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2003

CHINA’S INDUSTRIAL, INVESTMENT AND EXCHANGE

RATE POLICIES: IMPACT ON THE UNITED STATES

HEARING

BEFORE THE

U.S.-CHINA ECONOMIC AND SECURITY 

REVIEW COMMISSION

ONE HUNDRED EIGHTH CONGRESS

FIRST SESSION

SEPTEMBER 25, 2003

Printed for the use of the 

U.S.-China Economic and Security Review Commission 

Available via the World Wide Web: http://www.uscc.gov

(
U.S.-CHINA ECONOMIC AND SECURITY REVIEW COMMISSION

ROGER W. ROBINSON, Jr., Chairman 

C. RICHARD D’AMATO, Vice Chairman 

CAROLYN BARTHOLOMEW, Commissioner 

GEORGE BECKER, Commissioner 

STEPHEN D. BRYEN, Commissioner 

JUNE TEUFEL DREYER, Commissioner 

ROBERT F. ELLSWORTH, Commissioner 

MICHAEL LEDEEN, Commissioner 

PATRICK A. MULLOY, Commissioner 

WILLIAM A. REINSCH, Commissioner 

MICHAEL R. WESSEL, Commissioner 

LARRY M. WORTZEL, Commissioner

DAVID J. OHRENSTEIN, Executive Director 

KATHLEEN J. MICHELS, Associate Director

The Commission was created in October 2000 by the Floyd D. Spence National Defense Authorization Act for 2001 sec. 1238, Public Law 106–

398, 114 STAT. 1654A–334 (2000) (codified at 22 U.S.C. sec. 7002 (2001)), 

as amended, and the ‘‘Consolidated Appropriations Resolution of 2003,’’ 

Public Law 108–7, dated February 20, 2003. Public Law 108–7 changed 

the Commission’s title to U.S.-China Economic and Security Review Commission. 

The Commission’s full charter is available via the World Wide Web: http:// 

www.uscc.gov. 

The Commission’s Statutory Mandate begins on page 243. 

(II) 
iii

U.S.-CHINA ECONOMIC AND SECURITY REVIEW COMMISSION

OCTOBER 14, 2003

The Honorable TED STEVENS, 

President Pro Tempore of the U.S. Senate, Washington, D.C. 20510

The Honorable J. DENNIS HASTERT, 

Speaker of the House, Washington, D.C. 20515

DEAR SENATOR STEVENS AND SPEAKER HASTERT:

On behalf of the U.S.-China Economic and Security Review Commission, we are 

pleased to transmit the record of our hearing on September 25, 2003, on ‘‘China’s 

Industrial, Investment and Exchange Rate Policies: Impact on the United States.’’ 

These issues are at the forefront of U.S.-China economic relations, particularly in 

light of the impact that China’s exchange rate and industrial policies are having on 

global investment trends and on U.S. manufacturing and trade deficits. We are 

aware that both the Executive Branch and Congress are examining initiatives to address U.S. concerns in this area and therefore we outline here several of the Commission’s key findings and recommendations arising from our hearing and research 

activities to help inform Congressional deliberations. 

As you know, the Commission is mandated by law (P.L. 108–7, Division P) to examine, among other areas, China’s economic policies and the United States trade 

and investment relationship with China, including assessing the qualitative and 

quantitative nature of the shift of United States production activities to China. This 

latter charge includes examining the relocation of high-technology, manufacturing 

and R&D facilities to China and the effect of these transfers on United States economic security, employment and the standard of living of the American people. 

At our September 25 hearing, the Commission heard testimony from a number 

of Members of both the House and Senate, including the principal sponsors of various Congressional initiatives designed to address China’s exchange rate practices. 

Representing bipartisan Congressional concerns, these Senators and House Members have introduced differing bills aimed at providing appropriate incentives to the 

Chinese government to end its apparent mercantilist trade policies, most particularly its artificially undervalued currency, as well as other unfair trade practices 

such as export subsidies, dumping, and other WTO-inconsistent practices. The Members testified that such practices by China amounted to a forced redistribution of 

trading and investment balances that violate the principles of free and fair trade 

embodied in China’s WTO accession obligations as well as in its bilateral trade arrangements with the United States and other international agreements, such as the 

IMF charter. One result of China’s unfair trade practices has been its rapid accumulation of foreign exchange reserves, now totaling some $355 billion, the second highest in the world after Japan. 

Exchange rate policies. Based on our examination of this issue, it appears clear 

that China continues to follow a policy of one-way market interventions by the government to maintain its currency at a level that economists estimate is between 15–

40 percent undervalued. In this regard, China is purchasing U.S. dollars at an estimated rate of $120 billion per year to prevent appreciation of its currency against 

the dollar. In assessing causes of the worsening U.S. trade deficit and loss of U.S. 

manufacturing jobs, some hearing witnesses argued that the lack of net new savings 

in the U.S. economy, the global mobility of factors of production and/or low labor 

costs in China were the principal factors. In any event, based on the evidence presented, we believe the inappropriate exchange rate between the Chinese yuan and 

the dollar is negatively impacting the competitiveness of U.S. manufactured goods 

and is contributing to a migration of world manufacturing capacity to China and 

an erosion of the U.S. manufacturing base. 

Section 3004 of the Omnibus Trade and Competitiveness Act of 1988 (22 U.S.C. 

Sec. 5304) requires annual reports from the Department of Treasury on foreign 

countries’ exchange rate policies and requires the Secretary to enter into negotiations on an expedited basis with countries found to be manipulating their currencies 

to gain an unfair competitive trade advantage. Past reports from the Treasury on 

China have sidestepped this conclusion, which appears now to be inescapable. The 

Commission believes it is clear that China, in violation of both its IMF and WTO 

obligations, is in fact manipulating its currency for trade advantage and therefore 

finds it imperative that the Treasury immediately and forcefully enter into negotiations with the Chinese government to resolve this matter. China’s continued maintenance of an undervalued exchange rate with the U.S. dollar will continue to promote 
iv

major distortions in the flow of trade and investment, to the detriment of American 

companies and workers, and therefore requires decisive action by Washington.

Recommendation: The Treasury Department should make a determination in 

its foreign country exchange rate report to Congress that China is engaged in manipulating the rate of exchange between its currency and the U.S. dollar to gain 

an unfair competitive trade advantage and immediately enter into formal negotiations with the Chinese government over this matter. Should these efforts prove 

ineffective, the Commission urges the Congressional leadership to use its legislative powers to force action by the U.S. and Chinese governments to address this 

unfair and mercantilist trade practice. For the near future, continued vigorous development of such legislative initiatives as were outlined by Members of Congress 

during our hearing, linking China’s performance on its exchange rate policies to 

its continued full access to the U.S. market, appears essential to ensure the appropriate level of effort by both governments to this matter.

China’s Investment and Industrial Policies. China has attracted a total of over 

$400 billion of foreign direct investment (FDI), most of it in the last six years. This 

compares with $1.3 trillion for the U.S., $497 billion for the U.K., $482 billion for 

Belgium-Luxemburg, and $480 billion for Germany. As FDI flows to China are now 

expanding by over $50 billion per year, China will soon have accumulated the second largest stock of FDI in the world. 

Our hearing indicated that China’s undervalued currency is just one of several 

factors behind that country’s success in attracting massive inflows of FDI, particularly into its manufacturing sector. Our hearing examined the extent to which China’s industrial policies have played a role. In this regard, we learned that:

• China has pursued industrial policies that have catalyzed its growth as a manufacturing powerhouse, particularly in increasingly higher-technology production. 

The Chinese government has designated a number of ‘‘pillar industries’’ and 

pursued a strategy of ‘‘picking winners’’ among China’s emerging high-tech or 

industrial enterprises. 

• Manufacturers in China are supported through a wide range of national industrial policies, which include: tariffs; limitations on foreign firms’ access to domestic marketing channels; requirements for technology transfer by foreign investors; government selection of partners for major international joint ventures; 

preferential loans from state banks; privileged access to listings on national and 

international stock markets; tax relief; privileged access to land; and direct support for R&D from the government budget.

Recommendation: The United States Trade Representative and the Department 

of Commerce should identify whether any of China’s industrial policies are inconsistent with its WTO obligations and engage with the Chinese government to 

mitigate those that are significantly impacting U.S. market access. Appropriate 

Congressional Committees should be fully briefed on the actions the agencies are 

taking to resolve these issues.

Recommendation: The Commission believes it is essential that U.S. policymakers have a clearer, more comprehensive, and timely picture of global investment and R&D flows to China, particularly in the manufacturing sector. The 

Commission’s 2002 Report to Congress urged Congress to consider establishing an 

enhanced, mandated corporate reporting system to capture better this information 

by requiring firms to report ‘‘their initial investments in China; any technology 

transfer, offset, or R&D cooperation agreed to as part of the investment; the shift 

of production capacity and job relocations resulting from the investment, both 

from within the United States to overseas and from one overseas location to another; and contracting relationships with Chinese firms.’’ We believe the need for 

such a system has only increased in urgency since our 2002 Report and again 

urge Congress to consider taking such action.

Impact on U.S. Economy. In his September 15, 2003 prepared remarks at the Detroit Economic Club, Commerce Secretary Don Evans reports that ‘‘the President believes that our economic and national security require a stable, robust manufacturing 

sector that produces sophisticated and strategically significant goods here, in the 

United States.’’ Manufacturing employs 14 percent of the American workforce, but 

has accounted for nearly 90 percent of all the job losses since total U.S. employment 

peaked in March 2001. Over 2.7 million American factory jobs have been lost over 

the past three years, roughly one in every six manufacturing jobs. 

At our September 25th hearing the Commission heard testimony that supported 

a conclusion that China’s undervalued currency and government investment strategies are having a deleterious effect on the competitiveness of U.S. manufactured 
v

goods and contributing to a migration of world manufacturing capacity to China, 

with a concurrent erosion of the U.S. manufacturing base.

Recommendation: The Commission believes that the President’s pending Manufacturing Initiative should include provisions that strengthen the competitiveness 

of U.S.-based manufacturers in light of the growing shift of production to China, 

especially high-tech and R&D. The Initiative should address de facto Chinese government subsidies, particularly those not covered under the WTO, such as tax incentives, preferential access to credit, capital, and materials, and investment conditions requiring technology transfers.

It is the hope of the Commission that the results of this hearing will contribute 

to the fashioning of legislation by the Congress which will help to illuminate the 

economic impact that China is having on U.S. producers, better identify unfair Chinese trade practices, and steer Chinese economic practice into more sustainable and 

fairer channels. 

Yours truly,

Roger W. Robinson, Jr. 

Chairman 

C. Richard D’Amato 

Vice Chairman 

(VII)

CONTENTS 

Page 

THURSDAY, SEPTEMBER 25, 2003

CHINA’S INDUSTRIAL, INVESTMENT AND EXCHANGE RATE POLICIES: 

IMPACT ON THE UNITED STATES 

Opening remarks of Chairman Roger W. Robinson, Jr. ....................................... 1

Prepared statement .......................................................................................... 1

Opening remarks of Vice Chairman C. Richard D’Amato .................................... 2

Prepared statement .......................................................................................... 2

Opening remarks of Commissioner June Teufel Dreyer, Hearing Co-Chair ...... 3

Prepared statement .......................................................................................... 3

Opening remarks of Commissioner Patrick A. Mulloy, Hearing Co-Chair ......... 4

Prepared statement .......................................................................................... 4

CONGRESSIONAL PERSPECTIVES

Statement of Phil English, a U.S. Congressman from the State of Pennsylvania ...................................................................................................................... 5

Statement of Lindsey Graham, a U.S. Senator from the State of South Carolina ........................................................................................................................ 7

Discussion, Questions and Answers ....................................................................... 9

Statement of Charles Stenholm, a U.S. Congressman from the State of Texas 13

Statement of Byron L. Dorgan, a U.S. Senator from the State of North 

Dakota ................................................................................................................... 15

Statement of Charles E. Schumer, a U.S. Senator from the State of New 

York ....................................................................................................................... 18

Discussion, Questions and Answers ....................................................................... 22

Statement of Donald A. Manzullo, a U.S. Congressman from the State of 

Illinois, and Chairman, House Small Business Committee .............................. 25

Statement of Sander (Sandy) M. Levin, a U.S. Congressman from the State 

of Michigan, and Ranking Democrat, Ways and Means Trade Subcommittee .............................................................................................................. 30

Prepared statement .......................................................................................... 32

Discussion, Questions and Answers ....................................................................... 34

PANEL I: EXCHANGE RATE ISSUES

Statement of C. Fred Bergsten, Ph.D., Director, International Institute for 

Economics ............................................................................................................. 43

Discussion, Questions and Answers ....................................................................... 46

Statement of Stephen S. Roach, Ph.D., Chief Economist, Morgan Stanley ........ 53

Prepared statement .......................................................................................... 55

Statement of David Hale, Chief Economist and Founder, Hale Advisors, LLC . 64

Prepared statement .......................................................................................... 67

Statement of Ernest H. Preeg, Ph.D., Senior Fellow in Trade and Productivity, Manufacturers Alliance/MAPI ................................................................. 69

Prepared statement .......................................................................................... 72

Discussion, Questions and Answers ....................................................................... 76

AFTERNOON SESSION

Remarks of Chairman Roger W. Robinson, Jr. ..................................................... 93

Remarks of Vice Chairman C. Richard D’Amato .................................................. 94
Page

VIII

Remarks of Commissioner Patrick A. Mulloy, Hearing Co-Chair ....................... 95

Remarks of Commissioner June Teufel Dreyer, Hearing Co-Chair .................... 96

PANEL II: CHINA’S INVESTMENT STRATEGIES

Statement of Peter Hugh Nolan, Ph.D., Sinyi Professor of Chinese Management, University of Cambridge ........................................................................... 98

Prepared statement .......................................................................................... 101

Statement of Edward S. Steinfeld, Ph.D., Associate Professor of Political 

Science, Massachusetts Institute of Technology ................................................ 130

Prepared statement .......................................................................................... 133

Statement of Kathleen (Kate) A. Walsh, Senior Associate, The Henry L. 

Stimson Center ..................................................................................................... 145

Prepared statement .......................................................................................... 147

Discussion, Questions and Answers ....................................................................... 152

PANEL III: U.S. ECONOMIC IMPACT

Statement of Paul Craig Roberts, Ph.D., Chairman, Institute for Political 

Economy, and former Assistant Secretary of the Treasury for Economic 

Policy ..................................................................................................................... 171

Prepared statement .......................................................................................... 172

Statement of Franklin J. Vargo, Vice President, International Economic Affairs, National Association of Manufacturers; On Behalf of the National 

Association of Manufacturers .............................................................................. 174

Prepared statement .......................................................................................... 177

Statement of Thea M. Lee, Assistant Director of Public Policy, American 

Federation of Labor and Congress of Industrial Organizations (AFL–CIO) ... 186

Prepared statement .......................................................................................... 189

Statement of Willard A. Workman, Senior Vice President, International Policy 

and Economic Reform, U.S. Chamber of Commerce ......................................... 191

Prepared statement .......................................................................................... 193

Discussion, Questions and Answers ....................................................................... 217

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Testimony of Senator Olympia J. Snowe ............................................................... 234

Testimony of Grant D. Aldonas, Under Secretary of Commerce for International Trade Administration ........................................................................... 236
(1)

CHINA’S INDUSTRIAL, INVESTMENT AND 

EXCHANGE RATE POLICIES: IMPACT ON 

THE UNITED STATES 

THURSDAY, SEPTEMBER 25, 2003

U.S.-CHINA ECONOMIC AND SECURITY REVIEW COMMISSION, 

Washington, D.C. 

The Commission met in Room 124, Dirksen Senate Office Building, Washington, D.C. at 8:54 a.m., Commissioners Patrick A. 

Mulloy and June Teufel Dreyer (Hearing Co-Chairs), presiding. 

OPENING REMARKS OF CHAIRMAN ROGER W. ROBINSON, JR. 

Chairman ROBINSON. We would like to begin this morning at this 

time. This is the third hearing of our second year reporting cycle 

at the Commission. Today’s subject, as you know, is China’s Industrial Investment and Exchange Rate Policies: Impact on the United 

States. 

We are delighted that Representative English is with us today, 

and we’d like to hear from him and other Members first. Accordingly, I’d like to turn it over to our Vice Chairman, Dick D’Amato 

and then to our Co-Chairs. 

The Co-Chairs of our hearing today will be Commissioners Patrick Mulloy and Dr. June Teufel Dreyer. Commissioner Mulloy will 

preside over the morning session. Dr. Dreyer will be taking the 

gavel this afternoon. 

I’m now pleased to turn over our deliberations to Commission 

Vice Chairman Dick D’Amato for a brief statement, and he in turn 

will move it to the Co-Chairs. Thank you. 

[The statement follows:]

Prepared Statement of Chairman Roger W. Robinson, Jr. 

Today the Commission holds the third in its series of hearings during the 108th 

Congress. 

Our first two hearings, in June and July, focused on the important topics of media 

control in China—specifically how it played out during the SARS outbreak—and on 

China’s behavior with respect to the critical issue of the proliferation of weapons of 

mass destruction and ballistic missiles, with a focus on China’s pivotal role in the 

ongoing nuclear crisis with North Korea. 

Today we will be examining issues on the economic security side of our portfolio, 

namely China’s exchange rate policies and industrial and investment strategies and 

their impact on the U.S. economy, particularly our manufacturing sector. These 

issues are currently receiving substantial media attention, but have been in our 

mandate and on our research agenda from the first year of the Commission’s establishment. 

Indeed, in quoting one of the findings from our first annual report to the Congress 

in July 2002, ‘‘Continuing trade surpluses, vast investment inflows, and very high 

foreign exchange reserves are evidence that China is manipulating its currency by 
2

holding down its value thereby gaining an unfair trade advantage that increases the 

U.S. trade deficit.’’

In America, people in varying capacities—business, labor, academia, the media 

and government—have come to better understand the almost tectonic economic 

forces now shaping the U.S.-China economic relationship. With increasing sophistication, China has become a manufacturing powerhouse. Its central and local government policies have supported development of key industrial sectors. In the 

1990’s, China became embedded in what has become a global supply chain for many 

traded products and saw its share of global trade in manufactured goods triple. 

In the meantime, there is increasing unease in the U.S. over the declining share 

of manufacturing output and employment in our overall economy. And this is happening while China’s currency—the yuan—remains pegged to the U.S. dollar at a 

rate set by government fiat nine years ago. What are the causes and effects here? 

What are the key linkages? Are there steps the U.S. should be pursuing to remedy 

these challenging and, in some cases, debilitating circumstances? 

Today we will be exploring these and other important questions with a distinguished group of panelists. We are particularly honored that we will be joined by 

several Members of the House and Senate, from both sides of the aisle, who will 

lead off the hearing by giving us their perspectives on these crucial matters. The 

Congress is profoundly concerned about the issues we are discussing today, and a 

number of Members have introduced thoughtful legislation to address these concerns. We look forward to working with the Congress as it moves forward in its consideration of appropriate remedies. 

The co-chairs of our hearing today will be Commissioners Patrick Mulloy and Dr. 

June Teufel Dreyer. Commissioner Mulloy will preside over the morning session and 

Dr. Dreyer will take the gavel after lunch. I am now pleased to turn the hearing 

over to Commissioner Mulloy and our distinguished Congressional guests.

OPENING REMARKS OF VICE CHAIRMAN C. RICHARD D’AMATO 

Vice Chairman D’AMATO. Thank you very much, Mr. Chairman, 

and I thank Commissioners Mulloy and Dreyer for organizing this 

important hearing. 

I want to welcome Congressman English for coming before us 

this morning on this very important matter. I want to commend 

you for the legislative actions you are taking with others to address 

modern Chinese mercantilism, now pouring tens of billions of dollars of U.S. investment technology and manufacturing resource unfairly in many ways into China. This distorted transfer of U.S. economic treasury to Beijing is now so big that Congress has told this 

Commission to evaluate the implications for U.S. national security 

and identify what tools we have to put the brakes on this transfer. 

We look forward to your thoughts on what tools are now necessary 

to address this problem, as we explore the options that are available to us. 

[The statement follows:]

Prepared Statement of Vice Chairman C. Richard D’Amato 

Thank you, Mr. Chairman and I thank Commissioners Mulloy and Dreyer for organizing this important hearing today. I welcome Congressman English, Senators 

Schumer, Dorgan, and Graham, Congressmen Manzullo, Stenholm and Levin, other 

Members, and commend you for the legislative actions you are taking to address 

modern Chinese mercantilism, now pouring ten’s of billions of U.S. investment, technology and manufacturing resources unfairly into China. This distorted transfer of 

U.S. economic treasure to Beijing is now so big that Congress has told this Commission to evaluate the implications for U.S. national security, and identify what tools 

we have to put the brakes on it. We look forward to your thoughts on actions that 

are now necessary, and explore the options that are available to us. 

The creation of this Commission in the winter of 2000, during the debate over giving China most favored trade status on a permanent basis was predicated on several important assertions. First, the Clinton Administration stated that granting 

such status and admission to the WTO was predicated on the assumption that 

China would play by the rules of the international trade game, certainly not promote permanent unfair subsidies or mercantilist practices. Second, the National Se-
3

curity Advisor, Sandy Berger, stated repeatedly that it was in America’s ‘‘vital national security interests’’ for China to be granted these important trade concessions. 

A third assertion was that increased economic growth and higher standards of living 

in China would lead to democratic reforms, and the eventual extinction of widespread tyranny practiced at home by the Communist rulers. 

So far, these assertions do not appear to be playing themselves out. China still 

has a poor record of honoring its promises and agreements, and this hearing focuses 

on one of the most important and glaring: artificially pegged exchange rates calculated to give China across the board highly unfair advantages vis-a`-vis its socalled trading ‘‘partners.’’ Second, this Commission has been created to examine the 

questions of the national security implications of the policies practiced by both the 

Clinton and Bush Administrations vis-a`-vis China on trade. The large scale and increasing sophistication of U.S. resources being transferred, with increasingly important high technology components, is adversely effecting our basic economic foundations from a strategic perspective. Third, democratic reforms have been squelched 

in China, after some brief flicker of hope in connection with the SARS health crisis. 

Openness is still treated as an enemy of the governing regime. The regime maintains tyrannical practices in a widespread gulag against its own people. 

Given these realities, the question today is what actions Congress should promote 

to push these trends in healthier directions for our own national interest.

OPENING REMARKS OF COMMISSIONER JUNE TEUFEL DREYER

HEARING CO-CHAIR 

Co-Chairman DREYER. Our focus this morning is on the yuan’s 

value, China’s exchange rate policies, and relevant policy options 

for the U.S. Government. 

This afternoon we will shift focus, first to look at the dynamics 

of China’s strategies for attracting foreign investment and channeling both domestic and foreign resources into key industries and 

technologies. Many observers of China believe this topic, and not 

just the exchange rate question, is key to assessing the overall impact of China’s economic policies and development on the U.S. 

economy. 

I look forward to hearing the testimony of our panelists. Thank 

you. 

[The statement follows:]

Prepared Statement of Commissioner June Teufel Dreyer

Hearing Co-Chair 

Our focus this morning is on the yuan’s value, China’s exchange rate policies, and 

relevant policy options for the U.S. Government. 

This afternoon we will shift focus, first to look at the dynamics of China’s strategies for attracting foreign investment and channeling both domestic and foreign resources into key industries and technologies. Many observers of China believe this 

topic, and not just the exchange rate question, is key to assessing the overall impact 

of China’s economic policies and development on the U.S. economy. 

This afternoon we will be considering the factors behind the remarkable growth 

of manufacturing capacity in China, now labeled the ‘‘workshop of the world’’ for the 

21st century, and what the implications are for the U.S. economy. One obvious driving force is the global search for low-cost production of quality goods, which has led 

to increased domestic and foreign investment in expanding such production capacity 

in China. Low-cost labor is often the determining factor here. But other factors in 

this growth in capacity may stem from the Chinese government’s own industrial 

policies—for example its designation of so-called ‘‘pillar industries’’—as well as policy and financial support for key manufacturing, infrastructure, S&T and R&D 

projects. Other factors may be more related to globalization in general than China 

in particular, such as the way transnational corporations operate globally integrated 

manufacturing and distribution networks with China as an important node embedded in this web of production. Another key factor at work here is the speed with 

which Chinese manufacturing and R&D are moving up the value chain to encompass more technologically advanced products and research. 

We will first hear from three expert witnesses who have studied the development 

of China’s export-oriented manufacturing sector and its connection to the global supply chain. Professor Peter Nolan of Cambridge University has written extensively 
4

about China’s connection to what he calls the Global Business Revolution. Professor 

Ed Steinfeld of MIT has researched China’s industrial policy and done case studies 

of large Chinese firms’ performance in the domestic and global marketplace. Kate 

Walsh, Senior Associate of the Stimson Center, has done field research and written 

a recent monograph on the growth of foreign-funded research and development activities in China. Each panelist comes at the question of China’s industrial and investment priorities and strategies from a different angle, and I expect we will obtain 

a good three-dimensional picture from their testimony and follow-on discussion. 

In the second and final panel of the afternoon, we will hear testimony from four 

witnesses with differing perspectives on the question of how the U.S. economy is 

being affected by China’s exchange rate, industrial and investment policies and 

trends. Our panelists will be: Frank Vargo, of the National Association of Manufacturers; Thea Lee, of the AFL–CIO; Paul Craig Roberts, Chairman of the Institute 

for Political Economy and a former Assistant Secretary of the Treasury; and Willard 

Workman, of the U.S. Chamber of Commerce. I expect their statements and followup dialogue with Commissioners will reveal a broad range of views and different 

emphases on policy prescriptions.

OPENING REMARKS OF COMMISSIONER PATRICK A. MULLOY

HEARING CO-CHAIR 

Co-Chairman MULLOY. Congressman English, thank you very 

much. As a fellow Pennsylvanian, I am delighted that you are here 

with us. Please go ahead. 

[The statement follows:]

Prepared Statement of Commissioner Patrick A. Mulloy

Hearing Co-Chair 

I am very pleased to have been asked by Chairman Robinson and Vice Chairman 

D’Amato to co-chair, along with Commissioner June Teufel Dreyer, a noted China 

scholar, this hearing on China’s exchange rate, industrial, and investment strategies 

and their impact on the U.S. economy. 

This bipartisan commission was created by the Congress in October 2000. It is 

composed of 12 Commissioners, three of whom were appointed by each of the Congressional leaders in both the House and Senate. It issued its first report to the 

Congress in July 2002 by a vote of 11–1, which signifies our bipartisan consensus 

on the key issues in U.S.-China relations within the Commission’s mandate. 

One of the tasks we have been given by the Congress is to ‘‘analyze and assess 

the qualitative and quantitative nature of the shift of United States production activities to China, including the relocation of high technology, manufacturing, and 

R&D facilities.’’ We were also asked to examine the effect of such transfers on 

United States economic security, employment, and the standard of living of the 

American people. In addition, Congress asked us to assess ‘‘the need for corporate 

reporting on United States investments in China and incentives that China may be 

offering to United States corporations to relocate production and R&D to China.’’

In keeping with this mandate, today’s hearing will focus on the increasingly complex and dynamic factors in the U.S.-China trade and investment relationship. 

These issues rise amidst concerns in our country over the large loss of manufacturing jobs in our economy in recent years, the continued shrinking of manufacturing output as a percentage of U.S. total production, and the ongoing shift of investment capital and manufacturing employment abroad, notably to China and 

other Asian countries. 

We look at these issues in the context of Commerce Secretary Evans’ statement 

of September 16 that ‘‘the President believes that our economic and national security require a stable, robust manufacturing sector that produces sophisticated goods 

here in the United States.’’ The Commerce Department is leading the Administration’s effort to craft a manufacturing strategy to help meet the current challenge 

posed by the ongoing erosion of our manufacturing sector, and we will be following 

these developments closely. 

I would like to note that we extended invitations to both the Treasury and Commerce Departments to participate today and share their perspectives with us on the 

Administration’s exchange rate discussions with China and its manufacturing sector 

initiatives. Unfortunately, the key officials on these matters were unable to attend, 

but both Departments will be submitting statements for the record. The Commerce 

Department has committed to testify before the Commission on its manufacturing 

strategy later this year and we hope to hear directly from the Treasury on its 

progress with China on exchange rates at a later date as well. 
5

At today’s hearing we are fortunate to be able to hear from a bipartisan group 

of distinguished Members from both Houses of Congress to give us Congressional 

perspectives on the issues before us. Among those we will hear from are Senators 

Dorgan of North Dakota, Schumer of New York, and Graham of South Carolina and 

Congressmen Manzullo of Illinois, Chairman of the House Small Business Committee, Levin of Michigan and Stenholm of Texas. We very much appreciate their 

taking time to be with us today and look forward to their testimony. 

On our second panel this morning we will hear from some of the top experts in 

the country on China’s exchange rate policies. We will hear differing and sometimes 

conflicting views on whether China’s effort to peg its currency, the yuan, at about 

8.3 to the dollar, constitutes an unfair trade practice, and whether such pegging has 

a positive or detrimental effect on the U.S. economy. These experts are:

C. Fred Bergsten, Director of the International Institute for Economics; 

David Hale, Chief Economist and Founder, Hale Advisors, LLC; 

Ernest Preeg, Adjunct Fellow, the Hudson Institute; and 

Stephen Roach, Chief Economist, Morgan Stanley

My co-chair, Dr. Dreyer, will preside over and introduce the two afternoon panels, 

but let me provide a preview. 

In the first panel after lunch we will hear from three noted experts on China’s 

efforts to attract foreign investment to help build its industrial and research and 

development base: Prof. Peter Nolan of Cambridge University; Prof. Ed Steinfeld of 

MIT; and Kate Walsh, Senior Associate at the Stimson Center in Washington. 

The last panel of the day will explore the concrete impact of our economic engagement with China on the U.S. economy. The four panelists will be: Frank Vargo, Vice 

President for International Economic Affairs at the National Association of Manufacturers; Thea Lee, Chief International Economist of the AFL–CIO; the Honorable 

Paul Craig Roberts, Chairman of the Institute for Political Economy and a former 

Assistant Secretary of the Treasury; and Willard Workman, Senior Vice President 

of the U.S. Chamber of Commerce. 

We hope the knowledgeable views brought together in this hearing room today 

will contribute to the research and debate now taking place in America as we try 

to devise appropriate strategies to deal with the economic challenges presented by 

China’s fast-growing economy.

CONGRESSIONAL PERSPECTIVES 

STATEMENT OF PHIL ENGLISH

A U.S. CONGRESSMAN FROM THE STATE OF PENNSYLVANIA 

Congressman ENGLISH. I want to thank the Members of the 

Commission and the Co-Chairs. It is a real privilege to be able to 

appear today and offer my views on U.S.-China trade. This is perhaps the single largest economic issue in my district right now. It 

is an issue where I believe Americans, and particularly people who 

work for a living, demand a quick resolution and serious action 

from Washington. 

Your hearing and the focus of this Commission are particularly 

important in that process and in that debate. The topics this hearing will assess are of critical importance to me and of my district 

in Northwestern Pennsylvania, which has a large concentration of 

manufacturing jobs. 

When President Clinton approved China’s entry into the WTO in 

1999, many believed a new era of opportunity for U.S. businesses 

and workers had opened. Those in Congress like myself, who were 

a little skeptical, viewed this opportunity as potentially one fraught 

with risks. Yet we voted to grant permanent normal trade relations 

to China as our piece of moving that process forward, but only after 

insisting that special safeguards relating to Chinese imports be included. I want to particularly thank my colleague, Mr. Levin, for 

leading that fight and making sure those provisions were included. 

Looking back to China’s accession to the WTO, I want to deliver 

to you a very clear message. Few of the benefits that had been in-
6

tended for America have been realized because China has not abided by the terms of their international commitments. While the current Administration has developed some steps to develop a comprehensive strategy to ensure China plays by the rules, these steps 

must be broadened, accelerated and strengthened. This is where I 

believe Congress and the Administration must be prepared to work 

in unison. Congress has already provided many of the tools the Administration needs to apply leverage to encourage Chinese compliance with their international obligations. It is up to Congress to 

maintain a watchful eye so that those tools are fully and properly 

used, and every time they are needed in order to provide U.S. manufacturers and agricultural producers a level playing field. 

Congress must strengthen the Administration’s hand, but if the 

Administration does not act, we also need to move forward to force 

their hand. 

The U.S. trade deficit, frankly, Commissioners, has doubled since 

1998 vis-a`-vis China and it has exceeded $100 billion for the second 

year in a row. This is a serious concern to Congress because it reflects a large number of distortions that China employs to place 

U.S. employers and workers at a growing disadvantage. 

I hear a lot of rhetoric in Washington about free trade, but I am 

here to say to you that Chinese State-sponsored mercantilism is 

not free trade, and we need to be prepared to act to make sure that 

in the international trading system China, as it enters, it enters it 

with the understanding that it must follow the rules. While I understand that participation in an open and fair global economic system is essential to U.S. economic growth and job opportunities, 

when China breaks the rules the U.S. suffers the consequences. 

There are many reasons I suspect domestically why China feels 

that they have to do the things that they do, but whatever problems China has in their economy they should not be permitted to 

export to our economy. 

I would like to mention very briefly, Mr. Co-Chairman, a couple 

of the specifics that concern us about China. Under the heading of 

currency manipulation, this is widely seen as providing an unfair 

advantage to Chinese producers. Even though China joined the 

WTO and nominally embraced a rules-based regime, they still see 

it in their interest to pursue a policy of state-sponsored mercantilism that is most importantly grounded in a manipulation of 

their exchange rate. 

To correct this destructive WTO illegal trade distortion I have introduced H.R. 3058, the China Act. While there have been three 

bills and one resolution introduced in Congress on this topic, this 

legislation enjoys the most robust co-sponsorship, currently it is cosponsored by over 60 Members of the House of Representatives. 

The premise of the legislation is straightforward. It requires the 

Secretary of the Treasury to determine if China is manipulating its 

currency to gain an advantage in trade. If the Secretary finds manipulation is occurring, then he is directed to impose a tariff equal 

to the degree of distortion being imposed. 

Chinese currency manipulation beggars Chinese consumers. It 

also beggars our producers. Ultimately it is something that economists will say is unsustainable, but in the short term, given the 

large foreign reserves that China is holding, they appear to be able 
7

to get away with it, and at our expense. In other words, our bill 

would create a countervailing duty mechanism to deal with currency manipulation, an issue that is not dealt with adequately 

within the WTO dispute resolution process. This is a measure that 

actually levels the playing field. It strips China of their ability to 

give themselves an arbitrary advantage. It is a flexible tariff and 

it can be adjusted to meet the actual extent of the distortions from 

the artificial undervaluation of the yuan. 

In addition we need to address the non-tariff barriers that China 

has been imposing on our products. China’s non-tariff barriers contribute to the enormous trade imbalance by strangling U.S. exports 

to China. Chinese non-tariff barriers affect every sector of the U.S. 

economy. A complete lack of transparency exists as China transitions to a rules-based economy. China provides only fleeting windows for public comment if any at all. No uniformity exists between 

localities for licensing requirements or import permits. 

Furthermore—and this is very important—China’s value-added 

tax policies are designed to favor domestic products at the expense 

of imports, and China’s border trade policy places U.S. producers 

at a disadvantage by providing a tax break to neighboring countries simply by virtue of being neighbors. This is a clear violation 

of the WTO standards. 

Perhaps the most egregious non-tariff barrier is the complete disregard for intellectual property rights. U.S. licensed trademarks 

are routinely used illegally on Chinese manufactured goods, costing 

U.S. producers billions of dollars annually. 

Also, I would note there is widespread evidence that subsidies 

are still a major part of China’s means of doing business. Stateowned enterprises engaged in the production of sensitive or strategic goods are particularly large beneficiaries of government subsidy. All of these issues have the effect of putting our products at 

a competitive disadvantage. I believe that it is critical that Congress and the Administration act now to address these problems. 

I have further testimony, but I would like to submit it for the 

record. If I could field any questions, Mr. Co-Chairman? 

Co-Chairman MULLOY. Congressman English, Senator Lindsey 

Graham is also here. If Senator Graham would want to come up 

and perhaps join you, and then if he wants to make his statement, 

and then if you both have time, we would open it up to a few questions.

STATEMENT OF LINDSEY GRAHAM

A U.S. SENATOR FROM THE STATE OF SOUTH CAROLINA 

Senator GRAHAM. Thank you, Mr. Chairman. 

I guess my comment would be amen to what Phil said. There is 

no use restating all the facts and figures given to you. You know 

those better than I. I just come here from South Carolina, and one 

thing I have learned in the last couple of years is that everywhere 

I go the manufacturing community at home keeps bringing up one 

topic, Chinese competition. 

We have lost 2.7 million jobs in the last three years. 2.6 million 

of them have been manufacturing. Something is going on out there. 

I do not believe that our workforce is lazy. I do not believe that we 
8

are intellectually inferior, and I certainly do not believe that about 

the Chinese people. We have a clash of theories here. 

He has described to you the trade balance has doubled. The Chinese exports to the United States have doubled in the last five 

years. In ’97 to 2002 they have gone from 62 billion to 125 billion. 

We have been able to increase our exports to China from 13 to 19. 

Something is going on. 

Let me tell you what is going on at home. We have lost 250 textile plants. I know a lot of people say, well, that is high-intensive 

labor type production and you are just not going to make it in the 

21st century. Well, if we do not make it, so be it. I just do not want 

to not make it because other people cheat. China cheats. We have 

a clash of theories here. The theory of free trade is a great theory. 

It only works if the other people will buy into that theory. We have 

a clash of theories of how you run your government. It is hard to 

have free trade if you do not believe in free speech. Somebody in 

our government has got to come to grips with the idea that we are 

dealing with a country that cheats. And it is a communist dictatorship, and what do you expect? 

Other problems exist. The European Union I think unfairly restricts market access in the agricultural arena because of genetic 

manipulation arguments. In Mexico they do the same. Other countries play around with the rules, and maybe we do at time, but the 

difference between the European Union, Mexico and other parts of 

the world, and China, is that China is set up in a totally different 

manner. It is hard to get a government to buy into being a member 

of the world of nations when that government is so out of sync with 

everything else that goes around free trade. Democracies will be 

able to work these problems out. The only way you are going to get 

China’s attention in my opinion is to be hard and to ask for one 

thing, fairness. 

I have introduced a resolution with Senator Schumer, and if you 

got any doubt about the political spectrum this covers, Lindsey 

Graham and Chuck Schumer on the same bill. 

That does not happen a lot in the Senate. Chuck and I see things 

very similar. South Carolina and New York are a world apart in 

many ways, but we buy into the basic value system that holds this 

country together, and we have come together to understand that 

our companies in this country will not be able to long survive if we 

do not deal with China in an aggressive fashion, and that is the 

only thing that country will understand. 

Steel. There are two steel plants in my State that are about to 

go under. The Chinese steel market has doubled to 20 percent of 

the world market share in the last 10 years, and the way they have 

been able to do that is that the government subsidizes the steel industry. It is pretty hard to convince somebody in South Carolina 

they are going to be okay if they are competing with a Chinese 

competitor and the government in China pays the power bill, because we are not going to pay their power bill. 

So I implore you to speak as freely and as openly as you can, call 

it as you see it. The currency valuation problem is what we are 

talking about with Chuck Schumer. It is only the tip of the iceberg. 

It is something that is readily obvious to most people who are a lot 

smarter than I am, that they are cheating when it comes to manip-
9

ulating their currency. But it goes deeper. The fundamental problem is that China is trying to get an advantage and they do not 

have many rules in their own country, and the rules that they do 

have are pretty harsh. To expect them to play by the rules without 

pushing back is going to be absolutely impossible to achieve, and 

the most disturbing thing is that the growth in the Chinese economy is not being shared by its people, because one of the reasons 

we are losing jobs is because you can build a plant in China and 

people work for a dollar a day. There is no OSHA. There are no 

minimum wages. China is taking advantage of trade regimes. They 

are cheating and they are taking the money to build up their military. It is lose-lose. 

It is time for us to stand up and do something about it. We need 

your help. Thank you very much. 

With that, I am going to have to leave, and Phil can answer the 

questions far better than I can anyway. Thank you. 

Co-Chairman MULLOY. Senator, thank you very much. 

Senator GRAHAM. Thank you. 

Discussion, Questions and Answers 

Co-Chairman MULLOY. Congressman English, both you and Senator Graham have introduced bills that would put tariffs on the 

Chinese if the Treasury determines that they are a currency manipulator. 

Congressman ENGLISH. Yes. 

Co-Chairman MULLOY. Senator Graham implied that the issues 

with China though are not just currency, that there are a lot 

broader things going on here. So even if the bills were passed and 

the tariffs were put on, what are the other priority issues that you 

think that the U.S. has to go after in terms of putting more balance 

in this economic relationship? 

Congressman ENGLISH. Mr. Co-Chairman, I must tell you that I 

think even if China floats its currency, which many economists believe is absolutely essential for it to offer a level playing field, with 

what we calculate to be a 40 percent distortion in the price of Chinese products exported to the United States, a 40 percent undervaluation just because of the currency factor. Even if we were to 

deal with that and China were to accede to our wishes, they would 

still have a range of core issues that I think they would have to 

address even for a level playing field with the comparative disadvantages that Mr. Graham has described. 

One of the issues that I do not think attracts enough attention 

has to do with distortions that are the result of China’s tax regime, 

which has been evolving rather slowly. They have put in place a 

value-added tax that gives their products a competitive advantage 

because of the way it is applied. What is particularly disturbing is 

that that includes an explicit preference for neighbors. 

For example, American chemical companies cannot compete with 

Russian chemical companies for products that are not specialized 

because we are talking about a product with a relatively thin profit 

margin typically, something that is generally available and is 

mass-produced, a typical manufactured product. With a product 

like that, a relatively modest price differential makes a huge difference, and for chemicals produced in the United States to be 
10

shipped into China, they have imposed on them not only a substantial tariff structure, but also a layer of taxation that is not applied 

to competitors coming in from Russia. This puts many of our products, products that we expected to be able to sell in China at an 

enormous competitive disadvantage. 

There are others. I mean there are tariff laws that China imposes on top of everything else that I think are unfair, but those 

are things typically that can be negotiated down over time. 

I think, as Senator Graham pointed out, there is a real concern 

about intellectual property rights. Many American companies go 

into China—and a number have shared this concern with me—they 

find that if they sell their product to China, they are likely to face 

that product being produced as a knock-off in direct competition 

with them within a few years. There have been cases, we believe, 

where American products have been sold to China, and then 

through reverse engineering, the Chinese have been able to duplicate the production process, steal the technology and then sell 

those products in third markets in direct competition with the 

original U.S. producers. 

For many U.S. companies there is no obvious remedy. Going into 

China and filing a lawsuit is simply not an option. For many of 

these companies competing in third markets and chasing down 

these competitor products is much too expensive a process. The 

level of protection to intellectual property rights, which is envisioned in the WTO simply does not exist in China, and without 

that it is very hard to picture our having a healthy trade relationship with them in the long term. 

Those are just a couple of the very large concerns that I think 

would still be in place even if China were willing to float its currency. 

Co-Chairman MULLOY. Do you have time to stay for another? 

Congressman ENGLISH. I can certainly stay for a few minutes, 

and I appreciate the opportunity. 

Co-Chairman MULLOY. Thank you, Congressman. 

Commissioner Wessel, you had a question, and then Commissioner Dreyer. 

Commissioner WESSEL. Yes. Thank you, Mr. English. It is a 

pleasure to have you here, and your insightful testimony and true 

leadership on this issue with Congressman Levin, as you mentioned, and many others. 

This is not a partisan issue, as you and others have pointed out, 

and clearly this Administration and the past Administration had a 

somewhat similar approach on China in terms of embracing trade. 

You have talked about some of the tools, your legislation and other 

tools we might use. The Administration has many of these tools in 

its quiver right now, arrows in its quiver. The business community 

and the AFL–CIO are talking about a 301 action which could be 

self-initiated by the Administration. And there is some frustration 

I guess that many in the private sector, both business and labor, 

have that many of these tools are not being used. 

As Senator Graham just said, the time is coming for us to act. 

When do we say that enough is enough and move forward on action, not just the rhetoric of all this, but how quickly do we need 

to act? 
11

Congressman ENGLISH. Commissioner, I think we need to act 

very quickly. If Mr. Levin would point out, many of the anti-surge 

implements that were built into the enabling legislation that went 

along with the entry of China into the WTO have not been activated. There have been at least several instances where we believe 

the Administration could have stepped in and could have aggressively used these tools to confront the Chinese. I believe it’s very, 

very important that the Administration, having clearly focused on 

a number of aspects of the problem, having recently directly engaged the Chinese on currency manipulation, I think it is very important that the Administration make clear that these mechanisms 

are not a dead letter and be prepared to use them aggressively 

against Chinese products where it is warranted, and we believe 

there have been a number of instances where it has already been 

warranted. 

I think the Administration inherited a policy, which in turn the 

prior Administration had inherited, that has been a longstanding 

policy to encourage trade with China. But what we have discovered 

in recent years is that increasingly that relationship is lopsided. 

The volume of trade I think is requiring us to adjust our thinking, 

and I believe—and I have sought to engage the Administration on 

a number of different levels on this issue—I think it is very important that the Administration act quickly to signal a significant 

change in our attitude toward Chinese trade. 

Beyond that, I think it is also very important that the Administration maintain the sort of relationship with China that will allow 

them to engage the Chinese and push them in the right direction. 

Whether we like it or not, China is now part of the WTO and is 

going to be part of this overall international apparatus. I think we 

have some obligation to make sure that they follow those rules, and 

that is going to take steady pressure from the Administration that 

is not—how do I want to put this—is not subject to veto by diplomatic concerns. 

Co-Chairman MULLOY. Commissioner Dreyer. 

Co-Chairman DREYER. Congressman, first let me congratulate 

you for that very diplomatic turn of phrase. 

I have a concern. I spend a lot of time every day reading the 

Asian press, and also the American press speaking about Asia, and 

I have noticed that there is a claque within the United States of—

I guess conservatives would call them ‘‘panda-huggers,’’ and also 

within the Asian press. And they say this is an unwanted attack. 

This is China bashing. And what can you expect? There is an election year coming up and these Members of Congress and the Administration are taking out on China the deficiencies of the American economy. We cannot keep up, yadda, yadda, yadda, and it is 

all going to go away after the election. 

How would you answer the charge that, yes, in the United States 

we subsidize our agricultural producers among others, and that we 

are in fact attacking the Chinese for something we do, and furthermore, it is just election year hoopla? 

Congressman ENGLISH. I think that is a very easy myth to knock 

down. We have the most open economy in the world. We clearly are 

engaged in protecting certain sectors. But I know Mr. Becker would 

agree with me, sometimes we wish that we provided the sort of 
12

support for, say, the steel industry and other manufacturers that 

we do for some segments of our agricultural industry. 

But having said that, I think the record is fairly clear on this, 

the U.S. has been a strong advocate of free trade. What we are 

combating here is not free trade. The practices I have outlined are 

unfair trade. The criticism here is coming from nontraditional 

sources. I have been in Congress for many years, and I have never 

been identified as a China basher. I come from a community, Erie, 

Pennsylvania, that going back to the late ’70s has had a sister city 

on the Chinese mainland and has benefited from regular cultural 

exchanges. Yet in the downtown of our city on Labor Day this year, 

perhaps 400 people showed up for a rally against unfair Chinese 

trade practices. This is a dramatic change because we have seen 

more and more of our jobs at risk, not from fair competition, not 

from competition based on differences in the terms of trade of competitive advantage, but jobs potentially lost due to aggressive mercantilism on the part of the Chinese. 

I would also say to those who are skeptical of criticisms of Chinese practices, that I do not think we do China or Chinese consumers any favors by pulling our punches on this issue. It is important that China evolve into a modern economy with property 

rights, with labor rights, with proper human rights, that we be prepared to engage them where they go astray. The policies that are 

being set here are maybe beneficial in the short term for some aspects of Chinese society, but by papering over China’s problems 

and some of China’s weaknesses, and creating a very unhealthy 

trade imbalance, I think in the long run the status quo is not 

where China needs to be, and I think we do them a favor by being 

frank with them at this point. 

I do not believe that this is a phenomena that is associated with 

one election cycle. I think the pressure is building because of the 

imbalance in this trade relationship is going to be with us for many 

years. 

And I fear also that it runs the risk of undercutting the arguments for our participation more broadly in the global trading system. I think unless we get trade with China right, we are very 

much at risk of seeing many of our other trade policies and trade 

relationships go sour as well. So I find that some of the editorial 

comments that I have seen that are similar to what you have described are I think particularly shortsighted. 

Co-Chairman DREYER. Thank you. 

Congressman ENGLISH. Thank you, Commissioner. 

Co-Chairman MULLOY. Commissioner Reinsch. 

Commissioner REINSCH. It is good to see you again, Mr. English. 

Congressman ENGLISH. Thank you, sir. 

Commissioner REINSCH. Let me say first, as someone who 

worked for John Heinz for a long time, I am delighted to see someone else from Pennsylvania pick up the trade portfolio as thoughtfully and articulately as you have. 

We are going to have testimony later on today from some people 

on all sides of this issue, obviously, and some of them are going to 

say that the exchange rate issue may be a problem, and others will 

have different views on that, and will say that the real problem is 

investment, that is, the investment of U.S. multinational compa-
13

nies in China and the production that ensues, that then comes 

back here in the form of Chinese exports that both enlarge the 

trade deficit that we have and also moves jobs over there. 

Have you considered that and thought about that, and if so, do 

you have a comment on the extent to which that is the problem? 

Congressman ENGLISH. I think it is a very serious component of 

the problem. I began to focus on some aspects of this issue because 

of local problems. You will appreciate from your prior work how big 

a component of the American tool and die industry exists in Northwestern Pennsylvania. 

We asked the ITC to do a 332 study, which they did, on what 

was going on with tool and die, and gave us a remarkable snapshot 

a couple of years ago of what was going on. The impression from 

a lot of producers was that they were under direct pressure from 

Chinese trade, direct foreign competition. 

That turned out to be a less significant problem than the fact 

that their customers were shifting, along with a significant part of 

the U.S. manufacturing base, to China, based not merely on differences in the terms of trade, but also on the fact that China has 

contractual means by which it coerces companies that are seeking 

to do business in China into locating production facilities there. 

This is a significant part of the problem as well. 

My insight is that this is a very broad problem. This again is 

classical mercantilism on the part of China, and my sense is that 

until we directly engage that and make it a part of our agenda as 

well, challenging China’s right to pressure American companies directly to move jobs onto the mainland, then I think we are going 

to continue to see many of these other indirect effects, and I think 

we are going to continue to see a significant loss of our manufacturing base here. 

Commissioner REINSCH. I see another victim has arrived, so I 

will not follow up, but thank you. 

Co-Chairman MULLOY. Congressman Stenholm of Texas has 

joined us, Congressman English. 

Congressman Stenholm, would it be appropriate for you to give 

your statement now and then if Congressman English can stay, 

fine. Otherwise, we will focus on what you have to say. 

Congressman ENGLISH. Mr. Co-Chairman, if I might, I do have 

a couple of pending engagements on the House side. I would love 

to be excused, but would welcome another opportunity to engage in 

the future. 

Co-Chairman MULLOY. Congressman English, thank you very 

much for sharing your thoughts with us. 

Congressman ENGLISH. Thank you so much. 

Co-Chairman MULLOY. Congressman Stenholm.

STATEMENT OF CHARLES STENHOLM

A U.S. CONGRESSMAN FROM THE STATE OF TEXAS 

Congressman STENHOLM. Thank you, Mr. Chairman. I thank all 

of you for affording me this opportunity to be with you this morning and to share just a few ideas and views regarding the subject 

for which you are convened. 

I had the privilege of visiting China for the first time with Congressman Don Manzullo, a CODEL in which we spent a fascinating 
14

ten days in that country. It was an education for me. It shed a lot 

of new light on that country, China, and that whole area and this 

whole subject, which we are now talking about, and that is, competition in an international marketplace and what constitutes fair 

competition. 

I also was in Cancun for four days and watched the WTO break 

up because of the inability of 148 nations to come together and to 

agree unanimously on anything. 

But the subject today is China and currency manipulation. Let 

me put it in this perspective, if I might: I am the ranking Democrat 

on the House Agriculture Committee. I’m used to getting beat up 

about our farm subsidies. It’s something that our own press delights in criticizing, that which we do. And there’s always some 

merit in what they say. But as one of the prime architects of the 

2002 farm bill, we said it was important for America to stand 

shoulder to shoulder with our producers in the international marketplace, with the full recognition that negotiations are necessary, 

that you have to sit down in the marketplace—if I’m buying and 

you’re selling, we have to come to an agreement. And usually, if I’m 

asking a hundred and you’re willing to give 50, you usually come 

together at 75. That’s usually the way negotiations go. 

But if you have an advantage, as certainly we use the Europeans as the biggest example, when they subsidize their farmers $323 an 

acre and we subsidize 30, that’s not a level playing field. 

Now, there are other subsidies, and currency manipulation or 

having your currency cheaper gives you the direct effect of the 

same thing that a tariff would give you. And one of the messages 

that we attempted to deliver to our Chinese friends when we were 

there is I don’t know how long America can continue to run $500 

billion fiscal deficits, $500 billion trade deficits, without the law of 

economics or politics taking over. And we made the point. When 

you’ve got a currency advantage that’s causing the problems that 

you’re causing with American manufacturing, as we say in Texas, 

that dog won’t hunt forever. 

Therefore, we have to sit back and say, okay, it’s important to 

take a look at it, and not just take a look at but deal realistically 

with that advantage. And so I was happy to join with Congressman 

Don Manzullo, Baron Hill, and Mike Rogers on the House resolution in which we’re not suggesting protectionism; what we’re suggesting is it is time to deal openly and honestly with, in this case, 

currency manipulation. 

But as I said when the Ambassador from China came to my office after some of our comments, I said, when we voted—and I 

voted, and I am one that has voted for every trade bill, I believe, 

that has come in the House of Representatives for 25 years because 

I believe in trade. Trade is what will make the world a better 

place. 

Free trade, I try to avoid that term because, being practical, I 

don’t think we’re going to see total free trade in my lifetime. But 

the closer we come to it, the better everyone will be. 

And when I voted for trade promotional authority, passed by one 

vote—I can take the credit or get the blame for that, but with China’s accession into the WTO, all we said to them and continue to 

say, when you agree to do certain things, it’s important to live up 
15

to it. And when you fudge on whether or not you are, in fact, going 

to do what we think you have agreed to do, that’s creating problems. And then you have the currency manipulation factor on top 

of that, it becomes a real problem. 

So I think you’re seeing a growing indication in the House of 

Representatives, and I will conclude with this brief final statement. 

I think it is absolutely critical that we have the kind of negotiation, 

in this case specifically with the Chinese, but I say it with all countries of the world, that goes back to the practical effect of saying 

let’s look at the issues as they are, let’s realize we’ve all got problems. And I recognize the problems of China, et cetera. But we 

can’t keep doing business like we’re doing it and continue to destroy the manufacturing base in the United States. We can’t do 

that. 

So I appreciate the opportunity to be here and welcome any questions you might have. 

Co-Chairman MULLOY. Congressman Stenholm, thank you. 

We’ve been joined by Senators Dorgan and Schumer, and it 

would be my hope, if we could have Senator Dorgan’s statement 

and then Senator Schumer’s, and then if people have time, we 

could take questions across the board, if that would work for you, 

Congressman. 

Senator Dorgan. And thank you very much for being here, Senator. We really appreciate it.

STATEMENT OF BYRON L. DORGAN

A U.S. SENATOR FROM THE STATE OF NORTH DAKOTA 

Senator DORGAN. Well, Commissioners, thank you very much. I 

don’t know what has been said prior to my arrival, and I hope I 

don’t duplicate it. 

Let me make a couple of comments. You have the charge of holding a hearing on something that is incredibly important because it 

relates to the question of what kind of industrial base, what kind 

of a manufacturing base this country maintains in the years ahead. 

China is a very large trading partner of ours. They have in recent years developed a very, very large trade surplus with us, or 

we a deficit with them. We’ve become a cash cow for China’s hard 

currency needs, and we in this country are a market for their trinkets, their trousers, their shirts, their shoes, and all their production moving like a sponge into our marketplace. And yet we discover that even two years after we did a bilateral agreement with 

China, a trade agreement—which I would have voted against had 

we the opportunity to vote on it here in the Congress. Two years 

after that, in the areas that I’m especially keen to, that is, grain 

and wheat, for example, even then a short time after the bilateral 

agreement China was not abiding by the terms of that agreement. 

There are several things that, it seems to me, you ought to consider. One you can’t do a lot about, and that is that we negotiate 

fundamentally incompetent trade agreements. I don’t know who negotiates them. I wish I could put a name and a face to the negotiators and put a jersey on them that says ‘‘USA’’ so they could occasionally look down and see who they work for. 

But the negotiations have been fundamentally incompetent, and 

I’m talking then about you put a blindfold on, the murmurs coming 
16

from these negotiators couldn’t distinguish between one political 

party or the other. It’s just incompetence, and that doesn’t know 

partisanship. 

Let me give you one example of that. Perhaps other expert witnesses can explain this. The bilateral with China said, by the way, 

after a lengthy phase-in, we would agree with respect to automobile trade for you to have a tariff that is ten times higher in 

China on U.S. cars going to China than we would have on any Chinese cars potentially sold in our marketplace. Now, a country with a $103 billion surplus with us, we say it’s 

okay in the future for your 1.4 billion people to be treated to a tariff that is ten times higher on U.S. automobiles sold in their marketplace? I mean, excuse me, I think that’s nuts. I don’t know who 

negotiated it, but that’s just the tip of the iceberg of the fundamental incompetence of the negotiators in these trade agreements. 

But aside from that, you’re going to talk today, I suspect, about 

currency fluctuations. I’ve talked about this for decades. In Congress, I’ve talked about trade for many, many years, both in the 

House and the Senate. I’ve always said you cannot have a trade 

agreement that is an effective instrument creating free and fair 

trade between countries unless you have a shock absorber dealing 

with currency fluctuations. If you don’t have it, you lose. 

We negotiated at great length with Mexico and reduced tariffs of 

Mexico somewhere in the 10 to 15 to 20 percent range, and then 

Mexico devalued the peso, 50 percent. So we’re 30 percent farther 

behind. Does it pass the laugh test at some point for us to be doing 

all of this, albeit incompetently, but still doing it, and then discovering that currency fluctuations wipe out whatever minuscule gains 

you make in negotiating lower tariffs? The answer clearly is no. 

You must deal with this. 

But in deference to my friend, Chuck Schumer from New York, 

while I support, I fully support the effort he makes dealing with 

the issue of the Chinese currency manipulation that is not the only 

issue, and perhaps not even the most significant issue. No matter 

what the value of the currency in China, at 3 cents an hour or 13 

cents an hour for 12-year-old kids, for 7 days a week at 14 hours 

a day, it’s hard to compete, probably impossible to compete. 

My colleague the other day pointed out that the Huffy bicycles 

he used to buy made by 1,100 good workers in Indiana, you can 

still buy those Huffy bicycles—and, by the way, they still sell at the 

same price in American outlets, except those 1,100 people don’t 

make them in Indiana. They’re now made in China. That is symbolic of the movement of the manufacturing base. 

You will have testimony—I see my friend Fred is about ready to 

testify, and he and I have discussed this over the years, not so recently but discussed this over many years. Look, I believe expanded 

trade is important to this country. I do not believe creating walls 

of protectionism enhances this country in any way. But I do believe 

this country has the economic strength to demand and insist on 

fair trade. 

I want to just finish with this. Let me just get this through the 

lens of wheat because wheat is very important. Historically, it has 

always been important. Thomas Jefferson early on in the formation 

of this country suggested that legislators be paid in wheat. They 
17

did not adopt that, but had that been the case, perhaps wheat 

prices would have been better for family farmers. 

But wheat, China used to buy $500 million worth of U.S. wheat 

10 years ago, 12 years ago. Now $25 million a year in wheat. The 

Chinese Agriculture Minister, after having an 8.5 million metric 

ton tariff rate quota on wheat, implying in the bilateral that that 

quantity of wheat could come into the Chinese marketplace at low 

tariffs, the Chinese Agriculture Minister went to southern China, 

I think Guangzhou, and I think in the South China Post or the 

South Asia Post was quoted as saying, ‘‘You know that 8.5 million 

metric tons?’’ Now, he was speaking to his constituency. ‘‘You know 

that 8.5 million metric tons? Don’t worry about that. That’s just 

theory. That doesn’t mean that’s what’s going to come into China.’’ 

And guess what? We’ve had two years of experience, and it ain’t 

coming into China, not from this country. 

I’m really glad you’re doing what you’re doing. I hope that you 

have an opportunity to listen to all sides and conclude what I have 

concluded, and I think what my colleague from Texas has concluded and my colleague from New York has concluded. This country needs a good, stiff vitamin B12 shot, industrial strength, that 

gives it the energy and also a backbone and some will to stand up 

and say this country demands and insists on fair trade relationships. And if not, send all your trinkets, trousers, shirts, and shoes 

to sell in Zambia and see what kind of market exists there. 

There is no substitute for the American marketplace on the face 

of this Earth—none. And the fact is we have the capability to demand fair trade between us and our trading partners. We have 

never had the will or the backbone or the strength to do it. And 

I hope this Commission is able to sort through all this and come 

up with some recommendations that enhance the opportunities 

that those of us who are concerned about this have been talking 

about here in the Senate. 

Thank you for taking the time this morning. 

Co-Chairman MULLOY. Senator Dorgan, thank you very much for 

being here, and thank you for all your support of this Commission 

and its predecessor commission that was looking at the whole concept of the current balance of payments deficit as well, which was 

another thing that Congressman Stenholm mentioned. This is a 

huge $500 billion problem, and it’s growing at a very rapid rate. 

Senator Schumer, thank you very much for being with us as 

well. 

Senator SCHUMER. Thank you. 

Congressman STENHOLM. Mr. Chairman, might I interrupt? I’ve 

got a meeting with Secretary Veneman and Ambassador Zoellick on 

this subject right now, so if I might be excused? 

Co-Chairman MULLOY. Congressman Stenholm, thank you very 

much for sharing your time with us, and we hope to stay in touch 

with you and your staff as we go after these issues. 

Senator DORGAN. Mr. Chairman, I, too, am going to depart. I’m 

going to leave for China with a bushel of wheat. 

Seriously, thank you for the opportunity to address a very serious issue. 

Co-Chairman MULLOY. Thank you. 
18

Senator DORGAN. And my colleague speaks for many of us in the 

Senate with respect to this concern about currency fluctuations. 

Co-Chairman MULLOY. And we’ll keep you and your staff fully informed of what we’re doing, Senator. 

Senator DORGAN. Thank you very much.

STATEMENT OF CHARLES E. SCHUMER

A U.S. SENATOR FROM THE STATE OF NEW YORK 

Senator SCHUMER. Commissioner, thank you, and I want to 

thank my colleagues here and every one of you who is serving your 

country, and I very much appreciate your being here and the talent 

and intelligence on this Commission, as well as the importance of 

it. 

Now, I think first I would say to you, Commissioners, we’ve 

reached a crossroad in Congress on the issue of free trade, and I 

think these hearings could not come at a better time. I’m not going 

to address the broader issue, but I will tell you this: The consensus 

for free trade in this Congress is rapidly eroding. 

I voted for every MFN for China. I lost the AFL–CIO endorsement when I was in the House a few times because of my views 

on free trade. And it’s just getting us nowhere. And it’s not just 

that we’re losing low-end jobs. We’re losing high-end jobs. When 

IBM, Intel, and Goldman Sachs say that they’re moving their topend people overseas, you’ve got to ask yourself: What’s going to be 

left here? Manufacturing is leaving. Agriculture has left. Well, at 

least we had high-tech service jobs. They’re going like that [snaps 

fingers]. 

I’m just going to share with you one story. A head of a major 

New York investment bank told me the following: He said, ‘‘We 

have 800 people in New York who do computer software programming.’’ Very complicated stuff. These are derivatives and stuff like 

this. He said, ‘‘Over the next three years, those 800 will lose their 

jobs in New York.’’ Oh, they make an average of $180,000 a year. 

These are not middle-level or service jobs. He said that in the next 

three years they are all going to China and India. He said, ‘‘We can 

hire engineers just as capable, just as competent there for $18,000 

a year.’’ Eighteen thousand. 

Now, I’m not blaming his company. They’re doing what a capitalist free market company does. But what’s left here? What is 

going to be left here? 

The theory of free trade is comparative advantage. If we don’t 

have comparative advantage in computer software programmers 

who make $180,000 a year, what do we have? 

Someone else told me radiology will not be practiced in the 

United States in ten years, that because of instantaneous communications, a patient will walk in, a technician will take the picture 

here, and it will be sent to China or India because a radiologist 

there is capable, except maybe if it’s very complicated, you’ll have 

an expert here. 

Interns will stay here, internists, because they have to look at 

you. But anything where they don’t have to do it right to the customer is going there. 

So I am wondering what’s left. That’s a general comment not related to this. But I hope the Commission will look at that. 
19

The economists and the editorial boards stick to the doctrine of 

free trade from Ricardo—comparative advantage. It’s worked for a 

long time. It’s created discombobulation, but it’s worked. But we 

have never had a situation where communication and transportation is instantaneous. And you have 200 million well educated, 

from an American point of view, highly underpaid people, mainly 

in China and India, who can take just about any job. And that’s 

something we’re all going to be grappling with. I’ve talked to some 

very smart people who are wondering about this. 

When I talk to the economists—I don’t know if we have any free 

trade economists on the Commission. But when I talk to them, they 

say, well, it will eventually adjust itself. It will, in about three generations when the wealth of America and the wealth of all these 

other countries is about even. 

I ask you, I ask my colleagues, I ask our President, I ask the 

American people: Is that a good enough answer for us? No. Okay. 

That’s just the context here. Let’s just talk within the context of 

free trade. Within the context of free trade, every economist will 

tell you part and parcel of free trade and open borders and comparative advantage is to let currencies float. China doesn’t. Japan 

to an extent doesn’t as well. But International Trade 101 teaches 

that an open and free system of trade demands that international 

exchange rates be set by the free flow of currency and goods between countries. 

Government interference in the market by hoarding currency or 

pegging currency rates distorts the trade system and harms countries that play by the rules. That’s why we have international 

agreements on free trade. 

But, unfortunately, despite agreeing to play by these rules when 

it joined the WTO two years ago, China has shown itself to want 

all the advantages of free trade and none of the responsibilities. 

And their currency by general consensus is undervalued. Some put 

it as low as 15, some put it as high as 40. 

Even if you still assume the theory of free trade, which I said I 

have my doubts about these days, even if you assume it, you’ve got 

to let the currency float. You can’t undervalue it. It means that 

every American export to China costs 15 to 40 percent more than 

it should and every Chinese export to America costs 15 to 40 percent less than it should. 

I have seen manufacturers of high-end, excellent products 

throughout New York, and they say, ‘‘We can even compete with 

the low-paid Chinese labor force. But you add another 40 percent 

on top of that and we’re dead.’’

Now, the Chinese are thumbing their nose at us. It was amazing. 

Before Secretary Snow got off the plane in China and discussed 

this, the Chinese said, ‘‘We’re not touching it.’’ So we’ve tried diplomacy, and it is not working. And I have to tell you, the Bush Administration has shown a disappointing lack of leadership on this 

issue until recently, and now they’re not doing enough either. 

They’re beginning to talk about the issue. Talk isn’t going to bring 

the jobs back that are unfairly lost and not coming back, and those 

are manufacturing jobs. We’ve heard about those losses, but it’s 

also beginning to be service jobs. 
20

I’ll tell you one more thing. Why are the productivity numbers 

so high? Well, it may be in part because our companies here are 

more productive because they’re sending all the jobs over there 

where you can do the same job at one-tenth the cost. Our productivity figures are through the roof. And I don’t think it’s just because they’re applying more computers and technology and faxes 

here. It’s just too high. I think a little bit of it and more and more 

in the future is going to be because of the export of even these 

high-end jobs. 

So I’d say that this Administration has shown a disappointing 

lack of leadership. The rules of the WTO allow the U.S. to file a 

dispute against China for its unfair trade practices. The Administration refuses to do it. All the verbiage in the world will not satisfy most of us, a bipartisan coalition in Congress, until some action is taken. 

There is word that labor and businesses together will file such 

a case, and that’s good. But we need the Administration to do 

more. 

So what we’ve seen on China is a lot of talk and no action. So 

that leaves us with only one option to save whatever’s left of free 

and fair trade with China. And that is for us to take action in the 

Congress ourselves. 

And so Senator Graham, Senator Dole, and Senator Bunning—

Members of the Republican Party—Senator Bayh, Senator Durbin, 

and myself have filed a bill which would say that we will put a 

27.5-percent tariff on every Chinese import, 27.5 because that is 

halfway between 40 and 15. 

It is bipartisan. We don’t want to politicize the issue—this is too 

important to give to one party or the other for advantage. We want 

to make this happen. And this does what the Chinese won’t. It 

brings their currency to a right level. It would be better if they’d 

let their currency float. 

Now, let me just say by the way, that maybe it won’t—in fact I 

hope it doesn’t pass. I hope by the time it starts moving—and it’s 

going to move—China acts on its own. You mark my words. No one 

is paying attention now. When Senator Graham and I put this bill 

on the Senate floor, it’s going to pass. And we’re going to put it on 

the Senate floor before we leave. And it’s going to send a shot 

across the bow around this world, and then maybe the Chinese will 

do something, and then maybe the rest of the world will help. 

Now, there are a few arguments against it. There is no doctrinaire argument. They’re all practical arguments. 

One, the Chinese hold a huge amount of American currency, 

bonds, and if we do this, they’ll let those go and it will hurt our 

bond rates. Who’s going to buy them? 

I heard this. I have experience in this. Japan would not open 

American markets for financial firms in the mid-1980s. That was 

very important to my city and State of New York. If you were Merrill Lynch, you couldn’t get a seat on the Japanese stock exchange. 

If you were Citibank, you couldn’t open up an ATM machine—even 

though we were much better at those things than the Japanese. 

And everyone said, well, we’ll talk about it. And we talked and we 

talked and we talked. 
21

Then I put in a bill that said they can’t sell their stuff here if 

we can’t sell our stuff there. It was horrible, all the economists 

said. They made the same argument. Japan won’t buy our bonds. 

They had as many of the U.S. bonds and treasuries in the late 

1980s as—China has more, I think—than China has now. And I 

said, forget it, they’re not going to sell the bonds, cut their nose to 

spite their face, decrease the value of one of the largest assets they 

have. No country or businessperson would do that. 

And they said it will create a trade war. Well, lo and behold. The 

bill passed the House. I was in the House then. And all of a sudden, Japan opened up its financial markets. They had said there 

was no space on the Tokyo stock exchange, and then suddenly they 

found space. They said there were all sorts of restrictions. And 

that’s what I hope would happen with our legislation. I don’t want 

it to pass. I’d rather it importune people to do the right thing. But 

I’ll tell you, we’ll keep pushing it if it doesn’t—if it won’t pass, because it’s a better alternative. 

And the other thing they say is the Chinese banking system is 

so weak that this will send it downward. Well, it’s not going to get 

better by keeping a fixed rate. It’s not going to get better. It will 

get worse as China gets bigger. 

And I’ll tell you this: When are we going to look out for the problems we have? The Chinese are screwing up their banking system. 

We should worry about that, but why should we make it more important than us losing all our jobs? Unfairly, not through any theory of comparative advantage. 

So we’re going to push this legislation. It’s quiet now because the 

economists say—they’re living in the old world. They don’t see 

what’s happening. And when I ask them what’s going to take the 

place of these high-end service jobs that are leaving, they say, well, 

something will. Well, maybe it will. But no one has suggested anything yet. 

And so this is indeed a shot across the bow. It’s legislation that 

we believe will correct a real injustice. It will force China to live 

up to its responsibilities. It will make the Chinese banking system 

better. But it will also, if you believe in free trade—and I guess 

there’s division on this panel—it’ll save it, if it’s worth saving. And, 

again, as I said, five years ago I would have said by all means it 

is. Today I’m not so sure. 

So I hope you’ll pay attention to what this legislation is all about. 

I’d be interested in your thoughts and comments on it, not today 

if that’s not appropriate, but down the road. And I’d be interested 

in what solutions you come up with if this is no good, because so 

far there has been none. 

Thank you. 

Co-Chairman MULLOY. Senator Schumer, we very much appreciate the comments and your leadership. And I think, as you mentioned earlier in your testimony, this is a much broader issue than 

just the exchange rate issue, and this country has to do some very 

serious thinking about how we’re engaged in the global economy. 

We’re trying to do that somewhat today to get it going and think 

about it. 

Senator SCHUMER. It’s a great job you’re doing, a great service. 
22

Co-Chairman MULLOY. Congressman Manzullo, could you give us 

a chance to have one or two questions with Senator Schumer and 

then make your statement? 

Congressman MANZULLO. Go ahead and finish. 

Senator SCHUMER. Great. Thank you. 

Discussion, Questions and Answers 

Co-Chairman MULLOY. Commissioner Wortzel, you had a question. 

Commissioner WORTZEL. Well, I did. One, of course, was answered by the Senator’s explanation of how he arrived at 27.5 percent. I appreciate that. 

Senator Schumer, I’m also interested in your views on the fact 

that China, whose citizens have such a high savings rate, doesn’t 

allow the freedom to let those citizens put their money in any bank 

they want, and whether the freeing of capital controls in China, 

would also help address some of these problems. 

Senator SCHUMER. The Wall Street Journal editorial page sort of 

knocked our legislation, or if not our specific legislation, they said 

it would be a lot better if the average Chinese citizen could buy a 

stock or buy a bond here in America. I agree. But when I look into 

the eyes of the hundreds every week of manufacturing jobs and 

now service jobs that are being lost, some of it, at least—not all; 

I don’t want to overclaim, through this unfair advantage. I say why 

are we waiting—if the Chinese have a better solution, you know 

what I’d say? Pass this. Then maybe they’ll do that. 

They, again, want all the advantages and none of the liabilities. 

Congressman MANZULLO. Or responsibilities. 

Senator SCHUMER. Or responsibilities. That’s a better word. 

Thank you, Congressman. That’s what they want. You can’t do it 

halfway. 

And, by the way, if we stick to this system, it will screw up the 

world trade mechanism even worse, because it’ll get so big it’ll 

burst. And this legislation is intended to force some rational transition out of it, because my guess is, again, if it passes the Senate 

and begins to pass the House, maybe they’ll come up with a plan 

and say let us get to where you’re saying over five years. I’d look 

at something like that, although I even hate to admit that because 

five more years of unfair advantage, who knows what will happen? 

But, still, at least that’s a light at the end of the tunnel. Right now 

there’s no light at the end of the tunnel. 

And it’s easy for economists and editorial page writers to say, the 

Chinese should do this, it’s a better solution. But I’m not a Chinese 

legislator. They don’t have a Chinese legislator who has any power 

to do anything. 

So what’s the alternative? Yes, there are better ways to do it. I 

don’t know any better way that we can control here in the United 

States. That’s the question, not ‘‘are there better solutions.’’ Are 

there better solutions that we, that the President, the Congress, 

the American people can implement? 

Co-Chairman MULLOY. Commissioner D’Amato. 

Vice Chairman D’AMATO. Senator, thank you very much for your 

testimony and the argumentation underlying it. I think the legislation that you’ve introduced is very important. 
23

This Commission took the position last year that if we’re going 

to change Chinese behavior, we have to at least threaten to take 

away some of the things they hold dearly, which, of course, in the 

case of your legislation is access to the American market. 

Senator SCHUMER. Exactly. 

Vice Chairman D’AMATO. We also suggested that they are beginning to hold dearly access to our equities market, another area 

where, if you were to impose some penalties, that would get their 

attention. 

Senator SCHUMER. Yes. 

Vice Chairman D’AMATO. I have two very quick questions. The 

letter that you sent with many of your colleagues to the President 

on July 31st, I just wondered if you have received an answer yet. 

Senator SCHUMER. I think we’ve gotten an answer from Secretary Snow, but not from the President. We wrote to Snow as well, 

and he did send us a letter, but it was just, well, we’re trying to 

do something. 

Vice Chairman D’AMATO. Yes. 

Senator SCHUMER. That was about the thrust of the letter. And 

they are talking about it more, which they didn’t do six months 

ago. And maybe the Commission helped push them in that direction. But talk is not enough. 

And when the Chinese—I mean, that was insulting that before 

the Treasury Secretary got off the plane, they said, ‘‘We’re not 

changing our currency.’’ You know what? That was the best thing 

that happened for my legislation. 

Vice Chairman D’AMATO. One other question relating to the argument now being used to justify going soft on the Chinese in this 

area is the argument that for the first time the Chinese have been 

engaging actively on the diplomatic front on the North Korea issue. 

Senator SCHUMER. Right. 

Vice Chairman D’AMATO. And that in order to encourage them 

to continue to take a leadership role and support us there, we’ve 

got to go soft on the trade front. 

Senator SCHUMER. Yes, you’re right. That’s outside the economic 

realm, and that’s really the job for the President to sort of integrate. And if we pass through all these other arguments, we’ll ultimately get to that one. 

Well, if tomorrow North Korea announced that it was getting rid 

of nuclear weapons, well, then, maybe they’d have a discussion 

about it. Again, I still look into the eyes of workers in Syracuse 

who are losing their jobs through unfair advantage. It’s hard to 

make the tradeoff, but that’s what Presidents are paid to do. But 

I haven’t seen the progress yet. I see the jobs being lost. I haven’t 

seen the progress with North Korea, and I don’t even think our Administration says we’re making progress with North Korea. 

Vice Chairman D’AMATO. Thank you, Senator. 

Co-Chairman MULLOY. Commissioner Wessel, and then Commissioner Robinson, and then we’ll probably let you go, Senator. 

Commissioner WESSEL. Thank you. Thank you, Senator. I appreciate your being here, and Mr. Manzullo and the others who have 

been here. And while Mr. Stenholm was testifying earlier, I was 

thinking of a term he taught me many years ago, and it seems to 
24

apply to the President, that he’s all hat and no cattle, as we look 

at this problem——

Senator SCHUMER. We don’t use that one much in Brooklyn, but 

I know what you mean. 

Commissioner WESSEL. I’m from White Plains, so I understand. 

You said earlier that the time for action is now. Clearly, the Chinese have not responded to our pleas for many years, and you have 

to admit they’re pretty smart not to because they’re winning the 

battle right now. 

In your discussions with the Administration, have they taken a 

position on your legislation? Are they welcoming it? Are they ignoring it? 

Senator SCHUMER. Well, publicly, they are not supporting it. I 

don’t know if they’ve actually put out a letter in opposition yet, because, frankly, we’re just starting. People are saying, oh, this is 

just some kind of—they don’t realize how dead serious I am, and 

I just refer people to look at what happened with Japan. It’s almost 

the same exact scenario. And I am dead serious, and the Senate 

gives you the ability to add legislation—Senator Graham and I—

from the other party. Senator Graham and I have—so it’s bipartisan. That’s the only point I wish to make. We’ve agreed we’re 

going to add this legislation to something in the Senate before we 

leave. So then we’ll start getting some real talk about this. So far, 

not yet. But it’s beginning to make—it’s beginning to make its stir. 

Commissioner WESSEL. Thank you. 

Co-Chairman MULLOY. Commissioner Robinson. 

Chairman ROBINSON. Senator, thank you so much. I think that 

your remarks have been provocative and thoughtful. 

I just wanted to make a comment more than anything else, or 

an observation on the basis of what Vice Chairman D’Amato mentioned concerning the argument that Beijing’s assistance, which is 

purported to be very substantial, in defusing the North Korean nuclear crisis is of such a critical nature that it has to supersede the 

very important issues that we’re discussing today. 

It might be interesting for you and others to have a look at the 

transcript of a hearing we held on July 24 on Chinese proliferation 

practices, and particularly their role, which is a pivotal one, on the 

Korean Peninsula. It turns out that in the extensive research done 

by our staff and the expert testimony we received in the course of 

that hearing, that, in fact, China, does have very substantial leverage. 

Senator SCHUMER. It’s the only country that does. 

Chairman ROBINSON. Eighty to 100 percent of the oil, depending 

on which estimate you’re listening to, and about 40 percent of the 

food. But as you know Beijing is focused on facilitating the sixparty talks. Diplomacy is important and that is a net positive 

movement by the Chinese. But when you talk about serious leverage being exercised by them to defuse what could be the end of 

global nonproliferation regimes and reprocessing that could provide 

North Korea in the next year a nuclear arsenal of some 10 to 13 

weapons that they can sell or test, and afford to do so because they 

have a sufficient number, many of us that have looked at Beijing’s 

role are very skeptical as to how serious Chinese take this crisis. 
25

So it’s something to keep in mind when we hear that the currency valuation issue and the U.S. manufacturing job losses have 

to take a second seat. I think that policymakers need to take a 

hard look at the level of cooperation that, in fact, China is exhibiting in respect to the Korean nuclear crisis. 

Senator SCHUMER. And it’s also—I mean, they should be doing 

both. They want to be part of the family of nations. They’re going 

to have a lot of advantages. Look at the prosperity and growth in 

China. They have to live up to the responsibilities. And it’s responsible to deal with North Korea, and it’s responsible to really be a 

free trader. 

It’s almost like if we have to make that choice, losing all our jobs 

or having a nuclear North Korea, it’s like what they do in Utah, 

death by firing or hanging. It’s not the kind of choice you want to 

have to make. 

Co-Chairman MULLOY. Senator Schumer, thank you again for 

your time and your leadership. 

Senator SCHUMER. Thank you. 

Co-Chairman MULLOY. And we hope to stay in close touch with 

you and your staff. 

Senator SCHUMER. I appreciate it very much. 

Co-Chairman MULLOY. We’re very privileged now to have the 

Chairman of the House Small Business Committee, who has played 

a leadership role in bringing to the attention of the country the crisis in manufacturing and the loss of manufacturing jobs and what 

that means for our total economy. We are also fortunate in having 

the Ranking Member of the Trade Subcommittee of the House 

Ways and Means Committee, Congressman Levin, with us, as well. 

So, Chairman Manzullo, if you could give your remarks.

STATEMENT OF DONALD A. MANZULLO

A U.S. CONGRESSMAN FROM THE STATE OF ILLINOIS, AND

CHAIRMAN, HOUSE SMALL BUSINESS COMMITTEE 

Congressman MANZULLO. Thank you very much for the opportunity to be here. The bottom line is this. We have been losing an 

average of 70,000 manufacturing jobs in this country for about the 

past 38 months, and there are about 40 to 50 Congressional districts out of the 435, plus the five territories and the District of Columbia, that really have a significant manufacturing base. 

But it wasn’t until an astounding article appeared in Business 

Week this past February that talked about the tremendous loss of 

high-value white-collar jobs. At that point, it brought in people 

such as Jerry Nadler, who doesn’t have much manufacturing there 

in Manhattan but obviously has a lot of white-collar jobs. Jerry has 

become a member of the Manufacturing Caucus, which Congressman Tim Ryan and I founded just a few months ago, and we are 

already at over 50 members that belong to that. 

But the problem that we have seen is the manipulation of the 

currency taking place in China. 

Here is what it means in practical terms. For every item that an 

American manufacturer wishes to sell to China, it’s the equivalent 

of a 15 to 40 percent tariff to get the goods into China. And it’s 

also the equivalent of everything that the Chinese want to sell us, 

which they obviously do because of a low wages: it’s the equivalent 
26

of an additional 15 to 40 percent discount on the existing low price 

of what they’re selling back to the United States. 

I think that’s how we have to couch the terms of the argument 

with regard to the significance of the pegging of the RMB to the 

U.S. dollar ever since 1994. When currencies do not float against 

each other, the currencies are rigged and rigged currencies do not 

evidence any indication that this is, in fact, a free trade situation 

that is taking place. That’s the purpose of Senator Schumer’s bill. 

Now, I’m not on his bill. We sent out a joint letter that Senator 

Schumer and I signed to the Senators and the Representatives saying there are six bills out there that deal with this. Representative 

Jim Walsh from Syracuse, N.Y. has a bill that says unless a company has at least half their workers in the United States, they get 

no government contracts. That is Jim Walsh’s bill. He is being 

murdered up there. 

The bill that I’m on, working with NAM that says, look, there are 

several remedies out there that could be used. There’s Section 14 

of the WTO. There’s the IMF. You could use the Equalization Stabilization Fund. There’s Section 301. And there’s just hard-nosed 

politics that, dang it, we should not be in the position of having to 

give away our jobs to the Chinese as some type of incentive for 

them to get moving on the North Korean issue. 

You cannot tie in the loss of our manufacturing jobs with politics 

around the world, because guess who loses every single time on 

that. It is us. And as much respect as I have for Senator Schumer’s 

bill, I’m opposed to the steel tariffs that were imposed because they 

were imposed politically. It killed manufacturers here in the United 

States, actually sent some of my manufacturers overseas. 

That is one of the problems with tariffs. Tariffs should be imposed only in those situations where you’ve gone through an adjudicatory process, such as on a 301 case or the various stages of the 

WTO or the IMF. It’s a more deliberative process. It’s a little bit 

slower, but it follows a rule of law in there. 

But what we did was, Senator Schumer and I sent out this ‘‘Dear 

Colleague’’ and said, look, you may feel comfortable with one or 

three of the bills that are out there. This is your particular choice 

depending on your particular philosophy. But what’s important 

about it is that it’s people of all philosophies may get on one or 

more of those bills to show how important this has come to the attention of the American people. 

Now, NAM estimates China has over $300 billion in foreign currency reserves, and here’s the story on it. This is really shameful 

on what is taking place in the United States. 

Number one, we lose manufacturing jobs to China all the time, 

and I’m at 11.3 percent unemployment in the second biggest city 

in Illinois. In 1981, Rockford led the nation at 24.9 percent. We 

know what it is like to take a hit. It’s the tool and die center of 

the world. Whenever sales go down on tool and dies, that is the canary in the coal mine. For three years, I’ve been screaming that 

this economy is in the tubes and all we do is have people in Washington listen to the economists. 

Listen to my machinists, not the economists. The economists 

don’t know what a pink shop rag is that you use for wiping machine oil. And that’s the barometer in this country as to the health. 
27

If you don’t have any orders for new tools and equipment, that 

means there’s no new orders for new products that are being manufactured. That means the economy is going into the dumps. 

And so we’ve been spending so much time on this Small Business 

Committee trying to educate Washington finally. The Financial 

Services Committee held an astounding hearing with Chairman 

Greenspan. I also sit on the Financial Services Committee. The 

Chinese have 450 million people in their employment force. They 

add ten million each year. They must grow their economy by 8.6 

percent just to bring in the new people. Their manufacturing is up 

16.9 percent and their exports are up by almost a third. 

I said, in our country, if you listen to the NAM statement—NAM 

is a very responsible organization—they said, if we continue to lose 

manufacturing jobs at this pace, then we will lose the leverage we 

have in the world for innovation. Then Americans will have to get 

used to a lower standard of living. 

I said, ‘‘Do you agree with that statement?’’ Chairman Greenspan 

said, ‘‘Misguided.’’ I said, ‘‘Tell me why.’’ He said, ‘‘Well, what you 

lose in the manufacturing sector, you gain in the high-end whitecollar sector.’’ I said, ‘‘Those jobs are leaving.’’ What is it going to 

take Washington to wake up? 

And then with these huge reserves, the Chinese come over and 

they manipulate our debt market by buying the Treasuries, and 

then their argument is, well, if you get hard on us with the trade 

imbalance and with the fixed RMB, we, because we buy so much 

of your bonds, can be responsible for you having to increase your 

interest rates and driving up the cost of living. No nation should 

be held hostage by that type of foreign currency manipulation. 

And I want to tell you something. I’ve been working on this thing 

for years and I am hot that the United States economy is being 

bound by the Chinese and that is going to stop. It is going to stop 

now. The bleeding is oppressive in manufacturing. 

If you don’t have agriculture, manufacturing, and mining, you become a third-world nation. When you go back home—you know, 

what people want back home, Commissioner Bartholomew? Do you 

know what they want? They want to be able to live in the same 

town as their grandkids. What you’ve got going on in America 

today is six or seven centers in America where all the kids run off 

to the jobs and the beautiful little towns are desolated because the 

little shops could no longer compete because somebody says we 

can’t criticize the Chinese too much because of the currency manipulation. It’s got to come to an end. 

And Senator Schumer is right over there. It’s significant what he 

said. He introduced a bill that he doesn’t want to pass because he 

knows it’s the only way that you can gather the attention of the 

United States Congress and the people and the policymakers. 

We found out about a year and a half ago that the Fed thought 

that the recession was over. I said, well, that’s interesting, and, 

therefore, getting ready to raise interest rates. And I said, hello. So 

we held a hearing in the Small Business Committee and brought 

in Dr. Roger Ferguson, a marvelous man, deputy to Greenspan. 

And I said, ‘‘Dr. Ferguson,’’ I said, ‘‘manufacturing is 16 percent of 

GDP.’’ He said, ‘‘Well, it’s only 16 percent.’’ Now it’s down to about 
28

12 or 13 percent. Only ten percent of all the jobs in America are 

manufacturing now, we’re losing them so fast. 

And I said, ‘‘Have you ever smelled the sweet smell of machine 

oil on your hands?’’ He looked at me and he said, ‘‘No, but I will 

be there.’’ And the next day his office called and he came out and 

we took him into a tool and die shop where you make the molds. 

We have a constituent back home, Don Metz, who actually makes 

the molds for the Oscars. Remember when a bunch of those got 

swiped or lost in Chicago? Well, they got a hold of Don and said, 

‘‘You keep your mold. That’s proprietary.’’ And then he took it down 

and put solid gold in or whatever—it couldn’t have been solid gold, 

but whatever it was, put some metal in there and made up these 

20 or so Oscars that had been lifted overnight. 

And we showed Dr. Ferguson and he said, this is the beginning. 

This is the first step from the mind of the inventor. And then we 

took him over to Dial Machine, and as a result of that, Eric 

Anderberg has gone on to the unofficial board of the Fed in Chicago 

as a manufacturing advisor to give testimony as to the Beige Book. 

We found out that the Fed was never using the machine tool index 

as an indicator to manufacturing in this country. Hello. You don’t 

find machines within the beltway of Washington, D.C. 

So we got involved in this and formed this coalition. We have 

been working with Treasury Secretary Snow, who is an absolute 

godsend to this country. This man understands exactly what is 

going on. He has a transportation background at CSX, and people 

that move things think differently. That’s just the genre of their 

minds and it’s been great. 

From the beginning, in fact, it started with Secretary Evans a 

couple of months ago where he just let out a blast. He said, ‘‘We’re 

going to send someone over there every month until you do something about it.’’ And Snow went over there and raised all kinds of 

cain with China. Then he met in Dubai with the G–7 countries and 

they went in there and they started rattling the cages. Of course, 

the stock market went down. 

But you know what? You could have interest rates at zero. It 

doesn’t mean anything if the people don’t have jobs. And as I go 

across my Congressional district, we are heavy into manufacturing, 

heavy into agriculture and value-added agriculture, and heavy into 

growth in the Chicago suburbs, and a lot of those people coming 

out of the Chicago suburbs into my Congressional district are working in the financial market. 

So what are the suggestions that we have to do? First, is H. Con. 

Res. 285, which encourages the Administration to continue with 

these actions while pursuing other options, too. Currency moves by 

emotion. Don’t ask me how that works, but it does. It works by 

pressure. We must vigorously enforce laws that provide remedies 

that counteract foreign currency manipulation. That’s what’s available in the WTO, the 301, the IMF. 

Second, the U.S. must continue to encourage harmonization of an 

international exchange rate policy of freeing foreign exchange rates 

based on market forces. The G–7 said, look, what’s more important 

to us than a stable currency rate is one that floats. 

And third, the U.S. must enable the dollar and other currencies 

to move towards equilibrium rates by correcting market imperfec-
29

tions, countering foreign currency manipulations, and seeking cooperation within major countries, and seeking coordinated actions. 

And then, of course, again with 301. 

But there are other problems that we have on our side. We have 

been working with different agencies to make it possible—listen to 

this—for the Chinese who want to buy our high-end stuff, just to 

get a visa to come to America to shop. Now, you think about that. 

We complain about the fact that we have this trade imbalance, 

and then our own policies, and sometimes, excuse me, but the overemphasis upon homeland security, that every Chinese person is 

somehow a terrorist and treated like one because it takes sometimes a year to get a visa, they just give up on us and they go to 

another country to buy their stuff. 

So is that the Chinese’s fault? No. That’s our fault. And we held 

a hearing on this in the Small Business Committee, and that hearing, as a result of that, Matt Symanski, who is my Chief of Staff, 

who has been to China seven times in the past year and a half, 

has been trying to meet with the different agencies that are very 

reluctant because of orders coming from the top, and the great people we’re working with, to work with the businesses. 

So we sit here saying, Sandy, we have people in our districts that 

want to sell to the Chinese but we can’t bring them over. So we 

pick up the phone every time and make a special request in order 

to get them in. That’s pure stupidity on the part of the American 

government. Those are the things that we can do ourselves. 

Well, I’ve spoken longer than I should have. 

But you can tell our passion on this. Our people are desperate. 

They’re desperate. They don’t talk about the Iraq war at home. 

They come to hand me resumes, and they come up and say, ‘‘Congressman, can you help me get a job?’’ And you know what I do? 

And I know Sandy does the same thing, because his heart is just 

like mine. 

I was at a Fourth of July parade and the young man ushering 

me around said, Don, four of our neighbors just got pink slips. 

Now, this is in wealthy McHenry County, a suburb of Chicago, 

where the unemployment rate is about seven percent. And I called 

those four individuals. And you talk about the spirit of America 

and what these people are doing. Just to follow up, how did you 

lose your job? What happened? What is the outsourcing? What exactly is involved in your situation? 

I spend so much of my time helping people to get jobs individually, almost like an employment agency. These aren’t government 

jobs, because there aren’t government jobs out there to be gotten. 

But we know firsthand what is happening to our people and how 

they are hurting. Again, if I could have my full statement be made 

part of the record, I would appreciate it. 

Co-Chairman MULLOY. We will do that, Mr. Chairman. 

Congressman MANZULLO. And if you want to curtail the questions in deference to Mr. Levin’s testimony, that won’t bother me 

one bit. It really won’t. 

Co-Chairman MULLOY. Okay. Mr. Chairman, we will stay in 

close touch——

Congressman MANZULLO. That would be fine. 
30

Co-Chairman MULLOY. —and if we could have Congressman 

Levin, and then if you could stay around and we will have a couple 

questions and then we will——

Congressman MANZULLO. We can do that. Why don’t you go with 

Sandy’s testimony and maybe ask us questions together. 

Co-Chairman MULLOY. Congressman Levin, thank you very 

much for taking time to come over here and share your thoughts 

with us.

STATEMENT OF SANDER (SANDY) M. LEVIN

A U.S. CONGRESSMAN FROM THE STATE OF MICHIGAN, AND

RANKING DEMOCRAT, WAYS AND MEANS TRADE SUBCOMMITTEE 

Congressman LEVIN. Thank you for holding this hearing. I have 

a statement that also has attached a statement that I put forth 

yesterday at the hearing with the meeting of the Congressional Executive China Commission and I ask that it be part of the record. 

Co-Chairman MULLOY. Yes, Mr. Congressman. 

Congressman LEVIN. Let me spend a few minutes, if I might, trying to put this currency issue in perspective. 

China was accepted, acceded to the WTO. There was a broad 

feeling that I shared that we needed to engage China and also 

pressure it, that isolation of China economically would never work 

because of its size. 

So it went into the WTO. Actually, it would have gone in without 

approval of the U.S. But it went in as the U.S. Congress acted on 

the terms of their accession. 

The terms of their accession included tariffs, and everybody 

seems to be comfortable about the issue of tariffs. Everybody acknowledges that is part of trade. Also, the accession covered nontariff barriers and there remains controversy about that, but there 

were specific provisions placed in China’s accession agreement regarding non-tariff barriers. 

The same was true of subsidies. The accession agreement covered 

the issue of subsidies that is also a controversial issue as we go up 

the ladder of what is trade, what relates to trade, and what does 

not. 

We also placed in the accession agreement a provision on safeguards. That has remained very controversial, but it’s very much 

there, meaning that if there is a flood of imports from China in any 

sector, there was a provision for the U.S. to act. It was the strongest safeguard provision ever placed in American law. 

There was no reference to currency and there was no reference 

directly to another controversial issue, and that relates to labor 

markets. 

There was a provision for an annual review. We wanted the U.S. 

to work hard to make sure within the WTO there was an annual 

review of China’s compliance, and that eventually happened. To 

date, China’s compliance with the provisions that I mentioned, especially non-tariff barriers, subsidies, that compliance has not been 

satisfactory. There are many areas where China is complying, but 

many areas where they are not, and it is spelled out in my testimony. 

For example, the imposition of quotas, import licensing, ways to 

get around opening their markets, limiting distribution opportunities. Written into that agreement was very clear terms regarding 
31

distribution. The same was true as to non-tariff barriers like standards. 

They are also not complying in the services area regarding, for 

example, high capital requirements, and also, they are making auto 

financing, which was critical for the U.S., exceptionally difficult by 

their capital requirements. 

I don’t think we have actively pursued—surely not enough—efforts to make sure that China complies with its promises. And the 

second annual review is now coming up through the WTO and I 

hope very much that the U.S. will be much more energetic and not 

complacent, and I spell this out in my testimony. 

I’m also not satisfied with the use or the non-use of the safeguard provision, which we worked very hard on. The first two cases 

under that safeguard provision that came before the Administration, they decided, contrary to what was recommended by the ITC, 

not to utilize it. 

So there are issues of compliance. I continue to think, especially 

because of China’s size and importance, there has to be a combination of engagement and of pressure. 

Now, let me talk about currency. Some of these other issues remain controversial and some people argue, don’t worry. They focused tariffs all right, but on anything else, if a country doesn’t follow the rules, it only hurts itself. It’s protectionism to insist on 

China complying with what they agreed to, for example, on nontariff barriers or on subsidies. And it’s, in quotes, ‘‘protectionism’’ 

to utilize the safeguard mechanism. That’s mind-boggling to me, 

since the purpose of it is to increase the flow of open trade, not to 

shut it down. 

So now we come to the issue of currency. On this ladder, it perhaps is the most controversial because the minute it is raised, some 

people say, protectionism. What they ignore is that for decades, 

there’s been a provision within the international rules relating to 

currency. Article 15, Paragraph 4 of the GATT, and this goes back 

before any of us were born, in the ’40s——

Article 15, Paragraph 4, and I want to read it because it needs 

to be remembered. It prohibits WTO members from using, in 

quotes, ‘‘exchange action’’ to, in quotes, ‘‘frustrate the intent of the 

GATT, now WTO, provisions.’’

That hasn’t been used, in part, I think, because currency manipulation on a broad scale is relatively new compared to these other 

trade issues. It isn’t entirely new, because that’s what Japan was 

doing in the ’80s and into the ’90s. 

So what was the response? The response was to send Secretary 

Snow over to Japan and to China to jawbone. In Japan, as far as 

I can tell, the Secretary never raised the issue. And in China, as 

my friend Don has mentioned, it was raised. There was jawboning, 

but nothing else. 

And I just quickly want to remind everybody of what Japan is 

doing. The two systems differ a bit. One has a peg and the other 

uses other forms of manipulation. This was a story in the New 

York Times not so long ago. Japan is spending heavily to pursue 

a weak yen policy, and what they’re doing is spending billions of 

yen to buy many hundreds of millions of dollars to keep the dollar 

strong and the yen weak. 
32

So what do we do about it? Jawboning hasn’t worked with Japan. 

I understand the complexities. I don’t want to make this a simple 

issue. But complexity should not lead to complacency, to doing 

nothing. 

So some weeks ago, our office and I began to look at Section 301. 

Section 301, its utilization would be an effective prelude to possible 

action under Article 15, Paragraph 4. And here’s what an investigation would do if it were self-initiated by the Administration. 

It would provide an opportunity for a thorough examination of 

the issues, positions, and options. We would have, instead of a debate in a few newspapers, an open debate about what we do when 

currency manipulation or control is used to affect trade. Clearly, 

that is true in the case of Japan and China. 

Secondly, if the USTR self-initiated an investigation in a 301, it 

would demonstrate the Administration’s commitment to take this 

issue seriously. It would be a signal to other countries and a signal 

to American manufacturers and farmers and workers. There may 

be other solutions, but this self-initiation of 301 is there for USTR 

to utilize. 

And I simply want to close with this. I hope we’re beyond the 

issue of discussing trade basically in terms of protectionism versus 

free trade. When it comes to these issues whether it’s subsidies, 

subsidies are a phony trade issue. I mean, Cancun broke down in 

part because of the failure to look seriously at subsidies in Agriculture. 

Labor market conditions, we recognized with China that it was 

going to take time and we had to use other vehicles to raise these 

issues. But labor market issues are trade issues and currency, let 

no one scare off this Commission or anybody else from raising currency issues within a trade context. It’s one of the three or five or 

seven or four or six, whether you like odd or even numbers, vehicles that are used by countries to determine the terms of trade, and 

it is foolish for this country to be scared off looking at these issues 

because of false cries of protectionism. 

Many of us who are concerned about this have worked to expand 

trade, but under terms that are effective for the people of the 

United States of America, and that’s what this currency issue is all 

about. 

Thank you for having this hearing. I’m glad many of my colleagues have raised the flag. It should not simply be shot down because somebody cries a word. We need to look at it seriously. 

Thank you very much. 

[The statement follows:]

Prepared Statement of Sander (Sandy) M. Levin

A U.S. Congressman from the State of Michigan, and

Ranking Democrat, Ways and Means Trade Subcommittee 

The United States needs to both engage and pressure China. We must engage 

with China because the country is too important to ignore and we are better off if 

China is a part of the international system than if it is isolated. We must pressure 

China because our values demand that we help China to move in a positive direction and to prepare for a future based upon the rule of law, open markets, and respect for human rights. It continues to be vital that we carefully monitor and actively shape our relationship with China. 

During the PNTR debate, it was often necessary to remind people to look at China 

not only as a potential market, but also as a competitor. And China’s accession to 
33

the WTO helped address both of those facets of the relationship—China agreed to 

open its markets to U.S. goods and services and at the same time it agreed to be 

bound by a thorough set of rules establishing acceptable terms of competition with 

the rest of the world. 

I have taken an active interest in ensuring that China plays by the rules—that 

it complies with its WTO commitments and that U.S. manufacturers and producers 

have a fair shake in China. Over the past several months I have become increasingly concerned that China is not complying with its WTO commitments and is in 

fact trying to give itself an unfair advantage. 

WTO Commitments, Industrial Policy, Investment Policy 

A number of the concerns in our economic relationship with China relate to China’s industrial and investment policy. Yesterday I had a chance to speak on China’s 

WTO compliance at some length. I am attaching a copy of that testimony. To briefly 

summarize the points in these comments:

• China has used its quota administration and import licensing rules as ways of 

keeping out undesired imports. 

• China has continued to limit trading rights and distribution rights, effectively 

limiting trade in U.S. products throughout China. 

• China has used standards and other technical product regulations as a non-tariff barrier. 

• In the services sector, China has set up barriers to establishment and expansion 

to keep out U.S. service providers, such as unreasonably high capital requirements in the financial services industry, including in the auto financing sector. 

• China recently released a draft ‘‘Development Policy for Auto Industry’’ setting 

forth a proposed industrial policy that would use subsidies, product standards, 

technology transfer requirements, import barriers and other tools of state control to advantage domestic production of autos and auto parts.

China has moved toward compliance in some important respects, but in others, 

there is non-compliance and bending of the rules in support of what is essentially 

a mercantilist industrial policy to the detriment of U.S. workers, farmers, and businesses. It is necessary for America to adopt a more active approach. 

It is remarkable that in the face of China’s non-compliance, the Bush Administration has refused to use all of the tools that the U.S. bargained for. As part of the 

China PNTR deal, we included a special safeguard so that U.S. industries would not 

be injured by surges of imports from China. But, the Bush Administration has denied relief to two U.S. industries which the independent ITC found to be injured 

by Chinese imports. 

The China PNTR bill also called for a special annual review in the WTO of China’s commitments. The reason for this provision is that, unlike the normal WTO accession process, China was allowed to join before it had made the changes to its 

laws necessary to be in compliance with its WTO obligations. This fact, and the 

clear importance of China’s economy, required an intensive review of China’s WTO 

implementation. China has blocked effective use of this specially-negotiated review, 

refusing to provide written (and sometimes any) answers to questions or giving 

vague and evasive answers. The Bush Administration has essentially acted as if resigned to continuing uncooperativeness by China. The USTR has also failed to demonstrate any inclination to bring cases in the WTO against clear violations by 

China. 

Currency Manipulation 

This essentially passive approach has characterized the Administration’s handling 

of the currency issue. Currency manipulation has characterized our relationship 

with Japan for years. The U.S. Government never took any concrete action to address this problem. The failure to address this problem had and continues to have 

a negative impact on the United States, limiting access of U.S. goods to Japan. It 

also had and continues to have a negative impact on Japan. Japan has maintained 

a protected domestic market too long, and has used export-led growth as a substitute for necessary domestic reforms. 

China’s undervalued currency now also poses a major problem. The China and 

Japan situations are not identical—China maintains a peg, while Japan actively intervenes to manipulate the level of its currency. However, many economists agree 

that the outcome is the same—undervalued currencies hurt U.S. exports and advantage Chinese and Japanese imports. 

Just as we need to actively utilize all the tools available to engage and pressure 

China in other areas, we need to actively consider what action to take in response 
34

to China’s undervalued currency. And, we must act responsibly; this is an admittedly complicated issue. 

Article XV, paragraph 4 of the GATT—the original WTO agreement—prohibits 

WTO members from using ‘‘exchange action’’ to ‘‘frustrate the intent of the [GATT] 

provisions.’’ To my knowledge, Article XV has never been used. The obligation has 

been in trade rules since the inception of the multilateral system in 1947 in recognition of the importance that exchange rates have on trade. 

The Administration’s current approach of ‘‘jaw-boning’’ has demonstrably failed. 

Secretary Snow’s trip to China yielded only a re-statement of China’s policy that 

calls for an exchange rate determined by market forces as an ultimate goal without 

any timetable, and with an attitude by the Chinese government that makes it unclear when, if ever, this might occur. Worse, he did not even mention currency when 

he visited Japan. 

As a prelude to utilization of Article XV, paragraph 4, USTR has the power to 

self-initiate a ‘‘Section 301’’ investigation into the ‘‘exchange action’’ by China and 

Japan. A Section 301 investigation would provide an opportunity for a thorough examination of the issues, positions, and options. If the USTR self-initiated a Section 

301 investigation, it would demonstrate the Administration’s commitment to take 

this issue seriously—an issue so important to America’s manufacturers, farmers, 

and workers. 

If there are other reasonable approaches, they should also be considered. One way 

or another, we need to get serious and start taking concrete actions that yield results to address imbalances in our trade relationships. 

These problems in our trade relationship with China demonstrate vividly the importance of expanded trade and the importance of vigorous efforts by Congress and 

the Administration to shape the terms of expansion. Thank you.

Discussion, Questions and Answers 

Co-Chairman MULLOY. Congressman, could you both stay for just 

a couple of questions——

Congressman LEVIN. Sure. 

Co-Chairman MULLOY. —and then we will move on to the next 

panel. 

Congressman MANZULLO. That’s fine. 

Co-Chairman MULLOY. One, thank you very much, both of you, 

for your testimony. 

Congressman MANZULLO. Could I make a comment on——

Co-Chairman MULLOY. Yes. 

Congressman MANZULLO. —if I could, on the Section 421, on the 

surges. 

Co-Chairman MULLOY. Yes. 

Congressman MANZULLO. The problem that we have—I’ve got a 

manufacturer back home who makes brake rotors and drums. The 

ITC will not allow tracking of loss in product prior to the date of 

China coming into the WTO along with loss after that date. Are 

you with me on that? Even if it shows a tremendous drop going on, 

they say, well, no, no, no, under the law, we can only look at the 

loss that’s occurred since China came into the WTO and we’ve essentially had to ignore losses before that date. That is an erroneous 

interpretation, Sandy, because you drew that legislation. 

Congressman LEVIN. No, and now that you raise it, I will go back 

and look at the language, because the surge provision—there’s also 

a separate one on textiles, but the surge provision was one of the 

three major ingredients of the amendments. The second one was 

the annual review and the third was the creation of this Commission, of the Commission, the Congressional Executive Commission. 

So, Don, I’m glad you raised it. Let me go back. So far, the two 

cases that the ITC has handled, they’ve made clear their interpretation of that provision. We’ll look at it. 
35

Co-Chairman MULLOY. Commissioner Dreyer. 

Co-Chairman DREYER. Yes. First of all, I thank both of you. Representative Manzullo, in a town where bland complacency seems to 

be the order of the day no matter what’s happened, I congratulate 

you on the passion you bring to this. 

I would also suggest that it’s a bit worse than either of you have 

suggested in that, increasingly, Chinese are moving not only into 

jobs in high-tech sectors, but they’re taking positions in academia, 

including, by the way, in the service academies. So when you are 

getting economic analysis, you are getting it through a Chinese 

perspective. 

My question to you is, this challenge that’s been raised, that 

China is currently the engine of world economic growth, it is doing 

better economically than anywhere else, and if they are forced to 

float their currency, to reduce their subsidies, things both of you 

have mentioned, this engine will stall, and when this engine stalls, 

it’s going to create international financial instability with it and no 

one will win. How would you reply to that? 

Congressman MANZULLO. Well, the U.S. isn’t winning now. And 

we’re Americans. We have to look after ourselves. If the leader 

leads responsibly, then that means that that type of leadership will 

bring with it the correct answers. 

But I’m just tired of the American economists taking the side of 

the Chinese. 

Co-Chairman DREYER. And it’s going to happen more. 

Congressman MANZULLO. Rockford, Illinois is at 11.3 percent unemployment. It’s much bigger than that because the people give up. 

They go off the unemployment rolls. Look at it from the American 

perspective. How can you possibly lead if all you worry about is 

what the Chinese think. I know the Chinese Ambassador. I’m the 

Chairman of the American-Chinese Interparliamentary Exchange. 

I meet with him frequently. 

You know what you’ve got to do? You have to take a textbook out 

of Henry Ford. Pay your people enough to buy your own stuff and 

not depend upon the United States buying 40 percent of your exports to bail you out. I said, have you ever thought about that? 

Duh. Well, they don’t like that. You know why? Because they 

would be less competitive internationally. I care about what goes 

on in world trade, but I also care about the factories that are being 

shuttered and the people being unemployed, massive unemployment. How much more unemployment, Sandy, do we have to take 

in this country before people of both parties—this isn’t a Republican or Democrat issue—wake up to the fact that we’re losing on 

this thing? 

Co-Chairman MULLOY. I guess he asked you the question——

Congressman LEVIN. So I’ll respond. 

Co-Chairman MULLOY. Yes. 

Congressman LEVIN. There is clearly a major challenge to manufacturing in the United States, clearly. Now, we have to have an 

honest discussion about it because there are many in our midst, 

and they’re not only economists, who think that there’s a shifting 

going on from manufacturing to services and that is basically a 

very beneficial shift. We have to talk that through. 
36

As some on the panel and I and others have pointed out, manufacturing is the major user of high-tech in this country. So when 

you diminish manufacturing, it’s going to have an impact on hightech. 

We need to have a grand debate about the role of manufacturing. 

The auto industry, once again, has been the first engine pulling the 

United States out of a recession, and there are others, but they 

were the first. So there is a challenge, indeed, I think a crisis. 

I want to put this, if I might, in the perspective I see. When we 

consider China’s accession to the WTO, many of us said, look, it’s 

not only a market and a greater one later, but it is now and will 

increasingly become a competitor, and that is happening way beyond where they were just five years ago. They’re a competitor. 

So this isn’t a question of being pro- or anti-Chinese. It’s a matter of China being integrated into the world economic community 

on the basis of rules that everybody abides by, including them. And 

because they are so large, it is especially important that they play 

by the rules. It’s not quite as important if it’s an economy onetwentieth the size of the United States. China is now arguably, or 

soon will be, the third-largest economy in the world. It depends 

how you calculate. 

So now to your question about China and the engine of growth, 

and this is one of the arguments used by some, and it’s not only 

economists. If you—and I read it in the New York Times this morning, if you get after them in terms of manipulation of their currency or their pegging the currency, and the same is said as to 

Japan, you’re going to shut down economies that have been important to the world global—to the world economy. 

I think there are a couple of answers to this. Number one, I don’t 

think very many are suggesting a radical change tomorrow. We’re 

talking about China floating its currency and doing so with some 

definite date in mind. All they’re saying is some time in the future. 

And with Japan, also we need a policy, I think, that doesn’t change 

it radically tomorrow. Lord, we would have accepted gradual 

change in the ’80s in terms of their non-tariff barriers and their 

currency. But it’s been 20 years and we’re the same place as we 

were with Japan 20 years ago. 

The second point is, China is large, but compared to the United 

States and Europe, it remains not as large, and to argue that 

they’re playing by the rules in a responsible way would shut down 

the world economy, I think is a gross overstatement. 

Co-Chairman MULLOY. Commissioner Becker. 

Commissioner BECKER. Yes. Thank you, Mr. Chairman. I wanted 

to raise a couple of questions to Senator Schumer and Senator Dorgan. Of course, they’re gone now, but your testimony has all been 

sort of the same, particularly from you. 

Congressman MANZULLO. Yeah. We’re all losing jobs. 

Commissioner BECKER. Right. We’re all in this together. 

The first thing I wanted to mention was the reference to Cancun 

and the collapse. I think that was Senator Dorgan, or Stenholm, 

I’m not sure. 

Congressman LEVIN. Probably Charlie Stenholm. 

Congressman MANZULLO. Representative Stenholm. 
37

Commissioner BECKER. He had mentioned that. I don’t want to 

promote him here. I’ll leave that for his constituencies. And he 

talked about the incompetencies of those who negotiate our trade 

agreements and how lopsided they are. I wanted to mention one 

thing in regards to that. 

Congress has tried to give direction to USTR in a very strong 

way of how to deal with or how to handle attempts to weaken our 

trade laws, particularly the anti-dumping and the countervailing 

duties. But contrary to this, in Doha, the USTR put on the table 

as one of the modalities that was going to be worked out between 

then and Cancun just exactly those items, the anti-dumping and 

the countervailing duty. They would have been on the table at 

Cancun for negotiations had everything went much more smoothly, 

but that was not the case. I just wanted to mention that in spite 

of direction from Congress, they proceeded in an entirely different 

way. 

The other point I wanted to make, though, was to ask for comments on, and it sort of goes to what Commissioner Dreyer had 

pointed out, was some of the testimony that we’re going to hear 

this afternoon, I expect we will talk about the frailties of the economic system in China and that pursuing the change in the RMB 

could actually collapse the economic structure and perhaps even 

collapse the government. 

This is of great concern to multinationals who have invested a 

lot of money and efforts into China and to the financial institutions 

that are developing a strong foothold into China and I was just 

wondering if you had any comments on that and the feeling as to 

whether that would be as drastic a response. It’s sort of implied 

that, from what I’ve read, it’s sort of implied that we have a responsibility for the stability of the Chinese government and that we 

should be very careful of what we’re doing. 

Congressman LEVIN. Should I comment first on the trade laws? 

I didn’t agree with the trade promotion authority bill that passed. 

We had an alternative. But both of them were strong in terms of 

the trade laws. 

I think, as you know, at Doha, a step was taken by our Trade 

Rep that opened the door to renegotiation, and at Doha, I expressed the belief that was a mistake. I think it turned out that 

it was opening the door, because if Cancun had proceeded, everything was going to be on the table on our trade laws and that was 

what we should be avoiding. 

I was involved in the Uruguay Round and in the final negotiation 

of the anti-dumping and countervailing duty provisions. We negotiated hard. We reached an agreement, and that agreement should 

not be undone. 

I might say that I think that whatever was the motivation of the 

Administration in terms of steel, and there was, I think, too large 

a political motivation, I think you need to look at the policy of it, 

and I think in terms of policy, the action of the Administration was 

correct and it’s working out, as Mr. Becker knows better than anybody else here, I think, to have some reconstruction within the 

steel industry with everybody contributing, both management and 

labor, and I think we’ll end up with a steel industry, while if no 
38

action had been taken we would have ended up with a very tiny 

one, a diminishing one, in any event. 

When the people come before you and make the argument that 

you suggested, and it was discussed a bit earlier, I suggest that you 

challenge them and don’t let them paint the picture as if we’re saying to the Chinese, float your currency without any limitations tomorrow, or the same with Japan, don’t—just don’t buy any more 

dollars. No. The question is whether the currency state of affairs 

is satisfactory, and I think the answer to that is no. The answer 

to that is no. Japan cannot continue on its course without continuing to injure American industry, its business, and its workers. 

And just talk to business people and they will tell you that. 

And as to China, the same is true. If they continue to peg their 

currency and there is no change at all, it is going to have a considerable impact on U.S. industry and eventually on services. So don’t 

let them paint you as suggesting a radical position when there are 

alternatives between doing nothing and a total change overnight. 

And you challenge them. Don’t let them make you a radical, because when we propose answering these trade issues, there is always an understanding that there has to be—you have to tailor it 

to the specific situation. But they don’t even go to the sewing machine. They don’t tailor anything. They just throw up their hands 

and say, the best trade policy is hands off, even if the other guy 

is rigging the system. That’s what the basic issue is. 

Co-Chairman MULLOY. Congressman Manzullo. 

Congressman MANZULLO. I just want to say, with regard to hurting the multinationals, multinationals are in China for two reasons. One of the reasons is there’s a huge market over there for 

their product to the people living in China itself, and you can understand why. It just makes sense in most occasions to continue to 

manufacture there. 

But you can’t have it both ways. You can’t outsource from the 

United States, such as GM and Ford, to China and expect to have 

a guaranteed cheap source of labor by taking the position that having a fair system of currency exchange is somehow going to hurt 

the company. You can’t do that any more than you can put on a 

price freeze. 

I’m sure the unions in Detroit would not be agreeable to a price 

freeze on their labor. And essentially, this is what the multinationals have done. I’m not being critical, because these are our 

companies and they support a lot of our jobs here, too, but what 

the multinationals are saying is that they want a price freeze on 

Chinese labor, to be guaranteed a cheap supply of Chinese labor so 

they can do more and more outsourcing of parts coming into our 

automobiles, and I’ve got a Chrysler facility in my Congressional 

district—and you can’t do that. 

World trade does not depend upon a fixed guarantee system of 

labor being frozen. And when you convert it into those terms, then 

you can see how dramatically wrong it is to have a currency that 

does not float. 

The second thing is you need an incentive—to keep manufacturing in the U.S. Let me tout our bill. You know, the FSC/ETI bill, 

the WTO held that it violated the WTO, and essentially, that was 

a blessing in disguise. So there is a bill out there now, Crane, Ran-
39

gel, Manzullo, Levin, which says that, with regard to C corporations, to the extent that they manufacture in the United States, 

their income tax will be lowered by up to ten percent. 

So it answers the call, and there are a lot of companies that are 

multinationals that are on it. UTC is on it, the Boeing Corporation, 

and other big corporations. But their thinking is, if we do so much 

outsourcing around the world, who’s going to have a job left in the 

United States to buy the stuff we’re manufacturing overseas? Does 

anybody ever ask that question? And it has to be asked. 

So when we’ve been working very diligently on this bill—Sandy, 

I think we have 150 cosponsors in the House——

Congressman LEVIN. Yes. 

Congressman MANZULLO. The other side of the bill is Congressman Thomas, the Chairman of the Ways and Means Committee. 

He’s got a bill out there. Senator Grassley just introduced a bill 

that really adopts the concepts of ours, and that is American companies would be rewarded for keeping manufacturing in the United 

States by a decrease in the taxes that they pay. The bill that we’ve 

been working on, Sandy, very diligently, that has a lot of steam, 

but it’s up against the Chairman of the Ways and Means Committee. 

But what we see going on in this city is that all of a sudden, that 

more and more people are cognizant to the issue of manufacturing—Sandy, you would agree on that——

Congressman LEVIN. Very much so. 

Congressman MANZULLO. —because they see the bleeding. Now, 

we’re creatures of our Congressional districts, it’s obvious. We 

know what machine oil is. Chairman Thomas is a wonderful man, 

but he doesn’t have the industrial base that we do. He has pistachios and pecans and lettuce and the high-end ag and tech. He’s 

lost a lot of jobs. And we talked about garlic, both from my ethnic 

background and the fact that the Chinese are flooding the market 

with garlic and hurting many of his garlic growers. 

It’s been a very interesting discussion of public policy that’s been 

very open. There’s been no contention. We bring in the backgrounds of the Members of Congress with regard to these various 

bills, because as the Constitution envisions, we are creatures of our 

Congressional district and we represent our people. 

And then Bill Thomas just, what, about two or three weeks ago, 

Sandy, added that massive manufacturing component to his bill on 

replacing that. So in a sense, we’re encouraged that more and more 

people are waking up to the fact that we’re losing this manufacturing base. 

Co-Chairman MULLOY. Here’s what we’re going to do now. We’re 

going to have one more question from a Commissioner, then two 

Commissioners want to make a brief comment to both of you, and 

then we’re going to take a five-minute recess, and then we’re going 

to have our next panel, which are exchange rate experts who have 

all different views on this issue to talk with us for a couple hours. 

But Commissioner Bartholomew. 

Commissioner BARTHOLOMEW. Thank you very much, and thank 

you to our witnesses, both for coming today and being so generous 

with your time. I know how difficult that is, to fit in so much time, 

and also for your leadership on behalf of the American people. 
40

I, of course, had the good fortune of having worked for now 

Democratic Leader Nancy Pelosi for 15-and-a-half years and I 

know that she and a number of other people on both sides of the 

aisle started raising concerns about some of these trends in the 

U.S.-China relationship going back 13 years, concerns about the 

trade deficit, about manufacturing, about what was going to happen in the service sector and intellectual property rights, about 

tech transfer, in fact, all of these things that we’re now talking 

about. 

China’s accession to the WTO, the whole PNTR debate, of course, 

one of the major selling points on Capitol Hill was that it was 

going to be providing an effective mechanism to address some of 

these concerns. And, in fact, as you both have testified, things have 

really gotten worse. 

I was wondering if you just had thoughts on why those mechanisms haven’t worked. Is it flaws in the mechanism? Is it lack of 

political will? Is it something else? Why are we where we are? 

Congressman LEVIN. Quickly, the annual review can be very 

meaningful if everybody will work at it. The Chinese government 

position was they weren’t going to actively participate in terms of 

back and forth, in terms of written communications. I think if the 

WTO is serious about it that the Chinese in this second round 

more likely will cooperate more. 

It needs to be made clear. This wasn’t anti-China. Why an annual review? It’s because most countries come into the WTO already complying with WTO provisions. In the case of China, that 

wasn’t true. 

Secondly, China’s size. The annual review should be and can be 

meaningful. 

Thirdly, the surge provision is, as I said, the most tightly written 

surge provision ever placed in American law. We need much more 

vigorous use of it by the Administration. They ducked it the first 

two times, and they were small amounts of money, but the issue 

was a big one. The Commission that was created, the Executive 

Congressional Commission, along the lines of the Helsinki Commission, can become a very, and I think is becoming a more effective 

instrumentality. 

So I think there are vehicles there that can be used to make sure 

that China abides by its commitments, plays by the rules. We need 

to more actively work with the Europeans and with others as well 

as the Chinese. 

So in part, I think it’s been the failure of the Administration to 

be vigorous enough in the utilization of the provisions that were 

put into the law. 

Congressman MANZULLO. What we have here is a clash of two 

cultures. The Chinese have 6,000 years of history, 5,000 years of 

recorded history, and the Chinese think, not for their own generation, but for second and third generations down the line. 

We in America, the longest long-range planning most corporations have is three months. It’s true. It’s the next quarterly estimate of profit. And we don’t think long-range. 

There’s a book that’s been written by an author by the name of 

Alan Kennedy called The End of Shareholder Value. I don’t know 

if he’s a ‘‘D’’ or an ‘‘R.’’ I have no idea what his political philosophy 
41

is. But he talks about the changing nature and the pressure put 

on corporations in this country, raise the value of the stock so that 

the retirement portfolio of the retirees will be something they can 

live on. 

But on the other hand, raising the price of the stock isn’t all 

there is, and what we’ve seen in America, and how American companies differ from Chinese companies. In America at one time, you 

were profitable if your company made a reasonable profit and you 

took care of your employees because employees were always considered to be capital assets. Today, the definition of profits has 

changed. You have to be more profitable than your competitor, as 

if there’s only room in the economy for one person. 

That has squashed long-range planning. It’s made the inevitable 

estimates on the quarterly earnings to be paramount, and that’s 

why you’ve seen, I believe it was AT&T who said, we’re not going 

to do that any more. Warren Buffet at Coca-Cola said we’re not 

going to comment on those quarterly earnings. Pepsi-Cola said you 

can’t do that. 

We’re actually going to have a hearing on the changing nature 

of American corporations. And again, this is not fault. We’re talking about sociological changes and financial changes that have 

made American companies think differently in terms of the longrange investment and the impact that it has because they’re under 

so much pressure in order to bring these profits up. 

No one wants to talk about that. And again, this is not anti-capitalism. This isn’t corporation bashing. But it’s an opportunity for 

revisiting to see what are we doing wrong in our culture in the 

terms that we raise our companies. That’s quite an issue, but I 

think that stands at the root of it. 

We’ve got a vote coming up shortly on the continuing resolution. 

Go ahead. 

Co-Chairman MULLOY. Commissioner Reinsch, do you want to 

say one word, and then Dick, and then we’ll move out of here. 

Commissioner REINSCH. I just want to commend both of you for 

different reasons, if I may. 

Mr. Levin, picking up on something that Commissioner Bartholomew said, I really appreciate your very thoughtful and 

nuanced statement that makes one very important point that others have not made, which is that there are existing structures and 

laws both in WTO and in U.S. law that are designed to address 

these problems. I think you’re right, they haven’t been fully or 

properly implemented, and that’s something to work on. But I 

think it’s very important to note that the structures exist. Some 

people like you work very hard to put them in place and I think 

we ought to look to them before we go off and create new ones. 

Mr. Manzullo, I particularly want to commend you for a point 

you alluded to only in passing, and that is your work on the visa 

issue. I testified at your hearing. You are the only Chairman in the 

House or the Senate that has not been intimidated by the security 

people and has taken this issue on. 

Congressman MANZULLO. Well, we have no jurisdiction. That 

doesn’t mean anything to us. 

Commissioner REINSCH. Well, your work is very important. I 

mean, whether or not there’s an issue with the Chinese, we some-
42

times do shoot ourselves in the foot, and this is the classic case of 

having done that and it has prevented us from increasing our exports to China and other places, as you note. I wish you well on 

that and hope that your staff in the follow-on work that they’re 

doing with my other hat organization and others bears some fruit, 

because we’re not having a lot of luck with anybody else and I appreciate it. Thank you. 

Congressman MANZULLO. Bill, if I could follow up on that for just 

a second. We got involved in this when I found out that the Army 

had ordered 2.5 million black berets for their soldiers, and they 

were going to be made in South Africa, Romania, Sri Lanka, India, 

China, Canada, and then some in the United States. And you know 

what I had to do? I had to subpoena in—I’m not proud of this, but 

I had to do it—the Chief of Staff of the Army, a four-star general, 

General Shinseki, a marvelous man, and two generals from the 

DLA and say, what are you doing? Have you ever made the connection between the loss of manufacturing jobs in this country and the 

giving away of our procurement? 

Do you know what is going on now? DLA wants to order 30,000 

flight jackets with Pakistani goat leather because they don’t think 

there’s enough U.S. goat leather around. Representative Charlie 

Stenholm is the goat king—and in working with him, I’m going to 

become an expert in goats. But I have to when you’re around this 

place. 

But we go one by one by one, and it carries over into other areas 

of procurement. We have an investigation going on of the F–35. It’s 

important to bring it up. That’s 90 percent American money where 

we’re guaranteed to buy 3,000 of those plans. This is the joint 

strike force. The Brits put up about five percent of the money. 

They’re guaranteed to buy 400 of them. Five other nations get a 

huge amount of the manufacturing and they’re under no obligation 

to buy any of those aircraft. Now, you tell me that’s right? 

What has happened is that one of the subcontractors on the F–

35, instead of buying a high-quality, high-end drilling machine 

from Ingersoll Milling Machine in Rockford, Illinois, bought it from 

the Spaniards, who are not part of that seven-nation consortium, 

based upon best value. It’s cheaper to buy there because of the currency. 

U.S. taxpayers’ dollars for U.S. aircraft flown by men and women 

in U.S. uniforms, giving away the store in procurement. There’s 

balance somewhere. 

But that, again, it’s a whole new area of the loss of our manufacturing base. We are all over it, had to order a GAO study. We get 

statements that say it would cost millions of dollars to monitor 

where these parts are coming from, but they’re already bound by 

the Berry amendment and by the Buy American Act to follow those 

rules and they’re not following existing rules and it’s causing the 

loss of hundreds of thousands, if not millions, of manufacturing 

jobs in this country. That’s where we can start, is with our own 

government’s procurement policy. 

We do have to go vote now, Sandy. It went off. Thank you. 

Co-Chairman MULLOY. Thank you. 

Congressman LEVIN. Thank you very much. 
43

Co-Chairman MULLOY. We want to work with you and your 

staffs as we proceed on these issues. Thank you again, both of you. 

Congressman MANZULLO. Thanks again. 

Congressman LEVIN. Thank you so much. 

Co-Chairman MULLOY. We’re going to take a five-minute break 

and then we’ll have our next panel. 

[Off the record.]

PANEL I: EXCHANGE RATE ISSUES 

Chairman ROBINSON. Excuse me. Time is tight for some of our 

witnesses. If we could all take our chairs, that would be very helpful. Thank you. If we could all take our seats, please. 

Co-Chairman MULLOY. For this panel, I want to let our witnesses 

know how much we appreciate them taking time to be here, and 

also for the excellent testimony that has been submitted by the 

panelists. Mr. Roach, I found your testimony very interesting. A little different approach than we have been hearing so far. 

And here is the other thing. Each witness will speak for 7 minutes. Dr. Bergsten has to be out of here by noon today. This panel, 

we are going to run it right on into 1 o’clock. So if we could have 

Dr. Bergsten deliver his statement, take some questions, and then, 

Dr., if you could stay around and listen to the others, fine, but if 

you have to be out of here by noon, we want to have an exchange 

with you. Then we will go through each of the others. Sevenminute opening statement. 

The Commissioners, we are going to limit their question time to 

five minutes so that they can get in and out. When you are taking 

a question, if it is kind of wrapping up here, meaning their time 

is done, kind of finish up with your answer and do not extend it 

on. If we could do that, that would be enormously helpful. 

On this panel we have Dr. C. Fred Bergsten, the Director of the 

International Institute for Economics. We have Mr. Stephen Roach, 

who is the Chief Economist with Morgan Stanley. We have Mr. 

David Hale, who is a friend of the Commission, been here with us 

before. He is the Chief Economist and Founder of Hale Advisors. 

And Dr. Ernie Preeg, who is an adjunct fellow at the Hudson Institute, and I believe you served in the Reagan Administration in a 

policy-level position in that Administration. I know Dr. Bergsten 

also served in a high-level position, Assistant Secretary of the 

Treasury. 

So if we can start with you, Dr. Bergsten, and give your statement and then we will have a few questions to you.

STATEMENT OF C. FRED BERGSTEN, Ph.D.

DIRECTOR, INTERNATIONAL INSTITUTE FOR ECONOMICS 

Dr. BERGSTEN. Lots of topics have been raised this morning, but 

I take it our focus here is the exchange rate. I also take it that 

most people, not everyone, but most people agree that the renminbi 

is substantially undervalued and needs to be raised in terms of reducing China’s surpluses and helping the U.S. reduce its deficit. 

So I am going to address three issues: how much should the currency be changed? How should the mechanism of change be pursued? And why I believe it is in China’s interest to do it, as we are 

suggesting they should. 
44

First, how much? China has not been running a very large global 

surplus. A lot of people here focus on the bilateral surplus with the 

U.S. but that is wrong. We should focus on its global surplus, 

which normalized over the last few years, has been about 2 percent 

of its GDP. I believe we should seek a change in its exchange rate 

and other policies that would move it to a current account deficit 

of about 2 percent of its GDP. It can easily finance that from direct 

investment and other capital inflow. So the goal, I would submit, 

is a change in China’s trade position by about a minus 4 percent 

of its GDP. 

We have calculated, with trade elasticities and the like, how 

much that would take and our conclusion is that a revaluation of 

20 to 25 percent of the renminbi would do the job. That, incidentally, should permit other Asian currencies, including Japan, Taiwan, Korea, to go up at least partway, maybe 10 percent or so, because with the renminbi appreciating, they would be willing to appreciate against the dollar since it would actually create a depreciation of their own currencies against the Chinese currency, their 

main competitor. 

If you put all those currency changes together the result would be a reduction of about $50 billion in the U.S. current account deficit, which in turn translates to something like 500,000 high-paying 

jobs, mainly in manufacturing in this country. 

I am not going to spend time talking about our overall deficit. It is getting close to $600 billion a year. We have to import $4 billion 

of foreign capital a day to finance it, plus our own capital outflows. 

It was exactly right, as Senator Schumer and Congressman Manzullo both said, that the situation is unsustainable—in terms of 

both our domestic politics—and in terms of the capital markets and 

the risk of a dollar crash at a later point. We have a huge interest 

in changing the situation, and a 20 to 25 percent appreciation of 

the renminbi with follow-up changes by the other Asian currencies 

would be an essential part of that correction. 

Point two, how to get it? This is a critical point because I believe 

Secretary Snow, the G–7 and all of the Congressmen who spoke 

this morning have it wrong. They are proposing that China float 

the renminbi, and that is a worthy long-term goal. We all believe 

in floating rates, markets and all that, but if we put our effort in 

that direction it will not happen for 5 years or more. 

The Chinese are correct not to float their currency because to do 

so in a meaningful way they would have to eliminate their capital 

controls, and Secretary Snow was consistent in asking them to 

eliminate their capital controls as they go to a floating rate. The 

problem of course is that China has a bankrupt banking system, 

that the vagaries of international capital flows are such that no 

country wants to expose itself to those uncertainties when its internal financial system is not sound, and that it will take a long time 

to occur. To put it pragmatically, if China actually floated the currency and freed up its capital controls, the renminbi would probably go down in value, not up. The reason is because there is a 

huge amount of wealth in China, invested in China, which through 

the natural process of portfolio diversification would in the first few 

years, after freeing the capital account and floating exchange rate, 

go out. The rate would go down, their competitive position would 
45

improve. The situation would get worse. So on both conceptual and 

pragmatic grounds, our government, and the Members of Congress 

who spoke today and the G–7 over the weekend in Dubai were asking for the wrong thing. 

What they should be asking for, and what I believe is eminently 

doable, is for the Chinese to keep their fixed exchange rate system 

but to change the price: revalue the currency, as I said, by 20 to 

25 percent on a one-shot basis. Tell the Chinese we respect their 

desire to maintain a fixed exchange rate and maintain some restrictions on the capital account as long as they have a bankrupt 

banking system, et al. Yes, move toward correction and reform of 

that over the long run. But, in the short run to deal with the problem we are all talking about here today, we want a one-shot revaluation of a substantial amount, as I have calculated, which would 

give a substantial improvement to our international position, convert them into a sustainable position, and I believe significantly 

dampen, though not of course eliminate, all the kinds of pressures 

we have talked about today. 

Point three. I believe it is very much in China’s interest to do 

this for half a dozen reasons. First, they are now experiencing huge 

inflows of speculative capital, which believe the renminbi is going 

to go up. That is further ballooning the Chinese money supply, 

adding to financial instability in the country. Indeed, the Central 

Bank has begun to raise reserve requirements to deal with an incipient bubble. The only way to choke off the capital inflow is a 

substantial revaluation of the currency to end the incentive for 

speculative capital flight in an inward direction. 

Moreover, note that the worst thing to do would be to widen the 

band and permit the rate to go up by only 2 or 3 percent. That 

would say to the speculators, ah, they are going to move the exchange rate. We know 2 or 3 percent will not do it. We are going 

to pile in. It would intensify the speculative pressure. So widening 

the band, like asking them to float all of a sudden, are both nonremedies or worse. I come back to a one shot revaluation. 

The Chinese will thus do it, one, because it will help dampen internal speculation, inflationary pressures and ballooning of the 

money supply, which worsen the situation of their already unstable 

financial system. Two: a higher currency, and therefore a shift of 

their external position from surplus to deficit, will stop the build 

up of reserves, which is a huge misallocation of Chinese resources. 

China is a country with a GDP of a trillion dollars, and $350 billion 

of foreign exchange reserves is 35 percent of the GDP. If we did 

that, we would have foreign exchange reserves of $31⁄2 trillion as 

compared to the $160 billion that we have. In other words, this is 

a massive misallocation of China’s own resources, putting money in 

T-bills earning 2 percent when their own economy is growing at 7–

8 percent a year and they could have a return of 10–20 percent on 

their internal investment. 

There is a big debate on that in China. The government is under 

much criticism internally for such resource misallocation. A change 

in their exchange rate and external position would help enormously. 

Third. The pressures that you are hearing in this discussion this 

morning. Call it protectionism, call it defending our industrial base, 
46

call it what you want, the current situation is unsustainable. There 

will be very strong reaction, not only in U.S. incidentally but in 

other countries around the world, to a continued rapid build up of 

Chinese reserves, trade surpluses and the like. The Chinese have 

made a huge commitment to joining the WTO, joining the world 

system, and using trade liberalization—yes, I said trade liberalization in China, which is very profound—to promote their internal 

domestic reforms. If they wind up with a bunch of trade actions 

against then, their leadership will have massive egg on its face and 

be in very bad shape. For that reason too, they will want to avoid 

it. 

Finally, China places a lot of importance on its role in East Asia 

and its role in the world. They got justified praise for not letting 

their currency depreciate and not devaluing in the Asian crisis and 

making it worse. Now they need to make an equally positive contribution to the world economy, global stability and avoidance of 

trade backsliding, by raising the value of their currency. It would 

be the best thing they could do for their neighbors, much better 

than the China-ASEAN free trade agreement that they are discussing in response to the concerns of their neighbors about their 

competitiveness. It would provide a major step in global leadership 

terms for the Chinese, which is also very important to them. 

In short, we can see how much change is needed: 20–25 percent. 

There is a clear path to get it: a one-shot revaluation, not some chimera of floating half a decade from now. The Chinese themselves 

have a major interest in doing it. 

I would be happy to answer any questions if there is time to do 

that. 

Discussion, Questions and Answers 

Co-Chairman MULLOY. Are there any questions? Commissioner 

D’Amato. 

Vice Chairman D’AMATO. Thank you very much for your very interesting comment, Mr. Bergsten. Do you think that there is a center of gravity in the Chinese economic elite that essentially not 

only understands but makes the same argument that you do and 

reaches the same conclusion? Is there authoritative evidence do you 

think in writing or at least in commentary that would lead us to 

think that they agree with your analysis? 

Dr. BERGSTEN. I can personally testify that they agree with a lot 

of it. On my last trip I had dinner with the Minister of Finance, 

a long meeting with the Governor of the People’s Bank of China, 

and they said explicitly: ‘‘We know that the currency is undervalued. We are not even sure it is a good thing that it is undervalued. We have a game plan to correct that situation. We have uncertainty about how much, how to do it, and the timing.’’ In fact, 

when I asked about the timing, the answer I got was, ‘‘Well, maybe 

sometime around the Olympics’’ but of course they mean their 

Olympics, the Beijing Olympics in 2008. I suggested that was a bit 

too leisurely and one ought to think about doing it more quickly. 

But again, to the extent we ask them to float and free the capital 

account, we are postponing likely action rather than promoting 

early response to the kind of problems that we are discussing here 

today. 
47

Vice Chairman D’AMATO. I do think that the comments that Congressman Levin made indicates that he is more in agreement with 

you than you think. I mean in saying floating, he did not mean releasing it all together. He did say staging it. I think it is not that 

big a step from staging it to what you are saying. 

I have a second question, and that is on your commentary on Tbills and the size of their buying on that account. Is it your understanding or your impression that they have reached a conclusion 

that they have done too much of that and they need to start curtailing it radically? And what would the impact be if they did start 

curtailing their purchase of T-bills radically? Or would they be willing to start selling off some of their stock? A lot of people are worried about this. 

Dr. BERGSTEN. I think Chinese reserves are excessive. There is 

no rational basis for having $350 billion of reserves in China so 

they should sell some off. But that is not going to kill our T-bill 

market. Someone will buy the T-bills. The price may change to 

some extent but, if we are talking about getting our trade deficit 

down, and realizing that we have to bring the exchange rate of the 

dollar down as the only mechanism to bring our trade deficit down, 

the prices are going to change. But it is fascinating how over the 

last 18 months the dollar has come down 40 percent against the 

Euro, down by a trade-related average of 10 percent, and U.S. interest rates have been at their lowest levels in 40 years. In short, 

it is not axiomatic that a decline of the dollar will push up interest 

rates. 

If our economy goes to full employment, if we overheat, and if 

our friends in these buildings push the budget deficit not only to 

$500 billion but keep going up of course interest rates are going to 

go up, but that is not the fault of the Chinese. 

I agree with Chairman Manzullo that we should not be hostage 

to the decisions of other countries in operating our financial markets. But gentlemen and ladies, we are not. The Chinese did not 

create our trade deficit. We create our trade deficit. It is up to us 

to take action to correct our trade deficit. Part of that will be a 

lower exchange rate for the dollar. That is not good for our welfare 

but it will reduce the instabilities and unsustainabilities that I 

have talked about. 

Co-Chairman MULLOY. If I could do this, if any of the other witnesses, even though you have not yet delivered your full statement, 

if you have comments on anything that Dr. Bergsten says in response to questions that he is taking now, feel free to do that. 

Commissioner Wessel, and then Commissioner Ellsworth. 

Commissioner WESSEL. Thank you. It is good to see you again, 

and I appreciate your coming before this panel. 

Some weeks ago a number of articles appeared that the Chinese 

in fact might respond to this problem by freeing up the ability of 

Chinese interests to invest in the U.S. market, going through 

bonds, equities, in fact, to companies themselves. We saw just a 

couple of weeks ago, Magnequench, a defense concern in Indiana 

was purchased by the Chinese and moved all their production 

equipment to China. Are we possibly going to see a replay of the 

1980s vis-a`-vis Japan, where Japan with Rockefeller Center, with 

the investments they made here, decided to deal with some of their 
48

trade problems by shifting production patterns, buying our equities, and in fact, I would argue in some ways neutering our political system at times by creating an investment network here in the 

country that limited our responses to some of our trade problems? 

Dr. BERGSTEN. It is not only a replication of Japan in the 1980s 

but a replication of Germany in the 1960s, and indeed every surplus country who winds up with an undervalued currency and tries 

to carry out every kind of gyration possible to resist revaluation of 

its currency. There will be efforts to manipulate export tax rebates, 

for example. The Chinese are talking about that. There will be 

moves on both capital inflows and capital outflows, all in an effort 

to fend off the evil day when they have to revalue the exchange 

rate. I have suggested it is actually in their interest to do so, and 

they should not view it as an evil day, but certain forces within the 

country certainly will, as in all other countries facing that situation. 

The problem again is that the markets know that those are not 

effective substitutes and will not sustain a new equilibrium of a 

lasting nature and so those steps tend—as I mentioned with widening the currency band—to promote more speculative inflow and 

worsen the existing problem and indeed push it toward eventual 

resolution. As in the case of Japan you mentioned, remember the 

yen exchange rate eventually kept going up and up and it finally 

got to 80 yen to the dollar in 1995. I will also take the occasion 

to say that China today is not Japan in the 1980s. 

Dr. ROACH. Can I just echo that? I think there is one huge misconception here, that China should be treated on a par with every 

other trading partner that the United States has, whether it is 

Germany or Japan. To Fred’s point, there is one critical difference 

here. China is a poor country. At today’s levels, Japan’s per capita 

income is 40 times that of China. China is committed to the most 

extraordinary political and economic transformation that we will 

ever see in our lifetime. There is absolutely no credit being given 

to what China is attempting to do in order to transition its economy through tough reforms and to take the risk to join our rulesbased system so then it can be subjected to accountability in hearings like this. 

China does have huge issues that it is dealing with internally in 

managing its transition, none of which have been discussed here 

today. So far, this discussion makes it sound like China is the 

world’s most powerful nation, bringing America to its knees, and 

I would say that you have got that one dead wrong. 

Co-Chairman MULLOY. Let me just speak to that. 

Dr. BERGSTEN. Could I say, Mr. Chairman, I had a different 

point in mind but it goes in the same direction. Steve’s right about 

China of course being a relatively poor country. The point I was 

getting to is that China, for all the trade problems that were mentioned before, and correctly so, is an incredibly open economy. The 

share of imports in the Chinese economy is 21⁄2 times what it is in 

Japan or in ours. The share of foreign investment contributing to 

value added is 25 times what it is in Japan, and China’s exports, 

yes, are rising 30, 40 percent a year but note that its imports are 

rising 40 to 50 percent a year. Its imports are rising faster than 

its exports are rising. It is a very open economy, amazingly so for 
49

a continental landmass like us at an early stage of development. 

It is a very different model than Japan. 

One other key point. We have all noted how China pegged to the 

dollar in 1994. If they were trying to pursue a policy of competitive 

undervaluation, they were incredibly stupid because the dollar hit 

its all-time record low in 1995 and, as we know because that is the 

chief reason for our trade deficit, the dollar rose from 1995 until 

early 2002 by 40 percent, and the Chinese pegged to the dollar and 

rode the dollar up, not down, by 40 percent over a 61⁄2 year period. 

It has ridden the dollar back down over the last 18 months. As I 

said, I believe it is undervalued and needs to be revalued. But the 

Chinese currency, vis-a`-vis the rest of the world, is substantially 

stronger today than it was in 1994 when they pegged to the dollar 

because they rode us up. So again, being fair, balanced to the Chinese and others on this—and I am at the front of the queue of the 

hawks saying they should revalue the exchange rate, you know my 

bonas fides on that—they rode the dollar up a lot longer and a lot 

further than they have ridden it down. 

Co-Chairman MULLOY. Let me say this, and then we will turn to 

Commissioner Ellsworth. We have a panel this afternoon, Dr. 

Roach, of Mr. Nolan, who is an expert on the Chinese society and 

economy coming in from Cambridge England. We have another 

Professor Steinfeld from MIT, who lay out some of the issues I 

think that you are concerned that we may get a misimpression of 

the total Chinese society and economy, and we have structured this 

hearing to guard against that effort. 

Now, when you have a panel of people here, elected representatives of our people, you get a sense of the anguish going on in our 

heartland about some of the things that are going on. And that is 

what this hearing is about, what is happening here and what 

should we be thinking about and how to rectify it. 

Dr. ROACH. Can I just comment on one thing about the anguish 

in the heartland? 

Co-Chairman MULLOY. Sure. 

Dr. ROACH. Fred alluded to this, and what I heard today sitting 

at this table, as well as from some of you, with all due respect, was 

that the economists do not get it. This is not about economists 

versus politicians, but just think for a second, please, about one 

simple macroeconomic accounting identity. America has no savings. 

Our national savings rate, if you add it up for businesses, consumers and the government sector, adjust it for depreciation, is 

now down to zero. The biggest swing factor in that has been the 

dramatic shift in our government sector savings position from surplus to deficit. 

When we are saving short, we have to import surplus savings 

from abroad to grow our economy, and to get that capital we have 

to run current account and trade deficits. Is that China’s fault? If 

we were not trading with China, close down everything with China, 

as Chuck Schumer wants to do, we would have to run trade deficits 

with somebody else. Those deficits would be with higher cost producers, and that would then represent a tax on the American consumer. 

The anguish of the American people should be directed at the 

people in these halls that have given us these massive budget defi-
50

cits that have squandered our domestic savings. The job issue is directly tied to that, not to what China is doing to America. That is 

a huge disconnect between what I have heard here today and what 

I believe in my heart is a very important fact. 

Commissioner WESSEL. If I could just reclaim the time that I lost 

earlier, we certainly understand that, Mr. Roach, that this is a jigsaw puzzle with a lot of pieces. Our job, our charge from Congress 

is to comment on the U.S.-China situation. Some of us served on 

the U.S. Federal Trade Deficit Review Commission some years ago 

and understand clearly the enormity of the problem. I could argue 

to you that if we were to repeal the Bush tax cuts, we would be 

taking a significant step towards resolving some of our problems. 

That is not the issue before us today, so understand that as we 

look at this, we are simply addressing the U.S.-China bilateral relationship, understanding the enormity of the problem. 

Dr. BERGSTEN. Could I make one analytical point on that because 

it is really critical for you all. I am sure you have heard it but I 

want to make sure. The U.S. bilateral trade deficit with China is 

huge. At my Institute for International Economics we have analyzed it in depth and our conclusion is that 70 or 80 percent of all 

the imports that we now bring in from China were previously 

brought in from other countries or would be brought in from other 

countries if somehow China disappeared from the face of the earth. 

They would not be substituted for by U.S. production. That is a 

critical analytical point to understand and really goes exactly, I 

think, Mike, to what you were saying, because it means the China 

dimension does have to be seen in that broader global context. But 

I just wanted to put it on the record. 

Commissioner WESSEL. The Mexicans have made it very clear to 

us that NAFTA, they do not believe, is the problem any more, that 

the problem is China, and they are seeing jobs flowing to China as 

well, so clearly we have heard and we understand much of that. 

Co-Chairman MULLOY. Let me turn to Commissioner Ellsworth. 

Dr. Preeg, did you have a comment? 

Dr. PREEG. Very briefly, I just wanted to say that even if I 

agreed with all of the wide-ranging comments and differing views, 

I still do not believe that justifies the fact that China has been in 

clear violation of its IMF Article IV commitments, which is a part 

of the issue and a part of the problem, and which I will try to explain later when my turn comes. 

Co-Chairman MULLOY. Thank you. 

Commissioner Ellsworth. 

Commissioner ELLSWORTH. From reading the papers and from 

listening to the testimony this morning, I have gotten the impression, right or wrong, that our approach to China has been to say 

to them we have got a lot of pain and we are morally superior, and 

therefore, change your exchange rate. 

Now, you took a different approach. You said it is in their interest to change their exchange rate, and you explained very clearly 

what it would do for China. My question to you—and I know you 

have had a lot of experience in this field in a practical way—if we 

were to go to China, clearly and unambiguously and say, ‘‘This is 

in your interest and here is why,’’ what do you think the chances 
51

are of the Chinese understanding that and responding accordingly, 

just your gut feeling? 

Dr. BERGSTEN. I hope that our representatives and negotiators 

are putting it in those terms since that is the most likely to achieve 

success. The Chinese are very smart people and they understand 

their interests. As I said, I have personally discussed it with them 

and found great understanding and some sympathy for moving in 

the direction we are talking about. There is always a delicate diplomatic question of course, do you help get what you want by bringing some pressure to bear or do you lead to push-back that undermines your own case? 

I think, for all the reasons we are talking about today, it is totally legitimate for the U.S. to put this issue frontally on the table. 

Ernie Preeg is right that the Chinese have not lived up to their 

IMF obligations but the IMF has never asked them to do so. And 

the United States, as the chief shareholder of the IMF, has never 

asked them to do so. And the G–7, which is supposed to more or 

less steer the world economy, has not until this weekend in Dubai 

begun to do so. 

So I have same forgiveness for the Chinese that I have had for 

other countries in the past when nobody called it to their attention 

what they were supposed to do. Nobody, in short, was minding the 

store at the center of the system as they were supposed to do. 

So it is a blend of all these things. There are international obligations, both trade and financial. There is the role the U.S. inevitably has to play as the steward of the system. I think we are right 

to raise this. Indeed, without it, you probably would not get action. 

But I think if diplomacy can be done properly, there is a good 

chance that China and other countries in Asia will see it in their 

interest to move in the right direction. 

Commissioner ELLSWORTH. Thank you. 

Co-Chairman MULLOY. Commissioner Becker, did you have a 

question? 

Commissioner BECKER. Yes, just very quickly. 

I really appreciate your comments, and it is very well laid out. 

But in the end, in spite of the pleadings and in spite of the arguments, if we are unable to get the Chinese to voluntarily change 

a relationship between the RMB and the U.S. dollar, you yourself 

have said this is unsustainable. I have heard that word for the last 

5, 7 years on deficits. What do you see as a result if we are unable 

to change that? What do you see as a result of the effect on our 

economy here in the United States? 

Dr. BERGSTEN. I think two things inevitably occur, and that is 

why I say unsustainable in two senses: a domestic political sense 

and a financial market sense. 

The domestic political sense is what we are talking about here 

today. I believe that if the U.S. current account deficit keeps rising 

and the dollars remains overpriced by 25, 30 percent in world markets, therefore undermining the competitiveness of American industry by those amounts, that we will get a sharp reversal of U.S. 

trade policy. Call it protection, call it defending the industrial base, 

call it what you wish, I think it will happen. 

In 1985, when Reaganomics and high interest rates at the time 

pushed the U.S. for the first time into a huge trade deficit and be-
52

coming a debtor country and all that, my friends on the Ways and 

Means Committee said the Smoot–Hawley tariff itself would have 

passed if it had come to the floor at that time. Mike was there and 

tried to deal with it in a responsible way. But that was the pressure. 

So trade policy will go up in smoke. That would be hugely costly 

to us and it could tear down the world economy. 

The second thing that will happen is that, if we do not get a 

gradual orderly balanced correction of this exchange rate misalignment, which is, make no mistake, at the heart of the problem, at 

some point the dollar will crash. We have seen three sharp dollar 

crashes in the post-war period and they are very unpleasant. They 

lead to sharp increases in interest rates. They lead to significant 

inflationary pressures. They can be extremely disruptive of world 

capital markets. 

So there is an international financial dimension which can hit us 

very hard. There is a domestic political dimension which will hit 

us I think even earlier, and I think those are the results, unless 

a constructive response is found to the problem. That is why I believe the gradual orderly decline of the dollar over the last 18 

months was a hugely positive thing. But it only went about a third 

of the way necessary and, to get it the rest of the way, we cannot 

just keep depreciating the dollar against the Euro. It has got to 

bring in the Asian currencies with the big surpluses and the big 

reserve buildups. China is the key because its currency peg to the 

dollar means that the Koreans, the Taiwanese, even the Japanese, 

while they might grudgingly accept a rise in their currency against 

the dollar, hate the thought of a rise in their currency against the 

renminbi because China is their big competitor. 

And that is why China is central to the global systemic correction 

of this whole set of problems centered on the U.S. deficit but radiating out to, and with profound effects on, the economies of Europe 

as well as the Asians themselves, and indeed the entire world. 

Co-Chairman MULLOY. Ernie, Dr. Preeg. 

Dr. PREEG. Trying to respond to the question briefly but a little 

more directly, if, as I understand the question, we finally after all 

these years, as Fred said, we start doing something saying, ‘‘You 

are in violation of your commitments, you need to move,’’ and they 

don’t, well, quite frankly, with violation of IMF and closely-linked 

WTO commitments under Article 15, as was raised earlier by Senator Schumer, we would have a case. And if they won’t do it, we 

can take it to the WTO dispute settlement procedure, and we 

would almost certainly win. Then they would either have to change 

or we would have the right to retaliate. 

I would hope and assume it would never get that far, but that 

would be a straightforward course of action if they just continue to 

turn us down. 

Dr. BERGSTEN. Could I give you an even more straightforward 

course of action? Ernie’s right, but those things will take two years 

or more to play through. There is a much more direct reaction: we 

buy renminbi. People say, ‘‘Oh, this would be really dirty play.’’ I 

have proposed this in the case of Japan. Japan, in my view, is even 

more incorrigible on the exchange rate because the market has 
53

been pushing the yen up for the last two years. Japan has intervened now, and built its reserves to $550 billion. 

I have said to Secretary Snow personally, but I have also testified publicly, that every time Japan buys a dollar (or sells a yen 

to buy a dollar) to keep the dollar excessively strong, we should sell 

a dollar. In fact, we should just tell them that every time they buy 

a dollar we are going to sell a dollar and I am confident they would 

quit and the yen would find its market rate. 

Now, interestingly, over the weekend at Dubai, the G–7 reached 

an agreement and the yen has gone up 5 percent. I don’t know 

whether anybody said that to them, I don’t know what leverage 

was used, but somehow Japan stopped defending the yen at 117:1 

and now it is at 111:1. Good progress. I congratulate Secretary 

Snow. I congratulate the G–7. They have made good progress on 

the yen. Fine. Let’s do something like that on the renminbi. All we 

have to say is, ‘‘Fellows, we have got a lot of dollars. We can buy 

renminbi as fast as you can sell renminbi.’’ And if you want to find 

a way to encourage market forces to push the currency up, that is 

the way to do it. 

This would smack of John Connelly ‘‘treading on the manicured 

playing fields of international finance,’’ but it would be a lot more 

effective than 301’s and Article 15’s and Article IV’s of the IMF, 

which take a very, very long time to do. 

Co-Chairman MULLOY. How much longer can you be with us? 

Dr. BERGSTEN. I have to go. 

Co-Chairman MULLOY. Okay. I do not want to keep you past 

time because it was agreed that you would need to get you out of 

here by noon. Dr. Bergsten, thank you very much. 

I am sorry that we had to go out of order on that for you other 

panelists, because you have very, very good statements. Why don’t 

we turn to those now, and Dr. Roach, you can lead off. 

Thank you again, Dr. Bergsten. 

Dr. BERGSTEN. I apologize to my colleagues on the panel. They 

are all good friends and I appreciate your tolerance.

STATEMENT OF STEPHEN S. ROACH, Ph.D.

CHIEF ECONOMIST, MORGAN STANLEY 

Dr. ROACH. Fred, I learned to be tolerant of you over the years. 

It is never easy though. 

Thank you. I have 7 minutes? 

Co-Chairman MULLOY. Seven minutes, doctor. 

Dr. ROACH. I would like to submit my complete testimony for the 

record and summarize my key conclusions at this point. I do believe, as I have stated just a few minutes ago, that there are some 

serious and worrisome misunderstandings about the role of China 

in the global economy that are being conveyed at this hearing 

today. I have to say, I have participated in hearings in Washington 

for 20 years. This is honestly, up until this point in time—and 

maybe it will be different this afternoon—the most one-sided hearing that I have ever heard. 

What I would like to do is just highlight what I think are three 

key flaws in the current thinking about the so-called China threat, 

and then just give you some thoughts on what I think needs to be 

done to address this problem. 
54

Number one, I would like to give some numbers that put an 

order of magnitude around the so-called power of the Chinese export machine. On the surface it looks like China’s exports are rising at rates to threaten all of us in ways that we could never, ever 

contemplate. In the last decade China’s exports have gone from 

$120 billion to $365 billion over a decade. If you take the numbers 

apart, however, 65 percent of that growth over the 10-year period 

is traceable to Chinese subsidiaries of multinational corporations 

and joint venture partners who have consciously set up operations 

in China through record inflows of foreign direct investment. 

Last year China was the largest recipient of foreign direct investment of any nation in the world. Were multinationals forced to do 

that? I would argue today that what is going on here is simply the 

globalization of supply chains in country after country around the 

world who cannot compete on a high-cost basis in an increasingly 

open global economy. As painful as it is, that is the way the world 

works. Is this China’s problem or is this our problem? Who is the 

competitive threat? Is it them or is it us? That is misconception 

number one. 

Secondly—and Fred alluded to this and I would just like to underscore this emphatically—China’s role in the world trade system 

is far more that of an assembler of product produced elsewhere 

than it is of a pure producer of Chinese-made product. Economic 

research has shown this for a number of years. A colleague of mine, 

Professor Lawrence Lau at Stanford University, has done some outstanding econometric work in analyzing the value-added content of 

Chinese exports. And his work and that of his associates demonstrates very clearly that for every dollar of Chinese exports that 

is shipped out, only 30 cents of it represents domestic-value added 

by domestic producers. In fact, for the exports going to America 

that number drops to 20 cents. That means the great Chinese export machine, whether it is outsourcing or pure exports, benefits its 

trading partners more than it does the domestic Chinese economy. 

The third misconception is the one I already alluded to, and that 

is where do these trade deficits come from? To me, they are inexorably linked, as I stated earlier, to America’s lack of national savings. Savings must always equal investment. It is not a theory. It 

is just an accounting identity. So when we do not have any domestic savings, we have to import surplus savings from abroad. To do 

that we have to run current account and trade deficits. I put it to 

you again, as I said earlier, if you close China down, we would still 

have a trade deficit because we do not have any savings. The alternative is just to slow our growth rate down. And if you think we 

have a job problem now, contemplate the consequences of what 

that would mean. We are blaming China for our own inability to 

run an effective fiscal policy in the United States. 

I ask you, should China be blamed for Washington’s fiscal irresponsibility? 

What needs to be done here? I give you three recommendations: 

I totally disagree with Fred that you can arbitrarily determine 

what the appropriate value of the renminbi is. I have charts in my 

formal testimony that show a trade-weighted value of the renminbi 

right now. It is no different than it was, on average, since 1998. 

In fact, as Fred said, China is running a very small overall trade 
55

surplus suggesting its currency is not undervalued in any way 

whatsoever. 

I would further put to you that if you start moving around the 

currency, that would destabilize the global supply chain that our 

cost inefficient companies are so desperately trying to establish in 

order to make themselves competitive in the global economy. 

Secondly, I think if you want to get the fix on the U.S.-Chinese 

trade deficit problems, fix our budget deficit. 

Thirdly, I think you have to recognize that what you have heard 

here this morning, from Congressman after Congressman, Senator 

after Senator, is nothing other than bald-face protectionism. It 

smacks to me of some of the most dangerous rhetoric I have heard 

in the U.S. Congress in my career. I agree with Commissioner 

Wessel that this is right out of the script of the Smoot–Hawley type 

sentiment that existed in 1930 after a speculative bubble popped 

in the U.S. stock market. I think it is appropriate to go on record 

calling protectionists a very serious threat to the U.S. and the global economy. 

Thank you. 

[The statement follows:]

Prepared Statement of Stephen S. Roach, Ph.D.

Chief Economist, Morgan Stanley 

Getting China Right

A persistently weak global economy is now moving into a very dangerous place—

the slippery slope of trade frictions and protectionism. As political cycles now enter 

the macro equation, the blame game has begun. Such sentiment is nearly unanimous in singling out a new scapegoat—a rapidly growing Chinese economy. World 

opinion has become increasingly united in putting pressure on China to revalue its 

currency. In my view, that would be a serious mistake for China, the United States, 

and global economy at large. I think the world has got the China story dead wrong. 

The blaming of China goes something like this: With real GDP growth in the industrial world holding on a subpar path for a third year in a row, the ongoing vigor 

of the Chinese economy obviously sticks out. Industrial output was up an astonishing 17% year-over-year in August, and exports surged by 27%, clear signs that 

China is capturing market share in an otherwise sluggish world. China’s currency 

peg is widely believed to be compounding the problem. Many believe the renminbi 

is undervalued to begin with. Moreover, tied to a now-depreciating U.S. dollar, the 

RMB appears to have been given a competitive boost against non-dollar currencies. 

Assuming the dollar has a good deal further to go on the downside—perhaps as 

much as another 20% over the next couple of years—most fear that China’s competitive advantage will become all the more pronounced. Suddenly, China’s image has 

been transformed from the land of opportunity into a serious threat to the United 

States and the broader global economy. 

Bad Economics 

If the world economy were thriving, China’s rapid growth would be welcome. Unfortunately, that’s not the case. In a still-sluggish global economy, market share is 

a very precious commodity. Any threats to competitive positions, compounded by 

hiring shortfalls, can trigger hostile responses. These pressures are very much in 

evidence today. China’s huge and growing bilateral trade surplus with the United 

States is widely seen as a mounting source of tension. The culprit, goes the argument, is China’s currency peg. A revaluation of the RMB is now thought to be a 

necessary antidote. I believe that would be a serious mistake for three major reasons:

First and foremost, there is enormous confusion over the character of the so-called 

Chinese export threat. In my opinion, the world has formed an erroneous impression 

that newly emerging Chinese companies are capturing global market share with 

reckless abandon. In fact, nothing could be further from the truth. For more than 

a decade, the real export dynamic in China has come far more from the deliberate 

outsourcing strategies of multinational corporations headquartered in the developed 
56

world than from the rapid growth of indigenous Chinese companies. Over the 1994 

to mid-2003 interval, China’s exports essentially tripled from US$121.0 billion to 

$365.4 billion. It turns out that ‘‘foreign-invested enterprises’’—Chinese subsidiaries 

of global multinationals and joint ventures with industrial-world partners—have accounted for fully 65% of the total increase in Chinese exports over that period. In 

other words, China’s increasingly powerful export machine has America, Europe, 

and Japan stamped all over it. 

This is hardly an example of China grabbing market share from the rest of the 

world. Instead, it is more a by-product of the struggle for competitive survival by 

high-cost producers from the industrial world. Last year, a record US$52.7 billion 

of foreign direct investment flowed into China, making the country the largest recipient of FDI in the world. This inflow did not occur under coercion—it was entirely 

voluntary. A high-cost industrial world has made a conscious decision that it needs 

a Chinese-based outsourcing platform to increase productive efficiencies. Dismantling the RMB peg would destabilize the very supply chain that has become so integral to new globalized production models. Ironically, it would be a serious negative 

for those same economies—Japan, the U.S., and Europe—that have led the rush to 

Chinese outsourcing. By putting pressure on China to change its currency regime, 

the industrial world runs the risk of squandering the fruits of its own efforts. Fear 

of the so-called China export threat completely misses this critical point. The power 

of the Chinese export machine is more traceable to ‘‘us’’ than it is to ‘‘them.’’

A second argument in support of a stable Chinese currency hinges on the nation’s 

competitive prowess. Contrary to widespread perception, China does not compete on 

the basis of an undervalued currency. It competes mainly in terms of labor costs, 

technology, quality control, infrastructure, and an unwavering commitment to reform. My guess is if China were to revalue the RMB upward by 10% or even 20%—

a change I do not expect nor advise—its exports would suffer minimal loss of market 

share. A key reason for this is that China’s export prowess is mainly in the role 

of an assembler—its exports have a high content of materials and products made 

elsewhere. By contrast, only a small portion of its exports are actually made in 

China. Stanford Professor Lawrence J. Lau and his colleagues have estimated that 

for every dollar of Chinese exports, only 30 cents reflects value-added by domestic 

Chinese production (see C. Xikang, L. Cheng, K.C. Fung, and L.J. Lau, ‘‘The Estimation of GDP and Employment Induced by Exports: An Application to Chinese Exports to the United States,’’ Revised December 2001). For Chinese exports going to 

the United States, the domestic-value added share is even lower—only 20 cents on 

the dollar. That means even a substantial revaluation of the RMB would not make 

much of a difference to the price competitiveness of Chinese exports. If, for example, 

the RMB peg to the dollar were adjusted upward by 20%, this research suggests 

the price of Chinese exports to the U.S. would go up by only 4%—hardly enough 

to trigger a major demand shift back into American-made products. 

There’s even a more basic element to this argument insofar as the U.S. is concerned: China’s currency is pegged to the dollar—an arrangement that hasn’t 

changed one iota since 1994. That means there have been no currency-induced shifts 

in relative prices that can explain the deterioration of the U.S.-China trade deficit 

from $30 billion in 1994 to $103 billion in 2002. Furthermore, no nation’s competitive threat to the broader world economy should be judged on the basis of bilateral 

trade imbalances. It’s the overall trade position that matters. In the first eight 

months of this year, China’s trade surplus amounted to just US$8.9 billion, less 

than half the pace of a year ago. Consistent with this condition of near balance, our 

estimates suggest that the trade-weighted value of the RMB is basically in line with 

average levels prevailing since 1998. It’s hard to conclude on the basis of these 

trends that the Chinese currency represents a serious competitive threat to the 

broader global economy. 

Third, dismantling the peg could destabilize world financial markets. It is important to stress that there is little doubt over the endgame. China has consistently 

reiterated its long-term commitment to opening its capital account and eventually 

making its currency fully convertible. At the same time, China knows full well that 

a good deal of heavy lifting on the reform front has to occur before these objectives 

can be accomplished. That’s true of both capital-market reforms and the need to 

clean up its banking problems. China has taken great strides on these fronts, but 

a lot more needs to be done. Until there is more progress on financial reforms, I 

believe it would be entirely premature and very risky for China to float its currency 

and open its capital account. Such ill-timed actions could lead to heightened instability in Chinese, Asian, and world financial markets that could seriously jeopardize 

the global economy. This is a critical lesson of the Asian financial crisis of 1997–

98 that an impatient and politically charged world should not lose sight of when 

putting pressure on China. Nor should we forget the key role China played in tem-
57

pering that crisis when it resisted the temptation to follow other Asian nations 

down the road of devaluation. 

Several other considerations argue against an RMB revaluation: an intensification 

of imported deflationary pressures on a Chinese economy that is only now climbing 

out of deflation; the possible emergence of bubbles in other Chinese asset markets, 

especially property; and a signal to market speculators that the RMB would now 

be ‘‘in play.’’ Moreover, there is one of history’s most salient lessons to remember: 

Poor countries like China will never close the development gap with rich countries 

if they are repeatedly forced to revalue their currencies. Finally, some observers believe that an open capital account actually would allow Chinese investors the opportunity to diversify their currency holdings into dollar-denominated assets—triggering an asset allocation shift that could backfire and result in a weaker RMB. 

The Political Agenda

I fear there’s a deeper meaning to the pressures now being put on China: Unwilling to accept responsibility for their own economic shortcomings, the wealthy nations of the industrial world are making China a scapegoat for their weak recoveries. That’s especially true of the United States, still mired in a jobless recovery 

fully 22 months after the last recession hit bottom in November 2001. Frustrated 

over persistent job losses, America’s politicians have become convinced that China 

is the culprit. And so Washington is now taking dead aim at the ‘‘China problem.’’ 

Legislation recently has been introduced in the U.S. Senate that threatens to impose 27.5% across-the-board tariffs on Chinese exports into the U.S. if the RMB peg 

is not abandoned (S. 1586). Two of the sponsors of this bill—Senators Schumer and 

Graham—have presented their views to you this morning. I am strongly opposed to 

this action, as well as to comparable measures recently introduced in the U.S. 

House of Representatives (H.R. 3058). I believe these proposals pose grave risks to 

the U.S. and world economy. 

At present, I would judge the odds of such legislation being enacted as no higher 

than one in five. Yet those odds will undoubtedly rise as the U.S. political cycle 

heats up—especially if America remains stuck in a jobless recovery. Perceptions of 

job and income security have long been the defining issue in U.S. Presidential campaigns. It’s hard to believe that it will be any different this time around, especially 

since America’s current hiring shortfall—some 4.2 million jobs and counting, by my 

reckoning—is the worst in modern, post-World War II experience. Significantly, this 

Congressional assault on China is bipartisan. That underscores the breadth of support for actions proposed against China, an especially worrisome sign of more protectionist initiatives to come. For that reason, alone, it is hard to dismiss the real 

significance of recent anti-China measures introduced in the U.S. Congress. They 

are shots across the bow of America’s commitment to globalization. 

It is ironic that by pointing the finger at China, the U.S. Congress is avoiding 

its fair share of responsibility for America’s conundrum. The U.S. has an extremely 

serious saving problem—a net national saving rate that fell to a record low of 0.7% 

of GDP in the first half of 2003. In recent years, the biggest swing factor behind 

this plunge in national saving has been the extraordinary deterioration in the fiscal 

position of government units—at the Federal, State, and local levels. The combined 

government-sector saving rate has swung from a surplus of about 3% of GNP in 

2000 to a deficit of nearly 4% in mid-2003. Moreover, courtesy of Washington’s latest bout of fiscal profligacy, the government shortfall is set to widen by another 1 

to 1.5 percentage points over the next 12 months. Unless there is a spontaneous and 

lasting revival in private-sector saving—highly unlikely, in my view—national saving can only fall further. Hooked on spending, America has no choice other than to 

import surplus saving from abroad in order to finance economic growth. And the 

only way to get that capital is for the U.S. to run massive current-account and trade 

deficits. 

That’s where China enters the equation. Yes, America’s largest trade deficit is 

now with China—a $103 billion shortfall in 2002 and on track to exceed that 

amount in 2003. But keep in mind, a severe domestic saving shortage means the 

U.S. has to run trade deficits with someone—unless, of course, it is prepared to curtail sharply domestic consumption. If America weren’t trading with China, those 

deficits would have to occur with other nations—Canada, Mexico, other Latin economies, Japan, elsewhere in Asia, or possibly even Europe. That poses perhaps the 

most introspective question of all: Should China be blamed for Washington’s reckless fiscal adventures? 

It is dangerous and wrong for the U.S. to point the finger at China as a major 

cause of its massive and still-widening trade deficit. If the United States wants to 

reduce its trade gap, it must come to grips with more fundamental problems of its 

own, namely the rapidly vanishing national saving rate. Until it does so, U.S. trade 
58

deficits are likely to be the rule, not the exception, and the low-cost, high-quality 

option of Chinese trade is in America’s best interest. In fact, this is exactly the way 

the theory of comparative advantage—one of the mainstays of economics—is supposed to work. By importing from China, American consumers are getting a break 

in purchasing power. Shifting our trade deficits elsewhere—precisely what would 

have to occur for a saving-short U.S. economy—would only erode that windfall of 

purchasing power. Tariffs on China would, in fact, raise the cost of doing business 

for many American companies. For example, Wal-Mart, America’s largest company 

in terms of revenues, reportedly sources some $15 billion of product in China. Under 

S. 1586, Wal-Mart would be hit with the functional equivalent of a $4 billion tax 

hike. American shareholders and consumers would only suffer as a result. 

China helps the U.S. economy in other ways. In particular, it plays a very important role in financing America’s current-account deficit. China’s net purchases of 

long-term U.S. securities hit $60 billion in 2002 and are running well in excess of 

that pace so far in 2003. With the bulk of that demand concentrated in Treasuries, 

there can be no mistaking the role that China has played in holding down U.S. interest rates and thereby supporting America’s economic recovery. If the RMB were 

adjusted upward, Chinese accumulation of currency reserves would slow and its demand for dollar-denominated assets could easily slacken as a result. That, in turn, 

could lead to a backup in long-term U.S. interest rates that could jeopardize a key 

source of support for America’s economic recovery. 

Don’t Ignore Japan

I am also concerned about the China bashing that has been going on in Japan 

for well over a year. Senior Japanese officials have blamed China for exporting deflation and for the ‘‘hollowing out’’ of the Japanese labor market. Nothing could be 

further from the truth. Low-cost, high-quality Chinese imports provide a windfall 

to the purchasing power of beleaguered Japanese consumers—precisely the same 

type of benefits that Japan’s export machine provided the world in the 1970s and 

1980s. If you want an example of an undervalued currency, study the path of the 

yen during Japan’s economic renaissance; it averaged close to ¥300 versus the dollar 

in the 1970s and about ¥220 in the 1980s—dramatically cheaper than its current 

reading in the ¥110 to ¥115 range. It strikes me as hypocritical for Japan to criticize 

China for emulating a strategy that was central to its own development model. Putting pressure on China to revalue its currency is a poor excuse for Japan’s own inability or unwillingness to reform. 

Moreover, as I travel through the newly industrialized ‘‘special economic incentive 

zones’’ in China, I am repeatedly struck by the widespread presence of Chinese subsidiaries of Japan’s most successful companies. In fact, I am hard-pressed to identify 

any major Japanese producer that does not have a significant presence in China. 

Corporate Japan is not being forced to shift its production to China. This is the rational response of uncompetitive, high-cost Japanese producers attempting to maintain market share in an increasingly open global economy. 

Over the years, I have learned the most about Asia when I hop directly between 

Beijing and Tokyo—an opportunity recently experienced by U.S. Treasury Secretary 

John Snow. I can only hope that Secretary Snow has been able to appreciate the 

extraordinary contrasts between these two economies. A post-bubble Japanese economy has been in a period of relative stagnation for nearly a dozen years—with real 

GDP growth averaging only 1.1% from 1992 to 2002; over the same period, China’s 

real GDP growth has averaged about 10%. Yet as the second largest economy in the 

world, Japan’s per capita national income was still some 40 times that of China at 

market exchange rates in 2001 (or 6.5 times that of China on a purchasing power 

parity basis). Notwithstanding this dramatic disparity in living standards, there can 

be no mistaking the shift in the pendulum of economic power in Asia. China remains unflinching in terms of its commitment to reform and structural change. By 

contrast, Japan has taken the concept of inertia to a new level. It would be tragic 

if the political cycle came down hardest on the economy that is playing the greatest 

role in reshaping the world. Yet that’s precisely the risk as the politics of 

globalization now come into play. 

While China is being charged with maintaining an artificially depressed currency, 

Japan has long written the book on currency intervention and manipulation. Indeed, 

in order to prevent a market-induced strengthening of the yen, Japanese authorities 

have spent well in excess of a record US$80 billion on official currency intervention 

so far this year. To the extent the U.S. and the rest of the international community 

condones such massive intervention, the incentive for Japanese reforms may well 

be diminished. Unlike China, where there is a steadfast commitment to reforms, in 

Japan there is a very explicit trade-off between reforms and foreign exchange rates. 

I remember full well the sheer sense of panic that gripped Japan Inc. in the spring 
59

of 1995 when the yen/dollar cross rate hit ¥80. The Japanese recognized at the time 

that radical reforms were the only way to cope with a super-strong currency and 

were getting ready to implement such measures. But in the end, the world flinched 

and allowed the yen to depreciate by some 45% versus the dollar over the next three 

years or so. And Japan never really lifted a finger on reform. 

That’s a lesson that should not be lost on U.S. politicians and authorities elsewhere around the world as they overlook Japan’s transgressions and focus on China. 

Japan’s line of reasoning is that its economy is too weak to tolerate a stronger currency. But to the extent that currency manipulation forestalls long-overdue progress 

on the Japanese reform front, then there is good reason to question the wisdom of 

such tactics. Countries that manage foreign exchange rates in order to suit their 

own purposes are explicitly bringing others into the equation. From the standpoint 

of the U.S., that means the Japanese authorities are, in effect, short-circuiting a depreciation of the dollar that would otherwise be the inevitable by-product of a classic 

current-account adjustment. From the standpoint of Europe, Japanese currency manipulation could well force a disproportionate share of the dollar adjustment onto 

the euro. 

Fortunately, there is reason to believe that the world may now be coming to its 

senses on bringing Japan into the global rebalancing equation. At the recently concluded G–7 meetings in Dubai, the call for greater flexibility in exchange rates was 

an unmistakable signal to Japan that the world was losing patience with massive 

currency intervention by a major developed nation. A firmer economy has given Japanese authorities some leeway to back away from this effort, at least for the time 

being. As a result, the yen has now strengthened through the ¥115 threshold versus 

the dollar, and the burden of America’s current-account adjustment now stands a 

greater chance of being spread more evenly throughout the global economy. This is 

good news for global rebalancing—provided, of course, Japan stays the course and 

refrains from returning quickly to its long standing practices of currency intervention. But what applies to Japan—the world’s second-largest economy—does not 

apply to China, still a very poor country. As I have stressed above, China’s transition to a flexible currency regime must occur on terms that are conducive to its own 

stability, in economic as well as in financial terms. Japan is rich enough to welcome 

the verdict of market-clearing exchange rates. China is not—at least, not yet. 

Something Must Give

There are times when economic weakness and politics make for strange bedfellows. This appears to be one of those times. The political season is starting to 

heat up in the United States, and all eyes are on the stresses and strains of America’s jobless recovery. This puts the politics of globalization in an entirely different 

context. Reflecting the often intense interplay between the political and economic cycles, China has now become the tension point du jour in the geopolitical debate. 

In tough economic times, politicians always need a scapegoat. That’s what this 

wave of China bashing is really all about. It has little to do with economics and everything to do with the blame game. Yet this politically-inspired foray is symptomatic of a much deeper macro problem that now confronts an unbalanced world. 

The world’s sole growth engine—the U.S.—is encumbered with the largest current 

account deficit in modern history. This reflects not only the inherent pitfalls of a 

saving-short U.S. economy but also the utter lack of autonomous domestic demand 

growth elsewhere in the world. As America pulls the world economy along for the 

ride, it goes deeper and deeper into the quagmire of trade deficits, budget gaps, saving shortfalls, and excess debt accumulation. This is hardly a sustainable outcome 

for the U.S. or for the rest of the world. It speaks of a worrisome and dangerous 

build-up of tensions in the global economy. 

Like steam in a teapot, ultimately these pressures need to be vented. As I see 

it, the possible remedies range broadly between two extremes—the economics of a 

U.S. current-account adjustment and the politics of trade frictions and protectionism. The recent shift in G–7 currency policy is an encouraging sign of an economic resolution to the world’s imbalances. Yet the interplay between America’s jobless recovery and Presidential election cycle could well shift the odds from the economic to the political remedy. Right now the odds of a politically driven solution are 

low. But the risk is that they will rise. 

Unfortunately, the saber-rattling over China in the U.S. and Japan is not an isolated example of mounting trade frictions elsewhere in the world. Two other recent 

examples come to mind that paint a picture of a world veering all too close to protectionism. First is the recent breakdown of talks at the WTO ministerial meetings in 

Cancun. Tensions between rich and poor countries came out in the open on such 

long-standing issues as agricultural subsidies, investment and competition rules, 

and financial market transparency. The failure of this meeting of the World Trade 
60

Organization is reminiscent of the fiasco in Seattle in 1999 and raises serious questions about the successful completion of the Doha Round of trade liberalization slated for 2004. 

Second, European leaders have joined the fray, aiming to protect their long-sluggish economy. Their fear is that the euro may bear a disproportionate share of the 

burden of further dollar depreciation. Such concerns are at the root of charges recently leveled at Asian countries whose currency pegs are perceived to insulate 

them from adjustments in the dollar. This sentiment, which came to a head at a 

recent gathering of European finance ministers in Stresa, Italy, appears to have 

spilled over into a more formal protest at the recently-concluded G–7 meetings in 

Dubai.In 1930, Senator Reed Smoot and Representative Willis C. Hawley sponsored 

legislation that significantly raised the level of U.S. tariffs. Courtesy of a recently 

burst equity bubble, the U.S. economy was in recession and a Republican administration favored the protectionist remedy to provide relief for American workers. 

President Herbert Hoover signed the Smoot-Hawley Tariff Act into law in June 

1930. Global trade retaliation quickly followed, as did a downward spiral in world 

trade. Many believe that such frictions ultimately set the stage for the Great Depression that followed. These lessons should not be ignored in today’s post-bubble 

era. No one, including myself, thinks such an outcome is likely today. Yet that’s a 

risk that can no longer be taken lightly as politics now comes face to face with the 

dark side of globalization. 

I strongly believe that China is the world’s greatest development story of the 21st 

century. Its emergence will benefit not only the 20% of the world that lives in its 

most populous nation but also the 80% of us who do not. But China’s road to prosperity is not without pitfalls and risks. Nor can economic stability be taken for 

granted in the far richer developed world. Yet in the end, we must all learn to live 

with the stresses and strains of globalization. Turning inward is not an option for 

the U.S. Our commitment to globalization should be unwavering in bad times as 

well as good. Unfortunately, the combination of a politically charged atmosphere 

and a tough economic climate often creates scapegoats. China is today’s scapegoat. 

It’s high time to put an end to this dangerous blame game.
61

Getting China Right

China remains the fastest-growing economy in the world.

Source: Morgan Stanley Research

While China is still a small economy, its growth is having a major impact on the 

rest of the world.

Source: IMF, World Trade Organization, Morgan Stanley Research
62

China’s industrial growth dynamic is heavily influenced by outsourcing.

Source: IMF, Morgan Stanley Research

East Asian economies have played a key role in funding America’s gaping currentaccount deficit.

Source: CEIC, Morgan Stanley Research
63

China is now closing in on Japan as a source of foreign demand for dollar-denominated assets.

Source: CEIC, Morgan Stanley Research

While China’s currency has depreciated slightly in recent months, it can hardly be 

called undervalued.

Source: DataStream, Morgan Stanley Research
64

Co-Chairman MULLOY. Well, we know where you stand, Dr. 

Roach. 

Mr. Hale.

STATEMENT OF DAVID HALE

CHIEF ECONOMIST AND FOUNDER, HALE ADVISORS, LLC 

Mr. HALE. Well, thank you very much for the opportunity to 

speak to this Commission. I think you face unique challenges because really the debate today is not just about China’s currency, 

it’s about the much larger question of how the world is going to 

cope with the reemergence of China as a great economic power. 

On the eve of the British Industrial Revolution 230 years ago, 

China accounted for almost a third of world output. After 20 years 

of communism, it accounted for only 2 percent of world output. And 

now, with the very high rate of economic growth coming from market-oriented economic policies and very far-reaching reforms, China 

will at some point in the next 20 years once again represent 10 percent of world output. So we have to make a lot of adjustments to 

this very profound and very far-reaching change in China’s status 

in the global economy and global geopolitics. 

Now, the currency question has come into focus recently because 

China has been experiencing a great export boom. Year-on-year 

growth rates for exports are almost 33 percent. China’s share of 

world exports will be this year almost 6 percent, compared to only 

3 percent five years ago. In the case of the United States, China 

has now emerged this year as our second largest trading partner. 

In the first half of this year, it displaced Mexico. China’s share of 

our imports now is 11.4 percent, Mexico’s falling to 11.2. And I can 

tell you that in the case of Mexico, the government there and the 

corporate community is deeply concerned that Mexico, not the 

United States, could lose tens of thousands of jobs to competition 

with China. 

Now, as a consequence of this export boom and this growing 

share of world trade, there’s growing pressure everywhere for 

China to revalue its currency, not just here in Washington but demands have been made by the governments of Japan, Korea, and 

other Asian countries are sympathetic because the East Asian 

countries perceive that over the last ten years they’ve lost market 

share to China in terms of both trade and also attracting FDI. 

And, indeed, if you look at the share of U.S. imports from other 

Asian countries, it has over the last seven or eight years fallen 

across the board. Indeed, the total Asian share has fallen from 40 

percent to 35 percent because of these countries not being as competitive as they would have been 10 or 15 years ago. 

China’s resisting this pressure to revalue for a variety of reasons. 

I think we should spend a couple of minutes examining them because they’re very critical in formulating our own policy response. 

First, during the great Asian financial crisis five years ago, 

China maintained a stable exchange rate at a time when other 

countries were devaluing by 30, 40, 50 percent. I was in Beijing in 

January of 1998 for conversations with Premier Li Lanqing about 

this policy, and he was then in the midst of discussions about what 

they should do, and they decided to remain pegged to the dollar. 

Where they had been for several years at 8.3, he went to the Davos 
65

World Economic Forum, ten days later made a speech to announce 

this policy, and the following day there was a huge rally across 

Asia in the stock markets, 14 percent in Hong Kong alone because 

of relief that China would not promote further financial contagion 

by devaluing. 

I think it’s important we recognize the financial statesmanship 

of China five and six years ago during this period of extreme crisis 

in the Asian region. 

Secondly, while China’s having an export boom, it’s also having 

a great import boom. A few months ago, import growth was 40 percent year-on-year. And as a result, it’s quite possible that China’s 

trade surplus will simply vanish without having a currency revaluation. The fact is WTO entry is opening China to an unprecedented 

wave of foreign competition and foreign imports. And because of 

this $500 billion of FDI in China, many foreign firms—American, 

Japanese, British, German—now have distribution systems in 

China, something they never got in Japan in the whole of the modern period because, after World War II, Japan effectively banned 

foreign direct investment, didn’t allow it, to protect domestic companies. Because China is so open, this import penetration will go 

much, much further. 

Thirdly, China’s confronting a major crisis in its domestic financial system. The stock of nonperforming loans in its banks is 30 or 

40 percent, a number of $300 or $400 billion. They have over the 

last three years begun to address this by restructuring $100 billion 

of bank loans, but the fact is they have a long ways to go. 

Because of this banking crisis, the S&P credit rating agency 

warned two weeks ago that if China were to float its currency or 

have a big revaluation, they would lower the country’s credit rating 

because they perceive a currency revaluation would be destabilizing to both the Chinese corporate sector and to the banking 

system and might even promote speculative capital flight. 

Fourthly, as I just mentioned, China’s had an extraordinary FDI 

boom. As Steve Roach just explained, the reason for this export 

growth is foreign companies, not just Chinese companies. Fifty-five 

percent of China’s exports come from foreign companies compared 

to 41 percent seven or eight years ago, and this share is still increasing. Again, I want to stress the contrast with Japan and Korea. 

On the eve of the great Asian financial crisis five years ago, 

Japan had only $17 billion of FDI, Korea had $12 billion, because 

both countries did not want foreign competition. China has opened 

the door to an unprecedented level of foreign investment. 

What this also means, by the way, is if we do get a 25-percent 

currency revaluation, it’s not clear what it will mean for China’s 

export prices. True, weak, unprofitable Chinese companies will be 

forced to raise their prices, but many multinational companies will 

probably engage in transfer pricing and not raise the price of the 

goods they export. They will simply absorb it in their global profit 

margins. This is a very, very different model than we confront in 

the past with Japan, Korea, and other Asian countries. 

Finally, China has a major problem with unemployment. We’re 

concerned about job losses here. So are they. In the last five years, 

they have lost 50 million jobs in the state-owned companies. They 

have got 150 million peasants who want to move to the cities from 
66

the countryside. They’ve got a huge human population they’ve got 

to reemploy in the private sector over the next five or ten years. 

And, needless to say, export growth is one way to do that. 

As a consequence of these five factors, I think China will be in 

the short term very reluctant to revalue. But as Fred indicated, 

there is a great debate going on. A year ago, Premier Zhu Rongji 

made a speech to a group of 50 Hong Kong businessmen, promising 

within six months they’d go to a wider currency target band, not 

30 or 40 percent but 5 or 10 percent. They didn’t do it because they 

were at that time entering a political transition to new party leaders, a new President, and it was very, very difficult to make big 

policy changes in the midst of a political transition. But the fact 

he made this speech tells you this issue has been in play for some 

time. 

The major reason for China to revalue is very simple. First, this 

huge growth in foreign exchange reserves is now producing potentially inflationary levels of monetary growth. Money growth is now 

running at 20 percent compared to 12 percent 12 and 18 months 

ago. This is leading to real estate inflation. In contrast to Japan 

15 years ago, it hasn’t yet led to a stock market inflation because 

Chinese investors, like American investors, lost a lot of money two 

years ago in the stock market, so they’re still very risk averse. But 

there’s no doubt this money growth does create the risk of more inflation. So there’s an incentive for China at some point to change 

policy to control its money growth, but they’ll move, I think, very, 

very slowly. 

I think what we have to do basically is keep focusing on market 

opening to ensure that China complies with the new trade rules, 

to give access to imports as well as to FDI, to encourage over time 

more exchange rate flexibility, but not demand it immediately. 

And, finally, just to finish up here, we have to recognize that 

what we’re demanding could also have consequences for our own financial markets. There is today a new phenomenon in the world 

not well recognized in Washington. The basic underpinning of this 

Administration—foreign policy, economic policy—is a new geofinancial balance of power in the world, represented by the fact 

that the countries of East Asia collectively account for 70 percent 

of the world’s foreign exchange reserves compared to 30 percent ten 

years ago. And they’ve been rolling over these reserves almost universally into American dollar financial assets. This is what’s been 

funding in the last 18 months the American budget deficit, the 

American current account deficit. China alone has bought $100 billion of U.S. Government securities in the last 15 months. Japan 

has done $150 billion. Other Asian countries, $40 or $50 billion 

more. 

If we lost access to these savings, to these capital flows because 

of a change in currency policy, it would lead to higher American 

bond yields, higher American mortgage rates, a weaker housing 

market, and slower growth of domestic consumption. That would 

help to reduce the trade deficit, but it would also depress the 

growth rate of the American economy. So we should recognize that 

we also have potential vulnerabilities to any major changes in the 

exchange rate policies of China and other East Asian countries. 

[The statement follows:]
67

Prepared Statement of David Hale

Chief Economist and Founder, Hale Advisors, LLC 

Should China Revalue Her Currency?

There is little doubt that China’s exchange rate policy has emerged as a major 

global topic. During recent months, the governments of Japan, Korea, and the U.S. 

have called upon China to revalue the country’s currency. Many Americans blame 

China for the fact that manufacturing employment has been declining for a year 

after the economy bottomed. China is perceived as a threat because it has been enjoying export growth of 35% during recent months. As a result of booming foreign 

direct investment and the return of flight capital, China also has foreign exchange 

reserves of $355 billion or the second highest in the world after Japan. 

China has been resisting pressure for exchange rate appreciation for a variety of 

reasons. 

First, China maintained currency stability during the east Asian financial crisis 

of 1997–1998. China kept her exchange rate firm in order to lessen the risk of greater financial contagion in the region. Her policy was an act of financial statesmanship which she believes weakens the case for exchange rate appreciation today. Secondly, China has recently joined the WTO and slashed import barriers. Her import 

growth is now booming at a 40% annual rate and her trade surplus is likely to fall 

sharply this year despite robust exports. Thirdly, China is deeply concerned about 

rising unemployment because of layoffs at state-owned companies. These firms have 

shed over 50 million jobs during recent years. As exports are now 28% of GDP, 

China regards the foreign trade sector as a growth locomotive for containing unemployment. Finally, China’s financial system is highly fragile. The big four stateowned banks have $300–400 billion of non-performing loans (30–40% of the total) 

and also must prepare for greater foreign competition because of the WTO rules. 

China fears that currency volatility could bankrupt more state-owned companies 

and undermine confidence in the country’s financial stability at a time when the 

WTO rules will be exposing the troubled state-owned banks to foreign competition. 

The decision by China to maintain a stable currency during the Asian financial 

crisis caused her real exchange rate to appreciate but it did not greatly damage her 

competitive position because of rapid productivity growth. As a result, China is now 

emerging as an important workshop in the global supply chain between Asia and 

the world. China is increasingly playing the role of an assembly shop for components produced by other Asian countries. Pan Asian exports to China rose from 

$72.1 billion in 1995 to $160.6 billion in 2002. The imports for domestic consumption grew from $42.2 billion to $78.7 billion while imports for reprocessing grew 

from $29.8 billion to $81.9 billion. Imports for reprocessing now account for 51% of 

China’s imports from east Asia compared to 41% in 1995. As a result, China is now 

running trade deficits with other east Asian countries because of imports of components and raw materials while running trade surpluses with North America and 

Europe because of rapidly growing exports of manufactured goods. On the basis of 

Chinese data, the country has trade deficits of $31.5 billion with Taiwan, $13.1 billion with Korea, $7.6 billion with Asean, $5.0 billion with Japan, and $1.3 billion 

with Australia. Taiwan’s exports to China now exceed 13% of the island’s GDP. 

China has displaced the U.S. as South Korea’s largest trade partner. 

The changing role of China can be seen in the composition of U.S. imports. China 

now produces about 11% of U.S. imports compared to 5% in the late 1980s. But the 

east Asian share of U.S. imports has slumped from 40.1% during 1994 to 32.5% recently. Many of the goods formerly produced by Taiwan, Singapore, and Korea for 

the U.S. market now come from China. There has also been intense price competition which has reduced costs for American consumers. Morgan Stanley estimates 

this competition has saved American consumers $100 billion. 

The major cause of China’s booming exports is not an undervalued currency. It 

is an upsurge of foreign direct investment which has significantly boosted China’s 

productive capacity and managerial competence. China now has over $400 billion 

of FDI compared to $1.3 trillion for the U.S., $497 billion for the United Kingdom, 

$482 billion for Belgium-Luxemburg, and $480 billion for Germany. As FDI is now 

expanding by $55–60 billion per annum, China will soon have the second largest 

stock of FDI in the world. Foreign companies produce over half of China’s exports 

and accounted for 65% of export growth during the past decade. China’s openness 

to FDI is also in striking contrast to the policies of Japan and Korea, which tried 

to restrict trade in the past by discouraging FDI. On the eve of the Asian financial 

crisis six years ago, Japan had only $17 billion of FDI while Korea had just $12 

billion. 
68

The role of FDI in China’s economy makes for a striking contrast with Japan and 

Korea. On the eve of the east Asian financial crisis six years ago, there was only 

$17 billion of FDI in Japan and $12 billion in Korea. Both countries effectively 

banned FDI for almost half a century to nurture domestic companies. Japanese companies also developed their own brand names and distribution channels to conquer 

global markets. As a result, both large and small American companies often felt that 

Japan was an unfair trade partner. China is totally different. More than half of China’s exports come from American, Japanese, and other foreign companies. China has 

no global brand names. It sells primarily under the names of foreign companies. As 

a result, most multinational companies are satisfied with Beijing’s trade and investment policies. The major complaints are coming from small- or medium-sized U.S. 

companies which don’t have the capital to invest in China or have not yet had time 

to penetrate the market there. If Beijing could improve market access for small companies, there would be fewer demands for trade protection or currency revaluation. 

The major risk posed by China’s decision to retain a stable exchange rate lies in 

the area of monetary policy. The boom in forex reserves is encouraging rapid growth 

of money and credit. The growth rate of M1 and lending has accelerated from 10–

12% during early 2002 to nearly 20% during recent months. The surge in money 

growth has not had a major impact on asset markets. The stock market is below 

its peak of two years ago. Real estate prices have been increasing at a 5% annual 

rate. But the central bank is very concerned about over investment in real estate 

and recently announced new regulatory controls on property lending. Property lending had been expanding at an annual rate of 25% while the volume of mortgage 

loans has shot up to 924 billion rmb from only 19 billion during 1998. What the 

central bank cannot fully regulate is the tendency for easy credit and surplus liquidity to promote an inefficient allocation of capital throughout the economy. China 

now has the highest rate of investment in the world. In 2002, investment averaged 

42.2% of GDP compared to a previous peak of 41.3% during the boom of the mid1990s. There is a danger that such a high level of investment could encourage the 

creation of so much excess capacity that firms will find it difficult to achieve profitability. In such a scenario, the investment boom could set the stage for corporate 

liquidity problems and an investment recession in two or three years. Korea experienced such a crisis during the late 1990s. If China wants to maintain a stable exchange rate without running a dangerously expansionary monetary policy, she will 

have to liberalize her controls on capital outflows. If Chinese people and companies 

could purchase foreign assets, there would be slower growth of foreign exchange reserves. There were large capital outflows by Chinese companies during the late 

1990s because of concern about the Yuan being devalued. But this money has returned and swelled forex reserves recently because of the new confidence in China’s 

currency. 

It is ironic that the U.S. Government has joined the list of countries calling upon 

China to revalue her currency. The U.S. is now able to finance its large fiscal deficits and current account deficits only because of currency intervention by Asian central banks, especially Japan and China. The central banks of China and Hong Kong 

have purchased nearly $100 billion of U.S. Government securities during the past 

eighteen months. The east Asian central banks now have 70% of the world’s foreign 

exchange reserves compared to only 30% in 1990 and 21% in 1970. They keep their 

$1.7 trillion of reserves 80–90% invested in U.S. Government securities. In the 

1960s, France sold U.S. dollars for gold in order to protest the role which the dollar 

played promoting America’s super-power status but continental Europe is now irrelevant to the dollar’s direction because it has only 8.6% of global foreign exchange 

reserves compared to 40% in 1972. If China were to protest U.S. foreign policy by 

selling the dollar for Euros or gold, it could set the stage for a large correction which 

would drive up U.S. bond yields, weaken the housing market, depress American domestic consumption, and jeopardize the President’s reelection. But China has a $105 

billion trade surplus with the U.S. and is anxious to promote American consumption, so it will do nothing to challenge Bush policies through the currency market. 

There is no simple answer to the debate about China’s currency policy. There are 

increasing fears in the U.S., east Asia and Europe about China’s competitive challenge. China is naturally reluctant to alter her currency policy because of concerns 

about high unemployment, the weak banking system and the legacy of the east 

Asian financial crisis, and the competence of Chinese firms at hedging currency risk. 

These concerns will cause China to change policy gradually. But as the recent upsurge of monetary growth will testify, China cannot totally insulate herself from the 

burgeoning foreign exchange reserves resulting from speculation about her currency 

policy. The most sensible policy is to introduce a wider target bank of 3–5% for the 

currency and let the market begin to reflect the factors which have caused forex reserves to increase so dramatically.
69

Co-Chairman MULLOY. Thank you, Mr. Hale. 

Dr. Preeg.

STATEMENT OF ERNEST H. PREEG, Ph.D.

SENIOR FELLOW IN TRADE AND PRODUCTIVITY

MANUFACTURERS ALLIANCE/MAPI 

Dr. PREEG. Thank you, Mr. Chairman. It’s a pleasure to be here, 

a pleasure to be back here. Some of you may recall I was here two 

and a half years ago to present a paper on Chinese currency manipulation. It was a very lonely feeling at that time. Almost nobody 

had heard the term ‘‘currency manipulation’’ before or thought 

about it much. 

Co-Chairman DREYER. Deja-vu all over again. 

Dr. PREEG. Well, this morning, as I heard the seven Members of 

Congress, I had the distinct feeling of being something like a Dr. 

Frankenstein in a lot of chapters of that book. 

But, in any event, let me sally forth. I have three issues I’d like 

to raise to clarify: one is the Chinese currency manipulation is in 

violation of IMF/WTO; second, the impact, a couple of comments on 

the trade balance and the economy; and, third, what would be the 

appropriate U.S. policy response. 

Just to start, though, China has been in clear violation of IMF 

and WTO commitments over the past three years by maintaining 

an unfairly low exchange rate to gain a competitive advantage. 

IMF Article IV, Section 1, states that members should ‘‘avoid manipulating exchange rates . . . in order . . . to gain an unfair competitive advantage over other members,’’ and Section 3 of Article IV 

stipulations ‘‘the right of members to have exchange arrangements 

of their choice consistent with the purposes of the Fund and the obligations under Section 1 of this Article,’’ which is very clear that 

whether they have a floating rate policy like Japan, fixed rate like 

China, they have to do it in a manner, in a way that does not lead 

to currency manipulation. 

Then, what is currency manipulation? Again, defined very clearly 

in the surveillance provision related to Article IV, it is ‘‘protracted 

large-scale intervention in one direction in the exchange market.’’ 

That’s it. And ‘‘one direction’’ means buying because that’s the way 

you buy foreign currencies, that’s the way you keep your currency 

lower and, therefore, get a competitive advantage. 

So the case of violation rests on what China has in fact been 

doing protracted large-scale intervention in one direction. But can 

there be any question? I have some figures here. There is nothing—

it is totally unprecedented in the 60 years of the IMF experience, 

and Japan and China are sort of neck and neck in the last couple 

of years. But, in China, what is especially important is that there’s 

been an upward movement over the last few years. The monthly 

purchases of foreign exchange by China went from $3.8 billion a 

month in 2001 to $5 to $7 billion a month in 2002 to $10 billion 

a month this year. And their reserves have almost doubled, $166 

billion to 357. So there should be no question about violation of Article IV. 

As to the WTO Article XV that was raised earlier today, it says 

‘‘you should not frustrate the intent of the Agreement.’’ What is the 

intent? It’s very clear in the preamble of the GATT. The objective 

is to enter into reciprocal and mutually advantageous arrange-
70

ments directed to the substantial reduction of tariffs and other barriers to trade. Well, obviously, the currency manipulation would 

frustrate the intent. And, quite importantly, there is a direct link 

between Article XV of the GATT to IMF Article IV, presumably, in 

saying that the members of the GATT/WTO ‘‘should accept all findings of statistical fact presented by the Fund relating to foreign exchange.’’ So, therefore, an Article IV finding would make the case 

in the WTO. 

So that’s the legal case. I’ll come back to briefly at the end on 

what our policy response should be. 

What has been the impact of this massive unprecedented currency manipulation of the last three years? Japan, China, but also 

others—South Korea and Taiwan—clearly are in that category. I 

have made some estimates—they’re presented in a paper I presented earlier this year—as to how much lower the—or how much 

higher the Chinese currency would be under a market-based floating rate and how much larger our trade deficit is as a result of currency manipulation. 

The basic concept involved is that official purchases of foreign exchange, as being done by the central banks of China, Japan, and 

elsewhere, they take off the market the net inflow of foreign currencies during a period, during the year, that otherwise would have 

put upward pressure on the exchange rate. And the relevant relationship is between the extent of this intervention, buying up the 

foreign exchange, and the size of the current account surplus, and 

the new flow of long-term investment, mainly foreign direct investment. 

In the case of China, in 2002, they had a $35 billion current ac- count surplus. They had about $50 billion new inflow of FDI, or an 

$85 billion—this is called ‘‘basic balance’’—plus $85 billion. During 

the same period, though, of that 85 net inflow, the Chinese central 

bank bought up—just put away $75 billion, or almost 90 percent. 

And that’s a very substantial amount of offset, and this year it’s 

likely to be over 100 percent of their purchases. 

Now, there are other factors at play, and there’s no way to do 

a precise statistical estimate. There is some econometric work on 

the U.S. side and the Asia side, but in any event, in rough terms, 

what I came up with, my estimates are that as a result of currency 

manipulation the last two or three years, the Japanese yen is undervalued by at least 20 percent and the Chinese currency by in 

the order, in the rough order of 40 percent. And Taiwan and South 

Korea are also in the 20-percent category. 

Now, what that means, impact on trade deficit, there’s a lot more 

econometric work in this area and, consistent with comments made 

by Fred, with this degree of undervaluation about $100 billion of 

our $400 billion trade surplus would be related or be a result of 

such a currency manipulation. The other three-quarters can be explained by a lack of saving and other factors. And of that $100 billion, $50 billion or more can be attributed to China, directly or indirectly, as explained in the paper. 

There are other economic effects I won’t go into. A lot of this has 

been discussed already. This would be part of the adjustment process. There would be adverse impacts on our interest rate, inflation, 

although at some point we do have to adjust. Probably the cir-
71

cumstances are as good as they can get now to go through the landing, if you will, of the dollar. 

Another broader economic effect that has been mentioned briefly 

earlier today is that the manufacturing sector in the United States 

is the engine for growth. Two-thirds of the R&D of our country is 

in manufacturing. Well over 90 percent of patents come out of manufacturing. And this productivity surge in recent years has been 

largely new manufactured products and applied services, technology intensive, being spread throughout the economy. Well, when you have—this year we will have a $500 billion deficit in manufactures, or almost. That amounts to one-third of the 

value-added of our manufacturing sector. In other words, if we had 

balanced trade in manufacturing, we would have a manufacturing 

sector one-third larger and a smaller services sector, and that’s a 

lot larger. It would be a lot broader base for the engine of growth, 

many more resources for the R&D, the patent development, et 

cetera. 

Conversely, East Asia, throughout East Asia, China perhaps 

most importantly, has a bigger engine for growth as a result of 

having this large inflow of trade surplus plus a large inflow of foreign direct investment with embedded new technologies. And 

there’s nothing wrong with both of us having engines for growth. 

That should be the objective. But it should be done in a way that 

does not involve something that would be an unfair competitive advantage, namely, currency manipulation. 

There’s also a defense relationship in the paper. I won’t go into 

it, because if we have a smaller engine of growth than we would 

have had otherwise, technology, intensive manufacturing, and they 

have a larger one, the capability is building up. 

Co-Chairman MULLOY. I think, Dr. Preeg, if you could finish up 

within 30 seconds or so, and then we really want to open it up for 

some questions. 

Dr. PREEG. Well, just the policy response. We need a stronger response. I mentioned three things that we should do. One is we 

should be explicit in saying they’re in violation of IMF and WTO. 

It doesn’t take a year or two. Once you do that, a lot more pressure 

to move ahead, and most of these cases settle out of court promptly, particularly when one side sees they’re going to lose at the end 

of the day. 

The second point is—and this hasn’t been raised today—there 

should be equal treatment if we do proceed with this currency manipulation concern, not just single out China but Japan, South 

Korea, and Taiwan. It’s better bargaining, and for the China relationship, I think it’s quite important that Taiwan be treated equally with China to show that this is not a protectionist attack on 

China. 

And, third, highlight the mutual benefits. This has already been 

raised. China would gain some things. One specific wasn’t mentioned: If they did revalue 20 percent, their oil price would go down 

20 percent throughout their economy, and they’re now close to two 

million barrels a day, and it’s growing. 

And finally, finally, what do I recommend what they should do 

as a suggestion? They have to decide. And as I have at the end 

here, I believe they should revalue up, a 20-percent re-peg to get 
72

closer to a market-based rate. They admit they’re undervalued, as 

Fred said, but at the same time, they should then convert to a convertible capital account with a band around the new peg. And then 

with the band, they could see how it works and over time, whatever length, they could gradually widen the band toward the ultimate objective, which seems to be agreed, of a floating rate. 

Thank you. 

[The statement follows:]

Prepared Statement of Ernest H. Preeg, Ph.D.

Senior Fellow in Trade and Productivity, Manufacturers Alliance/MAPI 

Chinese Currency Manipulation and the U.S. Trade Deficit

This presentation addresses three issues:

1. Chinese currency manipulation in violation of IMF and WTO commitments. 

2. The impact on the U.S. trade balance and economy. 

3. The appropriate U.S. policy response. 

1. Chinese Currency Manipulation in Violation of IMF and WTO Commitments 

China has been in clear violation of its IMF and WTO commitments over the past 

three years by maintaining an unfairly low exchange rate in order to gain a competitive advantage in international trade and investment. IMF Article IV, Section 

1, states that members should ‘‘avoid manipulating exchange rates . . . in order . . . 

to gain an unfair competitive advantage over other members,’’ and Section 3 stipulates ‘‘the right of members to have exchange arrangements of their choice consistent with the purposes of the Fund and the obligations under Section 1 of this 

Article.’’ In other words, exchange rate policies, whether a floating rate as in the 

case of Japan or a pegged rate as in the case of China, must be implemented in 

a way that does not lead to the currency manipulation stricture of Section 1. 

The IMF definition of currency manipulation is very explicit in the surveillance 

provision related to Article IV, which refers to it as ‘‘protracted large-scale intervention in one direction in the exchange market.’’ ‘‘In one direction,’’ of course, means 

buying foreign currencies since this is the way to maintain an undervalued currency 

in order to gain an unfair competitive advantage. 

Within these clearly defined IMF provisions, currency manipulation by China 

rests on the assessment as to whether or not China has been undertaking ‘‘protracted large-scale intervention in one direction in the exchange market.’’ But can 

there be any doubt? Table 1 shows the average monthly purchases of foreign exchange by the Chinese Central Bank from 2001 through July 2003. During this period, the foreign exchange holdings of the Bank have more than doubled from $166 

billion to $357 billion. Moreover, there is a strong upward trend in official purchases 

throughout the period, from $3.8 billion per month in 2001 to $5–$7 billion per 

month in 2002 to $10 billion per month in 2003. These Chinese purchases, along 

with official Japanese purchases, as also shown in Table 1, are far beyond any 

precedent throughout the almost 60-year history of the IMF.

Table 1. Official Chinese and Japanese 

Foreign Exchange Purchases 

($ billions, monthly average) 

China Japan 

2001 (Jan.–Dec.) 3.8 3.4

2002 (Jan.–June) 5.1 6.9

2002 (July–Dec.) 7.3 3.8

2003 (Jan.–June) 10.0 12.5

2003 (July) 10.0 11.1

Source: IMF, International Financial Statistics; and Coalition for 

a Sound Dollar, ‘‘Currency Manipulation Monitor.’’

The Chinese violation of World Trade Organization (WTO) commitments pertains 

to GATT Article XV, dealing with ‘‘Exchange Arrangements,’’ which stipulates that 

members should not take exchange rate actions that ‘‘frustrate the intent of the provisions of this Agreement.’’ The intent of the Agreement, as stated in broadest terms 
73

1 Ernest H. Preeg, ‘‘Exchange Rate Manipulation to Gain an Unfair Competitive Advantage: 

The Case Against Japan and China,’’ contained in Dollar Overvaluation and the World Economy, C. Fred Bergsten and John Williamson, eds. (Institute for International Economics, February 

2003), pp. 267–284. 2Some observers conclude that currency manipulation has no significant impact because an- nual official foreign exchange purchases, even at $100 billion per year, pale by comparison with 

a trillion dollars per day of international financial transactions. The error in this assessment 

is to compare net and gross financial flows. The very large majority of gross market financial 

transactions are offsetting inflows and outflows, just as most trade consists of offsetting export 

and import payments in its impact on exchange rates. What really counts for upward and downward pressures on exchange rates is the net dollar inflow or outflow on trade, current, and longterm capital accounts, which is directly offset, dollar for dollar, by Central Bank purchases of 

foreign exchange. 

in the Preamble, is the objective of ‘‘entering into reciprocal and mutually advantageous arrangements directed to the substantial reduction of tariffs and other barriers to trade.’’ Clearly, ‘‘exchange rate manipulation to gain an unfair competitive 

advantage,’’ as defined by IMF Article IV, meets the ‘‘frustrate the intent’’ test. In 

fact, GATT Article XV also provides for full consultation with the IMF, including 

that members ‘‘should accept all findings of statistical fact presented by the Fund 

relating to foreign exchange.’’ Thus, there is a direct linkage between IMF proscribed currency manipulation and violation of WTO Article XV, including recourse 

to WTO trade dispute procedures. This linkage is addressed more fully under issue 

three below. 

The critical conclusion is that China—as well as Japan, Taiwan, South Korea, and 

perhaps some others—have been in clear violation of IMF and WTO commitments 

related to exchange rate policy. There should be no controversy about this conclusion, which leads to the follow-on questions of the economic impact of such currency 

manipulation on the U.S. trade balance and economy, and the appropriate policy response by the United States and other trading nations suffering the unfair competitive disadvantage from currency manipulation. 

2. The Impact on the U.S. Trade Balance and Economy

Currency manipulation results in a lower than market-based exchange rate, with 

a consequent larger trade surplus by the manipulator and larger trade deficits for 

its trading partners. How much lower the Chinese exchange rate and how much 

larger its trade surplus with the United States are, as a result of Chinese currency 

manipulation, cannot be measured with precision, but even approximate orders of 

magnitude are sufficient to indicate a significant competitive disadvantage for U.S. 

export and import competing industries. 

The estimates provided here are explained in detail in an earlier study.1 The estimates were based on the period through mid-2002, and in the year since then currency manipulation by both China and Japan has accelerated sharply, as shown in 

Table 1, and thus, if anything, the cited estimates understate the more recent impact of the manipulation on exchange rates and trade. 

The basic concept involved is that official purchases of foreign exchange take dollars and other foreign exchange off the market that otherwise would have created 

demand for the national currency and put upward pressure on the exchange rate. 

The relevant relationship is between the extent of official purchases and a country’s 

‘‘basic balance,’’ that is its current account (mostly trade) plus the net flow of foreign 

direct investment (FDI).2 For example, in 2002 China had a current account surplus 

of $35 billion and a net inflow of FDI of about $50 billion, and thus a basic balance 

of +$85 billion which, in relation to the size of overall Chinese trade and investment, would have put very strong upward pressure on the exchange rate. The Chinese Central Bank during 2002, however, purchased $75 billion of foreign exchange, 

thereby directly offsetting almost 90 percent of the upward pressure on the currency 

from the very large basic balance surplus. In 2003, official foreign exchange purchases will likely exceed 100 percent of the Chinese basic balance dollar inflow. 

The estimates I made in the IIE book cited above derive from this basic relationship and available econometric work relating exchange rate adjustment to changes 

in the trade balance. The estimates provided are that the Japanese yen was at least 

20 percent undervalued as a result of currency manipulation, and that the Chinese 

renminbi was in the order of 40 percent undervalued. Together with currency manipulation by South Korea, Taiwan, and others, the estimated impact on the U.S. 

trade deficit was that approximately $100 billion, or one-quarter of the total $400 

billion trade deficit in manufactures in 2002, was caused by currency manipulation. 

The $100 billion larger trade deficit equates to 1.0–1.5 million jobs in U.S. manufacturing. In 2003, both the trade deficit and the intensity of currency manipulation 
74

3The assessment in this section is drawn from U.S. Manufacturing: The Engine for Growth 

in a Global Economy, Thomas J. Duesterberg and Ernest H. Preeg, eds. (Praeger Publishers, 

October 2003). 

have increased substantially, which again might justify an upward revision of these 

numbers. 

As to the impact on the U.S. trade deficit by China alone, there is both a direct 

and an indirect effect. Based on the shares of trade and estimated undervaluation 

of currencies, China directly accounts for about $40 billion of the $100 billion larger 

U.S. trade deficit. Indirectly, however, China has an additional impact because 

Japan, South Korea, Taiwan, and others throughout Asia claim they have to intervene and keep their currencies undervalued because of the very low manipulated 

Chinese rate. In other words, they say they have to manipulate their currencies to 

remain competitive with China. There is also good reason to believe that if China 

were to substantially revalue its currency, the other Asians could be persuaded to 

scale back their Central Bank purchases and allow their currencies to float upward. 

Thus, putting the direct and indirect effects of Chinese currency manipulation together, $50 billion or more of the $100 billion trade deficit increase can be attributed to China. 

As for the broader impact of Chinese and other East Asian currency manipulation 

on the U.S. economy, there are three principal effects, one involving short-term adjustment of the U.S. trade deficit, and the other two having more fundamental and 

longer term consequences.

1. Short-term adjustment of the trade deficit. There is widespread agreement that the $500 billion U.S. current account deficit cannot be sustained indefinitely, 

and that the inevitable downward adjustment will involve a significant lowering of 

the dollar exchange rate. As noted above, such adjustment should be of substantial 

benefit to U.S. export and import-competing industries, but it also has its costs, including upward pressure on interest rates and inflation and perhaps some downward effects on the stock market. The current outlook, however, is about as favorable as it can get for minimizing these adverse adjustment effects. Inflation is very 

low and most indicators point to a relatively strong economic growth path, with relatively low interest rates, over the next year or two. 

In this context, the huge official purchases of dollars by East Asians, including China, are currently financing more than half of the $500 billion U.S. current account deficit, thus tending to postpone the inevitable current account adjustment. 

And the longer we postpone the trade adjustment through such borrowing from foreign governments, the ‘‘harder the landing’’ for the dollar and the U.S. economy will 

likely be, including the likelihood of a larger necessary adjustment during less favorable domestic economic circumstances.

2. Adverse impact on U.S. manufacturing as the engine for growth. The 

manufacturing sector is the engine for growth for the overall U.S. economy.3 Twothirds of research and development and over 90 percent of new patents derive from 

the manufacturing sector. The application of new technologies throughout the economy is predominantly through manufactured products with an increasing component of related services for training, application, and maintenance also supplied by 

manufacturing companies. Productivity growth in the U.S. economy has soared from 

1.5 percent in 1990–1995 to 2.5 percent in 1995–2000 to 3.4 percent since 2000, and 

the engine for this extraordinary growth record is the manufacturing sector. 

The unprecedented U.S. trade deficit in manufactures, however, has resulted in 

a much smaller engine for growth in the United States and a corresponding larger 

engine in East Asia, including China, in particular. The U.S. trade deficit in manufactures has increased steadily from about $150 billion in 1997 and $250 billion in 

1999 to $373 billion in 2001, and it is projected to exceed $450 billion this year, of 

which 70–80 percent is with East Asia, and over $100 billion with China alone. The 

trade deficit in manufactures currently amounts to about one-third the value added 

in U.S. manufacturing industry. Put another way, if U.S. trade in manufactures 

were in balance, the U.S. manufacturing sector would be one-third larger, including 

about five million more jobs. The net result would be a substantially larger engine 

for growth, with substantially greater resources available for research and development, investment, and training to upgrade employee skills. 

This relationship between the evermore technology-intensive manufacturing engine for growth and the trade balance is clearly evident in the economic strategy 

of the East Asian export powerhouses, including China. A large trade surplus plus 

a net inflow of technology-intensive direct investment in manufacturing is a central 

policy objective, and currency manipulation to maintain or increase the surplus is 

a highly effective policy instrument to this end. A sustained trade surplus as a pol-
75

4 A related and utterly absurd financial relationship is that China still receives several billion 

dollars per year in long-term concessionary loans from the multilateral development banks, 

which could be provided internally from less than one month’s purchases of foreign exchange 

by the Chinese Central Bank. China should immediately be converted from an aid recipient to 

an aid donor country in view of its massive official foreign exchange holdings. 

icy objective has long been called ‘‘mercantilism’’ by economists. In current East 

Asian form, it can be more pointedly described as ‘‘advanced technology mercantilism,’’ and China is the outstanding practitioner.

3. Adverse impact on U.S. defense capability. This impact follows principally 

from the previous point of a larger East Asian manufacturing engine for growth relative to the United States as a result of currency manipulation and its impact on 

the U.S. trade deficit. A broader Chinese manufacturing base, with strong incentives 

to upgrade technological content, enables China to modernize its military capability 

at a faster pace. Likewise, a relatively smaller U.S. manufacturing base would have 

a restraining effect for the United States to maintain its high technology lead in 

weapons, related information systems, and other defense capabilities. 

Another indirect effect of Chinese currency manipulation on Chinese military 

modernization is the enhanced capability to purchase weapons and other defenserelated goods and services from abroad, largely from Russia in recent years. With 

close to $400 billion of foreign exchange sitting idly (while gaining interest) in the 

Chinese Central Bank, China has virtually unlimited funds available for cash purchases of advanced military capability.4

3. The Appropriate U.S. Policy Response 

U.S. policy has been in a state of denial about currency manipulation for many 

years. The 1988 Omnibus Trade Act requires the Secretary of the Treasury to report 

to the Senate Banking Committee twice each year with an assessment of currency 

manipulation by trading partners. The congressional motivation for this provision 

was concern about Japanese exchange rate manipulation dating back to the mid1980s. Secretaries of the Treasury, however, have almost always responded with 

brief statements denying any signs of currency manipulation. Neither Japan nor 

China has ever been mentioned as possible currency manipulators. One consequence 

of this U.S. denial is that the IMF Secretariat has avoided the subject as well. If 

the Secretary of the Treasury of the largest IMF member, which also suffers the 

principal competitive disadvantage from currency manipulation, every six months 

categorically denies manipulation by any other IMF member, no one else would be 

so presumptuous as to disagree with him. 

There has recently been significant change in this policy. Secretary John Snow is 

now urging China and Japan to move toward a more market-based exchange rate 

policy. The United States also pressed the Group of Seven (G–7) finance ministers 

on September 20 to adopt language calling for more flexibility in exchange rates to 

promote adjustment based on market mechanisms. There has still been no public 

statement, however, about violation of IMF and WTO commitments, and the country 

focus is very uneven, with a predominant focus on China. Japan, in fact, stated that 

the G–7 statement represented no change in policy for Japan. 

A more complete and effective policy response would put the issue in broader context, in terms of both substance and procedure. 

A. The Substantive Response 

The United States should make a clear and comprehensive statement about the 

problem of currency manipulation and its adverse impact on the U.S. trade deficit. 

It should consist of three basic points:

1. Violation of IMF and WTO commitments. The United States should state 

clearly that China, Japan, and some others are in violation of IMF Article IV and 

WTO/GATT Article XV commitments as described in section 1 above. This is the factual cornerstone of the problem, and a clear statement would counter frequent criticism that the United States is pursuing a protectionist trade policy toward China. 

The IMF/WTO legal case also strengthens U.S. bargaining leverage to resolve the 

problem as an urgent matter. 

2. Equal treatment for all currency manipulators. The current policy of singling out China is inconsistent conceptually and can have adverse impact on other 

U.S. foreign policy interests with China. It also adds to the perception of U.S. protectionism because of the very large U.S. bilateral trade deficit with China. At least 

Japan, South Korea, and Taiwan should be approached on equal terms, with a view 

to terminating IMF proscribed currency manipulation. Japan, in fact, has been ma-
76

5The Japanese Central Bank simply intervenes in a floating rate market to buy foreign currencies and thus maintain a lower than market-based exchange rate. China, with a dollar 

pegged rate that is nonconvertible on capital account, requires all incoming foreign exchange 

not used on current account to be sold to the Central Bank. The net result is the same in terms 

of IMF proscribed currency manipulation, but the process is more indirect and less clearly perceived by some observers. 6The substantive economic benefits to both the United States and China from a multilateral 

free trade agreement for manufactures are described in detail in Ernest H. Preeg, From Here 

to Free Trade in Manufactures: Why and How (Manufacturers Alliance/MAPI, August 2003). In 

view of the failure of the WTO ministerial meeting in Cancun, the United States and China 

should indeed give urgent consideration to such an initiative as a way to salvage the multilateral trading system as well as to reap the substantial direct economic benefits. 

nipulating its currency far longer than China and in a more obvious way.5 The inclusion of Taiwan is significant not only because Taiwan is a long-time manipulator, 

with foreign exchange holdings of $186 billion, up $30 billion in the past 12 months 

alone, but as a demonstration to Beijing that the United States is treating both Chinas on an equal basis for this purely economic and commercial issue. 

3. Highlight the mutual benefits. There is a short-term competitive trade advantage for China from currency manipulation, but there are also disadvantages. If 

China were to revalue its currency up by 20 percent, for example, the cost of imported oil—currently 1.5 million barrels per day and rising rapidly—would decline 

by 20 percent throughout the Chinese economy. Likewise, the ensuing reduction of 

Central Bank purchases of foreign exchange would provide additional financial resources for internal needs such as building infrastructure and reducing poverty. 

Longer term transition to a more efficient market-based exchange rate, in conjunction with movement toward free trade, is clearly a mutual economic interest of both 

China and the United States as global trading nations.6 These overriding positive 

dimensions should be highlighted in discussion between the governments about the 

currency manipulation issue. 

B. The Procedural Response 

Based on such a substantive statement of policy, the United States should undertake further bilateral, group, and institutional consultations with a view to a 

prompt ending currency manipulation by trading partners. Bilateral consultations 

would begin with the four named East Asian trading partners that are having the 

largest adverse impact on U.S. commercial interests. Group consultations would 

take place within the Asia Pacific Economic Consultation (APEC), in view of the 

transpacific concentration of both currency manipulation and the U.S. trade deficit, 

and in the G–7 industrialized country grouping, wherein the Europeans and Canada 

also suffer adverse consequences from East Asian currency manipulation because 

they have been absorbing a disproportionately large share of the trade impact from 

the decline in the dollar thus far. 

Institutional consultations would be initiated in the IMF with respect to violations 

of Article IV and in the WTO with respect to violations of GATT Article XV. These 

formal consultations could be delayed pending early resolution of the issue through 

informal bilateral consultations, but the United States should be clear that this is 

an urgent matter and that the United States is prepared to move forward promptly 

to such formal consultations if necessary. 

***

A final question pertains to what would be the most appropriate policy response 

by China. An abrupt switch from the current fixed pegged to the dollar, nonconvertible on capital account, to a market-based floating rate, could cause some short-term 

disruption in financial markets. A more balanced action proposed here would be an 

immediate 20 percent revaluation of the renminbi to bring it closer to a marketbased level, together with a transition to convertibility on capital account within a 

band around the newly established peg. Over a couple of years, this band could be 

progressively broadened until a market-based floating rate is achieved. This is, however, only a well-intentioned suggestion. The ultimate choice is up to China, as provided in IMF Article IV, Section 3, which stipulates the right of members to have 

exchange rate policies of their choice, as long as they do not lead to currency 

manipulation to gain an unfair competitive advantage.

Discussion, Questions and Answers 

Co-Chairman MULLOY. Thank you. 
77

I am going to have the first five minutes, and we’re going to limit 

ourselves to five minutes so everybody has a chance before we have 

to break. 

First, I want to just tell you, in the context of this hearing, we 

tried to think it through—and it was some months ago—what we 

wanted to do with it. There weren’t all these congressional bills in 

there three months ago or two months ago when we started putting 

this hearing together. This issue has hit, and I think it hit because 

there is a major problem out there and that Congressmen are trying to understand how to deal with it. And once we decided to look 

at those bills that the Congressmen and Senators were putting in, 

we felt it very important to bring these people—these elected representatives of the people in here to find out what they think is 

going on, because they are a transmission belt from the larger society to policymakers. And you don’t always get that when you’re in 

the Administration, what’s really going on out there. 

The other thing I want to say, I was around this town when 

PNTR was going through the Congress. And, remember, it had to 

get through both Houses of Congress. And part of the problem, I 

think, was the way it was sold. It was sold to the elected representatives of the people that it was going to correct the trade imbalance 

with China by opening up China to American exports. That was 

the way it was sold. 

Now, I want to read to you an article that appeared—and I think 

it’s very important for people out in the larger community to understand this. The Wall Street Journal on May 25, 2000, the day after 

the House voted and approved PNTR, said this in an article about 

that vote. It said, ‘‘And while the debate in Washington focused 

mainly on the probable lift for U.S. exports to China, many U.S. 

multinationals have something different in mind. ‘This deal is 

about investment, not exports,’ said Joseph Quinlan, an economist 

with Morgan Stanley Dean Witter.’’ I think that is your firm, Dr. 

Roach. ‘‘U.S. investment is about to overtake U.S. exports as the 

primary means by which U.S. companies deliver goods to China.’’

So, in our first report, we said China’s effort to get into the WTO, 

a key part of it was to get investment. It was sold here that it 

would help Americans sell more to China, and I think part of the 

problem now is that the members had a misimpression of what was 

happening here. And I think that’s now created a political problem 

that we should be thinking about how to deal with rather than attacking these Congressmen, who are really telling you that there’s 

a problem out there that’s not being dealt with. 

Now, I think it’s more than an exchange rate issue, personally. 

Paul Craig Roberts, who was an Assistant Secretary of the Treasury under Ronald Reagan, is going to testify here later today, along 

with other economists, and he’s going to tell us that part of the 

problem is the fact that mobile factors of production—capital, technology, and even labor through Internet transfers of high-level jobs. 

He’s going to tell us that that has changed what has been the perception for a century about what trade was about, that you make 

goods here, you ship them there. And he’s saying that you really 

need to rethink what we’re doing here, because when you can move 

factories, technology, and white-collar jobs and everything out of 
78

your country to another country, that changes the perception of 

what people thought was trade. 

So I would just like—with that statement just ask: Do you think 

there’s any validity to these concerns, Dr. Roach? And others, if you 

want to comment. 

Dr. ROACH. Let me just comment. And, look, I apologize if I got 

a little hot here. But I sat here and listened to Congressman after 

Congressman expressing tremendous frustration and anger at China’s role in accounting for, as one Congressman put it, ‘‘the bleeding’’ that’s going on in America. 

The reason that this issue is so important right now is because 

here we are 22 months into an economic recovery and jobs are still 

going down. 

Co-Chairman MULLOY. Right. 

Dr. ROACH. In fact, this is the most jobless recovery in the history of the modern-day U.S. business cycle. And so, therefore, the 

Congressmen, as typical refuse to accept responsibility for anything. They want to point their finger at someone else. And yet 

there’s a legitimate argument to be made. And the 

counterargument here is that they’re the problem. That by creating 

these irresponsible deficits that go on forever, they have cooked the 

books in terms of giving us trade deficits for as far as the eye can 

see, because we have no national savings. And that’s a huge issue. 

I wish that there were some Congressmen here to respond to this. 

But, as they usually do, they just sort of dip in and they dip out 

because they’re always so busy. They don’t like to really discuss 

issues with you. They like to preach. 

And then you raised, I think, an absolutely critical issue—and 

Craig Roberts, if he’s going to talk about it, God bless him. The 

whole concept of trade is being transformed by IT-enabled 

connectivity that allows us now to extract labor input from anywhere around the world, whether it’s in tradable goods or what we 

used to call non-tradable services. 

The really big story that no one is alluding to here is that services may be next. Chuck Schumer did allude to that, but he’s so 

focused on manufacturing, he can’t see past the loss or the closing 

of some auto plants in parts of New York. But we’re a service economy. Eighty percent of our workforce is services. That’s six times 

the share of manufacturing. And now, courtesy of the Internet, 

we’re able to extract increasingly high value-added service output 

from places like India. 

So I’m sure there’s going to be a U.S.-India Commission that is 

going to be set up at some point in the not so distant future. Once 

we deal with China, then we’re going to go attack India. 

Is that the way the world’s greatest nation wants to behave? I’m 

not proud of that at all. Yet, I think that’s a serious risk that’s 

where we’re going. Here in this room you’re charged with U.S.-

China relations. But what I do as a macroeconomist is try to figure 

out how this all fits into the broader picture. 

Yes, America is a great country, and if we just stay focused on 

investing in human capital, and innovation, I guarantee we’ll be 

fine. Go back and read the hearings, if they exist, of what the farmers felt in the late 1800s or the sweatshop workers felt in the early 

1900s. You’re getting sentiment today that’s very reminiscent of 
79

those earlier junctures when there were fears and anxiety over the 

future. 

And America was always great enough to come up with that next 

new thing. Yet by looking inward and going protectionist, we’re 

doing exactly the opposite. That worries me a lot. 

Co-Chairman MULLOY. I’d like to engage further, but my time is 

up. 

Commissioner Reinsch. 

Commissioner REINSCH. Thank you, Mr. Chairman. 

First, just for the record, I just want to say I agree with Mr. 

Roach that the real underlying problem here is our extraordinary 

budget deficit and, to use my words, the irresponsible fiscal policy 

of the Administration. If you compare fiscal ’00 to the current year, 

the change is just extraordinary, probably greater than ever in our 

history, and I think that does underlie a lot of the problems. 

Nevertheless, as Mike Wessel said, we’re here to talk about 

China, and so we have a narrower focus, and I have just two questions, and I would ask for short answers, please, so we can squeeze 

them in. 

The first one is: Mr. Hale made, I think, a point that some others 

have made which is very important, which is that the Chinese not 

only have had an export boom but an import boom. I guess the first 

question is: Why aren’t more of those imports coming from the 

United States? 

Mr. HALE. No simple answer. Last year, we had about $20 billion 

of exports to China, and U.S. multinational companies had $26 billion of what I’d call sales in China from their own production in 

that country or their own local sourcing. China’s huge import boom 

has actually been from other Asian countries. China is currently 

running a trade deficit of $32 billion with Taiwan, $10 billion with 

Korea, $5 billion with Japan, $7 or $8 billion from ASEAN. 

The reason is very simple: China’s basically turned into a huge 

assembly shop. They buy a lot of components, more raw materials 

from East Asia, especially Taiwan, and turn it into finished goods. 

Commissioner REINSCH. Well, why aren’t they buying them from 

us? 

Mr. HALE. Because I don’t think we produce a lot of the components anymore that drive this industrial boom. Those are produced, 

have been produced over the last 10 or 15 years by other Asian 

countries. The fact is a lot of these industries left the U.S. going 

back 10, 15, 20 years ago, and so we don’t have the same link in 

the supply chain that the other countries do. 

Will that change? Who knows? I mean, as China goes more up 

market to more sophisticated industries, to more high-value-added 

industries, it’s quite possible that our share will increase because 

those kinds of goods are still produced here as opposed to the components, the widgets and things like that. 

But, the fact is, as Fred Bergsten indicated, a lot of the things 

that China produces just aren’t produced here anymore. 

Commissioner REINSCH. Well, you make a very good point because what you’re talking about is an erosion of the manufacturing 

base that extends way beyond our relations with China. It’s been 

going on for 20, 30 years. 
80

Mr. HALE. Well, a huge change. We can say that the manufacturing output share of GDP is still relatively high. Employment has 

fallen steadily for many years, especially in the last three or four 

years, because we’ve just gone to a different product mix. And because the Chinese economy is still, as Stephen indicated, relatively 

poor, its capacity to absorb what I would call the most sophisticated products, the most high-value-added products, is somewhat 

limited compared to Europe or Japan or other affluent societies. 

Commissioner REINSCH. Let me pick up—do you want to say 

something, Dr. Roach? 

Dr. ROACH. Let me just briefly add one thing. Under WTO accession, I think some of the greatest opportunities that lie out there 

for U.S. companies in China is in the liberalization of services. 

And, again, that’s where the bulk of our jobs are. There’s tremendous opportunity for us to get involved in Chinese service markets 

in a fashion that would benefit U.S. workers significantly. 

Commissioner REINSCH. Ernie, do you want to throw in ten seconds’ worth? 

Dr. PREEG. Just on the U.S. manufacturing sector, it’s been hit 

hard cyclically in the last three years. But over the last 20 or 30 

years, the share of GDP in labor has gone down because productivity growth consistently has been two to three times higher in 

manufacturing than services. The quantity of manufactures 

throughout the 1990s grew faster than the quantity of services. 

Commissioner REINSCH. Okay. 

Dr. PREEG. That’s a positive thing. 

Commissioner REINSCH. That’s very helpful, and I appreciate 

that. 

The other question picks up on something that Mr. Hale said, 

which is that China has become a giant assembly operation. 

They’re sucking in imports from elsewhere, putting them together, 

and shipping them here. That makes sense. It seems to me that 

that is sort of, nevertheless, kind of a short-term or static picture. 

The real debate that we probably ought to be having, and are 

not, is if or when, at what point are they going to turn the corner 

and move into product development and design of their own and 

ultimately begin developing all those parts and components domestically and change the equation that you’ve just described. 

I attended a conference last February where there was much debate about this and much speculation about whether that would 

ever happen and what the consequences would be if it does. Would 

any of you like to opine on that? 

Mr. HALE. Well, China, for example, is now developing a semiconductor industry, but, again, with foreigners driving the process. 

Taiwan companies are leading it. 

Commissioner REINSCH. Yeah, but that’s technology transfer. 

That’s not——

Mr. HALE. America’s companies are also playing a role. China’s 

also proposed in the last two years, to appease the Asian countries 

that are concerned about its economic takeoff, a regional free trade 

zone encompassing ASEAN, Korea possibly, someday even Japan, 

if they can get over all the agricultural problems they have. 

So China is trying to actually demonstrate to the other countries 

in the region that it’s not going to basically displace them com-
81

pletely, but this integration process will continue and there will be 

a competitive advantage for somebody to engage in two-way trade. 

And, again, the structures that we have right now won’t necessarily be there in five or ten years. They’ll be constantly evolving. 

China, for example, has a computer company called Legend, 

which is very successful. It’s got a 26-percent market share in 

China. IBM and Dell are 3 or 4 percent each. But 80 percent of the 

components for Legend computers come from Taiwan. Basically, it’s 

an assembly operation for Taiwan components. 

And now, what’s happened in the last three years is that all 

these Taiwan companies have moved to the Mainland. Taiwan investment last year in China was $30 billion. Five years ago, it was 

$10 or $15 billion. Taiwan, which is a huge factor in many technologies, is now moving 60, 70 percent of its output to the Chinese 

Mainland. So what would have been in the past a U.S. trade deficit 

with Taiwan will now be a trade deficit with China instead. 

Dr. ROACH. I would just say I think it’s perfectly logical to expect 

what you laid out. This is the continuum of economic development; 

poor countries lacking in capital, both physical and human, start 

out assembling. Then as they slowly start to climb up the curve of 

development and prosperity, they become more educated, more 

technologically adept, and they turn those skills into producers. 

This very process is now unfolding in China, and I think we can 

expect more of it. This is the way globalization works. We can expect it in countries all over the world. 

Our challenge in America is always the same to stay ahead of 

the curve. And we’ve been great at that over time. The risk, 

though, is that we react to new pressures, that and start to look 

inward and protect ourselves. I don’t think there is anything to 

fear here. This is what global prosperity is all about. It’s a win-win 

for us. 

Commissioner REINSCH. I think you’re exactly right about the 

challenge. The question in this case is whether China is different 

from other previous cases because of its size and because of the nature of its economy. But my time is up. 

Mr. HALE. Just to stress again, China is different because of its 

size and because of its scope. But, again, in contrast to the other 

Asian countries that we were concerned about ten years ago, Japan 

and Korea, it’s incredibly open. This development model is incredibly open, so, therefore, the opportunities there are much greater 

than they were a generation ago in Japan or in Korea. We’ve got 

to recognize that. This is not a closed economy model. It’s employing cheap labor. It’s got a reasonably well-educated population. 

They produce 300,000 graduates every year in the engineering 

area. So it’s formidable. But it doesn’t mean that we can’t find huge 

opportunities if we focus and organize our efforts in the correct 

way. 

Co-Chairman MULLOY. I think that’s the key. I think we’ve got 

to figure out how to organize ourselves a lot better and think about 

that we’re into this global economy now, how do we organize ourselves, and we haven’t really thought that through. And that’s 

what we’re trying to think through here with you——

Mr. HALE. I just have an anecdote. I gave a speech a few months 

ago to the U.S.-China Chamber of Commerce in Chicago. I spoke 
82

to almost 350 people. After my speech, I looked at the corporate 

guest list to see who I was speaking to. I did not recognize a single 

name on the list. Every single firm there was a small Midwestern—Illinois, Indiana, Iowa—manufacturing company, very 

concerned about China. 

Twenty businessmen came to me after my speech and said, ‘‘Can 

you help me buy a plant in China? I have to go there to be competitive.’’

Co-Chairman MULLOY. Right. 

Mr. HALE. But these were the small companies. And what’s driving this whole debate about China’s exchange rate policy is not 

General Motors or Motorola. They’re fine. They’ve got $5 billion investments in China. They have a huge market share. It’s the small 

companies who have not yet accessed China because they lack the 

resources, lack the expertise, lack the skills. And we have to help 

those companies penetrate China, and China should be helping 

those companies. 

Co-Chairman MULLOY. Commissioner Wessel. 

Commissioner WESSEL. Again, thank you. And, Mr. Roach, thank 

you for your passion. I have followed your writings and speakings 

for many years, and you are honest and forthright in your beliefs, 

and we appreciate that. 

I do believe that this is not intended as a one-sided discussion. 

The Members of Congress are reflecting a comment you made just 

a couple of minutes ago, that this is the most jobless recovery we 

have seen in probably the post-war period. And our defined unemployment rate does not reflect the real unemployment rate, which 

I would argue is well over 10 percent, with those who have given 

up, those who are working part-time jobs because they can’t find 

full-time jobs. And, really, that may be the root of the larger problem in the sense that when you’re out of a job, you can’t save. 

When you’re underemployed, you can’t save. You’re spending every 

dime you get to try and stay out of debt and try and make sure 

that your family has food on the table and can afford what it needs 

to live on a daily basis. So as I said before, we do recognize that 

there is a larger problem. The China problem is a part of that. 

But I’d like to ask all three of you here: If one were to take 

present circumstances, meaning a skyrocketing deficit and the laws 

we have on our books without much change, the frustration that 

people are seeing, that the American public sees, is because they 

see their jobs moving to China. As I said earlier, they’re moving 

from Mexico to China and elsewhere, and this may be the overall 

globalization problem. 

Do you believe we can sustain our high standard of living without dramatic change in U.S. policy? 

Dr. ROACH. I think that this perception that Americans see their 

jobs moving to China is a perception that’s very much shaped in 

the hallowed halls of Congress. Those perceptions are very hard to 

validate—especially the trade-off between U.S. layoffs and Chinese 

hiring. 

Consider America’s jobless recovery: By my estimates, we’re 

probably about four and a quarter million jobs below where we 

would normally be at this point in a business cycle. About half that 
83

shortfall is in manufacturing. About half that shortfall is in services. 

Why are companies laying off workers? Is it China’s fault? Is it 

Korea’s fault? Is it Japan’s fault? Is it our fault? Probably 

everybody’s at fault because what is going on here are the perfectly 

normal cross-border transfers of globalization. Your challenge is so 

tough because you’re charged with looking at China, alone. But you 

just said it: This so called China problem must be examined in a 

bigger context. 

In an era of globalization, the concept of capacity and supply 

takes on totally different meanings. And it simply may well be that 

we have a huge global imbalance between supply and demand. 

We’ve got excess capacity everywhere around the world in literally 

everything we do, and as we take our barriers down, we’re now realizing this for the first time ever. Moreover, the Internet enables 

us to tap sources of supply that we’ve never been able to tap before, 

both in manufacturing and in what we used to call non-tradable 

services. 

The final piece of this puzzle is that because of this imbalance 

between supply and demand, companies don’t have any pricing leverage as they used to. And so they have to keep cutting costs to 

survive and deliver returns to shareholders. That’s why we’ve had 

this inflation-deflation debate—an extraordinarily different aspect 

of our macro scene that hasn’t been evident for a long time. 

So, to survive as a business when you’re lacking in pricing leverage and facing competition that you’ve never seen before, you have 

to keep pushing down on the cost curve. And that means going to 

outsourcing chains, whether they’re in China, whether they’re in 

India, or any other low-cost producer around the world. And this 

does put pressure on what we think we’re entitled to in terms of 

our standard of living as the world’s most prosperous nation. 

But those entitlements get drawn into question when we run 

reckless economic policies as we are doing today with these massive budget deficits. And I agree with you that the unemployment 

rate is probably a good deal higher than the official numbers suggest, consistently with these pressures or our standard of living. 

But as much as you’re charged with dealing with U.S.-China in 

the narrow sense, I think you would be doing the country a huge 

service if you, simply stated, that this problem is one piece in a 

much bigger puzzle. We can’t pretend to just isolate U.S.-China relationship on a bilateral basis anymore. There are forces much bigger than U.S.-China that are affecting the prosperity and the 

standard of living of the American worker. 

Mr. HALE. I think we should recognize that China has actually 

had a benign effect on the standard of living of the American people by producing a big disinflation in the cost of many consumer 

products. Andy Xia, his colleague in Hong Kong, produced a report 

two weeks ago suggesting that the cost savings in the last five 

years have been worth $100 billion per annum for American consumers. Basically China buys a lot of commodities. In fact, its commodity demand is so great it’s pushing up the price of copper, aluminum, and steel, but turns it into very cheap final goods, which 

in turn enhance our living standards. 
84

Now, the jobless issue is a very profound one, and just a few 

numbers to put it in perspective. Since President Bush became 

President three years ago, we’ve lost 2.7 million jobs. No American 

President since Herbert Hoover has lost jobs on this scale. Even 

the Presidents we think were failures outperformed the current 

President: his father, ten years ago, 2.6 million jobs; Gerald Ford, 

terrible recession, 2.8 million jobs; Jimmy Carter, a disaster, plus 

10 million jobs. 

This is a very unique period, and I fear that if the 5-percent GDP 

growth we’re now experiencing here in the third and fourth quarters doesn’t give us two or three hundred thousand jobs in the 

fourth quarter, even President Bush may resort in the new year to 

protectionist trade policies, big dollar devaluations, who knows 

what, because he doesn’t have any policy levers. We’ve got a massive budget deficit. Interest rates are 1 percent. Where else do you 

go to find jobs but to bash foreigners? It’s really a political choice, 

perhaps. 

But as Steve just indicated, the bottom line is: What will produce 

a highly competitive, highly entrepreneurial economy to produce 

jobs and produce wealth? And the answers are always the same. 

A good level of savings and investment, a well-educated labor force, 

a reasonably good set of institutions to make the economy function 

correctly. 

Our savings rate is the lowest in recorded history. That’s why 

our current account deficit is so large; our budget deficit is massive, 

because we have, since September 11th, taken on some major responsibilities. 

I would add that the budget deficit has not cost us jobs. If we 

had not had the big budget deficit, the big increase in defense 

spending, we might have lost four million jobs, not 2.6 million. The 

deficit is helping in the short term. But in the long term, we have 

to bring it under control to get that savings and investment balance right, to have a high-growth, prosperous economy. 

So the policy answers are not complex. They’ve been there for a 

long, long time. We know about them, but they do require political 

will, they require some creativity, and they require some courage 

from the people who are responsible for making public policy. 

Co-Chairman MULLOY. Commissioner D’Amato. 

Commissioner WESSEL. Can we hear from Mr. Preeg? 

Co-Chairman MULLOY. Oh, I’m sorry. 

Dr. PREEG. Well, two quick comments. 

First, obviously there are a lot of factors in play. I just want to 

say that this week we put out a book called ‘‘U.S. Manufacturing: 

The Engine for Growth in a Global Economy.’’ I’m co-editor. It has 

the full thing. There’s a lot about fiscal policy, the deficit, about restructuring to have enough incentive for innovation and investment. There’s a lot about tort reform. There’s a lot about health 

care reform. So there are lots of things we should be doing to make 

sure our manufacturing industry keeps its momentum. 

But I don’t think we should lose sight of the fact—which is the 

subject of this hearing—the exchange rate issues, because this is 

only one part, but it’s an important part, substantively, and it does 

have the potential of moving into protectionist directions. And in 

our membership, we have 450 companies, manufacturing compa-
85

nies. We’re essentially a private sector think tank, a lot of interaction. They’re all interested in China when you put the question 

to them. But if the exchange rate were 40 percent different or even 

20 percent, not everyone but a lot of them say: Well, then we would 

do it differently. Then we could keep our contracts here. They 

would restructure. 

It’s a very dynamic, changing circumstance, but a major revaluation of the Chinese currency, in my view, would have quite substantial effects, as we said, perhaps $50 or $100 billion of a trade 

deficit. That’s very substantial. 

Commissioner WESSEL. If I could just clarify one thing, I believe it was Dr. Bergsten who said that a $100 billion switch would 

equal roughly 500,000 jobs. Is that an estimate that you’d agree to? 

Dr. PREEG. It’s generally 10,000 per billion. A hundred billion is 

a million jobs. 

Commissioner WESSEL. Thank you. 

Co-Chairman MULLOY. Commissioner D’Amato. 

Vice Chairman D’AMATO. Thank you, Mr. Chairman, and I want 

to thank the panelists for their testimony. I think this is the kind 

of debate that we were hoping for. 

I would like to point out that if we were intending to have a massive one-sided hearing, we certainly would not have invited this 

panel. We certainly would not have invited Dr. Roach. 

So I would like to just make that point up front. We enjoyed having his testimony because we have a lot of preachers here. We had 

a number of preachers this morning, and I think we have some 

preachers this afternoon, too, on each side of the issue. And, Dr. 

Roach, I don’t want to single you out, but I think that you make 

a textbook case for globalization and for multinational corporations. 

You say, ‘‘. . . in the end, we must all learn to live with the stresses 

and strains of globalization’’—for some reason. ‘‘Our commitment to 

globalization should be unwavering in bad times as well as good 

times. . . .’’

And I just would like to point out that the emotion you saw this 

morning it is palpable. It’s really coming hard at us. And there are 

reasons that there is a lot of smoke out there, and usually where 

there’s smoke there’s fire. So, I think that there are some legitimate issues on both sides of this case. 

When I think of globalization and multinational corporations, 

you’ll forgive me, but I think of corporations like the Big Eight accounting firms, like Tyco, like Enron, like WorldCom, like Global 

Crossing. And I think of fraud, massive fraud, and criminal behavior. One can make that case, too. Now, quaint as the Congress is, 

it’s useful to have regulatory operations on behalf of average people. 

When we had the debate over PNTR for China—it’s true that the 

Administration made very clear arguments, without which and it 

would not have been passed by the small majority it did in the 

House, i.e., without these arguments—that the Chinese were going 

to be brought to a rule-of-law system, they were going to be abiding 

by their WTO commitments, and we were going to ensure that they 

did so. 

The second set of arguments—which you may not remember, but 

we remember—is that this would inevitably lead to openness in the 
86

Chinese society as well as the Chinese economy and would lead to 

democracy. These arguments were made very, very strongly. And 

what this Commission has found out through its assessment of 

what happened in the SARS crisis and the post-SARS crisis is that 

democratic reforms and openness in democracy have not occurred 

in China. Indeed, the regime seems to be going in the opposite direction. 

So we’re worried about that because, if were going to create a 

very, very powerful China and the assumption was that it’s going 

to be a China that’s based on openness not only in the economy but 

in its society and political system, there is some reason for worry. 

So we’re worried about is the extent of China’s commitment to the 

rule of law. 

Now, as Mr. Preeg points out, in the manipulation, which is the 

subject of this hearing, manipulation of currency, we regard that 

as a violation of their commitments under the IMF and the WTO, 

and that is the rule-of-law process that we were told is going to be 

enforced. 

Now, today, we don’t have any representative from the Treasury 

Department here. We’ve invited the Treasury Department for the 

last month, tried to get somebody from Treasury to testify. 

Co-Chairman MULLOY. Two months. 

Vice Chairman D’AMATO. Two months. And guess what? Nobody 

was available, but they would send up their testimony. 

Well, we just found out that the testimony was written and approved in Treasury, sent to the White House, and the White House 

decided, no, we’re not sending that testimony up. So the White 

House is sitting on the testimony. They say we’ll get it in a couple 

of weeks. 

So the question we have then is: What is the commitment of the 

Administration to addressing this question of manipulation of currency as an example, an important example of enforcing the rule 

of law? This country prides itself on honoring its commitments, and 

we have a history with the Chinese not really complying with the 

commitments they have signed with us. 

The WTO was going to be different, and we’re hoping that it will 

be different. But in order to enforce those commitments, we need 

to be tough. The Administration has got to go along with the Congress in being tough and enforcing those commitments. Otherwise, 

where are we going here? 

You’re going to get that kind of emotional reaction from the 

Members of Congress who see us being used and a system that is 

being rigged against us. 

But let me ask all the panelists this question: Do you agree that 

this currency manipulation is, in fact, a serious matter and conforms in many respects to 19th century mercantilism? This is certainly not globalization. This is mercantilist behavior. This is not 

the kind of thing that you’re talking about. And if the Chinese are 

practicing mercantilism and we are promoting a rule of law, what 

is it that is going to bring the Chinese into conformity to these 

agreements? If they do not you will certainly see an acceleration 

of the emotion you saw this morning in the political arena, and it 

will overwhelm everything. 

That’s my view. Can you comment on that? 
87

Dr. ROACH. Well, I take your warning and your concerns very seriously. It is certainly clear to me, even before I came here this 

morning, that this is a very serious issue. Now, having heard the 

debate firsthand, I go back with even deeper concern than I had 

before I left from New York this morning. This is a very, very worrisome development. 

Ernie Preeg makes the case for currency manipulation being a 

violation of IMF and WTO/GATT provisions, and he clearly knows 

a lot more about that than I do. But what is important to understand is he did not make the case to single out China. He made 

that case in the context of anyone who is manipulating their currency, especially wealthy countries like Japan who has intervened 

massively in excess of $80 billion so far this year to prevent its currency from reaching fair value. So the risk is again in singling out 

China, a very poor country, especially compared to Japan, that this 

is scapegoatism at work. It is not what we as the world’s greatest 

nation should feel proud of. 

In terms of the WTO promises that we think we had when we 

got into this agreement with China, I think you have got your finger on exactly the remedy. If there is a consensus of opinion in the 

body politic in the United States that China is in violation of the 

spirit under which it has joined WTO, then the remedy is simple. 

This was the whole idea of WTO accession from China—to bind 

them to a rules-based system that we have control over. So if you 

believe there is a violation, call them up on charges and make 

them be accountable for their actions. That is what this system is 

all about. We just can’t complain about it. If we feel strongly that 

they are violating international standards that they have agreed to, 

then let’s make them explain their case, defend their case, and subject them to the penalties if in fact they are in violation. I happen 

to think they are not. There are estimates in written my testimony 

that look at the value of renminbi relative to a basket of currencies 

that China trades with. It does not show anything all that out of 

line, nor does China’s trade surplus on an overall basis. These are 

the types of issues that need to be debated in establishing the merits of the concerns that are addressed here today. 

Again, I just reiterate my basic concern. I hear you. I think the 

emotion in Washington is high. It cannot be taken lightly, but it 

is up to us as responsible citizens to try to understand that emotion 

and deal with it in a way that is not damaging to our country and 

to the broader global economy. 

Co-Chairman MULLOY. Dr. Preeg. 

Dr. PREEG. Well, as you may have guessed, I do believe it is a 

serious issue and I do believe we should, as we now seem to be 

agreeing, we should be calling the other—if in fact we find them 

in violation of their commitments, we should say so and do something about it. 

Just a correction though. The assessment of what they are violating is not on some of these broader measures, but it is very 

clearly protracted large-scale intervention in one direction. That is 

the direct policy action that pushes the currency down more, and 

here it is quite clear. 

Now, what the policy background is for, what should happen 

next, it goes back to the Omnibus Trade Act of ’88 when the Con-
88

gress took the initiative. Currency manipulation is in there. Twice 

a year the Secretary of the Treasury has to say, ‘‘Has anybody been 

manipulating currency?’’ Consistently, over all the years, they said 

a brief statement, ‘‘No.’’ They have never mentioned Japan or 

China once in 15 years. I have talked to some of the people writing 

these statements. I do not want to get too much into it. 

The reason is, first of all, once you say they are in violation, you 

have to do something about it. And we finally reached that point, 

because they never said it, even Secretary Snow. He has used the 

term currency manipulation, but he has never said it is a violation 

of IMF Article IV or Article 15. We are coming up in the next report in October, and I think one reason they are probably sitting 

on your statement is that they know that people for once are actually going to pay attention to what he says. Because usually he just 

goes—I was there at Senate Banking. I was testifying along with 

Secretary O’Neill a year ago, and it was a two-sentence statement 

saying, ‘‘Oh, we did not find any.’’ So it is really coming down. 

But if he once says, ‘‘Yes, we believe they are in violation,’’ then 

he has to push ahead, and then you are going to have real pressure, and I would presume that there would be movement for a lot 

of reasons. The protectionists, all the reasons Fred said, that it is 

a mutual interest to deal with this issue. 

Vice Chairman D’AMATO. Let me just make one statement, if I 

may, Mr. Chairman. 

Yes, the new report will be coming in October, and I am hoping 

that this hearing will help to generate some interest down there in 

getting it done on time. 

The last report, have any of you recently read anything by 

Kafka? I think they have subcontracted with Kafka to write the exchange report, because the last one I have here, July 2002 to December 2002, quote, ‘‘No major trading partners of the United 

States manipulated exchange rates.’’ Okay. So there you have 

Kafka. 

Dr. PREEG. That is the full analysis called for in the Trade Act, 

one sentence. 

Vice Chairman D’AMATO. If they were to find that there was manipulation, then by the law of the Trade Act of ’88, the Administration has got to start negotiations to it. 

I think this next report is going to be where the rubber meets 

the road, as they say, on this issue. 

Co-Chairman MULLOY. Before we turn to Commissioner Dreyer, 

just let me say I was with the Banking Committee when that provision was put into the ’88 trade bill. Treasury Under Secretary 

Mulford used it a couple times. He identified Taiwan and he identified Korea, early on, ’89, ’90 period. And when he was there, they 

were even talking about China in ’90, ’91 period. But then things 

changed and the leadership of the Banking Committee changed. 

Senator Gramm became Chairman, it became less important. So 

last year was the first time the Committee held a hearing on that 

provision in six or seven years. And Chairman Shelby got a commitment out of Snow in a hearing two months ago that Snow 

would be back up with that report and testifying on it in October. 

Commissioner Dreyer. 
89

Dr. PREEG. Just in response, I agree with you and there were 

early on a couple references to Taiwan, but Taiwan, I did mention 

earlier if we were pursuing Taiwan and China evenly on this, I 

think it would help the bilateral relationship with China. Let me 

just, one sentence. Taiwan is significant, not only because Taiwan 

is a long-term manipulator, with foreign exchange holdings, 186 

billion now, up 30 billion in the last 12 months. They have a much 

smaller economy and so pro rata they are right up there with 

China and Japan and they really should be brought into this as 

well as South Korea. 

Co-Chairman MULLOY. Commissioner Dreyer. 

Co-Chairman DREYER. Dr. Roach, I totally agree with you when 

you say that we need to fix our budget deficit. I am also with you 

when you say we, as Americans really should think about saving 

more before we complain about others. A third factor which you did 

not mention, but which I hope in future testimonies you will, is 

that we should fix our educational standards in this country, which 

are rotten and abysmal. I am a professor. I have carte blanche to 

say this. Increasingly, this mantra of ‘‘leave no child behind’’ means 

dumbing down educational standards so that every child can pass, 

and this is particularly true in science and technology. This is the 

reason that increasingly our high-tech companies import their talent from China, from Bangalore and from where-have-you. 

That said, I beg you to consider that there are some nuances to 

some of the other things you said. One of them is that China is a 

poor country, and what I see increasingly is that yes and no, increasingly there is a poor China getting relatively poorer in the 

hinterland. On the coast you have a wealthy China getting wealthier. It is this China that we need to be concerned about. 

China, yes, as you say, basic manufacturing, but it is getting 

more high-tech all the time. This Commission has listened to testimony in another venue of Boeing executives who agree that they 

will set up a production facility there if the workers are trained, 

and the workers are no sooner trained then they decamp and a 

whole new set comes in to be trained. This is not quite the way it 

was going to work. 

Your statement, if we did not buy from China, we would have to 

buy from somewhere else, sure. But if we buy from Malaysia and 

Indonesia and Philippines, we are not buying from a country that 

is developing a high-tech weapons industry with the avowed purpose of beating, quote, ‘‘a certain superpower that is technologically 

very powerful.’’ That is a category of one. 

I think in your ‘‘why are we worried so much about China’’ you 

really must take these other factors into consideration. I suppose 

I am barking up the wrong tree when I ask an economist to consider non-economic factors, but nonetheless, once in a while some 

of them are relevant. 

Dr. ROACH. Look, I think it is critical for all of us, politicians, 

businessmen, economists, to think holistically. So much of what 

you just said resonates—especially the point on education in America. I have 6 children that have completed various phases of the 

educational system, and 2 of them are in the labor market right 

now—looking for work. Believe me, it is not an easy search. 
90

And economics is not a science. The problem is that we spend a 

lot of time on statistics and mathematics and think we have the 

answers. Yet the real world is the interplay of economics, politics, 

sociology and global forces that are well beyond anything we can 

capture in our old models. Unfortunately, we use these old models 

to estimate the future when the future is radically different than 

any of the history on which these models are built. And that is one 

of the challenges of globalization. The issues that you raise are profound and those are the ones that we need to look at. The military 

considerations that you raised with respect to China are something 

that I leave it up to you—that is your charge. I know nothing about 

that. Those are the judgments that you are empowered to make. 

But again, the thing that concerns me the most about this 

issue—and I just go back to the point I made at the outset—is that 

we have a problem in America. It’s a big problem that is coming 

to a head right now. As Mr. D’Amato just said, it is the job issue, 

and how do we deal with this job issue? The educational point that 

you just made has got to be central to the solution because that has 

always been our edge. If we lose the edge—investing in human capital—then the job issues we are facing today are going to get worse. 

That is not economics. It’s common sense. 

Co-Chairman MULLOY. Do you have time to take—we have two 

other Commissioners who have questions for you. 

Mr. HALE. I have another conflict, yes, because you said 1 o’clock. 

Co-Chairman MULLOY. I know that. So, Dr. Hale——

Dr. PREEG. I will answer for him. 

Co-Chairman MULLOY. Thank you again for being with us. 

Commissioner Robinson, did you have something? 

Chairman ROBINSON. If I might, as a follow-on to Commissioner 

Dreyer’s remarks, I’ve reflected on some of the frustration that you 

heard on the part of Members earlier in these proceedings. Like 

our Commission, their mandate is to explore not just the economic 

and financial dimensions or layers of the bilateral relationship, but 

the strategic, political and military side of the equation. We heard 

a number of thoughtful remedies and perhaps even some over simplification of the nature of the challenges we face here, both on the 

trade and currency fronts. 

But it is looking at that integrated picture which most Members 

have to cope with. As Commissioner Dreyer was talking about, we 

see a robust offensive military buildup, one of the world’s leading 

proliferators of weapons of mass destruction, ballistic missiles, a 

human rights abuser, ICBMs targeted at the United States now 

with ever more accurate mobile varieties, either already deployed 

or in the pipeline, not to mention the threatening of Taiwan’s autonomy and way of life as a fairly ongoing event. 

So we are also coping with what China is doing with its large 

export surpluses, with the funds that it is attracting through FDI 

and that inordinate sucking up of the East Asian percentage of 

FDI. Another example is what kind of Chinese entities are coming 

to our capital markets to attract funds and what are they doing 

with those funds? 

So there are a number of issues here that differentiate China in 

important ways from Malaysia, Singapore and our other trading 

partners. Of course that is something I know you are aware of, but 
91

I just wanted you to also understand that some of what you have 

heard today is I think conditioned by this broader look at the bilateral relationship. 

Dr. ROACH. I am in favor of the broad look. That is what I am 

all about. I would say just two things in response. 

One, if we do have these deeper, broader issues with China and 

it is critical for us that we remain engaged with China rather than 

put up walls that cause frictions and distancing. I go to China 

quite frequently. At first they are hard to talk to. After a while you 

get to know them and they are very engaging. It is critical for us 

to stay engaged. Protectionism is the opposite of that. 

I think that the frustration that I heard the most this morning 

pertains to jobs. The frustration that you heard the most from me 

is that we are not reorganizing our role in creating the so-called 

China problem. I hold our fiscal authorities responsible right now 

for the most reckless outcome of U.S. economic policy that I have 

seen in my career. Their unwillingness to accept one iota of responsibility for their own actions is hugely frustrating to me as someone 

who has spent his professional life in financial markets as a practicing macro economist. So there are frustrations on all sides of this 

issue. 

I congratulate you for giving me the chance to vent some of my 

own frustrations as well. 

Co-Chairman MULLOY. We have one more Commissioner who has 

a question for this panel. Commissioner Becker. 

Commissioner BECKER. Thank you. I don’t want to beat a dead 

horse on this thing. It has been covered a little bit, rather broadly 

in a way. I would like to go back to what Commissioner Reinsch 

had asked about why don’t the Chinese buy from us, imports from 

the United States. 

I am concerned about why we cannot sell anything to the Chinese, any industry in the United States. Virtually all the small 

manufacturing has been shut down and either moved to Mexico or 

China. Usually they move to Mexico on a border, then they move 

to China. When one of them goes, then the others have to either 

go out of business or follow suit because people cannot work for 

nothing. You cannot compete against 25 cent an hour labor. When 

we talked about—Congressman Levin talked about democracy as 

part of the PNTR, the move in that direction. You do not have 

workplace democracy. Workers cannot share in the wealth they 

helped create. 

The bottom line is the hysteria that you talked about here in 

Washington on having to do something about the job loss and the 

plants leaving America, it is not just in Washington. I can take you 

to Ohio and Indiana and Pennsylvania and Detroit, Michigan, virtually anywhere. Now it has spread beyond the industrial belts in 

the United States. It is into the high-tech areas. I just do not know 

how this is going to level out and how you see this leveling out. 

If they don’t raise wages in China, and I don’t mean by pennies—

the differential that showed up in some of the testimony here was 

$26 for manufacturing, high-paying manufacturing jobs, $26 an 

hour versus 25 cents an hour in China. 

We are concerned about what this leaves us here. If we continue 

down this road with nothing being done, we are going to lose all 
92

the manufacturing industry, all of it. So people are grabbing. Right 

now they are grabbing on the exchange rate as something that may 

be like a magic bullet and turn things around. I think it is much 

deeper than that. 

You mentioned the multinationals, the large corporations being 

secure, like the General Electrics and the General Motors. The fact 

of the matter is what they do is they have called all their suppliers 

together and have told them they are going to relocate into China 

so that they can lower the price of the product that they buy. I 

mean this is truly a race to the bottom, that we are looking for 

something in there that is going to give some help in that. I do not 

see that. 

If you have anything that you would add to that or comment on 

that, I would appreciate hearing. 

Dr. ROACH. I understand your concerns, and I will just say a couple things. I do go to China a lot. I take the opportunity to walk 

into stores, not just the glitzy ones, but some of the smaller grocery 

stores off the beaten path. One of the things that first of shocked 

me that there is an awful lot of U.S. branded products sitting on 

shelves. The Chinese are poor people. I take your point on the two 

Chinas, but I do not share the idea that on the coastal region you 

have a wealthy, vibrant Chinese economy. You have a Chinese 

economy that is moving ahead, but they are many, many multiples 

behind what I would consider to be a wealthy, prosperous nation. 

They have an appetite for American products. They have an appetite for American services. You go down the streets of Beijing, 

and you see that increasingly—whether it is fast food franchises or 

retail product. They have American brands on them. Whether that 

retail product is made in our textile mills in South Carolina, as 

Senator Graham would love it to be, is a fair question. But he has 

been losing textile jobs there for a lot longer than China has been 

a factor in the global economy. Is that China’s fault? 

You keep coming back to this question about where we are going 

as a nation. Then you also tell me that you are just charged with 

dealing with U.S.-China bilateral. Where we are going as a nation 

transcends the U.S.-China bilateral relationship. That is the context. Those are the questions that need to be addressed. I totally 

agree with that. But I also think if you just stick within your narrow guidelines here, you can come up with answers that could be 

inconsistent with the bigger picture. That does worry me a lot. 

Co-Chairman MULLOY. Ernie. 

Dr. PREEG. Well, to respond slightly broader, my impression this 

morning, which has been a very exciting morning for me, listening 

to everyone, is that there is this growing protectionist sentiment, 

movement because of the imbalance and all the problems with jobs. 

This is getting linked together with the exchange rate, the currency 

relationship. And free trade, I believe that we can both benefit by 

having open trade. We should keep pushing China to open up its 

system as they become more competitive. But I really do see that 

the currency relationship in the last few years has become a major 

issue that could trigger the protectionist backlash very easily. 

And what the challenge is—and I am just going to refer briefly 

to a paragraph—in case you don’t all get to read to page 7—because this relationship between ever more technology intensive 
93

manufacturing engine for growth and the trade balance is clearly 

evident in economic strategy throughout East Asia, including 

China. And this trade surplus, plus a net inflow of investment, it 

has been called mercantilism over the years, and as I say, in current East Asian form it can be more pointedly described as quote, 

‘‘advanced technology mercantilism,’’ and China is the outstanding 

practitioner. 

We just have to say that it is a mutual interest to have open 

trade investment. Comparative advantage means certain areas you 

are going to be more competitive, you have lower labor costs, but 

it has to be balanced, it has to be by rules that are in fact free 

trade rules. Right now the rule that is most out of line, if 40 percent is even roughly correct of their currency, that this is a major 

issue and if we do not do something about it there will be very likely the protectionist backlash we have heard so much about here 

today. 

Co-Chairman MULLOY. Let me just thank you both very much for 

being with us today. I would invite you both if you have further 

thoughts about a strategy we ought to be doing, we will welcome 

them. 

We are going to be back here at 2 o’clock with a panel of Dr. 

Peter Nolan of Cambridge University, Dr. Steinfeld of MIT, and 

Kate Walsh of Stimson Center, to talk about China’s effort to build 

its own industrial and technological base, and then at 4 o’clock a 

panel on the impact on the U.S. economy. 

Thank you very much. 

[Whereupon, at 2:00 p.m., the luncheon session concluded, the 

afternoon session to convene at 2:05 p.m., this same day.] 

AFTERNOON SESSION, 2:05 P.M.

THURSDAY, SEPTEMBER 25, 2003

REMARKS OF CHAIRMAN ROGER W. ROBINSON, JR. 

Chairman ROBINSON. Excuse me. If everyone will take their 

seats, we’ll begin the afternoon session, please. Thank you. 

Okay. We’d like to begin, if you don’t mind. We had a number 

of Congressional Members, seven in all this morning. For those of 

you who had an opportunity to attend the morning session, it was 

a very animated session and I think had immense value-added to 

the subject we’re here to discuss. 

Today the Commission holds the third in a series of hearings 

during the 108th Congress. Our first two hearings in June and 

July focused on the important topics of media control in China, specifically how it played out during the SARS outbreak and on China’s behavior with respect to the critical issue of the proliferation 

of weapons of mass destruction and ballistic missiles, with a focus 

on China’s pivotal role in the ongoing nuclear crisis with North 

Korea. 

Today we will be examining issues on the economic security side 

of our portfolio, namely, China’s exchange rate policies and industrial and investment strategies and their impact on the U.S. economy, particularly our manufacturing sector. These issues are currently receiving substantial media attention but have been in our 

mandate and on our research agenda from the first year of the 

Commission’s establishment. 
94

Indeed, in quoting one of the findings from our first annual report to the Congress in July 2002, ‘‘Continuing trade surpluses, 

vast investment inflows, and very high foreign exchange reserves 

are evidence that China is manipulating its currency by holding 

down its value, thereby gaining an unfair trade advantage that increases the U.S. trade deficit.’’

Our first-year report went on to state, ‘‘The Commission believes 

China’s currency manipulation needs to be addressed and that the 

Chinese should be pressured to change their exchange rate policy 

and eliminate capital controls. Moreover, while it is not presently 

in China’s interest to use its very large dollar reserves as an economic weapon against the United States, in the future this possibility exists.’’

In America, people in varying capacities—business, labor, academia, the media, and government—have come to better understand the almost tectonic economic forces now shaping the U.S.-

China economic relationship. With increasing sophistication, China 

has become a manufacturing powerhouse. Its central and local government policies have supported development of key industrial sectors. 

In the 1990s, China became embedded in what has become a 

global supply chain for many traded products and saw its share of 

global trade in manufactured goods triple. 

In the meantime, there is increasing unease in the United States 

over the declining share of manufacturing output and employment 

in our overall economy, and this is happening while China’s currency, the yuan or RMB, remains pegged to the U.S. dollar at a 

rate set by government fiat some nine years ago. 

What are the causes and effects here? What are the key linkages? Are there steps the U.S. should be pursuing to remedy these 

challenging and in some cases debilitating circumstances? 

Today we’ll be exploring these and other important questions 

with a distinguished group of panelists. We’re particularly honored 

that we have been joined this morning by several Members of the 

House and Senate from both sides of the aisle who contributed substantially to this hearing by giving us their valuable perspectives 

on these crucial matters. The Congress is profoundly concerned 

about the issues we’re discussing today, and a number of Members, 

as you know, have introduced thoughtful legislation, including that 

of Congressman English, who appeared before us as the first witness this morning, to address these concerns. We look forward to 

working with Congress as it moves forward in its consideration of 

appropriate remedies.

REMARKS OF VICE CHAIRMAN C. RICHARD D’AMATO 

Vice Chairman D’AMATO. Thank you very much, Mr. Chairman. 

I welcome this panel this afternoon. 

By way of a little background, the creation of this Commission 

in the winter of 2000 during the debate over giving China mostfavored-nation status on a permanent basis was predicated on several important assertions. 

First, the Clinton Administration stated that granting such status and admission to the WTO was predicated on the assumption 

that China would play by the rules of the international trade game 
95

and certainly not promote permanent unfair subsidies or mercantilist practices. 

Second, the National Security Adviser as well as the President 

stated repeatedly during that debate that it was in America’s, 

quote, ‘‘vital national security interests for China to be granted 

these important trade concessions.’’

A third assertion was that increased economic growth and higher 

standards of living in China would lead to democratic reforms, 

democratic political reforms, and the eventual extinction of the 

widespread tyranny practiced by the Chinese communist regime. 

So far, these assertions do not appear to be playing themselves 

out. China still has a poor record of honoring its promises and 

agreements, and this hearing focuses on one of the most important 

and glaring: artificially pegged exchange rates calculated to give 

China across-the-board highly unfair advantages vis-a`-vis its socalled trading partners. 

Second, this Commission has been created to examine the questions of the national security implications of the policies and practices by both the Clinton and Bush Administrations vis-a`-vis China 

on trade. The large-scale and increasing sophistication of U.S. resources being transferred, with increasingly important high-technology components is adversely affecting our basic economic foundation from a strategic perspective. 

Third, democratic reforms have been squelched in China. After 

some brief flicker of hope in connection with the SARS health crisis, openness is still treated as an enemy of the governing regime, 

and the regime still maintains a widespread gulag against its own 

people. 

Modern Chinese mercantilist practices have resulted in pouring 

billions of dollars of U.S. investment, technology, and manufacturing resources unfairly into China. This distorted transfer of economic treasure to Beijing is now very large, and Congress has told 

this Commission to evaluate the implications of it for U.S. national 

security and identify what tools we have to address this issue. 

Given these realities, the question today is what actions Congress should promote to push these trends in healthier directions 

for our own national interest. We look forward to your testimony. 

Mr. Chairman.

REMARKS OF COMMISSIONER PATRICK A. MULLOY

HEARING CO-CHAIR 

Co-Chairman MULLOY. Thank you. I wanted to note that we did 

have seven Members of the Congress here with us earlier today. 

They appeared as their schedule permitted, and we had a very 

good discussion. I should note that Senator Olympia Snowe, the 

Chairman of the Senate Small Business Committee—we had the 

Chairman of the House Small Business Committee. She has submitted a statement for the record, which we will put in the record, 

and we will get that around to all Commissioners. 

I think our witnesses should know that here is what we’re wrestling with. We were asked to look at the impact of the interrelationship between our economy and that of China and the impact on the standard of living of our people and our national security interest. 
96

Now, there has been tremendous erosion, at least many think, of 

our manufacturing sector, and that’s the context that we’re trying 

to look at this issue. Secretary of Commerce Evans spoke in Pittsburgh two weeks ago, and he said this: ‘‘The President believes 

that our economic and national security require a stable, robust 

manufacturing sector that produces sophisticated goods here in the 

United States.’’ That’s President Bush’s statement. The Administration is putting together a manufacturing initiative. 

So your help in helping us understand the Chinese economy, the 

multinational investments in China, and your interpretation of 

what this means will be very helpful for us in going forward and 

trying to tell the Congress what we found out in our investigation 

and what we ought to be doing. And so any policy recommendations that you have, as well as your analysis, would be most helpful 

to us. 

Thank you again for being here with us. 

Dr. Dreyer.

REMARKS OF COMMISSIONER JUNE TEUFEL DREYER

HEARING CO-CHAIR 

Co-Chairman DREYER. Welcome to the afternoon session of our 

hearing. For those of you who were not here this morning, we had 

a three-part focus: one, the value of the Chinese yuan, AKA the 

renminbi; second, China’s exchange rate policies; and, third, what 

policy options does the United States Government have in response 

to dissatisfaction with the way those first two are going. 

This afternoon, we have somewhat of a shift of focus. We want 

to look first at the dynamics of China’s strategies for attracting foreign investment and channeling both domestic and foreign resources into key industries and technologies. 

A number of observers of China believe that this topic and not 

just the exchange rate question per se is the key to assessing the 

overall impact of China’s economic policies and development on the 

U.S. economy. 

We’ll be considering the factors behind the remarkable growth of 

manufacturing capacity in China, now dubbed ‘‘the workshop of the 

world’’ or ‘‘the shop floor of the world’’ for the 21st century and 

what are the implications of this for the United States economy. 

One obvious driving force is the global search for low-cost production of quality goods, and this has led increased domestic and foreign investment in expanding such production capacity in China. 

The determining factor here is often low-cost labor, but other factors in this growth and capacity can stem from the Chinese government’s own industrial policies, for example, its designation of certain pillar industries as well as policy and financial support for key 

manufacturing infrastructure, science and technology, and research 

and development projects. 

Other factors may be more related to globalization in general 

than to China in particular, such as the way transnational corporations operate globally integrated manufacturing and distribution 

networks with China, as an important node embedded in an overall 

web of production. 

Another key factor at work here is the speed with which Chinese 

manufacturing and research and development are moving up the 
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value chain to encompass more technologically advanced products 

and research. 

We’re going to hear today from three expert witnesses who have 

studied the development of China’s export-oriented manufacturing 

segments and its connection to the global supply chain. 

Professor Peter Nolan of Cambridge University has written extensively about China’s connection to what he calls the global business revolution. 

Professor Ed Steinfeld of MIT has researched China’s industrial 

policy and done case studies of large Chinese firms’ performance in 

the domestic and global marketplace. 

And Kate Walsh, Senior Associate of the Stimson Center, has 

done field research and written a monograph on the growth of foreign-funded research and development activities in China. 

I just happen to have a copy here of Foreign High Tech R&D in 

China, a very interesting book worth your while. I do not get a cut 

on how many copies Kate sells of this. And I commend Ms. Walsh 

for being not only extremely informative but, an aberration for academics, you are very concise as well. 

Now, each panelist comes at this question of China’s industrial 

and investment priorities and strategies from a somewhat different 

angle, and I expect we’re going to get a good multidimensional picture from the collective testimony and the follow-on discussion. 

The second panel and final panel of the afternoon, we’re going to 

hear testimony from four witnesses, also with differing perspectives, in this case on the question of how the U.S. economy is being 

affected by China’s exchange rate and its industrial and investment 

policies and trends. 

Our panelists in the second panel will be Frank Vargo of the National Association of Manufacturers; Thea Lee of the AFL–CIO; 

Paul Craig Roberts, who chairs the Institute for Political Economy, 

and he was formerly an Assistant Secretary of Treasury; and Willard Workman of the U.S. Chamber of Commerce. 

I anticipate that your collective statements and follow-up dialogue with us will reveal a broad range of views and different emphases on policy prescriptions. 

My fellow Co-Chair here has shoved timing regulations that I am 

supposed to let you know about. Each of you is going to be given 

seven minutes to present his or her oral remarks, and we’re going 

to ask each member of the panel to present testimony before beginning the question-and-answer period. 

Now, our ground rules, lady and gentlemen, are that we are 

given five minutes for each round of questions, and this includes 

the time not only that we ask but the answer that the panelist 

gives. And so you are, I supposed, allowed to yell ‘‘unfair’’ if some 

Commissioner takes up time with a four-minute question. 

I’m going to have a light here, and it will go from green to yellow 

when there are two minutes left, and it will flash red at the end 

of the allotted time and also make a very annoying noise. 

Okay. Without further ado, Professor Nolan, could we start with 

your testimony?
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PANEL II: CHINA’S INVESTMENT STRATEGIES 

STATEMENT OF PETER HUGH NOLAN, Ph.D.

SINYI PROFESSOR OF CHINESE MANAGEMENT

UNIVERSITY OF CAMBRIDGE 

Dr. NOLAN. I’ve tried in my paper to suggest that understanding 

this question is best viewed in a wider context of China’s system 

fragility, and I think China’s political economy is at a critical and 

very difficult stage in its evolution. Most fundamental is the question of poverty and the fact that it has 800 million people who 

earn, on average, about 85 cents a day; 150 million migrants who 

flock into the cities and earn between $1 and $2 per day; and all—

everything about China’s political economy, a huge amount of 

things flow from this reality. 

In addition, China is at a crisis in terms of its environmental situation. The party itself is in what can only be described as a crisis, 

self-recognized and attempting to be self-diagnosed. The financial 

system is also, in everybody’s view, in an acute state of crisis. 

In addition, China is confronted by an extremely difficult situation in international relations, and its relationship with a much 

stronger global power, the United States. This clearly stands at the 

very front of every consideration in China’s politics and economics. 

However, on top of these very difficult questions of system fragility lies the issue of China’s relationship to the global business 

revolution. China undoubtedly has intense ambitions to create a 

group of globally competitive large corporations—that has existed 

for the last 20 years and that still exists today. That ambition extends not just from the center but also down to the provinces and 

to the cities and even to lower levels. And China has learnt and 

studied the experience of past countries that successfully initiated 

and carried out industrial policies, including Hamiltonian policies 

in the United States through to the policies of Japan and Korea in 

more recent times. 

We can say China has been very successful in various ways. It 

absorbs huge amounts of FDI, as we know, which is one of the 

main reasons we’re here today. There’s been a massive rise in the 

value of low-value-added manufactured goods, a huge rise in output, and China can point with pride to 11 firms in the Fortune 500. 

However, I believe it’s essential for the Commission to truly understand, apart from these headline figures, the nature of the competitive capability of China’s corporations in order to reach appropriate policy conclusions. 

First of all, all of China’s Fortune 500 firms are highly protected 

state-owned enterprises, mostly with huge manning levels. They 

are not globally competitive firms. China has just one firm in the 

world’s top 600 firms by R&D expenditure. It is a minnow in terms 

of the generation of R&D knowledge on a global scale. 

If we look at China’s high-technology sectors—semiconductors, IT 

hardware, aerospace, pharmaceuticals—China’s firms lag a long 

way behind the global leaders, and in this regard we can say that 

China’s catch-up compares very unfavorably with that which was 

achieved by Japan in a very different epoch, both politically and 

economically, in the 1950s, 1960s, and 1970s. 

In mid-technology sectors, also, the so-called pillar industries—

like autos; sectors such as earthmoving equipment, which are less 
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widely studied; lifts, which people hardly think about—lifts for tall 

buildings, but they’re very important; medical equipment; large 

power stations, over 600 megawatts—in these sectors, also, there 

is an immense gap between China’s indigenous firms and those 

that are successful in the global environment. 

Even in low-technology sectors, it’s not as simple as it might 

seem. Everybody imagines that a simple product like a soft drink 

or a simple product like coal is naturally an area in which China 

can excel. But there are high-valued-added sectors in even the coal 

industry and, of course, simple consumer goods have behind them 

immensely capable and long-developed global brands. And in these 

sectors, China also is far behind the global leaders. 

So we can say, why has China’s industrial policy faced such difficulties? Why can we say that in many senses it has not succeeded? There are many internal questions which I shall not discuss at this point in this brief presentation, but concentrate instead 

on the reality, the extraordinary reality that is so challenging for 

us all, for me as an Irish-origin British citizen standing in the middle of it, and for the United States, and for China. And I think it’s 

useful to not be a part of either civilization or culture. 

The reality is China has joined the global economy at a stage in 

which concentration of business power has never, ever been greater, and that is the challenge for everybody. This period has seen 

an explosive merger and acquisition, the period in which China 

was thinking about joining the WTO. During my own studies in the 

course of the China Big Business Program, it was amazing. Every 

few months something explosive happened in the course of our initial studies involving both Chinese and Western firms. 

This period has seen the full flowering of competitive concentration. There is almost a universal rule; the top four, five, or six 

firms account for 50 to 70 percent of global markets: aerospace, 

autos, pharmaceuticals, power equipment, IT hardware, software, 

ice cream, tobacco, beer, soft drinks. The list goes on and on and 

on. 

In our studies in China and our policy discussions, a common observation was if we can’t win and tackle the global systems integrators, at least we can compete further down the value chain. And 

my answer to the Chinese in these discussions was think very carefully about what the nature of the global value chain is. 

We have identified a process that we call the cascade effect 

whereby concentration amongst first-tier systems integrators—in 

autos, aerospace, soft drinks, other sectors—flows like water down 

the hill over the companies that are below it, and they force them 

to concentrate, to meet their needs on a global basis in industry 

after industry after industry. 

So, for example, in our discussion with the aerospace industry, 

the people said, well, where in the value chain can we sit? And we 

said, well, at the moment it’s pretty difficult because you can’t compete with GE, Pratt & Whitney, and Rolls Royce because they control 100 percent of the aircraft engine market, and that’s the first 

tier of the value chain. And you can go further into the first tier 

of the value chain in aerospace. 

In automobiles, you may not be able to compete with VW or Ford 

or General Motors or Toyota, but you can compete with whom? 
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With Bosch, with Denso, with Valev, with Visteon, with Delphi? 

These are giant, immensely capable corporations that have now 

concentrated whole segments of the vehicle under their control and 

through their capabilities provide better and cheaper products and 

orchestrate the whole value chain. But the challenge for China’s 

business thinkers and leaders and politicians is absolutely immense and far beyond what it appears at first sight. 

This is an immense challenge, and, of course, all these firms, almost without exception, are located in the high-income countries, 

have their headquarters there, and a very large fraction of those, 

of course, are American, but not exclusively. Many of these are also 

Japanese, and a certain proportion are European. 

So, in conclusion, in sum, two simple conclusions that I would 

suggest. If China wishes its large firms to make progress and catch 

up with the global leaders, I can see no way in which it can do it 

without some kind of industrial policy. The idea that on the global 

level playing field by exposing China to competition spontaneously 

large Chinese firms will emerge and compete, I think, on any widespread basis is a fantasy. 

Alongside that, there undoubtedly is intense interest, hopes, and 

aspirations amongst all sorts of people at every level of the political 

system, from the center to the province to the city, to try and build 

their own successful firms that can compete, provide employment 

and technology for their own people. And I stress, without industrial policy, I cannot see how that can possibly happen on any 

widespread basis. 

If the WTO rules are really strictly applied—and I’m not an expert, a lawyer, on WTO rules. But if they were strictly applied, it 

seems to me this would lead to a steady, indeed a rapid increase 

in the already substantial dominance in many sectors of the modern high-value-added sector of the Chinese economy—not, of 

course, those producing for the myriad of Chinese poor people by 

the global giants. And June mentioned China is becoming the 

workshop of the world. I prefer to think of the phrase ‘‘workshop 

for the world.’’ It is nothing like the workshop of the world of Britain. Britain produced all the high-technology products of the world. 

It supplied the engines to America. It supplied the steel rails to 

America. It supplied textile machinery across the world. China 

today, their firms are not in the same league in this competition, 

but China is the home for many of the world’s global corporations, 

not its own corporations as the workshop for the world. 

The strict insistence, if successful, of the application with WTO 

rules in full I believe will be very likely to contribute to overall systems instability in China through the impact on unemployment. Already 40 or 50 million people have lost their jobs in SOEs. And 

when one talks about—I’ve just come back from researching in Malaysia and the Far East—about hollowing out 40 to 50 million people in China who’ve lost their jobs in SOEs surrounded by 800 million poor people, it’s a very different environment for hollowing out. 

It’s an immense challenge for the Chinese government. They have 

their own huge hollowing-out problem despite absorbing the FDI of 

the world. It’s very challenging for them, as it is for us. 

I think also, finally, the impact on social inequality is likely to 

be very, very large. And if this process proceeds too rapidly, then 
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one has to wonder whether the social structure is capable of absorbing this process. 

A final, final word. I think the impact on Chinese political consciousness has to be considered. The Chinese people are proud, 

have a long history, and if in the full application of the rules of the 

WTO in a successful way China’s firms were to lose out in every 

significant respect and China was to become, if you like, a dependent economy, albeit one that had lots and lots of industrial manufacturing taking place within it, then one should not underestimate 

the sense of disappointment, impact on national consciousness, and 

that in its turn would also have a contribution to make to system 

instability. 

[The statement follows:]

Prepared Statement of Peter Hugh Nolan, Ph.D.

Sinyi Professor of Chinese Management, University of Cambridge 

System Fragility, Industrial Policy and China’s International Relations, 

With Special Reference to Strategic Industries

1. Introduction

This paper examines the motivation for, and the outcome of China’s industrial 

policies in key strategic industries and considers the consequences for China’s relationship with the high-income countries, especially the USA. 

For almost two decades China has implemented a wide range of industrial policies, with the stated aim of nurturing indigenous ‘‘national champions’’ (as well as 

local ones). Despite these policies, China has been unsuccessful in producing a group 

of globally competitive large firms. At a comparable stage in its development, Japan’s industrial policies had nurtured a large troupe of several dozen giant, globally 

competitive firms, with global markets, global brands, and leaders of global technology in their field. They were also in the forefront of global management systems, 

having developed an immensely effective structure consisting of an extended supply 

chain around the core companies. 

China is in the remarkable position of becoming the ‘‘workshop of the world,’’ but 

in a quite different sense from that of Britain in the nineteenth century. British 

firms were uniquely powerful in the world’s most advanced technologies, exporting 

their high technology products across the world. China has become the home to 

most of the world’s giant corporations, either producing directly in the country, or 

using it as a source of procurement. These firms’ investments have contributed enormously to the progress of production systems within China. However, among successful late-comer countries China has become uniquely dependent on global capital 

and technology, and production within the production systems of foreign firms. This 

new phenomenon is a challenge for policy makers in both China and the high-income countries, especially the USA. 

The analysis contained in this paper raises some obvious questions: Should China 

abandon industrial policy, or should it pursue it with renewed vigour and in new, 

creative ways to meet the unprecedented competitive challenge that face large indigenous firms on the global level playing field within the WTO? Is it possible for global giant firms to build their production systems in China while China itself simultaneously nurtures a group of globally competitive large indigenously owned firms? 

The dimensions of the policy challenge for both China and the USA are even 

greater if we recognise the fragility of China’s political economy within which the 

explosive growth of these production systems is taking place. Section 2 of this paper 

outlines some of the key aspects of these challenges. The rationality of international 

pressure to force China’s compliance with its WTO obligations, to abandon industrial policy, to fully open itself to multinational direct investment, to allow market 

forces to determine the exchange rate and permit free movement of capital into and 

out of the country, must be considered in relation to this wider environment of political economy and the possibility of system collapse. 

Section 3 summarises the evidence concerning the competitive capabilities of China’s large firms today, shortly after China’s entry to the WTO. It concludes that in 

the markets for high value-added goods and services, China does not yet possess 

any globally competitive large firms. This is partly due to the internal difficulties 

that China faces in implementing industrial policy. However, even more important 

is the fact that the competitive environment internationally is quite different from 
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1For a fuller treatment of the issues analysed in this section, see Nolan, 2003. 

that which faced previous late-comer countries. China is rapidly integrating with 

the global economy at a time when the concentration of business power among firms 

based in the high-income economies has never been greater. 

The intense international pressure upon China, especially from the USA, to abandon industrial policy needs to be considered in relation to a realistic appraisal of 

the dimensions of this challenge and the likely outcome of abandoning industrial 

policy. In order to provide a more realistic evaluation of these potential consequences, the Appendix analyses in closer detail the challenges facing China’s national champions in the critical strategic sectors of aerospace and oil and petrochemicals, which have themselves formed the object of sustained industrial policy 

in the USA. 

2. China at the Crossroads 1

China has achieved remarkable results in its social and economic development 

since the process of ‘‘reform and opening up’’ was initiated by Deng Xiaoping over 

two decades ago. However, that same process has produced a series of formidable 

challenges for the entire system of political economy. One of these is the challenge 

of the Global Business Revolution, which is analysed in Section 3. The other principle challenges are outlined in this section. 

Poverty, Inequality and Social Tension

Behind almost every aspect of China’s development process in the early 21st century lies the harsh reality of the ‘‘Lewis model’’ of ‘‘economic development with unlimited supplies of labour’’ (Lewis, 1954). 

China has a huge population of almost 1.3 billion, increasing by over 15 million 

each year (SSB, ZTN, 2002). Almost 70 percent of the Chinese population still lives 

in the countryside. Employment in agriculture is stagnant, and there are estimated 

to be as many as 150 million ‘‘surplus’’ farm workers. As the impact of the WTO 

on Chinese agriculture (and on rural township and village enterprises) increases, 

pressures on rural employment will intensify. The unavoidable reality is that the 

level of rural underemployment will continue to rise rapidly in the early years of 

the 21st century. Since the late 1990s, rural real incomes have fallen year upon 

year. 

Despite the decline in absolute poverty in the early years of China’s rural reforms 

(Nolan, 1988), there still are huge numbers of people who are absolutely poor in 

terms of international poverty lines. The average per capita income of China’s 800 

million rural residents is just US$290 (RMB 2,366), or 80 cents per day (SSB, ZTN, 

2002: 343). The massive growth of rural underemployment provides intense incentives for rural-urban migration, and great downward pressure on non-farm wages 

in unskilled and low-skilled occupations. By 2002, there were around 150 million 

rural residents who worked in the urban areas without permanent urban residence 

qualifications. These were predominantly ‘‘lumpen’’ labour, with limited skills. The 

rate of pay is the equivalent of roughly US$1–2 per day, which is the price of 

‘‘lumpen’’ migrant labour throughout human history (at today’s prices). 

There are estimated to be as many as 48 million people who are without work 

as a result of reform in state-owned enterprises. The explosive increase in unemployment has become the ‘‘most challenging issue in China’s economic and social development’’ (UNDP, 2000: 58). 

Privatisation in China has been characterised by widespread insider dealing and 

corruption. A very narrow group of just two to three million people has been able 

to ‘‘get rich quickly.’’ It is estimated that that just 0.16 percent of the population 

controls 65 percent of the nation’s US$1.5 trillion liquid assets in Mainland bank 

deposits (SCMP, 29 March 2003). 

By 2002, China’s accumulated stock of FDI had reached around US$450 billion. 

This investment is creating clusters of modern businesses in relatively isolated 

areas within China’s major cities. These virtual ‘‘Treaty Ports’’ are emerging as 

areas with a relatively high degree of de facto autonomy, and form a nucleus of 

high-income employment for both Chinese and foreigners, isolated from the surrounding society. A rapidly-growing group of China’s highest income earners live in 

isolated, protected compounds. 

There has been much discussion about the growth of the Chinese urban ‘‘middle 

class.’’ However, the average per capita income of China’s total of 480 million officially registered urban residents in 2001 was just US$830. If we included the unofficial urban population of around 150 million migrant workers, then the figure would 

be even lower. One recent study estimates that among China’s urban households, 

the income of only around 20 million has caught up with the average of the urban 
103

households in East Asia’s newly industrialised countries (Qu Hongbin, 2002). In 

other words, China’s emerging middle class, those who can afford, for example, to 

buy automobiles, is a ‘‘besieged’’ minority among a sea of urban poor people, who 

vastly outnumber them. The 21st century meets the eighteenth century at the window of Starbucks. The vast majority of the urban population are excluded by their 

low incomes from Starbucks or Wal-Mart and excluded by armed guards from the 

apartment blocks of the new middle class, except where they are employed for domestic service. 

Official data show that the Gini coefficient of the urban distribution of income 

rose from 0.25 in 1992 to 0.34 in 2001 (SSB, ZTN, 1993 and 2002). However, the 

official data do not include most of the 150 million migrants who are not registered 

as part of the urban population. The data also greatly underestimate the income of 

the highest segments of the native Chinese urban population. Nor do they include 

the high incomes of the fast-growing population of foreign employees of the multinationals. If all these factors are taken into consideration, the distribution of China’s urban incomes is likely to be among the most unequal in the world. 

The reform process has entered a period in which there is an increased danger 

of social instability compared with the past twenty years of reform. There has been 

extensive discussion among policy makers about how to ensure that during this 

tense period, China is sustained as a ‘‘steady and harmonious society.’’ China’s leaders have a declared vision of an ‘‘everlasting and peaceful nation.’’ There has been 

intense debate about how to build a dynamic economy, while ‘‘laying the groundwork for a market that is moral and fair.’’

The Environment

China’s environmental deterioration reflects the intense pressure of a huge and 

growing population upon China’s already fragile natural environment, with the impact hugely reinforced by high-speed industrial growth in a poor country with limited resources at the disposal of the state. 

Around 38 percent of the entire country is affected by serious soil erosion (UNDP, 

2000: 70). The area of desert is increasing at around 2,500 square kilometres per 

year, equivalent to the area of a medium-sized country. In the past four decades, 

almost one-half of China’s forests have been destroyed. There is a serious and worsening shortage of fresh water. ‘‘Rampant water pollution’’ is making the situation 

worse. The flow of the Yellow River has reduced to a mere trickle for long periods 

of the year (see Wang Xiaoqiang, et al, 1999). China is experiencing the ‘‘most severe, large-scale and profound ecological destruction in [its] history’’ (UNDP, 2000: 

70). 

China’s explosive industrial growth has led to high-speed expansion of energy-intensive industries. By the late 1990s, these accounted for around 36 percent of the 

country’s manufacturing value-added, compared with just 23 percent in Japan and 

21 percent in the USA (Nolan, 2001a: 700). China has a relatively limited amount 

of oil and gas, but has huge reserves of coal. By the mid-1990s, China had overtaken 

the USA as the world’s biggest coal producer, accounting for almost thirty percent 

of global output. Coal provides a low-cost way to meet a large fraction of China’s 

booming demands, accounting for around 70 percent of the country’s primary energy 

used in electricity generation (Nolan, 2001a: 699). The ways in which coal is mined, 

transported and used as a fuel approximates that of the advanced economies before 

the 1950s. This has caused a huge burden of air pollution. 

The implications of China’s mode of industrialisation are of the greatest importance for the physical sustainability of life across the whole planet. China already 

is the world’s second largest producer of ‘‘greenhouse gases’’ after the USA (World 

Bank, 2001: 292–3). If it follows the U.S. free market approach to industrialisation, 

allowing, for example, complete dominance to the automobile, then the prospects for 

the world are terrifying. If China’s 1.4 billion people were to sustain their current 

growth path and at some point catch up with today’s USA level of per capita income, 

and were to use similar technologies, China’s use of commercial energy and emission 

of carbon dioxide would be one-fifth greater than those of the entire world today—

a terrifying prospect. 

Party and State

Party. The Chinese Communist Party, with 64 million members, is at the heart 

of the Chinese state. Leadership by the Communist Party is the foundation of Chinese modernization. However, the Party faces a rising tide of corruption. 

In his speech on 1 July 2001 to celebrate the 80th anniversary of the founding 

of the Chinese Communist Party Zemin emphasized the possibility of complete system disintegration: ‘‘To rally the 1.2 billion and more people behind the socialist 

modernization drive in a large and multi-ethnic developing country like China, it 
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2The information in the paragraph is all from World Bank, 2002. 

is a must to have the strong leadership of the Communist Party of China. Otherwise, the country will . . . not only fail to realize its modernization but also sink into 

a chaotic abyss.’’ He pointed out the serious danger of loss of power by the Party 

if the corrosive trends were not checked: ‘‘[W]e must be strict in Party discipline. 

We should have a deeper understanding of the loss of political power by some Communist Parties in the world that had long been ruling parties and learn a lesson 

from them.’’ He emphasised that combating corruption and building clean government was vital for the survival of the Party. The level at which Party members were 

investigated and brought to trial for corruption rose to include many in high positions, some of whom were sentenced to death. 

The reason that so many cases of corruption have come to light, and been written 

about in the Chinese press, is precisely the fact that the Chinese leadership is fully 

aware of the deep threat that it poses, and is trying hard to do something about 

it. Offical reports to the National People’s Congress in early 2003 declared that in 

the previous five years, the war against corruption had been substantially stepped 

up, with a total of almost 13,000 prosecutions of government officials (SCMP, 11 

March 2003). 

Reforming the Party itself is a massive task. ‘‘Regime improvement’’ rather than 

‘‘regime change’’ is the only logical way to proceed in order to meet the needs of China’s vast population. The massive effort to try to clean up the country’s financial 

institutions after the Asian Financial Crisis demonstrated the continued and improved effectiveness of this mighty apparatus. In Guangdong province alone, a vast 

clean-up operation involved thousands of Party cadres at every level. They closed 

hundreds of local financial institutions, and ensured that their massive obligations 

were dealt with in a way that preserved social stability. Such tasks are vital for 

the Chinese development effort in the period ahead.

State. China is a vast, poor country with urgent development needs, many of 

which can only be met by state action of one sort or another. Huge advances have 

been in the technical competence of the Chinese bureaucracy. However, during the 

reform period, the state’s budgetary revenue fell from over 31 percent of GDP in 

1979 to just 14 percent in 1999 (SSB, ZTN, 2001: 256). This was not only below that 

of many developing countries, such as Indonesia and Malaysia, but also below that 

of Russia, which is perceived as having experienced ‘‘state desertion’’ during the reform period. In this sense, China’s level of ‘‘state desertion’’ during the ‘‘transition’’ 

period outstripped even that of Russia, which has ‘‘gravely undermined the [Chinese] government’s capacity to promote economic development’’ (UNDP, 2000: 41). 

The state’s greatly weakened fiscal capability has serious implications for social 

stability. In order to dampen the impact of large-scale lay-offs, the Chinese government has been trying for many years to develop a comprehensive social security system. However, such programmes had made very limited progress by the end of the 

1990s. While they are being established they require a large infusion of government 

funds, but the state’s fiscal weakness made this impossible (UNDP, 2000: 76). 

A high degree of responsibility for public action has been devolved to localities, 

which now account for around two-thirds of total budgetary expenditure (World 

Bank, 2002: 31). They now have responsibility for almost nine-tenths of total budgetary expenditure on culture, education and health (World Bank, 2002: 31). Local 

governments have increasingly turned to the market to fund welfare provision. 

By the end of the 1990s, state budgetary allocations covered just 46 percent of 

actual expenditures on education.2 The increasing use of individual payments to acquire educational services has resulted in a substantial deterioration in the educational status of the poor. Under the rural people’s communes in the 1970s, around 

85 percent of villages had a cooperative medical system, albeit often rudimentary, 

but this structure was largely dismantled after de-collectivisation in the early 1980s. 

When the agricultural collectives were disbanded in the early 1980s, the financial 

basis for risk-sharing was largely eliminated. Today, more than 90 percent of the 

rural population are without any coverage from collective risk-pooling schemes. In 

1999, the government budget funded just eleven percent of total health expenditure, 

while 59 percent came from out-of-pocket payments. These changes have resulted 

in highly unequal access to health services. 

Finance

China’s participation in the international financial system has been compared to 

a boat setting out to sea. What are the prospects for the ‘‘weather’’? How well constructed is the ‘‘boat’’?
105

What are the prospects for the weather? The concept of free movements of capital is fundamentally different from that of free trade in goods. Capital flows are 

particularly subject to asymmetric information, agency problems, adverse selection 

and moral hazard. Keynes (1936: chapter 12) provides the foundation of the modern 

critiques of the potentially destabilising effects of uncontrolled financial markets. He 

strongly attacked the idea that stock markets and currency markets are efficient, 

and based on rational expectations. He famously warned of the negative impact of 

speculation, which he likens to gambling: ‘‘Speculators may do no harm as bubbles 

on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of 

a country becomes a by-product of the activities of a casino, the job is likely to be 

ill-done’’ (Keynes, 1936: 159). 

Keynes’ fears have been amply realised since the 1980s, as controls on capital 

movements were liberalised across the developing world. The period has seen an unprecedented number and intensity of financial crises, affecting radically different 

types of economy. These ranged from ‘‘small, well-regulated and open’’ Hong Kong 

at one end to huge, state-interventionist, Indonesia at the other. The common factor 

was financial liberalisation and asset bubbles provoked by a huge inflow of speculative capital relative to the size of the economy. The bursting of the bubble in each 

case had massive social and economic consequences. In the case of Indonesia, this 

resulted in ‘‘regime-change.’’ One of the most successful ‘‘developmental states’’ in 

the Third World was overthrown in a matter of months from the onset of the Asian 

Financial Crisis. China and India, each of which had only limited convertibility of 

the national currency, were almost alone among Asian countries in escaping the 

worst effects of the Asian Financial Crisis. 

China has been well-served by the pragmatic reform philosophy of ‘‘groping for 

stones to cross the river.’’ At the end of the 1980s there was intense pressure for 

high-speed political reform to precede deepening of economic reform. The USSR’s 

collapse provided an object lesson for China. It showed that there were huge dangers in pursuing extensive political reform prior to economic system reform. This reality was quickly understood by everyone in China, and people across the world 

(Nolan, 1995). The Asian Financial Crisis provided another deep lesson to China’s 

policy makers—the ‘‘Financial 4 June.’’ Financial system reform is the most sensitive and difficult part of the whole process of system change. If mistakes are made 

in this area, with its deep roots in everyday lives of the whole population, it threatens the whole socio-political fabric. The Asian Financial Crisis reinforced the need 

for China’s policy makers to be incredibly cautious in liberalising capital flows and 

moving towards full convertibility of the renminbi.

How strong is the boat? Despite implementing important changes, China’s big 

four banks continue to be heavily influenced by government institutions in their 

lending decisions. Much of the pressure to continue to make policy loans results 

from the intense competitive environment that confronts China’s indigenous large 

firms with China’s entry to the WTO (see below). The big four banks continue to 

generate huge amounts of non-performing loans (NPLs). Many international experts 

believe that the conditions are ‘‘ripe for a financial crisis.’’

The big four banks face immense difficulties in changing corporate governance 

practices. In the late 1990s, the impact of the Asian Financial Crisis on Hong Kong 

and neighbouring Guangdong Province helped to bring about the collapse of two 

giant local financial institutions, Guangdong International Trust and Investment 

Corporation (GITIC) and Guangdong Enterprises (GDE), the flagships of the province. The subsequent bankruptcy and restructuring respectively revealed the 

shockingly inadequate nature of corporate governance within these two institutions, 

which only a few months previously had been held up in international financial analysts as paragons of financial management. The shock of these events helped to 

stimulate a widespread clean-up of both central and local financial institutions. The 

‘‘clean-up’’ itself exposed the depth of the problems that the government faced. 

In early 2002, it was revealed that the five bank officials at the BOC branch in 

Kaiping city (Guangdong) had stolen the equivalent of around US$500 million. In 

its report on the Kaiping scandal, the Chinese financial journal Caijing (5 May 

2002) concluded that the Kaiping scandal illuminated the ‘‘terrifying complexity and 

scale of the challenge facing China’’: ‘‘Only by drawing a lesson from this bitter experience and facing reality bravely will the Chinese banking industry be able to 

make up for lost time.’’

In the past two years, banking officials at the apex of the country’s banking system have encountered serious difficulties. Most notable were three of the four ‘‘cando commanders’’ hand-picked by Premier Zhu Rongji to lead the country towards 

modern, well-run financial institutions. Zhu Xiaohua, former deputy governor of the 
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People’s Bank of China and head of management of China’s foreign exchange reserves, was arrested and sentenced to fifteen years in prison. Wang Xuebing, formerly head, successively, of the China Construction Bank and the Bank of China, 

was arrested and dismissed from the Party. He is awaiting trial. Li Fuxiang, also 

a former head of the management of the country’s foreign exchange reserves, committed suicide while under official investigation. 

Reform of the country’s financial institutions is being carried out in challenging 

circumstances. China’s large financial firms face the prospect of an intense escalation of competition from global financial institutions. Leading financial services 

firms, all from the high-income economies, recently have been through a period of 

unprecedented merger and acquisition, to take advantage of global markets, and of 

economies of scale and scope in respect to research and development, branding, 

human resource acquisition, and central procurement (e.g. IT systems). Super-giant 

financial services firms, predominantly American, such as Fidelity, Citigroup, JP 

Morgan Chase, GE Capital, Morgan Stanley Dean Witter, Merrill Lynch and AIG, 

have emerged. Citigroup alone has annual revenues of US$112 billion and profits 

of around US$14 billion, many times greater than the entire group of China’s ‘‘four 

big banks.’’ They have rapidly acquired dominant positions in the financial markets 

of most of Latin America and Eastern Europe. When Citigroup acquired Bannamex, 

Mexico’s ‘‘national champion’’ in financial services, the Financial Times commented: 

‘‘The acquisition of Bannamex underscored the rapacious appetite of Citigroup for 

assets in the developing world.’’ Citigroup immediately stated: ‘‘China is top of our 

radar screen.’’ Experienced U.S. bankers in China believe that is only a matter of 

time before the leading global financial institutions take the ‘‘cream’’ of the Chinese 

market. 

The less that China’s indigenous large financial firms are able to achieve their 

own self-reform, the stronger will be the argument made by the global giants to 

allow them to ‘‘take command of the boat,’’ as experienced ‘‘sailors’’ who can run the 

country’s financial institutions well. Citigroup argues that the big four banks in 

China should be ‘‘torn apart into small units in order to avoid a financial crisis.’’ 

Undoubtedly this would make it far easier for the global giants to ‘‘rout the enemy 

one by one’’ (gege jipo). 

International Relations

Maoism comprehensively stressed social equality and the importance of ‘‘positive’’ 

freedoms for all social strata. The Communist Party has moved away from the inward-looking anti-capitalist ideology of the Maoist period. However, it is unimaginable that it will embrace a pure free market philosophy, with comprehensive emphasis on Hayekian individual ‘‘negative’’ freedoms and a minimal role for the state. 

This philosophy achieved a high point in political influence in the USA in the late 

nineteenth and early twentieth century. However, since the 1960s it has once again 

emerged to dominate the U.S. political mainstream. By contrast, China’s leaders are 

groping their way towards an ideological ‘‘Third Way’’ between state and market, 

which is based on China’s rich historical experience, ‘‘using the past to serve the 

present’’ (gu wei jin yong) (Nolan, 2003). In this sense, namely, struggling for the 

dominant ideology of the epoch of globalisation, China poses a threat to the current 

mainstream of U.S. political thinking. However, it is on common ground with a long 

tradition of U.S. political thinking which has emphasised the importance of the 

state in enabling the realisation of ‘‘positive freedom’’ for all segments of society 

(Foner, 1998). 

China’s development policies since the late 1970s have produced a powerful economy, that is viewed as becoming a serious potential rival for the dominant world 

power, the USA, within a relatively short period of time. As we will see in the following sections, China’s industrial firms are still technologically far behind U.S.-

based firms. Those who wish to emphasise the size of the Chinese ‘‘challenge’’ point 

to the fact that measured in ‘‘purchasing power parity’’ (PPP) dollars (essentially 

using the prices of the USA), China is already the world’s second largest economy, 

36 percent larger than Japan, and over one-half the size of the USA (World Bank, 

2001: 230–1). However, the PPP figures are highly suspect as a true measure of China’s economic might. Using the PPP figures, China uses the same amount of energy 

per unit of GDP as the USA itself (Nolan, 2001a: 914), hardly a plausible proposition. Even if one disregards the PPP figures, it is indisputable that, if China maintains its high growth rate, at some point it will, indeed, become a serious challenger 

to the USA’s dominant position. China’s massive economic potential means that it 

will increasingly be a competitor with the USA for access to the world’s major 

sources of primary energy and raw materials. 

In the above senses, China is viewed by many Americans as a ‘‘strategic competitor.’’ ‘‘China’s rise’’ and its consequences for the USA is the central issue for U.S. 
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foreign policy in the twenty-first century. China will be in an immensely vulnerable 

position in this relationship for a long time to come. 

The USA is the world’s comprehensively dominant military power. The first Gulf 

War demonstrated vividly that the USA stood at the centre of the ‘‘Revolution in 

Military Affairs,’’ both in terms of the production of the relevant technologies and 

the assembly of arms to deliver these technologies in battle. It emphasised the growing gap between the U.S. and Europe. Successive wars in the former Yugoslavia, 

Afghanistan and Iraq have demonstrated that the gap is growing even wider and 

will continue to do so as the U.S. military budget rises while that in Europe shrinks. 

The USA has made clear its nervousness about China’s growing military capability. President George W. Bush’s policy statement, ‘‘America’s Security Strategy’’ 

(quoted in full in the FT 21 September 2002) warns China: ‘‘[A] quarter century 

after beginning the process of shedding the worst features of the Communist legacy, 

China’s leaders have not yet made the next series of fundamental choices about the 

character of their state. In pursuing advanced military capabilities that can threaten 

its neighbors in the Asia Pacific region, China is following an outdated path that, 

in the end, will hamper its own pursuit of greatness. It is time to reaffirm the essential role of American military strength. We must build and maintain our defenses 

beyond challenge. . . . Our forces will be strong enough to dissuade potential adversaries from pursuing a military build-up in hopes of surpassing, or equaling, the 

power of the U.S.’’ (emphasis added). As the war against Iraq demonstrates, the 

USA’s friends of today can become their enemies tomorrow. The current international situation is one of the most unstable for a long time. China’s military strategists cannot rule out the possibility that at some point, the object of ‘‘regime 

change’’ may even include China. 

In the year 2000, the U.S. Congress established the Congressional-Executive Commission on China (CECC) to ‘‘monitor China’s compliance with international human 

rights standards, encourage the development of the rule of law, establish and maintain a list of victims of human rights abuses, and promote bilateral cooperation’’ 

(CECC, 2002). The CECC’s first annual report, in September 2002, was extremely 

critical of alleged human rights abuses in China. It made a number of recommendations to the U.S. Government to expand its activities to identify Chinese human 

rights abuses and support the redress of those abuses, especially among migrant 

workers and women. Such activities would contribute to increased social and political instability at a critical stage in China’s system evolution. 

In sum, China faces a fundamentally different position in its international relations than that which faced Japan, Korea or Taiwan at comparable stages in their 

development. Each of these achieved their modern ‘‘take-off’’ as close allies of the 

USA in the international struggle against communism, especially the People’s Republic of China. The USA tolerated a ‘‘developmental state’’ in each case, which 

heavily protected the economy, kept global financial institutions at arms length, and 

strongly controlled international financial flows. 

The final shape of the USA’s view of how best to ‘‘engage’’ with China is still unclear. However, there is a powerful set of interests that believes serious conflict with 

China is unavoidable. Henry Kissinger has warned that the hawks in the U.S. Government see China as ‘‘a morally flawed inevitable adversary’’ and believe that the 

U.S. should act ‘‘not as a strategic partner, but as it treated the Soviet Union during 

the cold war, as a rival and a challenge’’ (quoted in FT 20 August 2001) (emphasis 

added). By distancing itself from the moderating influence of international institutions, including the cautious voices of ‘‘Old Europe,’’ the U.S. constitutes an unpredictable force at the heart of international relations. The increased unpredictability 

in the foreign policy of the world’s hegemonic power constitutes a formidable challenge for China’s own foreign policy. 

Conclusion 

As China enters the twenty-first century it faces a wide-ranging series of deep 

challenges that threaten the entire social, economic and political system. These challenges arise from both inside and outside the country. It is a period of high-speed 

economic and social change. During such periods the potential for political instability is acute. The Chinese government is working hard to try to increase its risk 

management capabilities to meet this challenge. 

Due to the number and intensity of the challenges that China faces, there is a 

high possibility that at some point a ‘‘fire’’ will break out. It cannot be predicted 

where, when, or how. It is highly likely that it will be connected with the financial 

system. We have seen that China faces a massive challenge in the financial sector. 

During the Asian Financial Crisis, China came close to a major financial and, by 

implications, a social and political crisis. Only by bold and effective policy measures 

was the country able to survive. With full convertibility of the national currency it 
108

would be far harder to survive a collapse of confidence by global financial markets 

of the kind that has regularly occurred in other developing countries under financial 

liberalisation. If the ‘‘fire’’ does not begin with the financial system then it likely 

that it will quickly spread into the financial system. If China were to face a financial crisis of the dimensions of those that have regularly attacked other developing 

countries during the epoch of globalisation and liberalisation since the 1980s, it 

would be immensely difficult to maintain system stability. The relationship of political instability with financial crisis is long-standing. As Karl Marx pointed out in 

1853: ‘‘Since the commencement of the eighteenth century there has been no serious 

revolution in Europe which has not been preceded by a commercial and financial 

crisis’’ (Marx, 1853: 9). 

3. China and the Global Business Revolution

China’s Ambitions

China began liberalizing the post-Mao economy in the late 1970s. A consistently 

stated goal of China’s industrial policy has been to construct globally powerful companies that can compete on the global level playing field:

In our world today economic competition between nations is in fact between 

each nation’s large enterprises and enterprise groups. A nation’s economic might 

is concentrated and manifested in the economic power and international competitiveness of its large enterprises and groups. . . . Our nation’s position in the international economic order will be to a large extent determined by the position of our 

nation’s large enterprises and groups.

(Wu Banguo, Chinese State Council, August 1998.)

China’s chosen global giant corporations have been supported through a wide 

range of national industrial industrial policies, which include: tariffs, which were 

gradually reduced during the reform years; non-tariff barriers, including limitations 

on access to domestic marketing channels, requirements for technology transfer and 

to sub-contract to selected domestic firms as the price for market access; government selection of the partners for major international joint ventures; preferential 

loans from state banks; privileged access to listings on national and international 

stock markets; tax relief; privileged access to land; direct support from R&D from 

the government budget; government procurement policy; and government mediated 

mergers and acquisitions. 

As the reforms have progressed, the Chinese government has made it increasingly 

clear that the country intends not only to establish a group of globally competitive 

large firms in the manufacturing sector, but also in financial services and telecommunications. China Mobile and China Unicom, with massive international flotations, as well as China Telecom and China Netcom, were at the forefront of this 

process. International flotations of the mainland business of the three leading commercial banks are under intense discussion. The Bank of China’s Hong Kong operations were floated in 2002. As China entered the WTO, the country’s commitment 

to building globally competitive large firms remained undiminished:

The state will encourage big state-owned businesses to become internationally 

competitive corporations by listing on domestic and overseas stock market, increasing research and development expenditure, and acquiring other businesses. 

The country will develop thirty to fifty large state-owned enterprises in the next five 

years through public offerings, mergers and acquisitions, restructuring and cooperation.

(Bai Rongchun, Director General, Industrial Planning Department, State Economic and Trade Commission, July 2001.)

China’s planners carefully studied the industrial policies used by the high-income 

economies in their early stages of development. From Britain during the Industrial 

Revolution, the U.S. and Continental Europe in the nineteenth century, through to 

the East Asian ‘‘Tiger’’ economies of the late twentieth century, almost without exception, late-industrializing countries used some form of industrial policy to nurture 

‘‘national champions’’ (Nolan, 1995; Chang, 2002). Each of these late-industrialising 

countries was able through different methods to nurture a group of globally competitive large firms. 

However, the most powerful influence on the thinking of China’s policy makers 

was the Japanese experience. During a similar period in Japan’s development, from 

the 1950s to the 1970s, Japan’s industrial planners supported the growth of a series 

of giant companies that developed into globally powerful firms. In many sectors the 

state nurtured just two or three dominant firms that were in an oligopolistic position in the domestic market. After two decades of industrial policy, there was a 
109

whole corps of globally competitive Japanese companies. By the late 1980s, it had 

twenty of the largest one hundred corporations in the Fortune 500 list. These companies developed through extensive support from state industrial policies, similar to 

those adopted by China forty years later. 

As well as continued support for the construction of a ‘‘national team’’ of internationally competitive firms, local governments at both the provincial and the city 

level also are determined to make use of industrial policies to nurture a local 

‘‘team.’’ The best-known Chinese firm internationally is, probably, the consumer 

electronics firm, Haier. Apart from the high entrepreneurial capabilities of its CEO, 

Zhang Ruiming, its growth owes much to the support given by both the Shandong 

provincial government and the Qingdao city government. Shanghai intends that 

large local firms such as Shanghai Auto, Shanghai Aerospace, Jinshan Petrochemical Company and Baoshan Steel Company, will become global industry leaders. The fact that China has joined the WTO has not dimmed the ambition of local 

provincial and city governments to use industrial policy to nurture local champions. 

The population of China’s provinces is mostly as large as substantial countries and 

the population of most large cities is bigger than city-states such as Singapore or 

Hong Kong. The growth of autonomy in devising industrial policies at the level of 

the province and the city is a reflection of the weakening capabilities of the central 

government and advance in fissiparous tendencies in the Chinese state structure. 

China’s Success

In the course of two decades, China’s large enterprises advanced their business 

capabilities, undertaking evolutionary institutional changes in key aspects of their 

business organisation (Nolan and Wang, 1998). China’s large, state-owned enterprises have grown rapidly in terms of value of sales. A group of them has floated 

on international stock markets. They have absorbed a great deal of modern technology. They have learned how to compete in the marketplace. They have substantially upgraded the technical level of their employees. They have learned wide-ranging new managerial skills and gained substantial understanding of international financial markets. They have become sought-after partners for multinational companies. China’s large state-owned enterprises avoided the industrial collapse of the 

former USSR. China has become the fastest-growing part of the global industrial 

economy. 

Under the policies of reform and opening up, China has attracted huge amounts 

of foreign direct investment. A ‘‘herd’’ mentality to participate in the ‘‘Chinese miracle’’ developed among global giant corporations. By the year 2002, China had overtaken the USA as the world’s largest recipient of FDI, with the stock of FDI reaching around US$450 billion. Global corporations now view China as central to their 

long-term strategy. 

However, despite the evidence of remarkable progress, it is crucially important for 

proper policy formulation in the USA to evaluate carefully the extent and nature 

of progress in large Chinese firms compared with that of the global leaders. 

Benchmarking the Chinese ‘‘National Team’’

How capable are China’s ‘‘national champions’’ to compete on the ‘‘global level 

playing field’’ within the WTO? In the course of the China Big Business Programme, 

since the mid-1990s we have tried to answer this question, using detailed case studies from China’s ‘‘national team’’ in several different sectors, benchmarking them 

against the global leaders in the respective sector (Nolan, 2001a and 2001b). So far 

these studies have included aerospace, pharmaceuticals, oil and petrochemicals, 

power equipment, automobiles and components, steel, consumer electronics, telecommunications, mining, IT hardware, soft drinks, beer, retail and financial services. In each case we have found evidence of intense efforts by Chinese industrial 

entrepreneurs and government departments, and highly significant progress in business capability. However, in every case we found that deep problems remained. The 

micro-level evidence from our case studies suggests that in most key respects, China’s industrial policies have not yet succeeded in building globally competitive large 

firms. 

At the start of the 21st century, not one of China’s leading enterprises had become 

a globally competitive giant corporation, with a global market, a global brand, and 

a global procurement system. The Chinese companies included in the Fortune 500

mostly faced huge problems of downsizing. China had no less than five of the top 

eleven companies in the Fortune 500 in terms of numbers of employees, a dubious 

achievement. All of China’s eleven Fortune 500 companies were either wholly or predominantly state-owned firms, operating with a high degree of state protection from 

international competition. China has just two companies in the FT 500 which ranks 

firms by market capitalization. These are CNOOC (China National Offshore Oil 
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3The commoditised, low value-added part of the mobile phone market is being increasingly 

penetrated by Chinese consumer electronics firms. However, the global giants (including Nokia, 

Motorola, Ericsson, Cisco, Siemens, Alcatel, and Lucent) either through imports or their large 

production networks of within China comprehensively dominate the supply of high technology 

IT equipment to the Chinese telecoms service industry. 

Company), and China Mobile, each of which operates in a protected domestic environment. Moreover, the vast bulk of the high technology IT hardware equipment for 

China’s telecoms companies is purchased from the global giants.3 China has only 

one company in the world’s top 600 companies by R&D expenditure. China does not 

have any representatives in Morgan Stanley Dean Witter’s list of the world’s top 

250 ‘‘competitive edge’’ companies. China does not have a single company in Business Week’s list of the world’s top 100 brands. 

The brutal reality is that after two decades of reform China’s large firms mostly 

are still far from being able to compete with the global giants. The gap is especially 

marked in the high-technology sectors, including semi-conductors, aerospace, largescale power equipment (over 600 MW), IT hardware (especially the high technology 

networking equipment sector), and patented pharmaceuticals. For example, in the 

critically important high technology sector of semi-conductors, which supplies the 

‘‘food’’ for all other advanced technology industries, China has only negligible capability. It is estimated that around eighty percent of China’s total consumption of 

semi-conductors are imported, and the ‘‘domestic’’ production of semi-conductors is 

totally dominated by the local subsidiaries of the global giants. Among the top thirty 

suppliers of microchips to the mainland market, there is not one indigenous Chinese 

firm (SCMP, 9 September 2003). Moreover, despite intense Chinese government efforts to attract the world’s leading semi-conductor makers to China, most of the 

world leaders in the sector are content to export these exceptionally high value 

products to China rather than produce within the country. 

The gap is marked even in ‘‘mid-technology’’ sectors such as oil and petrochemicals, auto assembly and auto components, large-scale construction and mining 

equipment, and elevators for tall buildings. Even in sectors with apparently less advanced technology, such as steel, beverages, coal, and domestic electrical equipment, 

there is a wide gap with leading global companies in the highly branded and/or high 

technology, high value-added segments of the market. The challenge is not confined 

to the manufacturing sector. China’s four main commercial banks, large accountants 

and insurance companies lag far behind the global giants in almost all respects. The 

global giants are already well on their way to constructing oligopolistic industrial 

structures in the highly branded and high technology parts of the Chinese market 

in a wide range of goods and services. 

In the two strategic industries of oil and aerospace (see Appendix and Zhang Jin, 

2004), China’s national champions lag behind the world’s leading firms. Despite success in completing restructuring and flotation within just over one year, PetroChina 

and Sinopec are at a disadvantage in terms of the global distribution and quality 

of reserves, technology, and financial strength. There remains a deep internal struggle to establish a cohesive corporate culture to integrate their powerful subordinate 

companies and establish a truly unified company. In simple measures of revenue 

and profit, China’s aerospace companies AVIC 1 and 2 are far behind leading aerospace sub-systems suppliers such as Honeywell, Pratt & Whitney, and GE engines. 

Even taken together, they are minnows compared with system integrators Boeing 

and Lockheed Martin. Moreover, they remain highly diversified companies with a 

high proportion of revenues coming from non-aviation production. 

Why has the result of industrial policy in China been so different from that in 

post-war Europe, Korea, Taiwan, or Japan? This was partly due to internal and 

partly to external difficulties that were peculiar to China. 

Internal Difficulties

Policy inconsistency. As we shall see in the oil and petrochemical industry, 

within the same industry, radically different reform policies were pursued at different times. At the same time, completely different policies were pursued in different sectors such as the aerospace, oil and petrochemical industry. For example, 

while control was being centralised in the oil and petrochemical industry, AVIC was 

being broken up into two separate entities, each of which was even less able than 

before to compete with the global giants.

Where is the firm? The foundation of China’s economic reform was to increase 

‘‘enterprise’’ autonomy. The core of most large ‘‘enterprises’’ was a single large production unit. This had many benefits, including the development of a strong sense 

of corporate ambition at the enterprise level. However, it caused difficulties in the 

subsequent attempts to build multi-plant firms with unified central control over in-
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4For a detailed analysis, see Nolan (2001a), chapter 2, ‘‘The challenge of the global business 

revolution.’’

dividual production units. For example, it involved huge struggle to centralise control over powerful companies such as Daqing under CNPC and Shanghai Petrochemical Corporation under Sinopec.

Impoverished economy. China is still a poor country, with a relatively small 

global middle class. In almost all sectors, from power plants to beverages, markets 

are highly segmented. Alongside the modern, high value-added, globalized sector, 

there is typically a huge, low value-added, commoditized segment, which supplies 

goods and services for poor people. A large fraction of domestic demand is for low 

price, low value-added products for over one billion peasants, internal migrants and 

poor urban residents. Here is a different world of ferocious competition between 

myriads of anonymous ‘‘perfectly competitive’’ indigenous firms. Indigenous firms 

have to fight a battle on two fronts, on the one hand with global giants in high 

value-added products, and on the other hand, with domestic small and medium enterprises (SMEs) in low value-added products.

Local protectionism. China has a strong tradition of relatively autonomous local 

government. There has been persistent local resistance to cross-regional mergers, 

due to fears of downsizing and/or loss of control of a ‘‘local asset.’’

Inheritance from the planned economy. Unlike the other ‘‘late-comer’’ countries, China’s large enterprises inherited huge manning levels, which are extremely 

hard to reduce without causing social instability. In 2002, CNPC and Sinopec each 

still employed around one million people. AVIC 1 and AVIC 2 together employ over 

400,000 people, more than twice as many as Boeing and Lockheed Martin do. This 

will remain a deep problem for many years.

Incentive to diversify. The inability of China’s emerging large firms to compete 

on international markets, plus the fact that they each have a huge workforce, produced a high incentive for the individual enterprise to diversify. A single large enterprise could easily have hundreds of ‘‘children’’ and ‘‘grandchildren’’ subsidiaries 

and related companies. For example, AVIC has 116 subordinate enterprises grouped 

under 56 ‘‘children’’ enterprises. This gives the ‘‘illusion of scale,’’ but beneath an 

apparently large firm there are typically hundreds of uneconomically small firms 

and immense problems of corporate governance.

Problems for China’s bureaucracy. China’s bureaucracy lacked the intense nationalist incentive to build large firms successfully that drove Japanese (and Korean) policy makers. Also, China’s leaders are engaged in an intense drive to root 

out corruption from the country’s huge bureaucracy. Corruption undermines the bureaucracy’s ability to lead industrial policy effectively.

Ideological commitment to state ownership. China remained for most of the 

reform period committed to state ownership as a goal in its own right, rather than 

building powerful corporations by whatever means was suitable. It proved hard to 

achieve the separation of government and enterprise that has been advocated for 

many years. Even today, the internationally floated former Chinese state-owned enterprises are still majority state-owned in all cases, and most domestically listed 

firms are still majority state owned. Even the most famous ‘‘non-state’’ firms, such 

as Haier in consumer electronics and Legend in computers, have extremely complex 

ownership structures, with a substantial degree of state ownership and control. 

External Difficulties

China’s attempt to build large globally competitive firms coincided with the most 

revolutionary epoch in the world business history, possibly even including the Industrial Revolution. The transformation of global business structures since the 

1980s amounted to nothing less than a ‘‘business revolution.’’ This presents a fundamental challenge for China’s industrial policy, and amounts to a very different policy environment from that which faced other late-comer countries in their attempt 

to ‘‘catch-up.’’ 4

Liberalization of world trade and capital markets. The period since the late 

1980s witnessed for the first time the opening up of a truly global market place in 

goods, services, capital and skilled labour. The only market which still remains 

bound firmly by nationality is the vast sea of unskilled labour. The total stock of 

FDI in developing countries rose from $344 billion in 1985 to $2,181 billion in 2001 
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5Despite the rapid growth, in 2001, China still accounted for only 18 percent of the total stock 

of FDI in developing countries (UNCTAD, 2002), significantly below its share of population. 

Latin America’s total stock of FDI in 2001 stood at $693 billion, 75 percent greater than that 

of China. Latin America’s population (509 million) is only 41 percent of that of China.

(UNCTAD, 2002). China was the main single focus of attention.5 The struggle 

among the world’s leading firms has deeply penetrated the most developed parts of 

the low- and middle-income countries. China is at the centre of this battle. 

Explosive M&A and concentration. The period since the 1980s witnessed the 

world’s most explosive period of mergers and acquisitions (M&A). The size of the 

merger boom of the 1990s eclipses that of any previous epoch. It will leave a longlasting imprint on the global business structure. The process of concentration was 

most visible at the level of the global system integrators. In sectors as diverse as 

large civilian aircraft, military aircraft, integrated oil and petrochemicals, automobiles, pharmaceuticals, power equipment, semi-conductors, computer systems, 

mobile phones, lifts, camera film, electronic games, tobacco, ice cream and soft 

drinks, a small number of focused global producers dominates the world market 

(Nolan, 2001a, p. 40–42). Competitive capitalism’s inbuilt tendency to concentration 

and oligopoly has flowered on a global scale. There appears to be a universal rule 

of concentration, namely, that a small number of firms, around three to six, control 

around fifty to seventy percent of the total world market, concentrating on high 

value-added products in any given sector, while hundreds or thousands of anonymous, local small- and medium-sized firms battle for the remaining part of the market.

‘‘Cascade effect.’’ Not only have the core ‘‘systems integrators’’ experienced an 

explosive process of concentration. The deepening interaction between core companies and supplier companies has created an explosive ‘‘cascade’’ effect that is rapidly 

leading to concentration and focus among the first tier suppliers and spilling over 

even into second and third tier suppliers. In sector after sector, the ‘‘first tier’’ suppliers are themselves multi-billion dollar companies with ‘‘global reach.’’ For example, in the aerospace industry, just three firms produce large jet engines. In the auto 

industry, just three firms account for around three-fifths of the entire global market 

for tires, and just two firms account for over one-half of the world’s entire supply 

of brake systems. In the mining industry, just three firms account for almost the 

entire international coal trade, while just two firms account for over one-half of the 

global market for large excavation equipment. In the industrial gas industry, just 

five firms account for around three-fifths of the global market. In the accountancy 

industry, just four firms account for almost all audits conducted among Fortune 500

companies. In banking, just four firms account for almost all investment banking 

services for large corporations. In advertising, just three firms account for almost 

all advertising services for large corporations. This makes the competitive landscape 

even more challenging for firms from developing countries. If they can’t compete as 

‘‘systems integrators,’’ how can they compete with the established giant firms in the 

first tier of the global supply chain, or even at lower tiers, where concentration is 

also progressing at high speed?

The ‘‘external firm.’’ Through the hugely increased planning function undertaken by systems integrators, facilitated by recent developments in information 

technology, the boundaries of the large corporation have become blurred. Competitive advantage for the systems integrator requires that it must consider the interests of the whole value chain in order to minimize costs across the whole system. 

Far from becoming ‘‘hollowed out’’ and much smaller in scope, the extent of control 

exercised by the large firm has enormously increased during the global business revolution. Indeed, one can speak of a new form of ‘‘separation of ownership and control.’’ In the epoch of the global business revolution, facilitated by advances in IT, 

core firms within the value chain exercise tight control over firms across the whole 

value chain. Firms that wish to be selected as ‘‘aligned’’ or ‘‘partner’’ suppliers to 

the leading systems integrators, must agree to cooperate with the core firms within 

the sector in opening their books, planning their new plants, organising their R&D, 

planning their production schedules and delivering their products to the core firms. 

This is a new form of industrial planning which extends across the boundaries of 

formal ownership structures and radically undermines old ideas of the size and nature of the firm.

Dominance of firms based in advanced economies. Firms headquartered in 

regions containing a small fraction of the world’s population have comprehensively 

dominated the global business revolution (Table 1). The high-income economies contain just 16 percent of the world’s total population. They account for 93 percent of 
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the world’s total stock market capitalization, 93 percent of Fortune 500 companies, 

95 percent of the FT 500 companies, 98 percent of the world’s top 600 companies 

by value of R&D spending and 99 percent of the world’s top brands. The USA alone 

has with 192 of the Fortune 500 companies, 240 of the FT 500 companies and 275 

of the top 600 companies in terms of R&D expenditure. 

Developing countries are massively disadvantaged in the race to compete on the 

global level playing field of international big business (Table 1). The whole of the 

developing world, containing 84 percent of the world’s population, contains just 37 

Fortune 500 companies, 27 FT 500 companies, 15 of Morgan Stanley’s list of the 250 

leading ‘‘competitive edge’’ companies, one of the world’s top 100 brands, and just 

ten of the world’s top 600 companies by R&D expenditure, of which seven are in 

Korea and Taiwan. Across the whole of the rest of the developing world, there are 

just three firms in the world’s top 600 firms by R&D spending. There is just one 

each in China and Brazil. Most dramatically, there is also just one in Russia, which 

built a vast storehouse of high technology under Soviet Communism. These data 

vividly illustrates the fantastic inequality in the global distribution of technological 

prowess: ‘‘Large MNCs are the chief repositories of the world’s stock of knowledge, 

and all the screaming in the world will not change this’’ (Martin Wolf, FT, 17 November 1999).

Table 1. Dominance of Firms Based in High-Income Countries of the 

Global Big Business Revolution 

Population GNP, 1999 

(a) 

GNP, 1999 

(b) 

Fortune 500

companies 

(2003)

(c) 

FT 500

companies 

(2003)

(d) 

Top 600 

companies 

by R&D 

spend 

(2002) 

Stock market capitalization 

(1999) 

billion % $b. % $b. % No. % No. % No. % $b. %

HIEs 926 16 22,921 78 21,763 56 463 93 473 95 590 98 33,603 93

L/MIEs 4,903 84 6,311 22 17,324 44 37 7 27 5 10 2 2,427 7

(e) (f) (g) 

Sources: FT, 28 May 2003; World Bank, 2001: 274–5, and 304–5; Fortune, 28 June 2003; DTI, 2002. 

Notes: (a) at prevailing rate of exchange 

(b) at PPP dollars 

(c) ranked by sales revenue 

(d) ranked by market capitalization 

(e) of which: Korea = 13, China = 11, Brazil = 4, Russia = 3, Mexico = 2, Taiwan = 1, Singapore = 1, 

India = 1, Malaysia = 1

(f) of which: Hong Kong = 9 (of which, Mainland Chinese companies = 2, Brazil = 2, Taiwan = 3, Singapore = 2, Mexico = 1, India = 1, Korea = 4, Saudi Arabia = 3, Russia = 2

(g) of which: Korea = 4, Taiwan = 3, China = 1, Brazil = 1, and Russia = 1. 

HIEs = High Income Economies 

L/MIEs = Low/Middle Income Economies 

Paradox of the big business revolution. The past fifteen years or so has witnessed an unprecedented increase in the degree of global concentration of business 

power. However, alongside this has emerged a result that is extremely problematic 

from the perspective of traditional mainstream economics. Far from the intensity of 

competition weakening as almost all mainstream economists would have predicted, 

the period has seen a greatly increased intensity of oligopolistic competition between 

giant firms, alongside an increase in the extent of concentration within each sector 

and sub-sector. This period saw unprecedented concentrations of expenditure by 

giant firms on technical progress through R&D spending, global procurement, marketing, human resource development and on spreading best practice techniques 

across the whole value chain. In sector after sector the period witnessed the paradox 

of falling prices and improved product quality to meet consumer wants alongside the 

intense growth of oligopoly. 

Conclusion

China’s rapid move towards ‘‘close’’ integration with the world economy is occurring at a time of revolutionary change in the global business system. Large Chinese 

firms are far from ready to compete on the ‘‘global level playing field.’’ This presents 

an extreme challenge for China’s industrial strategy. Privatisation of China’s large 

enterprises will not be sufficient to make them globally competitive. If China’s firms 

cannot generally compete at the level of ‘‘system integrator,’’ it is hard to see either 

how in most industries they will be able to compete at the level of first tier supplier. 

China’s entry to the WTO greatly reduces the scope for industrial policy. Strict application of the rules of the WTO Agreement at every level of Chinese business and 

government would drastically limit the state’s actions to support indigenous firms 
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6 It is the second largest measured in terms of PPP dollars (World Bank, 2001), but as discussed elsewhere, this greatly overstates the true size of China’s national product. 7 In addition, a substantial fraction of China’s huge exports of electrical goods ($85 billion in 

2001) were produced by indigenous Chinese firms acting as ‘‘Original Equipment Manufacturer’’ 

suppliers to the global giants. 8 ‘‘The International Monetary Fund (IMF) and the World Trade Organisation can be said to 

represent ‘‘global’’ interests, and their constituency may be construed as the world. In reality, 

however, they are heavily American dominated.’’ (Brzezinski, 1997: 27). 9See, for example, Prasad, et al., 2003. 

in their efforts to ‘‘catch-up.’’ For a substantial period ahead, China would have to 

accept that, under the terms of the WTO Agreement, its best hope would be to be 

a workshop ‘‘for’’ the rest of the world, housing the production facilities for global 

giant firms and the leading parts of their supply chain, headquartered in the highincome countries, rather than a workshop ‘‘of’’ the world as Britain was in the midnineteenth century. 

To devise a strategy to deal with the today’s overwhelming imbalance in business 

power requires great skill and leadership ability. China’s leaders at both the national and local level are trying simultaneously to juggle two contradictory forms of 

‘‘industrial policy.’’ On the one hand, they are trying to encourage multinational investment by offering a wide range of incentives to produce a ‘‘good investment environment.’’ On the other hand, they are trying to nurture local and national ‘‘industrial champions.’’

China is becoming increasingly ‘‘dependent’’ in the classical sense used by the 

Latin American economists in the 1950s (Frank, 1967). In every case, successful 

late-comer industrialising countries, from the USA in the late nineteenth century 

to South Korea in the late twentieth century, have produced a group of globally 

competitive firms. China is the first successful late-comer not to have done so. It 

is remarkable that China reached a position in which it had the world’s sixth largest economy 6 and was the seventh largest exporter without having a group of internationally competitive large firms. This is highly significant in the history of economic development. Already, over 30 percent of industrial profits, and one-half of 

China’s export earnings are generated by foreign-invested firms.7 If the ‘‘bubble’’ of 

foreign direct investment in China were to burst, it would have serious consequences for the growth path and for the country’s socio-political stability. There 

is intense debate at all levels of Chinese society about the significance of this phenomenon. Many popular books and articles draw comparisons with the dependent 

nature of Chinese economic development from the mid-nineteenth century until 

1949. 

This presents a big challenge for China’s policy makers. China faces far greater 

global industrial concentration and competition than any previous late-comer country. Given the drastic inequality in competitive power between its own firms and 

the global leaders, China has to find a different strategy from that adopted by other 

late-comer countries, if it is to build a substantial group of large globally competitive 

firms. 

4. Conclusion 

U.S. foreign policy played an important role in the collapse of the USSR. Through 

the instrument of the international institutions, especially the IMF,8 the USA also 

played an important role in the disastrous choice of policies which plunged postcommunist Russia into prolonged economic crisis, which has been only partially alleviated by the current high price of oil (Nolan, 1995). Through intense efforts within 

the IMF, U.S. foreign policy played a central role in pushing developing countries 

to liberalise the flow of short-term capital. It is now widely recognised, even within 

the IMF itself,9 that premature liberalisation of financial flows in developing countries has been extremely harmful to developing countries. In extreme cases, such as 

Indonesia, the consequential financial crisis helped precipitate ‘‘regime change,’’ and 

socio-economic chaos. Even the paragon of the free market and well-regulated banking, Hong Kong, was deeply affected by the crisis. It is still far from a full recovery. 

The unfolding disaster in Iraq serves as a salutary reminder of the dangers for 

U.S. foreign policy of ‘‘state collapse,’’ from whatever cause, in geopolitically significant countries. 

Despite many appearances to the contrary, China’s political economy is at a critical and fragile stage in its evolution from the planned economy (Nolan, 2003). Its 

own leaders have warned of the dangers of system collapse. This is not an idle 

warning to justify continued one-party rule. It reflects a realistic evaluation of the 

magnitude of the development challenge that confronts the new leadership. Collapse 

of the former USSR was a disaster for the Soviet people, and was harmful to global 

prosperity and stability, not least through the effect on terrorism. Financial insta-
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10 In fact, Brazil has not totally abandoned industrial policy. Some of its most successful firms, 

such as Embraer, CVRD Ambev, and Petrobras, only exist due to past and present actions by 

the Brazilian state to nurture ‘‘national champions.’’ Without such policies, the degree of dominance by global giants in Brazil would be even greater than it is. 11 Among the top 25 ‘‘Brazilian’’ firms in 2001, fourteen are global giants, including (in descending order of revenue within Brazil in 2001) Volkswagen (2), GM (3), Fiat (5), Unilever (7), 

Bunge Foods (9), Phillip Morris (10), Nestle (11), Ford (12), Cargill (13), Daimler Chrysler (16), 

Siemens (20), Ericsson (21), BASF (22), and Motorola (24). 

bility across wide swathes of Latin America, East and Southeast Asia, has also 

harmed the prospects for global economic progress and stability. The consequences 

of the disintegration of China’s political economy would dwarf these. This outcome 

would be disastrous, not just for China, but for the USA also. 

There are numerous channels through which such an outcome could be triggered, 

most obviously through the financial sector. Intense international pressure in respect to industrial policy is another possible (and closely related) channel. China’s 

large firms face a severe challenge in competing on the ‘‘global level playing field’’ 

with the world’s leading system integrators in manufacturing, as well as with the 

leaders in the first tier of suppliers. The gap in competitive capability is at least 

as wide in that part of the service sector which meets the needs of global firms and 

the global middle class. Strict application of the WTO rules, enforcing the ‘‘global 

level playing field,’’ would make it impossible for most large Chinese firms to compete with the global leaders. 

All of the group of large Chinese firms which are groping their way towards becoming globally competitive, such as CNPC, Sinopec, CNOOC, Baoshan Steel, China 

Telecom, China Netcom, China Unicom, China Mobile, Haier, Huawei, and Legend, 

owe a great deal to state industrial policy. Even for these firms, and even with continued state industrial policy, the long-term outlook is far from certain. The challenges facing China’s aspiring global giants are far greater than those that faced 

any previous late-comer country. Without sustained industrial policy large Chinese 

firms will mainly fail in their efforts to catch up with the world’s leading firms. The 

example of Brazil, which has a per capita income far above China’s, illustrates vividly the likely outcome in the absence of state industrial policy.10 Over one-half of 

Brazil’s leading firms (by sales revenue) are global giants.11

In almost every case, successful late-comer countries, from Britain and the U.S. 

in the eighteenth and nineteenth centuries, to Korea and Japan in the late twentieth centuries, used one form or another of industrial policy to nurture their own 

‘‘national team’’ of large, globally competitive firms. China’s ambitions are no less 

intense. To deny China the chance to use the same mechanisms that they themselves used is tantamount to ‘‘pulling up the ladder’’ through which they themselves 

developed globally competitive firms (Nolan, 1995; and Chang, 2002). Indeed, the attempt by high-income countries to pressurise poor countries, such as China, to give 

up national industrial policy, is itself a form of industrial policy, since it amounts 

to clearing the ground for competitive success for the dominant firms headquartered 

in the high-income countries. 

It may be argued that it no longer matters that a firm is ‘‘American’’ or ‘‘Chinese,’’ 

because production systems are global. It may be argued that in the long-run large 

global firms will become ‘‘Sinicised’’ due to the growing role of Chinese institutional 

and individual shareholders and Chinese people working within the global corporation. It may be argued that in the long-run there is a powerful incentive for high 

technology activities to be increasingly located in China, close to the world’s greatest 

concentrations of highly qualified, relatively low-paid employees. 

However, these are speculations about the long run. Today, under the WTO rules 

of the ‘‘global level playing field,’’ China’s large firms face an intense threat. That 

competitive threat had already become clear well before China was admitted to the 

WTO, since it had already relaxed numerous constraints on FDI in the preceding 

years. However, the terms of China’s admission to the WTO, if fully applied, amount 

to a comprehensive dismantling of Chinese industrial policy, which greatly intensifies that threat. The pace of growth of FDI by global giant firms in China is accelerating sharply. 

The pressure from within China to continue with industrial policies arises from 

at least three directions. In part it arises due to nationalist feelings. This is far from 

unique to China. In the USA in the 1970s and 1980s national sensibilities were inflamed by the rapid penetration of Japanese firms. Similar sensibilities are aroused 

in China at the explosive intrusion of global giant firms, often U.S.-based, in that 

country. It would be naı ̈ve not to draw attention to the surge of anti-American feeling in developing countries associated with the U.S.-led globalisation process. Such 

feelings erupted in China after the bombing of the Chinese embassy in Belgrade. 
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12See, for example, the discussions of oil, U.S. energy security and U.S. foreign policy in 

Brzezinski, 1997, and Yergin, 1991. 13Petrobras (Brazil) is partially privatized. 

The incentive to continue with industrial policy arises also due to concern at the 

ferocious pressure that unconstrained opening up to global giant firms would exert 

upon employment in the Chinese state-owned sector. Explosive growth and domination of large segments of the modern economy by global giants is already helping 

to press forward high-speed downsizing of employment in Chinese state-owned 

firms, providing fuel to the fire of social discontent. 

The attempt to nurture indigenous national champions is also perceived as important by Chinese policy makers because of the implications for national security. The 

U.S. Government has long supported the U.S. aerospace industry through industrial 

policies for precisely the reason that it is a key to the generation of a wide network 

of new technologies. The oil and petrochemical industry has long been regarded as 

a ‘‘strategic industry’’ in the USA, with intimate inter-twining of business interests 

and international relations in a form of industrial policy the goal of which is to secure primary energy supplies to the USA.12 In industries such as these, which it 

considers are of special strategic significance, it is to be expected that Chinese policy 

makers will continue to try hard to nurture indigenous national champions. 

China’s high-speed move towards becoming the world’s largest manufacturing 

base is giving rise to understandable anxiety not only in the USA, but across all 

the high-income countries, not least among China’s immediate Far Eastern neighbours, including Taiwan. This has caused ferocious domestic debate about 

‘‘hollowing out’’ of these economies. 

In order that there is a balanced policy response towards China’s industrial policies to nurture its indigenous firms, it is necessary to appreciate the intensity of 

the competitive threat that confronts large Chinese firms on the global level playing 

field of the WTO. At a meeting in Beijing in the Great Hall of the People in 2001, 

one U.S. Representative said: ‘‘Competition from abroad will help the Chinese to 

raise their level of efficiency, just as the U.S. car industry did in the 1980s in the 

face of Japanese competition.’’ To compare the indigenous Chinese auto industry 

today with Chrysler, Ford and GM in the 1980s shows little appreciation of the true 

nature of the competitive structure of global big business and the magnitude of the 

inequality between large firms from the high-income countries and those from developing countries. 

In order to produce a balanced policy response it is also vital to appreciate the 

wider setting of the fragility of the entire system of Chinese political economy. Excessive pressure upon China to capitulate to U.S. demands to enforce in the strictest 

terms the WTO regulations and essentially abandon industrial policy could make a 

serious contribution to destabilising the entire system of political economy. This result would ultimately be in no one’s best interests, either in China or in the USA. 

In sum, given the immense imbalance in global business power, especially in high 

technology sectors, it is easy to understand why China might wish to continue to 

support indigenous firms through various measures of industrial policy at both the 

national and the local level. If these measures were, indeed, to be implemented successfully, then they might contribute to global peace and prosperity by helping to 

stabilise China’s political economy. 

APPENDIX: CATCH-UP IN CHINA’S STRATEGIC INDUSTRIES

A1. Oil and Petrochemicals

The Global Setting

Crude oil and natural gas remain central to global political economy. However, 

the regional distribution of world oil and gas reserves, production and consumption 

are highly uneven. This is of special importance for global political economy. China 

is poorly endowed with oil and gas. Its share of the world oil and gas reserves 

amount to only 2.3 percent and 0.9 percent respectively (BP, 2001). In 2000, China 

was the third largest oil consuming country after the United States and Japan. 

After 1993, China became a net crude oil importer. Oil imports in 2000 was equivalent to 31 percent of China’s total oil consumption. 

At the end of the 1990s, among the world top 25 oil companies ranked by operating performance, fourteen (fifteen if Petrobras is included) 13 were state-owned national oil companies (NOCs), all based in developing countries (Petroleum Intelligence Weekly, 18 December, 2000). These NOCs own the majority of the world oil 

and gas reserves and are the world’s largest oil producers. However, they are rel-
117

14FT, 25 February 2003. 

atively weak in downstream refining and marketing. There have been no cross-border mergers among the NOCs. 

(i) Mergers and Acquisitions 

Extensive privatisation of the oil and petrochemical industry opened up new opportunities for mergers and acquisitions in both the advanced and developing countries. In the late 1990s, a frenzy of consolidation began to sweep through the global 

oil majors. This fundamentally changed the competitive landscape in the industry. 

The mergers and acquisitions include BP’s trans-Atlantic merger with Amoco and 

its takeover of Atlantic Richfield Company (Arco), securing BP’s position as one of 

the top ‘‘big three’’ western oil companies; Exxon’s merger with Mobile, the new 

company created overtaking Royal Dutch/Shell as the largest western oil company; 

the merger between TotalFina, created through French Total’s takeover of the Belgian PetroFina, and Elf Aquitaine; the merger between Chevron and Texaco. The 

consolidation process accelerated among the mid-sized integrated oil and petrochemical companies. The merger between Conoco and Phillips in 2001 created the 

world’s sixth largest energy company in terms of reserves and production. In February 2003, BP combined its Sidanco holdings with Tyumen Oil (TNK) for $6.75 billion, creating Russia’s third largest oil and gas company, together with Alfa Group 

and Access-Renova (AAR). Only two months later, Russia’s largest oil producer, the 

Yukos Oil Company, took over Sibneft, the fifth Russian oil company for $13 billion. 

The new company YukosSibneft became the world’s fifth largest publicly traded oil 

company in terms of production. At 2.4 million barrels of oil a day, the new company 

ranks behind Exxon Mobil, Royal Dutch/Shell, BP and Chevron Texaco. In August 

2003, BP agreed to purchase a quarter of Slavneft for $1.35 billion. If realised, the 

deal will position BP as the world’s second largest publicly traded oil and gas producer, ahead of Royal Dutch/Shell (FT, 2 August 2003). 

The Middle East, the Caspian Region, and the West Africa are the terrain to battle for hydrocarbon resources. In March 2003, the Saddam Hussein regime was overthrown and the world embarked on a post Iraq War era. Before the War, global majors called for a ‘‘level playing field’’ for all oil companies in the post-Saddam Iraq. 

The Russian, Italian, French and Chinese oil companies have made deals with Saddam Hussein’s government, amounting to $38 billion.14

(ii) The ‘‘Cascade’’ Effect

The consolidation of the global large oil companies promoted the ‘‘cascade’’ effect 

in each sector from upstream to downstream: Halliburton and Schlumberger in oilfield service; ABB Lummus and Amec in petrochemical process technologies and 

construction; GE and Rolls-Royce in pipeline pumps; Acelor and POSCO in pipeline 

steel. The consolidation of the big oil companies also helped to promote the oil shipping companies to consolidate. 

(iii) Repsol-YPF

During the period of large-scale mergers among the western major oil companies, 

Spain’s Repsol successfully launched a hostile bid for Argentina’s YPF in 1999. YPF, 

Argentina’s ‘‘national champion,’’ was privatised, restructured, and subsequently 

listed in the stock exchanges in Buenos Aires and New York in 1993. It was then 

the largest publicly traded oil company in Latin America. The deal is highly significant in that it is the first time that a large privatised western oil company has 

taken over a major, formerly state-owned oil and petrochemical company from a developing country. 

(iv) Competitive Obstacles for Firms Based in Developing Countries 

The mergers in the world’s oil and petrochemical industry during the global business revolution have created a group of new super-giants that stand in a position 

of greatly enhanced competitive advantage compared to potential competitors from 

developing countries. These new super-giants greatly increased their size and their 

assets base. They have constructed a portfolio of high quality oil and gas reserves 

distributed around the world. They are able to invest large amounts in R&D to sustain and extend their technical lead over other companies. They have the resources 

to invest in large-scale information technology systems that can better integrate 

their extended internal value chain, stretching from exploration to the petrol station. They have developed marketing systems with immensely powerful global 

brands. They have built massive multi-billion dollar central procurement capabilities with large consequent cost-savings. MSDW estimates that the super-majors, 

namely Exxon Mobil, Shell and BP, have a capability to sustain their competitive 
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15 In January 2003, PetroChina expressed its intention to make overseas acquisitions to meet 

the company’s oil and gas production targets at an annual rate of 5 percent for three years to 

2005.

edge in the industry for at least fifteen years (MSDW, 1998). Not one integrated oil 

and petrochemical firm based in a developing country has been able to challenge 

the global giants in this sector. By far the most successful example was YPF. However, as that case vividly illustrated, privatisation, liberalization and high quality 

management, are far from a guarantee of independent survival.

China’s Response

In the same period that the merger frenzy swept through the global major oil 

companies, China’s oil and petrochemical industry underwent massive restructuring. After an intense debate on how to reform the oil and petrochemical industry, 

the Chinese government created two large integrated oil companies through administrative measures.

(i) The 2000/1 Flotations of PetroChina, Sinopec and CNOOC

In April 2000, PetroChina, created on the basis of the core businesses of CNPC, 

listed in New York and Hong Kong (China) Stock Exchange. The parent company 

CNPC held a 90 percent of PetroChina’s total equity. BP became PetroChina’s strategic investor. In October 2000, Sinopec, established on the core businesses of the 

oil Sinopec (now known as Sinopec Group) listed in the stock exchanges in New 

York, Hong Kong and London. Sinopec Group controlled 56 percent of Sinopec’s equity. Exxon Mobile, BP, Shell and ABB Lummus became Sinopec’s strategic investors. Equity involvement by the global super-majors was crucial to their successful 

listing of PetroChina and Sinopec. After the failure in international flotation in 

1999, CNOOC Ltd., China’s small/medium-sized offshore producer, was eventually 

listed in New York and Hong Kong in February 2001.

(ii) Business Capabilities

• Reserves and Output

PetroChina’s oil reserves and production were close to the level of the world’s 

leading companies. Sinopec is similar to ENI in terms of oil reserves and oil 

production. In terms of gas, PetroChina follows behind the ‘‘big three’’ and 

Sinopec lags considerably behind the global majors (Table A1). However, the 

two leading Chinese oil companies have a crucial difference with the global giants in terms of global distribution and the quality of the portfolio of oil and 

gas assets. PetroChina and Sinopec produce entirely within China.15 Daqing, at 

which 50 percent of PetroChina’s oil reserves are located, is declining seriously. 

About one-third of PetroChina’s gas reserves are in the Tarim Basin in 

Xinjiang. It will require advanced technology and involve high transportation 

costs to produce and transport the gas from Tarim to the main consuming areas 

in the eastern part of the country (xi qi dong shu). Less than five of 

PetroChina’s oil fields can make a profit when the oil price is at $10–15 per 

barrel, the benchmark price at which the global giants can still make a profit. 

• Refining

China’s refining sector needs revamping, upgrading and expanding. 

PetroChina and Sinopec between them only have four refineries with capacities 

greater than 10 million tons. With more than half of the oil imports from the 

Middle East, most of China’s refineries need to add capabilities to process sour 

crude oil. In addition, more stringent environmental regulations for refined 

products calls for high-conversion refineries. With tariff reduction due to China’s terms of admission to the WTO, few of PetroChina’s refineries can survive 

in near-open competition with imported refined products.

• Marketing Petroleum Products

Only around one quarter of the service stations owned by each of PetroChina 

and Sinopec (Table A1) were franchised retail outlets bearing the companies’ 

brands, ‘‘PetroChina’’ and ‘‘Sinopec’’ respectively. Neither refined products supplies nor the price of refined products are centrally controlled, nor are accounts 

centrally consolidated, even for the network of service stations owned and operated by the two companies themselves. The two companies’ wholesale entities 

have no effective coordination of supply, price or customers. PetroChina and 

Sinopec still have a long way to go before they develop the logistics expertise 

of the global giants or possess a comparable brand based on the safe and lowcost operation of a huge logistics system. This is a crucial part of the development of the brand for globally competitive oil and petrochemical company. 

Moreover, the Chinese companies still must face the challenge of rationalising 
119

16They are the USA, UK, Germany, France, Italy, Switzerland, Japan, Canada, Mexico, and 

Singapore. 17For example, Schlumberger spends more on R&D than Shell (£324 million compared with 

£313 million), while Haliburton spends more than ENI (£160 million compared with £146 million) (DTI, 2000: 54).

the market. It is estimated that in 2001 the average annual throughput per 

service station in China was 750 tonnes/year, only 27 percent of the average for 

other ten countries 16 (Yin and Dong, 2002). However, the number of service station per hundred kilometres in China was 5.7, compared with the average 2.8 

for the other ten countries. In 2002, Sinopec reported the annual throughput 

for its service stations was 1,560 tonnes per station, compared with approximately 2,400 tonnes for ENI’s service stations. 

• Petrochemicals

The average annual capacity of petrochemical sites is just 400,000 tonnes, 

only half of that of the global majors. Instead of having a small number of 

giant, low-cost integrated sites situated in a few concentrated areas, as the global giants do, these 18 ethylene crackers are located at 16 sites in 15 cities. For 

petrochemical production, high value-added products only account for 30 percent 

of China’s total production. Imports of petrochemicals account for up to 50 percent of the Chinese market (Sinopec, 2001). With further reductions in import 

tariffs since China’s entry to WTO, even these low value-added petrochemical 

products face intense competition not only from global majors but also from lowcost producers in the Middle East and the South East Asia. China’s downstream 

sector will experience severe impact after 2006 when China’s phase-out period 

for WTO finishes.

• R&D

The technological capabilities of PetroChina and Sinopec both upstream and 

downstream are relatively backward. A Chinese industry expert pointed out 

that the country’s low level of technological innovation upstream would pose ‘‘a 

great constraint on the industry’s competitiveness and efficiency’’ (China Petroleum, January 1999). In petrochemical production, backward technology resulted in a high level of energy consumption and a low percentage of chemicals 

for further processing and utilisation (Chen, 1998: 29). In terms of R&D spending, the global majors are able to spend more in absolute terms due to the sheer 

size of their sales revenue (Table A2). Moreover, they are able to purchase 

greater amounts of the R&D ‘‘embedded’’ in the products of specialist suppliers 

to the oil and petrochemical industry.17

Table A1. Operating Data Compared: Global Majors Versus PetroChina 

and Sinopec, 2002

Company 

Proved

reserves Production Refinery 

throughput

(mmb/d) 

Oil 

product 

sales 

(mmb/d) 

Petrochemical 

production 

(mmt) 

Service 

station 

number 

Oil 

(bb) 

Gas 

(bcf) 

Oil 

(mmboe/d) 

Gas 

(bcf/d) 

Exxon Mobil 12.6 55,718 2.5 10.5 5.5 7.8 26.9* 42,000

Royal Dutch/Shell 10.1 53,438 2.4 9.4 4.1 7.4 21.4* 46,000

BP 7.8 45,844 2.0 8.7 3.1 6.6 27.0 30,000

TotalFinaElf 7.2 21,575 1.6 4.5 2.3 3.2 16.4† 16,600

Chevron Texaco 8.7 19,335 1.9 4.4 2.1 3.9 — 20,400

ENI 3.8 18,629 0.9 3.1 0.65 1.0 — 10,700

Repsol YPF 2.0 18,205 0.58 2.6 1.2 1.0 3.5 6,600

PetroChina 11.0 38,817 2.1 1.7 1.6 1.1 3.5 13,000

Sinopec 3.3 3,329 0.74 0.49 2.1 1.4 10.5 28,000

CNOOC Ltd. 1.4 3,548 0.3 0.27 — — — —

Note: * Sales † Capacity 

bb = billion barrels, bcf = billion cubic metres, mmboe/d = million barrels of oil equivalent per day, bcf/d 

= billion cubic feet per day, mmb/d = million barrels per day, mmt/y = million barrels per year, mmt = 

million tonnes 

Sources: Compiled from company reports 
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18This can be observed through the price at which ‘‘non-traded’’ shares are exchanged among 

state-owned companies.

(iii) Financial Performance 

• Revenue. Their sales revenue places PetroChina and Sinopec alongside the 

leading second tier of global oil and petrochemical companies, but far short 

of the industry leaders, Exxon Mobil, Shell and BP. Even the combined revenue of PetroChina, Sinopec and CNOOC at $71.9 billion is less than that of 

Chevron Texaco (Table A2).

• Profit. In 2002, the combined net profits of PetroChina and Sinopec were 

$7.6 billion, just 36 percent of the combined net profits of the top two global 

giants, Exxon Mobil and Shell (Table A2). Profits per worker at PetroChina 

and Sinopec are minuscule compared to those at the global oil giants. CNOOC 

is a ‘‘lean’’ company and its profit per employee significantly exceeds even 

that of the industry leader Exxon Mobil. However, the Chinese companies are 

still operating in a protected situation. Moreover, the Chinese companies have 

huge demands on their profits. For example, they have to finance their own 

downsizing but also that of their parent companies, which still have huge 

workforces (Table A2).

• Market Capitalisation. If one assumed that the whole company was floated, 

then at the share price as of 4 January 2001, the market capitalisation of 

PetroChina and Sinopec would be $47 billion and $19 billion respectively, 

only a fraction of the $251 billion for Exxon Mobil, $166 billion for Royal 

Dutch/Shell and $160 billion for BP (Table A2). Of course this greatly overstates the true market capitalisation of Chinese floated companies, since the 

value of the non-traded shares is typically considerably below that of the traded shares.18 The low level of operational efficiency and the high level of uncertainty in their performance after China’s accession to the WTO are serious 

concerns among industry experts and analysts. 

Table A2. Financial Indicators Compared: Global Majors Vs PetroChina 

and Sinopec, 2002

Company 

Revenue 

($billion) 

Net

profit 

($billion) 

R&D 

spending 

($million) 

Market 

Cap§ 

($billion) 

Employee 

numbers 

(thousand) 

Profit/

Revenue (%) 

Profit/

Employee

($) 

Exxon Mobil 204.5 11.5 631 251 92 5.6 125,000

Royal Dutch/Shell 179.4 9.4 472 166 116 5.2 81,034

BP 178.7 6.9 373 160 115 3.9 60,000

TotalFinaElf 107.7 6.2 695 106 121 5.8 51,240

Chevron Texaco 98.7 1.1 221 79 53 1.1 20,755

ENI 50.3 4.8 315.3 64 80.6 9.5 59,553

Repsol YPF 33.8 1.9 132◆ 20 30.6 5.6 62,092

CNPC 42.1 6.4 — — 1,100 15.2 5,818

of which: 

PetroChina 29.5 5.7 218 4.7† 419.5 19.3 13,588

Sinopec Group 41.6* 1.5* — — 960 3.6 1,563

of which: 

Sinopec 39.2 1.9 182 3.8‡ 418.8 4.8 4,537

CNOOC Ltd. 3.2 1.1 13.3 11 2 34.4 550,000

Notes: * Figures are company estimates 

◆ Figure in 2001

§ Market capitalisation on 10 June 2003

† Flotation 10% of company value 

‡ Flotation of 20% of company value 

Sources: Company reports, CBSMarketWatch.com 

(iv) Organisational Structure 

Although the organisational structure of PetroChina and Sinopec is superficially 

similar to that at an international integrated oil company, the superficial similarity 

conceals important differences. The global giants have a strong ‘‘one company’’ cor-
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19 Based on PetroChina’s dividend payment of $0.02 per share and the weighted average number of 171,630 million shares issued and outstanding in 2000. 20The issues of creating shareholder value and protecting minority shareholders are discussed 

in China Petroleum, April 2000, p. 18–29 and an article ‘‘Oil industry: choices after flotation’’ 

by Zhang Jiwei in Finance (Caijing), November 2000. 

porate identity and culture. Within PetroChina and Sinopec there exist powerful entities that over the years developed strong independent corporate identities and ambitions. Both PetroChina and Sinopec are integrating these powerful subordinate 

companies by centralising control over planning, personnel, investment and finance. 

Nevertheless, establishing a unified corporate identity and culture remains a formidable challenge. 

The relationship between the two listed companies and their parent companies remains ambiguous. The bulk of the income of CNPC and Sinopec Group is from the 

dividend payment of the two listed companies. In 2002, CNPC received an approximate $3.1 billion dividend payment from PetroChina,19 accounting for 53 percent of 

its net profit. In 2002, the non-core businesses of CNPC and Sinopec Group still employed more than 680,000 people and 540,000, respectively. A large fraction of these 

activities are loss-making. To what extent PetroChina and Sinopec have autonomy 

in making decisions with respect to business strategy, dividend payments and appointment of senior management remain unclear. Such a structure has caused concern to be expressed about the respective companies’ commitment to creating shareholder value and protecting the rights of minority shareholders.20

(v) Complex Penetration 

The global giants are deeply interested to develop their business in China from 

upstream to downstream. According to the State Economic and Trade Commission, 

in upstream exploration and development, by 1999, total foreign investment reached 

$1.1 billion in onshore upstream and $6.45 billion in offshore upstream. In petrochemicals, global petrochemical giants will set up six joint ventures petrochemical 

complexes by 2005, each of the projects involving $2.5–4.5 billion investment and 

located in the coastal regions, which have the highest average income level in 

China. If we assume all the joint venture projects start production in 2005, they 

would account for 42 percent of total projected ethylene demand in China at 10 million tons (Oil and Gas Journal, 10 January 2000). The global giants are in most 

areas technologically far ahead of their Chinese counterparts in these joint ventures. 

From the perspective of the foreign partner in the joint venture, they each form a 

part of the respective global business system, typically a single business unit. In 

this sense, they represent an important growth of the multinational giants within 

the ‘‘body’’ of the indigenous Chinese firm. 

As discussed above, the global majors have become strategic investors in 

PetroChina and Sinopec. In April 2001, PetroChina and BP established a marketing 

joint venture in Guangdong, aiming for 500 service stations by 2001. Each of the 

global majors, Exxon Mobil, Shell and BP, are setting up joint ventures with 

Sinopec for 500 service stations in Guangdong, Jiangsu and Zhejiang, respectively. 

For the three companies, this was ‘‘but the beginning of their attempts to capture 

a share of the world’s largest retail market’’ (Petroleum Economist, October 2000) 

(emphasis added). The strategy of the global giants to expand their downstream, 

high-margin business, each in a different part of China’s high-income coastal markets, is clear. In the middle of 2003, Shell’s joint venture with Sinopec was approved. 

(vi) Overseas Expansion 

China stepped up its acquisition of overseas oil and gas assets in the late 1990s 

(Andrew-Speed, 2002: 33–36). CNPC was the sole entity to invest in overseas oil and 

gas assets before 2002, the year in which Sinopec and CNOOC started their overseas expansion. Currently, CNPC has relatively large investments in Sudan and 

Kazakhstan and a presence in Syria, Venezuela, Peru, Canada, Myanmar, Thailand 

and Indonesia. In 2002, CNPC obtained 10.2 million tons of oil from its overseas 

assets. However, this accounted for less than 10 percent of CNPC’s total production. 

Sinopec has assets in Algeria, Yemen and Indonesia. CNOOC acquired assets in 

Australia and Indonesia. It is notable that Sinochem, approved by the State Council 

in 2001, joined the three Chinese oil majors for overseas acquisition. In February 

2003, Sinochem acquired the Atlantis project from the Norwegian oil-filed service 

company PGS. Sinochem aims to become ‘‘a vertically-integrated state-owned oil 

company’’ (Wang, 2003). 

The Chinese oil major’s overseas investment programme has had serious setbacks. 

At the end of 2002, CNPC made a bid for the Russian government’s 74 percent hold-
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ing in Slavneft, the eighth largest oil company in Russia. However, just two days 

before the bidding date, the Russian Duma passed a resolution, forbidding any entity controlled by foreign governments to bid for Slavneft. CNPC withdrew from the 

bidding process. In early 2003, the proposed oil pipeline from Angarsk in eastern 

Siberia to Daqing was held up due to a rival proposal supported by Japan to construct the oil pipeline to the Russian port of Nakhodka on the Sea of Japan. In May 

2003, CNOOC and Sinopec’s purchase of an 8.3 percent stake from BG in the North 

Caspian Sea oil and gas project in Kazakhstan was blocked by the other partners 

(Shell, Exxon Mobil, TotalFinaElf, Conoco Philips and ENI), exercising their preemption rights. The project was considered to be ‘‘the largest oil field discovered in 

the last half century.’’ Commentators regarded the pre-emption as ‘‘[flying] in the 

face of the traditional practice among Western businesses to court Chinese interests 

at all costs’’ (SCMP, 3 June 2003). 

(vii) Summary 

The process of restructuring and flotation of PetroChina and Sinopec was 

achieved through administrative measures within just one year. Despite this 

achievement, substantial question marks remain. Across the whole value chain from 

upstream to downstream, PetroChina, Sinopec and CNOOC are at disadvantage in 

terms of the quantity of oil and gas reserves compared with the national oil companies, and in terms of global distribution and quality of reserves compared with the 

super-majors. They are at disadvantage in technology and financial strength compared with the global majors. There remains a deep internal battle to establish a 

cohesive corporate culture to integrate their powerful subordinate companies and establish a truly unified company. The relationship of the floated companies with the 

parent remains unresolved. Across the value chain, PetroChina, Sinopec and 

CNOOC have been actively forming ‘‘strategic alliances’’ and establishing joint ventures with global oil and petrochemical companies. Their future relationship with 

each other and with the global giants remains highly uncertain, and strongly depends on the path taken towards them by their majority owner, the Chinese state. 

On the verge of China’s entry to the WTO, a meeting convened by the State Planning and Development Commission reported China’s petrochemical industry ‘‘faces 

severe challenges’’ (Xinhuanet, 2001). It remains an open question whether 

PetroChina, Sinopec and CNOOC will succeed where YPF failed. 

A2. Aerospace

Global Trends

(i) Consolidation 

The dramatic change in the demand side of the world’s aerospace industry in the 

1990s has been a powerful force to drive forward consolidation. After the Cold War, 

both the USA and Europe drastically reduced their defence spending (IISS, 1999, 

37). Procurement techniques rapidly moved towards those of the civil aerospace 

world as governments push contractors to lower costs. Alongside the decline in 

defence procurement, European and U.S. military aircraft manufacturers have been 

able to sell to markets that were inaccessible during the Cold War (IISS, 1999, 283). 

Since the 1980s, privatisation as well as international alliances among the world’s 

airlines placed great pressure on aircraft suppliers to reduce cost. Following the 

events of 11 September 2001, a decline in commercial aircraft purchase will be partially compensated by increased purchase of military aircraft (including large transport planes) and other military equipment. In May 2003, the U.S. Congress approved a $400 billion defence budget for the year 2004, $20 billion more than the 

Pentagon requested and a $45 billion increase over the budget for this year. Defence 

observers comment that even though the actual funding for 2004 would scale back 

to the levels initially requested by the Pentagon, ‘‘the U.S. would spend more on its 

military next year than the next 10 largest-spending nations combined’’ (FT, 13 

June 2003). Moreover, the Pentagon’s five-year defence plan forecasts increases of 

$20 billion per year through to the end of the decade.

USA. Initiated by the Pentagon over the ‘‘Last Supper,’’ over $62 billion-worth of 

mergers and acquisitions occurred between 1994 and 1998 in the USA (FT, 3 September 1998). Between 1990 and 1998, the number of prime contractors for fixedwing aircraft fell from 8 to 3; rotary wing aircraft 4 to 3; tactical missiles 13 to 4; 

expendable launch vehicles 6 to 2; satellites 8 to 5; and, strategic missiles 3 to 2 

(James, 1998). During the 1990s, more than 50 companies were compelled to consolidate into today’s ‘‘Big 5’’: Boeing, Lockheed Martin, Northrop Grumman, 

Raytheon and General Dynamics. The most significant event in this process was the 

merger between Boeing and McDonnell-Douglas. The resulting extraordinarily high 

level of industrial concentration received ‘‘strong support from the USA administra-
123

tion’’ (FT, 23 September 1997). The merger resulted in Boeing being the only producer of jet airliners in the USA and accounting for no less than 84 percent of the 

world’s total commercial aircraft in service (FT, 23 September 1997). After the 

merger, Boeing and Lockheed Martin completely dominated military aircraft sales 

to the U.S. Government (FT, 3 September 1998). On 26 October 2001, the Pentagon 

awarded the $200 billion Joint Strike Fighter (JSF) programme, the biggest defence 

procurement, to Lockheed Martin. The procurement decision ‘‘catapults Lockheed 

into an unassailable position as the world’s top builder of fighter aircraft’’ (FT, 29 

October 2001). Moreover, it is expected that over the lifetime of a given plane, the 

final cost will be several times that of the initial procurement, which will amount 

up to $1 trillion at today’s prices.

Europe. The European military aerospace industry with much smaller and fragmented government procurement than their counterparts in the USA realised that 

it must unify or perish before the U.S. challenge. In October 1999, Dasa of Germany 

and Aerospatiale-Matra of France and Spain merged into a new giant company 

called the European Aircraft, Defence and Space Company (EADS). However, EADS 

now has serious problems with its management structure leadership (FT, 16 November 2001). Moreover, BAe Systems, EADS’s partner in Airbus and Eurofighter, 

now is a full partner with Lockheed Martin in the JSF programme. France is committed to its own Rafale fighter through Dassault and competes for export orders 

with EADS’s Eurofighter. Italy has decided to quit the European programme to 

build a large military transport aircraft, the A400M. In addition, the events of 11 

September will put severe pressure on Airbus, especially given the large outlays already undertaken on the super-large aircraft A380, for which the market now looks 

much less optimistic. In sum, the final shape of the European aerospace industry 

is far from certain.

Transatlantic Option. The USA has the world’s largest arms market by far. In 

an effort to prevent the emergence of a ‘‘Fortress Europe’’ in the arms industry, the 

U.S. Government has been moving towards relaxing its controls on foreign investment in the industry and greater technology sharing with European-based defence 

firms. Jacques Gansler (the then Head of Procurement, Pentagon) announced that 

the Pentagon was willing to allow European or Asian companies to ‘‘buy major U.S. 

defence companies under certain conditions,’’ one of which was that other countries 

must reciprocate, allowing similar access to their own markets (International Herald 

Tribune, 8 July 1999). The 1990s saw increases in programme-level collaborative arrangements between industrial firms. The JSF programme is by far the most significant one. The UK is the sole Level 1 partner that commits $3.3 billion to the development costs and ‘‘will be given a deeper insight into the workings of the F–35 [JSF] 

programme.’’ The Netherlands and Italy are the Level 2 partners, which will allow 

them to ‘‘influence the aspects of the F–35’s design.’’ The Level 3 partners include 

Canada, Denmark, Norway and Australia, with Singapore, Turkey and Israel expected to follow before the end of 2003. Level 3 partners will be given ‘‘access to 

technical, cost and schedule data’’ so that ‘‘they can shape their requirements 

around the aircraft’’ (FT, 22 July 2002). However, as a Level 1 partner, BAe System’s demand for the source codes for the F–35 caused anger in the U.S. administration. Without the source codes, Britain would have no autonomy to adapt the aircraft for operational requirements or perform important upgrades: ‘‘Reprogramming 

the aircraft to face any future threats, . . . could be done only once the U.S. had 

given its permission’’ (FT, 14 July 2003). 

(ii) Systems Integration 

Integrating the Supply Chain. Modern aircraft and engines have become so 

complex that a major aspect of competitive advantage has become the ability to integrate the whole system of supply to produce the final product. The supply base of 

the aerospace industry cuts across many industries: ‘‘As much as 60–80 percent of 

the end-product value of aerospace products derives from this supply base’’ 

(Murman et al, 2002, p. 18). The system integrators—the designer and assembler 

of the civilian aircraft or the prime contractors for defence industry contracts—make 

large investments in IT systems to integrate the supplier networks tightly with the 

core design and assembly location, and involves increasingly detailed, instantaneous 

exchange of information. The surrounding system of suppliers today constitutes a 

veritable ‘‘external firm,’’ whose activities are closely coordinated and planned by 

the core systems integrators. For example, Airbus has more than 1,500 suppliers in 

27 countries, including over 500 U.S. companies, and suppliers in Singapore, India, 

Australia, Indonesia, Korea, Japan and China. The size of the ‘‘external firm’’ can 

greatly exceed that of the core companies. Rolls-Royce has around 20,000 people in 
124

its aerospace division in the UK, and estimates that around 40,000 people work fulltime to supply the company with goods and services.

Building Internal Systems Integration Capabilities. Alongside the trend towards concentration among component and sub-system suppliers, the leading systems integrators are themselves tending to become more vertically integrated. This 

enables them to perform the increasingly complicated tasks involved in integrating 

complex sub-systems with multiple interfaces. For example, Raytheon bought a succession of military businesses in the 1990s, including the military electronics company, E-Systems, the military systems and electronics business of Texas instruments, and the Hughes military electronics business from General Motors. By the 

late 1990s, Raytheon had become a huge company with a $20 billion annual turnover, and a wide range of systems integration capabilities in missiles and torpedoes. 

For the defence aircraft producers, the emphasis has changed to ‘‘the integrations 

of systems rather than the production of individual combat platforms’’ (FT, 13 April 

2003). In April 2003, EADS announced that it would integrate its defence electronics, military fighter aircraft and telecommunications activities into one division. 

The division will have annual revenue of $5.4 billion and 24,000 employees in nine 

countries. 

(iii) The ‘‘Cascade’’ Effect

In order to meet the demands of the systems integrators, the major components 

suppliers themselves needed to invest heavily in R&D and to grow in order to benefit from cost reduction through economies of scale. A powerful merger movement 

is taking place among first tier suppliers to the systems integrators. In the crucial 

aircraft engine sector, there are now only three engine makers left that have the 

capability to produce large modern jet aircraft engines, namely Rolls-Royce, Pratt 

& Whitney of United Technology and GE Engine of GE. Between them, they formed 

the joint ventures IAE (Pratt & Whitney and Rolls-Royce), Engine alliance (GE and 

Pratt & Whitney), and CFMI (GE and Snecma). By 2000, the market share of installed jet engine in the world airline fleet between them was 36 percent for Pratt 

& Whitney, 20 percent for CFMI, 14 percent for GE, 10 percent for Rolls-Royce and 

3 percent for IAE (AECMA, 2002). The Allied Signal/Honeywell merger in 1999 created a company that has ‘‘a strong position in everything from manufacturing cockpit controls to handling aircraft service and maintenance’’ (FT, 8 June 1999). Smiths 

Industries Aerospace has built a leading position in the control and management 

of aircraft utilities, and in the electrical, mechanical and hydraulic systems through 

a series of acquisitions in 2000, including the aerospace division of Invensys, the actuation division of BAe Systems. Through the merger with the TI Group in the same 

year, Smiths strengthened its first-tier aerospace supplier status by integrating 

Dowty of the TI Group. The trend towards concentration is also affecting smaller 

companies within the industry as exemplified in Meggitt’s takeover of Whittaker 

Corporation. The new company supplies valves, ground fuelling products and fire 

and smoke detectors to ‘‘virtually every aircraft maker in the West’’ (FT, 10 June 

1999). The merger was explicitly driven by the assemblers’ push to reduce the number of parts suppliers. 

(iv) Competitive Obstacles for Firms Based in Developing Countries

The aerospace industry is a capital-intensive high-technology industry with high 

barriers to entry. The profound transformation of the leading aerospace companies 

based in the U.S. and Europe in the 1990s created even higher barriers to entry 

than existed before. Today, major aerospace companies in developing countries face 

greater obstacles than ever in their attempt to catch up with the world leaders. 

Aerospace companies based in Europe and the U.S. benefit from vast military procurement, which together account for around 60 percent of the world total military 

procurement. They have massive economies of scale in assembly with long production runs for each aircraft type. They have huge R&D spending and large R&D support from their respective government (Fransman, 1995, 107), especially in the 

capitalisations, access to export credit guarantees supported by the U.S. Government, which has enabled them to sustain their technological lead: ‘‘The development 

of the U.S. aerospace industry was largely government-funded. As late as 1986, close 

to 80 percent of all R&D in this industry was federally-supported. Today this is a 

large employer (480,000 in 1994) and one of the largest exporters ($30 billion per 

year in 1980–94) in the nation’’ (White House, 2000) (emphasis added). They have 

huge financial strength and resources reflected in large market and often have the 

benefit of co-finance of industrial development with the government. They have high 

capabilities in system integration in both the internal and external firms on a global 

scale. They have established globally recognised brands both for aircraft and for key 

sub-systems. 
125

21 In recent years, Fokker, BAe and Faicchild Dornier have all exited this sector due to the 

intense competition and low profits. 

Not one firm from a developing country has succeeded in challenging the aerospace giants of the developed countries either as a systems integrator or a major 

first tier supplier. Embraer represents the highest achievements so far for developing countries in the field of commercial aerospace. However, it is far from certain 

that in the foreseeable future it will be able to compete successfully with the established giants in even the regional jet market, let alone in the market for larger aircraft. It is best regarded as a substantial player in the ferociously competitive niche 

market for regional jets,21 rather than a competitor to the global giants. 

China’s Response 

The restructuring of China’s aerospace industry started at the same time that the 

world’s leading aerospace companies entered a period of profound change. In 1993, 

Aviation Industries of China (AVIC) was established, assuming responsibility for the 

management of all the aviation industry assets formerly under the Ministry of Aviation Industry. It was formally turned into an experimental state holding company 

in 1996. The goal of the holding company was to transform the nationwide collection 

of enterprises into an internationally competitive aviation company ‘‘with worldwide 

fame and influence’’ (AVIC, 1998: 2–4). 

(i) The Year 1999 Restructuring: Splitting Into Two 

By early 1999, debate over how to restructure it in the light of its own internal 

problems and the explosive changes going on in the world industry outside became 

increasingly intense. In early 1999, the Chinese government decided to split AVIC 

into two fully integrated parts, AVIC 1 and AVIC 2. The stated goal of the reform 

was the ‘‘break up of monopoly and the fostering of fair market economy mechanism’’ (China Daily Business Weekly, 31 January 1999). While the world’s leading 

aerospace corporations were in the midst of an unprecedented epoch of consolidation, the Chinese aerospace industry was being divided into smaller segments. After 

the restructuring, the new AVIC 1 took over businesses in manufacturing interceptors, interceptor-bombers, tankers, transporters, trainers, and reconnaissance airplanes while the new AVIC 2 focused on helicopters, transporters, trainers, and general aircraft. 

(ii) AVIC’s Businesses

Size. In 2002, the combined total sales of AVIC 1 and AVIC 2 are less than onetenth of Boeing’s and one-fifth of Lockheed Martin’s, and, as we shall see, a large 

fraction of their revenues is now from diverse non-aerospace products. Their combined total revenues are only about one-fifth of the revenue of aerospace suppliers 

United Technologies and Honeywell, respectively (Table A3). However, AVIC 1 and 

AVIC 2 together employs over 400,000 people, more than twice as many as Boeing 

and Lockheed Martin do. If AVIC’s aerospace division adopted Western manning 

levels, . . . then the entire aerospace division would employ only around 5,000 people. 

If AVIC’s entire engine division were a separate company, and adopted Rolls-Royce’s 

manning levels, it would employ only around 1,200 people (Nolan, 2001a: 227). 

Moreover, the world leading aerospace companies have multi-billion dollar market 

capitalisations. This enables them to finance M&A through the stock market even 

if they have negative profits (Table A3).

Non-Aviation Production. In line with the policy of ‘‘military to civilian conversion’’ and the strategy of ‘‘civilian supports military,’’ AVIC had been turned into 

a vast empire of diversified businesses. By 1997, AVIC manufactured more than 

5,000 types of non-aviation products. In real terms, the sales of non-aerospace products rose by around 23 percent per annum from 1979 to 1997. Automobiles, auto 

components and motorcycles together accounted for 62 percent of the total value of 

AVIC’s revenue in 1997. Sales revenue of motor vehicles accounted for 72% of the 

total sales revenue of AVIC 2 (AVIC Economic Research Centre, 2000, p. 9).

Sub-Contract/Sub-System Joint Ventures. AVIC had progressed from purely 

compensation trade to becoming a competitive global supplier of components, including being the sole suppliers of some items (B–747 wing rear ribs, B–737 maintenance doors, BAe 146 doors, Dash-8 cargo doors and LM2500 turbine disks). Following the collapse of the proposed joint production plans for the AE–100 and the 

MD–90, Airbus and Boeing both responded with offers of considerably enhanced participation by AVIC in the production of sub-systems. Boeing is leading in that strategy with 74 percent of all parts built in China going to Boeing (Aviation Week & 

Space Technology, 8 May 2000: 63). Airbus agreed that AVIC could ‘‘participate in 
126

the development’’ of its 107-seat A318 programme, but, to date this remains very 

limited in scope. In the foreseeable future China’s sub-contracting industry seems 

likely to lag far behind the level of sales and technological sophistication achieved 

by the sub-contracting industry in Japan and South Korea. Despite AVIC’s intense 

efforts to win contracts and their substantial growth, China’s sub-contracts with the 

global giants are small-scale. In 2001, AVIC 1’s total subcontract sales were around 

a mere $120 million, the size of a small-scale engineering company in the West. In 

the aero-engine sector, the total output value of the joint venture between Xian 

Aero-engine Company and Rolls-Royce to manufacture turbine blades will be only 

around $30 million at full production in the early 21st century (China Daily Business Weekly, 11 October 1998). 

AVIC does not participate in the decisions over aircraft purchase in China. This 

limits its ability to place leverage on the global aircraft makers to sub-contract within China. Moreover, the main Chinese aircraft manufacturers are competing with 

each other to obtain sub-contract work, which weakens the overall industry’s bargaining power in obtaining sub-contracts, and in settling the terms for the sub-contracts. In addition, China’s sub-contractors lack ability to co-finance on a large scale. 

In the meantime, China’s leading sub-contractors face intense international competition from Israel in military sub-contracting, and from Japan and South Korea in 

civil sub-contracting. China’s sub-contractors are generally only able to contract for 

‘‘Level 3’’ contracts, compared to the sub-contract of Japan and South Korea usually 

at Levels 4 or 5. The latter usually involves co-financing and co-designing.

Table A3. Relative Size of Selected Aerospace Companies, 2002

Company 

Assets

($b) 

Revenue ($b) Profit

($m) 

Market Cap.*

($b) 

Employees

(000s) 

Boeing 52.3 54.1 492 20.9 165

EADS 49.7 28.3 ¥283 — 103

Lockheed Martin 25.8 28.2 500 21.9 125

Northrop Grumman 42.3 17.8 64 15.8 117

Raytheon 23.9 17.0 ¥640 11.8 76

General Dynamics 11.7 13.9 917 12.3 54

BAe Systems 25.1 12.1 ¥1,030 3.7 68

Rolls-Royce 4.8 9.2 84 1.2 39

United Technologies 29.1 28.2 2,200 27.6 155

of which: 

Pratt & Whitney 6.1 7.6 1,300 — —

Honeywell 27.6 22.3 ¥220 17.9 108

GE 575.2 131.7 14,100 259.6 315

of which: 

GE Engine — 11.1 2,100 — 26

AVIC 1 4.2 2.6 18.1 — 280

AVIC 2 3.8 2.4 2.4 — 210

Notes: Market capitalisation 

Sources: Fortune Global 500, 2003, FT Global 500, 2003, companies’ reports, research 

(iii) AVIC’s Organisational Structure

Children and Grandchildren. The business structure of AVIC is extremely 

complex. The function of the headquarters in monitoring, control, coordination and 

unifying the whole company to utilise resources and maximise returns is extremely 

weak. AVIC had 116 subordinate plants grouped under 56 ‘‘children’’ enterprises. 

There was a cascade of businesses each with investments in subordinate companies, 

from ‘‘children,’’ through ‘‘grandchildren,’’ ‘‘great grandchildren,’’ ‘‘great-great-grandchildren’’ and ‘‘great-great-great-great grandchildren.’’ The result was a typical East 

Asian diversified conglomerate, investing in any activity that brings some shortterm profit, but without a common focus. This structure raises deep problems for 

corporate governance and central control over the operations of subsidiaries and related companies. After the 1999 restructuring, each of AVIC 1 and AVIC 2 inherited 

this hugely unwieldy and unfocussed business structure.
127

Flotation of Subsidiaries. The institutional structure of AVIC has changed 

gradually since the mid-1990s through the flotation of different parts of the Company. By 1998, seven subsidiaries had floated. The typical flotation is of a minority 

share in the floated company, with the majority shareholding still held by AVIC 

through its subsidiary company. For example, in the case of XAC International, 

XAC held 64.71 percent of XAC International.

Flotation of AVIC 2. At the beginning of 2003, AVIC 2 was awaiting State Council approval of its international flotation. AVIC 2 undertook restructuring in late 

2002 and merged four of its subsidiaries into a new company for flotation. The proceeds from the international listing would be used to fund businesses such as aircraft and helicopter manufacturing and mini-van production (China Daily, 13 January, 2003). If AVIC 2 succeeds in the flotation, it will be the first time that part 

of China’s defence industry has been listed overseas. 

(iv) Comprehensive Penetration 

In military aircraft, it is likely that there was a real fall in the amount of resources allocated to modernisation of China’s indigenous industry during the economic reform period. The number of military aircraft produced is reported to have 

fallen significantly (Nolan, 2001). In the mid-1990s, China had ‘‘a fleet of 5,000 obsolete combat aircraft, most of them based on old Soviet designs such as the MiG–

21 and MiG–19 fighter aircraft, and the Tu–16 bomber’’ (Sergounin and Subbotin, 

1999: 74). During the 1990s, Chinese fighter aircraft production facilities have produced no more than 36 planes a year (Kondapalli, 1999: 171). By 2002, China has 

about 1,000 fighter aircraft, among which over 650 are J–7 (MiG–21) series, 200 J–

8 (Finback) series, and 90 Su–27s. The country’s airforce is hugely reliant on the 

Russian Su–27s for their most advanced fighters. It is estimated that China has 513 

military transporters (IISS, 2002: 147–148). The technical capabilities of the muchanticipated J–10 (produced by AVIC 1) are no rivals to the world’s advanced fighter 

aircraft. Although it has a ‘‘secure’’ internal market for upgrading the PLA Air 

Force, it only has a tiny niche export market and has political constraints in selling 

into those markets. This will greatly limit the economies of scale that can be 

achieved in producing the J–10. 

In civilian aircraft, a total of only 130 Y–7s, a small turboprop aircraft, had been 

produced by the late 1990s, and new orders had dried up completely. To compound 

matters, a Y–7 exploded in mid-air in 2000. Following the conclusion of the crash 

investigation, all 64 Y–7s were taken out of service in June 2001. By the end of 

2002, of the 561 large jetliners (above 100 seats) operating in the mainland of 

China, Boeing had 406 airplanes and Airbus had 124. Together they accounted for 

95 percent of the unit market share in the country. 

China’s attempt to build its own indigenous large passenger aircraft, the Y–10, 

ultimately failed. China’s domestic airlines refused to buy the plane. It was extremely heavy compared to the Boeing 707, with high fuel consumption and a very 

limited range. After the conclusion of the Y–10 programme in 1985, the Ministry 

of Aviation devised a ‘‘three-step take-off plan,’’ from the MD–90 assembly MD–90 

to jointly design and manufacturing the AE–100 with Airbus to the ultimate goal 

of self-design and building a 180-seater plane by 2010. One by one each of these 

objectives fell by the wayside. The termination of the MD–90 programme and the 

AE–100 programme were perceived outside China to ‘‘deal a severe blow to China’s 

nascent aviation industry’’ and ‘‘throw into doubt its plans to become a substantial 

aircraft manufacturer’’ (FT, 5 August 1998 and 6 October 1998). Many people in the 

Chinese aircraft industry felt that it had been let down not only by Boeing and Airbus, but also by the Civil Aviation Administration of China (CAAC), which had refused to order either the MD–90 or the planned AE–100. 

(v) Development Plans

• New Regional Jet Programme

At the end of 2000, it was apparent that China had abandoned the ambition 

to build a medium-capacity, single-aisle airliner. ‘‘We cannot compete with aviation giants such as Boeing and Airbus in financial clout and market share’’ 

(Zhang Hongbiao, Vice Minister of the Commission of Science, Technology & Industries of National Defence (COSTIND), quoted in China Daily, 6 November 

2000). China’s ‘‘best bet’’ would be producing regional airliners. COSTIND will 

invest $600–$725 million in R&D for the new regional jet programme aiming 

to build a new 50–70-seat turbofan aircraft to international standards. AVIC 1 

has since established AVIC 1 Commercial Aircraft Company (ACAC) to oversee 

resources, production, certification and marketing of ARJ21, the new 79–99 seat 

regional jet. AVIC 1 hopes to sell 300 ARJ21s to the domestic market and ex-
128

port 200 in twenty years. GE has been chosen to supply the CF34–10A engine 

and the Honeywell and Parker Hannifin team is to develop, produce and support the ARJ21’s flight control system. AVIC 1 has also been in discussions with 

Bombardier about a regional jet joint venture, but the future of this is uncertain. In the meantime, AVIC 2 has devised a separate three-step plan for developing regional aircraft: establishing a joint venture for final assembly, producing components locally and developing by-products and new products. AVIC 

2’s joint venture with Embraer to produce a 30–50-seat regional plane in Harbin has been approved. 

The market prospect for regional jets in China is promising even after the 

events of 11 September 2001. Boeing has predicted that around 70 percent of 

the total of the 1,800 new medium- and large-sized commercial aircraft purchased by China over the next twenty years would be single-aisle regional jets 

(Keck, 2001). The competition for selling regional jets to China is intense. Bombardier and Embraer are racing each other for selling into the Chinese airliners. Boeing and Airbus continue to actively market their smallest aircraft to 

Chinese airlines in an effort to capture the growing regional jet market. Price 

competition in all aircraft categories can be expected to intensify following the 

collapse in the world aircraft market after 11 September 2001. This is good 

news for Chinese airlines, but bad news for a potential regional jet produced 

in China. If China is, indeed, successful in designing and building its own regional jet, it will be far behind in the race for its own national market by the 

time that the first deliveries begin. This will be a huge disadvantage in an already intensely competitive segment of the world aircraft market. 

(vi) Summary

The aerospace industry’s supply chain incorporates a large fraction of the world’s 

most advanced technologies. These technologies are almost entirely embedded in 

firms headquartered in the high-income countries, especially the USA. Since the 

early 1990s, the world’s leading aerospace companies (including the systems integrators and the main participants in the supply chain) based in the high-income countries, especially those in the USA, have achieved massive competitive advantage 

through high-speed consolidation and through achieving great progress in their systems integration capabilities, hugely strengthening their already immensely powerful competitive position. Moreover, this period witnessed the near-disintegration of 

the former Soviet Union’s civilian aerospace industry, which had the potential to seriously challenge the dominant position of U.S. and European civilian aircraft makers. In this period there also took place a drastic weakening of Russia’s military aircraft industry. 

In this period, despite intense efforts, AVIC has failed to make any inroads on 

the dominant position of the world’s leading corporations from the high-income 

countries, especially the USA. 

Abbreviations 

FEER—Far East Economic Review 

FT—Financial Times 

SCMP—South China Morning Post 

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Co-Chairman DREYER. Thank you, Professor Nolan. 

Professor Steinfeld.

STATEMENT OF EDWARD S. STEINFELD, Ph.D.

ASSOCIATE PROFESSOR OF POLITICAL SCIENCE

MASSACHUSETTS INSTITUTE OF TECHNOLOGY 

Dr. STEINFELD. Thank you very much, Madam Chairperson. It’s 

a pleasure to be here today, and I appreciate and am honored by 

the invitation. 

Picking up on some points that Peter Nolan made and that have 

been made by others here, we are all aware that a significant portion of global production activities have migrated over to China, 

somewhat to the consternation of some individuals outside China, 

some are celebrating. Nevertheless, those activities have moved. 

What strikes me and what’s continually striking to me in my recent years of field work in China is that, as I move from Chinese 

domestic enterprise to enterprise, whether they are privately 

owned or state-owned, I find that the managers in these enterprises are doing anything but celebrating. In fact, most of these 

firms across virtually every sector find themselves locked in intense 

bidder competition with domestic peers. 

One of the reasons why they’re locked in this kind of mostly price 

competition is that the firms, whether in high-tech sectors or low, 

tend to congregate around the sort of lowest value activities, the 

most commodified, codified activities in the global supply chain, activities that don’t really require innovation, proprietary designs, or 

proprietary skills in manufacturing or marketing. So the firms can 

really compete only on the basis of price, and they, therefore, engage in this cutthroat price-cutting and drive their profit margins 

down. 

Now, I’ll wait until the end to mention Chinese governmental, 

central governmental ambitions to pursue industrial policy, or at 

least traditional industrial policy as we understand it involving distortions of markets and funneling of resources into a small number 

of large enterprises that are protected and encouraged to export. I 

would say there’s ambivalence toward industrial policy in that 

sense, although there are efforts to carry it out. But even putting 

that aside, the sort of aims and objectives, I think it’s fair to say 
131

that industrial policy, to the extent it is carried out in China, is 

failing. 

What I’d like to do is spend just a few minutes to explain why 

I believe it is failing without attaching any value judgment to 

whether it’s good or bad that this policy is failing. 

I think the answer, ironically, lies in some of the institutional aspects of the system that have allowed reform to proceed. In other 

words, the changes in the system institutionally that allowed an effective transition from command planning to the market have undercut in many circumstances the ability of the government to sort 

of manipulate and manage traditional industrial policy, and it has 

also undercut the ability of firms in China, whether state-owned or 

private, really to engage in substantial upgrading up the global 

supply chain. Let me just list a couple of these institutional factors. 

One, governmental decentralization. In order to make reform palatable and in order to allow a certain degree of experimentation 

across a varied country, the central government pursued a great 

deal of decentralization of authority throughout the reform era, 

which continues. That’s fine. Local governments have bought into 

reform, and they have started and maintain close relationships 

with many enterprises. But when the center tries to carry out the 

building of pillar industries, its only mechanism available is to filter that industrial policy through many different municipalities 

and localities, a very different model from what South Korea or 

Japan, arguably, pursued earlier. 

We have a duplication of industrial policy across many municipalities and localities leading to lots of duplication and redundancy 

of investment. Moreover, local governments protect local firms, be 

they private or state-owned, and these governments tend to resist 

consolidation and merger across the domestic economy which would 

allow the creation of sort of domestic giants that we would associate with traditional industrial policy. 

The second area institutionally pertains to low state capacity, 

low ability of the state really to carry out and implement its policies. With very rapid economic growth in China, economic transitions have become much more complex, and the demand for sort of 

public goods of regulation—courts and effective regulations, transparent regulations—the demand has grown very rapidly, but the 

ability of government at any level to supply this demand and accommodate this demand, arguably, has not grown very rapidly. 

Now, in some sense that’s good. And it was certainly good in the 

early reform era because localities or even higher-level governments couldn’t really interfere with the reform process effectively. 

They couldn’t halt reform. But today they’re not very effectively 

providing public goods of governance. 

What that means for enterprises is, first, that enterprises really 

have to operate on the basis of trust, so they stay local, they stay 

small, they stay with relationships that they won’t need to resort 

to courts or anything else to enforce contracts. 

The second aspect of low state capacity is the sort of information 

that’s required and ability to exact and pull out information from 

the economy that we would associate with running an effective industrial policy. Whether we like industrial policy or not, the government at the central level doesn’t seem to have that capacity in 
132

China. In fact, it seems desperately and troublingly starved for information, which undercuts its ability to regulate. 

And this last institutional feature I point to in this system is the 

general level of informality that exists, particularly in the area of 

property rights. 

Now, until quite recently, the development of private firms or 

even the specification of property rights even to public firms was 

a sensitive issue in China politically. Well, in order to move reform 

forward, the architects of reform simply dodged the issue, again, 

until quite recently, which is fine. It’s a very effective strategy of 

moving reform forward, sort of sidelining certain issues that are 

sensitive politically. 

The problem is that when firms emerge in this environment with 

very unclear property rights, a few things happen. Number one, the 

boundaries of the firm are quite unclear. It’s unclear where the 

firm begins and ends, whether it’s a part of another firm or not a 

part. Because the firm level boundaries are opaque, it becomes very 

hard for these firms to access capital from any kind of bank, sometimes whether state-owned or a more commercial bank. So the 

firms, again, stay small and don’t generally have resources to engage in upgrading. They have resources to engage in global production in certain kinds of activities, but not higher-end activities. 

The second thing that happens with informality and this blurring 

of boundaries is the boundaries between local government and firm 

become very blurred. So there is a lot of local protection, but protection in part against foreign firms but often against other domestic firms. A local government in one municipality will protect its 

firms against encroachment from other municipalities, and in some 

cases, municipalities will compete against one another to get foreign direct investment and will lower the barriers to foreign direct 

investment. So there’s competition and protection in a variety of 

ways that sometimes benefits outsiders, sometimes hurts outsiders, 

both domestically and in China. 

Now, just the last point about what really is the nature of the 

industrial policy aims of the Chinese state, particularly the central 

state. Well, I’ll just say that many of us find the changes associated 

with globalization, changes in the way production activities are organized globally, we find these troubling and confusing here in this 

country, and understandably so. In China also, officialdom finds 

these changes very confusing, and there’s great ambivalence with 

regard to industrial policy. 

On the one hand, there’s a belief among many officials that in 

order to grow and in order to grow domestic firms, these firms have 

to be opened up to global supply chains; they have to be very 

densely linked with foreign partners; they have to be exposed to 

free, liberalized markets. And, hence, we see one arm of Chinese 

industrial policy, with a comparative advantage strategy, WTO accession. But I must say there is an alternative ambition as well, 

the belief that firms really have to be funded by the state and supported in order to be built up and to compete head to head with 

foreign global leaders in manufacturing, in production. 

I must say, while both of these ambitions are clearly there in 

China, the evidence as far as actual policies that are carried out, 

I’d say first off tends to congregate toward the comparative advan-
133

tage strategy. In other words, the real action on the ground seems 

to lean more toward the comparative advantage than the pillar industry policies, although there are pillar industry policies. 

But lastly, and most important, even though there are these pillar industry policies, like them, love them, or hate them, the ability 

of the government, the proven ability to carry out these policies has 

been very, very limited. 

Thank you. 

[The statement follows:]

Prepared Statement of Edward S. Steinfeld, Ph.D.

Associate Professor of Political Science

Massachusetts Institute of Technology 

China’s Shallow Integration: Networked Production and the

New Challenges for Late Industrialization

Summary

Chinese enterprises have become extensively linked with the global economy, yet 

in a decidedly shallow manner. They remain stuck in commodity manufacturing, undifferentiated activities for which innovation is absent, and competition revolves 

around cutthroat cost cutting. This outcome stems from three factors. First, it reflects the new challenges to development posed by globally networked production. 

Second, it reflects tensions between the political economic imperatives of successful 

post-socialist transition and the institutional imperatives for upgrading in 

networked economies. Third, it reflects uncertainty surrounding the adjustment of 

traditional industrial policy to the new demands of development through participation in global supply chains. 

I. Introduction

By the late 1990s, the significance of China’s economic development from the outside world’s perspective was undergoing a major shift. No longer was China just a 

story of impressive marketization and transition, a model whose lessons were perhaps relevant to the developing world. Instead, China was increasingly becoming 

the story of a rising economic powerhouse, a force for reshaping the distribution of 

power not just in the developing, but the developed world as well. Today, China 

stands as the fourth largest manufacturing nation in the world, its rise making 

high-quality goods available at unprecedented low cost to consumers across the 

globe. At the same time, the world’s richest nations are expressing ever more strident concerns about China’s competitive threat, concerns most recently focused on 

the connection between Chinese currency valuation and the decline of developed 

world manufacturing jobs. 

These arguments, however, miss the point. China’s emergence is occurring in the 

context of a fundamental shift in the organization of global production, a shift that 

makes China’s rise categorically different from that of predecessors like Germany, 

Japan, and South Korea. That something is truly different is underscored by a phenomenon upon which this paper will focus. As indicated by a 2001 World Bank survey of 1,500 enterprises across five major Chinese cities, Chinese firms are integrating extensively with the global economy, but they also remain stuck in primarily 

low end, commodity manufacturing, activities for which they have few other options 

but to compete on the basis of cutthroat discounting. In global economic terms, 

China is integrating extensively, but also shallowly. 

This paper makes three main arguments. First, the combination of extensive but 

shallow integration can be understood only as a byproduct of a new mode of industrial organization, globally-networked production. This manner of organization presents unique challenges to developing countries, even ostensible success stories like 

China. Second, China’s pattern of integration—especially the difficulty firms face in 

climbing the ladder of industrial upgrading—stems from contradictions between the 

political economic requirements for effective post-socialist transition and the institutional imperatives for upgrading within the context of globally networked production. Basically, the institutional changes that permitted China’s successful climb out 

of socialist command planning are now impeding the efforts of Chinese firms to 

build global competitiveness. Third, the shallow integration of Chinese firms also 

stems from the difficulties faced by policy makers in fitting old models of development—namely the industrial policy focus of Japan and South Korea—into the newer 

and more ambiguous imperatives of networked production. 
134

II. The Shifting Architecture of Global Production 

Technological change, particularly digitization, has dramatically altered the architecture of production processes globally. By facilitating the management and transmission of vast amounts of information, digitization has allowed the codification of 

highly sophisticated processes of production. Once codified, processes can be split 

into discrete steps—modules, in effect—and standards to ensure their connectivity 

can be established. Modularization, in turn, has permitted activities that once had 

to be co-located geographically and managed organizationally within the confines of 

a single firm to be spread out across great geographic and organizational expanses. 

The issue is not that any activity can be done anywhere, or that all manufacturing has been completely modularized, but rather that new options for structuring 

activities now exist. For some processes, individual steps have become completely 

modularized such that the rules of connectivity between upstream and downstream 

steps are fully codified and stable. At the other extreme are processes whose component steps cannot easily be codified and disaggregated. They may be separated geographically and organizationally, but their integration into a final product requires 

extensive coordination and communication among the producing parties. This sort 

of ‘‘integral’’ production architecture may be pursued as a matter of choice by a lead 

firm (i.e., a vertically-integrated organization), but also may be dictated by the state 

of technology. 

Chinese enterprises have skillfully exploited the opportunities of modularization, 

aggressively upgrading their manufacturing skills so as to meet outsourcing demands by leading global players. In some cases, Chinese firms have autonomously 

pushed the replacement of traditional integral architectures of production with more 

modularized, open forms, thus forcing the commodification—and outsourcing to 

China—of certain activities, regardless of the preferences of overseas lead firms. 

Yet, while modularization affords new opportunities, it also creates major 

vulnerabilities for later entrants. Fully modularized, open production architectures 

virtually by definition entail the manufacturing of standardized, non-differentiated 

products. Firms focusing on such activities have little choice but to compete on the 

basis of low cost and high volume. Moreover, they continually run the risk of being 

unseated by the next low cost entrant, particularly since fully modularized products 

are easily substitutable from the consumer’s perspective. That Chinese firms have 

mastered modularized production accounts for China’s emergence as the globe’s 

shop floor. It also accounts for the fact that Chinese firms across a variety of sectors 

today find themselves locked in mutually-destructive price competition. 

Once new entrants commence modularized production, they rapidly face pressures 

to upgrade, not so much in terms of the complexity of their manufacturing activities, 

but rather in terms of the source of their competitiveness. Several options exist. The 

modularized producer can attempt to control the supply chain by actively setting 

rather than passively accepting rules of connectivity in the upstream and downstream directions. Alternatively, the producer might elect to shift away from 

modularization, instead moving back toward more integral processes, ones that 

must be coordinated and co-designed with upstream and downstream partners in 

the network. Finally, as is done by many leading global players, the firm may compete by providing key services—overall product definition, branding, and marketing—that shape the entire supply chain and command the bulk of final product’s 

value. 

These options require innovation in some sense, a daunting challenge for even the 

most sophisticated commodity manufacturers. Again, there exist both opportunities 

and pitfalls in this area. To the extent a modular manufacturer is engaged in multiple supply chains—i.e., by producing a stand alone component that can be plugged 

into a variety of downstream products—the manufacturer’s fate ends up tied to no 

single final product. Hence, the manufacturer is free to innovate in ways that not 

only incrementally improve existing downstream products (‘‘sustaining’’ innovation), 

but also in ways that unseat such products by facilitating new substitutes (‘‘disruptive’’ innovation). Similarly, open, modularized supply chains permit the rule makers—those determining the rules of connectivity—to shift the standards, and thus 

force the rule takers to scramble in compliance. Such freedom undoubtedly contributes to the extremely rapid product cycles and dizzying pace of innovation characteristic of high tech industry today. Yet, it also creates major vulnerabilities for 

the rule takers, the commodity producers, and all the rest of the supply chain participants that must respond to innovative lead firms. 

III. The Phenomenon in Contemporary China: Price Wars and Corporate 

Structure

Much of Chinese industry today consists of small-scale firms competing intensely 

on the basis of discounting. In theory, this could be understood as a prelude to in-
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dustry-wide shakeouts that should eliminate smaller firms and consolidate activities 

into a few larger producers, presumably the sort that might engage in industrial upgrading. Evidence of such progression, however, remains sparse. Instead, a pattern 

of corporate organization has persisted that sets Chinese firms apart from many of 

their global counterparts, and certainly from the lead firms in global supply chains. 

First, and not surprisingly given China’s relatively recent marketization, Chinese 

firms tend to be both newer and smaller in scale than their global counterparts. In 

the World Bank’s 2001 survey of 1,500 higher technology enterprises in China, firms 

averaged just over 600 employees, and generally had been in existence for only 10 

to 15 years. Even China’s more famous firms—those with known brands and national, if not global, status—tend toward the smaller side. 

Second, Chinese firms, though their output often ends up either in foreign hands 

or in overseas markets, tend to be extremely localized in terms of their actual operations. In the World Bank’s 2001 survey, 41 percent of the manufacturing firms in 

the sample reported producing to specifications set by foreign firms. Twenty-one percent reported directly producing parts for foreign firms, while 25 percent reported 

producing final products for such customers. Indicative of China’s liberal policies toward foreign direct investment (FDI), 25 percent of all firms in the survey reported 

having foreign equity partners, with the foreign ownership stake on average hovering just over 50 percent. 

Despite foreign interaction, however, the firms’ upstream supply network and 

downstream customer base tended to be confined geographically. The 2001 survey 

suggested that on average, over 50 percent of upstream suppliers were located in 

the respondents’ own respective cities. Approximately 75 percent of the supply network on average was located within China. Downstream, the survey indicated that 

for the average Chinese firm, approximately half of the customer base is located 

within the firm’s own municipality. Approximately 15 percent of the customer base 

on average was reported to be overseas. Whether for upstream or downstream interactions, rather traditional means prevailed—communication was conducted primarily by phone and fax, while goods themselves moved primarily via surface transportation. 

The localized nature of Chinese commercial networks leads to a third point, the 

relative shallowness with which Chinese firms integrate into global supply chains. 

Despite high levels of foreign ownership, only 15 percent of the manufacturing firms 

surveyed by the World Bank in 2001 reported designing parts for foreign customers, 

a sign that the respondents are essentially ‘‘rule takers’’ in open, modularized production processes. Only seven percent reported providing customers R&D or other 

specialized services. The figures are surprisingly low given that the sample specifically targeted higher-tech sectors, the very ones in which we should expect high degrees of innovation, networking, and development of firm-specific proprietary knowledge. 

The firms were failing not only to design for downstream customers, but also to 

develop deep relationships of any kind with such customers, again, a sign of open, 

modularized production. Sixty-nine percent of the survey respondents reported using 

trading companies to handle interactions with the broader customer base, thus suggesting essentially arms-length rather than deeply enmeshed customer relations. 

In terms of identifying factors inhibiting greater exports, respondents focused on 

the difficulties and costs of meeting foreign product standards, and particularly the 

intense cost competition they face (Table 1). Managers preferred to produce for export markets, and few claimed that targeting the domestic market offered better financial gains, but managers perceived that their firms lacked the capabilities needed to meet foreign standards in a cost-effective manner. At the same time, they perceived themselves to be in an intensely cost competitive environment, with pressures bearing down from both domestic and foreign counterparts. 

That leads to a fourth and final point regarding innovative capacity. Chinese enterprises today face great pressure to upgrade their technological capabilities, and 

managers—as they did in the 2001 survey—routinely report high levels of what they 

at least perceive to be innovative activity. The pressures are understandable. Modern production, whether for ostensibly low end goods like textiles or high end goods 

like semiconductors, virtually by definition entails the management of complex processes, complex machinery, high quality expectations on the part of customers, and 

rapid turn-around times. 

That Chinese firms are so extensively involved in production for overseas markets 

represents a major achievement, indicating extremely impressive degrees of learning 

on their part. It would be incorrect, however, to assume that such learning actually 

constitutes—or necessarily leads to—‘‘innovation.’’ It is not at all clear that these 

firms are developing intellectual assets, production skills, modes of serving customers, or actual products that can be understood as in any way proprietary—things 
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that cannot be duplicated by hundreds or thousands of other firms in their immediate environment. In the 2001 survey, nearly half of all firms reported innovations 

in shop floor production processes, and another 46 percent reported innovations in 

managerial techniques, all measures that allow for the cutting of costs. What few 

if any of the firms reported were innovations that allowed the firm to charge a higher margin rather than a lower one—in other words, innovations that would encourage customers to pay a premium. Moreover, given the prevalence of product ‘‘wars’’ 

and cutthroat discounting among the proliferation of small producers in China, it 

appears that nobody has discovered the sort of proprietary cost-cutting solutions 

that afford competitive advantage over a reasonable period of time. 

The response to this dilemma often entails another activity that survey respondents term ‘‘innovation,’’ the introduction of new products or entirely new lines of 

business. Commodity producers end up chasing one surplus market after another, 

a pattern true even for China’s more advanced branded companies. Even the most 

established firms cope with increasing competition by aggressively discounting and 

expanding sales volume on existing products, entering new product areas in which 

they can compete again only on the basis of discounting and razor-thin margins, or 

finally, by trying to export their way out of trouble by pursuing overseas markets. 

In essence, firms focus on activities with low barriers to entry. Once the cost pressures become too intense, rather than moving upward into higher end activities or 

taking the time to develop proprietary skills, the firms diversify into other low entry 

barrier markets. 

IV. Reform Style, Governmental Capacity, and Industrial Policy

The pattern described above stems in large part from the interaction between 

three factors: governmental reform style, state capacity, and industrial policy. This 

interaction has at once permitted the integration of Chinese firms into the global 

economy, and substantially constrained the depth of that integration. 

Reform Style 

Since the dawn of reform, China’s approach to market transition has been characterized by informality, experimentation, and decentralization. Central leaders have 

set the overall policy aim (economic growth) and the basic constraint (the maintenance, in the vaguest terms, of ‘‘socialism’’). Local officials, then, have been granted 

broad leeway to engage in policy experiments, virtually all of which have involved 

elements of market economics. ‘‘Socialism’’ is maintained simply to the extent that 

the experiments remain informal. When experiments prove successful, the center 

encourages their implementation—again on informal terms—nationally. If success 

continues, the experiments stand to be adopted post hoc as official government policy. Finally, in some—but not all—cases, the center formalizes the outcomes with 

new institutional rules, many of which directly challenge the initial condition of 

‘‘maintaining socialism.’’ Through a certain element of linguistic legerdemain, that 

which began as an experimental alternative to socialism (and hence its explicitly informal status) gets legitimized as socialism itself, albeit socialism ‘‘with Chinese 

characteristics.’’

The approach has proven brilliant in many respects. Without it, China’s transition 

to what much of the world terms capitalism could never have proceeded smoothly. 

It also explains how private enterprise—anathema just twenty years ago in China—

now constitutes the predominant ownership form in Chinese industry. 

There are, however, negative ramifications. Entrepreneurial firms can thrive and 

engage in international commerce under such conditions, but their property rights 

tend to remain either undefined or, to the extent they tuck themselves under the 

auspices of a governmental bureau or state-owned firm, inaccurately defined. Without clear property or formal title to assets, these firms face limited financing options. Borrowing from a bank becomes virtually out of the question. Instead, they 

have little choice but to self-finance, a situation that may ensure hard budgets, but 

one that also tends to limit enterprise growth. 

In a pattern consistent with that of virtually all firms in China save for larger 

SOEs, enterprises in the World Bank’s 2001 sample reported relying primarily on 

retained earnings as their main source of financing (Table 2). Firms consistently reported that upwards of 50 percent of all financing came from retained earnings. 

Bank loans amounted to 19 percent of total financing on average, though the figures 

were somewhat lower in Tianjin (15 percent) and somewhat higher in Chengdu (24.8 

percent). Equity financing, not surprisingly given governmental quota restrictions 

on stock market listings, was low across the board (averaging 0.6 percent across the 

sample). Personal loans from family and friends constituted an important source of 

financing, averaging 8.6 of total financing for firms in the sample. 
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Limited financing options lead to tight liquidity constraints. The enterprise response often involves operating on a cash basis, but that then leads to the forgoing 

of transactions that in more formalized systems allow for greater enterprise expansion. Furthermore, rather than investing in existing business lines and developing 

specialized skills, cash-starved firms jump to alternative businesses simply to maintain cash flow Such diversification addresses liquidity issues, but it does not encourage the development of firm-specific proprietary assets or skills. Instead, firms remain stuck in low entry barrier activities. 

Informality, to the extent it dilutes the firm’s legal status, also limits the firm’s 

geographical reach. Without legal standing, the firm must engage predominantly in 

trust-based transactions. The surest way to ensure trust is to stay local, essentially 

by buying from known local suppliers (or better yet, backward integrating to ensure 

reliable supplies) and selling to reliable local customers (so as to ensure payment). 

When dealing with international markets, the main option becomes to sell to a local 

trading company. 

For foreign companies dealing with such informal organizations, the optimal 

strategy often entails either buying from a more formalized state trading company 

or actually taking equity in the local producer itself. Indeed, FDI, to the extent that 

it places the recipient into the special regulatory category of ‘‘foreign owned,’’ constitutes a formalization mechanism, one that benefits provider and recipient alike. 

In some case, Chinese firms sell their assets to foreign firms at a discount, but in 

so doing achieve a degree of formality that permits access to credit and insulation 

from arbitrary governmental policy. 

Like informality, governmental decentralization leaves a mark on entrepreneurial 

organizations. Many local governments in the reform period have eagerly promoted 

economic development, and as part of that goal, have frequently promoted local entrepreneurship. They have been less eager, however, to facilitate development that 

benefits areas beyond the locality. Early in the reform era, this reluctance manifested itself in regional trade wars and overt barriers to inter-provincial trade. More 

recently in the 1990s, given central crack downs on overt protectionism, localities 

have used more subtle methods: selective enforcement of product standards, more 

rigorous registration and licensing requirements for outsiders, and prejudicial application of health codes, just to name a few. 

Similar issues impact sectoral and geographic rationalization in industry. Whereas rational mergers and acquisitions are frequently blocked through administrative 

interventions, commercially irrational mergers are often imposed by local administrative fiat. Particularly in the state sector, financially-sound firms have been 

forced, often under duress, to assume ownership of insolvent organizations simply 

to stave off bankruptcies. That the acquiring firm is sometimes accorded preferential 

policy treatment as a sort of quid pro quo only further distorts budget constraints 

and incentives for productive growth. 

More generally, when firms are forced to merge with failing local neighbors or to 

source only from local counterparts, they are indirectly prevented from interacting 

with the best, most advanced suppliers. Administratively-imposed restrictions on 

such linkages, particularly restrictions that confine the linkages to a given municipality, prevent Chinese firms from accessing not only the best global suppliers, but 

even the best national ones. Deprived of high quality components and important 

learning opportunities, many Chinese firms are pushed only further down the road 

of low-end manufacturing and cost-based competition. Moreover, when localities try 

to keep the firm local, the firm’s problems of small scale and limited financial resources simply deepen. 

State Capacity 

By the later 1990s, the architects of Chinese reform began to tackle many of the 

problems discussed above, and efforts across a variety of areas to formalize China’s 

market system have risen to the top of the policy agenda. The problem, however, 

is that these imperatives have collided with the reality of limited state capacity in 

China. 

The issue manifests itself in at least two respects: the ability of the center to coordinate policy across the government’s administrative hierarchy, and the ability of 

the government as a whole to regulate commercial activity in the civil sphere. The 

first problem has arguably receded in recent years. The second, however, has proven 

more vexing. As might occur in any developing economy, the Chinese system has 

experienced a dramatic increase in the complexity and density of interactions between economic actors, most of which are no longer under the direct administrative 

control of the state. Across the board—whether in terms of financial relationships, 

contracts, issues of corporate control, or intellectual property rights—demand within 

the civil sphere has increased for both objective rules and reliable enforcement. This 
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demand, however, has outpaced the ability of the state to provide governance-related public goods. Courts are overwhelmed with cases, judges are often inadequately trained, and enforcement mechanisms are generally weak at best. 

It is widely recognized in China today that rule of law is essential for sustained 

growth, but it is far less clear how rule of law can be achieved or even exactly what 

rule of law entails. Meanwhile, the absence of effective legal institutions encourages 

rent-seeking behavior that further erodes trust in commercial transactions and society more broadly. In the financial area, for example, we have witnessed the emergence of what some Chinese describe as a ‘‘non-payment’’ economy. Commercial buyers make purchases, and then refuse to pay. Borrowers take out loans, and then 

default. Banks accept deposits, and then squander them in ill-advised lending. In 

each case, the victim is left with little recourse. 

What results is neither utter lawlessness nor an absence of growth. Instead, there 

exists a subtle pattern of unclear rules, low levels of trust, and frequent efforts to 

skirt the boundaries of legal strictures, conditions that—as indicated earlier—all impact on the organizational structure and global competitiveness of Chinese firms. At 

the very least, the environment impinges on both the capacity and inclination of 

firms to innovate. 

Industrial Policy 

Lurking behind the aforementioned capacity issues is the issue of ultimate governmental aims. China throughout the 1990s has pursued institutional reforms that 

encouraged market deepening and a leveling of the playing field for all economic actors. That said, contemporary Chinese industrial policy retains a rather schizophrenic quality. 

On one side, the government pursues what it now terms a ‘‘comparative advantage’’ strategy of development, an essentially neoclassical notion that development 

proceeds through the natural convergence of factor prices across nations. The country’s relative factor endowments at any particular time are taken as given (in China’s case, surplus labor and scarce capital), and development is understood to unfold 

as the country specializes in the production and export of goods intensive in the use 

of the abundant factor. As long as external trade and internal markets are opened 

up—conditions that become central goals of this aspect of industrial policy—a dynamic international division of labor should ensue. 

Policy makers in Beijing, at least on this particular side of industrial policy, have 

followed the theory’s prescriptions, albeit with some modifications. Reform, since its 

very inception, has been promoted as a process of ‘‘opening up,’’ and opening up specifically to foreign trade, knowledge, and technology. China throughout the 1980s, 

and particularly after 1992, dramatically reduced statutory import tariff rates. Since 

1997, the government has also substantially expanded policy initiatives that exempt 

certain domestic firms and institutions from paying the import duties that formally 

do exist. Finally, in 2001, China formally became a member of the World Trade Organization, binding itself to an accession protocol more expansive, in terms of both 

market access and permissible trade practices, than that faced by any other developing nation in history. 

Equally important, reformers have pursued what has amounted to the most liberal FDI policy of any Asian developing nation. Here, a bit of practicality has tempered slavish devotion to textbook abstractions. Heckscher-Olin-Samuelson theories 

assume perfect knowledge. That is, as long as capital and labor are allowed to flow 

freely, prices should equalize across countries, and productivity should equalize 

across firms. The actual knowledge of how to produce is presumed to be trivial, presumably moving much like a library book from borrower to borrower. As long as the 

prices are right, the firm is presumed capable of producing. Non-competitiveness, 

therefore, can be attributed primarily to bad policy: government distortion of prices, 

excessively high wages, and illiberal trade regimes. 

Policy makers in Beijing, however, instead of waiting passively for ‘‘natural’’ 

transfers of knowledge and technology, have chosen proactively to build a vector, 

foreign direct investment through industrial joint ventures. In exchange for transferring technology and know-how to Chinese counterparts, outsiders have been 

granted privileged access to the Chinese domestic market or preferential treatment 

on other grounds. 

Over two decades, China’s FDI policies—not to mention its liberal policies toward 

emigration—have led to a monumental scaling up of managerial expertise in the 

country. Whether in foreign firms or domestic, an essentially world-class population 

of managers has been created at the highest tiers of the economy. Increasingly, this 

population has begun to flow back and forth between employment in foreign and domestic companies, and between employment within China and outside. 
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Of course, the question is whether particularly in domestic firms these managers 

can operate in an institutional environment conducive to enterprise success. Skilled 

domestic managers now exist, but can physical assets really flow? Will commercially 

moribund firms—legacies of the prior era for the most part—be allowed to go under, 

and entrepreneurial firms be permitted to rise from their ashes? 

Again, at least on this side of the industrial policy ledger, major strides forward 

have occurred. Between 1994 and 2000, with the government’s policy of zhua da 

fang xiao (grasping the large, and releasing the small), almost 60,000 small to medium-sized SOEs have been ‘‘restructured,’’ a term that generally signifies outright 

liquidation, privatization, or transfer to employee ownership. At the same time, the 

private sector has been permitted to burgeon, and now constitutes the largest single 

ownership form in Chinese industry. In the past, ‘‘enterprise reform’’ in China 

meant measures to improve performance in existing state owned firms. Today, ‘‘enterprise reform’’ has increasingly come to mean measures for eliminating poor performers. 

Conceptually, then, this particular guise of Chinese industrial policy—the exposure of firms to foreign competition, the encouragement of FDI and knowledge 

transfer, and the ruthless downsizing poor performers—can be understood as a ‘‘creative destruction’’ centered vision of development. Industrialization becomes the 

progeny of market forces, and those forces themselves are understood as the mechanism for winnowing winners from losers. The continual composition and decomposition of constellations of assets—in other words, the rise and fall of firms—is treated 

as a good unto itself, one that outweighs the intrinsic value of any given firm. Innovation, the driver of development, is envisioned not as the product of a steady accumulation of tacit knowledge and internal experience within long-lived corporate organizations, the sort that must be protected by governmental policy. Rather, innovation grows out of the maelstrom of intense inter-firm competition, the continual 

overtaking of conservative incumbents by radical newcomers, and the wild dynamism of organizational destruction and recreation. 

What makes Chinese industrial policy so difficult to comprehend, though, is that 

for all its focus on market-based approaches and comparative advantage, it also 

happens to have an entirely different side, one that embodies assumptions of heavily 

statist Japanese and South Korean models of the past. Policy makers in Beijing may 

be employing all the mechanisms associated with comparative advantage strategies, 

but the ultimate aim of such policies remains the creation of ‘‘national champion’’ 

firms in self-reliant, vertically integrated ‘‘pillar’’ industries. This, after all, is what 

the ‘‘grasping the large’’ side of the zhua da fang xiao (grasping the large, and releasing the small) enterprise restructuring policy is all about. It is about creating 

exactly the type of organizations associated with the Japanese and Korean models 

of yore: large, vertically-integrated business groups that encompass entire industries 

from upstream to down, operate at the cutting edge of technology, and dominate 

global markets from their home base in China. Yet, this is a story that involves 

more than just new techniques for achieving old industrial ambitions. Rather, it is 

a story about a government claiming as its ultimate policy aim precisely the type 

of firms that its most high profile restructuring (and trade) policies militate against. 

In essence, the government is seeking to create the very firms that comparative advantage, not to mention global technological change, select against. 

Of course, as some policy makers in Beijing are inclined to admit, China’s effort 

to build ‘‘national champion’’ conglomerates must differ from earlier Japanese and 

South Korean efforts in a few respects. First, the Chinese economy today is much 

larger and more diversified than were the Japanese and South Korean systems at 

the height of their respective experiments with dirigiste industrial policy. Simply to 

exert the same degree of control associated with the Korean model, Chinese policy 

makers would be dealing with an exponentially larger task and exponentially more 

complex information flows than anything experienced in 1970s Korea. 

Second, the Chinese government, in no small part because of the reformist legacies of decentralization and informality, operates in a less unified manner than 

that of Japan or Korea decades ago. Whether by design or default, policy makers 

in Beijing today implement most national policy through local agents. This has certainly proven true in the effort to build ‘‘national’’ pillar industries, a task that has 

been essentially farmed out to individual provinces and municipalities. Consequently, while China’s industrial planners proclaim the need for national steel, 

auto, or machine building firms, what results is the duplication of such entities in 

virtually every province and large municipality. 

Third, Japanese and South Korean developmental efforts were premised on the 

idea that at least in their home markets, key industrial conglomerates would be 

granted sweeping protection. They would be held to international standards and encouraged to compete head to head with foreign firms in foreign markets, but on the 
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home front, they would be showered (selectively) with subsidies and sheltered from 

outside competition. As signified by the terms of China’s WTO accession, though, 

the world today is not that of the 1960s and 1970s, in no small part because the 

world’s wealthiest countries—though hardly paragons of free trade—do not tolerate 

the sorts of protectionism they once did with regard to Asian developers. Nor, somewhat ironically, are they inclined to tolerate the sorts of export flows previously generated by Asian ‘‘national’’ firms. 

Whether or not the Korean-style industrial policy was effective on its own terms 

and in its own era is a major question, but one not immediately relevant to this 

paper. What is relevant, however, is the basic reality that while China may seek 

to build the kinds of firms associated with such models, it has at its disposal few 

of the policy instruments and external conditions enjoyed by industrializers decades 

ago. 

How can Chinese policy makers then square the circle between the highly divergent conceptions represented by each of these approaches? Decision makers may 

presume that to the extent they get industrial policy ‘‘right,’’ the resulting ‘‘national 

champion’’ pillar industry organizations will be globally competitive and hence sustainable after WTO-mandated market liberalization takes place. 

Yet, that really begs the question of how the divergent premises of ‘‘comparative 

advantage’’ and ‘‘national champion’’ can be reconciled. After all, one view stresses 

the primacy of churning and market selection—creative destruction—as the driver 

of innovation and growth. The other stresses virtually the opposite, the degree to 

which innovation occurs through the evolution and sustenance of established incumbents, corporate repositories of knowledge and experience. One view emphasizes the 

market’s role as a selection mechanism, a ruthless judge of winners and losers. The 

other emphasizes the market’s role as an incentive mechanism, a treatment that 

when applied to preexisting organizations encourages efficiency. One view says that 

firm-level incentives are inseparable from, and indeed can be understood only as 

emanating from, the system-wide process of ‘‘creative destruction.’’ The other suggests that market incentives, by encouraging existing firms to maximize efficiency, 

obviate—or at least reduce the likelihood of—such destruction. Indeed, in this latter 

view, if selection begins spontaneously to operate—if losers start to appear, particularly on a grand scale—then something must have interfered with the proper operation of the market, be it politicization, insufficient liberalization, or ‘‘bad policy’’ in 

any of its other guises. One view, in essence, understands the firm as a byproduct 

of the market. The other takes the firm, particularly the modern industrial conglomerate, as the linchpin and driver of the market. 

Policy makers could try, as is done in China, to hedge by operating on both sets 

of premises simultaneously. In so doing, however, they frequently adopt policies that 

function at cross purposes. For example, the quest for a ‘‘national team’’ has led to 

persistent governmental distortions of financial markets. Such distortions, though, 

by withholding capital from China’s most dynamic, market-oriented firms—its private enterprises—limit the ability of these firms to respond to competitive pressures 

being induced by ‘‘comparative advantage’’ market liberalization measures. In essence, the distortions aimed at building the national team undercut the global (and 

domestic) competitiveness of a huge swath of Chinese industry. 

Along similar lines, policy makers encourage the development of vertically-integrated pillar industry firms, but then pass on the actual developmental task indiscriminately to localities. What results is neither the verticality nor overall scale that 

traditional Korean-style industrial policy calls for. ‘‘National champion’’ firms end 

up in reality as little more than local or regional players. At the same time, the 

focus on verticality encourages localities to think not in terms of cluster economies, 

innovative communities, or cross-cutting supply chains—the sorts of environments 

from which effective ‘‘comparative advantage’’ competitors are likely to emerge 

today—but instead in terms of self-contained industrial units, units that may coexist, but not interact. Firms end up with locally focused captive supply chains, a 

worst of all worlds situation even if one agrees with the goal of building integrated 

national conglomerates. To the extent the supply chain is held captive, it should at 

least be permitted to extend broadly in geographic terms (so as, hopefully, to incorporate ‘‘best in class’’ suppliers nationally). Keeping it local almost guarantees that 

the firm will fail to access the best suppliers, and hence will fail to produce world 

class products. At the other extreme, to the extent one believes that firms should 

focus on modular activities and then link into upstream and downstream activities 

on a global basis (in line with the ‘‘comparative advantage’’ approach), administratively enforced captive supply chains should disappear altogether. 

More generally, by merging essentially irreconcilable visions for industrial development, policy makers end up achieving the aims of neither. Localization and geographic duplication undermine the scale and supply chain quality conditions that 
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might, under the theory’s own assumptions, produce globally competitive conglomerates. At the same time, the institutional distortions induced to achieve national 

champions (local as they may be) undercut the ability of non-state firms to compete 

effectively on purely market terms. The firms shielded from creative destruction remain weak, while the distortions behind that shielding leave everybody else handicapped in the face of creative destruction. That many in the latter group have survived is testament more to their fortitude than to the brilliance of industrial policy 

per se. Unfortunately, such survival, achieved primarily through commodity production and cutthroat discounting, is hardly the basis for extended success in the future, whether at the enterprise or national level. 

V. The Issue of Catch Up

The preceding discussion still leaves open the question of catch up—the question, 

of whether China’s lead firms, for all their problems today, may just be in the first 

stages of catching and ultimately surpassing their foreign rivals. In other words, 

might we be witnessing today the opening stages of a situation analogous to the 

Japanese auto industry’s rise vis-a`-vis American auto companies in the 1970s? Is 

it the same story of new competitors figuring out how to produce products inexpensively, introducing those products overseas first into lowest end market segments, 

gradually and quietly building market share, and then finally down the road becoming dominant in high value products? 

In answering these questions, it is worth considering the conditions under which 

Japanese and South Korean industrial firms rose decades ago. Industries then could 

still in a meaningful sense be understood as separate, self-contained entities, and 

often self-contained in national terms. We could refer to the American steel or the 

French auto industry, and we could contemplate whether rising industrializers like 

Korea would develop strength in a particular industrial sector. Moreover, in these 

relatively autonomous industries, product innovation occurred in incremental terms, 

and manufacturing processes tended to be integral. The various steps in the process, 

while perhaps understood in broad terms in these stable industries, were uncodified 

(and given the state of information technology at the time, probably uncodifiable). 

As such, they could not organizationally be pulled apart from one another, instead 

tending to be particular to each firm or each firm’s captive supply chain. Challengers then, to the extent they could amass the resources needed to enter these 

capital-intensive industries, could compete on the basis of process innovation, the 

ability to produce the same products as incumbents but at significantly lower cost. 

Because manufacturing processes remained uncodified and integral within the firm, 

shopfloor innovations were truly proprietary. They were, in effect, a form of art or 

craftsmanship that neither incumbents nor other entrants could easily copy. 

Chinese firms today are operating in a dramatically transformed era. First, it is 

not whole industries that move today from developed to rising nations, but instead 

activities. What has moved to China en masse, whether at the bequest of leading 

global companies or through pressures from Chinese firms themselves, are the manufacturing-intensive segments of particular value chains. More precisely, it is the 

codified, commodified, non-integral manufacturing activities that move. Competing 

in these areas, while hardly trivial, often does involve mastering open processes 

rather than developing proprietary ones. It is for that reason in part that we see 

so many new entrants from China in manufacturing rather than the handful of 

firms that entered from Japan and South Korea in previous decades. 

Second, when Japanese and South Korean competitors emerged, they were rising 

up against relatively stable incumbents, incumbents whose focus was still on manufacturing. As such, the incumbents were essentially stationary targets whose products could be substituted by lower cost alternatives. Today, the situation is quite 

different. In large part because of modularization, the incumbents—global lead 

firms—are hardly stationary, and in many cases have completely transformed themselves. Chinese firms like Legend, Haier, Huawei, and Bird may be rising on the 

basis of their low cost manufacturing expertise. At the same time, most lead firms—

whether IBM, Electrolux, Cisco, Motorola, Dell, or many others—are moving away 

from manufacturing entirely. Instead, they are increasingly focusing on what may 

be broadly termed the ‘‘service’’ side of production: overall product definition, design, 

marketing, and supply chain management. 

That then leads to a third point about the way the terms ‘‘industry’’ and ‘‘national 

industry’’ are understood today. In previous decades, it made sense—with a certain 

degree of simplification—to conceive of industries as distinct silos. Particular nations, then, could be mapped over one or more of those silos. In the current era of 

modularization, however, it is not just that activities within discrete industries have 

been split apart, but rather that these independent, highly specialized activities now 

cut across multiple industries. What were once distinct industry supply chains now 
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overlap, intersect, and interact in myriad forms. As such, it becomes increasingly 

difficult to say exactly which ‘‘industry’’ a given firm or nation specializes in. Is a 

semiconductor foundry in the electronics industry, or, since its chips go into cell 

phones, in the telecommunications sector? Is the ‘‘fabless’’ semiconductor design 

house designing chips for automobiles—along with semiconductors for a host of 

other applications—in the auto industry? Perhaps it also happens to be integral to 

aerospace, telecommunications, or home appliances. 

Because the specialization associated with modularization has led to the blurring 

of boundaries between industries and growing interaction across them, it now may 

make more sense to think of matrices and webs of specialized activities rather than 

discrete, stand-alone industrial sectors. Among other things, such organizational 

change leads to the phenomenon of modularized innovation and ripple effects of 

such innovation across formerly unrelated industries. The ‘‘fabless’’ chip design 

house, in its efforts to design a telecommunications application, may come up with 

a new capability applicable to aerospace. For the chip innovator, the ultimate downstream application may be irrelevant, so long as the design gets purchased in great 

quantity. Yet, the downstream application certainly is not irrelevant to those who 

are competing in the downstream activities, particularly when the new application 

may lead to downstream substitutes. A firm like Microsoft may keep churning out 

operating software for PCs, but so too does it focus on enabling the sorts of products—palmtop computers, digital writing tablets, web-capable mobile phones—that 

may undercut or otherwise replace PCs. One can begin to see how in the 

modularized world specialized innovations lead to unpredictable outcomes. 

One can also begin to see the challenge for contemporary industrial policy. It is 

not just that the pace of change is faster now than in the heyday of Japanese or 

South Korean industrialization. More important, the organizational mechanism of 

change—particularly the extent to which it is spread across ostensibly unrelated 

firms and ‘‘industries’’—is completely new. For a nation to be strong in autos, aerospace, or telecommunications, what fundamentally does it need? Software companies? Semiconductor design houses? Handset manufacturers? Steel firms? Marketing 

firms? 

That it is hard to say underscores the risks entailed in forcing the vertical integration of industries. From a product architecture perspective, it may be impossible 

to determine the exact boundaries of a given industry. Yet, Chinese industrial policy, by selecting ‘‘pillar’’ industries does precisely this in an artificial sense. It operates under the idea that a country can, from upstream to down, ‘‘build’’ a steel or 

auto or aerospace sector. Similarly, for various institutional reasons, individual Chinese companies may themselves elect to vertically integrate their activities. Whether through institutional default or conscious policy, they end up forcing the integration—whether under a single company roof or within a single national geography—

of activities that are not in any technological sense ‘‘integral.’’ In effect, they push 

together within a given organizational boundary activities that could just as easily 

stand alone from one another. In so doing, as such activities are held captive within 

single ‘‘industry’’ supply chains, policy makers and corporate strategists limit the extent to which modular innovation and cross-fertilization can occur. It is not surprising, therefore, that China perceives itself, probably correctly, as lagging behind 

India, let alone developed countries, in industries like software. Similarly, it is not 

surprising that China lags in high end semiconductor design capabilities. 

In China today, the industrial policies and institutional deficits that encourage 

vertical integration isolate even the best Chinese enterprises from state of the art 

technology, reduce the likelihood that Chinese firms will set rules of connectivity 

globally, and end up facilitating specialization among foreign lead firms. What results is not so much catch up as a greater division of labor, one that arguably widens the gap between overseas lead firms and Chinese follow-on producers. 

VI. Conclusions

This paper has argued that the innovative capacity of Chinese firms and their 

ability to upgrade within global supply chains are impeded by legacies of Chinese 

reform style, current bottlenecks in the institutional reform process, and inconsistencies in governmental industrial policy. To be sure, progress has been made on a 

number of fronts. The Chinese government has moved aggressively in administrative terms to tackle issues of market fragmentation, local protectionism, and regulatory inconsistency. Unfortunately, a number of these issues extend beyond the administrative and into the political. Their resolution, at least in part, depends on the 

willingness of the state and Party apparatus to subject itself fully—at any jurisdictional level—to the rules and regulations of the system. 

At the same time, governmental apparatus must come to terms not just with the 

benefits of market economics, but also the limits. The goal of building nationally au-
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tonomous industries may be justifiable on societal or national security grounds. Yet, 

the goal is not consistent with the sorts of corporate organizations and production 

architectures that in today’s world realize achieve commercial sustainability. Efforts 

to employ market liberalization to achieve ‘‘national industries’’ will, therefore, likely lead to two equally undesirable, albeit related results: the industries themselves 

will fail (and the resources that went into building those firms will have been wasted) or markets will get administratively distorted to ensure the industries’ ‘‘success.’’ 

Unfortunately, both outcomes are likely to inhibit the further integration and upgrading of Chinese firms in global production networks. 

More broadly, however, whether for China or any other country, the organizational revolution surrounding networked production has fundamentally challenged 

many of the basic analytical approaches so often applied to late industrialization 

and economic development more generally. Given the newness of this revolution, 

scholars and policy makers alike are frequently left to make ‘‘shot in the dark’’ assumptions, assumptions that can lead to highly divergent notions of causation and 

highly divergent implications for policy. 

To the extent one understands technology as relatively stable, product cycles as 

fairly long, and production networks as consisting of fully modularized, discreet 

processes, one could imagine that innovation would primarily fall within the ‘‘sustaining technologies’’ category, and that it would occur within the confines of the 

incumbent firm. The goal of industrial policy then might be to create the kinds of 

large, self-contained organizations that could dominate a particular piece of the supply chain. These organizations would diverge significantly from the ideas of vertical 

integration popular in China today, but so too would they diverge from the vision 

of small start ups conjured by ‘‘creative destruction.’’

Yet, if one understands technology as highly unstable, product cycles as extremely 

short, and production networks as defined by extensive coordination between upstream and downstream producers in integral processes (in other words, if coordination needs undercut full modularization), then innovation would fall primarily in the 

‘‘disruptive technologies’’ category, and might be understood as occurring primarily 

through interaction between firms. Under such circumstances, the policy goal would 

be to create not particular kinds of companies, but rather particular kinds of communities (a la Silicon Valley). Chinese industrial policy may be creating neither of 

these, but one can sympathize with the dilemmas policy makers face. 

Finally, for all the problems surrounding upgrading efforts in Chinese firms, it is 

worth asking what the relevant comparison or benchmark for China really is. Chinese firms today in most sectors are locked in intense competition, competition for 

which the dominant strategy still seems to involve deep discounting rather than 

specialization and innovation. By virtually any measure, Chinese firms are not as 

innovative as global leaders—namely multinationals producing branded products—

in any given supply chain. But are the global leaders really the relevant comparison? China’s per capita income in 2001 was US$890, roughly 1⁄40th of Japan’s or the 

United States’. It is perhaps not surprising that Chinese firms are failing to unseat 

incumbents from these far richer countries. Yet, in terms of positioning in global 

supply chains, can we say that Chinese firms are performing poorly relative to 

Mexican firms, Malaysian firms, or Thai firms (firms hailing from countries with 

per capita incomes, respectively, six times China’s, four times China’s, and twice 

China’s)? The point is that Chinese firms may not be innovating relative to one another and relative to globally branded leaders. Yet, they are out-competing rivals 

from far wealthier developing countries, and they are doing so by rapidly developing 

competence in increasingly complex manufacturing processes. Simply to remain in 

the game—simply to compete even on the basis of cost—firms in the contemporary 

era must upgrade rapidly, and that is precisely what Chinese enterprises have proven able to do. They may not be ‘‘innovating’’ in the traditional sense, but they are 

keeping pace with a dynamically evolving system of global production, an achievement that appears to elude many of their developing country counterparts. While 

that may not fit the Chinese goal of ‘‘catching up,’’ keeping pace represents an 

achievement worth celebrating—and understanding analytically—in its own right.
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Table 1. Main Inhibitors of Export Growth (data from 2001 World Bank Survey) 

All firms Beijing Shanghai Tianjin Guangzhou Chengdu 

Shipping and transport costs 9% 6% 8% 7% 15% 8%Cost of meeting foreign legal and product standards 15% 13% 11% 13% 18% 16%Inability to produce to clients’ standards, specifications, and schedule 15% 15% 12% 13% 19% 13%Inability to match prices of domestic competitors who export 11% 13% 10% 14% 8% 9%Inability to match prices of foreign competitors 12% 11% 17% 11% 4% 9%Inability to meet demands by foreign clients for product upgrades and changes in 

specifications 6% 4% 7% 9% 7% 5%

Difficulty of recovering payments from abroad 3% 4% 2% 5% 4% 2%Supplying the domestic market is relatively more profitable 7% 7% 8% 6% 4% 8%Costs of establishing a foreign distribution network too high 17% 16% 18% 12% 13% 22%Domestic content requirements 4% 11% 7% 9% 8% 8%

Table 2. Sources of Enterprise Financing (data from 2001 World Bank Survey) 

Channels of Financing By Percentage Observations All firms Beijing Shanghai Tianjin Guangzhou Chengdu 

51.5% 51.7% 51.2% 49.2% 50.1% 55.1%

Capital from retained earnings/internal funds 1486 (39.84) (40.09) (40.68) (42.92) (39.60) (35.57) 

0.8% 1.1% 0.6% 0.7% 0.4% 1.0%

Capital from letter of credit 1486 (5.50) (9.2) (3.91) (5.21) (2.55) (4.12) 

3.3% 3.1% 4.2% 3.0% 4.0% 2.8%

Capital from supplier credit 1486 (11.21) (10.71) (13.20) (11.04) (12.62) (7.70) 

18.9% 17.0% 19.3% 14.9% 18.7% 24.8%

Capital from bank loans 1486 (27.94) (25.98) (28.21) (27.77) (28.73) (28.14) 

1.6% 1.2% 2.0% 1.1% 0.7% 3.1%

Capital from other financial institutions 1486 (8.34) (7.40) (10.62) (6.98) (4.75) (10.33) 

8.4% 7.6% 11.9% 8.6% 8.9% 5.1%

Capital from a parent or partner company 1486 (24.63) (24.16) (28.96) (25.73) (25.74) (16.61) 

0.6% 0.1% 1.1% 1.0% 0.1% 0.6%

Capital from equity finance 1486 (5.89) (0.65) (8.53) (9.41) (1.17) (3.17) 

8.6% 7.8% 3.2% 17.2% 8.6% 6.2%

Capital from personal, family and friends 1486 (24.94) (23.89) (15.45) (35.08) (24.88) (18.44) 

6.3% 10.3% 6.6% 4.4% 8.5% 1.9%

Capital from other sources 1486 (21.45) (26.38) (21.53) (19.07) (25.22) (10.33) 
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Co-Chairman DREYER. Thank you. 

Ms. Walsh.

STATEMENT OF KATHLEEN (KATE) A. WALSH

SENIOR ASSOCIATE, THE HENRY L. STIMSON CENTER 

Ms. WALSH. Thank you for inviting me. I’m pleased to be here 

and talk about some work that I’ve been involved in, and thank 

you also for the very nice plug. The report is available for free on 

the website, and if anyone is interested, I’m happy to send a copy. 

But the report does frame the nature of my remarks today. I will 

be talking in similar terms, but really take more of a global perspective, and then turn to the Chinese economy. 

My view of China’s current market focuses on China’s high-tech 

industry really—what my focus is, the information technologies, information technology industry sector, so not automotive, not aerospace, not some of these other areas where China has had difficulties over the past few years and decades. Really I’m focusing on the 

one sector which I think has its own dynamics and actually lends 

itself to the trends I’ll be talking about and also explains a bit why 

China has had some success there. 

That is, one of the things that we found in looking at investments in China and technology transfer mechanisms and motivations for foreign companies that invest in transfer technology to 

China was that more and more foreign investors were investing in 

R&D in China. 

Now, this trend became apparent in the mid- to late 1990s, and 

it’s continued, in fact, accelerated, over the past several years. And 

the reason, at least in my view, and others’, for this, despite the 

market environment that one finds in the PRC, where you obviously have problems with intellectual property rights and industrial policies and lots of challenges for foreign companies investing 

in China, you still see investments in R&D. So the curiosity was, 

what is R&D in this context, and why are companies investing in 

it in China? 

Well, I think the answer lies in the global economy, as we’ve already heard. I think having looked at some studies that exist by 

economists—and I’m not an economist. I take a security perspective 

to these issues in U.S.-China relations but it seems clear that the 

global supply chain is evolving to the point where companies selling their products or manufacturing products abroad now more and 

more need to add value to their products and value that is tied to 

the local tastes of the foreign markets in which they’re investing. 

And so this has led to not only an offshore manufacturing 

trend—which I won’t get into in detail, but it is a concern—but also 

on top of this, complicating matters, is a growing trend toward 

outsourcing of R&D, corporate high-tech R&D, which is following 

this manufacturing. 

Now, one important distinction, at least in my view, from the 

manufacturing R&D trends is that I think in manufacturing you 

may see sort of a one-for-one loss perhaps in the U.S. economy and 

see this manufacturing emerging in China and India and elsewhere. 

On R&D, I’m not sure that that’s the case. I think the R&D investments we’re seeing, at least today, are additional R&D assets 
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being added or moved abroad and not necessarily replacing R&D 

assets here in the U.S., which is important, I think, as we determine what implications this trend has. 

And I think this overseas R&D trend overall presents some very 

important opportunities for U.S. industries, and obviously also 

some new challenges. Internationally, regionally, and in bilateral 

relations, this is affecting the global economy in terms of 

outsourcing, but also the regional economy. How do Japan, South 

Korea, and other states in the region deal with a China that is becoming more of a high-tech competitor? And this may seem surprising to some, but my view of China is that their economy can 

allow an agricultural, rural economy and also increasingly have a 

high-tech end that we’re seeing in the coastal areas of China. 

And I think that’s one of the important implications of the study 

I’ve been engaged in, which is we should not measure China’s hightech competitive capability by the same measures we use for the 

United States, or for other Asian nations. I think China will be 

able to compete in high-tech sectors, and we’re already seeing that 

in the China market, in the regional Asian economy, and also increasingly globally. 

China, I think, also has the advantage of being involved in the 

global economy at just the right time, particularly, again, in terms 

of information technologies. China has been opening its market 

over the last 20 years, which has coincided with the latest wave of 

globalization, which has, in turn, been founded on the information, 

communications technology revolution. So this has coincided, and I 

think China is trying to exploit these trends, and has had some 

success in doing so. 

China, like other countries in the world, is trying to create a 

knowledge-based economy. They saw the enormous growth in the 

U.S. economy in the 1990s and would like to mimic it. And even 

further back, the enormous growth and innovation both on the 

commercial side and the military side that the United States witnessed post-World War II, this lesson has not been lost on China 

and other countries, that if you invest in R&D and you focus on 

innovation among academia, industry, and government, that it will 

pay long-term dividends. And I think China is pursuing that strategy. 

So given all of these ongoing dynamics, it is no surprise to me 

at all that China is implementing the industrial policies that we’ve 

seen in terms of pillar industries, picking winners, local content requirements, tech transfer demands and so forth. 

I think it’s important—and we are engaged now in making 

sure—that China is living up to its commitments under WTO. I 

think that’s essential. And it will be a constant battle. It’s not 

going to be a one-time issue to deal with. Your Commission, I expect, and others will have to deal with this issue every year to 

make sure that China is keeping to its commitments. And I think 

it’s important to do it publicly, not to undermine U.S. relations 

with China but to keep it at the forefront of our relations so that 

this can be a win-win situation, which is also in China’s interest. 

But I’d suggest that that’s not sufficient. I think to address these 

trends that we’ve talked about very briefly—the global trends we’re 

seeing and the growing high-tech competition by and in China—we 
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* The views outlined above are those of the author alone and do not reflect an official position 

or view of the Henry L. Stimson Center. 

need to respond to these trends that characterize globalization. And 

I don’t think we’ve done enough of that as yet. 

There are many implications for U.S. policies and trade policies 

and export controls. I won’t get into those now. But I think essentially if our strategy is to stay ahead of China, whether it be one, 

two, or more generations of technology, I think what we need to do 

is focus on getting a better picture of the global economy and China’s role in it. An analogy is the battlefield picture that we have. 

Because of information technologies, we can actually see or visualize the battlefield today. That’s an enormous asset for our military. 

I think we have to do something similar with the global economy 

so that we understand the forces that we’re dealing with, our industry can exploit those forces, and we can maintain our technological gap with China and other countries that may be of concern 

long term. We don’t have that capability today, and I think that 

we need to focus our government resources on developing that capacity. And there are important reasons to do so. 

I guess my time is up, so I’ll leave my comments there. Just one 

last issue. I think that we need to invest in the long term. I admire 

many of China’s efforts to advance its education and language 

skills, engineering skills, and so forth. I think it’s time that the 

United States commit again to investing in these types of programs, funding R&D, Federal funding in investment long term, 

education, retraining, all of these basic investments that we have, 

I think, not done recently, and we need to invest for our own future 

so that we can maintain our technological edge. 

Thank you. 

[The statement follows:]

Prepared Statement of Kathleen (Kate) A. Walsh *

Senior Associate, The Henry L. Stimson Center 

Summary

The U.S.-China economic and security relationship is undergoing fundamental, 

structural change due to global economic forces. As a result, China may witness 

much more rapid development of its commercial—and, indirectly, defense industrial—capabilities than demonstrated by other developing economies. To meet this 

challenge, respond effectively, and avoid potential negative side-effects, U.S. policymakers require better, more timely, and comprehensive data and analysis of emerging global trade dynamics and China’s efforts to exploit these trends. In particular, 

the rise of global R&D in commercial high-tech industries and the growing level of 

foreign R&D investment in China warrant greater U.S. Government attention and 

resources. 

The Changing Nature of Global Trade and Investment Presents New Opportunities, and New Challenges 

As barriers to international trade and foreign investment are lowered under world 

trade rules, the very nature of international trade and investment is changing. Increasingly, multinational corporations (MNCs) are able to exploit foreign markets, 

labor pools, infrastructure, communications systems, and supply chains. As a result, 

numerous MNCs are expanding (and, in many cases, shifting) production lines overseas. Moreover, multinationals competing in these overseas markets are beginning 

to move up the value chain of production, which is leading to the distribution of 

more advanced manufacturing processes worldwide. This growing trade dynamic 

has begun to generate many questions and concerns—particularly during the current economic downturn—as more and more manufacturing jobs and related services move offshore, many of them to China. 
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1Figures are from the Bureau of Economic Analysis, U.S. Department of Commerce; and Donald Dalton and Manuel Serapio, Globalizing Industrial Research and Development (Washington, 

DC: U.S. Department of Commerce, 1999). 2 National Science Board, Science and Engineering Indicators (Washington, DC: U.S. Government Printing Office, 1993 and 2002); Donald Dalton and Manuel Serapio, Globalizing Industrial Research and Development, Table 1: Percentage of R&D financed from foreign sources, selected countries 1981–1999 (Washington, DC: U.S. Department of Commerce, 1999); and OECD 

Science, Technology & Industry Outlook (2002) (Paris, France: OECD, 2003). 3 As part of its accession agreement to the WTO, China made a specific commitment to ensure 

the ‘‘elimination and cessation of enforcement of trade and foreign exchange balancing requirements, local content and export performance offsets and technology transfer requirements made 

effective through laws, regulations or other measures.’’ However, the U.S. Secretary of Commerce recently cited complaints by U.S. companies of continued ‘‘forced transfer of technology 

from firms launching joint ventures in China.’’ Anecdotal evidence supports this finding, although there does appear to be some lessening of this dynamic. See WTO Accession Protocol 

of the People’s Republic of China (WT/L/432), November 23, 2001, § IV(8)a, p. 16; and Donald 

Evans, ‘‘Remarks by Commerce Secretary Don Evans to the Detroit Economic Club’’ (September 

15, 2003), available online at http://www.commerce.gov/opa/speeches/Evans/2003/Septl15l EvanslmanufacturinglDetroit.htm. 4Science and Engineering Indicators 2002. 5Kathleen Walsh, Foreign High-Tech R&D in China: Risks, Rewards, and Implications for 

U.S.-China Relations (Washington, DC: The Henry L. Stimson Center, June 2003), available online at http://www.stimson.org. 6 Estimates cited in PRC press reports suggest that there are somewhere between 120 to 400 

foreign-invested high-tech R&D centers in China, but it is unclear what specific criteria were 

used in determining these figures. A study by the Chung-hua Institute for Economic Research 

in Taiwan cites a figure of 148. See ‘‘China Tipped to Become World Hi-tech Center,’’ People’s 

Daily Online (June 2002), which notes that ‘‘Foreign businesses have set up over 120 R&D centers in China, and there will be 10 more this year.’’; ‘‘China’s Foreign Trade Sets New High 

Despite Adverse Circumstances,’’ People’s Daily Online (October 28, 2002), citing ‘‘. . . nearly 400 

R&D centers of various types . . .’’; and ‘‘Taiwan’s R&D Should Differentiate From That of 

But there is an additional dynamic that has emerged as a result of growing global 

trade that has yet to receive the attention it deserves: the increasingly global nature 

of commercial high-tech research and development (R&D). While the United States 

continues to enjoy an overall net inflow of R&D dollars, U.S. companies in the year 

2000 invested almost $20 billion in overseas commercial R&D (up from about $5 billion in the mid-1980s).1 This trend mirrors developments in other Western economies, which are also witnessing increased levels of inward and outward commercial 

R&D investment. Today, the percentage of foreign-funded R&D in the United States 

(15%) and in the U.K. (16.8%) is about double that of two decades ago (up from 6.2% 

and 8.7%, respectively, in 1981); similarly, Canada and most other OECD states 

have experienced a rise in commercial R&D investment from abroad.2

In large part, the driving force behind the globalization of R&D is the need for 

commercial ventures to increase the value-added quality of the goods or services 

they are manufacturing and selling abroad. For this purpose, research, design, and 

development work is often best done (at least in terms of cost concerns) near to one’s 

production base. Thus, as manufacturing moves offshore, so too is industrial R&D. 

Generally, the R&D assets being added or moved abroad is not the most advanced 

or basic type of research work, which is for the most part still undertaken at the 

high-tech company’s home base. More often R&D conducted overseas involves various forms of technology development or applied research work. Other reasons 

MNCs establish offshore R&D ventures include the need to set up ‘‘listening posts’’ 

in other high-tech business centers (i.e., Silicon Valley and its equivalents abroad), 

for localizing foreign products to match local tastes, for training and marketing purposes, and in the China market, for improving guanxi (generally, building connections or relationships) and/or to meet continuing (if now less formal) technology 

transfer demands.3

An important aspect of the global R&D dynamic, however, is its expanding international scope. R&D investments by multinational corporations are no longer limited to industrialized economies in Europe and Asia (or to close U.S. allies). Today, 

the world’s leading high-tech companies are establishing commercial R&D centers 

in many parts of the developing world as well. Although the data concerning levels 

of foreign R&D investments abroad is very limited (even with regard to Western 

economies), it is becoming clear that countries in the developing world too, particularly China and India, are experiencing a rapid rise in the level of foreign R&D investment.4 According to a recent Stimson Center study, high-tech multinationals in 

the information communications sector have established over 200 separate R&D 

centers on the Mainland over the past dozen years (1990–2002).5 Other estimates 

place the overall number in China today at somewhere between 100 and 400 foreign-funded R&D sites.6 This growing trend represents a new stage in economic 
149

China,’’ Asia Pulse (December 5, 2002). Charles McMillion cites reports by China’s Ministry of 

Foreign Trade and Economic Cooperation in 2000 of ‘‘nearly 100’’ foreign R&D centers and a 

CAS figure of 124 such centers in 2001. See Charles McMillion, ‘‘China’s Very Rapid Economic, 

Industrial, and Technological Emergence,’’ prepared for the U.S.-China Security Review Commission, June 5, 2002. 7For a comprehensive review of this trend and its implications for both the United States and 

China, see Walsh, Foreign High-Tech R&D in China. 

globalization, yet, its overall implications for U.S. economic and security interests 

and U.S. relations with China have not yet been fully explored.7 Meanwhile, China 

and other recipients of this potentially more advanced form of technology transfer 

are encouraging further R&D investment from abroad in hopes of accelerating the 

development of their own domestic high-tech industries and ‘‘knowledge-based’’ 

economies. 

Finally, the ongoing revolution in information communications has helped fuel the 

growth in offshore manufacturing, services, and commercial R&D. In particular, 

high-tech industries that are heavily reliant on communications technologies (such 

as telecommunications or computer software development) have been able to take 

advantage of an increasingly global marketplace by employing the Internet or other 

communications platforms to increase productivity while reducing costs and expanding their worldwide presence. For example, research teams connected electronically 

and collaborating on a single R&D project may be located in two or three or more 

different sites around the world, making it possible to conduct commercial research 

on a continuous 24–7 work cycle. Under this model, different research centers generally focus on select segments of the overall research project based on the particular skill set or other advantages and resources specific to each researcher or center. Oftentimes, the result from this type of collaboration is in intangible or electronic form (for example, computer software code), meaning it can be easily and rapidly transferred almost anywhere around the world. 

All of these global trends—the growth of offshore manufacturing, global R&D, and 

the information communications technology revolution—present substantial potential economic and investment opportunities for U.S. companies. At the same time, 

however, they present serious challenges to U.S. trade and security policy, particularly in the area of export controls. Moreover, the still-limited data available on 

these global trends points to the need for a much closer examination of how they 

are impacting U.S. interests at home and abroad. 

China’s Role in the New Global Economy 

The PRC has been a prime beneficiary of all of the above-described global trade 

phenomena due to its enormous market potential, expanding role in the world economy, and the Mainland’s many policies, programs, and incentive plans designed to 

take advantage of these new international dynamics. In fact, China may be uniquely 

positioned to benefit from today’s increasingly globalized marketplace. As a very 

large, generally stable, but still under-developed market, the PRC presents not only 

plentiful opportunities for foreign investment but also actively seeks high-tech investment from overseas, becoming in 2002 the world’s most popular site for foreign 

direct investment. In addition, China enjoys the advantage of a very large labor 

force that is not only comparatively cost-efficient but also includes an impressive 

and growing generation of skilled scientists and engineers (many of whom receive 

their degrees from U.S. universities). These assets plus China’s own investments in 

infrastructure, market-oriented economic reforms, and the government’s emphasis 

on developing strategic high-tech industries has placed the PRC in an exceptional 

position to exploit the global trends outlined above—which is exactly what China 

has been trying to do. 

The PRC’s selection of ‘‘pillar industries,’’ its strategy of ‘‘picking winners’’ among 

China’s emerging high-tech or industrial enterprises, its incentive programs for certain high-tech industry and R&D investments (including tax credits, favorable landlease terms, preferential loan programs, etc.), and other regulatory practices that affect both domestic and foreign investors are all part of an effort to reap the benefits 

of an increasingly global economy. Thus, it is likely, in my view, that China will 

continue to utilize these types of strategies in the future, at least as long as they 

are able to do so without incurring substantial costs in terms of foreign investment 

or international reputation. 

Yet, while U.S. attention is rightly focused on creating a more fair trade environment in the PRC and making sure that China lives up to its considerable commitments under the WTO, our attention should also be focused on (and we should be 

preparing for) the potential for China to advance far more quickly in terms of developing its own high-tech industry—and, indirectly, it defense industrial capabilities—

than has been demonstrated by other developing economies in the past. Because 
150

China is so well-positioned to exploit the global dynamics described above and has 

adopted development strategies designed to do so, already there are Mainland competitors emerging in critical high-tech industries such as computer software development, telecommunications, and low-end semiconductor manufacturing. There is no 

doubt that much of this capacity is due to foreign investment and technological 

input (which could conceivably be withheld if deemed necessary, but would be extremely costly in many ways). But it is also clear that a number of Chinese enterprises have already moved beyond their dependence on foreign partners and are 

gaining substantial market share in critical high-tech sectors in China and beyond 

long before many would have predicted. Therefore, it arguably makes greater sense 

to focus our resources on trying to prevent possible technological surprise in the 

case of China than on trying to obstruct China’s technological advancement (an increasingly difficult prospect). For if we are better able to gauge China’s high-tech 

trajectory, the United States can continue to trade with China armed with a growing confidence that we understand the impact U.S. technology transfers may be having on China’s development, while ensuring that we remain ahead of the curve (with 

the added benefit of economic growth at home). But if we are to run faster, we need 

to know how far, how fast, and in what direction. 

Added to this dynamic is the growing influx today of foreign scientific and technological know-how and equipment to China (and other parts of the world) that is integral to conducting high-tech commercial R&D, whether at home or overseas. This 

could serve as an important, additional accelerant in China’s plans to modernize its 

economy, industry, and military (although China’s past efforts at assimilating foreign technology demonstrate that this is by no means certain). The best evidence 

of this potential is the United States, which emerged as a bona fide world power 

following World War II mainly due to the enormous Federal investments made in 

basic science and engineering as well as the increased collaboration that took place 

among industry, academia, and government researchers during and after the war. 

This lesson has not been lost on China or other nations that aspire to create more 

advanced industrial and knowledge-based economies such as ours. Today, however, 

it is likely to take far less time to achieve; such is the advantage of late developers. 

Once again, the challenge it poses for U.S. policymakers is not how to prevent China’s technological advancement, but how to stay ahead of it. 

Implications for U.S. Policy 

There are several important policy questions, concerns, and implications that flow 

from this discussion. 

• Realize that changing global trade dynamics are already impacting U.S.-

China relations.

One immediate effect of the dynamic shifts in global trade is that the U.S.-

China economic and security relationship is already undergoing fundamental—if 

subtle—change. China is becoming less the high-tech competitor of the future, and 

increasingly the competitor that industry is facing today, both in China and the 

global market. As the PRC continues to advance technologically, becomes more 

competitive globally, and does so more rapidly than some might expect, relations 

between the United States and China will continue to change. U.S. policy toward 

China must also adjust to this new reality. This could be a change for the better, 

or it could easily undermine today’s ‘‘candid, cooperative, and constructive’’ relationship. In order to avoid an inadvertent decline in bilateral relations, the United 

States and China will need to work together to enhance transparency, reduce barriers to trade, improve the balance of trade, and to gain greater understanding 

of how these global trade dynamics are impacting our domestic economies, industrial capabilities, and defense modernization efforts. 

• Add information exchanges on high-tech R&D investments to the agenda 

of meetings held under the U.S.-China S&T Cooperation Agreement.

Chinese officials and academics are as interested in analyzing and quantifying 

the growing global R&D trend as are U.S. officials, business executives, and analysts. Over the past year, in particular, analysts in the PRC have conducted a 

number of surveys to try to determine the actual number of foreign-funded R&D 

programs in China. In addition, China now enjoys observer standing in the 

OECD, where studies on global R&D investments also are under way. The U.S. 

and Chinese National Science Foundations, too, are cooperating on standardizing 

collection of statistical data. The present, therefore, seems an opportune time to 

establish a bilateral (or multilateral) system for tracking data on international 

R&D investments in China. The United States and the PRC have much at stake 

in understanding these activities and both would benefit from more precise and 

regular collection of data. The existing bilateral S&T Cooperation Agreement 
151

8 Conversation with BEA official (September 23, 2003). 

9See National Academy of Sciences, Board on Science, Technology and Economic Policy 

(STEP), ‘‘Panel on R&D Statistics at the National Science Foundation’’ (April 7, 2003), materials 

available online at http://www7.nationalacademies.org/step/STEPlProjectslR&DlDatal

Needs.html. 

could provide a positive atmosphere, near-term opportunity, and official umbrella 

under which to conduct, or at least begin undertaking, a joint effort such as this. 

• Develop a regular, more comprehensive process for collecting data on 

high-tech R&D activities abroad.

Whether undertaken as a cooperative or domestic enterprise, greater effort is 

needed to provide policymakers and business executives with a clearer, more comprehensive, regular, and timely picture of global R&D activities. To gain a deeper 

understanding of the impact these activities are having on the U.S., Chinese, and 

global economy, annual statistical data of inward and overseas R&D investment 

is essential and must be coordinated with other countries. The U.S. National 

Science Foundation, Bureau of Economic Analysis (BEA), and the Bureau of the 

Census under the U.S. Department of Commerce have signed a Memorandum of 

Understanding to pool their statistical resources in order to track global R&D investments (based on existing reporting requirements on U.S. companies). This 

project is now underway and should provide initial findings later this year.8 This 

effort should be continued and expanded over time to provide a more comprehensive picture of this important and fast-developing global dynamic. 

• Increase U.S. Government investment in basic research and education in 

order to maintain the United States’ global lead in critical high-tech industries and innovation.

U.S. Government funding for R&D has been holding steady over the past few 

years, but this is due mainly to concerted efforts and support from Congress. U.S. 

policymakers must not sacrifice funding for science and technology to other priorities such as homeland security; both are essential to long-term U.S. national security interests. Funding levels must also increase over time if the United States 

is to remain economically, technologically, and militarily competitive. The PRC is 

not alone in adopting multiyear strategies to achieve high-tech advances; Europe, 

Japan, and other states and regions are competing for a greater share of the 

world’s high-tech market. In an increasingly global environment, these efforts are 

likely to be more successful, much more quickly, than in the past. As other nations and regions move up the technological ladder, however, many of the foreign 

nationals supporting U.S. labs, universities, and high-tech companies will begin 

to find similar work and living standards in their own economies. Thus, to ensure 

U.S. competitiveness over the long term, policymakers must invest more in grade 

school and secondary education, focusing particularly on the basic sciences, mathematics, and engineering fields. To ensure that the U.S. economy continues to 

benefit from a global marketplace (and that the U.S. standard of living continues 

to move upward as promised by supporters of global trade), significant investment 

also is needed for re-training and education of U.S. workers today. Without a serious, government-led effort to realize the gains from globalization, we risk not only 

a ‘‘race to the bottom’’ but also falling behind in critical advanced technological 

capabilities vis-a`-vis the PRC and other emerging high-tech competitors. 

• Conduct a U.S. innovation survey to aid assessment and monitoring of 

America’s high-tech edge.

Due to the growing realization around the world of the new global trade dynamics that are taking shape and the need to better understand the implications they 

hold for future economic development, countries such as Canada, Japan, and the 

European Union have undertaken—or are in the process of undertaking—comprehensive innovation surveys of their high-tech industries. While there has been 

some discussion among U.S. Government officials about conducting a similar survey of U.S. high-tech industry, this effort is unlikely to move forward without specific Congressional authorization and appropriation.9 Given the fast-growing 

trends described above and their inevitable impact on U.S. economic and security 

interests as well as relations with the PRC, Congress should authorize and fund 

an innovation survey by the National Science Foundation or other appropriate 

government agency(s) as soon as possible. 
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10Ministry of Foreign Affairs of the People’s Republic of China, ‘‘U.S. President Bush and 

Other U.S. Officials Meet Visiting Foreign Minister Li Zhaoxing,’’ Press Release (September 23, 

2003), available online at http://www.fmprc.gov.cn/eng/wjdt/wshd/t26239.htm.

• Modify U.S. commercial deemed export controls to cover R&D-related 

transactions abroad. 

At present, U.S. deemed export controls for commercial items do not apply overseas (unlike munitions trade controls). For dual-use technologies, deemed export 

licenses are required only for firms in the United States wishing to hire foreign 

workers with advanced skills or education from certain countries (primarily 

China) to work in certain technologically sensitive areas. Given the growing trend 

of overseas R&D, particularly in places like China and other states of potential 

proliferation concern, this policy makes little sense in today’s world. At the same 

time, however, simply applying a system that is widely regarded (at least among 

industry, many non-governmental experts, and the GAO) as being ineffective and 

unduly burdensome to the small number of companies that comply (but are vital 

to U.S. high-tech industry), is not the answer and would prove impractical as well. 

Rather, the answer lies in a different approach to export controls that would 

provide a middle ground between full licensing review and complete decontrol. In 

other words, an exception such as that used for commercially available encryption 

technology could be applied to R&D-related transfers overseas. Such a system 

could require companies simply to notify the government of pending transactions 

so as to provide a record of these transactions that could then be analyzed, monitored, and reviewed by officials elsewhere in the government to determine what 

overall impact these transactions may be having on U.S. economic and security 

interests. Using modern information communications technologies to ensure an efficient and time-sensitive process, an electronic monitoring system to track these 

transfers could also aid government officials in gaining greater transparency and 

accountability of U.S. R&D-related investments in China and elsewhere. 

In order to successfully implement such a program, however, the support of not 

only Congress but also senior Executive Branch officials—representing the White 

House or National Security Council—is needed. The Bush Administration stated 

upon coming into office its intention to reform export controls to meet 21st Century challenges. The advent of foreign-invested high-tech R&D in China poses just 

this sort of immediate and long-term challenge. To ensure that U.S. economic and 

security interests are being met as high-tech R&D moves further offshore, export 

control reforms must be made a priority and be given the high-level attention this 

concern warrants. 

Conclusion 

The global economy presents the United States with great opportunity to enhance 

our economic and security interests as well as serious, long-term challenges. According to recent remarks by China’s Foreign Minister, Li Zhaoxing: ‘‘China is willing 

to step up dialogue and cooperation with the U.S. side in economy, trade and finance with a view to continuously propelling the stability and growth of the economies of both countries and the world in general.’’ 10 The United States should take 

China up on this offer. 

Discussion, Questions and Answers 

Co-Chairman DREYER. Thank you very much. 

The first question from Commissioner Mulloy. 

Co-Chairman MULLOY. Let me ask all three panelists if you 

would comment on this. Professor Nolan, I believe you said that 

the concentration of business power in the world today is at historic highs, in your estimation. Is that correct? 

Dr. NOLAN. Yes. 

Co-Chairman MULLOY. And the second thing you said, it’s not in 

our interest or in China’s interest to force them to comply with 

their WTO obligations. 

Dr. NOLAN. I said there were consequences that would flow from 

that that we should consider very carefully. 
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Co-Chairman MULLOY. I think you went further than that. I 

think you said it would be in our interest not—in their interest, 

definitely, and probably not ours. 

Dr. NOLAN. Yes. Okay. 

Co-Chairman MULLOY. Okay. So the third thing is the article 

that appeared in the Wall Street Journal right after Congress approved, the House approved China’s PNTR vote, which meant 

China was going into the WTO, that was all sold on the basis we 

were going to make a lot more sales to China. 

Dr. NOLAN. Yes. 

Co-Chairman MULLOY. After it, an article appeared in the Wall 

Street Journal quoting this: ‘‘U.S. multinationals have’’—‘‘Washington focused mainly on the probable lift of U.S. exports to China. 

Many’’—this is the Wall Street Journal. ‘‘Many U.S. multinationals 

have something else in mind. ‘This deal is all about investment, not 

exports,’ said Joe Quinlan, an economist with Morgan Stanley. U.S. 

foreign investment is about to overtake U.S. exports as the primary 

means by which U.S. companies deliver goods to China.’’ And I 

might add at the end of that quote, not only goods to China, but 

goods back here to the United States. Wal-Mart does over 75 percent of their global sourcing out of China, my understanding. And 

that’s $15 billion a year coming here out of China by Wal-Mart 

alone. 

Now, if the WTO was all about investment and then further, Dr. 

Nolan, you say on page 14 of your testimony, ‘‘By the year 2002, 

China had overtaken the USA as the world’s largest recipient of 

FDI, with the stock of FDI reaching around US$450 billion.’’

Dr. NOLAN. Yes. 

Co-Chairman MULLOY. Okay. In light of this, what do the American people get out of China being in the WTO? We see massive 

amounts of investment flowing out of this country to China, and we 

see—we heard this morning the erosion of manufacturing and job 

losses here in the country. And then you’re telling us it’s not in 

China’s interest to comply with its WTO obligations. What is this—

I mean, think through further, what does this mean? Where are we 

headed? And, obviously, it’s in the interest of multinationals and 

their bottom lines. I can see that. But what does the average person in this country get out of all this? Where are we headed here? 

All three of you. 

Dr. NOLAN. Do you want to go ahead? Please. 

Ms. WALSH. Wonderful. Ladies first. Well, I value the question, 

and I don’t have a pat answer to that question. I think it’s very 

difficult. But I think we need to find how it is that we win from 

this situation. 

We have, I think, assumed for a long time that we would benefit 

from globalization because there was the assumption that the highvalue-added goods and high-wage jobs and skills and technology 

that we have here would be our advantage and that no one would 

really be able to catch up to us, and, therefore, we’d have the advantage in this type of relationship. But I don’t think we can take 

that for granted anymore because the global economy has witnessed fundamental shifts, and it’s rapidly moving up in terms of—

advancing in terms of value-added, the supply chain, which is global. 
154

So our role in that economy I think has changed, and we haven’t 

really responded to that. We need to get a better picture of what 

this is so that we can make this benefit, U.S. labor force and others, both the blue-collar and the white-collar both. And I think that 

we’ve not paid sufficient attention to that, and now we see that 

there are some challenges. 

Co-Chairman MULLOY. Dr. Steinfeld. 

Dr. STEINFELD. It’s a very complicated and good question that 

you ask, and I would say that my answer is basically that in every 

major industrial transformation that’s occurred in history—I’m saying the United States, from agriculture to industry or industry to 

higher-end industry and a post-industrial service economy, there 

are gains to productivity and gains to national wealth and tremendous destruction, socially, the social fabric destruction to jobs that 

were anchored in the old economy, be it agriculture or industry. 

That is a reality of progress, and I say that not normatively. That 

seems to be a historical reality, and we’re engaged in that now. 

I think we can’t say to a person who has lost a lower-end, arguably manufacturing job in the United States that this change is 

good for you. It is not good for that citizen, and I think it’s incumbent upon us socially, as it is in China for their displaced workers, 

to come up with a social answer. 

But I think over the long run the changes associated with 

globalization do benefit our country in allowing a division of higher-productivity activities and lower-productivity activities, and a 

concentration of the higher-productivity activities in North America 

and Europe, and an even harder game of catch-up for those, say, 

for example, in China and the developing world than even was 

faced earlier by South Korea or Japan before that. 

Co-Chairman MULLOY. Dr. Nolan? 

Dr. NOLAN. I can answer? Okay. Very briefly—the time is 

going—I just would emphasize I think that in terms of the exports 

from China of U.S.-based corporations in China, this certainly benefits U.S. consumers, no question at all. That’s a huge gain. But 

I think that the motives for global corporations are solely profits. 

That is their raison d’etre. I’m a shareholder directly and indirectly 

through my pension fund, and my pension fund will put great pressure on the companies to source where it’s cheapest and best for 

their profits. So the motive for going to China, clearly, building the 

value chain in China is because it’s more profitable for them to do 

so. 

But I think that provides tremendous challenges for both societies. There’s never been a period in which FDI has moved at such 

a pace across boundaries, and it’s moving into a huge part of the 

world, with a relatively cohesive domestic market that has the capability to suck FDI in a way that no other society ever had the 

capability to do. And the pace of change involved in that presents 

tremendous challenges for both societies, China and the U.S. 

Co-Chairman MULLOY. Thank you. 

Co-Chairman DREYER. Commissioner Becker. 

Commissioner BECKER. Thank you very much. I’d like to really 

focus my questions to Kate Walsh. I am interested very much in 

the R&D, research and development, and what is happening to all 

this. I never quite gathered from your testimony, your written tes-
155

timony and your remarks, whether you felt this was good or bad, 

this transfer of research and development. But let me make a few 

points that were not pointed out in your testimony and have you 

comment on that. 

At this Commission and other commissions, we’ve had industry, 

large industry, complain about being coerced by the Chinese to create research and development institutions and to staff it with the 

brightest people that we had. They would even tell them who they 

wanted in there, which raises a couple of questions, because in 

these joint ventures on research and development, we found linkage with the PLA through the Chinese universities. And I’m wondering how you feel about that, how you would assess that. 

And, further, I would point to CFIUS, which is the organization 

that has oversight—I guess that’s the best way to put that—

through Treasury on military security and sensitive acquisitions, 

and whether you would consider the research and development 

that’s being established as a sensitive industry, in effect, that 

would require or should require CFIUS oversight before that’s 

done, because as I understand, these linkages on research and development go not just from—into China with a company from the 

United States, but that this funnels back to the main company in 

the United States. And how do you put a transfer, export transfer, 

on an idea that’s in a person’s head? 

Have you examined this at all? I mean, this is quite an extensive 

paper on research and development. I would be interested in your 

comments on that, and from the other two panelists, if they care 

to. 

Ms. WALSH. Thank you. It’s all in there actually, in the monograph. But is R&D in China good or bad? It can go either way, I 

think, and it’s important. I’m less worried now than I was when 

I worked with Commissioner Reinsch and others on this issue earlier, in the late 1990s. 

At that time, R&D investments by U.S. and other high-tech firms 

in China was either, one, exploratory or what they now—everyone 

now calls ‘‘show R&D.’’ It was R&D basically for the sake of answering to local content and technology transfer demands by Chinese officials and joint venture partners. 

So they set up something called R&D at the time, and some of 

these programs were what we would term R&D, research and development, but most of it was really just a center of some sort that 

was called R&D with computers and maybe some software. It really wasn’t what we would define as R&D. 

However, there have been several stages now, at least three distinct phases of this type of investment, and I am actually less concerned about it now, and the reason is that rather than being driven primarily, although not exclusively, by the demands made by 

the Chinese partners or local government for technology transfer, 

the main motivation now for foreign firms to invest in R&D in 

China is because of this global supply chain evolution. That is, 

they’re making a strategic decision, the companies themselves, that 

they need to invest in R&D in China. They’re not being driven by 

outside forces as much as their own internal corporate needs in a 

global economy. And that has tangible effects on the way in which 

they do the R&D, which is what we would in many cases now real-
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ly call at least technology development, or applied research in 

China. 

And so they put in place—you can see the changes from the 

1990s to today in terms of security and protecting their intellectual 

property, security gates and guards, and so forth. 

So it’s a different dynamic now than it was, and so even though 

the research and development going on in China is more advanced 

and it’s real R&D in many cases today, it is, I think, less troubling 

because of that. 

Another factor is that these are often today wholly foreign-owned 

enterprises, no longer joint venture partnerships in most cases 

today, or at least they’re moving that way. 

They’re also consolidating their R&D ventures and enterprises in 

China, no longer expanding them throughout China as they were 

being pushed and incentivized to do earlier. So it’s more strategic 

thinking about R&D in China and, therefore, more carefully 

thought out. 

So in that sense, I’m less concerned. Whether it’s good or bad, 

I don’t know. It could go either way, depending on a lot of factors. 

But understanding the evolution, I think, is important. 

As far as the PLA, it’s very difficult to know if this feeds in. One 

indicator, though, that China is recognizing it’s had trouble doing 

spin-on, spin-off type of work, even in information and communications technologies areas where they’ve had some success, is that 

they’re sending PLA students now to the civilian universities, the 

high-tech universities, Tsinghua University and Beida and others, 

to be schooled there in commercial technology engineering and so 

forth. So, they haven’t, I think—that’s an acknowledgment they’ve 

had some trouble there. 

CFIUS I believe only covers investments in the United States, 

but one of the issues I’ve looked at since doing this report—I mentioned it just very briefly there—is the issue of deemed exports. We 

control foreign students or workers who come to the United States, 

most of whom are Chinese, who are working in sensitive high-tech 

areas. We deem that an export, and they’re tied to the H–1B visas 

or the L–1 visas. 

We don’t do that (deemed export licensing) overseas, and there 

are practical reasons for that. But to me, because so much more 

R&D is moving offshore and the workers, the engineers are all Chinese locals—it makes little sense, I think, to be controlling exports 

here, Chinese working at Intel and Motorola here, and not controlling it there. How do you control intangible technology transfers? 

It’s very difficult. I would suggest that we need a new way to do 

it. That is, something other than a full license review, which you 

can’t really do a background check on a Chinese in China, it’s impractical. And we don’t want to completely decontrol this either. 

Again, the idea I would put forward is to try to get a picture of 

these trade dynamics, and that would require some data. And industry is who has the information. So I would—something along 

the lines of the encryption exception, where much of the technology 

is allowed to go forward without a full license review, but the Commerce Department or the U.S. Government has some notification, 

some electronic record that this transfer or transaction took place. 

And I think that kind of data—it would be a lot, but I think it 
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would be useful to analysts like myself, and others, to see the ebb 

and flow of the technology and people. And where are they going? 

Are they clustered? Are they moving around? Those kinds of 

trends, I think, broadly would be very helpful to get a picture of 

these very fast-moving dynamic forces that we’re seeing in the 

China market and globally. 

Commissioner BECKER. Thank you. 

Co-Chairman DREYER. I’d like to ask—I’m very interested, having some acquaintance with what you’re saying myself about the 

problems of within-region competition, that it’s factory eats factory 

within a region rather than being able to compete globally, or even 

just all over China. 

How does the odd Haier break out of this and even just on a 

China-wide company, like Hongda, the Red Pagoda cigarettes? And 

you hear people like Lai Changxing saying, perhaps disingenuously; the only way to do it is by bribery and corruption because 

there’s no other way. What do you think about that? What did enable Haier to break out and become a globally recognized name? 

How do they do it? And is this liable to pave the way for other companies, or is this a complete aberration? 

Dr. NOLAN. I think Haier has actually connected these two arguments in a very interesting way. The first thing is that Haier is 

not actually a globally recognized brand. It’s recognized by those of 

us who work in technology, but if you ask most people——

Co-Chairman DREYER. Sold at Brandsmart in Washington, D.C., 

area. Sorry. Globally known, advertised in the Miami airport. 

Dr. NOLAN. Okay. But, as we know, what it sells at the moment 

is very low-end small refrigerators. Its capability to compete with 

GE Electrical Appliances Division, BSH, Whirlpool, Electrolux is 

very low. It is a highly successful firm in all sorts of ways with a 

brilliant CEO. Whether it would have been able to succeed without 

industrial policy of one sort or another is a question, and I think 

it’s very unlikely. I think Haier is very successful up to a certain 

point. Whether it will succeed beyond that point is questionable because it faces an immense difficulty in moving into the high-valueadded segments of that market. And there is ferocious competition 

in the low-value-added segment of the market. 

So I think—yes, go on. Sorry. 

Co-Chairman DREYER. How come it succeeded to the extent that 

it is available in the United States market even though it faces all 

this high-value competition at home? 

Dr. NOLAN. To answer that it would take a very long time to expound. I mean, I’ve just emphasized that the level—its level of success is very limited. It has some global brand name, but not a great 

global brand name, a very narrow niche, and its capability to compete with the world giants, if you talk to Zhang Ruimin, is rather 

limited. They have a long, long way to go. They’ve done very well, 

but they’re probably the most successful Chinese firm in international terms. But think of how limited that niche is: dormitory, 

small refrigerators for students. And its attempt to move into the 

high-tech, the higher-technology sectors, it is still unknown as 

whether it will be successful. 

I would just, if I may, just link in terms of this technology transfer question, that the idea that technology is being transferred to 
158

China is certainly true. There’s an awful lot of R&D going on in 

China that was not formerly being done in China. But the question 

is: Within whom? It’s being done within global giant firms predominantly within China, within Alcatel, within Motorola, within NEC. 

If you look at the bread, the food for the whole high-technology 

sector and that which supplies the chips for Haier, China has not 

one single microchip company among the top 30 companies listed 

as suppliers within China or to China. And so it’s a long, long, long 

way to go. And on the global level playing field in semiconductors, 

the idea that China would spontaneously compete with Intel or 

Samsung is a fantasy. 

Co-Chairman DREYER. Dr. Steinfeld. 

Dr. STEINFELD. I would just very quickly say, on the one hand—

here a two-handed academic, of course. 

My apologies. On the one hand, Haier to some extent is a symbol 

of where things are headed in China in the sense that the central 

government recognizes how this highly divided domestic market 

undercuts Chinese growth, and so there are great efforts to beat 

up, to some extent, on localities to prevent local protection, and one 

of the reasons, I think, for China’s joining WTO is for the center 

to use WTO as a lever against localities. 

Haier has to some extent been better than other domestic firms 

in unifying the domestic market. But even in this case, the company operates—in order to survive, it operates an incredibly complex portfolio of very low-value activities. In other words, a very 

complex portfolio of manufacturing low-end refrigerators, low-end 

cell phones, low-end appliances of various kinds. And what that 

means is the company can survive doing that. It’s very entrepreneurial. In some cases, it exports to North America and Europe because that’s an easier market than selling within its own domestic 

market. But I would say that because it’s operating this portfolio 

of very narrow-margin activities, it doesn’t generally have the resources to upgrade technologically in its business, even if we discount some of the technology, it doesn’t really have the resources 

to engage in the very sophisticated marketing strategies that would 

allow it to compete head to head. 

But its success is not to be sneezed at, and I think it is an indicator of where things are headed slowly in China. 

Co-Chairman DREYER. Ms. Walsh. 

Ms. WALSH. I would take a slightly different view, and I don’t 

know Haier’s background specifics, so let me talk more generally 

about firms such as Haier that we’re becoming more familiar with 

here in the United States and elsewhere in the global economy. 

And, that is, I think Haier and others have—companies in China, 

the strategy has really been to work with as many foreign partners 

as possible. And this is along the range of business services, from 

distribution, sales, manufacturing, services, and all the rest. 

And so I think because of the variety of foreign partnerships in 

the different parts of the business, the Chinese firms have had a 

very good opportunity to learn the business from the best in the 

world who have come to China, which is a magnet for foreign investment. And they’ve taken advantage of that. 

Now, of course, there is uneven or mixed success in that, but 

overall I think the strategy has been very successful. And even in 
159

high-tech sectors where there’s sophisticated and—you know, the 

world’s leading computer companies are in the China market, but 

they don’t have the dominant market share in China. Legend is a 

Chinese domestic firm, and they enjoy by far in the PC market the 

market share in China, and now also in Asia. And now they’re exporting to the United States and elsewhere around the world. 

So they’ve learned the business from the foreign investors, in 

part because there have been demands on the foreign investors to 

provide training, technology transfer, local content requirements, 

and the Chinese partners have taken advantage of this. And I 

think they’re smart to do so. 

The question, too, is at what point can they become competitive. 

In the China market, I think the question, both commercially and, 

frankly, militarily, is when do they have the capacity to manufacture, produce, or design technology that’s good enough. And I think 

that’s really the measure that we need to look at, that it’s good 

enough technologically to compete. And so Legend became very 

quickly and surprisingly the leading PC firm in China and beyond 

because it had a Chinese brand name, frankly, which is obvious if 

you’re a Chinese consumer, you prefer to buy a Chinese brand 

name. It had the first assembly capability, but further down the 

road they were able to develop their own components and equipment to put into the PCs. So they’re growing their business from 

the bottom up and learning from the best in the world how to do 

so. 

So I think it’s been a very effective strategy, and they haven’t 

had modest ambitions. They’ve had from the start ambitions to go 

global, not just to capture their own domestic market but to quickly 

become a global competitor as well. And I think that’s what we’re 

seeing. In fact, we see R&D investment going two ways. You see 

high-tech companies, Chinese companies investing in R&D here in 

the U.S. and elsewhere abroad, mostly just to have a presence, not 

to conduct R&D per se. But it’s stage one of this dynamic. 

So I take a different view on this, and having visited with some 

of the Chinese companies, I’ve asked them how they’ve advanced 

so quickly, and they show me the list of foreign companies that 

they’re involved with in different ways and do so with great pride. 

And they have certifications from this and other companies. So, I 

think they’ve taken advantage of the draw of foreign investment in 

a very smart way. 

Co-Chairman DREYER. Thank you. 

Commissioner Bartholomew. 

Commissioner BARTHOLOMEW. Thank you very much, and first I 

really wanted to thank all of our witnesses who have provided, I 

think, a very interesting and different perspective than what we 

often hear. So I think it’s giving us the ability to think in some different ways about this. 

I have three not exactly questions but sort of points or issues. I’m 

going to put them all out on the table at once, and you can choose 

which ones, any or all of them, you would like to comment on or 

share our thoughts on. 

The first one is I think I’m a little confused in that some ways 

Ms. Walsh’s study sounds to me as though it’s essentially a sector 

of the Chinese economy, and in a lot of ways, what she says paints 
160

a very different reality than what our two other witnesses talked 

about as what they see as trends in the development of corporations or industries in China. And I think that one of the reasons 

that’s particularly important for us, of course, here in the U.S. is, 

as we seem to be losing our manufacturing base, we’ve been told 

all along, certainly politicians have been told all along that our 

U.S. competitive advantage is our intellectual property, it’s our intellectual advantage, and high-tech is critical to that. So if anybody 

can elucidate some of the differences that they see that could be 

defining these contradictions. 

The second one is a point that I think that investing in R&D for 

American companies going to China is not necessarily a free market choice. It is my understanding that there’s been a practice in 

the past that deals have required tech transfer and R&D transfer, 

and just any thoughts that you might have on that. Is that still 

going on? I think as part of the WTO that was a practice that was 

supposed to stop. 

And, third, I’m a little surprised that we haven’t heard a little 

bit more about the challenges of corruption, which Chairwoman 

Dreyer mentioned, and also counterfeiting, the impact of all of 

those things on development of the corporations. 

It’s a lot, but you can pick your menu there. 

Dr. STEINFELD. Maybe I’ll just pick the first one very quickly. I 

think the Legend example that was just raised is a very good one, 

and let me try to square the circle a little bit between, I think, 

what we were both saying. 

Legend is a successful company by many measures in China. It 

has very significant market share domestically in PC manufacturing. What’s interesting about Legend—and it has many partnerships with overseas companies—is when Legend sells a computer, 

it’s a Legend computer, but it’s Intel inside and it’s IBM inside and 

various other pieces inside. 

And so the global lead companies are still, for the most part, occupying the high-value production. Where that production happens 

is an important issue, and it’s in various places. But the ownership 

is over the high-value activities, and Legend is left assembling 

these high-value components and trying to make a business out of 

capturing tiny margins. I personally wouldn’t want to be in the PC 

business because the margins are deathly. 

The alternative for a company like Legend is to find some kind 

of niche, innovative strategy to market, as Dell has, but it’s not 

easy to do that. And the Chinese, I think, are farther behind in 

that sort of soft side of the business than they are even in the technology. They have a long way to go before they’re really competing—Legend, I would say, has a long way to go before it’s competing on high-tech. 

Ms. WALSH. Well, I’ll take the latter two questions, the first of 

forced technology transfers. Certainly this was the case before 

China signed or acceded to the WTO, and you’re correct certainly 

that China made commitments not to require local content technology transfer, R&D, and other issues. And Secretary Evans in his 

speech in Detroit remarked that there are at least, he’s still hearing complaints from U.S. industry about these demands. 
161

My own experience, talking with foreign investors, U.S. and others in China, in 1998 and then in 2002, is that this still goes on, 

but I think it’s less—again, less of a factor than it was, at least. 

Now, that may not be great progress, but, again, I think the driver 

is more the foreign investors today than the demands from the Chinese, and this has important effects, as I suggested. 

So it still goes on, certainly. It’s not transparent. It’s very hard 

to document. And it’s something that we’ll have to keep after. But, 

it doesn’t really surprise me. But I think they’ll probably get less 

for their efforts today than they perhaps have in the past. 

As far as corruption, counterfeit, IPR, it’s an ongoing battle. I 

think companies are more aware today of the challenges in the 

China market, particularly as they’re moving towards high-tech 

R&D. These are important assets that they’re using, and opening 

some of the windows onto their own innovative processes and management styles to Chinese and Indian and other overseas R&D centers. So I think they’re being more careful. That would certainly 

make sense. But there certainly could be some concerns there as 

well. 

And for the United States, you know, a lot of this technology and 

know-how, again in the information technology industry, comes 

back to the United States. If it’s a wholly foreign-owned subsidiary 

in China,in the computer software area. For instance, the computer 

code is e-mailed back to the United States headquarters. Oftentimes these R&D centers in China and elsewhere are given only 

one piece of the R&D project, and so they don’t always have the 

whole overview of the project or how to move a project from design 

to market, which is one of the reasons why you see growing numbers of Chinese entrepreneurs who have come back from the U.S. 

to China, and then they work for the R&D center, and they say, 

well, you’re only showing me a piece of this, I can do more. They 

go off and work for themselves, despite the challenges this entails. 

So it’s a changing dynamic, and there’s pros and cons to it, which 

are complicated and I think will—uncertain what the effect is, but 

I think, as I said, I’m less worried now with this activity than I 

was before where it was expanding and there was less corporate 

oversight over it. Now it’s the opposite. It’s contracting, consolidating, and there is much more corporate oversight on the activities going on because obviously if you’re doing R&D of any sort in 

China, in a market like China, you need to take greater caution, 

and companies are starting to do that. But I think the government—perhaps the Commission could suggest this, that the more 

information we can provide industry on these issues, the better off 

they will be, and certainly that’s something that’s needed in my experience. 

Dr. NOLAN. I think there’s a general question for the whole 

world, which is—certainly for the sort of Anglo-Saxon world, which 

is the decline in interest amongst our young people in science and 

technology, and also the absolute decline in the numbers of people 

in terms of the world population. So I think there’s a general issue 

which goes beyond our present discussion or the Sinification or 

Indianisation of global research and development, because the reality is that the proportion and absolute numbers of people from 

Indian and Chinese origin who are interested and capable of doing 
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science and technology is growing at a rate that far exceeds that 

of Anglo-Saxon people. 

The question is whether that’s done in Europe or in the United 

States or whether it’s done in India or in China, and I think what’s 

happening is that some of this activity is flowing back to where the 

people are and is substituting—it would be interesting to look at. 

I suspect that an awful lot of the people who have lost their jobs 

in those industries actually are Chinese and Indian origin. So 

that’s a wider question of who is doing the science and technology 

across the world. It’s quite a complicated question. 

To come back to the R&D in China, I would entirely endorse 

what Ed has said about Legend, Intel inside, IBM inside, and the 

enormous challenge that faces. It’s very, very far from being a globally competitive R&D company. 

In the past, some of the companies that we’ve studied have been 

successful in moving part of the way up the technology ladder 

through pre-WTO activities. We studied, for example, Harbin 

Power Equipment Company, which was—there was a deal brokered 

by the Chinese government with what was then CE, Combustion 

Engineering. And as a condition for penetrating the Chinese market, CE—it was required. It’s quite open. Everybody knows it. It’s 

transfer of technology in order to move up several notches in the 

technology rung. But that, of course, was all—it was pre-WTO. 

The point is that without such transfers mediated by, in that 

case, the central state, it is impossible to imagine that Harbin 

would have even made it up a few rungs of the ladder. 

And if you look at the Three Gorges, the biggest project in China 

by far, 800 megawatts, 24 units, those are all—23 of the 24 are 

supplied in one way or another, whether it’s imports or through 

global joint ventures, by global giants. So even though they come 

up the ladder, traditional Chinese firms, while they can compete 

now very well in small power stations, still find it very, very 

hard—I think about 60 to 70 percent of the market for 600 

megawatts and above power stations in China, the highest technology are still taken by global companies either through imports 

or through manufacture in China. 

I could say more, but I think that reasonably complements, I 

hope, what the——

Co-Chairman DREYER. Commissioner Bartholomew, did you find 

your question on corruption answered? 

Commissioner BARTHOLOMEW. On corruption specifically, I don’t 

think so. I think everybody did a wonderful job of answering all my 

other questions, but any thoughts or comments on the corruption 

issue and the impact that it’s having? 

Dr. NOLAN. I’d like to say something, a little bit about that, 

which is that the corruption issue is absolutely central for the Chinese government. Everybody knows it. They know it. Jiang Zemin 

knows it. Hu Jintao knows it. And they are fighting very, very, 

very hard indeed to cope with a tide, a surging tide of corruption. 

It’s public, in all the newspapers, and it’s a life-and-death struggle 

for them to try to ensure that their party maintains a direction, 

has a sense of where it’s going, a sense of purpose, and it is in the 

midst of great difficulties. 
163

One doesn’t need to say more than that. For them, it’s survival 

of system stability. And if you want to put it in sort of simple 

terms, my own view is it’s logical to support regime improvement, 

if you like, in China rather than to think about changing the regime, because the alternative is awful, the chaotic outcome, which 

would be disastrous for the world. 

And so I think any ways that people—that anybody outside 

China can facilitate improvement in the capabilities of the Chinese 

party to effectively rule this country is in the whole world’s interests. 

Co-Chairman DREYER. Commissioner Reinsch. 

Commissioner REINSCH. Thank you. 

First I want to commend the attention of Commissioners and the 

audience to Ms. Walsh’s work, both this book and her preceding 

work, which I think has just been really groundbreaking on the 

question of Chinese technology policy. And I say that with some 

bias because at one point I paid for part of it, but it really is excellent, and I think it makes her one of the foremost people in the 

country in terms of her work on this subject. 

I also want to thank you for your deemed export idea, Kate. I’m 

not sure that it’s a good one, but at least you’ve got one, which is 

better than the rest of us. I’m inclined to think the major beneficiary would be researchers, which might make it helpful to you, 

but I’m not sure about anybody else. But we can have that discussion off-line. 

I think the question I want to ask the panel is an attempt to 

bring to bear something that was said or a couple of things that 

were said previously. This panel and the previous panel seem to be 

suggesting that really what’s going on in China is normal for developing country movement up the value-added chain, that we 

shouldn’t be particularly surprised at this development. That 

doesn’t mean we have to welcome it, but that it’s not unusual except in one respect, and that seems to be, at least according to Professor Nolan and others, the rapid pace of movement, the rapid 

pace of change in comparison with other countries. 

Mr. Roach in the previous panel made the same point about 

what the Chinese are doing, and then said that the classic American response to that sort of thing in other situations has been simply to stay ahead of the curve and innovate more quickly and stay 

ahead particularly of the technology curve as the rest of the people 

are gaining on us. 

I guess my question for you all is—assume for the moment that 

that’s an intelligent policy. How do we do that when the pace of 

change is as rapid as you’ve described it in the Chinese case? 

Ms. WALSH. I will take a swing at that. 

I think two ways. One, we need to reform the controls that we 

have in place. I think the export controls we have—and I am 

speaking on the commercial side—today, are really out of date and 

do not address the global dynamics that we have been talking 

about here, and in particular the R&D globalization factor. So I 

think we need to change the way that we—whether we even try to 

control technologies or beyond the most critical choke point technologies which I think would be a relatively small number of technologies, what do we do with the vast number of still sensitive 
164

dual-use technologies that we would like to somehow keep a hold 

of. 

Commissioner REINSCH. Yes, but if I can interrupt, that is how 

we hold them back. How do we run faster? 

Ms. WALSH. That is one aspect of it, that I think we need to 

change the controls so as to fit better with our industry needs and 

government needs, and I would suggest that information is security 

in that sense. The other part of it is, is how do we maintain this 

technology gap? How do we run faster? It is not just a matter of 

running faster. It is how far, how fast and in what direction. If you 

have true global R&D, we should expect innovations and inventions 

appearing in China, India, Ireland, all over the place, and no 

longer what we have had the benefit of—high-tech innovation 

mostly in the United States. So how do we capture those new technologies, new ideas that are going to be appearing elsewhere in the 

world, and at the same time maintain our own gap, so we avoid 

technology surprise and keep ahead of the curve? 

The only way, in my view, to do that is, as I said, sort of a visual 

battlefield, you know, an all-knowing picture of what is going on 

with global trade dynamics. To do that we need data, we need to 

track the trends, and we are not doing that now. We have periodic 

studies here and there, and we find later, oh, that is what has been 

happening. It is really too late at that point. So I would say it is 

a two-pronged strategy, and we need attention paid to both. 

Commissioner REINSCH. Do either of the rest of you want to comment? No need if you do not want to. 

Dr. STEINFELD. Very quickly. I would say that for me—and my 

expertise is nowhere near as great as Ms. Walsh’s in technology, 

but I would say my impression is that knowledge is the key, and 

human capital is really the key, and that what has kept the United 

States at the forefront, and I hope what will continue to keep us 

in the forefront, is that we have the world’s most talented people 

emigrating to this country, and to the extent that we can keep that 

flow coming, primarily by staying at the top of tertiary education, 

postgraduate education in the world, which all due respect to my 

colleague from Cambridge, England, I think that will be a key component of keeping our cutting edge status in the world. 

Moreover, maintaining the sort of entrepreneurial environment 

that we have means that when these individuals come and occasionally go back, be it to India or China, I think usually they keep 

one and a half feet in the United States. Their spouses, their children, they view themselves Americans. To the extent that continues, I am relatively confident we will stay considerably far 

ahead of the curve. 

Commissioner REINSCH. Good answer. Although I would comment that this Administration, in the name of security, is in the 

process of not letting any of those people in, which may—we may 

put a crimp in the policy. 

My time is up. Professor Nolan, did you want to make a comment or not? 

Dr. NOLAN. I would like to have done, but if the——

Commissioner REINSCH. No, go ahead. I will——

Dr. NOLAN. You will take the time. 
165

Commissioner REINSCH. That is all right. I will just refrain from 

asking my next question. Go ahead. 

Dr. NOLAN. You made a very important general statement, observation, which is that it is normal to move up the value-added 

chain. I just want to emphasize that there is not very much movement up the value-added chain for indigenous Chinese-owned firms 

if you look at the example of aerospace, which is absolutely critical, 

which is an appendix to my paper, you will see very, very little 

movement up the value chain. Painful, painful slow progress for 

reasons that Ed and I have both investigated and talked about in 

our studies. 

In the case of Japan, when Japan moved very rapidly and normally up the value chain, as you put it, it was Japanese firms. It 

was Matsushita and Toyota and Sony and so on. This is abnormal. 

It is a normal movement but in a very abnormal and new way, that 

I emphasize is very challenging for all of us, because Chinese firms, 

indigenous and certainly large Chinese corporations have had very 

little participation in this process. 

For many Chinese firms, the problem is that they are losing 

their people too. So if you look, for example, at the aerospace industry, they are hemorrhaging good scientists and technologist into 

western corporations, Intel, NEC, Samsung, if you can include Japanese and East Asian as western, such global firms. And for them 

that is a problem. 

In terms of what we do, how we run faster, something that has—

I am not an expert, but it vexes me to think about what finally determines where the location of the best R&D activities takes place, 

and while the price is important, I think the environment is extremely critical and that is a wider environment, a physical environment, and an interesting place to be intellectually. And I am 

not an expert in that, but I know the people who do study that 

question say the initial answer is it stays in California because it 

is a nice place to be, or in Cambridge with Cambridge Science 

Park. 

But I think the reality is that many places in China, despite the 

ghastly environment of the physical environment and pollution 

that is going on around it, are building some very nice environments in an intellectual sense, interesting, good places for families 

to live, very stimulating places to live, and building a community, 

which is where companies like NEC, Samsung, Intel and Motorola 

are going, and I think we need—as an inexpert, if I may say so—

more attention to the question of the wider environment surrounding these activities across the world. 

Commissioner REINSCH. That is very interesting. That opens a 

whole new chapter which we do not have time to go into. So thank 

you, Madam Chairman. 

Co-Chairman DREYER. I will say parenthetically, Dr. Steinfeld, to 

your comment about American universities maintaining their technological superiority, I do not know about your university, but as 

I look at who wins the Rhodes scholarships and the Phi Beta 

Kappa’s in my university, they are not native-born Americans. 

Commissioner Robinson. 

Chairman ROBINSON. Thank you. 
166

Dr. Nolan, I was particularly intrigued by your description of I 

think what you termed China’s systemic fragilities, and you ticked 

off several in your opening statements. I was wondering if you 

might elaborate on the financial dimension a little more, as well as 

provide your big-picture judgment on whether or not China’s fundamental stability and cohesion may be at risk in the period ahead. 

As I, for better or worse, have the privilege of being the last questioner, I would certainly be interested——

Co-Chairman DREYER. You are now the next to the last. 

Chairman ROBINSON. Oh, okay, there we are. But I would be interested if I could also have the thoughts of the other panelists on 

that broad question, because we have heard all day about China’s 

inordinate share of foreign direct investment and the numerous 

other competitive advantages that China is enjoying and the fact 

that it is moving ahead at an extremely robust pace in a number 

of areas, seemingly at the expense of regional economies, as well 

as our own. 

That said, obviously, there are still some very serious systemic 

bottlenecks and challenges ahead for China, and I was just curious 

as to how you all view this situation. 

Dr. NOLAN. I think everybody knows the financial system is in 

a very, very difficult state. The problem of non-performing loans 

has been much analyzed, and the degree to which they threaten 

the Chinese system one can debate, but it is certainly a very, very 

deep problem. 

Behind that lies not just the question of bad management and 

bad judgment but also deep systemic problems in the sense that 

when we talk about industrial policy, a policy loan is industrial policy in WTO terms. If a government says, please, you must lend 

some money to this entity that is contrary to the spirit of WTO. 

However, the question is to whom and to what? What entity are 

you lending it? One of the main reasons that Chinese entities are 

lending money is because their firms are so challenged. The SOEs 

have tremendous difficulties as they are often lending to firms that 

are being deeply challenged by the threat of operating on an increasingly global level playing field. 

So there is a Catch 22. They are having to not just trying to help 

new firms to rise up, but also old firms to survive in the interest 

of social stability, which is a very, very deep challenge for them. 

On the other hand, when we talk about the global business revolution, there has been a dramatic revolution in global financial institutions, in global financial firms, at JP Morgan Chase, Citigroup 

and so on really—everybody likes to talk in economics, but not me, 

about mergers and acquisitions failing. But what I am struck about 

is how often mergers and acquisitions succeed in the sense the 

firms survive and prosper in the long term, and Citigroup and JP 

Morgan Chase are pretty obvious exemplars of that. I think the 

Chinese are really stuck in a very difficult situation because they 

have to improve corporate governance in their firms. It is a very, 

very difficult task to do so, and of course, JP Morgan Chase and 

Citigroup would be very pleased to do this for them. 

Of course that then presents a huge increased challenge for their 

own financial firms, and I think the financial system is at the core 

of everything, and it is in a very parlous state. 
167

Chairman ROBINSON. Any thoughts on the big picture as to how 

much risk China faces in this period ahead in terms of stability? 

Dr. STEINFELD. I would just add that I think it is common among 

academics who study China that for many people inside China. For 

maybe the last 15 years we have felt that there is urgency in handling some of these issues, and amazingly China has been able to 

avert crisis or collapse, but I must say the financial system, as Professor Nolan said, really is in a powerless state. 

And I would add that it is not just a matter of government induced policy lending by banks to firms, but it is also an example 

of the sort of absence of control and absence of the sort of public 

goods of governance. It relates to Commissioner Bartholomew’s 

question about corruption. 

What that means is that often banks are utterly unregulated and 

pour money into closely connected firms, be they state owned or 

private. We see recently I think a great deal of real estate lending. 

What this is indicative of is not just old style command planning 

or industrial policy, but new style markets gone awry or markets 

poorly governed, and that is a major challenge for the Chinese government. 

I would add though, I study the financial sector, but do not find 

it the most troubling issue for China. Rather I think the demographics are the most troubling issue. China is undergoing a massive industrial revolution and a massive shift from agriculture to 

industry. That is good, it provides growth. But it also means that 

millions upon millions of workers from the countryside are being 

pulled out of their own sort of social fabric and put into cities or 

are moving to cities where they have no safety net. That obviously 

creates tremendous tensions. The only organization around to 

maintain order in a sense is the party. It always amazes me, no 

matter how many times it happens when I visit a large private 

firm in China, to be greeted by the Party Secretary. That is a 

strange circumstance. But that these social pressures are there 

without any substantial safety net, or even any substantial social 

organization, governmental organization to handle them is breathtaking, breathtaking for me as an outsider, and it has to be breathtaking for those trying to govern this country. 

Ms. WALSH. I would only add—and I am not an expert at all on 

China’s financial structure—but I do get the sense also that it is 

rather fragile, in having spoken to foreign investors in China and 

also Chinese business managers as well. But at the same time I 

think it has its own strengths. The mother of invention is necessity, and I think the Chinese have found ways to get around the 

problems. So on a central level I think there is some concern that 

foreign direct investment, for instance, will not continue. It is generally, essentially, the bubble cannot continue at this level forever. 

So what does China do then is I think the concern. And then at 

the same time how do you have Chinese entrepreneurs at all? 

Where do they get the capital from? There is no venture capital in 

China for instance, but there are still entrepreneurs and they have 

managed to get the capital that they need to set up a business. 

These are the exceptions, but still it is possible within the Chinese 

system. 
168

I think measuring against Western standards is useful, but you 

have to go beyond that and look at it in the context of the Chinese 

market to understand how fragile or strong China’s financial structure may be, and I do not know where that lays but I see evidence 

of both. 

Chairman ROBINSON. Thank you very much. 

Co-Chairman DREYER. Vice Chairman D’Amato. 

Vice Chairman D’AMATO. Thank you, Madam Chairman. 

I want to follow up a thought on Chinese entrepreneurial capacity. My question deals with the Chinese fixation on importing western technology by hook or by crook, both ways they have extensive 

programs, in getting western firms in and stealing technology if 

necessary. The effect of that, coupled with the effect of the pervasiveness of corruption and the presence of an often suffocating 

party elite in terms of its control of the system, I wonder whether 

or not they are damaging their own entrepreneurial capacities. 

They are never going to be able to import enough to keep up because by definition they will always going to be somewhat behind 

the West. 

Do you have the sense that one of the so-called system fragilities 

is the question of sacrificing their own entrepreneurial capacities 

as a result of all of this that they are killing themselves and their 

ability to compete in the long run because of all these things. Is 

that a fair question? 

Dr. NOLAN. Good point. That is really a nice point. I think this 

is very important. I think they have devoted so much attention, I 

mean had such positive short term gains from this massive increment of FDI, and there are huge gains, no question at all, but also 

tremendous tensions. I think exactly as you say one of the questions is precisely the impact it has had on entrepreneurial in an 

R&D sense, technological innovation sense. People are hemorrhaging out of universities into Intel, Motorola, NEC and 

Samsung, leaving their own corporations behind. 

I think the ability to transfer—obviously in every economy pieces 

of technology are stolen. I do not want to comment on whether this 

is a large or a small amount. It is not my job, but every economy 

has that question. I think the key question is in order to use technology, well, you have to have an effective company with high managerial and technical abilities to make use of it in an effective way. 

I think the former Soviet Union illustrated that very well. The 

former Soviet Union had tremendous science and technology, but 

no integration with daily life, and so the import, as we know, 

McDonnell Douglas, MD planes and so on, their ability to go forward beyond that and then turn them into real productive goods 

that people wanted to buy was a very different matter. I think your 

point is a very real one, a very interesting one, and well worth reflecting on and researching. 

Dr. STEINFELD. I would agree. I would second those comments. 

I would also say that it is striking how entrepreneurial many Chinese citizens are. It is again breathtaking how entrepreneurial. But 

the question is in what directions is that entrepreneurial energy 

sort of focused? What are the incentives? 

My feeling now, again, visiting many enterprises across numerous sectors, is that entrepreneurial businessmen realize the incen-
169

tives are not high to sort of directing their energy toward innovation and high-tech development. Rather, the entrepreneurial sort of 

business energy is directed toward managing very complex portfolios of utterly unrelated narrow margined businesses, which is 

impressive, and one can make a certain amount of money doing 

that, but it is not the kind of activity that leads to major upgrading, frankly. 

I must also say that a great deal of entrepreneurial effort is directed toward negotiating a cumbersome bureaucratic system and 

a poorly institutionalized one, and that gets back to the corruption 

issue. There is great entrepreneurship in figuring out how to direct 

the payments appropriately. 

Vice Chairman D’AMATO. Ms. Walsh. 

Ms. WALSH. That is a really difficult question and I am not sure 

I have an answer to it. But when you were speaking I was thinking 

of a similar, I think argument, which is China will develop a concern for intellectual property rights once they have intellectual 

property to control. I mean it is akin to will you have entrepreneurs if the environment does not support it? 

I do not buy that argument—that China will, only when it has 

intellectual property, become concerned about intellectual property 

rights, and that that will sort of solve itself, or on the other hand, 

sort of the flip side of that, that if it does not happen, then you will 

not have intellectual property. 

What we have witnessed lately is companies in China, who to 

some extent know that their technology and know-how will be 

leaked, stolen, whatever to some extent, and that is a cost in many 

cases that companies are willing to incur to some extent. The practical reality in China is that, at least in the past, you have not 

been able to do much about it. 

I was at a conference recently hearing a lawyer speak about this 

issue and a practical application of Chinese law on counterfeit and 

other concerns, piracy and so forth, and apparently most often the 

result is, even if you take a Chinese competitor or firm or individual to court in China, the result is often an apology, which in 

the west does not mean that much, although in the Chinese context 

it is enormous in a certain way. 

So there is no redress, and so is the answer not to bother because 

you are not going to get the result that you like? Well, I would say 

no, even though the results may not be what you would wish for, 

and I think this ties into what we were talking about today, some 

of the challenges of China’s WTO commitments. It is important to 

keep after it even though the results are not what we had hoped 

for, because now these same companies, partners that some U.S. 

firms in China have been dealing with, they are now seeing that 

their former partners or competitors are exporting goods offshore. 

Qualcomm is the best example, for instance. They claim that 

Datong’s telecom technology is based upon Qualcomm CDMA technology. If you wait until—and this is what I was told by a number 

of foreign investors in China, that they draw the line at the point 

when Chinese firms started to export goods that were based on 

U.S. technologies. So they draw the line because then it is really 

very threatening to the U.S. companies’ and industries’ concerns. 

Well, it is too late, I would argue. 
170

So on the one hand I do not think that you will not have entrepreneurs just because the market is not very welcoming. I think 

again they will find ways, and have found ways to go around that, 

in very creative entrepreneurial ways. At the same time I think we 

have to address the IPR problems that we see now at an early 

stage even if the result is not what we would like because it will 

have an effect over time. 

If we ignore it—and I think we have done that because it has not 

made practical sense—I think it just builds the problem into the 

future to the point where it becomes a political problem that could 

undermine relations and turn again a win-win into a lose-lose situation. 

I hope that answers your question. 

Vice Chairman D’AMATO. Thank you. 

Co-Chairman DREYER. I would like to thank all of our witnesses 

for their very wise comments and thoughtful comments, and your 

testimony and submissions will be on our website, and we hope 

very much that we can call on your expertise as we write our report. This has been very valuable for us. 

I would like to adjourn this panel, and we should take a 5-

minute break and reconvene for the fourth and last panel of the 

day. 

Again, thank you very much. 

[Recess.]

PANEL III: U.S. ECONOMIC IMPACT 

Co-Chairman DREYER. Let me begin this afternoon’s panel, and 

our panelists will be Paul Craig Roberts, Chairman of the Institute 

of Political Economy and former Assistant Secretary of the Treasury, who will, I understand, go first because he has an earlier 

plane than anybody else to catch; and Frank Vargo of the International Association of Manufacturers; Thea Lee of the AFL–CIO, 

and last but scarcely least, Willard Workman of the U.S. Chamber 

of Commerce. May I say you have a last name more appropriate 

to the AFL–CIO, but that is life. 

Mr. WORKMAN. I have a cousin in the AFL–CIO. 

Co-Chairman DREYER. I see. 

Co-Chairman Mulloy would like to say a word. 

Co-Chairman MULLOY. I just wanted to thank Paul Craig Roberts for making this special effort to come up here after we talked, 

and I appreciate that very much, and your service to our country 

in many capacities, both on the Hill and in the Administration of 

President Reagan. 

Frank, I also want to thank you. Frank, as you might know, I 

was a political appointee in the Commerce Department in the past 

Administration, and Frank, who served over 30 years in the Commerce Department, wrestling with these issues, was an invaluable 

help to me over there. So I wanted to thank you again. 

Mr. VARGO. Pat, you were a great boss. 

Co-Chairman MULLOY. Thank you. 

Co-Chairman DREYER. Without further ado, you remember the 

ground rules? You get 7 minutes, a light goes on after 5, and then 

the Commissioners themselves have 5-minute questions, but that 

includes your answers. 
171

Mr. Roberts.

STATEMENT OF PAUL CRAIG ROBERTS, Ph.D., CHAIRMAN

INSTITUTE FOR POLITICAL ECONOMY, AND FORMER

ASSISTANT SECRETARY OF THE TREASURY FOR ECONOMIC POLICY 

Dr. ROBERTS. Thank you. Members of the Commission, I have 

been here all day, and I have listened to all of the testimony and 

the Q&A with you, and what I have come to do is offer you a totally different view of the problem or the situation. 

You will not hear from me that the problem is the U.S. budget 

deficit and the zero saving rate or the Chinese exchange rate or 

currency manipulation or their industrial policy. What we are witnessing is simply the normal result of economic incentive. There 

are two new developments, and these are new developments, that 

have made it possible to substitute inexpensive Asian labor for expensive American labor in American production functions. What we 

are witnessing I propose is the substitution of U.S. labor out of 

U.S. production functions in a wide range of tradeable goods and 

services. It pays to do that. 

What are these two new developments? One is the collapse of 

world socialism, and the other is the rise of the Internet. Now, 

what does the collapse of world socialism mean? It means that for 

the first time the mobility of western capital and technology or 

American capital and technology is no longer confined to the first 

world. It can leave North America, Europe and Japan. 

What does it mean when American capital and technology 

leaves? It means all of a sudden Asian labor, if you are talking 

about manufacturing, Asian labor, which I am told can be purchased at 25 cents an hour, can be substituted for American labor, 

which is $25 an hour. So you are talking about a hundred-fold difference in wage rates. So the mobility of these factors of production 

means they flow into countries with vast excess supplies of labor. 

You see, the United States, in the first world, labor tends to be 

paid the value of its marginal product. That is it tends to be paid 

the value that its productivity contributes to the firm’s revenues, 

but that is only because it is relatively full employment. 

In China the overhang on the labor market is about the size of 

the United States’ population. And these huge excess supplies of 

labor, which is highly productive labor because it is working with 

modern capital, modern technology, can be had at a very low price. 

This is a new development. American labor was long protected 

against what was called cheap foreign labor because American 

labor worked with better technology, more capital, and better education. These things are no longer true. 

Let’s then go to the second factor, the Internet. The Internet has 

created a new form of labor mobility. It is now possible for knowledge jobs to be performed from most any location—we now have 

people checking into offices in Chicago and New York and LA and 

they live in China or India. We have hospitals that do not hire radiologists. They send the CAT scans to India to be read. The Internet has made it it possible to substitute highly paid knowledge jobs 

out of our production functions and bring in inexpensive foreign 

labor. This threatens a wide range of jobs, engineering, design, accounting, stock analysts. You read about this in the paper all the 

time. 
172

So if what we then are really confronted with is the ability of 

multinational firms to substitute expensive labor out of their production functions, you can see why it is not something that can be 

handled with exchange rate revaluations. 

We hear a lot about free trade, fair trade, getting the level playing ground, that sort of thing. But does the free trade model apply? 

Does the mobility of factors of production essentially negate the 

basis on which you can have a comparative advantage? Ricardo, 

who developed the whole idea of free trade, showed why every 

country could gain even though they had no absolute advantage. 

But for this to work, resources had to be mobile within a country 

but not internationally. Ricardo said if factors of production are 

internationally mobile they will flow out of the country to the countries that have the greatest absolute advantage. 

Where is the productivity of capital and technology the highest? 

It is where labor is most abundant, and this is why you see the 

flow of capital and technology to China. Where is the productivity 

of labor the highest? It is where capital is the most abundant, and 

this is why you see the flow of Asian labor through the Internet 

to the U.S. Both ways American labor is caught because if you can 

hire an engineer in India for $6,000 you do not need to pay him 

60. 

Now, to wind up. The jobless recovery or the job loss recovery 

may be a myth. It may be a lot of jobs are being created. They are 

just not in the United States. 

And this is a serious possibility. Then remember too, that things 

bite back. A revaluation of the Chinese currency, if it actually 

worked, would mean higher prices in Wal-Mart, and at a time 

when people’s disposable incomes are not growing. If you had a 

nice rise in the prices of all the imported goods on which we are 

now dependent, you would see a big hit on U.S. disposable income, 

on real disposable income. Sometimes the solutions bite back and 

do about as much harm as the problem. 

Remember, the panel that spoke this morning, both Mr. Roach 

and Mr. Hale brought to our attention that about 55 percent of 

China’s exports to the United States actually come from foreign 

companies that are located in China, and it is basically offshore 

production for the American markets. So that supports my view 

that what you basically see happening is the flow of factors of production to where their productivity is highest. That means capital 

and technology go to China or India, and it means Asian labor 

comes here by the Internet. 

So this is a much different problem and a much bigger one than 

we have been dealing with today. The way you deal with this I 

think is quite more challenging. 

Thank you very much. 

[The statement follows:]

Prepared Statement of Paul Craig Roberts, Ph.D.

Chairman, Institute for Political Economy, and

former Assistant Secretary of the Treasury for Economic Policy 

Members of the Commission, I appear before you as an independent witness, representing no interest group. I was Assistant Secretary of the Treasury for Economic 

Policy during President Reagan’s first term. I have worked on the Hill for Jack 

Kemp (I wrote the Kemp–Roth bill), for the House Budget Committee and for Orrin 
173

Hatch and the Joint Economic Committee. I have held a number of academic posts. 

I was an editor and columnist for the Wall Street Journal and for 16 years a columnist for Business Week. Currently, I am Chairman of the Institute for Political 

Economy, a Senior Research Fellow in the Hoover Institution at Stanford, and a 

syndicated columnist. 

I offer a different perspective on the ‘‘job loss recovery.’’ If my view is correct, we 

face a new problem that cannot be handled with exchange rate adjustments, retraining programs, employee protections, tax cuts, low interest rates, tort reform, and deregulation. If I am correct, the job losses that we are experiencing are not the result 

of the normal workings of free trade through which resources are reallocated from 

uses where they are noncompetitive to uses where they have comparative advantage. 

I suggest for your consideration that comparative advantage, which permits free 

trade to create gains for trading partners, has been undermined by the international 

mobility of factors of production. Instead of sectorial adjustments from changes in 

competitive conditions, we might be experiencing the flight of factors of production 

to countries where their productivity is highest. Let me explain. The case for free 

trade is a strong one with which I agree. David Ricardo discovered the principle of 

comparative advantage and based the case for free trade on this principle. He 

showed that if countries avoided self-sufficiency, instead specializing in economic activities where they had the greatest advantage or least disadvantage and trading 

for other goods, the gains from trade would make each country better off than if 

countries remained self-sufficient. 

For comparative advantage to work, resources within each country must be mobile 

so they can be reallocated to areas of comparative advantage. However, factors of 

production must not be internationally mobile; otherwise, they will flow to those 

countries that possess the greatest absolute advantages. The productivity of factors 

of production is greatest in countries with absolute advantage. 

Historically, there have been barriers to the international mobility of factors of 

production. In Ricardo’s time, GDP was largely determined by climate and geography, neither of which can migrate. In our own time, world socialism served to constrain capital and technology within the first world of North America, Western Europe and Japan where there are not large differences in labor costs. Multinational 

corporations would have felt unsafe investing in China and India even if they had 

been permitted by those governments to do so. 

The collapse of world socialism has made vast pools of cheap and willing labor 

in Asia and Mexico available to U.S. capital and technology. The Internet has made 

the physical location of employees unimportant for many knowledge and Information Technology jobs. The Internet, outsourcing, and offshore production for the 

home market allow U.S. firms to substitute cheap foreign labor for expensive U.S. 

labor in their production functions. 

The questions I pose are these:

• Are the job losses that we are experiencing the result of internationally mobile 

factors of production flowing to where their productivity is highest? 

• Does the ease with which foreign labor can be substituted for U.S. labor in the 

production functions of U.S. firms make foreign labor internationally mobile to 

the U.S. where its productivity is highest? 

• Alternatively, does the international mobility of U.S. capital and technology 

allow these factors of production to be put to more profitable use in countries 

with abundant and cheap labor?

Traditionally, American wages were protected by American productivity. Americans worked with more capital, higher technology and better education, which made 

them much more productive than cheaper foreign labor. An American’s pay was 

higher because his output was higher. 

The mobility of capital and technology means an Asian can work with the same 

capital and technology as the American. However, the Asian does not have to be 

paid the same wage. He lives in countries with lower costs and standards of living. 

The large excess supply of labor in Asian markets means that the market wage is 

far lower than the value of labor’s marginal product or contribution to the firm’s 

revenues. It will be many years before Asian labor markets tighten to the extent 

that workers will be paid in keeping with their productivity. 

In the meantime, will the U.S. continue to bleed jobs, both manufacturing and 

knowledge jobs that don’t require an on-the-scene presence? 

Understand that the incentive to substitute foreign for American labor is greatest 

among high productivity jobs. The hundred-fold difference between 26 dollar an 

hour U.S. manufacturing wages and 25 cents an hour Chinese wages is a great in-
174

centive to offshore production. Hospitals that have their CT scans read in India for 

$20 don’t have to hire $300,000 a year radiologists. 

Understand that when Americans are substituted out of high productivity jobs, 

by default they move into lower productivity jobs. National income is adversely affected. The U.S. cannot lose its high productivity jobs and remain in the first world. 

Understand that foreign hires, outsourcing and offshore production for U.S. markets add to our trade deficit and are paid for by Americans giving up ownership 

of assets and the future income streams produced by these assets. 

What to do? 

A revaluation of the Chinese currency would reduce the gains from substituting 

Chinese labor for American, but the current differences in pay scales are probably 

beyond correction by revaluation. Moreover, revaluation makes Americans poorer. 

All those cheap goods in Wal-Mart would go up in price. This would simultaneously 

set off U.S. inflation alarms and reduce American real incomes. 

Capital and technology controls and protective tariffs bring their own inefficiencies. 

The solution, to the extent that there is one, comes from Sir James Goldsmith: 

One free trade zone for the first world, one for the second world, one for the third 

world. When countries move from one world to another, they depart one zone and 

enter another. Foreign investment could continue, only U.S. investments in China 

would be for that market, not for displacing U.S. production in the home market. 

This would deal with manufacturing. But what about knowledge workers hired 

over the Internet who work in their home countries for U.S. offices? One solution 

is an employment tax on foreign hires. Multinational or transnational corporations 

could evade this tax by assigning foreign hires to foreign payrolls. More costly regulation would be required to attempt to determine which entity is the recipient of 

the employee’s work. 

What we are witnessing in part is the loss of a sense of national identity. Many 

things have brought about this loss of identity. Open borders, massive immigration 

of third-world peoples, attacks on American identity by cultural Marxists and postmodernists. Many things are eroding a sense of cohesiveness. A tower of Babel is 

not a country. 

Our approach to the world is based on the assumption that we are experiencing 

free trade. If, instead, we are experiencing the flow of factors of production to absolute advantage, our entire trade policy will need to be revised. 

As the solution is draconian, it is important to be certain that we are experiencing 

the substitution of American labor out of American production functions, and not 

merely lagging employment after a recession or layoffs due to productivity increases. 

Time will tell. If the economy continues to shed jobs while it grows, either in absolute terms or relative to the established growth-employment relationship, the case 

for my view strengthens. 

In the meantime, it would be helpful to track the kinds of jobs that are lost and 

the kinds that are gained. If we are losing manufacturing and knowledge jobs and 

gaining retail and government jobs, the ladders of upward mobility are collapsing 

along with the growth of income.

Co-Chairman DREYER. Thank you, Mr. Roberts. 

Mr. Vargo.

STATEMENT OF FRANKLIN J. VARGO

VICE PRESIDENT, INTERNATIONAL ECONOMIC AFFAIRS

NATIONAL ASSOCIATION OF MANUFACTURERS;

ON BEHALF OF THE NATIONAL ASSOCIATION OF MANUFACTURERS 

Mr. VARGO. Thank you very much. And thank you for giving the 

National Association of Manufacturers the opportunity to testify on 

a subject, which is of such great importance. 

I can tell you we hear more from our members about China than 

we do about all other trade subjects put together. It is of immense 

importance to manufacturers because China has both a large, rapidly growing market for U.S. products and services, and a very 

fierce competitor in the U.S. and global marketplace. 

Now, China’s accession to the World Trade Organization was a 

very important positive development because it represented the 

first time that China had to be subject to the international trade 
175

rules that we and others follow. As China concludes its second year 

in the WTO, we have to say its compliance record is quite mixed. 

The NAM submitted a report to USTR on this, and I brought a 

copy, which I would like to have submitted for the record. 

Our top concern though is China’s currency manipulation. In our 

view China’s undervalued currency is the single most important 

factor driving the growing trade imbalance between the United 

States and China. There have been estimates that China’s currency 

could be undervalued by as much as 40 percent. As of July, China 

was sitting on more than $350 billion of foreign exchange reserves. 

It is building them up at the rate of about $3 billion a week in 

order to be able to maintain its peg, and to us this is a clear indication of currency manipulation and undervaluation. 

As the NAM has publicly stated, we have decided to support the 

Coalition for Sound Dollars Initiative to move forward with a 301 

case on this unjustifiable distortion of our trade. 

I would like to comment for a moment on what Mr. Roberts was 

just talking about because that has worried me as well. I hear that, 

well, gee, China is different because it has the same production 

function we have. It has got the best equipment and the cheapest 

labor. When I thought about that and looked up the Census Bureau statistics, I said, ‘‘Hmm, you know, with U.S. production function, the average U.S. labor content of production labor and benefits is 11 percent of the cost of the product.’’ So if they are using 

our production function, even if their labor were free, if capital 

costs and everything else were the same, China would have an 11 

percent price advantage over U.S. products, and we hear of Chinese 

products coming in at 70 percent less than the U.S. product, et 

cetera. 

So I have to take issue with this. If they were using our production function, we would not have that much of a problem. 

Now, China’s advantage is still in the fact it is using a different 

production function. It is using labor intensive—you see that because the industries that are being impacted the most, furniture 

and tool and die and foundries, these are all more labor intensive. 

So I wish they would move to our production function. Our problem 

would pretty much disappear. 

Let me state at the outset though, the competition with China 

cannot be viewed from the broader competitive problems facing 

U.S. manufacturers, most particularly the fact that because of 

international circumstances and the overvalued dollar globally, 

that we have no pricing power. Our prices have fallen on average 

6 percent since 1994, but prices in the rest of the economy have 

gone up 18 percent, and we have to pay those prices for health 

care, regulation and other factors, and this is putting a tremendous 

squeeze on manufacturing and that is a major factor leading companies to look at whether they ought to move offshore. 

Now, we have lost over 2.7 million jobs in manufacturing. This 

whole recession is a manufacturing recession. Now, why should we 

care? Some people say—a lot of people say, who cares about manufacturing? It is 16 percent of the U.S. economy. We don’t need it. 

This is a post-manufacturing services economy. Not so. 

The fact of the matter is, if manufacturing collapsed or was seriously impaired in the United States, this would take down our en-
176

tire economy, our national security, and our role in the world. Why 

is that? Because manufacturing is the innovation industry. That is 

where all the innovation comes from. 

People say, well, look at agriculture. It is three percent of the 

U.S. workforce. It feeds the United States and can feed half of the 

rest of the world. Why? The answer to that is because of the combines and tractors and fertilizers and seeds and geosatellites and 

everything else that allow agriculture to be that productive, and 

the same is true with services. 

But the most fundamental reason is that manufacturing is how 

we pay our way in the world. It is 80 percent of all the merchandise exports. It is two-thirds of all of our exports of goods and services. This year, America’s farmers will export a little over $50 billion. America’s manufacturers export almost that much every 

month. There is no combination of farm goods and services that 

could make up for that. 

Were we to lose competence in manufacturing, we would see a 

collapse in the dollar, and I’m not talking about bringing it back 

to where it belongs because it’s still about 16 percent overvalued 

from where it was in ’97 and it’s still three percent overvalued—

more expensive today than the day that Secretary Rubin took office. It was too expensive then. It’s too expensive now. 

We’re very pleased with the growing level of awareness on the 

part of the Congress and the Administration about manufacturing. 

The NAM is proposing a five-step initiative, which is described in 

my testimony, which is basically leveling the international playing 

field, reducing production costs in the United States, promoting innovation, ensuring an adequate supply of skilled workers for the 

future—a real problem, and improving the policy infrastructure. 

Now, the leveling the playing field, an important aspect of that 

is China. China is not our only trade problem, and actually through 

last year, from ’97 to 2002, the biggest increase in our trade deficit 

was not with China, it was with the European Union and that’s because of the dollar again. 

However, China is a rapidly growing problem. The last page of 

my testimony contains a matrix showing that if we follow the 

trends of the last 20 years, within five more years, our trade deficit 

with China will triple to over $330 billion. This country will not 

take that. The situation will get out of hand. It is still manageable, 

and we propose that the Congress and the Administration manage 

it. 

Now, some people say, well, imports from China are only three 

percent of consumption of manufacturers in the United States, and 

that’s true. However, in 2000, it was only two percent. That one 

percent increase in import penetration is very significant. 

Since manufacturing started to go down in 2000, the consumption of manufactured goods in the U.S. has fallen six percent. Imports from the rest of the world, other than China, have fallen six 

percent. Imports from China are up 38 percent since that time. 

And that one percent increase in the penetration of the U.S. market is worth about $43 billion. That $43 billion is 53 percent of our 

entire loss of manufacturing production, so it’s a very significant 

figure. 
177

China is also very important as an export market, and we need 

to really push that. 

We can get into a discussion of investment. I have to say, from 

Commerce’s figures, there’s no visible big movement of investment 

yet into China, but the figures are always a couple of years old. 

Things could have changed dramatically. 

We seek a very positive agenda with China. We want to reject 

any protectionism. We seek full WTO compliance. We seek end of 

currency undervaluation. We seek an end to subsidization and nonmarket production. We seek addressing counterfeiting and a great 

expansion of export promotion. This is the time to build up our exports to China, as well as get a currency that reasonably reflects 

economic reality so that trade flows can begin to reflect the true 

relationship between the countries. 

Thank you very much. 

[The statement follows:]

Prepared Statement of Franklin J. Vargo, Vice President

International Economic Affairs, National Association of Manufacturers;

On Behalf of the National Association of Manufacturers 

Mr. Chairman and Members of the Commission: I am pleased to testify today on 

behalf of the National Association of Manufacturers (the NAM), and I want to compliment the Commission for holding this important hearing. 

The NAM represents 14,000 U.S. manufacturing companies, including 10,000 

small- and medium-sized firms. No other trade subject comes close to commanding 

the attention that China is getting from both large and small NAM members. China 

poses a unique set of challenges for U.S. manufacturers. While competition from 

Chinese imports and fear that U.S. manufacturers will move production to China 

dominate the concerns of many companies, others see China as their only growth 

market and want to ensure that the trade relationship does not deteriorate. 

Competition with China cannot be viewed separately from the broader competitive 

problems facing U.S. manufacturers—importantly including the factors that are 

making it more expensive to produce in America at the same time that cost increases cannot be passed on in the form of price increases. Illustrating the problem, 

since 1994 prices in the rest of the economy have risen 18 percent, but prices of 

manufactured goods as a whole have fallen steadily and now stand nearly 6 percent 

below their 1994 level. Cost pressures, though, have continued, including those from 

tax and regulatory policy, excessive litigation, increasing health care costs and energy prices. Something had to give, and that has included a lot of manufacturing 

jobs. 

Over 2.7 million American factory jobs have been lost over the past three years 

in a roughly one in every six jobs. That is an astonishing figure, unprecedented in 

such a period of time. The losses are continuing, and manufacturing lost 44,000 additional jobs last month alone. 

The current economic slowdown is essentially a manufacturing recession—a deep 

one. The rest of the economy, while not growing at its usual rate, has not felt the 

same pain as manufacturing. Manufacturing represents 14 percent of the American 

workforce, but has accounted for nearly 90 percent of all the job losses since total 

U.S. employment peaked in March 2001. No wonder 75 percent of manufacturers 

in a recent NAM survey said that manufacturing is in crisis. 

Despite recent promising signs that the manufacturing sector is recovering from 

its three-year long recession, U.S. manufacturers continue to struggle in the face of 

weak demand and the most intense global competition in history. As stated earlier, 

the cost of manufacturing in the United States is rising steadily. At the same time, 

global competition prevents manufacturers from raising prices to offset these costs. 

Notwithstanding significant increases in productivity, many manufacturers have 

found no alternative but to cut back production, relocate plants abroad or stop producing altogether. 

Before going further, let me address the question of whether manufacturing matters to the United States. It is not uncommon for me to encounter individuals who 

say that since manufacturing only represents about 16 percent of the nation’s output, who cares? Isn’t the United States a post-manufacturing services economy? 

Who needs manufacturing? 
178

The answer in brief is that the United States economy would collapse without 

manufacturing, as would our national security and our role in the world. That is 

because manufacturing is really the foundation of our economy, both in terms of innovation and production and in terms of supporting the rest of the economy. For 

example, many individuals point out that only about 3 percent of the U.S. workforce 

is on the farm, but they manage to feed the nation and export to the rest of the 

world. But how did this agricultural productivity come to be? It is because of the 

tractors and combines and satellite systems and fertilizers and advanced seeds, etc. 

that came from the genius and productivity of the manufacturing sector. 

Similarly, in services—can you envision an airline without airplanes? Fast food 

outlets without griddles and freezers? Insurance companies or banks without computers? Certainly not. The manufacturing industry is truly the innovation industry, 

without which the rest of the economy could not prosper. Manufacturing performs 

over 60 percent of the nation’s research and development. Additionally, it also 

underlies the technological and mechanical ability of the United States to maintain 

its national security and global political leadership. 

Manufacturing, moreover, makes a disproportionately large contribution to productivity, more than twice the rate of the overall economy, and pays wages that are 

about 20 percent higher than in other sectors. But the most fundamental importance of manufacturing lies in the fact that a healthy manufacturing sector truly 

underlies the entire U.S. standard of living—because it is the principal way by 

which the United States pays its way in the world. 

Manufacturing accounts for over 80 percent of all U.S. exports of goods. America’s farmers will export somewhat over $50 billion this year, but America’s manufacturers export almost that much every month! Even when services are included, manufacturing accounts for two-thirds of all U.S. exports of goods and services. If the U.S. 

manufacturing sector were to evaporate or become seriously impaired, what combination of farm products together with architectural, travel, insurance, engineering 

and other services could make up for the missing two-thirds of our exports represented by manufactures? 

The answer is ‘‘none.’’ What would happen instead is the dollar would collapse, 

falling precipitously—not to the reasonable level of 1997, but far below it—and with 

this collapse would come high U.S. inflation, a wrenching economic downturn and 

a collapse in the U.S. standard of living and the U.S. leadership role in the world. 

And that, most basically, is why the United States cannot become a ‘‘nation of shopkeepers.’’

But manufacturing is definitely at risk because for too many years it has been 

taken for granted, and burdens and costs have been imposed on manufacturing that 

are now being reflected in falling unemployment and growing outsourcing. The evidence has been building for some time. A recent study commissioned by the NAM’s 

Council of Manufacturing Associations, Securing America’s Future: The Case for a 

Strong Manufacturing Base, prepared by noted economist and former Council of 

Economic Advisors member Dr. Joel Popkin, documents the serious challenges facing manufacturing and the erosion of our industrial base. 

But even more importantly the study examines just how important manufacturing 

is for supporting overall economic growth, technological innovation and a high 

standard of living for American workers. The study is clear in its warning that ‘‘if 

the U.S. manufacturing base continues to shrink at the present rate and 

the critical mass is lost, the manufacturing innovation process will shift to 

other global centers. If this happens, a decline in U.S. living standards in 

the future is virtually assured.’’

This must not be allowed to happen. 

The NAM has initiated a campaign to promote economic growth and manufacturing renewal through education, involvement and advocacy. A key goal is to make 

the public and policymakers aware of the pressing challenges that manufacturers 

face in an increasingly competitive global marketplace and obtain needed public policy changes. 

We are very pleased with the rising level of awareness on the part of the Administration and the Congress. On Sept. 15, Commerce Secretary gave a major speech 

in Detroit announcing the launch of a new Administration initiative on manufacturing that includes many of the NAM’s own recommendations. In addition, Members of Congress have shown more interest in manufacturing issues and proposed 

several resolutions that address concerns the NAM has raised, notably on China’s 

undervalued currency. 

The NAM is now working to harness the energy of other organizations concerned 

about manufacturing. This month the NAM started forming a Coalition for the Future of Manufacturing that will seek to raise public awareness and promote public 

policy changes needed to strengthen manufacturers’ competitiveness and global 
179

leadership. The coalition will bring together national, State and local organizations, 

as well as individual companies and their employees, that are interested in promoting economic growth, job creation and high living standards through a strong 

manufacturing base. 

Advancing these goals will require a sustained long-term effort. Much, however, 

can be done in the remainder of the 108th Congress and the Bush Administration. 

We have identified the following as priority initiatives that could be achieved in 

2003–04 and would help materially to grow the manufacturing sector, create jobs 

and strengthen American competitiveness. But this will be an evolving process, and 

we will make additional refinements as the need arises. There are five critical areas: 

1. Leveling the international playing field 

• Launch a new strategy on China that deals firmly with any violations of WTO 

rules and unfair trade practices, including counterfeiting and subsidies, and 

redirects additional resources for fact-finding, analysis and enforcement. 

• Press key trading partners, particularly China and other Asian countries, to 

adopt a flexible, market-oriented exchange rate and stop currency undervaluation to gain unfair competitive advantage. 

• Advance negotiations on the Free Trade Area of the Americas (FTAA), other 

free trade agreements (notably with Australia and Central America) and, to 

the extent possible, the WTO Doha Development round, and ensure that the 

final negotiating frameworks include the complete or substantial dismantling 

of market barriers to manufactured imports. 

• Expand and strengthen U.S. export promotion and develop more active programs in countries, such as China, where export markets are growing fast but 

language, cultural and infrastructure barriers limit access by U.S. companies. 

2. Reducing production costs in the United States 

• Enact asbestos and class action reform legislation. 

• Pass comprehensive energy legislation that helps to ensure adequate, affordable and reliable energy supplies, including natural gas. 

• Establish a more systematic way for the whole U.S. Government to review and 

assess the impact of all relevant regulations on manufacturing in the United 

States and provide adequate resources to undertake this function. 

• Replace immediately the 30-year Treasury bond interest rate used for pension 

calculations with a more accurate long-term corporate bond rate, and over the 

longer term, policymakers should focus on reforms that both enable and encourage employers to participate in the private pension plan system. 

• Seek to reduce the rapid increases in health care costs and make health care 

more affordable by enacting Medicare and medical liability reforms, expanding 

tax-based assistance and group purchasing through association health plans 

and encouraging greater individual responsibility. 

3. Promoting innovation, investment and productivity

• Pass legislation to resolve the FSC/ETI dispute in a fair and equitable way 

that improves the competitive position of U.S. manufacturers. In addition, simplify and reform current international tax rules to level the playing field for 

U.S. companies. 

• Support continued movement towards a capital cost recovery system that allows companies to expense capital equipment in the tax year it is purchased. 

Strengthen and make permanent the R&D tax credit set to expire on June 30, 

2004. Continue to press for repeal, or at a minimum significant reform, of the 

Alternative Minimum Tax (AMT)—the ‘‘Anti-Manufacturing Tax.’’

• Challenge the world’s major trading nations to match the U.S. with a harmonized, cost-based, electronically based patent system by 2008, and begin by 

fully funding the Patent and Trademark Office and ending the diversion of 

patent fees. 

• Survey the full range of government programs that contribute to manufacturing R&D and seek additional funding for R&D programs that have proven 

successful in promoting manufacturing innovation and competitiveness. 

• Restore full funding in the FY2005 budget to the Advanced Technology Program (ATP) and Manufacturing Extension Partnership (MEP), two key programs that encourage public-private partnerships to stimulate business innovation and spread its benefits throughout the economy. 
180

4. Ensuring an adequate supply of skilled workers and effective help for workers 

needing re-training and re-employment 

• Make greater efforts to demonstrate the linkage between ‘‘leaving no child behind’’ and the need to educate young people for competing in the global marketplace. 

• Redirect funding in the reauthorized Carl D. Perkins Act to update vocational 

and technical training in high schools and establish technical career paths into 

junior college and universities. 

• Strengthen implementation of the Workforce Investment Act to channel more 

of existing funds into business-directed ‘‘one stop service centers,’’ with particular emphasis on involving small and medium-size companies. 

• Ensure that transparent and efficient visa policies enable the United States 

to access the best global business talent and facilitate personnel movement 

around the world while also effectively protecting homeland security. 

5. Improving the policy infrastructure to advance the manufacturing agenda 

The Administration has demonstrated that it is taking manufacturers’ concerns 

seriously and making credible efforts to promote economic growth and manufacturing renewal. Secretary Evans has announced several important initiatives to improve performance in the Department of Commerce. The following steps should be 

part of government-wide efforts to create a stronger policy infrastructure on manufacturing issues:

• Ensure that the new Commerce Department assistant secretary for manufacturing has adequate resources and staff to advance the manufacturing agenda 

in Commerce and other U.S. agencies. Redirect more resources to investigating 

and following up on unfair trade practices of our trading partners. Provide sufficient expert staff to the new Office of Industry Analysis to assess the costs 

and economic impact of new rules and regulations on the manufacturing sector. 

• In conjunction with these Commerce Department initiatives, establish a senior-level position in the White House National Economic Council staff to work 

with the new Commerce assistant secretary and help drive the interagency 

policy process, enlisting the support of the President and his senior staff as 

needed. 

• Form a Presidential Council on Manufacturing that would make independent 

recommendations to the President and issue an annual report card on implementation of the Administration’s manufacturing agenda. On a regular basis, 

highlight and review progress on the manufacturing agenda in the President’s 

annual economic report and the Federal budget presentation. 

The Role of Trade 

As is obvious in the NAM agenda, trade is not the only problem facing manufacturing, but it is an important one. Trade—both imports and exports—affects manufacturing much more than the rest of the economy. In fact, trade is seven times as 

large a factor in the manufacturing sector than in the rest of the economy. Trade 

has been a key factor in the current manufacturing recession—particularly the decline in U.S. manufactured goods exports. These exports fell $84 billion in the last 

two years, accounting for roughly one-third of the total fall in U.S. manufacturing 

shipments during that time. Given that U.S. data on manufacturers’ shipments includes double-counting and exports do not, the actual export loss is almost certainly 

more than 40 percent of the total loss. 

Imports have also been a factor in the current situation, but less so than the export loss. Since 2000, import penetration (the import share of the U.S. market for 

manufactured goods) raised U.S. imports of manufactured goods by about $40 billion 

above where they would have been had the import share not increased. 

It is important to stress that imports are not ‘‘bad’’ for the economy. They must, 

of course, be consistent with international trade rules and U.S. trade laws. Imports 

are how we receive goods and services that can be produced more efficiently in other 

countries, and exports—which tend to be the goods and services we make most efficiently—are how we pay for what we import. Imports provide a broad range of products to industry and consumers and enhance the U.S. living standard. 

So long as trade is in reasonable balance, some U.S. industries are growing while 

others are contracting—but manufacturing as a whole gains and becomes more productive. This doesn’t alleviate the difficulties of individual companies or industries, 

but tends to bring about the movement of resources within the economy in a way 

that generally benefits all. But when trade is not in reasonable balance, then manufacturing as a whole can be hit hard and firms losing customers cannot find other 
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outlets for their production and workers displaced from one industry cannot find 

employment in another. The overall U.S. merchandise trade deficit rose from $180 billion in 1997 to $470 

billion last year—roughly a $300 billion increase. About 80 percent of that increase 

occurred in manufactured goods trade, which went from a deficit of $130 billion in 

1997 to a deficit of $360 billion last year. The $230 billion increase in the manufactured goods deficit has had a very serious effect on U.S. production and jobs. A robust manufacturing recovery and restoration of many of the lost jobs just is not possible until manufactures trade turns around. 

Imports from China have played an important role here, but have not been the 

only factor. For example, the largest increase in the U.S. trade deficit since 1997 

was not with China, but with the European Union—where the deficit increased from 

$16 billion in 1997 to $82 billion last year. The U.S. deficit rose virtually everywhere in the world. China, however, now accounts for nearly one-third of the U.S. 

trade deficit in manufactured goods, up from a little over one-fifth in 2000. 

The fundamental cause of the overall deterioration in the trade balance was the 

seriously overvalued dollar. No other factor even comes close. After a decade of stability, the dollar started rising against other currencies in 1997, and peaked at an 

increase of 30 percent in February 2002—making U.S. exports 30 percent more expensive and imports up to 30 percent cheaper. For example, the euro fell from $1.17 

to $0.86, making it impossible for many American companies to compete in Europe 

or against European companies. This particularly affected smaller U.S. manufacturers and had a disastrous effect on our trade. This is why the NAM worked so hard 

to obtain a dollar policy based on market-determined exchange rates reflecting economic fundamentals. 

The Administration began enunciating such a policy last year, and since then the 

dollar has moved about two-thirds back to normal levels, when viewed against 

major currencies. Recently, Treasury Secretary Snow has been very definite in his 

statements that markets must set currency values free of intervention to prop currencies up or keep them below market-determined rates. A dollar reflecting economic fundamentals is by far the most important factor needed to cut back the enormous U.S. trade deficit. 

The euro is now about $1.15, which is close to the $1.20 average value during the 

1990s for the European currencies that now constitute the euro. The Canadian dollar also rose significantly, from $0.63 to $0.73—an increase that will do much to alleviate some of the significant trade tensions that have arisen with Canadian trade. 

IMPORTS FROM CHINA 

Let me now turn specifically to trade with China and its effects on U.S. manufacturing. Beginning in the 1970s, the United States granted what is now called ‘‘Normal Trade Relations’’ (NTR) status to China, opening the way for China to begin 

selling into the U.S. market. China faced the same small U.S. import duties that 

we applied worldwide, averaging less than 2 percent for manufactures. 

The Chinese market, however, stayed very closed to U.S. exporters. Over the 

years, this situation led to faster growth of China’s exports to the United States 

than was the case for U.S. exports to China. In fact, for the last 20 years, U.S. imports from China have grown at an average annual rate of 20 percent per year, 

while U.S. exports to China have grown at an average annual rate of 12 percent. 

Last year U.S. merchandise imports from China were $125 billion, while exports 

to China were $22 billion, resulting in a trade deficit of $103 billion—the largest 

with any country in the world. U.S. imports from China are now six times as large 

as exports to China, making it a very difficult task merely to halt the growth of 

the deficit much less than to reverse it—as is shown in Exhibit 1 (attached). The 

exhibit contains a matrix showing the trade balances with China that would result 

from various alternative growth rates for exports and imports. If, for example, the 

20-year trends of 20 percent import growth and 12 percent export growth were to 

continue for just five more years, the U.S. trade deficit with China would triple to 

over $330 billion. 

The problem is still manageable if it is addressed now. Apparent consumption of 

manufactured goods in the United States (using the North American Industrial 

Classification System—NAICS—employed in U.S. Government statistics) was $4.325 

trillion during January–July 2003, at an annual rate. Manufactured goods imports 

from China during this period were $134 billion at an annual rate—3.1 percent of 

apparent consumption of manufactures. 

This sounds like a small number, incompatible with the pain being expressed by 

many U.S. industry sectors. The reason for this pain, however, can be seen by examining what is happening at the margin—what is happening to changes in production 

and imports. In 2000, China accounted for 2.1 percent of apparent consumption of 
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manufactures, so its share increase to 3.1 percent so far in 2003 represents a 50 

percent increase. Viewing the situation differently, between 2000, when the U.S. 

manufacturing industry entered its severe recession, and 2003 to date (at an annual 

rate), apparent consumption of manufactured goods fell 6 percent. Imports of manufactured goods from the world fell 2.4 percent. But imports from China rose 38 percent during that period. 

Frequently, we are told by our member companies that Chinese products are 

being offered for sale at prices so low that the U.S. company just cannot compete. 

In fact, it is not unusual to hear that the Chinese product is being offered for sale 

at prices below the cost of the U.S. company’s component or raw material costs. One 

NAM member told us, ‘‘I recently lost a job to China when they built three molds 

for my domestic customer for a total of $1,800. The cost of the steel is more than 

that!’’ That raises serious questions that need answering, for even low labor costs 

and an undervalued currency could not bring about such a phenomenon. 

The situation is not uniform, though. Not all of China’s rapid export growth to 

the U.S. market is necessarily competing with U.S. production. For example, Japan’s share of U.S. imports has fallen as China’s has risen—implying the possibility 

of considerable substitution of Chinese for Japanese goods in the U.S. market. Consider, for instance, that China is now the largest supplier of computers and related 

components into the U.S. market. Yet as recently as 2000, China was only our fifthlargest supplier of these products. Though total U.S. imports of computers and components fell from 2000 to 2002, imports from China soared nearly 50 percent, while 

imports of these products from Japan fell 50 percent and from Korea fell over 40 

percent. 

CHINA AS A MARKET 

It is also very important to avoid viewing China in a one-sided manner. In addition to being a rapidly rising supplier of imports into the U.S. market, China is also 

a quickly growing market for foreign goods and services, and this must not be overlooked. Last year China was our fastest-growing export market. While our overall 

exports fell 5 percent, our exports to China were up 15 percent. Last year China 

was the second-largest market for U.S. commercial jet aircraft. China has the same 

potential for many products. 

Moreover, the growth is accelerating. In the first quarter of this year our exports 

are up over 37 percent compared to the year-ago period—by far the fastest growth 

to any market in that time period. Moreover, there is enormous potential for expansion. Less than 10 percent of China’s imports come from the United States. The European Union, for example, sells 30 percent more to China than we do. 

It is also important to contemplate the significance of the fact that China’s trade 

with the rest of the world as a whole is in deficit. In 2002, using U.S. data, China’s 

surplus with us was $103 billion. China’s global trade surplus was $30 billion, implying a $73 billion deficit with the rest of the world. Much of this is imports of 

oil and other commodities, and large amounts are also comprised of electronic components that China purchases from other Asian countries to assemble into final 

products for export to the United States. 

It is clear that the United States must have a balanced approach to China, considering the import impact being felt, but also considering that China is about the only 

growth market in the world right now—and that it has the potential to be among 

the world’s two largest import markets in the future. We need a productive two-way 

trade relationship. 

INVESTMENT IN CHINA 

Another growing concern among many companies is the fear that U.S. factories 

are closing their doors and that production is moving to China. There is a considerable amount of anecdotal information regarding U.S. plants shutting down and new 

American plants being opened in China. The statistical data, however, do not bear 

this out—at least not so far. 

Commerce Department data show that total sales of U.S. manufacturing affiliates 

in China in 2000 (latest data available) were $26.0 billion, of which $18.3 billion 

were sold in China, $4.8 billion were exported to countries other than the United 

States, and $2.9 billion were exported to the United States. Thus, according to U.S. 

Government data, only 3 percent of U.S. manufactured goods imports from China 

in 2000 came from U.S.-owned companies. The rest came from Chinese or foreignowned plants. Additionally, over 90 percent of U.S. affiliate exports of manufactures 

to the United States were computers and other electronic components. 

Preliminary data for 2001 do not indicate a significant change. Global U.S. foreign 

direct investment outflows for manufacturing in that year were $36 billion, of which 

80 percent went to Europe and Canada. This is in keeping with typical patterns, 
183

for the vast bulk of U.S. foreign direct investment in manufacturing typically goes 

to Europe, Canada, and other high-wage countries to supply local demand. New U.S. 

manufacturing investment in China in 2001 was $1.4 billion, according to the Commerce Department’s data. 

The statistics and the anecdotal information seem to be saying different things. 

In seeking to reconcile this, it should be noted that the statistics would not reflect 

instances in which a U.S. firm ceased production and rather than investing in 

China, simply started to import products made by Chinese-owned or other foreignowned factories. Additionally, we may just be at the beginning of the problem. It 

is a rare executive who returns from China without shaking his or her head and 

saying that unless things change they just don’t see how we can compete against 

Chinese production and keep American manufacturing from moving offshore. 

A POSITIVE AGENDA 

The question is, what do we do about this? How do we assure the health of our 

nation’s manufacturing industry in the face of this rapidly growing challenge? At 

the outset, we must reject protectionism as the answer. We cannot undo seventy 

years of trade liberalization and the attendant benefits to our standard of living and 

our competitiveness that have resulted from trade. Protecting industries from competition is not a formula for success and would likely result in a spread of protectionism around the world that would end up hurting everyone—including ourselves. 

We need a positive agenda in addressing China. We need to recognize that China 

is not only our fastest-growing competitive problem right now, but also that it is 

going to be among our fastest-growing markets in the world. We need a combination 

of steps to ensure that trade follows market principles and is free of government 

distortions, and to ensure that U.S. productivity and technology continues to provide 

us a competitive edge. 

The first step has already been taken: getting China into the WTO so it has to 

follow global trade rules. We worked hard to get China into the WTO for this very 

reason. We need to dispel the too-common view that China’s entry into the WTO 

is the cause of the rapid rise of imports from China. The U.S. market was already 

open to China before its entry into the WTO. The United States made no import 

concessions when China entered the WTO—no reductions in U.S. tariffs or other 

trade rules whatsoever. All of the concessions, and all of the reductions in barriers 

are on the Chinese side. That was the price they had to pay to join the WTO. 

Our exports, on the other hand, have clearly broken from their earlier trend and 

have started rising considerably more rapidly than before China’s entry into the 

WTO. This is exactly what we expected—the direct result of the reduction in tariff 

and trade barriers that has already taken place in China. As China implements its 

several-year schedule of further market opening moves, much more U.S. export 

growth is achievable. Had China entered the WTO a decade ago, there is no question that our trade deficit with China would be much smaller today than it actually 

is. 

In the NAM’s view, we now need to pursue a set of steps to ensure more marketdriven trade between China and the United States. This would include:

1. Seek Full WTO Compliance. We must ensure that China complies with its 

commitments as a new World Trade Organization member to follow all international trade rules and open its internal market in accordance with specific 

benchmarks set forth in its membership agreement. The NAM has established 

a WTO compliance monitoring program of its own and submitted its second annual compliance report based on member input to the U.S. Trade Representative (USTR) on Sept. 10. We have also pressed for more Commerce and USTR 

resources for monitoring and investigating compliance problems. 

2. Stop Currency Undervaluation. We must press China to end the manipulation of its currency and allow the yuan/dollar exchange rate to be determined 

by the market. Economists estimate that China’s currency is undervalued by 

as much as 40 percent, and this is having a huge distorting impact on trade. 

Currency undervaluation is one of the key factors pushing China’s trade surplus with us to a record $130 billion this year. China is now purchasing U.S. 

dollars at the rate of $120 billion a year to prevent appreciation of its currency 

against the dollar. Secretary Snow’s visit to Asia was an excellent start in raising the issue, and getting the G–7 Finance Ministers to agree that the China 

currency situation is a global problem added considerable further forward 

movement toward a resolution. The International Monetary Fund (IMF) is also 

raising its voice, pointing out that Asian currency manipulation is a dangerously destabilizing element in the global economy. 

3. End Subsidized and Non-Market Production. We must ensure that the development of Chinese industry follows market principles and does not benefit 
184

from direct or indirect subsidies that distort trade flows. We hear too many reports from NAM members that Chinese imports cost less than the cost of raw 

materials. In our dialogue with China, we must insist that the prices of traded 

goods are determined by real economic costs and not costs artificially set by 

the government. 

4. Address Counterfeiting and IPR Violations. We must take firm actions to 

end China’s rampant counterfeiting of U.S. and other products. Today, China 

is the epicenter of world counterfeiting, costing us tens of billions of dollars in 

lost exports and the related jobs. Moreover, counterfeit products pose significant risks to health and safety—such as in bogus pharmaceuticals or phony 

brake linings. We must also insist that the Chinese government take effective 

action to enforce the protection of patents, copyrights, trademarks and other 

intellectual property. 

5. Expand Export Promotion to Support U.S. Business. Finally, we must 

undertake a massive joint public-private export trade effort to increase U.S. exports to China. In 2003, China is set to become the world’s 3rd largest importer 

($380 billion) but the United States only has an 8 percent share of all Chinese 

imports. U.S. companies need to increase their marketing efforts but greatly 

expanded Commerce Department and other promotion assistance is also needed. 

CONCLUSION 

Let me conclude, Mr. Chairman, by stating that we will not succeed in preventing 

the migration of our manufacturing base to China and other foreign countries if we 

do not address the high cost of manufacturing in the United States and get the U.S. 

economy moving again. 

U.S. industry is burdened by legal and regulatory systems that retard growth and 

destroy jobs. Unrestrained asbestos liability alone, for example, could cost U.S. industry $250 billion, resulting in the bankruptcy of even large corporations. Rapidly 

rising health care costs are a constant worry, particularly for small manufacturers. 

Uncertainty over sources of energy supply has led to price volatility. Lack of support 

for research and development threatens to undermine U.S. leadership in cuttingedge technology. And shortages of skilled workers have left many manufacturers 

wondering how they will keep the engines of industry running when growth does 

resume. 

Additionally, bilateral, regional and WTO trade agreements must be negotiated as 

quickly as possible to get foreign trade barriers eliminated, or at least down to our 

own low level. U.S. tariffs on manufactured goods average less than 2 percent, while 

in many parts of the world U.S.-made goods face tariffs 10–15 times higher—or even 

more. 

Unless these challenges are also addressed, we can expect a significant further 

erosion in the U.S. industrial base. Competition with China will only accelerate the 

trend. However, if we begin to act now, with both a refocused and positive trade 

policy toward China and a concerted strategy on economic growth and manufacturing renewal, we can restore the dynamism and competitiveness of U.S. industry 

and ensure the global leadership that is so central to our economic and national security. 

Thank you, Mr. Chairman.
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ALTERNATIVE U.S. TRADE DEFICITS WITH CHINA 

20-Year Trend: Exports to China up 12 percent per year;

Imports up 20 percent per year 

If these trends continue for five more years

the China trade deficit will be $330 billion—

an increase of $227 billion.

Export%

12% 25% 33%

Import%

20% Ø$330 ¥$290 ¥$252

15% ¥$246 ¥$205 ¥$167

10% ¥$178 ¥$138 ¥$100

7% ¥$144 ¥$104 ¥$66

NAM National Association of Manufacturers
186

Co-Chairman DREYER. Thank you. Ms. Lee.

STATEMENT OF THEA M. LEE

ASSISTANT DIRECTOR OF PUBLIC POLICY

AMERICAN FEDERATION OF LABOR AND

CONGRESS OF INDUSTRIAL ORGANIZATIONS (AFL–CIO) 

Ms. LEE. Thank you very much. I really appreciate the opportunity to testify today on this very important topic on behalf of the 

13 million working men and women of the AFL–CIO. Frank Vargo 

said that China is the issue he hears about from his members in 

the National Association of Manufacturers. I have to tell you that 

is very, very true in the labor movement, as well. 

I also want to thank the Commission and applaud the work that 

you’ve already done to bring so much urgent attention to this issue. 

China’s industrial, investment, and exchange rate policies have 

had a profound impact on the bilateral trade between our countries 

and, hence, on the health of our own manufacturing sector and 

economy, especially on jobs in the manufacturing sector. 

I want to focus my remarks today on two aspects of these policies 

which have had very serious negative consequences for America’s 

workers: the Chinese government’s manipulation and undervaluation of its currency, and the government’s egregious and ongoing 

violation of the fundamental human rights of its workers. And finally, I want to talk about some of the policy solutions that we’d 

like to put forward. 

The Chinese yuan has been pegged to the dollar at a fixed exchange rate since 1996. Underlying economic conditions have 

changed during that time, leading to a severe misalignment of the 

exchange rate, which can only be maintained through the Chinese 

government’s massive accumulation of U.S. dollar reserves, now 

over $350 billion, as Frank said. 

This is an inherently unstable and unsustainable situation, and 

policymakers in both the United States and China need to be addressing this issue now before it gets more and more out of whack 

and out of hand. Addressing the issue now is what can save us 

from having a more severe adjustment and crisis at a later date. 

The Chinese government’s development path has clearly been 

predicated on export-led growth, with the U.S. consumer economy 

playing a starring role as the primary purchaser of Chinese made 

goods. While, of course, all governments look out for the interest 

of their own people, as they ought to do, they have to do that within the context of international rules and constraints. 

WTO rules clearly prohibit currency manipulation to gain trade 

advantages inconsistent with GATT provisions. As you all know, 

and I think there’s been a lot of discussion about this today, currency undervaluation is equivalent to raising tariffs or to imposing 

illegal subsidies, both of which are disciplined by WTO rules. It is 

also a violation of the principle of most favored nation treatment 

as the Chinese government has pegged its currency specifically 

with respect to the U.S. dollar, having an adverse impact on our 

country’s trade balance with China relative to other countries. Certainly you see that when you look at China’s overall trade relationships with the U.S. and with the rest of the world. 

This choice that China has made, to artificially bolster its own 

manufacturing sector at the expense of the United States and other 
187

countries indirectly, is a violation of its obligations under the WTO 

and we need to use the provisions that we have in place to address 

this issue. 

Professor Robert Blecker from American University has estimated that the overvalued dollar relative to all currencies, not just 

the Chinese yuan but to all currencies, has resulted in about 

740,000 lost U.S. jobs since 1995, as well as a loss of nearly $100 

billion in annual profits and $40 billion in annual investment over 

the same period. Professor Blecker does not break out the impact 

of the dollar-yuan relationship specifically, but these estimates give 

some sense of the magnitude of the impact of the currency misalignment. 

Most estimates place the undervaluation of the yuan between 15 

and 40 percent. A currency misalignment of this magnitude has 

enormous significance in the context of U.S.-China trade. While it 

is not the only factor contributing to the massive U.S. trade deficit 

with China, it is a significant one and one that ought to be addressed urgently. 

Many times we give a lot of attention in international trade negotiations to getting tariff barriers down that are much smaller 

than this 40 percent misalignment. I am baffled sometimes by the 

fact that people say, ‘‘Well, it is not the only thing wrong; therefore, 

we don’t need to do anything to address it.’’ I think if we have a 

40 percent distortion in relative prices, we need to do whatever we 

can within the context of the rules to fix that, and then we can 

start addressing some of the other questions. 

So we believe the Chinese government must allow the yuan to 

reflect the underlying economic and market forces. It must end the 

peg and cease its accumulation of U.S. dollar reserves. While the 

Chinese government’s reluctance to take this action is perhaps understandable—everybody understands governments are looking out 

for their own interests—fearful of the loss of jobs in their own 

country—the Bush Administration’s failure to act decisively in this 

area is not understandable. 

We call on the Administration to use all the tools at its disposal, 

including initiating a WTO case, to send a clear message to the 

Chinese government that the current situation is unacceptable and 

will not be tolerated. We applaud the efforts in Congress to force 

action on this issue, as it now is clear that simple diplomacy and 

jawboning have failed to move the Chinese government in this 

area. 

In addition to the unfair competitive advantage gained through 

currency manipulation, the Chinese government’s systematic repression of fundamental workers’ rights is a key contributor to the 

unfair advantage Chinese exports enjoy in the U.S. market. Chinese workers do not enjoy the right to form or join an independent 

union, as the U.S. State Department reports every year in its annual human rights report, nor do they enjoy the political freedom 

to criticize, let alone change, their government. 

These policies amount to a deliberate and artificial suppression 

of wages by the Chinese government. This exploitation impacts 

American workers as well as workers in other developing countries 

and artificially lowers the price of Chinese exports in the U.S. market. 
188

The Administration’s failure to take concrete actions to address 

China’s human rights and workers’ rights violations allow these 

violations to continue. Workers in China, the United States, and 

around the world pay the price for this inaction, while companies 

producing in China enjoy the profits. 

In addition to inaction on China’s currency manipulation and 

workers’ rights violations, the Bush Administration has failed to 

enforce U.S. trade laws effectively with respect to China, denying 

American workers the trade relief they’re entitled to under U.S. 

law. 

We understand that rifts within the business community have 

contributed to the U.S. Government’s passivity and failure to act 

to date. Companies that produce in China for the U.S. market, retailers, and importers clearly do benefit from an undervalued Chinese currency, as well as from the abuse of workers’ rights. WalMart, for example, which is alone responsible for almost $10 billion 

of the U.S. trade deficit with China, has openly supported current 

Chinese government policies with respect to the yuan. 

On the other hand, companies that are actually producing in the 

United States, whether for the domestic market or for export, face 

debilitating and unsustainable disadvantages from both the currency manipulation and the violation of workers’ rights in China. 

Workers, of course, are rooted here in the United States. We don’t 

have the flexibility to move our production offshore when currencies become misaligned or when workers are treated badly in 

other countries, and so we have a very different view on this issue, 

obviously. 

But American policymakers have a choice to make in trade relations with China. They can side with the importers and the 

outsourcers and stand by passively as China takes advantage of its 

WTO membership and access to the U.S. market, abusing its own 

workers and artificially undervaluing its currency in order to undercut American workers and domestic manufacturers. Or, they 

can take a stand for American jobs and act now to ensure that 

China plays fair in the global economy. 

This seems to us too important an issue for our government to 

stand by passively at a time like this. The kind of impact that this 

trade deficit and trade relationship is having on the U.S. economy 

and, in fact, on the global economy, is very significant. One of the 

things that we’re increasingly hearing from our trade union counterparts in developing countries is that they, too, feel that they’ve 

been put into a box by the Chinese government’s repressive policies 

in terms of workers’ rights. Governments of other developing countries find themselves in direct competition with China, and they 

must decide how to compete with China in the global economy. 

Every other developing country in the world has also felt downward pressure on wages and working conditions and workers 

rights. So the problem even goes beyond the U.S.-China trade relationship and affects the very nature of competition in the global 

economy today. 

I thank you very much for your attention and for the invitation 

to appear here today and I look forward to your questions. 

[The statement follows:]
189

Prepared Statement of Thea M. Lee

Assistant Director of Public Policy, American Federation of Labor and 

Congress of Industrial Organizations (AFL–CIO) 

Mr. Chairman, Members of the Commission, I thank you for the opportunity to 

testify today on this very important topic on behalf of the thirteen million working 

men and women of the AFL–CIO. We applaud the Commission for holding this 

hearing and for the valuable work you have already done to bring urgent attention 

to this issue. 

China’s industrial, investment, and exchange rate policies have had a profound 

impact on the bilateral trade between our countries, and hence on the health of our 

own manufacturing sector and economy, especially on jobs in the manufacturing sector. 

I would like to focus most of my remarks today on two aspects of these policies, 

which have had very serious negative consequences for American workers: the Chinese government’s manipulation and undervaluation of its currency, and the government’s egregious and ongoing violation of the fundamental human rights of its 

workers. Finally, I will discuss some policy solutions that should be put in place to 

address these problems. 

The U.S. bilateral trade deficit with China hit $103 billion last year, and is up 

24 percent in the first seven months of this year compared to the same period last 

year. Meanwhile, the United States has lost almost 3 million manufacturing jobs 

since 1998, including 431,000 so far this year. While many factors contributed to 

this devastating job loss, it is crucial for policymakers to focus their attention on 

policies that are feasible, quick, and will begin to ameliorate the job losses we have 

already experienced. Addressing the Chinese government’s flouting of its international obligations with respect to currency values and workers’ rights ought to be 

a top priority in this regard. 

The Chinese yuan has been pegged to the dollar at a fixed exchange rate since 

1996. Underlying economic conditions (relative inflation and growth rates, among 

other things) have changed during that time, leading to a severe misalignment of 

the exchange rate, which can only be maintained through the Chinese government’s 

massive accumulation of U.S. dollar reserves—now over $350 billion. 

This is an inherently unstable and unsustainable situation. Both U.S. and Chinese policymakers should focus now on taking steps to address this situation, so 

that appropriate transitions can be put in place. This is necessary to avoid a more 

abrupt and severe crisis at a later date. 

The Chinese government has clearly charted a development path predicated on 

export-led growth, with the U.S. consumer economy playing a starring role, as the 

primary purchaser of Chinese-made goods. While it is every government’s right and 

obligation to look out for the interests of its citizens, it must do so within the context of international rules and constraints. 

WTO rules clearly prohibit currency manipulation to gain trade advantages inconsistent with GATT provisions. Article XV of GATT 1994, for example, provides that 

‘‘Contracting parties shall not, by exchange action, frustrate the intent of provisions 

of this agreement’’ (emphasis added). Deliberate undervaluation of the yuan vis-a`-

vis the U.S. dollar also violates the principle of most-favored-nation treatment, as 

it targets one country’s currency, adversely impacting that country’s trade. Certainly, the enormous bilateral U.S. trade deficit with China relative to other countries is evidence of the uneven impact of China’s currency policies on its trading 

partners. Currency manipulation nullifies tariff concessions made through WTO 

processes and amounts to a de facto illegal subsidy of Chinese exports. China’s 

choice to artificially bolster its own manufacturing sector at the expense of the 

United States (and other countries indirectly) is therefore a violation of its obligations under the WTO. 

As American University economist Robert Blecker wrote in a recent Economic Policy Institute briefing paper, ‘‘[T]he sheer magnitude of the reserves accumulated by 

these East Asian countries, and the rapidity with which these reserves have increased in recent years, is prima facie evidence of efforts to keep their currencies 

undervalued and prevent their currencies from appreciating to exchange rates that 

would be conducive to more balanced trade relations with the United States. This 

is outright currency manipulation of a mercantilist nature, intended to maintain 

those countries’ trade surpluses with the United States, which by 2002 accounted 

for about 40% of the overall U.S. trade deficit’’ (‘‘The Benefits of a Lower Dollar: 

How the high dollar has hurt U.S. manufacturing producers and why the dollar still 

needs to fall further,’’ EPI Briefing Paper, May 2003). 

Professor Blecker estimates that the overvalued dollar (relative to all currencies) 

has resulted in about 740,000 lost jobs since 1995, as well as a loss of nearly $100 
190

billion in annual profits and $40 billion in annual investment over the same period. 

Blecker does not break out the impact of the dollar-yuan relationship specifically. 

Most estimates place the undervaluation of the yuan between 15 and 40 percent. 

A currency misalignment of this magnitude has enormous significance in the context 

of U.S.-China trade. While it is certainly not the only factor contributing to the massive U.S. trade deficit with China, it is a significant one, and one that ought to be 

addressed urgently. Many international trade negotiations focus on eliminating or 

phasing out tariff barriers much lower than this, and trumpeting the potential benefits of doing so. Just because China has other low-cost advantages over the United 

States is no reason for us to tolerate as much as a 40% distortion in relative prices. 

The Chinese government must allow the yuan to reflect underlying economic and 

market forces. It must end the current peg and cease its accumulation of U.S. dollar 

reserves. While the Chinese government’s reluctance to take this action is perhaps 

understandable, the Bush Administration’s failure to act more forcefully in this regard is not. 

We call on the Administration to use all tools at its disposal, including initiating 

a WTO case, to send a clear message to the Chinese government that the current 

situation is unacceptable and will not be tolerated. We applaud efforts in Congress 

to force action on this issue, as it is now clear that simple diplomacy and jawboning 

have utterly failed. 

In addition to the unfair competitive advantage gained through currency manipulation, the Chinese government’s systematic repression of fundamental workers’ 

rights is a key contributor to the unfair advantage Chinese exports enjoy in the U.S. 

market. Chinese workers do not have the right to form or join an independent union 

(as the U.S. State Department has repeatedly reported in its annual human rights 

report), nor do they enjoy the political freedom to criticize, let alone change, their 

government. 

Enforcement of wages, hours, and health and safety rules is lax or non-existent 

in many areas of the country, and forced and child labor are prevalent in some sectors. These abuses allow producers in China to operate in an environment free of 

independent unions, to pay illegally low wages, and to profit from the widespread 

violation of workers’ basic human rights. Together, these policies amount to a deliberate and artificial suppression of wages by the Chinese government. This exploitation impacts American workers, as well as those in other developing countries, 

and artificially lowers the price of Chinese exports in the U.S. market. 

During 2001 and 2002, the number of labor disputes and protests in China rose 

significantly. In response, the Chinese government jailed a number of workers for 

demonstrating for their rights and cracked down on any organization that might 

support the beginnings of an independent trade union. The official labor union—the 

All China Federation of Trade Unions (ACFTU)—continued to discourage strikes 

and work stoppages, and to negotiate sweetheart deals with employers. 

In the face of these grave problems, the Bush Administration chose not to even 

raise the case of China before the UN Human Rights Commission in April of 2003, 

despite the United States’ regular practice of doing so previously. In addition, President Bush did not demand any specific improvements in human rights when he met 

with China’s President Hu in the summer of 2003. Instead, the Bush Administration has only engaged in ‘‘cooperative dialogue,’’ a strategy that has not worked. 

Since deciding to pursue a dialogue instead of UN action or public pressure, Administration officials have noted ‘‘backsliding’’ and a ‘‘deterioration in human rights’’ in 

the country during 2003, including arrests of democracy activists, harsh sentences 

for labor organizers, and the suppression of independent media, church groups, and 

Tibetans. 

Yesterday’s Wall Street Journal reported that the Chinese government has recently cracked down on free speech and political dissent, closing four Web sites and 

clamping down on foreign funding and organizations (Kathy Chen, ‘‘China Curbs 

Growing Debate over Politics,’’ Wall Street Journal, September 24, 2003). The government issued a document warning against ‘‘hostile forces,’’ urging increased vigilance against Chinese organizations’ use of foreign funding or cooperation with foreign experts and organizations. In August, the Chinese government attempted to 

halt debate on three topics, now labeled ‘‘not allowed’’: political reform, constitutional amendments, and the reassessment of historical incidents (presumably referring to the 1989 crackdown on protesters in Tiananmen Square). 

The Administration’s failure to take concrete actions on human rights and workers’ rights in China allows rampant violations to continue. Workers in China, the 

United States, and around the world pay the price for this inaction, while companies 

producing in China enjoy the profits. 

In addition to inaction on China’s currency manipulation and workers’ rights violations, the Bush Administration has failed to enforce U.S. trade laws effectively 
191

with respect to China, denying American workers the trade relief they are entitled 

to under the law. 

Rifts within the business community have contributed to the U.S. Government’s 

passivity and failure to act to date. Companies that produce in China for the U.S. 

market, retailers, and importers clearly benefit from an undervalued Chinese currency, as well as from the abuse of workers’ rights. Wal-Mart, for example—alone 

responsible for almost $10 billion of the U.S. trade deficit with China—has openly 

supported current Chinese government policies with respect to the yuan. On the 

other hand, companies actually producing in the United States—whether for the domestic market or for export—face debilitating and unsustainable disadvantages 

from both currency manipulation and violation of workers’ rights in China. 

American policymakers have a choice to make in trade relations with China. They 

can side with the importers and outsourcers, and stand by passively as China takes 

advantage of its WTO membership and access to the U.S. market, abusing its own 

workers and artificially undervaluing its currency in order to undercut American 

workers and domestic manufacturers. Or they can take a stand for American jobs 

and act now to ensure that China plays fair in the global economy. 

Thank you for your attention and for the invitation to appear here today. I look 

forward to your questions.

Co-Chairman DREYER. Thank you, Ms. Lee. 

Mr. Workman.

STATEMENT OF WILLARD A. WORKMAN

SENIOR VICE PRESIDENT, INTERNATIONAL POLICY AND

ECONOMIC REFORM, U.S. CHAMBER OF COMMERCE 

Mr. WORKMAN. Thank you. My name is Willard Workman. I’m 

the Senior Vice President for International Policy and Economic 

Reform at the U.S. Chamber and I’m also the Vice President of the 

Chamber’s affiliate, the Center for International Private Enterprise, which is one of the four core institutes of the National Endowment for Democracy. Both the Chamber and CIPE, as we call 

it, receive Federal funding to develop trade, build market-based 

economic regimes, and promote democracy in the developing world. 

I’m pleased to be here today to discus China and I’m submitting 

for the record two documents that the Commission should find of 

interest. The first one is very easy. It’s one page long. It is known 

as the Chamber’s criteria for international investment, also known 

as the 12 commandments for foreign direct investment. And the 

second one is the Chamber’s second annual report on China’s performance in meeting its WTO accession commitments. 

I think this is important and I want to focus a little bit on this 

issue of investment and why do private companies invest in China, 

or anyplace else, for that matter. If you look at the criteria, you 

may be surprised to know that this is not rocket science. It is more 

or less common sense. 

A company sits down and they use these 12 criteria—the Japanese tend to use 18, the Germans use 15 but they all use at least 

these 12 criteria, not only the multinationals, but small manufacturers, as well. And just quickly scanning through the group, you 

see that they look at things like the size and the potential for 

growth of the domestic market. Certainly, China’s domestic market 

would be attractive. 

Freedom of access to the market, that’s why a lot of companies 

are very interested in the WTO accession negotiations with China. 

Labor force skills and availability of raw materials. Protection from 

currency devaluation. If you buy something in dollars and the next 

day your property or asset in Beijing is devalued by 50 percent, 
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you’ve lost half of your investment. Favorable taxation and tax incentives. Low political risk, and so on. 

Each individual company assigns a different weight or priority to 

the individual items depending on their line of business, but all 

companies, and I repeat this, all companies, American and foreign, 

use at least these 12 commandments, if you will, to guide their investment decisions in China or any country, including the United 

States. 

In the most recent report on investment, from September 5 of 

2003, UNCTAD, the United Nations Conference on Trade and Development, noted that foreign direct investment in China for 2002 

increased by $53 billion, making China the number one foreign direct investment destination among developing countries. When you 

think about this, this is not surprising in light of China’s accession 

to the WTO in 2002. 

However, absent Chinese adherence to its WTO commitments, 

something that the Chamber and Frank at the NAM have both 

looked at, not only from our perspective, not only in manufacturing 

but in a variety of areas that I’ll list in a minute, if they don’t stick 

to what they’ve committed to, then you can assume that foreign direct investment to China will level off or even decline. 

The things that we looked at in terms of—think about what the 

Chinese committed to in their WTO accession agreement. In the 

area of agriculture, which is a major issue for them and was one 

of the sticking points that the disappointing Cancun ministerial recently in Mexico of the WTO. Autos, there was a section they made 

major commitments to open up their domestic market to automobiles and particularly their distribution system. Express delivery 

services, Federal Express, United Parcel Service, DHL, and others 

are looking at the very large China internal market as a place for 

growth and opportunity. 

Financial services—we noted that China has begun to make 

progress in its obligations in financial services by revising some of 

its laws, and in fact, our affiliate, CIPE, in partnership with a private nongovernmental economic think tank in China, has been 

working to rewrite the Chinese bankruptcy laws, which is essential 

if they’re going to make the transition from state-owned enterprises 

to publicly-owned enterprises. They have to recover the useful assets in the, quote, ‘‘bankrupt state-owned enterprise’’ and reapply 

it very efficiently and in a timely manner to productive enterprises. 

Intellectual property rights—this has been an issue of particular 

concern to the Chamber, not just in what you would think of, the 

soft intellectual property rights related to software, CDs, music, 

and video, but even some of our auto manufacturers and heavy industry manufacturers have had a particular concern about this. 

The Vice Chairman of my policy committee, who is a small business manufacturer from Wichita, Kansas, who makes grain elevators and have been exporting to China for 16 years, never sends 

his engineering designs to China with the equipment. He just 

sends the equipment. 

Finally, the trading rights and distribution services—there were 

a number of commitments that the Chinese made in that area. 

Finally, there have been concerns raised about China’s currency 

exchange rate policies. The Chamber shares these concerns about 
193

Chinese as well as other East Asian countries’ policies. The following points we think are important to consider. 

We believe that currency exchange rates are best left to market 

forces. We believe that countries should not manipulate currencies 

to gain a competitive advantage. China’s currency has been pegged 

to the U.S. dollar since 1993. During the 1997 Asian financial crisis, China was praised for the stabilizing role it played by maintaining the level of its currency. 

Chinese success in entering the U.S. market is based on several 

factors. While its undervalued currency is one factor, Chinese exports over the past ten years have grown without regard to the relative strength of its currency. 

The U.S. Chamber supports the Administration’s bilateral engagement of the Chinese government in discussions on such matters as currency levels, trade flows, investment regimes, and compliance with international agreements. In addition, the Chamber 

supports the increased attention of the International Monetary 

Fund to China’s exchange rate policies since that was the reason 

at Bretton Woods the IMF was created in the first place. 

The Chamber reiterates its call on China to fully implement the 

commitments it made when it joined the WTO. China’s progress in 

meeting its WTO market opening commitments will create new export opportunities for U.S. companies of all sizes and a business 

friendly investment environment that is increasingly based on the 

rule of law. 

Finally, as moves in both the U.S. House of Representatives and 

the United States Senate to retaliate against Chinese currency 

practices by mandating tariff increases on Chinese products as an 

effective way to increase U.S. manufacturing employment, quite 

frankly, we don’t see the connection. If you want to increase manufacturing employment, more productive areas to pursue are tort, 

tax, regulatory reforms, and according at least to our manufacturing members, are sorely needed. Raising tariffs on imports is of 

dubious value in an economy striving to gain steam and create 

jobs. Thank you. 

[The statement follows:]

Prepared Statement of Willard A. Workman

Senior Vice President, International Policy and Economic Reform

U.S. Chamber of Commerce 

Executive Summary

My name is Willard A. Workman, Senior Vice President, International Policy and 

Economic Reform, of the U.S. Chamber of Commerce and Vice President of the 

Chamber’s affiliate, the Center for International Private Enterprise (CIPE), one of 

the core institutes of the National Endowment for Democracy. Both the Chamber 

and CIPE receive Federal funding to develop trade, build market-based economic regimes and promote democracy in the developing world. 

I am pleased to be here today to discuss China. I am submitting for the record 

two documents that the Commission should find of interest: the U.S. Chamber’s second annual report on China’s performance in meeting its WTO Commitments; and, 

the U.S. Chamber’s Criteria for International Investment, also known as ‘‘The 12 

Commandments for Foreign Direct Investment.’’

Smart companies invest in China, or in other countries based on the following criteria:

1. Size and potential for growth of the domestic market; 

2. Freedom of access to the market; 

3. Labor force skills and availability of raw materials; 
194

4. Protection from currency devaluation; 

5. Remittance of dividends, interest, royalties and technical assistance 

payments; 

6. Property rights protection; 

7. Export potential; 

8. Regulatory burdens; 

9. Favorable taxation and tax incentives; 

10. Low political risk; 

11. Predictable macroeconomic management; and, 

12. Reliable infrastructure support.

Each individual company assigns different weight or priority to individual items 

depending on their line of business, but all companies, American and foreign, use 

at least these ‘‘12 Commandments’’ to guide their investment decisions in China or 

any country, including the United States. 

In its most recent (September 5, 2003) report on investment, UNCTAD (United 

Nations Conference on Trade and Development) noted that foreign direct investment in China for 2002 increased by $53 billion, making China the number 1 FDI 

destination among developing countries. This is not surprising in light of China’s 

accession to the WTO in 2002. However, absent Chinese adherence to its WTO commitments, as detailed in the Chamber’s report, FDI to China will level off or decline. 

A summary of the Chamber’s specific assessments of China’s adherence to its 

WTO commitments include the following six areas:

AGRICULTURE

Issue Assessment: While there has been progress in some areas, the agriculture 

industry continues to face a range of Chinese government actions that have held 

back the potential growth in U.S.-China agricultural trade.

AUTOS

Issue Assessment: Auto finance reform is nearly two years behind schedule, and 

delays in the release of the relevant regulations have hindered the ability of U.S. 

automakers to realize some of the expected benefits of China’s WTO accession. 

Greater transparency in regulatory processes and in procedures for quota application and allocation is necessary to fully and fairly implement the WTO automotive 

quota.

EXPRESS DELIVERY SERVICES

Issue Assessment: The lack of an independent regulator creates challenges in the 

express delivery services sector, where China Post is trying to use its regulatory authority to expand its postal monopoly into a market already well served by existing 

commercial operators. U.S. industry representatives are encouraged at the dialogue 

with Chinese officials on draft postal legislation, but China will ultimately be judged 

by the extent to which the new law complies with its WTO commitments.

FINANCIAL SERVICES

Issue Assessment: China has begun to implement its WTO obligations in the financial services sector by revising its laws, regulations, and administrative practices, but excessive capitalization requirements are limiting the healthy development of the market.

INTELLECTUAL PROPERTY RIGHTS

Issue Assessment: China’s classification of value-added services has become more 

restrictive in the period since WTO accession. The reduction in the scope of valueadded services and the increase in the scope of basic services are especially problematic given the unreasonably burdensome registered capital requirement for foreigninvested basic service joint ventures.

TRADING RIGHTS AND DISTRIBUTION SERVICES

Issue Assessment: China’s trading rights and distribution services commitments 

are now the subject of serious discussion between Chinese officials and U.S. negotiators regarding China’s interpretations of their commitments in this area. 

Finally, there have been concerns raised about China’s currency exchange rate 

policies. The Chamber shares these concerns about Chinese as well as other East 

Asian countries’ policies. The following points are important:
195

• The U.S. Chamber believes that currency exchange rates are best left to market 

forces. The Chamber believes that countries should not manipulate currencies 

to gain a competitive advantage. 

• China’s currency has been pegged to the U.S. dollar since 1993. During the 

1997 Asian financial crisis, China was praised for the stabilizing role it played 

by maintaining the level of its currency. 

• Chinese success in entering the U.S. market is based on several factors. While 

its undervalued currency is one factor, China’s exports over the past ten years 

have grown without regard to the relative strength of its currency. 

• The U.S. Chamber supports the Administration’s bilateral engagement of the 

Chinese government in discussions on such matters as currency levels, trade 

flows, investment regimes and compliance with international agreements. In addition, the Chamber supports the increased attention of the International Monetary Fund to China’s exchange rate policies. 

• The U.S. Chamber reiterates its call on China to fully implement the commitments it made when it joined the World Trade Organization (WTO). China’s 

progress in meeting its WTO market-opening commitments will create new export opportunities for U.S. companies of all sizes and a business-friendly investment environment that is increasingly based on the rule of law.

Finally, moves in both the U.S. House of Representatives and United States Senate to retaliate against Chinese currency practices by mandating tariff increases on 

Chinese products are an ineffective way to increase U.S. manufacturing employment. Tax, regulatory and tort reforms are more likely to yield a speedy resurgence 

in manufacturing and all sectors of the economy. Raising tariffs on imports is of dubious value in an economy striving to gain steam and create jobs. 
196

CHINA’S WTO RECORD: A TWO-YEAR ASSESSMENT

OVERVIEW 

Testimony Backdrop 

This testimony focuses strictly on how China is carrying out its World Trade Organization (WTO) commitments and does not attempt to encompass the many other 

aspects of the U.S. commercial relationship with China. We recognize that such 

issues as the U.S.-China trade deficit, the impact of an undervalued Chinese currency, and the challenges created by Chinese import competition are currently getting increased political attention, but these subjects, though important, are not the 

focus of my remarks. That said, the current focus on such broader issues is driving 

an examination of China as a global economic player and its ability to follow 

through with its obligations. Absent more progress toward fulfilling its WTO commitments, concerns about China will only rise. 

The undertakings in China’s WTO accession were massive, the most ambitious 

any country ever made to accede to the WTO or its predecessor, the General Agreement on Tariffs and Trade (GATT). The international business community judged 

these wide-ranging, comprehensive commitments necessary because of China’s growing role in the international economy. Implementation of obligations as broad as 

China’s was always understood to be difficult, and American businesses have never 

assumed that it would be a short or smooth ride. In some respects, China’s implementation efforts have been impressive, and the rapid growth in two-way trade and 

investment into China reflects this. But partial implementation is not what China 

promised nor what the international community and American business can accept. 

China’s WTO compliance has been uneven and incomplete. Unless this picture improves, there will be an increasing crescendo of complaints about China’s record. A 

number of companies are already publicly expressing the view that China is 

dismissive of global trade rules and commitments. Since the country’s WTO entry 

on December 11, 2001, we have not seen enough new contracts, new access, and new 

customers to stem this tide. Faithful implementation of China’s WTO obligations 

will have positive commercial ramifications and demonstrate that its membership 

in the WTO is leading to new opportunities for exporters and investors. 

It is important to also place these issues in their larger context. On political and 

security issues, China and the United States enjoy the most cooperative relationship 

that they have had in recent times. There has been close coordination on efforts to 

combat terrorism and with respect to developments on the Korean peninsula. Moreover, China and the United States share certain multilateral priorities connected to 

the new Doha Round of trade talks and are both involved in a series of regional 

and bilateral free trade agreement discussions. While these high-priority political 

and economic agenda items require continued attention, China’s WTO record also 

merits the focus of the two governments at the highest levels. 

Throughout my testimony, there are examples of U.S. companies interested in 

providing input and engaging in dialogue and consultations on how to develop laws 

and regulations that comply with both the letter and spirit of China’s WTO commitments. China has demonstrated a willingness to work with us, but we need to see 

more progress in the months ahead. If progress is not made, there will be political 

and commercial ramifications and the full potential of this critical partnership will 

not be realized. 

In this environment, we make the following observations: 

Key Observations 

• Additional implementation progress is critical. China’s entry into the WTO 

brought expectations of new opportunities for American business in the form of 

new licenses, contracts, and exports. Without tangible improvements, there will 

be political consequences as well as a possible souring of business views about the 

market. The U.S. Chamber supports the provision of greater funding to the Office 

of the U.S. Trade Representative and the U.S. Department of Commerce to buttress China WTO monitoring and enforcement efforts.

• Regulatory transparency remains a key concern in the second year of 

China’s WTO membership. A lack of transparency remains a systemic problem. 

Improvements in regulatory clarity and the consistent use of advance consultations—one of China’s WTO commitments—would do much to advance the prospects for success in industries ranging from autos to telecom.

• China must stay focused on having a positive WTO record as it works 

through significant leadership changes and other challenges. China has an 

important stake in delivering a positive WTO record to match the significant political and economic commitments the country made. Changes in China, from the 
197

new political leadership to the restructuring of key trade-focused agencies to the 

battle against SARS, must not be allowed to delay movement on WTO issues. The 

newly formed Ministry of Commerce must have sufficient authority and resources 

to secure compliance from other ministries and agencies and from provincial and 

municipal governments.

• China should refrain from actions that represent backsliding from the 

spirit of the WTO, even if they are not strictly WTO violations. While not 

a violation of specific WTO commitments, certain new Chinese directives and policy announcements are of concern to U.S. companies. For example, a draft procurement directive under consideration in Beijing could limit Chinese government 

purchases of foreign software, while a draft industrial policy for the automotive 

sector contains recommendations and guidance that appear to be contrary to the 

spirit of China’s auto commitments.

• If China does not adequately address compliance deficiencies, it is likely 

to face an increase in both bilateral and multilateral disputes, including 

at the WTO. If there is not progress in addressing some of the WTO shortcomings identified in this report, we are likely to see increased challenges to 

China, both in the bilateral and multilateral context. Taking trade disputes to the 

WTO should be viewed as a last resort after dialogue and direct negotiations have 

failed, but the United States must be willing to consider the WTO dispute resolution system when progress is elusive. At the time of this writing, China’s failure 

thus far to implement its commitment on agricultural tariff-rate quotas (TRQs) 

could be the first case that the United States will take to the WTO.

• U.S. businesses are ready and willing to work with China to develop constructive solutions to trade differences. U.S. businesses recognize that trade 

disputes serve neither side’s interest, and there is a serious commitment to work 

with China to facilitate its progress toward implementation through such means 

as technical assistance and issue consultations. There are promising examples of 

healthy dialogue in a number of industries where differences related to China’s 

WTO commitments have arisen, including in the insurance, express delivery services, and direct-selling industries. This report offers additional recommendations 

of steps China can take to both fulfill its obligations and underpin the healthy 

development of its economy. 

Executive Summary of Recommendations 

AGRICULTURE

• China’s General Administration of Quality Supervision, Inspection, and Quarantine (AQSIQ) should restrict its activities to import quarantine procedures 

that are science based and compliant with WTO and international conventions 

and should not impose delays, uncertainties, or commercially discriminatory or 

commercially unrealistic requirements that inhibit free trade. • AQSIQ should approach the approval of import permit requests in a timely and 

commercially realistic manner. 

• AQSIQ should ensure that all formalities are transparent, with clear timelines 

openly promulgated. 

• China should honor its TRQ obligations and not engage in such practices as delaying announcements; granting insignificant, uneconomic quotas; applying restrictions that are not required of domestic producers or merchants; or designing nontariff trade barriers that circumvent TRQ obligations. 

• China should ensure that there is greater transparency in the TRQ process and 

comply with the requirement to publish a list of importers that have been 

granted TRQ allocations.

Issue Assessment: While there has been progress in some areas, the agriculture 

industry continues to face a range of Chinese government actions that have held 

back the potential growth in U.S.-China agricultural trade. 

AUTOS

• China should put in place a regulatory structure that reflects global norms and 

not institute capitalization requirements and net asset ratios for auto loan institutions that act as market access barriers. In light of the nearly two-year delay 

in implementing its auto finance commitments, China should expedite the approval of applicants. 

• Draft regulations covering distribution services should be made available for 

prior public comment, and final regulations must allow foreign-invested auto 

enterprises to engage in distribution activities as soon as possible, with no requirement of a separate distribution system for domestic and imported autos. 
198

• The allocation of the remainder of the 2002 and 2003 auto quotas and the reallocation of unused 2002 and 2003 quotas should take place promptly. China 

should also provide assurances that there will be a fair, transparent, and open 

process for the 2004 quota application and allocation. 

• China should actively enforce compliance with the WTO’s Trade-Related Intellectual Property Rights (TRIPs) agreement as it applies to the automotive industry. 

• China’s draft auto industrial policy should be modified to bring it fully in line 

with the letter and spirit of its WTO commitments.

Issue Assessment: Auto finance reform is nearly two years behind schedule, and 

delays in the release of the relevant regulations have hindered the ability of U.S. 

automakers to realize some of the expected benefits of China’s WTO accession. 

Greater transparency in regulatory processes and in procedures for quota application and allocation is necessary to fully and fairly implement the WTO automotive 

quota. 

EXPRESS DELIVERY SERVICES

• New postal legislation must reflect China’s WTO commitments and not allow 

China Post to extend its existing monopoly to new areas. 

• The new legislation should define the scope of the postal monopoly as packages 

and documents weighing less than 350 grams where the price is less than three 

times that of the lightest ordinary mail over the shortest domestic distance. In 

two years, this should be reduced to 250 grams and two times the price of ordinary mail; two years later, it should be reduced to 150 grams and the price of 

ordinary mail. 

• Although not technically a WTO mandate if certain requirements are met, 

China should ensure competition and efficiency by separating the postal regulatory function and the postal business function into different and independent 

entities. The postal regulator should focus on the quality of postal service, pricing related to cost, and related accounting systems to prevent abuse of the exclusive rights granted to the universal service provider. 

• China should regulate businesses that operate outside the scope of the defined 

postal monopoly by using a nonpostal regulator, such as the Ministry of Commerce, for international freight forwarders.

Issue Assessment: The lack of an independent regulator creates challenges in the 

express delivery services sector, where China Post is trying to use its regulatory authority to expand its postal monopoly into a market already well served by existing 

commercial operators. U.S. industry representatives are encouraged at the dialogue 

with Chinese officials on draft postal legislation, but China will ultimately be judged 

by the extent to which the new law complies with its WTO commitments. 

FINANCIAL SERVICES

• China should bring registered capital requirements in line with global best 

practices and regulatory standards. 

• China should improve the clarity and specificity of financial services regulations 

and administrative measures and consistently provide advance notice and reasonable comment periods on proposed measures. 

• China should allow foreign insurance companies to expand geographically according to the terms of its WTO commitments and permit the use of a single 

branch/sub-branch structure throughout the country without any additional 

capitalization requirements or lengthy application processes. 

• China should allow foreign insurance companies to establish more than one 

branch at a time—that is, on a concurrent, not consecutive basis—commensurate with domestic counterparts. 

• China should adopt prudential criteria for the banking sector based on international norms and should avoid the use of borrowing restrictions that limit the 

efficient functioning of the market. 

• China should avoid proposals that would limit the maturity of interbank transactions and create difficulties for banks to match the maturity structure of their 

assets. 

• China should make the qualified foreign institutional investors system more 

workable by eliminating some of the requirements under the current system.

Issue Assessment: China has begun to implement its WTO obligations in the financial services sector by revising its laws, regulations, and administrative practices, but excessive capitalization requirements are limiting the healthy development of the market. 
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INTELLECTUAL PROPERTY RIGHTS

• China should undertake a coordinated nationwide intellectual property rights 

(IPR) enforcement campaign against traditional (e.g., book, cassette) and recent 

or emerging (e.g., CD, VCD, DVD, Internet-related) piracy, end-user piracy of 

software and other copyrighted materials, and counterfeiting. China should also 

immediately eliminate the high criminal thresholds and procedural obstacles 

that prevent the effective use of criminal prosecutions in addressing IPR violations. At the same time, China should make revisions to the Penal Code such 

that it fully applies to all rights under copyright as well as all other piracy-related crimes. 

• China should take similar effective enforcement actions in other manufacturing 

sectors to stem the tide and culture of piracy, including in areas such as pharmaceuticals that pose grave public health risks. 

• China should take more effective customs and border measures to curtail the 

massive importation of pirated materials into the country. 

• China should continue with its efforts to train judges in IPR laws; provide adequate resources to relevant police, prosecutors, and administrative agencies; 

and ensure that penalties for intellectual property violations are sufficiently 

strong to serve as a deterrent. 

• China should ratify the World Intellectual Property Organization Copyright 

Treaty and the Performances and Phonograms Treaty.

Issue Assessment: Improvements in China’s IPR legal framework must be 

matched by greatly enhanced enforcement efforts at the local level. 

TELECOMMUNICATIONS SERVICES

• China should not reduce the scope of its commitments in the category of valueadded services by reclassifying them as ‘‘basic’’ services, a category that is far 

more restrictive for foreign investors. The capitalization requirements that 

China has established for providers of basic telecommunications services are unrealistic, bear no reasonable relationship to commercial or public interest requirements, and constitute a barrier to entry. This high capitalization requirement should be eliminated. 

• China should promote greater transparency in legal and regulatory proceedings, 

including the consistent use of required advance notice and comment periods. 

• China should take steps to increase the independence of the regulator, the Ministry of Information Industries, from the major state-owned telecommunications 

operators. 

• China should cease to restrict the ownership and operation of international 

gateways to wholly owned telecom service providers.

Issue Assessment: China’s classification of value-added services has become more 

restrictive in the period since WTO accession. The reduction in the scope of valueadded services and the increase in the scope of basic services are especially problematic given the unreasonably burdensome registered capital requirement for foreigninvested basic service joint ventures. 

TRADING RIGHTS AND DISTRIBUTION SERVICES

• China should put forward transparent and WTO-consistent regulations that 

spell out precisely how U.S. enterprises can begin to realize the benefits of China’s commitments in the area of trading rights and distribution services. 

• These regulations should eliminate the artificial restrictions imposed on companies that made investments in China before its accession to the WTO and 

should make clear that all companies may conduct operations in China as they 

would anywhere in the world. 

• China should make draft rules relating to trading rights and distribution services available for prior public comment.

Issue Assessment: China’s trading rights and distribution services commitments 

are now the subject of serious discussion between Chinese officials and U.S. negotiators regarding China’s interpretations of their commitments in this area. 

A TWO-YEAR ASSESSMENT 

A Look Back at Year-One Developments 

The September 2002 report of the U.S. Chamber’s China WTO Implementation 

Working Group represented the group’s views on how China’s WTO implementation 

efforts were proceeding nine months into its membership in the global trading body. 

That report highlighted a number of positive areas where China had faithfully complied with its obligations and where its efforts—in such areas as WTO education 
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and training—were indicative of a high-level commitment. That report also highlighted areas where compliance had certain shortfalls. 

Many of our initial assessments are still valid today. China seems committed to 

the WTO process, but there remains a continued need for progress, including in 

such areas as regulatory transparency and the establishment of fully independent 

regulatory bodies—that is, regulators that are not also competing in the market. 

With respect to individual industries, excessive capitalization requirements in the 

financial sector, delays in permitting nonbank institutions to provide auto financing, 

the lack of a functioning agricultural TRQ system, and continued delays in granting 

permanent approvals for genetically modified crops are among the year-one issues 

that carry over as concerns. 

On the positive side, tariff cuts continue to be made in a transparent fashion and 

according to the agreed upon timetable. This past year also saw progress with respect to China’s participation in the Information Technology Agreement (ITA) as the 

country removed certificate requirements on 15 tariff items that previously had to 

meet conditions before qualifying for the ITA tariff rates. In addition, as just one 

example of consultations with foreign companies to develop WTO-consistent regulations, the direct-selling sector has been pleased by the willingness of the new Ministry of Commerce to consult with companies about the form and substance of new 

regulations being drafted to govern that industry. 

While the 2002 report did not mince words about our expectation of full compliance, it reflected our members’ understanding about the scope and likely challenges 

of the effort ahead. It recognized the time that would be needed to develop or amend 

literally thousands of regulations to ensure their compliance with China’s WTO commitments and to put in place the physical and human capacity to implement those 

regulations in a transparent and predictable manner. 

One year later, expectations are rising, and the degree of progress in implementing WTO commitments in year two and beyond will impact how quickly China’s own economic modernization efforts proceed, how foreign investors view opportunities in that important marketplace, and how political leaders in the United 

States, particularly in the U.S. Congress, approach the bilateral relationship. 

New Commitments and Expectations for 2003

China’s commitments in the second year of its WTO membership range from the 

continuation of tariff cuts that began upon its accession to the second phase of gradual market openings being implemented over a period of years. Some of the most 

significant commitments in the second year include those related to financial services, telecom services, and trading rights and distribution services. Many of these 

are highlighted below.

SELECTED YEAR-TWO COMMITMENTS

Tariff Rates by January 2003

China’s second-year tariff commitments took effect January 1, 2003, and were administered with few anomalies.

Customs Valuation by December 2003

China must adopt two WTO customs valuation decisions concerning the treatment 

of interest charges and the valuation of carrier media-bearing software for data 

processing equipment.

Value-Added Telecommunications Services by December 2003

China must permit foreign suppliers to establish joint ventures (with no more 

than 50% foreign equity) with no geographic restrictions.

Advertising by December 2003

China must permit foreign majority ownership in advertising firms.

Financial Services

Life/Nonlife Insurance by December 2003

China must allow foreign life and nonlife insurers and brokers to operate in the 

Chinese cities of Beijing, Chengdu, Chongqing, Fuzhou, Ningbo, Shenyang, Suzhou, 

Tianjin, Xiamen, and Wuhan. China must allow foreign nonlife insurers to provide 

the full range of nonlife insurance services to both foreign and domestic clients.
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Banking by December 2003

China must allow foreign banks to provide local currency services in Chengdu, 

Chongqing, Fuzhou, and Ji’nan, as well as local currency services to Chinese enterprises.

Securities by December 2003

China must allow foreign providers to establish fund management joint ventures 

(limited to a 49% equity stake).

Trading Rights and Distribution Services

Right to Trade by December 2003

By December 11, 2002, foreign-invested enterprises holding minority foreign 

shares were to receive full trading rights, and those holding majority foreign shares 

must receive those rights by December 2003. There are ongoing reductions (continuing through December 2004) in the list of goods to be traded only by companies 

designated by the central government (affects natural rubber, timber, plywood, wool, 

acrylic, and some steel products).

Wholesale and Commission Agents’ Services by December 2003

China must permit foreign distributors of most products to establish majorityowned enterprises with no geographic restrictions.

Retailing Services by December 2003

China must permit foreign retailers of most products to establish majority-owned 

enterprises with no geographic restrictions.

Source: General Accounting Office and U.S. Chamber analysis of China’s WTO commitments.

This testimony makes constructive recommendations regarding some of the highpriority trade differences with China in the hope of avoiding more serious trade disputes. Let’s take a closer look at some key areas. 

AGRICULTURE 

China’s WTO commitments to reduce both tariff and nontariff barriers in the agricultural sector have met with mixed results. There has been welcome progress in 

some key areas such as tariff reductions. Unfortunately, however, many nontariff 

barriers continue to limit the progress anticipated from China’s WTO membership. 

Some of the key issues that need to be addressed include

• a range of problems with the implementation of China’s promised TRQ system, 

including a lack of transparency, delay in the announcement of quotas, granting 

of insignificant and uneconomic quotas, imposition of restrictions that are not required of domestic producers or merchants, and other unnecessary restrictions; 

• uncertainty regarding biotech regulations and the issuance of permanent safety 

certificates for biotech products; 

• labeling and information requirements on meat and poultry products that raise 

export costs without enhancing food safety; 

• administrative interference with import trade by China’s quarantine authorities 

and Ministry of Commerce, including requirements that importers get import permits before signing purchase contracts and making shipments; 

• significant export subsidies for agricultural products, particularly corn; and 

• Chinese adherence to the WTO’s Agreement on the Application of Sanitary and 

Phytosanitary Measures. There is particular concern regarding the failure to utilize the International Plant Protection Convention, ‘‘zero tolerance’’ pathogen 

standards that are neither science based nor practical, and undue quantitative restrictions on meat and poultry imports.

The agricultural TRQ issue has the potential to be the first case against China 

under the WTO dispute resolution system. 

The U.S. Chamber’s September 2002 report called for science-based, permanent 

rules for genetically modified organism (GMO) imports, a transparent TRQ system, 

and an end to agricultural export subsidies. 

While China has eliminated or reduced some tariff barriers, the benefits from 

these actions can be quickly offset by continued nontariff barriers that restrict trade 

into China, create significant marketplace uncertainty, and discourage further foreign investment. 
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1 China’s Ministry of Commerce and National Development and Reform Commission have recently published a draft regulation amending management of TRQs for imported agricultural 

products. At the time of writing, the U.S. Chamber of Commerce is uncertain whether the draft 

regulation will address the current concerns of the U.S. agriculture sector with respect to China’s TRQ systems. 

We urge the governments of China and the United States to work collaboratively 

to reduce these unjustified barriers to agricultural imports and the modernization 

of Chinese food production. 

For 2003, the U.S. Chamber has chosen to highlight two specific areas where reform is urgently required for China to comply with the spirit of its WTO commitments: (i) regulatory practices of AQSIQ and (ii) agriculture TRQ systems. 

AQSIQ Regulatory Practices 

U.S. soybean, cotton, and meat traders have reported significant restrictions on 

exports of products to China stemming from AQSIQ’s posture on the issuance of Import of Animal and Plant Quarantine permits and its inspection procedures. Chinese 

quarantine regulations require importers to obtain import permits before entering 

into purchase contracts and effecting shipments. With import permits valid for only 

90 days, buyers are locked into a very narrow period to purchase, transport, and 

discharge their cargoes before expiration of the permits. 

While the technical requirement imposed on importers is to obtain an import permit in advance of contracting for commodity shipments, the current AQSIQ requirement is essentially unworkable as importers buy products when prices are low—

sometimes months ahead of actual shipment. Contracting parties cannot wait to obtain an import permit first before making a contract for shipment of commodities. 

Although China removed soybean import quota control in 1999, the Chinese government now appears to control import volume through WTO-inconsistent methods 

such as the use of quarantine import permits. Many of the administrative requirements of the import permit system—such as factory inspections, the requirement 

that buyers not import more than they did in previous years, rules that restrict buyers from using premium/basis or other forward delivery contracts, and rules that restrict the issuance of permits only to processing plants and not to traders supplying 

multiple plants—have no relevance to the enforcement of animal and plant health 

regulations. The requirement for a surface inspection of imported grain and feed ingredients prior to discharge has no scientific validity. 

AQSIQ has recently slowed the issuance of permits, which has resulted in significant commercial uncertainty and, in some cases, has placed U.S. foreign investment 

in the Chinese agricultural sector at risk. Because of the commercial necessity to 

contract for commodity shipments when prices are low, combined with inherent 

delays in having import permits issued, many cargoes of soybeans end up arriving 

in Chinese ports without import permits. This has created delays in vessel discharge 

and resulted in demurrage bills for Chinese buyers. 

AQSIQ has committed to notify importers about the result of their permit applications within 30 days of receipt. However, some importers are waiting well beyond 

30 days without obtaining any feedback from AQSIQ, as it appears that provincial 

inspection and quarantine offices that act as intake centers for import permit applications are asked to delay submitting these applications to AQSIQ in Beijing. This 

effectively extends the 30-day notice period AQSIQ has to respond to the party requesting an import permit. 

Most recently, AQSIQ has suggested to foreign diplomats that it will take action 

to restrict specific firms from exporting or importing soybeans based on allegations 

that the firms have failed to meet certain quarantine regulation and mandatory 

quality requirements. 

Recommendations: 

• China’s General Administration of Quality Supervision, Inspection, and Quarantine (AQSIQ) should restrict its activities to import quarantine procedures 

that are science based and compliant with WTO and international conventions 

and should not impose delays, uncertainties, or commercially discriminatory or 

commercially unrealistic requirements that inhibit free trade. • AQSIQ should approach the approval of import permit requests in a timely and 

commercially realistic manner. • AQSIQ should ensure that all formalities are transparent, with clear timelines 

openly promulgated. 

Agricultural Tariff Rate Quotas 

China has not made sufficient progress 1 in implementing tariff-rate quotas for 

bulk agricultural commodities such as wheat, corn, cotton, and vegetable oil in a 
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manner that opens the market to trade as anticipated under China’s WTO accession 

agreement. Regulations designed to establish TRQ systems were late in being released, lacked sufficient transparency, and introduced unreasonable licensing procedures for importers. In some cases, China contravened its accession agreement by 

allowing TRQs reserved for ‘‘nonstate trading companies’’ to be issued to stateowned enterprises. 

The TRQs for corn and wheat in many cases were distributed in such small quantities as to render them uneconomic to fulfill. When TRQs were issued, it has been 

very difficult, if not impossible, to ascertain which companies were granted quotas, 

and the authorities responsible have refused to publish full lists of quota recipients, 

in violation of the WTO agreement. 

We are encouraged by China’s recent proposed elimination of current State Development and Reform Commission requirements that a significant portion of each 

TRQ be used only for processing and mandatory reexport of finished products. This 

restriction is most important for cotton, where well over one half of the TRQ has 

been restricted to reexports, and represents a violation of China’s accession agreement. 

Recommendations: 

• China should honor its TRQ obligations and not engage in such practices as delaying announcements; granting insignificant, uneconomic quotas; applying restrictions that are not required of domestic producers or merchants; or designing nontariff trade barriers that circumvent TRQ obligations. 

• China should ensure that there is greater transparency in the TRQ process and 

comply with requirements to publish a list of importers that have been granted 

TRQ allocations. 

AUTOS 

China’s WTO commitments in the automotive sector were designed to address a 

range of policies and practices that limited the ability of automakers to fully engage 

in the Chinese automotive market. These commitments include a significant reduction in automotive tariffs, phaseout of auto tariff quotas and licensing requirements, 

easing of restrictions on investment, permission of nonbank automotive financing, 

phasein of trading rights and distribution services, full adherence with the WTO 

agreement on technical barriers to trade for auto standards and certification, and 

active enforcement of the WTO agreement’s commitments on intellectual property. 

Overall, compliance with these commitments has been uneven. The commitment 

China made to lower tariff rates has largely been met. In many other areas, however, China has fallen short of fully meeting its obligations. 

A case in point is in the area of auto financing. China agreed that upon accession 

it would allow nonbank financial institutions to provide auto financing without limitations on market access or national treatment. Almost two years later, final implementing regulations have not been issued, and the most recent draft regulations 

contain excessive capitalization requirements and net asset ratios that are significantly higher than are found in other markets around the world. These requirements will make it difficult for U.S. and other foreign firms to provide these services 

to consumers in China, which will, in turn, dampen the demand for automobiles in 

China and reduce the economic contribution that the auto sector can make to the 

Chinese economy. 

With regard to its auto quota and import licensing commitments, China agreed 

to a three-year global auto quota for the importation of finished motor vehicles and 

select components. The quota was US$6 billion for the first year (2002) and is scheduled to grow 15% annually until all quota restrictions are eliminated by January 

2005. While the 2003 import quota on motor vehicles (US$9.125 billion) exceeded 

minimum WTO commitments to expand the quota levels, the delay in issuing the 

regulations and quota allocations has resulted in uncertainty and significant disruption of distribution and retail businesses for imported vehicles. 

China also committed to phase in trading and distribution rights for joint ventures and foreign-owned enterprises within three years of accession. The ability of 

automakers to fully utilize trading rights to freely bring in motor vehicles and distribute them to complement the vehicle models manufactured in China is critically 

important. This will enable automakers to market a wide range of vehicle options 

and provide consumers with more choices. Although draft implementing regulations 

granting and governing trading rights and distribution services have not yet been 

released, there is a growing concern that automakers will be required to establish 

separate distribution systems for domestic and imported vehicles, which would 

clearly be inconsistent with the intent of the WTO commitments on trading rights 

and distribution services. 
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Protection and enforcement of IPR, as defined in the WTO TRIPs agreement, is 

increasing in importance to automakers operating in China. Since China’s accession 

to the WTO, there has been an increase in IPR violations of automotive products, 

such as automotive braking, steering, and emissions systems. The violations have 

an adverse commercial impact on those automakers that hold the patents and trademarks for these products, but more importantly, they pose a serious safety and 

health risk to Chinese citizens. 

In early May 2003, China released for comment a draft update of the industrial 

policy governing China’s automotive industry. In general, the policy appears to promote a return to top-down, government-directed management of the fundamental 

structure and scope of the industry. For example, the policy contains guidance on 

the close management of automotive production, investment, distribution, trade, and 

technology, which is inconsistent with the great strides China has taken toward a 

more market-oriented economy. We are encouraged that China is seeking input on 

the draft auto industrial policy and support modification of the policy to ensure that 

it is fully consistent with the letter and spirit of China’s WTO commitments. 

Recommendations: 

• China should put in place a regulatory structure that reflects global norms and 

not institute capitalization requirements and net asset ratios for auto loan institutions that act as market access barriers. In light of the nearly two-year delay 

in implementing its auto finance commitments, China should expedite the approval of applicants. • Draft regulations covering distribution services should be made available for 

prior public comment, and final regulations must allow foreign-invested auto 

enterprises to engage in distribution activities as soon as possible, with no requirement of a separate distribution system for domestic and imported autos. • The allocation of the remainder of the 2002 and 2003 auto quotas and the reallocation of unused 2002 and 2003 quotas should take place promptly. China 

should also provide assurances that there will be a fair, transparent, and open 

process for the 2004 quota application and allocation. • China should actively enforce compliance with the WTO’s TRIPs agreement as 

it applies to the automotive industry. • China’s draft auto industrial policy should be modified to bring it fully in line 

with the letter and spirit of its WTO commitments. 

EXPRESS DELIVERY SERVICES 

In the U.S. Chamber’s 2002 report, it called on China to prohibit the State Postal 

Bureau, which is both a regulator and a competitor in the market, from acting inconsistently with its WTO obligations by adopting measures that either expand the 

traditional postal monopoly to new areas, such as express delivery, or accord more 

favorable treatment to China Post when supplying express delivery services in direct competition with private operators. In 2003, express delivery service providers 

continue to call for WTO-consistent regulations and laws that encourage, not hinder, 

competition. 

China needs to separate China Post’s regulatory functions from its business operations, define the postal monopoly as narrowly as possible, and promote fair competition in sectors, such as express delivery, where China Post competes with private-sector operators. Express delivery companies can then operate outside the 

scope of the defined postal monopoly without obtaining any entrustment or approval 

from China Post. 

U.S. industry representatives are concerned that the current draft revisions to 

China’s postal law, which the National People’s Congress (NPC) has announced that 

it will pass this year, violate China’s WTO market access and national treatment 

commitments. The draft law would expand China Post’s monopoly to all shipments 

under 500 grams, which would greatly impair the ability of express delivery carriers 

to provide services in China. 

Express delivery companies are encouraged that the NPC and the State Council’s 

Legislative Affairs Office have met with them to discuss this draft and appear to 

be making a serious effort to listen to the views of foreign participants in the market. But China will be judged by its actions. The draft must be revised to reflect 

China’s WTO commitments and to promote beneficial competition in the market. 

Specifically, China must remove the existing 500-gram threshold for shipments in 

the draft postal legislation. These restrictions would allow China Post, the dominant 

carrier, to extend its monopoly from private letters to other shipments. 

Recommendations: 

• New postal legislation must reflect China’s WTO commitments and not allow 

China Post to extend its existing monopoly to new areas. 
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• The new legislation should define the scope of the postal monopoly as packages 

and documents weighing less than 350 grams where the price is less than three 

times that of the lightest ordinary mail over the shortest domestic distance. In 

two years, this should be reduced to 250 grams and two times the price of ordinary mail; two years later, it should be reduced to 150 grams and the price of 

ordinary mail. 

• Although not technically a WTO mandate if certain requirements are met, 

China should ensure competition and efficiency by separating the postal regulatory function and the postal business function into different and independent 

entities. The postal regulator should focus on the quality of postal service, pricing related to cost, and related accounting systems to prevent abuse of the exclusive rights granted to the universal service provider. 

• China should regulate businesses that operate outside the scope of the defined 

postal monopoly by using a nonpostal regulator, such as the Ministry of Commerce, for international freight forwarders.

FINANCIAL SERVICES

Insurance 

Since joining the global trading body, China has made considerable progress toward openness and the acceptance of international norms, and much of this progress 

has come in the financial services sector where China made substantial liberalization commitments. In insurance, foreign nonlife carriers will be able to provide insurance to indigenous Chinese companies by the end of 2003. In addition, China will 

eliminate geographic limitations on foreign insurance company expansion by the end 

of 2004. Foreign companies may already provide master policies (if the headquarters 

of the insured is located within the insurer’s licensed city) and large-scale commercial risks without geographic restrictions. Moreover, under China’s WTO obligations, 

foreign insurance brokers may now form joint ventures and may gradually transition to wholly owned foreign enterprises by December 2006. 

Some of China’s reforms go beyond its WTO commitments. Allowing nonlife insurance companies to provide accident and health products, under the terms of the recently amended Insurance Law, is an encouraging development. China has not, 

however, succeeded in meeting all of its commitments, and significant challenges remain. The U.S. Chamber is pleased with recent actions by CIRC offering public comment periods on the ‘‘Trial Implementing Rules on the Regulations of the People’s 

Republic of China for the Administration of Foreign-Invested Insurance Companies’’ 

and ‘‘The Administrative Regulations on Insurance Companies’’ and applauds this 

move to realize China’s transparency commitments. 

However, certain draft regulations are inconsistent with China’s WTO obligations, 

including the requirement for insurers to convert existing branch operations to local 

subsidiaries. China should also allow insurers to conduct business on a branch/subbranch operating structure, as is widely permitted under established international 

norms. Foreign insurers await CIRC’s reply to their request for confirmation of their 

understanding on a series of issues that they have identified as vague regarding the 

treatment of domestic and foreign companies, including from the national treatment 

standpoint. Generally, foreign insurers believe China’s drafts are a move in the 

right direction and expect CIRC to provide further clarification during its next meeting with industry representatives and officials from the Office of the U.S. Trade 

Representative. Such a meeting will represent the next stage in an ongoing dialogue 

and collaborative process initiated in December 2002. Given the number of outstanding questions that exist on a range of significant issues, foreign insurers consider it important that the next meeting be held during the fall of 2003. 

The current approach of specific regulations for domestic insurers and separate 

regulations for foreign insurers may be necessary in the early stage of opening the 

insurance sector. However, as China implements national treatment for all insurers, 

we look forward to the day when China will have a single, unified set of regulations, 

based on international best practices, for all insurance companies operating in 

China. 

At this time, of greatest concern are the following three issue areas:

Excessively High Registered Capital Requirements

The U.S. Chamber’s 2002 China WTO compliance report called for policies that 

would allow foreign insurance companies to establish a branch with a reasonable 

initial capitalization backed up by the strength of the parent organization. It also 

called on China to permit geographic expansion in compliance with scheduled phaseouts of geographic restrictions and without having to separately capitalize each location. Unfortunately, in 2003, excessive capitalization requirements to enter or ex-
206

pand in the insurance market remain a major concern for many U.S. Chamber 

members. 

China’s imposition of extremely high registered capitalization requirements—substantially higher than similar requirements in the vast majority of insurance markets throughout the world—has negative implications for both foreign and domestic 

insurers. Such high capitalization requirements severely limit the WTO benefits of 

greater market access for foreign firms seeking to enter the market and the removal 

of geographic restrictions on firms already in the market. These requirements also 

represent a poor utilization of capital for all insurers, preventing them from using 

capital efficiently and thus hindering the sound development of an important component of China’s integration into the world economy. 

China’s current regulations were put in place when the Chinese insurance market 

was relatively closed and when regulations sought to govern a primarily domestic 

insurance industry. Those regulations may have made good sense at that time and 

in that context. But China’s growing role in the global economy requires the acceptance of global practices and regulatory standards as the Chinese are now regulating 

global insurers with global assets, not just domestic insurers with domestic assets. 

The modernization of these requirements will help China achieve its goal of a more 

developed, open, and competitive market for the benefit of insurance consumers 

throughout the country. 

Capital requirements that emphasize overall insurer solvency over registered capital would free up resources that would allow both domestic and foreign insurers 

to introduce new products and technologies and help build a thriving insurance market. In place of excessive capitalization requirements, levels could be calibrated according to the scale of a company’s business and levels of risk being covered, which 

would address any present or future concerns about the viability of smaller market 

players.

Lack of Transparency and Clarity in Regulatory Environment

China should provide more clarity and specificity with respect to insurance regulations and administrative measures. A number of China’s insurance regulations are 

vague and permit a wide degree of bureaucratic discretion, which has led to confusion, misinterpretation, and inefficient operating practices. In line with its WTO 

commitments, as well as internationally accepted standards and good business practices, China should make consistent use of advance notice and comment periods. 

Both local and foreign insurance professionals should be given a reasonable period 

of time to review and comment on proposed new measures. 

In the past, the Chinese Insurance Regulatory Commission (CIRC) rarely allowed 

insurance companies and/or other interested parties to comment on draft measures 

before they became effective. CIRC should take advantage of the international experience that many foreign insurance professionals bring to China and work more 

closely with the private sector to ensure the development and acceptance of timely, 

market-oriented, and economically sound policies. CIRC should also establish and 

maintain a regular dialogue with industry experts and consumers to address the 

needs of the industry and consumers of insurance services. 

U.S. insurance companies are pleased by the dialogue CIRC has undertaken with 

a U.S. Government-industry group and hope to contribute to solutions that will both 

promote solvency and build an internationally competitive Chinese insurance market.

Restrictions on Branch/Sub-branch Operating Structure

China’s WTO commitments on branching clearly state that China will permit 

branching consistent with the phaseout of geographic restrictions. But China’s current regulations do not allow insurers to sub-branch off a branch operation except 

within the immediate, licensed territory (e.g., Shanghai). While foreign and domestic 

companies may apply for more than one branch at a time, the Chinese government 

has not approved more than one branch at a time for foreign insurers. In addition, 

China has not permitted geographic expansion of existing foreign life insurance companies with the same corporate structure they had established before China’s WTO 

membership. 

Without a change in current practice, foreign insurers will be unable to achieve 

the economies of scale necessary to build a truly national business like their domestic counterparts. This means that both commercial and individual consumers will 

remain underserved in many parts of China and will not benefit from the competition that market opening was intended to stimulate. 

Foreign insurance companies should be allowed to expand geographically in China 

in line with established international norms and operating practices (i.e., through 
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the use of the internationally accepted branch/sub-branch structure). Specifically, 

foreign insurance companies should be able to establish a branch with a reasonable 

initial capitalization backed up by the strength of the parent organization. They 

should be allowed to expand throughout the country—in accordance with China’s 

timetable for the phaseout of geographical restrictions—through the establishment 

of sub-branches that are not limited to the immediate, licensed territory. Additionally, the company should not have to separately capitalize each new location. 

In most countries, when insurance companies enter foreign markets, they are allowed to establish an initial branch and then expand to new locations throughout 

the country through a network of sub-branches that report to the original branch. 

This branch/sub-branch structure is supported by, and legally tied back to, its corporate parent. Thus, branch operations should not be treated as if they were separate, stand-alone entities. Likewise, because a branch/sub-branch structure is supported by its parent corporation’s assets, the company should not have to recapitalize when expanding to a new location. This branch/sub-branch operating structure is an established international norm and a widely accepted principle of operation. 

Recommendations: 

• China should bring registered capital requirements in line with global best 

practices and regulatory standards. 

• China should improve the clarity and specificity of insurance regulations and 

administrative measures and should consistently provide advance notice and 

reasonable comment periods on proposed measures. 

• China should allow foreign insurance companies to expand geographically according to the terms of its WTO commitments, and should permit the use of 

a single branch/sub-branch structure throughout the country without any additional capitalization requirements or lengthy application processes. 

• China should allow foreign insurance companies to establish more than one 

branch at a time—that is, on a concurrent, not consecutive basis—commensurate with domestic counterparts. 

Banking 

In the banking sector, concerns revolve around recent Bank of China proposals 

to limit the renminbi (RMB) interbank loan market and high dotational or endowment capital requirements for branches of foreign banks—which rise many times 

over for also conducting business in Chinese currency. 

The proposed regulation to cap borrowing at 40% of total liabilities and to limit 

borrowing tenors would lead to an inefficient use of capital, and would contravene 

national treatment principles by discriminating against foreign-funded financial institutions. The U.S. Chamber’s 2002 report also spoke out against such a cap, which 

would negatively impact the foreign-funded institutions that depend on this financing to serve their clients, mainly foreign-invested enterprises that are making positive contributions to the Chinese economy. 

Foreign banks depend on interbank RMB loan agreements as they are still not 

allowed to accept RMB deposits from Chinese enterprises or individuals, except in 

very limited cases. Moreover, foreign-invested enterprises deposits in RMB do not 

usually exceed what they borrow. Chinese banks are much less dependent on interbank refinancing as they do not face the same legal restrictions as do foreign banks 

regarding drawing on deposits and, unlike foreign banks, have access to the savings 

pool of Chinese citizens. 

China’s WTO commitments in the banking sector do not encompass such a borrowing restriction. Article XVI of the General Agreement on Trade in Services 

(GATS) says that, among other things, limitations on the total value of service 

transactions in the form of numerical quotas shall not be maintained or adopted in 

sectors where market access commitments are undertaken. Therefore, the cap is a 

violation of this article. And as a prudential measure, quota restrictions on certain 

refinancing sources are inferior to liquidity supervision approaches that relate the 

maturity structure of a bank’s liabilities to the maturity structure of its asset portfolio. 

Also a violation of the GATS article is the proposal that would restrict the maturity of interbank transactions to three years, in addition to the possible rollover of 

not more than half of the original maturity. Such a step could prevent banks from 

matching the maturity structure of their assets when they are already placed at a 

competitive disadvantage with respect to Chinese banks due to Bank of China minimum interest regulations on loans, a refinancing cartel of the Chinese banks, and 

a tax on foreign bank branches based on their interbank refinancing interest rate. 
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As China finalizes implementing regulations for financial services, the U.S. 

Chamber encourages the Chinese authorities to bring financial services capitalization levels and refinancing conditions in line with common global practices and regulatory standards. New regulations must not be allowed to undermine the benefits 

that the WTO accession agreement was designed to bring or to hinder China’s ability to develop a thriving financial sector. 

Recommendations: 

• China should bring banking sector capitalization levels and refinancing conditions in line with common global practices and regulatory standards. • China should adopt prudential criteria for the banking sector based on international norms and should avoid the use of borrowing restrictions that limit the 

efficient functioning of the market. • China should avoid proposals that would limit the maturity of interbank transactions and create difficulties for banks to match the maturity structure of their 

assets. 

Asset Management 

China’s entry into the WTO was a significant step in opening up the asset management market in China. Under the country’s accession agreement, foreign firms 

are permitted to own up to 33% of a Chinese asset management firm as of December 11, 2001, and up to 49% of an asset manager by December 11, 2004. For the 

asset management sector, the concerns regarding WTO implementation are similar 

to the challenges that exist within other segments of the financial services sector, 

including a lack of transparency and high capitalization requirements. 

When the China Securities Regulatory Commission (CSRC) published the draft 

joint venture rules under which foreign firms could participate in the asset management market, there was concern that the draft rules did not provide a complete list 

of objective criteria for approving foreign institutions. Unfortunately, when the 

CSRC adopted its final rules, it did not clarify the criteria that it intended to use 

in its approval process. Instead, it replaced the unclear text with language providing 

the CSRC with broad discretion to impose additional requirements for qualification 

of a foreign firm. Regulations that lack transparency or provide broad discretion to 

officials in approving applications create uncertainty for foreign firms that wish to 

enter foreign markets. Moreover, when the CSRC published the draft joint ventures 

rules for comment, interested persons had only 10 days to respond. 

Under the final joint venture rules, a foreign institution seeking to enter a Chi- nese joint venture must have no less than RMB 300 million [US$36 million] in capital. This high level of mandated capital for asset management firms is excessive 

and represents a barrier to entry. The business of asset management is not capital 

intensive, and client assets typically are not in the custody of the asset manager 

and are not at risk if the asset manager experiences financial reversals. Moreover, 

a high capital requirement disproportionately affects foreign asset managers because their operations in each country will typically not be as significant as their 

operations in their home country. 

A-Share Market 

China has taken steps to open the A-share market to foreign investors by adopting rules governing qualified foreign institutional investors (QFIIs). A number of aspects of the new QFII rules, however, limit their practicality by (1) restricting the 

percentage of an issuer’s securities that may be held by any one QFII and by all 

QFIIs in the aggregate, (2) requiring each QFII to commit total investments of at 

least US$50 million to a dedicated QFII account, (3) requiring the amount invested 

to remain in the QFII account for at least one year for open-end funds and three 

years for closed-end funds, and any remittances from the account to be approved 

in advance by the State Administration of Foreign Exchange, and (4) lacking specific 

criteria to be applied for certain aspects of the licensing process. 

Recommendations: 

• China should put in place transparent regulations and administrative practices 

to ensure that foreign firms will not be treated in an arbitrary manner and that 

approvals of applications will be based on objective and fair criteria and rules 

that protect investors. 

• China should provide a meaningful period of time for comment in promulgating 

financial services regulatory requirements. 

• China should reconsider the high capital requirements it has imposed on fund 

management companies. 

• China should make the QFII system more workable by eliminating some of the 

requirements under the current system as described above. 
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INTELLECTUAL PROPERTY RIGHTS 

China was required to fully meet its WTO obligations in the area of IPR protection before its accession on December 11, 2001. But after nearly two years of membership in the global trading body, it is clear that the country’s IPR enforcement 

system still has significant weaknesses and is far from effective. Upon accession, 

China’s laws and regulations and enforcement systems had to comply with the substantive and enforcement provisions of the TRIPs Agreement. Although the country’s statutory legal regime was largely in place prior to its accession, IPR enforcement continues to be a major concern, as it was in the Chamber’s 2002 analysis. 

The International Intellectual Property Alliance estimate of losses due to copyright piracy was US$1.85 billion in 2002, with piracy rates above 90%. Trademark 

and patent enforcement has fallen short as well. 

Enforcement of IPR, a key obligation under TRIPs, cannot be considered effective 

until civil and criminal penalties are routinely applied to infringers of IPR. While 

China’s government at the central and provincial levels carries out raids and other 

enforcement actions, there is limited coordination of these efforts and no commitment to pursue criminal prosecutions with deterrent penalties. Pirated music, 

books, (especially higher-education textbooks, pirated translations, and increasing 

counterfeiting using well-known publisher trademarks, authors’ names, and trade 

dress), business software, movies, and video games are readily available throughout 

the market, hindering the ability of both indigenous and U.S. creators and rights 

holders to build successful businesses. Newly emerging problems include Internet 

piracy, such as the illegal and unauthorized download of online journals and other 

materials. Without a strong criminal remedy, rights holders have turned to more 

expensive and less effective civil actions, which are not providing the necessary deterrent effect. 

Also worrisome are increasing reports of counterfeiting in industrial areas beyond 

the copyright industry. Manufacturing sectors, such as the automobile industry, report an increasing prevalence of theft of industrial designs. 

Ultimately, China will not continue to attract foreign investment in research and 

development if the resulting intellectual property will not be protected long enough 

for creators to see a return on that investment. And as more trade is stimulated 

through China’s continued implementation of its WTO commitments, IPR-related 

frictions are likely to grow with trading partners with resulting damage to China’s 

international reputation as an investment destination for knowledge-based industries. 

Pharmaceutical Industry Intellectual Property Concerns 

China is a large and increasingly significant market for U.S. pharmaceutical companies. In 2002, the country made positive strides in promulgating laws that will 

improve intellectual property protection for pharmaceutical products in China, including a regulation extending all patents to 20 years, as required by TRIPs. Other 

improvements include adopting provisions on data protection and patent linkage. 

But counterfeit pharmaceuticals continue to be a significant problem in China, especially over-the-counter products sold outside hospitals, of which 10%–15% are by 

some estimates counterfeit. Although Chinese authorities, including the State Food 

and Drug Administration (SFDA), are devoting time and resources to addressing 

this problem, success will be limited without laws on the books that strengthen 

criminal penalties for counterfeiters. 

Currently, only if a substandard pharmaceutical seriously injures someone is the 

infringer subject to incarceration. Affixing someone else’s intellectual property onto 

one’s own packaging or labeling only subjects the infringer to incarceration if the 

infringement is ‘‘serious.’’ Without criminal sanctions, including mandatory minimum incarceration at a relatively low threshold for all counterfeiting, it will be difficult to significantly curtail the counterfeiting of pharmaceuticals in China. And in 

the wake of the recent SARS epidemic, it is more important than ever that the Chinese authorities take effective actions to ensure the integrity of the drug supply. Action includes not only promulgating laws strong enough to take action against this 

criminal activity but also strong and consistent enforcement activities by law enforcement and judicial officials. 

In the area of data exclusivity, China committed to encourage clinical trial development by adopting provisions that would provide a six-year period of exclusivity. 

Data exclusivity encourages the investment into clinical trials by not allowing a second registrant to rely on the pioneer’s data package for the period of exclusivity. 

While the industry welcomed the promulgation of new regulations in 2002, it has 

still received relatively little feedback on how these provisions are to be implemented. 
210

On the issue of patent linkage, it is critical that the regulatory authorities at 

SFDA do not grant marketing approval to infringing generic producers of products 

receiving patent protection. Provisions to provide for such linkage between drug regulators and IPR agencies are found in Articles 11 and 12 of the Drug Registration 

Regulation. 

However, there is concern that the SFDA does not publish drug registration application information with a sufficient degree of transparency to enable the patent 

holder to identify a registration application of an infringing product. U.S. pharmaceutical companies look forward to working with Chinese drug registration authorities to increase transparency, both at the national and provincial levels. 

Recommendations: 

• China should undertake a coordinated nationwide IPR enforcement campaign 

against traditional (e.g., book, cassette) and recent or emerging (e.g., CD, VCD, 

DVD, Internet-related) piracy, end-user piracy of software and other copyrighted materials, and counterfeiting. China should also immediately eliminate 

the high criminal thresholds and procedural obstacles that prevent the effective 

use of criminal prosecutions in addressing IPR violations. At the same time, 

China should make revisions to the Penal Code such that it fully applies to all 

rights under copyright as well as all other piracy-related crimes. 

• China should take similar effective enforcement actions in other manufacturing 

sectors to stem the tide and culture of piracy, including in areas such as pharmaceuticals that pose grave public health risks. 

• China should take more effective customs and border measures to curtail the 

massive importation of pirated materials into the country. 

• China should continue with its efforts to train judges in IPR laws; provide adequate resources to relevant police, prosecutors, and administrative agencies; 

and ensure that penalties for intellectual property violations are sufficiently 

strong to serve as a deterrent. 

• China should ratify the World Intellectual Property Organization Copyright 

Treaty and the Performances and Phonograms Treaty. 

TELECOMMUNICATIONS SERVICES 

China’s Ministry of Information Industries (MII)’s classification of value-added 

services has become more restrictive and rigid in the period since WTO accession. 

The 2003 Telecommunication Services Classification Catalog moves several services 

from the value-added service category to the basic service category. Equally troubling, MII’s most recent catalog eliminates the value-added service of ‘‘code and protocol conversion’’ that China specifically listed in its WTO commitment. The current 

framework establishes a ceiling rather than a floor as to what qualifies as a valueadded service, providing no transparent opportunity for an applicant to demonstrate 

that a new and innovative unlisted service should qualify as a value-added service. 

This post-accession increase in barriers on value-added service providers runs contrary to China’s market-opening commitments. 

China’s reduction in the scope of value-added services and increase in the scope 

of basic services is especially problematic given the unreasonably burdensome registered capital requirement for foreign-invested basic service joint ventures. The 

Foreign-Invested Telecommunications Enterprises regulation specifies that basic 

service joint ventures must meet a 2 billion RMB (US$240 million) registered capital requirement to be eligible for application. This requirement ‘‘could not reasonably have been expected’’ when China’s commitments were made, as required by Article VI 5 (a)(ii), because it was effected by an administrative regulation dated December 11, 2001, after WTO members approved China’s accession on November 10, 

2001. The unjustified and unrealistic amount of this capital requirement bears no 

reasonable relationship to commercial or public interest requirements and represents a barrier to entry that China must eliminate. 

China should do more to improve the degree of transparency in it its regulatory 

processes, including providing required advance notice and comment periods. For example, the 2003 Telecommunications Service Classification Catalog was released in 

Chinese on the MII website without any prior notice or opportunity for public consultation. The effective date was two weeks following release, limiting any meaningful opportunity for public comment. 

Additional measures are necessary to increase the independence of the regulator—MII—from the major state-owned operators in the telecommunications industry. Currently, by designation, MII occupies dual roles as a protector of state enterprise operators and as the industry regulator. The first role should be removed without delay. 
211

Recommendations: 

• China should not reduce the scope of its commitments in the category of valueadded services by reclassifying them as ‘‘basic’’ services, a category that is far 

more restrictive for foreign investors. The capitalization requirements that 

China has established for providers of basic telecommunications services are unrealistic, bear no reasonable relationship to commercial or public interest requirements, and constitute a barrier to entry. This high capitalization requirement should be eliminated. 

• China should promote greater transparency in legal and regulatory proceedings, 

including the consistent use of required advance notice and comment periods. 

• China should take steps to increase the independence of the regulator—MII—

from the major state-owned telecommunications operators. 

• China should cease to restrict the ownership and operation of international 

gateways to wholly owned telecom service providers. 

TRADING RIGHTS AND DISTRIBUTION SERVICES 

A key year-two priority is ensuring that China will allow foreign firms to take 

full advantage of the trading rights (i.e., the right to import and the right to export) 

and distribution services commitments set forth in its WTO accession agreement. 

This area is one of the most critical to a wide range of industries and will be a key 

measure of how China’s implementation is evaluated. China’s trading rights and 

distribution services commitments are now the subject of serious discussion between 

Chinese officials and U.S. negotiators regarding China’s interpretations of their 

commitments in this area. 

Full compliance in the area of trading rights and distribution services is particularly important in China, as many of the companies that invested there in the years 

prior to its WTO accession were forced to agree to restrictions to normal business 

practices in order to enter the market. In granting full trading rights, China should 

remove all artificial restrictions on company operations, such as those placed on 

companies whose investment licenses specified that they could not sell imported 

products or products purchased from third parties. 

China committed to allow foreign-invested enterprises to receive full trading 

rights for virtually all products over a three-year period. Minority-share joint ventures should have received these rights—without having to satisfy export performance, prior experience, and other similar commitments—by December 11, 2002. In 

fact, regulations were vague about how this would happen and, in some cases, they 

made new requirements contrary to the stated commitment to provide full rights. 

With respect to distribution services (wholesaling, commission agents, retailing, 

and franchising), a similar three-year phasein is to take place. Foreign minority 

joint ventures providing direct retailing services (and subordinate and related services) were to have been permitted upon China’s WTO accession, subject to certain 

geographic and numerical limitations. Minority-share foreign joint ventures in 

wholesale business and commission agents’ business operations were to have been 

permitted by December 11, 2002. 

Currently, foreign-invested manufacturing enterprises may only engage in wholesale and commission agents’ services and may provide after-sales services for those 

products that they manufacture in China and, in some cases, for imported parent 

company products. Other enterprises with minority foreign ownership that obtain 

specific distribution licenses can provide these services, as well as direct retailing 

services, for others’ products, subject to stringent requirements not authorized by 

China’s accession agreement. And there is ongoing concern in the auto industry because China is reportedly considering requiring automakers to establish separate 

distribution systems for domestic and imported vehicles, which would be a clear violation of the national treatment principle. 

China has also issued vague, problematic measures covering subordinate and related services. A July 2002 Notice regarding foreign-invested logistics companies 

technically met China’s obligation to permit foreign minority joint ventures by December 11, 2002, but the text did not define precisely how enterprises could expand 

their business scope to include distribution. In addition, a November 2002 Notice 

opened up goods transport, loading and unloading, and warehousing to foreign majority ownership but capped foreign investment levels at 75%, contrary to China’s 

commitment not to impose such caps on foreign participation. 

Members of the China WTO Implementation Working Group are monitoring closely how distribution services commitments, one of the key benefits of China’s WTO 

accession, are implemented. 
212

Recommendations: 

• China should put forward transparent and WTO-consistent regulations that 

spell out precisely how U.S. enterprises can begin to realize the benefits of China’s commitments in the area of trading rights and distribution services. 

• These regulations should eliminate the artificial restrictions imposed on companies that made investments in China before its accession to the WTO and 

should make clear that all companies may conduct operations in China as they 

would anywhere in the world. 

• China should make draft rules relating to trading rights and distribution services available for prior public comment. 

Conclusion 

The U.S. Chamber’s China WTO Implementation Working Group believes that the 

Chinese government remains committed to implementing its WTO obligations as a 

crucial underpinning of its own economic development and modernization goals and 

has seen many examples of a willingness to work with the American business community as it seeks to fulfill its WTO obligations. 

We knew at the outset that this would be a complex undertaking. China would 

be amending or writing literally thousands of new laws and regulations as part of 

a fundamental transformation of its system, and this would not be a process without 

challenges. But in advocating for China’s WTO membership, our expectation has always been that this process would lead to a more open and transparent Chinese 

market based on the rule of law. In addition, we expect that China’s compliance 

with its commitments will create tangible examples of new business opportunities 

for exporters and investors. Unfortunately, evidence of new commercial opportunities is not yet as strong as it should be. 

At the end of the day, China will ultimately be judged on the extent to which it 

opens its markets, puts in place a more transparent system based on the rule of 

law, and creates a business environment in which foreign companies and Chinese 

companies alike can thrive. When China achieves this goal, we will see the kind of 

commercial results that American business and political leaders anticipated when 

they gave their strong support for China’s membership in the WTO. 

The U.S. Chamber will continue to represent the interests of its member companies doing business in China or seeking to do business there. By providing forums 

and other opportunities for dialogue and the fostering of new business relationships, 

we hope to contribute to the strengthening of U.S.-China relations. The U.S. Chamber urges the two governments and business communities to find ways to resolve 

WTO-related challenges through ongoing dialogue and consultations and stands 

ready and willing to assist in these efforts. 
213

U.S. CHAMBER OF COMMERCE

Washington, D.C. 20062–2000

WHAT GOES INTO A COMPANY’S FOREIGN

MARKET INVESTMENT DECISIONS? 

1. Internal Market—the size and potential for growth of the domestic market, 

especially the purchasing power of its customers are key. You don’t invest where 

you have little potential to make a profit.

2. Freedom of Access to the Market—the strength of the competition as well 

as governments’ interference to entering the market. Freer access increases its 

attractiveness as an investment opportunity.

3. Labor Force and Raw Materials—while the investor brings capital, technology and management to the table, the quality of the indigenous work force and 

the availability of in-country raw materials are also important ingredients in the 

recipe for success.

4. Protection from Currency Devaluation—simply stated, if you make an investment in euros or yen or rubles, and then the local assets (valued in the local 

currency) are devalued, you have lost part (or possibly all) of your original non-dollar-based investment.

5. Remittance of Dividends, Interest, Royalties and Technical Assistance 

Payments—if you can’t get your money out of the country, then why invest?

6. Property Rights Protection—likelihood that a company’s property, real or 

intangible (patents, copyrights, etc.), will be stolen.

7. Export Potential—ability to source from an operating unit in one market to 

serve nearby markets or maximize a company’s global efficiency by trading among 

its various operating entities in different countries to round out its product lines.

8. Regulatory Burdens—the cost of government intervention on business (and 

profits) in the United States.

9. Favorable Taxation and Tax Incentives—although tax incentives geared to 

attract initial investments are important, the final investment decision is usually 

based on how taxation at the national, provincial and local levels will affect the normal operating environment.

10. Low Political Risk—an investor’s ability to rely upon the integrity of the 

host government (Federal, State or local) and its ability to maintain local law and 

order is essential to any long-term investment.

11. Predictable Macroeconomic Management—confidence that the economy 

where the investment takes place will be managed in a competent/predictable way 

and that rules will not change midway in a contest.

12. Reliable Infrastructure Support—the ability to consummate transactions 

and get products and services to market is critical. Whether it is reliable transportation services, power generation, insurance and accounting services, a competent 

financial system, or other basics, investments cannot yield reliable returns without 

them. 
214

INVESTING IN CHINA OR INDIA?

China and India are the giants of the developing world. Both enjoy healthy rates 

of economic growth. But there are significant differences in their FDI performance. 

FDI flows to China grew from $3.5 billion in 1990 to $52.7 billion in 2002; if roundtripping is taken into account, China’s FDI inflows could fall to, say, $40 billion. 

Those to India rose from $0.4 billion to $5.5 billion during the same time period (box 

table II.4.1). 

Even with these adjustments, China attracted seven times more FDI than India 

in 2002, 3.2% of its GDP compared with 1.1% for India. In UNCTAD’s FDI Performance Index, China ranked 54th and India 122nd in 1999–2001. FDI has contributed 

to the rapid growth of China’s merchandise exports, at an annual rate of 15% between 1989 and 2001. In 1989 foreign affiliates accounted for less than 9% of total 

Chinese exports; by 2002 they provided half. In some high-tech industries in 2000 

the share of foreign affiliates in total exports was as high as 91% in electronics circuits and 96% in mobile phones (WIR02, pp. 162–163). 

About two-thirds of FDI flows to China in 2000–2001 went to manufacturing. In 

India, by contrast, FDI has been much less important in driving India’s export 

growth, except in information technology. FDI in Indian manufacturing has been 

and remains domestic market-seeking. FDI accounted for only 3% of India’s exports 

in the early 1990s (WIR02, pp. 154). 

Box II.4. China and India—What Explains Their Different

FDI Performance? 

Even today, FDI is estimated to account for less than 10% of India’s manufacturing exports (UNCTAD forthcoming a). For China the lion’s share of FDI inflows 

in 2000–2001 went to a broad range of manufacturing industries. For India most 

went to services, electronics and electrical equipment and engineering and computer 

industries. What explains the differences? Basic determinants, development strategies and policies and overseas networks. 

Basic Determinants 

On the basic economic determinants of inward FDI, China does better than India. 

China’s total and per capita GDP are higher (box table II.4.1), making it more attractive for market-seeking FDI. Its higher literacy and education rates suggest that 

its labour is more skilled, making it more attractive to efficiency-seeking investors 

(World Bank 2003c, p. 234; UNDP 2002). China also has large natural resource endowments. In addition, China’s physical infrastructure is more competitive, particularly in the coastal areas (CUTS 2003, Marubeni Corporation Economic Research Institute 2002). But, India may have an advantage in technical manpower, particularly in information technology. It also has better English language skills. 

Some of the differences in competitive advantages of the two countries are illustrated by the composition of their inward FDI flows. In information and communication technology, China has become a key centre for hardware design and manufacturing by such companies as Acer, Ericsson, General Electric, Hitachi Semiconductors, Hyundai Electronics, Intel, LG Electronics, Microsoft, Mitac International Corporation, Motorola, NEC, Nokia, Philips, Samsung Electronics, Sony, Taiwan Semiconductor Manufacturing, Toshiba and other major electronics TNCs. India specializes in IT services, call centers, business back-office operations and R&D. 

Rapid growth in China has increased the local demand for consumer durables and 

nondurables, such as home appliances, electronics equipment, automobiles, housing 

and leisure. This rapid growth in local demand, as well as competitive business environment and infrastructure, have attracted many market-seeking investors. It has 

also encouraged the growth of many local indigenous firms that support manufacturing. 

Other determinants related to FDI attitudes, policies and procedures also explain 

why China does better in attracting FDI.

• China has ‘‘more business-oriented’’ and more FDI-friendly policies than India 

(AT Kearney 2001). 

• China’s FDI procedures are easier, and decisions can be taken rapidly. 

• China has more flexible labour laws, a better labour climate and better entry 

and exit procedures for business (CUTS 2003).

A recent business environment survey indicated that China is more attractive 

than India in the macroeconomic environment, market opportunities and policy towards FDI. India scored better on the political environment, taxes and financing 

(EIU 2003a). A confidence tracking survey in 2002 indicated that China was the top 

FDI destination, displacing the United States for the first time in the investment 

plans of the TNCs surveyed; India came 15th (AT Kearney 2002). A Federation of 
215

Indian Chambers of Commerce and Industry (FICCI) survey suggests that China 

has a better FDI policy framework, market growth, consumer purchasing power, 

rate of return, labour laws and tax regime than India (FICCI 2003). 

Development Strategies and Policies 

The different FDI performance of the two countries is also related to the timing, 

progress and content of FDI liberalization in the two countries and the development 

strategies pursued by them.

• China opened its doors to FDI in 1979 and has been progressively liberalizing 

its investment regime. India allowed FDI long before that but did not take comprehensive steps towards liberalization until 1991 (Nagaraj 2003). 

• The two countries focused on different types of FDI and pursued different strategies for industrial development. India long followed an import-substitution policy and relied on domestic resource mobilization and domestic firms (Bhalla 

2002; Sarma 2002), encouraging FDI only in higher-technology activities.

Despite the progressive liberalization, imposition of joint venture requirements 

and restrictions on FDI in certain sectors, China has, since its opening, favoured 

FDI, especially export-oriented FDI, rather than domestic firms (Buckley forthcoming; IMF 2002). Such policies not only attracted FDI but led to round-tripping 

through funds channelled by domestic Chinese firms into Hong Kong (China), reinvested in China to avoid regulatory restrictions or obtain privileges given to foreign 

investors. In India, round-tripping, mainly through Mauritius, is much smaller and 

for tax reasons. It has been suggested that domestic market imperfections associated with problems of outsourcing, regulations and local inputs have led to ‘‘excessive internalization’’ of production activities by TNCs in China. So part of the FDI, 

occurring because of the imperfections of the domestic market, is undertaken as a 

second best response by manufacturing TNCs to the Chinese environment (Buckley 

forthcoming). 

For India the situation is somewhat different. A tradition of entrepreneurship has 

spawned a broad based domestic enterprise sector (Huang and Khanna 2003). This 

combines with the necessary legal and institutional infrastructure and restrictive 

FDI policies followed until the 1990s. As a result, TNC participation in production 

has often taken externalized forms (such as licensing and other contractual arrangements). Even after a significant liberalization of FDI policies, internalization is not 

necessarily dominant. Consider information technology, industries where 

outsourcing to private Indian firms is efficient and there are quality domestic subcontractors. 

China’s accession to the WTO in 2001 has led to the introduction of more 

favourable FDI measures. With further liberalization in the services sector, China’s 

investment environment may be further enhanced. For instance, China will allow 

100% foreign equity ownership in such industries as leasing, storage and 

warehousing and wholesale and retail trade by 2004, advertising and multimodal 

transport services by 2005, insurance brokerage by 2006 and transportation of goods 

(railroad) by 2007. In retail trade, China has already opened and attracted FDI from 

nearly all the big-name department stores and supermarkets such as Auchan, Carrefour, Diary Farm, Ito Yokado, Jusco, Makro, Metro, Pricesmart, 7-Eleven and 

Wal-Mart (PricewaterhouseCoopers 2002). 

In India the government is planning to open some more industries for FDI and 

further relax the foreign equity ownership ceiling (EIU 2003a). To identify approaches to increase FDI flows, the Planning Commission established a steering 

committee on FDI in August 2001. Following the Chinese model, India recently took 

steps to establish special economic zones. China’s special economic zones have been 

more successful than Indian export processing zones in promoting trade and attracting FDI (Bhalla 2002). 

Overseas Networks 

In addition to economic and policy-related factors, an important explanation for 

China’s larger FDI flows lies in its position as the destination of choice for FDI by 

Chinese businesses and individuals overseas, especially in Asia. The role of the Chinese business networks abroad and their significant investment in mainland China 

contrasts with the much smaller Indian overseas networks and investment in India 

(Bhalla 2002). Why? Overseas Chinese are more in number, tend to be more entrepreneurial, enjoy family connections (guanxi) in China and have the interest and financial capability to invest in China—and when they do, they receive red-carpet 

treatment. Overseas Indians are fewer, more of a professional group and, unlike the 

Chinese, often lack the family network connections and financial resources to invest 

in India. 
216

Both China and India are good candidates for the relocation of labour-intensive 

activities by TNCs, a major factor in the growth of Chinese exports. In India, however, this has been primarily in services, notably information and communication 

technology. Indeed, almost all major United States and European information technology firms are in India, mostly in Bangalore. Companies such as American Express, British Airways, Conseco, Dell Computer and GE Capital have their back-office operations in India. Other companies—such as Amazon.com and Citigroup—

outsource services to local or foreign companies already established in the country 

(AT Kearney 2003). Foreign companies dominate India’s call centre industry, with 

a 60% share of the annual $1.5 billion turnover. 

Investor sentiment on China as a location for investment is improving (MIGA 

2002; AT Kearney 2002; American Chamber of Commerce in China 2002). Nearly 

80% of all Fortune 500 companies are in China (WIR01, p. 26), while 37% of the 

Fortune 500 outsource to India (NASSCOM 2001). Despite the improvement in India’s policy environment, TNC investment interest remains lukewarm, with some 

exceptions, such as in information and communication technology (AT Kearney 

2001). 

The prospects for FDI flows to China and India are promising, assuming that both 

countries want to accord FDI a role in their development process—a sovereign decision. The large market size and potential, the skilled labour force and the low wage 

cost will remain key attractions. China will continue to be a magnet of FDI flows 

and India’s biggest competitor. But, FDI flows to India are set to rise—helped by 

a vibrant domestic enterprise sector and if policy reforms continue and the government is committed to the objective of attracting FDI flows to the country.

Source: UNCTAD.
217

Discussion, Questions and Answers 

Co-Chairman DREYER. Thank you very much, Mr. Workman. 

We will now have questions from the Commissioners. I believe 

Ambassador Ellsworth was first. 

Commissioner ELLSWORTH. Thank you, Madam Chairman. 

Mr. Roberts, what an interesting presentation you made to us 

just a few minutes ago. Thank you for that. Congratulations on it. 

Dr. ROBERTS. Thank you. 

Commissioner ELLSWORTH. If that is true, that is to say that the 

cause of what we’re talking about here today, that is the impact 

of a huge rise of manufacturing in China at the expense of jobs 

here, if your explanation is true, that is to say that it is due to the 

collapse of world socialism and the rise in the use of the Internet, 

then there isn’t much we can do about it, is there? 

Dr. ROBERTS. There may not be. 

Commissioner ELLSWORTH. Right. And so just hypothetically, 

let’s you and I assume here for a moment that this trend that we’re 

distressed about in the United States is going to continue for a long 

time. I don’t know how long. Perhaps you don’t, either. But that 

it’s going to continue for a long time, and my question is, isn’t that 

going to permanently change the terms of trade between particularly—in the world between manufacturing in Japan, North America, and Europe on the one hand, and commodities on the other 

hand, like oil and foodstuffs and so forth? Would you expand on 

that for a few minutes? 

Dr. ROBERTS. Well, if this substitution—this labor substitution 

continues, first of all, I assume it’s happening if the figure that’s 

used everywhere that 55 percent of the Chinese imports is offshore 

production of U.S. multinational firms—so we talk about Chinese 

products, but it’s Chinese labor—it’s really not trade. It’s like arbitrage, isn’t it, where the cost of two things is so different. It’s like 

arbitrage. 

And it’s not really the success of the Chinese in entering our 

market, it’s the success of——

Commissioner ELLSWORTH. Absolutely. 

Dr. ROBERTS. —firms going to lowest factor costs, producing 

there and sending back here. So if it continues, then what you 

would see, it’s the highest productivity American labor that’s most 

vulnerable. It’s not the low-cost labor, it’s the highest because 

that’s where the biggest gain you substitute out engineers and radiologists and skilled manufacturing. 

So you have to ask, where do those people go? And in economics, 

to the extent that I understand it, when you’re moved out of your 

highest productivity use, you have to move into a lower productivity use. So if you see a pattern of U.S. labor—and I’m not just 

talking about manufacturing labor, I think the most vulnerable 

now are the high-paid knowledge jobs—you’ll see a roll down in the 

productivity of the American jobs. That is, you’ll find the software 

engineers doing something else. In fact, it’s already happening. 

So what happens through time is you get rolled out of the higher 

productivity jobs. What happens to the growth of income? What 

happens to the ladders of upward mobility? So they collapse. They 

collapse on you. There are no ladders of upward mobility. This is 

a good way to become a third-world country very quickly. 
218

So if this is really happening, suppose we have two more years 

of recovery and we still lose jobs. Then it looks more like what I’m 

saying is happening. If all of a sudden we start creating jobs again, 

then maybe this isn’t what’s happening. But if you look at all the 

announcements of so many of the corporations, we’re moving out 

1,500 engineering jobs, we’re moving out research and development, we’re moving out white collar jobs, then it has to be simple 

economic incentive. There are a lot of skilled, educated people that 

are now available to us and we are being substituted out. 

I don’t know if that answers you, but——

Ms. LEE. If I may, I’d like to agree with Mr. Roberts’ assessment 

of the severity of the problem and what the likely impact is on the 

U.S. economy if it’s allowed to continue unchecked. The impact on 

the whole middle-class wage structure, I think is very serious. 

But I disagree about the lack of solutions. I think it’s very clear, 

we have an international trading system. We’ve written the rules. 

We have trade agreements. And we’ve, in my view, written a set 

of rules that have systematically disadvantaged American workers 

and American manufacturers, through our tax system as well as 

our trade rules. 

One of the key areas has to do with workers’ rights, the failure 

of the United States to protect workers’ rights and human rights 

and democracy in the set of global trading rules, both at the WTO 

and in some of the trade agreements we’ve signed. 

We have a system of trading rules that is lopsided, that has done 

a pretty good job or a medium-good job of protecting corporate and 

commercial interests, but has really neglected the whole social dimension of globalization, the workers’ side of globalization. What 

we see is a system where workers are systematically disadvantaged, whether they’re in the United States or in China. Chinese 

workers aren’t taking jobs away from the U.S. and laughing all the 

way to the bank. They’re also having their wages kept down. 

But if you had a system where workers’ basic human rights were 

respected, where they were able to bargain for a fair share of the 

benefits they create in the global economy, have a say in the political system and so on, you would see a development of a middle 

class and you would at least have a hope of having a more reciprocal trading relationship. Then we could trade with developing 

countries, and the wages of workers would be rising with economic 

growth and productivity. 

What we’re seeing now, though, is wages stagnating all over the 

world, and so the production moves overseas, American workers 

lose the jobs, and yet the consumption power of the whole global 

economy is undermined as those workers’ wages are kept lower. 

Co-Chairman DREYER. Mr. Roberts, could you comment on Ms. 

Lee’s comments? 

Dr. ROBERTS. Well, look. In China and India, there are huge 

overhangs in the labor market. As I said, in China, what is it, it’s 

300 million easy. 

Co-Chairman DREYER. The population of the United States. 

Dr. ROBERTS. The population of the United States, maybe more. 

Well, when you have such huge excess supplies of labor, how are 

you going to be paying them American wages? 
219

Ms. LEE. I didn’t say American wages, but wages that reflect 

their productivity. 

Dr. ROBERTS. How are you going to pay them any wage? 

Ms. LEE. Well, if there——

Dr. ROBERTS. There’s a huge—it’s supply and demand. 

Ms. LEE. If they’re producing goods for the U.S. market, we can 

pay them a decent wage. 

Dr. ROBERTS. Not necessarily, because we go there because the 

labor’s cheap and we——

Ms. LEE. If we pay them a decent wage, then they provide the 

consumer market themselves. If we pay them a rock-bottom 25-

cent-an-hour wage, they’re never going to be consumers. 

Co-Chairman DREYER. Mr. Workman. 

Dr. ROBERTS. The notion that you can fix—it’s kind of like listening to Fred this morning tell us how we can fix the price of the currency and solve the problem. And now we’re told we can just fix 

the price of Chinese labor and we can solve the problem. 

Ms. LEE. Not overnight. 

Dr. ROBERTS. You can’t—you wanted solutions, and I don’t really 

have a solution, but I do remember a few years ago, a few perceptive people saw this coming, and one was Sir. James Goldsmith, 

and he said that what you had to have was free trade among 

equals. You could have a first-world free trade zone. You could 

have a second-world free trade zone. You could have a third-world 

free trade zone. And as the countries move from one world to the 

other, they could move from one zone to the other. And there could 

be some overlap so that there was movement, exchange between 

them. 

And you could still have foreign investment, only the foreign investment would be like it used to be. Foreign investment used to 

be it went to a country and produced for the markets in that country, you see. But what we have now is foreign investment goes 

somewhere and produces there for markets back home. It’s a different use of foreign investment, and it’s due to the availability of 

the labor. It has not previously been available. 

It’s a new development, and China, of course, was suppressed for 

all those years with this communist system, so they are really behind the curve. So they have massive supplies of labor. It’s willing. 

It works good. It’s available now. That’s the real problem. It’s not 

the exchange rate that’s the problem or, I mean, fixing it. To what 

extent is a fix? What fixes it? But you might improve something 

a little bit. 

But the real problem is that the productivity is—capital is the 

highest where labor is most abundant. 

Mr. WORKMAN. I thank the Ambassador for the question and I’m 

struggling to overcome the depression that Mr. Roberts’ comments 

are visiting on me. 

It now explains why I haven’t been able to land a job as a civil 

engineer for 30 years. 

Just a couple points. I don’t disagree in terms of what’s changed 

out there in this era of globalization, and I think if—and I’ve had 

a lot of discussions with a lot of different, quote, ‘‘elites, academics, 

press, politicians, government civil service as well as business people on both sides of the Atlantic and Pacific about this.’’
220

And I think the one thing that everybody focuses on that characterizes globalization is speed. Globalization has been going on since 

the Roman Empire. The difference today, with the modern telecommunications system, which is way beyond the Internet, is the 

time frame within which decisionmakers, both in the public sector 

and in the private sector, the time frame is compressed enormously. 

So whereas 50 years ago, a manager had the luxury of taking 

three to six months to make a decision about whether or not to invest someplace, now, in order—because of competitive pressures, he 

may have two or three days to make that decision and less than 

perfect information. So I agree on the Internet, but it is beyond the 

Internet. 

The collapse of world socialism, I’m reminded of the words of 

Mark Twain, reports of my death are premature. The last time I 

checked, the social democrats were the government in the Federal 

Republic of Germany. There’s a social contract in the European 

Union. From my perspective at the Chamber, there are vestiges of 

socialism that are around. And, in fact, at CIPE, we have courses 

in economic journalism training where we teach the press, who 

first learned their economics at Karl Marx University, how a market-based economy is supposed to work and what their role in a 

market-based economy is, legitimate role for the economic press. 

So I have a little bit different take on this than Mr. Roberts, and 

I am somewhat optimistic that maybe that’s because my name is 

Workman and I have a cousin in the AFL–CIO. 

Co-Chairman DREYER. Poor Mr. Vargo has been left out here. 

Mr. VARGO. Oh, I’m enjoying the relaxation. I’d like to reiterate 

a comment I made earlier, and that is that only 11 percent of the 

cost of a U.S. manufactured good is labor. So no matter how cheap 

labor is overseas, that is a factor, certainly, but it is not the dominant factor. And if a product gets a 20 percent or a 40 percent price 

advantage because of a currency, that is a much more significant 

factor. 

But I’d also like to touch briefly on a couple of other allegations 

that have been made, that 55 percent of our imports from China 

are coming from U.S. affiliates. Department of Commerce data, 

which are available only through the year 2000, so I’d be delighted 

to see someone else’s data, said only three percent of our imports 

from China come from our affiliates. In the year 2000, the Department’s data, which are our balance of payment statistics, indicate 

that U.S. affiliates produced $26 billion in China and only $2.9 was 

exported to the United States. 

Census Bureau data on related party trade, which can be a Japanese company in China shipping to the same company’s affiliate in 

the United States, are 20 percent. I infer from that, then, that 17 

percent is coming from other country investment into China. 

A final brief comment. It is still true that 90 percent of U.S. overseas direct investment in manufacturing goes to Europe, Canada, 

Japan, Australia, and Singapore, and Singapore has an average per 

capita GDP that’s as high as Europe. So 90 percent of our investment is still going to the high-income companies and it is for local 

consumption there. 

Co-Chairman DREYER. Mr. Ellsworth, did you have a follow-up? 
221

Commissioner ELLSWORTH. Who handed me this note? A colleague handed me a note that reminds me, and I pass it on, the 

FDI in China, cumulatively, not just last year, but cumulatively 

over the years is largely from Hong Kong, Taiwan, Japan, and 

Singapore and that we account cumulatively for only ten percent 

of the FDI in China. So multinationals largely are buying from 

each other inside China. 

But I still think that Mr. Roberts’ insight here—I haven’t heard 

it or seen it before and I don’t know whether there’s been a whole 

lot written about it, but I think it’s very illuminating. It’s depressing. It’s discouraging. 

And by the way, Mr. Workman, for a civil engineer, you’re really 

sophisticated here on these FDI things, so congratulations. 

Mr. WORKMAN. It was on-the-job training at the Chamber. 

Co-Chairman DREYER. Commissioner Bartholomew. 

Co-Chairman MULLOY. Did you have something more to say, Mr. 

Roberts? 

Dr. ROBERTS. Well, I would respond to Frank. You see, the figures that he gives about where our foreign investment goes is very 

misleading because you couldn’t put anything in China until recently. I mean, even if you wanted to, they wouldn’t let you. And 

yet, we’ve had 100 years to invest in Canada and Europe, and over 

100 years, you build up a lot of investments. And just the investment it takes to maintain those investments is huge. 

So the fact that you have—that we have so much in the first 

world doesn’t really mean anything. We’re talking about the flows 

now. 

And as I said in my testimony, I give you this as questions. I’m 

not dogmatic about it, but I present it to you as a new way to look 

at it and it bears watching, because if job losses continue despite 

a recovery, then something has to explain it. There’s really not a 

whole lot to explain it. 

So that’s really all else I wanted to say. Thank you. 

Co-Chairman DREYER. Commissioner Bartholomew. 

Commissioner BARTHOLOMEW. Thank you very much, and thank 

you to our witnesses for coming and talking to us today. I was particularly encouraged by reports that the National Association of 

Manufacturers and the AFL–CIO might be working towards common ground and some initiatives to help——

Co-Chairman DREYER. It’s those cousins. 

Commissioner BARTHOLOMEW. —to help American workers, so 

I’m not sure of the status of that, but more power to you and I hope 

that things work out. 

My question actually specifically is for Mr. Workman. I’ve gone 

over this list of the 12 commandments for foreign investment and 

by my count, at least seven of these are problematic in terms of 

what is going on in China. Now, a number of them are improving, 

but I’ll tell you the ones that I think are potentially troublesome, 

which leads me to believe that either dealing with China is not 

playing by the same rules, which is an issue that’s been ongoing 

with China, or something else is going on that falls outside the parameters. 

But I wondered if I could get your thoughts, not necessarily on 

the specifics of this but what else might be going on. The ones that 
222

I think are questionable would be, two, freedom of access to the 

market; five, remittance of dividends, interest royalties, and technical assistance payments; six, property rights protection; eight, 

regulatory burdens; nine, favorable taxation and tax incentives; 

ten, low political risk; and 12, reliable infrastructure support. 

Now, as I say, some of those, I think, are better than they were 

ten years ago, but I’m not convinced that they meet a test that 

would actually justify the level of foreign direct investment going 

into China and wondered really your thoughts on that. Do we need 

a set of 12 different commandments or what else is at play? 

Mr. WORKMAN. No, I don’t think we need a different set of commandments. This makes, as I said, common sense. It passes the 

horse sense test. 

You have to understand that this is relative, because companies 

are looking, for example, do I make the investment in China or do 

I make the investment in South Korea or do I make the investment 

in India, and so it is a relative comparison that is going on with 

these companies and these are the factors that they consider within 

that context. 

By no stretch of the imagination does—the reason why the 

United States in the year 2002 was the number one destination for 

foreign direct investment is because, for the most part, we look 

pretty good on this criteria and we have a good return on investment, although the FDI going into the U.S. last year dropped by 

50 percent from the year before. That’s because we were in a recession and what have you, so we weren’t that attractive. But again, 

it is relative. 

And I’d be happy to submit for the Commission for the record—

I didn’t bring it with me today, but within the UNCTAD world investment report, there is an actual comparison between India and 

China. So you’ve got 1.4 billion Chinese and 1.1 billion Indians and 

why is it the Chinese are much preferred, the number one preferred FDI investment amongst the developing countries and the 

Indians are the 53rd element? One is a democracy that has an incredibly rigid economic regime. The other is an authoritarian regime, but in the economic sector, since 1979, has been loosening 

and introducing flexibility into its economic regime. 

Our more detailed 25-page cure for insomnia report—that I’ve 

also attached—will tell you in detail where we think the Chinese 

need to go further, at least in meeting what they promised to do 

when they joined the WTO. If they do that, then they become an 

even more attractive destination for foreign direct investment, not 

only from the United States, but from all over the world. 

Just one thing about this issue of exports and investment. 

Transnational corporations—a term I don’t like, but the U.N. uses 

it—there’s about 78,000 transnational corporations. In 2001, the 

last year data is available, they accounted for about $8 trillion in 

global exports. So they were shipping something somewhere. The 

same companies in 2001 had $18 trillion in sales from their overseas affiliates, i.e., where they have invested to produce in a domestic market or in a regional market. 

So that’s why we tend not to focus as a country on this issue of 

investment. The money doesn’t go away. That $18 trillion in sales, 

some of it comes home, comes home to papa. So there is an advan-
223

tage to that and that can be plowed back into R&D. It’s up to the 

company what they want to do. 

So the other aspect about investment which I find intellectually 

interesting is that there is no multilateral investment regime. 

There is a small piece in the WTO called TRIMs, trade-related investment measures. There was an effort in 1996 in the OECD to 

come up with a regime that failed, and that’s among the rich countries. 

So essentially, when you’re talking about investment flows, 

you’re talking about what—the only people really sort of self-regulating themselves are the private sector companies. So it makes 

for—and the governor on them is if they make a bad investment 

decision, then their board is going to fire them. 

Dr. ROBERTS. May I just make a comment. The Commission 

ought to know that, at least in recent years, the vast bulk of foreign investment in the United States is not new plant and equipment. It’s foreigners acquiring ownership of existing assets. They’re 

acquiring ownership of companies, real estate, equities, bonds, and 

these figures are available. I didn’t bring them with me. And that’s 

because we have a huge trade deficit, and so all the dollars that 

go out comes back and they acquire ownership of the assets. 

So you can get confused thinking that we are an investment 

Mecca. This is not plant and equipment and new stuff but this is 

a change in ownership. We’re paying for the trade deficit by giving 

up assets, and that’s what is measured by this large figure of foreign investment in the United States. 

Commissioner ELLSWORTH. How much trouble would it be for you 

to provide us with that? 

Dr. ROBERTS. I could do it when I get home, or——

Commissioner ELLSWORTH. Please. 

Dr. ROBERTS. —your staff can do it. 

Co-Chairman DREYER. Yes. We would be very interested in that. 

Dr. ROBERTS. It’s online with the, what, BEA, probably. I’ll talk 

to the staff and we’ll find it. It’s easy. It’s easy to do. 

Co-Chairman DREYER. Good. Commissioner Wortzel. 

Commissioner WORTZEL. Well, I want to start by addressing Assistant Secretary Roberts for a second. If all these overseas assets, 

or these domestic assets are being bought by overseas investment, 

are they being shipped out of the country, or——

Dr. ROBERTS. Well, it’s just ownership. 

Commissioner WORTZEL. It’s just ownership, and they’re employing Americans? 

Dr. ROBERTS. A lot of it was mergers, acquisitions. 

Commissioner WORTZEL. It seems like that’s a good thing. I 

mean, people are still working. The equipment’s not leaving. 

They’re producing goods for the United States. 

Dr. ROBERTS. I didn’t say it was good or bad. 

Commissioner WORTZEL. All right. 

Dr. ROBERTS. But there’s often an inference is made that we are 

a Mecca for investment and people think, oh, this is plant and 

equipment. They’re building things here. But what I’m telling you, 

in recent years, it’s just a change of ownership. 

Commissioner WORTZEL. Right. 
224

Dr. ROBERTS. So whether it’s a good thing or not, you see, Americans actually are losing all the future income streams that flow 

from the loss of ownership. If you don’t own the real estate or the 

companies, you don’t get the profits or the rents, right? 

Commissioner WORTZEL. But if you’re over there in the AFL–

CIO, you’re pretty happy. 

Ms. LEE. So long as it’s a union company. 

Commissioner WORTZEL. As long as it’s a union company. 

I’m interested if any one of the witnesses could enlighten me. 

What other currencies are pegged to the U.S. dollar for value so 

strongly. I know we’re saying the Chinese are getting this great 15 

to 40 percent advantage; what other currencies are pegged like that 

that we’re ignoring? I know we’re a China panel, but that would 

be interesting to know. 

Co-Chairman DREYER. Almost but not quite. 

Commissioner WORTZEL. I came up with almost the same factors 

that Commissioner Bartholomew came up on the wisdom of companies making investment decisions in China. Number two, freedom 

of access to the market. There’s not much freedom of access to the 

Chinese market. 

Remittance of dividends—if you can’t get your money out of the 

country, why invest? And in China, you can’t get your money out 

of the country. You’ve got to go through all kinds of silly ways to 

get it out of there. 

Property rights—terrible. Intellectual property rights and any 

other property rights in China are very poorly protected. 

Of course, the export potential is real high because the goods are 

coming back to the United States, don’t you. Favorable taxation 

and tax incentives, not very good. 

Political risk, you have collapsed legitimacy for a dictorial ruling 

party, a communist party that’s repressing its people and is using 

a couple million armed people to repress the population. Political 

risk, it seems to me, is pretty high. 

Predictable macroeconomic management—there’s not much of 

that in China. Reliable infrastructure support, fairly poor except 

around the coast. 

So if all this is going on in China, I wonder if you took , the top 

50 United States investors in China, what is the percentage or risk 

of their total investment outside the United States compared to the 

risk they are taking in China. How much are they really risking 

when they go into China; where else are they investing; and what’s 

their return on that percentage of risk? I think those are more interesting sorts of statistics. 

Mr. WORKMAN. Okay. Well, again, as I mentioned to Commissioner Bartholomew, this is relative. In 2002, the investment outflows from the United States were $183 billion. Frank will correct 

me if I’m wrong. I think something like $20, $29 billion went to 

China, is that right? What was the number? 

Mr. VARGO. Oh, from the U.S.? 

Mr. WORKMAN. Yes. 

Mr. VARGO. Not nearly that high, no. 

Mr. WORKMAN. Okay. So in relative terms, yes, there are some 

American investors that are investing in China, but the bulk of 

American investment, 43 percent of all American foreign direct in-
225

vestment in the world is in the European Union, and 45 percent 

of all their foreign direct investment is in the United States. 

So the bulk of the investment is—80 percent of world investment 

is in the Northern Hemisphere and it’s amongst the OECD countries. The other 20 percent, 20, 25 percent, to the developing world. 

China for the past ten years gets one-fourth of that, and that really—that went up in 2002 and I think I—because there was an expectation on the part of investors that the Chinese were going to 

be more open, they were going to live up to their WTO commitments, they were encouraged and they took some risk, so they invested more in China. 

It’ll be interesting a year from now to look at the 2003 data, because both Frank’s organization and my organization, our conclusion in terms of how are the Chinese doing, this is our second report on the subject, and they’re not doing as well as they were last 

year in terms of meeting their commitments. 

Commissioner WORTZEL. I appreciate your response. That would 

have been my final question. It seems to me that from what I’m 

reading this year, your second year assessment is far less rosy than 

what I saw last year—when I was out in Shanghai and read this 

stuff. 

Mr. WORKMAN. That’s correct. 

Mr. VARGO. Could I just add to that? Could I encourage you, the 

Commission, to task the Bureau of Economic Analysis to provide 

you with the figures, because you don’t have a clue. There’s this 

myth that all this American investment is going into China and it’s 

not. When you look at American manufacturing investment, or the 

bulk of the investment that Wally mentions, and I believe the overall figure is correct, is in financial institutions, services, wholesaling. Only a relatively small fraction of that is manufacturing investment. And of our manufacturing investment, about one percent 

of it or two percent of it’s going into China. 

Co-Chairman DREYER. Mr. Vargo, would you have any idea 

where the bulk of the FDI in China, then, is coming from? Is it Taiwan, Hong Kong? 

Mr. VARGO. It is exactly Taiwan and Hong Kong, Japanese investment, some Korean, and these figures are readily available to 

the Commission. 

Ms. LEE. But a lot of it is also masked by the fact that U.S. companies are buying products from other companies, subcontracted 

out from China. So it doesn’t show up under the majority-owned 

foreign affiliates. 

Mr. VARGO. Undeniably. Undeniably. 

Co-Chairman DREYER. But you see it in the $100 billion trade 

deficit. 

Mr. VARGO. Sure. 

Co-Chairman DREYER. So whether we’re having that impact is 

pretty clear. Whether it comes from U.S. foreign investment or U.S. 

companies buying goods from a Taiwanese-owned company doesn’t 

really matter in the end. 

Commissioner BECKER. Could I make a very small point on that 

very quickly? 

Co-Chairman DREYER. Yes. 
226

Commissioner BECKER. When we issued our report last year, this 

was researched, at least to that point. The significant point that I 

think about that is 90 percent of the investment coming into the 

United States is, as Mr. Roberts says, is to buy existing property 

without creating anything new, whereas 90 percent of the investment, direct foreign investment going into China, is to build new 

facilities. I think that’s a point that tells you what really is happening in the world. 

Commissioner BARTHOLOMEW. I have actually just one issue I’d 

like to add to Commissioner Wortzel’s. The same 50 companies that 

he was talking about, it would be interesting to know how many 

of those 50 companies are getting some sort of U.S. Government 

risk insurance or guarantees for their investment so that their violation of the 12 commandments here are putting the U.S. taxpayer 

on the hook rather than necessarily putting themselves on the 

hook. 

Co-Chairman DREYER. Yes, because you’ve really got to take into 

consideration the relatively small percentage of companies involved 

in business in China who say they are making a profit. 

Okay. Commissioner D’Amato. 

Vice Chairman D’AMATO. Thank you, Madam Chairman. 

I think this is a great panel because whenever anybody starts to 

make a point, all the rest of you shake their heads. 

So I know we’ve got a real debate going on here. 

Co-Chairman DREYER. This is proof of a successful panel. 

Vice Chairman D’AMATO. And I think there’s a lot of—I’m trying 

to understand what the nature of the underlying problem is here, 

because I think that Mr. Roberts’ comment is very interesting because we have some international mobility factors of production 

which confuse us because they don’t fit into our traditional models. 

So comparative advantage as a traditional Ricardo model doesn’t 

apply here, and we don’t have a new model to—we don’t really 

have a new model. 

What I think we have is, and I’ll be grossly oversimplifying, of 

course, the question I have is who’s in charge here, and my answer 

is the multinationals are in charge. That’s what we call 

globalization. Let’s face it. Those are the multinationals. They’re in 

charge. They’re the ones that are allocating the factors of production around the world. 

And I guess the question is, the other side of globalization is nationalism, and so we derogate nationalism by calling it protectionism. That’s very convenient for multinationals because then it 

looks like nationalism is a dirty word. 

But I think the fundamental question is, who’s going to be in 

charge of allocating the factors of production, whether you call it 

investment overseas or control of ownership here, if the national 

authorities are not going to assume that they should be in charge 

of protecting the economic health of the country. Then, of course, 

it seems to me the only other answer is this is going to be run by 

multinationals. That’s my simplified take of it. 

It seems to me that national authorities, such as the building 

that we sit in, exist for the health of the nation state. And I guess 

the question is interesting, because Mr. Roberts says he doesn’t 
227

have any answers. I think the fundamental question is, who is the 

dominating agent that’s going to come up with the answers? 

Is it going to be the nation state or are we going to leave it up 

to the multinationals? If we leave it up to the multinationals, then 

we’re just here charting—we’re charting the flow of these factors of 

production. If it’s the nation state, then we have to come up with 

new sets of principles that go beyond the sense of calling it protectionism, a new set of principles that the nation state is going to operate under to protect the nation state. Otherwise, we are going to 

end up eventually with no nation states. 

Does that make any sense to you? Anybody can answer. Everybody else can shake their heads. 

Mr. WORKMAN. Well, I have some difficulty with when you get 

in—you asked the question, who allocates the factors of production 

within a nation state, because we already went through a 75-year 

history where the answer, at least in the Soviet Union, was the 

government will allocate the factors of production. And so I have 

some concern about that. 

Do the multinationals, these nameless, faceless corporate folks, 

are they really allocating factors of production? I think they’re responding to market circumstances, but I think you’re getting close 

to the point about the challenge of China, because in the case of 

China, we have a hybrid. 

We have—we used to call it in export control days, we used to 

talk about non-market economies and how do we deal with them 

because they’re immune, they’re protected from market forces. In 

the case of China, we have an economic system that is moving towards being responsive to market forces. But we have a political 

regime that is not moving towards being responsive to political 

forces which are spun off by the economic pressures. 

In my point of view, and one of the reasons why CIPE has been 

involved in China—and we are not viewed as being friendly because we have an affiliation with this word democracy in our mission, we are viewed somewhat suspiciously, but they understand 

that, for example, in our economic journalism training, when you 

go to the China news agency, and we train all the economic journalists, and they have got a certain amount of freedom to report 

economic news, information, statistics, objectively and without government interference. 

Well, their colleagues on the other side of the newsroom who are 

reporting political news or reporting the daily outbreak of SARS in 

Beijing or whatever, they’re censored. They don’t have the same 

kind of freedom of the press the economic journalist has. That creates pressures within China. 

But I think the challenge for us all is to figure out how to help 

China, hopefully, through this transition from a non-market economy to a market-based economy, but also a pluralistic political system, as well. 

Ms. LEE. I’d like to step in, if I may. 

Dr. ROBERTS. I’m going to leave, so let me do it. 

Ms. LEE. I have to leave, too, but go ahead. 

Dr. ROBERTS. Oh. 

Ms. LEE. Go ahead. 
228

Dr. ROBERTS. Your question is good, and the implication of economic globalism is one world government, because otherwise 

there’s no way to make all the adjustments that happen within a 

national economy when regions shift in their importance. So you 

could have a case where economics is far ahead of politics, and that 

is a very difficult thing to deal with. 

Ms. LEE. Can I leap in quickly? Thanks, because I’m afraid I do 

have to leave, as well. 

You’re absolutely right that the question is who’s writing the 

rules for the global economy, what is a rational framework of economic incentives that we put in place that we can all feel confident 

about. 

One of the things that’s changed, I would say a little bit differently from what Mr. Roberts said, we still live to some extent 

in a world of comparative advantage. We have mobile capital now 

and somewhat mobile labor and that creates a different situation. 

But we also have comparative advantage operating in a world of 

very different social regulatory frameworks and democracies. 

What we don’t want in the global economy is a set of rules that 

disadvantages democracies and countries that live up to their international human rights obligations, that have decent environmental 

laws. All those things cost money. We have a political system 

where we make those tough decisions at the national level. 

We don’t have a political system to make those decisions at the 

international level, and yet the result of not being able to talk 

about things like workers’ rights or environmental protections, democracy at the international level is this race to the bottom, the 

idea that countries like China that are aggressive, that are large, 

that are not democracies, that have horrible, horrible workers’ 

rights policies and human rights policies are winners in that global 

economy. 

We want the winners to be the democracies, the countries that 

nurture their trade union movements, that have a middle class, 

that are really developing, but we haven’t written the rules that 

will give us that outcome, and that’s what we need to do. That’s 

what the United States needs to do, to say we have an economic 

interest in seeing a different set of economic incentives facing both 

companies and governments. We shouldn’t reward the worst players in the global economy, and that’s what we’re doing by failing 

to address these other issues. 

Vice Chairman D’AMATO. Yes. Let me just make one comment. 

It may be that we sort of have a bifurcated system, that the Chinese are exercising more nationalism than we are and they are tailoring what’s going on economically to their view of where they 

want to go in terms of building a powerful Chinese state. 

That is certainly not true in the United States. In the United 

States, I think we have more economic decisionmakers, multinationals that are operating independently without regard to political authorities. I certainly don’t think that’s as true in China. 

China has got their eye on the ball, and that is national economic 

growth and becoming a powerful nation state. 

Co-Chairman DREYER. Commissioner Becker really, really wants 

to ask Ms. Lee a question before she departs. 
229

Commissioner BECKER. I wanted to ask everybody a question, 

but——

Co-Chairman DREYER. Your mike. 

Commissioner BECKER. Let me go ahead and push this and I’ll 

tell you right now. Earlier this morning, you weren’t here. We had 

some legislators that gave their perspective of the trade with China 

and what’s happening with our trade laws. Senator Dorgan, Sandy 

Levin, and Representative Stenholm, they all talked about Cancun. 

They all talked about the trade laws and the ineffectiveness of the 

trade laws. In fact, there were some very pointed comments made 

about the incompetent people that are negotiating these trade laws 

on behalf of the United States. 

You were at Cancun and you represented the AFL–CIO in the 

trade arena. I want to refer back to Doha. I’d like you to give us 

your perspective on what is happening with—specifically with our 

anti-dumping and countervailing duties, our safeguards in the 

hands of the USTR. Tell us, if you would. 

Ms. LEE. Thank you, George, for the question. What I see happening is when the USTR goes into these very difficult international negotiations, is when they come under pressure, they have 

been willing to put U.S. trade laws on the negotiating table, on the 

chopping block, even as 140 other countries in the WTO have made 

it clear that their intention in these negotiations is to weaken and 

gut U.S. trade laws. The clear intention of the U.S. Congress has 

been that those trade laws not be put up for renegotiation, that we 

maintain them and we be able to use them effectively. 

The U.S. Government has been willing to open negotiations in 

way that could weaken our trade laws, which puts us in a very vulnerable, precarious situation, and I think it’s very dangerous. 

The other thing that was dangerous for us in both Doha and 

Cancun is that the USTR’s position is to take global tariffs to zero 

without getting any progress on workers’ rights, to open negotiations on our trade laws, and not to achieve reciprocal market access 

from developing countries. It’s actually written into the Doha Declaration that we’re not even going to seek reciprocal market access 

from developing countries. Special provisions affecting China are 

also actually written into the draft declaration. The newly acceded 

WTO countries are actually given even more of a pass on lowering 

their own trade barriers because it’s been recognized that they’ve 

already made certain accessions. 

So we’re in a very troubling place in terms of what this Administration has been willing to put into the negotiations in the WTO 

round in a way that is really undermining the position of both 

American manufacturers and American workers. 

Mr. VARGO. I’d like to comment on that, because Thea won’t be 

surprised, I have a different view. I think the Administration is 

doing a great job in negotiating. 

Over the years, the United States followed the philosophy, we’re 

going to cut tariffs and get the other industrial nations to cut tariffs and we let the developing countries not do anything. So here 

we are—largely because of the Cold War. So here we are, after 20, 

30 years of industrial countries cutting trade barriers and the developing countries, India, China, Taiwan, all of these countries 

have enormous tariffs against American industrial goods and we’ve 
230

got to get them down. The only way we can get them down is by 

getting into negotiations. 

I have no concerns that U.S. trade laws are going to be put up 

on the chopping block. I think that Ambassador Zoellick did a great 

job in deflecting that and in setting up the negotiations in such a 

way that we address the causes that bring these laws around, the 

subsidies that they have. So I think we’re in good hands. 

Mr. WORKMAN. If I could offer a point of view, there’s—on the 

issue of the anti-dumping laws, there’s not any difference between 

what Thea said and what the U.S. Chamber believes. We did not 

want the anti-dumping laws put on the negotiating table at Doha. 

That was our position. Well, we didn’t win on that. 

We’re pleased with the way the negotiations have——

Commissioner BECKER. Collapsed. 

Mr. WORKMAN. —gone slowly in the 15 months since Doha, and 

that will be one of the key criteria that we look at, the key issues 

that we look at when and if there is a Doha Round agreement. 

The most contentious issue within our membership in the Uruguay Round was on the changes, the weakening from our point of 

view, of the anti-dumping countervailing duty laws that would necessarily ensue from the Uruguay Round agreement, and we didn’t 

like it then and we don’t like it now. 

So this is one of those odd situations where the Chamber and the 

AFL–CIO see eye to eye, and we have a history for the past ten 

years of testifying jointly on this particular issue. 

Now, the other comments that Thea had, we part company. But 

I just wanted to make that point. 

Commissioner BECKER. I was going to comment, when Mr. Roberts was here, it was Thea against three on the thing. But there 

are alliances there. 

Mr. WORKMAN. Sure. 

Commissioner BECKER. That’s developed and very good. 

What I wanted to do was just make sure that she was able to 

put this onto the record. I didn’t necessarily want it to be from me. 

Mr. WORKMAN. Well, you’ve got a bunch——

Commissioner BECKER. We’ve always had a position going back 

to GATT that our trade laws were untouchable. Mickey Kantor 

came back from the Uruguay Round and told us—told everybody 

very bluntly that we talked about it, it was a one-time talk, they 

would never be on the table again. We made it very clear that our 

trade laws were untouchable. And now we find out that in spite of 

being told that they weren’t put on the table, that after Doha, I 

mean, this was put together and we’re very concerned about that. 

Mr. WORKMAN. Well, there’s this nuance where we’ll have a discussion and we’ll study it. They can study it until the cows come 

home, but I just don’t want them to reach any conclusions. 

Commissioner BECKER. Very good. 

Co-Chairman DREYER. Final question. 

Commissioner BECKER. Thank you very much. 

Co-Chairman MULLOY. I want to come back to the exchange rate 

issue. Frank, you and the AFL–CIO, my understanding is, are 

working on a 301 to go on the China exchange rate issue. Now, 

help me understand this. The 301 is for USTR to begin a process 

of identifying China as an unfair trader, and if that is done, the 
231

way I understand the WTO, the EU took us to the WTO to knock 

301 out of our laws and the WTO let us keep 301 on the basis that 

it would be used in compliance with the way the WTO works. 

So even if USTR does do that and identify, we still have to go 

to the WTO then to bring a case, in which the WTO would then 

rule that, yes, China is violating their IMF and WTO—well, their 

WTO obligations, and they would look for the IMF for advice on 

that in terms of whether they’re a manipulator, and then we would 

get permission after that process. And my understanding, that 

process could take up to two years. Is that the way you see it, and 

then I have a follow-up. 

Mr. VARGO. Well, let me begin by saying that while it’s certainly 

true that NAM and AFL–CIO are going to—discussing and exchanging views on 301, the 301 process is coming from what is 

called the Coalition for a Sound Dollar, not from NAM or AFL–

CIO, and AFL–CIO is currently not a member of that coalition. 

Co-Chairman MULLOY. It’s not a member? 

Mr. VARGO. No. Whether they will become one is something that 

we will see. And again, the NAM has said, as one of 90 members 

of that coalition, that we are going to support this initiative. While 

many other associations have also stepped forward, the coalition is 

still in the process of polling its entire membership. 

Now, a 301 case, what we are seeking is elimination of the problem, which is the undervalued currency, which is not merely 

pegged. Other currencies are pegged, as you point out, and they 

sometimes buy dollars and sell dollars to maintain the peg, but 

only China has to spend $3 billion a week to maintain that peg because of their huge surplus, and that’s the problem. 

The remedy—we want this solved. We’re not out looking for 

trade restrictions. 

Co-Chairman MULLOY. But the 301, what it gets you is USTR 

saying it’s an unfair trade practice and then——

Mr. VARGO. Or unjustifiable. 

Co-Chairman MULLOY. —and unless China changes that, unless 

China decides to change that at that point, then the only way to 

get that enforced would be to go through WTO, is that correct? 

Mr. VARGO. Not necessarily, and the USTR website says that 

there can be unilateral action. But we are not looking at what the 

teeth might be. It has teeth. It does have teeth. Whether it goes 

through the WTO or does not, we will leave that for another way. 

Co-Chairman MULLOY. Senator Schumer has a different approach, and let me just—his approach is to say, I’m going to use 

Article 21 of the GATT WTO to put immediate sanctions on, because as you pointed out and as the President agrees, manufacturing is essential to our national security. You said that earlier. 

And therefore, he would use that to say we’re not going to let this 

unfair trade practice have that moves our manufacturing sector 

out. 

Mr. VARGO. We’ve told the Senator that we cannot support that 

and we don’t think that this is anywhere near an appropriate use 

of the National Security Clause. 

Co-Chairman MULLOY. Wally, are you at all involved with the 

Coalition for a Sound Dollar and the 301 action, or is it——
232

Mr. WORKMAN. No, and at our policy committee meeting in two 

weeks, we’ll bring it up and see how our members want to go. Of 

course, we represent manufacturers, but we also represent everybody else. So I’ll let you now then. 

But maybe I can provide some technical assistance on this, because the Chamber was involved in helping craft the changes to 

Section 301 in 1988 in the trade bill. From start, the coalition could 

initiate or file a petition with USTR claiming that it’s unjustifiable 

or unreasonable. There are a number of different criteria that you 

can use on a 301 case. USTR then has 90 days to accept or reject 

the position. 

Co-Chairman MULLOY. Right. 

Mr. WORKMAN. They can reject the position—the petition. Or, 

USTR could self-initiate a Section 301 case and go forward. 

Depending on whether it’s the 90 days if NAM and the coalition 

go forward or if it’s a self-initiated USTR case, you’re looking at, 

by the time you get to the end of the road, between 18 and 21 

months. 

Now, in the context of the WTO, if you asked Pascal Lamy if Chinese currency exchange rates are a matter for the WTO, you will 

hear the answer that he gave at a conference Roll Call sponsored, 

as well as the Chamber and others, two weeks ago, which is no. 

So, therefore, Senator Schumer is talking about bringing a case before the WTO, and if it’s on exchange rates, I think a large number, 

but it only takes one in the WTO, will say no, this is not in our 

court. 

What that means is—then the United States, if they want to, because 301 is broad, they can say, well, exchange rates falls under 

301 and we’re going to raise this and initiate a 301 investigation 

of Chinese exchange rate function. 

So that’s how the process and the time lines and everything work 

and at least what publicly some of the key players, like Lamy from 

the EU have been saying about this. I think it’s helpful, and what 

we’re going to try to do for our members in two weeks is to focus 

on the problem and what are solutions, near-term solutions to the 

problem. And right now, my best guess is we dust off the IMF and 

we keep Secretary Snow jawboning, because the issue is not just 

China. 

Co-Chairman MULLOY. No, I know. 

Mr. WORKMAN. Japan is a problem, too. 

Co-Chairman MULLOY. Yes. That was brought to our attention 

this morning by a very—and not just Japan, but Taiwan, Korea. 

One last thing. On Schumer, his bill doesn’t take to the WTO. 

Mr. WORKMAN. Okay. 

Co-Chairman MULLOY. His would take immediate action and let 

the Chinese take us to the WTO if they’re unhappy with what 

we’re doing. So that’s a different approach than Manzullo, who 

could take China to the WTO. 

Mr. WORKMAN. Well, I’m not sure how we could take immediate 

action unless it’s a 301——

Co-Chairman MULLOY. No, he’s——

Mr. WORKMAN. —and I just don’t see how that works. 

Co-Chairman MULLOY. Thank you. 
233

Co-Chairman DREYER. He has introduced a bill, I think is what 

Commissioner Mulloy means, but I’m going to have to cut this off—

it’s 5:30—and thank you. 

Mr. VARGO. Before you do, could you give me 30 seconds here, 

because——

Co-Chairman DREYER. Okay, 30 seconds. 

Mr. VARGO. Nobody here has hit on the point that we’re hearing 

from our companies on China, which is that, they’re getting subsidized energy, they’re getting export subsidies, they’re getting free 

plant, et cetera. When you look at why China is so super-competitive, don’t dismiss those as possibilities. 

Co-Chairman MULLOY. Could you lay those out and give—is that 

part of your testimony, Frank, or——

Mr. VARGO. No, it is not. 

Co-Chairman MULLOY. Could you give us that in a separate submission? 

Mr. VARGO. Yes. 

Co-Chairman MULLOY. That would be very helpful. 

Co-Chairman DREYER. Yes, that would be very helpful. And 

meanwhile, thanks to both of you, not only for coming and presenting your testimony, but for sticking it out to the absolute bitter 

end, and we really appreciate it. This has been extremely valuable. 

The Chair of the Commission, Roger Robinson, would like to say 

a couple of concluding words. 

Chairman ROBINSON. Well, first, I’d like to chime in and thank 

you all for a truly stimulating afternoon, and we will, Frank, value 

very much that last input of data and assure that it gets proper 

attention. 

I’d also like to congratulate and thank the Co-Chairs of this 

hearing, which was, I think, very well conceived and involved an 

intensive amount of work, so I thank them. 

Also, our staff, the entire Commission staff, by and large, worked 

on this particular hearing because of its timeliness and its import, 

particularly James Swanson, Steve Schlaikjer, and Tony Sutton. I 

know all of us Commissioners value enormously the effort that 

went into preparing this hearing. 

And with that, I’d like to adjourn our session. Many thanks. 

[Whereupon, at 5:30 p.m., the hearing was adjourned.] 

[Submissions for the record follow:] 
234

Testimony of Senator Olympia J. Snowe 

I would like to thank the U.S.-China Economic and Security Review Commission 

for calling this hearing today and for inviting me to testify. This Commission has 

been charged with the crucial task of analyzing our economic policies vis-a`-vis China 

and the effect they have not only on our bilateral relations, but also on the U.S. 

economy and our national security. As China becomes a larger player in the international trade arena and our trade relationship increases, we must remain vigilant 

in monitoring its practices and policies that affect our competitiveness both here and 

abroad. 

Congress granted Permanent Normal Trade Relations (PNTR) for China because 

we knew that China would become a major player in international markets whether 

we wanted them to or not. After all, China already enjoyed total access to our market while we did not have the same benefit. Perhaps most importantly, we supported PNTR because a China in the World Trade Organization is bound by the 

same international trade rules as the United States or any of our other trading 

partners. While many were optimistic about the increased market access to the 

world’s largest population, few dared to expect this to be an easy path. 

Part of this Commission’s purpose is to serve as an objective observer, and an active investigator, into the veracity of that commitment and China’s compliance with 

WTO rules. Of particular importance is China’s deliberate undervaluation of its currency to maintain an unfair trade advantage. 

That policy is clearly in violation of the principles behind Article XV of the General Agreement on Tariffs and Trade, which states that WTO members ‘‘shall not 

by exchange rate action frustrate the intent of the provisions of this agreement,’’ 

which is to create fair and open markets for global commerce. China has joined the 

world trading system—it must now play by its rules and adhere to these principles. 

In an open trading system, manipulation of currency—either by frequent intervention or by a calculated undervaluation of one’s currency through a fixed exchange 

rate—undermines the concept of comparative advantage by creating market distortions. These disruptions not only affect trade, but also result in the loss of real jobs 

for U.S. manufacturers. This is particularly devastating in my State, which has lost 

over 17,300 manufacturing jobs in this latest economic downturn. 

There has not yet been a comprehensive study into what effect China’s pegged exchange rate has on U.S. jobs or the economy. However, manufacturers have told me 

that they see China’s currency as one of the leading causes of our manufacturing 

job losses. That is why, as Chair of the Senate Committee on Small Business and 

Entrepreneurship, I have joined with my House counterpart, Chairman Manzullo, 

to ask the GAO to investigate the cost to U.S. workers of China’s monetary policy 

and determine the full extent of this harmful practice. 

I am greatly concerned about what I believe they will find, because I have heard 

from company after company who have had to face the reality that they can no 

longer compete with unfairly priced Chinese products. Some argue they were forced 

to close their doors because of China’s low labor costs, and others argue it is the 

lack of labor and environmental regulations in China that makes us uncompetitive. 

However, the full extent of China’s advantage is the combination of an artificially 

undervalued currency, unfair non-tariff barriers, and low cost of production. 

While we all want wages, labor rights, and environmental protection to improve 

in China, the biggest concern that every manufacturer brings to my attention is that 

they can’t compete with a currency undervaluation that economists estimate could 

be as high as 40 percent. This serves as a de facto subsidy that no competitor can 

surmount. 

For this reason, I have been among a core group in Congress that has called on 

the Administration to take strong action with regards to the foreign manipulation 

of currencies. I was pleased to work with my colleagues to ask the Treasury Secretary to make China’s currency the top priority of his recent trip to Asia. 

Secretary Snow took the message to China that the manipulation of its currency 

must end and that China should take steps to freely float its currency. I was pleased 

with his action and look forward to this Administration’s continued strength and resolve to bring China’s currency into the free market. 

I have also joined with several of my colleagues to send a stern, but constructive, 

message through a bipartisan Sense of the Senate that Congress believes China 

should start taking the necessary steps towards a flexible exchange rate immediately. 

This change in Chinese monetary policy is a process that will take time, but I 

believe China is capable of taking some immediate steps towards a market-based 

currency. At the very least, China should make a moderate revaluation of the yuan, 

combined with a widening of the currency band and a loosening of some capital con-
235

trols. They could also move from a peg with the U.S. Dollar to a basket peg with 

several major currencies, including the Japanese Yen and the Euro. In so doing, 

China would be in a better position to strengthen its domestic financial system 

enough to permit a significant liberalization of capital outflows and, in the not too 

distant future, adopt a freely floating currency. These types of steps would remove 

some of the burden from U.S. manufacturers while promoting a more prosperous 

and stable China. 

The U.S. is not alone, Europe and others have begun to express growing concern 

over China’s rigid currency. The IMF has blamed currency manipulation for impeding global economic recovery and creating greater economic insecurity. Also, as the 

G–7 noted in its last meeting in Dubai, flexibility in exchange rates promotes 

smooth adjustments in the international financial system, based on market mechanisms. 

Clearly, this issue is not only in the interests of the U.S. and our manufacturers, 

it is also in the interest of China, Asia, and the global economy. As the growing 

international coalition illustrates, word is getting out and people are waking up to 

the effect of China’s currency manipulation. 

Addressing the currency structure will not be an easy task for China, but if they 

are going to continue reaping the benefit of being part of the WTO, then China too, 

will have to abide by its rules. If China does not, the Administration should bring 

appropriate action under existing U.S. trade laws and through the World Trade Organization dispute settlement mechanism. 

The U.S.-China Economic and Security Review Commission has a critical role to 

play in providing policymakers with your objective analysis on a constructive path 

toward solving this difficult policy dilemma. I applaud the work you have been doing 

and look forward to your report on this and other important areas of U.S.-China 

economic relations. 
236

Testimony of Grant D. Aldonas

Under Secretary of Commerce for International Trade Administration 

Members of the Commission, thank you very much for inviting me to participate 

in this hearing to discuss our trade relationship with China and the Department’s 

role in implementing the President’s Manufacturing Initiative. Both issues are timely and I appreciate your willingness to focus the Commission’s attention on these 

two interrelated topics. I regret that I was unable to testify in person at the actual 

hearing last week, but I appreciate you allowing me to submit this statement for 

the hearing record. I would welcome the opportunity to discuss with you the Initiative and the broader market rigidities that have impact for U.S. manufacturing. 

The Economic Context 

Let me start by setting the economic context for discussing both the health of our 

manufacturing sector and our trade relationship with China. I want, first, to underscore the continuing strengths of our manufacturing sector. We tend to forget that 

the United States remains far and away the largest producer and exporter of manufactured goods in the world. Standing alone, our manufacturing sector would rank 

as either the 4th or 5th largest economy in the world. Far from being hollowed out, 

our manufacturing sector is, in fact, larger than the entire economy of China. 

In addition, I think it’s important to stress that productivity in manufacturing 

today is higher than it was even during the late 1990s when everyone was speaking 

about a ‘‘new economy.’’ Those increases in productivity, and the policies that we 

have adopted to reinforce them, have allowed the United States to reclaim the top 

spot in the World Economic Forum’s rankings as the most competitive economy in 

the world. 

The productivity numbers are important for another reason that reaches beyond 

the current economic prospects of our manufacturers. What they reinforce is the importance of a healthy manufacturing sector at the core of our economy. According 

to Paul Krugman, the noted economist and, I should add, at times a critic of this 

Administration, ‘‘Productivity isn’t everything, but in the long run it is almost everything. A country’s ability to raise its standard of living over time depends almost 

entirely on its ability to raise output per worker.’’ What both the latest statistics 

and Krugman’s comment point out is the contribution that manufacturing makes to 

innovation—innovation that is key to raising our productivity and the standard of 

living enjoyed by all Americans. 

Having said that, there is no doubt that our manufacturers face some very significant economic challenges in today’s business environment. Most importantly, they 

face continuing pressure on pricing power and profit margins due to the excess capacity on the market even as the recovery from the recent recession takes hold. The 

most recent figures suggest that the economy grew at a 3.3% rate in the second 

quarter of this year and the pace of economic activity appears to have accelerated 

since then. Timely fiscal stimulus and management of the money supply appear to 

have set the foundations for a solid recovery. 

It now appears that manufacturing, after many months of very slow growth, is 

beginning to participate in that broader economic recovery. Durable goods orders 

have been up generally, although down in August. And, the Purchasing Manager’s 

Index, a key indicator of future economic growth, is now consistently above the level 

that means stronger growth ahead. 

Even on the unemployment front, there are signs of job growth consistent with 

a stronger economy. It’s probably worth recalling that unemployment has remained 

above 6 percent for four months. Not that long ago, that would have been perceived 

as relatively low in terms of unemployment. 

Having said that, I want to reiterate, as the President has, that the Administration is committed to working towards an economic climate where everyone that 

wants a job has one. And there is an important story to tell about the unemployment figures in manufacturing. 

The recession in manufacturing began in 2000, ten months in advance of the general recession in the economy. The economy was just beginning to cope with the effect of a sharp drop in business investment as industry pulled back from a period 

of heavy investment in technology. Not surprisingly, most of the job losses in manufacturing came in precisely those industries—telecommunications equipment and 

computing—that benefited most from the boom in investment related to the 

‘‘dot.com bubble’’ of the late 1990s. 

What has surprised most economists has been the fact that manufacturing continued to shed jobs deep into the recovery of the economy. As recently as this past 

month, manufacturers dropped another 93,000 from the employment rolls. Employment in manufacturing has been declining for decades as productivity gains have 
237

significantly reduced the number of man-hours needed to produce a given product. 

Those gains have averaged 3% or more for the last 15 years. And, employment in 

manufacturing has fallen commensurately. 

Some share of the recent reduction in manufacturing employment during the initial stages of the recovery and expansion is directly attributable to the efforts of 

manufacturers to cut costs and raise productivity. Under considerable competitive 

pressure, American manufacturers are finding ways to do more with less. And, the 

labor market is responding by shifting jobs to other industries. 

That said, the more important thing to focus on for purposes of our discussion 

today is the link between the competitive pressure that has driven American manufacturing to pursue those productivity gains and what is going on in the international environment, particularly with respect to our trade with China and its 

emergence from a fully state-controlled economy to become a major force in manufacturing. 

On the international front, one of the most frequently cited statistics is our trade 

deficit, which has been growing overall and particularly with China. Although the 

trade deficit is often thought of as an indicator of our competitiveness, and over long 

periods of time it is such an indicator, today it is better understood as a measure 

of the relative growth in our economy compared to our trading partners. In past recessions, continuing growth abroad mitigated the effect of the U.S. recession on our 

manufacturers. In the most recent recession, that did not happen. Japan led and 

Europe followed us into the recession and neither has yet to climb out to any significant degree. 

The data behind the trade deficit bear out the effects of differences in economic 

growth rates between economies. While the common perspective is that the entire 

deficit is due to an increase in imports, the truth is that our exports have fallen 

off far more sharply. That points to the fact that the economies of both Europe and 

Japan are stagnant. As former Treasury Secretary Lawrence Summers put it, ‘‘The 

world economy is flying on only one engine.’’ That engine happens to be the United 

States. In eleven of the last twelve years, U.S. economic growth has outpaced that 

in Japan, Germany, and the European Union. 

What’s more, slow growth among our leading trading partners is not new. Japan’s 

economy, which still represents close to 2/3 of the gross domestic product of Asia, 

has barely grown for a decade. Germany’s economy has not grown appreciably in 

three years. On top of that, the rest of Asia, with the notable exception of China, 

has presented a very mixed picture in terms of economic growth since the onset of 

the Asian financial crisis in 1997. While some economies have recovered, others 

have not. And, these are markets that were once among the fastest growing in the 

world—markets that had become significant consumers of the sorts of advanced 

technology capital goods that our manufacturers sell. 

What that should tell us, both in terms of the economy as a whole, and the manufacturing sector in particular, is that perhaps the most significant single action we 

could take is to step up encouragement of our trading partners, particularly Japan 

and Germany which together make up 20 percent of the world economy, to jettison 

their anti-growth policies and to adopt policies that are designed to boost economic 

growth. We need to preach what we practice because the alternative to growth is 

always a zero-sum game of dividing up the existing pie and that leads directly to 

the sort of strains we are seeing now in our trade relationships. 

Our Trade Relationship with China 

Which leads me to China. In the more than 20 roundtables the Department held 

with manufacturers across the country over the past six months, there was no single 

country that garnered more attention than our trade with China and its emergence 

from state-imposed economic isolation to become a major center of manufacturing. 

The Chinese have made considerable progress over the last two decades in lifting 

more than 200 million people out of poverty by relying ever more heavily on the 

market to direct resources within its economy. 

The stakes involved are high. China is our fourth largest trading partner. Bilateral merchandise trade reached $147.2 billion in 2002. Last year, China overtook 

Japan to become our third largest source of imports. In July of this year, China surpassed Mexico to become our second largest source of imports. Our imports from 

China are more than five times greater than our exports. The bilateral trade deficit 

hit $103 billion in 2002 and reached $65 billion in the first seven months of this 

year. In addition, China has provided help on a number of fronts—from the arms 

talks with North Korea to the War on Terrorism. China has helped on the economic 

front as well. Along with the United States, China accounts for most of the current 

growth in the world economy. 
238

The upside is that China’s economic policies have brought about a rising standard 

of living in China and considerably higher disposable income. All of that makes 

China an attractive market for much of what we produce in the United States. 

It is worth noting that since 2001, China has been our fastest growing export 

market by far among our top ten trading partners. Our exports to China surged 19% 

in 2001, 15% last year, and more than 22% in January–July even though our exports to the world declined 7%, 5%, and rose less than 3% during the same respective time periods. 

One of the basic reasons for negotiating for 13 years with the Chinese over their 

accession to the World Trade Organization was to ensure that we would knock down 

the many barriers to entering China’s market. On paper, the accession agreement 

represents a considerable success. Today, the tariff rates that China imposes are 

lower on average than much of the rest of the developing, and in some instances, 

the developed world. In addition, the WTO agreement obliges China to protect the 

intellectual property of U.S. manufacturers and service suppliers. The agreement 

also eliminated many of the barriers to the free distribution of American goods 

throughout the Chinese economy, instead of being beholden to trading through a 

Chinese state enterprise as in the past. 

The situation facing our manufacturers from a competitive perspective was far 

worse prior to China’s entry into the WTO. Our manufacturers lacked access to the 

Chinese market, but their manufacturers had relatively free access to ours. In the 

first year following China’s accession to the WTO, I think both Congress and the 

President showed an extraordinary amount of patience as China worked to pass the 

literally thousands of new laws needed to bring the country into compliance with 

WTO rules. 

Now, as we move deeper into the second year of China’s participation in the WTO, 

we need to see actual enforcement of those laws and basic compliance with WTO 

rules in other areas. I know that the President, Secretary Evans, Ambassador 

Zoellick, and most recently Secretary Snow have all made that point vigorously with 

their counterparts in China. And, I can attest that, at a working level, the rest of 

us have taken up the cause just as vigorously. 

But, there is still a very, very long way to go. We have considerable challenges 

in terms of WTO compliance, particularly in areas like the protection of intellectual 

property that represents the key U.S. competitive edge in many manufacturing industries. In fact, no country raised more attention as a source of concern than China 

during the roundtable discussions. Our manufacturers complained about rampant 

piracy of intellectual property; forced transfer of technology from firms launching 

joint ventures in China; a broad range of trade barriers; and capital markets that 

are largely insulated from free-market pressures. We also heard rising concerns 

about the timeliness and direction of China’s implementation of its WTO commitments in areas such as transparency, IPR protection, trading rights and distribution 

services, agriculture, and financial services. 

Fundamentally, China’s change from a non-market economy to one that operates 

fully on market principles is incomplete. Although the Chinese often make the case 

that they are a market economy because they want the benefits that designation 

would yield under our antidumping laws, the simple fact is that many of the main 

drivers of the Chinese economy remain in state hands. Whereas U.S. companies face 

continuing pressure from our capital markets to turn a profit, that pressure simply 

does not exist in many cases in China. 

In one sense, this problem is not new. American firms have seen the same pattern 

in other Asian markets for years. Even the 1997 financial crisis has not weaned industries or governments from those unhealthy practices—witness Korea’s continuing 

support for the Hynix semiconductor operations, a company that was otherwise 

headed for liquidation. 

I recognize that many commentators see a demand for a ‘‘level playing field’’ as 

a demand for protection, but that is not always, or even usually the case. Most manufacturers I have spoken with over the last six months didn’t want protection; they 

wanted the unfair trade practices that rigged the game against them eliminated. A 

good example is the forest products industry, which has an enormous fight with 

Canada over subsidies. In the context of our roundtable on forest products manufacturing their principal request was for the President to negotiate the elimination of 

the barriers they faced abroad and the subsidies they faced in terms of competition 

from imports. 

The same held true for most manufacturers with whom we discussed China. 

There was a strong recognition that we were better off in a world in which the rules 

were observed and the competition was fair, than a world segmented by trade barriers which would mean less trade and slower economic growth for all. 
239

At the same time, I also must stress that there are significant parts of our manufacturing sector that are under extraordinary pressure to adjust to new levels of 

competition from imports, particularly from China. Industries like textiles and apparel in the South and tool and die in the Northeast and Midwest offer examples 

of the sorts of pressures our manufacturers face. Both the challenges and the pain 

felt in many communities are very real. 

In the case of textiles and apparel, the challenges are particularly intense because 

the industry is emerging from a 40-year period when it was protected by quotas on 

imports of competing material and clothing. As a consequence, the industry remains 

highly fragmented and is being forced to go through, all at one time, the adjustment 

and consolidation that most U.S. industries went through in the 1970s and 1980s. 

In the last round of world trade negotiations, President Clinton agreed to phase 

out the quota system that had protected the textile industry. Most of the truly sensitive items from the perspective of U.S. industry were given the longest phase-outs. 

But, the quotas will come to an end on January 1, 2005, and that will mean still 

stronger competition from imports. 

What is not generally understood is that most of the sharp increase in Chinese 

imports has come at the expense of our other trading partners. As new products 

have come free of quota arrangements, retailers no longer face the need to source 

products from multiple countries. Instead, much of what was previously shipped to 

the United States from other Asian countries now comes to us from China. But, that 

has not meant less pressure on U.S. manufacturers in terms of price competition. 

While the argument most frequently raised about China by commentators seems 

to be the difference in wage rates, most of my conversations with manufacturers, 

particularly in textiles, suggested other reasons for increased Chinese competition. 

What is not often understood is that, today, the textile industry is actually very high 

tech. There is very little labor involved in many products that come out of the industry and wages are a relatively small portion of the total cost of production except 

in the case of products that require considerable hand stitching. 

The truth of that statement was brought home to me in a conversation with a 

North Carolina manufacturer of textile products used in the luggage industry. Most 

bags today are made with some form of rip-stop material, none of which is hand 

sewn. Nor is the frame of most roll-on bags manufactured by hand. Yet, the North 

Carolina manufacturer showed me 5 suitcases, one nesting inside the other, that 

sold for a total price—delivered from China—of under $30. In other words, the total 

cost of the five bags was below the North Carolina manufacturer’s cost of materials 

alone. 

The point to that story is simply that it is not wages alone that allowed the Chinese manufacturer to sell the 5 pieces of luggage for a delivered price of less that 

$30. The cost of most of the materials is determined in world markets, so if the Chinese economy were open to international trade and competition, then the Chinese 

manufacturer’s materials costs would be comparable to that of the U.S. costs. This 

means that to get the delivered price down to below $30 there must be a very large 

amount of government subsidy, express or implied, to the manufacturer—a subsidy 

that can take the form of an outright cash grant to the exporter, but more often 

will take the indirect form of tariff protection against competition, the forgiveness 

or rebate of taxes, or the continuing extension of credit to uncreditworthy enterprises. 

In my view, although the textile industry is commonly criticized for seeking protection based on the past 40 years of quotas, the complaint that has led the industry 

to seek safeguards against Chinese imports stems from a different motive. There is 

no real argument that the Chinese market operates fully on a market basis, and 

the reasons for the industry’s request for help stems from that simple difference between the pressures they face in our market on a day-to-day basis and the pressures 

that their Chinese competition doesn’t. 

What that also points out is the fact that, in addition to pressing the Chinese at 

every opportunity on their compliance with their WTO commitments, we also have 

to be extraordinarily vigilant regarding the injurious effects of other forms of government support for Chinese industry that are not covered by current WTO rules. 

Those sorts of practices require a different type of tool—one that requires digging 

out the facts regarding the underlying competitive differences that our industry 

faces in terms of import competition from China. 

As I noted above, the textile industry is not alone in facing Chinese subsidies and 

protection. Other industries like tool and die face similar competitive conditions. 

That is why one of the most forward-leaning recommendations we intend to make 

regarding our trade is the establishment of an office in the Commerce Department 

the sole function of which will be to investigate these sorts of practices. When we 
240

find these anti-competitive practices, we will vigorously seek their elimination by 

the Chinese and by other trading partners. 

The one thing I can assure you is that the Department of Commerce is dedicated 

to making sure China does play by the rules. We will vigorously pursue China’s 

compliance with its WTO commitments and we will enforce our domestic unfair 

trade laws rigorously and fairly, as both President Bush and Secretary Evans have 

made clear. 

The Department of Commerce’s Role in Trade With China 

The Department of Commerce, in close coordination with USTR and other agencies, has adopted an aggressive and multi-pronged approach to ensure that China 

honors its WTO commitments and that U.S. companies benefit from these opportunities. We will target unfair trade practices wherever they occur. We are exploring 

the use of new tools to expand our trade promotion activities in China. We are expanding efforts to engage Chinese officials to make sure they ‘‘get the rules right’’ 

as they continue their enormous task of restructuring their economic system. 

The Commerce Department has actively provided WTO-related technical assistance to China since September 2000, well before China’s accession to the WTO. Initial programs focused on increasing the awareness of general WTO principles among 

Chinese government officials. As China developed an increasingly sophisticated understanding of the WTO system, our programs have been tailored to more specific 

areas, such as standards development and intellectual property right (IPR) protection. For example, in 2003 Commerce sponsored or coordinated programs on fertilizer standards, antitrust, government procurement, medical device regulatory 

training, and information and communication technologies standards and conformity 

assessment. 

Despite China’s commitments to crack down on rampant piracy, counterfeit CDs, 

DVDs, and pharmaceuticals continue to flood the market. In addition, piracy and 

counterfeiting in China has a significant impact on U.S. intellectual property rights 

holders in China itself. In fact, the International Intellectual Property Alliance estimates that business software, music, movie and entertainment software piracy rates 

in China exceed 90%, with damages of $1.85 billion in 2002. We have raised specific 

IPR concerns during our meetings with senior Chinese government officials and 

have repeatedly demanded that the Chinese government uphold its bilateral and 

multilateral IPR commitments. 

Through the annual Special 301 process, we scrutinize China’s IPR conditions in 

close coordination with our colleagues in other agencies. To make sure that China 

has the tools to implement its commitments, we have organized a series of seminars 

with Chinese officials. Programs in development for later this year include a WTO 

pharmaceutical regulatory seminar and anti-counterfeit training, and IPR criminal 

and border enforcement seminars. We have worked on these programs on an intra 

and inter agency basis, using the resources of U.S. Patent and Trademark Office, 

Department of Justice and other agencies. We think China can and should do better 

in these areas. We continue to press for progress. 

However, keeping our focus on China’s WTO implementation and the country’s 

other trade practices is only part of the solution. We must continue to enhance the 

ability of U.S. businesses to compete in China. We are increasing our efforts to ensure that U.S.-developed technical standards are accepted in China just as they are 

throughout the world. We are launching ‘‘Doing Business in China’’ seminars in cities across the country to address concerns about the Chinese market from smalland medium-sized businesses. We are exploring ways to develop more trade leads 

in China and to provide even more targeted information on opportunities in China 

for companies in the U.S. 

Combined with these domestic efforts, we regularly engage Chinese government 

officials to ensure trade agreement compliance and market access for our products 

and services. Secretary Evans will visit China in October to advance U.S. interests 

and advocate for a level playing field in our economic relations with China. We will 

have another opportunity to raise outstanding issues during the 15th U.S.-China 

Joint Commission on Commerce and Trade (JCCT) to be held in Washington in 

early December. 

The President’s Manufacturing Initiative 

With that, I would like to turn to the topic of the President’s Manufacturing Initiative. In March of this year, during Manufacturing Week, Secretary Evans had the 

opportunity to speak before the National Association of Manufacturers in Chicago. 

At that time, he announced the President’s Manufacturing Initiative. 

As a part of that initiative, Secretary Evans directed me to lead a comprehensive 

review of the issues influencing long-term competitiveness of U.S. manufacturing. 
241

The central goal of the review is to develop a strategy to ensure that government 

is fostering an environment that promotes a dynamic manufacturing industry. The 

review will conclude with the release of a report later this fall. 

The Commerce Department’s senior management, including Secretary Evans and 

Deputy Secretary Bodman, all pitched in. We held roundtable discussions with manufacturers in the aerospace, auto, semiconductor, and pharmaceutical sectors, 

among others, in more than 20 cities across the United States—from Manchester, 

New Hampshire to Columbus, Ohio, to Detroit to Los Angeles—to develop the report 

and recommendations. 

What we heard from manufacturers in terms of the challenges they face was significant. While the international competition is what has garnered most of the attention in the press, by far the greater weight of the manufacturers’ comments focused on domestic issues—what I call ‘‘keeping our side of the street clean.’’ What 

I mean by that is simply paying attention to the needs of our manufacturers as we 

develop legislation or implement regulations. It is the steady accumulation of multiple burdens, rather than a single cause, that has had the most severe impact on 

the competitive environment in which our manufacturers operate. 

The list of issues our manufacturers identified should not surprise anyone who 

has taken a serious interest in manufacturing. While our manufacturers have tightened their belts and raised their productivity in an effort to remain competitive and, 

in fact, to succeed in the day-to-day competition in the marketplace, they have seen 

that advantage and the hard-won productivity gains eroded by everything from 

higher energy costs to higher medical and pension costs to higher insurance costs 

due to a run-away tort system. 

Just a few examples might suggest why manufacturers have seen their costs rise. 

We heard from manufacturers in New Jersey that 30 cents of every dollar of revenue went to pay health benefits for employees. Manufacturers gladly pay for their 

employee’s health benefits because they see their own interest served by a healthy 

and motivated workforce, but if we are serious about manufacturing, we have to be 

serious about grappling with the underlying drivers that have created 145 percent 

increases in health care insurance costs that obviously are not sustainable indefinitely. 

In Michigan, I met with auto parts suppliers that faced continuing pressure from 

the auto companies to lower their prices by 20 percent or face the prospect that the 

auto companies would turn to overseas sources of supply. Much of the concern those 

parts suppliers reflected the terms on which they compete with those overseas suppliers, particularly in China. But the auto parts suppliers knew that the ultimate 

source of the problem lay in an auto industry that is grappling with the same sorts 

of legacy costs that burdened the steel industry. If we are serious about manufacturing, then these industries will have to get those financial obligations under control. 

In Columbus, Ohio, Des Moines, Iowa, and in my hometown of Minneapolis, Minnesota, I met with manufacturers in the plastics and adhesives businesses that are 

heavy users of natural gas. The companies in the plastics businesses in particular 

risk seeing whole new markets fall to their foreign competitors who see lower natural gas prices. If we are serious about manufacturing, we have to adopt a national 

energy plan that will help us access new sources of supply and improved transmission to reduce the cost of energy to our manufacturers as well as to consumers. 

Another example we heard from virtually every manufacturing trade association 

we met with was the need to eliminate the complexity and the disincentives our tax 

system creates for investing in manufacturing in the United States. Any number of 

issues fall in that category. Take the bias in the current tax code against equity financing, which raises the cost of capital, thereby reducing the investment. This bias 

also translates into a preference for debt, which yields highly leveraged companies 

and a highly leveraged country, all the while encouraging the worst sorts of gaming 

as clever tax lawyers try to find ways to take what is an equity interest and call 

it debt in order to qualify for an interest deduction. Taken together, even without 

cutting rates, reforms of the tax code could make a profound difference to the relative attraction of investing in manufacturing in the United States. 

But, perhaps the most egregious example comes out of the tort system in this 

country. If we are serious about manufacturing, we have to get serious about reforming the tort system. 

One issue, in particular, stood out among the manufacturers’ concerns about the 

tort system. That was the ongoing asbestos litigation. There, the continuing litigation has yet to help many individuals who were harmed by prolonged exposure to 

asbestos, while, at the same time, the litigation hangs over virtually all U.S. manufacturing, raising their insurance costs and dampening their returns. 
242

Manufacturers pointed to declining vocational school programs, declining enrollments in engineering and the funding of scientific research, all of which are essential to the productivity gains that keep our manufacturing sector competitive and 

keep a skilled workforce employed. 

Finally, as I noted above, in addition to keeping our own side of the street clean, 

U.S. manufacturers demanded a level playing field. For most, that translated into 

a demand that we negotiate down tariff rates that are higher than ours and break 

open new markets. Or it translated into a demand for the enforcement of rules barring the theft of intellectual property. It translated into a demand for the enforcement of our unfair trade laws or laws against customs fraud. 

What I did not see was an interest in outright protection. Rather, most manufacturers saw trade as a simple question of equity. If we keep our markets open to 

our trading partners goods, they should do the same for us. But, where our trading 

partners did not live up to the terms of our agreements or otherwise heed the rules, 

our manufacturers expected that those trading partners should pay a price. 

While we are still in the process of finalizing the report and recommendations 

across many fronts, Secretary Evans has outlined several new initiatives in response to the concerns we heard from manufacturers, particularly the need for a 

stronger focus within the U.S. Government on manufacturing and the most immediate cases of unfair trade affecting our manufacturers. The first initiative, announced by the President on Labor Day, is a new Assistant Secretary of Commerce 

to serve as the point person in the Administration and within the U.S. Government 

for manufacturers and as an effective advocate for the manufacturing sector’s competitiveness. There are many programs within the Federal Government that bear 

on manufacturing, but heretofore there was no one person or one office responsible 

for bringing their efforts into a coherent strategy. The second would call for the creation of Assistant Secretary for Trade Promotion to boost our exports, particularly 

to those markets that our negotiators have recently opened to our trade like China. 

And, the third is the establishment of an Unfair Trade Practices Team to track, detect, and confront unfair competition before it injures an industry here at home. 

We expect the report and the remainder of the recommendations to be out soon. 

In addition to moving on the implementation of those recommendations, we intend 

to do two things to follow up. The first is to go back to the manufacturers we visited 

earlier this year to get their reaction on what we have suggested and to help us 

refine our approach as we move forward. The second is to discuss the next set of 

issues we intend to tackle as part of our on-going commitment to support our manufacturing sector. 

That concludes my testimony. I would be pleased to answer any questions that 

you may have. 
(243)

STATUTORY MANDATE OF THE U.S.-CHINA ECONOMIC AND SECURITY 

REVIEW COMMISSION 

Pursuant to Public Law 108–7, Division P, enacted February 20, 

2003

RESPONSIBILITIES OF THE COMMISSION.—The United 

States-China Commission shall focus, in lieu of any other areas of 

work or study, on the following:

PROLIFERATION PRACTICES.—The Commission shall analyze and assess the Chinese role in the proliferation of weapons of 

mass destruction and other weapons (including dual use technologies) to terrorist-sponsoring states, and suggest possible steps 

which the United States might take, including economic sanctions, 

to encourage the Chinese to stop such practices.

ECONOMIC REFORMS AND UNITED STATES ECONOMIC TRANSFERS.—The Commission shall analyze and assess 

the qualitative and quantitative nature of the shift of United 

States production activities to China, including the relocation of 

high-technology, manufacturing, and R&D facilities; the impact of 

these transfers on United States national security, including political influence by the Chinese Government over American firms, dependence of the United States national security industrial base on 

Chinese imports, the adequacy of United States export control 

laws, and the effect of these transfers on United States economic 

security, employment, and the standard of living of the American 

people; analyze China’s national budget and assess China’s fiscal 

strength to address internal instability problems and assess the 

likelihood of externalization of such problems.

ENERGY.—The Commission shall evaluate and assess how China’s large and growing economy will impact upon world energy 

supplies and the role the United States can play, including joint 

R&D efforts and technological assistance, in influencing China’s energy policy.

UNITED STATES CAPITAL MARKETS.—The Commission 

shall evaluate the extent of Chinese access to, and use of United 

States capital markets, and whether the existing disclosure and 

transparency rules are adequate to identify Chinese companies 

which are active in United States markets and are also engaged in 

proliferation activities or other activities harmful to United States 

security interests.

CORPORATE REPORTING.—The Commission shall assess 

United States trade and investment relationship with China, including the need for corporate reporting on United States investments in China and incentives that China may be offering to 

United States corporations to relocate production and R&D to 

China.
244

REGIONAL ECONOMIC AND SECURITY IMPACTS.—The 

Commission shall assess the extent of China’s ‘‘hollowing-out’’ of 

Asian manufacturing economies, and the impact on United States 

economic and security interests in the region; review the triangular 

economic and security relationship among the United States, Taipei and Beijing, including Beijing’s military modernization and 

force deployments aimed at Taipei, and the adequacy of United 

States executive branch coordination and consultation with Congress on United States arms sales and defense relationship with 

Taipei.

UNITED STATES-CHINA BILATERAL PROGRAMS.—The 

Commission shall assess science and technology programs to evaluate if the United States is developing an adequate coordinating 

mechanism with appropriate review by the intelligence community 

with Congress; assess the degree of non-compliance by China and 

[with] United States-China agreements on prison labor imports and 

intellectual property rights; evaluate United States enforcement 

policies; and recommend what new measures the United States 

Government might take to strengthen our laws and enforcement 

activities and to encourage compliance by the Chinese.

WORLD TRADE ORGANIZATION COMPLIANCE.—The 

Commission shall review China’s record of compliance to date with 

its accession agreement to the WTO, and explore what incentives 

and policy initiatives should be pursued to promote further compliance by China.

MEDIA CONTROL.—The Commission shall evaluate Chinese 

government efforts to influence and control perceptions of the 

United States and its policies through the internet, the Chinese 

print and electronic media, and Chinese internal propaganda. 
(I)

LIST OF WITNESSES, COMMUNICATIONS, AND 

PREPARED STATEMENTS 

Page 

Aldonas, Grant D., Under Secretary of Commerce for International Trade 

Administration ..................................................................................................... 236

Bergsten, C. Fred, Ph.D., Director, International Institute for Economics ........ 43

D’Amato, Vice Chairman C. Richard 

Opening remarks of .......................................................................................... 1

Prepared statement .......................................................................................... 1

Dorgan, Byron L., a U.S. Senator from the State of North Dakota .................... 15

Dreyer, June Teufel, Hearing Co-Chair 

Opening remarks of .......................................................................................... 3

Prepared statement .......................................................................................... 3

English, Phil, a U.S. Congressman from the State of Pennsylvania ................... 5

Graham, Lindsey, a U.S. Senator from the State of South Carolina .................. 7

Hale, David, Chief Economist and Founder, Hale Advisors, LLC ....................... 64

Prepared statement .......................................................................................... 67

Lee, Thea M., Assistant Director of Public Policy, American Federation of 

Labor and Congress of Industrial Organizations (AFL–CIO) .......................... 186

Prepared statement .......................................................................................... 189

Levin, Sander (Sandy) M., a U.S. Congressman from the State of Michigan, 

and Ranking Democrat, Ways and Means Trade Subcommittee ..................... 30

Prepared statement .......................................................................................... 32

Manzullo, Donald A., a U.S. Congressman from the State of Illinois, and 

Chairman, House Small Business Committee ................................................... 25

Mulloy, Patrick A., Hearing Co-Chair 

Opening remarks of .......................................................................................... 4

Prepared statement .......................................................................................... 4

Nolan, Peter Hugh, Ph.D., Sinyi Professor of Chinese Management, University of Cambridge ................................................................................................. 98

Prepared statement .......................................................................................... 101

Preeg, Ernest H., Ph.D., Senior Fellow in Trade and Productivity, Manufacturers Alliance/MAPI ........................................................................................... 69

Prepared statement .......................................................................................... 72

Roach, Stephen S., Ph.D., Chief Economist, Morgan Stanley .............................. 53

Prepared statement .......................................................................................... 55

Roberts, Paul Craig, Ph.D., Chairman, Institute for Political Economy, and 

former Assistant Secretary of the Treasury for Economic Policy .................... 171

Prepared statement .......................................................................................... 172

Robinson, Chairman Roger W., Jr. 

Opening remarks of .......................................................................................... 1

Prepared statement .......................................................................................... 1

Schumer, Charles E., a U.S. Senator from the State of New York ..................... 18

Snowe, Senator Olympia J., .................................................................................... 234

Steinfeld, Edward S., Ph.D., Associate Professor of Political Science, Massachusetts Institute of Technology ......................................................................... 130

Prepared statement .......................................................................................... 133

Stenholm, Charles, a U.S. Congressman from the State of Texas ...................... 13

Vargo, Franklin J., Vice President, International Economic Affairs, National 

Association of Manufacturers .............................................................................. 174

Prepared statement .......................................................................................... 177

Walsh, Kathleen (Kate) A., Senior Associate, The Henry L. Stimson Center .... 145

Prepared statement .......................................................................................... 147

Workman, Willard A., Senior Vice President, International Policy and Economic Reform, U.S. Chamber of Commerce ....................................................... 191

Prepared statement .......................................................................................... 193