statistics, Wang Yan, etc. (2001), Liu Shangxi, etc. (2002), the author estimation Table 5 and Charter 3,4 and 5 list revenues, spending, deficits, debt balance in different fiscal prospects. Under the benchmark situation, the government debt balance in a proportion to GDP will gradually decline after 2004. But in this situation, fiscal sustainability is secured at the cost of public services absence and accumulated historic debts. So obviously this fiscal prospect cannot meet the requirements of the WTO entry and economic reform. However against the backdrop of the WTO entry, if the government has to assume all spending responsibilities while cannot get additional revenues, the fiscal debt as a proportion to GDP remains 140% to 150% between 2002 and 2015. No doubt the Chinese fiscal system cannot develop in a sustainable way. Since the pension payment gap will gradually form in the next 50 years, we come up with another way of pension debt repayment in the mid-term fiscal prospect upon the WTO entry, i.e. rather than reveal the current hidden debt balance, we will bridge the gap in the form fiscal spending. Based on the former studies, we assume that additional fiscal spending (equal to 0.9% of the GDP) will pay pension debt deficit from 2003 to 2015. According to Table 5 and Charter 5, although the amount of debts decreases at the early stage, the debt balance will later reach as high as 130% of the GDP as a result of expanding basic fiscal deficits. So under this situation, the fiscal system cannot develop in a sustainable way either. Since fiscal sustainability can be undermined by the WTO entry and further reform, policy

readjustment in fiscal revenue and debt management is quite necessary. Generally speaking, more taxes and sales of state-owned assets can prevent debts from growing fast. However it is not viable to support fiscal sustainable development by collection more taxes to offset debts because the current fiscal debt is as high as 150% of GDP. Tax overburden will distort normal economic activities and negatively affect the long-term economic growth. In addition, plus extra-budgetary funds, the actual tax burden in China can be above 25% (Liu Shangxi, 2002). So there is no room for further increase. Since there are a lot of state-owned assets, it is viable to finance quasi-fiscal debts, esp. contingent debts by selling some state-owned assets. Table 5 Mid-term fiscal prospect, 2002-2015

2002 2003 2004 2005 2006 2007 2010 2015

Macro-eco assumption

Real GDP growth

rate(%) 7.0 7.7 7.7 8.5 7.9 7.8 7.4 6.6

Real interest rate(%) 3.3 2.9 2.5 2.4 1.4 0.9 1.8 2.5

Inflation rate(%) 1.5 1.7 1.8 2.0 2.0 3.0 3.5 3.5

Benchmark situation( as a proportion to GDP %)

revenue 17.8 18.2 18.7 19.1 19.6 20.0 20.0 20.0

spending 21.2 21.4 21.4 21.4 21.4 21.4 21.4 21.4

Interests 0.7 0.9 0.9 0.9 0.9 0.9 0.9 0.9

Basic spending 20.5 20.5 20.5 20.5 20.5 20.5 20.5 20.5

Basic fiscal balance -2.7 -2.3 -1.8 -1.4 -0.9 -0.5 -0.5 -0.5

Overall fiscal balance -3.4 -3.2 -2.7 -2.3 -1.8 -1.4 -1.4 -1.4

Debt balance 26.2 26.5 26.9 26.6 26.0 24.8 21.7 19.0

WTO situation (as a proportion to GDP %)

revenue 17.8 18.2 18.7 19.1 19.6 20.0 20.0 20.0

Spending 21.2 22.4 22.9 23.6 24.2 24.7 26.9 27.8

interests 0.7 0.9 0.9 1.0 1.1 1.1 1.7 2.8

Basic spending 20.5 21.5 22.0 22.6 23.1 23.6 25.2 25.0

Basic fiscal balance -2.7 -3.3 -3.4 -3.5 -3.5 -3.6 -5.2 -5.0

Overall fiscal balance -3.4 -4.2 -4.3 -4.5 -4.6 -4.7 -6.9 -7.8

Debt balance 147.7 143.4 141.6 139.2 139.8 140.9 148.5 151.9

WTO situation, suppose pension payment gap comes into being in the next 50 years (as a proportion to GDP % )

revenue 17.8 18.2 18.7 19.1 19.6 20.0 20.0 20.0

spending 21.2 24.2 24.8 25.4 26.1 26.7 28.0 29.2

interests 0.7 0.9 1.0 1.1 1.2 1.3 1.9 3.3

Basic spending 20.5 21.5 22.0 22.6 23.1 23.6 25.2 25.0

Additional pension

spending

0.9 0.9 0.9 0.9 0.9 0.9 0.9

Basic fiscal balance -2.7 -5.1 -5.1 -5.3 -5.3 -5.4 -6.1 -5.9

Overall fiscal balance -3.4 -6.0 -6.1 -6.3 -6.5 -6.7 -8.0 -9.2

2002 2003 2004 2005 2006 2007 2010 2015

Debt balance** 87.7 89.6 92.4 94.6 98.4 102.3 117.1 129.8

*Including the low estimation of quasi-fiscal debts in Table 4.

**Including the low estimation of quasi-fiscal debts in Table 4, but excluding hidden pension debts

0

5

10

15

20

25

30

2001 2003 2005 2007 2009 2011 2013 2015

(占G

DP的

％）

债务余额

收入

基本支出

Charter 3. Fiscal revenue, spending and debt under the benchmark situation, 2001-2015

0

20

40

60

80

100

120

140

160

2001 2003 2005 2007 2009 2011 2013 2015

(占G

DP的

％）

债务余额

收入

基本支出

Charter 4. Fiscal revenue, spending and debt upon the WTO entry, 2001-2015

0

20

40

60

80

100

120

140

2001 2003 2005 2007 2009 2011 2013 2015

(占G

DP的％）

债务余额

收入

基本支出

Charter 5. Fiscal revenue, spending and debt upon the WTO entry, 2001-2015 (excluding Pension debt) We have proposed a mid-term fiscal reform prospect for demonstration, where the mid-term fiscal sustainable development can be guaranteed by increasing fiscal revenue and selling state-owned assets. Against this backdrop, we suggest that great efforts should be made to collect taxes and expand taxation coverage. Only in doing so, can the fiscal revenue be as much as 6% of the GDP in the next 5 years. Thus the fiscal spending in public service sector can come from the general tax income. As a result, basic fiscal spending and revenue will be in balance. Meanwhile in the next 7 years, the sales of state-owned assets will provide as much as 6% of the GDP every year to pay quasi-fiscal debt principals and interests. After 2010, the overall fiscal debt will remain 40% of the GDP and continue to decrease (See Table6 and Charter 6). Table 6. Proposed mid-term fiscal reform prospect, 2002-2015

2002 2003 2004 2005 2006 2007 2010 2015

revenue 17.8 19.4 21.1 22.7 24.4 26.0 26.0 26.0

spending 20.5 23.2 23.6 24.4 24.9 25.4 26.8 26.5

Interests 0.7 0.9 0.9 0.9 0.9 0.8 0.7 0.6

Basic spending 20.5 21.5 22.0 22.6 23.1 23.6 25.2 25.0

Additional pension

payment

0.9 0.9 0.9 0.9 0.9 0.9 0.9

Basic fiscal balance -2.7 -3.0 -1.8 -0.8 0.4 1.5 -0.1 0.1

Overall fiscal balance -2.7 -3.9 -2.7 -1.7 -0.5 0.6 -0.8 -0.5

Sales of State-owned

assets 4.5 6.1 5.2 5.5 6.0 6.6 6.3 0

Debt balance 83.2 78.2 74.1 68.6 62.9 56.0 41.4 39.7

0102030405060708090

100

2001 2003 2005 2007 2009 2011 2013 2015

(占G

DP的

％）

债务余额

收入

基本支出

Charter 6. Fiscal revenue, spending and debt under the proposed fiscal reform situation, 2001-2015 Of course the above mid-term fiscal framework and situations are just rough models for analysis. To analyze and make policies in real sense needs more detailed revenue and spending analysis as well as mid-term fiscal planning. However based on these rough frameworks, we can at least find out the relations among major variables in the fiscal development and identify the risks and uncertainties in the future. Only after these research activities can we make further analysis on the fiscal sustainability. 5.Conclusion It is true that the WTO entry will have some negative impacts on China’s fiscal revenue, to be more exact, mainly on the central fiscal system. However challenges to fiscal spending are greater than revenues. No matter what the purposes are, say to meet the challenges upon the WTO entry or promote domestic market-oriented economic reform, the fiscal spending and debts will be sure to increase dramatically. Thus the fiscal sustainable development will be greatly challenged. Therefore we should come up with a comprehensive reform agenda, which covers trade system, domestic taxation system, fiscal spending system and central-local fiscal revenue relation. Such a comprehensive reform will not only contribute to smooth transition upon the WTO entry but also enhance the resources distribution efficiency so as to support the sustainable economic growth in China. Bibliography: Li Shantong，Wangzhi，Zhai Fan，Xu Lin. 《WTO: China and World》，China Development Publishing House，2000

Liu Shangxi，Zhao Quanhou，“Government Debts：Preliminary Analysis of Risks”，《Management World》，2002. 5

Wang Yan，Xu Dianqing，Wang Zhi，Zhai Fan，“The hidden Debts, reform cost, ways of reform with respect to pension in China and their impact”，《Economic Research》，2001. 5

Hertel, Tom, Zhai, Fan and Wang, Zhi (2001). "Implication of WTO Accession for Poverty in China”, mimeo, 2002

Lardy, Nicholas(2000), “Fiscal Sustainability: Between a Rock and a Hard Place”, China Economic Quarterly

Wang, Yan, Dianqing Xu, Zhi Wang and Zhai, Fan (2001), “Implicit Pension Debt, Transitional Cost, Options and Impact of China’s Pension Reform”, World Bank Working Paper 2555

Zhai, Fan and Li, Shantong (2000). "The Implications of Accession to WTO on China's

Economy," Third Annual Conference on Global Economic Analysis, Melbourne, Australia, June

27-30.

Zhai, Fan and Wang, Zhi (2001). "WTO Accession, Rural Labor Migration and Urban Unemployment in China” paper presented at the international conference on “Urbanization in China: Challenges and Strategies of Growth and Development”, Xiamen, China, June 2728, 2001