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June 7, 2007
At a recent China Town Hall forum at the East-West Center, Joseph J. Borich, executive director of the Washington State China Relations Council and former U.S. Foreign Service Officer with long experience in China including a posting as Consul-General in Shanghai from 1994 to 1997, addressed the opportunities and challenges posed by China's growing economic, political, and military power. The China Town Hall forum was sponsored by the National Committee on U.S.-China Relations, the Pacific and Asian Affairs Council, the East-West Center, and the University of Hawaii Center for Chinese Studies.
The transformation of China over the past quarter-century is unprecedented in human history. China's economy today is ten times larger than it was in 1980 and continues to grow by about 10 percent per year. It is likely to continue to grow at about this rate until 2020 at least, by which point it will challenge the U.S. for the title of the world's largest economy.
For purposes of comparison, Latin America's economy cumulatively has grown a total of 10 percent in the past 25 years. India, the other big emerging market sharing the spotlight of late with China, has grown by an average of 6 percent per year and only over the past 15 years. China's economy is now three times larger than India's and the gap is growing.
China's spectacular growth has been fueled largely but not exclusively by foreign trade and foreign direct investment. In 1978 China's total trade was about $20 billion and it was ranked thirtieth among trading nations.
In 2005, China's total volume of trade exceeded $1.4 trillion and it is now the third largest trading nation. By the end of this year China will export more than the U.S. and at some point in the next two years China will move up a notch past the U.S. and become the world's second largest trading nation.
China's growth has also been spurred by large inflows of foreign direct investment, which now cumulatively totals about $650 billion. Over the past several years, China has attracted more new foreign direct investment (FDI) than any other nation.
Of late we have seen the emergence of the reverse flow of foreign investment as China has stepped up its investment in other countries. Encouraged by new Chinese government policies, Chinese companies have increased outbound investment from about $550 million in the year 2000 to about $7 billion in 2005. However, that figure reflects only investment approved by the central government. It does not include investments approved by local governments or those made by Chinese overseas subsidiaries. Estimates of China's total investment overseas from all sources range from 50 percent to 300 percent more than the official figure.
Beijing has recently earmarked between $200-300 billion of its more than $1 trillion in foreign exchange reserves for outbound direct and portfolio investment. This could benefit many companies in the U.S. and elsewhere as well as have a measurable impact on global financial markets.
About half of China's outbound investment thus far has been targeted at petroleum, minerals and metals. The other half, though, has gone toward buying brands, technology and engineering skills as well as access to markets. The most publicized example of an investment aimed at acquiring a brand, technology and market access was Lenovo's purchase of IBM's PC business a couple of years ago.
For all of that, though, China's emergence as one of the world's leading economic powers has not been trouble-free. After accession to the World Trade Organization (WTO) in 2001 China quickly became a key link in the global supply chain. The trend of shifting manufacturing from elsewhere in Asia, Europe and the U.S. to China has accelerated rapidly since 2001.
One important consequence of this was that China's trade surplus with the United States has reached record levels. From 2002 onward, the U.S. trade deficit with China each year has been higher than any bilateral trade deficit we've ever posted, and, in fact, is reaching the level of our global trade deficit just a few years ago. Last year the deficit with China exceeded $232 billion.
Although the U.S. global trade deficit (nearing $900 billion) is very troubling, Washington's bilateral trade deficit with Beijing is not particularly important economically for reasons I will explore shortly.
Politically, however, the trade deficit with China is a different story. Since early 2005, China has come under increasing congressional and media criticism for its skyrocketing trade surplus with the U.S., intentional undervaluation of its currency as a means of subsidizing its exports, disruptions of the U.S. market, failure to provide adequate measures to protect U.S. intellectual property and to quash rampant piracy of intellectual property, along with assorted complaints about the pace and direction of China's implementation of its WTO commitments.
Over the past two years there have been over 20 bills on China proposed in the U.S. Congress calling for actions against China that range from the symbolic to those that are harsh enough to seriously disrupt the relationship.
As the new Congress, now controlled by the Democratic Party, has settled in, the Congressional spotlight is beginning to shine even more harshly on China and the Bush administration, on trade issues in particular. Some of the criticism being handed out is well deserved and some form of Congressional action will no doubt happen.
Already the Bush administration has filed several WTO complaints alleging China has failed to keep its WTO commitments to protect intellectual property. Another U.S. complaint to the WTO charges that the Chinese government is using subsidies to boost Chinese exports.
In another tactic, in April the U.S. Commerce Department found that Chinese government subsidies had given an unfair advantage to Chinese made coated paper in the U.S. market and began charging countervailing duties against the product. This is the first time that the U.S. has ever levied countervailing duties against a non-market economy.
These actions followed growing Congressional pressure on the administration to address the trade deficit with China. However, these measures may be too little, too late.
Recently congressional leaders of both parties and in both houses have said they will introduce legislation to slap import duties on Chinese products to offset alleged export subsidies. Another bill, drafted by Senators Charles Schumer and Lindsey Graham, would impose a 27.5 percent tariff on all imports from China if China did not significantly revalue its currency.
Another measure put forth would terminate Permanent Normal Trade Relations status for China and subject bilateral trade to an annual Congressional review. And these are but some examples of legislation that could be passed by Congress this year.
The problem is that the issues here are complex and broad and will not be "fixed" to the advantage of our overall national interests by shortsighted and narrowly focused legislation. The measures cited above reflect more the degree of Congressional frustration and anger and less a rational approach to addressing imbalances and inequities in our trade relationship with China.
Late last month, the second round of the Strategic Economic Dialogue met in Washington, DC co-chaired by Treasury Secretary Hank Paulson and China's Vice Premier Wu Yi. These semiannual high level talks were agreed to by Presidents Bush and Hu Jintao when they met over a year ago. The first round was held in Beijing last December.
The Strategic Economic Dialogue was originally intended by the leaders of both countries to focus on medium to long term goals and to help anticipate and better manage issues that would inevitably arise. In particular the dialogue was designed to focus on areas such as reform of the financial sector, cooperation in energy and the environment and innovation.
Such is the state of tension right now in U.S.-China economic relations that the original intent of the dialogue was cast aside because of pressure to deal with more immediate issues, in particular, those that are especially contentious from the U.S.' perspective: revaluation of the Chinese currency; protection of intellectual property; and full implementation of China's WTO commitments, particularly but not only in the area of financial services, among others.
On the question of better protection of intellectual property rights (IPR) there was only a vaguely worded agreement to create a program for greater exchanges between the two countries' customs authorities to strengthen IPR enforcement. There were no announcements regarding China's exchange rate policy, although China broadened the band for the Renminbi daily exchange rate on the eve of the meeting from 0.3 to 0.5 percent, which led to a record high close of 7.65 Renminbi to the Dollar during the meetings.
This marked a cumulative appreciation of 8 percent since the summer of 2005 and would yield an appreciation of about 12 percent by year end if the wider band is maintained.
The results of the recent Security Economic Dialogue were thus were modest indeed and are unlikely to deflect Congressional action, which may happen as early as June.
Are we sliding toward a trade war with China? If we are, we should weigh the likely consequences carefully.
Unilateral action against China as the result of ill considered legislation (or pre-emptive administration actions to thwart such legislation) invites comparable retaliatory actions by China and also risks WTO-imposed penalties. There is much at stake here for American businesses, workers and farmers.
China is now the fourth largest export market for the U.S. and U.S. exports to China have been growing at a much faster rate over the past two years than our imports from China. The volume of U.S. sales to China in 2005 was nine times that of 1990.
Also, U.S. exports to China have been growing at a much faster rate than with any of our other major trading partners.
For example, exports to our second-largest export market – Mexico – are only about quadruple what they were in 1990. Sales to Japan have increased only about 15 percent since 1990.
On the import side, our burgeoning trade deficit with China is not particularly noteworthy from an economic perspective.
Trade displacement, especially in Asia, has driven down our trade deficits with other Asian countries by almost the same amount as our bilateral deficit with China has grown. This is simply because Asian countries have shifted export production from their home markets to China.
Taiwan, for example, used to be the leader in laptop production, but is no longer making any laptops in Taiwan. All of Taiwan's laptop factories have moved to the Mainland.
In fact, about 60 percent of China's exports are produced or assembled in foreign invested enterprises there. The actual added value of Chinese inputs is only 25-30 percent of the total value of China's exports.
Thus, an increase in U.S. tariffs on imports from China, as is being considered in various forms by Congress, would penalize foreign (including American) invested enterprises in China far more than Chinese domestic enterprises.
Another group that would be penalized by increased tariffs on imports from China would be U.S. consumers, especially those on tight budgets who depend on finding in places like Wal-Mart a steady stream of good value, low cost items supplied mainly from China. Higher import duties simply constitute a consumption tax on Americans since the duties are for the most part passed on through the wholesale/retail chain and translate as higher shelf prices.
Finally, the growing list of American companies who export to China will be hurt, too, because China will almost certainly retaliate in kind against any measures adopted by the U.S. to constrain imports from China.
The point here is that a trade war helps no one.
What, then, to do?
On April 2, Senator Max Baucus, Democrat from Montana and chairman of the powerful U.S. Senate Finance Committee, visited Seattle and gave an important foreign policy address on U.S.-China economic relations. The event was hosted by the Washington State China Relations Council.
As Chairman of the Finance Committee – which has jurisdiction over international trade – Baucus will have enormous influence on U.S.-China relations.
Although delivered in trade friendly Seattle, Baucus' speech was directed to Beijing and to Washington, DC. He began by saying: "We must send a message of what China can do. We must send a message of what America can do. We must send a message of what our two countries can do together. We must begin a dialogue of the possible."
Baucus believes we must challenge our myths and engage in a dialogue of the possible with China because, "An increasing number of American workers, manufacturers and Members of Congress view China as the cause of stagnating wages and economic distress."
"In America, we risk creating a generation filled with resentment and suspicion. We risk creating a generation convinced that China is a greater threat than it is an opportunity. We risk creating a generation that blames China for job losses, factory closings and other hardships."
And, at the same time, "
more and more Chinese harbor suspicions about whether American really wants China to succeed."
In this climate, according to Baucus, we must send China a message that is "carefully calibrated," one that is firm but fair. He said, "If we solve our problems with China, we can solve them elsewhere. If we unlock the potential of the China market, we can unlock the potential of other markets.
If we can learn to cooperate with China, we can build stronger partnerships around the world. Yet if we fail with China, we will likely fail elsewhere."
In his speech Baucus called on China to bring more flexibility to its currency exchange rate, liberalize its markets by fully meeting its WTO commitments, protect intellectual property and actually move beyond WTO to define new levels of openness and liberalization.
However, Baucus also called on the U.S. to pull its share of the load, especially by spending more on export promotion and getting Americans to save more of their incomes and spend less. For after all, China is only exporting what Americans choose to buy and in the quantities Americans are demanding.
Further, he called on the two countries to work more closely together in areas where we clearly have shared national interests, for example, in energy.
Unlike other proposed policies and legislative action plans gathering momentum in Congress, Baucus' plan offers very important trade-offs that could help both countries (and the world) find not only an economic, but political, equilibrium. His proposals deserve careful study, and many elements of his proposed course of action hopefully will garner strong support in both Beijing and Washington, DC.
Absent a carefully calibrated and mutually acceptable plan for addressing the inequities in our bilateral trade relationship such as proposed by Baucus, we will likely be left with ill-considered policy changes or legislation by the end of this year that could seriously disrupt bilateral relations and trade.
This would certainly have dire consequences for Washington State, which is the most trade dependent state in the U.S. and whose largest export market is China. But, a trade war would hurt Hawaii, too.
Hawaii is a global center for tourism, for example, and could play a pivotal role in the further development of China's tourism industry and also be a magnet for increasingly wealthy Chinese globetrotters who already number in the tens of millions.
By 2020, China will be the world's most popular tourist destination with projections of 180 million visitors per year. With its rich experience in the tourism industry, Hawaii is uniquely positioned to benefit from China's pressing need to upgrade its tourism infrastructure.
Another pressing need for China that Hawaii can help meet is education and training. Hawaii offers a wide range of professional, vocational and executive training programs, exactly the huge gap that China desperately needs to fill.
Hawaii is a world leader in sustainable tourism development; international business; teaching; health care and medical technology; government; science and technology; and agriculture and aquaculture. Beyond expertise, Hawaii offers a multicultural environment and a safe and healthy place to study.
Hawaii can certainly build upon its comparative advantages including the historic and cultural ties to China to forge a deep and broad economic relationship with China that will be mutually beneficial. But, this can only happen if the two countries manage this relationship wisely.
However you slice it and whether we like it or not, the relationship between the U.S. and China is the most important for both countries and the rest of the world and will remain so for the balance of this century, at least. How both sides manage that relationship will have a lot to say about whether the 21st Century is recorded by future historians as one of peace and prosperity, or one of conflict and suffering.
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Joseph Borich can be reached at the Washington State China Relations Council at +(206) 441-4419 or via email at borich@wscrc.org
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