The Sectoral Impact of China s Access to the WTO - A Dynamic CGE Analysis. Li Xuesong, Arjan Lejour * June 2000 ABSTRACT

Transcription

1 The Sectoral Impact of China s Access to the WTO - A Dynamic CGE Analysis Li Xuesong, Arjan Lejour * June 2000 ABSTRACT This paper focuses on the sectoral impact of China s accession to the WTO based on a recursive dynamic CGE model for China. We take into account both tariffs cut and non-tariff equivalents reduction. Moreover, we model also the phasing out of the MFA agreement and take account of the broad tariff exemptions. The 40 sectoral dynamic model is based on the latest database in The analysis is carried out We find GDP rises 0.8 percent and the household welfare gain (EV) reaches $4 billion in 2010 for the whole WTO package, but the exchange rate is devaluated slightly. Export expands in most sectors especially in textiles and wearing apparels, but falls in agriculture, food products and tobacco and electronic and telecommunication equipment. Import goes up in almost all sectors especially in such high-protected sectors as agriculture, transport equipment, post and telecommunication service, and finance and insurance. Most industrial sectors benefit from China s access to the WTO, especially textiles and wearing appeals, but many service sector are hurt. Li Xuesong Economic Modeling Division Institute of Quantitative &Technical Economics (IQTE) Chinese Academy of Social Sciences (CASS) Jianguomennei Street 5 Beijing, China lixs@public.bta.net.cn Arjan Lejour International Economic Analysis Division CPB, Netherlands Bureau for Economic Policy Analysis P.O.box GM The Hague The Netherlands aml@cpb.nl * The authors would like to express their thanks to Wang Tongsan, Hans Timmer, Zhang Zhongxiang and Nico Van Leeuwen for their help of this work. 1

2 1. Introduction About 14 years ago, China launched its campaign to enter the GATT/WTO. After finishing hard negotiations with its trading partners, China will become WTO member this year. Since 1978, many scholars have studies the impact of different rates of tariff reductions by China on itself and other economies. Most studies use an applied general equilibrium model, such as the GTAP model (Hertel, 1997), G-Cubed world model (McKibbin and Wilcoxen, 1998). Almost all simulation results show that both China and its major trading partners (US, European Union, Japan, and countries in South- East Asia) will benefit from China s participation in WTO. Some results also point out that China (including Hong Kong) will be the biggest winner with net welfare gain of about US$ 30 billion (Bach, et al., 1997; Wang, 1997) annually. At a sectoral level the picture is completely different. The overview of McKibbin and Wilcoxen (1998) shows the lack of agreement on the sectoral effects. Even authors who use the same model and data (GTAP) predict different sectoral effects. Bach et al. (1997) pick Wearing Apparel and Light manufacturing as winners and Textile as the loser. Yang (1996) predicts that Textile is the second winner behind Wearing Apparel. Lejour (2000) concludes from comparing simulations including and excluding tariff exemptions that modeling of exemptions influences the sectoral effects significantly. Another research (Zhang Shuguang, etc., 1999) provides an analysis of the static costs of trade protection and the corresponding static benefits of liberalization for 25 highly protected goods in China based on a computable partial equilibrium model. The results show that the short-term costs of trade liberalization for those highly protected goods will be substantial both in terms of lost domestic output (a drop of about $40 billion, or 32 percent of pre-liberalization output in the protected sectors) and lost jobs (about 11.2 million workers in the protected sectors). However, the long-term benefits of liberalization would be substantial. The static benefits to consumers (the so-called Harberger rectangles and triangles) from fully liberalizing the protected sectors would amount to $35 billion annually (about 1.1 percent of GDP), and the pure efficiency gains would be about $5 billion annually. An important reason for these differences is the lack of agreement of the size of tariff cut, in particular on relative cuts, across sectors. The underlying reason is a lack of high quality data on import protection. Ideally, these data should not only include statutory tariff rates but also tariff exemptions, and indirect subsidies and non-tariff barriers. For example, the import tariffs of the GTAP data (McDougall, etc. 1998) are too high to match with the collection rates of import tariffs in China. The World Bank (1994) explains these low collection rates for a great part by tariff exemptions for importing intermediate and investment goods used in exports industries. Most models do not take account of these exemption rates, except for Bach et al. (1996) and Li and Wang (1998). However, bilateral data on a sectoral level including the final destination of imports are not available. For this reason it is difficult to introduce the exemptions in an accurate way. This paper focuses on middle term and sector level impact of China s accession to the WTO based on a recursive dynamic CGE model for China. We take into account both tariffs cut and non-tariff equivalents reduction. We also introduce the current practice of broad tariff exemptions for imports used in production. Moreover we model the elimination of the MFA agreement. The model is a recursive dynamic CGE sectoral model for the Chinese economy, which is developed on the basis of Zhang (1998) and Garbaccio (1994). Additional modeling of the tax rebates for exports, the broad tariff exemptions, the MFA and non-tariff barriers is inspired by the work of Li and Wang (1998). The model is calibrated on the new Social Accounting Matrix (SAM) for China from This SAM discriminates many sectors such that we are able to analyze many service and 2

3 manufacturing sectors. We discriminate 40 sectors. The analysis is carried out for the period 1997 to The structure of this paper is organized as follows. Section 2 summarizes trade liberalization in China during and provides sector tariff rates, exemption rates, and non-tariff equivalents used in the model. Section 3 outlines the structure of the Chinese CGE model. Section 4 describes the design of scenarios and the baseline results. Section 5 presents the simulation results ( ). Section 6 shows sensitivity analysis, and section 7 concludes. 2. Trade Liberalization in China ( ) Prior to 1978, China s trade system was centralized and its objective was pursued in a relatively non-transparent way through the decisions of planning and trade officers. The process of reform began in 1978 has involved the gradual development of instruments for indirect control and has resulted in a progressive restructuring of China s foreign trade system into one whose basic operation is more comparable to the foreign trade system of developing market economies. In particular, during the period , China has actively reformed its trade policies, bring its practices closer to international norms. 2.1 Tariff Reductions ( ) From 1949 to 1998, China has made Import and Export Tariff Rule for there times in total. The first one was promulgated in 1951, the second one was made in 1985, and the third one was formulated in Since 1992, when the third Import and Export Tariff Rule by Harmonized System (HS) was promulgated, trade liberalization has accelerated and further tariff cuts have been undertaken in China for six times during Table 2.1 summarizes the process of these reductions. Table 2.1 Six Times of Tariff Reductions in China ( ) (%) Dates Adjusted Commodities Unweighted Average Tariff No. Of Reductions or Tariff Lines Rates After Adjustment 0 Jan 1,1992 The Third "Tariff Rates Rule" Dec 31, tariff lines Dec 31, tariff lines Jan 1,1994 Car Jan 1,1995 Tobacco,Liquor,Tape,Mobile Apr 1, tariff lines Oct 1, tariff lines 17.0 Source: Yang Shengming, etc (1997). In early 1992, the average unweighted tariff rate was 42.5 percent, by the end of 1992, it had been down to 39.3 percent due to the adjustment for 3371 duty codes by an average of 7.3 percent. In December 1993, China again reduced import tariffs, this time for 2898 duty codes by an average of 8.8 percent and which brought the average unweighted tariff level down to 36.4 percent. In January 1994, the import tariff rates for cars were declined and then the average tariff level was lowered to 35.9 percent. At beginning of 1995, the rates for tobacco and liquor, magnetic tapes, middle automobiles, etc. were reduced and therefore the tariff level lowered to 35.6 percent. 3

4 Besides these, another two times of significant reductions on tariff levels was implemented on April 1, 1996, and October 1, 1997, respectively. The broad range of tariff reductions in 1996 involved 4997 duty codes, i.e percent of the total tariff lines (6554), and the tariff rates were lowered by a big margin of 35 percent on average. After the adjustment, the average tariff rates declined significantly to 23.4 percent in comparison with 35.6 percent in The reduction in October, 1997 also involved lots of tariff lines and cut the rate level by a big margin, after that time, the average unweighted tariff rate has been brought down to 17.0 percent. 2.2 Non-Tariff Reductions ( ) Besides tariff reductions described above, China has also gradually moved toward to eliminate nontariff barriers. Table 2.2 presents the main non-tariff barriers reductions in China during In 1992, the number of commodities under quota control was lowered from 212 to 183, and at the same time, import licenses for 16 categories was removed. On December 31,1993, import licenses for another 9 categories of 283 kinds of commodities including steel, medicine, civil aircraft, Black- White TV set was removed. In May 1994, China stopped issuing all mandatory plans for import and export, and canceled the import licenses and quotas for another 195 kinds of commodities. Those included 30 kinds of goods that were to be relieved of requirements by the end of 1994 in accordance with a Sino-US memorandum of understanding. In1995, the import license for another 120 commodities was eliminated. In April 1996, the number of the remaining quotas was cut again by 30 percent. Table 2.2 Non-Tariff Barriers Reductions in China ( ) Year NTBs Reductions 1992 (1) lowered the number of license export commodities from 212 to 183. (2) Removed import license for 16 categories (3) Eliminated import license for another 9 Categories of 283 kinds of commodities including steel, medicine, civil aircraft, BW TV set (4) Stopped issuing mandatory plans for imports and exports. (5) Canceled the import licenses and quotas for 195 kinds of commodities (6) Eliminating import licenses for 120 kinds of commodities (7) Cut the number of remaining quotas by 30 percent. Source: Zhang, Shuguang, etc. (1999) 2.3 Estimates of Tariff Exemption Rates A distinctive feature of China s tariff regime is its relatively minor contribution to revenue generation. Compared to most other developing countries, China s import duties account for a very small proportion of total government revenues. In 1992, China collected only 4.9 percent of the c.i.f. value of imports in duties. In large part, it is China s extensive import duty exemptions and rebate system that accounts for such low collection rates. For comparison purposes, data on import values and the corresponding tariff revenues since 1991 are presented in Table 2.3. The tariff revenue collection rate has declined from 4.9 percent in 1992 to 2.6 percent of the value of imports in There are several reasons bring out such low actual tariff collection rates and such high exemption 4

5 rates in China. First, the broad exemptions are allowed for export production, there are about half of total imports belonging to the processing trade at present. Second, duty concessions of 50 percent are also provided for border trade and materials used by foreign funded enterprises in their production for the domestic market, and duty exemptions are also provided for compensation trade. Table 2.3 Actual Tariff Collection Rates & Exemption Rates in China ( ) [1] [2] [3] [4] [5] [6] Nominal Import Tariff Actual Exemption Year Tariff Rates Values ($bn) Revenues ($bn) Collection Rates Rates Source: SSBC (1998). Notes: The nominal tariff rates in column [1] are unweighted, the actual collection rates in column [4] are weighted. We do not really use these exemption rates in the model, here they are shown for illustrative purposes. 2.4 Sector Tariff Rates, Exemption Rates, and Non-tariff Equivalents Table 2.4 provides the tariff rates for ordinary import, exemption rates, and non-tariff equivalents on sector level to be used in our model. The nominal rates are derived from MFTEC (1997). However, even if we take account of exemptions government revenue based on these nominal tariff rates would be too high. According to table 2.3 the collection rates is only 2.6% in To mimic those collection rates, the nominal rates are reduced by about 50% in the base year. We have tried to maintain the current tariff structure. The column in table 2.4 shows that tariffs are very low in mining products. In most industrial sectors the import tariffs are about 9%. The tariff rate in transport equipment is high, to protect this industry. Also in textiles, wearing apparels and food processing tariffs are slightly higher than the average tariffs is. There are no import tariffs is service sectors. In these sectors the non-tariff barriers are high. In finance and insurance and post and telecommunication the rate reaches 60%. In manufacturing the non-tariff barriers are much lower, except for transport equipment. Non-tariff barriers in agriculture are also high. The levels of the non-tariff barriers are guessed by the authors and partly based on existing sources such as Hoekman (1995). We assume that imports for intermediate use and fixed investment are duty free, therefore the exemption rates can be derived by comparing the volume of intermediate use and fixed investment with that of total domestic use. The resulting exemption rates are also presented in table 2.4. The exemption rates are very high. This corresponds to the analysis of the World Bank (1994) on the low collection rates in China. Exemption rates are low in products that are often used for final consumption, such as agriculture, food processing and wearing apparels. In others sectors like mining, metal industries and chemicals products are often used for intermediate use. As a result the exemption rates are high. These sectors will probably not be heavily affected by trade liberalization because the effective import tariff rate is very low, unless the non-tariff barriers are high. Sectors like agriculture, food processing and wearing apparels are probably much more affected. 5

6 Table 2.4 Sector tariff rates, exemption rates, and non-tariff equivalents in 1997 Tariff rates for Exemption Non-Tariff No. 40 Sectors in the model ordinary import Rates Equivalents 1 Agriculture Coal mining and processing Crude petroleum and natural gas products Metal ore mining Non-ferrous mineral mining Manufacture of food products and tobacco processing Textile goods Wearing apparel leather furs & related products Sawmills and furniture Paper printing and record medium reproduction Petroleum processing and cooking Chemicals Nonmetal mineral products Metals smelting and pressing Metal products Machinery and equipment Transport equipment Electric equipment and machinery Electronic and telecommunication equipment Instruments meters cultural and office machinery Maintenance and repair of machinery and equipment 22 Other manufacturing products Scrap and waste 24 Electricity steam & hot water production and supply Gas production and supply 26 Water production and supply 27 Construction 28 Transport and warehousing 29 Post and telecommunication Wholesale and retail trade 31 Eating and drinking places Passenger transport Finance and insurance Real estate 35 Social services Health services sports and social welfare Education culture and arts radio film and television Scientific research 39 General technical services 40 Public administration and other sectors Average Sources: SSBC (1998), MFTEC (1997), and own calculations. 6

7 3. Model Description 3.1 Agents, Endowments and Sectoral Classification In this China s recursive dynamic CGE model there are four types of agents - households, firms, the government, and the rest of the world, and two types of endowments - labor and capital. All foreign producers and consumers are included in the rest of the world, which are assumed to have the same tastes. Households consist of numerous homogeneous domestic consumers. Firms in each sector include numerous producers with same production technology. 40 sectors are distinguished in the model, as shown in table 2.4. There is one primary industry sector, Agriculture. Twenty-six secondary industry sectors are distinguished, from No. 2 to No. 27 in table 2.4, and thirteen tertiary industry sectors, from No. 28 to No. 40 in table Model Structure The model consists of eight blocks. These blocks cover prices, production, investment, income, expenditure, trade, equilibrium identities, and recursive dynamics. The model and its data set are described in detail in Zhou, Mingwu, etc (1998) and its second dynamic version (reviser: Li, Xuesong, 1999). The model is developed on the basis of Zhang, Zhongxiang (1998) and Garbaccio, Richard F. (1994). Price Block The domestic prices of imports and exports are in the Chinese currency yuan, and incorporate an assumption of price taking on the world markets (the small-country assumption). The domestic price of imports is calculated as the tariff and non-tariff equivalent times world import price and the exchange rate, which is the price of a dollar in terms of the Chinese currency. The domestic price of export equals export tax, subsidy and MFA equivalent times world export price and the exchange rate. The composite commodity price and domestic sale price (output price) reflect the linear homogeneity of the constant elasticity of substitution (CES) import aggregation and constant elasticity of transformation (CET) export transformation functions. These mean that the users minimize their costs by using the composite commodities combining import and domestically produced goods, and the producers maximize their profits by selling products on the domestic and foreign markets. The sectoral net prices (value added prices) are derived by subtracting indirect taxes from output prices, then deducting the cost of intermediate inputs. The sectoral user price of capital is computed as fixed share of the average user price of capital. As we know, all supply and demand functions in the CGE model are assumed to be homogeneous of degree zero in prices. Consequently, only relative price matters to determine the quantities of goods supplied and demanded. We focus here on economic issues like growth, resource allocation, and structural changes rather than analyzing the causes of inflation. Thus, the GDP price deflator is chosen as the numeraire price index, which is fixed exogenously and all other prices are measured relative to it. For simplicity, in the base year all prices are assumed to be equal to one. In this way, the benchmark data are set in value terms, with no need to specify the underlying volumes. Production Block 7

8 As indicated above, there are 40 sectors in the CGE model. All sectors are supposed to operate at constant returns to scale. The production technology in each sector is represented by Cobb-Douglas (CD) - Leontief function, it combines Leontief specification for intermediate goods with Cobb- Douglas aggregations of capital and labor, the latter in fact forms the composite capital-labor inputs or value added outputs. Given the production technology described above, optimal demands for the inputs of labor and capital could be derived by the assumption that producers minimize their production costs. Demands for intermediate goods are determined by fixed input-output coefficients. Investment and Capital Accumulation Block In the equilibrium block to be discussed later, the aggregate nominal gross investment will be determined by one of the macroeconomic balance conditions. Here we discuss the allocation of aggregate investment across sectors. In the CGE model, two kinds of capital investments are distinguished, fixed capital investment and circulating capital investment. Circulating capital investment is the so-called investment in new inventories or changes in stocks. Circulating capital investment by sector of destination is determined by exogenous inventory coefficients times production. The inventory coefficients define the amount of circulating capital goods required as inventory in the period t to produce one unit of good i in that period. Total nominal fixed capital investment is computed by subtracting total nominal circulating capital investment and the government overall budget deficit from the aggregate nominal gross investment. And then the total fixed capital investment is allocated among sectors of destination by exogenously given share parameters, which sum to one over all sectors. Total depreciation of fixed capital stock is simply the sum of sectoral depreciation of fixed capital stock, which equals sectoral depreciation rate times sectoral fixed capital stock. Income Block Labor income is simply the product of the wage rate and employment. The wage rates in each sector are assumed to grow at the same rate. This specification for structural rigidity of sectoral wage rates reflects the wage match behavior among sectors. Moreover, the overall growth rate of wage in each period is assumed to be flexible enough to clear the labor market that is treated as though it is competitive. In nominal terms, the wage rates thus adjust according to the Laspeyres price index of consumer goods. Capital income is determined as the residual of total value added minus labor income. Net firm income, which will be distributed to households, is defined as total firm income (capital incomes plus government subsidies) minus firms (direct) tax revenue to the government, depreciation, and firm saving (retained earnings). Firm savings are determined through a fixed rate of firm retained profits. Households receive income from their role as labors and as owners of capital (private businesses and farms) and from the government in the form of transfers and price subsidies. Households also receive remittances from abroad. Household disposable income equals household income less household income tax. Household savings are computed as disposable income times by the marginal propensity to savings. The government receives revenue from indirect and direct taxes on firms, household tax on household income, tariffs and non-tariffs on imports, and foreign borrowing. A short fall in revenue 8

9 is made up though the overall budget deficit. Total savings are composed of firm savings plus depreciation allowances, household savings, government savings, and net foreign savings. Nominal GDP is calculated at market prices. It is determined as the sum of value added, plus indirect taxes, tariffs, non-tariffs, and rent of MFA. Expenditure Block The expenditure block determines the demand for goods and services by households and the government. Household spending of consumer goods and services is determined through a modified linear expenditure system (LES). Government consumption demand is determined through fixed expenditure shares of aggregate real government spending on goods and services. Real GDP is computed from the expenditure side, and is the sum of final demand, plus exports, and minus imports. Trade Block As most CGE models, here Armington specification is also adopted to model foreign trade block in order to capture the empirical reality of two-way trade in most commodities. This implies that imported goods are imperfect substitutes for domestically produced goods, so product differentiation prevails. Accordingly, our CGE model has relative-price-dependent import demand and export supply functions, reflecting the choices by agents at home and abroad between the goods from two sources of supply. This treatment of imports and exports partially insulates the domestic price system from changes in world prices. In addition, the small-country assumption for China is imposed, which implies that the world (dollars) prices of imports and exports are considered to be exogenously determined. According to Armington, the domestic producers and consumers are taken to demand a composite good that is a CES aggregation of imported and domestically produced goods with the same sectoral classification. Import demand functions represent the first-order conditions derived by minimizing the cost of purchasing the composite commodity subject to the CES aggregation function. Changes in the demand ratios of imports to domestic sales are brought about by changes in the domestic market to import price ratios. The price elasticity of substitution determines the degree in which the domestically produced goods are substituted for imported goods. In the classic theory of trade, price elasticity of substitution is infinity, and the domestically produced goods are perfect substitutes for the imported goods. In the case where price elasticity of substitution is zero, the demand ratio is fixed, and the goods from two sources of supply are perfect complements. In all other cases but the special ones, as price elasticity of substitution gets larger, the sensitivity of the demand ratio to changes in the relative prices rises. In sectors in which there are no imports, the CES import aggregation function is dropped, and the composite good demand is simply equal to the domestic sales. The specification for exports is similar to that for imports. The CET export transformation functions describe how production can be transformed into goods for either domestic or foreign markets. The export supply functions represent the first-order conditions derived by maximizing profits from sales on domestic and world markets subject to the CET transformation function. The changes in the ratios of exports to domestic sales are brought about by changes in the export to domestic market price ratios. The price elasticity of transformation determines the degree in which the domestic sales are transformed to exports. For sectors with no exports, the transformation function is dropped and domestic output equals the domestic sales. 9

10 Equilibrium Block Our CGE model is designed as a time-recursive dynamic structure. The agents are assumed to behave myopically, and only react to current prices. Consequently, the economy evolves in a sequence of period-related, but intertemporally uncoordinated, temporary flow equilibrium as compared with an intertemporally equilibrium under the assumption of perfect foresight. This temporary equilibrium is taking place in each period such that the market clearing conditions for commodities and primary factors are satisfied. There are three clearing conditions. The first one is product market clearing, which imposes the condition that the total supply of each composite commodity must equal all domestic demands in the same category. The second condition is labor market clearing. Generally, labor is viewed as homogeneous and mobile across sectors in response to the demand changes for it. This standard assumption is also used in our model. Furthermore, full employment and supply of labor being inelastic are assumed. Therefore, the labor market clears in each period when total labor demand by sectors, which is the sum of endogenously determined demands for labor in each sector, is equal to the exogenously projected supply of total labor force. The third condition is capital market clearing. In the short run capital is sector-specific. Therefore, unlike the single clearing condition for labor market discussed above, for capital there exists a separate market clearing equation for each sector in each period. This reflects the assumption that, even in the short run, labor is mobile across sectors whereas capital, once installed in a sector, is immobile. However, in the long run, capital is assumed to be intersectorally mobile. Thus, in each period the capital market clearing condition, which is similar to that of labor market, holds given the exogenously determined amount of total fixed capital. Except the three market clearing conditions, there are two macroeconomic balance conditions for the current account and saving-investment. As far as the surplus on balance of trade (balance on the current account) is concerned, it is determined as the sum of net foreign borrowing, net remittances from abroad, net foreign savings, and less foreign trade deficit. The effect is that the exchange rate serves as the equilibrium variable to ensure the balance of trade constraint. Alternatively, the exchange rate can be fixed (relative to the price numeraire), with the balance of trade and either net foreign borrowing or net foreign saving becoming endogenous. The final macroeconomic balance imposes that total savings equal total investment. As discussed above, total savings are consisting of firm savings plus depreciation allowances, household savings, government savings, and net foreign savings. The model is a saving-driven model. This is so-called neoclassical closure, which implies that the high rates of savings that have characterized the Chinese economy are likely to continue in at least the medium-term future. Recursive Dynamic block The recursive dynamic block describes the total capital stock year by year, the total capital stock in period t is consisting of new gross investment in t-1 plus old capital stock in t-1 after subtracting the total depreciation. As to total labor force and total factor productivity (TFP) for the dynamic part, they are set to be exogenous in table 3.1 over the period These dynamic conditions imply that the growth rates for real GDP and total capital stock for dynamic are calculated endogenously. As discussed above, the GDP deflator serves as the price numeraire in the model. For simplicity, it is set at unity in the base year. The price numeraire is assumed to rise at an annual rate of 3% during 10

11 Table 3.1 Exogenous growth rates in the model (annual % change) Labor force 1.0 TFP 2.7 GDP deflator Scenarios Design and Baseline Results ( ) In order to simulate the impact of China access to WTO, we design one baseline scenario and four simulation scenarios during , as shown in table 4.1. Table 4.1 Scenarios design B Baseline scenario (1) All tariff rates, exemption rates, non-tariff equivalents, and MFA keep the same level during as those in (2) All other tax rates keep unchanged. S1 Tariffs Reduction scenario (1) All tariff rates cut 50% gradually from 1998 to (2) And then keep the 2005 tariff level during S2 Non-tariff equivalents reduction scenario (1) Non-tariff equivalents cut 50% gradually for the primary and the tertiary industry from 1998 to (2) Non-tariff equivalents cut 80% gradually for the secondary industry during (3) And then keep unchanged during (1) MFA phases out gradually during S3 MFA Phases out scenario S4 Whole WTO package (1) S1, S2, and S3 combined. In the baseline we assume that trade policy will not change from 1997 onwards. This implies that we keep the current level of import tariffs, exemption rates, non-tariff barriers constant such as these are presented in section 2. Moreover we assume that the Multi-Fibre Agreement will still exist. In the policy simulations we modify the trade policies, which is one of the negotiated conditions to enter the WTO. First we analyze the reduction in tariff barriers. We reduce the import tariffs in Agriculture and manufacturing by 50% between 1998 and In services there are no import tariffs but only other trade barriers. The second policy simulation (S2) assumes that the level of the non-tariff barriers is reduced. In manufacturing non-tariff barriers are reduced by 80% and in agriculture and services by 50%. The barriers are reduced in the period 1998 to Because the initial non-tariff barriers are much higher in agriculture and services, the effects or reducing these barriers by 50% is larger than for manufacturing. The third policy simulation (S3) assumes the elimination of the MFA in This will largely affect the sectors Wearing Apparels and Textiles. In the end we combine all these policy simulations as S4. In all policy simulations we will analyze the effects of trade liberalization on GDP, value added, household and government consumption, gross fixed investment, export, import, and exchange rate. This analysis is carried out by comparing the results from the baseline simulation with the tradeliberalization simulation. 11

12 Table 4.2 summarizes the main macroeconomic results of the baseline in 1997 and As shown in table 4.2, GDP is expected to grow at an average annual rate of 7.8% from 1997 to According to the Chinese Proposals during the period , the GDP will double in 2010 compared to Given that growth of the labor force is very small (see table 3.1), which means that its contribution to output growth is also small in absolute terms, such rapid economic growth is attributed partly to the increased TFP and mainly to increased capital stock. This reflects the long-established policy of the Chinese policymakers to rely on capital accumulation as the primary source of economic growth. The gross fixed investment is expected to grow at faster rate than GDP. Figures provide some important change trends of economic indicators in the baseline during , which including GDP, value added structure, export and import, export and import inside the three kinds industries, export structure, import structure, and labor force structure. Table 4.2 Main Macro results of baseline (trillion yuan, 1997 price) Year Annual % change GDP % Gross fixed investment % Household consumption % Government consumption % Total import % Total export % CPI (price level) Exchange rate per dollar Figure 4.1 shows baseline GDP volume change trend from 1997 to 2010, and Figure 4.2 presents value added structure change trend. In 1997, the percents of the primary, secondary and tertiary industry in total value added are 20%, 52%, and 28% respectively. However in 2010, the percent of the primary industry declines to 11%, but the secondary and tertiary industry increase to 58% and 31% respectively. Figure 4.3 shows the baseline change trends of export and import volume during The trade surplus decreases from 410 billion yuan in 1997 to 54 billion yuan in 2010, according to our exogenous assumption. Figures provide change trends of export and import volume for the primary, secondary, and tertiary industry in the baseline respectively, given the total trade surplus as exogenous. Figure 4.4 indicates a small trade surplus in Agriculture sector in 1997 becomes a big trade deficit in Figure 4.5 implies a small trade surplus in the secondary industry becomes a small trade deficit in However, Figure 4.6 indicates trade surplus in the tertiary industry continues to rise, this result relies mainly on the increase in service sectors as wholesale and retail trade, social services including travel, transport, and post and telecommunication in the baseline case. We should mention here why the surplus in the tertiary industry rises so much on the baseline (see Figure 4.6). One important reason comes from the data source. In 1997, the base year, trade surplus in the tertiary industry reaches 25.2 billion dollars, which is quite large according to 1997 Input- Output Table of China. As shown in Table 4.3, if we compare with another source from the Sheet of Balance of International Payments, trade deficit happens in service sectors. Since we don t want to change the data from I-O table directly, therefore the large trade surplus appears in the tertiary industry, as shown in Figure

13 Table 4.3 Different trade data on services in 1997 ($bn) Sources Export Import Trade surplus (1) Input-Output Table (2) Balance of International Payments Figure 4.7 describes the baseline structure change of labor force. In 1997, the percents of the primary, secondary and tertiary industry in total labor force are 50%, 24%, and 26% respectively. In 2010, the percent of the primary industry falls to 38%, in the meantime the percents of the secondary and tertiary industry increase to 30% and 32% respectively. 13

14 Baseline GDP (100 mln yuan,1997 price) Fig 4.1 Baseline GDP Primary Secondary Tertiary 100% 50% 0% Fig 4.2 Baseline Value Added Structure Export Import (100 mln yuan,1997 price) Fig 4.3 Baseline Export & Import 14

15 Export Import (100 mln yuan,1997 price) Fig 4.4 Baseline Primary Industry Export & Import Export Import (100 mln yuan,1997 price) Fig 4.5 Baseline Secondary Industry Export & Import Export Import (100 mln yuan,1997 price) Fig 4.6 Baseline Tertiary Industry Export & Import 15

16 Primary Secondary Tertiary 100% 50% 0% Fig 4.7 Baseline Labor Force Structure 5. Simulation Results of Trade Liberalization ( ) Once the baseline is generated, the simulation results from trade liberalization are reported as a percent change from this baseline. Tables 5.1 to 5.5 and Figures 5.1 to 5.11 present these results. Table 5.1 shows some macroeconomic simulation results in 2010 (% change from base). In all the four policy simulations, export, import, households consumption, gross fixed investment, and GDP increase, and GDP rises 0.8 percent in 2010 for S4, the whole WTO package. Because non-tariff equivalent falls more in S2 than both the tariff reductions in S1 and the MFA equivalent in S3, government income and so government consumption goes down more in S2 than that in S1 or S3. With the same reason, GDP goes up more in S2 than that in S1 or S3, and so are household consumption, gross fixed investment, export, and import. In all scenarios except S3, the exchange rate of Chinese currency is devaluated slightly. The difference is that the elimination of the MFA (S3) increases China s competitiveness in Textiles and Wearing Apparel. Their exports in these sectors will boost which will exert an upward pressure on the Yuan. In the other simulations (S1 and S2) import restrictions are lifted. This reduces competitiveness of China s producers, in particular at the home market. Imports increase and the Yuan depreciates slightly. Table 5.1 Some Macro Simulation results in 2010 (% change from base) Simulation scenarios S1 S2 S3 S4 GDP Household consumption Government consumption Gross fixed investment Export Import Exchange rate EV volume ($bn) As in many applied general equilibrium models, our model also takes equivalent variation (EV) as a measure of the welfare impacts of trade liberalization in China. EV takes the pre-policy equilibrium 16

17 income and consumer price index as given and measures the changes in income required obtaining post-policy utility level at pre-policy consumer price index. This can be written as follows: EV = CPI ( CS i CB ) i i i Where CPI = pre-policy (base) consumer price index. CB i = sectoral pre-policy (base) household consumption. CS i = sectoral post-policy (simulation) household consumption. At each point in time, EV can be calculated according to the equation above. If EV is positive, trade policy improves welfare; if it is negative, trade policy reduces welfare. Table 5.1 also provides EV volumes in 2010, the consumer welfare is quite moderate, which will increase by around $4 billion for the whole WTO package in Tables record detailed change inside the three kinds of industries for the four scenarios respectively. Comparing S1 and S2, as shown in Tables 5.2 and 5.3, import in the primary and secondary industry rises more in S2 than that in S1, because of the non-tariff equivalents are higher than the import tariffs in these sectors before the trade liberalization. For S3, as shown in Table 5.3, after MFA completely phases out, export in the secondary industry rises. Since the trade surplus is as exogenous, export in the primary and tertiary industry falls. For S4, the whole WTO package in Table 5.5, output and value added rise in the primary and secondary industry, but falls in the tertiary industry, export increases in the secondary and tertiary industry, but falls in the primary industry, import rises inside all the three kinds industries. Table 5.2 Sector percent change from base in 2010 (S1 Scenario) Primary industry Secondary industry Tertiary industry Output Value added Export Import Table 5.3 Sector percent change from base in 2010 (S2 Scenario) Primary industry Secondary industry Tertiary industry Output Value added Export Import Table 5.4 Sector percent change from base in 2010 (S3 Scenario) Primary industry Secondary industry Tertiary industry Output Value added Export Import

18 Table 5.5 Sector percent change from base in 2010 (S4 Scenario) Primary industry Secondary industry Tertiary industry Output Value added Export Import For simplicity, Figures only show the results for S4, the simulation of the whole WTO package. Figure 5.1 shows GDP grows more quickly than in the baseline simulation. By the year 2010, GDP is around 0.8 percent up baseline GDP. After 2005 faster GDP growth slows down slightly, because trade policy is not changed from 2005 onwards. As shown in Figures , although government consumption falls, household consumption and gross fixed investment rise more in volumes and therefore a permanent rise in the Chinese capital stock. After 2005, government consumption even increases a bit compared to the baseline. The reason is that government income does not decrease any more as it did between 1997 and 2005 because of the reduction in trade barriers. Figure 5.5 shows both export and import expands during the adjustment period, given trade surplus exogenous in the model. The faster increase in trade diminishes after 2005 in absence of further reductions of trade barriers. Figure 5.6 describes the exchange rate percent change from base, it indicates that the exchange rate is devaluated much more quickly in the period of trade liberalization ( ), comparing to the period after liberalization ( ). However, the devaluation is limited. Figure 5.7 shows the export and import changes for all sectors in Export expands in most sectors especially in textile goods (up 11.6 percent) and wearing apparels (up 15.8 percent), which is due to phase out MFA. Export falls in such important sectors as agriculture (down 2.2 percent), manufacture of food products and tobacco processing (down 1.8 percent) and electronic and telecommunication equipment (down 3.0 percent). Import rises in almost all sectors especially in such high-protected sectors as agriculture (up 2.8 percent), transport equipment (up 4.5 percent), post and telecommunication (up 6.0 percent) and finance and insurance (up 6.1 percent). Figure 5.8 shows the sector level value added percent change from base in The value added rises in agriculture sector and all industrial sectors except electronic and telecommunication equipment. Due to the phase out of the MFA, value added rises fast in textiles and wearing apparels. The very modest changes in agriculture, and food processing, and the decline in electronic and telecommunication equipment are due to the elimination of the relatively high trade barriers. The value added also rises in 6 service sectors like transport and warehousing, post and telecommunication, wholesale and retail trade, eating and drinking places, finance and insurance, and real estate. It falls in the other 6 service sectors: passenger transport, health, sports and social welfare, education culture, arts, radio, film and television, scientific research, general technical services, and public administration. The government often consumes these services, and government consumption reduces due to the reduction in tariff revenues. Therefore, we can make the conclusion that most sectors benefit but half service sectors lose from China access to the WTO. Figures describe inside the three kinds industries how the export, import and value added change during For the primary industry, export falls much and import rises much but the value added still rises slightly due to a higher increase in its investment and consumption. For the secondary industry, both export and import rise and also the value added rises. For the tertiary industry, import rises but export falls until 2009, and the value added falls during the adjustment 18

19 period but is to be expected to rise again after 2010, which means the losses in the short to middle term but benefits in the long term in service sectors. 19

20 GDP Deviation 1.0% 0.5% 0.0% Fig 5.1 GDP Percent Change from Base Household Consumption Deviation 0.3% 0.2% 0.1% 0.0% Fig 5.2 Household Consumption Percent Change from Base Government Consumption Deviation 0% -1% -2% -3% -4% Fig 5.3 Government Consumption Percent Change from Base 20

21 Gross Fixed Investment 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Fig 5.4 Gross Fixed Investment Percent Change from Base Export Import 2% 1% 0% Fig 5.5 Export & Import Percent Change from Base Exchange Rate Deviation 0.5% 0.4% 0.3% 0.2% 0.1% 0.0% Fig 5.6 Exchange Rate Percent Change from Base 21

22 Export Import 1.agric 2.mcoal 3.mpetr 4.mmetl 5.mnfrs 6.ifood 7.itext 8.iwear 9.isawm 10.ipapr 11.ipetr 12.ichem 13.inmtl 14.imsmt 15.imetl 16.imach 17.itran 18.ielec 19.ietoc 20.iinst 21.irepr 22.iothr 23.iscrp 24.ietic 25.igass 26.iwatr 27.icons 28.stran 29.spost 30.swhle 31.seati 32.spass 33.sfina 34.sreal 35.ssocl 36.shlth 37.seduc 38.sscis 39.stech 40.sadmi -4% 0% 4% 8% 12% 16% Fig 5.7 Sector Export & Import Percent Change from Base in

23 -4% -3% -2% -1% 0% 1% 2% 3% 4% 1.agric 2.mcoal 3.mpetr 4.mmetl 5.mnfrs 6.ifood 7.itext 8.iwear 9.isawm 10.ipapr 11.ipetr 12.ichem 13.inmtl 14.imsmt 15.imetl 16.imach 17.itran 18.ielec 19.ietoc 20.iinst 21.irepr 22.iothr 23.iscrp 24.ietic 25.igass 26.iwatr 27.icons 28.stran 29.spost 30.swhle 31.seati 32.spass 33.sfina 34.sreal 35.ssocl 36.shlth 37.seduc 38.sscis 39.stech 40.sadmi Fig 5.8 Sector Value Added Percent Change from Base in

24 Export Import Value added 3.0% 1.5% 0.0% -1.5% -3.0% Fig 5.9 The Primary Industry Export Import Value added 2.0% 1.5% 1.0% 0.5% 0.0% Fig 5.10 The Secondary Industry Export Import Value added 2% 1% 0% -1% -2% Fig 5.11 The Tertiary Industry 24

25 6. Sensitivity analysis The results discussed in the preceding sections are conditional on a range of assumptions built into the model. For a model like this, which focuses on trade, the particularly important sets of parameters are those governing the responsiveness of trade to changes in the prices of trade goods (the Armington elasticities and the CET function parameters). In this section we examine how changes in the Armington parameters affect the policy simulation results. For comparison, we have conducted two groups of the Armington parameters analyses: one group which we set elasticities at a relative higher average values (Higher Armington case), and the other in which we set the Armington parameters at values as half as the former (Lower Armington case). The Higher Armington case is our baseline. These results were discussed extensively in the previous sections. The results for the two cases are contained in Figures 6.1 to 6.6, which show the effects of varying the Armington parameters on simulation results. Firstly, lower Armington parameters result mainly in larger imports, as shown in Figure 6.1. Because we set the trade surplus or net export as given in the model, so the exports also expand, as shown in Figure 6.2. However, in order to expand exports, the exchange rate has to devaluate more than it has to do in the higher Armington case, as shown in figure 6.3. Secondly, the macro economic effects of other Armington elasticities are very small. Figure 6.4 to 6.7 shows the effects on household and government consumption, investment and GDP. These are negligible. Except for other values of the Armington parameters, we have changed an assumption on government revenue. From the discussion of Figure 5.7 and 5.8 it became clear that many services sectors would decline because government demand for these sectors decreases. Government consumption is reduced because of less government revenue due to the dismantling of trade barriers. Alternatively we could assume that income taxes would increase such that the loss in government revenue is compensated. Government consumption is higher and so will be value Added of the service sectors that are often demanded by the government. The sectoral pattern is different. Most manufacturing sectors increase less than in the case with constant income taxes. The decline of the service sectors is reduced. Textiles and Wearing Apparels are still the most exported goods with construction in the third place. The sectors electronic and telecommunication equipment is still the sector which is most a heavily affected by trade liberalization. 7. Conclusions In this paper we have used a Chinese dynamic CGE modeling framework to examine the sectoral impact of China access to the WTO. We have taken account of VAT rebates, the Multifibre agreement, non-tariff barriers and imports exempted from import duties. The model is calibrated for 1997.We obtained the following conclusions. (1) GDP rises 0.8 percent in 2010 for the whole WTO package. (2) Household consumption and gross fixed investment rise but government consumption falls, however, the former rises more than the latter in volumes, and so the total value added and GDP increase. (3) Exchange rate is devaluated slightly in the middle term. (4) Export expands in most sectors especially in textile goods (up 11.6 percent) and wearing apparels 25