Enter the Dragon How China's accession to the WTO will affect Thailand's agricultural and food industries Caveats: Market Changes in China After WTO   Published on January 4, 2002

Countries looking to invest in China are expected to face a number of transitional challenges during the onset of China's market liberalization process. The reduction of customs duties, liberalization of trade and investment, and the opening up of the domestic market (previously monopolized by state-run enterprises) to foreign competition will all favor foreign businesses looking to expand their interests in China. However, in the initial stages, investors expect trade liberalization to be the "honey pot".

Purchasing Power in China

Although China will be the single largest market in the world, the population's purchasing power will likely remain low as trade liberalization will create greater unemployment in some sectors. China's farmers are likely to be the hardest hit. The country's roughly 600 million farmers, making up two thirds of the labor force, currently receive less than half the average income of their urban counterparts.

Furthermore, farmers' income growth dropped from 4.8 per cent in 1997 to only 2.1 per cent in 2000, well below the growth rate of the national economy as a whole, and as a result, 40 per cent of rural residents rescued from abject poverty since 1979 have fallen below the poverty line again, according to a recent China Daily report.

For the time being, the number of unemployed in rural areas is believed to be well over 150 million. Increases in cheaply imported foreign products will undoubtedly drive more Chinese farmers out of work. A study by China's agriculture ministry finds that only 168 million farmers will be needed in 2005; the remainder will either have to be absorbed in the cities by working as migrant workers or by starting their own businesses. The estimated number of displaced workers during this shift is expected to reach about 13.2 million. Therefore, it is equally important for foreign companies to take advantage of China's cheap labor and create employment, thereby ensuring steady purchasing power.

Net Producer to Net Importer

China's population is projected to reach 1.6 billion by 2030. Geographically, most of that population is concentrated in the region through which several great rivers, including the Yellow and the Yangtze, flow. Those rivers provide the irrigation needed to grow much of the food for China, as well as the water for its burgeoning cities and industries.

China's farmers' ability to provide sufficient food for the nation is constrained by a range of factors. Water supply is a huge problem in China, and this will be a limiting factor in its agricultural output capacity. In addition, the country is also faced with other encroachments on agriculture, such as the construction of roads over once-productive farmland, the erosion of soil, diminishing benefits of fertilizer and a rising backlog of the technology used to raise land productivity. However, it is the swelling diversion of irrigation water, combined with heavy losses to aquifer depletion that has emerged as the most imminent threat to China's food security

China has serious ecological limitations on agricultural production, and although the country is the world's largest agricultural and aquatic producer after the United States, the country has a host of problems to solve. Unfortunately, China's agricultural sector faces financial constraints brought on by local corruption, excessive production fees, taxes levied on rural farmers and reduced earnings of Township and Village Enterprises (TVEs). This will make expanding agricultural output and domestic food security and sustainability increasingly difficult for Chinese producers looking to produce competitively in the world market.

The poor population-to-arable-land ratio leaves China in a much inferior position compared to other relatively land-rich countries (e.g., the U.S., Canada, Australia and Thailand), adversely affecting their competitive advantages. Imported goods are expected to replace domestic agricultural products, which will hurt domestic agricultural production and increase unemployment among farmers.

Chinese farmers who survive trade liberalization will have to cope and strictly manage the country's limited arable land, water and irrigation systems. In addition, Chinese farmers will have to learn to compete without the tools China once provided for their farmers to help them compete and survive. For example, national policies that deter the free trade of agricultural goods will be abolished. Furthermore, supporting measures such as export subsidies, price support, reductions in the interest on loans owed to the State by SOEs, subsidies for seeds and fertilizers, and impartial plant and animal quarantine inspections are among the methods that will be prohibited under the WTO. A liberalized market will force China to only produce items that they can do so with a substantial competitive advantage.

Although China's agricultural sector will for the most part be at an extreme disadvantage upon trade liberalization, China is likely to remain a net exporter of some agricultural products. Agricultural economists suggest that China is expected to stay competitive in the production of fruit and vegetables. In terms of planting areas and production, China is the world's no. 1 producer of fruit and vegetables. At the same time, the quality and breeding structure of China's fruit and vegetable products are improving. In addition, China is competitive in labor-intensive industries, such as aquatic products and animal husbandry. Unfortunately Chinese producers have a long way to go in improving their product quality, prices and quantity, as well as their processing, packaging and marketing skills.

Investment Potential in China's Food Industry

For foreign companies with the right products, the investment potential in China could be enormous. Studies have shown that the diets of Chinese households adjust in line with economic growth. Exotic flavors, including the spicy, salty, sweet and sour tastes of Thai food, could easily become popular among the Chinese population due to the variety of flavors, as well as the similarities to Chinese food in terms of presentation and preparation.

Aside from the allure of exotic flavors, convenience is recognized as a factor that could lead to ensuring products become successful in China, and the market for fast food is expected to take off. A survey by the State Administration for Industry and Commerce shows that the fast food market has grown by more than 20 per cent per annum over the last decade. Most of the fast food chains are foreign, however, China also has a number of domestic fast food chains. The biggest local fast food chain, Malan Noodle Fast Food Chain Store Co Ltd, generated more than $ 40 million in revenue last year, company officials say. Companies looking to share in the success of the fast growing market segment should specifically tailor products to it, for example, manufacturing easy to prepare convenience foods, such as frozen vegetables or meat.

Investments in fruit and vegetable processing in China could be advantageous for producers manufacturing products to supply to the domestic Chinese market, instead of importing processed fruit and vegetable goods from Thailand or elsewhere. China's meat, fruit and vegetables have a price advantage over foreign products. However, it is unlikely that China will be able to export a much larger quantity following its entry into WTO because its quarantine standards, freshness retention technology and processing are all still of a lower standard than many other nations. In addition, the shape and taste of its products may not yet be appropriate for export markets.

Joint ventures focusing on Thai raw materials and Chinese labor and processing should be rewarding. The cost of labor in China is significantly lower than in Thailand. Once trade in agriculture is further liberalized, it's natural that Chinese processors will import raw materials and process value added foods in China both for domestic use and export.

China has agreed that any entity will be able to import most products into any part of China, phased in over a three-year period, with all entities being permitted to import and export at the end of that period. At present, China imposes low import tariffs on agricultural products from the U.S., Japan and Southeast Asia. However, the import tax is still 30-45 per cent on average for fruits and beef.

Barriers to the Chinese Market

Strategies to protect a nation's market from foreign competition are becoming increasingly sophisticated, and as with any market, exporters should follow strict import regulations for compliance under the WTO. Under the WTO, foreign competition will force the Chinese market to rid itself of inefficiencies. For example, pre-WTO regulations and policies subsidized farmers and supported oversupply. However, under the WTO regulations, China has made a commitment not to use export subsidies for agricultural products. It has also made a commitment to cap and reduce trade-distorting domestic subsidies, which were set at 8.5 per cent during the last round of negotiations.

The import tariffs on agricultural products entering China are scheduled to decline from an average of 22 per cent to 17.5 per cent. Therefore, imports of foreign agricultural products are expected to surge as prices decrease. Foreign competition will threaten any Chinese products that are not competitive in the world market. In addition, under the regulations of the WTO, China will be required to give up its monopoly power over agricultural production and distribution, as well as most state controls over imports and exports. Henceforth, China's agriculture will be subject to market forces, with some very painful consequences for local farmers and entrepreneurs.

The Chinese government has always regarded agriculture as a key strategic sector for the national economy. Many believe that China will initiate new protective policies that are WTO-compliant to ward off sharp rises of foreign imports. These may include strict inspection criteria as well as WTO's "Green Box" policies, which allow domestic agricultural support policies not subject to reduction commitments.

Transportation logistics in China are somewhat of a market barrier, and this lack of transportation and trade infrastructure is a worrisome issue for exporters. Presently, China's port and transportation infrastructure is insufficient to adapt to major increases in trade volume. Therefore, the extent to which China's trade profile will change due to the WTO accession depends, at least to some extent, on the country's ability to rapidly increase imports and deliver them thought the country.

The Chinese government has said its plans to provide technology, an improved infrastructure and other support, such as banking services, so that farmers can shift from resource-intensive industries (such as the production of grains and edible oils) to labor-intensive industries (such as the production of vegetables, fruit, dairy products and food processing). Whether the government actually carries out these programs will be important in relation to the kinds of foods an exporter is going to invest in trading. In the upcoming months it will be important for exporters to carefully follow domestic news in China.

Reorganization and adjustments in government departments will be inevitable, which is expected to cause some confusion in trade. Upon China's accession to the WTO, changes will include reducing customs duties, eliminating non-tariff trade barriers and allowing foreign companies to compete in most of China's markets. When China begins to fulfill its commitments to liberalize farm product trade, such things as import permits are also expected to change for the foreign farm products sold in China. Therefore, importers may face some confusion until all China's importing regulations have been made public.

Conclusion

Environmental limitations and WTO regulations on subsidies applied to agricultural goods in China are expected to limit the domestic production of non-competitive products. Although less competition should result in higher sales for exporters, initially it is expected to result in weakened purchasing power for displaced farmers during the transitional period, who will no longer be able to compete with imported agricultural products. Therefore, anxious investors looking to China may choose to sit back and wait until China has become used to the logistics of liberalized trade. First-movers into this market will be like guinea pigs, testing out import regulations, documentation, national policies, transportation, logistics and business culture within the country.

Although there are expected to be many trade uncertainties initially, accession into the WTO is expected to result in increased agricultural imports into China. WTO accession may induce major policy changes in China, such as reductions in the government's ability to enforce self-sufficiency, which will further impact China's agricultural production and trade, affecting the purchasing power potential within the domestic economy. Therefore, expect the Chinese economy to be weak for some time. Focusing on cheap processed foods or investing in processing facilities which utilize an imported product from your country may initially be the most cost efficient step to take initially.