China WT/TPR/S/161 
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I. ECONOMIC ENVIRONMENT 
(1) OVERVIEW  
1. China's "open door" policy and economic reforms,  which began in 1978, have allowed the 
emergence alongside the public sector of a private sect or, particularly in manufacturing, and gradually 
opened up the economy to international trade and i nbound foreign direct investment (FDI).  As a 
result its GDP has, according to official figures, grown by an average of about 9.4% annually, 
consistently faster than any other economy during this period.1  These reforms and resulting growth 
have enabled China to raise GDP per head from US$148 in 1978 to US$1,700 in 2005.2  T h e  
associated income growth has lifted about 400 million people out of poverty (defined as US$1 a day 
of expenditure), a remarkable accomplishment.3  The proportion of China's people living below the 
US$2 per day poverty line fell from 72.6% of the population in 1990 to 32% in 2004.4  Indicators of 
health and education have also shown great impr ovement.  At the same time, however, inequalities 
have widened as the distribution of income and em ployment opportunities have shifted in favour of 
urban areas and coastal regions, leaving rural ar eas and less developed regions further behind.5  The 
Government is attempting to address the widening inequality, which is due, at least in part, to 
inflexibilities in the domestic labour market.6  Widening inequality notwithstanding, the nearly nine-
fold rise in GDP per capita and dramatic drop in China's population living in poverty since 1978 demonstrate clearly the value of integrating more liberal trade and foreign investment policies into 
broader macroeconomic and structural reforms in order to promote economic development. 
2. During the period 1998-05, real GDP growth av eraged 8.9% per annum.  Since 2001, this 
growth appears to have been driven largely by ex ports and investment (Table I.1).  Rapid economic 
growth, and increased integration into the worl d economy, especially since its accession to the WTO 
in 2001, has increased China's share of world trade to 6.7% in 2004.  Thus, it has become the third 
largest trader (after the European Union (14.5% ) and the United States (13.6%), having overtaken 
Japan (5.9%) in 2004) and a major engine of growth in the global economy.  In 2005, total merchandise exports and imports amounted to some 63.9% of GDP, compared with less than 10% in 
1978.  China is also now one of the main destinati ons for foreign direct investment, much of which 
has been attracted to manufacturing, as a platform for exports;  foreign-invested companies based in 
                                                     
 
1 There has been considerable speculation that the official statistics have understated both the size of 
China's economy and recent econo mic growth (see, for example, IMF (2004 a), p. 4).  According to the latest 
adjustment to GDP announced on 20 December 2005 as a result of the First National Economic Census, China's 
GDP in 2004 was almost Y 16 trillion, Y 2.3 trillion (or 16.8%)  higher than the previous official estimate, which 
means that China's economy was the si xth largest in the world.  Moreover, GDP reportedly grew by 10.1% in 
2004, substantially faster than the original estimate of 9.5%. 
2 National Bureau of Statistics (2005b).  Nonethel ess, according to the authorities, China's GDP per 
capita in 2004 still ranked only 107th in the world (see "China remains largest developing country", 
20 December 2005.  Available at:  http://english.gov.cn/2005- 12/20/content_132456.htm).  
3 World Bank (2003). 
4 World Bank (2004). 
5 China's Gini coefficient index, an internationally accepted measure of  income inequality, was 44.7 in 
2001 (up from 40.3 in 1998 ) and recent reports suggest that it is appr oaching 50 (an index of zero represents 
perfect equality, while 100 indicates perfect inequality).  These figures can be compared, for example, with 59.3 
for Brazil, 43.4 in Hong Kong, China, 40.8 in the United States, 32.5 in India, 28.3  in Germany, and 24.9 in 
Japan) (UNDP, 2005). 
6 According to the authorities, other factors behind the widening income inequality include natural 
endowments and the Government's development strategy. WT/TPR/S/161 Trade Policy Review 
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China conduct more than 50% of China's foreign trade.7  Ongoing reforms have been given added 
impetus by China's membership of the WTO;  its commitments have provided a catalyst for reform, 
thereby paving the way for continuing st rong growth in the foreseeable future. 
Table I.1 
Selected macroeconom ic indicators, 1998-05  
  1998 1999 2000 2001 2002 2003 2004 2005a 
National accounts (Percentage change)  
Real GDP (production based) 7.8 (7.8) 7.1 (7.6) 8.0 (8.4) 7.5 (8.3) 8.3 (9.1) 9.5 (10.0) 9.5 (10.1) (9.9) 
Consumption .. .. 9.4 7.2 7.4 6.1 6.4 .. 
Gross fixed capital formation .. .. 9.1 7.0 14.1 19.9 16.8 .. 
Exports of goods and non-factor 
services .. .. 30.6 9.6 29.4 26.8 26.7 .. 
Imports of goods and non-factor 
services .. .. 24.5 10.8 27.5 24.8 25.2 .. 
Unemployment rate (%)b 3.1 3.1 3.1 3.6 4.0 4.3 4.2 .. 
Productivity (Percentage change)  
Labour productivity 4.0  3.6 7.9 7.5 6.9 10.4  ..  .. 
Prices and interest rates (Per cent)  
Inflation (CPI, % change) -0.8 -1.4 0.4 0.7 -0.8 1.2 3.9 1.8 
Lending rate  (period average) 6.39  5.85 5.85 5.85 5.31 5.31  5.58  .. 
Deposit rate  (period average) 3.78  2.25 2.25 2.25 1.98 1.98  2.25  .. 
Money credit (end period) (Percentage change)  
Money supply (M2) 14.8 14.7 12.3 17.6 16.9 19.6 14.5 .. 
Credit to private sector (end period) 16.2 11.5 11.5 9.5 30.6 21.2 8.1 .. 
Exchange rate        . .  
Yuan per US$ 8.2790  8.2783 8.2785 8.2771 8.2770 8.2770  8.2768  8.1917 
Real effective exchange rate index 
(% change) 2.0  -3.3 2.6 4.3 -1.6 -5.8  -1.8  .. 
Nominal effective exchange rate 
index (% change) 4.6  -2.2 2.8 4.5 -0.9 -6.9  -4.6  .. 
 (Per cent of GDP, unless otherwise indicated)  
Fiscal policyc         
Government balance -1.2 (-1.1) -2.1 (-1.9) -2.8 (-2.5) -2.6  (-2.3) -3.0 (-2.6) -2.5 (-2. 2) -1.5 (-1.3) -1.5 (-1.3) 
Total revenue 12.6 
(11.7) 13.9 
(12.8) 15.0 
(13.5) 16.8 
(14.9) 18.0 
(15.7) 18.5 
(16.0) 19.3 
(16.5) 19.5 
(16.7) 
Tax revenue 11.8 
(11.0) 13.0 
(11.9) 14.1 
(12.7) 15.7 
(14.0) 16.8 
(14.7) 17.1 
(14.7) 17.7 
(15.1) 18.2 
(15.7) 
Total expenditure 13.8 
(12.8) 16.1 
(14.7) 17.8 
(16.0) 19.4 
(17.2) 21.0 
(18.3) 21.0 
(18.1) 20.8 
(17.8) 21.0 
(18.1) 
Public sector total debt ..  20.3 
(18.6) 22.2 
(20.0) 23.6 
(20.9) 25.1 
(21.9) 25.6 
(22.1) 23.6 
(20.2)  22.3 
(19.2) 
Domestic debt ..  .. 17.7 
(16.0) 19.4 
(17.2) 21.2 
(18.5) 21.9 
(18.9)  20.4 
(17.5) 19.6 
(16.8) 
Saving and investment          
Gross national savings ..  39.4 
(36.1) 38.2 
(34.4) 40.0 
(35.5) 43.2 
(37.8) 47.1 
(40.7) 50.1 
(42.9)  52.4 
(45.0) 
Gross domestic investment 37.7 
(35.0) 37.4 
(34.2) 36.3 
(32.8) 38.5 
(34.2) 40.2 
(35.2) 43.9 
(38.0) 45.9 
(39.3) 46.3 
(39.8) 
Savings-investment gap ..  2.0(1.8) 1.9 (1.7) 1.5 (1.3) 3.0 (2.6) 3.2 (2.8)  4.2 (3.6)  6.1 (5.2) 
External sector         
Current account balance 3.3 (3.1) 2.1 (1.9) 1.9 (1.7) 1.5 (1.3) 2.8 (2.4) 3.2 (2.8) 4.2 (3.6) 6.0 (5.2) 
Net merchandise trade 4.9 (4.6) 3.6 (3.3) 3.2 (2.9) 2.9 (2.6) 3.5 (3.0) 3.1 (2.7) 3.6 (3.1) .. 
Table I.1 (cont'd) 
                                                      
7 In 2005, imports and exports by foreign-invested enterprises accounted for 58.5% of China's total 
foreign trade;  the corresponding figure for state-owned enterprises wa s 25.7% (General Administration of 
Customs, 2005). China WT/TPR/S/161 
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  1998 1999 2000 2001 2002 2003 2004 2005a 
Value of exports 19.4 
(18.0) 19.6 
(18.0) 23.1 
(20.8) 22.6 
(20.1) 25.6 
(22.4) 30.9 
(26.7) 35.9 
(30.7) .. 
Value of imports 14.5 
(13.4) 16.0 
(14.7) 19.9 
(17.9) 19.7 
(17.5) 22.2 
(19.4) 27.8 
(24.0) 32.3 
(27.7) .. 
Services balance -0.3 (-0.3) -0.5 (- 0.5) -0.5 (-0.5) -0.5 (-0.4) -0.5 (-0.5) -0.6 (-0.5)  -0.6 (-0.5) .. 
Capital account 0.0 (0.0) 0.0 (0.0) 0.0 (0.0) 0.0 (0.0) 0.0 (0.0) 0.0 (0.0) 0.0 (0.0) .. 
Financial account -0.7 (-0.6) 0.5 (0.5) 0.2 (0.2) 3.0 (2.6) 2.5 (2.2) 3.7 (3.2) 6.7 (5.7) .. 
Direct investment 4.3 (4.0) 3.7 (3.4) 3.5 (3.1) 3.2 (2.8) 3.7 (3.2) 3.3 (2.9) 3.2 (2.8) .. 
Balance of payments 0.7 (0.6) 0.9 (0.8) 1.0 (0.9) 4.0 (3.6) 5.9 (5.2) 8.3 (7.1) 12.5 
(10.7) .. 
Terms of trade .. .. .. .. .. ..  ..  .. 
Merchandise exports (% change) 0.5 6.1 27.9 6.8 22.4 34.6 35.4 28.4 
Merchandise imports (% change) 0.3 15.9 35.2 8.1 21.3 39.8 35.8 .. 
Service exports (% change) -2.7 9.8 15.9 9.5 19.2 17.6 33.6 .. 
Service imports (% change) -4.6 18.4 14.1 9.0 18.5 18.9 30.4 .. 
Gross official reservesd 
(US$ billion) 149.2  157.7 168.3 215.6 291.1 408.2  614.5  818.9 
in months of imports ..  7.6 7.5 8.0 7.9 8.6  10.1 14.0 
Total external debt (US$ billion;  
end period) 146.0 151.8 145.7 170.1 171.4 193.6  228.6 303.0 
Debt service ratioe 10.9 11.2 9.2 7.5 7.9 6.9  3.2 .. 
a Projection.  
b Registered unemployment in urban areas. 
c Including central and local governments. 
d Excluding gold. e Debt service ratio refers to the ratio of  the payment of principal and interest of foreign debts to the foreign exchange rece ipts 
 from foreign trade and non-trade services of the current year. 
 Note: Data in brackets correspond to adjusted GDP figures announ ced on 10 January 2006 by the National Bureau of Statistics. 
Source: WTO Secretariat based on National Bureau of Statistics, Statistical Yearbook (various issues);   S t a t e  
 Administration of Foreign Exchange ( 2005);  International Monetary Fund (2005),  IMF Country Report 
 No. 05/411,  November.  
3. Notwithstanding these reforms, duality is a ke y feature of China's economy.  While the 
opening up of the economy to trade and FDI have re sulted in the emergence of a private (non-public) 
sector8, oriented largely towards the export of ma nufactured goods, public ownership remains a 
critical element of the economy, especially for servi ces.  The Government's stated objective is to 
allow the two different forms of ow nership to develop side by side.9 
4. In March 2004, the 10th National People's Congress, in its second session, emphasized the 
importance of a more balanced approach to develo pment and the need to push ahead with structural 
reforms.  It focused attention on social and economic developments as well as measures to address 
widening regional and rural-urban income disparities,  including initiatives to raise farmers' incomes, 
develop the inland regions, and establish a social sa fety net.  The Congress also cautioned against 
excessive investment in some sectors and indicated its determination to increase the pace of structural 
reforms, particularly in relation to the key areas of taxation, state-owned enterprises (SOEs), and the 
financial sector.  China's 11th Five-Year Plan, proposals for which were approved by the CPC Central 
                                                      
8 The definition of the private sector in China is rather complex;  the Provisional Act on Private 
Enterprises defines private enterprises as firms with assets belonging to individuals and that employ more than 
eight workers (Chapter III(4)(v)).  In this Chapter, th e private sector refers to the non-public sector unless 
otherwise indicated. 
9 See "Several Opinions of the State Counc il on Encouraging, Supporting and Guiding the 
Development of Individual and Private Economy and other Non-Public Sectors of the Economy", 24 February 2005. WT/TPR/S/161 Trade Policy Review 
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Committee in October 2005, is expected to reitera te these goals of achiev ing rapid but balanced 
development across regions, improved energy efficiency, and continued economic reform.10 
(2) MAIN DEVELOPMENTS :  POLICY AND ECONOMIC PERFORMANCE  
5. China commenced its gradual transition from a planned economy to a more market-based 
outward-looking economy in 1978.  The reform s began on several fronts including SOEs and 
agriculture, where there were moves to link remune ration to output and grant autonomy to farming 
households as far as their production decisions were concerned.  In the mid-1980s, economic reforms 
were extended especially to manufacturing with, inter alia,  the establishment of special economic 
zones aimed at attracting FDI (together with re lated technology) and oriented towards export 
processing.  In 1986, China began ne gotiations on the resumption of its status in the GATT.  Then, in 
October 1992, the Government made explicit its inte ntion to establish a "socialist market economy", a 
preliminary form of which was deemed, by the 16th National Congress of the Communist Party, to 
have been established in 2002.  China became a Member of the WTO in 2001.  Its commitments in 
the WTO provided a catalyst for further far-reaching ec onomic reforms.  According to the authorities, 
these reforms are aimed at "further perfecting the socialist market economy", where market-
determined prices and private investors play a more  important role in the allocation of resources and 
economic development.  Key structural reforms,  which are inter-related, include the continued 
reorganization of state-ownership and measures to  develop a smooth-functioning capital market that 
will eventually meet the financing needs of the emerging dynamic private sector as well as the Government.  Progress in this regard has been such  that the private sector now accounts for well over 
half of China's GDP and three-quarters of its e xports, the bulk of which are produced by foreign-
controlled companies.
11  Private firms have greatly improved productivity and profitability in the 
whole economy and are the main source of new jobs.  But with the gradual reduction of the role of 
SOEs in the economy and the resulting laying off of 16 million workers (by state-owned industrial 
companies) between 1998 and 200312, there is also the need to develop a smooth functioning labour 
market that can provide alternative employment  opportunities for displaced workers, as well as new 
entrants to the labour force and migrants from rura l areas, and to establish a social safety net that 
would replace the support system hitherto largely provided by SOEs. 
6. Trade and inbound FDI have played a major role in the growth of China's economy.13  The 
gradual reduction in the simple applied aver age MFN tariff (from 35% in 1994 to under 10% at 
present) and the lowering of non-tariff barriers to tr ade, together with the opening of the economy to 
FDI, have stimulated competition and thereby contributed to the improved competitiveness of 
domestic producers.14  Thus, their ability over the longer term to compete not only in the domestic 
market against imports, but also in export market s has also improved, thereby providing new job 
opportunities.  By helping to re-orient parts of the economy from state-ownership, including through 
joint-ventures (involving the state and foreign partners), the large inflow of FDI (and associated 
                                                      
10 See for example CCTV.com online information.  Available at:   http://english.cctv.com/english/ 
20051012/101138.shtml [12 October 2005];  and People's Daily Online.   Available at:  http://english. 
people.com.cn/200510/12/eng20051012_213835.html [12 October 2005]. 
11 OECD (2005a), p. 18. 
12 OECD (2005a), p. 95. 
13 In the first half of 2005, growth in net exports  accounted for 3.6 percentage points of the 9.5% 
growth in GDP (SAFE, 2005). 
14 According to the World Economic Forum's 2005 Growth Competitiveness Index and Business 
Competitive Index, respectively, China ranked 49th (out of 117 countries) and 57th (out of 116 countries).  
Among the factors contributing to this ranking were concerns over red tape, corruption, judicial independence, 
and trade barriers (World Economic Forum online information.  Available at:  http://www.weforum.org/site/ 
homepublic.nsf/Content/Growth+Competitiveness+Index [16 January 2006]). China WT/TPR/S/161 
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entrepreneurship, management skills and technology)  has also contributed to the emergence of the 
private sector, whose growth in output and prod uctivity has far outstripped SOEs, and created 
alternative employment opportunities.  Furthermore,  FDI has served as a platform, enabling China to 
manufacture products that meet world-market specif ications with regard to quality, design, and 
technological content, thereby greatly contributi ng to the export orientation of the economy.  
7. The accumulation of capital, financed for the most  part by domestic savings, has also been 
vital.  Gross domestic investment and gross nati onal saving, respectively, amounted to 39.3% and 
42.9% of GDP in 2004.15  During the period 1998-03, for exam ple, growth in the capital stock 
accounted for 4.9 percentage points of the average 8% annual growth rate of GDP (Table I.2).  
Moreover, with capital growing much faster than labour, capital accumulation contributed 
4.6 percentage points to the 7.4% growth in labour productivity, a key determinant of living standards.  
Growth in total factor productivity (TFP), a key determinant of economic competitiveness, accounted 
for 2.8 percentage points of the grow th in both GDP and labour productivity.16  The re-allocation of 
labour from agriculture and the improved quality of  the labour force through the increased average 
level of education, respectively, accounted for 0. 5 and 1.1 percentage points of the growth in TFP.17  
However, TFP growth appears to be slowing down.  This is also true for capital productivity, which 
fell by an average of 1.2% annually in 1998-03.18  This decline in capital productivity may be partly 
due to over-investment in aggregate19, or, perhaps more likely, the misallocation of investment owing 
to continued government "guidance" and the weakn ess of China's fledgling capital market, partly as 
reflected in the banks' non-performing loans (NPLs).20 
8. Notwithstanding the restructuring of the economy resulting from reforms, the official urban 
registered unemployment rate, although still relativel y low, has been gradually rising, from 3.1% 
during 1998-00 to 4.2% in 2004.  But the effective unemployment rate may be higher than the official 
rate.21  There is also probably significant underemployment, particularly in SOEs.22  Inflation, as 
                                                      
15 Investment may be overstated.  Unlike in other coun tries, the official measure of investment does not 
appear to be constructed on a value-added basis like GDP.  It includes all land sales, regardless of whether they involve new development.  There are no official estimates of the capital stock. 
16 Total factor productivity (TFP) re flects the efficiency with which f actors of production are used and 
is thus a major determinant of an economy's performance.  TFP should be distinguished from labour productivity, which is the amount of output per employee or per hour.  T FP growth and capital accumulation are 
the main determinants of improvemen ts in labour productivity.  Capita l accumulation contributes to improved 
labour productivity by increasing the amount of  capital that employees have to work with. 
17 Additional potentially important sources of TFP growth include economies of scale and 
technological progress.  The latter often tends to be the most important source of TFP growth in the long run;  
hence, the need to ensure adequate protection of intellectual property rights. 
18 Similarly, according to the IMF th e marginal productivity of capital has experienced a sustained fall, 
which suggests that the efficiency  of investment is increasingly declining (IMF, 2005, p. 12). 
19 As a result of high investment during the past d ecade, China's capital-output ratio is believed to have 
risen from 2.2 in 1994 to 2.8 in 2004 (Kuijs and Wang, 2005, p. 2).  With the recent upward adjustment of 
China's GDP by 16.8%, owing to the inclusion of services, insofar as production of the omitted service 
providers tends to be less capital intensive, China's gross domestic investment may constitute a substantially 
smaller portion of GDP than officially estimated.   
20 According to Boyreau-Debray and Wei (2005), capita l mobility in China declined significantly in the 
1990s relative to the 1980s.  Moreover, the governmen t-dominated financial system has systematically re-
allocated capital from more to less productive regions so as to favour inefficien t state-owned enterprises. 
21 Xue and Zhong (2003), for example, estimated that the urban unemployment rate reached 11.5% in 
2000 (compared with the official registered rate of 3.1%), thus becoming a major cause of urban poverty and 
worsening inequality.  A labour force survey of five la rge cities conducted by the Chinese Academy of Sciences 
suggests an unemployment rate of 14% among permanent residents of these cities in 2002.  For China as a 
whole, between January 1996 and September 2002, the unem ployment rate of urban residents rose from 6.1% to WT/TPR/S/161 Trade Policy Review 
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measured by the consumer price index, has remained  relatively low, albeit rather volatile, fluctuating 
between -1.4% and 3.9% between 1998 and 2005.  (The GDP deflator is even more volatile, 
fluctuating between -2.4% and 6.3%.)  Inflati on may be somewhat repressed, however, owing to 
administrative controls on certain prices, including those charged for utilities.23  
Table I.2 
Sources of output and productivity growth, 1983-03 
(Per cent)  
 1983-88 1988-93 1993-98 1998-03 
Output 12.1 8.9 9.8 8.0 
Capital 5.0 4.5 5.5 4.9 
Labour 1.5 1.0 0.3 0.3 
TFP 5.6 3.4 4.1 2.8 
Labour productivity growth 8.9 6.7 9.2 7.4 
Capital/labour 3. 3 3.3 5.1 4.6 
TFP 5.6 3.4 4.1 2.8 
Capital productivity growth 2.7 0.4 -0.6 -1.2 
Total factor productivity 5.6 3.4 4.1 2.8 
Sectoral change 2.2 0.8 -0.3 0.5 
Education 1.0 0.9 0.9 1.1 
Residual 2.4 1.7 3.4 1.3 
Note: Figures may not add up due to rounding. 
Source:  WTO Secretariat, based on data in OECD (2005a).  
9. The widening gap between China's gross nationa l saving and gross domestic investment is 
reflected in the growing current account surplus, which increased from 1.3% of GDP in 2001 to 3.6% 
in 2004, and is projected (by the IMF) to reach 5. 2% of GDP in 2005 (Table I.3).  In 2004, services 
accounted for only 9.5% of the total value of exports, and whereas China currently runs a 
merchandise trade surplus of 3.1% of GDP (based on balance of payments data24), services trade is in 
deficit.  During 2001-04, FDI was relatively stable , at around 3% of GDP per annum.  (Portfolio 
capital inflows are still heavily restricted by the Gove rnment.)  Overall, the total inflow of foreign 
currency owing to the surplus in the balance of payments amounted to 12.5% of GDP in 2004, up from 4% in 2001.
25  This has put upward pressure on the monetary base, thereby complicating the 
operation of monetary policy and limiting the ability to ensure stable inflation.  Efforts by the central 
bank to "sterilize" this inflow of foreign curre ncy resulted in the accumulation of US$819 billion in 
official reserves by the end of 2005 (amounting to more than 14 months of import cover)26, much of 
which has been used to purchase government securities issued by G7 countries.27 
                                                                                                                                                                     
11.1% and that of all urban residents, including temporary residents (e.g. migrants) increased from 4% to 7.3% 
(Giles, Park and Zhang, 2005, pp. 149-170).  
22 A recent OECD report also suggests that ther e is significant underemployment in agriculture 
(Chapter IV(2)). 
23 The Government reportedly told provinces to cap pr ices for utilities if local inflation starts to soar, 
despite shortages of electricity, for example.  The pl anned curbs on price rises apparently operated where 
inflation rose above 1% per month or 4% year on year for three consecutive months.  (BBC online information.  Available at:  http://news.bbc.co.uk/go/pr/fr/-/2/hi/business/3699477.stm [10 May 2004].) 
24 Imports in the balance of payments are calculated on a "free on board" (f.o.b.) rather than c.i.f. basis. 
25 The figure for 2004 was 10.7% once the recent 16.8 % official upward adjustment of China's GDP in 
2004 is taken into account. 
26 SAFE (2005). 
27 Economists estimate that more than 70% of Chin a's reserves are invested in U.S. dollar assets 
("China signals reserve switch away from dollar", Financial Times , 5 January 2006). China WT/TPR/S/161 
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Table I.3 
Balance of payments, 1998-05 
(US$ million and per cent)  
  1998 1999 2000 2001 2002 2003 2004 2005a 
Current account 31,471.4 21,114.2 20,519.2 17,405.3 35,422.0 45,874.8 68,659.2 114,000.0 
as percentage of GDP 3.3 (3.1) 2.1 (1.9) 1.9 (1.7) 1.5 (1.3) 2.8 (2.4) 3.2 (2.8) 4.2 (3.6) 6.0 (5.2) 
Goods and services balance 43,836.6 30,640.9 28,873.5 28,086.2 37,382.7 36,078.9 49,283.6 .. 
Trade balance 46,613.5 35,980.4 34,473.6 34,017.2 44,166.6 44,651.6 58,982.3 .. 
Exports 183,529.2 194,715.8 249,130.6 266,075.0 325,650.8 438,269.6 593,392.5 .. 
Imports 136,915.6 158,735.4 214,657.0 232,057.8 281,484.2 393,618.0 534,410.2 .. 
Services balance -2,776.9 -5,339.5 -5,600.1 -5,931.0 -6,783.9 -8,572.7 -9,398.6 .. 
Receipts 23,896.3 26,248.1 30,430.5 33,335.1 39,744.5 46,733.6 62,434.1 .. 
Transportation 2,300.8 2,420.1 3,671.0 4,635.1 5,720.2 7,906.4 12,067.5 .. 
Tourism 12,601.7 14,098.5 16,231.0 17,792.0 20,385.0 17,406.0 25,739.0 .. 
Communication 818.9 589.6 1,345.5 271.1 550.1 638.4 440.5 .. 
Construction 594.1 985.2 602.3 830.2 1,246.4 1,289.7 1,467.5 .. 
Insurance 384.4 203.9 107.8 227.3 208.9 312.8 380.8 .. 
Financial 27.0 110.7 77.8 99.1 51.0 152.0 93.9 .. 
Computer and information 133.5 265.3 355.9 461.5 638.2 1,102.2 1,637.1 .. 
Fee for patent or royalty 62.7 74.5 80.3 110.1 132.8 107.0 236.4 .. 
Consultation 518.0 280.4 355.7 889.3 1,284.9 1,884.9 3,152.5 .. 
Advertisement and publicity 211.0 220.6 223.4 277.3 372.8 486.3 848.6 .. 
Movies and audio-video 
products 15.4 6.7 11.3 27.9 29.7 33.4 41.0 .. 
Other commercial services 6,212.3 6,909.3 7,083.9 7,281.8 8,761.1 15,055.8 15,950.8 .. 
Government services n.e.s. 16.6 83.2 284.5 432.6 363.3 358.8 378.5 .. 
Payments 26,673.2 31,587.6 36,030.6 39,266.2 46,528.4 55,306.3 72,132.7 .. 
Transportation 6,763.2 7,897.9 10,396.1 11,324.1 13,611.9 18,232.8 24,543.8 .. 
Tourism 9,205.4 10,864.5 13,113.7 13,908.8 15,398.4 15,187.3 19,149.3 .. 
Communication 207.5 193.4 242.0 326.0 470.4 427.4 472.2 .. 
Construction 1,119.7 1,539.8 994.4 847.0 963.9 1,183.2 1,338.8 .. 
Insurance 1,758.1 1,921.1 2,471.4 2,711.0 3,245.7 4,564.2 6,123.6 .. 
Financial 163.4 166.9 97.4 77.4 89.8 232.5 138.1 .. 
Computer and information 333.0 223.6 265.0 344.7 1,132.9 1,035.8 1,252.7 .. 
Fee for patent or royalty 419.7 791.6 1,281.0 1,938.1 3,114.0 3,548.1 4,496.6 .. 
Consultation 758.1 524.4 639.7 1,502.1 2,630.5 3,449.5 4,734.3 .. 
Advertisement and publicity 265.0 219.0 202.4 258.1 394.4 457.9 698.3 .. 
Movies and audio-video 
products 39.0 34.0 37.4 50.2 96.0 69.5 175.8 .. 
Other commercial services 5,435.8 6,589.8 6,117.2 5,743.6 4,932.0 6,463.8 8,478.1 .. 
Government services n.e.s. 205.2 621.7 172.8 235.0 448.4 454.1 531.0 .. 
Income and profit balance -16,643.7 -14,470.3 -14,665.5 -19,173.3 -14,945.1 -7,838.4 -3,522.7 .. 
Credit 5,584.1 8,330.1 12,550.9 9,389.6 8,344.3 16,094.7 20,544.1 .. 
Compensation of staff and 
workers 96.5 145.7 201.9 297.5 673.8 1,282.6 2,014.4 .. 
Profit from investment 5,487.6 8,184.4 12,349.0 9,092.1 7,670.5 14,812.1 18,529.7 .. 
Debit 22,227.8 22,800.3 27,216.4 28,562.8 23,289.4 23,933.1 24,066.8 .. 
Compensation of staff and 
workers 203.9 522.6 679.4 851.6 950.3 1,120.2 1,382.2 .. 
Profit from investment 22,023.9 22,277.7 26,537.0 27,711.2 22,339.1 22,812.8 22,684.6 .. 
Current transfers (net) 4,278.5 4,943.5 6,311.3 8,492.3 12,984.4 17,634.2 22,898.2 .. 
Credit 4,660.7 5,367.3 6,860.8 9,124.7 13,795.4 18,482.5 24,326.3 .. 
Government 183.0 200.5 147.4 138.0 86.5 113.8 97.5 .. 
Other departments 4,477.7 5,166.7 6,713.4 8,986.7 13,708.9 18,368.7 24,228.8 .. 
Table I.3 (cont'd) WT/TPR/S/161 Trade Policy Review 
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  1998 1999 2000 2001 2002 2003 2004 2005a 
Debit 382.2 423.8 549.5 632.4 810.9 848.3 1,428.1 .. 
Government 92.3 92.6 93.8 204.7 160.1 105.7 186.6 .. 
Other departments 289.9 331.2 455.7 427.7 650.8 742.6 1,241.6 .. 
Capital and financial account -6,321.4 5,179.5 1,922.2 34,775.4 32,290.8 52,725.9 110,659.8 .. 
Capital account -46.8 -25.5 -35.3 -53.5 -49.6 -48.1 -69.3 .. 
Financial account -6,274.6 5,205.0 1,957.5 34,829.0 32,340.5 52,774.0 110,729.1 .. 
Direct investment 41,118.1 36,978.1 37,482.9 37,355.9 46,789.6 47,229.0 53,131.4 .. 
Chinese direct investment 
abroad -2,633.8 -1,774.3 -915.8 -6,885.4 -2,518.4 152.3 -1,805.1 .. 
Foreign direct investment in 
China 43,751.9 38,752.5 38,398.7 44,241.3 49,308.0 47,076.7 54,936.5 .. 
Portfolio investment -3,732.6 -11,233.6 -3,990.7 -19,405.9 -10,342.5 11,426.8 19,689.9 .. 
Assets -3,830.0 -10,534.9 -11,307.5 -20,654.3 -12,094.5 2,983.1 6,486.4 .. 
Capital stock 0.0 0.0 0.0 31.6 0.0 0.0 0.0 .. 
Liability stock -3,830.0 -10,534.9 .. - 20,685.9 -12,094.5 2,983.1 6,486.4 .. 
Liabilities 97.4 -698.7 7,316.7 1,24 8.3 1,752.0 8,44 3.6 13,203.4 .. 
Capital stock 765.0 612.0 .. 849.0 2,249.0 7,729.0 10,923.2 .. 
Liability stock -667.6 -1,310.7 .. 399.3 -497.0 714.6 2,280.2 .. 
Other investment -43,660.1 -20,539.5 -31,534.6 16,879.0 -4,106.6 -5,881.7 37,907.8 .. 
Assets -35,040.8 -24,395.3 -43,863.5 20,812.8 -3,076.7 -17,921.5 1,979.7 .. 
Trade credit -22,091.8 -22,898.2 -12,959.9 702.3 1,098.0 -1,465.0 -15,897.0 .. 
Loans -1,411.4 -3,436.3 -18,429.6 15,313.6 -5,391.1 13,927.4 -9,657.9 .. 
Currencies and deposits 638.5 11,270.6 -6,048.9 -3,213.8 -2,486.3 -6,552.1 20,206.7 .. 
Other assets -12,176.1 -9,331.4 -6,425.0 8,010.7 3,702.7 -23,831.8 7,327.9 .. 
Liabilities -8,619.3 3,855.8 12,328.8 -3 ,933.8 -1,029.9 12,039.8 35,928.1 .. 
Trade credit 0.0 13,266.7 18,232.4 -2,441.9 2,849.4 4,720.3 18,595.0 .. 
Loans -3,267.2 -547.2 -2,391.2 -1,490.1 -4,139.6 6,614.3 13,752.9 .. 
Currencies and deposits -5,287.6 -3,931.9 -53.6 492.2 286.8 742.4 1,561.0 .. 
Other liabilities -64.4 -4,931.8 -3,458.7 -493.9 -26.4 -37.3 2,019.2 .. 
Net errors and omission -18,724.0 -17,788.3 -11,893.1 -4,855.6 7,794.3 18,422.4 27,045.1 .. 
Reserve assets -6,426.0 -8,505.3 -10,548.4 -47,325.1 -75,507.1 -117,023.1 -206,364.0 .. 
.. Not available. 
a Provisional. 
Note: Data in brackets correspond to adjusted GDP figures announ ced on 10 January 2006 by the National Bureau of Statistics. 
Source:  State Administration of Foreign Exchange (SAFE).  
10. China's rapid growth and reduction in absolute  poverty levels has been accompanied by a 
widening disparity in incomes and employment opportun ities.  Income disparities  reflect in particular 
wage differentials owing to differences in labour productivity, which are especially wide between 
urban and rural areas.  Labour productivity in non-a gricultural activities is apparently more than 
four times that in agricultural activities.28  China's rapid growth and increased urbanization has also 
had implications for the environmen t.  Government policies under the 9th and 10th five-year plans have 
improved pollution control29;  a balanced development perspec tive, including an environmentally 
friendly approach, is to be further stressed in the 11th Five-Year Plan. 
11. China's investment boom has attracted large ne t inflows of FDI, particularly to export-
oriented manufacturing industries.  With a de facto fixed exchange rate in relation to the U.S. dollar 
(until July 2005), the resulting accumulation of foreig n reserves has caused rapid growth in the money 
                                                      
28 Prasad (2004), p. 56;  and OECD (2005a), p. 46. 
29 The quantity of sulphur emissions, for example, rose by only 5% between 1993 and 2003, despite 
GDP increasing by 136%.  Nonetheless, the benefits from reduced air pollution are likely to considerably 
exceed the costs.  One study has sugg ested that bringing all China's majo r cities into conformity with WHO 
standards would generate health benefits equivalent to between 3% and 8% of GDP (OECD, 2005, p. 57). China WT/TPR/S/161 
 Page 9 
 
 
supply and bank lending, which c ould lead to economic imbalances and contribute to increased 
inflation.  The recent increase in oil prices could tend to dampen growth in China.  According to the 
International Energy Agency, a sustained US$10 rise in the price of oil reduces real GDP growth in 
China by 0.8 percentage points in the first and second years of higher prices.30  Reportedly, the 
authorities intend to reduce energy costs per unit of GDP by 20% in the next five years, which would 
reduce the sensitivity of GDP growth to oil prices and reduce pollution.31 
12. Industry and services are the main economic activ ities in China, with agriculture accounting 
for a declining share.32  In 2004, industry and services accounted for almost 78% of GDP, while 
agriculture's contribution declined to 15.2%, from 18.6 % in 1998 (Table I.4).  As a result of the recent 
revision in GDP figures, it seems th at the shares of industry and services are even larger (46% and 
41%, respectively) with agriculture accounting for a lowe r share, at 13% of GDP.  In contrast to its 
declining share of GDP, agriculture makes the biggest contribution to employment, some 44% in 2002.  Even with the recent upward adjustment of  services' share of GDP to almost 41% and also 
presumably their share of employment, these shares ha ve remained considerably lower than those in 
other major developing (not to mention devel oped) countries, which suggests that there is 
considerable scope for expanding the services sect or.  The main service activities are:  wholesale, 
retail trade and restaurants and hotels;  transpor t, storage and communications;  and finance and 
insurance.  Services and industry have also been the most rapidly growing sectors of the economy;  growth in industry was particularly rapid, at an average of almost 11% annually between 1998 and 
2004.  According to a recent study, over 90% of in dustry's growth during the past decade was due to 
labour productivity growth, led mainly by large-sca le investment and the resulting increase in the 
capital-output ratio, with employment growth contributing relatively little.
33 
Table I.4 
Basic economic and social indicators, 1998-05  
  1998 1999 2000 2001 2002 2003 2004 2005 
Nominal GDP 
(yuan billion) 7,834.5 
(8,440.2)  8,206.8 
(8,967.7)  8,946.8 
(9,921.5) 9,731.5 
(10,965.5) 10,517.2 
(12,033.3) 11,739.0 
(13,582.3)  13,687.6 
(15,987.8) (18,232.1) 
Nominal GDP 
(US$ billion) 946.3 
(1,019.5)  991.4 
(1,083.3)  1,080.7 
(1,198.5) 1,175.7 
(1,324.8) 1,270.7 
(1,453.8) 1,418.3 
(1,641.0) 1,653.7 
(1,931.6) (2,225.7) 
GDP per capita (yuan) 6,038.0 
(6,765.1)  6,551.0 
(7,129.3) 7,086.0 
(7,828.0) 7,651.0 
(8,591.8) 8,214.0 
(9,367.9) 9,111.0 
(10,510.4)  10,561.0 
(12,299.4) (13,926.0) 
GDP per capita (US$) 729.3 
(817.1) 791.4 
(861.2) 856.0 
(945.6) 924.4 
(1,038.0) 992.4 
(1,131.8) 1,100.8 
(1,269.8) 1,276.0 
(1,486.0) (1,700.0) 
 (Annual percentage change)  
GDP by economic 
activities at 1978 
indices         
Agriculture, forestry 
and fishing 3.5 (3.5)  2.8 (2.8) 2.4 (2.4) 2.8  (2.8) 2.9 (2.9) 2.5 (2.5)  6.3 (6.3) (5.2) 
Industrya 8.9  
(8.9) 8.5 
 (8.5) 9.8 
(9.8) 8.7
 (8.7) 10.0 
(10.0) 12.8 
(12.8) 11.5  
(11.5) (11.4)b 
Construction 9.0  4.3  5.7 6.8 8.8 12.1  8.1  .. 
Table I.4 (cont'd) 
                                                      
30 International Energy Agency (2004), p. 10. 
31 See for example, People's Daily Online  13 October 2005.  Available at:  http://english.people.com. 
cn/200510/13/eng20051013-214194.html [16 January 2006]. 
32 "Industry" includes manufacturing;  mining and quarrying;  and production and supply of electricity, 
gas, and water. 
33 See Kuijs and Wang (2005), p. 6. WT/TPR/S/161 Trade Policy Review 
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  1998 1999 2000 2001 2002 2003 2004 2005 
Services 8.3 (8.3)  7.7 (9.3) 8.1 (9.7) 8.4 (10.2) 8.7 (10.4) 7.8 (9.5)  8.3 (10.0)  (9.6) 
Wholesale, retail 
trade; restaurants and 
hotels 7.7  7.2  8.2 7.5 8.1 9.1  6.3  .. 
Transport, storage 
and communication 10.6  11.3  11.5 9.5 7.9 6.3  14.9  .. 
 (Per cent)  
Share of main sectors 
in GDP         
Agriculture, forestry 
and fishing 18.6 
(17.3) 17.6 
(16.2)  16.4 
(14.8) 15.8
 (14.1) 15.3 
(13.5) 14.4 
 (12.5)  15.2  
(13.1)  (12.5) 
Industrya 42.6 
(40.3) 42.8 
(40.0) 43.6 
(40.3) 43.5
 (39.8) 43.7 
(39.4) 45.2 
(40.5) 45.9  
(40.8) (47.3)b 
Construction 6.7  
(5.9) 6.7 
 (5.8) 6.6 
(5.6) 6.6
 (5.4) 6.7
 (5.4) 7.0 
 (5.5) 7.0 
(5.4) .. 
Services 32.1 
(36.5) 32.9 
(38.0) 33.4 
(39.3) 34.1 
(40.7) 34.3 
(41.7) 33.4  
(41.5) 31.9  
(40.7) (40.3) 
Wholesale, retail 
trade;  restaurants 
and hotels 8.4  8.4  8.2 8.1 8.1 7.9 7.4  .. 
Transport, storage 
and communication 5.3  5.4  6.0 6.1 6.1 5.7  5.6  .. 
Finance and 
insurance 6.0  5.9  5.8 5.7 5.7 5.5  ..  ..  
Real estate 1.9  1.9  1.9 1.9 2.0 2.0  ..  ..  
Social, health care, 
sports and social 
welfare 4.3  4.4  4.6 5.0 5.2 5.1  ..  ..  
Education, culture 
and arts 2.3  2.6  2.7 2.8 2.9 2.9  ..  ..  
Public administration 
and social 
organizations 2.5  2.7  2.6 2.7 2.7 2.7  ..  ..  
Other 1.6  1.7  1.6 1.6 1.7 1.6  ..  ..  
Share of sector in 
total employmentc         
Agriculture, forestry 
and fishing 47.0  46.9  46.3 45.2 44.1 ..  ..  ..  
Mining and quarrying 1.0  0.9  0.8 0.8 0.8 ..  ..  ..  
Manufacturing 11.8  11.4  11.2 11.1 11.3 ..  ..  ..  
Electricity, gas and 
water 0.4  0.4  0.4 0.4 0.4 ..  ..  ..  
Construction 4.7  4.8  4.9 5.0 5.3 ..  ..  ..  
Services 23.3  23.1  23.8 23.9 24.7 ..  ..  ..  
Geological 
prospecting and 
water conservation 0.2  0.2  0.2 0.1 0.1 ..  ..  ..  
Transport, storage 
and communication 2.8  2.8  2.8 2.8 2.8 ..  ..  ..  
Wholesale and retail 
trade and catering 
services 6.6  6.7  6.5 6.5 6.7 ..  .. .. 
Finance and 
insurance 0.4  0.5  0.5 0.5 0.5 ..  ..  ..  
Real estate 0.1  0.1  0.1 0.1 0.2 ..  ..  ..  
Social services 1.2  1.3  1.3 1.3 1.5 ..  ..  ..  
Table I.4 (cont'd)) China WT/TPR/S/161 
 Page 11 
 
 
  1998 1999 2000 2001 2002 2003 2004 2005 
Health care, sporting 
and social welfare 0.7  0.7  0.7 0.7 0.7 ..  ..  ..  
Education, culture 
and arts, radio, film 
and television 2.2  2.2  2.2 2.1 2.1 ..  ..  ..  
Scientific research 
and polytechnical 
services 0.3  0.2  0.2 0.2 0.2 ..  ..  ..  
Government agencies 
party agencies and 
social organizations 1.6  1.5  1.5 1.5 1.5 ..  ..  ..  
Other 7.2  7.0  7.8 8.0 8.5 ..  ..  ..  
Memorandum         
Number of students 
per 10,000 persons         
College and university  27.3  32.8  43.9 56.3 70.3 86.3  142.0  .. 
Secondary school  ..  ..  .. 697.0 733.0 763.0  788.2  .. 
Per capita expenditure 
for public health 
(yuan) ..  ..  .. 403.6 442.5 511.10  .. .. 
Life expectancy at 
birth 70.1 70.2 70.5 70.6 70.9 71.6  .. .. 
Infant mortality rate 
(per 1,000 live births) 38 33 32 31 31 30  .. .. 
.. Not available. 
a Including mining and quarrying, manu facturing, and production and suppl y of electricity, gas, and water.  
b Including construction. 
c Total does not add to 100% due  to missing employment data. 
 Note: Data in brackets correspond to adjusted GDP figures, as announced on 10 January 2006 by the National Bureau of Statistics . 
Source:  National Bureau of Statistics, Statistical Yearbook (2005);  China Labour Statistical Yearbook 2002;  UNDP, 
 Human Development Report  (various issues);  and Chinese authorities.  
(3) MACROECONOMIC POLICIES  
13. A prerequisite for a smooth functioning ma rket economy is a stable macroeconomic 
environment.  Monetary and exchange rate po licies together with fiscal policy are especially 
important in shaping such an environment.  Un til July 2005, when a managed floating exchange 
regime was introduced, monetary a nd exchange rate policies, through a currency peg have maintained 
the stability of the Renminbi in nominal terms in re lation to the U.S. dollar, while allowing a certain 
volatility in inflation.  Fiscal policy has operated in a stabilizing fashion; the overall fiscal situation is 
seemingly sound with rapid growth of tax revenues and tight control over expenditure bringing the 
overall budget deficit down to around 1.3% of GDP a nd keeping public debt stable at around 20% of 
GDP (using 2004 data). 
(i) Monetary and exchange rate policies 
14. The People's Bank of China (PBC) was establis hed on 1 December 1948 and assumed the role 
of central bank following a decision by the State Council in September 1983.  Under the guidance of 
the State Council, the PBC, inter alia,  "formulates and implements monetary policy, prevents and 
resolves financial risks, and safeguards financial stability".34  The PBC is also responsible for 
"administering foreign exchange a nd regulating inter-bank foreign exchange market".  The PBC is 
obliged to submit to the State Council for approval  its decisions concerning the annual money supply, 
                                                      
34 People's Bank of China online informati on.  Available at:  http://www.pbc.gov.cn. WT/TPR/S/161 Trade Policy Review 
Page 12 
 
 
interest rates, exchange rates, and other important i ssues before they are put into effect.  It is also 
obliged to report to the Standing Committee of the National People's Congress on the conduct of monetary policy and the performance of the financial sector. 
15. The objective of monetary policy is "to mainta in the stability of the Renminbi and thereby 
promote economic growth".
35  Officially, China has had a mana ged floating exchange rate regime 
since 1994, when the official rate was devalued a nd multiple exchange rates abolished.  However, 
after a mild appreciation in 1994-97, the currency was de facto  fixed to the U.S. dollar from 1997 
until July 2005, with the authorities purchasing or  selling foreign currency according to market 
demand to keep the exchange rate almost constant at  Y 8.28 to the U.S. dollar;  the daily variation was 
kept within a very narrow range of 20 basis points.   (The Renminbi was made fully convertible for 
current account transactions in 1996;  full convertibility does not extend to capital account 
transactions.)  Intervention to main tain a stable exchange rate agai nst the dollar was strengthened in 
the middle of 2001, with reserves rising from 14.8% of GDP at the end of 2001 to almost 43% of 
GDP at the end of 2005;  in 2005 alone, offici al reserves grew by a total of US$204 billion, which 
was equivalent to 9.2% of that year's GDP (adjus ted).  This intervention successfully stabilized the 
nominal exchange rate against the dollar.  However,  the real effective exchange rate of the RMB has 
depreciated in line with the weakening of the U.S. dollar during the past 3-4 years.  In November 2005, it was about 13% below its previous peak in February 2002 (Chart I.1). 
90919293949596979899100101102103104105106
1998 1999 2000 2001 2002 2003 2004Chart I.1      
Exchange rates and consumer price index, 1998-04
Source :  National Bureau of Statistics;  and International Monetary Fund,  International Financial Statistics. CPI
 (preceding year=100)Real effective exchange 
(2000=100)Nominal effective exchange rate
(2000=100)
 
16. The combination of a de facto  fixed exchange rate (until July 2005) and large foreign 
exchange inflows owing to the balance-of-p ayments surpluses has put upward pressure on the 
monetary base, thereby complicating the operation of monetary policy and limiting its ability to 
                                                      
35 While China's currency is called the Renminbi (RMB ), the unit of the currency is denominated yuan. China WT/TPR/S/161 
 Page 13 
 
 
ensure stable inflation.  The PBC has thus attempted to prevent the overall money supply from 
expanding through "sterilization" , thereby insulating the domestic economy from the consequences of 
these inflows.  Sterilization has mainly involved sal es of central bank bills as well as increases in the 
reserve ratio of banks.  Sterilization has contribut ed to the accumulation of some US$819 billion in 
official reserves, a large part of which has b een used to purchase government securities issued by 
G7 countries, especially the United States, although that policy may be changing.  However, full 
sterilization has not always been achieved, with the result that the PBC has sometimes exceeded its 
targets for the growth in money supply. 
17. Instead of relying on market-based instrument s of monetary policy, the authorities have 
attempted to curtail credit growth since 2003 th rough "window guidance", thereby largely avoiding 
significant increases in administered interest rates (w hich could hamper indebted companies' ability to 
repay bank loans).36  Such "guidance" has involved monthly meetings with commercial banks, the 
purpose being to urge these banks to avoid excessive  credit expansion without placing a hard brake on 
lending.  At the same time, some sectors were subject  to administrative controls over their investment, 
thereby reducing their demand for credit.  Such ad ministrative guidance, rather than the use of 
market-based pricing instruments, tends to dist ort the capital market, preventing it from allocating 
credit to the most profitable investments.  Notw ithstanding these administrative controls, the banking 
system has continued to accumulate excess reserves.   Hence, in October 2004, the PBC decided to 
raise the central bank benchmark interest rates fo r deposits and lending (for the first time since 
July 1995), allowing financial institutions to lo wer RMB deposit rates and broadening the range of 
lending rates.  The benchmark rates for one-y ear deposits and loans were both raised by 
0.27 percentage points, from 1.98% to 2.25% and from 5.31% to 5.58%, respectively.  The PBC also scrapped a rule that forbade commercial banks from charging more than 1.7 times that rate, thereby 
allowing them more freedom to take on riskier loans.
37  (Banks are still not allowed to lend at less 
than 0.9 times that rate.)  The rise in interest ra tes constitutes an important step in moving away from 
administrative control of monetary policy to indire ct control involving price mechanisms, such as the 
interest rate, which could pave the way for a more  efficient transmission of monetary policy to the 
real economy through the capital market.   
18. A more flexible exchange rate regime could enable China to operate a more independent 
monetary policy, which would be better suited to en suring a low and stable rate of inflation in both 
product and asset markets and allow market forces to assume a greater role in determining interest 
rates.38  However, the authorities are concerned about the impact of a more flexible exchange rate on 
economic growth, macroeconomic and financial st ability, employment, domestic enterprises, and 
foreign trade as well as on neighbouring countries, regions, and the world economy.  But to the extent that they cannot fully sterilize capital inflows, th e outcome may well be higher domestic inflation, 
which would tend to push up the real effective exchange rate in any event.
39  Arguably, it would be 
better for the Chinese economy to avoid this higher infl ation route to restoring external balance since 
inflation tends to distort markets.  It is unlikely th at a completely freely floating exchange rate can be 
achieved with the current set of re gulations and controls in place. 
19. In July 2005, the PBC, with the authoriza tion of the State Council, announced a 2.1% 
revaluation of the RMB in relation to the U.S. doll ar, and reform of the exchange rate regime.  As 
regards the latter, the PBC announced that it was moving into a "managed floating exchange rate 
                                                      
36 OECD (2005a), p. 63. 
37 However, rural and urban credit cooperatives, which finance SMEs and micro-credits, and thus have 
higher overheads, are still subject to a ceilin g of 2.5 times the benchmark interest rate. 
38 There have been calls by some of its main trading partners for China to revalue its currency.  If it 
were undervalued, the resulting "exchange rate protection" would tend to deter imports and encourage exports. 
39 Hitherto, the PBC appears to have had little difficu lty selling its "sterilization bonds", but this could 
change.  WT/TPR/S/161 Trade Policy Review 
Page 14 
 
 
regime"  based on market supply and demand with refe rence to "a basket of currencies" so that the 
currency would no longer be pegged to the U.S. dollar.   The PBC added that whereas the daily trading 
price of the RMB in relation to the U.S. dollar would continue to be allowed to  float within a narrow 
band of 0.3% of the central parity, the trading pr ices of non-U.S. dollar currencies would be allowed 
to move within a certain band announced by the PBC.   Since this revaluation and the move towards a 
more flexible exchange rate regi me, the nominal effective exchange  rate has (as of November 2005) 
appreciated by roughly 5% (two percentage points owing to the initial evaluation of the RMB in 
relation to the U.S. dollar in July and since then a further 0.3 percentage points plus almost another 
three percentage points as a result of the RMB's appr eciation in line with the U.S. dollar against the 
euro and the Japanese yen).40  On 4 January 2006, in the latest move towards a more flexible 
currency, the PBC launched over-the-counter trading for the RMB.41 
(ii) Fiscal policy 
20. China's fiscal position would seem to be sound.   As a result of major tax reform in 1994 
(section (4)(i)), tax revenues have grown steadily, wh ile public spending has been used to stimulate 
demand and thereby maintain growth during economic downturns.  Fiscal deficits have been moderate 
and so government debt is low.  In the wake of the Asian financial crisis, and resulting weak domestic 
demand, China embarked on a "pro-active" fiscal policy in 1998, which included, in particular, 
increased expenditure on infrastructure and issuance of national construction bonds.  Since 1998, the 
Government's total revenue has risen steadily, to 16.5% of GDP in 2004.  Total expenditure rose 
between 1998 and 2002 to 18.3% of GDP, before dr opping slightly to 17.8% in 2004.  The outcome 
was a fiscal deficit of 1.3% in 2004, slightly up from 1.1% in 1998, but considerably lower than in the 
intervening years.  In 2004, gross government debt  was 20.2% of GDP (around 3.2 percentage points 
involves foreign debt).42  All debt is owed by the Central Government:  local governments are 
required to balance their budgets annually. 
21. The Government recognizes that there is room fo r improvement in the transparency of fiscal 
policy, and is seeking to address this.  In par ticular, the Central Government's ordinary budget 
expenditure and debt figures do not reflect several  important off-budget items, including contingent 
liabilities of sub-national governments, which migh t conceivably weaken China's otherwise strong 
fiscal position.43  The main contingent liabilities involve  non-performing loans (NPLs) incurred by 
financial institutions; these are estimated at some 30% of GDP, only a fraction of which has been recognized as government debt, some being transfer red to government asset management companies.  
In addition, local governments have apparently been  able to circumvent balanced budget rules by, for 
example, borrowing through public en terprises established for this purpose.
44  Debt accumulated at 
                                                      
40 The RMB's appreciation against the U.S.  dollar was 0.44% by 14 December 2005. 
41 Since the revaluation of the RMB in July 2005, there has apparently been a significant drop in 
speculative inflows of capital into China;  such a drop  would reduce the need for sterilization and thus make it 
easier for the PBC to conduct monetary policy ("Cooling down",  The Economist,  28 January 2006, p. 73). 
42 OECD (2005a), p. 178. 
43 Nor do the figures take into account any possible quasi-fiscal cost of sterilizing foreign currency 
inflows.  Such a cost arises in so far as the interest rates paid by the PBC to induce domestic residents to 
voluntarily absorb "sterilization bonds" are higher than those received by th e PBC on its reserves.  Sterilization 
does not involve such a quasi-fiscal cost  at present because foreign exchange  reserves are invested largely in 
medium-term government securities issued by G7 coun tries, whose average yields currently exceed by two 
percentage points or so, the interest rate paid on central bank bills (the main sterilization instrument) sold by the 
PBC.  While the authorities are therefore making a profit on the interest rate spread, the associated exchange 
rate and interest rate risks are potentially large.  For example, if the RMB/U.S. dolla r exchange rate appreciated 
by 10% and U.S. treasury bond yields rose by 100 basis points, the PBC would be exposed to capital losses 
amounting to 2-3% of GDP (IMF, 2004b, p. 13).  
44 IMF (2004a), p. 16. China WT/TPR/S/161 
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the county, township, and village level has b een estimated at some 10% of GDP in 2002.45  I n  
addition, local governments may have provided credit guarantees even though this is prohibited by 
law.46  A special task force was established recently to study the potential liabilities being generated 
by local governments.47  The problem of dealing with these contingent liabilities would seem to be 
manageable. 
22. In order to increase budget transparency, the Government has adopted a series of major 
reforms since 2000.  These include:  the introduction of  departmental budgets so that all spending is 
assigned to a specific ministry or agency;  a treasu ry single account reform, which was started as an 
experiment in 2001 and has been extended to 1 40 central government departments;  bringing off-
budget items into the budget;  abo lishing unauthorized local fees and ch arges, such as those levied on 
farmers;  establishing the government procur ement system;  introducing a new budgetary 
classification system (possibly in 2007);  and bri nging the definition of figures more into line with 
international standards.  Nonetheless, more compre hensive public accounts are needed to ascertain the 
full impact of quasi-fiscal activities and continge nt liabilities on the Government's overall fiscal 
position. 
23. In the longer term, the Government also faces the prospect of additional future demands on 
the budget to deal with liabilities arising from public  pensions, the main component of the social 
insurance system (around 70% of revenues and expenditures) established in 1997, when it was 
extended to the entire urban labour force.48  Reflecting previous reforms, the present pension system 
evolved from a pay-as-you-go public pension system into a three-tiered system:  the first tier is 
mandatory (there are two components, one involving a basic flat-rate pension and the other involving 
individual accounts that are notional rather than fully-funded and to which both enterprises and individuals contribute), whereby current contributions are used to pay current benefits
49;  the second, 
voluntary tier, is funded by enterprise and indivi dual contributions;  and the third encourages 
individual saving for retirement.  With current contributions being used largely to pay current benefits, the public pension system is vulnerable to the rapid aging of China's population over the next 
30 years.  For example, the ratio of employed people to those over 65 years of age is projected to 
move from nearly 7:1 in 2005 to approximately 4:1 in 2025.
50  According to the World Bank, the 
transition cost of shifting from the present system to fully funded individual accounts could amount to a net present value of 70% of GDP (over the next 75 years).
51  On the other hand, the Government 
estimates that to ensure the viability of the public  pension system on a pay-as-you-go funding basis, 
contributions would have to rise from 20% to 35% of wages in the next 30 years to keep pace with 
benefit payments. 
24. In 2005, the State Council decided to adjust the orientation of fiscal policy towards a more 
"neutral" stance, aimed at bringing its fiscal defic it down to roughly 2% of GDP, a move that could 
ease pressure on the central bank to raise interest rates.  Such a shift entails reducing government 
investment in infrastructure projects, some of w hose cost-effectiveness may be questionable.  Some 
public projects have been characterized by a low de gree of accuracy in planning, underestimation of 
costs, inadequate forecasts of demand, delays in  project implementation, and a lack of ex post 
                                                      
45 Song, Li (2003). 
46 OECD (2005a), p. 181. 
47 IMF (2004a), p. 16. 
48 OECD (2005a), p. 187. 
49 In 2000, the Central Government established a Natio nal Social Security Fund to serve as a reserve 
fund and cover cash flow deficits in the first tier.  In principle, this fund is supposed to receive 10% of the 
proceeds from the sale of state-owned enterprises when there is an initial public offering or new share issues. 
50 OECD (2005a), p. 53. 
51 Dorfman and Sin (2001). WT/TPR/S/161 Trade Policy Review 
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evaluation.52  According to the OECD, waste is particularly severe in public projects financed by 
bonds, with only half of projects meeting their targ ets.  The authorities are currently reviewing the 
cost-effectiveness of public expenditures, including i nvestment projects, creating benchmarks against 
which actual expenditures can be assessed.  While this is a step in the right direction, efficiency of 
public spending, especially investment, could be enhanced by better exploitation of the market 
mechanisms, including competitive bidding in conn ection with government procurement.  The 
gradual reallocation of public expenditures from areas where social returns are low, to those, such as 
health and education, where social returns are hi gh would improve the efficiency of public spending 
and improve the growth prospects of the economy.  Education has become an increasingly important 
element of development policy during the past deca de.  In 2004, budgetary expenditure on education 
accounted for 2.46% of GDP, while total government-fi nanced capital spending has been over 9% of 
GDP in recent years.53  Insofar as the social returns on inv estment in human capital exceed those in 
physical capital, a reallocation of government spendi ng from the latter to the former could raise total 
factor productivity in China's economy. 
25. Increased expenditure on health, education, and other public services both in rural areas and 
for migrants in urban areas may well require a suitable adjustment of fiscal relations, including tax 
revenue sharing and transfers, between the central and local governments to ensure that funds reach 
the level of government responsible for delivering th ese public services.  Such expenditure would help 
reduce income disparities, if complemented by labour market reforms. 
(4) MAIN STRUCTURAL REFORM ISSUES  
26. Among the most difficult of China's structural refo rms have been taxation, the restructuring of 
SOEs, matters concerning labour markets (such as appropriate adjustment measures to address 
unemployment, including the establishment of a soci al safety net), and the financial sector and the 
related establishment of a smooth-functioning capital market. 
(i) Tax reforms 
27. China is a moderately taxed economy, with total tax revenues accounting for 15.1% of GDP 
in 2004.  Taxation increased in importance when the Chinese Government adopted economic policies 
aimed at attracting foreign investment and estab lishing a market-oriented economy.  The present tax 
system is relatively new, having been established in 1994 with the implementation of China's first 
market-oriented tax legislation.  The 1994 reform  followed those in the 1980s, whose objectives were 
to collect necessary tax revenues in an equitable ma nner, enhance the role of taxation as a tool of 
macroeconomic policy, encourage foreign investme nt, and make taxation more compatible with 
reforms of SOEs and enhance their self-management.54  The reforms were thus to create a tax system 
more conducive to China's economic development.  Under the present system, the core tax categories 
are indirect taxes levied on goods and services a nd direct taxes on the incomes of enterprises and 
individuals.  The bulk of tax revenue is collected from indirect taxes. 
28. The main indirect taxes are the value-adde d tax, the business tax, and the consumption 
(excise) tax, which accounted for 37.3%, 14.8% and 6. 2% of total tax revenues, respectively, in 2004.  
Whereas VAT revenues are shared between the central and local governments in the ratios 75% and 
25%, respectively, the business tax is assigned larg ely to local governments, and consumption tax 
revenues all go to the Central Government.  The current VAT, which is levied on the sale or 
importation of goods and some serv ices, is production-based, thereby including capital goods in the 
                                                      
52 OECD (2005a), p. 186. 
53 OECD (2005a), pp. 24, 185. 
54 OECD (2002b), p. 625. China WT/TPR/S/161 
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tax base, unlike a consumption-based VAT.  T hus, the present VAT penalizes capital intensive 
industries.  Another unusual feature of the VAT, whic h is generally levied at  13% and 17%, is that, 
depending on the goods concerned, it is not always fully rebated on exports.55  Insofar as the rate of 
rebate falls short of the rate at which the VAT is levied, the difference constitutes a levy on exports.  
Hence, while the main reason for not fully rebati ng VAT on exports may well have been budgetary 
(that is, to reduce tax revenue s hortfalls owing, for example, to  tax evasion), certain non-budgetary 
considerations have resulted in th e rebate being used as an instrument of economic policy, with the 
Government varying the rate at which the VAT is rebated and thereby restraining exports of certain 
products, presumably to encourage or discour age exports or to ensure domestic supply.56  By contrast, 
the business tax is a turnover tax on most services,  levied at 3%, 5%, a nd 20%, depending on the 
service involved;  insofar as taxed services are th emselves exported or embodied in exported goods, 
the business tax gives rise to cascading and thus constitu tes a levy on exports.  The consumption tax is 
essentially an excise tax levied at various combinations of ad valorem  and specific rates on certain 
items, notably cigarettes, alcoholic beve rages, gasoline and automobiles;  ad valorem  rates can reach 
as much as 45% on some types of cigarettes (see  Table III.11).  As in the case of the VAT, 
consumption tax may be rebated on exports. 
29. Direct taxes, levied on the incomes of ente rprises and individuals, accounted for 16.4% and 
7.2% of total tax revenue in 2004.  Income tax revenues are shared between the central and local 
governments in the proportions 60% and 40%, respectiv ely.  The enterprise income tax is unusual in 
that it consists of two distinct systems, one for do mestic enterprises and another, preferential one, for 
foreign-invested enterprises (FIEs).57  Whereas domestic enterprises are subject to a statutory income 
tax rate of 33%, FIEs operating in special economi c zones and other zones enjoy reduced rates of 15% 
and 24%.  These lower tax rates were designed original ly to attract foreign investment into China.  
However, these rates (and other tax measures) have provided additional scope for tax avoidance, if not 
evasion.  For example, Chinese companies are thoug ht to have disguised their investments as 
originating from abroad, a process the authori ties refer to as "faked foreign investment" 
(section (5)(iv)). 
30. The Government is currently working on a major restructuring of the tax system.  This may 
involve a switch in the basis for the VAT from production to consumption, depending on the success of a pilot project in N.E. China.  There are also  indications that the authorities may unify the dual 
enterprise income tax system
58;  this could usefully reduce the scope of incentives whose effectiveness 
may, in any case, be doubted.  Furthermore, conscious  of the growing urban-rural income disparities, 
the Government is phasing out agricultural taxes le vied on farmers;  the tax has been abolished in 
28 of China's provinces and autonomous regions.  The Government envisages that this process will be completed as of 2006 (two years ahead of schedule).
59  Insofar as these or other possible tax reforms 
entail revenue losses for sub-national governments, there could be the need for a compensation 
mechanism so as not to exacerbate regional income  disparities.  In order to compensate local 
governments for the loss in revenue owing to th e abolition of the agricultural tax, the Central 
Government made an additional transfer paymen t of Y 14 billion in 2005 to supplement the 
Y 21.6 billion payment in 2004.  
                                                      
55 There was also the matter of arrears on approved VAT refunds, which amounted to 2.1% of GDP in 
2003.  Such arrears also constitute a potential levy on export s.  However, as a result of the VAT rebate reform in 
2004, there are no long er any such arrears. 
56 For example, the rate of rebate  was lowered for exports of textiles and clothing from January 2004 
(for fiscal reasons, according to the authorities), increased  for exports of IT products from November 2004, and 
eliminated for exports of some steel products in April 2005. 
57 FIEs include equity joint ventures, contractual joint ventures and wholly foreign-owned enterprises.  
58 The authorities state that it is difficult to provide a concrete timetable for this. 
59 "China exempts all agricultural taxes in 2006", 5 March 2005.  (CEI online information.  Available 
at:  http://www.cei.gov.cn/ce/doc/cep7/200503111968.htm.)  WT/TPR/S/161 Trade Policy Review 
Page 18 
 
 
(ii) Re-orientation of the economy from the state-owned to the private sector 
31. Before China began its economic  reforms in the late 1970s, the economy was dominated by 
state-owned enterprises (SOEs), which accounted for virtually all GDP (and employment).  SOEs had 
geared production to development goals and auto matically received financing from state commercial 
banks (SOCBs) according to a national developmen t plan.  Since the onset of market-oriented 
reforms, however, many SOEs have found it difficult to adjust and thrive in the emerging market 
economy.  While their economic performance has on average improved in response to increased 
competition from private, particularly FIEs, SOEs ar e still considerably less efficient than private 
enterprises.60  For example, TFP in private-sector compan ies is more than double that in SOEs and 
this gap has been widening.  The closure and divestment of SOEs a nd the reallocation of resources to 
the private sector have contributed to increased  overall productivity and growth in the economy as a 
whole.  The private sector's share of GDP su rpassed 50% in 1998 and reached 59% in 2003.61  The 
continued re-orientation of the economy towards the private sector could bring considerable 
additional gains in growth in GDP and real incomes.  In the industrial sector, for example, the change 
in ownership structure raised TFP by 9.5% betw een 1998 and 2003.  If the change in ownership 
patterns continued at the same pace for the next fi ve years, TFP could be raised by up to 8%.  
However, the pace of reform has been conditioned by concerns about social stability, as lay-offs from 
SOEs have added to regional income disp arities and strained the social safety net. 
32. A major recent development in this regard  was the establishment of the State Assets 
Supervision and Administration Commission (SASAC) in 2003, as a central custodian to address the 
problems faced by central non-financial SOEs (see Chapter III(4)(iv)).  The creation of SASAC offers 
the potential for greater transparen cy in the operation and divestment of state-owned assets.  The 
extent to which the SASAC acts as a fiduciary fo r the Central Government, to maximize returns on 
state-owned assets, or more as an instrument of the Central Government in implementing its industrial policy, remains to be seen, although the authorities ma intain that the latter is not their intention. 
33. In recognition of the importance of the role of  the private sector in economic growth and job 
creation, the authorities are taking steps to reduce th e barriers to the private sector's expansion.  In 
February 2005, the State Council issued "Guidelines on Encouraging and Supporting the Development of the Non-Public Sector including Individual and Private Enterprises" that include 
measures for improving the operating environment for private enterprises.  These new guidelines 
provide for greater market access by private enterp rises to many industries that were previously 
restricted, including those dominated by state monopo lies and heavily regulated sectors such as public 
utilities, financial services, social services, and nati onal defence.  They also provide for the equal 
treatment of private enterprises and SOEs, calli ng for rules that discriminate against private 
companies to be rescinded and directing local governments to implement the new constitutional 
amendment guaranteeing private property rights.  N onetheless, the intention is to "keep public 
ownership as the mainstay and allow diverse fo rms of ownership to de velop side by side".
62 
(iii) Labour market reforms 
34. With the official unemployment rate rising and ad ditional workers expected to be displaced as 
China continues with its economic reform, labour ma rket reform is of major importance.  China's 
employment-related policies have become more market-oriented since the opening up of its economy 
                                                      
60 OECD (2005a), p. 39. 
61 OECD (2005a), p. 82. 
62 "Several Opinions of the State Council on Encouraging, Supporting and Guiding the Development of 
Individual and Private Economy and other Non-Public  Sectors of the Economy", 24 February 2005. China WT/TPR/S/161 
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in the late 1970s.63  Previously, under central planning, th ere was direct allocation of jobs and 
administrative controls of wages.  Employers had little control over their labour force or wage bill, 
while employees had little say in where they wo rked.  In addition, population movement was 
controlled through a combination of the citizen registration ( hukou ) system requirements, rural 
commune controls, and food rationing, all of which tended to prevent the development of a national 
labour market. 
35. During the past 20 years or so, China has undert aken gradual reforms to establish a labour 
market.  This has allowed, inter alia , greater flexibility in wage determination as well as in hiring and 
laying-off employees.  In particular, the introducti on of a new Labour Law in 1994 gave management 
more discretion over wage setting.  As a result, th e share of bonuses in total wages for all enterprises 
rose from 2% at the start of reforms in 1978 to a bout 16% in 1997.  The Labour Law also included 
minimum wage standards, which have been establis hed in all provinces, alt hough the Government has 
encountered difficulties in enforcing compliance w ith these standards, especially with regard to 
migrant workers.  At the same time, a labour cont racting system was gradually introduced, marking a 
shift away from lifetime job tenure, with the result that the proportion of urban workers on contract 
nearly doubled between 1994 and 1997 to roughly one third.64  Restrictions on the movement of 
workers between firms were also removed in an a ttempt to reduce the scale of the mismatch of labour 
inherent in the pre-reform system.  Furthermore,  during the 1990s, SOEs were allowed to lay-off 
permanent workers.  In addition, measures aimed at the gradual relaxation of the hukou  registration 
system were initiated in the mid-1990s and the aut horities believe that conditions are becoming more 
ripe for a comprehensive reform of the system (though not its abolition). 
36. As a consequence of these labour market a nd other reforms, employment in FIEs and 
collectives rose rapidly.  SOE employment also rose, albeit more slowly.  But as reform of SOEs gained pace in the late 1990s, around 24 million SOE employees were laid off during 1998-02 as part 
of a re-employment programme that provides a social safety net.  Under the programme, laid-off workers could enter re-employment centres (RECs), wher e they could stay until they found jobs or for 
up to three years.  Job losses at SOEs (and collectives)  were more than offset by those created in the 
private sector (including FIEs). 
37. One of the biggest challenges now facing the economy is how to absorb the considerable 
surplus labour and create employment for new entran ts while undertaking the structural adjustment 
necessitated by China's membership of the WTO.  It is estimated that well over 100 million jobs will 
need to be created during the next decade to absorb the wo rkers laid off as a result of the restructuring 
of the economy, together with migration from rura l areas, and new entrants into the labour force.
65  In 
this regard, despite China's rapid growth in GDP, employment growth has been relatively slow.  This 
is reflected in China's employment elasticity, which in the 1990s was 0.129, down from 0.33 in 1980s.
66  In other words, a one percentage increase in  GDP growth is associated with an increase in 
employment of only 0.129%, which is low for a relatively labour-intensive economy.  As the 
production techniques used by export-oriented manuf acturing firms, including FIEs, are frequently 
imported from industrialized economies, where labour is a relatively expensive factor of production, 
these techniques tend to be labour-saving.  Theref ore, such techniques may not necessarily be the 
most appropriate for China, where labour is relativ ely cheap and abundant.  At the same time, the 
Government's emphasis on the development of  manufacturing, which tends to be more 
capital-intensive than services, m eans that the latter's potential ro le in absorbing surplus labour, 
                                                      
63 Prasad (2004). 
64 Prasad (2004), p. 56. 
65 Surplus labour of about 150 million is thought to exist in rural areas and a further 10-11 million in 
SOEs (Brooks, 2004, p. 51).  
66 Asian Development Bank (2005), p. 31. WT/TPR/S/161 Trade Policy Review 
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particularly in agriculture, appears to have been  rather neglected.  Moreover, with traditional low-
skilled labour-intensive industries losing their co mpetitiveness owing to their low productivity, there 
is the immediate challenge of raising the quality of the labour force to achieve higher levels of 
productivity. 
38. The related challenge of widening income di sparities among regions a nd between urban and 
rural areas also needs to be addressed.  One of the primary causes of such disparities is wage 
differentials, which reflect di fferences in labour productivity.67  These differentials may be partly due 
to government policies that impede migration betw een provinces and from rural to urban areas, such 
as the hukou  registration system, and the separate but related problem of migrants obtaining 
entitlements to local social services, including those pertaining to health and education.68  A s  
mentioned above, the hukou  registration system is being re laxed gradually.  Another major 
impediment involves restrictive land tenure policies, which raise the cost of moving away from a rural 
area.69  However, there is a growing awareness by the Government that the movement of labour from 
rural to urban areas is a normal outcome of a market-based economy and that, consequently, no 
barriers should be placed on employment of rural workers in urban areas.70  The easing of these 
restrictions could raise output by as much as 2%71, significantly reduce income inequality, and 
encourage greater investment (since businesses main tain that such restrictions on labour mobility 
constitute the most significant barrier to the inter-provincial expansion of their firms).72 
39. One important way of alleviating income disparities is through improved education and 
training.  The authorities are taking steps to impr ove training and education of the largely unskilled 
migrants and "xiagang" (laid-off workers).  Moreove r, a variety of programmes have been put in place 
raising the access of the poor to education in the 1990s, including an effort to achieve nine-year 
universal education by 2010.73  However, funding remains inadequa te in many poorer areas, although 
the Government's medium-term objective appears to be to raise budget spending on education.  Such 
investment in human capital could not only improve  employment opportunities and raise wages, but 
also the long-term prospects for growth and prod uctivity in the Chinese economy.  Judging by the 
average number of years of education of the labour  force, the annual increase in TFP attributable to 
the accumulation of human capital was about 1% over the past two decades.74 
(iv) Capital market reforms 
40. Reform of the financial sector began in 197 9, when the monopoly of the People's Bank of 
China was dismantled and its commercial functions  separated into four state-owned banks.  
Previously, the PBC's role was largely to collect  revenue from SOEs, and to allocate investment 
(mainly to SOEs) in accordance with government po licy.  Since then, China has implemented a series 
of measures with a view to the eventual establis hment of a smooth-functioning capital market that 
would allocate savings to the most profitable inv estments, thereby raising the productivity of capital 
                                                      
67 See Kuijs and Wang (2005), p. 7. 
68 According to recent research, the hukou  system is significant in preventing movement 
towards a more equal distribution of income in China (Whalley and Zhang, 2004).  See BBC online 
information.  Available at:  http://newsvote.bbc.co.uk /mpapps/pagetools/print/news.bbc.co.uk/1/hi/world/asia-
pac [16 November 2005]. 
69 OECD (2005a), p. 112.  Segmentation between rural and urban areas (and even within urban areas) 
of the social insurance system also constitutes an obstacl e to labour mobility and hence the creation of a national 
labour market (OECD, 2005a, p. 187). 
70 State Council (2003). 
71 A substantial part of the Chinese Taipei's investment in China is thought to be funnelled discretely 
through the British Virgin Islands in order to circumvent Chinese Taipei's curbs on investment in China. 
72 OECD (2005a), pp. 112-113. 
73 World Bank (2001). 
74 OECD (2005a), p. 32. China WT/TPR/S/161 
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and thus economic growth.  A smooth-functioning cap ital market is a key to tackling China's aging 
population by ensuring that savings and pension f unds can be invested with the expectation of a 
reasonable return.  In addition, a fully deve loped capital market would facilitate government 
borrowing and the servicing of its debts resulting fr om budgetary deficits.  While financial sector 
reforms have helped to improve competition and thus the functioning of the capital market, major 
challenges remain. 
41. In particular, the capital market remains heavil y dependent on the banking system, which is 
still under-developed and relatively inefficient;  it is dominated by the same four state-owned 
institutions, whose combined market share is 54%.  Leaving much of China's large domestic savings 
in the hands of such banks, which have lent mainly to SOEs (accounting for roughly one-half of 
outstanding bank credit in 2000) has resulted in consid erable over-investment in certain sectors, with 
insufficient regard to returns on capital.  To the extent  that SOE returns have fa llen short of the cost of 
capital and they have still undertaken new investment, the latter has, in effect, been subsidized.  By 
contrast, the capital market has played a more limite d, albeit growing, role in financing private-sector 
businesses, especially small and medium-sized enterprises (SMEs), which account for around 60% of 
industrial output and 79% of newl y created jobs, but continue to face difficulties in obtaining 
financing.75  
42. State-owned commercial banks are among the fi nancial institutions most exposed to non-
performing loans (NPLs);  NPLs amounted to about 25% of total loans or 30% of GDP by end 2004 
(Chapter IV(5)(iii)).76  SOEs cannot reduce their costs very easily (due, for example, to impediments 
to laying off employees), which limits their profitabil ity and ability to service thei r debts.  At the same 
time, however, because of their continuing importan ce and the large number of employees involved, it 
is very difficult to cut off SOEs' financing.  T hus, while banking reforms are essential for sustained 
growth over the long-term, they could be disruptive in the short-term.  Nonetheless, since the 1990s, 
in the context of broad financial reforms, the Go vernment has been attempting to deal with the 
problem of NPLs, especially those of state-owned ba nks.  This includes capital injections by the State 
and the transfer of NPLs to asset management companies (Chapter IV(5)(iii)).  Other measures announced include the resolution of NPLs, strengthe ning of the banks' corporate governance, reform 
of the shareholding system, the use of external auditors to assess the true underlying financial position 
of the banks, and enhanced external oversight of  the banks' operations, including taking prompt action 
in the event that the capital base is threatened.  In order to assess progress under these reforms, the 
China Banking Regulatory Commission has established a number of performance indicators. 
43. Other challenges concerning the development of  the capital market include the relatively 
small size of bond issuances and IPOs as well as the fact that the majority of shares (accounting for 
roughly two thirds of the total stock market capita lization) are not traded, although the authorities are 
currently addressing this matter (Chapter III(4)(vii) a nd Chapter IV(5)(iii)).  In order to promote the 
development of the capital market, the State Counc il issued guidelines in January 2004 to allow 
qualified non-bank financial institutions to issue secur ities and to give more latitude to insurance and 
pension funds to participate in the capital market;  a number of structural changes are being carried 
out under these guidelines, including to improve co rporate governance of listed companies, and 
supervision of the securities market and to develo p new financial products including for small and 
medium-sized firms.  Changes in the Company Law and the Securities La w, which took effect on 
1 January 2006, are also expected to sp eed the development of the capital market. 
                                                     
 
75 See for example, Kuijs and Wang (2005), and Wu (2005). 
76 IMF (2005), Annex I.  Official estimates put NPLs at 13.2% of banking assets at the end of 2004. WT/TPR/S/161 Trade Policy Review 
Page 22 
 
 
(v) Competition policy 
44. In the course of its gradual transition from a centrally-planned to a more market-based 
economy, China's competition policy needs to address, inter alia,  the economy's duality (whereby 
public ownership remains a mainstay of the economy with the public and private sectors developing 
side by side), the continuing role of administrativ e and other state monopolies, and the persistence of 
barriers to inter-regional trade.  Since the 1990s, Ch ina has had legislation dealing with aspects of 
unfair competition and specific anti-competitive practi ces such as fraud, forgery, abuse of market 
dominance, predatory pricing, and collusive tenderi ng.  However, it lacks a modern, comprehensive 
competition law incorporating broad provisions to deal with cartels, anti-competitive mergers and 
other practices.  The extent to which this gap is f illed during the current legislative term (the "Tenth 
National People's Congress") by the adoption of a co mprehensive competition law remains to be seen.  
The main challenges for China will be to estab lish an effective enforcement authority and to 
implement the new law in a way that:  (i) addresses the challenges posed by administrative and state 
monopolies and other anti-competitive arrangements in  the Chinese economy, in a manner consistent 
with current economic learning;  (ii) ensures non-discriminatory treatment of private enterprises 
versus state-owned enterprises throughout China;  and (iii) ensures continuing non-discriminatory 
treatment of foreign corporations opera ting in China (see Chapter III(4)(vi)). 
(5) DEVELOPMENTS IN TRADE AND FOREIGN INVESTMENT  
45. Since China's adoption of an "open door" policy and economic reforms beginning in 1978, 
international trade and inward foreign direct invest ment (FDI) have played a key role in its rapid 
economic development.  The ratio of China's trad e to its GDP rose more than seven-fold between 
1978 and 2004, from less than 10% to 76.3%, with  exports and imports (of goods and services), 
respectively, accounting for 39.7% and 36.7%.77  As a result, China is now the world's third largest 
trader (after the United States and the European Communities).  China has also become one of the 
largest recipients of FDI, which has grown from vi rtually zero to approximately 4% of GDP annually 
during the past decade.  Much of this involved the establishment of FIEs, which tend to go to 
economic and technology development zones, where they are eligible for preferential treatment;  
processed imports and exports accounted for 48.5% of total merchandise trade in 2005, down from 
53% in 1998 (Tables AI.1 and AI.2).  Total accumulated FDI rose from US$1.8 billion in 1982 to 
US$562 billion in 2004.  By contrast, FDI outflows have, until recently, been relatively low, reaching 
only US$5.5 billion in 2004, for an accumulated total of US$44.8 billion.78 
(i) Composition of merchandise trade 
46. Manufactures accounted for 91.4% of China's total merchandise exports in 2004, up from 
87.2% in 1998.  During 1998-04, the value of these exports more than tripled.  The value of exports of 
relatively high technology products, involving t ypes of machinery and transportation equipment 
(particularly office machines and telecommunicati ons equipment and parts) , which now account for 
nearly half of manufactured exports, increased more than  five-fold (Chart I.2).  By contrast, exports of 
relatively low technology products  barely doubled.  In the case of textiles and clothing, exports 
increased slightly more than two-fold, although these products remain important;  they account for roughly 17.6% of manufactured e xports, down considerably from 26.7% in 1998.  The share of 
processed exports in total exports  remains high, 54.7% in 2005. 
                                                     
 
77 In the first half of 2005 exports and imports were US$342.5 billion and US$288.2 billion, up by 33% 
and 14%, respectively, from 2004.  In 2005, the merchandise trade surplus was US$101.9 billion, three times 
more than for 2004 (China Customs Statistics). 
78 In the first half of 2005, the FDI outflow was US$3.9 billion, an increase of 284% from the same 
period in 2004 (SAFE, 2005). China WT/TPR/S/161 
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Chart I.2
Product composition of merchandise trade, 1998 and 2004
1998 2004
(a)    Exports (f.o.b.)
Other consumer 
goods
21.7
Manufactures
87.2
Total:   US$183.8 billion Total:  US$593.3 billion
(b)    Imports (c.i.f.)
Chemicals
14.4Iron & steel
4.6Transport  equip.
4.5
Manufactures
80.6
Office machines &
 telecommunication 
equipment
15.7Other electrical
machines  
5.9
Non-electrical 
machinery
14.4Textiles
7.9
Other mining
  5.0Fuels
4.8
Non-electrical
machinery
11.5Other
0.3
Other electrical 
machines
6.3Office machines & 
telecommunication equipment
29.0
Other semi-manuf. 
3.8Transport equipment
4.2
Chemicals
11.7Manufactures
76.3
Office machines &
telecommunication
equipment
22.9
Total:   US$140.2 billion Total:   US$561.2 billionPer cent
Manufactures
91.4
Transport equip.  3.8
Other electrical
 machines
7.2Iron & steel  2.3
Other electrical 
machines
6.2
Other consumer goods  
                      8.9Other
0.5Mining
4.3
Office machines & 
telecommunication equipment
13.8Textiles 
7.0Other
0.2
Other semi-
manuf.  7.4
Non-electrical 
machinery
5.3Agriculture
4.1
Iron & steel   1.8
Source :  UNSD, Comtrade database (SITC Rev.3).Other  consumer goods
                   6.0
Mining
15.9Other consumer goods
15.9
Clothing   
10.4
Transport 
equip.   
3.5Other semi-manuf.
7.5
Non-electrical
machinery
3.8
Other semi-manuf.
  7.2Mining
4.8Agriculture
7.8
Agriculture
7.5Agriculture
9.0
Mining
9.8
Iron & steel
4.2Clothing
16.3Textiles
5.6Chemicals  5.6Chemicals  4.4Other 
0.2
Textiles  2.7
Other mining
7.3Fuels
8.6
 WT/TPR/S/161 Trade Policy Review 
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47. Manufactures accounted for 76.3% of China's to tal merchandise imports in 2004, somewhat 
less than in 1998.  During 1998-04, the value of  these imports nearly quadrupled.  Imports of 
relatively high technology products involving typ es of machinery and transportation equipment, 
which now account for 59% of manufactured imports, more than quadrupled.  Imports of relatively 
low technology products roughly tripled.  In 2005, 41.5% of imports entered China under the 
"processing trade regime". 
(ii) Direction of merchandise trade 
48. The main destinations for China's merchandi se exports are currently the United States 
followed by the EC-25, Hong Kong, China (presumabl y involving largely entrepôt trade), and Japan 
(Table AI.3 and Chart I.3).  Whereas the United States'  and the EC-25's shares of China's total exports 
have risen, respectively, from 20.7% and 16.2% in 1998 to 21.4% and 18.9% in 2005, the shares of Hong Kong, China and Japan, as well as Asia  generally, have declined markedly. 
49. The main sources of China's imports in 2005 are Japan (15.2%), Korea (11.6%), 
Chinese Taipei (11.3%), the EC-25 (1 1.1%), and the United States (7.4%) (Table AI.4 and Chart I.3).  
With the exception of Korea, the shares of all th ese Members in China's imports have declined since 
1998. 
50. In 2005, China runs large trade surplu ses with the United States (US$114 billion), 
Hong Kong, China (US$112 billion), and the EC-25 (US $70 billion) (Table AI.5).  By contrast, it 
runs large trade deficits with  Chinese Taipei (US$58 billion), Korea (US$42 billion), and Japan 
(US$16.5 billion).  These trade deficits partly reflect outsourcing by these Members, whose 
companies have invested in China.  To a larg e degree, those companies' operations involve the 
importation of parts and components from their ho me bases for processing and assembly in China, 
with the finished products subse quently being exported not just back to the home bases but to other 
parts of the world, notably the United States and th e EC.  In this way, Chinese Taipei, Korea, and 
Japan have, in effect, exported their trade surpluses with the United States and the EC through China.  
China's intra-industry trade with Chinese Taipei acco unts for more than half of China's intra-industry 
trade with the world (Tables AI.6 and AI.7). 
(iii) Trade in services 
51. Services comprise 9.5% of China's total exports  and 11.9% of its imports in 2004 (9.2% and 
11.8%, respectively during the first half of 2005).  During the period 1998-04, exports and imports of 
services almost tripled, which means that they grew more slowly than merchandise exports and 
imports.  Travel, business, and transportation were the main services traded (Chart I.4). 
(iv) Foreign investment 
52. China has become a major destination for foreign di rect investment (FDI), much of it oriented 
towards trade.  FDI has also been a major source of employment.  FDI in China increased from 3.8% 
of GDP in 2001 to 3.9% in 2002, but fell to 3.3% in 2003 and 2004.
79  As a percentage of China's 
total fixed assets, however, it dropped from 10.5% in  2001, to 10.1% in 2002, and to 8.0% in 2003.  
In 2003, FIEs added industrial value of Y 1,117 billion,  27.2% of the total industrial value-added, an 
annual increase of 20%.  Compared with other typ es of enterprises, FIEs showed a much greater 
orientation towards trade;  in 2003, exports acc ounted for roughly 46% of their industrial output, 
29.2 percentage points higher than for other types of  enterprises.  In 2005, FIEs' exports amounted to 
US$444.2 billion, up by 31.2% from the previous year, and accounted for 58.3% of total exports;  
their imports amounted to US$387.5 billion, up by 19.4%, and accounted for 58.7% of total imports. 
                                                      
79 FDI in 2005 was US$60.3 billion, very slightly down from the previous year (NBS online 
information.  Available at: http ://www.stats.gov.cn/English/newsandcom ingevents/t2006012 5_402302848 .htm). China WT/TPR/S/161 
 Page 25 
 
 
Chart I.3
Direction of merchandise trade, 1998 and 2005
1998 2005
(a)    Exports (f.o.b.)
Other Asia  
11.7Asia
52.3
Total:   US$183.8 billion Total:  US$762.0 billion
(b)    Imports (c.i.f.)
Free
Zones
2.2Other Asia  
7.5EC25
14.9CISa  3.1
United States
12.0EC25
11.1CISa   3.1   Africa  3.2
Singapore  2.5
United States
7.4
Total:   US$140.2 billion Total:   US$660.1 billionPer cent
Asia
45.6
Other Asia  
13.6Middle East
2.9Japan
16.1
Middle East
4.7Korea, Rep. of
11.6
Korea, Rep. of
10.7United States
20.7Other Europe  1.4
Other Asia  
10.4United States
21.4
Source :  UNSD, Comtrade database (SITC Rev.3); and China's Custom Statistics.Japan
15.2EC25
18.9Middle East   2.2
Asia
55.9Asia
59.9Japan
20.2
Free Zones
8.4Hong Kong, China
17.0
EC25
16.2Hong Kong, China
21.1Japan
12.4
Other America
4.7
Malaysia  3.0Chinese Taipei
11.3
Chinese Taipei
11.9
Hong Kong, China
4.7Other America
4.0Korea, Rep. of
4.7 Korea, Rep. of   
3.4
Other America
3.7Other America
5.2Middle East  2.3
Hong Kong, 
China  1.9Singapore  3.0
a        Countries included in Commonwealth of Independent States (CIS) are listed in Tables AI.3 and AI.4.CISa  1.3
Other Europe
1.1Africa  2.2CISa  2.8Africa  2.5
Other Europe  0.8
Other Europe  1.0   Africa  1.1
Malaysia  1.9
 WT/TPR/S/161 Trade Policy Review 
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Chart I.4
Trade in services, 1998 and 2004
1998 2004
(a)    Exports 
Business
29.9
Total:   US$23.9 billion Total:  US$62.4 billion
(b)    Imports 
Travel
34.5Insurance &
 finance
7.2
Construction
4.2Business
27.0Transportation
25.4
Travel
26.5Other
1.6
Construction
1.9Travel
41.2
Insurance & finance
8.7
Total:   US$26.7 billion Total:   US$72.1 billionPer cent
Construction
2.4Travel
52.7
Other
1.7Other
2.1
Transportation
19.3
Source :   State Administration of Foreign Exchange.Business
35.0
Communication
3.4Transportation
9.6
Construction
2.5Other 
1.9
Business
27.3Transportation
34.0
 China WT/TPR/S/161 
 Page 27 
 
 
53. Up to now, manufacturing has attracted the most FDI to China, accounting for around 70% of 
newly established FIEs between 2002 and the first ha lf of 2005.  The share of services (excluding 
electricity, gas, water, and construction) in FD I inflows was around 23% during the period 2001-04.  
By the end of 2003, FIEs directly employed ar ound 24.5 million people, approximately 10% of the 
urban and township labour force.80 
54. In 2004, China's main source of FDI was Hong Kong, China, which accounted for about one 
third of the total, followed by the British Virgin  Islands (11%), Korea (10%), Japan (9%), EC-15 
(7%), the United States (6.5%), and Chinese Taipei (5%) (Chart I.5).81  A significant part of the 
inflows from Hong Kong, China and other sources (t he British Virgin Islands, Western Samoa, and 
the Cayman Islands) presumably originated from other countries, including China itself, with part of 
such capital possibly being recycled through these te rritories in order to benefit from the preferential 
tax treatment offered by China to foreign-based comp anies.  Part of FDI inflows may involve "faked 
foreign investment" or  "round tripping", which sugg ests that China's capital controls may be looser 
than previously thought.82 
Hong Kong,
 China
38.1
Other
7.4
Cayman Islands 
1.5British Virgin 
Islands
9.4EC15
11.0Singapore
5.3Japan
7.2
Chinese Taipei
5.6Korea, Rep. of
3.7Chart I.5
FDI inflows by origin, 2000 and 2004
2000 2004
Source:  National Bureau of Statistics (2001 and 2005), China Statistical Yearbook .Total: US$40.7 billionTotal:  US$60.6 billionHong Kong, 
China
31.3
Other
11.1United States
6.5Korea, Rep. of
10.3
Cayman Islands
3.4
 British Virgin 
Islands  
11.1Singapore
3.3Japan
9.0
  Chinese Taipei
5.1Per cent
United States
10.8EC15
7.0
 Western 
Samoa
1.9
 
55. China's FDI outflow amounted to US$5.5 billion in 2004.  The increased outflow was in large 
part driven by demand for natural resources, for exam ple, oil, gas, and mining products.  In particular, 
                                                      
80 Ministry of Commerce online information.  Available at:  http://www.fdi.gov.cn/common/ 
info.jsp?id=CENSOFT000000 0008759 [10 December 2004]. 
81 When a labourer leaves agricultu re to work elsewhere in the econ omy, the value created by this 
labourer increases five-fold (Chapter IV(2)(i)). 
82 Xiao (2005).  In addition to the preferential tax treatment of foreign enterprises, a reason given for 
such round tripping is that the Chinese authorities and the legal system offer better intellectual property rights protection to foreign companies. WT/TPR/S/161 Trade Policy Review 
Page 28 
 
 
Chinese SOEs invested in the oil industry in many countries, such as Indonesia, Kazakhstan, 
Myanmar, the Sudan, and Yemen, as well as in aluminiu m, steel, and coke industries in Brazil.  Some 
Chinese enterprises have also started to purchase shares of foreign enterprises.83 
(6) PROSPECTS  
56. With its vast human resources, thrifty popula tion, and increasingly market-oriented economy, 
China looks set to continue rapidly along its path  to economic development in the foreseeable future, 
provided it maintains the pace of its outward-looking , market-oriented economic reforms.  Proposals 
for China's 11th Five Year Plan for National Economic and Social Development, approved in 
October 2005, set the goal of doubling GDP per cap ita in 2010 relative to 2000, while building a 
"harmonious society".  This would require average annual growth of just over 7%.  This goal would 
appear to be reachable given that annual growth  averaged roughly 9.3% during the period 2000 to 
2005.84  Only a slight slowdown is expected in 2 006, provided the "open door" economic reforms that 
have contributed to this rapid growth are continue d, thereby integrating China further into the global 
economy. 
57. At the same time, however, the Chinese economy faces a number of important challenges.  
One is how to create more than 100 million jobs estim ated to be needed during the next decade.  This 
is necessary to absorb the worker s laid off as a result of the restructuring of the economy, including 
the shrinkage of the state-owned sector, together w ith migration from rural areas, and new entrants 
into the labour force.  With a view to creating th ese jobs, the Government might usefully reappraise 
its broad economic development stra tegy, which has hitherto attached high priority to encouraging 
export-oriented capital-intensive manufacturi ng, and place greater emphasis on removing 
impediments to the expansion of the services sector, which tends to be less capital-intensive.  At the 
same time, however, with traditional low-skilled labour-intensive industries losing their external 
competitiveness owing to their low productivity, there is the immediate challenge of raising the quality of the labour force to achieve higher levels of productivity across all sectors of the economy.  
There is also the related challenge of addr essing widening income disparities among regions and 
between urban and rural areas, one of the primary causes of which is wage differentials reflecting 
differences in labour productivity.  Over the longer term, there is also the problem of how to cope with China's rapidly aging population.  In addition, bottlenecks in land, water, and energy resources as 
well as environmental protection need to be addr essed.  Furthermore, to the extent that "over-
investment" has created excess capacity in certain sect ors, in the event of a substantial slowdown in 
the growth of the economy, NPLs may be expected  to rise if the financial sector and the capital 
markets are not sufficiently rest ructured.  These and other challenges are being addressed by more 
market-oriented policies aimed at ensuring more ef ficient use of resources together with socio-
economic policies concerning, in particular, educa tion and training, health, and social security. 
                                                     
 
83 Financial Times,  28 October 2004. 
84 According to the latest adjustme nt to GDP announced on 20 Decembe r 2005 as a result of the First 
National Economic Census.