China and the Long March to Global Trade: The Accession of China to the World Trade Organization

China and the Long March to Global Trade

“China and the Long March to Global Trade is an indespensable source on China’s WTO accession. The analysis of China’s integration and adjustment process is in-depth and insightful, and thus is of enduring value as a case study for other potential WTO aspirants and new WTO members as well.” Raj Bhala, Associate Dean and Harris Research Professor, The George Washington University Law School “Timely and insightful – a must for experts and non-experts alike interested in China’s ‘long-march’ towards economic development and integration in the international economic system.” Dr Arthur E. Appleton, Lalive & Partners, Geneva On December 11, 2001, China joined the World Trade Organization (WTO). China and the Long March to Global Trade examines the prolonged negotiations leading up to this historic event and supplies a necessary and important analysis of key areas: ●

● ●

The emergence of China as a market economy and its integration into the global trading system. The rise of the WTO as a successor to the GATT. Legal reform in China to facilitate WTO implementation.

This edited collection assumes little prior knowledge of the Chinese accession process yet provides an in-depth examination of the related issues. It is therefore suitable for both those who require an introduction to the field and those with an existing interest in China and the WTO. Sylvia Ostry is Distinguished Research Fellow, Centre for International Studies, University of Toronto. She is a Fellow of the Royal Society of Canada. Alan S. Alexandroff is currently the Director of Research for the Program on Conflict Management and Negotiation at the University of Toronto, and a Principal of LECG Inc. Rafael Gomez is Lecturer at the Interdisciplinary Institute of Management, London School of Economics and Political Science.

Routledge Studies in the Growth Economies of Asia

1 The Changing Capital Markets of East Asia Edited by Ky Cao 2 Financial Reform in China Edited by On Kit Tam 3 Women and Industrialization in Asia Edited by Susan Horton 4 Japan’s Trade Policy Action or reaction? Yumiko Mikanagi 5 The Japanese Election System Three analytical perspectives Junichiro Wada 6 The Economics of the Latecomers Catching-up, technology transfer and institutions in Germany, Japan and South Korea Jang-Sup Shin 7 Industrialization in Malaysia Import substitution and infant industry performance Rokiah Alavi 8 Economic Development in Twentieth Century East Asia The international context Edited by Aiko Ikeo 9 The Politics of Economic Development in Indonesia Contending perspectives Edited by Ian Chalmers and Vedi Hadiz

10 Studies in the Economic History of the Pacific Rim Edited by Sally M. Miller, A. J. H. Latham and Dennis O. Flynn 11 Workers and the State in New Order Indonesia Vedi R. Hadiz 12 The Japanese Foreign Exchange Market Beate Reszat 13 Exchange Rate Policies in Emerging Asian Countries Edited by Stefan Collignon, Jean Pisani-Ferry and Yung Chul Park 14 Chinese Firms and Technology in the Reform Era Yizheng Shi 15 Japanese Views on Economic Development Diverse paths to the market Kenichi Ohno and Izumi Ohno 16 Technological Capabilities and Export Success in Asia Edited by Dieter Ernst, Tom Ganiatsos and Lynn Mytelka 17 Trade and Investment in China The European experience Edited by Roger Strange, Jim Slater and Limin Wang

18 Technology and Innovation in Japan Policy and management for the 21st century Edited by Martin Hemmert and Christian Oberländer 19 Trade Policy Issues in Asian Development Prema-chandra Athukorala 20 Economic Integration in the Asia Pacific Region Ippei Yamazawa 21 Japan’s War Economy Edited by Erich Pauer 22 Industrial Technology Development in Malaysia Industry and firm studies Edited by K. S. Jomo, Greg Felker and Rajah Rasiah 23 Technology, Competitiveness and the State Malaysia’s industrial technology policies Edited by K. S. Jomo and Greg Felker 24 Corporatism and Korean Capitalism Edited by Dennis L. McNamara 25 Japanese Science Samuel Coleman 26 Capital and Labour in Japan The functions of two factor markets Toshiaki Tachibanaki and Atsuhiro Taki 27 Asia Pacific Dynamism 1550—2000 Edited by A. J. H. Latham and Heita Kawakatsu 28 The Political Economy of Development and Environment in Korea Jae-Yong Chung and Richard J. Kirkby 29 Japanese Economics and Economists since 1945 Edited by Aiko Ikeo

30 China’s Entry into the World Trade Organisation Edited by Peter Drysdale and Ligang Song 31 Hong Kong as an International Financial Centre Emergence and development 1945—1965 Catherine R. Schenk 32 Impediments to Trade in Services Measurement and policy implication Edited by Christoper Findlay and Tony Warren 33 The Japanese Industrial Economy Late development and cultural causation Ian Inkster 34 China and the Long March to Global Trade The accession of China to the World Trade Organization Edited by Sylvia Ostry, Alan S. Alexandroff and Rafael Gomez 35 Capitalist Development and Economism in East Asia The rise of Hong Kong, Singapore, Taiwan, and South Korea Kui-Wai Li 36 Women and Work in Globalizing Asia Edited by Dong-Sook S. Gills and Nicola Piper 37 Financial Markets and Policies in East Asia Gordon de Brouwer 38 Economic Development in South East Asia Dependency and the automotive industry Jason Abbott 39 Law and Labour Market Regulation in East Asia Edited by Sean Cooney, Tim Lindsey, Richard Mitchell and Ying Zhu 40 The Economy of the Philippines Elites, inequalities and economic restructuring Peter Krinks

China and the Long March to Global Trade The accession of China to the World Trade Organization

Edited by Sylvia Ostry, Alan S. Alexandroff, and Rafael Gomez

London and New York

First published 2002 by Routledge 11 New Fetter Lane, London EC4P 4EE Simultaneously published in the USA and Canada by Routledge 29 West 35th Street, New York, NY 10001 Routledge is an imprint of the Taylor & Francis Group This edition published in the Taylor & Francis e-Library, 2003. © 2002 selection and editorial matter, Sylvia Ostry, Alan S. Alexandroff and Rafael Gomez; individual chapters, the contributors All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging in Publication Data A catalog record for this book has been requested ISBN 0-203-56327-1 Master e-book ISBN

ISBN 0-203-34452-9 (Adobe eReader Format) ISBN 0–415–23361–5 (Print Edition)

Contents

List of illustrations About the editors List of contributors Preface Acknowledgements 1 General introduction

ix x xii xiii xv 1

ALAN S. ALEXANDROFF AND RAFAEL GOMEZ

PART I

Background to China and the World Trade Organization 2 The WTO: post Seattle and Chinese accession

7 9

SYLVIA OSTRY

3 Negotiating China’s Protocol of Accession

22

JEFFREY L. GERTLER

4 Avoiding deadlock

30

CLAUDE BARFIELD AND MARK GROOMBRIDGE

PART II

China’s global economic integration: economic reform 5 A litmus test for China’s accession to the WTO: reform of its state-owned enterprises

45

47

HARRY G. BROADMAN

6 China’s great leap of faith: telecommunications and financial services commitments RICHARD JANDA AND MEN JING

66

viii

Contents

7 Pressures on China from the Asian financial crisis

99

JOHN D. LANGLOIS JR.

PART III

Transparency and the rule of law: legal reform in China 8 Article X and the concept of transparency in the GATT/WTO

121 123

SYLVIA OSTRY

9 The evolution of law in contemporary China: challenges for WTO implementation

136

PITMAN B. POTTER

10 China’s accession to the WTO: legal system transparency and administrative reform

154

SARAH BIDDULPH

11 Administrative process and the rule of law

192

HUDSON N. JANISCH

PART IV

Provisional membership and transition mechanisms

209

12 A transitional review mechanism: has an effective multilateral mechanism been created?

211

ALAN S. ALEXANDROFF

13 Conclusion: where do we go from here?

231

ALAN S. ALEXANDROFF AND RAFAEL GOMEZ

Index

235

Illustrations

Figures 5.1 5.2 6.1 7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8

China’s implementation of the modern corporation Organizational structures of China’s state asset management system Structure of China’s current financial system Hang Seng China Enterprises Index 1997–9 Hang Seng Index, Hang Seng China Enterprises Index 1997–9 Hang Seng China Enterprises Index, China Mobile (HK) 1997–9 Center–local share of fiscal income 1985–99 Fiscal deficit 1995–9 Change in general CPI 1997–9 Consumer goods retail sales growth 1996–9 Change in exports and imports 1996–9

51 54–5 79 105 105 106 107 108 110 111 111

Tables 6.1 Establishment: foreign financial institutions in China versus China’s commercial banks 6.2 Business scope: foreign financial institutions in China versus China’s commercial banks 6.3 Overview of China’s commitments 2000 7.1 China’s trade balance 1997–9 7.2 Moody’s Ratings: announcement of December 4, 1998 7.3 China’s responses to the Asian financial crisis 1998–9

76 77 81 106 109 110

About the editors

Sylvia Ostry is Distinguished Research Fellow, Centre for International Studies, University of Toronto. She has a Ph.D. in economics from McGill University and Cambridge. After teaching and research at a number of Canadian universities and at the University of Oxford Institute of Statistics she joined the Federal Government in 1964. Among the posts she held were Chief Statistician, Deputy Minister of Consumer and Corporate Affairs, Chairman of the Economic Council of Canada, Deputy Minister of International Trade, Ambassador for Multilateral Trade Negotiations and the Prime Minister’s Personal Representative for the Economic Summit. From 1979 to 1983 she was Head of the Economics and Statistics Department of the OECD in Paris. In 1989 she was Volvo Distinguished Visiting Fellow, Council on Foreign Relations, New York. She has received 18 honorary degrees from universities in Canada and abroad and, in 1987, received the Outstanding Achievement Award of the Government of Canada. In December 1990 Dr. Ostry was made a Companion of the Order of Canada, the highest award in the Canadian national system of honours. In June 1991 she was admitted as a Fellow of the Royal Society of Canada. She is a director of a number of international institutions and private corporations. Her most recent publications include The Post-Cold War Trading System: Who’s On First? (University of Chicago Press, 1997) and A New Regime for Foreign Direct Investment (Group of Thirty, Washington, DC, 1997). Alan S. Alexandroff is Research Director for the Program on Conflict Management and Negotiation at the Munk Centre for International Studies at the University of Toronto and a Fellow-in-Residence for International Policy at the C.D. Howe Institute. In the private sector world, Dr. Alexandroff is the Toronto/Canada Office Director of LECG, LLC, an economic and finance consulting firm, where he consults on trade policy. Finally, he is a Director of Mediated Solutions Incorporated, a full service dispute resolution firm. He received his B.A., cum laude, with distinction in all subjects, from Cornell University in 1972, his M.A. from the London School of Economics and Political Science in 1974 and his Ph.D. in Government from Cornell University in 1979. He also obtained his LL.B. at the McGill Law School in 1984; he has written and spoken on a variety of trade and global economic subjects. In 1994, he was the project consultant on the international economy for the Canada 21 Project. In September 1994, Dr.

About the editors xi Alexandroff and Dr. Sylvia Ostry completed “The Challenge of Global Trade, Investment and Finance for Canada,” one of the four position papers prepared for the Special Joint Committee of the Senate and the House of Commons reviewing Canadian Foreign Policy. He has written recent articles on Canada’s trade policy, North American trade policy issues and a number of articles on China’s accession to the WTO as well as articles on WTO trade policy generally. Rafael Gomez is a Ph.D. graduate of the University of Toronto’s Centre for Industrial Relations. He is currently a lecturer at the Interdisciplinary Institute of Management, London School of Economics and Political Science. He also holds joint appointments as Research Fellow at the Centre for International Studies, Centre for Industrial Relations, University of Toronto and Centre for Economic Performance, London School of Economics. Since 1999 he has delivered lectures and taught courses in Human Resource Management, Labour Economics and Comparative Industrial Relations. Dr. Gomez has been a speaker at several national and international conferences.

Contributors

Claude Barfield is Resident Scholar and Director of Science and Technology Policy Studies at the American Enterprise Institute. Sarah Biddulph is Senior Lecturer at the University of Melbourne Law School. Harry G. Broadman is Senior Economist at the World Bank. Jeffrey L. Gertler works at the World Trade Organization as the Secretary of the Working Party on China Accession to World Trade Organization. Mark Groombridge is a research fellow with the Center for Trade Policy Studies, The Cato Institute. Richard Janda is Professor in the Faculty of Law, McGill University. Hudson N. Janisch is a Professor of Law at the University of Toronto. Men Jing is a graduate of the Institute of Air and Space Law, McGill University. John D. Langlois Jr. is Professor in the Department of East Asian Studies, Princeton University. Pitman B. Potter is Director of the Institute of Asian Research at the University of British Columbia.

Preface

The chapters in China and the Long March to Global Trade: The Accession of China to the World Trade Organization (Long March) are primarily intended to introduce the Chinese accession process to those with little prior knowledge of how accession occurs at the World Trade Organization (WTO) and how this accession proceeds. The book is designed, however, for those who have deep interests in both China and the WTO. The contributions are essentially non-technical but do present a mixture of methodological approaches. Although the chapters can be read in any order, they are grouped in four parts, which reflect some of the more common organizing principles that characterized the accession process. The volume begins with a general introduction and ends with a general conclusion, both of which highlight the cross-cutting issues raised in many of the contributions. The chapters were edited to eliminate extraneous or dated information, but in some cases we thought it best to keep certain time-sensitive information in, if only to see how the issues were viewed at the time of the negotiations. Most of the chapters in the Long March were produced as part of a larger project, housed at the Centre for International Studies at the University of Toronto. Many of the papers were presented at seminars held by the China/WTO Accession Project (Project), which was chaired by Dr. Sylvia Ostry; it was her original idea to create the Project, an informal grouping of trade and China experts from across the globe in hopes of assisting the formal negotiation process. Dr. Alan S. Alexandroff became the Director and Rafael Gomez soon joined the Project as its only researcher. These Project seminars commenced in November 1996 and continued on into 2000, meeting in a variety of settings including: Geneva, Switzerland, Tokyo, Japan, Toronto, Canada and Washington, DC in the United States. Many of the chapters that appear in this volume in somewhat altered form were originally commissioned for a particular seminar. The Long March then is in large part a product of the earlier Accession Project. As such we must give thanks to the funders of the Project: without them this book would never have been possible. A number of private firms gave generously for three successive years to ensure that the Project had sufficient resources. They include the Bank of Montreal (especially Neil Tate), Atomic Energy of Canada Limited, AECL (especially R. Allen Kilpatrick), and Manulife, as it then was known

xiv Preface (including the President, Dominic D’Alessandro and Mike Landry). In addition a number of law firms also gave generously over several years: Heenan Blaikie (especially William “Bill” Orr) and Goodman, Phillips and Vineberg, again as it then was known (including former Ontario Premier Bob Ray and Jon Johnson). The Donner Canadian Foundation was a major support to the Project and we are grateful for the enthusiasm shown at the foundation for the Project, notwithstanding its rather unconventional operation. Allan Gottlieb, the Chair and Patrick Luciani, the Executive Director were strong supporters within the Foundation and recognized that though China was an immense challenge, the Foundation was advancing the agenda by supporting this small informal project. Lastly we must not fail to thank the Canadian Department of International Trade and Foreign Affairs. Though there was grave doubt that such a Project could play a meaningful role, the Department gave us our first bit of funding and started us out on our own long march. Finally, this volume would not have been possible without the valuable research and editorial assistance of Susie Hensler, Miriam Kreiger, Josie Weiss, and the staff at the Centre for International Studies. Sylvia Ostry Alan S. Alexandroff Rafael Gomez

Acknowledgements

We would like to thank the Canadian Business Law Journal for their kind permission to reproduce “China and the WTO: tensions between globalized liberalism and local culture” by Pitman B. Potter, originally published in vol. 32, no. 3 (1999), and UCLA Journal of International Law and Foreign Affairs for allowing us to reprint “China and the WTO: the transparency issue” by Sylvia Ostry, originally published in vol. 3, no. 1 (1998).

1

General introduction Alan S. Alexandroff and Rafael Gomez

After almost six years of “silence” following Tianamen Square in 1989, China and the member countries of the World Trade Organization resumed seriously negotiating its entry into the WTO (formerly the General Agreement on Tariffs and Trade or GATT).1 The negotiations, particularly the critical bilateral market access negotiations, occurred primarily with the major Western economies, namely the United States (US) and the European Union (EU). Following the resumption of serious negotiations in 1995, it was apparent that China was significantly different from the applicant of earlier negotiating years. China had grown enormously, its economic influence had spread globally and, despite a slight decline in growth following the soon to strike Asia crisis, China was more economically powerful and more globally involved than it had ever been since the establishment of the People’s Republic of China (PRC). During this same period, a new set of emerging economies had grown quickly as well, notably Malaysia, Thailand and even Vietnam, but it was China that represented the spectre of an economic and political superpower unequaled in the developing world. Indeed, it is the size of China’s population, its economy today and its potential tomorrow that attract such critical attention in both popular discourse and academic fields of study. This economic size and potential for growth underlines the uniqueness and dramatic importance of China’s admission to the WTO. The ways in which China has been studied and the ways in which its economic success has been accounted for are to a large extent embodied in this book. A principal aim of this study, China and the Long March to Global Trade: The Accession of China to the World Trade Organization (Long March) is to provide the reader with a critical analysis of the implications for the global economy and its institutions, of China’s entry to the WTO. It uses the main disciplinary approaches (economic, legal and political) and their theoretical frameworks, which have been employed in the study of China’s economy and society to examine China’s accession. There are several ways, in fact, in which this book provides a guide to the study of China’s accession. First, while it does look briefly at the process by which China sought to accede to first the GATT and then the WTO, a distinction is drawn between China’s integration into the global economic system and its actual legal accession to the WTO. In this regard, the Long March is more accurately viewed as an examination and overview of China’s integration into the multilateral trading

2 Alan S. Alexandroff and Rafael Gomez system. Though the accession process is central to the book (and provides this book with much of its distinctive focus) there is also a clear concern to address the variety of ways in which Chinese accession is intertwined with a whole set of domestic (to China) and external economic, legal, social and cultural factors. Thus, the Long March certainly focuses on accession, but examines equally the implications of China’s accession on the role which the Chinese government and state have played in relation to Chinese economic development, the behavior of Chinese legal authorities, as well as the larger socio-cultural context within which the Chinese economy operates. Accordingly, the Long March not only pays close attention to the events and processes specific to China’s accession to the WTO and their analysis by China scholars, but also scrutinizes the critical issues involved in explaining how China came to be a member of the multilateral trade regime. How China and the WTO may respond once accession is officially in place, and the extent of Chinese integration or lack thereof into the global trading system may be seen to connect to larger patterns of social and economic processes inside and outside of China, and are questions that are addressed in this study as well. With these aims in mind, the Long March explores not only the various aspects of Chinese accession but also the contemporaneous legal, social and economic events that occurred while China was negotiating accession. So while it gives considerable attention to popular topics such as the effect of the Asia crisis on the Chinese economy, it also examines some very pertinent, but less visible aspects of Chinese society, such as China’s administrative legal system, which operates quite differently than that of Western judicial systems. The Long March also reviews the diversity of opinion held about China within the United States (China’s largest trading partner). In consequence, it familiarizes readers with the debates concerning whether, or under what terms, China should be permitted to accede to the WTO, as well as the theories and critical approaches that were held about China before the accession deal was finalized in September 2001. As the different contributors to the Long March indicate, the study of Chinese accession has rendered problematic many of the assumptions that have traditionally governed our (Western) understanding of the WTO and has therefore entailed the need for more appropriate alternative perspectives and scenarios of what may occur once China accedes (given its size and its distinct legal and cultural traditions). The result is a book which, it is hoped, successfully conveys the variety of ways in which Chinese accession to the WTO has been studied and the genuine debate among trade negotiators, politicians and analysts that has characterized this historically long accession. The Long March does not adopt one “line” or advocate one critical approach above all others (even though individual authors may often agree with the particular framework or critical preferences of the editors) but seeks instead to suggest the issues that have been a feature of the accession process. It makes no attempt to iron out any differences between various approaches: readers are left to make up their own intellectual and political minds concerning the critical approaches employed and are free to sample those chapters of most relevance to their own enthusiasms. This book is unique in that for the first time, but now likely not to be the last, the

General introduction 3 Long March has brought together trade law and policy experts with a variety of China specialists. In order to comprehend both the impact of China on the multilateral trade regime, particularly on the WTO, as well as to understand the extent of China’s integration into the global economy and the influence of the accession on China, its economic, political, legal and administrative structures, it is vital to call on the expertise of both communities of analysts and scholars. We have done this. Indeed one of the satisfying aspects of the Project that resulted in the commissioning of many of these chapters was the often clashing perspectives that these different experts brought to Project meetings whether in Washington, Geneva or Tokyo.2 The structure of the book attempts to give voice to differing perspectives brought together to examine China’s accession. Part I introduces the three episodes or phenomena that are the central focus of the book. Individual chapters outline the process of transformation of the world trading system beyond border barrier issues such as tariffs and quotas as embodied in the pre-Uruguay rounds of global trade negotiations. In addition, chapters examine the expansion of the global trade regime to include member states such as China, and then how the accession process itself is changing the multilateral trade regime. Thus, the chapters examine not only the timeline of China’s entry into the WTO but also the various contextual differences between this accession process and all others. This part of the Long March, therefore, begins with an examination of how different the multilateral trade regime actually is, when compared to the relatively simple world of the GATT and its tariff and subsidy issues. The chapters also set out how the China accession process took place under this changing trading system. Part II focuses on China’s global economic integration and its own internal reforms. Since the end of the Uruguay Round in 1993, the thrust of multilateral negotiations has been toward the designing of institutions, which can promote deep integration. Deep integration, in its most benign form, simply refers to the harmonization of domestic laws so as to make the global economic system a fair one for the world’s transnational firms. Part II focuses on the Chinese economy and its potential for reform. It is therefore hardly surprising that a key stumbling block for China’s successful accession was that much of its domestic economy was (and still is) centrally planned and behaves largely in non-market ways. Part II looks at the effect of this legacy in relation to China’s state-owned enterprises (SOE) and the necessary changes that have to be made in order for China to implement financial and telecommunication agreements. Part III of this book is devoted to the non-economic aspects of China’s WTO accession, in the sense that the WTO is as much a political and legal institution as it is an economic one. While this may sound only of passing interest, it is in fact essential to understand that underlying the WTO is a set of practices, assumptions even values that are taken for granted in developed capitalist economies. Many of these practices are derived from the civil and common law traditions, in particular American common law jurisprudence. This Western, largely American legal framework has little or no precedence in China. On the contrary, the presence of administrative law and more generally the rule of law as conceived of in the Western sense is a very recent development in China. Part III explores the evolution of law in

4 Alan S. Alexandroff and Rafael Gomez contemporary China and the administrative legal changes required to implement some of the basic accession requirements. Part IV of this book discusses – both from a contemporaneous standpoint and by looking back with the benefit of hindsight – the debate that occurred in the US Congress and the ever present clamor from the political right and left for close scrutiny of a variety of Chinese polices such as its labor and environmental policies as well as human rights practices and even its military spending. These Congressional divisions not only made the process of Chinese accession all the more complicated but also, in retrospect, gave Western negotiators the needed leverage with which to advance market access negotiations between China and the United States. Although the Long March aspires to be comprehensive, it is not exhaustive in its coverage. There is naturally a degree of selection and readers will find more on certain areas, less on others, than they might have expected. This is particularly the case with Part IV, where the debate surrounding Chinese accession in the US is singled out, rather than giving full coverage of debates that occurred in Europe, in Japan, or among other member countries such as India or Mexico. Thus while certain countries are omitted, it is expected that the critical concepts and issues raised in this part will be seen to have meaning beyond the context of the member countries examined. The authors of individual chapters have been asked not only to survey their particular area but also to identify some of the questions that will remain following China’s official accession to the WTO. In this way, it is planned that readers should gain some sense that this process is not over, that China’s integration into the multilateral trading regime is still incomplete even after the signing of the accession protocol. It is ultimately in this spirit that the Long March is presented: to provoke thought and encourage debate, and to stimulate ongoing research into the implications of Chinese accession not only for China, but for the global economy as well. The excitement surrounding China’s integration into the global economy is that, despite a growing institutionalization of China’s internal reform process, it still remains a phenomenon in which a variety of disciplinary approaches coalesce and compete and in which basic questions remain unsettled. If the Long March communicates some of that excitement to its readers then it can be judged a successful endeavor.

Notes 1 Most believe that the accession negotiations were suspended following Tianamen. In fact, as noted in Chapter 3 by Jeffrey L. Gertler, the GATT Working Party on China undertook almost no bilateral or multilateral activity for some two and a half years before the massacre. However, the Working Party did commence discussions in October 1992 and continued periodically thereafter. In December 1995 this Working Party was converted into a WTO Working Party on China Accession. 2 The Project was begun in November 1996 by Dr Sylvia Ostry, a former Deputy Minister of International Trade for the Canadian government who became the Chairman of the China/WTO Accession Project. Dr Alan S. Alexandroff became the Project Director. The

General introduction 5 Project was designed as a multi-year, multinational and non-governmental effort to track, analyze and disseminate information about China’s WTO accession negotiations. In addition the Project analyzed and commented on the impact of China on the WTO and chief trading parties such as the US, the EU, etc. To accomplish these objectives, Drs Ostry and Alexandroff organized an international team. The members of the Project included former trade negotiators, trade policy experts and China experts. These experts were drawn from Canada, the United States, Europe, Japan, South Korea and China. The Project continued for three years meeting periodically in various cities to track progress and problems in the accession. In an effort to assist with problems as they arose in the negotiations, the Project commissioned a variety of research papers, many of which in altered form are now chapters in this book.

Part I

Background to China and the World Trade Organization

2

The WTO Post Seattle and Chinese accession Sylvia Ostry

Introduction The saying that timing is everything is particularly apt – even if somewhat dismal – in trying to assess the impact of China’s accession to the WTO. If China had joined the GATT in the 1980s, the negotiations would have centered on traditional trade issues or border barriers. The negotiations would probably have been difficult but since China was well embarked on a reform policy, including trade liberalization which would have been facilitated by GATT accession, the impact on China and the trading system would have been, on balance, welfare enhancing. But the transformation of the system wrought by the Uruguay Round and its after-effects rather dramatically changes the conditions for access, and also changes the likely impact of Chinese accession on the WTO as well as the impact of the WTO on China. This is a vast subject, of course, and this chapter will be selective. Three main issues will be discussed: the North–South divide in the WTO; the rise of the environmental movement; and the increasing legalization of the WTO. In this concluding section I shall try to highlight the implications of these changes for Chinese accession.

The North–South divide in the WTO The Uruguay Round could be characterized as a North–South Grand Bargain. Prior to the Uruguay Round developing countries negotiated mainly to secure unreciprocated access to OECD (Organization for Economic Cooperation and Development) countries’ markets. Most lacked the expertise and analytical resources for trade policy-making but that really did not matter much because the focus of negotiations was on border barriers for industrial products, and also because agriculture was largely excluded. The tried and true GATT model of reciprocity worked well as the negotiations were led by the United States and managed by the transatlantic alliance with the European Community. The so-called Third World was largely ignored as a player in the multilateral trading system. The Uruguay Round was a watershed in the evolution of the multilateral trading system. For the first time agriculture was at the centre of the negotiations and the European effort to block the launch of the negotiations, in order to avoid coming to

10 Sylvia Ostry grips with the Common Agricultural Policy, went on for half a decade. This footdragging also spawned a new single-interest coalition – the Australian-led Cairns Group – which included Southern countries from Latin America and Asia determined to ensure that liberalization of agricultural trade would not be relegated to the periphery by the Americans and the Europeans as it always had in the past. But the role of a group of developing countries, tagged the “G10 hardliners” and led by Brazil and India, was in many ways even more important in the Uruguay Round’s transformation of the system. The G10 were bitterly opposed to the inclusion of the so-called “new issues” – General Agreement on Trade in Services (GATS), intellectual property and investment central to the American negotiating agenda. Without the new issues it is doubtful that the American business community or American politicians would have supported a multilateral negotiation and, indeed, the long delay in launching the Round was the most significant factor in the origins of the US multi-track policy in the 1980s which included bilateralism, unilateralism and – if possible – multilateralism.1 A major objective for the US in the bilateral negotiation with Canada, which resulted in the Canada–US Free Trade Agreement (CUSTA) of 1989, was to include the new issues;2 also, to amplify the message to the G10, the little-used Section 301 of the 1974 Trade Act, an instrument of aggressive unilateralism, was activated in 1985. Indeed a new Special Section 301 of the 1988 Trade and Competitiveness Act was targeted at developing countries with inadequate intellectual property standards and enforcement procedures. As the Uruguay Round negotiations proceeded, the message from Brasilia and New Delhi became clearer: given a choice between American sanctions or a negotiated multilateral arrangement, an agreement on trade-related aspects of intellectual property rights (TRIPS) began to look better. Moreover, by the onset of the 1990s a major change in economic policy was underway. The debt crisis of the 1980s, and thus the role of the International Monetary Fund (IMF) and the World Bank, plus the fall of the Berlin Wall – a confluence of two unrelated events – ushered in a major transformation in the economic policy paradigm. Economic reforms – deregulation, privatization, liberalization – were seen as essential elements for launching and sustaining growth. Economic regulatory reform is at the heart of the concept of trade in services. Even without the thrust from the Uruguay Round, many developing countries began to see reforms of key service sectors such as telecommunications as essential building blocks in the soft infrastructure underpinning growth, and the GATS as a means to furthering domestic reform. While this changed view did not lead to significant liberalization in trade in services during the Round, acceptance of the GATS opened the way to further developments in the telecommunications and financial services negotiations. Thus, well before the end of the Round the “hardline coalition” had disappeared and coalitions of developing countries concentrated on liberalization of agriculture and textiles and clothing.3 Many undertook unilateral liberalization of tariffs and other trade barriers and by December 1993 were among the strongest supporters of the negotiations they had so adamantly opposed in the 1980s. The Grand Bargain was complete and was quite different from old-time GATT reciprocity. It was

WTO: post Seattle and Chinese accession 11 essentially an implicit deal: the opening of OECD markets to agriculture and laborintensive manufactured goods, especially textiles and clothing, for the inclusion into the trading system of trade in services (GATS), intellectual property (TRIPS) and (albeit to a lesser extend than originally demanded) the Agreement on TradeRelated Investment Measures (TRIMs). And also – as a virtually last minute piece of the deal – the creation of a new institution, the WTO, with the strongest dispute settlement mechanism in the history of international law. Since the WTO consisted of a “single undertaking” (in WTO legalese) the deal was pretty much take it or leave it for the Southern countries. So they took it but, it is safe to say, without a full comprehension of the profoundly transformative implication of this new trading system. The Northern piece of the bargain consisted of some limited progress in agriculture, with a commitment to go further in new negotiations in 2000; limited progress in textiles and clothing involving a promise to end the Multi Fibre Arrangement in 2005 with most of the restrictions to be eliminated later rather than sooner; a rather significant reduction in tariffs in goods in exchange for deeper cuts and more comprehensive bindings by developing countries (whose tariffs were higher with a smaller percentage of bindings) and with significant tariff peaks remaining on manufactured exports from developing countries. On the whole, not great but not bad when compared with previous rounds centred on traditional GATT-type market access negotiations. But this was not a GATT negotiation as the Southern piece of the deal so amply demonstrates. The essence of the South side of the deal – the inclusion of the new issues and the creation of the new institution – was to transform the multilateral trading system. Indeed the full transformation is indeed still underway and difficult to forecast (especially after Seattle). In the present context the most significant feature of the transformation was the shift in policy focus from the border barriers of the GATT to domestic regulatory and legal systems — the institutional infrastructure of the economy. The barriers to access for service providers stem from laws, regulations, administrative actions which impede cross-border trade and factor flows. Thus, as noted earlier, economic regulatory reform is at the heart of the new issues. Implicit in this shift embodied in the GATS is a move away from GATT negative regulation – what governments must not do – to positive regulation — what governments must do. This aspect is now apparent in the telecommunications reference paper that sets out a common framework for the regulation of competition in basic telecommunications. In the case of intellectual property the move to positive regulation is more dramatic since the negotiations covered not only standards for domestic laws but also detailed provisions for enforcement procedures on individual (corporate) property rights. But the Round also dealt with social regulation which has grown so rapidly in the OECD countries since the 1970s that it has been termed “regulatory inflation!” In the area of social regulation (covering environment, food safety, etc., as well as labour market issues) the positive regulatory approach is procedural rather than substantive and the model is the Western, especially American, administrative procedures model. The move from border barriers to domestic policy will require major upgrading

12 Sylvia Ostry and change in the institutional infrastructure of many or most Southern countries: governance; administrative regimes; legal systems; regulatory systems, etc. The changes required in China will be most dramatic since China has never adopted the Western concept of a rule of law. These changes will take time and cost a lot of money, as some recent analyses have shown. It has been estimated that for the least developed countries implementation costs would exceed several years’ development budget.4 The transition periods for implementation for developing countries were arbitrary and not based on any analysis or, indeed, on any awareness of this systemic problem. The technical assistance promised by the North was not implemented. And a new trade institution with an increasingly litigious and evidentiary-intensive dispute settlement system required a level of legal expertise rare in non-OECD countries, and pots of money to purchase Northern legal services. And, lest we forget, all this in return for minimal liberalization in agriculture and textiles and clothing. How was such a lopsided bargain achieved? There is no simple answer to this question. But it is very important to underline once more that the implications of the transformation of the system were not well understood by either side. Most developing countries were unable to participate in the negotiations, lacking the expertise both in Geneva and at their home base. But even the so-called Quad (the US, EU, Japan and Canada) had not thought through the consequences of the structural transformation of the shallow integration of the postwar system to a new mode of positive regulation of domestic policies and systems housed in a new institution that could never have even been imagined at Punta del Este in 1986. Thus a serious North–South divide among the member countries of the WTO was one of the unintended consequences of the Grand Bargain. The notion of a North–South divide among the members of the WTO is, of course, an oversimplification since the Southern countries are hardly homogeneous and include the poorest or least developed (perhaps 50–60 members) as well as middle-income countries. Yet there was a broad consensus among the Southern countries that the Uruguay Round Agreement was asymmetric and must be “rebalanced” before any new negotiations were launched. What is most interesting about the pre-Seattle discussions, however, was the proactive role of the Southern countries who submitted over half of the more than 250 specific proposals for the ministerial meeting. 5 And, of course, the Seattle meeting ended with the walkout of virtually all non-OECD countries. Their decision to close down the meeting was catalyzed by the fervour of street demonstrations dominated by a labour and environmental alliance (the “Turtle Teamsters”) and the threatened use of trade sanctions to enforce labor standards by President Clinton. Finally, it is important to underline that Seattle demonstrated, in more ways than one, that the political economy of the trade policy process has been transformed. First, the EU–US divide today is not only about agriculture but also about the basic agenda for a new round of negotiations and the extent and nature of the domestic policy space to be delineated in a new set of global trade rules. In the US, the end of the Cold War has led to a steady decline in congressional deference to the Executive and thus greatly increased the power of interest groups in the trade policy process. It

WTO: post Seattle and Chinese accession 13 is not too much of a stretch to argue that the postwar transatlantic alliance ain’t what it used to be. Second, the North–South divide stems not only from the seriously flawed Grand Bargain and the rise of new actors but also because of changes in the policy process of the Southern countries. Among these changes, which I have explored in greater depth elsewhere,6 the most important have been the rise of democracy and the growing awareness of trade policy issues in the general public, political institutions, and the business community. The role of the business community in trade policy has been greatly enhanced by regional initiatives both in Latin America and East Asia where business networks have been established and spawn a continuous diffusion of information and analysis. And business is not the only new player. Most of us are aware of the growing prominence of Northern nongovernmental organizations (NGOs) in international policy, especially after Seattle.7 But the growing role of Southern NGOs in shaping the agenda of the South is less well known. A number of these NGOs, based in developing countries, were created in the 1990s, and focus on trade policy or trade-related issues, especially the environment. They are also linked to a wide array of Northern NGOs with a Southern focus, including research and analysis as well as training and capacity-building, although they are often in conflict with other Northern NGOs.8 I have termed these North–South NGO networks a “virtual secretariat” whose role is to provide information ranging from technical research to policy advocacy, most of it on the Internet since the mid1990s. They also network with the United Nations Conference on Trade and Development (UNCTAD: a “real secretariat”) which has played an increasingly important role in developing a proactive policy agenda. The opposite seems to be the case for the so-called Quad of major trading countries for whom the adjective “paralyzed” would be more appropriate. Proactive versus paralyzed? Not quite. There are very proactive players in the North — the NGOs, especially the environmental NGOs.

The rise of the environmental movement Environmentalism as a key policy issue in the industrialized countries has had a major impact on both domestic and international policy. The regulatory inflation noted earlier began in the 1970s with the rise of consumer and environmental NGOs in the US and Canada and later spreading to Europe. With respect to domestic policy, while few studies are available, one analysis estimates an increase of 300–400 percent in OECD countries’ regulations on the environment, food safety, product labeling, etc., in OECD countries between 1970 and the mid-1990s.9 In the international arena two major UN conferences are landmarks in the rise of the environment as a global issue: the Conference on the Human Environment in Stockholm in 1972 and the Conference on Environment and Development in Rio in 1992 (the “Earth Summit”). There are now over 200 Multilateral Environmental Agreements (MEAs) of which about 20 include trade provisions. There is little coherence among these MEAs and no policy agreement as to how the MEAs relate to the WTO. There is plenty of scope for conflict which I shall return to shortly.

14 Sylvia Ostry The environmental movement of the 1970s, which was very different from the conservation movement of the early twentieth century, grew out of anti-nuclear protests. Greenpeace was formed at a meeting in Vancouver in 1970 to demonstrate against nuclear testing in the north and by 1972 was in France protesting French nuclear testing. (The diffusion of protest had begun and, of course, has accelerated with the use of the Internet.) In Europe, this advocacy route to influencing the process of policy-making was less widespread and, probably because of differences in the political systems, proceeded on a political party route. By the early 1980s the Green party was in the Bundestag, and today there are social democratic and green coalitions in four European countries (Germany, France, Italy and Finland) as well as an increasing number in the European parliament. It would be interesting to compare the impact of the two different routes – advocacy versus political – but little information exists on this issue. In the meantime the NGOs are highly visible and are clearly playing an increasingly important role in both defining agendas, feeding into the policy process in various ways and, by fostering corporate codes, influencing corporate behaviour.10 Before turning to the trade and environment issues in the WTO it is useful to provide some factual information on the largest and most activist environmental NGOs. First, they are transnational with affiliates around the world. A few examples will make the point. Greenpeace in Amsterdam has organizations in 20 countries; Friends of the Earth in 50; the World Wildlife Fund (WWF) in 28. The Sierra Club has a department dedicated to international issues and networking. A unique feature of the North American NGOs is their focus on litigation and thus the establishment of specialized litigation NGOs such as the Environmental Defense Fund (EDF) and the Centre for International Environmental Law (CIEL) established in Geneva in 1995 by Washington-based CIEL. In addition to the emphasis on litigation, another feature of these green NGOs is their wealth. While it is very difficult to obtain information on funding sources, a recent American study does provide some figures.11 The assets of EDF are over $18 million; Greenpeace (US) $15 million; Natural Resources Defense Council $40 million; World Wildlife Fund $90 million. The annual income of the WWF was described by Mike Moore as three times that of the WTO! But these NGOs are also richer than many member countries. Of course – and it is important to put this in context – so are the resources of most multinational enterprises. The most valuable asset of the NGOs, however, is knowledge. Marching on the streets is theatre and may influence the policy agenda (for good or ill). But strategic knowledge is essential in affecting the policy process and outcome in the two-stage policy game, first at the national and then at the international level. The use of the Internet has greatly enhanced the power of the NGOs both to mobilize support for specific issues and to influence national governments in the formulation of a policy stance on specific issues. Perhaps the best example of this enhanced power derived from the Internet is the demise of the Multilateral Agreement on Investment (MAI) at the OECD in 1998.12 The demise of the MAI has had a severe chilling effect on the US government as well as business, and the US was unwilling to support the efforts by the EU and others to include investment in any new WTO round.

WTO: post Seattle and Chinese accession 15 On the more specific issues of trade and the environment in the WTO the NGOs have pursued a dual track. One could classify these two tracks as legislative, i.e. to negotiate new rules to increase the weight of environmental considerations in the WTO, and legalistic, i.e. to seek incremental changes in these rules through the dispute settlement mechanism. Mainstream environmentalists have concentrated not on abolishing trade but on fostering change in the WTO to turn it from a trade institution to a new institution dedicated to sustainable development – a rather vague term that has never really been adequately defined. The basic issue of concern is to provide more room for domestic environmental policy without impinging on international trade rules. This is not an unreasonable argument in and of itself, since the GATT was indeed premised on this view and domestic policy space was safeguarded by a set of rules to permit temporary blockage of imports under specified terms, i.e. as a buffer or interface between the international objective of sustained liberalization and the objectives of domestic policy. But at the time of the creation of the Bretton Woods institutions there was a prevailing consensus among the founding member countries, the Keynesian consensus on full employment and the postwar welfare state. There is no prevailing consensus today on the social regulatory state – au contraire. Nonetheless, for the Northern environmentalists a start could be made by tackling two major issues in the current WTO rules: ●

●

to allow countries to block imports of products based on the nature of the process and production methods (PPMs) in response to cross-border environmental spillover or global commons resource problems to ensure that MEAs which include trade restrictions take precedence over WTO rules. (This was included in the Doha Development Agenda.)

In each case the actions would have to be suitably constrained to ensure that they were not misused for protectionist purposes. These changes would involve a renegotiation of current WTO rules – Technical Barriers to Trade (TBTs) and Article XX on exceptions – which restrict the use of regulations and standards because of their potential for “disguised protectionism,” and have been strongly opposed by most if not all non-OECD countries. And some modality of cooperation with the MEAs secretariats would be required. The Committee on Trade and the Environment (CTE), established shortly after the WTO was founded, has made little progress in these or other related issues. A dialogue of the deaf might be an apt description. This is the most serious outcome of the North–South divide and was exacerbated by the twinning of labor and environmental issues in Seattle. That marriage of convenience was largely reflective of domestic pressures and vividly displayed the US union movement’s frustration with the lack of adequate programmes to cushion structural change. It is important to separate these two issues because labor standards belong in the International Labour Organization (ILO), and environment is already in the WTO. Because of gridlock in the CTE, the failure to revive talks in Geneva, and a dim

16 Sylvia Ostry outlook for new negotiations, the legalistic route may yield more results. For whatever reasons, a recent decision of the Appellate Board (AB) has opened the door to PPMs in environmental disputes. In the late 1990s a contentious case involved a US import ban on shrimp trawled by a method harmful to certain species of sea turtles. The 1998 AB decision in effect overruled an earlier Panel decision, which had prohibited the US ban on tuna imported from Mexico because they were caught in a way that harmed dolphins. The AB ruling, it has been argued by many lawyers, in effect made new rules. Indeed, some US trade officials suggest that the AB has endorsed the use of unilateral, extraterritorial sanctions based on PPMs. Most Southern countries were extremely critical of the decision and have argued that the door may now be open to other unilateral actions based on PPMs, perhaps even labor standards or domestic environmental standards with no international spillover. In the same Shrimp/Turtle case the AB ruling included another explosive issue – whether panels and the AB are obliged to accept amicus curiae briefs in its submission and the panel agreed with the complainants that they should not be allowed. When the AB overruled the panel, outrage was expressed by many countries. Yet a more recent panel involving the US case against British steel included amicus briefs from American steel producers and was supported by the AB over the strong opposition of the EU and virtually all other members. The pressure from American NGOs on the US government has made the amicus issue a major policy priority for the Americans. Once the litigation route is open to NGOs others will demand equal treatment, for example for corporations, unions, consumer groups and, of course, private legal firms. The result would be to transform the dispute settlement mechanism into a largely litigious and adversarial process. It would, moreover, tilt the system in favor of those countries rich in legal expertise and increase asymmetry in the WTO. (Given the current state of flux in the Chinese legal institutions and the likelihood of an explosion of disputes, the impact of increased litigation is scary to contemplate.) There have been some suggestions for modifying of the dispute mechanism but the only way to really tackle the basic policy issues is through the legislative route. This would mean debating how to amend the relevant articles that deal with the scope for domestic policy space in environmental issues and the relationship between the MEAs and WTO rules, but also with the rising conflict, especially between the US and the EU, over food safety issues. The debate over these issues (and genetically modified organisms or GMOs) is rapidly heating up and, once again, may be “settled” through inserting changes into the WTO rules via the AB and not the CTE.13 It seems clear at this point in time, and for some time to come, that the legalistic route is a dangerous path and the legislative route is stalled. This provides a breathing space and an opportunity to catalyze positive movement. What is needed is to establish a policy forum in the WTO. Such a forum would permit trade and environment officials from national capitals to discuss and debate the basic issues and not the legalistic details. The WTO’s research capability would have to be enhanced by a research network linked to other institutions such as the OECD, UNCTAD, private think tanks, NGOs, business groups, etc. could facilitate the diffusion of knowledge both in Geneva and national capitals. Most Southern countries

WTO: post Seattle and Chinese accession 17 have refused to engage in dialogue perhaps because the current WTO committee structure is so rigid and the ultimate focus is not on policy discussion but on enforceable rules. But, of course, the absence of a policy forum for discussion of transformative issues is perhaps most glaring (and damaging) in the case of Chinese accession and its impact on the WTO, the subject to which I now turn.

Increasing legalization of the WTO There has been no analysis of the implications of Chinese accession for the functioning of the multilateral trading system by the WTO and other institutions.14 The World Bank and others have produced models to estimate the impact both on China and other countries in terms of trade and growth. But institutional impact cannot be estimated econometrically and, if mentioned at all, is impounded in ceteris paribus. Still, even a broad-brush political economy approach suggests that the singular focus of the bilateral negotiators on market access is grossly inadequate and that a long-run systemic approach is required to ensure an effective and sustainable integration of a country as large and, in many ways, unique as China. In this respect I would suggest that three fundamental questions should be tackled: China’s impact on the North– South gridlock; the impact on the WTO and on China of the legalization of the trading system; and the implications of the ongoing structural transformation in China on the accession transition mechanism. I emphasize the word questions because there are no simple clear-cut answers, but some reasoned speculation and discussion among experts in trade, international law, political economists and China experts could produce useful policy scenarios and proposals. This discussion can only raise a few points that might be usefully explored in a multidisciplinary forum. On the North–South divide the received wisdom at present seems to be that China will be pragmatic. On some issues – such as the use of Special and Differential (S&D) to provide leeway for some form of industrial policy, especially technology transfer arrangements – China will seek alliances with other emerging economies. This is likely to increase the opposition of many OECD countries, especially the US, to any expansion or redefinition of S&D. On the “trade and” issues China will certainly seek to strengthen an opposition coalition and, unfortunately, make any meaningful discussion of the environmental issues in the WTO even more difficult. But on many other issues China’s strategy would include shifting alliances, including playing off the EU against the US. One example of the latter could be the GMO debate which will soon be raging since China – unlike most of the Southern countries – aims to be a major producer of genetically altered crops as part of a broader effort to move up the technology ladder.15 On balance it is probably reasonable to conclude that, while China seems unlikely to act as a leader of a blocking coalition, the Chinese role over the foreseeable future is also unlikely to be energetic in encouraging policy options to narrow the divide and facilitating the negotiations. In any case, since a new round would involve even greater structural adjustment than accession will require, one can certainly understand a lack of zeal on the part of this new member country. But, alas, if the

18 Sylvia Ostry choice is legislate or litigate, the former would certainly be the lesser of two “evils” for China. The built-in tendency towards the further legalization of the WTO has already been noted above. It can also be observed in the growing evidentiary content of all disputes: panels are now in effect preparing reports less for the parties than for the AB. The requirement for ever increasing amounts of detailed information has only just begun. Imagine what disputes in China’s services sector or food safety and risk assessment would entail in terms of evidence. Or what about a dispute on subsidies in China’s SOEs, which could include a demand for information on non-performing bank loans, non-existent “services” of subsidiaries, or cross-subsidization in telecommunications services. But this aspect of so-called transparency (the most opaque word in the trade policy lexicon) is by no means the only problem. Far more important over the long run is the fundamental aspect of transparency as a pillar of the GATT and now the WTO, a pillar as important as non-discrimination in the origins of the system. This needs some explanation. The drafting of the Charter of the International Trade Organization (ITO), which was to have been a part of the Bretton Woods institutional architecture, coincided with a new development in the US legal system, the establishment of the Administrative Procedure Act (APA) in 1946. The APA stemmed from the expansion of the role of government as a result of the New Deal and World War II. It was, in effect, designed to constrain the discretionary power of bureaucrats. When the ITO died, the main elements of the APA which had been included in the Charter became Article X of the GATT, entitled Publication and Administration of Trade Regulations. No founding member objected, probably because all industrialized countries had adapted similar legislation as a result of the expanded role of government. And all therefore required the establishment of norms to control what bureaucrats do and how they do it. However, it is important to underline that the US approach was different in several respects in placing more emphasis on independent regulatory agencies with quasi-judicial or quasi-legislative functions; an emphasis on the right of notice and comment; freedom of information; and judicial review. The US approach (more adversarial and fact intensive than the European) was reflected in Article X, although it is weaker than the APA in speaking of the desirability rather than the necessity of independent tribunals and judicial review, probably as a result of compromise in the negotiating process. In any case it was hardly a major item in the negotiations because the GATT’s focus was on border barriers which are obviously “transparent.” The Tokyo Round nudged transparency and legalization a bit further by including rulemaking inside the border (subsidies, anti-dumping) and agreeing on an Understanding Regarding Notification, Consultation, Dispute Settlement and Surveillance which stresses advance notice and expands the notification requirements. But a seachange was introduced by the Uruguay Round with the inclusion of the new issues and positive regulation in both substantive and procedural law. So transparency (the word actually appears in the TRIPs Agreement) now requires the publication of laws, regulations and the mode of administration in services, as well as detailed enforcement procedures in TRIPs. Of course, the Accession Protocol of China

WTO: post Seattle and Chinese accession 19 reflects these changes, including requirements on the administration of the Trade Regime and sections on transparency and judicial review. Can China deliver on these requirements? The short answer would be not yet – and it is not clear when. Thus, transparency covers publication of laws and regulations in goods, services, TRIPS, foreign exchange control; right of comment before implementation; enforcement only of those laws and regulations published; creation of a single inquiry point with a time limit for response. Unfortunately, while Beijing may be able to publish all central government laws, etc., it is widely agreed that many (an unknown number) of relevant state laws will not (and cannot) be covered, nor will the unpublished “normative documents,” a leftover from the old regime, still in use by local and state officials. More broadly, the multilayered complexity of the evolving Chinese legal system – including several administrative procedures laws – makes it impossible to conform to WTO transparency. Chinese laws at present lack specified procedures to constrain bureaucratic discretion and include no mandatory right of comment. Finally, the requirement for Judicial Review faces the basic problem that there is no separation of powers in the Constitution, and therefore no concept of an independent judiciary. As several Chinese legal experts have noted, Chinese tradition regards law as an instrument to maintain social discipline, not to limit the power of the state – rule by law not rule of law. There is no question that there is ongoing legal change in China and recognition by at least some officials of the need for further change to conform to the basic requirements of the WTO. However, far more important than changes in the written law will of course be a pervasive and profound change in culture. The Chinese legal system is thousands of years old but the concept of control of the Mandarin was not part of it. It will take considerable time to change. After all, Japan adopted a Western legal system at the end of the nineteenth century. A comprehensive administrative procedures law (to improve “transparency”) was adopted in 1995. And there are still lots of complaints about “too much administrative discretion.” Since the adaptation of the Chinese legal institutions (and culture) will take some considerable time, one serious consequence of accession is likely to be a flurry of disputes which threatens an already overburdened system and may well be regarded by many Chinese as “political,” thus provoking a political response. These issues should be considered in the context of another provision of the Accession Protocol – the transition arrangements, a subject which at the time of writing seems not yet agreed. A major reason why China wants to be inside the WTO is that it provides an external anchor to support and sustain the economic reform launched in the 1980s. However, this domestic reform will involve major changes, including restructuring the SOEs and the banking system. Joining the WTO will enhance reform prospects but also involve significant unemployment in capital-intensive industries and rural areas, widening the already growing rural–urban and regional inequality. A social safety net and other forms of adjustment assistance are essential if serious and destabilizing backlash unrest is to be avoided. Yet none of these issues has been considered in the years’ long discussions of the transition arrangements to be covered in the accession agreement.

20 Sylvia Ostry The accession arrangements should include a time-specific transition period (probably 10 to 15 years) with a monitoring arrangement to ensure the legal and institutional change essential to implementation of WTO rules. Some form of multilateral sanction would have to be agreed if China failed to deliver the commitment specified in designated benchmarks. And, in order to avoid an overloading of the dispute system, an agreement to rely on negotiation and arbitration for specified cases would be useful. The mechanism should also include technical assistance jointly supplied by the WTO and the World Bank, coordinated with the financial assistance from the Bank designed to facilitate domestic structural change. At present the two institutions are trying to coordinate assistance for the least developed countries, a first effort at improved “coherence” in international economic policy – one of the objectives of the Uruguay Round.16 The China project would provide a much bigger and probably more complex example of coherence. But the experience could be useful as a generic approach to the accession of economies in transition, such as Russia, a different but equally challenging task for the WTO – or rather for the member countries who bear the ultimate responsibility for maintaining global stability in an increasingly interdependent world.

Notes 1 Sylvia Ostry, Governments and Corporations in a Shrinking World, Council of Foreign Relations, New York, 1990, p. 23. See also “Regional versus Multilateral Trade Strategies,” ISUA: Canadian Journal of Policy Research, vol. 1, no. 1, University of Montreal Press, 2000. 2 CUSTA was the first international trade agreement that included services but for a number of reasons related to Canadian domestic policy and politics, intellectual property (IP) was not included and limited progress was made on the investment issue. But this was rectified by the North American Free Trade Agreement (NAFTA) which improved on the services agreement of CUSTA, included IP and a comprehensive investment agreement. 3 For a comprehensive exposition, and analysis of the role of developing countries in the Round see Gilbert R. Winham, “Explanations of Developing Country Behaviour in the GATT Uruguay Round Negotiation,” World Competition Law and Economics Review, vol. 21, no. 3, March 1998, pp. 109–134. 4 J. Michael Finger and Philip Schuler, “Implementation of Uruguay Round Commitment: The Development Challenge,” World Economy, op. cit., pp. 511–525. They provide some estimates of implementation costs for just a few of the Uruguay Round Agreements based on World Bank projects suggesting amounts equal to as much as a year’s development budget for the least developed countries. 5 Rubens Ricupero, “A Development Round: Converting Rhetoric into Substance,” a note circulated as background to the Conference on Efficiency, Equity and Regitimacy: The Multilateral Trading System at the Millennium, John F. Kennedy School of Government, Harvard University, June 2000, p. 1. 6 Sylvia Ostry, “The Uruguay Round North–South Grand Bargain: Implications for Future Negotiations,” paper prepared for conference on The Political Economy of International Trade Law, University of Minnesota, September 2000 (mimeo). 7 Sylvia Ostry, “WTO: Institutional Design for Better Governance,” Kennedy School Conference, Harvard, June 2000 (mimeo). 8 Ostry, Minnesota, op. cit.

WTO: post Seattle and Chinese accession 21 9 OECD, Report on Regulatory Reform, Vol. II: Thematic Studies, Paris, 1997, Chapter 2, pp. 191–248. 10 Sylvia Ostry, “Business Trade and the Environment,” The Second Environment Summit: Confederation of Indian Industry, New Delhi, October 2000 (mimeo). 11 James M. Sheehan, Global Greens: Inside the International Environmental Establishment, Capital Research Center, Washington, DC, 1998, pp. 165–199. 12 Ostry, Kennedy School, op. cit. 13 Ostry, New Delhi, op. cit. 14 This section is based on Sylvia Ostry, “China and the WTO: The Transparency Issue,” UCLA Journal of International Law and Foreign Affairs, vol. 3, Spring/Summer 1998, no. 1, pp. 1–22. See also Mark A. Groombridge and Claude E. Barfield, Tiger by the Tail: China and World Trade Organization, AEI Press, Washington, DC, 1999. 15 Craig S. Smith, “China Rushes to Adopt Genetically Modified Crops,” New York Times, October 7, 2000. 16 Ostry, Kennedy School, op. cit. The project is known as The Integrated Framework for Trade-Related Assistance to Least Developed Countries (IF).

3

Negotiating China’s Protocol of Accession Jeffrey L. Gertler

Editors’ note: This chapter was commissioned before China successfully acceded to the WTO. We have not altered the original text. We feel that it stands on its own as a piece which encapsulates the thoughts of a key WTO negotiator at the time of the negotiations. What we have done instead is include an addendum which encapsulates the final round of negotiations that culminated in the November 2001 Dubai agreement.1

Introduction Each accession to the WTO is a unique event,2 but few would argue with the proposition that China’s accession has been more unique than others. After all, China was one of the 23 original contracting parties to the GATT in 1948, and its application for readmission to the multilateral trading system dates back 14 years to July 1986, easily making it the longest and most arduous accession negotiation in the history of the GATT/WTO.3 The purpose of this chapter is to lay out – in descriptive fashion – the steps remaining in China’s accession negotiations. Inevitably, such a description involves some degree of speculation; but given that those of us involved in this process over the years have repeatedly had occasion to speculate as to when China will get in, we must accept a degree of speculation as a necessary part of the process, while trying to keep it within reasonable bounds. The remaining steps can rather naturally be classified under three headings: ● ●

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conclusion of bilateral market-access negotiations conclusion of multilateral negotiations in the Working Party – including the draft Protocol and its Annexes – setting out the terms of China’s accession to the WTO, and preparation of and agreement on the Working Party Report approval of these terms of accession by WTO Members and acceptance of them by China.

Before delving into a description of these three steps, it may be worth briefly reviewing the many ups and downs China has experienced along its accession trail. In particular I am referring here to: the significant progress that was being made just

Negotiating China’s Protocol of Accession 23 prior to the Tiananmen incident; the almost two-and-a-half years following Tiananmen during which there was virtually no activity on the accession front; China’s participation in the Uruguay Round negotiations, but failure to conclude negotiations on its status as a GATT contracting party in time to be considered as an original Member of the WTO;4 the conversion of the GATT Working Party into a WTO Accession Working Party in December 1995; China’s unfulfilled desire to be in by the time of the December 1996 Singapore Ministerial; considerable optimism about an accelerated process in early 1997, the eleventh-hour failure of a bilateral deal with the United States in April 1999; the US bombing of the Chinese embassy in Belgrade in May 1999; and, most recently, the conclusion of bilaterals with the United States in mid-November 1999, followed by a spate of other bilateral deals in the first part of 2000. Clearly, WTO Members and China have been on a rollercoaster ride of major dimensions since 1986.

Negotiations and agreements Altogether, 36 WTO Members (counting the 15 member states of the European Union as one) have expressed an interest in concluding bilateral market-access negotiations with China. Once these deals are struck, China’s consolidated Schedules of Concessions and Commitments to the GATT 1994 and its consolidated Schedule of Specific Commitments to the GATS will be prepared with assistance from the WTO Secretariat. Thereafter, they will be reviewed in the Working Party and will be multilateralized, i.e. extended on a most-favored nation (MFN) basis to all WTO Members, as China’s Goods and Services Schedules, annexed to the Protocol of Accession. In other words, these bilateral commitments become part of the terms of China’s membership in the WTO. By the end of February 2000, China had concluded bilateral agreements with some 23 WTO Member governments, specifically: Australia, Brazil, Canada, Chile, Cuba, the Czech Republic, Hungary, Iceland, India, Indonesia, Japan, Korea, New Zealand, Norway, Pakistan, Peru, the Philippines, Singapore, the Slovak Republic, Sri Lanka, Turkey, the United States and Uruguay. China has still to conclude negotiations with 13 other WTO Members. These include the European Union, Argentina, Colombia, Costa Rica, Ecuador, Guatemala, the Kyrgyz Republic, Latvia, Malaysia, Mexico, Poland, Switzerland and Thailand. For many years there was little progress in bilateral negotiations, mainly due to difficulties in the discussions between the United States and China. However, since the United States and China initialed a comprehensive bilateral accord in November 1999, China has been able to conclude deals with many other Members. The most significant trading partner still yet to reach agreement is the European Union. Although progress was reported in two rounds of bilaterals in February, the same reports indicate continuing divergent positions – both on the tariff and quota regime and on the percentage of foreign ownership to be permitted in telecom and insurance service sectors. It now seems inevitable that further discussions between the EU and China will need to be scheduled. China will also be sending a negotiating team to Latin America in early March with a view to wrapping up bilaterals with Argentina,

24 Jeffrey L. Gertler Colombia, Costa Rica, Ecuador, Guatemala and Mexico. The Chinese hope to conclude with the remaining Members also in the course of March. One element contributing to pressure on China and Members to rapidly conclude bilateral accords (along with the Protocol and Working Party Report) is the Clinton administration’s agreement with China – as a quid pro quo for China’s market-access concessions – that the United States would provide China with permanent MFN status, thus eliminating the annually renewed conditional MFN provided under the Jackson–Vanik Amendment to the US Trade Act. The US president is anxious to have the accession package completed this spring so that he can put the request for “permanent normal trade relations” to the US Congress before its summer break. Many commentators have suggested that it would be very difficult to get the congressional votes for amending this US law any later in the year, particularly in view of the national elections scheduled for November.

Rounds accession With the bilateral market-access negotiations nearing completion, WTO Members have shown renewed interest in wrapping up the many outstanding multilateral elements of the accession package. At the very least, three more substantive meetings of the Working Party are likely to be required to complete the draft Protocol, including its many annexes, and to prepare the draft Working Party Report. In anticipation of this work, and in recognition of the fact that much of the information China originally submitted to the Working Party – and more recently – is very incomplete or now out-of-date, the Chairman of the Working Party, Ambassador Pierre-Louis Girard of Switzerland, has requested China to submit updated information on all key aspects of China’s trade regime. Prominent among the types of information China has been asked to furnish are notifications – in a working language of the WTO (English, French or Spanish) – of relevant laws, regulations and other policy measures in the diverse areas of the trade regime. For instance, China has been asked to furnish updated notifications on its industrial and agricultural subsidies; sanitary and phytosanitary measures; mandatory standards; import licences, quotas and tariff-rate quotas; state-trading restrictions; regulations affecting foreign investment; regulations affecting various service sectors; patent, trademark and copyright laws and procedures; and so on. China has indicated that it will be complying with these requests on an urgent basis. Clearly, such information is indispensable to Members’ assessment of the consistency of China’s trade regime with WTO rules, as well as to preparation of the draft Protocol and Report. It may be worth pointing out, however, that what has been requested of China is no different from what has normally been requested by the WTO – at least in recent years – of all acceding governments. The difference in China’s case is that here we are dealing here with such a big economy, one in which different sectors reflect widely differing stages of development and liberalization. Identifying trouble spots and agreeing on specific timing – including possible transition periods – for China to bring any WTO-inconsistent policy measures into compliance with WTO obligations present major challenges for all concerned.

Negotiating China’s Protocol of Accession 25 Working Party members and China will then have to return to consideration of the draft Protocol of Accession and its various annexes. The Working Party last considered this matter jointly in early 1998, based upon a draft circulated to members in May 1997. As of that draft, there was already substantial agreement on large portions of the Protocol, subject of course to overall agreement on the entire package of accession documents. Agreement, in principle, existed on the preamble; general provisions; commitments relating to administration of the trade regime, including uniform administration, special economic areas, transparency and judicial review; commitments on non-discrimination, special trade arrangements, trading rights, state trading, non-tariff measures, import and export licensing, price controls, taxes and charges levied on imports and exports, domestic support and export subsidies in agriculture, standards and technical regulations, sanitary and phytosanitary measures; a transitional review mechanism to oversee compliance with the terms of the Protocol; and final provisions. At the same time, significant differences of opinion remained on draft provisions addressing the distribution of import licences, quotas and tariff-rate quotas; the timing for full implementation of the Agreement on Trade-Related Investment Measures (TRIMs); subsidies commitments; commitments related to balance-of-payment measures; the phasing out of the transitional review mechanism; the establishment of product-specific and general safeguard mechanisms; and a special provision on price comparability in determining subsidies and dumping. Members and China recognize that more work needs to be done in each of these areas, as well as some redrafting of a technical nature and an overall review to ensure consistency in form. Additional work will need to be done on the draft Protocol to bring it into line with certain commitments China has agreed to – or may yet agree to – in the context of bilateral negotiations. Prominent here are provisions worked out as part of China’s deal in November 1999 with the United States. Among the provisions to be discussed multilaterally are: particular actions by China to comply with the WTO’s national treatment obligations; other specific actions to progressively liberalize its state-trading regime; an additional period for phasing out restrictions on imports of China’s textiles and apparel products, going four years beyond the period provided for under the Agreement on Textiles and Clothing; a product-specific safeguard that would last 12 years and be based on a lower threshold of injury than that contained in the WTO Safeguards Agreement, namely market disruption rather than serious injury, and permit a Member invoking the special safeguard to apply restraints on a discriminatory basis against imports from China; and the ability for other Members to treat China as a non-market economy in determining dumping prices for a period of 15 years. Beyond this, the Working Party will need to review and make any necessary amendments and clarifications to the many transitional annexes of the Protocol. These include annexes on: Products subject to State-Trading; Products subject to Designated Trading; Non-Tariff Measures subject to Phased Elimination; Products and Services subject to Price Controls; Notification and Phase-Out of Subsidies; Export Taxes and Charges; Products subject to Statutory Inspection; Restrictions Maintained Against China; Issues to be Addressed in the Periodic Consultations of

26 Jeffrey L. Gertler the Working Party on Trade with China; Schedules of Concessions and Commitments to the GATT 1994; Schedules of Specific Commitments to the GATS; and List of Article II (MFN) Exemptions under the GATS. We can anticipate considerable time being devoted to these matters, particularly to resolving complexities of transitional measures. Finally, in the multilateral context, members of the Working Party and China will have to agree on the text of a Report of the Working Party. The Secretariat prepared an outline of a draft Report back in 1994 and the latest version was circulated in the Working Party in May 1997. Substantial work remains to be done in order to complete this document. Of particular note are clarifications in the Report dealing with trading and distribution rights; actions by the Chinese government to ensure that state-trading enterprises conduct trade in accordance with commercial principles; conformity with WTO provisions of the trade regime in China’s special economic areas; and recourse to certain developing country provisions of the Agreement on Agriculture. No doubt this list of issues will grow as Working Party members seek further clarification from China on the many different aspects of China’s trade regime. A Working Party meeting has been scheduled for the week of 20 March and it is likely that the Chairman will call for a further session in April. From there, we will have to wait and see how fast the whole process can be put to bed.

Approval and acceptance Once there is consensus in the Working Party on the final accession package – Report of the Working Party, with a draft Decision and Protocol of Accession and Annexes as attachments – this will be forwarded to the General Council for decision. In accordance with established procedures, the General Council will then adopt the Report and approve the draft Decision. The acceding government becomes a Member of the WTO 30 days after it accepts its Protocol of Accession. Although Article XII:2 provides that “the Ministerial Conference shall approve the agreement on the terms of accession by a two-thirds majority of the Members of the WTO,” pursuant to a 1995 decision of the General Council all accession decisions are to be approved by consensus (with possible recourse to voting only where consensus is not achievable.) Under current Chinese law, all treaties signed by the Chinese government must be submitted to the People’s Congress for ratification. In other words, acceptance in China’s case – as in the case of most governments – not only requires signature of the Protocol of Accession, but also requires domestic ratification. However, there is the possibility that, exceptionally, China would modify its constitutional procedure so as to provide advance approval by the People’s Congress to the executive branch, extending authority to the government to accept the Protocol by signature alone. Such a procedure would shorten the timeframe for China becoming a WTO Member once the terms of her accession are approved by the General Council. More importantly, definitive acceptance by signature would prevent a situation arising whereby the Chinese executive would not be able to control the timing of accession.

Negotiating China’s Protocol of Accession 27 This consideration may be of interest to the Chinese authorities, given that China wishes to become a WTO Member prior to the Separate Customs Territory of Taiwan, Penghu, Kinmen and Matsu – known in the WTO as Chinese Taipei – and WTO Members may approve the terms of accession for Chinese Taipei shortly after approving the terms for China.

Concluding comments Much remains to be accomplished before the accession package for China can be said to be complete. At the same time, there is little doubt that WTO Members and China are now very eager to see this matter brought to a successful conclusion. The reader should be assured that this desire to achieve closure on China’s accession is also shared by the Secretary of the Working Party.

Addendum Alan S. Alexandroff (February 6, 2002) With all things seemingly related to this accession, the final stages of accession in fact took longer and were more contentious than most expected. Indeed it was not until the Doha Ministerial in Qatar in November 2001 that the General Council formally received the Report of the Working Party with a draft Decision and Protocol of Accession.5 There the General Council adopted the Report and approved the draft Decision. Thus, the People’s Republic of China became the 143rd member of the WTO on December 11, 2001.6 There were surprises all along the way to final agreement on accession. In achieving the final result there were numerous issues that resurfaced following the so-called completion of the US bilateral and significantly delayed the completion of the European Union bilateral. Notwithstanding that the US–China bilateral was concluded in November 1999, it was not signed-off on until March 3, 2000. What had appeared resolved in various bilateral negotiations proved not to be so. Indeed, many of these issues were fought over again and clarified anew in Geneva as bilateral matters were multilateralized. Finally, the European Union bilateral was not concluded until much later, in fact not until June 20, 2001 – barely three months before completion of the Working Party on China.7 Indeed the Working Party on China continued its lengthy efforts until completion of its eighteenth session, reaching agreement only on September 17, 2001 just two months before the Doha Ministerial. Also interesting is what proved to be a relatively uneventful approval by the United States Congress of permanent normal trade relations (PNTR) although the votes over permanent MFN status reflected, notwithstanding the often heated rhetoric, that there was continuing support for liberalized trading relations with China.8 The House of Representatives approved the legislation known as H.R. 4444 on May 25, 2000 and the Senate followed on September 19, 2000. Many issues presented themselves in the negotiations that continued in Geneva

28 Jeffrey L. Gertler principally but in other meeting of officials and leaders between late 1999 and late 2001. Some of the most charged issues included: ●

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Chinese insistence again that it be accorded developing country status, which had particular implications for longer transition periods in implementing WTO agreements on agriculture and industrial export subsidies. The agricultural supports were one of the last items settled. A compromise of 8.5 percent (product specific support) was struck between the US and China, which split the difference between the allowable developing country status of 10 percent and the developed country support of 5 percent. China also agreed not to apply any export subsidies thus forgoing a right provided to developing countries. Insurance and reinsurance areas presumed dealt with by bilateral negotiations came back onto the negotiating agenda and required lengthy negotiations among not only key trading parties and China, the US and EU, but also included negotiations between the EU and the US. First the US and China agreed that China would phase out over a five-year period China’s requirement that 20 percent of policies written for non-life, health and personal accident insurance be reinsured with China’s state-owned reinsurance company. In addition, much discussion was undertaken to resolve the “grandfathering” granted to US insurer AIG. This heated issue involved the EU in some ways more so even than the Chinese. The issue arose because, while there was agreement that AIG’s currently 100 percent wholly owned Chinese subsidiaries would be preserved, it was disputed whether new wholly owned subsidiaries would be allowed or the general limitation of 50 percent foreign ownership would be invoked. In the end language that supported, conceivably, both the EU and the US was agreed on in the Report of the Working Party. The US and China were required to negotiate over the definition of chain stores. The issue arose after China detailed an expansive definition that might well have swept in gas stations and auto dealerships. The negotiated definition agreed to include foreign-owned stores that would sell products of different types and brands from different suppliers and include more than 30 outlets.

In the end, of course, what will count is less the negotiation than the implementation. Yet the words of the US Trade Representative, Robert B. Zoellick to the US–China Business Council recently give some sense of immediate closure to this phase of China’s long march to global trade: China’s 15-year long journey to attain membership in the World Trade Organization has been a modern long march, not to the caves of the hinterland, but toward the seas of commerce and the ports of new open doors.9

Notes 1

Jeffrey L. Gertler is Senior Counsellor, Legal Affairs Division and Secretary, Working Party on the Accession of China, World Trade Organization, Geneva. The views

Negotiating China’s Protocol of Accession 29

2

3

4

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6 7 8

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expressed in this chapter are those of the author and are not to be attributed to the WTO, its Members or the Secretariat. Article XII of the Marrakesh Agreement Establishing the World Trade Organization, which governs accessions, is striking in its brevity. The operative provision reads: “Any State or separate customs territory . . . may accede to this Agreement, on terms to be agreed between it and the WTO.” There are currently 32 accession working parties in existence. After China’s revolution in 1949 and the split between Mao Zedong and Chiang KaiShek, the government in Taiwan announced in 1950 that China would leave the GATT. Although the government in Beijing never recognized this withdrawal decision, nearly 40 years later in 1986, the People’s Republic of China notified the GATT of its wish to resume its status as a GATT contracting party and its willingness to renegotiate the terms of its membership. A working party to examine China’s status was established in March 1987 and met for the first time in October of that year. The GATT Working Party on China’s Status met on over 20 occasions, but without conclusion. With the coming into being of the WTO in 1995, the GATT Working Party was converted into a WTO Working Party on the Accession of China. The WTO Working Party has met eight times. Pursuant to Article XI:1 of the Marrakesh Agreement Establishing the WTO, “the contracting parties to GATT 1947 as of the date of entry into force of this Agreement [1 January 1995], and the European Communities, which accept this Agreement and the Multilateral Trade Agreements and for which Schedules of Concessions and Commitments are annexed to GATT 1994 and for which Schedules of Specific Commitments are annexed to GATS shall become original Members of the WTO” (emphasis added). On November 11 the PRC notified the WTO that it was in compliance with the agreements reached with the WTO. That notification started the 30-day clock that led to it formally becoming a member by December 11. Though there had been some concerns, the PRC was followed a day later by ChinaTaipei as the 144th member of the WTO. The last hold-outs turned out to be the EU and then finally Mexico. In fact there was but one occasion in 1990, when a majority of the House of Representatives actually voted to disapprove of the president’s waiver of Jackson–Vanik. The vote was not concurred in by the Senate, ending that effort to eliminate MFN status toward China. Remarks by Robert B. Zoellick to the US–China Business Council, Washington, DC (January 31, 2002).

4

Avoiding deadlock Claude Barfield and Mark Groombridge

Editor’s note: This article was completed before China’s accession was accomplished. One of the authors, Claude Barfield, is now working on a monograph that will both describe Chinese trade and investment patterns, particularly within East Asia, and the changes China has made in its legal and administrative rules to accommodate WTO membership.

Introduction With the signing of the bilateral agreement between China and the United States, China is now poised to enter the World Trade Organization, the multilateral institution governing international trade in goods and services. While other final hurdles have to be cleared, such as the passage of permanent normal trade relations by the US Congress and the conclusion of a few more bilateral agreements (particularly the European Union), the broad outlines of China’s market access commitments are now clear. The successful conclusion of the US–China bilateral agreement in November 1999 surprised many. Just several months earlier, in April 1999, Chinese Premier Zhu Rongji put forward a similar market access offer during his visit to Washington that was rejected by a Clinton administration under pressure from labor unions. A double blow was dealt one month later with the accidental bombing of China’s embassy in Belgrade during the Kosovo crisis by NATO forces. In the aftermath of the rejection of Zhu’s offer and the embassy bombing, the Clinton administration came under a barrage of criticism and it is widely known that many within the White House considered Clinton’s actions in April a mistake. Eager to move past what was arguably the worst year in Sino-US relations since the Tiananmen Square incident took place in 1989,1 the Clinton administration made a concerted effort to correct its April mistake. The timing of the November 1999 bilateral agreement between the United States and China was also propitious in that it came on the eve of the Seattle Ministerial. There is evidence that Clinton knew the Seattle meeting would end in disaster, which, in fact, it did. The signing of the US–China agreement on the eve of Seattle, while by no means guaranteed (there is credible evidence that the United States almost walked away on several occasions), there is good reason to believe that US Trade Representative Charlene Barshefsky was under intense pressure to conclude a deal. On almost all accounts, the deal reached by China and the United States entails a

Avoiding deadlock 31 number of sweeping market liberalizing reforms on the part of the Chinese. In a number of sectors (see Appendix 1), China has agreed to open up its markets and subject its enterprises to increased foreign competition. The unexpected and startling events that transpired during November 1999, though, serve to reinforce the central argument and thesis of this chapter: that though market access concessions – tariff reduction and sectoral liberalization – are important for China’s bid for WTO membership, the real future challenges for China and the WTO revolve around issues related to “transparency,” or the legal and administrative policies and institutions that the PRC must put in place to ensure the equitable and efficient resolution of commercial and trade disputes. Our concern regarding transparency and administered protection issues is heightened by the sweeping nature of the package of reform China has offered – and to our skepticism concerning the ability of China, even with the best of intentions, to deliver on key elements of this package. Market liberalization on the scale promised by China as the price of WTO membership will undoubtedly increase the efficiency and productivity of the Chinese economy in the long run; but in the short and medium term, these reforms will force a massive overhaul of the Chinese economic system and create enormous social and political pressures on China’s government and ruling party. For all of these reasons, we shall argue that the final Protocol of Accession for China’s WTO membership voted upon by all 135 WTO members should include a detailed blueprint for fundamental changes in China’s current legal and administrative system, as well as special procedures for dealing with import surges (antidumping and safeguards actions). We do so because we think that the options are clear: either China agrees to create and implement a rules-based, legally tighter administrative system which commands the respect and trust of the international trading community, or “managed trade” solutions – targeted import quotas, market share mandates – will be sanctioned by the WTO and implemented by individual nations for years to come. Thus the core of this chapter presents our views and recommendations for “avoiding deadlock,” while putting in place rules that will provide a better operating environment for China to meet its WTO obligations.

Contingency protection: anti-dumping and countervailing duty laws With 15 transition economies from Eastern Europe and the former Soviet Union applying for accession to the WTO, the terms of accession for China as they relate to contingency protection will have far-reaching consequences. At the present time, the relevant section of the Protocol states: It is recognized that, in the case of imports of Chinese origin into a WTO Member, special difficulties may exist in determining price comparability in the context of anti-dumping and countervailing duty investigations. In such cases, the importing country may find it necessary to take into account the possibility that a strict comparison with domestic prices in China may not always be appropriate.2

32 Claude Barfield and Mark Groombridge The bilateral US–PRC WTO membership agreement reached by the trade ministers of the two governments in mid-November 1999 provided explicit detail regarding how the supposed “difficulties in determining price comparability” would be overcome. Under the agreement, for a period of up to 15 years, China will be treated as a non-market-economy (NME) and thus subject to very different methods for determining dumping and subsidies than are used by current WTO members against each other.3 In the United States, since the passage of the 1988 Trade Act, the margin of dumping for non-market economies is determined by either of two methods: the “factors of production” method, whereby the NME manufacturer supplies cost data on each input in the manufacture of an article and then the cost of each factor is calculated from a comparable market economy; or the “surrogate” country method where, in countries where input data are not available, all data are drawn from a surrogate country of comparable economic development. Before addressing specific issues inherent in forcing China to accept NME status for 15 years, it should be noted that a threshold problem is that there is no WTO rule – and no widely accepted consensus among WTO members – for defining the criteria for determining what constitutes a market versus non-market economy. In the United States, the issue is dealt with on a case-by-case basis even though the 1988 Trade Act did provide criteria for evaluating market forces within transition economies. The six factors were: ● ● ● ● ●

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extent to which the currency is convertible extent to which wages are determined by free bargaining extent to which joint ventures with foreign firms are permitted extent of government ownership of means of production extent of government control over allocation of resources and price and output decisions other factors that the administering authority considers important.4

There are two problems with the 1988 criteria, one specific to the list itself and a second, more general issue. First, there is no guidance in the legislation from Congress regarding priorities or weighting among the factors; and thus no quantitative calculations can be made. The Commerce Department noted this very point when it complained to Congress that “because the statute does not assign weights to the various criteria, it is difficult to say which of these factors should be more important in determining whether a country should be treated as a non-market economy country.”5 There is a more fundamental flaw in the treatment of NMEs under US antidumping and countervailing duty law: many of the transitional economies – and this is particularly true with China – have moved so far toward “mixed” economies that it is difficult to distinguish them, at least in many sectors, from some WTO developing country members. As some commentators have stated, “for example, the governments of developing market economy countries often heavily regulate foreign exchange and the availability of long-term capital; rely on price controls; and own many of the country’s basic industries, much like the behavior of the NMEs.”6 Thus, as we shall elucidate further below, even though they were forced to capitulate

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Avoiding deadlock 33 and accept up to 15 years of NME status, the PRC should immediately begin pressing the United States and other WTO members both to clarify the criteria for market versus non-market economies and to establish and carry through rules and procedures for some sectors to make the transition before the 15-year timetable. In pursuing this campaign, Chinese officials will have recourse to promises made by US trade officials when the bilateral agreement was signed. At a November 15, 1999 press conference announcing the details of the agreement, US Trade Representative (USTR) Charlene Barshefsky stated: With respect to anti-dumping methodology, our laws and regulations do provide for the graduation of sectors or an economy as a whole from these rules if it can demonstrate that it has become market-oriented. And as we’ve indicated to the Chinese, of course, to the extent that they request review of individual sectors, or the economy as a whole, we will do that under the bounds of our law.7

Anti-dumping: signs of past US flexibility There is ample precedent in US law and practice to establish an anti-dumping transition mechanism if the USTR and the US Department of Commerce can summon the political clout and courage to follow through on Ambassador Barshefsky’s promise. Twice since the early 1990s the White House and the Commerce Department have shown awareness of the deficiencies in current anti-dumping regulations as they apply to China and other NMEs: first, in cases in the early 1990s where the department espoused a so-called “bubbles of capitalism” approach; and second, in proposed legislation implementing the decisions of the WTO Uruguay Round.8 In two anti-dumping cases that related to Chinese companies (involving fans and lug nuts from the PRC), the Commerce Department attempted to introduce new concepts and methods for calculating prices, costs of production, and ultimately, dumping margins. Labeled the “bubbles of capitalism” approach, Commerce undertook to determine if individual sectors were free enough from state control to warrant the use of the Chinese company’s own price and production data in calculating whether dumping was occurring and by what margin. In each case the Chinese company argued that the government had no control over the type or volume of production, the prices charged, the distribution of profits, or the company’s ability to obtain, use and dispose of capital. Unfortunately, because of protests from US producers and from their allies on congressional trade committees, the Commerce Department quickly retreated. In another case which represented a reversal of the original lug nuts decision, department officials moved to a new concept, the “market-oriented industry approach,” which established much more rigid rules for allowing PRC manufacturers to prove that market forces determined prices for their products. Further, Commerce now evinced deep skepticism that “bubbles of capitalism” could even exist in non-market economies such as China and now argued that in order to conclude that an individual NME producer was governed by market forces it would “have to be persuaded that all prices and costs faced by the individual producer are market determined.”9

34 Claude Barfield and Mark Groombridge Several years later, the Clinton administration (the Commerce Department again had the lead on these issues) put forward another alternative for dealing with transition economies when it drafted implementing legislation for the Uruguay Round Agreement. Under the new procedures, for a period of five years, the US International Trade Commission (USITC) would assume responsibility for transition economies – defined as countries in process of introducing private property rights and privatizing state-owned enterprises. The proposal would have eliminated dumping calculations altogether and granted relief upon a showing of “serious injury or threat of injury” to the complaining industry – a higher standard than currently exists for relief under normal anti-dumping rules. The USITC would have full authority to tailor a remedy, including so-called “suspension agreements” in which the NME producer would agree to increase prices and/or agree to quotas to avoid dumping penalties.10 In the area of anti-dumping and transition mechanisms and policies for China and other NMEs, we have two recommendations. First, ideally we think that the Protocol of Accession for China and for other NMEs should establish a formal process for moving beyond the transition period to full market-economy status. To this end, the Protocol should provide a clear set of criteria and goalposts for guiding and evaluating Chinese progress toward a market economy. If it is not possible to include such language in the Protocol itself, then the United States and other leading WTO members should work through the WTO Council to establish such criteria and an orderly process by which NMEs can graduate into full WTO membership. Second, regarding specific anti-dumping actions, a system should be established that would create incentives for individual companies, and indeed whole industrial sectors, to press for market pricing of factor inputs. One possibility would be to go back to the Commerce Department’s aborted “bubbles of capitalism” concept. Analytically, this methodology is superior to the “surrogate” systems currently in place. It allows a detailed focus on input costs and introduces a larger degree of predictability into the dumping action process – and it is certainly more accurate than attempting to compare costs with another economy allegedly at the same level of development. Further, it focuses on the individual manufacturer’s costs and need not attempt the more difficult task of determining costs across an entire industry. Finally, there is a built-in incentive for individual manufacturers to cooperate with the dumping investigation as they attempt to prove to the Commerce Department that they have accurately calculated market-priced inputs. A second possibility would to shift away from dumping entirely and substitute a safeguards system during a transition period, as the Clinton administration seemed to be suggesting in the Uruguay Round Agreements Act (URAA) legislation. The US–Chinese bilateral agreement, unfortunately, is as retrograde on safeguards as it is on anti-dumping; but for reasons explained below, the use of the safeguards mechanism for dealing with imports is generally superior – from the perspective of more liberal results for the overall trading system – than is the use of antidumping actions.

Avoiding deadlock 35

Safeguards Safeguards are measures (generally tariffs or quotas) that create temporary protection against sudden import surges which injure or threaten to injure a domestic industry. During the Uruguay Round, rules for safeguards were substantially revised and tightened. As a result, the current rules allow WTO members to provide relief for a period of four years and then to renew the safeguards actions under certain restricted circumstances for an additional four years. The standard for invoking safeguards is higher than that generally used for dumping: imports must threaten “serious” injury as opposed to the less stringent “material” injury test for dumping. In addition, except for extraordinary circumstances, nations cannot single out particular sectors for relief (selective safeguards) and must take action against all imports. Finally, countries invoking safeguards provisions must take steps to phase out the restrictions over time (degressivity) and put in place adjustment programs for the industry under competitive pressure. The special safeguards provisions negotiated by the United States for inclusion in the Chinese Accessions Protocol establish special rules for 12 years after accession that will allow much greater freedom for WTO members to intervene against a surge of imports from the PRC. There are rules for both general and selective safeguards. Under the more general safeguards provision, as a result of any “development in their trade in goods and services” with China, a WTO member can ask for consultations and then, if the member cannot agree with the PRC on mutual remedies, that country may also suspend concessions or obligations. If this happens, the PRC is also given the right to suspend concessions to an equivalent amount of trade. With regard to the product-specific safeguard, the Protocol states that where imports of a particular Chinese product have increased in disproportionate percentage in relation to the total increase in imports in the product during the representative period and are causing or threatening to cause material injury (the lower standard that is used for dumping actions), the affected WTO member may either withdraw concessions in other areas or limit imports of the specified product. A third WTO country may also take like action if it finds that trade is being diverted because of the safeguard arrangement that results from the initial conflict. Again, in each circumstance China is allowed to take equivalent retaliatory action.11

Dumping versus safeguards Both the dumping and the safeguards provisions forced upon China by the US negotiators are retrograde, but from a systemic perspective the anti-dumping regime is by far the more damaging of the two means of dealing with import surges. Why are both retrograde? There are two reasons, one external to China (and other transition economies later if the same systems are put in place), and one internal to China. In both cases, the long transition period (15 years for anti-dumping and 12 years for safeguards) will mean that protectionist interests in major WTO countries will become accustomed to the cushion of “managed trade” and lack of competition with Chinese industries. They will move heaven and earth to keep the system in

36 Claude Barfield and Mark Groombridge place when the deadline approaches for a more market-oriented approach in the contingent protection area. Second, on the Chinese side, “managing” trade through bureaucratic means sends just the wrong message to government officials who will preside over the export quotas on Chinese companies which will surely result from the safeguards and anti-dumping actions. Old-style Communist “command and control” attitudes will be all the more difficult to eradicate. That said, use of safeguards actions to deal with import surges is marginally superior to anti-dumping actions. There are two reasons why this is so. First, safeguards actions are based on a system that avoid the inflammatory rhetoric inherent in anti-dumping cases (allegations of “unfairness” and “predatory pricing”). Second, under safeguards there is no attempt to spuriously compare prices and to measure the amount of dumping associated with particular products. As noted above, even for market economies, most economists severely criticize the techniques used by domestic trade agencies – for NMEs, the necessity to “construct” prices or find a surrogate country simply adds to the arbitrariness and absurdity of the process. Thus, China and other transition economies will fare much better under a safeguards regime than under a system which uses anti-dumping actions as the chief means of rolling back imports. For this reason, the authors recommend that the Bush administration go back to the method suggested in the Uruguay Round implementing legislation – and have the USITC assume responsibility for the transition economies, eliminate dumping calculations altogether and grant relief when there is a showing of a serious threat of “material” injury to industry.

Transparency and due process At the core of the difficulties facing both China and the WTO in fulfilling the obligations for Chinese WTO membership is the rudimentary state of its administrative law system, and the lack of an objective and equitable system of judicial review of administrative decisions. US Trade Representative Charlene Barshefsky highlighted this fundamental problem when she admitted, after signing the bilateral accession agreement with China, that: “Look, we’re trying to fit a square peg into a round hole . . . What are the hallmarks of the world trading system? The rule of law and transparency. China doesn’t have either one.”12 Unfortunately, with so much attention and negotiating energy devoted to market access and contingency protection against import surges, little or no attention has been paid to provisions in the Protocol of Accession that would mandate change and reform in the Chinese commercial law and administrative procedures as a condition of WTO membership. In this section, we describe in more detail the characteristics and flaws in the current Chinese legal and administrative systems and make recommendations for additions to the Protocol which would aim to ensure that China moves put in place more efficient and equitable rules and procedures. Under the heading “Judicial Review,” Paragraph D of the draft protocol states that: China shall establish or designate, and maintain, tribunals, contact points and procedures for the prompt review of all administrative actions relating to the

Avoiding deadlock 37 implementation of laws, regulations, judicial decisions and administrative rulings of general application . . . The tribunals shall be independent of the agencies entrusted with administrative enforcement.13 One commentator has described the role of courts in Chinese society and government as thus: In some ways, it would be more accurate to regard [the People’s Courts] as but one category among a number of organizations of the state which are required to a greater or lesser extent to interpret and apply laws and regulations . . . Far from having anything like a monopoly of what in other countries would be regarded as such essential judicial functions as interpretation of legislation and adjudication of disputes, the courts in China share responsibility for these activities with other “courts” – ministries, commissions and other bodies. The reason for this, he argues, is the “influence of Chinese legal culture, to which Montesquieu’s theory of separation of power was wholly unknown.”14 Several other idiosyncratic elements of the Chinese system should also be noted. First, the very general nature of Chinese laws and regulations means that it is impossible to determine a legal or practical response without access to the specific administrative rule. Further, another consequence of the overly broad legislative directions is a high degree of discretion given to Chinese officials in administering commercial laws – and no compulsion to provide the rationale behind a particular action. Two recent legislative enactments, however, may well be harbingers of important future changes. First is the Administration Litigation Law (ALL) of 1990, which grants to courts the authority to review the lawfulness of certain specific administrative actions, including fines, restricting property rights and denying licenses. In future proceedings the administrative agency has the obligation to prove, with documentation, that the act or regulation is lawful. The second positive legislative development is the Administrative Review Regulation (ARR) of 1991, which supplements the changes in the ALL. Specifically, the ARR establishes a system by which administrative acts may be reviewed by a higher-level administrative department.15

Suggested revisions in the draft accessions protocol: separate courts for international litigation and more detailed administrative procedures Robert Herzstein has queried whether, in light of the current weaknesses and contradictions in Chinese law and procedures, the Protocol “should set forth an obligation for China to establish a modern and effective system of administrative law.” This would mean that the Protocol would spell out in much greater detail: (1) standards and procedures for businesses to obtain information of government measures and actions; (2) means by which business would be consulted in making

38 Claude Barfield and Mark Groombridge laws and regulations affecting business opportunities; and (3) procedures for allowing businesses to contest, before an independent tribunal, government actions they consider improper or illegal.16 In general the authors agree with Herzstein’s recommendations – but in one regard we would go farther and require that China establish an entirely separate system of administration and court review for disputes relating to trade, investment and the WTO. There is precedent for this move both from international legal norms and from changes already indigenously taking place within the Chinese legal system. Internationally, though there are variations, generally national legal systems fall into two large categories in regards to administrative law: the common law tradition of the US and Britain (and former members of the British Empire), and the civil law tradition epitomized by France, Germany, most of Latin American and many other developing countries. One major distinction between the two systems is the bifurcation of the legal regime into private rights and public rights. In civil law systems, controversies between private citizens over contracts or liability are handled by ordinary courts. Controversies which pit the citizen against the state, however, are handled by a separate hierarchy of administrative tribunals. In some countries – Germany is a prime example – high value is placed on specialized judicial expertise, and there are a number of separate hierarchies dealing exclusively with particular disputes – taxes, social security, labor relations, for instance. Though the modern Chinese legal traditions are still in a rudimentary state, movement toward a civil law regime many be beneficial for two reasons: first, and of most interest for this chapter, whether in trade or tax law, separate courts would encourage specialization and more advanced, sophisticated rulemaking and judicial expertise; and second, operation of private courts would reinforce the shift toward an emphasis on private rights and obligations that are separate from, and independent of, the public citizenship obligations that characterized the prior Marxist/Maoist “dictatorship of the people.” Further, in some countries with civil systems, such as France and Germany, there has never been a systematic codification of administrative law: it is entirely judge- or court-made. This pattern of court-made law over time might well work to the advantage of the Chinese in that, if specialization and increased expertise evolve in individual subject areas, this will increase the likelihood that at least pockets of modern legal structure and doctrine will expand, whatever the overall pace of such advances in the larger Chinese legal system. There is already precedent in the Chinese legal system for the PRC to create a separate administration and judicial system to deal with foreign trade and investment matters. Though not formalized, within the People’s Court system special economic divisions are increasingly being tapped to handle more complicated litigation which requires complex economic judgments, particularly in geographic areas of concentrated commercial activity such as Shanghai, Guangdong and Beijing. In addition, in 1993 China began establishing separate courts within the People’s Court system to deal with intellectual property rights (IPR) cases. By early 1998, there were 20 such IPR tribunals established in intermediate and higher courts.

Avoiding deadlock 39 China has also created a separate system of arbitration for foreign enterprises that is presided over by the central trade agency, the China Council for the Promotion of International Trade (CCPIT). Building upon these domestic precedents, plus the historical procedures in civil law systems, these separate, specialized courts for foreign trade and investment disputes could in the future provide the foundation for new legal and administrative doctrines, and for creating a cadre of lawyers and judges expert at WTO and other international economic rules and procedures.17

Administrative procedures The limited goal of our recommendations in this section will be to establish certain minimum procedural obligations that would be required of Chinese agencies, commissions or courts which handle foreign commercial, trade and investment disputes. These rules will be of great importance because, as Herzstein has pointed out, the first years after Chinese WTO accession will certainly be characterized by situations in which “foreign companies seeking to do business in China will encounter very uneven conditions, lack of transparency [and] perceptions of discrimination or other violations of WTO rules, and inadequate remedies.”18 (A more thorough review of Chinese administrative procedure can be found in Chapter 10 by Sarah Biddulph in this volume.) Among the procedures which should form part of the mandate are the following. When new regulations are being considered, interested parties should have the right to advance notice of hearings and the right to appear and give comments on proposed rules changes. The protocol should also require that a record of the rulemaking hearing be published by the Ministry of Foreign Trade and Economic Cooperation (MOFTEC) and that new rules and regulations be accompanied by documents explaining the rationale behind their promulgation. Rules governing administrative adjudication should be more explicitly stated in the Protocol. First, the right of a hearing on the record by the aggrieved or affected party should be written into the agreement, as well as provisions for notice, right of counsel and other safeguards to ensure that the rights of foreign businesses and investors are protected. In addition, deadlines should be established for assuring prompt decisions, and standards of evidence should be required (though the Chinese should also have some freedom to decide on the level of the standard). Of great importance, the Protocol should require that the administrative or court decision be published immediately, and that it include a complete discussion of the reasons behind the decision. Finally, the Protocol should flesh out in some detail how the Chinese will implement the mandate that appeals tribunals be independent of the original administrative agency. In summary, what the authors advocate is a “bare bones” set of procedures to ensure basic due process. They are the minimum necessary to assure fairness for foreign entities in trade and investment disputes – and the minimum needed to deflect inevitable criticism that the Chinese system is biased and arbitrary and constitutes a “trade barrier” to China’s ability to live up to the obligations of WTO membership.

40 Claude Barfield and Mark Groombridge

The Trade Policy Review Mechanism: a new role The most obvious vehicle for handling the complex issues associated with transition economies and the WTO is the Trade Policy Review Mechanism (TPRM) which was established in 1989 to provide WTO members with unbiased information about the trade policies and practices of other members. Though first created as an experiment, the TPRM was formally incorporated into the newly established WTO in the January 1995 Marrakesh Agreement at the conclusion of the Uruguay Round. The Marrakesh Agreement describes the function of the TPRM as follows: The objectives of the TPRM are to contribute to improved adherence by all WTO Members to rules, disciplines and commitments made under the Multilateral Trade Agreements and, where applicable, the Plurilateral Agreements, and hence to the smooth functioning of the multilateral trading system, by achieving greater transparency in, and understanding of, the trade policies and practices of Members. [The TPRM] is not intended to serve as a basis for the enforcement of specific obligations under the Agreements, or for dispute settlement procedures, or to impose new policy commitments on Members.19 In order to carry out its policy review mission, the Trade Policy Review Body (TPRB), composed of all members of the WTO, was created to oversee the reviews and a separate staff unit from the WTO Secretariat, the Trade Policy Review Division (TPRD), took over the tasks of assembling and analyzing the information. Since 1989, the TPRM has conducted over 80 trade policy reviews, covering over 60 countries.20 Under current practice, the interval between reviews depends upon the relative importance of the country in world trade. Thus, the US, the EU, Canada and Japan are reviewed every two years; 16 member countries next in the amount of trade are reviewed every four years; other members every six years (though some least developed countries may go longer without scrutiny). Once a nation has been selected for review, the WTO Secretariat sends out a detailed questionnaire regarding trade laws, regulations and practices. This is followed up by one or more visits by the Secretariat staff for meetings with government officials, business leaders, consumer and other non-government organizations, and private research and academic institutions. The staff prepares a preliminary report based upon its own analysis and the country report stemming from the questionnaire. This is followed by a meeting between the TPRD (or those members of WTO who choose to participate in this particular review) and representatives from the government of the country under review. Often this meeting includes quite sharp exchanges between TPRD members and representatives of the country under review. After the meeting the TPRD prepares a final report which consists of the initial Secretariat report, the country’s self-report, and the minutes of the meeting.

Avoiding deadlock 41

Arguments for new role for TPRM In recommending that the TPRM be adapted and expanded to include oversight of the NME accessions process, the authors make the following arguments.21 First, the central questions raised in the reviews, with some amendments, reordering and expansion, represent exactly the kind of information which will be needed – in depth – to facilitate the progressive integration of the NMEs into the WTO. Further, as noted above, melding the format and the substantive agenda in the reviews with the accessions process would place both the old WTO members and the new members on an equal footing regarding the assessment of whether they were fulfilling the obligations of WTO membership. Again, particularly for China, this would lessen suspicions that it would face the spectre of second-class citizenship in perpetuity. This is not to say that there are not changes that would be necessary to combine the TPRM with a more general accessions process for the NMEs. Because the regular TPRM process will continue to operate, a subcommittee of the TPRB should be established to deal exclusively with NME accessions. Clearly, it would include the major trading nations (the EU, Japan and the US), plus other countries who volunteered for the responsibility. The authors also recommend a change in the timing of the TPRM reviews to reflect the new priorities for the WTO and the limited resources available from the Secretariat. For the next decade at least, integration of the NMEs will remain a major challenge for the multilateral system and the TPRM should thus concentrate it reviews on these nations as they enter the WTO. Specifically, the NMEs should receive top priority and be reviewed every two years, while the current two-year reviews for the US, EU, Canada and Japan should be stretched out to four or six years. This change reflects another reality – that is, whatever their flaws, the trading practices and institutions of these countries do not change very much over short periods of time, so little would be lost in terms of trade liberalization. It is true that small WTO members which do not have the resources to monitor the complex trade policies of larger nations utilize the TPRM as a check against actions against their interests. Again, we do not believe that slippage from two to four or six years will greatly affect their ability to challenge serious infractions of WTO rules by the major players. We recognize that there are trade-offs, and some change in philosophy must be made as a result of this proposal. First, it is true that the TPRM, particularly the TRBD subcommittee which would oversee NME transitions, would move to a somewhat more activist role and away from the merely “external audit” function. Its role in presiding over the separate safeguards and anti-dumping actions we have suggested for NMEs, however, would still not include a dispute settlement function. This function would still proceed through the regular WTO process. The major new activist responsibility would entail oversight of the market access pledges and fashioning appropriate penalties for failure to meet these deadlines. Second, there will be the concern from small nations that their ability to evaluate and criticize the market barriers in large WTO countries will somehow be weakened. Because we see that the regular TPRM process will go on as before, we think that this will not happen. But to the extent that there is a trade-off we think, at

42 Claude Barfield and Mark Groombridge least for the next decade, both small and large WTO members are best served by revising institutions and practices to give top priority to the integration of the NMEs into the multilateral trading system.22

Conclusions The goal of this chapter is not to denigrate the importance of the sweeping market access commitments put forward by China, which are an important component of any WTO accession agreement. Market access commitments, however, are of secondary importance, particularly over the long term. Other issues related to transparency and administrative reform are far more important. Moreover, a daunting reality for the West hangs on the outcome of the negotiations for Chinese WTO membership. China will set an important precedent for the way the WTO deals with the numerous other nonmarket economies, such as Russia, which remain outside the system. Regardless of the particular market-access agreements reached, it is important that compliance with WTO rules and principles is evaluated on the basis of the process by which trade is conducted – rather than on the volume of trade between member nations. It will also be important for US and other Western leaders to convince the Chinese that the legal and economic reforms being demanded as the price of WTO membership are in their own economic interest – and not onerous obligations pressed upon them to undermine their economic progress. Such a commitment from China to beef up transparency and administrative reform will be crucial in resisting pressure to manage China’s trade after accession. This is why administrative reform in China is so crucial, for it is the only way that the WTO will be able to evaluate the situation and render competent judgments when disputes arise. Without such a commitment, it seems likely that the WTO will face enervating disruptions for years to come. It will be much easier for Western countries to win frivolous dispute settlement cases and impose unilateral protectionist measures. Such an outcome is in the interest of neither China nor the WTO.

Notes 1 Some think that the year 1999 was even worse than 1989 given the range of issues which served as sources of disagreement including persecution of democratic activists and Christians, the increasing bilateral US trade deficit with China, missile proliferation, campaign finance scandals, and nuclear espionage. 2 “Special Report: Confidential Draft Protocol Proposes Unlimited China Safeguard,” Inside US Trade, January 27, 1995, pp. 2–3. 3 Shai Oster, “US, China Reach Groundbreaking Accord on Accession to World Trade Organization,” International Trade Reporter, November 17, 1999, pp. 1852–1853. 4 Mark A. Groombridge and Claude E. Barfield, Tiger by the Tail: China and the WTO, Washington, DC, AEI Press, 1999, pp. 47–48. 5 Ibid., p. 49. 6 Judith H. Bello, Alan F. Holmer and Jeremy O. Preiss, “Searching for ‘Bubbles of Capitalism’: Application of the US Antidumping and Countervailing Duty Laws to Reforming Nonmarket Economies,” George Washington University Journal of International Law and Economics, vol. 25, 1992, p. 689.

Avoiding deadlock 43 7 WTO: Third Ministerial Conference, 30 November–3 December 1999: http://www. usia.gov/topical/econ/wro99/pp1115b.htm. 8 For a more detailed description and analysis of the “bubbles of capitalism” approach, see Groombridge and Barfield, op. cit., pp. 42–54. 9 Sanghan Wang, “US Trade Laws Concerning Nonmarket Economies Revisited for Fairness and Consistency,” Emergy International Law Review, vol. 10, 1996, p. 637. 10 Robert H. Lantz, “The Search for Consistency: Treatment of Nonmarket Economies in Transition Under United States Antidumping and Countervailing Duty Laws,” American University Journal of International Law and Policy, vol. 10, 1995, pp. 1050–1054. 11 Oster, op. cit., p. 1852. 12 Jim Mann, “Getting China to Adhere to Trade Deal Next Hurdle,” Los Angeles Times, November 17, 1999, p. 1. 13 “Special Report: Confidential Draft Protocol Proposes Unlimited China Safeguard,” Inside US Trade, January 27, 1995, p. 10. 14 Anthony Dicks, “Compartmentalized Law and Judicial restraint: An Inductive View of Some Jurisdictional Barriers to Reform,” China Quarterly, March 1995, p. 86. 15 For a more complete discussion of Chinese legal system and recent legislative changes, see Groombridge and Barfield, op. cit., pp. 63–66. 16 Robert Herzstein, “A Transition Mechanism: Outline of Questions for Discussion,” mimeo, prepared for the China–WTO Accession Project, Washington, DC, March 5–6, 1998, p. 16. 17 The recommendations in this section are taken from Groombridge and Barfield, op. cit., pp. 69–72. 18 Herzstein, op. cit., p. 16. 19 As quoted in Donald B. Kessing, Improving Trade Policy Reviews in the World Trade Organization, Washington, DC, Institute for International Economics Press, 1998, pp. 5–6. 20 For other descriptions and evaluations of the TPRM, see Sven Arndt and Chris Milner, “Editorial Introduction,” The World Economy, 1995, pp. 1–9; Petros Mavroides, “Surveillance Schemes: the GATT’s New Trade Policy Review Mechanism,” Michigan Journal of International Law, vol. 13, no. 2, 1992, pp. 374–414; and Aasif H. Qureshi, “The Trade Policy Review Mechanism,” The World Trade Organization: Implementing International Trade Norms, Manchester, England: Manchester University Press, 1996. The Arndt and Milner issue of the World Economy contains assessments of 12 country TPRM reviews by noted economists and trade policy analysts. 21 Our proposals here are similar in some respects to an earlier recommendation by Sylvia Ostry, “The Threat of Managed Trade to Transforming Economies,” Occasional Paper 41, Washington, DC, Group of Thirty, 1993, pp. 17–20. 22 Over 30 countries have applied for WTO membership, some 19 of which may be considered NMEs. These include 13 former states of the Soviet Union: Armenia, Azerbaijan, Belarus, Estonia, Georgia, Kazakhstan, Kyrgyz Republic, Latvia, Lithuania, Moldova, Russian Federation, Ukraine, Uzbekistan; in Asia, Cambodia, China, Laos, Mongolia and Vietnam; and in Eastern Europe, Albania. Of these, only four can be expected to become large or mid-sized trading nations: China, Russia, Ukraine and Vietnam (at some distant time). See Kessing, op. cit., p. 15.

Part II

China’s global economic integration Economic reform

5

A litmus test for China’s accession to the WTO Reform of its state-owned enterprises Harry G. Broadman

Introduction The progress the Chinese leadership makes in reforming the nation’s state-owned enterprises is a prism through which to view China’s readiness to assume the obligations of membership in the World Trade Organization. Most other countries in transition from socialism to a market system have turned to systemic, widespread privatization of large SOEs. In China, the state maintains ownership of key businesses, and government agencies carry out shareholder functions typically performed by private owners in market economies. Indeed a new “state asset management” regime, rather than ownership change, is the core feature of China’s “socialist market economy.” While market-oriented SOE incentives have been implemented since China began economic reform in 1978, today, Chinese SOEs still account for almost one-third of national production, over one-half of total assets, two-thirds of urban employment and almost three-quarters of investment. Preparing the way for subjecting China’s generally inefficient SOEs to WTO’s rule-based trade system poses a major challenge to the Chinese authorities. This chapter sheds light on this challenge by analyzing the incentives and constraints on China’s SOE reform program. I begin with a description of the “SOE problem” currently confronting the Chinese leadership. This is followed by a brief outline of the country’s industrial structure. I then turn to an assessment of how China’s authorities are seeking to implement the modern corporate form as the centerpiece of their state asset management reform initiative for SOEs. Four aspects of the reform program are highlighted and evaluated against the backdrop of international experience in public enterprise restructuring: clarification of SOE property rights; holding companies and other new organizational structures; corporate governance; and financial accounting and auditing. The chapter concludes with policy recommendations for Chinese officials to accelerate the modernization of the country’s SOEs so as to improve their efficiency under the rigors of the international marketplace.

China’s “SOE problem” President Jiang Zemin’s widely reported speech during the Fifteenth National Congress of the Communist Party in the fall of 1997 contained a more formal

48 Harry G. Broadman embrace of ownership diversification of SOEs than heretofore had been the case. When he declared that “even if the state-owned sector accounts for a smaller proportion of the economy, this will not affect the socialist nature of our country”, many observers concluded that China’s leadership had turned to embrace privatization, marking a watershed shift of reform strategy for the largest transition economy in the world. But Jiang also announced in the same speech that public ownership of enterprises should retain the dominant position in the economy. Amid Western news reports in the summer of 1998 that China had turned its back on SOE reform, Jiang sought to clarify the leadership’s position noting that “without a stateowned industrial sector, there can be no socialism.” China’s experiments in state asset management reform have been wide ranging.1 They have included use of incentive contracting; giving SOE managers greater autonomy; “corporatization” of SOEs; and transforming SOEs into shareholding companies. A centerpiece of these experiments has been decentralization of governmental authority, with all but about 2,000–3,000 industrial SOEs placed under the supervision of local governments rather than under the central authorities in Beijing. Most recently, a multi-tiered organizational network of state asset management bureaus, state asset operating companies and state asset supervisory committees has begun to emerge. At the same time, large-scale national enterprise groups or holding companies, entrusted to directly manage state assets, are being established. These various entities are to be the representatives of the state as the owner of SOEs, as sector line bureaus and ministries, which have been the traditional hallmarks of the planned economy, are either phased out or limited to carry out “trade association” or non-ownership, governmental regulatory functions. But the fact remains that of the 114,000 Chinese industrial SOEs, relatively few – between 2 and 5 percent – have been divested to the nonstate sector, and virtually all of these divestitures have involved small SOEs. To be sure, there have been payoffs to China’s strategy of SOE reform. Reforms have boosted SOE factor productivity growth rates, although the magnitude of the increase has been difficult to measure with precision.2 Moreover, SOEs remain key drivers of China’s industrial sector. SOEs still provide essential raw materials and dominate such capital-intensive sectors as power, steel, chemicals and machinery. Indeed, SOEs remain firmly entrenched despite an increase in the size of the “nonstate” sector, whose growth has been propelled by reforms that have liberalized market entry, removed price controls, eased investment restrictions, increased tax neutrality across enterprise forms, and exposed the domestic market to international competition. But profits of SOEs have declined from 6 percent to below 1 percent of the gross domestic product (GDP) in recent years. Moreover, many of them continue to be technologically inefficient. Most remain obligated to provide “cradle-to-grave” social services to workers and their families. They also carry a rising proportion of redundant employees and retirees on their payrolls. The result is that an increasing proportion of China’s SOEs are losing money: between 1999 and 2001 about onehalf of industrial SOEs incurred net losses – up from one-third just two years earlier. These losses amount to more than 1 percent of GDP. Factory capacity utilization rates for major industrial products of SOEs have also fallen below 60 percent.

A litmus test for China’s accession to the WTO 49 Exacerbating these “real sector” inefficiencies, China’s SOEs absorb more than three-quarters of domestic bank credit, and their borrowing comprises about 60 percent of the total nonfinancial public sector deficit.3 This demand on borrowing crowds out investment by nonstate firms, which have been the engine of China’s growth. It also undermines a weak state-dominated banking system: 20 percent of China’s bank portfolios contain nonperforming loans to SOEs. As a result, despite some past progress, China’s SOE reforms have not met the policy aspirations of the Chinese authorities. There is little question that many of the experiments carried out have been genuinely creative. But while some of the reforms have provided temporary relief, few are enduring successes. The fact is that few have fundamentally tackled the core problem of public enterprise reform. Worse still, some SOE reforms have been contradictory, engendering wholly new problems including asset-stripping, the privatization of assets and socialization of liabilities, tax evasion, de-capitalization and wage manipulation. By spilling over to the fiscal and financial sectors, China’s “SOE problem” jeopardizes other critical elements of the government’s economic reform program. Indeed it undermines overall resource allocation and macroeconomic stability. Of course, these problems are the product of, and are compounded by, the complex transition process China’s economy is undergoing.

China’s industrial structure The total number of firms in China’s industrial sector is about 8 million. Of these 8 million firms, there are 114,000 SOEs, 1.6 million urban “collectives” and rural “township and village” enterprises (TVEs), 6 million “individually owned” firms (with no more than seven employees), and 70,000 “other” firms (includes private firms with more than seven employees, joint ventures and fully foreign-funded businesses).4 China’s SOEs account for 29 percent of the country’s gross value of industrial output (GVIO). The GVIO share for collectives and TVEs is 39 percent, for “individually owned” it is 16 percent, and for “others” it is 17 percent. In Chinese statistical terminology, “nonstate” enterprises include all ownership forms other than SOEs. Most collectives and TVEs are public enterprises. However, there are significant differences between these firms and SOEs in terms of property rights, fiscal subsidies, access to bank credit, social functions and other features such that they operate more similarly to private sector-oriented enterprises found in other economies around the world.

The Chinese corporate form China’s authorities have called for establishing a “modern enterprise system” early in the new millennium. In many respects, the model for SOE reform that the Chinese program is based on is the modern corporation.5 Consequently, within the context of the “socialist market economy,” the Chinese corporate form – as set out in the 1994 Company Law6 – has effectively become the vehicle for “separating” governmental and business functions and “state asset preservation and increase.”

50 Harry G. Broadman These are the two policy goals that lie at the heart of China’s state asset management reforms.7 The universal problem of a modern corporation’s owners – whether in China or elsewhere – is how to structure the enterprise internally to provide sufficient incentives for managers to attain owners’ goals. At the same time, the firm should be exposed to various external incentives that discipline the conduct of managers in such a way to enhance firm performance. Internal incentives generally involve the clarity of property rights, the nature of the firm’s organizational structure that reflects owner–manager relations consistent with these property rights, and the institutional rules that allow for such rights to be exercised so as to bring about sound corporate governance. Decisions concerning internal incentives include such matters as election of the firm’s board of directors; mergers/acquisitions; increases and decreases in share capital; disposal of assets; and determination and deployment of retained earnings and dividends. External incentives include the extent of interfirm competition, such as entry by new rivals or exit by non-viable firms; an absence of fiscal subsidies; scrupulously fulfilling debt-service obligations; the competitiveness of the labor market; social service functions; and compliance with institutional obligations, such as monitoring of financial accounts through independent audits. As Figure 5.1 illustrates, China’s implementation of the modern corporate form is still evolving.

China’s SOE property rights One of the main thrusts of China’s SOE reforms is to clarify property rights. This effort has focused on delineating the roles of the state and SOEs through introducing business autonomy; corporatizing SOEs; clarifying the role of the state as SOE owner; and defining the role of the state as regulator. Management autonomy Some degree of business autonomy has been introduced. Beginning in 1992, a regulation was issued to cede to SOE managers Fourteen Autonomous Management Rights, such as the right to set prices, the right to hire and fire workers, and so on. To date, the implementation of the Fourteen Autonomous Management Rights is highly uneven. Few industrial SOEs enjoy all such rights.8 Corporatization Corporatization of industrial SOEs is proceeding, but only gradually. The business license registration process illustrates why, absent policy changes, transforming Chinese SOEs into companies is likely to proceed slowly. Identification of an SOE’s “investor,” which must be specified in the articles of association under the Company Law, is often a difficult task. This is not simply a problem of tracing funds; it is a political economy problem of assigning property rights. The competing claimants –

▼ ▲

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Markets Product Labor “Corporate control”

. . .

Pension funds

Financial sector Debt Equity

. .

Figure 5.1 China’s implementation of the modern corporation.

Social functions Contracted at cost

Core functions

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Operates

Management board

Reports to

Appoints & monitors ▼

Bankruptcy

Supervisory board ▲

External incentives

Internal incentives

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State

Labor

Shareholders

Owners

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In Chinese SOEs, internal and external incentives are blunted; social functions are integral to the firm . . .

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Government

Owners

Financial sector . Debt . Equity

Social functions

Noncore

Core Noncore divisions Noncore

Noncore

Management

Internal incentives

. . .

Markets Product Labor “Corporate control”

Bankruptcy

External incentives

52 Harry G. Broadman the various government departments and agencies, including line bureaus and ministries – often cannot reach consensus as to who is (or shall be) the “investor.” This property rights assignment problem is compounded in most cases when an SOE has large (explicit and implicit) liabilities. Everybody wants the valuable assets, but nobody wants the liabilities. With the unclear assignment of property rights, this leads to an asymmetry in the allocation of rights and obligations for good and bad assets. Because assignment of the liabilities is difficult to implement, they are socialized. Role of state as owner Not only is it the case that government departments and agencies are still exercising both the shareholder and administrator roles, but also there are multiple government departments exercising the role of owner, often overlapping with one another. The result is that across agencies – both horizontally and vertically – there is fragmentation and partial exercise of the ownership function, with no single entity responsible for an SOE’s “bottom line.” Consequently SOE managers are de facto enjoying more autonomy than otherwise formally indicated. But they are doing so in great part because of poorly defined property rights. To the extent that subsidies (either from the budget or hidden in the financial system) still make their way to SOEs, to the extent that the firms are protected from competition in product and factor markets by policy barriers to entry or similar institutional constraints, or to the extent that debt-service obligations can continue to go unmet (because the state-owned banks themselves do not yet operate according to commercial principles), managers can engage in opportunistic behavior. State as regulator Not surprisingly in this environment, SOEs resist regulatory organs as they fear erosion of their rights. This gives rise to disputes between stakeholders. There are, however, no formal, transparent mechanisms to settle these disputes and build a body of case law to interpret the SOE legal framework. The resulting unchecked insider control leads to, in effect, the privatization of SOE assets and the socialization of their liabilities, with the state as owner assuming the unlimited liabilities of lossmaking SOEs. The socialization of the liabilities, in turn, ultimately translates into greater national debt via further subsidies from the budget and the state banking system. Society as a whole thus bears not only the direct liabilities of the loss-making SOEs but also the extra costs of macroeconomic instability. Of course China is not the only transition economy facing these SOE property rights problems. But in economies where there are well-defined and enforced private property rights, any particular shareholder’s or stakeholder’s attempt to escape their liabilities arising from the negative present value of a corporation’s net assets would violate other shareholders’ or stakeholders’ property rights. The result is that all shareholders have incentives to monitor each others’ fulfillment of their liabilities and obligations. By the same token, international experience shows that the

A litmus test for China’s accession to the WTO 53 mechanisms of self-enforcing contractual relations and internalization of liabilities are weakened or absent when the state is the dominant owner of enterprise assets and is an ultimate enforcer of contracts and property rights.9 The possibility of negative net asset values may not be a serious social problem in mature market economies if property rights over assets in the corporation include only claims on positive residual profits. When the present value of residual profit streams becomes negative or zero, the owners of the corporation’s net assets would lose all of their investment but would not incur any more liabilities than their original investment in the corporation (the limited liability feature of the modern corporation). Any negative present value would have to be shared by other stakeholders, including banks, bondholders, suppliers, customers and employees. This would likely trigger a process of bankruptcy where legal procedures would define how liabilities would be shared. In principle, China’s economic legal framework does provide an adequate basis to help define, separate and allocate the ownership, management and regulatory roles of government and SOEs. But, in practice, there is effectively little separation between the affairs of business and those of administration. Substantial progress is thus needed on mechanisms for the implementation of the economic legal framework and clear assignment of property rights. Several gaps in the law need to be addressed, including regulations regarding the transfer of state property and regulations further clarifying managers’ autonomous rights. There is also a need for a comprehensive property law that defines and enforces property rights in all sectors of the economy and without regard to ownership or nationality. At the same time, accelerating the process of corporatization under the Company Law, regardless of an enterprise’s financial performance, would be highly beneficial.

Organizational reforms Organizational changes have been the most visible aspects of China’s state asset management reform process. The key structural manifestation of these changes is the emerging multi-tier network of dedicated state asset management institutions at the central and subcentral levels. At each level of government – national, provincial, municipal and district – there are typically three tiers: an “upper-tier organization,” which represents the state as owner, usually through an executive body; an “intermediate organization,” which is entrusted by the upper-tier institution to manage state-owned assets; and the “operational enterprises,” i.e. the SOEs. At the same time, the other significant organizational reform in the Chinese state asset management is the transformation of SOEs into large enterprise groups companies. At the national level, the upper-tier institution is the State Council (or Cabinet), acting as the “ultimate owner” on behalf of the people of China. The administrative arm of the State Council to carry out its state ownership functions is the National Administrative Bureau of State Owned Property (NABSOP). Analogous to NABSOP, upper-tier executive bodies are also being established nationwide at subcentral levels of government, such as municipal-level state asset management bureaus (SAMBs). The main function of the upper-tier organs, regardless of their

54 Harry G. Broadman location, is to set out broad policy parameters and goals for asset management. The intermediate tier is generally comprised of provincial- and municipal-level state asset operating companies (SAOCs), which are modeled on the concept of the modern holding company. Finally, there are the SOEs themselves. Figure 5.2 illustrates how China’s state asset management system has evolved since the creation of NABSOP in 1988, the current phasing out of line bureaus and ministries, and the prospective objective of bringing in new stakeholders. In general, the new multi-tiered state asset management organizational structures and holding companies lack clear internal lines of authority. The boards of directors (a) In the past, line ministries/departments managed state assets in SOEs People of China National People’s Congress

Central Party Committee State Council

NABSOP Line Ministries/Departments SOEs Subsidiary SOEs

(b) At present, new state asset management organizations and enterprise groups are being introduced People of China National People’s Congress

Central Party Committee State Council

NABSOP/Provincial– Municipal SAMBs

Line Ministries/ Departments

National Enterprise Groups

State Asset Operating Companies/Group Cos. Board of Directors of SOEs and SOE Group Cos. SOEs Subsidiaries or Functional Departments

A litmus test for China’s accession to the WTO 55 (c) In the future, line ministries/departments will be phased out; the new state asset management organizations, enterprise groups and other stakeholders will participate in SOE governance People of China National People’s Congress

Central Party Committee State Council Line Ministries/Departments

NABSOP/Provincial– Municipal SAMBs State Asset Operating

National Enterprise Groups Other stakeholders (other SOEs, banks, nonstate companies, etc.)

Board of Directors of SOEs and SOE Group Cos. SOEs Subsidiaries or Functional Departments

Figure 5.2 Organizational structures of China’s state asset management system.

and the senior executives are often the same people. In addition, board members are nominated not by a commercially oriented owner’s representative, but by governmental or party bodies. To date, introducing individual shareholders through public listing has not effectively redefined the main organizational characteristics of ownership/management interests; on the other hand, ownership diversification by institutional investors has been an effective mechanism in some cases to discipline new corporate structures. With a few exceptions, sector line bureaus, existing group enterprises and existing large enterprises are transforming into SAOCs without introducing a modern corporate form or developing modern matrix management structures. In virtually all cases, SAOCs retain governmental as well as ownership functions. In fact, many of the underlying SOEs see no difference between the old line bureaus and the new SAOCs – other than a name change. The result is that the multi-tiered network is burdened with conflicts of interest that prevent the effective separation of business from government. The greatest success in meeting this objective has been at the enterprise level, where the Chinese corporate form is evolving towards the international model. But it is clear that, overall, China’s present state asset management organizational structures and their component bodies need to be greatly simplified and their organizational layers eliminated. This is particularly true for the large enterprise groups being formed. The problems of Korea’s chaebols provide a powerful lesson in this regard.

56 Harry G. Broadman Indeed, at the intermediate and upper tiers, the Chinese approach has not taken advantage of international experience to reconcile contradictions between a state’s governmental functions and enterprise ownership interests. In the more effective international models of state asset management – the French and New Zealand systems – these contradictions are present. Both the French and New Zealand authorities have come to realize that these inherent contradictions stand in the way of better SOE performance that match the results of private sector firms. As a result, they have been privatizing SOEs to lock in hard-won reforms and ensure superior business performance, especially in the competitive manufacturing sector. But even where privatization has not been used, these systems employ bona-fide market-based incentive structures to mitigate these contradictions. For example, use is made of “outsiders” – that is participation from the nonstate sector – in SOE decisionmaking. In China, nonstate participation could be increased through: ● ●

●

appointing nonstate representatives to SOE boards of directors diversifying SOE ownership through selling shares on national and international stock exchanges to bring on nonstate shareholders and create passive minority state ownership shares managed by independent advisors contracting out the provision of services (e.g. transport, accounting, social services) to the nonstate sector.

At the same time, measures should be taken so that SOE board members come from different regions and have diverse backgrounds. Cross-sectoral and cross-regional diversification of managers as well as of the shares held by SAOCs and the other state asset management organizations should also be instituted. Chinese authorities recognize that SOE organizational reforms must include the transfer of many of the social service burdens SOEs carry – employee housing, hospitals, schools, administration of pension insurance, restaurants, among other facilities – to municipal or regional governments or to new or existing nongovernmental entities. Separating these social functions from SOEs’ productive functions is critical because their continuance, especially enterprise-provided housing, which is the largest component of the typical SOE’s social costs, hinders the mobility of workers and managers. As long as housing remains linked to jobs, agile labor markets, which are key to the establishment of a modern corporate system in China, cannot develop. While reforms for de-linking social services from SOEs must be accelerated, work is underway.10 SOE housing subsidies are being reduced, for example, over a several-year period through either raising rental rates or by converting them into wages. Sales of apartments are also being conducted. Cross-firm municipal pooling of pension obligations and payroll taxes earmarked for pension and health benefits are gaining prominence. By the same token, schools and hospitals are being slowly divested from SOEs to local governments. Even more so than the de-linking of social burdens from SOEs, appreciable progress is being made in enhancing labor flexibility. Whereas contracted (as opposed to permanent) workers and staff accounted for only 5 percent of the industrial SOE laborforce in 1985, by 1998 the proportion

A litmus test for China’s accession to the WTO 57 was more than 60 percent. Unemployment insurance schemes are also gaining prominence through municipality-based earmarked payroll taxes (collected from firms of all ownership forms).11 Still, China’s current policy regarding the disposition of surplus workers emphasizes maintaining social stability. In implementing reform measures, therefore, local governments carefully monitor the socially affordable level of unemployment in light of the strength of the local economy. Government policy-makers recognize that this is inefficient, but the social security system is not yet adequately developed to handle significantly larger open unemployment rates. Nonetheless, developing a class of professional, commercial managers independent of the state is an imperative part of organizational reform. Compensation and job security of managers must be closely linked to enterprise performance. In short, China needs a robust “market for managers” to allow for efficient deployment of managers not only within a firm, but also across firms, across sectors, and across regions.

Corporate governance Operating a large modern corporation inevitably involves the separation of the firm’s ownership from its management. The owners select managers to run the firm, and in the process the owners relinquish some of their control as they delegate some decision-making to managers. “Corporate governance” refers to the set of relationships that link ownership and control of an enterprise, the mechanisms through which these relationships are mediated (e.g. monitoring and evaluation controls), and the nature of incentives, risks and constraints that affect how the actions of a firm’s owners, managers and workers as well as others (e.g. banks, suppliers and customers) influence the firm’s conduct and performance.12 Providing systems for and exercising sound corporate governance is a challenge that all large modern corporations the world over must meet. It is difficult to ensure that the actions of a firm’s managers (the “agents”) are consistent with the interests of the firm’s owners (the “principals”). When managers do not act in the interest of owners, “principal–agent problems” arise. The extent of this conflict depends on a number of factors, most importantly the degree of information available about the activities of the managers. Owners have dealt with principal–agent problems through a variety of means including improved information incentives; more intense monitoring by owners and others (including banks) of managers’ conduct and performance; and implementing mechanisms to better align the interests of managers and owners/shareholders (for example through performance contracts and stock options). Different types of corporate governance systems have been used to solve the principal–agent problem. The United States and the United Kingdom rely heavily on shareholders’ actions in stock markets. Japan utilizes a bank-based system. Germany’s governance framework is centered on institutional investors (other companies and banks). There is no obvious ranking as to which of these three, or any other, corporate governance system is best for promoting efficient corporations in China. But there is a clear consensus worldwide that all of the most successful

58 Harry G. Broadman corporate governance systems make judicious use of commercially based incentives.13 The Chinese state as owner – or its representative organs – has generally weak organizational structures to provide clear information about SOE managers’ actions and enterprise performance. Effective corporate governance is difficult to exercise when few state asset management institutions regularly receive timely, accurate and useful information about the financial performance of the firms they control. The lack of clear ownership identification of SOEs also undermines corporate governance as it leaves open the issue of who exactly should be monitoring the managers. Clearly, the difficulty in identifying owners – and specifying who will be responsible for SOE liabilities – is typically a constraint on governance. The commingling of SOE commercial and social functions and the fact that the ultimate owner of SOEs – the state – is also the regulator of SOEs, give rise to conflicts of interest and unclear governance objectives. Relatively few outside monitors, especially banks, exercise strong discipline on China’s SOEs, which in turn contributes to weak corporate governance. The four specialized banks are mainly other agents of the state, making the concept of “limited liability” of little relevance for SOEs, as the owner and creditor are one and the same. Banks are attempting to transform into commercial entities, as called for by the new Commercial Banking Law. But they have still a way to go in establishing their independence.14 In contrast, nonstate enterprises, either acting as legal-person institutional investors in SOEs or as their suppliers and customers, provide some degree of external SOE governance. The bottom line is that without a fundamental reorientation in governance incentives toward market principles, China’s SOEs will either continue to be ruled by the old procedures – which will undoubtedly retard enterprise restructuring – or will continue to find themselves in a corporate governance vacuum. The result, as noted earlier, is that managers (and other insiders) end up with de facto control over the enterprises. The evidence from many transition economies is that insiderdominated corporate control has many costs and risks: asset-stripping, poor investment decisions, decapitalization through excessive wage increases, and increases in other private benefits. This is not to suggest that insider-dominated firms cannot deliver efficient performance, as in the case of small firms with an owner-manager structure. But this is true only if certain conditions exist – if, in particular, the firm does not receive any fiscal and financial system subsidies, faces robust inter-firm competition in product and factor markets, and scrupulously fulfills its debt-service obligations. Fundamental reform of China’s SOE corporate governance system will mainly stem from correcting underlying problems in the incentive framework. In particular, reforms are needed to ensure that SOEs face “hard budget constraints;” that in product and factor markets there is robust inter-firm competition; that SOEs incorporate judiciously diversified ownership structures; and that there is a “market for corporate control,” where the assets and liabilities of poorly performing firms can be rechanneled to higher values in use through market-based transactions. Putting in place these reforms is difficult and will take time.

A litmus test for China’s accession to the WTO 59 Ending fiscal and financial subsidies The experience of other transition economies is that a key determinant of SOE restructuring is the application of hard budget constraint; that is, enterprises pay the full economic costs for all their inputs and charge market-determined prices for their outputs. In China, fiscal (or budgetary) subsidies to SOEs have in fact decreased steadily in recent years. In 1993, SOEs in all sectors received direct subsidies through the budget of Y44.5 billion (equivalent to almost 2 percent of GDP); in 1995 such subsidies fell to Y36.6 billion (equivalent to 1 percent of GDP), and in 1997 they were smaller still. But dealing with subsidies provided through China’s financial system has been more problematic. They are less transparent than fiscal subsidies and therefore are less easy to monitor and reduce. While some reduction has taken place, it has principally come through the tightening of credit under inflation control programs. However, the four main state-owned banks still often automatically roll-over unpaid credits (principal and interest) to SOEs. Interest rates also have not been liberalized enough for the banks to differentiate terms among enterprises according to credit risks, giving rise to cross-subsidies. Clearly the banks need to step up their governance involvement with SOEs, especially in calling on debt-service obligations. More specifically, the banks need to be empowered to obtain more frequent and better financial information from SOEs, including the requirement to request independent audits. In cases where fiscal and financial system budget constraints have in fact “hardened,” Chinese SOEs – like SOEs in other countries undergoing transition – have nonetheless been able to avoid needed governance restructuring by resorting to inter-enterprise arrears. Alternatively, they arrange for soft financing on nonmarket terms from public utilities or other enterprises. The State Statistical Bureau has estimated that in the past few years inter-enterprise debts were roughly equivalent to Y1 trillion (about one-fifth of GDP), an increase from Y600 billion at year-end 1994. Inter-enterprise competition Another potent reform that the Chinese authorities are using to engender better SOE governance has been to increase the degree of product and factor market competition. In the aggregate, the national market share of industrial output of SOEs has been eroded by collectives, TVEs and other nonstate firms during the 1980s and 1990s from about three-quarters to one-third. Still, as a result of the legacy of a planned economy and substantial decentralization, in some market niches (notably heavy industry) SOEs enjoy regional autarky and face few nonstate competitors. In 1996 a World Bank survey of 156 industrial SOEs in five cities revealed that the average provincial market share for each firm’s principal product is 53 percent.15 The survey also suggests that on both the input and output sides of interfirm product sales and purchases, SOEs are interlocked with one another: the average share of inputs purchased from each SOE’s largest supplier is 60 percent, and 78 percent of the surveyed SOEs said their largest supplier is another SOE. By the same token, the

60 Harry G. Broadman average share of sales made to each of the surveyed SOE’s largest customer is 41 percent, and 60 percent of the surveyed SOEs indicated their largest customer is another SOE. Implicit and explicit policy barriers to entry – especially among would-be rivals based in different regions of China – are being reduced, but they are still substantial. Business licensing procedures, for example, deter new entrants from “foreign” provinces. The result is that in key industrial sectors such as electronics, petrochemicals and machinery, interprovincial market share patterns have not altered appreciably in the past several years, particularly at the wholesale level. In “downstream” industrial and commercial sectors, however, cross-market penetration is becoming more pronounced. Exit, bankruptcy and liquidation of commercially nonviable SOEs is much less common. Many governmental authorities, enterprise managers, bankers and workers are reluctant to pursue bankruptcy or other forms of exit; instead, mergers and acquisitions are the preferred routes for dealing with money-losing SOEs. Within 56 “experimental reform cities” there were 472 industrial SOEs identified for bankruptcy in 1997, but procedures had begun for only 161 of them, and only 58 firms had been declared bankrupt. More generally, the picture that emerges is that exit of money-losing SOEs is not widely practiced in China, except in cases of small or (to a lesser extent) medium-size SOEs. Most locales reported 15 to 25 SOE bankruptcy cases since 1996, all confined to small and medium-size SOEs. Ownership diversification China’s experience in diversifying SOE ownership (to both individuals and legalperson institutional investors) suggests that ownership diversification could provide an important opportunity for improving governance. Partial divestiture to nonstate interests through minority shareholding is increasing in its frequency, mainly through Sino-foreign joint ventures and through ownership diversification on stock exchanges in China and elsewhere. In the World Bank’s survey of 156 SOEs, among the 44 SOEs that had become companies under the Company Law the average ownership share of the state was 53 percent, the average ownership share for nonstate interests (nonstate firms, employees, managers or other individuals) was 34 percent, and the average foreign investor share was 13 percent.16 It is not sufficient, however, to simply diversify ownership of SOEs. Without the proper institutional safeguards, ownership diversification may compound rather than help existing insider control problems and create perceptions of unfairness. Implementing and managing SOE ownership diversification should therefore be done with well-defined institutional responsibilities and through transparent and competitive procedures. In this regard, international experience suggests that the keys to success are to ensure ownership diversification is both cross-regional and cross-sectoral; that there is transferability of ownership shares; and, most importantly, that investments on behalf of the state are supervised or managed by independent professionals – nonstate custodians or trustees – whose remuneration is incentive-linked to investment performance.

A litmus test for China’s accession to the WTO 61 This point should be emphasized. Like other transition economies, China’s authorities need to recognize that there is a trade-off between maintaining control of SOEs and enhancing their asset values. Fundamentally reorienting SOEs’ incentives toward the market may well entail reducing the state’s involvement in SOEs to passive minority ownership. The government will have its hands full in trying to improve the performance and competitiveness of its chosen 1,000 “priority” SOEs (see below). That job is complex, and government’s resources in skills and budget are limited. Mergers and a “market for corporate control” The restructuring of large and medium industrial SOEs through mergers and acquisitions, through participation in domestic and foreign joint ventures, and through other forms of integration and consolidation is in full swing in China. These initiatives in part are important because they help solve the problem of duplication of facilities and suboptimal plant scale, which exists as a result of the earlier decentralization drive that engendered artificial regional self-sufficiency. Mergers and acquisitions of debt-ridden SOEs are being promoted by granting five-year suspensions on loan payments of interest to the acquiring firm (for the debts of the acquired entity). Conversion of inter-enterprise debts (payables and receivables) into equity shares is also resulting in increased mergers and consolidations of money-losing SOEs. But these mergers are for the most part administratively arranged by government, which plays the key role in identifying the parties and arranging for the transaction. The Tianjin municipal government, for example, has taken the lead in trying to solve the city’s SOE problems by issuing regulations that provide a one-year readjustment period for merged enterprises with surplus employees; during this period the municipal labor bureau will pay unemployment benefits to the surplus employees. Moreover, if an enterprise finds itself unable to pay off the debts of enterprises taken over, Tianjin authorities will mediate between the enterprise and banks to seek a solution. The city has sponsored the formation of several large conglomerate groups with sales volumes exceeding Y10 billion. In general the increased attention being paid to SOE mergers, acquisitions and other forms of consolidation of operational enterprises is to be encouraged – to the extent that the resulting integration of SOEs serves to maximize economies of scale and scope. But because many of these mergers are administratively arranged, they do not necessarily lead to rationalization and lower average production costs. Instead, they become a device for saddling more efficient firms with the redundant workers and obsolete equipment of other less-efficient firms. A “market for corporate control” could be fostered that would provide for SOE mergers and acquisitions to be transacted through freely functioning competitive forces (subject to the condition that a publicly provided social safety net is established to facilitate dealing with redundant workers). Such a mechanism, which would serve to make the threat of potential takeovers of inefficiently managed firms credible, could help to strengthen external incentives, ensure that state-owned assets

62 Harry G. Broadman are being deployed to their highest value in use throughout the Chinese economy, and promote the creation of a unified economic space. In this regard, an emerging network of property transactions centers could be enlarged and strengthened.

Accounting and auditing of SOEs financial performance Accounting and auditing reforms are prerequisites to provide SOE owners, boards of directors and managers with reliable information to monitor enterprise performance. Without accurate, transparent and commercially meaningful financial information on enterprise performance, all other aspects of Chinese SOE reform could be for naught. China’s rules for financial accounting (issued in 1993) and International Accounting Standards (IAS) differ in several respects: on the policy basis of the accounting framework; the intended audience; and the definition and application of terms. Most other national accounting standards identify “investors and creditors” as the primary users of accounting information. China’s accounting standards generally do not. China’s standards give priority to administrative control, which conflicts with the goal of separating government and enterprises. Newly drafted Chinese accounting standards are more precise and comprehensive than the general principles embodied in the 1993 rules. If they are fully implemented, accounts prepared under Chinese and international standards will become more similar. But even with the issuance of improved accounting standards, there are other barriers to implementing meaningful accounting practices. Many of China’s SOEs lack the capacity to prepare such accounts. At the same time, tertiary businesses’ assets, costs and implicit liabilities, especially social obligations, are unclear. Inconsistencies also exist within a single enterprise group. Moreover, costs are often determined arbitrarily. In many SOEs different independent profit center workshops or production units still rely on an “internal banking system.” Each unit writes checks and makes demands on the central finance department with little coordination. Most units and the “internal bank” lack sufficient information to plan or to deal with working capital shortages. Exacerbating the problem is that many SOEs are heavily indebted to other SOEs. Finally, and perhaps most importantly, SOE financial accounts are not generally subject to bona-fide independent audits. The fact is that most of the accounts and the financial control mechanisms in China’s industrial SOEs are still aimed at counting rather than financial management. This does not create strong incentives for transparency and efficiency. Sound accounting standards and independent audits will enhance the system of checks and balances. Cash-flow forecasts also need to be issued on a semiannual or quarterly basis. Control systems to manage inter-enterprise debts also need to be strengthened.

Conclusion China’s state asset management initiatives for improving the performance of SOEs reflect a serious commitment to reform within the context of the “socialist market

A litmus test for China’s accession to the WTO 63 economy” framework. But in the medium term, if China’s SOEs are to operate competitively under WTO’s international trading system, more than marginal adjustments to current policies are necessary. Most critically required is to: ●

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● ●

●

● ● ●

extensively diversify ownership, allowing for passive state minority shares managed on behalf of the state by independent professionals simplify organizational structures, including enterprise groups and holding companies integrate cross-regional and cross-sectoral shareholding further develop property right/asset exchanges, and establish a “market for corporate control” eliminate policy-induced barriers to entry and exit in inherently competitive sectors intensify incentives so that bank-enterprise debt-service obligations are met create a market for managerial talent require independent audits of financial accounts based on international standards and make them publicly available.

In important respects President Jiang Zemin’s speech at the Fifteenth National Congress began to lay the groundwork for such a reform agenda. Jiang’s pronouncement came on the heels of several earlier high-level SOE reform announcements. This includes the “10,000–1,000–100–10 Experiment” initiated in 1994 (where the numbers refer to the count of enterprises and cities undergoing various reforms) and, more importantly, the Ninth Five-Year Plan (1996–2000).17 The Ninth FiveYear Plan incorporates a decision to “grab and reinvigorate” 1,000 large “priority” SOEs selected by the central authorities while “letting go” all remaining SOEs. It calls for providing a special fund to them to encourage “reorganization, bankruptcy, debt write-offs, mergers into partnerships, leasing, contractual operation or sales, as their specific circumstances permit.” Improvements in enterprise profitability engendered by such reforms will help to reduce public sector borrowing, thus adding to the country’s macroeconomic stability. At the same time, these policies are vital to completing the transformation of SOEs into modern corporations – the ultimate goal of the Chinese leadership. But decisively reorienting enterprise incentives toward the market also means reducing the state’s fundamental involvement in SOEs. Authorities have already stated their intention to loosen controls on them, but the government could go further and faster. It could do so by orchestrating a complete withdrawal of state involvement in inherently competitively structured industries. While the details of such a divestiture program will need to be worked out, promulgating such a decision would make formal a process that is already emerging. It would signal a credible commitment by government for deeper SOE reform in a portion of the economy where state ownership brings few benefits and many costs; in fact, the divestiture process could yield significant state revenues. More importantly, it would change behavior and expectations on the part of remaining SOE managers and the international community that the government is more serious about embracing

64 Harry G. Broadman nonstate competition as a way of fostering stronger business performance in China.

Acknowledgement and disclaimer Harry G. Broadman is Principal Economist and Program Leader for Russia Operations at the World Bank in Washington, DC. From 1993 to 1997 he was the Bank’s Senior Economist for China Operations. This chapter draws from his China’s Management of Enterprise Assets: The State as Shareholder, published by the World Bank in 1997. The views expressed here are the author’s alone and do not necessarily reflect those of the World Bank Group, its member countries, or its board of directors.

Notes 1 For a history of China’s SOE reforms see Broadman (1995). 2 For the debate over the impact of Chinese SOE reform on total factor productivity see Groves et al. (1994); Jefferson and Rawski (1996); Woo et al. (1994). 3 World Bank (1996). 4 In general these statistics come from State Statistical Bureau of China (1997). 5 For a classic description of the modern corporation see Berle and Means (1932). 6 See Lichtenstein (1993). 7 For a more complete description of these objectives see World Bank (1997). 8 See Broadman (1996). 9 See Broadman and Xiao (1997). 10 See Hu (1996). 11 For analysis of labor flexibility in Chinese SOEs see Lane et al. (1998). 12 For a survey see Shleifer and Vishny (1997). 13 See Aoki and Kim (1995). 14 For analysis of China’s financial sector see Lardy (1998). 15 The survey results are contained in World Bank (1996). 16 Analysis of foreign direct investment in China is contained in Broadman and Sun (1997). 17 The “10,000–1,000–100–10 Experiment” is described in Broadman (1995).

References Aoki, Masahiko and H.-K. Kim, (eds) (1995) (February) Corporate Governance in Transitional Economies. Washington, DC: EDI Development Studies, World Bank. Berle, A. and G. Means (1932, reprinted in 1967) The Modern Corporation and Private Property. New York: Harcourt, Brace and Jovanovich. Broadman, Harry G. (1995) Meeting the Challenge of Chinese Enterprise Reform. Washington, DC: World Bank. Broadman, Harry G. (ed.) (1996) Policy Options for Chinese Enterprise Reform. Washington, DC: World Bank. Broadman, Harry G. and Geng Xiao (1997) The Coincidence of Material Incentives and Moral Hazard: Labor Compensation and Enterprise Performance in China’s Transitional Economy: 1980– 94. Cambridge, MA: Harvard Institute for International Development. Broadman, Harry G. and Xiaolun Sun (1997) “The Distribution of Foreign Direct Investment in China,” Policy Research Working Paper no. 1720. Washington, DC: World Bank.

A litmus test for China’s accession to the WTO 65 Groves, T., Y. Hong, J. McMillan and B. Naughton (1994) “Autonomy and Incentives in Chinese State Enterprises,” Quarterly Journal of Economics 109: 183–209. Hu, X. (1996) “Reducing State Owned Enterprises’ Social Burdens and Establishing a Social Insurance System,” in Broadman (1996). Jefferson, G. and T. Rawski (1996) (March) “Chinese Industrial Productivity: Trends, Measurement Issues and Recent Developments.” Unpublished manuscript, Brandeis University. Lane, J., H. Broadman and I. Singh (1998) “Labor Flexibility, Ownership and Firm Performance in China,” Review of Industrial Organization (online journal). Lardy, Nicholas (1998) China’s Unfinished Economic Revolution. Washington, DC: Brookings Institution. Lichtenstein, Natalie (1993) “Enterprise Reform in China: The Evolving Legal Framework.” World Bank Working Paper Series 1198. Washington, DC: World Bank. Shleifer, Andrei and Robert W. Vishny (1997) “A Survey of Corporate Governance,” Journal of Finance, June: 737–83. State Statistical Bureau of China (1997) Statistical Yearbook of China. Beijing: State Statistical Bureau of China. Woo, W.T., W. Hai, Y. Jin and G. Fan (1994) “How Successful has Chinese Enterprise Reform Been?” Journal of Comparative Economics, 18: 410–37. World Bank (1996) China: Reform of State-Owned Enterprises. Report no. 14924–CHA. Washington, DC: World Bank. World Bank (1997) China’s Management of Enterprise Assets: The State as Shareholder. Washington, DC: World Bank.

6

China’s great leap of faith Telecommunications and financial services commitments Richard Janda and Men Jing

Introduction Perhaps the most remarkable breakthrough in the China WTO accession negotiations came with China’s acceptance of substantial liberalization commitments for telecommunications and financial services. In assessing these commitments, it is important to underline just how much of a sticking point this aspect of the negotiations had become. As late as 1998, Chinese negotiators were indicating that it was unrealistic to expect China to make any significant commitments respecting market access to telecommunications and financial services. Subsequently, China had shown only modest flexibility in considering some market access commitments in a strictly limited number of cities. Even later, in April 1999, when Premier Zhu Rongji visited Washington and when the contours of the ultimate November agreement had emerged, no elements of an agreement had been reached with respect to banking or securities. Concerning financial services, and banking and securities in particular, one can understand China’s reluctance. Foreign entry means a huge policy shift. Major currency reforms allowing for currency convertibility have yet to be undertaken. Policy lending, the system linking banks to the state plan, was abandoned only in 1998, and the four main state banks remain in a fragile financial position. Foreign banks are currently allowed to conduct foreign currency business only with foreign clients. The fledgling Chinese securities market still has no direct foreign participation of any kind in Chinese underwriting. Only the insurance market is in some measure open to Chinese business. But this is the case only in Shanghai and Guangzhou and only to a limited number of hand-picked foreign firms with handpicked Chinese partners operating in a limited range of industries. Chinese reluctance concerning telecommunications has similar elements to it. Current policy strictly forbids even indirect foreign investment in telecommunications carriers. Foreign entry is allowed only into value-added services. Currently there is no telecommunications law in place establishing anything like clear licensing conditions or a framework for regulatory oversight. And national security concerns have always lurked in the background of any discussion over telecommunications liberalization. These sectoral concerns are conjoined with the more general argument that China

China’s great leap of faith 67 is a developing country with a sovereign right to pursue its own regional, city-based path to development – an approach to market opening that has its roots in nineteenth-century Chinese practice. This practice includes discretion to approve numbers of entrants and who their partners will be. In the end, although China did succeed in preserving its regional liberalization approach over a short transitional period, its commitments to nationwide access by foreign service providers and to high levels of foreign equity participation represents a significant leap of faith. Other WTO members have tended to freeze in place existing levels of market access together with commitments to implement policy initiatives that were already under way. This has led some commentators to suggest that the WTO financial services and telecommunications protocols have achieved very little by way of new liberalization commitments.1 Indeed, the pace of domestic liberalization in countries like India, Korea and Thailand has outstripped WTO commitments, at least in the field of telecommunications.2 By contrast, the Chinese commitments surely cannot be characterized as modest or conservative. They greatly exceed the commitments made by developing countries and indeed most of those made by transitional economy countries. These commitments push China into uncharted territory and call for significant institutional transformation in the Chinese regulatory environment. They will put strong competitive pressure on existing state-owned telecom and financial service providers and, in principle, pave the way for a significant foreign presence in these key sectors. What, then, explains the remarkable – some might say inconceivable – reversal in China’s stance? In the first place, significant commitments on financial services and telecommunications quite simply became a major part of the price of WTO entry. Key US and EU firms were pushing for this result, and it is unlikely that permanent normal trading relations could have been achieved without such commitments. However, this explains only the persistence of the push on China without explaining why China was ultimately prepared to yield. The Chinese leadership obviously chose to use WTO entry not only to solidify existing reforms, but also as an engine for further and more dramatic reforms in the key financial services and telecommunications sectors. This is a clear sign that any residual temptation in China to pursue a policy of autarchy has been abandoned: global markets have overtaken the possibility of sustainable economic self-sufficiency. Of course, since China is making commitments when the implementation of some of the underlying legislative and policy frameworks have yet to be commenced – something almost unheard of in WTO negotiations – the question arises as to whether China has been pushed too far. Fundamental legislative measures, for example involving telecommunications, will have to be enacted. Longstanding discretionary administrative practices will have to be abandoned. Independent, transparent prudential regulatory oversight will have to be fashioned out of all but whole cloth. The main issues to which this gives rise are: first, what will be done to facilitate and monitor the implementation of China’s commitments over the six years following WTO accession; second, and closely related, whether the scope of China’s commitments places a heavy burden upon the WTO dispute settlement mechanism; third, whether high foreign percentage of equity participation in

68 Richard Janda and Men Jing Chinese service providers translates into high levels of managerial control; fourth, whether state-owned enterprises, particularly in the Chinese banking sector, will be strong enough to withstand foreign competition without a contagion of bankruptcy; fifth, whether increasing competition, notably with foreign-backed firms, will bring about modernization in China’s antitrust laws; and sixth, whether the proliferation of actors in the Chinese market will provide an impetus for change to internal policymaking processes? This chapter sketches out the existing regulatory environment in China, describes and characterizes the commitments China has made, and analyses the issues to which these commitments give rise.

CHINA’S TELECOM AND FINANCIAL SECTORS The Chinese telecommunications and financial services sectors have experienced rapid growth and the introduction of significant new competition during the 1990s. However, foreign service provider access to these markets has been severely restricted. Foreign participation in telecommunications services has been all but banned and foreign participation in financial services has been restricted according to the scope of product and geographic markets. With the conclusion of the China– US bilateral agreement on WTO accession, China has been pushed to accelerate the already considerable pace of its market reforms. What follows is a brief sketch of the state of competition in and foreign access to these service sectors.

The telecommunications sector China has been experiencing staggering growth in its telecommunications infrastructure, adding some 15 million new lines in 1999 – the equivalent of a US Baby Bell – and now has a total office telephone switchboard capacity in excess of 145 million lines, the second largest national fixed telephone network in the world, following that of the United States.3 The country has 70 satellite communications networks, 5,321 communications earth stations, and 10,000 one-way satellite stations. Growth in the cellular market has been phenomenal as well.4 The capacity of its mobile switching system has added up to 57 million lines. In one year, 1997, the market doubled to 13.6 million subscribers and now has over 30 million subscribers. The paging market is the largest in the world, with over 60 million subscribers. The number of Internet subscribers hit 7 million at the end of 1999, more than tripling in 12 months.5 Yet China’s national telephone penetration rate remains low, nudging 8 percent, although this rate has tripled in five years and the urban rate is significantly higher at 26 percent. Some 40 percent of Chinese villages do not have telephone access. The 1990s witnessed four main milestones in the liberalization and modernization of China’s telecommunications regulatory environment. First, in 1993 China Unicom, in which the Ministry of Electronics Industry (MEI) was the lead shareholder, was created as a competitor for China Telecom, itself reorganized as an

China’s great leap of faith 69 “independent business-accounting enterprise” operating under the auspices of the Ministry of Post and Telecommunications (MPT). At the same time, Ji Tong was created to compete in value-added services.6 After its creation, China Unicom was also licensed for international long-distance telecommunications service, and the operation of a GSM mobile network,7 formerly dominated by China Telecom.8 It has also gained the right to construct and operate the CDMA network in China.9,10 The two mobile networks extensively enhanced China Unicom’s role in the mobile market. In addition, China Unicom has recently started providing Internet services and become the fifth Internet provider in China.11 Second, in 1997, and with celerity that demonstrates the capacity of China to effect rapid change when it so decides, the Ministry of Post and Telecommunications created China Telecom (Hong Kong) (CTHK). The firm was established under the direct control of the MPT through an unlisted parent company, and was to serve as a “window company” to explore investment opportunities in Hong Kong for the cellular market on the mainland. The company was initially assigned the assets of the two largest provincial cellular networks under the control of China Telecom – Guangdong and Zhejiang – with the possibility of further asset injections in the future. The MPT agreed, in turn, that it would not participate in the provision of cellular service in any province where CTHK operates. Despite no shareholder role in controlling management, the initial public offering for CTHK, now listed on the Hong Kong and New York Stock Exchanges, raised US$4.2 billion even in the midst of the Asian financial crisis. In April 2000, CTHK purchased the China Telecom assets of Jiangsu, a third provincial cellular network. With this acquisition, CTHK now has over 30 percent of the cellular market in China. Further projected purchases of provincial networks could soon allow CTHK in effect to divest China Telecom of all of its cellular assets, paving the way for further reorganization of China Telecom. CTHK’s unlisted parent company, China Telecom (Hong Kong) Group, also holds 13 percent of Hong Kong Telecom. Third, in 1998, a major ministerial reorganization was effected, creating the Ministry of Information Industry (MII) by merging the MEI and MPT and functions for information and network management of the Ministry of Radio, Film and Television, China Aerospace Industry Corp and China Aviation Industry Corp. This paved the way for a more complete separation of the regulatory function from the service provider function. Previously, the MPT had championed its carrier, China Telecom, whereas the MEI had championed the carrier in which it was the lead shareholder, China Unicom. As concerns telecommunications, the main functions of the MII are to draft laws and regulations and to act as a regulator through licensing approval, tariff oversight, service quality oversight, maintenance of fair competition, and supervision of interconnection.12 However, one practitioner based in Beijing has described the current regulatory structure as an “odd mix of detailed regulations in certain areas, such as the Internet and paging, and the lack of a comprehensive and national telecoms law and governing regulations which address industry concerns.” The current absence of a telecommunications law – the MII had been considering a ninth draft bill – has left telecommunications policy directly in the hands of officials and has given rise to a complex patchwork of approaches to

70 Richard Janda and Men Jing services, standards and prices at the level of provincial telecommunications administrations. In principle, these come under the authority of the Ministry in Beijing, but in practice they have acted with considerable independence. The principal regulatory instrument in China’s telecommunications industry is not legal at all. It is merely an opinion of 1993 — the Opinion of the Ministry of Posts and Telecommunications Markets.13 Fourth, and most recently in 1999, in an effort to break China Telecom’s lock on the domestic telecommunications market, the Chinese government decided to split China Telecom into four companies, focusing respectively on paging service, mobile telecommunications, ground network and data business, and satellite telecommunications. Together with its Hong Kong-listed arm – CTHK,14 China Telecom had operated at least 90 percent of cellular and fixed-line networks across the country and dominated China’s fixed telephony market.15 The decision to break up China Telecom demonstrated MII’s independence from China Telecom. Furthermore, it has been MII’s policy to promote China Unicom’s role as a comprehensive basic telecommunications provider. Thus, the paging company separated from China Telecom was integrated into China Unicom, adding 13 billion yuan worth of assets and some 40 million subscribers – an eightfold increase in China Unicom’s existing subscribers.16 China Unicom has thus become the largest paging service provider in China’s domestic market. The Ministry of Railway, 17 the State Administration of Radio, Films and Television (SARFT), and others who possess networks have also been encouraged to enter into basic telecommunications market. China Netcom Corp (CNC), which provides network access and carrier-to-carrier services for China’s Internet service providers and large companies and is funded in part by the Ministry of Railways and the SARFT, has been recently approved to establish an Internet-based basic telecommunications network.18 The establishment of the CNC is hoped to restructure China’s telecommunications market and further challenge the existing big players. Another, perhaps surprising, but increasingly active player in the market is the People’s Liberation Army (PLA), which has been using both excess capacity on its own fixed telecommunications network and spectrum allocated for military purposes to offer services. Like China Unicom, the PLA has been exploring joint venture arrangements with foreign firms in its effort to establish a national CDMA mobile network. Foreign companies are allowed to provide value-added services over a network operated by a Chinese company. However, they are prohibited from offering international value added services. Given that the current regulatory regime bans direct foreign investment in ownership, operations and management of telecommunications networks, and given that China Telecom is barred from entering into joint ventures with foreign firms, China Unicom became the sole vehicle for foreign participation in the Chinese telecommunications market – and this very indirectly. 19 Foreign partners seeking to invest negotiated a predetermined rate of return with Unicom and then linked with a local partner in a joint venture. The joint venture then funded Unicom. These were so-called Foreign-Chinese-Chinese or F-C-C joint ventures, since the foreign entity cannot enter into direct partnership with the Chinese telecommunications operator. As of March 1998, 23 joint venture contracts

China’s great leap of faith 71 of this kind worth US$1.5 billion had been concluded with equipment sellers or operators for mobile networks. Yet even this practice was deemed by MII to run foul of Article V of the 1993 MPT Opinion, which banned all foreign joint ventures in public communications networks.20 In contrast to the cellular and fixed voice telephony markets, the pager market is currently open to domestic competition: 280 pager networks operate in 22 provincial capitals. There are thousands of small paging companies, many of them unlicensed to operate. China Telecom nevertheless has 75 percent of the market, followed by China Unicom, with 2 percent of the market. Foreign firms have done extremely well in selling pagers, with Motorola holding 30 percent of the market. There is now considerable speculation that China will hive off the paging operations of China Telecom and merge them with the paging operations of the provincial telecommunications administrations (PTAs) so as to create a new listed national paging company in advance of opening the market to foreign competition. As CTHK acquires cellular assets, China Telecom could be left only with its local and long distance fixed network, which in turn might be separated into different entities. Four service providers are currently authorized to offer Internet access in China, but they must use MII’s international gateways. Two provide commercial services: ChinaNet and ChinaGBN, which is operated by Ji Tong Corporation, formerly a subsidiary of the Ministry of Electronic Industry. Two are established for academic purposes: CERNET, which is supported by the State Education Commission and connects 100 key universities and colleges; and CASNET, which is operated by the Chinese Academy of Sciences and links approximately 100 science and technology research institutes nationwide. Sales of information technology products have been subject to successful foreign competition since Motorola’s initial sales of cellular equipment in 1986–7. However, some taxes and import duties have effectively required foreign firms to establish operations in China rather than simply to sell foreign manufactured products. Tariffs of between 6 and 30 percent now cover these products, and China has been pressured to conform to the WTO Information Technology Agreement, which provides for the elimination of such tariffs by the year 2000.

The financial sector China’s domestic banks In 1980, there were only two types of financial services transactions in centrally planned China – deposit and credit. Insurance was only for foreign transactions. Before 1979, China had what was essentially a monobank system run through the People’s Bank of China (PBOC).21 The PBOC combined central banking functions with commercial banking operations and embraced both government entities and individuals.22 Furthermore, the PBOC, as the state’s financial agent, was responsible for monitoring the implementation of state plans, and through its own credit plans, directed loans to priority sectors under the state plan.23 In the banking sector, the first modest steps toward reform of the monobank

72 Richard Janda and Men Jing system came in 1979. Two departments of the PBOC, the Bank of China (BOC) and the Agricultural Bank of China (ABC), were elevated to the status of independent banks, while the People’s Construction Bank of China – now the Construction Bank (CB) – was spun off from the Ministry of Finance.24 The BOC was to support China’s international links and, in addition to its general banking powers, was authorized to sell bonds on the international market. The ABC was to increase funds available for agricultural reform. The CB began to support new investment projects. A more significant change came in 1984, when the Industrial and Commercial Bank of China (ICBC) was created to take over all commercial banking business from the PBOC.25 This left the PBOC to assume the functions of a central bank: issuing currency; setting interest rates; supervising foreign exchange; and setting reserve requirements for other banks. The creation of a two-tiered system of state banks – the PBOC on the one hand and the four commercial banks on the other – was ultimately formalized in two pieces of 1995 legislation: the Central Bank Law and the Commercial Bank Law. Through the 1980s, the four state-owned commercial banks began to face greater competition, first from each other and then through the creation of new joint stock company banks and non-bank financial institutions. These new banks fall into two main groups: national commercial banks and regional commercial banks. The two largest national banks are the Bank of Communications (BOCom),26 the shares of which are held by the central government, local governments and enterprises, and the CITIC Industrial Bank, the shares of which are held by the China International Trust and Investment Company (CITIC) Group. Two smaller national banks, Everbright Bank and Huaxia Bank, are associated with industrial groups. A third, Minsheng Bank, is a private shareholding bank whose shareholders are drawn from the All-China Federation of Industry and Commerce.27 The regional commercial banks,28 which are supervised by local branches of the PBOC and have varying ownership structures, are subject to geographic restrictions on branching, although some, like the Merchants Bank and Shanghai Pudong Development Bank, operate almost on a national scale.29 Unlike the four state banks, the national and regional commercial banks are not obliged to extend “policy loans” pursuant to the state credit plan. Rather, under the terms of the Commercial Bank Law, they can make lending decisions according to economic criteria, although they are subject to influence by lead industrial group and government investors. Within a relatively short period of time, the new commercial banks have come to account for approximately one-quarter of banking assets.30 In principle, this left the PBOC in a strong position to enhance the efficient operation of the state-owned enterprises.31 However, since the credit plan was an aggregation of sectoral and local financing needs accumulated from the bottom up, there was an expansionary bias inherent in the system. By contrast, from their inception the four state banks were responsible for policy lending. In particular, SOEs were entitled to borrow from the state banks as required of their target without being restrained by interest rates and credit ceilings. Moreover, plans enabled loss-making SOEs to receive banking loans anyway. This impaired the PBOC’s ability to manage monetary policy.32 In addition, the loss-

China’s great leap of faith 73 making SOEs were not allowed to go bankrupt if they were not able to repay the loans.33 The exercise of policy lending has therefore allowed many money-losing SOEs to remain in business. Prior to 1996, 70 percent of bank loans were channeled to the state sector, which produced only some 34 percent of total industrial output.34 The large state banks have thus been saddled with a large portfolio of nonperforming loans.35 Various steps have been taken to release the state banks from policy lending and to relieve them of at least part of their burden of bad loans. In 1994, the Import and Export Bank of China, the State Development Bank of China and the Agricultural Development Bank of China were created as policy banks to free the four state banks from policy lending.36 Furthermore, the state credit plan was abandoned and the mandatory responsibility of the state banks for policy lending was completely abolished in 1998. Most recently, in 1999, the four state banks set up their own assetmanagement companies, which were funded by the Ministry of Finance, to take over a portion of the bad debts of the banks.37 The government has also made efforts to re-capitalize the four state banks. In 1998, the government issued a special treasurybond issue of 270 billion yuan to boost the capital adequacy ratio of the four state banks.38 Despite these efforts, it is generally acknowledged that the four state banks, which account for some two-thirds of financial institution assets in China, still face serious problems resulting from the accumulated debt associated with policy lending. China’s domestic insurance companies In the insurance sector, the first major reform initiative came with the resumption of the domestic insurance business in 1980. The state-owned People’s Insurance Company of China (PICC) was granted authority by the State Council to engage in the life and non-life insurance business.39 The PICC had a monopoly until 1988,40 when a second insurance company, Ping An Insurance Company of China, was established.41 From that date forward, competition has gradually expanded, with 29 insurance companies now operating in China. This includes 14 domestic insurers, 5 of which are state-owned and 9 of which are joint-stock corporations. In addition, in 1999 there were 11 branches of foreign insurance firms and 4 joint ventures.42 China’s insurance business has increased a thousand-fold since 1980. In 1998, China’s insurance companies did 124.7 billion yuan (about US$15 billion) worth of business and had 199 billion yuan worth of assets. Official Chinese statistics show that by the end of 1998, the proportion of Chinese people insured was 1.57 percent. Low as that number is, China nevertheless ranks as the fifth largest insurance market in the world. The average coverage is US$12 per person, ranking sixtieth in the world.43 This helps to put into context the enormous challenge facing Chinese reform of the social safety net. As pension and unemployment benefits are “socialized” so as to be decoupled from SOEs and made a state responsibility, China will also increasingly count on private insurance to add significant coverage. The insurance industry is under the supervision and regulation of the China Insurance Regulatory Commission (CIRC). Previously, the People’s Bank of China

74 Richard Janda and Men Jing was the only regulatory body governing all kinds of financial institutions in China. The PBOC had functioned as the supervisor and regulator of all insurance companies. Ironically, PICC was a ministry level institution and of a higher standing than its supervisors, the Department of Insurance under the PBOC. This had caused disorder in system management. It was not until the end of 1998 that CIRC was established to take over PBOC’s supervision and regulation rights for the insurance business. Currently, the CIRC is under the direct control of the State Council and has the same standing as the PBOC. PICC and other domestic and foreign insurance organizations in China all come under the CIRC’s jurisdiction. The Insurance Law of the People’s Republic of China was adopted in 1995 and applies to domestic insurance companies as well as branches of foreign insurance companies and Sino-foreign joint venture insurance companies. However, the latter two are also subject to specific regulations governing foreign financial institutions, which supercede the Insurance law when conflicts exist. The insurance law also provides that insurance firms can invest their money only in bank deposits, treasury bonds and projects approved by the State Council. They are not allowed to invest in the stock market.44 In 1996, the former monopoly insurance company, the PICC, restructured so as to operate through three separate subsidiaries: PICC Property Company, PICC Life Company and PICC Reinsurance company. The PICC was further restructured in early 1999 with the three subsidiaries becoming entirely separate entities. PICC Property took over the old name of PICC with a registered capital of 7.7 billion yuan (US$930 million), handling 80 percent of the property insurance market. The new PICC is a wholly state-owned commercial insurance institution. PICC Reinsurance has become China Reinsurance Company (CRC). PICC Life has become the China Life Insurance Company.45 China’s domestic securities industry The securities industry has been a more recent beneficiary of financial sector reform and is best described as a fledgling industry.46 The first step was the creation of the Shanghai and Shenzhen stock exchanges in 1990 and 1991 respectively. Public offerings listed on these exchanges have been chosen by the government not simply on the basis of strength of market demand, but also on the basis of regional quotas and general public policy objectives. The market is segmented: “A shares,” traded in China and available to Chinese purchasers, granting voting rights to elect the Board of Directors; “B shares,” traded in China and available to foreign purchasers, entailing no voting rights; and “H shares,” traded on foreign exchanges, also carrying no voting rights. In 1992, the State Council created the Securities Committee and China Securities Regulatory Commission which divide between them the task of securities supervision. Regulations have been promulgated governing stock issuance, bonds, stock exchanges and securities fraud, although there is as yet no comprehensive securities act. At present, China’s stock exchange trading system reaches all large and mediumsized cities with 2,412 retail branches all over the nation. By the end of 1998, the total

China’s great leap of faith 75 market capitalization was RMB 1,950.5 billion, equivalent to 24.46 percent of GDP; the outstanding capitalization RMB 574.5 billion, 7.2 percent of GDP; and the annual turnover was RMB 2,354.4 billion.47 Foreign participation In 1994, the rules allowing for the establishment of foreign financial institutions in China were promulgated in the Regulations Governing Financial Institutions with Foreign Capital (RFIFC.)48 According to the RFIFC, foreign financial institutions are allowed to operate in China through the following forms:49 ● ●

●

foreign bank branches solely foreign-invested subsidiary banks or finance companies incorporated by foreign capital with their head offices in China equity joint-venture banks or finance companies in between foreign financial institutions and Chinese financial institutions.50

The establishment of a representative office is the prerequisite for a foreign financial institution to operate in China through any of the three forms. Representative offices of foreign financial institutions are banned from doing business aimed at profit. They can only act as consultants, do liaison work, and conduct market investigations. The representative office is not allowed to operate any commercial business such as deposit-taking, lending etc.51 In order to establish a foreign bank branch or subsidiary, the foreign financial institution must have maintained a representative office in China for at least two years.52 However, an equity joint venture can be initiated once the foreign financial institution has a representative office in China (see Table 6.1).53 According to the RFIFC, the locations that foreign financial institutions are allowed to operate in China are determined by the State Council.54 To date, these institutions have been allowed into 23 cities and Hainan province.55 Foreign financial institutions are allowed to operate most banking businesses involving foreign currencies.56 However, their clientele is restricted to non-resident individuals, overseas non-bank clients and joint ventures. Except for several select foreign banks in Shanghai, Shenzhen and a number of southern and coastal provinces,57 foreign financial institutions are not allowed to carry on a domestic currency business.58 However, the fact that Chinese currency is non-convertible hampers competition in the domestic currency market (see Table 6.2).59 As of today, there are some 200 foreign financial institutions operating in 23 Chinese cities and Hainan province. 60 Despite the formal legal restrictions against it, the government has nevertheless authorized a number of foreign financial institutions to operate in the domestic currency business.61 The insurance market started opening up with the operation of American International Assurance Co. Ltd. in Shanghai on a trial basis in 1992. Since then, foreign insurance companies have been systematically setting up representative offices in Beijing, Shanghai, Guangzhou, Wuhan, Chengdu and Dalian. In the last

76 Richard Janda and Men Jing Table 6.1 Establishment: foreign financial institutions in China versus China’s commercial banks Solely foreign-invested bank/finance company ●

the applicant is a financial institution

●

the applicant has maintained a representative office in China for two years or longer

Foreign bank branch

Equity joint venture bank/finance company

China’s commercial bank

each partner to the joint venture is a financial institution ● the foreign partner has a representative institution in China

The establishment of commercial banks in China is subject to the “Company Law of the People’s Republic of China.”

The minimum registered capital: equivalent to RMB 300 million yuan; the paid-up capital shall not be below 50 percent of the registered capital

The minimum registered capital for setting up a commercial bank is RMB 1 billion yuan. The minimum registered capital for setting up an urban cooperative commercial bank is RMB 100 million yuan, and the minimum registered capital for setting up a rural cooperative commercial bank is RMB 50 million yuan. The registered capital should be the actually paid capital.

●

the total assets of the applicant at the end of the year prior to its application are not to be below US$10 billion ● there is a sound system for financial regulation and supervision in the home country or region of the applicant

the applicant has maintained a representative institution in China for two years or longer ● the total assets of ● the total assets of the the applicant at the foreign partner at the end of the year prior end of the year prior to the application to the application shall not be below are not to be below US$20 billion US$10 billion ● there is a sound ● there is a sound system for financial system for financial regulation and regulation and supervision in the supervision in the home country or home country or region of the region of the applicant applicant

The minimum registered capital: equivalent to RMB 300 million yuan; the paid-up capital shall not be below 50 percent of the registered capital

Its head office shall allocate a working capital: equivalent to no less than RMB 100 million yuan without any repayment or recompense

●

●

few years, they have focused business operations in Shanghai.62 Under Shanghai’s “Interim Measures for Foreign Insurance Institutions,” foreign companies are granted “super national” incentives: a 15 percent deduction of income tax and zero sales tax within the first five years in China. They are also subject to more flexible capital requirements than are domestic companies. A new law entitled “PRC

China’s great leap of faith 77 Table 6.2 Business scope: foreign financial institutions in China versus China’s commercial banks Solely foreign-invested financial institutions foreign bank branch

Joint venture financial institutions

Subject to the supervision and regulation of PBOC

China’s commercial banks

Subject to the supervision and administration of the PBOC in accordance with laws.a

The State Council determines the locations that are open to The establishment of foreign financial institutions commercial banks should go through the process of examination and approval by the People’s Bank of China ●

foreign currency deposittaking

●

absorb public deposits

issue short-term, mediumterm and long-term loans ● foreign currency bill● foreign currency bill● arrange settlement of both discounting discounting domestic and overseas accounts ● approved foreign exchange ● approved foreign exchange ● handle the discount of investment investment negotiable instruments ● foreign exchange remittance ● issue financial bonds ● foreign exchange guarantee ● foreign exchange guarantee ● issue, cash and sell government bonds as agents ● import and export ● buy and sell government settlement bonds as agents ● foreign currency dealing ● foreign currency dealing ● do inter-bank lending and and brokerage and brokerage borrowing ● exchange of foreign ● foreign exchange trust ● buy and sell per se or as currencies and bills business agents foreign exchanges denominated in foreign currency ● foreign currency credit card ● provide letter of credit (L/C) payment service and guarantee ● custody and safe-deposit ● handle receipts and box service payments and insurance businesses as agents ● credit verification and ● credit verification and ● provide safe boxes consultation consultation ● approved business ● approved business ● undertake other businesses activities in domestic activities in domestic approved by the People’s currency and other foreign currency and other foreign Bank of China currencies currencies ●

foreign currency lending

foreign currency deposit of US$100,000 in minimum for each deposit with a maturity of three months or longer ● foreign currency lending ●

●

78 Richard Janda and Men Jing Table 6.2 continued The foreign currency deposit-taking refers to the following deposits denominated in foreign currencies: ● inter-bank deposits both in China and abroad ● deposits taken from the non-bank clients located outside China ● deposits taken from foreigners in China ● deposits taken from overseas Chinese and compatriots from Hong Kong, Macao and Taiwan ● deposits taken from enterprises with foreign investment in China ● re-deposits as occurred as a reault of lending by financial institutions with foreign capital to non-enterprises with foreign investment ● other approved foreign exchange deposits

Business scope is to be defined in the articles of association of the banks and reported to the People’s Bank of China for approval

Note: a Article 10 of the Commercial Bank Law, online MOFTEC: http://www.moftec.gov.cn/moftec/official/ html/laws_and_regulations/finance6.html

Foreign Insurance Company Management Act,” drafted by CIRC, will soon come into force. It specifies the conditions for entry into the insurance market and will replace Shanghai’s “super national rights” with national treatment. By the end of 1998, 9 insurance companies from the United States, Canada, Japan, Switzerland, Germany, Britain, France and Australia had opened 12 business offices in Shanghai and Guangzhou. Another 113 foreign insurance institutions from 17 countries have set up 202 representative offices in the country, while 5 foreign companies have been approved to set up solely foreign-invested firms or joint ventures in China. CIRC has recently granted 4 more foreign insurance companies63 the access to the Chinese market.64 Currently, the number of foreign capital and joint venture insurance companies in China exceeds the number of Chinese ones and they have obtained certain market shares. But Chinese insurers still hold a lion’s share of the premium income. Of the RMB 124.73 billion yuan premium income on the Chinese market in 1998,65 foreign capital insurers grabbed only 6 percent. As concerns the securities industry, the current foreign entry regime is straightforward: Chinese underwriting, whether domestic- or foreign-currency denominated, is closed to foreign companies and foreign firms are not granted seats on the Chinese exchanges (see Figure 6.1). Notes to Figure 6.1 (opposite) a The Huatai Insurance Co. Ltd, the first Chinese shareholding property insurer, opened a branch in Shanghai on 19 November 1999. Huatai Insurance’s shareholders include more than 63 large state-owned enterprises, and that its premium income in 1999 reached 180 million yuan. The insurer’s total assets are now valued at over 1.6 billion yuan. Please see CEInet, “Huatai Insurance Opens Branch in Shanghai” (20 November 1998) online http://ce.cei.gov.cn/echn.htm. b Currently, foreign financial institutions are not able to establish solely foreign-invested insurance companies. This type of form exists only in principle. c Branches of foreign insurance companies provide commercial insurance service. So far, they are allowed to manage only property insurance service. There are, to name but a few, American International Assurance Company Ltd., Shanghai Branch, American International Assurance Company Ltd., Guangzhou Branch, AIU Insurance Company, Shanghai Branch, The Tokyo Marine and Fire Insurance Co. Ltd., Shanghai Branch, Winterthur Swiss Insurance (Asia) Company, Shanghai Branch, Royal & Sun Alliance Insurance Company,

Central Bank

People’s Bank of China (PBOC)

Other commercial banks

Commercial banks

State commercial banks

Agricultural Bank of China (ABC) Bank of China (BOC) Construction Bank of China (CBC) Industrial and Commercial Bank of China (ICBC)

National banks

CITIC Industrial Bank Everbright Bank China Investment Bank Bank of Communications (BOCom) Huaxia Bank Others

Regional banks

Merchant Bank Shanghai Pudong Development Bank Guangdong Development Bank Shenzhen Development Bank Fujian Xingye Bank Others

Policy banks

China Agricultural Development Bank State Development Bank Import and Export Credit Bank

Credit cooperative banks

Urban Credit Cooperative Banks Rural Credit Cooperative Banks

Non-banking financial institutions

Insurance Companies

State-owned

People’s Insurance Company of China (PICC) China Reinsurance Company (CRC) Ping An Insurance Company of China China Pacific Insurance Company Ltd. China’s Life Insurance Co. Ltd.

Non state-owned

PICC Property Company of China Hua Tai Property Insurance Company Ltd. a New China Life Insurance Company Ltd. Tai Kang Life Insurance Company Ltd. Tian An Insurance Company Ltd. of China Da Zhong Insurance Company Ltd. of China Sinosafe General Insurance Company Ltd. Yong An Property Insurance Company Ltd. Xin Jiang Agriculture and Construction Insurance Company of China

Foreignb

Branches, c Joint Ventures d and Representative Officese

Security firms Assets Management firms

Foreign financial institutions

d

e

China Cinda of the China Construction Bank China Oriental of the Bank of China Great Wall of the Agricultural Bank of China Hua Rong of the Industrial and Commercial Bank of China Representative offices Chinese–foreign joint-venture banks Foreign bank branches Solely foreign-invested banks (subsidiary banks)

Shanghai Branch, The Minan Insurance Company (HK) Ltd., Shenzhen Branch, The Minan Insurance Company (HK) Ltd., Hai Kou Branch, Zhong Hong Life Insurance Company Ltd. Joint ventures are allowed to manage life insurance service. They include Pacific and Aetna Life Insurance Company Ltd., Shanghai, Allianz-Dazhong Life Insurance Company Ltd., Pudong, Shanghai, AXA Minmetals Assurance Co. Ltd., Shanghai, Health Alliance Insurance Group and People’s Insurance (Life) Company of China. Sedgwick Insurance and Risk Management Consultants (China) Ltd., Employers Reinsurance Corporation (ERC), US based, Yasuda Fire & Marine Insurance Co. Ltd., Japanese, Chongqing representative office, Commercial Union Assurance Co. Ltd., Chengdu Office.

Figure 6.1 Structure of China’s current financial system.

80 Richard Janda and Men Jing CHINA’S COMMITMENTS After Premier Zhu Rongji’s visit to the United States in April 1999, telecom and financial services commitments remained significant issues of contention. Although the US side was in general “extremely pleased” by China’s April proposal during bilateral negotiations in the United States,66 as concerns telecom and financial services China’s apparent unwillingness to move beyond regionally limited market openings and the lack of clear commitments on allowable foreign investment thresholds had the makings of a log jam. In the April talks, for the first time China had indeed made commitments to open up its telecommunications sector.67 In some respects, China’s April telecom proposals appeared more aggressive than what was contained in the ultimate text of the Sino-US bilateral. In April 1999, according to the US summary, China was willing to allow 49 percent foreign investment in all services, with no timetable for implementation, and 51 percent foreign ownership for value added and paging services within four years of accession. In its ultimate commitments, China allowed 49 percent foreign ownership in mobile services within five years of accession; 49 percent in international and domestic land and sea (not mobile) services within six years; 49 percent in most other services upon accession; and 50 percent in valueadded services within two years. As concerns the financial sector, in April 1999 China offered the US access to insurance markets in key cities of priority to US interests within two to three years of accession. However, China’s ultimate commitments were to phase out all geographic restrictions. In April 1999, both the securities and banking sectors remained under discussion. In the end, China made substantial commitments to opening access to those sectors as well. It must therefore be acknowledged that the ultimate form taken by China’s commitments in the November 1999 bilateral agreement went very far in the direction of US demands. Although in each case the commitments have a transitional regional restriction, the phase-in periods never exceed six years. Some acceleration of these transition periods was achieved in the Sino-European bilateral, which also in some cases expanded upon China’s substantive commitments.68 Posttransition period foreign ownership restrictions vary from 49 percent to 51 percent. When benchmarked against the commitments made by other WTO members, China’s telecom and financial services commitments significantly exceed those of developing countries and compare favourably with those of transitional economy countries and developed countries (see Table 6.3).69

Telecommunications Value-added and paging services Foreign service suppliers will be able to provide the following services through joint venture enterprises:70 electronic mail, voice mail, online information and database retrieval, electronic data interchange, enhanced/value-added facsimile services

China’s great leap of faith 81 Table 6.3 Overview of China’s commitments 2000 Market access issue/product

Current conditions

Telecommuni- Closed to foreign cations investment.

Banking

Local-currency business with Chinese clients is prohibited.

Insurance

Foreign companies may operate only in Guangzhou and Shanghai.

Post-accession conditions

●

Regulatory principles: implementation of the Reference Paper on Regulatory Principles (including cost-based pricing, interconnection rights and the establishment of an independent regulatory authority.) Technology-neutral scheduling.

●

Geographic scope: all geographic restrictions for paging and value-added services phased out within two years of accession; mobile/cellular within three years (note: US bilateral was five years); and domestic wireline services within six years. Beijing, Shanghai and Guangzhou will open immediately on accession in all telecommunications services.

●

Investment: 49% foreign ownership in mobile services within three years of accession (note: US bilateral was five years); 49% in international and domestic land and sea (not mobile) services within six years; 49% in most other services upon accession; 50% in value-added services within two years.

Gain full market access within five years of accession. ● Be able to conduct local-currency transactions with Chinese enterprises two years after accession. ● Be able to conduct local-currency business with Narrow geographic Chinese individuals from five years after accession. ● Non-banks be able to conduct motor vehicle restrictions on where foreign banks finance upon accession without restrictions (note: may operate. US bilateral had been auto finance). ● Foreign banks will have the same rights (national Foreign financial treatment) as Chinese banks within designated institutions require geographic areas. approval – granted ● Geographic and customer restrictions will be on a discretionary, removed five years after accession. case-by-case basis – for new representative offices and branches. ●

Geographic scope: foreign property and casualty firms permitted to insure large-scale risks nationwide immediately upon accession, and all geographic limitations eliminated in three years.

Restrictive licensing ● Product scope: China will expand the scope of practices have limited activities for foreign insurers to include group, the number of foreign health, and pension lines of insurance, which

82 Richard Janda and Men Jing Table 6.3 continued Market access issue/product

Current conditions

insurers in China’s market to less than 20, and restricted each company to a narrow range of operations.

Post-accession conditions

represent about 85% of total premiums, phased in over three years (note: US bilateral was five years). Brokerage services are also covered (note: added in Europe bilateral). ●

Prudential criteria: China has agreed to reward licenses solely on the basis of prudential criteria, with no economic needs test or quantitative limits on the number of licenses issued.

Foreign companies must join with government-approved ● Investment: Life insurance: 50% foreign ownership in Chinese partners, and are unable to sell life insurance joint ventures. Life insurers will be group or pension able to choose their own joint-venture partners policies. with management control permitted (note: last element added in Europe bilateral). Non-life: Upon accession, China will allow the establishment of branches, or 51% ownership in joint ventures, and will permit the formation of wholly foreign-owned subsidiaries in two years. Reinsurance: Completely open to foreign providers upon accession. Brokerage: 50% foreign ownership upon accession, majority in three years, completely open in five years (note: added in Europe bilateral). Securities

Closed to foreign investment.

Foreign financial institutions will be allowed a 33% stake in fund management enterprises upon accession. The stake will rise to 49% after three Underwriting by years. ● Foreign underwriters will also be allowed to invest foreign banks of domestic securities up to 33% in joint ventures. and foreign-currency ● Joint ventures in which US firms have minority denominated stakes will be allowed to underwrite domestic securities is securities issues as well as underwrite and trade in prohibited. foreign-currency denominated securities (debt and equity); and will be allowed to engage in fund management on the same terms as Chinese firms. ●

Source: The White House Office of Public Liaison and http://www.uschina.org/public/wto/uscbc/ wtobilat.html (consulted 15 May 2000).

(including store and forward, store and retrieve), code and protocol conversion, online information and data processing (including transaction processing) and paging services. Foreign service suppliers may hold 30 percent foreign equity share upon accession, 49 percent after one year and 50 percent after two years. It is interesting to

China’s great leap of faith 83 note that neither the United States nor the EU was able to persuade China that the 50 percent equity level included permission of operation and management control. This is in contrast with the language that the EU successfully got included with respect to insurance services. Foreign service suppliers may provide services to Beijing, Shanghai and Guangzhou upon accession, to Chengdu, Chongqing, Dalian, Fuzhou, Hangzhou, Nanjing, Ningbo, Qingdao, Shenyang, Shenzhen, Xiamen, Xian, Taiyuan and Wuhan after one year, and nationwide after two years. Mobile voice and data services Foreign service suppliers will be able to provide all analogue/digital cellular services and personal communications services through joint venture enterprises. Foreign service suppliers may hold a 25 percent foreign equity share upon accession, 35 percent after one year and 49 percent after three years. The EU was able to negotiate a two-year acceleration of this transition period, as compared with the five-year transition agreed upon by the United States. Foreign service suppliers may provide services in and between Beijing, Shanghai and Guangzhou upon accession,71 with the area expanded to Chengdu, Chongqing, Dalian, Fuzhou, Hangzhou, Nanjing, Ningbo, Qingdao, Shenyang, Shenzhen, Xiamen, Xian, Taiyuan and Wuhan after one year, and nationwide after two years. The European Union was able to negotiate immediate access to the Beijing, Shanghai and Guangzhou inter-city markets. The US bilateral had specified only access to the intra-city markets. Domestic and international services Foreign service suppliers will be able to provide domestic and international voice, packet-switched data transmission services, circuit-switched data transmission services, and facsimile services through joint venture enterprises. International closed user groups voice and data services are also included. The EU was able to negotiate a specification that joint venture enterprises engaged in domestically leased circuit services will be allowed to establish their own independent network and to sell capacity to clients in China. The EU also negotiated an increase in the number of companies allowed into the international corporate communications market. Foreign service suppliers may hold a 25 percent foreign equity share three years after accession, 35 percent after five years and 49 percent after six years. Foreign service suppliers may provide services in Beijing, Shanghai and Guangzhou after three years, Chengdu, Chongqing, Dalian, Fuzhou, Hangzhou, Nanjing, Ningbo, Qingdao, Shenyang, Shenzhen, Xiamen, Xian, Taiyuan and Wuhan after five years, and nationwide after six years. As an ancillary matter, the EU also obtained a settlement of outstanding claims by Siemens Deutsche-Telekom, France Telecom and Telecom Italia regarding their aborted joint venture with China Unicom.

84 Richard Janda and Men Jing Internet and satellite services Internet and satellite services are included, but not explicitly scheduled, following the scheduling convention of most WTO members, including the United States. Internet services are subsumed under value-added services. For satellite services, China has attached to its services schedule and signed the “Notes for Scheduling Basic Telecom Services.”72 This means unless explicitly excluded in China’s sectoral column, any basic service may be provided through any means of technology (e.g. cable, wireless, satellites). Access to international services All international telecommunications service suppliers shall be licensed by China’s telecommunications authorities, which will act as an independent regulatory authority. The decisions and procedures used by regulators shall be impartial with respect to all market participants. Other commitments China has agreed to undertake all the obligations contained in the WTO Reference Paper on Regulatory principles. This entails, in particular, that China has committed to non-discriminatory interconnection at any technical feasible point subject to transparent arrangements and dispute settlement through an independent domestic body. Furthermore any licensing requirements must be transparent and the regulator body must be independent. China also made commitments in accordance with the Notes for Scheduling Basic Telecom Services and Market Access Limitations on Spectrum Availability.73

Financial services Financial services licenses As a general matter, criteria for authorization to deal in China’s financial services sector are solely prudential and contain no economic needs test or quantitative limits. This is specified both in Part A of the Financial Services Schedule (Insurance) and in Part B (Banking and Other Financial Services). Banking and finance company licenses Any existing non-prudential measures restricting ownership and juridical form shall be eliminated within five years. Foreign financial institutions having more than US$10 billion in assets will be allowed to establish bank or finance company subsidiaries or a Chinese–foreign joint bank or joint finance company. Foreign financial institutions with more than US$20 billion in assets will be allowed to establish foreign bank branches.74 Foreign financial institutions that have had business operations in China for at least three years and have been profit-making for

China’s great leap of faith 85 the previous two years will be allowed to conduct local currency business. Banking services Banking services are broadly defined to include deposit-taking, lending, financial leasing, payment services, guarantees and commitments. However, financial leasing will be allowed for foreign-owned banks only when allowed for domestic banks, which is currently not the case.75 Cross-border supply of services is unbound except for provision and transfer of financial information and financial data processing, and advisory, intermediation and other auxiliary financial services. China will expand the scope and geographic opportunities for foreign banks to conduct local currency business. Product scope Upon accession, foreign financial institutions are allowed to perform all types of foreign currency business to all types of clients. Local currency business with foreign clients will be permitted upon accession, with Chinese enterprises two years after accession, and with Chinese individuals five years after accession. Geographic scope Upon accession, there are no geographic restrictions upon foreign currency business. Local currency banking will be permitted in Shanghai, Shenzhen, Tianjin and Dalian upon accession, Guangzhou, Qingdao, Nanjing and Wuhan one year after accession, Jinan, Fuzhou, Chengdu and Chongqing two years after accession, Kunming, Beijing and Xiamen three years after accession, Shantou, Ningbo, Shenyang and Xian four years after accession, and nationwide five years after accession. In the Sino-US bilateral, Zhuhai, which holds several EU banks, had been listed among the cities slated for market opening three years after accession. The EU succeeded in negotiating an acceleration of that timetable. Motor vehicle finance Currently, only certain Chinese banks are authorized to conduct auto financing and only for certain vehicle models. Upon accession, distributors and other non-bank financial institutions will be permitted to provide motor vehicle financing without any market access or national treatment limitations. The EU succeeded in expanding the scope of China’s auto financing commitments under the Sino-US bilateral to include all motor vehicles. Insurance services Insurance services are defined to include life, health and pension and annuity insurance, non-life insurance, reinsurance, and services ancillary to insurance including brokerage services. Cross-border supply of insurance services is unbound

86 Richard Janda and Men Jing except for international marine, aviation and transport insurance, as well as reinsurance services and brokerage services. The EU succeeded in extending the definition of insurance to include brokerage services, including brokerage of largescale commercial risk and reinsurance, and to insist on access for cross-border brokerage services. Non-life insurance Upon accession, foreign non-life insurers will be permitted to establish branches and joint-ventures with a 51 percent equity share. Wholly owned subsidiaries will be permitted within two years from the date of accession. Upon accession, foreign service suppliers will be permitted to provide master policy and/or large-scale commercial risk insurance (i.e. an insurance company headquartered in city X can provide nationwide coverage for a corporation headquartered in city Y or with multiple operations throughout China); insurance for enterprises located abroad, property insurance, related liability insurance and credit insurance for foreigninvested companies. Within two years from the date of accession, foreign service suppliers will be permitted to provide the full range of non-life insurance services to both Chinese and foreign clients. The EU succeeded in negotiating a two-year acceleration of this timetable as compared with that in the Sino-US bilateral. Life insurance Upon accession, joint ventures will be permitted with a partner of choice at 50 percent equity share. The EU succeeded in stipulating that the 50 percent equity share could entail effective management control by the foreign partner and would be free from regulatory interference in the privately negotiated contract. Upon accession, foreign service suppliers will be able to provide individual (not group) policies to both foreign and Chinese clients. Within two years from the date of accession, foreign service suppliers can provide health insurance to foreign and Chinese clients. Within three years, foreign service suppliers can provide group policies, pension, and annuities to both foreign and Chinese clients. The EU succeeded in negotiating a two year acceleration of this timetable as compared with that in the Sino-US bilateral. Reinsurance Upon accession, the cross-border provision of reinsurance, as well as investment as a branch, joint-venture or wholly owned subsidiary, without geographic or quantitative limitations. Brokerage The EU succeeded in negotiating a right of establishment of foreign brokerage firms based on 50–50 joint venture agreements upon accession, foreign majority within three years of accession, and no equity limits within five years of accession.

China’s great leap of faith 87 Insurance geographic restrictions Transitional geographic restrictions apply to life and non-life insurance. Shanghai and Guangzhou open upon accession. Within two years from the date of accession, foreign service suppliers can establish in Beijing, Chengdu, Dalian, Chongqing, Fuzhou, Suzhou, Xiamen, Ningbo, Shenyang, Wuhan and Tianjin. All geographic restrictions will be phased out within three years of accession. As compared with the Sino-US bilateral, the EU succeeded in accelerating access to Shenzhen, which had been on a two-year timetable, and Foshan, which had been on a three-year timetable. Securities and asset management services As a general matter, China took a more restrictive approach to securities services than it did to other financial services. Thus, it was unbound with respect to crossborder services except with respect to allowing foreign securities dealers to deal directly in “B shares,” which are already designated for foreign trading. Foreign securities institutions will be permitted to deal directly in “B shares” without a Chinese intermediary upon accession. Also upon accession, representative offices of foreign securities institutions will be eligible to become “Special Members” in all Chinese stock exchanges. Three years after accession, foreign institutions will be permitted to establish joint ventures to underwrite “A,” “B” and “H shares” and corporate and government debt, and to trade in all these securities except “A shares.” Foreign participation will be restricted to 33¹/³ percent. In addition, three years after accession foreign institutions will be permitted to establish joint ventures to conduct domestic securities investment and to manage assets. Foreign participation in the latter businesses will be restricted to 49 percent. Other financial services Upon accession, China will permit, both through cross-border service provision and via commercial presence, the provision of financial information, data processing and advisory services, such as portfolio research and corporate restructuring services. China has agreed to grant licenses on a prudential basis, without numerical restrictions or discretionary economic needs tests. Companies can obtain a license if they have more than thirty years of experience in a WTO member country; a representative office established in China for two consecutive years; and global assets of more than US$5 billion.

Summary In most cases, the technique through which the accession agreement became possible was the two pronged combination of transitional city-specific market opening with the channeling of foreign investment through joint ventures, having caps on foreign equity participation. This allowed China to maintain its insistence upon a regional economic development strategy at least for brief period, typically five years. Although the transitional city-specific market access approach leading

88 Richard Janda and Men Jing ultimately to nationwide access is novel from the WTO standpoint, and arguably problematic from the standpoint of Articles I, XVI and XIX of the GATS, it was a way of “squaring the circle” of Chinese policy with WTO rules.76 China’s willingness to accept foreign–Chinese joint ventures as the investment vehicle of choice represents a significant transformation of her economic policy. As noted previously, China had been reluctant heretofore to accept even so-called F-C-C joint ventures that did not allow for direct foreign participation in local business instead only creating the possibility of passive investment. China has in effect leapfrogged other WTO countries, like India, which have restricted the number of foreign joint ventures on the basis of need. China has formally abandoned efforts to restrict the numbers of foreign players and has paved the way for a shift from passive to active investment. China’s initial concerns about national security in the telecommunications field were apparently overcome by the recognition that the technique of foreign–Chinese joint ventures, coupled with the national security exceptions in the GATS, would allow adequate oversight of the publicly switched telephone network. Foreign bank access to the Chinese local currency business is perhaps the greatest leap of faith taken by China in trade in services. At a time when the Chinese banking system is going through major restructuring, foreign bank access will itself become an engine for change. The foreign joint venture technique may then become the way of injecting new capital into domestic banks improving the overall soundness of the financial system.

POST-ACCESSION ISSUES Six post-accession issues deserve to be underlined by way of conclusion to this chapter: ● ● ● ●

● ●

the facilitation and monitoring of implementation potential burdens upon the dispute resolution process managerial control of foreign–Chinese joint ventures the impact of foreign entry on SOEs in these sectors (notably the Chinese banking sector) the need to modernize Chinese competition law pressure to change policy-making processes in China.

Facilitation and monitoring of implementation Because Chinese accession is in this respect fundamentally different from the pattern of commitments through the Uruguay Round, it is surprising and probably unfortunate that, beyond the phasing in of market access commitments, no framework of milestones for implementation was established. The focus in negotiations was apparently on prying the most out of China without much attention being given to how China would deliver on what it promised. The initial annual reviews through the Trade Policy Review Mechanism will provide occasions for discussion but not much in the way of a clear agenda for action.

China’s great leap of faith 89 As concerns regulatory independence, China’s most ambitious commitment is the implementation of the Reference Paper on Regulatory Principles. The Ministry of Information and Industry, though functionally distinct now from China Telecom, has yet to assume the role of a regulatory agency and is operating in the absence of any regulatory regime. It, or its successor, will now be charged with overseeing costbased pricing, non-discriminatory observance of interconnection rights, transparent licensing, and independent regulatory decision-making. By contrast, the commitment to engage in solely prudential regulation under the Annex on Financial Services, though requiring a change in institutional practice and orientation, will at least be layered onto existing regulatory agencies. The ambition of the telecom commitments to the Reference Paper is highlighted by the fact that India, which has in place an independent two-tiered Telecommunications Regulatory Authority of India and a strong tradition of judicial review, has made much more cautious and circumscribed commitments to the reference paper principles! This is because India’s Department of Telecom (DoT) and its Mahanagar Telephone Nigam Ltd (MTNL) remain government owned and operated service providers. For the time being, Chinese telecoms are also government owned and operated.

Potential burdens upon the dispute resolution process If China is to fulfill its commitments in the near term, before a full-fledged legislative and regulatory framework can be established, Chinese courts will have to develop a judicial review doctrine to control the arbitrary use of administrative discretion and failure to comply with WTO obligations. There will inevitably be a dangerous temptation within China to implement changes only after the WTO dispute resolution process has signaled problems. But this will only anger investors and be calculated as a factor of increased country risk. Indeed, what one might term “implementation through WTO dispute resolution” could clog the WTO system and undermine the functioning of the Dispute Settlement Body (DSB). Thus, it will become important for Chinese courts to play a role in mandating WTO-consistent policies and institutional changes so as to foreclose disputes.

Managerial control of foreign–Chinese joint ventures One example of an issue that seems destined to give rise to disputes is the management control of joint ventures. Although pushed to specify in a number of instances that foreign ownership stakes could entail management control, China was prepared to specify this only with respect to life insurance joint ventures as a concession to the EU. Is one to infer that management control is otherwise subject to Chinese discretion? According to Art. 4 of the Equity Joint Venture Law, if the foreign partner names the Chair of the joint-venture then the Chinese partner names the Vice-Chair, or the other way around as the case may be. All “major decisions” are to be made according to “equality and mutual benefit.” Although this provision does not rule out the possibility of foreign management control, it can be used so as to make such control difficult to exercise. More speculatively, would it be consistent

90 Richard Janda and Men Jing with Chinese commitments to provide, for example, that telecom and financial services joint ventures could only be carried out with a proportion of the equity stake held only in “B” and “H shares,” which do not entitle holders to vote for the Board of Directors? It is worth noting that India, which has allowed for 49 percent foreign ownership of telecoms, permits these stakes to be held through a holding company that exercises control.

Impact of foreign entry on SOEs in these sectors Foreign entry into the Chinese market will have a complex set of consequences for state-owned enterprises. In some cases, it can be anticipated that restructuring SOEs will take advantage of their incumbent status and market power to outperform new entrants with foreign partners. In other cases, some SOEs may themselves find foreign partners who will assist them in restructuring and even to privatization. In a third class of cases, some SOEs may be outperformed by new entrants and face insolvency. In can be anticipated that some combination of each of these cases will indeed arise. The most problematic situation is the banking sector. Here, foreign entry through subsidiaries or branches will mean that investment in SOEs need not be the vehicle of entry of choice. Although the four main state commercial banks do currently enjoy a dramatic advantage with their branch networks, they also face a high burden of bad debt. The question remains as to whether these banks will be deemed too big to fail by state authorities and whether that will place unacceptable pressures on the national treasury and the financial system.

Need to modernize Chinese competition law Although the General Agreement on Trade in Services has no formal requirement that countries implement competition law principles – Arts. VIII and IX simply require that countries regulate the abuse of monopoly power and coordinate and consult on competition law matters – the restructuring of SOEs and the proliferation of foreign firms and joint ventures will create pressure on China to modernize its competition law and to establish a truly independent competition authority. The Reference Paper on Regulatory Principles governing the telecommunications sector, adopted by China, requires policing of the abuse of dominant position notably with regard to anti-competitive cross-subsidization and interconnection. Whereas China’s Law to Counter Unfair Competition of 1993 provides the rudiments of an antitrust framework and applies directly to state-owned monopolies, it does not yet constitute a comprehensive legislative regime including independent agency oversight. The process of adopting new legislation, now being considered by the Chinese government, will have to be accelerated to reinforce and channel sectoral regulatory policies for telecommunications and financial services. Indeed, China may want to improve antitrust oversight so as to address mergers with foreign firms and the abuse of dominant position by foreign firms.

China’s great leap of faith 91

Pressure to change policy-making processes It bears underlining that Chinese concessions in telecommunications and financial services demonstrate an unprecedented willingness on China’s part to negotiate its internal policies with its international partners. While this is characteristic of WTO membership, it is a dramatic departure from China’s previous policy stance. The relinquishment of the state’s monopoly on managing the pace of change could signal a more important transition in the nature and exercise of sovereignty in China. Sovereignty is perhaps the most delicate subject of discussion in China, and there certainly will be no official acknowledgement that sovereignty is undergoing a change with WTO accession. But China’s full participation in modern networked economies and the ascendancy of trade policy over defence policy – demonstrated neatly by China’s abandonment of the national security argument against telecom liberalization – will transform national control over policy-making in China as it has elsewhere. WTO entry could indeed mark a shift in China toward assuming the role of the state as an intermediary in the negotiation of internal and external policy outcomes among governments, market actors and ultimately actors in civil society as well. Such a shift could also allow China to become a leading policy intermediary in the world economy.

Conclusion According to a story from The Hundred Words Sutra in Analogies dating from the Qi dynasty (AD 402–589), a wealthy man, having seen a magnificent new three-story castle near his village, sought out the architect who had built it and commissioned him to build another just like it – but only the third floor. When the architect objected that he could not build the top of the castle without its base, the wealthy man was angered, saying he did not intend to use the first and second floors and only wanted the third. There is a sense in which China’s wealthy trade partners, full of admiration for the edifice of liberalization, have asked China to build open markets without the foundation of independent regulatory oversight being in place. As it enters the WTO, has China been asked to build a castle in the air? China’s judicial system will be an early testing ground for the implications of WTO accession, with telecommunications and financial services commitments among the most important potential source of disputes. For example, what will happen when a foreign-backed telecom joint venture faces difficulty in securing local right of ways or obtaining interconnection with the incumbent carrier? Even assuming that state authorities will attempt to smooth the way for foreign investors and will no longer attempt to impose joint-venture partnerships or restrict the geographic scope of operations, the absence of a telecommunications law – which is unlikely to be ready soon after accession – means that courts will be called upon to adjudicate. Will the judiciary attempt to enforce WTO commitments or wait for the People’s Congress to enact those commitments in detail? In the face of uncertainty in China as to whether WTO commitments are selfexecuting, and in the face of a massive legislative reform agenda that cannot be

92 Richard Janda and Men Jing completed simultaneously with accession, the prudent course for China would be to give legal effect to China’s commitments as part of internal law. This would allow the judiciary to review the exercise of administrative discretion for consistency with China’s international obligations. As China adopts specific legislative and regulatory dispositions to give effect to its commitments, those dispositions could displace more open-ended judicial review. Indeed, individual judicial decisions could signal the need for prompt legislative clarification. If the judiciary is unable to take up this role, the WTO’s DSB will be overburdened with litigation involving China, resulting in the shying away of investors. This will give rise to disappointment inside and outside of China as the benefits of market opening fail to materialize. Empty commitments will look like a castle in the air. If, on the other hand, the judiciary does take up this role, the necessity of which many Chinese judges seem to acknowledge, there will be pressure to ensure that the Chinese judicial system itself becomes more transparent and independent. While great strides in that direction have been taken in recent years, much remains to be done to ensure the absence of political interference, notably through the control of judicial committees within each level of court, and to grant full security of tenure to professional judges.77 China’s judiciary could also play a critical role in ensuring that significant foreign equity interests translate smoothly into managerial control without a spate of disputes among joint-venture partners. If WTO accession is accompanied by significant institutional change, including changes to the role and function of the judiciary, China may be on the path toward prosperity. It will have deepened its commitments to using international norms to restore domestic law and will have become embedded in networks of global governance. If this can be accomplished, far from building a castle in the air, China will have built a remarkable monument to international trade.

Notes 1 See, for example, W. J. Drake and E. M. Noam, “Assessing the WTO Agreement on Basic Telecommunications,” in G. C. Hufbauer and E. Wada (eds) Unfinished Business: Telecommunications after the Uruguay Round, Washington, DC: Institute for International Economics, 1997, at 27–61. 2 See R. Janda, “Benchmarking a Chinese Offer on Telecommunications,” (1999) 2 International Journal of Communications Law and Policy IJCLP Web-Doc 6–2–1999 available at http://www.digital-law.net/IJCLP/2_1999/ijclp_webdoc_6_2_1999.html. 3 MII, “China’s Telecommunications in 50 Years” (August 1999) in Chinese, online MII: http://www.mii.gov.cn/dx50/dx00.htm. 4 CEInet, “China Developing Radio-Technology” (30 June 1999) online: http:// ce.cei.gov.cn/efor.htm. 5 Data from the MII Statistics online http://www.mii.gov.cn. See also “Beijing to Open Sector Earlier Than Promised,” South China Morning Post Internet Edition (6 January 2000) online http://www.scmp.com. 6 For details on the creation of Ji Tong and China Unicom, see M. Mueller and Z. X. Tan, China in the Information Age: Telecommunications and the Dilemmas of Reform, Westport, CT: Praeger, 1997, at 49–53. See also C. O. Long, Telecommunications Law and Practice, 2nd edn. London: Sweet & Maxwell, 1995, at 363–4.

China’s great leap of faith 93 7 GSM stands for Global System for Mobile Communications. Originally it was called Group Speciale Mobile. It is a European digital cellular: see B. A. Petrazzini, Global Telecom Talks: A Trillion Dollar Deal, Washington, DC: Institute for International Economics, 1996, at 95. 8 That is expected to bring China Unicom 12 percent of the mobile market by the end of this year. See CEInet, “China Unicom Approved to Operate GSM Service Nationwide” (3 November 1998) online http://ce.cei.gov.cn/echn.htm. 9 CDMA stands for Code Division Multiple Access, which is an American digital cellular. 10 The CDMA network was expected to reach the capacity of 10 million subscribers covering 250 cities by the end of 2000. At present, the capacity of China Unicom’s mobile switching systems reached 5.42 million lines that has settled in 99 cities and with accumulated number of the network users exceeding 1.6 million. See CEInet, “China Unicom Licensed to Build, Operate CDMA Network” (16 June 1999) online http:// ce.cei.gov.cn/echn.htm. 11 The other four IP are CSTNET, ChinaNet, CERNET and China Golden Bridge Network (ChinaGBN). China Unicom will be under the name of UNINET. It was expected to cover 100 cities before the end of 1999 and most of China’s local networks by 2000. But dial-up service has not yet been on its agenda. See CEInet, “China Unicom to Provide Internet Service” (16 June 1999) online http://ce.cei.gov.cn/echn.htm. 12 MII Web site online http://www.MII.gov.cn. 13 It was approved by the State Council, China’s cabinet level organization of executive branch of government, on 3 August 1993. 14 China Telecom (Hong Kong) was created under the former MPT in 1997, to explore investment opportunities in Hong Kong for the cellular market on the mainland. See Richard Janda, “Benchmarking a Chinese Offer on Telecommunications: Context and Comparisons” (1999) 2 International Journal of Communications Law and Policy IJCLP WebDoc 6–2–1999 available online: http://www.digital-law.net/IJCLP/2_1999/ijclp_ webdoc_6_2_1999.html. See also Andrew Chetham, “CTHK Set to Continue March into Provinces,” South China Morning Post Internet Edition (11 June 1998) online http:// www.scmp.com. 15 Only recently China Unicom was authorized to start a trial of fixed telephony business in three cities – Tianjin, Shenzhen and Chongqing. See CEInet, “China Unicom Expanding Quickly” (31 May 1999) online http://ce.cei.gov.cn/echn.htm. 16 The Guoxin Paging Co., Ltd. was established on the basis of tens of paging service providers affiliated to the former MPT. It was a part of China Telecom services before the split of China Telecom at the end of 1998. Owning 39.55 million subscribers, it was the largest paging service operator in China and clinched three-fifths of the domestic market. With 13 billion yuan in total assets and 7 billion yuan in net assets, the company raked in more than 8.36 billion yuan in main operating turnover and 1.45 billion yuan in profits last year. Its turnover in the first quarter of 1999 reached 2.25 billion yuan, tripling the turnover of China Unicom in the same period. After the split of China Telecom, Guoxin Paging was merged in China Unicom. CEInet, “China Unicom Expanding Quickly” (31 May 1999) online http://ce.cei.gov.cn/echn.htm. 17 The Ministry of Railway itself has a complete nationwide network that consists of 120,000 kilometers of telecommunications lines, 66,000 long-distance lines and 4,593 kilometers of digital microwave lines. The railway network is second only to China Telecom. However, it has a capacity of only 1.5 million lines, 1 percent of China Telecom’s capacity. So far, It has provided channels for China Unicom’s GSM cellular phone system and other services for China Ji Tong. See X. W. Wang, “Telecommunications: Three New Challengers for China Telecom,” South China Morning Post Internet Edition (27 May 1999) online http://www.scmp.com. 18 SCMP, “Mainland Sets Launch of Third Telecoms Giant,” South China Morning Post Internet Edition (20 September 1999) online http://www.scmp.com. CEInet, “Another Telecom Basic-Service Giant Emerges” (30 April 1999); see also “China Set for Third Major Telecom Company” (21 April 1999) online http://ce.cei.gov.cn/.

94 Richard Janda and Men Jing 19 MOFTEC, “Catalogue for the Guidance of Foreign Investment Industries” (20 June 1995) online http://www.moftec.gov.cn/moftec/official/html/laws_and_regulations/ investment25.html. 20 State Council document, 1993 Regulation 55, State Council approves MPT proposal regarding further strengthening regulation of the telecommunications markets. On the position taken by MII, see CEInet, “China Unicom Investigation Favorable to Investors: MII” (5 February 1999), see also “China Unicom Under Investigation” (29 December 1998) online http:// ce.cei.gov.cn/echn.htm. 21 The People’s Construction Bank of China, which was at one stage an entity within the PBOC, was nevertheless at some points a separate banking unit. Furthermore, there was a network of rural cooperatives. See Nicholas R. Lardy, China’s Unfinished Economic Revolution, Washington, DC: Brookings, 1998, at 59–63. Prior to 1949, there were a number of financial institutions and financial markets in China. After the Chinese Communist Party adopted the centrally planned economy, the PBOC was designed as a monobank. Old financial institutions were either confiscated or nationalized, and were merged with the PBOC. Financial markets were closed and financial instruments were prohibited. For a historical review of China’s financial sector before 1979, see C. R. Dipchand, Y. C. Zhang and M. J. Ma, The Chinese Financial System, Westport, CT: Greenwood, 1994, at 1–18. See also J. L. Wu, “China’s Economic and Financial Reform,” in O. K. Tam (ed.) Financial Reform in China, London and New York: Routledge, 1995, 83 at 85. 22 At that time, the government was the main saver and investor. On the eve of the reforms in 1978, household savings accounted for only 3 percent whereas the state budget accounted for 46 percent of total national savings. See J. C. H Chai, China: Transition to a Market Economy, Oxford: Clarendon, 1997, at 118. See also J. L. Wu, op. cit. 23 See generally C. Holz, The Role of Central Banking in China’s Economic Reforms, Ithaca, NY: East Asia Program, Cornell University, 1992, at 38–52. 24 Under the monobank system, the BOC and the ABC were then two departments under the auspice of the PBOC, while the PCBC was an agent of the Capital Construction Finance Department of the Ministry of Finance (MOF). For a detailed introduction to the BOC, ABC and PCBC, see C. R. Dipchand, Y. C. Zhang and M. J. Ma, op. cit., at 56–68. 25 The ICBC is the largest commercial bank in China. It lends loans to the state-owned commercial and industrial enterprises. 26 The Bank of Communications is now the fifth largest bank in China, next to the four state banks. It was first set up in 1908. In the old China, it was one of the currency-issuing banks. After the liberation in 1949, it was restructured by the PBOC. It functioned as a public-private operated bank until 1958, when its business was taken over by the PBOC and the BOC. Its Hong Kong office remained under the supervision of the BOC. The BOCom was reestablished as a national commercial bank in 1987. For an introduction to the BOCom, see C. R. Dipchand, Y. C. Zhang and M. J. Ma, op. cit., at 73–82. 27 See N. R. Lardy, op. cit., at 69. 28 The major regional banks are China Merchants Bank, Guangdong Development Bank, Shenzhen Development Bank, Fujian Xingye Bank, Shanghai Pudong Development Bank, Hainan Development Bank, Yantai Housing Bank and Bengbu Housing Saving Bank. 29 See Lardy, op. cit., at 70–71. 30 “In 1996, the top six new commercial banks had grown about 28 percent in both loans and deposits, while state-owned banks achieved only about 21 percent growth . . . In terms of loans, figures are probably higher, in deposits, probably lower: new commercial banks alone account for about 15–20 percent of loans but only 8–10 percent of deposits.” R. Stride and G. Gaeta, “Sector Must Tread a Rocky Path to Reform,” South China Morning Post Internet Edition (14 May 1998) online http://www.scmp.com (consulted 19 January 1999). 31 See P. Bowles and G. White, The Political Economy of China’s Financial Reforms: Finance in Late Development, Boulder, CO: Westview Press, 1993, at 55–68.

China’s great leap of faith 95 32 See H. Mehran and M. Quintyn, “Financial Sector Reforms in China” (March 1996) online: Finance & Development http://www.worldbank.org/fandd/english/0396/articles/ 040396.htm. 33 “If the enterprises was unable to repay the loans, it would not be allowed to go bankrupt.” P. Bowles and G. White, op. cit., at 62. 34 “China: A Funny-Looking Tiger,” The Economist (17 August 1996) at 18. 35 There is no clear information on the amount of non-performing loans in China. The PBOC estimated that bad loans were 2.9 percent of the assets in the banking system at the end of 1999. If non-performing and delinquent loans are added, official figures are about 20 percent. Some foreign estimates top out at 70 percent. The consensus of foreign estimates remains at about 40 percent. See G. Chang, “Big Four Banks Bleeding But Far From Deathbeds,” South China Morning Post Internet Edition (9 September 1999) online http://www.scmp.com. According to Moody’s Investors Service, the mainland’s banks could have an estimated 30 percent of total loans. See Bloomberg, “Rule Change Poised to Produce Bad-Loan Surge,” South China Morning Post Internet Edition (26 August 1999). A conservative estimation by Standard & Poor’s revealed that non-performing loans in China’s banking system amounted to US$200 billion at the end of 1997. See P. Chan and M. O’Neill, “Asia Woes Spur Beijing To Act,” South China Morning Post Internet Edition (14 May 1998) online http://www.scmp.com. 36 Currently, the three policy banks have a loan portfolio roughly equivalent to 6 percent of the big four banks. See R. Stride and G. Gaeta, op. cit. 37 They are China Cinda of the China Construction Bank, China Oriental of the Bank of China, Great Wall of the Agricultural Bank of China and Hua Rong of the Industrial and Commercial Bank of China. See M. O’Neill, “Third Key State-Owned Bank Starts Unit for Bad Loans,” South China Morning Post Internet Edition (19 October 1999) online http:// www.scmp.com (consulted 19 October 1999). 38 See P. Chan and M. O’Neill, op. cit. It is far less than the figure estimated the investment bank Goldman Sachs, which is about US$272 billion. See X. W. Wang, “Goldman Puts Loan Clean-Up Bill at US$272b,” South China Morning Post Internet Edition (24 September 1999) online http://www.scmp.com. 39 The PICC was established in October 1949, but it did not operate normal insurance business until 1980. Since then, it had handled all insurance business and reinsurance business. In 1996, it was restructured into the PICC Group with three subsidiaries: life, property and reinsurance. Until recently, PICC’s three subsidiaries became independent and gained equal standings to the PICC. 40 Article 8 of the Law of the People’s Republic of China on Chinese Foreign Joint Ventures states that Chinese insurance companies serve all Joint Venture insurance needs. However, when the Joint Venture Law was adopted, the PICC was the only authorized insurer. Thus, this provision effectively granted it a domestic monopoly. 41 Ping An Insurance was established as the first shareholding insurance company. It is, thus far, the only one that has foreign shareholders. 42 CEInet, “China’s Insurance Market,” online http://www.chinaeco.com/emar.htm (consulted 3 August 1999), please see also “Insurance Business Successful: Official” (4 June 1999) online http://ce.cei.gov.cn/echn.htm (consulted 3 August 1999). 43 CEInet, “It is Inevitable to Open Insurance Market” (14 June 1999) online http:// ce.cei.gov.cn/echn.htm. 44 But recently, The Economist argued that insurers should be allowed to invest in stock market, given that the central bank’s six interest-rate cuts over the past two years have shattered the revenue base of the insurance firms (21 May 1999) online http:// ce.cei.gov.cn/echn.htm. 45 CEInet, “China’s Insurance Market Restructuring” (22 March 1999) online http:// ce.cei.gov.cn/echn.htm. 46 See generally Hong Zhu, “Reforming the China Securities Regulatory Commission,” McGill Institute of Comparative Law LL.M. thesis, 1996.

96 Richard Janda and Men Jing 47 CSRC Web site, “Introduction to China’s Securities Market”, online http:// www.csrc.gov.cn/CSRCsite/eng/esmintr.htm (consulted 20 June 2000). 48 The text of RFIFC can be found online http://www.chinalaw.net/dcd001/owa/ cei.fgdetail_query?incode=112203199401. 49 Foreign financial institutions are defined in the Article of the RFIFC, cited as follows: Article 2 Financial institutions with foreign capital mentioned in these Regulations refer to the following financial institutions that are established and operate in China upon approval in accordance with the relevant laws and regulations of the People’s Republic of China: (1) subsidiary banks incorporated by foreign capital whose head offices are in China (hereinafter referred to as foreign banks); (2) branches of foreign banks in China (hereinafter referred to as foreign bank branches); (3) banks incorporated jointly by foreign and Chinese equity institutions (hereinafter referred to as equity joint-venture banks); (4) finance companies incorporated by foreign capital whose head offices are in China (hereinafter referred to as foreign finance companies); and (5) finance companies incorporated jointly by foreign and Chinese financial institutions (hereinafter referred to as equity joint-venture finance companies). 50 Article 2 of the RFIFC, ibid. 51 The representative offices are subject to the Administration of the Establishment of Resident Representative Offices in China by Financial Institutions with Foreign Investment Procedure (1991 Representative Office Procedures). It expressly prohibits the conduct of profitable commercial banking operations by representative offices of foreign financial institutions. However, many representative offices engaged in such activities as discounting trade bills for importers and exporters and confirming letters of credit etc. in China in the late 1980s. See S. H. Mac Cormac, “Foreign Banking in China: Opportunities for US Investors in the 1990s,” Journal of Chinese Law, Fall 1993, at 237. 52 Article 6 and 7 of the RFIFC. 53 Article 8 of the RFIFC. 54 Article 2 of the RFIFC. 55 CEInet, “2 US Banks Given Branch Approval” (1 April 1999) online http://ce.cei.gov.cn/ echn.htm. 56 See Table 6.1 “Establishment: foreign financial institutions in China versus China’s commercial banks.” 57 Local-currency banking business was opened to a select group of Shanghai-based foreign banks in January 1996, and to Shenzhen-based foreign banks in August 1998. See Colin Galloway, “Sector Door Remains on Tight Latch,” South China Morning Post Internet Edition (13 August 1998) online http://www.scmp.com. Later in 1999, China opened more localities to foreign banks to conduct local currency business. They include China’s Jiangsu, Zhejiang, Guangdong and Hunan provinces, and the Guangxi Zhuang Autonomous Region. See CEInet, “Foreign Banks Allowed to Deal in Yuan in More Chinese Localities” (6 August 1999) online http://ce.cei.gov.cn. 58 See “China Takes New Step in Opening Financial Sector” (27 January 1999) online Embassy of the PRC in the USA: http://www.china-embassy.org/Cgi-Bin/Press. pl?financeopen. 59 “Mainland Widens Foreigners’ Access” South China Morning Post Internet Edition (15 May 1999) online http://www.scmp.com. 60 By the end of February 1999, the number of foreign financial institutions operating in China stood at 191. Their assets totaled US$36 billion. CEInet, “2 US Banks Given Branch Approval” (1 April 1999) online http://ce.cei.gov.cn/echn.htm. 61 Shanghai and Shenzhen are the only two Chinese cities where foreign banks are allowed

China’s great leap of faith 97

62

63

64 65 66 67 68

69 70

71

72 73 74

to conduct renminbi business. Shanghai was opened for renminbi business in late 1996 and Shenzhen in 1998. China has also broadened the scope of renminbi business that foreign banks can conduct. Initially, they were allowed to grant renminbi loans only to foreign-funded firms. Now they can also participate in syndicated lending to Chinese enterprises. See ibid. Shanghai is a standard insurance market for both Chinese and foreign insurers. There are presently fifteen insurance companies in Shanghai, among which eight are foreign ones. The premiums of foreign insurance companies in Shanghai hit 1.022 billion yuan in 1998, accounting for 10 percent of the city’s total. The life insurance premiums increased to 7 billion yuan in 1998 from 1.8 billion yuan in 1992. According to local sources that before the year 2010, Shanghai will allow in one or two more foreign insurance companies each with assets ranking among the top 100 of the world for consecutive three years and credit rating as AAA for consecutive three years. These foreign insurance companies” businesses are restricted in Shanghai and they are allowed to operate their capital, various reserves and other assets within China. Please see “Shanghai to Open Insurance Market More Widely” (8 April 1999) online http://ce.cei.gov.cn/echn.htm. They are the United States’ Chubb Group of Insurance Companies and the John Hancock Mutual Life Insurance Company, Britain’s Prudential Assurance Company Limited, and Canada’s Sun Life Assurance Company, according to the Ministry of Foreign Trade and Economic Cooperation. The four world-famous insurance giants have all had representative offices opened in China for more than four years, and have been cooperating well with Chinese counterparts. On 5 April 1999, they got licenses to open branches or to establish joint ventures in China. Please see “Foreign Insurance Firms Get Green Light” (6 April 1999) online http://ce.cei.gov.cn/echn.htm. CEInet, see note 5; see also “China to Further Open up Insurance Market” (28 April 1999) online http://ce.cei.gov.cn/echn.htm. US$1.00 = RMB 8.00. W. W. L. Lam in Washington, “WTO quest nears finish,” South China Morning Post Internet Edition (10 April 1999) online http://www.scmp.com. See “Market Access and Protocol Commitments” online USTR: http://www.ustr.gov/. See “The Sino-EU Agreement on China’s Accession to the WTO: Results of the Bilateral Negotiations” http://europa.eu.int/comm/trade/bilateral/china/res.pdf (consulted 5 June 2000). See R. Janda, op. cit., note 3. The following descriptions are based on the Fact Sheets provided by the China Trade Relations Working Group on Telecommunications (15 February 2000) available at www.chinapntr.gov/industry%20fact%20sheets together with the text of the US–China bilateral, available at www.uschina.org and the overview of results of the Sino-EU bilateral provided by the available on the European Union’s official web site: www.europa.eu.in/comm/trade/bilateral/china/res.pdf. China’s key telecommunications services corridor in Beijing, Shanghai and Guangzhou represents approximately 75 percent of all domestic traffic. See “Beijing to Open Sector Earlier Than Promised,” South China Morning Post Internet Edition (6 January 2000) online http://www.scmp.com. S/GBT/W/2/REV.1, Notes for Scheduling Basic Telecom Services Commitments – Revision (16 January 1997) online WTO: http://www.wto.org/wto/services/tel16.htm. S/GBT/W/2/REV.1 and S/GBT/W/3 (online WTO: http://www.wto.org/wto/services/ tel17.htm) respectively. These thresholds can be put into perspective by noting that according to the statistics of the Office of the Superintendent of Financial Institutions, as of 1999, Canada’s “Big Five” banks (Royal, CIBC, Bank of Montreal, TD and ScotiaBank) would all have met the US$20 billion threshold and sixth largest bank, the National Bank, would have met the US$10 billion threshold. See http://www.osfi-bsif.gc.ca/outgoing/YearEnd/bk99e.pdf (consulted 5 June 2000).

98 Richard Janda and Men Jing 75 See Fact Sheets provided by the China Trade Relations Working Group on Banking (15 February 2000) online http://www.chinapntr.gov/industry%20fact%20sheets/ banking%20and%20securities.htm. 76 See R. Janda, op. cit., note 3. After canvassing the various strategies that WTO members had adopted to address regional differences within countries, the author concluded: “If these alternative provincial strategies remain unsatisfactory from the Chinese standpoint, one way of squaring the circle would be for China to make initial commitments to implement a liberalization within specific provinces coupled with a timetable for extension of liberalization to the entire country.” 77 On the subject of judicial independence in China, see Stanley Lubman, “Dispute Resultion in China after Deng Xiaoping: Mao and Mediation Revisited” (1997) 11 Columbia Journal of Asian Law 229.

7

Pressures on China from the Asian financial crisis John D. Langlois Jr.

Introduction The Asian financial crisis started with devaluation in Thailand in 1997 and quickly spread to Korea, Malaysia, Indonesia and the Philippines. The result was a rapid decline in intra-regional trade and an explosion in financing costs for the Asian economies. China is said to have avoided the crisis.1 It held its currency stable and maintained a positive GDP growth rate, relying heavily on the strength of its fiscal stimulus even as domestic demand plummeted. The United States congratulated the Chinese for keeping their system working and maintaining their currency’s value in US terms. The Chinese kept their official foreign currency reserves at a very high level, in the neighborhood of US$145 billion during the crisis and climbing higher since, and their trade balance has remained positive with a growing surplus. But pressures on China remained very high over the two to three years following the crisis, and the Chinese made many adjustments to their system in response. Some of these adjustments had been previously planned, but because of the crisis were accelerated. Others the government implemented in the wake of the crisis in order to reinforce its central controls. Still others were forced upon the leadership. In 1998 and 1999, Chairman Jiang Zemin and Premier Zhu Rongji both made speeches commenting on the difficulties China was facing in the midst of the Asian crisis. These included corruption in the Communist Party, smuggling, unemployment, social disorder, and the separation of government offices from commercial activities, to name a few. Others that could be added are deflation, softening exports, weakness in the banking system, and environmental damage. In all of these areas, the direct impact of the Asian financial crisis on China was to exacerbate the domestic pressures on the regime. How was that impact felt? The answer lies primarily in the immediate economic sphere in the form of falling exports, increased international borrowing costs, declining availability of short-term liquidity, and downward pressure on the GDP growth rate. In 1999, China’s international borrowing rates improved substantially vis-à-vis the height of the crisis in 1998, but the rates were still much higher than they had been immediately prior to the crisis. The Asian financial crisis consisted of investor reaction – or more precisely, overreaction. Investors used to take exposure in the region partly on faith. Too much

100 John D. Langlois Jr. faith led to over-investment in the region and to the first cousin of over-investment: over-priced investment. When investors got their baths of cold water in 1997 starting in Thailand, they reacted by withdrawing their funds, and by raising the price of their funds. As the Chinese government made and continues to make adjustments to its reform program “on the fly,” so to speak, it exposes itself to criticisms on all sides. Domestic critics argue that the reform is unleashing forces that will destabilize the power and authority of the Communist Party. These critics therefore push for a slowdown or even a temporary halt to the reform of the state-owned enterprises.2 Proponents of ongoing reform push the argument that the process must not be reversed or stopped because doing so would only lead to extreme popular discontent. Since the mid-1990s, a group of leaders in Beijing have sought to increase China’s international entanglements in order to create irreversible benchmarks by which the regime may be judged internationally – and by extension, domestically. Vice Minister of Finance Liu Jibin in 1995 stated that one reason for China’s active involvement in international capital markets, through bond issues, was precisely to create the basis for scoring China’s success in reforms. If China performed badly, the markets would “grade” China’s performance in the form of higher yields on China’s bonds. Conversely, if China performed well, its bonds would sell at lower yields. One key rationale for issuing bonds in the international markets was here, Liu said, and not because China needed to do so to fund its fiscal shortfalls. Minister Liu’s comments were a frank admission that at home, certain critics did not want China to borrow in the international markets. Leverage is bad, they said, because it put China’s fate in the hands of foreign investors. Better to do things the old way, with China’s own resources, accumulated through hard work and thrift. But China went ahead with dollar bond issues, and these benchmarks for measuring China’s performance can now be studied on a daily basis in the international financial press. Since the formation of the PRC in 1949, the regime has argued that production assets – including land – must be owned by the state. Today the state still owns all land, but production assets are increasingly owned by non-state enterprises and individuals, and land usage rights are regularly traded. It is frequently observed that the number of profitable SOEs is about 40 percent; the rest lose money. The lossmaking portion of the SOE sector is growing, not shrinking, and the crisis among these enterprises has been greatly inflated by the Asian financial crisis.

Privatization and revision of the constitution In January 1999 the Communist Party of China, acting through the party Central Committee, asked the National People’s Congress to look into revising the constitution to provide a greater role in the economy to the private sector. Within a very short time, the press began bruiting the notion that the private sector was “an important component” of the overall socialist market economy. These new buzzwords finally replaced old ones in the PRC constitution, whereby the private sector

Pressures from the Asian financial crisis 101 was said merely to “complement” the socialist economy. The March 1999 revision of the constitution in this way was the consummation of several years of debate, beginning in October 1997, when a senior economist in Beijing called for constitutional revision in order to afford greater protection to the private sector.3 The Asian crisis, which had blown in by that time, certainly contributed to the urgency of the scholar’s plea. Much went on beneath the rhetorical displays. The popular media controlled by the party began slipping expressions like “survival of the fittest” into discussions of economic livelihood. The word “privatization” is still anathema to the regime; after all, one must recall that the word “communism” in Chinese is translated “common property” (gong chan). If this one-party regime wants to retain its name “communist,” it can hardly endorse privatization at the same time. But nevertheless, the leopard is changing its spots. Not too far in the future, private property will make its way back in. Already it is back in limited form. Individuals can own a car, an apartment, a bank account, a securities account and a transferable right to use land for a period of time. What one cannot own, at the present time, is land. And major corporations are still primarily held by the state. The state-owned corporations listed on the Shanghai, Shenzhen and certain overseas stock exchanges have sold minority interests to private shareholders. Corporations not held by the state are said to be held by “collectives” ( ji ti), which is a face-saving way of saying private. Indeed, in Wenzhou, on the coast of Zhejiang province, virtually the entire economy is private in this way. Indeed, some 90 percent of the province’s enterprises are not state owned and contribute some 90 percent of the province’s revenues.4 Debate on private property has been extensive over the past few years. Although there have been limited public discussions of a radical nature, scholars at prestigious research organizations like the Chinese Academy of Social Sciences have participated in discussions about the complete revival of private property rights, including land rights. Thus the rhetorical changes in the PRC constitution are the surface indications of fundamental changes that are being discussed at senior levels. Still, the government will continue to cling to its control of the largest corporations, especially those corporations which are important to China’s security such as petrochemicals, telecommunications and banking. Many Chinese recognize that the economic problems in China stem from the way in which property is owned. They know that assets owned and run by the government are usually managed according to political considerations. They know that the returns from those enterprises are low and even negative. And many Chinese know that privately held assets are managed better and earn higher returns. But this general awareness has not translated into a mandate to privatize the crown jewels of the state-owned economy. China is changing its system. An unannounced program of triage or corporate euthanasia has been steadily reducing the resources under SOE control. The number of SOE employees has fallen, and the number of state-owned corporations has fallen. Resources dedicated to the SOE sector would have fallen even more rapidly had the Asian crisis and the drying up of domestic demand not forced the regime to reverse course temporarily and to pump money into the state-owned sector. The purpose of this reversal, however, was not to turn back the course of

102 John D. Langlois Jr. reform, or to throw resources back into the hands of hard-line communists. It has been a stop-gap to keep the economic growth rate positive in a time when the trends were negative. These stop-gaps included encouraging the four main banks to step up their lending to SOEs, directly reversing instructions in 1997 to behave commercially and to cease producing non-performing loans (NPLs). Because of the stop-gap measures taken in 1998, the creation of NPLs continued at an unacceptably high level. We do not have details on the extent or the degree of trouble, but the backtracking interrupted the continued reform of bank balance sheets. Publicity about the now-famous asset management companies (AMCs) set up for each of the four big state-owned banks, into which the banks have unloaded a certain amount of questionable loans, is encouraging. But the fact is that the engine creating NPLs has not been shut off; in fact, it has been refueled. The AMCs, on their part, received the equivalent of over US$4 billion in capital injections from the government, with which they have purchased a number of qualified loans from the four big banks. Most of the purchases were not made for cash; instead, the AMCs issued interest-bearing notes, and then in many cases swapped the loans into equity in the state-owned companies. Thus the banks’ loans to state-owned enterprises have been converted to AMC-held equity in the same companies. By booking these transactions at face value, the banks have been freed from writing off their losses on these loans, and have been released from the obligation to post reserves against them. These non-cash transactions have helped to recapitalize the SOE beneficiaries by reducing their nominal leverage, while not materially changing the risk profiles of the banks. This is so because the risk of SOE exposure, now on the shoulders of the AMC, directly impacts the risk of the notes issued to purchase the loans from the banks. Yet the virtually complete consensus in Beijing around the issues of NPLs and their toxic nature is palpable. Almost no one disputes the gravity of the problem. The only serious issues on the debating table are the pace and scale of the reform of the NPL problem. Fear of the collapse of the banking system is never far from the surface of any discussion about the issues. Though the fear is well known, it has not yet translated into a public fear and a resultant withdrawal of deposits from the four main banks. The government has been careful to dispel the idea that it would allow one of its main banks to go down in a crisis. While the government has undertaken no written legal commitment to guarantee all deposits in the four main banks, no one doubts the regime’s commitment to do so.

Ideological debates without ideology China’s non-public discussions about economic reform are handicapped by an inability to espouse certain approaches which are deemed un-Chinese ideologies. Even though the days when Chinese citizens routinely denounced “capitalist roaders” as “running dogs” are long gone, it is still not feasible for prominent leaders to announce that they are believers in private capital and capitalism. Lip service to Deng Xiaoping’s “Chinese socialism” or variations thereon is mandatory in today’s China. This means that there is no systematic body of economic or social literature

Pressures from the Asian financial crisis 103 to which the leadership can publicly refer for guidance in devising the institutions of future China. Privately they can and do refer to the writings of Milton Friedman and other economic reformers who paved the way for reforms in the United States and the UK which have made possible current economic vitality in those countries. But publicly the Chinese cannot pay homage to these reformers, nor are there usable Chinese substitutes for intellectual leadership. The ideological debates in China are therefore without “ideologies.” Only pragmatism reigns, in its fully ad-hoc and unpredictable glory.

Why does China not implode? The condition of China’s financial system could easily be the subject of a doomsday scenario. It would go something like this: China’s banking system is insolvent; no equity remains in the system. Banks are still creating NPLs because they have been ordered not to cut off credit to the state-owned enterprises. The non-bank financial institutions are bankrupt. The sovereign balance sheet and income statements are a disaster; revenues are falling as a percentage of GDP, deficits are extending far into the future, and growing. Unemployment is high and growing, and the SOEs are losing money and wasting resources. The people recognize this, so they are reluctant to spend money; they save record amounts realizing that there is no upside to their economic lives and that the government will not provide a social welfare safety net. Private sector businesses cannot get credit. The government refuses to liberalize lending fearing that lending institutions would cut off credit or reprice it, putting the SOEs out of business. Corruption is endemic and unstoppable. Government officials are stealing assets and money from the state, using the chaos of the economic transition to line their pockets and to provide offshore patrimony for their heirs. The legal system is under the thumb of the officials. The only corrupt officials tried and convicted of corruption are those the party decides to sacrifice. How in this incredibly gloomy picture is China able to hold itself together? Why do China’s citizens continue to plow their savings into the state-owned banking sector? Is this gloomy picture wrong? Many observers ask these questions. The answers are obvious but difficult to document quantitatively. The economy is producing value, but it is the non-state sector that is producing it. Savers are willing to put their money in the banks because they accept a few simple hypotheses: ● ● ●

The government will bail them out. The government has the capacity to bail them out. This capacity comes not from traditional fiscal income; rather, it comes from unrealized gains in the non-state sectors. These gains are owned not by the government but by municipal and local governments, township and village enterprises, and by private enterprises. The state still owns the land under these enterprises. The state has a residual capacity to tax these enterprises and under duress to confiscate their profits. Beyond these areas, the state has the residual capacity to sell its interests in the few successful state-owned enterprises.

104 John D. Langlois Jr. The sum total of the unrealized gains in these areas is sufficient to justify a Chinese saver’s willingness to place his or her savings with one of the four big state-owned banks.

Increased cost of funding China launched a US$400 million five-year global bond in October 1997, which sold at a spread of 68 basis points over the yield on the comparable five-year US Treasury note. Soon after that issue, however, China’s outstanding debt paper began falling in price as the Asian financial crisis drove investors to withdraw liquidity from the region. Chinese sovereign credit risk was substantially repriced by the international investor market throughout 1998 and most of 1999. Evidence for this is supplied by the fact that China sold US$1 billion in ten-year global bonds in December 1998 at a spread of 280 basis points over the Treasury bond of the same maturity. However, in mid- to late 1999, and continuing in early 2000, Chinese paper traded up in value to yield about 137 basis points over the comparable US government issues. Yet even this substantial improvement was far from the pricing that China achieved on the eve of the financial crisis almost four years earlier. Non-sovereign issuers from China fared worse than the sovereign. Quasisovereign issuers like the China Development Bank saw the yields on their outstanding bonds rise to 390 basis points over Treasuries, while other governmentowned issuers like the Bank of China and CITIC saw their bonds yield even more than these figures. Issues by these well-known entities were very thinly traded, so no one really had a good feel for the market value of these instruments. None of these names were willing to brave the market in the post-crisis years. The collapse of the Guangdong International Trust and Investment Company (GITIC) in late 1998 was caused in part by the withdrawal of liquidity from the PRC by the international investor and lender community. GITIC, the principal borrowing window of the Guangdong provincial government, had been rated investment grade not long before then. In 1998, it became insolvent. Japanese lenders had started to withdraw their funding from Asian borrowers with the emergence of the Asian financial crisis in 1997. They were the principal providers of credit in the region from 1995 to 1997. Their withdrawal triggered a massive repricing and realignment of investors and borrowers in the region. The downfall of GITIC was perhaps triggered, but not caused by, this withdrawal. Not only did China’s international borrowing costs increase as a result of the Asian financial crisis, but also the demand for Chinese exports fell. The net result is that China’s overall export growth remained flat year-on-year. This in turn had a strong negative impact on consumer confidence in China, despite the fact that exports per se account for a small portion of China’s GDP. China’s equity fund-raising offshore slowed to a virtual stop in activity due to the crisis. The cancellation of the Hong Kong listing of Shandong International Power Development Co. (SIPDC) in February 1999 showed that investors had become very leery of Chinese names, a caution that stemmed in part from the shock of the GITIC failure.5 SIPDC was the third China-related listing failure in the same period.6

Pressures from the Asian financial crisis 105 By early 1999, the Hang Seng China Enterprise Index of H Share companies was down 45 percent from its level at the close of 1997 and remained basically flat through the end of 1999 (Figure 7.1).7 The poor performance of the China Enterprises Index occurred despite the fact that Hong Kong stocks generally performed reasonably well during the same period. An inference might be that investors lost their positive view on China’s exposure. Comparing the two indices since the start of 1997 until the end of 1999, the Hang Seng Index increased over 20 percent, while the China Enterprises Index declined 50 percent (see Figure 7.2). But such an inference would be inaccurate. Investors did not actually give up on Chinese stocks altogether. The shares of China Mobile (Hong Kong) Ltd., a Red Chip floated on the Hong Kong exchange in 1997, steadily traded well above its initial offering price during the post-crisis period (Figure 7.3).8 Thus investors were willing to hold Chinese stocks that possessed strong positions in their markets and had transparent business strategies and focuses. China Mobile is an exception, however, as most Red Chips were in poor condition compared to their initial prices. Thus Chinese names generally found the 2000 1500 1000 500 01/10/1999

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106 John D. Langlois Jr.

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Figure 7.3 Hang Seng China Enterprises Index, China Mobile (HK) 1997–9.

equity markets very unfavorable to their presence during the post-crisis years, and new share issues were few. One consequence of the Asian financial crisis lies here: investors were no longer willing to close one eye when they considered investing in China-related stocks. China Mobile passed muster, but most did not. Deflation is another by-product of the Asian financial crisis. While China was generally in an inflationary environment in the 1990s, the post-crisis period saw negative growth in consumer prices (more on this later in the chapter). The cause of deflation in China can be debated, but at its heart is the lack of consumer confidence on the part of China’s citizens. Facing growing uncertainty in the economy due to the Asian crisis and the steady winding down of the state-owned enterprises, the Chinese people wondered about the safety of their future livelihoods. This uncertainty caused them to be cautious consumers. Only in 2001 did this unwillingness to spend finally begin to reverse itself. The basic data point to some other problems. Foreign direct investment, which had been growing by leaps and bounds until 1997, flattened out in the post-crisis period. Export volumes were relatively flat over the same period. Meanwhile imports increased again after a slight fall in 1998. Thus China’s trade surplus, while still large, was down significantly (Table 7.1). Critical to understanding the Chinese economy and the reform program is the fact Table 7.1 China’s trade balance 1997–9

FDI inflows Exports Imports Trade balance

1997

1998

1999

45.4 182.7 136.4 46.2

45.6 183.5 136.9 46.6

41.0 194.7 158.5 36.2

Source: Asian Development Bank, People’s Republic of China, Country Economic Review, October 2000.

Pressures from the Asian financial crisis 107 that it is dependent on a very low tax base. When reforms began in 1978, the government sought to increase its fiscal resources, and fiscal income represented a reasonably large share of GDP. In the 1990s, this percentage fell to the mid-teens. In 1994, the government shifted its former “tax farming” system to one based on percentages assigned to the various tax-paying enterprises in China. Under the old tax-farming system, the government negotiated a tax payment with each province, and the province was responsible for the collection of tax revenues from its taxpaying corporations. Under the assignment system, the government sought to act as the collector of tax, and percentages were stipulated by the central legislative authority. In theory, the central government then allocated back revenues from its central collection mechanism to the provinces.9 The 1994 reform caused the central– provincial split of revenues to shift in favor of the center, although this effect slightly contracted in 1999 as Figure 7.4 shows. Low government revenue as a percent of GDP throughout the 1990s has been a mark of China’s slow transformation to a market economy. China’s fiscal weakness is a serious handicap to its development, as it forces the government to maintain financial repression over many of its enterprises and over the non-state sector. Although the 14 percent ratio achieved in 1999 is an improvement over 1998, when it was only 12.6 percent, and over 1995’s 10.7 percent, it is still a far cry from the 15.8 percent of 1990 and the much higher figures of the 1980s.10 Nor is this level very impressive in comparison with developed economies. A consequence of accelerated fiscal spending coupled with revenue weakness is the rapidly growing fiscal deficit (Figure 7.5), financed increasingly with government bond issues. The post-crisis years showed a sharp jump in the deficit, as the government resorted to fiscal stimulus to keep the economy growing. As the current tax assignment system is new, it is perhaps not surprising that it does not function as the planners would have liked. The government is heavily dependent on the state-owned sector for its tax base, yet that sector is performing poorly. The state collects a large proportion of its tax revenue from banks through financially repressive taxation. In order to ensure that banks keep paying taxes, the Ministry of Finance restricts the amount of loan write-offs that the banks can make in a year. In practice, it limits taxable write-offs to 1 percent of total assets, although it 100% 80% 60% 40% 20% 0% 1985

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Figure 7.4 Center–local share of fiscal income 1985–99. Source: Zhongguo tongji zhaiyao 2000, p. 58.

108 John D. Langlois Jr. 174.4

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Figure 7.5 Fiscal deficit 1995–9 (billion yuan). Source: China Statistical Yearbook 2000, p. 255.

did make an announcement in 1998 that the write-off limit would be raised to 3 percent. Thus the banks, which might be reporting losses if they accounted for their NPLs properly and wrote them off as they should, instead are reporting profits. These profits are bogus, but the resultant tax revenues are entirely real. In the non-SOE sector, corporations routinely evade taxation by underreporting their income. The government’s policing mechanisms are rudimentary, and much of the non-SOE economy is off the books. Thus government’s ability to tax the nonstate sector is severely limited. The local governments have been implementing numerous fees charged to businesses in their regions. These are not officially sanctioned taxes but instead are ad hoc administrative charges imposed on a willy-nilly basis. Enterprises are frustrated by these fees which damage their profitability. Since they are ad hoc, they cannot be anticipated. The central government has been trying to abolish this chaotic system through a campaign known as “converting fees to taxes,” or fei gai shui. Through conversion, the central government effectively puts the local governments out of the business of collecting administrative fees, and instead transforming the payments into predictable taxes.

Rating agency responses to the crisis: downgrades of China’s credit The major rating agencies adjusted their credit ratings of China’s banking institutions in part due to their estimates of the impact of the crisis on the banks’ ability to repay foreign currency debt. Yet they did not change their ratings of the sovereign issuer itself. In December 1998, on the eve of China’s US$500 million sovereign bond issue, Standard & Poor’s downgraded two of China’s policy banks’ credit ratings, and put five Chinese financial institutions on its “credit watch with negative implications.”11 In the same month, the rating agency Moody’s said of China that its “commitment to protect the creditworthiness of the sovereign, and its ability to do so in view of the prospects for the maintenance of a strong external position over the near to medium term, offer strong support to the ratings.” While it confirmed China’s respectable A3

Pressures from the Asian financial crisis 109 Table 7.2 Moody’s Ratings: announcement of December 4, 1998 Old rating

➔➔➔ ➔➔➔➔

A3 A3 Baa1 Baa1 Baa1 Baa1 Baa2 Baa3 Baa1 Baa3 Baa3 Ba1

➔➔

State Development Bank of China Export-Import Bank of China Bank of China Industrial and Commercial Bank of China China Construction Bank Agricultural Bank of China CITIC CITIC Industrial Bank Bank of Communications China Merchants Bank Guangdong Development Bank Shanghai Pudong Development Bank

Change

New rating Baa1 Baa1 Same Baa2 Baa2 Baa2 Same Same Baa2 Ba2 B1 Ba2

long-term debt rating, it lowered the ratings of the major state-owned banks with the exception of Bank of China, CITIC and CITIC Industrial Bank, which it kept unchanged (Table 7.2).12 Moody’s explained that the downgrades of most of the banks were based on “a continued decline in the financial health of the Chinese banking system, despite the central authorities’ accelerated reform efforts, the consequent heightened credit risk of the banking system, and the widening credit risk disparity among different groups of the banks in the system.” More specifically, Moody’s singled out a few reasons for the downgrades and mentioned that “the overall economic and operating environment for the Chinese banking system has become more difficult in recent years.” The conditions that Moody’s included in this general comment consist of issues such as the slowdown in the domestic growth rate, deflation of commodity prices, overcapacity in the industrial sector and the overall Asian financial crisis. All of these factors are interrelated. Overcapacity is a function of demand, which was lower than desired. Demand in turn was depressed by deflation, which caused consumption to decline as purchasers waited for lower prices and placed a premium on holding cash. GDP growth naturally declined as a result of these things. And the Asian financial crisis caused a drop in demand for China’s exports.

China’s responses to the Asian currency crisis The varied responses by China to the Asian financial crisis are summarized in Table 7.3.

Deflation Deflation in China in 1998–9 led to a radical fall in demand growth. This depression of demand will not be easily reversed without an inflationary policy. Over the past few years the trend has been extremely pronounced (see Figure 7.6).

110 John D. Langlois Jr. Table 7.3 China’s responses to the Asian financial crisis 1998–9 Sector or measure

1998

1999

Public spending

Three-year plan to spend US$1.2 trillion in public works

Cut interest rates

Eight cuts since 1996, three in 1998

Not much room for further cuts

Money supply

Increase by 11.9% in 1998, 17.7% in 1999

Probable continued high growth

Lending, credit supply

Increase in bank loans in 1998 of US$111 billion

Increase in 1999 of $120 billion

Inflation/deflation

Deflation in 1998

Continued

Debt write-offs

Up to $6 billion per year

Set up asset management companies for the major banks and ITICs

Non-banks, SOEs

GITIC closed in 1998, many smaller SOEs closed, triage starting

“Survival of the fittest” is new buzzword, continued closures

Currency

Not freely convertible

Continued

Tax refunds to exporters VAT refunds increased Improve environment for Decline in FDI in 1998 foreign investment

Continued Flat in 1999, but government taking measures

Import–export trading license liberalization

Forty-one private companies in 1999 granted licenses

Twenty private companies in 1998 granted licenses

2.8

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1998

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Figure 7.6 Change in general CPI 1997–9. Source: China Statistical Yearbook 2000, p. 290.

China experienced a disastrous inflation in the pre-1949 era, on a scale similar to that of prewar Germany. The Nationalist Party’s loss of the mainland to the Communists is often ascribed in part to the havoc caused by runaway inflation. The memory of this is imprinted in the minds of China’s Communist leaders, and for this reason they are inclined to view deflation as a boon. But nearly all leaders today recognize the negative consequences of deflation. The question has become whether China’s monetary policy is able to fine-tune itself to the degree of being able to generate benign inflation on the order of 2–3 percent per annum. Even in the late 1980s and early 1990s, China had encounters with excessive inflation. One cause contributing to the unrest in the 1989 Tiananmen incident was price inflation, which

Pressures from the Asian financial crisis 111 eroded the earning power of the populace to the point that urban unrest, labor disputes and public dissidence became a serious problem for the regime.

Fall in domestic retail sales and exports Retail sales in China fell off significantly in 1998, reflecting the lack of consumer confidence caused by the increase in uncertainty due to layoffs and price cuts. Figure 7.7 shows this trend clearly, with the growth in retail sales below the reported growth in GDP. Retail sales growth for 1999 showed further deterioration along the trend. Matching the slowing growth rate of domestic demand in the post-crisis period, caused by (and a cause of) deflation and the growth in unemployment, China faced a deterioration in its trade balance in 1998, the first full year of the crisis. China’s exports grew 20.5 percent in 1997, but in 1998 they posted a gain of only 0.5 percent over the previous year. Imports contracted in 1998 as well, showing a belt tightening by Chinese importers. But by 1999, exports were growing at a reasonable 5.9 percent, while imports exploded 18 percent over the previous year. Even so, the trade balance growth went from a negative 0.4 percent in 1998 to a positive 11.2 percent in 1999, showing a strong recovery in the trade fundamentals (see Figure 7.8). The lack of export growth in 1998 is unsurprising given the Asian crisis and the drop in demand from China’s neighbors. But during that year, the Chinese tried 20.1%

10.2%

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6.8%

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Figure 7.7 Consumer goods retail sales growth 1996–9. Source: China Statistical Yearbook 2000, p. 554. 25 20 15 10 5 0 -5 1996

1997 Exports

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Figure 7.8 Change in exports and imports 1996–9 (%). Source: China Statistical Yearbook 2000, p. 588.

112 John D. Langlois Jr. various means – short of a devaluation – to stimulate exports. There was a significant shift in the destination of China’s exports, with a sharp increase in goods shipped to the United States, offsetting the fall-off to the rest of the world. But this reflects less a strategy and more a consequence of the fact that only the US showed sufficient consumer demand to make up for the lack of demand in China’s more traditional markets. Capital construction investment in 1997 showed an increase of 15.7 percent over the previous year, but in 1998 as a result of the government’s effort to spend its way out of the crisis, this figure jumped to 20.2 percent. By 1999, however, the government slowed the growth rate of this expenditure to 4.5 percent. Similarly, investment in state-owned fixed assets, which in the early 1990s had grown at 29 percent per annum, grew 20.1 percent in 1997. The growth rate of this figure fell to 17.4 percent in 1998, and plummeted to 3.8 percent in 1999.13 This shows that the government has wisely started to cut off the new funds that are spent on the less productive state-owned sector.

Bank reform: disposition of NPLs Bad loan disposal No one has provided detailed information on the non-performing loans held by the financial institutions in China. The governor of the central bank Dai Xianglong offered up the number 5–6 percent for the share of non-collectible loans, but only guesses will do for the total number of bad loans. The central bank has, since the start of 1999, talked about imposing a five-class ranking of bad loans, following international practice. All the banks are making efforts to classify their loans accordingly. But the new standards are by no means fully in place, and the Ministry of Finance itself is blocking the introduction of these standards by not permitting more rapid write-offs, as mentioned above. Until the Chinese develop data about default histories by industries and by companies, they will not have a good grasp of the default risks in their loan portfolios. This will take several years to organize. In the meantime, only rules of thumb will suffice to guide the planners. Demonstrating the seriousness of the effort, the central bank announced in 1999 that the top four banks would each establish stand-alone entities to hold nonperforming loans. Modeled to some extent on the Resolution Trust Company in the United States, these asset management companies were meant to spearhead China’s effort to strip the bad loan burden away from the main banks. After several years, however, it is still unclear whether the AMCs will be merely debt-to-equity conversion vehicles or if they will actually engage in loan workouts and corporate restructuring. Questions awaiting resolution are many, and include when the market will be allowed to set asset values, and how the AMCs will improve governance of the SEOs they buy into. To date several billion dollars equivalent in loans have been converted to equity through these asset management companies. The loans have supposedly been made to viable companies. The theory is that such companies are viable but for the fact that

Pressures from the Asian financial crisis 113 they are over-leveraged. By converting debt to equity, the Chinese government effectively recapitalizes these companies and provides them with a new lease on life. But these accounting entries do not involve cash infusions to the companies. They are merely accounting games, changing the label on the paper from “debt” to “equity.” This releases bank reserves, but whether this will lead to improved management of the borrower entities is a question that remains to be answered. For now it is safe to be skeptical.

Reorganization of the “ITICs” Aside from the banks, there is a group of non-bank financial institutions known as “ITICs” and “TICs”, abbreviations for “international trust and investment companies” and “trust and investment companies.” At the start of 1999, there were something like 239 such institutions, made notorious by the collapse of GITIC and by the liquidity problems at many of the ITICs. These non-banks were established in the 1980s as “windows” for borrowing by regional or urban areas. Many of them borrowed on the backs of implicit government support, and lenders often failed to carefully examine the true credit risks involved. GITIC was the highest flyer among these non-banks, and even obtained an investment grade rating (BBB-) from the international rating agencies. But lenders and the rating agencies relied on the belief that the Guangdong provincial government would provide full support to GITIC’s obligations. There was never a legal obligation for the government to provide that support in the form of a guarantee, and indeed the central government’s stated policy proscribed local governments from providing financial guarantees. Yet many big banks and the major rating agencies believed that, in a crunch, the local government would stand behind GITIC. The government’s decision to close GITIC marks the further development of China’s international financing efforts. Although a number of investors lost money when it became clear that the sovereign would not bail them out, this was only the formal recognition of the non-sovereign status of GITIC. Going forward, the “window” concept of local financing is probably now completely dead. GITIC might have survived if the Asian financial crisis had not caused lenders, particularly Japanese banks, to withdraw liquidity from the region. Despite GITIC’s now well-known problems, it is likely that lenders would have continued to rollover their credits to GITIC on the theory that someday the government would provide the needed support. But the crisis pulled away the safety net and GITIC’s true nature was exposed. The central bank announced a radical plan to restructure the trust and investment company sector. The plans included closures and mergers, with an end result of some five international TICs and 50 domestic TICs. The progress on this plan has not gone as quickly as originally anticipated. In early 2001 there were still many ITICs in existence, many of them in poor financial condition. Moody’s downgraded three ITICs in January 2001, expressing dissatisfaction with the pace of China’s reform of this sector.14

114 John D. Langlois Jr.

“Keynsianism with Chinese characteristics” Deficit financing In the wake of the crisis, the PRC government stepped up its fiscal deficits rapidly in order to fund its pump-priming program to create jobs. The increased expenditures include welfare-like payments to help people get through the SOE downsizings, and payments to replace lost earnings by the military as the armed forces give up commercial activities. The fiscal deficit grew only 10 percent in 1997, but in the first year after the crisis it increased by 53.3 percent and in 1999 it increased another 89.1 percent.15 The total amount at the end of 1999 reached 174.4 billion yuan, which was equivalent to about 2.1 percent of GDP, not an exorbitant ratio. Government spending on infrastructure has propped up the GDP growth rate. As the economy lost momentum in the first half of 1998, Beijing inaugurated what some observers have dubbed “Keynesianism with Chinese characteristics,” punning on China’s oft-cited “socialism with Chinese characteristics.” The aggressive government spending program channeled money into roads, railways, power lines and telecommunications networks. As a result of these efforts, China maintained its nominal growth rate at or above the targeted 8 percent per annum. This figure has been challenged by Thomas G. Rawski, who points out serious flaws in China’s statistical data.16 Similarly, the government kept state investment quite high in the wake of the crisis. In 1998, the amount of investment in this category increased 17.4 percent. But this increase was lower than the previous year and significantly lower than the average rate for the period 1990–95. And in 1999, the figure fell sharply to 3.8 percent, a radical contraction.17 Thus in this respect, the government seems to have been tough-minded, despite the pressures to pump prime the GDP.

Efforts to establish a broader tax base Anti-smuggling drive Rampant corruption by government officials nominally responsible for stopping smuggling led the government to create a special anti-smuggling police force, staffed initially by 6,000 police.18 The new force was meant to watch the existing police, the PLA, and customs officials in an effort to put some teeth into the anti-corruption campaign. Nothing like Hong Kong’s tough Independent Commission Against Corruption, however, appears to be in the cards.19 There is no evidence that the Communist Party is ready to surrender its authority to an independent watchdog agency. The party prefers to watch over itself. Separation of SOEs from government departments Many government-owned commercial enterprises have been spun off by government departments, sponsored and staffed by former ministerial officials. This trend

Pressures from the Asian financial crisis 115 became very pronounced in the telecommunications sector where the government ordered the Ministry of Information Industry to shed its control of the telecommunications companies and to focus instead on its regulatory functions. China Mobile is the product of this effort, and its listed company in Hong Kong had a market cap equivalent to almost US$100 billion in February 2000. As an indicator of its quality, the stock has been added to the FT/S&P Actuaries World Indices. A similar effort can be seen in the energy sector where the State Power Co. was spunoff from the Ministry of Electric Power, and the latter was reorganized as a regulatory body. Tax reform In January 1999, the government announced that it was canceling the tax breaks extended to foreign companies through development zones first established in the early 1980s. The government decided to close down all but five special zones among the 44 such zones that had been formally approved by Beijing. There are actually hundreds of other zones that local governments approved without central authorization, and these had already been deemed illegal by the central government. The result of the abolition of a special zone is to place the companies that operate there under a tax regime that is the same as that which applies to companies in the rest of China. For the time being, the government left in place the zones in Shenzhen, Shantou, Zhuhai, Xiamen and Hainan.

Rush to start venture capital investment without venture capital structure Beijing, Shanghai and Shenzhen have all set up entities under the leadership of the respective municipal governments whose functions are to promote venture capital (VC) in China. The boom in VC investment-driven growth in the United States during the 1990s has been well reported in the Chinese press, and numerous factfinding groups of Chinese planners and city government staff have toured around Silicon Valley in search of the secrets of VC. Jiang Zemin even made a high-profile visit to Beijing’s Haidian district, home of China’s leading high-tech companies and of Peking and Tsinghua universities, to publicize the attention the government is paying to VC. Each of the three cities has allocated substantial sums of money to the new municipal VC committees and has assigned the committees with the task of jump starting VC business in China. Pioneers from some of the US’s VC firms have visited China to learn about opportunities there, and some have placed a small amount of funds into investments in start-up companies. From the Chinese government’s viewpoint, VC may turn out to be one way of holding up China’s GDP growth rate. So far there is little evidence that the municipal committees have recognized the need to employ professional managers in the effort, or the importance of turning over their funds to “general partners” who would make investments on behalf of the fund providers. Instead, the committees want to be

116 John D. Langlois Jr. themselves general partners, making the key investment decisions. This becomes a kind of government-sponsored and government-funded VC, a very different animal from the US species. Shanghai municipality is actually a huge holding company for investments in Shanghai. Such prominent corporations as Shanghai Automobile, Shanghai Electric, Shanghai Industrial, and so on are effectively subsidiaries of the city. It remains to be seen whether government-led efforts to promote VC in these cities will be successful in the style of Silicon Valley.

Reorganization of the central bank In 1999, the People’s Bank of China, the central bank, reorganized itself into nine regional offices under the tight control of Beijing. This marked a major improvement in the PBOC structure, which previously was a congeries of 30 provincial branches and bloated staff. Its regulatory mission is in the process of being enhanced, and other activities – those not directly related to regulating the financial sector – are being cast off.

Separation of the securities and banking industries China has gone in the reverse direction of the United States by moving to separate the securities and banking industries. In the early stages of China’s financial system (i.e. in the period from the mid-1980s until about 1996), the banks all set up securities divisions and subsidiaries. The banks became significant providers of liquidity to the stock markets in Shanghai and Shenzhen, and thus an indirect cause of market instability. The securities companies were poorly supervised and many abuses of clients’ funds – and banks’ funds – went unchecked. To eliminate the abuses, the government decided in 1997 to rip apart the two sectors. Banks have been forced to close their securities departments and divest their interests in securities companies. A victim of this reform is the destruction of liquidity in the market for domestic government bonds. The auction system that was under development in 1996, for the sale and distribution of government debt, became in 1997 a system characterized by non-tradable debt, distributed through the banks and priced by fiat. This is undoubtedly a temporary condition, and will be rectified once the government reinstitutes orderly regulatory supervision of the securities companies and banks. The effort to clean up China’s securities markets was stimulated further by the Asian financial crisis. The long-awaited Securities Law finally saw the light of day in late 1998, and provides “teeth” to regulators in order to stamp out insider trading and other securities abuses. It also creates the obligation to exercise due diligence on the part of company officers who are involved in disclosure of company performance. An important but little publicized reform is the new requirement, effective April 1, 1999, that certified public accountants (CPAs) engaged in securities work must be members of independent partnerships and bear unlimited personal liability.20 Until then, the great majority of CPAs who audited state-owned enterprises were employees of the enterprises they audited.

Pressures from the Asian financial crisis 117

Revision of the growth model One of China’s growth models in the 1990s was Korea, until the autumn of 1997. Japan’s great pre-1945 industrial combines and groups known as zaibatsu are paralleled in modern Korea by the chaebol, where leverage was taken to heights nearly unmatched anywhere else in the world. Over-concentrated investments in certain industrial sectors, about which the Korean government planners believed they had superior insights into market potential, led to overcapacity and woeful returns. The banking system as a result has been saddled with very high burdens of non-performing loans. China has many of these same problems. The Chinese modified their stance on conglomerates as a result of their observations of Korea during the crisis. In 1996 the Chinese pursued a “bigger is better” strategy, known in Chinese as zhua da fang xiao , in an attempt to put companies together and create China’s candidates for the “Global Fortune 500.” But in 1997 they shifted to favor instead industrial logic. Thus the forced merger of Baosteel in 1998 with weak and inefficient local steel companies was an effort to promote efficiency and scale economy in the steel industry. The State Council approved the merger in November 1997, when the Asian storm was blowing hard.21 Unfortunately the effects were diluted by the decision to find a safety net for the less efficient, using Baosteel’s successful cash flow and management to prop up companies that otherwise would be candidates for corporate triage. But who is China’s rapid development model to be now that Korea, and even its preeminent model Japan, with its ten-year no-growth stagnation, have fallen by the wayside? Without an obvious role model, China has become more selective in choosing its policies, and a lot less bold. The growing intellectual exchanges with the United States are actually proving to be the most significant factor in determining China’s economic development. Translations of the economic literature from the US, with its heavy concentration of post-Hayek and post-Friedman liberalism, are having a huge impact on China’s thinking about the role of private capital. The experience of the US in resolving its bad loan problems of the 1980s and early 1990s has been intensively studied by the Chinese, and visits by such veterans as Paul Volcker and Bob Seidman, with eager receptions by the Chinese financial leadership, have become commonplace. The Chinese are well aware of the pitfalls of the welfare economy constructed in Europe and experimented with in the UK and the US. In a conversation with an officer at the State Administration of Foreign Exchange in 1998, this writer was told that China in no way was interested in creating welfare disincentives to work. While the government was prepared to spend money to support state-owned enterprises, the reason for this was simply to keep people employed while the economy went through its radical restructuring. The alternative of creating a welfare model would only convey the message to people that the government was underwriting their welfare forever. Instead, by providing short-term funding for the state-owned enterprises as they went through their restructuring – and often their winding up – the government was providing a limited amount of welfare in the form of work, not handouts.

118 John D. Langlois Jr. Many SOEs are running out of money and the government is extending support to only some of the SOEs. The well-reported bankruptcy in November 1998 of the Heilongjiang Acheng Sugar Plant in the northeast is a case in point.22 The company employed 4,500 workers and ran up RMB 700 million in liabilities when the political leaders decided to close it down. Overcapacity in the industry was a key factor in the company’s demise, showing over-investment by the state planners. Having been founded in 1905, the Acheng Sugar Plant had a long history. But its production capacity was only 3,000 tons of beet sugar per day, and the plant had been virtually shut down since 1993. Thus it seems that the lenders, led by the Industrial and Commercial Bank of China, took at least five years to bite the bullet and close the company.

Conclusion Rumors about the demise of China’s reform effort are grossly exaggerated. The Asian financial crisis may have forced significant changes in the reform program but it did not force an abandonment of the reforms. The Communist Party’s own selfinterest motivates it to continue the reforms, for without them it would soon be unable to finance the operations of the government. Indeed, without future reforms, its fiscal problems may prove fatal. Tax revenues are its life blood, and an economy that generates poor returns does not create a strong and dynamic tax base. The Chinese were deeply affected by the Asian financial crisis: they became well aware that China does not live in a vacuum. China is increasingly interacting with the world economically. Foreign direct investment, trade and intellectual interchange, all bind China to the rest of the world in a way that is competitive and beneficial – and disciplinary. The reforms implemented since 1998 have been significant. The risks involved in disturbing the labor market in China are immense. No country faces the problem on the same scale as China. The bad loan problem is equally daunting. The bad loans that must be written off represent a very large share of China’s GDP. Nothing like this ever challenged the United States. The Chinese Communist Party knows that its legitimacy depends on delivering a rising standard of living to its people. How they manage the difficult balance between efficiency and return on capital on the one hand, and helping the losers in the new world adjust to their increasingly dire situation on the other, is the art that they must display.

Notes 1 John G. Fernald and Oliver D. Babson, “Why Has China Survived the Asian Crisis So Well? What Risks Remain?”, Board of Governors of the Federal Reserve System, International Finance Discussion Papers no. 633, February 1999. 2 Li Peng, president of the National People’s Congress, pleaded for such a “temporary halt” in a speech given in late December 1998. See the Hong Kong weekly Zheng ming no. 162 (February 1999), p. 7. 3 The economist was Peking University professor Xiao Zhuoji. See South China Morning Post, “Private Sector Protection,” October 14, 1997.

Pressures from the Asian financial crisis 119 4 China Daily, Wang Ling, “Small Firms Benefit Economy,” June 13, 2000, on www.chinadaily.com.cn/highlights/economy/news/200006/613firm.html. 5 Shandong International Power Development finally listed in Hong Kong in July 1999. The February 1999 failure was the third attempt to list the company. The first one was 1994. See South China Morning Post, Christine Chan, “Underwriters Say Jittery Investors Afraid to Accept Shandong Offering,” February 6, 1999; Helen Johnstone, “Shandong Woes Threaten SAR Finance,” February 7, 1999; Christine Chan, “SAR Listings Blow as Shandong Flops,” February 9, 1999; Christine Chan, “Fresh Listing Attempt for Mainland Arm,” May 13, 1999. 6 Zhujiang Steel Pipe and Heilongjiang Agriculture failed their listing attempts earlier in the same year. See South China Morning Post, February 9, 1999. 7 HSBC Investment Banking report. Red Chips are Hong Kong companies whose assets are principally in China. H Share companies are PRC companies listed in Hong Kong. 8 China Mobile (HK) Limited has its principal assets in the cellular phone systems of 13 provinces, municipalities and autonomous regions. The company listed on the New York and Hong Kong stock exchanges on October 22 and October 23, 1997, respectively. Some 24.2 percent of its shares are publicly traded. The balance is held by its mainland parent, a state-owned enterprise. The company’s original name was China Telecom (HK) Limited; it changed its name to the present one on June 28, 2000. See www.chinamobilehk.com. 9 Donald J. S. Brean, “Fiscal Reform in Modern China: An Overview,” in Donald J. S. Brean (ed.) Taxation in Modern China (New York and London: Routledge, 1998), pp. 1–30. 10 China Statistical Yearbook 2000 (Beijing: China Statistics Press, 2000), p. 62. 11 South China Morning Post, Lana Wong, “Banks on Credit Watch in Poor Environment,” December 19, 1998. 12 South China Morning Post, Renee Lai, “Moody’s Credit Backing Boosts China Bond Sale,” December 5, 1998. 13 China Statistical Yearbook 2000, pp. 172–173. 14 South China Morning Post, “Moody’s Downgrades Itics Amid Fresh Debt Concerns,” January 28, 2001. 15 China Statistical Yearbook 2000, p. 255. 16 Thomas G. Rawski, “China’s GDP Statistics: A Case of Caveat Lector?”, 2001, http:// www.pitt.edu/~tgrawski. 17 China Statistical Yearbook 2000, p. 172. 18 Financial Times, January 7, 1999. 19 The ICAC was formed in 1974 after citizens in Hong Kong became angry at the rampant corruption in the colony. 20 Anthony Neoh, “China Strengthens its Markets,” Far East Economic Review, January 14, 1999. 21 Baoshan Iron and Steel Corp. took over Shanghai Metallurgy Group by order of the government. Baosteel had slightly more than 10,000 employees; Shanghai Metallurgy had about 120,000 employees. See South China Morning Post, Foo Choy Peng, “Link-up Approval Lays Foundation for World Heavyweight,” November 25, 1997; Matthew Miller, “Baogang Merger Raises Employment Question,” November 25, 1997. The second company taken over by Baosteel was Shanghai Meishan Group. See South China Morning Post, “Baoshan Becomes Giant After Merger,” November 18, 1998. 22 See Muzi.com Latelinews at http://dailynews.muzi.com/ll/english/9986.shtml.

Part III

Transparency and the rule of law Legal reform in China

8

Article X and the concept of transparency in the GATT/WTO Sylvia Ostry

Introduction I have often (only partly in jest) described the word transparency as the most opaque in the trade policy lexicon. This is because while it is considered one of the basic rules governing the postwar trading system as embodied in the GATT and now the WTO, its genesis is obscure, its definition – captured in Article X of the 1947 GATT (see Appendix) – imprecise, and the extent and nature of its implementation pretty well unknown. The use of the word transparency, however, has become so widespread that it has reached an exalted status – as argued in a column by William Safire of the New York Times (January 4, 1998). Its use now goes well beyond trade circles: as Safire notes, it is key to the “diplolingo” of arms control; it became the buzzword of the Asian financial crisis; and is an icon of civil society through Transparency International, an NGO created to expose and destroy bribery and corruption. It is important to assure the reader that the title of this chapter was not derived from Safire’s annointment of the term. The reason was that, however imprecise the GATT/WTO definition of transparency, the core of that definition goes to the heart of a country’s legal infrastructure, more precisely the nature and enforcement of its administrative law regime. And the current nature of China’s administrative legal infrastructure will require extensive transformation before full and effective WTO integration is possible. Without such transformation, Chinese accession could be seriously damaging to the long-term viability of the WTO. In the remainder of this chapter, I want first to review briefly the growing legalization of the trading system which makes the WTO, especially in this respect, a very different institution from its predecessor, the GATT. This legalization is largely a reflection of changes in US trade policy beginning in the latter half of the 1970s. Finally I shall examine the nature of administrative law in the context of the WTO/ China accession conditions which include, inter alia, a strong emphasis on transparency.

The legalization of the trading system The postwar architecture of international economic cooperation was largely the product of US leadership and, understandably, primarily reflected American values

124 Sylvia Ostry and views of that period.1 The idea of transparency as a norm for the trading system was based on US administrative law, a new legal terrain connected to the expanding role of government initiated by the New Deal. Indeed it was in 1946, while the negotiations for the new trading system were underway, that Congress codified views on the law of administrative procedure with passage of the Administrative Procedure Act. The September 1946 State Department document Suggested Charter for an International Trade Organization of the United Nations, Article 15, entitled “Publication and Administration of Trade Regulations – Advance Notice of Restrictive Regulations” – became Article 38 in the Havana Charter for the International Trade Organization and Article X of the GATT, which survived the death of the ITO.2 Article X’s title does not include “advance notice of restrictive regulations” but otherwise, there is no significant difference from the State Department drafting. By way of contrast most other articles of the original American proposals involved considerable haggling and compromise, especially with the British. The Canadians, who participated in the negotiations from their launch in London in October 1946 to their conclusion in Havana in November 1947, in a memorandum to the Secretary of State for External Affairs which tracks the negotiating process and the changes in each article at each stage, noted that Article 38 “was not altered nor were any interpretive notes” required. The memo goes on to state: “This article imposes no obligations upon Canada not already complied with, and the general benefit to international trade needs no elaboration.”3 Evidently each of the 56 delegations at Havana felt exactly the same! Why this indifference and/or endorsement of the American position as a pillar of the new international trading system? There is obviously no way of definitively answering this question, but a look at the nature and origins of administrative law are suggestive. Administrative law is not substantive but procedural. It establishes norms to control what government bureaucrats do and how they do it: one could say its essence is to prevent what Kafka depicted. It arose essentially because of the delegation of power from legislators to administrative bodies propelled by the expanded role of government in the industrialized countries that began in the 1920s and 1930s. While all Western countries developed administrative law regimes in the period after World War I, the American system has some characteristics which distinguish it from continental European regimes and also from the English common law legal family. The US system reflects not only its common law roots but also its origins in the American Revolution which created a unique diffusion of power among the three branches of government and a system of checks and balances intended to defend against any accretion of power. This is significantly different from common law parliamentary systems in the UK, Canada or Australia, which rest on legislative primacy and a strong executive. Among the more important distinguishing characteristics of the US system are a greater use of independent regulatory agencies, often with quasi-judicial as well as quasi-legislative and executive/administrative functions; a greater emphasis on a notice-and-comment for administrative rules and on and freedom of information laws; and a greater reliance on judicial review of the rule-making activity (as well as quasi-judicial actions) of

Article X and the concept of transparency 125 administrative agencies or departments. By and large, the US system is more adversarial and hence more fact- or evidence-intensive, and it is designed to have room for administrative discretion.4 Article X in the GATT replicates most of the American approach. The word transparency does not appear (Safire tracks its origin to the 1970s) but the article spells out in detail the rules for “publication and administration” of trade regulations with the latter emphasizing the desirability (rather than necessity) of independent tribunals and judicial review. Perhaps this “dilution” reflected a compromise with the UK in earlier negotiations or a recognition by the State Department that some of the participating countries had not yet fully established their legal infrastructure. Be that as it may, the inclusion of Article X on transparency at the time of GATT’s origin appeared to be non-controversial or perhaps, deemed insignificant to the drafters of the new system because in a very real sense, it was. The main focus of trade policy at the end of World War II was to reduce the border barriers erected during the 1930s with such disastrous results. Border barriers such as tariffs and quotas are, for the most part, quite transparent. Successive rounds of GATT negotiations in the 1950s and 1960s were termed the “golden age” of trade liberalization, defined implicitly as the reduction of border barriers. The onset of a different mode of trade liberalization began in the 1970s with the Tokyo Round. The mid-decade OPEC oil shock had produced a new economic malady termed “stagflation;” a marked increase in so-called “new protectionism” including voluntary export restraints (VERs), quasi-legal market sharing agreements (orderly marketing arrangements, or OMAs) and an explosion of subsidies to support declining industries – especially in Europe – adding to the enormous subsidy support in the Common Agriculture Policy. The GATT system was not equipped to handle either non-transparent measures such as VERs and OMAs or domestic declining industry strategies. The weak dispute settlement mechanism added to American frustration with system. The US administration’s response to the rise of the new protectionism was to begin the move of the trade policy agenda inside the border. The Tokyo Round included negotiations on trade-impeding barriers arising from domestic policies such as industrial and agricultural subsidies; government procurement and regulation of product standards; as well as a strengthening of anti-dumping rules to facilitate the use by business of its favorite remedy against “unfair” trade. Thus the focus of the Tokyo Round was, for the first time in GATT experience, no longer simply on reducing border barriers to trade. Rules governing domestic policy with trade spillover were now on the table. Perhaps increased legalization was inherent in the shift from reciprocal bargaining over tariffs to rule-making. But arguably more important was the changing nature of American trade policy. There was growing conviction among business groups and labour unions that other countries were engaged in unfair trade practices and that the “free ride” of the 1950s and 1960s had to stop. For the administration, the best option seemed to be a strengthening of the trade remedy laws. Congress demanded detailed legalistic prescriptions to prevent circumvention by any future administration unwilling to defend “national interests.” One notable result of the Tokyo Round was the

126 Sylvia Ostry enormous increase in anti-dumping use by both the US and the EU (and an equally impressive rise in American countervail actions against “unfair” subsidies) that marked the onset of the 1980s. This rise in the use of trade remedy laws was dubbed “administered protectionism.” One interesting side-effect of administered protectionism was the Canada–US Free Trade Agreement (CUSTA) of the late 1980s in which Canada, the demandeur, failed to persuade the US to abandon anti-dumping but did secure an agreement to a binational judicial review of domestic agency actions (Chapter 19). This is the first, but doubtless not the last, example of international administrative law designed to ensure due process. When the CUSTA became NAFTA, Mexico, with a civil rather than a common law inheritance, agreed to redraft its anti-dumping and countervail legislation to conform with US and Canadian statutes.5 Finally, the Tokyo Round also nudged transparency a bit further. An “Understanding Regarding Notification, Consultation, Dispute Settlement and Surveillance” was adopted at the close of the Round. Paragraph 3 of the Understanding introduces a modified version of surveillance and underlines the desirability of advance notice.6 These concepts are greatly expanded in the new WTO Trade Policy Review Mechanism which was promoted by the FOGS (Functioning of the GATT System) negotiating group in the Uruguay Round. The TPRM was based on the OECD “country studies” designed to enhance the effectiveness of the policymaking process through informed public understanding, i.e. transparency. If the Tokyo Round was the first step in trade policy legalization the Uruguay Round, launched in 1986, moved the regime much further down that road. This is best exemplified by the inclusion in the agenda of the so-called “new issues” of services, intellectual property and investment. The inclusion of the new issues was demanded by the Americans (and strongly opposed by a coalition of developing countries led by Brazil and India) to correct the basic structural asymmetry of the GATT which did not cover areas of current American preeminence that were of little significance after the war. However, the new issues were far more radical than simply a rebalancing of GATT structure. They exemplified a world of deepening integration toward a single global market. In trade policy terms, the barriers to access in these areas are not at the border but involve domestic regulatory regimes and domestic institutional infrastructure including, of course, formal legal regimes and enforcement practices. The regulatory regime covering financial markets or basic telecommunications services is established by substantive statutory law. But administrative law governs the procedure of the regulatory institutions. Now transparency has a radically different meaning. It would require publication of laws and regulations and the mode of administration in tradable services or, to a more limited extent, investment regimes. In the case of intellectual property, the US was primarily concerned with enforcement. So the agreement on TRIPS (traderelated aspects of intellectual property rights) included detailed enforcement procedure which mirrors step-by-step the administrative and judicial mechanisms in the United States. Further, to underline the legalization trend, an unprecedented feature of TRIPS permits a domestic challenge procedure and thus an avenue for

Article X and the concept of transparency 127 extensive and expensive litigation. This new and significant concept of “direct effect” is also included in the government procurement agreement and is likely to be a condition for any further negotiations on investment to begin in 1999. Finally, the TRIPS agreement underlines the transparency issue: the word is used as a heading in the relevant article. A separate council is established to which notification of regulations and administrative arrangements must be made and this council is mandated to monitor compliance. Disputes will come under the new quasijudicial arrangements which represent a major achievement of the Round and also, of course, underlines the legalization momentum. The Uruguay Round dealt with many other agenda items including traditional GATT-type negotiations on tariffs; the corrosive and long-standing issue of agriculture; and other “leftovers” from the 1970s such as the new protectionism. But in the present context – the issue of transparency and the implications for Chinese accession – the shift of trade policy inside the border has created a trading system profoundly different from that designed in the postwar world of shallow integration. And one key feature of that system is a vastly expanded concept of transparency including, as a central feature, the administrative law regime of WTO member countries. Let me turn, then, to China and the transparency issue as defined in the protocol of accession.

Chinese accession to the WTO The draft protocol of accession includes under the heading Administration of the Trade Regime a section on Transparency and a separate section on Judicial Review.7 The transparency section strengthens the original Article X in several significant ways including: ●

●

●

●

extension of coverage (including goods, services, TRIPS and foreign exchange control) publication before implementation with right of comment (a replication of the APA, which requires some sort of consultation phase)8 enforcement only of those laws and regulation that are published (Article X restricts this to any increase in barriers) a single inquiry point with a time limit for response (not in Article 8).

The judicial review section requires China to provide independent institutions for “prompt review” of all “administrative action.” This goes beyond the GATT Article X specification which allowed the “loophole” that even though such institutional arrangements are absent, alternative procedures which are provided for “objective and impartial review of administrative action” are acceptable. The challenges which these transparency and review requirements present to the Chinese legal system are formidable. Let us start with the most basic elements of transparency.

128 Sylvia Ostry

Publication of laws; enforcing only those laws that are published; right of comment The multilayered complexity of the evolving Chinese legal system makes this apparently simple and straightforward requirement impossible to implement at present. Although administrative procedural laws were passed in 1987 and 1989, they apply only to the top level of the legislative system which consists of the National People’s Congress; the Standing Committee – which is the operating arm of the Congress; and the State Council, which is the executive branch of government. The legislative and administrative action at the local level, which technically is controlled by Beijing, operates with very limited supervision and virtually no transparency. This opacity is the basis of the growth of what is termed “local protectionism,” a problem of growing concern to foreign investors and others. But that is not the only problem. Below the formal system of laws and administrative regulations is another body of “rules,” termed “normative documents,” used extensively, especially at the local level, by administrative bodies. Indeed they are a relic of the pre-reform period when legal mechanisms were largely absent. Whether they are legal or not (and no clear ruling exists) they are not published but are probably binding on the bureaucrats who use them. Beijing or rather the Ministry of Trade and Economic Cooperation is purportedly trying to eliminate them. While in October 1993 MOFTEC established its own Gazette for publication of all laws, regulations and administrative rules related to foreign trade and investments, this does not include state and local laws and of course excludes “normative documents.” Thus there is really no “single inquiry point” which is comprehensive in coverage. Further, to add to the problem, the Chinese laws tend to be highly generalized and absent specific procedures through or by which policy will be developed. This leaves enormous scope for the bureaucrats who implement them, since implementation requires specific regulations and procedures. While there is now an effort to improve legislative drafting, this too will take some time. In sum, given the present state of both substantive regulatory and administrative procedural law, China cannot fulfill this aspect of transparency. Trends underway suggest efforts to improve transparency, but it is not clear how long this would take. Further, without some rebalancing of legislative and administrative power, the opacity of local level rule-making will continue. Finally, another key feature of the Protocol is the “right of comment” rule based on the APA. No Chinese legislation, at either the highest level or the local level incorporates a mandatory requirement for consultation with either the general public or foreigners. While consultation does take place during legislative drafting (sometimes even with foreigners) there is virtually none for drafting implementing regulations, especially at the lower level.

Judicial review Turning to judicial review, the problems are equally challenging, albeit of a different nature. The essence of the problem is that there is no clear separation of powers in

Article X and the concept of transparency 129 China – only a separation of functions. There cannot be, therefore, an independent judiciary. This is entrenched in the new (1982) Constitution. If the courts cannot interfere in the exercise of the administrative powers of the state, it follows that it is not possible for China to fulfill the requirement in the draft Protocol for review of administrative actions. This characteristic of the current Chinese polity is worth underlining. As one noted expert on Chinese law has described it, while there has been an enormous increase in new laws and the role of lawyers since the onset of economic reform in 1978, these accomplishments have created legal institutions but not a legal system. There is no underlying principle that law is supreme. Although Chinese leaders talk about the rule of law, they seem to mean rule by law, which is to use rules as instruments to maintain social discipline rather than to limit the power of the state. The conflict between a rule of law and supremacy of the Chinese Communist Party has not even been addressed.9 Nowhere is this absence of the rule of law better exemplified than in the field of administrative law. Since the origin of administrative law in Western countries was the growth of government and the raison d’être of the law was to constrain this expanding administrative power – to control the bureaucrats – the profound cultural chasm between the Western legal families and the Chinese tradition, with deep historical roots in Confucianism, is indeed best exemplified in this legal domain. The Chinese image of the mandarin is not Kafkaesque. The poor training and qualifications of judges is not only due to the impact of Mao but also echoes a longer historical tradition. This impedes the capacity of China’s courts to compel production of evidence and enforce awards. The often parochial view (local protectionism) taken by local courts and security departments toward enforcement of judicial awards rendered outside the immediate area of jurisdiction reflects ingrained traditions of localism and the centrality of personal relations as the basis of behaviour.10 The problem of securing reliable information has created severe problems for the effective resolution of commercial disputes within China.11 Given the increasing legalization of the WTO dispute settlement mechanism which involves considerable evidentiary input, Chinese accession will certainly affect the functioning of the WTO. While convergence between the Western and Chinese legal cultures seems unlikely (except perhaps over the very long run) adaptations are plausible. First of all, it is important to underline that there are significant differences in the extent and nature of judicial review between the US version of common law and other versions of this legal family in English-speaking countries, as well as differences between common law and continental European systems. Moreover, the US system itself is changing. The reaction against the “big government,” launched in the New Deal and

130 Sylvia Ostry entrenched in the postwar welfare state (albeit less in the United States than any other OECD country), has given rise to a momentum to reinvent (or de-invent) government. As a recent analysis suggests, this proliferation of market-like approaches, often involving a mix of private and public actors, will generate a new administrative law requiring, inter alia, greater reliance on bargaining and negotiation models of decision-making by agencies and a new “doctrinal feasibility” for the courts. This is because “the automatic judicial imposition of ‘activist procedures’ in situations that call for more nuanced and efficient governmental approaches can be counter-productive.”12 These changes imply greater administrative discretion and a less litigious and adversarial system. Perhaps then, an incremental adaptation of the Chinese regime over a timecertain transition period is a more feasible approach today than it was in earlier decades when differences between the American and other regimes were so extreme. What would be required, however, is the coordination of the extensive legal assistance programs of both multilateral and bilateral agencies, plus an effective mechanism to link the technical assistance program with the WTO accession negotiations. A number of recent changes in Chinese administrative law suggest that there may be a receptivity to significant reform but also underline both the complexity and risks of doing nothing. Thus the Chinese Administrative Litigation Law (ALL) of 1990 gave the courts the power to review the lawfulness of administrative acts such as the imposition of fines; the denial of business licences; and the restriction of property rights. Moreover, ALL permits challenges against individual officials abusing their power to elicit bribes. But ALL excludes rule-making, standard setting and other administrative norm-making activity – in other words it omits most procedural activity.13 The ALL was followed by a flurry of other administrative statutes in the 1990s; perhaps “maze” would be a more appropriate noun to capture the current state as they hardly add to transparency of the system. While opening up an increasing number of channels for complaint, none of these statutes deals with the heart of the transparency conditions which are based on full information and a uniform administrative procedures regime grounded in the right of an individual to challenge a government official. Perhaps facilitating the establishment of something as “arcane” as WTO-compatible administrative norms and principles could throw light on something more fundamental than the transparency of the trading system, i.e. a rights-based regime. A similar view is expressed by William Alford, writing about the highly contentious problem of protecting intellectual property rights in China: If the purpose of US policy towards the PRC concerning intellectual property is to secure meaningful protection for American property interests, it is necessary, therefore, first to understand why such protection is no more readily available for the Chinese . . . [T]he most important factor in explaining the late appearance and relative insignificance of the idea of intellectual property in the Chinese world lies in what, for lack of a better term, we might describe as its political culture, and especially in the central importance of the state, for purposes of legitimation and power, of controlling the flow of ideas. A system of state determination of which ideas may or may not be disseminated is funda-

Article X and the concept of transparency 131 mentally incompatible with one of strong intellectual property rights in which individuals have the authority to determine how expressions of their ideas may be used and ready access to private legal remedies to vindicate such rights.14 Of course, political cultures change and the process of economic reform in China has already affected the pace and direction of that change. So, of course, will full and effective integration into the global economy through membership in international institutions such as the WTO.

Conclusion A key element in China’s accession to the WTO relates to the transparency of laws, regulations and other rules related to trade and investment. There is, at present, a very considerable mismatch between the WTO transparency requirements and the Chinese legal regime. A fundamental reason for the mismatch is embedded in historical and cultural traditions which will not and cannot be eliminated easily or quickly. While the legal reforms of the 1990s do point in a positive direction, they would not permit China to implement the transparency requirements of the WTO protocol. Without some new initiative to facilitate significant change in the administrative law regime, Chinese accession to the WTO will create serious problems both for China and for that institution. One aspect of the legalization of the system has been the juridification of dispute settlement arrangements. Panel judgments are increasingly based on more and more detailed information as this evidentiaryintensive mode of operation is seen as necessary in case of appeal. The accession of China could both overburden the dispute mechanism (if the weak record of Chinese enforcement of foreign arbitral awards does not markedly improve) and may create a very serious problem for both the panels and the WTO secretariat in securing relevant information. A series of dispute judgments against China would be seen by many Chinese as politically humiliating and could affect the support for reform. As noted earlier, some concerted and coordinated technical assistance program (possibly with the World Bank) plus a mechanism to link this program with the accession protocol would be essential if WTO membership is to serve the dual purpose of encouraging Chinese reform and strengthening the global rules-based trading system.

APPENDIX ONE

Article X Publication and administration of trade regulations 1

Laws, regulations, judicial decisions and administrative rulings of general application, made effective by any contracting party, pertaining to the classification

132 Sylvia Ostry

2

or the valuation of products for customs purposes, or to rates of duty, taxes or other charges, or to requirements, restrictions or prohibitions on imports or exports or on the transfer of payments therefor, or affecting their sale, distribution, transportation, insurance, warehousing, inspection, exhibition, processing, mixing or other use, shall be published promptly in such a manner as to enable governments and traders to become acquainted with them. Agreements affecting international trade policy which are in force between the government or a governmental agency of any contracting party and the government or governmental agency of any other contracting party shall also be published. The provisions of this paragraph shall not require any contracting party to disclose confidential information which would impede law enforcement or otherwise be contrary to the public interest or would prejudice the legitimate commercial interests of particular enterprises, public or private. No measure of general application taken by any contracting party effecting an advance in a rate of duty or other charge on imports under an established and uniform practice, or imposing a new or more burdensome requirement, restriction or prohibition on imports, or on the transfer of payments therefor, shall be enforced before such measure has been officially published. (a) Each contracting party shall administer in a uniform, impartial and reasonable manner all its laws, regulations, decisions and rulings of the kind described in paragraph 1 of this Article. (b) Each contracting party shall maintain, or institute as soon as practicable, judicial, arbitral or administrative tribunals or procedures for the purpose, inter alia, of the prompt review and correction of administrative action relating to customs matters. Such tribunals or procedures shall be independent of the agencies entrusted with administrative enforcement and their decisions shall be implemented by, and shall govern the practice of, such agencies unless an appeal is lodged with a court or tribunal of superior jurisdiction within the time prescribed for appeals to be lodged by importers; Provided that the central administration of such agency may take steps to obtain a review of the matter in another proceeding if there is good cause to believe that the decision is inconsistent with established principles of law or the actual facts. (c) The provisions of sub-paragraph (b) of this paragraph shall not require the elimination or substitution of procedures in force in the territory of a contracting party on the date of this Agreement which in fact provide for an objective and impartial review of administrative action even though such procedures are not fully or formally independent of the agencies entrusted with administrative enforcement. Any contracting party employing such procedures shall, upon request, furnish the CONTRACTING PARTIES with full information thereon in order that they may determine whether such procedures conform to the requirements of this sub-paragraph. (Source: WTO, Guide to GATT Law and Practice, Geneva, 1995)

Article X and the concept of transparency 133 APPENDIX 2

Federal Administrative Procedure Act 553.

Rule making

Parallel Sections of 1946 Act

Sec. 4(a).

Sec. 4(b).

Sec. 4(c).

(a) This section applies, according to the provisions thereof, except to the extent that there is involved— (1) a military or foreign affairs function of the United States; or (2) a matter relating to agency management or personnel or to public property, loans, grants, benefits, or contracts. (b) General notice of proposed rule making shall be published in the Federal Register, unless persons subject thereto are named and either personally served or otherwise have actual notice thereof in accordance with law. The notice shall include— (1) a statement of the time, place, and nature of public rule making proceedings; (2) reference to the legal authority under which the rule is proposed; and (3) either the terms or substance of the proposed rule or a description of the subjects and issues involved. Except when notice or hearing is required by statute, this subsection does not apply— (A) to interpretive rules, general statements of policy, or rules of agency organization, procedure, or practice; or (B) when the agency for good cause finds (and incorporates the finding and a brief statement of reasons therefor in the rules issued) that notice and public procedure thereon are impracticable, unnecessary, or contrary to the public interest. (c) After notice required by this section, the agency shall give interested persons an opportunity to participate in the rule making through submission of written data, views, or arguments with or without opportunity for oral presentation. After consideration of the relevant matter presented, the agency shall incorporate in the rules adopted a concise general statement of their basis and purpose. When rules are required by statute to be made on the record after opportunity for an agency hearing, sections 556 and 557 of this title apply instead of this subsection. (d) The required publication or service of a substantive rule shall be made not less than 30 days before its effective date, except— (1) a substantive rule which grants or recognizes an exemption or relieves a restriction; (2) interpretative rules and statements of policy; or

134 Sylvia Ostry (3) as otherwise provided by the agency for good cause found and published with the rule. (e) Each agency shall give an interested person the right to petition for the issuance, amendment, or repeal of a rule. Sec. 4(d).

Acknowledgements This chapter has been adapted with permission from the UCLA Journal of International Law and Foreign Affairs.

Notes 1 The analysis in this section is based on Sylvia Ostry, The Post-Cold War Trading System: Who’s on First?, University of Chicago Press, 1997. 2 World Trade Organization, Guide to GATT Law and Practice, Volume 1, WTO, Geneva, 1995, p. 309. 3 Canadian Legation, Report of the Canadian Delegation to the United Nations Conference on Trade and Employment at Havana, Berne, July 13, 1948, p. 32 (mimeo). 4 For a review of different administrative law regimes see Lief H. Carter, Administrative Law and Politics: Cases and Comments, Little, Brown and Company, Boston, MA, 1983: H. B. Jacobini, An Introduction to Comparative Administrative Law, Oceana Publications Inc., New York, 1991; John Peter Giraudo, “Judicial Review and Comparative Politics: An Explanation for the Extensiveness of American Judicial Review Offered from the Perspective of Comparative Government,” Hastings Constitutional Law Quarterly, vol. 6, no. 1137, Fall 1979, pp. 1137–1185: Peter H. Schuck, Foundations of Administrative Law, Oxford University Press, New York, 1994. 5 For a fuller exposition see Gil Winham, “NAFTA Chapter 19 and the Development of International Administrative Law: Application in Anti-Dumping and Competition Law,” Journal of World Trade, vol. 31, no. 1, February 1998. Winham argues that even in the WTO Antidumping Code, there is a move to international administrative review, but one far weaker than Article 19. The “standard of review” in the Code is weak largely because of opposition by both the EU and the US in the final bargaining stage of the Round. If it is strengthened in the next set of negotiations to begin in 1999 this will further reinforce the move to an international administrative law regime and create stronger pressure for regime convergence. 6 “Contracting parties moreover undertake, to the maximum extent possible, to notify the CONTRACTING PARTIES of their adoption of trade measures affecting the operation of the General Agreement, it being understood that such notification would be without prejudice to views on the consistency of measures with or their relevance to obligations under the General Agreement. Contracting parties should endeavour to notify such measures in advance of implementation. In other cases, where prior notification has not been possible, such measures should be notified promptly ex post facto. Contracting parties which have reason to believe that such trade measures have been adopted by another contracting party may seek information on such measures bilaterally, from the contracting party concerned.” WTO, op. cit., p. 300. 7 This section is mainly based on Sarah Biddulph, “Legal System Transparency and Administrative Reform,” China/WTO Project Background Paper, March 1997 (mimeo) and the chapter in this volume. 8 Sections 4(b), (c) and (d) of the 1946 APA. See Appendix Two. 9 Stanley B. Lubman, “There’s No Rushing China’s Slow March to a Rule of Law,” Los

Article X and the concept of transparency 135

10 11

12

13

14

Angeles Times, October 19, 1997, M2. For a fuller exposition of the implications of the law as an instrument of policy enforcement see Lubman, “Studying Contemporary Chinese Law: Limits, Possibilities and Strategy,” American Journal of Comparative Law, vol. 34, 1991. Pitman B. Potter, “China and the WTO: Tensions Between Globalization and Local Culture,” China/WTO Project Background Paper, March 1998 (mimeo), pp. 7–8. Donald C. Clarke, “Dispute Resolution in China,” Journal of Chinese Law, vol. 5, 1991; Pitman B. Potter, “Riding the Tiger: Legitimacy and Legal Culture in Post-Mao China,” The China Quarterly, June 1994; and Matthew Bersani, “The Enforcement of Foreign Arbitral Awards in China,” Journal of International Arbitration, vol. 10, no. 2, 1993. Alfred C. Aman Jr., “Administrative Law for a New Century,” in Michael Taggart (ed.) The Province of Administrative Law, Hart Publishing, Oxford, 1997, pp. 97 and 117. While the evolving US regime enhances administrative discretion, the new (1993) Japanese Administrative Procedures Law does not eliminate but does constrain the scope for “administrative guidance” largely as a result of American pressure over several decades. See Ken Duck, “Now that the Fog has Lifted: the Impact of Japan’s Administrative Procedures Law on the Regulation of Industry and Market Governance,” Fordham International Law Journal, vol. 19, no. 1686, 1993, pp. 1680–1763. See Pitman B. Potter, “Judicial Review and Bureaucratic Reform: The Administrative Litigation Law of the PRC,” in Potter (ed.) Domestic Law Reforms in Post-Mao China, M. E. Sharpe, Armonk, NY and London, 1994. William P. Alford, To Steal a Book is an Elegant Offense: Intellectual Property Law in Chinese Civilization, Stanford University Press, Stanford, CA, 1995, p. 119.

9

The evolution of law in contemporary China Challenges for WTO implementation Pitman B. Potter

Introduction: globalization and legal cultures Globalization has emerged as a dominant paradigm to explain transborder flows of goods and capital.1 Globalization of the liberal legal order is exemplified by efforts at unification of international commercial law, through conclusion of the Vienna Convention on Contracts for the International Sale of Goods (CISG),2 preparation of the draft Multilateral Agreement on Investment,3 and completion of agreements associated with the World Trade Organization.4 The CISG convention purports to establish uniform standards for international sales contracts.5 Work on the agreement was confined initially to processes within the UN Commission on International Trade Law (UNCITRAL), but interest in the treaty gradually increased on the part of the industrialized economies and particularly the United States, such that the final version drew heavily on liberal principles associated with the US Uniform Commercial Code.6 The abortive Multilateral Agreement on Investment, while limited by its terms to the OECD economies, stood as a model for a global investment protection treaty.7 The agreement embraced policy preferences of capital exporting economies with regard to property rights in foreign direct investment.8 The treaty also entrenched the principle that corporate actors should enjoy private rights of action against states, expanding on the arbitration provisions of International Centre for the Settlement of Investment Disputes (ICSID).9 The GATT also reflects the export of the liberal legal order, standing as the archetypal document underlying the international free trade system. Particular attention has been given to the broad themes of “most-favoured nation treatment” (GATT, Article I), “national treatment” (GATT, Article III) and “non-discrimination” (GATT, Article XIII), as well as the requirements on reducing and eliminating tariffs and trade subsidies.10 These derive from liberal principles accepting the theory of comparative advantage, which essentially relegates the role of government to promoting the efficiency and utility of a state’s existing or acquired economic attributes, and opposes state actions to inhibit the economic activities of other states through mercantilism and protectionism.11 Thus, the development of the international free trade system seeks to minimize the capacity for local interests to

Evolution of law in contemporary China 137 interfere with transnational economic relations.12 With the completion of the Uruguay Round of the GATT and the conclusion of the January 1995 Marrakesh Agreement, the GATT’s liberal market paradigm was given new enforcement reach through the formation of the World Trade Organization.13 Efforts at unification of international commercial law strive to integrate international economic norms with domestic institutions.14 Yet these approaches tend to reject or even ignore conflicts between liberal law norms and norms of local communities and cultures. The perceived perils of globalization have led to calls for greater controls over the relations between local communities and the global system.15 Indeed, the extent to which the international economic system remains dependent on the interaction of national economies has allowed states the opportunity to pursue nationalistic economic policies aimed at protecting local interests.16 Whether in pursuit of protecting local communities from the perceived deleterious effects of “globalization,” or merely to ensure that local elites gain advantage in their participation in the international economy, political leaders have used the rhetoric of sovereignty in attempts to insulate local economies and societies from international influences.17 Where trends toward global economic integration have undermined strict reliance on national sovereignty, regional economic arrangements have been accepted to balance the imperatives of local autonomy with participation in the world economy.18 Regionalism has been a particularly attractive theme in the context of developing economies, where export-led growth benefits from access to international markets, but where full integration in the world economy is seen as entrenching dependence on global capital markets.19 In the East Asian region especially, notions of “open regionalism” as envisioned by the APEC (Asia–Pacific Economic Cooperation Conference) forum, and even narrower interpretations of regional preferences, have played a significant role in the articulation of national policies aimed at balancing cooperation and protection in the interaction between local and international economies.20 These tensions between globalization and local legal culture are of particular interest in the context of the application by the People’s Republic of China for accession to the WTO. China’s application to resume its seat at the GATT and to join the WTO has generated a wide array of analysis and discussion in scholarly discourse as well as the popular media. 21 China’s attempts to rejoin the GATT/ WTO as well as to bring market reforms to its own domestic economy appear on the surface at least as persuasive evidence that the values of market liberalism are increasingly becoming universal.22 Yet, China’s accession bid has not been without controversy. The OECD countries and particularly EU members and the United States have expressed concerns over Chinese compliance with GATT principles.23 In China meanwhile, increased opposition has been raised to making further concessions as conditions for rejoining the GATT/WTO.24 This chapter will examine China’s WTO accession application in the context of tensions between the liberal regulatory norms of the GATT/WTO and China’s legal norms and regulation, dispute resolution and intellectual property protection.

138 Pitman B. Potter

Regulatory cultures: WTO liberalism and the challenge for China A key issue in the dissemination of GATT principles is the question of regulatory norms.25 Regulatory norms affect virtually all aspects of the relations between state and society, but are particularly important in economic relations. As the following discussion suggests, significant differences exist between the regulatory ethos of the GATT/WTO and the regulatory tradition and practices of China. The GATT places significant emphasis on state responsibility for compliance, and on regulatory transparency as the basis upon which the GATT’s substantive free trade principles rely. Compliance with GATT rules by signatory states is in part a matter of internal administration. Accordingly, Article XXIV(12) requires each contracting party to take “necessary measures” to ensure observance of the GATT by regional and local governments and authorities. This provision has been amplified by the “Understanding on the Interpretation of Article XXIV of the General Agreement on Tariffs and Trade” attached to the Uruguay Round.26 Signatory states are “fully responsible . . . for the observance of all provisions of GATT 1994” and are required to “take such reasonable measures as may be available . . . to ensure such observance by regional and local governments and authorities.” These requirements are linked to the enforcement of provisions on dispute resolution coming out of the Uruguay Round.27 In response to the requirements of Article XXIV(12), federal states adopt various approaches to ensure that their political subdivisions remain in compliance with GATT principles. In the United States, constitutional provisions accord the federal government exclusive jurisdiction over international trade and interstate commerce, and thus provide authority to bind states to GATT principles. However, even after Congress approved the GATT 1994 following the Uruguay Round, wariness over accession to the GATT still affects the dynamics of US compliance, which remains subject to the 1947 Protocol of Provisional Application.28 In Canada, the exclusive authority of the federal government to regulate international trade is less clear, and as a result Canada’s participation in GATT negotiations entails significant consultations with provincial authorities to obtain their commitments to comply.29 Under the Constitution of the PRC, China is a unitary state whereby provincial and local authorities are bound by decisions and edicts from the central government, subject to a modicum of consultation between central and local authorities.30 However, in recent years there has been a significant devolution of power from Beijing to the provinces and localities. The concentration of economic growth in the southern provinces, particularly Guangdong and Fujian, has decreased the capacity of the central government to control local behaviour through its traditional mechanisms of political patronage and financial allocations. 31 As well, the gradual dismantling of the state planning apparatus without the establishment of effective replacement institutions to regulate the newly emerging market economy has contributed to reduced government capacity to control local commercial behaviour.32 Beijing’s general inability to control the localities is compounded by the crisis of corruption, which not only undermines the regulatory authority and capacity of government institutions,33 but also extends even to the state’s own

Evolution of law in contemporary China 139 information-gathering processes, hampering the ability to manage policy effectively.34 These obstacles to central government control deminish China’s capacity to ensure that its political subdivisions reach compliance with GATT requirements, particularly in the foreign trade centres in the southern provinces. Enforcement of GATT rules is also dependent on the provisions of Article X requiring publication of trade regulations, and uniform, impartial and reasonable administration of laws and, regulations.35 The contracting parties are required to establish judicial, arbitral, or administrative tribunals or procedures for review and correction of administrative action regarding Customs matters (which include virtually all aspects of trade regulation). Thus the transparency and enforcement provisions of Article X provide the framework for implementing the substantive norms expressed elsewhere in the Agreement. For in the absence of transparency about the content and application of trade regulations, trading partners and their businesses cannot know whether or not the central GATT principles of free trade are being granted or denied. The substantive and operational norms complement each other and set the tone for GATT’s regulatory culture. However, liberal norms of transparency and uniform application of law and regulation are not widely accepted or enforced in China.36 The Final Protocol of Accession (2001) sets forth the general terms for China’s accession to the WTO, and suggests the extent to which China’s regulatory ethos remains at odds with GATT principles. Thus paragraph I.2.A.2 of the Protocol requires China to administer in a uniform, impartial and reasonable manner all its laws, regulations etc. governing trade and goods services, trade-related aspects of intellectual property rights and foreign exchange. Section I.2.A.4 requires China to establish a mechanism by which non-uniform application of the trade regime may be brought to the attention of the national authorities – implying the availability of a system of administrative review. Section I.2.C requires China to undertake significant transparency reforms, including publication of laws and regulations, while Section I.2.D requires China to establish a system of judicial review. In effect, the Final Protocol sets forth a program for bringing the Chinese regulatory system into compliance with the terms and principles of the GATT regime, while also suggesting that China has some distance to go in this regard. With the conclusion of the Uruguay Round, the norms of national treatment, most-favoured nation treatment, non-discrimination; and transparency were extended to inter alia dispute resolution, trade in services and intellectual property, with associated agreements being incorporated into the Marrakesh Agreement. Accordingly, China’s compliance with the GATT must extend beyond general principles and performance in government regulation generally, to include compliance with GATT norms on dispute resolution and intellectual property protection.

Dispute resolution: different approaches to enforcement of substantive norms Dispute resolution is essential to the process of empowering economic actors to seek enforcement of substantive norms of government regulation. Thus, institutions for

140 Pitman B. Potter resolving disputes are critical to lend meaning to substantive regulatory norms. A comparison of WTO norms on dispute resolution with Chinese norms reveals apparent convergence in form but significant divergence in substantive performance. The WTO dispute resolution understanding Appended to the Marrakesh Agreement is the “Understanding on Rules and Procedures Governing Settlement of Disputes.”37 The Understanding applies to disputes arising under the Marrakesh Agreement, as well as the associated agreements on trade in goods, trade and services, and trade-related aspects of intellectual property rights, as well as an array of plurilateral trade agreements on matters such as civil aviation, government procurement, dairy and bovine meat issues. The Understanding establishes a Dispute Settlement Body charged with hearing and resolving disputes between states member to the Marrakesh Agreement. While the Understanding has been seen as a significant improvement over the original GATT dispute resolution system that centred on non-binding panel decisions, the DSB still faces significant obstacles in assuring that its decisions are implemented. Article 21 of the Understanding provides for an ongoing surveillance of implementation of the DSB recommendations and ruling and authorizes the DSB to permit disputants to suspend trade concessions or other obligations in the event a DSB ruling in favour of such a party is not enforced by the other party. The Understanding also encourages parties to undergo arbitration in the settlement of disputes. This is augmented by the Protocol on China’s accession, which provides in Section I.2.D.2 for appeals without penalty by parties affected by administrative decisions on trade matters, thus encouraging affected parties to challenge improper administrative rulings. Dispute resolution in China China’s economic and legal reforms have seen significant attention paid to establishing and strengthening institutions for dispute resolution. Commercial litigation in China is generally handled by the People’s Courts, which have within them different specialized chambers that handle cases in distinct subject areas, such as criminal law, civil law, economic law, foreign business law, intellectual property law and administrative law. The overall jurisdictional structure is set forth in the Organic Law of the PRC for the People’s Courts (1979). The Supreme People’s Court, which administers the court system as a whole, also acts albeit infrequently as a trial court at the national level and as a court of last appeal. At the provincial and prefecture levels respectively the Higher and Intermediate Level People’s Courts hear appellate and trial cases. The Intermediate Level People’s Courts are nominally courts of first instance for cases involving foreigners, although it is common for commercial disputes involving foreign interests to be transferred to the provincial-level Higher Level People’s Courts. The Basic Level People’s Courts hear domestic trial cases at the county level. The procedural rules for civil litigation in the People’s Courts are set forth in the PRC Civil Procedure Law (1991, draft 1982). The People’s Courts are also involved in carrying out foreign arbitral awards under the New York

Evolution of law in contemporary China 141 Convention on the Recognition and Enforcement of Foreign Arbitral Awards, to which China acceded effective 1987.38 These institutional developments parallel a dramatic increase in the number and complexity of civil cases brought to litigation.39 Unfortunately, despite its increased role in dispute resolution and the increasing demand for its involvement, the Chinese court system continues to reveal significant problems of process and effectiveness. A legacy of traditional Chinese attitudes and Maoist influences has contributed to a low level of political status and authority for formal legal institutions generally, and this impedes the capacity of China’s courts to compel production of evidence and enforce awards.40 The often parochial view (referred to as “local protectionism”) taken by local courts and security departments toward enforcement of judicial awards rendered outside the immediate area of jurisdiction reflects ingrained traditions of localism and the centrality of personal relations as the basis for behaviour. Judicial processes of internal and informal factfinding and decision-making mean that disputants are seldom protected against abuses of power and political connections by their adversaries. As well, the Communist Party continues to play a dominant role through the adjudication committees attached to each court, which in effect review and approve judicial decisions notwithstanding official directives ordering that the intervention of adjudication committees be curtailed.41 Finally, corruption among judicial officials has become a serious problem, undermining confidence in the courts and the judiciary, and diminishing their capacity to resolve civil disputes reliably and consistently.42 These problems pose significant challenges to effective judicial resolution of the everincreasing numbers of commercial disputes that have accompanied economic reform. Aside from the judicial system, China has a variety of separate arbitration systems. Arbitration of disputes involving Chinese domestic enterprises may be handled by various administrative departments with jurisdiction over the subject matter: for example, labour disputes are handled by the local Labour Administration, while contract disputes are under the authority of the State Administration for Industry and Commerce.43 Under China’s Arbitration Law (1994), arbitration committees are being established under the local people’s governments to handle a wide array of economic disputes.44 Maritime disputes are subject to the China Maritime Arbitration Commission.45 Arbitration and conciliation between Chinese and foreign parties in economic and trade matters is under the jurisdiction of the China International Economic and Trade Arbitration Commission (CIETAC) under the China Council for the Promotion of International Trade in Beijing and its sub-councils in Shanghai and Shenzhen. The CIETAC Arbitration Rules have been amended several times over the past few years, to accommodate the concerns of foreign parties and to accord more closely with international practice. While arbitration proceedings are often perceived as reasonably fair and effective, problems remain. Requests for cooperation by other administrative units in the collection of evidence, seizure of assets, production of witnesses and other matters often go unheeded. As well, arbitrators are known to engage in what are essentially ex parte contacts with the disputants, either during the course of the mediation process that previously was intertwined with arbitration, or during the course of

142 Pitman B. Potter preparing the matter for hearing.46 While rules have been enacted requiring fairness and impartiality by arbitrators,47 such activities continue – supported by Chinese traditional norms regarding the judge/arbitrator, who is expected to meet regularly with disputants and personally investigate facts.48 Bureaucratic politics have also played a role, as Chinese courts continue to insist on subjecting arbitral decisions to extensive review prior to enforcement. In the area of international commercial disputes, China’s participation in the ICSID treaty remains voluntary, in accordance with the terms of the Washington Convention,49 and hence is of little help in forecasting China’s likely performance under the GATT Dispute Resolution Understanding. China’s performance in the context of anti-dumping cases originating in the United States and the European Community suggests a willingness to combine vigorous legal defenses with a general lack of cooperation in providing the evidence and information required by the process.50 However, China’s record of compliance with the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards has been undermined by the Revpower case.51 Revpower’s inability to enforce a Stockholm arbitral award in the amount of US$6.6 million plus interest against Shanghai Far East Aero-Technology Import & Export Corporation (SFAIC) is a well-known example of China’s apparent failure to abide by the terms of the New York Convention on Recognition and Enforcement of Foreign Arbitral Awards. Unfortunately, the Revpower case was no means the only instance where Chinese courts have refused enforcement of foreign arbitral awards.52 Summary: dispute resolution cultures in tension Even where the state expresses vigorous and consistent support for GATT principles, enforcement institutions remain critical. The dispute resolution principles articulated in the WTO Understanding on dispute resolution underscore the importance of national compliance with decisions by the DSB. As well, the Understanding contemplates referring to arbitration, which brings into play the New York Convention on Recognition and Enforcement of Foreign Arbitral Awards and the Washington ICSID Treaty. Thus, the dynamic of the WTO Understanding requires that national judicial systems act in compliance with existing international treaty obligations and norms, but in an expanded range of trade relations. While these principles are applied to China through the Protocol on China’s Accession, the institutions and practices of the Chinese dispute resolution system lag seriously behind. The local culture that informs the behaviour of Chinese legal institutions and actors continues to place a high priority on local parochial concerns and political arrangements. The increased numbers of commercial disputes brought on by the market reforms have created a certain degree of institutional competition for a share of the dispute resolution “market.”53 This may bode well for the emergence of independent and effective dispute resolution processes both in the courts and in arbitration. However, so far there is little to indicate that the competition for dispute resolution cases has motivated courts or arbitral organs to increase their autonomy and/or procedural rigour. Instead, institutional competition

Evolution of law in contemporary China 143 seems to be taking the form mainly of increased efforts to strengthen ties with government departments.54 The structural deficiencies of the Chinese court system, combined with the generally weak record of enforcement of foreign arbitral awards suggests that Chinese legal culture remains a dominant obstacle to compliance with international norms on dispute resolution, as reflected in the WTO Understanding.

Intellectual property protection: China and the TRIPs agreement Intellectual property rights offer a useful example of the significance of integrating substantive standards with mechanisms for enforcement. The standards for protection of patents, trademarks, copyright and trade secrets involve complex and highly technical substantive norms that are the basis for the protection of proprietary information. At the same time, however, the procedures and institutions for enforcing these norms are equally important. A comparison of the WTO’s intellectual property rules and the Chinese IPR system is particularly useful to illustrate the extent to which Chinese local cultural norms remain at variance with the liberal norms of the WTO. The WTO TRIPs Agreement Appended to the Marrakesh Agreement is the Agreement on Trade-Related Aspects of Intellectual Property Rights.55 The TRIPs Agreement incorporates into WTO system the provisions of the 1967 Paris Convention on Industrial Property, the 1971 Berne Convention on Copyrights and a number of other agreements. The TRIPs Agreement extends to seven categories of rights, including copyrights, trademarks, geographic indications, industrial designs, patents, integrated circuit designs and trade secrets. The Agreement incorporates principles of nation treatment and mostfavoured nation treatment, as these are already enshrined in the WTO and GATT and as they are provided for in the Paris and Berne Conventions. The TRIPs Agreement contains provisions against unfair competition, and particularly protects against the disclosure of privileged information. Of particular importance in the TRIPs Agreement is Part III on enforcement of intellectual property rights. This section requires that the member states ensure that enforcement procedures are available to permit affective action against infringement of intellectual property rights. This includes civil and administrative procedures and remedies through the use of judicial and administrative tribunals. Particular emphasis is given to the role of injunctions and that the payment of compensatory remedies. As well, the TRIPs Agreement incorporates GATT principles of transparency, and requires the member states to publish laws and regulations as well as final judicial decisions and administrative rulings of general application, and also provide for the release of judicial and administrative decisions and rulings to interested parties whose rights may be affected by them. In conformity with the growing demands for treaty-based remedies, the TRIPs Agreement provides for judicial injunctive relief and contemplates private damage awards to compensate for infringement. In sum, the TRIPs Agreement establishes substantive standards for

144 Pitman B. Potter the protection of intellectual property rights consistent with the international treaty regimes, principles for enforcement, and principles of transparency. Chinese approaches to international IPR norms China’s approach to conformity with international regimes such as the WTO can be identified by reference to the conflicting Chinese approaches to compliance with various bilateral Memoranda of Understanding (MOU) with the United States between 1989 and 1995.56 China executed various MOU with the United States dated 1989, 1992 and 1995, which imposed specific obligations on China to improve its IPR regime. These agreements grew out of the 1979 US–China Trade Agreement and reflected US efforts to use formal agreements to bind China to comply with general provisions of multilateral treaties. The three Sino-US MOU also reflected the ongoing tensions between China’s emphasis on legislation and rule-making in IPR enforcement,57 and the attention given by the US and many of China’s other foreign trading partners to practical implementation. US–China MOU no. 1 (1989) Under the 1979 Trade Agreement with the United States, China agreed that patent, trademark and copyright protection for US firms and individuals should be commensurate with US protections in these areas offered to Chinese parties. Ten years later, the US government and many US companies believed that China’s IPR system remained inadequate. China was one of nine nations and regions (including Taiwan) placed on the “priority watch list” in 1989 when the Special Section 301 provisions of the US Trade Act became effective. In order to avoid the imposition of trade sanctions, China agreed in May 1989 to a Memorandum of Understanding with the US that contained broad language about improving IPR protection. In the agreement, China stated that it was actively studying the possibility of joining various international IPR conventions, but agreed to a number of specific steps as well. The 1989 MOU committed China to introducing copyright legislation by the end of the year, which would include computer software as a category of protected work. China also agreed to revise its patent law by the end of 1989 to extend the duration of patent protection and expand its scope in accord with international practice. Although not stated explicitly, the intent of this provision was, inter alia, to lengthen the period of protection from the then-current fifteen years for inventions and five years for utility models and industrial designs, and to permit Chinese patent protection for chemical formulas. In return the US agreed to drop China from the priority watch list. In large part as a result of the 1989 MOU, China enacted a Copyright (“Authorship Rights”) Law. Protected works include printed, visual and audio material, as well as diagrams, designs and computer software. While copyrights generally belong to the creator of a work, they may attach to an employer or other legal entity if the work is created in the course of employment or completed primarily with material support from an employer. The right of a creator to publish,

Evolution of law in contemporary China 145 use and receive compensation for a work is the life of the creator plus 50 years if a natural person and 50 years if a legal person, such as a business association. For natural or legal persons in China a copyright comes into existence upon the date of the creation of the work. For foreigners a copyright begins on the date that the works are first published in China, or for works published outside of China, within 30 days after initial foreign publication.58 The Copyright Law does not specifically protect the works of foreigners first published outside of China, but leaves this to multilateral or bilateral agreements to which China is a party. Infringement is defined under the Copyright Law to be the publishing or reproducing of another’s work without permission, or using the work without providing compensation. lnfringers may be required to discontinue the infringement, eliminate the damages of the creator, pay compensation, or make a public apology. There are no criminal sanctions. Infringement disputes may be resolved by conciliation, arbitration, or court adjudication. While the Copyright Law included software as a protected item, it stated that software would be addressed in a separate set of rules.59 On 1 October 1991 China promulgated the Computer Software Protection Regulations,60 which provide protection for computer software that is either first published in China or created by the nationals of countries that have entered into bilateral agreements with China or multilateral agreements to which China is a party. While concerns remain over the provision for registration of software as a condition for receiving protection, the regulations were seen as a major first step toward effective protection of foreign software. US–China MOU no. 2 (1992) Although the 1989 MOU was significant in terms of identifying problems, it was flawed by an absence of detail. While China believed that it had satisfied the requirements the Agreement – and indeed China did enact a Copyright (Authorship Rights) Law effective in 1991, the US believed that China had failed to comply in other respects. Particular issues included copyright protection for software, patent protection to pharmaceuticals and other chemicals and better enforcement. As a result of these concerns, the US placed China on the “priority foreign country” list yet again in 1991. In January 1992 a second MOU was entered into between the US and China by which China agreed to accede to the Berne Convention on Protection of Literary and Artistic Works by October 1992,61 and to amend its newly enacted Copyright Law and issue new regulations in order to implement the convention. The Convention permits foreign copyright owners to obtain rights of priority for copyrighted property first registered outside of China.62 China also agreed to limit its compulsory licensing provisions. China agreed to extend copyright protection to existing literary works and sound recordings as well as to new works, and agreed that computer software would be protected as a category of literary work for a period of 50 years. In the patent area, China agreed to extend the duration of patent protection to 20 years, and to afford patent protection to chemical substances (including pharmaceuticals and agricultural chemicals). Finally, China agreed to introduce legislation for protection of trade secrets.

146 Pitman B. Potter US–China MOU no. 3 (1995) While the 1989 and 1993 MOU were aimed primarily at encouraging China to step up its law-making efforts, the third MOU signed in 1995 focused primarily on enforcement. By mid-1994 the USTR determined that China was not enforcing the intellectual property laws that it had enacted, particularly with respect to copyrightable material such as computer software and compact discs (CDs). China was again placed on the Special 301 priority watch list, and in February 1995 the US announced the imposition of 100 percent tariffs on $1.08 billion worth of Chinese imports. One day before the tariffs were to go into effect, China signed another MOU containing two major components: first, an exchange of letters between PRC Minister of Foreign Trade and Economic Cooperation (MOFTEC) Wu Yi, and US Trade Representative Ambassador Mickey Cantor, and second, an Action Plan for better protection of intellectual property rights. The exchange of letters reviewed the Chinese side’s accomplishments since the conclusion of the 1992 MOU, and set forth each side’s commitments for future cooperation in IPR matters. China agreed to a number of general points, including: ●

● ●

continuing to permit US individuals and entities to enter into revenue sharing arrangements with Chinese entities under licensing agreements; adhering to principles of non-discrimination and non-arbitrariness; avoiding restrictions in trade in the course of enacting measures to protect public morals or public order.

For its part, the US agreed to provide assistance regarding the protection and enforcement of intellectual property rights, and to provide cooperative and reciprocal assistance by US Customs. Under the most recent Sino-US MOU, the Action Plan for compliance is particularly noteworthy. The Action Plan contemplated a three to five year sustained enforcement effort by the Chinese State Council’s IPR Working Conference (Bangong huiyi) to improve enforcement of intellectual property rights, and to strengthen dissemination of information and training. The Working Conference was established to replace what formerly had been a leading small group (LSG) in charge of intellectual property. Headquartered at the State Science and Technology Commission (SSTC), the Working Conference is an inter-agency liaison group with counterparts at the Provincial Science and Technology Committees. The Action Plan’s enforcement system also envisioned the creation of Task Forces responsible for intellectual property protection and enforcement. These Task Forces are to operate independently under the authority of their respective convenors, the National Copyright Administration, the State Administration for Industry and Commerce, the Patent Office, the police and so on. Thus, while the Working Conference is an effort at inter-agency cooperation, the enforcement Task Forces are aimed at pursuing enforcement within specific spheres of jurisdiction. As with the Working Conference, the task forces are mandated by the Action Plan to maintain public contact information and be accessible to foreign and domestic intellectual property rights-holders.

Evolution of law in contemporary China 147 In compliance with the requirements of the 1995 Sino-US MOU and the attached Action Plan, the State Council’s Intellectual Property Working Conference has begun issuing annual reports on the status of intellectual property enforcement in China. The 1995 annual report, issued 17 June 1996 focused primarily on piracy in CD factories.63 The report reviewed actions by the Chinese government to close twelve licensed CD factories and three underground factories involved in CD piracy, and specified that underground CD factories are to be closed whenever discovered. The report also notes a prohibition on establishing new factories, and cites title verification procedures involving the use of SID codes to confirm lawful ownership of CDs in the future. In addition the 1995 report reviewed the activities of the Ministry of Public Security in including IPR crimes as part of the broader “strike hard” campaign. The 1995 report also addressed border enforcement in the areas of prohibiting imports and exports of pirated CDs, CD-ROM, laser disks and video compact disks (VCDs), as well as production equipment. Enforcement provisions include increased inspections of CD plants, and a commitment to share information with the US side. Other measures by the Chinese government discussed in the report include efforts to inform and encourage Chinese publishing houses in the area of licensing agreements for audio-visual, motion picture and print media publications. The 1996 report resulted in an agreement by the US not to impose sanctions on US$2 billion worth of Chinese imports. The 1996 annual report that was published in May 1997 is somewhat broader in scope. The report addresses the expansion of China’s patent application review system and addresses efforts to strengthen enforcement of trademark rights.64 The report reviews the work of the PRC Ministry of Culture in exercising supervision over the audio-video market, which work has extended to confiscating and destroying unlawful audio-video products on grounds either of unlawful copying or violations of content rules. The 1996 report continues the previous year’s review of the Ministry of Public Security’s “strike hard” campaign on pornographic and pirated CDs. The report also addresses continuing work in the area of customs and border controls, while addressing new initiatives in public education. The annual reports issued by the Chinese government on intellectual property enforcement represented an effort to provide regular monitoring and reporting on implementation of the action plan appended to the 1995 MOU. While the reports provide important information on China’s enforcement efforts, it remains uncertain whether these efforts have become fully institutionalized, or remain the product of periodic campaign-style measures. Despite provisions permitting parties claiming infringement to bring action directly to the courts, little effective support is provided to private litigation in pursuit of compensatory remedies.65 Instead, enforcement remains largely in the hands of local administrative agencies.66 Aside from the very real problems that exist where local regulators have parochial interests that discourage them from pursuing infringement cases vigorously, there remains the problem that local enforcing agencies lack the power to prohibit and punish infringements. The sanctions permitted under the relevant intellectual property laws and regulations emphasize cease and desist orders and the role of apology in resolving infringement problems.67 Even where a penalty is levied, enforcement

148 Pitman B. Potter requires intervention by the local Public Security Bureau (possibly, but not always with involvement by the local Procuracy or People’s Court), whose local parochial interests are not served by vigorous actions against local enterprises.68 As a result, effective action against infringers is often delayed or prevented altogether. Although there appears to be gradual realization at the central level of importance of IPR enforcement, the resources and political will necessary to restructure the political and economic interests at the local level in order to make IPR enforcement a reality will be substantial. Summary: IPR regimes in tension The WTO TRIPs Agreement places considerable emphasis on the interplay between substantive standards and enforcement procedures. The Agreement adopts World Intellectual Property Organization (WIPO) standards, and makes specific reference to the Paris Convention, the Berne Convention and other sources of substantive norms. However these do not operate in isolation, but rather are integrated into principles of enforcement which emphasize injunctive relief and private compensatory remedy within a broader context of judicial and administrative enforcement procedures. While the Chinese IPR system has to a large extent adopted substantive standards for protection of patents, trademarks, copyrights, and trade secrets, these are not well integrated into the enforcement system. Enforcement remains the produce of highly publicized political campaigns – often which give primary attention to the security apparatus, as the Public Security Bureau and the Cultural Market Administrative Bureau take the lead role in the activities of the enforcement task forces. Moreover, public and punitive sanctions are generally given priority over private compensatory remedies. While China can point with justification to its legislative accomplishments in the IPR field, the essential component of a globalized IPR system as expressed in the TRIPs Agreement emphasizes enforcement. In this area, the resiliency of Chinese legal culture and its emphasis on political tutelage and public/penal sanctions remain significant impediment to the assimilation of globalized norms.

Conclusion The WTO represents in part an effort to internationalize various principles of free trade, such as uniform standards, enforceability and transparency. Successful management of China’s accession to the WTO will require not only that China express formal acceptance of these provisions, but also that conditions in China be conducive to their implementation. These conditions include vigorous and consistent government support for GATT principles, institutional mechanisms for enforcement, and effect local compliance. Chinese institutions and processes for commercial regulation, dispute resolution and intellectual property face significant challenges in ensuring meaningful compliance with GATT free trade principles.

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Notes 1 See generally, T. McGee, “Editor’s Introduction,” Pacific Affairs, 1997, vol. 70, p. 1; L. W. Pauly, “Capital Mobility, State Autonomy and Political Legitimacy,” Journal of International Affairs, 1995, vol. 48, p. 373. 2 “U.N. Doc. A/Conf.97/18, Annex I,” 11 April 1980, International Legal Material, 1980, vol. 19 (entered into force 1 January 1988). For discussion of the CCISG’s role in unifying international private law, see J. Spanogle, “The Arrival of Private International Law,” George Washington Journal of International Law and Economics, 1991, vol. 25, p. 477. 3 See e.g. J. Thomas, “A First Look at the Multilateral Agreement on Investment,” presented to the 27th Annual Workshop on Commercial and Consumer Law, UBC Faculty of Law, 17–18 October 1997. Also see T. Clarke, “The Corporate Rule Treaty,” manuscript, 1997. 4 See generally, J. H. Bello and M. E. Footer, “Preface to Symposium: Uruguay Round GATT/WTO,” The International Lawyer, 1995, vol. 29, p. 335. 5 U.N. Doc. A/Conf.97/18, Annex I, 11 April 1980 (entered into force 1 January 1988). For discussion of the CCISG’s role in unifying international private law, see J. Spanogle, op. cit. 6 See collected articles on the CISG convention in Cornell International Law Journal, 1988, vol. 21 and Journal of Law and Commerce, 1988, vol. 8. 7 See e.g. J. Thomas, op. cit. Also see T. Clarke, op. cit. 8 For discussion on long-standing US policy, see Bilateral Investment Treaties: Hearings Before the Senate Foreign Relations Committee, 9 August 1988, 100th Congress, Second Session; “United States Government Policy on International Investment,” Weekly Compilation of Presidential Documents, 9 September 1983, vol. 19, p. 1214. 9 See “Convention on the Settlement of Investment Disputes Between States and Nationals of Other States,” UNTS, 1966, vol. 575, p. 160; I. F. I. Shihata, Towards a Greater Depoliticization of Investment Disputes: The Roles of ICSID and MIGA, Washington, DC, ICSID, 1993. Also see T. L. Brewer, “International Investment Dispute Settlement Procedures: The Evolving Regime for Foreign Direct Investment,” Law and Politics in International Business, 1995, vol. 26, p. 633. 10 See text of the General Agreement on Tariffs and Trade, in Basic Instruments and Selected Documents (BISD). Among the many useful treatises on the GATT are J. H. Jackson, World Trade and the Law of GATT, Indianapolis, IN, Bobbs-Merrill, 1969; F. Stone, Canada, the GATT and the International Trade System, 2nd edn, Montreal, Institute for Research on Public Policy, 1992. 11 For a skeptical review, see generally B. S. Brown, “Developing Countries in the International Trade Order,” Northern Illinois University Law Review, 1994, vol. 14, p. 347. For discussion of the role of governments in directing foreign trade policy, see B. J. Cohen, Crossing Frontiers: Explorations in International Political Economy, Boulder, CO, Westview, 1991. 12 See E. M. Fox and J. A. Ordover, “Internationalizing Competition Law to Limit Parochial State and Private Action: Moving Towards a Vision of World Welfare,” International Business Lawyer, 1996, vol. 24, p. 453. 13 For an excellent treatise on the World Trade Organization, see J. S. Thomas and M. A. Meyer, The New Rules of Global Trade: A Guide to the World Trade Organization, Scarborough, Ont., Carswell, 1998. For documentation and commentary, also see International Legal Material, 1994, vol. 33, p. 1125 et seq. 14 See e.g. P. T. B. Kohona, “The Implementation of International Economic Agreements Within Municipal Legal Systems and Its Implications,” Washington University Law Quarterly, 1987, vol. 65, p. 842.

150 Pitman B. Potter 15 See e.g. S. S. Silbey, “‘Let Them Eat Cake’: Globalization, Postmodern Colonialism, and the Possibilities of Justice,” Law and Society Review, 1997, vol. 31, p. 207. Also see generally, W. M. Corden, Trade Policy and Economic Welfare, Oxford, Clarendon Press, 1974. 16 See generally, M. Obstfeld and K. Rogoff, Foundations of International Macroeconomics, Cambridge, MA, MIT Press, 1996. 17 See e.g. L. W. Pauly, op. cit., p. 369; S. Sassen, Losing Control? Sovereignty in an Age of Globalization, New York, Columbia University Press, 1996. 18 See e.g. M. P. Van Dijk and S. Sideri (eds) Multilateralism versus Regionalism: Trade Issues After the Uruguay Round, London, Frank Cass, 1996; R. Faini and E. Grilli, Multilateralism and Regionalism after the Uruguay Round, New York, St. Martin’s Press, 1995; H. G. Preusse, “Regional Integration in the Nineties: Stimulation or Threat to the Multilateral Trading System,” Journal of World Trade, 1994, vol. 28, p. 147; A. Wyatt-Walter, “Regionalism, Globalization, and World Economic Order,” in L. Fawcett and A. Hurrell (eds.) Regionalism in World Politics, Oxford, Oxford University Press, 1995; S. Hainsworth, “Sovereignty, Economic Integration, and the World Trade Organization,” Osgoode Hall Law Journal, 1995, vol. 33, p. 583. 19 See e.g. S. Haggard, Developing Nations and the Politics of Global Integration, Washington, DC, Brookings Institution, 1995; B. S. Brown, op. cit. 20 See e.g. M. Pierson, “East Asia – Regional Economic Integration and Implications for the United States,” Law and Policy in International Business, 1994, vol. 25, p. 1161; M. Rudner, “Cooperation in the Asia Pacific Area,” Transnational Law and Contemporary Problems, 1994, vol. 4, p. 159; M. Sornarajah, “Protection of Foreign Investment in the Asia-Pacific Economic Co-operation Region,” Journal of World Trade, 1995, vol. 29, p. 105. 21 See e.g. M. Oksenberg (ed.) China’s Participation in the IMF, the World Bank and GATT: Toward a Global Economic Order, Ann Arbor, MI, University of Michigan Press, 1990; S. MacCormac, “Eyeing the GATT,” The China Business Review, March–April 1993, p. 34; and T. Benson, “Will this Year’s Financial Reforms Qualify China for the WTO?”, China Law and Practice, October 1996, p. 19. For discussion of implications for Taiwan, see J. V. Feinerman, “Taiwan and the GATT,” Columbia Business Law Review, 1992, vol. 1, p. 39. 22 For discussion of the potential for universal values accross cultures, see P. de Cruz, A Modern Approach to Comparative Law, Deventer, Kluwer, 1993. 23 One useful expression of these concerns is contained in the 1997 Draft Protocol on China, prepared by the Working Party on the Accession of China to the WTO. While this document emerged from extensive negotiations between the WTO Working Party and the Chinese, it nonetheless contains useful examples of the concerns raised by the US and other OECD countries on issues such as transparency, enforcement, etc. 24 See e.g. “China Sets Deadline for GATT Re-entry, Slams US ‘Road Blocks’,” Agence France Presse English Wire, in China News Digest, online (10 July 1994); “Foot-stomping Helps China in GATT Bid,” South China Morning Post, in China News Digest, online (1 August 1994); “China Vows Not to Beg for WTO Membership,” China News Digest, online (23 September 1995). 25 For discussion of norms, see H. Kelsen, General Theory of Norms, M. Hartney (trans.) Oxford, Clarendon Press, 1991. For application in the context of regulation of competition, see P. P. Craig, Administrative Law, 3rd edn, London, Sweet & Maxwell, 1994, pp. 221ff. Also see P. Bryden, “Canadian Administrative Law: Where We’ve Been,” Queens Law Journal, 1991, vol. 16, p. 7. 26 See International Legal Material, 1994, vol. 33, p. 1161. 27 See ibid., p. 1226. 28 See generally D. F. Vagts, Transnational Business Problems, 2nd edn, Mineola, NY, Foundation Press, 1998, pp. 35–40. 29 See J. G. Castel et al., The Canadian Law and Practice of International Trade, 2nd edn, Toronto, Edmond Montgomery Publications, 1997, pp. 21–26. 30 See Constitution of the PRC, 1982, 1993, Art. 3. Also see K. Lieberthal, Governing China: From

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41 42

43 44 45

Revolution through Reform, New York, W. W. Norton, 1995, ch. 6; A. H. Y. Chen, An Introduction to the Legal System of the People’s Republic of China, Singapore, Butterworths, 1992, ch. 4. See State Statistical Bureau, China Statistics Yearbook (annual). Also see generally, D. S. G. Goodman and G. Segal (eds) China Deconstructs, London, Routledge, 1994. See generally essays by R. Dernberger, J. Oi and D. Solinger at “Conference on the PRC at Fifty,” organized by the Universidade de Aveiro and The China Quarterly, 28–31 January 1999. Also see B. Naughton, Growing Out of the Plan, New York, Cambridge University Press, 1995. See Xinhua reporting on PRC Supreme People’s Court President Ren Jianxin’s reports to the First Session of the Eighth National People’s Congress, 22 March 1993, in “Court President Ren Jianxin Reports to Session,” FBIS Daily Report-China, 23 March 1993, pp. 40–42. Also see generally J. Kohut, “Going to War on Corruption,” South China Morning Post, 17 April 1994, p. 5. See generally C. Feng, “Dalu [Wu gua feng] meng gua bu zhi” (The wind of corrupt reporting in the Mainland is blowing unceasingly), Zhengming (HK), April 1994, no. 198, p. 19. See text of the General Agreement on Tariffs and Trade, in Basic Instruments and Selected Documents (BISD). Among the many useful treatises on the GATT are J. H. Jackson, op. cit.; F. Stone, op. cit. See generally, S. Lubman, “Introduction: The Future of Chinese Law,” The China Quarterly, 1995, no. 141, pp. 1–21. See International Legal Material, 1994, vol. 33, p. 1226. Also see generally, M. K. Young, “Dispute Resolution in the Uruguay Round: The Lawyers Triumph Over Diplomats,” The International Lawyer, 1995, vol. 29, p. 389; G. R. Shell, “Trade Legalism and International Relations Theory: An Analysis of the World Trade Organization,” Duke Law Journal, 1995, vol. 44, p. 829. See “Convention on the Recognition and Enforcement of Foreign Arbitral Awards,” TIAS 6997, UNTS, vol. 330, p. 3; Supreme People’s Court of the PRC, “Notice Concerning the Enforcement of United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards Acceded to by Our Country,” 10 April 1987, Circular no. 5; C. Salbaing, “Dispute Settlement in China,” in Streng & Wilcox, Doing Business in China, Irvington-on-Hudson, NY, Transnational Juris, looseleaf, ch. 21. For case reporting, see e.g. Liu Zhun (ed.) Renmin fayuan anli (Selected Cases of the People’s Courts) Beijing, People’s Courts Publishing House, 1992; PRC Senior Judges Training Centre and People’s University of China Law Faculty (eds) Zhongguo shenpan anli yaolan (Collection of Judicial Decision in China), Beijing, Public Security Press, 1993. See generally D. C. Clarke, “Dispute Resolution in China,” Journal of Chinese Law, 1991, vol. 5, p. 245; S. B. Lubman, “Studying Contemporary Chinese Law: Limits, Possibilities and Strategy,” American Journal of Comparative Law, 1991, vol. 39, p. 333; P. B. Potter, “Riding the Tiger: Legitimacy and Legal Culture in Post-Mao China,” The China Quarterly, June, 1994, vol. 138, p. 325. See S. B. Lubman, “Introduction,” in P. B. Potter (ed.) Domestic Law Reform in Post-Mao China, Armonk, NY and London, M. E. Sharpe, 1994. See acknowledgement of the problem of judicial corruption in the reports on the work of the Supreme Court and the Supreme People’s Procuracy to fifth meeting of the NPC’s Internal and Judicial Affairs Committee, in FBIS-CHI-98–260, 17 September 1998. See “Regulations on Arbitration for Economic Contracts of the People’s Republic of China,” in Chinese Laws for Foreign Business, looseleaf, para. 10–620. See “Arbitration Law of the People’s Republic of China,” in Chinese Laws for Foreign Business, para. 10–470(8), Art. 10 et seq. See “Arbitration Rules of the China Maritime Arbitration Commission issued by the China Council for the Promotion of International Trade,” in Chinese Laws for Foreign Business, para. 10–545.

152 Pitman B. Potter 46 For examples, see H. Yanming, “The Stylization and Regularization of the Management and Operation of the Chinese Arbitration Institute,” Journal of International Arbitration, 1994, vol. 11, p. 77 and “Mediation in the Settlement of Business Disputes,” Journal of International Arbitration, 1991, vol. 8, p. 23. 47 See H. Yanming, “The Ethics of Arbitrators in CIETAC Arbitration,” Journal of International Arbitration, 1995, vol. 12(2), p. 5. 48 See generally D. Bodde and C. Morris, Law in Imperial China, Philadelphia, PA, University of Pennsylvania Press, 1967, pp. 5–6; A. Coates, Myself a Mandarin, London, Frederick Muller, 1968; and R. Van Gulik, Celebrated Cases of Judge Dee, New York, Dover Publications, 1976. 49 For discussion of the ICSID Convention, see Soley, “ICSID Implementation: An Effective Alternative to International Conflict,” The International Lawyer, 1985, vol. 19, p. 521. 50 See generally L. Bellocchi, “The Effects of and Trends in Executive Policy and Court of International Trade (CIT) Decisions Concerning Antidumping and the Non-Market Economy (NME) of the People’s Republic of China,” New York International Law Review, 1997, vol. 10, p. 177, esp. pp. 203–211 and cases cited. 51 Details of the Revpower case are set forth in A. Mora, “The Revpower Dispute: China’s Breach of the New York Convention?” in China Law and Practice (ed.) Dispute Resolution in the PRC: A Practical Guide to Litigation and Arbitration in China, Hong Kong, China Law and Practice, 1995, p. 151. Also see testimony of R. A. Aronson, CEO of Ross Engineering before the House Ways and Means Trade Subcommittee, 23 May 1995, Federal Information Systems, 1995. 52 See generally M. Bersani, “The Enforcement of Foreign Arbitral Awards in China,” Journal of International Arbitration, 1993, vol. 10, p. 47. 53 For dicussion in the context of private international commercial arbitration institutions, see Y. Dezalay and B. Garth, “Merchants of Law as Moral Entrepreneurs,” Law and Society Review, 1995, vol. 29, p. 27. 54 For a preliminary discussion, see S. B. Lubman, “Setback for the China-Wide Rule of Law,” Far Eastern Economic Review, 17 November 1996, p. 38. 55 See International Legal Material, 1994, vol. 33, p. 1197. 56 The discussion in this section is drawn from P. B. Potter, “Comments on International and Bilateral Treaties,” Asia Law and Practice (ed.) Protection of Intellectual Property in China: The Law, Hong Kong, Asia Law and Practice, 1996. 57 Indeed, the PRC “White Paper on Intellectual Property Rights,” 1994, makes little effort to articulate specific proposals to improve China’s intellectual property protection system. See “White Paper in Intellectual Property Protection.” Also see “China Defends Copyright System Ahead of US Sanction Threat,” Agence France Presse English Wire, in China News Digest, online (16 June 1994). 58 See Copyright Implementing Rules, Art. 25. 59 See Copyright Law, Art. 53. 60 See “Computer Software Protection Regulations of the PRC,” in Chinese Laws for Foreign Business, para. 11–704. 61 See Memorandum of Understanding Between the Government of the People’s Republic of China and the Government of the United States of America on the Protection of Intellectual Property, 1992, Art. 3. 62 See Berne Convention on the Protection of Literary and Artistic Works, 1886, 1971, Art. 18(1), WIPO Doc. 287(E). 63 General Office of the State Council Working Conference on Intellectual Property (ed.) “Report of Chinese Enforcement Actions Under the 1995 IPR Agreement,” 17 June 1996. 64 Office of State Council Intellectual Property Executive Conference (ed.) “Status Report of the Enforcement of IPR Laws in China, 1996,” May 1997. 65 See generally P. B. Potter and M. Oksenberg, “A Patchwork of IPR Protections,” China Business Review, Jan./Feb. 1999, pp. 8–11.

Evolution of law in contemporary China 153 66 See generally Asia Law and Practice (ed.) Intellectual Property Protection in China, 2nd edn, 2 vols, Hong Kong, Asia Law and Practice, 1998. 67 See Patent Law of the PRC, Art. 60; Trademark Law of the PRC, Art. 39; and Copyright Law of the PRC, Art. 46. 68 See e.g. J. T. Simone, “Countering the Counterfeiters,” China Business Review, Jan./Feb. 1999, pp. 12–19.

10 China’s accession to the WTO Legal system transparency and administrative reform Sarah Biddulph

Introduction The question of transparency of China’s legal system is one of the significant issues of concern in determining China’s accession to the WTO. The requirement for transparency contained in Article X of the 1947 GATT underpins all substantive areas of regulation. As Sylvia Ostry has said, “it is considered one of the basic rules governing the post war trading system as embodied in the General Agreement on Tariffs and Trade (GATT) and now the World Trade Organisation (WTO)” (Ostry 1998: 1). These transparency requirements are replicated in paragraphs C and D of Part 1 of the draft protocol for China’s accession to the WTO (the Draft Protocol). What do we mean when we talk about transparency? At a conference in Washington in March 1998,1 Jonathon Fried set out the basic propositions particularly succinctly.2 He asserted that there are three facets of transparency. They are that: ● ●

●

the laws and regulations governing trade are publicly available; there is procedural fairness, that is, that the process of administrative decision making is principled, comparatively stable, and the basis for making a decision can be known; there is an independent and impartial system for review of administrative decision making.

This chapter considers these three aspects of transparency. It examines the ways in which and the extent to which they are reflected in the Chinese legal system. It also evaluates the features of the Chinese legal system that impinge upon China’s capacity to meet her WTO commitment of transparency in the legal system. This chapter is concerned with both the regulatory framework currently in place and issues about law enforcement that significantly affect individual experience of the regulatory regime. In terms of the regulatory structures, this chapter focuses in particular on reforms to the framework for administrative decision making that have taken place primarily since the early 1990s. It argues that these reforms have gone very far towards instituting a structure that embodies the principles of transparency required under the Draft Protocol, though a number of significant barriers remain to the establishment of a system which is transparent.

China’s accession to the WTO 155 Despite these major reforms, there are aspects of structure of the system itself which, combined with bureaucratic culture and practice, continue to permit bureaucratic behaviour and are inconsistent with the transparency ideals of the WTO. There are three areas in particular where this issue is apparent. The first example is in the complex and overlapping nature of rules that make it difficult for foreign and even domestic parties to feel confident about which rules govern their conduct and how different rules relate to each other. The second is the particularly broad administrative and judicial discretion created by the legal regulatory regime itself which, together with bureaucratic culture, tends to lead to unprincipled exercise of discretion and abuse of power. A third and related issue is the existence in some areas of administrative controls over the application and enforceability of legal rules. These issues are discussed in the fifth section of this chapter. To understand the origin and nature of these issues, it is essential first to examine the structure and content of the administrative legal system. This chapter argues that these issues must be understood in the context of China’s rapidly developing legal system and economic transition. Although no country can claim perfectly to implement the three components of transparency I have set out above, in considering the question of conformity of China’s legal system to the basic ideals of transparency, there are questions we must ask ourselves. One is to what extent will the problems with the Chinese legal system be ameliorated with further development of the legal infrastructure. Another is the extent to which the state should be made responsible for ensuring that enforcement of laws in practice is consistent with the purpose and content of laws over and above its obligation merely to pass the laws themselves. One possible standard could be that the system must basically work, or that there is not such widespread abuse of the system as it currently exists that it could be concluded that the system itself is not functioning. Other standards may be equally viable. Careful consideration should be given to determining the criteria that is to be applied to judge whether the degree to which the laws are implemented, either in accordance with their terms or at all, is acceptable. It is only when the standard of performance required by the Chinese government is made express, that conclusions drawn about the functioning of the Chinese legal system can themselves be seen to be transparent and fair. This chapter is mainly concerned with the administrative legal system. It is divided into five sections. The first looks at some of the basic issues concerning the status of law in China. This discussion forms the conceptual basis upon which the examination of the three elements constituting transparency set out above may be understood. The second looks at the law-making system and how that affects the capacity of parties to know what the rules are and how they apply to them. The third looks at the developing body of rules that govern procedures for administrative decision making and the extent to which they institute a system that is “procedurally fair.” The fourth examines judicial and administrative review of administrative decision making and recent reforms in the administrative law system which impact on these channels for review. The fifth raises some of the most difficult problems

156 Sarah Biddulph facing parties currently dealing with the Chinese administrative legal system. In the concluding section I make some comments about the obstacles to China fulfilling its WTO obligations in relation to transparency.

Rule of law and the status of law The rule of law, law and policy Discussions about transparency of laws and legal mechanisms for review of administrative decision making presume the existence of a fairly stable and well entrenched legal system. Because of China’s recent legal history, there remains an underlying unease about the status of law in China and the possibility of arbitrary state action. This unease is often expressed as concern about the relationship between law and policy, or the party and the state and a concern that personality politics will again dominate. An important affirmation of the position of law and the existence of the political will to respect it occurred at the National People’s Congress meeting in 1998 when several senior officials, including the then Premier Li Peng and the chief judge of the Supreme People’s Court, Ren Jianxin, retired as required by the Constitution after their second five-year term.3 There are a number of good reasons to be confident about the existence of political will for development of a stable legal system, not the least of which is the interrelationship between law and the continued legitimacy of the Chinese Communist Party (CCP) which is seen as being tied to the success of the economic reform process that itself depends on the existence of a functioning legal system. The predominant policy is the economic reform program introduced by the Communique of the Third Plenum of the Eleventh CCP Central Committee in December 1978. The program includes, and is underpinned by, the creation of a comprehensive and stable legal system. Law then can be seen as a fundamental component of the current state program (Deng 1984: 157). At the same time it is important to remember that China is still in the process of creating a comprehensive legal system whose rules have popular legitimacy and normative effect. Debate both within China and abroad about the rule of law has tended to focus on the dichotomy drawn between the “rule of law,” where the state and the party are subject to the laws, and “rule by law,” where law is used as a tool of management by the state (e.g. Feinerman 1997: 280; Potter 1998). The regime has an instrumental view of law. That is, law is a tool of policy, or a means for concrete implementation of major party programs. That proposition flows from the four cardinal principles,4 and in particular, submission to the leadership of the party and adherence to Marxism, Leninism and Mao Zedong Thought. Generally speaking, law will be changed to meet the “actual” situation as determined by the CCP. Although this remains the dominant interpretation of the status and function of law, there is now a much broader debate in China about the role of law and the significance of the concept of rule of law in the Chinese legal system.

China’s accession to the WTO 157 Normative force of laws Although the state has been engaged in construction of a comprehensive legal system, a more problematic issue is the extent to which legal norms are understood and accepted in the community and by government officials. Work has been done which suggests that there is still poor understanding and acceptance of law among the public (Potter 1994: 326). The state has undertaken a series of legal education campaigns since November 1985 in an attempt to improve public knowledge of the legal system generally, citizens’ legal rights and duties and contents of specific laws. Part of the problem is certainly poor knowledge of legal process and the specific content of law. A more important problem is that state propaganda is no longer an effective way of legitimizing law if the public cannot see the law being implemented in what they perceive to be a substantively uniform and fair way (Potter 1994). Problems of corruption, favouritism and partial enforcement of laws do a great deal of damage to the state’s attempts to build a “popular legal culture” (Liang 1995: 31).5 Many people continue to rely on non-legal means to achieve their objectives such as using friends, relatives and other connections to arrange matters through the back door. Acceptance and enforcement of law by government officials is not consistent throughout the country. The basic principles for government administrative action are that “all actions must be carried out on the basis of law” ( yifa xingzheng ÒÀ·¨ÐÐÕþ) (Ying 1992: 415; Jiang 1995b: 651–4). The CCP Constitution and the state Constitution both set out the basic principle that no one is above the law. Despite these reforms, there are numerous examples of officials, especially high party officials and local officials, ignoring or breaking the law with impunity. Attitudes of influential people in some local areas that “I am the law around here” still persist. They are the source of great frustration among foreign business people and Chinese people who encounter them. A traditional attitude of bureaucrats was that law did not apply to them. Their tasks were to implement policy and act on behalf of the state. Law was something which applied to the people (Huang 1992). This attitude has changed at different rates throughout the country. In recent years a range of mechanisms have been introduced for scrutiny of the legality of actions of officials. The legal mechanisms for supervision of administrative action are dealt with in more detail below. Conclusion This brief introductory section is intended to highlight certain features of the Chinese legal system which underpin all legal developments and in particular developments in the administrative legal system. The first is that the legal system is in a state of rapid transition. Reconstruction of the infrastructure of legal institutions and rules has been given legitimacy as a policy only since the early 1980s. The second is that merely passing laws will not necessarily ensure that they are effectively or uniformly implemented throughout the country. Some reasons for poor or

158 Sarah Biddulph inconsistent implementation of laws have to do with lack of political will at the local or central level, or lack of specific mechanisms for implementation. Other reasons have to do with lack of uniform understanding or acceptance of laws. Any evaluation of China’s legal system, the structure and operation of any part of it should take these factors into account.

Transparency and legislation The first aspect of transparency involves both being able to know what the law is and that it will be enforced according to its terms. The principles of rule of law which underpin a Western understanding of the concept of rule of law and transparency are that legal rules and principles are clear and knowable, they are enforced according to their terms and that they are fairly stable. Related ideas are that the drafting process is open and that only those laws that are known will be enforced. The Draft Protocol requires the Chinese legal system to contain adequate mechanisms for: ● ● ●

publication of laws and enforcing only those laws that are published consultation in drafting laws and rules setting up an inquiry point where people can find out what the law is in a particular area.

In China, the question about knowing what the law is and how it will be enforced involves more than merely the presence or absence of mechanisms for publication and consultation. Criticisms of the Chinese system of rule making are not only of the failure to publish all relevant rules and regulations but also that publication of central level laws and rules itself does not give business people an accurate understanding of the content of the legal regime with which they are obliged to comply. There is some force in this argument. Some of the uncertainty about what the law is in practice stems from the system itself rather than simply from a failure to publish documents. To gain a clearer understanding of the issues that surround this type of complaint about the Chinese legal system, some consideration needs to be given to the basic elements of the system of rule making. Publication of rules is not identical to having the tools to be able to determine the substantive content of the regulatory regime in a particular area. The Chinese system of legislation is complex and multilayered which preserves some aspects of the pre-existing system of administrative ordering of conduct of government officials. The structure of the system itself permits a high degree of flexibility in interpretation and enforcement of rules. Relevant considerations are: ● ●

a wide range of sources of law; the form of law, which both permits and depends upon particularisation of the general principles contained in laws by way of administrative regulations and rules; related to this is the lack of an effective mechanism for scrutiny and resolution of conflicts between different regulations and rules;

China’s accession to the WTO 159 ●

●

●

the comparative lack of stability of legal norms, because of the need completely to reconstruct the legal system and problems of keeping pace with the rapid transition to a “socialist market economy;” requirements for publication of only certain categories of laws and rules after they are passed; limits on participation in the drafting process.

Sources of law: the system of legislation Central and local level laws, administrative regulations and rules The legislative system is unitary and hierarchical (Zhou1988: 271). Unified power rests in the National People’s Congress (NPC);6 it is exercised on a day-to-day basis by its Standing Committee. These bodies exercise the legislative power of state and pass laws.7 Under the NPC are the State Council, the executive organ of state, the Supreme People’s Court, the Supreme People’s Procuratorate and the Central Military Commission. The State Council exercises power to pass administrative measures, regulations and rules.8 It has also received specific delegations of legislation, making power from the Standing Committee. For example, in 1985, it received a delegation of power to make regulations to implement economic reform.9 The State Council creates departments under it and defines the scope of their powers.10 Departments make administrative rules within their areas of jurisdictional competence.11 Local people’s congresses and governments are established at the provincial, county and township levels. Provincial level governments and congresses are able to pass local regulations and rules.12 Decentralization of power to the localities giving them responsibility for local economic development has given these organizations major incentives to pass a large volume of local regulations and rules. Some Special Economic Zones have received special delegations of power from the Standing Committee to pass laws relating to economic matters.13 They are often empowered to pass laws within limited geographical scope as a trial for a new regime. The rules made by these congresses and governments fall outside the ordinary, geographically organized, hierarchy for rule making. Interpretation powers In 1981 the Standing Committee divided power to interpret law into three.14 This Resolution was superseded with passage of the PRC Legislation Law (Zhonghua Renmin Gongheguo Lifa Fa ).15 The system of interpretation instituted prior to passage of the Legislation Law provided that legislative interpretation was exercised by the Standing Committee. Judicial interpretation was exercised by the Supreme People’s Court and Supreme People’s Procuratorate. Administrative interpretation was exercised by the State Council or the Ministry or Commission in charge of implementing the law. Before passage of the Legislation Law, the Standing Committee had been inactive in the area of interpretation. The Supreme People’s Court had been very active in carrying out judicial interpretation, so much so that

160 Sarah Biddulph many suggested that it had often exceeded the scope of its power by issuing interpretations which looked very much like legislative interpretations. Courts in general do not have power to determine the validity of laws and rules, nor to decide that there is a conflict between a lower level rule and a law passed at a higher level. The fragmentation of the power to interpret legislation, coupled with the very broad exercise of the judicial interpretation power of the Supreme People’s Court added another layer of complexity to the structure for rule making. In practice the interpretations issued by the Supreme People’s Court provided, and arguably will continue to provide, detailed explanation of the scope and application of the law where there may be no other. As a consequence they have been of considerable practical importance. The Legislation Law provides that legislative interpretation is to be carried out by the Standing Committee of the NPC where meaning of a provision requires clarification and where a new situation arises after passage of the law requiring clarification (art. 42). Legislative interpretation issued by the Standing Committee has the same status as national level legislation (art. 47). In the explanatory speech introducing the draft Legislation Law, Zhang Chunsheng (1998) indicated that the Supreme People’s Court retains its power to interpret the meaning of provisions of the law for their application in a specific case, though the exercise of this function must not contradict any interpretation given by the Standing Committee.16 The Legislation Law, however, is silent about what, if any power the Supreme People’s Court retains in respect of what was formerly called judicial interpretation. From the interpretation regime established by the Legislation Law, it is not clear whether the powers of state organs apart from the Standing Committee to give meaning to laws in the course of their application in practice has been abolished or whether these powers have been retained, with the interpretation power set out in the Legislation Law established as the final and authoritative interpretation. The effect of the Legislation Law in this regard remains to be seen. Normative documents Below the level of the formal system of legislation, administrative regulations and rules is another body of documents which are grouped together under the heading “normative documents.” They are a poorly defined category of documents that have been used extensively, especially by departments and at the local level. This type of document was particularly important in the pre-reform period when state administration was carried out by way of administrative directive rather than by use of legal mechanisms. Normative documents are primarily used within the hierarchy of a particular state organ or department as a means of giving instructions to local officials on the content and manner of performing their functions. Their use has gradually decreased as the legal system develops. Normative documents sit uncomfortably in the new legal order contemplated by the 1982 Constitution and subsequent developments in the legal system. At present there is uncertainty about whether these documents fall within the formal category of law at all (Zhou 1988; cf. Ying 1993: 93).17 For practical purposes, this distinction

China’s accession to the WTO 161 may not be relevant as these documents are clearly binding on officials in the system within which they were formulated and to whom they are directed. They are documents that are intended to give specific and practical instructions about matters of internal organization or methods of work of that agency. However, even when confined to this scope, which they are not necessarily, they affect rights and duties of actors external to the administrative system to the extent that they define the ways in which state agencies carry out their work and implement the law. Concerns about both the public availability of law and changeability of legal rules are often directed at this category of documents. Most government departments have scaled down their use of normative documents and internally issued (neibu faxing ) documents. However, it would be difficult to imagine that such a well-entrenched mechanism for the internal management of decision making could be abolished overnight. It may be that the substantive detail and most importantly, the procedures to be followed in implementing both the law and the implementing rules are provided, to the extent they are at all, in normative documents. As the legal system develops, the nature of the rules which create particular standards and procedures to be used by administrative officials is becoming regularized. There is a recognition of the need to phase out the use of normative documents. Officials in a range of different state organs have stated that the status and use of normative documents will gradually decline with the creation of more comprehensive sets of legal norms to interpret and implement laws and to specify the internal organization of state organs. It is impossible to speculate how quickly this may occur. Form of law: particularization of legislation The principles applied in drafting central level legislation are those of “generality” and “flexibility.”18 Laws traditionally have not specified procedures for their implementation in the text of the law itself. Laws are often expressed in such general terms that they cannot be implemented without further particularisation (Jiang 1995a). That is achieved by way of implementing regulations, rules, measures and in some circumstances, interpretations made by the relevant administrative agency or by the Supreme People’s Court. These regulations and rules, which are issued at both the local and central levels, are extremely voluminous. There may be areas in which they appear to or do overlap, be in conflict with, or supersede an earlier regulation or rule. Sometimes the legislation itself will specify the agency which has power to make implementing rules. In many cases it is the agency responsible for implementing the law. For example, the Foreign Trade Law authorizes the State Council to determine the methods and measures for quota allocation at article 20 and the Ministry of Foreign Trade and Economic Cooperation to formulate lists of goods and technologies restricted or prohibited from import with the approval of the State Council at article 18. Where implementation and interpretation power is not specified in the law, the administrative agency responsible for implementation of the law often in

162 Sarah Biddulph practice exercises this power. Administrative agencies have used implementation and interpretation of laws as a way of controlling the detailed content of the law and as a way of enhancing their own power (Jiang 1995b; Keller 1994).19 The likelihood of the law being implemented also depends upon the power and motivation of the department responsible for its implementation (Clarke 1991). For example, MOFTEC is responsible for drafting implementing regulations that will implement the Foreign Trade Law governing a wide range of matters including; the import– export licensing system, foreign trade agents, establishment of joint venture trading companies, management of border trade and establishing a chamber of commerce for import and export. That is not to say that the power to pass implementing regulations and rules is used in an arbitrary fashion. There is a close working relationship between relevant departments, party organs and government. It would be unusual for a department to pass rules or an interpretation without input from other interested ministries or organizations. Agencies also make extensive use of normative documents to deal mostly, but not always, with specific questions and problems, short-term issues and changes in policy which require altered implementation of the law. It is here that the border between law making and enforcement becomes blurred. The degree of enforcement of the law will also be affected by the power of the agency concerned and the incentives it has actively to enforce the law. Comment This legislative framework is unfamiliar to many common law trained lawyers, who are accustomed to working with very detailed statutes and regulations. There has been some trend recently toward drafting more detailed legislation, but this is not uniform. The PRC Company Law and the newly passed PRC Contract Law are examples of legislation that are comparatively long and detailed in their provisions. The PRC Contract Law is intended to be a code and so contains detailed provisions governing general contract principles as well as for specific types of contract.20 These laws were passed with the intention that they would be directly enforceable without the need for passage of implementing regulations. A contrary example is the PRC Negotiable Instruments Law,21 which, possibly because of the still not widespread use of negotiable instruments and for other reasons, is comparatively shorter and more general. The nature of the legislative system itself makes finding the regulations and rules currently in force a complex task. Detailed legal obligations with which a person must comply are often contained in a range of documents, many of them departmental rules and local regulations and rules. Having access to the highest level legislative instruments will not give a detailed understanding of how the law will be particularized or enforced. It is important for those people trying to operate in the Chinese legal environment to have access to all levels of laws, administrative regulations, rules and interpretations. It would be difficult to expect change in the short term of this form of multi-

China’s accession to the WTO 163 layered law making. Government agencies and local level governments and congresses have too much at stake willingly to abandon their law making powers. One of the reasons why the draft Legislation Law, which was intended to clarify the limits of legislative competence of all agencies of state, was difficult to finalize was because it was intended to delineate more clearly the boundaries of legislative competence and so to restrict the rule-making power of a range of state agencies.22 However, the Legislation Law as passed does not provide any further or greater definition of the limits of law making powers of state organs with the exception of specifying those matters which may only be the subject of legislation passed by either the NPC or its Standing Committee (art. 8). Publication requirements Part C paragraph 1 of the Draft Protocol provides that “only those laws, regulations and other measures pertaining to or affecting trade in goods, services . . . that are published and readily available to other WTO members, individuals and enterprises shall be enforced.” Read narrowly, this provision relates to publication of laws, regulations and rules. In China there are now rules that require publication of a substantial proportion of laws, administrative rules and regulations. Laws specifying the procedures for drafting, passing and promulgating laws, administrative regulations and rules in different state organs were passed starting from the mid- to late 1980s. Before passage of these laws, many laws, but not all, were published in the gazette of the relevant organ and often in the national daily newspaper. Since passage of these laws, publication is mandatory. The NPC and its Standing Committee passed laws governing procedures to be followed in passing laws in 1989 and 1987 respectively.23 In 1987 the State Council passed the Provisional Regulations on the Procedure for Formulating Administrative Laws and Regulations.24 Laws and administrative regulations passed at the level of the NPC, its Standing Committee and the State Council must all be promulgated to the public. Below this level, prior to the passage of the Legislation Law, there was no uniform requirement that administrative rules be published. The Legislation Law supersedes these laws and requires the promulgation and publication of all legislative instruments: laws passed by the NPC and its Standing Committee (arts. 23, 41, 52), amendments to those laws (art. 53), administrative regulations (art. 62), local level and autonomous self-governing regions’ regulations (art. 70), departmental rules (art. 77) and local level rules (art. 77 which must be published in that locality). Prior to passage of the Legislation Law, some provincial people’s congresses and governments, for example Shanghai, had already passed their own rules governing law-making procedure which also require publication of local level rules. There had already been a marked trend since the mid-1990s toward publication of laws and rules passed by different organs of state at different levels. A number of departments had already started publishing collections of their own rules in books or established their own gazettes. In October 1993, MOFTEC established its own gazette in which all laws, regulations and administrative rules

164 Sarah Biddulph relating to foreign investment and trade were published. It was established specifically to meet the GATT requirement that relevant laws and rules be published. It contains laws passed by the NPC, its Standing Committee, the State Council as well as those passed by MOFTEC. This gazette was intended to be the authoritative source of foreign related trade and investment laws and regulations. Publication of central and local level laws, administrative regulations and rules are now required by the Legislation Law to be published. China can now argue that she has substantially fulfilled the requirement to publish, in a timely fashion, laws and regulations relating to foreign trade and investment as specified in Part C, paragraph 2 of the Draft Protocol. The fundamental area of complaint about lack of publicity lies in the area of normative documents, in particular those formulated by departments and at the local level. These documents often contain detailed directions to local officials on how to carry out their duties, so directly affect the public. Because of the lesser degree of formality of these rules, they can be changed easily to deal with new situations as they arise or altered policy requirements. Those designated for internal circulation only are very difficult for the general public to obtain. It may be that passage of the Legislation Law will lend some force to the argument (referred to above) that normative documents do not constitute “law.” The requirement of Article X and the Draft Protocol that those laws and rules not published should not be enforceable is not met where normative documents are not published. At present, publication is not a prerequisite to their validity and enforceability. As the formal legal system becomes more comprehensive, the trend has been for the use of these documents gradually to decline. The laws establishing mechanisms for supervision of administrative decision making increasingly provide that administrative agencies may not make decisions that affect a person or entity unless the laws and regulations upon which they are based have been published. For example, the Administrative Punishments Law, discussed in more detail below, provides that an unpublished law may not form the legal basis for imposition of an administrative punishment.25 An administrative punishment based on an unpublished law or rule will be void.26 Decreasing the use and weight attached to such documents will be a gradual process which depends both on the development of adequate rules to govern administrative decision making, as well as changing management culture in departments. Although it is reasonable to keep pressure on the Chinese government to publish its normative documents and to decrease reliance on them, we should not expect total abolition of this type of document in the short term. Resolution of the issue purely of publication of laws, regulations and rules is only part of the substantive issue of perceived lack of transparency. In fact there is now a large number of publications of Chinese laws, regulations and rules, none of which are complete. The State Council is currently engaged in a major project for translation into English and publication of laws, administrative regulations and some departmental rules and local regulations and rules. Projects such as these have the potential to provide access to a comprehensive set of laws, administrative regulations, departmental rules and local regulations and rules.

China’s accession to the WTO 165 The problem of inability to locate relevant regulations is becoming more one of difficulty of research rather than of secrecy per se. The multilayered system of law making and poor coordination between law-making and rule-making activities of different state agencies gives rise to an arguably more significant problem of obtaining a working understanding of how the frequently large volume of relevant rules and regulations fit together. This is a problem of competence in researching and understanding the applicable rules. However, this problem is not confined to foreign lawyers or agencies. Chinese enterprises and lawyers have the same difficulty in working their way through the sometimes bewildering array of laws, regulations and rules which regulate a certain area of activity in an uncoordinated and in some cases inconsistent fashion. The rapid development of the regulatory regime in particular areas and lack of clear mechanisms for resolution of conflicts between different regulations and rules or interpretation of their relationship are important factors that contribute to the impenetrability of the legal regime. Stability of legal norms In more established legal regimes, legal norms, especially the underlying ones, are comparatively stable. This feature is understandably absent from the Chinese legal system. The stability of legal norms is affected by both the incapacity of law to keep pace with economic reform on one hand, as well as rapid change in the regulatory environment in an attempt to keep pace with these reforms. The principle of legislative drafting has been to formulate rules on the basis of experience (Deng 1984). Because of lack of experience and possibly consensus among the relevant departments, in the early 1980s many laws and rules were designated “tentative,” “interim,” “temporary” or “for trial implementation.” Many of them remained in force unchanged for much longer than originally intended. Special Economic Zone’s such as Shen Zhen were also granted power to pass local rules about some matters in the absence of national legislation, for example companies, as a form of localized legislative trial. On the basis of experience gained in implementing these rules, national legislation could then be drafted. Often, a new area of economic activity, such as for example futures trading in metals, would take place in the absence of national legislation. In those cases, the department in charge, or the exchange itself (in this case the Shanghai Metals Exchange) would draft regulations and guidelines to deal with practical issues and problems often only as they arose. At some later stage those rules may be enacted as legislation or the experience used as the basis for legislation. Resolving conflict between rules passed by different administrative agencies The possibility of conflict between regulations passed by different ministries and at the local level affects both law-making activities and law enforcement. After introduction of the economic reform policy in 1978, the primary legislative focus was on economic legislation. Less attention was paid to administrative laws defining the

166 Sarah Biddulph structure, powers and operation of administrative organs of state and their interrelationship. The State Council is empowered by the Constitution (art. 89(3)) to specify the duties and powers of the departments established under it. It has done so in a range of documents that are akin to constitutional documents for each department. These have traditionally not been promulgated, are broad and have not clearly delimited the rule making authority of each department. As a result there is still poor definition of the limits of rules making powers of administrative agencies. The result has been overlap and sometimes conflict between the laws and rules passed by central government departments and local congresses and governments. The rules passed by each department under the State Council are technically binding only within its own vertical hierarchy. Sometimes where there is overlap in jurisdiction, different departments will jointly issue a notice or rule that is binding on personnel in each department. The Legislation Law provides that departments may either enact such a rule jointly or request the State Council to enact it as an administrative regulation (art. 72). Informal cooperation between departments will often obviate problems of overlapping jurisdiction. The State Council has authority to resolve conflicts between rules passed by different departments if the problem cannot be resolved by other means. However, there are not yet any established principles for resolution of conflicts between ministerial level rules and local regulations. These conflicts, when they come to the attention of the State Council must be resolved on a case by case basis. Where power to regulate a certain sector is held by more than one department, issues often arise with both the overlapping regulatory responsibilities and multiplication of the number of departments involved in implementation of the regulatory regime. For example in the area of foreign investment, both the State Economic and Trade Commission and MOFTEC have responsibilities. Even though the status of the State Economic and Trade Commission is slightly higher than that of MOFTEC, they each exercise responsibilities in different areas and pass their own rules to carry out their own tasks. If they do not cooperate well in carrying out these tasks, then it becomes more difficult for a potential investor to obtain the necessary approvals from both expeditiously. In practice, potential investors would ensure that they coordinated closely with all relevant ministries from the earliest stages of the proposed project. In some areas these problems have been resolved by the local government by establishment of “one stop chop shops.” The Legislation Law has specified principles by which resolution of conflicts between different legal instruments are to be resolved and has designated the agencies with authority to determine which regulation or rule is to prevail in the event of a conflict between them (arts. 83, 85, 86, 88). A shortcoming of the Legislation Law is that it has not gone any further in defining the limits of the rule-making powers of administrative agencies of state or of local people’s governments and congresses, nor in establishing generalized principles for the resolution of conflicts between regulations and rules passed by these organs. It does provide that laws, regulations and rules that are passed in excess of power, or that violate legally prescribed procedures may be amended or cancelled by the organ

China’s accession to the WTO 167 responsible for their supervision (art. 87). For this provision to be effective, it will be necessary better to define the rule-making power of administrative departments and local congresses and governments as well as rule making procedures, especially for departmental rules, local regulations and rules. One practical impediment to implementing the system of supervision over rule making that is set out in the Legislation Law is that the law does not specify either the procedures for making an application for supervision, nor the specific office or department within the designated supervision organs which has responsibility for receiving applications and resolving these conflicts. Supervision of lower level rule-making activity Technically, local people’s congresses and governments have limited power to pass local level regulations and rules. Local level regulations and rules and departmental rules must be consistent with laws and administrative regulations passed by the NPC, its Standing Committee and by the State Council. However in practice, local governments and congresses sometimes exceed their power and pass local level regulations and rules that conflict with centrally promulgated laws and administrative regulations. This problem has been exacerbated by the inability of the system for central supervision over local level rule making to exercise real scrutiny, much less control, over lower level rule making. The specific legal basis of the system for scrutiny of departmental rule and local regulation and rule making was established in 1990 when the State Council passed the Regulations and Rules Reporting Provisions.27 These provisions required that departmental rules and local level regulations and rules be sent for the record to the Office of Legislative Affairs of the State Council within 30 days of issue. The State Council was empowered to disallow a rule which is in excess of power or conflicts with a central level law or administrative regulation, or to require amendments to be made. This reporting regime has now been superseded by the more broad-ranging system set out in the Legislation Law. The law specifies the state agencies to which different classes of legislative instruments must be reported as well as the state organs with power to amend or cancel those rules (art. 89). State organs empowered to carry out supervision over different levels of rule making are empowered to amend or cancel regulations and rules on grounds including: they are beyond power, inappropriate, conflict with a higher level law or regulation, or that they violate legally prescribed procedures (art. 87). The three factors that rendered the mechanism of scrutiny previously in place comparatively ineffective have also the capacity to hinder the effective implementation of the system of supervision of rule making instituted in the Legislation Law. The first was the sheer volume of regulations and rules reported under these provisions and the small number of personnel to scrutinize them.28 The second factor was that the agency with the reporting obligation determined which regulations and rules fall within the relevant categories required to be reported, and so, the scope of the reporting requirements.29 The third and possibly most important factor was and still is that the effectiveness of the regulation or rule in general does

168 Sarah Biddulph not depend upon it being reported. The exception is now made in the case of rules passed by comparatively large cities, which are required to report those local regulations30 to the Standing Committee of the people’s congresses at provincial level before they become effective (art. 63) and self-governing provisions31 passed by people’s congresses of autonomous self-governing regions, prefectures or counties which must be reported to next higher level Standing Committee before they can be effective (art. 66). Apart from this there appears to be no effective sanction for not reporting, as the system of supervision operates to permit amendment or invalidation only after the regulation or rule has been passed and has already taken effect (art. 87). Under the previous reporting system, the lack of effective sanction for failure to report led to many regulations and rules not being reported in a timely fashion. Some consideration was been given to changing the reporting provisions to make the effectiveness of the regulation or rule dependent upon approval by the supervising body. However, it appears that it was not politically possible and practicable to implement such a system at a time when China is, partly in response to WTO requirements for economic and legislative reform, moving to a more decentralized model of governance. Inquiry point In light of the discussion above, it is arguable that the requirement of publicity relates not just to access, though this is important, it also relates to obtaining a working understanding of substantive content of regulation. If the requirement in the Draft Protocol about establishing an inquiry point relates merely to access to relevant regulations passed relating to foreign trade, then MOFTEC would be competent to provide this information as the Ministry with the principal (though not sole) responsibility for this area of activity. If the object of the requirement is greater than provision of information and includes interpretation of the content of regulation, then, after passage of the Legislation Law, it appears that the Standing Committee is the state agency with authority to interpret law. Consultation during the drafting process Requirements in the Draft Protocol The requirement in the Draft Protocol that laws and regulations be made available prior to their implementation does not find a corollary in Chinese law. The requirement appears similar to the regulatory drafting model incorporated in the US Administrative Procedure Act s. 553. This obligation is premised on the existence of a legislation and rule-drafting procedure which incorporates a consultation phase or some other formal system of scrutiny before the law or rule can validly be passed. China has not yet enacted a comprehensive system of legislative drafting that imposes a universal requirement for consultation during the drafting phase. The Legislation Law now sets out the formal rule-making procedures for the NPC and its

China’s accession to the WTO 169 Standing Committee (though not for lower level regulations and rules) and requires that legislative instruments passed at all levels of government be promulgated and published. It has only been recently that the highest law-making organs of state: the NPC, its Standing Committee and the executive, the State Council, have implemented the rules governing formal rule-making procedures that require promulgation of the law or rule once passed. These rules currently do not impose a mandatory requirement for the organ to consult with the general public or with particular foreign interests before validly passing the law or rule. Lower level administrative organs of state, although now subject to certain parameters in their rule-making activities are still not required to engage in consultation with the general public before passing rules. Consultation, however, does take place. Foreign input into Chinese legislative drafting is limited, but has been increasing in recent years. There are a number of channels for foreign input into legislative drafting. The Legislation Law makes it possible for the NPC and Standing Committee as part of the formal law making procedure to elicit comments from interested parties and public opinions on drafts of laws where considered necessary (arts. 5, 21, 31, 34, 35, 36). The procedures set out in Chapter Three, which governs the drafting of laws to be passed by the Standing Committee of the NPC, are to be used as a reference in determining the procedures to be used for passing departmental rules and local government rules (art. 74). This provision means that law now permits consultation in the drafting of laws and rules rather than requiring consultation. Current experience of consultation on drafting laws The consultation procedure undertaken during legislative drafting can be very extensive, and will vary, depending on the nature and level of the legislation or regulation. Draft legislation is commonly sent to relevant ministries, state organs and groups for comment. In the past, important laws were also sent to the Standing Committee of the Political Bureau of the Central Committee before they are sent to the National People’s Congress. The role of the party in vetting legislation has decreased significantly. Drafts of laws are occasionally published in the newspaper to elicit comments from the community at large. In 1995, the draft revised Criminal Procedure Law was published in the form of a book. In September 1998 the draft Contract Law was published in a national newspaper, the Legal System Daily. In the past, foreigners were not consulted on draft legislation. This position has changed somewhat. While there is no general system in place for publication of drafts for foreigners, organs responsible for drafting different laws and regulations are increasingly using foreign consultants. The World Bank and the Asian Development Bank (ADB), among a range of other agencies, have funded a number of legal consultancies. Legislative drafters do take account of the regulatory regimes of foreign countries by gathering legislation, talking to experts in the field, going on overseas visits and fact finding missions. This process is not confined to market-related laws. For example, members of the drafting committees of the Criminal Procedure Law and the

170 Sarah Biddulph Legislation Law travelled to a number of different countries to gain information about the systems in place in those countries and how they operated. Harmonization with international legal norms is an objective, but it operates on the basis of drafting laws which are appropriate to China’s particular situation. The process of drafting legislation differs considerably from that for drafting implementing regulations or lower level rules. The latter is often less open. Comment on the Draft Protocol In the absence of a comprehensive system for consultation in the process of rule drafting, the nature and extent of the obligation as it is currently framed is unclear. Much legislation goes through an extended drafting process, as discussed above, and may be changed a vast number of times before some type of consensus is reached between the different groups involved in drafting the legislation. The different groups participating in the drafting process may be reluctant for differences of opinion between them to be made public. Rather than making an ambit claim for consultation, it might possibly be more productive to state clearly and as precisely as possible to what types of documents access is sought, at what stage of the drafting process and for what purposes. Specific procedures would need to be worked out with relevant institutions to make this obligation operational. If the purport of this obligation is to provide foreign interests a well-defined channel for input into the drafting process, then this should be made explicit. Conclusion The discussion of China’s system of law making is intended is to show that many of the problems of difficulty in knowing what the law is and how it will be enforced are inextricably linked with both the structure of the state and the legal system itself. Many of the problems are exacerbated by the economic reform process and transition to a market economy. Problems such as poor definition of legislative competence of different organs of state, the conflict and overlap between regulations and rules have proven very difficult to rectify because they are entrenched in the constitutional structure of the state and have not been addressed in detail in the Legislation Law. Within China there is awareness of these problems and recognition of the need to address them. Concerted efforts have been and continue to be made to better define the limits of regulation and rule making powers of different state organs, to decrease the usefulness and importance of normative documents and to find ways to resolve the uncertainty that arises because of the existence of a wide range of disparate legislative instruments seeking to govern a particular area of activity. Other difficulties in being able to understand and apply the relevant laws, regulations and rules have to do with the complexity of the law making system itself, as well as with the substantive content of regulations which often do not create a clear regulatory regime and create large spaces for the exercise of discretion. It is

China’s accession to the WTO 171 arguable that the publicity requirements of Article X are not concerned with these issues. Some problems, such as non-publicity of local rules and normative documents, can and should be addressed. These issues so far as they relate to laws, administrative regulations and rules and local regulations, have been addressed in the Legislation Law which requires their publication. MOFTEC had already established a gazette which is the authoritative source of China’s foreign trade laws and rules. This could arguably be an appropriate vehicle for inclusion of those types of documents which may not currently be published. In terms of publicity it is arguable that China has already substantially complied with the publication requirements of the Draft Protocol. The use of documents that are not publicly available has decreased. As the legal system further develops, they will decline in importance, even if they do not disappear. Problems such as these are gradually being addressed. In section four of this chapter which discusses mechanisms for supervision of administrative decision making, we can see that the laws which establish these supervision mechanisms contemplate that only those rules and regulations that have been published will be able to be used as the basis for determining the lawfulness of a particular act. Although these laws have not yet successfully excluded the operation of unpublished documents, it is clear that the state is attempting to restrict the use and effect of normative documents. In the area of foreign trade and investment, there are other incentives to increase the publicity of rules and the way in which administrative functions of state are exercised. MOFTEC has recently started using the Internet and electronic data interface (EDI) to enhance the transparency and efficiency of quota allocations and licence administration, to coordinate information available from other related ministries and to provide other information relevant to foreign trade. It has recognized that it is in its own interests to have the broad range of information publicly available in order both to promote efficiency and as a way of preventing fraud. The continued existence of the “internal” document cannot, in itself, be used to say Chinese law does not sufficiently comply with the publicity requirements of the Draft Protocol. More important is the manner in which the issues discussed in this section that arise out of the structure of the legislative system interact with the specific content of the regulatory regime, in particular procedural requirements and the mechanisms for supervision of administrative conduct. These impact on the objective expressed in Article X that there be “uniform, impartial and reasonable” administration of its laws regulations and rules and are discussed further later in this chapter.

Procedure: procedural fairness Development of laws governing procedure Interest in procedural law, particularly administrative procedure, mainly developed following passage of the Administrative Litigation Law in 1989 (Zhang Chunsheng 1998). This law for the first time contained a clear provision that an administrative

172 Sarah Biddulph decision made in breach of lawfully specified procedure rendered the action unlawful and so a grounds for its recision by a court.32 Procedural fairness forms a key element of many Western legal systems. The requirement that reasons for a decision be given to the affected person is seen as being “an essential component of fair procedure” (Richardson 1997 [1986]: 212–13). Traditionally, Chinese law, in contrast with common law traditions, has concerned itself more with regulation of substantive rights rather than with procedural rules (Zhang Chunsheng 1998: 3). In China, specification of mandatory procedures for exercising administrative power coupled with the legal requirement to provide reasons for a decision is still a comparatively novel concept. These principles were enacted in relation to administrative punishments in the Administrative Punishments Law in 1996. In general Chinese legislation, for example, has tended to provide for the existence of a particular right and not necessarily for the mechanisms concerning how that right is to be enforced, which is a question of paramount importance to a common lawyer. In the area of administrative law, procedures have frequently been specified by normative documents. Normative documents have been of great importance as they not only provide the detailed mechanism required by the implementing agency for enforcement of any particular law, but also shape the ways and so the extent to which rights and duties specified in those laws are able to be enjoyed. This contrasts with the model of procedure law that provides public and mandatory procedural requirements for the valid exercise of a substantive power. In China, there is a growing acceptance of the need to pass laws specifying procedural rules governing both the exercise of administrative power and the channels through which citizens may seek to enforce the rights given to them by law. The Civil Procedure Law was amended in 1991. The Criminal Procedure Law was also substantially amended in 1996. Although there is growing support for passage of an Administrative Procedure Law and drafting is underway, there is still substantial ground to be covered before general acceptance can be obtained for the idea, let alone the content, of such a law. Since early attempts to draft a comprehensive Administrative Procedure Law were rejected, the contents of administrative procedure have been passed in a series of laws of narrower scope. For example, laws that touch generally upon the area of administrative procedure include the Administrative Litigation Law, the Administrative Punishments Law, parts of the State Compensation Law and most recently the Administrative Review Law. Other procedural requirements have been specified in laws dealing with substantive rights. An example is the Law on Assemblies Processions and Demonstrations 1989 which deals with the procedure for applying for a permit to hold a demonstration. It provides that if the application is refused, reasons should be given and if public security organ fails to respond within the prescribed time, permission is deemed to be given.33 Administrative Punishments Law The Administrative Punishments Law 1996 is considered to represent an important development in legislating mandatory administrative procedures. It is of direct

China’s accession to the WTO 173 relevance to the regulation of international trade in two ways. The first is the substantive area regulated by this law. That is, decisions relating to imposition of administrative punishments such as fines, confiscation of unlawfully obtained income or property, suspension or revocation of licences or permits and even administrative detention all directly affect entities involved in international trade in goods and services. The second is that this law is intended to be the model upon which a more general law of administrative procedure will be based (Zhang Chunsheng 1998: 6). For this reason, a detailed examination of the content of the Administrative Punishments Law is warranted. Chapter Two of the Administrative Punishments Law contains provisions setting out the legislative competence of different state organs to make rules that create different types of administrative punishments.34 For example, only the NPC and its Standing Committee have the power to pass laws specifying deprivation of personal freedom as an administrative punishment.35 This restriction has been enacted in the Legislation Law (arts. 8 and 9). The law also limits the range of state agencies empowered to give administrative punishments.36 This law can be seen as one specific way of addressing the problems of overlapping and conflicting rule making discussed in the second section of this chapter. The Administrative Punishments Law also specifies basic principles for the exercise of power to give administrative punishments. These principles are that the decision must be just, open, based on facts and the penalty must be proportionate to the social harm caused.37 This is also an extremely significant development in regulation of administrative conduct. Until now there has been a noticeable absence of regulation for the basic standards that should underpin all decision making. It has the potential to provide a legislative basis requiring the principled exercise of administrative discretion. This is an important component in ensuring that laws are implemented in a uniform, impartial and reasonable manner. The Administrative Punishments Law specifies one of three mandatory procedures depending on the severity of the punishment to be given.38 Before giving a punishment, the administrative agency must inform the party of the facts, evidence and law upon which the decision is based and give reasons for the decision.39 The party to be punished must be allowed to respond to the facts and evidence of the accusation provide other evidence or debate the basis for the decision without penalty.40 As there is no general law on freedom of information in China, this provision is an important first step. For the most serious administrative punishments such as imposing a large fine, revocation of a business licence or permit, or ordering suspension of production or business, the administrative agency is required to inform the party that he or she has a right to request a hearing. The hearing is to be convened within the administrative department making the original decision, but the panel is to constitute the officials who were not involved in making the decision in the first place.41 The model of creating a hearing procedure has subsequently been adopted in other legislation, such as for example the Pricing Law which was passed in 1997.42 By specifying mandatory procedures for giving an administrative punishment, the Administrative Punishments Law broadens the scope of mechanisms for review of the lawfulness of administrative decision making contained in the Administrative Litigation

174 Sarah Biddulph Law and the Administrative Review Law and for the appropriateness of administrative decision making under the Administrative Review Law. Future developments At present work is under way on drafting a range of laws including the Administrative Licenses Law, the Administrative Exactions Law and the Administrative Enforcement Action Law which are intended to incorporate the basic principles and procedural elements contained in the Administrative Punishments Law. The draft Administrative Licences Law, for example, specifies the organs of state with power to pass laws and rules requiring people to obtain licences before they carry out some act, criteria for entitlement to a licence, mandatory procedures for considering licence applications, providing reasons for failure to approve licence applications or revocation of licences, giving the party an opportunity to respond and in serious cases, instituting an opportunity for a hearing. Another important area under discussion is the specification of the activities for which a licence must be obtained and those where, as long as the person complies with legally specified standards, a licence will not be required and the different criteria that may be used for granting a licence. For example, it may be that for potentially harmful products such as pharmaceuticals or chemicals, there is no permission to carry out that range of activity unless a specific licence is obtained on a case by case basis, administratively controlled. In the case of other, less hazardous activities it may be that the applicant need only meet specified criteria in order to obtain a general licence. As no draft of the Administrative Licences Law is currently available, it is impossible to say with any certainly what exactly is to be included in such a law. It is most likely that the contents of the draft have not yet been agreed, much less finalized. The Administrative Punishments Law has been passed too recently to make any judgments on how successfully it is being implemented in practice. One of the most significant aspects of the passage of this law is that it provides an existing legislative model upon which the drafting of a more comprehensive Administrative Procedure Law may be based. These principles form an important basis for creation of a legal system that promotes uniform impartial and reasonable administration of laws. Efforts to draft and pass the Administrative Procedure Law should be encouraged.

Judicial review and administrative law reforms Judicial review Article X requires establishment of tribunals, independent of the decision-maker, to review administrative action relating to customs matters. Paragraph D (2) and (3) of the Draft Protocol set out those areas where administrative review must be available. At present there are two channels for review of administrative decision making. They are administrative litigation which is conducted in the people’s court and administrative review which is conducted by either the higher level administrative

China’s accession to the WTO 175 department in charge of the decision maker or the people’s government at the same level as the original decision maker. A party dissatisfied with an administrative act may choose to commence either litigation or review, but not both at once, unless the law otherwise provides.43 A trend in some areas has been to require the dissatisfied party first to seek administrative review of the decision before being able to commence administrative litigation.44 It is also possible for the law governing the substantive act to exclude the jurisdiction of the courts. This last provision has been a sticking point. For example the grant of a patent under the Patent Law is not reviewable by the courts as their jurisdiction is completely excluded by the Patent Law. China has agreed in principle to remove this restriction on the capacity of a party to commence litigation to review such a decision. By using the heading “judicial review” and requiring that the review agency be independent of the original decision maker, the Draft Protocol implies that the main task of scrutiny of administrative decision making will be performed by courts. Although the people’s courts now have capacity under the Administrative Litigation Law to scrutinize the lawfulness of administrative acts, that power is comparatively limited. The courts have a number of structural weaknesses which will be difficult to overcome in the short term. Before placing too much importance on finding a correlate to some Western notion of judicial review, it is important to consider the role that the courts can and do play in resolving disputes both between business partners and with state organs. Other forms of review of administrative decision making have been generated internally, that is by the review agency and have followed the hierarchical organization of the state. The higher level department in charge (within the vertical line ministry) and the people’s government at the same level have traditionally exercised powers of scrutiny under the Chinese system of dual supervision. These forms of supervision are initiated from within the system, sometimes as the result of a complaint from citizens. Supervision by the Ministry of Supervision and the CCP Discipline Inspection Committee are commenced about alleged illegal conduct by an official or a party member either in response to a complaint or from within the department. The decision to commence an investigation is made by the organ. More recently, systems of administrative litigation and administrative review have been established. These break from earlier models of supervision in that the supervision process is initiated by an aggrieved individual. These forms of scrutiny accord more closely to our common law understanding of review of administrative action. Judicial independence: the people’s courts and lawyers The courts occupy a very different position in the Chinese state than they do, say, in Australia. The existence or absence of judicial independence has been seen as an issue of fundamental concern to China’s compliance with the review provisions in the Draft Protocol. There is no separation of powers as the Constitution provides that all state power is unified in the NPC, but there is separation of function. The NPC creates and supervises the activities of the executive (the State Council), the

176 Sarah Biddulph people’s courts and the people’s procuratorates, so structurally, courts cannot be independent of the NPC and its Standing Committee. The courts are entitled to exercise their adjudication functions without interference by other state organs, which is the concept of “separation of function” (Constitution art. 126). However, the converse is also true, the courts are not permitted to interfere in the legitimate exercise by other organs of state of their powers. An important principle that limits the scope of the court’s power is the prohibition on the courts to interfere in the exercise of administrative powers of the state which consequently results in limitations on court powers to review and change administrative conduct. Despite the concern about structural lack of independence of the people’s courts and of judges, a more important consideration is whether judges and the courts are able to exercise their adjudication function in accordance with the law and without interference in individual cases. The constitutional structure anticipates that courts should be able to exercise without interference from other agencies. One important consideration is the courts and judges have a lower status and are less well paid than their Western contemporaries. Lack of financial independence of the court structure from local government is a major structural impediment to the independent exercise of judicial power. The administrative agencies of state have comparatively much more power. Corruption in the judiciary has also become a problem. It is serious enough to warrant public comment and formulation of measures designed to prevent corrupt behaviour such as accepting gifts, dinners, trips and entertainments such as ten pin bowling outings. The guarantee of “judicial independence” in the Constitution (art. 126) refers to independence of the court system as a whole from interference by external bodies and organizations. It does not refer to independence of individual judges in hearing and determining matters (Woo 1991). In fact there are several systems in place for internal review of judgments both before and after an individual case is decided. For difficult and important cases, the adjudication supervision committee, comprising the chief judge and heads of each division of the court, may review the case which has already been heard by the collegiate bench and decide it. The judgment is then given by the collegiate bench hearing the matter. Until recently, the adjudication committee could remove a matter from the collegiate bench at its own instigation. The amended Criminal Procedure Law reduces the power of the adjudication supervision committee to remove the case from the collegiate bench. The collegiate bench itself should now request removal of a case under its control to the adjudication supervision committee if the judges cannot decide it themselves. This reform is intended to strengthen the autonomy of the collegiate bench which is responsible for the trial and determination of the case at first instance. It will be a while before we can determine what effect this reform has on the adjudication system as a whole. Higher level courts periodically do random reviews of cases handled by lower courts to check on the quality of the decisions. Where a case is very difficult, there is also an informal mechanism for referring the case before it is decided to the higher level court for an opinion. However, referring a matter to the higher level court for an opinion has correctly been criticized as prejudicing the right of litigants to appeal against decisions with which they are dissatisfied, as the higher level appeal court

China’s accession to the WTO 177 may have already considered the case and formed an opinion before the appeal is heard. The existence of these measures illustrates something of the bureaucratic work-style of the courts. It also reflects a concern to ensure that judicial decision making is internally consistent and properly made on the basis of law. In the past legal training of judges was poor or even non-existent. Since the end of the Cultural Revolution, law schools and faculties have been reopened and many new law schools have been established. Many people working as judges undertook night school and extra legal training courses. Now, with the exception of some of the more remote areas of China, the level of legal awareness of judges has dramatically improved. Another issue commonly raised in discussions on judicial independence is party leadership. Leadership of the Communist Party is one of the four cardinal principles. All courts and judges are required to carry out their work under the leadership of the party and in accordance with its policies. In most situations this guidance is intended to be exercised at the policy level. The volume of cases before the courts is far too great for the local party committee to be able to scrutinize them all, even if it wanted to. The requirement that cases be submitted to the Party Secretary for approval before judgment has been removed. However, there are still some circumstances when the party, or party committees such as the Politics and Law Committee, will involve themselves in a particular matter. The Politics and Law Committee is established at all levels above county level and is responsible for coordinating the work of the police, procuratorate and courts. The chief of each of those organs is represented on the committee. An area with which it is particularly concerned is the maintenance of public order. As a consequence, it is more likely that the committee will be interested in the handling of “important and difficult” cases in the area of criminal and administrative law than in it will be civil and economic cases. Many disputes will not end up in court. Parties are encouraged to attempt to resolve their dispute through informal channels such as negotiation and conciliation. An arbitration clause in a contract will exclude the jurisdiction of the court. It is very common for foreign-related joint venture contracts to include an arbitration clause of some type. The Civil Procedure Law of 1991 reduces the importance of in court mediation as a means of disposing of a case. Under the Civil Procedure Law (for trial implementation) 1982, judges were encouraged to mediate both before trial and during the trial. Despite the changes in the law, there are many examples still of cases where judges have been reluctant to make findings of absolute right and wrong in civil and economic matters and prefer to find a compromise position between the parties. The parties to the dispute should be responsible for putting all arguments and supporting information to the judge before trial. Despite some recent changes to trial procedure contained in the Criminal Procedure Law that incorporate aspects of the adversarial system, judges still deal with and form a view about the issues before the trial commences. On matters that are difficult to decide, they may invite further submissions from the parties to the case or independently consult external experts on various points in contention. It is not clear the extent to which these reforms were intended to apply to trial of cases outside the criminal jurisdiction. In a small number

178 Sarah Biddulph of complex disputes involving trade, investment and futures, the law may be unclear or non-existent, which makes trial of the matter difficult. In these cases, the responsible judge will often ask both parties to provide extensive information, including the laws of other countries, on the legal issues in question. A number of evidentiary problems may arise in the course of litigation. An example is that although Chinese law recognizes international custom, there are no clear evidentiary rules to enable a party to prove it. In this situation, the individual judge has a regulated and unfettered discretion to determine what evidence can be used to show both the existence and content of international custom. In recent years the numbers of lawyers who are well trained and familiar with the operation of the market economy have increased dramatically. Economic law and especially foreign-related economic law is the most lucrative areas of practice and so competition both domestically and with foreign law firms for this type of work is intense. The new Lawyers Law (passed on 15 May 1996 to take effect on 1 January 1997) has placed the accreditation and regulation of lawyers’ activities on a more professional footing. Still, the quality of lawyers remains very uneven. Administrative Litigation Law 1989 Before this law was passed,45 the courts exercised some extremely limited powers to review the lawfulness of some administrative actions under specific laws. The Administrative Litigation Law gave the courts a much broader power to review the lawfulness, though not reasonableness, of listed types of administrative acts. When the law was being drafted, some suggested that the courts be empowered to examine the lawfulness of acts which infringed upon any of the rights of citizens set out in the Constitution. This broader formulation was rejected. Reasons for its rejection were that China did not have a culture of citizens suing officials and unless the scope of actions which could be scrutinized was made specific, then the courts would be unable or unwilling to implement the law (Zhang Shuyi 1992). Abstract administrative acts are excluded from the scope of acts that may be challenged under the law.46 Abstract administrative acts include rule making, standard setting and other administrative norm-making activity. Disputes concerning disciplinary action taken by a work unit in relation to a member of that unit also fall outside the ambit of the law.47 Courts make a determination of the lawfulness of an action on the basis of laws and administrative regulations and regional legislation.48 Under this law, the court is only required to “refer to” administrative rules and regulations promulgated by departments.49 The effect of this provision is that if there is a conflict between a rule and a higher level law or regulation, then the court may ignore the lower level rule. Courts are not empowered to determine that a rule is unlawful or invalid. That power is exercised by the higher level administrative department up to the State Council level, with final power in the Standing Committee of the NPC to quash a rule. This power is rarely used. In theory, courts are not required to refer to internally circulated rules or to normative documents. In practice they do, as these documents often form the specific basis for the action. It means that it may be very

China’s accession to the WTO 179 difficult for potential litigants to know the strength of their case before trial if unable to obtain access to these documents. The law also permits foreigners, as well as Chinese, to commence an action under this law. So, for example, if the applicant consider that a decision not to grant a licence was unlawful, that person may commence an action under this law. The law does not extend to actions by MOFTEC in exercising powers of general application, such as inclusion of a particular good on the restricted import list. This type of act is classified as an abstract administrative act. The administrative agency is required to prove that the act was lawful and must supply documents and rules upon which the particular decision was based. If it refuses to do so, the court is entitled to find that the act was unlawful and quash it. Courts have very limited power to amend an administrative act. They may amend a punishment, as opposed to other types of act, only if it is “manifestly unfair.”50 Explanations of the scope of what is manifestly unfair have been framed very narrowly. The limited nature of orders a court can make is due to the requirement that courts do not interfere in the exercise of administrative functions of the state as discussed above. This law represents a major reform in the legal system. There are still only comparatively few cases brought under this law. In many cases people may be reluctant to commence an action, either because of fear of retribution from officials with whom they will be forced to have ongoing contact,51 lack of confidence in the courts, because of traditional attitudes such as “officials are high up and the people low down” and that a person suing an official does not know his or her place and is looking for trouble (Huang 1992). Since promulgation of the law, the state has conducted extensive propaganda to inform people of their rights under the law and to encourage them to sue officials. Rates at which actions are commenced varies dramatically throughout the country. This demonstrates how implementation of laws often depends on the degree of legal knowledge of the relevant official and the extent to which they are willing to submit to the law. A number of issues have arisen in conduct of trials. There are cases of the courts being reluctant to accept cases in the first place, especially where they fear retribution from the defendant, for example, the local government. There are also high and increasing levels where the applicant withdraws the action before hearing; either as a result of pressure from the court, from the defendant, or the parties reach a satisfactory compromise, despite the rule that mediation of result between the parties is not permitted under the law, or the applicant finds that his or her claim lacks merit. Despite the shortcomings in both the law and its implementation, the system of administrative litigation represents an important development in legal systems of accountability of government officials for their actions. Administrative Review Law 1999 The Administrative Review Law was passed on 29 April 1999.52 It replaces the Administrative Review Regulations which came into effect from 1 January 1991. The

180 Sarah Biddulph Administrative Review Regulations established a system of internal review of specific administrative acts by the higher level administrative department in a way that largely followed and complemented the regime set up under the Administrative Litigation Law. Later amendments to the Administrative Review Regulations added the government at the same level as the administrative decision maker as an alternative site of review.53 The Administrative Review Law at article 12 excludes the jurisdiction of review agencies established in local government in respect of decisions made inter alia by customs, finance departments, taxation authorities foreign exchange control authorities, and state security agencies. The Administrative Review Law is claimed to have established an independent administrative review mechanism in China which is not merely designed to accompany the administrative litigation system (Yu 1999). The Administrative Review Law differs from both the previous Administrative Review Regulations and the Administrative Litigation Law in that the scope of administrative actions that may be reviewed under it is much broader. Under the Administrative Review Law a citizen or entity may seek review of any administrative act which they believe infringes upon their lawful rights and interests.54 Under the Administrative Litigation Law, a person or entity may only commence litigation in respect of the types of administrative acts listed in the law.55 The Administrative Review Law is broader in scope than the previous Administrative Review Regulations and the Administrative Litigation Law as the review agency can determine appropriateness as well as the lawfulness of the specific administrative action,56 change the administrative act to the extent of its functional power,57 but is also required to amend or overturn the rule on which the action was based within the scope of its functional power or, if it does not have the power to do so, then to refer it to a state organ which does have that functional power.58 The Administrative Review Law also goes further towards embodying principles discussed above in relation to the Administrative Punishments Law in that it specifies mandatory procedures for carrying out review and requires reasons to be given for decisions. Unless specifically excluded by the law which governs exercise of a certain power, if a person is dissatisfied with the decision made on review then that person has 15 days within which to appeal against it to the people’s court.59 The Administrative Review Law provides greater protection of the litigation rights of citizens than under the Administrative Review Regulations as it provides that a person may commence litigation from a administrative review decision that the law provides is final if the review agency fails to accept the application for review within the legally specified time limits, or does not provide a decision within the specified time limits, or if the review decision does not contain a statement of reasons.60 The Administrative Review Law provides that review is to take place on the documents unless otherwise requested by the applicant or the review agency considers it necessary in which case oral evidence may be taken and an investigation be carried out in person.61 The review organs have considerably more power than courts to make determinations and ensure compliance with their decisions.

China’s accession to the WTO 181 The trend with recent administrative legislation has been to strengthen procedural requirements of laws, require greater openness in that the agency must give reasons for its decisions and allow the party affected an opportunity to respond before the decision has been made. Administrative appeals tribunal One topic that has been under discussion since at least 1988 has been the establishment of an administrative tribunal that is independent of the administrative agencies and which has broad powers to review decisions of those agencies. Given the proliferation of different channels for review of administrative decision making in the 1990s, it is unlikely that there will be adequate support for the establishment of yet another review agency. There appears, quite reasonably, to be opposition to adding yet another layer of review on top of those already existing channels especially after passage of the Administrative Review Law which is designed to strengthen the administrative review system already in place. Arguably, the existence of too many different channels for supervision of administrative acts fragments and further weakens the system of supervision as a whole. Even if there is a decision to add a new channel for review in the form of a tribunal, there is no reason why it would have any greater efficacy than pre-existing channels, unless the practical power relationships between decision maker and supervisory organ were properly worked out. State Compensation Law Another major reform to the system of administrative law was made in the State Compensation Law.62 This law enables a person who has suffered loss as the result of an unlawful act by an official under either the administrative or criminal law to claim compensation for that loss. The standard for calculation of the amount that can be claimed is specified in the law. Comments on paragraph D of the Draft Protocol China now has in place several mechanisms for review of administrative decision making. It primarily permits oversight of specific decisions rather than rule-making activities. Formal mechanisms for oversight of rule-making by both ministries at the central level and at the local level remain poorly developed. It is unreasonable to expect that courts in China will be able to operate in the way they do in Australia, especially to exercise broad powers of judicial review. Despite this limitation, in recent years there has been a dramatic increase in the number of channels for bringing complaints about administrative decision making and the scope of matters which may be subject to scrutiny. The system at present suffers from being fragmented, with a range of different institutions exercising some powers of scrutiny, each with their own particular limitations. For this reason, adding yet another channel for review of administrative

182 Sarah Biddulph decision making may not achieve the desired objective and so may not be a desirable course of action. The Draft Protocol currently demands that tribunals for oversight of administrative decision making be independent of the decision maker. This requirement is not satisfied under the current system of administrative review to the extent that the aggrieved person may seek review of the higher level department in charge. However, the Administrative Review Law now permits an application for review to be brought to the people’s government at the same level as the decision maker unless otherwise excluded and, unless excluded by law, a review decision may be appealed to the people’s court. In the previous sections, this chapter has discussed the ways in which administrative agencies exercise comparatively greater power than do the courts. It is quite possible that a person would choose to approach the higher level department in the same line ministry to seek review of the decision because of its greater power to make and enforce its decisions. A strong argument in favour of ensuring independence of the tribunal, on the other hand, is the real fear that the department in conducting the review will be biased in favour of its own officers. Due to problems of local protectionism that are discussed below, the local government may also be reluctant to make a decision unfavourable to the local organization. Many of the weaknesses of the system set out here arise as a result of the structure of the system rather than failure to institute a system of review, such as, for example, the weak position of the people’s court and local protectionism. As the system for challenging administrative, decision making is still comparatively new and runs contrary to long-established bureaucratic culture, it is not surprising that it still does not work very well. The system of arbitration, while it may work satisfactorily in resolving disputes between parties to contracts, is not an appropriate forum for resolution of grievances against actions of state officials. It is also, I suggest, impractical to superimpose yet another review mechanism on top of the several that currently exist.

The requirement that laws be administered in a uniform, impartial and reasonable manner: enforcement of legislation The Draft Protocol and Article X require that laws, regulations, decisions and rulings be administered in a “uniform, impartial and reasonable manner.” At least this requirement is that laws be enforced according to their terms and that they be applied consistently in similar fact situations. Enforcement of law has arisen as one of the major problems in development of the legal system. Some of the practical problems of law enforcement have been mentioned above, such as lack of understanding and respect for law and lack of faith that the law will deliver a just result, and how the general terms in which laws are framed allows for great flexibility in their interpretation and implementation. In this section, I discuss some of the other factors that influence enforcement of the law.

China’s accession to the WTO 183 Discretion A consequence of China’s model of law making is that laws often give both local and central authorities broad discretion in making some decisions. The exercise of discretion is an important part of administration in all countries. China differs from others in degree, as at present officials exercise very broad discretions. Even if all rules were publicly available, the problem of knowing how the law will be implemented in any particular situation will not necessarily be resolved because of the existence of these broad discretions. The source of discretion may come from undefined terms, ambiguous phrases, or powers given in general terms. The legal system does not yet effectively regulate or set principles for the exercise of discretion. As the legal system develops, the scope of discretion is gradually being narrowed. In legislation such as the Administrative Review Law and the Administrative Punishments Law we can see the start of legislative definition of principles for the exercise of discretion.63 This is a long-term ongoing process that not only requires changing the legal structure for the exercise of discretion but also will require a long period of intensive education to change existing attitudes of state officials towards the exercise of state power. Part of the difficulty to date in the legal rules for the exercise of power has been that they have not clearly specified the basic spirit or principles that should govern exercise of the power. Socialist construction and economic modernization arguably do not provide helpful principles for the exercise of discretion in particular instances. Many practical problems arise from the unprincipled exercise of administrative and judicial discretion. If there is no legal basis for exercising that discretion, then the official will often take non-legal considerations into account. Most commonly, an official would be guided by policy priorities. Examples are foreign investment guidelines, the priorities specified in the state plan and a general notion of national interest. Possibly more disruptive of uniform and proportional law enforcement practices are those policies that require concerted action in relation to a targeted areas of activity to be carried out in the short term. These policy directives appear regularly and encourage widely variable and unstable law enforcement practices and create great uncertainty about the manner in which the regulatory regime will be interpreted and enforced at any particular time. In the area of administrative law, since passage of the Administrative Litigation Law there has been scholarly debate about the fundamental principles for the exercise of administrative powers and in particular administrative discretion. In many countries we take these principles for granted. Legislators are seeking to include these principles into the Administrative Procedure Law, which will make them applicable to all areas of administrative decision making. Failure to act in accordance with these principles is not yet clearly a ground for challenging the lawfulness of an administrative decision under the ALL, but it does provide assistance to a willing court in administrative litigation when it must for example decide if the decision was an abuse of process. Specification of these principles will arguably expand the scope

184 Sarah Biddulph of administrative litigation. It certainly expands the scope of administrative review where a consideration of appropriateness of a decision is also to be made. The Administrative Punishments Law is the first to specify out such a normative framework for the exercise of administrative punishments powers. The APL requires that decisions be open, fair, based on facts and proportional to the degree of social harm caused. These principles apply also to the exercise of discretion. China does not have general freedom of information laws. It is not possible to require an official to provide reasons for a particular decision, with the exception of administrative decisions that fall within the scope of the Administrative Punishments Law which requires the official to provide reasons for imposition of the punishment. Controlling the exercise of judicial discretion is more problematic. Procedural rules are set out in the Civil Procedure Law, the Criminal Procedure Law and to an extent in the Administrative Litigation Law. However, in other important areas, especially evidence, the court has an almost unfettered discretion to determine what matters it will take into account and what weight it will accord to them. This becomes an issue for foreign parties who, for example, may want to prove the existence of international custom in a particular area. What evidence they will be permitted to bring to show the existence of international custom will depend largely on the individual judge and may be particularly problematic when that evidence is case law from foreign, common law, jurisdictions. Local protectionism One of the major problems in ensuring uniform implementation of law throughout China is local protectionism. The problem arose largely out of decentralization of financial control and tax collection. Local governments have much more power to attract foreign investment and to undertake a wide range of activities independent of the centre. There is also fierce competition between provinces for markets and to attract investments. These activities are very hard for MOFTEC and other central agencies to control. The authority of central agencies is also reduced because of the formation of strong alliances between local business interests, either domestic or foreign, (this is especially so with overseas Chinese, Taiwanese and Hong Kong business) and local government (Potter 1995). In addition, the power of local governments and people’s congresses to make laws and rules which are appropriate for the local level is fully used and often exceeded. Although the Legislation Law seeks to address these problems by instituting a system of supervision over rule making, it remains to be seen whether this regime will be effective either in the long or short term. Local protectionism also creates a particular problem for law enforcement. Local governments exercise a very high degree of power over local organs of state, including courts and procuratorates, because they fund their operation. Local courts are often unwilling to make a finding adverse to a local company, entity, or government agency for this reason. If they do, then they have great difficulty in enforcing it. Courts in practice lack effective coercive powers to enforce judgments. It is a matter of grave concern both within and outside China that courts are very

China’s accession to the WTO 185 often unable to enforce judgments. For example, when a judgment is made against a local enterprise, or is sought to be enforced against an enterprise from a different locality than the party seeking enforcement of the judgment, the court often finds that the money has been removed from the bank account from which the award is to be satisfied, or if the award is to be satisfied from sale of a factory and its equipment, then the factory is empty. This problem has been recognized at the highest levels, but it is also very difficult to remedy. Within its own ministerial hierarchy, MOFTEC is well organized and coordinated. MOFTEC is aware that localities often flaunt foreign investment and trade rules or find ways of avoiding them. During the 1990s it has encouraged foreign parties to make enquires directly of it concerning laws, rules and policies. This is also a way for it to collect information and ensure that the investment rules are being adhered to at the local level. Administrative controls over the application of law Remnants of the planning system may still be seen to be operating in the application of laws in particular circumstances. These practices have a great impact on the uniform application of law and specific regulatory regimes and are not readily apparent. An example to illustrate this point relates to recent policy on bankruptcy of enterprises in China. Even though the Enterprise Bankruptcy Law of the PRC itself is drafted in very broad terms, there are now many enterprises that would be eligible to be bankrupted in accordance with this law. However, an administrative quota system operates which means that limits are placed on the number of enterprises in each area that may be bankrupted in each year. The same type of administrative planning mechanism has been used to regulate the number of companies permitted to apply for listing on the Shanghai and Shen Zhen stock exchanges in order to preserve the stability of the market. The existence and content of these superadded planning mechanisms are not apparent from an examination of the relevant laws and regulations.

Conclusion: law and practice, can China meet its WTO obligations concerning transparency? It is too easy to assume that passing a law will necessarily be sufficient to ensure that the system it contemplates will sooner or later become respected or enforced in practice. This view gives too much credence to the view that administrative and social norms will change to follow the regulatory regime that has been put in place. Arguments that the central government need pass laws only in order to demonstrate that the fundamentals of a transparent system are in place cannot be supported. On the other hand, it is an oversimplification simply to dismiss Chinese law as being so far away from practice and the entrenched norms for the exercise of power that it is ineffective to influence practice. It is undeniable that the immense efforts put into creating a comprehensive legal system and into seeking to educate officials and citizens to respect it has had a significant impact.

186 Sarah Biddulph Within the limits of the state structure, the central congress and government have passed laws that go far towards introducing the main components of a transparent system. They have passed laws requiring publication of laws, creating mechanisms for individuals to challenge administrative decision making and, more recently, to establish mandatory procedural requirements for administrative action. As discussed in this chapter, there is still further legislative work to be done, some not yet started and more is in the drafting stages. Viewed over the 20-year period since the decision was made to re-establish a stable legal system, the rate of development has been remarkable. However, the Draft Protocol appears to require a certain result to be achieved as well as the creation of a legal structure. The question we must answer for ourselves is what do we expect the central government to do to ensure that the laws are uniformly enforced and enforceable at the local level. When is failure to enforce laws uniformly at the local level to be seen as a failure of the law and the legal system itself? If we return to the three criteria for transparency set out at the beginning of this chapter, publicity of laws, procedural fairness and independent review, it is possible to comment about some of the features of the Chinese legal and administrative system that create problems in realizing the goal of transparency. One seemingly intractable obstacle to achieving some degree of procedural fairness lies in the continued existence of unprincipled discretion in administrative and judicial decision making. Part of this problem can be traced to the rapid, and at times, uncoordinated development of the infrastructure of formal rules upon which administrative and judicial decision making should be based. As I have asserted earlier in this chapter, this problem should be seen as a consequence of the urgent need to develop a formal legal framework. Continuing efforts are being made to alleviate this problem. Another factor affecting the ability to ensure principled exercise of discretion and thence procedural fairness, derives in part from the nature of regulation itself. Many laws both empower the implementing agency to pass implementing rules and entrench broad discretionary powers in individual decision makers. It is neither possible nor desirable to seek completely to eliminate the exercise of discretion. However, entrenching an excessively broad discretion facilitates arbitrary decision making and corruption. It also undermines the effectiveness of the review mechanisms that have been established to scrutinize that decision making. The tendency to pass laws which are then turned on or turned off because of political, policy or administrative dictates, or operate subject to quota, is contrary to the basic concept of transparency. This phenomenon differs significantly in degree from uneven or inconsistent enforcement of laws, which takes place in all countries. The significant impact that local protectionism has upon the operation of local administrative and judicial decision making creates probably the most difficult obstacle in achieving the ideal of transparency. Local protectionism strikes at all three elements of transparency, though, most noticeably it affects local decision making and so procedural fairness and impairs independent review of local decision making. These problems are deeply entrenched in the system and, though easy to identify, are difficult to remedy.

China’s accession to the WTO 187 Local protectionism also provides a good example of how difficult it is to determine the extent to which blame for the problems local protectionism causes should be laid at the feet the central government and if it is, what the central government should be required to do to address this problem. Decentralization of power has been a significant factor in promoting economic reform. To require the centre to recentralize power in judicial or administrative structures in order to address problems of local protectionism would be seen as politically unacceptable. Arguably, it is already far too late to do it. It is overly simplistic to expect that problems of local protectionism will be solved in the area, for example of judicial review, even if the central government took responsibility for paying judges more and removed local responsibility for providing the financial resources needed for court infrastructure. To engage in a process of minimizing the causes of local protectionism and the effects it has on rule making and on administrative and judicial decision making, will be an ongoing process that requires creative solutions and cooperation between countries as well as willingness at the official level. It may be that in the end, to deal with these problems requires a radical reassessment of the way in which the administrative and judicial system is organized and funded, though that is a matter which will be decided by the Chinese government. Long-term collaboration and cooperation are the only ways to address these issues.

Legislation Administrative Litigation Law (ALL) passed on 1 April and came into effect on 1 October 1990 Administrative Punishments Law passed on 17 March 1996 and came into effect on 1 October 1996 Administrative Review Law (ARL) passed on 29 April 1999 and came into effect on 1 October 1999. This law replaces the Administrative Review Regulations (ARR) which were passed in 1990 and became effective on 1 January 1991 Assemblies, Processions and Demonstrations Law 1989 Civil Procedure Law of the PRC 1991 replaced the Civil Procedure Law of the PRC (for trial implementation) 1982 Company Law of the PRC 1993 Constitution of the PRC 1982 Contract Law of the PRC was adopted by the Second Session of the Ninth NPC on 15 March 1999 and promulgated to take effect from 1 October 1999 Criminal Law of the PRC 1997 Criminal Procedure Law of the PRC 1996 Decision of the Third Session of the Sixth National People’s Congress of the People’s Republic of China on Authorizing the State Council to Formulate Interim Provisions or Regulations Regarding Economic System Reform and the Policy of Opening to the Outside World, 10 April 1985 Enterprise Bankruptcy Law of the PRC adopted 2 December 1986 and effective on 13 April 1988

188 Sarah Biddulph Foreign Trade Law of the PRC 1994 General Principles of the Civil Law of the PRC 1986 Negotiable Instruments Law was promulgated on 10 May 1995 and took effect on 1 January 1996 Patent Law 1984 Pricing Law of the PRC passed on 29 December 1997 and came into effect on 1 May 1998 Procedural Rules of the National People’s Congress of the People’s Republic of China, 4 April 1989 Procedural Rules of the Standing Committee of the National People’s Congress, 24 November 1987 Provisional Regulations on the Procedure for Formulating Administrative Laws and Regulations 1987 Provisions on Reporting and Filing Regulations and Rules (commonly known as the Bei’an Provisions) 18 February 1990 Resolution of the Standing Committee of the National People’s Congress on Authorising the People’s Congresses of Guangdong and Fujian Provinces and their Standing Committees to Formulate Separate Economic Regulations for their Respective Special Economic Zones, 26 November 1981 Resolution of the Standing Committee of the National People’s Congress on Strengthening the Interpretation of Laws, 10 June 1981 State Compensation Law passed on 12 May 1994 and came into effect on 1 January 1995

Notes 1 China/WTO Accession Washington Meeting, sponsored jointly by the University of Toronto Centre for International Studies and the Institute for International Relations and Foreign Policy, UCLA 5–6 March 1998. 2 Fried was at that time Assistant Deputy Minister, Trade and Economic Policy, Department of Foreign Affairs and International Trade, Canada. 3 They retired at the Fifth Plenum of the Ninth NPC on 17 March 1998. 4 The principles are adherence to the socialist road; adherence to the tenets of Marxism, Leninism and Mao Zedong Thought; leadership of the Communist Party and adherence to the people’s democratic dictatorship. These principles are set out in the Preamble to the Constitution. In addition to these four cardinal principles, the Legislation Law adds the requirement of adherence to Deng Xiaoping Theory (art. 3). 5 Liang Zhiping (1995: 31) argues that the legal system will be effective only if people have confidence in it. He points to growing public demands with the introduction of the market economy to use law to resolve all social problems and for the legal system to deliver some form of “justice” or to be “fair.” 6 PRC Constitution article 2. 7 falu, . 8 xingzheng fagui . 9 Decision of the Third Session of the Sixth National People’s Congress of the People’s Republic of China on Authorising the State Council to Formulate Interim Provisions or Regulations Regarding Economic System Reform and the Policy of Opening to the Outside World, 10 April 1985. The Legislation Law limits the capacity of the NPC and its Standing Committee to delegate legislation making power with respect to certain designated areas, including those related to criminal law and punishment, deprivation of political rights and deprivation of personal freedom (art. 9).

China’s accession to the WTO 189 10 Ministries, Commissions and Offices are collectively referred to in this chapter as “departments” “bumen” ( ). 11 guizhang . 12 difangxing fagui . 13 Resolution of the Standing Committee of the National People’s Congress on Authorising the People’s Congresses of Guangdong and Fujian Provinces and their Standing Committees to Formulate Separate Economic Regulations for their Respective Special Economic Zones, 26 November 1981. 14 Resolution of the Standing Committee of the National People’s Congress on Strengthening the Interpretation of Laws, 10 June 1981. 15 The Legislation Law of the PRC (Zhonghua Renmin Gongheguo Lifa Fa) was passed at the Third Session of the Ninth NPC on 15 March 2000 and came into effect on 1 July 2000. 16 Zhang Chunsheng “Explanation of the (Draft) Legislation Law of the PRC” People’s Daily Online http://www.peopledaily.com.cn/item/lifafa/bj13.html at point 3. 17 For a narrow view see Zhou Wangsheng (1988: 263–4). For a more inclusive definition of the types of documents that constitute law see Ying Songnian (1993: 93). 18 Chen Shouyi (1988), “A Review of Thirty Years of Legal Studies in New China”, 2 Journal of Chinese Law 181 at 199. 19 See for example discussion in Jiang Ping (1995a: part VI); Keller (1994: 738–41). Keller argues that the power of administrative agencies to interpret the laws that they are responsible for implementing is a reason for weakness of the Chinese legal system. 20 The Contract Law of the PRC was adopted by the Second Session of the Ninth NPC on 15 March 1999 and promulgated to take effect from 1 October 1999. It contains 428 articles. 21 The Negotiable Instruments Law was promulgated on 10 May 1995 and took effect on 1 January 1996. It contains 111 articles. 22 In the explanatory speech made by Zhang Chunsheng (1998) when introducing the Legislation Law into the Third session of the NPC, he said that drafting of this law commenced in the second half of 1993. 23 Procedural Rules of the National People’s Congress of the People’s Republic of China (4 April 1989) and Procedural Rules of the Standing Committee of the National People’s Congress (24 November 1987). 24 21 April 1987. 25 Administrative Punishments Law (APL) article 4. 26 APL article 3. 27 Provisions on Reporting and Filing Regulations and Rules (commonly known as the Bei’an Provisions). 28 The number of local regulations and rules reported under these provisions were: in 1993, 810, in 1994, 1694, in 1995, 1710, in 1996, 1580 and in 1997, 2410. The number of departmental rules reported were: in 1993, 140, in 1994, 580, in 1995, 450, in 1996, 320 and in 1997, 350. 29 Article 2 of the Bei’an Provisions excludes the following classes of documents from the reporting requirements: internal documents passed by local people’s governments and departments used for the purpose of setting up specific system of work, documents and notices (bugao ) announcements relating to particular issues (gonggao ). 30 difangxing fagui . 31 zizhi tiaoli . 32 Administrative Litigation Law (ALL) article 54(2) (iii). 33 Article 9. 34 APL Chapter 2. 35 APL article 9. 36 APL Chapter 3. 37 APL article 4. 38 Simplified procedure for minor punishments which can be given on the spot, ordinary procedure and hearing procedure. APL Chapter 5. 39 APL article 31.

190 Sarah Biddulph 40 41 42 43 44

45 46 47 48 49 50 51 52

53 54 55 56 57 58 59 60 61 62 63

APL article 32. APL article 42. Pricing Law article 23. Administrative Review Law (ARL) article 16. If the substantive law governing the administrative act requires a dissatisfied party to seek review of a decision before commencing litigation, for example under the Security Administrative Punishment Regulations, the party will not be permitted to commence litigation until after the decision has been reviewed. ARL article 16. This law came into force 1 October 1990. ALL article 12 (b). ALL article 12 (c); these are also called internal administrative acts. ALL article 52. ALL article 53. ALL article 54(4). Officials are sometime called the fumuguan, mother and father official, which is an indication of their perceived status vis-à-vis the object of the decision. The Administrative Review Law was passed on 29 April 1999 and came into effect on 1 October 1999. This law replaces the Administrative Review Regulations (ARR) which were passed in 1990 and became effective on 1 January 1991. ARR article 11. The ARR were amended on 9 October 1994. This provision has been embodied in the ARL at article 12. ARL articles 6, 9. ALL article 11. ARL articles 1, 28. ARL article 28 (3). ARL article 27. ARR article 47; ARL article 5 also permits appeal from a review decision. ARL article 19. ARL article 22. Passed on 12 May 1994 and came into effect on 1 January 1995. For example the ARL at article 4 specifies the principles of review to be lawfulness, fairness, timeliness, accuracy and conveniencing citizens, actively correcting mistakes and protecting the accurate implementation of the law and regulations.

References Clarke, Donald C. (1991) “What’s Law Got to Do with It? Legal Institutions and Economic Reform in China.” 10(1) Pacific Basin Law Journal 31. Deng Xiaoping (1984) “Emancipate the Mind, Seek Truth from Facts and Unite as One in Looking to the Future,” reproduced in Selected Works of Deng Xiaoping vol. 2 (1975–82) Beijing, Foreign Languages Press. Feinerman, J. V. (1997) “The Rule of Law . . . with Chinese Socialist Characteristics,” Current History September: 280. Huang Jie (1992) “On the Administrative Litigation Law,” 24, no. 3 Chinese Law and Government 43. Jiang Ping (1995a) “State and Society, on the Change of Legal Concepts in Modern China,” Conference Proceedings of the 1995 Annual Meeting, Research Committee on the Sociology of Law, Legal Culture: Encounters and Transformations, part I. Jiang Ping (1995b) “Xingzheng Guanli Xiangduiren de Quanli Qiuqi” (Rights of the objects of Administrative Management to Seek Redress) in Xia Yong (ed.) Zou Xiang Quanli de Shidai Zhongguo Gongmin Quanli Fazhan Yanjiu (Heading towards an Age of Rights: A Study

China’s accession to the WTO 191 of the Development of Civil Rights in China) Beijing, China University of Politics and Law Press. Keller, P. (1994) “Sources of Order in Chinese Law,” vol. 42 The American Journal of Comparative Law 711 at 738–741. Liang Zhiping (1995) “Zhuanxing shiqi de falu de shehui zhengyi,” Dongfang 4–10, translated in (1995) no. 2 China Perspectives 28 at 31. Ostry, S. (1998) “China and the WTO: The Transparency Issue,” Spring 3 UCLA Journal of International Law and Foreign Affairs 1. Potter, P. B. (1994) “Riding the Tiger: Legitimacy and Legal Culture in Post-Mao China,” The China Quarterly 326. Potter, P. B. (1995) “Foreign Investment Law in the People’s Republic of China: Dilemmas of State Control,” The China Quarterly 155. Potter, P. B. (1998) “Curbing the Party Peng Zhen and Chinese Legal Culture,” vol. 45, no. 3, Problems of Post Communism 17–28. Richardson, G. (1997 [1986]) “The Duty to Give Reasons: Potential and Practice,” Public Law 437 reproduced in Allars, M., Australian Administrative Law Cases and Materials, Sydney, Butterworths. Woo, M. Y. K. (1991) “Adjudication Supervision and Judicial Independence in the P.R.C.” 29 The American Journal of Comparative Law 95. Ying Songnian (ed.) (1992) Xingzheng Fa yu Xingzheng Susongfa Cidian (Dictionary of Administrative Law and Administrative Litigation Law) Beijing, University of Politics and Law Press. Ying Songnian (ed.) (1993) Xingzheng Xingweifa: Zhongguo Xingzheng Fazhi Jianshide Lilun yu Shijian (Administrative Action Law: Theory and Practice of the Construction of China’s Administrative Legal System) Beijing, People’s Press. Yu An (1999) “Several Basic Questions about my Country’s Administrative Review Law,” Fazhi Ribao (Legal Daily) 6 May 1999 p. 7. Zhang Chunsheng (1998) “The Development and Prospect of Administrative Procedure Law of China,” unpublished paper given at the International Symposium of Administrative Procedure Law, Shanghai, 16 November. Zhang Shuyi (1992) “Examination of Several Controversial Issues in the Administrative Litigation Law (Draft)”(1992) 24, no. 3 Chinese Law and Government 47. Zhou Wangsheng (1988) Lifaxue (The Study of Legislation) Beijing, Peking University Press.

11 Administrative process and the rule of law Hudson N. Janisch

Introduction In seeking integration into the world’s trading system at this time, China will have to give practical legal expression to a recognition that the World Trade Organization’s scope was significantly expanded in the Uruguay Round so that the trading regimes of Members are now very much more open. In succeeding to the General Agreement on Trade and Tariffs, the WTO has gone well beyond border measures such as import duties, and now reaches into areas of domestic policy to require the opening of distribution channels and the dismantling of state-owned monopolies, as well as allowing access, for example, to foreign financial institutions and telecommunications service providers (Houben 1999: 3). The shift from a trade regime involving the exchange of goods to a rules-based regime concerned with access to markets by competitive service providers will ineluctably make greater demands on domestic legal regimes. Indeed, in its commitment to “transparency,” contemporary trade law has bought extensively into administrative law principles, especially those prevalent in the US (Ostry 1998: 1– 19). This raises the immediate prospect that without significant changes to China’s system of administrative law, a mis-match between international commitments and domestic public law will go far to undermine China’s accession to the WTO. This will be especially so if, as reported, the US puts in place a special monitoring plan for China (Wall Street Journal, May 3, 2000). While trade law has moved to a transparent, legalized basis (Ostry 1997), China’s economy is still one based on relationships. As Shuhe Li and Shaomin Li, two economists at the City University of Hong Kong, have noted, in advanced economies companies do business within a rules-based system. This means that business is generally conducted in a publicly verifiable manner by way of contracts under laws that are widely known and consistently enforced. In an economy based on relationships, business transactions are made on the strength, not of contracts, but of personal agreements which are neither verifiable nor enforceable in the public sphere. A rules-based system needs a high and costly level of public order; a relations-based system needs only minimal public order. Instead of incurring the high fixed costs involved in setting up a rules-based system, China has taken the cheaper route of relationship-based development. (The Economist 2000:7). While this

Administrative process and the rule of law 193 approach has been very successful in the short term as a supplement to kin-based petty capitalism, China is now being called on to accommodate the radically different demands of international trade. The fixed costs of a rules-based system (such as the establishment of an effective legislature and judiciary, the drafting and interpretation of laws and the implementation of contracts) may no longer be avoided, at least in those sectors of the economy most affected by international trade. In time, given the permeability of international trade today, a more general move away from guanxi (relationships or connections), may have to be made throughout the economy.

A touchstone Overall, this chapter is concerned with the impact on domestic administrative processes which will inevitably accompany any shift to a rules-based system of international trade in China. However, rather than analyze administrative process and rule of law issues generally and in the abstract, telecommunications will be employed as a touchstone to bring things down to earth and to ensure a somewhat greater degree of specificity in analysis. The telecommunications sector is particularly appropriate for our purposes for a number of reasons. First, it is widely recognized that telecommunications provides the essential infrastructure for modern, information-based economies. Second, the development of telecommunications has had a high priority in China due to official recognition that it is central to the modernization ambitions of the Chinese government and as a facilitator of overall economic growth. With generous investment and favourable policies from central and local governments, it has been the most rapidly developing industrial sector in China in the 1990s (Xu and Pitt 1999: 247). Third, it has been a sensitive issue in accession negotiations in part because of concern that more efficient foreign-backed service providers could overwhelm governmentowned entities leaving behind massive stranded investment. As well, there have been substantial security concerns, especially with respect to foreign satellite broadcasting and the Internet. Fourth, as we shall see, international trade rules governing telecommunications are both ambitious and intrusive. Here, domestic capacity to live up to international commitments will be sorely tested. Fifth, having pushed very hard to achieve a significant breakthrough with respect to telecommunications in the late 1990s, it is to be expected that the United States Trade Representative, urged on by AT&T and other major US carriers, will aggressively seek to make sure that markets are in fact open. Indeed, as of April 2000, the USTR had already lodged complaints against nine countries, including Canada, Mexico, Japan and South Africa, alleging widespread failure to live up to WTO commitments. It is thus very likely that this will be a sector soon tested after accession.

Telecommunications: from exchange of traffic to trade in services The governing principles underlying the traditional exchange of traffic regime of the International Telecommunications Union (ITU) may be summarized as:

194 Hudson N. Janisch ●

●

●

service provided by separate national systems, domestically closed, but internationally coordinated clear recognition of the sovereign right of each nation to organize and regulate its telecommunications system as it thought proper international policies, rules and standards developed collaboratively, but actual services conducted under bilateral agreements.

In sharp contrast, the new trade in services regime recently developed under the WTO is based on the following principles: ●

●

● ●

●

Transparency: full publication of all laws, regulations and administrative guidelines. Progressive liberalization: progressive reduction in any adverse impact of laws, regulations and administrative guidelines on effective market access. National treatment: foreign entities to be treated as if domestic entities. Most-favored nation (MFN) treatment: treatment given a service provider from one foreign country must be no less favorable than that accorded a service provider from any other party to the agreement. Market access: the most basic principle. It includes the right to establish or expand a commercial presence, the elimination of measures that restrict services from outside the country, and the creation of minimal, reasonable, transparent and non-discriminatory licensing requirements.

Most significantly, participation in the ITU’s exchange of traffic regime did not derogate from national control (Janisch 1999: 66). The premise was that, in order to exchange traffic, each nation was exclusively responsible up to its gateway; thereafter the two nations shared joint ownership of facilities to some mythical midpoint between them. Very differently, in a market access regime, substantial constraints are placed on national control to ensure effective market access.

The Fourth Protocol to GATS It will be recalled that, at the completion of the Uruguay Round, member states agreed to create a General Agreement on Trade in Services. Negotiations with respect to the telecommunications sector were, however, limited to value-added services and were included in the Telecommunications Annex. While no agreement was reached on basic telecommunications, members did agree to continue work with negotiations which were assigned to a special forum, the Negotiating Group on Basic Telecommunications (NGBT). The initial negotiating deadline was April 30, 1996, but due to a lack of adequate offers, no agreement was reached. Negotiations were then extended to February 15, 1997 and a few hours before that deadline, 69 countries with telecommunications markets worth US$570 billion annually agreed to liberalize their markets to varying degrees starting January 1, 1998. Many countries agreed in the Fourth Protocol to GATS to lower or remove domestic barriers to international investment and to competition in the provision of local, long

Administrative process and the rule of law 195 distance and satellite services. And most important for our purposes, many countries pledged to adopt pro-competitive and transparent regulatory principles. These were set out in the Regulatory Framework Reference Paper (Reference Paper).

The Reference Paper As we have seen, by its very nature, the Fourth Protocol to GATS has a distinct domestic impact. Rather than simply confining itself to transactions across borders and leaving it up to signatories to bring their domestic law into line, the Protocol provides for the first time for a set of pro-competitive regulatory principles that amount to a rudimentary form of international competition law for telecommunications ( Janisch 1999: 70). It has been suggested that “the most remarkable feature” of the Protocol was that virtually all countries had agreed on a set of pro-competitive regulatory principles contained in the Reference Paper prepared during negotiations. It covers competitive safeguards; interconnection, licensing, allocation of scarce resources and the maintenance of universal service (Bronckers and Larouche 1997: 22). The section on competitive safeguards addresses appropriate measures to be taken to prevent anti-competitive practice by any major supplier, defined as any supplier with an ability to affect terms of participation – that is, price and supply – in the market for basic telecommunications through use of its position in the market or control of essential facilities (facilities exclusively or predominantly supplied by a single or limited number of carriers and those that cannot feasibly or technically be substituted). Specific practices that must be guarded against include anti-competitive crosssubsidization; the use of information from competitors with anti-competitive results; and failure to make available to other service providers, on a timely basis, technical information about essential services and commercially relevant information necessary to provide services. Any major supplier must provide interconnection on non-discriminatory terms, in a timely fashion, at cost-oriented rates that are transparent, reasonable and unbundled; and, on request and at cost, at points in addition to the network points offered to the majority of users. The major supplier must make all interconnection agreements publicly available. Where licences are required, all criteria, the period within which decisions are normally made, and terms and conditions of individual licences must be made publicly available. Reasons for the denial of a licence must be made known to the applicant on request. The category of scarce resources includes frequencies, numbers and rights of way, all of which must be allocated in an objective, timely, transparent and nondiscriminatory manner. The basis for the current allocation of frequency bands must be made publicly available. Regulation must be by a body that is separate from, and not accountable to, any supplier of basic telecommunications services. Its decisions and procedures must be impartial with respect to all market participants. This body may be the same independent domestic body that provides dispute settlement with respect to interconnection.

196 Hudson N. Janisch Signatories have the right to define the kind of universal service they wish to maintain. Universal service obligations are not regarded as anti-competitive provided they are administered in a transparent, non-discriminatory and competitively neutral manner and they are not more burdensome than necessary for the kind of universal defined (Fredebeul-Krein and Freytag 1997: 477–91; 1999: 625–44). Such then is the new international telecommunications regime which exemplifies, in striking terms, Sylvia Ostry’s observation of the “legalization of the trading system” (Ostry 1997). With the Reference Paper’s principles in mind, let us now take a look at how China’s administrative processes have been coping with the challenge of change.

Policy in flux Given the inherently volatile nature of telecommunications, no regulatory regime, no matter how well designed or implemented, could ever be expected to operate without some degree of confusion as technology undermines older ways of doing things faster than even the most prescient regulator can respond. Indeed today, regulatory forbearance is essential so that the regulator is able to get out of the way of market forces. However, stability and predictability with respect to the basics is essential, or at least a clear understanding is needed how change in the rules is to be achieved in a fair and timely fashion. If there can be no certainty as to substance, there should at least be certainty as to process. Recently in China there have been indications that the administrative process has been unable to keep up. While there has been impressive large-scale investment in basic telecommunications, there has been relatively little investment in the fixed costs of a rules-based system such as will be necessary to lay down the groundrules for the vibrantly competitive, multi-player, foreign participatory industry of the future. Foreign ownership Given the level of foreign interest in China’s telecommunications markets and the need in China for capital, technical know-how and specialized management, it will come as no surprise that a rule which forbade any foreign investment at all simply led to schemes to get around it. But what is perhaps surprising is that failure to achieve a realistic accommodation of these mutually reinforcing domestic and international interests led to an embarrassing fiasco, likely to have long-term negative repercussions. Initially China Unicom, which had been established as a competitor to China Telecom in 1995, made little progress as it was not well aligned in the inter-ministry rivalry which characterized early competitive developments. However, three years later, as a result of adopting Internet telephony technology and a CDM wireless network (of which more later) and with foreign “partners” under ingenious “ChinaChina-Foreign” (C-C-F) joint ventures, it appeared to be heading to be a serious competitor to the incumbent, China Telecom. Indeed, in mid-1999, it proposed to

Administrative process and the rule of law 197 float a $1 billion initial public offering (IPO) on both the Hong Kong and New York stock exchanges (Wall Street Journal, June 1, 1999). However, in August 1999 China Unicom was abruptly told that its C-C-F joint ventures with two dozen foreign companies were “irregular,” and it was ordered to dissolve them immediately. This led to protracted negotiations with the foreign investors who threatened to block the proposed IPO. Such was the outcry from foreign investors that the IPO had to be put on hold. After months of wrangling, it was reported that China Unicom had finally managed to settle the C-C-F mess, which should pave the way for a multibillion dollar stock listing. Those burned in this US$1.4 billion debacle included vital future allies and investors such as France Telecom, Bell Canada International, NEXTEL, Sprint and NTT (Trends Report March–April 1999: 7–8; ibid., May–June 1999: 7; ibid., July–Aug. 1999: 7; ibid. Jan.–Feb. 2000: 12; Wall Street Journal, April 3, 2000a). The Internet To a considerable extent, the extraordinarily rapid growth of the Internet has overtaken conventional telecom policy-making. While behemoth telephone and cable companies talked endlessly about an information superhighway, the “ants” actually went ahead and built the Internet (The Economist 1995). In advanced economies, the resultant free flow of electronic information has been seen as being very largely beneficial. However, China has sought to put in place a “Great Firewall” to keep dissent offline (Wall Street Journal, Jan. 27, 2000; Globe and Mail, March 11, 2000). Nevertheless, it is by no means clear that political censorship will be effective given the availability of “proxy servers” overseas which make it possible to circumvent the Chinese government’s web-site obstacles (New York Times, Aug. 1, 1999; Wall Street Journal, Sept. 9, 1999). As well as this overarching issue of political censorship, the Chinese administrative process has sought to grapple with a number of related Internet concerns including foreign ownership, overseas stock market listings and encryption. Again, the recent track record is one of inconsistency and confusion. As will be highlighted in the next section of this chapter, China has now agreed to open telecommunications to foreign investment. Prior to the successful conclusion to negotiations with the US, Chinese officials announced that there was to be no foreign investment in the Chinese Internet industry (Wall Street Journal, Sept. 15, 1999). However, a major investor, Intel Corp., let it be known that it was going ahead anyway, its president of operations in China saying: “A lot is going on around the country, and the government is taking the position of letting it happen” (Wall Street Journal, Sept. 17, 1999). A number of venture capital funds did cut back on their investments following the advice of Beijing lawyer John Huang who counseled them “to go anywhere there is a clear mechanism for approval” (Wall Street Journal, Sept. 20, 1999). Following the signing of the US trade deal, it was reported that foreign investors were unleashing a tide of venture capital into the thriving Chinese Internet industry, although there was still need for caution as regulations to implement market-opening measures had yet to be put in place. “That is likely to be a complex and conflict-

198 Hudson N. Janisch ridden process as competing government agencies vie for power under the new rules” (Wall Street Journal, Nov. 18, 1999). Caution seemed justified when the Minister of Information Industries, Wu Jichuan, outlined the planned regulations in an interview with the press. He said that China would require content on the Internet to be controlled, that all Internet companies would have to apply for licences and that foreign investors would need official approval before taking stakes in such companies. His comments almost directly contradicted earlier statements that such investment would flow unimpeded. Indeed, after they signed the trade deal in Beijing, US officials had implied that existing caps (to the extent they could be determined) would be removed. “Foreign investment in Internet-content providers was ‘no longer an issue. We have rights to invest,’ US Trade Representative Charlene Barshefsky said on the day the deal was signed.” Interestingly, industry executives did not call for an explanation of this inconsistency, but rather pointed to ways around the rules “common in bureaucratic China and easy in the borderless world of the Internet” (Wall Street Journal, Dec. 13, 1999). In February 2000, two leading Internet companies received approval from the authorities in Beijing to float initial public offerings on the Nasdaq Stock Market in New York. The initial terms of the approval appeared to reflect the government’s concern that there not be a raft of new offerings which might swamp the market and kill investor appetite as had happened several years previously when companies backed by state entities had flooded the Hong Kong market (Wall Street Journal, Feb. 16, 2000). However, it later became clear that the real purpose here was to force web portals seeking finance abroad to separate content from carriage in a manner which ensured that control over the flow of online information, especially politically sensitive news, remains under exclusive Chinese control. Again, it is important to note the business response was that firms would hand control over their portals to Chinese-owned sister companies and then have the foreign listed organization provide technical support to the portals for very high fees (Financial Post, April 16, 2000). This is a similar device to the C-C-F joint ventures which, as we have seen, were employed by China Unicom with such disastrous consequences. Encryption Encryption software is widely used to encode everything from email messages to financial transactions and to shield information from thieves (and governments) that would try to read it on the sly. A directive issued by a little-known government agency, the State Encryption Management Commission (thought to have close ties to the Ministry of State Security), required all companies to register details of software programs employed for encryption purposes by January 31, 2000 (Wall Street Journal, Jan. 25, 2000a). While the USTR promptly sought an explanation for this “draconian” measure from the Chinese authorities, the measure itself was widely ignored by foreign companies (Globe and Mail, Jan. 28, 2000). As the regional manager for the Chubb Group of Insurance Companies put it: “In China you don’t cross bridges before you have to because the bridge structure might change” (Wall Street Journal, Feb. 1, 2000).

Administrative process and the rule of law 199 It soon became only too apparent how difficult it would be to implement the encryption directive. Its unworkable overbreadth was particularly evident when Microsoft released Windows 2000 in China. It includes some of the most powerful encryption software programs available and Microsoft bluntly announced that it would not comply with registration requirements. It even turned out that Chinese ministries themselves were ignoring the directive. For instance, the Ministry of Information Industries (MII) approved a deal to sell US mobile-telephone technology, even though it included encryption to authenticate callers (Wall Street Journal, Feb. 17, 2000). In mid-March 2000, just six weeks after the encryption directive came into effect, it was withdrawn. The State Encryption Management Commission’s circular noted that “China’s government in accordance with WTO regulations and promises to foreign governments has already begun to research and revise relevant laws and regulations,” including the one regarding encryption products (Wall Street Journal, March 13, 2000). Internet telephony The use of the Internet to transmit telephone calls is growing rapidly in China and again illustrates how easily technology-driven telecommunications developments can outstrip a plodding administrative process. As is often the case in China, this business took root before it was legal. Indeed, the first visceral reaction by the government to Internet telephony was to arrest and fine those enterprising enough to provide a service deemed to be illegal. Now, however, in face of the inevitable, licences have been granted to firms with various degrees of state backing in an effort to control that which could not be prohibited. Internet companies, which charge about one-third the price for standard long-distance services, present the strongest challenge yet to state-run China Telecom’s profitable long-distance business and could make China the world’s biggest markets for Internet phones in record time (Wall Street Journal, Dec. 21, 1999). While the MII would like to see high-tech data applications running over the Internet, the high price of long-distance calls provide strong economic incentives for more mundane telephone service. This, in turn, threatens the incumbent, China Telecom, which has made massive investments in conventional telephony. A sophisticated regulator with a clear and comprehensive mandate will be required to balance the benefits of lower long-distance prices against the risks of stranded investment. Here a need for a high and costly level of public order to underpin a rules-based administrative process, is all too evident. The role of the PLA It is, perhaps, not surprising that, of all the businesses the People’s Liberation Army has entered in recent years, it has in the face of the clearest orders from the Communist Party to divest itself of hundreds of companies by the end of 1999, only openly continued to conduct a wireless telecommunications undertaking. In part this reflects the close nexus which exists between civilian and military communications,

200 Hudson N. Janisch especially in advanced wireless services; in part it reflects the huge growth and profitability of mobile phone networks in China. In the event, the military has refused to hand over its commercial wireless networks to China Unicom (Wall Street Journal, March 2, 2000). What is particularly important here is that the military is deploying CDMA or code division multiple access technology, which it was widely assumed would be assigned exclusively to China Unicom. The adoption of American-developed CDMA technology had been a major issue in China–US trade negotiations. In February 2000, in the afterglow of the successful conclusion of negotiations, it was announced by the government that China Unicom would, indeed, be deploying the American technology. A week later, Beijing postponed its adoption indefinitely. “There is no commercial reason why that would be,” the president of the local manufacturer of CDMA gear observed, “so that leaves only the political” (Wall Street Journal, Feb. 24, 2000).

The implementation of commitments Before identifying the precise commitments made, and the challenge they will present to acceptable implementation, it would be well to place our specific concerns in a broader international trade context. But before doing so, one final closely related specific example of administrative high handedness, followed by an equally abrupt retreat, might be in order. Western magazine publishers in China have for some time obtained licences by forming joint ventures with Chinese magazine partners. However, as of January 1, 2000 they were instructed that they must use a direct translation of the often obscure name which appeared on their licences, or use no English name at all. Thus Cosmopolitan was required to call itself “Trends Lady” and Woman’s Day, “Friends of Health.” The Chinese government contended that many companies were publishing without proper licences; the publishers replied indignantly that they were being penalized unfairly by a regime which kept changing the rules. Officials at the Press and Publications Administration insisted that all publications, foreign and domestic alike, were simply being required to publish under the registered Chinese names of their magazines. They were not prepared to take into account the impact of the removal of widely known English brand names. As the president of Hearst’s international magazine division put it, “If a country takes your name off your product, you’re gone” (Wall Street Journal, Feb. 2, 2000). By mid-April, 2000 it was reported that the ban on famous names of magazines had been reversed (Wall Street Journal, April 14, 2000). Those with experience in negotiating trade matters with China continue to insist that a wide gap remains between commitment and ability to implement. For instance, Robert Herzstein who, as US Undersecretary of Commerce in the 1980s negotiated for business access to China’s market, remains concerned that China does not have the habits, culture or legal institutions needed to restrain its officials from improperly controlling or influencing business deals. While the WTO calls on its members to recognize a bright line between business and government, Herzstein

Administrative process and the rule of law 201 emphasizes that China’s economy has been built on a different assumption. Indeed, some of China’s leaders may resist reforms necessary in a rules-based trading system just because such reforms would reduce the discretionary powers of officials by bringing them under the rule of law (Wall Street Journal, Nov. 16, 1999a). He concluded: It appears that upon entering the WTO, China will agree to administer its laws affecting trade in a uniform and impartial manner, to make its rules and policies publicly available to and to provide a forum for legal review of administrative actions affecting trade. But it is not likely that the globally oriented and wellintentioned trade officials in Beijing who negotiated these commitments will be able to control the protectionist behaviour of countless officials and Communist Party leaders with their own agendas. Legal tribunals for impartial, effective and speedy resolution of disputes with the Chinese authorities are not in place. The dispute-resolution resources of the WTO will not be capable of handling the workload of hundreds, or thousands, of complaints that would be forthcoming if that becomes the primary forum for enforcing China’s compliance with the rules. China’s admission to the WTO should be accompanied by unambiguous and enforceable commitments to regulate its bureaucrats and party officials through a modern and effective system of administrative law, including judicial review. Its progress in making the necessary reforms should be assisted by WTO members and monitored by a WTO working party. In a similar vein, Winston Lord, US Ambassador to China 1985–9 and Assistant Secretary of State for East Asia and Pacific Affairs 1993–7, has urged that the US must proceed without illusions (Wall Street Journal, Nov. 19, 1999). In noting that the US faced “serious problems of implementation,” he continued: Whether because of government obfuscation, Beijing’s difficulties in cracking down on local culprits, or corruption, Chinese observance of past agreements has been at best sluggish. The case of intellectual property rights vividly illustrates how signing documents is only a prelude to the real work. China remains a country ruled by men, not law. Cronyism remains rampant; conservative leaders and protectionist industries will balk at change. It is with these sobering cautions in mind that we should now turn to the specific commitments made with respect to telecommunications. As we have seen, the Fourth Protocol of GATS envisages both foreign investment and pro-competitive, independent regulation. Foreign investment was front and centre in the negotiations with the United States. When Premier Zhu Rongji visited Washington in April 1999 and made a number of dramatic concessions, his willingness to allow for extensive foreign investment in telecommunications was understandably highlighted (Wall Street Journal, April 6, 8, 1999; Financial Post, April 10, 1999). When President Clinton held

202 Hudson N. Janisch back and negotiations stalled, Zhu was denounced by Minister of Information Industries Wu Jichuan for going too far, it being rumored that he had even offered to agree to majority foreign ownership in some aspects of telecommunications (Wall Street Journal, April 14, May 21, Nov. 10, 1999). In the end, substantial foreign investment short of majority control was agreed to. While it was reported that China had thereby “balked at one of the issues nearest and dearest to the hearts of the Americans: opening up China’s telecommunications market to majority foreignownership,” Charlene Barshefsky insisted that in light of the conservative back-lash against Zhu’s apparent concessions, “Fifty-one percent became politically impossible.” While there was much support for the China–US agreement within the US telecommunications industry, it was recognized that it was not clear that US operators could succeed in China without controlling stakes in Chinese phone firms. Many American companies which have invested successfully abroad have done so because they control their own fates. Thus MCI Worldcom, which is building its own networks in Europe and Japan, indicated that it had no plans to go into China (Wall Street Journal, Nov. 16, 1999b). Most interestingly, the EU has continued to press China on the foreign ownership issue. A number of European mobile-phone operators are already active in China and they view the agreement with the US, which allows for 49 percent ownership after five years, as inadequate (Wall Street Journal, April 3, 2000b, May 12, 2000). Incidentally, it might seem to be somewhat incongruous that the EU is insisting on majority foreign ownership at a time when it is far from clear that its members are prepared to practice at home what they preach abroad. For instance, in 1999 Deutsche Telecom’s attempt to acquire Telecom Italia fell apart after the Italian government appeared to favour a rival bid from Olivetti, while in May 2000, the Spanish government blocked a merger of Telefonica and Dutch firm KPN (Wall Street Journal, May 8, 2000). In the end, the EU did not obtain the majority ownership it sought, but it did achieve concessions which will allow European companies to consolidate their dominant position in China (Wall Street Journal, May 22, 2000). Despite limits on foreign ownership, it seems likely that there will be extensive foreign participation in the Chinese telecommunications market. This means that China’s adoption of the entire Reference Paper with its commitment to transparent, pro-competitive regulation will soon be put to the test. Given the recent record of abrupt policy fluctuation, it is evident that there will have to be a very large investment in the high fixed costs involved in setting up a rules-based system. Has there been any progress thus far?

Towards a rules-based administrative system Looked at broadly, it may be said that some significant progress has been made towards creating an appropriate degree of separation between the regulator and the industry it regulates. At the same time, little progress has been made towards establishing a clear legal basis for regulation. Soon after the establishment of China Unicom in 1994, the Directorate General of Telecommunications, the operating arm of the Ministry of Posts and Telecom-

Administrative process and the rule of law 203 munications (MPT) was separated out and renamed China Telecom. However, China Telecom was not fully independent as key functions, including finance and planning, remained under MPT control. Thus the MPT, which had been designated as the regulator of duopoly competition between China Telecom (the incumbent) and China Unicom (the new entrant), was both referee and player (Xu and Pitt 1999: 248). This is precisely the type of incestuous relationship between a supplier of basic telecommunications services and the regulatory body which is not allowed under the Regulatory Framework. In 1998 a new super ministry, MII, was established which combined the old MPT with the Ministry of Electronic Industry and the Network Division of the Ministry of Radio, Film and Television. MII as a separate entity now regulates both China Telecom and China Unicom, thereby substantially reducing the risk of competitive discrimination. For a number of years promises have been made with respect to a telecommunications act. For example, in March 1999, Minister Wu Jichuan of MII stated that a wide-ranging telecommunications law would be forthcoming in July of that year (Trends Report, March–April 1999: 7). The failure to enact foundational legislation largely accounts for the intractable, conflictual and complicated nature of existing regulation. (Pitt et al. 1996). Absent a telecommunications act, senior governmental officials typically settle disputes between the incumbent and new operators on issues such as spectrum allocation and network interconnection on an ad-hoc basis through sporadic intervention (Xu et al. 1997). It is understandable why there has been this delay in enacting sectoral legislation. Telecommunications is by its nature highly volatile: it is as if one were seeking to regulate quicksilver (Janisch 1993: 697). With converging technologies, multiple industry entry and boundary line decay, Any attempt to identify the constituent forces of the information economy is more akin to tracking a motion picture than describing a photograph. What makes the task even more difficult is that the script for the picture remains uncompleted and unwritten, for we are dealing with the future rather than the past. (Janisch and Irwin 1982: 610) Consider, for example, the long-standing assumption that copper wire local telephony is a quintessential natural monopoly. By contrast, with the adoption of wireless technology (microwave) in long distance, it was thought that that market would no longer have attributes of natural monopoly and was thus ready for competition. Now, wireless technology (cellular and fixed wireless) is invading the copper wire world of local distribution and wire (fibre optic) is reoccupying the longdistance market with massive capacity, economies of scale and declining long-run costs. This means that we may have got it all back to front. “If there is going to be a monopoly, it will be in the long-distance market. The local exchanges should be – and soon will be – competitive” (Huber et al. 1993: 1.1). With this high degree of uncertainty, it is essential that in legislative drafting the right balance be struck between rule and discretion, a judgment call made even more

204 Hudson N. Janisch difficult by the importance of telecommunications on the one hand, and its everchanging nature on the other. This mandates highly incremental decision-making which, in turn, presupposes the establishment of an independent regulator capable of effective incremental decision-making. As well, a line has to be drawn between independence in decision-making and accountability for major policy-making in a manner which ensures that benefits of independent regulatory adjudication and overall governmental responsibility for broader policy matters will be achieved. Most important for our immediate purposes, legislation must entrench a transparent administrative process. This means that in regulation the identity of the decision-maker must be known, the precise basis on which decisions will be made must be apparent and known in advance and fair and open procedures must be applied. Sylvia Ostry (1998) has succinctly identified the consequences of lack of transparency in Chinese domestic law: Chinese laws tend to be highly generalized and lack any specific procedures through or by which policy will be developed. Thus, bureaucrats who implement law are given enormous scope and discretion. While there is now an effort to improve legislative drafting, this too will take some time. Given the present state of both substantive regulatory and procedural administrative law, China cannot fulfill the WTO requirement of transparency. (Ostry 1998: 13) This would seem to be a very likely result if the only support for transparency comes from Robert Herzstein’s “globally oriented and well-intentioned trade officials in Beijing.” However, a somewhat more optimistic scenario would suggest that with the liberalization of domestic telecommunications the need will arise for impartial, independent regulation in any event and a transparent administrative process (which will complement the need to respect international trade commitments) will have to be developed.

Prospects The China–US trade agreement and the immediate likelihood of China’s accession to the WTO has been seen as the triumph of progressive, reformist forces led by Premier Zhu Rangji. His WTO victory suggests that he won out over more timid opponents who fear that faster reforms may lead to political and social instability. “‘WTO is the lever that the reformers need to open the system’ said Rick Baum, a political scientist at the University of California in San Diego. ‘You can’t reform from above. You can’t reform from below. So you reform from outside’” (Wall Street Journal, Nov. 16, 1999c). While it is evident that MII’s Minister, Wu Jichuan, remains highly protective of his domain, it may well be that unwittingly forces have been unleashed which will necessitate an administrative approach more in line with that mandated in the WTO. Moves toward liberalization, including the separation of China Telecom into four separate companies to provide fixed telephone, mobile, paging and satellite services, should probably be seen as part of a domestic agenda.

Administrative process and the rule of law 205 Though China Telecom’s breakup undoubtedly will help foreigners enter China’s multibillion dollar telecom-service market, the primary motivation for the change wasn’t to meet Western demands or to clear a path for China’s entry into the World Trade Organization, but to satisfy China’s own needs – an important signal of the way China works these days. And as Premier Zhu is reported to have bluntly put it: “Now we must support . . . competition to promote the development of telecommunications in China” (Wall Street Journal, June 8, 1999). If there is to be increasing competition in telecommunications, there has to be investor confidence that there will be even-handed, predictable regulation. Indeed, supporters of China Unicom played an important role in ensuring that regulation was removed from the MPT, which as we have seen had been both player and referee, and placed in the hands of a more detached, less operational, MII (Xu and Pitt 1999: 248). It seems likely that the pace of change will speed up, especially with the spectacular acquisition of Hong Kong Telecom by Pacific Century Cyberworks. Here a relatively staid, traditional telephone company has been acquired by a start-up web company which will soon enter the greater China market in a very aggressive, innovative fashion. Ironically, Minister Wu who had intervened to thwart Singapore Tel’s bid to acquire Hong Kong Telecom, will now find that he will have to put in place a greatly strengthened administrative process which is capable of dealing with a radical “web upstart,” not a conservative, compliant, governmentowned company (Wall Street Journal, Jan. 25, 2000b, Feb. 16, 28, 29, 2000).

Conclusion The record of inconsistent, abrupt and secretive regulation of telecommunications up to this point makes it clear that a transparent administrative process appropriate to a rules-based world trading system and respect for the basic tenets of the rule of law, still remains to be established in China. Given continued reliance on a relationsbased system of economic development, the prognosis for rapid reform and effective implementation of international trade commitments is not good. However, if Premier Zhu’s enthusiasm for competition as a means of further developing telecommunications prevails, means will have to be found to create an independent and impartial referee. Change demanded under pressure from outside will often be resisted. The same change, if at least in part congruent with domestic concerns, could well be adopted. And the same could be true in other sectors of the economy with a similar congruence between domestic concerns and international commitments.

References Bronckers, M. C. E. J. and Larouche, P. (1997) “Telecommunications Services and the World Trade Organization,” 31 Journal of World Trade, pp. 5–45. Financial Post, April 10, 1999: “Beijing Concedes,” p. 9, col. 2. —— April 16, 2000: “Chinese Web Portals Forced to Restructure,” p. C13, col. 1. Fredebeul-Krein, M. and Freytag, A. (1997) “Telecommunications and WTO Discipline: An

206 Hudson N. Janisch Assessment of the WTO Agreement on Telecommunications Service,” 21 Telecommunications Policy, pp. 477–91. —— (1999) “The Case for a More Binding WTO Agreement on Regulatory Principles in Telecommunication Markets,” 23 Telecommunications Policy, pp. 25–41. Globe and Mail, Jan. 28, 2000: “China’s Encryption Rules Draw Protests,” p. B7, col. 3. —— March 11, 2000: “For the Internet Age, China Builds ‘Great Firewall’,” p. A1, col. 2. Houben, H. (1999) “China’s Economic Reforms and Integration into the World Trading System,” 33(3) Journal of World Trade, pp. 1–18. Huber, P. W., Kellogg, M. K. and Thorne, J. (1993) The Geodesic Network II: 1993 Report on Competition in the Telephone Industry, Washington, DC: Geodesic Company. Janisch, H. N. (1993) “At last! A New Canadian Telecommunications Act,” 17 Tecommunications Policy, pp. 691–8. —— (1999) “International Influences on Communications Policy in Canada,” in Dale Orr and Thomas Wilson (eds) The Electronic Village: Policy Issues of the Information Economy, Toronto: C.D. Howe Institute. Janisch, H. N. and Irwin, M. (1982) “Information Technology and Public Policy: Regulatory Implications for Canada,” 20 Osgoode Hall Law Journal, pp. 610–41. New York Times, Aug. 1, 1999: “Out of Control: The Internet Changes Dictatorship’s Rules,” p. K1, col. 1. Ostry, S. (1997) The Post-Cold War Trading System: Who’s on First?, Chicago: University of Chicago Press. —— (1998) “China and the WTO: The Transparency Issue,” 3 UCLA Journal of International Law and Foreign Affairs, pp. 1–19. Pitt, D. C., Levine, N. and Xu Yan (1996) “Touching Stones to Cross the River: Evolving Telecommunications Policy in Contemporary China,” 5 Journal of Contemporary China, pp. 347–65. The Economist (1995) “The Accidental Superhighway: A Survey of the Internet,” The Economist, July 1, p. 4. —— (2000) Survey of China: “Now Comes the Hard Part,” The Economist, April 8, 2000, pp. 1–15. Trends Report (various dates) Telecommunications International Trends Report, CRS Business Intelligence. Wall Street Journal, Feb. 18, 1999: “China Approves Nasdaq Listing of Two Dot-Coms,” p. A12, col. 4. —— April 6, 1999: “An Interview wish China’s Zhu Ranji,” p. A23, col. 1. —— April 8, 1999: “China Offers a Flurry of Trade Concessions with US,” p. A2, col. 2. —— April 14, 1999, “China’s Press Plays Down Zhu’s Visit to US Lest it Upstage Jiang at Home,” p. 23, col. 1. —— May 21, 1999: “China’s Zhu Ranji Under Attack Amid Anti-American Outbreak,”, p. A9, col. 6. —— June 1, 1999: “China’s Unicom Weighs Offering of About $1 Billion,” p. A17, col. 4. —— June 8, 1999: “How China Redefined Reform with Break-up of Telecom Monopoly”, p. A1, col. 1. —— Sept. 9, 1999: “In a Chinese Battle, the web is Mightier than the State,” p. B1, col. 3. —— Sept. 15, 1999: “Chinese Official Claims Internet is Off Limits to Foreigners,” p. A25, col. 3. —— Sept. 17, 1999: “Intel Ignores Chinese Curb on Investment in the Internet,” p. A11, col. 3. —— Sept. 20, 1999: “China’s Internet Firms Face Growth Roadblock,” p. A20, col. 3.

Administrative process and the rule of law 207 —— Nov. 10, 1999: “Growing List of Trade Disputes Looms as China and US Work on WTO Deal,” p. A19, col. 1. —— Nov. 16, 1999a: “Is China Ready for WTO’s Rigors?,” A30, col. 3. —— Nov. 16, 1999b: “Big Business Seeks Benefits Amid Details of China Deal,” p. A19, col. 5. —— Nov. 16, 1999c: “WTO Deal is Major Victory for China’s Zhu,” p. A21, col. 3. —— Nov. 18, 1999: “Foreign Investors to Flood China’s Web in WTO Deal,” p. A16, col. 3. —— Nov. 19, 1999: “WTO: Proceed without Illusions,” p. A20, col. 4. —— Dec. 13, 1999: “China Internet Investors Face Web of New Rules,” p. A25, col. 3. —— Dec. 21, 1999: “Internet Phone Service Catches on with Millions in China,” p. A14, col. 3. —— Jan. 25, 2000a: “China to Issue New Rules on Software for Foreign Firms,” p. A10, col. 3. —— Jan. 25, 2000b: “Asian Telecom Pair May Join to Create Regional Giant,” p. A13, col. 4. —— Jan. 27, 2000: “China Cracks Down on Information Disclosure,” p. A14, col. 3. —— Feb. 1, 2000: “China Deadline Over Software Passes as Issue Stays Unclear,” p. 18, col. 3. —— Feb. 2, 2000: “Chinese Officials Force Magazines to Go without Famous Names,” p. B1, col. 6. —— Feb. 16, 2000: “China Quietly Enters Battle for Hong Kong Telecom,” p. A23, col. 1. —— Feb. 17, 2000: “Microsoft is Test Case for Chinese Rules,” p. A13, col. 1. —— Feb. 24, 2000: “Beijing Postpones US Phone System Agreed to Days Ago,” p. A13, col. 6. —— Feb. 28, 2000: “Upstart Offers $38.5 Billion Deal for Hong Kong Telecom,” p. A21, col. 3. —— Feb. 29, 2000: “Web Upstart Wins Hong Kong’s C&W,” p. A3, col. 1. —— March 2, 2000: “China’s Army Plays Wireless-Mogul Role,” p. A23, col. 1. —— March 13, 2000: “China Reverses Harsh Internet Rules, Easing Threat to Trade,” p. A21, col. 3. —— April 3, 2000a: “China Unicom Proposes IPO by Ending Foreign-Firm Ventures,” p. A26, col. 1. —— April 3, 2000b: “EU Fails to Reap Coveted Concessions in Chinese Talks,” p. A21, col. 3. —— April 14, 2000: “Asia/Pacific Briefs,” p. A15, col. 2. —— May 3, 2000: “Clinton Offers Big Plan to Monitor China,” p. A2, col. 2. —— May 8, 2000: “Telefonica, KPN Mergers is Thwarted,” p. A25, col. 6. —— May 12, 2000: “EU to Press China on Increasing Foreign Stakes in Phone Ventures,” p. A16, col. 1. —— May 22, 2000: “China EU Gain on Edge in WTO Deal,” p. A30, col. 1. Xu Yan and Pitt, D. C. (1999) “One Country Two Systems: Contrasting Approaches to Telecommunications Deregulation in Hong Kong and China,” 23 Telecommunications Policy, pp. 245–60. Xu Yan, Pitt, D. C. and Levine, N. (1997) “Network Interconnection: Bottleneck to Future Chinese Telecommunications Deregulation,” 21st Century Communication Networks, Amsterdam: IOS Press, pp. 106–14.

Part IV

Provisional membership and transition mechanisms

12 A transitional review mechanism Has an effective multilateral mechanism been created? Alan S. Alexandroff

Creating a multilateral monitoring system Buried in the Protocol of Accession is the Transitional Review Mechanism (TRM). The debate that took place over its creation seldom if ever became noticeably public. It was in contemporary parlance a debate that took place “below the radar screen.” Yet significant consequences may well follow as a result of the debate and now the creation of such a multilateral monitoring system found in the Protocol of Accession. The debate and final structure reflect the ambivalence of all sides regarding China’s entry into the WTO. Fundamental questions over constraints to national sovereignty, the inclusion of China in the multilateral trading regime, the level of marketization for member countries and the oversight by member countries with obligations agreed to by entering countries were raised and ultimately resolved. The TRM reveals how current member countries see the organization of the world economy. In the end the member countries of the WTO (Members) put a TRM in place that reflects a multilateral trading system that is still more reflective of the system before the Uruguay Round as opposed to after. The consequences of the failure to match the oversight and review to changes required of a China in transition to a more market-driven economy will be known only in the medium term. The guessing in the short term is that this TRM will be unable to maintain the drive for reform in China or encourage China to meet its obligations under the Protocol of Accession. If so, then the multilateral system’s monitoring limitations may well encourage Members to re-establish oversight and monitoring in national capitals, including Washington, DC.1 Such a reversion would be unwelcome in many quarters and would signal a weakening of the multilateral trading system.2

The issues over China accession The debate over how China could, or could not, meet its WTO obligations took place in universities, think tanks, national capitals and in the permanent missions of WTO Members in Geneva. It formed a backdrop to this longest protocol of accession negotiation. The issues raised formed critical concerns for the GATT Contracting Parties (CPs) (then member countries or Members), the organization of

212 Alan S. Alexandroff the multilateral trade system and its institutions and administration. The issues raised reflect the tensions inherent in the global economy and the multilateral trading system. One of the great unknowns of the Uruguay Round was the failure of trade negotiators to take into account the “revolutionary” events occurring during the lengthy negotiation – the fall of the Berlin Wall, the end of the Cold War and then the break-up of the Soviet Union. In the midst of the trade negotiations, state Communism, exemplified by the leading proponent, the Soviet Union, disappeared. Yet the fall of the Berlin Wall, the beginning of the end of the Soviet Empire, failed to generate a major examination by the trade negotiators of how GATT might be called on to admit major transitional economies, in Central and Eastern Europe and the Far East.3 The GATT/WTO, today, remains silent on whether, or how and when, to admit as member countries with something significantly less than a market economy. There is no guidance on how, or when, to admit a transitional economy such as the People’s Republic of China. The WTO establishes no benchmarks or economic thresholds for admittance. This lack of guidance is made more eventful when considering “China” – a major economy in the multilateral trading system. For the GATT/WTO, the lack of rules for transitional economies, the absence of what constitutes adequate market thresholds, institutional requirements – economic, legal and regulatory, underlines major negotiating problems in China’s accession at the bilateral market access negotiations but also at the multilateral discussions in Geneva. This lack of framing for transitional economies was complicated by China’s off-and-on again demand that it be treated as a developing country status. While a number of Members in particular the United States made clear that it was unwilling to negotiate on the basis of China being accorded developing country status,4 the matter returned to the accession discussions time and time again. That China is “no ordinary country” applicant impacted the accession debate throughout the negotiations. As with many issues in this negotiation, the issue influenced the debate and results were in equal and opposing ways. On the one hand, the size and possible future competitiveness of the Chinese economy raised serious concerns in a variety of major national capitals. China by the 1980s was integrated far enough into the world economy to reveal that it was bound to be a serious competitor for many Asian economies and indeed developing economies worldwide. This gave pause to some Members and was reflected in a number of difficult bilateral negotiations.5 On the other hand, there were repeated calls for China’s accession. How could China remain outside the multilateral trade system and its principal institution the GATT/WTO represent the workings of the global economy? China had to be inside the global trade tent so argued Members’ representatives from the permanent missions and from the national capitals.6 As is evident from various draft protocols of Accession going back to the mid1990s, a TRM was being considered by the Working Party on China for some period of time.7 This obligation caused Chinese negotiators to object strongly. The negotiators raised a variety of arguments that reflect values well established in the organization. In particular, China’s negotiators argued that Members are all equal. Once China acceded to the WTO it needed to be treated the same as any other

A transitional review mechanism 213 Member. Moreover, the review that was being considered by the Working Party on China was likely to impinge on China’s sovereignty. The heart of the debate on China’s accession was an assessment by Members on the impact of China’s economy on trade and investment patterns for the WTO and the impact that economy and polity would have on the organization. There remains disagreement over the consequences of this large transitional economy taking membership in the multilateral trading system. Furthermore, there is disagreement over how far Members can insist, and what means might they devise, to ensure continued domestic reform. As we will see at least three different positions emerged. One view suggested that the GATT/WTO could not risk the admittance of such a large non-market unreformed economy. Another position urged that the obligations needed to be clearly established by the Working Party and then it was up to China to meet those obligations. Implicit in this view, largely supported by China itself, was that China would carry out the necessary economic, legal and administrative reforms. Members, according to this view, only needed to be concerned about whether China met the obligations it had agreed to pursuant to the Protocol of Accession. In those instances where China could be shown to have breached its obligations, Members had recourse through consultation and where necessary the Dispute Settlement Body to resolve matters. Finally, there was a small coterie of former trade negotiators and academics who urged that China be admitted but that the multilateral trade system monitor China’s domestic reforms to ensure compliance.

Sovereignty and membership: the history of benchmarking and provisional membership in the GATT It is to those who urged surveillance and monitoring of China while admitting China to the WTO, that we turn attention to in the next section. However, a closely related matter needs to be examined before exploring the TRM. The issue is the equality of the Members. It is generally assumed that subject to exceptions identified with the Protocol of Accession once a state becomes a member of the GATT/WTO it automatically undertakes the full responsibilities and enjoys all the privileges and benefits of Members. Yet there is a little-known history in the GATT of provisional membership for a number of states as well as benchmarking for a select number of transitional economies that acceded decades before China. This history is important because it underscores that not all GATT CPs were viewed as equal and that in a number of instances CPs were prepared to establish targets for new entrants. Japan Japan was where provisional membership was first articulated when differences appeared between CPs, particularly between the United States and a number of European countries. In 1953 Japan was invited to participate in the work of the sessions of the CP for a period of three years but without the right to vote (it was also pointed out that voting occurred infrequently and that Japan could express its opinion in any case). Also CPs could accept a Japanese schedule of tariffs binding

214 Alan S. Alexandroff tariffs on 85 percent of Japan’s imports in 1952. Some countries accepted the Schedule; some did not. No special safeguard clause was adopted. In 1955 Japan acceded although 14 CPs accounting for some 40 percent of Japan’s exports of all CP invoked Article XXXV (Non-application of the Agreement) and therefore had no GATT obligations. Switzerland Switzerland like Japan accepted a two-part approach to accession. This approach was adopted to deal with the Swiss insistence that it maintain quantitative restrictions on imports of agricultural products. Switzerland also refused to join the IMF or to accept the provisions of a special exchange agreement that had been drawn up. Switzerland did not become a CP until 1966 with its reservations intact largely although it agreed to act in exchange matters in a manner fully consistent with the principles of the special exchange agreement. Yugoslavia Like the interest in Poland (see next subsection) the CPs sought to develop a closer relationship with Yugoslavia. In 1959 the CPs adopted two instruments providing, in fact, for less than provisional accession. Part of the problem for Yugoslavia was that it failed to have many of the features required of a CP such as a customs tariff. To the extent that Yugoslavia brought itself into line with GATT instruments or obligations, CPs would accord Yugoslavia such treatment as would achieve an equitable balance of rights and obligations as accorded under the GATT. In 1962 Yugoslavia was able to accede provisionally. Yugoslavia acceded fully only in 1966. Poland Poland applied to accede to GATT in 1959. The CPs invited Poland to participate in the work of GATT without time limit. Poland simply declared that, being guided by the objectives of the General Agreement, they desired to expand their trade on the basis of mutual advantage in trading conditions and opportunities. In 1967, Poland acceded fully on the basis that it increase, pursuant to its Protocol of Accession (Annex B), the total volume of its imports from CPs. This is the most evident example of CPs attempting to establish with a transitional economy a benchmark and surveillance mechanism though the effort was rather crude. The benchmark set was to have Poland increase imports from CPs by no less than 7 percent per annum. The Protocol also established an annual review with the intent of establishing Polish targets for imports from the CP as a whole in the following year. The Protocol allowed CP to continue to maintain existing discriminatory restrictions (including discriminatory quantitative restrictions without agreement to eliminate) during a transitional period, which was to be decided later. The Protocol also contained provisions for an annual review of Polish trade and two special safeguard clauses (where after several consultation steps the party that had raised a concern that

A transitional review mechanism 215 imports were causing or threatened to cause serious injury, the CP using a product specific safeguard) could restrict imports while Poland could deviate to the extent of substantially equivalent trade. Romania Finally and similar to Poland the Protocol of Accession for Romania included benchmarking but with no specific import commitment. However, it did commit Romania to an import rate for CPs in line with import targets under Romania’s fiveyear plan. The then current discriminatory measures of Romania again were permitted. Other countries A number of countries applied for provisional accession even before all negotiations had been completed. Israel acceded provisionally in 1959 and did not accede fully until 1962. Others that acceded provisionally included Tunisia, Argentina, Egypt, Iceland, the Philippines and Colombia. All these states eventually acceded fully but in many cases their provisional status was extended several times. For example, Tunisia maintained provisional status from 1959 to 1989, a period of some 30 years.

The differing voices on China The debate on the TRM and more broadly on China’s accession involves in part a debate by officials particularly trade negotiators. It also involves political debates in number of national capitals especially in the United States. In the US in particular administration officials and legislators hotly discussed whether or not China should be granted Member status at the WTO or whether or under what conditions the US would grant normal trade relations (in the past called permanent most-favored nations relations). Finally, it concerns a debate among trade experts and China experts across the globe. It is this latter debate I want to identify in part since it went on with little public exposure. The examination of the positions is not comprehensive but provides the range of opinion on China that was expressed over the years at all levels of discourse. Hawks There was a strong current of opinion that opposed China’s accession. This view identified here as “hawks” employed political as well as economic arguments. The hawk view was expressed most strongly in the United States. Greg Mastel was a prominent hawk who expressed strong opposition to China’s entry to the GATT/ WTO without reform.8 Mastel focused on an evident weakness in the GATT – it had no framework for the admittance of transitional economies. Mastel raised pointedly the problem of transitional economies, or socialist market economies and admittance to the GATT:

216 Alan S. Alexandroff Still the market principles enshrined in the WTO are fundamentally at odds with those of socialist/Communist economies. To try to bend those rules enough to accommodate a major economy in an intermediate state between socialism and capitalism risks allowing the exception to overpower the rules of the system. Particularly as other countries inevitably try to exploit the exception made for China, the entire global trading system that has provided some order for global trade in the era since World War II could be destroyed.9 For Mastel and others China had to reform first. Mastel additionally argued that China’s poor track record in maintaining its obligations on intellectual property and market access more generally under the US-Sino bilateral agreements indicated that China would be a problem if it acceded to the GATT/WTO. Mastel also argued that China had to have the rule of law in China before GATT/WTO membership.10 The result as Mastel has testified recently in Washington is a WTO member systematically unable to enforce trade obligations: The problem of poor enforcement/implementation of trade agreements in China appears to go beyond a simple matter of countries ignoring provisions of trade agreements so as to not to offend important domestic constituencies. As many Chinese leaders have conceded China lacks a reliable rule of law. In the trade arena, this means that it is difficult or impossible for any entity in the Beijing government to direct policy changes that bind China’s diverse collection of Ministries, State Owned Enterprises and provincial governments.11 “Down-payment firsters” The hawks have not represented the dominant opinion concerning China’s accession to the GATT/WTO. That position is one I have named “down-payment firsters.” This position is one advocated by many trade negotiators and by Chinese negotiators as well. It also was one advocated by many China experts as well. This view suggests the need for a balance between the obligations that China must accept under the accession agreement and the required reforms that China must undertake to become fully integrated into the world economy. It calls for reasonable demands on China but also requests that China be given time through phase-in periods to adjust to the world economy. Proponents also suggest that China had shown that it was willing to meet international obligations as opposed to the contrary view of the hawks. Moreover, some advocates argue, Members could, where they believe that China had breached obligations, bring actions through the DSB to bring China into compliance. One of the advocates for China’s accession is China expert Nick Lardy from the Brookings Institution.12 While Lardy understood the need to closely monitor China he advocated the following: The appropriate analogy is buying a house. We want China to buy the “house” i.e. to come into compliance with the expectations of the established inter-

A transitional review mechanism 217 national trading system. We should not lower the price of the house i.e. allow China to be a member on concessionary terms . . . What we should do is lower the down payment on the house to a level that is politically affordable to China. That means coming into compliance with many but not all WTO standards as a precondition for membership. And it means a “mortgage” of sufficient duration to allow China to come into compliance with those criteria that it is unable to meet at the outset. Specifically, China should be allowed in a few cases relatively long phase-in periods for the dismantling the barriers protecting its most sensitive industries. Long phase-in periods for some sectors would allow China to spread the very substantial costs of adjusting to international competition over a longer period of time, thus making them politically more manageable . . . In short, the down payment should be reduced but it should still be substantial.13 This and more was described by China’s chief negotiator Vice Minister Long Youngtu. The following is part of a statement by China’s Chief GATT/WTO negotiator following the Working Party on China’s Accession in July 1998: First, the WTO accession is [sic] in consistence with the policy of China’s reform and opening up and therefore it is in our interest. The positive attitude of China towards its WTO accession has not changed. Meanwhile, China accession is also in the interest of WTO members. Without China’s participation, the WTO would be an incomplete global multilateral trade organization. Second, in the opening up its market, China can only take a step-by-step approach in line with its current level of economic development. Excessive demands or hasty actions in this regard will not only endanger China’s economic development, also damage the interests of those countries, which are willing to develop economic and trade relations with China. Thirdly, after its accession to the WTO, China is prepared to fulfill the obligations of a WTO member. At the same time, it should also enjoy the due rights. The rights and obligations should be balanced.14 “Agree but verify” Nick Lardy, as some other trade experts and trade negotiators, did not ignore monitoring. He raised the possibility of monitoring China seeing such surveillance as an important means of ensuring China’s compliance with the obligations of the WTO. As he remarked before the Senate Committee on Ways and Means in 1996: Second, the protocol governing Chinese accession can be written to embody very tight reviews of the progress China makes over time in coming into full compliance with specific commitments set forth in the protocol. These periodic reviews could be conducted under the provisions of the Trade Review Mechanism set forth in the Final Act of the Uruguay Round supplemented or modified as specified in the protocol in order to provide more assurance of compliance.15

218 Alan S. Alexandroff It would seem that experts of various opinions identify the concept of monitoring China in some form by the WTO. It is in the scope and detail that experts differ widely as we will see. The perspective of “agree but verify” acknowledges that the multilateral trade system needs and desires Chinese accession to the WTO. On the other hand, this view does not ignore, nor is it willfully blind to, the possible impact of a large but still largely non-market China on the WTO. Nor does this view ignore the need for China to continue to reform – economically, legally and administratively, to enhance the prospect that China will be able to meet its obligations and comply with them as set out in the Protocol of Accession and the Final Act of the WTO.16 However, there are strong differences of view from trade and China experts over whether China must be monitored for continuing reform or that “at the border” trade indices represent sufficient benchmarks. In addition, there are wide differences over the nature of surveillance and in particular whether it should include incentives and also sanctions. Claude Barfield and Mark Groombridge in their Chapter 4 in this volume, as well as in their monograph, Tiger by the Tail,17 urged monitoring not only to identify and counter unexpected flows (import surges) from China but also to track issues related to “transparency” or “the legal and administrative policies and institutions” of the PRC. Transparency and the reform of legal and administrative policies required surveillance and monitoring of domestic institutions and domestic processes. Notwithstanding the Uruguay Round’s move to inside the border attention, this was not, and is not, comfortable ground for trade negotiators. Trade negotiators would be alert to the former but the latter two categories posed great difficulties for trade and China experts, trade negotiators and officials from national capitals. It raised, among other things, questions of Member “equalness” and the defense of national sovereignty. Groombridge and Barfield nevertheless suggested that a meaningful review mechanism would include two instruments: contingent protection particularly safeguards, as opposed to trade remedy through anti-dumping and countervailing duties, and then a surveillance and monitoring of general obligations. This monitoring of general obligations would potentially also include tracking of reforms in China of the economic structure and also the legal and administrative institutions. The chief trading parties in the global economy and in the WTO, including the United States and the European Union have been far more alert to the contingent protection aspects of accession and hesitant if not directly antagonistic to a substantial monitoring through a TRM. And as we will see from the actual TRM accepted, there is little on the face of the TRM that acts as a sanction or an incentive for China to comply with its obligations or to spur continued domestic reform. One of the earliest proponents, if not the earliest proponent of surveillance and a transition review mechanism, was Robert Herzstein, a former Under Secretary of International Trade at the United States Department of Commerce in 1980–81. His position is somewhat complicated by his approach of describing a TRM for China within a provisional membership as the solution to China’s market transition problems. In 1986 Herzstein suggested that China’s entry be conducted in stages in

A transitional review mechanism 219 order to take account of China’s ongoing economic reforms and for domestic reforms to gain sufficient hold that China would be able to meet the commitments it had accepted in the Protocol of Accession.18 From this perspective full membership would be part of the incentive for reform and meeting commitments. Herzstein writing more recently on the subject of the TRM and a product specific safeguard described it in the following way:19 It seems desirable to structure the Protocol in a way that provides China with a substantial and concrete incentive to continue shaping its government and commercial institutions so that businesses in other countries will regard China as a market in which trade can take place on an open and non-discriminatory basis. As the experience of Japan and some other countries in the global trading system over the past two decades has revealed, this perception of openness and fairness cannot be established simply by complying with the letter of GATT rules.20 In addition Herzstein argued that the structure of the Chinese economy needs regulatory policies, which encourage competition and new market entrants as well as the reduction in cartel-like arrangements, which raise barriers to entry and maintains features of a non-market economy. With respect to economic structural reform, Herzstein suggested that the benchmarks or milestones that could form the basis for determining transition might include:21 ●

● ●

● ●

●

reduction in price controls on major categories of products, with prices responding to supply and demand reduction of price controls on the inputs used in making such products reduction of central planning measures so that purchasing decisions are made on the basis of price, quality and other commercial factors competition between Chinese companies to purchase foreign products the substantial elimination of export subsidies and trade-distorting internal subsidies availability of information concerning potential Chinese purchasers, their needs and procedures for doing business with them. 22

For Herzstein these structural economic benchmarks could assure foreign enterprises and their governments that China had achieved a market economy sufficient to insure the employment of price mechanisms and transactional freedom. Since that time Herzstein and others, including China law experts such as Stanley Lubman, Sarah Biddulph and Pitman Potter, extended a searching focus on legal and administrative institutions in China and the need for reforms.23 Sylvia Ostry has spoken since the mid-1990s on the need for a “transition mechanism.”24 She believes such a transition mechanism would include time-certain markers with specific benchmarks that would serve to embed the Chinese reform process while ensuring a predictable trade policy environment for China. In such a

220 Alan S. Alexandroff model these benchmarks would be identified in the Protocol of Accession accompanied by a monitoring mechanism that could evaluate the attainment of the objectives.25 These benchmarks could include macroeconomic, structural, legal and administrative reform markers. In contrast to the Herzstein view, Ostry realized early on that much time had passed since the accession negotiations for China had commenced. As a result, Ostry avoided tying the issue of provisional membership to the TRM although she assumed that an effective TRM would include incentives and sanctions.

TRM and the Protocol of Accession: the multilateral approach Set out in the appendices to this chapter are the transitional review requirements agreed to by member countries of the WTO and the PRC. In the Protocol of Accession these requirements are described in Paragraph 18 and then relevant information is set out in Annex 1A and 1B. As set out, the TRM shall operate on the following basis: ●

●

●

It will operate yearly for eight years, break for a year and then a final review will occur in the tenth year (or earlier if decided by the General Council). In advance of the review, China will provide relevant information, including information set out in Annex 1A and 1B, to the appropriate subsidiary body. The subsidiary bodies will report, in turn, to the General Council. The General Council finally can “make recommendations to China and to other Members in these respects.” Relevant information as set out in the appendices will include economic data, economic policies, data on the making and enforcing policies in China; policies affecting trade in goods (this includes tariff rate quotas, non-tariff measures, import licensing, customs valuation, export restrictions, safeguards, technical barriers to trade, TRIMS, state trading entities and government procurement) policies affecting trade in services, TRIPS and then information responding to specific questions received from the General Council or a subsidiary body.

A perusal of Annex 1A and 1B reveals a very wide scope of relevant information collection. In comparison to say the much earlier Polish or Romanian Protocols of Accession, there is in the China Protocol an enormous scope of inquiry identified. What remains deeply troubling, however, is the lack of defined sanctions and incentives. While the TRM talks of “recommendations” it is unclear what the result of the information collection is. What are Members likely to do? Moreover the TRM provides no framework that would “incentivize” continuing reform in China or that would make clear the penalties for failure to meet obligations. As such the TRM applies no “pressure” to maintain domestic reform. It is not clear that the TRM even applies any incentive to meet China’s general obligations under the Protocol of Accession. Finally, the TRM relies on China providing the relevant information. What incentives are there for Chinese compliance with the information gathering set out in the appendices?

A transitional review mechanism 221 An examination of the Annexes suggests a very heavy focus on traditional trade barriers and on some new trade subjects such as TRIPs or services. But the same focus is not apparent for reforms beyond the border particularly in the areas of domestic economic production, law, regulation and administration that impact on trade. For example, the Protocol of Accession specifically requires pursuant to the judicial review section (Paragraph 2(D)) tribunals that will be independent and impartial of the agencies entrusted with administrative enforcement. Yet there does not appear to be an evident subsidiary body to review this aspect of the Protocol. Instead there appears to be information required including lists of laws, regulations administrative guidelines and other measures for services as well as lists of authorities that among other things receive appeals for trade in services. It would appear that these lists are not generalizable for all trade-related matters. Nor do the Annexes suggest any evaluation of the quality of judicial review. Another key area is Paragraph 3 – non-discrimination, examining the procurement of inputs or the costs, prices and availability (from authorities, public or state enterprises) for goods and services including transportation, energy, basic telecommunications other utilities and factors of production. The only pricing information asked for appears to be information on China’s state trading enterprises for exported products that is to be provided to the Council for Trade in Goods. There is a specific request of information for three areas (silk, textiles and fertilizer and oil) of state trading entities but the only information required of state-owned enterprises are the shares of imports and exports accounted for by these entities. In addition there may be additional information gained on SOEs by the request for annual economic development programs, China’s five-year programs and any industrial or sectoral programs or policies released by the national and sub-national levels. Overall, however, the character and influence of SOEs on China’s economy and trade will be unevaluated. Thus in summary with the evaluation spread throughout the subsidiary bodies, without a framework for thresholds and incentives to act and sanctions to eliminate breaches or non-actions, there is doubt that the TRM can indeed “agree but verify.” With an imperfect ability to see and an unclear framework to act, the TRM could well revert to form as identified by reports of the TPRM. That could prove to be damaging for the WTO and for the Members including China.

APPENDICES

18. Transitional Review Mechanism 1. Those subsidiary bodies* of the WTO which have a mandate covering China’s commitments under the WTO Agreement or this Protocol shall, within one year after accession and in accordance with paragraph 4 below, review, as appropriate to their mandate, the implementation by China of the WTO Agreement and of the related provisions of this Protocol. China shall provide relevant information, including information specified in Annex 1A, to each

222 Alan S. Alexandroff subsidiary body in advance of the review. China can also raise issues relating to any reservations under Section 17 or to any other specific commitments made by other Members in this Protocol, in those subsidiary bodies which have a relevant mandate. Each subsidiary body shall report the results of such review promptly to the relevant Council established by paragraph 5 of Article IV of the WTO Agreement, if applicable, which shall in turn report promptly to the General Council. 2. The General Council shall, within one year after accession, and in accordance with paragraph 4 below, review the implementation by China of the WTO Agreement and the provisions of this Protocol. The General Council shall conduct such review in accordance with the framework set out in Annex 1B and in the light of the results of any reviews held pursuant to paragraph 1. China also can raise issues relating to any reservations under Section 17 or to any other specific commitments made by other Members in this Protocol. The General Council may make recommendations to China and to other Members in these respects. 3. Consideration of issues pursuant to this Section shall be without prejudice to the rights and obligations of any Member, including China, under the WTO Agreement or any Plurilateral Trade Agreement, and shall not preclude or be a precondition to recourse to consultation or other provisions of the WTO Agreement or this Protocol. 4. The review provided for in paragraphs 1 and 2 will take place after accession in each year for eight years. Thereafter there will be a final review in year 10 or at an earlier date decided by the General Council. * Council for Trade on Goods, Council for Trade-Related Aspects of Intellectual Property Rights, Council for Trade in Services, Committees on Balance-of-Payments Restrictions, Market Access (covering also ITA), Agriculture, Sanitary and Phytosanitary Measures, Technical Barriers to Trade, Subsidies and Countervailing Measures, Anti-Dumping Measures, Customs Valuation, Rules of Origin, Import Licensing, Trade-Related Investment Measures, Safeguards, Trade in Financial Services.

ANNEX 1A 2

INFORMATION TO BE PROVIDED BY CHINA IN THE CONTEXT OF THE TRANSITIONAL REVIEW MECHANISM China is requested to provide information on the following in accordance with Article 18.1 of the Protocol of Accession. The requested information should be provided annually, except in those cases where China and the Members agree that it is no longer required for the review.

A transitional review mechanism 223 I. ECONOMIC DATA (a) most recently available import and export statistics by value and volume, by supplier country at the HS 8-digit level (b) current account data on services, by source and destination in line with the statistical requirements of the IMF (c) capital account data for inward- and outward-realized foreign direct investment by source and destination in line with the statistical requirements of the IMF (d) the value of tariff revenues, non-tariff taxes, and other border charges levied exclusively on imports by product or at the highest level of detail possible, but at least by HS heading (4-digit) at the beginning of the review mechanism (e) the value of export duties/taxes by product (f) the volume of trade subject to tariff exemptions by product or at the highest level of detail possible, but at least by HS heading (4-digit) at the beginning of the review mechanism (g) the value of commissions, mark ups and other fees charged on imports subject to state trading or designated trading imposed through government regulation or guidance, if any (h) the shares of imports and exports accounted for by the trading activities of state-owned enterprises (i) annual economic development programmes, China’s five-year programmes and any industrial or sectoral programmes or policies (including programmes relating to investment, export, import, productions, pricing or other targets, if any) promulgated by central and sub-central government entities (j) annual receipts under the Value-Added Tax (VAT), with separate information for imports and domestic products as well as information on VAT rebates 2 This “information” refers to information other than that required by the general notification requirements for WTO Members. To avoid duplication, it is understood that Members will accept information provided on an annual basis by China to other WTO bodies as satisfying the information requirements in Annex 1.

II. ECONOMIC POLICIES 1. Non-Discrimination (to be notified to the Council for Trade in Goods) (a) the repeal and cessation of all WTO inconsistent laws, regulations and other measures on national treatment (b) the repeal or modification to provide full GATT national treatment in respect of laws, regulations and other measures applying to internal sale, offering for sale, purchase, transportation, distribution or use of: after sales service, pharmaceutical products, cigarettes, spirits, chemicals and boiler and pressure vessels (for pharmaceutical products, chemicals and spirits there is a reservation of the right to use a transitional period of one year from the date of accession in order to amend or repeal relevant legislation)

224 Alan S. Alexandroff 2. Foreign Exchange and Payments (to be notified to the Committee on Balance-of-Payments Restrictions) (a) exchange measures as required under Article VIII, Section 5 of the IMF’s Articles of Agreement and such other information on China’s exchange measures as was deemed necessary in the context of the transitional review mechanism 3. Investment Regime (to be notified to the Committee on Trade-Related Investment Measures) (a) completed revisions to investment guidelines in conformity with the WTO Agreement 4. Pricing Policies (to be notified to the Committee on Subsidies and Countervailing Measures) (a) application of existing or any other price controls and the reason for their use (b) pricing mechanisms of China’s state trading enterprises for exported products

III. FRAMEWORK FOR MAKING AND ENFORCING POLICIES 1. Structure and Powers of the Government/Authority of Sub-Central Governments/Uniform Administration (to be notified to the General Council) (a) revision or enactment of domestic laws, regulations and other measures related to China’s commitments under the WTO Agreement and Protocol, including those of local governments at the sub-national level, that have been promulgated since accession or the previous meeting of the relevant body under the Transitional Review Mechanism (b) establishment and operation (upon accession) of the mechanism pursuant to Section 2(A), paragraph 4 of the Protocol under which individuals and enterprises can bring cases of nonuniform application of the trade regime to the attention of national authorities

IV. POLICIES AFFECTING TRADE IN GOODS 1. Tariff Rate Quotas (to be notified to the Committee on Market Access) (a) administration of TRQs on a transparent, predictable, uniform, fair and non-discriminatory basis using clearly specified timeframes, administrative procedures and requirements and evidence of a consistent national allocation (and reallocation) policy including:

A transitional review mechanism 225 (i) provision of volume/value of the quota or TRQ made available; (ii) reallocated quota or TRQ applied for; (iii) the volume/value of requests for allocation or reallocation denied; (iv) fill rates for the quota or TRQ; (v) for TRQs, the amount of any goods entered at the over quota rate; and (vi) time taken to grant a quota or TRQ allocation. 2. Non-Tariff Measures including Quantitative Import Restrictions (to be notified to the Committee on Market Access) (a) the introduction, re-introduction or application of any non-tariff measures other than those listed in Annex 3 of the Protocol and elimination of non-tariff measures (b) implementation of the schedule for phased elimination of the measures contained in Annex 3 (c) quota allocation and reallocation in conformity with WTO requirements, including the Agreement on Licensing Procedures following criteria set out in the Report of the Working Party on the Accession of China (“Report”) (d) distribution licences, quotas, tariff rate quotas or any other means of approval for importation are not subject to conditions set out in Section 7, paragraph 3 of the Protocol 3. Import Licensing (to be notified to the Committee on Import Licensing) (a) implementation of the provisions of the Agreement on Import Licensing Procedures and the WTO Agreement applying the measures set out in Section 8 of the Protocol including provision of the time taken to grant an import licence 4. Customs Valuation (to be notified to the Committee on Customs Valuation) (a) the use of valuation methods, other than the stated transaction value 5. Export Restrictions (to be notified to the Council for Trade in Goods) (a) any restrictions on exports through non-automatic licensing or other means justified by specific product under the WTO Agreement or the Protocol 6. Safeguards (to be notified to the Committee on Safeguards) (a) implementation of China’s Regulation on Safeguards 7. Technical Barriers to Trade (to be notified to the Committee on Technical Barriers to Trade) (a) notification of acceptance of the Code of Good Practice not later than four months after China’s accession

226 Alan S. Alexandroff (b) periodic review of existing standards of government standardizing bodies and harmonization of the same with relevant international standards where appropriate (c) revision of current voluntary national, local and sectoral standards so as to harmonize them with international standards (d) use of the terms “technical regulations” and “standards” according to their meaning under the TBT Agreement in China’s notifications under the TBT Agreement, including under Article 15.2 thereof and publications referenced therein, and in modifications of existing measures (e) review of technical regulations every five years to ensure international standards are used in accordance with Article 2.4 of the Agreement and provision for adoption of international standards as the basis for technical regulation as part of its notification under Article 15.2 of the Agreement (f) progress report on increase of the use of international standards as the basis for technical regulations by ten percent in five years (g) provision of procedures to implement Article 2.7 of the Agreement (h) provision of a list of relevant local governmental and non-governmental bodies that are authorized to adopt technical regulations or conformity assessment procedures as part of China’s notification under Article 15.2 of the Agreement (i) ongoing updates on the conformity assessment bodies that are recognized by China (j) enactment and implementation of a new law and relevant regulations regarding assessment and control of chemicals for the protection of the environment in which complete national treatment and full consistency with international practices would be ensured within one year after China’s accession following conditions set out in 3(t) of the TBT Working Party Report (k) information on whether, one year after accession, all conformity assessment bodies and agencies are authorized to undertake conformity assessment for both imported and domestic products and are following the conditions outlined in Section 13, subparagraph 4(a) of the Protocol (l) assignment of the respective responsibilities of China’s conformity assessment bodies solely on the basis of the scope of work and type of product without any consideration of the origin of a product no later than eighteen months after accession (m) notification of the respective responsibilities assigned to China’s conformity assessment bodies to the TBT committee 12 months after accession 8. Trade-Related Investment Measures (to be notified to the Committee on Trade-Related Investment Measures) (a) elimination and cessation of enforcement of trade and foreign exchange balancing requirements, local content and export performance offsets and technology transfer requirements made effective through laws, regulations or other measures

A transitional review mechanism 227 (b) amendments to ensure lifting of all measures applicable to motor vehicle producers restricting the categories, types or models of vehicles permitted for production (to be completely removed two years after accession) (c) increased limits within which investments in motor vehicle manufacturing could be approved at the provincial government at the levels outlined in the Report 9. State Trading Entities (to be notified to the Council for Trade in Goods) (a) progressive abolishment of state trading in respect of silk measures, increasing and extending trading rights, granting the right to trade to all individuals no later than 1 January 2005 (b) access to supplies of raw materials in the textiles sector at conditions no less favourable than for domestic users, and not adversely affected access to supplies of raw materials as enjoyed under existing arrangements (c) progressive increases in access by non state trading entities to trade in fertilizer and oil and the filling of quantities available for import by non state trading entities 10. Government Procurement (to be notified to the Council for Trade in Goods) (a) laws, regulations and procedures (b) procurement in a transparent manner and application of the MFN principle

V. POLICIES AFFECTING TRADE IN SERVICES (to be notified to the Council for Trade in Services) (a) regularly updated lists of all laws, regulations, administrative guidelines and other measures affecting trade in each service sector or sub-sector indicating, in each case, the service sector(s) or sub-sector(s) they apply to, the date of publication and the date of entry into force (b) China’s licensing procedures and conditions, if any, between domestic and foreign service suppliers, measures implementing the free choice of partner and list of transport agreements covered by MFN exceptions (c) regularly updated lists of the authorities, at all levels of government (including organizations with delegated authority) which are responsible for the adoption, implementation and reception of appeals for laws, regulations, administrative guidelines and other measures affecting trade in services (d) independence of the regulatory authorities from the service suppliers (e) foreign and domestic suppliers in sectors where specific commitments have been undertaken indicating the state of play of licensing applications on sector and sub-sector levels (accepted, pending, rejected)

228 Alan S. Alexandroff VI. TRADE-RELATED INTELLECTUAL PROPERTY REGIME (to be notified to the Council for Trade-Related Aspects of Intellectual Property Rights) (a) amendments to Copyright, Trademark and Patent Law, as well as relevant implementing rules covering different areas of the TRIPS Agreement bringing all such measures into full compliance with and full application of the TRIPS Agreement and the protection of undisclosed information (b) enhanced IPR enforcement efforts through the application of more effective administrative sanctions as described in the Report

VII. SPECIFIC QUESTIONS IN THE CONTEXT OF THE TRANSITIONAL REVIEW MECHANISM (to be notified to the General Council or relevant subsidiary body) (a) response to specific questions in the context of the transitional review mechanism received from the General Council or a subsidiary body

ANNEX 1B ISSUES TO BE ADDRESSED BY THE GENERAL COUNCIL IN ACCORDANCE WITH SECTION 18.2 OF CHINA’S PROTOCOL OF ACCESSION – Review of the reports and the issues referred to in Section 18.1 of China’s Protocol of Accession. – Development of China’s trade with WTO Members and other trading partners, including the volume, direction and composition of trade. – Recent developments and cross-sectoral issues regarding China’s trade regime. The Rules of Procedure of the WTO General Council shall apply unless specified otherwise. China shall submit any information and the documentation relating to the review no later than 30 days prior to the date of the review.

Notes 1 In the case of the United States two national surveillance instruments have already been established. These are the United States–China Security Review Commission set up in the Defense Authorization legislation of 2001 and the Congressional-Executive Commission of China established in the Permanent Normal Trade Relations legislation of the US Congress. In a future article I shall examine the potential for mischief of these two American oversight mechanisms. 2 The China Accession to the WTO is an evident move to multilateralism and away from bilateral and unilateral arrangements and actions. This multilateralization includes the multilateralization of review and monitoring. Thus, the failure of surveillance and the

A transitional review mechanism 229

3

4

5

6

7 8

9 10 11 12

13

14

15 16 17 18

return of monitoring to national capitals such as Washington, DC would be an evident backward step in the evolution of the multilateral trading regime. It is clear from the examination of provisional membership later in this chapter that transitional economies applied for and were admitted to the GATT, for example Poland, Romania and Yugoslavia. And of course it was clear from the mid-1980s that China was seeking admission. Accession was and is viewed as somewhat sui generis. Each case was treated separately, though the Working Parties were no doubt aware of the terms of succession for each. But the underlying free trade and market principles of the institution were barely touched notwithstanding that by the 1980s the majority of Members were developing countries, many of which had powerful state actors in their economies and heavily regulated ones as well. To the degree and accommodation was considered it was in the area of special rules for developing countries. The Working Party on China and various bilateral negotiations on market access turned to exceptions, phase-in and phase-out periods to provide forms of special and differential treatment while formally refusing to accept China’s assertion that it be accorded developing country status. An example was the difficult bilateral negotiations that went on between Mexico and China. This bilateral was concluded only shortly before China became a member of the WTO. A classic summary of the “Big Tent” argument was expressed by David Blumenthal in “Applying GATT to Marketizing Economies: The Dilemma of WTO Accession and Reform of China’s State-Owned Enterprises (SOEs),” Journal of International Economic Law (1999) pp. 113–153. There Blumenthal states at p. 118: “The paper does not advocate on behalf of the Chinese government. It does submit, however, that a world trade organization in which China plays no part is a contradiction in terms, and that the international norms that the WTO represents will not be fully accepted until the institution embraces all nations.” The earliest draft the author was able to review is dated December 20, 1994. Mastel worked in Congress including Chief International Trade Adviser to the Chairman of the Senate Finance Committee’s International Trade Subcommittee. He was Vice-President and Director of Studies at the Economic Strategy Institute, Director of International Trade Studies at the Center for National Policy and is currently Director of the Global Economic Policy Project at the New America Foundation. Greg Mastel, “A New US Trade Policy toward China,” Washington Quarterly vol. 19, no. 1 (Winter, 1996) at p. 193. Greg Mastel, “Is WTO Ready for China?” Far Eastern Economic Review (May 8, 1997), at p. 29. Greg Mastel, Testimony Before the Trade Deficit Review Commission, February 24, 2000. Nicholas R. Lardy is a Senior Fellow at the Brookings Institution. He is an economist and an expert of the Chinese economy. Nick was a member of the China/WTO Accession Project that was established at the University of Toronto in 1996. Sylvia Ostry chaired this Project and the author of this chapter was its director. China and the WTO, a Prepared Statement for a Hearing on Accession of China and Taiwan to the World Trade Organization by Nicholas R. Lardy for the Committee on Ways and Means, Subcommittee on Trade (September 19, 1996), at pp. 3–4. “Speech by Vice Minister Long Youngtu at the Eighth Session of the Working Party Meeting on China’s Accession to the WTO,” Inside US Trade, http://www. insidetrade.com/sec-cgi/as_web.exe?SEC_world44+B+iwp983888. China and the WTO, at p. 5. Final Act Embodying the Results of the Uruguay Round of Multilateral Trade Negotiations. Tiger by the Tail: China and the World Trade Organization (Washington, DC: AEI Press, 1999). Robert E. Herzstein, “China and the GATT: Legal and Policy Issues Raised by China’s Participation in the General Agreement on Tariffs and Trade,” Law and Policy in International Business, vol. 18, no. 2 (1986), pp. 371–415.

230 Alan S. Alexandroff 19 Robert Herzstein, Preliminary Draft – A Transition Mechanism (March 2, 1998). Dr. Sylvia Ostry asked Herzstein early on to join the China/WTO Accession Project. This paper was presented at a meeting of the China/WTO Accession Project at conference in Washington, DC on March 5–6, 1998. 20 Draft at p. 15. 21 Herzstein, 1986 at p. 411. At the time Herzstein failed to have the benefit of the current drafts of the Protocol of Accession, nor could he benefit from GATT, 1994 provisions in particular agreements such as the Agreement on Subsidies and Countervailing Measures (SCM). 22 In the context of the current Draft Protocol of Accession it might suggest a confirmation of the elimination of subsidies pursuant to Article 3 of the SCM and Section 11 Subsidies of the Draft Protocol of Accession. 23 Robert Herzstein, “Is China Ready for the WTO’s Rigors?” The Wall Street Journal Interactive Edition (November 16, 1999), http://interactive.wsj.com/archive...riod%3D 53A720&location=article&HI; Robert Herzstein, “Fitting China into the WTO: Can China Function in a Law-Governed Trading System?” Harvard China Review, vol. 2, no. 1 (Spring/Summer, 2000) at pp. 63–67. Also see Sarah Biddulph’s chapter in this volume, “China’s Accession to the WTO: Legal System Transparency”; and Pitman Potter’s chapter, “China and the WTO: Challenges for Implementation”; and finally Stanley Lubman, Bird in a Cage: Legal Reform in China after Mao (Stanford, CA: Stanford University Press, 1999). 24 As noted a transition mechanism was first publicly raised by Robert Herzstein, a prominent Washington lawyer, and former Commerce official during the Carter Administration, back at the time that China first announced its intention to apply to rejoin the GATT in 1986. It was Sylvia Ostry as Chair of the China/WTO Accession Project that put the transitional review mechanism back in the experts’ debates. 25 The idea of monitoring or surveillance received some acceptance in the Uruguay Round with the creation of the Trade Policy Review Mechanism (TPRM). Sylvia Ostry notes in her book, The Post-Cold War Trading System: Who’s on First? (Chicago: University of Chicago Press, 1997) at p. 201: The idea of surveillance was strongly recommended by the trade experts during the 1980s as a means of counteracting the new protectionism by improving the understanding of policymakers and the public of the of the full economy-wide impact of trade measures. International surveillance also creates peer group pressure that can assist domestic policy makers in resisting protectionist lobbies and provide a means of monitoring the impact of trade-related policies on the international economy While the TPRM was adopted on an interim basis at the midterm ministerial meeting in December 1988, it is now established as a Trade Policy Review Body under the General Council of the WTO. While the TPRM would not have the tools or authority to undertake the monitoring required (notwithstanding that experts urged that it take on the monitoring function for China transition) of in a transition mechanism, nevertheless it points the way.

13 Conclusion Where do we go from here? Alan S. Alexandroff and Rafael Gomez

Closing the deal On September 18, 2001, in the lobby of a hotel in central Geneva, China was granted entry to the WTO. This date, coincidently enough, marked the eighteenth meeting of the Working Party for the Accession of China into the WTO (WPAC).1 For almost 16 years the WPAC had been entrusted with the task of negotiating China’s entry into the multilateral trading regime as defined by the GATT and then the WTO.2 After many years of often torturous negotiations, China and its future GATT partners (represented by the working party) concluded their negotiations with a Working Party Report that was several hundreds pages in length and a Protocol of Accession that was nearly 900 pages long once annexes were included. Although the official entry of China into the WTO would not occur until December 2001, as of the fall of 2001, China was able to take its place alongside the other major trading countries of the global economy. The unanswered and very large question left open for all those interested in the ongoing process of Chinese economic integration into the global economy was (and still is): “So where do we – China and the member countries of the WTO – go from here [e.g. after the accession]?” It is all well and good to have China as part of the WTO, but what of the reforms – economic, administrative and legal – that China must implement in order to comply with not only the letter but also the spirit of the accession protocol? And how will the multilateral trading regime advance and evolve now that such a large transitional state – with an economy that, by most standards, does not yet possess a market economy – is a fully fledged member? China remains a country where the economy is still dominated by large state-owned enterprises, a country where the rule of law remains problematic and where administrators seldom feel compelled to explain their decisions.

A contest of three visions To answer the above question of “where do we go from here?” one needs to understand the debate that occurred “under-the-radar-screen” among trade, governmental and legislative decision-makers during the accession negotiations. These groups defined quite differently the entry conditions for China and the obligations that it

232 Alan S. Alexandroff and Rafael Gomez was required to assume upon entering the GATT and then the WTO. There were essentially three distinct visions expressed.3 One way of characterizing these distinct visions, and the groups espousing them, is with the following terms: there were the “hawks,” the “down-payment firsters” and the “agree but verify” groups. For the first group, China’s lack of liberal democratic principles and lack of a market economy (and the many attributes that go along with a market economy and democracy) led these proponents to insist that China remain outside of the WTO until it had become a fully fledged market economy. These so-called hawks were located mostly in the United States and particularly in the US Congress. They were drawn from both Republican and Democratic ranks and were opposed to the exclusion of Jackson–Vanik (the Congress’s annual review of most-favored trading nation status) until such time as China could be seen to have made necessary internal political and economic reforms. These so-called necessary reforms included such things as the selling-off of state-owned enterprises, the reform of the legal and administrative systems in China, the end of governmental and Communist Party corruption, and improvements in human rights practices in China. The second group – the “down-payment first” crowd – maintained, in support of the arguments often made by China’s chief negotiator for accession Long Yongtu, that China should be allowed entry as quickly as possible so as to ensure China’s continued improvement in such areas as human rights, the economy, and perhaps most importantly, to lock in China’s already established economic reforms. With a “down-payment” (i.e. the terms of accession) China could be admitted and would then assume all the obligations and benefits that WTO accession would bring. According to this view, the longer that China remained outside the WTO, the less likely that it would be able to move along the domestic reform path. Those who urged this approach, and it included many of the foreign country trade negotiators, often coupled the approach with an argument that within China there were many domestic forces opposing the reform process (i.e. mostly provincial and interministerial officials). The down-payment firsters argued that once China found itself inside the multilateral trading system, compliance with WTO directives would provide the required leverage needed by central officials such as Jiang Zemin, Zhu Rongji, along with other reformers, to implement changes in the economy as well as in the legal and administrative systems. In the extreme, remedial action could be launched through dispute settlement to correct inappropriate behavior and bring China into conformity with its obligations. Though these first two views are by far the better known, there was a third perspective that offered a different way in which to condition the accession process. This approach – the “agree but verify” approach articulated at an early stage of the negotiations – was seldom examined and discussed within the context of formal negotiations. According to this view, one did not have to approach the accession of China to the WTO as a dichotomous process. Rather than playing an ultimatum game with China, as the hawks were — insisting that China either reform and become a market economy and then be admitted – or allowing China to reform after entry – as the down-payment firsters wanted – this third approach argued that China

Conclusion: where do we go from here 233 should be given provisional membership. Provisional WTO membership status would consist of an ongoing carrots-and-stick process. This perspective relied on the multilateral system to ensure continued reform within China and it would consist of a multilateral surveillance and monitoring mechanism through the GATT/WTO. Provisional membership would give China clearly worded and observable benchmarks to reach. The attainment of these benchmarks would be accompanied by technical assistance and a variety of structured incentives from the multilateral trading system. Once a set of benchmarks was achieved (in administrative reforms for example) China would gain equal treatment over a previously negotiated area in the Protocol of Accession (in financial services for example). This measured approach was due to the fear that China could very well alter the regime that had been established after the Uruguay Round. There was also a recognition that if a non-market economy of this size was admitted without any practical means to ensure continued political and economic reform, it might well undermine the entire multilateral trading system. At the time of China’s return to formal negotiations in 1995, the WTO was a nascent but critical institution and the Dispute Settlement Body was thought to be incapable of coping with the potential glut of complaints emanating from the entry of such a large non-market economy. In addition, those who urged provisional membership, or a transitional review mechanism, insisted that without continuing incentives to maintain economic, administrative and legal reforms in China, there was inadequate guarantees that reform would indeed continue . Without the means to insist on continuing progress, China would be incapable of achieving real integration into the global economy. In the end, of course, it was down-payment firsters that won. China would not be placed on any probationary list or any contingent category; instead it would be a fully fledged member country of the WTO. The monumental task of reforming China’s banking sector and legal system would continue at its own pace, while the world would now be driven to use the settlement dispute mechanism to challenge any “illegal” Chinese economic activity.

Why China is so unique? Dispassionate observers often look bewildered when told that the China’s entry into the WTO required 16 years of negotiations. They ask, quite naturally, what took so long? The answer is quite simple: China posed a problem for negotiators generally and the Working Party of the GATT (and then the WTO) in particular. This problem stemmed from a set of inherent characteristics which made China different from every other country who had negotiated accession before. First and foremost, China is very large and has a potentially enormous productive capacity. From the national capitals of the member countries there was a constant concern that China had the ability to swamp domestic economies with cheaply produced products and services. Second, China – despite its record of stellar economic growth in the 1990s – is in many respects still very much a non-market economy. Its currency is not convertible. It has a huge SOE sector that is clearly not ready to cope with international competition, a fact which will have huge social costs

234 Alan S. Alexandroff and Rafael Gomez if the experience of other non-market economies such as Russia is anything to go by. These problems are serious, but more to the point, these problems have profound implications for the governance and regulatory capacity of the world trading system.

What happens next? The question of what happens now that China has officially entered the WTO is multifaceted. First, we have to ask, what happens domestically to China’s reform process and its economy? Second, we need to ask, what happens to China’s partners? And finally, what happens to the regime itself? Can the WTO cope with the potential raft of complaints launched by member countries against China pursuant to the DSB? In a sense, the statement we made earlier about a contrast of visions having been won by those seeking collaboration with China is still very much the key to understanding the future. We now have a means to assess whether the downpayment firsters were right. If the pace of change quickens and becomes more firmly entrenched in China post-accession, then in retrospect, the notion of granting China provisional membership would be seen (quite rightly) as having been unnecessary. However, if the process stalls, if a backlash to market reforms occurs within China, if there is a significant rush of actions against China through the DSB, then perhaps the third way was right. If this alternative (albeit downbeat) forecast occurs, then China should have been kept out of the WTO until such time as member countries with more expertise could have helped in getting China’s own domestic house in order. At this point, of course, one can only speculate as to the eventual outcome. What is certain is that China will have a profound effect on the world trading system. In the long march towards a free, open and prosperous multilateral system of trade and competition, China’s accession to the WTO is clearly the biggest step yet for the global economy.

Notes 1 On November 11, 2001 China notified the WTO that it had achieved compliance with the agreements it had reached with the member countries. Pursuant to the rules of the WTO, China formally became a member country on December 11, 2001. 2 The details of the accession negotiation are set out in Chapter 3 of this volume by Jeffrey Gertler, Senior Counselor, Legal Affairs Division and Secretary, Working Party on the Accession of China. Gertler along with its Chairman Pierre Louis Girard of Switzerland have served WP for the entire period of the negotiation of the accession of China. 3 These positions were paralleled, indeed grounded, in a debate that was initiated by trade and China experts over the years. These positions have been examined by Alan Alexandroff in his analysis of a transitional review mechanism in Chapter 12.

Index

This index is written in alphabetical, word-by-word order. It does not cover the introductory pages or notes to chapters. All location references are to page number. accession negotiations 22–3, 211–13; approval/acceptance 26–7; balancing obligations and reforms 216–17, 232; bilateral agreements 23–4; finalising 27–8; information required 24; monitoring of compliance 217–20, 232–3; opposition 215–16, 232; post-accession issues 88–92, 231–4; rounds accession 24–6; unique position of China 1, 233–4; see also Protocol of Accession administered protectionism 126 Administration Litigation Law 1990 37, 130 administrative law 124–6, 129, 192; changes in Chinese 130–31; see also laws administrative legal system 18–20, 31, 42, 91–2; appeals tribunal, establishment 181–2; criticisms 158–9; development of stable system 156, 200–1; difficulties with changing 162–3, 170–1, 181–2; exercise of discretion 183–4, 186; future developments 174; inability to locate documents 165; increasing public knowledge of 157; judicial independence 175–8; judicial review of administrative actions 128–31, 174–5; procedural fairness 171–2; resolution of conflict 165–7; right of comment 128; separate system for trade/investment disputes 38–9; standing committee interpretation 159–60; State Council departments’ rules 166; suggested Protocol revisions 37–9; supervision of lower level rule-making 167–8; transparency issues 36–7, 154–6, 185–7, 200–1, 218–20 Administrative Litigation Law 1989 178–9

Administrative Procedure Act 1946 18, 124; s.553 133–4 Administrative Punishments Law 1996 172–4, 184 Administrative Review Law 1999 179–81 Administrative Review Regulation 1991 37 Agreement on Trade-Related Investment Measures (TRIMs) 11 aims of text 1–2 anti-dumping 31–3; comparison with safeguards regime 35–6; increase in use after Tokyo Round 126; transition economies 33–4 Appellate Board decisions 16; see also World Trade Organisation arbitration 141–2 Article X (GATT) 18, 131–2; Chinese accession 127–31; enforcement provisions 139; transparency 123–7, 139 Asian financial crisis: Chinese reaction to 99–100; Chinese responses to, summary 110; withdrawal of Japanese funding 104 asset management companies 102, 112–13 avoiding deadlock 30–1, 42; anti-dumping 31–4; safeguards 35 background to text 1–4 bankruptcy 73, 185 banks: credit ratings 108–9; foreign participation 75–8, 84–5; impact of foreign entry on state-owned enterprises 90; liberalization commitments 81; loan write-offs 107–8, 112–13; loans to state-owned enterprises 49, 72–3, 102; People’s Bank of China, reorganisation 116; policy lending 73; reform of system

236

Index

71–2; separation of securities industry 116; willingness of Chinese people to use 103–4; see also financial services industry bilateral agreements 23–4; with USA 27, 30, 34 bond issues 100, 104–6, 116 Cairns Group 10 certified public accountants, securities industry 116 China Enterprise Index 105; see also stock exchanges China Mobile (Hong Kong) Limited 105–6, 115 China Telecom 69–70, 203–5 China Telecom (Hong Kong), creation 69 China Unicom: code division multiple access technology 199–200; creation 68–9; joint foreign ventures 196–7; paging services 70 collectives 49, 101 Conference on Environment and Development (Rio Earth Summit) 1992 13 Conference on the Human Environment (Stockholm) 1972 13 constitution, March 1999 revision 100 copyright law 144–5; enforcement 146–8 corporate governance 57–8; see also stateowned enterprises corruption, anti-smuggling force 114 court system in China 140–1, 175–8; enforcement of judgments 184–5; establishment of separate courts 38–9; judicial discretion 183–4; judicial independence 175–8 credit ratings: downgrading 108–9; Moody’s rating 1998 109 currency restrictions: business scope of foreign finance institutions 77–8; removal 85 deficit financing 114; see also fiscal policy deflation 106, 109–10 development zones, closure 115 dispute resolution 139–40, 142–3; arbitration system 141–2; commercial litigation 140; foreign arbitral awards 141–2; problems with Chinese court system 141; trade/investment disputes 38–40, 89; WTO understanding 140 Dispute Settlement Body, WTO 140, 142–3; see also World Trade Organisation

early negotiations 1 economic regulatory reform 10–11, 118; benchmarks 219–20; lack of ideology concerning 102–3 encryption software 198–9 environmental movement 13; background 14; changes to WTO policy 15–17 equity investments, decline 104–6 European Union: bilateral agreements with China 23, 27; division with USA 12–13; foreign ownership of telecommunications industry 202 exports, effect of Asian crisis on 111–12 financial services industry: domestic securities 74–5; financial institutions, business scope 77–8; financial institutions, requirements of 76; foreign entry, impact on state-owned enterprises 90; foreign participation 68, 75–8; implementation of change 88–9; joint ventures, managerial control 89–9; liberalization commitments 66–8, 80–2, 87–8; modernization of competition law 90; motor vehicle financing 85; structure 80; see also banks; insurance industry financial system, worst-case scenario 103–4 fiscal policy 106–7; center–local share 1985–99 107; deficit 1995–99 108; deficit financing 114 foreign arbitral awards 141–2; see also dispute resolution funding, increased cost of 104–6 General Agreement on Tariffs and Trade (GATT): Article X 18, 124–7; compliance with rules 138–9, 148; countries with provisional membership 213–15; international legal culture 136–7 General Agreement on Trade in Services (GATS) 10–11; Fourth Protocol (Telecommunications) 194–5; Regulatory Framework Reference Paper 195–6 globalization of legal culture 136–7 growth models, revision 117–18 Guangdong International Trust & Investment Company, collapse 104, 113 Hang Seng Index 105; see also stock exchanges Herzstein, R. 37, 39, 200–1, 218–19

Index 237 Hundred Words Sutra in Analogies 91 ideology, difficulties in reforming 102–3 imports, effects of Asian crisis on 111–12 industrial structure 49; see also state-owned enterprises inflation 110–11 insurance industry: foreign participation 75–8, 85–7; liberalization commitments 81–2; reforms 73–4; see also financial services industry intellectual property rights 10, 130–1, 143–4; enforcement problems 148; US–China Memoranda of Understanding No. 1 (1989) 144–5; US–China Memoranda of Understanding No. 2 (1992) 145; US–China Memoranda of Understanding No. 3 (1995) 146–8; see also Trade-Related Aspects of Intellectual Property Rights (TRIPs) international trust and investment companies, reorganization 113 internet industry: foreign investment 197–8; internet telephony 199 Japan: legal system 19; provisional membership of GATT 213–14 Jiang Zemin 47–8, 63 99, 115 judicial discretion 183–4 judicial independence 175–8 judicial review of administrative actions 128–31, 174–5; see also administrative legal system land ownership 101 Lardy, N. 216–17 laws: Administration Litigation Law 1991 37, 130; Administrative Litigation Law 1989 178–9; Administrative Procedures Act 1946 18, 124, 133–4; Administrative Punishments Law 1996 172–4, 184; Administrative Review Law 1999 179–81; Administrative Review Regulation 1991 37; central/local 159; competition law, modernization 90; consultation in drafting process 168–70; controls on application 185; enforcement 157, 182, 186; future developments 174; implementation rules 161–2; inconsistent implementation 157–8, 183–4, 186; interpretation powers 159–60; local protectionism 184–5, 187; normative documents 128,

160–2, 164; publication 19, 128, 163–4; rule of 156; stability of legal norms 165; State Compensation Law 1995 181; status of 156; transparency 19, 158–9, 185–7 legal systems: Chinese 19, 129–31, 140–2; globalization, effect on 136–7; Japan 19; national 38; USA 129–30 life insurance 86; see also insurance industry Liu Jibin 99 local protectionism 184–5, 187 Long, Youngtu 217 Lord, W. 201 Mastel, G. 215–16 Ministry of Information Industry, creation 69 motor vehicle financing 85; see also insurance industry Multilateral Agreement on Investment 14, 136 Multilateral Environmental Agreements 13 Ninth Five-Year Plan 63; see also state-owned enterprises non-governmental organisations 13; assets 14; changes to WTO policy 15–17; strategic knowledge 14 non-market economies 32–3; trade reviews for WTO accession 41–2; see also transition economies non-performing loans 72–3, 102; disposal 112–13; write-off 107–8, 118 normative documents 128, 160–2, 172; publication 19, 164; see also laws North/South divide in WTO 9–13; impact of China’s entry 17 paging services 70–1; foreign service supply 80–3 patent protection 144–5; enforcement of regulations 146–8 People’s Bank of China, reorganization 116; see also banks Poland, accession to GATT 214–15 privatization 100–2 Protocol of Accession: approval of draft by General Council 26; final agreement 27–8; judicial review 127–31; ratification by People’s Congress 26–7; right of comment 128; safeguards provisions 35; suggested amendments 31, 34, 37–9; Transitional Review Mechanism 220–8; transparency issues

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127–8, 131; Working Party considerations of draft 25–6; see also accession negotiations Publication and Administration of Trade Regulations (Article X, GATT) 18, 131–2; Chinese accession 127–31; enforcement provisions 139; transparency 123–7, 139 regulatory cultures, compliance with GATT 138–9 retail sales, slump 111–12 “Revpower” case (foreign arbitral awards) 142 Romania, accession to GATT 215 safeguards 35–6; see also anti-dumping Safire, W. 123 securities industry: devolvement from banking industry 116; foreign participation 78, 87; liberalization commitments 82, 87; reform 74–5; see also financial services industry; stock exchanges software, protection regulations 145; enforcement 146–8 Special Economic Zones 159, 165 state asset management 48, 53–6; asset management companies 102, 112–13; see also state-owned enterprises State Compensation Law 1995 181 State Council, powers 159 state-owned enterprises 47; accounting reforms 62; auditing reforms 62; bank loans 49, 72–3, 102; corporate governance 57–8; corporatization 49–52; decline in number 101; ending subsidies 59, 118; future requirements 62–4; halting of reform process 100; impact of foreign entry to markets 90; inefficiencies 48–9; inter-enterprise competition 59–60; management autonomy 50; mergers and acquisitions 61–2; organizational reforms 53–6; ownership diversification 60–1; profitability 100; separation of social functions 56–7, 117; state as owner 52, 114–15; state as regulator 52–3; state asset management 48, 53–6; stock exchanges 74–5; application for listing, regulation of numbers 185; China Enterprise Index 105; China Mobile (Hong Kong) Limited 105–6, 115; foreign participation 78, 87; Hang

Seng Index 105; reluctance to invest in Chinese companies 104–6; see also securities industry structure of text 3–4 Switzerland, accession to GATT 214 tax collection 107–8; establishment of broader tax base 114–15 telecommunications industry: change commitments 80–1; current policy 69–70; encryption software 198–9; foreign ownership 196–7; foreign participation 68, 70–1, 202; foreign participation, impact on state-owned enterprises 90; foreign supply of domestic/international services 83–4; foreign supply of internet services 84; foreign supply of mobile voice/data service 83; foreign supply of valueadded/paging services 80–3; future prospects 204–5; GATT Fourth Protocol 194–5; GATT Regulatory Framework Reference Paper 195–6; implementation of change 88–9; internet industry 197–8; internet telephony 199; joint ventures, managerial control 89–90; legislation, need for 202–4; liberalization commitments 66–8, 81; liberalization milestones 68–71; military communications 199–200; modernization of competition law 90; paging services 70–1, 80–3; size 68; WTO principles 193–4 Tokyo Round 18, 125–7 trade balance 106 trade/investment disputes 38–9, 89; transition economies 40; see also dispute resolution trade law, WTO transparency requirements 192–3 Trade Policy Review Mechanism 40, 88, 126; oversight of non-market economies’ accession 41–2 Trade-Related Aspects of Intellectual Property Rights (TRIPs) 10–11, 18–19, 126–7, 143; see also intellectual property rights transition economies: anti-dumping 33–4; entry to WTO 212–13, 215–16; provisional membership of WTO 213–14; trade disputes 40; see also nonmarket economies transitional review mechanism 211–13, 215, 218; in Protocol of Accession 220–8

Index 239 transparency 18–20, 42; concerns over implementation 19, 31, 131; definition 123; facets of 154; GATT Article X 126–7, 131–2; in legislation 158–9; lack of in administrative legal system 36–7, 154–6, 185–7, 200–1, 218–20; monitoring 218–20; publication of laws 128, 163–4, 168; trade law 192–3; see also administrative legal system trust and investment companies, reorganization 113 United States of America: bilateral agreements 23–4, 27, 30, 34; division with European Union 12–13 Uruguay Round 9–13, 126–7 venture capital 115–16 Vienna Convention on Contracts for the International Sale of Goods 136 welfare provision, transfer from state-

owned enterprises 56–7, 117 World Trade Organisation: accession of China, official entry date 231; accession of China, reforms required 18–19, 200–1; accession of China, transition arrangements 20; accession of nonmarket economies, trade reviews 41–2; admission requirements 212; Appellate Board, decisions 16; changes desired by environmentalists 15–17; Dispute Settlement Body 89, 140, 142–3; effect of China’s entry 234; increasing legalization 17–20; North/South divide 9–13; provisional membership 213–14; trade in services, principles 194; Trade Policy Review Mechanism 40–2 Wu Jichuan 198, 202–5 Yugoslavia, accession to GATT 214 Zhang Chunseng 160, 171–3 Zhu Rongji 30, 80, 99, 201–2, 204