Globalization and China’s Economic and Financial Development

Abstract: This paper surveys China’s globalization in terms of in and out flows of goods, capital,

information/technology and people from both the Chinese and the Western, especially American,

points of view. It includes a discussion of the issue of revaluation of the RMB.

Globalization and China’s Economic and Financial Development

1

To understand China’s economic reform and development since 1978 one may

conveniently divide the topic into its domestic and international aspects even though the

two are closely related. It is the purpose of this essay to examine the international aspects

as China has taken part in the process of world economic globalization, a salient feature

of world history today. The Chinese leader Deng Xiaoping who initiated and directed

economic reform from a planned to a market economy understood the importance of

globalization and adopted what he called an “open-door policy” as an essential part of his

reform program.

The term globalization refers to the crossing of national boundaries. It means the flow of

goods, capital, information/technology and people across national borders. China

practiced globalization in the Han dynasty (206BC-220AD) when trade took place

between the Han Chinese and neighboring people in the North-west through the Silk

Route. During the Tang dynasty (618-901) trade flourished and the Silk Route expanded

as Chinese traded with the Romans. However, in the Qing Dynasty and in the period of

the PRC up to Deng Xiaoping’s open-door policy China tried to close its doors and

resisted globalization. I will survey the accomplishments of globalization for China’s

economic development and clarify some controversial issues concerning globalization.

1. Foreign Trade

First consider foreign trade or the flow of goods across national borders. Since 1978

China has encouraged free trade and abolished trade restrictions step by step. The

government has changed its policy from the administration of foreign trade by the

Ministry of Foreign Trade, to giving provincial governments much autonomy in foreign

trade and to allowing private enterprises to engage in foreign trade. The total volume of

foreign trade or the total volume of exports and imports increased from 20.64 billion US

dollars in 1978 to 620.8 billion in 2002, accounting for 65 percent of GDP and was

growing at the rate of 35 percent per year. In 2004, the trade volume reached 1.1 trillion

US dollars, and had a growth rate of 30 percent. China became the third largest trading

country in the world, next to the United States and Germany.

Today exports from China can be found all over the world. In terms of US-China

economic relations exports from China have benefited many Americans in providing

them with high-quality consumer goods at low prices, but have also generated resentment

and resistance by some American manufacturers and workers. Chinese exports to the US

may hurt some US industries producing similar products. US workers in these industries

may suffer temporarily, but in the long-run the labor market is able to adjust as new

industries are developed to hire the displaced workers. In the long run, the aggregate

unemployment rate (now at 5 percent) has not been visibly affected by the American

imports of foreign goods. Note also that exports from China, in fact about 60 percent of

them, are produced by foreign invested enterprises in China and some are American

companies.

Outsourcing of jobs such as having someone in Asia read X-ray or answer phones has

also created resentment in the United States. From the economic point of view,

outsourcing of jobs as illustrated above is the same as import of services from China. The

effects are the same as for the import of goods produced in China that I just talked about.

Such imports are good for China and for US although some workers may be displaced

temporarily. Although this point is valid, Professor Greg Mankiw of Harvard and at the

time Chairman of the President’s Council of Economic Advisers got into trouble when he

made this valid point in a Congressional hearing in 2004 because such a viewpoint can be

unpopular for American workers and politicians.

As an importer China provides a large market for foreign manufacturers and has gained

economic power as a result. Demand for imports to China propels economic growth of

other countries in the world. China first took a mercantilist stand in the restriction of

imports, but after the rapid expansion of Chinese exports, the table has turned as some

developed countries including the US are considering the imposition of restrictions on

imports from China. The imposition of quotas on textiles from China is an example.

In 2001 China joined the World Trade Organization. Membership in WTO required

China to lower its tariffs for manufacturing as well as agricultural products. The lowering

of tariffs helped increase competition for Chinese manufacturers and farmers and provide

cheaper products for Chinese consumers.

Foreign trade has helped economic growth in China in three aspects. First international

specialization that takes place as each country produces the goods for which it has a

comparative advantage in producing will enable the country to obtain more goods than by

domestic production alone. Second, exports are a part of aggregate demand and an

increase in aggregate demand helps increase the country’s national output. Thirdly, trade

together with foreign investment has brought in modern technology and method of

management that has increased productivity in China.

2. Foreign Investment

A. Flow of physical capital in the form of foreign direct investment has been good in

promoting China’s economic growth. Since economic reform started in 1978 China’s

policy concerning foreign investment has made a 180 degree turn, from treating it as a

form of exploitation by foreigners to welcoming it for China’s economic development. In

the years 2001 to 2003, the amounts of direct foreign investment actually utilized were

respectively 49.7, 55.0 and 56.1 billion US dollars. Foreign investment has provided

physical and financial capital, technology, and management skill and practice to China.

However foreign investment is not a fundamental economic factor in China’s rapid

growth but only a vehicle propelling that growth. There are three fundamental factors,

namely (1) abundance of high-quality human capital that includes skillful and

hardworking laborers and resourceful entrepreneurs, (2) sufficiently well functioning

market institutions and (3) the position of a late comer that can adopt modern technology

from the more developed countries. These three fundamental factors have enabled China

to attract foreign capital; otherwise the capital could have been invested elsewhere.

Now China is exporting capital, not only to less developed countries but also to the

United States. Chinese investment has helped the economic development of some Asian

and African countries. Investment in the United States is illustrated by the attempt in the

Spring of 2005 by the Chinese National Offshore Oil Corporation Cnooc to buy Unocal

in the United States although the attempt turned out to be unsuccessful. The attempt is a

part of the free flow of capital.

From the viewpoint of the United States, export of capital from US to China that takes

place when a US factory moves from Cleveland to Shanghai is also considered a case of

the outsourcing of jobs as the factory is supposed to go to Shanghai to take advantage of

the less expensive and good quality labor in China. This case of outsourcing of jobs is

different from simply buying goods or services from China that I talked about earlier

since it takes the form of foreign investment. Capital flows to China in this case but not in

the previous case that involves only foreign trade. Such an investment is good for the US

as it raises US GNP. The reason is that what this piece of capital can produce in China is

more than it could be producing in the US; otherwise the factory would not have moved.

Therefore the move increases total output of the US which the economists call gross

national product or GNP. The move, however, has a harmful effect on the workers in

Cleveland who lose their jobs when such a factory moves. As in the case of competition

from imports from China, there will be job loss in selected industries in the short run

But aggregate employment in the US in the long run will not be affected.

In the course of globalization there is movement of resources between nations. The

movement is good for each nation in the long run but may have harmful effects in the

short run for a segment of the population. The same can be said about the movement of

economic resources between different regions of one country. In US history, the

movement of textile factories from New England to the South to take advantage of the

lower labor cost is good for the country’s economic development, both in New England

and in the South. In New England some workers were displaced during the move but

other industries were developed and people were employed again without leading to an

increase in the unemployment rate in the region.

On the negative side, there may be environmental problems associated with new factories

built in the course of globalization, but this problem exists for domestically financed

factories and for economic development in general. The Chinese government has paid

serious attention to environment protection. Economists try to balance the harm from

possible damage to the environment with the gain in having more output. In general

poorer countries in the course of economic development are willing to accept some

environmental degradation in exchange for more output but they should be aware of the

damage which may be long-lasting.

B. Concerning financial investment, the free flow of financial capital is one objective in

the development of financial markets. China welcomes foreigner to invest in its stock

markets in Shenzhen, Shanghai and Hong Kong, and also desires to invest its capital

abroad. Movement of financial capital is one aspect of the free flow of resources to where

they yield the highest return so that total output of the world would be larger. In this

connection I would like to call your attention to the fact that the working of the free

market involving the free flow of resources was well understood by the great Chinese

historian  of the Han dynasty. In chapter 69 entitled “The biographies of the

money markets” of his book Historical Records he wrote:

“There must be farmers to produce food, men to extract the wealth of mountains and

marshes, artisans to produce these things and merchants to circulate them. There is no

need to wait for government orders: each man will play his part, doing his best to get

what he desires. So cheap goods will go where they will fetch more, while expensive

goods will make men search for cheap ones. When all work willingly at their trade, just

as water flows ceaselessly downhill day and night, things will appear unsought and

people will produce them without being asked. For clearly this accords with the Way and

is in keeping with nature.” What he calls nature is what we call the law of economics.

On the negative side of the free flow of financial capital it enables financial crises to take

place, including the Asian financial crisis of 1997-8. This crisis did not affect China very

much as the Chinese government has had a wise policy of adopting international financial

reform at a moderate speed especially in allowing a gradual opening of financial markets

and of the capital account in international finance because economic institutions are not

ready. But globalization itself is good for the reform of banking and financial institutions

in providing foreign competition to push the reform forward. Using foreign competition

to speed up economic reform was the main reason for the former Premier Zhu Rongji in

leading China to join the WTO in the first place.

The strategy of using foreign competition to speed up economic reform of domestic

institutions, however effective, has limitation in promoting the reform of China’s banking

system and large state-owned enterprises for two reasons. First, while Chinese

government officials have been pragmatic in most aspects of economic reform, they have

been conservative and slow in allowing foreign banks to enter the domestic market.

Second, Chinese banks and state enterprises are state-owned and controlled and operated

by bureaucrats who can take advantage of the economic power conferred upon them to

benefit themselves. Corruption is a major hindrance to economic reform at the current

juncture of China’s economic development as I have discussed elsewhere. See

(2005) for a discussion of the problem of corruption and  (2005) that

contains measures for China’s financial reform that may be hindered by corruption as

well.

The Exchange Rate Issue

An important determinant of foreign trade and foreign investment is the exchange rate. A

low value of Chinese RMB makes Chinese exports cheaper and investment in China

more attractive if the investment is to produce for export. Many countries in the world

including those in the European Union, Japan and Taiwan, have adopted the flexible

exchange rate system while China adopted a fixed exchange rate up to July 2005 but the

government did change the fixed rate several times in the 1980s and early 1990s relative

to the US dollar as its government deemed appropriate. Most recently the Chinese

government has adopted a managed floating rate with the government deciding the rate

around a small band daily relative to the value of a basket of foreign currencies but the

basket is not explicitly specified. There are pros and cons of the fixed and the floating

exchange rate systems. (.) A fixed

exchange provides an anchor for the government in the conduct of its monetary and fiscal

policy. It limits the discretionary power of the government in the exercise of its monetary

and fiscal policy that may lead to excessive inflation or deflation. An expansionary

monetary or fiscal policy would lead to inflation and lower the value of the currency as

compared with a more stable US currency. Thus the fixed exchange rate system might be

good for a developing country which has difficulty in disciplining itself in the exercise of

its monetary and fiscal policies. The flip side is the power that it gives up and its

dependence on the monetary policy of the US if the exchange rate is fixed as in terms of

the US dollar. I was one of the several economists who proposed a flexible exchange rate

for Taiwan three decades ago. After the Taiwan government adopted it the economy

seemed to function well.

Let us consider two questions: First, what exchange rate regime should China adopt?

Second, given the current regime of a managed float should the RMB be revalued? Since

the Chinese government has already declared its position to adopt a more flexible regime

in the long run as the situation permits, I should not comment on the first question.

Making recommendations on policy which is already decided is fruitless. Let me just

point out that in the adoption of a suitable exchange rate system the Chinese government

is practicing its tried and proven method of reform of economic institutions, namely,

gradualism and experimentation in order to decide on a good system and when to adopt

it.

On the second question many foreign governments including the US government have

pressured the Chinese government to raise the value of the RMB for their own benefits.

Some US economists including Alan Greenspan have said that the effect of the exchange

rate of the RMB on the US economy is rather limited. Concerning the effect on the

Chinese economy, I believe that the RMB is still undervalued and revaluation is good for

the Chinese economy. We have witnessed the undervaluation of the RMB or the

overvaluation of the dollar in terms of the RMB by the excess supply of the dollar in the

foreign exchange market in China due to its high price and the resulting accumulation of

a large amount of foreign exchange reserves in China in the amount of over 700 billion

US dollars. The increase was over 200 billion just in 2004 alone. An undervalued RMB

has caused the large export surplus and large inflow of foreign investment and the

associated large inflow of foreign exchange reserves. The inflow of foreign exchange has

been converted into RMB and has caused a rapid increase in money supply M2 in 2002.

The rapid increase in money supply has led to great increases in investment and output in

2003-5 and in prices in 2004-5 (while from 1998 to 2002 China had a very stable or

slightly decreasing price level). A more detailed discussion of the effects of money

supply on aggregate output and prices can be found in  (2004).

Thus the undervalued RMB was a main cause of an overheated Chinese economy in

2003-4. The Chinese government tried to slow down the overheated economy by the

administrative means of controlling the extension of credits by banks and limiting the

number of construction projects. If the banks had had no extra money to lend out in the

first place, there would have been no need to control the amounts of bank credit and to

restrict investment in construction which was financed by such credits. Thus an

undervalued RMB is the culprit of the overheated Chinese economy. To solve the

potential problem of overheating and inflation in the future the government needs to raise

the value of the RMB substantially. Another reason for revaluation of the RMB is that a

high valued RMB would enable the Chinese to buy more imports for consumption and

economic development rather than accumulating an extremely large amount of foreign

reserves that are mostly lying idle or earning a small amount of interest from investing in

US Treasury bonds.

3. Transfer of Information and Technology

Together with the flow of goods and capital is the transmission of information and

technology. This has benefited China by upgrading its technology. So far China has

mainly been an importer of technology but it will soon be an important exporter as it is

already an exporter of technology to some less developed countries. In recent years the

Chinese government has spent a large amount on higher education and Chinese

universities, especially the top ones, improved rapidly. See (2005). This

will help China to become one of the world leaders in technology.

As of today, China has already helped many developing countries in Asia and in Africa

by investing in these countries, providing them with technology, labor and assisting them

in economic development in general. China seems to have done very well in this regard,

in view of the fact that it has its own poor regions to develop also. Chinese diplomacy is

based on mutual respect, treating a small country as equal and trying to help solve its

problems if it is feasible. The effort of the Chinese government in assisting the

developing countries and its diplomatic posture as a friendly country are doing as much

in increasing China’s influence in the world scene as its rising economic power.

Returning to China as an importer of technology, we know that the import of technology

from the US to China is good for China, but is it good for the US? A part of the answer is

yes. The main reason for capital and technology to move from US to China is to get a

higher return to capital. It raises US GNP as I have explained and that is good for the US.

In the very long run, however, one can make a case that this transfer of technology might

be bad for the US although it is not necessarily so. To make the case, the transfer may

enable China to improve its technology in the future to a point when it will overtake the

US in the industries in which the US now has monopoly power. To illustrate, when the

Japanese took over much of the monopoly power of the US automobile industry in the

1950s and 1960s, the US lost is comparative advantage in producing automobiles. One

can argue that the transfer of technology in producing automobiles from the US to Japan

was bad for the US. See Samuelson (2004) which makes the simple point that when there

is technological change that improves the technology of country 1 (China) in the

production of good 1 in a two-good economy, the welfare of country 2 (United States)

may decrease if it can no longer specialize in producing good 1 and does not engage in

trade with China.

This above argument that the US may lose economically by transferring technology to

China is different from the fear of military threat from China after it acquires the

technology. The fear of military threat can justify restricting the transfer of military

technology to China. I personally believe that the Chinese government has no desire for

military expansion but many Americans have an opposite view. This is not an issue that

can be settled by further discussion in this essay.

4. Migration of People

Fourth, about the movement of people. The Chinese have moved to many parts of the

world to find jobs, to settle down or to get educated. They have contributed to the

countries where they have settled or are visiting. The out migration of Chinese has been

considered a problem for China especially when the emigrants are educated or have

skills. The problem is called brain drain. This problem was considered an issue much

discussed in Taiwan in the 1970s but is not considered a serious problem in China today.

I do not consider it a problem for China. Even when the overseas Chinese live abroad,

they are helping China by short-term visits as lecturers, traders and advisers. More

overseas Chinese will return as opportunities improve in China as the number returning

has continued to increase in recent years. People moving to live and work in China have

benefited China also. They show the Chinese how to improve their life style by living in

other ways if desired and may help improve the legal system and legal behavior of the

Chinese people. Here again the free movement of people has more benefits to the movers,

to their home countries and to the host countries than possible harm.

statement “So cheap goods will go where they will fetch more, while expensive goods

will make men search for cheap ones” applies not only to the free flow of goods, but of

capital and people as well.

In China’s economic globalization there is one aspect of the movement of people which

is very important and unique and is independent of foreign investment and foreign trade.

This is the movement of overseas Chinese all around the world who are educated and

experienced in their profession and are willing to return to China to give lectures and

advice in the process of reform and development. This is an important component of the

human capital contributing to China’s economic development. It is unique to China in

terms of the number of overseas people involved and their willingness to help, although

Israel has had a similar experience as well. The contrast with the case of Russia’s

economic reform and development is sticking. Here the open-door policy has worked

again.

Conclusion

After examining the facts of globalization for China we can all recognize that the opendoor

policy first advanced by Deng Xioping when China had a very different ideology

has been a great success in helping to modernize China. The dream of the Chinese people

for over one hundred sixty years since the Opium War of 1840 to modernize China has

been finally realized. A main contribution to the modernization process is the open-door

policy which allows globalization to take place.

In this essay we have surveyed the four important aspects of globalization in China’s

economic reform and development since 1978. Understanding the nature and historical

development of China’s open-door policy for the purpose of modernization will enable us

to appreciate the forces at work that will propel China’s economic growth in the future

and the role of China in the world economic community.

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