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Front. Econ.

China (2006) 3: 311−372


DOI 10.1007/s 11459-006-0011-8
RESEARCH ARTICLE

LI Xiaoxi

A report on the development of China’s market


economy 2005

©Higher Education Press and Springer-Verlag 2006

Abstract This paper dicusses on the issue of the development of China’s


market economy from six aspects. (1) Basic Content and Conclusions on the
development of China’s market economy. (2) Further progress in building
market-oriented economy in China. (3) Assessment of the degree of market
economy development in China. (4) New progress in 2004 in developing
market economy in China. (5) A general analysis of twelve key questions
concerning market economy. (6) Resolution of the “non-market economy”
issue: a win-win option.

Keywords China, market-oriented economy, win-win option, finance, trade


JEL Classification B22 D4 D23 E5 Q21

1 Introduction

Following China’s accession to the WTO, the number of antidumping inves-


tigations initiated involving Chinese products has risen rapidly, instead of
decreasing. One of the key grounds relied upon by the initiating countries is

Received March 5, 2006

LI Xiaoxi( )
Institute of Economic and Resources Management, Beijing Normal University, Beijing
100875, China
E-mail: lxx62205058@263.net
Notes: This project was presided by LI Xiaoxi and finished by Institute of Economic and Re-
sources Management, Beijing Normal University.
312 Front. Econ. China (2006) 3: 311−372

China’s being characterized as a “Non-Market Economy (NME)”. However,


thanks to over two decades of reform and opening-up, a market economy
system has already taken shape in China. In order to contribute to the
knowledge of foreign friends with regards to China’s market economy, we
drafted the Report on Development of China’s Market Economy 2003 (here-
inafter the Report of 2003). And at the request of friends from overseas, we
recently completed the Report on Development of China’s Market Economy
2005 (hereinafter the Report of 2005). As the Report covers developments
up till the end of 2003, we compiled a supplementary report entitled the Lat-
est Developments in 2004 in China’s Market Economy. To facilitate the un-
derstanding of foreign readers, this abridged Report of 2005 incorporated the
key elements of the two afore-mentioned reports and is translated into the
English language as reference for foreign friends.
This abbreviated version of the Report contains the basic elements and
conclusions in the Report of 2005, which gives an account of the further
achievements in China’s market economy process, present the results of the
assessment of market economy degree in China and provide a general analy-
sis of some of the key issues concerning market economy. Here we must
note with emphasis that in the Report of 2003, according to our calculation,
the market economy degree in China reached 69% in the year 2001. In the
Report of 2005, we continued to apply the comparable index measurement
system and methodology and reached the conclusion that the market devel-
opment degree in China reached 72.8% and 73.8% in 2002 and 2003, re-
spectively, which once again proved that China is already a market economy
as a developing country.
It should be noted that the calculation of China’s market economy devel-
opment degree is based on the same criteria, i.e., the five criteria based on
the specific circumstances of the developments in China and developed by
drawing upon the criteria for market economy status (MES) under the anti-
dumping laws of the US, EU and Canada.

1.1 The role of the government

Issues of interest to the EU and the US include the possession, allocation and
control by government of natural, capital and human capital resources, the
control and management by government of the national economy, production
decisions (such as, who produces what in what amounts and for whom,
which involves the ownership structure, profit distribution and bankruptcy
mechanism), international and domestic trade, and intermediaries (such as
chambers of commerce and trade associations), etc. All these questions boil
Front. Econ. China (2006) 3: 311−372 313

down to the role of the government, or to be more precise, the role of the
government in the market economy and its relations with the firms. In the
final analysis, it involves such questions as who allocates the resources and
makes decisions regarding the use and pricing of resources, the government
or the market; whether the government respects and protects the right of
economic entities in their operations; whether it treats enterprises unfairly and
etc. We summed up this criterion as “rules-based government behavior”.

1.2 Rights and behavior of enterprises

The US Department of Commerce is interested in whether the government


intervenes in the enterprises making decisions concerning output quantities
and prices, whether enterprises are independent in their operations and free
to export, whether they are free in choosing their management, allocating
profits and making up for the losses, whether they are free to negotiate and
sign the terms of contracts, and particularly whether exporters enjoy those
rights. The EU is also interested in the right of the enterprises in determining
export price and volume, whether their basic accounting books are up to the
international standards, whether they have the right to financing and remit-
ting profits abroad as well as the form of enterprise ownership and progress
in SOE reforms. All these questions relate to the rights and behavior of en-
terprises. All in all, what they care about is whether the enterprises’ behavior
in their production and operations is market-based or administrative-led. We
sum it up as “liberalization of economic entities”.

1.3 The cost and pricing of input factors

The US Department of Commerce is interested in the degree of control exer-


cised by a government over the allocation of resources and whether the price
paid for inputs are market-based. The EU is interested in whether the price of
input factors is determined by the market and the authenticity of the costs of
firms. In short, they all take an interest in whether the factors of production
such as raw materials and labor are market-based. This is quite understand-
able as the price of inputs is related to the cost of products and has a direct
impact on their price, which is relevant to antidumping investigations.
Therefore, all importing countries would look carefully at the authenticity of
the costs and the rules under which the products are prices with regard to
products from an exporting country. This may be termed “marketization of
production factors”.
314 Front. Econ. China (2006) 3: 311−372

1.4 Trade environment

The EU, US and others are interested in such issues as whether transactions
are free or suppressed in both international and domestic trade, whether
market infrastructures and market legislation and judicial system are
well-functioning, whether market intermediaries are independent and what
role they play, whether enterprises are independent in pricing their products
under a country’s trade policies, how the government administers exports
and exporters and whether enterprises are free in their commercial activities.
All these relate to trade environment and conditions and we name this crite-
rion “fair trade environment”.

1.5 Financial parameters

The EU, US and others are particularly interested in whether the interest rate
and exchange rate of the investigated country are shaped by the market, if
there are differences in terms of interest rate among different enterprises,
domestic trade, foreign trade and various industries, whether financials of an
enterprise are not subject to distortions by the previous non-market eco-
nomic system, whether enterprises may remit profits or capital abroad,
whether they are free to transact in and deposit foreign exchange etc. To sum
up, they are concerned with the fairness of the formation and scope of the
two major financial parameters of interest rate and exchange rate and, further,
the reasonableness of the basis on which these parameters are established,
i.e., the financial institutions. These criteria may be summed up as “ration-
alization of financial parameters”.
It is clear that the above five factors for judging a market economy are put
forward within the context of fair trade, based on our understanding of the
modern theories and realities of market economy and by drawing upon the
market economy criteria contained in antidumping rules of the EU and the
US. We consider them to be pragmatic market economy measurements to be
used for comparisons and discussions.
We welcome comments from readers from both home and abroad, par-
ticularly those from abroad on the developments in China’s market economy.
We will adhere to an objective and scientific approach in seeking the truth,
having full exchanges and reaching consensus so as to do our part for a
comprehensive resolution of China’s “non-market economy status”, acceler-
ating the process of improving China’s market economy and advancing
non-discriminatory global trade.
Front. Econ. China (2006) 3: 311−372 315

2 Basic content and conclusions of the Report of 2005 on Development of


Market Economy in China

2.1 Basic content of the report

The Report of 2005 on Development of Market Economy in China contains


three sections, ten chapters, twelve questions and six appendices.
The introduction to the report gave a summary of the developments con-
cerning China’s market economy during 2002 and 2003, analyzed the efforts
of China and the results in resolving the non-market economy issue, ex-
pounded on the researchers’ basic views on this issue and briefly presented
the main content and views in the Report of 2005.
Section I, entitled “Latest Developments in Market Economy 2002–2003”,
has ten chapters. Following the structure of the Report of 2003, the first nine
chapters gave an empirical analysis on the latest developments in nine as-
pects of China’s market economy in 2002 and 2003, namely the reform of
government administration, operation of enterprises under market conditions,
market-based labor flow and wages levels, market-based capital transactions,
market-based land transactions, market-based trade, scale of intermediary
organizations and their market-based operations, market-based currency and
financial institutions and improvement in China’s market economy legal
framework. Chapter 10 “Measurement of the Development Degree of
China’s Market Economy” improved further the evaluation indices system
and found the market development degree of China to be 72.8% and 73.8%
for 2002 and 2003, respectively. This section, combining qualitative analysis
with quantitative analysis, lays the foundation for the entire Report.
Section II, entitled “Development of China’s Market Economy by Western
Standards”, contains altogether 12 questions. In light of the needs of both
research and negotiations, and given the European and American criteria for
MES, the Report summed up those major theoretical and practical points of
contention during the process of China’s market economy development and
particularly the questions the EU and the US have for China’s MES into
twelve questions, i.e., extent of RMB convertibility, extent of the independ-
ence of financial sectors, freedom of employees in negotiating with employ-
ers regarding their wages, the extent to which foreign investment is permit-
ted, the extent of possession or control by government over means of pro-
duction and enterprises, the extent of government regulation over enterprises
in determining their output, pricing and sales and over resource allocation,
protection of property rights and the bankruptcy law, enforcement of laws
and regulations on investment and taxation, company law and corporate
316 Front. Econ. China (2006) 3: 311−372

governance, laws on accounting and auditing standards and their enforce-


ment, the use and disposal of the assets of SOEs and other factors. This sec-
tion explained and replied to the twelve listed questions.
Section III “the Appendices” contains six appendices, including “explana-
tion of the indices for evaluating market development”, “introduction to the
economic freedom index”, “latest developments in the development of the
market economy in China’s rural areas 2002–2003” and “laws and regula-
tions promulgated or taking effect in 2002 and 2003”. The appendices may
serve as reference for comparative studies.

2.2 Basic conclusions and main features of the report

The Report of 2005 on Development of Market Economy in China made a


comprehensive analysis of the development of market economy in China in
2002 and 2003 by applying the five tests of “rules-based government behav-
ior”, “liberalization of economic entities”, “marketization of production fac-
tors”, “fair trade environment” and “rationalization of financial parameters”.
The basic conclusion is that China’s market economy was developing in both
breadth and depth during 2002 and 2003.
Compared with the Report of 2003, Report of 2005 has the following three
features.
First, the Report of 2005, though based on the results of the Report of
2003, emphasized the changes and problems that have taken place in the last
two years so that the continuity of the entire research is maintained. The
calculation by the Report of the degree of China’s market economy devel-
opment in 2002 and 2003 with the latest data, combined with the results of
2001, can reveal the development and changes in China’s market economy
during this period of time. The calculation followed the approach adopted by
the Report of 2003, thus ensuring continuity and comparability. The ten
chapters in Section I of the Report of 2005 correspond to the first ten chap-
ters of the Report of 2003 in terms of contents. However, “market-based
domestic trade” and “market-based international trade” were merged into
one chapter to better reflect the integral nature of trade activities under mar-
ket conditions, help people overseas to better understand and faithfully re-
flect the results of China’s economic restructuring efforts.
Secondly, as the Report looks at the development of China’s market
economy by Western standards and tries to respond to the questions of for-
eign governments particularly those of the leading developed countries con-
cerning China’s MES in a more direct and focused manner, the Report takes
special care to integrate its research aspects with its practical purposes.
Front. Econ. China (2006) 3: 311−372 317

Compared with the Report of 2003, a new section (Section II) was added to
examine, assess and illustrate the actual situation in China in light of each
and every MES criterion of the European and American sides. It responded
to some of the major theoretical and practical controversies concerning the
development of China’s market economy and addressed with balanced
comments some of the doubts and criticisms of Western scholars in particular.
In its analysis, the Report tried to address some of the “difficult issues”, such
as the convertibility of RMB and independence of China’s financial sectors.
Given China’s specific conditions and the way academic issues are presented
in China, in order to make the communication as effective as possible, the
Report used to the extent possible concepts and statistics that are compre-
hensible to all sides to explain the current state of affairs in China. Aided by
comparative international study and an in-depth examination of China’s ac-
tual situation, the Report gave an objective analysis of the efforts and pro-
gress China has made over the recent years in building its market economy
system.
Thirdly, as far as the analytical method is concerned, the Report is more
scientific and standardized in that it combined both quantitative and qualita-
tive analysis, and Chinese features with international standards. As usual, the
Report is based on large amounts of research and study, drew upon various
methods of research and calculation from both home and abroad, had them
improved and readjusted in light of China’s national conditions and features
so that the methodology and indices are more scientific and complete. At the
same time, it paid special attention to harmonizing the international stan-
dards for analyzing market economy development by fully absorbing the
outcomes of relevant research efforts both at home and abroad. In another
word, the issue of the development of China’s market economy should first
and foremost be viewed within the context of China while international
standards must be applied to the assessment and analysis of the degree of
such development. The Report once again assessed the market development
degree of the main components of China’s economic system. For example, it
assessed and analyzed again the consistency of the structure of government
administration and the extent of market-orientation in terms of the enter-
prises, means of production and the financial sector and, on that basis, as-
signed a value to the overall progress in China and identified the develop-
ment degree of China’s market reforms in recent years. By listing large
amounts of facts, statistics, policies as well as laws and regulations, the Re-
port gave an institutional inspection and a well-structured theoretical expla-
nation to the level of market economy in China, which corresponds with the
results of quantitative calculations. Such detailed empirical analysis has pro-
vided in a timely fashion comprehensive information for judging the devel-
318 Front. Econ. China (2006) 3: 311−372

opment of market economy in China and an objective basis for friends both
in and outside China in identifying the level of such development.

3 2002−2003: Further progress in building market-oriented economy in


China

The years of 2002 and 2003 are the first two years after China’s accession to
WTO and an important time period for China’s economic development and
restructuring. The Report of 2005 analyzed in detail the five aspects of gov-
ernment, enterprises, means of production, trade environment and financial
parameters.

3.1 More rules based government behavior

-- Government restructuring was carried out further resulting in continued


cut in government size. In 2002, the number of units under the State Council
was reduced from 40 to 29. In March 2003, the new administration cut the
figure from 29 to 28 and reduced the number of review and coordinating
agencies and interim agencies from 33 to 27. Administrative staff was cut by
a big margin with a total of 74,000 posts eliminated at the provincial level
governments, 890,000 posts or 19.4% in Party, Administrative and Social
agencies at the city, county and township levels with another 430,000 ex-
tra-budget posts cleared up. Government employees as a percentage of the
urban employed dropped from 17.86% in 1992 to 12.59% in 2003. Govern-
ment expenditure as a percentage of GDP has all along been kept at a rela-
tively low level, 12.64% in 2003 which was close to one percentage point
down from the year 2001.
-- With continued in-depth reform in the regime of administrative approval,
the number of items subject to administrative approval in the field of eco-
nomic activities has been greatly reduced. In 2002 and 2003, China achieved
initial progress in its reform aimed at canceling administrative approval sub-
jects. The State Council in October 2002 cancelled the first group of 804 is-
sues requiring approval involving 56 departments and units under the State
Council, in which 567 or 70.5% were related to regulation of economic ac-
tivities, 169 or 21% to regulation of social affairs and 68 or 8.5% to admin-
istrative and other affairs. In 2003 a second batch of 406 issues requiring
government approval were cancelled and another 82 were left for industrial
associations or other intermediary organizations to regulate. With more is-
sues removed from the approval list and the approval procedures streamlined,
Front. Econ. China (2006) 3: 311−372 319

there has been a noticeable improvement in the environment for enterprise


operations and residents consumption.
-- Government investment regime was better disciplined. The Plan for
Reforming Investment Regime was adopted in December 2003 and imple-
mented in 2004, which established the role of enterprises as the main invest-
ing entity and disciplined further government investment behaviors. In 2003,
domestic loans as a percentage of total national investment in fixed assets
rose rapidly to a record-high of 24.4%. Funds raised by the enterprises
themselves rose from 45.7% in 2002 to 47.8% in 2003. Government invest-
ment accounted for 7.02% of GDP in 2003, 2.71 percentage points higher
than in 2002, as a consequence of the changes in the macro-economic situa-
tion at home and abroad, particularly Beijing’s successful bid for hosting the
Olympics of 2008 and the need for diverting more resources to combating
SARS that required the government to step up its investment in infrastruc-
tural sectors such as transport, construction, energy and raw materials and
public services and facilities in fields of public health and medical studies.
-- Direct government intervention in production activities of enterprises
was by and large eliminated. Price subsidies as a share of GDP in China con-
tinued to go down, from 1.21% in 1992 to 0.53% in 2003 with minimal cov-
erage in terms of both scope and quantity. Products are priced in accordance
with market supply and demand. Government set the price of only 3.0%,
1.9% and 9.9% in 2003, showing a very low involvement of the government.
Total amounts of subsidies to SOEs for their losses declined from RMB
44.496 billion yuan in 1992 to RMB 22.439 billion yuan in 2003, with their
share in GDP down from 1.67% in 1992 to 0.19% in 2003. SOEs have
gradually been freed from state intervention and become independent eco-
nomic operators responsible for their own profits and losses. In addition, the
Standing Committee of the National People’s Congress (NPC) adopted in
August 2003 the Law of the PRC on Administrative Approval which speci-
fied both the role and limits for the government under market conditions.
The Provisional Regulation on the Supervision and Administration of State
Assets of Enterprises promulgated by the State Council in May 2003 clearly
characterized the relationship between the Government and SOEs as one
between investor and invested enterprises. The reform was stepped up to
transform SOEs with shares and corporate systems and involvement of
non-public capital is encouraged so as to accelerate the ownership diversifi-
cation process.
-- Restrictions continued to ease on market access to Govern-
ment-monopolized sectors. In 2002 and 2003, the Chinese Government sped
up reforms in sectors of administrative monopoly, such as power,
telecommunications and civil aviation. In December 2002, establishment of
eleven
320 Front. Econ. China (2006) 3: 311−372

new or restructured power companies was announced. Through industrial re-


structuring, China’s power industry achieved “the separation of power plants
with power grid” and competitive and open regional power markets took
form. Also in 2002, China Telecom was broken up along geographic lines
into the new China Telecom Group and China Netcom Group (CNC), two
landline telecom networks that cover the whole country. By the end of 2003,
a competitive telecom market participated in by China Mobile, China Tele-
com, China Netcom and China Unicom was put in place. The monopoly in
the civil aviation sector was also broken. Since October 2002, the General
Administration of Civil Aviation was de-linked from the carriers that used to
be directly managed by the former and three air transport groups and three
air logistics groups were established anew or by restructuring. Market access
was eased up, allowing foreign and private investment to enter into this sec-
tor.

3.2 Freer economic entities

-- Continued rapid growth of non-SOEs. In 2003, the added value created


by non-public sectors accounted for 69.0% of GDP, 2.74 and 5.63 percentage
points higher than 2002 and 2001, respectively, representing an average an-
nual growth rate of 2.82 percentage points. Fixed asset investment by
non-public sectors accounted for 63.01% of total fixed asset investment, 6.41
and 10.32 percentage points higher than 2002 and 2001, respectively, repre-
senting an average annual growth rate of 5.16 percentage points. Urban em-
ployment in non-public sectors took up 73.18% of the total urban employ-
ment, 2.09 and 5.09 percentage points higher than 2002 and 2001 respec-
tively, representing an average annual growth rate of 2.55 percentage points.
Tax revenues from non-public sectors made for 71.76% of the total tax
revenues of the country, up by 3.18 and 7.34 percentage points from 2002
and 2001, respectively, representing an average annual growth rate of 3.67
percentage points. The share of imports and exports by non-public sectors in
China’s total import and export trade was 67.06%, 5.29 and 9.58 percentage
points higher than 2002 and 2001 respectively, achieving an average annual
growth rate of 4.79 percentage points.
-- Greater market access for non-public sectors. After China’s accession to
the WTO, with the exception of few industries explicitly closed to
non-public entities (such as arms manufacturing and gold production) and a
small number of industries where access requires approval, there have been
no special restrictions on non-public entities. In line with China’s WTO
commitments, the State opened further to foreign investors such sectors as
Front. Econ. China (2006) 3: 311−372 321

banking, insurance, securities, telecom, tourism and intermediary services.


With eased market access, private businesses started to enter heavy industry
and sectors in the tertiary industry, such as financial services, education and
culture, urban infrastructure and public utilities. In 2003, another 41,081 for-
eign invested enterprises (FIEs) including those with investment from Hong
Kong, Macao and Taiwan were established in China, up by 20.22% and
57.16% on 2002 and 2001, respectively, representing an average annual
growth rate of 25.36%. A total of USD 53.505 billion in foreign investment
was utilized, up by 1.44% and 14.14% over 2002 and 2001, respectively, or
6.83% in terms of average annual growth rate.
-- Enterprise ownership and equity structure were further diversified. Di-
versification of SOE ownership has been achieved mainly by transforming
SOEs into limited liability or shares limited companies with diversified eq-
uity structure as well as joint ventures. In 2003, there were 1,619
State-owned large enterprise groups among which 1,212 saw their parent
companies restructured with corporate system, or 74.86% of the total. For
749 or 61.80% of the restructured groups, the parent company was trans-
formed into a wholly State-funded company, down by 1.44 and 0.93 per-
centage points on 2002 and 2001, respectively. Parent companies in 463 or
38.20% of them were transformed into non-wholly-State-funded companies,
up by 1.44 and 0.93 percentage points on 2002 and 2001, respectively. The
percentage of restructured companies over which the State has absolute con-
trol was dropping while the percentage of companies where the State exer-
cises a relative control was rising. Compared with unlisted companies, there
was even a clearer pattern of equity diversification in listed companies. In
2002 through 2003, the number of companies in which the State gave up all
its shares rose from 23 to 61. Companies with no State equity as a share of
all listed companies rose from 18.96% to 23.5%, a 4.54 percentage point in-
crease. The percentage in all listed companies of companies in which the
State takes a non-controlling position rose by 0.92 percentage points, from
12% to 12.92% while the percentage of State-controlled companies dropped
by 5.46 percentage points, from 69.04% to 63.58%.
-- Market-based production and operations by enterprises. As far as fi-
nancing is concerned, the SOEs mainly rely on their own funds, bank loans,
bond or equity issue for operational funds. In 2001 through 2003, their eq-
uity financing on the stock market rose from RMB 125.234 billion yuan to
RMB 135.775 billion yuan, representing an average annual growth rate of
4.12%. Corporate bond issue rose from RMB 14.7 billion yuan to RMB 35.8
billion yuan, by an annual average of 56.06%. Added bank loans rose from
RMB 1,243.941 billion yuan to RMB 2,770.230 billion yuan, by an annual
average of 49.23%. In 2002, the State investment continued to withdraw
322 Front. Econ. China (2006) 3: 311−372

from under-performing SOEs with merger & acquisition, bankruptcy and


writing-off of non-performing loans focusing on military, non-ferrous, coal
and defense logistics enterprises as well as local SOEs that urgently needed
to be closed down or liquidated. In 2002, a total of 533 SOEs were closed
down or went bankrupt. In 2003, the figure rose to 3307. With regard to
SOEs in ordinary competitive sectors, the non-SOEs, private citizens and
overseas investors were encouraged to participate in their restructuring and
transformation by way of State equity transfer and were allowed to take a
controlling position. Many SOEs including some large-sized SOEs were thus
transformed into non-State controlling companies with a diversified owner-
ship structure.

3.3 Notably higher level of market orientation for factors of


production

-- Funds allocation is increasingly market-based. In 2002 and 2003, chan-


nels for enterprise project financing were widened further to allow enter-
prises of different kinds, the private businesses in particular, to raise funds
by way of equity financing. A multi-tiered capital market featuring various
instruments complementing each other was gradually taking shape. The
number of private businesses going listed on the securities market was on the
increase. Foreign investment, FDI in particular, had continued to grow rap-
idly in scale. In 2003 the foreign investors contributed to 74.8% of the total
combined registered capital of all foreign funded enterprises, up by nearly 4
percentage points over 2001. In 2002 through 2003, the amount of funds
raised overseas and their share in the utilized foreign investment were both
rising. Particularly the share went up to 12.07% in 2003, 7.9 percentage
points higher than 4.17% of 2002, which reflects the improvement in the in-
ternational securities markets as well as international investors’ recognition
of the strengths of China’s domestic enterprises. China’s bond market has
been developing steadily. Government bonds and policy financing debt rose
by RMB 523.77 billion yuan in 2002 over 2001 and by RMB 486.34 billion
yuan in 2003 over 2002. The balance of bonds as a share of GDP rose by
2.87 percentage points and 1.16 percentage points in 2002 and 2003, respec-
tively over the previous year. The expansion in the balance of bonds, the ex-
pansion in government bonds and policy financing debt in particular, shows
the market-oriented development of China’s capital market in terms of the
means and size of financing as well as the constant improvement in the level
of securitization in China.
-- Steady improvement in the market conditions for labor mobility and
Front. Econ. China (2006) 3: 311−372 323

wages determination. The right of employment of SOEs was further con-


solidated. Labor contract coverage in large-sized enterprise groups reached
87.89% and 94.20% in 2002 and 2003, respectively, expanding by a big
margin over 2001. By yearend of 2003, there were 2.6 million layoffs from
SOEs, 2.55 million less than 2001. Non-SOEs enjoy the same treatment as
SOEs in terms of employment policies. By the end of 2003, employment
with non-SOEs accounted for 66.3% of total urban employment. Starting
from 2002, various provinces, municipalities and autonomous regions
launched reform of the residence registration system with the focus on “can-
celing quota restriction and implementing access system” and “breaking
down the urban–rural boundary and integrating urban–rural residence regis-
tration system”, which has helped to facilitate the orderly flow of labor. In-
ter-regional and cross-sectoral labor mobility has accelerated. The by-region
“difference of permanent residents and registered residents”-to-“registered
residents” ratio rose from 3.4% in 2001 to 3.6% in 2003. The “inter-sectoral
job reallocation variance ratio” rose from 4.1% in 2001 to 6.3% in 2003. In
2002 and 2003, governments at various levels made great efforts in promot-
ing the establishment of the collective bargaining system in foreign funded
enterprises. In 2003, the system was introduced in as many as over 290,000
enterprises, 270,000 more than in 2002. The number is still increasing rap-
idly.
-- Market-based land transaction system has hit a fast-track. The policy for
developing a land market featuring “bidding, auctioning and listing” was
implemented. By the end of 2003, the system for transferring land use right
by bidding, auctioning and listing had been introduced in all of China’s
thirty-one provincial regions. Remarkable progress was made in 2003 in
building a market-based land transaction system. A comparison of the
State-owned land supply transfer in 2001 through 2003 shows that the share
of land use granted by government declined from 41.4% to 22.8%, down by
18.6 percentage points. Paid transfer of land use right rose by 17 percentage
points from 50.6% to 67.6%. The share of land use transfer by bidding, auc-
tioning and listing rose by 20.7 percentage points from 7.3% in 2001 to 28%
in 2003. As far as the types of land are concerned, land transferred with
payment was used for building villas/high-class apartments, warehousing,
ordinary commercial housing and commercial and services facilities, ac-
counting for 97.5%, 85.4%, 81.1% and 72.8% of the land supplied under the
categories, respectively, all of which are much higher than the national av-
erage of 67.6%. The share of land transferred by “bidding, auctioning and
listing” as a percentage of total land supplied in the above categories was
also much higher than the national average. Land transferred by grant was
mainly used for public purposes, such as transportation, public buildings and
324 Front. Econ. China (2006) 3: 311−372

facilities.

3.4 A fairer trade environment

-- Major progress made in the reform of the trade administration regime.


The Ministry of Commerce (MOFCOM) was established and charged with
the administration of domestic and foreign trade and international economic
cooperation, which would help to speed up the integration of domestic and
foreign trade. A pattern featuring diversified trade operators came into being.
The process of reforming the trade-related approval system was hastened. A
total of 46 items requiring administrative approval were cancelled in 2002,
including the examination of applications for increasing registered capital in
foreign funded projects, approval of application for trading rights and labor
services projects by commercial and materials enterprises and approvals for
the production and trading in certain specific products. In 2003, MOFCOM
issued the Views of Guidance on Expanding Market and Stimulating Domes-
tic Demand, which proposed to further deepen the reform of the commodity
circulating system and actively develop various kinds of modern means and
forms of circulation such as agency and franchised operations.
-- Domestic market was opened further. An economic and trade legal
framework that meets the needs of a market economy and conforms with the
WTO rules has taken shape. Pursuant to its WTO accession commitments,
China has opened further its market, eased up market access and allowed
foreign businesses to set up cooperative firms engaged in commission
agency, wholesaling, retailing and licensed operations and services and deal
in the import, wholesaling and retailing businesses of products other than
tobacco and its products, edible salt, publications, medicines, pesticide, ag-
ricultural film, fertilizers, crude oil and finished oil products. Foreign inves-
tors, large transnational corporations in particular, started to flock into
China’s domestic market. About 40 of the top 50 retailers in the world have
entered into China’s market. The net sales of foreign funded retailers as a
share of the total retail sales in 2003 already reached 6.92%.
-- Process of liberalizing import and export trade was accelerated. Since
2002, China’s foreign trade has seen dramatic increases. In 2003, China’s
imports totaled USD 412.84 billion, taking China up to the third place in the
world, after the US and Germany. Since 2002, China has continued to make
deep cuts into its tariffs and taken steps to eliminate non-tariff measures in
the area of trade in goods. The arithmetic average tariff rate dropped to 11%
in 2003. As for non-tariff measures, China removed in January 2002 quota,
license or designated bidding management over eight categories of products,
Front. Econ. China (2006) 3: 311−372 325

namely, grains, wool, cotton, acrylic, polyester, PET, fertilizers and certain
tires. China cut the number of products under import license management
from 26 to 12 in 2002 and then to 8 in 2003. In 2003, China cancelled all
non-tariff measures over agricultural products. In terms of improving the or-
der of import and export trade, China, in accordance with WTO rules, has set
up a state trading regime and designated trading regime. Currently there are
ten categories of imports that fall under state trading and five categories un-
der designated trading. There are 13 categories of exported products under
state trading and 2 under designated trading. Since 2002, China has fulfilled
its WTO accession commitments in a number of service sectors, such as
business services, telecommunications, construction, distribution, financial,
tourism and transport, and opened them further to the outside world.
-- Composition of trading entities is further diversified. Foreign trading
rights have been made widely available and trading entities have become
more diversified. Since 2002, SOEs have taken a decreasing share in import
and export trade while foreign invested enterprises and private enterprises
have seen their share rising rapidly. SOEs’ share dropped from 42.52% in
2001 to 32.95% in 2003 while that of foreign invested enterprises went up
from 50.83% in 2001 to 55.48% in 2003, making them the leading force in
China’s foreign trade. At the same time, private businesses have emerged as
a new growing force in trade. Their share in total import and export trade in
2003 grew by 307.69% over 2001.
-- The legal framework of market economy has been further improved.
Laws promulgated or implemented during 2002 and 2003 include: (1) with
regard to government administration, the promulgation of the Law of PRC
on Government Procurement and the Law of PRC on Administrative Ap-
proval; (2) with regard to foreign trade, the implementation or promulgation
of the Regulation of PRC on Import and Export Administration of Goods,
Regulation of PRC on Import and Export Administration of Technologies,
Provisional Measures on Establishment of China-Foreign Joint Venture
Trading Companies, Regulation of PRC on Import and Export Tariffs, Cus-
toms Measures for Determining Customs Value of Imported and Exported
Goods and the Law of PRC on Inspection of Imported and Exported Goods;
(3) with regard to foreign investment, the promulgation or revision of the
Rules for Guiding Foreign Investment Destinations, Industrial Catalogue of
Guidance for Foreign Investment, Provisional Measures on Investment in
Domestic Securities by Qualified Foreign Institutional Investors, Circular on
Relevant Issues Concerning Transfer to Foreign Investors State-Owned
Shares and Legal Person Shares of Listed Companies, Provisional Rules on
Restructuring SOEs with Foreign Investment, Provisional Rules on Merger
& Acquisition of Domestic Enterprises and Rules on Foreign Investors
326 Front. Econ. China (2006) 3: 311−372

Establishing Investment Companies; (4) with regard to protection of intellec-


tual property rights, revisions to the Regulation for Implementing the Law of
PRC on Trademarks, Regulation for Implementing the Law of PRC on Copy-
right, Regulation of PRC on Customs Protection of Intellectual Property
Rights, the promulgation of Measures of Implementation on Administrative
Penalties for Copyright Violations, Rules on Certification and Protection of
Famous Trademarks, Measures on Compulsory Licensing of Patents and
Measures on Administering Patent Agency; (5) with regard to banking and
insurance, revisions to the Law on People’s Bank of China, Law on Com-
mercial Banks and Law on Insurance, the promulgation of the Law of PRC
on Securities Investment Funds, Law of PRC on Regulation of the Banking
Industry and Rules on Solvency Margin and Regulatory Targets for Insur-
ance Companies; (6) with regard to fair trade, the promulgation of the
Regulation on Safeguard Measures, the Regulation on Countervailing
Measures and the Regulation on Antidumping Measures, Rules on Industrial
Injury Investigation and Determination of Safeguard Measures, Rules on
Industrial Injury Investigation and Determination of Countervailing Meas-
ures and Rules on Industrial Injury Investigation and Determination of An-
tidumping Measures.
-- Intermediary organizations have grown stronger. The size of the inter-
mediary sector in China continued to expand in 2002 and 2003. They oper-
ated more professionally and by the market rules. By 2003, there were
25,109 industrial associations nation-wide, in which 362 were national asso-
ciations in the fields of industry and commerce organized by the Govern-
ment and they, as a whole, had dwindled drastically in size. The number of
local industrial associations and chambers of commerce established volun-
tarily by enterprises reached over 2,000. They were concentrated in regions
where non-SOEs and private businesses had developed to an advanced de-
gree. Insurance intermediaries were developing rapidly. By the end of 2003,
707 insurance intermediaries were open for business, up by 340% over 2002,
showing a pattern of high-speed development. Intermediaries in legal and
financial consultancy services grew stronger. There were over 60,000 prac-
ticing CPAs and close to 80,000 non-practicing CPAs in 2003 as well as
nearly 5,000 accounting firms, all higher to varying degrees than 2002. By
the end of 2003, there were 72 accounting agencies and 102 appraisal agen-
cies qualified for handling securities. In 2003 there were 155 securities in-
vestment consultancy agencies in the country with 1,599 practicing analysts.
The Chinese intermediaries in the field of legal and financial consultancy
developed further and were better disciplined in 2002 through 2003.
Front. Econ. China (2006) 3: 311−372 327

3.5 A more rational mechanism for determining financial parameters

-- A higher degree of monetization and financialization. In 2002 through


2003, entities on the financial market were more diversified and the money
market developed further in China. Monetization and financialization are
measured by the ratio of M2 and GDP (M2/GDP) and the ratio of financial
aggregates and GDP (FA/GDP), respectively. In 2003, the ratio of M2 and
GDP was 74.18%, 4.44 percentage points higher than 2001 and the ratio of
financial aggregates and GDP was 255.57%, 22.27 percentage points higher
than 2001.
-- More intensified competition among the banks. The banking sector is
more open to the outside world. By the end of 2003, the banking regulatory
authorities of China had approved the establishment of 28 rep offices, 12
branches and 6 subsidiaries of foreign banks in China. The share of the
State-owned commercial banks in the total banking assets in China was
55.5% in 2003, 5 percentage points lower than that of 2001. State owned
commercial banks received 59.58% of savings in 2003, 1.4 percentage points
lower than 2001. As the financial sector is more open to the outside world,
competition has heated up.
-- New progress was made in the reform for market-based interest rate.
Since 2002, the reform for market-based interest rate in China has made
marked progress. In September 2002, the interest rate reform of rural credit
cooperatives on a pilot basis was expanded to cover all provinces and
autonomous regions with the exception of municipalities. In December 2003,
the People’s Bank of China (PBOC) decided to once again broaden the float
band for the loans of financial institutions starting from 1 January 2004. The
band for commercial banks and urban credit cooperatives was broadened to
[0.9, 1.7] and that for rural credit cooperatives to [0.9, 2]. The band is no
longer based on the ownership nature or size of the recipients. In addition to
the broadened float band, a number of supporting measures have been taken
to remove restrictions over the way RMB loan interest is calculated and set-
tled and to lift the cap over interest rate for five years and longer loans.
-- Restraints over RMB convertibility under capital account have been no-
ticeably relaxed. In 2002 through 2003, China further deregulated its forex
regulations over RMB under the capital account. While continuing with the
policy of attracting investment, China vigorously promoted the strategy of
“going global”. The IMF groups capital transactions into 43 items. Accord-
ing to China’s existing laws, regulations, policies and practices, the 43 items
may be grouped into four categories, namely the fully convertible, basically
convertible, the more restricted and the strictly controlled. Compared with
2001, the capital account became clearly more convertible. Another seven
328 Front. Econ. China (2006) 3: 311−372

items were added to the fully convertible and basically convertible catego-
ries, up by 58%. The number of items under the strictly restricted category
was cut from 15 to 6, down by 60%.
-- The market-based exchange rate determination mechanism has taken
shape. In 1994, China replaced the double-track exchange rate system of the
country’s RMB yuan with a market supply-and-demand-based, unitary and
managed floating exchange rate system and preliminarily established the
prominent role of the market in allocating forex resources. In June 2002, the
inter-bank lending business was introduced into China’s forex market. Start-
ing from October 1, 2003, two-way transactions have been permitted on the
inter-bank market, which has contributed to the convergence of the domestic
and international markets and helped to further improve the RMB exchange
rate regime. China took further steps in 2004 to improve its forex market by
allowing more entities to participate, the China Forex Transaction Center to
officially open its forex transaction business and more banks to engage in
enlarged forward settlement and delivery services on a pilot basis. On July
21, 2005, the exchange rate between the USD and RMB yuan was changed
to 1:8.11 and it was announced that the float band would be readjusted in
light of the developments on the market and the changing economic and fi-
nancial situation. Hence, the exchange rate of RMB is no longer pegged to
the USD and a more flexible RMB exchange rate mechanism has taken
shape.
The above analyses have shown that in 2002 through 2003, major progress
has been made in China’s market economy in the following five fields:
rules-based government administration, liberalized economic entities, mar-
ket-based reallocation of means of production, fair trade environment and
rationalized financial parameters. The market economy in China has grown
in greater breadth and depth, which has come as both the result of China’s
faithful fulfillment of its WTO accession commitments and the logical out-
come of the reform and development of China’s economic system.

4 2002−2003: Evaluation of the degree of China’s market economy


development

This research team has developed a system of factors and indices for meas-
uring market development within the context of antidumping investigations,
in light of the European and American criteria for MES in antidumping pro-
ceedings, general theories of market economy and the system for measuring
economic freedom, after taking into full account the state of China’s market
economy. We have developed the scoring standard and index formula for
Front. Econ. China (2006) 3: 311−372 329

measuring market development by drawing on the criteria of the Heritage


Foundation’s economic freedom survey. On this basis, we calculated the
score of market development of China for the years 2002 and 2003.
To ensure the continuity and dynamic comparability of the market index,
the criteria used by the Report of 2005 stays the same as the Report of 2003.
By “the same”, it means in the following four ways: first, the number of in-
dices remains 33; secondly, the 11 subsets and 5 categories on the basis of
the 33 indices remain unchanged; thirdly, the method of calculation remains
unchanged; and fourthly, the names of the 33 indices stay unchanged. Based
on the ratings system which is still based on that of the Heritage Foundation
(a band of five points, the lower the value, the higher the market develop-
ment level, one being the highest, five being the lowest), we had results in
terms of the variable indices, factors and overall levels.

4.1 Ratings of the indices

According to the presumed criteria for measuring market development, we


rated the various indices for 2001−2003 and the results are shown in Table 1.
Table 1 Scores of the indices of market development level
Indices 2001 2002 2003
1 Government Consumption as Share of GDP 2 2 2
2 Average Income Tax of Enterprises 3 3 3
3 Government Investment as Share of GDP 3 3 4
4 Transfer of Payment and Government Subsidies as Share of GDP 3 3 3
5 Government Employment as Share of Urban Employment 3 3 3
6 Added Value by Non-SOEs as Share of GDP 2 2 2
Fixed Asset Investment by Non-SOEs as Share of Total Fixed Asset
7 3 3 2
Investment
8 Urban Non-SOE Employment as Share of Urban Employment 2 2 2
Tax Revenues Contributed by Non-SOEs as Share of Total Tax
9 2 2 2
Revenues
10 Trade Volume of Non-SOEs as Share of Total Trade Volume 3 2 2
11 Subsidies for SOEs Losses as Share of GDP 2 2 1
12 Large SOEs’ Independence in Recruiting Executives 2 2 2
13 Large SOEs’ Independence in Operations 2 3 2
By-Region Difference Between Permanent Resident and Registered
14 3 3 3
Residents as Share of Registered Residents
15 Inter-Sectoral Job Reallocation Variance Ratio 3 4 4
16 Labor Contract Coverage in Large Enterprises 2 2 2
330 Front. Econ. China (2006) 3: 311−372

Continued
Indices 2001 2002 2003
Foreign Investment, Self-Raised Funds and Other Funds as Share of
17 1 1 1
the Total Fixed Asset Investment
Foreign Capital as Share of the Total Registered Capital of Foreign
18 1 1 1
Invested Enterprises
Auctioned Urban Land Use Right as Share of Total Land Use Right
19 3 3 1
Transferred
20 Market-Based Pricing as Share of Total Consumer Retails 1 1 1
Market-Based Pricing as Share of All Agricultural Product Pur-
21 1 1 1
chases
22 Market-Based Pricing as Share of All Means of Production Sales 2 2 2
23 Average Tariff Levels 4 3 3
24 Revenues from International Trade as Share of Total Trade Volume 3 2 2
Closed Cases as Share of Case Initiated for Contravention of Laws
25 3 2 2
and Regulations on Unfair Competition
26 Closed Cases as Share of IPR Case Initiated 2 3 2
27 Assets of Non-State Owned Banks as Share of Total Bank Assets 4 4 4
Savings with Non-State Owned Financial Institutions as Share of
28 3 3 3
Total Savings with Financial Institutions
Short-Term Loans to Foreign Invested, Self-Employed and Private
29 Businesses as Share of All Short-Term Loans Issued by Financial 4 4 4
Institutions
30 Average of Inflation Rates in the Most Recent Five Years 1 1 1
Range Co-efficient of Interest Rate of One-Year Loans of Financial
31 3 1 1
Institutions
32 Unrestricted Items as Share of All Items under Capital Account 4 3 3
Deviation Between RMB/US Dollar Exchange Rate and Monthly
33 Average Absolute Difference of Singapore Non-Deliverable For- 2 1 4
ward (NDF)

An analysis of the 33 indices has shown that from 2001 through 2003, 19
of the indices were going up, indicating improvements in market develop-
ment and 7 were going down, indicating negative impact on the market de-
velopment. Among the remaining 7 indices, 5 got worse in 2002 over 2001
but improved in 2003 over 2002, and 2 improved in 2002 over 2001 and
worsened in 2003 over 2002. The overall performance of the 33 indices has
shown that the economy is increasingly market-oriented.

4.2 Ratings of the subsets for assessing market development

The 11 sub-sets are based on the above 33 indices and they have covered all
the various aspects of market development assessment.
Front. Econ. China (2006) 3: 311−372 331

Table 2 Scores of sub-sets 2002–2003


Sub-Set 2001 2002 2003

1. Fiscal Burden of Government 2.5 2.5 2.5


2. Government Intervention in the Economy 3 3 3.33
3. Contribution by Non-SOEs 2.4 2.2 2
4. Enterprise Operations 2 2.33 1.67
5. Labor and Wages 2.67 3 3
6. Capital and Land 1.67 1.67 1
7. Freedom in Pricing Traded Products 1.33 1.33 1.33
8. Freedom of External Trade 3.5 2.5 2.5
9. Legal Protection of Fair Trade 2.5 2.5 2
10. Banking and Currency 3 3 3
11. Interest Rate and Exchange Rate 3 1.67 2.67
Note: This table is compiled based on the sub-set classification of the Report and the results of Table 1.

4.3 Categories and aggregate index

The Report lists five categories of factors, namely, rules-based government


behavior, liberalized economic entities, market-based allocation of factors of
production, fair trade environment and rational financial parameters. These
five aspects have encompassed the above 11 subsets. The score of each of
the five categories is the simple arithmetic average of the scores of the sub-
sets under the category and then the scores of the categories are added up
and then averaged to get the aggregate indices of 2002 and 2003.
Table 3 Scores of categories and the overall index
Index 2001 2002 2003
1. Rules-Based Government Behavior 2.75 2.75 2.92
2. Liberalized Economic Entities 2.2 2.27 1.84
3. Market-Based Allocation of Factors of Productions 2.17 2.34 2
4. Fair Trade Environment 2.44 2.11 1.94
5. Reasonable Financial Parameters 3 2.34 2.84
Overall Index 2.51 2.36 2.31
Note: This table is compiled based on the categories classification of the Report and the results of Ta-
ble 2.

The results of the above tables have shown that the market index of China
in 2002 and 2003 was 2.36 and 2.31, respectively on the five-point scale of
332 Front. Econ. China (2006) 3: 311−372

the economic freedom index of the U.S. Heritage Foundation. To give read-
ers both inside and outside of China a more direct understanding, we have
converted the above scores based on the five-point scale into scores on the
100-point scale by dividing the 100 points into five zones, i.e., 0–20, 20–40,
40–60, 60–80, 80–100. According to the index system of the heritage foun-
dation, 3 points and plus indicates freedom for the most part and thus are set
as 60 points on the 100-point scale. On this basis, zone 1 corresponds to 5
points on the five-point scale, zone 2 to 5–4 points, zone 3 to 4–3 points,
zone 4 to 3–2 points and zone 5 to 2–1 points. Clearly, the overall market in-
dices for 2001 to 2003 fall within zone 4 (60–80 points). The indices may be
easily converted into indices on the 100-point scale by interpolation, i.e., to
insert a point (x, y) between point (2, 80) and point (3, 60) to satisfy the con-
dition that (x-2)/(3-2)=(80-y)/( 80-60) which is simplified to y=120-20x.
Based on this formula, the market indices for 2002 and 2003 are 72.8% and
73.8%, respectively (see Table 4).
Table 4 Overall index on two scales
Year 2001 2002 2003
Score on 5-Point Scale 2.51 2.36 2.31
Score on 100-Point Scale 69 72.8 73.8

This is a very important table and shows the final results of multi-layered
computations. We may find from the table the concrete progress made in the
market economy of China in 2002 and 2003.

4.4 Analysis of the changes in indices of 2002 and 2003

4.4.1 Dynamic comparison of the overall index

The level of market development in China continued to increase in 2002 and


2003. According to Table 4, the index went higher than 70% in 2002 and
close to 74% in 2003. This is proof that the market economy in China has
not only gone far beyond the critical level of 60% but also, without any
doubt, made China a market economy as a developing country. At the same
time, it also shows that two years after China’s accession to the WTO at the
end of 2001, the market economy was growing in both width and depth, par-
ticularly in terms of providing a fair trade environment. China has, following
its WTO accession, fulfilled its accession commitments and worked to pro-
mote the fair competition and development of enterprises of different own-
Front. Econ. China (2006) 3: 311−372 333

ership structures. At present, non-SOEs contribute to 69% of the GDP, over


90% of the products have their prices determined entirely by the market, tar-
iff level has dropped below the average of developing countries and China’s
policies, laws and regulations on foreign trade and economic cooperation are
in line with the international rules.
In order to verify the accuracy of the market indices, we have compared
them with the findings of some international institutions over freedom of
different economies. The findings in 2000 through 2002 of the US Heritage
Foundation in its Index of Economic Freedom and the Canadian Frazer In-
stitute in its Economic Freedom of the World Report on the economic free-
dom of China are given in Table 5.
Table 5 Findings on economic freedom of China
Heritage Foundation’s Index of
Frazer Institute’s Economic Freedom of the World Report
Economic Freedom
Before Adjustment After Adjustment
Year Score Ranking Year
Score Ranking Score Ranking
2000 3.55 127 2000 5.28 101 5.8 85
2001 3.64 128 2001 5.49 100 5.9 84
2002 3.46 112 2002 5.7 90
Note: A total of 156 countries and
Note: A total of 123 countries and regions were ranked
regions were ranked
Data source: Online information in Economic Freedom of the World: Annual Reports 2002, 2003 and
2004 at www.fraserinstitute.ca and Index of Economic Freedom 2003, 2004 and 2005 at www.heritage.
org.

Table 5 has shown clearly that economic freedom of China after its WTO
accession has improved notably. The findings of the Heritage Foundation
indicated that China climbed 16 places in 2002 on 2001, and 10 places if
measured by Frazer’s results. Such a speed of development is in keeping
with that of market development index of this Report. It must be noted that
both international indices were based on information up to the year of 2002
only, lagging by two years.

4.4.2 Dynamic comparison of the factors

Improvement in China’s market development index is reflected in various


fields, which is supported by the scores of the various indices, subsets and
categories given in the Report. The improvement in the overall index of
2002 and 2003 came as a result of the positive movements of most of the in-
dices towards market orientation.
334 Front. Econ. China (2006) 3: 311−372

Let’s begin by probing deeper into the eleven subsets of factors. Judging
from the assessment of the eleven subsets, compared with 2001, six subsets
improved in 2003, in which, the grade of “contribution by non-SOEs” im-
proved from 2.4 to 2, “enterprises’ operations” from 2 to 1.67, “capital and
land” from 1.67 to 1, “legal protection of fair trade” from 2.5 to 2, “interest
rate and exchange rate” from 3 to 2.67, and “freedom in foreign trade” from
3.5 to 2.5. The level of 2 subsets remained unchanged, namely, “banking and
currency” and “fiscal burden of government” which remained 3 and 2.5, re-
spectively for the past three years. In addition, scores of two subsets deterio-
rated, one being the “government intervention in the economy” which went
from 3 in 2001 to 3.33 in 2003, mainly as a result of the increased share of
the government investment in GDP. This reflected the expansionary fiscal
policy of the Chinese Government and the accelerated pace of government
investment in response to the SARS epidemic. However, this was the result
of short-term macro-economic policy and would not last for long. The other
deteriorating factor is “labor and wages” which went from 2.67 to 3. This
was mainly caused by inappropriate statistical methodologies. The
“by-region ratio of the difference between permanent residents and regis-
tered population to registered population” is calculated based on the total net
national change. This index declined from 2.57% in 2001 to 2.53% in 2003.
However, calculated on the basis of the absolute values of provincial
changes, the index has kept rising since 2001, from 3.40% in 2001 to 3.43%
in 2002 and then 3.60% in 2003. Although the absolute value approach is
more objective, the previous method was adopted to keep the stability of the
index. The “inter-sectoral job reallocation variance ratio”, another index un-
der the “labor and wages” subset, has a similar problem. The score was cal-
culated based on the overall net change in the sector and thus was made
lower. But if calculated based on the overall variance ratio, the value would
rise from 4.10% in 2001 to 6.30% in 2003. If calculated on the basis of the
overall scale, the market development level of the “labor and wages” subset
would have been higher. We hold that, compared with calculation by net
amounts, calculation by aggregates is more accurate in reflecting the labor
flow between different regions and sectors. Therefore, we are contemplating
modifying the method of calculation of the above two indices in future an-
nual reports.
An analysis of the five category-indices has shown that all factors, except
for “rules-based government behavior” have improved in terms of market
development and contributed to the overall market development index. The
downward readjustment of the score of “rules-based government behavior”
was mainly the consequence of the expansionary fiscal policy of the gov-
ernment and the increased government investment as a result of the SARS
Front. Econ. China (2006) 3: 311−372 335

epidemic. And with changes in the economic policies, this index is expected
to change significantly.
Based on the above, we may reach the following conclusions:
First, findings of the sub-sets and categories of market development fac-
tors in 2002 and 2003 were positive. Negative results of a small number of
indices came mainly as a result of special macro-economic policy changes
and different statistical methodologies.
Secondly, development of the market economy has been uneven in differ-
ent sectors. The fastest-improving factor is “freedom in external trade”
whose score was down by one point in 2003 over 2001. “Capital and land”
came second, down by 0.67 points, followed in descending order by “legal
protection of fair trade”, “contribution by non-SOEs”, “interest rate and ex-
change rate” and “enterprises’ operations”, all of which have improved to
varying degrees. If calculated based on the aggregate values of labor flow,
the score of “labor and wages” would have improved by a bigger margin.
Thirdly, the standstill or decline in the value of a small number of factors
is quite normal and shall not be construed as indicating the deterioration of
the overall market development level, as the intensity of government inter-
vention in the economy would change with time as a result of the fluctua-
tions in the macro-economy or certain contingencies. At the same time, there
are statutory limits to government intervention. In addition, even though
macro-control was strengthened in China, the overall level of market devel-
opment has shown a pattern of improving.

5 Latest developments in China’s market economy in 2004

The facts and data in the Report of 2005 on Development of Market Econ-
omy in China were up to the end of 2003. Here we summarize as follows the
latest developments in China’s market economy in 2004.

5.1 Government intervention in the economy was reduced further

5.1.1 Administration by law enjoyed all-round development and the


efficiency of government services improved significantly

-- The legal framework was further improved. On 1 July 2004, the Law of
the PRC on Administrative Approval was officially implemented. To better
implement this law, the State Council issued the Guidelines for Implement-
336 Front. Econ. China (2006) 3: 311−372

ing the All-Round Promotion of Administration by Law, which clearly pro-


vided that the objective of building a government that acts by law shall be
achieved after about ten years of unremitting efforts.
-- Items requiring administrative approval were cut back.

5.1.2 The government further relaxed its regulation over means of


production

-- Markets of means of production were opened further to the outside


world. On 30 November 2004, the State Development and Reform Commis-
sion (SDRC) and the Ministry of Commerce (MOFCOM) jointly issued the
Industrial Catalogue of Guidance for Foreign Investment (revision 2004),
which came into effect on 1 January 2005. The revised Catalogue, in re-
sponse to the need for opening-up and attracting advanced technologies,
added new industries and products that urgently need development as en-
couraged categories or modified the existing encouraged categories to add
new contents, particularly in the fields of raw materials and basic means of
production.
-- The market-based coal price reform entered into a new stage of devel-
opment. The Circular No. 47 issued by the General Office of the State Coun-
cil in June 2004 provided that after readjustment of electricity price, price of
power coal shall be negotiated between the supplier and purchaser, be it “key
contract” or not. In December 2004, the SDRC issued the Circular on Estab-
lishing the Coal and Power Price Linkage Mechanism, which proposed the
establishment of the mechanism linking the price of coal and the price of
power along the line of “market orientation, coordination by mechanisms,
price linkage and integrated regulation”.
-- Market-based water price reform fully unfolded. On 1 January 2004, the
Measures for Regulating the Water Supply Price of Water Conservancy Pro-
jects jointly issued by the SDRC and the Ministry of Water Conservancy en-
tered into effect, which signified that the water supply price of water con-
servancy projects was incorporated into a system based on law, standards
and science and that the water price reform embarked on a new stage of de-
velopment.

5.1.3 Reform of the monopolistic sectors and urban utilities


accelerated

-- Reform of the monopolistic sectors. Thanks to the reform of the power


Front. Econ. China (2006) 3: 311−372 337

regime, power generation plants and power grids have been by and large
separated and a pattern of power generating plants competing with each
other came into being. The power grid in south China was established. The
power markets in the northeast and east China came into simulated opera-
tions. The direct power purchase by key customers program already took off
on a pilot basis. The power price forming mechanism continued to be im-
proved. With regard to reform of the civil aviation sector, price of air cargo
services is now guided instead of set by the Government. With regard to re-
form of the railway regulation regime, the reform of five transport enter-
prises with the shares system was carried out on a pilot basis, efforts to have
enterprises spin off their social functions made steady progress and the pro-
gram of separating the main business from the supporting business and re-
structuring the supporting business was launched on a pilot basis in three
Railway Bureaus (or Sub-Bureaus).
-- Reform of urban utilities. The State Council introduced the water price
reform plan that has allowed the price mechanism to play a more prominent
role in saving water and protecting water resources. The Ministry of Water
Conservancy continued to improve the price determination mechanism and
regulatory system of water supply by water conservancy projects. The Min-
istry of Construction opened further the urban public transport market. In
Beijing, Hebei, Henan and Guizhou, intensive efforts were made to separate
administrative affairs from enterprise functions and social affairs and to
separate social affairs from enterprise functions with regard to the public
utilities and to open these sectors to investment, management and operations

5.2 Freedom of economic entities improved somewhat

5.2.1 Reform of SOEs has accelerated

-- Shares system reform and efforts to implement a modern corporate sys-


tem continued. So far, 1464 of the 2903 State-owned and State-controlled
large-sized enterprises were restructured into corporate enterprises with mul-
tiple shareholders, accounting 50.4% of the total. Reform of large SOEs with
the shares system was hastened. Such Central Government controlled com-
panies as China Shipping Containers Lines (CSCL), China Power Interna-
tional Holding Limited, and China Netcom (CNC) launched their overseas
IPOs. A group of large companies including China Mobile, China Telecom
and Wuhan Iron & Steel achieved public listing of their main business as a
whole. A total of 14 Central Government controlled enterprises such as
338 Front. Econ. China (2006) 3: 311−372

China National Aviation Holding Company (CNAH), Shenhua Group and


Dong Feng Motor Company were restructured into limited shares companies.
Bao Steel successfully took over Shanghai Baojian, blazing a new trail in
transforming large SOEs in their entirety.
-- Reform of small- and medium-sized SOEs deepened further. Over 80%
of the small- and medium-sized SOEs in such provinces as Shanxi, Liaoning,
Hubei, Hunan, Guangdong, Chongqing, Sichuan, Yunnan, Shan’xi and
Ningxia were transformed. After transformation, these local SOEs diversi-
fied their ownership, changed their structure and updated the capacity of
their employees, which resulted in notable improvement in economic re-
turns.

5.2.2 Non-public owned enterprises such as the self-employed and


the private businesses developed rapidly

-- The policy framework for encouraging the healthy development of


non-public owned enterprises was further improved. In February 2004, the
State Council formulated the Suggestions of the State Council for Encourag-
ing, Supporting and Guiding the Development of the Non-Public Owned En-
terprises Including the Self-Employed and Private Businesses. The Sugges-
tions put forward that market access for non-public owned enterprises be
eased, that their capital be allowed into industries and sectors not prohibited
by laws and regulations and into those industries and sectors where foreign
investment is allowed and that shares percentage restrictions be relaxed.
Non-public owned enterprises shall be treated the same as all enterprises of
other ownerships in terms of investment approval, financing services, fiscal
and taxation policies, land use, foreign trade and economic and technological
cooperation.
-- The number of newly established self-employed and private businesses
along with their strength increased rapidly. From January through September
2004, the number of private businesses in the country rose by 530,200 to
3,535,700, up by 17.64% over the same period last year. They employed a
total of 49,069,100, adding 6,277,700, up by 14.14%. Their total registered
capital added another RMB 99,750,500 yuan to RMB 4.53 trillion yuan, up
by 28.25%. The number of self-employed industrial and commercial entities
amounted to 23,395,500,136,400 or 0.58% less than the same period last
year. Their capital totaled RMB 47,448,000 yuan, adding 5,578,100 or
13.32%. While growing quantitatively, non-public owned enterprises are ex-
tending from traditional tertiary industries such as catering and services to
emerging industries such as specialty sectors and high- and new-technology
Front. Econ. China (2006) 3: 311−372 339

sectors, with an increasingly salient feature of being industrialized.

5.2.3 The utilization and disposal of SOE assets were more


market-based

-- The regulatory framework for SOE assets took shape. State Asset Com-
missions in all 31 provinces and the Xinjiang Production and Construction
Corps were established. By the end of 2004, State asset regulatory bodies
had been established in 203 cities, accounting for 45.3% of the total, in
which state asset commissions had been set up as a separate body in 176 of
them, or 39.3% of the total. The framework of law and regulations were im-
proved further. Budgetary work of the State owned assets took off. The su-
pervisory board of SOEs was strengthened. Some provincial State asset
commissions began to experiment with combining supervisory board super-
vision with other means and ways of supervision.
-- Market-based State owned shares transfer of publicly listed companies
was promoted further. In December 2004, the Shanghai Stock Exchange,
Shenzhen Stock Exchange and China Securities Depository & Clearing
Corporation Limited jointly issued the Rules for the Transfer of
Non-Circulating Shares of Publicly Listed Companies. The Rules provide
that transfer of the shares of publicly listed companies must be made at stock
exchanges and handled by the Shanghai Stock Exchange, Shenzhen Stock
Exchange and the China Securities Depository & Clearing Corporation Lim-
ited. Illegal OTC shares transactions are strictly prohibited. The introduction
of the Rules played a positive role in regulating transactions in State owned
shares of listed companies and in promoting the market-based approach for
their transfer.

5.3 Allocation of factors of productions continued to be more


market-based

5.3.1 Determination of labor issues and wages was notably more


market-based

-- Determination of wages at SOEs was more market-based. The


State-owned Assets Supervision and Administration Commission (SASAC)
introduced in June 2004 the Provisional Measures for Regulation of Remu-
neration of Responsible Officials of Enterprises under the Central Govern-
340 Front. Econ. China (2006) 3: 311−372

ment. The Measures stipulated that the remuneration of the executives of


those enterprises shall be composed of base salary, performance bonus and
mid- and long-term incentives. The Measures made it clear that the remu-
neration must be linked with the results of performance audits and proposed
specific measures for regulation and linkage of the remuneration, thus
achieving substantive breakthroughs in the remuneration system reform.
-- Protection of the lawful rights and interests of workers was strengthened.
On 1 November 2004, the State Council promulgated the Regulation on La-
bor Security Supervision. The implementation of the Regulation has helped
to further step up the enforcement and supervision of labor security, stan-
dardized the enforcement, protected the lawful rights and interests of work-
ers and promoted the harmonious development of labor relations.

5.3.2 Allocation of financial resources was significantly more


market-based

-- Enterprises were more actively investing and financing overseas. In


September 2004, the Ministry of Commerce (MOFCOM) promulgated the
Rules on Issues Requiring Verification and Approval Concerning Overseas
Investment and Establishment of Enterprises which encouraged finan-
cially-sound Chinese enterprises to enhance their investment overseas. In
July 2004, the China Securities Regulatory Commission (CSRC) issued a
Circular on Issues Concerning Regulating the Overseas Listing of Subsidi-
aries of Domestically Listed Companies, which encouraged domestic enter-
prises to enter into the international market. By 10 December 2004, 38 listed
companies had invested a total of approximately RMB 7 billion yuan over-
seas, up by 217% over the same period of the previous year. In addition,
2004 witnessed more large-scale overseas investment projects. Altogether, 8
projects involved the investment of more than RMB 100,000,000 yuan,
twice the number of such projects in the previous year.
-- Reform and opening-up continued to move forward in the securities
market and developed steadily. In February 2004, the State Council issued
the Suggestions on Promoting the Reform, opening-up and Steady Develop-
ment of the Capital Market. In August 2004, the State Council promulgated
and implemented the revised Securities Law which, in response to the
ever-changing capital market, made new provisions with regard to the de-
termination of IPO price and the issue of corporate bonds.
-- The SME board was launched, expanding channels of financing. On 27
May 2004, with the approval of the State Council, the SME board was offi-
cially launched in the main board market of the Shenzhen Stock Exchange
Front. Econ. China (2006) 3: 311−372 341

and the verification process of the implementation plan for the SME boards
was kicked off. This was a symbol of the beginning of the process of foster-
ing the development of SMEs with good growth potential and high technol-
ogy content by making use of the capital market. On 2 June 2004, Zhejiang
Xinhecheng Co. Ltd (002001) became the first company listed on the SME
board. By the end of 2004, a total of 37 enterprises had raised funds at the
SME board.
-- The bond market had developed rapidly. The Measures for Regulating
Short-Term Financing by Securities Firms, implemented in November 2004,
further expanded the financing channels of securities firms, specified the is-
sue and transaction of short-term bonds by securities firms, promoted the
further development of the currency market and protected the lawful rights
and interest of investors. In December 2004, the People’s Bank of China
(PBOC) introduced the Detailed Rules on Examination of Inter-Bank Bonds
Transactions and Circulation, which, in order to promote the issue of corpo-
rate bonds, encourages qualified enterprises to issue bonds and provides the
necessary conditions for inter-bank deposit and circulation of the bonds, thus
creating a development opportunity for the corporate bonds.

5.3.3 Process of market-based allocation of land accelerated

-- The policy environment for market-based land administration was opti-


mized further. China introduced, on 22 October 2004, the Decision of the
State Council on Deepening Reform and Tightening Land Administration, a
landmark document on administration of land resources after China’s acces-
sion to the WTO at the end of 2001. The Decision set out clear provisions for
promoting market allocation of land resources, thus eliminating at the insti-
tutional level the artificially lower price of land use in the market and the
“hidden land market” and reinforcing the market-based pricing mechanism
for land transactions
The “bidding, auction and listing”-based land transaction system was fully
implemented and land transactions became more market-based. In March
2004 the Ministry of Land Resources and the Ministry of Supervision jointly
issued a circular that required that by 31 August 2004 all issues left over
from before the implementation of the Rules on Transfer the State-Owned
Land Use Right by Bidding, Auction and Listing must be resolved. This
meant the end of the model of for-profit land transfer by agreement and the
bidding, auction and listing system, a fully market-based land transaction
system, was thus fully implemented.
342 Front. Econ. China (2006) 3: 311−372

5.4 Notable improvement in trading environment

5.4.1 Freedom in conducting foreign trade would be noticeably


improved
-- Further cuts in tariff rates. Since 2004, China’s average tariff level in
trade in goods dropped progressively from 15.3% at the time of China’s
WTO accession to 10.4%. The average tariff level for industrial products in
particular dropped from 14.8% to 9.5% and that for agricultural produce
from 23.2% to 15.6%. Non-tariff measures were reduced further too. By the
end of 2004, the import quotas and licensing requirement for 342 of the 377
committed tariff lines of products had been cancelled in successive stages or
transformed into tariff quotas or automatic import licenses in conformity
with the WTO rules. Import quotas and licensing requirements for the elec-
tro-mechanic products (automobiles and their key components) under the
remaining 35 tariff lines were also cancelled as of 1 January 2005.
-- Trading rights were fully opened up. The newly revised Foreign Trade
Law explicitly replaced the requirement for approval to engage in foreign
trade with a filing requirement and removed requirements with regard to op-
eration qualifications. Starting from 1 July 2004, approval was not needed
for any foreign trade entities and only filing for registration was required.
Individual citizens, after fulfilling statutory procedures, may also engage in
foreign trade. From 1 July to 1 December 2004, a total of 28,387 foreign
trade operators filed for registration, in which 26,729 were domestic enter-
prises, 348 were enterprises with investment from Hong Kong, Macao and
Taiwan, 972 were foreign-invested and 338 were self-employed.
-- The legal framework for foreign trade regulation was improved further.
The Standing Committee of the Tenth National People’s Congress (NPC)
passed the revised Law of the PRC on Foreign Trade. The revised law placed
a special emphasis on the important role of the Government in foreign trade
regulation, e.g., in terms of intellectual property protection, foreign trade in-
vestigation and trade remedies, establishing a public information services
system for trade, aggravating penalties for violations and building a surveil-
lance and monitoring system for domestic and international markets. All this
made clearer the important responsibilities and orientation of the Govern-
ment in foreign trade and gave full expression to the important role of the
Government in appropriately participating in foreign trade regulation.

5.4.2 Intermediaries have enlarged constantly in scale and coverage


-- Opening of the intermediaries market was greatly accelerated. The
Front. Econ. China (2006) 3: 311−372 343

Ministry of Commerce (MOFCOM) issued in January 2004 the Provisional


Rules on the Establishment of Foreign Invested Conference and Exhibition
Companies, which encourages foreign investors to set up within China for-
eign invested conference and exhibition companies. The Measures for the
Regulation of Representative Offices in China of Foreign Insurance Institu-
tions that went into effect in March 2004 placed the opening of the insurance
intermediary market on a clearer and rules-based path. Regulations issued in
2004 that involved the opening of intermediary market also covered such
areas as cargo agency, auction houses, advertisement agency, shipping
agency, trademark agency and goods sales agency and brokerage.
-- Intermediaries grew rapidly in scale. By now non-Government groups
have come to form a nation-wide system that covers a full range of forms,
levels and areas of social life. By the end of 2004, non-Government groups
of various kinds in China numbered over 280,000 in which nearly 150,000
were social groups, up by 5.4% over the previous year, 133,000 were
non-enterprise entities, up by 6.7% over the previous year and 902 were
foundations.

5.4.3 The legal framework for market economy in China was


improved further

-- With regard to the protection of private property, the Second Session of


the Tenth National People’s Congress (NPC) adopted the Amendment to the
Constitution of the PRC on 14 March 2004, which provides that the lawful
private property of the citizens is inviolable. The State protects the private
property and the right to inherit of the citizens according to law. Out of need
for public interest, the State may take or use according to law the private
property of citizen, and make compensation. The above clauses at the con-
stitutional level provided for the private property of citizens and greatly im-
proved the private property protection system in China.
-- In terms of financial law, the State Banking Regulatory Commission
promulgated in 2004 the revised Detailed Rule for the Implementation of the
Regulation of the PRC on Foreign Invested Financial Institutions, which
was officially implemented on 1 September 2004. Its promulgation marked a
new step in the process of the opening of China’s banking sector and regula-
tion of foreign invested financial institutions.
-- In terms of foreign trade law, the Standing Committee of the Tenth Na-
tional People’s Congress (NPC) adopted the revised Law of the PRC on For-
eign Trade on 6 April 2004, which came into effect on 1 July 2004. Revi-
sions mainly fall within the following three areas: modifying provisions in
344 Front. Econ. China (2006) 3: 311−372

the existing Law on Foreign Trade that were not in conformity with the
WTO rules; providing for the mechanism and procedures for implementing
China’s rights as a WTO Member in accordance with China’s accession
commitments and WTO rules; and revisions made in order to adapt the ex-
isting Law on Foreign Trade in light of the developments since it came into
force and the need for promoting the healthy development of foreign trade.

5.5 The banking sector is steadily more market-based

5.5.1 Competition among financial institutions continued to intensify

-- Reform of State-owned commercial banks moved ahead. On 26 August


and 21 September 2004 the Bank of China (BOC) and the China Construc-
tion Bank (CCB) were successively transformed into limited shares compa-
nies where the basic framework of modern corporate governance was estab-
lished. In the year 2004 the Industrial and Commercial Bank of China (ICBC)
and the Agricultural Bank of China (ABC) also made great efforts in im-
proving operation institutions, stepping up internal reforms, improving risk
management and improving profitability, laying the groundwork for their
reform with shares system
-- The share of the assets of non-State owned commercial banks continued
to rise. The share of the assets of State owned commercial banks in the com-
bined assets of all financial institutions dropped from 56.1% at the end of the
third quarter of 2003 to 54.1% at the end of the third quarter of 2004. During
that period, the total assets of State-owned commercial banks rose by 8.9%,
while 11 shares commercial banks rose by 21.7%, urban commercial banks
by 17.3%, foreign invested banks by 51.8%, urban credit cooperatives by
19.5% and rural credit cooperatives by 15.5%.

5.5.2 Market-based interest reform registered remarkable progress

On 1 January 2004, the People’s Bank of China (PBOC) lifted the upper
limit of the float band of the lending interest rate of commercial banks and
urban credit cooperatives to 1.7 times the base rate, that of the rural credit
cooperatives to two times the base rate and lifted the restrictions on the way
the lending interest rate is determined and how the interest is settled. On 25
March of the same year, PBOC announced the float of the re-lending interest
rate. On 29 October, PBOC announced the lifting of the upper limit of the
Front. Econ. China (2006) 3: 311−372 345

lending interest rate of commercial banks, that the interest rate of both urban
and rural credit cooperatives was enlarged to 2.3 times the base rate and that
the downward float system for RMB deposit interest rate be implemented.
This marked another important step in the process of steadily moving the
market-based interest rate forward and would help the lending interest rate to
better cover the risk premium, ease the difficulty facing SMEs in securing
loans and at the same time create the conditions necessary for financial in-
novations.

5.5.3 The financial sector was opened further to the outside world

The newly revised Detailed Rules for the Implementation of the Regulation
on Foreign Invested Financial Institutions that officially came into effect on
1 September 2004 relaxed further the market access standards for foreign
invested banks. By the end of December 2004, foreign banks had set up a
total of 211 for-profit entities in China, in which there were 167 branches, 14
foreign invested legal person entities and 220 representative offices. A total
of 111 foreign invested banks had been licensed for RMB business, 61 had
been licensed for RMB business of domestic enterprises, 13 had been per-
mitted to launch online bank services, 33 had received derivatives license
and five had been approved as depositors of QFII. Permitted to provide over
100 services, foreign invested banks had USD 67.8 billion dollars in com-
bined assets in China in 2004, up by 37% over the year 2003. Their foreign
exchange lending accounted for 18% of all lending by financial institutions
in China. Their cumulative profits reached USD 282,000,000 dollars in
2004.

5.5.4 Level of RMB convertibility increased constantly

On 16 April 2004, the State Administration of Foreign Exchange (SAFE) is-


sued the Circular on Issues Related to the Adjustment of Standards for De-
termining Limits of Foreign Exchange Accounts under the Current Account,
which increased the foreign exchange retention ratio of foreign exchange
accounts under the current account from 20% of the foreign exchange in-
come under the current account of the previous year to 30% or 50%. On 26
May 2004, the SAFE issued the Circular on Improving the Examination of
Foreign Exchange Settlements under the Capital Account by Foreign In-
vested Enterprises (FIEs) and the Regulation over the Registration of Their
External Debt, which improved regulation in terms of implementing the for-
346 Front. Econ. China (2006) 3: 311−372

eign exchange payment and settlement system and improving foreign ex-
change settlement of FIEs under the capital account as well as in terms of
strictly administering the regulatory policies regarding the external debt in-
curred by FIEs. On 16 November 2004, the PBOC issued the Provisional
Measures on Foreign Exchange Sale and Payment for Outward Transfer of
Private Property, which eased, starting from December 2004, restrictions
over the outward transfer of lawful assets of emigrants by allowing individu-
als to take the principal of and returns on their property and their assets out
of China in the form of cash in foreign exchange.

6 A general analysis of twelve key questions concerning market economy

6.1 Degree of convertibility of RMB

During 2002 and 2003, the policy regarding foreign exchange under the cur-
rent account was improved further and the degree of convertibility under the
capital account continued to increase.

6.1.1 RMB under the current account has already achieved complete
convertibility

-- Foreign exchange policy of the current account was improved further.


After achieving free convertibility, China focused on authenticity checking
in regulating foreign exchange under the current account by mainly relying
on post-event supervision and indirect management. In September 2002,
China implemented the second phase of reform in the foreign exchange ac-
counts under the current account, merging the settlement account and special
account into foreign exchange account under the current account, applying
further the same policy towards the opening of foreign exchange account by
domestic and foreign invested enterprises, simplifying the clearance proce-
dures for import and export transactions, standardizing policy on non-trading
foreign exchange sale and payment, increasing the foreign exchange limit for
residents, establishing a regulatory system for foreign exchange settlement
and sale business of banks and thus greatly improving the foreign exchange
regulation and services.
-- Efforts were made to foster the foreign exchange market and steadily
advance the process of RMB convertibility. The scope of forward foreign
exchange settlement and sales business on a pilot basis was expanded to
Front. Econ. China (2006) 3: 311−372 347

cover more market risk management instruments. Starting from 1 October


2003, two-way transactions were instituted on the inter-bank foreign ex-
change market. At the same time, forward foreign exchange settlement and
sale business was promoted.

6.1.2 Convertibility of RMB under the capital account increased


significantly

-- Efforts were made to steadily move forward the process of convertibil-


ity of the RMB under the capital account. Starting from the year 2002, regu-
lation over the source of overseas investment and the requirement for bond
deposit for repatriation of overseas investment profits were relaxed further.
Restrictions over purchase of foreign exchange for advance servicing of do-
mestic foreign exchange loans and external debt and over the conversion of
external debt into loans were lifted. Procedures for examining foreign ex-
change loans issued by foreign invested banks in China were simplified,
examination of the sale of foreign exchange as capital fund under the capital
account and procedures regarding registration, account and servicing of
principal and interest for foreign exchange loans in China are now directly
handled by qualified designated foreign exchange banks and a Circular On
Issues Concerning Improving Regulation of Foreign Exchange in Foreign
Direct Investment. The QFII was implemented on a full scale in 2003 and by
the year’s end 12 overseas institutions were approved as QFIIs.
-- Number of regulated items under the IMF classification decreased
gradually. Among the 43 capital transaction items under the IMF classifica-
tion, 20 or 46.5% were completely convertible or basically convertible (sub-
ject to registration or approval) by the end of 2003.

6.1.3 Convertibility of RMB will accelerate

-- The issue of convertibility of a country’s currency must be put in per-


spective. International experience has shown that complete convertibility of
the capital account would require such external conditions as a stable
macro-economic environment, robust macro-mechanisms, a healthy finan-
cial sector, effective financial supervision and a favorable international en-
vironment. Therefore, even developed market economy countries would ex-
ercise a certain degree of regulation over the capital transactions.
-- The process of RMB convertibility will gradually accelerate with
changes in the external conditions. Following the principles of incremental-
348 Front. Econ. China (2006) 3: 311−372

ism, emphasizing planning and coordination, proceeding from easier to more


difficult tasks and leaving sufficient room for maneuver, the Chinese gov-
ernment has been opening the capital transactions in a phased and selective
manner. Restrictions were eased first on the inflow side and then on the out-
flow side. Long-term capital movements were opened up before the
short-term movements. Restrictions were lifted over financial institutions
before non-financial institutions and residents. Deliverable transactions were
allowed first and then the non-deliverables.

6.2 Independence of financial sector

During 2002 and 2003, the reform of China’s financial sector accelerated,
resulting in greater market orientation and independence.

6.2.1 The legal framework that ensures the independence of the


financial sector was established

-- The relevant articles in the Law on the People’s Bank of China clearly
set forth the independence of the central bank in terms of policy-making,
funds and financials. The Law on Regulation of the Banking Sector promul-
gated in December 2003 provides that the China Banking Regulatory Com-
mission (CBRC) regulates independently and according to law financial in-
stitutions including the banks and their business activities. The General
Rules of Loans and the Law on Commercial Banks provide that the commer-
cial banks shall operate under the principles of safety, liquidity and earnings
and do so independently, bear the risks, be responsible for profits and losses
and exercise self-discipline.

6.2.2 The commercial banks were more independent in terms of


pricing and making business decisions

-- Reform for market-based interest rate provided China’s banking sector


with autonomy in pricing. Since 1996, the inter-bank rate, securities repur-
chase rate, rediscount rate and the rate of state bonds and policy financial
bonds were deregulated successively and the float band and coverage of loan
interest have been expanded on a number of occasions. Towards the end of
2003, the Central Bank expanded further the float band of loan interest and
allowed the interest of deposits to move downward. The float band of loan
Front. Econ. China (2006) 3: 311−372 349

interest has met fully the needs of commercial banks and has at the same
time helped financial institutions to improve their operations and manage-
ment, the internal pricing and risk management mechanisms.
-- The shares system reform enhanced the independence of the commer-
cial banks in their decision-making process. In December 2003, the Bank of
China and the China Construction Bank started shares system reform on a
structure of modern commercial bank. So far the two banks have finished
asset reevaluation conducted by international accounting standards and im-
plemented reforms to improve the governance structure. Shares system re-
form of other State-owned commercial banks is also proceeding steadily.
Such reform has created conditions necessary for strengthening the inde-
pendence of the commercial banks in issuing loans.
-- The commercial banks follow an independent policy of making loans.
Under the Law on Commercial Banks, various kinds of commercial banks no
longer provide any enterprise or individual with policy loans or issue
government guidance loans and thus have become truly market entities. The
General Rules of Loans prohibits exemption of loan repayment without ap-
proval of the State Council. Meanwhile requirements by commercial banks
for issuing loans for different types of enterprises are uniform and SOEs no
long enjoy any privilege in terms of bank credit.

6.2.3 A pattern of competitive and pluralistic financial sector has


been formed
-- The commercial banks are engaged in heated competition with each
other. By the end of 2003, there were a total of 35,498 financial institutions
in China’s banking sector, in which only four were State-owned commercial
banks. The combined assets and balance of deposits and loans of shares lim-
ited commercial banks and urban commercial banks have increased notably
as a share of the total with their share in assets rising from 8.56% in 1995 to
21.1% in 2003.
-- Foreign invested banks accelerated their entry into China’s banking
sector. They are involved in expanded financial and geographical areas. By
the end of 2003, foreign invested banks in China numbered 84 with total as-
sets of USD46.6 billion, up by 36% over the year of 1998.

6.3 The extent of freedom of employees in their collective bargaining


with employers over wages
During 2002 and 2003, reform for market-based labor and wages systems
350 Front. Econ. China (2006) 3: 311−372

made major progress. The incidence of collective wages bargaining in-


creased dramatically.

6.3.1 China ranks roughly in the middle in the world’s line-up in


terms of government regulation of wages

-- According to Canadian Frazer Institute in its Economic Freedom of the


World Report 2004, the score of China under “regulation of the labor mar-
ket” ranks 62nd place among 95 countries surveyed, at par with Lithuania,
Brazil and Belgium.

6.3.2 Supply and demand of labor is market-based

-- The workers enjoy a relatively sufficient freedom in choosing their jobs.


The Law of the PRC on Labor provides for the right of the worker to equal
employment and choosing jobs and such right is reflected in the law’s im-
plementation. At present, university graduates and newly added labor force
in urban areas are employed on market terms. All discriminatory restrictions
on employment of rural labor force in urban areas have been eliminated and
the free flow of labor from rural to urban areas is accelerating.
-- Enterprises of different types recruit independently. Recruitment by
non-SOEs has been market-based from the very beginning. By the end of
2002, employment by non-SOEs accounted for as high as 68% of the total
urban employment. With the reform of the SOEs and the increasing popular-
ity of labor contracts, SOEs have come to enjoy greater independence in
terms of recruitment. They hire and fire employees in light of the market and
their own performance.
-- Major progress was made in building the labor market. The information
network of the labor markets has been completely established. Intermediary
agencies in the labor market have grown rapidly. The wages guideline sys-
tem had been set up in 29 provinces, autonomous regions or municipalities
in China by the end of 2002.

6.3.3 The equal wages consultation system between the employer


and the employee was forcefully promoted

-- The wages consultation and negotiation system has been established.


Such a system is not only one of the means for setting the wages for labor,
Front. Econ. China (2006) 3: 311−372 351

but also a mature practice of the market. In 2000, China promulgated the
Provisional Measures on Collective Wages Bargaining, which clearly stipu-
lated the wages consultation and negotiation mechanism between the em-
ployee and the employer and further clarified the wage setting by consulta-
tion system. By the end of 2003, the collective wages bargaining system was
established in nearly 300,000 enterprises in China. Governments at local
levels are forcefully promoting the implementation of this system.
-- The lawful rights and interests of the employee are protected. The
workers may join labor unions according to law to safeguard their own law-
ful rights and interests. China has also, according to the international practice,
established and improved the minimum wages standard so as to protect the
most fundamental and reasonable rights and interests of the employee. The
workers have their rights awareness constantly reinforced in handling their
labor disputes with the employers and the results of the disputes are increas-
ingly in their favor.

6.4 The extent to which foreign investment is allowed into China

During 2002 and 2003, the freedom with which foreign investment entered
into China was greatly enhanced.

6.4.1 Blanket elimination of restrictions over the establishment of


foreign invested enterprises (FIEs)

-- Restrictions were gradually relaxed. China’s law contains no discrimi-


natory provisions for the amount of registered capital by foreign investor(s)
in a FIE. Over the past two years, China’s legislature revised such basic laws
governing direct foreign investment as the Law on China-Foreign Equity
Joint Ventures, the Law on China-Foreign Cooperation Ventures and the Law
on Wholly Foreign Owned Enterprises and their detailed rules of implemen-
tation and thus reaffirmed protection of the rights and interests of foreign
investors.
-- FIEs are allowed to merge with or acquire SOEs. China introduced in
November 2002 the Circular on Issues Concerning Transfer to Foreign In-
vestors of the State Owned Shares and Legal Person Shares of Listed Com-
panies and the Provisional Rules on Reorganization of SOEs with Foreign
Investment (effective 1 January 2003). FIEs were allowed to merge with or
acquire Chinese enterprises on the capital market of China and both foreign
investors and enterprises with foreign investment may become a party to the
352 Front. Econ. China (2006) 3: 311−372

merger or the acquiring party.

6.4.2 FIEs have full access to the various fields

-- Fields accessible to foreign investment were enlarged. At present, with


the exception of a few sectors such as weapons and gold production, which
are explicitly off limits to non-SOEs or which require approval for entry,
there are no special restrictions for FIEs and their participation is even en-
couraged by the Government policy. The revised Industrial Catalogue of
Guidance for Foreign Investment that took effect in 2002 listed 262 sectors
for which investment is encouraged, up from 186, and 75 sectors where in-
vestment is restricted, down from 112, showing a clearly higher degree of
opening-up.
-- During 2002 and 2003, foreign investment in various industries in-
creased. The highest growth was seen in the transportation sector, 26.29% in
average annual growth rate, followed by the banking and insurance sector,
25.97% in terms of the average annual growth rate of the amount of foreign
investment. The banking and insurance sector also saw high growth in the
number of enterprises, the average annual growth rate for the two years be-
ing 30.45%. At present, direct foreign investment in China has involved a
wide range of areas, covering almost all sectors of the three industries.
-- Foreign investment in China will show an even stronger momentum. As
the transitioning period for China’s WTO accession draws to an end, the
Chinese Government will continue its positive approach towards foreign in-
vestment. The investment environment in China has continued to improve
and the existing FIEs are now capable of expanding further in China. All this
will help to attract more investment into China.

6.5 The extent of government ownership or control over means of


production and the enterprises

After over two decades of development, Chinese markets of means of pro-


duction have achieved diversity in market entities and the pricing and trading
have become market-based.

6.5.1 Supply of means of production is market-based

-- Market entities in the field of the production of means of production are


Front. Econ. China (2006) 3: 311−372 353

diversified. Of the 42 categories of commonly-used means of production ex-


cluding land, the share of SOEs exceeds 50% only in four categories, namely,
water, power, heating and fuel gas, while private businesses and enterprises
of other ownership structures produce over 50% of the remaining 38 catego-
ries. From 2002 to 2003, the share of SOEs continued to drop.
-- Market entities in the field of circulation of means of production are
also diversified. In the case of minerals, construction materials and chemical
wholesale, which sell mainly means of production, SOEs accounted for only
26.46% of all the enterprises in the industry in 2003 while enterprises of
other ownership types such as FIEs and private businesses took up 73.54%.
-- Direct intervention by the Government in the producers and sellers is
eliminated. This has been achieved by the following three ways: first, by re-
structuring the SOEs and attracting investment by private businesses and
FIEs so as to diversify the market entities; second, by establishing and im-
proving the modern corporate system in the SOEs and replacing the tradi-
tional administrative control with a new type of “Government-SOE” asset
management relationship; and third, by restricting the power of the Govern-
ment with legal means.

6.5.2 The Chinese Government regulates a small number of means


of production in accordance with international practice

-- The great majority of the commonly-used means of production are sub-


ject to no restriction in terms of production or pricing. By the end of 2003, of
the 42 categories, production restrictions existed for only natural gas and
timber, accounting for only 4.6% of the total. As for price regulation, Gov-
ernment pricing or Government guided pricing only apply to a small number
of products such as natural gas, water, electricity, fuel gas, heating and oil
products while 74.42% of the common means of production are subject to no
price regulation of any form. All means of production under regulation are
those with a significant impact on the bio-environment, naturally monopolis-
tic and related to public good.
-- The Chinese Government has been constantly easing price regulation
over the means of production and price regulated means of production take
up a very small share in the total economic aggregates. In 2003, the sales of
Government-priced means of production accounted for only 9.9% of the to-
tal sales, those under Government-guided pricing accounted for only 2.7%
while the market-priced reached 87.4%.
354 Front. Econ. China (2006) 3: 311−372

6.5.3 The Government no longer directly intervenes in the operations


of the enterprises

-- Non-SOEs operate independently and by law, free from control of the


Government. Non-SOEs in China such as the equity enterprises, private en-
terprises and foreign invested enterprises are natural products of the market
economy. Ever since their birth, they have been free from the direct control
of the Government. The relationship between the Government and SOEs is
one of asset management. The SOEs, as legal persons, are entitled to invest,
provide guarantees and import and export products independently and free
from Government intervention.
-- Enterprises of various types may access means of production by way of
the market without discrimination. Both SOEs and private and foreign in-
vested enterprises must access means of production via the market, including
those means of production that are under Government control. Some indi-
vidual enterprises purchase raw materials at a low price as part of their nor-
mal operational tactics.

6.6 The extent of Government regulation over production volume,


pricing, sales and resource allocation of the enterprises

Direct intervention by the Chinese Government in the production and sales


of enterprises has been eliminated and resources are allocated by means of
the market.

6.6.1 Direct Government intervention in production and sales by


enterprises has been eliminated

-- Limited restriction is in place for the production and sale of only a very
small number of products. Guidance plans have all been eliminated for agri-
cultural products. As for industrial products, the State only implements
guidance plans for five products, namely tobacco, edible salt, timber, gold
and natural gas and all other products are produced under market conditions.
-- Direct Government intervention in monopolistic sectors has also been
eliminated. The Chinese Government stepped up the market-based reform of
such monopolistic sectors as telecommunications, aviation, power, grain and
cotton. On the one hand, market access has been made easier to allow multi-
ple market players to compete with each other. On the other hand, the tradi-
tional administrative system has been replaced with the modern regulatory
Front. Econ. China (2006) 3: 311−372 355

system under market conditions. The Government no longer intervenes in


the production and sale of these enterprises.

6.6.2 Production and sale are priced by the market

-- The great majority of the products are priced by the market. In 1992, the
Government set the prices of 5.6% and 10.3% of the total consumer retail
sales and total purchases of agricultural products. The figures dropped to
3.0% and 1.9%, respectively in 2003.
-- The Chinese Government exercises price regulation over a small num-
ber of products in line with the international practice. Under the Price Law
of China, when necessary, the Government may set out a Government
guided price or Government set price on the following five categories of
commodities and services: (1) a very small number of commodities of vital
importance to the national economy and people’s livelihood; (2) a small
number of commodities that are rare resources; (3) commodities under natu-
ral monopoly; (4) important public utilities; and (5) important public ser-
vices.
-- Price regulation has been eased up further. The pricing mechanism for
natural gas is moving towards a market-based one. Urban water price is to be
floated. The reform for power suppliers to compete in price has continued to
be deepened. The purchase price of grains and cotton is already mar-
ket-based. The regulation over aviation pricing has become indirect.

6.6.3 Products and means of production are allocated by means of


the market

-- The supply of products has become market-based. The production and


circulation of the great majority of consumer products and means of produc-
tion are now market-based. The supply and demand sides make transactions
and allocate the products through the market. Even for the very small num-
ber of products under regulation, they are subject to only production volume
and price regulation, not allocation regulation. Their allocation is mar-
ket-based.
-- The means of production must be allocated by means of the market.
Land transactions are much more market- and rules-based. Bidding, auc-
tioning and listing for transfer have become the main models of transaction.
The market has played a significantly greater role in determining labor and
wages. Allocation of funds is much more market-based too with the domes-
356 Front. Econ. China (2006) 3: 311−372

tic loans and self-raised funds taking up a rising share of the total national
investment in fixed assets.

6.7 The guarantee of property rights and the law on bankruptcy

During 2002 and 2003, substantial progress was made in China in building
the legal framework for the protection of property rights.

6.7.1 The property rights of China’s private businesses are protected


by law

--. The law has been improved further. The Amendment of 2004 to China’s
Constitution explicitly provides that the lawful private property of citizens is
inviolable, further improving and developing the regime for protecting pri-
vate property. The draft Civil Code contains a special chapter on property
rights that clearly stipulates for the protection of the private property. Local
regulations have been adopted in 26 provincial jurisdictions in China that
protect the property rights of private enterprises.
-- Thanks to the support of law and policies, the private enterprises in
China have enjoyed exceptionally rapid growth. The total wealth created by
them since 1992 have been growing at an annual average rate of over 30%.
In 2003 they created a total of RMB 1,896.45 billion yuan in industrial out-
put, up by 31% over the previous year, 91.5 folds higher than the year of
1992.

6.7.2 Protection of intellectual and land property rights has been


strengthened

-- The protection of intellectual property rights (IPR) has been stepped up.
Over ten laws and regulations such as the Detailed Rules for the Implemen-
tation of the Law on Trademarks and the Regulation on Protection of Com-
puter Software have been revised or promulgated since 2002, resulting in a
more complete legal system for IPR protection. IPR tribunals have been es-
tablished in courts at different levels. The IPR cases accepted by the judicial
agencies cover all the areas under the TRIPS Agreement. A parallel
two-track system for IPR protection involving enforcement by the courts and
administrative agencies has been established.
-- The protection of the land property rights has been strengthened. The
Front. Econ. China (2006) 3: 311−372 357

Law of the PRC on Land Administration and the Provisional Regulation of


the PRC on the Transfer and Reassignment of the Right to Land Use clearly
spell out the protection of the land ownership and right to use. During 2002
and 2003, the Chinese Government stepped up the protection of the land use
right of private businesses and foreign invested enterprises. Now the private
businesses acquire the right to use of land and pay the fees in exactly the
same way as other investors.

6.7.3 Enterprises of various types implement uniform bankruptcy


procedures

-- A relatively complete legal system for bankruptcy has been formed in


China. The Law of the PRC on Bankruptcy of Enterprises, the Law of the
PRC on Civil Procedures and the Rules of the Supreme People’s Court on
Certain Issues Concerning the Trial of Enterprise Bankruptcy Cases consti-
tute China’s legal system for bankruptcy. Be it SOEs or private businesses,
when meeting the statutory causes for bankruptcy, they would go bankrupt
according the relevant legal procedures. In addition, the revised Law on
Bankruptcy will be introduced very soon.
-- In China, enterprise bankruptcy is common and normal. From 1994
through 2003, China’s court system tried a total of 61,464 enterprise bank-
ruptcy cases, closed 50,806 such cases, representing an average of 5,080
cases annually and a case closure rate of 82.6%, in which 33,313 cases in-
volved the bankruptcy of SOEs, accounting for 54.2% of all the cases ac-
cepted.

6.8 The implementation of the laws and regulations relating to


investment and taxation

Various types of enterprises in China are subject to practically the same law
in terms of investment and taxation.

6.8.1 Enterprises of different types are equal before the law on in-
vestment and taxation

-- As for taxation, apart from the tax on enterprise income, foreign and
domestic funded enterprises are subject to the same law. Such laws and
regulations as the Provisional Regulation on Value-Added Tax, Provisional
358 Front. Econ. China (2006) 3: 311−372

regulation on Consumption Tax, Provisional Regulation on Business Tax,


Law on Individual Income Tax, Regulation on Import and Export Tariff Du-
ties and the Law on Administration of the Levy of Taxes apply uniformly to
both domestic and foreign invested enterprises.
-- Enterprises of different types enjoy the right to make investment-related
decisions and the equal right to financing. The Decision of the State Council
on the Structural Reform of Investment issued in July 2004 clearly provides
that the principle of having the investors make the decision and bear the risks
shall be applied to categories of projects encouraged or allowed by the State,
i.e., it is up to the enterprises themselves to invest within the bounds of the
law.

6.8.2 Private businesses enjoy “national treatment” for investment


and taxation

-- The areas open to investment by private enterprises have been con-


stantly broadened. In December 2002, the former State Development and
Planning Commission promulgated the Rules on Promoting and Guiding
Private Investment, which clarified that capital of the private businesses may
be invested in all areas where foreign investment is encouraged or permitted.
At present the State law and regulations impose no special restrictions over
the non-SOEs with the exception of a small number of sectors such as
weapons production and gold production, which must be monopolized and
therefore are explicitly closed to non-SOEs.
-- Private businesses and SOEs are subject to a uniform set of taxation
laws and policies. The Chinese Government applies taxation laws and poli-
cies uniformly to SOEs and non-SOEs and the law is not discriminatory
against private businesses in terms of taxation. The law also applies uni-
formly and stringently to the collection of taxes.
-- The environment for the private enterprises has also been greatly im-
proved. The improvement in the policy and legal framework has resulted in
the rapid development of private companies. During the period from 1992 to
2003, the added value contributed by non-SOEs as a share of the GDP rose
from 53.6% to 69%.

6.8.3 Foreign invested enterprises enjoy national treatment for


investment and taxation

-- Areas open to foreign investment have been constantly broadened. The


Front. Econ. China (2006) 3: 311−372 359

newly revised Industrial Catalogue of Guidance for Foreign Investment is-


sued by the Chinese Government in March 2002 increased the number of
encouraged categories from 186 to 262 and reduced the number of restricted
categories from 112 to 75. It relaxed the restrictions on equity ceiling for
foreign investment in enterprises. It opened up new areas to investment, list-
ing for the first time in history such sectors as telecommunications and urban
piping systems, including fuel gas, heating and water supply and sewage
where investment used to be prohibited from foreign investment. It opened
further such service sectors as banking, insurance and commerce.
-- As far as taxation is concerned, the FIEs enjoy more preferential treat-
ment than the domestic enterprises. In the case of income tax, the basic tax
rate is 33% for domestic enterprises and 30% for FIEs. In special economic
zones, economic and technological development zones and coastal economic
open zones, FIEs generally enjoy a 15% preferential tax rate while domestic
enterprises may enjoy the 15% rate only in high and new technology devel-
opment zones. Qualified FIEs may also enjoy a two-year tax holiday fol-
lowed by a three-year half-tax rate treatment starting from the first year
when they turn a profit.

6.9 Company law and corporate governance

A relatively complete legal system on corporations in China has been estab-


lished and corporate governance has been increasingly rules-based.

6.9.1 Company law is in line with that of developed countries

-- The establishment, organizational structure and the issue of stocks of


companies in China are in line with those in developed countries. The Com-
pany Law of China was promulgated in 1993. As there had been no legisla-
tive practice on the company law, the Law was written by drawing upon and
being compared with the successful experience of other countries in legisla-
tion. The majority of the provisions of the Law reflects the international
practice. On the establishment of limited shares companies, there are no sub-
stantive differences between China and Western countries. They share the
same basic legislative principles and objectives. The provisions over the or-
ganizational structure of limited shares companies are also basically the
same. On the issue and transfer of shares, China’s Company Law not only
follows the principle of equality among shareholders but also implements
even stricter controls to protect the interests of investors.
360 Front. Econ. China (2006) 3: 311−372

6.9.2 Corporate governance became more rules-based

-- There has been constant improvement in the legal framework. Over the
past decade and more, the Chinese Government, drawing upon the interna-
tionally accepted rules, has introduced a series of important laws and regula-
tions such as the Company Law, Securities Law, Rules on Governance of
Listed Companies and the Guidelines on the Establishment of the System of
Independent Directors, which have played a fundamental promoting role for
improving the governance of companies in China.
-- The mechanism of corporate governance was further improved. In 2003,
among the large enterprise groups in which the parent company had already
been restructured, 90.63% established the conference of shareholders system,
97.16% established the board of directors and 81.18% established the board
of supervisors. Information disclosure of listed companies was improved too,
providing greater protection for the rights and interest of investors.
-- The Board became more independent. A great majority of the listed
companies had independent directors and nearly half of all listed companies
established special committees under the board. The right of shareholders to
elect Board members was strengthened with over half of the listed compa-
nies prescribing in their Constitution the election of Board members by cu-
mulative vote. The deliberation function of the Board was gradually im-
proved as over 90% of the listed companies have developed rather detailed
rules for Board deliberations.
-- The ratings of China’s corporate governance by authoritative foreign
agencies are higher than some market economy countries and regions. In the
report on corporate governance across the global emerging markets issued by
Credit Lyonnais Securities Asia (CLSA) in 2001, the score for China’s
mainland was 49.1 (on a 100-point scale), higher than such countries as
ROK, the Philippines and Indonesia. In the Standard & Poor’s report that
assessed corporate governance of 1,600 listed companies across the world,
the score for China’s mainland was 5 (on a 100-point scale), which was
higher than Indonesia, the Philippines and Chinese Taipei, at par with ROK,
but higher than ROK in terms of financial transparency and disclosure.

6.10 Law on enterprise accounting and auditing standards and its


enforcement

The accounting and auditing standards of China are already in conformity


with the international standards and have been effectively implemented.
Front. Econ. China (2006) 3: 311−372 361

6.10.1 Law on accounting standards is effectively enforced

-- By the end of 2003, a relatively complete four-tiered accounting legal


system with the Law on Accounting as the core had been formed in China,
the first tier being the Law on Accounting, followed by the Regulation on
Enterprise Financial Accounting Report, the Enterprise Accounting System
and its detailed standards and the Basic Working Standards of Accounting.
There are essentially no major discrepancies between the existing accounting
law and regulations of China and the international accounting standards in
terms of the basic accounting concepts, principles and the specific methods
of determination and calculation.
-- The Chinese Government has taken a number of measures to ensure the
full implementation of the accounting laws and regulations. First, training
and inspection have been stepped up. Financial authorities at and above the
county level are in charge of regular inspections and the Ministry of Finance
is responsible for organizing nation-wide enforcement inspections. Secondly,
requirements for the enterprises to implement the laws and regulations have
been enhanced. It is made clear that the senior management shall be respon-
sible for the accounting of the enterprises. Book-keeping rules have been
improved. Professionalism of accounting personnel has been improved, and
accounting computerization and network-building have been accelerated.
Thirdly, the role of CPA firms and other intermediaries as supervisors has
been strengthened.
-- The authenticity of the books of the enterprises is guaranteed. First, the
judicial organs have been trying cases of accounting violations to safeguard
the dignity of law and regulations and ensure that accounting activities and
acts are conducted according to law. Secondly, administrative supervision
has played its role in restraining and regulating the accounting activities and
acts of the enterprises. Thirdly, CPAs are entrusted by their clients to audit
the latter’s accounting statements and make auditing comments and rectify
their accounting activities and acts. Lastly, the violating enterprises and in-
termediaries would be penalized severely.

6.10.2 The law on auditing standards is effectively implemented

-- In China a complete independent auditing legal system has been estab-


lished. From 1993 to 2003, a series of laws and regulations on auditing were
formulated and enacted that resulted in an auditing legal system centering on
the Law of the PRC on Auditing. In addition, China’s auditing standards are
moving towards the international auditing standards.
362 Front. Econ. China (2006) 3: 311−372

-- Enterprises are more independent in auditing. Since its inception in


2003, the State-owned Assets Supervision and Administration Commission
has stepped up the auditing of the Central Enterprises by formulating the
Provisional Measures on Auditing and Regulation of Economic Liabilities of
Central Enterprises, which stipulates that the senior management of enter-
prises shall be subject to economic liability audit upon leaving office or ex-
piry of their terms. China’s National Audit Office adopted a more targeted
approach towards different types of enterprises in its Audit Work Develop-
ment Program from 2003 to 2007.
-- Independent auditing standards have come to play an increasingly im-
portant role. It is mandatory to have CPAs audit the accounting statements of
listed companies and provide investors with reliable information. The stan-
dards for independent audit have been revised and improved all the time.
The intermediaries are playing a more and more important role in audit.

6.11 The use and treatment of SOEs’ assets

The Chinese law has set forth rules for the accounting treatment and use of
the State-owned assets that are clear and consistent with the international
practice.

6.11.1 The way the use of SOEs’ assets is treated in the accounting
books is in conformity with the rules of the market economy

-- With regard to the depreciation of fixed assets, the Enterprise Account-


ing Standards: Fixed Assets that came into force in January 2002 set out
clear provisions for the definition and depreciation scope of fixed assets and
how depreciation shall be calculated. Its basic principles and methods are
already in line with the international practice. For example, on the account-
ing treatment of the land, the Enterprise Accounting Standards: Fixed Assets
provides that land that is entered into the books as fixed assets after being
separately valuated shall not be depreciated. The IAS 16: Property, Plant and
Equipment provides that land normally has an unlimited useful life and
therefore it shall not be depreciated. It can be seen that the two are in con-
formity with each other.
-- On amortization of assets, China’s Enterprise Accounting Standards:
Basic Standards and Enterprise Accounting Standards: Intangibles set out
provisions for the amortization of the assets and are aligned with the interna-
tional accounting standards. For example, the Enterprise Accounting Stan-
Front. Econ. China (2006) 3: 311−372 363

dards: Intangibles requires that all intangibles including goodwill must be


amortized within the expected period of use. Both the IAS 22: Business
Combinations and the IFRS 3 that took effect on January 1, 2005 require that
the goodwill bought be amortized. The stipulations are the same.

6.11.2 The State-owned assets are treated by the market rules

-- On appraisal of the State-owned assets. The State Council of China is-


sued in 1991 the Measures on Regulating the Appraisal of State-Owned As-
sets, which provides that the assets shall be appraised if the unit that pos-
sesses the State-assets engages in one of the following activities: auction or
transfer of the assets, or enterprise merger and acquisition, buyout, joint op-
erations and operation with a shares structure. The Provisional Measures on
Regulating the Transfer of State-Owned Property Rights by SOEs also re-
quires that the State-owned assets to be transferred must be appraised by a
qualified assets appraiser in accordance with the relevant rules of the State.
The valuation report, upon approval or being filed, shall be the reference for
the determination of the price for the State-owned assets to be transferred. In
order to improve the quality of the service of China’s appraisers the China
Appraisal Society adopted the Provisional Guidelines on Appraising Enter-
prise Value by drawing upon the international appraisal standards.
-- On the reform and asset transfer of SOEs. The Chinese Government
formulated in 2003 the Suggestions on Regulating the Reform of SOEs and
the Provisional Measures on Regulating the Transfer of State-Owned Prop-
erty Rights of Enterprises, which made clear stipulations on the reform and
asset transfer of SOEs. The reform of SOEs shall take the forms of reorgani-
zation, alliance, merger, transfer of State-owned assets or shares cooperation.
The assets, including the intangibles, and the land use right must be ap-
praised. State-owned assets must be transacted on the floor. The transferring
party shall organize the enterprise that transfers the asset to verify its assets
and capital and hire an accounting firm to execute a comprehensive audit. The
transaction must be disclosed to the public and conducted by competition.

6.12 Others (including corruption, trade relations etc.)

6.12.1 Corruption

-- Corruption has little effect over dumping. As a common challenge to the


364 Front. Econ. China (2006) 3: 311−372

countries in the world, corruption would exert a huge impact on the domestic
political life and economic development. However, it has little effect on
dumping as it has no direct impact on the cost and price of products. Even if
it has an impact, the result is uncertain as it may either raise or lower the cost
or price. For example, in industries such as color TV set and furniture where
competition is fierce and the profit margin is thin, acts of corruption such as
bribery may only drive up the cost, add to the burden for the enterprises and
dull their competitiveness.
-- China has taken seriously the fight against corruption and stepped it up.
First, by streamlining the government structure, introducing laws and regula-
tions to restrict government intervention and reducing administrative ap-
proval, China has sought to stem corruption at its root. Secondly, China has
further regulated and improved the bidding procedures for projects, intro-
duced a comprehensive system for bidding, auction and listing for transfer of
the right to use land for profit and implemented the government procurement
system to make the market regulation more transparent and open. Lastly, a
relatively complete system that balances and restrains power and a legal
framework that fights corruption have been established.

6.12.2 Export Administration

-- China has improved its trade laws and regulations according to the
WTO rules. China has fully opened up the access to the import and export
trade right. All domestically invested enterprise registered in China are sub-
ject to a uniform policy in terms of qualifications regulation for import and
export trade and all of them may apply for the trade right, which is obtained
by registration and filing. Rules such as the Provisional Measures on En-
quiry to China-WTO Notification and Enquiry Center have been formulated
to increase the transparency of foreign trade administration.
-- Export rebate rates have been significantly reduced. In October 2003,
China reformed the existing export rebate system. The revised export rebate
rates were set at five levels, i.e., 17%, 13%, 11%, 8% and 5%. The average
rebate rate was three percentage points lower.
-- The export license system is more rules-based. The Regulation of the
PRC on Imported and Exported Commodities that became effective in Janu-
ary 2002 implements a classification-based system for managing the import
and export of commodities and requires public bidding for exported com-
modities subject to quota and license management. The Chinese Government
has also constantly cut back the restrictions on import and export trade. By
the end of 2003, the number of commodities subject to export license man-
Front. Econ. China (2006) 3: 311−372 365

agement had been reduced to 52.

6.12.3 Barter trade

-- Barter trade takes up a very small percentage in China’s overall trade


and is on the decline. This share in total trade dropped from 0.021% in 2000
to 0.014% in 2001 and further down to 0.005% in 2003. Barter trade is also
dwindling drastically in absolute terms. Its volume dropped by more than
half, from USD 98.54 million in 2000 to USD 47.43 million in 2003.
-- Modern barter trade is still in its inception in China. Compared with the
traditional barter trade whose share is going down, modern barter trade has
developed somewhat in some large- and medium-sized cities in China. At
present, there are only a few barter traders in China, such as the Dalian Bar-
ter Exchange Center, China International Barter Network and Huaxia Barter
Trade Co. On the whole, the sector is still in the start-up stage.

7 Resolution of the “Non-Market Economy” issue: a win-win option

To resolve China’s “Non-Market Economy” issue would, on the one hand,


require the Chinese side to provide information to prove otherwise and, on
the other hand, take a whole new approach on the part of the EU, the US and
other countries, i.e., to examine their trade ties with China from a mutual
benefit point of view. Moreover, discussions at the technical level must be
combined with decision-making at the political level. Absent facts and theo-
ries at the technical level, it would be difficult for the decision to be taken at
the political level. Without the vision and courage at the political level, the
work at the technical level would be shelved. Therefore, it is utterly critical
that a consensus be reached at the political level.
On the political plane, a reversal of the traditional perceptions and mindset
is of primary importance. The traditional or old thinking holds that if China
is kept on the list of NMEs, its competitiveness in exporting would be un-
dercut. The market would remain the way it was carved up, which is good
for the trade interest of the existing players. Such a line of thinking actually
betrays a lack of vision. Nor does it hold water. The new thinking would ar-
gue that bilateral or multilateral economic exchanges and trade must be
viewed in the bigger context with considerations given to one’s own interest
and that of others so as to achieve mutual benefit and win-win results. Top
priority shall be given to development and differences shall be resolved by
expanded economic cooperation and trade. Bilateral economic and trade co-
366 Front. Econ. China (2006) 3: 311−372

ordination mechanisms must be allowed to play their role to facilitate com-


munication and consultations and avoid escalation of tensions. Consultations
must be held on an equal footing by seeking greater converging interests
while putting aside minor differences, instead of willfully jumping to restric-
tive measures or sanctions. At the same time, economic and trade issues shall
not be politicized1. The above five principles are set in the WTO framework
and based on the basic principles of international trade. Their essence is de-
velopment, equality and mutual benefit. Development is the driving force,
equality is the precondition and mutual benefit is the purpose. To be more
specific, the benefits that arise from treating each other as equals outweigh
those from straitjacketing and containing China’s development. This is the
new thinking that needs to be advocated in the context of fair trade.
International trade benefits all. This has been borne out by theories and
practices of the Western countries over the past hundreds of years. It is par-
tial and shallow to equal trade deficit with interest lost. It is a consensus in
the theory of international trade that a country pursues balance of interna-
tional payments, not just surplus. In another word, one must look compre-
hensively at the relationship between trade accounts and capital accounts,
not just the surplus or deficit in the trade accounts alone. For example, the
US has deficit in its trade with China. But much of China’s foreign reserve is
spent buying the US Government bonds, which in itself is a contribution to
the balance of international payments of the US. Even if we look at the trade
only, the export of large quantities of Chinese products to the US causes no
injury to the latter’s economic interest. The products of China provided at an
affordable price but with a good quality have contributed significantly to
meeting the needs of the Americans in their lives. And many of the products
from China are produced by enterprises invested by the US or other coun-
tries or purchased or ordered by American merchants in China after careful
selection. What Chinese workers get is very low processing fee while the
firms in the US makes profits, including the logistics companies, wholesalers
and retailers who profit from the transport and sales of Chinese commodities.
Therefore, the China–US trade is mutually beneficial. It is normal that some
US firms that compete with Chinese exports have come to feel some pres-
sure. Such an imbalanced structural distribution of commercial interests ex-
ists in all countries in the world. The visionary statesmen would make their
judgment from a strategic point of view. It is unreasonable and impossible
for a major power to demand that it enjoy surplus in its trade with all other

1
Speech entitled “Work Together to Write A New Chapter in China-US Economic Cooperation and Trade”
made by Premier of China Wen Jiabao at luncheon hosted by American Bankers Association on December 8,
2003 in New York. In the speech, Premier Wen put forward five principles for advancing fair trade between the
two countries.
Front. Econ. China (2006) 3: 311−372 367

countries or in all lines of products. Not all China’s firms or industries are
happy with foreign imports into China either. But China is aware that trade is
done by the firms and the choice of millions of consumers. The increase or
decrease in trade volume is governed by economic and market laws. There
are bound to be profits and losses in the competition. China incurs a
long-term deficit in its trade with ROK and South-East Asian countries. Has
China ever expressed complaint or raised any excessive requests with these
countries? The answer is negative. The developing trends show an even
clearer picture of complementary trade ties between China and other coun-
tries. China’s import volume in 2003 ranked the third in the world. It is ex-
pected that the annual import of China by the year 2010 will top one trillion
USD2. The frequent resort to trade barriers to roll back China’s export may,
in the short run, serve the interest of some enterprises in Europe and the US.
However, it may cause greater long-term losses for China’s trade partners in
terms of reduced exports to China. It is fair to say that to give support to
China’s economic development today, putting trade with China in perspec-
tive and playing by fair rules are actually supporting their exports to China in
the future.
Some developed countries have always claimed that they support China in
its reform and opening-up and its transition to a market economy. However,
when it comes to specific economic interest, they more often than not would
develop their fair trade policies by proceeding from their own interest only.
If every country should act this way, international rules would be
non-existent. What we recognize is the fair trade under the WTO rules, not
the fair trade under the rules of one single country. It is hoped that those de-
veloped countries which have manifested a strong inclination for unilateral-
ism in their fair trade policies will not only protect their domestic enterprises,
but also set an example in safeguarding the internationally recognized rules.
It is important that in addressing China’s MES, they will show a truly fair
approach and give their support to China’s economic reform with concrete
action.
From a technical point of view, to recognize a country’s market economy
status, though it may simplify somewhat the antidumping procedures, does
not preclude antidumping investigations. In fact, to grant China the market
economy status does not impede, and may even facilitate antidumping pro-
ceedings by China’s trade partners targeting Chinese firms. First, by re-
questing the status, China is not asking for some preferential treatment, but
for the right to trade on an equal footing. Therefore, it is not against anti-
2
Speech by China’s Minister of Commerce Bo Xilai at the International Forum on Common Development of
China’s Economy and the World Economy jointly organized by the Ministry of Commerce, UNCTAD and Ren-
min University of China on September 10, 2004.
368 Front. Econ. China (2006) 3: 311−372

dumping, but rather against unfairness. To be more specific, China is op-


posed to antidumping proceedings conducted in violation of the fair trade
principles and supportive of normal antidumping proceedings. Secondly, we
have seen that the antidumping investigations targeting firms of market
economies are direct investigations, while those targeting NME firms are in-
direct ones. The scope of the former is a given firm in a given country while
the scope of the latter is world-wide. In terms of findings, those of the for-
mer are definitely more real, accurate and true to the reality. The former ap-
proach is also far less expensive in terms of the cost of investigation. Given
the above, we are of the view that the issue of NME has actually complicated
things. To plant too much seed of trouble to the counterpart in the detailed
provisions of laws, regulations or treaties would excessively complicate the
trade terms and increase the transaction cost for international trade. Anti-
dumping is a double-edged sword which, if overused, may backfire.
Free trade used to be the banner of industrialized nations represented by
Britain when they made their way into the markets of agricultural countries.
However, when export from developing countries started to peak, developed
countries acted swiftly to develop their fair trade policies ahead of the de-
veloping countries and to counter free trade with fair trade. This is a note-
worthy historical phenomenon. Generally speaking, the developed countries
provide assistance and support to developing countries not only to win sup-
port of the world but also to create a better framework for their own future
development. This would bring mutual benefit and win–win results. Con-
versely, there would be criticism and boycott by developing countries. On
April 15, 1994, representatives of 124 governments and the EU that partici-
pated in the Uruguay Round of Negotiations adopted the Marrakesh Decla-
ration in Marrakesh, Morocco which stressed the special and differential
treatment for developing countries and took particular note of the special
situation of the least developed countries (LDCs). However, as we have seen
over the past few years, in the antidumping investigations involving products
of China, no effective actions have been taken to explore possibilities of
constructive remedies before applying antidumping duties where they would
affect the essential interests of developing country Members as required by
the WTO ADA.
Of course, it must be pointed out that over the past couple of years, the EU
and the US have had exchange of views and discussions with China over the
NME issue, which is a good start to recognizing China’s market economy
status. In 2004, the European Commission, in its response to the formal re-
quest for MES by China’s Ministry of Commerce (MOFCOM), set up an
experts group on NME and made a preliminary assessment report on the
Report of 2003 on Progress in China’s Market Economy provided by the
Front. Econ. China (2006) 3: 311−372 369

Chinese side. At the Fifteenth Session of the China–US Joint Committee of


Commerce and Trade (JCCT), the two sides agreed to consult on China’s
MES issue and had an in-depth exchange of views over the work plan of the
working group. Canada decided to presume all Chinese industries to be
market-oriented industries (MOI). By the end of 2004, a total of 34 countries
had publicly recognized China’s market economy status. Still though, there
remain lots of issues to be studied and views and data to be exchanged be-
fore China’s NME issue can be fully resolved. We will continue to work for
an early consensus among all the parties.

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