China - Socialist economic development (Vol. 9 of 9) : Annex H: External trade and finance

Repot No. 339-CHA China: Socialist Economic Development 3V3o9 (In Nine Volumes) Annex H: External Trade and Finance June 1, 1981 (reprinted March 10, 1982) East Asia and Pacific Regional Office FOR OFFICIAL USE ONLY Docunent of tm Wdo Ban This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS The Chinese currency is called Renminbi (RMB). It is denominated in yuan (Y). Each yuan is subdivided: 1 yuan = 10 jiao = 100 fen Exchange rates used in this report are as follows: 1977 $1.00 = Y 1.828 1978 $1.00 = Y 1.661 1979 $1.00 = Y 1.541 WEIGHTS AND MEASURES Chinese statistics are usually in metric units; in additio.., mu and jin are often used: 1 mu = 0.1647 acres = 0.0667 hectares (ha) 1 jin = 0.5 kg FISCAL YEAR January 1 - December 31 TRANSLITERATION The Pinyin system is used in this report.  FOR OFFICLIA USE ONLY CHINA: SOCIALIST ECONOMIC DEVELOPMENT ANNEX H EXTERNAL TRADE AND FINANCE Table of Contents Page No. 1. TRENDS AND PATTERN OF FOREIGN TRADE . . . . . . . . . . . . . . 1 Size of External Trade .... . . . . . . ... . . . . . . I Trends in External Trade .... . . . . . .. . 3 Commodity Structure of Trade .... . . . . .. . 7 The Direction of Trade .... . . . . . . .. . 16 2. THE INSTITUTIONAL SETTING . . . . . . . . . . . . . . . . . . 18 The Basic Organizational Framework . . . . . . . . . . . . . 18 Decentralization of Foreign Trade Management . . . . . . . . 20 3. NEW MEASURES FOR PROMOTING FOREIGN TRADE AND INVESTMENT . . . . 23 Export Processing .... . . . . . . . . ....... . . . 23 Compensation Trade .... . . . . . . . ....... . . . 24 Cooperative Production .... . . . . . . ...... . . . 25 Joint Ventures ..... . . . . . . . .. .2.6.... . . . 26 Joint Operations .... . . . . . . . . .. . 29 Preferential Treatment in the Special Economic Zones . . . . 29 Problems in Direct Foreign Investment ... . . ...... . 30 S-mary Appraisal . . . . . . . . . . . . . . . . . . . . . . 31 4. PLANNING AND PRICING IN FOREIGN TRADE AND EXCHANGE . . ... . . 32 Foreign Trade and Foreign Exchange Plans . . . . . . . . . . 32 Pricing in Foreign Trade and Exchange . . . . . . . . . . . . 35 Profits/Losses in Foreign Trade and Exchange Conversion Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . 39 Planning for External Borrowing . . . . . . . .. . . . . . . . 40 5. BALANCE OF PAYMENTS, EXPORT PROSPECTS AND EXTERNAL BORROWING . 41 Recent Balance of Payments Developments . . . . . . . . . . . 41 Export Prospects . . . . . . . . . . . . . . . . . . . . . . 44 External Borrowing ... . . . . . . . . . . . . . . .... . 51 Thi docuneut has a rescted disbuton and may be used by recipients only in the performance of their offici dutis Its contents may not otherwis be disclosed without World Bank authorization.  C46400/J79077/D836/62 - ii - Page No. TABLES IN TEXT 1.1 Merchandise Exports and Imports as a Percentage of GNP - an International Comparison, Average for 1977 and 1978 . . 2 1.2 Average Annual Growth Rates of the Value (in Current Dollars) of Exports and Imports, 1953-80 . . . . . . . . . 3 1.3 Exports to and Imports from Centrally Planned and Market Economies, 1950-80 . . . . . . . . . . . . . . . . . . . . . 5 1.4 Imports by Broad Commodity Categories, 1950-79 . . . . . . . . 8 1.5 Major Imports, by Volume and Value, 1976-80 . . . . . . . . . 11 1.6 Merchandise Imports by Commodity Group, 1976-79 . . . . . . . 12 1.7 Merchandise Exports (SITC Categorization), 1976-79 . . . . . . 14 1.8 Major Exports, by Volume and Value, 1976-80 . . . . . . . . . 15 1.9 Direction of Trade, 1977-80 .17 5.1 Unofficial Balance of Payments Estimates, Current Account, 1977-80 . . . . . . . . . . . . . . . . . . . . . . . . . . 42 5.2 Unofficial Balance of Payments Estimates, Capital Account, 1977-80 .45 5.3 Agreements on Official or Officially Supported Medium- and Long-Term External Loans .52 APPENDICES A. Foreign Trade Corporations under the Ministry of Foreign Trade B. Corporations not under the Ministry of Foreign Trade that can Engage in Exporting and Importing  C46400/J79061/D836/02 1. TRENDS AND PATTERN OF FOREIGN TRADE Size of External Trade 1.01 Because of the country's diversified resource endowments, its huge size in terms of both area and population, and its large domestic commerce, China's foreign trade has been small in relation to the whole economy. For at least two decades after the establishment of the People's Republic, various international events and domestic developments hampered the expansion of external trade. The embargo by Western countries since the start of the Korean War and the lack of diplomatic recognition by a number of countries restricted China's trade with nonsocialist countries for a long time. Trade with the USSR and East European countries has been conducted on a bilateral, balanced basis, except for loans (mainly Soviet) received and repaid by the mid-1960s. The experience with the Soviet aid led China to pursue even more resolutely a policy of self-reliance. 1.02 Moreover, under the centrally planned economic system, the domestic market has been insulated from the world market. Import-substitution has progressed without interruption from consumer goods to capital goods, and further to intermediate goods. Furthermore, after full repayment of the Soviet debt in 1965, imports and exports were maintained more or less in balance. Whenever a trade deficit occurred for a few consecutive years, imports and exports would be planned to restore the trade balance or create a surplus. 1.03 Since the early 1970s China has concentrated on the task of modern- ization. Its attitude towards external trade and capital has become more positive. Recognizing the importance of the foreign exchange constraint, the Government has accorded exports high priority, and foreign investment and finance have been allowed. Even with these changes, and the consequent more rapid growth of trade, China's exports in 1977 and 1978 were on the average still only 4.5% of GDP. In an international comparison (Table 1.1), China shares the lowest position with Turkey; its average is considerably lower than those of comparable large countries and much below the average of 11% for all low-income developing countries. In Turkey as well as in India, however, the import ratio to GNP is substantially higher than that in China (4.7%) as a result of substantial capital inflows. The low level and non- competitive nature of trade in China's economy have apparently contributed considerably to the bottlenecks and low efficiency in production. This si- tuation can be greatly improved if China-s foreign trade under the present policy expands over a long period more rapidly than the GDP growth rate. In fact, the much higher growth rate of foreign trade than GDP in 1979 and 1980 has already increased the exports/GDP ratio to 6.4% and the imports/GDP ratio to 6.9%.  C46400/J79039/D836/03 -2- Table 1.1: MERCHANDISE EXPORTS AND IMPORTS AS A PERCENTAGE OF GNP - AN INTERNATIONAL COMPARISON, AVERAGE FOR 1977 AND 1978 Country Exports/GNP Imports/GNP China /a /b 4.5 4.7 India 6.1 6.9 Indonesia 26.2 15.1 Bangladesh 7.1 17.0 Turkey 4.0 10.3 Brazil 7.3 8.2 Mexico 6.0 8.0 Japan 11.2 10.0 USA 6.5 8.5 USSR 5.6 5.2 All developed countries (1978) 15.5 16.0 Low-income developing countries (1978) 11.1 12.4 Middle-income developing countries (1978) 16.5 21.2 /a For China, GDP figures were used; the GDP figures were adjusted by the mission on the basis of national data to make them comparable with data from other countries. See Annex A. /b For 1979 and 1980, the percentages are estimated as follows: Exports/GDP Imports/GDP 1979 5.4 6.2 1980 6.4 6.9 Sources: For China, State Statistical Bureau (SSB) and Ministry of Foreign Trade; for other countries, World Bank, World Development Report, 1980. 1.04 China's trade accounts for less than 1% of world trade. Except in the trade of some nonferrous metals (such as tungsten, antimony and tin) and medicinal herbs, of which China is an important supplier on the world market, China's influence on the world market is very small. Exports of tungsten, antimony and tin amounted to $221 million in 1979 and accounted for 1.6% of China's total exports. Exports of medicinal herbs, consumed mostly by overseas Chinese, are very small.  C46400/J79077/D836/04 -3- Trends in External Trade 1.05 There are neither quantum indexes nor appropriate deflators to determine the trends in China's imports and exports in real terms, but an indication may be gained by using the rates of change in the international price index. Since the economy had largely recovered from the many years of warfare in the 1940s by 1953, it may be taken as a base year. During 1953-80, the value of China's exports increased from $1 billion to $18 bil- lion, or at an annual average growth rate of about 11%. The corresponding average rate of growth for imports was 10%. Allowing for increases in international prices, the annual growth rate of China-s trade in real terms can be roughly estimated at 5.3% for exports and 4.5% for imports (Table 1.2). Table 1.2: AVERAGE ANNUAL GROWTH RATES OF THE VALUE (IN CURRENT DOLLARS) OF EXPORTS AND IMPORTS, 1953-80 (x) World Exports Imports inflation /a 1953-80 11.2 10.4 5.9 /b 1953-70 4.8 3.3 1.4 /c 1970-80 23.1 23.5 14.0 1977 10.7 9.7 8.6 1978 28.4 51.0 18.3 1979 40.2 44.1 14.5 1980 32.7 23.5 12.5 /a Based on the "International Price Index" compiled by the World Bank-s Economic Analysis and Projections Department, November 12, 1980. /b 1955-80. 7- 1955-70. Sources: Ministry of Foreign Trade and SSB. 1.06 During the 1970s, however, both exports and imports increased much more rapidly. The value of both exports and imports in current dollars increased at slightly over 23% a year on average. Allowing 14% for world inflation, the annual average growth of the real value of exports and imports can be estimated at about 9%, substantially higher than the average real GDP growth rate of about 6%, in sharp contrast with the rates for 1953-70 (Tables 3.8 and 6.10 in the Main Report).  C46400/J79039/D836/05 -4- 1.07 The growth trend of China's foreign trade has by no means been smooth. Changing international relations, together with domestic political movements interwoven with shifts in development strategies and economic fortunes, have greatly affected foreign trade. In 1952 the "Five Anti Move- ment' against national capitalists disrupted industrial and trade activities. Foreign trade recovered quickly the following year and grew fairly rapidly during the First Five-Year Plan period (1953-57), mainly due to the close economic cooperation with the USSR and Eastern European countries as China-s trade with the West fell dramatically. Soviet aid was a major factor in trade development: "from 1950 to 1959, the Soviets delivered $1.35 billion worth of equipment and completed about 130 projects, including factories for trucks, machine tools and generating equipment."/l (Of these loans, $430 million was specifically for economic development.) This was reflected in the large a- mount of imports from, as well as the trade deficit with, the USSR from 1951 to 1955. Trade with centrally planned economies reached 70% of China-s total trade in 1953 and two thirds in 1957 (Table 1.3). 1.08 However, the economic crisis of 1960-62, together with the deterioration of relations with the USSR and the Eastern European countries, resulted in a rapid decline in foreign trade. Trade with the USSR was vir- tually stopped. The total trade value registered its second decline in 1962. As the development strategy shifted to readjustment and more balanced growth, China's economy recovered after late 1962 and foreign trade with market economies grew impressively for about five years. Western trade restrictions were gradually being relaxed after the mid-1950s, and China turned to Western Europe and Japan for large-scale imports of foodgrains, fertilizers, and plants and technology. '"From 1963 to 1966 contracts were signed for more than 50 plants worth more than $200 million. A number of the plants were financed under medium-term credits and included the services of Western technicians."/2 China's trade with centrally planned economies fell to 22% of the total in 1966 and that with market economies correspond- ingly increased. The total value of trade in 1966 approached the previous peak of 1959. 1.09 The Cultural Revolution, which started in late 1966, interrupted production and disrupted transportation, and the trade level fell again in 1968. The continuation of Cultural Revolution activity after 1968, though subdued, prevented the economy and trade from recovering, so that China's total trade value in 1970 was still below the peak of 1966. /1 Richard E. Batsavage and John L. Davie, "China's International Trade and Finance" in Chinese Economy Post-Mao (Joint Economic Committee, US Congress, 1978), p. 710. /2 Batsavage and Davie, ibid., p. 711.  Table 1.3: VXP'0RTS TO ANI) lHt0PRTS FROM CENTRAI.I.Y PlANNED AliD lIARKET ECONOtIlFS, 1950-80 ($ millioln) Total trade Fxport -Imports Trade balance Vitb To From w1th centrally centrally ceutrally centrally planned' With aarket pla)ned To m,arket planined From market Over- plannted With market Year Total economieA economlie Total ecou,omles ecoulonles Total ecoioimies economles all economies economies 1950 1,135 368 767 552 176 376 581 I 2 391 -31 - 16 -15 1953 2,360 1,662 706 1,022 717 305 1,346 945 401 -324 -228 -96 1951 3,103 2,065 1,038 1,591 1,129 468 1,5(16 936 570 91 193 -102 1962 2,663 1,180 1,483 1,490 799 691 1,173 381 792 317 418 -101 1966 4,614 1,014 3,600 2,366 514 1,792 42,248 440 1,808 118 134 -16 1910 4,586 739 3,847 2,260 475 1,7P5 2,326 264 2,062 -66 211 -217 1975 14,750 2,269 12,481 7,264 1,267 5,991 7,486 1,0J02 6,484 -222 265 -487 1916 13,433 2,140 11,293 6,855 1,039 5,616 6,578 1,101 5,477 277 - 62 339 1977 14,8104 2,276 12,520 1,590 1,321 6,269 7,214 955 6,259 376 366 10 1918 20,638 2,836 17,P02 9,745 1,49% 8,250 10,893 1,341 9,552 -1,148 154 -1,302 1979 29,332 3,566 25,766 13,65R 1,664 11,944 15,674 1,902 13,712 -2,016 -238 -1,710 1980 /a 37,508 n.a. n.a. 18,121 n.a. Il.H. 19,187 l.d. n.d. -1,266 n.a. Il.h. /a Estimated from data In domestic currency In thie Stale Statistical Haireazs's Communilque on thle F,,lfillmelit of Cisia's 1980 Natioinal Economic Plan, converted at an excI,anpe rate of $1.00 - V 1.501. Source; Hliniltry of Forelgn Trade  C46400/J91942/D836/06 -6- 1.10 China's foreign trade began a new course of rapid expansion in the 1970s, with the total value of exports and imports at current prices in 1980 at eight times the 1970 level. Trade relations with many countries, most importantly the USA and Japan, have been greatly improved since the resumption of China's representation at the United Nations in 1971. At the same time, trade with centrally planned countries also picked up after the resumption of annual trade agreements with the USSR and improved relations with Eastern European countries. In current dollars, total trade with centrally planned countries increased at an average rate of about 19% a year during 1970-79, although their trade share continued to fall to 12% in 1979. In the early 1970s, China began to accept credit from Western countries and Japan in purchasing foodgrains, machinery and equipment. On the export side, the most important factor was the emergence of petroleum, the price of which has risen sharply since 1973. In 1977, crude petroleum was the largest export item, accounting for 10% of total export value; its share has since increased rapidly to 17% during the first nine months of 1980. 1.11 However, the trend of rapid trade expansion has not been without interruption. Trade deficits re-emerged in the second half of 1974 because of rising repayments of grain credits and lagging exports due to world recession, as well as sharply higher machinery and equipment deliveries. Also, the last thrust of the Cultural Revolution and the death of key political leaders led to a stagnation of economic activity in 1975/76. The Government began to tighten imports, and the total volume of trade levelled off in 1975 and declined in 1976. Nevertheless, after the present political leadership assumed power, a firm policy of promoting foreign trade as a part of the modernization drive has been established. A number of policy measures for promoting exports were introduced, including such innovative forms of trade as processing imported materials or assembling imported components for export, compensation trade, special economic zones, etc. For more efficient conduct of foreign trade, its management by the state has also been decentralized. At the same time, laws and regulations for attracting foreign investment have been promulgated. These changes, together with the general economic recovery, have resulted in an impressive growth of foreign trade since 1977. 1.12 The increase in the total value of exports accelerated from 11% in 1977 to 28% in 1978, 40% in 1979, and 33% in 1980. The increase was spread fairly evenly among all commodity groups. Exports of oil, textiles and light manufactured products, agricultural sideline products (raw and processed) and nonferrous minerals grew slightly faster than the average, as a result of the sharply higher oil price in 1979 and 1980, recovery of industrial and agri- cultural sideline production (under the new policy of decentralizing decisions to the production team level in rural areas), and the more liberal attitude towards exporting natural resources. Excluding oil, China's total export value during 1970-79 increased at an estimated average annual rate of 20%, or 6-7% in real terms, after allowing for world inflation. This compares  C46400/J79077/D836/07 -7- favorably with slightly below 5% a year during 1953-70 in nominal terms and no more than 3.5% in real terms. While the increase in oil exports was most spectacular, in recent years the increase in manufactured exports was also impressive. During 1976-79, manufactured exports at current prices increased at an annual average rate of 27%, or about 10% in real terms. Thus, even considering the favorable effects of short-term economic recovery, these impressive export growth rates may reflect an underlying strength, indicating a break from the long-term sluggish trend. 1.13 The increase in the total value of imports accelerated faster than that of exports in 1978 and 1979. The rate of growth of imports increased from 10% in 1977 to 51% in 1978 and 44% in 1979. Imports of machinery, equipment, and materials for heavy industry were particularly high in 1978. Cereal imports also increased substantially. The high level of producer goods imports continued in 1979, even when the Government launched a readjustment program in the middle of the year to shift the emphasis from capital construc- tion and investment in heavy industry to agriculture and light industry. In 1980, import growth slowed down significantly to about 23%, but is still sub- stantially higher than the planned 5.8%. The more rapid increase in imports than in exports turned a $0.38 billion trade surplus in 1977 into trade deficits of $1.15 billion in 1.978 and of $2.04 billion in 1979. The deficit was, however, reduced to $1.27 billion in 1980, with the slowdown in import growth. 1.14 In short, in the 1970s China's foreign trade has expanded substan- tially, particularly in the second half of the decade. Trade with both centrally planned economies and market economies increased, but that with the latter increased much faster and in 1979 it accounted for 88%, following China's more open policy towards foreign trade and capital. While oil exports have been an important element in the rapid increase in trade during this period, manufactured exports have also increased impressively during the second half of the decade. The increased foreign exchange earnings and acceptance of foreign capital have allowed a corresponding expansion of imports, particularly in plant and equipment for the introduction of modern technology. Commodity Structure of Trade 1.15 In spite of the effects on China's foreign trade of shifting inter- national relations and domestic political movements during the last 30 years, changes in the commodity structure of trade have reflected to a large degree the transformation of the economy and the development strategy adopted. The system of central planning has had a considerable effect on the commodity structure of trade, under which trade has only a balancing role: imports make up domestic production shortfalls and provide necessities that cannot be produced domestically in sufficient quantity, if at all; exports are not viewed as an instrument to promote growth and employment, but merely as a necessity to pay for imports. In addition, through the planned pricing policy, the domestic price structure has been effectively insulated from international prices. However, in recent years, China has paid more attention  C46400/J7911 1/D836/08 -8- to the role of foreign trade in modernization and development, and foreign trade planning has become less rigid. 1.16 Changes in the Structure of Imports. 3efore the establishment of the People's Republic, China's foreign trade pattern was similar to that of underdeveloped countries in the nineteenth century, i.e. exporting raw materials and importing consumer and capital goods. The perception that trade had been utilized by the imperial powers to gain political dominance in China was quite widespread. After 1949, imports of consumer goods were drastically cut, except for necessities such as foodgrains. Most of the scarce foreign exchange available was used to import producer goods for reconstruction in industry and transportation. In 1950/51, imports of producer goods (machinery and equipment as well as raw materials) already accounted for 85% of the total and imports of consumer goods only 15% (Table 1.4). Table 1.4: IMPORTS BY BROAD COMMODITY CATEGORIES, 1950-79 (%) 19130 1953 1957 1976 1977 1978 1979 Producer goods 87.2 93.0 92.7 86.8 76.1 81.4 81.3 Machinery & equipment n.a. n.a. n.a. 30.9 17.7 17.5 25.2 Raw materials n.a. n.a. n.a. 55.9 58.4 63.9 56.1 of which: for heavy industries n.a. n.a. n.a. (33.7) (32.0) (38.2) (32.9) for light industries n.a. n.a. n.a. (16.5) (19.6) (19.4) (17.3) for agriculture n.a. n.a. n.a. (5.7) (6.8) (6.3) (5.9) Consumer goods 12.8 7.0 7.3 13.2 23.9 18.6 18.7 Sources: SSB, Ten Great Years (Peking, Foreign Languages Press, 1960), p. 176; and Ministry of Foreign Trade. 1.17 In the 1950s, China made great strides in industrialization and agricultural development. The import of large amounts of machinery and equipment from the USSR under a loan program raised the percentage of producer goods imports to about 93% during 1953-57. The rapid pace of industriali- zation during the First Five-Year Plan was similar to that under the USSR's first two five-year plans. Emphasis was placed on basic industries, including electric power, iron and steel, cement and machine building. This large capital goods import program was accompanied by a high level of domestic investment to expand light industries that produce consumer goods, which necessitated considerable imports of raw materials (such as cotton) and oil. At the same time, as peace was restored in the rural areas after a decade of  C46400/J79039/D836/10 -9- warfare and the completion of land reform, agriculture recovered smoothly and developed further. Thus in the 1950s, China imported virtually no grain and in fact was a net grain exporter of 0.5-1.6 million tons of grain (including rice). This, together with the import substitution in manufactured consumer goods, explains why the proportion of consumer goods in total imports was as low as 7% during 1953-57. 1.18 In the 1960s, China's import commodity pattern underwent profound changes. In agriculture, the disturbance of the Great Leap Forward in the late 1950s, bad weather, and errors in economic planning and management created an acute agricultural crisis in the early 1960s. A direct effect on trade of three successive bad harvests was the great increase in foodgrain imports. Constant pressure also came from continuous population growth and the scarcity of arable land. Between 1961 and 1966, China imported 4.5-6.5 million tons of grain, mainly wheat, declining gradually to 3-5 million tons around the end of the 1960s. By taking advantage of the favorable price of rice compared to wheat, China exported considerable amounts of rice to obtain foreign exchange to pay for imported wheat. However, in the 1960s rice exports consistently lagged behind grain imports, and China changed from a net grain exporter to a net grain importer./l To step up agricultural production after the food crises, imports of chemical fertilizers also increased sharply from about 1 million tons in the early 1960s to more than 2 million tons in the early 1970s, although domestic chemical fertilizer output also increased./2 1.19 The rapid buildup of industrial capacity in the 1950s and 1960s increased considerably China's ability to produce machinery and other manufactured goods. This, together with the end of the delivery of Soviet-financed equipment, reduced significantly China's imports of machinery and equipment, but increased its import requirements for intermediate goods, particularly high quality iron. and steel materials, nonferrous metals and raw materials. In 1966, imports of crude materials and metals and metal manufactures amounted to one third of China's total imports, as compared with one fifth in 1955. Similarly, while machinery, equipment and military goods together comprised at least one half of total imports in the 1950s, their share fell to about one fifth throughout the 1960s and early 1970s. Clearly China-s import-substitution had progressed from consumer goods to capital goods./3 1.20 In the 1970s, the Chinese planners pursued import-substitution still further, this time focusing on intermediate goods, especially steel, chemical fertilizers and synthetic fibers for their manufacturing industries and agriculture. They turned to Western countries and Japan for equipment and modern technology, which involved importing whole plants. For instance, /1 Feng-Rwa Ma, The Foreign Trade of Mainland China (Aldine Atherton, 1971), p. 36. /2 A. Eckstein, China's Economic Revolution (1977); p. 251. /3 Eckstein, ibid., p. 250, Table 7-2.  C46400/J79039/D836/11 - 10 - during 1973-76, 60 whole plant contracts with a total value of $2.6 billion were signed, of which 60% were for chemical fertilizer, petrochemical and chemical industries and 23% for the steel industry./1 In the case of man-made fibers and petrochemicals, imported equipment virtually created new industries. Import-substitution in steel appeared to be less successful. Although steel producing capacity increased by about one third after the mid-1970s, production did not always match demand. Imports of steel products increased sharply from 4.9 million tons in 1976 to 8.5 million tons in 1979 (Table 1.5). Valued at $3.5 billion in 1979, steel was China-s largest single import and has accounted for slightly over 20% of total imports for several years. 1.21 Contracts for whole plants and technology imports surged again under the modernization drive of the new political leadership after 1977. They amounted to about $8.5 billion in 1978/79. Actual imports of machinery and equipment increased from $0.9 billion in 1977 to $1.4 billion in 1978 and $2.6 billion in 1979 (Table 1.6). The readjustment policy adopted in mid-1979 still had not had much effect on the reduction of machinery and equipment imports in 1979. In 1980 and early 1981, China decided to carry out further readjustments and therefore cancelled or postponed a number of large import contracts, including some steel, petrochemical, chemical and mining projects. The emphasis has also changed from importing complete plants to importing selected machinery and equipment. 1.22 Another important change in the 1970s was that China changed from a petroleum importer to a petroleum exporter. China used to rely on the USSR and Romania for its petroleum imports, which absorbed about 10% of its export earnings. However, successful geological exploration and oil drilling and development since the early 1960s reduced oil imports to a negligible amount in the late 1960s, and China became a net oil exporter in 1972./2 /1 C. Howe, China's Economy, A Basic Guide (New York, Basic Books, Inc), p. 154, Table 54. /2 UN Statistical Office, World Energy Supplies, Series J, 1950-74.  Table 1.5: HAJOR IMPORTS, BY VOLUME AND VALUE, 1976-80 Volume Value ($ million) 1979 1980 1976 1977 1978 1979 1977 1978 1979 Jan-Sep Jan-Sep Total Value of Imports .. ,. .. .. 7,214 10,893 15,675 11,417 13,140 Trucks /a (units) 18,248 14,916 21,872 24,768 139 310 450 297 227 Shtpa and vessels (units) 13 15 29 47 162 156 231 140 208 Atrplanes (untts) 38 18 13 14 67 43 25 21 43 Steel products ('000 tons) 4,931 5,256 8,638 8,473 1,477 2,698 3,522 2,571 1,304 Copper ('000 tons) 67.3 91 134 134 III 168 234 168 208 Aluminusm ('0M tons) 300.1 15o 211 146 150 215 183 135 107 Pig Iron (-000 tons) 429.8 1,1R3 1,391 726 97 130 97 67 43 Iron ore ('000 tons) 1,400.7 2,568 8,022 7,162 30 109 101 77 70 Natural rubher ('000 tons) 197.6 257 227 246 112 201 280 198 227 Chemical fertlitzer ('000 tons) 4,588.1 6,396 7,333 q,395 340 481 655 501 749 Chemtcals .. .. .. 402 530 63 5 464 608 Agricultural chemicals ('000 tons) 45.1 72 82 82 60 75 110. 78 50 Wood pulp (0n0O tons) 171.5 216 221 239 55 49 75 48 8i Paper ('000 tons) 154.1 254 364 487 55 102 173 129 139 Watches ('OO units) 763.6 937 2,197 1,876 11 39 31 )9 24 Televisions ('000 units) .. 31 89 784 4 12 82 43 37 Tape recorders ('000 units) .. .. .. 201 - - 6 1 12 Cotton ('000 tons) 188.4 181 510 549 318 680 815 580 1,212 Acrylic fibers ('000 tons) 18.6 19 24 26 22 29 32 24 21 Polyester fibers ('000 tons) 94.2 142 180 126 134 157 160 91 209 Polyamtde fibers ('000 tons) 9 It 13 15 28 34 54 31 61 Cereals ('000 tons) 2,337.2 7,014 8,642 11,176 679 949 1,485 1,385 1,482 Soybeans ('000 tons) 29.5 330 190 579 100 52 159 66 113 Animal fats and otlaeeds ('000 tons)/b 102.5 284 330 298 153 182 194 156 152 Sugar ('000 tons) 577.1 1,598 1,299 1,096 342 264 219 168 254 Timber /c ('000 cu m) 737.7 539 535 554 37 50 41 77 108 Cocoa ('000 tons) 10.7 12 15 17 31 54 61 61 38 Coffee ('0o0 tons) 6.3 6 5 4 30 17 11 11 14 /a Includes chassis, trucks, jeeps, tratlers, cabs, etc. 7i; In oil equivalent. 7c laumber only; does not include other kinds of wood. Sources: Ministry of Foreign Trade; data on value were given to the IMF by Government sources.  C46400/J91942/D836/12 - 12 - Table 1.6: MERCHAbMISE IMPORTS BY COMMODITY GROUP, 1976-79 ($ million) 1976 1977 1978 1979 /a Total Value of Imports 6,578 7,214 10,893 15,674 Technology (whole plant) 1,123 377 469 1,189 Other machinery and equipment 921 907 1,448 2,600 Metals and minerals 2,080 2,207 4,027 4,643 Chemicals 984 1,202 1,595 1,922 Light manufactured goods } } 298 503 Handicrafts } 143 } 187 19 37 Textiles 548 694 1,138 1,284 Food items 659 1,453 1,679 2,418 Livestock and related products 121 188 220 234 /a Components do not add to the total for 1979. Source: Ministry of Foreign Trade. 1.23 Imports of cereals, normally the second largest item, continued to fluctuate with the harvest during the first half of the 1970s, but increased continuously during the second half. Several good harvest years cut back grain imports in 1971, but the poor harvest in 1972/73 necessitated sharp increases in grain imports. A good crop in 1974 permitted China to almost halve the 1974 level of wheat and corn imports (to 3.3 million tons) the following year. However, following the difficult year of 1976, cereal imports (excluding soybeans) again increased, to 7 million tons, and reached to 11.8 million tons in 1979. During the first nine months of 1980, cereal imports had reached $1.48 billion, the level for the whole of 1979 (see Table 1.5). Cereals account for about 11% of total imports. With continuous population growth and limited agricultural land, the long-term rising trend is likely to continue. 1.24 China relies heavily on imported cotton for its textile industry. Cotton is the third largest import item. Valued at $815 million in 1979, cotton accounted for 5.2% of total imports (see Table 1.5). 1.25 The share of consumer goods imports, after reaching a low in the 1950s, recovered to about 13% in 1976 and rose considerably during 1977-79 to an average of 20%. This reflects partly large cereal imports and partly the policy of economic readjustment to improve living standards.  C46400/J79039/D836/13 - 13 - 1.26 Changes in the Structure of Exports. Changes in China's economic structure are also reflected in the composition of its commodity exports. In 1953, about 82% of China's total exports were agricultural and processed agri- cultural products. With rapid industrial development, and growing domestic consumption, this share fell to 72% in 1957, and to about 60% in 1976./1 Another important factor in this decrease was the dwindling of soybean and oil seeds exports in the agricultural depression years of the early 1960s. 1.27 On the other hand, exports of light manufactured goods, particularly textiles, have sustained a steady long-term increase. The share of textile exports in the total increased from 8.8% in 1955 to about 18% in 1959 and 1970, and 21.4% in 1979. Textile exports were maintained through economically difficult years by cutting domestic rations to the minimum. Recently textile output has expanded considerably and rationing has been liberalized. However, textile exports still compete with domestic consumption. Other light manu- factured goods that exhibited a steady rise in exports (mostly to developing countries) are thermos bottles, ballpoint pens, watches and furniture. In 1979, total textile and light manufactures exports accounted for 35.5% of the total (Table 1.7). 1.28 An important change,in the commodity composition of China's exports in the 1970s was the emergence of oil as a major export item. Crude oil exports reached 8.5 million tons in 1976 and 13.4 million tons in 1979 (Table 1.8). In addition, because of the sharp increases in oil prices in recent years, the share of crude oil in China's total export value increased from 10% in 1977 to 12.8% in 1979 and 17.2% in the first nine months of 1980 (Table 1.8). For all "mineral fuels, lubricants and related materials" (SITC 3), the export share increased from 13.7% in 1976 to 19.5% in 1979 (see Table 1.7). 1.29 Nonetheless, manufactured exports still accounted for 46% of China's total exports in 1979. This proportion is high compared with those of most other developing countries at the same income level and reflects China's greater industrialization, due partly to the large size of the country and partly to its chosen development strategy. Textiles and light manufactured goods still account for the major proportion of total manufactured exports, and heavy and chemical industrial products for only a small proportion (11% of total exports in 1979). Thus despite China's emphasis on the development of machinery and chemical industries, these are apparently not yet efficient enough to tap the world market. Agricultural exports (raw and processed) accounted for one third of total exports and are still an important source of foreign exchange. /1 SSB, Ten Great Years and Ministry of Foreign Trade.  C46400/J78855/D1194/57-58 WS Table 1.7; MERCHANDISE EXPORTS (SITC CATEGORIZATION), 1976-79 ($ million) 1976 1977 1978 1979 Value Share Value Share Value Share Value Share (x) (X) (x) (x) Total Value of Exports 6,855 100.0 7,590 100.0 9,745 100.0 13,658 100.0 Primary Products: 3,744 54.6 4,065 53.6 5,216 53.5 7,315 53.6 Food and animal products mainly for use as food (1,661) (24.2) (1,797) (23.7) (2,316) (23.8) (2,701) (19.8) Beverages and tobacco (62) (0.9) (71) (0.9) (71) (0.7) (86) (0.6) Nonedible raw materials (excluding ^ fuels) (1,038) (15.2) (1,088) (14.3) (1,417) (14.5) (1,804) (13.2) Mineral fuels, lubricants and related raw materials (924) (13.7) (1,068) (14.1) (1,345) (13.8) (2,654) (19.5) Animal and vegetable oil, fats and wax (41) (0.6) (41) (0.6) (67) (0.7) (70) (0.5) Industrial Products: 3,111 45.4 3,525 46.4 4,510 46.5 6,343 46.4 Hleavy and chemical industrial products 808 11.8 851 11.2 1,010 10.4 1,497 10.9 -Chemical and related products (198) (2.9) (184) (2.4) (234) (2.4) (424) (3.1) -Machinery and transport equipment (238) (3.5) (296) (3.9) (332) (3.4) (464) (3.4) -Other heavy industrial products (372) (5.4) (371) (4.9) (444) (4.6) (609) (4.4) Light industrial and textile products 2,303 33.6 2,674 35.2 3,519 36.1 4,846 35.5 Source: Ministry of Foreign Trade.  TabIl 1.8: MAJOR EXPORTS, BY VOLUNE ANI) VALUE, 1976-b0 Vo Ituac Valucv (~ ioil oio) 19 79 1980 19 76 19 77 1978 19 79 197 7 19 7 19 79 Jali-Sep Jaii-Sep Total Value of Exports. .. . 7,59L1 9,745 J3,657 9,515 12,982 C~ereals ('000 tons) 1,474.9 1,365.1 1,682.8 1,542.1 361 516 489 364 392 Rice ('000 tons) 876.1 1,032.9 1,435.2 1,053.1 256 442 318 215 324 Soybeaas ('000 tons) 199.2 129.5 112.9 305.9 41 32 98 77 24 Beans ('000 tons) 84.4 55.4 45.8 67.2 42 24 31 26 17 Other cereals ('000 tons) 211.9 147.3 88.9 115.9 23 17 22 13 20 Groundntut oil ('000 tons) 13.7 4.3 11.2 37.4 5 13 17 15 19 Groundnut kerniel ('000 tons) 28.4 14.9 18.1 35.2 13 38 36 31 55 fresh eggs ('000 jin) 69,700 67,62u 81,t70 99,530 32 38 46 36 37 Live hogs ('000 head) 2,310.8 2,313.0 2,462.8 2,422.1 169 179 197 350 150 Frozeni pork ('000 tons) 38.4 26.2 42.8 44.9 45 70 72 52 81 Frozen rabbit meat ('000 tonis) 28.5 27.8 39.3 43.5 90 53 53 39 33 Aquatic products ('000 tons) 93.4 87.7 92.0 97.8 258 258 348 269 267 F~ruit ('000 tons) 198.5 227.9 251.0 259.1 67 82 95 41 45 Ca nnied fruit ('000 tons) 197.8 183.3 222.2 286.3 154 202 273 195 253 lbeer ('000 cases) .. 1,354.3 1,162.4 1,247.4 7 6 6 5 7 Cotton yarn ('000 bales) 146.1 117.5 128.8 133.7 52 57 68 48 60 Cotton cloth ('000 meters) .. 771,610 1,095,640 1,108,830 400 580 699 490 50 F"ilature silks; (tons) 6,483 5,022 8,739 9,040i 130 255 271 211 223 F Silk and satin materials ('000 meters) 115,546.9 95,220 123,520 145,750 136 200 263 181 17 Woolen materials ('000 meters) 8,546 6,63U 6,390 12,650i 26 25 47 34 4 Tea ('000 tons) 61.2 83.8 86.9 106.8 358 186 210 156) 166 Resin ('000 tons) 160.5 127.4 142.1 183.9 50 52 78 58 59 Jute bags ('000) 27,81)0 24,200 37,550 52,850 8 34 23 18 37 bristles ('000 cases) 139.5 140.8 330.5 * 174.7 59 55 80 57 48 bristle bruslhes ('000 dozensa) 2,739.6 3,860.0 4,180.0 5,770.0 to 19 18 12 16 Camel hair (tonts) 580 6b9 623 3,019 4 3 6 5 3 Rabbit liair (tonso) 1,970 1,876 2,250 2,675 28 42 60 41 82 Carpets, superior quality hadndmade ('000 siquare meters) 343.8 501.5 7 410.2 850.4 38 63 83 58 69 Woat skin ('000 lildes) 5,304 6,840 8,160 13,010 21 26 53 38 421 Fuir mattresses ('000 pieces) 4,07b.6 3,030 5,090 6,350 50 6)5 88 69 73 Paper ('000 tons) 331.5 104.1 134.0 361.2 44 57 78 57 69 Sewinig machtines ('000 unitLs) 3 36.0t 284.0 386.3 496.7 12 38 21 14 15 bicycles ('000 units) 392.8 375.9 302.8 642.1 13 12 26 16 28 Purcelain ('000 piecesi) 542,190 629,810) 5u8,030 740,330l 80 03 117 77 9 T'in ('000 tons) 7.8 5.6 5.5 4.6 57 65 67 46 42 Anitimonly ('000 tons) 2.5 7.7 31.5 12.5 22 2e i7 27 38 TuAngsten ('000 tonsa) 20.5 13.6 18.2 21.3 149 3 72" 201 126 139 Coal ('000 tolls) 2,270 2,6.10 3, 121) 4, 6341 70 11)0 177 121 196 Crude oil ('000 tons) 8,495.9 9,310 33,'310 13,430 713 958 1,750 1,173 2,234 Paraffin wax ('000 tuns) 84.5 49.e 62.7 66.0 14 24 31 20 38 Tires ('000 setsi) 299.5 269.8 2189.3 414.8 20 20) 23 17 2J 3Kichline tools (piecesi) 4,366 4,296 ,805 6,S5b 38 22 31 38 35 Sources. MI ntstry of Forcign Trade; data oll vallue were givyei L.i Llkk! 111" by GjiVer'IHncikL ~ources.  C46400/J89897/D836/15 - 16 - The Direction of Trade 1.30 The great swing in the direction of trade, away from centrally planned economies and towards market economies, was completed by the final repayment of the Soviet aid in 1966. In 1953 when the delivery of Soviet aid equipment was well under way, 70% of China's trade was with centrally planned economies. By 1966, China's Soviet debt had been fully repaid through commodity exports, and the share of China's trade with the centrally planned economies fell to 22/%' (trade relations with the USSR virtually ceased). As China increasingly turned to the market economies for both imports and exports, the share of the centrally planned economies in China's total trade declined further to 12% in 1979. 1.31 In the last few years, there has been little change in the direction of China's exports, except for the rise in Japan's share. Hong Kong has been China's largest single export market (except in 1979), accounting for about one quarter of Chinese exports (Table 1.9). An unknown, but substantial, proportion of Chinese exports to Hong Kong is re-exported, mostly to developing countries. Agricultural products, such as live hogs, meat, eggs, aquatic products, fruits, vegetables, etc., are, however, largely consumed in Hong Kong. Japan, which purchases mostly oil and coal, is the second largest market, accounting for 20% of China's total exports. The substantial rise in the price of oil, as well as the increased volume of oil and coal shipped to Japan, accounts for the increase in Japan's share in 1979 and 1980. Other industrialized countries, led by the USA, the UK and the Federal Republic of Germany take about 20% of China's exports, and another 20% goes to developing countries other than Hong Kong. 1.32 In 1979, one fourth of China's total imports came from Japan. The next highest share came from the USA, which increased its share sharply from 1.6% in 1977 to 18.3% in the first nine months of 1980, thus surpassing the shares of the Federal Republic of Germany, France, Canada, Australia and the UK. The sharp increase in imports from the USA was largely due to the increased imports of foodstuff and the resumption of diplomatic relations between the two countries in the beginning of 1979. 1.33 In general, China has a small trade surplus with the centrally planned economies, with accumulated assets of about $400 million by the end of September 1980; a large trade surplus, totaling $3.8 billion in 1979, with developing countries (except with Latin American countries), including Hong Kong (with which it had a surplus of $2.1 billion in 1979); and a huge deficit, totaling $5.6 billion in 1979, with market economy countries. The USA, Japan and the Federal Republic of Germany shared the leading position in China's trade deficit in 1979, with about $1.2 billion each. For the USA, the deficit mainly results from China's large imports of foodgrain and cotton, and for Japan and the Federal Republic of Germany, from the imports of machinery and equipment, as well as intermediate goods, including steel, and chemical and petrochemical products.  Table 1.9: D314EcTION Of3 rHAI)E, 1977-80 Exports (S million) -ta( million) Exports (2) Impurts (2) Trade bkalance 1977 1978 1979 3980 1977 3918 1979 3984) 3917 7 3979 19 77 3979 1977 1979 (Jail-Sep) (Jan-Sep) Jndustrial Countries USA 179.6 270.7 595.0 718.0 334.6 721.1 1,856.6 2.401.2 2.4 4.4 1.6 13.8 65.0 -1,261.6 Canada 80.0 94.5 145.1 300.5 460.6 574.0 622.4 607.4 1.3 3.3 6.4 4.0 -380.6 -4717.3 Ausitralia 100.9 137.6 356.1 325.7 517.9 71S.1 985.2 863.8 1.3 1.3 7.2 6.3 -437.0 -829.1 Japant 1,356,7 3,718.7 2.764.1 2, 932.7 2,308.5 3,105.2 3,944.0 3,357.0 317.9 20.2 29.2 25.2 -751.8 -1,179.9 France 143.5 178.4 234.0 250.3 279. 2 24 7.3 406.2 209.9 1.9 1.7 3.9 2.6 -137.7 -372.2 Federal Rep. of Germaniy 260.8 329.5 459.2 519.6 529.8 1,0 30).1 1,739.4 928.8 3.5 3.4 7.3 31.1 -269.0 -1,280.2 Italy 132.2 365.5 302.8 273.0 95.9 190.9 308.7 1.764.0 3.5 2. 2 3.3 2.0 16.3 -5.9 Belgium 28.0 36.8 66.4 64.8 37.6 80.2 106.7 48.0 0.5 0.5 0.5 0.7 -9.6 -40.3 Wtielerlanids 66.7 92.2 336.9 34 2. 7 39.5 325.8 20U.0 83.2 0.9 1.0 0.5 1.3 27.2 -63.1 Spain 19.0 21.9 56.0 39.1 17.9 50.4 93.7 28.9 0.3 0.4 0.2 0.6 1.3 -35.7 Sweden 48.3 47.2 75.0 63.3 38.2 74.3 332.6 58.0 0.6 0.5 0.5 0.7 9.9 -37.6 Switzerlaged 86.0 103.4 169.3 197.5 370.7 299.2 207.6 168.4 1.3 1.2 2.4 3.3 -84.7 -38.3 UK 253.0 370.4 478.9 397.4 279.4 296.3 503.2 431.3 3.3 3.5 3.9 3.2 -28.4 -22.3 Developing Countries Af rica Nigeria 32.6 43.7 24.7 38.0 32.4 - 7.9 4.9 0.4 0.2 0.2 0.3 20.2 36.8 Sudan 42.4 38.2 44.7 24.0 51.6 54.9 89.3 54.6 0.6 0.3 0.7 0.6 -9.2 -44.6 Tanzaniia 33.0 23.7 16.4 6.3 20.5 18.2 1.9 9.2 0.2 0.3 0.3 .. -7 .5 14.5 Zambia 9.3 1.9 3.6 5.9 28.9 31.8 59.5 56.7 0.3 . 0.4 0.4 -39.6 -57.9 Asia- Indonesia - 0.2 - 3.3 2.0 0.4 - 12.0 - - .. - -2.0 - hung Konig 2,012.0 2,668.0 3,548.0 3,044.6 136.2 14.7 214.4 336.4 26.5 26.0 3.9 1.4 3,875.8 3,333.6 Mlalaysia 94.0 363.1 373.4 129.6 305.3 133.2 189.3 335.3 3.2 3.3 3.5 3.2 -31.3 -17.7 Pakistan 63.9 89.3 121.8 86.6 8.5 43.0 30.2 136.2 0.8 0.9 0.3 0.2 55.4 93.6 Plillipptnes 60.6 86.3 334.7 3188.9 33.1 51.2 47.2 44.3 0.8 1.0 0.5 0.3 27.5 87.5 St iga pore 202.1 247.9 296.5 256.8 76.3 46.3 104.7 149.9 2. 7 2 .2 3.3 0.7 126.0 393.8 ?&iddle East Iran 52.5 65.0 36.5 102.6 48.0 53.5 31.4 56.5 0.7 0.3 0.7 0.2 4.5 5.3 Iraq 83.7 69.3 334.7 308.8 23.0 56.8 48.6 117.1 3.3 3.0 0.3 0.3 60.7 ~86.3 Kuwait 94.5 93.0 336.2 323.5 20.9 33.1 38.7 20.4 1.3 3.0 0.3 0.2 73.6 9 7. 5 Libya 43.6 37.1 22.6 3.2 - - - - 0.6 0.2 - - 43.4 22.6 Egypt 55.4 53.7 69.4 70.3 37.2 62.9 56.5 96.6 0.7 0.5 0.5 0.4 18.2 32.9 Westerni hemita phe r e Ar Be it lIna 3.2 2.3 36.2 23.9 136.5 89.6 273 .2 355.8 .. 0.3 3.6 1.7 -315.3 -255.0 Brazil 0.3 8.0 93.5 184.3 19.5 74.4 122.4 45.4 .. 0.7 0.3 0.8 -39.2 -28.9 a,33e 2.9 6.0 30.7 33.2 34.6 38. 7 86.4 79.2 .. 0.3 0.2 0.6 -11.7 -7 5. 7 Mexico 3.2 6.3 9.0 13.4 50.7 303.3 302.5 69.0 .. 0.3 0.7 0.7 -49.5 -93.5 Socialist Counttrieg Northi Korea 227.2 230.7 331.0 328.6 3417.2 223.6 330.2 223.4 3.0 2.3 2.0 2.3 80.0 -33.2 USSR 376.5 229.7 242.2 340.0 352.6 206.9 250.4 359.7 2.3 3.8 2.1 3.6 23.9 -8.2 VLet Nam 53.7 36.3 - - 21.7 40.7 - - 0.7 - 0.4 - 24.0 - Polanid 62.9 3105.3 34 2.9 90.0 79.6 65.5 366.5 352.0 0.8 3.0 3.3 3.3 -36.7 -23.6 Czechioslovakia 83.3 339.1 112.6 8.1.0 93.2 309.0 363.6 301.5 3.3 0.8 1.3 3.0 312.1 -49.0 iltng~ary 34.7 57.6 63.7 1). 6 33.4 48.8 80.5 633.8 0.5 0.5 0.5 0.5 1.3 -38.8 German Deam. Rep. 121.1 362.2 397.9 135.4 1333.7 352.5 397.6 2217. 2 3.7 1.4 3.8 3.3 30U.6 0.3 Iloma ad a 254.3 396.3 490.3 3b3.2 272.9 368.8 603.7 342.9 3.4 3.6 3.8 3.9 -38.6 -333.6 Yugoslavia 4 3.17 58.4 48.4 22.6 45.8 29.2 50.3 90.3 0.6 0.4 0.6 0.3 -2.1 -3.9 Total 7,590.0 975011 58- f13.09.3 7l214.0 10 I93. Lo 33 0 376.0 -,1. Source: Mostly fromn thse IltnlstKy of Foreiga, Trade.  C46400/J79061/D836/16 - 18 - 2. THE INSTITUTIONAL SETTING 2.01 Shortly after the establishment of the People's Republic, the Government built up a comprehensive set of institutions to manage foreign trade. It moved from a strict licensing system to a state trading system after the agricultural sector had been largely collectivized and the indus- trial sector largely nationalized. After 1956, foreign trade was a state monopoly, with no major organizational changes up to 1978. 2.02 Since this system placed significant power in the hands of the state, the Government was able to use foreign trade to further not just economic but also political objectives. Although the direction, emphasis and priority of these objectives have changed during the last 30 years, the main objectives remain unchanged, i.e. strengthening national sovereignty, self- reliance and modernization of the country. In pursuing these objectives, the Government believed foreign trade and other international transactions should follow the principle of equality and mutual benefits. This attitude was greatly influenced by the perception that trade had been utilized by the imperial powers before 1949 to gain political dominance in China, that trade linked with aid should forge important ties with friendly socialist and Third World countries, and that trade with other countries could only be increased with full diplomatic relations. These considerations are reflected in the changes of direction in China's foreign trade (paras. 1.30-33). 2.03 Since 1977, after the Cultural Revolution, the country s priority objective in foreign trade has clearly been modernization, with a more flexible interpretation of self-reliance. Emphasis has been placed on the economic gains to be derived from foreign trade and capital. Parallel with the reform of the economic system, steps have been taken to decentralize foreign trade management. Also, innovative measures have been introduced to promote foreign trade and investment. Accordingly, organizations that deal with foreign trade and finance have been changed considerably, but it is too early to speculate on what their final form will be. The Basic Organizational Framework 2.04 Before the recent moves towards decentralization, China had a completely centralized foreign trade system, with the Ministry of Foreign Trade (MOFT) at the center. The MOFT, established in 1952, is primarily responsible for planning, supervising and conducting foreign trade. In conjunction with the State Planning Commission (SPC), it draws up the annual and medium-term foreign trade plans. The MOFT and its overseas represent- atives may sign trade agreements with governments that have full diplomatic relations with China. It controls foreign trade corporations (FTCs), which each have a monopoly over the import and export of a specific group of commodities (the present 16 FTCs are listed in Appendix A). The FTCs were the only units under the MOFT allowed to sign foreign trade contracts and conduct  C46400/J79039/D836/17 - 19 - foreign trade /1 before the recent organizational changes. Other agencies officially under the jurisdiction of the MOFT are the General Customs Administration and the General Administration for Inspection and Testing of Commodities, as well as the China Council for the Promotion of International Trade. 2.05 Each province, autonomous region and centrally administered munici- pality has a Foreign Trade Bureau (FTB), and many localities have FTB branch offices. These lower level foreign trade administration and planning bodies are vertically under the MOFT, but they also receive guidance, supervision and assistance from the regional government; the MOFT is dominant in this "dual leadership" system. In parallel, the FTCs maintain branches in most provinces and local offices in areas where trade in their product lines is particularly important. These local branches and offices have traditionally been under the vertical leadership of their respective FTCs, but they also receive guidance, supervision and assistance from the regional or local FTBs, with the former dominating. Recently, important changes have been introduced that affect these relationships (see para. 2.13). 2.06 In line with the foreign trade plan, the FTCs procure goods domestically and sell them abroad, surrendering the foreign exchange earned to the Bank of China. The FTCs also purchase goods abroad for production and other purchasing units, under import licenses issued by the MOFT according to the foreign trade plan; foreign exchange for these purchases is allocated by the Bank of China and the State General Administration for Foreign Exchange Control according to the foreign exchange budget. The FTCs engage directly in foreign trade and are "independent accounting units". The monopoly trading power of the FTCs has been the main factor in the close central control over the level, direction and composition of exports and imports. 2.07 This centralized organizational structure was appropriate when the principle of self-reliance was followed, or when foreign trade was conducted mainly with countries that had similar, centrally planned economies. However, since 1976, when modernization has been emphasized as a goal, the Chinese authorities' attitude towards foreign trade has become increasingly more positive and China's trade policy has been made increasingly more flexible. Self-reliance is now seen as a long-term objective, and the introduction of modern technology is regarded as a means of eventually achieving it. More- over, the international division of labor is increasingly recognized as advantageous to China's modernization, although it is still considered to be subordinate to the general aim of establishing an independent and integrated socialist economic system. /1 Some other agencies that are authorized to trade but do not come directly under the MOFT are: Guozi Shudian (International Book Store), China National Publications Import Corporation, and China Film Corporation. No changes were made in their positions as a result of the recent decentralization.  C46400/J79039/D836/18 - 20 - Decentralization of Foreign Trade Management 2.08 With the lion's share of its trade now being conducted with market economy countries, and the level of such trade increasing fast in recent years, China has found its centrally managed trade structure too rigid and inefficient. The FTCs cannot follow closely changes in the world market situation, as well as technical characteristics of the many exports produced in various parts of such a big country and of imports required by so many different agencies and enterprises. With no direct contact between end users and foreign suppliers or between domestic suppliers and foreign buyers, trade negotiations through intermediaries (i.e. the FTCs) tend to be prolonged and good market opportunities are missed. Thus, since 1978, China has introduced significant organizational reforms to decentralize foreign trade management in two directions: laterally to other ministries and vertically or geographic- ally to local government levels. In addition, new agencies are also being established at various administrative levels to institute the recently adopted policy measures to promote exports, introduce foreign technology and attract foreign investment. 2.09 Supra-Ministerial Level. Two new commissions, the Foreign Investment Control Commission.(FICC) and the Import-Export Commission (IEC), were recently established under the State Council to supervise and coordinate the work of ministries and other agencies that deal with foreign trade and investment matters. These new agencies have a status roughly equivalent to that of the other state commissions. The IEC, the most recently established, apparently shares staff temporarily with the FICC, and the division of labor between the two commissions has yet to be clarified. The FICC appears to be concerned primarily with the approval of joint ventures, foreign investment and technology introduction. The IEC is concerned primarily with foreign trade policy guidelines, treaties and laws, foreign trade agreements, large foreign trade ventures and special trade practices. The IEC may also have broad authority in determining the overall foreign trade plan, in conjunction with the MOFT and SPC, and in supervising and coordinating the foreign trade activities of entities not under the jurisdiction of the MOFT. The SPC and the MOFT seem to have retained primary responsibility for "normal" or "tradi- tional" trade, while such new trade practices as compensation trade, export processing and joint ventures are under the authority of the FICC/IEC. 2.10 Another new institution is the China International Trust and Investment Corporation (CITIC), established on July 8, 1979. The CITIC is a business organization in charge of negotiating joint ventures, finding appropriate Chinese partners, and coordinating the introduction of foreign investment and technology. It has branches in several Chinese cities, as well as a Hong Kong branch, which operates with considerable independence. However, final approval of foreign investment rests with the FICC.  C46400/J79039/D836/19 - 21 - 2.11 Ministerial Level. Several new export and import corporations have been established under the production ministries to conduct foreign trade directly. Corporations under the production ministries are responsible for the plants and other facilities used in production; they and their subordinate enterprises are the end users of producer goods imports, and they thus have the technical expertise to negotiate the import of complex technology, machinery and equipment. With the recent increased access to such imports, representatives of these corporations have been allowed to handle technical negotiations with foreign suppliers, while the FTCs handled commercial negotiations and signed contracts. These corporations could not discuss their exportable products with foreign customers. Usually, they were not fully aware of international market needs and trends, so some have continued to produce goods unfit for export, which has resulted in accumulating stocks, particularly of machinery products. 2.12 For these reasons, some of the production ministries are now allowed to organize their own export and import corporations. The corporations have the authority to conduct technical as well as commercial negotiations with foreign firms and to sign contracts, thus bypassing the FTCs; they also coor- dinate contacts between foreign suppliers or buyers and the enterprises. There are 17 of these corporatTons directly conducting foreign trade in light industrial products, electronics, general industrial machinery equipment, precision machinery, scientific instruments, mining equipment and minerals, aircrafts, etc. (see Appendix B). In ministries that have yet to form export- import corporations, the production corporations (such as the China Petroleum Corporation and China National Chemical Fibers Corporation) may also discuss projects with foreign firms. 2.13 Local Government Level. The authority to directly conduct foreign trade has been granted to several provincial and municipal governments. The local governments may organize foreign trade corporations to handle foreign trade, as well as transportation, chartering, warehousing, packaging and advertising, in their province or municipality. They can communicate directly with foreign enterprises to pursue trade and investment ventures within their own jurisdictions. These local corporations direct the operations of the local FTC branches, which, however, still report to the national FTCs on planning and budgeting matters. The dominant role in the dual leadership system has thus shifted to the local foreign trade corporations, whose authority to conduct foreign trade directly puts them in a better position to coordinate the activities of the various local FTC branches and to promote more vigorously the interests of local foreign trade and economic development. The municipalities of Beijing, Tianjin and Shanghai, the coastal provinces of Guangdong, Fujian, Liaoning and Hebei, and the Guangxi autonomous region have all formally established local foreign trade corporations./l 2.14 In addition, several local trust and investment corporations have been set up to interest foreigners or overseas Chinese in investing in local /1 China's Foreign Trade, Beijing, January 1981.  C46400/J78363/D836/20 - 22 - enterprises, by finding Chinese partners for joint ventures, compensation trade and other kinds of projects. One of them (the Fujian Investment Enterprise Corporation) is also authorized to float bonds outside China to finance local projects. The functions of these corporations are much like those of the CITIC for the country as a whole, but the corporations are not subordinate to the CITIC; the CITIC seems to focus on relatively large projects while local corporations normally deal with smaller projects. Four such corporations have been established so far, in Beijing, Shanghai, Tianjin and Fujian. 2.15 Special Economic Zones. Special economic zones are being estab- lished in the two coastal provinces of Guangdong and Fujian, which are adjacent to Hong Kong, Macao or the South China Sea. The zones are, in particular, intended to attract foreign investment in light and manufacturing industries catering to export markets. Special facilities, including infra- structure and services, are to be provided and preferential tax treatment granted to the enterprises (see paras. 3.23-3.26 below). The zones are administered directly by the provincial authorities, with a simplified bureaucracy and broad investment guidelines. At the August 1980 session of the National People's Congress, detailed regulations were approved governing the three economic zones in Guangdong, which are near the cities of Shenzhen (next to Hong Kong), Zhuhai (near Macao) and Shantou (near the Fujian border). Applications for investment, joint ventures and other undertakings are to be submitted to the Guangdong Provincial Administration Committee in Charge of the Special Economic Zones. The Guangdong Provincial Special Economic Zones Development Company is to be set up to take part in fund raising and trust investments, operate joint venture enterprises, act as an agent in business transactions with other parts of China, and provide services for business negotiations. In late 1980, the Xiamen (Amoy) Special Economic Zone Administration Committee (in Fujian) was established to plan, build and administer the Huli subzone. 2.16 Summary. All these efforts towards decentralization in foreign trade management aim at bringing more direct contacts between Chinese exporters and foreign markets, and between Chinese end users and foreign suppliers (as well as between Chinese enterprises and foreign investors). This would allow traders to develop an intimate knowledge of their markets, as well as to save time and seize trading opportunities - none of which would be possible if all export and import trade arrangements still had to go through the FTCs. However, it is not clear how far the decentralization will go in allowing individual enterprises to conduct foreign trade independently as the economic system is reformed. Some enterprises have made direct contact with foreign firms, obviously on a trial basis. But competition among the Chinese enterprises and their ignorance of world markets (for instance, in the case of porcelain exports) have brought export prices down considerably. Current thinking in China appears to favor organizing trade associations among enter- prises in the same lines of production and letting these associations conduct foreign trade for their member enterprises. This represents a further step towards decentralization and could be more business oriented and efficient than the existing system. Nonetheless, the bulk of China's foreign trade is currently still carried out by the FTCs.  C46400/J79039/D836/21 - 23 - 3. NEW MEASURES FOR PROMOTING FOREIGN TRADE AND INVESTMENT 3.01 China has recognized that some innovative export promotion measures adopted by other successful developing countries have the advantages of earn- ing additional foreign exchange, providing new jobs, introducing modern technology and improving the quality of products. Thus, since late 1978, China has become more flexible and imaginative in adopting new measures (summarized below) to promote trade and attract foreign capital. It no longer relies only on simple procedures and sales contracts with cash payments. It has agreed to use foreign designs, specifications, trademarks, raw materials, components and equipment, and increasingly it is using advertising. It is also eager to gain access to international markets through the connections of foreign firms. Export Processing 3.02 Under this arrangement, foreign firms supply raw materials, semi- finished goods, packaging materials and/or components, while the Chinese enterprises process or assemble products according to foreign contractors designs, specifications and quality requirements. All the products are passed on to the foreign contractors or their agents, and the Chinese enter- prises receive a processing fee. All the machinery and equipment used are Chinese made, unless specific machinery and equipment needed are not avail- able in China, in which case they can be imported and the cost is deducted from the processing fee. Imported materials, components, etc. are exempted from duties and taxes, but the volume of these imports has to be appropriate for the amount of final products; none of them may be used for products sold in domestic markets. At present, the processing fees in garment, textile, yarn, and cloth-making enterprises are cheaper than the corresponding costs in Hong Kong and Macao, not to mention Japan, because wage rates are lower in China. The Chinese firms engaged in export processing of these articles are profitable. 3.03 By the end of June 1980, 18 provincial, municipal and autonomous regional governments had begun export processing operations and compensation trade (see paras. 3.05-3.08 below). Most of the export processing enterprises are located in the special economic zones near Hong Kong and Macao and the two large industrial cities, Shanghai and Tianjin. There were about 6,300 export processing projects, largely operated by medium-sized and small plants; 70% of the projects were with Hong Kong and Macao, 20% with Japan, and 10% with other countries. From July 1978 to the end of June 1980, China received a total of $60 million in export processing fees; this figure is expected to increase to $100 million by the end of 1980. Between mid-1978 and mid-1980, China imported about $96 million of equipment for export processing. 3.04 The advantages of processing for export are obvious. This arrange- ment provides more stable sources of supply of material inputs than domestic sources. Also, export processing operations earn foreign exchange, create  C46400/J79039/D836/22 - 24 - employment and utilize excess industrial capacity. In addition, they allow Chinese enterprises to become familiar with foreign markets and modern ideas, as well as helping to introduce modern equipment. Compensation Trade 3.05 Under this mode of trade, China provides the factory-building and labor, while foreign firms supply capital, equipment, technology, training, designs, and possibly supervisory personnel. Foreign firms are either paid directly by the goods produced or indirectly by other products agreed upon by both sides. In the case of indirect compensation, for instance, imported beer brewing equipment can be paid for by starch or wheat germ rather than by beer, if the latter is in oversupply on foreign markets. The beer so saved is sold on the domestic market, where beer is in short supply. However, indirect compensation trade agreements are rare, as they involve rather complicated negotiations and there are difficulties in reaching agreements. Once all the payments are made, the equipment becomes entirely Chinese owned. 3.06 From mid-1978 to mid-1980, agreements on about 330 compensation trade projects were signed with medium-sized and small industries; 60% of the projects were with Hong Kong'and Macao, and 34% with Japan. In terms of project value, however, Japan accounted for 47% and Hong Kong and Macao only 41%. By industry, textile, garment and silk fabric enterprises accounted for one half; other light industries for one fourth; and firms producing chemi- cals, metal and minerals, machinery and food for the remainder. In most cases, it will take 2-3 years to pay for the equipment imported, but for some relatively large projects, 7-8 years. 3.07 Compensation trade has an advantage over direct foreign investment in that equipment ownership and management are all in the hands of the recipient country. (Compensation trade is in fact practised by the USSR and East European countries.) The main financial advantage of this form of trade is that it allows machinery and equipment to be imported without cash payments in foreign exchange; thus it helps the importing country in maintaining a trade balance. However, it also entails many difficult problems. For instance, deciding how many and what kinds of products are required, and over what period, in exchange for what kinds of equipment. Normally this would be decided based on prices prevailing in international markets when the contract is signed. However, because the Chinese negotiators were unfamiliar with international markets and the equipment, they seem to have had bad experiences in some of these deals: the equipment imported was inappropriate (by being so advanced and automatic that it was difficult to handle or it generated too few jobs), or sometimes it was obsolete and became less useful even before it was fully paid for; in. some cases the quality of products has been a cause for dispute, and any rejection of products causes losses; in still other cases, unfavorable world market developments have hampered sales of finished products and prices had to be cut, thus reducing profits. Moreover, foreign contractors who are interested in selling equipment to China may not be in  C46400/J79061/D836/23 - 25 - the business of marketing the finished products internationally, and they would therefore be reluctant to enter into compensation trade agreements. Exports under medium-sized and small compensation trade contracts have so far been minimal and involved ony about 20-30 product lines. 3.08 All export processing and compensation trade projects of over $1 million in the provinces and smaller municipalities and of over $3 mil- lion in the three large municipalities (Beijing, Tianjin and Shanghai) are subject to the approval of the Import and Export Commission; those below the above ceilings can be approved by the local governments. For very large compensation trade projects involving the development of coal, petroleum, iron and steel, and other resources, however, the prime responsibility for negotiation and implementation rests with the relevant ministries. Cooperative Production 3.09 This type of arrangement is halfway between compensation trade and joint ventures (see paras. 3.12-3.21 below). It is a form of technology transfer whereby a foreign firm helps a Chinese enterprise to set up a factory and produce an item under license, by giving extensive technical assistance in stages. In the early stages,-the Chinese enterprise imports a large proportion of parts and components and completes the final assembly in its own factory. Gradually, the Chinese enterprise takes on more complex parts of the manufacturing process, until after several years it can complete the product entirely or mostly from its own materials and components./1 Normally, a Chinese FTC or ministry imports equipment and technology to construct a new assembly line or a new workshop in an existing factory or service industry./2 Payment is often made by supplying over an extended period, either free or at a discount, a share of the output generated by the facilities built or modernized with foreign assistance. Negotiation of these contracts can be very complicated, as they involve such issues as quality control over the resulting products, costs and prices of the products and equipment, payment guarantees, and insurance of the equipment. No equity investment by the foreign partner is involved, as the facilities are entirely Chinese owned. 3.10 Cooperative production appears to be motivated by the consideration that greater "learning" of foreign technology and greater foreign exchange savings can be achieved in this way than by importing complete plants. The first co-production agreement came about through China's inability to produce sophisticated equipment under license./3 /1 China Business Review (Washington, D.C.), November-December 1979, p. 20. /2 See US Department of Commerce, Doing Business with China, November 1980. /3 See description by Kang Shien, 5/4/79, in CBR July-August 1979, p.17.  C464nO/J77994/D836/24 - 26 - 3.11 Many of the cooperative production contracts are for large projects, sometimes involving construction of a new production plant. Among the more important contracts already signed are one involving toy manufacturing ($50 million) and one for two petrochemical factories with a company in the Federal Republic of Germany ($21 million total)./L China has signed preliminary agreements with McDonnell Douglas for joint production of DC-9 Super 80 jets and with Bell Helicopter Textron for production of helicopters./2 Joint Ventures 3.12 A Joint Ventures Law was promulgated on July 14, 1979, to attract direct foreign investment in Chinese enterprises; in addition, a new institu- tion was created to promote foreign investment through joint venture arrange- ments (para. 2.10). In general, the share of foreign investment should be no less than 25%, but no maximum limit for foreign capital is stipulated. In practice, however, the Chinese share of the equity capital has been 50% or more in the ventures already approved. After-tax profits will be shared by the Chinese unit and the foreign firm according to their respective capital shares. Profits may be remitted outside China. The Chairman of the Board of a joint venture must be Chinese, but the position of general manager is rotated between Chinese and foreign candidates, even if the share of foreign capital is less than 50%. Initially, a foreigner is normally appointed, and a Chinese candidate is the deputy manager, so that the Chinese staff can learn modern methods of management. 3.13 On July 26, 1980, the State Council approved two sets of regulations governing joint ventures, one on registration and the other on labor manage- ment. On September 10, 1980, the National People's Congress adopted two income tax laws, one concerning joint ventures and the other individual income; on December 14, 1980, the detailed regulations of these laws were announced by the iMinistry of Finance. The law provides that a 30% corporate income tax will be levied on joint ventures by the Government, with a 10% local surtax, resulting in a total of 33%. In addition, an income tax of 10% will be imposed on profits remitted outside China. Favorable tax treatment is provided for reinvestment of profits in China. Joint ventures scheduled to operate for more than 10 years may have their income exempted from taxation in the first profit-making year and are allowed a 50% income tax reduction in the second and third years. Joint ventures engaged in such low-profit operations as farming and forestry or located in remote, underdeveloped areas may be allowed a further 15-30% reduction in income tax for an additional 10 years. The taxes on joint ventures exploiting petroleum, natural gas and other natural resources are to be fixed separately. /1 CBR March-April 1979, pp. 72-73. /2 CBR November-December 1979, p. 21.  C46400/J79111/D836/25 - 27 - 3.14 The corporate income tax rates and the tax rate on profit remit- tances are lower than those in most developed countries and in many developing countries. However, the regulations do not allow interest payments to be treated as a cost, which seems unusual and unattractive to foreign investors. Also, the 20 year depreciation period allowed for buildings seems too long. 3.15 The individual income tax, with rates varying from 5% to 45%, applies to foreigners who reside in China for more than a year. Since it allows deduction of living expenses of the individual and his or her family, the exemption limit of Y 800 income per month after deductions may not be as low as it appears. Also, the regulations allow the reduction of income tax abroad from the income tax due to the Chinese Government, thereby avoiding double taxation. 3.16 Private foreign investors are particularly concerned about the prob- lem of labor management in a joint venture with a Chinese enterprise. The regulations on labor management have now clarified legal requirements, which may have alleviated the concern of foreign investors. The regulations provide that the workers and staff should all be selected by the joint venture after examination to determine their qualifications, but those recruited must be approved by the labor management department. A labor contract is to be signed jointly by the joint venture and the venture's trade union organization (except in relatively small joint ventures). A joint venture can discharge workers or staff if they fail to meet the job's requirements after training and are not suitable for other work. However, compensation must be given by the enterprise, and the trade union has the right to object and seek an alter- native solution with the enterprise's board of directors. The wage level of the workers and staff in a joint venture are set at 120-150% of the wages of employees of state-owned enterprises in the same trade and locality. Also, a joint venture must pay labor insurance for its Chinese workers and staff (to cover their medical expenses and various government subsidies) in line with the standards prevailing in state-owned enterprises. 3.17 While China is actively seeking foreign investment, it seems to be proceeding cautiously and realistically, giving due consideration to con- straints and priorities. During the current economic readjustment period, utilization of external capital is likely to increase gradually within the limits of China's financial and absorptive capacity. In accepting joint ventures, China is particularly careful about weighing the availability of raw materials, fuel, power, water, transportation and communication facilities, and other urban infrastructure, as well as its construction capacity. 3.18 Following the current readjustment policy, priority is being given to joint ventures that (a) modernize or restructure existing industries using a relatively small amount of capital, but achieving high yields quickly, as well as generating additional foreign exchange, (b) develop energy resources and install energy-saving devices, (c) construct critical infrastructure facilities to remove production bottlenecks, and (d) develop remote, backward  C46400/J79039/D836/26 - 28 - areas. More specifically, Chinese officials have cited the following as priority areas for foreign investment (not necessarily in order of importance): (a) Agriculture. Development of agriculture, forestry, livestock and marine products, or comprehensive development in remote areas, such as Hainan Island and Xinjiang. (b) Energy. Development of coal mining, petroleum exploration and extraction, nuclear power and other sources of energy. Of immediate importance is using foreign capital for investment in energy-saving devices in existing enterprises. (c) Transportation. Development of railroads and harbor, particularly to remove bottlenecks in transporting coal for both domestic use and export. (d) Urban Development. Improvement of infrastructure facilities in the urban areas, including telecommunications. (e) Renovation of the Textile and Light Industries. Plants and equip- ment to upgrade the quality and increase the variety of products, with emphasis on exports and import-substitution in labor-intensive industries. (f) Machinery and Electronics Industries. Improving the quality and diversifying the product mix of the electronics industry, by accept- ing imported parts and components from foreign investors. For the machinery industry, emphasis will be on introducing new types of energy-conservation devices through research and development. Also, China is eager to develop its capability to manufacture large precision instruments. (g) Building Materials. Development of China's capability to manu- facture alloy steel, synthetic fibers and plastics, synthetic rubber, and other new types of building materials. (h) Tourist Industry. Constructioa of both large and medium-sized tourist hotels, with either luxurious or standard accommodations, which hitherto has been rather slow because of the backwardness of the building materials and construction industries. 3.19 Up to the end of 1980, 17 joint ventures had been approved,/l most of them in tourism and the light and handicraft industries. These include /1 China Daily News, New York, December 12, 1980, quoting Chinese Economic News, published in Hong Kong.  C46400/J78363/D836/27 - 29 - hotels (3 in Beijing), an airline food catering service, woolen textiles (in Xinjiang), watch faces, rattan furniture, artificial flowers, elevators and wine. Most of the foreign investors are overseas Chinese (but three are from Japan and one each from France, Switzerland and the USA), acting on their own or with other investors. Many of these joint ventures are investments to expand or modernize existing Chinese plants. The exact amount of foreign capital involved is not known, but is not believed to be very large. 3.20 Four contracts have been signed between the Chinese Petroleum Corporation and some French and Japanese companies for offshore oil explor- ation in the Bo Hai and the South China Sea. This kind of risky undertaking normally has a contract of only one year in order to assure speed and effi- ciency in execution. If oil is discovered, the cost will be borne by China; if not, it will be borne by the foreign company. 3.21 About 70 joint ventures are now being negotiated. Feasibility studies have been completed and initial memoranda signed with US companies for offshore oil exploration, coal mining and precision instruments manu- facturing; with companies in the Federal Republic of Germany for automobile assembly and parts manufacturing, and the electronics industry; with Japanese companies for automobile assembly and light industries; with UK companies for float glass manufacturing; and with France for nuclear power generation. Joint Operations 3.22 A slight variation on a typical joint venture, the joint operation, is found mostly in Guangdong and usually involves small enterprises. The arrangement is halfway between a joint venture and cooperative production: the foreign investor provides equipment but his profit share need not be in proportion to his capital contribution (it is subject to negotiation). Management is in the hands of the Chinese partner, and the foreign capital will usually be repaid within 3-5 years, but certainly within 10 years. The operations- products are mainly for export. Up to the end of 1980, there were reportedly 289 joint operations, with the equipment provided by foreign investors estimated at $500 million. Preferential Treatment in the Special Economic Zones 3.23 Enterprises in Guangdong's three special economic zones (para. 2.15) are granted preferential treatment. Foreign or overseas Chinese investors are being allowed, for the first time, to set up wholly foreign owned enterprises in these zones. Moreover, foreign investors are allowed to run their own enterprises in the special zones, employing foreign personnel for technical and administrative work. In the special zones, land-levelling projects and work to provide various public utilities (water supply, drainage, power, roads, wharves, communications and warehouses) are undertaken by the local authorities. Bank and insurance facilities are also provided.  C46400/J79039/D836/28 - 30 - 3.24 Other special privileges granted in August 1980 to enterprises in the special zones include-the following. (a) Land in the special zones remains the property of China, but favor- able consideration will be given to foreign investors in matters such as land rent, the size of the plot, and the length of tenure. (b) The rate of corporate insurance tax is 15%, which is half the rate in other parts of China. Preferential treatment will be given to enterprises established within two years of the promulgation of these regulations; to enterprises with an investment of $5 mil- lion or more; and to enterprises that use high-level technology or have a relatively long period of capital turnover. Firms that reinvest their profits in the special zones for five years or more may apply for exemption of income tax on profits from such reinvestment. (c) Import duties are waived for machinery, spare parts, raw materials, vehicles, and other means of production for the enterprises in the special zones. Needed consumer goods are subject to the full or a lower import duty, or they may be exempted. Enterprises in the special zones are encouraged to use Chinese-made machinery, raw materials and other goods. Preferential prices will be offered on the basis of China's export prices for similar commodities, with settlement in foreign exchange. (d) Legitimate after-tax profits of investors, and salaries and other earnings (after paying personal income tax) of foreign workers and staff members may be remitted outside China. On termination of the business, foreign investors may, after clearing their debts, remit their remaining asset funds outside China. (e) Wages and labor protection regulations for local workers differ little from those in the general foreign investment law, except that wages are not fixed as a proportion of wages in similar state enter- - prises. 3.25 Products of enterprises in the special zones are to be sold on the international market. If an enterprise wants to sell its products on the domestic market, it must have the approval of the local authority and pay customs duties. 3.26 Shenzhen is the most advanced of the special economic zones. It reportedly has some 60 factories in operation and nearly 200 more under negotiation. Problems in Direct Foreign Investment 3.27 Despite these efforts to attract direct foreign investment, progress has been slow and most investment to date has been by overseas Chinese from Hong Kong in medium-sized and small enterprises, without much significant  C46400/J79039/D836/29 - 31. - transfer of modern technology. For large Western multinational corporations, investment in China appears to be like charting an unfamiliar sea. The gaps in China's legal structure and unfamiliarity with China's socialist economic system make it difficult for them to envisage how the joint ventures will be operated and to evaluate risks and profitability. Realizing this, the Chinese Government is currently perfecting its laws relating to foreign-investment. It is determined to protect the interests of foreign investors and is now negotiating bilateral agreements, including one on political risk insurance, with the USA and the Federal Republic of Germany. 3.28 An important problem China faces concerns the foreign exchange earned by joint ventures. Since a large part of the salaries and wages of foreign workers and staff members, dividends, raw materials and equipment will have to be paid for in foreign exchange, joint venture enterprises must export enough products to pay for these items, and if possible retain a surplus in China. However, export markets are uncertain and foreign investors might not want to export extensively if this encroaches on their existing international markets, preferring instead to sell on the Chinese domestic market. This issue has yet to be resolved, as the Chinese authorities continue to emphasize not only costs and profitability, but also net foreign exchange earnings, when considering the economic feasibility of joint ventures. Summary Appraisal 3.29 It is difficult to judge the efficiency of each of these new ways of conducting foreign trade, since China has had only limited experience with them. Moreover, with the policy priority given to economic readjustment since late 1980, arrangements with large foreign firms for relatively large-scale endeavors under some of these schemes have been discouraged. However, it can already be seen that export processing /1 is perhaps the easiest way of reach- ing agreements with foreign firms, although it does little to bring in significant modern technology. Nevertheless, it can introduce numerous small innovations in designs and packaging, which would have a widespread, favorable impact on China's medium-sized and small industries. Its main benefits would be to earn foreign exchange, utilize existing equipment more fully and increase employment opportunities for surplus labor. The special economic zones, though proceeding rather slowly, would eventually yield similar benefits. Further development of these forms of trade would seem appropriate during the readjustment period and for the medium term. 3.30 Compensation trade is more difficult to arrange, because of the problems involved in pricing the equipment and products. Although China has signed agreements on about 330 compensation trade projects for medium-sized and small industries, there is little information to judge their significance, as well as their costs and benefits. In negotiating compensation trade /1 The present levels of trade are low: receipts of export processing fees are likely to be no more than about $70 million for 1980, and factories operating in Shenzhen perhaps number no more than 80.  C46400/J79061/D836/30 - 32 - arrangements, Chinese firms should pay more attention to the kinds of equip- ment they obtain and the contracted prices of this equipment and the manufac- tured products. In fixing the future prices of export products, the projected inflation rate in particular should be taken into account. 3.31 At present, only 17 joint ventures have been approved, and the number of cooperative production contracts is perhaps even lower. Joint production and joint venture arrangements are complex and difficult to reach agreement on. However, they appear to be suitable for cooperating with large foreign corporations in transferring modern technology to China. After the period of economic readjustment is over, China will perhaps be more interested in these kinds of foreign trade and investment schemes. In the long-term, they can become more significant in both quality and quantity terms, although it will take some time to overcome the initial lack of understanding between the Chinese and foreign firms. While all these schemes would help China gain access to foreign markets, they will be no substitute in the long run for China establishing its own marketing network. 4. PLANNING AND PRICING IN FOREIGN TRADE AND EXCHANGE 4.01 The planning of foreign trade is an essential part of China's cen- tral economic planning, which was initially established in the 1950s. Since then the most significant changes in foreign trade management (paras. 2.08- 2.15) were made after 1978, following the rapid increase in China-s trade with market economy countries. However, it is not yet clear to what extent China would resort to foreign trade as a means of economic development or to what extent China would blend planning with price mechanisms in conducting foreign trade. Foreign Trade and Foreign Exchange Plans 4.02 The framework of foreign trade and foreign exchange planning has remained virtually unchanged since the mid-1950s. The trade and exchange plans are essential parts of the national economic plans, and their prepara- tion is guided by the overall objectives of the latter. The current practice in foreign trade and exchange planning is first to promote exports, with due consideration of domestic supplies of essential goods, then to determine the level of imports based on expected foreign exchange earnings, thereby maintaining the current account in balance. 4.03 The foreign exchange plan is drawn up by the State General Administration for Foreign Exchange Control and incorporates the foreign trade plan drawn up by the MOFT, both in conjunction with the SPC. While the two former agencies are primarily responsible for preparing well-balanced plans, the SPC is concerned with the overall balance between the external sector and other sectors of the economy (production, capital construction, people's living requirements, commodity distribution, public services, etc.). The planning process is the same for both the annual plans and the five-year plans.  C46400/J79039/D836/31 - 33 - 4.04 Preparation of the annual foreign trade plans begins in June-July of the preceding year. At that time, all the central ministries and other agencies in charge of production and supply, all foreign trade corporations, and foreign trade bureaus in the provinces, municipalities and autonomous regions are requested to report to the SPC and the MOFT their estimates of goods available for export and their import requirements for the coming year. In working out their trade plans, the local trade bureaus coordinate with the local planning commissions, which are concerned with the balance between all sectors of the local economy. These plans, along with those of the central ministries, are put together by the MOFT and the SPC and submitted (as a part of the annual national economic plan) to the State Council for consideration. At the national foreign trade planning conference in September-October, the MOFT and the SPC see what import requirements of one locality can be met by the proposed exports from another, with the aim of reducing total potential imports and exports. The revised foreign trade plan is then submitted to the State Council by the year's end for approval. 4.05 Import Planning. The purpose of import planning is to find out import requirements by commodities, then to balance these with what can be made available domestically in order to determine net import requirements. For instance, the Steel Ministry would provide steel output targets, which would then be matched with the demand targets provided by the State Bureau of Materials Allocation based on data on the steel requirements of steel-using ministries and agencies. The balance between the requirements and production targets are presented to the import departments of the SPC and MOFT. Simi- larly, the import requirements for machinery and equipment are determined by the capital construction plan and production programs agreed among the SPC, the State Capital Construction Commission and State Economic Commission, and approved by the State Council for inclusion in the national plan. All import requirements for means of production are in turn balanced with other import requirements and expected foreign exchange receipts, and adjustments are made by the SPC and MOFT. For instance, a reduction is normally made in steel import requirements. Priorities are established regarding the timing of machinery and equipment imports, so that negotiations with foreign suppliers begin first for items with a higher priority. 4.06 Imports of consumer goods have to be coordinated with domestic supplies. The Ministry of Commerce estimates national purchasing power (sales) of consumer goods and then coordinates this with estimates of goods available. For consumer goods likely to be in short supply, decisions have to be made either to increase production or to import. The principle is to avoid importing finished consumer goods if possible, by importing raw materials and manufacturing consumer goods (e.g. importing cotton to make cloth). The import plan for consumer goods and raw materials for light industries is finally decided after consultation among the SPC, the MOFT, the Commerce Ministry and other relevant ministries.  C46400/J79039/D836/32 - 34 - 4.07 The composition of imports is basically determined by the overall objectives and direction of national policy. Under the First and Second Five-Year Plans (1953-62), the emphasis was on basic capital construction, so imports of the means of production (i.e. machinery, equipment and raw materials for production) accounted for the bulk of imports (about 80-90%); imports of consumer goods were small. During the subsequent readjustment period, imports of consumer goods such as foodgrains, cotton, edible oil and sugar increased more rapidly than imports of the means of production. In the recent past, the relative trends were again reversed; but since 1979, with the emphasis on economic readjustment, imports of consumer goods have again tended to increase more rapidly. 4.08 Export Planning. The main determinants of export items are produc- tion capacity, demand and supply conditions, and prices in the foreign market. The preliminary compilation of an export plan is the responsibility of the MOFT, in coordination with the SPC; the MOFT also consults ministries in charge of production and the Ministry of Commerce regarding domestic demand. In the past, the emphasis was on satisfying domestic demand, but now an effort is being made to allocate some output for export if foreign markets are favorable. From the exportable goods targets, an export plan is formulated, which, as a part of the foreign trade plan, is further balanced and coordinated with total import requirements at the annual foreign trade planning conference. The current guiding principles are not to make export targets too high, and to allow some flexibility for unexpected adjustments. 4.09 The foreign trade plan is in turn incorporated into the foreign exchange plan./l For nonmerchandise transactions in the foreign exchange plan, the Ministry of Foreign Economic Relations prepares the part dealing with external assistance and Chinese loans to Third World countries. The foreign exchange receipts and outlays of other government departments are pre- pared by the Ministry of Finance. The General Administration for Foreign Exchange Control (GAFEC) draws up the part of the plan covering local and provincial nontrade transactions, receipts from overseas Chinese, tourist receipts (in consultation with the Tourism Bureau), and individual receipts. The plan, drawn up in dollars, includes all transactions, even those under bilateral agreements. The overall foreign exchange plan is coordinated and balanced by the GAFEC. The SPC reviews the plan and reconciles it with the other plans; it is then submitted to the State Council for approval and thereafter sent back to the localities and ministries for implementation. The GAFEC is responsible for supervising the implementation of the foreign ex- change plan. At the end of each quarter, the SPC reviews the implementation of the plan and determines whether corrections are necessary. 4.10 Since 1979, some flexibility in foreign exchange planning has been allowed by the introduction of a foreign exchange retention system. This system encourages local authorities and trade corporations not under the MOFT /1 See IMF, The People's Republic of China, Recent Economic Development (January 1981), Appendix VIII.  C46400/J79061/D836/33 - 35 - to earn more foreign exchange, by allowing them to retain a proportion of the foreign exchange earned in their jurisdictions. For merchandise exports by the local authorities, 40% of earnings above the base period (1978) amount may be retained. However, if an export commodity produced by local enterprises comes under the jurisdiction of the FTCs, the local authorities may only retain 20%. In both cases, the enterprise concerned is entitled to 15% of the retained foreign exchange. For nontrade items, the proportion of foreign exchange earnings that may be retained by the local authorities varies: 20% for harbor dues, 30% for overseas Chinese remittances (100% if these are used to purchase bricks and tiles for housing construction), and 40% for tourism receipts. The local authorities in turn allocate retained foreign exchange earnings to their subordinate departments, tourist hotels and enterprises. 4.11 Trade corporations not under the direct jurisdiction of the MOFT retain a proportion of their foreign exchange receipts that varies from 30% to 100% (depending on the commodity) of earnings above the base period (1978) amount. The percentage is lower for items that sell well abroad, e.g. 30% for lathes, but higher if foreign markets are relatively unfavorable, e.g. 100% for complete plants. Pricing in Foreign Trade and Ezchange 4.12 When economic planning and management are centralized, implementa- tion of the foreign trade plan is almost entirely in the hands of the FTCs and their branches. The corporations are "essentially agents to which the rele- vant ministries and their subordinate organs and enterprises entrust tasks of buying and selling specific quantities of goods at the best prices obtainable and in accordance with the economic plans of the state."/1 This is particu- larly true of implementation of the import plans, which involves almost entirely negotiations with foreign sellers and purchases from abroad of either complete plants, equipment, and high-technology goods, or foodgrains and raw materials in bulk. To implement the export plan, exports manufactured by enterprises are centralized by the national trade corporations for pro- curement, negotiations and delivery. However, in the export of agricultural commodities, which are supplied by numerous small collective units, local trade organizations have played a role. 4.13 Despite the recent decentralization of foreign trade management, all agencies, in implementing the foreign trade plan, have to follow the prices fixed by the state. The State Price Bureau under the State Council fixes prices for both domestic and foreign goods. To facilitate this task and accounting in foreign trade, the Price Bureau trusts agencies engaged in foreign trade to price import and export goods in accordance with a set of uniform criteria. The basic principle is that domestic prices are isolated from world market prices for the dual purpose of maintaining domestic price stability and of protecting domestic industries. /1 Audrey Donnithorne, China's Economic System (New York, Praeger, 1967), pp. 326-7.  C46400/J79039/D836/34 - 36 - 4.14 The domestic prices of imported goods are generally made consistent with prices of similar domestically produced goods. Uniform prices for indus- trial goods produced by state enterprises are fixed by the Price Bureau accor- ding to ex-factory prices, which include the cost of production, profits and the consolidated industrial or commercial tax. Income tax is added for goods produced by collective enterprises. These price data are transmitted to the foreign trade agencies as a base for fixing the price at which imported goods are sold to the purchasing agencies. If uniform ex-factory prices do not exist, but there are announced wholesale prices /1 for similar domestically produced goods in the major trading ports, the prices of imported goods are fixed accordingly. 4.15 Similar methods apply for pricing imported agricultural products. If they exist, national supply prices are applied for purchases of similar imported products (such as foodgrains, edible oil and fats); if not, the wholesale prices in the port of arrival are used. Any adjustments required must be referred to the State Price Bureau for examination and approval. 4.16 The prices of imported goods may be adjusted (upwards or downwards) to reflect differentials in quality and specifications, after negotiation between the MOFT and the ageneies that ordered the goods. The State Price Bureau will mediate in case of failure to reach agreement. 4.17 While about 80% of the prices of imported goods can be determined using these methods, some cannot, for instance, if the imported goods are not produced domestically or are produced infrequently (e.g. a whole set of equip- ment, electrical machinery, etc.). In these cases, prices are fixed according to the c.i.f. value at the port of arrival (converted at the prevailing official exchange rate), plus the import duty, consolidated industrial and commercial tax, and a fee charged by the foreign trade agency. For some time, import duty and profits on foreign trade were combined, but since 1978 they have again been separated./2 Customs duties are collected by the MOFT and the receipts, which are forwarded to the Ministry of Finance, are not treated as trade profits. /1 These prices are fixed by the Ministry of Commerce and the State Price Bureau. /2 In the early years after liberation, the customs administration was inde- pendent, but later it was merged with the MOFT. Customs revenues were therefore counted as part of MOFT's revenues in calculating profits and losses in import trade.  C46400/J79061/D836/35 - 37 - 4.18 Import duties under the general tariff /1 fall into 25 categories, ranging from 7.5% to 400%. Duties under the minimum tariff fall into 21 cate- gories, ranging from 5% to 200%. In general, tariff rates are relatively low on imports of the means of production (raw materials and capital goods), but high on consumer goods. The tariff rates for most consumer goods range from 15% to 80% ad valorem with the top rates on high-class consumer goods. Import duties only affect resale prices for the 20% of imports for which similar domestically produced goods do not exist; for the remaining imports, the duty due only affects the distribution between MOFT's trading profits and receipts collected for the Ministry of Finance. If imported machinery, equipment and whole plants belong to the former category, the rate of import duty, as well as the fees charged by the MOFT, influences their domestic price and to some extent also the demand for these imports. Only some imports for manufacturers in the special economic zones are exempt from duty (para. 3.24). In 1978, the average import duty, calculated as a percentage of total custom receipts to total import value, was about 15%./2 4.19 Trade agencies procure export commodities at the ex-factory price for domestic procurement (para. 4.14). The selling prices abroad are, how- ever, determined by the export market conditions. This pricing policy, together with the foreign trade plan and the given official exchange rate, has resulted in a rather complicated picture of profits and losses in foreign trade. The lack of data makes it difficult to determine the exact financial situation, or assess the real costs and benefits. The Chinese price system generally keeps agricultural prices and the prices of other daily necessities (such as coal) low vis-a-vis industrial prices, which should help maintain low and stable living costs on the one hand, while accelerating industrialization on the other. Moreover, high industrial prices result in high profit margins, which are an important source of government revenue. 4.20 This kind of price differential has become more apparent in compari- son with world market prices through foreign trade. Thus, for example, impor- ted wheat was bought at $200 a ton in late 1980; adding $60 for transportation costs, it would cost about Y 390 a ton at the official exchange rate of Y 1.5 - $1.0. As domestically produced wheat was priced at Y 300 a ton, the state trading corporation was losing Y 90 a ton, or about 23%. For the same reason, Chinese exported foodstuffs and other agricultural goods were sold at a significant premium in Hong Kong. The most striking example of this is rice: the price of Chinese rice exported at the official exchange rate was about /1 Except for imports into Xizang (Tibet), China applies a two-column import tariff with a general rate and a minimum rate. The minimum rate is applied to goods from countries with which China has concluded reciprocal commercial treaties. The general rate applies to all other countries. /2 IMF, ibid.  C46400/J79039/D836/36 - 38 - 400% higher than the price in Hong Kong./l Similarly, bituminous coal of good quality was selling on the international market at $45-50 a ton, while the domestic price of this coal was only slightly over $20 at the official exchange rate before the end of 1980. Thus, in general, the Chinese trading corporations made considerable profits on exports of agricultural and mining output (including petroleum). However, low prices would not necessarily increase the export volume, because the trade corporations cannot pay higher procurement prices than those paid by the domestic purchasing agencies, and the export volume is subject to decisions made by the planners. Moreover, the low prices for most food items and agricultural raw materials, which have been maintained for a long period, have discouraged production, and exports compete with domestic consumption./2 Agricultural prices were raised in 1978, but the price differentials between agricultural and industrial commodities still seem fairly large by international standards. 4.21 The prices of manufactured goods in China appeared to be generally higher than world market prices at the official exchange rate before the end of 1980. For instance, a domestically made 12" black and white TV set was sold for Y 400 in November 1980, but the cost of an imported set was Y 300 at the prevailing official exchange rate. The price policy would require the domestic market price of the latter to be at least Y 400, despite its lower cost; moreover, since it is of better quality and has more features, its price was actually fixed at Y 500. The state trading corporations therefore made considerable profits (after tariffs) on this kind of import. This pricing method does, however, -nke imported goods noncompetitive and therefore pro- vides no incentive for cost reductions in domestic production. On the other hand, Chinese manufactured goods competing on foreign markets were mostly sold at much less than the domestic price at the official exchange rate before the end of 1980. For instance, Chinese-made electric fans, portable radios, watches, alarm clocks, nylon pants, and shirts were selling in Hong Kong at below 45% of the prices in Guangzhou, and cameras, pens, blankets, pencils, basketballs, thermos bottles, bicycles, and sewing machines at 50-90%. Losses on these exports are borne by China's trading corporations, which have to export these goods to earn badly needed foreign exchange and to meet export plan targets. The production units are unaffected by these losses and continue to produce these goods without pressure to reduce costs. 4.22 In sumary, imports are purchased at world market prices and sold at the prevailing domestic price, while exports are purchased at the domestic price and sold at world market prices. At the exchange rate prevailing before the end of 1980, domestic prices on average exceeded both import prices and export prices (all expressed in local currency). As a result, most imports were making an accounting profit, while most exports were making an accounting loss; these differences are evened out within the whole state trading system. /1 Jung-Chao Liu, "A Note on China's Pricing Policies" (Mimeo), March 19, 1980. /2 Because of shortages, some agricultural products such as rice, wheat, and edible oil have been rationed for a long time.  C46400/J78363/D836/37 - 39 - Profits/Losses in Foreign Trade and Exchange Conversion Ratios 4.23 Since both exports and imports of a category of commodities are undertaken by one trading corporation (each of which is an independent accoun- ting unit), losses in export trade can be offset by profits in import trade. The FTC's net profits (or losses) are aggregated in the MOFT account, which in turn is submitted to the Ministry of Finance for incorporation into the national budget./l The MOFT attempts to keep down exports of commodities that suffer losses, but expand exports of those making profits. As a rule, an appropriate amount (subject to negotiation between the MOFT and the Ministry of Finance) of net profit from foreign trade should be realized in terms of local currency. So far the MOFT has generally maintained a surplus, though this had apparently dwindled in the second half of 1980. 4.24 One way of looking at the accounting profit or loss, for instance in exports, is to compare the amount of local currency needed to procure domestically the amount of an export commodity that can be sold for $1.00 on the world market. Except for its exports of oil, coal and most minerals, and agricultural and agricultural sideline products, China can scarcely obtain $1.00 by exporting domestic goods worth Y 1.5. Even for textiles and garments (except those made of silk), the domestic procurement cost of $1.00 of export earnipgs would be more than Y 1.5. For other light manufactured goods, the domestic cost would be even higher. The domestic cost of most machinery items was about Y 2.5-3.0 per dollar, and for electronics components, Y 5-6. At the autumn 1980 trade fair in Guangzhou, contracts for machinery sales got on average only Y 4 for a dollar. The trade corporations of manufactured goods generally consider Y 2.6 for a dollar an acceptable level. 4.25 The exchange conversion ratios for manufactured exports can be improved if the domestic unit cost of production can be reduced, or if the goods are exempted from the consolidated industrial and commercial tax (as they are in most developing countries). The exchange conversion ratios can also be improved by raising product quality and design standards, provided the additional cost incurred is smaller than the additional revenue obtained. However, it will take some time to achieve cost reductions and product improvements under existing industrial conditions. Any tax exemptions would reduce government revenues, but they would also reduce export losses, which currently detract from import profits. The net effects on the national budget might not be very large. 4.26 Profits and losses in state trading could be considered just as accounting conventions. Since the whole trading system is making a reasonable net profit, and all exports and imports are planned, accounting profits and losses for individual commodities, or even for individual FTCs, have no real /1 Profits and losses on foreign trade conducted by trade corporations and other agencies not under the MOFT-s jurisdiction are incorporated in the accounts of their respective supervising ministries, and then in the national budget.  C46400/J791 11/D836/38 - 40 - economic significance. This may have been true before the decentralization of foreign trade in 1978, but now other agencies involved in direct trading (production ministries, provincial and municipal governments, and individual enterprises) are responsible for their own trade profits and losses. Moreover, profit has increasingly become an important criterion in judging performance and entitlement to bonuses. Since some agencies engage mostly in exporting and others mostly in importing, the former would suffer losses and the latter large profits under the official exchange rate prevailing before the end of 1980; neither could be attributed to performance. Furthermore, under these conditions, imports appear to have been encouraged too much, particularly in machinery, equipment and whole plant (which China does not produce). while exports were discouraged. These problems will become increasingly important as more enterprises are allowed to conduct foreign trade directly. 4.27 These considerations appear to underly the recent change in the so-called "internal settlement rate" for foreign trade and trade-related transactions (from about Y 1.5 = $1.0 to Y 2.8 = $1.0) and the introduction of a new experimental foreign exchange trading system. This rate was first introduced on an experimental basis at the start of 1980 for selected enterprises. Since January r, 1981, the new rate, which is pegged to the dollar, has applied to all enterprises and corporations engaged in foreign trade, as well as to receipts and expenditure in foreign exchange for trade-related invisible transactions, such -Is shipping and insurance. The official exchange rate, which is still pegged to the value of a basket of currencies, remains in effect for all other invisible transactions and for all settlements denominated in renminbi with nonresidents. Also, since November 1980, the Bank of China has established a new experimental trading system for foreign exchange in a few areas, such as Beijing, Guangdong, Hebei, Shanghai, and Tianjin. Enterprises holding foreign exchange earned through the system of retention quotas may sell this foreign exchange (through the Bank of China) to other enterprises that are allowed to spend foreign exchange. Planning for External Borrowing /_ 4.28 In recent years, China has gradually shifted from a policy of "no debt" to a policy of accepting foreign borrowing to foster modernization. External borrowing is also planned. All government departments that wish to borrow abroad must prepare a plan showing the amount of foreign exchange needed, how much of this will be earned and how much borrowed from abroad, and the kinds of imports the loan is intended to finance. All these plans are submitted to the SPC, which reviews them in cooperation with the Import-Export Commission and the Foreign Investment Control Commission. If the imports are for new capital construction the plans are also reviewed by the State Construction Commission. /1 See IMIF, ibid.  C46400/J79077/D836/39 - 41 - 4.29 Approval of foreign loans is based on consideration of the need for foreign capital, the ability of the borrower to repay, and China's overall debt-service ratio. Loans for vital projects or projects that have a rapid rate of return and good ability to earn foreign exchange are given priority approval. Most loans have been made through the Bank of China or - for some loans to provinces or enterprises that can repay the loan themselves with Bank of China guarantees. Bodies other than the Bank of China require the approval of the State General Administration for Foreign Exchange Control before they can receive loans from abroad. In the future, however, official borrowing from multilateral agencies, such as the World Bank and the IMF, as well as from foreign government agencies, will tend to assume a greater proportion. 4.30 The policy of accepting foreign capital should add a new dimension to foreign exchange planning, because inclusion of imports financed by foreign capital inflows in total imports would create an import surplus in the current account. This would go against the traditional principle of keeping the cur- rent account in balance. To make foreign exchange planning consistent, the balance of payments current and capital accounts should be planned jointly, to work out the implications of their interrelationships. To obtain a meaningful comprehensive picture, this will become even more necessary once China starts to service its foreign debt. 5. BALANCE OF PAYMENTS, EXPORT PROSPECTS AND EXTERNAL BORROWING /1 Recent Balance of Payments Developments 5.01 Different foreign trade data were provided by the MOFT and the Bank of China. The IMF has adjusted the Bank of China data to include exports not settled through the Bank of China, foreign aid exports not included in the MOFT data, etc. On the import side, MOFT data are smaller than the Bank of China data, because the latter also include imports by agencies not under the MOFT. Thus the Bank of China's import figures are more accurate, though to them must be added an estimate for imports under compensation trade arrange- ments and for imports financed by official loans from Belgium and Japan. 5.02 These unofficial estimates indicate that China's trade deficits are larger than those shown by the MOFT's trade statistics, but they still reflect the same trend over recent years. The merchandise trade balance shifted from a small surplus of $0.4 billion in 1977 to deficits of $1.7 billion in 1978 and $3.3 billion in 1979 (Table 5.1), with imports expanding more rapidly than exports as an ambitious modernization program was implemented and new foreign trade and investment measures introduced. The effects of the readjustment program, introduced in mid-1979 to reduce the level of investment, have begun /1 Further discussion of trade prospects and foreign borrowing policy options is contained in Chapter 6 of the Main Report.  C46400/J79077/D836/40 - 42 - to be felt only in 1980. With imports growing more slowly (at 21%) than exports (at 28%) - both estimated on an adjusted payments basis - the trade deficit was reduced by almost 7% to $3.1 billion in 1980. This trend is likely to continue in the short term. Table 5.1: UNOFFICIAL BALANCE OF PAYMENTS ESTIMATES, CURRENT ACCOUNT, 1977-80 /a ($ million) 1980 1977 1978 1979 estimate Exports 8,050 9,745 13,987 17,900 Imports -7,627 -11,399 -17,266 -20,968 Trade Balance 423 -1,654 -3,279 -3,068 Transportation & Insurance, net 255 344 622 777 Travel receipts - 116 241 413 457 Bank interest & charges, net 65 70 196 287 Other services, net -375 24 -106 -322 Service Balance 61 679 1,125 1 199 Overseas remittances 497 597 656 680 Foreign grants-in-aid -70 -69 -30 - Transfers, Net 427 528 626 680 Current Account Balance 911 -447 -1,528 -1,189 /a An official balance of payments table for China is being prepared by the Bank of China and may be available in mid-1981. The very tentative esti- mates given in this table were prepared by IMF staff and will be super- seded by the official figures when they become available. 5.03 China has consistently had a surplus on its services account, because of the large receipts from shipping and tourism. China's policy has been to expand its own merchant fleet while encouraging the carriage of freight on Chinese ships. During the past several years, the Chinese merchant fleet has grown faster than that of any other country, and the share of China's trade handled by its own fleet is reportedly 70%, the highest percentage in the world./I Equally impressive is the rapid growth in receipts /1 US Department of Commerce, International Trade Administration, "Prospects for PRC Hard Currency Trade Through 1985: An Update," by Damian T. Gullo (July 1980), p. 8.  C46400/J91942/D836/41 - 43 - from harbor dues, insurance, etc., although the amount of insurance receipts is very small. During 1978-80, receipts from transportation and insurance have grown at an average annual rate of 43%. Tourism receipts have also grown rapidly, following the opening of the country to foreign tourists in 1978;/1 the amount doubled in 1978 and increased by over 70% in 1979. However, because of the shortage of hotel accommodation in Beijing and Shanghai, the growth has slowed down considerably in 1980./2 The number of Chinese residents travelling and studying abroad has also increased, as reflected in the "other services" figures; this expenditure was, however, much smaller than tourism receipts. Both interest receipts and payments have increased rapidly in recent years. Apart from the factor of higher interest rates, it appears that on the receipts side, the business of Bank of China branches and Chinese-owned banks abroad has been expanding; on the payments side, China has been using short-term bank borrowing to finance its balance of payments deficits. For the service account as a whole, China's surplus has increased rapidly in recent years and is estimated at $1.2 billion for 1980. 5.04 A traditional major factor in China's balance of payments has been remittances from overseas Chinese. Following the adoption of a more favorable attitude towards overseas Chinese and renewal of connections between rela- tives, remittances have increased impressively in recent years. However, the rate of increase appears-to have slowed down in 1980 and reached a saturation point. But remittances, estimated at $680 million in 1980, are still quite substantial. In addition, China's aid (in the form of grants) to Third World countries (about $70 million in 1977/78) was less in 1980 than in earlier years. 5.05 Surpluses in invisibles have helped China to offset its trade deficits in the last three years. Thus, the deficit in the current account amounted to $0.5 billion in 1978, $1.5 billion in 1979 and $1.2 billion in 1980. 5.06 Foreign aid loans by China dominated the capital account from the mid-1960s until recently. The aid loans were extended to friendly Third World countries, with long terms and low (or no) interest. During 1961-69, China managed to extend $1.6 billion in external aid (grants and low or no interest loans) to other developing countries. The amount increased to $5.8 billion during 1970-77, before it began to level off./3 In 1977 and 1978, foreign aid loans amounted to $1.06 million and $0.90 billion, respectively, but declined to $253 million in 1980. /L At present, 122 cities are open to foreign tourists, of which 40 are popu- lar tourist spots. /2 A recent press report indicated that tourism receipts increased by about 31% to $617 million in 1980, which is much higher than the estimate in Table 5.1. /3 See OECD, The Aid Program of China (Paris, 1979).  C46400/J79039/D836/42 - 44 - 5.07 Since the mid-1970s, China has used short-term borrowing and deferred import payments to finance its balance of payments deficits, but only in 1979 did it begin to accept medium- and long-term loans. China used a rather large amount of commercial bank Eurodollar credit in 1979 ($1.3 bil- lion), mainly in the form of deposits with the Bank of China. Also, China began to accept imported equipment to be paid for by goods produced in the future; this kind of credit was estimated at about $1.1 billion in 1979. The large amount of foreign borrowing, together with sharply increased export earnings, financed an unusually large amount of machinery, equipment and whole plant imports in 1979. In 1980, the readjustment program slowed down capital goods imports and reduced commercial bank borrowing. However, China began to accept bilateral official loans (from Belgium and Japan) and export credit guaranteed by the exporting countries export credit agencies, although the amount disbursed was not very large (about $400 million). On the other hand, the repayments of short-term debt and deferred import payments were quite large ($2 billion). Thus, 1980 ended with a decline of about $560 million in international reserves (Table 5.2). Export Prospects 5.08 China's policy on external trade and borrowing has changed funda- mentally over recent years, so past long-term trends provide little guidance for the future and projections are very tentative. Even trends over the past four to five years cannot be relied upon in making projections, because they reflect considerably the short-term recovery from the recent political turmoil. These comments apply especially to imports, the future level of which will depend largely on China's ability to earn foreign exchange and accept external financing, which in turn is limited by the country's debt servicing capacity. The recent high rate of increase in exports may not continue, even with the new policy of encouraging exports, because of supply constraints and market constraints, which may limit the expansion of many Chinese manufactured exports. However, the current economic readjustment and reform of the economic system will tend to build a sound base for a sustained economic growth over the long term, and exports will have a better chance of accelerating after the mid-1980s. Moreover, China has traditionally had a surplus in its invisible account, and the prospects here are quite promising, particularly for transport and tourism receipts. Increased foreign earnings could support substantial expansion of imports after the mid-1980s.  C46400/J79111/D836/44 - 45 - Table 5.2: UNOFFICIAL BALANCE OF PAYMENTS ESTIMATES, CAPITAL ACCOUNT, 1977-80 /a ($ million) 1977 1978 1979 1980 estimate Current account balance 911 477 -1,528 -1,189 Long-Term Capital -990 -830 1,919 2,110 Export credit .. .. 36 133 Eurocurrency borrowing .. .. 1,330 360 Official loans .. .. - 259 Credit under compensation trade .. .. 1,097 1,256 Foreign aid: Loans -1,600 -900 -613 - Repayment 70 70 69 70 Short-Term Capital -82 -512 415 -1,964 Short-term bank borrowing, net -524 135 630 -1,362 Unrepatriated export earnings, etc. 442 -233 -535 20 Increase in deferred import-payments n.a. -35 447 -650 Changes in bilateral payments agreements, assets n.a. -379 -127 28 Errors and omissions 670 1,004 -133 340 Total Capital Account -402 -338 2,201 486 Allocations of SDRs - - - 146 Changes in reserves (- indicates increase) -509 785 -673 557 /a An official balance of payments table for China is being prepared by the Bank of China and may be available in mid-1981. The very tentative esti- mates given in this table were prepared by IMF staff and will be super- seded by the official figures when they become available. 5.09 Merchandise Exports. On the basis of the MOFT's 1979 data, about 33% of China's merchandise exports were agricultural (raw and processed) commodities, 21% minerals, including mineral fuels, and 46% manufactured goods (including a small amount of nonferrous metals)./l The share of mineral fuels probably rose to more than one quarter in 1980, however, as a result of the sharp rise in the world price of oil. The future volume of agricultural exports will depend on how much surplus the economy can realize after allowing /1 See Table 1.7. An estimated 2% of mineral raw materials are deducted from "Nonedible raw materials" and included in mineral exports ("mineral fuels, lubricants and related materials.")  C46400/J79111/D836/45 - 46 - for domestic consumption, which is rising considerably under the current economic policy. The supply constraint is somewhat mitigated by the recent policy of emphasizing agricultural production increases. The greater freedom given to the production teams in deciding what to plant, as well as to the farmer in using his private plot and marketing his surplus, is particularly conducive to increases in a wide range of farm products. During 1976-79, the annual average rate of increase in volume terms was 5.3% for frozen pork; 6-10% for rice, peanut kernels, bristles, peanut oil and fruits; 11-15% for rabbit hair, filature silk, fresh eggs, canned fruits, frozen rabbit meat and soybeans; and 21-28% for tea, camel hair and goat skins. Some minor agricultural export items either increased less rapidly or declined slightly. Food exports go mostly to Hong Kong and Japan. If China continues to follow its new agricultural policy, exports of such agricultural products could increase at a reasonable rate. However, domestic consumption tends to increase along with increases in incomes; moreover, the land scarcity means that increases in exportable surpluses over the long term will have to come from increases in agricultural productivity, which may be difficult to achieve. 5.10 Crude oil is China's largest single export item. In addition, China also exports oil products, which together with crude oil exports ($1.75 bil- lion in 1979) were estimated at $2.45 billion,/1 or 18.6% of total exports in 1979. A sharp rise in world-prices caused China's earnings from crude oil to nearly double in the first nine months of 1980 compared to the same months of 1979 (Table 1.8 above). However, China's output of crude oil declined in 1980 for the first time since 1967, although only by about 0.2%. This declining trend is likely to continue, since oil production from existing fields, which has remained virtually unchanged since 1978, appears to have peaked (see Annex E). 5.11 In September 1980, China notified Japan of its decision to cut crude oil supplies in 1981 and 1982 to 8.3 million tons a year, down from the targeted 9.5 and 15.0 million tons, respectively, stipulated in the long-term trade agreement. Prospects for continued exports of oil in the 1980s will depend largely on success in conserving energy and in switching from oil to coal, as well as in enhanced recovery from existing fields and in development of new fields. (For a fuller discussion of these issues, see Chapter 6 of the Main Report.) 5.12 China has abundant coal reserves and coal production is quite high (600 million tons in 1980). The coal is largely consumed domestically, with less than 1% of the total exported (in 1979, coal exports were 4.6 million tons and accounted for 1.5% of total exports). Coal production increased only moderately in 1979 (2.8%) and decreased in 1980 by about 2.4%, because of the difficulty of working some seams in the large mines and many small pits becoming inefficient after excessive mining in previous years, when ambitious annual output targets were emphasized. Coal exports have nonetheless increased quite rapidly, because the relatively small amount of exports scarcely affects domestic consumption, the export price is very favorable /1 Exports of "mineral fuels, lubricants and related materials" minus coal exports.  C46400/J79111/D836/46 - 47 - compared with the domestic price, and foreign exchange earnings are highly desirable. During 1976-79., the volume of coal exports increased at 26.5% a year on the average. During the first nine months of 1980, the value of coal exports increased by 62%, as compared with the corresponding period of 1979, reflecting the doubling in value of coal exports to Japan. 5.13 The principal buyers of China's coal have traditionally been the East European countries. However, in 1978, Japan emerged as an important customer, buying about one fourth of China's total coal exports. Under a long-term bilateral trade agreement, coal exports to Japan are scheduled to reach 2.5-2.7 million tons in 1981 and 3.5-3.7 million tons in 1982 (the latter would more than double exports in 1980). Exports for the following eight years are to be determined through negotiations in 1981. Recently, China assured Japan that coal supplied to Japan in 1981/82 will meet the agreed targets, although coal production is encountering difficulties. Important constraints for coal exports are rail transport and harbor facilities, which are critical for moving high quality coal out of Shanxi, Shandong and Anhui. In the medium term, the rehabilitation of existing coal mines and the development of larger new mines (some under arrangements with the Japanese Export-Import Bank) will likely increase output significantly. However, the switch from oil to coal will increase domestic consumption. Over the longer term, the average annual rate of growth of coal exports can be expected to remain fairly high, although perhaps somewhat below the rate of the recent past, provided the plan to develop coal mining is implemented and transportation problems are solved. With this rate of increase China will probably not encounter market constraints. 5.14 Although China is believed to have large reserves of nonferrous metals, exports of mineral products other than petroleum and coal accounted for only 2-3% of total merchandise exports in 1979. By far the most valuable is tungsten, but its export volume has increased very slowly. The volume of antimony exports has increased rapidly, but their value is still very small. Tin exports have declined. Other nonferrous metals believed to exist in large quantities are manganese, mercury and molybdenum. Deposits of aluminum ores, copper, lead and zinc are also considered extensive. To develop an export surplus in these mineral products, China must not only build up its technical capability to construct new mines, but also establish the necessary infrastructure, such as power stations, workers' accommodations and transport facilities to carry the products to the ports. In view of the shortages of capital and technical manpower, development of the nonferrous metals industry will have to rely heavily on foreign capital and technology. China hopes that mining development can be achieved by using imported modern mining equipment or through compensation trade arrangements with foreign firms. Large-scale production of ores and concentrates is at least five years away, so exports of nonferrous metals can only be expected to increase appreciably after 1985. 5.15 Manufactured exports /1 comprise textiles and clothing (estimated at 24% of total exports), light industrial goods (11%), and heavy and chemical /1 See also Annex D, Chapter 5, for a fuller discussion of issues relating to manufactured exports.  C46400/J7911 1/D836/4 7 - 48 - products (11%). Developed countries purchase only about 35% of China's textile and clothing exports, and less than half of those in every other category except leather goods. Exports that go almost entirely to developing countries (including goods re-exported through Hong Kong) include fabricated metal products, iron and steel, machinery, electrical products and paper. Exporting manufactured goods other than textile products to Japan, North America and Western Europe is just beginning. 5.16 The current economic readjustment policy emphasizes the expansion of agriculture and light industry as well as exports. Thus, textiles, clothing and other light industrial exports receive special attention. Firms manu- facturing for export are given priority in the supply of raw materials and power. Incentives are given to firms processing imported materials or assembling imported components for export, as well as to those with compensa- tion trade arrangements and those established in the special economic zones. 5.17 Import quotas are the most serious obstacle to expanding China's exports of textiles and clothing to developed countries. On September 17, 1980, a bilateral agreement was signed regulating China's exports of textile products (cotton, man-made fiber and wool) to the USA. China has accepted annual quotas for 1981-82 on six major categories of clothing./l If the USA believes that exports of other textile products from China are contributing to actual or threatened "market disruptions," it may request consultations with view to negotiating a quota. If no agre,ement is reached, it may impose a quota based on import levels in the immediate past, but this quota wi11 1row by 20% in the following year (except for wool products, where the growth rate will be 6%). China's earlier agreement with the European Economic Community is somewhat more restrictive and includes quotas that increase only slowly for cotton yarn and cotton and man-made fabric, as well as major items of clothing. Other developed countries (such as Canada and Sweden) also impose quotas on China's goods; Japan, however, has thus far resisted an import quota system. Overall, textile quotas should allow some room for expansion of China's exports of textiles and clothing, even under the existing arrangements. However, to raise the unit value of its textile exports, China needs to improve the quality of its dyeing and printing, as well as to adopt styles and designs that suit various markets. Useful experience can be gained in these areas through export processing arrangements, under which Chinese enterprises produce goods that meet foreign buyers' specifications and requirements. 5.18 Other light industrial exports consist mostly of labor-intensive consumer goods (canvas and rubber shoes, brushes, carpets, porcelain, paper, etc.) and metal products (kitchen utensils and consumer engineering goods /1 Four involve cotton clothing: trousers, slacks or shorts for men or women; shirts (not knit) for men and boys; shirts and blouses (not knit and knit) for women, girls and infants; and cotton gloves. In most instances, the quotas allow some growth over past US imports from China. There are provisions that allow quotas to be switched among categories and years.  C46400/J79111/D836/48 - 49 - such as radios, electric fans, watches, clocks, thermos bottles, sewing machines, bicycles, etc.). So far, these products have largely gone to the poorer Asian and African countries. To capitalize on the large potential of higher income markets, Chinese enterprises require knowledge of other coun- tries' designs, styling, demand trends and marketing channels; this can be attained by frequent travel abroad or even establishing overseas marketing operations, and by greater direct contact with foreign buyers. Judging from the experience of semi-industrialized countries,. China's prospects for breaking into new markets are quite good. 5.19 While China's exports of machinery and equipment amounted to only $464 million, or 3.4% of total exports in 1979, China is already one of the world's major producers of these goods. China's own market for capital goods is large and growing fast, and potential scale economies are enormous. China's strength at present is in capital equipment specially designed or peculiarly suited to developing countries with conditions similar to those in China: for example, small-scale plants in processing industries (e.g. particle board, paper or phosphate fertilizer), medium-sized and small tractors, pumps, and other farm machinery; electric motors, generators and equipment for small hydrostations; machinery for light industries such as textiles; and cheap, durable machine tools such as general purpose lathes. However, there is con- siderable potential for making goods to order (castings, components, and finished equipment of many other types), provided that Chinese industries can meet foreign specifications and requirements. To make existing capital goods more saleable abroad, improvements in performance and design are generally needed. These can be partly achieved by replacing unsuitable domestic parts by imported, high quality parts (such as numerical controls for lathes). Also, after-sale technical servicing of equipment and provision of spare parts are essential. The world market for machinery and equipment is wide open, particularly markets in most developing countries; and import restric- tions are rare and tariffs extremely low in developed countries. Thus, from both the demand and supply sides, China is in a favorable position to expand its exports of machinery and equipment, as well as consumer engineering products. 5.20 A major constraint to the expansion of light manufactured exports is the limited range and quantity of raw materials available and, for machinery exports, the lack of some critical high quality components. However, China need not to rely only on its own supplies, which sometimes are of inferior quality, but can instead import raw materials or key components. This approach is particularly economical in terms of transportation costs, at least for industries in the coastal area, thus leaving domestic raw materials for industries in the hinterland, which manufacture for domestic markets. The raw material imports can be financed by foreign exchange loans, which are repaid using some of the foreign exchange generated by exporting the manufactured products. This revolving foreign exchange loan fund can be supported by possible external borrowing. The Bank of China's Shanghai branch has already initiated such a loan program, which may be expanded and extended to other cities.  C46400/J79077/D836/49 - 50 - 5.21 Even with the new internal foreign exchange settlement rate, additional incentives may still be needed to expand manufactured exports, particularly tax incentives. Such incentives would make Chinese exports more competitive on the world market; the loss in government revenue would be compensated for by the increase in foreign exchange earnings. This matter needs careful study to formulate a rational incentive system. 5.22 Invisible Receipts. The prospects for foreign exchange earnings from nonmerchandise sources, particularly tourism and transportation, appear to be quite good. Income from port dues and shipping operations have increased very rapidly in recent years (43% a year during 1977-80) and should continue rising rapidly as the merchant fleet and trade expand and port facilities are enlarged. China's merchant marine, one of the world