Antecedents of the open-door policy

Many elements of the open-door policy, including technology imports, foreign aid, loans and investment had been accepted in Mao's era. In the 1950s, China relied heavily on Soviet loans, technicians, turnkey projects and blueprints, and at least 150,000 Chinese technicians and workers were trained in the USSR. Joint stock companies with the USSR also existed.

The importance of maintaining an economic relationship with the capitalist world was not ignored in Mao's era. For example, China recognized the importance of maintaining ties with the capitalist world through Hong Kong, and left the colony in British hands in 1949 at a time when China could easily have taken it by force. When the Korean War broke out in 1950, China imported most of her strategic supplies from Hong Kong. Although the American-led United Nations trade embargo against China (after China's entry into the Korean War) prevented a rapid development of ties with the capitalist world, China continued to export to the capitalist world through Hong Kong. Chinese imports arriving via Hong Kong dwindled because of the United Nations trade embargo; nevertheless, significant quantities of strategic supplies were smuggled into China through Hong Kong.

After the Sino-Soviet rift of the early sixties, China became isolated. The much-publicized policy of self-reliance made a virtue out of necessity and was more in line with Mao's ideology. At a pragmatic level, China re-oriented her trade from the Soviet bloc to the Organization for Economic Cooperation and Development (OECD) countries, and began to import complete industrial plants from Japan and Western Europe during the period 1962–65.

The role of Hong Kong as a trading partner is discussed broadly in Chapter 2. This chapter will examine the relative participation of Hong Kong in China's exports and imports by commodity categories. The role of Hong Kong in helping China to circumvent barriers to trade will be examined, as will the future prospects of China's direct exports to Hong Kong and Hong Kong's domestic exports to China.

Hong Kong's share in Chinese trade by commodity

Table 6.1 summarizes Hong Kong's share of Chinese exports by commodity. Chinese exports to Hong Kong are divided into exports retained in Hong Kong and exports re-exported through Hong Kong. Hong Kong does not publish statistics on the commodity composition for re-exports by country of origin, but they can be obtained from the Census and Statistics Department. Such statistics are necessary to compute the commodity composition of Chinese exports (i) retained in Hong Kong, and (ii) re-exported through Hong Kong. The many studies on the significance of Chinese exports in the Hong Kong market have unfortunately tended to estimate the commodity composition of Chinese merchandise retained in Hong Kong instead of obtaining correct data from the Census and Statistics Department; such estimates are inaccurate. In the Appendix, Census and Statistics Department data are compared with the estimates of two well-known studies, the first by Hsu (1983) and the second by Hsueh and Woo (1981).

In Chapter 2 the argument is put forward that an increasing share of China's commodity trade, tourist trade and loan syndication is handled through Hong Kong, despite the fact that China now has many more direct links with the rest of the world. This paradox is explained by a theory of intermediation, which predicts a surge in demand for intermediation as the economy is decentralized.

In this chapter, the entrepôt function of Hong Kong is examined in detail because of its empirical and theoretical importance. The theory of intermediation developed in Chapter 2 is elaborated upon and applied specifically to entrepôt trade. Alternative explanations of entrepôt trade, such as historical and cultural factors, monopoly power, and economic distortions are also examined and applied to the analysis of the China–Hong Kong connection. China's indirect trade through Hong Kong relative to its total trade is analysed in detail by country and commodity.

The function of Hong Kong as a centre of trans-shipment will also be analysed. However, the data on trans-shipment are not as detailed as those available for entrepôt trade. Hong Kong trading firms performing a purely brokerage role in China's direct trade also appear to be important, but this part of the analysis will be brief as the data are fragmentary. The role of Hong Kong as a gateway for tourists to China is covered in Chapter 2 and is not repeated here.

More than ten years have elapsed since the inauguration of the open-door policy. Commodity trade, services trade and foreign investment in China have increased by leaps and bounds, but thorny problems remain. Unsustainable trade deficits have emerged in the liberalization phase of each of the three reform cycles, and the reforms suffered setbacks as a result of administrative measures taken to stabilize the economy. The growth of foreign investment has been below expectations and symptoms of economic inefficiency abound in both trade and investment. The achievements and deficiencies of the open-door policy in the areas of trade and investment are detailed below.

The rapid increase in trade

The increase in exports and imports since 1979 has been extremely rapid. From 1978 to 1988, China's exports (imports) have grown at the average annual nominal rate of 17 (18) per cent in terms of the US dollar, increasing slightly less (more) than fivefold in the ten-year period. Due to the repeated devaluation of the yuan, the US dollar provides a more reliable yardstick with which to measure the growth of China's trade. Though the US dollar appreciated strongly against major currencies from 1978 to early 1985, this has been largely offset by its subsequent depreciation. Measuring the growth of China's trade by the US dollar or by a trade-weighted basket of currencies gives similar results over the period 1978–88 (Sung 1988:19).

The ratio of China's exports (imports) to its GDP has also risen rapidly since 1978.

More than a decade has elapsed since the beginning of Deng's open-door policy. By the standard of Stalinist economies, China has taken giant strides in institutional reforms in order to open its door: the power of foreign trade and investment has been significantly decentralized, the renminbi has been devalued substantially, a grey market for foreign exchange has been introduced, foreign joint ventures and fully owned foreign enterprises have been allowed, special economic zones have been established, and the formula of ‘one country, two systems’ has been promulgated for Hong Kong and Macau. The last two innovations are unheard-of in communist countries.

However, so far, the results of the open-door policy are mixed. Export expansion has been rapid but uneven, and the 1979–80, 1984–85 and 1988 reform drives have resulted in severe internal and external imbalances. On each of the three occasions, economic planners were forced to recentralize and adopt restrictive macro-policies. China succeeded in lessening its dependence on oil exports, but its dependence on textile exports is high and increasing. China relies increasingly on Hong Kong for marketing, re-exporting and transshipment. Service exports have boomed, especially tourism, but most foreign tourists are Hong Kong residents. Reform of the trading system has not met initial expectations, and the radical 1984 trade reforms have been only partly implemented. The existing system of trade controls is not effective and leads to many inefficiencies.

Under the open-door policy, the traditional Chinese system of foreign trade proved to be inadequate for meeting the demands of an increasing variety of economic interactions. Organizational changes and new incentive structures were thus adopted from 1979 onwards.

Prior to 1979, international trade had been monopolized by nine National Foreign Trade Corporations (NFTCs) under the control of the Ministry of Foreign Trade. The Foreign Trade Corporations operated according to mandatory plans, purchasing fixed quantities of domestic goods at fixed prices for export and importing fixed quantities of foreign goods for domestic distribution at fixed prices. All foreign exchange earnings had to be remitted to Beijing. Because the renminbi was overvalued, corporations usually incurred losses on exports but earned profits on imports. However, this was not a matter of concern since the Ministry of Foreign Trade bore the losses and siphoned off the profits.

The system enabled planners to enforce their priorities at the cost of inhibiting international trade. Buyers and sellers could only conduct business through an intermediary. This lack of direct contact between producers and end-users also obstructed the transfer of technology that usually occurs between foreign producers and endusers. Moreover, such a rigid system could not respond to rapid changes in the international market.

The first reform drive and retrenchment (1979–81)

In 1979, new central agencies for trade and investment were created by the State Council in response to the need for functional specialization in implementing the open-door policy.

The open-door policy that has evolved in China since the death of Mao Zedong and the Purge of the Gang of Four in 1976 has had far-reaching repercussions for the Chinese economy as well as for the world economy. The open-door policy is a vital part of China's new development strategy of intensive growth — growth through adaptation and diffusion of technology, especially foreign technology. Although China imported foreign technology, including capitalist technology, in Mao's era, the novelty of the ‘open door’ is the willingness to acquire technology through foreign investment. Moreover, foreign technology is broadly interpreted to include not only technology embodied in plant and equipment, but also knowledge, including management skills and even the practices and ideas of a modern society. The traditional mechanism of ‘arm's-length’ trade cannot adequately promote the transfer of this knowledge, and consequently closer interaction with foreigners through direct foreign investment has become a central element of the new development strategy. This recognition of the importance of direct foreign investment has accounted for the willingness of the Chinese to utilize special trade and various forms of industrial cooperation agreements.

Another vital aspect of China's modernization drive is the reform and partial marketization of China's Stalinist economic system. The open-door policy and the reform drive are mutually reinforcing. The commitment to the open-door policy forces China to modify a rigid economic system to facilitate economic interaction with world markets.

The open-door policy that has evolved in China since 1979 has far-preaching implications for the Asian-Pacific region and the world. It has long been recognized that Hong Kong is the key to China's door to the outside world, and the focus of this book is on the multifaceted roles of Hong Kong in China's open-door policy. The Chinese giant reaches out to the world on the back of the Hong Kong midget, and the Chinese leadership value Hong Kong so much that they have promised, in a formal agreement with Britain, that they will preserve the capitalist system in Hong Kong for fifty years after 1997.

Since 1979, China has built numerous direct links with the outside world. Paradoxically, the shares of China's merchandise trade, tourist trade, shipping, foreign loans and foreign investments handled by Hong Kong have been rising. In this book, in order to explain this paradox, a theory of intermediation is constructed and the theory is applied to analyse the roles of Hong Kong in China's merchandise trade, tourist trade, shipping, foreign loans and foreign investments. Besides the China–Hong Kong connections in trade and investment, the reform of China's trade regime is also described and analysed in detail.

The discussion takes account of developments up to June 1990. The open-door policy suffered a severe setback as a result of the violent suppressions of the pro-democracy movement in June 1989.

In examining the role of Hong Kong in China's trade, it is important at the outset to distinguish between trans-shipment, entrepôt trade, and direct trade.

Trans-shipment means that goods are consigned directly from the exporting country to a buyer in the importing country, although the goods are transported via an entrepôt and may be temporarily stored at the entrepôt for onward shipment. Trans-shipped goods may change their mode of transportation at the entrepôt: Chinese goods, for example, are carried by train or coastal vessels to Hong Kong where they are consolidated into containers. Trans-shipped goods are not usually regarded as part of the trade of the entrepôt and they do not clear customs because they represent goods in transit and are not imported into the entrepôt.

Unlike trans-shipment, entrepôt trade is indirect trade, as imports for re-export are consigned to a buyer in the entrepôt and the buyer takes legal possession of the goods after clearing customs. These imports may then be processed before being re-exported; processing may include packaging, sorting, grading, bottling, drying, assembling, decorating, diluting, or even minor manufacturing (such as the pre-shrinking of grey cloth). According to the official definition in Hong Kong, any manufacturing process that permanently changes the shape, nature, form, or utility of the basic materials used in manufacture would turn the product into a domestic export, that is, an export manufactured in Hong Kong.

The role of Hong Kong as financier is briefly surveyed in Chapter 2 with particular reference to foreign investment and loans. This chapter analyses this aspect in greater detail and also examines Hong Kong's contribution to the development of financial expertise and financial markets in China. In addition, this chapter studies the link between Hong Kong investment and the development of export industries in China, particularly in the Pearl River delta in Guangdong.

Foreign loans

According to Chinese statistics (presented in Chapter 2), Hong Kong is the predominant source of foreign investment in China, but Hong Kong's share in total contracted loans was only 5 per cent in 1987 (Table 2.2). China's statistics, however, grossly understate the contribution of Hong Kong for two reasons. First, as is mentioned in Chapter 2, Hong Kong is the major centre of loan syndication to China. It is very difficult to trace the source of funds for such loans and the funds may not come entirely from Hong Kong banks. Second, Hong Kong banks also lend to foreign enterprises in China, and such loans are not recorded in China's statistics unless the Chinese government is involved in the borrowing. Statistics on syndicated loans in Hong Kong and Hong Kong loans to customers in China can be obtained from Hong Kong statistics.

Table 5.1 shows the liabilities and claims between the Hong Kong banking system and China.