China is the world’s largest trader, and trade liberalization played a key role in its post-1978 economic success. But despite past reform, China has a persistent, systemically large trade surplus still shaped by residual and new forms of protectionism, undermining trade relations abroad and productivity and consumer welfare at home. To sustain its growth potential, China needs to remove trade and investment barriers that are inefficient for its own consumers, and cause structural friction with foreign partners.
To gauge trade liberalization progress, we assess the change in China’s imports of a selection of highly protected goods and services using a composite trade liberalization index (CTLI). Scores higher than 100 indicate a growing role for these imports relative to GDP since 2013; lower scores indicate a falling role. Supplemental gauges look at other variables in China’s trade picture: current account–to–GDP ratios for goods and for services, whether goods imports are consumed in China or just reexported, the services trade balance by component, renminbi exchange rates, and trade trends in overcapacity sectors.
Quarterly Assessment and Outlook
On balance, 2Q2017 indications do not show stepped-up progress in opening trade for China’s highly protected goods and services – the place where it counts. Halfway through 2017, China’s global surpluses and bilateral surplus with the United States are turning up, not down. Domestic action focused on trade facilitation took a backseat to managing the U.S.-China trade relationship, which to date has not shifted significantly, or convinced other major traders of a sea change in China’s trade policy direction. Even if Beijing placates Washington, the bilateral balance is not equivalent to overall Chinese trade reform. Beijing’s commitment to implement its Made in China 2025 industrial policy plan with benchmarks for reducing imports and taking larger global market shares in numerous high-value sectors is clear, and it will continue to fuel trade tensions if more trade openings do not follow. Furthermore, exports of Chinese overcapacity goods through 2017 will cause further international reaction.
This Quarter's Numbers
As of 2Q2017, our composite trade liberalization index (CTLI) suggests no progress over the past four years. The CTLI indicates protected imports on balance are only fractionally higher relative to GDP than they were when China’s Third Plenum reforms were announced in November 2013. The slightly positive current reading is due to recent strength in high-tech imports. The agricultural goods subindex reflects increasing openness to meat imports over the quarter, but imports of our selected agricultural goods trended down within the quarter through June even as U.S. and Chinese officials announced resumed beef trade under a bilateral 100-day trade action plan. Since our earliest observations, China’s import of services, including intellectual property and commercial services, has never risen above Third Plenum levels and continued in negative territory in 2Q2017. Imports of protected manufactured goods have also continued to fall relative to GDP.
Throughout this quarter, China’s trade policy scene was dominated by international frictions rather than domestic reforms.
Our supplemental indicators provide further perspective. After the global financial crisis lows in global trade growth in 2016, external demand for China’s exports recovered this year. External Trade shows China’s current account balance rising from 0.4% of GDP in 4Q2016 to 1.8% in 2Q2017, driven principally by goods trade. Imports classified as intermediate inputs to be processed and reexported, and thus contributing to export growth, continue to fall relative to both exports and imports, suggesting more of what China imports is for final consumption at home, and more of what it exports is local value-added and not just assembly (see Structural Change in Goods Trade).
China’s services deficit partly offsets the large goods surplus, and in 2Q2017 it reached 2.5% of GDP – its largest value level on record – on the back of $74 billion in reported services imports. Tourism – which also includes overseas education, travel expenses abroad, and a degree of capital outflows – typically accounts for upward of 80% of China’s quarterly services trade deficit; its share barely changed from 86% in 2Q2016 to 84.9% in 2Q2017, after peaking at more than 100% in 1Q2015. We leave tourism aside and show other services activity more relevant to trade liberalization in Services Trade Openness. Little progress has been made in opening services sectors of priority concern to China’s trading partners. At USD 6.5 billion, China’s net payments for intellectual property and royalties were nominally a record in 2Q2017, but just barely over 2014–16 levels. The financial services balance has been in surplus (slightly, but growing) for China for seven quarters, indicating little progress in further opening to international players. This balance should indicate whether recent commitments to accelerate approvals for U.S. electronic payment systems operators are fulfilled.
As reflected in Exchange Rate Fluctuation, renminbi depreciation pressures have eased due to USD weakness this year, reducing concerns that currency manipulation is boosting Chinese exports. But as seen in Trade and Overcapacity, exports are surging in sectors in which China suffers from production overcapacity, an indication that supply-side factors rather than exchange rate dynamics are likely to aggravate global trade policy debates in the period to come. Things may get worse before they get better, as initial Chinese production cuts in overcapacity industries cause price spikes that incentivize producers to expand production further, adding to global supply surpluses despite Beijing’s pledge to rationalize.
Policy Analysis: 2Q2017
Throughout this quarter, China’s trade policy scene was dominated by international frictions rather than domestic reforms, particularly with President Donald Trump threatening a range of trade actions. With much of Beijing’s reform-minded momentum taken up with controlling immediate domestic financial risks in 2Q2017 (see Financial System reform cluster), moves in trade policy were minimal and tactical, though authorities continued to work on simplifying customs procedures.
United States–China trade relations dominated the discussion in 2Q2017. After a warm April leaders’ meeting in Florida, a “100-Day Plan” was agreed upon to address trade irritants and imbalances, with priority objectives for both sides to be met by July 16. Outcomes from this process focused on long-standing U.S. complaints about nontariff trade barriers reflected in our primary CTLI indicator – delayed approvals in financial services, sanitary restrictions on U.S. beef exports, and market access for credit ratings providers. Most deliverables had been under negotiation for a year or more and represented a focus on near-term successes, rather than a fundamental strategy for the bilateral trade relationship. No substantive outcomes were announced at the July Comprehensive Economic Dialogue (CED) meeting, resulting in uncertainty about renewed bilateral trade frictions.
The U.S. launched two investigations under Section 232 of its 1962 Trade Expansion Act in the quarter, on the impact of steel and aluminum imports on U.S. national security. Despite statements that the investigation would be quickly concluded, it is still ongoing. Meanwhile, China’s production of crude steel reached a record 73.2 million tons in June 2017, adding to the likelihood of excess production spilling abroad.
The domestic trade policy discussion focused on trade facilitation reforms, which aim to create a unified “single window” electronic platform for international trade to reduce and simplify customs clearance procedures. In April 2017, the State Council and the National Development Reform Commission (NDRC) issued opinions on key tasks for deepening reform for the remainder of the year, with trade tasks focusing on facilitation, free trade zone promotion, and services trade innovation. On May 1, the State Administration of Foreign Exchange issued new regulations to allow electronic records of customs clearance to be made available to banks in a move intended to crack down on trade misinvoicing as well as to improve supervision and trade receipt management at financial institutions.
One additional theme bridging the domestic and international trade policy conversation was the Belt and Road initiative (BRI), which continued to receive heavy play from both leaders and bureaucrats in the second quarter and throughout the year. With this plan, Beijing aims to stoke investment and development across a broad set of roughly 70 developing countries. Some have criticized the plan as principally conceived to boost demand for China’s overcapacity sectors such as basic materials, capital goods, and construction services. There are also concerns about the impact of BRI on sustainable development challenges, particularly in relation to carbon intensity levels. Most of all, some skeptics point to the unsolved legacy problems of debt-driven growth inside China and seek assurances that these will not be replicated in 70 other countries. At the same time, the potential for a BRI-like initiative to fuel potential economic growth for a large part of the developing world is powerfully alluring and desires earnest attention.