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The Impact of China's WTO Accession on Capital Freedom
By John Greenwood
Introduction
The World Trade Organization focuses primarily on exchanges among nations of goods and services—i.e., the outputs of firms and households. Capital is, of course, a factor of production, which means it is an input. If this was the whole story, then conformity to WTO rules on competition, openness, lack of government subsidies, etc., would require China's outputs to be competitively priced. To maximize benefits, China would find it necessary to supply goods and services through transparent, competitive markets. Hence, although WTO membership does not explicitly mandate open, efficient capital markets, China would be implicitly required to do so in order to attain the full benefits of membership. However, membership requirements do go further: in particular they require the financial sector to be opened to foreign competition within five years of accession. In effect, membership in the WTO implies membership in a global community that subscribes to the operation of free, private markets not only in goods and services but also in the underlying factor markets.
In this paper, I discuss China's capital markets under two main headings: domestic and international. The latter includes any capital flows that should properly be recorded in China's international balance of payments. As soon as China joins the WTO and agrees to a program of rapid tariff reductions to comply with WTO rules, a series of pressures or even shocks will start to be imposed on Chinese mainland industries and firms, which will require urgent, concurrent structural reforms. WTO membership, therefore, will intensify the need to become internationally competitive and increase the pressure for domestic structural reform, which implies a radical shake-up of China's capital markets.
I start with the international aspects of China's capital flows and their implications for capital markets, monetary policy, and the exchange rate regime, and then turn to discuss the state of China's domestic equity and bank credit markets, and the desperate need for reform in these two areas.
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