Although joining WTO will have undoubted long term benefits, in the short tem accession will make things tougher for China, says Chan. For example, China's share of world output will decrease to 5.21% in 2005 compared to 5.3% it could have had if the country stayed out of WTO.
On the other hand, WTO will enable China to become anchored within the global trading structure, with its share of exports and imports rising to 6.8% and 6.6% respectively, compared to 4.8% and 5.3% had the country not joined WTO, says Chan.
However, joining WTO will not break China's unfortunate tradition of low corporate profitability, he warns. So far, China's impressive GDP growth has largely failed to be reflected by listed companies, most of which show dismal return on equity (ROE).
Most of China's listed companies are state-owned enterprises which rely on soft bank loans and funding from the country's topsy-turvy equity markets to stay afloat.
By using the income approach to GDP growth, Chan shows that the operating surplus (or the portion of GDP which reverts as profit to shareholders) China managed to generate from 1994 - 2000 was just 21% of GDP, compared to 30.4% in Korea, 31.4% in Taiwan and 20.5% in Japan.
In particular, Chan believes poor capital allocation has lead to over-investment, leading to high levels of fixed capital consumption and low macro profitability.
"With WTO intensifying competition within China, profitability will go down in the short-to-medium term, leading to an even lower operating surplus by 2005," states Chan.
In a comparison with Japan, Chan points out that China's average of a 37% investment to GDP ratio from 1978 through to 2000 was comparable to Japan's, during its boom period. This was from the time Japan joined the WTO's predecessor GATT in 1955, to 1997. Both countries saw similar investment and export booms.
However, Japan was far more successful in generating an operating surplus from its investments than China. "This issue is a major concern for China," he concludes.
Continued lower operating surpluses will be the short-to-medium future trend in the wake of China's accession to the WTO.
Poor capital allocation will exacerbated by fierce foreign competition, on the back of large amounts of foreign direct investment producing products which have a far shorter life-cycle than is common in China.
Longer product life cycles lead to stable profits, while the profits for shorter life cycle products can be very high, but more volatile.
Long product life cycles are generally found in uncompetitive markets, in which there is little pressure to innovate. Consumers in developing markets also tend to be more interested in pricing than technological upgrades.
Shorter product life cycles will put pressure on Chinese manufacturers whose products have much longer life cycles than in developed markets, and which will have to spend large sums to establish brands that are competitive with western manufacturers.
The automobile and banking sectors will face the biggest challenges in shortening the life-cycle of their product life cycle, followed by telecom services, chemicals and metals, says Chan.
In the banking sector, Chan points out that western banks will benefit from the high concentration of deposits in China's major cities of Guangzhou, Beijing and Shanghai. High and stable interest rate spreads make it an attractive market to western banks, whicy will only have to compete for deposits in rich cities, putting further pressure on China's banks.
Promising sectors, because they have benefited from little state protection, are China's PC and retailing sector. These sectors already have much shorter product life cycles and have superior levels of flexibility in facing foreign competition. In addition, the need for regular upgrades in the technology sector is more widely accepted.
