China’s Immunity Gap
The Zero-COVID Strategy Leaves the Country Vulnerable to an Omicron Tsunami
The research on which this article is based was sponsored by The Brookings Institution. The author wishes to express his appreciation for their support and make clear that the views expressed are his own.
In June 1971, a month before Henry Kissinger's secret trip to Peking, the United States lifted the trade and payments embargo that had been in effect on the Chinese People's Republic ever since 1949. The move followed a number of lesser measures of relaxation taken from 1969 onward, and of course set the stage for the Kissinger visit and President Nixon's trip in February 1972. In the Shanghai Communiqué, the two nations agreed "to facilitate the progressive development of trade between their two countries."
Roughly four years after these dramatic events, it is a good time to take stock of the trade aspect of the Sino-American relationship. For it has followed a course few, if any, would have predicted in 1971. On the import side, to be sure, there has been the slow and gradual upward trend that seemed logical, from both political and economic standpoints, for the trade pattern as a whole. But U.S. exports to China have been a different story, rising much more rapidly in 1973 and 1974 than anyone had forecast-so much so that America became, next to Japan, China's most important supplier. Then, in the current year of 1975, exports have been dropping back so sharply that it now looks as though total trade both ways will be less than half the levels of the two previous years. As shown in Table I, these divergent export and import trends have also produced very wide fluctuations in the Sino-American trade balance, which rises from a 2:1 ratio in our favor in 1972 to almost 12:1 in 1973 and then (based on current projections) reverts to less than 2:1 in 1975.
U.S.-CHINA TRADE, 1971-1975
(in millions of U.S. dollars)
1971 1972 1973 1974 1975
U.S. Exports 0.0 63.5 739.7 820.5 250
U.S. Imports 4.9 32.4 63.9 114.7 150
Total Trade Turnover 4.9 95.9 803.6 935.2 400
Why these drastic fluctuations? Are we seeing here the renewed impact of political factors, especially on the Chinese side? Or are there serious disabilities, partly political and partly economic, that account for the United States being only a residual supplier of grain to China, and only a minor source for the industrial plants that China has been purchasing since 1972?
These are central questions for the current and future state of Sino-American relations generally. But before one can provide reasonable answers one must look at the foreign economic policy of the People's Republic as a subject in itself. For the cumulative evidence of the last four years clearly shows that in this period China has not only embarked on a major shift in her foreign policy, including the separate rapprochements with the United States and Japan, but has adopted far-reaching changes in her trade policy and indeed in her whole outlook toward close economic relations with foreign countries. The nature, depth, and permanence of these changes are vital elements in any estimate of the future policies of China under the successors to Mao Tse-tung and Chou En-lai.
The fall of Lin Piao in September 1971-and his death in an airplane crash between China and Russia-marked the culmination of a period in which the role of the military in China had been very much enlarged. With the virtual disintegration of the Party apparatus during the Cultural Revolution (1966-68), the Army was called upon to perform many Party roles and to serve as the cement holding the polity and economy together.
This enlarged political role of the Army was reinforced by rising Sino-Soviet tensions, aggravated by the enunciation of the Brezhnev Doctrine and the Soviet invasion of Czechoslovakia in 1968. The perception of a grave Soviet threat apparently spread and gained increasing credibility in China thereafter. The accumulated tensions then exploded in the Chenpao (Damyanski) Island incident of March 1969, leading to large-scale border clashes between Soviet and Chinese troops along the Amur river border. All these developments combined seem to have then prompted a rapid rise in military outlays between 1969 and 1971.
However, during 1971, it appears that the Chinese leadership must have engaged in a fundamental reappraisal of its internal and external policies. In part, of course, this reappraisal must already have been under way, as shown by Mao's interview with Edgar Snow in December 1970 in which he indicated that Nixon would be welcome to visit China "either as a tourist or as President."1
Perhaps most notably, the steep rise in military expenditures was not only halted but reversed, so that since 1972-according to analyses recently published-Chinese military expenditures may have declined by as much as 25 percent measured in constant dollars.2 Never formally announced by the Chinese leaders, the reasons for this abrupt change can only be surmised: one, quite possibly, was that the perception of a Soviet threat seemed less acute. With the reopening of relations with the United States virtually assured after the Kissinger trip, Chinese policy-makers may have begun to rely implicitly and tacitly at least on American deterrence to check incipient or overt Soviet expansionist tendencies in Asia.
Internal needs and developments must also have contributed to the shift in the allocation of resources. As the Party was being reconstituted in the post-Cultural Revolution period, it was once more bidding for supremacy of control over all institutions including the Army. Shrinking military expenditures would necessarily involve some reduction in the Army's control over resources. At the same time, the Cultural Revolution-engendered disruptions had led to a decline in the nonagricultural sectors of the economy, and there was also an accumulated backlog of investment forgone during this period. These deficiencies had been made more critical by the 1969-71 subordination of economic requirements to military claims on resources.
It seems probable that debate on these issues was acute while Lin was still alive and in good standing, and that he himself was deeply involved. Whether his fall reflected or triggered a denouement we shall perhaps never know. In any case, the full thrust of a new line of policy began to emerge after his death.
Basically this new line raises the priority ranking assigned to sustained and long-range economic development. It has been evidenced in the decisions taken by the Chinese leadership and in the large number of new projects launched since early 1972, and was most clearly, explicitly, and authoritatively enunciated recently in Premier Chou En-lai's Report on the Work of the Government delivered at the National People's Congress in January 1975. In this speech he sketched out his hopes for China's future economic development, speaking of turning "a poverty-stricken and backward country into a socialist one with the beginnings of prosperity in only twenty years and more." Before the end of the century, China "is to accomplish the comprehensive modernization of agriculture, industry, national defense and science and technology so that our national economy will be advancing in the front ranks of the world."3
The full sweep of actions under the new development policy need not detain us here. From the standpoint of foreign economic policy, the key point is that the leadership appears to have recognized from the outset that the central elements in the new policy-increased investment, stress on more fertilizer production and other agricultural assistance, and advanced technology generally-inevitably called for increased imports of capital goods and even of some capital. And the leadership could not proceed very far along this road without coming into conflict with the more or less autarkic Chinese foreign trade policy that had dominated the 1960s.
Since 1949 Chinese policy-makers have in effect pursued three different foreign trade policies. In the 1950s they followed an open and active foreign trade orientation. China's foreign trade grew at an average annual rate of 15 percent (in real terms) between 1952 and 1959, much faster than GNP, so that in a literal sense the Chinese economy was becoming more rather than less foreign-trade oriented.4 Foreign trade was leading growth in an economy in which it necessarily constituted a quite small sector. And, in particular, the Chinese economy became heavily dependent on the Soviet Union; foreign trade expansion meant primarily a rapid growth in commercial exchanges with the U.S.S.R. and Eastern Europe.
About 1960 this trade policy was reversed, and the Chinese turned to a policy of "self-reliance," interpreted at that time as import minimization. The triggering event was, of course, the rising Sino-Soviet tension that led to the sudden withdrawal of Russian technicians in 1960. A number of complete plant projects had to be left standing in an unfinished state for years, and there was a significant delay in the Chinese nuclear program and a disruption in the weapons procurement process. Faced with these consequences of the Soviet withdrawal, the Chinese apparently resolved not to become dependent again on any foreign country.
The withdrawal of Soviet technicians happened to coincide with the onset of a deep economic depression (1960-62) in the wake of the failure of the Great Leap Forward. This depression forced the Chinese to cut back exports, thus reducing their earnings of foreign exchange. Therefore imports had to be curtailed sharply. At the same time the economic decline led to large cutbacks in investment and to an attendant shrinkage of machinery and equipment imports. Concurrently, the scarce foreign exchange had to be husbanded for financing grain imports needed for filling part of the gap left by a succession of poor harvests. Thus China's economic growth rate was significantly reduced in the 1960s, and the combination of slow growth and autarkic trade policy naturally produced a stagnation in foreign trade levels.
THE FOREIGN TRADE OF THE CHINESE PEOPLE'S REPUBLIC, 1950-74.
(in millions of U.S. dollars)
Year In current prices In constant 1963 prices
Exports Imports Exports Imports
1950 620 590 NA NA
1951 780 1,120 NA NA
1952 875 1,015 795 1,005
1953 1,040 1,255 995 1,295
1954 1,060 1,290 930 1,345
1955 1,375 1,660 1,295 1,715
1956 1,635 1,485 1,560 1,555
1957 1,615 1,440 1,530 1,380
1958 1,940 1,825 1,940 1,825
1959 2,230 2,060 2,315 2,085
1960 1,960 2,030 1,920 2,070
1961 1,525 1,490 1,540 1,520
1962 1,525 1,150 1,585 1,180
1963 1,570 1,200 1,570 1,200
1964 1,750 1,470 1,685 1,435
1965 2,035 1,845 2,005 1,785
1966 2,210 2,035 2,155 1,915
1967 1,945 1,950 1,930 1,840
1968 1,945 1,820 1,920 1,735
1969 2,030 1,830 1,920 1,690
1970 2,050 2,240 1,865 1,890
1971 2,415 2,305 2,180 1,880
1972 3,085 2,835 2,570 2,115
1973 4,895 4,975 3,000 2,760
1974 (preliminary) 6,305 7,410 2,765 3,165
SOURCE: Nai-ruenn Chen, "China's Foreign Trade, 1950-74," in China: A Reassessment of the Economy, p. 645.
As may be seen in Table II, China's foreign trade peaked in 1959 and thereafter exports and imports fluctuated around a more or less stable level until 1972. Foreign trade lagged behind growth so that the economy was becoming less foreign-trade oriented. The trade share of GNP dropped from an estimated 8 percent in the 1950s to perhaps around 5 percent for Chinese exports and imports combined. This compares with 7 percent for the United States, 15 percent for India, 18 percent for Brazil, and 22 percent for Japan, with much higher ratios for small countries. Thus even by the standards of the large continental economies, China's trade ratio was (and still is) low.
This autarkic policy of the 1960s was apparently relaxed, on present evidence, in 1971 or 1972. While the Chinese continue to speak of "self-reliance," more and more it has become evident that the slogan has been reinterpreted. Apparently, it no longer means minimizing imports. On the contrary, it implies a much more open foreign-trade orientation. To the extent that "self-reliance" still has any of its old meanings, this may be in the sense of seeking to minimize the country's foreign financial dependence. The Chinese have repeatedly stressed that they are not interested in foreign credits, and are not prepared to accept these. China's foreign trade must be self-financed and, in principle, should be constrained by the country's ability to export and earn foreign exchange. We shall see later whether even this principle has been strictly followed in actual practice.
China's new international economic policy became visible in several quite dramatic ways. Foreign trade was expanded very rapidly, a large program of importing complete plants was launched and a most substantial expansion of oil production and exports was decided upon. At the same time, major commitments have been made to developing the whole foreign trade infrastructure, that is, port facilities, shipping, pipelines, railways and aviation.
As noted before, China's foreign trade contracted very sharply in the early 1960s, reaching its low point in 1962. It then nearly recovered to 1959 levels by 1966, only to experience a setback due to disruptions engendered by the Cultural Revolution. By 1971 foreign trade not only started to recover once again but was clearly following a vigorous expansionary path. As a result, former peak levels were finally exceeded in 1972. This was followed in 1973 by a dramatic 35 percent rise in imports and a 15 percent increase in exports, representing a sharp spurt in total trade turnover, all expressed in real terms. The marked rise-particularly in imports-resulted from greatly stepped-up purchases of capital equipment, industrial materials and grains, to fuel the invigorated development program on the one hand and to fill the food supply gap on the other. The last was an emergency action probably outside the original plans; we shall come back to this in the context of Sino-American trade relations.
An ambitious plant import program was initiated in late 1972, with the first contracts signed in December of that year. This involves sales to China of complete factories and power plants, with the buildings constructed by the Chinese. Machinery and equipment are transported to China, to be installed with the assistance of foreign technicians, who also help in the training of engineers and other operational personnel charged with running the plant. Between December 1972 and the spring of 1975, the Chinese entered into approximately 45 contracts for the purchase of about 100 complete plants valued at around 2.2 to 2.5 billion U.S. dollars.5
This is clearly a very massive program which will greatly augment China's present production capacity, particularly in steel, petrochemicals, chemical fertilizer and electric power generation, the industries in which most of the purchases are concentrated. The scope and importance of the program can perhaps best be gauged in comparison with plant imports from the Soviet Union and Eastern Europe in the 1950s. Building on foundations previously laid and representing the core of the first five-year plan, that earlier program went a long way toward creating China's present industrial base; in terms of 1973 prices it was a three-billion-dollar program first conceived about 1950 and executed over the period roughly from 1953 to 1960, at an average annual rate of delivery of about $430 million. By comparison it now appears that virtually all the plants bought between late 1972 and early 1975 will be put in place over a three-year period, between 1975 and 1978, representing an annual delivery rate of about $700 to $800 million. Therefore on an annual basis the present program is much more intensive than the complete plant imports of the 1950s, although in the aggregate it is still about 25 percent smaller.
If the program of importing complete plants bears a significant resemblance to Chinese undertakings in the 1950s (except, of course, as to source), the second striking feature of post-1971 trade policy-China's increasing role as an oil exporter-is entirely new and original in Chinese economic history. Until the 1960s it was generally thought that China was poorly endowed with oil resources. Indeed, Chinese crude oil production was quite small and the country was dependent on imported supplies of petroleum and its products, mostly from the Soviet Union. As part and parcel of the self-reliance policy and to free themselves from dependence on the Soviets, the Chinese then embarked on a most active program of geological exploration. As a result, sizable deposits were discovered in North and Northeast China, the Pohai Gulf, and offshore along the continental shelf.
Although the Chinese have said little to this day about the scope of these discoveries, their impact became apparent in a small way even in the mid-1960s when the Chinese ceased to have to import oil. By the early 1970s China was exporting small marginal quantities, and the leadership must have been aware that it had, in oil, a major potential asset that could transform China's capacity to earn foreign exchange. It is intriguing to speculate on the weight this revelation may have had in setting the new overall policy; what is clear is that the Chinese have for some years been making the heavy investments-in exploration and drilling, and now in shipping-required to develop and sell their oil in quantity abroad.
Thus, in recent years, we have seen a dramatic rise in Chinese oil production and especially in exports. Total output, a mere 5 million tons a year in 1961 (or 100,000 barrels per day), has now been estimated at 54 million tons in 1973 and 65 million tons in 1974. (By comparison, Indonesia's 1974 production was 70 million tons.) And in 1974 exports of oil first became a substantial entry in the Chinese trade ledger; between 5.5 and 6 million tons were exported, and the return to China was around an estimated $500 million, or approximately 8 percent of China's total export earnings. The bulk of the 1974 shipments went to Japan, about 500,000 tons were destined for the smaller countries of Asia, and 1 to 1.5 million tons went to North Korea and North Vietnam.6
The best present estimate is that in the current year, 1975, Chinese oil exports will rise to 10 million tons (or 200,000 barrels per day). Japanese energy planners, perhaps the best-informed foreigners on the subject, currently project Chinese oil shipments of 30 to 50 million tons to Japan by 1980. Should these materialize they would provide about 10 to 15 percent of Japan's oil import requirements.7
Actually in projecting China's oil export capabilities and Japanese purchases of this oil over the next five to ten years, a number of complex factors must be taken into account. As indicated above, China's 1974 oil production was estimated at 65 million tons (or 1.3 million barrels per day). There seems to be a fair degree of consensus among oil industry and energy specialists who have followed Chinese developments that 200 million tons may be a reasonable production estimate for 1980. This is projected on the assumption that output will grow at an average rate of 20 percent per year and that virtually all of it will come from fields in which drilling is already under way.
These fields are preponderantly onshore, with some drilling anticipated in the shallow waters of the Pohai Gulf, close to shore. To attain these production levels will require additional investment in drilling facilities, pipelines, and harbor facilities so as to get the oil transported. On present indications, these investments do not seem to be beyond China's capabilities either in terms of the resources or technology required.
This process could be greatly accelerated if the Chinese wished to commit themselves to rapid development of offshore drilling. Correspondingly, it could be slowed down if the necessary investments for further expansion of onshore drilling and for transport were not sustained. At present the development of oil production is clearly assigned top priority along with food and steel, as was underlined again this spring by Vice-Premier Teng in a meeting with a group of American newspaper editors. One can of course never rule out the possibility that these priorities may be altered, but barring a major political upheaval or economic disaster this is not too likely over the next few years.
Quite powerful economic and foreign policy considerations converge in support of a high priority for the development of the petroleum industry. Rising oil exports can greatly augment China's foreign exchange earnings. At the same time they can minimize Japan's inducements to invest in the development of Siberian oil resources, thus also diminishing Japan's interest in seeking closer economic and political links with the Soviet Union. However, China's interest in the development of her oil resources has at least up to now not gone so far as to encourage a large-scale program of offshore exploration and drilling. Given the highly complex technology involved, such a program would require some form of technical assistance by major international oil companies, apparently on terms which are not compatible even with China's liberalized self-reliance policy. Therefore, on the basis of present indications, the Chinese prefer to embark on this effort by themselves, purchasing the drilling rigs, other equipment and technical assistance abroad as needed but managing the whole enterprise themselves. This will necessarily be a slower development, but in the light of the considerable potential for onshore exploitation in the next five years at least, there is no great pressure on them to accelerate the offshore program.
This analysis of China's oil export potential has thus far only considered factors bearing on supply availability. What about the character of demand and markets for this oil? Given Japan's geographic proximity and almost total dependence on imported oil, she can be justifiably viewed as the most natural or logical outlet for China's surplus. Nevertheless, there are a number of conflicting considerations that must be taken into account in assessing China's prospects in the Japanese oil market.
First of all, Chinese oil has certain peculiar characteristics. Some of it is of low quality (e.g., Shengli oil), primarily suitable for burning as fuel. This does not apply to most of the exported product, which has a low sulphur but high wax content and leaves a heavy residue after refining-quite similar to Indonesian but different from Middle Eastern oil. Since Japanese refineries are largely geared to processing Middle Eastern oil, Chinese oil presents special problems and requires special refining equipment or devices. Therefore the market for this type of oil is limited and must be shared with Indonesia.
Since the Japanese have a strong interest in maintaining close links with Indonesia, they consider it most important to continue importing sizable quantities of oil from there. Necessarily this then constrains the demand for China's oil in Japan. The problem is further complicated by shipping bottlenecks-specifically the inability of Chinese ports to accommodate large tankers so that most of the oil has to be shipped in smaller bottoms which drives up the transport costs. However, there are several counteracting factors at work. Viewed from the perspective of the Japanese government, an important national objective is to diversify the country's sources of oil supply and thus minimize the risks attendant upon primary dependence on Middle Eastern oil. Therefore from the standpoint of long-run energy policy, there is a strong incentive for the Japanese government to subsidize the importation and refining of Chinese oil, and in fact various schemes designed to accomplish this are under active consideration.
There is also a serious concern that unless the Chinese can find an outlet for their products, they will not have the purchasing power required to buy Japanese machinery, equipment and other products. In these terms, too, Chinese oil imports are much more welcome than textile shipments which compete directly with Japanese textile manufactures. Finally, political considerations reinforce the economic factors cited. There seems to be a strong and deep commitment in Japan today to develop closer links with China and to use trade as perhaps the most important avenue for building a long-term relationship between these two neighbors.
Thus, what may be emerging in China's foreign trade is a new pattern. As Table III shows, until recently China has been selling agricultural products (including rice) and textiles, the proceeds of which are used to purchase wheat, some other grains, chemical fertilizer, machinery and a variety of other products. However, the Chinese have experienced increasing difficulties in placing their cotton textiles, silk and some other products in recent years, and this in turn has placed definite constraints on the level of trade.
COMMODITY COMPOSITION OF CHINA'S TRADE, 1966 AND 1973
1966 1973 1966 1973
Foodstuffs, of which 26 20 Foodstuffs, of which 28 33
Grains (20) (17) Animals, meat & fish (10) (10)
Crude materials, fuels Grains (7) (11)
and edible oils, of which 17 20 Fruits & vegetables (5) (5)
Rubber (4) (3) Crude materials, fuels
Textile fibers (7) (8) and edible oil, of which 22 18
Chemicals, of which 12 9 Oil seeds (4) (2)
Fertilizers (8) (4) Textile fibers (5) (6)
Manufactures, of which 45 50 Crude animal materials (4) (3)
Textile yarn & fibers (2) (1) Chemicals 4 5
Iron and steels (11) (19) Manufactures, of which 42 44
Nonferrous metals (3) (8) Textile yarns & fabrics (14) (16)
Machinery and Clothing (8) (6)
equipment (22) (17) Iron and steel (4) (2)
Other 1 1 Nonferrous metals (2) (1)
Total, in percent 100 100 Other 5 1
in millions of dollars 2,035 4,975 Total, in percent 100 100
in millions of dollars 2,210 4,895
(Components may not add to totals shown due to rounding.)
Viewed from this perspective, China's rapidly rising oil production and exports provide an opportunity for breaking away from the old constraints on her trade. In effect, the new oil exports pave the way for a continued high level of imports of plant and equipment. Since these developments are quite recent they do not yet show up in the figures presented in Table III but may be expected to appear clearly in China's export and import data for 1974 and 1975. If this is in fact to be the pattern at least for the next few years, its significance is very great indeed.
Certainly this transformation in China's trading pattern must pose some political dilemmas. It could significantly augment China's involvement in the international economy, and thus expose the Chinese economy to the vagaries and uncertainties of the world market-as we shall see was amply demonstrated in 1974. An enlarged international sector may also entail more contact between foreigners and Chinese businessmen, officials, technicians, scientists and others. One of the prime avenues for extensive contacts is provided by the complete plant program. For instance, the construction of the large steel complex in Wuhan-being jointly installed by DEMAG and Nippon Steel-will require the presence of 20 German and 200 Japanese technicians in China and a six-month stay for training by Chinese in Japan. There will be approximately 250 to 300 Americans engaged in the installation of eight fertilizer plants, with perhaps a maximum of 100 to 120 present at any one time for periods ranging from two to fifteen months. It has been crudely estimated that a total of 2,000 to 3,000 foreign technicians will be stationed in China between 1974 and 1977. This then may not only bring with it transfer of foreign technology, but transfer of foreign ideas, approaches and influences.
These issues have clearly been debated in the top ranks of the leadership-as evidenced by occasional attacks on the policy in the Chinese press and by periodic rebuttals and counterattacks. They have almost certainly constituted one of the foci of policy conflict between the contending groups in the leadership. Nevertheless, the course that took shape in 1971 and 1972 seems to have been followed quite consistently since, apparently with the full backing of Premier Chou and with the probable blessing of Chairman Mao.
The development of oil resources and the rapid expansion of foreign trade imposed very heavy strains on China's port and shipping facilities. In 1973 and the first half of 1974, the China trade was replete with complaints of port congestion, long turnaround time for ships, shallowness of ports so that large tankers could not use the harbors, and poor bulk loading and unloading facilities. Given the character of Chinese ports, Chinese oil is shipped in 20,000- to at most 30,000-ton freighters rather than 100,000- to 200,000-ton tankers. This necessarily raises transport costs and reduces somewhat the competitiveness of Chinese oil as compared with other sources of supply available to Japan. At the same time, lack of container port and bulk handling facilities has slowed down the delivery of grain, iron ore and a number of other products.
Against this background, Chinese planners have allocated substantial resources to correct this situation. A major effort is under way to deepen the ports, and in this connection large orders for port dredging equipment have been placed abroad. The Chinese are also building a major container port near Tientsin and possibly in one or two other harbors, and an offshore oil loading facility is being built near Dairen which will accommodate large tankers. An oil pipeline network is under construction in North and Northeast China, with a long spur from the Taching oil field to the port of Chinghuangtao and another running from this port to a refinery on the outskirts of Peking completed recently.
Finally, as part and parcel of this effort to create the necessary infrastructure for the support of a foreign trade expansion program, the Chinese have invested heavily in expanding their merchant marine. Since 1971 or 1972 they have added about 1.5 to 2.0 million tons to their shipping fleet, about 1.1 million of which consists of 64 secondhand ships mostly bought from Japan, Norway, Poland and Yugoslavia.8
China embarked on her new foreign economic policy at a time when the world economy was experiencing a boom. The opening of relations with the United States, the entry of the People's Republic into the United Nations, and the normalization of relations with a number of countries, all occurred while the world economy was rapidly expanding. In these circumstances-and even before oil came into the picture-the climate was favorable for a significant increase in China's traditional exports which then could be used to finance the increasing imports needed to meet new development priorities.
Expansion of imports was also facilitated by China's readiness to accept what were in effect intermediate-term credits-typically up to five years. These took the form of deferred-payment schemes, through suppliers' credits financed by commercial and government banks and in most cases government-guaranteed. Willingness to accept these forms of financing was another manifestation of the more open economic posture since 1972, although the Chinese had entered into similar arrangements on a much more modest scale with West European manufacturers in the early 1960s.
The advent of the world recession and the concomitant "slumpflation" in late 1973, however, confronted the Chinese with an entirely new and unprecedented situation. In the 1950s, when China's trade was likewise growing very rapidly, it was expanding primarily within the context of guaranteed markets, defined through bilateral agreements between the Soviet Union and East European countries on the one hand and the People's Republic of China on the other. Then, in the 1960s, when China started to reorient her trade after the Sino-Soviet break, China's total trade was sluggish, while the world economy and world trade were expanding rapidly. Therefore, the Chinese had no difficulty in finding markets for their goods. Moreover, during the 1960s world market prices were reasonably stable so that Chinese planners could pretty well forecast their foreign exchange earnings and requirements. They could then plan for a balance-of-payments equilibrium, usually with a small surplus.
As world inflation gained momentum in the early 1970s, the prices of China's imports were rising along with the volume of imports and thus the total import bill was increasing rapidly. For a time this was compensated both by higher prices that could be charged for the country's exports and by the quantitative increase-as noted earlier, the volume of exports rose by about 15 percent (in real terms) in 1973.
However, in 1974 the world situation became one of widespread and deep recession linked with double-digit inflation. As a result, Chinese trading corporations found it quite difficult to place their traditional exports. This was most pronounced in textiles, but by no means confined to it. Thus, Chinese sales to Hong Kong in 1974 were about 22 percent below 1973 levels if one adjusts for price increases. And while total Chinese exports to Japan rose in 1974 with the surge of oil, non-oil exports declined by about a quarter.9 Since about 30 percent of China's exports go to Japan and 20 percent to Hong Kong, the impact was serious.
All told, China's exports may have declined by about 10 percent in 1974 if expressed in real, quantum terms. On the other hand, import schedules designed in 1972 had created a momentum which carried forward well into 1974. Complete plants began to be delivered in 1974, and the demand for imported industrial materials was steadily rising. Furthermore, grain imports, greatly stepped up in 1973, continued at almost the same rate in 1974 in order to build up domestic reserves badly depleted following the inferior 1972 harvest.
Chinese planners could not and almost certainly did not anticipate the seriousness of the world recession or the resulting decline in Chinese sales. Consequently they apparently did not slow down the pace of import orders until the latter part of 1974. Thus, in spite of belated corrective measures, the 1974 trade deficit turned out to be about one billion U.S. dollars, by far the largest incurred by the People's Republic in its 25-year history.
However, this may be expected to be a short-term phenomenon. In 1975 and 1976 Chinese planners may be expected to scrutinize imports more carefully than they did in 1973 and 1974. But a sizable share of imports are based on advance commitments, and there are strict limits to how far purchases from abroad can be curtailed without slowing down domestic investment and the pace of development. As the world economy gradually pulls out of the recession, China's traditional exports-mostly agricultural and textile products-may once more find somewhat readier markets. Most importantly, year by year China's oil exports are rising very rapidly and this will almost certainly reestablish the country's trade balance while providing greatly enlarged foreign exchange resources.
In the meantime how are the Chinese financing their trade gap? The measures taken perhaps represent the clearest illustrations of the new and reinterpreted self-reliance policy. One of its most explicit formulations is the following statement by Vice-Premier Teng Hsiao-ping in October 1974: "Only self-reliance is a sure-fire method. Why is there world inflation, with only the Renminbi [People's currency or yuan] not likely to be affected? Because of our reliance on our own resources. We now also accept installment payment terms for machinery from abroad but only in the knowledge that we are capable of making regular payments. We must remain free from debts, both at home and abroad, and go not further than that."10
Clearly short-term and medium-term indebtedness is considered compatible with the self-reliance policy provided it is not labeled credit and in its overt form comes from a commercial supplier in the form of deferred payment rather than a bank or a government finance agency. In implementing this policy, the Chinese have used a number of expedients to cover the large trade deficit of 1974 and a smaller deficit in 1973. In this process, the Bank of China has greatly expanded its operations in recent years and has become very active in international financial markets.
A whole variety of devices have been used either to defer payments for goods received or to obtain foreign exchange to pay for them. These range from quite short-term 30-day suppliers' credits to 5-year deferred-payment schemes linked to complete plant deliveries. Even during the 1960s, when a quite strict self-reliance policy was pursued, the Chinese purchased grain on 12- and 18-month installments from Australia and Canada respectively. More recently, the massive purchases of grain from the United States in 1973 and 1974 were financed by 12- to 18-month credits extended in large part by American banks operating through foreign or multinational banks.
This spring a contract was signed for the purchase of 1.5 million tons of steel from Japan, to be delivered within six months and paid for over a 12-month period. This was the first time that a deferred-payment scheme was used for steel shipments to China. In the last year or two the Chinese have also greatly stepped up their reliance on short-term financing of deliveries in virtually all commodity categories. These involve commercial credits ranging from 30 to 180 days. In addition, a number of West European and Japanese banks have been invited to place foreign currency deposits in the Bank of China. Apparently these deposits are for periods up to one year, renewable year by year. They are placed at Eurodollar rates or at rates approximating these, and they may have totaled several hundred million dollars in 1974. They could be considered as loans in disguise.
There are unconfirmed reports that the Chinese have sought and obtained a large three-year loan financed by an international banking consortium. There have also been occasional rumors that Iran and possibly one or two Arab countries may have extended substantial and rather long-term credits to the Chinese. While this cannot be ruled out, it is improbable since it would represent a radical departure even in terms of recent Chinese policy and practice, at least in form and principle.
Will the Chinese relax their practice on foreign credit still further? Or may they swing in the opposite direction, tightening up and reverting to past standards? At this writing there is little evidence or basis for judgment, though one can sense that the steadiness of recovery in major Chinese markets will weigh heavily in deciding the direction of Chinese policy, as will the future direction of the country's foreign and domestic policies as a whole in a post-Mao/Chou era. The Chinese will not lightly repeat the 1974 experience, but with the growth of oil exports there is little reason to anticipate that they would need to run that risk, unless the world demand for oil is drastically curtailed or the OPEC cartel collapses within the next five years. Barring these contingencies, Chinese earnings should be adequate to finance a substantial development program, at least by past Chinese standards. If there should be a significant expansion in foreign borrowing, it would suggest a whole new degree of commitment to a markedly accelerated program of domestic economic development and a complete abandonment of the self-reliance policy-with far-reaching internal political implications.
It is time now to come back to Sino-American trade and to the questions that surround it. It was purely fortuitous that a foreign policy reorientation, the crystallization of a new foreign economic policy, and the opening of relations with the United States coincided with a poor harvest year in China. Yet this particular combination of circumstances goes a long way toward explaining the peculiar pattern of Sino-American trade referred to at the outset.
China's new foreign policy and the opening of Sino-American relations were a necessary precondition for Chinese imports from the United States. These would have been precluded as long as our China policy was based on containment and isolation. The absence of any trade served both as an illustration and as an embodiment of our China policy between 1951 and 1971. Concurrently China's new foreign-trade policy, a more relaxed attitude toward credits and deferred payments, and the generally more active foreign-trade orientation discussed in preceding sections may have encouraged Chinese planners to permit the accumulation of sizable trade deficits if need be-something they would have tried to avoid at all cost in years past.
With these considerations in mind, Chinese foreign-trade planners had apparently very little reason to hesitate in placing purchase orders in the U.S. market once a clear need could be demonstrated. In these terms, the sharp rise in U.S. exports to China in 1973 and 1974, and the subsequent drop in 1975, can be explained summarily as follows: whereas U.S. trade benefited very greatly from China's need to remedy the effects of the bad 1972 agricultural harvest, the United States from the outset had only a very limited share in Chinese purchases of capital goods, especially complete plants. And, when the boom in U.S. farm exports broke, not only was there no steady rise in industrial exports to take up the slack but even in the agricultural area the United States found itself relegated to the role of a residual supplier not needed in normal times.
Take first the situation in sales of complete plants. Out of the approximately 100 complete plants purchased by the Chinese between late 1972 and mid-1975, only eight are American, and these account for $200 million out of a total program of about $2.5 billion. Therefore the U.S. share is about eight percent in terms of both numbers and value. By far the largest supplier is Japan, followed by the West European countries as a group. The same picture presents itself in relation to machinery and equipment purchased by China outside the complete plant framework. It is not surprising therefore that in 1973 and 1974 only 10 to 15 percent of our sales to China comprised industrial materials and equipment.
Needless to say this has been contrary to all earlier forecasts and expectations, which suggested that the United States would become a major supplier of capital goods to the People's Republic. How can one explain the poor performance of our capital goods sector in the China trade? No doubt the Japanese enjoy certain advantages in terms of geographic and cultural proximity, a long experience of trading with the P.R.C., perhaps a more aggressive pursuit of the China market, and certainly in some fields at least a competitive edge in terms of costs. However to this list must be added another most important factor which distinguishes the Japanese and U.S. situations: there is no obstacle in Japan to complete plant sales on a five-year deferred-payment or credit basis.
These credits are directly or indirectly Japanese Export-Import Bank financed at a six percent rate of interest.11 In effect this means it is government-financed at subsidized interest rates. Under present circumstances this type of financing could not be pursued in our case for several reasons. There are institutional, corporate and individual claims by Americans against assets confiscated by the P.R.C.; correspondingly, Chinese holdings in the United States were frozen at the time of the Korean War. There is some evidence to suggest that though the United States has sought to resolve these claims-assets issues separately, the Chinese may wish to tie their settlement to full normalization of relations. In turn, until the claims-assets question is settled, U.S. Export-Import Bank financing is probably barred by law. In this sense, then, the absence of formal relations places U.S. exporters of machinery, equipment and complete plants at a disadvantage.
Given the slow growth of our capital goods exports to the P.R.C., the volatility of our trade-dramatic rise followed by sharp curtailment-is entirely due to the marked fluctuations in our sales of farm products to China. The rise in our China exports from about $63 million in 1972 to $740 million in 1973 was due preponderantly to increases in agricultural sales-both in 1973 and 1974 about 80 percent of our exports to China were agricultural. Why are these then dwindling in 1975? This question can only be illuminated through a brief analysis of China's grain import demand.
Through the 1950s China was a net exporter of grains, primarily rice. This trend was reversed under the impact of the acute agricultural crisis between 1959 and 1962. Consequently China began importing large quantities of grain in 1961, primarily from Australia and Canada and secondarily from France and Argentina. At first they imported about 6 million tons of grain annually, mostly wheat. This then declined somewhat and since the mid-1960s purchases have fluctuated between 3 and 5 million tons. At the same time they resumed rice exports, although these did not match the grain imports in terms of quantity or value. Then, in 1973, China's grain imports (wheat and corn combined) increased from 3.4 million tons in 1972 to a record of 7.3 million tons, dropping back only slightly to 6.9 million tons in 1974. They are now expected to drop to 5.5 million in 1975. In 1973-74 the Chinese also stepped up their imports of other farm products, notably soybeans and cotton, again reflecting harvest fluctuations.
Canada and Australia had been China's traditional suppliers of grain. However when China rapidly raised her requirements just at a time when U.S.-China relations were opened, she looked to the United States to meet the greatly increased demand; in a tight world grain market it is improbable that Australia and Canada could have provided the additional quantities. Then, when import orders were curtailed following a good 1974 harvest, China reverted to her traditional sources of supply in 1975, treating the United States as a residual supplier of agricultural products and thus sharply reducing purchases here.
However, this account does not appear to explain fully why, when China curtailed her farm import orders, the whole burden of reduction was shifted to the United States, and not equally distributed among Canada, Australia and the United States. There is no question that there were quite serious quality problems with the wheat, corn and soybeans supplied by the United States. Moreover, China has three-year wheat import agreements with Australia and Canada and not with the United States. Yet, these considerations do not seem an adequate explanation, nor do they apply at all to the 1975 cancellation of raw cotton orders from the United States, particularly since China continued to import cotton from other sources. Therefore it would not be unreasonable to assume that the lack of formal diplomatic recognition constituted an additional reason for the cancellation of contracts. It is more than probable that, in anticipation of President Ford's visit later this year, the Chinese wished to indicate to the American government and business community that full normalization of diplomatic relations is a necessary precondition for wholly normal and sustained trade relations.
The experience of other countries may be instructive in testing this proposition. As shown before, China's foreign trade rose rapidly after about 1970 under the combined impact of domestic development and a more open foreign trade orientation. This was also the period during which a number of countries established formal diplomatic relations with Peking. For 14 of these there are continuous trade figures including the period since 1970. If one takes for comparison the level of exports in the year preceding diplomatic recognition and then in 1974, in the case of Canada, Japan, Germany, Italy and Spain, exports to China did not increase more rapidly (in some cases less rapidly) than total non-communist world exports to the P.R.C. over these intervals. On the other hand, nine countries exhibited appreciably faster trade growth with the P.R.C. following recognition than the non-communist world as a whole for equivalent periods. This phenomenon was particularly pronounced in the case of Australia, Belgium, Iran, New Zealand, Nigeria, Turkey and Peru. It was somewhat less so for Argentina and Mexico.
Clearly, even in these purely descriptive terms, the relationship between recognition and rate of export growth is far from conclusive. A number of complex economic and political factors govern the course of exports between any one country and China. Therefore one cannot simply pick out a single variable such as diplomatic recognition and ascribe to it alone decisive importance. However it is impossible to avoid the inference that political factors have played an important role in many cases.
The case of Australia may be of particular interest. Australian exports to China were quite significant throughout the 1960s, ranging between $100 and $200 million, largely due to wheat exports, and were around $130 million in 1970. They then dropped below $30 million and $50 million in 1971 and 1972 respectively. After the new Labor government in Australia extended diplomatic recognition to the P.R.C. in December 1972, however, exports nearly trebled in 1973 (to $140 million) and rose very sharply again in 1974, to $320 million. The inference seems plain, that the Chinese cancelled their grain purchases in 1971 and 1972 as a way of exerting pressure, reinstated them in 1973 after relations were normalized, and kept on expanding trade to other fields and commodities as well, which accounts for part of the marked increase between 1973 and 1974.
Turning to other factors, the claims-assets and Ex-Im Bank financing problems-both linked to normalization-are not the only practical obstacles to a sustained expansion of Sino-American trade. Another barrier is the absence of most-favored-nation treatment (MFN), so that a full tariff is levied on Chinese goods entering U.S. markets. According to several tentative studies, it would seem unlikely that our imports from China would increase by more than 25 percent even if the MFN barrier were removed-in 1975 from a projected level of $150 million to less than $200 million; our imports from China would still be quite low, ultimately because our market for the kinds of products the Chinese export is quite limited.
But if a change in MFN status in and of itself could be expected to have only a marginal effect on our China trade, the political significance of MFN is still substantial as a symbol of discriminatory treatment and thus of less than completely normal relations. Paradoxically, under the stipulations of the recent trade act, it would be easier to lift the MFN restrictions on Russia than on China. This act not only includes the Jackson-Vanik Amendment but a number of other stipulations, the most crucial of which makes MFN treatment conditional upon a government-to-government trade agreement. If the Russians chose to relax their emigration barriers-and thus satisfy the requirements of the Jackson-Vanik Amendment-they could reinstate the 1972 Moscow trade agreement and become eligible for MFN treatment. However, in the absence of a similar formal intergovernmental trade agreement, the Chinese would not be eligible even if they were to meet the emigration requirements of the Amendment or even if they were exempted from its requirements by the Act of Congress now proposed by Senator Mansfield. And it seems most improbable that the necessary trade agreement can be concluded in the absence of formal diplomatic relations.
In sum, a careful analysis points inescapably to the conclusion that the lack of diplomatic relations is a more serious obstacle to the further development of trade than is generally recognized. Financing problems, the claims-assets issue, and the lack of MFN status or of a formal trade agreement-all these barriers can be traced back to the question of full normal relations. And the evidence of Chinese import selectivity toward the United States underscores the point. Unless and until this basic problem is cleared up, Sino-American trade will necessarily be erratic, sharply fluctuating and devoid of a firm, systematic, and fully institutionalized footing.
1 Life, April 30, 1971.
4 Alexander Eckstein, "China's Economic Growth and Foreign Trade," U.S.-China Business Review, July-August 1974, p. 16.
7 Based on interviews with Japanese economists, government officials and businessmen in April and May 1975.
8 Based on information provided by Japanese shipping and commercial sources in interviews with the author in April and May 1975.
10 Teng made this statement at a reception of Overseas Chinese in Peking on October 2, 1974; quoted in U.S.-China Business Review, No. 1, Vol. 2, p. 34.
11 In reality the Ex-Im Bank only finances up to 80 percent of the sales value while the remaining 20 percent must be obtained from the commercial banks. Typically the Ex-Im Bank lends these funds either to a commercial bank which then finances the supplier, or it lends it directly to the latter. In either case, the Chinese deal only with the supplier of the complete plant.