JPRI Critique Vol. 4 No. 5: July 1997
The Current U.S. Debate over China Policy
by Alan Wm. Wolff

The factors affecting the Sino-American relationship are as difficult to describe as the currents of the Yangtze River as it passes through the Three Gorges. The river does not so much have a steady flow in one direction as it is a contest among various conflicting forces. U.S. policy toward China appears on occasion to be like a small boat on such a river-alternatively pulled down, pushed up, or swept around in a whirlpool.

China wears many faces for Americans. Its seemingly vast market calls out to them with promises of great rewards reminiscent of the California Gold Rush. China's rapid economic development-characterized by the more than one-thousand cranes currently building a new Shanghai-is a cause for widespread admiration. Strong positive forces-economic, historic, and geopolitical-pull Americans toward China. At the same time, they hear the personal stories of Chinese dissidents (especially after Tiananmen); have concerns over China's export of weapons (from missiles to millions of cheap but effective land mines) and of nuclear technology; are surprised (perhaps naively so) by the vehemence of the Chinese Government's reaction to the permission granted to the President of Taiwan, Lee Teng-hui, to speak at Cornell, and the shelling of waters off Taiwan; and are nagged by concerns over how individual freedom will fare in Hong Kong after reversion.

Many Americans conclude that their policymakers should strive hard to forge close ties with China. Some others view China primarily as a threat-economic, political, and military. A few urge consideration of rearming Japan as a counterweight to the planned expansion of China's military capabilities. These are stunningly opposite views to accommodate within a policy debate.

The current debate in Washington on U.S. policy toward China has spread from scholarly journals to the front sections of America's newspapers because of three factors: the upcoming reversion of Hong Kong to China at the end of June of this year, China's application for accession to the World Trade Organization (WTO), and the allegations that Chinese funds and interests were illegally involved in financing campaigns in the November 1996 U.S. elections. Whatever the merits of the allegations prove to be, the effect can be to slow, at least for the present, progress toward closer ties between the United States and China. All aspects of the bilateral relationship and the policies and actions of China and the U.S. as they affect each other have now become prominent parts of America's internal policy discussion.

America's interests are deemed by the U.S. Administration to be best served by what it calls a "policy of comprehensive engagement." Some observers consider this to be more an approach than a clearly articulated policy. Nonetheless, it is important as a direction, and there are concrete policy elements associated with it. Under the 'comprehensive engagement' umbrella, there are six current headings: (1) nuclear nonproliferation and arms control; (2) human rights; (3) trade; (4) Hong Kong reversion; (5) Taiwan; and (6) cooperation on terrorism and the global environment.

I will not address all of the topics on this list since my area of professional expertise is trade. There are three dominant features of the trade landscape: WTO accession, the trade imbalance, and permanent Most Favored Nation status.

WTO Accession

There has never been a case of accession to the World Trade Organization (WTO) as complex as that presented by China's application. First, China is the largest trading nation by far to join (or rejoin) the world trading system well after the system's establishment. Second, China is far from being fully a market economy country. For accession to take place, intensive negotiations are needed, and have in fact been long underway. China has taken some recent, very important steps to make near-term accession more feasible. The most important of these has been its agreement to apply the rules of the WTO's intellectual property agreement (TRIPs) immediately with no phase-in period. It has also agreed to grant extensive trading rights with a very short phase-in period.

What are the other key issues?

(1) Market Access. It is easier to write the words "market access" than to deliver on them.

(a) A threshold problem-state ownership. The GATT has dealt only to a slight degree with state trading (that is, where a state monopoly controls the sale and importation of a commodity). It has never faced the problem of widespread state ownership. The essence of the WTO/GATT is that decisions to buy and sell are to be driven by market forces, that is, solely by commercial considerations. What would a Korean "Buy-national" program look like were one adopted by China, where the potential market consists largely of state-owned enterprises? Where there is state ownership, is a central government "suggestion" a command? This issue may not pose an insurmountable problem, but it is a real problem.

(b) Tariffs. There will be a reluctance on the part of China to open its economy too quickly. Yet, being closed has its own costs. Rather than proselytizing for open markets, let me merely cite one current illustration-the Information Technology Agreement (ITA). Under the ITA, by the year 2000, almost all computers, telecommunications equipment, semiconductors, software and semiconductor-making equipment will flow in international trade free of duty. Countries entered this agreement not primarily because they would gain greater foreign-market access but because taxing their own information technology imports threatened their ability to participate in the information age. On the heels of the ITA, countries further agreed that opening their own economies to international competition in telecommunications services made equally good sense, and struck a deal to do so. It may be too much to hope that the historical model of promotion of domestic industry through protection has been completely discarded, but at least the mold has cracked.

(c) The Exchange Rate. Trade ministers are not allowed to concern themselves with exchange rates. That is the preserve of finance ministers. Yet, what does a reduction of a tariff mean if the currency of the importing country is substantially undervalued or if it engages in competitive depreciation? At a minimum, as in the case of Mexican accession to NAFTA, a change in exchange rate relationships (accompanied or caused by a collapse in domestic confidence) can deprive a party to a trade agreement of near-term anticipated benefits. Ignoring exchange rate effects can undermine domestic support for trade liberalization.

The yuan is still not freely convertible. It was undervalued and has been depreciating in real terms. Some understanding of its proper valuation must underpin China's trade commitments.

(d) The Rule of Law. One of the basic assumptions under which trade takes place is that contracts will be honored and that anticompetitive private practices will be prevented. China must have a full understanding of the legal infrastructure necessary to support trade.

(e) Other Nonmarket Factors. Key concerns in trade with China are other factors that can distort markets. Guanxi (personal relationships) and anti-corruption campaigns in China are recurring themes. Clearly a major problem for foreign access to the Japanese market over time has been the interrelationships within and among keiretsu, which can overcome market factors in determining competitive outcomes. Japan's move toward re-establishing holding companies is currently creating concerns among Japan's trading partners. No trading partner wants to repeat, in the case of China, the market access experience faced in Japan. Nor do they want to cope with, in China, the corruption that is said to plague business in India and Indonesia.

(2) Freedom of Investment. China has become one of the world's most attractive places to invest. Yet, serious concerns have been raised about investment- related performance requirements. These include: conditioning investment approvals on technology transfer, trade or foreign exchange balancing requirements, local content requirements, export requirements, or other offset arrangements.

(3) Dumping. The WTO/GATT condemns dumping-the sale of goods below fair value causing injury to an importing country's competing industry. A prerequisite for obtaining broad U.S. industry support for China's WTO accession is that current rules for dealing with nonmarket economy imports be retained and that adequate, effective and accessible anti dumping provisions be maintained.

(4) Industrial Targeting. The marshalling of national resources for industrial policy purposes, accompanied by protection of domestic industry, has been an economic development technique employed by both Japan and Korea. The WTO generally disaggregates packages of measures to see whether subsidies, dumping, and/or protection may run afoul of its rules. However, major trading countries, having their own commercial interests, must of necessity study the entirety of trade-distorting industrial-policy efforts of any trading partner in any given industry and determine whether to respond with their own policy measures.

The Trade Imbalance

By any measure the trade imbalance between the United States and China, running now at an annual rate of between $40-$50 billion, is vast. It is also politically unsustainable in the United States. It is the same order of magnitude as the U.S. trade deficit with Japan, but with two major differences: (1) the amount of U.S. exports to China is very small, so that the trade is far more one-sided than it has been with Japan, and (2) the composition of the Chinese surplus is made up largely of goods that have been imported into the U.S. for a long time, e.g., apparel, footwear, consumer electronics, and the like. Both the economic and political effects in the U.S. of imported goods displacing other imports are different from the impact of imported goods displacing domestic production (e.g., autos, auto parts, machine tools, steel, and ball- bearings).

This compositional difference may explain why the Japanese trade surplus with the United States has been a source of irritation for decades, whereas the Chinese trade surplus, although more lop-sided, has so far attracted less attention. Another factor that may have diminished the political sensitivity of the U.S.-China trade imbalance is the fact that investment into China has been encouraged while investment into Japan has been very difficult. Whatever the reasons, it is likely that the lack of a strong adverse reaction to the U.S.-China deficit is now coming to an end. Following, as it does, the last great trade debate in the U.S. on NAFTA, the China trade debate is likely to be highly charged with concerns over whether there is wage stagnation in the American economy and whether imports from a low-wage country are a causal factor. Permanent Most Favored Nation Status

This should be a subject that goes hand-in-hand with WTO accession, but it is more politically sensitive because: (1) it is within the purview principally of the Congress, and (2) the issue is really less about economics than about human rights. The vote on permanent MFN will be affected by issues such as China's treatment of dissidents, and completely controlled by any convulsive event, in the context of Hong Kong reversion or otherwise. The subject of human rights is seen in Washington in terms of the treatment of individuals and not whether trade policies enhance the material well-being and freedom of the population generally. Reflecting on the Next Century

China, Japan, and the U.S. are most likely to determine whether the Pacific Rim countries-one entire hemisphere-can find and apply a formula for international cooperation that will serve to ensure peace, prosperity, and freedom for its peoples and their neighbors for the coming century. China's integration into the world economy is of vital importance to us all. That is why the U.S. supports WTO accession for China, and why I am confident that it will happen. Growing trade relationships will increase the stakes so that the costs of a return to animosity will be too high to be contemplated by any country. What is required of all of us is to work together creatively to foster the building of more positive economic relationships among our countries.

ALAN WM. WOLFF is a former U.S. Deputy Special Representative for Trade Negotiations and is currently Managing Partner of Dewey Ballantine's Washington, DC office. This paper was first presented on May 6, 1997, in Shanghai, at the Trilateral Forum on China-U.S.-Japan Cooperation in Promoting Liberalization in Trade and Investment in the Asia-Pacific Region. Alan Wolff is also a member of JPRI's Board of Advisers.

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