Guest blogger Lawrence J. Lau makes the case for keeping the trade door open, outlining options for China and the world.
The “open door” policy was a critical component of the economic reforms China introduced in 1978, opening the country to the outward and inward flow of goods and services, of capital, and of people.
Deng Xiaoping’s government brought China into the globalised economy, expanding international trade and attracting foreign direct investment, which brought with it capital, technology, markets, new business models and methods needed after decades of relative isolation. It permitted hundreds of thousands of Chinese scholars to go abroad for exchange and advanced study, and let foreign experts become involved with China. The “open door” underpinned the extraordinary growth of the Chinese economy over the past three decades.
The metaphor of the open door has taken on increased significance today, as the worst recession since the 1930s has made the world realize that serious protectionist pressures are far from a relic of the past. Keeping the door open is now an imperative for policymakers, whether this refers to China’s international trade or maintaining the growth of global commerce more generally.
Not only must the Chinese government resist the temptations of protectionism, it must also coordinate with the other major countries of the world to jointly resist protectionism. We must avoid a repetition of the experience in the 1930s, when every country erected tariff barriers against one another, prolonging the global economic depression. We must also avoid competitive devaluation during this crisis. The forthcoming G20 summit is an ideal forum for taking a joint stand against protectionism.
Coordinated action to liberalise trade, rather than simply not obstructing it, would benefit the global economy by increasing the economic bang for each additional buck spent by governments. Most countries are now in the process of adopting and implementing economic stimulus packages, It would enhance the ‘global multiplier’, in the words of Joseph Stiglitz, and accelerate global economic recovery, if all of them could lower their tariff and non-tariff barriers to imports. This is because one country’s imports is another country’s exports. The economic stimulus packages would thus jointly benefit everyone, but everyone would be helping itself too. The East Asian crisis of 1997-98 provides an example of a sharp simultaneous economic downturn in East Asian economies that was followed by an equally sharp upturn due to simultaneous expansion and recovery in all of them.
In the context of joint economic stimulus, this is also the right time to accelerate the implementation of Free Trade Areas (e.g., the ASEAN + 3 Free Trade Area) and the negotiation of free trade agreements (FTAs). The Doha Round of negotiations at the World Trade Organization (WTO) could perhaps be revived. An important contribution will be made to global trade if the mind-numbingly complex “Rules of Origin” regulations governing the eligibility of products for trade concessions can be replaced by something simpler and more straightforward, based, say, on relative value-added.
With the credit freeze in the United States and Europe still affecting the availability of trade finance – an obstacle to commercial exchange that has nothing to do with trade barriers or declining demand for imports — Chinese and East Asian commercial banks could, with the support of their respective national Export-Import Banks, provide substitute financing for exports as well as imports. For example, a Chinese commercial bank could help finance the exports of a Chinese enterprise to long-term customers in the United States on a consignment basis or on extended payment terms. It could also finance imports from the United States.
There is also the important question of the settlement of international trade transactions. Global trade is largely denominated and settled in US dollars. That is what has given rise to the huge foreign demand for US dollar balances. The US dollar reserves held by central banks around the world provide in part the liquidity and transactions balances necessary to support the growth of world trade. The scarcity of credit in US dollars and the expected reduction in the US trade deficit would reduce the supply of US dollars to the rest of the world and ought to add impetus to the consideration of alternative ways to settle trade transactions.
One obvious alternative would be to allow the importer to pay for the imports in its own currency, provided that the exporter, or the exporter’s country’s central bank, is willing to accept and to hold the currency. For example, a Chinese exporter may be willing to accept payment in Indonesian rupiah for its exports to Indonesia, as long as he knows he can sell it to the People’s Bank of China, China’s central bank. No US dollars would be necessary for the transaction.
The People’s Bank of China may decide to hold the Indonesian rupiah as part of its reserves (after netting out the payments for Indonesian imports denominated in rupiah). Eventually, the central bank may wish to consider holding the rupiah in interest-bearing assets such as bonds issued by the Government of Indonesia, preferably indexed to Indonesian inflation to preserve the purchasing power of the central bank’s rupiah-denominated assets.
Such an arrangement is not so different from what has been made possible by the Chiang Mai accords. Moreover, the issuance of inflation-protected bonds by developing economies has many advantages, among which is the possibility of borrowing in its own currency. Foreign currency borrowing frequently causes financial crises because of currency mismatch (and often also maturity mismatch).
As for international trade, governments must guard against economic nationalism in cross-border flows of both direct and portfolio investment. Every country will sooner or later have one of its enterprises being either a buyer or a seller. Symmetric treatment is necessary. The best way to safeguard against economic nationalism in investment is to extend national treatment to all enterprises, domestic and foreign. National security-related exceptions should be specified in advance, rather than in the heat of debate over a possible acquisition. The rules should be clean and transparent; ad hoc action would risk being perceived as discriminatory.
China can improve the investment environment for both domestic and foreign direct investors by reducing or removing internal trade barriers, illegal under Chinese law, erected by the local authorities. Only then would investors truly be able to benefit from China’s huge market. Adequate protection of intellectual property is also important in attracting foreign direct investment into China.
In this time of global financial crisis, China should take advantage of its high savings rate to supplement the global capital markets as well as to boost domestic.
For example, China could open up its stock markets for blue-chip overseas enterprises to raise capital in the form of Chinese Depositary Receipts (CDRs) and corporate bonds. It could encourage its commercial banks to provide US dollar financing to blue-chip foreign enterprises, e.g., by purchasing their commercial paper.
The Chinese government could also encourage its commercial banks to finance inbound foreign direct investment. China really does not need any additional foreign exchange or capital. But it should continue to welcome foreign direct investment because it brings with it technology, knowhow, and markets that Chinese enterprises may not have. Chinese commercial banks could provide 100 percent finance to qualified foreign direct investment projects as long as the parent company in the home country guarantees the loan. Such arrangements would relieve foreign direct investors of exchange rate risks, as their assets and liabilities in China would both be denominated in yuan.
Domestic demand will be an increasingly important driver of China’s growth. In the short and medium term, the most promising areas for increases in consumption are probably consumer durables including automobiles and large-ticket items such as refrigerators, television sets and other home appliances, education, healthcare and tourism. Sources of durable long-term growth of domestic demand include the owner-occupied residential sector, education, urbanization and mass-transit systems, and green technologies. Strengthening the social safety net would also help enhance the propensity of Chinese households to spend rather than build up savings.
The open door also refers to the flow of people across borders, which enhances mutual understanding and is an important consumption activity. Despite the temporary setback in the United States and other developed economies, they are still fundamentally strong and technologically advanced. Cultural and educational exchange should continue to be encouraged. Reciprocal visa relaxations and waivers should be considered with selected countries and regions. Inbound and outbound tourism should be promoted.
I believe that in this global financial crisis, it is in the interests of China and the world for China to continue to maintain an “open door” policy with respect to the cross-border movement of goods and services, capital, and people.
Dr. Lawrence J. Lau is the President and Ralph and Claire Landau Professor of Economics at the Chinese University of Hong Kong and the Kwoh-Ting Li Professor in Economic Development, Emeritus, at Stanford University.
This article is part of a forthcoming compilation “Rebuilding Global Trade: Proposals for a Fairer, More Sustainable Future” edited jointly by Dr. Carolyn Deere Birkbeck (Global Economic Governance Programme) and Ricardo Meléndez-Ortiz (International Centre on Trade and Sustainable Development (ICTSD)). The compilation is available at: http://www.globaleconomicgovernance.org/wp-content/uploads/rebuilding-global-trade.pdf
